082 Strategy+business Magazine Spring 2016 [PDF]

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RAISE YOUR DIGITAL IQ • DANAHER’S CHANGE ENGINE • 10 PRINCIPLES OF ORG CULTURE

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editor’s letter

Illustration by Lars Leetaru

Capabilities No One Else Can Match For years, it was assumed that corporations thrived through economies of scale. It was taken for granted that the biggest companies were the most likely to succeed. Then, when Internet commerce made company size less relevant, many observers thought nimble, small companies would have an edge. Yet today, the leaders in most industries are big and entrenched. But they’re not like the huge conglomerates of yesteryear. The difference lies in their capabilities and the way they use them. Companies that can consistently do things no one else can match — companies such as IKEA, Starbucks, Apple, Natura, and Danaher — have an advantage over everyone else, an advantage that carries them through tumultuous times. They even make it look easy. “Creating a Strategy That Works,” by Paul Leinwand and Cesare Mainardi, describes the five unconventional acts that create this advantage (page 42). The article is adapted from the new book, Strategy That Works: How Winning Companies Close the Strategy-to-Execution Gap. A roundtable of Danaher executives amplifies the argument by discussing the ways they build and

develop powerful capabilities, including a remarkable approach to executive development (page 52). Other articles in this issue tackle the challenge of adopting leading-edge digital technology. In “Raising Your Digital IQ,” Chris Curran, Tom Puthiyamadam, and Chrisie Wendin show how companies are adapting their own proficiencies in the world of data analytics, cloud computing, and the Internet of Things (page 64). “A Strategist’s Guide to Blockchain,” by John Plansky, Tim O’Donnell, and Kimberly Richards, explores the system of self-enforcing encrypted verification that is the foundation of digital currency. It then considers its potential for disrupting a variety of services (page 76). On page 30, you’ll learn how enterprise architecture planning, when linked with the capabilities concept, is making a comeback. It’s no coincidence that GE CEO Jeffrey Immelt is quoted in two of these articles. GE is one of many industrial companies rediscovering its roots through the opportunities inherent in this new digital wave. Elsewhere, Jon Katzenbach, Carolin Oelschlegel, and James

Thomas take you through 10 principles for fostering a better organizational culture (page 22). In the Thought Leader interview, ethics expert Jonathan Haidt explores entrenched attitudes about capitalism and how they might affect the future of business (page 86). On page 9, innovation expert Andrew Hargadon debunks the idea that big breakthroughs happen in isolation. Governance experts Charlotte M. Roberts and Martha W. Summerville address the evolution of thinking on corporate boards (page 36). This quarter, we say farewell to associate editor Christie Rizk, who has been a stalwart contributor to ongoing features here (such as s+b Trend Watch). These days, the rest of us at s+b are — like most of our readers, I suspect — spending our time figuring out how to better develop and deploy our own distinctive capabilities, so we, too, can stride up mountains with confidence and style. Art Kleiner Editor-in-Chief kleiner_art@ strategy-business.com

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leading ideas 6

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Secrets of the Activist Manager Larry Jones and Joseph Duerr Outside investors have their megaphones. But insiders have a more powerful tool for creating value: deep knowledge of their business and customers.

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In Search of Ingenuity Andrew Hargadon The quiet heroes of innovation do the little things that bring big ideas to life.

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Mike Christian on Mindfulness and Mental Energy Laura W. Geller The UNC Kenan-Flagler professor explains the science of self-control, and how it affects your performance at work.

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Breaking Bad Barriers Paul Barnett In her new book, journalist Gillian Tett shows how companies can be constrained by silos that inhibit collaboration — and how they can break out of them.

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Mutually Assured Disruption Ramesh Nair and Ken Favaro Why established companies should join forces with upstart competitors.

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s+b Trend Watch: New Opportunities in Entertainment and Media

essays ORGANIZATIONS & PEOPLE

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10 Principles of Organizational Culture Jon Katzenbach, Carolin Oelschlegel, and James Thomas Companies can tap their natural advantage when they focus on changing a few important behaviors, enlist informal leaders, and harness the power of employees’ emotions. TECHNOLOGY

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Enterprise Architecture Planning 2.0 Jack Topdjian, Dirk Klemm, and Carl Drisko A new approach to digital strategy reinvents legacy IT by aligning it to a company’s capabilities. ORGANIZATIONS & PEOPLE

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The Mindful Board Charlotte M. Roberts and Martha W. Summerville Directors facing complex corporate governance challenges can develop their capacity to think together about the implications of their decisions.

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features 42

STRATEGY & LEADERSHIP

THE THOUGHT LEADER

Creating a Strategy That Works

INTERVIEW

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Ann Graham The NYU social psychologist says that the ethical risks for a business depend on its ingrained cultural attitudes.

Paul Leinwand and Cesare Mainardi The most farsighted enterprises have mastered five unconventional practices for building and using distinctive capabilities. 49 The Idea of IKEA

Per-Ola Karlsson, Marco Kesteloo, and Nadia Kubis

STRATEGY & LEADERSHIP

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Danaher’s Instruments of Change An s+b Roundtable Moderated by George Roth and Art Kleiner Highly focused and diversified, this industrial company grows through acquisition, customerfacing innovation, and continuous improvement.

BOOKS IN BRIEF

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Raising Your Digital IQ

The Margin of Safety David J. Lynch

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The Empathy Solution Edward H. Baker

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The Fed’s Original Intent Neil Irwin

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My Tunes Jon Fine END PAGE: RECENT RESEARCH

104 TECHNOLOGY

Jonathan Haidt

One Bad Apple Spoils the Company Matt Palmquist Don’t let the performance of superstars distract you from the damage toxic employees inflict.

Chris Curran, Tom Puthiyamadam, and Chrisie Wendin A global survey of business leaders shows how the smartest companies develop and wield their technology strategy.

Cover illustration by André da Loba

72 The New Chief Digital Officer

Roman Friedrich, Pierre Péladeau, and Kai Mueller 74 How to Activate Your Digital Growth Engine

TECHNOLOGY

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A Strategist’s Guide to Blockchain John Plansky, Tim O’Donnell, and Kimberly Richards The distributed ledger technology that started with bitcoin is rapidly becoming a crowdsourced system for all types of verification. Could it replace notary publics, manual vote recounts, and the way banks manage transactions?

Issue 82, Spring 2016

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strategy+business

Published by PwC

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

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leading ideas

Leading Ideas Secrets of the Activist Manager Outside investors have their megaphones. But insiders have a more powerful tool for creating value: deep knowledge of their business and customers. by Larry Jones and Joseph Duerr

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n theory, management and shareholder activists have the same goal: maximizing longterm value. A stronger and more valuable company not only benefits its shareholders financially, but lays the economic foundation for the company to serve the interests of other stakeholders, including customers, employees, suppliers, and its community. Many activists — institutions and individuals who take a position in a publicly traded company with the intent of improving its value by changing its strategy, fi-

nancial structure management, or board — share these long-term objectives. But some, the type often branded as dangerous corporate raiders, take a short-term view. They believe it is possible to push share prices higher (and soon!) by reducing costs, increasing leverage, and selling assets. According to a 2015 PwC report (“Shareholder Activism: Who, What, When, and How?”), the number of hedge funds pursuing such strategies has increased dramatically since 2005, and they collectively have more than US$100 billion in assets. But the reality is that in many instances, although activist investors are successful at improving margins, they struggle to drive growth. We analyzed 55 companies over the past 10 years in which shareholder activists had a significant impact on company governance and strategy, and compared their performance to that of their industry peers. (The aims of activist actions included business focus, board composition, business restructuring, director election, focus on growth, board representation, general cost cutting, operational efficiency, and removal of CEO.) In each of five industries, we found at

least seven instances of what we identified as highly “activated” companies. In four of the five industries, the targets improved EBITDA margins relative to their “non-activated” peers during the three years after being activated. But in all five industries, highly activated companies grew revenues much more slowly than their non-activated peers in the same time frame. Why is growth so important? When breaking apart an average company’s stock price in the S&P 500, we find that a third of the value of the company is driven by future profitable growth. So short-term activism that focuses only on imminent margin improvement is missing a large part of what drives long-term shareholder returns. And yet management often has difficulty responding to specific activists. To respond more effectively, and increase the chances of boosting long-term value, management should develop a solid plan before being approached by an activist. Senior managers can do so by making use of their chief advantage: information. What does management know that the activists don’t? Plenty. As

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Illustration by Robert Neubecker

Understanding Where Value Lies

Value is always highly concentrated within a business — by company attribute, segment, product, customer, and geography — often to a degree not evident on the surface. Despite the wealth of disclosures that companies make in regulatory filings, investor presentations, and media releases, outside activists get only snapshots (often fuzzy ones) of what’s going on inside the company. By contrast, management has the ability to see in high resolution and in three dimensions. Understanding where and why value is concentrated enables management to prioritize investment in the highest-potential areas for growth and identify areas where margins need to be improved. Management should use this infor-

mation to develop a plan that is more effective than any an outsider could create — and do it in advance of being approached by an activist investor. In most customer and product markets, only a third of customers or products create value for shareholders; another third are valueneutral, and the final third are actually destroying value. Understanding where and why value is concentrated at this granular level allows management to reduce investment in

ships. Within a year, the territories that employed the new techniques for priority customers were growing 10 times as rapidly as those employing the standard approach. Management also can best understand which areas of the business are consuming value, and then use that knowledge to improve margins through a combination of improving price, enhancing mix, and reducing costs. Doing so will improve the company’s long-term health and enhance its ability to serve all its

The reality is that in many instances, although activist investors are successful at improving margins, they struggle to drive growth. areas where value is being destroyed and to increase investment in areas with the highest potential for profitable growth. In fact, the further you dig down within a company, the more concentrated value becomes. In one industrial products company, the top 5 to 10 percent of the company’s customers in a single market represented 60 to 70 percent of current profitability and 70 to 90 percent of the potential profitable growth for the entire market segment. Before this analysis was done, managers had a hard time justifying investments in new offers, services, pricing, and support. Why? They were attempting to serve the needs of their average customer, including the vast majority who were not producing much value. An outside activist likely would have made the same recommendation. But as soon as inside managers identified the 5 to 10 percent of customers who were truly creating value, they felt compelled to make investments to capture a greater share of these relation-

stakeholders. In these cases, management will take many of the same actions an outside activist would — but the managers’ information advantage will enable them to carefully cut with a scalpel, rather than wield an ax. Plan of Action

Once opportunities for improving margins and enhancing profitable growth have been identified, the activist manager will also have a better-informed view than the outside activist of the best course of action. Short-term activists often assume, as a default response, that

leading ideas

insiders, senior managers have access to a deep and detailed understanding of the company’s operations, customers, markets, and competitors. Because they know how the business works, they can determine which customers, geographies, and business lines are creating value for the company and which are consuming it, and where profit pools exist in the market. They can translate this information advantage into a performance advantage by developing new strategies to capture a greater share of these profit pools and by making better resource allocation decisions. Accordingly, the activist manager should follow a three-step approach. First, evaluate, systematically and dispassionately, where the opportunities for value creation exist. Second, evaluate and execute options to deliver on those opportunities. And finally, communicate the growth plan to value-oriented investors.

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understanding of what additional capabilities need to be developed or acquired to support the growth plan. In the example of the consumer packaged goods company, if the management team had not had the capability and capacity to fix the European business, exiting the business would have been a preferable choice. This capabilities-driven strategy can create a cycle of continuous renewal that leads to top-line growth in both existing and adjacent markets. Once strategies have been agreed upon, they need to be translated into a specific implementation plan that lays out clear roles, responsibilities, actions, resources, key performance indicators, and financial

Senior managers can make their IR function a proactive force rather than an entity that merely responds to investor questions. was considering divesting the business. But a thorough review revealed that the business could be profitable if management could successfully provide new and more valuable offers to customers, become more disciplined about pricing, reconfigure the supply chain, and streamline support. Rather than sell, management embarked on an 18-month turnaround that made the business profitable, and generated tens of millions of dollars more in shareholder value than it would have with a quick sale. Not every strategy will work for every company, as each has a unique history and set of capabilities. For that reason, these strategic options need to be grounded in the set of distinctive capabilities that enable the company to deliver in its key markets in a way that competitors can’t match, and in management’s

commitments. This detailed plan is essentially the road map for a corporate transformation. Execution of the plan should be a top priority for management, and must encompass the alignment of current resources, budgeting, performance management, and incentives. Communicating the Plan

The value-maximizing plan must be communicated not only to preempt or respond to an activist, but also to attract shareholders who voice their objectives for long-term value creation. Here, again, management should focus on building an information advantage — this time about investors. Understanding and attracting the right type of investors is like understanding and attracting the right type of customers. Management needs to know the motivations of the company’s current

shareholder base, and to be able to identify investors who don’t hold the stock today but who would benefit from holding a position in the future. Senior managers can make their investor relations (IR) function a proactive force rather than an entity that merely responds to investor questions. The IR team should research and understand the motivation of current and potential investors. In particular, companies should identify and target shareholders who are making decisions based on the long-term intrinsic value of the company. Management needs to understand which key variables these investors are using to assess the company, and adjust the company’s messages, metrics, and methods to tell the value story most effectively. Leaders of companies in which activists express interest should start from a position of confidence. They already know which management practices work best for the company. And the secrets of the activist manager are embedded in the informational advantages that management already possesses. By seizing these advantages — unearthing them, understanding them, acting on them — leaders can reinvigorate their company and create long-term profitable growth in ways that competitors, upstarts, and activist investors won’t be able to match. + Reprint No. 16101

Larry Jones [email protected] is a principal in the strategic value consulting group of the PwC US deals practice. He is based in Chicago. Joseph Duerr [email protected] is a director in the strategic value consulting group of the PwC US deals practice. He is based in Portland, Ore.

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business segments or groups of customers that are consuming value today should be exited or abandoned. But “firing” customers should be done only as a last resort, because it closes the door on any potential future growth from those customers or segments. In many cases, managers can use their detailed understanding of their customers and operations to fix the underlying issues that have caused these relationships to be unprofitable. In the process, they can unlock hidden value and future growth. For example, a global consumer packaged goods company was struggling to make one of its European businesses profitable. Management

In Search of Ingenuity The quiet heroes of innovation do the little things that bring big ideas to life. by Andrew Hargadon

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ew people may recognize the name Norman Heatley. Even the Nobel Committee overlooked him when, in 1945, it awarded the Nobel Prize in Medicine jointly to Alexander Fleming of St. Mary’s Hospital and Ernst Chain and Howard Florey of Oxford University for discovering the lifesaving antibiotic penicillin. But it was Heatley, working side by side with Chain and Florey, who devised the first methods for growing enough penicillin to study its chemical structure and activity, purifying it, and measuring its potency. Sir Henry Harris, who succeeded Florey as head of Oxford’s Dunn School of Pathology, once summed up Heatley’s role by saying, “Without Fleming, no Chain or Florey; without Florey, no Heatley; without Heatley, no penicillin.” Most of the credit and attention for breakthroughs typically goes to the individual with a grand vision, the genius whose exceptional creativity reshapes a company or even an industry. Heatley didn’t have the sudden insight that sparked a big idea. Rather, he put into practice the hundreds of small insights necessary to make a big idea real, figuring out how to get things done against all odds — enabling a major scientific breakthrough in the worst of wartime Britain.

Heatley provides a critical lesson for companies: The pursuit of innovation doesn’t depend on genius. Instead, it demands ingenuity — the ability to come up with solutions that are original and clever given the constraints that you and everyone else face. The lightbulb was a 40-year-old invention when Edison found a way to make it a commercial success. Google was not the first search engine. Amazon’s Kindle followed a decade of electronic book readers. Apple’s iPod was released five years after the first MP3 player hit the market. As technologies and markets converge, ideas appear to many people at the same time. At first, those ideas are out of reach, but gradually the gap between what’s possible and what’s practical gets smaller. Ingenuity enables a company to jump that gap before its competitors do. A Life-Changing Mold

In 1928, when Alexander Fleming made his now-famous discovery, penicillin’s potential to treat bacterial infections was already well known. Yet Fleming soon abandoned penicillin as too unstable for clinical use. He was not alone — the major pharmaceutical firms also thought penicillin was too expensive an effort for an outcome that was so uncertain. The challenge? Making penicillin required growing the penicillium mold, harvesting its secretions, and then isolating and stabilizing the active ingredient. The only profitable path, everyone assumed, was to develop a synthetic version. But because nobody knew what the active ingredient was or how to purify it, and even laboratory quantities were too costly to produce with existing technologies, the idea remained out of reach.

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methods. But this was World War II, and materials and resources for even the most basic research practices were scarce. To build a contraption that cooled, mixed, dissolved, and extracted penicillin from harvested mold broth, he used a discarded oak bookcase, glass tubing, pumps, laboratory bottles and tubes, an old doorbell, colored warning lights, copper coiling, and other plumbing pieces. This makeshift factory produced enough penicillin to treat — and cure — five more patients, finally demonstrating penicillin’s miraculous abilities. Armed with their

The penicillin story makes clear that the need to come up with a new and brilliant idea is overrated. The ideas are out there. People just can’t see how to realize them. he found the best means of purifying the resulting “brew.” Heatley’s small improvements may have lasted for only a week or so before being superseded by the next improvement. But each brought new ways of raising penicillin’s yield and strength and, as often as not, new insights into its chemical nature. The team progressed on the shoulders of these many small insights, and the demand for penicillin climbed. The first test, on two mice, used up the entire supply. A few weeks later, they had enough to run tests on eight mice, then 24, and ultimately 50. Testing penicillin on the first human subject, a man suffering from sepsis, again used all the penicillin they had. The patient improved, but the team ran out of medicine before he could fully recover. Through it all, Heatley kept improvising and improving his

samples, data, and methods, the team would soon gain the commitment of the U.S. government and the pharmaceutical industry to invest in commercial production. Within two years of Heatley’s first efforts, monthly global production soared from roughly 100 units to 100 million units. The drug was made widely available for military use; two years later, in 1944, it became available to the broader public. Thanks to a concerted marketing campaign by St. Mary’s Hospital, Fleming’s “discovery” quickly became the public image of penicillin’s origins. So much so that when the Nobel Committee considered awarding its 1945 prize in medicine to Fleming, scientists from across Europe and the United States urged them to also acknowledge the work of the Oxford scientists. Ultimately, Florey and Chain were honored, leaving out Norman Heatley.

Find Your Heatleys

The penicillin story makes clear that the need to come up with a new and brilliant idea is often overrated. The ideas are out there, and people can see them. They just can’t see how to realize them — at least not with the approaches they’re used to. In other words, it’s the how that matters, not the what. If your company is trying to drive its own breakthroughs, the trick is to find your Heatleys. Google has publicly acknowledged that when it hires graduates with the best GPAs, it sees little correlation with those who succeed most at work. Transcripts and test scores don’t predict how people will face real-world challenges. Heatley had formal training in biology and biochemistry, but he also possessed technical skills in optics, glass- and metalworking, plumbing, and carpentry, and a willingness to use these skills to quickly build and test new ways of getting things done given the available resources. Your innovation team needs people who are makers as much as they are thinkers. These are people who, when faced with uncertainty, don’t wait until they see a clear path and a right answer but who prefer to start doing — seeing what works and what doesn’t. Moreover, innovation requires people with the confidence to know that they can find a way to cross any bridge when they get there — even if they have to build a new bridge to do it. Look for people with an aptitude for ingenuity, and encourage and enable them not just to think differently, but to act differently. Some of them may already be in your organization, unrecognized, unnoticed, or bound by “the way we do things around here.” Imagine

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A decade later, advances in biochemistry gave Florey and his team hope they might succeed where so many others had failed. However, they quickly reached the same impasse. Without funding, progress depended on Heatley’s ability to cobble together new production methods. Little by little, he began experimenting. First he created a quick and accurate way to test each batch’s potency. Then he found the best medium for growing the mold (an early experiment with yeast from a local brewery cut the production time in half). Next he identified the most productive strains. And finally

Illustration by Serge Bloch

“Do the Experiment”

Unfortunately, ingenuity often does not align with ordinary corporate practice. Innovation projects run a gauntlet of up-front analysis and committee approvals. The process is designed to map every step of the path forward, to justify large and long-term commitments. It reflects established companies’ desire to know how they will get to the idea before they’ve even started. But ingenuity thrives on figuring out new ways to produce, distribute, support, and scale existing ideas. As those new ways emerge, they change your understanding of what’s possible. To find those new ways, you have to create the conditions in which your Heatleys can thrive. Encourage them to start experimenting. Experiments do more than test assumptions — they also force the

connection between abstract possibilities and concrete realities. Whenever it came to talking about ideas, Heatley’s boss Howard Florey was famously impatient: “Do the experiment” was his motto. When people are pushed to turn vague concepts into specific choices that can be built, tested, and improved, their ingenuity takes over. Of course, funding experiments can backfire without a disciplined approach. Counterintuitively, the best experiments are often the cheapest. They don’t require perfect conditions, they can be built quickly and with materials close at hand, and, should they fail to deliver, they can be improved and run again. Consider that Ernest Lawrence built the first subatomic particle accelerator in the late 1920s for $25. As a rule, always run the inexpensive experiment first, and then gradually increase the investment. Big companies have more resources and can afford to go straight for the

Reprint No. 16102

Andrew Hargadon [email protected] holds the Soderquist Chair in Entrepreneurship at the Graduate School of Management at the University of California— Davis and is author of How Breakthroughs Happen (Harvard Business School Press, 2003).

leading ideas

what would happen if you could identify them and empower them to innovate from the inside out.

big price tag, but that doesn’t mean they should. Finally, avoid making long-term funding commitments or basing milestones on outcomes that were set before the real work and learning began. Instead, fund projects with a series of tranched investments tied to specific learning goals over short periods. Base each new tranche on what the team has learned (and how that has changed the original plan). Doing so provides room for the trial-and-error nature of ingenuity and lets the team reevaluate goals based on what worked and what didn’t. Fostering ingenuity doesn’t mean you should throw out your existing practices or deliberately starve your project teams. Heatley and his colleagues at Oxford were working during a world war; chances are, your circumstances won’t be as dire. But focusing on ingenuity does suggest a different way of thinking about innovation. When the right people are encouraged by supportive leaders to challenge constraints the rest of the company and market accept as a given, to focus their efforts on the how rather than the what, and to experiment early and often, you can set the best ideas free. +

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The UNC Kenan-Flagler professor explains the science of self-control, and how it affects your performance at work. by Laura W. Geller 12

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e’ve all come to work exhausted, or under the weather, or while experiencing some sort of physical pain. We power through it as best we can, unaware that our brains are redirecting critical resources to manage these issues. These efforts enable us to cope. But as Mike Christian, an assistant professor of organizational behavior at the University of North Carolina’s Kenan-Flagler Business

Christian has also studied mindfulness — a hot feature of many corporate wellness programs — as a means of preventing workplace retaliation. It turns out that being in the moment can help mitigate the effects of unfairness on our fight-orflight response. Selected as a Poets & Quants “Best 40 under 40” business school professor in 2015, Christian followed an uncommon path to academia. Before earning his Ph.D.

“The way leaders act, and whether or not people perceive these actions as fair, can affect people’s reserves of mental energy.” School, has found, they take a toll on our performance. When our mental energy is depleted, we are less able to exercise control over our emotions and behaviors — and are more likely to be disengaged, break rules, take part in deception, or even act unethically. Christian’s research delves into the internal and external factors that chip away at our ability to selfregulate, as well as so-called moderator effects that help us regain our footing. In one study, for example, he found that coffee really does help restore in the short term mental resources drained by lack of sleep.

from the University of Arizona, he worked in construction, and as a restaurant manager, sommelier, tennis instructor, telemarketer, consultant, and childhood autism therapist. Christian spoke with strategy+business about how we can avoid falling prey to our biological impulses.

S+B: Let’s start with external factors. Why do people react a certain way to perceived unfairness or injustice? CHRISTIAN: The mental perception

that we are being treated unfairly results in both “hot” and “cold” reactions. The hot reaction is a flash of anger and emotion that you experience if someone acts rudely toward you or if you’re not getting the promotion that you thought you rightfully deserved. It’s a quick, automatic response that’s hard to control. The cold reaction is also known as cognition. That’s when you think about the situation and process what

S+B: What role does self-regulation play in our performance at work? CHRISTIAN: Humans have a unique

ability to exert self-control. It’s what has allowed us to form organizations that have rules and guidelines, to develop social norms, to have ef-

Mike Christian

Photograph courtesy of UNC Kenan-Flagler Business School

leading ideas

Mike Christian on Mindfulness and Mental Energy

fective social interactions, and to resist temptation and focus on longterm goals. But our ability to self-regulate is influenced by various external and internal factors. The way leaders act, and whether or not people perceive these actions as fair, can affect people’s reserves of mental energy. That’s an external factor. Examples of internal factors include how much sleep people get, or how sick they might be feeling, or if they’re experiencing pain.

their attention on their breath cycle if their mind started to wander. We told the control group they could think about anything they wanted to, and to let their mind wander freely. When we compared the two groups after they experienced an injustice, we found that people who were trained in mindfulness were

“People who are trained in mindfulness are better able to control their thoughts and are less quick to act. They’re more ‘in the moment’ and less likely to take things personally.” taliate against a supervisor could end up experiencing negative outcomes, possibly even losing their jobs or otherwise damaging their careers. Although it might be satisfying in the short term to retaliate against somebody who we feel wronged us, in the long term finding proactive solutions is usually a more productive and less risky approach.

much less likely to have hot and cold negative reactions, and they thus retaliated less than those without the training. We tested this with employees in a field survey. We looked at “trait mindfulness” — an ingrained tendency to be mindful. Some people’s

thoughts are constantly wandering; I happen to be one of those people. Others find it quite easy to focus, to put their attention in the moment. We measured whether or not people have that tendency using a validated scale. Once again, we found that the mindful people were much less likely to experience anger when they felt like they were treated unfairly. They were much less likely to ruminate over that unfairness, and they exhibited lower retaliation.

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S+B: Turning to internal influences on self-regulation: You’ve studied the effects of sleep deprivation. CHRISTIAN: We know that the brain

is affected by lack of sleep — its activity levels are reduced in some ways, especially in the prefrontal cortex. And we know that the prefrontal cortex is responsible for controlling impulses. I found that if

S+B: How can people avoid succumbing to these hot and cold reactions? CHRISTIAN: My research has shown

that people who are mindful, or who have been trained in mindfulness, are better able to control their thoughts and are less quick to react. They’re more “in the moment” and are less likely to take things personally, to have that flash of anger, and to ruminate about what happened. In one study, my colleague Erin Cooke Long and I had undergraduate students with no prior mindfulness training listen to a recording of instructions consistent with emerging conceptualizations of mindfulness. We told them to think about their breath and to be curious about their thoughts, but not to have judgment, and to practice refocusing

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happened. “Person A just got a raise, but I’m doing a better job than Person A. I should be the one getting rewarded.” You go over the experience again and again in your mind. It’s a dual process — anger and rumination — and both factors contribute to employees making a decision to retaliate. Employees who re-

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S+B: Is the answer just “get more sleep”? CHRISTIAN: That’s certainly one

answer. But it is not always realistic. It’s hard to disengage from work at night, because we’re increasingly connected to work at home. There’s also a biochemical effect that’s occurring when you’re using your smartphone from your bed. When you have a smartphone close to your face, it is emanating blue light into your eyes that causes your body to think that it’s morning. This inhibits the secretion of melatonin, which is what induces us to sleep. With some colleagues at the University of Arizona, I investigated whether or not the popular belief that caffeine can help make up for lack of sleep is actually true. We gave a piece of gum to participants who were sleep-deprived, but didn’t tell them that it had caffeine in it. In our experiment, they were less susceptible to unethical behavior — specifically, engaging in deceptive behavior for money — than those who were sleep-deprived but not given caffeine. In fact, the sleep-deprived par-

ticipants given caffeine behaved similarly to those in our control condition [well-rested participants]. That was encouraging, that at least in the short term, caffeine can help us replenish our mental regulatory resources. Of course, caffeine isn’t a long-term substitute for sleep, and overuse carries its own risks. I’m currently involved in research looking at other moderator effects. We haven’t published this study yet, but we have some early data suggesting that people who feel like they’re given power in their jobs can actually use that power as a resource to make up for lack of

regulate is diminished, you’re more susceptible to that kind of influence. S+B: What have you found about how chronic pain affects performance and motivation? CHRISTIAN: Along with my col-

leagues Tali Kapadia and Noah Eisenkraft, I wanted to look at the idea of “working sick” — of coming to work when you’re not feeling well. A manager might infer from an employee’s behavior that he or she is not motivated or is a bad worker. But in truth there are events occurring in everybody’s lives that can cause them to have depleted feelings of

“I found that if people are sleep-deprived at work, they’re going to have less of the self-control they need to be high-functioning contributors.” sleep. The hypothesis is that just perceiving that you have control over your job gives you more energy — that this experience activates what we call your behavioral approach system, which controls goaloriented behavior. S+B: Are there factors that can exacerbate the effects of lack of sleep? CHRISTIAN: We found that people

who were more sleep-deprived have a harder time resisting social influence to act inappropriately. If somebody tells you to lie, and you’re in your “right” frame of mind, you’re going to think, “This is wrong, and I’m not going to listen to this person.” This changes when you are overtired. If your ability to self-

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wellness, and thus decreased motivation, on certain days. As you’d suspect, when you’re in high levels of pain at work, it has a negative impact on performance. But my colleagues and I found that pain levels fluctuate, even for people who have chronic symptoms, like back pain or fibromyalgia. Some days are better than others, and on good days, there’s an uptick in people’s level of engagement in their work. We also found that people who experience chronic symptoms get used to the demand on their energy that comes from the pain over time. It’s almost as if they grow a larger capacity to self-regulate. S+B: We’ve talked about factors that can deplete our ability to self-regulate, and factors that can mitigate some of these negative effects. Are there factors that can make us more motivated at work?

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people are sleep-deprived at work, they’re going to have less of the self-control they need to be highfunctioning contributors. I first looked at workplace deviance — when otherwise good people break rules or don’t follow norms or guidelines — and found a link between such behavior and lack of sleep. In subsequent studies my colleagues and I have also looked at unethical behavior, more than simple rule breaking, and found a similar link.

search now with Noah Eisenkraft and Erin Cooke Long on this topic. What we’re finding so far is that on days when people feel like their jobs are meaningful and important — when they feel like the work they’re doing affects others in a positive way — people invest more in themselves. They are able to dig deep to get the motivation they need to do their job. There’s also some interesting research showing that vacations help people get back to their full level of self-control. Sabine Sonnentag [of the University of Mannheim, in Germany] and Charlotte Fritz [of Portland State University] have shown that whether you come back to work refreshed after a vacation depends not only on the amount of time you are away, but also on what you do during your vacation. People who engage in what they call mastery experiences — those where they learn a new skill, like scuba diving — are able to really disconnect and feel accomplished. When they get back to their jobs, they are much more replenished than people who sit on the beach and might still ruminate about work. This gets back to my research on mindfulness. Being able to focus on the moment raises your level of self-control, but it can also recharge you, better preparing you to meet your goals. + Reprint No. 16103

Laura W. Geller [email protected] is senior editor of strategy+business.

