324. How strategy creates value: The four foundations that drive long-term performance

0:02Tim Koller: Just for the moment and the era we're in and the pace that needs to happen, like does moderate confidence in your strategy allow you to reallocate 30 % of your resources towards a new market? Are you really sure that your mode's being defended? So it's not so much that people aren't doing it or don't have a sense of strategy, but is the conviction around that strategy strong enough to actually act and for large companies to act at scale?

0:26Whitney Zimmerman: For McKinsey & Company, I'm Sean Brown, and welcome to Inside the Strategy Room. That was Andy West, co-author of the forthcoming book, Strategy and Value, The Four Foundations That Drive Long-Term Performance. The new book, which we'll link to in the show notes, distills decades of McKinsey client work and research into a powerful, integrated framework. It moves beyond short-term metrics and market noise to focus on what truly drives sustainable value. It also provides an essential roadmap for leaders seeking to navigate complexity and enable their teams to act with courage. In this episode, Andy and his co-authors join us to step through the four essential foundations that link strategy and value creation.

1:12Whitney Zimmerman: Andy is a senior partner based in our Boston office and co-leads our strategy and corporate finance practice globally. Tim Kohler is a partner emeritus based in Denver and a founding member of our strategy and corporate finance practice. And he's also the co-author of the bestselling book Valuation, now in its eighth edition. And Whitney Zimmerman is a distinguished expert on strategy based in our London office. Welcome everyone. So while we're here today to talk about the key messages from your book, obviously there's no lack of strategy books and frameworks that are already out there on the market.

1:46Whitney Zimmerman: So Andy, I was hoping maybe first you could talk about why you and your co-authors decided to write this book and why now is such an important time to talk about this topic?

1:57Tim Koller: Yeah, thanks, Sean. It's a great question. And I think some of the answer lies in the question, the way you phrased the question itself, which is there's a lot of information out there. We're kind of living in a world of abundant information. So the more data, more synthesis, more frameworks, as you mentioned, than ever before. And on top of that, we're seeing a lot of change, right, that's happening in the world where there's real shifts as we kind of enter what we call McKinsey New Era, right, whether that's AI technology, geopolitics, trade-right dynamics, kind of customer channel dynamics.

2:30Tim Koller: You know, and when we look at industry boundaries, we see that those are changing at a pace. And we'll share some of that data as we talk today. But we see all of this change happening in the world. Do you think it's going to be a bit of a golden era of strategy? I mean, now is the time to take advantage of these pivots and these moments. And yet, when I talk to executives, there's just a general sense of ineffectiveness around strategy overall, whether it's just comments about the strategy process being broken. Strategy, in many cases, is not happening. Just tactics have taken over. Quarterly adjustment shifting, project after project with a lack of the end in mind is happening.

3:08Tim Koller: Budgets being generally ineffective and too slow. Like, you name it, people are generally dissatisfied. And I think a lot of that empowerment that I talk about with abundant information is also making executives really reactive, whether it's boards or customers or employees, investors, everyone has more information. And so we're this kind of constant cycle of being reactive. And one of the great things of co-leading a practice at McKinsey is I get to sit and I get to think about these challenges and what do we want to do about it. And when I have these kinds of problems, I usually call the smartest people I know.

3:42Tim Koller: And in this case, it was Tim and Whitney and said, are you seeing the same thing from from your vantage point? And we basically said, yeah, you know, and as we talk about what do we do with this conundrum, we're saying we're really going back to the fundamentals in most of our conversations. We're using all of this asymmetry and all of this information to enrich conversations about the fundamentals of decision making, as opposed to kind of throwing another log on the fire of complexity. So we thought, hey, there might be something. If the fact that the three of us are all having similar conversations, maybe there's a book in there somewhere, and here we are.

4:18Whitney Zimmerman: And Tim, as I mentioned, you've co-authored eight editions of Valuation across more than three decades. What excited you most about this new book?

4:27Andy West: I'm excited about the book because it's a chance to bring together strategy and value creation topics that are often treated separately. One of the reasons I joined McKinsey 40 years ago was because I was working in a financial consulting firm and I was frustrated that we were trying to answer questions without sort of dealing with the strategy issue. And McKinsey really created an opportunity to do that. And that's what we can do with our clients. And so the opportunity to actually document the linkages and make it accessible to a broad audience of how these things fit together is exciting to me.

5:06Andy West: In the academic world, the strategy professors rarely talk to the finance professors. And so this is something that's not out there. So it's exciting to me to put something out there that really brings the two together and shows how they link up and why that's important.

5:22Whitney Zimmerman: Thank you, Tim. And Whitney, what's been exciting about the book for you? Are there any particular challenges that leaders that you work with are facing today that the book is addressing? The one thing I would add is over the last couple of years, I've led our work counseling two strategy officers on how to succeed in the role. I talked to a lot at three to five, five a week. And one of the things that I'm hearing a lot right now is that with AI, a lot of people are all of a sudden becoming managers. AI is equipping people across organizations with superpowers, right? With the ability to think about, ideate, explore ideas.

