Strategy’s Most Dangerous Dogma - And What To Do About It Evan M. Dudik

1. Strategy’s Most Dangerous Dogma - And What To Do About It Evan M. Dudik Evan M. Dudik and Associates, Inc.

2. What are Strategy’s Basic Building Blocks? First Class Corporate Strategy Verified Theories about Markets and Competitors Sustainable Competitive Advantage Concept Needed Resources Cultural and Organizational Alignment Other Factors

3. Create doubt in your mind about Verified Theories as the Foundation of Strategy Propose an Alternative Mind-Set for developing Strategies Gain some Feedback on these Ideas Purpose of Today’s Discussion

4. “Our cell phone market research shows that 23% of the market would pay a 12% premium for wireless email capability.” “In our industry you get superior returns if you are # 1 or #2.” “Our database of the past 25 years and 2 million transactions shows 95% of the time that the yields of interest-bearing bonds converge within 30 days.” “New products are more profitable than old ones. Our strategy is to have 80% of our sales from products that are less than 5 years old.” 1. Examples of Verified Theories

5. Conclusions based on observation of data (“fact-based”) Synthesizes recognizable patterns Is expressed mathematically Has a track record of predictive success What more could you want? 1. Ideas Behind Verified Theories

6. How Philosophers of Science Look at Drawing Conclusions from Data: Example 1: Raw Data

7. Example 1 continued

8. Example 1 continued

9. Useful Beautiful Consistent Memorable Basis for Prediction Hundreds of “confirming” examples No basis in reality Observations from Example 1

10. Example 2: Danger of "The First Right Answer"

11. Example 3: Power of Past Experience

12. Example 4: Power of Context

13. Provides checks for internal consistency Statistics can measure variations due to chance Strong associations suggest causality Makes for persuasive presentations Will Mathematics Save Us From Misleading Inferences?

14. Example 5: Using Mathematical Models Demand Higher than average Lower than average Linear Regression LowIncomeHigh

15. Example 5: Context Makes Sense School Test Performance Higher than average Lower than average Linear Regression LowIncomeHigh

16. Example 5: Ignore Outliers? School Test Performance Higher than average Lower than average Linear Regression LowIncomeHigh

17. In particular, at Mt. Tabor and other high-performing schools: Scheduled routine teacher conferences with principal during regular working hours Implemented new teacher mentoring system Dug into the test data: teachers, students, course items Identified specific weak spots: e.g. understanding science texts literally, not just high-energy teaching Started homework clubs, extra work for those above grade level Created schools-within-schools (Bill & Melinda Gates Foundation Lessons from the Outliers:Due to Chance?

18. Major discoveries and investigations due to examining the outliers: AIDS—the 2% of women who got HIV but never developed AIDS Discovery of H. Pylori—bacteria causing 80% of ulcers School teacher incentives encourage cheating: data in test scores where answers are same 220-Age = Maximum heart-rate: Bogus Discovery that extra-solar system planets may be stars Lessons from the Outliers:Outliers: Crucial in Science

19. Dot-com mania: A few, highly imitated business models, e.g. advertising-based; disintermediation-based; auction-based “Be #1 or #2 in every market you compete in”—repudiated 6 years ago in secret Learning curve-based strategies And now…Sustainable competitive advantage-based strategies Business Strategies Not Immune to Astrological Thinking Verification Mania

20. If any business runs on statistics, it’s insurance. Yet: Merrill Lynch: Limiting health care costs by expanding benefits Spells the end of managed care as we know it Anybody listening? Progressive Insurance: auto insurance paid by the mile instead of all-you-can drive Exploits “new” technology for a more precise matching of product to customer Business Strategies and Outliers

21. Outliers provoke good questions about causality Merrill Lynch: better ideas about causes of high health insurance claims Progressive: better ideas about causes of high auto insurance claims Outliers provoke good questions about mathematical models (summaries) of data Outliers provide suggestions about better ways to segment markets Merrill Lynch: companies with long-term employees and white collar jobs may be targets for highly interventionist medical insurance Progressive: Low-mileage, cost-sensitive drivers; highly congested areas. Business Strategies and Outliers:Lessons Learned

22. Difficult to separate facts from their interpretation: there are no “pure facts” Consultants to the contrary not withstanding Math can obscure the true structure of a phenomena Create patterns rather than show patterns (constellations) Obscure 3rd variables Often don’t handle extremes (quantum mechanics, light) Better for falsifying rather than confirming Patterns are rhetorically persuasive but poor strategic guides Patterns of others (e.g., GE, learning curve) Mathematical patterns (e.g. regressions) Challenging outliers is one method for pursuing the essence of a strategy Resting Data on Unshakeable Facts:Lessons Learned

23. No. Sir Karl Popper says: A theory cannot be proved right It can only be rendered so precise as to be tested until it fails. When it fails, it: Clarifies why it “passed” all prior tests Provides deeper insight into the phenomenon it is supposed to explain Points the direction to the next test Outliers are sometimes true anomalies outliers - but sometimes they illustrate where theory fails. Can We Rest Strategy on Verified Theories?

