The PIMS Principle: Linking Strategy to Performance

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9780029044308: The PIMS Principle: Linking Strategy to Performance

Since 1972 the PIMS (Profit Impact of Market Strategy) Program, working with an extraordinary data base of 450 companies and 3,000 business units, has developed a set of principles for business strategy so effective and consistent that they must now be considered part of the basic education of managers in a free-enterprise system. In this important new book, authors Buzzell and Gale summarize and explain PIMS methodology and applications in by far the most comprehensive and penetrating look at PIMS yet published, to help managers understand and predict how strategic choices and market conditions will affect business performance.

The use of PIMS to explore the general relationship between strategy and performance is accepted worldwide as a proven method to produce greater effectiveness for individual firms and the economy as a whole. Taking into account three kinds of information -- market conditions, competitive position, and financial and operating performance -- PIMS rejects the notion that there are "formulas" for management decision-making or that "easy wins" can be had by applying general rules to specific problems. Instead, the PIMS approach is based on studies of the actual experiences of businesses that have been documented in a unique data base. The principles drawn from this data base provide a solid foundation for the situation-specific analysis that managers must perform to arrive at good decisions.

Unlike Portfolio Planning methods, PIMS explores many possible dimensions of strategy and market environment, such as investment intensity, product or service quality, labor productivity, and vertical integration, all of which have powerful effects on business performance. For example, PIMS shows how the quality edge boosts performance two ways and earns superior profit margins. It verifies how market share and profitability are strongly related but also shows why that does not mean that every business can or should strive to increase its share, as demonstrated by the disastrous "kamikaze attack" launched in the early 1980s by Yamaha on the market leader Honda. Most important, it analyzes why forecasts of cash flow based solely on the growth-share matrix are often misleading and why, in fact, many so-called "dog" and "question mark" businesses actually generate cash, while many "cash cows" are dry.

Finally, Buzzell and Gale discuss the PIMS measure of "long-term value enhancement," which has been applied to more than 600 businesses in the PIMS data base over seven or more years, to uncover any conflicts between maximizing current profitability and building long-term values. Whether it's looking at market leaders or followers, picking profitable markets, or developing well-positioned business clusters whose synergy creates advantages for lasting shareholder value, PIMS is made simple and understandable in this incisive, comprehensive volume that is an invaluable addition to every personal and business library.

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About the Author:

Robert D. Buzzell is Sebastian S. Kresge Professor of Marketing at the Harvard Business School and a trustee of the Strategic Planning Institute. He also serves as a director of Chelsea Industries; General Nutrition, Inc.; United States Shoe Corporation; and VF Corporation.

Excerpt. Reprinted by permission. All rights reserved.:

Chapter 1

Are There Any General Strategy Principles?

The central theme of this book is that we can relate business strategies to performance by studying past experience. Every manager, of course, learns from his or her own experience, from that of associates, and by studying competitors' actions. Besides learning from these direct sources, we believe that general relationships between strategy and performance can also be found by analyzing the experience of many companies across a wide variety of industries. This is the kind of research that we and our colleagues at the Strategic Planning Institute have been doing since The PIMS (Profit Impact of Market Strategy) Program was initiated in 1972. Since that time, more than 450 companies have contributed information to us, documenting the strategies and financial results of nearly 3,000 strategic business units (SBUs) for periods that range from 2 to 12 years. The data base available for study covers large and small companies, markets in North America, Europe, and elsewhere, and a wide variety of products and services, ranging from candy to heavy capital goods to financial services.

By exploring the actual experiences of this vast array of businesses, we believe that we and our co-workers have succeeded in showing important linkages between strategies and results in different market and competitive settings. In this book, we summarize the principal lessons that have been learned from the PIMS research, and from its application since the early 1970s to hundreds of real-life situations. We have also tried to integrate our PIMS-based work with the ideas and research findings of others, including such authorities as Peter Drucker and Michael Porter and the empirical investigations of the Federal Trade Commission's Line of Business research program.

We believe that the general principles of strategy outlined in this book should be included in the basic education of managers in free-enterprise economies. These principles do not provide formulas for resolving specific business issues, any more than the general principles of hydraulics or thermodynamics do for specific engineering projects. But they can provide a foundation for the situation-specific analysis that is always needed to arrive at good decisions. In this way, we believe that our explorations of general relationships between strategy and performance can contribute to greater effectiveness for individual firms and for the economy as a whole.

The PIMS Approach

How can "strategy principles" be discovered? The approach we have used in the PIMS Program has been that of documenting the actual experiences of many businesses, operating in many different kinds of market and competitive settings. For each of these businesses we have collected three kinds of information:

* A description of the market conditions in which the business operates. These include such things as the distribution channels used by the SBU, the number of its customers, and their size, and rates of market growth and inflation.

