• 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.

The number of white spots is almost unlimited, with opportunities ranging across all strategic dimensions. Small and midsize enterprises in Germany, choosing to exploit geographic opportunity, entered Eastern European markets after the fall of the iron curtain and succeeded because larger players initially hesitated. The Body Shop also prospered by exploiting white spots: founded in the United Kingdom in 1976 in a single storefront, it had grown so much by 1995 that it was operating more than 600 shops in 38 countries. Unlike the dominant players in the cosmetics industry, The Body Shop refused to allocate 30 percent of its revenue to advertising, conducted no elaborate promotions, and sold its products in simple plastic bottles. Madison Avenue viewed that approach with great skepticism, citing the maxim that successful cosmetics companies create hopes rather than sell products. Yet Body Shop founder Anita Roddick stuck to her guns and saw turnover soar more than 23-fold from 1984 to 1991 while pretax profits grew more than 19-fold.

The difficulties The Body Shop encountered in the mid-1990s, particularly in the United States, illustrate the pitfalls of failing to maintain strategic differentiation. Attracted by the high returns the company earned, a large number of competitors, including Bath & Body Works, Garden Botanika, and H2O+ entered the market. (Bath & Body Works increased its sales from $112 million in 1993 to more than $1 billion in 1999.) The Body Shop’s failure to reinvent its concept to ensure ongoing strategic differentiation led to a steady decline in the number of its US franchises, hurting revenues and earnings. Between 1996 and 1998, more than 20 franchises, some with more than one location, withdrew, complaining of the company’s failure to outwit an ever-growing number of imitators by developing new products, formats, and packaging.

Another company that broke with the herd, Sweden’s IKEA, balances quality and price in the furniture it offers through more than 130 stores in 26 countries. Contrary to the industry norm of outsourcing as much as possible, IKEA acquires stock in its more than 2,300 suppliers so that it can enforce its quality standards. Control of product design allows the company to specify construction methods. Careful attention to detail, construction, and packaging has helped it keep costs low. Thanks to this unorthodox but very well-executed strategy, the number of IKEA stores has grown 12-fold, its staff 15-fold, and its revenue 40-fold over the past 20 years, even as the industry grew by no more than 2 to 4 percent a year.

Best practice doesn’t always equal best strategy. Best-practice benchmarking, rightly viewed as one of the most important tools for improving operational efficiency, can be a double-edged sword. Managers must guard against transforming what is a purely process-related technique into the overriding goal of strategic decision making. When industry competitors begin to herd around a single strategy, declining margins are bound to follow.

This article was written by Philipp Nattermann, a consultant in McKinsey’s New York office. It originally appeared in The McKinsey Quarterly, 2000 Number 2.

Measuring Strategic Differentiation

The first step in determining the degree of strategic differentiation among competing companies is to measure their products’ “characteristics” numerically. These include not only each product’s inherent physical attributes (in the case of an automobile, for example, its horsepower, weight, and size) but also the commercial environment in which it is marketed, including the customer segments the company has targeted, the channels it employs, its advertising, and the locations of its activities.

Generating a two-dimensional plot that relates product characteristics to price is the next step. The strength of customer preferences for each product characteristic is estimated, and these estimates are used to calculate a price/product-characteristics index for all companies in the comparison. The higher the value of the index, the greater the number of desirable product characteristics the company offers at a given price. (In the case of two cars with identical product characteristics, the one with a lower price would have a higher index.)

The price/product-characteristics index of each company describes its position vis-à-vis its competitors in the strategic landscape. The variance among the companies’ individual indexes, denoting the degree of strategic differentiation across the industry, generates the strategic-differentiation index (SDI).

A company with a high individual index has succeeded in differentiating itself clearly from competitors. But the value of the industry’s SDI at any given time is of little interest; it is change over the long term, or simply over the course of an industry cycle, that establishes whether herding has taken place. A sharp decline in the SDI demonstrates that managers are engaged in strategic herding.

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