Strategy business fall 2015 by coorerfsuclk

NEUROSCIENCE AND BIAS DEALS THAT WIN A HEALTHCARE GOLD RUSH

Celebrating Two Decades of s+b

Grow from Your Strengths

The History of Management Thinking

Autumn 2015 $12.95 Display until November 24, 2015

www.strategy-business.com

YOUR BUSINESS CHALLENGE IS THE SUBJECT.

EXECUTIVE EDUCATION COMPREHENSIVE MANAGEMENT • LEADERSHIP • STRATEGY FINANCE • MARKETING • SOCIAL ENTERPRISE

Columbia Business School Executive Education offers over 30 programs that prepare today’s leaders for tomorrow. Executives can bring their real-workplace challenges to collaborate on and solve.

Meet your needs at gsb.columbia.edu/execed

editor’s letter

Illustration by Lars Leetaru

20 Years and Counting I keep working at this magazine for four reasons. First, I have to support myself and my family. Second, I enjoy working for an optimistic, growing enterprise, like our publisher, the PwC network, and I want to contribute to that growth. Third, at strategy+business, I’m privileged to work with colleagues who operate at a high level of creative, insouciant savoir faire, putting out an intrinsically cool body of work. I hope and believe that this vitality comes through in everything we publish. The fourth reason is our subject: strategy and business. More than ever before, civilization depends on the effectiveness of business and the public sector. If we can help raise the level of management practice, even in a small way, we make a signiﬁcant contribution. Since Joel Kurtzman founded the magazine in 1995, through Randall Rothenberg’s tenure as editor-in-chief (starting in 2000), and since I took the helm in 2005, this perspective has kept our project going, even when its survival seemed improbable. The articles in this 20thanniversary issue make that kind of contribution. For example, on page 38, Gerald Adolph and Kim David

Greenwood explain how to achieve the kind of sustainable business growth on which prosperity depends. The key factor for a business is not necessarily M&A proficiency or the ability to launch new products or services. It’s the willingness to focus your strategy on expanding the strengths you already have, step by step. Of course, if you are interested in growing through M&A (and what senior executive isn’t?), you’ll want a good track record. On page 50, J. Neely, John Jullens, and Joerg Krings describe a five-year research project on M&A success. The premium on capabilities-driven deals (“deals that win”) is more than 14 percentage points, and some positive aspects of this approach — such as improving capabilities through making deals — aren’t even measurable. Other themes covered in this issue include the changing global electric power system (page 80), new investment priorities in capital from Asia (page 9), and healthcare delivery (page 32). Lotte Bailyn, the influential MIT-based researcher on the limits of work–life integration, explains how to transcend those limits in a compelling interview (page 98). Neuroleadership experts Heidi

Grant Halvorson and David Rock explain the brain-based roots of bias, and why it takes an organization to make a bias-free decision (page 90). Management itself is evolving, and on page 68, business advisor and author Frederic Laloux colorfully explains how. The “Teal” entities he identiﬁes, including Patagonia and the Dutch nursing enterprise Buurtzorg, are likely the forerunners of the winning ventures of the future. You may disagree with his premise, but I think you’ll be fascinated by his view of the history of business, from its roots in Game of Thrones–like “wolf packs” to the enlightened practices emerging today. Another view of management history begins on page 60. We’ve broken down all the business ideas we know into 20 pragmatic but universal questions. We think they cover all the bases. But I wouldn’t be at all surprised if there are more intrinsically cool management innovations waiting to be discovered during our next 20 years. Art Kleiner Editor-in-Chief kleiner_art@ strategy-business.com

leading ideas 6

Mobile Payments: The Delay of Instant Gratiﬁcation Kevin Grieve Platforms like Apple Pay and Google Wallet will need to ensure a seamless and secure experience for merchants and consumers.

The New Geography of M&A Vikas Sehgal, Joachim Reinboth, and Evan Hirsh Before industrial companies sell assets, they must understand the motivations of the full array of potential buyers, especially those emerging in the East.

Vertical Integration 2.0: An Old Strategy Makes a Comeback Ken Favaro More companies are seeking greater control of their value chain — but they should do so with caution.

How Tech Clusters Form Christie Rizk

Rutgers professor Brett Gilbert describes the development of entrepreneurial communities, from Silicon Valley to Johannesburg.

The Next Innovation Opportunity in China Dominique Jolly, Bruce McKern, and George S. Yip Multinationals are shifting their R&D focus from cost savings to knowledge-based research.

Trend Watch: 20 Years of strategy+business

essays ORGANIZATIONS & PEOPLE

20/20 Foresight Ram Charan Many business leaders need to improve their perceptual acuity. Here’s how you can develop the ability to look around corners — and become a catalyst for change.

CONSUMER PRODUCTS

How Adidas Found Its Second Wind Nicholas Ind, Oriol Iglesias, and Majken Schultz The sportswear giant’s embrace of its heritage shows how reconnecting with the past can inspire a company’s future.

HEALTHCARE

Staking Your Claim in the Healthcare Gold Rush Carl Dumont, Sundar Subramanian, and Christoph Dankert Revolutionary changes in the delivery, ﬁnancing, and management of healthcare present a choice: Do you want to be a gold miner or a bartender?

features STRATEGY & LEADERSHIP

Grow from Your Strengths

ORGANIZATIONS & PEOPLE

Beyond Bias Heidi Grant Halvorson and David Rock Neuroscience research shows how new organizational practices can shift ingrained thinking.

Gerald Adolph and Kim David Greenwood The only sustainable way to capture new opportunities is to remain true to what your company does best.

STRATEGY & LEADERSHIP

THE THOUGHT LEADER

Deals That Win J. Neely, John Jullens, and Joerg Krings

INTERVIEW

Lotte Bailyn Laura W. Geller

Twelve years of data shows that mergers and acquisitions that apply or enhance capabilities produce superior returns.

For more than 50 years, the MIT professor has challenged companies and policymakers to redeﬁne the rules of work and family.

STRATEGY & LEADERSHIP

20 Questions for Business Leaders Art Kleiner and Nancy Nichols The entire history of management ideas can be seen as a series of answers to a few pragmatic queries.

BOOKS IN BRIEF

108

The Race Goes to the Bold Allison Schrager

110

The Wright Stuff Theodore Kinni

111

The Prescriptions of Dr. Sachs David K. Hurst

STRATEGY & LEADERSHIP

The Future of Management Is Teal Frederic Laloux Organizations are moving forward along an evolutionary spectrum, toward self-management, wholeness, and a deeper sense of purpose.

113

It’s Getting Hot in Here Katie Fehrenbacher END PAGE: RECENT RESEARCH

116

What Makes a Company More Likely to Protect LGBT Rights? Matt Palmquist The unexpected factors that shape corporate policy.

ENERGY

A Strategist’s Guide to Power Industry Transformation

Cover illustration by Craig and Karl

Norbert Schwieters and Tom Flaherty The way we create, use, and manage electricity is ﬁnally changing, and the implications go far beyond the utility sector.

Issue 80, Autumn 2015

www.strategy-business.com

strategy+business

Published by PwC

EDITORIAL Editor-in-Chief Art Kleiner kleiner_art@ strategy-business.com

Executive Editor Daniel Gross gross_daniel@ strategy-business.com

Managing Editor Elizabeth Johnson johnson_elizabeth@ strategy-business.com

Senior Editor Laura W. Geller geller_laura@ strategy-business.com

Senior Editor Jan Alexander alexander_jan@ strategy-business.com

Deputy Managing Editor Sally Errico errico_sally@ strategy-business.com

Associate Editor Christie Rizk rizk_christie@ strategy-business.com

Chief Copy Editor Victoria Beliveau info@ strategy-business.com

Information Graphics Linda Eckstein info@ strategy-business.com

Assistant to the Editors Natasha Andre andre_natasha@ strategy-business.com

Contributing Editors Edward H. Baker Susan Cramm Ken Favaro Bruce Feirstein Lawrence M. Fisher Ann Graham

Sally Helgesen William J. Holstein David K. Hurst Jon Katzenbach Theodore Kinni Tim Laseter

Cesare R. Mainardi Eric J. McNulty Gary L. Neilson Rob Norton Jim O’Toole Matt Palmquist

Jeffrey Rothfeder Michael Schrage Thomas A. Stewart Christopher A.H. Vollmer

Production Director Catherine Fick Publishing Experts Inc. cﬁck@publishing experts.com

Designers Art Director Laura Eitzen John Klotnia klotnia@optodesign.com eitzen@optodesign.com Jennifer Thai jennifer@ optodesign.com

Editor, Digital Melanie Rodier rodier_melanie@ strategy-business.com

PUBLISHING Publisher and Business Manager Gretchen Hall Tel: +1 617 521 8808 hall_gretchen@ strategy-business.com

Senior Marketing Manager Charity Delich Tel: +65 9359 4784 delich_charity@ strategy-business.com

Advertising Director Judith Russo Tel: +1 212 551 6250 russo_judy@ strategy-business.com

Business Operations Manager Bevan Ruland Tel: +1 973 630 6924 ruland_bevan@ strategy-business.com

Circulation Director Beverly Chaloux Circulation Specialists Inc. bchaloux@circulation specialists.com

Global Head of PwC Strategy& Les Moeller

Head of Global Thought Leadership John Sviokla

Head of Thought Leadership, PwC Strategy& Ivan de Souza

Public Communications Review Ann-Denise Grech Julie Weidemann Natasha Andre

Editorial and Business Ofﬁces 101 Park Avenue New York, NY 10178 Tel: +1 212 551 6222 Fax: +1 212 551 6732 info@strategybusiness.com

Retail Comag Customer Service Tel: +1 800 223 0860

Subscriber Customer Services Tel: +1 855 869 4862 Outside the U.S., +1 903 636 4955

strategy+business magazine contains only paper products that the Forest Stewardship Council™ certiﬁes have come from well-managed forests that contribute to conservation and responsible management.

PwC PwC Vice Chairman, Clients and Markets Robert Swaak

Scan this QR code with Design Services your smartphone reader Opto Design Inc. to get the s+b iPad app. 153 W. 27th Street, 1201 New York, NY 10001 Don’t have a reader? Tel: +1 212 254 4470 Search for “QR code info@optodesign.com reader” in your app store.

Back Issues & Reprints www.strategybusiness.com/reprints Tel: +1 703 787 8044 Permissions www.strategybusiness.com/press/ permissions-faqs Tel: +1 973 630 6924

customerservice@ strategyandbusiness .info

Articles published in strategy+business do not necessarily represent the views of the member ﬁrms of the PwC network. Reviews and mentions of publications, products, or services do not constitute endorsement or recommendation for purchase.

www.strategybusiness.com/ subscribe strategy+business P.O. Box 8562 Big Sandy, TX 75755

strategy+business (ISSN 1083-706X) is published quarterly by the member ﬁrms of the PwC network. © 2015 PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its member ﬁrms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details. No reproduction is permitted in whole or part without written permission of PwC. “strategy+business” is a trademark of PwC. Postmaster: Send changes of address to strategy+business, P.O. Box 8562, Big Sandy, TX 75755. Annual subscription rates: United States $38, Canada and elsewhere $48. Single copies $12.95. Canada Post Publications Mail Sales Agreement No. 1381237. Canadian Return Address: P.O. Box 1632, Windsor, ON, N9A 7C9. Printed in the U.S.A.

leading ideas

Leading Ideas Mobile Payments: The Delay of Instant Gratiﬁcation Platforms like Apple Pay and Google Wallet will need to ensure a seamless and secure experience for merchants and consumers. by Kevin Grieve

n October 2014, when Apple debuted its iPhone 6 with an electronic wallet called Apple Pay, people immediately began to wonder whether it would overtake its competitors in the mobile payments business. The company has an impressive track record of releasing products and technologies that quickly disrupt and dominate markets. Nearly a year and well over 100 million iPhone 6 sales later, Apple Pay has emerged as the clear leader — but we’re still waiting for disruption. Smartphones have yet to displace cash or credit cards at the retail point of sale. To put the waiting game for mobile payments into perspective,

consider the history of credit cards. They made their first appearance as Diner’s Club Cards in New York City in the 1950s, but it took 28 years for credit cards to be used by 50 million consumers. It took debit cards 12 years and PayPal accounts five years to reach the equivalent penetration level. The same milestone will probably be reached with mobile payments, but to get there, merchants and financial institutions must work together to deliver a seamless experience. Adding further complexity, retailers will need to make a significant investment — an estimated US$8 billion to $10 billion across the industry — to upgrade existing technology. Countless mobile payment systems are active today — Apple Pay,

Google Wallet, the Merchant Customer Exchange (MCX) CurrentC platform, and so on — but none has yet gained signiﬁcant traction with merchants or consumers or become the standard for mobile transactions. (See “Competing Mobile Payment Solutions,” page 8.) And none of them look likely to seize that role for a while. Several events, all of which took place in early 2015, highlight the rough and rapidly shifting waters ahead for all players: Best Buy, an MCX member, announced it would accept the rival system Apple Pay; PayPal announced it would acquire Paydiant, the underlying technology supporting MCX; and MCX announced that its CEO was stepping down and being replaced. During the next few years, many competitors, from both ﬁnancial services and the hardware and software industries, will jockey for control of the sector. Payments for retail purchases through smartphone apps still represent a tiny fraction of transactions for the $2 trillion worth of goods and services that pass through retail establishments and banks each year in the United States; still, by 2018 digital

strategy+business issue 80

Illustration by Phil Marden

to use different mobile payment apps for different brands and different types of transactions. But only a few general-purpose branded e-wallets are likely to be left standing when the industry shakes out; that’s the nature of shared platforms. The companies that ultimately control the mobile payments platform may be technology companies or banks

cards are accepted at 99 percent of merchant locations. 2. Interoperability. In its current version, Apple Pay does not support all cards or merchants; some privatelabel store credit cards and regional debit networks are excluded. Eightythree percent of the credit-issuing market had agreed to be part of Apple Pay when it launched, but that

Only a few general-purpose branded e-wallets are likely to be left standing when the industry shakes out. or retailer consortiums, or a combination of all three. The winners will be those platforms that offer ﬁve critical elements: 1. Merchant acceptance. Apple Pay is accepted at more than 700,000 merchant locations, but that number is less than 10 percent of the 8 million to 10 million merchant locations in the United States. This is signiﬁcant: Consumers are less likely to use a credit card that’s not accepted everywhere. As a point of contrast to mobile adoption, Visa and MasterCard’s traditional plastic

left almost 20 percent of the market unsupported. Recently, Apple has started to expand its coverage. For example, the company worked out an agreement with Discover in April 2015 that will give Discover customers access to the app beginning the following fall. Further expansion will be critical if Apple is to ensure that any customer is able to make a transaction from his or her bank. 3. Security. For consumers and merchants alike, the fear of a breach is currently the number one obstacle to adopting mobile payments. Retailers have taken to heart the experience of Target, whose profits declined 45 percent after its wellpublicized security breach in late 2013. The CEO and CIO were let go, and the company spent $250 million, excluding insurance offsets, to address the issue. Apple advanced the game by “tokenizing” the transaction (removing account information from the data flow) and using fingerprint recognition technology. But until end-to-end encryption is in place to secure the entire transaction, security holes will persist. Financial institutions and merchants will continue to battle global criminal sophisticates.

leading ideas

wallet transactions will likely grow to represent about 6 percent of total card transactions — the majority being small-ticket purchases made online or within apps. This figure may sound small, but it’s a significant shift: Few would argue that ecommerce isn’t mainstream, yet Internet sales represented only 6 to 7 percent of all retail sales in the United States in 2014. Globally, mobile payments are making significant inroads, especially in regions where consumers aren’t as accustomed to a physical point-of-sale. In Kenya, M-Pesa, a mobile money service, is used by 19 million people, and 25 percent of the country’s commerce flows through the mobile service. In China, Alibaba now has some 350 million active users. The company reports that close to 80 percent of the transactions on its various platforms are made using mobile payments. Just as people tend to compartmentalize their use of credit cards — one card for daily purchases, another for big purchases, and several for specialty retail — they are likely

single-point mobile innovations exist, but they do not fit together seamlessly. One such app is Milo (acquired by eBay in 2010), which performs online searches for specific products in stores near its users’ location. Another app acquired by eBay in 2010, RedLaser, allows consumers to scan a product’s barcode in a store and immediately uncover the lowest price for that product, online or at nearby retailers. Some major retailers, including Starbucks and Walmart, have their own mobile apps with payment capabilities. At first glance, apps like these may seem to offer little more than convenient electronic credit cards. But an app, compared to a mobilebased website, is a more controllable, customizable handheld environment for the retailer. It enables businesses to better analyze customers even as customers gain more intelligence about products and services. With the people on both sides of the point-of-sale becoming smarter about one another, the behavior of shoppers and retailers is poised to change. As part of this transition, retailer loyalty, reward, and payment programs need to be supported by and integrated into shared mobile payment platforms. 5. Marketing data integration.

Historically, for a variety of reasons, merchants have been unable to consistently and correctly link an individual consumer record directly to every payment transaction. Today, the convergence of the mobile phone, the payment transaction, and the online environment enables companies to track individual customers from the initial marketing impression all the way through the purchase. Those providers that leverage their mobile platforms for

Competing Mobile Payment Solutions Apple Pay (Apple) Launched October 2014 Strengths • Has not attempted to supplant any player in the current ecosystem, which has allowed Apple to create partnerships. • Uses a combination of tokenized and biometric security. • Has a strong consumer following. Limitations • Its NFC contactless technology is accessible only to iPhone 6 users. • Disabled by some merchants aligned with CurrentC. • Is not yet integrated with merchant loyalty programs. CurrentC (Merchant Customer Exchange, or MCX) 2015 (forthcoming) Strengths • Uses QR codes and scanners rather than NFC terminals. • Is device-agnostic and works with Android and iOS. • Uses tokenized security. • Allows customers to use points earned at one store at other retailers within the MCX network. • Has lower transaction fees for merchants. Limitations • Privacy concerns over CurrentC’s intentions to share purchasing data with developers, app stores, and phone manufacturers may deter consumer adoption. • Requires multistep payment process: opening the app, scanning, and conﬁrming the codes. Google Wallet (Google) Launched September 2011 Strengths • Accepts store loyalty cards, gift cards, and coupons. • Allows funds transfer through Gmail. • Works on hundreds of Android phone models, arguably giving it the broadest global reach. Limitations • Limited traction with mobile carriers and merchants. • Impact of Softcard (the app previously supported by Verizon Wireless, AT&T, and T-Mobile) acquisition unclear. Samsung Pay (Samsung) 2015 (forthcoming) Strengths • Partnerships with major credit cards and ﬁnancial institutions. • Proprietary security tokenization technology. • Could work with retailers that have not directly signed up. Limitations • Available only on a limited number of Samsung phones.

Note: This is not an exhaustive list of services in the global mobile payments marketplace. Source: PwC, “Payments on the Go: Making Sense of the Evolving Mobile Payments Landscape,” March 2015

one-to-one marketing — before, during, and after a retail payment transaction — will have a leg up on the competition. They can achieve

the holy grail of consumer marketing: precise marketing ROI calculations for segments of one. For example, a merchant could send a

strategy+business issue 80

leading ideas 8

4. Platform integration. Many

Illustration by Peter Oumanski

Reprint No. 00347

Kevin Grieve kevin.c.grieve@strategyand.pwc.com is a leader with Strategy&, PwC’s strategy consulting group. He specializes in ﬁnancial services and leads its North American cards and payments practice. He is based in Chicago.

The New Geography of M&A

leading ideas

digital coupon via text and allow consumers to opt in, and then send personalized reminders only to those consumers. The merchant could then track coupon usage from mobile payments to determine the conversion rate and the overall marketing ROI. Such scenarios hold great promise. But realizing them requires the establishment a complex web of institutional relationships. Who will track the data? Who will store the data? How will different institutions coordinate? Which standards will be used? And what emerging business models can monetize the new value creation? Not all the answers are obvious. But it is clear that traditional banks and financial institutions will find their greatest opportunity by leveraging their data. When financial institutions couple internal data with external data sources, they can begin to help merchants grow their business and provide consumers with a more personalized and robust shopping experience. The winners will convert that data into enhanced solutions across the value chain: targeted local and national offers, multifactor authentication, and security alerts. The payment providers that stitch together merchant acceptance, mobile solution integration, and marketing fueled by data will be well on their way to success. Once that finally happens — and it will — customer relationships and marketing will never be the same. +

Before industrial companies sell assets, they must understand the motivations of the full array of potential buyers, especially those emerging in the East. by Vikas Sehgal, Joachim Reinboth, and Evan Hirsh

onsumer-facing companies have long known that it pays to tailor products for local tastes as they enter emerging markets. McDonald’s offers a McAloo Tikki sandwich in India — a patty made of peas and potatoes. In China, Kraft’s iconic Oreo cookies come with green tea ﬁlling. For marketing executives, success is all about understanding the customer. The same imperative holds true for a different class of professionals who are increasingly ﬁnding customers in emerging markets in Asia: corporate executives in the automotive and industrial sectors seeking to sell assets or businesses. The volume of mergers and ac-

quisitions is rising toward the peaks seen prior to the financial crisis. Every Monday seems to bring a slew of new announcements of high-profile deals. Historically, the participants in these sales processes have been a relatively homogeneous lot — Western companies or private equity firms. And because they tend to speak a common financial language, the attributes they look for have tended to be similar: EBITDA, cash flow, strategic fit. But the world is changing; the world’s center of economic gravity is moving toward Asia. Most analysts project that China is on a path to overtake the U.S. as the world’s largest economy. Even considering its recent growth troubles, Japan sports the third-largest GDP in the world. With its population of 1.2 billion,

ticularly attractive — for example, fundamental performance (growth and EBITDA margins), intellectual property and proprietary technology, and the customer base and diversified geographic exposure. Different buyers from around the globe will place different emphases on these attributes. Focusing only on profitability and growth in cash flow is a proven method of enticing U.S. private

Investments by current owners that may not make much sense from the standpoint of shortterm proﬁtability can add value when it comes to pitching the company to a new global audience. from one another — is crucial. It is important to adopt what we call a market-back approach to positioning assets or entities for exit. This involves taking a broader view of the potential universe of buyers, understanding their different needs and values, preparing assets for sale long before the initiation of a sales process so they can appeal to a large array of potential purchasers, and understanding the nuances and cultural differences that may affect the outcome. To succeed to the fullest possible extent, companies need to move away from the quasi-automated approach of focusing on EBITDA and cash ﬂow, and instead recognize the key business, cultural, and procedural attributes that will be important for buyers in the future. Gauging Value

Companies that are considering selling assets must ensure that their investments are channeled in a way that will attract the new cast of buyers. But value is in the eye of the beholder. A host of factors can make a company or business division par-

equity buyers. And Western buyers generally tend to place a higher priority on strategic fit. But a Chinese family-owned company may not care as much about last quarter’s EBITDA, especially if the deal will allow the company to obtain valued technology that it can further develop for the massive local market. By contrast, a state-owned enterprise (SOE) in China has to take into account broader public agendas, and may be more interested in maintaining employment in its province than in hitting a cash-flow multiple. Companies in both India and China often place a higher weight on brand than Western companies might, because acquiring premium brands allows them to differentiate themselves from local competition. As a result, investments by current owners that may not make much sense from the standpoint of short-term profitability — such as pumping up investments in R&D — can nonetheless add value when it comes to pitching the company to this new global audience. The intellectual property and know-how

gained can trump the value that was lost by having a slightly lower EBITDA margin. As an example, consider a transaction announced in September 2014. Ficosa, a Spanish manufacturer of rearview mirrors for cars, entered into a capital and business alliance with Japanese technology company Panasonic. In the years prior to the deal, Ficosa had invested in building electronics into the mirror to differentiate itself from the competition. Whereas many Western peers focused on how such a partnership could work in terms of cost synergies, Panasonic viewed Ficosa as an opportunity to gain valuable “real estate” in the driver’s vision area. The Japanese hardware and software supplier saw taking a 49 percent stake in Ficosa as an opportunity to leverage its own automotive technologies and gain further access to certain European car manufacturers such as BMW. By investing in R&D, Ficosa expanded the market of potential buyers, gave itself more options, and likely wound up with a stronger valuation. One important differentiating factor to consider is the “cost of constitution.” That is, when buyers from emerging markets evaluate opportunities, they may ask themselves how much it would cost them to build, from scratch, a business comparable to the one currently for sale. In 2010, Geely, a private Chinese car company, acquired Volvo Cars of Sweden from Ford Motor Company. Geely had approached Ford as early as 2007 about a potential acquisition, even though Volvo’s business was sagging. Ford — and other Western automakers — didn’t see much value or potential for the brand. However, Geely’s chairman and founder, Li Shufu, clearly iden-

strategy+business issue 80

leading ideas 10

India is a rising consumer and commercial power. So to a degree, it’s not surprising that companies from these countries, as well as from industrial powerhouse South Korea, have become signiﬁcantly more active and sophisticated in the global M&A market. Understanding the strategic intent of potential buyers from different regions and how they may differ from traditional purchasers — and

The proportion of automotive deals with an Asian buyer involved in the final round has risen sharply in the last decade. So too has the portion of transactions in which an Asian company was the purchaser. 75% 70–80% Percentage of automotive deals... in which Asian companies were involved in the final round 50%

won by Asian companies 40–50%

25% 15–20% 10–12%

10%

2005

2008

2011

2014

Source: CapitalIQ, Rothschild

tiﬁed Volvo as a strategic steppingstone for his own company. This acquisition would enable Geely to become one of the leading private Chinese car manufacturers in a domestic market otherwise dominated by SOEs. It would also allow Geely to gain control of a strong brand that would give it an international presence — both rarities for Chinese carmakers at the time (see exhibit). Understanding Diversity

Just as the rise of Asian buyers has brought a wider range of motivations to the scene, it has also presented a wider range of ownership structures. In Europe and the U.S., companies are typically classified as publicly held or privately held, and the latter are often owned by families or financial sponsors. Asian companies, however, inhabit a much more diverse spectrum. Their particular circumstances can influence

management’s strategic agenda, affect financing, and enable M&A to be seen in a much broader context. In Japan, many companies belong to keiretsu: conglomerations of businesses linked by cross-shareholdings to form a robust corporate structure. Therefore, it is important to understand how an asset may fit into the larger strategic puzzle of a potential Japanese buyer. SOEs in China are often able to obtain favorable financing from local banks to support a strategic acquisition. Sellers must also become comfortable with a broader range of sales processes. In our experience, compared with their Western counterparts, Asian buyers often require a lot of time as they assess opportunities. The pace and priorities not only reflect the overall organizational structures and decision-making processes, but can also typically also be traced to cultural factors. Not allowing some extra time for a Japanese player to conclude detailed and rigorous due diligence may jeopardize a potentially important buyer and value creator. Having an advisor with a local team who understands the potential buyer is particularly important when involving Chinese parties, given the gauntlet of regulatory approvals through which any deal must pass. The key is to start early in planning for a more diverse world. Cereal companies don’t wait until the boxes are on the shelves of local retailers to start thinking about how their products will appeal to new consumers. The process begins much earlier — with everything from the recipe to the design of the box. Similarly, owners of corporate assets have to think further in advance about potential buyers of their assets, and the concerns and needs of these buyers.

Taking a market-back approach and segmenting buyers may allow for the construction of a better strategy for grooming an asset over the duration of the ownership period. Of course, earnings and financial fundamentals will continue to be paramount in the eyes of many buyers. But the range of factors that may be considered has expanded. Whether parties ultimately negotiate over a multiple of EBITDA, or the future value of a technology, or the economic stability a buyer could create in a specific geographic area if running the factories, or the impossibility of the buyer’s accomplishing a desired goal without the new asset, the goal is the same: To end up with a best final offer that sits at the real value threshold of a buyer. Knowing the motivations of all potential customers will soon be part of every smart seller’s strategic agenda. + Reprint No. 00348

Vikas Sehgal vikas.sehgal@rothschild.com is a partner and executive vice chairman at N.M. Rothschild & Sons in London, and is the global head of the bank’s automotive sector. Joachim Reinboth joachim.reinboth@rothschild.com is an assistant director at Rothschild. Evan Hirsh evan.hirsh@strategyand.pwc.com is a leader with Strategy&, PwC’s strategy consulting group, in Cleveland. He specializes in the automotive and industrial sectors. The authors thank Mihir Sarkar and Ambika Sahay Verma for their research support.

leading ideas

Exhibit: Rising Involvement of Asian Buyers

More companies are seeking greater control of their value chain — but they should do so with caution. by Ken Favaro 12

“

wning the value chain” was a favorite strategy in the early part of the 20th century. Companies sought advantage by moving “upstream” to control the means of production that supplied their main business or “downstream” to ensure their path to market. For example, 100 years ago Ford owned rubber plantations, coal and iron ore mines, and even railways. But vertical integration largely fell out of favor when conglomeration became fashionable during the late 1960s and early 1970s. In fact, many industries underwent vertical dis-integration. Today, for example, almost three-quarters of the parts used in American cars are sourced from outside the United States. Whereas computer companies once made the memory and processing chips and wrote the operating and applications software for the computers they manufactured and sold, specialists in chip making, software development, and hardware assembly now dominate the industry. And although some energy companies still ﬁnd oil in the deep sea, process it in their reﬁneries, and sell it to Jane Doe at her corner gas station, the oil industry now has “pure play” companies in each stage of its value chain.

Is vertical integration a thing of the past? On the contrary, it seems to be making a comeback, particularly in Silicon Valley, where it’s been given a new label — just to remind us that everything that emanates from there is innovative! It’s called the “full stack” business model. Some companies are migrating upstream. Netﬂix and Amazon are getting into the original programming business. Harry’s, a U.S. startup that sells men’s razors and shaving cream by monthly subscription, acquired a factory in Germany to make its own razor blades. Others are integrating downstream.

Vertical integration is a strategy driven by a lack of trust that upstream and downstream players will come through for you. If that is well founded, there’s a failure in the market. Consider Apple owning and operating a retail chain to sell its own products and Google launching a wireless telecom network in the United States. Some companies are doing both. Tesla, for instance, is bypassing traditional dealerships to sell its cars directly to the consumer while also building the world’s largest battery plant. Many non-tech companies are also pursuing vertical integration. Ferrero, a chocolate company, made

without the power or capabilities to exploit a market failure, it’s a very risky strategy. Netflix, for example, is backward-integrating into programming because it says that it can significantly reduce the cost per hour viewed by producing a series such as House of Cards instead of licensing all its content. In effect, Netflix is saying that the content providers are profit gouging. Similarly, the pension funds setting up their own private

strategy+business issue 80

leading ideas

Vertical Integration 2.0: An Old Strategy Makes a Comeback

its first-ever acquisition in 2014. It bought a Turkish company that processes hazelnuts, the key ingredient in Nutella, its world-famous chocolate spread. Howard Schultz calls Starbucks’s business model “vertical integration to the extreme,” because the company buys and roasts all its own coffee and sells it through company-owned stores. Back in 2012, Delta Air Lines bought a refinery to have its very own source of aviation fuel. There’s even a growing trend of pension funds bypassing private equity funds by setting up internal shops to do private equity investments on their own. Are all these modern forms of vertical integration good strategies? Yes, if two special conditions are met. The first is a market failure that is hurting your business; the most common are supply risk, demand risk, and profit gouging. The second is that you have the power or capabilities to fix and even exploit that market failure. Without market failure, vertical integration is just plain ole diversification. And

Illustration by Greg Mably

be just an unnecessary complication if they are wrong. The Google and Apple examples are good illustrations of using vertical integration to manage demand risk. Frustrated with the lack of innovation at incumbent telecom companies, Google set up its own mobile network. The company is hoping to demonstrate that better Internet service is possible — so customers will demand more from established operators, which will in turn drive more Internet trafﬁc and thus greater demand for its search business. Apple built its own stores to ensure that its products are displayed, sold, and supported on the sales ﬂoor in a manner that is consistent with its brand values. It doesn’t trust other retailers to do that. Because Google’s and Apple’s main businesses are so dominant, they can afford to forward-integrate into businesses that are not all that profitable. But these strategies will become dangerously expensive if their main businesses ever lose their stronghold. In the end, vertical integration is a strategy driven by a lack of trust that upstream and downstream players will come through for your business, and not overcharge you. If that lack of trust is well founded, there’s a failure in the market. And if you have the market power or essential capabilities to enter your suppliers’ or customers’ business, vertical integration makes sense for your strategy. But those are two very big ifs. + Ken Favaro kenfavarowork@gmail.com is an independent strategy couch and founding partner of Recombinators. He was formerly a leader with Strategy&, PwC’s strategy consulting group.

