5 ways to stress test your strategy.
It’s altogether too easy to lose track of the root-level principles that make for good strategy. Indeed, there seems to be a perennial quest prosecuted in search of the next big thing, silver bullets, or some secret sauce.
This is actually quite natural—successful strategies are the result of a continuous accumulation of frameworks that claim to hold the key to a competitive advantage. All too often, this can also lead to accumulation of dead weight—large quantities of documentation, reams of case studies, and staggering amounts of data.
In fact, there’s even confusion as to what, exactly, constitutes “a strategy.’’ We adopt the position that a strategy is a mode, method, or manner of collecting, processing, and thinking about information, not a formulaic procedure or even a set of abstract “frameworks.” By adopting this stance, it becomes immediately clear that the most important thing is to rigorously determine what is objectively true and then reliably finding and executing on that.
What follows is a selection of just some of the tests Anoloriya employs to help us evaluate and form bespoke winning strategies for our clients.
Does your strategy beat the market?
This is ultimate goal of any strategy, after all: winning. At the same time, this test is the most abstract and is a lagging indicator, at best.
Nonetheless, to beat the market, you have to capture and keep an economic surplus, which is the delta between earnings and cost of capital. Unmolested, a market will tend to drive any surplus of all participants toward zero.
So, to capture and keep an economic surplus, there must be an imperfection in the market that you exploit. There is no silver bullet; markets drive performance to revert to the mean, which means that yesterday’s killer strategy will soon be employed by your competition—–the sauce only stays secret for so long.
What’s more, markets are inherently random. Many of today’s top companies are the result of happy accidents or lucky choices made some time ago.
Thus, a winning strategy will emphasize, amplify, or exploit some difference between you and your competitors. These advantages need to be robust and responsive to the inexorable march of time and and inherent randomness that markets are shot through with.
Does your strategy use a real advantage?
In a market, an advantage is derived from scarcity or some deficiency in position or capability.
Advantages in position can be obtained in markets that are asymmetric. Such a structure usually comes about through some sort of upheaval or dramatic change in the conduct & performance of participants.
For example, in the middle of the 20th century, there were numerous manufacturers of aircraft for civil aviation. Progressive consolidation, however, has led to a marketplace where Boeing and Airbus have a duopoly on airliners. Similarly, Intel and AMD are the only manufacturers of full-power consumer microchips; the enormous sunk capital cost required to obtain the expertise, tooling, and rights or permission to enter the consumer microchip space means that these two firms are likely to enjoy their position for quite some time.
And, of course, when was the last time you saw a zipper that wasn’t branded YKK?
Intellectual property, exclusive rights, and specialized processes are typical examples of advantages of capability. Rights and IP, technically, are tradeable assets that can be bought and sold.
Other capabilities, generally referred to as “distinct competencies” are unique to a single firm and represent something it is particularly good at. While it’s tempting to pat yourself on the shoulder and say that you’ve got some process or tooling that nobody else can get, these advantages should be rigorously investigated and tested before folding them into any strategic planning.
Notable examples include Apple’s ability to very precisely mill aluminum laptop cases at scale and Aldi’s bare bones model for store layout. The prohibitive expense of spinning up a machine shop that can operate at scale the enromous capex Wal-Mart would have to lay out to, more or less, gut their stores means that Aldi and Apple really do have a distinct competency they can use in their strategies.
Does your strategy keep you ahead of the curve?
Many strategies fail because they are predicated on the false assumption that today’s status quo will forever remain just that. At best, most strategists look 5 years back and use this sliver of data to make projections into the future. This window is entirely too small to account for the randomness and volatility of markets.
Even setting aside true black swan events, typical, rote shocks like new regulation regimes (or deregulation, as the case may be), changes to tariffs and taxes, or major technological advances can set off a wholesale reorganization, at best, or outright extinction event in a marketplace.
What’s more, trends tend to emerge in a slow, creeping fashion. By the time somebody notices that it’s sneaked up on the bottom line, it’s entirely too late to mount an effective response, to say nothing of capitalizing on the trend and turning it into an advantage.
Your analysts and strategists should always be closely examining the edges. How are your most savvy or advanced consumers behaving? What about the small, upstart market entrants? Woe is you if you fall victim to one of these nimble firms “disrupting” your market.
Does your strategy make space for uncertainty?
The most difficult thing for a strategist and her principals is to face the fact that our strategies often require us to make one or more decisions today in anticipation of reaping a reward or payoff at some arbitrary point in the future. A future, mind you, that we can neither control nor predict with anything even approaching perfect certainty.
A firm can’t embrace or account for uncertainty if it’s uncertain about that very concept. Characterizing, or at least developing an understanding of, the contours of the spectre of uncertainty is very valuable and also exceedingly rare—even at companies that generally do a good job of thinking critically about their strategy.
Over the last several years, we have developed a tiered system that we have found to be quite useful at characterizing uncertainty:
- Tier 1: Odds on
- Tier 2: Probable
- Tier 3: Possible
- Tier 4: Ambiguous
In our practice, “odds on” stands more or less in contrast to the “risk on” of the capital markets; a bet on 00 at the roulette wheel is a distinctly beta-heavy, risk-on bet that has unlimited upside. We love a good rush, but many of our clients and their stakeholders can’t tolerate such a risk profile.
Instead, we classify stances and positions in relation to their certainty intervals. An odds-on position has significantly-better-than-even chances of of returning a moderate alpha coefficient while minimizing exposure from the beta tensor.
Many companies tend to oscillate between the relative certainty of Tier 1 events before colliding with a 4th Tier event they never saw coming. This is not at all the same thing as a black swan event which, incidentally, Anoloriya is named after; this is just an impoverished or deficient view taken by the “victimized” firm.
In reality, a diligent analysis will categorize most events into tiers 2 and 3. Companies with winning strategies will primarily live in Tier 2, neither all-in nor vacillating, and reliably making winning bets on Tier 1 events while possessing a detailed map of the possible worlds bounded by Tiers 3 and 4.
Does your strategy strike a balance between rigidity and flexibility?
This test naturally follows on from measuring uncertainty. A strategy that relies heavily on Tier 1, odds-on events is likely to be rather rigid in its stance and lacking the ability to nimbly respond to probable events. Rose-colored glasses, as They say. (They sure do talk a lot, don’t They?)
Indeed, flexibility occurs in inverse proportion to how committed or “all-in” a firm is. Commitment is required, of course, for a firm of any size to execute on a strategy. While many thousands of decisions are made by each member of an organization each day, genuine strategic decisions are taken more seldom and by a smaller cadre of stakeholders. In order to create or seize a market-beating competitive advantage, as discussed in the first test, it is often necessary to make long-term, difficult-to-undo investment decisions about various assets today.
The timing of these decisions is as important as the competitive advantage they are meant to confer. Too early is like a lemming jumping off a cliff while the risks of being too late tend to be fatal in an even more horrific fashion.
A well-built and -implemented market-beating strategy will require a small number of critical, binding decisions right now while preserving options and flexibility as time moves forward.