6:00Whitney Zimmerman: and that creates enormous strategic potential, which firms need to compete in this modern era and to drive prosperity and innovation and growth. It also creates a bit of a risk if people across an organization are not well-grounded in the fundamentals of how strategy creates value, what good strategy looks like and how it drives value. And if they don't share a common language for what that means for your business, then that energy can go in too many directions. It can cause more problems than potential. And so we think that in this era, it is particularly important to equip people with the essentials for how to understand as a manager, as a leader, as a designer, as an operator, how does strategy create value?

6:41Whitney Zimmerman: And as a result of that, how can you take the very best initiative for your business? Well, this is great. I'm really excited for the conversation. So Andy, Whitney just described some of the challenges that leaders are facing as a result of AI and technological change. How are you seeing uncertainty also play into this?

7:00Tim Koller: So uncertainty as a concept has certainly been increasing. And you'll see when we look at the data, we look at a few different things. One is how do managers feel? And as I talked about our rationale for the book, this concept of, I don't know where the future is taking me. I don't know what's coming around the corner, you know, does encourage strategic thinking. And yet, at the same time, you'll see, as we talk about some of our other finding, you know, the quality of the strategy has been diminishing over time. When we look at the World Uncertainty Index, for example, this basically says, how often are you talking about uncertainty?

7:37Tim Koller: You can see this incredible spike lately. People are talking about it. When you look at investor calls and how people are actually talking about business, how they're talking about performance, you see a 31 percentage increase in topics like AI, transformation, ESG, not the core business topics or strategy topics that you'll normally see. So you bring these two things together and we think we're in actually kind of a fundamentally different world in the way that executives are just considering the problem sets that are in front of them. And I know, Tim, if you wanted to comment at all on investor side, but we're certainly seeing a lot of changes there.

8:15Andy West: uh yes the world is just much more complex from their perspective um they want to know is there still a focus on uh the fundamental what is your strategy why is it going to succeed etc but you have to layer on to that from for to satisfy investors sort of so how are you how does ai affect what you're doing what kind of transformation are you doing how does that affect what about social issues how are you dealing with those all these things uh are additive to what you've had to deal with in the past.

8:47Whitney Zimmerman: Thanks, Tim. And Andy, now I'd like to pick up on how you've observed that the quality of strategy has actually been diminishing. Could you talk a little more about that?

8:57Tim Koller: As I mentioned, when you look at what actually happens in terms of the quality of strategy, one of the things that we measure over time is the 10 tests of strategy. So how many organizations are actually passing the 10 tests over time? And we looked at the change between 2010 and 2025 in the last 15 years under this hypothesis that strategies are coming under pressure for all the reasons we've described. And you certainly see it in the data, 40 % decrease in the quality of strategy. So we're in this golden age of strategy potentially, and yet the quality of strategy is decreasing. And then when you look at the way that economic profit has migrated over a similar period from 2000 to roughly 2020, over that era, you see a significant change in the distribution of economic profit.

9:44Tim Koller: So when we think about economic profit, what we're thinking about is the returns that actually the top quintile of companies realize over their cost of capital as opposed to the bottom quintile. And what you see over the last 20 years is that that distribution has increased in the positive by 245%. So the winners are winning much bigger. the bottom quintile, the losers have decreased by 170%. The losers are losing even more. So strategy is becoming more relevant. Now, you could say, oh, that's just the Magnificent Seven. That's just the tech industry. Now, when you control for the Magnificent Seven, when you control for all of the different industries out there, this phenomenon is happening all over the place.

10:25Tim Koller: So even extracting the data is roughly the same, extracting those factors. The data is the same. Now, Whitney, you and I have spent a couple of years thinking about the efficacy of strategy and what's actually happening in some of our research. So you want to talk a little bit about that 40 % delta?

10:41Whitney Zimmerman: Yeah, I think it's a really important trend and great that we have data on this because it's what we feel, right? That despite the opportunity, that is the uncertainty, the strategy is about leaning into uncertainty and taking advantage of it, betting on the future. And despite that, we have more ways than ever, right? of creating real value because we're developing new ways of making strategic moves and creating value. And it's for whatever reason, that abundance of opportunity has been getting actually overwhelming executives. In our 10 tests, they are not really just, is your strategy good, right?

11:20Whitney Zimmerman: They are tests that get at the underlying robustness of what's going into your strategy, right? Are you getting granular enough? Are you really challenging and building on true competitive advantage on things you know and others don't? Are you really aiming to beat the market as opposed to just your competitors? It is intentionally difficult to pass these tests, right? But that the scores have been falling, I think, shows that leaders are overwhelmed by both the opportunity they have in front of them, but also the number of ways of facing a strategy that reinforces our conviction that leaders need, in order to increase the quality of strategy, a grounding in the few fundamental things that matter most to creating value.

12:05Whitney Zimmerman: And Whitney, is it possible that the need for strategy might actually be diminishing due to the massive industry shifts we're seeing accompanied by increasing volatility, uncertainty, complexity, and ambiguity? In other words, does strategy really still matter? And if strategy still is important, then what are the implications for how we actually develop it? I think it's such a good and important question. We should never assume that something matters, right? We should know why we believe things. For us, strategy is about a few coherent choices that represent the biggest and most important opportunities that resources should be allocated against that are explained by some sort of underlying theory or thesis of how we uniquely are going to change the trajectory of our business.

