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How strategists really think - tapping the power of analogy by peterzhangonline

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									              A R T I C L E

                                 How Strategists Really
                                 Tapping the Power of Analogy

                                 by Giovanni Gavetti and Jan W. Rivkin

                                 Included with this full-text Harvard Business Review article:

                               1 Article Summary
                                 The Idea in Brief—the core idea
                                 The Idea in Practice—putting the idea to work

                               2 How Strategists Really Think: Tapping the Power of Analogy

                              12 Further Reading
                                 A list of related materials, with annotations to guide further
                                 exploration of the article’s ideas and applications

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                                                                                                                                          How Strategists Really Think
                                                                                                                                          Tapping the Power of Analogy

                                                                                        The Idea in Brief                                 The Idea in Practice
                                                                                        When Charles Lazarus replicated success-          To tap the power of analogical thinking, apply       hicles. Moreover, the company sold cars at
                                                                                        ful strategies from the supermarket indus-        these steps:                                         fixed, posted prices, with no haggling—
                                                                                        try to launch Toys R Us (think exhaustive                                                              which reduced mistrust between custom-
                                                                                                                                          • Articulate the analogy. In deciding to
                                                                                        selection, low prices, self-service), he used                                                          ers and used-car dealers. It also paid sales-
                                                                                                                                            launch CarMax, a chain of used-car outlets,
                                                                                        analogical thinking: He drew lessons from                                                              people a flat fee per vehicle—eliminating
                                                                                                                                            successful electronics retailer Circuit City
                                                                                        one business setting and applied them to                                                               incentives to push more expensive cars on
                                                                                                                                            drew an analogy between the electronics-
                                                                                        another.                                                                                               customers.
                                                                                                                                            retailing environment of the 1970s (its
                                                                                        Sometimes analogies spark breakthrough              “source” setting) and the used-car industry        But CarMax adjusted Circuit City’s formula
                                                                                        strategies—as Toys R Us’s successful launch         of the 1990s (its “target” setting).               to reflect the two settings’ differences. For
                                                                                        shows. But when analogies are based on                                                                 instance, unlike the electronics-retailing in-
                                                                                                                                          • Identify why the “source” strategy worked.
                                                                                        surface-level similarities, they can lead                                                              dustry, the used-car industry lacked reliable
                                                                                                                                            The 1970s electronics-retailing industry was
                                                                                        managers astray. Consider Enron: By ignor-                                                             supply sources. CarMax addressed this dif-
                                                                                                                                            dominated by small, local retailers of vari-
                                                                                        ing key differences between natural gas                                                                ference by placing well-trained buyers in
                                                                                                                                            able quality and efficiency. Untapped effi-
                                                                                        trading and broadband trading, Enron em-                                                               each store who offered to buy used cars di-
                                                                                                                                            ciencies (for example, unexploited econo-
                                                                                        barked on a diversification scheme that                                                                rectly from consumers. Then it thoroughly
                                                                                                                                            mies of scale) and unmet customer needs
                                                                                        proved disastrous.                                                                                     inspected and reconditioned used cars be-
                                                                                                                                            (stores suffered frequent stockouts) also
                                                                                                                                                                                               fore reselling them.
                                                                                        How to tap the power of analogical think-           characterized the industry.
                                                                                        ing while sidestepping its pitfalls? First, ar-                                                        CarMax’s reward? Revenues of $4.6 billion in
                                                                                                                                            Circuit City’s strategy? Offer large stores that
                                                                                        ticulate the analogy your management                                                                   2004, a multibillion-dollar market capitaliza-
                                                                                                                                            stocked exhaustive selections and pair au-
                                                                                        team is using to weigh a potential new                                                                 tion, and equity returns that roughly
                                                                                                                                            tomated distribution centers with sales-
                                                                                        strategy. Only by making your analogy ex-                                                              matched the S&P 500’s.
                                                                                                                                            tracking technology to ensure product
                                                                                        plicit can you then assess its soundness.
                                                                                                                                            availability. Differentiating itself on selec-
                                                                                        Ford Motor Company, for example, exam-
                                                                                                                                            tion and product availability, the company
                                                                                        ined Dell Computer’s innovative supply
                                                                                                                                            crushed smaller rivals.

                                                                                        chain model before deciding that produc-
                                                                                        tion similarities between the auto and PC         • Assess similarities and differences be-
                                                                                        industries were outweighed by differences           tween the source and target setting. The
                                                                                        in industry cost structures. Finally, decide        1990s used-car industry strongly resembled
                                                                                        how well your strategy will translate to a          the 1970s electronics-retailing industry. For
                                                                                        new setting—and fine-tune it to address             example, customers didn’t trust retailers;
                                                                                        key differences.                                    economies of scale and barriers to entry
                                                                                                                                            were limited; and information and distribu-
                                                                                        It’s impossible to make analogies 100% safe.
                                                                                                                                            tion technology were primitive.
                                                                                        But by employing several straightforward
                                                                                        steps, you can boost your chances of avoid-         But important differences existed as well.
                                                                                        ing analogical thinking’s dangers—and               For instance, in consumer electronics, Cir-
                                                                                        make smart, successful strategic choices.           cuit City had a large base of dependable,
                                                                                                                                            reputable suppliers—while most used-car
                                                                                                                                            dealers bought inventory from variably reli-
                                                                                                                                            able wholesalers or individual car owners.

                                                                                                                                          • Translate your strategy to the new setting.
                                                                                                                                            Circuit City’s strategy for CarMax closely
                                                                                                                                            matched its electronics-retailing operation.
                                                                                                                                            For example, CarMax’s large-lot superstores
                                                                                                                                            offered broad inventories of 200 to 550 ve-

                                                                                                                                                                                                                                      page 1
                                                                                                                               Much of the time, executives use analogies to make strategic choices.
                                                                                                                               The best strategists know both the power and peril of such comparisons.

