• 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.

Intense strategic herding also harms the margins and returns on equity of original-equipment manufacturers (OEMs) of consumer electronics products, such as Philips, Sony, Toshiba, and Zenith. The OEMs’ television-manufacturing activities are acute cases of industry herding around a product’s physical characteristics. TVs from every manufacturer not only come with the same screen sizes but are also, excluding minor differences, identical inside. Even innovative technological features, such as Sony’s Trinitron picture tube, are typically copied within six months to a year. Brand strength, the only discernible difference among manufacturers, requires huge advertising expenditures to sustain. Partly as a result of the lack of marginal strategic differentiation among the consumer electronics OEMs, the market capitalization of the industry’s top five players increased by only 8 percent between 1994 and 1998. During that time the S&P 500 rose by 168 percent.

Other factors reinforce the herding reflex. For one thing, it dovetails nicely with the short-term orientation of many current investors, who are more likely than investors in the past to sell stock in companies that don’t meet their earnings expectations. That tendency pressures companies to match the short-term results of their most successful direct competitors, even if long-term opportunities are sacrificed in the process. Indeed, many executives don’t regret this; by embracing the industry leader’s product, performance, and financial goals, they can blame performance setbacks on the fate of the industry as a whole. Finally, equity analysts by and large evaluate a corporation’s results against those of its industry peer group and not against the absolute earnings levels of all industries.

Bucking the Urge to Converge

Understandably, in specific cases executives have trouble distinguishing the operational and strategic uses of best-practice benchmarking. Precisely because the slope is so slippery, executives should constantly ask themselves whether they have taken those first fateful steps toward destroying value.

Many companies have resisted the temptation to extend the best-practice technique into the realm of strategy. Chrysler, for example, introduced the minivan in 1984, when the station wagon segment was dying. Another such company was The Home Depot, which entered the do-it-yourself home improvement business in 1979, just as the baby boomers started becoming home owners; the company enjoyed growth rates of 20 percent a year, well surpassing the 5 percent rate for the overall building-supply industry.

Or consider Southwest Airlines, which managed to grow at a rate seven times the industry average in an era of overcapacity and flat demand. Southwest broke ranks with the other airlines by targeting a customer segment that, while price conscious, cares more than other price-sensitive customers about the quality of the flight experience.

Whatever industry these companies competed in, they all actively looked for “white spots”—that is, unexplored areas on the strategic landscape. White spots can take the form of new product niches, value-added services, and sales channels, as well as unexploited price points. Venturing into these uncharted regions obviously entails risk, but companies that do so increase the number of features from which to draw value and obtain first-mover advantages. Because such gains are bound to expire quickly, however, managers must continually reinvent niche products or services.

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