324. How strategy creates value: The four foundations that drive long-term performance

Just for the moment and the era we're in and the pace that needs to happen. Like, does moderate confidence in your strategy allow you to reallocate 30 of your resources towards a new market? Are you really sure that your moat's being defended? So it's not so much that people aren't doing it or don't have a sense of strategy. But is the conviction around that strategy strong enough to actually act, and for large companies to act at scale?

From McKinsey and Company, I'm Sean Brown, and welcome to Inside the Strategy Room. That was Andy West, co-author of the forthcoming book Strategy and Value, the four foundations that drive long-term performance. The new book, which we'll link to in the show notes, distills decades of McKinsey client work and research into a powerful integrated framework. It moves beyond short-term metrics and market noise to focus on what truly drives sustainable value. It also provides an essential roadmap for leaders seeking to navigate complexity and enable their teams to act with courage.

In this episode, Andy and his co-authors join us to step through the four essential foundations that link strategy and value creation. Andy is a senior partner based in our Boston office and co-leads our strategy and corporate finance practice globally. Tim Koller is a partner emeritus based in Denver and a founding member of our strategy and corporate finance practice, and he's also the co-author of the best-selling book Valuation, now in its eighth edition. And Whitney Zimmerman is a distinguished expert on strategy based in our London office.

Welcome everyone. So while we're here today to talk about the key messages from your book, obviously there's no lack of strategy books and frameworks that are already out there on the market. So, Andy, I was hoping maybe first you could talk about why you and your co-authors decided to write this book, and why now is such an important time to talk about this topic.

Yeah, thanks, Sean. It's a great question, and I think some of the answer lies in the question, the way you phrase the question itself, which is there's a lot of information out there. We're kind of living in a world of abundant information, so the more data, more synthesis, more frameworks, as you mentioned, than ever before. And on top of that, we're seeing a lot of change, right? That's happening in the world. There's real shifts as we kind of enter what we call McKinsey, new era, right?

Whether that's AI, technology, geopolitics, trade right dynamics, kind of customer channel dynamics, you know, and when we look at industry boundaries, we see that those are changing at a pace. And we'll share some of that data as we talk today. But we see, oh, there's change happening in the world. You think it's gonna be a bit of a golden era of strategy. I mean, now is the time to take advantage of these these pivots and these moments.

And yet, when I talk to executives, there's just a general sense of ineffectiveness around strategy overall. Whether it's just comments about the strategy process being broken, strategy in many cases is not happening, just tactics have taken over. Quarterly adjustment shifting, you know, project after project, uh, with a lack of of the end in mind is is happening, um, budgets being generally ineffective and too slow. Like you name it, people are are generally dissatisfied. And I think a lot of that empowerment that I talk about with abundant information is also making executives really reactive, whether it's boards or customers or, you know, employees, investors, everyone has more information.

And so we're this kind of constant cycle of being reactive. And one of the great things of of co-leading a practice at McKinsey is I get to sit and I get to think about these challenges and what do we want to do about it? And when I have these kinds of problems, I I usually call the smartest people I know. And in this case, it was Tim and Whitney and said, Are you seeing the same thing from from your vantage point?

And we basically said, Yeah, you know, and and as we talk about what do we do with this conundrum? We're saying, you know, we're really going back to the fundamentals. In most of our conversations, we're using all of this asymmetry and all of this information to enrich conversations about the fundamentals of decision making, as opposed to kind of throwing another log on the fire of complexity. So we thought, Hey, you know, there there might be something if the fact that the three of us are all having similar conversations, maybe there's a book in there somewhere, and here we are.

And Tim, as I mentioned, you've co-authored eight editions of Valuation across more than three decades. What excited you most about this new book?

I'm excited about the book because it it's a chance to bring together strategy and value creation topics that are often treated separately. One of the reasons I joined McKinsey 40 years ago was because I was working in a financial consulting firm and was frustrated that, you know, we're trying to answer questions without sort of dealing with the strategy issue. And and McKinsey really created an opportunity to do that, and that's what we can do with our clients.

And so the opportunity to actually document the linkages and and make it accessible to a a broad audience of how these things fit together is exciting to me. In the in the academic world, the strategy professors rarely talk to the finance professors, and so this is something that's not out there. So it's exciting to me to put something out there that, you know, really brings the two together and shows how they link link up and why that's important.

Thank you, Tim and Whitney. What's been exciting about the book for you? Are there any particular challenges that leaders that you work with are facing today that the book is addressing?

The one thing I would add is over the last couple of years, I've I've led our work counseling two strategy officers on how to succeed in the role. And I talk to a lot, you know, three to five, five a week. And one of the things that I'm hearing a lot right now is that with AI, a lot of people are all of a sudden becoming managers. AI is equipping people across organizations with superpowers, right, with the ability to think about, ideate, explore ideas.