How Tech Clusters Form Rutgers professor Brett Gilbert describes the development of entrepreneurial communities, from Silicon Valley to Johannesburg. by Christie Rizk

ilicon Valley is recognized globally as the birthplace of some of today’s most popular and iconic technologies. Many of its startups have a particular dynamic to thank for their success: the formation of clusters, or groups of companies and organizations that congregate in a region around a particular ﬁeld. Brett Gilbert, an associate professor in Rutgers Business School’s department of management and global business (and @ProfGilbert on Twitter), studies the formation and inﬂuence of these clusters. When a prominent university or a powerhouse company draws other, smaller organizations to its region, a tech cluster forms, supporting entrepreneurs as they develop their own breakthroughs. This model has been observed for decades in the United States. Now, emerging markets such as South Africa are seeing nascent cluster formation. And the success of these nations in the global economy may depend, at least in part, on their

leading ideas

equity offices are forward-integrating to avoid what they consider to be excessive fees from third-party firms. In each case, the companies are entering a new business in direct competition with those for whom that business is the main focus. If their moves show sustained success, we will know that there really was price gouging going on; if they fail, they will learn that companies have to pay up for things that are not so easy to replicate on their own. Starbucks and Ferrero are attempting to mitigate supply risk. Starbucks buys and roasts its own coffee because it does not trust industry suppliers to provide the quality its main business requires. When it bought a hazelnut processor, Ferrero broke its long-standing avoidance of M&A because it feared a disruption in the supply of the essential ingredient in its most important product. Both companies are now among the biggest buyers of coffee and hazelnuts, respectively, in the world. Thus, they both have the firepower to be their own suppliers of the core commodities required to fuel their main businesses. If they are right about their supply risk, vertical integration will indeed be a critical ingredient to their continued success. But it will prove to

how clusters form in emerging markets, with a focus on South Africa. The government is in the process of trying to develop a cluster of IT ﬁrms in Johannesburg in hopes of spurring more economic growth and development. It’s still in the very early stages, and at this point much of the effort has been in establishing tech incubators [enterprises that assist startups with ofﬁce space, guidance, and services]. The South African government has some tools at its disposal. For example, it has laws mandating that multinationals operating in the

“When you have a cluster with a single dominant firm, the other companies often tend to service that larger firm rather than focus on breakthrough innovations of their own.” companies looking to form clusters may not find themselves with the same support other technologyfocused communities have. S+B: How do tech clusters form? GILBERT: Technology companies

tend to group and develop in the same location. Some clusters have emerged from the work of a university: Stanford was very instrumental in the development of Silicon Valley, for example. A cluster can also start with a company. Consider Seattle, which has a somewhat small, but very influential, software development and information technology cluster. Microsoft had an important role in spawning that cluster, and most of the firms located there tend to develop products that largely build on or support Microsoft offerings. They essentially position themselves within the value chain of the dominant firm. Recently, I’ve started looking at

country contribute back to the economy. They are required to help develop small and medium-sized enterprises, and to contribute a certain percentage of their proﬁts to employee development. Thus far, such rules have mostly been used by the government to support entrepreneurial ﬁrms, rather than as a deliberate attempt to forge clusters. However, the city of Johannesburg now

has an ofﬁcial who is responsible for supporting cluster development, so it’s moving in that direction. S+B: Do new clusters tend to emerge near venture capital money, or does money come to the cluster? GILBERT: They coevolve to a certain

extent. Silicon Valley, for example, didn’t necessarily have venture capitalists first — the U.S. government funded early research in the 1950s that led to the founding of many Silicon Valley companies. That said, I think there’s still a tendency for venture capital to concentrate in certain areas in the same way that firms tend to concentrate in certain areas. And venture capitalists, of course, tend to have a preference for financing companies that are within their geographic region, or at least within a certain distance, so they are able to get to the companies for mentoring and other activities. I think a viable cluster requires a little bit of private- or public-sector funding early on, along with a steady stream of self-generated entrepreneurship. Once those two things feed off each other, we begin to see more investment happening within clusters and more venture capital being attracted to the area. S+B: How are clusters in emerging markets such as South Africa different from those in more established countries? GILBERT: In emerging markets,

Brett Gilbert

other factors are often at play. For example, many multinational technology companies are operating in Johannesburg, but they may actually be a hindrance to seeing a technology cluster emerge there. Many people would rather have the stable job with a large multinational, as opposed to venturing out on their

Photograph courtesy of Brett Gilbert

leading ideas 14

ability to make clusters work. Gilbert, who has a Ph.D. in entrepreneurship from Indiana University and served a gubernatorial appointment as an advisory committee member for the Texas Emerging Technology Fund from 2008 to 2010, recently spoke with strategy+business about her research in the U.S. and abroad. She says South Africa is on the right track toward building its own vibrant tech community, though it will face challenges unique to the country’s history and economy. Gilbert also explains why clean-energy tech

S+B: What are the advantages and disadvantages of being in a cluster? GILBERT: In the United States, clus-

ters do tend to be very beneﬁcial for startups in the early stages, primarily because if the startups survive, they have access to resources, knowledge about industry trends, and maybe even technological developments that are useful for them in terms of developing their own concepts. And whether they form around a university or a company,

clusters can ultimately result in both job creation and wealth creation in a region. One thing I’ve found, however, is that startups that are founded in clusters have a tendency to overemphasize their existing products. I think what happens within the cluster is that, because they’re constantly learning about what other

in a developing country context, some of the disadvantages of clusters in established markets — such as ﬁrms being overly focused on their existing products and technologies — may not be a disadvantage when the business environment has so much room for improvement. I also think that multinationals realize that they can’t move into

“African culture is very relational and communal. Given that clusters require strong knowledgesharing and a level of trust between actors, I see no reason they wouldn’t thrive in South Africa.” firms are doing, they’re taking that knowledge and incorporating it into their current portfolio, as opposed to using it to develop new products. For example, when you have a cluster with a single dominant firm, the other companies often tend to service that larger firm rather than focus on breakthrough innovations of their own. And if you have a lot of companies that are thoroughly dependent on one dominant firm, they’re vulnerable to changes to that firm’s economic state. It’s still very early to speculate on whether we’ll see these same advantages and disadvantages in South Africa. But African culture is very relational and communal in nature. Given that clusters require strong knowledge-sharing and a level of trust between actors, I see no reason they wouldn’t thrive in South Africa. In fact, Kenya started down this path a few years back and is seeing strong success with the development of a tech hub near Nairobi [dubbed “the Silicon Savannah”]. Moreover,

: Meet the next generation of business thought leaders at strategy-business.com/youngprofs.

emerging markets without adapting to the local culture. This presents a unique opportunity for startups in clusters: They can learn what they need from the larger corporations, in terms of developing technologies, and then learn what unique offering they can bring to the market that the corporation hasn’t thought of. It’s also worth noting that there are regional clusters that actually discourage the emergence of new technological paradigms. In my research on clean-energy technology, for example, I found that universities have been instrumental in the development of some newer technologies, such as fuel cells [technology that converts a fuel such as hydrogen into electricity to power a vehicle]. However, in regions where established industries may slow or even prevent the development of innovative technology — as the oil and gas industry might do for a fuelcell company in the United States, for example — universities haven’t been as involved. Just because there’s an energy cluster doesn’t mean that it’ll be good for all types of energy tech companies.

leading ideas

own. Under the current government system, if you are a white South African, it’s risky to leave a job. The country’s post-apartheid employment policies ensure that a percentage of jobs go to black South Africans, which means that leaving a job increases the risk for a white South African that he or she may not get another one down the road. Black South Africans, meanwhile, having been shut out from the economy for so long, are now able to enjoy a middle-class lifestyle. Walking away from this life to start a business isn’t easy for many to do. However, although having large, multinational corporations in the country isn’t necessarily helping an entrepreneurial community emerge, I think it’s still fairly early in terms of the long-term impact. I know that Microsoft, in particular, has been actively involved with trying to help grow the cluster in Johannesburg. But from what I can tell, as far as the company’s interaction with the entrepreneurial community goes, a lot of it is focused on building technologies using Microsoft products.

harder to form because these types of companies have more challenges to deal with than a software company might. I’ve found that incumbent technologies are dominant in the minds of a lot of stakeholders. As entrepreneurs are trying to bring green technologies to the marketplace, they have to compete not only against one another, but also against the existing energy systems. Fuelcell technology companies, for example, are having a difﬁcult time even being able to make their value proposition in the marketplace. They came after solar and wind, and many people don’t necessarily see the need for any other options. There are also other complications: If we’re going to have fuel-cell cars, for example, changes will be required within the automotive industry and related infrastructure. Fuel-cell cars are designed to run on hydrogen fuel, which means you need hydrogen fueling stations in places where people can access them. It’s kind of a chicken-and-egg situation, in which the automotive manufacturers would like to see the energy companies investing in hydrogen fueling stations, and the energy companies would like to see the automotive manufacturers put these cars on the road before they make the investment in the fueling stations. As a result, they’re at a bit of a standstill. + Reprint No. 00349

Christie Rizk christie.rizk@strategyand.pwc.com is associate editor of strategy+business.

The Next Innovation Opportunity in China Multinationals are shifting their R&D focus from cost savings to knowledge-based research. by Dominique Jolly, Bruce McKern, and George S. Yip

ust 15 years ago, China was home to 200 foreign-run R&D centers. Today, multinationals operate more than 1,500 innovation facilities throughout the country — and this number is poised to increase 20 percent by 2018 (see exhibit). But this trend involves more than sheer presence. Over the last 10 years, we’ve witnessed a dynamic shift in what motivates multinational corporations (MNCs) to set up an innovation shop in China. For many, what began as low-cost support for local operations became an effort to adapt technologies to cater to local market demand. Now, some multinationals are changing course yet again: Having recognized China’s rise as a global innovation leader, they are tapping into the country’s thriving science and technology knowledge base to pursue fundamental research. To better understand this evolution, we conducted a study of 50 R&D centers established by MNCs in China. The companies have headquarters in the U.S., Europe, or Asia, and operate in the chemicals, pharmaceuticals, automotive, and IT industries, among others. Some of the centers in our sample were launched more than 10 years ago, but most were set up more recently. Ten of the centers have more than

1,000 employees, and 25 have between 100 and 1,000; only 15 have fewer than 100 employees. On the basis of our research and experience working with companies in China, we believe that our survey results are indicative of the foreign R&D picture in the country as a whole. We found that 72 percent of our survey respondents are still focused almost exclusively on the ﬁrst two stages of innovation activities: those centered on cost savings, or “costdriven” R&D (18 percent), and those aimed at entering the Chinese market, or “market-driven” R&D

Exhibit: Shifting R&D Focus, 2008–18 The number of foreign innovation centers in China is on the rise, and more are conducting knowledge-driven R&D. R&D centers in China 2,000

Knowledge-driven R&D Market-driven R&D Cost-driven R&D

1,500

1,000

500

0 2008

2013

2018 (est.)

Source: Survey interviews; Maximilian von Zedtwitz, “Managing Foreign R&D Laboratories in China”; PwC, “Tax Preferential Policy for R&D Activities in China,” Jan. 2012; Arthur Yeung et al., The Globalization of Chinese Companies: Strategies for Conquering International Markets (Wiley, 2011)

strategy+business issue 80

leading ideas 16

S+B: What does that mean for clean-tech clusters? GILBERT: Clean-tech clusters are

Illustration by Tang Yau Hoong

Three Phases of R&D

The ﬁrst foreign-run R&D centers in China appeared in the mid1990s. At that time, MNCs sought to support their local manufacturing facilities by setting up labs inside their factories. These companies wanted to reduce R&D personnel and operating costs by offshoring to China parts of the costly development phase of innovation. Companies that still conduct cost-driven R&D are largely focused on “end of development” activities, working on products close to commercialization for which repetitive tasks are the norm. This group is dominated by companies in industries that require laborious testing operations. For example, some software companies have several thousand employees dedicated to such tasks in China.

For many companies, however, as China’s economy grew, the cost advantage began to fade. By the late 1990s, China’s B2B and B2C markets had exploded. Multinationals realized that their Chinese competitors had quickly become masters at serving local needs. Moreover, foreign companies discovered they couldn’t simply transfer all of their technologies from developed countries to China. Adaptation was essential to meet local demand, to adjust to locally available resources, and to comply with local regulations. This strategy was initially most prevalent in industries such as autos, food, cosmetics, and construction materials — all of which make products that are differentiated for national markets and that incorporate domestic components. This phase led MNCs into market-driven R&D. In this type of R&D, companies conduct pri-

mary development, such as creating variants of products using existing prototypes, but only rarely do they conduct applied research (for example, research leading to new patents and prototypes). Our survey revealed that in foreign automotive companies’ R&D centers in China, 95 percent of the staff is employed only for development, such as designing cars using platforms developed outside China. That leaves just 5 percent to work on applied research (and none to perform fundamental research). In the third phase, beginning in the mid- to late 2000s, some forward-thinking multinationals recognized that China was developing signiﬁcant science and technology know-how. These companies don’t perform R&D in China to reduce costs or ﬁt the market. Instead, they seek to integrate their R&D with the latest research coming out of

leading ideas

(54 percent). In the past, such activities could almost guarantee success, and companies were relatively unconcerned with intellectual property (IP) rights. But that was in a different China. The country now has leading research universities, modern science and technology parks, and innovative startups. Chinese companies, which are investing more and more in R&D, are demonstrating a growing concern for IP rights. Since 2011, China has ﬁled the most domestic patent applications of any country. And in ﬁelds such as telecommunications equipment and photovoltaic panels, China has become a recognized leader in technology development. Forward-looking MNCs are transforming their R&D focus to capitalize on this shift: 28 percent of our respondents have now engaged in “knowledgedriven” R&D.

Barriers to Knowledge

Transitioning to knowledge-driven R&D will become increasingly important for foreign multinationals in China. But along the way, they will need to confront several key challenges. First, they will have to decide where to locate their R&D centers. Companies have traditionally emphasized one speciﬁc type of innovation at a given facility. But it’s often impossible to simply change a facility’s focus. Cost-driven R&D has had to follow the manufacturing sector into China’s interior, where costs are lower than in coastal regions. Marketdriven R&D needs to be close to where the customers are. For example, automakers’ equipment suppliers need their R&D centers to be near the automakers’ factories, which are scattered across the country. Knowledge-driven R&D, in contrast, needs to be conducted close to research universities and public research institutes. These are predominantly established in the

coastal provinces — in ﬁrst-tier cities, but also in second-tier cities such as Hangzhou, Nanjing, and Suzhou. A company pursuing knowledgedriven R&D will therefore typically need to open a new facility. Fortunately, MNCs can often receive incentives from provincial or municipal governments eager to attract investment and create jobs. The second challenge MNCs face involves talent. Companies conducting cost-driven or market-driven R&D are used to hiring people with bachelor’s degrees, but people who conduct knowledge-driven R&D typically need master’s degrees or Ph.Ds. This means building close links with leading universities and research centers to get preferential access to new graduates. In many locales, MNCs encounter people with limited international exposure; this makes interactions with expatriates and with teams from the company’s headquarters more difﬁcult. Additionally, foreign companies are limited by China’s hukou household registration system, which constrains where citizens can work. Here, Chinese-born returnees, most of whom

more dynamic than ever, and churn is high; the annual turnover rate is currently more than 10 percent in the innovation sector. MNCs are no longer the most favored places for young scientists and engineers to work. Private Chinese companies are growing rapidly, and stateowned enterprises can help recruits get the right hukou. MNCs will need to develop creative means to stabilize their workforce. This depends less on salaries (offering competitive pay is a given) and more on inspired leadership and providing opportunities for challenging work and overseas assignments. Next, companies pursuing knowledge-driven R&D need to ﬁnd the right academic and business partners. MNCs must adopt a longterm strategy to become accepted players in the Chinese innovation ecosystem. To do so, they’ll need to become “insiders” as early as possible. They should build relationships with university researchers and government research institutes by working on joint projects of mutual interest, preferably ones that ﬁt national or local government priorities. Newcomers will have to devote

MNCs must adopt a long-term strategy to become accepted players in the Chinese innovation ecosystem. To do so, they’ll need to become “insiders” as early as possible. are not limited by the hukou system — especially if they have dual citizenship — can be assets. They know how multinational corporations work, can bridge the experience gap, and have experience leading teams and mentoring young staff. Retaining people is perhaps even more challenging than ﬁnding them. The Chinese labor market is

resources to catching up by conducting thorough assessments on the ground and making sustained efforts to visit key research centers across the country. Finally, managing IP rights remains a continuing challenge for MNCs in China. By many accounts, China’s regulatory landscape and strategies for protection are evolving

strategy+business issue 80

leading ideas 18

Chinese institutions. They are interested in the full R&D spectrum: development, applied research, and, more and more frequently, fundamental research. A large part of the group pursuing this third phase of R&D is in the pharmaceuticals industry; others come from chemicals and electronics (three industries supported by the Chinese government in its ﬁve-year development plans). These knowledge-driven companies target the pool of high-quality researchers who have recently emerged in China. To do so, they establish research partnerships with leading universities and public research centers and work with local partners and startups.

Compounding these practical concerns, company leaders must also commit to a change in mindset. They need to recognize China’s rise as a global innovation leader, and understand that knowledge is quickly becoming the next big source of competitive advantage. Among our survey respondents, this shift is already under way. Our advice for those whose innovation presence is focused on the early phases? Take stock of your R&D needs in today’s competitive market, and determine whether your China facility is still meeting them. +

Dominique Jolly dominique.jolly@skema.edu is a professor of strategy at SKEMA Business School in France and a visiting professor at the China Europe International Business School (CEIBS) in Shanghai. Bruce McKern bmckern@ceibs.edu is a visiting fellow at Stanford University’s Hoover Institution and Oxford University, and a visiting professor of international business at CEIBS. George S. Yip gyip@ceibs.edu is a professor of strategy at CEIBS, and codirector of its Center on China Innovation. He is also a visiting professor at Imperial College Business School in London.

Reprint No. 00350

s+b Trend Watch What does 20 years of management coverage look like? We identiﬁed keywords that represent the topics we’ve written about since 1995 and ranked them according to the number of times they have appeared. Here are the topics mentioned most frequently. Goodbye, reengineering and globalization. Hello, healthcare and disruption.

20 Years of strategy+business Keywords currently in the top 10 by number of mentions Keywords previously in the top 10 Leadership Strategy Innovation Operations CEO Capabilities Disruption Diversity Mergers/Deals Supply Chain

1 2 3 4 5 6 7 8 9 10

Sustainability Healthcare Women Oil and Gas Globalization Reengineering

25 1995

1996

1997

1998

1999

2000

2001

Source: strategy+business, Raven Creative

2002

2003

2004

2005

2006

2007

2008

2009

2010

leading ideas

quickly. Still, companies need to have clear internal policies for employee IP security at their R&D centers. To reduce security breaches, they can break R&D projects into components — dealing with one part in the West and another part in China. And patents, including IP produced outside China, must be registered in China both for local protection and to foster a positive relationship with the authorities. MNCs that have failed to protect existing IP in China have sometimes found that a local company has registered the patent, along with full rights to use it.

2011

2012

2013

2014

2015

20/20 Foresight Many business leaders need to improve their perceptual acuity. Here’s how you can develop the ability to look around corners — and become a catalyst for change. by Ram Charan

he immense uncertainty that today’s business leaders face is something truly unique. In its scale, ferocity of impact, and ubiquity, it is different — by orders of magnitude — from anything I’ve seen before. We’ve been living with uncertainties forever, of course. What’s new is structural uncertainty. It is structural because the longterm, irresistible forces now at work can explode the existing structure of your market space or your industry, putting it at risk of being drastically diminished or completely eliminated. If you are unprepared, the massive changes these forces bring are like sudden bends in the road. They appear, seemingly without warning, to convey you away from the future you envisioned for your business. But in a world that is projected to

add a minimum of US$30 trillion of GDP in the next decade, where human needs and wants are both multiplying and changing, structural uncertainty also creates myriad new needs, new industries, new businesses, new business models, and new market segments. Taking control of uncertainty and successfully steering your organization through frequent bends in the road is the fundamental leadership challenge of our time. And it will call for a distinctly different type of leadership than the one you were trained for and are likely currently exercising. The advantage now goes to those who don’t just learn to live with change, but who create change. I call these people catalysts. Instead of waiting and reacting, catalysts immerse themselves in the ambiguities of the external environment, sort through them before

things are settled and known, set a path, and steer their organization decisively onto it. They seize upon a force or combination of forces — for example, linking a demographic trend with an existing technology — and conceive of a new need or a total redefinition of an existing need, often with a new business model in mind. (See “What SelfMade Billionaires Do Best,” by John Sviokla and Mitch Cohen, s+b, Dec. 14, 2014.) Unconstrained by conventional wisdom, creative thinkers paint a detailed, specific picture of what the new company will be. Then they take the organization, along with its external constituencies, on the offensive. Of the skills required to thrive as a catalyst, the first — and perhaps most important — is perceptual acuity. Although the phrase rarely appears in accounts of business breakthroughs, perceptual acuity often turns out to mean the difference between success and failure. Perceptual acuity is the psychological and mental preparedness to “see around corners” and spot potentially significant anomalies, contradictions, and oddities in the external landscape before others do. It is your human radar for seeing through the fog of uncertainty so you can act first. Some people are simply born with it. Ted Turner, for instance, is a catalyst who was blessed with exceptional perceptual acuity. “He sees the obvious before most people do,” as Robert Wright, the former president of NBC, told an interviewer. “We all look at the same picture, but Ted sees what you don’t see. And after he sees it, it becomes obvious to everyone.” Turner had ventured into TV by buying a small UHF station in Atlanta in 1970, soon after taking

Illustration by Lars Leetaru

essay organizations & people

ORGANIZATIONS & PEOPLE

Crusaders in Action

provide more programming. Next, he asked why consumers had to get the news at a set hour, typically 6 p.m. Why not make it available at any time, day or night? And so was born CNN with its precedentsetting 24-hour news format.

You can cultivate perceptual acuity by watching catalysts and adopting the disciplined practice of looking over the horizon and searching for new ideas, events, technologies, or trends — things that an imaginative person could combine to meet an unmet need or create a totally new product. As your acuity sharpens, you’ll spot catalysts more easily and begin to see the world as they see it: as full of new possibilities and opportunities. The key is to train yourself to stand back from your business and its environment. In particular, look for the larger signiﬁcance of anomalies, contradictions, and oddities — that is, things that depart from or challenge familiar

patterns and differ from what you’ve known or believed previously. Then you need to imagine what the new shape of the landscape might be if what you’re seeing is a signal of powerful change — and importantly, imagine how you might take advantage of the shift. Practicing perceptual acuity is now part of your job and will raise your value as a leader. And in fact, building it is less a matter of carving out time than of exercising the focus and discipline to watch and listen for different things in the ordinary course of your day, all through the year. Change doesn’t wait for your annual planning cycle. It’s important to go through the process of trying to identify the seeds of change and catalysts frequently. Structural changes are often misdiagnosed as operating problems when they ﬁrst surface, so it’s a good idea to involve people at many levels of the company to help spot those changes. There are several tools you can use to develop perceptual acuity for

market segment under the rubric of

and helps companies worldwide

safety systems.

improve their practices.

Building Perceptual Acuity

Ruben Mettler, a longtime CEO

Today, safety instructions appear

of the automotive and aerospace

on a galaxy of products and in places.

company TRW, was a catalyst who

When I was serving on the board of

catalyst, someone who creates

was inspired by Nader’s insights.

Dallas-based Austin Industries, a

change before others fully see

TRW’s defense division was widely

leading regional builder of struc-

the possibilities, can be a gadﬂy. One

recognized for its technological in-

tures and airports, we discussed

example is Ralph Nader, an energetic

novation, and Mettler saw that some

safety as a regular practice; Austin’s

critic of American business and poli-

of its technology could be applied to

safety record became a competitive

tics for 50 years. Nader’s 1965 book,

passenger restraint systems. The

advantage in bidding. Unsafe at Any

Unsafe at Any Speed (Grossman), was

company made the necessary invest-

Speed is close to being a picture-

a pioneering analysis of automak-

ment and became the world leader in

perfect example of the two sides of

ers’ failure to think about the safety

vehicle safety. It became the number

structural uncertainty. Whereas the

of their products. The storm that

one supplier of airbags and other

big car companies saw it as a threat,

followed changed the expectations of

safety systems to Ford and a major

other players recognized an oppor-

consumers and government regula-

supplier to GM. Safety concerns also

tunity and went on the attack. And

tors about product safety. Nader’s

created a huge opportunity for Du-

the book’s larger message became

critique thus created multibillion-

Pont, which developed a methodology

woven into society as a whole.

dollar opportunities in a totally new

for safety-focused cultural change

—RC

essay organizations & people

over his father’s billboard advertising business. He saw the possibility of combining satellite transmission and cable networks into a national network before the enabling technologies and regulatory mechanisms were fully in place. The plan was to beam signals from his tiny local station to a satellite, then download them to dishes across the country and transmit the captured signals to viewers via cable. Turner wanted a national license, but the Federal Communications Commission (FCC) granted licenses only for local markets. Turner pressed Congress to intervene on behalf of giving consumers more choice. Soon after, the FCC approved Turner’s proposal for a national license, and his local station was instantly transformed into a “superstation.” Turner found clever ways to ﬁll the hours with programming, such as the now common practice of running old movies and TV shows. He bought the Atlanta Braves baseball team to

Cultivate Perspective

Test your perceptions by talking with other people, especially those

you suspect have opposite or divergent views. Surrounding yourself with people from different levels of the company, from different industries and backgrounds, and with different cognitive bandwidths and attitudes about risk taking helps you see the same world through different lenses. The seeds of change that could make a company or industry obsolete usually hit one product or market segment ﬁrst. So middle managers, who are often close to the customers and to supplier networks, should be honing their skills at developing insights about how the external environment is taking shape just as much as those in positions at a “higher altitude.” In addition, senior executives should look outside the organization. When “Clare,” an executive in her mid-40s, became CEO of a company with $10 billion in revenue, she took the initiative to ﬁnd four other people about her age, also newly appointed as CEOs and running global businesses. Each had a different personal background and worked in a different sector of the economy: consumer products, Wall Street, information technology, and industrials. They continue to get together four times a year for dinner. Each group member also has access to varied insights from their diverse boards of directors, direct reports, suppliers, and friends. Their meetings and informal conversations between get-togethers serve as a sounding board for each to cross-check thinking, and provide a foundation for superb foresight. By making it a habit to seek out and listen to people whose expertise or endeavors give them insight into external change, they create a multiplier effect, magnifying one another’s perceptual acuity.

Another way to develop your perceptual acuity is to look in the rearview mirror. Spend time with colleagues and look at a big external change that hit your industry or some other industry sometime in the past 50 years. Dissect that change. What were its seeds, and who were the catalysts who caused the change? Take, for example, the shift to personal computers from mainframes and minicomputers, which obliterated highfliers like Digital Equipment Corporation and Wang Laboratories. Try to be specific about who and what caused that shift to happen — and why the losers failed to see the significance of what was happening. These kinds of discussions take time and mental energy, especially at first, but they are an important part of your work. You will get better and faster over time, and be able to detect things sooner. Listening for Risk and Change

General Electric manufactures, sells, installs, and services its products in countries with unstable governments that are at geopolitical risk. In contrast to many companies that seek to avoid risk, GE stipulates that risk is a part of its business model that should be managed, and that the company should be paid for the risk it takes in its business. GE’s water and power business unit, headquartered in Schenectady, N.Y., operates in some 50 countries in areas considered high risk, such as many parts of Africa and the Middle East. The unit sells items that often cost hundreds of millions of dollars and represent long-term investments by customers. The lion’s share of its revenues, proﬁts, and investments are not based in the United States. To have an edge in managing the risk and taking advantage of the op-

strategy+business issue 80

essay organizations & people 22

yourself and your organization in this way. One of the most valuable is a simple exercise at the start of any staff meeting. Allocate the first 10 minutes to learn about and discuss anomalies in the external landscape. Ask a different staff member at each meeting to present to the team a structural uncertainty or bend in the road in another industry. Discussing who is taking advantage of the bend in the road or the uncertainty, and who is on the attack, widens the lens of the whole team, attunes their antennae, and helps them become more insightful. Most importantly, it alters their attitude toward change — and gives people permission to suggest changes in their own business. Steve Schwarzman, chief executive officer of Blackstone Group, the giant private equity firm, uses a form of this social tool at his Monday morning meetings. Those attending Blackstone’s staff meetings are connected on a daily basis to people at the highest levels of government, to investors, to leaders in diverse industries in countries around the world, and to sources of information about what is coming in the future. Schwarzman asks everyone at the meeting what is new, what they are detecting, and who the catalysts are. With a time lag of no more than a week, this group gains extensive knowledge about what is going on in the world, which in turn helps them contemplate what they can do to shape the game of their business and go on the attack. They can see structural uncertainties, especially those tied to the inherent instability of the global financial system.

essay organizations & people

portunities, Steve Bolze, president of the unit, receives weekly information from each of those countries, carefully analyzed and synthesized. He makes a habit of studying these reports and looking for early warning signals and catalysts, and he spends time with people in those countries, listening carefully. “In terms of dealing with uncertainty, there’s nothing that substitutes for a personal visit,” he explains. “Having ongoing relationships with people in that country helps you understand the ongoing drivers there. Helping customers solve their problems also helps us understand the context.” Bolze’s perceptual acuity is paying off: His unit’s margins, market share, revenue growth, and cash generation are now the best in the industry. He has emerged as a leader who can anticipate bends in the road and win in highly risky areas. One of the most skilled individuals in the world at listening for external context is investor Warren Buffett. At a recent CEO summit convened by Microsoft, I was joined at a lunch table by Buffett and eight other people. We talked about our sources of knowledge, and Buffett told us that he reads 500 transcripts of investor calls each year, where all the presenters state their views about their company and industry and what they anticipate in the future. In general, his practice is to let people run the individual businesses of Berkshire Hathaway; he watches for changes across industries that might prompt him to shift the resource allocation in the portfolio. Since Buffett has been practicing this for decades, his acuity has become highly honed in detecting signals and catalysts that are over the horizon, an impressive skill given that his port-

Short Courses, Big Impact MIT Sloan Executive Education offers a flexible portfolio of short programs—including two-day courses throughout the year—to help executives from around the world advance their organizational and career goals. Hone leadership skills, understand global markets, capitalize on leading technology, and learn from world-renowned faculty.

Enroll today in one of our many short courses and learn to solve the challenges most critical to you and your organization. executive.mit.edu/sb

Ask “What’s New?”

Jack Welch, CEO of GE from 1981 to 2001, had a habit of trying to ﬁnd out what really was new from the wide variety of people he met, and perking up when he heard something fresh. One day in the early 1990s, I ran into him on an elevator at the Hyatt Regency in New Orleans. I said, “Good morning, Jack.” He looked at me with his piercing eyes and said nothing. Suddenly he asked, “What’s new?” I shot back a three-word response to his two-word question: “Zero working capital.” To that he said, “Are you trying to sell me some consulting? Did you make it up? Who does it?” He was skeptical but not dismissive. I then gave him details about a company I knew that was using zero working capital in the manufacturing, assembly, and delivery of products, thus freeing up cash to invest in growth (and at the same time improving customer satisfaction because it enabled the company to make items to order). Welch called the CEO of this company and took a business unit manager with him to spend several hours learning the details. He then sent his executives to visit the company’s plants. Welch ultimately set a goal for using zero working capital and initiated a course on it at Crotonville, GE’s executive education institute. By the time Welch retired, the approach had saved GE several billion dollars in cash, which could be used to fund growth. A lengthier but more precise way to open discussions about what’s new is by asking, What practices and underlying assumptions are common throughout our industry? Those commonalities are a source

of systemic risk. One example is the remarkable similarity of mortgage lending practices before the financial crash of 2008–09, when credit standards were uniformly lax. The overleveraged housing market was observable. If you see a similar buildup of some kind, consider what could light the fuse. For mortgage lenders, it was loss of confidence in the financial instruments that had been created to spread the risk of bad loans. Form scenarios of what might happen and watch for signals that the buildup is taking further shape. Who could be the catalyst for a good change, or a bad one? Watch, Read, Repeat

When you watch video news reports, pay close attention to how society is changing and what new consumer behaviors are emerging. Social issues get picked up quickly by the media and are sometimes followed by increased scrutiny or regulation as they work their way into the political sphere. Clinical drug trials, for example, became a hot subject in India in 2012 when some political leaders noticed concern about the number of deaths associated with them. The rhetoric escalated, corruption accusations were hurled against some doctors, and activists ﬁled a public interest lawsuit alleging the use by global companies of Indians as human guinea pigs. The public and political debate led to tough new rules adopted in 2013, which squarely laid responsibility for any injuries or deaths from the drug trials on the shoulders of the testing company. The government may have overreacted, but momentum had built to the point where leaders felt compelled to act vigorously. When reading books and pub-

lications such the Financial Times, New York Times, Wall Street Journal, and Economist, look for what surprises you, what is an anomaly. My technique is to first read the roughly half-page “Lex” column on the last page of the first section of the Financial Times. I read Lex with a sense of curiosity about what is new, what I didn’t know, what might be the start of a trend. There may be days and weeks in which I find nothing. But when I do find something intriguing, I reflect on what it might mean and for whom. Who will be on the attack, who on the defensive, and why? Is there a game changer here? Asking these questions in response to whatever you read will increase your capability to identify signals and catalysts that might create bends in the road. Continually stimulating your thinking and self-reflection is a critical aspect of building and maintaining your attacker’s advantage. By pinpointing the sources of uncertainty, defining a path forward, and making the necessary frequent adjustments to steer your organization along it, you will see that uncertainty is not something to fear. On the contrary, by immersing yourself in it, you can discover possibilities for creating something new and immensely valuable. The more you embrace uncertainty and practice the skills to deal with it, the more self-confidence you will develop and the better prepared you will be to lead. + Reprint No. 00351

Ram Charan ofﬁce@charanassoc.com is the author of several books, including The Attacker’s Advantage: Turning Uncertainty into Breakthrough Opportunities (Public Affairs, 2015).

strategy+business issue 80

essay organizations & people 24

folio of businesses spans a signiﬁcant portion of the national economy.

UPCOMING 2015 PROGRAMS LEADERSHIP & BUSINESS ACUMEN: Executive Development Program Nov. 1–13, 2015 Executive Negotiation Workshop Nov. 2–6, 2015 Advancing Business Acumen Nov. 8–13, 2015

Moving forward in today’s competitive landscape requires strategic business savvy and insight. Wharton Executive Education offers experiential programs designed to advance leaders at all levels by providing knowledge that enhances leadership skills and advances business acumen. Wharton’s world-class faculty bring analytical rigor and an industry expertise to executive education that is unparalleled. Learn alongside international peers and gain the global business knowledge you need to make an immediate impact within your organization.

Leading Organizational Change Nov. 30–Dec. 3, 2015 Strategic Thinking and Management for Competitive Advantage Nov. 30–Dec. 4, 2015

Seek greater challenges:

www.WhartonImpact.com

How Adidas Found Its Second Wind The sportswear giant’s embrace of its heritage shows how reconnecting with the past can inspire a company’s future. by Nicholas Ind, Oriol Iglesias, and Majken Schultz

ow does a company cope with change? It’s a question that looms large for many executives who are struggling to keep up with the breakneck pace of business. Those who fail to answer it may face loss of market share, or, in extreme cases, ﬁnancial ruin. All too often, companies respond to these pressures by ﬁxating on the future. What will consumers want? Where will technology take us? What are the most critical emerging business opportunities? Although these are important considerations, this future-focused perspective leads some companies astray. They are constantly looking forward, not realizing that their greatest strength could be hidden

in their past. Companies such as Adidas, Lego, Burberry, and Apple have lived through phases during which their heritage was ignored, their identity was blurred, and their strategic focus was lost. However, at some point, each company realized that it had a distinctive history rich with memories, experiences, and signature processes that could be used to design the future — not through a slavish adherence to tradition, but through thinking differently about strategy, innovation, and products. In the case of Adidas, an important transitional event — record losses and near bankruptcy — pushed the company to reconnect to its past. In the late 1970s and 1980s, Nike’s rise gave Adidas a jolt. Adidas responded to these new competitive pressures by pursuing growth frantically in new directions. The com-

pany was distracted and lost sight of the capabilities that had formed the backbone of its earlier success. Adidas would later experience a resurgence in the market, but only after it channeled its heritage. Today, at the company’s global headquarters in Herzogenaurach, in southern Germany, and at its U.S. headquarters in Portland, Ore., managers, innovators, and designers pore over company history, discuss its relevance, and determine what to discard and what to keep. In a process full of both continuity and change, they reach back to the lessons of the past and stretch forward to adapt to the changing needs of athletes and consumers. The results speak for themselves: Adidas has transformed itself from a consistent loss maker in the late 1980s and early 1990s to a brand with a market cap of US$17.1 billion. Rediscovering and rejuvenating capabilities is not a simple process. To better understand how Adidas accomplished it, we interviewed senior managers from the company’s marketing and innovation departments, designers, product developers, and history managers (including longtime employees who were able to recall the challenges of the previous era), and analyzed Adidas’s published and archived materials. In doing so, we identiﬁed steps that any established company can follow. When leaders rediscover their company’s heritage and learn what works and what doesn’t, the core assumptions and values of the past are reabsorbed into the organizational culture, and come to deﬁne the company’s strategic choices. As Adidas found, the key is not only reconnecting with the past, but knowing how to use it effectively to meet the future needs of consumers.