                                                                                                                               How Strategists Really
                                                                                                                               Tapping the Power of Analogy

                                                                                                                               by Giovanni Gavetti and Jan W. Rivkin

                                                                                                                               Strategy is about choice. The heart of a com-      to their own analogical thinking will make
                                                                                                                               pany’s strategy is what it chooses to do and not   better strategic decisions and fewer mistakes.
                                                                                                                               do. The quality of the thinking that goes into

                                                                                                                               such choices is a key driver of the quality and    When Analogies Are Powerful
                                                                                                                               success of a company’s strategy. Most of the       We’ve explained the notion of analogical rea-
                                                                                                                               time, leaders are so immersed in the specifics      soning to executives responsible for strategy in
                                                                                                                               of strategy—the ideas, the numbers, the            a variety of industries, and virtually every one
                                                                                                                               plans—that they don’t step back and examine        of them, after reflecting, could point to times
                                                                                                                               how they think about strategic choices. But ex-    when he or she relied heavily on analogies. A
                                                                                                                               ecutives can gain a great deal from under-         few well-known examples reflect how com-
                                                                                                                               standing their own reasoning processes. In         mon analogical reasoning is:
                                                                                                                               particular, reasoning by analogy plays a role in       • Throughout the mid-1990s, Intel had re-
                                                                                                                               strategic decision making that is large but        sisted providing cheap microprocessors for in-
                                                                                                                               largely overlooked. Faced with an unfamiliar       expensive PCs. During a 1997 training seminar,
                                                                                                                               problem or opportunity, senior managers            however, Intel’s top management team learned
                                                                                                                               often think back to some similar situation they    a lesson about the steel industry from Harvard
                                                                                                                               have seen or heard about, draw lessons from it,    Business School professor Clayton Christensen:
                                                                                                                               and apply those lessons to the current situa-      In the 1970s, upstart minimills established
                                                                                                                               tion. Yet managers rarely realize that they’re     themselves in the steel business by making
                                                                                                                               reasoning by analogy. As a result, they are un-    cheap concrete-reinforcing bars known as re-
                                                                                                                               able to make use of insights that psychologists,   bar. Established players like U.S. Steel ceded the
                                                                                                                               cognitive scientists, and political scientists     low end of the business to them, but deeply re-
                                                                                                                               have generated about the power and the pit-        gretted that decision when the minimills crept
                                                                                                                               falls of analogy. Managers who pay attention       into higher-end products. Intel’s CEO at the

                                                                                        harvard business review • april 2005                                                                                                 page 2
                                                                                                                 How Strategists Really Think

                                           time, Andy Grove, seized on the steel analogy,       and economic principles to a specific business
                                           referring to cheap PCs as “digital rebar.” The       situation, weigh alternatives, and make a ra-
                                           lesson was clear, Grove argued: “If we lose the      tional choice. They choose the alternative
                                           low end today, we could lose the high end to-        that, according to their analysis, would lead to
                                           morrow.” Intel soon began to promote its low-        the best outcome. Trial and error, on the
                                           end Celeron processor more aggressively to           other hand, involves learning after the fact
                                           makers and buyers of inexpensive PCs.                rather than thinking in advance.
                                               • Starting in the 1970s, Circuit City thrived       Both deduction and trial and error play im-
                                           by selling consumer electronics in superstores.      portant roles in strategy, but each is effective
                                           A wide selection, professional sales help, and a     only in specific circumstances. Deduction typ-
                                           policy of not haggling with customers distin-        ically requires a lot of data and is therefore at
                                           guished the stores. In 1993, Circuit City sur-       its most powerful only in information-rich
                                           prised investors by announcing that it would         settings—for instance, mature and stable in-
                                           open CarMax, a chain of used-car outlets. The        dustries. Even where information is available,
                                           company argued that the used-car industry of         processing a great deal of raw data is very
                                           the 1990s bore a close resemblance to the elec-      challenging, particularly if there are many in-
                                           tronics retailing environment of the 1970s.          tertwined choices that span functional and
                                           Mom-and-pop dealers with questionable repu-          product boundaries. The mental demands of
                                           tations dominated the industry, leaving con-         deduction can easily outstrip the bounds on
                                           sumers nervous when they purchased and fi-            human reasoning that psychologists have
                                           nanced complex, big-ticket, durable goods.           identified in numerous experiments. For this
                                           Circuit City’s managers felt that its success for-   reason, deduction works best for modular
                                           mula from electronics retailing would work           problems that can be broken down and tack-
                                           well in an apparently analogous setting.             led piece by piece.
                                               • The supermarket, a retail format pio-             Trial and error is a relatively effective way
                                           neered during the 1930s, has served as an ana-       to make strategic decisions in settings so am-
                                           logical source many times over. Charlie Mer-         biguous, novel, or complex that any cogni-
                                           rill relied heavily on his experience as a           tively intensive effort is doomed to fail. In al-
                                           supermarket executive as he developed the fi-         together new situations, such as launching a
                                           nancial supermarket of Merrill Lynch. Like-          radically new product, there may be no good
                                           wise, Charles Lazarus was inspired by the su-        substitute for trying something out and learn-
                                           permarket when he founded Toys R Us in the           ing from experience.
                                           1950s. Thomas Stemberg, the founder of Sta-             Many, perhaps most, strategic problems are
                                           ples and a former supermarket executive, re-         neither so novel and complex that they require
                                           ports in his autobiography that Staples began        trial and error nor so familiar and modular
                                           with an analogical question: “Could we be the        that they permit deduction. Much of the time,
                                           Toys R Us of office supplies?”                        managers have only enough cues to see a re-
                                               Each of these instances displays the core ele-   semblance to a past experience. They can see
                                           ments of analogical reasoning: a novel prob-         how an industry they’re thinking about enter-
                                           lem that has to be solved or a new opportunity       ing looks like one they already understand, for
                                           that begs to be tapped; a specific prior setting      example. It is in this large middle ground that
                                           that managers deem to be similar in its essen-       analogical reasoning has its greatest power.
                                           tials; and a solution that managers can transfer        Analogical reasoning makes enormously ef-
                                           from its original setting to the unfamiliar con-     ficient use of the information and the mental
                                           text. When managers face a problem, sense            processing power that strategy makers have.
                                           “Ah, I’ve seen this one before,” and reach back      When reasoning by analogy, managers need
                                           to an earlier experience for a solution, they are    not understand every aspect of the problem at
                                           using analogy.                                       hand. Rather, they pay attention to select fea-
                                               Strategy makers use analogical reasoning         tures of it and use them to apply the patterns
Giovanni Gavetti (        more often than they know. Commonly,                 of the past to the problems of the present.
is an assistant professor and Jan W.       credit for a strategic decision goes to one of       Imagine, for instance, the challenge facing
Rivkin ( is an associate   two other approaches: deduction and the pro-         Charles Lazarus in the fast-changing, complex
professor in the Strategy Unit of          cess of trial and error. When managers use de-       toy industry of the 1950s. Had he sat down and
Harvard Business School in Boston.         duction, they apply general administrative           analyzed all of the interdependent configura-

harvard business review • april 2005                                                                                                      page 3
                                                                                                                    How Strategists Really Think