And that creates enormous strategic potential, which firms need to compete in this modern era and to drive prosperity and innovation and growth. It also creates a bit of a risk if people across an organization are not well grounded in the fundamentals of how strategy creates value, what good strategy looks like and how it drives value. And if they don't share a common language for what that means for your business, then that energy can go in too many directions.

It can cause more problems than potential. And so we think that in this era, it is particularly important to equip people with the the essentials for how to understand as a manager, as a leader, as a designer, as an operator, how does strategy create value? And as a result of that, how can you take the very best initiative for your business?

Well, this is great. I'm really excited for the conversation. So, Andy, Whitney just described some of the challenges that leaders are facing as a result of AI and technological change. How are you seeing uncertainty also play into this?

So uncertainty as a concept has certainly been increasing. And you'll see when we look at the data, we look at a few different things. One is how do managers feel? And as I talked about our rationale for the book, this concept of I, I don't know where the future is taking me, I don't know what's coming around the corner, you know, does encourage strategic thinking. And yet, um, at the same time, you'll see, uh, as we talk about some of our other finding, you know, the quality of the strategy has been has been diminishing over time.

When we look at the world uncertainty index, for example, this basically says, How are you? How often are you talking about uncertainty? You can see this incredible spike latest. People are talking about it when you look at investor calls and how people are actually talking about business, uh, how they're talking about performance. You see a thirty one percentage increase uh in topics like AI transformation, ESG, not the core business topics or strategy topics that you'll norm normally see.

So you bring these two things together and we think we're in actually kind of a fundamentally different world in the way that executives are just considering the problem sets that are in front of them. And I know, Tim, if you wanted to comment at all on investor side, but we're certainly seeing a lot of changes there.

Uh, yes, the world is just much more complex from their perspective. Um, they want to know, uh, there's still a focus on, uh, the fundamental what is your strategy, why is it going to succeed, et cetera, but you have to layer on to that from for for to satisfy investors, sort of so how are you? How does AI affect what you're doing? What kind of transformation are you doing? How does that affect? What about social issues?

How are you dealing with those? Uh, all these things, uh, are additive to what you've had to deal with in the past.

Thanks, Tim and Andy. Now I'd like to pick up on how you've observed that the quality of strategy has actually been diminishing. Could you talk a little more about that?

As I mentioned, when you look at what actually happens in terms of the quality of strategy, one of the things that we measure over time is the ten tests of strategy. So how many organizations are actually passing the ten tests over time? And we looked at the change between 2010 and 2025 in the last fifteen years under this hypothesis that strategies are coming under pressure for all the reasons we've described. And you certainly see it in the data.

40% decrease in the quality of strategy. So we're in this golden age of strategy potentially, and yet the quality of strategy is decreasing. And then when you look at the way that economic profit has migrated over a similar period, from 2,000, uh, to roughly 2020 over that era, you see a significant change in the distribution of economic profit. So when we think about economic profit, what we're thinking about is the returns that actually the top quintile of companies realize over their cost of capital as opposed to the bottom quintile.

And what you see over the last 20 years is that that distribution has increased in the positive by 245. So the winners are winning much bigger, the bottom quintile, the losers have decreased by 170, the losers are losing even more. So strategy's becoming more relevant. Now you could say, Oh, that's just the Magnificent Seven, that's just the tech industry. Now, when you control for the Magnificent Seven, when you control for all of the different industries out there, this phenomenon is happening all over the place.

So even extracting the data is roughly the same, extracting those, uh, those factors, the data is the same. Now, Whitney, you and I have spent a couple of years thinking about the efficacy of strategy and what's actually happening in some of our research. So you want to talk a little bit about that, that 40 delta?

Yeah, it I think it's a really important trend and uh, and great that we have data on this because it's what we feel, right? That despite the opportunity that is the uncertainty, strategy's about leaning into uncertainty and and and taking advantage of it, um, betting on the future. And despite the that we have more ways than ever, right, of creating real value, because we're developing new ways of making strategic moves and creating value. And it's for whatever reason, that abundance of opportunity has been getting actually has been overwhelming executives.

It, you know, our ten tests, they are not really just our easier strategy, good, right? They are tests that get at the underlying robustness of what's going into your strategy, right? Are you getting granular enough, you know, are you really challenging and building on true competitive advantage on things you you know and others don't? Um, are you really aiming to to beat the market as opposed to just your unique competitors? It is intentionally difficult to pass these tests, right?

But that the scores have been falling, I think shows that leaders are overwhelmed by both the opportunity they have in front of them, but also the number of ways of facing in strategy. That reinforces our conviction that leaders need, in order to increase the quality of strategy, a grounding in the few fundamental things that matter most to creating value.

And Whitney, is it possible that the need for strategy might actually be diminishing due to the massive industry shifts we're seeing, accompanied by increasing volatility, uncertainty, complexity, and ambiguity? In other words, does strategy really still matter? And if strategy still is important, then what are the implications for how we actually develop it?