Breaking Bad Barriers In her new book, journalist Gillian Tett shows how companies can be constrained by silos that inhibit collaboration — and how they can break out of them. by Paul Barnett

I

n the business word, silos have garnered something of a bad name. The term silo has become synonymous with narrow-mindedness, institutional bias, and rampant interdepartmental rivalries. Silos are a metaphor for business structures that prevent the corporate whole from being greater than the sum of its parts. But we shouldn’t reflexively regard silos negatively, says Gillian Tett. They are an inescapable and necessary consequence of organizational scale and complexity. More importantly, they exist because “humans are hardwired to classify the world and to sort it into buckets,” she writes in The Silo Effect: The Peril of Expertise and the Promise of Breaking Down Barriers (Simon & Schuster, 2015). We just need to master them before they master us. With detailed references to companies that have successfully broken through silos (or been constrained by them), Tett, the U.S. managing editor of and columnist at the Financial Times, provides a guide to doing that. The Silo Effect comes across in print much as Tett comes across in person — sharp, insightful, and concise. And the book, which is informed as much by her training as an academic anthropologist as by her experience covering the global financial crisis, is an excellent at-

tempt to help both organizations and individuals figure out how to harness the benefits of specialization without creating tunnel vision. Tett cites Facebook as an example of a company that strives to master the benefits of specialization, which include speed and accountability, without suffering the negative effects. To stop internal groups from becoming too competitive, Facebook consciously rotates people through different teams and functions, creates social ties, uses effective communication platforms, and ensures that different groups “collide” often. These initiatives, or “social experiments,” as Tett calls them, have been numerous, and stem from founder Mark Zuckerberg’s background as a Harvard student of psychology. Tett quotes one Facebook senior executive referring to the initiatives as deliberate attempts to be “anti-Sony and anti-Microsoft.” One social engineering initiative is Facebook’s six-week induction “Bootcamp,” designed to get new employees up to speed on the company’s practices while promoting good habits and establishing lasting social ties. But, as Tett told me in an interview, “the most important thing at Facebook is they’ve spent quite a lot of time thinking about it and trying to actually look at what they call the social graph — for example, how people interact.” Companies that consider social structure are much more attuned to the issues

leading ideas

CHRISTIAN: I’m doing some re-

15

content was so complete that there was very little congruence between the markets Sony addressed and the siloed internal environment it had created. Of course, humans are channeled into silos long before they enter the workforce. As Tett puts it, “educational systems make individuals so specialized that if we’re not careful, you end up basically getting sucked down one particular path that leads you into an intellectual and social ghetto, and you can’t see the bigger picture.” Jobfocused vocational training geared toward specific needs reinforces the same tendency. To aggravate matters, the very structure of today’s markets encourages and reinforces silo-like behavior. We are “living in a culture where being hyperefficient is seen as being very good.” And the enemy of efficiency is downtime. “You cut out any slack,” Tett said in the interview. “And slack is what you need to create serendipity and to allow people to roam and to collide with the unexpected.” This isn’t an entirely new argument. In his 1997 book, The Living Company (Harvard Business School Press), Arie de Geus, former head of strategy at Shell, advocated that companies give employees time to

play, to create models, and to consider scenarios. Doing so would allow workers to create “a history of the future” — mental visions of possible futures supported by a shared language. In today’s hypercompetitive world, such efforts may seem like an unaffordable indulgence. But Tett urges skeptical business leaders to recall the value of the time spent by Steve Jobs studying Japanese calligraphy, and the impact that had on his design thinking. Tett cautions that just like companies, individuals need to be aware of the dangers of silos, and take personal responsibility to avoid them. Avoiding mental silos, she notes, is challenging in part because the pressure to specialize seems as irresistible as the force of gravity. But it’s vital. Specialization can lead to narrow vision and limited, default ways of thinking. As humans, we may be prone to adopting habits that are hard to change. But Tett reminds us that “you don’t have to be trapped within the cultural patterns you inherit. We’re not all robots.” Breaking out of silos requires hard work — and it is a balancing act. To succeed in today’s workplace, you have to be a highly functional and useful employee and colleague as you toil in your cubicle. But as Tett argues convincingly, you also have to make a conscious effort to seek out new perspectives, expose yourself to new experiences, and sit in other people’s chairs. + Reprint No. 16104

Paul Barnett [email protected] is the founder and CEO of the Strategic Management Forum, a global membership organization with the purpose of advancing the professional practice of strategic management.

Illustration by Peter Hoey

leading ideas 16

surrounding silos, and can manage them more effectively as a result. But it’s not enough simply to rotate programmers from teams working on mobile to teams focused on apps. Efforts to undermine corporate rigidity can be undermined themselves by individual rigidity. It is people, not structures, that create culture. “Flexible minds are as important as flexible structures,” Tett says. The first part of the book covers entities that have been hampered by silos (including Sony, UBS, the Bank of England, and the U.S. Federal Reserve). The second half of the book offers contrasting stories from the Chicago Police Department, Facebook, Cleveland Clinic, and, finally, BlueMountain Capital Management. The last example describes how the hedge fund “has made money by taking advantage of the silos in the financial system around it.” Silos can be damaging because they encourage what management thinkers call strategic drift. “As time passes, in any organizational structure, people become very incentivized and invested to defend existing borders,” Tett says. “If someone is successful in a particular department, they’re going to try and defend it at all costs, resulting in power structures that get in the way.” In turn, that results in greater internal inflexibility even as the outside environment changes rapidly. Tett cites Japanese electronics giant Sony as a counterexample to Facebook. The company, she says, is a “classic example of a company which had hit upon a product [the Walkman] and created a lot of people invested in defending it.” By 2000, the convergence between hardware, software, and music

Why established companies should join forces with upstart competitors. by Ramesh Nair and Ken Favaro

I

n June 2014, Spanish bank Santander and online business lender Funding Circle announced a customer-sharing agreement in the United Kingdom. When Santander turns down a loan applicant, the company refers the borrower to Funding Circle. In exchange, Funding Circle sends some of its customers to Santander for cash management and other services. The relationship involves only referrals; there are no fee splits, risksharing provisions, or operational interactions. In a different type of arrangement, in April 2015 Citigroup agreed to fund US$150 million in loans to lower-income borrowers through Lending Club, an online consumer lender. Lending Club finds and evaluates borrowers, and a state-chartered bank in Utah makes the loans, which are then sold to a private equity firm through a credit facility provided by Citigroup. Financial services is just the latest sector to witness the forging of such partnerships between innovative online companies and incumbents. Across industries, the latter often face swarms of well-funded startups. Armed with next-generation technology capabilities in areas such as big data, social media, cloudbased computing, and data analytics, these startups can offer customers a better value proposition: lower

prices, greater convenience, and highly customized products and services. Unlike the traditional players, they are not encumbered by legacy IT systems. They build platforms that are far more advanced than incumbents’ systems in flexibility, speed, and efficiency. Many incumbents respond to these threats by trying to compete head-to-head, acquiring startups, setting up their own separate digital shops and venture funds, outsourcing, or becoming partners in joint ventures. And although some of these efforts may succeed in their

Collaborative reinvention involves the sharing of capabilities, through which each party benefits from the technology, know-how, resources, and experience of the other. own right, ultimately they fail to enable incumbents to commit to the kind of major rethinking of their business model that is demanded by disruption. To do so, companies need to engage their disruptors by entering into a new type of business relationship — what we call collaborative reinvention. These relationships aren’t necessarily based on an exchange of monetary value, though sometimes the incumbent will become an investor in the disruptor. Nor are the relationships set up to make a company’s existing capabilities less expensive or more efficient. Instead,

their preferences, transactions, and behavior over time. Next-generation startups can’t make the most of their data-crunching talents without access to this data. The customer algorithms that disruptors use to personalize transactions are mostly the output of proxy data from social media and other Internet sites. For example, industrial manufacturers such as General Electric, Caterpillar, and Deere & Company have equipped their products with sensors, and now control streams of data on customer usage patterns and machine performance. The disruptors have the capabilities to turn

leading ideas

Mutually Assured Disruption

collaborative reinvention involves the sharing of capabilities, through which each party benefits from the technology, know-how, resources, and experience of the other. A wellcrafted collaborative reinvention also opens up new revenue streams for each player. For example, the parties might decide to provide access to one another’s customers, as in the cases of Santander and Citigroup above. The startups share access to their proprietary platforms and processes, but they have much to gain in return. Large, established companies have the structures and processes needed to operate at scale and manage critical functions such as regulatory compliance, customer service, and fraud prevention. Perhaps more important, they possess long-standing customer relationships and have vast troves of customer profiles and other data, including

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The Fintechs Are Coming

In the financial-services sector, startup funding soared to $12 billion in 2014 from $4 billion in 2013, according to the venture capital database CB Insights. New “fintechs,” as they’re called, are born every day. They offer innovative new products and services with streamlined application processes that bypass traditional financial institutions. They leverage digital technology and analytics to keep costs low, and benefit from the increasing willingness of consumers to take their financial transactions online. Hundreds of fintechs are now targeting the most profitable, least complex segments of the market,

such as international payments and consumer loans. For example, consumer lender Affirm finances consumer purchases with point-of-purchase loans, using personal data from social media to evaluate credit risk and offer interest rates and repayment terms tailored to individual borrowers. Payments specialist TransferWise offers low-cost international money transfers by using a peer-to-peer model that matches the transfer requests of various customers. And student loan company PYT

Funds — PYT stands for “pay your tuition” — helps banks transform their “turndown pool” of student loan applicants into profitable customers by helping the applicants crowdsource the collateral required for bank approval. Fintechs provide the technical capabilities needed to reinvent incumbents’ back-office systems and processes at minimal cost, as well as contributing advanced front-office skills. “Fintechs have what banks want: superior underwriting engines

Illustration by Kotryna Zukauskaite

leading ideas 18

such information into new service offerings. In 2014, Caterpillar and the Chicago-based data analytics firm Uptake announced a partnership through which the young firm is helping the 90-year-old equipment maker compile, organize, and analyze sensor information from its bulldozers, backhoes, and other industrial machinery. Caterpillar, for its part, has taken a minority stake in Uptake. Similarly, in other industries, collaborative reinvention has resulted in new offerings that use technology to better serve existing customers (or to reach new ones). Carena, a healthcare technology firm, has partnered with several large hospital systems to provide both the technology platform and the associated operational support for low-cost telemedicine services. Online education company edX has partnered with universities including Harvard, Columbia, and MIT to provide the technology for online education; the schools bring their professors and curriculum into the venture.

with models and access to troves of big data, modern and relevant front ends aligned to customer expectations and preferences, and software architecture that has been developed from the ground up based on modern technologies and principles,” says PayPal cofounder Max Levchin, who recently launched Affirm. Yet Levchin also acknowledges that fintechs can’t keep growing larger without developing many of the resources of a traditional financial institution. As they scale up, fintechs will attract greater scrutiny from banking regulators, which have largely ignored them so far. This means these new firms will require full-fledged regulatory compliance and customer servicing capabilities — the bank charters, licenses, and compliance systems needed to meet regulatory requirements and operate within “industry guardrails” such as automated clearing house (ACH) payment networks — that banks have refined over generations. Although banking systems and platforms are not always cuttingedge, they most certainly have the controls, audit trails, scale, balance sheet, and fail-safe features required for large-scale lending and deposit taking. Already, major banks are lending their balance sheet strength to fintechs by purchasing securitized loans from online players. And as their lending activities grow, fintechs will need organizations, processes, and technologies for managing frauds, claims, and collections. Again, major banks can do all this. As Levchin puts it, fintechs “will soon be subsumed within the same things they were trying to solve.” He believes fintechs would be willing to share their distinctive capabilities with banks as long as the banks are willing to take on tradi-

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Getting Started

Collaborative reinvention can work anywhere that new players are using leading-edge technologies to attack profit pools controlled by incumbent companies. But to succeed, companies need to start by asking themselves four questions. • What part of our business needs reinvention? Companies should pri-

oritize the business lines, market segments, or parts of the value chain most in need of new capabilities. Wholesale transformation is usually a bad idea.

sheet or customer base, whereas an incumbent may need to upgrade legacy technology architecture or accelerate product development.

ruptors. By bringing together their respective skills and technologies, both can do things neither could have achieved alone. +

• How do these collaborative ef-

Reprint No. 16113

forts support our broader enterprise strategy? Your reinvention must

align with the fundamental choices you have made about which businesses to compete in, as well as your differentiating capabilities and value proposition. It takes more than a transitory relationship to facilitate a marketing campaign or build a mobile app. Answering these questions will lead to collaborations that offer opportunities for incumbents and dis-

Ramesh Nair [email protected] is an advisor to executives in financial services and information management services with Strategy&, PwC’s strategy consulting group. Based in Florham Park, N.J., he is a principal with PwC US. Ken Favaro [email protected] is a contributing editor of strategy+business and the lead principal of ACT2, which provides independent advice to chief executives on strategy, innovation, and organization.

s+b Trend Watch New Opportunities in Entertainment and Media Today's frontier cities are becoming the entertainment hubs of the future. Residents of Tokyo, New York, and London spend the most on media — including video and music streaming, publications, and advertising. But it’s cities like Nairobi, Mumbai, and Johannesburg that will witness the largest growth in spending over the next few years.

2013 Spending on Entertainment and Media US$ Billions $20

Tokyo

KEY

New York

• With whom should we collabo-

Circle size=population

rate? The logical choices are digital

disruptors focused on the segments identified in the answer to the first question. Because companies in this sphere may come from very different backgrounds, make sure both parties are like-minded players looking for a true collaboration based on mutual respect and appreciation. • What exchange of value will

Top 10 Cities for: Spending Spending Growth

London

3 million 25 million

$15

Seoul

$10 Sydney

$5

Hong Kong Los Angeles

Chicago

São Paulo Shanghai Beijing

Singapore Moscow

govern the relationship? Decide

Istanbul

which capabilities each party will contribute — the answer will depend on what each party needs. A tech startup, for example, may need access to an incumbent’s balance

Rio de Janeiro Jakarta

$0

Projected Annual Growth in Spending, 2013–18

5%

Johannesburg Mumbai Nairobi

10%

Source: PwC, "Cities of Opportunity: The urban rhythm of entertainment and media,” Feb. 2015

15%

strategy+business issue 82

leading ideas 20

tional banking functions for which the fintechs have no real aptitude or affinity. Levchin foresees a business model in which banks might become the gatekeepers to the guardrails — that is, regulatory compliance, funds transfer, and other traditional capabilities — and take a fee from the business that comes into their ecosystem from the fintechs, giving as an example a “startup service for ACH transfers.” He thinks fintechs would consider such capabilities a fair trade for helping banks reinvent their established, last-generation business models.

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10 Principles of Organizational Culture Companies can tap their natural advantage when they focus on changing a few important behaviors, enlist informal leaders, and harness the power of employees’ emotions. by Jon Katzenbach, Carolin Oelschlegel, and James Thomas

H

ow often have you heard somebody — a new CEO, a journalist, a management consultant, a leadership guru, a fellow employee — talk about the urgent need to change the culture? They want to make it world-class. To dispense with all the nonsense and negativity that annoys employees and stops good intentions from growing into progress. To bring about an entirely different approach, starting immediately. These culture critiques are as common as complaints about the weather — and about as effective. How frequently have you seen highminded aspirations to “change the

culture” actually manage to modify the way that people behave and the way in which they work? And how often have you seen noticeable longterm improvements? If the answer to these last two questions is “rarely,” it wouldn’t surprise us. We don’t believe that swift, wholesale culture change is possible — or even desirable. After all, a company’s culture is its basic personality, the essence of how its people interact and work. However, it is an elusively complex entity that survives and evolves mostly through gradual shifts in leadership, strategy, and other circumstances. We find the most useful definition is also the simplest: Culture is the self-sustaining pattern of behavior that determines how things are done.

Made of instinctive, repetitive habits and emotional responses, culture can’t be copied or easily pinned down. Corporate cultures are constantly self-renewing and slowly evolving: What people feel, think, and believe is reflected and shaped by the way they go about their business. Formal efforts to change a culture (to replace it with something entirely new and different) seldom manage to get to the heart of what motivates people, what makes them tick. Strongly worded memos from on high are deleted within hours. You can plaster the walls with large banners proclaiming new values, but people will go about their days, right beneath those signs, continuing with the habits that are familiar and comfortable. But this inherent complexity shouldn’t deter leaders from trying to use culture as a lever. If you cannot simply replace the entire machine, work on realigning some of the more useful cogs. The name of the game is making use of what you cannot change by using some of the emotional forces within your current culture differently. Three dimensions of corporate culture affect its alignment: symbolic reminders (artifacts that are entirely visible), keystone behaviors (recurring acts that trigger other behaviors and that are both visible and invisible), and mind-sets (attitudes and beliefs that are widely shared but exclusively invisible). Of these, behaviors are the most powerful determinant of real change. What people actually do matters more than what they say or believe. And so to obtain more positive influences from your cultural situation, you should start working on changing the most critical behaviors — the mind-sets will follow. Over time,

Illustration by Lars Leetaru

essay organizations & people

ORGANIZATIONS & PEOPLE

successful companies in the world. By adopting the following principles, your organization can learn to deploy and improve its culture in a manner that will increase the odds of financial and operational success.

1.

Work with and within your current cultural situations. Deeply embed-

ded cultures cannot be replaced with simple upgrades, or even with major overhaul efforts. Nor can your culture be swapped out for a new one as though it were an operating system or a CPU. To a degree, your current cultural situation just is what it is — and it contains components that provide natural advantages to companies as well as components that may act as brakes. We’ve never seen a culture that is all bad, or one that is all good. To work with your culture effectively, therefore, you must understand it, recognize which traits are preeminent and consistent, and discern under what types of conditions these traits are likely to be a

Executives who work with culture can greatly accelerate strategic and operating imperatives. said their firms achieved sustainable improvement in organizational pride and emotional commitment. That compares with 35 percent for firms that didn’t use culture as a lever. Although there is no magic formula, no brilliant algorithm, no numerical equation that will guarantee results, we have gleaned some valuable insights through decades of research and observation at dozens of enterprises, including some of the most

help or a hindrance. Put another way, there’s both a yin and a yang to cultural traits. For example, a European pharmaceutical company with a solid product development pipeline had a tendency to be inward-looking. It had great execution capabilities and an excellent record of compliance with regulators around the world. However, when new products were ready to be launched, the company

had a hard time marketing them to physicians and healthcare providers. Rather than bemoaning the company’s ingrained insularity — for example, its collective tendency to value the opinions of internal colleagues more than those of outside experts — the leaders decided to use this feature of its culture to its advantage. They set up a program through which employees were acknowledged and rewarded by colleagues for “going the extra mile” to support customers. By recognizing a new kind of internal authoritativeness, the company tapped a powerful emotional trigger already in place, and engendered a new (and strategically important) behavior in its sales force.

2.

Change behaviors, and mind-sets will follow. It is a commonly held view that behavioral change follows mental shifts, as surely as night follows day. This is why organizations often try to change mind-sets (and ultimately behavior) by communicating values and putting them in glossy brochures. This technique didn’t work well for Enron, where accounting fraud and scandal were part of everyday practice, even as the company’s espoused values of excellence, respect, integrity, and communication were carved into the marble floor of the atrium of its global headquarters in Houston. In reality, culture is much more a matter of doing than of saying. Trying to change a culture purely through top-down messaging, training and development programs, and identifiable cues seldom changes people’s beliefs or behaviors. In fact, neuroscience research suggests that people act their way into believing rather

essay organizations & people

altered behavior patterns and habits can produce better results. You may be asking: If it is so hard to change culture, why should we even bother to try? Because an organization’s current culture contains several reservoirs of emotional energy and influence. Executives who work with them can greatly accelerate strategic and operating imperatives. When positive culture forces and strategic priorities are in sync, companies can draw energy from the way people feel. This accelerates a company’s movement to gain competitive advantage, or regain advantages that have been lost. Research shows that companies that use a few specific cultural catalysts — that is to say, those that use informal emotional approaches to influencing behavior — are significantly more likely to experience change that lasts. Of the companies that reported consciously using elements of their culture in Strategy&’s 2013 Global Culture & Change Management Survey, 70 percent

23

the workplace, which engendered a greater sense of care for fellow employees and made them more likely to speak up when they noticed an unsafe situation. Changed behavior, changed mind-set.

3.

Focus on a critical few behaviors.

Conventional wisdom advocates a comprehensive approach — everybody should change everything that’s not perfect! But companies

At an Asian banking company, rapid inorganic growth had led to diverse ways of working across different units and geographies. To focus on improving teaming, customer outcomes, and the ability to realize synergies, the CEO and leadership embarked on a culture-led evolution program. They targeted just three critical behaviors: taking extra steps to delight customers, valuing performance over seniority, and backing up and supporting one another. They then converted these

Neuroscience research suggests that people act their way into believing rather than thinking their way into acting. must be rigorously selective when it comes to picking behaviors. The key is to focus on what we call “the critical few,” a small number of important behaviors that would have great impact if put into practice by a significant number of people. Discern a few things people do throughout the company that positively affect business performance — for example, ways of starting meetings or talking with customers. Make sure those are aligned with the company’s overall strategy. Also check that people feel good about doing these things, so that you tap into emotional commitment. Then codify them: Translate those critical behaviors into simple, practical steps that people can take every day. Next, select groups of employees who are primed for these few behaviors, those who will respond strongly to the new behaviors and who are likely to implement and spread them.

three general behaviors into specifics for each part of the company. Delighting customers, for instance, was translated into frontline staff collaborating with other colleagues to solve client problems and prioritizing the implementation of process improvements that affected customer outcomes. For all three behaviors, leadership recognized and celebrated examples in which people made an extraordinary effort. Senior leaders acted as role models, explicitly modeling these three new behaviors. The company also identified influential frontline, client-facing employees who could demonstrate these new behaviors in action.

4.

Deploy your authentic informal leaders. Authority, which is con-

ferred by a formal position, should not be confused with leadership.

strategy+business issue 82

essay organizations & people 24

than thinking their way into acting. Changes to key behaviors — changes that are tangible, actionable, repeatable, observable, and measurable — are thus a good place to start. Some good examples of behavior change, which we’ve observed at a number of companies, relate to empowerment (reducing the number of approvals needed for decisions), collaboration (setting up easy ways to convene joint projects), and interpersonal relations (devising mutually respectful practices for raising contentious issues or grievances). A telecommunications company was seeking to improve its customer service. Rather than trying to influence mind-sets by, for example, posting signs urging employees to be polite to disgruntled customers, or having employees undergo empathy training, the company focused on what psychologists call a “precursor behavior” — a seemingly innocuous behavior that reliably precedes the occurrence of problem behavior. Leaders had noticed that poor teaming led to poor customer service, so the company rolled out a plan to encourage better and more effective teaming within call centers. To accomplish this, they set up regular design sessions for improving practices. When employees felt they were part of a happy team, and sensed a greater level of support from colleagues, they began treating their customers better. In another example, a resources company in the Middle East was seeking to make its workplace safer. Rather than erect placards threatening workers with consequences, the company focused on a relatively basic precursor behavior: housekeeping. It organized a litter drive. Picking up trash as a team helped employees take greater pride in

collaboration, and captured success stories. Identifying, engaging, and nurturing such informal leaders allows companies to harness their talents and further the company’s transformation efforts.

5.

Don’t let your formal leaders off the

hook. Most organizations tend to shunt culture into the silo of human resources professionals. But leaders in all parts of the company are critical in safeguarding and championing desired behaviors, energizing personal feelings, and reinforcing cultural alignment. The signaling of emotional commitment sets the tone for others to follow. If staff members see a disconnect between the culture an organization promulgates and

(Harvard Business School Press, 1993), a real team is one with a high level of emotional commitment; the leadership role shifts easily among the members depending on their skills and experience and the challenges of the moment, rather than on any hierarchical positions. Team members hold one another accountable for the quality of their collective work. Interestingly, at GE Motors the senior leadership group members often demonstrated real team capabilities in running their individual business units and functions. So Rogers decided to find ways to break them into subteams of three or four members to address specific cross-organizational issues facing the larger group. Over time, he mixed the subgroupings to match emerging issues. By working

Authority, which is conferred by a formal position, should not be confused with leadership. the one its formal leadership follows, they’ll disengage quickly from the advertised culture and simply mimic their seniors’ behavior. The people at the top have to demonstrate the change they want to see. Here, too, the critical few come into play. A handful of the right kind of leaders have to be on board to start the process. When Jim Rogers was CEO of GE Motors in Fort Wayne, Ind., he became frustrated because his senior leadership group of more than 15 leaders seldom functioned together as a “real team.” As described by Jon Katzenbach and Douglas K. Smith in The Wisdom of Teams: Creating the High-Performance Organization

in different subgroup settings, the executives developed camaraderie, which in turn improved the effectiveness of the group as a whole.

6.

Link behaviors to business objectives. When people talk about feel-

ings, motivations, and values — all of which are vital elements of strong cultures — the conversation can often veer into abstractions. It may then range far afield of what it takes to succeed in the market. Too many employees walk away from culturefocused town halls or values discussions wondering how the advice on how to be a better person actu-

essay organizations & people

Leadership is a natural attribute, exercised and displayed informally without regard to title or position in the organizational chart. Because authentic informal leaders, who are found in every organization, are often not recognized as such, they are frequently overlooked and underused when it comes to driving culture. It is possible to identify such leaders through interviews, surveys, and tools such as organizational network analysis, which allow companies to construct maps of complex internal social relations by analyzing email statistics and meeting records. Once identified, these leaders can become powerful allies who can influence behavior through “showing by doing.” In fact, when companies map out their organizations, they can identify leaders who exhibit different core leadership strengths (see “Four Types of Authentic Informal Leaders,” page 27). At one major oil company, an informal leader named Osama became known as the “turbocollaborator.” His role gave him very little formal influence. But when he began working at the refinery, he walked the plant with the engineers, maintenance technicians, and operators, and took copious notes. As a result, he knew everyone and developed relationships across disciplines. Whenever somebody wanted to know how the place really worked, they would speak to Osama — who would either have the answer in his notebook or know precisely the right person to ask. When the company formed a buddy program between operations and maintenance aimed at using greater collaboration to improve plant reliability, it knew it needed Osama at the heart of it. He connected people, defined templates to encourage

25

7.

Demonstrate impact quickly. We live

in an age of notoriously short attention spans. That applies as much to organizational culture as it does to people’s media consumption habits. When people hear about new highprofile initiatives and efforts, and then don’t see any activity related to them for several months, they’ll disengage and grow cynical. That’s why it is extremely important to showcase the impact of cultural efforts on business results as quickly as possible. One effective method of doing so is to stage performance pilots — that is, high-profile demonstration projects. Pilots are relatively low-risk efforts that introduce specific behaviors that can then be evaluated and assessed. They often

When people hear about new high-profile initiatives and then don’t see any activity, they’ll disengage and grow cynical. related to decisions about whether to repair or replace equipment. Workers and managers began to recommend fixing expensive equipment rather than replacing it. The company celebrated and publicized cost savings identified by employees. The behaviors led to a change in focus and mind-set. When an employee noticed that fans were cooling the machinery during the winter, he felt empowered to call it out, and ask whether it was necessary to do so. It turned out that it wasn’t — and the company saved US$750,000 annually in power costs as a result.

rely on a dashboard that defines desired impacts, the tactics used, and the specific metrics to be employed. When Bell Canada first explored using new behaviors at the front line to improve its customer service and profitability, there were many more skeptics than believers within the leadership ranks. There simply wasn’t any numerical proof that the tactics would work. So CEO Michael Sabia decided to set up a pilot test in a sales unit near Toronto. The sponsors of the test blocked out a tight time frame of eight months, and developed realistic ways of measuring behavior

change, customer reactions, and actual sales and margin performance. Armed with positive results in these areas — a 29 percent increase in customer satisfaction in retail stores, a 31 percent increase in revenue per call at call centers — the company went on to accelerate the expansion of these efforts across the front line in different geographies, functions, and businesses.

8.

Use cross-organizational methods to go viral. Ideas can spread virally across organizational departments and functions, as well as from the top down and from the bottom up. One powerful way to spread ideas is through social media: blogs, Facebook or LinkedIn posts, and tweets — not from senior management, but from some of the authentic informal leaders mentioned in Principle 4. By now it is well established that social media can be more effective at spreading information, news, and music than traditional modes of distribution. The same holds with critical behaviors. People are often more receptive to changes in “the way we do things around here” when those changes are recommended or shared by friends, colleagues, and other associates. This kind of credible social proof is more compelling than similar testimonials from someone whose job it is to sell something. Just as there is an art to making content go viral, there’s a craft to making behavior go viral. For example, in a model that we have tested successfully in several situations, a company starts with a few carefully chosen groups of 12 to 15 informal leaders in three or four different parts of the business. After

strategy+business issue 82

essay organizations & people 26

ally translates into the work they do. To avoid this disconnect, offer tangible, well-defined examples of how cultural interventions lead to improved performance and financial outcomes. Select behaviors that are aimed specifically at improving business performance and can be measured over time. An oil company’s drive to reduce maintenance costs at an industrial installation highlights the importance of such an approach. The critical few behaviors included empowerment and good decision making. One of the company’s exemplars (employees who lead by example) decided it would be a smart move to make costs visible to workers. So he placed price tags on various pieces of machinery. These cues inspired behavioral changes

9.

Align programmatic efforts with behaviors. We’ve emphasized the role that informal leaders can play in helping ideas go viral. But it’s also important to match the new cultural direction with existing ways of doing business. Informal mechanisms and cultural interventions must complement and integrate with the more common formal organization

Four Types of Authentic Informal Leaders

E

very organization has people who influence and energize

others without relying on their title

components, not work at crosspurposes. By providing the structure in which people work — through disciplines such as organization design, analytics, human resources, and lean process improvement — the formal organization provides a rational motivation for employee

one of three battalions.) The formal leaders of those units are expected to know the intent of the officer two levels above them — and to call out any order or situation they perceive to be incoherent or in conflict with that intent. But there are also informal leaders: Each of the four

Just as there is an art to making content go viral, there’s a craft to making behavior go viral. actions, while the informal organization enables the emotional commitment that characterizes peak performance. The U.S. Marine Corps provides a classic example of integrating formal and informal leadership efforts. The “rule of three” dictates how the Marines design their organizations and projects and how they execute in a hierarchy. (Three squads form into one of three divisions, which form for improvement around them. Often found in the role of line manager, they

members of a frontline rifle team is prepared (and expected) to take the lead whenever the formal leader is disabled or loses the high-ground position. This means that the informal leaders also need to know the intent of that officer two levels above. Integrating informal norms with the formal structures helps enable the timely battlefield adjustments that have served the Marine Corps well for more than 200 years. and senior management cohorts. Networkers are hubs of per-

understand the motivations of those

sonal communication within the

with whom they work. They know

organization. They know many people,

how to foster a sense of excellence

and communicate freely and openly

among others. They can be found at

with them. They serve as links among

every level of a hierarchy; some of

people who might not otherwise

the most effective pride builders are

share information or ideas. If you

close to the front line, where they can

want to see an idea travel virally

or formal position in the hierarchy

interact directly with customers as

through an enterprise, enlist your

to do so. We call them “authentic

well as employees. Pride builders

networkers.

informal leaders.” They are a power-

often have powerful insights about

ful resource in spreading a critical

the culture and about what behaviors

latch onto and experiment with new

few behaviors from the bottom up.

are likely to lead to improvement.

technologies, processes, and ways

Among the many types of informal leaders present in organizations, the following are seen most frequently. Pride builders are master motivators of other people, and catalysts

Early adopters enthusiastically

Exemplars are role models.

of working. Involve them in your per-

They bring vital behaviors or skills to

formance pilots, or whenever you are

life, and others pay attention to them.

trying to demonstrate impact quickly.

