What Comes First – Business Strategy Or Structure?

bloombergquint.com/opinion/what-comes-first-business-strategy-or-structure

Michael Porter’s Five Forces framework grew out of the famous Structure Conduct
Performance framework used by Industrial Organisation experts. That framework is no longer
a useful way to think about corporate strategy. Great companies are able to change the
structure of the industry and thus completely upend the Five Forces framework.

The former U.S. Secretary of Defence, Donald Rumsfeld, famously said, “You go to war
with the army you have, not the army you might want or wish to have at a later time.” A
robust military structure built on the foundations of unswerving training and a
disciplined approach is one that is believed to win wars. This school of thought is
supported by the military strategy of ‘attrition warfare’ whereby an army wins a battle by
wearing down the enemy to the point of collapse through continuous losses in personnel
and material. In such a scenario, the war is more often than not won by the side with
more resources, the side with the bigger and stronger army so to say. The larger, more
solid military structure triumphs. In other words, structure determines strategy.

This approach has given way to a modern school of thought called ‘manoeuvre warfare’
wherein readiness and flexibility are imbibed in a military approach. Manoeuvre warfare
implies defeating the enemy by tactically limiting the enemy’s movement. Napoleon used
a combination of cavalry and fast infantry movement to defeat superior forces while
they still moved to their intended place of battle. Shivaji, was another proponent of
manoeuvre warfare, his army would use out-of-the-box strategies, and essentially the
element of surprise, to defeat the opponent. Manoeuvre warfare strategies are based on
the premise that a fluid structure, driven by a smart strategy and out-of-box thinking,
triumphs over a disciplined structure, i.e. strategy determines structure.

The age-old debate of what comes first – strategy or structure is not limited to military
warfare but extends to businesses as well. A study of the cause and effect relationship
between these two interdependent concepts leads to interesting results.

The Structure-Conduct-Performance or SCP framework which used to be famously used

in industrial organisation studies until about 20 years ago can be likened to attritional
warfare. It posits that an industry’s structure dictates how firms in the industry behave
and the behaviour of the company, in turn, drives its performance. Michael Porter’s five
forces framework drew from the SCP framework and made it widely popular. Porter and
industrial organisation economists, therefore, believe that structure determines strategy
(and the two together determine performance).

On the other hand, for ages, management theory has taught us that an organisation’s
strategy should determine its structure. The company’s vision and mission should drive
all business decisions – capital structure, supply chain, reporting structure, employee
policies, and so on. However, this implies that the management needs to mould the
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status quo to suit its objectives and attempt to alter external variables. Given the
difficulty of the task ahead of them, most management teams opt for the easier way out
– they change their strategy and vision to adapt to the existing industry and organisation
structure.

Companies often fall prey to the “this is how things are done in this industry”, “this is our
way of functioning”, leading to a gradual shift in strategy and alignment of all functions to
the organisation’s way of doing things. By trying to improve the way in which existing
structures operate, and then gaining efficiencies in that structure, managers become
creatures of the structure and succumb to the comforts of the known and trespassed.
Unknown territories are looked at with doubt and not ventured upon for fear of the
unknown.

Creators of structure knowingly or unknowingly become creatures of that structure.

While implementing any strategy, competitive forces and the industry structure often act
as invisible barriers that ordinary management cannot think beyond. This often serves as
a deterrent to any kind of disruption or innovation and the company is caught up in its
own narrow pond of thought. This results in a conundrum wherein all future strategy is
drawn up within the four walls of the organisation’s existing structure. Charles Ellis aptly
summarises this in his book Capital: The Story of Long-Term Investment Excellence (2004),
“The more successfully a corporation perfects the efficiency of its structure, the more surely
that structure will eventually strangulate the effectiveness of its strategy.” His namesake
Charles Darwin’s statement is as relevant to the field of business as to the field of
evolution “It is not the strongest of the species that survives, nor the most intelligent that
survives. It is the one that is most adaptable to change.”

Also read: Parallels Between Investing And Software Development

Investment Implications
Large, market-leading organisations are generally associated with bureaucracy and
processes that are difficult to change while younger, smaller organisations are associated
with nimble-footedness and agility. As a result, at Marcellus, we often face the paradox
of looking for dominant, market-leading franchises that are also extremely fluid, which is
why we end up investing from a small universe of stocks that portray this unique
combination of market leadership and agility. We typically look for organisations that
ideate like entrepreneurs and execute like MNCs. One of our portfolio companies, Bajaj
Finance Ltd. is a fitting example.

Every year, the company zero-bases its vital processes and starts from scratch to
counteract the anchoring bias.

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This lends the company the freshness of a new venture even while sustaining as a large
organisation. Whether it is Asian Paints Ltd. rethinking the structure of the paints
industry (read Chapter 2 of the ‘Unusual Billionaires’) or Bajaj Finance rethinking its
processes every year, it is rare to find companies which have the courage and conviction
to give strategy precedence over structure. It is this approach of completely altering the
status quo rather than focusing on incremental innovation that leads to disproportionate
benefits over long periods of time. Businesses that behave like Napolean and Shivaji
show the limitations of the Porter and SCP frameworks. Our framework of identifying
firms with long track records of outstanding results and then seeking to understand how
their strategy drives structure upend the Porter and SCP frameworks.

Apart from looking for new companies that possess this unique characteristic, fluidity is
an important conduit through which we also test our existing portfolio companies. In our
analysis of portfolio companies, we conduct the ‘lethargy test’ wherein we constantly ask
questions such as is the company nimble-footed, is it constantly innovating, is it only
reacting to changes or is it being proactive and anticipating changes and so on.

Fluidity and flexibility in structure would imply the true liberation of an organisation’s
strategy. Much like warfare, running successful companies is an art more than a science
and much like in war, only the nimble-footed stand the test of time. Apart from ensuring
that our portfolio companies keep demonstrating an ability to alter the status quo for
their benefit, it is our continuous endeavour to discover clean companies that have the
courage and clarity of thought to prioritise strategy over structure.

Saurabh Mukherjea is Founder and Tej Shah is Portfolio Counsellor at Marcellus Investment
Managers.

The views expressed here are those of the authors and do not necessarily represent the views
of BloombergQuint or its editorial team.

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