Innovative approaches for sustainable growth · PDF fileInnovative approaches for sustainable growth ibm.com/bcs Marc Chapman and Saul J. Berman, Editors IBM Business Consulting Services

Innovative approaches for sustainable growth

ibm.com/bcs

Marc Chapman and Saul J. Berman, Editors IBM Business Consulting Services

The growth triathlon

Eliminating the strategic blind spot

The specialized enterprise

Component business models

Plus fi ve executive interviews: – Bharti Tele-Ventures– Honda Motor Company– Napster– Procter & Gamble– Bank of Montreal


Marc Chapman and Saul J. Berman, Editors

IBM Business Consulting Services

The authors and publisher have taken care in the preparation of this book, but make no expressed or implied warranty of any kind and assume no responsibility for errors or omissions. No liability is assumed for incidental or consequential damages in connection with or arising out of the use of the information or programs contained herein.

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Acknowledgements

Thanks to the many people who contributed their time and ideas to this volume. Chiefly, of course, we owe a debt

of gratitude to the authors of the four articles that make up the bulk of the pages: Vivek Kapur, Jeffere Ferris, John

Juliano, Kevin McCurry, Saul J. Berman, Jeff Hagan, George Pohle, Peter Korsten, and Shanker Ramamurthy. Also

deserving of special thanks are the executives who generously agreed to be interviewed about the concepts discussed

in those articles: Anil Nayar, Dan Bonawitz, Chris Gorog, Filippo Passerini, Lloyd Darlington, and Karen Metrakos.

The following people aided us in numerous ways as this project proceeded on its course toward publication: Arvind

Mahajan, Jaideep Ghosh, John MacKinlay, Vineet Garg, Jennifer Sepull, Eric Pelander, Steven Foecking, Karen Keeter,

Don Gordon, Angie Casey, Kristin Biron, Bill Zobrist, Denise Arnette, Ragna Bell and Angela Suttie.

Acknowledgements


Table of contents

1 From the editors

3 A word on innovation

5 The growth triathlon Growth via course, capability and conviction By Vivek Kapur, Jeffere Ferris and John Juliano

23 Executive interview: Bharti Tele-Ventures Anil Nayar, Corporate Director

27 Eliminating the strategic blind spot Technology-driven business strategy spurs innovation and growth By Kevin McCurry, Saul J. Berman and Jeff Hagan

41 Executive interview: Honda Motor Company Dan Bonawitz, Vice President of Corporate Planning and Logistics

43 Executive interview: Napster Chris Gorog, Chief Executive Officer

47 The specialized enterprise A fundamental redesign of firms and industries By George Pohle, Peter Korsten and Shanker Ramamurthy

63 Executive interview: Procter & Gamble Filippo Passerini, Chief Information and Global Services Officer

67 Component business models Making specialization real By George Pohle, Peter Korsten and Shanker Ramamurthy

79 Executive interview: Bank of Montreal Lloyd Darlingon, President and CEO of Technology and Solutions Karen Metrakos, Senior Vice-president, Operations

83 Further reading

89 Credits

1 Innovative approaches for sustainable growth

In 1997, the formation of Iridium was announced with great fanfare. By launching and operating a global satellite network, Iridium promised truly global communi-cations capabilities – anywhere, anytime. Just two years and nearly US$5 billion of investment later, the troubled fi rm declared bankruptcy. Iridium's clunky handsets and pricey service did not fi nd the market acceptance necessary to sustain the business. The company's product and service turned out to be an interesting invention, but it missed a key ingredient for innovation – business insight.

The word “innovation” is often embraced as an ideal refl ecting novel and creative customer offerings, operating models and business strategies. But innovation can and must be made practical – an idea echoed by Michael Tushman in the pages that follow, as well as in much of his work. We believe that the creative application of technology combined with unique business insight is the essential means to innovation.

In this volume, the IBM Strategy and Change consulting practice and the IBM Institute for Business Value address the innovation challenges faced by CEOs. The four articles prescribe actions that your fi rm

can take to support innovation and sustainable growth. Through these perspectives, we establish an imperative for revenue growth, recommend an approach for business insight, demonstrate the need for specialization and illustrate a model for organizational success.

The fi rst article – “The growth triathlon: Growth via course, capability and conviction” by Vivek Kapur, Jeffere Ferris and John Juliano – addresses the factors that constrain growth and identifi es the levers that drive it. The authors assert that sustainable growth requires companies to be all-around performers. While triathletes must excel at swimming, cycling and running, companies need to perform successfully in three vital areas: course, capability and conviction. The strongest growers choose and set the right course through a clear view of the future. They are able to evolve their offerings and markets while they simultaneously pursue initiatives that reinforce the strength of their competitive model. Successful growers also have an in-depth understanding of their capabilities. They embrace a realistic view of strengths and weaknesses and evolve their operating model to support a feasible growth strategy. And lastly, the best growth fi rms

have a culture of conviction that supports the move from strategy to execution and creates organizational commitment from top to bottom.

Kevin McCurry, Saul J. Berman and Jeff Hagan explore how strategies can be developed in “Eliminating the strategic blind spot: Technology-driven business strategy spurs innovation and growth.” The authors build upon the foundation of the growth article and demonstrate that invention is not the same as innovation. Invention has little value without the business insight that determines how technological capabilities can be applied. And it’s not just a game of offense, but of defense as well. Market insights that are not pursued will lead to competitive threats from new entrants and other opportunists. Firms must include technology in business strategy development, as the speed, depth and breadth of technology’s reach extends to virtually every product and industry. Without fully considering the impact of technology, fi rms create a blind spot where competitive danger lurks.

George Pohle, Peter Korsten and Shanker Ramamurthy contribute two complementary articles to this volume. “The specialized enterprise: A fundamental redesign of fi rms and industries” highlights

From the editorsMarc Chapman and Saul J. Berman, IBM Business Consulting Services

From the editors

2

“We establish an imperative for revenue growth, recommend an approach for business insight,

demonstrate the need for specialization and illustrate a model for organizational success.”

the need for CEOs to simulta-neously achieve differentiation, responsiveness and effi ciency to be successful in today’s marketplace. As the global connectivity platform automates processes and reduces collaboration and transaction costs, companies are taking advantage of the expertise and scale that lies hidden in their own organizations and across the globe. By assembling a business model fashioned from groups of “specialized” capabilities, companies are now able to create hybrid business models that break through preconceptions of what their businesses can achieve. To thrive in this new world, companies must rethink the structure of their industries and their own business models. Ultimately, they must specialize in the few activities that confer absolute advantage in the marketplace while relying on external specialists to provide the capabilities that do not.

The authors’ second article – “Component business models: Making specialization real” – provides a framework and methodology for embracing special-ization. Component Business Modeling (CBM) is a proprietary framework developed by IBM Business Consulting Services which allows executives to identify the unique building blocks of an

enterprise. The article provides a comprehensive overview of CBM, including key defi nitions with real examples of components in action. The authors also provide the reader with a road map that translates strategy to implementation and supports the movement toward becoming a specialized enterprise. Importantly, the article highlights the success of three prominent fi nancial services fi rms – Allied Irish Bank, SEB Group and KB.

After each of these articles, we bring in an outside view through an interview with a senior executive whose company is grappling with some of the very concepts the articles describe. First, Anil Nayar of Bharti Tele-Ventures describes how they maintain their position as one of India’s fastest growing companies. Then, Dan Bonawitz of Honda Motor Company, and Chris Gorog of Napster, each describe how technology envisioning plays a key role in the success of their respective companies. Then Filippo Passerini of Procter & Gamble talks about his company’s drive toward special-ization. Finally, Lloyd Darlington and Karen Metrakos, both of Bank of Montreal, share their views on the power of Component Business Modeling.

The perspectives in this volume are a fraction of the fact-based research on industries and services produced by the IBM Institute for Business Value every year. We have provided highlights of additional studies at the end of this volume; in addition, our Global CEO Study 2006, focused on innovation, is currently under development. Please take the opportunity to visit ibm.com/iibv and browse through our collection of other papers.

Today’s CEOs face many chal-lenges, from intense competition to pervasive globalization to widespread digitization, all in the context of a shifting and unpredictable geopolitical environment. We hope that the feature articles and the executive interviews in this volume will inspire you to pursue a sustainable growth strategy.

Regards,

Marc ChapmanGlobal and Americas Leader, Strategy and Change Practice

Saul J.BermanGlobal and Americas Leader, Business Strategy


A word on innovation

In our book, “Winning through Inno-vation: A practical guide to leading organizational change and renewal,” Charles O’Reilly and I noted a universal pattern: success followed by failure, innovation followed by inertia. Even the most innovative organizations seem bound to rest on their laurels, until competitive or marketplace forces compel them back to the drawing board. In exami-nations of hundreds of companies, it seems that most businesses remain uncertain about how to integrate a proactive approach to innovation into day-to-day operational activities. However, by looking at companies that are able to renew themselves on a consistent basis, we can draw some instructive conclusions.

First, successful companies are able to balance short-term neces-sities – like driving toward effi ciency – with a longer term outlook. This blended view requires a strong sense of when to encourage inno-vation and when to make radical changes to renew the organization.

By combining an understanding of the necessities of today with a strong vision of tomorrow, companies can sometimes avoid the prevailing success-failure cycle. Clearly, this balanced approach is one that must be embraced at the highest levels of the company, and refl ected in its approach to people, organization and technological infrastructure.

Managers also must understand how success can be a double-edged sword. In other words, the more successful an organization is in the short term, the harder it may become to adapt over the long term. Once again, what we’re talking about here is balance – in this case, fi nding ways to stimulate both innovation and effi ciency. By developing what we have termed streams of innova-tion, organizations can run counter to the powerful (and necessary) forces of stability that might otherwise hinder adaptation and change.

We spoke above about people, organization and technology. The emphasis on technology is not

insignifi cant. Although not always the case, it is often true that a market-place innovation takes place in the technological realm. It is the emer-gence of industry standards and subsequent radical departures from them that make up a technology cycle. These cycles consist of funda-mentally different kinds of innova-tion – what we have above termed innovation streams – that are found across all markets. To succeed over the long term, organizations must not only manage innovation, but innova-tion streams.

To take a simple example, you might think of the automobile supplanting the horseless carriage. As the automobile was emerging, there was substantial competition among alternative technologies, energy sources (steam, battery, internal combustion), steering mechanisms, and the like. However, the Model T Ford quickly emerged as the dominant design. Key elements of the design included an internal

A word on innovationMichael Tushman, Harvard Business School

4

“To succeed over the long term, organizations must not only manage innovation, but innovation streams.”

combustion engine, steering wheel on the left, brake pedal on the right, clutch on the left, and so on. After this rapid change, a period of incremental change ensued – until General Motors introduced the fully enclosed steel automobile. More recently, innovation streams have challenged traditional corporations – from AT&T in the communications industry to Xerox in the document processing industry.

From the case of the car, you can understand the challenge of managing technology cycles and innovation streams. Even without the pressure to grow and succeed, managers must constantly readjust their strategies and realign their organizations to shape or refl ect the underlying dynamics of techno-logical change in their markets. For one thing, profound shifts in innova-tion streams change the bases of competition – which, in turn, creates the need for revolutionary rather than incremental organizational change. Winning through innovation hinges

on understanding the dynamics of technology cycles and innovation streams, and being able to proac-tively shape innovation streams through discontinuous organizational change. In other words, only by thinking creatively, and continuously, about the way organizations are structured can we begin to ensure that the path is laid for doing what they do best. If innovation is to be one of those things, then the chap-ters in this volume have much to contribute to that discussion.

Michael TushmanProfessor of Business AdministrationHarvard Business School



Course

Capability

Conviction

6

IntroductionGrowth is back on the CEO agenda after years of cost-cutting and risk management. But as companies turn their attention to growth, the question they confront is not “why,” but “how.” What factors constrain growth? And what are the levers to drive it?

A study by the IBM Institute for Business Value suggests that limits to growth are often self-imposed and, as such, can be overcome. Successful growers break free of perceived constraints related to size, industry boundaries and geographic neighborhood. Contrary to the common belief that mergers and acquisitions (M&A) inherently destroy value, successful growers can use these strategies effectively. And while they may not succeed with every initiative or exceed Wall Street’s expectations every quarter, successful growers possess the conviction and resilience they need to recover from setbacks and return to a growth path.

To achieve lasting, value-creating growth, companies must be all-around performers. Just as winning a triathlon requires an athlete to excel at swimming, cycling and running, winning the growth game requires companies to excel in three vital areas: course, capability and conviction. Successful growers set the right course – or growth direction – by forming a clear point of view on the future, evolving the product-market portfolio without being limited by history, building a competitive model to win and pursuing reinforcing initiatives to sustain growth. They truly understand their capabilities – based on realistic assessments of strengths and limitations – and evolve the operational model to support the growth strategy. Finally, while many companies develop excellent plans, truly successful growers build organizationwide conviction that translates intent into living, breathing action on the front line.

Join us for a review of our research and our learning on how you can win your growth triathlon!

The return of growthIn a 2004 IBM study of over 450 global CEOs, an overwhelming majority cited growth as the top priority for driving their companies’ performance.1 This marks a distinct break with recent experience. After concentrating on cutting costs and managing risk in the years following the market crash of the early 2000s, companies are once again turning their attention to growing the business (see Figure 1).

The growth triathlonGrowth via course, capability and conviction

Figure 1. Growth is back on the CEO agenda.

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90

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20

10

0Revenue growth

Cost reduction

Asset utilization

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Risk management

39.239.8

67.8

Source: “Your Turn: The Global CEO Study 2004," IBM Business Consulting Services. 2004.


By Vivek Kapur, Jeffere Ferris and John Juliano

Innovative approaches for sustainable growth7

The case for growth has always been self-evident. At an enterprise level, growth creates shareholder value, advances careers and makes work more rewarding. From a societal perspective, growth drives the economy, creates jobs and improves quality of life by bringing new products and services to the world. The challenge for executives seeking growth is not “why,” but “how.”

To investigate what successful companies do to achieve growth, and sustain it over long periods, the IBM Institute for Business Value conducted a global study that focused on three questions:

• Who are the successful growers and what patterns are associated with them?

• What do successful growers do differently?

• How can other companies apply what they do?

To answer these questions, the team analyzed the growth and value creation record of 1,238 companies over the decade spanning 1994 to 2003. The companies included in the study represent a wide range of sizes, industries and global geographies; together they account for 70 percent of the world’s market capitalization (see Study Methodology sidebar).

The team went on to examine the actions of several dozen of these companies in detail, focusing on what successful growers do differently from others. The study defined “successful growers” as companies that grew both revenue and total shareholder return (TSR) faster than the median for their peer group. These 413 companies are an eclectic group that spans multiple

industries and geographies. It includes firms such as Cisco Systems, Vodafone, Procter & Gamble, Countrywide Financial, Starbucks and China Mobile.

Based on this research, the team concluded that achieving long-term business growth is analogous to competing in a triathlon. This three-part sporting event – which grew from humble origins in 1974 California to debut as a world-recognized Olympic event at the 2000 Games in Sydney, Australia – requires athletes to hone multiple skills and harness them into a coherent whole. Similarly in business, excelling in a single event is not enough. Only the best all-around performers win. As successful triathletes train hard in three areas: swimming, biking and running, so do successful businesses; they train to excel in course, capability and conviction.

Study methodologyThe IBM research team developed a database of growth and shareholder return performance for companies included in the S&P Global 1200. Starting with the 2003 list, the team added the firms that "fell off" the listing over the preceding decade. Several of these had ceased to exist as independent companies or did not have data available. This approach helped mitigate “survivor bias” to some extent, but these companies still represent a more successful group than a random choice. The study worked with a final list of 1,238 companies with complete data over the decade. Collectively, this group recorded median annual revenue growth of 8.5 percent and median TSR growth of 8.8 percent.

The team analyzed the patterns of revenue growth and shareholder value creation over the decade, segmenting results by 4 component geographies and 18 industry groups. It selected 3 industries (consumer products, telecom services and electronics) for detailed assessment, developing cases studies for about 20 companies in each industry, picked to represent a range of successful and unsuccessful results.

The team formulated hypotheses to explain the variation in outcomes and analyzed these companies using primary and secondary research, culminating in two workshops with seasoned experts in each industry. After each of these six workshops, the team refined its hypotheses, a process that eventually yielded the "3C" model proposed here.

Based on the final model, the research team created a diagnostic scoring tool and formally applied it to the companies included in the study to confirm the model’s explanatory power against growth and TSR results. Finally, the team assessed the choice of growth paths across these companies to identify patterns and collaborated with functional experts to develop the capabilities required for each path.

“Revenue growth is the key, as [our company], like most players in [the] telecom space, is beyond the cost-cutting stage – that [was]

the trend of the past two years. Now it is growing the top line and

keeping the bottom line in check.” – Survey respondent,

“Your Turn: The Global CEO Study 2004.” 2


8The growth triathlon

The patterns of growthExecutives sometimes view their growth potential as limited by a number of factors: the maturity of their industry and geographic “neighborhood,” the size of the company and the difficulty of sustaining growth over time. This study strongly suggests these perceptions are self-imposed limits, not necessarily marketplace realities.

Neighborhood is not destinyWinners in the growth triathlon are not limited by industry maturity or geography. The companies in the S&P 1200 demonstrated a much wider range of growth within each industry and geography than across them. In each of the 4 geographies and 18 industries, high-growth companies not only outperformed their peers, but did so by wide margins. For example, top performers in the slow-growth consumer products and automotive industries outpaced median growth rates for the high-growth financial and electronics industries (see Figure 2). Similarly, the top growers in the slow-growth Japanese market outper-formed the median growth rates in other high-growth Asian markets.

The message is clear: neighborhood is not destiny. Executives have more room to be ambitious than they tend to believe. Winning companies set ambitious growth plans regardless of industry or geographic “limits.” They aim for targets above and beyond what they and their peers typically expect.

Growth is not a function of sizeAnother common perception is that large companies are slow-growing. Our study suggests otherwise. As Figure 3 illustrates, companies over US$10 billion grew revenue and TSR as fast as, if not faster than, their smaller counter-parts. Admittedly, a billion-dollar company is not exactly “small.” But this data is powerful motivation indeed for the leaders of multibillion dollar businesses.

What about M&A?The growth rates of large companies beg the question: Do they use M&A to sustain growth? The short answer is yes; companies with revenue greater than US$10 billion made 50 percent more acquisitions over the decade than smaller companies. Importantly, this acquisition-led growth did not come at the cost of value creation. In fact, large firms grew their value (TSR) at 10.5 percent, versus 7.2 percent for their smaller counterparts. Furthermore, we found that successful growers, regardless of size, were more likely to acquire companies than others. In the sample we studied, successful growers recorded twice as many acquisitions over the decade as other companies.

Several earlier studies have reported that a high percentage of acquisitions (typically more than 50 percent) destroy value. This study suggests acquisitions do have a meaningful role to play in driving growth and value. Why the difference? While M&A was not the focus

of this study, we do have two hypotheses worth examining further. First, some M&A studies take a short-term, typically one-year, view of results. This study takes a longer, 10-year view. One year may be an insufficient period to obtain a “full cycle” perspective on an acquisition. Considering the pains of integration, acquisitions may yield better results over the long term than they do in the first year.

Second, it appears from our research that a successful minority of companies make

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Source: IBM Institute for Business Value analysis.

Banking Pharma Electronics Telecom

Median revenue growthRange of revenue growth

5% 8% 8% 8% 10% 11% 10%

S&P 1200 companies revenue median and CAGR1994 - 2003

Figure 2. Strong performers outgrow their neighborhood by wide margins.


one analyst quipped that the company had “done it backwards in high heels with the whole world watching.”5 How was Cisco able to defy the odds? It maintained clarity on its objectives, built sustaining capability, and stayed disciplined in its execution. Cisco’s deals have consistently focused on acquiring technology capabilities rather than established revenue streams or an existing customer base. It has also limited its deals to a manageable size. Since 1994, only one acquisition exceeded 5 percent of the company’s market capital-ization at the time of the deal, and nearly all were less than 2 percent.

While Cisco’s approach reflects a carefully laid-out strategy, during the M&A explosion of the dot-com years, some of its peers fell into the trap of pursuing acquisitions “at any cost for any reason.” Between 1998 and 2000, for example, one of Cisco’s major competitors invested billions of dollars in acquisitions that proved to be failures. In the end, these acquisitions were either shut down or sold for a fraction of their purchase price.

Successful growers bounce backSuccessful growth is sometimes portrayed in the business press as the result of strategic genius or uncanny foresight. In practice, the vast majority of companies – even successful growers – stumble at some point (see Figure 4). Of the companies that outgrew their

Figure 3. Large companies can grow as fast as small ones.

more acquisitions. They are able to find better deals and execute them more effectively. This suggests that M&A is a game of skill, not chance. We also noted that the successful growers made acquisitions that seemed to stay closer to their core. For example, they made fewer (about half as many) international acquisitions than other companies. They were also about 50 percent more likely to acquire entire companies rather than business lines, brands, assets or partial shares of a company. Our research suggests that companies that build M&A skills can successfully leverage acquisitions to drive their growth agenda.

Cisco Systems is one such company. Over the years, Cisco has built a repeatable capability to leverage M&A. Its first acquisition, Crescendo Communications, was met with skepticism when it was announced in 1993. As it turned out, however, the move was based on a sound strategy, and Cisco’s revenue skyrocketed in the wake of the deal. The head of Cisco’s acquisition program during the 1990s noted that the initial Crescendo success made the company’s subsequent acquisitions easier.3

With the Crescendo deal as a foundation, Cisco embarked on a strategy of acquisitions. From 1994 to 2003, it executed over 80 such deals,4 while recording an annual growth rate of 40 percent per year and a TSR growth of 30 percent per year. Noting the scrutiny the strategy had to endure from Cisco’s shareholders,

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20-40 >40

Median CAGRMedian TSR

Overall median TSR 8.8%

Overall median revenue CAGR 8.5%

US$ billion

Growth rate by company sizeMedian revenue growth versus median annual total shareholder return (TSR), 1994 - 2003


10

industry median over the 10-year study period, only 6 percent did so every year of the decade. Fully 94 percent of successful growers experienced at least one year of below-median growth; 72 percent fell below the median for three years or more. What distinguishes successful growers is not perfection, but the courage and conviction to recover from imperfections.

The case of the Wrigley Company provides one example of such resilience. Through the 1990s, the company drove its growth via steady geographic expansion. But by the late 1990s, its results were

flagging.6 In 1999, as company leadership transitioned from one Wrigley generation to the next, the company outlined a plan to take bold steps into new product markets through innovation and acquisition. Like all transitions of its scope, Wrigley’s strategic shift was not entirely seamless, and, for a while, its results lagged those of its peers.7 But by 2001, the company had restored market momentum and confidence. Though the elder and younger Wrigleys followed markedly different strategic paths, the company’s resilience in making changes gave the Wrigley Company the ability to bounce back and beat

its industry peers in growth and value creation over the entire decade.

Growth doubles the odds of value creationFor an individual company, growth is neither risk free, nor a guarantee of value creation. For the S&P 1200, several companies with above-median growth delivered below-median value creation (see Figure 5). These “unsuccessful growers” saw above-median revenue increases while delivering below-median, or even negative, shareholder return.

However, on average, growth is strongly correlated with higher value. We found that the slowest growth quartile grew its TSR by under 1 percent a year over the decade. At the other end of the spectrum, the companies in the highest-growth quartile delivered over 16 percent TSR growth annually (see Figure 6).

In fact, superior growth doubles the odds of superior shareholder value creation (see Figure 7). A similar growth study conducted in 19988 found the same relationship – clearly the relationship between growth and value creation is a firm and stable one. Winners understand the counterintuitive reality that over the long haul, growth – rather than cost-cutting – is the lower-risk path. Indeed, the greatest risk is not to bet on growth enough.

How do winners put their risk taking into practice? How do they overcome the limits of neighborhood and size? What levers do they use to create both growth and value? Read on for what we learned.

“Shrinkers”(413 companies)

“Unsuccessful growers”(206 companies)

“Prudent managers”(206 companies)

“Successful growers”(413 companies)

Median CAGR: 8.5%Median TSR: 8.8%

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Revenue growth rate versus TSR in the S&P 12001994 - 2003

Figure 5. Not every company converts growth into value.

Figure 4. Sustaining revenue growth is difficult: hardly anyone gets it right all the time.

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The winning formula – course, capability and convictionThe winners of the growth triathlon focus on:

• Course: The identification and selection of oppor-tunities, the development of a winning model and the creation and funding of initiatives sufficient for sustaining growth. In setting course, executives should consider questions such as: where is the industry headed? Where do we play in this future? How will we win and keep winning?

• Capability: The activities, skills and assets that support the operational model and enable the successful execution of the growth strategy. Here, executives must ask: what do we need to win?

• Conviction: The creation of organizational belief, momentum and resilience in moving toward growth goals. The key question here is: how will we generate action, maintain momentum and bounce back from failure?

Course: The paths to growth are manyMost would agree that a clear strategic direction is fundamental to success. Yet the practice of formulating and adapting a course generates many schools of thought – and much debate. But what does a close examination of successful growers reveal? What strategic

principles are associated with their success, and what sort of levers do they use? Our examination of successful growers suggests four principles are critical to shaping and adapting a successful course.

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Note: Breakdown of quartiles determined by company CAGR 1994-2003. Median CAGR and TSR based on calculation of the median for each quartile.Source: IBM Institute for Business Value analysis.

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Overall median TSR 8.8%

Overall median revenue CAGR 8.5%

0.8 0.8

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Note: High and low growth companies defined by sample set median CAGR; above and below average SHV defined by sample set median TSR.Source: IBM Institute for Business Value analysis.

33% 67%

Low-growth companies High-growth companies

Below average SHV growth firmsAbove average SHV growth firms

Figure 6. Growth creates value.

Figure 7. Above-median growth doubles the odds of above-median value creation.


12

1. Develop a point of view on the futureSuccessful growers have a clear point of view on their industry, where it is headed and how they will create value in its new form or environment. Regulations change, customers exhibit new behavior patterns, new technol-ogies proliferate and new competitors arise. Successful growers are attentive to these dynamics and have a point of view on how to exploit them. That said, they recognize they are not clairvoyant and do not hesitate to revisit their point of view as reality unfolds. We found some of the greatest strategic failures occurred when CEOs heeded advice to be visionary, made big bets, but failed to notice or react decisively when unfolding events diverged from their view of the future.

Successful growers use a number of levers to put this principle into action. They:

• Understand the forces impacting the industry and how they will shape its future

• Demand and recognize insights from the business units and senior management on where value will be created

• Acknowledge areas of uncertainty and reassess the point of view on an ongoing basis

• Create internal forums for industry and strategic discussion, separate from operational reviews.

Consider the example of Staples. When Staples founder Tom Stemberg looked at the office products industry, he saw a multistep, high-cost value chain. He envisioned a future where he would create immense value for customers and for Staples’ shareholders by shortening the chain to capture margin, while offering small businesses lower prices, wider selection and more convenience. Staples enabled this value proposition with a model that supported its retail stores with its own

central distribution centers. The centers required greater operational scale, but allowed Staples to eliminate middlemen and increase margin. They also consolidated inventory in low-cost locations to reduce square footage and labor in more expensive store locations. Of equal importance, this model allowed Staples to differentiate by placing smaller stores closer to customers where they were more accessible.