They are well respected and are effective peer influencers in the middle

essay organizations & people

several weeks, an additional 10 to 15 groups of informal leaders are set up in every business unit. After about three months, the existing groups are encouraged to expand and bring in new people. After another three to six months have passed, the groups become more autonomous, allowed to control their own expansion. Meanwhile, the company facilitates connections among groups to share learning and insights. As behavior spreads, company leaders see increased performance as well as peer and leadership recognition.

27

Actively manage your cultural situation over time. Companies that have had great success working with culture — we call them “culture superstars” — actively monitor, manage, care for, and update their cultural forces. Why? As we noted at the outset, when aligned with strategic and operating priorities, culture can provide hidden sources

Although challenging, multidimensional, and often difficult to deal with, a company’s cultural situation constitutes a powerful set of emotional resources. As is the case with other resources — human, technological, financial — it is incumbent upon leaders to strive to get the most value out of it. To a degree, culture can be compared to natural forces such as

It is incumbent upon leaders to strive to get the most value out of a company’s culture. of energy and motivation that can accelerate changes faster than formal processes and programs. Even if you have a highly effective culture today, it may not be good enough for tomorrow. Southwest Airlines stands as an example of a battle-tested company in which culture has been managed over time. Famous for its long-term success in an industry where even the largest players routinely fail, Southwest for 40 years has been energized by a deep sense of pride among all employees. Southwest has found that constructing an environment that puts its employees first — above customers and owners — fosters a sense of emotional commitment and pride that delivers excellent customer service. But at Southwest, the work on culture is never completed. Just as the airline’s strategy, tactics, and technologies have evolved to cope with a changing external environment, specific HR practices, including informal behaviors, have shifted over time.

winds and tides. These elements are there in the background, sometimes unnoticed, sometimes obvious. Endowed with immense power, they can waylay plans and inhibit progress. They can’t really be tamed or fundamentally altered. But if you respect them and understand how to make the most of them, if you work with them and tap into their hidden power, they can become a source of energy and provide powerful assistance. The best way to start is to ask yourself a series of questions. What are the most important emotional forces that determine what your people do? What few behavior changes would matter most in meeting strategic and operational imperatives? Who are the authentic informal leaders you can enlist? And what can you and your fellow senior leaders do differently to signal and reinforce those critical behaviors? Of course, you shouldn’t plan for dramatic results overnight. Expect an evolution, not a revolution. One of the challenges of working

with culture is that, as we’ve noted, it changes gradually — often too slowly for leaders facing fast-moving competitors. That’s the bad news. The good news? If you approach culture with respect and intelligence, as a milieu in which you and your enterprise live, you can use it to accelerate your competitive momentum. There’s no better time than the present to start. + Reprint No. 16105

Jon Katzenbach [email protected] is an acclaimed advisor to executives for Strategy&, PwC’s strategy consulting group. He is a managing director with PwC US, based in New York, and founder of the Katzenbach Center, Strategy&’s global institute on organizational culture and leadership. He is a best-selling author on organizational culture, leadership, and teaming; his books include The Wisdom of Teams (with Douglas K. Smith; Harvard Business School Press, 1993) and Leading Outside the Lines (with Zia Khan; JosseyBass, 2010). Carolin Oelschlegel [email protected] is a director of the Katzenbach Center for Strategy&. She leads the global operations of the center and advises clients around the world on culture and leadership topics. Based in San Francisco, she is a director with PwC US. James Thomas [email protected] is a thought leader in organizational culture with Strategy&. He is the Middle East lead of the Katzenbach Center and an expert in culture and organizational topics. Based in Dubai, he is a partner with PwC Middle East. Also contributing to this article were Strategy& specialists Varya Davidson (partner with PwC Australia), Kenji Mitsui (partner with PwC Japan), Henning Hagen and Rutger von Post (principals with PwC US), and Shona Especkerman (senior manager with PwC Malaysia). strategy+business issue 82

essay organizations & people 28

10.

Living in Your Culture

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Enterprise Architecture Planning 2.0 A new approach to digital strategy reinvents legacy IT by aligning it to a company’s capabilities. by Jack Topdjian, Dirk Klemm, and Carl Drisko

N

o enterprise today can afford to spend a year or more incorporating digital technology into its core. The technology and the competition move too fast. Yet most Fortune 500 companies take at least that long just to put a new digital system in place, let alone to show results. The reason is understandable: Digitization is a complex and daunting challenge. It requires companies to adopt a new operational model, incorporating new and often unfamiliar technologies — including multichannel engagement, cloud computing, big data analytics, and “smart” infrastructure laden with sensors and real-time controls. They must do all this against the back-

drop of the soon-to-be-ubiquitous Internet of Things with real-time responsiveness embedded in technology throughout the enterprise. Running these new systems requires new behavior, and not just on the part of employees: Customers, vendors, suppliers, and distributors must all change their ways. Few of the largest companies have figured out a digital solution that will be comprehensive enough to span this whole business ecosystem, but simple enough for people throughout the company to use. Although companies look far and wide for solutions, the best place to look is often disregarded. That’s the company’s enterprise architecture planning (EAP) discipline. Many view EAP as a legacy approach. But when it was originally developed in the 1980s, EAP was

a bold response to the same perennial problem: integrating technology with the business strategy. The information technologies of that era were bumping up against old, clumsy, bureaucratic processes and practices. EA projects were supposed to replace those practices with more elegant, streamlined renditions, closely tied to business objectives. EAP borrowed techniques from the more mature “industrial” disciplines of architectural engineering and urban design (hence the name enterprise architecture) to accomplish its goals. Unfortunately, at most companies, EAP, or EA, was placed under the information technology function. It was often directed toward addressing narrow technology needs for particular business units, or subsumed into complex exercises in documenting incompatible systems. Then, as EAP was combined with reengineering during the 1990s, it was frequently used as an excuse for wholesale cost cutting, which ultimately tended to make companies weaker. This history helps explain why many EAP groups developed a poor reputation, or did not deliver value to the enterprise. Today, companies can proceed in a more strategic way — with something close to EA in scope, but more ambitious in spirit and pragmatic in achieving results. We call this approach capabilities architecture planning (CAP). It involves redesigning IT and organizational practices together, in service of a company’s most distinctive strengths. Unlike most enterprise architecture projects, CAP starts with strategy. It marshals digital technology to develop the company’s capabilities — the combination of processes, tools, knowledge, skills, and organi-

Illustration by Lars Leetaru

essay technology

TECHNOLOGY

of tools, electronic instruments, and industrial components to businesses and directly to consumers. It was a consummate fast follower, releasing relatively low-priced versions of its competitors’ innovations. Acme had several distinctive capabilities: interconnected systems of people, knowledge, technologies, tools, and processes that set it apart from other companies. It had a highly efficient logistics and merchandising proficiency that excelled at quickly getting products into customers’ hands. This was enabled by a global customer relationship management (CRM) system, through which marketing leaders and sales reps maintained close contact with hundreds of thousands of people around the world. Acme also had

CAP involves redesigning IT and organizational practices together, in service of a company’s most distinctive strengths. and aligns it all with the company’s value proposition. After the advances of the past few years, IT is finally ready to help close the gap between strategy and execution. CAP can be the vehicle for getting there. Acme’s False Start

To understand how a capabilities architecture plan — and the attitude shift that goes with it — might work, consider the story of a large U.S.-based industrial company, Acme Dynamics (a composite case study example, whose story is drawn from several real companies). In early 2013, Acme was in the business of selling a wide range

effective competitive intelligence and ergonomic design capabilities; it held few patents, but its tools and instruments were appealing, durable, and popular. Customers invariably chose Acme’s products because of the way they felt when using them. But rumblings of dissatisfaction began in early 2013. Although the CRM system worked well, it required a small army of administrators to keep it updated. Acme’s competitors, meanwhile, were equipping their salespeople with mobile devices that tracked customer activity and generated new offers immediately in response. These companies also streamlined business processes

and rooted out expensive, often duplicative IT systems, replacing them with more user-friendly, cloud-based apps that allowed employees to work together easily across functional lines. And they were offering products with software and Internet connectivity embedded in them, which Acme couldn’t easily reverse engineer. The resulting higher margins and lower costs led Acme rivals to greater profitability. The top executives of Acme watched their share price lag behind the sector average, listened to the increasingly loud complaints of shareholders, and fielded demands for change from the board. In March 2014, after a board-level discussion of digital technology, the board chair finally gave the CEO an ultimatum: Don’t fall further behind! The following week, the CEO summoned the company’s chief operating, information, and marketing officers to a meeting. He told them to assess the potential digital processes and technologies that the company needed, while reducing costs in line with the competition. They crafted a plan that carved up the company into more than 100 units of activity, each tied to a key group of products and services. For each unit, a small team of operations specialists led by enterprise architects in the IT department laid out a road map of technological change. But the transformation efforts went nowhere. Simply developing the new road map took more than nine months. In many of the small groups, the IT architects (who struggled to understand the business) and the business leaders (who never really understood the technology) squabbled over where to spend money. Some new systems proved difficult to install and integrate with

essay technology

zation — that give it a competitive advantage. This approach takes CAP out of the sole purview of the IT function. A truly distinctive capability is cross-functional; it typically involves innovation and customer insight, or data-driven synchronization between a buyer and a supplier — a retail store and a factory, for instance. (See “Think Functionally, Act Strategically,” by Deniz Caglar, Namit Kapoor, and Thomas Ripsam, s+b, Feb. 26, 2013.) CAP brings the indepth knowledge of IT functional leadership together with the customer insight of business leadership to better inform your strategy discussions. It blends the activities of IT with talent, operations, organizational change, and innovation,

31

Weaknesses and Strengths

Acme’s CEO didn’t ask the CIO, CMO, and COO to resign. Instead, in April 2015, the four company leaders sat down together for a postmortem. They concluded that they would have to approach the problem differently. They’d still need a top-to-bottom overhaul of business processes and technologies, the kind they had hoped the enterprise architecture plan would give them. But it would work only if it focused sharply on the capabilities Acme needed to compete. This time, Acme’s CEO didn’t take the company’s strategy for granted. He brought together the C-suite leaders and the heads of all the business units and functions for a four-day intensive retreat, starting on a Monday morning in June. The goal was to reexamine the company’s traditional identity as a fast follower, in light of the new digital age. They spent the first day looking in detail at the competition, and at their own capabilities, and realizing the depth of their problem. In just about every one of its product categories, Acme would find it harder and harder to compete unless it found a better value proposition. As part of this, the

company needed a breakthrough in digital technology — and now it was needed fast. That evening, as it happened, GE chairman and CEO Jeffrey Immelt appeared on the Charlie Rose Show. Most of the Acme leaders watched him, together, in the hotel bar after dinner. “It’s our belief,” Immelt said, “that every industrial company in the coming age is also going to have to be a software and analytics company.” He went on to say that anyone who denied “that digitization is going to impact every corner of the economy” would get left behind. (See “Raising Your Digital IQ,” by Chris Curran, Tom Puthiyamadam, and Chrisie Wendin, page 64.)

relationships was an unsung capability that had taken the company far. The top leaders realized that these capabilities, and Acme’s nononsense, pragmatic culture, would allow the company to migrate from being a fast follower to being a platform player. It could become known for ease of integration — a premium in any technical field — helping a wide range of tools, devices, and standards interconnect in a reliable and easy-to-manage way. An in-depth discussion of capabilities followed. One that deserved further investment was customer insight — enabling Acme’s systems to evolve more rapidly with the changing demands of the market. On the consumer side, bolstering consumer

“Every industrial company,” Jeffrey Immelt said, “is going to have to be a software and analytics company.” These remarks underlined the predicament faced by Acme’s leaders. Their company could not recover its lost ground simply by benchmarking and copying its rivals’ technology. Its competitors were too far ahead. Instead, Acme would need to make digital investments with an eye toward its existing strengths — to figure out what it did exceptionally well already, to articulate the gaps it needed to fill, and to leap ahead in that direction. Digitally Enabled Capabilities

But what did Acme have that set it apart? In design, logistics, and consumer insight, it excelled at doing “little things” that turned out to be not so little after all. For example, its ability to foster business-to-business

insight would require significantly better data gathering and analytics. Acme would have to gain greater insights into smaller segments of its market, develop a deeper understanding of its presence in each segment, and continually refresh its product portfolio to reflect changing consumer needs. For its business-tobusiness enterprises, Acme would leap ahead with digitally enabled operations, installing sensors and collecting and analyzing data about how the instruments were used. Acme’s industrial customers would use that data to make more informed decisions about their own operations and growth prospects. Other capabilities, such as certain aspects of talent management, were less important and required less

strategy+business issue 82

essay technology 32

older systems. Others, including the CRM system updates, simply didn’t work. They generated inaccurate and confusing data, which made customer service calls more frequent and more difficult. Frustrated employees ended up returning to their old ways. Many set up their own “shadow” IT systems to connect with their customers and suppliers. A year after the board meeting, very little of the road map had been implemented, while costs had continued to rise and Acme had fallen further behind its competition.

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ed to support a particular business, and most of them overlapped or were not aligned with Acme’s new direction. The CAP team phased out most of these completely, replacing them with new company-wide processes and systems aligned with the most important capabilities. The funds saved were then used to support the development of the new relationship-building and interoperability platforms, and particularly the proprietary software and other

products would also benefit from those efforts. But building an entirely new software development capability from scratch turned out to be an enormously complex task, in an area where the company had little or no experience. The resulting road map, as articulated by the CAP team, involved contributions from virtually every part of Acme’s organization, including product development, marketing and sales (which oversaw the data analytics needed to

Developing new capabilities would demand a complete transformation of the company’s approach to digital technology. gather and make sense of the output of the new services), learning and development, and procurement.

1. Set up a company-wide tran-

technologies that would distinguish them in these realms.

sition oversight team. Acme could

3. Blueprint a new capabilities

no longer keep EAP within the IT department. It established a new cross-functional capabilities architecture planning team to oversee digitization. Led by a top Acme executive, CAP included senior business unit and functional leaders. They were given a mandate to link the digital design plans to business strategy and capabilities building.

system unconstrained by tradi-

4. Pilot the new system with an

tional silos. Designing capabilities

emphasis on rapid results. Rather

for the entire enterprise required a great deal of attention. It included rethinking Acme’s operating model and business processes, choosing the right digital technologies, setting up training and recruiting to put people with the right skills in place, and fostering a digitally attuned culture. Because the new capabilities system was needed quickly, separate CAP teams were created for each capability within it. Each team picked one priority to focus on first, and used that project to demonstrate to employees, key customers, suppliers, and other stakeholders how the broader capability would operate in the future. For example, Acme needed to embed software into the industrial products it made, and its consumer

than seeking to implement their solutions perfectly, each of the Acme CAP teams established a baseline from which they could learn and improve. For example, the team embedding software into new products recruited two new full-time managers to bring this capability to life. They understood the company’s overall strategy, and were given authority to adjust the direction of the effort as needed. In turn, they reached out to a carefully chosen software firm and set up practices for coinvention and codesign with that firm, emphasizing the specialized capabilities that Acme needed to compete. The CAP team broke away from the conventional approach to software engineering, in which

2. Streamline the current system. Right out of the gate, the CAP

group was asked to find cost savings by identifying technologies and capabilities that could be decommissioned or outsourced. This freed up money to fund the digital transformation. Fortunately, low-hanging fruit was easy to find. The company was awash in dozens of different IT systems in every function — product development, sales and marketing, finance. Each was originally intend-

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attention. Still others, such as some of the company’s legacy marketing and innovation activities, could be dropped entirely. Rather than try to expand its solo R&D capability, Acme would partner with other companies in joint ventures around the world, extending its logistics and relationship-building capabilities into new arenas. It would also experiment with cross-boundary IT systems and crowdsourced approaches to product development. Now that Acme’s executives understood the value proposition, the capabilities that were required, and the ways in which digitization affected those capabilities, they were confident they could deliver. But the work was just beginning. Developing the requisite new capabilities would demand a complete transformation of the company’s approach to digital technology, in five successive steps:

ing and sales, they could help CAP leaders keep an eye on consumer habits, and on the new technologies that customers were demanding. Each cross-functional team monitored its progress through metrics focusing on how the new capabilities were creating value. Acme’s company-wide transformation program is only nine months old. But already the company has a rich body of experience on which to build. Still, the effort was not without its challenges and problems. For instance, some IT leaders protested that their function should run the capabilities architecture effort. Instead of arguing, the CAP leaders worked on improving day-to-day relationships with the IT leaders. They openly explored and explained the new value proposition, and gave the IT leaders a more integrated role, charging them with educating the

Your capabilities are your business, and technology should not be treated as a specialized field. into their own systems. Creating the first working prototype took just a few months, and the knowledge gained in the process gave the team a huge head start in creating future products. 5. Chart a new way to operate in the future, scaling up the early successes. The newly created software

business inside Acme served as a model for the entire company. It affected the clock speed of production, the schedule of releases to the external world, and the development of more permanent collaborative crossfunctional teams. Because these teams included people from market-

rest of the business leaders about the rapidly evolving digital technologies available to them. The software engineering effort also generated a great deal of early pushback. Many felt that agile development simply wasn’t the right approach, or that it wouldn’t work at scale. It took some early successes to prove to the nonbelievers that agile development could work at an industrial scale. By October 2015, when the first prototype was completed, Acme had dozens of well-synchronized and collaborative development teams at work. Acme’s story suggests that com-

panies focusing on distinctive capabilities can learn to compete more rapidly and effectively in an increasingly digital business environment. The key — for Acme and, we believe, for many other companies — lies in using the rigor of capabilities architecture planning directly, or adopting some of its tenets into an existing management approach, as a vehicle for collective mastery. Try to move your people, processes, technology, and partners into alignment as you carry out your capabilities architecture plan, making all of them parts of a single capabilities system. Your capabilities are your business, and technology should not be treated as a specialized field, set apart from the rest of your company: It is an inherent, inseparable aspect of what you do better than anyone else. + Reprint No. 16106

Jack Topdjian [email protected] is a thought leader on healthcare strategy and digital technology for Strategy&, PwC’s strategy consulting group. He is a principal with PwC US, based in New York. He leads the Strategy& technology and business enablement practice and is on PwC’s technology consulting group leadership team. Dirk Klemm [email protected] is a thought leader on capability architecture planning and digital technology for Strategy&. Based in Chicago, he is a principal with PwC US. He leads the Strategy& enterprise architecture practice with a focus on healthcare and customer engagement. Carl Drisko [email protected] is an advisor to executives on capabilities architecture planning, digital strategy, and transformation for Strategy&. He is a principal with PwC US, based in Boston. He leads the financial-services IT architecture team. Also contributing to this article was Chris Curran, a principal with PwC US and chief technologist for the firm’s advisory practice.

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managers carefully spelled out all the requirements for exactly how the new services-enhanced products would be integrated with Acme’s systems as well as those of its customers. Rather, the CAP team set up an agile development approach, in which groups of people assembled rapidly on a project-driven basis, working intensively on specific parts of the overall effort. As a prototype for this approach, the team chose the redesign of an important product with a large and loyal following, a product that was being targeted by competitors. They broke up the overall effort into small parts and gave them to separate groups of developers, who wrote their pieces of the puzzle in collaboration with willing customers. The pieces were then combined and the result tested with customers to make sure it could be integrated

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The Mindful Board Directors facing complex corporate governance challenges can develop their capacity to think together about the implications of their decisions. by Charlotte M. Roberts and Martha W. Summerville

I

n 1995, the board of directors of Methodist Hospital faced a profound decision over the institution’s future. The hospital, based in Indianapolis and owned by the Methodist Church, had significant financial assets, but its patient numbers were declining. It was considering a business relationship with both Riley Hospital for Children and University Hospital, two local academic facilities managed by and for the School of Medicine of Indiana University. As state-owned institutions, they lacked the funds and patient population to support their own three-part mission: education, research, and patient care. The church could have sold the hospital to a third party and invested the proceeds in church endeavors. But it recognized that the mission of the

prospective joint entity was far more important. Equally important, the board decided that loading the new organization with debt (to fund the consolidation) would be detrimental to its long-term mission. For nearly two years, Methodist Hospital’s board deliberated and discussed the practical and moral nature of such a merger. Meetings, updates from the task force that was negotiating details, and intense conversations with the local bishop informed the board’s evolving understanding of the terms of the transaction, the changing external environment, and the future mission of the hospital. On January 1, 1997, the Methodist Hospital board voted unanimously to join the consolidated entity, Clarian Health Partners. A second weighty decision arose a few years later. In 2003, Clarian Health Partners’ board members drew on their visceral memories of

the merger decision when they considered a statewide growth strategy. Clarian’s “Three-Front Strategy” focused on maintaining a commitment to the downtown academic health center, emphasizing success and growth for the suburbs surrounding Indianapolis, and continuing to develop in certain other regions of the state. The board recognized the political nature of the expansion, which would simultaneously transform the institution and its governance structure while having significant impacts on other stakeholders. Building new locations would pose challenges to existing medical relationships, bring the hospital into competition with more providers in the state, and require more debt. After a year of examining and refining the model for growth, the board approved the transformative strategy. In 2010, a third major decision was needed as the board reconsidered a complex challenge to change the organization’s name. Clarian Health Partners had been settled upon in 1997 as an “empty vessel”: the name symbolized its multifaceted origins, and its commitment to hold its consolidated entities without favoring any founding party. But as the organization grew and matured, the board realized that it would be more helpful to have a name that reflected its tripartite mission. And so the board changed the name to Indiana University Health in 2011. In 1997, the system had three primary locations, nearly 10,000 employees, and US$931 million in revenues; today, it has grown to 18 facilities, nearly 30,000 employees, and revenues exceeding $5 billion. These three important decisions may strike some observers as typical corporate moves. But the

Illustration by Lars Leetaru

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ORGANIZATIONS & PEOPLE

pressures require it to do so. Life in the C-suite is getting more complicated; boardroom challenges, too, are becoming knotty enough to impel an evolution in governance. People are seeking peaceful moments in a world fraught with intensity, stress, and complexity,

To begin each meeting, the board has a “connect to purpose” moment, such as a story or a video. Through that process, it strives to be aware of the broader contexts in which it operates. To begin each meeting, the board has a “connect to purpose” moment, such as a story from a patient or physician, or a video of a party for children at Riley Hospital. This moment is a way to remind those gathered of the spiritual side of healthcare and the organization’s effect on patients and their families. When confronted with a profound decision, one that will have wide impact on Indiana University Health’s three-part mission for generations to come, the board’s values and ethics committee convenes a group of citizens and members of the system for input before bringing a recommendation to the full board. The board is constantly looking at trends in providing healthcare to all citizens and envisioning their implications for Indiana University Health. This organization typifies an emerging style of corporate governance: the mindful board.

which is why mindfulness has become so popular in corporations today. Meditation, yoga, and consciousness-raising programs are being rolled out in offices from Silicon Valley to Wall Street. Mindfulness is a tool that executives and board members can find useful in observing thoughts, feelings, and biases during group deliberations. Insights arising from such reflection can influence subsequent actions. Our definition of the mindful board, however, goes far beyond personal mindfulness practices. Mindfulness in the boardroom refers to the capacity of a group of people to think in a deep way together. In

Exhibit 1: Evolution of the Board Species As boards evolve toward the mindful state, they develop the ability to expand their consciousness and have a greater impact.

STAGE 1

STAGE 2

STAGE 3

STAGE 4

Consent Board

Working Board

Strategic Board

Mindful Board

The Evolution of Governance

A governing board develops new capabilities and expanded purpose only when internal and external

assessing a current challenge, the mindful board looks to the past, present, and future. Deliberations encompass the impact of a decision not only on the enterprise, but on industry, society, and the planet. And the board considers how the decision will play out in both the short term and the very long term. Mindful boards intentionally look out at the world through multiple windows — technology, politics, sociology, environment, and economics. To leverage the power of using multiple windows, members of the mindful board hone their individual capabilities while practicing three interdependent disciplines as a governing body: leadership by the group, expanded consciousness, and fearless engagement. Through our experiences as board members, board leaders, and consultants, we have uncovered a developmental path that boards can choose to move along as their internal and external contexts change (see Exhibit 1). That path consists of four stages, of which the first three are relatively common and the fourth, which represents the next wave, is rare. Mindful boards, compared with other boards, are highly capable of meeting the increasingly com-

Source: Charlotte M. Roberts and Martha W. Summerville

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way in which they were made was innovative and forward-looking, as is the way in which Indiana University Health’s board continues to conduct itself. Simply put, the board has learned how to make weighty decisions mindfully with a formal process.

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parts and seeing the whole organization in the context of larger systems. But the strategic board is constrained by its focus on one industry or sector. When they are faced with a profound challenge, or when significant changes occur in society, technology, or economies outside the industry, the board members may fail to identify risks and opportunities. The strategic board looks out a variety of windows — all facing the same direction. Broader Perspective

The mindful board represents the fourth stage, and is beginning to emerge as external pressures increase and the negative impact of unintended consequences expands. In the world of corporate governance, mindfulness can be seen in trends such as the rise of the benefit corporation, or B-corp (firms mandated by their charter to benefit both their owners and the greater good); examples include King Arthur Flour and Patagonia. The corporate social responsibility (CSR) movement and the prevalence of socially responsible investment strategies are part of boardroom conversations. “CSR isn’t just becoming part of the CEO and board agenda; it is the CEO and board agenda,” said Dave Stangis, vice president of public affairs and corporate sustainability for Campbell Soup Company. As a board advances along the pathway, its purpose and capabilities transform. Members accumulate all the skills and capabilities from previous stages and expand the board’s capacity to govern in complex systems. The mindful board deliberates, discerns, and acts in a mindful way through critical decisions and episodes. Its purpose expands to include the well-being of

the enterprise and those affected by the organization and its actions, and the fulfillment of the organization’s raison d’être. Members think beyond the walls of the organization in time (considering the past, present, and future aspects of a decision), space (looking at implications for the enterprise, industry, society, and planet), and intention (exploring whether the decision will achieve their goals in the short run, in the long run, and in perpetuity). They draw from a deep well of acquired capabilities — fiduciary oversight, operational leadership, context intelligence, systems thinking, and strategic thinking. Imagine looking through multiple windows — that offer views in multiple directions. A board truly governs as mindful only when it consciously commits to the three interdependent disciplines mentioned earlier. The board gains its unique advantage from this trio: leadership by the group, expanded consciousness, and fearless engagement. Leadership by the Group

Let’s consider how leadership by the group is manifested by looking at a hypothetical case: an enterprise wrestling with new data about significant negative consequences on human beings, communities, and the environment from its production facilities in multiple countries. If the company has a consent board, the CEO presents the issues with a proposed solution, and the board chair frames the question for time-bound deliberation. If it has a working board, a committee vets the issue before presenting it to the whole board. Individual directors are expected to ask questions, respectfully challenge assumptions, and bring their expertise into the

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plex governance challenges faced by companies. Consent board. The consent board is the traditional model of governance. Engagement is minimal, as members focus on fiduciary oversight responsibilities and supporting the agenda set by the CEO. At its best, the consent board is efficient and tightly managed. Open dissent is discouraged, and monitoring officers’ actions is regarded as poor form. The limitations of this stage are evident when poor governance spills out into public view — as happened with the Enron and WorldCom implosions in 2001 and the 2008 serial banking debacles. Working board. Through its committee structure and in partnership with officers, the working board builds a greater understanding of operations and performance in key markets, and connects operational performance to competitive advantage. Although the board’s agenda remains driven primarily by the chief executive officer and the board chair, the members have an expanded view of operations and the business model. Yet that view does not increase the board’s likelihood of detecting broader issues and potential strategies that might move beyond senior management’s analysis. Strategic board. The strategic board understands the organization’s wider reaches in its regional, national, and international contexts. It takes a longer-term view of the organization’s business success and potential impact on the community and society. It seeks wider and longer perspectives, sometimes by turning to outside expertise, and distinguishes itself through systems thinking — both seeing the interdependencies among the constituent

Expanded Consciousness

Expanded consciousness describes the process of moving from looking

out one small window to looking out a larger window, then moving to multiple windows with a 180-degree view to the edges of the horizon, and then finally moving to more windows with an elevated 360degree view that extends farther. Expanded consciousness also requires the viewer to look inside himself or herself for biases and blind spots, and to strain to see what has been just out of sight in the environment. A consent board depends on the CEO to provide the insights and expanded awareness that are relevant to the immediate goals. By contrast,

And they appreciate that complex systems require balancing responsibility for the organization with the transcendent social responsibility to those beyond the company’s walls. When board members and officers dedicate time to expanding their collective understanding, they find answers to critical strategic questions and open up potential new pathways. Manifestations of such expanded consciousness can be seen in, for example, the recent decision by drugstore chain CVS to stop selling cigarettes — a $2 billion annual

The CVS board came to realize that the sale of tobacco products was no longer compatible with its mission. a working board will develop its expanded consciousness to improve operational performance and its competitive advantage. A strategic board, for its part, will develop and utilize expanded consciousness to anticipate industry or sector changes and expand its view of potential products, services, and markets beyond its traditional scope. Only the mindful board treats expanded consciousness as a necessary discipline in conducting its work. Individual board members and the board as a group expand their consciousness by continually learning about the business; the industry; the communities being served; and the global social, political, and economic trends. They proactively seek outside opinions and data to expand the view. Members challenge valued assumptions and beliefs and look to other organizations or cultures for insights.

business. Considering changes in the external environment and attitudes toward smoking along with changes in its business strategy to focus more on prescription drugs and health products and services, the board came to realize that the sale of tobacco products was no longer compatible with its mission. “It is the right thing for us to do for our customers and our company to help people on their path to better health,” said Larry Merlo, chairman of the board at CVS. “Put simply, the sale of tobacco products is inconsistent with our purpose.” Fearless Engagement

The most valuable board members have no qualms about discussing or exercising their capability to see an issue or situation through different lenses, and to draw attention to relevant connections and consequences. Fearless engagement can

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deliberations, which are directed by the CEO or board chair. In a strategic board, the board wrestles with the issue while paying attention to the long- and short-term risks and benefits associated with the proposed response. Board members are expected to engage in the debate about next steps, keeping the organization’s best interests over the next decade always front and center. A mindful board goes further. It creates the space for everyone in the room to fearlessly participate in deliberations and deep discernment. Any member can lead the conversation, and no one waits for an invitation to enter the dialogue. Everyone present is obligated to ensure that robust conclusions and decisions are made. Leadership by the group does not negate or devalue the importance of formal leadership roles and responsibilities; leaders frame and guide the work of the board. This group capability catalyzes insights that can make connections between forces outside the realm of the industry and the organization’s vision, strategy, and operations. Combining systems thinking and strategic thinking, board members can attend to the potential risks associated with a decision and the unintended consequences. Leadership by the group invites an outside-in perspective. In our hypothetical situation, group members raise questions about the organization’s responsibility to those impacted by the supply chain issues. They debate the best response for both the communities and the enterprise. Each member is accountable to the group and responsible for the quality of the group’s outcome.

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so opens new windows through which the board can see. A mindful board member must recognize the delicate balance of when to stop talking, when to persist, and when to allow the issue to ripen. Fearless engagement carries an obligation for each member to move conversations toward insight and a sense of unity among the group.

