Achieving sustainable growth is a perennial concern for senior managers. Yet the strategies they pursue often capture few or none of the intended benefits. Their efforts are rewarded with outright failure or with short-lived wins followed by rapid deterioration. Consider these cases of thwarted initiatives:

• Growing too fast. History is littered with companies that experience "boom and bust": rapid growth followed by steep decline, often into oblivion. In the UK life insurance industry, London Life pursued an aggressive salesforce growth strategy that put it out of business by 1987. Its hiring practices had set off a vicious spiral of falling skill levels, flagging motivation, and sinking performance.
• Too much too soon. A polymer company spotted an attractive, fast-growing market and invested heavily in new plant and equipment to meet demand. Four rival suppliers responded by dropping their prices. Though the company succeeded in achieving a large share, eroding margins made the market unprofitable.
• From glitter to glut. A leading high-tech company saw first-month orders for its latest product exceed capacity by 30 percent, and got its suppliers to increase their raw component stocks. Two months later, as stockpiles built up, orders collapsed, precipitating a huge "sludge" inventory. The product ended up being branded a dud. It transpired that much of the original demand consisted of "phantom orders" placed by distributors concerned about short supplies. Tight initial capacity had actually boosted early demand.
• A fix that failed. Many companies pursue growth by attempting to improve customer satisfaction, often through staff training and skill building. One automotive OEM required its dealers to increase technician training, but saw little improvement in either service performance or customer satisfaction. It had not foreseen that technicians would react to their extra training by spending less time in fault diagnosis, or that dealers funding the training would cut back on their investment in tools and equipment.
• Unintended consequences. These frustrating patterns occur in national economies too. In the United States, the 1990 luxury tax was intended to generate an extra $76 million in annual revenues, but it actually yielded only $13 million. The reason: the luxury market for planes, boats, and automobiles dried up overnight after the tax was introduced.

Why do plans that look good on paper go bad when they are executed?

Why do plans that look good on paper go bad when they are executed? The problem often lies in what might be called secondary effects—unforeseen by-products of strategy that confound its original intentions. The growth strategy of the polymer company, for instance, took no account of how competitors might react. The company won the volume it sought, but its profits were diminished because of actions by rivals threatened by its new capacity.

We believe that companies wishing to implement a successful and sustainable growth strategy need a better approach—one that takes account of the impact of these secondary effects and helps managers make more informed choices about how to accomplish their objectives.

Achieving sustainable growth

To understand these secondary effects, it is necessary to take a dynamic view of the marketplace—one that anticipates competitive reactions and explicitly incorporates them into strategy. An analytical technique called Business Dynamics has proven especially valuable in this context. Derived from system dynamics, it applies ideas about engineering control feedback to business and economic systems. It is based on six fundamental guiding principles (see the boxed insert).

In the cases below, a Business Dynamics perspective helps to explain how sustainable growth was achieved in two very different businesses.

Service satisfaction in the auto industry

For automotive OEMs, repurchase loyalty—what happens when existing customers return to their current auto maker to purchase their next vehicle —is worth many millions of dollars. As the quality and functionality of most vehicles approach parity, sales and service are growing in importance.

Several auto makers have decided that improving customer satisfaction with service at dealerships would raise repurchase loyalty. They have lavished vast sums and considerable management attention on training and technical support programs—but detected no noticeable impact. What has been going wrong?

The OEMs’ efforts have certainly not been misdirected. Analysis of customer survey data reveals that satisfaction with service accounts for one-third of total customer satisfaction, and is predominantly driven by the ability to repair a vehicle correctly, on time, and at the first attempt. Average dealer performance against this target is 65 percent—meaning that one in three customers would need to go back for further repairs. "Best in class" performance, however, approaches 90 percent, so there is ample room for improvement.

A fix that failed

The traditional solution to this performance shortfall was to establish a policy of mandatory training to make technicians more effective. But extra training meant they spent less time at work. Exacerbated by flat-rate compensation that favored throughput rather than quality of service, pressure mounted at dealerships. The diagnostic stage of the repair process was often rushed, leading to failure to detect faults and thus defeating the object of the training.

