Deloitte Review — Issue 1

1EDITOR’S INTRODUCTION

40 The Strategy Paradox An excerpt from the newest perspective on those surprise twins, success and failure Michael Raynor

AccordingtoauthorMichaelRaynor,moststrategiesarebuiltonspecificbeliefsaboutthefu-ture.Despiteourfixationonforecasts,however,noonecanpredictthefuture,makingitriskytobetthehouseoneventhemostbrilliantstrategy.Yetbreakthroughsuccessrequirestruecommitmenttoastrategy.Howcancompaniesresolvethisparadox?

48 Wealth with Wisdom Serving the aging consumer Cabrini Pak and Ajit Kambil

Gettingolderisafactoflife,butforbusinessesanagingsocietypresentsuniqueopportunities—andpitfalls.Fromproductdesign,tothepackagingofproductsandservices,thechangingneedsofanaffluentoldergenerationrequireasystematiclookbyexecutiveshopingtoserveitprofitably.

60 On Convergence: A conversation with Forbes Publisher Rich Karlgaard Ed Moran, Edited by Paul Lee

Newmediahavechangedovernightourperspectivesonnews,informationandentertainment.Canprintsurvive-profitably?Arevideopodcastsdestinedtoreplacetelevision?Whatwillthepublishingindustrylooklikeinadecade?InanexcerptfromtherecentlypublishedConver-genceConversations,EdMoraninterviewsRichKarlgaard,publisherofForbes magazine.

63 Perspective Richard Woodward

64 Contributors

40 48 4 12

ARTICLES2 Leader

3 Editor’s Introduction

12 Culture and the Myth of the Black Box Why you can—and should—manage your company’s culture Stephanie Quappe, David Samso-Aparici and Jon Warshawsky

Cultureisoftenviewedasthemagicalelixirthatmakesgreatcompaniesgreat,andthereisampleevidencethatculturessteepedininnovation,fellowshipandothergoodthingsfareunusuallywell.Butcultureisnotanarcaneart.Itistheoutcomeofdecisions—consciousorotherwise—aboutanorganizationandthebestcompaniestakeanactivehandinmanagingtheircultures.

34 The Two Faces of Risk Cultivating risk intelligence for competitive advantage Steve Wagner and Mark Layton

Enlightenedexecutivesdon’tjustworryaboutbadthingsthatcouldhappen,suchasthetheftofsensitivecustomerdata.Theyalsosweatthegoodthingsthatmightoccur,suchasthenexthitproduct.Howwelldoesyourorganizationanticipateandmanagethevariousincarnationsofrisk?

CONTENTS

DELOITTEREVIEW.COM DeloitteReview

1

2

YOU HEARD IT THE FIRST TIME YOU STEPPED ONTO the athletic field,andprobablyahundredtimesafterthat:keepyoureyeontheball.Itseemedsimpleenough.Masterthatandultimatelyyou’llbeastar.Asmanag-ersandexecutivesduringthe‘90s,weheardmuchthesamething,andtheballinquestionwasROI.Agoodbusinessleaderwoulddeliverthemaximumprofitonacompany’sassets,andallothertalkwassecondary.

ThissomewhatslantedfocusonoptimizingROIwassucceededbyafervorforriskcontrolandstewardshipthathasfeaturedheavilyduringtheearlypartofthe21stcentury.Inthewakeof‘irrationalexuberance’andSarbanes-Oxley, thereislittlemysterysurroundingshareholders’renewedobsessionwithrespon-siblecorporategovernance.Insomewaysitwasoverdue,andmuchgoodhascomeofit.

Butthewindshaveshiftedagain.Withtheessentialimprovementsofbet-terfinancialcontrolsandmoreengagedboardsofdirectors,wehaveseentheemergenceofamorebalancedapproachtooptimizingreturnswhileatthesametimereducingrisksrelatedtofinancialreporting(enoughtoinspirenostal-giainallofusforthedayswhen‘keepingyoureyeontheball’wasthesumofwhatweneededtokeeptopofmind).Themostsuccessfulcompanieswillbe

adeptatassessingandmanagingstrategicrisks,minimizingtherisksassociatedwithfinancialcontrols and reporting, and optimizing returns.

Inotherwords,thesecompanieswillbeadeptateverything.

Forleaders,thisrepresentssomethingofapushbeyondthekeycomponentsthatdrivemasteryofincomestatementsorbalancesheets.Itdemandsbothahighdegreeofflexibilityandadaptability, and at the same time considerable

automationandstandardization.Thosefinancialcontrolsandrationalizedprocessesweremorethanagoodpoint-in-timeidea—theyhavebecomees-sential,integralfeaturesinthemostsuccessfulbusinesses,akeytominimizingfinancialandreportingrisks.Automationintheseareashasbecometablestakes.

Atthesametime,strategicriskhasemergedasafarmorediverseandturbu-lentarenathanitwasevenadecadeago.Therearemoreoptionsavailablethaneverbefore,withastaggeringarrayofupsidesanddownsides.Today’sleadersmustconsiderthepotentialbenefits—andpitfalls—ofventuringintoChina,IndiaandEasternEurope.Isoutsourcingtherightanswer,orwouldco-sourcingmakemoresense?Willgrowthcomethroughafocusoninternalorexternaldriversofgrowth?Inthewildworldofmergersandacquisitions,isnowthetimetoacquireapromisingstartup,orsimplyaninterestwithanoptiontowalk?Maybethebestmoveistoputthenotiononiceandgroworganizationalcapabilitiesinternally.Orperhapsthetimeisrighttopursuethetalentofcompetitors,giventheunfoldingshortageinvariousskillsagainsttheback-groundofawrenchingdemographicshift.

Alloftheseoptionsarenowsetonaglobalstage,multiplyingthecomplexities. Technology,thankfully,isnolongerabarrier.Butitisnolongeranexcuseforplayingone’scardstooclose.

Anewballgame

“Strategic risk has emerged as a far more diverse and turbulent arena than it was even

a decade ago. There are more options available

than ever before.”

LEADER

DeloitteReview DELOITTEREVIEW.COM

3EDITOR’S INTRODUCTION

LIFE’S MOST REWARDING opportunitiesaren’tallthateasy.Playingscalesforyearswon’tmakeyouaconcertpianist.Andevenifaclutchandmanualgearboxsetyourbloodracing,yearsofnavigatingtheparkingdeckattheofficewon’thaveyouracinghistoricsportscars.Soitgoeswithbusiness,wherethesuccessthat gets a company to shareholder and business school-darlingstatusdemandsmorethanbalancingthebooksandpushingproductoutthedoorontime.Ourarticlesinthisissueareaboutthesedifficultanddefiningtasks–therocksonwhichmanycompaniesbreakandothershone their strengths.

Ifwehaven’tyetenticedyouthroughtheusualmagazinetricksofcoverartandplacement,I’lltossawaymylastpretensesofsubtletyandsteeryoutoDwightAllenandPunitRenjen’sarticleontruthsandhalf-truthsinM&A.Fewofushavemanagedorworkedforacompanythathasneverbeeninvolvedinamergerofsomesort.Therearemanyassumptionsabouthowthesearesupposedtowork—thebest-laidplans.Theauthors’listservesastherealitycheckmostofuscoulduseonoccasionandespeciallybeforeanoccasionascrucialasembarkingonamerger.

Ofcourse,thereareoccasionswhenanacquisitionorperhapsonlyapartialstakemaybetherightmove.WefeatureanexcerptfromMichaelRaynor’snewbook,The Strategy Paradox,whichdescribeshowthebeststrategiescananddofail,andhowthebest-managedcompaniescopewith—andprosperin—thefaceofuncertainty,throughinvestmentsinthemselvesandinothercompanies.

Whenitcomestoservice,mostcompaniesregarditasanecessarycost,somethingthatauthorsJeffreyGlueck,PeterKoudalandWimVaessenwouldtakeissuewith.InThe Service Revolution, they argue that manufacturersthatfailtoimplementandmeasureastrategyaroundservicesareoverlookingwhatforser-viceleadershasbecomesomethingofa(veryprofitable)crownjewel.Theirresearch,highlightedintheirarticle,putsservicesinanewlight.

Keepingwiththethemeofthingsthatsetthebestapartfromthecompetent,weputtheriseoftheagingconsumerunderthelens.Howdothebestcompaniesturnanunprecedenteddemographicupheavalintoamarketopportunity?

Theanswers,aswithallourtopicsintheSummer2007editionofThe Deloitte Review, are not so simple.

Ontherocks

DeloitteReviewISSUE1 , 2007

EXECUTIVE EDITORS

Mark Edmunds Partner,

Deloitte & Touche USA LLP

Punit Renjen Principal,

Deloitte Consulting LLP

Stephen Wagner Partner,

Deloitte & Touche LLP

Richard Woodward Principal,

Deloitte Consulting LLP

EDITOR Jon Warshawsky

Deloitte Services LP

EDITORIAL MANAGER Shiva Standifur


CREATIVE DIRECTOR Matt Lennert


ART DIRECTOR Tonya Weiland Sutfin

COPY EDITOR Nanci Healy

Contact

[email protected] (206) 716-7259

ABOUT DELOITTE

Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, its member firms and their respective subsidiaries and affiliates. As a Swiss Verein (association), neither Deloitte Touche Tohmatsu nor any of its member firms has any liability for each other’s acts or omissions. Each of the member firms is a separate and independent legal entity operating under the names

“Deloitte”, “Deloitte & Touche”, “Deloitte Touche Tohmatsu” or other related names. Services are provided by the member firms or their subsidiaries or affiliates and not by the Deloitte Touche Tohmatsu Verein.

Deloitte & Touche USA LLP is the U.S. member firm of Deloitte Touche Tohmatsu. In the United States, services are provided by the subsidiaries of Deloitte & Tou-che USA LLP (Deloitte & Touche LLP, Deloitte Consulting LLP, De-loitte Financial Advisory Services LLP, Deloitte Tax LLP, and their subsidiaries), and not by Deloitte & Touche USA LLP.

© 2007 Deloitte Development LLC.All rights reserved.

PHOTO: TIM MANTOANI

Jon Warshawsky, EDITOR


LETTER FROM THE PUBLISHERS

Mergers and acquisitions are high-risk propositions un-derthebestofconditions.Thechallengeiseventougherwhenthebusinessclimateisturbulentanduncertain.ItwouldbecomfortingtobelievethatM&Abestpractices

have become sowell-documented andwidelyunderstood that hard-pressedexecutivescanfindtheguidancetheyneedbyturningtore-positoriesofprevailingwisdomonthesubject.

ItistruethatthebodyofliteratureonM&Atransactionshasex-pandedinrecentyears,andthereisagooddealofagreementonwhatworksandwhatdoesn’t.Best-sellingbookssuchasDeals from Hell1 and Mastering the Merger2boildownthesecretsofM&Asuccessintoa few lessons.Others, suchasThe Art of Merger Integration,3 offermoredetailedprescriptionsonhowtodevelopandsustainarecordofconsistentM&Awins.Itistemptingtoconcludethatcompaniescan

THE OVERCONFIDENCE

TRAPGETTING IT HALF-RIGHT WON’T

WORK IN THE HIGH-STAKES GAME OF M&A INTEGRATION

BY DWIGHT ALLEN > PUNIT RENJEN

4


5THE OVERCONFIDENCE TRAP

PHOTO-ILLUSTRATION: MATT LENNERT DELOITTEREVIEW.COM DeloitteReview

THE OVERCONFIDENCE TRAP

heedthisadviceandlearntomanagetheirwaythroughtheM&Aexperienceeveninunsettled times.

Despiteasaggingbookshelf,however,itwouldbeunwisetoconcludethatM&Amanagementhasbecomeawell-developedscience.Thefieldremainsaworkinprogress,withbestpracticesnotyetdefinedprecisely.AlthoughbooksandpapersonM&Aagreeoncertainprecepts,closerexaminationrevealssignificantvariationsanddisparities.Itisn’tclearthateveryoneisapplyingthesametheories,orthatthenumbersexisttomakesolidjudgmentsaboutoutcomes.AndthereareplentyofdifferencesinthewayexecutivesunderstandandimplementparticularM&Aapproaches.WeshouldbehumbleratherthanhaughtywhenitcomestothemanagementofM&A.

WithrespecttotheimprecisionindefiningM&Abestpractices,wewanttohighlighttheextenttowhichmaximsabouteffectivedealmanagementcanbemisconstruedortwistedinwaysthatmissimportantpoints.Truismsespousedbyacademicsandadvisors,orsharedamongexecutives,canbelesscompletethantheyseemonthesurface.Whenthemarginforerrorisnarrow,thatcanleadtotrouble.ThefollowingexamplesaredrawnfromtheM&AliteratureandfromourexperiencebothinconductingandresearchingM&Aintegration.

HALF TRUTH 1:TO GAIN GROWTH, BUY A COMPANY THAT’S A PROVEN WINNER.Whole truth: If there’s upside left, a proven winner may be the right target, but the better bet could be an ugly duckling with disruptive potential.

Bigcompanieswithamaturecorebusinessoftentrytoexciteinvestorsbygoingafteratargetwithastrongrecordthatportendsfurthergrowth.Thequestionoftenaskedinsuchcasesiswhetherthetargetisaspromisingasotherpotentialmatchesandwhetheritsbonafidesholdupundercarefulscrutiny.

ButsometimestheM&Atargetswiththegreatestgrowthpotentialareuglyduck-lings that fit none of the conventional criteria for an attractive purchase.These arecompaniesworkingonnewtechnologiesandbusinessmodelsthatcouldrevolutionizemarketsanddestroyincumbents.That’swheretrulyexceptionalgrowthcomesfrom.

Yetadisruptiveinnovationdoesn’tstartofflookinglikeaworld-beater.Tothecon-trary,initsearlydaysadisruptoristypicallyasmallfirmwithafragilebusinessmodelservingalow-endmarket,offeringproductsthatarenomatchforthoseavailablefromindustry leaders.McDonald’s, Sony,Toyota, andWal-Mart began thiswayand theydidn’tlookveryformidableintheiryoungerdays.Whiletheapparentbesttargetmaybeacompanythathashititsstride(assumingitstillhasenergyleftforthenextlap),therearetimeswhenmanagementneedstothinkfurtheraheadandinvestinalessobviouschoicethatneverthelessrepresentsmorepotentialforvaluecreation.

HALF TRUTH 2: ACQUISITIONS ARE BETTER THAN LESSER FORMS OF OWNERSHIP.Whole truth: Depending on the strategic objective, outright acquisition may be overshooting.

Anoutrightacquisitionistypicallycleanerandsimplerthanestablishingajointven-tureorbuyingapartialequitystake.Butmakinganacquisitionmayentailmoreofacommitmentthanacompanywantsorneeds.InThe Strategy Paradox,4 Michael Raynor describeshowJohnson&JohnsonDevelopmentCompany(JJDC)investedinasmalllifesciencescompanytogiveitsparentcompany,Johnson&Johnson,accesstoanewsedationtechnology.AJ&JdivisionsawthistechnologyasintriguingbutnotsomethingitoranyotherJ&Jdivisioncouldpursue,giventheirexistingmandates.

Bybuying20percentofthecompany,takingaseatontheboard,andobtainingarightoffirstrefusaloncommercializationrightstothenewtechnology,JJDCcreatedanoptionitcouldexerciseifthetechnologydidwellinclinicaltrials.Alternately,itcouldabandonthetechnologyatlimitedcostifitfailedtopanout.BuyingthesmallcompanywouldhavetiedJ&Jmoretightlytothesuccessofthetechnologythanwaswarranted,andwouldhavecommittedcapitalJJDCcouldusetotakepositionsinothercompaniestocreatesimilaroptionsinotherareas.

6 THE OVERCONFIDENCE TRAP


HALF TRUTH 3:TO SATISFY INVESTORS, AN M&A TRANSACTION MUST UNLOCK BIG VALUE GAINS QUICKLY.Whole truth: The way to impress investors is to deliver on your promises, so resist the impulse to promise more than you can deliver in a short time.

Over-reaching can be a problem when it comes to defining strategic objectives.AchievingsuccessonawishlistthatrangesfromservicesgrowthtobetterR&Disveryambitiousandmayrequireadditionalacquisitions.Alonglistlooksgreatonpaper,butitcanbemurdertoexecute.Openingacomplicatedinitiativespanningseveralfrontsnotonlyjeopardizesthefulfillmentofpromisesaboutsynergies, itcaninterferewithgettingsystemsandprocessesreadytosupportthenewlycombinedorganization.Thatcanhaveanadverseimpactoncustomers,revenues,margins,businessmomentumandregulatory compliance.

HALF TRUTH 4: MAKING THE RIGHT ACQUISITION IS CRUCIAL TO INCREASING SHARE-HOLDER VALUE.Whole truth: It’s not only what you add that creates shareholder value, but what you discard. Divesting businesses that can do better elsewhere is important, too.

Sometimessheddingbusinessesorassetscanenhanceyourcompany’svaluecreationpotential.Thefactthatoneortwoofanacquiredcompany’sproductsareagreatfitwithyoursdoesn’tmeantheyallare.Keepingmisalignedsegmentsoftheacquiredcompanycan introduce a damaging drag.And even if there’s great synergy today, thatwon’tnecessarilycontinueindefinitely;changesinmarketandeconomiccyclescanalterthe

PHOTO: PETE STONE

“Disruptive innovation doesn’t start off looking like a world-beater.”

7THE OVERCONFIDENCE TRAP


8

calculationrapidly.Companiesshouldexaminetheirportfolioofbusinessesonaregu-larbasisandquestionwhetheranywouldbeworthmoreifownedbysomeoneelse.IndescribinghowKochIndustrieshasachievedan18percentcompoundedannualreturnoverseveraldecades,CharlesKochnotes thathisfirmbought37businesses -but italsoexitedfrom42.5Emotionsmaygetinthewayofobjectiveanalysis,ofcourse.The“fiefdomphenomenon”oftencausesexecutivestoresistsellingpiecesofthecompanyforwhichthey’reresponsible.Andthepersonwhochampionedanacquisitionwillquiverwhensomeonesuggestsitoughttobesold.Nevertheless,it’swisetoquestionwhethertherereallyisvaluetobeextractedorwhetherthebusinesswouldbeworthmoreunderdifferentmanagement.

HALF TRUTH 5: FOCUSING ON THE DEAL’S STRATEGIC PURPOSE DURING INTEGRATION ENSURES THAT THE VISION WILL COME TRUE.Whole truth: You should translate the vision into an “end-state” definition that includes the new company’s products, platforms, resources, locations and other attributes.

Topmanagementneedstotranslatetheacquisitionstrategyintoadefinitionofhowthecombinedcompanyshouldlookandfunctiontorealizeitsvision.Thismeansthinkingthroughthenewentity’sproducts,platforms,resources,locations,suppliers,managementstructureandorganization.Thatinturnrequiresaddressingissuessuchastherightbal-ancebetweenrevenuegrowthandcostreductionandwhatdegreeofintegrationwilloccur.Revenuegrowthisanattractivestorytotell,butcostreductioniseasiertoplanandtrack.Howmuchintegrationisneededmayvarybybusinessunitorfunctionandbytimeframe.Definingthedesiredendstatesuppliesthepeoplerunningtheintegrationprocesswithamorespecificpictureofthedestinationthey’resupposedtobedrivingtoward.

Howdoesthislookinpractice?Whentwolifesciencescompaniesmerged,theintegra-tionwasguidedbyadetaileddescriptionofwhatseniormanagementwantedthedealtoachieve.Thenewcompany’sstructureandfunctioningweredefinedthroughaprocessthatincludedattentiontotheperspectivesandexpectationsofcustomers,shareholders,employeesandotherkeyconstituencies.Themergerresultedinsubstantialcostsavingsbutthecareindefiningthedesiredend-stateensuredthatinitiativesdesignedtosavemoneydidn’tinterferewithotherstrategicobjectives.

HALF TRUTH 6: A DETAILED MASTER PLAN IS ESSENTIAL FOR A SUCCESSFUL INTEGRATION. Whole truth: You need an overall plan, but don’t overestimate what you’re likely to achieve by creating one or underestimate the need to augment and revise it as you go along.

Agreatplanwon’tspareyou fromhaving todealwithquestions thatneed togetsettledbeforetheorganizationcanfunctioneffectively,suchassensitivemanagementappointmentsordisagreementsoverfundamentalvalues.Ifyoudon’tgetthoseoutoftheway,theymayderailthenewenterprise.Avoidingtroubleearlyondoesn’tneces-sarilymeanyou’reintheclear-itmayburstoutawhilelater.Forexample,themergerof two high-tech companieswas nearly undonewhen differences among senior lead-ersfesteredandflareduntiltheorganizationwasrockedbyconfrontations,firingsandlitigation.Manyaspectsof the integrationweregoingfine,but thatdidn’taffect theacrimony at the top.

Assuming you’re quick to resolve such issues, be certain you exert the requisitedegreeofcontrolastheprocessgoesforward.Asingleone-yearmasterplanmaybetoohigh-level toachieve thisandmay incorporate invalidassumptions.Demand it-erativeone-monthplansthateachleadtosomeimportantandmeasurableoutcomes.Keepre-prioritizingasyoulearnmore.Anddon’toverlooktheimportanceofeffectiveprojectmanagement.Installthemechanismstocomprehensivelyandruthlesslyman-ageexecution.Otherwiseyourplansmaynotbeproperlycarriedout,nomatterhowwell-craftedtheyare.



9

HALF TRUTH 7: RESPONSIBILITY SHIFTS AS THE MERGER CYCLE PROCEEDS.Whole truth: There will be some role changes over the cycle, but the whole team should be on the field from start to finish.

Thelevelof intensitywillfluctuate,andthenatureofthecontributionwillvary,buteverymajorgroupshouldbefullyengagedfromstarttofinish.Unlikearelayrace,gettingamergeracross thefinish linerequirescontinuedeffortby thewhole team.Theoddsofwinningablueribbondecreasewhenpeoplefromcertainbusinessunitsor functionscontributeatthestartofthedealbutthenletothersgrapplewiththecomplexitiesthatariseinthelaterstages.Clearly,it’sdysfunctionaliftoomanydif-ferentplayersparticipatewithlittlecoordination.Makingamergerworkrequiresthecontinuousapplicationofmultipledisciplinesandperspectives.Andeverybodyneedsskininthegametoensuretheultimatesuccessofthetransaction;notonlyoperatingdivisionsbutcorporatedevelopment,accounting,tax,andlegaldivisionsshouldstayonboardforthedurationofthemerger.

HALF TRUTH 8: DURING INTEGRATION, YOU SHOULD STRIVE TO RETAIN KEY MANAGERS AND EMPLOYEES.Whole truth: You should re-enroll not only people inside the organization, but also other key constituencies, including customers, suppliers and business partners.

It’snot justyourexecutivesandemployeeswhoneedattention.Theearlydaysofamergerpresentanenormouschallengewithrespecttoretainingyourmostvaluable

PHOTO: PETE STONE

“The level of intensity will fluctuate, and the nature of the contribution will vary, but every major

group should be fully engaged from start to finish.”



10

cohorts-yourcustomers,suppliersandbusinesspartners.You’regoingtohavetospendalotoftimere-enrollingthembytalkingwithorvisitingthem;bymakingabsolutelycertainthatpreviouscommitmentstothemaremet;bycommunicatingyourplansoverandover;andbybeingacutelysensitiveandresponsivetotheirconcerns.

Sometimessimplethingscangetintheway.Youmaynothaveagoodinventoryofallyourimportantconstituencies;somecompanieshaveneverdocumentedalloftheiralliancepartners,forexample.Whataboutthealliancepartnersofthecompanyyou’recombiningwith?Giventhelikelihoodofchangesthatcomewithanymerger,it’svitaltomaintaintheflowofcommunicationswithcustomers,suppliersandbusinesspartners.Eventellingthemyouhavenonewstoshareatagivenjunctureisbetterthanlettingtoomuchtimepasswithnoupdateatall.

HALF TRUTH 9: CONSTANT COMMUNICATION KEEPS EMPLOYEES INFORMED AND PREVENTS UNWANTED DEPARTURES.Whole truth: Beyond words pouring forth from the front office, you also need lead-ers who model the desired values and behaviors of the merged organization, as well as mechanisms that permit communication from the organization to the leaders.