Illustration by Lars Leetaru

essay consumer products

CONSUMER PRODUCTS

Adi Dassler, a cobbler by training and a keen sportsman, started a shoe company with his brother Rudolf in 1924. Adi’s method seemed simple: He observed athletes, talked to them about their needs, and then experimented with novel ways of solving their problems. This iterative process relied heavily on prototyping and testing. While Adi concentrated on innovation and production, Rudolf was busy selling. The brothers were successful from the beginning. Adi acquired his ﬁrst patent on a pair of running shoes in 1925, and three years later a runner wearing the Dassler brothers’ shoes won Olympic gold. In 1936, Jesse Owens won four gold medals in their shoes. By 1938, the company was producing 1,000 pairs of athletic shoes a day. After World War II, the brothers fell out and split the existing business. Rudolf set up Puma, and Adi launched Adidas. The two companies reﬂected the brothers’ interests: Puma adopted a more salesoriented business model, and Adidas was more product focused. Until the arrival of Nike in the 1960s, these two companies dominated the global sports shoe market. During Adi Dassler’s lifetime, Adidas continued to expand and develop into new markets and sports. But the company was always united by Dassler’s belief in “only the best for the athlete” and his philosophy of industrialized craftsmanship. The latter involved creating products that were designed to perform for individual athletes but that could be produced at an industrial scale. As part of this philosophy, Dassler collected used Adidas athletic shoes to analyze wear and tear and to inspire employees (who began contributing

shoes to Dassler’s collection). Dassler never treated this personal archive with reverence; instead, it was highly pragmatic, enabling him to identify and solve design and production problems. After Dassler’s death in 1978, his wife, Käthe, and son-in-law Alf Bente took over. When Käthe died in 1984, Adi and Käthe’s son Horst became CEO. By this time, Nike had become a formidable competitor, and had displaced Adidas as the

in 1984. Jordan ultimately signed with Nike. The problem is obvious from a look at the advertising from that era. Whereas Nike demonstrated continuity, Adidas introduced a new campaign, communicating a different proposition, every year. The messages even varied across countries — largely because Adidas had grown internationally through third parties and lacked any real control. In the key U.S. market, it had four

essay consumer products

The Best for the Athlete

Companies are constantly looking forward, not realizing that their greatest strength could be hidden in their past. largest sports shoe brand. In an attempt to stay relevant, Adidas’s new management tried to assert its independence from the past. Most of Dassler’s shoe collection was thrown into storage boxes; some of it was donated to employees and museums. His books of copious notes were packed away. The strategy pursued in the late 1970s and 1980s, involving an expansion into leisurewear, was a rejection of Adidas’s heritage. The results were mostly poor — not least because the company at that time lacked the capabilities to compete to win in arenas beyond shoes. Employees were confused about the company’s direction, innovation had no focus, design and product quality deteriorated, margins suffered, and opportunities were missed. Most notably, the company passed on signing a sponsorship deal with basketball superstar Michael Jordan when he was drafted into the NBA

independent distributors. The company was struggling. Horst Dassler understood some of the problems, and particularly the need to manage the company brand better. But after his untimely death from cancer in 1987, with mounting losses and lenders threatening to cut credit unless more money was pumped into the business, the family decided to sell. A Journey of Rediscovery

In 1989, with the company at a crossroads, then CEO René Jäggi decided to invite two ex-Nike managers, Peter Moore and Rob Strasser, to visit Adidas. Moore had been creative director of Nike and the designer of the Air Jordan brand, and Strasser had been Nike’s marketing director. As the guardians of Nike’s image, they promoted the importance of a clear and consistent approach to building a brand. They had left Nike a couple of years be-

company was foundering and looking over its shoulder at Reebok (a brand that Adidas would acquire in 2005) and Nike. This, Moore and Strasser believed, was a mistake. A brand like Adidas had to lead, not chase. Free of cultural blinders, Moore and Strasser used the marketing skills they had developed at Nike to draw selectively from Adidas’s history. Initially as consultants

“It took only about five minutes in the museum before I realized that these people had a gold mine in their hands.” It can be difficult for managers to see the truth about their own organization. Accepting “the way we do things around here” can create a form of groupthink. Often, outsiders who come into companies, unencumbered by the existing culture, reinstitute strategies firmly rooted in the firm’s capabilities. Some examples are Jørgen Vig Knudstorp, the first non–family member to be named CEO of Lego; Angela Ahrendts, the American who turned around British fashion icon Burberry; and Steve Jobs, who had a second, triumphant tenure at Apple, the company he had founded and from which he had been ousted. Of course, it may not always be practical to have outsiders challenging the status quo. But at a minimum, insiders should be questioning and self-critical. Moore and Strasser believed that over the years since Adi Dassler’s death, Adidas had lost confidence. Consequently, instead of looking to its own capabilities, the

and then as the creative director and CEO of Adidas America, respectively, they deﬁned a new strategy and approach to innovation that guides the company to this day. The Heart of the Business

In looking to Adidas’s past, Moore and Strasser recognized two unique capabilities. First, they saw that the core of the company had been Adi Dassler’s hands-on approach to innovation — his philosophy of industrialized craftsmanship. Dassler’s closeness to athletes and his intimate understanding of their needs had created a stream of innovative products that enhanced athletic performance. When the company lost its connection to athletes, quality suffered. Moore and Strasser recommended renewing Dassler’s approach, and developed a new product line called Adidas Equipment. For Equipment, which was launched in 1991 and later evolved into Adidas Performance, Moore and Strasser created branding rules that emphasized product

quality. For example, they placed restrictions on the color, sizing, and placement of the logo, and initially even on the colors of the shoes themselves. They wanted consumers to focus on the quality of the shoe, and not be distracted by other features. They wanted to make the product the hero, just as Dassler would have done. “The idea of Equipment was that it was a model that you could build the whole company around,” Moore told us. “The model was to go back to what Dassler had tried to do all his life, which was to make the best products for the athlete to compete in.” Reconnecting in this way was emotionally uplifting — especially for those who had worked with Dassler — and helped restore employees’ conﬁdence. Today, Performance represents the core of the Adidas brand and accounts for more than 75 percent of its sales. Second, Moore and Strasser understood that Adi Dassler’s approach to design, which emphasized functionality over style, had created a portfolio of timeless, authentic shoe designs. The shoes were no longer cutting-edge in terms of their athletic performance (the technology had moved on), but they had a strong emotional appeal, especially in the burgeoning street-wear market epitomized by the Adidas-wearing hiphop group Run DMC and its fans. Adidas had struggled to create a leisurewear line, but it seemed the company unknowingly already had one. In a brief memo to the Adidas board, Moore set out the idea for a new brand of street-wear shoes. The suggestion was to take some key models from the past and modernize the quality, comfort, and ﬁt. Rather than blurring the clarity of Equipment, Adidas recognized that this new line should have a separate

strategy+business issue 80

essay consumer products 28

fore to set up a business to help create and develop other sports brands. Moore remembers their ﬁrst visit to Adidas vividly. They were taken to a small museum of artifacts at the company’s headquarters. As Moore told us, “It took only about ﬁve minutes in the museum before I realized that these people had a gold mine in their hands, and that they really had no idea what they had.”

Documenting a Heritage

We know that tacit knowledge is a powerful driver of innovation, but as long as it remains tacit, it has the potential to be forgotten. Managers are sometimes too busy managing to properly record and archive what they are doing. Sometimes (as with Dassler’s shoe collection and notes) experiences are seen as unimportant. Yet one lesson we can derive from Adidas is that mechanisms need to be found to make a company’s capabilities explicit through the ongoing management of artifacts that provide the organization with inspiration and direction. Moore and Strasser’s look backward was intuitive — based on a gut feeling that Dassler’s philosophy was still relevant. One might wonder why no one inside Adidas could see this. Bernd Wahler, the former head of innovation at Adidas, told us that the value the brand’s authenticity provided to consumers and employees had been lost. “They [Moore and Strasser], as the big Nike guys, were talking about Adi Dassler with so much respect,” he said. “Rob Strasser made Nike look like copyists and positioned Adidas as the true authentic sports brand — which it is, but people had forgotten it.” Wahler recalls that the way Moore and Strasser reworked the positioning changed the company’s orientation signiﬁcantly by bringing the organization’s capabilities back into view.

Strasser died in 1993, but Moore became the company’s global creative director and has remained the conscience of the brand ever since. When it came to documenting the past, Moore began to realize that the tacit knowledge that had underpinned the Adidas culture was disappearing as the influence of Dassler and his contemporaries waned. One Adidas manager who had worked with Dassler had taken on the role of collecting and cataloguing the products he could find. But Moore knew that to really bring the knowledge of the past back into view and make it relevant for the future, he would have to make it explicit. (See “The Practical Wisdom of Ikujiro Nonaka,” by Sally Helgesen, s+b, Winter 2008.) This tacit-to-explicit conversion began in the mid- to late 1990s under Moore’s guidance, and was solidified over the next decade. In the

pages of Dassler’s notes, and a selection was published internally as “Adi Dassler Standards.” The company now uses its knowledge of the past to guide its future direction in tangible ways. For example, when new products are being developed for forthcoming seasons, the history management department is briefed on the approach. The department then uses the explicit knowledge contained within the archive to search for and select ideas and artifacts from the past that have a relevant connection. These are presented and discussed with the designers. As concepts evolve and develop, the history management team provides new sources while designers consult the archives for their own inspiration. Back to the Future

Although Adidas looks to its past, it doesn’t live in it. Adidas is not simply

Leaders need to manage the tensions among what to remember, what to forget, and what to adapt. early 2000s, the company story was documented in an internal publication. In 2009, a history management department was established. Part of its task was to rebuild the archive by buying back shoes and clothes from collectors and asking for donations. Managers were also asked to think about their current work and what they wanted to save and document. The re-created archive currently holds 90,000 items and 10,000 images. Alongside the archive, in 2011, the company published a 600-pluspage history book. Additionally, managers located thousands of

a retro brand reworking old models. Rather, it uses its capabilities alongside insights into consumer behavior to create contemporary and innovative products. Embracing its history doesn’t mean being limited by it. It means being innovative in ways that are in line with the capabilities that were developed from the beginning. Company leaders need to manage the tensions among what to remember, what to forget, and what to adapt. This is not a matter of simple trade-offs, but rather a result of a deep understanding of the nature of the brand. At Adidas, Adi Dassler’s phi-

essay consumer products

name, “Originals,” and a distinctive presentation. As a testament to the success of the approach, Originals is now a $2.8 billion business. All of the shoes selected for updating at the launch of the initiative are still produced today, including the Stan Smith tennis shoe, 60 million pairs of which have been sold.

his continual search for new solutions, and his engineering mind-set remain “a guiding force.” “I think Adi Dassler was always about minimalism, just giving the athlete what he needed,” adds Steve Vincent, a senior vice president of Adidas Future. “And that inspired our Adizero collections, where we’ve taken soccer shoes down to 99 grams, and basketball shoes down to under nine ounces.” The company also extends its way of thinking into its partnerships. Adidas selects partners largely on the basis of their potential for alignment with the values and philosophy of the company. It encourages partners to uncover the essence of the Adidas brand, while pushing them to challenge it. For example, whereas the main Adidas brand is

The company encourages its partners to uncover the essence of the Adidas brand, while pushing them to challenge it. tions, wearing lightweight Adidas shoes with new screw-in studs. At the time, traditional soccer shoes weighed in around 500 grams (or roughly 18 ounces, and about twice that when wet). Dassler observed that in a 90-minute game, on average, a given player’s foot was in contact with the ball for just 90 seconds. So he reengineered soccer shoes to be lighter (only 350 grams, or about 12 ounces) and geared more toward running. Today, the company’s innovation team is guided by this way of thinking. Van Noy says that Dassler’s understanding of materials,

rooted in continuity, mainly because it needs to stay closer to mainstream consumer needs and desires, partners such as Yohji Yamamoto (Y-3) and Stella McCartney can take the brand in more experimental directions, drawing on their premium fashion positioning. Even though Yamamoto resembles Dassler in his interest in craftsmanship and functionality, Y-3 twists the heritage of the Adidas brand and its design language further than Adidas itself does in sports style. Similarly, Stella McCartney extends the idea of Adidas sports performance products through

distinctive cuts and materials. The radical designs of McCartney and Yamamoto open up new audiences and sales channels while also encouraging Adidas’s own designers to be more adventurous. As Steve Vincent says, “That’s the challenge — to do completely disruptive things that no one’s ever seen or expected, but still feel like they should come from this brand.” It’s an important lesson for companies facing rising competition and uncertainty, and wondering how to distinguish their brand. The answer may be hiding in plain sight. Look beneath the surface to uncover the deeper insights that have driven innovative thinking before, and then think about how to integrate them into the company’s strategies. As Dassler himself once wrote, “Come to work every day as if it were the ﬁrst time. This will prevent you being blinded by routine.” The past should be a source of inspiration, not constraint. It should be used selectively when it has the potential to add value. + Reprint No. 00352

Nicholas Ind nicholas.ind@mh.no is an associate professor at Oslo School of Management. Oriol Iglesias oriol.iglesias@esade.edu is an associate professor at ESADE Business School in Barcelona, and director of the ESADE Brand Institute. Majken Schultz ms.ioa@cbs.dk is a professor at Copenhagen Business School. strategy+business issue 80

essay consumer products 30

losophy drives innovation and gives the brand authenticity — which, in turn, inﬂuences employees’ sense of identiﬁcation, the reputation of the business, and consumer choice. As Al Van Noy, a senior vice president of Adidas Future, explained, “I look at this as a modern-day Adi Dassler workshop, living in his spirit and with the vision that he had when he approached innovating for athletes.” Managers have to look outward to better understand customers, but also inward to see how to use technology to create product and service improvements. In Dassler’s era, this approach was embedded in his way of working with athletes and his constant experimentation. For example, in the 1954 soccer World Cup in Switzerland, the West German team won, against all expecta-

Upcoming Programs STRATEGY IN ACTION Closing the Gap Between Strategy and Execution October 29â&#x20AC;&#x201C;30 Apply cutting-edge research and survey data to drive the execution of strategy in your organization.

COMPETITIVE ADVANTAGE Managing Product Platforms: Delivering Variety and Realizing Synergies November 5â&#x20AC;&#x201C;6

The Future of Management Starts Here MIT Sloan Executive Education is committed to developing dynamic executives who can solve the challenges facing their organizationsâ&#x20AC;&#x201D;and the worldâ&#x20AC;&#x201D; through strategic thinking and principled leadership. Our portfolio of 40+ short courses presents leading research, world-renowned faculty, and frameworks that help executives move their organizations into the future. Join a community of global leaders pursuing intellectual, personal, and professional discovery at MIT. FIND THE PROGRAM THATâ&#x20AC;&#x2122;S RIGHT FOR YOU. executive.mit.edu/sb

Learn how to implement a product platform strategy that delivers more variety to your customers and helps your organization stay competitive.

BEHAVIOR CHANGE Neuroscience for Leadership November 10â&#x20AC;&#x201C;11 Explore concepts and techniques derived from brain research and psychology that can improve your leadership behaviors and team performance.

EXTREME PRODUCTIVIT Y Maximizing Your Personal Productivity November 12â&#x20AC;&#x201C;13 Develop techniques for improving your productivity and managing more effectively.

STRATEGIC INNOVATION Strategy and Innovation Executive CertiďŹ cate Further your business knowledge and VNLOOV E\ SXUVXLQJ DQ ([HFXWLYH &HUWLĂ&#x20AC;FDWH RQ D FRQYHQLHQW Ă H[LEOH VFKHGXOH RI \RXU own design.

Staking Your Claim in the Healthcare Gold Rush Revolutionary changes in the delivery, ﬁnancing, and management of healthcare present a choice: Do you want to be a gold miner or a bartender? by Carl Dumont, Sundar Subramanian, and Christoph Dankert

he U.S. healthcare sector, which represents one-sixth of the nation’s US$17 trillion economy, is experiencing a number of simultaneous upheavals. Indeed, it’s difﬁcult to think of another industry of this size that is facing as much disruption and change in the way its services are delivered and ﬁnanced, and even in how it is regarded, in such a short time. The causes are a unique combination of technology and innovation, and of regulation and reform. As it is changing nearly every other business, the revolution in mobile communications and infor-

mation technology is changing the way healthcare is delivered, consumed, and managed. Healthcare information is quickly transitioning from its traditional repository in static, handwritten charts that reside in a doctor’s ofﬁce. It is moving to devices that sit in the palm of the hand while reaching back into the cloud, where patients can access and add to their records at any time. Continuous monitoring through wearable technologies and smartphone apps is creating a wholly novel, totally accessible, 24/7 digitized picture of people’s health. The volume of health and medical app downloads is projected to reach 142 million in 2016, according to Juniper Research. And by 2018,

IDC Health Insights predicts, 65 percent of consumer transactions involving healthcare will make use of a mobile device. At the same time that healthcare data is on the move, healthcare’s locus of delivery is shifting out of the doctor’s office and the hospital and into everyday life, through retail clinics, home-based diagnostics, and telemedicine. Thanks to enhanced connectivity, companies’ capacity to touch patients at every moment of the healthcare journey has never been greater, for both established providers and new entrants. When diagnosis and treatment can move to where the consumer lives and works, and patients’ health can be tracked anywhere in real time, it opens a new frontier in managing health. In a third, related shift, consumers are becoming more influential and empowered. Thanks to several factors — the proliferation of high-deductible plans, the trend of employees paying larger shares of premiums, and the increased number of people purchasing insurance on the federal and state exchanges — consumers are funding a larger portion of their own healthcare. These factors, combined with greater transparency, are pushing healthcare to become more of a consumer good. Historically, patients were caught between providers and payors; providers had incentives to facilitate more care, whereas payors dictated what would be paid for and how much would be paid. Patients had to rely on referrals from primary-care physicians to see specialists. Consumer antagonism reflected the realities: as patients had few care alternatives, had little to no capacity to shop for value, and continually encountered gatekeeping of services. Today, because the system can

Illustration by Lars Leetaru

essay healthcare

HEALTHCARE

lion in spending and $150 billion in proﬁts, according to our models. The shifts will also inspire critical thinking about the business of healthcare. Confronted with the changes, incumbents will have to reconsider their competitive positions. And upstarts and those in adjacent industries will be compelled to assess where — and even whether — they can ﬁt in. Players that thrive in this boomtown will do so by decreasing

to promote a 360-degree, long-term management approach. Dealing primarily with people who are sick, these large institutions — insurers, hospitals, and physicians groups — proﬁt by improving outcomes and sharing in the savings. After all, their strategy is based on the fact that the top 30 percent of utilizers of medical services account for 75 to 80 percent of medical spending. This medical management model surrounds the patient in a system of ongoing data

essay heatlhcare

gather data in real time and in any setting — and can make it transparent to the patient before anyone else — patients may be able to call the shots as to how (and with whom) they manage their health. Finally, these changes are all taking place against the backdrop of a profound shift in the way that medical care is financed, paid for, and regulated. The comprehensive reforms of the Affordable Care Act of 2010, the expansion of Medicaid, and the continuing growth in the Medicare-eligible population means that the federal government is taking on a bigger role as a payor, a setter of rules, and a shaper of markets. That is placing direct pressure on incumbents to change their business models. The emergence of public and private exchanges has led to more direct-to-consumer channels and the goal of creating “customer for life” relationships. Retail alternatives for urgent care have forced traditional providers to improve their customer service and convenience in order to keep patients within their integrated delivery systems. The federal government, flexing its muscle as both payor and regulator, is demanding that reimbursement be determined by quality, outcomes, and evidence-based value — not just the volume of care. And that is driving incumbents from a position of managing utilization to one of managing population health. This combination of technology, business innovation, and reform has led to immense opportunity amid severe challenges. Healthcare’s competition for resources at a new frontier can be analogized to a modern-day gold rush. New markets are creating new profit pools. To an unprecedented degree, healthcare spending is up for grabs — up to $1.5 tril-

To an unprecedented degree, healthcare spending is up for grabs — up to $150 billion in proﬁts. medical spending in a consumeroriented manner, and by capitalizing on newly informed consumer choices by improving outcomes. As companies approach these issues, we think it is useful for them to analogize themselves to one of two professions that thrive in actual gold rush environments: gold miners and bartenders. Gold Miners and Bartenders

In today’s healthcare industry, gold miners and bartenders represent two business models that operate in parallel. They have different time horizons for success. Gold miners. These vertically integrated players take ownership of healthcare. They proﬁt by mining value out of a resource — for example, by managing the health of a speciﬁc population, such as patients with diabetes, heart disease, or cancer. The gold miner strategy is closely aligned with population health management, which takes a deep understanding of chronic care

monitoring, analytics, and outreach by care providers. In a successful gold miner strategy, care expands into the patient’s world, shifting to timelier, more convenient, and less costly settings. Population health management extends the traditional commandand-control view of clinical decision making. Patients are empowered by the transparency of daily data, but care coordination is still physician-driven. Gold miners prosper by harnessing technology to develop new processes that let them conduct established business more efﬁciently and effectively. In healthcare, one of the key imperatives is to bolster the system — and outcomes — by containing medical spending on a given pool of patients. Population health management strategies, which are delivered via primary care and other care-coordination activities, are likely to become more widely adopted. Research already shows that the chronically ill, who

awareness of their health status and risks, enabling them to direct their own care and manage healthcare ﬁnances, and helping them adhere to treatment plans and goals. Margins shift into either consumer savings or retail revenues. Bartenders often hail from nontraditional sectors such as retail, software, electronics, and apparel. Examples include the drugstore chain Walgreens, which now operates a network of immediate-care clinics; Theranos, a Silicon Valley

such as the AliveCor EKG attachment, that turn the patient’s smartphone into an EKG machine. In a gold miner scenario, during the primary-care ofﬁce visit or after an electronic health record review, the patient is enrolled in a preventive cardiology program. A clinician prescribes a smartphone EKG app like AliveCor, and the results are similarly transparent, which helps motivate compliance. But the decisions involving data interpretation, diagnosis, and action plan

Bartenders profit by providing a service, by offering advice and information, and by managing customer experiences. startup that offers cheap, pinprick blood testing; and developers of fitness trackers such as Fitbit. The home health and wearables market is expected to reach nearly $160 billion in sales in North America by 2023, according to the Centers for Medicare & Medicaid Services, when margins of 15 percent will yield $35 billion in profit. Coexistence and Competition

Just as was the case in gold rush towns, gold miners and bartenders generally complement each other. Rather than offer a stark either–or choice, these typologies help provide a framework for understanding how to design business models to compete in the evolving market. Let’s take an example. Imagine a patient is troubled by inconsistent heart palpitations, which do not have the courtesy to show up at an annual visit. But there are devices,

design are made centrally by a clinical team. The team closely monitors the patient’s daily progress and adherence to the treatment plan, which reduces the potential for a critical-care episode. Follow-up might include app-generated texts or outreach from a nurse or social worker, perhaps through video calls, depending on the patient’s preferences and needs. Delivery of care shifts out of healthcare settings, upending the traditional revenue-generating sequence of appointments and tests. The healthcare manager proﬁts by avoiding the incidence of an expensive surgery or visit to the emergency room. In a bartender scenario, by contrast, this EKG app is marketed directly to the consumer. He or she makes daily recordings and uses the app’s many easy-to-understand options for how to interpret the data — it could be sent to a doctor, or

strategy+business issue 80

essay healthcare 34

often make health decisions on a daily basis, experience improved outcomes when connected to their provider via remote monitoring and other channels of communication. By using such tactics with its diabetic population, Geisinger Health System, a large, integrated provider in rural Pennsylvania, achieved an 18 percent reduction in admission rates, a 31 percent reduction in readmission rates, and a total cumulative savings of 7 percent. Bartenders. These players take a fundamentally different approach from that of gold miners. Bartenders proﬁt by providing a service, by offering advice and information, and by managing customer experiences and relationships. They serve healthcare consumers by offering customized and convenient options to address routine or everyday needs. Bartenders often have a narrow focus, providing speciﬁc services to rapidly growing niches. They prosper by selling goods and services with a margin. Unlike gold miners, whose primary innovation often lies in developing new processes, bartenders innovate with new products, and with marketing and design. Although a bartender company may also serve the chronically ill, its intent is not to preserve the existing patient–doctor relationship but to run parallel to it or to nibble away at it. Their consumer contact can be both physical and virtual, on a scale from big-box urgent-care clinics to apps that track blood-sugar levels. Like a gold miner, a bartender may use mobile health applications to capture an individual’s vital signs and lifestyle data. But its role is more advisor and service provider than director and manager. Consumers are responsive; they recognize the value of quick answers that provide better

Blurred Lines

It may seem that gold miners have little to fear from the bartenders’ capture of the mostly healthy consumer. But technological advances will keep pushing the boundaries of consumer options and the generation of health intelligence outside traditional settings and relationships. Walgreens’s immediate-care clinics have partnered with Theranos to greatly expand the diagnostics available in those locations. Device and analytics ﬁrms such as WellDoc and BlueStar use mobile self-management programs to monitor blood sugar and offer coaching to diabetic patients, resulting in signiﬁcantly fewer hospital visits and improved blood-glucose levels. A more informed consumer experience will prompt healthier choices and smarter testing. As a result, nearly $200 billion may be saved by shift-

ing care from hospital-based inpatient and outpatient settings (gold miners) to retail clinics, including those at big-box stores and pharmacies (bartenders). Indeed, patients who subscribe to bartender offerings will profoundly challenge providers to demonstrate their value in new ways: Patients who own and can interpret their own data will enter every healthcare encounter armed with meaningful, personalized expertise (not just a few pages printed from the Internet). They may even choose to crowdsource their diagnosis in a forum such as CrowdMed. When expertise becomes tailored to the individual and broadly accessible, providers must add value to the patient encounter through relationship building and a more profound understanding of their patients’ needs. This task is complicated by electron-

Exhibit: Ways to Play The new frontier of healthcare is encouraging innovation in business models. Here are some ways gold miners and bartenders are approaching the market.

BARTENDERS

GOLD MINERS

WAY TO PLAY

DESCRIPTION

EXAMPLES

ACO/Value-Based Contract Enabler

Engages in or provides solutions that track health outcomes and motivate population management and shared savings

Banner Health Network, Aetna

Population Health Enabler

Services and technology platforms for providers and employers to manage population health and wellness

Conifer, Truven

Integrated Delivery System

Delivers primary and secondary care through owned and integrated assets

Kaiser Permanente, Geisinger

Primary-Care Clinic-Based Delivery

Delivers primary care through owned or highly integrated clinics or other facilities

CareMore

Bundled Care

Offers care payment or delivery model to encourage reduced costs and increase quality outcomes for discrete bundles

Cleveland Clinic

Care Optimizer/Standardizer

Provides solutions that standardize and optimize clinical practice using research and analytics

XG Health Solutions

Customer Targeting

Uses insights about consumer preferences to design and optimize health and wellness outreach and programs

Silverlink, Redbrick Health

Wearables/Health Apps

Collects consumer health data for apps and programs that assess health and inform changes in behavior or care

Sentrian, MyFitnessPal, Fitbit, Apple Watch

Mobile/Personal Dx

Low-cost diagnostics and smartphone-enabled tools that empower consumers to be more involved in their diagnosis

CellScope, Theranos

Patient Community

Digital forums that connect patients, allowing an exchange of experiences, insights, and support

PatientsLikeMe, Smart Patient

Retail Solutions

Care (e.g., retail clinics) and coverage (e.g., in-store agents) services offered in retail settings

Walmart, Walgreens, emerging “urgent care” chains

Telemedicine

Remote medical care delivered through mobile devices by text, email, or video call

Teladoc, American Well

Source: Strategy&

essay heatlhcare

to a software vendor’s experts, or to a computer for analysis. The app also logs exercise, sleep, diet, and medications. As data accumulates, an algorithm might find a correlation between the taking of certain prescription drugs and heart palpitations, or it could flag potential symptoms of congestive heart failure; the app suggests next steps. In this scenario, the consumer has the prime decision-making role. Wait and see? Return to the physician or find another expert? Track other suggested symptoms? Going forward, the app offers a range of interventions, including text alerts reminding patients of diet and medication schedules or notifying a specified contact of emergent conditions. Every consumer choice represents a potential revenue stream that is up for grabs between incumbents and new players.

Which Strategy?

In the eyes of the consumer, the population health management (gold miner) approach and the consumer-focused (bartender) approach may initially look very similar. But they offer distinctly different views of where decision making resides. And they will compete for customers along those lines. Both industry incumbents and newcomers are likely to test-drive elements of each approach (see exhibit, page 35). IDC Health Insights estimates that 70 percent of healthcare organizations will offer some combination of wearables and virtual healthcare by 2018. Providers without risk-sharing arrangements as well as primary-care population health managers may offer a robust assortment of retail and virtual services in order to “own” the patient across various life stages. Large employers — especially those that self-insure — may experiment with gold miner activities to lower costs or address health issues speciﬁc to their employees. Generally speaking, new entrants such as consumer product and software companies will probably have an advantage in bartender strategies, because they possess both expertise in product development and freedom from established industry relationships, allowing them to design a consumer-focused healthcare experience. Large integrated healthcare systems will have a natural afﬁnity

for the gold miner strategy. Payor and provider partnerships are best positioned to move to risk-sharing proﬁt pools and develop a delivery of care model that encompasses the home, particularly given the growth of accountable care organizations (ACOs) and Medicare’s outcomesbased reimbursement efforts. Unlike previous risk-sharing HMO models, the new gold miner models will give primary-care physicians the tools they need to orchestrate comprehensive care for both better medical outcomes and improved cost management. Perhaps more strategically signiﬁcant, adopting elements of a gold miner

of their own health statistics and a way to translate that data into meaning and action. For gold miners, success is contingent upon developing a medical model that optimizes care and the ability to track changes in medical spending and value. This includes making investments in business capabilities, such as: UÊ / iÊ« ÞÃ V> ÊV>«>V ÌÞÊÌ ÊV ordinate care across home, primarycare, and specialty care settings; e.g., training social workers to conduct the follow-up required for high-risk patients. UÊ 6 ÀÌÕ> Ê V>«>L Ì iÃÊ Ì >ÌÊ V> Ê provide consumers with the right

What consumers need is reliable and secure tracking of their own health statistics and a way to translate that data into meaning. strategy will allow providers to keep pace with the federal government’s increasing emphasis on value, as expressed by continued Medicare/ Medicaid rate cuts, public audits of rate increases, and medical loss ratio regulation for payors. The Path to Success

To prosper, both gold miners and bartenders will have to make signiﬁcant investments in mobile health and analytics. Data capture and interpretation needs to be speciﬁc to the customer and able to identify relevant trends across multiple symptoms, both pre- and post-diagnosis. Consumers already have access to general healthcare information via the Internet. What they need is reliable and secure tracking

tools to motivate their adherence to treatment plans. Gold miners may be better served by incorporating brand name software/hardware than by building their own tools. Successful bartenders will cut through the wealth of options by designing products and services that compete with the best of consumer experiences. Ideally, components of their offering will include: UÊ Û `i Vi L>Ãi`Ê > > ÞÌ VÃÊ that combine with the patient’s preference for risk, and that are then translated into easy-to-understand, personalized care directives. UÊ ÊLÀ `}iÊvÀ Ê«À Û ` }Ê`>Ì>Ê and intelligence in the early stages of the patient’s journey to connecting patients seamlessly with specialty care as their needs intensify.

strategy+business issue 80

essay healthcare

ic health records. Why? Although they have improved the overall standard of care, they also decrease the need for conversational interaction — which tends to drain the patient– physician encounter of some of its depth and richness.

The gold rush, which has the potential to fundamentally shift profit pools in the industry by changing where intelligence is gathered and expertise is delivered, is already under way. Sitting out isn’t an option for anyone. Given the potential for industry destabilization, every player’s existing profit pools are at risk. If you’re a hospital or specialist, collaborating with primary-care physicians or payors may be essential to long-term survival, as gold miner strategies reduce the use of intensive care settings. Payors need to facilitate population health platforms or face the risk of being disintermediated by providers that take on risk through ACOs. Providers cannot rest on their incumbency, even if their incentives don’t favor population management. New entrants (particularly in medical analytics) and certain payors will carve out manageable chronic care populations, leaving the provider with only the most expensive and dire cases. The gold rush promises fortunes, but it is a fluid environment. Already, we’re detecting the presence of a third set of players. Socalled railroad pioneers build the infrastructure that binds bartenders and gold miners together, construct the platforms on which the new solutions stand, and develop services and technologies that eliminate bottlenecks and help systems run more smoothly. Examples include Citigroup’s Money2 for Health, a payment processing system, and Epic Systems, which builds health data management systems. Tech startups, consumer firms, and innovative health systems all have the chance to strike rich veins in this new frontier, where healthcare is more con-

tinuous and less episodic; where it is more tailored and less one-size-ﬁtsall; and where analysis and decision making are shared among consumers, clinicians, and artiﬁcial intelligence. The future will be more virtual and yet intensely personal and close to home. But a hundred staked claims mean nothing if one of them doesn’t hit it big. Success will require, more than ever, clarity about who you are as a company. Decide how you want to approach the market. Then, set about staking out your investments in a focused way using your preferred business model, forging new collaborations, and reshaping the value chain of healthcare. Rewards will abound for those that are brave enough to strike out for new territory. +

Carl Dumont carl.dumont@strategyand.pwc.com is a managing director in the health and technology practices of Strategy&, part of the PwC network, where he focuses on business transformation through innovative strategy and technology enablement. He is based in New York. Sundar Subramanian sundar.subramanian@strategyand.pwc.com is a principal in the health and operations practices of Strategy&, where he works with healthcare clients on designing transformative business models and operational improvement programs and leads the Medicare/Medicaid Center of Excellence. He is based in New York.

37 Christoph Dankert christoph.dankert@strategyand.pwc.com is a director in the health and technology practices at Strategy&, where he drives the ﬁrm’s thinking on new business models in the healthcare industry and helps payors improve the operational efﬁciency of their current businesses. He is based in New York.

Reprint No. 00353

WhiteWalls

Magnetic Whiteboard Steel Wall Panels

These whiteboard walls give you and your team an unlimited blank slate that encourages original ideas and fosters out of the box solutions. WhiteWalls.com

essay heatlhcare

Place Your Bets

800 624 4154

feature strategy & leadership

The only sustainable way to capture new opportunities is to remain true to what your company does best.

Illustration by Robert Samuel Hanson

by Gerald Adolph and Kim David Greenwood

Growth is the ultimate test of business vitality, yet questions about it haunt business leaders. How much will we grow this year, and beyond? How much growth do we need? What kind of growth do we need? How should we balance revenue growth against margin improvement? How far aﬁeld from our current business should we look for new customers? Once we know where we want to be, how do we get there? The best recipe for sustained, proﬁtable growth is simple in its basic concept. It requires a capabilities-driven approach — making the most of what you already do well — that goes well beyond traditional market-back approaches, which try to deliver whatever the outside world seems to need.

feature strategy & leadership

Grow from Your Strengths

feature strategy & leadership 40

Kim David Greenwood kim.david.greenwood@ us.pwc.com is a director with Strategy& and co-leads its growth strategy team. Based in San Francisco, he works extensively with technology, communications, hospitality, consumer product, and industrial companies.

It is also devilishly difficult in its details, because it assumes you will use any means at your disposal to achieve your goal. There need be no trade-off between current markets and adjacent markets, or between organic methods (such as marketing and innovation) and inorganic methods (such as mergers and acquisitions). You can and should blend all of these, ideally in a dynamic and fast-paced way, as long as they are aligned with the proficiency and advantages you already have. Thus, before you pursue growth directly, you should have in place the three elements of a clearly defined, coherent strategy: (1) a value proposition that resonates with customers, supported by (2) a system of distinctive capabilities, combined in a way that competitors can’t match, with (3) a portfolio of products and services that are all aligned to the first two elements. You must also be able to deliver on that value proposition, translating concept into competitive position with a viable, sustainable business model that generates profits and cash flow. You can grow profitably and sustainably only from a position of strength. If your enterprise is struggling to maintain its economic lifelines, then foundational work on strategy, organization, cost optimization, or other factors is needed before any new growth strategy can succeed. Companies that enter new businesses to escape a weak position generally become weaker still, because they move into markets where they lack the capabilities needed to succeed. Typewriter maker Smith Corona, for example, understood the needs of students and self-employed typists better than anyone else; this helped the company develop a successful line of word-processing computers in the 1980s. But the company couldn’t sustain that

business, because its efforts to expand into office supply distribution, kitchen appliances, daisy-wheel printers, and paints had left it without the resources to compete against other types of personal computers. Blockbuster Video sought to protect itself from disruption in the early 2000s by buying Circuit City — an effort to create synergy from two weakened businesses without a clear logic for creating value together. Let’s say you have that position of strength to start from: a capabilities-driven strategy and the wherewithal to exploit it. From there, you can chart a course toward sustainable and profitable expansion by combining four approaches to growth: 1. In-market leverage: seeking out new growth opportunities among your existing customers in your core market as currently defined. 2. Near-market expansion: pursuing opportunities in unfamiliar sectors or with new products. This approach is also known as expansion through adjacencies. 3. Disruptive growth: responding to dramatic change with entirely new business models and capabilities if and as appropriate. Though important at times, this is rarer than many businesspeople think and should be undertaken only if you have a clear idea of how to link your existing capabilities system to the new one you will need. 4. Capability development: building distinctive organizational proficiency in a way that supports the other three forms of growth. This can be accomplished through a variety of means, including M&A, innovation, and operations improvements. All four of these topics may seem familiar; they have been discussed over the years at most companies. But the linkages among them are often overlooked. By

strategy+business issue 80

Gerald Adolph gerald.adolph@ strategyand.pwc.com is a senior leader in Strategy&, PwC’s strategy consulting group. Based in New York, he specializes in growth strategy. He was formerly the senior partner leading the mergers and acquisitions practice at Booz & Company.

strengthening those linkages, your company can enter into a cycle of ongoing self-renewal. Most companies exhibiting consistent long-term growth — Amazon, Apple, Danaher, Disney, General Electric, Hyundai, Nike, Novo Nordisk, Oracle, Starbucks, and Walmart among them — have followed and continue to follow this path. Headroom for Growth

Near-Market Opportunities

When companies think about growth, they often start by looking for “adjacencies” (new nearby markets to enter) that stand out primarily for their market potential. But by rushing to the most seemingly attractive opportunities — the places with hot new technologies or burgeoning consumer populations — they risk diversifying past the point of no return, just as Blockbuster and Smith Corona did. But those high-growth oppor-

feature strategy & leadership

Companies frequently overlook the growth opportunities that are right in front of them. Sometimes they are tempted by attractive-looking opportunities in other markets, or lured by the idea of diversification into other businesses. Sometimes, they simply haven’t spent enough time trying to imagine how their approach in an existing market could be changed to unlock additional growth. The answer lies in finding headroom: potential new business in an existing market. The headroom for in-market leverage is the customer revenue a company could have beyond its current business, minus that which it is unlikely to get. For example, some fast-food restaurant chains have increased their revenues by selling premium coffee, espresso, and other specialty drinks to their regular breakfast or lunch customers, rather than ceding that business to Starbucks or Dunkin’ Donuts. Their headroom is the total potential premium coffee drink sales, minus the revenue from people who are unlikely to switch to them. Meanwhile, coffee retailers have added more meals to build headroom at the expense of the fast-food chains. Two food and drink businesses that were originally very different have thus evolved into competitors. Similarly, some cable and telecommunications companies are finding headroom in their current customer base. They are shifting from being TV or telephone service providers to becoming comprehensive sources of digital, information, and value-added services (by offering home control systems, for example). Their investments in broadband lines, stretching into customers’ homes and offices, and their monthly interactions with a broad consumer base (developed over years of being regulated monopolies) give them a platform for this in-market leverage that is very hard for other companies to compete with. To be sure, these new businesses require strong capabilities in customer acquisition and service, in an industry that has often been accused of ignoring consumer complaints. But some cable and telecom providers, such as AT&T, Verizon, and Cox Communications, are now developing these capabilities to help them enter new lines of business.