24. What Are Poorly Constructed Business Theories? • Vague/ General: • “Everything” confirms it, e.g.: • Being #1 or #2 • Our strategy is to focus on customer service • Our strategy is innovative products • Our competitive advantage is our people (knowledge base, philosophy of business, R&D, etc.) Metaphysical: Articles of faith that can’t be falsified: J&J Credo: mothers, employees, community, investors “We don’t test for AIDS because there is no AIDS in China.”

25. An hypothesis is a riskyIf…Then...Because statement that has guts enough to identify causality. The hypothesis must be specific: “If we increase store lighting by x lumens per square foot and widen aisles by y inches and employ greeters at $8.50/hours… “Then we can expect a sales increase of $x per square foot in the first 90 days $x + $y in the next 90 days in the a, b, and c departments… “Because x% more shoppers will be drawn to aisles in the A, B, and C departments and will spend y more minutes there” The hypothesis must be falsifiable: We increased the store lighting and employed the greeters We experienced a 5% per s.f. sales increase in departments A and B, but sales in C (auto supplies) were flat We experienced 6% more shoppers spending 1:39 minutes more in department A, 5.2% and 1:07 minutes in B; nothing different in C (auto supplies) Treat Strategies as Hypotheses Specific Enough to be Falsifiable:

26. Perhaps the lighting changes made gender specific differences (auto department vs. others). The greeter had no effect on sales The key to greater sales is getting shoppers to spend more time in the aisles And more… The Test of the Strategic Hypothesis Leads to New Insights and a New Hypothesis

27. Create competing hypotheses—and teams supporting each The proponents of each will do their best to falsify the opposing hypothesis CIA: “B” team created to falsify “A” team Gets rid of “my opinion is as good as your opinion” Pit consultants/strategic planning teams against one another Not (just) in the beauty contest Use market research for testing highly specific hypotheses—not fact-gathering Use math to falsify, not reveal patterns This Approach Suggests Practical Affects for the Strategic Planning Process

28. Conclusions About Strategic Theories “Keep looking around. There's always something you've missed.” - Australian Aviation Magazine • Don’t create strategies by looking for patterns in data—you’ll just see what you’ve already seen • Treat strategies as If—Then—Because Hypotheses • Make the strategic hypotheses testable and falsifiable • Create competing strategies and teams to defend them. • Understand the value of outliers. • Look for deeper layers of causality. “General relativity theory is ephemeral.” - Albert Einstein

29. Schools highly comparable on measures of income: Comparable percent of kids have taxpayer-provided lunches Comparable percent of parents college educated and no college Vastly different outcomes: Mt. Tabor had 77% vs. 64% reaching reading benchmark Mt. Tabor had 76% vs. 57% reaching math benchmark Over 1 grade level average difference Lessons From the Outliers:Different Outcomes

30. Interviews suggest a much deeper causality: Beaverton “Superintendent Yvonne Katz boasts that : "Our scores remain consistently higher than the state average." “A traditional collection of stories, each followed by a routine list of questions, got the nod over a series with more challenging literature and deeper questionsThe reason? The district's influx of novice teachers needed something easy to work with “Principal Nancy Bush-Lange says preparation for the test was uneven at feeder schools and Heritage needs more time to jell. “ "I'm proud of our kids, even though if you look at our (test) scores you'd say, 'Wow, I wouldn't send my kids there,' " Lessons from the Outliers:Due to Chance?

31. A Source for Confirming Data • “All hell” was to break loose in Miami in December 1990 and January 1992 due to alignment of earth sun and moon—and did. (Lots did happen—but not more than at other times). • Graphs prove homicides to peak at full moon (Only 3 of 48 tests showed any significant correlation). • Full moon peaks changed to “underlying semi-monthly rhythm.” (Just average adjacent data points) Voice of Authority