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Why Strategy Matters

To many people, strategy is a little bit of a mystery. Often we have a sense in order to know what strategy is, you have to be super senior. If there are a lot of job experience, it seems very complicated. Nonsense strategy. Simple is a plan to create value the way a company plans to create that value. That's the strategy of the company.

Of course, it's natural to look at financials. What are your margins, what's profitability, what's the return on invested capital? And that, of course, shows the result of strategy. It's an endpoint, it's a consequence. It's not actually where we start. The strategy is about looking forward to seeing the future, planning for the future.

We want to start with a sense of how much value do we create in the first place? Value for customers, value for employees and value for suppliers. Value is the difference between willingness to pay and willingness to sell. There's a really straightforward and simple way to show this. In a figure, the figure is called a value stick. And literally imagine at the top we have willingness to pay. At the bottom, we have willingness to sell. And the difference between the two is the value that the company creates. If I'm more successful, if I create more value, I can only do this in two ways, either by increasing willingness to pay or by decreasing willingness to sell.

Now, I'm going to ask, okay, so but what is willingness to pay? What is willingness to sell? Willingness to pay describes customers. It's the most a customer would ever pay for a product or a service. Charge me $0.01 more and I'm better off not buying. Now, the company is not going to give away its products, of course, and so overcharging a particular price, the price has to be below willingness to pay. Otherwise people will not buy the success for customers. It's just a difference between willingness to pay in price.

Value for employees is the difference between compensation and my willingness to sell.

It's a measure of the quality between what the person is looking for in work and what the company can offer. So total value created is the difference between willingness to pay and willingness to sell. And then it gets split three ways. Some of it goes to customers. That's the difference between willingness to pay in price. Some of it goes to employees. That's the difference between willingness to sell and compensation and the middle wedge. That's the margin of the company. That's financial success. In the end, how profitable an organization is reflects the amount of overall value creation. So one natural question is what are the ways I can raise willingness to pay? And there are really three buckets. The first one is the quality of your product or your service. More quality can mean very different things to different people, but the higher the quality, more appealing the product, the more appealing to service, the higher is willingness to pay. And then there are two different ways to also increase willingness to pay that are a little less obvious. The first one is, with the help of compliments, a compliment is a product or a service that supports willingness to pay off something else. Think razor razor blade, think printer and cartridges. Think espresso and espresso machines and espresso capsules. And the third is network effects for some products.

In some situations, the more popular the product is, the more widespread its adoption, the greater my willingness to pay. Social media is a great example. If all my friends are on Instagram, oh, it's so much better to also be on Instagram. My willingness to pay will increase as the adoption of Instagram increases. Really two ways to be more attractive in the market for talent. The first one is I just pay you more money. The moment I pay you more money, of course, I'm going to be more competitive in the marketplace for talent. The second option that seems similar is I make the job a better job. I create more attractive working conditions. Maybe I have a better training plan, maybe I have more generous promotion rules. Maybe you can work three days from home whenever I make the job a better job. Willingness to sell is going to go down. And so at the beginning you might think these things are really the same. If I pay more money, I create more value for my employees. And if I make a job, a better job, I lower willingness to sell. And thus that does the same thing. It creates more value. But there is a big difference. If I pay more, that just shifts value from the company to the staff to the employees. There's no value created. Value is just redistributed between the company and the people who work for the company.

If I make work more attractive, if the job is a better job. Willingness to sell goes down and that actually creates value. Let's talk about a specific example. You might know Best Buy, the electronics retailer in the United States. And if you go back, say, ten years or so, everybody, including myself, everybody was convinced that Best Buy was going to go out of business. Why many other electronics retailers had gone out of business. And with roughly 1000 stores, it just seemed impossible to compete against Amazon. At one point in time. Best Buy lost $1,000,000,000 in a single quarter, and then a new CEO comes in eventually. And remember, strategy is not complicated. It's all about either increasing willingness to pay or decreasing willingness to sell. And that's exactly what he does. Instead of building big distribution centers, big warehouses from which you ship online, he starts thinking about every store as a warehouse, and they start shipping from each individual store, typically from a store that is just down the road from where you are. We increase willingness to pay by having better shipping times, and then a second idea has to do with the retail store environment. He goes to Microsoft, he goes to Samsung, he goes to Lenovo, and he says, Well, you know, you can go down the Apple route and you can build really beautiful freestanding stores at millions and millions of dollars.

Or you can have a store in a store inside Best Buy where people are shopping for electronics products in the first place at a fraction of the cost lowering willingness to sell for the vendors to Best Buy. Now, what does it mean for employees instead of selling innumerable products? Now, I'm dedicated to the store in a store that's the Microsoft store or the store in a store that is the Sony store. I know so much more about the products I have. I can do much better job helping customers figure out which products are exactly right for them. My job is easier. I feel more successful willingness to sell drops. And if you look at employee engagement surveys at Best Buy, they are at an all time high after these big changes. So what they Best Buy do is increase customers willingness to pay and we have fewer pricing pressures. Next, they lowered willingness to sell and costs fall for Best Buy. The middle portion of the value stick, we have less pricing pressure. We have lower costs. Not surprisingly, the company is more profitable. They go from losing $1B dollars in a quarter to having a return on invested capital that exceeds 20%. Amazing. Why? Because they started with ideas about how to create value before we thought about how to capture a fraction of the value that we created.

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