                                         tions of choices in toy retailing—from market-            ing; and between the need for creative strate-
                                         ing to operations, from human resource man-               gies and analogy’s ability to spark creativity.
                                         agement to logistics—it is unlikely he would              Reflecting these matches, business schools typ-
                                         have come up with a strategy as coherent and              ically teach strategy by means of case studies,
                                         effective as the one Toys R Us adopted. The               which provide an abundance of analogies from
                                         analogy he drew to supermarkets was extraor-              which the students can draw. (See the sidebar
                                         dinarily efficient from an informational and               “Strategic Decision Making and the Case
                                         cognitive point of view. In one stroke, it gave           Method.”) Similarly, some of the foremost
                                         Lazarus an integrated bundle of choices: ex-              strategy consultants are famed for their ability
                                         haustive selection, relatively low prices, rapid          to draw lessons from one industry and apply
                                         replenishment of stock, deep investment in in-            them to another. Thus we have ample reason
                                         formation technology, self-service, shopping              to believe that analogical reasoning is a key im-
                                         carts, and so forth.                                      plement in the toolbox of the typical real-
                                            Analogical reasoning can also be a source of           world strategist.
                                         remarkable insight. Analogies lie at the root of
                                         some of the most compelling and creative                  How Analogies Fail
                                         thinking in business as a whole, not just in dis-         Though analogical reasoning is a powerful
                                         cussions of strategy. For instance, Taiichi Ohno,         and prevalent tool, it is extremely easy to rea-
                                         the foremost pioneer of Toyota’s famed pro-               son poorly through analogies, and strategists
                                         duction system, supposedly invented the kan-              rarely consider how to use them well. Indeed,
                                         ban system for replenishing inventory after he            analogies’ very potency requires that they be
                                         watched shelf-stocking procedures at U.S. su-             used wisely. To understand the potential pit-
                                         permarkets, and he devised the andon cord to              falls, consider for a moment the anatomy of
                                         halt a faulty production line after seeing how            analogy. Cognitive scientists paint a simple
                                         bus passengers signaled a driver to stop by               picture of analogical reasoning. An individual
                                         pulling a cord that rang a bell.                          starts with a situation to be handled—the tar-
                                            Reasoning by analogy is prevalent among                get problem (for Intel, the competition from
                                         strategy makers because of a series of close              makers of low-end microprocessors). The per-
                                         matches: between the amount of information                son then considers other settings that she
                                         available in many strategic situations and the            knows well from direct or vicarious experience
                                         amount required to draw analogies; between                and, through a process of similarity mapping,
                                         the wealth of managerial experience and the               identifies a setting that, she believes, displays
                                         need for that experience in analogical reason-            similar characteristics. This setting is the

Strategic Decision Making and the Case Method
The case method in business education has        ertoire of secondhand experiences from               ident in the experiment described in the
often been criticized, most recently by Henry    which students can reason. During their              main text); a deep one emphasizes similarity
Mintzberg, because it depicts management         managerial careers, former business students         along dimensions that truly drive business
as an abstract theoretical exercise removed      will seldom, if ever, encounter a situation ex-      performance.
from the reality of managerial work. We be-      actly like one they discussed in the class-             It is probably not surprising that two pro-
lieve this criticism misses the cognitive un-    room. But having studied and debated hun-            fessors at Harvard, the bastion of the case
derpinnings of managerial decision making.       dreds of cases from diverse settings,                method, would defend it. Yet our support
In their role as strategists, managers often     managers can draw upon a large set of vicari-        comes with important reservations. Too of-
face situations in which thinking by analogy     ous experiences as they make choices.                ten, students and managers alike reason
or by case has more power than other forms          Second, the case method gives students ex-        loosely and fail to assess whether there is a
of reasoning. Thus, teaching managers with       tensive experience in deciding what is and           clear causal mapping of their solution onto
cases, and to reason from cases, is an appro-    what isn’t important in a given business situ-       the problem. Students who are taught by the
priate and powerful approach. In fact, the       ation. This skill is crucial to analogical rea-      case method should be trained in the careful
case method has extraordinary potential to       soning. The difference between a superficial          use of analogy—and that, we fear, occurs
enable managers to draw better analogies,        and a deep similarity mapping is relevance. A        too rarely. Indeed, that fear was one of the
for two reasons.                                 superficial mapping focuses on irrelevant             factors that fueled our interest in analogical
   First, the case method creates a large rep-   similarity (such as the home state of the pres-      reasoning.

harvard business review • april 2005                                                                                                         page 4
                                                                                                              How Strategists Really Think

                                       source problem (the steel industry). From the        tricity markets. The characteristics included
                                       source emerges a candidate solution that was         fragmented demand, rapid change due to de-
                                       or should have been adopted for the source           regulation or technological progress, complex
                                       problem (a vigorous defense of the low end).         and capital-intensive distribution systems,
                                       The candidate solution is then applied to the        lengthy sales cycles, opaque pricing, and mis-
                                       target problem.                                      matches between long-term supply contracts
                                          In a variant of this picture, the solution        and short-term fluctuations in customer de-
                                       seeking a problem, an individual starts with a       mand. In such markets, managers were confi-
                                       source problem and a candidate solution, then        dent that Enron’s market-creation and trading
                                       uses similarity mapping to find a target prob-        skills would allow the company to make hefty
                                       lem where the solution would work well. Cir-         profits.
                                       cuit City’s managers, for instance, had an effec-        On the broadband opportunity, for in-
                                       tive solution in consumer electronics retailing.     stance, Enron Chairman Kenneth Lay told Gas
                                       They then found a new setting, used-car retail-      Daily, “[Broadband]’s going to start off as a
                                       ing, to which they believed their solution could     very inefficient market. It’s going to settle
                                       be applied with success.                             down to a business model that looks very
                                          Dangers arise when strategists draw an anal-      much like our business model on [gas and
                                       ogy on the basis of superficial similarity, not       electricity] wholesale, which obviously has
                                       deep causal traits. Take Ford, for instance. In      been very profitable with rapid growth.” But
                                       overhauling its supply chain, the automaker          Enron’s executives failed to appreciate impor-
                                       looked carefully at Dell’s key strategic princi-     tant, deeper differences between the markets
                                       ple of “virtual integration” with its suppliers as   for natural gas and bandwidth. The broad-
                                       a possible source for an analogy. On the sur-        band market was based on unproven technol-
It is extremely easy to                face, computer and auto production resemble          ogy and was dominated by telecom compa-
                                       one another. Both involve the assembly of a          nies that resented Enron’s encroachment. The
reason poorly through                  vast variety of models from a set of fairly stan-    underlying good—bandwidth—did not lend
                                       dardized components. It is easy, however, to         itself to the kinds of standard contracts that
analogies, and strategists             pinpoint differences between the two indus-          made efficient trading possible in gas and
rarely consider how to                 tries. In the PC business, for example, prices of    electricity. Perhaps worst, in broadband trad-
                                       inputs decline by as much as 1% per week—            ing, Enron had to deliver capacity the “last
use them well.                         much, much faster than in the auto industry.         mile” to a customer’s site—an expensive chal-
                                       To the extent that rapidly falling input prices      lenge that gas wholesalers didn’t face.
                                       play a role in Dell’s success formula, overlook-         The danger of focusing on superficial simi-
                                       ing this underlying difference could seriously       larity is very real, for two reasons. First, distin-
                                       undermine the usefulness of the analogy. For-        guishing between a target problem’s deep,
                                       tunately, Ford executives thought carefully          structural features and its superficial character-
                                       about the differences between the auto indus-        istics is difficult, especially when the problem
                                       try and the PC business, as well as the difficulty    is new and largely unknown. In the earliest
                                       of changing their existing supply chain, as they     days of the Internet portal industry, for in-
                                       used the analogy.                                    stance, it was far from clear what structure
                                          The experience of Enron shows how a se-           would emerge in the business. Players in the
                                       ductive but bad analogy can lead to flawed de-        market adopted analogies that reflected idio-
                                       cisions. Many factors contributed to Enron’s         syncrasies of the management teams rather
                                       startling collapse, but headlong diversification      than deep traits of the evolving industry. The
                                       based on loose analogies played an important         tech-savvy founders of Lycos, for instance, saw
                                       role. After apparently achieving success in trad-    themselves competing on a high-tech battle-
                                       ing natural gas and electric power, Enron exec-      field and assumed that the company with the
                                       utives moved rapidly to enter or create mar-         best search technology would win. Magellan’s
                                       kets for other goods ranging from coal, steel,       founders, the twin daughters of publishing
                                       and pulp and paper to weather derivatives and        magnate Robert Maxwell, aimed to build “the
                                       broadband telecom capacity. In a classic exam-       Michelin guide to the Web” and developed edi-
                                       ple of a solution seeking problems, executives       torial abilities. The pioneers of Yahoo, seeing
                                       looked for markets with certain characteristics      the portal industry as a media business, in-
                                       reminiscent of the features of the gas and elec-     vested in the company’s brand and the look

harvard business review • april 2005                                                                                                    page 5
                                                                                                            How Strategists Really Think

                                       and feel of its sites.                               anchors itself in a management team, it is no-
                                           But this is only part of the picture. Not only   toriously hard to dislodge. Psychologists have
                                       is it difficult to distinguish deep similarities      shown that this is true even when decision
                                       from surface resemblances in some contexts,          makers obviously have no reason to believe
                                       but people typically make little effort to draw      the initial idea. In a demonstration of this ef-
                                       such distinctions. In laboratory experiments         fect, Nobel Prize winner Daniel Kahneman
                                       conducted by psychologists, subjects—even            and his coauthor Amos Tversky told experi-
                                       well-educated subjects—are readily seduced by        mental subjects they would be asked to esti-
                                       similarities they should know to be superficial.      mate the percentage of African countries in
                                       In a study by psychologist Thomas Gilovich,          the membership of the United Nations. A rou-
                                       students of international conflict at Stanford        lette wheel with numbers from zero to 100
                                       were told of a hypothetical foreign-policy cri-      was spun, and after it had stopped, the sub-
                                       sis: A small, democratic nation was being            jects were asked whether the actual percent-
                                       threatened by an aggressive, totalitarian neigh-     age was greater or less than the number show-
                                       bor. Each student was asked to play the role of      ing on the wheel. They were then asked to
                                       a State Department official and recommend a           estimate the correct percentage. Surprisingly,
                                       course of action. The descriptions of the situa-     the roulette wheel had a strong impact on
                                       tion were manipulated slightly. Some of the          final estimates. For instance, subjects who saw
                                       students heard versions with cues that were in-      10% on the wheel estimated the real percent-
                                       tended to make them think of events that pre-        age at 25%, on average, while those who saw
                                       ceded World War II. The president at the time,       65% gave an average estimate of 45%. The rou-
                                       they were told, was “from New York, the same         lette wheel knew nothing about the composi-
                                       state as Franklin Roosevelt,” refugees were flee-     tion of the United Nations, obviously, yet it
Strategists will seek                  ing in boxcars, and the briefing was held in          had a powerful influence on people’s judg-
                                       Winston Churchill Hall. Other students heard         ment. (The current answer: African nations
evidence that their                    versions that might have reminded them of            make up 24% of the U.N.’s membership.)
                                       Vietnam. The president was “from Texas, the             The anchoring effect suggests that early
analogy is legitimate, not             same state as Lyndon Johnson,” refugees were         analogies in a company, even if they have
evidence that it is                    escaping in small boats, and the briefing took        taken root casually, can have a lasting influ-
                                       place in Dean Rusk Hall. Clearly, there is little    ence. This is especially true if decision makers
invalid. As a result, a                reason that the president’s home state, the ref-     become emotionally attached to their analo-
company may continue                   ugees’ vehicles, or the name of a briefing room       gies. For years, Sun Microsystems has focused
                                       should influence a recommendation on foreign          on delivering entire systems of hardware and
to act on a superficial                policy. Yet subjects in the first group were sig-     software even as the computer industry has
                                       nificantly more likely to apply the lessons of        grown less and less integrated. CEO Scott Mc-
analogy for a long time.
                                       World War II—that aggression must be met             Nealy often justifies his contrarian position by
                                       with force—than were participants in the sec-        highlighting an analogy to the automotive in-
                                       ond group, who veered toward a hands-off pol-        dustry. “You guys are all focusing on piston
                                       icy inspired by Vietnam. Not only were the stu-      rings,” he once told reporters. “Go and ask Ford
                                       dents swayed by superficial likenesses, they          about its strategy in piston rings. And carbure-
                                       were not even aware that they had been               tors. You don’t. You talk about the whole car.”
                                       swayed.                                              Though Sun has suffered financially, McNealy
                                           The implications are unsettling. Thanks to       has been reluctant to shift strategy, and, in-
                                       his or her particular history and education,         deed, he continues to use the auto analogy.
                                       each manager carries around an idiosyncratic         Perhaps that is inevitable for an individual
                                       tool kit of possible sources of analogies. In        whose father worked in the auto industry and
                                       choosing among tools or identifying new prob-        whose sons are named after vehicle models—
                                       lems for old tools, the manager may be guided        Maverick, Scout, Colt, and Dakota.
                                       by something other than a careful look at the           Confirmation Bias. The anchoring effect is
                                       similarity between the source and the target.        reinforced by another problem: decision mak-
                                           The tendency to rely on surface similarity is    ers’ tendency to seek out information that
                                       made even worse by two other common flaws             confirms their beliefs and to ignore contradic-
                                       in how people reach judgments:                       tory data. To some degree, this tendency arises
                                           Anchoring. Once an analogy or other idea         simply because managers like to be right—

harvard business review • april 2005                                                                                                 page 6
                                                                                                                                                                                                         How Strategists Really Think

                                           and like to be seen as right. But there is evi-                                                                                             Germany and East Germany, or Sri Lanka and
                                           dence from psychology that people are better                                                                                                Nepal?” Most people answered, “West Ger-
                                           equipped to confirm beliefs than to challenge                                                                                                many and East Germany.” A second set of sub-
                                           them, even when they have no vested interest                                                                                                jects was asked, “Which pair of countries is
                                           in the beliefs.                                                                                                                             more different, West Germany and East Ger-
                                              Consider an illustration. Experimental sub-                                                                                              many, or Sri Lanka and Nepal?” Again, most
                                           jects in Israel were asked during the 1970s,                                                                                                people answered, “West Germany and East
                                           “Which pair of countries is more similar, West                                                                                              Germany.” How can we reconcile the two sets
                                                                                                                                                                                       of results? The accepted interpretation starts
                                                                                                                                                                                       with the fact that the typical Israeli knew more
                                                                                                                                                                                       about the Germanys than about Sri Lanka and
                                                                                                                                                                                       Nepal. When asked to test a hypothesis of sim-
                   Avoiding Superficial Analogies                                                                                                                                       ilarity, subjects sought evidence of similarity
                   It’s often difficult to tell whether similarities between a                                                                                                          and found more between the Germanys than
                   familiar and an unfamiliar problem are deep or superficial.                                                                                                          between Sri Lanka and Nepal. When asked to
                   Managers facing strategic choices can improve their odds                                                                                                            test a hypothesis of difference, they sought dif-
                   of using analogies well by following these four steps.                                                                                                              ferences and found more of them between the
                                                                                                                                                                                       Germanys. Subjects search for the attribute
                                                                                                                                                                                       they are prompted to seek—similarity or dif-
                                                                                                                                                                                       ference—and do not look for evidence of the
                     Source                                             Target                                                                                                         contrary attribute.
                    Problem                                            Problem                                                                                                            Together, anchoring and the confirmation
                                                     1                                                                                                                                 bias suggest real problems for strategists who
                  Apparently similar                                   Your company’s
                    problem from       Recognize the analogy              problem                                                                                                      rely on analogies. Having adopted an analogy,
                   another context
                                       and identify its purpose.                                                                                                                       perhaps a superficial one, strategy makers will
                                                                                                                                                                                       seek out evidence that it is legitimate, not evi-
                                                                                                                                                                                       dence that it is invalid. Intel’s managers will
                                                                                                                                                                                       tend to look for reasons that microprocessors
                     Source                                             Target
                                                                                                                                                                                       really are like steel; Circuit City will try to con-
                    Problem                                            Problem
                                                                                                                                                                                       firm that consumer electronics and used cars
                                                     2                                                                                                                                 truly are alike. Given the variety of informa-
                                                                                               Copyright © 2005 Harvard Business School Publishing Corporation. All rights reserved.

                                       Understand the source.                                                                                                                          tion available in most business situations, any-
                    Solution                                                                                                                                                           one who looks for confirming data will doubt-
                                                                                                                                                                                       less find something that supports his or her
                                                                                                                                                                                       beliefs. Thanks to the anchoring effect, any
                                                                                                                                                                                       contradictory information may well be disre-
                     Source                Similarity Mapping           Target                                                                                                         garded. As a result, a company may continue
                    Problem                                            Problem
                                                                                                                                                                                       to act on a superficial analogy for a long time.
                   Candidate               Assess similarity.                                                                                                                          How to Avoid Superficial Analogies
                    Solution           Actively search for differences                                                                                                                 Reasoning by analogy, then, poses a dilemma
                                       between the source and the target.                                                                                                              for senior managers. On the one hand, it is a
                                                                                                                                                                                       powerful tool, well suited to the challenges of
                                                                                                                                                                                       making strategy in novel, complex settings. It
                    Source                                              Target                                                                                                         can spark breakthrough thinking and fuel suc-
                   Problem                                             Problem                                                                                                         cesses like those of Toys R Us and Intel. On the
                                                     4                                                                                                                                 other, it raises the specter of superficiality. Can
                   Candidate              Translate, decide,             Your                                                                                                          managers tap the power of analogy but side-
                    Solution                 and adapt.                Solution                                                                                                        step its pitfalls? The bad news is that it is im-
                                                                                                                                                                                       possible to make analogies 100% safe. Manag-
                                       Application                  Adjust the solution
                                                                    for glaring differences.                                                                                           ers are especially likely to rely on analogical
                                                                                                                                                                                       reasoning in unfamiliar, ambiguous environ-
                                                                    Fine-tune the solution
                                                                    using market feedback.                                                                                             ments where other forms of thinking, like de-
                                                                                                                                                                                       duction, break down. In those settings, it’s

harvard business review • april 2005                                                                                                                                                                                               page 7
                                                                                                                   How Strategists Really Think

                                            hard to distinguish the deep traits from the su-      pany is using any analogies it recognizes. Man-
                                            perficial. The good news is that four straight-        agers use analogies for a variety of purposes,
                                            forward steps can improve a management                after all—to brainstorm, to communicate com-
                                            team’s odds of using analogies skillfully. (See       plexity, and to motivate employees, for exam-
                                            the exhibit “Avoiding Superficial Analogies.”)         ple. (For thoughts on the uses of analogies, see
                                               Before laying out these steps, we must ac-         the sidebar “A Versatile Tool.”) Often, analogies
                                            knowledge our debt to political scientists, espe-     are used to spark ideas and emotions. In such
                                            cially Harvard’s Ernest May and Richard Neus-         cases, creativity and impact may be more im-
                                            tadt, who found that analogical reasoning             portant than strict validity. But when a com-
                                            often leads policy makers astray. The ap-             pany moves from brainstorming to deciding,
                                            proaches they developed to train such people          and when resources are at stake, managers
                                            to make better use of history have informed           need to ask tough, objective questions about
                                            our thinking.                                         whether the analogy is more than superficial.
                                               Recognize the analogy and identify its pur-        To answer these questions well, strategists
                                            pose. To defend against flawed analogies, a            must analyze chains of cause and effect. It is
                                            management team first must recognize the               useful to break this task into three further
                                            analogies it is using. Sometimes they are obvi-       steps.
                                            ous. It is hard to forget that “digital rebar” is a      Understand the source. Begin by examin-
                                            reference to the steel industry, for instance. In     ing why the strategy worked in the industry
                                            other cases, influential analogies remain hid-         from which the analogy was drawn. The clas-
                                            den. They often come from executives’ back-           sic tools of strategy analysis are extremely use-
                                            grounds. Though Merrill Lynch’s distinctive           ful here. Indeed, the key is to lay out in-depth
                                            approach to retail brokerage owed much to             analyses that are familiar to strategists, partic-
                                            the years that Charlie Merrill spent in the su-       ularly analyses of the source environment, the
                                            permarket business, only occasionally did             solution or strategy that worked well (or that
                                            Merrill confess that “although I am supposed          failed) in the original context, and the link be-
                                            to be an investment banker, I think I am really       tween the source environment and the win-
                                            and truly a grocery man at heart.”                    ning (or losing) strategy.
                                               It’s also important to identify how a com-            Consider Circuit City’s effort to apply its re-
                                                                                                  tailing solution to the used-car business, and
                                                                                                  start by analyzing the source environment.
                                                                                                  When the company began its rise to promi-

A Versatile Tool                                                                                  nence in the 1970s, the consumer electronics
                                                                                                  industry was dominated by mom-and-pop re-
This article focuses on the use of anal-       move from generating options to choos-             tailers of varying quality and efficiency. Bur-
ogy as a tool for choosing among possi-        ing among them.                                    geoning demand kept the retailers afloat, de-
ble solutions to strategic problems, but         Analogies are also powerful tools for            spite three negatives: Consumers were more
managers also use analogies for other          communicating complex messages                     committed to the national brands than to the
purposes. Most important, analogies            quickly. When the executives turning               retailers, the cost to switch from one retailer to
can be catalysts for generating creative       around Ducati began to speak of the leg-           another was low, and customers often feared
options. Seeking outside-the-box ways to       endary Italian motorcycle maker as an              that retailers were preying on their ignorance
speed customers through gas stations,          entertainment company comparable to                of high-tech products. The environment was
for instance, Mobil executives looked far      Disney, they made it clear, to insiders            marked by untapped efficiencies (for example,
afield—at the operations of race-car pit        and outsiders, that they planned to in-            few economies of scale were exploited) and
crews. And to improve service, they ex-        vest more in the experiential aspects of           unmet customer needs (each store carried a
amined the world-class operations of the       the brand and less in the physical prod-           limited selection of brands, and products were
Ritz-Carlton hotel chain. Similarly, a         uct. Chosen well, analogies have an                often out of stock).
management team might choose a com-            emotional impact that can rally a man-                Circuit City devised a highly effective strat-
pany it deeply admires in a distant busi-      agement team. By referring to cheap                egy that took advantage of the opportunities
ness and ask itself, “What would it mean       PCs as “digital rebar,” Andy Grove sharp-          and neutralized the threats in this setting. Key
to be the Wal-Mart or GE or Dell of our        ened his colleagues’ fears that Intel              to the strategy was a series of fixed invest-
industry?” We see little danger in using       could go the way of U.S. Steel. Sports             ments: large stores that could stock an exhaus-
analogies this way—as long as manag-           and military analogies are often used in           tive selection of consumer electronics, infor-
ers test any analogy carefully when they       this way, to motivate teams.                       mation technology that could track sales

harvard business review • april 2005                                                                                                         page 8
                                                                                                                    How Strategists Really Think

                                               patterns closely, automated distribution cen-       logic holds up in the target environment. In
                                               ters that were tied to the sales-tracking tech-     preparing to make that analysis, the strategy
                                               nology, and brand-building efforts. The com-        maker will find it useful to compile two lists of
                                               pany differentiated itself from competitors on      industry features: those that play a crucial role
                                               the basis of selection, availability, and con-      in the causal logic and those that don’t. In the
                                               sumer trust. It simultaneously drove down           Circuit City example, the list of crucial ele-
                                               costs. Circuit City’s low prices and its other      ments includes the following features of the
                                               strengths led to extraordinarily large sales vol-   pre–Circuit City electronics retailing industry:
                                               umes, which reduced unit costs. Those cost re-          • unsatisfied customer needs, especially for
                                               ductions permitted lower prices, which drove        product selection, product availability, and
                                               even greater volume, and so on in a virtuous        trustworthy retailers;
                                               cycle.                                                  • untapped economies of scale and latent,
                                                  Note how well this strategy matched the de-      but largely unrealized, barriers to entry;
                                               mands of the external environment. By meet-             • a fragmented base of rivals, many of them
                                               ing consumer needs and by building a brand          weak;
                                               that shoppers valued, Circuit City made it less         • unexploited opportunities to apply infor-
                                               attractive for customers to switch from store to    mation and distribution technologies for better
                                               store. As Circuit City’s brand rose to promi-       inventory management;
                                               nence, as sales volume grew, and as customers           • branded, powerful, reliable suppliers;
                                               came to rely on the recommendations of Cir-             • modest switching costs among consumers;
                                               cuit City’s salespeople, the company became         and
                                               far more powerful in negotiations with suppli-          • an absence of goods that are close substi-
                                               ers. Investments in branding, distribution, in-     tutes at the high end of the market.
                                               formation technology, and large stores raised           At least one notable feature of the industry
                                               new barriers to entry. And scale-driven cost ad-    appears not to have played a major role in the
                                               vantages gave the company a powerful way to         causal logic, according to our analysis. Demand
                                               overcome smaller rivals.                            for consumer electronics was growing rapidly
                                                  The preceding three paragraphs lay out a         when Circuit City became a success, but the in-
                                               chain of cause and effect that explains why Cir-    dustry growth rate does not loom large in the
                                               cuit City’s original strategy worked in the con-    causal story. The sheer size of the industry
                                               sumer electronics environment. The strate-          plays a role—without a critical mass of de-
                                               gist’s goal is to figure out whether the causal      mand, economies of scale cannot be tapped—
                                                                                                   but the growth rate does not seem critical.
                                                                                                       Assess similarity. The strategist now maps
                                                                                                   similarities between the source and the target
Background of the Work                                                                             and determines whether the resemblance is
                                                                                                   more than superficial. The understanding of
Field research sparked our interest in            of a simulation in which computer-mod-           the source that he or she has built up is crucial
analogical reasoning. While exploring             eled “managers” use analogical reason-           in this step. Rather than wrestling with the en-
the origins of strategies in the Internet         ing to solve strategic problems. Perhaps         tire target problem, which is much less famil-
portal industry, we were struck by the            the crucial ingredient in the research is        iar than the source, the strategist can focus on
prevalence of analogies. Discussions              that we—the authors of this article—             the key features of the causal logic. The ques-
with managers and academic col-                   come from very different academic back-          tion is whether the source and the target are
leagues, along with personal reflections,          grounds. One of us was raised within             similar or different along these features.
led us to recognize the broader signifi-           Wharton’s behavioral approach to man-                Similarities usually spring to mind quickly.
cance of analogical reasoning in strategy         agement, which emphasizes the limits             But the team must also search actively for differ-
making. This recognition fueled a series          on human reasoning, and the other                ences, seeking evidence that each essential fea-
of efforts, including a review of the liter-      comes from Harvard’s strategy tradition,         ture of the source problem is absent in the tar-
ature on analogy in psychology, cogni-            which stresses the power of rational eco-        get. This process rarely comes naturally—it is
tive science, political science, and lin-         nomic choice. Analogical reasoning lies          often thwarted by the confirmation bias. The
guistics; an initiative to examine and            in the middle ground between the two             team should also do something else that
improve the use of analogical reasoning           of us. It is a form of reasoning that is po-     doesn’t come naturally: ask whether the similar-
in the MBA classroom; and develop-                tent because it makes the most of                ities are largely superficial. The list of industry
ment, with Wharton’s Daniel Levinthal,            bounded cognitive abilities.                     features that are not crucial in the causal logic

harvard business review • april 2005                                                                                                          page 9
                                                                                                               How Strategists Really Think

                                       is very useful in this step. If many of the simi-      the source and the target settings. By now, ex-
                                       larities are on this list rather than the list of      ecutives have a sense of the most important
                                       crucial correspondences, the management                differences, and, in translating the strategy,
                                       team should sound an alarm. The analogy may            they try to make adjustments that deal with
                                       be based on superficial similarity.                     them. After the translation comes a go-no-go
                                           Circuit City’s entry into the used-car market      decision on whether to pursue the analogy in
                                       illustrates the process of assessing similarity. In    the marketplace. This involves a clearheaded
                                       many ways, the target industry in the 1990s re-        assessment of whether the translated strategy
                                       sembled the consumer electronics retailing in-         is likely to fare well in the new context. If exec-
                                       dustry of the 1970s:                                   utives opt to pursue the analogy, they face an-
                                           • Many customers were unsatisfied with,             other round of adjustment—adapting in the
                                       and distrustful of, current retailers.                 marketplace in response to feedback from cus-
                                           • Economies of scale and barriers to entry         tomers, rivals, suppliers, and others. It is here,
                                       were limited.                                          in the market, that managers truly learn how
                                           • The industry was fragmented.                     good their analogies are.
                                           • Information and distribution technologies            Circuit City’s translated strategy bore a
                                       remained fairly primitive, even though the in-         close resemblance to the company’s electron-
                                       ventory was highly diverse.                            ics retailing operation. On lots of up to 14
                                           • Consumers incurred few costs if they             acres, each CarMax superstore offered an un-
                                       switched from one retailer to another.                 usually broad inventory of 200 to 550 vehi-
                                           Note that all of these similarities match cru-     cles. CarMax went to special lengths to foster
                                       cial elements of the causal logic in electronics re-   customers’ trust. It sold cars at fixed, posted
                                       tailing. This bodes well for the analogy. On the       prices, with no haggling. It hired salespeople
                                       other hand, there were important differences:          with retailing experience, but not auto retail-
                                           • In consumer electronics, Circuit City could      ing experience, and gave them extensive train-
                                       rely on a large base of dependable, reputable          ing. CarMax compensated salespeople with a
                                       suppliers. In contrast, most used-car dealers          flat fee per vehicle sold rather than a fraction
                                       bought their autos from individual sellers or          of the revenue they generated. The company
                                       from wholesalers, some reliable and some not.          also put in place a sophisticated inventory
                                           • The inventory of used cars was even more         tracking system that mirrored the electronics
                                       diverse than that of consumer electronics. It          retailing system, and it offered money-back
                                       would be difficult to keep a predictable range          guarantees and warranties that resembled
                                       of products in stock. This might make it hard          those in Circuit City stores.
                                       for CarMax to detect sales trends quickly and              At the same time, CarMax adjusted the Cir-
                                       adjust its inventory to meet demand. More-             cuit City formula to reflect the differences be-
                                       over, the distribution expertise Circuit City had      tween the two settings. This required, for in-
                                       developed might not be useful in the used-car          stance, that the company find reliable sources
                                       industry.                                              of used cars. Toward this end, CarMax placed
                                           • It was not clear whether economies of            well-trained buyers in each of its stores and of-
                                       scale existed or barriers to entry could be built      fered to buy used cars directly from consumers,
                                       in auto retailing.                                     even those who did not intend to buy a vehicle
                                           • The used-car retailing market had an im-         from CarMax. The company started to sell new
                                       portant substitute at the high end of the mar-         cars at some sites, in part to generate used cars
                                       ket: new-car dealers.                                  from trade-ins. By 2002, individual consumers
                                           Translate, decide, and adapt. The final step        were CarMax’s single largest source of used
                                       is to decide whether the original strategy,            cars. Regardless of source, all CarMax used cars
                                       properly translated, will work in the target in-       were thoroughly inspected and reconditioned
                                       dustry. This step requires, first, that the man-        before they were resold.
                                       agement team say clearly what the strategy                 The diverse inventory of used cars pre-
                                       would look like in the new setting. Precisely          sented a new challenge. No single used-car lot
                                       what would it take to be the Circuit City of the       could show the full array of vehicles in Car-
                                       used-car industry or the supermarket of toys?          Max’s inventory. So CarMax developed a com-
                                       This requires some adjustment. Even the best           puter system that allowed consumers to peruse
                                       analogies involve some differences between             the company’s full inventory. The system told

harvard business review • april 2005                                                                                                    page 10
                                                                                                            How Strategists Really Think

                                       customers what was available nationwide and         on analogies, it is often wise to hold off on fine-
                                       what it would cost to transfer a desired car to     tuning the solution until the market can give
                                       the customer’s locale.                              its guidance.
                                          CarMax was neither an immediate nor an
                                       unmixed success. It took Circuit City most of       Toward Better Strategic Choices
                                       a decade to tailor its formula to the used-car      Analogies lie on a spectrum. At one end lie
                                       market. The company built some stores that          perfect analogies, where the source and target
                                       were too large and adopted an overly ambi-          are truly alike on the dimensions that drive
                                       tious rollout plan, and price wars in the new-      economic performance. The toy retailing in-
                                       car market and expansion by other used-car          dustry of the 1950s deeply resembled the gro-
                                       superstores occasionally hurt its stock price.      cery business, much to the benefit of Toys R
                                       Nonetheless, the effort to reproduce Circuit        Us, and the demands on Toyota’s kanban sys-
                                       City’s success in the used-car industry has         tem closely mirrored those related to super-
                                       produced a viable company with revenue of           market reshelving. At the opposite end of the
                                       $4.6 billion in fiscal year 2004, a return on        spectrum are profoundly problematic analo-
                                       sales of 2% to 3%, a multibillion-dollar mar-       gies, such as Enron’s comparison of broadband
                                       ket capitalization, and equity whose returns        and natural gas trading, that are based on su-
                                       have roughly matched the S&P 500’s since            perficial similarities yet plagued by underlying
                                       the IPO in 1997. This positive outcome re-          differences. The vast majority of analogies fall
                                       flects the close resemblance between the             somewhere in between—they’re imperfect
                                       electronics retailing industry and the used-        but useful. The challenge is to get the most
                                       car industry, especially in features pertinent      out of them. In our experience, the best users
                                       to the causal logic of the original success. It     of analogy harness deduction and trial and
                                       also reflects the company’s careful attention        error to test and improve the analogies that lie
                                       to the essential differences between the in-        in the middle of the spectrum. Intel’s analogy
                                       dustries—or at least the company’s ability to       involving the steel industry, for instance, was
                                       adapt to those differences.                         supported by a deductive theory of cause and
                                          A critical question in this final step is how     effect—Clayton Christensen’s ideas about dis-
                                       much a company should translate the candi-          ruptive technologies. It also drew strength
                                       date solution, on the basis of forethought          from trial-and-error experiments that gradu-
                                       alone, before launching it in the marketplace.      ally refined Intel’s approach to the low end of
                                       In studying the transfer of best practices within   the microprocessor market, much as Circuit
                                       companies, say from one bank branch to an-          City’s adjustments served to fine-tune Car-
                                       other, Insead’s Gabriel Szulanski and Whar-         Max’s strategy. Managers who wish to tap the
                                       ton’s Sidney Winter have found that managers        great power of analogy and sidestep its pitfalls
                                       overestimate how well they understand cause         must master multiple modes of thought.
                                       and effect relationships and, accordingly, ad-
                                       just too much on the basis of forethought. This     Reprint R0504C
                                       lesson applies to analogies, too. It makes sense    Harvard Business Review OnPoint 9661
                                       to adjust a candidate solution beforehand to        To order, see the next page
                                       account for glaring differences between the         or call 800-988-0886 or 617-783-7500
                                       target and the source. But in novel, uncertain      or go to
                                       environments, where strategists rely the most

harvard business review • april 2005                                                                                                 page 11
                                        How Strategists Really Think
                                        Tapping the Power of Analogy

                                        Further Reading
                                        Selection Bias and the Perils of                  Don’t Trust Your Gut
                                        Benchmarking                                      by Eric Bonabeau
                                        by Jerker Denrell                                 Harvard Business Review
                                        Harvard Business Review                           May 2003
                                        April 2005                                        Product no. 3604
                                        Product no. R0504H
                                                                                          Using intuition to make strategic decisions
                                        Like analytical thinking, benchmarking—           also has advantages and disadvantages. It
                                        studying the practices of successful compa-       saves time, but it subjects us to dangerous bi-
                                        nies in order to make strategic decisions—is a    ases as well. For example, we give dispropor-
                                        double-edged sword. When business leaders         tionate weight to information that confirms
                                        study only high-performing companies, they        our assumptions. And we let the first informa-
                                        draw conclusions from unrepresentative data       tion we receive distort our interpretation of
                                        samples—falling into the classical statistical    subsequent data.
                                        trap of selection bias. This form of bias leads
                                                                                          To avoid these biases, Bonabeau recommends
                                        decision makers to overvalue big-bet business
                                                                                          using computer-based tools to help manag-
                                        practices, seeing only those companies that
                                                                                          ers make strategic decisions about problems
                                        won big and not the ones that lost dismally by
                                                                                          with many interrelated but unpredictable ele-
                                        using the same practices. It also prevents de-
                                                                                          ments—such as global markets or supply
                                        cision makers from distinguishing cause from
                                                                                          chains. Southwest Airlines, for example, used
                                                                                          computer-based modeling to revamp its
                                        To discover what made a strategy successful,      cargo-handling rules—saving $2 million on
                                        look at both successes and failures. Even if      labor annually.
                                        data about failed companies is hard to come
                                        by, you can use relatively simple tools to cor-
                                        rect for selection bias.

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