Fearless engagement requires that people speak up about what is being ignored in the conversations. Doing so opens new windows. the problem. On a strategic board, fearless engagement may be encouraged in the interest of reducing the risks to enterprise health and sustainability, but board leaders may discourage people from going off on tangents. In contrast, the mindful board will consistently practice fearless engagement to broaden and deepen the discussion. The board member brings all his or her intelligences (fiscal, social, political, emotional, noetic, economic, cultural) into deliberations in service to the board, to the organization, and to the communities it serves. When board members engage fearlessly in deliberations, they take advantage of the group’s diversity. Fearless engagement isn’t mayhem. It is based in honesty, respect, and trust. Directors seek out one another’s points of view and are willing to challenge opinions and assumptions without damaging relationships. Fearless engagement requires that people speak up about what is being ignored in the conversations. Doing

Mastering Governance

When the board develops and employs the three governance disciplines in concert, it significantly improves the core business capabilities we associate with governance. These include fiduciary oversight, operational performance assessment, strategic thinking, and systems thinking. This is the primary distinction between the consent, working, and strategic boards, on one hand, and the mindful board, on the other. The latter leverages its ability to think beyond the walls of the organization in time, space, and intention. New insights emerge that lead to new ways of thinking about dilemmas or puzzles. As in the case of Indiana University Health, the expanded capacity of the mindful board makes it possible to simultaneously fulfill its mission, perform fiduciary oversight, evaluate operational performance, provide strategic direction with attention to impact on communities and society, and inculcate a sense of the organization’s mission.

Overcoming Resistance

The evolution to a mindful board is not easy or natural. Three of the greatest obstacles and sources of resistance to greater mindfulness are presented by process (concerns and complaints that the new way of operating takes too long), values (deeply held beliefs about the board–CEO relationship and the nature of leadership), and capabilities (the degree to which members can engage in leadership by the group, expanded consciousness, and fearless engagement). Indeed, resistance will be such that some board members will no longer fit the new board culture and will need to be replaced. New members can expand the board’s capabilities, while seasoned members provide continuity and stability during the transformation to a mindful board. A deliberate process can help overcome obstacles. A critical mass of board members and senior officers must be willing to ask provocative questions that compel people to participate in conversations about the pressures on the enterprise. The inspired band of board members convert their context intelligence into evidence the status quo is no longer adequate. Next, they create and drive an action plan that changes multiple aspects of the board’s structure and culture at the same time. The board chair and a few other members become the steering committee to manage the board’s attention to work and change. They create and sustain momentum by engaging board members and officers in active reflection and evaluation of progress and flex the path of transformation as needed (see Exhibit 2). To be sure, the mindful board, like any other model, has its limitations. It takes time to deliberate

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happen at any stage on the continuum. On a consent board, members take on risk if they challenge assumptions or offer an observation of how the problem is understood. On a working board, members will fearlessly engage in committee deliberations and be cautious in plenary sessions, following the lead of senior management on how to solve

OBSTACLES AND RESISTANCE

Process

New from University of Toronto Press

STRATEGIES

• Design board meetings to allot more time to strategic issues, guided by questions that engage members in mindful questions. • Get started with a simple tool: Use tent name cards and print three or four provocative questions about the context “beyond the walls” on the back so each participant is facing the questions during all deliberations.

Values

• Use board retreats as the time and place to set mutual expectations and board goals that pull the board toward mindfulness.

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Exhibit 2: Building Mindful Boards

• Work directly with the CEO on how the board’s transformation and evolution may affect the leadership of the CEO and senior officers, and how they may stay aligned.

Capabilities

• Engage the governance committee of the board to design learning conversations about how leadership by the group, expanded consciousness, and fearless engagement benefit the organization. External facilitators or members of the board can serve as discussion leaders. • Track and report examples of when these capabilities were actively used successfully and what the concrete outcome was — new strategic moves, positive changes in business metrics, public relations reports, etc.

Source: Charlotte M. Roberts and Martha W. Summerville

mindfully. Excellent conflict management and group facilitation skills are required of the board chair and every other board member to generate the depth of discernment and deliberation that adds unique value. Practicing mindful governance does not guarantee that the best and right decision will be made every time or that bad things won’t happen. Since the trend is still emerging, we don’t have data comparing mindful boards’ productivity and business returns with those of consent, working, or strategic boards. Measurement of the impact of board effectiveness on the organization’s bottom line is still in its infancy. However, just as personal mindfulness can yield concrete benefits, it is already clear that mindful boards can help companies address the impact of a global economy buffeted by geopolitical, social, and environmental forces. Mindful boards can serve shareholders and constituents while attending to transcendent social responsibilities without sacrific-

ing fiduciary responsibilities. They can serve the enterprise and make a significant mark in the world. There is never a good time for making tough, complex decisions whose consequences range far and wide. When multiple disruptions start to occur, boards that practice mindful governance in partnership with executives are better positioned to respond with courage and care. +

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Leadership is Half the Story

A Fresh Look at Followership, Leadership, and Collaboration by Marc Hurwitz and Samantha Hurwitz This book introduces the first model to seamlessly integrate leadership, followership, and partnerships and provides new ideas and practical advice for anyone working in an organization.

Reprint No. 16107

Charlotte M. Roberts [email protected] is an executive consultant and president of Blue Fire Partners. Her books include The Fifth Discipline Fieldbook (with Peter Senge et al.; Random House, 1994). Martha W. Summerville [email protected] is president of Summerville Consulting.

Small Business and the City The Transformative Potential of Small Scale Entrepreneurship by Rafael Gomez, Andre Isakov, and Matthew Semansky An inspiring account of the dynamism of urban life, Small Business and the City introduces a new “main street agenda” for the twenty-first century city.

utppublishing.com

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CREATING A STRATEGY THAT WORKS

Illustration by André da Loba

by Paul Leinwand and Cesare Mainardi

Almost every business today faces major strategic challenges. The path to creating value is seldom clear. In an ongoing global survey of senior executives conducted by Strategy&, PwC’s strategy consulting business, more than half of the 4,400 respondents said they didn’t think they had a winning strategy. In another survey of more than 500 senior executives around the world, nine out of 10 conceded that they were missing major opportunities in the market. In the same survey, about 80 percent of those senior executives said that their overall strategy was not well understood, even within their own company.

feature strategy & leadership

The most farsighted enterprises have mastered five unconventional practices for building and using distinctive capabilities.

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Cesare Mainardi [email protected] is an adjunct professor of strategy at the Kellogg School of Management and a member of the school’s global advisory board. He was previously CEO of Strategy& and, before that, of the global management consulting firm Booz & Company. He is one of the principal architects of the capabilitiesdriven strategy approach and a contributing editor of strategy+business.

These problems are not caused simply by external forces. They are the outcome of the way most companies are managed. In all too many businesses there is a significant and unnecessary gap between strategy and execution: a lack of connection between where the enterprise aims to go and what it can accomplish. Yet a few companies seem to have this problem solved. They naturally combine strategy and execution in everything they do. These companies seem to make the right choices about what type of value to offer and how to deliver it — and those choices often run contrary to the conventional wisdom of the industry. For example: A European retailer–manufacturer sells stylish, functional, inexpensive furniture so that people at any income level can more easily improve their lives. Its large retail stores are designed so shoppers can comfortably spend a whole day there, eating in the store’s restaurant and leaving their children in its play area. The enterprise has remarkable capabilities, including an innovative manufacturing process and supply chain; a proficiency in designing attractive furniture that ships in a flat box; and an ability to develop keen insights about the way customers live at home, and to translate those insights into new products. This rapidly growing enterprise, of course, is IKEA. In 2014, IKEA had 361 retail stores in 46 countries, with total annual revenues of ¤30.1 billion (about US$40 billion). Another example is a Brazilian purveyor of highquality, natural personal-care products. Its identity, captured by the Portuguese slogan bem estar bem (“wellbeing, being well”) celebrates health and quality of life at every age, rather than a forever-young ideal of beauty. The company has built a network of 1.5 million direct sales consultants, who have close relationships with

Also contributing was Strategy& campaigns director Nadia Kubis, a director with PwC Switzerland.

This article is adapted from Strategy That Works: How Winning Companies Close the Strategy-to-Execution Gap, by Paul Leinwand and Cesare Mainardi, with Art Kleiner (Harvard Business Review Press, 2016). For more information on related research, see strategyand.pwc.com/ strategythatworks.

seemingly every woman in Brazil. To give those consultants a reason to visit their customers every few weeks, the company has developed a proficiency in rapid-fire innovation, releasing more than 100 new products every year. It demonstrates respect for nature and local communities by sourcing many raw materials from remote villages in the Amazon rain forest, and by using its business skills to help make those regions economically and environmentally sustainable. You may not have heard of Natura Cosméticos unless you live in Latin America, but it is the largest personal-care products company in that region. It had revenues of 7.4 billion reals (about US$2.6 billion) in 2014. Another case is a U.S. enterprise known for buying industrial and technological companies, reframing the way its member businesses operate, and managing them for profitability. It has developed its own rigorous dayto-day disciplines for managerial excellence and continuous improvement. The Danaher Corporation, named after the founders’ favorite fishing creek, is recognized among management experts for its remarkable performance and its phenomenal M&A success rate. It had revenues of about US$19.9 billion in 2014. (See “Danaher’s Instruments of Change,” moderated by George Roth and Art Kleiner, page 52.) Several other well-known enterprises, including Apple, Haier, Industria de Diseño Textil (Inditex, known for its Zara brand), Lego, Qualcomm, and Starbucks, have also closed the strategy-to-execution gap. These companies are all idiosyncratic; at first glance, they seem to have little in common, and they are rarely thought of together. And yet, they have all built the kind of differentiating capabilities that give them a major strategic advantage.

strategy+business issue 82

Paul Leinwand paul.leinwand@ strategyand.us.pwc.com is global managing director of capabilities-driven strategy and growth for Strategy&, PwC’s strategy consulting business. Based in Chicago, he is a principal with PwC US, an adjunct professor of strategy at the Kellogg School of Management at Northwestern University, and a contributing editor of strategy+business.

Extraordinary Enterprises

Conventional wisdom

The unintended consequences of conventional wisdom

The alternative: unconventional acts

Focus on growth

Getting trapped on a growth treadmill: chasing multiple market opportunities where you have no right to win

Commit to an identity: Differentiate and grow by being clear-minded about what you can do best

Pursue functional excellence

Striving to be world-class at everything but mastering nothing; treating external benchmarking as the path to success

Translate the strategic into the everyday: Build and connect the crossfunctional capabilities that deliver your strategic intent

Reorganize to drive change

Falling into a habit of organizing and reorganizing: trying in vain to change behaviors and create success by restructuring alone

Put your culture to work: Celebrate and leverage your cultural strengths

Go lean

Cutting costs across the board: starving key capabilities while overinvesting in noncritical businesses and functions

Cut costs to grow stronger: Prune what doesn’t matter to invest more in what does

Become agile and resilient

Constantly reacting to market changes: shifting direction in the misguided conviction that if you listen hard and act fast, you will survive

Shape your future: Reimagine your capabilities, create demand, and realign your industry on your own terms

Source: Strategy That Works

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In our previous book, The Essential Advantage: How to Win with a Capabilities-Driven Strategy (Harvard Business Review Press, 2011), we described the financial advantage that companies enjoy when they build their business around a clear, coherent identity: a few distinctive capabilities aligned with their value proposition and their lineup of products and services. It’s not enough to simply have good capabilities; every company has them. To sustain success you have to have capabilities that are truly superior, and distinctive enough that others cannot copy them. When you have several such capabilities reinforcing one another, you will be able to both differentiate yourself from and consistently execute better than your competitors. Distinctive capabilities are not easy to build. They are complex and expensive, with high fixed costs in human capital, tools, and systems. How then do businesses such as IKEA, Natura, and Danaher design and create the capabilities that give them their edge? How do they bring these capabilities to scale and generate results? To answer these questions, we conducted a study between 2012 and 2014 of a carefully selected group of extraordinary enterprises that were known for their proficiency, for consistently doing things that other businesses couldn’t do. From dozens suggested to us by industry experts, we chose a small group, representing a range of industries and regions, that we could learn about in depth — either from published materials or from interviews with current and former executives. The 14 we studied are Amazon, Apple, CEMEX, Danaher, Frito-Lay (the snack foods enterprise within PepsiCo), Haier, IKEA, Inditex, the JCI Automotive Systems Group (the seat-making division of Johnson Controls

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Beyond Conventional Wisdom

Why does it pay to run your business with these five unconventional practices? Because most conventional management practices have developed through trial and error, often without a direct link to a company’s strategy. The enterprises we looked at tend to seek success on their own terms. The five unconventional acts embody the attitudes and actions that help them accomplish this, day after day, in their businesses.

1.

Commit to an identity. These enterprises may offer a

wide variety of products and services in multiple sectors, but their identity is always clear. Everyone who interacts with them — including customers, employees, suppliers, shareholders, and regulators — knows who they are and what they stand for. The identity of a successful company aligns three basic elements: a value proposition (how this company distinguishes itself from others in delivering value to customers); a system of distinctive capabilities that enable the company to deliver on this

value proposition; and a chosen portfolio of products and services that all make use of those capabilities. Thus, for example, the Apple value proposition combines the roles of innovator, aggregator, and experience provider. (These and similar terms are defined in our online “way-to-play” tool: strategyand.pwc.com/way-toplay-tool.) Apple’s computers, tablets, and smartphones form the hub of a single digital system that allows people to easily manage media production, media consumption, and communication. The company accomplishes this through extraordinary capabilities in consumer insight, intuitively accessible design, technological integration, and breakthrough innovation of products, services, and software. It has applied these capabilities to its computers, mobile devices, retail stores, online services, wearables (the Apple watch), and media players (Apple TV). Haier, the Chinese appliance company that has held the world’s largest market share in “white goods” since 2011, competes with Apple in a few categories, including televisions and computers. But it has a very different value proposition: that of an innovator and solutions provider, offering products and services that meet the needs of particular customers and help them deal with problems. For example, Haier makes a small washing machine designed for undergarments (which are washed separately in China) and a large one designed for the robes of Pakistani men. It makes nofrost freezers for countries where power outages are common. It makes air conditioners that clean polluted air (and indicate the level of air quality with colored lights), and water conditioners that can be tailored to filter out the particular chemicals in the water supply of thousands of different Chinese neighborhoods. To provide products like these (and many others), it has developed its own capabilities system, very different from Apple’s. Haier’s system combines consumerresponsive innovation, operational excellence, the management of local distribution in a variety of regions, and on-demand production and delivery. Like Apple, Haier applies its capabilities to a broad portfolio of products and services. These include water-quality

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Inc., since renamed the Automotive Experience Group), Lego, Natura, Pfizer (specifically its consumer healthcare business, sold to Johnson & Johnson in 2006), Qualcomm, and Starbucks. To be sure, these are not the only enterprises that successfully use their distinctive capabilities for competitive advantage. You might assemble a different list, and we would probably agree with many of your choices. But these businesses represent a cross-section broad enough to provide us with a clear understanding of what they, and other businesses like them, have in common. Success has not always come naturally to them. At some point in their history, each moved away from the conventional wisdom of mainstream business practice. Each in its own way, these businesses followed a similar path — a path of five unconventional acts. These five management practices represent an approach to strategy that makes it easier to consistently succeed (see table, previous page).

WE FOUND MANY REMARKABLE CAPABILITIES AMONG THE COMPANIES WE STUDIED, AND FEW, IF ANY, OF THEM RESIDE WITHIN A SINGLE FUNCTION.

2.

Translate the strategic into the everyday. The com-

panies we studied focus on a few capabilities that are worth their full attention, and devote themselves to making them excellent — rather than supporting dozens of capabilities that merely have to be pretty good. To develop these capabilities, the companies often blueprint them (designing in detail how they will work). They continuously build them out with small management changes (we call these “point interventions”) and with regular breakthrough innovations in their own technologies and practices. They bring these capabilities to scale by combining tacit (ingrained) and explicit (codified) knowledge. Though these capabilities tend to pay off even in their early stages of development, it usually takes quite some time for them to reach full

fruition. After all, if they could be created overnight, they wouldn’t be worth very much, because anyone could copy them. We found many remarkable capabilities among the companies we studied, and few, if any, of them reside within a single function. Instead of aiming for functional excellence or external benchmarks, these capability builders make their processes and practices their own. If you ask people at Starbucks what they know about the customer experience, ask people at Danaher how they manage postmerger integration, or ask people at Natura how they organize their supply chain, they respond with precision and artistry about what they do and why it matters. Each company is a broad ensemble of virtuoso performers, continually learning from one another. Their individual skills and talents become more significant when the company weaves them together to produce something unique to that enterprise.

3.

Put your culture to work. Business leaders know that

the culture of a company — the way people collectively think and behave — can either reinforce or undermine its strategy. Because culture is difficult to manipulate or control, many executives tend to regard it as an enemy of change. Indeed, at companies stuck in the strategyto-execution gap, executives tend to complain about cultural resistance and disharmony. This complaint is a symptom of lack of strategic focus. Since the company isn’t clear about where it is going, employees don’t know where they stand. The companies we studied, however, view their culture as their greatest asset. The details of their cul-

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monitoring for cities in China, interior design for new homeowners there, and microcredit lending for Chinese purchasers who need it. Despite the variance within the portfolio, all the offerings are fitting for a global innovator and solutions provider from a large emerging economy. Haier’s capabilities will also fit its expanding global portfolio after its planned purchase of GE’s appliance business. Staying true to your identity doesn’t mean becoming complacent or losing your ability to change. It means using your strengths as a guide as you move through a rapidly changing world. When the entire company focuses on a specific way of creating value, employees are not easily distracted. They can concentrate on differentiating the enterprise in ways that naturally outpace their competitors’ efforts.

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4.

Cut costs to grow stronger. Companies that close the

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strategy-to-execution gap spend more than their competitors do on what matters most to them and as little as possible on everything else. Rather than managing to a preconceived bottom line, they treat every cost as an investment. They know that the same sum of cash could be used to fund either powerful, distinctive capabilities or incoherent activities that hold them back. They base their decisions about where to cut and where to invest on the need to differentiate themselves. These companies don’t treat costs as something separate from strategy. Cost management itself is a way to make critical choices about identity and direction. It moves these companies to a high level of financial discipline, redirecting resources to the core capabilities that are strategically important. Even when times are tough, these companies don’t cut costs across the board. They find ways to double down on their strategic priorities and cut everything else. CEMEX, a global building materials company, cut most expenses to the bone when, along with the rest of

its industry, it suffered during the 2008 housing crisis and the recession that followed. But even in the midst of a threatening debt crisis, CEMEX continued to develop its internal knowledge-sharing platform, an investment in technology and training that other companies might have considered superfluous. Doing so allowed the company not just to sell cement, which is a commodity, but to offer guidance to its customers (such as home builders and small municipal governments, often in emerging economies) about materials, construction financing, and urban design and development. CEMEX’s leaders knew that its return to growth depended on maintaining a distinctive edge with this capability.

5.

Shape your future. Over time, most of the companies

we studied have developed capabilities that take them far beyond their original ventures. They seek out higher aspirations — applying their capabilities to a broader range of challenges and loftier goals, serving the most fundamental needs and wants of their customers, and ultimately leading their own industries. These companies are relatively unthreatened by disruption, because their capabilities give them opportunities for expansion into new markets. They build on their early success to shape their future. They tend to work hard to avoid complacency. They explicitly try to anticipate how their capabilities will need to evolve. They build privileged relationships with their key customers, creating demand instead of just following it. In the same way that beavers and earthworms (known as ecosystem engineers) transform their environment to better meet their needs, these companies stake out a dominant role in the sectors where they are clear leaders — using M&A in many cases to influence the structure of their industries. Frito-Lay was already successful when it faced the prospect of disruptive competition in the early 1990s. It responded by investing more in its most important capabilities, dramatically cutting other costs, taking charge of the snack food retail shelf, and (for at least the

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ture may be unique, but all of these companies have a culture that reinforces their distinctive strengths. Within them, people are committed to the work; they feel mutually accountable for results and develop a kind of collective mastery that is hard to duplicate. You immediately sense the high level of trust and enthusiasm in these cultures in the very specific pride people have about their companies. Natura’s people refer continually to the importance of relationships in everything they do, and Starbucks employees speak of their genuine love of coffee, along with the ambience of a barista-style establishment. At Qualcomm, you hear about the company’s persistence in solving complex technological problems and promoting its solutions throughout the industry, “even when others doubt us.” At Danaher, people refer to their willingness to learn from one another at a moment’s notice, taking every opportunity to raise their management game.

The Idea of IKEA by Per-Ola Karlsson, Marco Kesteloo, and Nadia Kubis

F

The second statement embodying the identity of this enterprise is a

company began explicitly creating a capability in consumer insight,

succinct reference to the way IKEA

learning how IKEA’s customers lived,

involves customers in its operating

how they aspired to live, and what

or a good example of the five

model: “You do your part. We do our

frustrated them about their current

unconventional acts of coherent

part. Together, we save money.” Each

living situation. Kamprad became

leadership, consider the story of IKEA,

store, for example, is laid out so that

known for walking up to shoppers

the world’s largest furniture manu-

customers pick up their furniture

in IKEA stores and asking, “How did

facturer and retailer. The identity of

from the warehouse and assemble

we disappoint you today?” Today’s

this enterprise is embodied in two

it at home.

company-wide requirement that

simple statements. The first lays out

From its earliest years, IKEA has

managers visit customers in their

its value proposition, which founder

devoted itself to building and manag-

homes is a direct extension of this

Ingvar Kamprad articulated this way

ing this identity. Kamprad started the

original practice.

in the mid-1950s: “to create a better

enterprise as a college-age entrepre-

everyday life for the many people.”

Value Proposition IKEA delivers value as a low-price player and experience provider. It creates “a better everyday life” at home for many people around the world — providing functional and stylish home furnishings at very low prices with a high level of quality, sustainability, and customer engagement. Capabilities System IKEA delivers its value proposition by excelling at four differentiating capabilities: • Deep understanding of how customers live at home: IKEA applies this insight to a variety of design, production, and retail practices. • Price-conscious and stylish product design: IKEA integrates customer engagement, supply chain efficiency, and price considerations into the design process itself. • Efficient, scalable, and sustainable operations: IKEA has developed its own distinctive operational capability integrating supply chain, manufacturing, and retail practices. • Customer-focused retail design: The company knows how to create a distinctive combination of immersive and openwarehouse environments that provide engagement, inspiration, and a distinctive “day out” shopping experience where people can comfortably spend time choosing the things they live with every day. Portfolio of Products and Services Known for its flat-packed furniture and its self-pick, self-carry, and self-assemble model, IKEA sells affordable furniture and other home-oriented products.

neur in 1943, selling seeds, postcards, world, it codified and standardized and stationery. In the 1950s, he real-

many practices, but it also purpose-

ized that furniture in Sweden was

fully reinforced its participative way

so expensive that many people,

of bringing capabilities to scale, and

especially those moving into their

thus translated the strategic into

first home, could not afford it. Part of

everyday practice. IKEA is a place

the expense came from an elaborate

where managers routinely let their

system of middle merchants that

coworkers figure out new ways to do

bought and distributed furniture.

things, and it deliberately percolates

From that moment, Kamprad’s

the best of these ideas back up to

company, IKEA, would give people

the central organization. As Torbjörn

low-cost style at home.

Lööf, CEO of Inter IKEA Systems

Kamprad demonstrated his

B.V. (which manages the worldwide

commitment to this identity when he

store franchise system and the “IKEA

began buying furniture direct from

concept,” the intellectual property

manufacturers, bypassing dis-

shared by the full system), puts it: “Of

tributors to reduce the prices paid by

course there are areas where we’re

customers. When Swedish industry

very strict and structured. But people

leaders saw the threat he posed, they

don’t resist. They know [the IKEA

tried to prevent their suppliers from

concept] has been extensively tested,

selling to him. So he moved on to pro-

[and] they know we’re constantly try-

ducers in low-cost Eastern Europe,

ing out new things, and if they prove

where manufacturers could custom-

out to work, [those ideas] become

ize the product to his needs and give

part of the concept.”

him an even better price.

IKEA is also known for its

The first IKEA retail store

ability to cut costs to grow stron-

opened in Älmhult, a Swedish vil-

ger. (See “Is Your Company Fit for

lage, in 1958. Kamprad and his staff

Growth?” by Deniz Caglar, Jaya

began to put a great deal of time and

Pandrangi, and John Plansky, s+b,

thought into translating the strate-

Summer 2012.) Its people look for

gic into the everyday: designing and

cost-saving opportunities relentless-

building capabilities that set IKEA’s

ly in every way that doesn’t affect the

retail stores apart. For example, the

(continued on next page)

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IKEA’s Identity Profile

As IKEA expanded around the

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second time in its history) using its prowess in distribution to gain leverage over its category that continues today. Danaher did something similar in the early 2000s, when it expanded its innovation capabilities to meet the needs of more scientific and technical businesses. In 2015, it announced a still greater effort to shape its future by splitting into two companies — one a focused science and technology company, the other a diversified industrial enterprise — each of which will benefit from capabilities systems more tailored to its business.

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How the Five Acts Fit Together

At one business school where we presented these findings, a student raised his hand. “I get that the conventional wisdom is problematic,” he said. “But most of our professors are telling us to do those things.” Executives tell us something similar. The five acts of unconventional leadership contradict what many believe is the right way to run a business. Companies that focus on growth are universally applauded, even if the new offerings don’t fit well together. Functional excellence, organizing for success, going lean across the

board, and agility are all regarded favorably in business circles. But those are precisely the approaches that often lead to a gap between strategy and execution. Another insightful comment came from a highranking official of a branch of the U.S. military. The conventional wisdom, he said, accurately captured the management style of his overall organization. “But there are small groups that do [the unconventional acts] very, very well.” These groups, he said, were typically the special forces units: Green Berets, Navy SEALs, and other elite groups that take on highly sensitive jobs. Most companies also have similar elite groups, which are insulated from the rest of the enterprise. Company leaders delegate the premium activities to their special forces. But if you truly want to have strategy linked seamlessly with execution throughout your company, you can’t rely on a few extraordinary performers. You have to create distinctive capabilities that will scale across your enterprise, involving everyone in applying them to all the company’s products and services. That takes a level of attention, and a way of thinking and acting, that may seem difficult to achieve at scale. These five acts em-

(continued from previous page)

quality of the merchandise, the cus-

tural part,” says former CEO Mikael

come complacent. As Jesper Brodin,

tomer experience in the stores, or the

Ohlsson. If you’re an IKEA manager,

the range and supply manager for

efficiency of operations. That frugal-

and you visibly waste resources or

IKEA of Sweden, put it, “Our number

ity is reinforced by an annual moment

reprimand a subordinate for sug-

one threat is not the markets or the

of discipline: The company reduces

gesting an idea, you’ll hear about it

European economy or the recession

prices by an average of 2 percent at

immediately, not just from your boss,

or anything like that. It is ourselves

the start of every fiscal year. “This

but from everyone around you.

and our own capacity to transform

means we always start with a minus,”

Finally, IKEA uses its global

says Peter Agnefjäll, president and

scale, and its status as the world’s

CEO of the IKEA Group. “If our group

largest home furnishings brand, to

turns over ¤27 billion [US$28.7 bil-

shape its future. For example, it

lion], we start with a minus of ¤ 500

purchases furniture in such large

million [US$532 million]. If we don’t

volumes that suppliers go to great

do more, we’re going to lose.” IKEA’s culture reinforces all

lengths to meet IKEA’s specifications. Although the leaders of this enterprise

these practices. “The glue, or the

are conscious of its enviable market

inner strength, of IKEA is the cul-

position, they are careful not to be-

and deliver.” Per-Ola Karlsson leads Strategy&’s activities in Dubai. He is a partner with PwC Middle East. Marco Kesteloo leads the Strategy& retail team. He is a partner with PwC Netherlands. Nadia Kubis directs campaigns for Strategy& and is a director with PwC Switzerland.

strategy+business issue 82

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EVEN TAKING A FEW STEPS IN THIS DIRECTION CAN BOOST A COMPANY’S ENERGY AND MORALE.

cally rewarding. Even taking a few steps in this direction can boost a company’s energy and morale. To be sure, it requires you to have the courage of your convictions. You have to be discriminating and decisive, willing to say no to opportunities that don’t fit the strategy and persistent enough to bring the entire organization along for the ride. But it is not a leap into the unknown. There is a great deal of precedent, and you are in good company: Some of the most renowned, creative, and influential enterprises in the world keep moving forward along this path. + Reprint No. 16108

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body practices that help companies reach that state. The five acts themselves are so interconnected that you have to adopt them all together. If you overlook any one of them, you fall back. For example: • When you don’t commit to an identity, you risk becoming scattered among a variety of objectives. It is all too easy to continually shift your focus — to deal with exigencies and never quite build the capabilities you need. You gain a right to play in many markets, but a right to win in none. • When you can’t find a way to translate the strategic into the everyday, you have to rely on your existing functions to achieve your strategic goals. You risk becoming a company that perennially promises great things but never seems able to deliver. • When your company doesn’t put its culture to work, your people feel trapped and disengaged. Yours might be one of those passive-aggressive companies where new strategies fail because people pay lip service to them without believing they will last. • When you fail to cut costs to grow stronger, you starve the parts of your company that matter the most and overindulge those you don’t need. Your critical capabilities lose support, and they blend and blur into the rest of the enterprise. • If you can’t shape your future, you run the risk of falling behind competitors that are shaping theirs. You might lose the opportunity to become influential and thereafter be dependent on more coherent and thus more dominant players in your industry. We do not hold up the five unconventional acts as the only path to success. But it is the only path we know that provides this kind of long-term, sustainable success. It is also an appealing path that feels intrinsi-

Resources Anders Dahlvig, The IKEA Edge: Building Global Growth and Social Good at the World’s Most Iconic Home Store (McGraw-Hill, 2012): The author is a former CEO of IKEA. Paul Leinwand and Cesare Mainardi, The Essential Advantage: How to Win with a Capabilities-Driven Strategy (Harvard Business Review Press, 2011): The authors’ original look into coherence lays the groundwork for the five unconventional acts. Paul Leinwand and Cesare Mainardi, with Art Kleiner, Strategy That Works: How Winning Companies Close the Strategy-to-Execution Gap (Harvard Business Review Press, 2016): In-depth guide to the strategic path described in this article. Strategy&’s Strategy That Works interactive profiler, strategythatworks.com/profiler: An online survey that can help you rapidly diagnose your organization in terms of the five acts. Strategy&, “Our Leading Research on Strategy,” 2015, strategyand.pwc. com/cds-leading-research-strategy: Source of data on executive responses on strategy. Also see “Companies Spend Money and Time at Odds with Their Own Strategy,” July 22, 2014: strategyand.pwc.com/ ffg-indexprofiler-results-infographic. More thought leadership on this topic: strategy-business.com/strategy_and_leadership

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Cap Comable Dan pany ahe : r

Highly focused and diversified, this industrial company grows through acquisition, customer-facing innovation, and continuous improvement. Illustration by John Hersey

AN S+B ROUNDTABLE

Moderated by George Roth and Art Kleiner

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Danaher’s Instruments of Change

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W

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

hen the Danaher Corporation announced in May 2015 that it would split into two separate enterprises in 2016, it seemed at first like a reversal of the company’s history. Danaher had built itself into a remarkably successful business over four decades by acquiring and integrating new companies into a unified whole, improving them through a group of distinctive management practices known as the Danaher Business System (DBS), then holding onto them. Although it’s sometimes compared to a private equity firm, Danaher is different — it buys and builds companies for the long term, not for rapid fix-up and sale. Divesting is not the Danaher modus operandi. But from a strategic point of view, the split makes sense. Although these two new companies have a common heritage and management approach, their businesses are distinct enough from each other that they require different capabilities. One new company, which will retain the Danaher name, will focus on science and technology businesses. Generally, these are enterprises with resilient business models, strong long-term growth, high gross margins, and significant business in aftermarket products, such as replacement parts and upgrades. The other company, Fortive Corporation, will be made up of what Danaher calls its “industrial growth” enterprises. These are industrial end-market businesses with slightly more cyclical markets, high operating margins, and strong cash flow. The split is intended to provide each company with its own focus and to increase capital deployment flexibility, thus providing more opportunities for growth in each company’s distinctive way.

