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SPOTLIGHT ON STRATEGY FOR TURBULENT TIMES

Spotlight ARTWORK Tara DonovanUntitled, 2008, polyester film

HBR.ORG

What Is
the Theory

f ̂ Fiof
y

Firm?
Focus less on competitive advantage and more on growth
that creates value, by Todd Zenger

f asked to define strategy, most execu-
tives would probably come up with
something like this: Strategy involves
discovering and targeting attractive
markets and then crafting positions that
deliver sustained competitive advan-
tage in them. Companies achieve these
positions by configuring and arranging
resources and activities to provide either
unique value to customers or common

value at a uniquely low cost. This view of strategy as
position remains central in business school curricula
around the globe: Valuable positions, protected from
imitation and appropriation, provide sustained profit
streams.

Unfortunately, investors don’t reward senior
managers for simply occupying and defending po-
sitions. Equity markets are full of companies with
powerful positions and sluggish stock prices. The
retail giant Walmart is a case in point. Few people
would dispute that it remains a remarkable firm. Its
early focus on building a regionally dense network
of stores in small towns delivered a strong positional
advantage. Complementary choices regarding ad-
vertising, pricing, and information technology all

continue to support its low-cost and flexibly mer-
chandised stores.

Despite this strong position and a successful stra-
tegic rollout, Walmart’s equity price has seen little
growth for most of the past 12 or 13 years. That’s be-
cause the ongoing rollout was anticipated long ago,
and investors seek evidence of newly discovered
value—value of compounding magnitude. Merely
sustaining prior financial returns, even if they are
outstanding, does not significantly increase share
price; tomorrow’s positive surprises must be worth
more than yesterday’s.

Not surprisingly, I consistently advise MBA stu-
dents that if they’re confronted with a choice be-
tween leading a poorly run company and leading a
well-run one, they should choose the former. Imag-
ine assuming the reins of GE from Jack Welch in Sep-
tember 2001 with shareholders’ having enjoyed a 40-
fold increase in value over the prior two decades. The
expectations baked into the share price of a company
like that are daunting, to say the least.

To make matters worse, attempts to grow often
undermine a company’s current market position.
As Michael Porter, the leading proponent of strat-
egy as positioning, has argued, “Efforts to grow blur

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SPOTLIGHT ON STRATEGY FOR TURBULENT TIMES

uniqueness, create compromises, reduce fit, and
ultimately undermine competitive advantage. In
fact, the growth imperative is hazardous to strategy.”
Quite simply, the logic of this perspective not only
provides little guidance about how to sustain value
creation but also discourages growth that might in
einy way move a compeiny away from its current stra-
tegic position. Though it recognizes the dilemma, it
offers no real advice beyond “Dig in.”

Essentially, a leader’s most vexing strategic chal-
lenge is not how to obtain or sustain competitive
advantage—which has been the field of strategy’s
primary focus—but, rather, how to keep finding new,
unexpected ways to create value. In the following
pages I offer what I call the corporate theory, which
reveals how a given company can continue to create
value. It is more than a strategy, more than a map to
a position—it is a guide to the selection of strategies.
The better its theory, the more successful an organi-
zation wül be at recognizing and composing stiategic
choices that fuel sustained growth in value.

The Greatest Theory Ever Told
Value creation in all realms, from product devel-
opment to strategy, involves recombining a large
number of existing elements. But picking the right
combinations out of a vast array is like being a blind
explorer on a rugged mountain range. The strategist
CEinnot see the topography of the surrounding land-
scape—the true value of various combinations. All
he or she can do is try to imagine what it is like.

In other words, leaders must draw from available
knowledge and prior experience to develop a cogni-
tive, theoretical model of the landscape and then
make an educated guess about where to find valu-
able configurations of capabilities, activities, and re-
sources. Actually composing the configurations will
put the theory to the test. If it’s good, the leader will
gain a refmed vision of some portion of the adjacent
topography—perhaps revealing other valuable con-
figurations and extensions.

Companies that enjoy sustained success are typi-
cally founded on a coherent theory of value creation.
All too often such companies get into trouble when
the founders’ successors lose sight ofthat theory—
whereas turnarounds, when they occur, often in-
volve a return to it. The history of the Walt Disney
Company provides a case in point. Its founder had
a very clear theory about how his company created
value, which was captured in an image held in the
company’s archives and reproduced here (see the

exhibit “Walt Disney’s Theory of Value Creation in
Entertainment”).

