How Paradigm Cycles Work

Metathought: The Initial Spark

A metathought is an overarching big idea that has the potential to influence business practice across decision domains or across firms or potentially both. It may not necessarily be a completely new or untested idea but it is popularized by a champion at a point in time and catches the fancy of many. For example, a metathought could be that one should create new and uncontested markets and get out of the way of competitors rather than fight with them for a share of an existing market. Now if the status quo were that most firms were actually engaged in a market share battle and collectively followed the same mind-set, then the new idea would be what we would call a metathought. An idea such as this would have the potential to influence organizations in many ways and across a variety of functional domains. For example, an organization that would follow the metathought will have to make a fundamental change in how it defines markets and how it would change its focus to creating new ones. It will also have to think differently regarding what competition means and why it might not be prudent to go head-to-head against it. The metathought will change the focus of its product development initiatives to market creation and away from share extraction. Finally, the metrics that it would use to evaluate the product development process, its marketplace performance, its financial performance, and the overall organizational risk will change. The new set of metrics may bear little resemblance to those that were used in the past or are currently used by others in related business sectors.

Similarly, another metathought could be that a customer’s ability to pay may be uncorrelated with an organization’s ability to profit. In other words, the most profitable customers may not be the ones who have the greatest individual earning power but are few in numbers—rather those with lower individual purchasing power but greater collective strength. If this metathought is adopted, then it has the power to change the market selection process and the mechanisms the organization employs to evaluate market attractiveness and to do an opportunity analysis. Organizations who follow the metathought would then think differently about product development, pricing formats, package sizes, distribution systems, and customer retention. In other words, the single metathought would change a lot of what the organization would do and how it would do it.

Yet another metathought could be that an organization should not do many things but focus on just one or a few areas of strength. The adoption of this premise will redirect an organization’s efforts away from diversification and a portfolio-based approach toward concentration and focus areas. This concentration could be in terms of resource allocation, skill building, market selection, or product policy. On the other hand, a somewhat different metathought could be that organizations can mitigate their business risk by doing many unrelated things. Such a thought would direct organizational energies in the exact opposite direction where coverage might become important, as would diversity of skill set and a broadening of the product line and a wider selection of markets. One can easily see that the two metathoughts would give rise to very different strategic directions that would have an impact on decision making at all levels from resource allocation to product positioning.

A metathought can also arise at a domain specific level. For example, an idea could be that if you treat your employees well they in turn will treat the customers well. An adoption of this metathought would direct much of the organizational energy toward fine-tuning its people management policies and ensuring that its employees are treated well and are cared for. It would unleash an employee-centered culture with the central premise being that satisfied employees will automatically satisfy the customer base.

Finally, another example of a domain-specific metathought would be the notion that a customer is only as good as the incremental cash flow that he or she can bring to the organization in the future. The adoption of this metathought would change the firm’s customer relationship strategies from backward looking to forward looking. It would directly evaluate customers in terms of their net financial value and would almost automatically impose a segmentation system where valuable customers are segregated from less valuable ones. And finally, it would direct resources toward customers who are valuable and away from those who are not. One such potential manifestation of resource allocation is witnessed in organizations that measure the worth of their customers in terms of not only the revenue the firm currently gets from them but also the incremental potential that is available. Such a perspective has heightened the interest in measures such as “share of wallet” that allow firms to juxtapose their current earnings from individual customers against the total category spend of these customers. With such an understanding, two customers with, say, a thousand dollars’ worth of revenue could be treated very differently if one of these customers allocates a 100% share to the firm compared to only 5% share allocated by the second customer. The firm can clearly see much larger incremental sales potential for the second customer, whereas without this perspective, both customers might have been treated identically.

Paradigm: Building the Framework

Paradigms are the visible or manifest faces of metathoughts and represent its key tenets to a wide audience (Figure 4.1). They might start as labels and may ultimately become the metaphorical version of the underlying metathought and represent the collection of practices under it.

For example, Blue Ocean Strategy is the paradigmatic version of the fact that one should create uncontested markets. In this case, red oceans metaphorically represent the battle among competitors within an existing market space and blue oceans represent the serene, separated, uncontested market that one is advised to create. The metaphor gives meaning to the metathought of creating uncontested markets and almost provides an automatic logic to it. Individual decisions and collective strategies get organized as blue ocean strategies. The paradigm also becomes the commonly accepted verbalization of the underlying metathought, and strategists start using it as a lens to view whether a chosen set of actions are consistent with the metathought or not.