In addition, rising training costs and forgone revenues ate into dealers’ profits, prompting them to reduce their investment in tools and equipment, thereby limiting technicians’ overall effectiveness.

OEM strategies concerning the use of advanced diagnostic equipment were also vitiated by unanticipated secondary effects. One extremely costly device designed to improve diagnostic accuracy had a very low usage rate, despite being considered technically superb. The reason for its neglect was the fifteen minutes or so that it took to set it up—time that pressured technicians felt they could ill afford to spend. Moreover, a lack of initial training produced low familiarity, reinforcing underutilization which in turn reinforced low familiarity.

One OEM decided that in order to improve performance, it needed to identify where bottlenecks were occurring, and why. It applied Business Dynamics to model the repair performance of an actual dealership. It tested a scenario involving several new initiatives it had devised to fix the service problem by enhancing training and building technical and diagnostic support. The modeled initiatives produced some improvements, but they were limited and short-lived.

Disappointing results can be reversed by addressing the powerful secondary effects inherent in the system

Analyzing the model revealed that these disappointing results could be reversed by addressing the powerful secondary effects inherent in the system. Incentives to diagnose the real underlying problem with a vehicle were weak, since pay structures encouraged technicians to complete jobs as quickly as possible. In addition, initial improvements in the service process tended to get caught up at existing bottlenecks, sometimes even making them worse. Service advisers became overloaded and less effective; increased retail demand, generated by better short-term performance, compounded time pressures and prompted technician shortcuts; and new technicians hired to meet demand diluted the average level of experience.

The analysis also showed that the OEM support initiatives brought least benefit to those who needed them the most—the low-performing dealers. The rate of improvement for these dealers was a mere 4 percentage points, whereas their high-performing counterparts achieved an 11-point leap. Thus the aspiration to improve "fix-it-right" performance to 85 to 90 percent was still way beyond reach (Exhibit 1).

Clearly, putting more business through a poorly managed system of processes and incentives yielded little net benefit to OEM, dealer, or customer. Modeling these dynamics revealed that the primary bottlenecks lay in dealer processes. No conceivable improvement in support from head office could work if dealers responded to higher volume by cutting back diagnosis and training.

Finding the right fix

Armed with these insights, the OEM is developing a series of dealer process initiatives that should bring about sustainable improvements in repair accuracy. The impact of this new approach has already been profound. First, it has revealed that individual dealers need their own tailored solutions; no single approach suits all cases. Second, it has shown that a well-designed portfolio of process improvements, coupled with OEM support, could raise the average dealer toward an 85 percent fix-it-right score, and at the same time enhance the net present value of the dealer franchise by around 35 percent. In short, all stakeholders should benefit.

Understanding the system at work in auto servicing should also permit the OEM to tap potent reinforcing benefits: better repair performance should lead to higher service volume, greater repurchase loyalty, strengthened profitability, and increased dealer resources to reinvest in the drivers of customer satisfaction. In addition, OEM programs should become even more effective once dealers improve their own processes. This combined approach is proving so powerful that rolling it out across the entire dealership network should create billions of dollars of shareholder wealth.

The lesson for the OEM was that working on a set of functional strategies in isolation would not yield expected benefits

The lesson for the OEM was that working on a set of functional strategies in isolation would not yield expected benefits. Instead, it needed to couple these strategies with actions in other parts of the business system to reinforce the impact of the functional improvements and limit the extent of any counteracting effects.

Building market share in life insurance

A case study from a different industry provides an equally vivid illustration of the ways unexpected secondary effects can sabotage growth strategies.

In the early 1970s, two UK life insurance companies, Equitable Life and London Life, enjoyed almost identical competitive positions. They even shared a large customer in common, a university pension fund. In 1975, when it withdrew its business, both insurers suffered a setback. With similar opportunities and challenges, they subsequently followed diverging paths.

