The Strategic Mistake Almost Everybody Makes

“It is simple math,” the strategist said in a tone that sounded suspiciously similar to how I explain things to my six-year-old daughter. “Decreasing churn by a percent — a single percent! — creates tens of millions of dollars of value. A point of market share creates five times that amount. Our growth investments are years from providing that kind of return.”

The general point is right — a dollar of investment in incrementally improving the core is almost always going to earn a greater near-term return than a dollar invested in a growth business that might take years to incubate. It’s one reason why it is so critical that companies begin to invest in growth before they need growth so they create space and time for those investments to mature.

Unfortunately, few companies do that. Instead…

“So,” the strategist continued. “If we just take our investment in innovation and redirect it to our core business, we’ll be much better off.”

No, no, no, no, no.

Sure, in the short term the company might be mildly better off. And I’m the last to argue against making today’s business as resilient as possible. After all, the free cash flow generated by today’s business is what funds investment in tomorrow’s business. However, slashing investment in new growth is perhaps the most dangerous thing that a company can do.

Every business and business model has a finite life. Products come and go. Customer preferences change. As Rita Gunther McGrath notes, competitive advantage is increasingly a transient notion. The companies that last over long periods of time do so by creating new products, services, and business models to replace yesterday’s powerhouses.

A few years ago we had Netflix founder and CEO Reed Hastings at a private event talking about disruptive change. This was before the PowerPoint  that Netflix created to describe how it approached the management of talent had spread throughout the Internet (I still find that document a very powerful descriptor of how to build a culture primed for creative destruction), and Blockbuster was still a very viable competitor. Hastings was describing how he thought about managing big transitions, like the one Netflix was inevitably going to make from delivering DVDs through the mail to online streaming.

“My point to the management team and the board is that the big risk we face is technology obsolescence. That is the dominant risk,” Hastings said. “The little risk is that somebody screws up some bug in some product or financial restatement. Those are not good things, but that’s not how companies fail. How companies fail is through lack of technology or business model innovation. And so if we’re going to be thoughtful stewards of value, we need to optimize around the big risks.”

Companies need to make sure they balance investment in strengthening today’s business with investment in creating tomorrow’s. They need to evaluate new growth investments using longer time horizons and use different management techniques to grapple with the high degrees of strategic uncertainty those investments entail.

Portfolio theory has its naysayers, but few argue with the fundamental idea that diversification decreases risks and increases a portfolio’s potential. Do you remember the most efficient buggy whip manufacturer or the most profitable distributor of packaged ice? Of course not.

Decreasing investments in diversifying your corporate portfolio increases the risk that the pace of disruptive change in your industry (which is likely going to be more furious than what your models are telling you) has a cataclysmic effect on your business. Don’t fall prey to the strategist’s fallacy.

Harvard Business Review