• Strategy
  • McKinsey & Co.

Best Practice Doesn’t Equal Best Strategy

Benchmarking is an important way to improve operational efficiency, but is not a tool for strategic decision making. When competitors all try to play exactly the same game, declining margins are bound to follow.

Management’s overriding goal is to position a company and its products where the market opportunity is highest. The more consumers who are located in a specific region of the strategic landscape, or the higher their disposable incomes, the higher this particular peak will rise (Exhibit 1). Especially in newer industries, the task of finding market opportunities is complicated by a lack of information about the willingness of consumers to spend, the exact distribution of their preferences, and other characteristics of the strategic landscape. Management really knows only its own company’s location and earnings, and those of its competitors insofar as they make this information public. Even then, the information doesn’t fill out the entire landscape.

The payoff a company receives for occupying any part of the landscape depend on the height of the point it occupies and on the number of companies operating nearby. A single firm operating at a particular peak receives all of the local market value. If a number of companies operate within a region, the market value or resources must be shared. The more companies that are located in a single region, the lower the payoff for each.

Tracking the Herd

This herding instinct first manifests itself in the corporate search for profit peaks. To improve earnings, laggard companies typically benchmark their performance against the best practitioners and migrate closer to them. The laggards do so by mimicking competitors’ product offerings, matching advertising and spending targets, using the same sales channels, and offering the same services. The migration continues as long as one of the companies earns higher returns than any of the rest.

Unfortunately, clustering around the strategy of the most successful company actually destroys value: the profits the industry leader earns are soon divided among the group of companies converging around its space. Companies that had been earning profits on lower peaks leave them to join the herd. Once forsaken, those sources of profit lie fallow unless other companies, seeing opportunity, occupy them. The combination of profits lost through the abandonment of smaller peaks and static overall earnings at the herding point forces industry earnings downward.

A strategic-differentiation index (SDI) can document the herding phenomenon and gauge the ensuing decline in industry margins (see “Measuring Strategic Differentiation” at the end of this article). German wireless telecommunications is a prime example of a relatively new industry that has destroyed value by herding. Two companies—Deutsche Telekom’s D1 and Mannesmann’s D2—joined the incumbent operator, C-Tel, in the market in mid-1992. Between then and the end of 1998, operators reduced the industry’s degree of strategic differentiation by 83 percent. Herding effectively eliminated differences among the individual carriers’ product offerings, tariffs, and customer segments. One of the alarming effects of this loss of differentiation has been a decline in industry margins by roughly 50 percent from mid-1993 to year-end 1998 (Exhibit 2).

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