If you are a CEO, your ultimate goal is simple: run your company in a way that generates a long-term stream of profits big enough to more than make up for the risks you are taking. In other words, your revenue has to be higher than your cost of capital and your goal is to deliver above average risk adjusted returns.

To generate extra ordinary profits in a conventional business, there really are only two options: create a consistently lower cost structure or generate a higher revenue stream. Here’s the catch; in this age of global competition, massive, über-consolidated corporations and accelerating technological improvements, it is incredibly hard to reduce costs and increase revenue at a pace that generates an above average stream of revenue.

Let’s examine the cost side of the equation first. Executives running companies today are facing an almost perfect storm of hyper-efficient competition. There are three driving forces:

First, the competition is getting bigger. Whether it’s Walmart or Citi Group, the size and scope of truly global companies has reached staggering proportions. Useless you are running one of these huge companies, you will face competition from a company that can reach economies of scale that will beat almost any cost efficiency program you can create, thus seriously challenging your profit margins. These companies produce more widgets than you do. They get better deals on raw materials and other inputs because they buy these inputs in greater bulk. Also, their size often leads to lower costs of capital.

Second, the competition is global. This means that in addition to better economies of scale, truly global companies can actually make out-sourcing work. This further reduces the cost of both their inputs and productive resources.

Third, constant technological improvement means that even if you can achieve the same economies of scale, the same raw input cost, the same costs of capital and the same productive resource costs, there is a significant chance that one of your competitors has access to better productive technology.

It turns out that exactly the same factors hit the revenue side of the equation. The competition has larger sales distribution systems, with global reach and the support of better sales technology in the form of better store designs, or better market research and data capture tools and the latest negotiation techniques for big-ticket items. As a result, it is hard for conventional companies to out pace their competition’s revenue growth when they compete head on, with commoditized products or services.

The Art of War Provides a Solution

In the face of bigger competition, globally efficient cost structures and accelerating technological improvements, the only way to generate extra-ordinary returns is pick-up Sun Tzu: The Art of War.

Sun Tzu advice: “Fight your enemy where he isn’t”.

In other words, create new products or services for which there is no competition.

The diagram on the below illustrates the profitability of a successful new product over time. After an initial investment and ramp-up period, these products generate extraordinary profits for a limited period. The profits attract competition, which eventually erodes the profit margins.

The important thing to realize is that only constant innovation will generate a long-term stream of above average profits.

The problem for any executive becomes how to generate constant innovation, and how to do it cheaply. The answer is obvious. Just as the Internet revolutionized communications by initially making better use of the existing telephone infrastructure, an executive wishing to generate constant innovation has to make better use of existing resources. That means redesigning the organization to generate constant innovation.