12:52Whitney Zimmerman: I don't think that ensuring that there are few clear choices in any given part of the business is ever not important. Number one, that skill is one that many, many companies do not have. They have a long list of priorities. They do not have real strategy. Their strategies are themes as opposed to real choices. They're not stopping things. They're not using that tool to change their business. Our research finds, if anything, that it's not that strategy becomes less important. It's that what is needed from how you approach strategy changes when uncertainty goes up. We have data on what specific capabilities need to be recalibrated against that.

13:26Whitney Zimmerman: It becomes much more important to frame challenges. It becomes much more important to understand true competitive advantage. It becomes much more important to be documenting underlying assumptions. The way you approach strategy becomes more important to give the entire business and organization a way of understanding how to make choices across it becomes more important than ever. But indeed, it's different. But strategy matters. Thank you, Whitney. You've convinced me. So is it that people need to talk about strategy then in different ways in this environment? Or is there just not enough attention being given to it?

13:59Whitney Zimmerman: Or perhaps there's a misalignment of confidence in a given company strategy. And that impacts how you drive results.

14:09Tim Koller: Well, we're not trying to be overly dramatic, Sean. Like strategy conversations are happening and people are working really hard at strategy. They're doing great market forecasting. They're out there. They're trying to make decisions. So it's not so much that strategy isn't happening or that we're saying like strategy just is completely ineffective just for the moment and the era we're in and the pace that needs to happen. Like the moderate confidence is moderate confidence in your strategy going to allow you to reallocate 30 percent of your resources towards a new market. Are you really sure that your mode's being defended?

14:42Tim Koller: So it's not so much that people aren't doing it or don't have a sense of strategy, but is the conviction around that strategy strong enough to actually act and for large companies to act at scale? And that's where we see a lot of people continuing to struggle. Now, what I would say, I'll put a caveat on it. I'll channel my inner Tim Kohler. If you've got a great strategy and you're printing money and things are out there and the world is not changing that much around you, you're probably fine. You're probably fine. And not every company at every minute needs to ask these foundational questions about, you know, how they're actually competing.

15:19Tim Koller: But you need to be aware of the foundations in every case just to know, because the other thing that we found is when we look at sources of advantage and what's happening with advantage over time, corporate competitive advantage is eroding at an incredibly rapid rate. Most people are unaware, or at least you're unaware until everyone else knows it as well. And then it's often too late to act. So, you know, we'll try to keep it in context.

15:43Whitney Zimmerman: All right. So, Andy, if we accept this broad view that there is room for improvement in strategy, what is your work uncovered about how to do that in practice and specifically how that ties to the four foundations that we'll be talking about today?

15:57Tim Koller: Yeah, let me introduce the four foundations. Two are based in finance. Two are based in strategy. And as Tim mentioned earlier, the confluence of the two is what really matters. So first, target growth and return on invested capital, right? At our very foundation, you know, this may seem obvious for those of you that are quite deep in finance or for the CFOs, people who lead FP &A or maybe have been around quite a bit. You may go back to business school and say, I get it. Cash flow creates medium to long term value. That's great. It's an important thing to understand. The challenge is that the number of people that continue to manage for earnings and continue to manage for accounting, not cash flow, is incredibly large.

16:38Tim Koller: And that gets in the way of great strategy. Compounding that problem is the focus on managing for the long term versus the short term. In order to grow, in order to deliver consistent returns on capital over time, you need to make sufficiently long term bets. You can't constantly be managing for the short term. That undermines your strategic choice. It undermines meeting the long-term capabilities. And yet everywhere we look, there's massive pressure from the markets, from investors, sometimes from the board to manage for short-term profits and short-term performance. That is quite orthogonal to strategy.

17:16Tim Koller: So on the finance side, grounding in the foundations is really important. On the strategy side, we talk about two different things. We talk about market attractiveness. And as we'll discuss, markets really make an incredible, incredible or have an incredible effect on how you perform overall and on the ceiling of performance. Highly contested markets where maybe competitive intensity is starting to spike have a very hard time earning returns. Whereas obviously more attractive markets, high growth markets, things like that, on average, tend to perform a little bit better and put you in a better strategic place.

17:52Tim Koller: It's really important to understand that. Now, when we talk about harnessing market attractiveness, it's not just recognizing the total kind of opportunity in your market. It's really understanding the nuance of that market. And that's where a lot of companies struggle today. It's understanding the nuances and it's having the conversation and the debate at the right altitude about the market. And the larger your company, the more distributed your company, often the harder that can be. And then finally, competitive advantage is really important. It's our fourth pillar. Now, this does not mean just being good at something, right?