2. Continuously evolve the product-market portfolioSuccessful growers are iconoclasts who evolve their product-market portfolio on an ongoing basis. Even seemingly rock-steady and unchanging firms exhibit a level of restless change behind the scenes. But they stay grounded by understanding their true strengths and are careful not to stray too far from them. In fact, they find opportunities to leverage their capabilities beyond the segments in which they traditionally play. They deploy several actions to bring this principle to life. They:

• Take an expansive, customer-based view of markets not limited by current definitions of product and service categories

• Understand the potential and respect the limits of the company’s capabilities

• Realign the portfolio based on the attractiveness of opportunities and their fit with capabilities

• Consider alliances, acquisitions and divestitures, if necessary. Build strong ability to execute and integrate transactions

• Develop an internal venture capital capability and an external new business network.

General Electric (GE) constantly evolves its portfolio to drive growth despite its large size and already significant presence in major markets. It encourages its executives and business units to take an expansive view of its markets as a means of unlocking growth initiatives that a product-centric view would miss. Often, when its market share exceeds 10 percent, it seeks to redefine the market more broadly to include adjacent products or services.9 This continual questing and restless energy lies behind its successful moves from manufacturing to services – for example, from manufacturing aircraft engines to servicing and financing them. It is the kind of thinking that has allowed GE to keep growing even in relatively low-growth industrial markets.

The IBM study defined “successful

growers” as companies that grew

both revenue and TSR faster than

the median for their peer group.



3. Develop a competitive modelBold industry-level visions notwithstanding, successful growers keep a sharp eye on their competitive proposition and how it is working on the ground, market by market, deal by deal. They:

• Use customer, competitive and technology insights to create compelling value propositions

• Define how to beat competitors in delivering and capturing value

• Influence the environment to shift the game.

Consider the example of Xilinx and Altera, both successful growers in the market for programmable logic device (PLD) semiconductors. For several computing applica-tions, industry customers had a choice between custom application-specific integrated circuits (ASICs) or standard microprocessors. ASICs are customized chips that can be optimized for performance against specific tasks. However, their custom design requires up-front time and investment. Standard microprocessors are available off the shelf and without up-front fixed cost, but their general logic may not be suitable for specialized applications. Altera recognized the trade-off customers were forced to make and found a way to compete with established players in both markets. It championed new technologies to create a complex programmable logic device (CPLD). This solution was based on easy-to-use software that let customers customize the design of chips and transfer the design code to the manufacturer. Customers were able to lower their design costs and shorten time-to-market for custom chips. This approach allowed Altera to compete with larger established players and emerge as the leader in the new PLD market.10

As the market matured, Xilinx saw the potential to leapfrog competitors by offering customers an even higher level of performance by leveraging another emerging technology: field-programmable gate arrays (FPGA). This technology benefited fully from Moore’s law, enabling a steeply rising performance curve. Xilinx also influenced the ecosystem, teaming with partners in silicon fabrication, design automation, system-level tools, intellectual property (IP) and design services to deliver a complete value chain for its customers.11 This proved highly attractive to a performance-sensitive group of

customers. Within the PLD market, the FPGA segment has now overtaken CPLDs, driving Xilinx’s growth. In turn, Altera has responded by developing strong capability in FPGAs and by seeking to lower its costs even further. As this rivalry between the Coke and Pepsi of the PLD market has played out, they have both emerged as leaders, creating value for their customers and realizing successful growth themselves.

4. Create and sustain multiple growth initiativesEvery strategy has a limited shelf life. Successful growers sustain the growth quest by developing multiple growth initiatives that are backed by ongoing cost and asset management to create funding. This allows the company to draw from a portfolio of options when an existing strategy inevitably reaches its expiration date. However, each company must take care that its portfolio is not simply an aggregation of disconnected initiatives, but rather adds up to a reinforcing whole. Successful growers:

• Create multiple, mutually reinforcing growth initiatives sufficient to achieve growth goals

• Build management systems to nurture initiatives through development stages, each with different needs

• Maintain ongoing focus on cost and asset management to create funding for growth initiatives.

The IBM team studied four common growth paths: product and service innovation, customer intimacy and market penetration, channel management, and new markets and globalization. We found that within a given industry, companies tend to cluster around a few paths. For example, much of the electronics industry follows a path of product and service innovation (see Figure 8). Yet each growth path is capable of yielding success. This suggests there is a strong case to be made for broadening the growth “gene pool.” Greater strategic creativity can contribute to the sustainability of growth by avoiding “me-too” strategies.

One way to increase potential is to combine mutually reinforcing initiatives. A number of successful growers in the electronics and telecom industries, for example, have crafted mutually strengthening innovation- and global-ization-related initiatives. Nokia dedicates 39 percent of its personnel to R&D, an exceptional investment in innovation.


14

New

Produce/service innovation• Enter new product categories• Build services around

products• Innovate faster/better

Source: IBM Business Consulting Services; adapted from Ansoff, H. Igor.”Strategies for Diversification.” Harvard Business Review. 1957.

Trad

ition

al

NewTraditional

Prod

ucts

Markets

Diversifi cation• Extend into new products

and new markets simultaneously

Customer intimacy and market penetration• Increase customer loyalty• Improve price realization• Gain wallet share • Attract new customers• Refresh products/services• Increase geographic depths

New markets and channels• Extend into new customer

segments• Enter new geographic/global

markets• Enter new channels

Recouping this investment requires scale, which the European company achieves through an aggressively global approach that attracts nearly half of revenue from the U.S. and Asia.12 Similarly, in the telecom industry, Telecom Italia Mobile (TIM) maintains its reputation as a pioneer in Italy while extending innovation to the rest of Europe and Latin America.13 Companies like these recognize the growth potential of regulatory changes that have opened new markets. For them, the alignment of innovation and globalization presents an opportunity for synergy: a winning formula at home can now be projected into new markets.

What paths should you consider? Exploiting the full potential of your current business is a natural starting point. This includes actions to increase market penetration and customer intimacy in current markets, as shown in the bottom left quadrant of Figure 9. Strategies to enter new product/service businesses represent a second direction of growth. These are most meaningful when there is rapid change in technology and customer needs that offers opportunity for new products and services. This direction succeeds most often when backed with strong innovation expertise and relevant technologies. Kodak is pursuing this path as it offers digital imaging products and services to its customers. Kodak’s current challenge, of course, is to

rapidly retool its capability to exploit very different photo-graphic technologies than film, and do so fast enough to outpace the erosion of its analog business. The company has realized some success in this area with its line of EasyShare cameras.14

Figure 9. Choose your growth course.

Figure 8. Industries tend to cluster around growth paths.

Perc

ent

100

75

50

25

0Successful

growersOthers

Demonstrated growth paths

Grow result 100

75

50

25

0Successful

growersOthers

100

75

50

25

0Successful

growersOthers

Electronics(n=24)

Telecommunications(n=19)

Consumer packaged goods

(n=20)

Product and service innovation

Customer intimacy and market penetration

Channel innovation

New markets and globalization

Note: Assessment based on selected companies in the Electronics, Telecommunications, and Consumer Package Goods industriesSource: IBM Institute for Business Value analysis.



Projecting current products into new customer segments, geographies and channels is a third growth direction. This is most valuable when existing markets are saturated and untapped customer segments and geographies are emerging. The targeting of fast-growing ethnic populations within the U.S., the emergence of “sub-prime” lenders to low income households, and the rush to tap China’s developing markets, are all examples of pursuing new customer and geographic markets. Channel innovation is often necessary to serve these new segments and geographies, especially when technology or regulatory changes allow disintermediation of existing channels. Adding services content to product businesses also often requires the development of channels to deliver complementary services.

Diversifying into new products and markets simul-taneously takes companies farther afield from home ground and adds risk. This should be considered only when changes in buyer behavior patterns or technology are linking previously distinct markets, a pool of M&A candidates are available at attractive valuations and the acquiring company has strong integration experience and capability.

Consider how Procter & Gamble harnesses its different growth initiatives into a coherent whole. First, it mines its traditional core categories of laundry, hair care, diaper and feminine products. It pursues growth through innovation in its current businesses, introducing regular technology upgrades on brands like Tide and Pantene. It has also not hesitated to acquire new brands as a means of driving growth in these core categories, where it can leverage its cost base to create advantage, as P&G did with the acquisition of Clairol and Wella to drive its hair care business.

Second, P&G has used acquisitions to enter other household product categories, as it did with the Iams pet food brand. In these businesses, P&G exploited its established strengths to create value.

It increased Iams’ distribution by 50 percent shortly after its acquisition and launched several new product initiatives. These actions have doubled sales to US$1.6 billion, taking the brand from number five to number one in the category.15, 16 P&G has also created new categories, as with the introduction of “Swiffer,” an alternative to mops and brooms.

Third, it has focused on large, emerging geographies. For example, the company’s recent growth in China is double its average across all geographies.17 This array of growth initiatives has been backed by actions to cut costs and create funding. In 1999, with the “Organization 2005” program, it created shared services centers to streamline back-office costs.18 Reaching the limits of that strategy, it has now outsourced these shared services centers to an external provider who can offer even greater scale and lower costs.

Capability: The paths to growth rest on a foundation of capabilitiesWhichever growth path a company chooses, it is vital to line up the operational model with the capabilities that enable it. As Figure 10 shows, each of the major growth paths requires a different set of capabilities. Capabilities are the sustaining foundation of a strategy. They require more than the ad hoc efforts of individuals, no matter how clever or committed they may be. Successful growers develop their capabilities methodically, harnessing process, organizational and technology elements to create an ingrained, repeatable strength. They seek

Product and service innovation

Source: IBM Business Consulting Services.

• Market planning• Portfolio management• Platform management• Pipeline management• Partner management

Customer intimacy and market penetration

• Customer strategy• Lifecycle relationship

management• Customer experience

management• Channel and partner

management• Brand management

New markets and globalization

• Market selection• Global model• Global innovation• Global channel

management• Global customer intimacy

Channel innovation

• Channel strategy• Account management• Web management• Solution selling

Figure 10. Each growth path requires distinct capabilities.


16

alliances when needed capabilities reside outside the company. These companies exploit several action levers to develop and align their capabilities. They:

• Define the operational model and capabilities against chosen growth strategies; identify required changes as strategies evolve, and close gaps

• Overcome the inertia of existing power structures to realign the model where necessary

• Consider alliances and acquisitions if necessary to develop timely capabilities.

For example, five capabilities support a product and service innovation strategy:

• Market Planning: Picking the right market segments and developing the right products and services for them

• Portfolio Management: Making the right investments in development; balancing return on investment (ROI), strategic direction and risk

• Platform Management: Creating product and process architectures that increase speed-to-market, knowledge reuse and leverage of development investments

• Pipeline Management: Striving for speed and efficiency across the total lifecycle, from concept to service, including people, processes and technology

• Partner Management: Building the organizational capability required to exploit the physical and intel-lectual assets of partners for mutual gain.

IBM Institute for Business Value research demonstrates that building these capabilities can drive growth that outpaces industry performance. Figure 11 illustrates one example: electronics companies that develop strong innovation capabilities and align them with their product and innovation strategy consistently outperform their peers.19

Consider how Intel developed its capabilities to sustain its growth path of innovation. Forced to exit the dynamic random access memory (DRAM) chip market in the late 1980s by Japanese competitors, Intel knew it had industry-leading logic circuit design skills but had been outclassed on its manufacturing platform.20 Each of its chip fabrication plants, or “fabs,” was different, requiring

different processes and a new learning curve at each fab when new products were rolled out. In response, the company launched “Copy Exactly,”21 an initiative to enable the transfer of new products and process flows into mass production with minimal variation.

This philosophy represented a significant change for the company. In practice, real-world limits typically prevent exact copying. For example, differences in European and U.S. supply voltages and frequencies had to be accommodated. With Copy Exactly, change control is initiated before technology transfer, and all changes are implemented directly into both the R&D and production lines within one week, or according to an approved schedule. As a result, products can be rolled out across fabs quickly, at low cost, and with faster diagnosis and correction of quality issues. By tying R&D and manufac-turing into a common, end-to-end pipeline capability, Intel can now roll out a package of product and process innovation rapidly across its facilities. The resulting “time to volume” is a critical differentiator in an industry where the profits are made in the first few months of a product’s life. Today, even as rival AMD catches up on design and products, Intel’s end-to-end “pipeline” capability gives it an additional layer of advantage to drive superior results.22

14

12

10

8

6

4

2

0Low Medium High

Reve

nue

5-ye

ar C

AGR

(per

cent

)

Source: IBM Institute for Business Value survey of leading electronics companies globally, 2002.Source: Cooper, Jonathan, Dan Greenberg and Dan Zuk. “Reshaping the funnel: Making innovation more profitable for high-tech manufacturers." IBM Institute for Business Value, 2002.

Capability score

2.5X

Figure 11. Companies that develop innovation capabilities outgrow their peers.



In the very different business of telecom services, Sprint has set out to drive growth through customer intimacy and market penetration. The company has set a goal of increasing customer satisfaction via superior service – while reducing cost. To achieve this goal rapidly, Sprint has leveraged a strategic partner23 and charted out a transformational program that features a number of customer-facing and enabling initiatives. These include better segmentation and the redesign of service treatments and processes against them, increase in self-service options for customers and the retooling of applications to enable them, reduction of call handling time by upgrading call routing processes and agent desktop technology. As a result of this program, Sprint expects to improve customer satisfaction dramatically while reducing customer service costs by US$550 million over three years.24 With these enhanced capabilities, Sprint can move forward simultaneously on its top priorities – improving customer satisfaction, driving new sources of revenue and operating its business with greater efficiency and flexibility.

Finally, consider Starbucks’ actions to develop its capabilities in support of its path of channel innovation. The company has launched two initiatives: the first to expand its food service accounts and the second to build its presence in grocery stores. To support the first initiative, the company has transitioned the majority of its food service accounts to broadline distribution networks and aligned its current food service sales, service and support resources with SYSCO Corporation, an established player in food service. To enable the second initiative, Starbucks is developing an alliance with Kraft Foods to market and distribute its whole bean and ground coffees to grocery stores. Starbucks is also strengthening its Web management capability (via starbucks.com) as a customer interaction vehicle that allows coffee drinkers to reload Starbucks stored-value cards.

Conviction: Are you for real?Course and capability are necessary but not sufficient conditions for successful growth. A company must also make its commitment to growth real in word and action. The blunt reality is that sustaining successful growth requires change. This is where so many otherwise

coherent plans fail to produce the intended results. Change can be wrenching, and organizations often resist it. Successful growers foster a culture that responds to the necessity of change, and leaders with the passion and follow through to make the change stick. When inevitable setbacks occur, these companies have the resilience to bounce back. They exploit several levers to drive conviction deep into the organization. They:

• Create an inspiring purpose and ambitious goals

• Communicate a believable and consistent growth strategy to employees and investors

• Establish an effective system of metrics and incentives against market and capability initiatives

• Foster a culture of honest, fact-based debate on strategy and performance, and create the management forums and processes to support it

• Stay alert to organizational impediments and act quickly to unblock them.

As we have seen, Staples created huge momentum with a breakthrough insight and an operational model to deliver competitive value. But as the market matured and it faced like competitors, the company recognized the need to evolve its model from an operational focus to include elements of advanced customer care. The company made a serious and concerted effort to craft the right mission statement, involving the best people from around the company. This seeded the shift in culture toward a high-value-add, customer service orientation. The program projected a vision where every associate would focus primarily on customer service and sales.25 Staples redesigned its employee incentive system and training to support this shift to customer service. As a result of these changes, it continued to prosper in a changed environment. What it took was commitment from the top, and leadership’s willingness to stay involved and unblock hurdles.

This ability to identify and overcome organizational impediments is one of the least celebrated yet most critical aspects of driving growth. Consider the case of a global, multidivision technology business. This company is pursuing a strategy of differentiation based on deals


18

of broad scope and global scale. In analyzing its wins and losses, the company discovered that its metrics and incentives were oriented largely toward single-business and single-country performance. The very largest of multicountry and multidivision deals enjoyed the visibility and top management sponsorship needed to overcome these hurdles. However, the more numerous middle-tier deals – the ones holding potential for breakthrough growth – were getting bogged down. In one case, a deal required 13 different approvals from country and business P&L owners. Each approver judged the deal entirely on the merits of his or her own business, and any of them could have said no. In fact, several did. That the deal survived was testament to the dogged follow-through of its advocates. The enterprise has now committed actions to examine and address these issues. How aggressively it does so, will be a vital factor in the growth it delivers.

This is not the glamorous stuff of business legend, of visionary CEOs buying and selling businesses, assembling the right pieces on the chess board, fuelling the buzz around high-profile new products or inaugurating a new facility in Shanghai. Nevertheless, the ability to identify and overcome organizational impediments is a vital aspect of turning potential into reality and translating a good strategy into real growth.

In turn, this ability requires a truth-telling culture that sees things as they are. During his tenure as CEO of Intel, Andy Grove introduced a culture of “constructive confron-tation” that frowned on ambiguity and stressed dealing with issues as they arose. He encouraged employees to challenge each other’s assumptions and even interro-gated managers to probe how informed they were about their products and projects. Never one to mince words, Grove would render detailed judgments (known as “blast reviews”) to rouse managers from intellectual stagnation.26 Grove’s somewhat combative style shaped Intel’s culture into one that shuns wishful thinking and holds fact-based debate in high regard. In 2004, when missteps in execution hurt results, the company saw some plain talk from CEO Craig Barrett.

Putting it togetherWe have examined each of the three Cs individually. How do successful growers put them together in practice?

Hit the high “Cs”As part of our maturity assessments, we found that successful growers not only score higher on the three Cs in aggregate, they score higher on each of the three Cs, with a far lower variation in performance than other companies (see Figure 12). This finding suggests one reason why growth is often so difficult: to succeed, businesses – like triathletes – need to excel in all three areas of the game, all the time.

In other words, course, capability and conviction are equally fundamental to achieving and sustaining growth over the long term. Over a sustained period, a smart strategy will not compensate for weak capabilities. Neither will a superior combination of strategy and capability lead to growth if the organization does not believe the commitment is real, or if management is unable to convert its intent into corresponding action.

Successful growers

Note: Scores based on a sample of 60 companies in the Electronics, Telecommunications and Consumer Package Goods industries.Source: IBM Institute for Business Value analysis.

Course 7.9 5.2

Capability 7.9 5.3

Conviction 8.2 4.6

Overall 3C score average 8.0 5.0

3C score standard deviation 0.8 1.5

Others“3C” scores (10 point scale)

Figure 12. Successful growers perform well on each of the three Cs.



Consider the experience of AT&T Wireless. It developed arguably one of the most effective strategies in the industry, but fell short in the areas of capability and conviction. Early in the wireless industry’s development, the company set a course for robust growth by aggres-sively buying spectrum to establish a broad presence across the U.S. market and build its AT&T Wireless (AWE) brand. The company recognized that its superior network coverage offered the potential for rate plans without roaming charges. Its launch of the U.S. market’s first “national one-rate” plan drove rapid share gains.27

Despite positioning itself for strong growth, and in fact building significant market share, it failed to fully develop corresponding capability by way of network and customer service capacity to support the increased volume. It fell behind competitors in building out adequate coverage to support a genuinely national service, instead remaining dependent on other providers for coverage in key markets. When quality began to suffer and complaints mounted, AWE was unprepared to respond.28 Over time, the strong sense of conviction that AWE had originally inherited from its founding entity, McCaw Cellular, waned. Increasing control from AT&T corporate and a series of leadership changes depleted the company’s entrepreneurial spirit, prompted the departure of employees and, eventually, undermined the company’s commitment to its course.

By 2003, AT&T Wireless, at this point an independent company spun off from AT&T, was reeling from high-profile customer service missteps, such as its slowness to fully implement wireless line number portability. It suffered declining growth and negative shareholder return over the period. In 2004, AWE was acquired by Cingular.

Align the “3Cs”To be effective, the three Cs must also be aligned in a coherent whole. As a successful grower, Procter & Gamble (P&G) works hard to develop each “C” in an integrated manner. In the late 1990s, based on its strengths in branding, innovation and go-to-market capability with global scale, P&G decided to pursue a new course. It moved to steadily shift its portfolio away from staid categories like food toward categories like beauty and healthcare that offered higher returns on innovation as well as global scale.

P&G realized that winning in these markets would require a fast pace of product introduction and sought to streamline the organization to strengthen this capability. In 1999, it launched the “Organization 2005”29 initiative that shifted authority from country general managers to newly created Global Business Units that would drive new innovations globally, unconstrained by organiza-tional boundaries. While this realignment was central to its goal of enabling faster deployment of innovation, it altered the company’s long-established management structure in fundamental ways. The associated turmoil contributed to an abbreviated tenure for CEO Durk Jager, and momentum faltered.30 But the new management demonstrated conviction in following through with the initiative. Now, five years later, it is evident the radical shift was a success. P&G’s organization combines the innovation excellence of integrated business units with the global reach and scale of its Market Development Organization (MDO).

P&G also realized that, to meet its growth goals, it needed to drive a greater number of product intro-ductions than it could generate in its own labs. So it adopted an explicit course of driving half its innovations from ideas sourced outside the company. To develop the required capability, it created a network of external partners that included contributions from academia and even competitors. Making this happen required the conviction to change a proud R&D culture that valued its unique capability. The new R&D leader has explicitly stated that the best ideas need not come from within the company.31 As visible proof, when P&G reinvented the cleaning category with the introduction of Swiffer in 2001, the success owed much to technology licensed from a Japanese competitor, Uni-Charm.32 This was no isolated instance. P&G management has since broken new ground in exploiting its own technology in new ways by forming a joint venture with competitor Clorox to commer-cialize technologies it developed. These instances are a far cry from its previous “go-it-alone” R&D culture.

The results of these changes speak for themselves. Not only did P&G outperform its industry during the decade, achieving annualized shareholder return of 15 percent over the period, it has also corrected missteps


20

and accelerated its growth in each of the last three years. While remaining an iconic leader in its industry, behind the scenes, the P&G of today is very different – in terms of portfolio and organization – than the P&G of a decade ago.

Evolve the “3Cs”No competitive model is successful forever. Sooner or later, every growth path runs its course and needs reinvention. Successful growers not only align the three Cs to begin with, they also evolve them over time.

Another successful grower, Vodafone, demonstrates this well. In the 1990s, it sought to project its “mobile only” business model on a global scale, pursuing an aggressive, acquisition-led course in major mobile markets. It acquired established players in mature markets and newer entrants in developing markets. At the same time, it divested businesses obtained through acquisition that did not fit with its mobile-only strategy. To enable its acquisition-driven strategy, Vodafone developed strong capability to identify and execute large global acquisi-tions. It sought the CFO role in acquired companies to drive financial integration and control cost and financing. Vodafone’s success at financial integration earned it the respect of the investment community. This, in turn, translated into higher valuations, providing currency for subsequent acquisitions.33 Leadership demonstrated conviction in driving Vodafone’s culture of growth by acquisition. It liberally dispensed options to align employee interests with the growth agenda.

But the game is different now, and Vodafone is in the midst of evolving its model significantly on each of the three Cs. As the company recognized it was filling out the “white space” of its acquisition strategy, it moved to

adapt its course from conquest to consolidation. It now seeks to exploit the global scale it has built to create greater global leverage of technology, procurement and customers. The new course requires new capabilities, and Vodafone is integrating its technology platform across markets as well as converging its phone models to better leverage its clout with suppliers. Despite struggling to overcome some barriers, in another show of conviction, management under the new CEO is seeking to replace the company’s deal-making focus with an operations focus, and has communicated resolve to see the changes through.

Vodafone has enjoyed a very successful decade, boasting almost 50 percent compound annual growth rate (CAGR) and 16 percent annualized shareholder return over the period. While its recent transformation remains a work in progress, and the results are not yet known, the company’s willingness to retool, and its thoughtfulness in doing so, is a necessary ingredient for sustained, successful growth.




Get going nowThe starter’s gun has gone off. The growth triathlon is underway. How are you positioned? What do you need to win? Consider the following actions:

• Assess your status against your growth ambitions and the 3C model winners follow

• Develop a point of view on the future and its opportunities

• Evolve your product market portfolio and initiatives

• Develop a competitive model

• Know your capabilities and align them with opportunities

• Embed your strategy in your words and actions.

1. Do you have a distinctive point of view on the industry future and where value will be created?• Has the organization assessed the key forces impacting the industry and how they will shape its future?• Do the executives possess, demand and recognize insights on where value will be created?• Are the key points of uncertainty identifi ed? Is there a process to reassess them periodically?• Do you have management forums for industry and strategic discussion, separate from operational reviews?

2. Are you evolving the product-market portfolio suffi ciently, based on the understanding of the industry future and your own capabilities?

• Do you take an expansive, customer based view of markets, not limited by defi nitions of product and service categories?• Is there management agreement on your own distinctive capabilities?• Have you reexamined your product-market portfolio recently, based on attractiveness as well as the fi t with your capabilities?• Are you considering alliances, acquisitions and divestitures, if necessary? Do you have strong ability to execute and integrate

transactions? • Do you have internal VC capability and/or an external new business network?

3. Do you have a competitive model that is creating and capturing value?• Do your businesses regularly use customer, competitive and technology insights to review and create value propositions?• Can the organization clearly articulate why your customer value proposition is superior to competitors’?• Are your mechanisms to infl uence the environment (technology, regulatory, customer, etc.) effective?

4. Is your growth sustainable? Do you have multiple, reinforcing growth paths and ongoing cost actions to fund them?• Do you have multiple growth paths suffi cient to achieve your growth goals? Does it take a special analysis to answer that

question?• Do you manage early stage, expansion stage, and mature initiatives with enough differentiation of mindset, metrics, incentives,

and people?• Are your cost and asset actions suffi cient to fund your growth initiatives?

5. Are your capabilities aligned to your growth strategy and evolving on pace to meet its needs? • Do you have a clear view of the operational model and capabilities against the growth strategies? Are your capabilities evolving

on pace to support changes in strategy?• Is the organization evolving to support the new capabilities, or is it getting in the way?• Have you examined alliances and acquisitions to accelerate capability development?

6. Are you demonstrating commitment to growth in word and action?• Does the organization believe you? Is it acting with urgency?• Do you have an inspiring purpose and ambitious goals? Are they authentic?• Are you communicating a believable and consistent growth strategy to employees and investors?• Do you have effective metrics and incentives against market and capability initiatives?• Do you have a culture of honest and fact based debate on strategy and performance?• Are you keeping your ear to the ground on the rate and pace of frontline change? Are you demonstrating quick and effective

action to unblock impediments?

Principle and action levers Your score(1-10)

3C

Course

Capability

Conviction

Diagnoses are no more useful than the thought you put into them. And there is no one more qualified than you to assess where you are. So it will be instructive to take a few moments to consider the questions below. While they represent a simplified version of our growth diagnostics, they do provide food for thought.

Assess your company on a scale of 1 through 10 for the 3Cs and their underlying principles. Remember, consistency is key. Only a score of eight or higher in all categories will put your company alongside the “successful growers” identified in the study. A score of less than eight in any category implies you have work to do in that area of growth development, even if your position is strong in the others. Act now to put yourself on the road to sustained growth and shareholder value.

22

The growth triathlonEndnotes

1 “Your Turn: The Global CEO Study 2004,” IBM Business Consulting Services. 2004.

2 Ibid.

3 Paulson, Ed. Inside Cisco: The Real Story of Sustained M&A Growth. John Wiley and Sons. 2001.

4 Cisco Systems. “Acquisition Summary.” http://www.cisco.com/en/US/about/ac49/ac0/ac1/about_cisco_acquisition_years_list.html.