Determining the size of your headroom in existing markets is a three-step process. First, find gaps between what other companies in the market offer and what customers need, and devise a way to close those “needs– offer” gaps with new or better offers. Second, identify the factors (such as features, incentives, or messaging) that would lead customers to switch to your new product or service. Finally, redeploy, leverage, and improve your capabilities — or, in some cases, add new ones — to close the gap and propel your customers to switch. Needs–offer gaps can be found in any market. Enormous opportunities for in-market leverage are often hiding in plain sight, accessible to those who can look with fresh eyes at existing customers. One large pharmaceutical company expanded sales by identifying patients who were not taking their medications as frequently as prescribed, and then encouraging them to do so. Video game producers sell additional apps or special in-game bonuses to customers already playing their games. Manufacturers have successfully targeted customers who want more quality at an affordable price (such as those who seek out reviews of more durable appliances), or who want access to features currently available only to top-tier customers (such as smartphone purchasers seeking better-quality built-in cameras). Regional banks have offered customers access to credit with more engagement than global financial institutions could offer. The levers available to close a needs–offer gap include adding or redeploying capabilities. For example, in retail, making incremental improvements in assortment and packaging, increasing access via a new distribution channel, or simply upgrading the customer experience in a way that outpaces competitors’ offerings. Amazon’s Prime membership is a good example. It doesn’t change any of the products Amazon sells, but it offers free two-day shipping on all purchases in return for an annual fixed fee, further leveraging Amazon’s distinctive supply chain capabilities.

Capability boundaries also often arise when companies seek geographic expansion. For example, consumer product and retail companies moving from Europe or the U.S. to emerging markets such as India must adapt to radically different requirements and build new types of relationships. Retailers may have to modify store formats, assortments, logistics approaches, and brand positioning for local markets — sometimes to the point where their capabilities system may not easily stretch to accommodate distant locations or cultures, and still take advantage of the same value propositions and capabilities systems that make them successful at home. In general, you should cross capability boundaries consciously and cautiously. The secret to successful near-market expansion is balancing creativity in how you extend your capabilities with a judicious view of when you are overstretching. Companies that use traditional adjacency definitions or ignore capability boundaries can easily find themselves in an adjacency trap. One famous example involved Sears Roebuck’s acquisition of the brokerage house Dean Witter Reynolds in 1981. This proved that customers didn’t necessarily want to “buy their stocks where they buy their socks,” as one critic put it. In some industries, companies are choosing to cross capability boundaries to survive. For example, as shown in Exhibit 1 (next page), convergence among the computer, telecommunications, and entertainment industries is forcing companies to expand their business definitions. Each company carves out its own path: Thus, Google and Netflix are moving from their established software businesses to generate digital television content, whereas other companies such as Apple and Microsoft have resisted the temptation to cross that capability boundary. Disruption vs. Evolution

A casual look at the business media would suggest that disruption is everywhere, but disruption has become one of the most overused words in the business lexicon. Too often, a rapid, innovative evolutionary change in an industry is confused with disruption. Knowing the difference has signiﬁcant implications for your growth strategy, capabilities system, and business model. Most industries evolve continuously, through technological change, business model innovation, and improvements in everyday practices. Evolution affects companies and their customers — lowering costs, creating new needs–offer gaps, and enhancing products or customer experiences. Even breakthrough innovations,

strategy+business issue 80

feature strategy & leadership 42

tunities have probably risen up in response to another company’s successful capabilities play, which will be very hard for another company to compete against. A better approach is to look for opportunities where you can leverage your own distinctive capabilities, find new customers for your existing products or services, or apply your strengths to new offerings. Begin with a thorough assessment of your own capabilities and their relevance for near-market opportunities. A capability is relevant because either it creates a distinctive economic advantage, such as eliminating costs, or it creates a customer-acquisition advantage, helping you capture prospective purchasers. If you don’t see that direct relevance, be cautious. Some apparent advantages, such as the ability to offer customers a single bundled source for purchases used together, won’t necessarily create real synergies. Summer barbecues may involve the purchase of grills, food, and charcoal briquettes or propane, but it’s hard to imagine a manufacturer in one of these sectors expanding successfully to the others, because of the disparate capabilities required for them. In your assessment, give yourself credit for nonobvious strengths that will help you grow. For example, you may have overlooked capabilities you can apply in your operations infrastructure — your sales force, financial back office, or IT system — or your customer insights and logistics network. American Express had exactly this type of asset in its loyalty program, which it originally built to enhance its core business, and then extended into a platform that enabled other companies to offer similar services. When you seek growth in near markets, be wary of stretching your capabilities system so far that the linkage breaks, and your current business model doesn’t apply the way you hoped it would. Leading companies in the chemicals industry, for example, traditionally expanded by leveraging the production system they already had in place. This reduced the costs of both product streams. However, this approach led commodity chemicals companies to enter specialty businesses, whose customers demanded custom manufacturing, hands-on service, and rapid-response design that they couldn’t easily deliver. They had crossed a capability boundary, as we call it, in which the old capabilities no longer provided economic or customer acquisition advantages. As a result, over time the industry has specialized, evolving away from multicompetency conglomerates. Some companies returned to commodities while others migrated to a focus on agricultural products or specialty chemicals.

Exhibit 1: Capability Boundaries in Technology These companies in the converging technology and telecommunications industries have used their capabilities to expand to new businesses. Shown in black are the capability boundaries that couldn’t be crossed without major investment. Connectivity and Transport

Hardware (Business and Consumer)

Apple

AT&T Comcast Dell Google

Microsoft

Original Business Model (”Historical Core”)

Source: Strategy&

Content Aggregation and Distribution

Content Production

Netflix KEY

Software Support (Business and and Services Consumer)

Subsequent Business Entry

Capability Boundary

novations in pharmaceuticals since the 1980s, enabling life science companies to develop entirely new kinds of genetically engineered drugs for treating diseases such as diabetes and cancer. However valuable these innovations have been, they simply provide another way of introducing molecules into the established regulatory, commercial, selling, support, and reimbursement systems. No major changes in the business models or capabilities systems have been required, at least so far. (Personalized medicines may turn out to be more disruptive.) In agricultural chemicals, however, biotech has been disruptive. The advent of genetically modiﬁed plant cells completely changed the roles that seeds and chemicals played throughout the industry’s value chain. Companies that provided genomics had to extend themselves upstream, downstream, and horizontally. Companies that provided agricultural chemicals had to integrate upstream into seeds, and to combine or partner with downstream companies in the processing and delivery chain. In some cases, agricultural companies had to create new brands at the end-user level to capture the value of their innovations. Companies can respond to evolution and even stepchange innovation by improving, and in some cases by adding to, their capabilities systems. But to respond to a true disruption, companies often need to intentionally cross capability boundaries, adding entirely new capabilities to survive. The Lowe’s hardware chain did this successfully in the 1990s. Traditionally, Lowe’s sold construction materials, mainly to professional homebuilders, through small, full-service outlets. In 1982, Home Depot introduced a disruptive new business model — “big box” stores in a home improvement center format. These outlets were much larger than Lowe’s

feature strategy & leadership

which deliver a step change in costs and beneﬁts but do not require fundamental changes in capabilities systems, are not necessarily disruptions. True industry disruptions are rare. They happen when a technological or business model innovation thoroughly changes or obliterates existing business models and their associated capabilities systems. Disruptions create situations in which every company has to reexamine its capability boundaries, or risk losing its livelihood. In the music business, the introduction of the compact disc in the early 1980s was a breakthrough innovation that led widespread evolutionary changes throughout the industry. But it was not disruption; it did not fundamentally change the prevalent talent development, promotion, and physical distribution–based business model. Most of the companies that were prominent before the compact disc held on to their positions and practices after it was introduced. The introduction of digital music ﬁles in the mid1990s, on the other hand, was disruptive. (See “The Portable Music Saga,” next page.) It utterly changed business models, capabilities systems, and supplier–buyer relationships throughout the industry. Internet-enabled innovations have driven many similar disruptions, in businesses as varied as book retailing, journalism, and on-demand dispatch and use of taxis and limousines. The impact of biotechnology on pharmaceuticals and agricultural chemicals is another good example of the difference between evolutionary and disruptive innovation. Advances in biotech have provided major in-

Sony faltered in the late 1990s,

With these innovations, Apple ﬁlled a needs–offer gap that few

when its capabilities system, based

other companies saw: It provided a

on consumer devices, was upended.

reliable, standardized system that

n-market, near-market, and

The shift to digital music ﬁle formats,

made purchasing, keeping, and

disruptive growth opportunities

such as MP3, required capabilities in

listening to music relatively easy. By

often happen in the same market

computers and software. Download-

2008, Apple had claimed nearly 50

over time. One of the most compelling

able music ﬁles had a clear advan-

percent of the market for music play-

examples is the market for portable

tage over compact discs in conve-

ers. Its nearest competitor’s share

recorded music and sound over the

nience, selection, and price. By 2001

was in the single digits. Adding video,

past 50 years.

there were 50 different portable MP3

games, publishing, and lifestyle apps,

players for sale on the U.S. market.

along with the iPhone, represented

dawn of rock-and-roll music, when

None of them, however, quite ﬁt the

a series of natural in-market growth

teenagers desperately wanted music

bill. Device interfaces were kludgy,

moves. For the next ﬁve years, Apple

that they could take with them to their

downloading and managing music

had a virtual lock on its customers;

rooms and to parties. They carted

ﬁles could be haphazard and difﬁcult,

they were unwilling to switch be-

around portable record players and

and online platforms could be quirky

cause of the compelling nature of the

boxes of vinyl 45 or 33 RPM discs.

and unreliable. Some were downright

company’s seamless offering.

When the cost of the transistor fell

sketchy (remember Napster?).

It started in the 1950s at the

feature strategy & leadership 44

discs supplanted cassettes.

in the mid-1950s, Texas Instruments

Enter Apple. This was one of the

Since 2013, however, a new needs–offer gap has been identi-

and Sony capitalized on this needs–

very few companies with capabilities

ﬁed: Streaming media is even more

offer gap by offering radios that

in user-friendly product and interface

convenient and less expensive than

could be easily carried and mounted

design, technological integration,

downloads. The online radio service

in automobiles. This manufactured

stylish fashion-forward market-

Pandora was the ﬁrst to ﬁll this gap,

product also helped build the market

ing, and the coordination of creative

and others are rushing to compete:

for recorded music, in the form of

media (which, along with Steve Jobs’s

Amazon with a near-market move,

vinyl record albums that people could

personal star power and friendships

and Spotify and Netﬂix as new en-

play at home.

with musicians, helped it negotiate

trants. Apple pursued an in-market

with record labels in the extremely

move with its Apple Music service, in-

insular music industry).

troduced in 2015. Apple Music builds

But recorded music and the convenience of portability did not exist in a single package, and thus a further

Apple was thus well positioned

on the acquisition of Beats, a startup

needs–offer gap existed. In 1979,

to make a dramatically successful

founded by music industry veterans,

Sony showed that it had found a cycle

near-market move; the iPod hit the

which improved Apple’s capabilities

of continuous renewal when it ﬁlled

market in 2001, at ﬁrst for Macintosh

for curating and enhancing audio and

that gap with the introduction of the

users only, and was soon outselling

video content. This new needs–offer

Walkman, a compact device for play-

its competitors. The company didn’t

gap is still only partly understood,

ing cassette tapes through miniatur-

stop there: It pursued headroom

and it’s not clear which companies

ized headphones. This dramatic new

within that territory, by opening the

will be favored. But it is likely that

play for headroom led the category

iTunes online music store, enabling

the headroom is not yet exhausted

for many years. Sony’s capabilities in

consumers to buy and manage digital

and further needs–offer gaps will be

designing and marketing small radios

music simply and reliably and sync-

discovered in the audio–video market

served it extremely well in the world

ing with Windows-based computers

as technology continues to evolve.

of small audio, even after compact

as well as its own.

strategy+business issue 80

The Portable Music Saga

If you respond to disruption by changing your business model and capabilities system, you can’t dabble. You have to commit fully.

The “poor prospects” lack distinctive capabilities and apparent opportunities, and thus are in a weak position. If you are in this group, your only path to organic growth success — assuming your business survives — is to do foundational work on strategy and execution. Focus on improving your core capabilities systems and value propositions. Only then can you consider either in-market or near-market growth strategies. If you are in the “capabilities-challenged” group, you have ample headroom for growth, but your capabilities aren’t a good ﬁt for the opportunities. This can happen when a company lets its performance drift, or

A Cycle of Continuous Renewal Exhibit 2: Starting Points for Growth Your capabilities fit (how well your capabilities match your opportunities) and the headroom available for growth in your markets characterize your company’s growth challenges. Large

CapabilitiesChallenged

Growth Leaders Refine investment in capabilities, seek market leadership

Headroom

Reimagine your business model

Poor Prospects Perform basic work on strategy and execution

HeadroomChallenged Reimagine your business

Limited

The goal of a growth strategy is to create continuous renewal so that your top-line revenue increases steadily. As we’ve seen, you need a single viable strategy combining in-market and near-market growth, backed up by the right group of capabilities. In-market growth converts your capabilities into increased wallet share, providing returns that fuel investment. Near-market growth makes the most of the investment by using your capabilities more broadly. Capabilities development makes both kinds of growth more successful. Success in each of these areas reinforces success in the others, and the cycle continues to accelerate as long as you stay in practice. But where to begin? That depends on where you are right now. The possibilities are best visualized as a matrix, in which the horizontal axis represents the distinctiveness of your capabilities system and its relative ﬁt with the opportunities you have or wish to create, and the vertical axis represents the headroom for growth in your current markets. Most companies ﬁt squarely into one of the four resulting quadrants (see Exhibit 2).

feature strategy & leadership

stores (90,000 square feet versus 15,000) and had much lower operating costs, mainly thanks to labor savings from scale and self-service. Lowe’s struggled to compete for nearly 10 years. Then in 1992, Lowe’s converted its own stores to the new home improvement format and became a strong, successful competitor. If you respond to disruption by changing your business model and capabilities system, as Lowe’s did, you can’t dabble. You have to commit fully to a new business model, and build the necessary capabilities as soon and as thoroughly as possible.

Incoherent

Source: Strategy&

Capabilities fit

Coherent

you can manage these dynamics — how skilled you become at seeing potential for growth, and building capabilities to realize that potential. Successful companies avoid getting stuck in the “headroom-challenged” category, or drifting into “poor prospects” territory, by continuously renewing their capabilities. You can build or expand some capabilities through organic methods such as innovation and marketing, you can “borrow” other capabilities through alliances with other enterprises, and you can buy still other capabilities through mergers and acquisitions. Sustainable Growth in Practice

One way to ensure this cycle of continuous renewal is through capabilities chaining: developing new capabilities that complement your existing ones, so that you can use all of this proﬁciency to enter a new line of business. For example, to expand from the photography industry to healthcare, Fujiﬁlm is using its existing capabilities in material science, engineering, and quality manu-

Exhibit 3: The Cycle of Continuous Renewal

Large

Repeated movement around this cycle keeps successful businesses from stagnating. As its capabilities mature, a company may temporarily lose its status as a growth leader, but can regain it through deliberate moves in near-market expansion and redeploying or enhancing its capabilities.

Redeploy or enhance capabilities

Find or create new near markets

Growth Leaders

Manage natural evolution

HeadroomChallenged

Incoherent

Source: Strategy&

Capabilities fit

Coherent

strategy+business issue 80

Headroom

CapabilitiesChallenged

Limited

feature strategy & leadership 46

when its market changes, creating new upsides that require different capabilities. Your growth challenge is adding or enhancing capabilities to capture your available headroom, not chasing unrelated markets. Other companies are “headroom-challenged.” They are successful in their markets as currently defined, but have little upside: Growth prospects are leveling off. If you are in this group, start looking for previously unnoticed opportunities for in-market growth, and leverage or improve your distinctive capabilities to exploit them. Alternatively, seek near-market opportunities by redefining or reimagining your business. A hardware or software supplier may redefine itself as a solutions provider (many tech companies have done this). A searchengine company can become an information management company, as Google has. A food company can recast itself as a nutrition company (consider Nestlé). Redefining your business puts you in the “capabilitieschallenged” group, where new skills will be required, and risk may increase — but so will opportunities. As your capabilities systems improve in response to their deployment in your new near-market expansion, you will move into the “growth leaders” category. If you are already among the fortunate companies in that quadrant, the key to sustained, profitable growth is a balanced mix of all the levers we have discussed, tailored to your company’s needs and culture. Continue to mine in-market opportunities, to use your insights and talent to capture valid adjacencies, and to reimagine your capabilities as necessary. From time to time, you’ll hit ceilings to your headroom and need to expand into new markets or build new capabilities. You may even face genuine disruption. Then you’ll move around the cycle again — identifying new headroom for growth that represents a good potential fit, developing the distinctive capabilities you need, and returning to your position as a growth leader (see Exhibit 3). Sustainable growth requires building this type of continuous renewal cycle. Your pace around the cycle may be set by the clock speed of your industry: Technology firms cycle more quickly than chemicals companies. But no matter how fast or slow your industry, your potential for continuous growth depends on how well

Sustainable growth requires building a continuous renewal cycle. Your pace around the cycle may be set by the clock speed of your industry.

such as acquisitions, are not actually a form of growth. They are capability

realize that potential. Thus the most successful

acquisition tools. An M&A deal does

acquirers are those that acquire

not automatically expand a com-

with a capabilities mind-set. They

ergers and acquisitions are

pany’s customer base or revenue

outperform those who are not

so closely associated with

stream beyond what the two merged

capabilities-driven by more than

expansion that the term inorganic

companies previously had available

14 percentage points in total share-

growth is frequently used to refer to

to them. It may increase potential

holder returns. (See “Deals That

such deals. But this terminology can

for growth, but the company still has

Win,” by J. Neely, John Jullens,

be misleading. Inorganic methods,

to put its new capabilities to use to

and Joerg Krings, page 50.)

facturing. To complement these, it bought two firms involved in regenerative medicine research: Cellular Dynamics International (based in the U.S.) and Japan’s Tissue Engineering Corporation (J-TEC). In March 2015, Fujifilm chairman and CEO Shigetaka Komori told the Japanese newspaper Nikkei, “If we combine the three companies’ technologies [those of Fujifilm, J-TEC, and Cellular Dynamics], they can be put to use in a variety of…applications, such as tissue and organ regeneration…. We’re aiming to become the world’s top regenerative medicine company.” When you create your own prospective capability chain map, draw pragmatic linkages between what you do well now and the opportunities you see ahead. The map shows what capabilities are needed for each new step, and identifies ways to take that step successfully. The art of growth is balancing and sequencing all the levers we have discussed: in-market leverage, nearmarket expansion, and capability development; organic tools, alliances, and mergers and acquisitions. Capabilities chaining brings your innovation and inorganic

options together into one coherent make-versus-buy framework. As an example, we have mapped the growth of some of General Electric, which has used capabilities chaining in this way since the 1950s (see Exhibit 4, next page). You seek an approach tailored to your company, combining insight and creativity with pragmatism and execution. And whenever you become too settled and secure, you look for new headroom and begin the cycle all over again. Cintas Corporation, which provides uniforms and specialized services to companies, is an example of a highly successful company that has created this type of continuous growth cycle. Cintas began in the Great Depression as an industrial laundry that reclaimed and cleaned rags for local factories around Cincinnati. The company later began renting towels to customers, replacing them or repairing them as needed. Over time, Cintas created a distinctive set of capabilities and its own business model — “The Cintas Way” — combining excellence in plant operations, a highly reﬁned logistics capability, and service innovation with customer

feature strategy & leadership

What about M&A?

The art of continuous growth involves reconciling activities that only seem to contradict one another.

Exhibit 4: Capabilities Chaining at GE, 1950–2010

feature strategy & leadership

Since the 1950s, General Electric has continuously grown through capabilities chaining. Each link shown below from one business to the next represents an enlargement of a previous capability: augmenting technology, deploying operations or distribution, or expanding to new markets or customer groups.

Irons and Ranges

Steam Turbines

Incandescent Lamps and Dynamos

Vacuum Tubes

Major Appliances

Consumer Financing

Gas Turbines

Military Jet Engines

Radio Transmitters

Consumer Credit

Consumer Products and Services Commercial Jet Engines Aerospace and Guidance Systems

Radar and Sonar X-Ray Equipment

Asset-Based Lending

Nuclear Imaging

Medical Diagnostics

Source: GE publications, Strategy& analysis

Exhibit 5: Capabilities Chaining at Cintas, 1950–2015 Each link shown below represents a step to a new business from existing capabilities, using market expansion (customers), operations (logistics), or technology to do so. In the “rollups,” Cintas acquired smaller businesses and merged them into a single enterprise, integrating the incoming capabilities and using them to enter new markets. Uniform Design and Manufacture Industrial Towels Laundry and Rental

Industrial Rags, Laundry

Uniform Sales

Floor Mat Laundry and Rental

Service Items (mops, soap, tissue, etc.)

Facility Services

Customers Logistics Technology Rollups

Divested

Source: Cintas publications, Strategy& analysis

First Aid Supplies Management

Health & Safety Products and Training

Fire Protection Services Secure Document Destruction

Document Storage

strategy+business issue 80

Uniform Rental

strong and consistent ﬁnancial performance over the decades, and enabled the company to successfully weather the post-2008 downturn. Today, Cintas is one of the largest business services suppliers in North America; it employs 30,000 people, serves more than 900,000 customers, and maintains 430 facilities, including six manufacturing plants and nine distribution centers. Companies that have struggled to grow consistently tend to think about growth in terms of contradictions: sticking with their current markets versus moving into new ones; leveraging versus enhancing their capabilities; growing their current business versus expanding via M&A; “staying true to themselves” versus leaving their corporate identity behind — but these are all false choices. The art of continuous growth involves reconciling activities that only seem to contradict one another. Combining them will yield a capabilities-driven strategy that will generate continuous growth. + Reprint No. 00354

feature strategy & leadership

knowledge and sales and service networks. The company has grown steadily through an integrated evolutionary approach. Cintas’s cycle of continuous growth included three major approaches to expansion (see Exhibit 5). 1. In-market leverage. Growth accelerated as the company pursued in-market opportunities, first renting (as well as laundering, repairing, and replacing) uniforms for factory workers, and then additionally offering uniforms for front-office personnel and specialty items such as flame-resistant garments for specific needs. At the same time, Cintas worked with manufacturers to develop new materials that would be resistant to staining, that would stand up to repeated washing and need little ironing, and that would provide protection as well as style. 2. Near-market expansion. Cintas enters new markets and geographies by cautiously testing whether its core business model will prosper before committing to those opportunities. The company has leveraged its capabilities system by adding other clearly linked services, including renting and cleaning floor mats; providing washroom supplies; and managing, cleaning, providing, and servicing first-aid kits and fire extinguishers. The company moved into adjacent businesses by offering services to existing customers such as employee safety training, and by expanding its customer base to include companies in other industries such as hotels and airlines. 3. Capability development. Cintas was also able to realize when it had reached the limits of its capabilities system. After entering and building a successful document storage and imaging business to offer additional services to customers, the company figured out that this new business was driven as much by commodity prices and real estate as by Cintas’s own strengths in logistics, services, and operations. In 2014, Cintas sold this business. Finally, Cintas has used mergers and acquisitions to access and test new capabilities and new services, and expanded by rolling up smaller companies in similar businesses, where the company could further leverage its capabilities. This cycle of continuous growth has given Cintas

Resources Deniz Caglar, Jaya Pandrangi, and John Plansky, “Is Your Company Fit for Growth?” s+b, Summer 2012: How to move out of the “poor prospects” category and find the resources you need. Ken Favaro, David Meer, and Samrat Sharma, “Creating an Organic Growth Machine,” Harvard Business Review, May 2012: How to develop an eye for headroom. Scott Foster, “Asia on the Move,” Strategic News Service, June 15, 2015: Source on Fujifilm’s expansion into healthcare. Paul Leinwand and Cesare Mainardi, “The Coherence Premium,” Harvard Business Review, June 2010: The benefits and basics of a capabilities-driven strategy. Bertrand Shelton, Thomas Hansson, and Nick Hodson, “Format Invasions: Surviving Business’s Least Understood Competitive Upheavals,” s+b, Fall 2005: Ahead of its time, this article showed how to grow by anticipating disruption. John Sviokla, “How Old Industries Become Young Again,” s+b, Autumn 2014: The difference between industry evolution and disruption. More thought leadership on this topic: strategy-business.com/strategy_and_leadership

feature strategy & leadership

Deals That Win By J. Neely, John Jullens, and Joerg Krings

Illustration by Adam McCauley

In May 2015, industrial conglomerate Danaher agreed to

buy the Pall Corporation, a maker of biopharmaceutical and medical products, for US$14 billion. Although it was far from the biggest deal of 2015 — plenty have dwarfed it — Danaher– Pall attracted a lot of attention from those who work in corporate mergers and acquisitions. The deal is intriguing for two reasons. First, Danaher announced it would split into two companies after the transaction, one focused on manufacturing and the other on life sciences and diagnostics, each company possessing a unique capabilities system. Second, this was the largest transaction ever completed by this highly active, highly competent acquirer. Danaher has made more than 400 acquisitions over the last 30 years, and a startlingly high percentage of them have worked out well.

feature strategy & leadership

Twelve years of data shows that mergers and acquisitions that apply or enhance capabilities produce superior returns.

feature strategy & leadership 52

John Jullens john.jullens@ strategyand.pwc.com is the emerging markets leader for the capabilitiesdriven strategy platform at Strategy&. He is based in Detroit.

Danaher’s success in M&A stems from the fact that it knows its area of greatest strength — an approach to continuous operational improvement known as the Danaher Business System — and concentrates on targets that can beneﬁt from it. Put another way, Danaher is a capabilities-driven acquirer that leverages its capabilities across its many acquisitions. And as it turns out, focusing on targets that leverage one’s capabilities provides the greatest chance of M&A success, not just for Danaher but for any big company at just about any point in time. This is the main lesson that emerges from Strategy&’s most recent study on the role of capabilities in M&A success. When we examined 540 major global deals in nine industries announced between 2001 and 2012, we found that deals that leveraged the buyer’s key capabilities or helped it acquire new ones produced signiﬁcantly better results, on average, than local stock market indexes in the two years following the deal. And they produced better results than deals done with other Exhibit 1: Many Happy Returns Capabilities-driven deals produced significantly better returns than deals driven by other rationales. Return to Shareholders Compared with Local Market Index Percentage points

5.4

4.4 2.6

Leverage Deals

Enhancement Deals

CapabilitiesDriven Deals 14.2 (Leverage or Enhancement) –9.8 Limited-Fit Deals

Note: Based on two-year annualized total shareholder returns. Source: Strategy&

Joerg Krings joerg.krings@ strategyand.pwc.com is a leader with Strategy& based in Munich. He heads the ﬁrm’s business efforts in the automotive industry as well as European M&A strategy.

rationales in mind. The overall premium for capabilities-driven deals above other types of deals was a 14.2 percentage point compound annual growth rate (see Exhibit 1) — even higher than the first time we did the study, in 2012, when we analyzed transactions that took place between 2001 and 2009. This year’s study was also more comprehensive, and included hundreds of deals that weren’t in the original study. (See Methodology, page 59.) Although only about half of the individual deals we studied helped the acquirers beat the local market index, the success rate of deals done with clear capabilities rationales was considerably higher; more than six in 10 capabilities-driven deals earned a premium. By contrast, only one-third of deals not taking account of capabilities (“limited-fit” deals, in our vernacular) showed returns that were above the local market index. The companies that were the most successful acquirers over the period of our study, such as Walt Disney Company and Abbott Laboratories, seem to implicitly understand the importance of taking a capabilitiesdriven approach to M&A, and focusing on building scale around their capabilities systems — that is, the three to six things they do uniquely well to create value for customers. These companies may not always describe their M&A activities using capabilities terminology, but their transactions nonetheless reflect a calculated awareness of what they already do — or could do — extraordinarily well. In our schema of M&A, deals fall into three categories: leverage, enhancement, and limited fit. Leverage deals are situations in which acquirers buy companies that they know or believe will be a good fit for their current capabilities system; for instance, a big pharma

strategy+business issue 80

J. Neely j.neely@strategyand.pwc.com is a leader with Strategy&, PwC’s strategy consulting group, and is based in Cleveland. He is a leader of the ﬁrm’s deals platform and is part of the consumer and retail practice.

a consolidator also offers signiﬁcant

No matter what the intention,

appeal, as does gaining access to a

however, deals typically do better

geographic market that seems like a

if they have clear capabilities

natural extension.

rationales.

ften the main thing that com-

Exhibit: Intentional Moves

panies focus on in deciding

Among capabilities-driven deals, those done as part of consolidation efforts produced the best returns.

whether to do a deal is the intention of the deal. As shown in this chart,

Number of Deals by Intention, as a Percentage of All Deals

Return Relative to Local Market Index (percentage pts.) LEVERAGE

there is still a lot of appeal in buy-

ENHANCEMENT

LIMITED FIT

ing something that is adjacent from

41%

Product/Category Adjacency

4.5

0.5

–7.4

a product or category perspective,

31%

Consolidation

7.9

12.1

–13.1

according to an analysis of the 540

17%

deals reviewed by Strategy&. Being

Geographic Adjacency

1.6

4.2

–8.9

Capability Access

6.1

2.0

–17.3

Diversification

2.1

–28.2

–4.6

Note: Based on two-year annualized total shareholder returns. Percentages do not total 100 due to rounding. Source: Strategy&

company buys a smaller competitor in order to extend its marketing capabilities in a therapeutic area both companies serve. Enhancement deals are designed to bring the acquirer capabilities it doesn’t yet have and that will allow it to intensify its own capabilities system. Limited-ﬁt deals occur when the acquirer largely ignores capabilities; the transaction doesn’t improve upon or apply the acquiring company’s capabilities system in any major way. (Deals also fall into categories based on their original goals; see “What Are Your Intentions?”) Enhancement deals are inherently more complex than leverage deals. But when they work, they can deliver outsized returns for the acquirer. Think of Google’s 2006 acquisition of YouTube. The $1.6 billion transaction for

the nascent video-sharing platform was far and away Google’s biggest at the time and propelled the searchengine company into uncharted territory. But nearly a decade later, with YouTube reaching more than a billion users per month and having a mindshare in online video not unlike the one its parent company has in search, few would question the thinking behind the deal. Indeed, information technology was a sector in which enhancement deals led to even higher returns than leverage deals over the period of our study (see Exhibit 2, next page). Our study has yielded further insights on the performance of different types of deals and ways in which companies can succeed as they choose their approaches.

feature strategy & leadership

What Are Your Intentions?

Enhanced Returns

fits manager like Caremark, which specialized in mailorder fulfillment and worked with big organizations, including corporations. The vertical-integration gambit paid off: Two years after the 2006 deal was announced, CVS’s shareholders had seen a 12 percentage point premium in annualized total shareholder return (TSR) versus the S&P 500. That premium has become even bigger; CVS’s shares have risen at a rate more than four times that of the S&P 500 since 2008, and have outperformed the shares of the company’s nonintegrated competitors (Walgreens, Rite Aid, and Express Scripts) by even more. In the IT sector, successful enhancement deals included Micron Technology’s purchase of Elpida Memory in 2012. The U.S. company purchased Japan-based Elpida to add expertise and manufacturing capacity in the area of mobile memory chips. The deal has been hugely successful, helping Micron to a two-year annualized TSR performance that was 129 percentage points higher than the S&P 500. (Enhancement deals are among the highest-return deals happening now in Asia; see “Enhancement Deals in Asia-Pacific: Outsized Returns.”) If anything, we think our study, which looked at only the biggest deals, may understate the incidence of enhancement deals and overstate their risks. A lot of en-

Exhibit 2: Powerful Leverage The superior performance of capabilities-driven deals can be seen across industries. Return to Shareholders Relative to Local Market Index Percentage points

LEVERAGE ENHANCEMENT LIMITED FIT

10 0 –10 –20

Retail

Consumer Staples

Industrials

Chemicals

Healthcare

Elec. & Gas Utilities

Note: Average returns based on annualized return on the buying company, two years after announcement of the deal, compared to the relevant local market index — either total shareholder return or, in the case of companies that do not pay dividends, simple stock price compared to the performance of a relevant index for the buying company. Source: Capital IQ, Strategy& analysis

Media

Financials

strategy+business issue 80

feature strategy & leadership 54

Although they again represented a relatively small part of our study sample, enhancement deals showed the most improvement in the 2015 over the 2012 study, outperforming the market by 2.6 percentage points on average. In our 2012 study, enhancement deals beat the market by half of a percentage point. Enhancement deals, which companies make to acquire a capability that allows them to augment their system of capabilities, are especially common in industries facing major technological or regulatory shifts. During the period covered by our study, healthcare companies — especially U.S. healthcare companies facing intensifying competition and regulatory changes — did the most enhancement deals (23 out of our sample of 60), followed by information technology companies, with 16. The media sector was another big originator of enhancement deals, doing 14 of them. Traditional newspaper and television companies are facing enormous challenges to their advertising and customer franchises because of the Internet and mobile computing. The $25 billion acquisition by drugstore chain CVS of Caremark Rx is one example of a successful, very large enhancement deal in healthcare. CVS bet that it would be able to cover the prescription drug market more effectively if it owned a pharmacy bene-

countries — having a long way to go

tier, as it might be called, so buying

in their capabilities development. An

Western companies can go a long way

industrial company in the U.S. might

toward bringing them to parity. This

not be able to improve its operations

march toward the capabilities frontier

or its marketing expertise very much

was a major factor in the acquisition

by buying a company in Europe. But

of German company Putzmeister, a

for a company in China, Indonesia,

maker of high-tech industrial pumps,

Malaysia, or Thailand, buying a

by Sany Heavy Industry, China’s big-

rom a geographic perspective,

smaller European company could

gest construction company, in 2012.

Asian companies obtained the

work to its beneﬁt for precisely these

Other prominent interregional deals

best results by far of any region in our

reasons. Chinese ﬁrms have been

in recent years, such as the acquisi-

study when it came to enhancement

particularly active buyers in recent

tion by India’s Tata Motors of Jaguar

deals. The annual total shareholder

years, snapping up midsized Euro-

Land Rover in 2008, the acquisition

returns for enhancement deals in

pean ﬁrms that are still reeling from

by China’s Geely of Volvo in 2010, and

Asia-Paciﬁc were a whopping 26

the 2008 ﬁnancial crisis but that have

the stake that China’s Dongfeng Mo-

percentage points higher, on average,

an abundance of advanced technol-

tor Corporation took in PSA Peugeot

than those for limited-ﬁt deals.

ogy and engineering talent.

Citroen in 2014, likewise have big ele-

This is a result of companies in

Companies in these still-devel-

the Asia-Paciﬁc region — and in par-

oping parts of Asia are nowhere close

ticular, in the region’s still-developing

to the international capabilities fron-

hancement deals between 2001 and 2012 likely fell under the radar — meaning that they were too small to be included in this study. But some of the most active and successful acquirers of the past 15 years — for example, U.S. insurer UnitedHealth Group, British brewer SABMiller, and French electricity distributor Schneider Electric — have done multiple small deals to enhance their capabilities. Capabilities-driven companies know how to alternate between leverage and enhancement deals to achieve their growth objectives. In this respect, it may

ments of capabilities enhancement.

be necessary to make a special effort to communicate a deal’s rationale to Wall Street, because of the unique postmerger integration skills required for a successful enhancement deal. Success in this category relies less on quickly identifying and capturing synergies, and more on taking the time to ﬁnd ways to manage cultural differences, retain essential people, and help those people’s ideas take root in the broader organization. (See “Why Don’t Enhancement Deals Do Better?” next page, for an additional look at the challenges surrounding these deals.)

feature strategy & leadership

Enhancement Deals in AsiaPaciﬁc: Outsized Returns

Enhancement Deals

Leverage Deals

Limited-Fit Deals

Number of enhancement deals in study: 119 (22% of all deals tracked)

Number of leverage deals in study: 223 (41% of all deals tracked)

Number of limited-ﬁt deals in study: 198 (37% of all deals tracked)

Proportion that earned a premium vs. local market index: 61%

Proportion that earned a premium vs. local market index: 64%

Proportion that earned a premium vs. local market index: 33%

Best enhancement deal*: Micron Technology’s acquisition of Elpida Memory (2012)

Best leverage deal: Lionsgate Entertainment’s acquisition of Summit Entertainment (2012)

Best limited-ﬁt deal: R.J. Reynolds Tobacco’s acquisition of Brown & Williamson Tobacco (2003)

Two-year annualized TSR premium relative to local market index: 79 percentage points

Two-year annualized TSR premium relative to local market index: 42 percentage points

feature strategy & leadership 56

Why Don’t Enhancement Deals Do Better?

multiples generally, but the negative

Exhibit: The Multiple Discount

impact is greater when the acquirer is

The change in multiple reflects the pricing in of current results, future expectation, and broader market conditions.

taking on new capabilities. The downward multiple adjustment may reﬂect the fact that these deals are more

Change in Multiple of Two-Year Post-Close Returns (percentage points)

complex and difﬁcult to carry off suc-

Leverage Deals

Enhancement Deals

hy don’t they perform as well

cessfully. In any event, the difference

–0.9

–3.4

as leverage deals? From a

suggests that those doing enhance-

TSR perspective, the biggest differ-

ment deals should be vigilant not only

ence (two years after a deal’s close)

in integrating their new pieces but

is the price-to-earnings multiple

also in making sure that everyone —

of the acquirer. Strategy&’s study

including the investment community

shows that doing deals takes a toll on

— understands the end goal.

