Sunday, February 4, 2018

Bradley, Hirt, & Smit, Strategy Beyond the Hockey Stick

Three McKinsey partners—Chris Bradley, Martin Hirt, and Sven Smit—teamed up to write Strategy Beyond the Hockey Stick: People, Probabilities, and Big Moves to Beat the Odds (Wiley, 2018). Although it’s a business book, it’s replete with insights for the investor.

The book’s organizing graphic is the power curve, which is divided into three sections: the bottom quintile (a steep curve down), the middle three quintiles (basically a straight line), and the top quintile (a steep curve up). The majority of businesses, those in the middle three quintiles, make almost no profit. In power law fashion, value accrues exponentially to the top quintile. The challenge for businesses on the flat line is how to make it to the top quintile. By definition, of course, few ever succeed. We don’t live in Lake Wobegon, and, even there, “above average” doesn’t mean extraordinary success.

Market forces are pretty efficient, with profits tending toward zero over time because they get competed away, but markets aren’t perfect, so profits are possible. As they are in the financial markets. Just ask companies like Apple or investors like Warren Buffett.

The role of industry in a company’s position on the power curve is so substantial that you’d rather be an average company in a great industry than a great company in an average industry. Once again, we see an obvious parallel to investing. It’s a lot easier to make money on investments in companies in leading sectors than in lagging sectors.

A metaphor that I especially liked was that of corporate peanut butter. The authors argue that spreading resources thinly, like peanut butter on bread, across all parts of the business almost guarantees that you won’t make a big enough move to get to the top of the power curve. Similarly, a broad diversification of investable assets may be the closest thing to a free lunch in the investment world, but a free lunch isn’t usually such a great perk. (Especially if it’s a peanut butter sandwich.)

The authors recommend thinking in terms of pot odds. They explain that if you have only a slim chance of winning but the bet costs you little and the potential payoff is huge, that might be an investment worth making. And, conversely, an expensive investment that generates a high probability of a small success may be a bad idea. It may be like picking up pennies in front of a steamroller.

Among the eight shifts that the authors suggest to a business that wants to move up the power curve are, echoing the points above, that it should stop spreading peanut butter and start picking its 1-in-10s. And it should shift from long-range planning to forcing the first step.

Strategy Beyond the Hockey Stick is a thoughtful, pragmatic guide to outsize business success, with models grounded in hard data. I found it surprisingly engrossing and read it in one sitting. As a bonus, it has some great cartoons.

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