I think it's such a it's such a good and important question. We should never assume that something matters, right? We should know why we believe things. For us, strategy is about a few coherent choices that represent the biggest and most important opportunities that should be that resources should be allocated against that are explained by some sort of underlying theory or thesis of how we uniquely are going to change the trajectory of our business. I don't think that ensuring that there are a few clear choices in any given part of the business is ever not important.

Number one, right? That skill is one that many, many companies do not have. They have a long list of priorities, they do not have a real strategy. Their strategies are themes as opposed to real choices. They are not stopping things, they are not using that tool to change their business. Our research finds, if anything, that it's not that strategy becomes less important, it's that what is needed from how you approach strategy changes when uncertainty goes up, right?

We have data on what, which specific capabilities need to be recalibrated against that. Um, it becomes much more important to frame challenges, it becomes much more important to understand true competitive advantage, it becomes much more important to be documenting underlying assumptions. The way you approach strategy becomes more important to give, uh, the entire business and organization a way of understanding how to make choices across. It becomes more important than ever. But indeed, it's it's different, but strategy matters.

Thank you, Whitney, you've convinced me. So, um, so, is it that people need to talk about strategy then in different ways in this environment, or is there just not enough attention being given to it? Or perhaps there's a misalignment of confidence in a given company's strategy and that impacts how you drive results.

Well, we're not trying to be overly dramatic, Sean, like, Y- strategy conversations are happening, and people are working really hard at strategy. They're doing great market forecasting, they're out there, they're trying to make decisions. So it's not so much that strategy isn't happening or that we're saying, like, strategy just is completely ineffective. Just for the moment and the era we're in and the pace that needs to happen. Like, does moderate confidence? Is moderate confidence in your strategy going to allow you to reallocate 30 of your resources towards a new market?

Um, are you really sure that your moat's being defended? So it's not so much that people aren't doing it or don't have a sense of strategy. But is the conviction around that strategy s, you know, strong enough to actually act, and for large companies to act at scale? And that's where we see a lot of, uh, a a lot of people, uh, you know, kind of continuing to struggle. Now, what I would say, I'll put a caveat on it, I'll channel my my inner Tim Koller.

You know, if you've got a great strategy and you're printing money and things are out there and the world is not changing that much around you, you're you probably fine. You're probably fine. Not every company at every minute needs to ask these foundational questions about, you know, how they're actually competing, but you need to be aware of the foundations in every case, just to know. Because the other thing that we found is when we look at sources of advantage and what's happening with advantage over time, corporate competitive advantage is eroding at an incredibly rapid rate.

Most people are unaware, or at least you're unaware until everyone else knows it as well, and then it's often too late to act. So, you know, we'll, uh, try to keep it in context.

All right, so Andy, if we accept this broad view that there is room for improvement in strategy, what has your work uncovered about how to do that in practice? And specifically, how that ties to the four foundations that we'll be talking about today.

Yeah, let me introduce the four foundations. Two are based in finance, two are based in in strategy. And as Tim mentioned earlier, the confluence of the two is what really matters. So, first, target growth and return on invested capital, right? At our very foundation, you know, this may seem obvious for those of you that are quite deep in finance, or for the CFOs, people who lead FDNA, or maybe you've been around, uh, quite a bit. You may go back to business school and say, Yeah, I get it.

Cash flow creates medium to long-term value. That's great. It's an important thing to understand. Yeah, the the challenge is that the number of people that continue to manage for earnings and continue to manage for accounting, not cash flow, is is incredibly large. And that gets in the way of great strategy. Compounding that problem is the focus on managing for the long term versus the short term. In order to grow, in order to deliver consistent returns on capital over time, you need to make sufficiently long-term bets.

You can't constantly be managing for the short term, uh, that undermines your strategic choice, it undermines meeting the long-term capabilities. And yet, everywhere we look, there's massive pressure from ex, you know, the markets, from investors, uh, sometimes from the board to manage for short-term profits and short-term performance. That is quite orthogonal to strategy. So, on the finance side, grounding in the foundations is really important. On the strategy side, we talk about two different things. We talk about market attractiveness, and as we'll discuss, markets really make incredible, incredible, uh, or have an incredible effect on how you perform overall and on the ceiling of performance.

Highly contested markets, right, where maybe competitive intensity is starting to spike, have a very hard time earning returns. Whereas obviously more attractive markets, high growth markets, things like that, on average, tend to, uh, perform a little bit better and put you in a better strategic place. It's really important to understand that now, when we talk about harnessing market attractiveness, it's not just recognizing the total kind of opportunity in your market. It's really understanding the nuance of that market, and that's where a lot of companies struggle today.

It's understanding the nuances and it's having the conversation and the debate at the right altitude about the market. And the larger your company, the more distributed your company, often the harder that can be. And then finally, competitive ad advantage is really important. It's our fourth pillar. Now, this does not mean just being good at something, right? This means being uniquely good at something that is actually defendable over time. And this, to me, is one of the most dynamic, you know, things in play right now.