London Life grew rapidly for a while, but became virtually insolvent after the 1987 stock market crash, and had to be rescued via an acquisition. Equitable Life, by contrast, became one of the most profitable companies in this market. Their contrasting stories highlight the role of management strategy in determining success or failure, and demonstrate how Business Dynamics can reveal opportunities and pitfalls that conventional strategic thinking often misses.

Different destinies

After the loss of the university pension fund, London Life stuck to its core business, rapidly expanding its salesforce in order to create economies of scale. Equitable Life, on the other hand, enforced a policy of putting new hires through more than a month of training to build skills oriented toward high-end business, and actually reduced its back-office staff in line with a slow, low-cost growth strategy.

It is not immediately obvious why this approach proved superior; indeed, it defies conventional industry wisdom, which holds that large salesforces are needed to build any life business. Two of Equitable Life’s distinguishing features—high average case size (the annual premium per policy sold by an agent) and an agent commission structure (a driver of initial expense ratio) that rose less than proportionately to policy sales—are rated as low in importance in a standard statistical model of the life insurance business. However, a dynamic analysis of the industry identifies these factors as decisive strengths (Exhibit 2).

In reality, the positive, reinforcing benefits of higher case sizes amplified Equitable Life’s success. Better compensation boosted salesforce motivation, stimulated productivity, and pushed sales and compensation still higher. At the same time, well-paid salespeople stayed with the company longer, raising skill levels and yielding fewer policies that were "orphaned" when the original sales agent left the company. Improved customer retention then reinforced the cycle of rising compensation and superior staff retention (Exhibit 3). The benefits compounded one another in a virtuous spiral of improvements.

The challenge to find a sustainable growth rate means striking a balance between growth drivers and constraints

Another factor that shaped the fate of the two companies was their growth aspirations. For any management, the challenge is to find a sustainable growth rate that maximizes company value. This means striking a balance between growth drivers, such as skill levels and case size, and growth constraints, such as back-office overload and limited coaching capacity. According to our cause and effect model of the business, London Life’s sustainable growth rate was around 12 percent—nothing like the 40 percent expansion that actually took place in the salesforce.

Grow slowly

Too rapid a growth rate destroys value in a number of ways. Limited coaching capacity inhibits skill development, for instance, so that sales-

force productivity stalls. Similarly, an overload in the back office diverts salespeople to administrative tasks, dampening sales effectiveness. The result is a downward spiral: shrinking compensation, salesforce defections, lower customer retention, flagging sales, and falling net worth.

If this is so obvious, why doesn’t management catch on and do something about it? One reason is that the high-growth strategy does seem to work—for a while (see Exhibit 4). Faster growth, up to 24 percent a year, raises insurance premium revenues. Productivity declines a little—but fast growth can be bumpy. For London Life, the bump it hit reflected Wall Street’s adage that bankruptcy is the market’s way of telling you to slow down.

Some analysts view London Life’s downfall differently. They hold that its risky security portfolio made it vulnerable in the 1987 stock market crash. But if we run a model of the industry that turns back the clock and replays events without a stock market crash, London Life still collapses—just a year later. The company was already severely wounded by its failed management policies. Indeed, its fate was sealed as early as 1983, when falling productivity and net worth were already entrenched.

Like the auto service case, London Life’s story shows what happens when the secondary effects of a growth strategy are ignored. So how can senior managers factor in these effects in their strategic thinking? Our experience suggests that two levels of insight are necessary. First, managers need to be alert to what we have termed "strategic pitfalls"—generic sources of failure. Second, they need to be able to apply dynamic analysis to their business to generate specific actionable strategies.

Minimizing secondary effects

In order to create value-generating growth, companies must take care to minimize undesirable secondary effects so as to maximize the impact of their strategic initiatives. Using these potential pitfalls as "sanity checks" on proposed actions can stimulate deeper strategic thinking and pay off in increased profits.

