Financial Executive: December 2011

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Feature Article

Strategy

Be an Early Mover

An “early mover” strategy has the advantage of time, allowing options for decision-making to create enterprise value. Failing to attain such a status can lead to lagging performance and prove fatal to an organization.

By James DeLoach and Jay Thompson

An “early mover” is a company that quickly recognizes a unique opportunity, or risk, and uses that knowledge to evaluate its options before it becomes widely known. Early movers have the advantage of time, which brings with it more options for decision-making as market shifts either create opportunities for entering new markets, introducing new products and initiating new innovations, referred to as “market exploitation opportunities.”

Or it can invalidate critical assumptions underlying their strategy, such that the strategy no longer reflects marketplace realities — a condition known as “industry dissonance,” the risk that strategic assumptions lag behind industry realities and the corporate strategy does not reflect the new conditions.

A market exploitation opportunity is a chance to advance an existing strategy and business model to create enterprise value. Industry dissonance requires management to revisit the strategy to avoid taking a company to the proverbial cliff’s edge and risk losing enterprise value. Failing to attain “early-mover status,” as defined here, can result in laggard performance. Even worse, it can be fatal.

Early Movers Aren’t Necessarily First Movers
In the context of this discussion, the early mover distinction is broader than the traditional focus on “first-mover advantage,” which typically refers to the initial significant occupant of a market segment. A marketing concept, first-mover advantage is often gained through technological leadership, entry into a space with room for only a limited number of profitable firms and the creation of significant switching costs.

When a first mover cannot capitalize on its advantage, it leaves the door open for another firm to gain second-mover advantage. There is a body of knowledge around first movers and second movers and the advantages and disadvantages of each. The transition from mainframes to minicomputers, from minicomputers and workstations to personal computers, and the current transition from personal computers to notebooks, tablets and smartphones are illustrative examples.

By contrast, the context for early movers is broader as it relates to detecting early signs of market shifts pointing to either market exploitation opportunities or industry dissonance and making decisions on whether to act on those signs. Thus, an early mover can include a second mover.

Apple, for instance, was an early mover with such products as the iPod, iPhone and iPad, but not necessarily a first mover. Therefore, the dichotomy is not “first” versus “second.” Rather, it is “early” versus “late,” with the market deciding what “late” means. The stakes of being an early mover can be as high as preserving the company’s right to play.

Driven by both the desire to create enterprise value and the need to protect enterprise value, early movers understand that changes in the business environment could alter the assumptions and risk/reward considerations management initially considered when establishing strategic direction.

They value an early warning capability in a rapidly changing world. They operate under the premise that companies with the awareness, resourcefulness, agility and discipline to position themselves consistently as early movers have competitive advantage, leading to superior longer-term enterprise value performance. These companies are more likely to thrive in and/or survive a major market shift than their less-aware and less-nimble peers.

Early Movers Recognize Opportunities and Risks
The distinguishing characteristics of an early mover can be summarized using three R’s — Recognize, React and Reflect. Recognize means a company is able to discern quickly the opportunities and risks that really matter. In other words, the company does four things well.

First, it understands critical assumptions underlying both its strategy and business model for seeking opportunities and undertaking risks. Second, it applies effective scenario analysis capabilities to evaluate situations arising from an event or combination of events that could either present market exploitation opportunities or create industry dissonance.

Third, it gathers intelligence on competitors and markets, focusing on the most important drivers that show the scenarios of greatest interest are either developing or have occurred. Finally, it distills information in a timely manner regarding its assumptions, scenario analyses and intelligence-gathering, and reports the insights obtained to decision-makers.

The focus on early movers is on strategic matters. The pervasive decline of the housing market that precipitated the financial crisis is an example of a strategic matter. The timing in which market participants recognized and reacted to the impending decline in housing values before the crisis crested made a huge difference in terms of their reputations and their standing within the industry today. The crisis demonstrated that companies with an effective early warning capability are more likely to be early movers in a changing environment.

Some firms recognized early vital signs that the end was coming. What did they do that other firms did not do? According to Senior Supervisors Reports of 2008 and 2009, there were a number of lessons from the financial crisis providing insight into this question that applies to many companies regardless of industry. The Senior Supervisors Group is a forum for senior representatives of supervisory authorities of various G10 countries to engage in dialogue on risk management practices, governance and other issues concerning complex, globally-active financial institutions.

For example:

Time to act is a valuable asset in managing risk and opportunity. For instance, the best-performing financial institutions were able to identify severe deterioration in housing prices a year or more ahead of their competitors.

Aligning strategic assumptions with market realities really makes a difference (firms with more adaptive processes are able to alter their underlying assumptions rapidly to reflect changing circumstances).

Undue reliance on the past in predicting market behavior may result in strategic error.

Depth and breadth of enterprise-wide communication about early warning signs must not be constrained by silos (e.g., hierarchical structures tend to filter information mov­ing up the management chain, resulting in delays and distortions of the message).