We'll spend more time talking about that. But why we focus on competitive advantages? When I go and I talk to a a go to a client, I'll talk to maybe ten executives, and I ask them, What's your source of advantage? I'll get three, maybe four, very emphatic, but quite different answers. And you know, that can be okay. You can be good at a lot of things, but in a highly competitive environment, in a world that's changing rapidly, not understanding how you're defending your competitive position, not being able to invest in it at scale or be able to use it to migrate to new attractive markets is a real miss.

And again, it's the combination of the four that we think is actually quite important. And getting really grounded in these fundamentals helps decision making, it helps with alignment, it helps with strategic pivots.

Got it. And and now I have a question for Tim on the finance foundations or the value side. Tim, you know, you're one of the authors of valuation. It's 800 page book now in its eighth edition with more than a million copies sold. So clearly, there are a lot more than just two principles in valuation. So how did you and Whitney and Andy settle on these two foundations, growth in ROIC and then the long-term management focus?

Pretty straightforward. When I look at a company, uh, or when I'm, you know, having discussions with a company, these are the two things I immediately turn to. What is the company's growth and return on capital? Uh, and what direction are those going? And secondly, is the company making investments to create value over the longer term? So those are the two things that I focus on immediately when I look at a company. So it's pretty easy for me to narrow down on these two things, which I think are the most important things.

And the other thing that's important is almost everything else in finance is a derivative or an application of these two ideas. Where where you're thinking about acquisitions or divestitures or resource allocation, it always comes down, you know, these things are are behind each of those things. So it's pretty easy to come up with these two as the essential ones that everyone needs to be thinking about.

Right now, Whitney, let me ask you the same question on the strategy side. Why market attractiveness and why competitive advantage?

Yeah, I think it's important to reinforce that this is about the intersection of strategy and value. It's not everything in strategy. These two foundations of harnessing market attractiveness and building competitive advantage, they're really driving at ensuring there is a very strong understanding of the why behind the where to play and how to win. There are so many strategy executives I speak with who struggle with their top teams or their teams really grappling with the why behind the where and play to how to win.

That don't really have strong, high quality conversations and debates about why their markets are fundamentally attractive and capable of supporting returns. What are the sources of attractiveness that really dominate and explain why returns or growth are possible, and whether those are frozen or not, and what it means for your business? And as Andy was talking about, there's lots of research that finds that competitive advantage is the most misunderstood term concept in in business, uh, and certainly in strategy, that it is so easy to, um, uh, confuse or blur the line between a strength and a true, uh, source of advantage that matters in a market.

And so we we are driving here at trying to enrich and reinforce the ability of leaders of organizations and across organizations to really build and hold a strong shared reality for why are we making money? Why is it possible to make money in this market? And why is it possible for us to earn more than our fair share of it? And when you do that, my experience, when you see teams really owning the why behind the where to play and how to win, right?

And like being able to link that to the long term and roic and growth, that's really where you see things come alive. And we believe in a in this time, it's important to to drive a lot of focus on a few simple things that ultimately explain a a lot of how strategy creates value, or, in in my view, uh, most.

Wonderful. So now let's dive a bit deeper into each of these four foundations. Tim, maybe you could start us out with the first one, growth and return on invested capital.

Uh, yes, sure. Ultimately, the value of any investment is driven by its cash flows discounted at its cost of capital. And the nice thing is is that we can decompose a company's cash flows into two strategically debatable concepts, which revenue growth and return on capital. So if you're just going to talk about cash flows, you can't really have a debate, right? But if you translate that into revenue growth, are we growing as fast as our markets, as fast as our peers?

Is our return on capital above our cost of capital? Is it increasing, decreasing? How does it compare to our peers? Then you can have a real strategic conversation, uh, by, uh, with, you know, that that that links these things together, right? It's not that we ignore earnings, we do look at earnings, right? But if you do a good job with growth and return on capital, you will also do a good job with earnings. But you can have attractive earnings, particularly accounting earnings, uh, if you're not earning an attractive return on capital, or if you're doing things to earnings just based on accounting things.

So that's why we want to focus it on focus you, uh, on return on capital and revenue growth as the ultimate drivers of value creation. And then it's also important to think about the dynamics of this. Uh, first of all, there's no, uh, uh, there's no uh standard for what you know. There are some companies that grow modestly but have high return on capital, like consumer packaged goods companies that create a lot of value. There are some companies that, um, grow faster with more moderate returns on capital.

There's no single right answer, uh, but it is important to understand the dynamics as well. And and if you look at how value changes and what are the levers that you can pull as you're thinking about strategy, it's also important to realize that if you are already a high return on capital business, uh, one, let's say higher growth. And focusing on growth will tend to create a lot more value than improving return on capital. And at the same time, if you have a moderate return on capital, let's say mid to low teens, focusing on improving the return on capital will make a big difference.