5 Paulson, Ed. Inside Cisco: The Real Story of Sustained M&A Growth. John Wiley and Sons. 2001.

6 “Wrigley Gives Rivals News to Chew On,” Financial Times (UK), October 16, 1999.

7 “Wrigley Rebounds with $70B for 3 Brands,” Brandweek, April 21, 2003.

8 Kapur, Vivek. “Creating growth and value”" IBM Business Consulting Services. 1998.

9 Buss, W. Christian. “Jack Welch took more than one punch in the nose; you don't have to.” The Business Review, May 30, 2003.

10 “Altera Celebrates 20 Years of Innovation.” PR Newswire. June 20, 2003.

11 Xilinx. “Company Overview.” http://www.xilinx.com/company/about/overview.html

12 Nokia 2003 annual report.

13 Telecom Italia Mobile 2003 annual report.

14 Dobbin, Ben. “Kodak growing in digital camera market.” BizReport.com. August 6, 2004. http://www.bizreport.com/news/7776/

15 Neff, Jack. “P&G claims Iams is top dog in pet food: Brand sales overtake giant Purina in Q4.” Advertising Age. March 10, 2003.

16 Procter & Gamble 2003 annual report.

17 Shobhana, Chandra. “P&G ready to post 40% profit rise: Sales growth in China, acquisitions drive earnings spurt.” Bloomberg News. August 2, 2004.

18 Peale, Cliff. “P&G cuts restructuring time.” The Cincinnati Enquirer. December 13, 2002.

19 Cooper, Jonathan, Dan Greenberg and Dan Zuk. “Reshaping the funnel: making innovation more profitable for high-tech manufacturers.” IBM Institute for Business Value. 2002.

20 Ladendorf, Kirk. “Intel architect Grove to step down. Visionary leader will take more long-term view as chairman; president will take CEO job.” Austin American-Statesman. March 27, 1998.

21 “Intel At 36: The CPU Business.” Fundamental Review. Kintisheff Research. June 17, 2004.

22 Ladendorf, Kirk. “Intel architect Grove to step down//Visionary leader will take more long-term view as chairman; president will take CEO job.” Austin American-Statesman. March 27, 1998.

23 Schwartz, Ephraim. “IBM lands huge Sprint deal.” InfoWorld. February 4, 2004. http://www.infoworld.com/article/04/02/04/HNbigblue_1.html

24 IBM Corporation. “IBM and Sprint announce comprehensive business agreements.” February 4, 2004. http://www-1.ibm.com/industries/telecom/doc/content/news/pressre-lease/1005755102.html

25 Stemberg, Thomas G. Staples for Success: From Business Plan to Billion-Dollar Business in Just a Decade. Knowledge Exchange. 1996.

26 Ladendorf, Kirk. “Intel architect Grove to step down//Visionary leader will take more long-term view as chairman; president will take CEO job.” Austin American-Statesman. March 27, 1998.

27 Richman, Dan. “The fall of AT&T Wireless.” Seattle Post-Intelligencer. September 21, 2004. http://seattlepi.nwsource.com/business/191742_attw21.html

28 Ibid.

29 “Moody's downgrades long term rating of Procter & Gamble (Senior to Aa3) – Confirms short term rating at prime-1 – Outlook stable.” Moody’s Investor Service Press Release. October 19, 2001.

30 Nelson, Emily. “Rehab takes toll on Procter & Gamble. One of first tasks for new CEO is to boost morale, plug management holes in wake of globalization upheaval.” The Wall Street Journal. September 1, 2000.

31 “P and G – How AG Lafley is revolu-tionizing a bastion of corporate conservatism.” BusinessWeek. July 7, 2003.

32 “Japan proves new-product gold mine for P&G.” Nikkei Weekly. July 12, 2004.

33 “Vodafone posts £4bn profit.” BBC News Online. May 29, 2001. http://news.bbc.co.uk/1/hi/business/1356896.stm



Executive interview

Q&A

It is only recently that business observers in the West have begun to take note of Bharti Tele-Ventures, which has emerged, in just 12 short years, as India’s fastest-growing telecommunications company. With Sunil Mittal at the helm, Bharti has become one of India’s largest and most respected providers of telecom services. Having grown revenues by nearly 60 percent per year over the past fi ve years, Bharti truly embodies a winner of the growth race. Bharti was also one of the fi rst companies in India to partner with European and American companies, in a kind of reverse outsourcing arrangement, to increase the speed and reliability of its networks – a move that Mittal has described as akin to “switching religions” in the telecom industry. We recently sat down with Anil Nayar, Corporate Director in the Chairman’s Offi ce of Bharti, to talk about “The growth triathlon.”

IBM: What “course” or market strate-gies did you follow to create this tremendous growth?

Nayar: For one, we were lucky to be in the right place, in the right business, at the right time, just as the economy was opening up. We actually started off fairly small, with just one license in the city of New Delhi out of India’s 23 license areas. But we were able to establish ourselves as a carrier which de-livered a high-quality service. And that has always been the vision of the founding members, that Bharti would deliver quality service to our customers, so that it becomes their fi rst choice.

We grew very slowly over the fi rst four years. Then, in ’99, the govern-ment decided to change the way the license fees were applied. That brought prices down and helped grow the market. Then the govern-ment decided to generate competi-tion by inviting fresh bids for new licensees in each of the territories. By 2000 we acquired a number of licensees from operators in other licensed areas, culminating with Calcutta.

In those years, we had 16 major projects being rolled out in different circles – including fi xed line, wireless and in long distance – in addition to the 6 operations that we were running. Fortunately, we success-fully completed all the projects. We

were ahead of time, and that had a huge impact in the marketplace. We surged ahead of the competition – people who were more established than we were. So that coverage strategy and also new service intro-duction into telecom helped us grow.

Behind all this was one factor: that we were able, as an industry and as a company, to drive down cost and therefore prices. It became quite a bloody battle, but the good thing was that it drove down prices and drove up usage, thereby bringing down cost per minute. At this moment I think we are probably the lowest cost producer of voice minutes anywhere in the world. I think our prices are probably also the lowest in the world.

So, these are the factors which have actually resulted in the high growth. And, of course, the reason for this is that our founding members are visionaries. They had a clear idea that this is a growth market. They were willing to take the risks that were involved with this. They were able to get the confi dence of the investors, and bring in suffi cient money. And our operations, except for a brief period, have always been profi table.

Anil Nayar, Corporate Director, Bharti Tele-Ventures

24

IBM: What was your point of view on the industry that led you to place the bets you did, versus other growth paths you considered?

Nayar: The bet we placed was to drive penetration. The other option was to focus on the cream of the market and maximize that segment. But we realized that India is a growth economy, and that telecom is a driver – it is critical to the infrastruc-ture and to the economy. When we considered the risks involved, and when we compared it with the level of penetration across the world, it was a no-brainer. The ability to execute was the key task.

IBM: Eventually, every growth strategy runs out of gas. How do you manage your pipeline of growth initiatives to sustain growth going forward?

Nayar: We are fortunate to have a canvas such as India where the penetration is just about 5.5 percent versus even China with penetra-tion at 15 to 20 percent. As you roll out into the hinterland into smaller towns with lower populations, the demand there is as much and the need is as much as in the bigger cities. So we’re seeing a lot of pent-up demand there – and the only feasible option is wireless.

Right now we are at about 21 percent in terms of customer market share, and about 27 percent in terms of

revenue market share. We believe that we would be able to maintain this in a fi xed-market type scenario. So, at least for the next fi ve years, it’s actually there. Meanwhile, there is also a possibility of an Average Revenue Per User (ARPU) increase because for customers who have been there in the system for longer periods, their needs for the data and database services have been increasing. India is also quite a young market, and there is an oppor-tunity to address different products for the youth segment.

So, overall, we have a two-pronged attack: increase coverage, which is the best of market and geography; and, two, introduce new value-added services to enhance ARPU for so-called maturing customers.

IBM: Do you see Bharti extending out of India in the next 5 or 10 years?

Nayar: Our focus at this moment is India. And I think there’s a lot to be done in India. But if you look at the growth model, which is based on low cost, we believe that as the world evolves, the type of model that we have developed in India would be equally applicable to different parts. And, therefore, we believe that we would be in a position to address that opportunity maybe a few years down the line.

IBM: Let’s turn to capability. What capabilities would you identify as critical to Bharti’s growth strategy?

Nayar: First and foremost, we have built a very good leadership team, which continuously scans the market for new opportunities and develops strategies to give us the competitive edge. That’s number one.

Number two is we have invested fairly heavily into technology compared to a lot of Indian com-panies. We believe that technol-ogy gives us the edge in terms of delivery of services. Third, we have created an environment and a culture that is open, and it results in dialogue and debate before decisions are taken. That way, when we execute, there is clear alignment

among all the decision makers.

Meanwhile, the senior leadership team is always out in the market-place, clearly looking at how the customer needs are evolving, how we adapt ourselves to new tech-nologies, new products which are emerging in the external developed world, and so on. And our philosophy is very clear: we don’t have to be leaders in technology in India. We just have to copy what the best have done overseas. And to help us grow at a faster rate, we have adopted two unique models, I think – basically

“...we realized that India is a growth economy, and that telecom is a driver – it is critical to the

infrastructure and to the economy.”

Executive interview – Bharti Tele-Ventures


an outsourcing model. One is that we have outsourced the running of our network to our suppliers, namely, Ericsson, Nokia and Siemens. We are growing so fast and trying to ensure that the brand and distribution are managed right, so we need people who actually understand the network. And we felt that people like Ericsson, who design, develop, and manufac-ture products for networks, were the

best partners for this.

In addition, it’s important to realize that in India we don’t have a very robust credit management system or credit rating system. And, therefore, we need to work with partners to ensure that the customers who come onto our network are creditworthy. And this calls for a very close partnership between the third parties and Bharti. So we have looked at our competencies and focused on the two or three critical areas, while we have partnered with world-class organizations like IBM, Ericsson and Nokia to help us achieve the capability to deliver these services.

IBM: This is a very distinctive approach to building capabilities. How did Bharti’s approach to part-nering evolve?

Nayar: We realized that if we stayed internal we would not be able to surge ahead. In addition, we were facing competition from very large organizations, like Reliance, with a lot of money behind them. The only way we could differentiate ourselves was to provide superior service. And the size of our networks was small, and there was nobody in India who could handle a large-scale network. So there were factors that said we shouldn’t do it. But the prevailing factor was that if we did not do it we would not grow at the rate we wanted to.

IBM: Weren’t you one of the fi rst companies in India to adopt this approach to partnering?

Nayar: Yes, I think we were the fi rst company to do it in the Indian marketplace. And it’s interesting that it happened at a time when there was a lot of hue and cry that America and Europe were losing jobs to India. And we were actually outsourcing back to companies like IBM and Ericsson and Nokia. So, I think it was unique, and I think it had an impact. It did involve

taking a risk, because very few companies had looked at outsourcing their network requirements.

In fact, I recall the CEO of one of the largest mobile operators telling Sunil Mittal, who is our chairman, “You know, you think you’ve done the right thing. But look, you’ve given away your network to someone – and that’s the core of this business. You don’t give these things off.” But now, one-and-a-half years down the line, a lot of companies come to us and say, “OK, how do you do it actually?” And people are seeing value in it, not only here in India but globally. So, I think there is something that we are doing which is in its own way unique.

IBM: It must have been a diffi cult decision – taking some of your core strengths and outsourcing them to somebody else – how did it come about?

Nayar: It wasn’t an easy decision. It was a hard sell, with a lot of push-back from management. But it helped that when employees moved from our company into the Ericssons and the Nokias and the IBMs, they saw a huge growth prospect for themselves, not only within India but also internationally – because some of the people who went to Ericsson

Q&A

26

or Nokia at that time were people who actually also helped them in projects overseas.

So Ericsson and Nokia, the partners, saw a strength – whereas the indi-vidual saw some growth opportuni-ties. And I think that was helpful. And from the perspective of knowledge, we understood that the Nokias and the Ericssons and the IBMs bring with them cutting-edge technology and knowledge, which does not normally come into the operators. We normally don’t pick up the tech-nology knowledge until a year or two down the line. So for the technical side of the company, it was quite a plus to start working with these premier technology partners.

IBM: Let’s move on to the concept of conviction – the idea of com-municating strategy and aligning actions throughout the organization. How important has that been to your success?

Nayar: It’s been absolutely critical. In the fi rst phase, the leadership team was able to clearly defi ne the growth strategy and communicate it to the organization – including holding an interactive session with the operating teams that are in the fi eld. And these forums happen at least once a quarter, in which someone from the

corporate offi ces visits some part of the business and interacts with them. We have tried to build a culture that allows for and respects difference of opinion. And there’s a lot of debate.

Our chairman very clearly says that our main task is to ensure that we have happy customers. And if we are able to do that, profi ts should follow. So the focus on the quarterly results is not with the objective of satisfy-ing the investor community or the market. That is only an end result.

IBM: How do you marry that with a performance-oriented approach so you not only grow revenue but also translate that into shareholder value?

Nayar: We monitor fi nancial metrics – top-line metrics like ARPU and the revenue from value-added services – while keeping an eye on cost per minute and the revenue-to-capital ratio. We also track functional metrics at various levels. Eighty percent of our processes are three sigma today, with a goal of moving to four sigma within a year. We actively share the best practices that drive these metrics. All that said, customer and employee satisfaction are our highest priorities. If the customer is unhappy, then it doesn’t matter what it costs to fi x it. That’s a very simple doctrine. We try to take the same approach with employees.

IBM: Finally, what challenges and opportunities do you see ahead? What’s next for Bharti?

Nayar: Right now we are around the 30th largest telecom in the world. We believe we can be in the top fi ve in the next fi ve to six years. And to be able to manage scale right, in a manner which will ensure continuous improvement and productivity and improvement in cost, is an enormous challenge. Not only that, but we must continue to deliver superior customer service.

“We realized that if we stayed internal we would not be able to surge ahead.”

Executive interview – Bharti Tele-Ventures



Innovation

Technology

Strategy

28

IntroductionWith growth rapidly moving past cost-cutting as the top corporate objective, executives are actively rethinking their business strategies, searching for innovative ways to spur sustainable growth. Despite all the consternation around finding the ideal strategy, perhaps the answer lies not in the strategy itself, but rather in how it is developed.

Guided by classic approaches, companies today generate volumes of data to analyze customer segments, relative market share, and current and potential competitive threats as they formulate their business strategies. They research ways current products and services can be enhanced and modified to deliver incremental value to current customers. But are these classic inputs – sometimes distilled into the “five forces” – enough? Do they sufficiently address the context in which companies must today formulate business strategy?

For more than a century, business leaders have viewed technology as a means to execute their business strategies. Strategy came first, and technology was simply a means to implement it. Unfortunately, given today’s technology context, this mindset leaves a large and expanding blind spot when it comes to strategy development.

Some executives confine their view of “technology” to information technology (IT). They tend to segregate firms into two categories – those that deal primarily with information and those that work with physical goods and services. For the “bit handlers” – the Ciscos, Motorolas and IBMs of the world – most would agree that

technology should be a factor in setting corporate strategy. But for the “atom” companies, many still view technology as an efficiency play or an after-the-fact enabler – a way to implement or optimize an already defined business strategy, not as a mechanism to determine what opportu-nities exist and what is strategically possible.

But technology is much more than IT. Technology in its broadest sense is defined as the means with which firms transform labor, land and capital into goods and services.1 With this perspective, technological advances are everywhere. Even more importantly, companies are facing a proliferating set of technologies that stand to directly impact or potentially disrupt their markets. Many of these technol-ogies cross into the world of atoms in the form of digital technologies. Further, changes in the technology context are coming much faster. Lag periods – the time between changes in technology context – are continually shrinking. Across virtually every industry, technology adoption curves are getting steeper (see Figure 1).

Eliminating the strategic blind spotTechnology-driven business strategy spurs innovation and growth

Sources: Federal Reserve Bank of Dallas. “Time well spent: The declining real cost of living in America.” 1997 Annual Report; “Benchmark 2004 Data Overview.” Forrester Research, Inc., June 2004; IBM Business Consulting Services analysis.

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Figure 1. Adoption rates for new technology-based consumer products within the U.S.


By Kevin McCurry, Saul J. Berman and Jeff Hagan


To innovate and grow in this type of world, where rapid-fire technological advances constantly upset the status quo, leaders must acknowledge that technology itself shapes, alters and increasingly defines the very nature of the businesses in which they compete. Technology can no longer be left as an implementation issue – it must be at the heart of strategy formulation.

Some successful companies have already caught on – their innovations sit at the intersection of market insight and technological know-how. As part of its study, the IBM Institute for Business Value examined ten of these companies to identify what they all have in common. Its research suggests that successful companies are eliminating traditional strategic blinds spots that have plagued industry peers by taking a fundamentally different approach to strategy development – one that IBM calls technology-driven business strategy.

Innovation – Path to growth Worldwide, CEOs are turning their attention to growth. Out of the 456 CEOs interviewed as part of the 2004 IBM Global CEO Study, a full 80 percent cited revenue growth as their top focus area for strengthening financial performance over the next three years.2

That intense focus is not surprising, given that today’s stock prices often reflect a significant growth expectation. Executives must drive material growth simply to maintain market value (see Figure 2); to raise shareholder returns, leaders must somehow find even more sources of growth.

This growth expectation is not readily met through classic management levers such as targeting current customers with enhancements, derivatives or extensions; increasing prices (even when competitively feasible); and capturing relative share of market growth within current markets. Acquisition might satisfy such growth expecta-tions, but at what cost premium? And at what realization risk? Yet, there is one additional source of growth. We define this source as innovation-based growth.

Innovation-based growth has the potential to provide companies with the sustainable growth they seek. By definition, innovation-based growth is not incremental in nature, but seeks to deliver fundamental new value to current customers and markets or create entirely new market opportunities. Such strategies are difficult for competitors to replicate, providing a more sustainable source of growth than the routine extensions of current products and services can offer.

Generally, innovation can be classified into three categories:

• Product or service – the traditional area associated with innovation whereby new products or services that deliver increased value to customers are brought to market

• Operational capability – innovation that emerges in the way companies acquire and organize resources, and ultimately deliver value to their customers

• Business model – innovation that is grounded in a new integrated value proposition, operating processes and profit mechanism that deviate significantly from an industry’s current business model.

Figure 2. Expected growth rates based on current stock valuation.

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5% risk free rate6% risk free rate7% risk free rate

Valuation variables• Beta = 1• Risk premium = 5.5%Growth stage• 10 years• Payout = 20%• Growth = X%Remaining years• Payout = 50%• Growth = 8%


30Eliminating the strategic blind spot

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Note: n = 1111.Source: IBM Business Consulting Services analysis; U.S. Patent Office; Compustat.

R2 = 0.0006

Figure 3. Across the S&P Global 1200, the number of patents awarded has no correlation with shareholder returns.

“I needed employees to start thinking about their jobs as

innovating, not just researching and developing. R&D means

improvements to existing products, quality assurance,

line extensions. Innovation is something truly different in the market that makes your

customers’ lives better.” – Herb Baum, Retired CEO of Dial 3

Invention is not innovationIn hopes of driving innovation-based growth, companies often invest heavily in R&D. Overall, the U.S. spends 2.7 percent of its gross domestic product on R&D. From 1994 to 2000, total R&D expenditures jumped from US$169.2 billion to US$265 billion, the largest increase for any six-year period in the nation’s history.4 With so much invested, one would expect a corresponding increase in market value.

Because they are tangible and easy to measure, patents can be construed as an indicator of successful innovation. Unfortunately, by this measure, invention does not guarantee revenue growth or shareholder value creation (see Figure 3). In fact, among the 10 organizations that were granted the most U.S. patents between 1993 and 2003, 4 out of the 5 publicly traded companies returned less to their shareholders than the S&P 500 over that same time period.5, 6

Although invention is part of the mix, innovation is clearly something bigger. IBM – based on its experience working with clients in various industries around the world – thinks of innovation differently. IBM believes that innovation emerges where market insight and techno-logical know-how intersect, when businesses match what the market needs with what technology makes possible.

This definition of innovation has several important implications. First, technology matters when it comes to driving growth and, thus, to the formulation of business strategies. Second, when factoring in technology, know-how, as opposed to invention, is sufficient. In fact, many innovation-based strategies are based on the unique market application of an existing integrated set of technologies rather than a new technological “invention.” Third, innovation occurs at the intersection. In an entre-preneurial venture, this intersection is inherent and often manifests itself initially in a single person – the visionary entrepreneur. In established companies, the intersection is not inherent. Although it may have both components, a company’s processes, planning approach and organiza-tional norms can prevent the natural blending of market insight and technological know-how. Finally, given today’s rapidly changing technological context, know-how can be fleeting, requiring companies to maintain pace with this changing context or risk being exploited by it.


Technology can create radical change in routine productsTechnology is providing the wherewithal to fundamentally alter the performance of everyday products like household appliances and vending machines. Italian electronics manufacturer Merloni has announced a line of innovative white goods that use RFID technology to change the capabilities of ordinary products. When loaded with RFID-tagged clothes, for instance, its washing machine can select the appropriate wash program and even warn consumers when incompatible fabrics are found in the same load. The refrigerator can

propose nutritious meals and recipe instructions based on its RFID-tagged contents and notify consumers before foods expire.9

The function of vending machines is changing too – from what is dispensed to how efficiently the machines run to how consumers

pay for merchandise. Known for their affinity for the convenience of vending machines, Japanese consumers are now using vending

machines to download music and software games.10 Businesses anxious to reduce the energy bills associated with their vending

machines are using devices equipped with motion sensors that can turn the machines off when no one is around.11 In many regions,

payment is now possible with a swipe of a card or through a mobile phone – not just with cash.

Laundry rooms at apartment complexes and college dormitories are combining technology advances in both domains to change

the typical laundry day. Users can check the status of washers and dryers remotely through a computer or mobile device and select

appliance functions such as soap and fabric softener dispensing. When the load is done, they are notified by e-mail to their choice

of device.12

Each one of these applications stands at different points in market realization. What is important, however, is that to conceive of these

opportunities, technology must be an input to the strategy formulation. In the absence of this input, missed market opportunities may

arise or strategic blind spots can emerge. In addition, key strategic questions must be answered:

• What are the technologies that must be in the strategic technology portfolio?

• How is the portfolio changing? And what are the implications to the core capabilities and competitive advantage of the business?

• How do the current strategic planning processes ensure that market insight intersects with this technological know-how to avoid

technology-push and ensure timely introduction of the innovation?

• How will the discrete technologies and associated capabilities be accessed and integrated? Will this be achieved via internal

development, partnership or sourced?

Technology-driven roller coasterAlthough technology has always had an impact on markets and competition, its influence has increased significantly over the prior two decades – driven by two trends described earlier: the proliferation of current and potential technologies that could impact a company, and the pace of change in the technology context for a given market or industry.

Historically, companies needed to manage only a limited number of technologies, and the associated technological know-how may have provided a source of competitive advantage. Now, many companies are faced with an expanded and potentially splintered set of technologies. The “legacy” technologies may become pedestrian in nature and no longer offer a competitive advantage. The new technologies may represent a source of competitive advantage within the current competitive context, or, as documented in recent literature, may even disrupt a market.7, 8 Companies cannot easily cover all potential outcomes, since capital and resource constraints

typically do not allow a company to directly invest in every technology. Thus, leaders must make critical, strategic decisions on where to invest, partner or procure. For example, pervasive and wireless technologies have entered, either implicitly or explicitly, many firms’ technology portfolios – in industries ranging from medical equipment to media content distribution to insurance underwriting.

Few companies are immune to this proliferation. Even product categories traditionally considered as low tech as toothpaste and mouthwash have seen rapid market expansion associated with new product categories (teeth-whitening products and breath strips) grounded in the application of technologies to create new markets.

This is not a transitory trend; one only needs to look at the automotive industry to see the steady progression that is remaking a historically mechanical product into a decidedly electronic one. By 2010, 90 percent of automotive innovation is expected to be electronics related (see Figure 4).


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Sources: “Reuse of Software in Distributed Embedded Automotive Systems.” Audi. 2004; Embedded Automotive Electronics Symposium, Peugeot, June 23, 2004; “Roland Berger Study Says Cost Pressure on Automotive R&D Will Increase.” PRNewswire. July 21, 2004; IBM Institute for Business Value interviews and analysis.

A = x years

Technology “A” Technology “B”

D = x - y years

Technology “A” context becomes obsolete as the next generation of emerging or disruptive technology, “B”, is introduced and accepted in the marketplace as the de facto standard. At this point, companies must be prepared to transition to the next generation of technology to sustain profi table growth.

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... at the same time, companies must identify and invest in the next wave of emerging potentially disruptive technologies.


Figure 5. Managing changes in technology context.

Figure 4. Automotive innovation is becoming predominantly electronics-related.

Not only is technological change pushing into new frontiers, its pace is also accelerating. More specifically, there are more frequent changes in the technology context, whereby the period of relative stability between technological shifts is decreasing. In a period where there are long lags between changes in technology contexts, a company can assume away or treat technology as a constant. Business strategies would implicitly, and safely, assume the current technology context. However, for many companies, this reality is eroding. Making the

assumption of a static technology context could prove strategically risky since, for most companies, the time period between context shifts is shrinking. Therefore, technology must be viewed as a critical business strategy input, and the frequency at which that input is evaluated must be increased.

These compounding trends are visually represented in Figure 5. Companies must make capital and resource allocation decisions on an increasing set of technologies relevant to today’s context – typically referred to as sustaining technologies. This is a necessity to compete and win in today’s market. A missed innovation cycle, for instance, could cause a loss in market share, competitive strength or pricing power. These activities are table-stakes to drive growth. To sustain growth, successful companies must also anticipate the shifting technology context – shifts which increasingly come much faster on the heels of their predecessors. These emerging – potentially disruptive – technologies, when invested in, appropriately nurtured and ultimately exploited by incumbents, allow companies to sustain growth over time. They often are the source of new markets and customers. Without managing both technology portfolios, firms risk failing to compete in the current context or failing to maintain their growth within a context shift.

With this need to manage dual portfolios and a shrinking time period between waves of change, companies can no longer afford to treat technology as a second-tier management issue. Ignoring the technology variable or assuming it away as a static variable in

business strategy formulation can put business growth at risk – with lost revenue or forfeited market share when innovation cycles are missed or even industry irrelevance when business models suddenly become obsolete.

