Your winning strategy has three vital components (see diagram below):
- A Target Customer with a specific problem.
- A Unique Value Proposition that solves their problem and delivers superior value relative to the competition.
- A Core Capabilities System that consistently delivers your unique proposition and is also hard for would-be competitors to replicate.
A winning business strategy must produce a return on capital that is greater than the cost of capital. From a valuation perspective, this translates into a business value that is higher than the cost of replicating your operating assets (tangible and intangible).
Why do you need a System of Capabilities?
Companies have resources (the inputs) that can be combined to create capabilities (the outputs). Examples of capabilities are innovation, brand building, time to market, customer service etc. Capabilities usually draw from multiple functions and are a mixture of people, process, technology, organisational capital etc.
Unique capabilities are hard to build as they have to deliver an outcome that reliably contributes to your unique proposition. Hence, companies typically only have a handful of genuinely unique ones. Capabilities are not best practices or “me too” practices where the benefits rapidly erode as they become an industry standard.
A well-designed capabilities system is hard to replicate
A competitive advantage built on one capability is likely to be fleeting as potential competitors will find a way to copy it. There are exceptions such as patents, but even patents have finite lives.
However, it is tough to copy a system of unique capabilities where every capability supports, reinforces and magnifies each other capability.
A winning strategy will have incorporated trade-offs which creates a moat around your business as would-be competitors will wreck their own capabilities systems if they try and copy yours.
An excellent example of this in practice is the low-cost, no-frills, point to point airlines. They entered the market with a new operating model and unique capabilities system compared to the full-service carriers. Once the incumbent airlines saw the traction these new entrants were getting, they tried to copy them but failed miserably (see examples below).
Southwest Airlines, a company we have been looking at in this series, is a low-cost US airline that has consistently outperformed its rivals. What is most amazing is that Southwest’s capability system has been well documented and is known in detail by all the full-service airline CEOs. Yet for decades, no full-service airline has been able to copy Southwest successfully.
Good strategy is a game-changer
Southwest had a unique positioning and incumbent airlines were left with the choice of either repositioning entirely or adding the new low-cost position to their existing routes and adjusting their business model. They opted for the latter and tried to run two unique strategic positions simultaneously, which in the language of strategy is aptly called Straddling.
A Straddling Strategy usually ends badly
Continental, a full-service US airline, set up Continental Lite in 1993 and copied more than half of Southwests’ capability system. The outcome was disastrous. Continental folded in 1995 as it lost hundreds of millions of dollars after it effectively started a price war; a terrible idea if you are not the low-cost provider. Trying to copy Southwest wreaked havoc in the core Continental business as it confused existing customers and layered on costs due to misalignment of the business.
The problem was not specific to Continental. United Airlines set up a low-cost subsidiary called Ted, Delta Airlines set up a subsidiary called Song, but both also failed. In Europe, KLM set up the low-cost subsidiary called Buzz and British Airways set up Go, both failed.
None of the full-service low-cost airline subsidiaries took-off because it is extremely difficult to run two sets of unique capability systems within the same organisation.
This fact is a big win for business strategy. It is also a big win for SMEs scaling in a niche as large firms can copy over half your capability system and only receive a fraction of the benefits, or worse, outright losses.
Unfortunately, less than 1 in 20 SMEs in the UK have a documented strategy, and therefore risk seeing and seizing these opportunities.
Why does your Unique Capability System drive your Business Valuation?
Your business will attract attention once it uncovers a profitable niche. Without barriers to entry, your party will be raided by would-be competitors who squash your niche’s return on capital.
Thankfully, a well-designed core capabilities system will keep the party going for a long time!
Competitors trying to muscle in on your niche have three choices (investors have the first two choices):
- Buy your company
- Replicate your company from scratch
- Adjust their company capabilities system
As was the case for full-service airlines, it can be extremely difficult to replicate a winning strategy that is underpinned by a unique core capabilities system.
If competitors and investors are effectively locked out of your niche by your capabilities system, then you can earn excess returns, or you can sell the company for a boosted valuation premium!
Key Takeaways
If you design a unique capabilities system that is hard to replicate and delivers superior value to customers relative to the competition, you will be rewarded by:
- A high business valuation or exit value relative to the industry
- Excess returns and cash flow relative to the industry
- Growth that delivers excess cash flow and increases your business value
Proctor and Gamble (P&G) and Southwest Airlines are excellent examples of how companies that translate their strategy into a system of hard to replicate capabilities will be rewarded by above-average returns and high business valuations. These are not anomalies and the same holds for companies like Inditex, Ikea, Starbucks, ASML, WD-40, MTU Aero Engines etc.
For brevity, in this blog, we illustrate the point with two powerful infographics and charts for P&G and Southwest Airlines that show their:
- Unique Capability System
- Long-term stock price progression
Proctor & Gamble Unique Capabilities System
Proctor & Gamble Stock Price (source: Macro Trends)
Southwest Airlines Unique Capabilities System
Log Chart of Southwest Airlines Stock Price (source: Macro Trends)
More importantly, we can help you to design a winning strategy that can help you to make it happen for your company also.
In our workshops, we spend time analysing the specifics of how your company’s strategy, operations and valuation are tied together. We identify the critical capabilities to build and how to integrate them into a system that helps you to build, scale, increase profits and boost business value (exit value).
In an upcoming series of blogs, we will connect IVC’s Strategy Blueprint© to our Valuation Blueprint© and show in detail how a winning strategy will boost your business value and exit value.
By Hugh Page
MD Integrated Value Consulting (IVC)
- IVC is a Business Advisory Firm enabling SMEs and investor-backed Startups to Build, Scale and Sell a Valuable Business at a premium
- We Demystify Strategy & Valuation to Increase Business & Exit Value and Attract & Wow investors for Debt / Equity Raises, Acquisitions & Exits
Take our Valuable Business Builder© Scorecard: get insights to maximise your business & exit value, for free.
For more details see www.ivconsulting.co.uk
Index of this 6 Part Blog Series
- Blog 1: Overview
- Blog 2: Mission Statement
- Blog 3: Target Customer
- Blog 4: Unique Value Proposition
- Blog 5: Core Capabilities System
- Blog 6: Measurement System
This 6-Part series is designed to add value on its own. To go faster, deeper, overcome inevitable obstacles and take your business to the next level, please schedule a call to see how we can help.
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