Communicationisvital,butnotjustcommunicationintheformofwordsfromman-agement. Inaddition to issuingannouncements, taping speechesandsendinge-mailupdates,seniorpeopleshouldmodelvaluesandbehaviorsconsistentwiththedesiredpost-mergerorganization.Thosevaluesandbehaviorsshouldbereflectedinemployeegoalsandevaluations.Provisionshouldbemadeforcommunicationfromemployeestomanagementaswellandthereshouldbemechanismsforsolicitingfeedbackandmea-suringopinion.Whatiftheretentionplandoesn’tseemfairtoemployeesorrumorsaredrowningouttheofficialpronouncements?Willtopexecutivesgetthemessageintime?

HALF TRUTH 10: TO ACHIEVE PLANNED REVENUE SYNERGIES, START IMPLEMENTATION EARLY AND PUSH HARD.Whole truth: In the early stages, the challenge is to keep sales and customer service from getting hurt by the turmoil. Focus on avoiding harm rather than achieving big gains.

Earlyon,youraimshouldbetoachievecostsynergieswhileavoidingactionsthatreduceexistingrevenues.Thisisnottosayattentiontorevenuesynergiesshouldbede-ferredforalongtime,particularlysincetheymaybeimportanttocertaindeals.ButintheearlystagesofanM&Aintegration,therearemanywaystoimpederevenuegrowth.Simplykeepingrevenuesontheiroriginaltrackisnosmallfeat.Witheverythingfromleadershiptoprocessestosystemsinflux,itisn’tsurprisingthatcompaniesinthethroesof integration frequently implementnewpractices that jostle customer relationshipsandtanglesalesoperations.Theguidingprincipleshouldbetheonearticulatedinthephysician’sHippocraticOath:“first,donoharm.”

HALF TRUTH 11: PRECISE TARGETS FOR REDUCTION ARE VITAL FOR CAPTURING SYNERGY.Whole truth: Being specific about reductions is important, but reductions from what? The starting point from which the cost reductions will be measured should be clear as well.

Withoutawell-definedbaselineforreference,confusionandcredibilityproblemsmayobscuregoodnewswhenearlierheadcountandcostscan’tbeclearlylinkedtosynergyclaims.Keepinmindthatsynergytargetsarefrequentlyhardertohitthanoriginallythought.Thereshouldbeformal,non-negotiableagreementsbetweentheCEOandse-nior integration leadersas towhatwillbeachievedbywhen,withallpartiesunder-standingwhatthetargetsmeaninrelationtothestatusquoante.



11

HALF TRUTH 12: DAY ONE SHOULD BE ISSUE-FREE.Whole truth: Issue-free doesn’t mean perfection. Focus on essentials and go with solutions that are 70 percent perfect but 100 percent achievable.

DayOneshouldbeissue-free.Butthatdoesn’tmeangoingflatouttohaveeverythingjustso.First,it’simportanttofocusonthingsthatabsolutelyhavetobeinplaceonDayOneandleavetherestforlater.Justgettingtheessentialsdonewillusuallybechal-lengeenough.Second,thereissuchathingasaimingtoohighandhittingDayOnewithanunfinishedmasterpiece.Operatebythe70/100rule:gowithsolutionsthatare70percentperfectbutcanbe100percentimplementedinthetimeavailable.Third,beforecommittingtohavesomethingreadybyDayOne,evaluatethetrade-offsbetweenspeedandrisk.Ifrushingisunavoidable,howmuchisDayOnereadinessworthintermsofdangerofmalfunction?Finally,acceptthatopeningdaymaybemuchlesssmooththanitappears tocustomers.Workingaroundthings thatremainunderconstructionwillhavetosufficeforDayOne.Notideal,butdon’tlettheperfectbetheenemyofthegood.

HALF TRUTH 13: DAY ONE MARKS THE END OF THE BEGINNING.Whole truth: Day One is a crucial milestone but hardly the end of the line. Much will remain to be done and integration efforts will need to be redoubled as Day One fades into history.

DayOneshouldbethefocusofintensiveeffort,butwhenitarrives,thenewcom-panywon’thavedeliveredonthevisionthatmotivatedthedeal,norwillitbedownhillfromhere.

Inthemergeroftwochemicalcompanies,successdependeduponthedevelopmentofnewsafetyprocedureswhichentailedarigorousandextensiveprocessextendingwellbeyondtheinaugurationofthenewcompany.Bymaintainingdiscipline,managementavoidedtroublewithwatchfulregulatorsand,moreimportantly,sawtoitthatpropersafetystandardswereupheld.

AfterDayOnethere’satemptationtoheaveasighofreliefandreturntodailybusi-ness,orshifttothenexttransaction.ButDayOnewillfindmanyelementsofthecom-binationstillunfinished(bydesignorotherwise),withsignificanteffortyettogo.Itmaywellbetimetoenergizetheprocessbybringinginfreshpeople,butDayOneshouldbejustaway-stationontheintegrationtimeline.Thedestinationwillstillbemonthsoff,andtheenergylevelneedstostayupasDayOnecomesandgoes.

A LOT TO LEARNAstheaboveexamplesshow,anM&Atransactioninvolvesmultiplestages,manyfacetsandmuchcomplexity.Theprinciplesandpracticesformanagingsuchaninitiativeeffec-tivelyareonlypartlycodifiedandimperfectlyunderstood.Evenwithrespecttoproventechniques,it’spossibletolosesomethingintranslationandjeopardizeadealthroughmisapplication.Executivesshouldresistthetemptationtoassumethattheirorganiza-tionspossessthewholetruthaboutM&Amanagementandapproacheachdealwiththewaryconvictionthatweallhavemuchtolearn.DR

Dwight Allen is a director with Deloitte Research, Deloitte Services LP specializing in M&A studies.Punit Renjen is a principal with Deloitte Consulting LLP. He leads the firm’s Merger & Acquisi-tion Integration Services practice and is also the global leader for the Strategy & Operations practice.

Endnotes1 Bruner,Robert,Deals from Hell: M&A Lessons That Rise Above the Ashes.JohnWiley&Sons,Inc.,2005.2 Harding,DavidandRovit,Sam,Mastering the Merger: Four Critical Decisions That Make or Break the Deal.HarvardBusinessSchoolPress,2004.3 Lajoux,AlexandraReed,The Art of Merger Integration: A Guide to Merging Resources, Processes, and Responsibilities.McGrawHill,1998.4 Raynor, Michael, The Strategy Paradox: Why Committing to Success Leads to Failure (and What to Do About It),Currency,2007.5 Koch,Charles,The Science of Success,Wiley,2007.



12 CULTURE AND THE MYTH OF THE BLACK BOX


12

13

WHY CULTURE MATTERSCulture tends to be something of an enigma in thestudy of companies.Everyone agrees over cocktailsthat culture is important and hopes their company hasa “good” cultureversusa “bad” culture.Forallofitsimpliedsignificance,however,culturalchangetends to rate alongside tarot card reading and astrol-ogyintermsofcredibility.Itlurksintheunfortunatecategoryof “soft” issuesthat leaderscan’tquitedis-cardforthenaggingsensethattheremayactuallybesomething there, something that may hold too much importancetodismissoutofhand.

CULTUREand the

MYTH of the

BLACK BOX

BY STEPHANIE QUAPPE > DAVID SAMSO-APARICI > JON WARSHAWSKYILLUSTRATION BY ANTHONY FREDA

why you can—and should—manage your company’s culture

CULTURE AND THE MYTH OF THE BLACK BOX


13

14

The Hard TruthInfact,cultureisnota“soft”issuecreatedbycheerleading,postersorpicnics.Cul-

turecanbeexplicitlydefined,anditgenerallydevelopsoutoftangible(andcontrollable)actionswithinacompany,notinamurkyblackbox.Moreover,itsimplicationsforcor-porateperformancearerealandcanbesubstantial.ResearchfromDenisonConsultingconcludesthatcompaniesdemonstratinghigherlevelsofperformanceinkeyareasofcorporateculture,includingadaptability,consistency,missionandinvolvement,deliverbetterresultswhenitcomestoreturnonassets,salesgrowthandincreasedvaluetoshareholders.1ThisfindingbuildsonJ.Kotter’sandJamesHeskett’s landmark1992study,2whichfoundthat,overa10-yearperiod,companiesthatintentionallymanagedtheir cultures outperformed similar companies that did not. Their findings includedrevenuegrowthof682percentversus166percent;stockpriceincreasesof901percentversus74percent;netincomegrowthof756percentversus1percent;andjobgrowthof282percentversus36percent.3Additionally,companieslistedonFortune’s100BestCompanies toWorkFor further demonstrate that thosewithwell-managed culturessignificantlyoutperformtheS&P500.

Culturesimilarlycantakeonincreasedimportanceinlargecorporatemergersandacquisitions,whereanestimated30percentofintegrationsgetstuckorfailoutrightasaresultofculturalissues.Disparitiesincorporateculture,aswellasthetendencyforoneculturetobecomedominant,createa“win-or-lose”mindsetthatinjectsagooddoseofmistrustintoanalreadycomplicatedprocess.4

Culture as a Driver of Business ResultsBeyondthehardnumbers,culturecanplayaprominentroleinseveralissuesthat

topbusinessleaders’agendas.Ethics,whichhasbecomesomethingofanobsessioninthewakeoftheEnronfiascoandtheresultantSarbanes-OxleyAct,hingesoneffectivecontrols,propersystems,and,most important,aculturethatvaluesethicalbehavioranddiscouragesdishonesty.Ifethicscanbedefinedaswhatonechoosestodowhennooneelseiswatching,thenculturecanbeasignificantpredictorofethicalorunethicalbehavior.Buildingsystemsandcontrolsasasortofscaffoldingaroundadysfunctional

company can be an (expensive)exerciseinfutility.

Business publications also are replete with stories about thewarfortalentandinnovationasa driver for growth. Jeff Rosen-thal and Mary Ann Masarech put a finer point on it: “Organi-zationsdependoninnovationforgrowth and high performance,which in turn depend on em-ployeeinitiative,risktakingandtrust-allqualitiesthatareeithersquelched or nurtured by an or-ganization’s climate.”5Moreover,they add, people are increasingly looking for more from their em-ploymentthanapaycheck.Some“senseofpurpose”andcamarade-rie,evenjoy,fitintomanywork-ers’ notion of a great job, andprojected demographic trendssuggest that retaining top talent

FIG.1 EXPRESSIONS OF A HIGH-PERFORMANCE CULTURE (OUTER CIRCLE)

• Goal setting and budgeting

• Reporting and measuring

• Human resources policies/practices

• Communication and employee feedback

• Compensation• Organization

• Decisions of senior leaders and key influences• Daily interactions of employess and managers

(i.e., one-on-one, in teams, and in larger forums)• Messages to peers, internal customers, and suppliers• Individual decisions regarding “discretionary effort”• Statements and practices

BEHAVIORS

SYMBOLS SYSTEMS

VALUES AND

BELIEFS

Business Strategy

• Resources invested (i.e., time, money, and emotional labor)

• Office layout• Span of control• Informal rewards

and recognition• Branding



15

willbecomeincreasinglyimportantasthetalentpool,andworking-agepopulationasapercentageofthetotalpopulation,diminishes.Ifacompanywantstoattractandretainthe best and the brightest, culture once again emerges as something that truly matters.

Andas for thegeniusof innovation, clearly theonepercent sparkof inspirationisnurturedbyapositiveculture.Butthe99percentperspiration ingredientcomesfromemployeeswholovewhattheydo,aswellaswheretheydoit,andwhoinvestinthatHolyGrailofproductivitycalled“discretionaryeffort.”Webelievethatthesparkandcommitmentofemployeesinthese“good”culturesareabigpartofwhatcreatesextraordinaryresults.

Not a Roll of the DiceThe crux of it is this:Ahigh-performance

culturecanbeacompetitiveweaponthatlead-erscanactivelymanage.Cultureshouldnotbesomething that simply happens and through afortuitousrollofthediceturnsoutinawaythatworks forus. It is theproduct of behav-iors, symbols and processeswhich should becontrollableandcontributetoordetractfromacompany’sperformance.

ANATOMY OF A HIGH-PERFORMANCE CULTURE

Everyonewantsahigh-performanceculturethatgetsthejobdonewhileattractingthe

bestandthebrightest.Butjustwhatisit?Notall definitions agree, but behaviors, symbolsandprocesses are visiblemanifestations of acompany’sculture.

Ahigh-performancecultureis“anintegratedsetofmanagementprocessesfocusedonextraordinaryperformance,”accordingtoDr.JohnSullivan,professoratSanFranciscoStateUniversityandnotedstrategichumanresourcesauthor.Whatit’snot,Sullivanadds,isacorporatecultureinthetraditionalsense,encompassingsuchthingsasvaluesandbeliefs.6

WhenKotterandHeskett examined the causality of corporate cultureandperfor-mance in the late ‘80s, theydividedculture into twoparts: (1) thepatternofsharedvaluesandbeliefsthathelpsindividualsunderstandorganizationalfunctioning(invis-ible)and(2)thoseconventionsthatprovidethemwithnormsofbehavior(visible).7Intheauthors’view,becausebehaviorsmanifestthemselvesinsuchdecisionsashowtoinvestthecompany’sresources,itmakessensetoaddsymbolsandsystems(processesandinfrastructure)totheequationasvisibleexpressionsofculture.Inshort,themodelusedhere(Figure1)combinesSullivan’sdescriptionofahigh-performanceculturewithKotter’smodelwhilefocusingontheexpressionofcultureasadirectresultofsharedval-uesandbeliefs.Theinterplayamongalloftheseelements-inherentvaluesandbeliefs,visiblesystems,behaviors,andsymbols-setagainstthebackdropofbusinessstrategyrepresentsacompany’sculture.

Do As I Say...Inahigh-performanceculture,valuesandtheirvisibleexpressioninbehaviors,sym-

bolsandsystemsare inextricably connected. It isnotenough to focusonsystems inisolationorprintmorepostersaboutvalueswithnocredibleincentiveforbehavioralchange. Symbols are equally integral to establishing andmaintaining culture. Howmanyemployeesgetmixedmessageswhenthecompany’snewcost-savingsinitiativeis

“The interplay among all of these elements—inherent values

and beliefs, visible systems, behaviors, and symbols—set

against the backdrop of business strategy, represents

a company’s culture.”



16

promotedduringanexpensivecorporateevent?Orworse,duringaneventtheyarenotinvitedtoattend!

The actual culture of a company ismost often revealed when observing howindividualsapproachandcompletetasksandactivities.Thisdependsondecisionsmade in linewith business strategy and can sometimes differ from officially de-claredvalues.Asdiscussedabove,howemployeeschoosetoexpenddiscretionaryeffort on behalf of the company is a direct reflection of the culture, either high-performingornot.

Consider another common scenario: A company implements the latest human re-sourcesinformationsystem(HRIS)orenterpriseresourceplanning(ERP)systemonlytofindemployees resisting thenewwayofdoingbusiness.The clashbecomesmucheasiertounderstandwhenviewedinlightoftheinherentbehaviorsandsymbolsofthecompany,which,unlesstheywereactivelychanged,are(surprise!)stillsupportingandrewardingtheoldorganizationalstructure.Thisiswheresystemsandprocesschangeneedtogohand-in-handwithintendedbehavioralchange.

Effortstochangeculturesolelythroughrecruitingoraflashycommunicationscam-paignoftenmiss thepoint, asdo the frequenthorror storiesabout companies imple-mentingperformance-trackingsoftwareto“solvethecultureproblem.”There’susuallymoretothemixandcompaniesmustusetheingredientstheyhaveattheirfingertips-behaviors,symbols,andsystems.

BUT WHICH TYPE OF CULTURE?GIVEN THE CONNECTION BETWEEN CUL-TURE AND STRATEGY, it is easy to overlook the most basic decision: Which type of high-performance culture makes sense for a com-pany? Which type of culture best supports the business strategy?

No one believes that an innovative, collegial culture would work in the military. Yet esprit de corps is synonymous with the word “military,”

just as initiative and creativity on the battlefield often are essential to victory. Corporate leaders often fall into the trap of designating every positive attribute as one to strive for without thinking about con-text, purpose or overall strategy. Choosing everything is effectively a non-decision. (Everyone prefers a nurturing, collegial, responsible, zealous culture over a conniving, clock-watching, distrustful one.) Or leaders might specify incompatible attributes which will cause implementation problems as a result of again ignoring context, purpose, and strategy.

Much as professional athletes focus on one sport, companies that achieve real cultural change focus on a few key attributes instead of chasing them all. Given the different positive aspects of culture that can position a company to achieve its goals, the question is how they can be integrated into day-to-day use. How can employees “do” the new culture? Leaders must first define the desired culture in terms of values and aspirations and then further describe it in terms of real behaviors that drive role clarity and accountability within the company.

For example, if a company’s culture aspires to be more collegial, employees need to know exactly what that means. If this is an aspirational behavior, then employees must not be good at it today. The company should describe what it means to be collegial through behavioral examples, both positive and negative. If an employee calls a meeting and distributes materials and an agenda in advance so team members can be prepared to discuss and interact, that may be viewed as collegial. Blindsiding the same people with a spur-of-the-moment meeting and no advance materials might not be seen as collegial.

Abstract values that cannot be measured cannot be part of a cultural change program. Inconsistent values, or ones that fly in the face of recognized and tolerated behaviors, can undermine the credibility of a culture change program.



17

UNLOCKING THE BLACK BOX

Webelievethatahigh-performanceculturethatmesheswithbusinessstrategywillresultfromconsistentandappropriatedecisionsonthoseaspectsofthecompany

thatareanythingbut“soft”:behaviors,symbols,andsystems.

1. Link Before You LeapBeforedivingintothechurningwatersofculturalchange,it’simportanttotakea

stepbackandquestionthepurpose.Whatsortofcultureismostinlinewiththecom-pany’sstrategyand,asimportant,howdoesthiscomparetothewaythingsaredonenow?Howdoweunderstandwherewearetoday?

Asanexample,ataMedicaidagency intheNortheast,asurvey foundemployeesgivinglowmarkstovirtuallyeveryculturalattribute,markingthedistancebetweenactualandidealasquitelarge.Cultureassessmenttoolscanhelptomappresentanddesired-statecultureasawaytoidentifyalistofdesiredbehaviors.Acomparisonoftoday’sculturalattributestothosedesiredisoftenusedtoindicatewherethebiggestbangcancomefromwhenchangingacompany’sbehaviorsandculture.

Butcompaniesdon’tgetpaidforfinishingatthetopoftheannualcultureawards:Theymeetorexceedtheirbusinessobjectivesbygainingmarketshareandbecomingmoreprofitable.Andwhileculturecanbeinfluencedbyoutsidefactors(competition,in-dustrystructuretechnologicalchange,forexample),italsoisanaspectofthecompanythatshouldbemanagedwithaneyetowardimprovingthecompany’sabilitytomeetorexceeditsbusinessobjectives.8

Inonecase,DeloitteConsultingLLPprovidedanationalbankwithsurveyresearchresultsonbankingindustry“success”factors.Theinformationwasusedtohelpthebankassessitscurrentcultureandhowitworkedwithitsbusinessstrategy.Tangiblemet-ricswereidentified,amongthemattritionandacquisitionnumbers,datathatcanhelpprovideimportantinsightsintodeficientprocessesand/orstrategies.Thisinformationcanhelpsuggestwhichculturalattributeshaveadirectcorrelationtohoweffectivelyacompany is reaching its strategic goals.

In thebanking surveyabove, those customerswhoseattitudes toward their bankwereambivalent,andthosewhowerevulnerabletoswitching,listedsuchitemsas“highswitchingcosts”and“locationandaccess”asleadingreasonsforremainingwiththeirbank.Atfirstblush,theseseemgoodenoughreasonsandmayevenreflectanadvantageinrealestateandbreadthofservice.Atthesametime,however,thethirdgroup,theloyalcustomers,rated“customerservice”astheoverridingattitudinalfactor.Thishasclear ties tobehavior that reflectsunderlyingculture.Moreover, suchadvantagesasfeesandlocationsarefairlyeasyforacompetitortoemulate.Butculturechangedoesn’toccurovernight,andabankwhosecultureisconducivetoabettercustomerexperiencehasacompetitiveadvantagenoteasilycopied.9

Aseventhisbriefexamplesuggests,cultureisanissuethatextendswellbeyondtheHRdepartment.Thereisadangerinconfusingculturewithmoraleoranyothernarrowmeasure.Webelievethatculturehasanenormousinfluenceonhowacompanydoesbusinessandindefininghowacompanyshouldconductitsbusiness.Andforculturetobecompetitive,itmustfinditssourceinthisstrategy.

2. Gather Strength and Reinforcement From Symbols and BehaviorApossiblyapocryphalstoryrelatesthetaleofawomanwhoshowsupatanupscale

departmentstoreanddemandsarefundforasetofdefectivetires.Ofcourse,thisstoredoesn’tselltiresandneverhas.Legendhasit,though,thatthesalespersonauthorizedtherefund.

Whetherthisstoryistruehardlymattersbecauseitiswidelytold,havingtakenonalifeofitsown,andthesymbolismisclear:Whilealmosteveryretailerhasplacardssaying that thecustomer isalwaysright, thisparticulardepartmentstoreembraced



18

theideainanextremeway.Reverenceforallcustomersatthisretailerrequiressalesassociatesofferinghandshakesfollowinganysale,comingaroundthecountertohandcustomerstheirpurchases,andprovidingtheirpersonalbusinesscardstocustomers.Handshakesaren’texpensive,buttheirmeaningisclear.

• Say It and Show ItGreatculturesaren’te-mailedintoexistenceandpostercampaignsportrayingthejoysofcollegialityaren’tmuchbetter.Symbolsandbehaviors,however,dospeakloudly.Ineffectingculturalchange,top-downandtangiblearethebywords.Executiveswhoem-bodytheperformanceculturehavelicense,inthemindsofemployees,toexpectthesamethroughouttheirorganization.Leadersshouldspeakanddoopenlywhatsupportsthedesired culture and be heard and seen in the process.

Isthecompanypresidentsittingbehindhisorherdeskandreadingstatusreportsoncustomerserviceissues,orvisitingthecallcenterandhandlingtheoccasionalcall?Didthecompanyacquireaninlineskatedivisionbecausetheaccountantsthoughtitmadesense,oristheheadofmarketingaweekendinlinehockeyplayer?Doesthecompanysponsoraleague?Areemployeeideasslippedintoasuggestionboxandforgottenordoesthecompanyholdlivemeetingstoargueabouttheideas?Areofficesreservedforexecu-tivesandcubiclesforjunioremployees?Issomeonepartofateamofthree,ordoheandseveralhundredcoworkersreporttoonemanager?

Tosomedegree,everyaspectoftheworkexperienceexpressesthecultureofthecom-pany.Contextisessentialandannualphotoopswiththerankandfilearenothingcom-paredtoexecutives’behaviormodelinginrealbusinesssituations.Big-productionrolloutsorcafeteriastyleculture-buildingthatthrowsinthreemonthsofcoachingtosolvethe“accountabilityproblem”arebothcommonandsuperficial.Realityiswhatpeopletouch,seeandhear,andthereisnocampaignthatcanoverrideavisibleexecutiverolemodelorathoughtfully-designedenvironmentthatshowsjunioremployeesarevalued.

Whenmisused, symbols can offer a tempting shortcut, but any change in culturerequirestime,effortandalearningprocess.Thenotionthata“culturechange”team,evenwithexecutivebacking,canimposeamindsetonemployeesisflawed.Realchange,culturalorotherwise,involvesrealdebateandleaderadvocates.Ithasbeensaidthatdisagreementisthekeytogettingagreement;withoutdisagreement,thereisnotesting.Employeesmayfallintoline,buttherewillbeonlycompliancetodirectionsgiven,withno commitment to the programs or their strategic intent.

Sosymbolscanbenegative,withunintendedconsequences,orpositiveandinspiring.Botharepowerfulandcaptureattention.Positivesymbolscanbesincereandrealorhumoroushyperbole.Bothkindshavetheirplaceandbothworktobuildandsustainculturechange.

MERGERS: MATCHES MADE IN HEAVEN—OR NOTMERGERS PRESENT A UNIQUE SET OF CHALLENGES on many levels, but it is cultural compatibility that is often overlooked or un-derestimated. Kell and Carrot “found a great-er incidence of successful mergers between companies in which employees displayed similar leadership styles or where the cultures tolerated different ones.” They went on to note

that while a company’s culture can be changed at least slightly, vast change may depend on the ongo-ing “hiring of people who represent the direction in which you are headed.”