Leveraging Up

Leverage deals are the most common type of capabilities-driven deal. In any given period, it isn’t surprising for the number of big leverage deals to be twice that of big enhancement deals. In the period covered by our study, leverage deals were also the most consistently successful deal type, earning 5.4 percentage points more than the local market on a compound annual basis and earning a premium over limited-ﬁt deals of about 15 percentage points. One of the better leverage deals in our study, the 2011 acquisition by SABMiller of Foster’s Group, was a European–Australian acquisition. SABMiller, a U.K.based global brewer, saw an opportunity to improve Foster’s performance, which was hampered by Foster’s having a split portfolio — beer and wine — and the distractions that that produced. (Foster’s spun off its wine business shortly before the deal with SABMiller

Source: Capital IQ, Strategy& analysis

was completed.) The deal produced an annualized twoyear TSR premium of 17 percentage points above the relevant market index. Another successful leverage deal involving a Western buyer (premium: 41 percentage points) was in the industrials sector, when Hertz Global Holdings snapped up Dollar Thrifty to increase its presence at airports and strengthen its offerings in the mid-tier car-rental segment. By their nature, leverage deals make the most sense when companies that already have advantaged capabilities can integrate products and services into their sophisticated, well-functioning systems. Chemicals, ﬁnancialservices, and consumer staples companies were among the most apt to complete big leverage deals in the period covered by our study; retailers got the highest returns on such deals. Leverage deals done in the developed world tend to have better returns than leverage deals done in developing regions (for example, Asia-Paciﬁc) because

strategy+business issue 80

Two-year annualized TSR premium relative to local market index: 129 percentage points

*Best is deﬁned as having the highest two-year annualized TSR relative to local market index.

Capabilities-driven companies know how to alternate between leverage and enhancement deals to achieve their growth objectives.

Limited-Fit Deals

Theoretically, we don’t have many positive things to say about deals that don’t begin with a capabilities rationale. The evidence suggests these deals usually lead to negative returns (compared to local market indexes), as happened in two-thirds of the limited-fit deals in our study. This finding holds across geographies and industries. There is also a fine line between a bad enhancement deal and a limited-fit deal. If an acquirer has miscalculated, some deals conceived of as adding important new capabilities to the acquirers’ systems in place can end up looking like limited-fit deals. That said, some industries had a slightly better track record than others with limited-fit deals over the period of our study. Electric and gas utilities was the

only sector to eke out a positive return with limited-fit deals. Chemicals companies did second best, and entered into fewer of these deals than any other industry save healthcare. Limited-fit deals can work when they have a lot of consolidative potential — that is, when there is overlap between the acquirer and the target, and a chance to drive synergies in areas such as procurement, or to remove a significant amount of cost. That was certainly the case with R.J. Reynolds Tobacco’s purchase of Brown & Williamson Tobacco more than a decade ago. The deal (which produced a two-year premium of 42 percentage points annually versus the S&P 500) allowed R.J. Reynolds to consolidate redundant HQ, sales operations, and manufacturing operations and generate in excess of $600 million in annual savings. Successful limited-fit deals often don’t have much to recommend them in terms of a capabilities rationale, but they serve as a reminder that in business, execution sometimes trumps strategy. Staying Flexible

The companies that seem to be most capabilities-driven in their deal making don’t stick to one deal type all the time. They may switch between leverage deals and enhancement deals depending on how much growth they think they can achieve in their existing markets and with their current capabilities systems. For instance, Disney — which has certainly had success as an acquirer — has strategically toggled back and forth between leverage and enhancement deals in the past 15 years (see Exhibit 3, next page). Its acquisition of Pixar (announced in 2006) was an enhancement deal: It gave Disney depth in the area of computer-

feature strategy & leadership

many of the developing-world companies need to deﬁne their capabilities systems. (The number of big leverage deals done by Latin American, African, and Middle East companies over the period of our study was too small to allow for meaningful comparisons.) One exception to the theme of Western dominance of leverage deals was the acquisition of Malaysia’s Titan Chemicals Corporation by South Korea’s Honam Petrochemical. The deal, struck in 2010, expanded Honam’s portfolio of ethylene- and propylene-related products and gave Honam a deeper presence in the developing markets of Asia. But as a South Korean company, Honam (which in 2013 merged with another South Korean ﬁrm, KP Chemical, to form Lotte Chemical Corporation) has more in common with Western companies than it does with developing-market companies. The high return it got on the Titan deal is therefore somewhat less surprising.

Besides sharpening the vision of prospective buyers, a capabilities lens can help a company ﬁgure out what doesn’t ﬁt — and what it should divest.

Exhibit 3: Magic Kingdom Disney has had great success with deals that enhance and leverage its capabilities.

feature strategy & leadership

$120

Disney Stock Price, in US$ Oct. 30, 2012

$100 Jan. 26, 2006

ANNOUNCED: July 24, 2001

$80

$60

LucasFilm

Aug. 31, 2009

Pixar DEAL TYPE: Enhancement BENEFIT: Fills a gap in Disney’s ability to create computer-generated animation

Fox Family Worldwide DEAL TYPE: Leverage BENEFIT: Another cable station for Disney’s family-oriented programming

Marvel Entertainment DEAL TYPE: Leverage BENEFIT: Monetizes Marvel’s characters using Disney’s various entertainment platforms

DEAL TYPE: Enhancement BENEFIT: Provides access to cutting-edge visual effects technologies

$40

$20

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Source: Capital IQ, Strategy& analysis

generated animation, where Disney wasn’t strong. By contrast, its acquisition of Marvel Entertainment (announced in 2009) was a leverage deal that gave Disney a new cast of iconic characters to push through its ﬁlm and television channels and to incorporate at its theme parks. In 2012 Disney undertook another enhancement deal, buying LucasFilm not just for its Star Wars franchise but for the smaller company’s leading-edge animation and visual effects technologies. With a company as large as Disney, it’s sometimes hard to pinpoint the impact of a relatively small acquisition (each of these deals represented less than 10 percent of Disney’s enterprise value at the time it was announced) compared with the impact of other management decisions and actions. But Disney’s deals have helped redeﬁne and strengthen the company, whose

stock outperformed market indexes in the two years after these three deals were announced and, as of this writing, is trading close to an all-time high. Besides sharpening the vision of prospective buyers, a capabilities lens can help a company figure out what doesn’t fit — and what it should therefore divest. The theory behind capabilities-driven divesting is simple: Get rid of the assets that don’t mesh with what you do best. These assets, which may be profitable, still distract companies from getting the most out of their capabilities systems. Ultimately, the assets that are clearly a good fit for the capabilities you have should get more funding so they can reach their potential. General Electric’s announcement in early 2015 that it would sell off GE Capital, its long-standing finance unit, reflects what is essentially a capabilities-driven ap-

strategy+business issue 80

Methodology

plus dividends — in the two years

ments, external press coverage, and

after the acquisition was announced.

SEC ﬁlings. For the capabilities-ﬁt

ur study looked at the 60 big-

We then compared that with the TSR

classiﬁcation, we ultimately relied on

gest global deals by transac-

compound annual growth rate of

our judgment, our analysis, and our

tion value announced between 2001

the large-cap index in the acquir-

experience with these companies to

and 2012 in each of nine target indus-

ing company’s home country. (The

determine whether the deals fun-

tries: chemicals, consumer staples,

benchmark indexes we used include

damentally leveraged, enhanced, or

electric and gas utilities, ﬁnancial

the S&P 500 in the U.S., the FTSE 100

ignored the acquirer’s capabilities.

services, healthcare, industrials,

in the U.K., the CAC 40 in France, the

information technology, media, and

DAX in Germany, and the KOSPI Index

multiple goals; for example, they

retail. The biggest deal captured by

in Asia.) If the company didn’t pay

were intended to both leverage and

our ﬁlter was Pﬁzer’s $79.6 billion

dividends, the TSR was equivalent to

enhance capabilities. We slotted

purchase of Wyeth in 2001; the small-

the change in the company’s share

those deals into the single main cat-

est was John Fairfax Holdings’ $492

price.

egory that we believed they ﬁt best.

million purchase of Trade Me Group in 2006.

One part of the research

Some deals appeared to have

The sample group of 540 com-

requires some judgment: the clas-

panies for this year’s study included 252 deals that were in our last study

especially the deals’ ﬁt from a capa-

on the topic, published in 2012. Two

ing company’s annualized total share-

bilities perspective. To help with this,

hundred and eighty-eight other deals

holder return (TSR) — stock price

we examined corporate announce-

were new to this study.

To measure the performance of

proach to divesting. In GE’s case, that doesn’t mean that it lacks the capabilities necessary for success in the areas of lending and credit. Rather, it means that maintaining these capabilities in light of intensifying regulatory scrutiny takes focus away from its core engineering-based capabilities. And in fact, every company’s thinking about which of its capabilities are indispensable, and which aren’t, should evolve in response to market changes and should be reﬂected in its M&A strategy. On the day in May 2015 that Danaher announced its acquisition of Pall, its executives held a conference call with Wall Street analysts to discuss the deal, and to explain their decision, once the deal was done, to split Danaher into two companies. The company’s structure would change, but its fundamental approach would remain the same. The executives assured investors that both companies — the healthcare-focused company that will still be called Danaher and the as-yetunnamed company that will focus on industrial products — will continue to rely on a zealous application of the Danaher Business System to create value for customers and returns for shareholders. As for the split itself, separate companies will allow for the establishment of two distinct capabilities systems. Danaher’s executives said the primary reason for the split was to give greater visibility into some exist-

ing businesses that have not had much access to merger capital. It turns out that Danaher has no intention of backing off from its use of inorganic growth tactics even after it becomes two companies. Given how well it has done with M&A so far, no one would expect it to. +

feature strategy & leadership

siﬁcation of deals’ intentions, and

these 540 deals, we took the acquir-

Reprint No. 00346

Resources Gerald Adolph, Cesare Mainardi, and J. Neely, “The Capabilities Premium in M&A,” s+b, Spring 2012: The original study on this theme showed that deals made to enhance or leverage the things that companies do well consistently outperform other deals. Ken Favaro, “How IKEA, Disney, and Berkshire Hathaway Succeed with Adjacencies,” s+b, Mar. 11, 2014: Many adjacency moves fail because they’re driven by the wrong motives. Cesare Mainardi, “Becoming a Capable Company,” s+b, Apr. 29, 2014: Advantage is transient, but corporate identity is slow to change. Figure out that paradox, and your company will be primed for success. Gregg Nahass, “Deals That Transform Companies,” s+b, Summer 2014: How to shift your business model with M&A integration. More thought leadership on this topic: strategy-business.com/strategy_and_leadership

feature strategy & leadership

20 Questions for Business Leaders The entire history of management ideas can be seen as a series of answers to a few pragmatic queries.

by Art Kleiner and Nancy Nichols

feature strategy & leadership

Whether we’re conscious of it or not, every management decision is motivated by a desire to find universal answers to very specific questions. People who succeed in organizations tend to be pragmatic problem solvers. They have to be, because of the myriad challenges they face. How to grow the enterprise. How to get work done. How to find customers. How to be themselves in the workplace. And so on. Because there are no easy answers to these complex problems, they test the answers by starting a company, launching a project, or making a move. As they succeed and fail, the most attentive of them learn from the results. The history of business is thus the story of entrepreneurs, executives, leaders, and employees, lurching from one experimental answer to another. They gain expertise and acumen, and profits and revenues, and, along the way, add to the theory of management.

Art Kleiner kleiner_art @strategy-business.com is editor-in-chief of strategy+business

feature strategy & leadership 62

Nancy Nichols nancy@greatideasstudio.com is a former senior editor of the Harvard Business Review and founder of the Great Ideas Studio.

For the 20th anniversary of strategy+ business, we, the editors and staff of this magazine thought we’d celebrate this grand story of management thinking by holding, in effect, a grand party. We’d invite all the luminaries of management thought, from antiquity to today, to join us in spirit. Or at least to have their ideas in the room. And you’re invited too. This catalog will give you an initial taste of the result: a browsable, everincreasing compilation of management ideas, recast and reframed as we think only s+b can do it. We could fit only a small portion of it in print, of course. The rest of the catalog, in its evolving complexity, can be found online at strategy-business.com/ managementhistory. It’s a kind of genealogy chart of management ideas, showing their sources, their influences, and a little bit about how they are put into practice. We started this catalog with a simple but grandiose idea: We’d celebrate our magazine’s history by tracking the most influential business ideas throughout history. We invited some of the most insightful business historians and observers we know to a workshop. Participants came prepared with lists of what they considered the milestones of management history.

We spent the day posting ideas on a conference room wall, grouping them, and trying to get to the heart of each with an incisive phrase or reference. We ended up with about 400 entries, more or less organized by theme. Then we reﬁned them to the version you see here. We found that each group of ideas could be fairly well summed up in a single question and there happened to be about 20 of them — 20 questions for 20 years of s+b, a heartening coincidence. Of course, this catalog of management thinking isn’t the last word. There never will be a last word with practical philosophy; there is always more coming, because the problems are never fully solved. But that means there will always be another chapter, another issue. As we mark our 80th issue, we hope strategy+business will continue to be one of the primary places to ﬁnd that next great management idea, and understand what it could mean for you and your organization.

How do we win?

Stake out a competitive position. Michael Porter Competitive Strategy (1980), and “What Is Strategy?” Harvard Business Review, 1996

What will help us make smarter decisions?

What do we know about change?

Watch out for megatrends.

Best practices

Systems change “Improve in nonlinear constantly and ways. forever” with Jay Forrester quality, lean, “The Prophet of and kaizen. Unintended

In the 1920s, Harvard Business School introduced the case study. Since then, companies systematically seek to learn from their competitors.

Large-scale changes in demographics, economics, urbanization, resources, and technology shape our world. “When Megatrends Collide,” s+b, 2014

SWOT (strengths, weaknesses, opportunities, threats) analysis

Cynthia Montgomery s+b Thought Leader interview, 2013

Anticipate black swans.

Developed in 1960, still in use in Silicon Valley in 2015

Consequences,” s+b, 2005

Cesare Mainardi and Paul Leinwand The Essential Advantage (2011), and Strategy That Works (forthcoming, 2016)

Imagine multiple scenarios. Explore several possible futures to raise your awareness of the present. Pierre Wack, “The Man Who Saw the Future,” s+b, 2003

W. Edwards Deming (quoted), Taiichi Ohno, James Womack, and many more “Seeing Your Company as a System,” s+b, 2010

Only the paranoid survive. Execute, execute, execute. Intel chief executive Andy Grove, 1996

Larry Bossidy and Ram Charan s+b Thought Leader interviews, 2002 and 2004

Nassim Nicholas Taleb, 2007

Close the gap between strategy and execution.

What’s the best way to do the work?

feature strategy & leadership

Keep asking “Why does the world need this company?”

How do we prepare for uncertainty?

Game theory Barry Nalebuff “The Game Maven of New Haven,” s+b, 2007

Your culture is your ally. Jon R. Katzenbach “Stop Blaming Your Culture,” s+b, 2011, and “The Critical Few,” s+b, 2015

Harness tacit knowledge by making it explicit. Ikujiro Nonaka and Hirotashi Takeuchi “The Practical Wisdom of Ikujiro Nonaka,” s+b, 2008

How can I possibly get everything done?

What systems should we use to track how we’re doing?

What’s our ideal organizational design?

How shall we grow?

You won’t. Get used to it.

Return on investment and related metrics

A federalist shamrock organization

Move into adjacencies.

John J. Raskob and Donaldson Brown at Dupont and GM “Resurrecting a Forgotten Capitalist,” s+b, 2013

Charles Handy “The Paradox of Charles Handy,” s+b, 2003

feature strategy & leadership

Henry Mintzberg “The Manager’s Job: Folklore and Fact,” HBR, 1975

Fit for purpose.

David Allen “The Productivity Promisers,” s+b, 2007

Robert Kaplan 1987

“Urbanites never complained of being busy until the end of the 19th century, when the telegram and the railroad crowded their lives with acquaintances.” Adam Gopnik, “Bumping into Mr. Ravioli,” New Yorker, 2002

“Doing business with the world’s 4 W. Chan Kim and Renée billion poorest Mauborgne people will Blue Ocean Strategy (2005) require radical Seek headroom. innovations Ken Favaro, David Meer, in technology and Samrat Sharma and business “Creating an Organic Growth Machine,” models.” HBR, 2012

Gary Neilson and the Organizational DNA team “How to Design a Winning Company,” s+b, 2013

Activitybased costing and Make lists. the balanced scorecard Platforms open to Know fewer the world people. Ingrained awareness at large instead of numbers

Haier CEO Zhang Ruimin s+b Thought Leader interview, 2014

N. Thomas Johnson “What Are the Measures That Matter?” s+b, 2002

What do we know about global expansion?

Use your capabilities. Gerald Adolph “Grow from Your Strengths,” s+b, 2015

C.K. Prahalad, Stuart Hart “The Fortune at the Bottom of the Pyramid,” s+b, 2002

The world is semi-globalized. Pankaj Ghemawat Redeﬁning Global Strategy (2007), and s+b Thought Leader interview, 2008

Emerging markets evolve in predictable ways. Ron Haddock and Alfonso Martinez “The Flatbread Factor,” s+b, 2007

What’s the best way to innovate?

Give them what they really want and need, whether or not it’s in your business category.

Disrupt your own business.

Ted Levitt “Marketing Myopia,” HBR, 1960

Segment with sophistication Daniel Yankelovich “New Criteria for Market Segmentation,” HBR, 1964, and s+b Thought Leader interview, 2005

Clayton Christensen The Innovator’s Dilemma (1997) and s+b Thought Leader interview, 2001

Thomas Davenport Competing on Analytics (2007), and “The ABCs of Analytics,” s+b, 2013

What is honorable?

How can we fulﬁll our potential?

Respect and empower them.

Charging others as we would have them charge us

Get another person’s perspective on your progress.

St. Thomas Aquinas Summa Theologica, 1265–73

Marshall Goldsmith “Leadership Is a Contact Sport,” s+b, 2004

“Mary Parker Follett: Prophet of Management,” s+b, 1996

Sprint and scrum. Zope Corporation and other agile software developers “Warfare, Software, and Industrial Design,” s+b, 2014

Align innovation to strategy.

Use analytics to gain in-depth awareness of your customers.

What do we do for our employees?

Barry Jaruzelski et al. “Proven Paths to Innovation Success,” s+b, 2014, and Global Innovation 1000, 2004–present

Reward them with meaning, not just money. Frederick Herzberg “One More Time: How Do You Motivate Employees?” HBR, 1968

Provide ﬁve things people crave: status, certainty, autonomy, relatedness, and fairness. David Rock “Managing with the Brain in Mind,” s+b, 2009

Building it to last Jim Collins, Jerry Porras “Climbing to Greatness with Jim Collins,” s+b, 2001

Understand the dynamics that underlie conﬂict. Edie and Charlie Seashore “Masters of the Breakthrough Moment,” s+b, 2006

feature strategy & leadership

How do we attract customers?

Being a giver, not a taker Adam Grant “Turning the Tables on Success,” s+b, 2013

Cultivate the “learning disciplines” of understanding, complexity, aspiration, and reﬂective conversation. Peter Senge The Fifth Discipline (1990)

How can I work here and still be me?

Why do business enterprises exist?

What the hell is leadership?

What about our CEO?

How does the world really work?

Find ways to overcome obstacles to success.

To take risks governments won’t or can’t.

It’s the tangible but invisible empowerment of the enterprise.

CEOs today seek“good growth,” aligned with ethics and sustainability.

Economic forces are set in motion by choices people make (and not always rationally).

Sheryl Sandberg Lean In: Women, Work, and the Will to Lead (2013)

feature strategy & leadership

Confront rankism: the tendency to ignore, abuse, and exploit other people.

Joint stock companies 17th and 18th centuries

For the people who buy their goods and services.

Dennis Nally “The Trust Agenda,” s+b, 2014

The Tao Te Ching (570 BC)

The better “A prince ought the CEO succession plan, to inspire fear the more likely in such a way that, if he does the company’s not win love, he success. Favaro, avoids hatred.” Ken Per-Ola Karlsson, and Niccolo Machiavelli The Prince (1513)

Peter Drucker Management (1973)

Gary L. Neilson “The $112 Billion CEO Succession Problem,” s+b, 2015

Robert Fuller “Diversity and Its Discontents,” s+b, 2004

Declare your identity in a way that promotes change. John Browne “The Business of Coming Out at Work,” s+b, 2014

For the shareholders. Milton Friedman “The Social Responsibility of Business Is to Increase Its Proﬁts,” New York Times Magazine, 1973

“Managers do things right, while leaders do the right thing.” Warren Bennis s+b Thought Leader interview, 1997

Daniel Kahneman and Amos Tversky s+b Thought Leader interview, 2003

“When the rate of return of capital exceeds the rate of economic growth, capitalism generates arbitrary and unsustainable inequalities.”

A great top team is a producer paired with The indusa performer. trial revolution turns in predictable, 80-year, long-wave cycles. Thomas Piketty Capital in the 21st Century (2015)

John Sviokla and Mitch Cohen The Self-Made Billionaire Effect (2015)

Carlota Perez s+b Thought Leader interview, 2005

Participants in the “20 Questions” workshop:

And from strategy+business:

Napier Collyns, member of the group planning scenario team at Royal Dutch Shell, cofounder of Global Business Network, and management historian

Art Kleiner, editor-in-chief and author of The Age of Heretics: A History of the Radical Thinkers Who Reinvented Corporate Management (Jossey-Bass, rev’d ed., 2008)

Andrea Gabor, author of The Capitalist Philosophers: The Geniuses of Modern Business — Their Lives, Times, and Ideas (Three Rivers Press, 2000), and chair of business journalism at Baruch College, City University of New York

Daniel Gross, executive editor and author of Better, Stronger, Faster: The Myth of American Decline…and the Rise of a New Economy (Free Press, 2012)

Walter Kiechel, author of The Lords of Strategy: The Secret Intellectual History of the New Corporate World (Harvard Business Press, 2010)

Elizabeth Johnson, managing editor

Laura W. Geller, senior editor

Bevan Ruland, business operations manager Duff McDonald, author of The Firm: The Story of McKinsey & Its Secret Inﬂuence on American Business (Simon & Schuster, 2013); and of a forthcoming book on Harvard Business School Jim O’Toole, research professor at the University of Southern California Center for Effective Organizations and author of Creating the Good Life: Applying Aristotle’s Wisdom to Find Meaning and Happiness (Rodale, 2005) Lex Schroeder, editor and community manager at the Lean Enterprise Institute; researcher on changes in work and leadership

John Klotnia, art director Linda Eckstein, information graphics specialist Photographs by Matthew Septimus

References in this article are to original publications from strategy+business and others. For an expanded digital version with links to original sources, see strategy-business.com/managementhistory.

feature strategy & leadership

Gretchen Hall, publisher

Jennifer Sertl, coauthor of Strategy, Leadership, and the Soul (Triarchy Press, 2010), advisor to the Center for Policy and Emerging Technology

67 Thomas A. Stewart, author of Intellectual Capital: The New Wealth of Organizations (Doubleday, 1997), former chief marketing and knowledge ofﬁcer at Booz & Company and editor of Harvard Business Review

feature strategy & leadership

The Future of Management Is Teal Organizations are moving forward along by Frederic Laloux

that the way organizations are run today has been stretched to its limits. In survey after survey, businesspeople make it clear that they see companies as places of dread and drudgery, not passion or purpose. Organizational disillusionment afflicts government agencies, nonprofits, schools, and hospitals just as much. Further, it applies not only to the powerless at the bottom of the hierarchy. Behind a facade of success, many top leaders are tired of the power games and infighting; despite their desperately overloaded schedules, they feel a vague sense of emptiness. All of us yearn for better ways to work together — for more soulful workplaces where our talents are nurtured and our deepest aspirations are honored.

Illustration by Martin O’Neill

Many people sense

feature strategy & leadership

an evolutionary spectrum, toward self-management, wholeness, and a deeper sense of purpose.

feature strategy & leadership 70

This article is adapted with permission from Reinventing Organizations. The evolution of organizations described here, and the use of colors to describe the stages, draws on the work of several thinkers, including Don Beck, Clare Graves, Robert Kegan, Jane Loevinger, Jenny Wade, and Ken Wilber.

The premise of this article is that humanity is at a threshold; a new form of organization is emerging into public view. Anthropological research suggests that this is a natural next step in a process that began more than 100,000 years ago. There have been, according to this view, at least five distinct organizational paradigms in human history. Could the current organizational disillusionment be a sign that civilization is outgrowing the current model and getting ready for the next? A number of pioneering organizations in a wide variety of sectors — profit and nonprofit — are already operating with significantly new structures and management practices. They tend to be successful and purposeful, showing the promise of this emerging organizational model. They show how we can deal with the complexity of our times in wholly new ways, and how work can become a place of personal fulfillment and growth. And they make most of today’s organizations look painfully outdated. A History of Organizational Paradigms

In describing the pattern of organizational evolution, I draw on the work of a number of thinkers in a ﬁeld known as developmental theory. One of its basic concepts is the idea that human societies, like individuals, don’t grow in linear fashion, but in stages of increasing maturity, consciousness, and complexity. Various scholars have assigned different names to these stages; some have used colors to identify them. For this article, I have borrowed a color scheme developed by Ken Wilber that evokes the light spectrum, from infrared to ultraviolet. It provides a convenient way to name the successive stages of management evolution (see Exhibit 1). Around 10,000 years ago, humanity started orga-

nizing itself in chiefdoms and proto-empires. With this shift away from small tribes, the meaningful division of labor came into being — a breakthrough invention for its time. With it came the first real organizations, in the form of small conquering armies. These organizations, which in integral theory are labeled Red, are crude, often violent groups. People at this stage of development tend to regard the world as a tough place where only the powerful (or those they protect) get their needs met. This was the origin of command authority. The chief, like the alpha male in a wolf pack, needs to constantly inspire fear to keep underlings in line, and often relies on family members in hopes that they can be trusted. Today’s street gangs, terrorist groups, and crime syndicates are often organized along these lines. Starting around 4000 BC in Mesopotamia, humanity entered the Amber age of agriculture, state bureaucracies, and organized religion. Psychologically, this leap was enormous: People learned to exercise self-discipline and self-control, internalizing the strong group norms of all agricultural societies. Do what’s right and you will be rewarded, in this life or the next. Do or say the wrong things, and you will be excommunicated from the group. All agrarian societies are divided into clearly delineated castes. They thrive on order, control, and hierarchy. In organizations, the same principles characterize the Amber stage. The fluid, scheming wolf pack–like Red organizations give way to static, stratified pyramids. The Catholic Church is an archetypal Amber organization, complete with a static organization chart linking all levels of activity in lines and boxes, from the pope at the top to the cardinals below and down to the archbishops, bishops, and priests. Historically, the

strategy+business issue 80

Frederic Laloux www.reinventing organizations.com is the author of Reinventing Organizations: A Guide to Creating Organizations Inspired by the Next Stage of Human Consciousness (Nelson Parker, 2014). A former associate partner with McKinsey & Company, he is now an independent scholar and advisor to organizational leaders.

Exhibit 1: Evolutionary Breakthroughs in Human Collaboration Color RED

Guiding Metaphor

Key Breakthroughs

Current Examples

Constant exercise of power by chief to keep foot soldiers in line. Highly reactive, shortterm focus. Thrives in chaotic environments.

Wolf pack

• Division of labor • Command authority

• Organized crime • Street gangs • Tribal militias

Highly formal roles within a hierarchical pyramid. Top-down command and control. Future is repetition of the past.

Army

• Formal roles (stable and scalable hierarchies) • Stable, replicable processes (long-term perspectives)

• Catholic Church • Military • Most government organizations (public school systems, police departments)

Goal is to beat competition; achieve proﬁt and growth. Management by objectives (command and control over what, freedom over how).

Machine

• Innovation • Accountability • Meritocracy

• Multinational companies • Investment banks • Charter schools

Focus on culture and empowerment to boost employee motivation. Stakeholders replace shareholders as primary purpose.

Family

AMBER

ORANGE

feature strategy & leadership

Description

GREEN • Empowerment • Egalitarian management • Stakeholder model

Businesses known for idealistic practices (Ben & Jerry’s, Southwest Airlines, Starbucks, Zappos)

• Self-management • Wholeness • Evolutionary purpose

A few pioneering organizations (see “Examples of Teal Management,” page 75)

TEAL Self-management Living organism replaces hierarchical pyramid. Organizations are seen as living entities, oriented toward realizing their potential.

Source: Frederic Laloux, Reinventing Organizations (Nelson Parker, 2014)

feature strategy & leadership 72

invention of formal roles and hierarchies was a major breakthrough. It allowed organizations to scale beyond anything Red society could have contemplated. Amber organizations produced the pyramids, irrigation systems, cathedrals, the Great Wall of China, and other structures and feats that were previously unthinkable. They also considerably reduced violence; a priest whose role is defined by a box in an organization chart doesn’t scheme to backstab a bishop who shows a sign of weakness. A second breakthrough was the invention of stable, replicable processes, such as the yearly cycle of planting, growing, and harvest in agriculture. Today, this hierarchical and process-driven model is visible in large bureaucratic enterprises, many government agencies, and most education and military organizations. In Amber organizations, thinking and execution are strictly separated. People at the bottom must be instructed through command and control. In today’s fast-changing, knowledge-based economy, this static, top-down conception of management has proven to be inefficient; it wastes the talent, creativity, and energy of most people in these organizations. Starting with the Renaissance, and gaining steam with the Enlightenment and the early Industrial Revolution, a new management concept emerged that challenged its agrarian predecessor. In the Orange paradigm, the world is no longer governed by absolute, God-given rules; it is a complex mechanism that can be understood and exploited through scientific and empirical investigation. Effectiveness replaces morality as the yardstick for decision making: The best decision is the one that begets the highest reward. The goal in an Orange organization is to get ahead, to succeed in socially acceptable ways, and to best play the cards one is dealt.

This is arguably the predominant perspective of leaders in business and politics today. The leap to Orange coincided with three significant management breakthroughs that gave us the modern corporation. First was the concept of innovation, which brought with it new departments such as R&D, product management, and marketing, as well as project teams and cross-functional initiatives. Second was accountability, which provided leaders with an alternative to commanding people: Give people targets to reach, using freedom and rewards to motivate them. This breakthrough, sometimes called management by objectives, led to the creation of modern HR practices, budgets, KPIs, yearly evaluations, bonus systems, and stock options. Third was meritocracy, the idea that anyone could rise to any position based on his or her qualifications and skills — a radical concept when it appeared. The transition to Orange brought a new prevailing metaphor. A good organization is not a wolf pack or army, but a machine. Corporate leaders adopted engineering terms to describe their work: They designed the company, using inputs and outputs, information flows, and bottlenecks; they downsized the staff and reengineered their companies. Most large, mainstream, publicly listed companies operate with Orange management practices. In just two and a half centuries, these breakthroughs have generated unprecedented levels of prosperity, added decades to human life expectancy, and dramatically reduced famine and plague in the industrialized world. But as the Orange paradigm grew dominant, it also encouraged short-term thinking, corporate greed, overconsumption, and the reckless exploitation of the planet’s resources and ecosystems. Increasingly,

strategy+business issue 80

The transition to Orange brought a new prevailing metaphor. A good organization is not a wolf pack or army, but a machine.

the traditional hierarchy through constant investment in training and culture, reminding leaders and managers to wield their power carefully, and raising the skills of people on the front lines. All of these organizational paradigms coexist today. In any major city one can ﬁnd Red organizations (entities at the fringes of the law), Amber organizations (public schools and other government entities), Orange organizations (Wall Street and Main Street companies), and Green organizations (values-driven businesses and many nonproﬁts). Look closely at how an organization operates — its structure, leadership style, or any core management process — and you can quickly guess the dominant paradigm. Take compensation, for example: How are people rewarded? In a Red company, the boss shares the spoils as he or she pleases, buying allegiance through reward and punishment. In Amber organizations, salaries are tightly linked to a person’s level in the hierarchy (“same rank, same pay”) and there are no incentives or bonuses. Orange companies offer individual incentives to reward star performers, and Green companies generally award team bonuses to encourage cooperation. Today, in small but increasing numbers, leaders are growing into the next stage of consciousness, beyond Green. They are mindful, taming the needs and impulses of their ego. They are suspicious of their own desires — to control their environment, to be successful, to look good, or even to accomplish good works. Rejecting fear, they listen to the wisdom of other, deeper parts of themselves. They develop an ethic of mutual trust and assumed abundance. They ground their decision making in an inner measure of integrity. They are ready for the next organizational paradigm. Its color is Teal.

feature strategy & leadership

whether we are powerful leaders or low-ranking employees, we feel that this paradigm isn’t sustainable. The heartless and soulless rat race of Orange organizations has us yearning for more. Postmodernity brought us another world view. The Green stage stresses cooperation over competition and strives for equality, solidarity, and tolerance. Historically, this perspective inspired the ﬁghts for the abolition of slavery and for gender equality, and today it helps combat racism, homophobia, and other forms of discrimination. Green organizations, which include many nonproﬁts as well as companies such as Southwest Airlines, Starbucks, and the Container Store, consider social responsibility the core of their mission. They serve not just shareholders but all stakeholders, knowing that this often results in higher costs in the short term, but better returns in the end. Green leaders have championed the soft aspects of business — investing in organizational culture and values, coaching, mentoring, and teamwork — over the hard aspects of strategy and budgeting so prized in Orange. Family is their metaphor; everyone’s voice should be heard and respected. You can’t treat knowledge workers like cogs in a machine. Empowerment and egalitarian management are among the breakthroughs they introduced. Practice shows, alas, that empowerment and egalitarian management are hard to sustain. Efforts to make everyone equal often lead to hidden power struggles, dominant actors who co-opt the system, and organizational gridlock. Green companies, universities, and organizations that take egalitarianism too far have tended to bog down in debate and factionalism. Successful Green companies maintain a careful balance: taming

Buurtzorg’s purpose is not for nurses to give shots and change bandages, but to help its patients live a rich and autonomous life.

feature strategy & leadership 74

In 2012, I set out to find some examples of Teal organizations and describe the factors that set them apart. To qualify, an organization had to employ a minimum of 100 people and had to have been operating for a minimum of five years in ways that were consistent with the characteristics of a Teal stage of development. After screening a great number of organizations, I focused on 12, selecting those that were most advanced in reinventing management structures and practices. (See “Examples of Teal Management,” where 10 are listed; the other two, AES and BSO/Origin, reverted back to more traditional management practices after a change of CEO or ownership.) I was struck by the diversity of these organizations. They include publicly held and privately held for-profit corporations along with nonprofits in the consumer products, industrial, healthcare, retail, and education industries. Typically, the leaders of these companies didn’t know about one another. They often thought they were the only ones to be so foolhardy as to rethink their management practices in fundamental ways. Yet, after much trial and error, they came up with strikingly similar approaches to management. It seems that a coherent new organizational model is emerging. Like previous leaps to new stages of management, the new model comes with a number of important breakthroughs: • Self-management. Teal organizations operate effectively, even at a large scale, with a system based on peer relationships. They set up structures and practices in which people have high autonomy in their domain, and are accountable for coordinating with others. Power and control are deeply embedded throughout the or-

ganizations, no longer tied to the speciﬁc positions of a few top leaders. • Wholeness. Whereas Orange and Green organizations encourage people to show only their narrow “professional” selves, Teal organizations invite people to reclaim their inner wholeness. They create an environment wherein people feel free to fully express themselves, bringing unprecedented levels of energy, passion, and creativity to work. • Evolutionary purpose. Teal organizations base their strategies on what they sense the world is asking from them. Agile practices that sense and respond replace the machinery of plans, budgets, targets, and incentives. Paradoxically, by focusing less on the bottom line and shareholder value, they generate ﬁnancial results that outpace those of competitors. Changing Paradigms at Buurtzorg

Buurtzorg, a large Dutch nursing care provider, is a good example of an organization running with Teal management structures and practices. Since the 19th century, every neighborhood in the Netherlands has had a local nurse who makes home visits to care for the sick and the elderly. These nurses worked through largely autonomous agencies until the early 1990s. Then, to maximize efﬁciency and reduce costs, the government created incentives for these local care-giving agencies to merge into larger enterprises. The new agencies, most of which were private companies, gravitated toward an Orange paradigm. Seeking to minimize downtime and allocate staff ﬂexibly, they set up centralized call centers; instead of calling their nurse personally, clients now had to dial the center. Planners were hired to devise daily visiting schedules

strategy+business issue 80

The Nature of Teal

Examples of Teal Management Buurtzorg: a Netherlands-based

Morning Star: a U.S.-based tomato

Sounds True: a publisher of multi-

processing company with 400 to

media offerings related to spirituality

2,400 employees (depending on the

and personal development, with 90

season) and a 30 to 40 percent share

employees in the United States.

of the North American market. (If you

healthcare nonproﬁt, proﬁled in this

have eaten pizza or spaghetti sauce

Sun Hydraulics: a maker of hydrau-

article.

in the U.S., you have probably tasted

lic cartridge valves and manifolds,

a Morning Star product.)

with factories in the U.S., the U.K.,

ESBZ: a publicly ﬁnanced school in

Germany, and Korea employing about

Berlin, covering grades seven to 12,

Patagonia: a US$540 million manu-

which has attracted international

facturer of climbing gear and outdoor

attention for its innovative curriculum

apparel; based in California and em-

Holacracy: a management system

and organizational model.

ploying 1,300 people, it is dedicated

ﬁrst developed at the Philadelphia-

to being a positive inﬂuence on the

based software company Ternary,

natural environment.

which has been adopted by a few

FAVI: a brass foundry in France, which produces (among other things)

900 people.

hundred proﬁt and not-for-proﬁt Resources for Human Development

organizations around the world,

dustry, and has about 500 employees.