18:24Tim Koller: This means being uniquely good at something that is actually defendable over time. And this to me is one of the most dynamic things in play right now. We'll spend more time talking about that. But why we focus on competitive advantages. When I go and I go to a client, I'll talk to maybe 10 executives and I ask them, what's your source of advantage? I'll get three, maybe four, very emphatic, but quite different answers. And, you know, that can be okay. You can be good at a lot of things, but in a highly competitive environment, in a world that's changing rapidly, not understanding how you're defending your competitive position, not being able to invest in it at scale or able to use it to migrate to new attractive markets is a real miss.

19:06Tim Koller: And again, it's the combination of the four that we think is actually quite important and getting really grounded in these fundamentals helps decision making. It helps with alignment. It helps with strategic pivots.

19:16Whitney Zimmerman: Got it. And now I have a question for Tim on the finance foundations or the value side. Tim, you know, you're one of the authors of valuation and it's an 800 page book now in its eighth edition with more than a million copies sold. So clearly there are a lot more than just two principles in valuation. So how did you and Whitney and Andy settle on these two foundations, growth in ROIC and then the long-term management focus?

19:43Andy West: Pretty straightforward. When I look at a company or when I'm having discussions with a company, these are the two things I immediately turn to. What is the company's growth and return on capital? What direction are those going? And secondly, is the company making investments to create value over the longer term? So those are the two things that I focus on immediately when I look at a company. So it was pretty easy for me to narrow down on these two things, which I think are the most important things. And the other thing that's important is almost everything else in finance is a derivative or an application of these two ideas.

20:23Andy West: Whether you're thinking about acquisitions or divestitures or resource allocation, it always comes down, these things are behind each of those things. So it's pretty easy to come up with these two as the essential ones that everyone needs to be thinking about. Right.

20:40Whitney Zimmerman: Now, Whitney, let me ask you the same question on the strategy side. Why market attractiveness and why competitive advantage? Yeah, I think it's important to reinforce that this is about the intersection of strategy and value. It's not everything in strategy. These two foundations of harnessing market attractiveness and building competitive advantage, they're really driving at ensuring there is a very strong understanding of the why behind the where to play and how to win. There are so many strategy executives I speak with who struggle with their top teams or their teams really grappling with the why.

21:12Whitney Zimmerman: behind the where and play to how when, that don't really have strong, high-quality conversations and debates about why their markets are fundamentally attractive and capable of supporting returns. What are the sources of attractiveness that really dominate and explain why returns or growth are possible and whether those are frozen or not and what it means for your business? And as Andy was talking about, there's lots of research that finds that competitive advantage is the most misunderstood term concept in, in business, uh, and certainly in strategy that it is so easy to, um, uh, confuse or blur the line between a strength and a true source of advantage that matters in a market.

21:56Whitney Zimmerman: And so we, we are driving here at trying to enrich and reinforce the ability of leaders of organizations and across organizations to really build and hold a strong shared reality for why are we making money? Why is it possible to make money in this market? And why is it possible for us to earn more than our fair share of it? And when you do that, my experience, when you see teams really owning the why behind the where to play and how to win, right? And being able to link that to the long-term and where I can grow, that's really where you see things come alive. And we believe in this time, it's important to to drive a lot of focus on a few simple things that ultimately explain a lot of how strategy creates value, or in my view, most.

22:44Whitney Zimmerman: Wonderful. So now let's dive a bit deeper into each of these four foundations. Tim, maybe you could start us out with the first one, growth and return on invested capital.

22:54Andy West: Yes, sure. Ultimately, the value of any investment is driven by its cash flows, discounted at its cost of capital. And the nice thing is, is that we can decompose a company's cash flows into two strategically debatable concepts, which are revenue growth and return on capital. So if you're just going to talk about cash flows, you can't really have a debate, right? But if you translate that into revenue growth, are we growing as fast as our markets, as fast as our peers? Is our return on capital above our cost of capital? Is it increasing, decreasing? How does it compare to our peers? Then you can have a real strategic conversation that links these things together.

23:39Andy West: It's not that we ignore earnings. We do look at earnings. But if you do a good job with growth and return on capital, you will also do a good job with earnings. But you can have attractive earnings, particularly accounting earnings, if you're not earning attractive return on capital, or if you're doing things to earnings just based on accounting things. So that's why we want to focus you on return on capital and revenue growth as the ultimate drivers of value creation. And then it's also important to think about the dynamics of this. First of all, there's no standard for what – there are some companies that grow modestly but have high return on capital, like consumer packaged goods companies that create a lot of value.

24:28Andy West: There are some companies that grow faster with more moderate returns on capital. There's no single right answer, but it is important to understand the dynamics as well. And if you look at how value changes and what are the levers that you can pull as you're thinking about strategy, it's also important to realize that if you are already a high return on capital business, 1%, let's say, higher growth and focusing on growth will tend to create a lot more value than improving return on capital. And at the same time, if you have a moderate return on capital, let's say mid to low teens, focusing on improving the return on capital will make a big difference.

25:13Andy West: So it's important as you think about strategy to understand these dynamics because they will influence how you think about your strategy. It's also important to think about this at a granular level within your company. Too many companies that I see, they want everyone to grow or they want everyone to improve their margins and return on capital at the same time. If you've got some businesses that have a higher return on capital, you probably want them to grow faster. If you've got some businesses with a moderate return on capital, you want them to improve their return on capital, improve their margins, improves our capital productivity, et cetera.