Distinctive capabilities have been central to Danaher’s success since the mid-1980s, when Mitchell Rales and Steven Rales, two brothers who owned a commercial real estate business, discovered they had a knack for buying and turning around ailing manufacturing companies. Over the years, the company had evolved from a highly leveraged startup to a profitable family of ventures with a market capitalization of more than US$40 billion in 2013. The Raleses, who had named Danaher after a Montana creek where they often fished, had invested heavily in the management skills of the people who ran it and its member firms. They and the other company leaders had developed a unique approach they called the Danaher Business System. This intensive continuous improvement program, derived from the Japanese quality movement, was augmented with homegrown approaches to innovation, commercialization, and leadership development that involved every level of management and were led directly by the company’s successive CEOs. At strategy+business, we have covered Danaher’s prowess with acquisitions (see “The Capabilities Premium in M&A,” by Gerald Adolph, Cesare Mainardi, and J. Neely, s+b, Feb. 22, 2012, and “Deals That Win,” by J. Neely, John Jullens, and Joerg Krings, s+b, July 14, 2015), but it wasn’t until we researched the book Strategy That Works (see “Creating a Strategy That Works,” by Paul Leinwand and Cesare Mainardi, page 42) that we realized how far Danaher’s capabilities have taken the company. The executive interviews in this roundtable were conducted in 2012 and rechecked and updated for this article. They show how an enterprise that organizes itself around what it does best can generate a long-term track record of consistent success.

strategy+business issue 82

George L. Roth [email protected] is a research associate at the MIT Sloan School of Management and a visiting associate professor of management at the University of New Hampshire. He is a coauthor, with Anthony DiBella, of Systemic Change Management: Five Capabilities for Improving Enterprises (Palgrave Macmillan, 2015).

Distinctive capabilities have been central to Danaher’s success since the mid-1980s.

Original Systems DAN COMAS: The

The Danaher Business System was born in 1986, when I was the president of the Jacobs Manufacturing Company in Bloomfield, Conn. “Jake Brake” was a formerly family-owned business that made brakes for diesel trucks. In 1984, the company had merged with Chicago Pneumatic, a maker of power tools and industrial equipment, which Danaher subsequently bought. Jake Brake was profitable, but it was ready to collapse because it was abusive to its customers, who began to look for alternatives. I had been convinced of the power of the lean approach ever since I had worked with a Japanese–U.S. joint venture several years before. So I started to adopt that approach as a laboratory for change. In early 1988, I learned that Yoshiki Iwata and Chihiro Nakao, two Toyota Production System sensei who had been handpicked disciples of its chief architect, Taiichi Ohno, were teaching at the University of Hartford. I took them to dinner and asked if their consulting company, Shingijutsu, could help us. Before saying yes, they demanded to see the plant, right away. There was a lot of anti-Japanese sentiment then, especially in the United Auto Workers, our union. So when I arrived at 11 p.m. with two Japanese guys, it got the attention of everyone on the night shift.

GEORGE KOENIGSAECKER:

Danaher’s Identity Profile With headquarters in Washington, D.C., Danaher is a group of companies that produce instrumentation and solutions for a broad range of end markets, including healthcare diagnostics, life science research, industrial manufacturing, maintenance, and service. With a global workforce of 71,000, it had revenues of $19.9 billion in 2014. Since 1980, its annualized returns to shareholders have been three times as high as those of the Standard & Poor’s Industrials Index. A split into two enterprises, Danaher and Fortive, is planned for the second half of 2016. Value proposition: As a “company that builds companies,” this consolidator adds value through M&A and operational excellence. Its member companies are B2B category leaders, consistently offering high-quality products and solutions to professional, medical, industrial, and commercial customers.

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founders, Steve and Mitch Rales, started out in the 1980s with a real estate company. They bought some poorly run manufacturing companies, and discovered they could rebuild them and run them profitably. It was a better business than real estate. Between 1985 and 1990, their little company went from almost nothing to a market cap of about $400 million.

Cap able Com Dan pany ahe : r

Capabilities System • Acquisition and integration: Danaher succeeds by acquiring and integrating companies that will thrive within its culture and with its capabilities system. • Leadership development: Through this capability, the company engages people in learning sophisticated management practices. • Intensive continuous improvement (the Danaher Business System): This capability drives operational improvement of quality, service, reliability, and cost, generating above-market growth and profitability. • Scientific and technical innovation: Danaher’s innovation capability enables product development that meets the evolving needs of its diverse customer base. • Portfolio of products and services: Danaher has more than 40 businesses spanning five segments: industrial (Kollmorgen, Videojet); test and measurement instruments (Fluke, Tektronix); dental (Kavo, Kerr); life sciences and diagnostics (Beckman Coulter, Radiometer); and environmental (Hach, Gilbarco Veeder-Root). —Adapted from Strategy That Works: How Winning Companies Close the Strategy-to-Execution Gap

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PARTICIPANTS

Cap able Com Dan pany ahe : r Dan Comas is an executive vice president and the chief financial officer of the Danaher Corporation.

Bill King is the senior vice president of strategic development at Danaher.

That Jake Brake plant is still a Danaher subsidiary. It has a huge market share, great customer satisfaction, and a high level of quality. Its example showed us the power of lean production in turning a business around — and in funding acquisitions by generating cash from operations. Probably every senior leader at Danaher can tell the story of saving the Jake Brake plant. It’s passed down from one generation of leaders to the next; it helps us learn why we are who we are.

JIM LICO:

As we grew the company through acquisitions, we rolled out the Danaher Business System to each new piece. We set up kaizen [continuous improvement] sessions and policy deployment [PD] reviews for every business. [PD reviews, also called hoshin meetings, are in-depth structured sessions used to assess progress toward previously agreed-upon goals.] We encouraged team members at every level of the company to take responsibility for specific pieces. Whether you’re in a strategic plan review, an operating review, or a growth initiative, or walking the plant floor, all the questions and challenging come back to some aspect of “How do we get better?” This isn’t something we would just talk about before an analyst conference or board meeting. People at Danaher talk about it every single day. It leads to great, rich discussions everywhere, including parts of the business outside the factory. You go to people down in payables for a day sales outstanding [DSO] number, and they say they don’t have it. You can push back, suggesting they use some of the DBS [Danaher Business System] tools or conduct a PD review, and you figure out something together. That’s how business is supposed to work.

STEVE SIMMS:

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As we walked around, Iwata made little jabs: “It’s a big warehouse. Where is your factory?” We were obviously buried in work-in-process. He said it was the worst factory he’d ever seen: “You should be fired immediately.” Finally, we got to our most important cell. “Would you like to fix it now?” he asked. The machine layout was backward. We’d set it up clockwise. If we changed it to counterclockwise, each worker would use his right arm, which is 3 percent stronger on average. That would get us a 3 percent productivity gain. But we would have to move all the machines. We worked until 5 a.m. redesigning the cell. This event launched a total transformation of our production system. We started working with Shingijutsu for a week every month. There’s magic in that weeklong cycle. It’s long enough to study, make changes, and get the change semi-established. Things began to move at a blistering pace. Danaher bought Chicago Pneumatic in a hostile takeover around the same time. As the new owners, Steve and Mitch Rales came up to see what we were doing. We thought they would kill our new approach. But their lack of an operations background turned out to be a godsend. If they’d been conventional manufacturing guys, it wouldn’t have made sense to them. But fortunately, they knew nothing about manufacturing, and it seemed logical — plus we were delivering strong productivity numbers. They asked us to make a presentation at Danaher’s first-ever corporate meeting, later that year. Soon after that, we had established these practices as the beginning of the Danaher Business System.

Thomas P. Joyce Jr. is the president and CEO of Danaher.

Kevin Klau is president of Hach Lange, and a former vice president of human resources at Danaher.

George Koenigsaecker is a former Danaher senior executive and a developer of the original Danaher Business System. He is now the owner of Lean Investment.

Jim Lico is an executive vice president of Danaher, and the designated president and CEO of Fortive Corporation, the new company that will spin off from Danaher in 2016.

SIMMS: The culture evolved from the top. With George Sherman there was no confusion; DBS was the only way to run the business. George was as conversant and skilled in the tools as anybody I’ve ever met. He was succeeded as CEO in 2001 by Larry Culp, who further reinforced our practice. Larry posted notes for all staff on the company’s intranet every day. We’d call it blogging today. He’d write about that day’s kaizens. Something like, “It’s 9:00 at night and Simms is supposed to be meeting me, but he’s not here because his team is still in the plant moving equipment.” The excitement and constant attention became part of the culture. Senior managers were actually rated every year on their proficiency with the DBS tools. Once a year we gathered for the Danaher Leadership Conference — a series of 40 or 50 presentations over three days highlighting best practices for the top 100 to 150 leaders at the operating companies. One example could be a story about how the water quality platform has captured customer insights for accelerated product development. Another could be, “We finally learned to do policy deployment right after 15 years.” Each presentation explained a problem, the root cause, the countermeasures taken to solve it, what [the people involved would] do differently in retrospect, and what they’d advise you to do — with an email address and phone number. “Call

Henk Van Duijnhoven is a retired senior vice president, formerly of Danaher’s dental businesses.

Steve Simms (not pictured) is a retired executive vice president of Danaher.

me, and we’ll talk about some ideas and people to help get you started.” Building Capabilities

We generally start teaching the Danaher Business System through classroom work and then move to actually applying this improvement at gemba [where the work is done: for example, the manufacturing floor, R&D, the lab, or on sales calls]. When people participate in the implementation of tools, that is as good a learning experience as you can have. We tie together culture, capability building, and people development this way.

HENK VAN DUIJNHOVEN:

LICO: The top 25 executives at Danaher, including the CEO, all teach two or more weeks per year. In those sessions, they don’t just teach; they create an environment where leaders can talk about the challenges of their business. We have had kaizens with the CEO on teams, in factories, and on the shop floor. SIMMS: All senior executives regularly teach the tools where they are certified. Before I retired, I was a black belt with some of these tools, which meant I had a commitment to lead others to use them and be evaluated on the results. I often taught at companies in other parts of Danaher that didn’t report directly to me. It would signal a high level of importance when I spent a week facilitating a team that wasn’t even in my group. We always tried to incorporate new things into DBS to have it grow and change as the portfolio changed. Lots of companies use the DBS tools as individual techniques. Danaher makes the tools part and parcel of the culture. When I was recruited to Danaher from Black &

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COMAS: In 1989, the Rales brothers hired George Sherman to become CEO. George was the chief operating officer — the number two guy — at Black & Decker, a much larger company at the time. Steve and Mitch, who can be very persuasive, must have convinced him that there would be a better future here.

Chris McMahon is a retired vice president of finance at Danaher.

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“We’ve kept a very consistent long-term approach. We just roll up our sleeves and do it. We know we will fail a hundred times before we get it right.”

The company doesn’t get distracted by fads, like Six Sigma or management by objectives. We’ve kept a very consistent long-term approach and method. We just roll up our sleeves and do it. We know we will fail a hundred times before we get it right. But with businesses that have demonstrated this discipline around core processes and tenets, slow and steady wins the race. That has helped Danaher focus on long-term growth, long-term margin expansion, and maintaining a great cash flow record over many years.

CHRIS MCMAHON:

LICO: We have been learning how to extend DBS to a larger and larger scale for more than a decade. In 2003, when I was running the DBS office, Mitch Rales asked me how I was going to teach DBS to 24,000 people in the next three or four years. I said, “We only have 24,000 people in the company.” Mitch said, “Yeah, but we’re going to double in size in the next three or four years and that’s our task.” As we get larger, we want each operating company thinking about how to scale DBS in its own way — as opposed to somebody at corporate deciding. We’ve also

become more codified than we were in the early days. We do more formal training and leadership development. Often new tools emerge from discussions of the Danaher leadership team, which is the top 20 leaders, most of whom operate companies in the Danaher system. This group gets together several times a year. When we develop a new approach — for example, a lead-generation tool for Web marketing — there’s not some committee that does it; we all become students. We quickly pick up everything we can from one another; then we make sure that it works in our environment. We typically implement a new tool by experimenting with it at a Danaher company that is already reasonably good, trying to take it to the next level. Then we take what we learn to a few other companies. Often within 12 months, we’ve gone to all the operating companies to demonstrate the tool. Not every operating company has to implement every tool; they choose the tools that will enable them to achieve their strategic goals, fix quality issues, or improve delivery or other operating company objectives. Product life-cycle management fits companies that have an active product pipeline, but it might not be important for one of our businesses like ChemTreat, which provides solutions for industrial cooling problems.

VAN DUIJNHOVEN:

A process orientation is fundamental to DBS. The tools we use may not always be easy, but they must be repeatable, sustainable, teachable, and simple. THOMAS JOYCE:

SIMMS: In the early 2000s, [then CEO] Larry Culp asked if I’d be willing to lead a team to identify oppor-

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Decker, I immediately recognized that the culture was unique and very powerful. My effectiveness and leverage were far greater than anything I had seen elsewhere. The senior management is quite good at calling out “fake DBS.” It might be pretty charts in three dimensions and perfect colors. Or a cell diagram presented by someone who can’t walk you through it when you ask them to. Danaher has a fact-based culture. As long as you have the facts or are willing to get them, you’re safe. If you’re touting pabulum, that’s an unsafe place to be.

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Meaningful Metrics

We hear the same thing from everybody who joins the company: Danaher is incredibly metric-oriented. We measure everything on a real-time basis — always monthly, often weekly, sometimes daily, and even hourly when you get down to a cell in a factory.

COMAS:

MCMAHON: In 2006, we stepped back and realized that we had 150 key performance indicators. We were driv-

ing ourselves crazy with all these metrics and data. We decided to narrow it to just the most important metrics. Those are our eight core value drivers. We had to do this if we wanted to scale up. JOYCE: The first four core value drivers are core growth, operating margin expansion, working capital returns, and return on invested capital. Those are the four shareholder-facing financial metrics. The next two are customer-facing metrics. On-time delivery is measured against when the customer wanted us to deliver something (even if that is yesterday). External quality is a broad measure of every dimension of a customer experience. There are two associate-facing metrics. The internal fill rate is the percentage of managerial positions we fill with internal candidates. Retention is the last metric. Every Danaher business uses those eight metrics to answer the question: Are we winning? In each business, we have a disciplined cadence of monthly operating reviews: eight-hour face-to-face meetings with a standing agenda and 20 monthly objectives for each business. The operating review is always held at the local business, not in Danaher’s headquarters in Washington. It’s very data-driven. We focus on things that are not going well and what we’re going to do to improve them. But the response to metrics is as important as the numbers. If an operating review shows green on all 20 monthly objectives, we know we probably have an issue. The objectives weren’t tough enough. And if they’re red on 10 out of 20, the way the team responds matters. You don’t want them to view it as OK, but you don’t want them demoralized, either. You want them to

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tunities for organic growth, beyond what we already had. This came from an analysis that correlated organic growth and superior shareholder value. We looked at different ways of thinking about product development and innovation inside and outside the company. We talked about advanced skills in sales, and pricing as a strategic weapon. We looked for companies that were best in class; we sent a team of people to Procter & Gamble. It’s a radically different company, but its concepts on innovation stretched our thought process and led us to do a number of things differently. We went to Starbucks several times to look at customer management. We talked to experts on pricing and pricing analysis. We customized what we learned to fit the Danaher culture. Then we piloted the resulting organic growth tools with targeted Danaher companies where we thought we had the greatest opportunity and capacity. Finally, we rolled it out across Danaher, by asking every business to talk through a simple matrix of strategies and growth tools. “If we’re going to be successful in organic growth, which tools are going to get us there? How do you build the internal muscle to be able to eventually lead that process yourself?”

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SIMMS: In our strategic planning, we come back to two questions. “What game are we trying to play? How are we going to win within that space?” Everyone is expected to be able to answer those two questions in relatively simple terms.

A Superior M&A Capability

Our approach to finding acquisition targets was 20 years in the making. It started when we decided we would not wait for Goldman Sachs to call us with their prospects. Instead, we did our own up-front research into prospective markets and started to build funnels of names of companies to buy and industries to enter. COMAS:

Other companies try to make one perfect bet. That’s a risky way of letting senior executives with no experience sit on a lot of cash. Instead, we continue to explore many acquisitions and bring a significant number to fruition. When you acquire frequently enough, you learn what to do and what not to do. You

VAN DUIJNHOVEN:

develop skill at assessment and integration, and you learn to hold these assets over a longer time than might happen in private equity. Our main criterion: Through this acquisition, can we ultimately become one of the market leaders in that industry? That typically requires that we pick up one of the stronger brands or assets within that industry, and that we generate at least as much value as, if not more value than, the current owners do. Often, when you do one deal, everybody thinks you’re not going to do another, so competitors come in thinking they have an advantage. On the contrary, we look for complementary companies to buy before we make an offer. When we bought Beckman Coulter in 2011, we were already aware that we wanted to buy Blue Ocean Biomedical, a cytometry firm that could reinvigorate Beckman’s hematology business. We snatched it up within six months of closing on Beckman.

BILL KING:

JOYCE: We have a very disciplined M&A process. It starts with having a clear sense of what markets we find attractive. We look for large global markets with good growth profiles and generally low cyclicality. We also look for the ability to develop sustainable competitive advantage through a brand and intellectual property. We also look, obviously, for good profitability and low capital intensity. If we don’t like the market, we don’t bother looking at specific companies. COMAS: We find that businesses with more branded products, especially those used by professionals, are inherently more profitable. Their products have more pricing power. They are also often poorly managed

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rise to the challenge, adopt stretch objectives, and seek to improve. You can walk up to a visual board on the shop floor in any Danaher business, and the metrics have the same labels: safety, quality, delivery, cost, and inventory. You can look at progress against clear targets — monthly, weekly, and daily cell-level targets. With that kind of visibility and transparency in performance, it’s easy to call it the way you see it. You can start a discussion by saying, “Based on the data, we’re not making progress.” We try to remember this is about winning in the eyes of our customer and against the competition in the market. People want to win because winning is fun.

“Our main M&A criterion: Through this acquisition, can we ultimately become one of the market leaders in that industry?”

We do 12 to 14 deals a year and turn down 10 times that, so we’re doing 150 due diligences a year all over the world. We do extensive due diligence on each one. Our pre-acquisition investigations, especially on the finance side, are designed to dig up, expose, and share every bit of risk, making sure we all know what we’re getting ourselves into. If something looks scary, let’s make sure we sit around the table and figure it out or walk away. We try to be patient and not to get emotionally tied to any particular investment. MCMAHON:

JOYCE: Larry Culp, my predecessor as CEO, could tell you stories about how long he cultivated Kathryn and Clifford Hach before acquiring the company they founded, the Hach Company, in 1999. It would make you wonder why we didn’t give up a lot sooner, but the model has proved successful. You’d have to go back to our earliest days to find a hostile takeover.

powerful tool. At any point we’re probably cultivating 200 companies that aren’t for sale today. We’ve cultivated some companies for 10 years. When they’re ready to sell, they’ll often come to us because they know we’re interested and they understand how we operate. During due diligence, we assess their potential with the same metrics we use in our daily business. “Here’s this company’s profitability today; where do we think we can get it in three years? What are the five or six building blocks to get there?” We look at it from the perspective of the factory, people, go-to-market investments, and new products. We publicly announce the return metric we want to see within a stated time period, and how we think we’re going to get there. When we started doing this, at least one banker warned us against it; it might tie our hands on a potential deal. But it’s worked the other way. Investors are comfortable with this approach. They understand that once the bidding on a deal gets up to a level where we no longer can hit our return, we move on. We also assess whether management will buy into the Danaher Business System. We have passed when we felt we could not work with the management team. On average, we probably change two or three of the 10 top roles in a new acquisition. Often we replace the CFO, because we’re very metric-oriented, and we want someone in place there who understands the Danaher metrics. For each acquired company, we establish a target of having a strategic plan in place within 100 days of the closing of the transaction. That process creates alignment, and allows us to quickly establish and reconfirm the financial targets from our due diligence. Due diligence only goes so far, and we need the company JOYCE:

COMAS: We might say to a company leader, “You don’t know us, but we’re interested in this space, and one day, if you think of selling your business, please talk to us. We have a long-term point of view and would like to stay in touch over time.” That’s proven to be a very

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from a cost perspective. They’re making money from their technology and brand, but manufacturing, supply chain, and the back office are afterthoughts. We sometimes have to explain to analysts why these companies, which might have a 50 percent gross margin, are attractive. It’s easier to improve their performance than it would be to improve a very well-managed manufacturer of industrial products that has a 25 percent gross margin. It sounds counterintuitive until you think about it.

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We ask all the companies why they do what they do. People quickly understand that we’re not trying to change everything. We’re really trying to help the business be better. A famous phrase we use at Danaher is “don’t let perfect get in the way of better.” We bought Beckman Instruments because we wanted the Beckman Coulter brand of biomedical laboratory instruments. We were very aware of what it had taken to build the strength of that brand over 100 years. We knew if we tried to change everything, we would trash the culture of Beckman and lose the brand continuity. We tried to preserve what was great about that business at the same time we brought in aspects of Danaher that added value. Beckman is successful today because its leadership and the associates embraced DBS. As we buy companies, we learn new things. The dental businesses had great sales management practices that were new to us. When we acquired Fluke and Hach, we learned better product management. When we bought Tektronix and some of the life sciences businesses, we learned more about technology development, advanced R&D, and software development. And those learnings were incorporated into all Danaher businesses. One of the most important things we can say about DBS is that it improves and changes as our portfolio changes. LICO:

The Soul of a Company

We devote a lot of attention to the people we hire — both in recruiting them and in helping them be

COMAS:

successful here. For many years we have worked with a group of psychologists to develop a custom assessment for Danaher executives, covering both talent and cultural fit. You do not come into the organization at midlevel or above without completing it. We look for people who are aggressive, smart, metric-oriented, OK with failure, nonpolitical, and not defensive. We want someone who is capable of saying, in a meeting with the CEO, “Hey, we underperformed this quarter. These are the three reasons we underperformed, and this is what we’re going to do differently to change that.” SIMMS: Often, the critical factor when you consider hiring an executive at Danaher is whether he or she can buy into the culture of process development and continuous improvement. For example, there might be a sales leader or manufacturing executive who has grown up in a culture of delivering his commitments through brute force or other “heroics” at the end of the quarter. At the end of the day, though, he didn’t leave a strong organization in place. That approach may be successful in some companies, but not at Danaher. Our goal is to hire, develop, and retain strong leaders who can create and continuously improve the necessary processes to achieve our goals and the expectations — without the need for brute force. That’s what creates competitive advantage. KEVIN KLAU: We throw key new hires into immersion. For 60 to 90 days, they don’t do their job. They are challenged with understanding the culture, experiencing Danaher in a variety of ways. It lets them build their internal network. It helps them understand what

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management teams to play an integral role in defining a path for their future, in concert with us.

“We have the soul of a small company. We still remember when we all pitched in to ship product on Fridays if the warehouse was full.”

We also have an immersion process for acquisitions, aimed at the many leaders who join us that way. But when we acquire a new business, we can’t take the entire leadership team out of their jobs for weeks. Instead, we conduct immersion over a longer period of time. It may take a year or two. We put the leadership team through a three-day training that covers all the basics of DBS. It provides an orientation to the tools. We give them kaizen experiences; they go to operating reviews at other businesses. We send Danaher experts into that business for an eighthour operating review every month. We look for a specific opportunity for performance improvement, often one that the team in the business has identified, that they have been dying to knock over for a long time. We organize our first weeklong kaizen around it, bringing together the senior team of the incoming business and some DBS leadership. We demonstrate the power of DBS tools and the fun that comes from knocking over a big problem in short order. And they start to turn the corner. JOYCE:

LICO: We

have the soul of a small company. We still remember the day when we all pitched in to ship product on Fridays if the warehouse was full, or we took a tech support call even if we were top executives. Although

those days are long gone, we remember and long to keep that culture while learning and evolving in ways appropriate for our future. COMAS: A lot of the leaders here like to be part of something special. We are sometimes compared to private equity firms because we are so acquisitive. We bristle at that a little, because this is not how we are wired. We rarely sell businesses. Sure, we want to monetize what we bought, just as much as private equity does, but we do it in a very different way. We aren’t passionate about selling the business. We’re passionate about building the business. +

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“good” looks like, and where different businesses and organizations are on their growth journeys. Then we drop them in their chairs better positioned to ask the right questions to drive performance in their function, with a better understanding about DBS, what makes this culture unique, and where to go internally to leverage best practices.

Reprint No. 16109

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Resources Bill Fischer, Umberto Lago, and Fang Liu, “The Haier Road to Growth,” s+b, Apr. 27, 2015: The Chinese appliance maker continually reinvents itself and expands around the world. Paul Leinwand and Cesare Mainardi, with Art Kleiner, Strategy That Works: How Winning Companies Close the Strategy-to-Execution Gap (Harvard Business Review Press, 2016): Danaher was one of 14 companies studied that succeeded through the way they built and used distinctive capabilities. J. Neely, John Jullens, and Joerg Krings, “Deals That Win,” s+b, July 14, 2015: Why Danaher and other capabilities-driven serial acquirers do so well at M&A. Thomas A. Stewart, “CEMEX’s Strategic Mix,” s+b, Apr. 13, 2015: Another company that distinguishes itself through the things it does consistently well. More thought leadership on this topic: strategy-business.com/strategy_and_leadership

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A global survey of business leaders shows how the smartest companies develop and wield their technology strategy.

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IQ RAISING YOUR DIGITAL IQ

CHRIS CURRAN, TOM PUTHIYAMADAM, AND BY

Illustration by Aad Goudappel

CHRISIE WENDIN

Like most other executives today, Thomas Okke Frahm thinks about how his organization can better exploit digital technology. But the biggest challenge he’s pondering at the moment doesn’t involve engaging customers through mobile devices, migrating applications to the cloud, or even beefing up cybersecurity. He’s thinking about cheese. Frahm is the vice president of global IT management at Chr. Hansen, an ¤859 million (US$940 million) multinational bioscience company based in Denmark. It produces natural food ingredients, microbiological cultures, and probiotics, mostly for consumer packaged goods companies such as food manufacturers. Now, Chr. Hansen is exploring the ways that sensors can help clients perfect their processes for making cheese, yogurt, and other foods that rely on cultures and enzymes. These foods are consumed by hundreds of millions of people daily.

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Tom Puthiyamadam [email protected] is a principal with PwC US, based in New York. He leads the firm’s management consulting practice. He also leads its digital services practice and oversees its Experience Center, which helps clients create next-generation experiences for their customers, employees, and partners.

Chr. Hansen (pronounced “Christian Hansen,” after the full name of its founder) has been operating continuously since 1874. One of the world’s oldest companies, with a heritage of consistent innovation, it is now being challenged by digital technology to leap ahead of its old ways of doing business. In the cheese-making project that Frahm oversees, sensors capture data about the pace and quality of bacteria development, thus improving production yields. Frahm says that consumer packaged goods companies could subscribe to this granular view of these processes as a digital service. But would they pay for it? A similar effort last year stalled; customers weren’t ready. Nor is Chr. Hansen fully ready itself, despite its strong embrace of digital technology. It is still figuring out how to bridge the gap between the petri dish and the production floor. “We [have been] a very traditional company,” says Frahm. “We have big silos between innovation and production.... If I can combine the two things, then we can be even faster from idea to final product.” He adds that the new digital technologies are eroding the value of old intellectual property. In the future, “it is the speed of innovation that’s going to matter.” Most business leaders have reason to agree. The acceleration of digital technology — and its effect on evolving capabilities, data proliferation, customer expectations, and seemingly everything else — is affecting all industries. Industrial companies such as Caterpillar, Deere and Company, and Siemens are analyzing immense amounts of data gleaned from the movement of their equipment in the field; power utilities such as Pacific Gas & Electric are building business models around the “grid of things”; publishers such as Axel Springer are

Chrisie Wendin [email protected] is an editor and technology writer with PwC’s Thought Leadership Institute, based in Silicon Valley.

*Digital IQ is a registered service mark of PwC United States.

migrating to online journalism platforms; banks such as Citi and Standard Chartered are reconceiving their customer interactions around the smartphone; specialized retailers such as Warby Parker are designing innovative multichannel boutiques that allow customers to try on purchases at home; and a few companies, such as Haier, are self-consciously redesigning their organizational structure to evoke Internet-style connectivity. From the front line to the corporate board, the push is on for each business to be reborn as a “digital company.” Exhibit 1: Ten Attributes for a Digital Growth Engine 1. Our CEO is a champion for digital. 2. The executives responsible for digital are involved in setting high-level enterprise strategy. 3. Business-aligned digital strategy is agreed upon and shared at the C-level. 4. The enterprise strategy and the digital strategy are well communicated throughout the organization. 5. We actively engage with external sources to gather new ideas for applying emerging technologies. 6. Digital enterprise investments are made primarily for competitive advantage. 7. We effectively use all the data we capture to drive business value. 8. We proactively evaluate and plan for security and privacy risks in digital enterprise projects. 9. We have a single, multiyear digital enterprise road map that includes business capabilities and processes, as well as digital and IT components. 10. We consistently measure outcomes from our digital technology investments. Note: In this study and this article, digital strategy means the strategy for designing and implementing digital technologies, and for integrating them with the rest of the business. Enterprise strategy or business strategy means the choice of a value proposition and capabilities system for the company as a whole. Source: “Lessons from Digital Leaders: 10 Attributes Driving Stronger Performance,” PwC, 2015, pwc.to/YourDIQ

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Chris Curran [email protected] is a principal with PwC US, based in the Dallas/Fort Worth area. He is the chief technologist for the firm’s advisory practice, where he is responsible for emerging technology strategy, digital architecture and innovation, and the development of thought leadership. He leads PwC’s Emerging Technology Labs and the firm’s ongoing Digital IQ* research.

What exactly that means is not the same for every business, nor should it be. Thus, if you are a senior executive developing a digital strategy, the first thing you need is a way to gauge whether that strategy is smart: whether it puts today’s technology to work in an appropriately advanced way, while being a good fit for your overall strategy and your way of doing business. In short, you need to check your Digital IQ — and if necessary, to raise it.