Serving people at the bottom of the pyramid is the paradigm that postulates that firms can build a profitable business by focusing on those who have the least ability to pay. It captures the essence of the metathought that it might not always be wise to chase those customers who might individually be the most profitable. It points to the collective power of those at the bottom of the pyramid and exhorts firms to change their product design, pricing formats, and business models to generate adequate returns from what would conventionally be considered an unprofitable segment. Recent announcements in the computing sector provide a testament to this changing orientation. In May 2008, Microsoft came up with an innovative piece of software, FlexGo, which keeps machines from working unless users type in a number from a prepaid card. After a certain number of hours, the computer becomes the property of the consumer. The intent is to minimize the up-front payment in developing countries, and instead charge such consumers some amount up front, and then the remaining over time. Similarly, Intel launched the “Community PC” in March 2008. This machine is targeted at rural Indians, who can share a machine or might want to share it with others in the family and community. The PC costs about $550, has a filter to keep out the dust, can run on a car battery during blackouts, and has a single-button recovery system in the event of a crash. At the same time, Intel introduced a $250–$350 miniaturized desktop, and Mexican officials have already ordered 400,000 of these for delivery.

Similarly, the notion of core competence is the paradigmatic version of the metathought that one should do a few things well and become better at those over time. The core competence label becomes the carrier of the metathought and provides face validity to it. The converse is the paradigm of diversification, which carries the message that it is unwise to put all of one’s eggs in one basket. And finally, the customer equity paradigm is the carrier of the metathought that a customer should be valued in terms of the future discounted cash flow that it is able to generate for the firm. Consequently, a firm should divert greater incremental resources to those customers who are more profitable and away from those who are not.

Models: Detailing the Paradigm

The acceptance of a paradigm often leads to models that delineate the process by which the paradigm is implemented and tested (Figure 4.1). For example, the customer equity paradigm has generated a number of models in both the conceptual and empirical domains. These models serve several interrelated purposes. First, they help finesse the key constructs that are central to the paradigm. They also help define what customer equity really means and what it does not. And finally, they also help separate the paradigm from those that are seemingly closely related with it, such as the customer loyalty paradigm or the brand equity paradigm.

Models also help answer questions that establish the domain or the outer bounds of the paradigm. For example, they will help delineate whether the notion of customer equity relates to only the current customers of the firm or extends to future potential customers as well. Does it focus on the current portfolio of products or take into account product additions and deletions as well? How does one use data to estimate the value of equity and then incorporate it into strategic decisions? Can the construct help answer strategic decisions at a firm level or tactical decisions at a product-market level?

Finally, conceptual models are translated into quantitative or statistical models. These translations help in developing a measurement system for sizing up the key constructs embedded in the paradigm. In addition, they help in identifying the upstream antecedents of these constructs and establish a system for measuring their downstream impact. To that extent, these models facilitate the translation of the paradigm into a form that can be implemented with data and help establish a system to evaluate the goodness of the implementation.

Initial Evidence: The Proof of the Pudding

Initial evidence that is consistent with their basic tenets is critical for the survival of new paradigms (Figure 4.1). This evidence could be qualitative and anecdotal or quantitative and statistical. For example, the early support could come from case studies that show in very general terms that following the paradigm led to superior business results. For instance, Cirque du Soleil is often cited as an example of an organization that witnessed tremendous growth using the Blue Ocean Strategy. Blue Ocean here refers to untapped market space with the potential for high and profitable growth. In contrast, Red Oceans describe marketplaces with intense competition. What Cirque du Soleil did was not compete against established competitors, such as Ringling Brothers and Barnum and Bailey, for market share of the kids’ audience, which was already drawn to other forms of digital entertainment. Instead of winning customers from the already declining circus industry, it created a new market space that made the competition irrelevant. It appealed to a very new demographic comprising adults and corporate clients that were willing to pay much higher prices for a great entertainment experience. Compelling initial evidence, such as this, provides the required face validity for a paradigm and helps generate broad-based support.

Replication: It Works Every Time

Once the initial evidence is in place, there is an urge among many to adopt the paradigm. In some cases, the replication might be successful while in others it might not be. However, stories of successful replications start coming forth and bolster the case for the paradigm. The collection of positive implementations becomes a resounding endorsement, and the paradigm is seen as more than just a temporary success. The failures to replicate tend not to become equally powerful stories and do not get an equal share of voice. Consequently, the landscape becomes dotted with stories of success, and the paradigm is thought to be more generalizable that what it actually might be.