25:46Andy West: So it is important also to understand these dynamics because these dynamics are going to be directly related to the choices you make for the different parts of the company and to the how and where to compete.

26:00Whitney Zimmerman: All right. So let's move now to the second foundation, managing for the long-term. Tim, what are the executives that you've worked with thinking and doing in this regard? And maybe you could share some examples.

26:11Andy West: We've done lots of work on this. This is just one example. So we asked a sample of executives. We asked them, if you give a lot of priority to the long-term, do you provide the right sponsorship? Do you provide the resources? Do you provide the talent to be successful? Do you grow faster or slower than your peers? And what we found was that those executives or those companies that do invest in the long-term, that do make sure that they're putting their priorities where the long-term matters, will create more value, particularly through, because they're going to be more innovative, they're going to grow faster.

26:54Andy West: And yet, on the other hand, we still see plenty of examples of companies that do not focus on the long term. For example, a retailer that, in order to boost profits, cut the frontline sales force and de-skilled the people, right? Another case, a high-tech company that saw a novel technology and had plenty of opportunity to invest in it, but at the same time, they were trying to achieve a 10 % EPS growth for a period of time when their core markets were pretty much flat. So instead of investing, they focused on the EPS growth. And as a result, they missed out on this big technology. And some of their peers have created massive amounts of value that they missed out on.

27:46Andy West: They knew it was coming, but they did not make the investments. So we see plenty of examples of companies that are not making these investments. And I'll say one more thing. When I hear a CEO or a CFO say to the world, either internally or externally, we're going to increase profits faster than revenues. To me, that's a sign to run, okay, if I was an investor. Because while it may work for a couple of years, right, Typically, companies have fat in them that can be taken away. If I can improve my distribution system while still meeting my targets of delivering to customers, that's great. If I can reduce costs in the back office.

28:34Andy West: What typically happens, though, when companies make those pronouncements, after two or three years, they've run out of ways to cut costs that are purely productivity that the customer doesn't notice, for example. And they start to cut things like product development and marketing because that's all they have left to cut in order to achieve that target of increasing their profits relative to revenues. And as a result, after a couple of years of that, then they find themselves in a real dangerous situation. Oftentimes when that happens, either they have to admit that they've made a mistake. oftentimes when the time for a CEO change or whatever.

29:19Andy West: So we still see this. So my rule of thumb that I advise companies is if you're going to cut costs, if the customer is going to notice it, don't do it.

29:32Tim Koller: Hey, Tim, one thing I would add, just one other structural challenge that companies face is that often the strategy decisions are made at a different level on the cost decisions. And so if you know you're putting implicit pressure on operating units or on a plant or on the field to manage costs without helping them with the tradeoffs as an executive that you need them to make, you know, water goes downhill. They're going to do what they need to do in order to meet the objective. So as an executive, it's often important to ask, am I setting up the environment for long-term behavior? Understanding that the pressure for short-termism at the edge, where a lot of decisions is made, can be quite great.

30:15Tim Koller: And you may not feel it the same way as an executive sitting at the center, a corporate center, or running a business or division.

30:20Andy West: And that's why the CEO and the CFO have to take the lead on that. And they have to understand what the different unit managers are actually doing to achieve their results. You don't congratulate a unit because they met their results. If they met their results by cutting costs, but their revenues didn't grow or their product innovation is not on track, you don't want to reward that, right? So you need a level of insight as a CEO and CFO into how your businesses are achieving the result, not just what their results are. Okay.

30:57Whitney Zimmerman: So I'm curious also about the relationship between taking that long-term view and the value creation thesis for a company. In a world of AI where things are changing so rapidly, does that mean you need to revisit your value creation thesis more frequently, say on a quarterly basis? And is that at odds perhaps with taking the long-term view we just discussed when the ground can actually be shifting quite quickly? Tim? Yeah.

31:25Andy West: For the vast majority of companies that are not directly involved in making AI software or building data centers or chips or whatever, the vast majority of companies, they're still going to be selling clothes. They're going to be making consumer products, et cetera. AI is a tool for them, right? And so yes, it is important to figure out how to use AI to improve the business. But if I'm making consumer products, I still have to have a value proposition for the consumer. Consumer doesn't care how I get there, whether I use AI or not, Right. So I have to do both. Right. I have to be I can't lose sight of the long term strategy.

32:07Andy West: Why are my products going to be the ones that consumers are going to want to buy? And how do I market those effectively? But in the background, in the back office, I have to figure out how to use these other things like AI to help me do that better. Yeah.

32:25Tim Koller: I mean, we were just literally having this debate yesterday. So, I mean, it's a great question. Yeah.

32:30Whitney Zimmerman: So, sir, I'm happy to give a view. So number one, the way that we think about value creation thesis is it's an underlying theory that explains the choices you're making, right? And sometimes the theory comes first. Sometimes it is used to explain the choices of strategy you're making. And it's important because it helps people across a business make their own choices at the edge that are coherent with the overall business's strategy. And it's built on a unique view of the future and a unique view about what makes you unique and why you're going to capture value. In the book, we introduce what we call the undelegatable roles of the CEO in strategy.