Strategic portfolio-related pitfalls

The first concern of the CEO should be strategic portfolio-related pitfalls, since failing here is lethal, no matter how strong is downstream strategy or execution:

• An imbalance in growth drivers and bottlenecks destroys value. London Life’s experience reveals the importance of understanding both the forces that drive growth and those that constrain it. Though the company’s strategy was based on expanding its core business, unforeseen bottlenecks produced by too rapid growth brought it almost to extinction.
• Overloaded initiatives reduce throughput. If an organization’s development capabilities are stretched in too many directions, not only will fewer products or services be launched, but time to market will grow longer. With longer development cycles, further delays in product or service launches can occur when design changes have to be made in mid-stream to keep up with rising market targets.
• Worsening results trigger still more fixes. If tax increases are not yielding desired revenues, or service initiatives improving customer satisfaction, the temptation is to introduce yet more taxes or initiatives. CEOs should avoid patching up a sinking strategy with ever more ineffectual remedies.

Cross-functional pitfalls

Arising at the interfaces between day-to-day operations, cross-functional pitfalls can prevent growth ever getting off the ground, or render initial gains unsustainable:

• Out-of-sync functional strategies undermine performance. A specialty steel producer suffered chronically late deliveries because of uncoordinated actions by various corporate departments. Finance squeezed what it perceived as "excess" inventory; marketing shifted some of this stock to export markets at low margins; operations reduced the working week to save money. The result: low profits and dissatisfied customers.
• Local incentives push problems around rather than solving them. Corporate games of hot potato can depress growth and profits. At an electric utility, pressured operators tried to lighten their workload by deferring "tagouts"—the process of marking equipment due to be taken off line for repair. The maintenance department, which normally requested these tagouts, responded by using more short-term fixes that could be made while equipment was still running. But more frequent repairs and higher forced outage rates resulted in even more requests for tagouts, increasing the pressure on operators.

  Local incentives often push problems around, but corporate games of hot potato can depress growth and profits

• Simplistic compliance can defeat objectives. An industrial goods distributor decreed that excess inventory must be reduced. Local managers responded by cutting easily controllable, fast-moving inventory items. As shortages emerged, customers started to mark their orders "urgent." The result: after a brief decline, surplus inventory soared higher than ever.
• Upstream actions trigger downstream bottlenecks. The OEM training strategy aggravated problems further on in the auto service process: time pressures causing weak diagnosis and poor equipment utilization, for example. The strategy was not inherently bad, but it failed to recognize downstream effects—a recipe for high costs and low effectiveness.
• Layered bottlenecks frustrate single fixes. One computer company worried that long delays within its materials resource planning system inhibited response to customer demand. Shortening MRP cycles to speed the release of orders for materials with long lead times helped delivery performance, but created a new problem—more "sludge" inventory piled up at the end of product life cycles. Solving one bottleneck simply brought another to light. Like squeezing a balloon, the pressure is transferred elsewhere, but it does not go away.
• The right strategy needs the right moment. Doing the right thing at the wrong time can be worse than taking no action at all. In the auto case, improving technician training yielded negligible benefits in customer satisfaction because the incentive system in place still rewarded output quantity over quality. If only incentives had been addressed before training, this initiative might have worked, and customer satisfaction would have increased.

Pitfalls in capabilities and resources

Deep in the guts of operations, yet other pitfalls surround capabilities and resource allocation:

• Reinforcing capabilities are not in place to drive growth. For many organizations, early wins are ephemeral, and performance soon stagnates. One company bucked this trend; its management set ambitious annual goals that pushed it to the outer limit of performance. The leading-edge understanding of equipment and process technology it gained paved the way for further breakthroughs. Heavy investment in new tools, training, and measurement systems helped the company achieve "turbocharged" improvements in volume, cost reduction, and profits, with an 8 percent a year fall in unit costs at the company’s leading plant. But such success is hardly an everyday story; few companies have the nerve to operate on the edge and stay there. For most, only a couple of experiments have to fail before management reproach nudges the organization back to its old, safe culture.