Embrace: The Herding Begins

Once the stories of successful replication surface, the rush to adoption begins. Suddenly everyone wants to be either customer centric or relationship oriented. Along the same lines, some limited success stories associated with the “net promoter score” as a metric of customer centricity has led to an adoption of the same, without verification of the tenets of the approach and its applicability to the industry, the company, or the research objectives. Many rush to find blue oceans or to serve the bottom of the pyramid, after successful case studies such as Cirque du Soleil discussed earlier. Others converge toward building an employee-centered culture or serve the customers with the greatest lifetime values or with the greatest cost efficiency. For example, Comfort Inn and Motel 6 have positioned themselves as low-cost alternatives to other hospitality brands such as Holiday Inn and Ramada Inn. Enterprise Rent-a-Car is a low-cost alternative to Hertz and Avis. Similarly, on the other end of the spectrum of the hospitality industry, hotel brands such as Marriott and Ritz Carlton take pride in their employee-centric cultures. At Ritz, the corporate motto is “We are ladies and gentlemen serving ladies and gentlemen,” and these organizations place great emphasis on employee welfare and engagement, and in turn, provide great customer experiences. Still others want to rationalize their brand portfolios and build the highest possible brand equity. There is, of course, nothing wrong in following any of these approaches and each has its own merit. However, once a group of players herds toward the same strategic mind-set, it tends to follow and mimic each other’s approaches and converges toward the same playbook. However, more importantly, while operating within a given strategic paradigm, the entire group suppresses the need for verifying the extent to which it is applicable to its own unique set of circumstances, and misses the opportunity to discover better and more appropriate pathways toward profitable business performance.

Entrenchment: Blocking the Exits

Not surprisingly, herding ultimately leads to strategic entrenchment (Figure 4.1). Organizations become “psychologically” wedded to the paradigm and accept it as one of the few truisms that guide their fate. Executives from many firms have shared such stories in the past. Employees at Nordstrom often cite an instance where the sales representative took back a customer’s 2-year-old blouse with no questions asked. Likewise, a frequently told story at UPS tells of an employee who, without authorization, ordered an extra Boeing 737 to ensure timely delivery of a load of Christmas packages that had been left behind in the holiday rush. As the story goes, instead of punishing the employee, UPS rewarded his initiative to manifest company support and commitment to worker empowerment and customer service. Similarly, Averitt Express uses the slogan “Our driving force is people” to communicate its commitment to treating employees and customers well. Google is wedded to the idea of bottom-up idea generation and strongly encourages employees at all levels of the organization to bring forth their ideas. This process is facilitated by an “ideas mailing list” that allows all employees to post their idea proposals. Such ideas are then short-listed for further review and development. 3M is known for its innovative ideas and emphasis on intrapreneurship, that is, entrepreneurship within the organization. The organizational structure at 3M is such that central research and development (R&D) researchers find and collaborate with business units that best understand the market for a new product. Executives at 3M have realized that once scientists are able to get their products from the lab to the market, they get hooked on the process. The R&D function is consequently streamlined for researchers excited about commercializing their research. This has led to a significant reduction in the product development life cycle as well as more efficient R&D spending that has churned out some of the most exciting new products within the world of nanotechnology, such as ultrabright cell phone displays, natural-looking dental fillings, and superconductive power cables.

As is obvious from such anecdotes, entrenchment is not without its benefits. It helps spread a core operating principle throughout the organization and serves as a control mechanism. For example, if an organization is wedded to customer satisfaction, then the entrenchment of the paradigm ensures that most, if not all, employees behave in a manner that is consistent with satisfying the customer. On the other hand, if an organization is wedded to an entrepreneurship culture, then it promotes such behavior among its employees, and the reward systems evolve to compensate them for exhibiting risk-taking behavior.

Entrenchment also serves to stabilize organizations and helps them find a course and stay the course for an extended period. For example, if an organization is built around the innovation paradigm, it is likely to continue on a path of producing novel products, services, or technologies for an extended period and not waver from that path every now and then. It also helps organizations weather storms that come from failures along the way. In the absence of entrenched paradigms, organizations may be changing course at a rate that might not be in their best long-term interest.