The board of directors must be engaged to understand risk and uncertainty fully.

These lessons are powerful because they point to the reasons why some firms recognized the vital signs early and others did not, positioning them to become early movers to exit an obsolete strategy no longer relevant given market realities. Companies that got a head start by as much as 12-to-14 months in reducing their exposure to the financial crisis ended in the strongest position.

Early Movers React to Significant Opportunities And Risks
Recognition, however, is not enough to attain early-mover status. React means that an early mover acts on the significant opportunities and risks it recognizes. In this context, an early mover possesses three attributes.

First, it fosters an organizational culture that facilitates consideration of the impact of changing market realities on market exploitation opportunities and critical strategic assumptions. Second, it stimulates and encourages the necessary managerial intuition and ingenuity to translate information regarding changing market realities into actionable revisions to strategic and business plans.

Third, it seeks organizational resiliency; that is, the ability and discipline to act decisively on revisions to strategic and business plans in response to changing realities. The point is that having knowledge of either an emerging opportunity or risk but not undertaking a process to convert that knowledge into hard choices and actionable plans is as useless as having no knowledge at all.

React is not as simple as it sounds, however. It implies the absence of “blind spots” spawned by such dysfunctional behavior as “tone at the top” issues, an unengaged board, a myopic, short-term focus on “making the numbers,” lack of transparency, an unbalanced compensation structure or a “warrior culture.”

For example, in financial services, a reward system based primarily on the volume of loans generated, without regard for the quality of the loan portfolio, may result in the failure or inability to act, even if management is aware of the risk of an unacceptable concentration of bad loans with financially distressed customers.

So what factors likely had the greatest impact on whether a financial institution separated itself from the herd during the financial crisis? The 2008 and 2009 Senior Supervisors Reports include several lessons offering some insights. Consider these three:

Survival often hinges on executive management involvement and board oversight when a company’s viability and reputation are at stake (sole reliance on the business units to make decisions individually can be fatal in such circumstances).

Establishing incentives for business lines to avoid unacceptable balance sheet growth and capital impairments engenders necessary business discipline. For example, the firms that most successfully endured the crisis deployed rigorous internal processes using market- aligned values consistently across the organization, creating internal pricing mechanisms that provided incentives to control activities driving unacceptable business behavior.

Imbalances between risk and reward in the compensation structure can create fatal blind spots. For instance, firms experiencing the most difficulty in managing the crisis permitted historical compensation arrangements that evidenced insensitivity to risk and skewed incentives to maximize revenues.

The bottom line is that once it is evident that market fundamentals are changing, an open and disciplined culture that focuses management on identifying options for decision-makers and making the best choices consistent with the enterprise’s appetite for risk is vital to effective reaction. React also requires the ability to convert decisions into actions, requiring change management to align behavior with new norms.

Early Movers Reflect on Failures to Recognize or React
Recognize and React are hard. Often, companies do one or the other, but not both. That is why there are so few early movers in an industry — all players within an industry rarely move quickly in response to a changing business environment.

The definition of early mover tends to differentiate firms to some extent. Early mover has been defined here as an organization that understands its critical strategic assumptions, monitors the vital signs over time, and is resilient when opportunities or risks emerge. However, it doesn’t always work out that way. Surprises hit reputable companies and opportunities are missed. The question is, “Why?”

Reflect means that an early mover learns from experience, es­pecially when it fails to Recognize or React. In this context, an early mover does two things. First, it encourages admission of errors and learning from them. Second, it commits to continuous improvement, as evidenced by the ability to internalize lessons learned by converting them into process improvements.

The speed and complexity of business will lead to occasional errors in judgment, either in terms of being completely surprised by events or situations or recognizing those events or situations are possible or inevitable, but failing to react on that knowledge. When that happens, companies aspiring to be early movers seek to learn from their mistakes.

As A.G. Lafley, former CEO of The Proctor & Gamble Co., wrote in “I Think of My Failures as a Gift,” a Harvard Business Review article: “Some of the most important and insightful learning is far more likely to come from failures than from successes. The learning has to be institutionalized to endure. Otherwise, you keep making the same mistakes over and over.”

Early movers possess early warning capability. They are informed, meaning the right people obtain the right information in timely fashion and have the right tools in place to analyze the company’s options. Whether they decide to act or not, they are usually early to see significant market shifts because they have organized capabilities to watch for them. Sometimes, they may choose to defer a decision and learn from the actions of others while they observe, gather more facts and then exploit opportunities not seen by others.

Attaining early-mover status on significant market developments over time can lead to superior longer-term enterprise value performance. Failing to attain early-mover status can result in lost market opportunities. In today’s complex and rapidly changing business environment, it can also be dangerous.

James DeLoach (jim.deloach@protiviti.com) and Jay Thompson (jay.thompson@protiviti.com) are managing directors with Protiviti, a global business consulting and internal audit firm composed of experts specializing in risk, advisory and transaction services.


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