Strategy Business Magazine-Special 2010

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DON TAPSCOTT • C.K. PRAHALAD • MARSHALL GOLDSMITH • GARY NEILSON • A.G. LAFLEY • DAVID ROCK

S P E C

IAL

A N N I V

E R S A R

I S S UE

CELEBRATING15YEARSOFTHEBESTBUSINESSTHINKING

Special Issue, Autumn 2010US $12.95 Canada C$12.95





a sound federal budget heading

toward surplus, and strong business

confidence. How could anythingpublished in those years matter to

anyone in 2010?

Yet despite all the turbulence

since then, there has been a slow but

steady increase in knowledge about

economic value and organizational

effectiveness. The importance of

managerial capability has been dis-

counted by economists (and others)

for years, but it is now becoming

increasingly apparent. Variance in

managerial prowess explains why

some companies weathered the eco-

nomic storm and others did not,

and why some new CEOs succeed

while others crash and burn. That’s

why, at s+b — through the editor-

ships of Kurtzman (1995–1999),

Randall Rothenberg (2000–2005),

and me (since 2005) — our primary

editorial mission has been to helpreaders find the most profound and

most pragmatic business insight,

and put it to use.

Consider, for instance, “Why

CEOs Succeed (and Why They

Fail): Hunters and Gatherers in the

Corporate Life” (page 8), written

in 1996 by an innovative venture

capitalist (Edward F. Tuck) and

a prominent anthropologist (Timo-

thy Earle). They show how the

CEO and the board of a major com-

pany play out the same roles in ourtime that the chiefs and elders of

prehistoric tribes established many

thousands of years ago. In that con-

text, the passage of 15 years is al-

most nothing.

Similarly, the 1997 article “10X

Value: The Engine Powering Long-

term Shareholder Returns” (page

16) anticipates many of the ideas

emerging now about the value of

coherence. Leslie Moeller (now a

Booz & Company partner) and

Booz alumni Charles E. Lucier and

Raymond Held studied 30-year

growth patterns of 1,300 publicly

traded companies in the U.S., and

found it is possible to raise a com-

pany’s value 10-fold in that time, if

you know how to muster the right

kind of innovation.

Don Tapscott’s 2001 article,“Rethinking Strategy in a Net-

worked World (or Why Michael

Porter Is Wrong about the Inter-

net)” (page 24) remains current

because the controversy it raised still

endures: Does the Internet make

corporate boundaries obsolete?

Should companies emulate Apple,

which retains tight control over

every aspect of its enterprise, or

Since its inception, strategy+business

has focused on the value of manage-

ment thinking and practice. Be-cause business knowledge is a mov-

ing target, in which there is always

something to learn from practice

and reflection, the best insights

about management often seem coun-

terintuitive at first. But they can

make a significant difference in your

effectiveness and the performance

of your enterprise — whether you’re

a CEO, a student, an entrepreneur,

or anyone else in business. This year,

we celebrate the magazine’s 15th

anniversary by looking back at the

wisdom we have published in our

pages. Much of it is still worth read-

ing now.

When s+b was founded in 1995

by former Harvard Business Review

editor Joel Kurtzman and a group of

farsighted partners at Booz & Com-

pany (then part of Booz AllenHamilton), the dot-com era was just

beginning, and the shape of the

world economy was very different

than it is today. Amazon and

Google did not yet exist; neither

China nor India was seen as a global

economic force. The United States,

where the magazine’s focus was cen-

tered at the time, was at a peak of

prosperity, with rising equity prices,

15 YEARSOF SIGNIFICANCE







8

MANAGEMENT

Why CEOs Succeed(and Why They Fail):Hunters and Gatherers

in the Corporate LifeEdward F. Tuck and Timothy Earle

In the corporate world, the laws of the jungle still rule.

CEOs and boards fall prey to the habits and practices of

prehistoric hunters and gatherers.

STRATEGY & COMPETITION

10X Value: The EnginePowering Long-term

Shareholder ReturnsCharles E. Lucier, Leslie Moeller, and Raymond Held

Your company can pursue 10-fold growth over 15 years

through strategic innovation: changing the rules of the

game for your industry.


Rethinking Strategy ina Networked WorldDon Tapscott

The original manifesto for open source, Internet-

conscious competitive advantage argued that Michael

Porter was wrong about partnerships and alliances.

Here’s why working outside your boundaries is central

to business success.

