The Idea in Brief
When Charles Lazarus replicated successful strategies from the supermarket industry to launch Toys ‘R’ Us (think exhaustive selection, low prices, self-service), he used analogical thinking: He drew lessons from one business setting and applied them to another.
Sometimes analogies spark breakthrough strategies—as Toys ‘R’ Us’s successful launch shows. But when analogies are based on surface-level similarities, they can lead managers astray. Consider Enron: By ignoring key differences between natural gas trading and broadband trading, Enron embarked on a diversification scheme that proved disastrous.
How to tap the power of analogical thinking while sidestepping its pitfalls? First, articulate the analogy your management team is using to weigh a potential new strategy. Only by making your analogy explicit can you then assess its soundness. Ford Motor Company, for example, examined Dell Computer’s innovative supply chain model before deciding that production similarities between the auto and PC industries were outweighed by differences in industry cost structures. Finally, decide how well your strategy will translate to a new setting—and fine-tune it to address key differences.
It’s impossible to make analogies 100% safe. But by employing several straightforward steps, you can boost your chances of avoiding analogical thinking’s dangers—and make smart, successful strategic choices.
The Idea in Practice
To tap the power of analogical thinking, apply these steps:
- Articulate the analogy. In deciding to launch CarMax, a chain of used-car outlets, successful electronics retailer Circuit City drew an analogy between the electronics-retailing environment of the 1970s (its “source” setting) and the used-car industry of the 1990s (its “target” setting).
- Identify why the “source” strategy worked. The 1970s electronics-retailing industry was dominated by small, local retailers of variable quality and efficiency. Untapped efficiencies (for example, unexploited economies of scale) and unmet customer needs (stores suffered frequent stockouts) also characterized the industry.
Circuit City’s strategy? Offer large stores that stocked exhaustive selections and pair automated distribution centers with sales-tracking technology to ensure product availability. Differentiating itself on selection and product availability, the company crushed smaller rivals.
- Assess similarities and differences between the source and target setting. The 1990s used-car industry strongly resembled the 1970s electronics-retailing industry. For example, customers didn’t trust retailers; economies of scale and barriers to entry were limited; and information and distribution technology were primitive.
But important differences existed as well. For instance, in consumer electronics, Circuit City had a large base of dependable, reputable suppliers—while most used-car dealers bought inventory from variably reliable wholesalers or individual car owners.
- Translate your strategy to the new setting. Circuit City’s strategy for CarMax closely matched its electronics-retailing operation. For example, CarMax’s large-lot “superstores” offered broad inventories of 200 to 550 vehicles. Moreover, the company sold cars at fixed, posted prices, with no haggling—which reduced mistrust between customers and used-car dealers. It also paid salespeople a flat fee per vehicle—eliminating incentives to push more expensive cars on customers.
But CarMax adjusted Circuit City’s formula to reflect the two settings’ differences. For instance, unlike the electronics-retailing industry, the used-car industry lacked reliable supply sources. CarMax addressed this difference by placing well-trained buyers in each store who offered to buy used cars directly from consumers. Then it thoroughly inspected and reconditioned used cars before reselling them.
CarMax’s reward? Revenues of $4.6 billion in 2004, a multibillion-dollar market capitalization, and equity returns that roughly matched the S&P 500’s.
Strategy is about choice. The heart of a company’s strategy is what it chooses to do and not do. The quality of the thinking that goes into such choices is a key driver of the quality and success of a company’s strategy. Most of the time, leaders are so immersed in the specifics of strategy—the ideas, the numbers, the plans—that they don’t step back and examine how they think about strategic choices. But executives can gain a great deal from understanding their own reasoning processes. In particular, reasoning by analogy plays a role in strategic decision making that is large but largely overlooked. Faced with an unfamiliar problem or opportunity, senior managers often think back to some similar situation they have seen or heard about, draw lessons from it, and apply those lessons to the current situation. Yet managers rarely realize that they’re reasoning by analogy. As a result, they are unable to make use of insights that psychologists, cognitive scientists, and political scientists have generated about the power and the pitfalls of analogy. Managers who pay attention to their own analogical thinking will make better strategic decisions and fewer mistakes.