(RHD): a 4,000-employee nonproﬁt

most famously by Zappos.

social services agency operating in 14 Heiligenfeld: a 600-employee mental

states in the U.S., providing services

Source: Frederic Laloux, Reinventing

health hospital system, based in cen-

related to addiction recovery, home-

Organizations (Nelson Parker, 2014)

tral Germany, which applies a holistic

lessness, and mental disabilities.

approach to patient care.

that minimized travel times. The agencies instituted time standards: 10 minutes for intravenous injections, 15 minutes for bathing, and 2.5 minutes for changing a compression stocking. Barcode stickers, placed on patients’ front doors, tracked the nurses’ progress so central managers could analyze their efficiency. As the nursing organizations consolidated, they added more layers of management, all with the intention of increasing efficiencies and squeezing out costs. The outcome has been distressing to patients and nurses alike. Clients, who are often elderly, have to cope with new faces in their home at every visit. They must repeat their medical histories to hurried nurses who have no time allotted for listening. The nurses, for their part, find these working conditions degrading. They know they should spend more time trying to understand the changing conditions of their patients, but they simply can’t. The whole system is prone to errors, conflicts, and complaints. Buurtzorg (the name means neighborhood care in Dutch) was founded in 2006 by Jos de Blok, who had experienced these problems firsthand, as a nurse for 10 years and then as a manager. His new organization is

extraordinarily successful, having grown from four to 9,000 nurses in its first eight years and achieving outstanding levels of care. He set up the company as a selfmanaging enterprise. Nurses work in teams of 10 to 12, each team serving around 50 patients in a small, welldefined neighborhood. Buurtzorg has a distinctive outlook on the nature of care. Its purpose is not for nurses to give shots and change bandages as efficiently as they can, but to help patients live, as much as possible, a rich and autonomous life. Nurses regularly sit down for coffee with their patients. They help them structure their own support networks and reach out to families and neighbors. Patients see the same one or two nurses all the time, and often form deep bonds of trust and intimacy with them. Clients and nurses love Buurtzorg. Only eight years after its founding, its market share had reached 60 percent. Financially, the results are stellar, too. One 2009 study found that Buurtzorg requires, on average, only 40 percent of the care hours needed by a more conventional approach, because patients become self-sufficient much faster. Emergency hospital admissions have been cut by a third, and the average hospital stay of a Buurtz-

feature strategy & leadership

gearbox forks for the automotive in-

At Patagonia, children’s laughter and chatter are regularly heard; at Sounds True, people bring their dogs to work.

Self-Management and Its Misconceptions

Buurtzorg’s 9,000 employees operate entirely with selfmanaging practices. Local teams of 10 to 12 nurses decide which patients to serve, how to allocate tasks, where to rent offices, how to integrate with the local communities, which doctors and pharmacies to work with, and how to collaborate with nearby hospitals. The teams monitor their own performance and take corrective action if productivity drops. They don’t have team leaders; management tasks are spread across the members, all of whom are nurses. One common misconception about self-management is that everyone is equal and decisions are made by consensus, which requires endless meetings. The truth is very different. Self-management requires a whole set of interlocking structures and practices, so that decision rights and power flow to any individual who has the expertise, interest, or willingness to step in to oversee a situation. Fluid, natural hierarchies replace the fixed power hierarchies of the pyramid. This requires explicit training. At Buurtzorg, all new team members take a course called Solution-Driven Methods of Interaction, learning sophisticated listening and communication skills, techniques for running meetings and making decisions, and methods of coaching one another and providing perspective. You might assume that all this is managed through staff functions — the source of capability and power in many Orange and Green organizations. But Buurtzorg’s

9,000 nurses are supported by fewer than 50 staff people. The nurses do their own recruiting and purchasing, contracting for specialized medical or legal expertise when needed. They align with the larger organization not through rules and procedures, but through the collaboration methods they learned. A powerful internal social network allows them to draw on guidance and medical expertise from fellow nurses in other parts of the country, many of whom they’ve never met. The Embrace of Wholeness

In Amber, Orange, and Green organizations, people typically show up wearing a mask: The bishop’s robe, the doctor’s white coat, and the executive’s suit all embody subtle, but real, expectations. Leaders fear that if people brought all of themselves to work — their moods, quirks, deepest aspirations, and uncertainties — things would quickly fall into disorder. Most people adopt an air of resolution and determination, favoring their masculine, rational selves. It feels unsafe to reveal the caring, inquiring, intuitive, and spiritual aspects of the self, or to express a desire for meaning. Many of us end up disowning some fundamental aspects of our selves. When an organization feels lifeless, is it because we bring so little life to work? Teal organizations start from the premise, resonant with many wisdom traditions, that a person’s deepest calling is to achieve wholeness. These organizations engender vibrant workspaces and practices where trust ﬂourishes. People feel they can truly be themselves. Simple management practices foster a sense of personal connection. At Patagonia’s headquarters in Ventura, Calif., for example, the company maintains a child development center for employees’ preschoolers. Chil-

strategy+business issue 80

feature strategy & leadership 76

org patient is shorter. It’s estimated that the Dutch social security system would save $2 billion per year if the entire home-care industry adopted Buurtzorg’s operations model.

Evolutionary Purpose

Most organizations define a purpose for themselves in the form of a mission statement, which is typically engraved on a plaque in the headquarters lobby. Most of these statements, of course, sound hollow. The espoused purpose can’t compete with the pursuit of profits or competitive advantage. Buurtzorg’s purpose, as discussed above, is to help sick and elderly patients live a rich and autonomous life. Its competitive advantage is the way it fulfills that purpose, with self-organization and wholeness. If it were a more traditional organization, it would try to keep this competitive advantage secret, and gain market share accordingly. Founder de Blok did the opposite. With Aart Pool, he wrote a book called Buurtzorg: Menselijkheid Boven Bureaucratie (Boom Lemma uitgevers, 2010, whose title translates as “Humanity above Bureaucracy”), in which he documented Buurtzorg’s revolutionary ways of operating in great detail. He accepts all invitations from competitors to explain his methods, and acts as an advisor for two direct competitors without compensation. “The whole notion of competition makes no sense,” says de Blok. “If you share knowledge and information, things will change more quickly.” Making purpose the cornerstone of an organization has profound consequences for leadership. In today’s dominant management paradigm (Orange), leaders are supposed to define a winning strategy and then marshal the organization to execute it, like the human programmer of a machine who controls what it will do. In the Teal paradigm, founders and leaders view the organization as a living entity, with its own energy, sense of direction, and calling to manifest something in the world. They don’t force a course of action; they try to listen to where the organization is naturally called to go. None of the organizations I researched has a strategy document. Gone are the often dreaded strategy formulation exercises, and much of the machinery of midterm plans, yearly budgets, cascaded KPIs, and individual targets. Instead of trying to predict and control, they aim to sense and respond. FAVI uses a metaphor to explain this. Other com-

feature strategy & leadership

dren’s laughter and chatter are regularly heard; kids visit their parents’ desks, join adults for lunch at the cafeteria, and run around in the playground outside. One sometimes sees a mother nursing her child during a meeting. At another Teal company, Sounds True, people regularly bring their dogs to work. Meetings often take place with two or three dogs lying at people’s feet. Having children and animals present tends to reconnect people with deeper parts of themselves; they see one another not only as colleagues, but as part of a common humanity. One harbinger of the rise of consciousness in the business world is the support given to contemplative practices. It’s becoming fashionable, even in Wall Street banks, to offer meditation classes. But these are often treated as add-ons, separate from the real work. At the Heiligenfeld hospital chain, inner work is woven deeply into daily life. Every week, colleagues from the chain’s five hospitals come together for 75 minutes of intensive, reflective dialogue about a theme such as dealing with risks or learning from mistakes. Heiligenfeld also devotes four days per year to silence. The staff speaks only when needed, in whispers; patients engage in forms of therapy that require no words, such as walks in the woods or painting sessions. People learn to interact from a deep place when words are not at hand. The quest for wholeness can also be seen on the factory floor. At FAVI, a French automotive supplier, all engineers and administrative workers are trained to operate at least one assembly-line machine. When orders must be rushed out, white-collar workers come in to run the machines for a few hours. It’s a wonderful community-building practice. People in engineering and administrative roles work under the guidance of the machine operators. They see for themselves how hard the work on the machines can be and how much skill it involves. FAVI also has an in-depth onboarding process that ends with new teammates writing an open letter to the colleagues they have joined. The letters often describe how, perhaps for the first time in their career as a machine operator, their voice counts at work and they are considered worthy of trust and appreciation.

Becoming a Teal Organization

Some companies, like Buurtzorg, are advanced in all three Teal breakthrough areas: self-management, wholeness, and evolutionary purpose. Others are more advanced in one area than others — FAVI in self-management, Heiligenfeld in wholeness. None of the Teal companies I have identified have the scale of the largest Orange companies (such as Walmart) or Green ones (such as Southwest Airlines). This is still the dawn of the Teal paradigm. However, its promise is suggested by the success these organizations are having. Every stage of organizational evolution is more mature and effective than the previous stage, because of the inherent attitude toward power. A Red leader asks, How can I use my power to dominate? An Amber leader asks, How can I use it to enforce the status quo? An Orange leader asks, How can we win? A Green leader asks, How can we empower more people? A Teal leader asks, How can everyone most powerfully pursue a purpose that transcends us all? Research suggests that there are two — and only two — necessary conditions for developing a Teal organization. 1. Top leadership. The chief executive must have an integrated world view and psychological development consistent with the Teal paradigm. It is helpful if a few close colleagues share this perspective. 2. Ownership. Owners of the organization must also understand and embrace Teal world views. Board members who don’t get it, experience shows, can temporarily give a Teal leader free rein. But when the organization hits a rough patch or faces a critical choice, owners will want to regain control in the only way that makes sense to them: appointing a CEO who exerts top-down, hierarchical authority. What about businesses, nonprofits, schools, hospitals, government agencies, and other institutions where these conditions are not in place? Can a middle manager hope to influence an entire enterprise by showcasing Teal practices locally? As much as I would like to believe this is possible, my hopes are not high. Experience shows that it takes more than a successful local example to catalyze this sort of system-wide change.

strategy+business issue 80

feature strategy & leadership 78

panies look ﬁve years ahead and make plans for the next year. FAVI leaders prefer to think like farmers: Look 20 years ahead, and plan only for the next day. A farmer must look far out when deciding which fruit trees to plant or which crops to grow. But it makes no sense to plan a precise date for the harvest. One cannot control the weather, the crops, the soil; each has a life of its own. Sticking rigidly to plan, instead of sensing and adjusting to reality, leads to having the harvest go to waste, which too often happens in organizations. Practices based on sensing and responding, combined with self-management, lead to high levels of innovation. Two nurses on a Buurtzorg team found themselves pondering the fact that elderly people, when they fall, often break their hips. Could Buurtzorg help prevent this? Their team created a partnership with a physiotherapist and an occupational therapist from their neighborhood. They advised patients on small changes they could bring to their home interiors, and changes of habit that would minimize the risk of falling. Happy with their success, they approached de Blok to suggest turning “Buurtzorg+” (Buurtzorg + prevention) into a national program. Had de Blok been a traditional CEO, he might have analyzed the idea and, if he approved it, assigned a team in headquarters to develop a comprehensive implementation plan. His actual answer was much humbler: Why should he, rather than the system itself, decide if this was a wise thing to do? He suggested that the same team of nurses package their approach and disseminate the idea on the company’s internal social network. Hundreds of teams showed interest and the idea quickly caught on. Within a year, almost all teams had incorporated prevention into their work using that model. In a self-managing, purpose-driven organization, change can come from any person who senses that change is needed. This is how change has occurred in nature for millions of years. Innovation doesn’t happen centrally, according to plan, but at the edges, when some organism senses a change in the environment and experiments to ﬁnd an appropriate response. Some attempts fail to catch on; others rapidly spread to all corners of the ecosystem.

Work in Teal organizations seems to unfold so easily it verges on the magical. Control and self-correction are embedded in the system.

have emerged. After the full emergence of the Teal paradigm, we will probably look back and find the organizational forms and practices of the late 20th and early 21st century alienating and unfulfilling. Already, it’s clear that we can create radically more productive, soulful, and purposeful businesses, nonprofits, schools, and hospitals. We are at an inflection point: a moment in history where it’s time to stop trying to fix the old model and instead make the leap to the next one. It will be better suited to the complexity and challenges of our times, and to the yearning in our hearts. + Reprint No. 00344

Resources Don Edward Beck and Christopher Cowan, Spiral Dynamics: Mastering Values, Leadership, and Change (Blackwell, 1996): Background for this history, including the work of Clare Graves. Art Kleiner, “Ellen Langer on the Value of Mindfulness in Business,” s+b, Spring 2015: Research on Teal-like attributes: wholeness and control over context. Frederic Laloux, Reinventing Organizations: A Guide to Creating Organizations Inspired by the Next Stage of Human Consciousness (Nelson Parker, 2014): In-depth explication of the Teal paradigm and the 12 organizations where it is manifested. Margaret J. Wheatley and Myron Kellner-Rogers, A Simpler Way (Berrett-Koehler, 1996): What organizations could be like if we sought inspiration from life and nature, rather than thinking about them as machines. Ken Wilber, A Brief History of Everything (Shambhala, 1996): An introduction to the developmental stages of people and civilization. More thought leadership on this topic: strategy-business.com/strategy_and_leadership

feature strategy & leadership

However, as a middle or senior manager, you can introduce some elements of the new paradigm for your own benefit and that of your colleagues. Practices that encourage people to show more of their true selves might come across as unusual, but are unlikely to raise red flags with top leadership. Some elements of selfmanagement can be introduced; for example, instead of imposing new targets, ask team members to determine, in a peer-based process, which targets could be changed. If the team functions well, don’t attend the meeting. Let them come up with the best solution on their own so the targets will be theirs. Or when it’s time to appoint someone to report to you, don’t do it yourself. Let the team one level below write up the job description, interview candidates, and select their boss. Executives who have tried this find that subordinates take choosing their boss very seriously, and the process gives the boss a much stronger working relationship with the team. The full benefit, of course, accrues to those organizations that fully embrace the new paradigm. When I spent a day with de Blok in the small headquarters of Buurtzorg, I was struck by how much simpler work life could be. Buurtzorg is a 9,000-person organization growing at breakneck speed. But after several hours of conversation, I realized we hadn’t been interrupted once. No urgent phone calls; no assistant coming in to whisper in the CEO’s ear that something had come up. Work in Teal organizations seems to unfold so easily it sometimes verges on the magical. Control and selfcorrection are embedded in the system, and no longer require leaders to be on top of everything at all times. In the past, with every change in consciousness (from Red to Amber to Orange and to Green), more powerful and life-enhancing forms of management

feature energy

THE WAY WE CREATE, USE, AND MANAGE ELECTRICITY IS FINALLY CHANGING, AND THE IMPLICATIONS GO FAR BEYOND THE UTILITY SECTOR.

feature energy

A Strategistâ&#x20AC;&#x2122;s Guide to Power Industry Transformation BY NORBERT SCHWIETERS AND TOM FLAHERTY

Illustration by John Hersey

In many ways, the electricity industry makes an unlikely

candidate for disruption. Not much changed between the 1880s, when Thomas Edison began building power stations, and the start of the 21st century. Top business leaders rarely had to think about electricity. They got their electricity from the power plant, or the local utility, or the government, and had little say in how it was produced, delivered, or managed. Utility executives, for their part, could make and execute long-term plans with a great deal of security. Demand tended to rise along with the economy; natural monopolies were the norm.

feature energy 82

Tom Flaherty tom.flaherty@ strategyand.pwc.com is a leader in the Dallas office of Strategy&, PwC’s strategy consulting group. He is part of the firm’s power and utilities practice and consults broadly to the electric and gas sectors.

No longer. Several coincident, significant transformations are causing a revolution in the way electricity — the vital fuel of global commerce and human comfort — is produced, distributed, stored, and marketed. A top-down, centralized system is devolving into one that is much more distributed and interactive. The mix of generation is shifting from high carbon to lower carbon, and, often, to no carbon. In many regions, the electricity business is transforming from a monopoly to a highly competitive arena. Until recently, for most users, electricity was a commodity over which they had little choice. Now, consumers can choose from a wide array of potential power sources and providers. Technology is giving them greater autonomy and more choices in the way they source, use, and store electricity — and maybe even the opportunity to make money at the same time. We have entered an age in which the technology-powered push and the customer-driven pull have beneficially collided. This has led to a paradigm shift within the power industry, from a premium on rigid capacity to a focus on flexibility. Long known for clear borders with sharply defined roles — generation, transmission, distribution, trading, and retail — the global electricity market is now characterized by new players and technologies, more provider–customer interaction, broader options, and eroding distinctions between industries. Incumbents accustomed to dealing only with one another are finding themselves facing a wide range of upstarts. As a result, the electric power system is evolving from a unilateral system to an integrated networked ecosystem. The digital revolution, which is layered on top of these changes, is transforming the system from static to dynamic, and from stable to disrupted. Shares of util-

ity companies were once referred to as “orphans and widows” stocks — so safe that even the most vulnerable citizens were secure in holding on to them. But in the emerging environment, utility companies themselves risk the possibility of being left behind. It’s no surprise that in PwC’s 2015 CEO Survey, utility executives stood out from their counterparts in other industries in recognizing that they faced disruption. But rather than fearing the changes, these leaders are realizing that they need to embrace them and seek to take advantage of the emerging opportunities. The root causes of the transformation of the sector are a unique conjunction of global megatrends. Concerns over emissions and climate change are bringing heavy political and social pressure to bear on providers — pressure both to change the mix of fuels they use and to encourage efficiency. According to PwC’s 2015 Global Power & Utilities (P&U) Survey, the falling costs of renewables such as solar energy, breakthroughs in large-scale and smaller-scale energy storage, and new energy-efficient technologies are catalyzing greater distribution of generation. The rise and adoption of big data and Internet-based applications are making systems more intelligent and interactive; altering the habits of personal energy usage; and stimulating the rapid development of new business models by incumbents, startups, and aggressive companies in adjacent fields. This momentum is not confined to mature power markets. In fact, the processes we’re describing may be even more relevant to less developed countries in which basic access to electricity remains a challenge. In regions such as sub-Saharan Africa, the adoption of distributed energy technologies is giving customers their first access to electricity. Just as mobile telephony

strategy+business issue 80

Norbert Schwieters norbert.schwieters@ de.pwc.com is a partner in the Düsseldorf ofﬁce of PwC and the leader of the ﬁrm’s global energy practice.

Disrupting Utilities

We think predictions of a death spiral for power utilities are overdone. But if utility companies don’t stay ahead of change, the dangers will intensify. New market and business models will become established as a result of this energy transformation and could quickly eclipse current company strategies. At risk for energy companies is their distribution channel to end customers, which upstarts could disintermediate, just as Amazon did to incumbent publishers and booksellers.

Utility companies will have to reconsider their strategy amid a shifting landscape. Because the economics are attractive on both a small scale and a large scale, more and more households and businesses are deciding to generate a portion of their own electricity — whether it is a homeowner in Germany generating a small amount of power on her rooftop or a manufacturer building an on-site co-generation plant in Brazil. According to the Deutsche Bank Research “2015 Solar Outlook,” in many countries around the world, rooftop solar electricity costs between US$0.13 and $0.23 per kilowatt-hour today, well below the retail price of electricity in many markets. The shape of demand is changing, too. An August 2014 report from UBS projected that battery costs would fall by more than half by 2020, and advances in battery design have already made them viable for electricity-powered transportation. The development of advanced battery storage is attracting investment capital, such as the $4 billion to $5 billion that Tesla Motors plans to invest in its gigafactory in Nevada. Economical storage of electricity could dramatically change customers’ view of the grid. It might go from being the primary supplier of electricity to being an occasional one, and growing numbers of customers could sell electricity to the grid themselves. Utilities may find that their role in supplying volatile demand will be undercut by widespread storage and new methods for managing consumption patterns. And they will be confronted with the need to transform the design of their systems to cope with a grid in which fewer users are available to bear the costs of maintenance and operation. Meanwhile, markets are changing rapidly. In virtually every part of the world, electricity is a regulated industry, sometimes regulated at multiple levels. In many instances, the current market designs won’t support the shift from a capacity-oriented system to a disaggregated, flexible power system without significant adaptations. However, because these designs need to evolve in the course of the transformation, we foresee the emergence of a number of new market models, which might appear alone or in combination within or across a region. Examples include green command-and-control mar-

feature energy

has proved to be a leapfrog technology in Africa, making the development of landlines unnecessary, local renewable energy systems have the potential to obviate centralized generation. In the face of all this change, companies that have been in the business and wish to remain so in the future clearly need to rethink their strategy. But the revolution carries implications for all businesses, whether they are part of the electricity sector and its supply chain or interact with it primarily as customers. Instead of being merely a cost over which companies have very little control, electricity is becoming much more variable — and potentially more valuable. These transformations are opening up immense opportunities while enabling consumers of electricity to approach power in a new way — as “prosumers,” who both produce and consume energy. Companies can participate in demand management programs, strike power purchase agreements for wind power (and hence bolster their green credibility), install storage that allows the avoidance of peak demand charges, and deploy data and software services to manage use effectively. In the coming years, they will be able to harness the technologies and applications that will boost the capability of customers to create and capture real beneﬁts. Each of these options presents business opportunities for new entrants, for companies in adjacent ﬁelds, and for savvy consumers. In short, it is now possible — even imperative — for a much broader range of leaders to think strategically about electricity, to imagine new possibilities, and to consider whether their capabilities match emerging demands.

The Industry Responds

feature energy 84

In deﬁning future business models, utilities need to understand and challenge their company’s purpose and positioning in tomorrow’s markets. In the past, operating an integrated utility from generation through customer supply was well understood. Now, unbundling opportunities are extending deeper into the value chain and enabling greater participation by specialists. As a result, electric companies will need to rethink not just their roles and business models, but also their service and product offerings and approaches to customer engagement (see Exhibit 1). We will continue to see utilities act in somewhat familiar ways. Energy suppliers will conduct centralized generation and sales, and systems integrators will focus on accommodating supply and demand peaks through technologies now distributed in the grid. Companies that are focused on asset-based business models in pursuit of energy supply and systems integration will likely fall into several categories: pure-play merchants — i.e., commodity suppliers — which own and operate generation assets and sell power into competitive wholesale markets at market clearing prices; grid developers, which acquire, build, own, and maintain transmission

Exhibit 1: Energy Business Models The traditional utility model, in which one company owned and conducted every vital function, is being challenged by new competitors that focus on small segments of the value chain. Traditional Utility

Generation

Transmission and Distribution

Generation

Commodity Supplier

Grid Manager

Product Innovator

ValueAdded Provider

“Gentailer”

Grid Developer

Services Bundler

Virtual Utility

Transmission and Distribution Retail

Retail

ASSET BASED

SERVICE BASED

More Integrated

Less Integrated

Source: Strategy&

assets that connect generators to distribution system operators; grid managers, which operate transmission and distribution assets and provide generators and retail service providers with access to their networks; and “gentailers,” utilities that both own generation assets and sell retail energy. Highly efficient asset optimization, in conjunction with “Internet of Things” technology, will be crucial to succeeding in these areas. We are also likely to see a great deal of innovation and opportunity in new areas, particularly those that involve customers, data, and technology. Smart grids, microgrids, local generation, and local storage all create opportunities for companies to engage customers in new ways. Companies that aim to enhance the value of the grid to all customers will use technology to improve system performance and customer engagement and to provide flexibility. They will offer solutions in scaled storage, virtual energy, home automation and convenience, and demand-side management. In a digital-based smart energy era, we expect that the main distribution channel for services will be online and the energy retailing price will hinge on innovative digital platforms. These more evolved retail competitors will also fall into several categories. Product innovators will offer electricity as well as so-called behind-the-meter products, expanding the role of the energy retailer and changing the level of customer expectations. We anticipate, for example, that many product innovators will seek to be active players in electric vehicle charging, providing premises-based infrastructure (and the management and integration of rooftop solar in combination with storage technology and fuel-cell products). In another category, beyond offering standard electric and gas products and their associated services, services bundlers will align with other firms — such as OEMs, marketers, and technologists — to address future customer needs by offering a range of entirely new energy-related services: life-cycle EV battery changeout, home-related convenience services such as new utility service setup coordination, and management of sales of home-produced energy to the grid. Virtual utilities will aggregate the generation from distributed systems and act as the intermediary between, and with, energy markets. A virtual utility can also act as an integrator of nontraditional services provided to customers by third parties — for example, distributed energy resources outside its traditional service territory. Finally, value-added providers will leverage their fundamental capacities for

strategy+business issue 80

kets, in which governments own and operate the energy sector and mandate the adoption of renewable generation and digital technology; ultra-distributed generation markets, in which deployment of distributed energy resources reshapes how the grid aggregates and balances supply and demand; local energy systems, in which communities demand greater control over supply or markets; and regional “supergrids” — cross-border and national systems that can transmit renewable energy over long distances.

IN A DIGITAL-BASED SMART ENERGY ERA, THE MAIN DISTRIBUTION CHANNEL FOR SERVICES WILL BE ONLINE AND THE ENERGY RETAILING PRICE WILL HINGE ON INNOVATIVE DIGITAL PLATFORMS.

cision making. It will be key for utilities to create these trusted relationships that might cement their differentiation from competitors outside the sector. As they focus on customers and move away from traditional models, utility companies need to measure their core capabilities against the type and level of capabilities necessary to compete and prosper effectively in a disaggregated marketplace. They have to determine which of their existing capabilities — say, dealing with regulators or managing big power producers — are adequate to the task, and which new ones may need to be developed. To improve customers’ insights through behind-the-meter technology or advanced data analytics, for example, utilities will need to become more expert at gathering, synthesizing, analyzing, and converting data from smart devices and the grid into actionable insight and foresight. Next, they’ll have to combine the data with additional layers of information about demographics, behavior, customer characteristics, and other factors to exploit the data opportunity. It is apparent that thriving in the new era may mean sailing into uncharted waters, even as customers continue to expect the high level of reliable service they’ve been receiving. To pursue two competing business models at once, it may be necessary to structurally separate the responsibility for developing new business models from the responsibility for developing value propositions, because they may be at odds with each other. This change might entail radical steps: For example, German power utility E.ON has announced its intent to focus on renewables, distribution networks, and customer solutions, and to spin off its power generation, global energy trading, and exploration and production activities into a separate entity, dubbed Uniper.

feature energy

information management, big data, and online applications. KiWi Power in the U.K., for instance, which provides services to industrial and commercial clients, offers demand reduction strategies that it says might help larger businesses reduce their electric bills substantially. Many companies are already shifting their positioning and business models into distributed energy and other new parts of the value chain. Instead of selling electrons, they’re clustering energy management offerings around a central energy efﬁciency and energy savings proposition and using new channels such as social media to engage with customers. And in the future, incumbents will evolve to provide the direct management of energy consumption for customers and provision of a portfolio of convenience products and services, such as home management. Regardless of the business model decisions they make, electric utilities will have to progress in their approaches to innovation and customer engagement. Most utilities are well behind the curve of how a competitive company thinks about innovation, tending to regard it narrowly as a focus on technology. Incumbents must expand their horizons and recognize that areas such as process, product, and business model are all elements of a system of innovation. All need to be considered as part of the utility innovation arsenal. Incumbents must also recognize that today’s hyperconnected customers are generally savvier than the power industry with respect to the use of social media and mobility-based communication and interaction. Incumbents will need to develop a much more engaged relationship with their customers, one that emphasizes how the utility can be the customers’ partner in “all things energy,” as they seek to simplify their energy de-

New Participants in a Transformed World

As they work to adjust to the new environment, utilities have the advantages of long operating histories, substantial assets, customer relations, and a host of relevant 86

capabilities. But they will confront a new set of competitors. The same forces that are pushing utilities to change are opening up new avenues for companies that, until now, have been only tangentially connected to the power industry, or that are newcomers entirely. History teaches us that the majority of business model innovations are introduced by newcomers. And the barriers to entry into the distributed energy market are much lower now than ever before. The market, currently worth tens of billions of dollars, covers a wide spectrum of opportunities, including energy controls and demand management activities, local generation, large-scale storage and regional supergrids, and software that encourages behavior change (see Exhibit 2). As a result, non-incumbent companies can take numerous strategic actions to participate in the rapidly developing power technology and customer markets. To begin with, ask yourself if you can be part of the changing game. What capabilities do you have that could be applied to the emerging electricity markets? The answer may have nothing to do with technology. In 2011, Vivint, a 15-year-old home security company based in Utah that utilized a mobile, direct sales force, decided to get into the solar business. It did not

Exhibit 2: Expanding Energy Ecosystems Innovations in technology, business models, and regulation schemes are fostering new businesses and even industry sectors while encouraging cross-sector collaboration.

Energy Management and Related Services Energy Management Devices

• Smart devices (thermostats, meters, accessories) • LED lighting • In-home display • Installation and service • Remote connect/disconnect

KEY • PRODUCT • SERVICE • MOBILE FUNCTION

Source: Strategy&, PwC

Energy Efficiency Consulting Energy Measurement

ENERGY EXCHANGES

Vehicles • Stations • Fueling • Installation and service

Energy Information/Services

• Usage monitoring • Installation and service •• Energy audit •• Billing and payment • Smart appliances • Efficient HVAC systems • Insulation

Renewables/ Microgeneration • Solar panels • Other on-site generators • Grid buyback • Installation and service

Home Experience • Insurance • Moving-related services • Home services • Water

HOME AUTOMATION

Monitoring Systems • Monitoring hardware • Mobile video access • Installation and service

• Telecom Services

strategy+business issue 80

feature energy

Another pathway could be undertaking targeted outsourcing or partnering with a community of new entrants and smaller ﬁrms. The incumbent utility can then nurture these innovations and help scale up the emerging products or services that gain traction — and then potentially buy the business to capitalize on its unique, marketable capabilities. Growing the current business through new revenue streams and channels will require forming alliances or partnerships with nontraditional providers and market participants, a set of disciplines in which the electric industry lacks a wealth of experience. In this context, any “make, partner, or buy” decision will demand a clear vision of the strategic differentiators that drive innovation and industry transformation and address new customers and segments. The utility needs to determine who is accountable for the user experience; who manages the grid and network landscape; who ensures efﬁciency, quality, and cost; and which core capabilities it should retain.

IN A DISTRIBUTED ENERGY COMMUNITY WITH ITS OWN GRID, COMPANIES OTHER THAN POWER UTILITIES CAN PLAY AN ENERGY OR DATA MANAGEMENT ROLE.

Energy, told Bloomberg Business-

tion in home automation and energy

week. “When we think of who our

management — and the acquisition

competitors or partners will be, it

opens up a large array of potential ap-

ncreasingly, we are seeing inter-

will be the Googles, Comcasts, AT&Ts

plications to the ambitious company.

est in the power sector from

who are already inside the meter.”

Addressing a recent PwC roundtable

companies in the online, digital, and

These companies already have wires

on customer transformation, Google’s

data management world. They are

or wireless connections to custom-

chief technology advocate, Michael T.

looking at opportunities for media

ers’ homes and lives. For example,

Jones, talked of the potential for “all

and entertainment, home automation,

Google, which holds a wholesale

electronic devices (to) talk about their

energy saving, and data aggrega-

power license in the U.S., in Janu-

power needs to an aggregator, and

tion. “The battleground over the next

ary purchased smart-thermostat

you can have an auction for the power

ﬁve years in electricity will be at the

maker Nest Labs for $3.2 billion.

for each one. All you need is someone

house,” David Crane, CEO of NRG

Doing so gave Google a strong posi-

to identify what the rates are.”

have demonstrated capabilities in installing solar panels. It did, however, have demonstrated capabilities in managing the logistics, training, and compensation of a vast army of door-to-door salespeople. By the spring of 2014, when the company staged a successful initial public offering valuing it at $1.3 billion, its salespeople had persuaded 22,000 homeowners to place solar panels on their roofs. And by May 2015, it had installed panels with a generating capacity of 274 megawatts — equal to a utility-sized plant. Engineering and technology companies such as General Electric and Siemens have long been important players as equipment providers in larger-scale segments of the distributed energy market. But the growth and extension of distributed energy is blurring the boundaries between such companies and the power utility sector, at both the individual customer and community levels. For example, Siemens has been working on a project

with the Parker Ranch, a large agricultural operation in Hawaii, which is constructing a powerful microgrid as part of an effort to reduce operating costs. In a distributed energy community with its own grid or microgrid, companies other than power utilities can play an energy or data management role. New entrants to the data center market are putting together product and service offerings that are as much about the world of power as they are about the world of data. For instance, U.K. private equity–backed company Hydro66 offers data center space in northern Sweden, which is naturally cool and close to sources of hydroelectric power. Opower, a U.S.-based company, has used big data analytics, cloud computing, and insights into behavioral economics to craft efﬁciency-encouraging billing and communications solutions that are used by more than 90 utilities with a combined 32 million customers.

feature energy

Home Bases

feature energy 88

One signiﬁcant area of convergence is between the electric car and the energy storage and production sectors. Elon Musk, the founder of Tesla, and one of the founders of Solar City, stands at the junction of these efforts. Tesla is using the expertise and scale it has built in constructing advanced car batteries to offer a new home energy storage product called the Powerwall, which can store excess electricity produced by solar panels as well as provide backup power. Such system solutions have a bright future, both for incumbents and for newcomers. The notion of smart cities is based to a large extent on combining digital technology with efﬁcient, renewable sources of energy on the one hand, with urban planning and construction on the other; the result should be to raise people’s quality of life with new forms of transportation and better healthcare, water, and waste management services. For instance, technologies such as electric vehicles in combination with Internet applications provide the foundations for new transportation systems in metropolitan areas, including driverless cars. According to our 2015 Global P&U Survey, smart cities and communities will play an increasingly important role over the next decade. Strategies for Entrants and Customers

Businesses that use large amounts of electricity now have a wide range of options if they want to pursue opportunities in the evolving marketplace. • Become a producer. The distributed energy market allows all sorts of players to generate and sell energy. IKEA has put solar panels atop virtually all its U.S. stores. Waste Management, the largest garbage collector in the U.S., has found ways to pivot into electricity

production. By capturing the methane released in 130 landfills around the country, and harnessing it to make electricity on-site, Waste Management has become a significant producer of what the U.S. Environmental Protection Agency defines as renewable energy — its generating capacity, at about 500 megawatts, can provide electricity for about 400,000 homes. In addition to using or selling the electricity, Waste Management has turned these capabilities into a line of business, as it becomes a project manager and advisor to cities that want to build such systems at their own landfills. Self-generation has long been a tactic used by intensive energy businesses. For example, Scandinavian building products company Moelven says it has a goal of obtaining at least 95 percent of its energy needs from self-produced wood-chip bioenergy and of taking “an active role in the technological and market development of the bioenergy sector.” • Look at your own usage. Electricity used to be regarded as an immutable fixed cost. But today, thanks to all the changes we’re seeing, opportunities for savings abound. What was once a cost can quickly transform into a lever for profits and operational excellence. In the 2015 PwC Global P&U Survey, energyefficient technologies were singled out as likely to have the biggest impact on the power markets between now and 2030. However, saving energy is only one way to profit from the energy transformation. Shifting demand to periods when energy is more abundant and cheaper is another way for industrial production companies to reduce costs significantly. Earning money through flexibility of demand, often referred to as advanced demand-side management, is not yet well exploited. That’s because, among other

strategy+business issue 80

SAVING ENERGY IS ONLY ONE WAY TO PROFIT. SHIFTING DEMAND TO PERIODS WHEN ENERGY IS CHEAPER IS ANOTHER WAY FOR COMPANIES TO REDUCE COSTS SIGNIFICANTLY.