Source: Thomas Kell and Gregory T. Carrot, “Culture Matters Most,” Harvard Business Review, Volume 83, Issue 5; p. 22, May 2005.



19

3. Build Support Through Organizational SystemsThewayacompanyconductsbusinesscanplayafundamentalroleindefiningits

culture.Amongtheworstmistakesanycompanycanmakeistofocusonthebenefitsofabusinessprocessandtheinformationsystemthatimplementsitinisolation.Thereisaninextricablelinkbetweenthedesignofthestepsinvolvedinthecollectivetasksofacompanyandthewaypeopleworktogether,orapart.

Wehavefoundthatinwell-runcompanieshiringtakesplacewithaneyetowardattractingpeoplewhowillsupportandthriveinthecompanyculture.Thesecompa-nieshaveperformancemanagementandrewardsystemsdesignedaroundspecificbehaviorsthatcomplementthebusinessstrategy,notaroundagenericlistofposi-tiveaccomplishments.

Systemscanaidleadersingoverningacompanyandincludetheseimportantcategories:

• Performance Management SystemsWhatisrewardedgetsdone.Period.Performanceratingsandcompensationremainthefundamentalrewardsmechanism.Wehavefoundthatcompensationisunfortunatelyalsoamongthemostsensitiveareastochangeinmanycompanies.Asaresult,thetightlinksbetweenperformanceandadoptionofnewdesiredbehaviorsareoftendeferred.Badlycalibratedordisconnectedperformanceandrewardssystemscanoverridevirtu-allyanyotherculturalimperative.

• Talent Management SystemsThetalentmanagementlifecycleencompassesrecruiting,developing,deployingandcon-nectingemployeeswithinacompany.Eachaspecthelpstocreateandfostertheattributesofthecompany’sculture.Forexample,acompanycanactivelyrecruitnewhiresbasedonculturallyconsistent,desiredbehaviorsandreinforcethesewhenpeoplejointhecompany.Amongexistingstaff,whoarethehigh-potentialemployeesbasedonthenewattributes?Whichexperiencedemployeeswereonboardwiththenewcultureevenbeforeitbecamethenewculture?Itispossible,andhelpful,toidentifybothnear-andlong-termroleback-upsbasedonnewattributes;oftenthismayinvolvelookingtootherdivisionsorfunctions.Ifthecriteriaarebasedonattributesandbehaviors,thenfunctionalexperiencebecomesapartoftheequation,asopposedtotheentireequation,forsuccessionplanning.

Top-downbehaviors(note-mails,butvisibleactions!)canhaveasignificantimpact,asnoted.Culturechangeshouldbelinkedtoleadershipassessmentanddevelopmentprograms because leaders have the biggest impact. After all, that’s why companiesspendsomuchtimeseekingtherightcandidatefortheCEOspot.Ifit’simportantthatthecustomersupportandorder-handlingteamssupportthenewculture,itiscrucialforthemanagementteamtoserveasaconstantrolemodel.

• Work SystemsAssumingthatsystemssupportthefocusofthenewculture,theycanbehelpfultoex-plaintherationalebehindtheprocesses.TheycancorroboratethatthereasonthingsaredoneinacertainwayisnotarbitraryormandatedbyITbutbecausethecompanyvaluestheresult.Ifsmart,independentdecision-makingisakeynewbehavior,forexample,coachinginthisskillcanbothhelpemployeesdevelopbetterskillsinthisareaandserveasavisiblesymbolofthisnewemphasisforthecompany.

Theconverseisalsotrue:Worksystemsthatareimplementedwithoutregardtoculture canunderminemuch ofwhat leadershiphopes to achieve.AnERP systemimplementedatanoilcompany,asanexample,resultedincostsavingsindatapro-cessing.However, it imposedcustomer-facingprocessesthatreducedthecompany’sabilitytotailortheproducttocustomerneedsandconstrainedwhathadbeenapro-ductiveculture.

Systemsaresofundamentaltoculturethatitishardlyastretchtosuggestthatcul-turalchangeintheabsenceofin-depthprocessknowledgeandexperienceisanexerciseinfutility.Theconversealsoseemstohold:processescontortedtofitthelatestinforma-tionsystemsareusuallyadisaster-in-waitingastheyaffectculture.



20

Webelievethisinterplayamongsymbols,infrastructureandbehavioristhekeytoculturalchange.DeloitteConsultingexperiencedthisfirsthandattheMedicaidagencydescribedabove,wherewehelped todevelopaCulturalActionPlan that focusedonchangingsymbolsandsystemstohelpshapeandsustainanimprovedculture.Theplanhelpedtheagencyinitseffortsto:

• improve itsperformancemanagementsystemto increaseaccountability, customerservice,andstaffinvolvement

• instituteasimplerprocessforhiringnewemployees

• useabehavioralinterviewguidethatguidesinterviewerstoaskcandidateshowtheyhavedemonstratedthedesiredvaluesandbehaviorsinpreviousroles

• createperformanceexpectationsatalllevels,signedbyemployeesateachlevelandposted in a public place

• restructurereportinglinestoproduceaflatter,moreaccountableorganization

• trainstaffandsupervisorsintheskillsneededtodotheirjobsandtoprovidebetterguidanceanddirectiontotheirstaff

• hireacommunicationsdirectortoimprovebothinternalandexternalcommunications.Beyond recruiting with an eye to the new culture, the agency made tangible

changestocorecharacteristics,rightdowntoitsstructure.Whileitmayseemlikeafootnote,thepublicpostingofperformanceexpectationsacrosslevelsrepresentedadramaticchangeinopennessandaccountabilityinanorganizationwherethesehadbeennotableweaknesses.

4. Measure Outcomes RepeatedlyEvenwithsupportivesymbolsinplaceandsystemsproperlyaligned,acompany’scul-

turecanbebuffetedbycompetitiveandtechnology-relatedpressures,makingitperiodi-callynecessarytodeterminewhetherthecompanyisontrack.Measurementisessential,anditalsocanbedifficult,asanyonewhohasadministeredanykindof“corporatehappi-nesssurvey”canattest.

Inahigh-performanceculture,themostaccuratemetricsshouldbeassociatedwithoutcomes.Forexample,supposeacompanywasstrivingforaculturethatsupportedandsharedinnovationratherthanonethatcededproductandserviceideastothehoard-ingthatcanhappeninacompetitiveenvironment.One(bad)waytomeasurethiswouldbetosurveyeveryonetofindoutwhethertheyfeltgoodaboutsharingideas.Abetterapproach,however,wouldbetoassesshowthecompanyhaddoneintermsofproducingideasandhowthoseideashadgeneratedincomeforthecompany.

Sometimesanecdotal evidence canserveas confirmation.At theMedicaidagency,symbolsandsystemswerechangedtosupportthenewculture,andbehavioralchangeoccurredover time.Butevenearly indicationspointed topositivebehavioral change.Duringasupervisortrainingsession,asupervisortoldofhowtwostaffmemberscametohimwithaconcernthathehadnotdonesomethingaccordingtopolicy,demonstratingtheirwillingnesstoholdhimaccountable.Thisrepresentedaclearbehavioralchangefromtheearlier,dysfunctionalcultureattheagency.“Ourculturehastraditionallynotbeenveryperformance-focused,”theagencydirector

said.“Theculturaltransformationthatweareundergoingnowwillnotonlyimproveemployeeengagement,butIalsoanticipatethatitisgoingtodriveemployeestoachieveresults.Forexample,ourclaimsunithasbeenbattlingabacklog thatseemed insur-mountable.Wewereabletoreducethebacklogby65percentoverthelasttwoandahalfmonthsbyfocusingonperformancemetrics.Thiswouldneverhavebeenpossibleinthepast.Theculturaltransformationhasbroughtasharedsenseofmission.”

Measurementalsoisworthattentionbecausehumanbehaviorisnotoriouslydifficulttopredict.Eveninacompanythatastutelymanagesculturalchange,it’sraretohaveaddressedeverythingthefirsttimeout.Measurementallowsforcoursecorrectionandreinforcementasneeded.



21

Endnotes

1 ANNARBOR,Mich.,Jan.25,2006/PRNewswire.

2J.KotterandJamesL.Heskett,Corporate Culture and Performance,TheFreePress,Simon&Schuster,2005.

3 JeffRosenthalandMaryAnnMasarech,“High-PerformanceCultures:HowValuesCanDriveBusinessResults,”Journal of Organizational Excellence, Spring2003,Volume22,Issue2,p.3.

4 IsaacDixon,“CultureManagementandMergersandAcquisitions,”SocietyforHumanResourceManagementcasestudy,March2005.

5 RosenthalandMasarech,seefn3.

6 “PerformanceImprovement-WhatIsaPerformanceCultureandHowCanYouFosterOneinYourFirm?”,Managing Training & Development, Copyright(c)2004TheInstituteofManagement&Administration(IOMA).

7 KotterandHeskett,seefn2.

8 RobGoffeeandGarethJones,“WhatHoldstheModernCompanyTogether?”,Volume74,Issue6,December1996.

9 “LoyaltyQuest:EnhancingtheRetailBankingExperiencetoDriveGrowth.”AjointwhitepaperbyDeloitteConsultingLLPandConsumerBankersAssociation(CBA),2005.

NOT A BLACK BOX

Commitmentmatters.Companieswhoseculturesgeneratecommitmentandsup-porttheirstrategieswininthemarketplace.Theyusetheirtalentmorefullythan

theircompetitors,wherecynicism,confusion,frustration,andechoesof“what’sinitforme?”sapenergyandmotivation.

Companiesandleaderswhoinspiretheiremployeesfindthattheiremployeesinturninspiretheircustomers.Andjustascompaniesthatdelighttheiremployeescanexpectsignificant“discretionaryeffort”fromtheirwork-force, so, too, can thesesamecompaniesexpectto see significant “discretionary revenue” fromcustomerswilling topaymore for excellence intheir interactions with a business. Positive cul-tureleadstopositivecashflow.

ThegoalinrevisitingandaugmentingKotterandHeskett’smodelwith the concepts of sym-bols,behaviors,andsystemshasbeento focusattentiononthevisiblemanifestationsofahigh-performanceculture.Whilerecruitingtherightpeople remains important, and a charismatic leader can be an asset, the best results havemostoftencomeincompaniesthatconsidertheirsymbols,behaviorsandsystemsinconcertwiththeirdesiredculture.Moreover,thatdesiredcul-ture isonethatfits thecompany’scompetitivestrategyinitsmarket.Thesecompaniesdonotsee their culture as static, but rather as a part of thebusinessmodel thathelps themachievetheirstrategicobjectivesandfinancialgoals.

In the coming years, companieswill havenochoicebut torethinktheircompanycultureandwhether itcanhelpthemachievetheirbusinessvisioninthefaceofglobalcompetitionandtalentscarcity.Opportunitiestoseizecultureasacompetitiveweaponwillbecomeapparenttosomeandremainamysterytoothers.Inthemeantime,itisimportanttorecognizethatculturehappens,butnotinablackbox.DR

Stephanie Quappe is a consultant with Deloitte Consulting LLP in New York, specialized in

organizational culture transformation and intercultural communication.

David Samso Aparici is a senior manager with Deloitte, S.L., currently on assignment in Barcelona, Spain. He specializes in strategic change and organizational transformation.

Jon Warshawsky is a senior manager with Deloitte Research, Deloitte Services LP. He is editor of TheDeloitteReview.

“So symbols can be negative, with unintended consequences, or positive and inspiring. Both

are powerful and capture attention. Positive symbols can

be sincere and real or humorous hyperbole. Both kinds have their

place and both work to build and sustain culture change.”



22 LETTER FROM THE PUBLISHERS

THE

SERVICE REVOLUTION

DeloitteReview DELOITTEREVIEW.COMDeloitteReview DELOITTEREVIEW.COM

23

THE

SERVICE REVOLUTION

MANUFACTURING’S MISSING

CROWN JEWEL BY JEFFREY J. GLUECK > PETER KOUDAL > WIM VAESSEN

PHOTOGRAPHY BY DAVID CLUGSTON

enryFordwasn’tjustabrilliantsupplychaininnovator.Hewasa natural entrepreneur who

understood business in all its dimen-sions.“Abusinessabsolutelydevotedto service will have only one worryabout profits,” he said. “Theywill beembarrassinglylarge.”Ford’sassertion,unfortunately,ap-

pearstohavegoneunheardbymanyof today’s manufacturing companies,who consider themselves designersand producers of tangible productsrather than providers of integrated

THE SERVICE REVOLUTION

DELOITTEREVIEW.COM DeloitteReviewDELOITTEREVIEW.COM DeloitteReview

23

24

solutionstocustomers’broaderneeds.Toooften,manufacturersviewtheirserviceop-erationsasancillarybusinessesseparatefromandbynomeansequalinstrategicoroperationalimportancetothe“core”productbusiness.1

Thatmindset is as risky as it is outdated.2 There has been a clearmigration to-wardserviceofferings,ashiftsparkedbyproductsrapidlybecomingcommoditiesandbygrowthinthenumberofcustomer“touchpoints”overthelifetimeofamanufacturedproduct.Theshiftappliestoconsumergoodsaswellastoindustrialproducts,andtocomplexindustrialmachiningcentersandcommercialrefrigerationunitsasmuchastovacuumcleaners.Thesaletransactionisessentiallyjustonetouchpointonacontinuumofpotentialinteractionsbetweenproducerandcustomer,andanearlyoneatthat.Atitsroot,thebasisofcompetitionisshiftingtowardtheabilitytodrivebusinessperformancethroughexcellenceinserviceandpartsmanagement.

DeloitteResearch, in collaborationwith theglobalmanufacturingpractices ofDe-loitteToucheTohmatsu, launchedamajormulti-yearresearchprogramin2005, theGlobalServiceandPartsManagementBenchmarkStudy(see“AbouttheResearch.”),3 designedtopinpointtheboundariesofbestpracticeinserviceexcellenceandtounder-standmoreabouttherisksofignoringtheservicesideaswellastheadvantagesofem-bracingit.Thestudyconclusionsrevealawidegapbetweenbest-practiceleaders-those

wecall“servicechampions”-andtherank-and-filemanufacturers whose service performance is farfromexcellent.Thefindingsdo,however,pointtoalargeuntappedmarketforthemanufacturersthatcanmaster theelementsof superiorservice.Thisarticle describes how most manufacturers todayapproach the service factor, compares thedriversofprofitabilityandgrowthontheserviceside,andmakesastrongcaseforchangeinawiderangeofmanufacturingsectors.

THE PROFITABILITY IMPERATIVE

Lettherebenodoubtabouttheimpactoftheser-vicebusiness.Ourresearchfoundthattheaver-

ageprofitabilityoftheserviceoperationswebench-markedismorethan75percenthigherthanoverall

businessunitprofitability.4Themostprofitableservicebusinesseswebenchmarked(thetop25percent)aremorethanthreetimesasprofitableastheaveragebusinessunit.Acrossthemanufacturingcompaniesthatwestudied,servicerevenuesaveragemorethanaquarteroftotalrevenuesbutdeliver46percentoftheprofits.Atmanyproducers,therewouldbelittleornoprofitabilitywithouttheservicebusiness.5(SeeExhibit1.)

Thesefindingsapplyjusttothecurrentimpactofserviceactivities,withthefutureimpact stillmore compelling.Ouranalysis suggestshugeuntappedprofitpotentialin“non-captive”aswellas“captive”markets.6Yetmostcompaniesarenotevenclosetotappingthatpotential.Althoughthefastest-growingserviceoperations(thetop25percent)aregrowingmorethantwiceasfastastheaveragebusinessunit,morethantwo-thirds of companies are seeing their service operations expand no faster thantheoverallbusiness; infact,theirservicegrowthratesoften lag thoseofthewholecompany.Themedianbenchmarkedcompanyderivesonly40percentofitsafter-salesservicemarketand75percentoftheafter-salessparepartsmarketfromservicingtheinstalledbaseof itsownproducts,whichconstituteitscaptivemarket.(Thosenum-bersaremuchsmallerforcategoriessuchasautomotiveoriginalequipmentmanufac-turers.)Asforservicingnon-captivecustomers,amarketupto10timeslargerthanthecaptiveopportunity,onlyafewmanufacturershavemadesignificantinroads.Mostaremanagingtheirpotentialhigh-growth“stars”as if theywereslow-growth“cash

Source: Deloitte Research, based on the Global Service and Parts Management Benchmark Survey.

Service26%

Business Unit74%

Share of Profit Contribution

Business Unit74%

Service46%

Business Unit54%

EX.1 MANUFACTURERS ARE DRIVING REVENUE AND PROFITS THROUGH THE SERVICE BUSINESS



25

cow”businesses.Afewleadingmanufacturers,suchasaircraftenginemakerRolls-Royceplc,under-

standtheshort-termandlong-termvalueoftheirserviceactivities.Rolls-Royceprovidesairlineswithwhatitcalls“PowerByTheHour,”sellingitsenginesalongwiththeser-vicestomaintain,repair,andoverhaulthemovermanyyears.Servicerevenuealreadyaccountsforabout53percentofRolls-Royce’s$11billion-plusinannualrevenues,wellabovethe26percentaverageforallthecompaniesbenchmarked.7Thecompany’sser-vicerevenueshaveincreasedbymorethan60percentoverthelastfiveyearsandalmosttripledoverthepastdecade,growingmorethantwiceasfastasRolls-Royce’soverallbusiness.Thiscompanydoesnotneedareminderthatservicemattersmorethanever,amessagethatbearsnewemphasisformanyothermanufacturingcompanies.Wecanpointtosixreasonswhy:

1. New basis of competition.Thebusinessmodelsofmanyglobalmanufacturersareunderassaultas customerdemands change,homemarketsmatureand low-costrivals raise their games. In developedmarkets, products are becoming commoditiesaspricingpressuresincrease,particularlyasaresultoflow-costcountrysourcing.Inemergingmarkets such asChina and India, service and parts operations are facingfiercepricewarsaswellascounterfeitparts,situationsthatdamagelong-termbrandreputationasmuchastheyhurtprofits.Protectingthebusinessthroughserviceexcel-lenceisonewayofkeepingoutthecompetitionwhileimprovingcustomerserviceandloyalty.

2. Product proliferation.Newproductsareintroducedmorefrequently.Ifnotproperlymanaged,thecombinationofshortersalescyclesandlongservicelifecyclesis a recipe for escalating costs, parts obsolescence, lost customer focus and dete-rioratingcustomerservicequality.Amongtheserviceoperationsbenchmarked,themedianinventoryobsolescenceratestoodatfivepercentandinmanycasesexceeded10percent.

3. Quality backlash.Qualityissuesandproblemswithdeliveryofserviceandpartscanexactaseveretollinwarrantycostsandbranddamage.Analystsestimatethatin-dustrialequipmentmakersalonewillinvestatotalof$1billionoverthenextfiveyearstooverhaulwarrantymanagementandsparepartslogistics.

4. Continued outsourcing.Manylargemanufacturersaresteadilyoutsourcingele-mentsoftheircoreoperations,includingpartsproductionandassembly.Ineffect,theyare relying more on the suc-cess of their customer-facing,service-oriented businesses,although those functions toooften lack the capabilitiesneeded to succeed.8

5. Service resilience.Intimesofeconomicdownturn,service and parts sales areoften far more robust thanthe main business. For ex-ample, during the economic and financial crisis in Ko-reafrom1997to1999,salesof new vehicles byHyundaiand Kia Motors dropped bynearly 36 percent, but theHyundai Mobis spare parts sales business posted a 5.6percent sales increase.9


Parts profitability

Service profitability

Customer satisfaction

Sales channel profitability

Customer profitability

Market share growth

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Little or no visibility Some visibility

Extensive visibility

EX.2 MANUFACTURERS CANNOT EASILY SEE WHERE THE VALUE LIES IN THEIR SERVICE BUSINESSES



26

6. Increasing business complexity. Whether caused by expansion into newmarkets,mergersandacquisitionsorproductproliferation,thegrowingcomplexityofbusinessmakesthechallengesevenmoredaunting.Customersare likelytodemandbetter-tailoredandbetter-managedservicesolutions,oftencombinedwithrisk-sharingagreements.Ensuringtherightcustomerexperience,whichinvolvesproducts,service,brandingandprice,deliveredtotherightplaceattherighttime,willbecomeevenmoredifficult.Butitwillalsobecomearequirementforsuccess.

UNDERSTANDING THE CHALLENGES

While most companies are eager to improve their global service and parts busi-nesses, our research shows that they continue to treat service functions as an

afterthought.10Threemajorproblemsareapparent:flawedstrategyandbusinessdesign,substandardoperationsplanningandmanagement,andpoorexecutioninbuildingtheprofitablecustomerinteractionsthatsustainloyaltyandsatisfaction.Eachchallengedeservescloserscrutiny:

Flawed strategy and business design.Manyseniorexecutivessimplydon’tun-derstandthepotentialoftheirservicesandpartsoperations,oftenviewingthemascostcentersratherthanprofitablegrowthbusinessesthatcandriveenterprisegrowth.Attheheartoftheproblemisalackofinsightintotherealopportunity.Onlyafifthofthecompanies benchmarked, for example, said they had extensive visibility into serviceprofitability. Just six percent had a clear idea of customer profitability and only sixpercentknewtheirkeyperformancemetricsonmarketsharegrowth.(SeeExhibit2.)Withoutgoodvisibilityintotheperformanceandpotentialoftheserviceandpartsbusi-ness,executivesarehard-pressedtounderstandthebusinessandarepoorlyequippedtojustifyorprioritizemajorinvestmentsforimprovement.

Theproblemgoesdeeper.Ourbenchmarksurveyfoundthatmanymanufacturershavedifficultyindevelopingastrategyandanefficientdesignfortheirserviceopera-tions.Whilenearly40percentofexecutivessaidthatcontinuousoptimizationofthe


Supplier delivery performance/reliability

0% 10% 20% 30% 40% 50%Percentage of companies indicating “major barrier”

Long lead times for purchased components

Inadequte/inflexible information systems

Supply chain visibility

Planning capabilities (includes multiple demand pattern and slow-moving parts)

Data management issues (e.g. master data inaccuracy)

Organization barriers/internal communication

Lack of investment/attention

Multi-echelon inventory management capabilities

Supplier relationships

EX.3 TOP TEN BARRIERS TO SERVICE EXCELLENCE



27

overallsupplychaindesignoftheservicebusinessisofthehighestimportanceoverthenextthreeyears,fewerthanonein10companiesperformwellinthisareatoday.Similarly, few respondents said theyhave achievedhigh performance in balancingcostwithcustomerservicelevels.Evenworse,morethan30percentofrespondentssaidtheyarenotdoingwell inbuildingglobaltaxefficiencyintonetworkmodeling,andanother40percentsaidtheydidnotevenknowhowtheyweredoinginthisarea.Takingaholisticviewofthebusiness,includingissuesoftaxandotherregulatoryandcomplianceissues,isofcrucialimportancetomostcompaniesstrugglingtogetvalueoutoftheirglobalinvestments.11

Atthesametime,onlyafewcompanieseffectivelyincludeservicemanagementis-sueswhenmakingdecisionsaboutproduct innovationandproduct lifecyclemanage-ment.Ineffectiveorganizationaldesignfurtherhampersservicebusinesses,whichtendtohavelowlevelsofinvestmentinthepeopleandcompetenciesneededforgoodperfor-mance.Giventhestrategicimportance,profitabilityandgrowthpotentialoftheservicefunctioncomparedtotheoverallbusiness,attractinganddevelopingtherighttalentshouldbeapriorityfortopmanagement.

Note: Process collaboration trend line: Y=1.21* + 0.60*X. R2 (adjusted)=0.78. Y=Benefit Level. X-Implementation Level. *significant at the 99 percent level. N=10. Technology adoption trend line: T=0.68* + 0.79* X. R2 (adjusted)=0.94. Y=Benefit Level. X-Implementation Level. *significant at the 99 percent level. N=14.