The image depicts a range of entertainment-
related assets—books and comic books, music, TV,
a magazine, a theme park, merchandise licensing—
surrounding a core of theatrical films. It illustrates
a dense web of synergistic connections, primarily
between the core and other assets. Thus, as precisely
labeled, comic strips promote films; films “feed ma-
terial to” comic strips. The theme park, Disneyland,
plugs movies, and movies plug the park. TV publi-
cizes products of the music division, and the film di-
vision feeds “tunes and talent” to the music division.
Walt’s theory in words might read: “Disney sustains
value-creating growth by developing an unrivaled ca-
pability in family-friendly animated (and live-action)

Walt Disney’s Theory of
Value Creation in Entertainment
This 1957 map of Walt Disney’s vision defined his company’s key

assets, including a valuable and unique core, and identified patterns

of complementarity among them. It implicitly revealed the industry’s

future evolution and provided guidance concerning adjacent competitive

terrain that Disney might explore. The asset and capability combinations

that emerged from the theory have evolved with time, but the theory

itself has not fundamentally changed.

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COMIC STRIPS

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WHAT IS THE THEORY OF YOUR FIRM? HBR.ORG

Traditionally, practitioners see strategy as the
process of discovering and targeting attractive
markets and then crafting positions that will
deliver sustained advantage in them.

Unfortunately, investors don’t

reward senior managers for

simply occupying and defend-

ing market positions. They look

for evidence that the company

can continually find new

competitive advantages.

To do that, managers

need a corporate theory that

explains how they can create

value by combining the

company’s unique resources

and capabilities with other

assets.

A good theory incorporates

foresight about an industry’s

future, insight into which inter-

nal capabilities can optimize

that future, and cross-sight

into which assets can be

configured to create value.

The successes of the Walt

Disney Company and Mittal

Steel were driven by good

corporate theories. In contrast,

AT&T’s strategic actions after

the spin-off of the Baby Bells

provide a cautionary tale about

what can happen when

a large company lacks a

coherent theory.

films and then assembling other entertainment as-
sets that both support and draw value from the char-
acters and images in those films.”

The power of this theory was perhaps most viv-
idly revealed following Walt’s death. Within 15 years
leadership at Disney seemed to lose sight of his vi-
sion. As the company’s films markedly shifted away
from the core capability of animation, the engine of
value creation ground to a halt. Film revenues de-
clined. Gate receipts at Disneyland flattened. Charac-
ter licensing slipped. The Wonderful World of Disney,
the TV show that American families had gathered to
watch every Sunday evening, in a nationwide em-
brace, was dropped from network broadcast. By the
time I entered college, in the late 1970s, the Disney
franchise many of us had grown to love as children
had all but disappeared.

Attesting to the depths of Disney’s disarray, cor-
porate raiders in 1984 attempted the unthinkable:
a hostile acquisition of the company with a view
to selling off key assets, including the film library
and prime real estate surrounding the theme parks.
The capital markets embraced this idea, leaving the
board with a critical choice: sell Disney to the raiders,
who would pay a significant price premium but dis-
mantle the company, or find new management. The
board chose the latter and hired Michael Eisner.

Eisner rediscovered Walt’s original theory and
used it to guide a heavy investment in animated pro-
ductions, generating a string of hits that included
The Little Mermaid, Beauty and the Beast, and The
Lion King. Over the next 10 years Disney’s box office
share jumped from 4% to 19%. Character licensing
grew by a factor of eight. Attendance and margins at
the theme parks rose dramatically. Disney’s share of
income from video rental and sales soared from 5.5%
to 21%. Eisner opened new theme parks, made fur-
ther investments in live-action films, and expanded
into adjacent businesses consistent with the theory.

including retail stores, cruise ships, Saturday morn-
ing cartoons, and Broadway shows. By essentially
dusting off Walt’s theory and aggressively pursu-
ing strategic actions consistent with it, Disney won
growth in its market capitalization from $1.9 billion
in 1984 to $28 billion in 1994.

That cycle has repeated itself in the years since:
Although the move into Broadway shows was com-
plementary to animated films, character licensing,
and theme parks, other strategic moves, such as the
1988 acquisition of a Los Angeles TV station, the 1995
purchase of Cap Cities/ABC, and the 1996 purchase
of the Anaheim Angels, failed to reflect the theory’s
logic. Meanwhile, Eisner allowed the core animation
asset to atrophy again as the company failed to keep
up with technology trends and the best-in-the-world
animators migrated from Disney to Pixar. Disney
gained access to their skills through a contract, but
the relationship between Disney and Pixar grew con-
tentious and was finally severed just before Eisner
stepped down, in October 2005.