So it's important, as you think about strategy, to understand these dynamics, because they will influence how you think about your strategy. It's also important to think about this at a granular level within your company. Uh, too many companies that I see, they want everyone to grow, or they want everyone to improve their margins and return on capital at the same time. If you've got some businesses that have a higher return on capital, you probably want them to grow faster.

If you've got some businesses with a moderate return on capital, you want them to improve their return on capital, improve their margins, improve their capital productivity, et cetera. So it is important also to understand these dynamics, because these dynamics are going to be directly related to the choices you make for the different parts of the company, uh, and to the how and where to compete.

All right, so let's move now to the second foundation, managing for the long term. Tim, what are the executives that you've worked with thinking and doing in this regard? And maybe you could share some examples?

We've done lots of work on this. This is just one example. So we asked a sample of executives, uh, we asked them, if you, you know, give a lot of priority to the long term, do you? Do you provide the right sponsorship? Do you provide the resources? Do you provide the talent to be successful? Do you grow faster or slower than your peers, right? And what we found was that those executives or those companies that do invest in the long term, that do make sure that they're putting their priorities where the long term matters, will, uh, create more value, particularly through because they're going to be more innovative, they're they're going to grow faster.

And yet, on the other hand, we still see plenty of examples of companies that do not focus on the long term. Uh, for example, a retailer, uh, that, uh, in order to boost profits, uh, cut the frontline sales force and de-skilled the people, right? Another case, a high-tech company that, uh, saw a novel technology and had plenty of opportunity to invest in it. But at the same time, they were trying to achieve a ten EPS growth, uh, for a period of time when their core markets were pretty much flat.

So instead of investing, they focused on the EPS growth, and as a result, they missed out on this big technology. And some of their peers have created massive amounts of value that they missed out on. They knew it was coming, but they did not make the investments. So we see plenty of examples of companies, uh, that are not making, uh, these investments. And I'll say one more thing. When I hear a CEO or a CFO say to the world, either internally or externally, we're going to increase profits faster than revenues.

To me, that's a sign to run. Okay, if I was an investor, uh, because, uh, while it may work for a couple of years, right? Typically, companies have fat in them that that can be taken away. You know, if I can improve my distribution system while still meeting my just my targets of delivering to customers, that's great. If I can reduce cost in the back office, what typically happens, though, when companies make those pronouncements after two or three years, they've run out of ways to cut costs that are purely productivity that the customer doesn't notice, for example.

And they start to cut, um, uh, they start to cut things like product development and marketing, because that's all they have left to cut in order to achieve that target of increasing their profits, reven, uh, relative to revenues. And as a result, after a couple years of that, then they find themselves in a real, uh, danger situation. Oftentimes when that happens, either they have to, uh, admit that they've made a mistake, oftentimes when the the time for a CEO change or whatever.

Uh, so we still see this, uh. So I my rule of thumb that I advise companies is if you're going to cut costs, if the customer is going to notice it, don't do it.

Hey, Tim, one thing I would just, I would, I would add just one other structural challenge that companies face is that often the strategy decisions are made at a different level than the cost decisions. And so if you if you know you're putting implicit pressure on operating units or on a plant or on the field to manage costs without helping them with the trade-offs as an executive that you need them to make. You know, water goes downhill.

They they're gonna, they're gonna do what they need to do, uh, in order to meet the objective. So as an executive, it's ofs often, you know, important to ask, am I setting up the environment for long-term behavior? Understanding that the pressure for short-termism at the edge, where a lot of decisions is made, can be quite, quite great. Uh, and you may not feel it the same way as an executive sitting at the center or corporate center, or or running a business or division.

And and that's why the CEO and the CFO have to take the lead on that. And they have to understand what their what the different unit managers are actually doing to achieve their results, right? You don't congratulate a unit because they met their results. If they met their results by cutting costs, but their revenues didn't grow, or their product innovation is not on track, right? You don't want to reward that, right? You need, so you need a level of insight as a CEO and CFO into how your businesses are achieving the result, not just what their results are.

Okay, so I'm curious also about the relationship between taking that long-term view and the value creation thesis for a company. In a world of AI where things are changing so rapidly, does that mean you need to revisit your value creation thesis more frequently, say on a quarterly basis? And is that at odds, perhaps, with taking the long-term view we just discussed, when the ground can actually be shifting quite quickly? Tim,

Yeah, for the for the vast majority of companies that are not directly involved in, you know, making AI software or building s data centers or chips or whatever, the vast majority of companies, they're still gonna be selling clothes, they're gonna be making consumer products, et cetera. AI is a tool for them, right? And so, yes, it is important to figure out how to use AI to improve the business. But if I'm making consumer package consumer products, I still have to have a value proposition for the consumer.

Consumer doesn't care how I get there, whether I use AI or not, right? So I have to do both, right? I have to be, I can't lose sight of the long-term strategy. Why are my products going to be the ones that consumers are going to want to buy? Uh, and how do I market those effectively? Uh, but in the in the background, in the back office, I have to figure out how to use these other things like AI to help me do that better.