Six Reasons There Is a New Economy

GLOBAL PERSPECTIVE

The Fortune at the Bottomof the PyramidC.K. Prahalad and Stuart L. HartLow-income markets present a prodigious opportunity

for the world’s largest companies to seek their fortunes

and bring prosperity to the billions of aspiring poor who

are joining the market economy for the first time.

16

24

28

32

features

66

16

8



features

MANAGEMENT

The Four Bases ofOrganizational DNAGary Neilson, Bruce A. Pasternack, and Decio Mendes

How does a company design its organization to

execute its strategy and successfully adapt whencircumstances change? The first step is to under-

stand how four key traits of an organization influ-

ence each individual’s behavior: the organizational

structure, the decision rights for processes, the

motivators, and the flow of information.

Focus: Testing Quest Diagnostics’ DNA

MANAGEMENT

Leadership Is a Contact

Sport: The “Follow-upFactor” in ManagementDevelopmentMarshall Goldsmith and Howard Morgan

A review of leadership development programs at

eight major corporations reveals that nothing

works better than interaction with colleagues.

Executives who follow up their training by

discussing their improvement plans and progress

with co-workers become the best leaders.

MANAGEMENT

Manufacturing MyopiaKaj Grichnik, Conrad Winkler, and

Peter von Hochberg

Why do manufacturers lose relevance and competi-

tiveness? Because their operations strategies are

often the same as they were 10 or 20 years ago.

Instead of drifting into decline, producers of goods

have a chance to seize the future by cultivating bet-

ter awareness about manufacturing costs and

means: learning to see their operations moreclearly and redesign them more flexibly.

The Roots of Myopia


P&G’s InnovationCulture

A.G. Lafley, with an introduction by Ram Charan

Lafley, the CEO of Procter & Gamble, explains how

his company built a world-class organic growthengine by investing in people. Going beyond their

book, The Game-Changer, the authors explore the

role of social systems in turning new ideas into

commercial success.

Becoming a Great Innovation Team Leader

Ram Charan

MANAGEMENT

Managing with

the Brain in MindDavid Rock

Neuroscience research is revealing the social

nature of the workplace and its implications for

management. The brain’s social needs — for status,

certainty, autonomy, relatedness, and fairness —

matter more than money.

BEST BUSINESS BOOKS 1995–2010

Essential Reading:

Highlights from15 Years of s+bBook ReviewsTheodore Kinni

Our all-time favorite business books.

ENDPAGE

Articles of SignificanceOf s+b’s many classic articles over the years, here

are a few of the editor’s favorites.

Cover illustration by Opto

Special Issue, Autumn 2010

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EDITORIAL

Editor-in-ChiefArt [email protected]

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Art DirectorJohn [email protected]

Associate Art DirectorJessie [email protected]

Designer

Mika [email protected]

Contributing EditorsEdward H. BakerNicholas G. CarrDenise CarusoMelissa Master

CavanaughMichael V. Copeland

Stuart CrainerDes DearloveTom EhrenfeldBruce FeirsteinLawrence M. Fisher

Ann Graham

Sally HelgesenWilliam J. HolsteinDavid K. HurstJon KatzenbachTim Laseter

Chuck Lucier

Gary L. NeilsonJustin PettitRandall RothenbergMichael SchrageMark Stahlman

Christopher Vollmer

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I l l u s t r a t i o n b y E l w o o d S m i t h

It is enormously destructive and expensive to

change the chief executive of a growth company who

stumbles in office. The human cost is high, as well:

competent executives, used to success, fail without

understanding why. They are branded with their failure.

Some succumb to bitterness and despair; a few aresuicides.

Why do these otherwise successful, competent,

well-trained people fail? Why, in the face of good advice,

do they do things that bring about their ruin? Why, after

they fail, can people of less training, skill, and intelli-

gence turn their failures into successes?

The authors of this article are an early-stage venture

seed capitalist and an anthropologist who specializes in

leadership. We have examined the most common ways

that CEOs fail by applying the findings and techniques

of anthropology to business organizations. We have

found that the cause of these systematic failures is not

the CEO’s lack of skill, nor even his or her psychology;

it is the changing institutional context in which the

CEO must perform.

A chief executive officer will fail most often in thesethree situations:

• He or she has moved to a much smaller company,

either as an entrepreneur or to take over a startup or

early-stage company.

• The CEO’s small company has grown into a mid-

sized company.