33:05Whitney Zimmerman: The things that really, if the CEO tries to delegate them to someone else, you're probably going to really put strategy's value creation at risk. First, second one is that really only the CEO can decide to change the value creation thesis of the business. It is something that really is at the center of how you see your business in your world. and it should be built on some real convictions and beliefs and assumptions about the future. If it is changing a lot, then I think that that potentially indicates that your foundations are not really in place, your shared reality isn't in place and you're reacting as opposed to driving into the future.

33:40Right?

33:41Whitney Zimmerman: But at the end of the day, if you have a shared reality about how you talk about and debate what you believe about your markets and about your advantage and about value creation, then it also allows you to know really when the signal tells you that we believe there's a different opportunity than with what we thought and that our thesis needs to change in our strategy too. Andy, you agree with that?

34:02Tim Koller: We spend a lot of time. There's a lot of noise. Yeah. There's just a lot of noise in the market right now. I think what we're trying to do with the four foundations is say, where is that signal? What is the true signal? And I think if at least, even if that signal is changing rapidly, having alignment around that in a pretty fundamental way will help you keep focused on the long-term if that makes sense. Right. I mean, it's just, It's very easy to say we're not going to make any long-term choices because the short-term is so volatile and we just don't know. And I think the purpose of this book and what we're trying to focus on is how you really need to be grounded in the fundamentals.

34:36Tim Koller: So as that change comes at you, you can actually pivot because pivoting at scale is what's going to create value and not just reacting.

34:43Whitney Zimmerman: All right. Thank you. So now let's shift to the two strategy foundations. Whitney, can you talk about market attractiveness? Yeah, absolutely. So the first strategy foundation is that you need to harness the attractiveness of your markets, which really means that you need to understand what allows for your market to be fundamentally attractive and support attractive returns or not. And there isn't any necessarily new knowledge here, but what we try to do is we try to make it easier for teams to be able to talk about and debate what drives the ability of a market to support returns alongside what drives your ability to capture more than your fair share.

35:24Whitney Zimmerman: So what we introduce is this concept of sources of market attractiveness. It's a language that is intended to be similar to sources of advantage, right? We say essentially that any given market's attractiveness is based on two things, generally speaking, right? The overall potential of the market to support returns and its dynamics, right? In a sense, the potential of the market sets a sort of ceiling on the returns in a market and the dynamics then determine whether or not the potential returns in a market are actually captured by those participants or are diffused out. This isn't new knowledge, but I think it is a lot, it reduces the cognitive load from being able to debate this.

36:00Whitney Zimmerman: And underlying market potential is these top level sources, as well as more granular ones in the book, growth, differentiation, right? So the potential for growth in a market, the potential for differentiation in a market, and the potential for defensibility of that market, like barriers to entry and barriers to exit. Under differentiation, for example, there is whether or not differentiation can be, innovation can be protected in a given market or whether or not when you innovate, others can quickly replicate that innovation. In markets where you can't protect your innovation, the potential is lower for returns in that market.

36:36Whitney Zimmerman: And then dynamics as well, customer dynamics, competitor dynamics, supplier dynamics. This isn't rocket science, But we really believe it's important to help executives and leaders have a better language and more efficient language for debating and holding together what are the dominant reasons why our markets are attractive or not. This matters because when you look across markets, some are more attractive than others. And this shouldn't be surprising, but to many, many leaders, it is. a lot of leaders sort of carry on with the markets they have, as opposed to really intentionally considering whether or not we should be in a market or not and why, right?

37:15Whitney Zimmerman: And when you are able to disaggregate, okay, what are the underlying sources of attractiveness that explain why a given market is attractive? You're able to make better decisions, both to enter, but importantly, to exit markets. This idea of exiting markets is one that is not done enough, but it's also a very old idea. Drucker used to talk about the importance of purposeful abandonment. In an age of AI, I think purposeful abandonment and the discipline to understand why our markets are attractive or not and to harness that knowledge to make good decisions is very, very important. And it's probably underused.

37:44Whitney Zimmerman: So if companies are now better able to determine whether or not a market is worth playing in or staying in and actually act on it, what does that mean for overall market dynamics then? And why is this so important now? It's particularly important because we're seeing competitiveness rise. So we have this thing called shuffle rate. And shuffle rate essentially looks at the amount of market share that is changing hand in any given market over a period of time. And so markets with higher shuffle rate are ultimately seeing more competition resulting in more market share changing hand, more competitive intensity.

38:18Whitney Zimmerman: And this goes up and down over time. But in average, it is increasing. Markets are becoming more competitive over time. That ultimately creates a lot of opportunity. If you've read our work on arenas of competition, you know that when you're looking at shuffle rate, when you look at, and I understand the fundamentals of market attractiveness, you could make better decisions, right? As a business about sensing the right opportunities, saying no to the wrong ones and managing your portfolio effectively. But that requires having a shared reality and a shared language for fundamentally why our markets are competitive or attractive or not.