The effectiveness of the use of digital technology has been a subject of research at PwC since 2007, when business technology was equated with back-office systems and well before digital became a corporate buzzword. For nine years, our Digital IQ study has examined technology strategy, practices, and attitudes by surveying hundreds of business leaders. The respondents include both senior technology executives — those with titles such as chief information officer (CIO) and chief technology officer (CTO) — and overall business leaders such as CEOs and other top executives. During all the years of research, a high Digital IQ has always signified the same thing: the ability to consistently make the kinds of digital investments that deliver and sustain value. Achieving it requires technological acumen, but not just on its own; it must be linked to a clear strategic direction for the enterprise. In our most recent study, conducted in fall 2015, we analyzed data from nearly 2,000 executives, representing 10 industries (and 51 countries). As we did in our inaugural study, we developed an index of digital prowess, analyzing 26 factors and isolating those that were most strongly correlated with higher levels of financial performance. The organizations in our study that embraced these practices were twice as likely to achieve rapid revenue and profit growth as other companies in our study. The resulting list of 10 attributes that make up our Digital IQ score was hardly a surprise (see Exhibit 1). In our research, we have repeatedly observed the same crucial factors in companies with effective digital strat-

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Attributes of Digital Prowess

egies. These fundamentals have never been more important than they are today, when technological prowess is a matter of survival. Meanwhile, many companies are becoming more mature in their digital focus. They have already used technology to improve productivity and wring out costs. Now they are using it to grow revenue, create compelling customer experiences, and build the kinds of distinctive capabilities that lead to ongoing success. The results are evident in the Digital IQ rankings of industries (see Exhibit 2). In 2007, the gap between the most effective digital industry (healthcare) and the least (power and utilities) was 20 percent. Since then, performance has improved across the board, with only a 5 percent margin separating today’s highest-ranked industry (technology) from its lowest-ranked (entertainment, media, and communications). Technological transformations are taking place in every sector. In healthcare, hospitals have broadly adopted electronic health records in the name of enhanced patient quality; industrial companies have made major investments in comprehensive Internet of Things–style platforms that can improve the way wind turbines, jet engines, and other large-scale machines are used.

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Exhibit 2: Digital IQ Score Industry Rankings, 2007 and 2015 Healthcare 1 Financial services 2 Technology 3 Hospitality and leisure 4 Retail and consumer 5 Public sector 6 Automotive*, 7 industrial products, and manufacturing Entertainment, media, and communications 8 Power and utilities 9 2007 rank

1 Technology 2 Retail and consumer 3 Power and utilities 4 Financial services 5 Healthcare 6

Industrial products and manufacturing

7 Energy and mining 8 Hospitality and leisure 9 Automotive* 10

Entertainment, media, and communications

2015 rank

*Automotive was categorized as part of industrial products and manufacturing in 2007. Note: Over the course of research, industry categorizations have been refined. Source: PwC Digital IQ surveys. Number of responses: 456 (in 2007); 1,988 (in 2015).

Exhibit 3: Digital Confidence by Industry, 2013–15 In these three years, respondents were asked to rate the digital acumen of their organization — how well people understood the value of digital technology and wove it into the fabric of activity. Rankings below show the percentage of respondents from each industry who agreed that their organization had a high Digital IQ. 90%

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80% Technology Financial services Automotive Retail and consumer Power and utilities Hospitality and leisure Entertainment, media, and communications Healthcare Industrial products Energy and mining

70%

60%

50%

40% 2013

2014

2015

Source: PwC Digital IQ surveys, 2013–15. Number of responses: 1,108 (in 2013); 1,393 (in 2014); and 1,988 (in 2015).

heaval. It’s also the response within established incumbents as they feel the pressure of digital technology. Three examples follow. • New spending patterns. Budgets are shifting to reflect the new realities in IT: lower costs with cloudbased services, digital technology that permeates every aspect of the business, and business leaders’ increased awareness of the art of the possible. Business units accustomed to depending on shared functional resources for, say, mobile customer apps now feel free to engage outside resources to develop their own. Departments can opt for pay-as-you-go collaboration services instead of investing in stand-alone systems, and functions such as marketing have their own tools with which to collect, analyze, and act upon data. In 2015, the majority of technology spending (68 percent) came from budgets outside the IT organization, a significant increase from 47 percent the prior year. Although the democratization of technology across an organization is generally a good thing, it can have such unintended consequences as duplicative efforts, incompatible systems, inadequate attention given to cyber-risks, and off-strategy investments. • New digital leadership. Enterprise technology used to be the sole domain of the IT function, led by the CIO. Now there is a trend toward broader-based oversight. Some companies are expanding the CIO role to foster a more direct connection between technology and strategy. Other companies are creating a chief digital officer (CDO) or similar role to lead digital transformation efforts. In some companies, titles for leaders who oversee digital strategy include the chief experience officer and chief data scientist. This trend focuses C-suite attention on a company’s Digital IQ, which is valuable; however, it also adds to potential uncertainty regarding responsibilities and governance. (See “The New Chief Digital Officer,” by Roman Friedrich, Pierre Péladeau, and Kai Mueller, page 72.) • A new digital debate. Every company has its own point of view about the value of digital technology and how it should be managed. Some of the executives we surveyed define digital as activities related only to the innovation of products and services. Others see it as in-

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This improvement correlates with an overall rise in digital confidence, albeit with some industries excepted. Since 2013, we have asked respondents to rate the strength of their organization’s digital acumen. In 2015, two-thirds of them said they had a strong or very strong Digital IQ. This percentage had risen about 2 percent during each of the previous two years. The fact that a majority are paying attention, and that they are generally increasing their effectiveness, is welcome news (see Exhibit 3). But there is a powerful countervailing force. The technological environment in which most businesses operate continues to grow more complex and competitive, at an ever-faster pace. It’s not just the competition from innovative, well-funded startups that causes up-

IT’S EASY TO UNDERSTAND ANY TECHNOLOGICAL ADVANCE. IT’S MUCH HARDER, AND MORE CRUCIAL, TO USE IT TO MAKE YOUR COMPANY STRONGER.

A Strategic Approach to IT

It’s relatively easy to understand the specifics of any technological advance. It’s much harder, and more crucial, to use that technology to make your company stronger — especially in a way that nobody else can copy. Breakthroughs in analytics, artificial intelligence, robotics, and other digital fields can revitalize your capabilities and thus enable new forms of growth, just as they are doing at Chr. Hansen. When you link your technology investments with your enterprise strategy, you get far more out of those investments. The executives we surveyed recognize this. More than half said they explicitly integrate their digital strategy with their overall business strategy. About onethird say the two are kept separate. The remainder, less than 20 percent, say they don’t have a digital strategy,

they don’t consider it when setting overall strategy, or they simply don’t know. That’s why the engagement of top leadership is so important. Only the CEO or equivalent managing director can mandate that digitization be a comprehensive, unified, enterprise-wide priority directly linked to what makes the company successful. At companies such as Apple, Frito-Lay, and Haier, the chief executive is directly involved in technological decisions, especially those involving key products or processes. At GE, CEO Jeffrey Immelt has been the technological leader of the company since he took office in 2001. Immelt has famously said that digitization will affect every corner of the economy, that every industrial company will soon be a software and analytics company, and that GE’s digital transformation is the company’s most important initiative since the mid-1980s. (See “Enterprise Architecture Planning 2.0,” by Jack Topdjian, Dirk Klemm, and Carl Drisko, page 30.) He is using $200 billion gained through major divestitures, such as the sale of GE Capital, to fund investment in new digitally enabled enterprises. This sort of strategic approach to information technology is “one of the big opportunities of the coming 10 years,” he told interviewer Tim O’Reilly at Next:Economy, a gathering of management and technology leaders convened by O’Reilly Media in November 2015. “If [industrial companies] don’t grab this next wave of the information age, we’re not going to have the kind of productivity that is required to be competitive.” At GE, two C-suite positions are devoted to the strategic use of digital technology. Chief digital officer Bill Ruh (in a role recently created) oversees digital business, which is what the company calls its line of industrial

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tegrating technology into all parts of the business. Still others say digital is merely a synonym for IT, and some use the term in reference to customer-facing initiatives or data analytics activities. Does this splitting of hairs over definitions really matter? It does if the CEO means one thing and members of the executive team hear something else, especially if it isn’t fully clear who is accountable for the digital strategy. All this fluidity creates a considerable challenge for business leaders intent on capitalizing on digital technology. Thankfully, there are ways of raising your Digital IQ. You can integrate your digital strategy and business strategy, which means getting top leadership directly involved; you can redesign your innovation practices; and you can invest in a few critical forms of digital prowess, including data analytics, cybersecurity, and the building of a digital road map.

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ALTHOUGH NOVEL IDEAS ARE SOMETIMES HOMEGROWN, AN OUTSIDE-IN APPROACH TO INNOVATION IS ESSENTIAL.

wind, represents another technological leap. Other major industrial companies, such as Cisco Systems, Honeywell, and Siemens, are making similar Industrial Internet investments. The Digital IQ study has tracked the relationship between CEO involvement with technology and financial performance since its inception in 2007, and has always found a strong correlation. At the same time, the percentage of organizations that see their CEOs as digital champions has fluctuated. CEO involvement, most prevalent at the outset of the survey, steadily declined until around 2012. Since then, more and more respondents have reported that technology had a permanent

Exhibit 4: Digital IQ Over Time These statements represent key attributes of a Digital IQ profile. The prevalence of agreement with at least two of them appears, after years of decline, to be rising.

100%

Percentage who agree that... Our CEO is a champion for digital

80%

Strategy is well communicated throughout the organization

60%

There is a single, multiyear digital enterprise road map 40%

20%

0% 2007

2010

2013

2015

Source: PwC Digital IQ surveys, 2007–15. Number of respondents: 456 (in 2007); 592 (in 2009); 724 (in 2010); 489 (in 2012); 1,108 (in 2013); 1,393 (in 2014); and 1,988 (in 2015).

strategy+business issue 82

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services and software, and CIO Jim Fowler manages the internal innovation required to generate new products and reinvent the company’s operations. Explains Fowler, “Between now and 2020, I’ve committed to delivering $1 billion of productivity across the General Electric Company through the use of technology. I’ve also committed to converting $1 billion of internal IT work that we do inside the company into commercial products that we’ll sell externally.” These changes reflect the evolution of the technology that GE sells. “A locomotive today is a rolling data center,” Immelt told the Next:Economy attendees. “It’s got all kinds of material science controls, and 600 sensors that poll real-time data about fuel efficiency, positioning, and emissions. We want to lead that nexus between the digital and analytical worlds.” Since GE has to develop a sophisticated technological platform for its products, he added, “why not do it for ourselves?” Hence the internal effort, led by the CEO’s office, to bring together separate functions such as innovation, operations, and customer support into a single, technology-enabled platform. The resulting Industrial Internet, as it is increasingly called, has led to a number of rapid successes in large-scale digital technology, making every aspect of operations more flexible, interoperable, and self-aware. GE and Southwest Airlines, for instance, are pioneering a data analytics effort based on cloud computing, showing how every detail adds to or detracts from an airplane’s performance. The improvements achieved in fuel efficiency alone can save an airline $100 million a year. The new GE wind farm, in which turbines with sensors in the blades are linked together to make the most of the available

Hoffstetter, underscores the value of engagement: “Your employees won’t accelerate this transformation if they don’t understand what you’re talking about.” Intelligent Innovation

Two aspects of innovation practice influence your Digital IQ. The first is your external openness, or how broadly you look for insights about emerging technology. Although novel ideas are sometimes homegrown, an outside-in approach to innovation is essential. Even among the companies that practice this approach, however, most don’t go far enough. Given all the potential avenues available for learning about emerging technologies, we were surprised by how many companies still turn to the obvious choices: industry analysts, customer advisory groups, and competitive intelligence. Only a few farsighted executives — typically those who told us they were more focused on business model innovation — said they cast a wider net, tapping into the open source and “maker” communities, crowdfunding platforms, and university labs. The venture capital and startup ecosystem provides another promising pipeline. Pizza Hut CDO Baron Concors, for example, regularly visits Silicon Valley. “We rely not just on the startups themselves,” he says, “but also on incubators that house hundreds of startups and can really help us have a lot of conversations in a short amount of time.” Bayer, the German pharmaceutical company, goes further; it launched a Grants4Apps accelerator program in 2014 to provide funding, mentorship, and office space to a select group of startups. Bayer thus gains early access to technologies that complement its own. Head of digital development Jessica Federer describes the impact it’s made on the Bayer culture: “It really does change the mind-set [here] because you see how much can be done in 90 days with that much passion and enthusiasm.” The second key aspect of innovation practice affecting your Digital IQ has to do with rigorous selection and pursuit. Actively engaging with multiple sources will help you gather numerous potential ideas, but you should experiment with and prototype only (continued on page 74)

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place on the CEO agenda (see Exhibit 4 ). Today, nearly every CEO seems to pay close attention to digital as part of his or her role. In most companies, other executive team members are also directly involved. Collaboration is especially vital between the CIO and chief marketing officer (CMO) because digital innovation often involves customer engagement. Although the CMO may oversee anything related to the customer, the CIO must be involved from the start in such aspects as back-end software architecture, vendor interaction, and integration. Companies may have their work cut out as they attempt to achieve a productive partnership: The CIO–CMO relationship was ranked the weakest of nine executive pairings by the leaders in our survey. Just over half said the two had a strong working relationship. Sometimes a seemingly simple marketing project may lead to far-reaching digital initiatives because organizations discover that systems, data, or processes don’t work together. That was the case at TE Connectivity, an industrial manufacturer based in Switzerland and the United States. When senior vice president and CMO Amy Shah started a Web storefront initiative, it seemed like a relatively small endeavor. It ultimately turned into a massive product realignment that involved more than 1,000 employees and demonstrated the power of an integrated approach to technology. “With the products [we] defined and digitized, we’re in a position to be influencing product design, engineering, the engineering-to-manufacturing system, and manufacturing-to-operations,” says Shah. “‘Customer first’ was a strong way to start it. Now, people [in other parts of the company] ask all the time: ‘How can we improve that process with digital?’” An effective digital strategy requires engagement from everyone in the organization, not just top leadership. We’ve seen this simple but powerful principle become more widely recognized over the last several years. Business leaders are filming videos, using social media, and reaching out to employees through their smartphones, not only to explain the digital strategy but to invite a dialogue about it. Renault’s CDO, Patrick

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by Roman Friedrich, Pierre Péladeau, and Kai Mueller

M

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panies, with 11 percent. At the other

data piece is actually the easiest,”

end of the spectrum, only

she notes. “Data is data. It’s the

1 percent of mining and metals com-

people piece that’s the challenge. So

panies had a CDO; just 2 percent of

we focus first on the people in the

those in the automotive, machinery,

organization, and how we connect

and engineering sectors did; and only

across synergies, across silos, over

ore than a quarter of the

3 percent in technology and electron-

platforms and data.”

world’s population owns a

ics did. One is also more likely to see

Soon after she was appointed,

smartphone. In 2014, global mo-

CDOs in European companies than

Federer created a digital council con-

bile data traffic reached 2.5 billion

in their U.S. or Asian counterparts,

sisting of the CIOs and CMOs of the

gigabytes per month, a figure that is

and CDOs are more likely to appear

relevant divisions at Bayer. Their task

30 times as large as all the traffic on

in large companies than small ones.

was to look at potential synergies.

the Internet for the full year 2000. No

We suspect that in many cases where

She also fostered a huge network

wonder global companies are moving

a CDO has not been appointed, it is

of people involved in some aspect of

rapidly to reshape their businesses

because the related responsibili-

digital transformation, to which she

to meet this new level of connectivity.

ties are already distributed among

gave the acronym NERD (Network

One way they are doing so is by ap-

other top management roles and

for Enterprise Readiness and Digital).

pointing a new kind of executive, the

are entrenched in all aspects of the

“They bring together digital market-

chief digital officer (CDO). The CDO’s

company’s culture.

ing with digital product supply with

mandate: to equip companies for the

In the past, traditional CIOs and

digital R&D,” says Federer. “We used

digital future. This executive has the

CTOs were focused primarily on their

to do this in silos, but now we do it by

dual task of developing an all-inclu-

companies’ IT, managing employee

sharing information.”

sive digital experience for customers

desktops and enterprise-wide ERP

and the internal capabilities needed

and CRM systems. The CDO role,

stetter is creating a centralized digital

to support that experience — while

although it varies from one company

transformation organization, which

simultaneously managing the con-

to another, is far more comprehen-

he calls the Digital Factory. This is

siderable investment required. The

sive. Besides customer experience,

not a literal factory, but a metaphori-

emergence of the new role to lead the

the development of digital features

cal center for people throughout the

organization’s digital efforts may in

in new products and services, and

company who already work on digital

part be a reaction to the chronically

the relevant operational changes,

projects and another group working

weak relationships between CIOs and

the CDO may oversee changes in

at about 65 outside suppliers. The

CMOs, which we’ve observed over the

technical infrastructure and innova-

factory is the nexus of communica-

last few years.

tions in data collection and analysis.

tions about the digital strategy, and

The CDO must also be an agent of

the place where resources and ex-

have hired CDOs remains small —

cultural change, championing the

perts come to design the transition to

just 6 percent globally, according to

digital transformation through-

what Hoffstetter calls “the connected

the results of the inaugural Strategy&

out the company and linking it to

employee.” The changes put into

study of digital leadership at 1,500 of

the development of the distinctive

place at the Digital Factory will affect

the world’s largest companies. But

capabilities that form the basis of a

how people work, what they expect

the number is growing rapidly. Of the

company’s strategy.

from the company, and what tools

The number of companies that

86 CDOs we found, 31 were appointed

Here are glimpses of chief digital

At Renault, CDO Patrick Hoff-

they are given.

in 2015. The sectors where the high-

officers (or people in similar roles) at

est proportion of companies have

four major companies, and the ways

this complex shift is a key part of

CDOs are travel and tourism, with 31

in which they meet the challenge of

the CDO’s role. “One reason most

percent; entertainment, media, and

digital transformation.

operations in digital strategy and

Balancing the timetable for

communications companies, with 13

Jessica Federer is head of

transformation are focused on sales

percent; and food and beverage com-

digital development at Bayer. “The

and marketing is that these functions

strategy+business issue 82

The New Chief Digital Officer

ONE IS MORE LIKELY TO SEE CDOs IN EUROPEAN COMPANIES THAN IN THEIR U.S. OR ASIAN COUNTERPARTS, AND CDOs ARE MORE LIKELY TO APPEAR IN LARGE COMPANIES THAN SMALL ONES.

and a priority for every member of its C-suite. Sooner or later, companies

“Whereas when it comes to the evolu-

that the best CDOs are reflective of

may get to a point where a trans-

tion of internal processes, internal

the business,” he says, “I think that

formation isn’t necessary, because

social networks, acceleration of col-

in many respects they are the busi-

it has already happened. Digital

laborative tools, and internal training,

ness.” To that end, he believes that

technology will be so well integrated

it’s much harder to show any payback, CDOs should “forget about digital. Forget about new media. The busiand it takes a lot longer.”

that it won’t be a separate issue anymore. It will simply be part of the way

Corinne Avelines, CDO of the

ness objective has to permeate the

people work, and the CDO will move

decorative paints division of the Dutch

thinking and the strategies and the

to some new type of challenge.

chemical company AkzoNobel, says

go-to-market approach of the CDO

broad support is critical: “Commit-

and his and her team. Never make

ment at the top management level to

the means the end. A million follow-

innovation and digitization has made

ers on Twitter is just a means. The

my job considerably easier,” she says.

end is the business goal.”

“Senior support is key to ensuring

The CDOs interviewed for this

commitment to digital at the com-

study all emphasized the importance

pany, especially one of this size.”

of working closely with every function

At the same time, she says, over-

of the business. Being part of top

all strategy must always drive deci-

management gives them a critical

sions about how and what to digitize.

strategic perspective, but they must

“Gaining a competitive advantage in

also be given the power and support

a fast-digitizing age is a challenge, so

they need from functional groups.

CDOs must understand their com-

Otherwise, they may find themselves

pany’s current position and future

with a seat at the table but without

strategy — what will make an impact

the strategic and operational input

on providing value to the customer

that the digital transformation needs.

— and focus on that. Worry about the other things later.” Visa CDO Chris Curtin says that

Ultimately, the goal of every CDO is to ingrain the digital agenda so deeply and efficiently that it will

he has learned to participate actively

become a way of life for everyone and

in the creation of the overall busi-

every function in the organization,

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have a direct, quite short-term impact ness strategy — and lead the process when necessary. “I not only think on the business,” says Hoffstetter.

Roman Friedrich is a leading practitioner with Strategy&, PwC’s strategy consulting business, and a partner with PwC Germany. He is based in Düsseldorf and Stockholm. Pierre Péladeau is a thought leader on digital strategy with Strategy& and a partner with PwC France, based in Paris. Kai Mueller is a specialist with Strategy& and a senior research and knowledge manager with PwC Germany, based in Berlin.

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How to Activate Your Digital Growth Engine

H

you communicate and develop your

that meets the needs of these cus-

shared digital vision.

tomers or matches their price point.

2. Conduct a digital strategy

If Clayton Christensen is right, this

workshop. Bring together key lead-

spin-off approach could grow one day

ers from around the enterprise to

to challenge your main business.

look at the results of your diagnosis,

5. Expand your ecosystem.

ow can you use Digital IQ

and to discuss the next wave of digital

Digital innovation is emerging from

to create competitive advan-

investments. Use the same workshop

places your organization may not

to raise awareness of other relevant

frequent, such as startup incubators,

issues, such as lack of coordination in

university labs, open source projects,

your technology spending.

and “maker” communities. Build new

tage? Consider these practices:

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1. Diagnose your company. First, capture your own personal sense of where your company stands,

3. Start a digital dialogue. Use

relationships with these sources of

for example, with the online assess-

technology — video, internal social

knowledge to keep your ideas and

ment at pwc.to/YourDIQ. Then, retake

media, and mobile — to engage large

skills fresh and flowing.

the assessment with your business

numbers of employees about the digi-

and IT leadership team. Look for

tal strategy and ways to implement it.

gaps: For example, you may find, as

4. Develop a disruption

6. Shake up your leadership. Create or reshuffle your organizational roles so that the CIO, CMO, head of

one large industrial company did,

strategy. Look for customers who

operations, and even CFO are aligned

that you are far ahead in managing

are not served by your current offer-

to the digital needs of your company.

cybersecurity and data analytics —

ings. Take on the challenge of using

If need be, put a CDO (or equivalent) in

but surprisingly behind in the way

digital technology to create a spin-off

place to tie all your initiatives together.

(continued from page 71)

those that fit well strategically. The top-performing companies in our study tell us that investment decisions are guided by their quest for competitive advantage, as opposed to being driven by cost savings or technological excellence. The most favored emerging technologies vary widely from one company to the next, but several appear on almost everyone’s short list: cybersecurity, data analytics, data visualization, digital delivery of documents and software, and private cloud technologies (systems behind a virtual firewall). A few less mainstream choices like non-relational databases, sensors for monitoring business activity (to gather data on employee and customer activity in workplace and retail settings, for example), and enterprise wearables (such as the use of smart watches and wristbands for warehouse picking, barcode scanning, or object recognition) will be important bets for competitiveness in the years ahead.

“Table Stakes” Capabilities

Some capabilities vary by sector, others reflect your strategy, and still others are table stakes: competitive necessities that every company must invest in and manage. In our Digital IQ research, four capabilities are consistently correlated with business success: data analytics, privacy and security management, digital road mapping, and results tracking. Some companies can take them to a high level: For example, the use of analytics by some industrial companies is now a competitive advantage, with distinctive capabilities to match. But every company must come to at least a minimum level of proficiency; these four cannot be avoided. Data analytics is a real challenge for organizations. Many executives report that they have not yet harvested real value out of the data they are capturing. The primary hurdle is not so much data quality or accuracy, but rather the skill needed to understand which data to

strategy+business issue 82

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ENTERPRISES WITH A HIGH DIGITAL IQ THINK ABOUT HOW THEIR CYBERSECURITY STRATEGIES CAN HELP BUILD BRAND, COMPETITIVE ADVANTAGE, AND SHAREHOLDER VALUE.

will also be easier to recognize new opportunities that fit, even if they’re less obvious. Finally, some attention to measurement is crucial. Businesses and their boards want to see the value they’re achieving from digital investments. Demonstrating it requires a selection of traditional metrics (such as return on investment) to track against growth goals. But it also requires less familiar measurements that track the intangible yet real value of being a smart technological leader. This might include the number of new innovation ideas, the response from the outside world to new online endeavors, the speed of taking an innovation to market, or something unique to your own company. Or it might include the rate of acceptance by your customers of the new ways you’re doing things — whether that involves sensors on an earth-moving machine, apps offering unprecedented convenience, or novel methods of manufacturing cheese. + Reprint No. 16110

Resources Deniz Caglar, Namit Kapoor, and Thomas Ripsam, “Think Functionally, Act Strategically,” s+b, Feb. 26, 2013: When a company competes on capabilities, all its specialist leaders — not just in digital and IT, but in HR, finance, and elsewhere — can play a new, influential role. Chris Curran, Tom Puthiyamadam, John Sviokla, and Gerard Verweij, “Lessons from Digital Leaders: 10 Attributes Driving Stronger Performance,” PwC, Sept. 2015: Longer report on the Digital IQ study results and their implications for business leaders. Roman Friedrich, Pierre Péladeau, and Kai Mueller, “Adapt, disrupt, transform, disappear: The 2015 Chief Digital Officer Study,” Strategy&, Dec. 2015: A study of 1,500 companies forms the basis of the sidebar in this piece. More thought leadership on this topic: strategy-business.com/technology

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use and how to use it. The sheer amount of data gathered today, the variety of sources (including online activity and sensors), and modern data’s unstructured nature (which lacks the organized fields and records of the databases of the past) all add to the difficulty. Consider the mass of data accumulated by the oil industry, where rigs and pumps have had hundreds of sensors for many years. Organizing and feeding the data into algorithms to predict maintenance needs is a daunting challenge. Leading companies are tackling this problem head-on with new tools such as data lakes (massive repositories) and graph databases, which allow for ongoing exploration and are less rigid than their relational cousins. Security and privacy issues represent another significant challenge — especially as companies open themselves to cloud-based applications, adding new technologies, customers, partners, devices, and data. Enterprises with a high Digital IQ address this challenge proactively. They think explicitly about how their cybersecurity strategies can help build brand, competitive advantage, and shareholder value. They also routinely include risk managers, security specialists, and IT leaders in conversations about new product and service development. Rallying the business around a multiyear road map — a plan for digital transformation — is another crucial practice. Unfortunately, fewer companies have a single road map in place today than in 2007, when we first tracked the practice. Given the rapid acceleration of technology, the three- to five-year time horizon of a road map may seem impossibly long term. Yet it can take that long to build truly distinctive, technologyenabled capabilities. With a multiyear road map in place, it will be easier to resist getting caught up in new opportunities that conflict with the strategy — and it

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76

A STRATEGIST’S GUIDE TO BLOCKCHAIN

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The distributed ledger technology that started with bitcoin is rapidly becoming a crowdsourced system for all types of verification. Could it replace notary publics, manual vote recounts, and the way banks manage transactions? BY JOHN PLANSKY, TIM O’DONNELL, AND KIMBERLY RICHARDS

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Illustration by Dan Page

An expensive work of art changes hands.

Neither the buyer nor the seller is named publicly, but the exchange is verified, the provenance of the painting travels with it, and the artwork is automatically insured against theft. A voting machine records votes in a frontier country known for past political corruption. Though there is no central government repository, each vote is tagged to an individual with no duplication. The individual identities remain anonymous, and the results of the election are undisputed.

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Tim O’Donnell [email protected] is a managing director with PwC US based in New York, specializing in banking products and operations strategies. He has extensive experience with payments innovation and technology solutions.

A consortium of banks gain market share by settling trades in real time (instead of waiting three days for the trade to clear) and underwriting loans in a day (instead of waiting two weeks), all with minimal risk. The same banks also start to execute same-day currency trades at optimal exchange rates, spending a fraction of the costs required in the past. All of these transactions are tracked and statistics are kept, so that governments are aware of the movement of capital across their borders, and activity is monitored for patterns that might indicate money laundering. But the identity of the individual traders or purchasers is untraceable. The technology that could make all this happen is blockchain. Originally the formal name of the tracking database underlying the digital currency bitcoin, the term is now used broadly to refer to any distributed electronic ledger that uses software algorithms to record transactions with reliability and anonymity. This technology is also sometimes referred to as distributed ledgers (its more generic name), cryptocurrencies (the electronic currencies that first engendered it), bitcoin (the most prominent of those cryptocurrencies), and decentralized verification (the key differentiating attribute of this type of system). At its heart, blockchain is a self-sustaining, peer-topeer database technology for managing and recording transactions with no central bank or clearinghouse involvement. Because blockchain verification is handled through algorithms and consensus among multiple computers, the system is presumed immune to tampering, fraud, or political control. It is designed to protect against domination of the network by any single computer or group of computers. Participants are relatively anonymous, identified only by pseudonyms, and every

Kimberly Richards kimberly.richards@ strategyand.us.pwc.com is a specialist in financialservices strategy with Strategy&. She is a manager with PwC US based in New York.

Also contributing to this article were PwC US director Jeremy Drane, principal Kevin Grieve, managing director James Solomon, Technology Institute editor Alan Morrison, and Financial Services Institute director Cathryn Marsh.

transaction can be relied upon. Moreover, because every core transaction is processed just once, in one shared electronic ledger, blockchain reduces the redundancy and delays that exist in today’s banking system. Companies expressing interest in blockchain include HP, Microsoft, IBM, and Intel. In the financialservices sector, some large firms are forging partnerships with technology-focused startups to explore their own possibilities. For example, R3, a financial technology firm, announced in October 2015 that 25 banks had joined its consortium, which is attempting to develop a common crypto-technology-based platform. Participants include such influential banks as Citi, Bank of America, HSBC, Deutsche Bank, Morgan Stanley, UniCredit, Société Générale, Mitsubishi UFG Financial Group, National Australia Bank, and the Royal Bank of Canada. Another early experimenter is Nasdaq, whose CEO, Robert Greifeld, introduced Nasdaq Linq, a blockchain-based digital ledger for transferring shares of privately held companies, also in October 2015. If experiments like these pan out, blockchain technology could become a game-changing force in any venue where trading occurs, where trust is at a premium, and where people need protection from identity theft — including the public sector (managing public records and elections), healthcare (keeping records anonymous but easily available), retail (handling large-ticket purchases such as auto leasing and real estate), and, of course, all forms of financial services. Indeed, some farsighted banks are already exploring how blockchain might transform their approaches to trading and settling, back-office operations, and investment and capital assets management. They recognize that the technology could become a differentiating factor in their own

strategy+business issue 82

John Plansky john.plansky@ strategyand.us.pwc.com is an advisor to executives in the financial-services industry for Strategy&, PwC’s strategy consulting group. Based in Boston, he is a principal with PwC US. He specializes in applying information technology to launch new products and enable global operating models for securities firms.