• The CEO has been a successful vice president or

chief operating officer and has been promoted to chief

executive, or has been recruited as chief executive for

another company.

BY EDWARD F. TUCK AND TIMOTHY EARLE

WHY CEOS SUCCEED (AND WHY THEY FAIL)

HUNTERS AND

GATHERERS IN THE

CORPORATE LIFEWhat are the factors that determine

which CEOs succeed and which fail?Even in the high-tech world,

the laws of the jungle still rule.





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These three modes of failure seem unrelated; they

are not. Something changes when a company reaches a

certain size that makes it somehow different to manage;also, running an independent company is different from

running a division of a large company. In short, small-

company CEOs fail in large companies, large-company

CEOs fail in small companies, and CEOs who have

risen through the ranks can’t work with their boards.

Camp, Corporation, and Community

Every company is a polity: a politically organized com-

munity. Even though employees may be hired and fired

at will, and may be called “resources,” “heads,” “directs,”

or some other impersonal term, each director, officer,

manager, and employee of a company is a functioning

member of the polity. This is true regardless of the

degree of democracy that exists in the company, regard-

less of an employee’s position and regardless of whether

he or she or the company’s management wants it to be

true. Everybody in a company is part of a politically

organized community, a polity, and each person’s role

and behavior in that polity is determined by his or her

inherited nature, upbringing, and training. In a com-

pany, as in any polity, each person behaves according tohis or her rules about behavior in groups. Some of these

rules come from upbringing and training. According to

anthropologists L.J. Eaves, H.J. Eysenck, and N.G.

Martin (Genes, Culture and Personality: An Empirical

Approach, Academic Press, 1989), half of this behavior

is inherited.

These rules come from our ancestors, and to a great

degree they are shared among the other members of

our species. When we are born we are humans, and we

know how to behave with other humans. When we try

to succeed in a group, we unconsciously call on those

primitive patterns of behavior that have evolved over

millions of years of living and working in groups; andthe structure of our groups comes from the way we

behave together.

Anthropologists have found patterns in these

“primitive,” isolated human polities that will help CEOs

understand and solve difficulties in their relationships

with their boards and their employees. We have found

that corporations and their boards have strong parallels

in primitive polities, and that boards are therefore orga-

nizationally different from the corporations to which

they are attached. We learned that the founder who is

ruined by his or her company’s success, the captain of

industry who cannot run a small company, and the sea-

soned executive who cannot be promoted are all victims

of the same simple and ancient effect, and we propose a

reason for that effect. First, let’s compare organizations.

Inside Primitive Organizations

Three primitive organizations have counterparts in

modern companies: the working group, camp, and hier-

archy. A fourth organization, the state, evolved later —

and it, too, has counterparts in modern companies.1. The working group. A “working group” is found

in all cultures. It is a temporary association of two to six

people with useful skills, and it has a specific purpose: to

hunt, to lay a section of railroad track, to right an over-

turned car, to catch a criminal. Working groups are vari-

ously called “hunting parties,” “task forces,” “work par-

ties,” “posses,” and “patrols”: names fitting the purpose

of the group and the group’s societal context. They exist

only for the purpose at hand, and they are organized

quickly and informally.

Edward F. Tuck

[email protected]

is the principal of Falcon Fund,a venture capital and privateequity fund for seed and early-stage investments, and CEO ofSocial Fabric Corporation, arelationship-prediction servicethat uses DNA samples. At thetime of publication, he was ageneral partner of KinshipPartners II, a venture capitalfund. He has also been thefounder or cofounder ofseveral companies, includingMagellan (the GPS pioneer)and Teledesic Corporation.

Timothy Earle

[email protected]

is professor and chair of thedepartment of anthropology atNorthwestern University, posi-tions he held at the time ofthis article’s original publica-tion. Formerly, he was a pro-fessor of anthropology at theUniversity of California at LosAngeles and director of itsInstitute of Anthropology.

Originally published FourthQuarter 1996.



When a hierarchical organization like a corporation

or an army sets up a working group, a leader is namedby the hierarchy (“chairman” or “squad leader”),

although the real leader of the group emerges informally.

Sometimes the group chooses its own leader by accla-

mation (“team captain”) or by lottery (“straw boss”);

usually, the leader arises without any special action as the

work progresses, and leadership passes from one person

to another smoothly as the nature of the work changes.