38:50Whitney Zimmerman: And not just the size of profit pools, right? Not just market share. And as these market dynamics are getting increasingly tougher, what are some of the challenges for companies that are trying to actually harness their market's attractiveness? So there are two analog challenges when it comes to harnessing market attractiveness that we talk about in the book. One is you have the wrong market map, right? There's a lot of businesses they don't really think about. What is our market? How do we define the boundaries? And that is particularly important in this day and age with competitive boundaries shifting.

39:24Whitney Zimmerman: Now, I always am careful with this idea that markets are shifting faster than ever. We've been talking for 20, 30 years about the fact that competitive boundaries are becoming more and more blurred. But it really is an issue today. And executives really need to face into the need to have discipline about always purposely defining our markets and redefining them as technology and customer preference and business model change influence them. So having the wrong market map is really dangerous for harnessing market attractiveness. And likewise, being blind to shifting dynamics is quite dangerous. Now, we know that lots of things are changing.

39:59Whitney Zimmerman: But to Andy's point about signal and noise, I think that in many markets, we know more than we give ourselves credit. When we look at markets through a lens of sources of market attractiveness, and we go through a given market and say, let's disaggregate this down. what are the dominant sources of market attractiveness that are explaining why returns are possible and the returns that are possible? And we think about, okay, to what extent are these frozen, especially the dominant ones? And to what extent are forces shifting them? You see a lot more signal and noise. Where things break down is when you don't spend the time as a team having the right language that really gets at the value creation element of markets.

40:42Whitney Zimmerman: And so being blind to ship dynamics is in part about looking at the source level of any given market's attractiveness and being able to debate at that source level whether a given force, whether a given uncertainty is actually influencing things that drive value in the market or not. And so what we're trying to do with this book is to be able to help teams more efficiently get to that map, read the signals and win in the long term. Super. So what are some of the metrics then that one might use to track or measure the durability of market attractiveness? You mentioned some signals. Are there any particular ones that you look out for in your work with clients?

41:17Whitney Zimmerman: Well, I think the most important signal or metric is the source level itself. And having a view of any given market, what sources of attractiveness and advantage are stable versus not is something that a lot of executive teams don't talk about, but also hopefully comes naturally the most effective ones. When you look beneath that, right, to growth, to the ability to protect differentiation or innovation, I should say, to the concentration of customers versus concentration of suppliers, et cetera, for each one of those, there's going to be a set of metrics. The rocket science or the magic is only not in the metrics, right?

41:54Whitney Zimmerman: It is in that middle level, right, of having the clarity about the source level explanation of why our markets are attractive or not that I think is very important. We have to be careful that we don't just look for a KPI as the source of signal, right? I think in this day and age, strategy creates value when you look beyond a single KPI, right, as a source of signal for insight. Got it. And Andy, anything you'd like to add here?

42:22Tim Koller: The only thing I'd add, Sean, is I just think most or many organizations, I don't know if it's most or not. I think in my own opinion, it's many. Competitor dynamics is really something that's very hard to talk about or people just don't talk about enough. You talk about your own forecast. You talk about what's happening, but you don't talk about and role play forward. What's likely to happen with your customers, given what competitors are likely to do. or you engage on it after the competitors have already made their move, which is usually a few quarters too late. So if I were to add something, in addition to what Whitney said, is by defining the market at the right level, is this really a market or is it a P &L, right?

42:58Tim Koller: If it's not a market and it's a P &L metric, you're not looking at the data the right way. So that's piece number one. So define the markets in the way that your customers define them and your competition defines them, not in the way that your P &L defines them. And once you're in there, of course, there's a lot of customer data that you'd look at and every organization's can be a little bit different based on its value proposition. But I would look at competitive dynamics. I would look at pricing in a highly granular way. I would look at competitive entry in a granular way. I would look at entrance, market entry.

43:28Tim Koller: I look at capital flows, right? These are the things that are telling you, is my market changing? And is the attractiveness of my market changing based on levels of competition and my ability to sustain my current position? Thanks.

43:42Whitney Zimmerman: And now let's talk through that fourth foundation, competitive advantage. Whitney, tell us more. Yeah. So as I mentioned before, competitive advantage is a notoriously misused concept in business. There's academic research on just how misunderstood it is. It's for a good reason. There are various schools of thought on competitive advantage. We thought it was important to put out a singular view that brings them together. We're proposing 10 sources of competitive advantage. The taxonomy is valuable, but what matters most is the bar, right? for what true competitive advantage is versus is not and how to think about measuring that with a series of sources of signal.

44:21Whitney Zimmerman: We see that being itself a real advantage. Only 10 % of companies we found track the drivers of competitive advantage at a market level. It is an epidemic in a sense of where companies do not really think hard about what allows us to capture more than our fair share, as opposed to what are we simply good at. And so we feel it's important to drive more rigor around competitive advantage and how you debate it. We also talked in the book about how you build and deepen it. Ultimately, there are four major ways to manage and maximize your returns from competitive advantage. You deepen advantage by widening the gap, widening the moat, investing in it intentionally.