1 2 3

Better processes pay off

Ave

rag

e Le

vel o

f B

enefi

ts A

chie

ved

(1

=Lo

w; 3

=M

ediu

m; 5

=H

igh)

4

3

2

11 2 3

Technology adoption generates results

Ave

rag

e Le

vel o

f B

enefi

ts A

chie

ved

(1

=Lo

w; 3

=M

ediu

m; 5

=H

igh)

4

4

3

2

1

Average Level of Process Implementation (1=None; 3=Moderate; 5=Extensive)

From highest to lowest implementation level:

• Customer visibility into their tracking order status

• Supplier performance tracking

• Supplier visibility into their order status

• Collaborative planning, forecasting & replenishment with suppliers

• Integration and automation of replenishment process with suppliers

• Integration and automation of replenishment process with customers

• Vendor managed inventory and suppliers

• Collaborative promotion management with customers and suppliers

• Vendor managed inventory with customer

Average Level of IT Implementation (1=None; 3=Moderate; 5=Extensive)

From highest to lowest implementation level:• Demand/Planning/Forecasting• Warehouse Management System (WMS)• Enterprise Resource Planning (ERP)• Field Service Order Scheduling, Dispatch System• Product Data Management (PDM)• Field Service & Technical Document Management

System• Field Service Analytics (SLA, reliability, performance)• Warranty management system• Advanced Planning and Scheduling System• Customer Relationship Management (CRM)• Transportation Management System (TMS)• Product Lifecycle Management (PLM)• Businesss Intelligence (BI)• Advanced Network Modeling and Simulation Tool

Trend line

Trend line

EX.4 BETTER PROCESSES PAY OFF ... AND TECHNOLOGY ADOPTION YIELDS RESULTS



28

Incontrast,theservicechampionsoperateonadifferentplane.LeadingproviderssuchasSiemensAGMedicalSolutionsmakeservicecentraltotheircorporatestrategy,designing the service business around customer requirements in order to create cus-tomersatisfaction,loyalty,andbusinessperformance.

Siemens’customersincreasinglyexpecttopayforequipmentuptime.Toachievethis,Siemensharnessessophisticatedtechnologyandadvancedprocessesandwork-flows,combiningonline,real-timerepairinformation,inventorymanagement,pric-ing and invoicingwith advanced logistics systems to give service technicians therightinformationandpartswhenandwheretheyneedthem.Forexample,thecom-pany isusingsimple lockboxes to storepartsnear customers, reducing the traveltimeforhigh-costandhighlyvaluedservicetechnicians.12Thebestwaytoassurehighefficiencyoffieldserviceengineers,theyhavelearned,istosynchronizecloselythearrivalofapartatthedrop-offpointwiththescheduledservicejoboftheengi-neer at the client site.

Substandard operations planning and management. Inadequate planning,managing,andmonitoringcapabilitieshampertheserviceoperationsofmanyof thecompaniesbenchmarked.Planningisaparticularchallenge.Amongthecompaniesre-sponding,themedianforecastaccuracyforpartsdemandislessthan80percent,andforaquarteroftherespondentsitislowerthan52percent.It’sevenlessencouragingthatnearly70percentofthemanufacturerssurveyedareunabletoreportonthefore-castaccuracyfortheirserviceandpartsactivities,suggestingdeep-rootedproblemsinmanagingdemand,inventory,andcapacity.

Manymanufacturersareineffectleavingmoneyonthetablebyrunningtheirserviceoperationsat lessthantheirpotential.Ininventorymanagementalone,wecalculatethat if theaverage$1billion servicebusinessbenchmarkedwere toaddoneannualinventoryturn,itwouldliberate$53millionayearinworkingcapital.

Askedtoidentifythemajorbarrierstoserviceexcellence,closetohalfoftheexecu-tives responding cited supplier responsivenessandovera thirdmentioned long leadtimes. (SeeExhibit3.) Inadequate informationsystemsgot their fair shareofblame,asdidlimitedsupplychainvisibility.Executivesatmanycompaniessaidtheyhadnoorvery limitedvisibility intokeyoperationalmetricssuchas inventoryatdealersorcustomers,demandandsalesforecastsatalldistributionlevels,andglobalavailable-to-promiseinventorytocommittocustomerorders.

Onceagain,theserviceleadersshowwhatispossible.TheexperiencesofleadingmanufacturerssuchasCaterpillarInc.showthatongoinginvestmentinandfocusonimprovingtheserviceandlogisticsoperationscanleadtooutstandingcustomerservice,resultingingreatercustomerloyaltyandafoundationforprofitablegrowth.(SeeSidebar.)

Poor execution.The“lastmile”tothecustomeriswherebattlesforcustomerloy-altyarewonorlost.Itisatoughjourney.Customerskeepraisingthebarforserviceexcellencebyrequestingshorterleadtimes,higherservicelevels,lowercostandbettercustomerservicesupport.Yetmostmanufacturersarestillunabletoprovidecustomerswithexcellentandcost-effectiveservice.Overall,ouranalysisofthebenchmarkresultssuggeststhatcustomersarelikelytogetexactlytheitemsthattheywant,attherighttimeandplace,lessthan75percentofthetime.Thatisadismalperformanceinaglobaleconomywherecustomershavemoreoptionsandmoreinformationthaneverbeforetotemptthemtoswitchtocompetitors’offerings.

Servicelevelagreements(SLAs)withcustomersaregaininggroundacrossmanyin-dustries,butcompaniesarerunningintodifficultiesinfulfillingthem.Becausetheyoftenhavelimitedaccesstocriticalcustomerdata,companiesareunabletoassess,quantifyandmanage contractual risks accurately.Theyusuallyhave limitedknowledge aboutthecriticalcapabilitiesneededtosatisfycustomers’realneedsatanaffordablecost.Theyarestrugglingtodevelopandmanageabusinessmodelthattheydonotfullyunderstand.



29

Notsurprisingly,themedianon-timecustomerresponseforSLAsisjust90percent,andformanycompaniesthenumberisfarbelowthat.Giventhehighcostofequipmentdowntimeinindustriessuchassemiconductormanufacturing,miningandmedicaldevices,lowservicelevelsareacostlyproblemandarenotlikelytogeneratemuchinthewayofcustomerloyalty.

Fortheservicechampions,though,deliveringserviceexcellenceiscentraltotheirbusinessmodels.AtHyundaiMotorCompanyandKiaMotorsCorporation,bothpartoftheHyundai-KiaAutomotiveGroup,serviceguaranteessuchasextendedwarrantiesareanessentialpartofthevalueprovidedtocarbuyers.Capturingalargershareinservicingtheover-24millionHyundaiandKiacarsoperatingworldwideformsacrucialpartofthegrowthstrategyofHyundaiMobis.HyundaiandKiaselltheircarswithwar-rantiesofupto10years/100,000milesinkeymarketsaroundtheworld.13Todothatcost-effectively, thecarsmustbeofhighqualityandtheserviceandpartsoperationmustoperateatthehighestlevelofefficiency.

HyundaiMobissuppliesservicepartstoHyundaiandKiavehiclesworldwide,whichinvolvesstockingmorethan890,000partsfor137vehicletypes.Thecompanyhasbuilta$55million,2.2millionsquarefootsparepartscenterinAsan,southofSeoul,tohelpdothismoreeffectivelyandsupportitsglobaldistributionnetwork.14Thecenterispilot-ingitem-levelradiofrequencyidentification(RFID)taggingcoupledwithacentralcom-putersystemusingartificialintelligenceformanagingandoptimizingthesparepartsbusiness.Customerscantrackthestatusoftheshipmentremotelyatanytimebetweenorderanddeliveryinrealtime.

CAT SEES BIG GROWTH IN SERVICESCATERPILLAR INC. IS A MASTER OF THE SERVICE GAME, with an inventory of more than half a million spare part numbers and a huge worldwide installed base of earthmovers, engines, excavators, and other equipment that in some cases needs service for 40 years or more. Yet Cat can ship its customers exactly what they want within 24 hours, 99.7 percent of the time.19

Cat has done so well on the service front that it has extended its capabilities in service parts manage-ment and logistics to external customers. Forming Cat Logistics in 1987, the company set out to build a global growth business and to capture more of the available market for service parts management. Today, Cat Logistics counts among its customers blue-chip companies such as Ford, Saab, Toshiba and Honeywell. It employs more than 9,000 logistics professionals across 25 countries and six continents, managing more than 18 million stock-keeping units (SKUs) and shipping more than 160 million orders and 16 billion pounds of freight each year. The external opportunities are significant. Says Cat chairman and CEO Jim Owens: “Cat Logistics has been generating growth of 25 percent annually in revenues from external customers, and massive opportunities remain for creative third-party logistics providers in this $170 billion industry.”20

Experiences at companies such as Caterpillar show that service excellence relies on processes and sys-tems that create visibility across the supply and distribution network. As early as the 1970s, Cat built a global database for tracking inventory across its network, initially focusing on parts that originated from Caterpillar’s central distribution centers. In 2002, the system was extended to include parts obtained locally to ensure global visibility into all parts in the distribution network. One outcome: since the late 1980s, the equipment maker has halved its service parts inventories while improving its already highly regarded customer service. For Caterpillar, top-notch customer service levels are the primary driver of repeat business. At the same time, these improve-ments are saving the company more than $460 million a year compared to the late 1980s.

Cat is not complacent about its wins to date. Knowing that its core competency is in supply chain management and logistics and not in software development, the company is developing its next-generation global service and parts management system in collaboration with SAP, Ford Motor Co., and Deloitte Consulting.



30

Industry

Aerospace and Defense

Endnotes

1 Source:Rolls-Royce,www.rolls-royce.com.SeealsoRolls-Royce,http://www.rolls-royce.com/civil_aerospace/overview/default.jspandDeloitteResearch, Making Customer Loyalty Real: Lessons from Leading Manufacturers(NewYork,1999).Formoreontheaftersalesservicebusinessinthecommercialairlinemarket,seealsoMarkDixonBüngerandHenryH.Harteveldt,“OverhaulingAirlineMaintenance,”Forrester,October13,2004.

2 SeeHyundaiMobisAnnualReport2004.

3 Appleshipped6,451,000iPodsduringitsfourthquarterendedSeptember24,2005.See“Applereportsfourthquarterresults:Appleconcludesbestquarter&bestyearincompanyhistory,”October11,2005.Seewww.apple.comSeealsoPaulTaylor,“DemandforiPodandNanohelpApplequadrupleprofits,”Financial Times,October12,2005,and“TheresurrectionofSteveJobs-Facevalue,”The Economist,September17,2005.

4 Seee.g.ABB Services Executive Review 2005.Seealsowww.abb.com.

5 SeepresentationbyFrankElssner,SiemensAGMedicalSolutions,“UptimeServices:SiemensMedicalSolutions,”Service Parts Management with SAP,Berlin,September28-29,2005.SeealsoSiemens Annual Report 2005 andJackEwingandDianeBrady,“Siemens’NewBoss,”BusinessWeek, January24,2005.

6 SeeKenSpencerBrown,“NewMarketingTack,”Investor’s Business Daily,August12,2005.ForXerox,servicerevenueshareiscalculatedastheshareof“post-saleandotherrevenue”intotalrevenues.“Post-saleandotherrevenue”includesservice,outsourcingandrentals,supplies,paperandothersales.SeeXerox Annual Report 2004.

Trend

Toward performance-based service and logistics agreements with customers, including guaranteed availability and reli-ability of equipment, modules, and entire platforms (such as jet propulsion) over long time periods.

Example

Rolls-Royce has long been focused on selling “Power By The Hour.” Customers can pay a fixed warranty and operational fee for the hours that their engines are running, so Rolls-Royce must focus on the entire package, from products, installation, after-sales maintenance, repair and overhaul, to overall service and parts manage-ment to ensure profitable long-term growth.1

Automotive, Commercial Vehicles

Excellence in service and parts manage-ment is key to the brand reputations and the entire business models of some companies.

For Hyundai and Kia, service parts management is an integral part of the corporate strategy. Many of their vehicles are sold with warranties of up to 10 years/100,000 miles, and the service and parts oper-ation must function at the highest level of efficiency to avoid customer service problems and excessive warranty costs, and to sustain profitable growth.2

Consumer Goods As more consumer products are sold with a service component, top business performance relies on service excellence as much as product quality.

With its wildly successful iPod players, Apple Computer is mixing sales of a very attractive tangible product with digital services. While iPod unit sales are impressive enough, it is perhaps more impressive that Apple is selling two million music downloads per day and building fast-grow-ing online video sales.3

Diversified Manufacturing and Industrial Products

Customers view provider service offer-ings as an integral part of the business.

ABB offers its industrial automation customers “performance service” tailored to their needs. The offerings range from simple, product-focused maintenance and field services to “Automation Performance Management” where ABB guaran-tees the performance levels and assumes the risks of the customer’s equipment over its life cycle whether or not it was originally made by ABB.4

Life Sciences As customers keep demanding more, manufacturers expect to see increased requests for same-day (instead of overnight or slower) service plus service-level agreements that put the risks and rewards on manufacturers’ backs.

Siemens Medical Solutions responded by creating a more complex and expensive distribution and service network that gets closer to customers and allows faster responses. The system makes wide use of sophisticated technology and work-flow processes.5

High Tech and Telecom Equipment

Equipment downtime can cost $100,000 or more an hour. Ongoing industry con-solidation means that many customers now have unwieldy mixes of installed hardware and software that often need to be serviced for decades.

Printer makers, such as Hewlett-Packard and Xerox, have derived more revenue and profit in selling ink and after-sales services than in initial printer sales for quite some time. For semiconductor equipment makers like Applied Materials, service and parts management is at a premium and it is pivotal to selling the equipment in the first place.6

SERVICE EXCELLENCE BY MANUFACTURING INDUSTRY



31

USING PROCESS AND TECHNOLOGY TO RESHAPE THE SERVICE BUSINESS

Ourresearchsuggeststhatmanufacturingcompaniescanmakestrategicandopera-tionalinvestmentsinprocessesandtechnologiestoleapfrogthecompetition.This

inturnleadstoongoingimprovementintheoperationalandfinancialperformanceoftheirglobalservicebusinesses.Thoseinvestmentsfallintotwocategories:

1. Collaborative processes canbeappliedacrosstheservicesupplychain, fromsuppliers to customers. Formost, if not all, applications, they are well-documented,provenandreadyforimplementation.Ouranalysisshowsastrongcorrelationbetweenthelevelofimplementationofprocesses,suchascollaborativeplanning,forecastingandreplenishmentwith customers, and the benefits achieved from implementation. (SeeExhibit4.)Acrosstheservicebusinessesbenchmarked,themoreextensivethelevelofimplementation,thehigherthebenefitsreportedfromadoptingkeyprocesses.

Forexample,theNorthAmericanoperationsofVolkswagenAGsawfirst-handthebenefitsofimplementingrobustprocessesforservicepartsmanagement.In2004,theautomakerwas strugglingwith low customer orderfill rates andwith incorrectly lo-catedpartsinventoriesspreadacrossabroaddistributionnetwork.15Thereweremorethan160,000partnumbers,withsuppliescomingfromEuropeandSouthAmerica.Thepartsoperationwashandling12millionorderlineitemsayearandserving1,000deal-ersnationwide.Tooverhaultheservicepartsoperations,VW’scustomer-focusedteamdeployedanewbusinessdesignaswellasnewprocessesandplanningtechniques(in-cludingleanwarehousemanagement).Theywereabletoreducetheirstructuralcost,improveinventorymanagementandproduc-tivity, and increase customer service levels.Orderfillratesdirectlyfromcustomer-facinginventorysoaredfrom76percenttothetar-geted94percentandnetworkfillratesusingtheentirepartsnetworkarenowaround98percent.Thecompanyalsomanagedtotake$25millionayearoutofitsNorthAmericanpartsinventoryandwarehousingcosts.

WhileVWknowsthepotentialontheser-vice side, the same cannot be said ofmanyothermanufacturers.Accordingtoourresearch,onlyoneinsevenoftheservicebusi-nessesbenchmarkedgivescustomersfullvisibilityintotheirorderstatus.Onlysevenpercenthaveimplementedextensivecollaborativeplanning,forecasting,andreplenish-mentwiththeircustomersandsuppliers.Infact,nearly70percentoftheserviceexecu-tivesrespondingsaytheyeitherhavenoimplementationofvendor-managedinventorypracticesortheydonotknowtheimplementationstatus.Clearly,therearesignificantopportunitiesforimprovementthroughbettercollaborativeprocesses.

2. Information systemsthathelpdesign,planandmanageserviceoperationsarematuringrapidly.Adecadeandmoreago,andinsomecasesasrecentlyasfiveyearsago,theITsystemsavailableweretheweakestlinksformostserviceandpartsbusinesses.Buttodaytheycansupportmostoftherequirementsofthelargestandmostcomplexserviceoperations.Infact,withoutsufficienttechnologysupport,itwillbeincreasinglydifficulttomanageandoptimizetheservicebusinessascustomerrequirementsincrease,productsproliferate,andtheservicefunctionitselfgrowsmorecomplex.

OurstudyshowsthatmanycompaniesareneglectingtoupgradetheirITinfrastruc-turetoallowthemtodifferentiateperformanceintheirservicebusinesses.16 ServiceexecutivespointedtoinadequateandinflexibleITsystemsasamajorbarriertoopera-tionalexcellence. Only11percentofthecompaniesbenchmarkedhaveimplementedcustomerrelationshipmanagementsystemsextensively,andjust10percenthavethesoftwaretostreamlineproductdatamanagement.AmeresixpercenthaveITtoolsforadvancedplanningandschedulingintheirserviceoperations.

“In fact, without sufficient technology support, it will be increasingly difficult to manage and optimize the service busi-

ness as customer requirements increase, products proliferate, and the service function itself

grows more complex.”



32

YetouranalysispointstoastrongcorrelationbetweenITsystemsimplementationandbenefitsachieved.(SeeExhibit4.)Someleadingcompaniesarecapitalizingontech-nologyininnovativeways.AtGeneralElectric,RFIDtools,whichbarelyrateatallwithmostmanufacturers,areusedtotagpower-generationpartsandmodulestomakeit

easiertoidentifyandassembletheequipmentatcustomers’sites.17Rolls-Roycealsooffersapow-erfulexample.Onatrans-Pacificflight,whenaRollsairplaneenginewashitbylightning,theengine shut down and restarted appropriately.Butinsteadofincurringanunscheduledinspec-tionuponlandingatacostofabout$1millioninmaintenanceanddelays,theairlinewasabletoscheduletheinspectionforamoreconvenientand less costly time.18 How? Rolls-Royce uses

sensorandcommunicationssystemstoaccessthedatafeedsfromtheenginemonitorsinflight.Themaintenanceproblemwasaddressedinrealtime-literallyonthefly.

NEXT STEPS: PUTTING THE SERVICE BUSINESS ON THE BOARDROOM AGENDA

Webelievethattheserviceandpartsbusinessistheoverlookedjewelinmanycor-porateportfolios.Exhaustiveresearchestablishesthatserviceoperationstypically

generate higher profitability than “core” product manufacturing activities, and theytypically offer amuch stronger growth potential. Yet the service opportunity is stillunder-exploitedinmostofthecompaniesbenchmarked.Serviceischieflyviewedasasecondaryactivity,andseldomreceivestheresourcesortheattentionitdeserves.

Adecadeago,itmighthavebeenpossibleformanagerstogetbywiththatviewpoint.Todaytheycannot.Theconsequenceswillnotnecessarilybeobviousnextquarterorevennextyear,butglobalcompetitionistoointenseandtoovolatile,andthebasisofcompeti-tionischangingtooquickly,formanufacturerstoenjoylong-termsuccesswithoutincor-poratingtheservicebusinessintotheirstrategicplanning.Threekeystepsarenecessary:

1.Seniormanagersshouldmapouttheircompanies’currentservicefunctionsandpinpoint thesynergiesbetweentheservicebusinessandtheircompanywidestrategyand operations inareas suchasmarketing, sales, customer service, productdevelop-ment,manufacturing,anddistribution.

2.Companiesmustbenchmarkthoroughlyagainstthebestoperationalandexecu-tionpractices bothwithin and outside their industry and conduct follow-on visits toselected best-practices businesses.

3.Basedontheiroverallcorporatestrategyandtheoperationalbenchmarkassess-ment,companiesneedtodeveloptheirroadmapfor“servicetransformation”bytarget-ingkeyareasforimprovementinstrategyandbusinessdesign,operationalplanningandmanagement,andexecution.

Theserviceissuemustbeincludedonthemeetingagendaoftheboardofdirectorstoreflectasenseofurgencyandtoensureexecutivecommitment.ServicechampionssuchasRolls-Royce,SiemensandCaterpillararemovingtheservicebusiness to theboardroomagendaandmakingserviceexcellencealitmustestforcompetitiveness.Withprofitabilityandgrowthlevelsontheservicesideoftenfarexceedingthoseinthemainbusiness,it isclearthattheservicerevolutioninglobalmanufacturingiswellunderway.Formostmanufacturers,itisnowamatterofembracingtheservicerevolutionorriskingbeingleftbehind.

ABOUT THE RESEARCH

Overthelastfewyearswehaveconductedin-depthcasestudiesandbenchmarkedtodatemorethan120companiesacrosstheUnitedStates,Europe,andtheAsia-

PacificregionwithcombinedrevenuesofmorethanUS$1.5trillion.

“The service issue must be included on the meeting agenda of the board of

directors to reflect a sense of urgency and to ensure executive commitment.”



33

Endnotes

1 Inthisstudyweusetheterms“servicebusiness,”“serviceoperation,”“serviceandpartsbusiness,”“serviceandpartsoperation(SPO),”andothersimilartermsinterchangeablyunlessotherwiseindicated.Formoredetailsonthisresearch,seeDeloitteResearch,The Service Revolution in Global Manufac-turing Industries(NewYork:2006).

2 Formoreontheglobaltrendsinmanufacturing,innovationandsupplychainmanagement,seeDeloitteResearch,Mastering Complexity in Global Manufacturing: Powering Profits and Growth through Value Chain Synchronization(NewYorkandLondon:2003);DeloitteResearch,Mastering Innova-tion: Exploiting Ideas for Profitable Growth(NewYork:2004);andDeloitteResearch,Unlocking the Value of Globalization: Profiting through Continuous Optimization(NewYorkandLondon:2005).

3 Serviceandpartsmanagementreferstothemanagementofaserviceandpartsoperationaftertheinitialsaleofthemainproductsandincludesinstalla-tionsalesandservices,sparepartsdistributionandsales,andpost-salesservices.

4 Profitabilityismeasuredasearningsbeforeinterestandtaxes(EBIT)asapercentageofsalesrevenue.

5 Profitabilityismeasuredasearningsbeforeinterestandtaxes(EBIT)asapercentageofsalesoverthelastfiscalyear.Revenuegrowthismeasuredastheaverageannualincreaseinsalesrevenueoverthepastthreefiscalyears.Otherresearchsuggeststhat“aftermarketserviceandpartsaccountfor20percentto30percentofrevenuesandabout40percentofprofitsformostmanufacturers.”SeeTimA.Minahan,“UnlockingValueandProfitsintheServiceChainServicePartsManagement,”AberdeenGroup,September2003.

6 Wereferto“captive”marketsasthoseforservicingacompany’sowninstalledproducts.The“non-captive”marketisdefinedasthemarketforservicingcompetitors’installedproducts.

7 Source:Rolls-Royce,www.rolls-royce.com.SeealsoRolls-Royce,www.rolls-royce.com/civil_aerospace/overview/default.jspandDeloitteResearch,Making Customer Loyalty Real: Lessons from Leading Manufacturers(NewYork,1999).Formoreontheaftersalesservicebusinessinthecommercialairlinemarket,seeMarkDixonBüngerandHenryH.Harteveldt,“OverhaulingAirlineMaintenance,”Forrester,October13,2004.

8 See“Extinctionofthepredator-theglobalcarindustry,”The Economist,September10,2005.

9 SeeHyundai Mobis Annual Report 2004.

10 SeeDeloitteConsulting,Aftermarket, Afterthought: Getting More Value from Your Service Parts Supply Chain(NewYork,2003).

11 SeeDeloitteResearch,Unlocking the Value of Globalization: Profiting from Continuous Optimization(NewYork,2005).

12 SeepresentationbyFrankElssner,SiemensAGMedicalSolutions,“UptimeServices:SiemensMedicalSolutions,”Service Parts Management with SAP, Berlin, September28-29,2005.SeealsoSiemens Annual Report 2005andJackEwingandDianeBrady,“Siemens’NewBoss,”BusinessWeek,January24,2005.

13 Estimate.SeeHyundai Mobis Annual Report 2004.

14 See“MobisopenslogisticscenterinAsanCenterdedicatedtoenhancedafter-salesservice.W54.7bil.spenttocombinelogisticsfunctions,”HyundaiMobis,June16,2005.Seewww.mobis.co.kr.