Blockchain could affect transactions in the same way that GPS changed personal transportation.

what they want most: speed, convenience, and control over their transactions. Develop a robust strategy, one in which your company thrives whether blockchain is transformative or not. The Roots of the Technology

Decentralized digital currency started in 2008 as a countercultural initiative. During its first few years, it was often described as a covert post–financial crisis protest against the global banking system, and bitcoins were used as an alternative currency by money launderers and illegal “dark Web” trading sites such as the “Silk Road” exchanges (which have been systematically shut down by legal authorities). The name of the bitcoin protocol’s creator, Satoshi Nakamoto, is widely assumed to be a pseudonym, and a number of attempts to detect his or her real identity have proven inconclusive. Nakamoto published the specs for the bitcoin system in 2008, and opened the peer-to-peer software system in 2009. At the time, 1,000 bitcoins were worth less than US$3. But digital currency was also recognized, from the start, as a potential wild card in legitimate finance — and as a possible investment vehicle. Its value began to rise rapidly after 2010. The currency reached its peak value on November 29, 2013, when a single bitcoin sold for $1,124.76. Since then, the price has stabilized considerably, hovering between $200 and $400 for most of 2015. The ultimate fate of the currency, including how broadly it will be accepted, is uncertain. Anyone can try to create a bitcoin, but it’s not easy. The technique for making bitcoins, known as “mining,” was deliberately designed to protect the currency’s value through scarcity. Bitcoins can be created only at a constrained rate — it takes about 10 minutes per coin,

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capabilities, enabling them to process transactions with more efficiency, security, privacy, reliability, and speed. It is possible that blockchain could affect transactions in the same way that the global positioning system (GPS) changed personal transportation, by making data accessible through a common electronic platform. But although the potential is immense, so is the uncertainty. On the one hand, distributed ledger technologies are so new, so complex, and so evolving so rapidly that it’s difficult to predict what form they will ultimately take — or even to be sure they will work. The Gartner Group declared in an August 2015 report that cryptocurrency was traveling a “hype cycle”: It had passed the Peak of Inflated Expectations and was headed for the Trough of Disillusionment. Another research firm, Forrester, titled its 2015 blockchain report “Don’t Believe in Miracles,” advising enterprises to wait five to 10 years before introducing blockchain, in part because of legal restrictions. On the other hand, some authorities advocate energetic R&D. “The distributed payment technology embodied in bitcoin has real potential,” said Andrew Haldane, chief economist of the Bank of England, in September 2015. “On the face of it, it solves a deep problem in monetary economics: how to establish trust — the essence of money — in a distributed network.” Strategists take note: Proceed deliberately. Don’t try to convert existing systems to blockchain initiatives right away. Rather, explore how others might try to disrupt your business with distributed ledger technology, and how your company could use it to leap ahead instead. Put one or two pilot projects into place. In all cases, link your investments to your value proposition, and give your business partners and your customers

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Exhibit 1: The Dynamics of a Blockchain (Distributed Ledger) Transaction Requested

Transaction Authorized

?

Network users request a transaction requiring a cryptocurrency transfer (such as an exchange of dollars for bitcoins) Network peer computers analyze past transactions on the blockchain using the specific algorithm or methodology employed by the system. Examples of algorithms: · Proof of work verification: a hash algorithm that generates random numbers · Consensus verification: agreement among the majority of qualified software systems

Transaction Executed

Upon authorization, value and assets change ownership

Transaction Recorded

The entire transaction, including asset ownership, is cryptographically recorded in the ledger. Blockchain provides users with an immutable and permanent audit trail to prove occurrence and timing of transactions

Source: Strategy&

because a message can be unlocked only when a public and a private element (the latter held only by the recipient) are linked. The term blockchain is derived from the way transactions are stored. For example, every time a bitcoin is created or changes hands, the ledger automatically creates a new transaction record composed of blocks of data, each encrypted by altering (or “hashing”) part of the previous block. The cryptographic connection between each block and the next forms one link of the chain. This process compounds the mathematical difficulty of committing a successful fraud, because blocks of transactions, as well as individual transactions, are continuously validated. The algorithms also incorporate an ID for each buyer and seller in a transaction, adding those IDs to the block. One of the most noteworthy features of the blockchain architecture is the decentralized technology, which helps ensure that a transaction is reliably reported. When a blockchain transaction (such as a bitcoin sale) takes place, a number of separate computers, connected across the network, process the algorithm and confirm one another’s calculation. The record of transactions thus continually expands and is shared in real time by thousands of people (hence the name “distributed ledger”). The ledger stores basic information about each transaction — such as sender, receiver, time, asset type, and quantity. The blockchain process ensures validity, by mathematically linking each new transaction to those that came before it. This provides the evidence of the provenance of each transaction in a chain of records going back to the creation of the database, block of code after block after block (see Exhibit 1). The combination of the ledger and the blockchain technology makes bitcoin — or any other system that uses that combination — a virtual, distributed, and decentralized entity. No one is needed to validate the transactions. This is why bitcoin is often referred to as a “trustless” system. You do not need to know anything about the other players, or trust them as individuals, to have faith in the system and invest your money there. Moreover, once committed to that distributed ledger,

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on average — and each new bitcoin is slightly more difficult to create than the one that came before. The processing power required for each bitcoin is so large the currency has been criticized for contributing to climate change, because of the carbon burned in running bitcoin-mining computers. As a medium of exchange, the bitcoin, like the U.S. dollar or any other currency, has no intrinsic value. It can be bought or sold, but it is not automatically redeemable for another commodity, such as gold. However, whereas most currencies are backed by a government or central bank, bitcoin is authenticated by the peer network that produced it. Everyone who purchases a bitcoin knows that it is valid because the same distributed ledger has tracked it, and all other bitcoins, since each was created. This distributed ledger — the first blockchain ledger ever created was for bitcoin, and it set the pattern for others — represents the most innovative and potentially influential aspect of the technology. Participants interact with one another using pseudonyms, and their real identities are encrypted. The ledger uses publickey encryption, which is virtually impossible to break,

Whereas most currencies are backed by a government or central bank, bitcoin is authenticated by the peer network that produced it.

Exhibit 2: The Blockchain Gang

BANKING SERVICES

USAA

Reportedly exploring how blockchain technology can decentralize back-office operations; also participated in Coinbase’s US$75 million Series C funding round

CBW Bank

Partnered with blockchain startup Ripple to use cryptocurrency for real-time cross-border payments

Barclays

Signed a deal with Safello, which operates an online exchange for bitcoin, to test combinations of traditional banking processes and blockchain technologies

Santander

Exploring use cases for blockchain technology; set up a $100 million financial technology (fintech) investment fund in 2014 and created a multimillion-dollar fund in 2015 to invest in and build fintech startups

Citi

Has built three separate internal blockchains within labs to test the technology, focusing primarily on international payments, followed by trading applications

UBS

Opening a technology lab in London to explore using blockchain technology in financial services

Goldman Sachs

In April, led a $50 million funding round for Circle Internet Financial, a startup allowing customers to send and receive bitcoins, and to convert U.S. dollars into them

BNY Mellon

Created its own digital currency, BK coins, and built an employee recognition application that rewards IT staff with the tokens, which can be redeemed for gift cards and vouchers

Nasdaq

Implementing the bitcoin blockchain technology in its Nasdaq Private Market, a marketplace for pre-IPO trading, to expand and enhance the equity management capabilities it offers

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Here are some examples of the early efforts by banks and other financial-services companies to prototype activities involving blockchain and distributed ledger technology, or to explore how they might affect their operations and offerings.

INVESTMENT SERVICES AND CAPITAL MARKETS

TRANSACTION AND PAYMENT SERVICES

American Express CEO has acknowledged the disruptive potential of bitcoin and expressed interest in its underlying blockchain technology First Data

Owner of Gyft, an online platform for buying, sending, and redeeming gift cards, which partnered with Chain, a blockchain startup, to run gift cards for thousands of small businesses on the peer network

PayPal

Partnered with BitPay, Coinbase, and GoCoin, three bitcoin startups, to allow its digital goods merchants to accept bitcoin payments

IBM

Developing its own version of blockchain as an open-source software platform, for use as the backbone of a collaborative network sponsored by the Linux Foundation

Intel

Expressed an interest in conducting blockchain research and is reportedly developing related projects involving cryptographic researc; also a member of the Linux Foundation network

TECHNOLOGY COMPANIES

Source: Strategy&

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If you’re known for rapid fulfillment, the fast turnaround rates enabled by blockchain could allow you to stay ahead of competitors.

In fact, this technology could affect a wide range of offerings and practices in financial services: • Greater access to financial services in emerging economies. Billions of people around the world lack ac-

Impact and Innovation

If you are a senior executive in a financial-services firm, you may already be experimenting with distributed ledger technologies, if only to see how they fit with your strategy. You have lots of company. By 2014, more than a dozen major companies were actively exploring blockchain-related ventures and their potential effect on core practices (see Exhibit 2, previous page). For example, blockchain might streamline transaction processing by establishing a single source of truth, available to all, updated in near real time. This could increase the speed of exchange, reduce the number of intermediaries (and the costs associated with them), improve security, digitize assets, give wider access to people who don’t have bank accounts, enable better bookkeeping, and improve regulatory compliance. The technology could also be used to create and support “smart contracts”: code-based, defined sets of rules that sit atop a blockchain database, and that execute only when specific actions occur. Eris Industries, a software firm that created one of the first blockchainbased platforms for this application, describes smart contracts as modular components, similar to apps on a financial network, that can be combined to provide verifiability to any type of transaction. According to the Eris website, the uses could be “as simple as upvoting a post on a forum, to the more complex such as loan collateralisation and futures contracts, to the highly complex such as repayment prioritisation on a structured note.”

cess to banks and currency exchange. Blockchain-based distributed ledgers could change this. Just as the smartphone gave people without phone lines access to communication, information, and e-commerce, these technologies can provide a person the legitimacy needed to open a bank account or borrow money — without having to prove ownership of real estate or meeting other qualifications that are challenging in many countries. • Improved bookkeeping. Companies can use the distributed, publicly verified, and nearly real-time ledger of transactions for bookkeeping, data mining, and records verification. This could reduce the effort spent on reconciling information among various computer systems. It could also link the systems to external information sources, such as pricing feeds (electronic vendors of trading data), in a more customizable and secure way. • More flexible reserves management. Faster settlement and immediate notification would reduce the amount of cash and other collateral that a bank must hold to mitigate settlement risk. Blockchain’s innately transparent tracking of capital flows could require banks to keep less money on reserve for working capital or foreign exchange capital needs. • More efficient regulatory compliance. A central, immutable ledger of transactions would allow auditors and regulators to rapidly monitor the flow of financial data, avoiding after-the-fact verification. • Improvements in common business functions.

Management processes for accounts payable and re-

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transactions are immutable. Records cannot be tampered with, because altering them would require coordinating many separate computers.

Four Steps to a Blockchain-Enabled Strategy

Your blockchain and distributed ledger efforts will be most effective if you see them as ways to reinforce or strengthen your company’s most distinctive capabilities — the ones that differentiate you in the market. For ex-

ample, if you’re known for rapid fulfillment and responsive customer service, the fast turnaround rates enabled by blockchain could allow you to stay ahead of competitors. At the same time, the technology is too new and unproven to base your company on. Therefore, your best investments are those that allow you to explore new approaches with strategic potential and understand the costs involved before committing to them. We recommend creating a core technology working group to better understand the possibilities. But keep a close watch. Working groups like these can easily get caught up in the promise of new technologies, at the expense of your overarching strategy. To counter this tendency, they need to have a clear idea of your company’s strategic goals, and how blockchain could enhance its value proposition — and then they need to constrain their efforts accordingly. Step 1: Find specific opportunities. Charge the core technology working group with designing an effective path to the future. Start by compiling a list of potential pilot projects for which a distributed ledger could make a difference. One good place to start is with pain points: back-office workarounds, delays, and areas of client dissatisfaction. The working group should include (or consult with) a wide range of stakeholders and specialists from both inside and outside the organization, in order to compile a full list of strong prospects. For example, a financial-services firm might try to use blockchain to improve risky or time-consuming business operations, such as reconciling cross-border payments to international subsidiaries. It might explore rethinking costly but necessary functions, such as compliance with anti–money laundering and know-yourcustomer regulations. There are many opportunities for streamlining operations, including transaction processing and the reconciliation of messages or data. The group could reduce the redundancy in data repositories, or look at identity issues, including the vulnerability of the company to cyber-attack. Or simply begin with consumer dissatisfaction, converting complaints to opportunities for improvement. Your working group may be tempted to favor op-

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ceivables could be automated. New types of brokerage accounts, enabled by smart contracts, could allow buyside institutions to trade directly with one another, or manage over-the-counter derivatives trading among a broad marketplace of players. Automated exchanges might take on some of the communications, settlement, and clearing functions that networks and central counterparties such as the Society for Worldwide Interbank Financial Telecommunication (SWIFT), central banks, and payment networks perform now. There could also be blockchain-based vehicles for issuing new shares of stock, or overseeing retail transactions. • More startups in the distributed ledger domain. A wide variety of ancillary businesses are rapidly emerging. Cryptocurrency exchanges, such as Armory and Coinbase, help their clients buy and sell cryptocurrency, store their holdings, manage the private encryption keys for those assets, and protect their currency holdings from online theft. (One favored approach is to keep the cryptocurrency stored on a dedicated computer that is not connected to the Internet.) Another company, Libra, helps corporations report, audit, and analyze digital asset transactions, regardless of the blockchain database used. Other startups, including Blockstream, Digital Asset Holdings, and itBit, facilitate digital asset transactions for banks and other financial institutions. And then there is Wallet Recovery Services, which helps the owner of a lost or forgotten password try to recover it through “brute force” decryption. This can be the only recourse for someone who kept their private encryption key in an electronic wallet on a smartphone, neglected to make a backup, and then lost the smartphone in a fire. (It’s happened.) More startups are sure to appear offering other new blockchain-related services, including guidance to help people navigate all these unfamiliar systems.

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way it affects bitcoin and distributed ledger technologies in those jurisdictions. Some jurisdictions may

have rules governing privacy and autonomy that could affect how you organize and disclose data. • Your competitive landscape. Consider how other relevant market participants (such as suppliers, customers, and competitors) might adopt the technology, and over what time frame. • Your own capacity for change. Some of these measures might require significant shifts in your operations, or a different cultural orientation within your company. Consider the ability of your institution to change business processes to take advantage of distributed ledger technologies. At the end of this step, you should have narrowed your list down to a few possible starting points. They should be limited and tangible enough to provide a good test of the technology — while also being relevant to your core business. And you should have a clear idea of how to develop prototype experiments for each of them. Step 3: Put your prototypes to work. As you move into implementation, you will adjust your parameters to make the prototypes work. Inevitably, people will improve your practices during the testing and evaluation process. You’ll also discover new ways to apply the prototype’s blockchain innovations, putting you in a better position to make strategic decisions. But stay true to your original hypotheses. Make sure that no matter how the prototype is altered, it remains relevant to your firm’s strategy and the distinctive capabilities that propel you forward. Monitor results frequently enough to get a clear sense of your momentum. If you don’t reach the milestones you expect, ask why, and keep refining and testing. Also, make it a fair test. Don’t put laggards, who are predisposed to the status quo, in charge of implementation. Pick leaders who are reasonably skeptical, but who have a clear understanding of the new technologies, and who are open to their promise. When hiring external consultants and technology providers, choose those who demonstrably understand your company’s strategic direction — not just their own technological

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tions that are most strongly linked to extreme disruption, or to the most talked-about technologies. But the press is often misleading, and technological change often takes place at a slower pace than people expect. It’s best to pick starting points that could most improve your own distinctive capabilities. For example, select pilot projects that show potential for helping you handle key business processes much faster than your competitors can. Step 2: Explore feasibility and readiness. For each of the starting points you’ve chosen, develop explicit hypotheses describing how distributed ledger technologies can make a difference. For example, perhaps the finance function could engage with a distributed ledger provider such as Ripple or PeerNova to manage internal money movements among geographically dispersed legal entities. The hypothesis: It would decrease the time required for adjustments, reduce the need for adjustments, and increase transparency. Or you might propose a smart contract test in your commercial banking function, using technology from startups such as Skuchain and Gazebo to simplify supply chain finance processes. If the test succeeds, you should see a certain level of cost reduction in a specified amount of time. To solidify your hypotheses, once again consult with key business stakeholders. In addition to your internal business and functional teams, include customers in this group. Engage with people from risk management, regulatory compliance, operations, IT, finance, and tax, among others, so that your early proofs of concept don’t require a restart after these stakeholders weigh in with their requirements. Some of the factors to consider, as you solidify your hypotheses: • The degree to which the technology will remain hidden to end-users. We recommend starting in the middle and back offices before moving to processes that are visible to customers. • The legislative and regulatory environment, and the

When faced with disruptive technologies, the most effective companies thrive by incorporating them into the way they do business.

gies could offer financial-services institutions a once-ina-generation opportunity to transform themselves. This technology could also create powerful opportunities in other industries. Connected-car and auto-sharing innovations emerged more than a decade after GPS became popular; years from now, there may be similar innovations that take advantage of blockchain. Companies that adjust their business models accordingly may well enjoy enormous rewards, including increased transparency, lower costs, and greater time efficiencies. Your challenge is to understand the technology well enough, and rapidly enough, to bet a bit of your future on it — without putting your entire enterprise at risk. +

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agenda — and who are ready to help you move there. Settle on a development time frame that is long enough to help you reasonably assess the outcomes. Step 4: Scale your efforts appropriately. With any luck, your prototype experiments will result in some immediate, tangible improvements that justify your interest in blockchain. They may also expand your awareness of its potential and what it will cost to implement real change. Now focus on its impact on your core business. Will this change the way you do business with the parties you work with most consistently? For example, if you’re a custody bank, set up to manage financial holdings such as securities and commodities, would blockchain technologies help you manage the most important asset classes more effectively? Develop a long-term plan based on the results of the first prototypes. Select a few long-range goals — increased revenue, better compliance, cost reductions, quality improvements — and agree upon them. Create a road map for scaling up in a measurable, achievable, and worthwhile way. It should be clearer at this point how much this technology will affect your core business practices. If it stays on the periphery, affecting relatively few customers, you will be glad you limited your investment to a few prototypes. However, if it moves into the mainstream of your business, then it could change everything. If that happens, by having invested in these prototypes, you’ll be prepared. You can scale up your prototypes to take advantage of everything blockchain offers. When faced with disruptive technologies, the most effective companies thrive by incorporating them into the way they do business. Distributed ledger technolo-

Reprint No. 16111

Resources Betsy Burton and David A. Willis, Gartner’s Hype Cycles for 2015: Five Megatrends Shift the Computing Landscape, Aug. 12, 2015: Gartner Group predicts that cryptocurrencies will reach a “plateau of productivity” in two to five years. Charity Delich, “Best of Multimedia: Bitcoin’s Turbulent History,” s+b, Mar. 14, 2014: Links to a comprehensive timeline of this technology. Andrew Haldane, “How Low Can You Go?” Sept. 18, 2015: Speech given by the Bank of England’s chief economist, on the future of central banks, discussing blockchain as a disruptive force. PwC Financial Services Institute, “Money Is No Object: Understanding the Evolving Cryptocurrency Market,” PwC, Aug. 2015: Definitive report on cryptocurrency, who is using it, and how it could evolve. Michael Santoli, “Currency Events,” s+b, June 30, 2015: Review of Digital Gold, Nathaniel Popper’s engaging history of bitcoin and related technologies. More thought leadership on this topic: strategy-business.com/technology

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THOUGHT LEADER

The Thought Leader Interview: Jonathan Haidt The NYU social psychologist says that the ethical risks for a business depend on its ingrained cultural attitudes.

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hat causes a company to undermine its own future through ethical missteps? What enables it to lie to regulators, conceal critical data, and take chances on fraudulent activity that might, sooner or later, come to light? Is it the rapacious nature of capitalism itself, as some believe? Is it the work of a few “bad apples,” unavoidable in a milieu of dynamic innovation? Or is it some innate aspect of human behavior, impossible to regulate completely, but possible to understand? This inquiry, framed

by New York University professor Jonathan Haidt and a global network of colleagues, could help keep companies out of trouble in the future — or perhaps change our view of what trouble really means. In July 2011, after 15 years as a professor of social psychology at the University of Virginia, Jonathan Haidt (pronounced “height”) headed to New York City for what he thought would be a one-year stint teaching business ethics in the Business and Society Program at New York University’s Stern School of

Business. Haidt, whose core field is moral psychology, had taken up an inquiry into business almost casually. “Honestly, I had little interest in business,” he confessed the day he met with strategy+business at his office at Stern in May 2015. But the topic gave him a respite from a major book project he’d just completed, The Righteous Mind: Why Good People Are Divided by Politics and Religion (Pantheon, 2012). The Righteous Mind focuses on the “culture wars” in U.S. politics, and the moral intuitions that shape political and religious debate. It proposes that the divisive views that make abortion, immigration, gay marriage, and climate change hotbutton issues can be linked to people’s personality traits and childhood experiences. All humans are, as Haidt says, “born to be righteous.” Political judgments and beliefs are tied to emotions that have deep cognitive sources. Haidt’s psychology research found that some people instinctively seek out change and have a high tolerance for unconventional behavior. They are more likely to become political liberals. Others are predisposed toward loyalty, authority, security, and sanctity. They are more

Photograph by Peter Gregoire

BY ANN GRAHAM

down to two diametrically opposed narratives, which are highly correlated with political views. Political activists on the left generally see capitalism as part of a long story of exploitation, and see government as the only authority that can contain rapacious market forces. Political activists on the right, by contrast, are likely to see capitalism as the force that liberated people from the despotism of kings and feudal lords, enabling people to start their own businesses and keep some of the value they created. In this second narrative, government is often corrupted by special interests that use regulation to block innovation. Because politically active people hold such radically different views of capitalism, discussions of economic issues are prone to misunderstanding. “In the U.S., when we discuss questions of economic policy, such as the minimum wage, or the right level of corporate income taxes, we talk past each other,” Haidt says. “Even economists do that.” In his work helping businesses create more sustainable cultures less prone to ethical risk, Haidt has tried to sidestep the conflict caused by divergent views of capitalism. He promotes an approach he calls ethical

systems design, which emerged from behavioral science. He describes it as “designing an ethical environment that makes [moral] behavior easy, automatic, and habitual.” Doing so is more effective, he says, than simply urging people to be more ethical while occasionally punishing malfeasance. To actually get results, you must work with human nature as it is and address the complexity of individual and group behavior through the context of where they work. In 2011, Haidt founded Ethical Systems, a Web-based research portal dedicated to “making the world’s best research available and accessible, for free, to anyone interested in improving the ethical culture and behavior of organizations.” He asked academic collaborators from leading U.S. business schools to join him in building the content on topics such as cheating and honesty, negotiation, conflicts of interest, and whistleblowing. The participants include best-selling author Dan Ariely of Duke University, Harvard’s Max Bazerman and Notre Dame’s Ann Tenbrunsel (who study blind spots in decision making), Adam Grant of the University of Pennsylvania (known for

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likely to become conservatives. The mutual distrust between liberals and conservatives is not always rational. People believe they’re right because of the way they feel. Could the same be true for attitudes about business and capitalism? Are some people predisposed to trust private enterprise more than government, or vice versa? Are they destined to disagree? Is there any way to resolve this “moral strife,” as Haidt calls it? Haidt’s curiosity about these questions was piqued further in September 2011, when he began to mingle with members of the Occupy Wall Street movement, which was unfolding just a mile south of NYU. When he rode his bike to the encampments in the financial district, he found a righteous indignation about corporations that reminded him of the complaints about government he had heard from Tea Party members and other conservatives. He wrote down the stories he heard — about being laid off suddenly or being trapped in an underwater mortgage — and incorporated them into the business ethics courses he was teaching at Stern. Haidt subsequently concluded that views about capitalism boil

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his work on “givers and takers”), and Linda Treviño at Penn State University (who has written extensively on organizational culture). Ethical Systems was formally established as a nonprofit in 2014. CEO Azish Filabi joined the organization in 2015 from the Federal Reserve Bank of New York. (Filabi was part of the team that implemented the New York Fed’s financial interventions and liquidity facilities during the 2008–09 financial crisis.) Ethical Systems aims to spark a new dialogue on finance reform that goes beyond compliance with regulation toward genuine commitment to ethical behavior. This is also a theme of Haidt’s new book in progress: Three Stories about Capitalism: The Moral Psychology of Economic Life (Pantheon, due out in 2018). Sitting amid stacks of unpacked source material collected on a trip to Asia last spring, Haidt discussed his epiphany about capitalism, his evolving research, and the nature of business morality. S+B: What motivated you to start a research collaborative on business ethics? HAIDT: Business was new to me

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when I arrived at Stern. I knew the

research on moral psychology quite well — that was my specialty —but I didn’t know enough to say anything useful about its application to business. I was trying to learn about what factors might affect ethics in organizations, and I quickly got overwhelmed. You can’t just study what makes individuals do unethical things. You have to understand at least a little bit about the law, corporate governance, finance, and accounting. If you want to improve ethical behavior within an organization, you have to think about many moving parts, take many different perspectives, and draw on research from many scientific fields. I knew I couldn’t master all those fields myself, so I thought I’d invite experts to join me. Over time, we’ve developed a different way of thinking about ethics within complex systems, which we think may be helpful to all types of private and public organizations. S+B: What’s involved in ethical systems design? HAIDT: All organizations are com-

plex systems composed of smaller complex systems and nested within larger complex systems. Taking an ethical systems point of view means

looking simultaneously at three levels of analysis. The first and lowest level of analysis is examining the psychology of an individual. Businesses are made up of individuals who have all the flaws that are catalogued in bestselling psychology books, such as Dan Ariely’s Predictably Irrational [Harper, 2008]; Dick Thaler and Cass Sunstein’s book, Nudge [Yale University Press, 2008]; Daniel Kahneman’s Thinking, Fast and Slow [Farrar, Straus and Giroux, 2011]; and my book, The Righteous Mind. If you want to reduce the risk that individuals will make bad decisions, we can help you. There is now so much great research on how the social context alters individual behavior. An ethical nudge could be something as simple as putting a picture of eyes nearby, or a photo of a person with very prominent eyes. This makes people feel that somebody is watching them, and it can decrease cheating. The second level is organizational. This is the level that sociologists study, because an organization emerges out of the interaction of individuals, but is more than the sum of its parts. Organizational identity and values emerge as individuals

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Ann Graham [email protected] is a contributing editor for strategy+business. She specializes in writing about the role of business in society.

and groups interact. From these interactions, the organization takes on a life and an ethos of its own. Improving organizational culture is

customs and laws. If you can get the regulatory system at the highest level to encourage the development of ethical cultures at the organizational

“Regulators know they can’t just write more rules. But to change behavior, what exactly would they reward? No one has figured it out.” level — and if those cultures encourage ethical behavior by individuals at the lower level — then you have full alignment. Alignment of the three levels is one of the most important features of an ethical system. S+B: How do you think about a problem at all three levels? HAIDT: Suppose you want to en-

courage honesty and integrity in your company. You want to increase the degree to which everyone can trust everyone else. You might start with nudges to reduce cheating and promote honesty at the individual level. For example, when people are reminded about ethics at the start of a meeting, it affects their business decisions; it helps to prevent the

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much harder to do than nudging individuals, but ultimately it’s more powerful and long-lasting. Financial regulators concerned about the culture of Wall Street are addressing an organizational-level problem. But it’s not clear that the big banks know how to manage cultural change. Our page on corporate culture explains how we think of ethical culture as a slice of the overall organizational culture. If the organizational culture is “how we do things around here,” the ethical culture represents “how we do things around here when we follow some shared moral principles.” At the third level, all of these groups are nested within an ecosystem composed of local and national

“ethical fading” that is so common when groups wrestle with complicated problems. Next, you’d look at the group level and think about your company’s culture. It’s nice to have ethics and integrity in your mission statement or list of key values, but research shows that such public pronouncements don’t correlate with having an ethical culture. Modeling behavior from the top is much more important. Leaders must be willing to hire, fire, and promote based on core values, not just hitting bottomline targets or advancing the business’s growth. Finally, you want to know the legal and regulatory environment in which your company operates, and be sure your company is operating in ways that will earn you credit for having an ethical culture, if a major ethical or legal problem arises. There is a lot of research to be done on U.S. law and on the effectiveness of ethics and compliance programs. S+B: What are the most important issues for regulatory systems? HAIDT: Regulators today recognize

the importance of culture and behavior. They know they can’t just write more rules. They need to in-

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tive measures of behavior like restatements of earnings. We don’t yet know which are the best specific measurement tools, but we do know that we’ll need more than two or three different methods. Ethical Role Models S+B: How would tracking and measuring employee behavior help prevent companies from falling into crisis? HAIDT: It can benefit individual em-

ployees to lie, cheat, and take extraordinary risks when they think

have moved away from criminal prosecutions since 9/11, when the Federal Bureau of Investigation and other agencies shifted away from white-collar crime to counterterrorism. Deferred prosecution agreements and gigantic fines became the norm, because they are just so much easier for prosecutors to obtain. But when people are freed from fear of criminal prosecution, and when fines are paid by shareholders, not by the people who made the reckless choices or engaged in illegal activity, there’s an enormous moral hazard — people can reap short-term

“In a healthy industry, the only way to get rich is to make other people better off.” they can get away with it, but the benefits they reap usually come at the long-term expense of the firm and its shareholders. We often heard a phrase in the wake of the global financial crisis: “IBG-YBG.” It stands for “I’ll be gone, you’ll be gone.” The companies, and their shareholders and customers, were left holding the bag. A lot of ethical systems design is therefore taking steps to get everyone thinking about the long term. We can do a lot of that with psychological and cultural techniques, but there’s also a crucial role for the law to play here: Many commentators have noticed that federal regulators

gains for themselves while imposing long-term costs on others. “IBGYBG.” That must change, and we are glad to see that the new U.S. Attorney General, Loretta Lynch, says that she’s going to increase the use of criminal prosecutions. S+B: Does your research apply to all countries? HAIDT: The laws and national cul-

ture of a country matter a lot. If you are working in a highly corrupt country that doesn’t have a free press disseminating information about unethical companies, it will be much harder to do ethical systems design. For now, we are concentrat-

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centivize people to improve those informal elements. But to change problematic business behavior, what exactly would regulators reward? No one has figured it out yet. Business ethics today is, in some ways, like medical practice was 50 years ago. It is based more on clinical experience than on evidence. This impedes our ability to design regulations and management systems that reward effective and ethical business behavior. It can be changed only through interdisciplinary research. Business and regulators need to collaborate in thinking about the results. And the research has to have a direct connection to practical issues. Our expert collaborators study every aspect of business functions, from leadership and accounting to personnel and hiring. The next step will be to correlate that information against the performance of real companies. We have [published research] on how ethics pays in the long run, and one of our goals is to work with regulators to make it pay even more. Jim Lager, who works at the U.S. Government Accountability Office, is one of our collaborators. We are looking at multiple approaches to measuring different facets of an ethical culture. You can’t use just one method, like sending out a survey to all employees. You have to supplement surveys with more qualitative interviewing, with big data approaches (such as text analysis of emails), and with objec-

ing on firms doing business primarily in the United States and other OECD [Organisation for Economic Co-operation and Development] nations that have reasonably good rule of law and a free press. We list research studies on corruption that have investigated whether, when, and why good ethics pays off for such companies, relative to their less scrupulous competitors. S+B: When Ann Tenbrunsel surveyed financial industry professionals in the U.S. and U.K. in 2015, many of them said that unethical behavior was necessary to succeed. Do you agree? HAIDT: Nearly all businesses create

S+B: What’s the alternative? HAIDT: I had lunch recently with a

guy named Mike Bontrager who runs Chatham Financial. His firm helps companies use derivatives to reduce financial risks. But they don’t place their own bets, so their interests are always aligned with those of their clients. Bontrager says they are clear about what they offer. When companies go to many Wall Street banks to help them hedge risk, they are sometimes like sheep to the slaughter. Because it’s so complicated, they don’t know what they’re getting. Some banks take advantage of that complexity. Their interests are at odds with those of their clients. But if Chatham and others like [that firm] succeed, fewer sheep will choose to enter the slaughterhouse, and that business model will eventually shut down.