* The business unit's competitive position in its marketplace. Measures of competitive position include market share, relative quality, prices and costs relative to competition, and degree of vertical integration relative to competition.

* Measures of the SBU's financial and operating performance, on an annual basis, over periods ranging from 2 to 12 years.

By analyzing these kinds of information for a sufficiently large number of business units, we can find common patterns in the relationships among them. To cite a simple example: if we compare businesses that typically sell to their customers in large average transaction amounts (over $1,000) with those that sell in smaller amounts, we find a substantial difference in average profitability. Businesses in the first group have an average pretax rate of return on investment (ROI) of about 21%, while the average ROI of those with smaller average transactions is 27%.

It is not enough, however, to simply observe a difference in the profitability of two groups of businesses. We must also ask whether the difference makes sense. Why should profitability be higher when sales are made in small amounts? In this instance, the reason is fairly obvious: when customers buy big-ticket products, or large quantities of products, they are likely to bargain more aggressively, and to shop around, because the potential savings are worth some effort. For small purchases, buyers are more likely to follow some kind of purchasing routine, such as sticking with the same supplier or selecting a known brand. (Compare your own last purchase of an automobile with your last purchase of batteries.) The impact of purchase amount and other aspects of customer buying patterns on performance are discussed in more detail in Chapter 4.

Our effort to discover and document strategy principles, then, involves both statistical analysis and the application of logic to find differences in business performance that are both significant and sensible. Sometimes the rationale for a principle is derived from economic theory: we investigated the linkage between market share and profitability, for example, because theory led us to expect that economies of scale would influence performance in most situations. In addition to formal economic theory, we have been guided by the judgments and beliefs of the many experienced managers who have participated in the design of The PIMS Program and the work that preceded it in the 1960s at the General Electric Company.

Key Differences Between PIMS and Portfolio Planning

Many business executives, management consultants, and academics in the field of strategic management view PIMS as a variant of portfolio planning. From this perspective, a PIMS-based appraisal of a business or collection of businesses is an alternative -- or sometimes a supplement -- to an evaluation in which businesses are classified according to their positions in a portfolio matrix or grid.

Portfolio classification systems come in a variety of shapes and sizes. The simplest one is the Growth-Share matrix popularized by the Boston Consulting Group in the early 1970s. Others include the so-called General Electric/McKinsey Attractiveness-Position matrix and the Competitive Position-Life Cycle classification scheme developed by Arthur D. Little, Inc. While there are important differences among these and other portfolio systems, the same rationale underlies all of them. As summarized by Richard Bettis and William Hall, the basic idea of assigning businesses to portfolio categories is that:

"...the position (or box) that a business occupies within the matrix should determine the strategic mission and the general characteristics of the strategy for the business."

In one form or another, portfolio planning methods are now widely used by corporations, especially by large and diversified ones, in the United States and other industrialized countries. According to a 1980 survey of large American companies by Phillipe Haspeslagh, more than half of them used portfolio planning systems. Over the years, the process of discussing, using, and appraising the portfolio approach has generated a new vocabulary for managers, consultants, and business school students, one that features such now-familiar metaphors as "dogs," "cash cows," and "milking strategies."

The logic of the approach we and our associates have used in assembling and analyzing the PIMS data base is similar to that of the popular portfolio approaches in one basic and important respect. We all take as a common starting point the notion that reasonable financial objectives for a business, and at least some of the general characteristics of the strategy it should adopt, depend on (1) its strategic position, and (2) the characteristics of its marketplace.

There are, however, some vital differences between the PIMS approach and portfolio classification systems. For one thing, portfolio systems attempt to explain business performance in terms of just a few key factors. The Growth-Share matrix, as its name implies, assigns businesses to one of four groups based on only two characteristics: market growth rate and relative market share. All of the many other things that affect profitability are implicitly ignored. In contrast, the PIMS Program was designed, from its inception, to explore many possible dimensions of strategy and of the market environment that might influence performance. We have, for instance, shown that investment intensity, product or service quality (relative to that of competitors), labor productivity, and vertical integration -- among other strategic factors -- have powerful effects on business performance. None of these dimensions of strategy is included in the widely-used portfolio classification systems.

A second big difference between PIMS and portfolio planning systems is that we have assembled and used a data base to determine how strategies affect results under different circumstances. This data base includes many different kinds of businesses operating in a wide variety of industries and countries. Only by investigating varied types of situations, we believe, can we or anyone else arrive at meaningful conclusions about competitive strategy. What works in one situation may be disastrous in another. Put another way, all "dogs" should not be treated alike, and neither should all "cash cows."