15 SeeVolkswagen AG Annual Report 2004.

16 ResearchindicatesthatspendingonserviceandpartsmanagementITis60percentbelowmainlinebusinessandthatautomationofservicelifecyclemanagementisimportant.Accordingtoonestudyof(mostly)NorthAmericancompanies,the65percentofbusinessesthathavenotautomatedtosup-portservicelifecyclemanagement(SLM)aretwiceaslikelytolosecustomersasareSLMleaders.SeeMarcMcCluskey,JudyBijesse,DavidO’Brien,andLindseySodano,“ServiceLifecycleManagement(Part2):BuildingaRoadmapforInvestments,”AMRResearch,September24,2002.Anotheranalysissuggeststhat“manufacturers’servicesupplynetworksaretenyearsbehindtheirproductsupplynetworksintermsofprocesssophisticationanduseofpackagedapplications.”SeeBrianAlbright,“IndustryRisestoAftermarketPartsChallenges,”Frontline Solutions,July2004.

17 PresentationbyJosephSalvo,PervasiveDecisionSystemsLaboratory,Information&DecisionTechnologies,GeneralElectricCompany,attheMas-sachusettsInstituteofTechnologyForumforSupplyChainInnovation,June15,2004.

18 Source:MilesCowdry,Director,Services,Rolls-Royceplc,atSAPPHIRE Europe,Copenhagen,Denmark,April,2005.FormoreonRolls-Royce’scustomerservicecapabilities,seeStanleyReed,DianeBrady,andBruceEinhorn,“Rolls-RoyceatYourService:CarefulAttentiontoCustomersisKeytoitsReboundinCommercialJetEngines,”BusinessWeek,November14,2005.

19 SeeMichaelSchmidtandSteveAschkenase,“TheBuildingBlocksofServiceExcellence,”Supply Chain Management Review,July/August2004.

20 SeeCaterpillar 2004 Annual Report.

Participants todate in theongoingDeloitteToucheTohmatsuGlobalServiceandPartsManagementBenchmarkStudy come froma diverse array of industries,withaboutsixpercentfromtheaerospaceanddefensesector,32percentfromautomotiveandcommercialvehiclebusinesses,30percentfromthediversifiedmanufacturingandindustrialproductsindustry,21percentfromhightechnologyandtelecommunications,and10percentfromlifesciences.Morethan60percenthavetheircorporateheadquar-tersinEuropeand34percenthaveheadofficesinNorthAmerica.

Theparticipatingcompaniesareallbigplayersintheirindustries,with77percentreportingannualcorporaterevenuesofmorethan$1billion.Nearlytwo-thirdsoftheserviceandpartsbusinessesbenchmarkedhaveglobalcoveragewhileanother17per-centhaveregionalormulti-nationalcoverage.

TheresearchwasconductedbyDeloitteResearch,apartofDeloitteServicesLP.DR

Jeff Glueck is the lead Technology Integration Services principal for the manufacturing industry practice of Deloitte Consulting LLP and leads both the OESA CIO survey and the Global Service and Parts Management Benchmark Program.

Peter Koudal is the director of the Deloitte Research - Manufacturing Institute, a part of Deloitte Services LP. He leads global manufacturing research and focuses on business strategy and perfor-mance, supply chain management, customer and service management, and innovation management and synchronization.

Wim Vaessen, a partner with Deloitte Consulting BV, is the Deloitte Consulting Manufacturing Practice leader for the EMEA Region and leads the European efforts on the Global Service and Parts Management Benchmark Program.




Cultivating Risk Intelligence for Competitive Advantage

THE TWO FACES

OF RISK


34

35

BY STEVE WAGNER > MARK LAYTONILLUSTRATION BY ANTHONY FREDA

REWARDS, AND LACK THEREOF

Traditionalapproachestoriskmanagementemphasizemitigation,focusingonthereadilyapparentrisksfacingacompanyintheareasofsecurity,privacy,

credit,regulatory,technology,fraudandmore.Thesethreatsare,ofcourse,im-portant and must be addressed.

Butenlightenedriskmanagers(andwearetalkingabouttheentireC-suitehere,notjustthechiefriskofficer)don’tworryjustaboutthebadthingsthatcouldhappen,suchasthetheftofsensitivecustomerdata.Theyalsoconsiderthegoodthingsthatmightoccur,likeintroducingahitproducttothemarketplace.Whileit’simportanttoevaluatepotentialcrises,it’sequallycriticaltoconsiderrisksthatarelinkedtosuccesssoyoucancapitalizeonopportunities.Whatif,forexample,yourfactorydoesn’thavetheproductioncapacitytomeetthedemandforyournewblockbusterproduct?You’vejustsquanderedanopportunity.

Wecallthesetwofacesofrisk“rewardedrisk”and“unrewardedrisk.”Unrewardedriskrepresentswhatpokerplayerscall“tablestakes”:you’vegotto

anteupjusttogetintothegame.Theante,ofcourse,doesn’tguaranteesuccess;itonlyensuresthatahandofcardswillbedealttoyou.Numerousexamplesofunrewardedriskappear inbusiness.For instance,everypublic company in theUnitedStatesmust complywithpayroll taxwithholding laws, observeOSHAhealthandsafetyrequirements,andpaybillswhentheycomedue.Yetcompaniesthatperformallofthesetasksinatimelyandcompetentmannerdon’tseetheirsharepricessurgeasaresult.Thesekindsofactivitiessimplymeetexpectationsofshareholders,regulators,suppliers,analystsandotherstakeholders.Theattendantriskscan’tbeignored,buttheprimaryincentiveforaddressingthemisvalueprotection,notvaluecreation.

YOU NEEDN’T BE A SEER OR SAGE TO PERCEIVE RISK. IT’S AS PREDICTABLE AND AS DEVASTATING AS A FLORIDA

HURRICANE AND AS FAR-REACHING AS A CORPORATE SCANDAL. BUT YOU DO NEED TO BE A VISIONARY TO SEE THE OPPOSITE

SIDE OF THE RISK COIN, THE ONE THAT LANDS FACE DOWN AFTER YOU FLIP. THE UNDERSIDE REPRESENTS OPPORTUNITY,

COMPETITIVENESS AND GROWTH.

WHAT DO THESE THINGS HAVE TO DO WITH RISK? QUITE A BIT, IN FACT.

THE TWO FACES OF RISK

DELOITTEREVIEW.COM DeloitteReviewDELOITTEREVIEW.COM DeloitteReview

35

36

Conversely,rewardedrisksrepresentthestrategicbetsthatyouplaceduringyourpokergame.You’veassessedyourhand,sussedoutthecompetitionandwageredastackofchipswiththeexpectationofrakinginmanymorethanyou’velaidout.Inbusiness,rewardedrisksarethosebetsyoumakeasyoudevelopnewproducts,enternewmarketsoracquirenewcompanies.Theprimarymotivationfortakingrewardedrisksistospurvaluecreation.

Fixateonjustonesideofthecoinandyou’llgetaone-sidedresult.Focusonvaluecreation(rewardedrisk)totheexclusionofvalueprotection(unrewardedrisk)andyou’llquicklyfindyourselfontheslipperyslopeofnoncompliance,litigation,reputationalriskandothernastiness.Similarly,addressonlyunrewardedriskandignorerewardedrisk,andyourcompanymaysurvivebutwillneverthrive.

In acknowledgement of these two faces of risk, we have coined the following businessmaxim:“Organizationsthataremosteffectiveandefficientinmanagingriskstobothexist-ing assets andtofuturegrowthwill,inthelongrun,outperformthosethatarelessso.Simplyput,companiesmakemoneybytakingintelligentrisksandlosemoneybyfailingtomanageriskintelligently.”

WHY YOU SHOULD CARE

Ifriskisnotonyourradarscreen,it’stimetoupgradeyourdetectionequipment.Aconvergenceoffactorshasconvertedriskmanagementprogramsfroma“nicetohave”

optiontoa“can’tlivewithout”imperative.Thesefactorsincludethefollowing.Regulatory pressures have increased:TheNewYorkStockExchangenowre-

quirestheauditcommitteesofall listedcompaniestoevaluatetheriskmanagementpracticesofthecompany.

Stakeholders are flexing their muscles:Institutionalinvestorsnowroutinelyin-cluderiskmanagementconsiderationsintheirinvestmentdecisions.Moneywillgravi-tatetowardthosecompanieswithsoundpracticesinplace.

The cost of capital is impacted:Moody’sandStandard&Poor’snowincludeen-terpriseriskmanagement (ERM)capabilities intheirevaluationcriteria.Companiesdeemeddeficientcanfaceanincreaseinthecostofcapital.

The Internet has changed the game:Whennews,dataandevencellphonevideoclipscantraversetheglobeinmereseconds,theabilityofcompaniestodiscreetlydealwiththreatstotheirreputationhaseroded.

Corporate risk has become personal:Theout-of-pocketsettlementsinrecentshare-holderlawsuitshavedirectorsandexecutivesclutchingtheirwalletsallacrossthecountry.

THE FAILURE TABOO

Ifyourexecutivesuiteislikemost,you’llhearlittletalkoffailurearoundtheboard-roomtable.Failureissimplytaboo.Only“negativethinkers”and“naysayers”raise

thespecterofsomethinggoingwrong,usuallyat theirownperil. Instead,discussionusuallycentersonthepositiveaspectsofthecompany’sstrategyandtheneedtorallyaroundsaidstrategy,withscantconsiderationofthedownsidepossibilities.

But at somepoint, you’ve got to push thehead-nodders and the yes-people asidebecauseit’stimetoputfailureontheagenda.Onlybyfirstacknowledgingandthenana-lyzingrisksanduncertaintiesthatthreatentheachievementofcorporateobjectivescancompaniesmanagethemeffectively.Onlybychallengingtheassumptionsthatunderliestrategicplanningcantheprospectforsuccessbestrengthened.Onlybyrecognizingthepotentialforfailurecanfailureitselfbeavoided.

Organizations that don’t address failure in advance often find themselves feelingtheeffectslater.Consider,forexample,thehypotheticalcaseofasuccessfulAmericanconsumerproductscompanyabouttomakeitsfirstforayoverseas.Perhapsblindedwithenthusiasmoveritsexpansion,thecompanymakessomecriticalerroneousassumptions.



37

Forone,itpresumesthatitsnewconsumersareessentiallynon-EnglishspeakingclonesofAmericancustomers,withthesameneedsandpreferences.Basedonthisflawedas-sessment,thecompanycreatesamarketingcampaignaroundcolorfulpackagingandeye-catching floor displays, assuming these aremajor drivers of consumer behavior.Unfortunately, in this new territory, consumers preferminimal adornment and lookaskanceatgarishlydisplayedgoods.Thecompanyalsopresumesthatitcanseverelyundercut the competition on price, but soon learns that that loss-leader pricing is illegal. And finally, the company offers discount coupons in exchange for customer

namesandemailaddresses,onlytodiscoverthatitsnewcustomersjeal-ouslyguardtheirprivacyandarereluctanttodivulgepersonaldata.

Thisfailuretoanticipateandinvestigatethepotentialnegativeconsequencesofitsoverseasexpansionprovesapainfullesson,asevidencedbyweaksalesfigures,scantmarketpenetrationand,ultimately,withdrawalfromthecountryaltogether.Thecostofthisfolly?Inthetensofmillions.

Formanycompanies,thefailuretoimaginefailurerepresentsagapingvoid.Funda-mentquestionsthatmustbeasked,notavoided,includingthefollowing.

Whatcouldcauseustofailin:

•attainingandsustainingrevenuegrowth? •increasingouroperatingmarginsandimprovetheefficiencyofourassets? •meetingtheexpectationsofourkeystakeholders?

Byaskingthesequestions,andbyunderstandinghowtheenterprisecanfail,plan-nersanddecision-makerscanthendecidehowtopreventit,howtomorereadilydetectearlywarningsignsandhowtoimplementcoursecorrections.

Thiscapacityto imagineandthenpreventfailuremustbebuilt intothestrategicplanningprocess.Organizationsneedtobeintelligentabouttheriskstheytaketogainandsustaincompetitiveadvantageaswellastheriskstheyavoidormitigatetoprotecttheirexistingassets.

THE RISK INTELLIGENT ENTERPRISE

WedescribethistypeoforganizationastheRisk Intelligent Enterprise.Theseexcep-tionalorganizationshaveattainedahighstateofriskmanagementcapabilities.A

RiskIntelligentEnterprisedisplayscharacteristicssuchasthefollowing:It develops full-spectrum vision:Anabundanceofrisksassaultcompaniesevery

day,includingcompliance,competitive,environmental,security,privacy,strategic,re-portingandoperationalrisk.Yet,inourexperience,it’stherarecompanythatkeepsthemallinview.Forexample,financialservicescompaniesmayhaveacomprehensivegraspofinterestrate,currencyandcreditrisk,buthowmanyarepreparedtodealwithaflupandemicthatincapacitatesalargepercentageofitsworkforce?Whileacknowledg-ingthatthere’snosuchthingasperfectprotection,aRiskIntelligentEnterpriseadoptsmanagementstrategiesthataddressthefullspectrumofrisks.

It bridges silos:There’snothingwrongwithriskspecialization.Infact,intoday’shigh-riskenvironment,deepknowledgeofspecificrisksandresponsesisessential.Butproblemsarisewhenriskspecialistsworkindivisionalorgeographicisolation,unaware

“Organizations that are most effective and efficient in managing risks to both existing assets and to future growth will, in the

long run, outperform those that are less so. Simply put, companies make money by taking intelligent risks and lose money by failing to manage risk intelligently.”



38

ofeachother’sactivities.RiskIntelligentEnterprisessystematicallybuildbridgesbe-tween these risk “silos” to open lines of communicationand share information.Thisentailsmorethanacoupleofriskmanagersmeetingoveranoccasionalcupofcoffee.Togainwhatwecalla“portfolioview”ofrisk,ariskmanagement“charter”shouldbees-tablishedthatcallsforthefullrosterofspecialiststoconductmeetingsthatarefrequent,formal, structuredanddocumented.Managementand theboard shouldbe regularlyapprisedofthesemeetingsandanyoutcomes.

It speaks a common language:Onebyproductofthetendencyofriskspecialiststowork insilos is that this insularworldbecomes itsownecosystem,with itsownlanguage,customsandmetrics.Thisresultsinafragmentedviewofrisk,confusionfor those outside the silo and a duplication of effort for risk assessment activities.RiskIntelligentEnterprisesdevelopcommonriskterminologysothateveryoneintheorganizationspeaksthesamelanguage.Thesecompaniesalsoadoptsimilarmetricsso that therisks facingonedivisioncanbereliablycompared to those facingothersegmentsofthecompany.

It assesses impact:With companies facing a nearly infinite number of risks,planningforeverysingleone isanear-impossibility.Instead,werecommendthatbusinessleadersfocusonthefiniteimpactsthatcouldresultfrommultiplethreats.Forexample,aterrorattack,ahurricane,andatransitstrikearethreeunrelatedrisksthatcanallhaveasimilaroutcome,preventingpeople fromgettingtowork.Addressingtheimpactratherthanthecauseallowsonecontingencyplantoaccom-modate multiple threats.

It cultivates risk consciousness:Ifriskmanagementisthoughtofassomethingthatinternalaudithandlesorthatcorporatecounselworriesaboutorthatthe

chiefriskofficerhasundercontrol,chancesarethatsignificantexposure

remains.Rather,riskmanagementshouldbeconsideredanorganization-wideresponsibilityandcompetency.Onlywhenriskmanagementpractices

are infused into the corporate culture, so that strategy and decision-makingevolve out of a risk-informed process, can a company truly be considered risk intel-ligent.Thosewhotraditionally focusonstrategywhile leavingriskconsiderationstoothers—theCEO,theCFO,theboard,andotherkeyexecutives—needtodevelopariskconsciousnessoftheirown.

It pursues risk-taking for reward:Asnotedearlier,RiskIntelligentEnterprisespracticenot only riskmitigationbut also risk-takingas ameans to value creation.Thesecompaniesvaluetheabilitytocapitalizeonmarketopportunitiesashighlyastheydopreparednessforpotentialdisruptions.Inotherwords,ariskintelligentap-proachisnotsimplyaboutbadoutcomestobeavoidedbutalsoaboutgoodoutcomesto be attained.

EAVESDROPPING ON THE RISK CONVERSATION

Ourrisk-relatedconversationswithbusinessexecutivesgenerallytakeoneoftwotracks:

“ERM?Yeah,we’redoingthat.”Towhichweusuallyanswer:“No,you’renot.”Toexplain,webreakdowntheterm“EnterpriseRiskManagement.”Westartwith

“Only when risk management practices are infused into the corporate culture, so that strategy and decision-making evolve out of a risk-informed process, can a company truly be considered risk intelligent.”



39

the firstword, “Enterprise,”which, by definition, encompasses the entire organiza-tion.Yet rarely do riskmanagement activities transcend corporate boundaries.Anactuaryoranalyst,holedupinanoffice,maybepracticing“RM,”butintheabsenceofcoordinationwithotherriskmanagers,the“E”cannotappropriatelybeappendedto that description. “Risk,”aswehavedefineditabove,comesintwoflavors,rewardedandunrewarded.

Ifacompanyonlyfocusesononeaspectofrisk,asdomost,itisignoringanareaofsig-nificantconcernandthusnottrulybeingrisk-intelligent.

And,finally,“Management”impliesacertainlevelofefficiencyandeffectivenessofactivity.Butifcompanieshaveneithertheentireorganizationinlinenorthefullspec-trumofriskscovered,“management”seemslikeanoverlygenerousdescription.

Thus,acompany’sclaimthatitis“doing”ERMissummarilyexposed.NextweencounterresponseNo.2:“ERM?Idon’thavethetimeortheresourcestotakeonanotherhugeproject.”Towhichwereply:Aprogramtobringriskintelligencetoyourorganizationdoesn’t

havetobeamassiveandexpensiveundertaking.Infact,werecommendjusttheoppo-site:smallstepstobringaboutmeaningfulchange.

STRIDING TOWARD RISK INTELLIGENCE

Herearethefirstfewpacesthatputcompaniesonthepathtoriskintelligence.Somearesimpleandintuitivewhileothersaremorecomplexandchallenging.Butall

representsmallstepsleadingtoabigreward.Trytacklingoneperweekoronepermonth.

1. Think through risk.Readeverythingyoucananddeterminehowitappliestoyour situation.

2. Get risk into the conversation.Engagepeers,superiors,andsubordinates.Talkituptotheexecutivesandtheboard.Don’tmissanopportunitytodiscussriskandriskintelligence.

3. Have a one-day offsite meeting to address risk.4. Create crisis response and escalation procedures.Whoismonitoringtheearly

warningsigns?Whoneedstoknowwhatwhen?Who’sincharge?5. Go for growth but imagine failure and how you can overcome it. Challenge

yourmostbasicbusinessassumptions.Whatcouldcauseyoutofail?6. Differentiate between rewarded versus unrewarded risk.Whatrisksdoyou

needtotaketobesuccessful?Whatrisksdoyouneedtoavoid?7. Improve risk knowledge.Shareintelligenceandunderstandtheinter-dependencies.8. Stress-test your resilience under different scenarios.Improveflexibilitytodeal

withuncertainties.9. Focus on finite effects versus infinite causes.Understandcriticalassetsand

dependenciesandhowlongyoucangowithoutthem.10. Prioritize. Focus on the vital few versus the trivial many. Don’t “boil the ocean.”11. Speak the same language. Harmonize (ensure risk managers all speak the same

language), synchronize (coordinate across institutional boundaries) and rationalize (eliminate duplication of effort) existing risk management functions to drive down the cost of good risk management.Anddon’tforgetthetwofacesofrisk.Youareinbusinesstomakemoney,toincrease

shareholdervalue,tobeatthecompetition.Considertherisksthatcouldpreventyoufromachieving these objectives.Risk-taking for reward is a fundamental premise ofcapitalism.Useriskintelligencetomakegoodthingshappen.DR

Steve Wagner is the managing partner for Deloitte & Touche LLP’s U.S. Center for Corporate Governance and the innovation leader for its Audit and Enterprise Risk Services practice.

Mark Layton is a partner at Deloitte & Touche LLP and global leader for Enterprise Risk Services.




PHOTO: GARY BRETTNACHER

THE STRATEGY PARADOX BY MICHAEL E. RAYNOR

Chapter 1: What Strategy Paradox?

Moststrategiesarebuiltonspecificbeliefs

aboutthefuture.Thisisaproblembecause

the future is deeply unpredictable.Worse,

the requirements of breakthrough success

demand implementing strategy inways thatmake it

impossibletoadaptshouldthefutureturnoutdifferently


41

than planned. The result is the Strategy Paradox:

strategieswiththegreatestpossibilityofsuccessalso

havethegreatestpossibilityoffailure.Resolvingthis

paradoxrequiresanewwayofthinkingaboutstrategy

and uncertainty.

Hereisapuzzlingfact:themostsuccessfulfirmsoftenhavemoreincommonwithfailed organizations than with those that have managed merely to survive. In fact,theverytraitsthatwehavecometoidentifyasdeterminantsofsuccessarealsothe ingredientsoffailure.Andsoitturnsoutthattheoppositeofsuccessisnotfailure,itis mediocrity.

1.1HIDDEN IN PLAIN SIGHTWhyisthisthefirstyouhaveheardofthestrategyparadox?Afterall,thereis

noshortageofwell-designedandwell-executedstudiesthathaveofferedusefulinsightsintothedefiningcharacteristicsofsuccessfulfirms.Similaritieswithfailedfirmsandtheimportanceofluckhavenottendedtofeatureprominently.

Thereasonmostbusinessresearch misses the strat-egy paradox is because, un-derstandably enough, fewstudies ever examine fail-ure. Instead, most investi-gators tend to study success;afterall,whowants to learnhowtofail?Insomecasesthisisbecausepursuingthesecretsofsuccessseemsmorerewardingthanpickingthroughthewreckageoffailure. Inothercasesitissimplyaflawedmethod: theresearchersembrace the idea thatbystudyingwinners theycandiscern thesecretsof success, forgetting that the factorsdifferentiatingwinners fromloserscanonlybeidentifiedbyanalyzingboth.Finally,thereistherealitythatfailuresareoftenhardertodocument,or,inthecaseoffailedcompanies,theorganizationisnolongeravailableforstudy.

So, researchers compare companies that have been very successful over ten or 15years(focalcompanies)withcompaniesthathavebeenlesssuccessfuloverthatsametimeperiod(comparisoncompanies). Somestudieslookforfirmsthathavedoneverypoorlyoverthattime,andotherslookforcomparisoncompaniesthathaveactuallydoneprettywell–justnotnearlyaswellastheirfocalcompanies.Eitherway,however,com-parisoncompanieshaveatleastsurvivedfortheperiodinquestion,andoveratenyearperiod,meresurvivalisactuallyaprettyhighbar.1

Whatthismeansisthatthese,andmanyother,studieshavebasedtheirconclusionsuponcomparisonsofsuccesswiththemediocre. Becausethesestudiessystematicallyseekoutsuccessfulcompanies,eachwillnecessarilyfindthosethatinthepastmadetherightcommitments.Andbecausethecomparisoncompaniesarealwaysfirmsthathaveperformedlesswell,butnotfailedcompletely,theywillnecessarilybefirmsthathaveavoidedthehigh-risk,high-returnstrategyofcommitment.

Byexaminingprimarilythosecompaniesthathaveguessedrightandcomparingthemwith those that have avoiding guessing,what has been largelymissed is the critical

“ANDSOITTURNSOUT,BEHAVIORALLYATLEAST,THEOPPOSITEOFSUCCESSISNOTFAILURE,BUTMEDIOCRITY.”

BOOK: THE STRATEGY PARADOX


42

importanceofmanaginguncertainty.Thegallantchargeandthecowardlyretreatarenottheonlyalternativestocatastrophe,forthereisawaytomitigateriskwithoutcom-promisingperformance,anddescribingthatsolutionisthepromiseofthisbook.

Acceptingthestrategyparadoxforcesustoacceptmediocrity,givingupachanceatgreatnessasthepriceofourcontinuedcorporateexistence.Resolvingitwillfreeusfromadebilitatingtradeoffbetweenriskandreturnandallowustostrivetobefirstwithoutgivingupthehopethatwewilllast.