45:05Whitney Zimmerman: You bridge your advantage taking capabilities, in terms of dynamic capabilities, taking them from one context into another, one market into another. You need to be very thoughtful about how you renew advantage. This links very carefully to, very importantly to what Tim was talking about in terms of where you're directing your investments and holding a high bar for what actually is going to drive record growth in the future. We spend a lot of time, or businesses spend a lot of time investing in things that aren't actually renewing their advantage and ultimately being purposeful about how you abandon advantages or that no longer are going to matter.

45:39Whitney Zimmerman: because of forces of change upon sources of advantage and managing that portfolio effectively. Super. Thank you, Whitney. And just to let our listeners know who might want to dive deeper on this, we also recently published an entire episode on how to evaluate and maximize your competitive advantage. And we'll include a link to that in the show notes. So now, Andy, this all sounds really sensible, but it does beg a question. Why aren't more companies thinking this way already about strategy and value creation? Why isn't there more of a focus on these four foundations?

46:16Tim Koller: I think when you just take a step back at what we're talking about, there is a fundamental problem that when you consider what does it take to reallocate resources in a meaningful way and a well-aligned way and a nimble way, which is really what we're talking about. And you think about the flow from getting ideas and analysis and inputs and all the market and competitive advantage, you know, insights that we talked about, designing and debating what a strategy might be. When you think about long-range planning, all the things that Tim talked about as well in terms of short-termism and the pressures that you have, you think about the budget cycle and what that looks like, and you think about then actually getting people to do something.

46:57Tim Koller: this is an insane value chain, right? It is complicated and it's getting more complicated. And as a result, it's generally ineffective. And so this needs to be fixed. We're not going to say, I do think it is a part of this being a golden era of strategy to go back to, to my original point. Like, why is it a golden age? Because I think we can fix this with technology. And I think the world is going to be much better. I think we're going to look back 15, 20 years from now, hopefully five and say, this absolutely made no sense. We had to manage in a different way. And thank God we don't have, you know, rolling forecast meetings and for, you know, all these other things that we do every single month and monthly operating reviews.

47:33Tim Koller: They just take up so much time, but don't add actually value to strategy. I think we'll look back and say that this is fundamentally different. But in the meantime, what we're trying to do is say, how do you shortcut this? And one way is to take this process that exists and has its merits and needs to continue until something better replaces it. How do you make it better? Well, our answer is you make it better by focusing on the four foundations and not all the noise, not all the other things. Make sure you're having healthy debates on the principles of how strategy is evolving and how that strategy is turning into value in a clear and compelling way.

48:09Whitney Zimmerman: So I guess I have one final question, Andy, and we alluded earlier to the undelegatable role of the CEO in strategy. And in your experience working not only with CEOs, but also CFOs and CSOs, what are some of the organizational implications for what we've been discussing today? And how would that group, the CEOs, CFOs, and CSOs, need to work differently to adopt these four foundations?

48:36Tim Koller: Yeah, I mean, I think a lot of organizations, we need another hour to talk about how to organize strategy and governance implications of the book. I think the one minute version is many organizations organized in different ways, right? It's just is what it is. Everybody does strategy a little bit different. And what we're trying to say is if you could bring in this foundation and cascade the foundations of thinking, so you're speaking the same language, you're driving alignment, not dispersion as you talk about value, as you talk about strategy, you understand your customer, which means CEOs need to be connected to the field.

49:08Tim Koller: They need to understand what's driving decision making so they can make great choices. like you can increase the signals that matter, right? Among that triad and everyone else in the organization. And I think through common language, through common approaches, through common understanding, we're hoping for a significant acceleration.

49:25Whitney Zimmerman: Thank you so much. And Whitney, Tim, any final thoughts you'd like to share before we close our episode?

49:30Andy West: No, I'll just add, you know, once again, go back to, you know, if you, you know, the four foundations are purposely straightforward and simple and easy to remember, right? So if you keep those four things in mind as you're thinking about strategies, you'll make progress even though you're not going to achieve perfection right away.

49:53Whitney Zimmerman: Couldn't have said it by myself. Awesome. Tim, Andy, Whitney, thanks so much for taking the time with us today. Thank you, Sean. Thanks, Sean. Thanks, Sean. And thank you to all of our listeners for joining us today. We hope you enjoyed the conversation and we welcome your feedback and ideas for future episodes. Just email us at itsr at mckenzie.com for inside the strategy room. You can also share your ratings and reviews on any podcast player with many thanks to all who've already done so. We really appreciate the comments and feedback we receive every week and encourage you to keep them coming.

50:25Whitney Zimmerman: And if you enjoyed this episode and you'd like to subscribe, you can follow our weekly series on any podcast player where you can also access our entire library of more than 320 episodes. Finally, if you'd like to automatically receive our latest publications and insights, we encourage you to sign up for email alerts on our insights page at mckinsey.com slash SCF for strategy and corporate finance, or connect with us on LinkedIn at the McKinsey strategy and corporate finance practice page. Thanks again for listening. We look forward to having you join us again next week inside the strategy room.

51:08Thank you.