The Psychology of Strategy

Giovanni Gavetti applies cognitive science to strategy to shake up the status quo.

In the aftermath of the Great Depression, a visionary named Charlie Merrill decided to radically rethink what banking could be. His institution, Merrill Lynch, had recently acquired Safeway supermarkets, one of the largest chains in the country, and the acquisition gave him an idea. What if banks could be more like your local Safeway, offering middle-class customers a menu of financial products?

Now, that might seem like an obvious strategy—indeed it’s how most banks today are run. But in the elitist banking system of the 1930s, it was revolutionary. “When something becomes obvious, people ask, ‘Why didn’t I think of that?’” says Giovanni Gavetti, an associate professor of strategy at Tuck. “But no one had the right mental model to spot it. The ‘financial supermarket’ business model was cognitively distant for everybody until Merrill looked at banks through a new lens: as supermarkets. And what was once cognitively distant became almost obvious to him.” The interesting question for Gavetti is why no one else had that insight—and what it takes to develop similarly revolutionary insights in business.

Gavetti has studied the psychological underpinnings of business strategy for almost 20 years. What he has found has gone against the prevailing strategic management theory, which holds that leadership involves identifying a company’s unique capabilities and building incrementally upon them to secure an advantage in competitive markets. “There is a diffuse presumption that we can’t be good at foreseeing stuff,” says Gavetti. “We can be pretty good at learning incrementally and reacting to proximate feedback, but the moment we try to foresee strategic opportunities that are not close by, we are doomed to failure.” In other words, under such a paradigm, the Charlie Merrills of the world can never identify game-changing innovations, much less use them to transform their industries, unless through chance or serendipity.

... a bee needs to look for a new flower, a flower other bees can’t find."

In a recent paper, “Toward a Behavioral Theory of Strategy,” published last year by Organizational Science, Gavetti forms a different conception of strategy based on modern cognitive science. In it, he argues that it is the opportunities that are “cognitively distant” from one’s typical experience that are the most potentially rewarding for a company, and cognitive science can help strategic leaders identify and pursue them. The problem is that companies tend to cluster around a few fruitful opportunities, depleting them through competition. “The image is of bees flying to look for nectar,” Gavetti explains. “When flowers are filled with nectar, all the bees will compete for it until there is no nectar left. To the extent that there are superior opportunities out there, a bee needs to look for a new flower, a flower other bees can’t find.”

There are three main reasons that these cognitively distant opportunities tend to be untapped. First, in order for them to be spotted, strategic leaders need to view their industry in a different way, and that is less natural to them than relying on their standard mental conceptions. Second, pursuing opportunities that radically depart from the status quo generally requires leaders to change their companies’ conceptions of themselves—their identities—and that is one of the hardest things to pull off.  Third, departing from the status quo also makes it imperative to convince outside observers—read Wall Street—that the opportunity is legitimate. Again, this is always hard.

For each of these challenges Gavetti identifies the same antidote—an ability to manage associative thinking. In order to conceive of something truly innovative, a company must create a new mental model based on a new association, like Charlie Merrill did with his supermarket analogy, that goes beyond logical deductive reasoning.

An analogy in itself isn’t enough, however. Merrill also had to transform the culture of the company in order to be successful.

Transforming an ingrained corporate persona is no easy task. Just ask George Fisher. When he took over Kodak, he was able to reconceive the company as a leader in digital imaging rather than film—but because he was unable to achieve buy-in from employees, that vision ultimately failed. Ducati’s Federico Minoli, on the contrary, had a more emotional message than digital versus print, a message that relied on an association. When he was handed the reins in the mid-1990s, Ducati was a company run by engineers focused on technical performance, but he reconceived it as a company selling a dream—an experience of freedom and excitement. “His analogy for that turnaround was Walt Disney,” says Gavetti. “Initially he faced a lot of resistance within the company, but with the power of that analogy he was able to pull it off, and now Ducati is a lifestyle company like Harley-Davidson.”

Persuading your own employees is one thing, but in order to be successful you must also persuade the business community of the viability of your dream. “There is evidence that when Wall Street reacts negatively, most companies give up,” says Gavetti. “The company that can shift its mental model in a way that can be understood might have a real opportunity.” In the 1990s, for example, Lycos and Yahoo were competing for legitimacy as the primary Internet search engine. Lycos presented itself as a technology company, while Yahoo presented itself as a media company; ultimately Yahoo won because the media association was more credible, vivid, and understandable.

Gavetti doesn’t dismiss the importance of deductive thinking in achieving business success. For instance, he acknowledges that Michael Porter’s frameworks have greatly helped generations of strategists make sense of their world. But he does see deductive reasoning as the status quo in business strategy that must be shaken up with associative thinking if companies desire opportunities outside the mainstream. “There is evidence in psychology that we are walking associative machines—this is our common way of understanding things,” he says. “The trick for me is to understand that capacity to the point where it can be disciplined and become a reliable tool in the hands of strategic leaders.”

“The strategic leader who is better at managing market forces is the one who is better at managing his own and others’ mental processes,” continues Gavetti. “Charlie Merrill saw the opportunity because he fundamentally shifted his way of thinking about banking. Your ability to see into the future hinges on adopting the right set of lenses—getting other people to wear them.”