Yeah, Whitney, you know, I mean, you, we were just literally having this debate yesterday. So, I mean, I discussed you. It's a great question, but, uh,

Yeah, so sorry, I'm happy to to give a view. So, number one, the way that we think about value creation thesis is it's it's an underlying theory that explains the choices you're making, right? And sometimes the theory comes first, sometimes it is it is used to explain the choices of strategy you're making. And it's important because it helps people across a business make their own choices at the edge that are coherent with the overall business's strategy.

And it's built on a unique view of the future and a unique view about what makes you unique and why you're going to capture value. In the book, we introduce, um, uh, what we call the undelegatable roles of the CEO in strategy, right? The things that really, if the CEO tries to delegate them to someone else, you're probably going to really put strategy's value creation at risk. First, second one is that really only the CEO can decide to change the value creation thesis of the business, right?

It is something that really is at the center of how you see your business in your world. And it should be built on some real convictions and beliefs and assumptions about the future. If it is changing a lot, then I think that that potentially indicates that your foundations are not really in place. Your shared reality isn't in place and you're reacting as opposed to driving into the future, right? But at the end of the day, if you have a shared reality about how you talk about and debate, what you believe about your markets and about your advantage and about value creation, then it also allows you to know really.

When the signal tells you that we believe there's a different opportunity than with what we thought, and that our thesis needs to change, and our strategy too. Andy, You agree with that?

we spend a lot of time. There's a lot of noise. Yeah, there's just a lot of noise in the market right now. I think what we're trying to do with the four foundations is say, where where is that signal, what is the true signal? And I think if at least, even if that signal's changing rapidly, you know, having alignment around that in a pretty fundamental way will help you keep focused on the long term, if if that makes sense, right?

I mean, it's just, you know, it's very easy to say we're not going to make any long-term choices because the short term is so volatile and and we just don't know. And I think, you know, the the the purpose of the this book and what we're trying to focus on is saying, you really need to be grounded in the fundamentals. So as that change comes at you, you can actually pivot, because pivoting at scale is what's going to create value, not just reacting.

All right, thank you. So now let's shift to the two strategy foundations. Whitney, can you talk about market attractiveness?

Yeah, so absolutely so. So the first, uh, strategy foundation is that you need to harness the the attractiveness of your markets, which really means that you need to understand what allows for your market to be fundamentally attractive and support attractive returns or not. And there isn't any necessarily new knowledge here, but what we try to do is we try to make it easier for teams to be able to talk about and debate. What drives the ability of a market to support returns, alongside what drives your ability to capture more than your fair share.

So what we introduce is this concept of sources of market attractiveness. It's language that is intended to be similar to sources of advantage, right? We say essentially that any given market's attractiveness is based on two things, generally speaking, right? The overall potential of the market to support returns and its dynamics, right? In a sense, the potential of the market set sets a sort of ceiling on the returns in in a in a market. And the dynamics then determine whether or not the potential returns in a market are are are actually captured by those participants or are diffused out.

This isn't new knowledge, but I think it is a lot. It reduces the cognitive load for being able to debate this. And underlying market potential is, uh, these top level sources, as well as more more granular ones in the book. Growth differentiation, right? So the potential for growth in a market, the potential for differentiation in a market, and the potential for defensibility of that market, like barriers to entry and barriers to exit. Under differentiation, for example, there is, you know, whether or not, uh, differentiation can be and innovation can be protected in a given market, or whether or not when you d when you innovate, others can quickly, um, uh uh, replicate that innovation.

In markets where you can't protect your innovation, the potential is lower, uh, for returns in that market, and then dynamics as well, customer dynamics, competitor dynamics, supplier dynamics, right? This isn't rocket science, but we we really believe it's important to help executives and leaders have a l a better language, a more efficient language for debating and and holding together. What are the dominant reasons why our markets are attractive or not? This matters because when you look across markets, some are more attractive than others, and this shouldn't be surprising, but to many, many leaders, it is.

Um, they don't. A lot of a lot of leaders sort of carry on with the markets they have, as opposed to really intentionally considering whether or not we should be in a market or not, and why, right? And when you are able to disaggregate, okay, what are the underlying sources of attractiveness that that explain why a given market is attractive? You're able to make better decisions both to enter, but importantly, to exit markets. This idea of exiting markets is one that is not done enough, but it's also a very old idea.

Drucker used to talk talk about the importance of purposeful abandonment. In an age of AI, I think purposeful abandonment and the discipline to understand why our markets are attractive or not, and to harness that knowledge to make good decisions is very, very important.

And it's probably underused. So if companies are now better able to determine whether or not a market is worth playing in or staying in and actually act on it, what does that mean for overall market dynamics then? And why is this so important now?

It's particularly important because we're seeing competent competitiveness rise. So we have this thing called shuffle rate, and shuffle rate essentially, um, looks at the amount of market share that is changing hand in any given market over a period of time. And so markets with higher shuffle rate are s ultimately seeing more competition, resulting in more market share changing hand, more competitive intensity. And this goes up and down over time, but in average, it is increasing. Markets are becoming more more, uh, competitive over time.