To me, that’s better than complex regulation. S+B: So we need more innovation and less regulation? HAIDT: Whenever possible, we

should encourage ethical business models to disrupt an ethically problematic status quo. We can use government to set some of the rules of the game, but complex legislative solutions just invite regulatory arbitrage and high fines and legal fees. Or we might even use philanthropy to incentivize or subsidize business models that make unfair or unethical behavior become unprofitable. S+B: What do you have in mind? HAIDT: Let’s look at a common

problem: Poor people are often exploited when they try to get credit. Payday lenders serve a function, but serve it badly. What if someone offered US$20 million to finance an entrepreneur who comes up with a business model that serves the needs of the poor better and doesn’t trap them in debt spirals? What if the poor flocked to this alternative company, so that the predatory ones went out of business? What if some socially progressive hedge fund managers put up the prize money to help get it launched? There’s a new emphasis among Silicon Valley firms to fund prizes for technology innovation. Whoever wins the competition gets a big pot of money and a lot of fame. Why not take that approach to ethical business model innovation?

thought leader

goods or services that other people want and are willing to pay for. In a healthy industry, the only way to get rich is to make other people better off. The financial sector does that in most cases. But finance is a special world because one of the central actions in finance is trading. A stock or some other instrument is traded at a particular price, and a year later it often appears that one side wins and the other side loses. So there is more incentive to hide information and manipulate the circumstances. Traders are not spending all day thinking, “How can I make the other guy better off?” They’re thinking, “How can I get an edge?” The constant temptation of insider trading as shown in Michael Lewis’s book Flash Boys [W.W. Norton, 2014] illustrates that mind-set.

The 2008 crisis showed us that some financial professionals were trying to win the game by making other people worse off — for example, by using hard-sell techniques to get uneducated consumers to buy mortgages or other financial products that were likely to harm them. When we see this happening, we automatically say we need more regulation. And it’s true that we need to stop people from abusing the system. But a thousand-page law to regulate how people are going to behave is sure to invite excessive expenditures on attorneys and vast exploitation of loopholes and complexity.

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A Third Path for Capitalism S+B: What motivated you to start your new book [Three Stories…] about the future of capitalism? HAIDT: When I talked to Occupy

Wall Street protesters in Zuccotti Park, I saw the same cognitive patterns I had found in the political righteous mind: morally righteous and convinced of the perfidy of the other side. For many of them, capitalism is the devil. But at the same time, the people I knew at NYU Stern had a very positive view of

capitalism: It represented innovation and entrepreneurship. They thought that businesses could usually solve problems far better than governments. As I began to learn more about the history of capitalism, I had the same kind of revelation I had when I first discovered biological evolution. In college in 1982, when I first read Richard Dawkins’s classic book The Selfish Gene (Oxford University Press, 1976), I would look around at nature and say, “Wow, now I know how all this stuff got here.”

It was the same for me in 2011, when I first started reading about capitalism. I saw that the evolutionary processes of variation and competition that drive change in the natural world are also continually going on in the economic world through capitalism. I also realized that the theory of creative destruction in capitalism, like natural selection in evolution, automatically activates moral concerns and negative emotions in many people. In the U.S., and in many European countries, the left is generally

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ambivalent toward capitalism or negative about it. The social conservatives on the political right sometimes have problems with capitalism, too, because it fosters materialism; in their minds, it pulls you away from God and it can undermine traditional authority. So social conservatives often have mixed feelings about capitalism. But then there are the libertarians who love capitalism. The poles of our political world, especially in the U.S., are very clear. To someone who studies moral psychology, this makes capi-

talism really interesting. I have found, looking at many other countries, that two stories have dominated the narratives about Western capitalism through the centuries. I capture these in two 90-second videos I use in my talks about the book. One story, which I call “Capitalism Is Exploitation,” views capitalism as a vampire squid, a curse, a virus, a disaster for the poor and the planet. In the second, “Capitalism Is Liberation,” everyone used to be a peasant or serf, oppressed by the nobles and royals.

But beginning in the 17th century, capitalism made it possible for people to rise. It created middle-class prosperity and freedom that has fed economic prosperity more than any other system. For example, the World Bank recently reported that in the next few months, the percentage of people living in extreme poverty will fall below 10 percent for the first time in human history. This is an epic achievement, and it is driven mostly by the spread of markets and commerce, not by government aid programs.

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S+B So what is your third story about capitalism? HAIDT: I am not sure yet. People

have looked for a third story that blends or bridges the first two for a long time. It may not be possible to tell an entirely new story about capitalism. The best we can do might be to start with the second story — capitalism is liberation — but then be wary of the tendency to idealize or become ideological about markets and companies. John Mackey and Raj Sisodia’s “conscious capitalism”

is a great example of a third story that is a variant of the second story. I’m currently examining thirdstory approaches from the point of view of moral and social psychology. I hope to write about them in ways that draw in readers from the left and from the right. It gets most interesting to me when you look at the ideological divisions within each nation. In the most contentious economic debates these days — the minimum wage, overtime pay, environmental regulation — the left is fighting for poli-

cies that it believes will help the most vulnerable (including animals and the environment). These people are willing to accept less economic dynamism. Many on the left don’t even like the idea of economic growth. They see it as a threat to the environment and to trustworthy human relationships. The right is fighting to keep businesses as free as possible; these people don’t want to do anything that might reduce growth. To the left, they come off as hardhearted — willing to trample on the poor in search of profits.

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S+B: Can these points of view be reconciled? HAIDT: Every nation must think

about how to increase dynamism and decency at the same time. Dynamism is the drive to work, create, and innovate. It’s the desire to solve problems and do big things. Free market societies bring out dynamism like no other kind of society. But we also know creative destruction can hurt people. That feels wrong. We turn to government to tame capitalism, to make it more decent.

Decency refers to our moral intuitions of what is fair and what is compassionate. European countries such as France make it difficult to fire workers. That seems very decent, but it makes companies more hesitant to hire and it reduces dynamism. The United States is more innovative and dynamic, but our employees have less security and we have a lot more inequality. There’s no one right answer; different countries will thrive with different forms of capitalism.

S+B: What do you hope your book will accomplish? HAIDT: I want to strip away the

moralism and help people have better, more open, and more productive discussions about capitalism and business, all over the world. I want to give people a tool kit of concepts — from ethics, economics, and psychology — to help them think. Getting capitalism right is, in my view, the most important challenge of the 21st century. + Reprint No. 16112

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The Margin of Safety by David J. Lynch Foolproof: Why Safety Can Be Dangerous and How Danger Makes Us Safe, by Greg Ip, Little, Brown, 2015

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ore than seven years after the onset of the worst financial crisis since the Great Depression, debate over its origins continues. The left blames deregulation or Wall Street greed. The right indicts government policies that promoted home ownership for those who couldn’t afford it. Regardless of your partisan slant, there were plenty of failures to go around. But what if the epic face-plant of 2008 was the result of too much success, not too much failure? That’s the argument made by Greg Ip, the Wall Street Journal’s chief economics commentator, in his thoughtful new book. In Foolproof: Why Safety Can Be Dangerous and How Danger Makes Us Safe, Ip says that the global financial system was ultimately the victim of its own success. Central bankers vanquished the inflation of the 1970s and the stock and currency panics of the

1980s and 1990s, and tamed the business cycle. Recessions, which used to occur every few years, appeared only once per decade. As a result, investors grew complacent. The era of steady growth and low volatility known as the Great Moderation, which had begun around the mid-1980s, created an “illusion of safety,” Ip writes, that enabled and encouraged increasingly risky financial engineering. The result: Trillions of dollars in wealth vaporized, and the U.S. saw double-digit unemployment for the first time in more than 30 years. “The most important factor,” Ip writes of the 2008 crisis, “was the sense of safety that resulted from years of successfully fighting crisis and recession.” The novelty in Ip’s argument lies in the patterns he identifies beyond the world of finance. Just as efforts to make global markets safer spawned unintended negative consequences, so too have attempts to sand down life’s rougher edges: We get consequences such as runaway

forest fires, nuclear meltdowns, and airplane crashes. Ip’s inspiration is U.S. economist Hyman Minsky, whose chief insight he summarizes as “stability is destabilizing.” Ip’s thesis is straightforward: Efforts to reduce risk ultimately create danger by making individuals feel safe enough to assume more (and bigger) risks. Football helmets provide protection but encourage players to use their head as a weapon while tackling, so the game has become more violent and dangerous. Antilock brakes reduce skids but embolden people to drive more aggressively. Antibiotics offer miracle cures until their overuse spawns new drug-resistant superbugs. “The pursuit of safety leads to behavior that makes disaster more likely,” Ip writes. Ip posits a philosophical tug-ofwar between “engineers,” who believe that complex systems can be mastered, and “ecologists,” who believe that such efforts inevitably lead to unintended and dangerous consequences. He doesn’t say so, but the

Illustration by Noma Bar

Books in Brief

former approach is emblematic of the human-over-nature approach embraced by contemporary Chinese leaders who have gambled China’s stability on their ability to divert water to drought-ridden areas via thousand-mile canals. Foolproof appears at an opportune moment. The 21st century thus far has offered those in the U.S. a crash course in the costly trade-

tive assessment of the death toll caused by consumption of coal, oil, and nuclear power. (Spoiler alert: Nukes come away looking pretty good.) And there is the occasional memorable phrase: Nassim Nicholas Taleb, author of The Black Swan, explains the credit default swaps market by comparing it to “having to buy insurance on the Titanic from someone on the Titanic.”

Ip’s thesis is straightforward: Efforts to reduce risk ultimately create danger by making individuals feel safe enough to assume more risks. Yet the tale inevitably begins to feel repetitive as the safeguard-andrisk pattern is elaborated upon again and again. Ip is a steady, sober guide to the trade-offs at issue. But he sometimes seems to wrestle with a straw man. In practice, no one really thinks it’s possible to attain the sort of belt-and-suspenders perfection he concludes is unattainable, whether in global finance or in nature. He’s also better at identifying vulnerabilities that could trigger the next crisis — including developing countries’ accumulation of excess foreign currency reserves — than he is at suggesting remedies. Early in the book, he sets as his aim determining “whether we can ever get the balance between safety and risk right.” Ip discovers no magic formula. It’s not a choice between indiscriminate crisis fighting and laissez-faire, he argues. Rather, people should embrace the best of both philosophies. But who draws the line? And where, and how? Ip says “the right tradeoff between risk and

David J. Lynch [email protected] covered the global economy for USA Today for 16 years, and is the author of When the Luck of the Irish Ran Out. He is the cybersecurity editor at Politico.

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offs between safety and risk: the 2001 terrorist attacks, the invasion of Iraq less than two years later, 2005’s Hurricane Katrina, and the financial panic of 2008. Ip’s writing ranges widely, displaying his command of the finer points of the financial system, aviation, flood control, and health. If the retelling of the recent crisis seems familiar, there is plenty of fresh material in his account of an ill-fated National Park Service attempt several years earlier to clear accumulated brush outside Los Alamos, N.M., with a “prescribed burn.” A fire intended to be confined to a 900-acre parcel instead exploded across 48,000 acres, consuming 200 homes and requiring 1,400 firefighters and 16 aircraft to contain it. Ip also favors the reader with morsels of random wisdom: a meditation on the rationale behind the equity risk premium; the observation that the tsar’s embrace of the gold standard helped trigger the Russian Revolution; and a compara-

stability will maximize the units of innovation we get per unit of instability.” Good luck measuring either the numerator or denominator of that equation. Such complexity apparently leaves Ip untroubled, as does the inevitability of failure. The occasional financial crisis that obliterates trillions of dollars in wealth is the price we pay for a system that rewards innovation and thus eventually leads to a higher standard of living, he writes. Likewise, periodic natural disasters, however tragic, are the handmaiden of the human desire to live in desirable places — for example, on coastlines. Ip settles on “space” as his preferred palliative. Space between combustible forests and highpriced homes. Space (expressed in terms of capital buffers) between a bank’s risky assets and its balance sheet. Space between the rising waters and human settlements. He doesn’t say so directly, but what Ip really offers as an antidote to hubris is greater humility. That’s sensible enough, but as an ultimate verdict it is a rather damp squib. As Ip concludes: “We can make disaster and crisis less frequent and more survivable, but we won’t end either.” +

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by Edward H. Baker Humans Are Underrated: What High Achievers Know That Brilliant Machines Never Will, by Geoff Colvin, Penguin/ Portfolio, 2015

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eoff Colvin opens his new book, Humans Are Underrated, with a particularly grim discussion of the future of work. Computers are becoming sufficiently powerful to take over large swaths of the work now done by humans — not just back-office and middle management work at large corporations, but skilled tasks in fields such as driving, journalism, law, psychology, and even war. “The

Computers are hardwired to make calculations. Humans, by contrast, are hardwired to care.

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overwhelming message seems to be that, in trying to outperform technology, almost no one is safe for long,” he writes. The race of humans against machines, which dates back to the legend of John Henry, is very much au courant. The standard response to the threat posed by the ongoing effects of Moore’s Law can be found in Erik Brynjolfsson and Andrew McAfee’s 2014 book, The Second Machine Age (W.W. Norton). The authors recommend, among other things, that workers fortify themselves by getting more education, perhaps through massive open online courses (MOOCs) in STEM — science, technology, engineering,

some appropriate way.” Empathy is the key to successful social interaction, and social interaction, Colvin says succinctly, “is what our brains are for.” Computers are hardwired to make calculations and spit out results. Humans, by contrast, are hardwired to care. In Colvin’s view, empathy is a skill — the only skill that distinguishes us from computers, and the skill we humans must learn if we are to survive and thrive in the 21st century. Upon first reading Colvin’s claims about the importance of empathy, I had an immediate reaction of skepticism. Does he expect companies to go out and hire thousands of empathizers to carry out the com-

plex work they need done? But Colvin does a pretty good job of backing up his claim with real-world examples. American Express, for instance, told its call-center workers to forget the canned scripts they had always used when talking to customers, and to try to understand — to empathize with — them instead. To implement the new tactics, the company stopped hiring workers with call-center experience and began hiring from relationship-based businesses such as hotels and cruise lines. The result: significantly higher profit margins and lower employee turnover. Other examples Colvin cites come from healthcare systems, such as the Cleveland Clinic; the U.S. military; and even technology companies themselves. He points to the decision of Yahoo CEO Marissa Mayer to bring all the company’s teleworkers back into the office in hopes of sparking the human interaction that can lead to real innovation. Other companies, he notes, are looking more and more for empathetic programmers and designers to serve their increasingly consumeroriented customer base. Unfortunately, Colvin points out, the supply of empathy seems to be drying up even as demand is increasing. Empathy is on the wane in the 21st century, especially among younger people — thanks in part to the social networks and smartphones enabled by the very computing power that appears to be taking away our jobs. The ability to empathize is dependent on face-to-face contact with other humans, and doesn’t increase through friending 500 people on Facebook, or exchanging vanishing text messages. Luckily, empathy can be taught. Simply letting children play together on their own, make up roles for

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The Empathy Solution

and mathematics — subjects. Of course, Colvin, senior editor at large at Fortune magazine and author of Talent Is Overrated (Portfolio, 2008), points out that work in these fields is most susceptible to takeover by computers. (Not to mention that a clear, if unstated, goal of educational institutions’ use of MOOCs is to save money by reducing the need to employ large numbers of teachers.) So if studying coding and nanotechnology isn’t the answer, what is? Colvin, who holds an economics degree and an MBA, both from Harvard, suggests that we bone up on a social science: psychology. Specifically, his solution is to double down on the distinctly human trait of empathy, which he defines as “discerning what some other person is thinking and feeling, and responding in

themselves, and settle disagreements — rather than keeping them pent up in highly structured, parentsupervised situations — improves empathy. Play, in fact, turns out to be a key factor. Colvin notes that role-playing is a critical element of any effort to increase empathy. Several healthcare systems, including the Cleveland Clinic and Weill Cornell Medical College, have put many

er and audience, one that dates back to our earliest days as languageusing humans. Colvin points to how World Bank executive Stephen Denning used stories to convince a recalcitrant institution to make knowledge sharing a key element of its mission. Like so many other recent business books, Humans Are Underrated relies on a breezy style and lots of

One un-empathetic person on a team can ruin its chemistry, even if all the others are “givers.” social science research. And like so many others, it rather overstates its argument. Colvin makes a very convincing case for empathy: It’s a wonderful, important trait, and one that can only improve how every organization operates. But is it the answer to all our employment ills? Are empathetic people assured of jobs that computers and robots can’t do? I doubt that. Colvin’s book is worthwhile reading for anyone interested in boosting the performance of his or her company or team. But for all we know, sooner or later, computers will learn to play together, work in teams, and tell stories, too. They may even learn to care about our feelings. Edward H. Baker [email protected] is a longtime business journalist and a contributing editor of strategy+business.

by Neil Irwin America’s Bank: The Epic Struggle to Create the Federal Reserve, by Roger Lowenstein, Penguin Press, 2015

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ometimes, it’s useful to read history for the pure entertainment of it — riveting stories of battlefield adventure, for example. Other times, we read history to understand more about the people who shaped the future of the world. But a small, satisfying subset of history books can also shed light on current events. They shrewdly point out that phenomena that may seem to be entirely products of our time are in fact just the latest iterations of debates that echo through decades and centuries. America’s Bank: The Epic Struggle to Create the Federal Reserve, by Roger Lowenstein, falls into this last category. It is, narrowly speaking, a book about the early-20thcentury fight over the creation of what would become the Federal Reserve. A journalist by training whose previous books have focused on more contemporary history (Warren Buffett, the 2008 financial crisis), Lowenstein exhibits a gift for making these old debates come alive. But broadly speaking, America’s Bank is a book about the same ideological clashes that shaped the response to the most recent financial crisis and the Fed’s subsequent era of activism. And because Lowenstein manages both technical precision in describing financial concepts and clean, accessible storytelling, the result is a compelling reminder of how much today’s bat-

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of their doctors through a role-playing exercise using actors as patients. The result, according to the book: “healthier patients, lower costs, and fewer lawsuits,” and presumably better bedside manners. Colvin’s argument for empathy also fits smoothly into two trendy management techniques: teaming and storytelling. Empathy is critical if teams are to be truly successful. And we have entered an era in which teams have taken over the role of the individual in the innovation process. One un-empathetic person — one “taker” — on a team can ruin its chemistry, even if all the others are “givers.” Similarly, the virtue of stories as a key element in getting people on one’s side, whether one is a leader or a team member, has been much discussed in recent years. Again, the reason is empathy: Stories, Colvin notes, trigger a particularly tight, even neural bond between storytell-

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years — particularly during the Great Depression — but before the creation of the country’s central bank, the United States’ banking system was in many ways a disaster. Each bank was more or less on its own in avoiding a crisis of confidence. In one memorable metaphor Lowenstein quotes, it was as if the

European powers had vanquished banking crises generations earlier by establishing governmentchartered central banks, which anchored financial systems and prevented crises by issuing credit when needed. But U.S. residents were deeply opposed to a central bank, a cleavage that dated to the earliest

America’s Bank is the story of how the U.S. laid the institutional groundwork for its 20th-century dominance over the global economy. U.S. was a “town without a fire department in which each family maintained a pail of water to quench blazes in its own house.” Lowenstein makes clear just how dysfunctional the system was. The mere turn of the seasons could cause a freeze-up in credit. Depressions were a routine fact of life in the 19th century, not a rare aberration. American companies looking to trade globally had to rely on London banks because their counterparts on Wall Street weren’t allowed to do business internationally.

days of the republic and the battles between Alexander Hamilton and Thomas Jefferson over centralized financial control. The ghost of President Andrew Jackson, who slayed the Second Bank of the United States in 1836, haunts the era that Lowenstein chronicles, which starts roughly with the Panic of 1907 and ends with the passage of the Federal Reserve Act on Christmas Eve 1913. Time and again, officials who proposed a central bank took great pains to explain that what they had

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tles over who should control banking owe to the past. Over the last few years, the Fed has played a more intensive role in managing the United States’ economy and financial system than ever before. Whether you view its aggressive policy actions as having saved the economy or having been a disastrous usurpation of democratic traditions and its own powers (or both), America’s Bank will help you understand how this institution came to be, why it has the byzantine structure it does, and why its role in the 2008 crisis — and our continued angst over that — has long roots in U.S. history. Even if Lowenstein does not explicitly say so, America’s Bank is also the story of how the United States laid the institutional groundwork for its 20th-century dominance over the global economy and financial system. At the start of that century, London was the unquestioned financial center of the world. And although two world wars that ravaged Europe did much to shift that role to New York, it couldn’t have happened without the events described in America’s Bank. It is easy to forget given all the mistakes the Fed has made over the

Wall Street, country banks, business, agriculture, and political leadership, while also creating an effective central bank. As America’s Bank moves to the legislative debate over the Federal

ongoing discussion of financial regulation. Tea Party Republicans, populist Democrats, and community banking interests share a distaste for Wall Street power, but often have different recipes for what

U.S. residents were opposed to a central bank, a cleavage that dated to the earliest days of the republic. Reserve Act, it becomes a tale of how to balance these competing interests. It is here where the echoes of our current time are loudest. For example, smaller banks and progressives both distrusted Wall Street power. Smaller banks wanted greater control vested in reserve banks around the country, which would be stocked with local leadership (think of the Kansas City Fed and its counterparts). Progressives advocated greater control in a Washington-based board connected to the executive branch, and that became the current Fed board of governors. Wall Street interests wanted more power vested within a local branch that would be solicitous of their needs, and that became the New York Fed. The same dynamic was evident during the debate over the Dodd– Frank Act in 2010 and during the

to do about it. The legacy of those debates is the bizarrely complicated structure of the Fed system itself, with authority shared across a dozen reserve banks, each with its own board of directors, and overseen by the presidentially appointed board of governors in Washington. “The past is never dead,” William Faulkner famously wrote. “It’s not even past.” As Lowenstein reminds us, 100 years after the creation of the Federal Reserve, the U.S. still hasn’t fully made peace with the idea of a central bank. + Neil Irwin [email protected] is an economics correspondent at the New York Times. He is the author of The Alchemists: Three Central Bankers and a World on Fire (Penguin Press, 2013).

books in brief

in mind wasn’t really a governmentcontrolled “central bank” like the ones that existed in Europe. Lowenstein draws a set of characters vividly enough that you can imagine them walking through the contemporary political scene. These include Senator Nelson Aldrich, the powerful Rhode Island politician who was the ultimate crony capitalist; Senator Carter Glass, a wily Virginia segregationist who started with little knowledge of finance but would leave a vast imprint on the country’s market system (besides the Federal Reserve Act, he coauthored the Depression-era Glass–Steagall Act); and Paul Warburg, a Germanborn banker who was alternately impressed and appalled by the ways of his new homeland. Not only was the United States’ system of banking regulation worse than that of Europe, “[Warburg] said, it suffered in comparison with that of the ancient Babylonians,” Lowenstein writes. Conspiracy theorists have fixated on a key episode in 1910, when Aldrich, Warburg, and others sneaked off to Jekyll Island, Ga., to design what would become the Federal Reserve System. On the one hand, it really was a secretive conspiracy among bankers and politicians. On the other hand, the Jekyll Island crew successfully found a way to balance the competing interests of

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by Jon Fine How Music Got Free: The End of an Industry, the Turn of the Century, and the Patient Zero of Piracy, by Stephen Witt, Viking, 2015

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any years ago — so long ago that the first Bush was nearing election, most college students weren’t on the Internet, and the primary technological threat to the music business was a Maxell cassette — my first band decided to self-release an album. Whereupon I made an interesting discovery. At that time, retail list prices for vinyl LPs were around US$8.98, and CDs cost almost twice that. But CDs cost far less to manufacture than LPs. And the packaging was cheaper to make, too. This is just one reason the big music business — the few companies that make billions in revenue off live music and recorded music — is loathed by so many of its customers and participants. Unlike the other glamour businesses (read: TV and movies) that strike complex deals with creative talent and often base their pay on byzantine internal accounting, the record business was always pretty transparent in how it overcharged consumers. Further, the physical quality of its wares was often terrible. Above all, the music industry didn’t grasp that people who bought its products might, you know, have a sense of ownership once they did. Thus it reacted humorlessly, hysterically, and counterproductively to sundry threats apparent only to the industry: home tapers and even stores selling used records and CDs.

ing music free. Glover is Witt’s real find and the book’s most fascinating character. In 1999, Glover hooked up with the notorious Rabid Neurosis warez crew of online pirates, and with its mysterious leader, Kali. Knowing personal details about each other was verboten in the code of the filesharing elite; Glover knew Kali only as an online presence and a voice on the phone. Legendary among rival crews for getting rips of soon-to-bereleased CDs on the Internet before

Unlike TV and movies, the record business was always pretty transparent in how it overcharged consumers. Thus, the industry had no other prior examples from which to learn. But it nonetheless took a long time for the major labels to grasp the dimensions of the problem, and by the time they did, it was too late. An intriguing point shared by Witt: When ur-file-sharing service Napster began introducing young consumers to the idea that music could be free, Hilary Rosen, who led the Recording Industry Association of America, pushed the industry to cut a deal with Napster. She was unsuccessful. Witt builds his book around three central characters: veteran music CEO Doug Morris (he ran Universal Music Group during the book’s time frame and, at 76, now runs Sony’s label); engineer Karlheinz Brandenburg (who invented the MP3, which made file-sharing possible); and Dell Glover, whose job at a CD pressing plant in Kings Mountain, N.C., left him uniquely positioned to play a key role in mak-

all others, Rabid Neurosis — RNS — first leaked to the Internet 20,000 albums between 1996 and 2007. Glover used the oversized belt buckles then in vogue in his hometown to smuggle prerelease CDs out of his very security-conscious workplace. He was alone responsible for around 2,000 of those 20,000, including chart toppers such as Eminem, Jay Z, Li’l Wayne, and Mariah Carey. (A central irony of the book: The same consolidation of the music business that would make Doug Morris much more powerful would funnel more releases to Glover’s workplace.) Brandenburg, an earnest engineer, is a much less vivid character than either Morris or Glover, and the story slows whenever he shows up. But once the carnage touched off by Glover’s and RNS’s activities kicks in — and is felt even in the rarefied air of Morris’s corner suite — How Music Got Free is absolutely enthralling, and occasionally cine-

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My Tunes

That same loathed big business, however, didn’t quite know how to respond to the underground that systematized digital piracy. In How Music Got Free, Stephen Witt skillfully and thoroughly documents this “warez” scene of file sharers that started up in the 1990s. (Witt was deep into that underground himself.) For many reasons — file size chief among them, thanks to the MP3 format — music would be the first media business radically destabilized by broadband Internet.

the legendary RNS, aka Adil Cassim, a mild-mannered pot-smoking IT worker in suburban Los Angeles, and Alan Ellis, the Brit who ran the equally legendary (and equally illegal) digital audio archive Oink, are both found not guilty of all charges. Recorded music revenues in the U.S. fall from $14.6 billion in 2000 to less than $7 billion in 2014. And what of music, now that it’s largely free? Witt recently told Vice that he’s optimistic, now that people pay for streaming services like Spotify. “This was a generation that was never supposed to pay for anything,” he said. Witt, an erstwhile rabid filesharer, now himself pays $140 a year for Spotify. And, judging from global live music revenues, which rose 60 percent between 2000 and 2013, there is still a premium placed on the one part of music that digital can’t replicate: the experience of performance. As for the bands I was in — underground, aggressive punk rock, not on major labels — the Internet has given as well as taken away.

When my band reunited in 2011 and 2012, in many cities we played to larger audiences than we had when we were an active band in the late 1980s. This experience was not unusual for reunited bands with any connection to the underground, even those as well known as My Bloody Valentine. The Internet had enabled new generations of fans to easily discover once hard-to-find music, and provided lots of online campfires around which the likeminded could gather. All the same, I can’t help but wonder if the 21st-century music business is retreating to a much more innocent time. Before the Internet, before stereos, before radio, music was ubiquitous because it was just what people did. The only exchange of dollars took place at performances. + Jon Fine [email protected] is executive editor of Inc. magazine. A musician in a series of bands that recorded extensively and toured on three continents, he is the author of the memoir Your Band Sucks: What I Saw at Indie Rock’s Failed Revolution (but Can No Longer Hear) (Viking, 2015).

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matic. Glover becomes a prolific movie bootlegger; his leaks are a means to gain access to new movies and video games, which he also sells on DVDs to locals. Eventually the softspoken rural North Carolinian tricks out a fully loaded Lincoln Navigator with $1,000 rims. We watch Morris, a wily character old-school enough to have gotten his start in the music biz not long after the Beatles played on Ed Sullivan’s show, struggle with the altogether new reality of declining sales before finally figuring out a way to make some coin off the Internet. Morris founded the ad-supported YouTube music video channel Vevo. Witt reports that the 1 billion Vevo plays of Justin Bieber’s “Baby” alone resulted in a gross of around $30 million, thanks to preroll ads. Ultimately, Glover gets popped by the Feds in the parking lot after finishing a shift at his plant, and does three months in prison. Brandenburg makes a tidy, if unspecified, fortune from royalties associated with his invention. Morris manages to stay on top. Kali, the ringleader of

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One Bad Apple Spoils the Company Don’t let the performance of superstars distract you from the damage toxic employees inflict. BY MATT PALMQUIST

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workers, about 4.5 percent of whom were terminated for toxic behavior. The data included evaluations by an organizational psychologist about employees’ abilities and technical skills, as well as self-assessments that measured workers’ confidence and attitudes toward company policies. Reports on employees’ daily productivity, firm performance, and feedback from customers and clients were also considered. Employees who were overconfident and self-involved, and who professed to follow the rules, were the most likely to turn toxic. But the particular danger of toxic workers is that their habits can spread. By examining data at the team level, the authors found that the higher the number of toxic colleagues surrounding a particular employee — even one not predisposed to bad behavior — the more likely it was that the worker would follow a destructive path. The authors also compared the savings associated with an employee whose productivity ranks in the top 1 percent of a firm’s output with the turnover costs incurred because of a toxic worker. Replacing a toxic employee with an average one generated twice the savings that replacing an

average worker with a superstar did. Complicating matters, toxic workers can appear much more productive than their colleagues. But this productivity reflects quantity, not quality. Although they complete tasks faster, toxic workers won’t improve firm-wide performance over the long haul because their bad behavior counteracts any speed-related benefits they offer. Think of the way supervisors at an investment bank might not recognize a rogue trader while he or she is racking up profits — until it’s too late. Indeed, the authors encourage managers to screen employees for the personality traits linked to toxicity and not lean so heavily on productivity-related assessments. Because when it comes to toxic employees, the bad ultimately outweighs the good. + Source: “Toxic Workers,” by Mi-

chael Housman (Cornerstone OnDemand) and Dylan Minor (Northwestern University), Nov. 2015, Harvard Business School Strategy Unit Working Paper No. 16-057 More Recent Research at: strategy-business.com/recent_research

Illustration by Elwood Smith

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uperstar employees get all the attention. Because the exemplary productivity of top performers has been shown to boost firm-wide profitability, companies make it a priority to recruit and retain them. Less scrutinized are the workers who may appear to be top contributors, but in reality are behaving badly or flouting regulations. The negative actions of employees run the gamut from relatively minor indiscretions such as pilfering office supplies to serious transgressions like fraud or sexual harassment. Leaving aside the corporate costs associated with so-called toxic employees — including litigation and hiring replacements — their behavior can take a toll on workplace morale, customer retention, and stakeholder attitudes. In fact, a new study suggests that avoiding or weeding out toxic employees can be much more valuable to firms than hiring or cultivating overachievers. Working with a software development company, the authors constructed a novel data set, pinpointing several personality traits associated with toxic workers. The sample covered 11 B2B firms, 184 of their subsidiaries, and more than 58,500

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