What makes innovators innovative?To learn more about how successful businesses innovate and



Technology helps Progressive pioneerWith more than 12 million customers, Progressive is the third largest auto insurer in the U.S.14 During the last decade, Progressive has certainly lived up to its name, launching a series of firsts in its industry:

• 1994 - Launched the industry’s first toll-free, 24-hour auto insurance comparison rating service

• 1996 - Followed with the first online auto insurance comparisons

• 1997 - Gave consumers their first opportunity to buy an auto insurance policy online in realtime

• 2000 - Became the first auto insurance company where customers could locate an agent using Web-enabled phones

• 2000 - Accepted the auto insurance industry’s first wireless payments.15

Over the years, Progressive has become adept at blending market insights with technological know-how to produce innovations that differentiate it from its peers. For example, Progressive knew that, after an accident, waiting only produced apprehension and frustration in its customers. Because of its working knowledge of satellite communications, the company recognized that claims agents did not have to be seated at their desks to serve customers. Taken together, this knowledge prompted Progressive to introduce 2,600 Immediate Response Vehicles in 1994, revolutionizing the way insurance companies handled claims. The lynchpin of the program was a fleet of specially equipped automobiles linked to global positioning satellites and outfitted with laptops, printers, mobile phones and, more recently, Internet connections. Using these Immediate Response Vehicles, trained adjusters could travel quickly to wherever customers were and provide on-the-spot estimates and settlement checks.16

Since the industry’s inception, auto insurance companies have strived to better understand risks so that they could appropriately price their products. For years, that calculation rested largely on demographic norms and (after insured) an individual’s accident history. As Progressive’s knowledge of GPS and cellular technologies grew, the company realized that it could get a much more accurate view of risk depending on how an automobile is actually used. Based on its understanding of the market, Progressive believed that consumers would be willing to share private information (when and where they drove) in exchange for lower premiums. To quickly understand the value of the opportunity, Progressive’s approach was to create learning opportunities and evaluate the technical feasibility by introducing a usage-based pilot driven by this blend of market insight and technological know-how. The Houston, Texas-based pilot effort was the first auto insurance program to give consumers direct control over how much they pay. The pilot program collected information on mileage and driving patterns and combined that with risk data to more precisely price premiums for its insured population.17

A steady stream of innovation has contributed to superior financial results at Progressive. In 2003 alone, the company’s net income increased 88 percent.18 Since 2001, Progressive’s stock has consistently outperformed both the Dow Jones Property and Casualty Insurance Index and the S&P 500.19

incorporate the technology variable into business strategy development, the IBM Institute for Business Value studied 10 companies that are known within their respective industries for strong innovation. These companies’ innovations stood out because they accomplished one or more of the following:

• Changed the basis of competition. At a particular point in time, within any given industry, businesses typically compete on a specific subset of performance dimensions such as product features, price, customer service or breadth of offerings. Companies most often invest energy in beating the competition along these “accepted” performance dimensions. Innovative companies, on the other hand, shift the game. Instead of competing head-to-head with industry rivals on historical performance measures, they differentiate themselves through a new dimension that exploits an emerging or unarticulated market need. For instance, an industrial products company might shift the basis of competition from product features to rapid fulfillment, or

a services company could change the focus from price to convenience. This type of innovation delivers new value to consumers, while creating competitive differen-tiation for the innovative company.13

• Broke the rules of scale. Within each industry, a certain set of implicit rules often exist around scale. For example, a new model of car must sell x units over the product’s life to be profitable, or a new book must sell x copies in its first printing to break even. Behind these heuristics are certain assumptions about scale that guide capital investment decisions, allocation of resources and market selection and entry strategies. Most companies seek to optimize operations within these boundaries. Innovative companies, however, also look for ways to break these rules – often leveraging technology to deliver profit at a lower scale point or, conversely, achieve scale advantage where previously none existed. eBay is a prime example: it managed to create scale advantage in a market that was long considered regional and hyper-fragmented.


34

Figure 6. Where innovation happens.

AirbusDesigner and manufacturer of aircrafts

Apollo GroupProvider of higher education programs

Brother IndustriesMaker of information and document

equipment, home and industrial sewing machines and production machine tools

CaterpillarManufacturer of construction and mining

equipment, natural gas and diesel engines, and industrial gas turbines

CemexSupplier of cement, ready-mix

concrete and aggregates

Charles SchwabProvider of securities brokerage and

related fi nancial services

DellSeller of computer products and services

for consumer and professional use

Frito-LayMaker of chips and snack foods

HertzSupplier of vehicle and equipment rentals

Progressive InsuranceProvider of automobile insurance and

related services

Market insight Innovation Technological know-how


Customers care about total cost to own and operate not just purchase price

Increasing number of adults wanted to further their education but didn’t have the time

Customers care about getting a job done, not about the specifi c technology

Customers care about total cost to own and operate not just purchase price

Customers have expensive capital waiting idle while they are waiting for cement deliveries

Many investors wanted cheap transactions not expensive advice

Customers wanted price, quality, fl exibility and convenience

Consumer demand and preferences vary from region to region, requiring local sales and marketing fl exibility

Travelers are willing to pay premium prices for convenience

Good drivers want and expect cheaper rates

Fly-by-wire technology reduces fuel consumption and enables effi ciencies through common cockpit design

Introduced online learning and became the University with the most enrollees in the country

Successfully transitioned from sewing machines, to typewriters, to fax machine, to printers, and now software

Introduced fl eet mgmt. tools that monitor equipment performance and automate earth-moving tasks

Changed the nature of competition by reducing the delivery window from 3 hours to 20 minutes

Introduced the fi rst discount brokerage after industry deregulation then disrupted old business with online business unit

Sells customized computers with standard parts at low prices

Enables salesforce to manage price, inventory, and customer changes in realtime in the fi eld

NeverLost on-board navigation system and #1 Club Gold expedited pick-ups and returns

Able to aggressively price policies for good drivers while increasing underwriting profi t

Fly-by-wire technology

Distance learning technologies

Continuously evolving and expanding capabilities

Electronics, GPS, engineering software

Satellite tracking technology and advanced scheduling software

Databases, call center, voice recognition technology, online trading

Supply chain integration, call centers, e-commerce

Hand-held devices, wireless communications, software

Hand-held devices, navigation systems

Satellite tracking technology and advanced risk calculating methodologies

• Introduced totally new business models. In each industry, a dominant business model usually prevails. Using the standard business model (the operating model employed to deliver on its value proposition and generate profits), traditional competitors seek to drive greater efficiencies and increase revenues. Meanwhile, innovative companies are constantly seeking out alternative business models that have the ability to disrupt or undermine the incumbent industry business model. Here again, technology can play a pivotal role, allowing a business model to emerge that does not rely on the historical operating model or profit mechanisms, often shifting large amounts of market value to the

innovative competitor. With its direct-to-consumer, build-to-order model, Dell turned its industry’s traditional build-to-stock model on end – allowing the company to avoid high-cost channels and excess inventory that often plagued rivals.

The accomplishments of the companies studied also reinforce the IBM view of innovation; in every case, these companies combined market insight with technological know-how to break stride with their competitors (see Figure 6). Looking across the broad cross-section of businesses and industries analyzed, there were no revolu-tionary inventions that precipitated their innovations. Most of the technologies involved were not proprietary – and



most had been available for quite some time. However, these companies’ familiarity and knowledge of technology provided a new lens through which they could explore solutions to market needs and opportunities. And that timely combination led to innovation.

The common threads What do these innovators have in common? Based on our research and experience working with clients, we have identified some common themes in how innovative companies approach business strategy development. We observed six strategic tenets that help companies create a business environment that is more conducive to innovation and promotes technology-driven business strategies:

• Consider technology a core input. Instead of viewing technology only as enabler of their business strategies, businesses should consider it a primary input to strategy formulation – on par with other necessary variables such as customers, markets and competitors. At Boston Coach, business strategies have to balance various (sometimes competing) objectives: customer satisfaction, operational efficiency and revenue growth. As dispatching, its core business process, became increasingly complex, it seemed unlikely that the company could simultaneously address their business objectives with a single strategy – until they decided to factor technology into their business strategy development process. The company hired a research team to identify applicable technological innovations and assess potential business implications. Based on its findings, the firm decided to create a proprietary scheduling algorithm and optimization engine capable of refining complex dispatch schedules in realtime. These innovations have become the foundation for a new operating model which has the capacity to support up to a 10 percent increase in sales without additional vehicles, drivers or dispatchers, while simul-taneously increasing productivity by 10 to 20 percent.20 By factoring technological possibilities into its core business strategy, Boston Coach was able to break

the rules of scale that had been implicitly governing its approaches up to that point. With its innovation, the company redefined the “norms” for revenue capacity per vehicle and the cost of a near-perfect on-time pickup rate – and set a new competitive benchmark.

• Revisit strategy and technology context regularly. For many industries, the technology context has the potential to change more rapidly than the historical three- to five-year strategic planning cycle. Thus, companies need to continuously manage and revise strategy to proactively take advantage of the evolving technological environment rather than reacting to technology-induced changes to their markets and businesses. Hertz, for instance, has continually leveraged wireless and satellite technologies to create new operational capabilities and customer solutions that deliver value to the customer and differentiate it in a market susceptible to commoditization.

• Uniquely manage emerging businesses opportunities. Companies need separate organizational procedures, structures and policies to manage emerging business opportunities differently than their core businesses, allowing market insight and technological know-how to intersect and innovations to take root. When Norwich Union embarked on its ground-breaking innovation for usage-based auto insurance policies, it shielded the emerging opportunity by setting apart a separate team dedicated to this particular project. This small team could experiment, refine their approach and make decisions much faster.21

• Plan for disruptions. By understanding the power of technology to change long-held business assumptions, companies can better anticipate market changes and actively plan out how to disrupt businesses, sometimes even their own. Both Norwich Union and Progressive have incorporated new technologies that make a usage-based insurance model real, creating the opportunity to unseat the historical underwriting, pricing, product and customer service models.


36

• Manage for today’s and tomorrow’s context. Knowing the rapid rate of technological change, businesses should manage a diversified portfolio of capabilities – comprised of both sustaining technologies (used to keep pace with the innovation cycles in their existing businesses) and emerging technologies (technologies that can create new markets or potentially disrupt current markets). Clearly, Charles Schwab has remained at the forefront of the technological advances that are pertinent to its existing business, winning recognitions such as Gomez’s number one Internet Broker, Forbes Favorite brokerage Web site and one of CIO Magazine’s top 100 companies. But, at the same time, the company continues to anticipate shifts and invest in emerging technologies such as grid computing. The company began to look at this emerging technology back in 2001 as a potential means to provide the computing power needed for intense advice computations like what-if simulations and Monte Carlo routines. Schwab was anxious to tap its own unused cycles and use that latent computing power to significantly enhance and scale its advice capabilities. In 2002, it ran a Grid pilot centered on providing custom portfolio recommendations for each customer. The results were impressive. By breaking down the application into manageable pieces that could be distributed to multiple processors and then reaggre-gated after computation, the grid-enabled system reduced processing time from an average of 8 to 10 minutes to just 15 seconds. With this newfound capability, Schwab could now dramatically change its relationship with customers. Instead of sending an investor home to wait for recommendations by e-mail, fax or mail, an advisor can provide recommendations in near-realtime while sitting and discussing options with the customer, thereby creating new market opportunity potential.22

• Focus technology on the customers’ priorities. Rather than focusing exclusively on technology-enabled internal efficiencies, companies must also concentrate on problems their customers are trying to solve and identify technologies and new business models that can impact

those particular issues. As part of its ongoing evaluation of products and markets, Siemens Medical Solutions makes a concerted effort to consider the entire business process, not just how a particular medical device is used. This holistic perspective has led the medical device manufacturer to focus on integration capabilities among devices as well as higher-value managed service offerings. For example, the company not only considers how to improve its medical imaging product, but also how to make imaging information available to clinicians when and where needed, even in the operating room. The Siemens’ syngo platform provides speech recognition features and online, realtime discussion capabilities to support surgeons’ needs, and automates routine workflow activities such as automati-cally notifying the intensive care unit about the patient’s impending arrival.23

Bye, bye blind spot – Technology-driven business strategyCollectively, these fundamental principles turn the typical strategy development approach on end (see Figure 7). Instead of being an implementation issue or a static assumption, technology becomes a catalyst at the very initial stages of strategic planning, merging with market insights to produce truly innovative ideas. IBM calls this approach technology-driven business strategy.

Because technology competencies are engaged at the outset, planning and prototyping can occur earlier. Companies can engage in “strategy prototyping,” testing a variety of potential strategies before a particular course is set.24 With this iterative, learning-based approach, prototyping takes on a higher purpose – exploring a spectrum of strategic possibilities, not just validating a selected strategy’s feasibility. Strategic planning is not anchored to a calendar, but is evaluated and revised to take advantage of insights gleaned from new learning and changes in the technology context.



Approach:• Analyze the known• Avoid areas of uncertainty• Procedural• Focus on market, customer, channels, products• Historical context

Goal of each phase:• Complete all activities and analyses before moving to

next stage• Meet hurdle or review criteria prior to moving to next

stage or remain in current stage

Characteristics:• Serial• Determines which decisions can be made• Segmented and hierarchical

Traditional strategy process

Approach:• Discovery-based• Recognize inherent uncertainty and incorporate

uncertainty resolution and management into process• Iterative• Focus includes market, customer, channels, products

and technology• Future oriented

Goal of each phase:• Create learning opportunities• Uncertainty resolution that enables next level of decision

making

Characteristics:• Dynamic• Collaborative, multidisciplinary• Determines which decisions must be made

Technology-driven business strategy process


Versus

Figure 8. Technology-driven business strategy development is quite different.


Figure 7. Technology-driven business strategy replaces the sequential nature of traditional strategy development with a parallel approach.

Traditional approach to strategy development

Technology-driven business strategy approach

Launch and operateBuildDesignPrototypePlanStrategy

Strategy

Plan

Prototype

Design

Build

Launch and operate

Start

Start Finish

Finish


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At its core, the technology-driven business strategy approach is fundamentally different than traditional strategy development (see Figure 8). In most strategic planning efforts, the emphasis is on analyzing what is known about the competition, suppliers and targeted buyers. But, under a technology-driven approach, the focus shifts to include exploration of new, uncharted areas – products and services that have no precedents, emerging market segments that no one else sees, new operational capabilities that change the nature of competition – actions that all support innovation.

Because of its inherent parallelism and the focus on merging market insights with technological know-how, technology-driven business strategy can offer some distinct advantages. It:

• Speeds time-to-market and reduces risk of technology obsolescence

• Provides early warning of potential business disruption – and the means to intentionally disrupt competitors

• Mitigates the bureaucracy of strategic planning pro-cesses that too often thwart innovation, particularly at large companies

• Accommodates the increasing speed and complexity of business which can become unmanageable with a traditional annual planning cycle.

Where is your strategy development approach taking you?Although their specific strategies change from time to time, many companies step through the same basic, calendar-driven strategy process year after year, without a second thought. And, correspondingly, many are disap-pointed with the degree of innovativeness their strategies exhibit – and the revenue growth they actually produce. If yours is one of those companies, it may be time to rethink your strategy development process.

Ten signs you may need to challenge your current business strategy development processes1. Shareholder growth expectations exceed what is possible

with the current product and market scope of your business.

2. New product/service introductions are consistently late or sometimes technologically obsolete by the time they reach the market.

3. Products or services lack differentiation, which has led to declining margins and commoditization.

4. Emerging business opportunities that are abandoned by your company are readily exploited by new market entrants.

5. Competitors’ new business models are challenging the industry’s current revenue and profit mechanisms.

6. The market and technology environment constantly demands more flexibility and responsiveness from your business.

7. The majority of technology-related spend is devoted to efficiency programs and process areas that do not directly contribute to market-based competitive advantage.

8. These business-led productivity programs tend to produce transitory cost savings rather than long-term structural cost reduction rooted in transformed operational capabilities.

9. Technology implementation programs typically have whale-curve ROI profiles with “hard” investments chasing after “soft” returns in out years.

10. Technologies that could break current industry rules of scale or change the basis of competition are often left unexploited until it is too late.



ConclusionAs business executives formulate strategy, they must consider some important points: • Innovation is critical to sustained growth. Growth has

once again assumed a prominent position within the strategic agenda for executives, and significant growth expectations have been embedded in many compa-nies’ current valuations. Innovation-based growth allows companies to meet these expectations. Managing through changing technology contexts allows compa-nies to sustain that growth.

• Innovation happens at the intersection of market insight and technological know-how. Invention is not the same as innovation. Technological capabilities are of little value without the market insight that determines their application. And market insights left unexploited by technology create vulnerabilities that can be attacked by opportunistic competitors or new entrants.

• Companies must factor technology into business strategy development. Technology’s reach extends to virtually every product and industry. And the technology context in which businesses and industries operate is changing more rapidly than ever. Deferring technology to a final strategy implementation step or treating it as a constant that can be safely reassessed every few years

precludes a host of potentially innovative business strategies that never surface for consideration. This sort of blind spot provides ample room for rivals to step in and out-innovate. To avoid gaps in business strategy, firms must consider technology – its shifts, possibilities and impacts – just as they do customers, channels, products and markets.

• Technology-driven business strategy helps companies channel innovation. Technology-driven business strategy can expand a company’s purview by putting perennial industry challenges (and the latest marketplace devel-opments) in a fresh context that stimulates innovation. With this approach, the important intersection between technological know-how and market insight is encour-aged, not blocked. Technology is evaluated in concert with customers, channels, products and markets, serving as a catalyst to drive strategic innovation.

Although stumbling upon an innovative strategy might help a company meet growth expectations for the current year, adopting a business strategy development process that systematically spurs innovation can foster the type of sustainable growth necessary to maintain industry eminence.

40

1 Mankiw, N. Gregory. “Principles of Economics.” Thomson South-Western Publishing. 2003.

2 “Your Turn: The Global CEO Study 2004.” IBM Business Consulting Services. 2004.

3 Baum, Herb and Leigh Buchanan. “Herb Baum on Innovation: Leapfrogging R & D.” Harvard Business Review. October 1, 2004.

4 Carey, John. “Flying High?” BusinessWeek. October 11, 2004.

5 U.S. Patent and Trademark Office. “All Patents, All Types.” http://www.uspto.gov/web/offices/ac/ido/oeip/taf/apat.htm#PartB

6 IBM Institute for Business Value analysis of public company infor-mation.

7 Christensen, Clayton M. The Innovator’s Dilemma. Boston: Harvard Business School Press. 1997.

8 Christensen, Clayton M. and Michael E. Raynor. The Innovator’s Solution. Boston: Harvard Business School Publishing. 2003.

9 McLindon, Andrew. “Merloni builds smarter appliances.” electricnews.net. April 8, 2003.

10 Bremner, Brian. “Internet Age Japan: PCs, Smart Phones, and...Vending Machines?” BusinessWeek online. November 1999. http://www.businessweek.com/bwdaily/dnflash/nov1999/nf91123b.htm

11 Powell, Alvin. “Smart machines save energy: Vending machine innovations slake thirst for sav-ings.” Harvard University Gazette. October 17, 2002.

12 Wrolstad, Jay. “IBM Sends Smart Laundry Machines to College.” Wireless NewsFactor. September 4, 2002.

13 Christensen, Clayton M. The Innovator’s Dilemma. Boston: Harvard Business School Press. 1997. See this work for additional analysis on changing the business competition in an industry.

14 Progressive Corporation. “The Progressive Corporation 2003 Annual Report.” 2003. http://www.progressive.com/investors/03_annual/03_annual/flash/index.html

15 Progressive Corporation. “Progressive Backgrounder.” http://www.progressive.com/newsroom/printme.asp?article=http://www.progressive.com/newsroom/back-grounder.asp

16 Ibid.17 Progressive Corporation.

“Progressive Awarded Second Patent for Usage-Based Auto Insurance Rating System.” July 13, 2000. http://www.progressive.com/newsroom/2nd_patent.asp

18 Progressive Corporation. “The Progressive Corporation 2003 Annual Report.” 2003. http://www.progressive.com/investors/03_annual/03_annual/flash/index.html

19 IBM Institute for Business Value analysis of public company infor-mation.

20 IBM Corporation. “Boston Coach drives to new heights of efficiency with a realtime dispatch system.” August 2004. http://www-1.ibm.com/industries/wireless/doc/con-tent/casestudy/1151769104.html

21 IBM Corporation. “Norwich Union’s pay as you drive insurance ini-tiative.” 2004. http://www-1.ibm.com/industries/wireless/doc/con-tent/casestudy/1153089104.html

22 Marshak, David S. “Charles Schwab Responds to Market Conditions and Customer Needs.” Patricia Seybold Group. December, 2003. http://www-306.ibm.com/software/ebusiness/jstart/news/schwab.pdf

23 Siemens Medical. “Workflow improvements at every point of care.” 2004. http://www.medical.siemens.com/webapp/wcs/stores/servlet/PSGenericDisplay? storeId=10001&langId=-1&cata-logId=-1&pageId=10793

24 Iansiti, Marco. Technology Integration. Boston: Harvard Business School Press. 1998. See this work for extensive analysis on the related topic of the impact of experimentation and market feedback in product development initiatives.

Eliminating the strategic blind spotEndnotes



When it comes to technology inno-vation in automobiles, few are as highly thought of as Honda. Whether it is development of the hydrogen-powered fuel cell vehicle, leadership in gas-electric hybrids or continued evolution of the ASIMO robot, Honda continues to aggressively push the envelope. We recently caught up with American Honda’s VP of Corporate Planning and Logistics, Dan Bonawitz, to talk about how to build a strategy that’s at the intersection of business insight and innovative use of technology.

IBM: How does technology envi-sioning – or having a sense of where technology is headed – impact your strategy development?

Bonawitz: It impacts us in a couple of significant ways, both in terms of the hardware – the product, if you will – and the software. We sell and service our products through a group of dealers to reach the end consumer, and our goal is to exceed those customers’ expectations. Our strategy is one of embracing both the dealer and the consumer. And technology plays a key role in that strategy; on the dealer side, it’s all about providing up-to-date informa-tion in realtime.

We have an information network where we download a lot of our training and our specifications. And there’s a field portal, so our sales reps that call on the dealers can access information through a laptop and even graph it for comparison purposes. It makes for a quicker and

more impactful presentation. Inside the car, we’re beginning to provide things like service scheduling, so again technology impacts how we are informing the dealer, which makes the dealers more effective and creates a closer customer/dealer/original equipment manufac-turer relationship.

IBM: Are there cases where you are looking to the future and antici-pating how technology will advance, and then coming up with a strategy based on that?

Bonawitz: For us it’s a stair step kind of situation. Sometimes tech-nology helps lead the strategy, and the converse can also be true. In cars, we are looking at trends like more traffic, traffic moving at a slower speed and people spending more time inside their automobiles stuck in that traffic – so how can we make that time productive and enjoyable? In the Acura brand, we’ve added things like XM Satellite Radio, Bluetooth technology so people can use their cell phones but use them safely, DVD surround sound – Acura was the first car to do that – so you can enjoy your music at a higher level and features like the voice-activated navigation system.

IBM: Do you end up having to revisit your strategy more frequently based on the constant, and rapid, evolution of technology?

Bonawitz: Certainly. From the vehicle point of view, we have to be careful – because the technology changes so rapidly, much more

rapidly than the vehicle – not to have the vehicle become outdated before its lifecycle. It becomes a question of updating or freshening the tech-nology – in other words, let’s augment the vehicle, not date the vehicle.

IBM: Can you tell us about some of the other technology-driven innova-tions Honda is currently working on?

Bonawitz: Realtime traffic is a great example – we are the first manu-facturer to make that available. By bringing a number of different tech-nologies together – different methods of reading the traffic – and then using the back channel of XM radio and other technology in the vehicle, we can provide realtime traffic information to the customer. That’s an excellent example of bringing various technologies together for real customer benefit.

IBM: How does an idea like that come about in Honda?

Bonawitz: One of the things I like about Honda is the constant focus on the customer – the philosophy is “man maximum, machine minimum.” How can you maximize the individual experience and minimize the vehicle interruption, or maximize the vehicle’s contribution to that experience? In the case of the navigation system, as we listened to customers, it was a question of, “I know how to get there, but I want to know the best way to get there.” So based on what the customers were saying, we pulled the technologies together to be able to do that.

Q&A

Executive interviewDan Bonawitz, Vice President of Corporate Planning and Logistics, Honda Motor Company

42

IBM: For Honda, what role does external partnering play in innovation and technology?

Bonawitz: It plays a significant role. Even though we’re doing a lot of development internally, we do work with external partners also, and they bring ideas to us. The rideshare program is a strong example. Honda’s longer-term vision is to be an organi-zation that society wants to exist, and of course there aren’t a lot of those. And that’s always driven us in our environmental leadership area, our fuel economy leadership, and so on.

We have programs in Japan and Singapore, and we’re developing the program here in the United States, in which one car is shared by multiple users during the course of a day. The program relies on technology advancements like back-office systems or card readers for access to the vehicle or black boxes that tell you exactly what is going on, where the vehicle is going, how it’s being used.

IBM: For a user, how does the program actually work?

Bonawitz: There is one, through a company called Flexcar in Seattle, that is actually an on demand car – so you can literally call an 800 number or go to a Web site and reserve a Honda hybrid for whatever period of time you want, and the cars are located throughout neigh-borhoods. This program also exists in Portland, LA, San Diego and

Washington D.C. – there are cars either in parking garages or parking spaces on the street. A lot of corpo-rations and even some universities are beginning to replace their fleet with vehicles like this.

IBM: And it’s the universal key that makes the program work?

Bonawitz: Yes, it’s a card reader with a key that is tied to a membership, and into the vehicle, so one knows who is driving the car at any given time. And it all ties back to the billing system.

IBM: Given the constant need for newness – customers are always looking for it – and the pressure around timelines, how do you help ensure that you’re making the right strategic decisions around tech-nology?

Bonawitz: That’s a very difficult question. The only real answer is to try to be as close to and understand the market and the customer for the segment or the vehicle – and then trying to interpret the problem into a solution. Obviously there are examples where the technology gets well ahead of the marketplace and creates significant problems for both the customer and the company.

IBM: Is it a sense of trying to deliver on what people want today? Or of trying to anticipate what people are going to want a year from now?

Bonawitz: There’s a fair amount of anticipation. Often people can’t articulate exactly what they want because it may not exist, but you again have to try to interpret their wishes or desires or problems and convert them into tomorrow. If you’re just developing for today, you’re already behind.

Generally we bring these new tech-nologies into a high-end vehicle, where you may have a little bit more pricing elasticity, and you can begin to get customer acceptance, customer awareness, customer appreciation. Then we look to migrate them pretty rapidly where you can get the volume up and drive the cost down, or in some technologies, where you may not be able to drive the cost down, you can continue to increase functionality. IBM: How do you determine which features go in which cars?

Bonawitz: Different vehicles are targeted for different demographics. Presently, we are straddling the “silent generation,” the baby boomers, the smaller Gen X and the early wave of Gen Y. For some, what’s important is the ability to play their iPod through their audio system, so on certain vehicles that has a lot more priority. Next year, we will be introducing the collision mitigation brake system on the other end of the spectrum – that plays to a much different demographic.

“Our strategy is one of embracing both the dealer and the consumer. And technology

plays a key role in that strategy...”

Executive interview – Honda Motor Company


Few companies exemplify the intersection of business and tech-nology as powerfully as Napster. The fi le-sharing service touched off a storm of controversy in the late 1990s but has since emerged, with Chris Gorog at the helm, as a force in online music distribution. Before Napster, Gorog was a key player at Disney, ITC Entertainment Group and Universal Studios. When he joined Roxio in 2000, he used it as the vehicle to acquire Napster and, in his words, “put its burning carcass together with our new entity and created the new legal version of

Napster.” It launched in early 2004.

IBM: How would you characterize your transition from these well-estab-lished media and entertainment entities – Disney and Universal – to a company which is typically consid-ered more cutting-edge?

Gorog: This kind of opportunity provides me the ability to move very quickly, which would be impos-sible at a larger organization. It’s interesting – since we launched the new Napster, we have been contacted repeatedly by some of the large media companies to either be acquired by them or do some strategic venture with them. These large corporations are lumbering through decision making about Internet policy. Some of these orga-nizations have been extraordinarily successful but are totally ill-equipped to perform in the very fast-moving Internet space. You can almost see panic starting to set in.

IBM: How does understanding the future of technology impact your strategy development?

Gorog: When you’re creating a product like Napster, the job of product creation never ends. It isn’t like another business where you

may add something to a product on an annual basis – rather, the funda-mental concept may dramatically change over a period of months, in terms of what is going to have the greatest resonance with consumers. It is absolutely impossible to do product development in a vacuum. You have to get extremely close to the product roadmaps of the other companies you’re relying on in your technological ecosystems. So in our case, it would be companies like Microsoft, which obviously is deeply involved in software, and operating systems, and digital rights manage-ment, and so forth.

It would be the product roadmaps of the hardware and device manu-facturers and, you know, Internet companies, all of which kind of map over some of the things we’re doing. So in some sense, you end up defining yourself by what everyone else is doing, and at the same time, you can’t go too far in that direction. There has to be a moment in time where you stand up against what’s going on and lay your own claim. We created a good example of that by pioneering portable subscription, frankly, before most people thought it was ready.

Executive interviewChris Gorog, Chief Executive Officer, Napster

Q&A

44

“When you’re creating a product like Napster, the job of product creation never ends. ”

We were the catalyst that created the portable subscription opportunity – meaning that, while the technology existed at Microsoft, we had to put together an informal consortium with the device manufacturers and ourselves, and to some degree with Microsoft, to make that happen and to create that consumer product. If we had sat and waited for the ecosystem to provide the opportunity, we’d still be waiting.

IBM: Was there something about your approach to developing strategy that made you more nimble or more able to do that?

Gorog: It’s partly because if we are not the most innovative, if we are not out there on the “bleeding edge,” we’re not on brand because that’s what Napster is known for. That’s what people expect from Napster, whether it’s the investor community, the media or, most importantly, music fans and early adopters and fans of technology.

The heritage of Napster was a company that completely broke the mold and reinvented the music business, and it’s our responsi-

bility to continue doing that. As a practical matter, because of our size as a small microcap company, if we aren’t the guys really leading these developments, then our competi-tive differentiators aren’t going to be strong enough to win in the market-place.

IBM: Take the subscription service – where did that idea originally come from? Was it driven by your seeing the technology was going to be available to make that possible?

Gorog: We just looked at the consumer experience and realized that, as music fans, the 99 cent a la carte model wasn’t much fun. And to have the ability to pay a flat fee and have unlimited access to everything was a great deal of fun, very empow-ering as a consumer, and very similar to the original Napster experience.

The obstacle was not figuring out how to do that, but figuring out how to make it portable. So you not only could download this to your hard drive on your PC, but we needed to figure out a way to download it to the hard drives or the Flash memories of your MP3 player.

IBM: Are there cases where the technology changes or creates the consumer desire for a different kind of experience?

Gorog: Well, certainly the original Napster is a wonderful example of that. The peer-to-peer file sharing that was created by Shawn Fanning really introduced consumers to the idea that there was a different way to enjoy music other than going down to their local record store and purchasing the CD. So I think that the peer-to-peer technologies were a catalyst for an entire industry being created around doing that legally. And so you have the birth of entire industries – the digital rights management software, all the codex around that, encryption, compres-sion, and so on.

Technology clearly was the catalyst for the future of the entertainment business. I don’t think there’s any question about that. It’s a great example of technology changing strategies.

Executive interview – Napster


IBM: If you were to hire a strategist here, what would you tell them they have to do different in thinking about the business because technology is so integral to what you do?

Gorog: I would tell them not to get too married to any strategy, because it is very organic in an Internet business. Look at eBay. What did they do different from Pets.com or any of the other companies littered on the side of the road? One thing eBay did is have an ever-changing, organic business plan. So it’s extremely fluid, and there cannot be any sacred cows in terms of your particular approach. And that’s all technology driven.

We’re still just in the early adoption phase of online music, people accessing music through their PC and downloading to MP3 players and so forth. And before we can even get our feet underneath us, there’s a large contingency of people that would say no, no, no, it’s all about wireless delivery to cellular handsets, which is a whole other set of tech-nologies.

One of the ways that technology affects our strategy is by interrupting it, and I mean on a daily basis. It’s very distracting, very disruptive – and it’s critically important to be able to handicap not only the potential successes of these various technolo-gies but also the time horizon when they’ll actually be available. Then we have to handicap whether anybody will give a damn. And will they pay for it? They’re actually talking about selling over-the-air downloads for three or four bucks when you’ve got a portable subscription with Napster. You can put 10,000 songs on a hard drive or cell phone and change them out every single day without paying anything aside from your base fee.

IBM: What process do you use for evaluating new technologies or new partners you might work with and whether or not that should drive a readjustment of your strategy?

Gorog: We have a very disciplined process. We start with the consumer experience and what we think the best, most fluid, easy to use, fun, valuable consumer experience is. And then we hunt for technologies

to implement that. For example, let’s talk about the living room. Because I believe that when consumers can come home at the end of their day and turn on the television set and see Napster up there along with ESPN and NBC, that will be enor-mously important for our business. There are a variety of ways that can happen. It can happen through part-nership with cable operators, satellite operators, ISPs. It can happen by doing a deal with a small Silicon Valley start-up that has a wireless box that connects to its audio-video receiver and receives a signal from your PC in your home office. It could be implemented by a MP3 player that’s Wi-Fi enabled.

So we’ll sit with the satellite com-panies, with the cable companies, with the ISPs, with the black box Silicon Valley guys, with the device manufacturers that may be working on Wi-Fi, and do a technological due diligence on where they are. So that will involve our CTO. That’s how we make our best bet – by being comprehensive in our analysis of those technologies.

Q&A

46

IBM: What if somebody brings you a technology you haven’t seen before?

Gorog: We have a voracious appetite for understanding what’s out there. I was over at a small company here in Los Angeles that’s deeply into interactive television and thinking about the applications for online music for interactive television. You’re watching TV, and when there’s a song in the background that you like, you have the ability to buy the song, and so forth.

So there may be an opportunity there that was not even remotely on our roadmap. So we try to under-stand as much as we can about it, and then we try to handicap the intelligence of the idea.

IBM: So if you give it a good score what happens next?

Gorog: Then we look at integrating into our roadmap. But even if we give it a good score, we still have to handicap its importance in our list of priorities. If we do feel it’s a

high priority, we’ll do a deal first. We’ll create some kind of strategic marketing partnership or shared technology partnership and begin an integration and some type of imple-mentation.

IBM: How often would you say that type of evaluation is taking place?

Gorog: At a minimum, it’s on a monthly basis. Twelve or fifteen times a year, a new technology comes in front of us that we say we need to really study this and understand this.

IBM: Is that a formalized process, or ad hoc?

Gorog: It starts out with two or three senior managers talking about something. Here’s a quick example: recommendation engines. You search for Jimi Hendrix, and it says people who like Jimi Hendrix also like the Allman Brothers. There are many different algorithms that people are working on to create better recommendation engines. And there are many different ways to approach it. We will look at every one of them.

It will start as an informal conversa-tion, maybe myself, my COO, my CTO: “Have you heard about these guys?” “Yes, they’ve been in-house before. We don’t think much of their technology.” That’s the end of it. Or there’s a consensus that, yes, there’s smoke here, there might be fire. Let’s get them in here. Let’s get a demon-stration.

IBM: Where in the loop would you say, “If we had this technology, how does that change our business model?”

Gorog: It’s a qualitative thing where everyone is confident that it will make our product better and we know that that will result in better retention or faster customer acquisition. It’s tough to quantify sometimes.

IBM: Do you rely on outside experts to evaluate technology?

Gorog: For the most part we use our own internal team. But the danger is that no matter how eclectic our team is, when people work together for several years, things become a little insulated. So it’s actually critical sometimes, particularly for a CEO, to step out of the room and explore concepts with third parties.

“Technology clearly was the catalyst for the future of the entertainment business. I don’t

think there’s any question about that.”

Executive interview – Napster



Differentiation

Responsiveness

Efficiency

48

Academic studies and the popular press have identified myriad trends impacting today’s business environment. From globalization to increased price competitiveness to more demanding financial markets to the proliferation of technology, the list of issues facing business executives is well known. But what should executives be doing to deal with these phenomena? In a 2004 global study, IBM asked more than 450 CEOs to identify the most critical imperatives of success in today’s economy.1 Their top responses – to achieve differentiation, responsiveness and efficiency – are a clear endorsement of business fundamentals: strong, differentiated value propo sitions are critical for growth and profitability; organizations must be able to sense and respond rapidly to customer and marketplace changes; cost structures and business processes must be adapted in a flexible manner to maintain productivity and reduce risk (see Figure 1).

What is striking about the CEOs’ responses is their recognition that, in today’s environment, business models must simultaneously achieve all three of these attributes. In the past, practical limitations forced companies to build their business models around only one of these attributes, keeping significant achievement of the others an intense desire but impractical to implement. Competing on price,

for example, tended to rule out highly differentiated products or top-notch customer service. Until recently, such tradeoffs were an undisputed reality of doing business. The barriers of time and distance limited the ability of companies to integrate internal and external capabilities.

Now CEOs sense – correctly – that times have changed. Information and communications technologies have made the world a smaller place. Operations and financials are more visible, and the risks of collaboration have declined. Companies can now tap a much broader range of capabilities, regardless of where they reside. (Even distances of thousands of miles pose few problems.) Moreover, it is now much easier to find the best providers of the capabilities that fit their business needs.

Strategically, however, many companies do not yet feel a sense of urgency to change their business designs. Instead, they maintain their traditional assumptions about the nature of the firm and what it means to be a successful player in their industries. These businesses underestimate just how radically the changes of the past few years could impact the competitive dynamics in their

The specialized enterpriseA fundamental redesign of firms and industries

Figure 1. Imperatives of today’s economy.

Source: “Your Turn: The Global CEO Study 2004” IBM Business Consulting Services. 2004; IBM Institute for Business Value.

Over 64% of CEOs globally believe new products and services will lead their enterprises’ growth

JetBlue• Better customer experience• Underserved airport locations• Simplifi ed fl ight patterns

CEOs fi nd that growth can come by increasing the customer voice in product development while reducing cycle time

Zara• Rapidly introduces new designs• Dynamically adapts to demand• Local decisioning• Limited runs reduce oversupply

Two-thirds of CEOs indicate that cost reduction will remain a major focus area, making it a not-too-distant second place to sales growth

Wal-Mart• Low corporate overhead• Tightly integrated suppliers• Leverages scale economies• Leadership in technology use

CEO perspective

Company examples

Effi ciencyResponsivenessDifferentiation


By George Pohle, Peter Korsten and Shanker Ramamurthy


industries. The progressive thinkers, however, consider the tools and capabilities that have emerged over the past decade as fundamental to their strategies and operations of their businesses. They are making it an imperative for their organizations to use them for competitive advantage and ultimately to redefine the competitive dynamics in their industries.

Operationally, years of reliance on the same “hard-wired” business functions and technology infrastructures have made it expensive and time-consuming to change a company’s business model. Creeping organizational complexity makes efficiency gains difficult to achieve. Attempts to establish best-in-class capabilities across all parts of the business have left many companies with a

lack of focus. Persistent business unit silos saddle others with redundant activities across the enterprise.

The organizations that have gone beyond these challenges are redefining their business models by assembling the best capabilities available in the market. For capabilities that confer the greatest competitive position and profit, they are creating pools of specialized capabilities within the structure of their own enterprises. For capabilities that do not provide competitive superiority or critical levers to profitability, they are establishing relationships with external parties, each of which is a specialist in its own right.

We refer to the business model assembled from these internal and external specialists as the specialized enterprise. By eliminating the tradeoffs executives have traditionally been forced to make between differen-tiation, responsiveness and efficiency, we believe that the specialized enterprise will fundamentally reshape firms and industries for the 21st century.

The rise of the global connectivity platformOver the last five years, a number of diverse business and technology architectures have matured and converged to form a global connectivity platform that supports widespread collaboration.2 By slashing the cost of coordi-nation both within the firm and externally, with partners, this new platform represents a de facto weakening of traditional business structures and boundaries.

The three interrelated, mutually reinforcing architectures that make up the global connectivity platform should be familiar to anyone who has followed the technology and business developments of the past decade.

First, communication networks, specifically broadband and wireless technologies, have made digital connec-tivity faster and more affordable. Today, the number of worldwide broadband connections is estimated to swell 22 percent per year,3 while the number of worldwide wireless hotspots is growing by 40 percent per year.4 This rapid spread of communication networks is accelerating global interoperability among businesses and allowing more companies to access information in realtime.

Second, information technology has evolved. With the consolidation of the enterprise software market (SAP currently owns 25 percent of the ERP market, while Siebel owns 45 percent of the CRM software market)5 and the proliferation of business integration software, companies now have a common platform upon which broader and better functionality can be built. The emergence of these common solutions across the business environment is enabling firms to organize and seek partnerships more easily along their process flows. This is creating, in effect, a new, shared infrastructure.

Third, open standards – both technology and business – are optimizing inter operability and creating the potential for truly modularized infrastructures. On the technology side, XML has been adopted by 25 percent of companies and is currently being rolled out in another 33 percent.6 On the business side, the increasing ability of enterprises to define common processes

The global connectivity platform is creating a

powerful new set of economic incentives that companies

ignore at their peril.


50

Coase’s Law – “The Nature of the Firm” (1937)Coase’s Law is about ownership. It helps executives evaluate the cost of completing an activity internally versus delegating it to be conducted externally. Coase’s Law asserts that the cost of completing an activity internally is equal to the internal production cost plus the cost of actually completing the transaction. The external cost reflects the market cost of the goods and/or services plus the associated transaction costs.

Coase identified four types of transaction costs – searching, contracting, coordination and risk – each of which has been lowered by the global connectivity platform.

The cost of searching is incurred while locating optimal resources. Today, the global connectivity platform has drastically cut costs by speeding search time and aggregating information under standard interfaces and universal search engines. One recent survey showed that 61percent of companies use the Internet to collaborate with suppliers.7 The Internet has also broken down geographic obstacles, allowing companies to quickly locate and communicate with potential partners regardless of location.

Once the partner is identified, there is the contracting cost of determining the true value and negotiating the appropriate price for the exchange. Standardization and knowledge sharing enabled by the global connectivity platform have reduced the cost of contracting and decreased negotiation time. An estimated 62 percent of companies use the Internet as a part of a request for proposal process.8 Standardized agreements have reduced the time needed to customize and negotiate the terms and conditions of external relationships.

After the resource is contracted, there are coordination costs associated with managing and monitoring the transaction. The cost of coordination has dropped significantly with the rise of the Internet and digital technologies. Indeed, by 2007 approximately 70 percent of companies will invest in self-service via the Internet, providing time and cost savings to both parties in the transaction.9 These technologies have succeeded because they reduce friction throughout the process, from procurement, fulfillment, management, invoicing, payment and supplier performance reviews.

Finally, throughout all these steps, a cost is incurred to reduce the potential risk associated with loss of control over the activity. Today, standardization, network reliability and partner quality have decreased the risk of partnering. This is demonstrated by the fact that two-thirds of Fortune 1000 executives say that their companies are now better prepared than before 9/11 to access critical data in a disaster situation.10

Source: IBM Institute for Business Value.

Paper catalog

Trade shows

Phone and fax

Libraries and Dewey

Employee directory

E-Catalog

Exchanges

E-Mail and Web

Internetand Google

Intranet

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File folders

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Open standards

Coordination

Proprietary

Kilobyte

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Petabyte

Customer service

99%

Self-service

99.999%

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Push

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Figure 2. Example of lower transaction costs (1995 to 2005)and activities is simplifying day-to-day commerce and improving work flow. The result is something new: a universal ability to piece together solutions quickly from disparate components. Today’s enterprises can increasingly “program” the business by selecting from a wide variety of established modules, all due to open connectivity in the marketplace.

Taken as a whole, the global connec-tivity platform presents firms with a wide array of new capabilities, ranging from wireless tracking to Web Services. But this same force is also creating a powerful new set of economic incentives that companies ignore at their peril. The driver: a game-altering fall in transaction costs. It is difficult to overestimate the importance of this development. In short, the dramatically lower transaction costs made possible by global connectivity are leading to a renaissance of business specialization.


Figure 3. Internal and external specialization.

Fall in transaction costsDue to the fall of transaction costs, more and more business activities can now be performed centrally by the enterprise or by other market participants

Internal specializationInternal specialists combine the advantages of centralized function (economies of scale, standardization and single base for improvement) with the benefi ts of decentralization (fl exibility, accountability)

External specializationFirms can profi t from effi ciencies and expertise of external specialists while focusing on capabilities that make themselves external specialists in their area

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In “The Nature of the Firm” (1937), noted economist and Nobel-laureate Ronald Coase divides transaction costs into four categories: the cost of searching (finding someone to transact with), the cost of contracting (creating the agreement), the cost of coordination (implementing and maintaining), and the cost of the risk associated with the transactions (see sidebar, “Coase’s Law,” for details).11

As Figure 2 illustrates, the global connectivity platform is transforming business in each of these areas. In the area of search, firms are using the Internet to locate suppliers and partners at negligible cost, and in minutes instead of days.

Contracting costs are declining as vendors leverage standard terms and promote variable pricing. Coordination costs are similarly falling as virtual connections proliferate and a local presence is no longer a prerequisite (at least for many types of businesses). Finally, the risks inherent to all three of these areas (search, contracting and coordination) are declining as companies use the global connectivity platform to shorten feedback cycles and boost the speed and quality of transactions through the use of digital certificates and other verification technol-ogies. When an issue arises, managers can verify and resolve it much more quickly, making the performance of the entire network more reliable.

The rapid decline of transaction costs is having an especially profound and lasting effect on ownership decisions. In a world of efficiently connected services, which capabilities, exactly, should a firm own? When comparing the costs and benefits of handling an activity internally or externally, firms are finding more and more opportunities to move away from traditional business designs. As seen in Figure 3, transaction costs have indeed reached a tipping point, beyond which ownership decisions within a firm and across the market are funda-mentally transformed.

Internal specialization: The path to business componentsThis fundamental transformation, enabled by the global connectivity platform, is the latest stage in a decades-long process. Over the past thirty or forty years, business design has migrated along three sequential stages of internal specialization, as seen in Figure 4. In the 1970s and 1980s, firms focused almost exclusively on optimi-zation at the business-unit level. As PCs and the Internet emerged onto the scene, enterprises recognized the need to optimize processes. Now, with the maturity of the global connectivity platform, firms are increasingly focusing on the optimization of their enterprises as a whole.

When companies were optimized around business units, activities were owned and operated by distinctly


52The specialized enterprise

different organizations within the same enterprise. In the most extreme cases, each unit took care of itself, performing a range of similar activities – from opening customer accounts to purchasing office chairs – with no coordination or knowledge-sharing among units. This early-stage business design embraced the development of management strategies such as “Strategic Business Units,” portfolio management and organizational matrices. In this stage, firms often looked to incorporate “best-in-class” practices, but these initiatives tended to overlook obvious opportunities to optimize at the activity level and often actually created complexity across the firm. While many companies progressed through this stage, a few visionary enterprises have managed to leapfrog optimization at the business unit level.

Firms disillusioned with business-unit optimization often turn to process optimization. Today, many companies are in this stage, optimizing key business processes across silos on an opportunistic basis. Process optimization typically advances as new technology capabilities arrive in the marketplace. “Business Process Reengineering” is a common practice in many firms, as an alphabet soup of business system solutions – Supply Chain Management

(SCM), Product Lifecycle Management (PLM) and Customer Relationship Management (CRM) – promise opportu-nities for cost reduction. Process savings can be further squeezed by using proven methodologies such as Six Sigma, Total Quality Management and ISO 9000.

While process optimization does allow firms to centralize some activities within a process area (e.g., a process center), they often retain legacy business unit silos that focus on specific products targeted for particular customer segments. And as process optimization takes hold, the defla-tionary effects of the global connectivity platform can begin to counteract initial efficiency gains. That is because, paradoxi-cally, falling transaction costs often drive up integration costs. As the unit cost of each transaction declines, the volume of transac-tions tends to rise as customers discover they can do more for less.

In the banking industry, for example, migrating to cheap, Web-based transactions had the long-term effect of raising the cost of serving each customer. Where customers used to visit the branch office once a week (then the ATM two or three times a week), the advent of Internet banking allowed them to manage their accounts much more often – to the point now that it is not uncommon for customers to check their balances multiple times per day.

In the final stage of internal specialization, firms optimize decisions at the enterprise level. Enterprise-optimized firms invest in the virtual centralization of cross-company activities to gain economies of scale across the business. Key activities are centralized into discrete business areas. Duplication of activities is reduced, and the enterprise operates as a networked “federation” of focused performance centers. Functions once diffused across the firm are centralized, including back-office functions (e.g., procurement, finance, IT and HR) and operational functions (e.g., channel unification, data mining, cross-selling and product bundling).

Optimizing at the enterprise level requires not only new technologies, but a new way of thinking about business design. As internal specialization matures, the aggregation

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Stage 2:Process

optimized

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optimized

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Silo 1

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Componentized enterprise

Business components

The virtual centralization of key and expensive cross-company processes allows fi rms to gain economies of scale

Firms often remain organized as business unit silos to develop a specifi c product targeted for a customer segment

Early stage business designs do not permit optimization at the activity level and create complexity across the fi rm


Silo 1

Silo 2

Silo 3

Process centers

Figure 4. Illustration of internal specialization.


Figure 5. Examples of internal specialization.

Manage Design Buy Make Sell

Business silo 2

Business silo 3


Business silo 1 Manage Design Buy Make Sell

Established(Labor- and/or

standards- intensive)

Emerging(Information- intensive and

integrative)

• Payroll• Benefi ts• Maintenance• Security• Food services

• HR• Finance• Training

• Product design

• Branding• Web design• Product ideation• Prototyping

• MRO procurement

• Strategic procurement

• Supply chain management

• Inventory management

• Assembly• Manufacturing

• Inventory tracking

• Product packaging

• Advertising• Collections

• Call center• Application

processing• Order tracking


of cohesive activities transforms the firm into a network of individual business modules, each encompassing a coherent set of activities supported by appropriate assets, including people, processes and technology. Each of these modules serves a unique purpose within the organization but could also, in principle, operate as an independent entity. One advantage of this “federation of modules” design is that it makes the process of deciding whether an activity should be internally or externally sourced more responsive.

We call these modules “business components.” Think of them as the building blocks of a firm, with each component interacting in a loosely coupled manner with the others. As an organizing principle, business components allow an enterprise to expand and evolve without increasing complexity, a common problem with traditional, “hard-wired” business design. Adopting a modular structure does not imply an abandonment of central control. While components require flexibility, they must also be aligned with the firm’s architecture and strategy.

To make enterprise optimization practical, we developed an approach to help clients evolve into a

better business design. The “Component Business Model” (CBM) framework provides firms with a new perspective on enterprise structure. Typically, CBM projects provide clients with a “future state” map of the business as a fully mature, internally specialized organi-zation. As a diagnostic tool, the map helps to identify and isolate the issues faced by firms organized around complex and rigid business models.

Are firms embracing enterprise-optimized internal specialization? Studies show that they are, albeit under different guises. For example, many firms have embraced internal specialization by centralizing common activities into shared service centers, which provide economies of scale. Over 95 percent of Fortune 500 companies have considered shared services strategies, and currently 86 percent have implemented or are currently deploying a shared services strategy.12 Internal specialization is especially popular in parts of the business that are labor-intensive or require strict standards. Further automation, consolidation and standardization of specialized capabilities help drive costs out of the businesses, with information-intensive parts of the business emerging as an opportunity area (see Figure 5).


54

External specialization: Leveraging industry networksThe flip side of internal specialization is, perhaps not surprisingly, external specialization. As standards-driven internal specialization matures, firms gain the ability to leverage the benefits of lower transaction costs by engaging with external partners through collab-orative industry networks. The flexibility afforded by interoperable business components allows enterprise-optimized firms to loosely couple with focused external specialists – be they independent providers or outward-facing components within larger organizations.

As Figure 6 shows, firms evolve toward external specialization in three sequential phases. Initially, “internally integrated” organizations try to participate in all areas of the industry. Most firms today have advanced to the “strategically partnered” phase, using a few select partners in areas of weakness. In the final phase, “industry-networked” firms focus on areas of strength as they find a role within a larger business ecosystem.

In the first phase of external specialization, the enterprise owns and manages nearly all segments of the industry value chain in the belief that vertical integration is the only way to maintain access to trusted suppliers and targeted customers. Thus, automakers once sought to own the rubber plantations that supplied their tire factories, while beer brewers owned the saloons where their products were sold. Firms in this “internally integrated” phase attempt to drive quality in their offerings by tightly controlling inputs and distribution. As a result, the internally integrated firm is often times a “customized” firm that develops and uses solutions in-house based on proprietary systems and interfaces across the business. This model was attractive when the threat of supplier power loomed large and distribution channels remained uncertain. But increasingly, internally integrated firms have difficulty partnering due to their one-of-a-kind configuration (which, not incidentally, also demands large investments in people, processes and technology).

Figure 6. Illustration of external specialization.Phase I:Internally integrated

Hardwired connectivity

An internally integrated design offered security to fi rms that owned and operated adjacent areas of the value chain

Phase 2:Strategically integrated

Proprietary connectivity

Firms began to strategically partner in key functions along the industry value chain

Phase 3:Industry networked

Standardized connectivity

The industry networked design is built around many connections to external partners that specialize in key areas

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Many firms have moved past the internally integrated design phase and learned to work with a few select partners. These “strategically partnered” firms identify key functions along the industry value chain where outside help is needed. While still relying on proprietary solutions, they embrace open standards in areas of partnership to support inter-enterprise communication. In this phase, firms begin to identify areas of specialization within the value chain. Elements of the old, internally integrated structure often persist, with many non-core activities still performed in-house.

In the final phase of external specialization, firms leverage the low transaction costs of the global connec-tivity platform to build connections to multiple external specialists. These “industry networked” enterprises focus on an area of expertise while transforming their organizations to play in a coordinated industry ecosystem. Communication between partners relies on open standards (such as XML, SOAP, Linux®) and business protocols. The industry networked firm concen-trates heavily on core activities while simultaneously orchestrating a value network that includes a mix of industry-specific and cross-industry specialists, as these best-in-class providers gain scale around their particular area of expertise. Ecosystems of niche players and value chain specialists emerge around major, growth-driving players.

Changes in the PC industry over the last three decades illustrate this evolution toward external specialization. In the 1970s, the vertically integrated model prevailed. IBM and Digital Equipment Company sourced and built every aspect of their PCs internally.13 (Of course, the term PC



External specialization across industriesTo better understand trends in the marketplace, we developed a qualitative methodology to measure the level of external specialization across 17 industries, based on a comparison of how each was structured in 1983 and 2003. Primary inputs included an assessment of value chains, economic trends, regulatory issues and merger activities within each industry. We also examined the leading firms in 1983 and 2003 to understand the impact of external specialization at the firm level.

The study’s findings, illustrated in Figure 7, indicate that, while some are progressing faster than others, each industry has moved away from an internally integrated structure toward a strategically partnered model.

Figure 7. Different industries are at different points along the path to external specialization.

One of the sectors at the forefront of external specialization is financial services, particularly in the areas of banking and financial markets. By and large, leaders in this sector no longer attempt to manage and deliver every aspect of the offerings they provide to the marketplace. Players in the mortgage game now thrive by focusing on discrete aspects of the industry, whether origination, servicing or risk management. Credit card divisions cross-sell mutual funds and insurance products from other providers along with their own cards. And the best performing firms leverage specialists in credit risk and portfolio optimization to deliver lower-cost solutions to customers and greater profits to shareholders. This “deconstruction” of traditional value chains – driven largely by technology – has fundamentally altered the financial services industry.14

What has happened in financial services is also happening elsewhere. Whatever their industry, executives should no longer be surprised when niche providers emerge and quickly dominate positions in industry value chains, even in roles that were once considered too small or too proprietary for specialization. More and more, executives need to address tough questions regarding the future market environment:

• Where will the greatest economic rents be earned, and where will nonprofitable competition take place?• Which positions are defensible through sustainable advantages, and which positions are prone to attack from new or

existing competitors?• What potential acquisitions or divestitures will reshape the industry?


External specialization level 1983 2003

BankingBanking

Insurance

Financial markets

Telecom

Media and Entertainment

Energy and Utilities

Consumer products

Retail

Life Sciences and Pharma

Travel and Transportation

Automotive

Aerospace and Defense

Chemical and Petroleum.

Electronics

Forest and Paper

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HealthcareHealthcare

Industrial products

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Aerospace and Defense

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Life Sciences and Pharma

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Energy and Utilities

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Telecom

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Internally integrated Strategically partnered Industry networked


56

was not usually used for those early personal machines.) During the same time period, Apple Computer sought to control the entire value chain with its propriety approach to operating systems and hardware designs. By the 1980s, the partnership model came into prominence and changed the face of the industry. Key technology providers such as Intel and Microsoft® staked strong positions and new brands such as Dell and Gateway emerged as customer-facing sellers. The industry moved into the networked stage in the 1990s as contract manufacturing enabled the commoditization of PCs. In less than thirty years, the dominance of internally integrated players has given way to an industry network of focused specialists.

Emerging value netsToday, business thinkers recognize that the old, internally integrated design is no longer efficient. Firms can create far more value by focusing on differentiating strategies while leveraging industry value networks to handle some activities. These value nets take two forms: industry-specific and cross-industry. In both cases, the economics are compelling: the value provided grows as transaction volume aggregates, economies of scale increase and unit costs per transaction decline. For the business enterprise, employing the services of these specialists frees up resources to be focused on strategic activities and processes.

Within industries, the standardization of common functions has given rise to best-in-class specialists that dominate their vertical markets. These specialists build their businesses around expertise in the undifferentiated capabilities specific to a particular industry. In this context, undifferentiated should not be confused with strategically peripheral. Indeed, some industry specialists provide highly customized solutions that play a key role in differen-tiating the core products of their customers.

For example, International Flavors & Fragrances (IFF) provides taste and smell technologies to the food and perfume industries. This leading company offers its expertise in sensory experiences to add differentiating value to the product development process, in many cases becoming an essential partner to its many clients. While the taste of a food product is certainly at the strategic core of the company that makes and distributes it, the capability that creates that distinctive taste is only strate-gically differentiating to the company that can provide it most effectively. Increasingly, that company will tend to be an external niche specialist.

This new dynamic can create tension for executives unaccustomed to the notion of ceding control of the elements that define their products. But in the age of external specialization, value will accrue to the provider with absolute advantage – regardless of where that provider resides. In other words, developing a capability in-house confers no differentiation if an outside specialist can provide the same capability more effectively or efficiently.

Employing the services of a best-in-class specialist can also allow industry participants to avoid the extra overhead of a do-it-yourself approach. Because the functions they perform do not differentiate industry players from each other, these specialists provide efficiencies that can be shared across the entire industry. A rising tide lifts all boats, but only those on board stand to benefit.

Cross-industry functions are likewise being standardized, and a similar population of best-in-class hubs has emerged to increase efficiency by leveraging tremendous scale. The common, undifferentiated processes of all market participants are handled by these specialists, whose core expertise is the common process itself. Ariba Inc. is one company that illustrates this principle. As a pioneer in the self-described “spend management” market, Ariba has built a wide range of software and service solutions for diverse customer segments.

Not all specialists are designed as such from the ground up. One advantage of modularity-driven specialization is that it enables industry players to grow an internal business component into a hub that serves other companies – as long as there is demand and the company can provide value to other firms that serve end customers. The sidebar “Lessons learned from best-in-class specialists” identifies three success factors that specialists should embrace to succeed in a networked industry.

The use of specialists is growing as enterprises seek out global providers to capture the economic benefits of scale, flexibility and expertise. Worldwide spending on business process outsourcing is expected to reach

In the age of external specialization, value will accrue

to the provider with absolute advantage – regardless of where

that provider resides.



approximately US$500 billion in 2005 and is projected to grow 11 percent annually through 2008.15 Much of this work will be conducted in the large emerging markets, such as India and China. In the United States, spending on offshore outsourcing increased 26 percent between 2000 and 2005.16 In 2003, the number of outsourcing deals over US$100 million increased by 49 percent, to 244.17

The specialized enterprise: New imperativesCapital follows efficiency. It is little wonder, then, that the seismic shifts of the global connectivity platform are transforming business first and foremost by lowering transaction costs. But there is a dark side to this revolution. Its downward pressure on Coase’s four costs creates new threats. Firms slow to react risk being inundated by the wave of change. Failure to embrace internal and external specialization – to jettison allegiance to traditional business design – will place many companies at an increasing competitive disad-vantage against their more differentiated, responsive and efficient peers.

This shift in business priorities is primarily related to the increasing importance of absolute advantage. In the world of the specialized enterprise, firms must evaluate component performance to determine where their advantage lies – where the greatest value (quality versus cost) is achieved. Declining transaction costs not only allow firms to externalize components that are not contrib-uting directly to their absolute advantage; they practically demand it. The alternative is to compete against rivals happy to leverage the absolute advantage of external specialists. Coase’s work suggests that a firm should only perform a function internally if it cannot be handled more cheaply by the market.18

The upside is just as real: Firms that fully embrace these new realities can become specialized enterprises. As seen in Figure 8, the specialized enterprise represents the intersection of internal and external specialization – the enterprise optimized and industry networked stages, respectively, as described above. The specialized enterprise is organized into components, which enables it to deliver best-in-class performance through internal excellence and external partnerships.

For most companies today, nonstrategic components play too large of a role in enterprise operations. Over the next five years, smart firms will begin to focus on internal strategic components by leveraging more external

Lessons learned from best-in-class specialistsStandardization of common functions within industries has led to a growing number of best-in-class specialists that dominate their markets. To better understand key success factors in partnering, we interviewed top executives at ten best-in-class specialists (Automatic Data Processing, Employease, Ariba, Celestica, salesforce.com, IMS Health, State Street, Fair Isaac, International Flavors & Fragrances, and Industrial Light & Magic) that serve a wide range of industries with unique areas of expertise. Three key lessons emerged that are helping sustain the success of these players.

Lesson 1: Pursue loose couplingBest-in-class specialists avoid hard-wired solutions and use interfaces that permit fl exibility. These fi rms connect externally with their customers and internally across divisions through standardized interfaces, so changes in service support remain invisible to the user. Loose coupling simplifi es the addition of features and functionality, supports knowledge gathering and improves benchmarking efforts. It also allows for dynamic confi guration and scalability. As one executive noted in an interview, “Customers want more fl exibility. They don’t want to be tied to your platform.”

Lesson 2: Support confi gurability, not customizationBest-in-class specialists standardize offerings across customers to gain scale and provide services that are confi gured to meet customer demands. The process of connecting and contracting should not require high levels of customization. Confi gurability provides quick time-to-value, enables the scalability of solutions for different customers and supports the addition of new types of services. It also simplifi es contracting processes, decreases the investment required for supporting new customers and reduces maintenance and servicing costs. As one Senior VP enthused, “We’ve stopped worrying about custom coding.”

Lesson 3: Provide broader and deeper valueBest-in-class specialists can gain share within their area of expertise and strengthen their advantages by looking to adjacent markets to extend the boundaries of their customer relationships. Doing so enables specialists to leverage existing clients for cross-sell opportunities and raises barriers to competition. It also fortifi es relationships, exploits existing market knowledge and limits investment requirements (and therefore risk). One executive noted that an expansion of offerings is demanded by customers, since they want “more of a full-service experience.” For example, the software players among the companies we spoke with said that they have or are likely to move into services.


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resources for nonstrategic activities. A large percentage of support roles will go from being conducted internally to being outsourced to external specialists.

Thanks to the pervasiveness of process reengineering and the benefits of partnering, most companies today already have a blended model that is part “process optimized” and part “strategically partnered.” But to mature into specialized enterprises, they must drive these trends to their logical conclusion, assessing each component – the individual business modules that play specific roles within the enterprise – to determine how and by whom it should be managed. This job is made easier by another feature of the specialized enterprise: the interaction between components is based on standardized inputs and outputs. This allows components to collaborate and integrate seamlessly with each other based on agreed cost and service levels. Separately, each component may function in a significant or subordinate role in differentiating the company’s strategy.

Using two criteria – ownership and strategic differ-entiation – companies can group their constituent components into four main categories: strategic, support, partner and utility (see Figure 9).

The bulk of management attention and investment are directed at the strategic components of the firm. In a specialized enterprise, strategic components embody functions that are critical to differentiating the firm in

Silo 1

Silo 2

Silo 3

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rnal

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izat

ion

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rnal

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tner

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Silo 1

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rise

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Most enterprisesare positioned

within this spaceand have modestlevels of internal

and externalspecialization

Figure 8. Internal and external specialization.

Figure 9. Firms assess each component to determine where and how it should be managed.

Internal specialization

Support component

Manage to meet the needs of strategic components

Example: Risk Management

Invest and expand to gain component advantagesExample: Product Ideation

Strategic component

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Example: Payroll

Ensure that partners meet critical business requirements

Example: Call Center


Non-differentiating Differentiating




the marketplace, and so are internally owned and managed. These functions require enterprisewide focus and continuous reinvestment to sustain their competi-tiveness, and they must be managed to maintain absolute advantage against competitors.

Specialized enterprises also manage support components internally, but for reasons of economic efficiency rather than strategic differentiation. Support components encompass activities that would incur high transaction costs if handled outside the firm, and thus are owned and operated internally. Sometimes these are required business activities that should not be performed outside of the firm due to liability issues. To increase the efficiency and control of support components, specialized firms aggregate these activities in shared services organizations.

Activities with high strategic differentiation and low transaction costs are aggre gated into partner components. As the name suggests, these components are owned and managed by external, best-in-class specialists. Although there are costs associated with searching, contracting, and coordinating with specialized partners, the overall transaction costs are low enough to merit the externalization of the associated activities.

The fourth class of components, utility components, are characterized by both low strategic differentiation and low transaction costs. Open business and technology standards allow the specialized enterprise to use more utility components than the traditional business model allows. Unlike partner components, utility components provide flexibility in choice of vendor. Specialized enterprises can source utility components as needed, based on market conditions and the changing require-ments of the organization.

Specialization and the composition of the firmAs specialization takes hold across the marketplace, the composition of firms will begin to change (see Figure 10). Many of the non-differentiating activities now conducted internally will be handed over to external specialists. As a result, the proportion of support components will tend to diminish as those functions are

shifted to utility components. Activities will also tend to migrate from differentiating partnerships toward looser, commodity service arrangements as the capabilities of utility specialists mature.

In other situations, activities will migrate in the opposite direction. During the process of assessing its business, a company may discover that some of its support components house top-notch capabilities. In such cases, it may make sense to repackage these capabilities as strategic components and offer their services to the marketplace – in essence transforming a cost center into a profit center.

A quick survey of the economic landscape reveals how leading companies are moving toward specialization, often along different paths. Sara Lee has transformed its organization around its strong brand as a leader in baked goods, divesting heavily and partnering for many tasks. Sprint PCS has pursued a similar strategy, focusing on its strong wireless network and leveraging specialists for distribution and customer service. Motorola has shifted its focus to handsets and externalized components that do not directly influence mobile devices. Siebel Systems has focused on shifting some of its support components to utility components, seeking partnerships to maintain IT infrastructure and facilities management and externalize non-core activities previously handled in-house. Conversely, UPS has converted support components into strategic components by parlaying the top-notch logistics capabilities it uses to support its shipping business into a profit-making business of its own.

As diverse as they are, each of these cases contains a common theme: firms evolve into specialized enterprises by maintaining a laser-like focus on the

Figure 10. As specialization takes hold, the balance of components tends to shift from internal to external.

Utility

Support Strategic

Initial business

Support









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Examples of specializationToday, few companies can claim to be exemplars of the specialized enterprise. While none have arrived at the final destination, many firms have taken steps along the path – some without realizing they are specializing as such. A visionary few have made significant strides. BP and Procter & Gamble are large enterprises that have restructured internally, consolidating key activities into dedicated business areas and increasing the use of external partners, particularly for back-office operations.

BPAs a leader in oil exploration and distribution, BP recognized the need to optimize the performance of its global organization and evolve its business design to provide greater flexibility and efficiency. The first step was to identify the company’s strategic business competencies, which included marketing, production, oil field assets and a strong network of filling stations. Based on these strengths, BP began taking steps for internal and external specialization.

BP’s internal specialization efforts began in the mid 1990s, when the company dismantled its centralized, hierarchical structure into 90 discrete units – each small enough to preserve one-to-one contact between leaders and workers. It also flattened its organization, with each unit reporting directly to the company’s nine-member executive suite. To give employees a sense of ownership, BP pushed decision-making out to the business units, replacing tangled bureaucratic procedures with transparent processes that encouraged learning and explicitly linked jobs to value creation. By 1997, the company had cut its roster to 53,000 employees, from 129,000 a decade earlier.19

Taking a modular approach also gave senior executives the flexibility to reconfigure the organization as performance and strategic requirements change.20 In an interview with Harvard Business Review, BP CEO John Browne described how the firm leverages its modular structure to drive specialization: “[W]e don’t think of our business units as permanent structures. When we were setting them up, we did a lot of experimenting to get them right. We’re still constantly scrutinizing them to make sure they serve their business purpose, maximize learning, and help teams perform. If they don’t, we change them: we split them up or combine them.”21

BP also turned to specialization in 1998, when it committed to cutting greenhouse emissions to 10 percent below 1990 levels by 2010. Instead of relying on central management to ration emission credits, the company decided to specialize, setting up its own electronic marketplace where credits could be bought and sold at market value. Specializing in markets allowed BP to coordinate efforts across the enterprise much more effectively. Instead of relying on the wisdom of central planners, the company was able to leverage the price mechanism to signal the changing value of a scarce commodity based on local information. Units that cut emissions ahead of schedule were free to sell surplus credits to peers who lagged behind. The approach yielded dramatic results: BP met its emission reduction goals by 2001, nine years ahead of schedule.22

On the external side, BP looked to partners to support the non-core parts of its business, forming a joint venture with Mobil in 1996 to improve its undifferentiated fuel and lubricants business.23 BP also centralized telecommunications services for its business units and signed contracts with external specialists to manage applications development and hosting.24 More recently, BP has outsourced its human resources, finance and accounting functions.25

Procter & Gamble As a leading consumer packaged goods firm, Procter & Gamble (P&G) has learned to rely on internal and external specialists in most every area of its business. Chairman and CEO A.G. Lafley explains the company’s philosophy this way: “Our core capability is to develop and commercialize. Branding is a core capability. Customer business development is a core capability. We concluded in a lot of areas that manufacturing isn’t. Therefore, I let the businesses go do more outsourcing. We concluded that running a back room wasn’t a core capability. You do what you do best and can do world-class.”26

Internally, the company maintains a strong product focus and is renowned for its research and development and branding expertise. But not all ideas need to be internal. Indeed, Lafley has expressed that he wants half of new ideas to come from outside of the company.27 Even within its core business, P&G leverages experts. For example, P&G partnered with design specialist Design Continuum to assist with the product development of the highly successful Swiffer mop business.28 P&G is also willing to leverage its R&D expertise with competitors, and in 2002 formed a joint-venture with Clorox’s Glad brand.29

Externally, P&G has extensively increased its use of partnerships and specialists in non-core parts of its business. In 2001, it began to consolidate its manufacturing in order to increase flexibility,30 and in 2002, it outsourced its global facilities management to external specialists.31 P&G’s IT infrastructure, finished goods distribution, and logistics are all fulfilled by specialists.32 Similarly, several aspects of human resources were outsourced to a third party in 2003.33


strategic components that define the heart of the business. As each company plays to its strengths, the whole marketplace benefits. Over time, companies that specialize will truly become players in a loosely-coupled industry network, able to assemble best-in-class capabil-ities from a wide range of sources.

Specialization in action: Differentiation, responsiveness and efficiencyBy driving the organization toward internal and external specialization, firms can deliver simultaneous, step-change improvements in differentiation, responsiveness and efficiency beyond the scope of traditional business designs.

Differentiation through componentization offers a variety of benefits. Differentiated firms command higher revenues through premium product pricing and new markets. Partnering with specialists improves margins and allows companies to exit nonprofitable markets. Maintaining fewer assets in-house enables the reallocation of resources for investment in more strategic components. The focus and expertise required for differentiation, and the ability to control performance offered by a component structure, serve as powerful risk mitigators. The key is to analyze the firm’s positioning within the overall industry environment and only invest in components that are truly differentiating, driving innovation in these key strategic components while pursuing the right partnerships to fill out the rest.

Responsiveness is a second advantage of specialized enterprises. Historically, companies have operated a deliberate business model based on forecasted oppor-tunities and perceived threats while forcing customers to accept the predicted value proposition. In effect, these companies are laden with fixed processes and relation-ships. This inflexibility boosts the lead time required to introduce new business and hampers the ability to partner effectively. In contrast, specialized enterprises sense and respond rapidly to otherwise unpredictable changes in the market environment and the needs of their stakeholders. Responsiveness is achieved through modularization, elimination of nonessential components and leveraging existing specialists.

Specialized enterprises are also far more efficient than companies with traditional business models. Traditional models solidify operations and organizations in silos. These enterprises invest in fixed assets, seek to build

scale all across the business and pursue in-house development of table-stakes capabilities.

The specialized enterprise differs in that it is able to adapt cost structures and business processes flexibly in order to reduce risk and to conduct business at higher levels of productivity, cost control, capital efficiency and financial predictability. This is accomplished by investing primarily in strategic components, while external specialists are selected on an optimal price-per-performance basis.

The result of this focus on differentiation, respon-siveness and efficiency is that specialized enterprises are able to provide much greater value to their customers, employees and shareholders. Customers benefit through increased choice, greater channel options and person-alization of services. They also receive greater value with faster time-to-gratification. Employees are presented with clear promotion paths, opportunities for advancement and training with non-commodity skills. Shareholders reap benefits from greater revenue growth, premium price-to-earning multiples, long-term investment strength and greater predictability.

The relationship between the enterprise and the people to whom it delivers value (customers, employees, and shareholders) is symbiotic. For each unit of value the enterprise delivers to a customer, employee or shareholder, it also creates value for itself. By satisfying customers, the enterprise can gain loyalty and limit price erosion. By satisfying employees, it increases the potential for better leadership and reduced churn. Finally, realizing value for shareholders can create increased levels of trust and more financing options.

ConclusionBy 2015, we expect business to be very different. The world’s most successful firms will be specialized enterprises that focus on a few critical pieces of the business. The deflationary economics of the global connectivity platform will keep a tight lid on transaction costs, imposing a new set of imperatives on business. Enterprises will join into high-volume, low-cost industry value networks. In these virtual business ecosystems, traditional competitors will become strategic allies. Cost centers will become sources of revenue. The transac-tions of the past will be parlayed into the relationships for the future. The boundaries that define today’s enterprise will continue to rupture as loosely coupled components replace integrated functional silos. In the end, the companies that succeed will be those that find the optimal balance of centralizing core activities within the firm and distributing non-core tasks to external specialists.


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1 “Your Turn: The Global CEO Study 2004,” IBM Business Consulting Services. 2004.

2 “On demand business: The new agenda for value creation.” IBM Institute for Business Value. 2003.

3 Jander, Mary. “IDC Sees Modest FTTP Growth.” Light Reading. November 18, 2003.

4 “Profiting from WiFi.” Communications Today. July - August 2004.

5 IBM Institute for Business Value analysis.

6 Ibid.7 ISM/Forrester Research. Report

On eBusiness July 2003. July 16, 2003. http://www.ism.ws/ISMReport/Forrester/FROB072003.cfm

8 Ibid.9 Goldenberg, Barton. “Customer

Self-Service: Are You Ready?” CRM Magazine. May 2004. http://www.destinationcrm.com/articles/default.asp?ArticleID=4011

10 “Disaster Preparedness,” CIO.com. August 13, 2003. http://www2.cio.com/metrics/2003/metric592.html

11 Coase, Ronald. “The Nature of the Firm.” Economica. 1937.

12 Hancock, Jonathan and Greenhalgh, Ian. “Shared Services: From Functions to processes?” Spectra Magazine. November 7, 2002.

13 IBM Institute for Business Value analysis.

14 “Deconstructing the Banking System,” Retail Banker International. 2000.

15 Perez, Juan Carlos. “IDC sees BPO spending, challenges increase,” InfoWorld. May 5, 2004. http://www.infoworld.com/article/04/05/05/HNidcbpo_1.html

16 Kaplan, Jeffrey M. “Other Voices: Goodbye IT, Welcome Back IS.” InformationWeek. June 23, 2003. http://www.informa-tionweek.com/story/showArticle.jhtml?articleID=10700263

17 Kotadia, Munir. “Outsourcing mega-deals double in 2003.” ZDNet UK. January 21, 2004. http://news.zdnet.co.uk/business/management/0,39020654,39119217,00.htm

18 Coase, Ronald. “The Nature of the Firm.” Economica. 1937.

19 Browne, John. “Unleashing the Power of Learning: An Interview with British Petroleum’s John Browne.” Harvard Business Review. October 1, 1997.

20 Ibid.21 Ibid.22 Malone, Thomas W. “Bringing the

market inside.” Harvard Business Review. April 1, 2004.

23 Browne, John. “Unleashing the Power of Learning: An Interview with British Petroleum’s John Browne.” Harvard Business Review. October 1, 1997.

24 “SAIC and BP Sign Major Outsourcing Agreement.” SAIC Press Release. August 11, 2000.

25 Banham, Russ. “One With Everything.” CFO, November 1, 2002.

26 Berner, Robert. “P&G: New and improved.” BusinessWeek. July 7, 2003.

27 Ibid.28 Nussbaum, Bruce. “The Power of

Design.” BusinessWeek. May 17, 2004.

29 “Clorox finalizes Procter & Gamble deal.” American City Business Journals Inc. November 14, 2002.

30 Peale, Cliff. “Ivorydale sale ends happily.” The Cincinnati Enquirer. April 1, 2003.

31 “Jones Lang LaSalle Selected By P&G For $700 Million Facilities Management Contract.” P&G Press Release. June 3, 2003.

32 Berner, Robert. “P&G: New and improved.” BusinessWeek. July 7, 2003.

33 Perez, Juan Carlos. “IBM finalising BPO deal with Procter & Gamble.” ComputerWeekly.com. September 1, 2003.

Specialized enterpriseEndnotes



One of the leading examples of a “specialized enterprise” is Procter & Gamble. To illustrate the principles of internal and external specialization in action, IBM’s Vineet Garg (the Global Relationship Partner for P&G) and George Pohle (the global leader of the IBM Institute for Business Value) spoke with P&G’s Filippo Passerini on the topic of organizational structure and business strategies.

In his role as the Chief Information and Global Services Offi cer, Mr. Passerini has restructured P&G’s IT services through internal transfor-mation and key outsourcing agree-ments. He has worked at P&G since 1981 and has management experi-ence across numerous countries and multiple continents. Robert Scott, a P&G Vice President in Global Business Services, also joined the conversation and provided additional perspectives on the topic of special-

ization.

IBM: What did P&G’s business model look like several decades ago?

Passerini: We had the same orga-nization model for a long period of time, which was primarily market focused. And then in the mid 1980s, we added an element of horizontal category management across geog-raphies. Over the following years, we looked to centralize and optimize scale, yet the bulk of the commercial structure stayed pretty much the same until six years ago.

IBM: How has P&G transformed its internal structure over the last few years to adapt to the marketplace?

Passerini: I think the most signifi -cant breakthrough occurred in 1999 with what we called, at that time, Organization 2005. The idea was to move from a market-based geographic structure to product-based Global Business Units.

While we knew that Organization 2005 would require tremendous restructuring and reorganization, we also knew that it was necessary. The company was growing at a tremen-dous pace, entering 55 new global markets in 14 years. By 1999, we had operations in 86 countries, with nearly all working as independent companies. Obviously, this structure had served the company well, as we had continued to grow and expand.

But looking into the future, we knew that if we were to continue meeting both the demands and opportuni-ties of our growing global business, we needed to both tap the benefi t of our scale and maintain the personal touch of our localized operations. We needed to consolidate, streamline, strengthen and focus. The result was the creation of Organization 2005, a three-pronged model for operating globally, yet locally.

We fi rst established Global Business Units, with the overarching respon-sibility of research & development, manufacturing and category and brand management. The second prong included the formation of Market Development Organizations to focus on commercializing our new initiatives and brands for the local markets, working with local consumers to understand and meet their needs and to customize our brands when needed. Then, the third prong called for the creation of a shared services organiza-tion – Global Business Services (GBS). We aggregated all business services previously fragmented across multiple geographies and organizations, to create scale, cost savings, greater effi ciency and more systematic, high-quality and consis-

Executive interviewFilippo Passerini, Chief Information and Global Services Officer, Procter & Gamble

Q&A

64

“The new model gives us scale when developing global initiatives, while at the same time allowing

us the flexibility to customize those initiatives when they are introduced into different markets...”

tent service delivery. We literally reengineered and united more than 70 services, including workplace services, fi nance, HR, relocation and facilities management.

IBM: How successful was the reorganization, and what are the key benefi ts?

Passerini: P&G has had some phenomenal recent years, probably the best in the company’s history. When our CEO A.G. Lafl ey is asked why P&G has done so well in the last few years, his answer is: “In large part, because this model is really working well for us.”

And the reason it’s working so well is because it offers us the opportunity to integrate and harness the best of two business models. This structure gives us scale when developing global initiatives, while at the same time allowing us to customize those initiatives when they are introduced into different markets. In short, the model aligns and gives fl exibility to more than 100,000 people operating in 86 countries and serving over 130 markets. We leverage our scale in research and manufacturing, and still maintain our local touch points with our customers and our consumers.

Our mantra is to “think globally, implement locally.” And it’s working very well for us.

Scott: In addition to scale, we gain focus. Today, the Global Business Units focus single-mindedly on understanding the consumer, creating winning brands and driving those brand equities. Meanwhile, the go-to-market strategies are the purview of the Market Devel-opment Organization. They are single-mindedly focused on winning customers around the globe, both regionally and locally. The tremen-dous amount of focus has acceler-ated our business growth through this period.

Passerini: One of the key factors in helping make the change successful was that we established clear accountability through profi t manage-ment responsibilities. With focus and accountability all in one group, we become very powerful.

IBM: How has information tech-nology been redefi ned and revital-ized with Global Business Services?

Passerini: “Redefi ned and revital-ized” are perfect descriptors for the work our information technology team has been leading – increas-ingly so in recent months. In short, we have worked to defi ne what IT will come to stand for and contribute in the years to come.

In late 2004, we united much of our IT capabilities with GBS. Since many of our services are enabled by IT systems, this union maximizes their synergies and leverages their combined impact and ability to add value to P&G’s business. Then, in Spring 2005, we unifi ed IT as a function. Previously, a large majority of IT employees worked within various business units, focusing primarily on the work at hand. The rest were in GBS, working on key business areas and projects. By unifying the function, we were able to outline a shared set of strategies and objectives. While there is continuing core focus on Operational Excel-lence, greater attention is now being placed on broad-scale innovation, focusing on a few key critical areas to which we believe we can uniquely contribute and lead.

We also changed the name of the function from Information Technology to Information and Decision Solutions (IDS) to better refl ect the fact that IT is a key business enabler that encompasses technology tools, strategic development, collaboration and decision making. We determined that Information is our unique asset; Decisions are what we can enable; and we want to provide Solutions instead of just systems. It’s simple – but there’s power behind it.

Executive interview – Procter & Gamble


IBM: What are the two key areas that IDS is focusing on?

Passerini: We wanted to focus on areas that we believe we can uniquely infl uence. One is creating for P&G better connections with our consumers, customers, partners, suppliers and employees. To bring this strategic direction to life, we already have developed three key programs that each will tap into new and existing channels and foster the creation of additional technology to support the goal of building one-on-one connections within our target audiences.

Second, we wanted to help P&G make better decisions across the board in all areas. This means faster decisions and smarter decisions, often realtime decisions. This is extremely exciting and ground-breaking work and also is supported by three key programs, all with tremendous potential to vastly impact the business.

IBM: How has the reorganization of IT impacted P&G’s overall strategy and where you compete?

Passerini: P&G’s guiding strategy is to remain in close touch with our consumers and customers so that we can deliver superior brands at superior value to improve

the lives of our consumers. That strategy remains solid. What IT’s reorganization and refocus does is give that strategy even more depth with more applications and higher deliverables.

The combination of staying focused on the consumer while leveraging our global scale – through GBS – is powerful.

Scott: Exactly. And as you think about connecting with consumers, information technology can dramatically enable and expand those interactions. Each of our brands works from a consumer-interaction framework that outlines up to seven touch points that a brand has with a shopper – ranging from an introduction in the store, to use, to repurchase. Virtually every touch point now can be enabled by information. Also, as we fi nd new ways to work with our key retail partners, information enables us to change the game and actually create greater value for ourselves and for them together.

IBM: In our “Specialized enterprise” paper, we talk about the benefi ts of partnering with best-in-class specialists. In what ways has P&G partnered with other fi rms?

Passerini: P&G has always been about partnerships. In fact, the company was built on a partnership between a candle maker and a soap

maker who saw the benefi t of joining efforts. Together, they grounded P&G in the unwavering principle that we can do more together. In fact many of our products, innovations and marketing strategies are the result of work we’ve done with best-in-class partners.

Recently, we applied – and expanded – this key principle when we signed long-term partnership agreements with four main fi rms to manage work that we determined to be outside our core business of making and marketing top brands. Each of these partnerships is within GBS. We work with IBM for employee services, including payroll and benefi ts, relocations and travel services; HP for IT infrastructure and transactional accounts payable; Jones Lang LaSalle for facilities management; and Sykes Enterprises for consumer relations. With each, we follow a fi rm and highly disciplined view that this is a mutually benefi cial partnership and not simply a business relationship. This view is not only consistent with our company’s guiding principles, but we fi rmly believe, the best way to do business.

Q&A

66

IBM: What are the biggest challenges in these partnerships?

Passerini: As I touched on earlier, the greatest challenge comes in managing a partnership as a true partnership with winners on both sides of the table. While this approach has tremendous long-term benefi ts, it also can be time-consuming. Just as with any relationship, it requires care, diligence, honesty, commitment and work. We have invested a signifi cant amount of time in establishing a governance organization for each relationship and then both hand-picking and training the employees who are a part of and manage that organization. Our partnerships are now 18-24 months old, and while still fairly new, already are showing tremendous signs of positive and deep-seeded cross-pollination. In so many ways, they are working exceptionally well. This is very exciting to see.

IBM: How has culture helped or hindered an organizational change towards specialization?

Passerini: In large corporations there often is a consolidated culture – we all grew up in a more formal, more stable organizational model. With few exceptions, status was based on how big the organization

was that you managed, rather than on how specialized you were. It is very challenging to move into internal specialization, because it requires a signifi cant cultural change.

Specialization also implies signifi cantly more fl uidity in the way people work and can require much more productivity in the way they operate. I think it is a signifi cantly more effective model, but there are challenges in that it is more complex to operate both individually and collectively.

IBM: We’ve talked about how the GBS organizational model permits focus in your business. How has it improved your responsiveness?

Passerini: We have become much more responsive, because we are keenly poised to better and more quickly tap into innovation, and then to apply it where needed.

This may not seem like a big change, but it has been for P&G. While we have always felt the need to learn more from partners and other companies, our employees take great pride in fi nding ways to do it better. It is part of the P&G culture. Moving away from the “not invented here” syndrome has been diffi cult. To foster this change, we shifted our focus in two simple but dramatic ways. First, we declared that half of

our innovation must come from the outside. Thus, good work is no longer about just having good inventions. The second was the sharpened focus on our consumers, starting with the consumer benefi t in mind.

Scott: The four walls that once defi ned Procter & Gamble have changed dramatically. We are coming up with collaborative partnerships that are allowing us to create products that we could not have done fi ve years ago. Swiffer, Scentstories and Crest SpinBrush are great examples of innovative products that really demonstrate the fact that we are becoming more and more of a networked enterprise, connected internally and externally.

“We have become much more responsive, because we are keenly poised to better and more quickly

tap into innovation and apply it where needed, thus allowing us to be more responsive to the market.”

Executive interview – Procter & Gamble


Component business modelsComponent business models

Specialized

Collaborative

Cohesive

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IntroductionOpen communication standards and plummeting transaction costs have ushered in the era of special-ization. Industry dynamics are changing substantially, presenting firms with new opportunities to create or destroy value. No matter how large, individual firms can no longer expect to control end-to-end industry value chains. Instead, they must specialize in areas where they command an absolute advantage in the marketplace. Easily said. But putting specialization into practice with the right operating model requires executives to think differently, not only about the construct of the company but also about the interrelationships of the assets they rely on to provide value to the marketplace.

Component business models offer a proven approach to driving a specialized focus, both internally and externally. Internally, components help firms rethink the leverage they can achieve with the assets and capabilities they own. Externally, components help firms source specialized capabilities that they cannot feasibly create themselves. Combining these types of specialization allows firms to redefine their competitive positions in the face of the sweeping changes in their industries, while simultane-ously achieving the competing benefits of scale, flexibility and efficiency.

CBM: A path to specializationIn an increasingly networked marketplace, special-ization is an imperative, not an option.1 As the traditional boundaries of the firm are ruptured by the economics of the global connectivity platform and the margins of success are increasingly determined by absolute advantage, focusing on a few critical activities will become a key to survival. But how can enterprises best pursue specialization?

Component business modelsMaking specialization real

Firms can use the concept of the component business model (CBM) to make the transformation to internal and external specialization a practical reality. CBM allows firms to evaluate the goals and strategy of the entire enterprise to take simultaneous advantage of internal and external specialization. Without increasing complexity, the model allows an organization to expand and evolve while reducing risk, driving business performance, boosting productivity, controlling costs and improving capital efficiency and financial predictability.

Specialization differs from process optimizationLarge media and entertainment companies have worked hard to optimize their sales and marketing processes with an aim toward selling television, radio and billboard space more effectively. While they were occupied, however, advertisers were busy changing the rules of the game. Demand is now growing for complete media packages that target consumers through multiple, coordinated channels for a single price. Ironically, process optimization has made the task of meeting this unantic-ipated shift in demand more difficult.

Specialization avoids such miscues by taking a broader view. Instead of honing processes based on an established way of doing business, media companies could fundamentally rebuild “customer targeting and reach” as a modular capability shared across the entire organization. Such specialization makes companies more resilient and flexible in the face of change. It can also drive superior performance and cost synergies across business units – two major goals of process optimization.


By George Pohle, Peter Korsten and Shanker Ramamurthy


So what are business components?As shown in Figure 1, business components are the modular building blocks that make up the specialized enterprise. Each component encompasses five dimensions:

• A component’s business purpose is the logical reason for its existence within the organization, as defined by the value it provides to other components.

• Each component conducts a mutually exclusive set of activities to achieve its business purpose.

• Components require resources, the people, knowledge and assets that support their activities.

• Each component is managed as an independent entity, based on its own governance model.

• Similar to a standalone business, each business component provides and receives business services.

For example, a bank decides to gather its credit decisioning activities into a single component. To realize efficiency gains, it centralizes all of the associated people, processes and assets that used to be spread across several business units. It also consolidates financial databases from across the firm, boosting the quality of information on which its decisioning activities rely. Keeping the information in a single place also allows credit appraisers to make better choices when it comes time to assess portfolio information across accounts (say, when a checking customer applies for a credit card). With a much clearer picture of a customer’s credit risk, the company can cross-sell its financial products much more effectively.

To drive as much benefit from componentization as possible, the firm takes care to aggregate only “highly cohesive” activities from across the firm – that is, activities that require similar people, process and technology infra-structures. (For details, see Loose coupling and cohesion). When determining the boundaries of the component, the company considers each of these three dimensions, not just one or two.

Previously, the company had five different groups that handled credit scoring, but the new, streamlined Credit Administration component now takes care of all the activities related to determining the creditworthiness of potential customers, such as administering the application process, allocating credit resources and facilitating compliance with credit policy.

The Credit Administration component has its own management structure and governance model, giving it a high degree of autonomy. In principle, it could operate as an independent business that serves the main company. It could also provide its services to another company, should the strategic need arise.

As it operates, the new component is highly collaborative, working in concert with other components both inside and outside the company. Collaboration is accomplished through the exchange of services, the inputs and outputs for all components. When it requires an input to complete a particular activity, Credit Administration procures it as a service from another component. That way it is able to gain access to the full range of inputs (such as customer information and account recovery) it requires. Conversely,

Business purposeWhy does it exist?

ActivitiesWhat simple, cohesive actions are regularly

performed?

ResourcesWhat tangible assets and human resources

are required?

GovernanceHow are activities and resources managed?

Business servicesWhat is taken from and offered to other components?


Direct

Control

Execute


Dimensions of a business component

Figure 1. The fi ve dimensions of a business component: business purpose, activities, resources, governance model and business services.


70Component business models

when another business component requires a Credit Administration service, such as a credit assessment or a credit activity report, the Credit Administration component is set up to provide it as an output. Predefined service-level agreements – covering such aspects as formatting, timing, quantity, quality, payment and provisioning – set the standards for all of these transactions.

This services orientation enables the Credit Administration component to maintain its distinct boundaries while collaborating through “loose coupling” with other components. As business conditions change, each component is able to terminate old links and form new ones with relative ease.

Loose coupling and cohesionBusiness components derive much of their advantage from two related but distinct traits: the loose coupling of links between components provides flexibility, adaptability and responsiveness, while the cohesion of activities within each component provides efficiency and enhanced quality.

Interaction between components is characterized by loose coupling. Instead of “hardwired” links based on proprietary or customized connections, components interface through clearly-defined service boundaries, forming and breaking connections as they initiate and respond to service requests. Loose coupling also relies on a common communication code, so that even incom-patible underlying systems can be joined on demand. For example, an Internet bank may boost customer service levels by enabling kiosks and Web portals to access call center functions. This aspect of components gives firms much more scalability in the services they provide and use, as well as more flexibility in deciding whether to source a capability within the firm or outside it. In either case, the component requesting a service is indifferent to how that service is implemented. Indeed, from the outside a component is a “black box” whose inner workings are, for all intents and purposes, irrelevant.

Internally, components deliver scale and efficiency gains through cohesion, the aggregation of similar activities from across the firm into a single logical module. In this sense, building a component is a matter of placing like with like. To achieve cohesion, each activity must belong uniquely within one component with no duplication within or between components.

An added benefit of bringing these activities together is to expose the relative performance discrepancies between true internal specialists and others that are not performing as well. Promoting the practices of the specialists during the integration will have the net effect of raising the overall quality of the service that the integrated component provides to the business or to customers. In effect, this is a practical extension of the concept of sharing internal best practices.

Many companies struggle to achieve cohesion. When the Internet first appeared as a delivery channel, for example, companies commonly built their Web presence as an entirely new line of business, complete with its own service, cross-sell and marketing activities. This approach left firms offering a confusing and complex mix of user experiences. While a visitor to the Web site might see one set of products and marketing messages, a customer who walked into a store or phoned the call center might be exposed to another. What these companies failed to realize is that service, sales and marketing share highly cohesive activities, irrespective of channel.

The smartest and most elegant way to leverage cohesion is to build the capability once and reuse it across multiple channels, with only the user interface changing to suit the medium. The way in which customers are treated, the range of products and services they are able to choose from, and the marketing messages they are exposed to should be consistent. Failing to consider the cohesion of these activities across people, process and technology has left many companies with dramatically higher complexity.

The CBM frameworkAs we have seen, components aggregate business activities into discrete modules that can be shared across the firm. But how do components work together within the context of an overall business model? As Figure 2 shows, CBM provides a framework for organizing components by competency and accountability level. By employing this framework, executives can begin to envision how current business activities might function as an interlocking set of modules.


Categorizing activities by business competency yields a high-level view of components according to the type of value they provide to the enterprise. Different firms in different industries will model their competencies differently, but, in every case, each activity should line up under a particular competency.

Assigning each activity to one of three accountability levels – direct, control and execute – can also help executives begin to flesh out the component vision. The level of a given component should be intuitive, although exceptions will exist.

• Direct. Components at this level provide strategic direction and corporate policy to other components. They also facilitate collaboration with other components.

• Control. These mid-tier components serve as checks and balances between the “direct” and “execute” levels. They monitor performance, manage exceptions and act as gatekeepers of assets and information.

• Execute. These “boots on the ground” components provide the business actions that drive value creation in the enterprise. They process assets and information for use by other components or the end customer.

The three accountability levels imply different priorities. At the “execute” level, for example, the emphasis is


Direct

Control

Execute

Accountability level• A simple framework

for separating strategic decisions (i.e., direct), management checks (i.e., control) and business actions (i.e., execute)

Business competencies• A high-level description of the activity

conducted• The framework should be simple, logical

and practical

Business components• Individual business modules that play a

specifi cally designed role within the enterprise ecosystem

• These components collaborate and integrate seamlessly with each other using agreed cost and service levels


Figure 2. Make internal and external specialization practical by organizing activities by accountability level and competency.

External componentInternal component

on keeping people fully occupied and productive. Components at this level tend to be structured in ways that make information easily available. From a technology standpoint, speed of data entry and realtime availability are key. When customers go to an ATM, for instance, they want a simple interface that provides accurate information in a straightforward format: how much money is in my account?

Contrast this with activities related to the “direct” tier, where such high-level activities as launching new products are handled. This level houses a small number of people who have a very large impact on shareholder value, so the design imperatives are nearly the opposite of those at the “execute” tier. Launching a new product requires collaboration among several elements, including marketing, risk, finance, regulatory and credit. Input from all of these stakeholders is needed to make the launch a success, so workflow is a key requirement. From a technology standpoint, activities typically require people to discern patterns and trends from rich, multidimensional data, usually stored in a data warehouse. So, systems at the direct level are not designed for speed of data entry, but rather for ease, breadth and depth of analysis. Realtime interfaces are not needed, as data is often months old and processed in batches.


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Embracing CBM: A strategic road mapCBM is not simply a way to imagine the future of the organization. It can also be used to put theory into action and drive the evolution toward a specialized enterprise, both internally and externally. This process involves three dimensions: one, developing a component view of the existing organization based on analysis of the business and the market environment; two, evolving toward special-ization based on a reinvention plan within the context of changing industry dynamics; and three, advancing the organizational and operational infrastructure toward component-based enterprise optimization.

Developing a component view of the enterpriseA firm can begin to develop a component view of the enterprise by using the CBM framework as an analytical tool to identify the gaps and redundancies it must resolve on the way to becoming a component-based enterprise. A good way to start is by mapping the current business as a network of components. As described in the previous section, this initial analysis involves identifying and grouping cohesive activities into discrete units and testing the overall logic. The result is a “component map.” Figure 3 shows an example of a component map for the retail industry. Of course, every business will have its own, unique perspective on its component structure, despite substantial commonality with other players in its industry.

The component map provides a basis for developing strategic and operating insights for the business. By gauging the relative business value of different areas of the map, executives can determine which components demand immediate attention. As Figure 4 illustrates, this type of analysis yields a “heat map” that highlights the components that represent the greatest economic value. To determine heat map priorities, executives will typically consider the following questions. Which components differentiate them most significantly in the marketplace? Which components have the most dramatic impact on their ability to maintain and grow margins? Which components offer significant cost and capital optimization opportunities?

For example, near-term changes that enhance the firm’s strategic differentiators are likely to be designated as “hot” areas. Parts of the business that already resemble components, such as shared service centers, may also be early priorities. Quick wins are typically found when disparate and duplicate functions are consolidated into true operational components. Efficiencies gained in the first round of componentization can be used to support subsequent change initiatives.

After the insight phase of CBM analysis comes the architecture phase (see Figure 5). Here, the firm overlays

Customers Products/ser-vices Channels Logistics

Business administration

Direct

Control

Execute


Figure 3. Mapping the enterprise as a network of business modules: an example from the retail industry.

Market strategy

Customer service strategy

Marketing strategy

Campaign management

Service management

Customer service

Customer communications

Marketing

Advertising

Public relations

Merchandise planningChannel planningAssortment planningSpace planningPromotion planningProduct developmentSourcing

Product fl owPlanogramming AllocationInventory mgt/OTBDemand forecastingPrice managementContent managementVendor management

Item managementProduct managementPO managementVendor managementReplenishmentRevenue/clearance management

Channel strategy

Store design

Real estate strategy

Internet design

Catalog/call center design

Channel management

Labor management

Order management

Real estate, construction and facilities management

Loss prevention

Order management

Inventory management

Merchandise management

Price/sign management

Network design

Warehouse design

Demand/fl ow planning

Inbound routing

Receipt scheduling

Delivery scheduling

Carrier management

Warehouse management

Transportation management

Fleet management

Reverse logistics

Corporate strategy

Corporate planning

Financial planning

Corporate governance

Business performance management

Treasury and risk management

Legal and regulatory compliance

Inventory control

Cash and banking

Financial accounting and reporting

Indirect procurement

HR administration

IT systems and operations

Business competencies

Acco

unta

bilit

y le

vel



Customers Products/ser-vices Channels Logistics

Business administration

Direct

Control

Execute


Figure 4. Heat maps identify “hot” areas to exploit business value.

Market strategy

Customer service strategy

Marketing strategy

Campaign management

Service management

Customer service

Customer communications

Marketing

Advertising

Public relations

Merchandise planningChannel planningAssortment planningSpace planningPromotion planningProduct developmentSourcing

Product fl owPlanogramming AllocationInventory mgt/OTBDemand forecastingPrice managementContent managementVendor management

Item managementProduct managementPO managementVendor managementReplenishmentRevenue/clearance management

Channel strategy

Store design

Real estate strategy

Internet design

Catalog/call center design

Channel management

Labor management

Order management

Real estate, construction and facilities management

Loss prevention

Order management

Inventory management

Merchandise management

Price/sign management

Network design

Warehouse design

Demand/fl ow planning

Inbound routing

Receipt scheduling

Delivery scheduling

Carrier management

Warehouse management

Transportation management

Fleet management

Reverse logistics

Corporate strategy

Corporate planning

Financial planning

Corporate governance

Business performance management

Treasury and risk management

Legal and regulatory compliance

Inventory control

Cash and banking

Financial accounting and reporting

Indirect procurement

HR administration

IT systems and operations

Business competenciesAc

coun

tabi

lity

leve

l

Hot components


Figure 5. The three phases of CBM analysis: Insight, architecture, investment.

InvestmentInsight Architecture

Develop business

component model

Assess business strategy Identify

“hot” components

Determine strategic business

model/value network

Operationalize strategic

business model/value network

Strategic architecture

54

3

2

1

Defi ne target

component requirements

Assess current

component capabilities

Business architecture

76

Develop shortfall impact

8

ProcessesPeople

AlliancesGovernance

IT infrastructure

Assets

Defi ne and prioritize

opportunities

Develop transformation

roadmap

109


74

the heat map onto the existing business. The goal is to identify gaps between the “to-be” vision of the compo-nentized business and the “as-is” view – a representation of how the firm presently organizes its people, processes and technology. To capture the full scope of the firm’s current capabilities and market positioning, this “as-is” representation must be firmly grounded in empirical data, such as organization charts, cost drivers, application portfolios, technology investments, key performance metrics and existing processes.

Finally, in the investment phase, the firm decides how to close the gaps: How big a leap can the firm take? How much change can be absorbed? Which areas should the company focus on fist? Where are the quick wins? (Good candidates include activities that are duplicated across processes and organizational units, especially those that would benefit from increased economies of scale, global sourcing options and shared information.) The result of this process is a “transformation roadmap,” a guide the firm uses to begin componentizing an area of the business (say, customer service) as a test case. Success in the initial area provides experience and proof points for further development of components.

Evolving toward CBM-based specializationAn enterprise can evolve toward its component-based vision by developing a reinvention plan. The good news is that many firms have already begun the CBM journey. Process reengineering and outsourcing have provided enterprises with modest levels of internal and external specialization. Most firms today have a blended process-optimized and partnered model and now need to decide where to go.

As shown in Figure 6, a firm can mature toward special-ization by considering the role (or, in the vast majority of cases, the blend of roles) that provides the greatest competitive advantage in the marketplace. “Network players” focus on external specialization, focusing on top-line growth through the construction of networks and ecosystems. “Enterprise optimizers” drive internal specialization, focusing on bottom-line improvements by reducing costs and becoming more flexible. “Visionary adopters” strike a balance between the two, aligning internal and external strategies with industry trends to move more directly toward a specialized enterprise.

Silo 1

Silo 3

Silo 2

Inte

rnal

spe

cial

izat

ion

Enterprise optimized

Process optimized

Business unit optimized

Internally integrated Strategically integrated Industry networked



Most enterprises are positioned within this space and have modest levels of internal and external specialization


Figure 6. Most fi rms today have a blended process optimized and partnered model and now need to decide where to go.

Enterprise optimizersFirms that focus on bottom-line improvements by reducing costs and becoming more fl exible Visionary adopters

Firms that have matched industry change through business model changes

Network playersFirms that focus on top-line growth through the construction of networks and ecosystems



CBM in financial servicesComponent Business Models have been used across a wide range of industries, including petroleum, pharmaceuticals, telecommunica-tions, manufacturing, retail and aerospace. In particular, the financial services sector has been an ideal incubator for CBM. Regulatory changes and economic pressures have forced firms to continuously consolidate, resulting in complex organizations and costly redun-dancies. And with multiple product lines across the enterprise, many firms are still organized by traditional product silos. Increasingly, these ad hoc infrastructures fall short of satisfying the needs of customers, shareholders and employees.

Financial services firms across the globe have implemented Component Business Modeling with undeniable success. For Allied Irish Bank, SEB Group and KB, CBM addressed key operational issues and aligned business and technology requirements.

Allied Irish BankAllied Irish Bank is the largest retail and commercial bank in Ireland and one of the largest in Europe, with significant operations in Northern Ireland, the United Kingdom and Poland. Business was booming for Ireland’s largest commercial bank because of the country’s robust economy, dubbed the Celtic Tiger. AIB wanted to manage the pace of growth and maintain its leadership position.

AIB searched for a group strategy that addressed the complexity of all of the different lines of business, rather than simply implementing single solutions at the divisional level. It understood that business and information technology solutions needed to be linked through a unified, efficient operating model. AIB partnered with IBM to use CBM to isolate and identify the many functions of the bank and break them into distinct business components.

CBM provided AIB with a granular view of the organization, and the framework of autonomous components appealed to a company that wanted to transform itself radically, but remain in control. CBM also fit with the strategic vision of transforming the Bank from a federation of operating divisions to a single Group structure with common processes and a greater use of shared services. In particular, CBM supported analysis of two key drivers in the banking business – efficiency and responsiveness. AIB and IBM used CBM to analyze related metrics against peer performance, and located opportunities to unlock hundreds of millions of Euros in additional value that were sitting within AIB’s enterprise.

Going forward, AIB will continue to use CBM to shift its cost structure, which is primarily fixed. By formalizing the business components and the operating model, pieces of the business can move to a variable cost structure and provide greater control and predictability of margins.

SEB GroupThe SEB Group is a North European financial banking group for companies, institutions and private individuals, with 670 branch

offices in Sweden, Germany and the Baltic States. SEB has more than 4 million customers, of whom 1.6 million are e-banking customers.

The firm had dual challenges of improving bottom-line profitability while simultaneously growing top-line revenues. SEB is pursuing a growth strategy, expanding primarily by acquiring financial institu-tions in different markets. It was experiencing a lack of profitability in its German branch, and needed to address cost and efficiency issues.

SEB needed a roadmap for the future, and the CBM methodology supported an analysis of the as-is situation while allowing for the development of a target business operating model. The end result was a consistent operating model with shared services and processes across countries, as well as consistency and standardization in appli-cations and product offerings across all of SEB’s retail banking units.

In particular, the new model supports greater responsiveness at both the product and corporate level. SEB expects to radically reduce time-to-market for development of new banking products by 50 to 70 percent. Consistent product offerings across its retail banking units allow SEB to quickly develop or customize products for particular markets. The consolidation and centralization created through CBM will also allow SEB to more easily integrate newly acquired banks in the future.

KBToday, KB (formally Kookmin Bank) has the largest number of customers of any South Korean bank. The company – which specializes in mortgage lending, consumer banking, credit card and asset management – was selected Best Bank in Korea for five consecutive years by Euromoney and Best Bank in 2003 by Asiamoney.

After the meltdown of the Asia Pacific economies in the late 1990s, the South Korean government initiated extensive consolidation in the banking industry. By 2002, consolidation reached its final phase and big banks like KB could no longer rely solely on size to compete. KB knew it had to differentiate to strengthen its existing relationships with customers and build market share.

There was one main obstacle in KB’s path: its siloed organization. The inability of different divisions to communicate and share information was preventing KB from getting a single, consistent view of its customers. Moreover, it was difficult to control costs and optimize operations.

To develop a comprehensive new enterprise model, KB leveraged IBM and its CBM methodology to identify a series of essential building blocks to be used and reused across the bank. Based on this analysis, KB has embarked on several initiatives to implement the operational model.

The bank expects to realize significant cost savings as it evolves through a series of planned initiatives, such as a call center transformation. Overall, KB expects the CBM project will reduce organizational complexity and enable the firm to become more responsive and customer-focused.


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Note that the three roles do not represent mutually exclusive approaches. Rather, they highlight the external, internal and blended aspects that all companies must take into account as they evolve toward specialization. Over time, the emphasis placed on any particular aspect will tend to vary depending on the firm, the industry and the current level of specialization. Most firms will find they must iterate between the external and internal dimensions strategically, selecting priorities that position them for further progress toward full specialization. At every stage, the enterprise should align its migration strategy with opportunities that create the most value most quickly.

Network players evolve toward external specialization by growing and differentiating the business through partnerships. In this role, the company seeks to leverage its competitive position to fundamentally alter industry dynamics and build industry networks around the de facto standards they establish. The payoff can be significant. In some cases, entire industry ecosystems can grow up around network players.

In pursuing the network player role, care must be taken to fight the right industry battles. Because absolute advantage is critical to success in a fully networked industry, it is vital for network players to carefully monitor competitors – both traditional rivals and new entrants – and to develop a thorough understanding of the trends that shape the industry network as it matures. Moving ahead of the market is a real risk, as is the chance that the industry will choose to rally around an open standard.

While network players look beyond the enterprise for growth, enterprise optimizers evolve toward internal specialization by reinventing – without rebuilding – the enterprise. Optimizers succeed by creating efficiency, flexibility and responsiveness. To overcome organizational inertia, they typically begin the journey with activities that already function as components. These “preexisting” components – shared service centers are one example – provide a momentum-establishing foundation of quick wins (and a funding base for carrying the strategy through to subsequent stages). Enterprise optimizers focus on initiatives that are aligned with the component map, eliminating or adjusting initiatives that do not embrace the

specialized enterprise vision, especially those that add process complexity or incur excess costs. Optimizers prioritize the creation of components based on financial value, strategic value and investment requirements. They also consider external issues, such as regulations, that may render componentization unfavorable in some areas.

The shortest path to becoming a mature, specialized enterprise is to optimize both external and internal dimensions simultaneously. Visionary adopters match industry changes with business model changes. They are flexible and forward-thinking, maintaining market share and state-of-the-market performance throughout the transformation – a tall order indeed.

Visionary adopters continuously monitor the market for value opportunities and risks, while constantly assessing their componentization plans based on the interplay between the enterprise (internal) and industry (external) views. This requires an ongoing measurement process that provides management with a feedback mechanism for reviewing the performance of components.

Visionary adopters follow best practices, create component benchmarks to support excellence and develop industry benchmarks within and across components. If internal components become best-in-class, they consider offering them externally to generate new revenues. If component performance lags, they leverage external partners.

Building a component infrastructureComponents are autonomous in the sense that they are freed from the constraints of hardwired processes and organizational silos. But they do not operate in a strategic vacuum. To effectively serve the firm, components must work together toward a common goal – the delivery of sustainable value to the firm’s stakeholders. Achieving this alignment of ends requires the right organizational model, process view and connectivity platform.

Successful component-based organizational models balance the need for flexibility and discipline. To be responsive, the governance structure must be tied strongly to the customer value proposition, yet must also provide a clear context of defined relationships



and measurable expectations as a basis for component interaction. Value networks should similarly be flexible and resilient, leveraging variable pricing and supply to support fluctuating demand while improving business continuity. Job descriptions should also be variable – based on organizational roles, rapid resource deployment and established methods for sharing knowledge and developing deep capabilities – rather than fixed around departmental structures. Finally, the organization’s culture should provide a collaborative work environment that empowers employees to engage in fact-based decision-making.

In addition to a flexible, disciplined organizational model, a successful component infrastructure also requires processes that are responsive across a sequence of components. Under CBM, processes are represented as sequences of activities performed via networks of collaborating components. The placement and timing of decision points that define the course of a process must be appropriate to the requirements of the organizational model. Recognizing and anticipating potential exceptions allows the enterprise to be more resilient.

Finally, the infrastructure should leverage the full power of the global connectivity platform to support the firm’s evolution toward a specialized enterprise. Fortunately, trends in this area continue to be favorable. The combination of high-performance connectivity, widespread technology platforms and open protocols boosts collaboration and reduces the costs of coordi-nation, both within firms and externally with partners. Technologies like broadband, wireless, instant messaging and voice-over-IP streamline collaboration by offering realtime access to information and seamless connec-tivity beyond traditional boundaries. Complex enterprise activities are increasingly optimized by standard software like enterprise resource planning solutions. Hardware, software and storage costs continue to decline, even as application functionality and processing speeds increase. Open standards like Linux®, XML and service-oriented architecture and programming (SOAP) help organizations tap the resources of the global connectivity platform while leveraging faster and cheaper plug-and-play substitution.

The right infrastructure can help banks componentize the account opening processBanks worldwide are looking for ways to eliminate the ineffi-ciencies that plague their account opening (AO) processes, including siloed product organizations, inefficient and repetitive processes, duplication of data and disparate channels. The high cost of AO can primarily be traced to the duplication of effort and systems, as well as the maintenance of interfaces among disparate legacy systems.

To address these problems, banks are centralizing AO activities into components that can be shared across the enterprise. This requires an enterprisewide data and workflow infrastructure that is horizontally rationalized across products and channels. Standardized processes can help banks ramp up business faster in new markets while reaping efficiencies in existing markets. For example, using a single, enterprisewide application form that is digitized and linked to back-office systems can result in real efficiency improvements and a less confused customer. During verification, technology can automate most of the process and allow enterprisewide information sharing during verification activities associated with other product sales. Banks can reap additional, significant cost savings by negotiating better procurement rates with providers of external information, such as credit reporting companies.

Connecting to other components that are critical to the AO process, such as a Regulatory Compliance component, can help banks adhere to applicable regulatory provisions and stay in compliance even as new laws are enacted. Similarly, by connecting to a Marketing component, the AO component can take advantage of the latest in neural and heuristic modeling to promote the right mix of products, allowing for a better cross-sell ratio, as well as new and existing customers who are happy to receive tailored products. Each component owner remains focused on the objectives of the component, while the bank’s organizational model aligns component objectives to enterprise objectives. This helps to prevent the dilution of focus that can otherwise diminish service levels and derail organic innovation.


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Conclusion: Leveraging CBM to deliver value To compete in the emerging world of flexible, open value networks, companies will need to focus on the few activities where they have a truly differentiating advantage in the value they provide or the cost at which they deliver versus the competition. CBM points the way forward by giving executives leverage to drive flexibility, scalability, efficiency and openness throughout the enterprise.

On the external side, CBM-driven specialization makes it easier and less expensive to collaborate with external specialists. A ready ability to tap industry networks enables component-based firms to assemble best-in-class capabilities and consolidate piecemeal offerings into solutions tailored for ever narrower market segments. The flexibility of open data protocols allows firms to incorporate variable pricing and risk-sharing into service agreements, making margins more sustainable and mitigating the potential downside of entering new markets. Availability and delivery also improve as products and services are exchanged through optimized channels and supply networks built on the global connectivity platform.

On the internal side, CBM enables firms to improve how they manage people, processes and technology. Aggregating people into cohesive groups allows them to focus clearly on what they know best, even as they learn to coordinate cross-organizational operations. Centralizing redundant processes into modules can drive scale gains and best practices across the organi-zation. Finally, componentization reduces the number of technology gaps, overextensions and duplications, allowing the firm to cut non-core investments and identify opportunities to develop new services based on excess capacity in existing technologies.

In the mid 1990s, the rise of the Web and the proliferation of enterprise software packages began to standardize the way companies interoperate. Today, we have reached the tipping point in this process. The global connectivity platform has forever rendered transactions cheap, simple and ubiquitous. In this new environment, proprietary industry value chains are an anachronism, and hardwired business structures are a liability. Firms that adapt will be able to better satisfy the demands of shareholders, employees and customers. Those that resist this change, or fail to comprehend it adequately, will simply not be able to compete in the longer term.

1 Pohle, George, Peter Korsten, and Shanker Ramamurthy. “The specialized enterprise: A fundamental redesign of firms and industries.” IBM Institute for Business Value. March 2005. http://www-1.ibm.com/services/us/index.wss/ibvstudy/imc/a1009224?cntxt=a1005266

Component business modelsEndnotes



Bank of Montreal (BMO) is at the leading edge of fi nancial services organizations which are fundamen-tally rethinking business models and organizational structure. BMO has incorporated component business modeling (CBM) into its core strategic approach, resulting in many opportunities to optimize the bank’s business. We sat down recently with Lloyd Darlington, BMO’s President and CEO of Technology and Solutions, and Karen Metrakos, Senior Vice-president, Operations, to talk about how BMO has benefi ted from a componentized view of its enterprise.

IBM: What are the factors that are driving you to think of BMO in terms of components?

Darlington: In the banking industry, spreads are under a lot of pressure. If you’re going to protect your bottom line, you look for smarter ways to operate the business – and for opportunities to scale across the organization. So we are driven by two things: the cost of support and the quality of support. And we saw CBM as an effective tool to help address both.

IBM: There are many approaches that can be used for this kind of opti-mization – for example, reengineering is a process-based technique. What led you to CBM?

Metrakos: We’ve been doing productivity initiatives and reengi-neering; it’s just that we’ve been doing it within the three pillars of the business: wealth manage-ment, investment banking and retail banking. And within those pillars, we’ve optimized as much as we can. So the next step is to take a

horizontal view – to see how you can actually bring like work together across these pillars and achieve economies of scale. And that’s why we really saw CBM as our next logical step.

IBM: How did you work through the organizational barriers or internal constraints that cutting across different organizations must have surfaced?

Darlington: There has to be support at the top of the bank to pull off a change of this magnitude. There are so many cultural endearments to the status quo of the organization, and to issues of who controls budgets and who controls investment decision making and all the rest, to say nothing of the people loyalties that occur within disparate organiza-tions. And the approach that Karen has taken effectively blew all that up. Despite all the impediments, we put together a centralized organiza-tion with the full support of the most senior management committee within the Bank.

Executive interviewLloyd Darlingon, President and CEO of Technology and Solutions, Bank of Montreal

Q&A

Karen Metrakos, Senior Vice-president, Operations, Bank of Montreal

80

“We are driven by two things: the cost of support and the quality of support. And we saw CBM as an effective tool to help address both.”

We didn’t think we had a chance of doing this in a matrix. So there had to be an understanding at the top as to what the prize was, and a strong commitment from us to deliver on the promises that we’re making.

Metrakos: The fi rst step in that journey was to make the change in the organization, to put the groups that we were talking about within the scope of the CBM program under one common management. We could not have made the progress that we’ve made without that initial step.

Darlington: Also, we didn’t just centralize – we took the superior executive leadership from the groups, and brought it in under common management as well.

IBM: As you go through this process, there must be some components that emerge as strategically critical for the long haul, versus opportuni-ties to create a utility or outsource it.

Metrakos: We’re using CBM to identify the like functions and bring them together. Whether they are core or noncore, we are trying to get the

economies of scale and improve the service that way and standardize on the process. In terms of the longer-term direction, do we take some of these and outsource them or do we continue to manage them ourselves? I think that’s an acid test we’re always going to do. But fi rst you’ve got to get it together, and you’ve got to have it working well.

Darlington: It has to be a very informed discussion. It’s hard if you have a big problem and you don’t understand it; it doesn’t usually help a lot to bring somebody else in to take it over. The good news is, we didn’t have a big mess to start with here. Each disparate part of the oper-ations area that is now part of this new structure had been improving in terms of effi ciency and quality. We just wanted to take it to the next level.

IBM: Do you have a sense of how this program might give you an edge over your competitors?

Metrakos: In the short term, we seem to be further ahead in this practice than most of our Canadian competitors. We’re hoping this will

make us more effective in terms of customer service than they are, and that our productivity will improve. But in the long term, as others start to catch on, it levels the playing fi eld.

Darlington: What I think makes us distinct – the secret sauce, if you will – is the element of organizational design. That’s not easily replicable. If you don’t do that, if you try to do it all through matrix management, it’s a recipe for spending a lot of time, a lot of churn and not getting the buy-in.

Metrakos: Even if you have great cooperation and you get the buy-in and do everything right, this is not a one-time event. It’s an organiza-tion that you have to sustain, and every new product that comes along you still have to integrate into your component-based model. And you can’t sustain that approach in a virtual environment.

Executive interview – Bank of Montreal


Q&A

Darlington: We will end up with a competitive advantage. The orga-nization design is critical. Karen’s got a customer care structure that’s focused on aligning with the business to ensure that we have a common bank view of exceptional service. So we’re all marching to the same drum. It’s critical to have a sharp line of sight on what you want to accomplish with the customer from a service perspective.

Metrakos: That’s right. When we pulled this structure together, we didn’t just bring in the operational units and begin applying CBM. We put in a function called operation risk management, and we put in another function which was customer care. We did that because it would be very easy to go down the journey of CBM to pursue improved productivity

results and lose track of the essential controls or the focus on customer service. We have incorporated these two focuses into our CBM implemen-tation.

IBM: An interesting facet of this operating model is that it’s much easier to port over additional operations onto this internal shared services utility – versus, for example, traditional merger integration work.

Darlington: Yes, our structure will be a major asset in any acquisi-tion that we consider, because we have excellent insight into how this business runs, and how it’s going to run in the future. We don’t have to talk to 25 department heads to get answers. We have a holistic understanding. This saves us a huge amount of the work that typically happens at the beginning of an acquisition or a merger with regards to understanding “what do you have, here’s what we have.” So you avoid the Noah’s Ark problem – two of everything.

IBM: What kind of performance improvements are you expecting to see from the CBM program?

Metrakos: Initially we are looking for a range of 15 to 25 percent produc-tivity improvement within Operations, which so far looks very doable. We are now also discovering intangible benefi ts to the lines of business such as freeing up their capacity and signifi cantly improving customer service.

IBM: If you were giving advice to another executive, what are the top three things they would need to think about when undertaking this type of project?

Metrakos: As you go forward with these shared service centers – which are really the components – it’s very important to maintain business alignment. We wanted to make sure that our line-of-business partners would not have to try and fi gure out who they have to deal with when they have a new product and bounce among multiple shared service centers. In other words, you

82

need to ensure that the traditional businesses don’t fi nd this model more complex to traverse. Otherwise you lose the advantages.

It’s also important to be transparent in terms of cost. It’s really based on activity-based pricing, because when you’re in a shared service center, you are servicing several lines of business and customer segments. Finally, there’s an enormous emphasis on risk management.

Darlington: Change management is a key consideration here. And you cannot underestimate the cultural implications of these changes. You need to have a good cultural under-standing of where you were, and the implications of making the change.

IBM: You’ve done this project in waves – is that what you would recommend?

Metrakos: That was the smartest thing we’ve done because basically we chose, in wave one, components that would require very little line-of-business involvement and would give

us immediate benefi ts. They were the easier ones, so we tackled those fi rst. And that allows us to demonstrate to our partners in the business that this project is highly worthwhile.

Our second wave heavily involves the business, because we can’t componentize these pieces without their involvement. Wave two is much larger, much more complex. We have four major, highly complex initiatives with end-to-end process focus that we believe will be the biggest wins. And wave three is the remainder of the organization. We plan to aggressively implement over the next three years.

“Change management is a key consideration here. You cannot underestimate the cultural

implications of these changes.”

Executive interview – Bank of Montreal


Further reading

Is your company ready to grow? Do you know why the next consumer will buy from your company, or buy from your competitor? Can you win more share in your market without knowing why you don’t win every consumer? Consumer decision process (CDP) modeling is a combination of traditional market research and unique quantitative modeling that takes the guesswork out of why consumers do or do not buy. With CDP, companies utilize detailed consumer insights to break down why consumers buy into strategies they can use to capture market share and grow incremental revenue. CDP deconstructs consumer decision processes into the tactical elements that affect decisions: from consumer attitudes to competitive prices, from advertising messages to salesperson tactics, and from consumer emotions to product characteristics.

Confounded by consumer purchase decisions?

Consumer decision process modeling takes the guesswork out of

revenue growthby Todd Gurley, Richard Maltsbarger,

Spencer Lin and Steve Ballou

Playing it safe is not a winning strategy in today’s electronics marketplace. Electronics represent a growing value add for today’s product markets, but electronics companies seem reluctant to choose what appears to be the most promising growth strategy: diversifi cation with new products into new markets. An ecosystem analogy can help electronics companies better understand how they can interact with each other to surface new opportunities, ease entry into new markets and achieve sustainable growth. Strategies based on innovation rather than domination can enable growth of the entire ecosystem – and the companies that comprise it. By taking the ecosystem view, global electronics companies can capture new growth by focusing on markets where electronics products are a core value add.

Rewiring electronics Discovering strategies for

sustainable growth from a business ecosystem perspective

by Dr. Hagen Wenzek

Further readingRecommended IBM Institute for Business Value reading

84

A recent study by MTV Networks revealed that their average viewer lives a 30-hour day. No, this doesn’t mean that the youth of America have given up sleep. It means they’re living in an on demand world: they surf the net, view DVDs, play MP3s, send instant messages, download movies, and even watch TV – doing most of this simultaneously enough to add up to 30 hours of daily, à la carte media consumption. And these multitasking teenagers aren’t alone: now, more than ever, audiences of all kinds want what they want, when they want it. In this paper, IBM examines how the industry got to this point, describes what an on demand media and entertainment business might look like, and provides a roadmap for executives that can help them compete successfully in the on demand world – without having to work 30-hour days of their own.

The 30-hour dayOn demand for media

and entertainment By Charles L Gerlach, Neil Parker

and Saul J Berman

As customer value drivers continue to fragment, traditional segmentation and analytical techniques will not provide retailers with the rich insights they need to differentiate themselves. It is increasingly important for retailers to understand why consumers shop, in addition to what, how and when they purchase goods and services. This paper reviews the result of a recent survey of U.S. consumers which explores the multiple dimensions of shopper behavior across different shopping occasions and product categories. It also discusses consumer decision process (CDP) modeling, which combines traditional market research and innovative quantitative techniques to take the guesswork out of customer analytics. With CDP, companies can devise practical strategies to capture market share and grow revenue.

Deeper customer insight Understanding today’s complex shoppers

by Steve Ballou, Julian Chu and Gina Paglucia Morrison

Visit ibm.com/iibv

Sign up to receive monthly e-mail updates, including IBM Institute for

Business Value studies and other fresh thinking from our consultants at

ibm.com/services/bcs/subscribe


The beginning of the twenty-fi rst century marks the era in which the structure of business begins to refl ect fully the changes brought about by the information age. Just as successful industrial age companies were substantially different than their predecessors in terms of scale, scope and organizational structures, the successful fi rms of the near future will look much different than they do today. Companies that will thrive in an increasingly turbulent market environment will be those that can transform themselves into even more focused, responsive, variable and resilient enterprises that connect their businesses end-to-end with suppliers at one extreme and customers at the other, fusing the best of business and technology, to accelerate value creation. We call these companies on demand businesses.

On demand business The new agenda

for value creationby Randall Hancock, Peter Korsten

and George Pohle

Across every industry, the business environment is becoming more complex, fast-paced and unpredictable. Under such strain, rigid business structures will eventually break. But those companies that have systematically replaced less fl exible organizational elements with more adaptable alternatives will enjoy a distinct competitive advantage – the ability to do business on demand. An on demand business can respond with fl exibility and speed to any customer demand, market opportunity or external threat. While many enterprises have become more adaptable in specifi c areas, fl exibility must become pervasive; it must be the primary design point of every aspect of how an organization operates – fi rst and foremost in its business model, but also in its structure and governance, value network, work practices and corporate culture.

It’s time to fl ex Create the organizational and cultural agility to do business

on demandby Simon Street, Richard Hossack,

Spencer Lin, Neil McGee and Peter Lawton

Further reading


86

Today, the business-to-business information industry faces a tough transition: competing in a digital world with a digitally savvy user. New online competitors are leveraging innovative technologies and new business models, providing customers and end users with a wider array of choices. With knowledge seekers atomizing and loyalties shifting, these competitive and substitution risks may be driving the industry toward an infl ection point. While the industry’s two historical barriers to entry – proprietary source content and proprietary analysis – are expected to hold in the near term, incumbents need to adapt swiftly or risk losing ground in key areas. Long term, the “opening” of source information will likely drive heightened competition and erosion of barriers. Despite this risk-laden outlook, incumbent players may be well positioned to leverage user intimacy to deliver compelling next generation services and solutions. Information providers must move “beyond access” and focus on delivering expertise and insights.

Beyond accessRaising the value of information in a

cluttered worldby Saul J. Berman, Adam R. Steinberg and

Louisa A. Shipnuck

Worldwide, banks are looking for ways to eliminate the ineffi ciencies that have crept into their business structures, not only to reduce operational costs, but to better attract and keep customers. The new generation of customers, accustomed to increasingly innovative shopping experiences, insists on satisfying and faster interaction with fi nancial institutions. Driven by high customer expectations and competitive pressures from market leaders, banks are being forced to reassess their delivery and customer management strategies. As an important function that often serves as the “fi rst face” to a potential customer, account opening (AO) is a natural candidate for improvement. Leading banks are looking to transform their AO activities at the enterprise level – an undertaking which is markedly different from the traditional process-based improvements performed within the business unit silos of organizations.

Unlocking the value of account opening with component

business modelingBy Sunny Banerjea

Visit ibm.com/iibv





Further reading


IBM Business Consulting Services conducted extensive interviews with 450 CFOs from 35 countries. These CFOs represented global enterprises with average annual revenues of US$8.4 billion. Over 77 percent of the interviewees were enterprise-level CFOs, while the balance represented business unit, regional and country perspectives. The project was undertaken to gain perspective on where fi nance is today and the direction in which CFOs say they are headed in the next three years. The report provides perspective on the continuing transformation of fi nance. The insights presented in this report provide a framework for CFOs and their fi nance organizations to use to drive a truly differentiated fi nance competency within their enterprise. Finance has done it before, and, with the right vision and plan, they can do it again.

CFO SurveyCurrent state and future direction

by Jim Bramante, Gregor Pillen and Doug Simpson

Making the decision to outsource human resource processes is a major step for many organizations. Once a company has decided to outsource human resource processes and has selected a vendor, the next major task is to implement an effective outsourcing arrangement. Transitioning to an outsourcing arrangement can pose a unique set of risks that must be proactively managed, given the complexities associated with transferring signifi cant operational processes to a vendor while maintaining ongoing service to internal customers. Clients and vendors need to work together to establish strategies that reduce or limit potential risks in the management of what we call HR Business Transformation Outsourcing (HR BTO). Rather than simply handing over a process to an outside fi rm to operate, HR BTO focuses on transforming HR activities to improve effi ciency and effectiveness, and create business value.

Preparing for human resouces business transformation outsourcing

Risk mitigation strategies

by Eric Lesser and Joanne Stephane

88

Visit ibm.com/iibv




This paper, a collaborative discussion by thought leaders from the IBM Media and Entertainment practice, discusses why industry and market forces will propel media businesses to become more open to business partners, customers and consumers – opening content reserves and formatting, production processes, packaging and sales options – without opening the company to increased vulnerability.

Media and entertainment 2010

Open on the inside, open on the outside: The open media company of the future

by Saul J. Berman

Long mainstays of the global economy, consumer packaged goods (CPG) companies have fared well historically, riding out the ups and downs of the fi nancial markets better than most. However, the business environment is steadily heating up – challenging fi rms to operate with ever greater speed, agility and cost-effectiveness. At the same time, internal constraints continue to occupy valuable time and resources. As the industry reaches a boiling point, some companies lulled into complacency may be surprised to fi nd that they are no longer able to keep up with consumer, customer and competitive requirements. Others though are paying attention to the changing market conditions and taking action now. They’re learning how to adapt to the heat and turn it into competitive advantage and profi table growth. We call these companies on demand businesses.

The heat is on Increasing challenges for consumer

products companies demand a new approach

by Bill Gilmour and Julian Chu


About the authorsThe growth triathlon: Growth via course, capability and convictionVivek KapurVivek Kapur is a San Francisco-based partner in the IBM Strategy and Change practice. He works with executive teams at leading electronics and consumer products fi rms to develop and deploy programs of business and technology transformation. Vivek leads IBM’s Growth and Customer Strategy initiative globally, and has published thought leadership on growth, industry collaboration, and on the Electronics industry. Vivek received his Bachelors in Engineering from the Indian Institute of Technology, Delhi and his MBA from the Indian Institute of Management, Ahmedabad.

Jeffere FerrisBased in Southern California, Jeffere is a corporate strategy consultant within the IBM Learning and Knowledge organization. His client work has included corporate and operations strategy consulting for major Media and Entertainment companies. Jeffere received his bachelor’s degree from the University of California and his MBA from Kellogg Graduate School of Management.

John JulianoJohn is a Strategy and Operations Consultant for the IBM Energy and Utilities practice in Washington, DC. He has more than fi fteen years' experience working with electric and gas utilities in North America, Europe, and Asia. In addition to the “Growth triathlon” paper, he has published over twenty papers in utility industry references, journals and magazines. John earned his BS in Nuclear Engineering at the Massachusetts Institute of Technology, his MS in Operations Research at the Johns Hopkins University, and his MBA at the University of Chicago’s Graduate School of Business.

Eliminating the strategic blind spot: Technology-driven business strategy spurs innovation and growthKevin McCurryKevin is a Boston-based partner in the IBM Strategy and Change practice and leads business strategy projects focused on technology, product development, fi nance and cost. He has worked with Industrial clients for over ten years and during his consulting career he has advised numerous Fortune 500 companies across a broad range of sectors. Kevin received his bachelor’s degree from Trinity College and his MBA, with Distinction, from the Harvard Graduate School of Business Administration.

Saul J. Berman Saul is a partner and global leader business strategy leader for the IBM Strategy and Change practice and also leads the Media and Entertainment practice. Based in Los Angeles, he has published numerous articles on cross-industry strategy issues as well as on media and entertainment trends. Saul is a frequent conference speaker and has been quoted in numerous magazines and newspapers, including The Wall Street Journal and BusinessWeek. In 2005, Consulting Magazine identifi ed Saul as a “Top 25 Consultant.” He received his bachelors’ degree from the Wharton School at the University of Pennsylvania and his MBA and PhD from Columbia University School of Business.

Jeff Hagan Jeff is an Alliance Development Manager with IBM Business Consulting Services. He has worked in the industrial sector for over ten years focusing on product to services business transformation and innovation and growth strategies. Mr. Hagan received his bachelor’s degree in Chemical Engineering from Lehigh University and his MBA from Carnegie Mellon University.

The specialized enterprise: A fundamental redesign of firms and industries, and Component business models: Making specialization realGeorge PohleGeorge is a partner and is the global leader of the IBM Institute for Business Value. Based in New York City, he leads global teams in developing business industry and business function thought leadership that helps client executives create and implement innovative business strategies. In addition to publishing and speaking on business issues, he has been working in senior line management and consulting roles for over twenty years. He received his bachelor’s degree from The Johns Hopkins University and his MBA from INSEAD.

Peter KorstenPeter is a partner and is a leader of the IBM Strategy and Change practice for the Europe, Middle East and Africa regions, and also serves as executive director in the IBM Institute for Business Value. Based in Amsterdam, he works closely on corporate and business strategy issues with numerous global clients in the industrial sector. He holds a Deans List (Honors) MBA from IMD (Lausanne, Switzerland) and has received further post-graduate education at the Harvard Business School/INSEAD, IMD, Ashridge and at Templeton College in Oxford.

Shanker RamamurthyShanker is the lead partner for the the IBM Financial Services Strategy and Change practice and is based New York City. Shanker has over twenty years of consulting experience and has worked with clients in over twenty-fi ve countries in North America, Europe and the Asia Pacifi c region. He is the global leader and one of the lead authors of the Component Business Modeling (CBM) method. He is a widely-quoted speaker and author on business transformation and innovation. He is a Chartered Accountant with an MBA in Finance from the Indian Institute of Management, Ahmedabad, and Masters in Information Science from the University of New South Wales in Sydney, Australia.

Credits

90

IBM Business Consulting Services

With business experts in more than 160 countries, IBM Business Consulting Services provides clients with deep business process

and industry expertise across 17 industries, using innovation to identify, create and deliver value faster – from strategy through

implementation. We draw on the full breadth of IBM capabilities, helping clients implement solutions designed to deliver business

outcomes with far-reaching impact and sustainable results.

IBM Institute for Business Value

IBM Business Consulting Services, through the IBM Institute for Business Value, develops fact-based strategic insights for senior

business executives around critical industry-specific and cross-industry issues. This book is based on in-depth studies by the

Institute’s research team. It is part of an ongoing commitment by IBM Business Consulting Services to provide analysis and

viewpoints that help companies realize business value. For more information, visit us on the web at ibm.com/iibv or send an e-mail

to [email protected].

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Documents

Innovative approaches for sustainable growth · PDF fileInnovative approaches for sustainable growth ibm.com/bcs Marc Chapman and Saul J. Berman, Editors IBM Business Consulting Services