That ultimately creates a lot of opportunity. If you've read our work on, uh, arenas of competition, you know that when you're looking at shuffle rate, when you look at and understand, uh, the fundamentals of market attractiveness, you can make better decisions, right? As a business about sensing the right opportunities, saying no to the wrong ones, and managing your portfolio effectively. But that requires having a shared reality and a shared language for fundamentally why our markets are competitive or or attractive or not.

And not just the size of profit pools, right? Not just market share.

And as these market dynamics are getting increasingly tougher, what are some of the challenges for companies that are trying to actually harness their market's attractiveness?

So there are two analog challenges when it comes to harnessing market attractiveness, um, that we talk about in the book. One is you have the wrong market map, right? There's a lot of, uh, businesses they don't really think about. One is our market, how do we define the boundaries? And that is particularly important in this day and age with competitive boundaries shifting. Now I always am careful with this idea that markets are shifting faster than ever.

We've been talking for 20, 30 years about the fact that competitive boundaries are becoming more and more blurred. But it really is an issue today. And executives really need to face into the the need to have discipline about always, uh uh, purposely defining our markets and redefining them as technology and customer preference and business model change, uh, uh, influence them. Um, so having the wrong market map is really is right for, uh, it is really dangerous for harnessing market attractiveness, and likewise, being blind to shifting dynamics is quite dangerous.

Now we know that lots of things are changing. But to Andy's point about signal and noise, um, I think that in many markets, we know more than we give ourselves credit. When we look at markets through a lens of sources of market attractiveness, and we go through a given market and say, let's disaggregate this down. What are the dominant sources of market attractiveness that are explaining why returns are possible and the returns that that are possible?

And we think about, okay, to what extent are these frozen, especially the dominant ones, and to what extent are forces shifting them? You see a lot more signal than noise. Where things break down is when you don't spend the time as a team having the right language that that really gets at the value creation element, right, of markets. And so being blind to shift dynamics is in part about looking at the source level of any given market's attractiveness and being able to debate at that source level.

Whether a given force, whether a given uncertainty is actually influencing things that drive value in a given market or not. And so what we're trying to do with this book is to be able to help teams more efficiently get to that map, read the signals and win in the long term.

Super. So what are some of the metrics then that one might use to track or measure the durability of market attractiveness? You mentioned some signals. Are there any particular ones that you look out for in your work with clients?

Well, I think the most important signal or metric is the source level itself. And having a view of any given market, what sources of attractiveness and advantage are stable versus not is something that a lot of executive teams don't talk about, but also hopefully comes naturally to the most effective ones. When you look beneath that, right to growth, to the ability to protect differentiation or or d or innovation, I should say, to the to the the concentration of customers versus concentration of suppliers, et cetera.

For each one of those, there's going to be a set a set of metrics. The The rocket science is is or the magic is only not in the metrics, right? It is in that middle level, right, of of of having the clarity about the the source level explanation of why our markets are attractive or not. That I think is very important. We have to be careful that we don't just look for a KPI as the source of signal, right?

I think in this day and age, strategy creates value when you look beyond a single KPI, right, as a source of signal for insight.

Got it? And Andy, anything you'd like to add here?

The only thing I would add, Sean, is I I just think m most or many organizations, I don't know if it's most or not. I think in my own opinion, it's it's it's it's many. Um, competitor dynamics is really something that's very hard to talk about, or or people just don't talk about enough. You talk about your own forecasts, you talk about what's happening, but you don't talk about and role play forward what's likely to happen with your customers, given what competitors are likely to do.

Or you you engage on it after the competitors have already made their move, which is usually a few quarters too late. So if I were to add something in addition to what Whitney said, it's about defining the market at the right level. Is this really a market or is it a PL, right? If it's not a market and it's a PL metric, you're not looking at the data the right way. So that's piece number one. So define the markets in the way that your customers define them and your competition defines them, not in the way that your PL defines them.

And once you're in there, of course, there's a lot of customer data that you'd look at, and every e organization's going to be a little bit different based on its value proposition. Um, but I would look at competitive dynamics, I would look at pricing in a highly granular way, I would look at competitive entry in a highly, uh uh, granular way. I would look at entrance, market entry, I look at capital flows, right? These are the things that are telling you, is my market changing?

and is the attractiveness of my market changing based on, uh, based on levels of competition and my abilities to stay in my current position?

Thanks. And now let's talk through that fourth foundation competitive advantage. Whitney, tell us more.

Yeah, so as I mentioned before, competitive advantage is a notoriously, um, uh, misused concept in business. There's academic research on just how how misunderstood it is, it's for a good reason. There are various schools of thought on competitive advantage. We thought it felt it was important to put out a a singular view that brings them together. We're proposing ten sources of competitive advantage. The taxonomy is valuable, but uh, what what matters most is the bar, right, for what true competitive advantage is versus is not, and how to think about measuring that, right, with with sources, source, uh, with a, um, a series of sources of of signal.