1.2MUST COMMIT Thecauseofthestrategyparadoxisasobviousasitisoverlooked.Asuccess-

fulstrategyallowsanorganizationtocreateandcapturevalue.Tocreatevalue,afirmmustconnectwithcustomers.Forafirmtocapturevalue,itsstrategymustberesis-tanttoimitationbycompetitors.Satisfyingcustomersinwayscompetitorscannotcopyrequiressignificantcommitmenttoaparticularstrategy–strategic commitments – to uniqueassetsortoparticularcapabilities.

Notjustanycommitmentwilldo,however.Successstemsfromcommittingtowhatenough customerswant, but few competitorshave. Commitments are a powerful de-terminantofsuccessbecausetheymakeastrategydifficulttoimitate,butonlybecausecompetitorswill onlywant to imitateyouonce itbecomes clearyouhavemadewhathappentobetherightcommitments.Sincetheywaitedwhileyoucommitted,youwillenjoyaperiodofrelativelylittlecompetitionbecauseitwilltaketimeforyourrivalstoreplicatethecapabilitiesyouhavesopainstakinglycreated.Forexample,newproductssnappedtogetherfromoff-the-shelfcomponentsareusuallyeasilyimitatedbycompeti-tors,whilethosebaseduponproprietarytechnologiesdevelopedoveryearsarefarlikeliertobethefoundationofadurablefranchise.Thedownsideofcommitmentisthatifyoumakewhathappentobethewrongcommitments,itcantakealongtimetoundothemandmakenewones.

The strategy paradox, then,arises from the collision ofcommitment and uncertainty. That is, the most successfulstrategies are those based on

commitments made today that are best aligned with tomor-row’scircumstances.Butnoone

knowswhatthosecircumstanceswillbe,becausethefutureisunpredictable. Shouldonehaveguessedwrongandcommittedtothewrongcapabilities,itwillbeimpossibletoadapt–afterall,acommitmentthatcanbechangedwasnotmuchofacommitment.Asaresult,successisveryoftenaresultofhavingmadewhatturned out to be the right commitments (good luck),while failedstrategies,whichcanbesimilar inmanywaystothesuccessfulones,arebasedonwhatturned out to bethewrongcommitments(badluck).Inotherwords,thestrategyparadoxisaconsequenceoftheneedtocommittoastrategydespitethedeepuncertaintysurroundingwhichstrategytocommitto;callthisstrategic uncertainty.

NewresearchdetailedinChapter3suggeststhatoftenthemainfactorseparatingsuccessandfailureisindeedluck.Mediocrefirms–thosethatsurvivebutdonotprosper–avoidcommitmentsthatexposethemtothevagariesofluck.Thepriceofavoidingthatriskisthelostopportunityforgreatness;therewardisanincreasedchanceofsurvival.Fornow,theseseemtobetheonlyalternativestofailure,andfirmsareforcedtochoose.Thereisnointrinsicmeritinoptingforgreaterreturnsoversurvivalorviceversa;theproblemisthatfirmsmustchooseatall.

Sony’scase,referredtoabove,isnotunique.Thestrategyparadoxismorethana theoretical possibility or a curiosity; it is a general condition.As recounted in

CALLITAN“EMOTIONALPARADOX”...LOVINGANDHATING—CAN

HAVEFARMOREINCOMMONWITHEACHOTHERTHANASEEMINGLY

INTERMEDIATESTATE.



43

Chapter3,ananalysisofthecompetitivestrategiesofseveralthousandoperatingcom-panies reveals thatorganizationspursuing themost commitment-intensivestrategiesgeneratethehighestreturns,buttheyalsosufferthehighestmortalityrates.Seeninthislight,Sony’sfailureswerenotaconsequenceofavoidablemistakesbutwereinsteadaninevitableresultofmakingcommitments–thedefiningelementofsuccessfulstrategy–despiteinescapableuncertainty.AndwhenthoseuncertaintieswereresolvedtoSony’sdetriment, it paid the price.

Thestrategyparadoxrestsontwopremises:commitmentscannotbeadaptedshouldpredictionsproveincorrect;andpredictionsareneverreliablyorverifiablycorrect.Arethesepremisestrue?

1.3CAN’T ADAPT Forallwemightthinkweknowabouthowtomakeorganizationsagile,flex-

ibleandadaptive,thedatasuggeststronglythat,ifanything,competitiveadvantageiserodingfasterthanever.Thisaccelerationisinterpretedbysometomeanthatthereisagreaterneedthaneverforadaptableenterprises.Suchanobservationisentirelycor-rect.Unfortunately,theacutenessoftheneeddoesnotmeanitcanbesatisfied.

Somemeasureofadaptabilityisvisibleinmostorganizations.However,asexplainedinChapter4,itisfarlessusefulthanwemightlike.Specifically,adaptationisonlyvi-ablewhenthepaceoforganizationalchangecanmatchthepaceofenvironmentalchange.Whentheenvironmentchangeseitherfasterorslowerthantheorganization,adaptationisnolongereffective;everyorganizationwillatsomepointfaceeither“fastchange”or“slowchange,”andeachcanprovedebilitating.

Fast change leavesan organizationhandcuffedbecause it leavesan organization’scapabilitiesoptimizedforanenvironmentthatsuddenlynolongerexists.Forexample,whenthepriceofoilrose400%inamatterofweeks,NorthAmericanautomakersfoundthatthemainstayoftheirproductlines–full-sizedcars–weresingularlyinappropriatetothenewcompetitiveconditions.Unfortunately,ittookthosesameautomakersyearstodesign,manufactureandmarketmore fuelefficientmodels,andthey lostvaluablemarketsharetobetter-positionedcompetitors.(Ironically,tohavethetideturnintheirfavorinthemid-1990swhencheapgasmadeSUVsalltherage,andthentoseetheirgoodfortuneevaporateonceagaininthefaceofhigh-pricedpetrol.)

Slow changepromptsanorganizationtoadapttoincrementalchangesintheenviron-mentaroundit,andbecauseoftheseincrementaladaptations,thecompanyoftenfailstoseetheneedforamorefundamentaltransformation.Theautosector’sresponsetothecurrentoilcrisismaybesubjecttothisslowchangepathology.Asoilpriceshavecreptup,automakershaverespondedbyextendingthelifeoftheinternalcombustionenginebydramaticallyincreasingfueleconomyandcreatinghybridelectricengines,amongothertechnologicaladvances.Butthedaymaywellcomewhen,dueeithertotheneedtolimitcarbonemissionsforenvironmentalreasonsortheinabilityofthegeneraleconomytoabsorbstillfurtherincreasesinoilprices,theinternalcombustionenginemustbeaban-doned.Shouldthatdayarrive,companiesthathavebeenexploitingtheiradaptivecapac-itybyextendingthelifeofthiscenturyoldtechnologywillbelargelyunabletorespond.

Compoundingthedifficultiesofrespondingtofastandslowchangesisthefactthatmostcompetitiveenvironmentsarecharacterizedbymultipleratesofchange,creatingtheimpossibleorganizationaltaskofchangingatdifferentratesatthesametime.

As a result, firms cannot expect to resolve or evenmitigate the strategy paradoxthrough adaptation.

1.4CAN’T PREDICT Thefirsthalfoftheparadoxiscommitment:companiescannotadapttheir

commitmentsshouldtheyturnouttobethewrongones.Mighttheyinsteadpredictthefutureaccuratelyenoughtoconsistentlymaketherightcommitmentsinthefirst



44

place?Futuristsmakesuchpredictions,believingthatbyanalyzingthepastandpres-enttheycanidentifyandinterpretthetrendsthatwillultimatelydefinethefuture.Sincetherealwaysseemstobesomeonewithatrackrecordofsuccessfulpredictions,wemightbetemptedtowriteofftheparadoxasanillusion.

Wewouldbewrongforthreereasons,whichareexploredinChapter5.First,noonecanlegitimatelyclaimtohaveameaningfulabilitytoforeseethefutureinanythinglikethelevelofdetailrequiredtomakeconsistentlysuccessfulstrategiccommitments.Anysuchclaimscanalwaysbeexplainedbythelawoflargenumbers:withsomanypeoplepredictingsomanythings,itisinevitablethatsomeoneisgoingtogetsomethingrightoccasionally.Sincewecannotknowwhothatsomeoneisgoingtobe,orwhattheyaregoingtogetright,thefactthatsomepredictionsturnouttobeaccurateisuseless.

Second,predictions inthe formofpointestimatesbetraya fundamentalmisunder-standingofwhatthefutureactuallyis.Thefutureisarangeofpossibleoutcomes,notaspecificsetofcircumstancesthatwillinevitablycometopass.Apredictionofthefutureas seen from the perspective of todaywouldhavetodescribeeachoftheeventsthatcouldhappenandtheirassociatedprobabilities.Unfortunately,thereisnowaytocompareourprobability-baseddescriptionofthefuturewiththetrueprobabilitiesastheyaretoday.Forinstance,ifIsaythatthereisa10%chanceofraintomorrow,whetheritrainstomor-rowornottellsyounothingabouttheaccuracyofmyprediction,foreitheroutcomeisconsistentwitha10%chanceofrain.

Onecould,ofcourse,noteallthoseoccasionswhenIpredicteda10%chanceofrainandthenseeifitrainedon10%ofthosedaysforwhichIpredicteda10%chanceofrain.Whenitcomestoweatherforecasting,thisisreasonable,butwhenitcomestostrategicforecasting,theoutcomesofinterestarerarelyrepeatedevents.Asaresult,thiskindoftrackrecordisimpossibletoestablish.Consequently,wehavenowayofdeterminingifsomeonecanprovideaccurate,probability-baseddescriptionsoftherangeofpossiblefutureevents.

Thethirdreasonaccuratepredictionisimpossibleistheubiquityofrandomness.Ran-domnessgenerallycanbethoughtofastheabsenceofthekindoforderthatallowsustopredictwhatcomesnextinaseries.Thatis,wemightbeabletoidentifyapattern,butunlessthatpatternrepeatsinwaysthatallowustoforeseewhatfollows,theseriesisultimatelyrandom.Itturnsoutthatthesystemswehopetounderstandandpredictfor thepurposesofmakingstrategiccommitmentsaresubject to twomainsourcesofrandomness.

First,competitivesystemsaresubjecttoexogenousshockssuchasnewtechnologiesorregulatoryregimesthatcreatenewcompetitorsandupsetlong-standingequilibria.Itistemptingtobelievethatwecanovercomethisproblembysimplyexpandingtheboundar-iesofouranalysis,butitisthenatureofthissourceofrandomnessthatassoonaswebeginexpandingourscopewedon’tknowwhentostop.Beforelongwefindourselvescompelledtobuilda“theoryofeverything”inordertopredictanythingatall.

Second,evenifthedynamicsofaparticularsystemarepredictable,competitivedy-namicsarehighlysensitivetopastcommitments–whatsystemsdynamicstheoristscall“initialconditions.”Whatconstitutestheinitialconditionsofasystemisajudgementcall,andgettingitwrongmakesanysubsequentpredictionshighlysuspect.

WecanseethesefirsttwosourcesofrandomnessatworkintheevolutionofToyotafrom itshumblebeginnings toaworld-classautomanufacturer. Theoil crisis of themid-1970swasanexogenousshockthatcreatedasurgeindemandinNorthAmericaforsmaller,fuelefficientautomobiles.Toyotahadamodelline-upofpreciselythesekindsofcars,andmanycustomerswhowouldnototherwisehavepurchasedaToyotaweremotivatedtopurchaseoneforthefirsttime.ManywerepleasantlysurprisedatthevalueToyotaoffered,andstuckwiththebrandasthepressureongaspricesreceded.Theoilshockwas,inasense,theluckybreakToyotaneededtogainaccesstothemainstreamoftheU.S.automarket.



45

ForGeneralMotorstohavepredictedthisshiftincompetitivefortunes,itwouldhavehadtofocusnotonitswould-becompetitor,butonthegeopoliticsoftheMiddleEast.GMwouldalsohavehadtopredictaccuratelytheimpactofthatshockonconsumerbuyingbehavior,and that the “temporary” interest inToyotawouldprove tohave long-termimplications.

AndwhywouldGMeverthinkthatToyotawouldbeathreattoitsbusinessratherthanhistoricalrivalsFordandChrysler?WasToyotablessedwithaprescienceoradapt-abilitythatwouldallowittoexploitunforeseeneventsthatotherswereblindto?Hardly:inToyota’shomemarketofJapangasolinehadlongbeenmoreexpensivethanintheUnitedStates,whileeconomizingonspacehadlongbeenapriority.These“initialcondi-tions”arefeaturesoftheJapanesemarketthatcanbeattributedtogeographic,political,andculturaltraitsthatarecenturiesold.ItisnotasthoughToyotahada“copyGM”strategyinthe1950s,butchangedcoursewhenit foresawtheoilcrunch;neitherdidToyotaadapttotheembargowhen it occurred. Rather,as a consequence of mar-ket pressures in its homemarket the company com-mitted a particular strategy (small, fuel-efficient, inex-pensive cars) thatwaseven-tuallyappropriatefortheNorthAmericanmarketforreasonsfewhadforeseen.ThistakesnothingawayfromToyota’ssuccess;asLouisPasteurputit,“fortunefavorsthepreparedmind.”Butthecorollaryofthisinsightisthatpreparationwithoutfortune–orworse,coupledwithbadfortune–amountstothewrongcommitments.

Insum,predictioncannotresolvetheparadoxanymorethanadaptabilitycan.

1.5MANAGING STRATEGIC UNCERTAINTY Thestrategyparadoxisaconsequenceoftheconflictbetweencommitmentand

uncertainty,i.e.,strategicuncertainty.Commitmentsarewhatallowanorganizationtocreateandcapturevalue.Uncertaintycreatesriskandopportunity.Theanswertotheparadoxliesinseparatingthemanagementofthesetwoelementsofstrategy,charg-ingsomewiththeresponsibilityofdeliveringonthecommitmentstheorganizationhasalreadymade,andotherswiththetaskofmitigatingriskandprovidingexposuretopromising opportunities.

Thefoundationforthisdivisionoflaboristhetraditionalorganizationalhierarchy.AsexplainedinChapter6,well-functioninghierarchiesaredefinedbyclearseparationbetweenlevelsaccordingtothetimeittakesforthoseatthatleveltoknowwhetherornottheyhavemadetherightdecisions.Mostwhoworkinlargeorganizationshaveanintuitionthatthisbasisoforganizationisright.TheCEOshouldbethinkingaboutthelongterm,whiledivi-sionalmanagement(typicallyanoperatingdivision)isworriedaboutthemediumterm,andin-the-trencheslinemanagementhastodeliverthegoods.

Intheshortrun,thereisverylittlestrategicuncertainty.Wetypicallyknow(evenifwecannotimplement)thebestwaytocreateandcapturevalueinthepresent.Wecannotknowhowbesttocreateandcapturevaluetenor20yearsfromnow.Therangeofstrate-giesthatmightbeoptimalinthefutureonlyexpandsaswelengthenthetimehorizonunderconsideration.Consequently,thereisagreatdealofstrategicuncertaintywhenconsideringthe long run.

Seniormanagement,becauseitisresponsibleforlongertimehorizons,shouldthereforefocusitseffortsonmanagingstrategicuncertainty.Thoselowerdowninthehierarchy,becausetheyareresponsibleforshortertimehorizons,shouldfocusondeliveringonthecommitmentsalreadyinplace.ThisneworganizingprincipleiscalledRequisite Uncertainty because each levelofthehierarchyisdefinedbyitsrelationshiptomanagingstrategicuncertainty.

“...THESAMEBEHAVIORSANDCHARACTERISTICSTHATMAXIMIZEAFIRM’SPROBABILITYOFNOTABLESUCCESSALSOMAXIMIZEITSPROBABILITYOFTOTALFAILURE.”



46

Theimplicationsofseparatingthemanagementofuncertaintyfromthemanagementofcommitmentsaremorefar-reachingthatitmightseem.Inthefirstplace,RequisiteUncertaintyprovidesafoundationforthewidely-heldyetoftenviolatedbeliefthatseniormanagementshouldnotbeconcernedwithshort-termresults.Thereisverylittlethatpullingonthestrategylevercandotoimprovethisquarter’scashflow,andanyCEOthatiscompelledtointervenefrequentlyonissuesthatcanaffectcurrentfinancialresultsislikelynotabletopayenoughattentiontostrategy.

Explicitlyidentifyingstrategicuncertaintiesandrequiringthatseniormanagementattendtothemmightwellbequitedifferentfromthemorebottom-upriskmanagementprocessesmany organizationshave inplace. Focused on important but shorter-termuncertaintiessuchasthesupplychain,thecompany’sreputation,andsoon,muchofes-tablishedrisk-managementpracticeoverlookstheriskthatthecompanyhascommittedtothewrongstrategy,andwhattodoaboutthat.

Perhapsmore controversially, applying theprinciples ofRequisiteUncertainty im-pliesthatCEOsshouldnotseetheirroleintermsofmakingstrategicchoices,i.e.,com-mitments. Rather, theyshould focusonbuilding “strategicoptions,” that is, creatingtheabilitytopursuealternativestrategiesthatcouldbeuseful,dependingonhowkeyuncertaintiesareresolved. It impliesalsothattheboardshouldnotconcernitselfasmuchwithengaging the substanceofafirm’s strategyaswithdetermining themostappropriateexposuretostrategicriskandopportunity.Onlybyshiftingtheemphasisatthetopofthehierarchyfrommakingandexecutingstrategytomanagingstrategicuncertaintycancorporationshopetomitigatestrategicriskwhilesimultaneouslycreat-ing strategic opportunities.

InChapter 7 a case study ofVivendiUniversal, a Frenchmedia conglomerate, il-lustrateswhathappenswhenaCEOsuccumbstothetemptationoftop-level,hands-onstrategy-making. Examinations of the diversifiedCanadian telecommunications com-panyBCEInc.andU.S.softwarecompanyMicrosofthighlightthebenefitsofanoption-creatingtopmanagement.Inparticular,theBCEandMicrosoftcasesshowhowcorpora-tionscanmanagestrategicuncertaintyinwaysthatinvestorscannotreplicate.

However,itwillbeapparentfrom these examples that thesuccessofanoptions-basedcor-

porate strategy has depended largely on the charisma, in-

fluence,andpoweroftheCEO–ithasrequiredpeoplesuchasBill Gates and Rupert Murdoch

todothissuccessfully.Noteverycompanyisledbysuchatitan.Consequently,weneedan explicit, process-baseddescription ofhowmanagersat all levels can contribute tomanagingstrategicuncertaintyinwaysthatmitigateriskandpositionafirmtocaptureemergingopportunities.ThisisthesubjectofChapter8,acasestudyofhowJohnson&Johnson (J&J), thediversifiedU.S.pharmaceutical,medicaldevices,andconsumerproductscompany,hastackledthischallenge.

J&Jisbreakingnewgroundinthemanagementofstrategicuncertainty.Thecompa-ny’soperatingdivisionsarenotexclusivelyresponsibleformanaginglongtermstrategicuncertainty.Rather,divisionalleadership’sprimaryroleistocommittoaspecificstrat-egy,becausemakingacommitmentistheonlywaytocreateandcapturevalue.Buttherangeofstrategiesavailabletotheoperatingdivisionsisafunctionoftheopportunitiescreatedbythecorporateoffice.Thatis,operatingdivisionsenjoyalevelofstrategic flex-ibility–adeliberateoxymoronthatqualifiestheirreversibilityofstrategiccommitmentswithoutunderminingtheircompetitivepower.

Operatingdivisionsthatmanagetheirownlong-termstrategicuncertaintywillmost

“FIRMSTHATACCEPTSTRATEGICRISKREAPEITHERGREATREWARD

ORUTTERRUIN.”



47

EndNotes

1 Fourstudiesworthreadingthatmakethesekindsofcomparisonsare,inalphabeticalorderbyfirstauthor’slastname,Collins,JamesC.andJerryI. Porras(1994)BuilttoLast:SuccessfulHabitsofVisionaryCompaniesNewYork:HarperBusiness;Collins,Jim(2001)GoodtoGreat:Whysomecom-paniesmaketheleap…andothersdon’tNewYork:HarperBusiness;Joyce,William,NitinNohriaandBruceRoberson(2003)What(Really)Works:The4+2formulaforsustainedbusinesssuccessNewYork:HarperBusiness;Marcus,AlfredA.(2006)BigWinnersandBigLosers:The4secretsoflong-termbusinesssuccessandfailureUpperSaddleRiver,NewJersey:WhartonSchoolPublishing.

2 SeePorter,M.E.(1987)“FromCorporateStrategytoCompetitiveAdvantage”HarvardBusinessReviewVol.65Iss.3.;andGoold,Michael,A.CampbellandM.Alexander(1994)CorporateLevelStrategyNewYork:Wiley.

likelyendupmediocreperformers,avoidinghighriskbetstoincreasetheiroddsofsur-vival. In addition, since great performance demands relentless focus on a particularstrategy,devotingresources–especiallymanagementtimeandattention–tocreatingoptionsistypicallybeyondthecapacityofanoperatingdivision.Consequently,StrategicFlexibilityisnotsomethingasuccessfuloperatingdivisioncantypicallycreateforitself.Onlybyfocusingthecorporateofficeonthemanagementofuncertaintycantheoverallcorporationachievehighresults(thankstocommitment-focuseddivisions)atlowerrisk(thankstotheuncertainty-focusedcorporateoffice).

Highlightedhereistheprofounddifference“growth”optionsandtruestrategic options. Often,companieswillmakeasmallinvestmentinanewventureandseeitasan“option”onfuturegrowth:iftheventuretakesoff,theninvestmoreinit;ifitfalters,letitwither,orperhapsevenexpediteitsdemise.Strategicoptions,however,enableestablisheddivi-sionstopursuefundamentallydifferentstrategies.Astrategicoptionisanoptiononanelementofanalternativestrategythatmightormightnotbeimplemented,notsimplyanoptiononfurtherinvestmentinanewbusinessthatmightormightnotsucceed.

Makingthecorporateofficeresponsibleformanaginguncertaintyisasignificantbreakfrommuchcurrentthinkingabouttheroleofthecorporateoffice.Mostprescriptionsonwhatacorporateofficeshoulddostartwiththepremisethatallcompetitiontakesplaceattheproductmarketlevel–thatis,inthedomainofoperatingdivisions.2Thisistrue,buttheconclusionthatallcorporateofficeactivitymust,therefore,bedirectedatimprov-ingthecurrentcompetitivenessofoperatingdivisions–by,forexample,facilitatingthecaptureofsynergiesbetweenoperatingdivisions–doesnotnecessarilyfollow.

Drawingtoodirectalinebetweentheactionsofthecorporateofficeandtheperfor-manceoftheoperatingdivisionsisanunhealthysideeffectofourcollectiveobsessionwithgeneratingreturns.Theframeworksfordevelopingcompetitivestrategythathaveemergedoverthelast30yearshavegivenusunparalleledinsightintohowcompaniescansucceed.Andcompetitivestrategyremainsenormouslyimportant,butitshouldbethepreserveofdivisionalmanagement.Butjustastherecanbenoleftwithoutaright,thereisnoreturnunaccompaniedbyuncertainty:operatingdivisionsworryaboutcom-petitivestrategytocreateandcapturevalue;corporatestrategyshouldbe focusedonthemanagementofstrategicuncertainty.RequisiteUncertaintydelegatestocorporatemanagementresponsibilityformanagingstrategicriskandopportunity,andStrategicFlexibilityistheframeworkforfulfillingthatresponsibilitythroughthecreationofstra-tegic options.

Itwouldbeamistaketothinkthatthedistinctionbetweencorporateandcompetitivestrategy,andhenceRequisiteUncertainty,appliesonlytoFortune500corporations.Anyorganizationwithgreatersizeandcomplexitythanasole-proprietorcornerstore–orsimplytheambitiontoachievesaidsizeandcomplexity–canbenefitfromthinkingcare-fullyaboutseparatinggeneratingreturnsfrommanaginguncertainty.Ifyourorganiza-tionhasoperatingmanagerswhoreporttostillmoreseniormanagers,thereisnotsimplythechancebutthelikelihoodthatthereisanunhealthyoverlapbetweenthejobseachlevelthinksitisdoing.Infact,thesmallertheorganization,thegreaterthetemptationofseniormanagementtoinvolveitselfinoperatingdecisions,withtheunfortunatecon-sequenceofleavingthemanagementofuncertaintylargelyto…chance. DR

Reprinted with Permission.




