Best Practice Doesn't Equal Best Strategy

Best practice. It may be the most readily recognized and widely used of all business management tools. And why shouldn't it be? To executives, modeling a company's performance on its best-in-class competitor is an ambitious but attainable aspiration. To investors, the strategy is a guarantee of the soundness of any company that embraces it. And to consultants, it is the tide that lifts every client's boat.

So why is it killing your margins? Everyone who follows business has seen the fat margins of growing young companies attract scores of new entrants, which eventually crowd the field and drive those very margins down. Why would top executives convert this regrettable fact of business life into a creed, especially when doing so simply hastens the endgame for everyone—first mover and Johnny-come-lately alike?

They act as they do because they don't understand that benchmarking is simply an operational tool. Instead, they all want to occupy the point on the strategic landscape that their most successful competitor has staked out. (See Eric D. Beinhocker, "On the Origin of Strategies", The McKinsey Quarterly, 1999 Number 4, pp. 38-45.) Soon other competitors can be seen herding, lemminglike, around that best-practice company's product, pricing, and channel strategies. Products and services become increasingly commoditized, and margins tumble as more and more incumbent companies compete for smaller and smaller segments of customers and industry resources.

Alarmingly, strategic herding appears to be in vogue in some of the most dynamic industries of the new information economy. A close look at the behavior of wireless telecommunications service providers in Germany indicates that strategic convergence by itself accounted for a 50 percent decline in margins from 1993 to 1998. Strategic herding also appears to be rampant in the manufacture of computers and consumer electronics goods and in the Internet strategies of many companies.

The Herding Instinct
Best-practice benchmarking—the measurement and implementation of the most successful operational standard or strategy available in an industry—can be one of the most effective tools for increasing a corporation's efficiency, productivity, and, ultimately, earnings. To see the benefits such benchmarking can yield, you need look no further than the US automobile industry, which transformed itself during the 1980s by adopting Japanese manufacturing techniques. More recently, Ericsson and Motorola copied the Finnish cell phone maker Nokia's use of the same phone chassis across different technologies to achieve economies of scale in design and production.

Broadly speaking, strategic decision making occurs along three dimensions: product characteristics, price, and market opportunity. When a company enters a new market, management's choices are restricted to the first two dimensions; the third element, market opportunity, consists of consumer preferences and income, which are beyond a company's ability to influence directly. (Strategic differentiation is more than simple product differentiation. In the early 1990s, Apple's computers were more distinctive than Dell's, but Dell became the more successful company because its approach to channel management was more innovative and it was continually reniventing its strategy. In addition, few customers wanted to purchase computers, however well designed or distinctive, that had a shrinking software base.)

Management's overriding goal is to position a company and its products where the market opportunity is highest. The more consumers who are located in a specific region of the strategic landscape, or the higher their disposable incomes, the higher this particular peak will rise (Exhibit 1). Especially in newer industries, the task of finding market opportunities is complicated by a lack of information about the willingness of consumers to spend, the exact distribution of their preferences, and other characteristics of the strategic landscape. Management really knows only its own company's location and earnings, and those of its competitors insofar as they make this information public. Even then, the information doesn't fill out the entire landscape.

The payoff a company receives for occupying any part of the landscape depend on the height of the point it occupies and on the number of companies operating nearby. A single firm operating at a particular peak receives all of the local market value. If a number of companies operate within a region, the market value or resources must be shared. The more companies that are located in a single region, the lower the payoff for each.

Tracking the Herd
This herding instinct first manifests itself in the corporate search for profit peaks. To improve earnings, laggard companies typically benchmark their performance against the best practitioners and migrate closer to them. The laggards do so by mimicking competitors' product offerings, matching advertising and spending targets, using the same sales channels, and offering the same services. The migration continues as long as one of the companies earns higher returns than any of the rest.

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