We see that being itself a a real advantage. Um, only 10% of companies we found track the drivers of competitive advantage at a at a market level. It is a an an epidemic in a sense of where where companies do not really think hard about what Dr. What allows us to capture more than our fair share, as opposed to what is what are we simply good at? Um, and so we feel it's important to, um, uh, to drive more rigor around competitive advantage and how you debate it.

We also talk in the book about how you build and deepen it. Um, ultimately, uh, there are four major ways to manage and maximize your returns from competitive advantage. Uh, you deepen advantage by widening the gap, uh, widening the moat, investing in it intentionally. Uh, you bridge your advantage, taking capabilities, you know, in terms of dynamic capabilities, taking them from one one dynamic, one one context into another, one market into another. You need to be very thoughtful about how you renew advantage.

Uh, this links very carefully to, um, uh, uh, very importantly, to what, uh, Tim was talking about in terms of where you're directing your investments and holding a high bar for, uh, what actually is going to drive record growth in the future. We spend a lot of time, uh, or or, or businesses spend a lot of time investing in things that aren't actually renewing their advantage. And ultimately, um, being purposeful about how you abandon advantages or that no longer are going to matter, uh, because of of of forces of change upon sources of advantage, um, and uh, um, and and and managing that portfolio effectively.

Super, thank you, Whitney. And just to let our listeners know who might want to dive deeper on this, we also recently published an entire episode on how to evaluate and maximize your competitive advantage, and we'll include a link to that in the show notes. So now, Andy, this all sounds really sensible, but it does beg a question. Why aren't more companies thinking this way already about strategy and value creation? Why isn't there more of a focus on these four foundations?

I I think when we when you just take a step back at what we're talking about, um, there is a fundamental problem that when you when you consider what does it take to reallocate resources in a meaningful way and a well-aligned way, in a nimble way, which is really what we're talking about. Uh, and you think about the flow from getting ideas and analysis and inputs and all the market and competitive advantage, you know, insights that we talked about, designing and debating, uh, what a strategy might be.

When you think about long-range planning, all the things that Tim talked about as well in terms of short-termism and the pressures that you have. And you think about the budget cycle and and what that looks like, and you think about then actually getting people to do something. This is an insane value chain, right? It is complicated and it's getting more complicated, and as a result, it's generally ineffective. And so this needs to be fixed. We're not going to say I do think it is a part of this being a golden era of strategy to go back to to my original point, like, why is it a golden age?

Because I think we can fix this with technology, and I think the world is going to be much better. I think we're going to look back 15 to 20 years from now, hopefully five, and say this absolutely made no sense. We had to manage in a different way, and thank God, we don't have, you know, rolling forecast meetings and for, you know, all these other things that we do every single month and monthly operating reviews. All these things that just take up so much time but don't add actually value to strategy.

Um, I think we'll look back and say that this was fundamentally different. But in the meantime, what we're trying to do is say, how do you shortcut this? And one way is to take this process that exists and has its merits and and needs to continue until something better replaces it. How do you make it better? Well, our answer is you make it better by focusing on the four foundations and not all the noise, not all the other things.

Make sure you're having healthy debates on the principles of how strategy is evolving and how that strategy is turning into value in a clear and compelling way.

So I guess I have one final question, Andy. And we alluded earlier to the undelegatable role of the CEO in strategy. And in your experience working not only with CEOs, but also CFOs and CSOs, what are some of the organizational implications for what we've been discussing today? And and how would that group, the CEOs, CFOs and CSOs, need to work differently to adopt these four foundations?

Yeah, I mean, I I think a lot of organizations we we need another hour to talk about how to organize strategy and governance implications of the book. I think the 1 minute version is many organizations organize in different ways, right? It's it just is what it is. Everybody does strategy a little bit different. And what we're trying to say is if you could bring in these foundations and cascade the foundations of thinking. So you're speaking the same language, you're driving alignment, not not dispersion.

As you talk about value, as you talk about strategy, you understand your customer, which means CEOs need to be connected to the field. They need to understand what's driving decision making so they can make great choices. Like you can increase the signals that matter, right? Among that, that triad and everyone else in the organization. And I think through common language, through common approaches, through common understanding, we're hoping for a significant acceleration.

Thank you so much. And Whitney, Tim, any final thoughts you'd like to share before we close our episode?

No, I I'll just add, you know, once again, go back to, you know, if you it, you know. The four foundations are purposely straightforward and simple and easy to remember, right? So if you keep those four things in mind as you're thinking about strategies, um, you'll, you know, make a lot of you. You. You'll make progress even though you're not going to achieve perfection right away.

Couldn't have said it by myself.

Awesome, Tim, Andy, Whitney, thanks so much for taking the time with us today.

Thank you, Sean.

Thanks, Sean, thanks, Sean.

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