His successor, Robert Iger, quickly moved not
merely to repair the Pixar relationship but to acquire
the company, for more than $7 billion. Disney’s re-
cent acquisitions of Marvel and Lucasfilm fuel this
central asset, although they carry the company into
somewhat unfamiliar terrain: The Marvel and Star
Wars casts are quite different from Disney’s tradition-
ally princess-heavy character set. Whether this stra-
tegic experiment proves to be value-creaüng remains
to be seen. But Walt Disney’s road map for growth
has clearly endured long past his death, providing
a remarkable illustration of posthumous leadership.

The Three “Sights” of Strategy
The Disney strategy has all the hallmarks of a power-
ful corporate theory. It has consistently given senior
managers enhanced vision—a tool they repeatedly
used to select, acquire, and organize complementary

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SPOTLfGHT ON STRATEGY FOR TURBULENT TIMES

Steve Jobs’s Corporate Theory of Value Creation
On August l o , 2on, Apple surpassed ExxonMobil to
become the world’s most valuable corporation—a
remarkable feat for a company left for dead in 1997.
Although credit for Apple’s success correctly goes to
Steve Jobs, the real substance of his genius has often
been misunderstood. Like Walt Disney’s, his greatest
contribution was not a product, a plan, or a managerial
attribute; it was a corporate theory of value creation-
one that nearly every purported industry or strategy
expert consistently encouraged him and his successors
at Apple to abandon.
Jobs’s theory was apparent in the

famous Apple II computer, launched in

1977. Although its inner workings were

the brainchild of Apple’s cofounder, Steve

Wozniak, Jobs was responsible for the

friendly packaging, the sleek casing, and

the marketing-focused company that

brought the product to consumers with

tremendous fanfare. A wave of entries into

the personal computing space followed,

each introducing a unique software and

hardware platform.

But in 1981 the industry was trans-

formed when IBM introduced the IBM

PC. It was an instant success, widely

applauded for its open architecture. The

industry rapidly moved toward generating

IBM-compatible software and hardware.

Cheaper, faster, and greater storage

capacity quickly came to define competi-

tive success. Competing platforms rapidly

disappeared and is years of intense

competition ensued, until Dell eventually

discovered a powerful position.

Jobs, however, continued managing to

a very different set of performance criteria,

reflecting his theory of value creation.

That theory not only guided Apple’s strat-

egy in computing but defined a succession

of future moves and choices. It took on

greater clarity with time, but essentially it

held that consumers would pay a premium

for ease of use, reliability, and elegance in

computing and other digital devices, and

that the best means for delivering these

was relatively closed systems, significant

vertical integration, and tight control over

design.

Like Disney’s, Jobs’s theory incorporated

all three strategic “sights.” It was inspired

by foresight about the evolution of cus-

tomer tastes. Jobs recognized that com-

puters would become a consumer good,

akin to the Sony Walkman. He believed

that consumers would appreciate aesthet-

ics and aspired to create a device with the

elegance of a Porsche or a well-designed

kitchen appliance.

His insight was that the internal capabil-

ity most critical to value creation in this

bundles of assets, activities, and resources. How can
you tell if your own corporate theory is as good? The
answer depends on the extent to which it provides
what I call the strategic “sights”: foresight, insight,
and cross-sight. Let’s look at these a bit more closely.

Foresight. An effective corporate theory ar-
ticulates beliefs and expectations regarding an in-
dustry’s evolution, predicts future customer tastes
or consumer demand, foresees the development of
relevant technologies, and perhaps even forecasts
the competitive actions of rivals. Foresight suggests
which asset acquisitions, investments, or strategic
actions will prove valuable in predicted future states
of the world. It should be both relatively specific and
somewhat different from received wisdom. If it is
too generic, it won’t identify which assets are valu-
able. If it is too widely shared, the desired assets and
capabilities will be expensive to acquire (because
competed for) or else not unique (and therefore un-
likely to create sustained value). Walt Disney’s fore-
sight was that family-friendly visual fantasy worlds
had vast appeal.

Insight. If competing companies own assets
identical to yours, they can replicate your strategic
actions with equal or perhaps even refined capac-

ity, thus undermining any superior foresight in your
theory. An effective corporate theory is therefore
company-specific, reflecting a deep understanding
of the organization’s existing assets and activities. It
identifies those that are rare, distinctive, and valu-
able. Disney’s key insight was recognizing the value
of the company’s early lead and substantial invest-
ment in animation and its capacity to create timeless,
unique characters that, unhke real actors, required
no agents.