A working group has a problem to solve and works dem-

ocratically, accepting suggestions from any member

regardless of his or her status outside the workinggroup. When the problem is solved or abandoned, the

group disbands.

The result of the group’s work has a strong effect on

the mood of its members. If the work is successful, they

are elated and often celebrate. If the work is a failure, its

members are depressed and uncommunicative for a

time. Working groups are short-lived, have only a few

members, and are re-formed as needed.

2. The camp. Hunting and gathering “camps” usual-

ly comprise about 30 people, from up to six families.

The business of the camp — hunting, gathering, cook-

ing, building — is done by temporary working groups

as defined above. Though many jobs in a camp are sepa-

rated by sex, little other specialization exists; today’s

hunter may be tomorrow’s gatherer or hut-builder,

although special skills such as stone tool making are rec-

ognized by all.

The hunting–gathering camp does not admit to

having a leader; in fact, members of the camp will deny

there is a leader. They will say, “We’re all leaders.”

Nonetheless, a member of a nearby camp will say,“That’s Joe’s camp.”

The camp thus does have a person who facilitates

decisions. He or she does not command, but is respect-

ed because of knowledge, judgment, and skill in orga-

nizing opinion. As Andrew Schmookler has noted, this

person does not give orders, but focuses the decision-

making process. Decision making in a camp is a politi-

cal, deliberative, consensual process. The camp’s elders

are expected to choose courses of action that are accept-

able to the camp, and to accept suggestions from every-

one. The whole camp behaves in a consensual manner,

and there is strong social pressure to conform. (In func-tioning camps, all members are interested in the facts,

are fully informed of them, continuously discuss them,

and are aware of the alternatives being considered.) At

no time are the people in the camp invited to solve a

problem as a group, nor do they wish or expect to do so.

Where a consensus is not found and distrust and

disagreement linger, the usual solution is for the smaller

faction to leave, striking off on its own. This is a fairly

normal event, as families frequently move from camp to

camp; but it is not without risk. The faction that takesoff risks its very survival if a new camp receptive to it

cannot be found.

When a camp grows to about 50 people, it becomes

unstable and splits into two or more camps. This pattern

of size-related instability is repeated in organizations of

all kinds across human society.

3. The hierarchy. The tribe, which may encompass

several camp-sized groups, is a hierarchy. Hierarchical

organizations have a clearly defined leader and often

many strata of authority. They have clear lines of author-

ity, and no inherent means to achieve consensus. They

evolved as a means of providing a mechanism for rela-

tions with other tribes (including commerce and war),

for conducting religious observances, and to allow occu-

pational specialization. But they had the fortuitous

result of solving the problem of instability in large

organizations. The tribal hierarchy made it possible for

more than 50 people to live and work together, at the

cost of personal and group autonomy.

Simple tribes are organized into local groups of a

few hundred, each with its own leadership. More com-plex tribes are organized into regional chiefdoms of

several thousand, each with a hierarchy of leaders. At the

top of every stable hierarchy there is a camplike consen-

sual group. Even in outright dictatorships there must be

an egalitarian council, as Machiavelli advised in The

Prince 500 years ago: “A prudent prince must…[choose]

for his council wise men.… He must ask them about

everything and hear their opinion, and afterwards delib-

erate by himself and in his own way, and in these coun-

cils and with each of these men comport himself so that



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everyone may see that the more freely he speaks, the

more he will be acceptable.”

4. The state. Eventually, in the archaic world, states

evolved to organize much larger populations, which

were often living together in cities and relying on market

exchange. It was at this time that real bureaucracies

emerged, both to solve efficiently the problems of large

groups and to control those groups for the will of dicta-torial rulers.

In the 18th and 19th centuries, with industrializa-

tion and the introduction of cheap transportation, peo-

ple began to live together in even larger groups. The

bureaucratic state then developed fully and became the

preferred method of managing any continuing enter-

prise employing more than a handful of people. At first,

these were outright dictatorships, but improvements in

communication, education, and the economy led to a

revision of societal values so that now all members of hierarchical societies have some voice. This voice varies

from union grievance procedures through election of

leaders and managers through public approval of certain

actions to formal consensus meetings; however, the

structure of any stable organization of more than 50 to

100 people is some form of hierarchy.

Size Determines Structure

Why are human organizations of different sizes struc-

turally different? Why does a small organization become

unstable as it grows? Why is the triggering size the same

in different cultures? It appears that six or seven is the

largest number of relationships that one person can deal

with continuously. We need the hierarchy, with its well-

defined roles and patterns of behavior, to allow large

numbers of people to work together without overload.

A study by anthropologist Gregory Johnson at the

City University of New York has shown that decision-

making performance in egalitarian groups falls off rap-

idly as the group size grows beyond six. This is a result

of a well-documented limitation of the human brain, which cannot simultaneously retain and process more

than about seven “information chunks” at once. (One

such study by the Bell System set the size of local tele-

phone numbers at seven digits.)

To make larger groups work while still retaining

their egalitarian nature, six or seven groups form a

“sequential hierarchy.” In this structure, consensus is

achieved first within small units — for example, nuclear

families — and then is attempted among the formative

groups themselves, with full consensus finally reached

after a lengthy process of referring the issue back and

forth from the smaller to the larger entities. The largest

stable group in which this process has been observed

contains about 100 people, and involves three levels of

consensus; the usual maximum is about 50 people (7

times 7), and uses two levels of consensus.

Two points to hold in mind are: 1) As group size

changes, so must its organizational structure. This is astrue for the long-term evolution of human society as it

is for the short-term evolution of a company; 2) Within

a single social system, groups of different scale exist and

require different organizational structures. A major dys-

function occurs when an organizational structure appro-

priate for one scale is used for groups of other sizes.

The Modern Organization

Thus, four types of organization have arisen when peo-

ple live together and try to do something in common:the working group, the camp, the general hierarchy, and

the state bureaucracy.

The most primitive of these is the working group,

up to six people. It is also the one that elicits the most

profound emotional response. The camp, up to 30 to 50

people, is the next most primitive, and is also a very old

structure.

The most modern organizations, and therefore the

ones for which we are by nature least adapted, are the

hierarchy and the bureaucracy. Behavior in a tribe, a

company, or a nation is not innate: It is learned, in con-

trast to behavior in camps and working groups. An indi-

vidual’s success in a hierarchy depends on how well he or

she has learned its rules, and to what extent his or her

innate behavior allows that person to conform to those

rules. A modern corporation employing more than 100

people is a hierarchy; a company of more than 1,000 is

a bureaucracy. A camplike board of directors is at the

top, to offer guidance by diverse experience and to pro-

vide intercorporate information. The corporation’s best

work is done by working groups.The advantages and satisfactions of recognizing the

egalitarian nature of the working group are now under-

stood; most traditional companies attempt to exploit

this. Very little analysis in a similar vein has been done

with boards of directors. Yet in corporations, the camp-

like consensual group, the prince’s council, is the board.

Since today’s boards are like the camps of primitive

societies, a successful CEO must remember how camps

behave.

A board is not a working party. It cannot solve





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working group to solve the company’s problems, or as a

part of the organization that he or she must supervise. If

the CEO is told to lead the board but not command it,and to work by consensus, he or she may find this guid-

ance incomprehensible. Denying the realities of the new

situation, the CEO may either actively avoid assuming

leadership of the board or try to manipulate it or dictate

to it. He or she can be further confused by fellow board

members, who may insist either that the board has no

leader or that the leader is the aging chairman.

If, in fact, the CEO does not lead the board, the

board’s other members, who are operating out of their

primitive, innate rule book, have little conscious insight

into the situation. They are confused and become un-

ruly. The CEO and sometimes the organization itself

then fail. Often, neither the board members nor the

CEO can explain the failure. They then go on to repeat

the pattern until the board gets a CEO who will lead or

until the CEO accepts his or her leadership role or re-

turns to a subsidiary role in another company.

Problems with becoming big: the faltering founder.

Unless he or she has access to an enormous amount of

money, the founder of a company must first found a

camp. In a camp, as we have seen, there is little special-ization; in a new company, it is common to hear, “I wear

a lot of hats.” It is also common to operate by consen-

sus: Members marvel at the speed with which decisions

are made, and at their feeling of mutual support, clear

objectives, and clean, unambiguous communication.

Employees at all levels speak as though they know what

is going on throughout the company. Most of the com-

pany’s people work far more hours than a normal work-

day; they enjoy their work.

If the company succeeds, it grows. At first, the com-

pany’s members are elated with the growth, and point to

the company’s new people as evidence of its success.

Soon, however, typically when the company reaches 25people, a few dissonant voices are heard: “She’s trying to

do my job,” “I don’t know what’s going on anymore,”

and, as the company continues to grow beyond the size

of a camp, “We’ve lost something important. I don’t

know what it is, but it’s gone. It isn’t fun anymore.” At

this point, one or two key employees decide to leave, or

simply begin to work 40-hour weeks.

If an insensitive CEO doesn’t understand what is

happening, he or she will say that the people are

ungrateful and will withdraw; a more sensitive CEO will

redouble efforts to communicate. Both will fail.

The appropriate action is to assemble a hierarchy,

using experienced people, when the staff numbers more

than 20. Some key people will be dissatisfied and leave,

because they left a hierarchy for the camplike feeling of

the small company; some will feel betrayed. Others will

adjust. The CEO must gradually abandon his or her role

as consensus leader and take on the role of chief.

This is a difficult transition even for CEOs who

understand the problem. Often, founders have chosen

their role because of difficulties in the hierarchy of a pre-vious company; they see the transformation of their

company to a hierarchy as a personal failure. At best,

they must deal with alienation and feelings of betrayal in

people with whom they have worked closely, and with

whom they shared the bonding and elation of a success-

ful working party. Sometimes, even if their companies

succeed, they are unhappy and unfulfilled.

Problems with going small: a chief without a tribe.

The opposite occurs when a CEO is recruited from a

large company to run a young one. Such people often

As the company continues to grow beyondthe size of a camp, people say,

“We’ve lost something important.It isn’t fun anymore.”



time, and whose work has largely been in hierarchies,

would be wise to find an insightful friend who has suc-

cessfully run a small company, or a person with exten-

sive board experience, to act as an advisor.

Venture capitalists, executive recruiters, and board

members of young companies who have a stake in the

success of the people they fund or recruit can reduce

their risks considerably by discussing consensual organi-zations with their candidates.

One of the authors of this article has made a recent

habit of exploring the central issues that have been dis-

cussed here with company founders (who are frequently

pro-consensus and anti-hierarchy) and with experienced

candidates for top management jobs (who are dramati-

cally the reverse). In two cases, after such a discussion, a

founder suggested that he take the role of a function

manager in the new company rather than be its CEO,

and that he and the investors go out together to recruitan experienced hierarchical CEO to run the new enter-

prise when it grew to an appropriate size.

In both cases, the company was unusually success-

ful. Perhaps more important, the founder happily

remained with the company in a productive and reward-

ing role. +

Reprint No. 96402

Resources

Timothy Earle, “Chiefdoms in Archaeological and Ethnohistorical

Perspective,” Annual Review of Anthropology (Annual Reviews, 1987): A

source of the insights in this article.

Eric Flamholtz, How to Make the Transition from Entrepreneurship to a

Professionally Managed Firm (Jossey-Bass, 1986): Describes what happens

when a camplike company must become a hierarchy.

Allen W. Johnson and Timothy Earle, The Evolution of Human Societies

(Stanford University Press, 1987): Includes observations on the structure

and leadership of primitive polities. Insights from this book have been

used throughout this article.

Gregory A. Johnson, “Organizational Structure and Scalar Stress,” inTheory and Explanation in Archaeology, edited by C.A. Renfrew, M.J.

Rowlend, and D.A. Segraves (Academic Press, 1982): Why consensus

doesn’t work in groups larger than six people.

Niccolò Machiavelli, The Prince, translated by Luigi Ricci (New American

Library, 1952): The classic for leaders of a state — or a hierarchy.

Andrew Bard Schmookler, The Parable of the Tribes (University of

California Press, 1984): This work, subtitled The Problem of Power in

Social Evolution, contains many strong parallels to modern corporate

behavior.

For more thought leadership on this topic, see the s+b website at:

www.strategy-business.com/organizations_and_people.

have no experience with consensus-based groups.

When the CEO arrives at his or her new company

and finds that everyone has a title and a place in an

organization chart, he or she is pleased, and often begins

the process of interviewing people to see if they are well

qualified for their positions.

The CEO is then usually dismayed. If he or she

concludes that the staff is incompetent, however, thatconclusion will be wrong. If, on the other hand, he or

she believes that the titles and the organization chart

describe the real organization, and then attempts to

operate the company accordingly, the CEO will fail

immediately. There is no hierarchical organization; it is

a camp. The CEO cannot delegate; he or she must work

by consensus.

Gaining Anthropological Guidance

The literature and techniques of anthropology and cul-tural evolution can be used to understand business

organizations at different scales. We have explained three

familiar failure modes of chief executive officers, derived

from studies of primitive societies and their leadership.

We have shown that these failure modes can be avoided

if the CEO and the company’s employees understand

and conform to the deep structure of their organization.

We have also shown that the board of directors of a

modern corporation is a more primitive and intrinsically

different structure from the organization it serves, and

that CEOs must use fundamentally different techniques

to work with their boards and with their companies.

Many failures of companies and their chief execu-

tives can be avoided by supplementing graduate business

training, which now deals largely with the structure and

management of hierarchies, with training in consensual

organizations such as boards, skunkworks, and small

companies. The goal is for the new CEO to have the

training to understand the differences between the

organization he or she is entering and the one he or she

is leaving.In the absence of knowledge, people do the things

that have worked for them in the past. When these

things fail to work, people simply do them more inten-

sively, like a tourist in a foreign country who just shouts

louder if he or she is not understood.

But new CEOs have staked everything on their new

jobs and they desperately want to succeed. When they

arrive in an unfamiliar organization, they are receptive to

guidance they believe may keep them from failing. A

person who is entering a small company for the first







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new customers with the latest promotion, or the exten-

sion of product lines at the expense of the long-term loy-

alties of current customers. The only reliable way to earnreturns for shareholders in the top 10 percent over a

period of 10 to 15 years is through a 10X value innova-

tion. Of course, our findings do not invalidate the

importance of rapid productivity improvements and

revenue growth in all businesses. To sustain even average

returns for its shareholders, a company must achieve

continual improvements in its productivity and target

increases in market share.

This article relates our findings on 10X value as a

cause of shareholder value growth and discusses the

implications for senior managers. These findings result

from an ongoing effort to uncover the dynamics of

growth. They are based on an assessment of the creation

of long-term shareholder value by more than 1,300 large

companies publicly traded in the United States between

1967 and 1997, supplemented by case studies of 65

companies in the top 10 percent of shareholder value

creation for at least a decade. Although the quantitative

research that underlies this article focuses on United

States companies, our subsequent research suggests that

the conclusions are equally valid in other countries.Indeed, many top-performing U.S. companies (for

example, the Coca-Cola Company) achieved much of

their growth by replicating their 10X value in other

countries.

Several findings from this research contradict con-

ventional wisdom. First, the relationship between rev-

enue growth and growth in shareholder value — defined

as increases in stock price plus dividends, adjusted for

stock splits — is not close in either the short term or the

long term. For example, despite significant growth in

revenue between 1985 and 1994, USAir, Fleming, and

Black & Decker had a modest or negative growth in

shareholder value. Additionally, industry growth rates are almost com-

pletely unrelated to the likelihood that a company will

create superior shareholder value over the long term.

Contrary to prevailing strategic thinking, companies in

slow-growth, mature markets are somewhat more likely

to create superior returns for shareholders than compa-

nies in fast-growth industries.

Finally, the tactics implied by traditional strategic

planning — which focuses on achieving better market

and cost positions than competitors through superior

planning and management — results, at best, in growth

rates a few points faster than average and significantly

less than the top-performing companies.

Innovation: The Value Multiplier

What then are the drivers of sustained superior long-

term growth in shareholder value? More than 90 percent

of the companies we studied that achieved top-decile

returns for at least 10 years have been able to sustain

rapid increases in operating earnings through the con-

tinual creation of 10X value for customers. They thenachieved top-line growth by replicating the 10X value to

attract new segments of customers (what we call a

“growth superhighway”).

To accomplish this, they relied on continual, high-

ly productive innovation: developing and constantly

enhancing unique approaches to serve customers more

effectively and sharing the value with customers. This

often resulted in value propositions that offered both

better differentiation and lower pricing. Although the

result of innovation is often a breakthrough that changes

Charles E. Lucier

[email protected]

is a writer and contributingeditor to strategy +business.He was instrumental in thefounding of this magazine.At the time of this article’spublication, he was a seniorvice president at Booz AllenHamilton (whose commercialbusiness later became Booz &Company), and the managingpartner of its Cleveland office.

Leslie Moeller

[email protected]

is a partner with Booz &Company in Cleveland. Heleads the firm’s NorthAmerican work in the con-sumer, media, and retailindustries. He is the coauthorof The Four Pillars of Profit-

Driven Marketing: How to

Maximize Creativity,

Profitability, and ROI (McGraw-Hill, 2009).