WEALTH WITH

WISDOMBY CABRINI PAK > AJIT KAMBIL

PHOTOGRAPHY BY DAVID CLUGSTON

Serving the Aging Consumer

When80-year-oldMarthaSmithwantstoboilacupofwaterinhermicrowave,sheturnsthe

dial to thepopcorn settingandhits ‘start’.Unabletoeasilyadjustthedigitaltimeronthedevice,sherepeatsthisthreetimesbeforeitiswarmenoughforacupoftea.Inasimilarfashion,Marthahasbecomeamasterofvariousmicrowaverecipes,allmeasuredintermsofhowmany“popcorns”ittakestocookthe

WEALTH WITH WISDOM 49


50

food.1At80yearsofage,Marthaispartofthefastestgrowingsub-segmentoftheage50+populationandillustrateshowsomeagingconsumersadapttonewproductsthathavenotbeendesignedwiththeirneedsorpreferencesinmind.

Theglobalpopulationisbothagingandlivinglongerduetoimprovementsinhealthcareandnutrition.Age50+consumersareagrowingeconomicforcethatwilltransformmultipleindustriesunlikeanypriordemographicshiftinrecenthistory.Yetmostcom-paniescontinuetodesignforandadvertisetotheyoung.Tocapturevaluefromtheage50+market,managerswillhavetomasternewskillsandleadthetransformationofproductsandstrategytoadapttoachangingmarketplace.

Withincreasinglongevity,therearealreadyoverhalfabillionage50+peopleintheworld,andalreadytheUnitedStateshasmorethan9.2millionage80+citizens.InJa-panandSweden,theoddsforwomentoliveonehundredyearswere1in50attheendofthe20thcenturycomparedwith1in20millionattheendofthe19th.2,3TheCentreforAging inLondon estimates that by 2020 therewill benearly 700million elderly(age65+)individualsintheworld.AsFigure1illustrates,thereisadramaticglobaldemographicshiftunderway.Increasedlongevitywillalsoseesignificantgrowthinthenumberofcentenarians.

SILVER LINING

Despite long-termmacroeconomic and social challenges, increasing longevityin the near term creates new economic opportunities. In theUnited States,

age65+consumersare themostaffluentofanyagesegment,withmanyhaving

FIG.1 GLOBAL POPULATION TRENDS BY AGE GROUPS AND BY SEX(populations in 100 millions)

Source: U.S. Census Bureau, International Database

80+

75-79

70-74

65-69

60-64

55-59

50-54

45-49

40-44

35-39

30-34

25-29

20-24

15-19

10-14

5-9

0-4

0 50 100 150 200 250 300 350350 300 250 200 150 100 50 0

2005 2010 2020

Female Male

WEALTH WITH WISDOM


51

multiple income sources.4With80millionbabyboomersand75million“tradition-alist”consumers(thosebornbetween1900-1945)inAmerica,theeconomicpowerof theage50+population is alreadydrivingmajor shifts inproduct and serviceconsumptionacrossindustries:Consumersover50accountforalmosthalftheto-talconsumerspendingintheUnitedStates.5Americansaged50+alsoaccountfornearlyhalfofthemarketshareinpersonalinsuranceandpensions,transportation,health,housingandfood.

While the numbers are impressive, tapping effectively into the opportunities ofemergingage50+marketswillnotbeeasy.Likeothermarkets,seniormarketscanvary by country or region, age, income andlifestyle.Age50+consumerscanbemorecom-plex in their preferences than their youngercounterparts.Moreover,thewidespreaduseoftechnologybyretiringbabyboomersmakes itlikely that they will exhibit dramatically dif-ferent technology use and consumption pat-ternswhentheyturn80thanMarthaandher current peers do.

Aging boomers clearly represent a signifi-cantmarketgrowthopportunityfortoday’sage-savvytechnologyproviders.Similarly,Genera-tionX(consumersborn1965-1980)differsfromboomersandGenerationY(consumersborn1981-2000),makingitdifficulttopredicttheconsumptionpreferencesoffutureage50+individuals.Navigatingthesesubtledifferencestotapintothepotentialofemergingseniormarketsrequiresadeeperunderstandingofagingand its impactson consumers.

UNDERSTANDING EMERGING AGE 50+ MARKETS: A FRAMEWORK FOR ANALYSIS

Agingconsumersfacespecificpatternsofchangealongseveraldimensions.InourDe-loitte Research report, Wealth with Wisdom,weintroducedaframeworkforthink-

ingaboutthechangesconfrontingseniorconsumers.Thisgeneralframework(Figure2)buildsonthebiological,psychological,economicandsocialchangesconfrontingage50+consumers.Understandingchangesalongthesedimensionscanhelptoinformproductandservicedesignanddeliverydecisions.

CHANGING BIOLOGY

Age 50+ consumers confront numerous biological changes as they age. Thesechanges in mobility, flexibility, elasticity, strength, vision and hearing can

haveamajor impactonhowseniors interactwithbusinessesandtheirproductsandservices.

Forbusinesses,thesechangescanunderminetraditionalapproachestopromotionandevenaffecthowconsumersinteractsafelywithproductsorservices.Certainvisionandhearingchallengescanberemediedwithbetterandmorestrategicallyplacedlight-ingandlargersignageorwithrelativelycommontechnologiessuchasspeakingkiosks,whitenoisedampenersormultimediaadvertising.However,morecomplexbiologicalchanges associatedwith agingwill requiremore complex adaptations of communica-tions to customers.

Finally,theelasticityandexternalappearanceoftheskinofage50+individualscanchangewithtime.Whilehundreds,ifnotthousands,ofproductsalreadyexisttoaddressthisconsumerconcern,themarketforsuchproductsandrelatedservicesisexpectedtocontinuetogrow.Thetechniquesandstrategiesusedtomarkettheseproductswillneed

“Age 50+ consumers are a growing economic force that will transform multiple industries unlike any prior

demographic shift in recent history. Yet most companies continue to design for and

advertise to the young.”

WEALTH WITH WISDOM


52

totakeintoaccountthepreferencesandtendenciesoftheemergingage50+consumers,whichmayvaryfromthoseweseetoday.

PSYCHOLOGICAL CHANGES

Agingcantriggerpsychologicalchanges, includingcognitivecapabilityor function,attitudeformationandchange,andevenmoodandemotion.Twosalientaspectsof

cognitivecapabilitythatcanchangearememoryandinformationprocessingcapabili-ties.Thesechangescanaffectcognitiveprocessesunderlyingbrandawareness,attitudeformation,informationsearches,comparisonofalternatives,pointofpurchasebehaviorandpost-purchasesatisfaction.

Forexample,aninformationprocessingchallengefacedbyage50+consumersisano-ticeabledeclineintheabilitytoignore“noise,”orirrelevantstimuli,whetheritisvisual,aural,tactile,orlanguage-related.Noisyadvertisingthatworksforyoungercustomersmaybackfirewithage50+customers.

Therateof learningnew informationalsodeclineswithage,althoughSpottsandSchewe(1989)foundthatlearningdeficiencyattributedtoagingdidnotoccurwhentheindividualwasallowedtoself-pacetheinformation.6Inlightofthis,managersneedtoassesshowtheyinformcustomersthroughadvertisingandpromotionsaswellashowtheydesignproducts and services that adjust to different styles and slower rates ofconsumer learning.

ECONOMIC CHANGES

Asindividualsandfamiliesage,theyarealsolikelytochangetheirpatternsofsaving,consumptionandinvestment.AstheeconomicsNobelLaureateFrancoModigliani

proposedinhislifecyclehypothesisofconsumption,peoplesaveinearlyyearstohave

FIG.2 AGING PROCESSES CAN TRANSFORM CONSUMERS

Source: Deloitte Research

• Reduction in pupil size limits the amount of light entering the eye

• Yellowing of the lens contributes to problems in color vision

• Reduction in hearing interferes with communication

• Loss of elasticity in joints, muscles and skin creates changes in range of motion and in overall body shape

• Decline in attention contributes to problems igorning “noise” or irrelevant stimuli

• The rate (but not the ability) at which new information is learned declines with age

• Unfamiliar settings elicit more cautious behavior

• The changes in economic resources and status over time require planning and management of money and assets

• Those who continue to work past retirement age face other challenges, like intergenerational collaboration

• Retirement creates shifts in resource pools like time and income

• Grandparenting, caregiving, empty nests and retirement reflect some of the role shifts that occur as people age.

• These role shifts create ripples of change in lifestyles, like locale (urban vs. rural or suburban), travel patterns, daily routines and atten-dance at social gatherings

Mobility, Vision, Hearing

Income flow shifts, Resource reallocation, addition, subtraction

Memory, Information Processing

Role shifts, Lifestyle changes

Biological

Economic

SocialPsychological

WEALTH WITH WISDOM


53

stableconsumptionopportunitiesinlaterlife.Althoughtheempiricalevidenceforthisismixed,especiallyintheUnitedStates,individualsnaturallytendtoearnlessandspendmorefromtheirsavingsastheygrowolder.Theaccumulatedwealthofage50+consumersintheUnitedStatesprovidesthemwithmorespendingpowerthananyotheragegroup.

OlderAmericanscontrolmorethanhalfoftheconsumereconomy,butindividuallytheyfaceavarietyofobstaclesasshoppersorpersonalfinancialmanagers.Ina2004studytheAmericanAssociationofRetiredPersons(AARP)noted:

•age45+consumersoftenlackknowledgeofbasicfinancialandinvestmentterms.•only52percentofrespondentsreportedknowingthatdiversificationofinvestmentsreducesrisk.

•individualsage65+arelesslikelythanallotheradultstohavecheckedtheircreditreports.

PRODUCTS TO HELP YOUGRIP, GRASP AND REACH

DON’T QUITE HAVE THE STRENGTH OR AGILITY to easily grip open that food container, grasp those gardening shears or load that hard-to-reach washer/dryer? Some forward-thinking makers of household appliances and tools are carefully adjusting the design of their prod-ucts to better suit aging consumers. In some instances, they are find-ing that redesigned products for this demographic can actually at-tract a trans-generational following that greatly appreciates the more thoughtful design. Among the early participants in this trend was Oxo International, a division of Helen of Troy Ltd. and maker of the Good Grips line of kitchen tools. The firm’s original collection of easy-to-grip gadgets was created by Sam Farber, a retired CEO whose wife Betsey suffered from arthritis in her hands.

Farber’s goal back in 1990, when Oxo was first launched, was to develop a line of kitchen gadgets in collaboration with Smart Design, a New York-based industrial design firm, that would be easier to grip, twist, push and squeeze and yet stylish and visually appealing. Original designs were based on discussions with aging consumers, chefs and arthritis suffer-ers. Currently, Oxo produces over 350 products that use rubber grips to prevent slippage and elliptically shaped handles, like those found in the design of hammers and axes, to ensure a more secure grasp.

Today, Good Grips tools boast a wide and diversified base of custom-ers. The designs have not only won many awards but they are part of the Design Collection of New York’s Museum of Modern Art.

Farber appears to be a proponent of what is known as “universal de-sign,” or the practice of designing products that convey a modern and stylish appearance and attract a broad range of customers even though they specifically address certain issues related to the physical limitations of the aging consumer.

WEALTH WITH WISDOM


54

•olderpersonsciteexperience,familyandfriendsaskeyinformationsourcesforfinan-cialinformationandmoneymanagement.OtherfindingsfromtheAARPstudynotethat30percentofbabyboomerscite“lack

oftime”asashortcomingtotheirfinancialmanagementcapabilities;11percentreportalackofinformation;and10percentciteconfusionaboutadvicetheyhadreceived.Inad-dition,approximately4.4millionhouseholdsage50+trytomanagetheirmoneywithoutacheckingaccount;manyolderconsumerskeepanongoingbalanceontheircreditcards;andthelevelofdebtandnumberofbankruptciesamongolderhouseholdsrosesharplybetween1991and2001.7

Despitetheeconomicpoweroftheagingconsumer,studiesshowthatmanyarenoteffectiveatmanagingtheirwealth.ThishasmotivatedtheAARPtoworkwiththefinancialservicesindustrytoimproveservicestotheelderly.Theseincludeincreasingfinancial literacy, improving the provision of customer information, increasing con-sumer choicesandfinancial service options, andprovidinghigher-quality advice toolder consumers.

CHANGING SOCIAL AND KINSHIP ROLES

Asindividualsmature,theirsocial,professionalandkinshiprolesandnetworkschange.Thesechangescanhaveprofoundimpactsonthepurchaseofhomes,vacations,

gifts,dining,entertainment,retirement, long-termhealthcareandotherpurchases.Becauseconsumersarenotislandsofpreferences,itisimportanttounderstandhowtheyaremutuallyconnectedandinfluencethepurchasesofothers.

Theagingofgroupmembersandtheextendedsocialnetworkcanchangethecon-sumptionoftheoriginalfamily.Forexample,asgrandparentsageandchoosetoliveinwarmerclimates,seasonalfamilyeventssuchasaChristmasholidayfamilydinnermaychangevenuefromalocationintheNortheasttoalocationthatiswarmerinwinterandmoreaccommodatingtoagingfamilymembers.

Similarly,theextendednetworkcaninfluencetheconsumptionofproductsandser-vicestargetedtoanothergeneration.Thepurchaseofgiftsbygrandparentsforgrand-children,forexample,candrivedemandforcertaintoys,clothingandotherproducts.Alternatively,thepurchaseofgoodsortheconsumptionadviceofferedbyadultchildrentotheiragingparentscanimpactconsumptionbehaviorsinavarietyofindustriesrang-ingfromtravelandleisuretohealthcare,education,workbenefitsprograms,lifeinsur-ance,financialservicesandrealestate.

THE SURGING POWER OF THE AGE 50+ CONSUMER

ACCORDING TO A U.S. CONSUMER EXPENDITURE SURVEY, consum-ers age 50+ have accumulated more wealth and have more spending power than any other age group in history. In addition, they spend more than $1.7 trillion on goods and services each year; control 50 percent of all discretionary income; are responsible for 75 percent of all prescription and drug spending; own 65 percent of the net worth of all U.S. households; and are responsible for 60 percent of all health care spending. Other analysts say that the numbers for this particular consumer category will only grow exponentially in the years ahead.

Source: “No Age Limit: Advertisers Craft Pitches to Appeal to Over-50 Boomers,” The Dallas Morning News, Oct. 31, 2004.

WEALTH WITH WISDOM


55

Likefamilynetworks,othersocialandprofessionalnetworksalsoinfluenceconsump-tions.Aspeopleage,theirnetworksbecomeincreasinglycomplexandoverlapasindivid-ualstakeonmultipleroles.Thesechangesinsocialandprofessionalrolesandnetworksyieldcomplexandinterrelatedneedsandconsumptionbehaviorsinage50+markets.Thusconsumptionisnotalwaysanindividualactionbutcanbecomeacollectiveactionofconsumers,theirfamiliesorothernetworkparticipants.

Thesechangesmakeforacomplexage50+marketplace.Someofthechangescanbemodeled,butforothersthereismuchwedonotknow.Canpersonal relevance contrib-utemeasurablytohow,whatandwhereconsumersbuy?Personalrelevancereferstohowmuchaspecificissueconcernsthecustomer.Itcanbeinfluencedbythecustomer’srelationships,priorbeliefsandavarietyofotherfactors.

Forexample,U.S.babyboomersaresaidtofocusonproducts,services,andinfor-mationthatreflecttheirsearchforhealthylifestyles,diet,exercise,comfortandim-age.Wehaveseenpeaksinsalesofbottledwater,non-fatfoods,dietbooks,non-stickfryingpans,spaservicesandcosmeticsinrecentyears.Anti-agingisthemantraofmanyolderAmericansandservesasapersonallyrelevanthandleinpackagingandadvertisingfortheseconsumers.Oneapproachtorespondingtothisgroupinvolvesreconnectingthemtotheirexperiencesasyoungpeoplefrommusictosharedeventsthat shaped their generation.

ALIGNING OFFERINGS TO AGING CONSUMER MARKETS

Despitethechallengesofmodelingcomplexdimensionsofcustomerintentandbe-haviors,anumberofcompaniesarealreadybeginningtoaligntheirproductsand

offeringstochangingcharacteristicsoftheage50+market.WhenFordMotorCompanydiscovereddriverfatalityrateswerehigherfordriv-

ersovertheageof50, itbegantoseekwaysto increaseoccupantsafetyforthesedrivers, including crash avoidance, crashwor-thiness and post-crash assistance.8 But howcould engineers and designers understand and experience the physical limitations thataccompanyoldage?

To address this challenge, Ford engineerscreated the Third Age Suit, which looks likea cross between a beekeeper’s protective gearandanastronautsuit.Wearingthesuitletsen-gineers simulate mobility, strength and some of thevision limitationsofsomeonenearly30years older. The suit adds bulk and restrictsmovementinkeyareasofthebodysuchastheknees,elbows,stomachandback.Gloves thatlessenthesenseoftouchandgogglesthatsim-ulatecataractsalsoreducecapabilities.Devel-opedin1994,theThirdAgeSuithasbeenusedinthedesignofmanyFordvehicles,allowingForddesignerstointroduceenhanceddesignforagingconsumers,includingeaseofentryandexitfromvehicles.

FordcontinuestousetheThirdAgeSuitintheergonomicstrainingofprogramteams,andthesuitisnowmakingitswaytootherfirmstryingtosimulateandde-signproductsandservicesfortheseniormarket.Forexample,architectsfromCapitaSymondsareusingthesuittohelpthemredesigntheDerbyCityGeneralHospitalintheUK.9

Boston-basedFidelity Investments, oneof theworld’s largestmutual fundandinvestmentcompanies,interactsinkeywayswithitscustomersthroughitswebsite.

“An information processing challenge faced by age

50+ consumers is a noticeable decline in

the ability to ignore “noise,” or irrelevant stimuli,

whether it is visual, aural, tactile, or language-related.

Noisy advertising that works for younger

customers may backfire with age 50+ customers.”

WEALTH WITH WISDOM


56

To improve the interaction,Fidelity’susability labhasbeen researching, throughunobtrusive observation and a series of “talk-through” sessions, how older usersnavigateitswebsites.Theresultshavebeenfruitful.10

Olderparticipantstendtoreadmostofthetextonapageandtobemorecautiousin everything theydo on theWeb, including clicking on links.Theyprefer largertext;aremorelikelytoclickobjectsthatlook“clickable,”includingbulletsandhead-ings,andtheyhavedifficultyclickingsmall text links.Numerousexperientialdif-

ferences contribute to older users’ overalllevelofconfidenceandanxietyinusingtheWebandtheyoftendonotunderstandtheterms that younger users consider common knowledge.Fidelity is incorporating theseinsights into an improved website designfor easiernavigationand taskaccomplish-ment by aging users.

In2003,WaltDisneyrolledout“MagicalGatherings,”anofferinglargelyaimedatpeo-pleover50whoareorganizingoutingswithfriends, grandchildren and former school-

mates.Theprogramallowscustomerstouseawebsitetoplanthetripandsimplifythecreationofacommonitinerary.“MagicalGatherings”ishighlyappealingtograndpar-entswhowanttotravelwiththeirgrandchildren,andDisney’sthemeparkscontinuetobeapopularvenueformultigenerationalfamilyvisits.11Thisofferingcleverlytapsintothesocialandkinshipnetworksofagingconsumers,creatingasocial landscapethatincludeseveryoneinthegroup.Fromrides,showsandentertainmentoptionstodiningandrecreationalrecommendations,thecompanyrecommendsexperiencesthatcanbeenjoyedtogether,withouthavingtoseparateorsplitupacrossgenerations.12Serviceindustriesthatdiscoveropportunitiestotapintothenetworksofseniorconsumershavetheoptionstocreatenewofferingsandtapnewrevenues.

Anothercompanyenteringtheage50+marketistheSagaGroup,basedintheUnitedKingdom.Sagaisdedicatedtoservingcustomersage50+.Saga,whichwasoriginallyadirectmarketerofvacationstoseniors,nowoffersservicesrangingfromalifestylemag-azinetofinancialservices(investmentsandinsurance),vacationtravel,healthproductsandadvice,andradiochannelstargetedtothetastesofage50+consumers.

Sagaalso enables its clientele to bettermanageand tap into their socialnet-works.Saga.co.uk,theonlineportaltoservicesfortheage50+market,has“com-munity”featuresthatallowuserstosearchforoldschoolfriends,colleagueswhohaveservedpreviouslyinthearmy,etc.,andallowsforconnectionsamongthosewithcommoninterests.

Therearetremendousopportunitiesandeconomicimperativestoservethismarketbetter. To profitably seize the opportunities,managersmust understand how seniormarketsevolveandadaptproductsandserviceofferingsalongmultipledimensionstomeettheneedsofseniorconsumers.

LESSONS FOR MANAGERS

Toofewcompanieshavepaidattentiontoandthoughtfullyadaptedtheirproductsandofferings toage50+markets.Followingour frameworkand theexamples of

companiesadaptingtoagingmarkets,wesuggestthreestepsthatmanagerscantaketotapintothismarket.

Walk a mile in the customer’s shoesAstheexamplesofFordandFidelity illustrate, it is important tounderstandthe

“Unless managers immerse themselves in the world

of aging consumers, observing and conversing

with them, they are unlikely to understand the customers and recognize

their true needs.”

WEALTH WITH WISDOM


various changes age 50+ customers undergo as they get older. Our framework(Figure 2) provides some guidance about these changes, but to really understandthesecustomersthereisnosubstituteforfirst-handexperiencetotestnewproductandserviceideas.

OnewaytosimulatetheexperienceistowearanagesuitasFordengineershavedoneortrytopickupyourproductatasupermarketorretailstoreandtrytoopenit.Isaccesstotheproductconvenient?Istheproducteasytouse?Isitlikelytomeettheneedsofanage50+customer?Ifitisafashionproduct,willitwearaswellonanage50+customerasitdoesona22-year-oldmodel?Takeawalkthroughyourstorewithagroupofage50+,60+,70+and80+customersandletthemtellyouwhatisgoingthroughtheirmindsastheybrowseandpickupitems.

Unlessmanagersimmersethemselvesintheworldofagingconsumers,observingandconversingwiththem,theyareunlikelytounderstandthecustomersandrecognizetheirtrueneeds.Similarly, employeesand customer service representativeswillneed tobetrainedtorespondtotheuniqueneedsofagingconsumers.Companiesmayalsoneedtotapintotheage50+workforceasretirementscutintotheavailabletalentandskillbase.

Analyze and fix the easy things firstBasedonabetterunderstandingofcustomers,managerswillneedtomodifytheirofferingstoage50+markets.Someofthemodificationswillbestraightforward,oftenfocusedontheshoppingenvironment,whileothers,focusingonproductandserviceattributes,willrequiregreaterstudyandchange.Basedonouranalysis,wehaveidentified numerous responses to make products and service offerings more age-friendly(Figure3).

Considerourvisit toaBostonareashoppingmall.Amid-afternoonvisit revealed

FIG.3 ALIGN WITH AGING ON MULTIPLE DIMENSIONS

Source: Deloitte Research

• Improve facilities

• Simplify and clarify signage, marketing materials, décor

• Difuse lighting and reduce glare

• Reduce background noise

• Redesign products and services

• Eliminate distracting or irrelevant stimuli from communication vehicles

• Offer a sense of comfort in new situa-tions — reduce learning requirements

• Make messages clear and easy to remember

• Offer opportunities to self-pace new information

• Sensitize and train staff

• Simplify communication of money management alternatives (finances)

• Reduce intergenerational frictions and increase collaboration

• Offer flexible transitions into retirement or reduced work

• Tap into social networks to uncover consumption preferences and priorities

• Provide opportunities for individuals to connect with their family and friends in multiple contexts

Mobility, Vision, Hearing

Income flow shifts, Resource reallocation, addition, subtraction

Memory, Information Processing

Role shifts, Lifestyle changes

Biological

Economic

SocialPsychological PersonalRelevance

WEALTH WITH WISDOM 57


58

crowdedandnarrowwalkways,hardfloors,kioskspokingall sorts ofprops into theaisles at head level, and a long stretch ofwalking areawith a fewwooden benchessparselyplaced inthemiddleof foot traffic.Mostshopshadnoseatingbecausetheystuffedtheaisleswithmerchandise.Similarly,cafesandsnackshopshadverylittleornoseating.Alargefoodcourt,surroundedbymultiplevendors,wasnoisyandcrowded;

noisepollutionfrommultiplesources,lightglarefrommallsignsandaclutteredvisualfield from multiple kiosks created a dis-tractingenvironment.