However, entrenchment closes doors to discovery and suppresses the emergence of alternative pathways to progress and performance. Sometimes the entrenchment is embedded inside what may be called the culture of the organization and deviations from it are either rare or not encouraged. One very often cited example is that of Apple, which today is arguably the most innovative company in its industry but for a long period was not the most financially successful. During this period of Apple’s history, skeptics had questioned if creation for the sake of creation is short sighted. However, innovation benefits an organization only if it generates cash to cover the cost of innovations and to reward the shareholders. For example, analysts often argue that Apple’s decision to not license its operating system in the 1970s precluded it from capturing a large share of the home PC market in its early years. The same analysts argued that Apple could have corrected the situation by capitalizing on its early lead in the $12 billion education market for PCs, which might have gotten Apple another way to enter the home PC market. Instead, Apple failed to develop an aggressive sales force, ceding its position to competitors, including some lesser known brand names such as Acer and Legend, both of which specialized in manufacturing clones of more popular PCs at the lowest possible cost. Industry observers believed that Apple focused on developing “cool” products, without an adequate emphasis on profit generation. As a result, as soon as Apple got a new product to the market, it was ready to work on the next big invention, leaving the monotony of sales and strategic partnerships to competitors. For a long time, its infatuation with R&D did not necessarily translate into equivalent business success.¹ In more recent product introductions however, such as the iPod, the iPhone, and the iPad, Apple has had more business success by paying attention to the downstream commercial aspects of these innovative offerings.

The Strategy Prison Forms: Bounded Thinking

We use the term “strategy prison” as a metaphor to represent the outer boundaries that individual managers or organizations as a whole build around their belief system. The prison affects their world view and strongly influences their perception of what works in their business and what does not. As they become trapped in the prison, they tend to follow the norms that are consistent with it and ignore or at least suppress ideas and processes that are contrarian to it.

One of the reasons why managers and executives end up in strategy prisons is because they fail to ask the right questions of their mental models, such as those asked in the previous chapter, and challenge the applicability of these models to all situations and under all circumstances. As a result, these models become an integral part of their strategic intuition and guide their decisions across a wide range of domains over extended periods. Ultimately, these executives get wedded to their mental models, claim public belief in them in front of external and internal stakeholders, and discount all reasonable challenges to them.

Being inside a strategy prison has several consequences. The first is structural in that an entrenchment within a belief system tends to limit the number of levers that the organization pulls or is willing to pull in order to move the business forward and take it to new heights. This is especially evident when the organization runs into serious headwinds. The response to a set of adverse circumstances is constructed using the same limited set of levers that the organization uses on a routine basis. Time after time, we find that when faced with adverse circumstances, cost cutting is an often resorted approach for overcoming the hurdles being faced by the organization. Often times, there is little or no consideration of the longer term impacts of such cost-cutting measures, some of which might be counter to organizational success.

The second consequence of being trapped in a strategy prison is that entrenchment defines the personality or the collective psychology of an organization. The levers that are pulled by the senior leadership tend to dictate internal processes and result in an alignment of the people within the organization along the direction in which the levers are pulled. For example, an organization that is efficiency driven will tend to promote cost consciousness at all levels and across all functional domains. On the other hand, a customer satisfaction–driven organization might lead to a service mind-set among its people. The net result is that it is not just the executive leadership or the senior management that is trapped inside its strategy prison; the rest of the organization is held captive as well.

The third consequence is that the performance measurement system, whether at the individual level or the organizational level, converges toward the current paradigm under which the organization operates. While it appears that this should always be the case, the systems become rigid as the organization becomes entrenched in the paradigm. The rigidity reduces the flexibility to discover new strategic options and at best allows the organization to optimize locally around its current practices. And more importantly, the rigidity tends to obviate the need to continuously verify whether the paradigm is indeed driving the financial results or the bottom line of the organization. As a result, even if the organization has the information and the data to test the continuing applicability of the paradigm to their business, it tends not to do it. A very common example that we have discovered has been the euphoria associated with improvements in customer satisfaction and loyalty scores, typically reported by customers in surveys sponsored by various organizations to gauge their level of health in the marketplace. While an improvement in these scores seems an appropriate aspiration, it often leads to adverse outcomes. For example, if the most profitable customers of the firm, who are often the ones with the highest expectations and therefore likely to be least satisfied, exit and are no longer required to take satisfaction surveys, the satisfaction scores may go up at the expense of profitability. Thus the firm could be lauding itself for eroding its profitability, without ever recognizing it, even though it might very well have the data to investigate this detrimental relationship.

In the next few chapters, we will outline how a flexible, data-driven, verification-based mind-set provides an escape route from the strategy prison and has the potential to enable organizations to discover new pathways toward their strategic goals. We will also describe a methodology called linkage analysis that is a powerful tool to discover the causal and structural relationships between the levers that an organization pulls and the results that it ultimately receives. Our belief is that an adoption of the linkage mind-set and the methodology will help most organizations better channel their resources and discover new possibilities toward attaining superior, long-term profitability.