New Video: Books@Baker Interview with Felix Oberholzer-Gee
Some companies gain advantage by commanding premium prices. Others lean on their world-class talent. But, a small slice of companies manages to do both—and dramatically outperform peers.
What sets these top businesses apart? It’s simple: They create the most value, says Harvard Business School Professor Felix Oberholzer-Gee.
In almost every segment of the economy, the very best companies lead their peers by wide margins. They take share by building on proven ideas and expanding in markets they know. Equally important, they eschew efforts—even bold, cutting-edge proposals—that are unlikely to generate value for customers, employees, or suppliers.
“Companies that raise customer willingness to pay in a distinctive manner attract the very customers that find the firm’s products and services extra appealing,” says Oberholzer-Gee, the Andreas Andresen Professor of Business Administration. “No wonder these businesses end up receiving rave reviews and loyal customers.”
If a US company that ranked 50th today jumped to 40th next year, its return on invested capital would increase by 21 percent.
Fortunately, most companies have the potential to create more value and increase their profits. Even modest advances can have dramatic implications.
“If a US company that ranked 50th today jumped to 40th next year, its return on invested capital (ROIC) would increase by 21 percent,” he says. “If a Chinese firm improved in this way, its ROIC would grow by 16 percent.”
Oberholzer-Gee elaborates on his approach to strategic decision-making in his new book Better, Simpler Strategy: A Value-Based Guide to Exceptional Performance, which comes out April 20. We recently sat down with him to discuss the importance of creating value.
Danielle Kost: What is different about the companies that put value at the center of their strategy?
Felix Oberholzer-Gee: I admire how disciplined they are. Every company that I studied for the book has many talented individuals with interesting-sounding ideas. There are dozens and dozens of proposals for projects. Value-based strategy teaches how to select among these ideas and projects. The most successful firms are very strict: Unless an idea creates value for customers, employees, or suppliers, they do not touch it. It might be fun to do. It might be interesting to explore, but it's not going to create the kind of value that ultimately gets translated into financial success.
Kost: In the first line of your book, you say that strategy is simple. Why is that such a provocative statement?
Oberholzer-Gee: Because no one experiences strategic decision-making as simple. The frameworks are complicated. The processes that companies install to develop their strategy are highly complex, hundreds of slides, dozens of analyses, many competing frameworks and considerations. I meet many managers who see strategic thinking as reserved for the most senior, most experienced executives.
One of the key messages in the book is that strategy is not complicated. There are only three levers: value for customers, value for employees, and value for suppliers.
It is even true in our own executive education courses. There's often this sense among younger participants that you need significant experience—gray hair and wrinkles—to think strategically. So one of the key messages in the book is that strategy is not complicated. There are only three levers: value for customers, value for employees, and value for suppliers. And the book shows how to operate these three levers. Conceptually, strategy could not be simpler. Once you start thinking about how to create value—that’s when it gets interesting. We get to be endlessly imaginative. Strategy poses little challenge for our conceptual thinking. But it presents the most exciting of challenges for our creative abilities.
Kost: How do you think value-based strategy differs from conventional approaches?
Oberholzer-Gee: I would emphasize three differences. First, we often think of strategy as answering two questions: Where do we play? How do we win? Many strategists consider the first question pre-eminent. I show in the book that for most companies, the best opportunities sit right in their industry, close to home.
Second, conventional strategic thinking teaches that companies can easily get “stuck in the middle,” with no discernible competitive advantage, unless they choose one of a limited number of strategic options such as cost leadership, differentiation, or focus. But the book is full of examples of companies that have dual and even triple advantages. The have an advantage in attracting talent and they charge customers a premium price. In fact, it is precisely because they create value for employees that they are then able to better serve their customers. This is particularly true in service industries.
A third difference is that I emphasize the strategic value of operational effectiveness. Traditionally, we did not make much of running your company effectively because, well, isn’t this what everybody does? My colleague Professor Raffaella Sadun has wonderful research that shows just how slowly even key managerial practices diffuse. All of a sudden, being a good manager confers a lasting competitive advantage.
Kost: You end the book by talking about the value that companies can create for society. Why should executives consider these issues as part of their strategy discussions?
Oberholzer-Gee: Unless you've been hiding in a faraway castle, you know that business doesn't have the best reputation today. About half the people believe that capitalism, as it exists today, does more harm than good. One reason is that many companies are preoccupied and enamored by value capture—how to make money. They think about how to capture value before they think about how to create value.
If we want to restore faith in the business community, value creation needs to be our first consideration.
Imagine a full airplane, most passengers will have paid a different price (and fees!). That’s great for the airline, but it is all just value capture, there is zero value created through the price discrimination. McKinsey’s work in the opioid crisis is an example of this value-capture mindset, a view that pays little attention to the well-being of society overall. The vitamin cartel provides another.