A Clear Trajectory

In a time of upheaval, companies need to see opportunities as much as they need to deal with threats. The energy transformation demands strategic decisions that should have board-level attention. Although policies and the ultimate shape of markets may be uncertain, the trajectory is clear. To date, concerns over climate change in conjunction with tech-

nological innovation have provided the main push for the transformation of the electricity industry. But we believe that as customers become more familiar with the tools at their disposal and as competition brings more compelling offerings, the technological pull will take over. That means that we are just scratching the surface. The potential for further disruption is immense — but so are the opportunities. +

feature energy

reasons, such flexibility is often not rewarded in the same way as the provision of energy. However, negative load — the term for the swift reduction of electricity use — can, at times, be as valuable to the power system as is the provision of energy. As markets shift from relying on fossil fuels to incorporating more renewable energy such as solar and wind (which are intermittent), markets for flexibility will need to be established to reward the shift of electricity demand. • Build power use into your brand. One of the unique factors at work in this environment is that for many companies, electricity use has become a part of the brand image. In the emerging world, the kind of power you use — and how you use it — is an integral component of your corporate culture. Power use becomes a way of differentiating yourself and aligning the corporation’s values with those of employees and local communities; it even becomes a form of marketing and advertising. In February 2015, Apple struck an $850 million deal with First Solar, under which the company will purchase the output of a giant solar farm to be constructed in California — enough to power its operations in the state. Doing so was part of Apple’s larger effort to be identified with low-emissions energy and to power all its global data centers with renewable electricity.

Reprint No. 00355

Resources Don Dawson, Earl Simpkins, and Josh Stillman, “Waiting for the Digital Grid,” s+b, Winter 2013: The modernized grid should revolutionize the way electricity is distributed and used, but its potential hasn’t yet been realized. “The Future of Electricity: Attracting Investment to Build Tomorrow’s Electricity Sector” (PDF), World Economic Forum, Jan. 2015: In-depth look at how the electricity sector can become more sustainable and reliable. PwC 18th Annual Global CEO Survey, 2015, “A marketplace without boundaries? Responding to disruption,” pwc.com/ceosurvey: Overview of chief executive attitudes. PwC 2015 Global Power & Utilities Survey, pwc.com/gx/en/utilities/ global-power-and-utilities-survey/index.jhtml: Looks at what is driving the change in the power sector and where it is leading. “Transforming America’s Power Industry: The Investment Challenge 2010–2030” (PDF), Edison Foundation, Nov. 2008: Finds that up to $2 trillion will be needed to build out the power capacity required in the United States. More thought leadership on this topic: strategy-business.com/energy

feature organizations & people

Neuroscience research shows how new organizational practices can shift ingrained thinking. BY HEIDI GRANT HALVORSON AND DAVID ROCK

for a position in which a new perspective would be valuable. But while reviewing resumes, you find yourself drawn to a candidate who is similar in age and background to your current staff. You remind yourself that it’s important to build a cohesive team, and make up your mind to offer her the job. Or suppose that you’re planning to vote against a significant new investment. This is the second time it’s come up, and you voted no before. A colleague argues that conditions have changed, the project would now be highly profitable, and you can’t afford to lose this opportunity. Upon closer examination, you see that his data is convincing, but you vote no again. Something about his new information just doesn’t feel relevant.

feature organizations & people

Beyond Bias

Illustration by Lincoln Agnew

IMAGINE THAT YOU ARE HIRING AN EMPLOYEE

feature organizations & people 92

David Rock david@neuroleadership.com is cofounder and director of the NeuroLeadership Institute, a global initiative bringing neuroscientists and leadership experts together. He is the author of Your Brain at Work: Strategies for Overcoming Distraction, Regaining Focus, and Working Smarter All Day Long (HarperBusiness, 2009). He is also the CEO of the NeuroLeadership Group, a global consulting ﬁrm.

These are examples of common, everyday biases. Biases are nonconscious drivers — cognitive quirks — that influence how people see the world. They appear to be universal in most of humanity, perhaps hardwired into the brain as part of our genetic or cultural heritage, and they exert their influence outside conscious awareness. You cannot go shopping, enter a conversation, or make a decision without your biases kicking in. On the whole, biases are helpful and adaptive. They enable people to make quick, efficient judgments and decisions with minimal cognitive effort. But they can also blind a person to new information, or inhibit someone from considering valuable options when making an important decision. A number of biases occur so often, in so many contexts, that cognitive scientists have given them names. (See “Common Biases,” next page.) Some, like the confirmation bias (which leads people to discount information that disagrees with their assumptions), have been critical factors in financial crises, including the one that began in 2007. This crisis also derived in part from the temporal discounting bias: Bankers chose to pursue immediate gains, even if that meant ignoring long-term risks. Two other common biases, the illusion of control and the planning fallacy, adversely affected Japan’s preparedness for the 2011 tsunami, as well as New York’s ability to recover from Hurricane Sandy in 2012. People overestimate the degree to which they can control the negative effects of a disaster and underestimate the time and effort it would take to prepare for one. All of these biases, and others, lead many great companies and institutions to make disastrous and dysfunctional decisions. In a hyperconnected world, where poor decisions

Also contributing to this article was Matthew D. Lieberman, director of the Social Cognitive Neuroscience Laboratory at UCLA.

can multiply as if in a chain reaction, breaking free of unhelpful bias has never been more important. That is why many large organizations are putting money and resources toward educating people about biases. For example, U.S. companies spend an estimated US$200 million to $300 million a year on diversity programs and sensitivity training, in which executives, managers, and all other employees are being told to watch out for biases, in particular when making hiring and promotion decisions. Unfortunately, there is very little evidence that educating people about biases does anything to reduce their influence. Human biases occur outside conscious awareness, and thus people are literally unaware of them as they occur. As an individual, you cannot “watch out for biases,” because there will never be anything to see. It would be like trying to watch out for how much insulin you are producing. How then can the negative effects of bias be overcome? Collectively. Organizations and teams can become aware of bias in ways that individuals cannot. Team-based practices can be redesigned to help identify biases as they emerge, and counteract them on the fly, thus reducing their impact. The first step is to identify the types of bias likely to be prevalent in organizations. To that end, we have grouped the 150 or so known common biases into five categories, based on their underlying cognitive nature: similarity, expedience, experience, distance, and safety. (Our research group has named this the SEEDS™ model.) Each category has defining features as well as mitigation strategies specific to that bias. Once you know which type of bias you are dealing with, you can put the strategies in place and make more effective decisions.

strategy+business issue 80

Heidi Grant Halvorson hghalvorson@ neuroleadership.com is a social psychologist. She is the associate director of the Motivation Science Center at the Columbia Business School and a senior consultant for the NeuroLeadership Institute. Her most recent book is No One Understands You and What to Do About It (Harvard Business Review Press, 2015).

Common Biases Experience

Similarity Ingroup Bias: Perceiving people who are similar to you (in ethnicity, religion, socioeconomic status, profession, etc.) more positively. (“We can trust her; her hometown is near mine.”)

Outgroup Bias: Perceiving people who are different from you more negatively. (“We can’t trust him; look where he grew up.”)

False Consensus Effect: Overestimating the universality of your own beliefs, habits, and opinions. (“Of course I hate broccoli; doesn’t everyone?”)

Expedience Base Rate Fallacy: When judging how probable something is, ignoring the base rate (the overall rate of occurrence). (“I know that only a small percentage of startups succeed, but ours is a sure thing.”)

Confirmation Bias: Seeking and finding evidence that confirms your beliefs and ignoring evidence that does not. (“I trust only one news channel; it tells the truth about the political party I despise.”)

Planning Fallacy: Underestimating how long it will take to complete a task, how much it will cost, and its risks, while overestimating its beneﬁts. (“Trust me, we can ﬁnish this project in just three weeks.”)

Availability Bias: Making a decision based on the information that comes to mind most quickly, rather than on more objective evidence. (“I’m not worried about car accidents, but I live in fear of airplane crashes since I saw one on the news.”)

Representativeness Bias: Believing that something that is more representative is necessarily more prevalent. (“There may be more qualified programmers in the rest of the world, but we’re staffing our software design group from Silicon Valley.”) Hot Hand Fallacy: Believing that someone who was successful in the past has a greater chance of achieving further success. (“Bernard Madoff has had an unbroken winning streak; I’m reinvesting.”) Halo Effect: Letting someone’s positive qualities in one area influence overall perception of that individual. (“He may not know much about people, but he’s a great engineer and a hardworking guy; let’s put him in charge of the team.”)

Fundamental Attribution Error: Believing that your own errors or failures are due to external circumstances, but others’ errors are due to intrinsic factors like character. (“I made a mistake because I was having a bad day; you made a mistake because you’re not very smart.”) Hindsight Bias: Seeing past events as having been predictable in retrospect. (“I knew the ﬁnancial crisis was coming.”)

Illusion of Control: Overestimating your inﬂuence over external events. (“If I had left the house a minute earlier, I wouldn’t have gotten stuck at this trafﬁc light.”) Illusion of Transparency: Overestimating the degree to which your mental state is accessible to others. (“Everyone in the room can see what I am thinking; I don’t have to say it.”) Egocentric Bias: Weighing information about yourself disproportionately in making judgments and decisions — for example, about communications strategy. (“There’s no need for a discussion of these legal issues; I understood them easily.”)

Distance Endowment Effect: Expecting others to pay more for something than you would pay yourself. (“This is sure to fetch thousands at the auction.”) Affective Forecasting: Judging your future emotional states based on how you feel now. (“I feel miserable about it, and I always will.”)

Temporal Discounting: Placing less value on rewards as they move further into the future. (“They made a great offer, but they can’t pay me for ﬁve weeks, so I’m going with someone else.”)

Safety Loss Aversion: Making a riskaverse choice if the expected outcome is positive, but making a risk-seeking choice to avoid negative outcomes. (“We have to take a chance and invest in this, or our competitors will beat us to it.”) Framing Effect: Basing a judgment on whether a decision is presented as a gain or as a loss, rather than on objective criteria. (“I hate this idea now that I see our competitors walking away from it.”)

feature organizations & people

Belief Bias: Deciding whether an argument is strong or weak on the basis of whether you agree with its conclusion. (“This logic can’t be right; it would lead us to make that investment I don’t like.”)

Anchoring Bias: Relying heavily on the ﬁrst piece of information offered (the “anchor”) when considering a decision. (“First they offered to sell the car for $35,000. Now they’re asking $30,000. It must be a good deal.”)

Blind Spot: Identifying biases in other people but not in yourself. (“She always judges people much too harshly.”)

Sunk Costs: Having a hard time giving up on something (a strategy, an employee, a process) after investing time, money, or training, even though the investment can’t be recovered. (“I’m not shutting this project down; we’d lose everything we’ve invested in it.”)

You can’t change your bias of preference for the ingroup, but you can bring more people into that afﬁliation. Pay attention to the goals, values, and experiences you share with the outgroup.

feature organizations & people 94

“People like me are better than others.” If you are like most people, you are highly motivated to focus your attention on anything that portrays you in the best possible light. This motivation affects the way you perceive other people and groups. The similarity biases are part of your brain’s natural defenses; they promote and protect those associated with you — including your family, team, and company. But they also perpetuate stereotypes and prejudice, even when counterproductive. The two most prevalent forms of similarity bias are ingroup and outgroup preferences. You hold a relatively positive perception of people who are similar to you (the ingroup) and a relatively negative perception of those who are different (the outgroup). Even when you are not aware of these two biases, they are reﬂected in your behavior. For example, as described earlier, you are more likely to hire ingroup members — and once you hire them, you’re likely to give them bigger budgets, bigger raises, and more promotions. Social neuroscience research has shown that people perceive and relate to ingroup and outgroup members very differently. In fact, merely assigning people to arbitrary teams creates great liking for fellow members of the team, less liking for members of other teams, and greater activity in several brain regions involved in emotions and decision making (the amygdala, orbitofrontal cortex, and striatum) in response to ingroup faces. Similarity biases affect many decisions involving people, including what clients to work with, what social networks to join, and what contractors to hire. A purchasing manager might prefer to buy from someone who grew up nearby, just because it “feels safer.”

A board might grant a key role to someone who most looks the part, versus someone who can do the best job. The bias is unfortunate because research (including that done by Katherine Phillips) has shown that teams and groups made up of people with varying backgrounds and perspectives are likely to make consistently better decisions and execute them more effectively. The best way to mitigate similarity bias is to find commonalities with those who appear different. You can’t change your bias of preference for the ingroup, but you can bring more people into that affiliation. Pay attention (and bring your team’s attention) to the goals, values, experiences, and preferences you share with the outgroup. This causes the brain to recategorize these individuals and thus create a more level playing field. For hiring and promotion decisions, remove potentially biasing information or features (name, sex, ethnicity) from formal materials. Even though people can’t help but be aware of ethnicity and gender in any face-to-face encounter, the absence of formal written reinforcing cues can help. Instead, cue similarity: Pepper the documents with references to the ways in which different types of people contribute, or how someone is “one of us.” Studies have found, for example, that considering a man and a woman for promotions at the same time leads to fairer treatment of both than considering either person alone. Expedience Biases

“If it feels right, it must be true.” Expedience biases can be described as mental shortcuts that help us make quick and efﬁcient decisions. As Daniel Kahneman pointed out in Thinking, Fast and Slow, the human brain has two parallel decision-

strategy+business issue 80

Similarity Biases

cess, as well as implementing a mandatory “cooling off” period (10 minutes of relaxation or a walk outdoors) before making decisions under pressure. Experience Biases

“My perceptions are accurate.” The human brain has evolved to regard its own perceptions as direct and complete. In other words, people tend to assume that what they see is all there is to see, and all of it is accurate. But this attitude overlooks the vast array of processes within the brain that construct the experience of reality. Your expectations, past experiences, personality, and emotional state all color your perception of what is happening in the world. Experience biases are particularly pernicious when they breed misunderstandings among people who work together. If you hold a strong conviction that you see reality as it is, you assume that anyone who sees things differently must be either incorrect or lying. As social neuroscientist Matthew Lieberman has noted, when two people each think the other person is crazy, mean, stupid, prejudiced, dishonest, or lazy, there is often an experience bias at work. It is very difficult to convince someone who has an experience bias that he or she might be the one who is mistaken. These biases are similar to visual illusions — even if you logically know that it is an illusion, your intuitive experience of it remains powerful. You may find it easy to identify other people’s biases, but not your own. (That’s known as the blind spot bias.) You might also fall prey to the false consensus effect: overestimating the extent to which others agree with you or think the same way you do. For example, if you prefer vanilla to chocolate ice cream, you are likely to think that most people have the same preference. People who prefer chocolate, however, will also assume that they are in the majority. In an organizational setting, this assumption can lead to unnecessary conflicts, especially if leaders assume that many others agree with their preferences, and make decisions accordingly. Experience biases often manifest themselves when you try to influence others or sell an idea. On a sales call, you might not realize that other people are less excited by your product than you are. When making a presentation, you might forget that others do not know the context. If you are a senior leader pushing for a major organizational change, you might not see that others don’t agree, or that they have legitimate concerns. Experience biases respond to an organizational ap-

feature organizations & people

making systems. “System 1” relies on information that can be retrieved without much effort: Its associations “feel right.” That’s what makes it expedient. When people need to make decisions based on more objective, less accessible information, the brain’s “System 2” has to get involved. System 2 is slower, more difficult to engage, and less pleasurable. It can be called upon to correct System 1’s mistakes, but it requires more cognitive effort and concentration. Most people naturally tend to favor System 1. One very common form of expedience bias is the availability bias. This is the tendency to make a decision based on the information that’s most readily accessible in the brain (what comes to mind most quickly) instead of taking varied perspectives into account. This bias inhibits people from looking for and considering all potentially relevant information. It can thus block the brain from making the most objective and adaptive decisions. The case of the lost investment described at the beginning of this article shows the subtle, corrosive influence of the availability bias. Expedience biases tend to crop up in decisions that require concentrated effort: complex calculation, analysis, evaluation, or the formation of conclusions from data. A sales rep or consultant who automatically reverts to a few familiar solutions, instead of really listening to client problems, is probably suffering from an availability bias. So is a doctor who assumes a new patient has a familiar condition, without more carefully analyzing the diagnosis. These portrayals of expedience bias are examples themselves, since they draw conclusions without fully exploring the details of the sales rep’s or doctor’s decision making. Expedience biases tend to be exacerbated when people are in a hurry or are cognitively depleted — exhausted from stress and multiple decisions. To mitigate the bias, you have to provide incentives for people to step off the easier cognitive path. Create incentives for them to challenge themselves and others, perhaps by identifying their own mistakes, and foster a culture that encourages this. For instance, you might relax a deadline to allow more time for considering alternatives, or ask a sales rep to lay out the reasoning behind his or her approach with a client, encouraging both yourself and the rep to identify flaws in the logic. You can also mitigate expedience biases by breaking a problem into its component parts. It may help to involve a wider group of people and get some outside opinions as part of the typical decision-making pro-

It is difﬁcult to manage for bias in the moment you’re making a decision. You need to design practices and processes in advance.

Distance Biases

“Near is stronger than far.” Proximity is a salient unconscious driver of decision making. Brain scan studies have shown that one network in the brain registers all types of proximity — conceptual proximity, such as whether or not you own an object, as well as proximity in space and in time. The closer an object, an individual, or an outcome is in space, time, or perceived ownership, the greater the value assigned to it. For example, given the choice between receiving $100 today and $150 tomorrow, most people will (quite rationally) wait a day to get the larger sum. But when the choice becomes $100 today versus $150 three months from now, the majority will choose the lesser but more immediate payment — despite the fact that there are very few other ways to earn a guaranteed 50 percent return on investment in three months. Thanks to a distance bias called temporal discounting, the further away in time the $150 is, the more its value decreases. Psychologically, $100 is worth more than $150 when time is a factor. Distance bias often manifests as a tendency toward short-term thinking instead of long-term investment. It can also lead you to neglect people or projects that aren’t in your own backyard — a particular problem for

global organizations whose managers must oversee and develop business and human capital at great distances. To mitigate this kind of bias, take distance out of the equation. Evaluate the outcome or object as if it were closer to you in space, time, or ownership. This orients you to recognize its full value. Of course, you will still consider time and physical distance as factors when making decisions. For example, as business strategy writer Pankaj Ghemawat has pointed out, the geographic and cultural distance of another country should affect any plans you have to expand your business there. And those elements should be consciously considered in the decision-making process, without the unconscious inﬂuence of a bias that might lead to an inferior conclusion. Safety Biases

“Bad is stronger than good.” The fact that negative information tends to be more salient and motivating than positive information is evolutionarily adaptive. A hunter–gatherer whose brain responds quickly to the threat of a snake would be more likely to survive than one whose brain responds first to the charm of its colorful markings. That’s why, for most people, losing $20 feels worse than finding $20 feels good. This principle manifests itself in safety biases such as loss aversion. When considering a transaction or investment, regardless of the merits of the deal, you are likely to be attracted if you perceive it as a way to avoid a loss rather than as a potential opportunity to gain. You may think of yourself as strongly oriented toward winning, but your actions are likely more influenced by the need to avoid losing, a very different concern.

strategy+business issue 80

feature organizations & people 96

proach, so put systems into place that minimize their inﬂuence. For example, you can set up practices for routinely seeking opinions from people who are not on the team or project. Other techniques include revisiting ideas after a break to see them in a fresh, more objective light, or setting aside time to look at yourself and your message through other people’s eyes.

Managing for Bias

All of the mitigation strategies described in this article engage the brain’s ventrolateral prefrontal cortex, which acts, in this case, like a braking system helping you exercise cognitive control and broaden your attention beyond your own, self-specific viewpoint. As you identify and mitigate biases in your organization, keep four general principles in mind: 1. Bias is universal. There is a general human predisposition to make fast and efficient judgments, and you are just as susceptible to this as anyone else. If you believe you are less biased than other people, that’s probably a sign that you are more biased than you realize. 2. It is difficult to manage for bias in the moment you’re making a decision. You need to design practices

and processes in advance. Consciously identify situations in which more deliberative thought and strategies would be helpful, and then set up the necessary conversations and other mechanisms for mitigating bias.

3. In designing bias-countering processes and practices, encourage those that place a premium on cognitive effort over intuition or gut instinct. 4. Individual cognitive effort is not enough. You have to cultivate an organization-wide culture in which people continually remind one another that the brain’s default setting is egocentric, that they will sometimes get stuck in a belief that their experience and perception of reality is the only objective truth, and that better decisions will come from stepping back to seek out a wider variety of perspectives and views. Although more research and development needs to be done on both the theory and practice of breaking bias, we believe that this approach can provide a useful step forward. By reducing the unhelpful biases that are at the heart of many organizational challenges today, not only do you reduce the risk of catastrophic loss — you redeﬁne what it means for an organization to win. + Reprint No. 00345

Resources Mahzarin Banaji and Anthony Greenwald, Blindspot: Hidden Biases of Good People (Delacorte Press, 2013): Two influential researchers explain many biases, including the ingroup and outgroup fallacies, with perspective and detail. Daniel Kahneman, Thinking, Fast and Slow (Farrar, Straus and Giroux, 2011): Describes the fundamental theory of biases and their influence, based on the brain’s two parallel operating systems. Matthew D. Lieberman, Social: Why Our Brains Are Wired to Connect (Broadway Books, 2014): Community perspective — seeing ourselves as others would see us — is a powerful way of counteracting bias and other harmful impulses. Katherine Phillips, “How Diversity Makes Us Smarter,” Scientific American, Sept. 16, 2014: Why teams with people from different backgrounds are more creative, more diligent, and more hardworking. David Rock, “Managing with the Brain in Mind,” s+b, Autumn 2009: As with biases, people bring cognitive responses to work, and they need to be managed deliberately, not intuitively. NeuroLeadership Institute Breaking Bias Research Project, www.neuroleadership.com/talent-challenges/bias/: More information on the SEEDS™ model and other research in this field. More thought leadership on this topic: strategy-business.com/organizations_and_people

feature organizations & people

Another safety bias is the framing effect, first identified by Amos Tversky and Daniel Kahneman in 1981. When an opportunity is framed as a gain, people tend to be relatively conscious of the risk involved. But if the risk is framed as a way to avoid a loss, people are more likely to ignore or justify it. This is true even when the objective information is the same in both cases. Safety biases can influence any decision about the probability of risk or return, or the allocation of resources including money, time, and people. These biases affect financial decisions, investment decisions, resource allocation, strategy development, or planning for strategy execution. Examples include not being able to let go of a business unit because of resources already invested in the project and not being willing to innovate in a new direction because it would compete with the company’s existing business. To mitigate safety bias, you can conduct conversations that add psychological distance to the decision. Imagine that you are giving advice to someone else rather than making the decision for your own enterprise. When making decisions for others, you can be less biased because the threat network is not as strongly activated. Or imagine that the decision has already been made, and you are seeing it from a later point in time. Studies suggest that recasting events this way, deliberately evoking a more objective, distanced perspective, makes those events less emotional and less tied to the self.

THOUGHT LEADER

Lotte Bailyn: The Thought Leader Interview For more than 50 years, the MIT professor has challenged companies and policymakers to redeﬁne the rules of work and family.

thought leader 98

otte Bailyn hates the phrase work–life balance. “Work–life” implies that the two exist in separate spheres. And “balance” implies that there’s a trade-off to be made. For Bailyn, the T Wilson Professor of Management, emerita, at MIT’s Sloan School of Management, the very existence of that phrase helps explain why organizations are still largely getting it wrong for both women and men. Bailyn was born in Vienna, but came to the United States as a child and was raised in New York City. Her

parents, both academics, were Jewish; the family ﬂed Austria in 1937, just before the Nazi occupation. After earning a Ph.D. in social psychology from Harvard University (then Radcliffe for women) in 1956, she found herself, like many of her female contemporaries, without any serious job opportunities. She took temporary research positions and raised her two sons. (Her husband, Bernard Bailyn, is a two-time Pulitzer Prize–winning historian at Harvard.) It was only in 1972, at the age of 42, that she started on the tenure track at MIT.

The late 1960s and 1970s were a dynamic time for women and families. Women entered the U.S. workforce in increasing numbers, challenging traditional gender roles and household structures. Between 1960 and 1980, the proportion of women in the workforce rose from 36 percent to 48 percent. Bailyn began interviewing couples, trying to understand how these changes affected people’s lives at home and their performance on the job. But gradually she came to realize that gender diversity wasn’t an isolated issue. Everyone has a life outside work, whether that life is deﬁned by parenthood, ongoing care for an elderly parent or sick relative, membership in a community organization, or any number of other responsibilities and interests. When Bailyn started talking to employees in organizations, she found that these priorities were nearly always in conﬂict with traditional expectations about productivity and success. Bailyn wrote Breaking the Mold: Men, Women, and Time in the New Corporate World (Free Press, 1993) to warn executives that their obsession with time as a measure of commitment, and by extension competence, was creating a situation that

BY LAURA W. GELLER

these benefits will have negative consequences for their compensation or advancement. Bailyn believes that even the most progressive policies fail to address the core issues and assumptions that underlie how people and organizations interact. Our society is still compartmentalizing “work” and “life,” looking for a way to even the scales, when we should be rethinking the perspective that values time as the ultimate capital. In systems based on such a mind-set, success comes to those who seem to be working the hardest, because they are always accessible. People cling to an outmoded view that work should be done by specific people at specific times, as determined by managers and company leaders. For much of the last half century, Bailyn has argued for a different approach. Work is completed most effectively, she says, when people are empowered to come together and figure out how to manage that work collectively, taking into account both the organization’s needs and one another’s needs outside the office. “The goal,” she wrote in the 2006 revised edition of her book, “is to break the mold of traditional assumptions; the hope is that the needs of organizations and employees can be brought into constructive harmony.” Bailyn spoke with strategy+ business this spring, in her office at the Sloan School in Cambridge, Mass. Now in her 80s and a grandmother of two girls, Bailyn still comes to the office several days a

week to work with students and participate in MIT diversity initiatives. Today, as debates over raising the minimum wage, providing paid sick leave and parental leave, and managing the cost of care gain traction, her pioneering work is particularly relevant. Companies have reason to value her insights, and Bailyn — her passion for understanding the complex relationship between people and organizations as strong as ever — is ready to share them. S+B: You chose a career in academia at a time when opportunities for women were limited. BAILYN: When I arrived at Harvard

in 1951, there were no fellowships for the Radcliffe Ph.Ds. There were no dorms for female graduate students. The college library was open only to men. Women had to enter the faculty club through a back door, and couldn’t sit in the main dining room. My husband-to-be was just finishing his dissertation at Harvard at the time, and when he told his advisor about my professional aspirations, the response was, “Does she type?” Even after I earned my Ph.D., I couldn’t find a job. My first position, doing research, was one that a male colleague had turned down. After that, I held a series of positions, some half-time, some fulltime — a research associate here, a lecturer there.

thought leader

would be unsustainable for the modern workforce in the long run. “Private life and public life can no longer be seen as conceptually separate,” she noted in the introduction. “Too much is at stake: the equanimity of employees, the welfare of families and communities, and even the long-run viability of American companies…. Appropriate responses to this situation go to the heart of the way that work is organized and rewarded.” The book, far ahead of its time, didn’t garner much notice — although it did come out the same year that the U.S. Congress passed the Family and Medical Leave Act, still the only federal law protecting the jobs of new parents or people caring for seriously ill relatives. (It provides unpaid leave, and covers only 60 percent of the workforce.) More than 20 years later, business has been fundamentally revolutionized by globalization, technology, and demographic changes. But the tensions persist, and companies are now recognizing them as a factor holding back productivity and competitiveness. Many businesses have implemented well-meaning policies designed to offer employees the opportunity to manage their personal and professional commitments. Human resources teams have added bereavement leave, compassionate leave, adoption leave, personal days, mental health days, and a host of other options to their menus. But like the meditation and relaxation rooms increasingly available at large ofﬁces, they often go unused. Employees fear that taking advantage of

S+B: What were you studying during those years? BAILYN: In the early 1960s, I at-

tended a conference sponsored by

thought leader 100

Daedalus called “The Woman in America.” I wasn’t sophisticated about gender issues back then, but I remember thinking, Isn’t that a funny name? Would anybody run a conference called “The Man in America”? In the late 1960s, when my family was on sabbatical in England, I started working with Bob and Rhona Rapoport. They were pioneers in the work–family ﬁeld, and wrote an inﬂuential book on the subject called Dual-Career Families [Penguin Books, 1971]. People were just beginning to talk about women working outside the home and what effect that might have on their children, and what husbands had to say. I was interested in a question that I hadn’t heard anyone else asking: What were men’s attitudes toward their own work, and what effect did that have on their partners’ careers and on the relationship? While still in the U.K., I took a sample of couples from the Rapoports’ study of British college graduates, and found that husbands with a traditional focus on career over family not only undermined their wives’ ambitions, but also decreased both partners’ satisfaction with the relationship. When we returned to the States,

I started working on a study of MIT alumni. I compared men who bought in completely to the notion that their identity depends on their careers and worked long hours with men who were more involved with their communities and families. The latter group had more positive relationships with their families, but many of them found their work lives somewhat problematic. Being engineers, they found that the people skills they honed outside work weren’t valued by their companies, and so they lost confidence. Some of this research became the basis for my first book, Living with Technology: Issues at Mid-Career [with Edgar H. Schein; MIT Press, 1980]. These studies opened my eyes to the problems inherent in thinking about work and personal life as separate spheres — and to the fact that organizations were leaving valuable skills on the table because of traditional views of success and what it takes to succeed. S+B: How did you start to connect these ideas with managerial practice? BAILYN: My first experience work-

ing in organizations, in the late 1970s and early 1980s, was in R&D

ﬁrms. These companies hired Ph.D. scientists, assuming that they wanted to work autonomously. They let the scientists choose what they wanted to do their research on. Then, when the companies didn’t get what they needed from the scientists, they started putting controls on them. So they gave them strategic autonomy, and then implemented operational controls. As I began to talk to the scientists and some engineers, I discovered this was exactly the opposite of what they needed to do their best work. They chose to come into industry because they wanted to contribute to the organization. They wanted to be told what goal they should work toward. But then they wanted to be left alone to execute in their own way. Instead, they were supposed to set their own goals, but were then being told how to accomplish them. The organizations’ assumptions didn’t align with what people really needed to be productive. When I starting working on a project at Xerox, funded by the Ford Foundation, in the early 1990s, my colleagues and I began to identify more of the typical assumptions that stood in the way of productive work.

strategy+business issue 80

Laura W. Geller geller_laura@ strategy-business.com is senior editor of strategy+business.

Many of these assumptions still exist today. One is the notion of the ideal worker — the worker who has complete allegiance to the organization, is always accessible, and shows commitment by being willing to do anything at any time. Related to this is the notion that companies can evaluate people’s commitment and competence by seeing how much time they spend at work. These assumptions lead to certain practices. For example, a manager can call a meeting anytime and

books. However, not very many people were taking advantage of them, particularly not men, and not even all women. And it wasn’t helping women move up within organizations. The premise of Breaking the Mold was that such policies weren’t helping either the employees or their companies because the policies were ﬁghting against basic assumptions and the practices that resulted from them. At Xerox, we were able to test this hypothesis. When we started

“We tried to show company leaders they didn’t have to worry that legitimizing people’s personal lives would interfere with their work.”

S+B: That sounds like the foundational assumption of Breaking the Mold. BAILYN: By the time I started work-

ing on the book, consulting companies had started to help organizations with things like child-care referral, to enable more women to enter and stay in the workforce. In fact, some progressive companies had multiple family policies on the

the project, we saw how difﬁcult it was to bring the domains of family and work together. As we interviewed people about both aspects of their lives, they would often respond by saying, “Why are you asking us about our work? You’re the work– family people.” The connotation was, “Aren’t you just here to help draft some family policies to help out these poor mothers, who can’t be good workers?” At the time, that was how this topic was understood. But organizations were changing rapidly. The days of a homogeneous workforce doing homogeneous work were quickly fading — replaced by more diversity and teamwork. Based on our interviews, in which we asked

S+B: Can you give us a few examples of these dysfunctional practices? BAILYN: We worked with business

units, pointing out how certain practices not only were making life difﬁcult for employees, but also weren’t working for the company. We tried to show company leaders they didn’t have to worry that legitimizing people’s personal lives would interfere with their work. In fact, when we started experimenting with different ways of working, we set out to try to change organizational practices and procedures in such a way that it wouldn’t hurt productivity. But it turned out that it actually helped productivity. For example, by throwing time at problems, managers were burning out their employees. By asking people to work such long hours, companies were also creating a sort of rigidity. But research has shown that creativity and innovation require time for reﬂection. Moreover, we know that if you constrain time,

thought leader

everyone will drop everything to attend. Of course, this modus operandi only works if there’s someone at home who’s taking care of everything else. And even though this is less likely today to be the case, the assumptions and practices persist.

people what it was about their work that made their lives difﬁcult, we could show how old assumptions and old practices weren’t effective for this new way of working. Once you point out the dysfunctional practices, the possible solutions actually become obvious. But these practices are typically so ingrained in the everyday workings of the organization that people just assume this is the way things have to be to get the work done. It takes an explicit bringing together of work and personal issues to draw them out.

101

Challenging Assumptions S+B: What was the response to Breaking the Mold? BAILYN: I got very little reaction to

the book when it came out [in 1993]. At the time, there wasn’t much mainstream academic research on work–family issues. I hoped that the book would inﬂuence business schools, and what they teach. For a

while I taught a course on these topics. But it was pretty marginal. It attracted more Wellesley students and MIT undergraduates than MBAs. But then slowly, afterward, attention began to pick up. By the time the revised edition of the book came out in 2006, work–family integration had become a huge field. However, it still wasn’t dealing with the issues as I think it should have been. Researchers were approaching the issues on a very individual level, by considering all the antecedents of work–family conflict. But they weren’t linking this conflict to organizational processes. And even when they did, they were focused more on job flexibility. Now, this approach is

what they work out, because he or she is afraid of setting a precedent. That makes it even worse when people inevitably find out. What if, instead, organizations promoted these arrangements? One group I worked with advertised flexible arrangements and gave prizes for the most innovative ones. They then gathered metrics showing how strong the resulting performance was, and advertised those metrics. This is important, because when other groups see success, the ideas spread. In one of the first organizations we worked in, the manager, based on our analysis, told his group that “anybody can take advantage of any of the flexible policies they want, as

“Nobody wanted to take the time to plan and be proactive in a system where individual heroics were rewarded.” very important. But it doesn’t get to the heart of how work is being done or to the assumptions that affect the extent to which work–family policies are going to help anybody. The conversation continued to be about individuals, rather than about individuals coming together, being forthcoming about their needs outside the ofﬁce, and then deciding collectively how they were going to accomplish their work. S+B: Can you say more about that? BAILYN: The typical way that ﬂexi-

bilities are managed in companies is the employee has a one-on-one conversation with the supervisor. The supervisor will often admonish the employee not to tell anybody about

long as the work gets done.” It turned out that everybody wanted something different. That included men, and people without children. Further, the supervisors soon realized they could not deal with all requests one-on-one — they had no choice but to let their groups deal with it among themselves. And what happened? People learned to delegate and to trust one another. Absenteeism went down and customer service went up, and people’s lives eased considerably. We termed it the dual agenda — meeting personal and business needs simultaneously. This way of working also enables development. I knew one manager who arranged with her boss to work from home one day a week.

strategy+business issue 80

thought leader 102

people work more intelligently. And from our own experience, we knew that if people work for 10 hours, they are never as productive as they are in the ﬁrst two. It’s not a linear relationship. We also sought to identify the “heroes” in the organization. Typically, they were people who came to a meeting with a problem, and then came up with a solution to that problem. In other words, they were heroes even if they had created the problem in the ﬁrst place. In this type of system, nobody received any kudos for preventing a problem. We could show that business units were getting into crisis mode, running from one problem to the next, because nobody wanted to take the time to plan and be proactive in a system where individual heroics were rewarded. I once worked with an engineering group in which the manager told us that one of his employees was the glue of the group. The group would fall apart if he wasn’t there. And yet the manager couldn’t get this employee promoted, because the criteria for promotion didn’t include skills like coordination and keeping operations running smoothly. Over the years, in various organizations, I saw a lot of that. Relational work was being undervalued, to the companies’ detriment.