Cross-sight. A well-crafted corporate theory
identifies complementarity that the company is sin-
gularly able to assemble or pursue by acquiring as-
sets that can be combined with existing ones to cre-
ate value. Disney’s theory suggested a broad array of
entertainment assets that could draw value from a
core of animation.

Together these three sights enable leaders to
compose a succession of value-creating actions.
Foresight regarding future demand, technology, and
consumer tastes highlights domains in which to
search for cross-sight. Insight regarding unique as-
sets focuses the search for foresight and cross-sight.
Cross-sight reveals valuable complementarities,
highlighting the domain of foresight.

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WHAT IS THE THEORY OF YOUR FIRM? HBR.ORG

competitive terrain was design. Of course,

that was in part a reflection of his person-

ality: Jobs was a self-proclaimed artist,

obsessed with color, finish, and shape; but

he transferred this obsession to the tech-

nology as well. Walter Isaacson, Jobs’s

biographer, wrote, “He got hives, or worse,

when contemplating great Apple software

running on another company’s crappy

hardware, and he likewise was allergic to

the thought of unapproved apps or con-

tent polluting the perfection of an Apple

device.” In pursuing Jobs’s focus on design,

Apple made heavy R&D investments, much

larger in percentage terms than those of

any of its competitors.

His theory also provided cross-sight, in

that it helped Jobs identify external assets

through which value could be created,

including the graphical user interface (GUI)

technology that Apple obtained from Xerox.

During his famous visit to Xerox, Jobs

repeatedly expressed incredulity that the

company was not aggressively commer-

cializing the technology. He saw that GUI

perfectly fit his theory, because it made

a computer easy to use and attractive

to engage with. Some regard what next

transpired as one of the greatest technol-

ogy transfers in history.

The Macintosh was the first fully formed

embodiment of Jobs’s theory, and it gar-

nered wide acclaim and remarkably high

margins (as Jobs had predicted). But the

IBM standard was already well established,

and the opposing network economics were

overwhelming. Although the Mac survived

as a very profitable niche product. Bill

Gates and others exerted enormous pres-

sure to port the look and feel of the Macin-

tosh operating system to the IBM platform.

Jobs, however, refused to countenance any

such experiment.

For years academics and journalists

derided this strategic refusal. Jobs was

banished from Apple for more than a

decade, in part for his dogged insistence

on sticking to his theory. His subsequent

vindication has become the stuff of legend.

He returned to Apple in 1996, shortly

after the struggling enterprise had been

shopped unsuccessfully to HP, Sun, and

even IBM. Most people anticipated that he

would simply dress the company up for

sale. Instead he reimposed his theory with

a vengeance, trimming the product range

and introducing a new line of Macintosh

products, not available for license. More

important, he used it to explore adjacent

terrain, producing a remarkably success-

ful series of strategic moves across a wide

range of product categories.

Apple was not the first to design a digital

music library, manufacture an MP3 player,

or market a smartphone. But it was the

first to craft and configure those devices

and their user environment with elegant,

easy-to-use designs and with tight control

of complementary products, infrastructure,

and market image. Apple has shown that

Jobs’s theory has broad application beyond

computing, with industries and product

categories ranging from TV, video systems,

home entertainment, portable readers,

information delivery, and even automotive

systems as possible targets. In contrast,

the well-positioned Dell has struggled to

find a way out of a declining PC industry.

When Strategy Lacks a Theory
Not all corporate theories are created equal, however,
and some companies never discover valuable ones.
The story of AT&T is a case in point.

In 1984 the seven regional Bell Operating Compa-
nies were spun off from AT&T, eliminating Ma Bell
from local telephone service and slashing assets
from $150 billion to $34 billion. AT&T was left with
its long-distance business, its manufacturing arm
(Western Electric), and its R&D organization. Bell
Labs. With no clear path for growth, the company
needed a new theory of value creation.

Its first strategic actions after the breakup sug-
gest that its leaders had composed a theory whereby
they would leverage what they perceived as broad
managerial competence to invest large cash ñows
from long-distance service in diverse acquisitions
and new businesses. Over the next several years the
company got into data networking, financial ser-
vices, computing, and an internet portal. The mar-
ket was distinctly unimpressed, and in 1995 AT&T
abandoned its diversification theory, announcing
that it would divest two key assets, NCR and Lucent
Technologies—essentially carving itself into three
distinct companies.

