Stuck in the Middle

Clowns to the left of me,
Jokers to the right, here I am,
Stuck in the middle with you.
— “Stuck in the Middle with You” a song by Stealers Wheel

The “middle” seems to be what every executive wants to avoid these days. There is ample research on business strategy that suggests the middle is to be avoided for fear of being stuck in it. The conventional view is to see the “middle” as the problem. I see things slightly differently: the problem is not the middle; it is allowing your firm to get stuck at all. How you see the problem has big implications for taking action.

Closer to home, a recent article, “Trouble in the Middle,” which appeared recently in The Economist, suggested that time may be running out for business schools that “aren’t quite elite.” The Economist uses its rankings to segment the market (readers of this blog will be familiar with my reservations about rankings.) The author argued that the value proposition of mid-ranked schools has worsened and presages a “shakeout…which could be nasty.” Thus, the problem of the middle is relevant beyond the boundaries of the for-profit sector.

Michael Porter of Harvard Business School originally discussed the problem of “stuck in the middle.” He said that the profitability of firms depends not only on the typical rates of return in an industry. It depends more importantly on the firm’s position and competitive advantage in that industry. And he argued that competitive advantage derives from one of two strategies: cost leadership or differentiation of products or services. Across most industries you can find firms and products that aim for advantage based on either cost or differentiation.

The problem, Porter said, was in trying to do both and thus doing neither very well. He seemed to be saying, “find what you are good at and stick to it.” This focus on competencies is very sound. Porter wrote, “The firm stuck in the middle is almost guaranteed low profitability. It either loses the high-volume customers who demand low prices or must bid away its profits to get this business away from low-cost firms. Yet it also loses high-margin businesses — the cream — to the firms who are focused on high-margin targets or have achieved differentiation overall. The firm stuck in the middle also probably suffers from a blurred corporate culture and a conflicting set of organizational arrangements and motivation system.” (Competitive Strategy, p. 41-42)

The following table gives some examples from various industries. The firms in “the middle” have felt or are feeling a severe contraction.

American Airlines recently filed for bankruptcy. Chrysler and GM required a government bailout in 2009. Piaggio acquired its way into the differentiated end of the market by buying Aprilia. Dr. Pepper was acquired by Cadbury Schweppes. As these examples seem to suggest, the middle is not a place to become stuck.

Porter’s characterization eventually spawned opposition, arguing that the middle may not be all that bad or that it may be entirely sensible for managers to test the middle for the sake of discovering possible new segments of demand. After all, demand can be defined on numerous dimensions, well beyond cost and difference, such as convenience, style, and location. Then too, there is the pesky problem that consumer demand keeps changing over time, which necessitates constant experimentation by firms to discover where the new demand is. Today’s single-minded focus on cost or difference may be tomorrow’s business graveyard.

I was a student of Porter’s in the 1970’s when his iconic treatise, Competitive Strategy, hit the business world. I recall that his readers quickly absorbed his thinking about competitive positioning and generic strategies. But it struck me that they often ignored another aspect of Porter’s work, the dynamic “jockeying for position” among firms. Firms and markets are not static. They continually change as firms try to best one another. And periodically, new technologies come along that completely upset the competitive field. Another great economist, Joseph Schumpeter, described the competitive turbulence of capitalism as the “gale of creative destruction.”

Being stuck in an unattractive business without a viable exit is one of the worst situations for a firm. For instance, a diversified firm that I studied owned a coal tar refinery that had operated for over 100 years. The facility was inherited in an acquisition many years earlier. The plant was antiquated and inefficient. Furthermore, the market had turned highly competitive, making the refinery very unprofitable. The firm wanted to exit the business, but couldn’t, because doing so would trigger environmental clean-up obligations from chemical leakage over the years. Eventually, the company appointed a new manager who immediately opened negotiations with the environmental authorities, and eventually negotiated a “workout” program in which the refinery would be closed immediately and environmental remediation would be conducted over time, rather than all at once. This was an enormous success for the company and the manager, who recognized that not only was the company stuck, but so were the environmental authorities, who had been stymied by the inaction of the company.

Nuclear power plants, petrochemical plants, and many manufacturing plants face exit costs that can ruin the economics of a business as it approaches its end. Another example of being “stuck” is encountered by a minority investor in an underperforming private firm—even if a minority investor wanted to exit, his or her investment could be stranded if the securities are illiquid. Such would be the case until the majority investor decides to sell the entire firm. An airline can become stuck by virtue of an aging fleet of airplanes, uneconomic union contracts, and/or landing rights that don’t fit the more profitable segments of demand. Retailers can become stuck by virtue of stores planted in neighborhoods with the wrong demographic trends. A technology company can become stuck because of a commitment to obsolete technology.

Irreversible strategic positions entail commitments that expose the firm to risks. In contrast, flexible positions can be altered as conditions change. You can think of flexibility as a call option on an alternative strategy–it is enabled, for instance, by holding excess manufacturing capacity, excess inventory, or excess cash. Management techniques such as lean manufacturing grant strategic flexibility.

An illustration of the creation of flexibility is apparent in the trend toward “modularization” of manufacturing. Complex business processes and products can be organized into sub-units, called “modules,” that permit specialization, encourage greater innovation, and promote efficiency. The innards of any personal computer and the success of Dell Computer illustrate the fruits of modularity: architectural flexibility pays.

Too often, MBA students and executives think that “risk management” means the active avoidance of risks. But societies need business managers to take sensible risks—to seek risk—because that’s where opportunities lie. The best executives understand that the great sin has less to do with risk-taking (such as exploring the “middle” of a market) and instead has to do with failing to develop flexibility—such as a sensible “Plan B”—if the dice turn against you.

I agree with The Economist that the field of b-schools is in for some turbulence. And if other industries are any guide, the turbulence could hit the middle hardest. But The Economist says little about the possible ingenuity of leaders of those schools or of the agility those schools might show. The next few years will be very interesting. As Yogi Berra said, “It ain’t over ‘till it’s over.”

Stealers Wheel characterize “stuck in the middle” as being caught between clowns and jokers. These may be weak competitors to your firm and therefore may present a great opportunity to serve markets and create value. If so, is the middle that bad? Yes it is, if you are stuck in some important way. The inability to respond flexibly and appropriately to new competitive conditions is the grave threat.