The Reaction Against Strategic Planning

Portfolio planning, and theoretical approaches to planning more generally, became faddish during the period from the early seventies up to the early eighties. Planning consultants and corporate planning staffs grew rapidly in number, size, and power. Perhaps inevitably, a reaction against this movement has taken place. As Kenneth Andrews put it in a 1984 article:

As with all enthusiasms that have swept the management community, a backlash has developed against strategic planning.

The backlash cited by Andrews has led to wholesale reductions in planning staffs, changes in planning procedures, and shifts in the kinds of work done by the consultants who popularized the new view of strategy a decade earlier. "Bashing" portfolio planning has become almost as much of a fad as the approach was in the first place.

Among the criticisms that have been levelled against formalized strategy analysis, one is of particular relevance here. Strategy consultants, it has been claimed, have misled managers by making recommendations that are based on excessively broad generalizations or "principles." Some commentators have gone so far as to suggest that there are no valid generalizations about strategy at all. Michael Lubatkin and Michael Pitts raised this issue in an article comparing what they termed the "policy perspective" with the "PIMS perspective." As they see it, the policy perspective assumes that "...no two businesses are exactly alike...there can [therefore] be few, if any, specific formulas for achieving competitive advantage." They go on to suggest that the "PIMS Perspective" involves a mechanistic application of formulas to complex management problems, with predictably unhappy consequences.

We should acknowledge that criticisms like these are, to some extent, reactions against the over-enthusiastic and oversimplified claims made by some advocates of PIMS and of other generalized approaches to strategy. When PIMS research results were first reported publicly in the mid-1970s, the whole idea of generalizing about strategy was new. Inevitably, in this first wave of enthusiasm for theories of strategic management, ideas were oversimplified and excessive claims were made. The same cycle of overselling and unrealistic expectations, followed by disillusionment and debunking, occurred a generation earlier when quantitative methods ("operations research") were first applied extensively to business problems.

Like those who have criticized PIMS and portfolio planning, we reject the notion that there are "formulas" for management decision-making or that "easy wins" can be had by applying general rules to specific problems. We hope we have avoided any appearance of such an oversimplified approach in this book. We do not claim to have discovered universal and precise "laws of strategy," like those of physics. But, once again, we suggest that there are general relationships that can provide valuable guidance to managers. It is just as much an oversimplification to say that every situation is unique as it is to say that they all fall into a few general categories.

Our view, then, is that there are principles that can help managers understand and predict how strategic choices and market conditions will affect business performance. Some of these principles apply to virtually all kinds of businesses, while others apply only to specific types or under certain conditions. None of them constitutes a complete formula or prescription for any individual case because there are always situation-specific factors to consider in addition to the more general ones. The general principles must be calibrated to fit the distinctive features of a particular situation, and elements of the situation that are not covered by any general principle must also be taken into account.

Strategy Principles: Some Examples

To illustrate what we mean by strategy principles, and to give a preview of some of the topics that are explored in subsequent chapters, we summarize here a half-dozen of the most important linkages between strategy and performance.

1. In the long run, the most important single factor affecting a business unit's performance is the quality of its products and services, relative to those of competitors. A quality edge boosts performance in two ways:

* In the short run, superior quality yields increased profits via premium prices. As Frank Perdue, the well-known chicken grower, put it: "Customers will go out of their way to buy a superior product, and you can charge them a toll for the trip." Consistent with Perdue's theory, PIMS businesses that ranked in the top third on relative quality sold their products or services, on average, at prices 5-6% higher (relative to competition) than those in the bottom third.

* In the longer term, superior and/or improving relative quality is the most effective way for a business to grow. Quality leads to both market expansion and gains in market share. The resulting growth in volume means that a superior-quality competitor gains scale advantages over rivals. As a result, even when there are short-run costs connected with improving quality, over a period of time these costs are usually offset by scale economies. Evidence of this is the fact that, on average, businesses with superior quality products have costs about equal to those of their leading competitors. As long as their selling prices are not out of line, they continue to grow while still earning superior profit margins.

The linkages between relative quality and business performance are shown in Exhibit 1-1. As the exhibit suggests, businesses usually achieve quality advantages first by innovating in product/service design and later via product improvements. Investments in quality, when successful, lead to gains in volume that provide scale economies.

We should emphasize that the sequence depicted in Exhibit 1-1 represents what happens on average, as reflected in the PIMS data base. Not all efforts to im

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