Sunday, January 15, 2006

Incentives matter

If a CEO wants to implement a change in corporate strategy, the CEO’s ability to achieve this change will depend heavily on whether the new strategy makes customers and partners better off.

If the benefits to the constituents of a new strategy exceed the costs of changing to conform to the new strategy, then the new strategy is more likely to succeed. In some cases, decision-makers neglect to take into consideration these cost-benefit calculations – thus increasing the chances that the new strategy will not succeed.

In 1986, an upstart Irish airline, Ryanair, decided to offer a cut rate service for the hour flight between Dublin and London. Ryanair hoped to turn into customers a chunk of the 750,000 people who took the nine hour, 55 IR£ train or ferry rides between the two cities. At 99 IR£, Ryanair’s offering was priced at half competitors’ such as British Air. Despite British Air’s was planned initial public offering, British Air decided to undercut Ryanair’s price before the service launched. Fortunately for Ryanair, the low industry price created so much demand – much of which came from rail and ferry customers seeking to save time – that Ryanair was able to operate the service at 100% capacity.

Decision-makers should consider how a new strategy will create value for key constituents. The more the benefits of a new strategy exceed the costs to constituents such as employees, customers, and partners, the greater the odds that the new strategy will create value for shareholders. If a new strategy does not create sufficient value, the strategy should be changed until it does.


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