Clearly,thisisnotthemostwelcomeen-vironmentforanolderconsumer.

Mall managers canmake a number ofsimple adjustments to enhance the shop-pingexperienceforage50+customers.Bet-terfloordressing(e.g.,carpettilestoreducenoise),adjustmentsinkioskplacementanddisplays, larger signage, non-glare lighting

andincreasedsittingareaswithmorecafescanofferaninfinitelymoreenjoyableexperi-encewhileaccommodatingabroaderspectrumofshoppersandvisitors.

Indeed,wenoticed that a fewanchordepartment storeshaveadded seatinginmultiplelocationswithintheirstorestoaccommodateconsumerswhoneedashortrestwhileshopping.Simplechangesbasedonanunderstandingofthebio-logicalandcognitivechangesconfrontingage50+customerscangreatlyenhanceshoppingenvironments.

Research and redesign for older consumersWhilesomechangestotheshoppingenvironmentcanbeundertakeneasily,others,es-peciallychangestoproductandserviceattributesandconnectionstosocialandothernetworksthatinfluencepurchase,requirecarefulresearchandredesign.Anyaspectoftheproductandshoppingexperiencecanmeritcriticalreview.AstheFordMotorCom-panyexampleillustrates,thereisasignificantbenefittoresearchingthechallengesofage50+consumersmethodically,adaptingproductstotheirneedsandpre-testingthemwitharepresentativesamplebeforerelease.Thisappliesaswelltothepackag-ingandcommunicationscampaignforsuchproductsacrossdifferentchannels,bothonlineandoffline.Themosteffectivedesignresearchwillincludedirectobservationofcustomersintheircontextsforproductorserviceconsumptionandconversationstoelicittheirpreferences.Ofcourse,informeddesignofproductsforage50+customerscan also appeal to many people in younger age groups.

Itisalsoimportanttofactorinthecognitivecapabilitiesoftargetcustomersduringtheproductredesign.Doproductgenerationshiftscreatetoomanycognitivedemandsoncustomers?RememberMarthaSmith.Whileamodernmicrowavehasanumberofdigitaloptions,Marthaisprobablymostfamiliarwithtwoknobs:onetosetthetimerandanothertosetthepower.Thisisasimpleanalogsolutionthatisrarelyavailableonamicrowavedisplaytoday.Asaresult,Marthadevelopedherownsolutiontomanagingtheinterface.Keepingtheoptionofanolderandfamiliarinterfacemaysometimesberemarkablyvaluable.

Brandshavebeenonemeansofreducingthecustomer’sinformationprocessingre-quirements.Astheage50+marketemerges,itisvitaltoconstructbrandmessagesthatareage-neutralandinclusiveoftheage50+market.Brandsthatappealoveralifetimetoconsumersatvariouslifestages,likeCocaCola,arelikelytobecomemorevaluableinthefuture.

Anotherarearequiringresearchandthoughtfulinvestmentincludesthesocialand

“The most effective design research will

include direct observation of customers in their contexts for product

or service consumption and conversations to elicit

their preferences.”

WEALTH WITH WISDOM


59

Endnotes

1 ThisexampleisadaptedwithpermissionfromapresentationbyDr.WilliamGribbons,directorofBentleyCollege’sHumanFactorsandDesignPrograms.

2 U.S.CensusBureau,2000.

3 Vaupel,J.W.andJeune,B.,“TheEmergenceandProliferationofCentenarians,”inB.JeuneandJ.W.Vaupel(eds.),Exceptional Longevity: from Prehis-tory to the Present — Monographs on Population Aging,2,Odense:OdenseUniversityPress,1995.

4 A2001SocialSecurityAdministrationstudyfoundthatfortheelderlyover65:90percentreceivesocialsecurity,62percentreceivedincomefromotherassets,43percentreceivedincomefrompublicandprivatepensions,and22percentcontinuedtoearnwagesandotherincome.

5 Consumer Expenditure Survey,U.S.DepartmentofLabor,BureauofLaborStatistics.TheAARPperformedanextensiveanalysisoftheU.S.DepartmentofLabor’sconsumerspendingdataandfoundthattheincreasesinmarketshare(52percentin2001,upfrom47percentin1984)werenotlimitedtotheBoomers-themarketshareofconsumersage75andolderalsoincreasedduringthesameperiod.

6 Spotts,Harlan,Jr.andSchewe,Charles,“CommunicatingwiththeElderlyConsumer:TheGrowingHealthCareChallenge,”Journal of Health Care Marketing,9(3),1989.

7 TakenfromBeyond 50.04: A Report to the Nation on Consumers in the Marketplace, AARP.

8 “FordResearchBenefitsSeniorDrivers”Automotive Engineering International,TechBriefs,Jan2001.

9 “TheSuitthatMakesYouFeelOld”BBCNews,August2004.

10 Web Usability and Age: How Design Changes can Improve Performance,AnnChadwick-Dias,MichelleMcNultyandTomTullis,FidelityInvestments,FidelityCenterforAppliedTechnology,HumanInterfaceDesign.PresentedatAgingbyDesignConference,BentleyCollege,Waltham,MA,2004.

11 “MultigenerationalGatheringsatThemeParks,”Smarter Travel,June2004.

12 http://disneyworld.disney.go.com/wdw/special/magicalgatherings/landing?id=MagicalGatheringLandingPage

relatednetworks that influence purchase decisions. If, likeSaga, one is to create orfacilitatecommunityinteractions,whatcommunitiesshouldbeselected?Whatwillbetherulesofparticipation inthecommunity?Whataretherisksversusthepotentialbenefits of the community interaction?Should your product or service be advertisedoraffiliatedwithcommunitiesdevelopedbyothers?Theseareemergingchallengesformarketingtobothseniorsandothersegmentsasconsumersincreasinglyparticipateinvirtualcommunities.

Beyond understanding the communities, cognition, and economic and biological pro-filesofage50+consumers,perhapsthemostchallengingpurchaseinfluencefactorstodeterminewillbethepersonalrelevanceofproducts,servicesandcommunications.WillspecificbuyervaluesdrivethepurchaseofaHummeroraPrius?Someanswersmaybeinferredfromthesetofnetworksinwhichthecustomerparticipates.Otherinferencesaboutbuyeridentityandshoppingmotivationsmayresultfromcarefulconversationswith,andobservationsof, customers.Whatare theexperiencesandcultural iconsofmostimportancetocustomer?Howaretheylikelytoshapethepreferencesofthecus-tomer?Oneapproachtoaddressingthisuncertainty istodevelopscenariosbasedonobservationsandinterviewsofprospectiveandcurrentcustomerstounderstandlikelyfactorsthatwillimpacttheirpurchases.Companiescanthendevelopstrategiesforal-ternativedriversofpersonalrelevanceandselectandscaleresponsesasfurtherinfor-mationbecomesavailable.

Finally,afourthareameritingresearchandredesigniscustomerservice.Salespeo-plerequirebettertraininginrecognizingtheuniqueneedsofseniorconsumersandpro-tocolstocommunicatewiththemandsolvetheirproblems.Fewcompaniesincorporatethisexplicitlyintotheirtrainingprograms.

CONCLUSIONS

Themajordemographictrendtowardincreasedlongevityandmorepeopleaged50+createsnewopportunitiesacrossmultipleindustries.Wehavepresentedaframe-

workforsystematicallythinkingthroughfourkeydimensionsofchange,andonewhichconsidersthefifthdimensionofpersonalrelevancethatmaybepartiallyshapedbytheotherfactors.Understandingtheuniqueimpactsofagingonvariouscustomerdimen-sionsisthefirststeptoreshapingbusinessesandtappingprofitablyintotheopportuni-tiesofemergingage50+markets.DR

Cabrini Pak,a research associate in Deloitte Services LP, focuses on demographic research and leads Deloitte Research’s Survey Advisory Services.

Ajit Kambil is global director of Deloitte Research, Deloitte Services LP.

WEALTH WITH WISDOM


60

PHOTO: TK

OnConvergence:A CONVERSATION WITH FORBES PUBLISHER RICH KARLGAARDINTERVIEW BY ED MORAN > EDITED BY PAUL LEE

Almost two years ago, Deloitte Touche Tohmatsu’s (DTT) Global Technology, Media and Telecommunications Group (TMT), made up of the TMT practices of DTT member firms, held the first of a series of Convergence Forums among 25 senior industry figures, designed to discuss the importance of an issue that at the time was awash in ambiguity and contradictions.

Each executive brought an original, valid perspective to the discus-sion. In late 2006, the edited version of these discussions was published in book form as ConvergenceConversations. Following is an excerpt from the book.

RichKarlgaardisthepublisherofForbesandtheauthoroftheweeklycolumn“DigitalRules.”Hewritesabout technology,entrepreneur-

ship,regionalandeconomicaldevelopment,andthefutureofbusinessandwork.HefrequentlylecturesonthesesubjectsandisaregularguestonFoxNewsChannel’s “ForbesonFox.” In2005,hebeganwritingadailyblog,whichappearsonthehomepageofForbes.com.Rich joinedForbesin1992tostartForbes ASAP,atechnologymagazine,alongwithForbesCEOandEditor-in-ChiefSteveForbes,andthefuturistandwriterGeorge Gilder. At Forbes ASAP,hecommissionedoriginalworksbyTomWolfe,JohnUpdikeandothernotableAmericanwriters.Heco-founded

twocompanies(GarageTechnologyVenturesin1997andUpsideMagazinein1988)andonecivicorganization(the5,500-memberChurchillClubin1985).

ForbesIncisafamily-ownedbusinessthatpublishesthebusinessmagazineForbes.Thecompanyalsoproducesa range of other titles, includingForbes FYI, American Heritage, and American Legacy. Inaddition, thecompanyoperatesapopularWebsite (forbes.com),organizesavarietyofbusiness-relatedconferences,andpublishesnewslettersandcustommagazinesforawiderangeofclients.ThecompanyisbestknownforitsannualForbes500rankingoftheworld’slargestandmostsuccessfulorganizations.

MORE AND MORE PEOPLE ARE GETTING NEWS FROM THE INTERNET. WHAT DOES THIS IMPLY FOR THE PUBLISHING INDUSTRY, INCLUDING FORBES? Ourwebsite,forbes.comisexperiencinga60percentannualgrowthinvisitors,anda50percentgrowthinrevenue.Atcurrentrates,we’regoingtogeneratemoreadvertisingrev-enuefromthewebsitethanfromthemagazinebylate2007orearly2008atthelatest.Ofcourse,we’renotgoingtosustain60percentgrowthforever,butwe’dstillexpecttogrowatasignificantrate.

Isthemagazinedoomed?Idon’tthinkso.Wheneveranewmediumappears,everyonepredictstheoldmediaaregoingtogooutofbusiness.Butthat’snottrue.Justlookatradio.Whenitwasfirstlaunched,radiooriginallyjustbroadcastcomedyanddrama.Televisioncamealonganddisplacedradioinbothoftheseareas.ThenasingerwithlongsideburnsfromMississippiappearedandradiobecameamediumforrockandroll.Thetransistorradio

Rich Karlgaard

is the publisher of Forbes magazine.

He writes and lectures about

technology, entrepreneurship,

regional economic development, and the future of busi-

ness and work.

Q+A: RICH K ARLGAARD


60

61

wasbeinglaunchedataboutthesametimeandasaresult,radiowasreborn.NextcameFM,whichgaveafurtherboosttoradio.Thensportsandtalkradiosemerged.Soratherthandying,radiohasproliferated.

Moregenerally,Ithinkthatforanymediumtosucceed,ithastoidentifywhatitcandothatalltheothermediacan’t.Byimplication,magazinesnowhavetofocusonwhattheWebcan’tdeliver.Inourcase,ourfortnightlyschedulehasmeantthatForbeshasalwayshadtodifferentiatebyfocusingonpredictions,notnews,andofferingcontrarianopinions.Ithinkouruniqueangleonworldeventsmeansthatwe’restillgrowingouradvertisingrevenuefromprint-uniquelyamongourcompetitors.

DO YOU THINK PRINT WILL ALWAYS HAVE ITS PLACE? Printwillalwayshavesomekindofadvantage.Forone,it’sextremelyportable.Furthermore,foranyarticlethat’sover800wordsandthathasphotographsandillustrations,printisstillpreferable.Andcrucially,asthevolumeofinformationcontinuestoexplode,thevalueofaneditorwhodistillsthingsforthereaderandgivesacoherentworldviewwillgrowconsiderably.

Ithinkmagazinesareinadecent,stableshapeingeneral,asarelocalnewspapers.How-everit’stheurbandailiesthatareintroubleandwillcontinuetobeintrouble.Propertywebsitesaregoingtotakeoutabigchunkofrealestateadvertisingfromnewspapers.Newsweeklieshavetofigureoutwhattheiruniquesellingpropositionis.

YOU HAVE MAINTAINED YOUR BLOG, DIGITAL RULES, FOR 10 MONTHS NOW. IS BLOGGING HAVING AN IMPACT ON THE PUBLISHING WORLD?

Thereare70millionormoreblogsoutthereandmorearebeingaddedeveryday.Thevastmajorityofblogsareverypersonalanddiary-like.Butwhenyougotosomeoftheprofessionalnewsandopinionwebsitesandseewhattheeditorshaveselectedasthebestcolumnsandopinioneditorials,youfindthattheydon’tdiscrimi-natebetweenprofessionalwritersandbloggers.Some20percentoftheircontentcomesfromblogs.

Idon’tthinkit’spossibleforbloggerstosaysomethingoriginaleveryday,buttheycanprovideaninterestingcommentonsomeoneelse’soriginalmaterialonadailybasis.Infactthat’swhatIdidinmyblogtoday,withalinktothesource.Theabilitytolinktosomeoneelse’scontentisagreatgamechanger.

HOW ABOUT PODCASTS?Therearesomanynewmediaalternativestochoosefromintheconvergedworldthatthere’sa real temptation to blast out in a million directions. Forbes currently has access to more capitalforexpansion,andit’stemptingtogoinlotsofdifferentdirections.However,rightnowthewebsiteisgrowingsofastthatwecanonlyexecuteonourcurrentplansandpodcastsdon’thaveaparttoplay.

Videopodcastsmaybeafewyearsaway.Whenthereisthebandwidthtodoasmuchvideoasaudio,whentheproductioncostsofvideocomedown,thenvideopodcastsmaybe-comemorefeasible.Itisbecomingcheapertoproducevideo,butit’sstillasignificantexpensetohaveastudiothatcanprojecttelevisionqualityontheWeb.Youcan’tuseawebcamsittingontopofaPC!

WHAT TRENDS, APART FROM THE EMERGENCE OF NEW TECHNOLOGIES, DO YOU THINK WILL DRIVE THE EVOLUTION OF CONVERGENCE?Onekeytrend,whichacolleaguerecentlywroteabout, is themash-upeconomy,where-bypeopleandcompaniescombinedifferentelementstocreatenewproductsandservices.Mash-upsarebecomingincreasinglyfeasibleassoftwarebecomesmorestandards-based.Cleverpeoplearemashingupvariouscomponentsandevensomesoftwarecompanies,likesalesforce.com,areencouragingtheiruserstomashupothertechnologywiththeirsto

“Is the magazine doomed? I don’t think so. Whenever a new medium appears, everyone predicts the old media are going to go out of business.”



62

createnewapplications.Tome,thisapproachisapowerfulcontributortotheoverallvalueofconvergence.

AnotherkeytrendiswhatIcallinmycolumn“thebacksideofMoore’sLaw,”orthe“cheaprevolution.”Everyone’sfamiliarwiththefrontsideofMoore’sLaw:adoublingofprocessingpowerevery18months;adoublingofbandwidthspeedsevery12monthsandadoublinginstorageeveryninemonths.Butthebacksidemaybemoreinteresting.Pricesfortechnology-basedproductsataconstantperformancelevelaredropping30percenteveryyearandabout50percenteverytwoyears.Thisismakingtechnology-basedproductsincreasinglyaffordableand hence accessible.

THERE SEEM TO BE MANY SMALL START-UP BUSINESSES MAKING WAVES IN THE WORLD OF CONVERGENCE. WHY DO YOU THINK THAT IS? The incumbents inany industryare obsessedwithgrowing their revenues to satisfy theirshareholders,bysay10percentperyear.Thatprecludesthemfromexperimentingandgoingaftermarketswheretheremaybeuncertainrevenue,orsmallinitialrevenues.Established

companiesarefocusedonupgradingexistingcustomers,squeezing10percentmoreoutofthosecustomerseveryyear,orelsegoingforcustomersinadjacentspaces.Becauseofthewayinwhichlargecompaniesare run there’snotmuch chance of reallydisruptivechangeorradicalinnovation.

Convergencetendstofavorpeopleandorganizationsthattin-ker.It’samazinghowmanytechnologyproductshaveevolvedoutofpeople’shobbiesorcasualexperiments.ThePCandWiFiwere

bothexperiments.Italsofavorscompaniesthatarepreparedtotakerisks,acharacteristicthat’sgenerallyrareamongincumbents.

WHAT’S THE IMPORTANCE OF BRAND IN A CONVERGING WORLD? Brandbecomesmuchmoreimportantwithconvergence.Inthe1930s,themoviestudioswerethedominantplayers.Astudio’sbrandhadabearingonamovie’spopularity.Thatpowerhassincebeensupplantedbyagentsandthestars.Today,therearefewstudiosthatputarecog-nizablebrandonamovie.

There’sapossibilitythesamecouldhappenwithcontentsuchasnews,unlessyouhaveabrandthatstandsforsomething.

InForbes’case,ourbrandisbasedonafirmviewthatentrepreneurialcapitalisgreatandthislineofargumentrunsthroughoutallofouroutput.Havingapointofview,aneditorialstanceandacoherentworld-viewisagoodthingrightnow,andwillbecomeanincreasinglycriticalthingasconvergenceevolves.Ourbrandidentityiswhatwilldifferentiateusfromthecompetition,andattractconsumerstous.Itwillbeamarkofquality,consistencyandsubstance.

OF ALL THE CONVERGENCE PRODUCTS AND SERVICES, WHICH DO YOU WISH YOU HAD CREATED?Tome, ithastobeGoogle’ssearchengine.Not justbecause ithasbeenahugecreatorofwealth,butalsobecauseIuseitsomanytimeseachday.IreallydofeelIhavealltheworld’sinformationatmyfingertips.SearchwillbecomethemostfrequentuseoftheInternet,evenmore than email.

HOW DO YOU GO ABOUT SPOTTING POTENTIAL WINNERS IN THE CONVERGED WORLD?Someoneonceobservedthatthechancesofanewtechnology,productorservicecatchingonandmakingmoneyisinverselyproportionaltothenumberofoldestablishmentfiguresthatdismissit!Ithinkthat’sareasonablygoodguide.Alltoooften,theoldguardrejectswhatitdoesn’tunderstandordidn’tinvent,andthat’swhyconvergencehassomuchpotentialtodisrupt.DR

“Search will become the most frequent use of the Internet,

even more than email.”



63

THE BEST COMPANIES SEARCH CONSTANTLYforwaystouptheirgameinexecutingtheirstrategies,andgettingtherighttalentisarguablythemostimportantingredientinthemix.Butthebestemployees,managementandexecutivesstillneedanenablinginfrastructuretoensuretheyareableandwillingtobothpursueandachieveexecutionexcellence.Itturnsoutthatwe’veaccomplishedalotwithregardto‘able’—butnotasmuchwith‘willing.’

Infrastructurehastwocrucialdimensions.Theharddimension—familiarbutcomplicatedterritoryforeveryexecutive—istheenablinginfrastructure:processes,dataandtechnologies.Leadingcom-panieshaveworkedaggressivelyontheirhardinfrastructures,andrightlyso.Employeeswerehandi-cappedbyinefficientprocesses,stale,irrelevantorinaccessibledata,andinadequatetechnology.Thesecompanieshavevastlyimprovedtheirabilitytoexecutetheirstrategies,largelybyattackingunneces-sarycomplexitiesintheseareas.

Theseconddimension,thesoft,referstotheinfrastructurethatensuresthatinterestsarealignedacrossemployeesandmanagement:the‘willingness’component.Ironically,thesoftinfrastructureisthehardpart.Aligninginterestsisthemostcomplicatedpartoftheexecutionequation.

Compensationsystems,organizationstructuresandculture(thesoftinfrastructure)playavitalroleinaligningtheinterestsofthedifferentsegmentsoftheworkforce.Infact,compensationexpertshavetheirownHolyGrail:gettingallemployeestoactlikeowners.Thebasicsaren’tallthatcontroversial: Puttherightpeopleintherightjobs,measuretheirperformanceasaccuratelyaspossible,andcompen-sate them accordingly.

Oftenneglected,however,isthebalancingofperson-alrisks—theconsequencesofpoorperformance—withcompensationlevels.Individualbehaviorsareoftendrivenbyperceivedandactualrewardsrelativetorisks.Animbalanceacrosssegmentsofthetalentpoolwilladverselyimpactyourorganization’sabilitytoreapthefullpotentialoftheseemployees.Donewell,thealignmentofexpectedrewardsrelativetopersonalriskwillensurethatinterestsarealignedandencourageallemployeestoactlikeowners. Complexcompensationstructures,ofcourse,increasethedifficultyofachievingthisbalance.

Significantimbalancesintheperformanceexpectationandcompensationarrangementsacross employeeandmanagementgroupswillweakenthe‘willingness’productofthesoftinfrastructure. Becausethetalentmarketisthetightestatthehighestlevelsofexperienceandtalent,therewillalwaysbejustifiablysignificantrewarddifferentials.Unfortunately,significantdifferentialscanimpedeexecu-tionexcellencebyunderminingthewillingnessofaworkforcetofullyengage.Oneapproachtocombattheappearanceofunfairnessistoensurethatpersonalrisksarecommensuratelylowerforthenon-ex-ecutivemanagementandemployees.Aforgivingcultureencouragesmiddleandlowermanagementandemployeestotakeappropriaterisksandactmorelikeowners.Inadditiontotogglingonpersonalriskdifferentials,ensuringthevaluecontributionfromyourmosttalentedemployeesisfullyrewardedis also critical.

Withtalentincreasinglyexpensiveandelusive,itiscriticaltobemindfulofhowyourorganization’sinfrastructurewilldeterminewhetherthetalentyousuccessfullyattractdeliversthevalueyouexpect.Simplifyingthesystems,data,andtechnologyinfrastructureisimportant.Butultimatelyitmaybe thesoftinfrastructurethatdeterminesthewillingnessofbrilliantworkerstoengageinthebusiness asnewowners.

Readyandable.Possiblywilling.

Richard Woodward, PRINCIPAL

“Aligning interests is the most complicated part of the execution equation.”

PERSPECTIVE

DELOITTEREVIEW.COM DeloitteReviewDELOITTEREVIEW.COM DeloitteReviewPHOTO: AUBRIE PICK

63

64

1 2

3 4

1. DAVID CLUGSTON isastudiophotographerbasedinSeattle.

Hecreatesboldandcolorfulimagesthatarehardtoforget.David

createdthecrownimageintheService Revolution article and

thevehicleinteriorimageintheWealth with Wisdom article.

2. ANTHONY FREDA is an artist and illustrator based in

Albrightsville,Pennsylvania.HisillustrationsgracetheCulture

and the MythoftheBlack Box article and The Two Faces of

Riskarticle.Anthonycombinesfoundsurfaceswithpainterly

techniqueandthendigitizesthemtogethisuniquetextures.

3. JIM MATTERN, an artist and metal sculptor based in Gig Harbor,

Washington,createdourcrownfortheService Revolution article.

He used random industrial parts including, most interestingly,

rejectedpiecesmanufacturedforthespaceshuttlethatwereoff

byamillionthofaninch.

4. PETE STONE isaphotographerbasedinPortland,Oregon.

Pete’scareerhastakenhimaroundtheworldshootinghigh

profilecelebrities,sportsfigures,andCEO’s.Petephotographed

our“garageguys”andprovideduswiththebeautifulfootball

player photo in the Overconfidence Trap article.


64 CONTRIBUTORS

Documents

Deloitte Review — Issue 1