The article “The Coherence Premium” by Paul Leinwand and Cesare Mainardi describes what companies enables to achieve long-term exceptional profits: They call it “coherency” – focusing on “what we do better than anyone”. For a coherent strategy, internal capabilities have to be aligned with the appropriate market position. For success here, the company has to answer the following questions: “How are we going to face the market?”, “What capabilities do we need?”, “What are we going to sell, and to whom?” In my opinion, a consistent answer to these questions indeed encompasses the potential for impressive profitability margins but does not sufficiently outline the best response for companies that operate in shrinking markets – would it be best to enter into more promising markets without having the fitting internal capabilities, would it be to try to alter the internal capabilities and thereby endanger the position in the original market or would it be a mixture of these two approaches?
How difficult this can be illustrates the example of the German toymaker Steiff, which is most famous for its high-quality teddy bears that are also sold in the US. In the early 2000s it faced the challenge of cheap stuffed animals from Southeast Asia more and more prevailing in large department stores. Up to 2004 it only produced in its high-wage home country Germany, which did not allow a good response to this trend. Thus, it made the decision to add an additional product line with cheaper stuffed animals being produced in China to tackle this trend. However, already after four years Steiff decided to pull out of the Chinese production because of massive quality issues and the concern of a brand dilution. The reason for these problems can be found in internal capabilities insufficiencies of the Chinese production: In contrast to its long-trained, skilled domestic workforce, in China workforce was much less loyal so that it often was already gone after the 12-month training. Furthermore, the large distance and shipping ways only allowed for a slow reaction to new market trends, which had been an important capability so far. In the end, Steiff stayed at its fully integrated domestic approach for its key product. In order not to shrink it instead began to deal with the trend of cheaper products by introducing new products in less related markets with a lower danger of brand dilution – it licensed clothes, which were manufactured in Turkey. This was a compromise between labor costs (more expensive than China) and distance (much closer than China with land carriage available).
This case exemplifies the difficulties for companies to ensure good profitability margins in shrinking market with no entirely coherent capability system for new markets. Only remaining in their shrinking market is also no option because the continuous costs for downsizing without entering insolvency, which are much higher in Europe than in the US with large-scale redundancy payment schemes and a growing relative company pension scheme, endanger long-term profitability as well. Finally, a mixture between core capabilities and new promising markets was chosen but I would not consider the Steiff example to be generally applicable and think that further guidance on the raised question of “Do we understand how to leverage the capabilities system in new or unexpected areas?” would be a valuable addition to the article for many companies that find themselves at the descending part of their product lifecycle curve.
The Coherence Premium (Leinwand and Mainardi, Harvard Business Review, June 2010)