Management quickly composed a new theory
that reflected its belief in the value of acquiring the

“last mile” connection to local customers and provid-
ing a bundled package of telephone, broadband in-
ternet, and cable services. This theory drove a series
of costly cable-industry acquisitions in 1998-1999,
totaling more than $80 billion. Unfortunately, the
theory was rather widely shared by other companies
and investors, and purchase prices reflected this (the
cost per subscriber exceeded $4,000). Nevertheless,
the market initially applauded these moves, driving
AT&T’s share price to an all-time high of $60. But by
May 2000 the stock had dropped back close to $40
a share. In response, AT&T again began questioning
its theory—or at least its ability to sell that theory
to Wall Street. In October 2000 the company an-
nounced that it would spin ofFthe wireless and cable
units, and five years later it put itself up for sale.

The moral of the AT&T story is clear: It pays to
invest a lot of time and energy in crafting a robust
theory that, like Disney’s, is quite specific as to how
combinations of assets create value. AT&T’s first
theory following the breakup never made clear how
the company’s supposed managerial competence
could be uniquely applied to new types of assets; it

June 2013 Harvard Business Review 77

SPOTLIGHT ON STRATEGY FOR TURBULENT TiMES HBR.ORG

lacked insight and cross-sight and certainly any vi-
sion of the future. The company’s second theory was
equally fiawed: It contained foresight, but in a form
that was already widely shared and thus could not
generate unique cross-sights.

Bargain Hunting with a
Corporate Theory
The real power of a well-crafted corporate theory
becomes particularly evident when companies go
shopping. Value creation in markets always comes
down to prices paid, and a good corporate theory en-
ables the acquirer to spot bargains that are uniquely
available to it.

Mittal Steel is a good example. From its origin,
in 1976, until 1989, it was a very small player in an

such assets—especially ones with integrated technol-
ogy and large iron ore deposits—was unthinkable, so
the field was wide open for Mittal.

Mittal’s insight was its understanding of the
value of DRI and its own ability to lead turnarounds
in formerly state-owned enterprises. Its foresight
was an early recognition of the value of iron ore as-
sets—given the strong growth in demand for steel in
emerging economies—and the virtues of industry
consolidation. Its cross-sight was to recognize the
types of assets that could benefit from the compa-
ny’s distinct capabilities.

By 2004 Mittal had emerged as the world’s largest
and lowest-cost steel producer. Lakshmi Niwas Mit-
tal, the company’s owner, is now one of the world’s
wealthiest people. This success came from having a

An effective corporate theory is company-
specific; it identifies those assets and activities
that are rare, distinctive, and valuable.

industry consistently ranked at the bottom in fi-
nancial performance. Mittal began as a small mill in
Indonesia, where it developed a capability in a new
iron ore input technology called direct reduced iron
(DRI), which provided mini-mills with a high-quality
alternative to scrap metal.

Mittal simply grew with Indonesia’s emergence as
a tiger economy. But in 1989 it made its first major ex-
pansion move by acquiring a troubled steel operation
owned by the government of Trinidad and Tobago—
a mill that was operating at 25% capacity and losing
$1 million a week. Mittal quickly proceeded to turn
this business around as it transferred knowledge, de-
ployed DRI, and increased sales. A succession of sig-
nificant acquisitions followed over the next 15 years,
primarily of assets in the former Soviet bloc; each
proved to be a gold mine.

A clear and simple corporate theory guided this
acquisition program: Mittal knew how to create value
from poorly understood and poorly managed state-
owned steel operations in developing economies
where demand for the product was growing fast. To
other steel companies, many of which were focused
on improving their internal operations, acquiring

corporate theory that functioned as a rather remark-
able treasure map, one that continues to reveal as-
sets uniquely valuable to Mittal.

THE PSYCHOLOGIST Kurt Lewin famously commented,
“There is nothing so practical as a good theory.” The-
ories define expectations about causal relationships.
They enable counterfactual reasoning: If my theory
accurately describes my world, then when I choose
this, the foUowing will occur. They aie dynamic and
can be updated on the basis of contrary evidence or
feedback. Just as academic theories enable scien-
tists to generate breakthrough knowledge, corporate
theories are the genesis of value-creating strategic
actions. They provide the vision necessary to step
into uncharted terrain, guiding the selection of what
are necessarily uncertain strategic experiments. A
better theory yields better choices. Only when your
company is armed with a well-crafted corporate
theory will its search for value be more than a ran-
dom walk. 0 HBR Reprint R1306D

B a Todd Zenger is the Robert and Barbara Frici< Profes- n n sor of Business Strategy at Washington University in St. Louis's Olin Business School.

78 Harvard Business Review June 2013

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Article Reading Notes (two pages) and Book Review (three pages) Format:

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