  Few companies have the nerve to operate on the edge and stay there

• Withdrawing resources from inefficient processes ultimately raises—rather than lowers—costs. Managers are frequently tempted to save money by reallocating resources, but this seldom works unless the processes concerned are improved at the same time. In the electric utility example, reducing short-term fixes in the field leads to more requests for tagouts, and costs rise.
• Resource limitations set up a spiral of shrinking effectiveness. Say I buy a car because my dealer assures me that the current incentive scheme is about to end. Ten days later, I discover that the program has been not only extended, but enhanced. I have every right to be annoyed. If customer dissatisfaction becomes widespread, promotions will falter, leaving a shortfall in auto sales that the OEM may try to make up by introducing more "sweeteners"—the source of the discontent in the first place. Promotional spending then hits budget limits and incentive programs are curtailed to save money, becoming still less effective. Sales fall short once more, and the downward spiral feeds on itself.

Pitfalls in competitive response

Many companies pay insufficient attention to possible competitive responses to their actions. Robust strategies recognize that competitors do not stand still. Avoiding the pitfalls means understanding how the companies in an industry are connected and how they may react to one another’s strategic moves:

• Pressured competitors fight to regain position. One international chemical company sought to expand into the fast-growing Asia Pacific market, building a new plant and a strong regional sales organization. Yet even as sales rose, worldwide profitability fell. The plant was supplying over 15 percent of the market normally served by North American facilities. Perceiving this as a threat, competitors were cutting prices and squeezing margins, first in North America, then in Europe and Asia. Worst of all, traditional accounting systems that track regional financial performance, but not interactions between regions, would never detect this cannibalization of earnings.
• "Boom-bust" behavior stifles growth. In another chemical market, several companies cut costs by 6 percent a year for three years in response to overcapacity and weak profits. However, they saw 85 percent of the cost reductions go straight to the customer as their attempts to win market share failed. Low prices triggered capacity shutdowns, but some time later, product substitution stimulated demand growth of over 5 percent a year. Within two years, prices were at record levels, but producers were caught by surprise with insufficient capacity to take advantage of the booming market.
• Competitive moves undermine the bases of profitability. Actions by one company can ripple through the industry to wreck the very assumptions that originally prompted the move. A major petroleum company invested in making "clean" products such as gasoline out of "dirty" products such as fuel oil at a time when the difference in price between the two was substantial. Within two years, the proliferation of clean products and the tighter supply of dirty goods had cut the price difference by 50 percent, transforming the expected profit into loss. A senior executive lamented: "We made a $1 billion mistake."

  Actions by one company can ripple through the industry to wreck the very assumptions that originally prompted the move

Avoiding bottlenecks

Strategies for growth can be blocked by bottlenecks anywhere in a business system (Exhibit 5). Understanding where bottlenecks might arise and crafting a strategy to work within or around them should be a priority for senior managers. A good way to start is by first mapping out interrelationships across the business system, then asking some fundamental questions:

• What creates the potential for growth in this business? Is it service performance, as in the auto case, or choosing the right market and growth rate, as in the life insurance case, or some other source specific to our industry?
• What are the primary bottlenecks that limit current growth?
• If we address them, which second-level bottlenecks will surface next? And how do we deal with those?
• As we put our growth strategies in place, how do we recognize and avoid potential strategic pitfalls?

There is certainly no shortage of ways to fail, but as the OEM and life insurance cases suggest, understanding business complexity and designing strategies around true leverage points can unleash genuinely profitable growth potential.

The CEO challenge

The Business Dynamics approach to building a better understanding of the secondary effects of growth strategies raises four key questions for CEOs to consider:

1. Under what conditions can growth be sustained in our industry?
2. How can we build skills and awareness so that our people will always take account of secondary effects in their strategic thinking?
3. How can we shape the structure and incentive systems of our organization in line with these insights to minimize the unintended secondary effects of our growth strategy and maximize its impact?
4. How can we use this capability to strike a more powerful strategic balance between efficiency measures (such as cost reduction) and effectiveness improvements (such as higher productivity)?

We are on the threshold of a new way of thinking for CEOs that gets at the answer to these questions and helps them better manage the growth of their businesses. The complexity of today’s competitive landscape is shaping a new senior management agenda: developing profitable, sustainable strategies for growth and understanding fully the dynamic secondary effects of their actions in pursuit of these strategies. Only then will businesses escape the pitfalls that have held them back for so long.