Compare this type of thinking to initiatives that are designed to create value. You might remember when Nike built a training center in Sri Lanka to get its suppliers to adopt Toyota-type production methods. That is true value creation. Both the margins of Nike and the margins of the suppliers expanded.
If we want to restore faith in the business community, value creation needs to be our first consideration. And it is more profitable, too. Value capture is zero sum, and the losing party will push back, limiting the financial upside. If you create value, no one pushes back.
About the Author
Danielle Kost is the editor-in-chief of Harvard Business School Working Knowledge.
[Image: iStockphoto/JamesBrey]
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Book Excerpt## Think Value, Not Profit
By Felix Oberholzer-Gee
There are few better places to observe value creation than outside the entrance of an Apple store. Watch customers as they exit with their elegant, beautifully packaged devices in hand. Sure, they paid a hefty price for the superb design, but just look at their faces, beaming with pride and anticipation! Or online, head over to Facebook and Instagram, where you will see other instances of value creation. Look at the pictures and videos your friends post when they receive a coveted job offer or earn a promotion. Happy faces again.
Apple competes at the top of the value stick by raising customer willingness- to-pay (WTP). Companies that offer exceptionally engaging work create value by lowering willingness-to- sell (WTS) (see figure 1).
Think of WTP and WTS as walk-away points. WTP is the maximum a customer would ever pay for a product. Charge one cent more, and the customer is better off walking away from the transaction. As the Apple example illustrates, many factors enter into WTP, including product attributes, quality, and the prestige a product might confer. At the bottom of the value stick, employee WTS is the lowest compensation a person is willing to accept for performing a particular type of work. Pay an employee less than his WTS, and he will walk away from the job.
As with WTP, many concerns flow into WTS. They include the nature of the work and its intensity as well as career concerns, social considerations, and the attractiveness of other job opportunities.
Value Capture
Companies create value by increasing WTP and decreasing WTS. They capture value by setting prices and compensation. The overall value that a business creates gets divided three ways (see figure 2).
The difference between WTP and price is value for the customer. Apple’s products may be expensive, but customer appreciation for the devices is even higher. The happy faces at the Apple store mirror the degree to which WTP exceeds the price. In value- based thinking, price is not a determining factor of WTP. We often use WTP and price inter-changeably. But it is useful to keep them separate.
At the lower end of the value stick, the difference between an employee’s compensation and her WTS is the satisfaction that she derives from work.
The idea is simple. If compensation were set exactly at WTS, she would be indifferent between work and her next best opportunity—perhaps another job, perhaps leisure. If the firm pays more than WTS, employee satisfaction increases. A similar logic applies to suppliers. Their share of value is the difference between how much they get paid by the firm (the firm’s cost) and their WTS. Think of it as a surplus that the suppliers earn from the trans-action. For example, a supplier might want to earn a minimum margin of 25 percent. This margin determines his WTS, the minimum price that he will accept. If the firm ends up paying more, the supplier earns a surplus.
The final portion of value—the difference between price and cost—accrues to the firm. Think back to chapter 2 and the dramatic differences in profitability that we observed. If we want to understand why some companies are much more profitable than others, a useful starting point is to identify the reasons why the middle section of the value stick—the firm’s margins—is slim for some companies and fat for others.
Value sticks are drawn for specific products and specific customers, employees, and suppliers. The WTP for Apple devices tends to be high for customers who adore sleek design and appreciate ease of use. Apple has a distinct advantage with this group: it can charge high prices and create significant customer delight at one and the same time. Apple also enjoys advantages with some of its suppliers. For example, shop-ping malls give Apple a special break. The company pays no more than 2 percent of its sales per square foot in rent, compared with 15 percent for a typical tenant.
Why are mall owners so generous to Apple? As figure 3 illustrates, malls have a particularly low WTS in their relationship with Apple; this is because the company increases foot traffic by about 10 percent for all the other stores in the mall. And, as the figure suggests, a busier mall allows owners to increase the rent for all the other stores to about 15 percent of sales.
Value sticks illustrate that there are only two avenues for companies to create value: increase WTP or decrease WTS. Every strategic initiative needs to be evaluated against these two metrics. Unless an activity increases WTP or decreases WTS, it will not contribute to the firm’s competitive standing. When I visit companies, I am always impressed by the myriad of activities I observe. At the same time, I often find myself at a loss to see how certain initiatives will help increase WTP or decrease WTS. If your organization feels overburdened, if you feel unreasonably stretched, here is your chance to cut back. Unless an initiative promises to increase WTP or decrease WTS, it is not worth pursuing.
Reprinted by permission of Harvard Business Review Press. Excerpted from Better, Simpler Strategy by Felix Oberholzer-Gee. Copyright 2021 Harvard Business School Publishing Corporation. All rights reserved.
