Here is an excerpt from an article co-authored by Chris Bradley, Martin Hirt, and Sven Smit for the McKinsey Quarterly online (January 2011). To Read the complete article, please click here.

Source: Strategy Practice

Ten timeless tests can help you kick the tires on your strategy, and kick up the level of strategic dialogue throughout your company.

“What’s the next new thing in strategy?” a senior executive recently asked Phil Rosenzweig, a professor at IMD [International Institute for Management Development] in Switzerland. His response was surprising for someone whose career is devoted to advancing the state of the art of strategy: “With all respect, I think that’s the wrong question. There’s always new stuff out there, and most of it’s not very good. Rather than looking for the next musing, it’s probably better to be thorough about what we know is true and make sure we do that well.”

Let’s face it: the basic principles that make for good strategy often get obscured. Sometimes the explanation is a quest for the next new thing—natural in a field that emerged through the steady accumulation of frameworks promising to unlock the secret of competitive advantage. [For a rich account of strategy’s birth and growth as a field, see Walter Kiechel, The Lords of Strategy, Boston, MA: Harvard Business School Press, 2010.] In other cases, the culprit is torrents of data, reams of analysis, and piles of documents that can be more distracting than enlightening.

Ultimately, strategy is a way of thinking, not a procedural exercise or a set of frameworks. To stimulate that thinking and the dialogue that goes along with it, we developed a set of tests aimed at helping executives assess the strength of their strategies. We focused on testing the strategy itself (in other words, the output of the strategy-development process), rather than the frameworks, tools, and approaches that generate strategies, for two reasons. First, companies develop strategy in many different ways, often idiosyncratic to their organizations, people, and markets. Second, many strategies emerge over time rather than from a process of deliberate formulation. [For a classic statement of the idea that strategies are more emergent than planned, see Henry Mintzberg, “Crafting strategy,” Harvard Business Review, 1987, July–August, Volume 65, Number 4, pp. 66–75.]

There are ten tests on our list, and not all are created equal. The first — “will it beat the market?” — is comprehensive. The remaining nine disaggregate the picture of a market-beating strategy, though it’s certainly possible for a strategy to succeed without “passing” all nine of them. This list may sound more complicated than the three Cs or the five forces of strategy. [The three Cs and the five forces are seminal strategy frameworks. The three Cs (competitors, customers, and company) were articulated by retired McKinsey partner Kenichi Ohmae in The Mind of the Strategist (McGraw-Hill, 1982). The five forces (barriers to entry, buyer power, supplier power, the threat of substitutes, and the degree of rivalry) were set forth by Harvard Business School professor Michael Porter in Competitive Strategy (Free Press, 1998).]

But detailed pressure testing, in our experience, helps pinpoint more precisely where the strategy needs work, while generating a deeper and more fruitful strategic dialogue.

Those conversations matter, but they often are loose and disjointed. We heard that, loud and clear, over the past two years in workshops where we explored our tests with more than 700 senior strategists around the world. Furthermore, a recent McKinsey Quarterly survey of 2,135 executives indicates that few strategies pass more than three of the tests. In contrast, the reflections of a range of current and former strategy practitioners (see “How we do it: Strategic tests from four senior executives”) suggest that the tests described here help formalize something that the best strategists do quite intuitively.

The tests of a good strategy are timeless in nature. But the ability to pressure-test a strategy is especially timely now. The financial crisis of 2008 and the recession that followed made some strategies obsolete, revealed weaknesses in others, and forced many companies to confront choices and trade-offs they put off in boom years. At the same time, a shift toward shorter planning cycles and decentralized strategic decision making are increasing the utility of a common set of tests. [For more on strategy setting in today’s environment, see Lowell Bryan, “Dynamic management: Better decisions in uncertain times,” mckinseyquarterly.com, December 2009; and “Navigating the new normal: A conversation with four chief strategy officers,” mckinseyquarterly.com, December 2009.] All this makes today an ideal time to kick the tires on your strategy.

[Here is the first test. To read the complete article, please click here.]

Test 1: Will your strategy beat the market?

All companies operate in markets surrounded by customers, suppliers, competitors, substitutes, and potential entrants, all seeking to advance their own positions. That process, unimpeded, inexorably drives economic surplus—the gap between the return a company earns and its cost of capital—toward zero.

For a company to beat the market by capturing and retaining an economic surplus, there must be an imperfection that stops or at least slows the working of the market. An imperfection controlled by a company is a competitive advantage. These are by definition scarce and fleeting because markets drive reversion to mean performance (Exhibit 2). The best companies are emulated by those in the middle of the pack, and the worst exit or undergo significant reform. As each player responds to and learns from the actions of others, best practice becomes commonplace rather than a market-beating strategy. Good strategies emphasize difference—versus your direct competitors, versus potential substitutes, and versus potential entrants.

Market participants play out the drama of competition on a stage beset by randomness. Because the evolution of markets is path dependent—that is, its current state at any one time is the sum product of all previous events, including a great many random ones—the winners of today are often the accidents of history. Consider the development of the US tire industry. At its peak in the mid-1920s, a frenzy of entry had created almost 300 competitors. Yet by the 1940s, four producers controlled more than 70 percent of the market. Those winners happened to make retrospectively lucky choices about location and technology, but at the time it was difficult to tell which companies were truly fit for the evolving environment. The histories of many other industries, from aerospace to information technology, show remarkably similar patterns.

To beat the market, therefore, advantages have to be robust and responsive in the face of onrushing market forces. Few companies, in our experience, ask themselves if they are beating the market—the pressures of “just playing along” seem intense enough. But playing along can feel safer than it is. Weaker contenders win surprisingly often in war when they deploy a divergent strategy, and the same is true in business. [See Ivan Arreguin-Toft, How the weak win wars: A theory of asymmetric conflict, Cambridge, UK: Cambridge University Press, 2005.]

Further reading:

Anita M. McGahan, How Industries Evolve: Principles for Achieving and Sustaining Superior Performance, Boston, MA: Harvard Business School Publishing, 2004.

Philipp M. Natterman, “Best practice does not equal best strategy,” mckinseyquarterly.com, May 2000.

Michael Porter, “What is strategy?” Harvard Business Review, November 1996, Volume 74, Number 6, pp. 61–78.

Nassim Nicholas Taleb, Fooled by Randomness: The Hidden Role of Chance in the Markets and in Life, New York: Texere, 2001.

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About the Authors

Chris Bradley is a principal in McKinsey’s Sydney office, Martin Hirt is a director in the Taipei office, and Sven Smit is a director in the Amsterdam office.

The authors wish to acknowledge the many contributions of McKinsey alumnus Nick Percy, now the head of strategy for BBC Worldwide, to the thinking behind this article.