The Essence of Strategy for Managers

3 Questions

Strategy is a term that has garnered immense attention through numerous books, articles, and online resources. Although it is widely acknowledged as crucial, the concept has evolved from its military origins to become a popular subject in business schools and a service provided by countless consultants. Strategy can be defined in various ways, but fundamentally, it involves taking a course of action to shape the future. At Gulfrock Capital, we value deep simplicity with comprehensive understanding and believe that an effective business strategy addresses three core questions:

1. Where are we today?

2. Where are we going?

3. How will we get there?

While these questions may appear simple, arriving at meaningful answers can be a challenging yet rewarding journey. The strategy development process is often intricate, perplexing, and tailored to large corporations with substantial strategy teams and vast revenues. Let’s tackle the first question, "Where are we today?" and later expand upon the remaining questions in subsequent posts.

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Where Are We Today?

A thorough diagnosis is crucial for devising a solid strategy, and answering the question, "Where are we today?" lays the foundation for this process. Instead of creating extensive presentations, we believe that the most vital insights can be discovered by examining four key areas:

1. Market Analysis

• Size: What is the market size, and what are its main segments?

• Growth: How have these market segments grown historically, and what are the future growth projections?

• Structure: Who are the competitors, what is their market share, and what factors drive competition? How has this evolved over time, and what disruptions are affecting the market

2. Financial Analysis

• Revenue: What are the primary revenue drivers (e.g., customers, products, geographies, etc.), how has this changed over time, and what growth opportunities exist?

• Costs: What are the major costs, how have these evolved over time (and what are the future expectations), and what opportunities for improvement are there?

• Profitability: How has profitability changed over time? How do we compare to best-in-class benchmarks? What is the profitability mix (e.g., by customer, products, geographies, etc.), and how is it shifting?

• Balance Sheet: What is the current capital structure, what opportunities exist to reduce net working capital and capital expenditures, and is there sufficient liquidity and manageable debt?

3. Customer, Value Proposition, and Operational Performance

• Customer: Who is the target customer? What is the overall customer experience and retention rate?

• Value Proposition: What products/services do we offer customers? What do competitors offer? How do we compare to competitors in terms of key purchase criteria?

• Commercial Processes: How effective are the commercial processes (e.g., sales, marketing, product development, technology, etc.)?

• Operational Performance: How effective are the operational processes (e.g., distribution centre, data centre, etc.)? How do operational metrics (e.g., percentage of shipments delivered on time, cost per package, website availability, etc.) compare to historical levels and best-in-class performance?

1. People and Culture

• Talent: What is the quality of our team? What are the critical roles and quality of people in these roles? What challenges must we address?

• Culture: How empowered, engaged, and committed are our people to their work? Is our culture aligned with our strategy? How do we perform on key talent metrics (e.g., employee engagement and retention)? What are our biggest opportunities?

Assessing your business drivers enables you to establish a factual understanding of the current state, recognise your strengths, identify areas for improvement, and anticipate future positioning. 

Charting the Course of a Business: Where are We Going?

Now we consider the question, "Where are We Going?" By building on the foundation established in "Where Are We Today?", the aim is to articulate the strategic vision of your business and evaluate the available options. We appreciate the "Where to Play" and "How to Win" framework for assessing strategic alternatives, as it clearly delineates where your organisation chooses to compete (and just as crucially, what you opt not to do) and how you intend to achieve success in your chosen market (e.g., leveraging sources of competitive advantage).

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Selecting the Playing Field: Where to Play?

"Where to Play" defines the key focus areas for your organisation. Although some choices may seem intrinsic to your business, it's important to take a step back and reevaluate these fundamental decisions, ensuring that the organisation aligns on key priorities. "Where to Play" options span a variety of dimensions, such as:

• Core Business: Identify your organisation's core operations

• Geography: Determine the regions you compete in (e.g., North America, Asia)

• Channel: Identify the methods for delivering your goods or services to consumers (e.g., direct sales force, digital delivery, etc.)

• Product / Service: Define your offerings

• Customer: Identify your core and secondary target audience

• Value Chain: Determine your position within the value chain (e.g., manufacturer vs. distributor, vertical vs. horizontal operator)

A crucial aspect of this process involves determining how these choices should evolve over time, such as expanding geographies, entering new product categories, or divesting non-core businesses.

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Crafting a Winning Strategy

"How to Win" outlines your organisations’ formula for success in your chosen markets. With markets being competitive, it's crucial to determine how your organisation will "win" and create value. Two key components of "How to Win" are value proposition and competitive advantage. Your value proposition explains why customers choose your offerings (e.g., low cost, high quality, speed of delivery, ease of accessibility etc.), while your competitive advantage prevents well-funded competitors from encroaching on your territory and eroding your margins, earnings, cash flow, and returns on capital.

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Warren Buffett refers to these advantages as “moats around the castle." We appreciate Pat Dorsey's framework, which categorises moats into four types:

1. Switching Costs: The expenses (e.g., money, time, risk, etc.) of changing to a new provider create customer loyalty. For instance, enterprise software may comprise a small portion of a company's overall budget, but changing providers can be costly and risky.

