Sep 12, 2014

Illusions of Control

Forward integrate or not? Indra Nooyi at Pepsi and Jeff Bezos at Amazon have said yes. They will very likely be proven misguided.

Nonetheless, for many CEOs and their corporate strategy chieftains, consolidation, forward distribution integration, and scale conversations are dominating the big corporate strategy debates of today. Yet if there is any truth in capitalist business environments, it must be this – no matter the strategy, you can’t hide from the market.

So let’s start our review of forward integration by taking a break from obfuscating economics-speak. When we use the term market, as in ‘let the market decide’, what we really are referring to is the sum of all the needs, desires, and resulting behaviors of final customers that sit at the end of any business system. Like it or not, these customers are both judge and jury.

This means that smart companies, as well as their strongest competitors and most astute regulators, will focus on a single dominant strategic question as they craft future direction and govern the allocation of scarce resources. What choices do end customers have as they evaluate alternatives, and who do they choose?

Yet designing and executing business systems to consistently and profitably win over these picky end customers is at once straight-forward and maddeningly complex. Even though strategists are as prone to confirmation bias as anyone (“the ‘don’t confuse me with facts’ problem), customers easily and willingly, and often quite forcefully, express the desired outcomes they seek as they make decisions about what to buy and how to buy it. That holds for both consumer and business buyers.

As a result, understanding what any company’s “ideal” growth strategy should be is the straight-forward part. It should be squarely focused on delivering the full range of what and how outcomes end customers seek, and delivering them profitably and better than any other alternatives available.

But the complex part comes barging in as companies intensely debate, across often warring internal functional factions, how to design, build, fund, and manage business system that will, at the end of the day, deliver better than any competitor those winning outcomes to customers. This brings us to the vertical integration question. And understanding it fully is as much a study of CEO psychology as it is of hard-edged financial and strategic analysis.

After years of unsuccessful efforts to stem erosion in market share and customer retention, frustrated CEOs of once-strong legacy brands often show signs of siege mentality, especially when tough questions are met with blank stares. Are we offering the right value proposition (outcome for customers)? Are we delivering it? What’s standing in our way? When answers prove elusive, either internally or from outside partners, these CEOs often make the fateful decision to “take control of their destiny” and vertically integrate.

The question is – what destiny? And is it one that leads to greater numbers of customers choosing their offerings at acceptable prices? Public rationales for most vertical integration moves are usually more about cost savings, efficiency, lower prices, and greater control. They typically make only vague allusions to the messy business of customers and new ways of winning them over. Let’s look at a recent example.

Larry Ellison, who at one time was the Red Bull of corporate IT systems, has abandoned his fierce loyalty to being a best-in-class and tightly-focused industry leader in favor of buying Sun Microsystems. Apparently as part of a drive to become a fully vertically integrated player. He seemed very tuned to the question on everyone’s mind – how will this help Oracle win over customers? - when he commented about Oracle’s decision this week that “we’re really brilliant, or we’re idiots”.

Indeed, Oracle would be wise to look at its own proud history for inspiration and strategic direction. IBM, once the world’s biggest and most powerful business system, was brought to its knees in the early-80s by a new generation of nimble, focused, best-in-class players. Players that were unencumbered by IBM’s high-cost, slow changing, vertically integrated old behemoth of a business model. A business model, as military strategists often despair, best prepared to fight yesterday’s war. In fact, Larry Ellison founded Oracle in 1977 as one of those new breed of competitor. One that offered end customers some fresh air in the form of open platform solutions. Ones that weren’t hand-cuffs like IBM’s all-or-nothing bundled alternative. So the question to Oracle is, Why this?

At the end of the day and no matter how difficult, the best business model innovations are those created in the spirit of fresh reinvention and influence over results delivered to end customers, not protection and control of the status quo. Practically, that raises tough questions about how to get best-in-class solution alliances and distribution partners to work collaboratively to create winning new end results for their common customers. While there may indeed be times when such collaboration is simply not possible, and when complete ownership and control is essential to success, they are generally few and far between. And Apple aside, they are rarely successful.

I suspect the rush to vertical integration we seem to be witnessing in today’s climate may have more to do with an overall lack of trust in market forces. And perhaps it’s also a desperate response to tough economic conditions and fast-changing industries. In fact, it might just be an ill-advised knee jerk effort to slow things down. But don’t be fooled. Customers will still have the final vote.

When it comes to vertical integration, Buyer Beware!

No comments: