10 Sanity Tests for Strategy Development

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Framework Primer
10 Sanity Tests for Strategy
Development
Presentation created by
?
Will your strategy beat the
market?
Is your strategy granular about
where to compete?
Does your strategy rest
on privileged insights?
Does your strategy
balance commitment and
flexibility?
Is there conviction to act on your
strategy?
Does your strategy tap a true
source of advantage?
Does your strategy put you ahead
of trends?
Does your strategy embrace
uncertainty?
Is your strategy contaminated by
bias?
Have you translated your strategy
into an action plan?
1
3
5
7
9
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4
6
8
10

2This document is an exclusive document available to FlevyPro members - http://flevy.com/pro
Contents
Overview
Strategy Sanity Tests
Templates
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Today is the ideal time for our company to kick the tires on our strategy
Presentation Overview
A shift towards shorter planning cycles and decentralized strategic decision making
are increasing the utility of a common set of tests.
Strategy is a way of thinking. It is not a procedural exercise or a set of framework.
Our company normally does not focus on the frameworks, tools, and approaches that generate
our strategies.
This presentation will introduce our company to the Ten Tests that will guide us to think
strategically. The ten tests will help us assess the strength of our strategies and focus on
testing the strategy itself.
These tests of a good strategy are timeless. But the need to pressure-test a strategy is timely
now.
This deck also includes slide templates for you to use in your own business presentations.
1 Our company develops our strategy in many different ways, often idiosyncratic to our
organization, people, and market.
2 Many strategies emerge over time rather than from a process of deliberate formulation.

Ten timeless tests can help our company kiss the tires on our strategy
10 Sanity Tests for Strategy
It is possible for a strategy to succeed without “passing” all nine tests.
Ten timeless “sanity tests” can help our company kick up the level of strategic dialogue throughout
our company.
Source: Have You Tested Your Strategy Lately, McKinsey, 2011
Test 1 is comprehensive, while
Tests 2-10 disaggregates the
picture of a market-beating
strategy.
Hopefully, the tests will prove a
simple and effective antidote: a
means of quickly identifying gaps
in our company’s strategic thinking.
The tests will open minds to new
ways of using strategy to create
value and improve the quality of
the strategy-development process.
Will your strategy beat
the market?
Is your strategy granular
about where to compete?
Does your strategy
flexibility?
Is there conviction to act
on your strategy?
Does your strategy
tap a true source
of advantage?
Does your strategy put
you ahead of trends?
Does your strategy
embrace uncertainty?
Is your strategy
contaminated by bias?
Have you translated your
strategy into an action
plan?
?
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5
7
9
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4
6
8
10

Contents
Overview
Templates

The first sanity test provides a comprehensive picture of our market
Strategy Test 1
Weaker contenders can win the war when a divergent strategy is deployed—this is
the same in business.
TEST 1 Will your strategy beat the market?
We operate in markets surrounded by our customers, suppliers,
competitors, substitutes, and potential entrants that are advancing
their positions. This process is creating economic surplus.
Our company can beat the market. We must just capture and retain
an economic surplus. An imperfection must exist that slows down the
working of the market. An imperfection that is controlled by our
company is our Competitive Advantage.
Markets drive a reversion to mean performance. As our company
learns from others, best practice becomes commonplace. As a result,
best practice ceases to be a market-beating strategy.
Good strategies emphasize differences against our direct
competitors. To beat the market, advantages have to be robust and
responsive in the face of onrushing market forces.
EXAMPLE
In 1920, 300 competitors were created
when the US tire industry was at its peak.
After 20 years, only 4 producers remain,
controlling more than 70% of the market
with strategic choice of location and
technology.

The focus of the second sanity test is to measure our company’s
Competitive Advantage
Strategy Test 2
Our organization must always take a dynamic view as competitors will always exploit points
of vulnerability.
TEST 2 Does your strategy tap a true source of advantage?
Competitive Advantage stems from two sources of scarcity: positional
advantages and special capabilities.
• Positional advantages are rooted in structurally attractive
markets. These advantages create an asymmetry between those
inside and those outside the high walls.
• Special capabilities are scarce resources whose possession
confers unique benefits. These can be distinctive competencies
that our company does well such as innovating or managing
stakeholders. These capabilities are powerful in creating
advantage but cannot be easily traded.
Special capabilities must be critical to our company’s profits and exist
in abundance within our company while being scarce outside.
We can bundle together activities that collectively create advantage.
This becomes more difficult for our competitors to identify and
replicate its exact source.
EXAMPLE
A highly successful discount grocery retailer
redesigned a typical business system of a
supermarket. This is to deliver its value
proposition of lower prices.
As a result, competitors found it difficult to
copy the total system.

Taking strategy test 3 helps our organization determine how detail our
strategy is in defining who our market is
Strategy Test 3
Eighty percent of the variance in revenue growth is explained by choices about where
to compete.
TEST 3 Is your strategy granular about where to compete?
The need to beat the market starts by asking which market.
What is the right level of granularity?
Is our strategy detailed enough to determine the right level
of market segmentation to compete with?
Defining and understanding our market segments correctly is the
most practical thing our company can do to improve our strategy.
EXAMPLE
Management at one large bank attributed
its fast growth and share gains to superior
customer perceptions and satisfaction. The
market was examined at a more granular
level.
Findings: The fast growth was due to high
exposure to one fast-growing city and its
presence in a fast-growing product
segment.
As a result, false assumptions about what
was and was not working were avoided to
build an effective strategy.

Strategy test 4 measures how effective our strategy is in keeping our
company ahead of trends
Strategy Test 4
We should always look to the edges.
TEST 4 Does your strategy put you ahead of trends?
The emergence of new trends is the norm. A major innovation or an
external shock in regulation, demand, or technology can drive a rapid,
full-scale industry transition. But most trends emerge fairly slowly that
our company fails to mount a strategic effective response.
Strategists must take trends analysis seriously.
How are early adopters and that small cadre of consumers
who seem to be ahead of the curve acting?
What are small, innovative entrants doing?
What technologies under development could change the
game?
To see which trends really matter, our company must assess the
potential impact of trends on the financial position of our company.
The decisions we make must be articulated differently if the outcome
were certain.
Example
An aging population is a trend. To effectively
react to this unavoidable trend, we need to ask
ourselves:
Which consumer behaviors would change?
Which particular product lines would be
affected?
What would be the precise effect on the P&L?
How does that picture line up with today’s
investment priorities?

Data today can be cheap, accessible, and easily assembled into
detailed analysis. Our company may feel that we possess an informed
strategy but this data is also available to our rivals.
There are important keys that can guide our company in collecting new
data.
Search for problems that can help our company.
• Ask questions whose answers would have major implications
on our company’s strategy.
• What will we regret doing and what will we not regret doing?
Conduct field observations or research rather than just
recycling industry reports everyone uses.
The 5th sanity test determines whether our strategy rests on privileged
insights
Strategy Test 5
Developing better strategy requires our company to experience the world from our
customer’s perspective routinely.
TEST 5 Does your strategy rest on privileged insights?
1
2
Our company can have
strategic breakthroughs if
we focus on simple, but
profound customer insights.

Strategy test 6 measures our strategy in the face of uncertainty
Strategy Test 6
Being able to manage uncertainty is a good gauge of an effective strategy.
TEST 6 Does your strategy embrace uncertainty?
A central challenge of strategy is that our company must
make choices now but the payoffs occur in a future
environment that we cannot fully know or control.
A critical step in embracing uncertainty is to try to
characterize what exactly our company is facing. Over the
years, we have faced 4 levels of uncertainty:
Clear view of the future: a range of outcomes
tight enough to support our firm decision.
There are a number of identifiable outcomes our
company should prepare.
The possible outcomes are represented by a
probability distribution and not by a set of points.
Total ambiguity: where even the distribution of
outcomes is unknown.
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4
We can understand the uncertainty our company faces
by going through 4 strategic steps.
List the variables that would
influence a strategic decision
and prioritize them according
to their impact.
Use economics at work
to highlight out comes
that are either mutually
reinforcing or unlikely.
Rule out impossible
outcomes.
Apply tools such as scenario
analysis to remaining, irreducible
uncertainty which is at the heart
of our company’s strategy.
1 2 3 4

In the 7th strategy sanity test, we take a look at the commitment and level
of flexibility of our strategy
Strategy Test 7
Underpriced options can be built into a strategy _capital projects just need to be
modularized or flexibility maintained.
TEST 7 Does your strategy balance commitment and flexibility?
• Commitment and flexibility exist in inverse proportion to each
other. The greater the commitment our company makes, the less
flexibility remains.
• Tension is one of the core challenges of strategy. Strategy is making
the right trade-offs over time between commitment and flexibility. An
effective trade-off requires an understanding of which decisions involve
commitment. Commitment is the only path to sustainable Competitive
Advantage.
• In a world of uncertainty, strategy is not about just where and how
to compete but also when. Committing too early can be a leap in the
dark. Being too late is dangerous because of opportunities gone by.
• A market-beating strategy will focus on just a few crucial, high-
commitment choices to be made now. Flexibility can be left for
other choices made over time.
1
In practice, we build our strategy as
a portfolio comprising of 3
elements.
Big bets or committed positions
aimed at gaining significant
Competitive Advantage.
No-regrets moves which will
pay off whatever happens.
Real options or actions that
involve relatively low costs now
but can be elevated to a higher
level of commitment as
changing conditions warrant.
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Strategy sanity test 8 determines if our strategy is contaminated by bias
Strategy Test 8
Imagining our company in the future where our decision turns to be a mistake and
identifying why they have been so can be a useful technique.
TEST 8 Is your strategy contaminated by bias?
Developing multiple
hypotheses and potential
solutions to choose among is
one way to “de-bias”
decision making. The typical
drill is to develop a promising
hypothesis and build a fact
base to validate it.
In contrast, it is also critical
to bring fresh eyes to the
issues. We need to maintain
a culture of challenge in
which the obligation to
dissent is fostered.
The decision-making
process can be de-
biased.
• Specify objective
decision criteria
in advance.
• Examine the
possibility of
being wrong.
Strategy is prone to faulty logic. It relies on
extrapolating ways to win in the future from a
complex set of factors observed today.
This is fertile ground for 2 big inference
problems.
1. Attribution error means succumbing to
the “halo effect.” It is strategy by hindsight
and assumes that replicating the actions
of another company will lead to similar
results.
2. Survivorship bias is an analysis focused
only on a surviving population. The
approach can skew our view of what
caused the success as well as the failure.
1
2

The 9th test is critical, as it checks on whether there is conviction behind
the strategy
Strategy Test 9
Developing our team into a support base of influencers connected to our strategy can
contribute to its success.
TEST 9 Is there conviction to act on your strategy?
Strategy Test 9 is about the investment our company has made in implementing our strategy. Many good
strategies fall short in implementation. The absence of conviction in our organization and among our top team
can strangle strategic change at birth.
A change of strategy happens because of changes in the external environment. To be able to move ahead with
implementation, our company needs a process that questions old assumptions and develop new set of believes
in tune with the new situation.
Our management must make sure that the whole team shares in the new beliefs that support the strategy. This
requires taking decision makers on a journey of discovery. This journey will create experiences that will help
our team grasp mismatches that may exist between the new strategy and the actions that have brought
success.
Strategy Test 9 is about the investment our company has made in implementing our strategy. Many good
strategies fall short in implementation. The absence of conviction in our organization and among our top team
can strangle strategic change at birth.
A change of strategy happens because of changes in the external environment. To be able to move ahead with
implementation, our company needs a process that questions old assumptions and develop new set of believes
in tune with the new situation.
Our management must make sure that the whole team shares in the new beliefs that support the strategy. This
requires taking decision makers on a journey of discovery. This journey will create experiences that will help
our team grasp mismatches that may exist between the new strategy and the actions that have brought
success.

Our company must define what we are moving from and where we are
moving to with regards our company’s business model, organization,
and capabilities.
To effect the change, an action plan must be prepared with important
elements.
A detailed view of what shifts are required to make the move.
Identification of individual executives who must be
accountable.
This is necessary to make sure that each major “from-to shift” is
matched with the energy to make it happen. The totality of the change
represents a major organizational transformation. Our company must
make sure that our senior team is drawing on solid advice on change
management.
The final test puts our strategy where it should be—in action—it focuses
on translating strategy into execution
Strategy Test 10
Efforts spent aligning the budget with our strategy will always pay off many times over.
TEST 10 Have you translated your strategy into an action plan?
Most importantly, our
ongoing resource
allocation must be aligned
with our strategy. Look
where the best people and
the most generous budgets
are and be prepared to
change things significantly.
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2

Contents
Overview
Templates

?
Insert headline
10 Sanity Tests for Strategy – TEMPLATE
Insert bumper.
Will your strategy beat the
market?
Is your strategy granular about
where to compete?
Does your strategy
flexibility?
Is there conviction to act on your
strategy?
Does your strategy put you ahead
of trends?
Does your strategy embrace
uncertainty?
Is your strategy contaminated by
bias?
Have you translated your strategy
into an action plan?
1
3
5
7
9
2
4
6
8
10

Insert headline
10 Sanity Tests for Strategy – TEMPLATE ALTERNATE
Insert bumper.
Will your strategy
beat the market?
Does your strategy rest on
privileged insights?
Does your strategy balance
commitment and flexibility?
on your strategy?
Does your strategy put you
ahead of trends?
Does your strategy
Is your strategy
strategy into an action plan?
1
3
5
7
9
2
4
6
8
10

Insert headline
Insert bumper.
Insert filler text, filler
text, filler text, filler text,
filler text.
filler text.
filler text.
text, filler text.
Will your strategy
beat the market?
Does your strategy rest on
privileged insights?
Does your strategy balance
commitment and flexibility?
on your strategy?
Does your strategy put you
ahead of trends?
Does your strategy
Is your strategy
strategy into an action plan?
1
3
5
7
9
2
4
6
8
10

Insert headline
Insert bumper.
Does your
strategy
embrace
uncertainty?
Does your
strategy
balance
commitment
and
flexibility?
Is your
strategy
contaminated
by bias?
Is there
conviction to
act
on your
strategy?
Have you
translated
your
strategy into
an action
plan?
Will your
strategy
beat
the market?
Does your
strategy
tap a true
source of
advantage?
Is your
strategy
granular
about where
to compete?
Does your
strategy
put you
ahead of
trends?
Does your
strategy
rest on
privileged
insights?
1 2 3 4 5
6 7 8 9 10
filler text.
filler text.
filler text.
text, filler text.

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documents can range from Business
Frameworks to Financial Models to
PowerPoint Templates.
Flevy was founded under the principle that
companies waste a lot of time and money
recreating the same foundational business
documents. Our vision is for Flevy to
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of business documents. All organizations,
from startups to large enterprises, can use
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find reference or comparison materials, or
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