2. Intangible Assets: Brands, patents, or licenses that increase customers' willingness to pay or reduce their search costs. Brand advantages may include search costs (e.g., Wrigley's, Coca-Cola), positional value (e.g., Tiffany, Louis Vuitton), or trust (e.g., large accounting firms).

3. Cost Advantages: These arise from lower costs through process, scale, niche market structure, or location. A marble quarry near major customers, for example, has an inherent cost advantage compared to a similar quarry 500 miles away.

4. Network Effects: The network's value grows as the user base expands. The more people who use Facebook, for example, the greater the utility for each user, as there are more connections and sharing opportunities.

A robust moat is rare and supports value creation by allowing a business to generate above-average cash flow and returns on capital. For instance, Microsoft earns attractive returns through the switching cost advantage provided by its software (e.g., Microsoft Office), which locks in customers by making their work less compatible and transferable to other programs, creating hurdles for new competitors. Many businesses lack a clear moat, and the strategy development process offers an opportunity to either build a moat (e.g., invest in a differentiated brand, develop proprietary technology) or strengthen existing ones.

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Navigating the Path to Success: How Will We Get There?

The final core question, "How will we get there?" focuses on the strategic initiatives that need to be executed to deliver on the "Where to Play" and "How to Win" choices. This requires a pragmatic approach and involves the allocation of resources, setting priorities, and defining clear action plans. 

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Strategic initiatives are comprehensive undertakings that propel your organisation from its current state to its desired future state. These initiatives should fortify your decisions regarding where-to-play and how-to-win, thus fostering a self-reinforcing cycle of victory (we have found that the most astute choices stimulate a flywheel effect). While formulating initiatives that robustly support your where-to-play/how-to-win choices, there are several guiding principles that should be kept in mind:

1. Prioritise Initiatives: Assess the strategic initiatives based on their impact on the organisation's competitive advantage, potential return on investment, and alignment with the overall strategic vision. Prioritise initiatives that offer the highest value creation potential and align with your organisation's core competencies. Our primary focus is to strengthen the main business through foundational initiatives, as we have discovered that the core often harbours latent potential.

2. Allocate Resources: Allocate resources (e.g., financial, human, technological) to the prioritised initiatives, ensuring that each initiative receives the necessary support to succeed. This may require re-allocating resources from less critical areas or identifying new sources of funding.

3. Set Clear Objectives and Metrics: Define clear, measurable objectives for each initiative, and establish key performance indicators (KPIs) to track progress. This provides a tangible roadmap for the organisation to follow and allows for regular assessment of the execution process.

4. Differentiate Between Foundational and Transformative: Distinguish your foundational initiatives from your transformative ones to maintain concentration (i.e., do not undertake multiple radical transformations simultaneously). Foundational refers to making incremental enhancements to the principal business, while transformative implies devising innovative offerings to cater to novel markets and customer requirements. Eg. Cinnabon's strategy of reducing its portion sizes and prices to make its indulgences more accessible can be seen as a foundational initiative, while capitalising on its brand to venture into licensing, like flavoured coffee creamer, counts as a transformative initiative.

5. Engage and Communicate: Engage and communicate with all stakeholders, including employees, customers, suppliers, and shareholders, throughout the strategy development and execution process. This promotes a shared understanding of the strategic vision and builds support for the planned initiatives.

It is essential to acknowledge that meticulous planning is not merely a formality but a vital prerequisite for success. A well-crafted plan not only provides a roadmap for the initiative but also fosters a sense of ownership among the team members, creating a shared vision of success. This shared vision cultivates alignment, which is crucial for the effective execution of the strategic initiatives. 

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Moreover, we believe in the power of iterative planning. As the business environment evolves and new information becomes available, we revisit and adjust our action plans accordingly. This iterative approach allows us to respond proactively to changes and maintain alignment with our strategic objectives. This adaptability is crucial in today's dynamic business environment, where change is the only constant. 

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Also, it is imperative to communicate these action plans effectively across the organisation. Effective communication ensures that everyone understands their role and responsibilities and aligns their efforts towards achieving the strategic objectives. Communication also fosters a sense of inclusion and empowerment among the employees, promoting engagement and commitment towards the initiatives. 

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Finally, our focus on setting objective measures for success (i.e., KPIs) underpins our belief in data-driven decision-making. By quantifying our goals and regularly monitoring our progress, we ensure that our strategic initiatives remain on track and achieve the desired outcomes. This data-driven approach also enables us to identify potential issues early and take corrective action, ensuring the success of our strategic initiatives.

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In Summary

The essence of strategy lies in effectively answering the three core questions: Where are we today? Where are we going? How will we get there? By approaching strategy with a deep yet simple understanding, organisations can chart a course towards a successful future. The strategy development process not only helps businesses identify their competitive advantages and create value but also serves as an opportunity to reassess and realign priorities, ensuring a sustainable and thriving business in an ever-evolving market landscape.

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Crafting the journey from "where we are today" to "where we want to go" involves thorough planning, effective communication, and data-driven decision-making. By focusing on these elements, we at Gulfrock, ensure that our strategic initiatives not only reinforce our where-to-play and how-to-win choices but also drive continuous growth

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At Gulfrock Capital, we remain committed to partnering with investors in navigating their strategic journey, leveraging our expertise and experience to create tailored solutions that drive lasting value creation and growth.

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