S+B: Still, many companies now offer the ﬂexible work arrangements that you talked about in your books. But the number of people who take advantage of them remains limited. BAILYN: Joan Williams, founding

director of the Center for Work–Life Law at the University of California’s

Hastings College of the Law, coined the term flexibility stigma to explain this phenomenon. Even though research (and practice) has shown that flexible arrangements work well both for people and for productivity, it goes against the basic assumptions that I’ve been describing. It also conflicts with many organizations’ view of their workers as a cost. In addition, protections offered by public policy are totally uneven. For example, some states, such as California and Connecticut, guarantee most employees some sick leave [a California state law mandating paid sick leave took effect on July 1, 2015]. In other states, it’s the furthest thing from legislators’ minds. Some cities have passed sick leave laws, but they often face battles with state government — this is playing out in Philadelphia even as we speak. On a national level, family policies in the U.S. are the weakest of any industrial country. The U.S. is a highly individualistic, achievementoriented society where identity is tied up with occupational success — as evidenced by the “what do you do?” conversation starter. Our policies reflect a belief that families and children are an individual choice,

and if you decide to have them, it’s your responsibility to take care of them. Of course, this way of thinking ignores how intertwined we all are. Children aren’t just an individual choice, they’re a social good: They are the future workforce, and your well-being as an older person will depend on their success. The fate of the economy and the fate of families are deeply connected. At the moment, many groups are trying to improve public policy on these issues. The U.S. Department of Labor, for example, kicked off its #LeadOnLeave campaign in September 2014 to encourage dialogue and experiments (through grants) on paid family leave — it’s a critically important initiative. But like ﬂexible work arrangements, many of today’s efforts don’t get at the heart of the problem, which resides in the expectations for the way work is being accomplished. Moreover, even though there’s been more talk about paternity leave in recent years, most of the debate around work–family issues still centers on women. There’s a long way to go to make this a conversation about everyone. It’s worth noting that many European countries see their workforce

thought leader

On the days when she was working remotely, her direct reports alternated being “in charge.” They gained valuable experience, which beneﬁted them personally, and was also useful for succession. In many ways, this goes back to Douglas McGregor’s Theory Y [as described in his book The Human Side of Enterprise (McGraw-Hill, 1960)]: If you think of your workforce as an asset, and assume that people are motivated and creative, they’ll ﬁgure out how to make all kinds of situations work to get the job done. A great example was Best Buy’s experiment ROWE, or the “results-only work environment.” Best Buy’s initiative yielded impressive results, but was killed in 2013 when a new CEO undertook a turnaround effort. This was right around the time that Yahoo ended its telecommuting policy.

103

gether people with different needs to accomplish these different tasks. Companies have to understand that people’s lives are more than just their work — that there is a deep connection between what people can do economically and what they face in their personal lives. If we don’t allow that connection to inﬂuence

“Senior leaders need to realize that the way they reached the top might not be the only way to do it.”

thought leader 104

the U.K. expanded its ﬂexible work rules to make all employees (not just those who are caretakers) eligible to request such arrangements. In addition, mandatory vacation is common in much of Europe, ensuring people have time to reﬂect and relax. Meanwhile, in the U.S., some companies are now giving employees endless or unlimited vacation. But that will never work. It looks nice on paper, but the majority of employees won’t take advantage of it for the reasons we’ve discussed. Beyond Flexibility S+B: What should company leaders be doing differently? BAILYN: For one thing, they need to

think less about the amount of time committed, and individual input, and instead consider the kinds of tasks that have to be done and what’s needed to do them. They would then realize that they can bring to-

the way we do the work, we’re going to hurt the company, people, and society in the long term. We’ll create a crisis of care. Critically, senior leaders also need to realize that the way they reached the top might not be the only way to do it. And in fact, in light of changes both in the makeup of the workforce and in the way that work is done as a result of new technologies, globalization, and so on, the way they did it may very well no longer be the most effective way. Of course, it’s very hard for people who have gone through one system to think, “Maybe I didn’t have to do it like this.” Once you’ve made sacriﬁces, it’s not easy to turn around and say to someone else, “You can do it differently, and have a more integrated life.” Finally, managers and company leaders need to think of themselves as role models. They have to stop modeling the old way of doing

things, and start modeling a new, more learning-based existence. If the CEO says that workers can take time off any time they need it, but he or she is at the office or connected all day and night, such policies are not going to mean anything. Middle managers are always the most resistant, because they feel they have the most to lose. But the reality is that they have many working years left, and should try to visualize a different way of working — one that is more effective and less stressful. Many companies are setting up wellness programs and promoting meditation, among other things. And that’s fine. But what if, instead, you were able to eliminate some stress by rethinking the practices that are causing it in the first place? S+B: Who is getting it right today? What are some of the initiatives that have the potential to make a difference? BAILYN: One of the people on our

Xerox research team, Leslie Perlow, is now a professor at the Harvard Business School. She wrote a book that’s made a big splash, called Sleeping with Your Smartphone [Harvard Business Review Press, 2012]. Leslie discovered that it wasn’t so much the long hours that bothered the people in her study, but rather the unpredictable hours. She conducted an experiment at a professional-services ﬁrm in which one night, from 6 p.m. to 9 a.m., each person on the team had to take time off. They would rotate; the dates

strategy+business issue 80

more as an asset to be managed. It’s a different way of thinking. The Scandinavian countries give ample paid leave for child care. Sweden allows parents to take 480 total hours per child, which can be used until the child is 8 years old — and a percentage of those hours is speciﬁcally dedicated to fathers. In June 2014,

law to push for change. For example, Joan Williams’s Center for Work–Life Law pursues cases in which people have been discriminated against by their employers because of adjustments made as a result of family issues. It’s called family responsibilities discrimination, or caregiver discrimination. These cases tend to be more successful than, say, tenure denial cases, which are usually based on some form of gender discrimination. S+B: Is it possible that as our workforce gets more and more diverse, the system will start to shift organically? BAILYN: I hope so. Company lead-

ers will need to seek out the talent of people who think differently, who have different values. Of course, one possibility is that they’ll select from the smaller and smaller group of gung-ho people, and the system won’t change — the top will just reproduce itself. But I think a shift is more likely. Recently, we’ve seen some companies beginning to respond to the challenges faced by low-wage workers. A growing number of companies — IKEA, Walmart, Target, and McDonald’s, among others — have raised or plan to raise the wages of their lowest-paid workers. Facebook announced in May 2015 that it would require its contractors to pay their employees a US$15 per hour minimum wage, plus some leave beneﬁts. These are important changes. But there’s still a major issue that affects many low-wage workers that is not yet being addressed to a large degree: the unpredictable nature of their jobs. Last-minute changes to their work schedules, which can be quite common, create havoc with

Stay informed. Keep current. Start a dialogue. PwC’s 365® app for iPad® and iPhone®

365®: Advancing business thinking every day. pwc.to/Get365

Free download on the App Store

thought leader

were set up beforehand, and couldn’t be changed (at least not for work reasons). On the night off, the employee couldn’t have any connection with work whatsoever. The group soon realized it would have to meet once a week to figure out how to make this possible for everybody. They had to team up, so that there was always another person available in case an urgent client need arose. In the process, they started talking more about how to deal with their clients, which they had never had time to do before. And they began to talk more about personal issues and personal needs. Attrition rates improved significantly. Down the road, Leslie talked to the clients, and they were happy because they were confident that they could always reach somebody. It’s a strong example of how bringing together people’s personal needs with the business’s needs benefits everyone in the end. Elsewhere, some interesting and important work is being done at the ThirdPath Institute, based in Philadelphia. It was founded by Jessica DeGroot, who is a Wharton MBA. She started with the concept of “shared care,” helping parents redesign their work lives so that both partners could support the family financially and care for their children. She’s since expanded to work with organizations that want to help people live what she calls integrated lives (the “third path”), and is growing a community of “integrated life advocates” who can share their stories and spread their influence within their companies and at the public policy level. The fact that an organization like ThirdPath exists is significant, because it’s making tools and resources available. In addition, others are using the

105

S+B: Today’s workplace is markedly different from the workplace you studied earlier in your career. But it’s plagued by some of the same core problems. BAILYN: I think the trouble with

thought leader 106

much of the advice out there right now is that it accepts the organizational and societal status quo. For example, there are companies that support telecommuting, but still require people to be accessible between 9 a.m. and 5 p.m. That defeats the purpose. The purpose of giving people autonomy is allowing them to work when they are most productive. Time is the wrong measure — the measure should be performance and results. I hope that people try to think differently. Some companies are doing noteworthy experiments. In May 2015, for example, the New York Times featured an article about the Geller Law Group [Editor’s note: No relation to the author of this article], a law ﬁrm started by women seeking to continue their careers as successful attorneys while participating more actively in their children’s lives. The article described how the employees work together to ensure that everyone’s personal and professional commitments can be met. This approach explicitly takes

into account people’s lives outside work in determining the way they organize their work — and that’s what is so critical. This is an exciting new ﬁrm, but established companies can also experiment. A division here or a work group there can try a more collective, integrated approach. If they are able to make the dual agenda work, their methods can spread to other groups within the company. However, it’s important to share both successes and failures, because it all contributes to learning within the organization. Every organization has forwardlooking managers, but their efforts are usually kept secret. S+B: Are people prepared to work in this new way? BAILYN: People have skills that they

learn in their communities and in their homes, but they aren’t really given the OK to bring them into the organization because of the fundamental separation of the work and home spheres. [See “Ellen Langer on the Value of Mindfulness in Business,” by Art Kleiner, s+b, Spring 2015.] Think about the types of skills you acquire managing a family or working in a community organization — delegating, negotiating, empathizing. These are skills that most organizations want in their people. And they are the skills that will enable people to ﬁgure out how to work together to complete projects effectively. But ﬁrst, companies need to legitimate their employees’ lives outside work, so that people

know that such skills are valued. We need to start by ﬁguring out what the assumptions and the corresponding practices are. You need to know what you’re trying to change, and it’s not going to be the same everywhere. If you develop a solution in one place and try to pick it up and move it somewhere else, it probably won’t work. It’s the process of revealing assumptions, adapting, and working together that makes the experiments succeed. There’s no best practice, unless you think of the whole process as a best practice. Challenging what lies beneath what people are doing — that’s what is so tough, but also what is most important. We tend to overemphasize the presence of ﬂexible policies, without digging deeper and trying to understand why it’s hard to make these policies available to everybody. And again, we have to deal with these issues systemically. There are individual accommodations, but there are no individual solutions. + Reprint No. 00356

strategy+business issue 80

child care or eldercare or any other obligations people may have outside work. And it’s not just obligations — many low-wage workers are simultaneously trying to get an education, and they can’t do that without some predictability.

The Oxford Executive MBA Go from a game player to a successful game changer. The Oxford Executive MBA is your opportunity to transform yourself and your ambitions. This modular programme offers you the chance to join one of the worldâ&#x20AC;&#x2122;s most powerful networks and create a new future for your organisation and for yourself as a leader.

The Oxford Diplomas in Strategic Management Join us and develop the extra focus required to perform consistently at the highest level. Diplomas in: , ! ! &$ & + , " '% ! %% , $ ! % & "! $% # , &$ & + ! !!"( & "!

Find out more and download brochures: www.sbs.oxford.edu

The Race Goes to the Bold by Allison Schrager Bold: How to Go Big, Create Wealth, and Impact the World, by Peter Diamandis and Steven Kotler, Simon & Schuster, 2015

books in brief 108

hat comes ﬁrst: the TED talk or the book? That’s the fundamental question readers might reasonably ask after ﬁnishing Bold: How to Go Big, Create Wealth, and Impact the World, the new book by Peter Diamandis and Steven Kotler. Bold follows up on the duo’s previous bestseller, Abundance: The Future Is Better Than You Think (Free Press, 2012), a paean to technology’s ability to solve even the most pernicious problems, which launched several TED talks. And Bold appears to be written either with the same intent or as a result of that process. Bold claims to be a guide on how to tap into new innovation and capitalize on it. The main and recurring theme is that innovation now occurs at an exponential pace. Readers familiar with mathematics may tire of the repetitive descriptions of the difference between ex-

ponential and linear growth. Sample: “Unlike the +1 progression of linear growth, wherein 1 and 2 becomes 3 becomes 4 and so forth, exponential growth is compound doubling: 1 becomes 2 becomes 4 becomes 8 and so on.” And because innovation now occurs at this rapid pace, say the authors, only the smartest and the quickest will prosper. Large meandering firms that can’t keep up will be wiped out. Instagram, the photosharing app bought by Facebook for US$1 billion, is an example of a bold company. Each chapter coins a new word or phrase to describe a long-present phenomenon and then lists a series of steps to take in order to achieve it. For instance, one chapter describes how to achieve flow, which is vital for success. Flow is simply being engaged and productive in your work. In another chapter the authors acknowledge that credibility is necessary to raise money and gain traction in the market. To illustrate this point, they construct a figure with one horizontal line labeled “credible” and a parallel line above it labeled “super credible.” Layered on top are several squiggly lines trending upward at different rates, which

represent potential paths. Readers are instructed to choose the one that puts them above the “super credible” line. Diamandis attempts to establish super credibility by frequently letting the reader know he attended MIT and has a relationship with Elon Musk, the uber-credible founder of Tesla and SpaceX. At times while reading this book, I couldn’t help but visualize a dark room, a large crowd, a speaker clad in black taking a pregnant pause, and PowerPoint slides. Although the book is coauthored, it is written in the ﬁrst-person singular from the perspective of Diamandis, who, in addition to MIT, studied at Harvard and has a medical degree. But instead of practicing as a physician, Diamandis pursued various entrepreneurial ventures in the boldest of pursuits: space exploration. One of his companies, Planetary Resources, mines asteroids. In addition, he runs the XPrize Foundation, which sponsors contests wherein winning teams that ﬁnd solutions working toward “bold and audacious goals” win cash prizes of $1 million or more. Diamandis also founded Singularity University, which offers workshops out of Silicon Valley on “ex-

Illustration by Noma Bar

Books in Brief

ponentially growing technologies” and aims to address “humanity’s grand challenges.” Humble, these authors are not. Indeed, Bold holds up a mirror to the often self-satisﬁed culture of America’s technology industry — which has plenty of accomplishments to be proud of, but which has also developed a sense of hubris and can be plagued by a lack of self-awareness. Bold provides a powerful glimpse into the central contradiction at the heart of the Silicon Valley culture. On the one hand, its denizens have outright disdain for existing, storied institutions, maturity, and wisdom. But on the other, the hostility coexists with relentless name-dropping to establish “super credibility.” When raising funds for Planetary Resources, the authors tell us, Diamandis and his partner included “folks like Larry Page, Eric Schmidt, Ram Shriram (Google’s ﬁrst investor), Ross Perot, Jr., Charles Simonyi (Microsoft’s chief architect), and Richard Branson.” Enlisting such boldface names

can “help turn dank coal into glittering diamonds.” Reading Bold, one can fully understand what leads a 25-year-old to believe he possesses the knowledge, expertise, and insight to change the world and totally dismiss older, more experienced people around

important people backing them (and at this point the authors again present a list of their powerful friends), can easily raise $100,000. These chapters stress the importance of building and cultivating an online community, which you can later tap to raise capital, or

When Diamandis raised capital for Planetary Resources, a $25 donation was rewarded with a “space selfie.” He raised more than $1.5 million. to launch a contest among your avid followers to do your grunt work. To be fair, the single prizewinning team (but no one else) will be paid for their efforts — in cash, not space selfies. Bold is heavy on anecdote, light on data. The authors claim the world is rife with possibilities for forming the next Google, but don’t reconcile that with the drop-offs in IPOs since the tech bubble. They also don’t explain why, despite a bounty of earthshattering innovations ripe for the picking, productivity has been relatively flat since the 1970s. But one can’t deny there is something seductive about the narrative. While reading it, you can’t help but believe that you, too, even if you don’t possess the authors’ money and connections, have the potential to change the world. You just have to try, fail forward, and ignore anyone who tells you different. +

books in brief

him, while telling you he once saw Steve Jobs drink herbal tea. That said, some of the nittygritty pieces of advice in Bold are fairly helpful. They include counsel on working hard; setting reasonable, achievable goals; and cooperating with your coworkers. Those who aren’t lucky enough to have MIT and Google founder Larry Page vouch for them can build “super credibility” through small, hardwon, and solid achievements. The ﬁnal three chapters would make a useful book in their own right. The prospective title? I suggest How to Get People to Give You Money and Work for Free. Bold explains the world of crowdfunding and crowdsourcing. Rather than offering debt or equity in exchange for capital, the authors suggest giving gifts or a T-shirt in response to donations. When Diamandis raised capital for Planetary Resources, a $25 donation was rewarded with a “space selﬁe” (someone takes a picture of your picture from outer space). He raised more than $1.5 million in 32 days. Bold suggests that anyone, even if they don’t have

Allison Schrager allison.schrager@gmail.com is a New York–based economist and writer. She’s @AllisonSchrager on Twitter.

109

by Theodore Kinni The Wright Brothers, by David McCullough, Simon & Schuster, 2015

books in brief 110

hat if you demonstrated a world-changing invention and nobody noticed? For years, that was the fate of the two self-taught men who pioneered a quantum leap in human transportation. On December 17, 1903, on the windy Outer Banks of North Carolina, Wilbur and Orville Wright made four short flights in a crude flying machine that they had built in their bicycle shop back in Dayton, Ohio. Totaling less than 1,500 feet and witnessed by only five men (three of them from a nearby lifesaving station in Kitty Hawk), the flights were a signal achievement in human history. “Their flights that morning were the first ever in which a piloted machine took off under its own power into the air in full flight, sailed forward with no loss of speed, and landed at a point as high as that from which it started,” writes David McCullough in his new biography The Wright Brothers. The story of how the Wright brothers mastered the challenge of powered flight is a fascinating one, and as you might expect from a writer and historian of McCullough’s stature, it is told well and in detail. McCullough, the dean of popular historians and the author of land-

powered ﬂight, and several European governments were also pursuing aviation projects. But even though the newspapers picked up the story (from a telegram the brothers sent home to their father and sister), the world did not beat a path to their door. Instead, the brothers returned to Dayton virtually unheralded.

For years after those first flights in 1903, no one appeared to notice or care that two bicycle mechanics had achieved the age-old dream of flight. newsworthy: From 1898 to 1903, the Smithsonian Institution and the U.S. Department of War had sunk $50,000 into a failed effort at

They continued to build and sell bicycles, and invested their proﬁts in the ongoing development of their Wright Flyer. To save money, they

strategy+business issue 80

The Wright Stuff

mark books on engineering feats such as the Brooklyn Bridge and the Panama Canal, describes how the brothers constructed their planes by trial and error — hand-shaping the propellers and the wings, and, with the help of Charlie Taylor, their sole employee at the bicycle shop, machining a simple gas engine from a block purchased from the Aluminum Company of America (now Alcoa). They then taught themselves to fly. They never flew together, lest they both die in a crash and fail in their quest. It’s a story of human ingenuity that I remember reading as a boy, and it is no less inspiring decades later. But, as McCullough pointed out in a talk he gave in Kitty Hawk last fall, the really odd thing about it is that for years after those first flights in 1903, no one appeared to notice or care that two bicycle mechanics had actually achieved the age-old dream of flight (and on a shoestring budget of less than US$1,000). Certainly aviation was

ter their first flights, the two became celebrities overnight. Unfortunately for aspiring entrepreneurs seeking insights on how to commercialize technological breakthroughs, that’s pretty much the end of the story for McCullough — he sums up most of the rest of the brothers’ lives in an epilogue. In 1909, they formed the Wright Company, but ended up devoting most of their energies to filing and fighting patent suits. Wilbur died of typhoid fever in 1912 at age 45, leaving an estate of approximately $300,000. Orville sold the company in 1918, just a few years after airplanes were first used by military forces in World War I. When he died in 1948, his estate was valued at just over $1 million. “On July 20, 1969,” concludes McCullough, “when Neil Armstrong, another American born and raised in southwestern Ohio, stepped onto the moon, he carried with him, in tribute to the Wright brothers, a small swatch of the muslin from the wing of their 1903 Flyer.” That was a nice gesture. But it’s not sufficient recognition for ushering in a technological revolution that changed the world and spawned an industry that will generate about $240 billion in sales in the U.S. alone this year. + Theodore Kinni tedkinni@cox.net is a contributing editor at strategy+business. He also blogs at Reading, Writing re: Management.

The Prescriptions of Dr. Sachs by David K. Hurst The Age of Sustainable Development, by Jeffrey D. Sachs, Columbia University Press, 2015

effrey D. Sachs is a brilliant, charismatic, controversial macroeconomist who plays a catalytic role in the inspiration, mobilization, and delivery of largescale development aid from rich countries to poor countries, especially those in Africa and South Asia. He is director of the Earth Institute at Columbia University and a special advisor to the secretarygeneral of the United Nations, Ban Ki-moon, on the Millennium Development Goals (MDGs). The Age of Sustainable Development is the aspirational title of a lavishly illustrated, thick (544 pages!) primer on the topic. As Sachs emphasizes throughout the book, our world is a long way from achieving this desirable state of sustainable development, deﬁned as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” The book itself is the product of a massive open online course (MOOC) of the same name, with 14 chapters that match the 14 lectures delivered. It is pitched at the broadest possible readership and requires no technical expertise to understand.

books in brief

stopped traveling to the Outer Banks for test flights and began using a cow pasture outside Dayton, which they rented from a local banker who thought them “fools.” In January 1905, with more than 105 flights under their belts, the brothers sent a letter offering their invention to the U.S. Department of War. They promptly received a standard letter of rejection. In October 1905, by which time they were routinely making flights of 25 miles and more, they again offered the Flyer to the War Department. Again, their offer was rejected. It wasn’t until the end of 1905 — two years after their first powered flights — that the Wright brothers were finally able to make a deal for their invention. A representative of a syndicate of French businessmen traveled to Dayton and agreed to purchase a Flyer as gift to the French government. “According to the agreement,” McCullough writes, “the brothers were to receive one million francs, or $200,000, for one machine, on the condition that they provided demonstration flights, during which the machine fulfilled certain requirements in altitude, distance, and speed.” Even then, it took the Wright brothers another two and a half years to win widespread recognition for their feat. In the summer of 1908, Wilbur flew at Le Mans in order to fulfill the terms of the French contract. Suddenly, the entire world recognized the brothers’ achievement. Almost five years af-

111

complex systems: the global economy, societal interactions, the Earth’s environment, and political governance. Among other facts, we learn that there are 10 planetary boundaries to growth, seven sources of poverty, six approaches to ethical questions, and ﬁve policies for dealing with the tragedy of the commons. Although comprehensive, this classiﬁcation system seems abstract and painfully thin, which is to say it

ple, been a great champion of the free distribution of mosquito nets as an effective protection against malaria. They work well — provided, that is, the locals use them to protect their children first and not their goats. In addition, when they are misused as durable fishing nets, as often happens, those nets can devastate local fish populations. In complex systems, unintended consequences abound.

The image of rich, smart, Western “doctors” prescribing treatments to poor, ignorant Third World “patients” bothered me throughout the book. reads like an accounting system that can capture, classify, and measure a vast range of transactions in an enterprise, but cannot differentiate correlation from causation. If Sachs’s sustainable development framework were just a measurement system, it would be a signiﬁcant achievement and a valuable addition to the ﬁeld. But his claims go well beyond data gathering. Sachs contends at the outset that the book represents a new way of understanding the world and solving global problems. This overblown claim lays the author open to charges of intellectual arrogance. He offers two tools, “backcasting” (working backward from a goal) and “technology road-mapping,” as ways of getting “from here to where we need to be.” But the success of these techniques depends entirely upon having knowledge of cause and effect in immensely complex systems, which is precisely what we lack. Sachs has, for exam-

By this time readers skeptical about “top-down,” modernist approaches to development will be thoroughly alarmed and reaching for their copies of Friedrich Hayek’s The Fatal Conceit. (In Hayek’s view, the fatal conceit was the notion that “man is able to shape the world around him according to his wishes.”) The instrumental rationality thread, anchored in the opening doctor–patient analogy, runs throughout the book. Sachs seems to believe that answers can be found in science and technology, whereas other forms of knowledge embedded in culture and language are seen, if only by implication, as a hindrance to change. No mention is made of other approaches to development such as the more organic positive deviance movement (see my review of The Power of Positive Deviance, by Richard Pascale, Jerry Sternin, and Monique Sternin, s+b, Winter 2010), which emphasizes harnessing local cultures and com-

strategy+business issue 80

books in brief 112

Other economists have criticized Sachs’s theory of development as “top-down,” “high-modernist” in character, a throwback to the mid20th century. In those days, it was thought that Western technocrats wielding financial aid, science, and technology could solve all of humankind’s problems. In those days economic development experts used an engineering, analytical style in their search for generalizable, scalable solutions to common challenges. Scientific knowledge was prized above all other kinds. Unfortunately, these well-intentioned efforts often foundered on unsuspected cultural obstacles and hidden social dynamics. (A classic case of this could be seen in Chicago, where slum-clearance efforts replaced lowrise housing with Cabrini-Green, a massive, densely populated, and soon crime-ridden housing project, which was built in the 1950s and demolished 50 years later.) The author does little to allay concerns that he may be urging an outdated approach with his master metaphor: Development experts are like doctors and countries are like patients. Sachs goes on to describe the role of “clinical economics” and emphasizes the need for a “differential diagnosis” in complex systems, where no two situations are quite the same. The image of rich, smart, Western “doctors” prescribing treatments to poor, ignorant Third World “patients” bothered me throughout the book. And there is plenty of time to be bothered. Following the basic “101” university courses that MOOCs are slated to replace, every chapter of this long book contains numerous lists of definitions, concepts, factors, forces, and metrics. Sachs methodically works his way through four

munities to tackle wicked, intractable problems and make change sustainable. Sachs has been an eloquent spokesman and a passionate activist in bringing the plight of the very poor to the attention of the afﬂuent people of the world. He has stressed the urgency of our response to climate change. Via the United Nations’ MDGs, he has created the goals and metrics so essential to improving the lives of millions. But to be effective, goals and metrics must be embedded either in a deep understanding of cause and effect or in a thoroughgoing learning process that leads to that understanding. Absent this, what was intended to be economic development becomes humanitarian aid — helpful perhaps, but not sustainable. In 2005, Sachs began the ﬁve-year (now 10-year) Millennium Villages Project as a practical intervention to demonstrate the pathways to achieving the MDGs and discover a scalable “formula” for success. Ten villages in 10 countries, each in a different “agroecological zone,” were chosen. Backers raised US$120 million to fund

the project, mainly from philanthropists such as George Soros. The experiment ends in 2015, and its results will be assessed in 2016. There is much debate about how decisive any evidence will be, given the uncontrolled nature of the experiment. But even if they work, it is unclear whether Dr. Sachs’s prescriptions will usher in an age of sustainable development. + David K. Hurst david@davidkhurst.com is a contributing editor of strategy+business. His latest book is The New Ecology of Leadership: Business Mastery in a Chaotic World (Columbia University Press, 2012). He blogs on strategy, leadership, and change at www.davidkhurst.com.

It’s Getting Hot in Here by Katie Fehrenbacher Climate Shock: The Economic Consequences of a Hotter Planet, by Gernot Wagner and Martin L. Weitzman, Princeton University Press, 2015

books in brief

iscussions about the dangers of climate change are often couched in terms that are emotional, value-laden, even biblical. But the world needs to start thinking about climate change in the cold, practical language of insurance and risk management. Viewed through this lens — or green eyeshade — spending money to address climate change in the short term through mechanisms such as a price on carbon emissions, investment in clean energy technology, and forest preservation funds could become a much more palatable topic for a broader class of leaders. That’s the argument you might expect two economists to make.

And indeed, it is roughly the underlying thesis of Climate Shock: The Economic Consequences of a Hotter Planet, written by Gernot Wagner, senior economist at the Environmental Defense Fund, and Martin L. Weitzman, professor of economics at Harvard University. The book delivers a brief but thorough look at the changing climate from economists’ perspective, comparing global warming with other risks and dangers that humanity faces. The most eye-opening ﬁgure in Climate Shock is Wagner and Weitzman’s own analysis that the likelihood of an indisputable global catastrophe — deﬁned as an eventual global average temperature increase of more than 6 degrees Celsius (11 degrees Fahrenheit) — occurring as a result of climate change is around 10 percent. The world would change irrevocably if only half that amount of warming were to occur. A catastrophic temperature rise could impose costs of between 10 percent and more than 30 percent of global economic output, or between US$7 trillion and more than $22 trillion in 2013 terms. Those costs would be associated with the massive industrial infrastructure investments needed to transition to a world with a new climate and higher sea levels. These economic costs would come on top of the harder-toquantify loss of human and animal lives and ecosystems. Given these odds, and considering the huge sums of money at stake, the authors point out that it makes supreme economic sense to invest substantially in addressing climate change in the near term. The jumping-off point for their discussion is governments around the world putting a price on carbon dioxide emis-

113

compelling. It is not designed to change the minds of nonbelievers about the fundamental science of global warming. However, the book does serve as a call to arms for business owners and leaders, economists, and policymakers who have been searching for a purely rational, ﬁnance-focused take on climate change. Although it includes talk of planetary catastrophe (an obviously necessary topic to include in a work on climate change), the book refreshingly avoids the kind of doom-and-gloom hand-

It’s hard to persuade people to insure against a phenomenon that they don’t believe will affect them.

books in brief 114

Australia just repealed its carbon tax. And the authors note that even fantastical notions, such as building an asteroid detection and deflection system for the Earth, seem somehow less controversial than investing in creating ambitious policies to address climate change. Why? Because, the authors point out, climate change is uniquely “global,” “long-term,” “irreversible,” and “uncertain.” And therein lies the very large rub. It’s hard to persuade people to insure against a phenomenon or possibility that they don’t believe will affect them imminently, or in which they don’t believe at all. A study released this spring did not find a single U.S. county in which a majority of residents believed global warming would hurt them personally. As is the case with much of the literature on climate change, if you don’t believe in the science on global warming, you won’t find this book

wringing that marks some of the current popular environmental literature on the subject. (In 2012, Wagner expressed his optimistic take in an interview with strategy+business.) I also appreciated the authors’ bold suggestions for helping address climate change. Carbon pricing is the underlying economic solution. But there’s also an entire chapter dedicated to “What You Can Do,” which includes “vote well,” “recycle well,” “scream well” (be a vocal activist), and profit from fighting climate change. In this way, the book tries to bring the global issue down to the personal level. The focus on the financial and practical rationales for fighting climate change make the book somewhat dry and plodding at times. And as one might expect from two data-focused economists, it reads more like a group of lectures collected in book form than a consistent nonfiction volume that weaves

a narrative, guiding the reader from start to finish. Activists such as Bill McKibben, the New Yorker writer turned global warming alarmist, face significant (and reasonable) criticism for creating movements with unobtainable goals. McKibben wants the world to return to a state in which the concentration of carbon dioxide in the atmosphere is 350 parts per million — where the level was 25 years ago. That’s technologically and economically impossible. Other “solutions,” like divestment from fossil fuels, offer a measure of emotional satisfaction but may not produce useful results. And yet there’s something to be said about the emotion-driven campaigns that can galvanize groups. Climate Shock highlights the potential jolt to balance sheets. It remains an open question as to whether the fear of that shock will be sufficiently powerful to spur the largest and most powerful institutions to action. + Katie Fehrenbacher katiefehren@yahoo.com is a senior writer at Fortune, where she covers energy and technology.

strategy+business issue 80

sions of at least $40 per ton, through taxes on either energy use or energy production. That’s higher than the price in many other regions — for example, the U.K. has a carbon price ﬂoor of £18 (US$27) per ton — but lower than the price in more aggressive emissions battles. Sweden has a carbon tax of $150 per ton. Economists ﬁnd so-called Pigovian taxes, such as taxes on carbon emissions, to be elegant, relatively easy to collect, and rational. But even modest carbon taxes have been remarkably contentious issues.

1995â&#x20AC;&#x201C;2015 For 20 years, strategy+business has been bringing you the stories that raise the game for management from the best minds in business. Celebrate with us by enjoying exclusive anniversary content online, including an interactive guide to the history of management thinking, a gallery of s+b's best covers over the years, and blog posts on prescience, the digital world, the science of leadership, and more. And explore our newly reimagined website: + A fresh interface that responds to whatever device you're using + Easier-to-read article layouts + Bigger images + More multimedia

strategy-business.com

What Makes a Company More Likely to Protect LGBT Rights? The unexpected factors that shape corporate policy. BY MATT PALMQUIST

end page 116

a company to adopt LGBT-friendly HR policies, according to a new study of Fortune 1000 firms. The authors analyzed corporate data alongside annual reports from the Human Rights Campaign’s Corporate Equality Index. The authors also gathered information about whether states housing the firms’ headquarters had laws on the books by late 2012 that focused on 12 LGBTfriendly policies, including hospital visitation privileges for same-sex partners, adoption and marriage rights, and workplace antidiscrimination regulations. Surprisingly, the sexual orientation of employees within an industry had no noticeable influence on corporate policy. The inducement for change seemingly derived more from external sources. Firms that were headquartered in states with progressive gay rights laws tended to extend more safeguards to their LGBT employees. And this pattern applied to companies that had enacted policies from the early 2000s onward — they didn’t jump ahead of legislation, but they consistently reacted when prompted to do so by changing laws, evidence that the shifting political

environment regularly influences the stance taken by leading firms on cultural and social issues. Companies with more women on their board were also more likely to enact LGBT-friendly standards, and the influence of these women has grown over the past decade or so. As female directors’ tenure increases, so does their eagerness to advocate for progressive HR policies, the authors write. Finally, firms whose industry competitors had enacted LGBTfriendly practices tended to follow suit. Presumably wary of the costs and potential contentiousness of the new policy, these companies often waited until a few rivals acted or until so many competitors followed suit that they had to change their stance or risk being left behind. + Source: “Predictors of the Adoption

of LGBT-Friendly HR Policies,” by Benjamin Everly (University of Sussex) and Joshua Schwarz (Miami University), Human Resource Management, Mar./Apr. 2015, vol. 54, no. 2

More Recent Research at: strategy-business.com/recent_research

Illustration by Elwood Smith

uring the past year, the debate over whether certain workplace rights should be guaranteed to lesbian, gay, bisexual, and transgender (LGBT) employees has moved from the court of public opinion to the U.S. Supreme Court. Most equal-opportunity laws at both the federal and state levels fail to address LGBT discrimination. The state governments of Indiana and Louisiana, among others, have generated a media firestorm with their attempts to limit businesses’ responsibilities to LGBT employees. Taking matters into their own hands, a diverse range of major corporations — including giants Apple and Walmart — have started voluntarily providing benefits for domestic partners and introducing other policies that specifically address the rights of LGBT employees. These moves have been praised as socially responsible and good for business. Indeed, recent research suggests that companies implementing LGBTfriendly policies see positive effects on their stock returns and attract a wider range of qualified employees. But attracting new employees and doing right by its current workforce aren’t the only factors that lead

GENERAL MANAGERS NEED A BROADER PERSPECTIVE DEVELOP YOUR CROSS-FUNCTIONAL SKILLS AND EXPAND YOUR OUTLOOK. Today’s global economy demands leaders with a holistic view of business. The General Management Program at HBS Executive Education combines on-campus sessions with off-campus opportunities to apply what you’ve learned at your organization. Gain comprehensive perspective and accelerate your transition from accomplished functional specialist into outstanding business leader.

General Management Program 2015 SESSION: AUGUST–NOVEMBER 2015 2016 SESSION: JANUARY–MAY 2016

Learn more www.exed.hbs.edu/gmp-sb

N E X T- G E N E R AT I O N C R E D E N T I A L S F O R H R P R O F E S S I O N A L S

SHRM-CP SHRM-SCP

SHRM CERTIFICATION

Competency-Based. Always Relevant. Business success depends on getting the most out of people. Now more than ever, businesses rely on HR professionals to make the most of a changing workforce. Because great HR makes great organizations. Earning your SHRM Certified Professional (SHRM-CP) or SHRM Senior Certified Professional (SHRM-SCP) makes you a recognized expert and leader in the HR field—and a valuable asset to your organization, keeping you and your organization more competitive in today’s economy.

Prepare for your certiﬁcation exam with the most effective preparation: 2015 SHRM Learning System® for SHRM-CP/SHRM-SCP • Interactive online study tools and learning

modules with updated content teach you everything you need to prepare for your exam. • Multiple learning options are available so you

can choose the one that best matches your schedule and learning style.

Preview the SHRM Learning System demo for free!

shrmcertiﬁcation.org/learning/s+b