Raymond Held

is the chief financial officerof Kellogg de Mexico. At thetime of this article’s publica-tion, he was a senior associatein the engineering and manu-facturing group at Booz AllenHamilton.

Originally published ThirdQuarter 1997.



the rules of the game, all of the companies we studied

relied on a series of innovations, not a single “big idea.”

The highest-performing companies were dividedinto two types of innovators. Strategic innovations —

dramatic improvements in the entire business system

that deliver value to customers — powered about half of

them. For this group of “strategic innovators,” willing-

ness to share the benefits with customers was an essen-

tial factor — to drive top-line growth, and to stimulate

additional improvements in the business system and

remain ahead of competitors. Innovation in products or

services that create 10X value for customers powered the

other half of the top-performing companies.

• Strategic innovators. Although it is not surprising

that a successful strategic innovator creates extraordinary

value for its shareholders, we were surprised to discover

that nearly half of the top decile of companies for each of

the three decades we studied fall into this category.

Strategic innovation is unusual in any one industry: in

the 75 industries in the United States that we investi-

gated, we found an average of 0.6 successful strategic

innovations per industry per decade. Nonetheless, 5 per-

cent of all large publicly traded companies are strategic

innovators, which is a significant number.Because strategic innovators change the rules of the

game in their industries, most of their stories are well

known. Nevertheless, three findings common to all of

the strategic innovators deserve mention.

First, strategic innovations are not brainstorms or

concepts that emerge fully formed: The initial concept is

different from the typical game-changing innovation.

Strategic innovation requires not only a breakthrough

idea, but also the commitment and the feedback

processes to refine the idea until it is successful. For

example, FedEx Corporation was founded to provide

guaranteed overnight delivery, which was a break-

through idea. However, the initial target market waspurveyors of critical supplies, such as medical supplies

and parts. It was the later discovery that most of the vol-

ume of material sent was paper, and the subsequent

positioning of FedEx to provide the reliable delivery of

important business material, that really drove growth.

Innovations that in retrospect may appear to be a single

idea were in fact the result of a series of linked innova-

tions and adaptations.

Second, strategic innovation is difficult and time-

consuming to put into practice. Home Depot Inc., for

example, was a strategic innovator in its transforming

the category of home improvement retailing. An indi-

cation of the magnitude of the difficulty is the 15 years

required for any of its competitors to create an equally

successful format — even though they could build upon

Home Depot’s experience. A strategic innovator’s com-

petitive advantage is not the breakthrough idea, but

rather the myriad details of the successful business sys-

tem and the ability to adapt rapidly and improve.

Finally, to create superior value for shareholders,

strategic innovators don’t need to start in a large marketsegment. In fact, the companies that created the highest

rate of return for their shareholders over a decade were

somewhat smaller (in revenue) than the average large

publicly traded company at the beginning of the decade

and larger than the average large publicly traded com-

pany at the end of the decade. Strategic innovators are

much more likely to succeed when they initially focus

on a peripheral segment. The innovator can learn how

to make its breakthrough idea really work to deliver 10X

value in the periphery, often without reaction from the

The initial target market was purveyorsof medical supplies and parts.

Then FedEx discovered that most ofthe material sent was paper.



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dominant competitors focused on the core markets.

Nucor Corporation illustrates the pattern. Nucor

began as a manufacturer of steel joists and a regional

manufacturer of reinforcing bars — the lowest-quality

steel, of least interest to the major integrated mills. Over

time, it moved into light structural shapes, medium

structural shapes, and finally, flat rolled steel. By the

mid-1990s, Nucor had become the second-largest steelproducer in North America.

• Product and service innovators. These companies

bring a series of successful “new to the world” products

to market. Their success lies in coupling an effective

innovation process with a superior product concept, and

repeating this success time after time. Just one new

product is no longer enough to power superior share-

holder value; top-decile growth in shareholder value

requires getting new products right consistently.

Although the most successful product innovatorsare effective throughout the innovation stream of activi-

ties, it is excellence in one of four activities that powers

success. These are market understanding (defining cus-

tomer and channel needs and opportunities ahead of

competitors); technology management (ensuring that

the correct high-impact technologies are available when

needed); product planning (integrating market needs

with product architecture to enable competitive specifi-

cation, development, and delivery of products); and

product development (translating a product line or

process specification into an engineered design that can

be competitively delivered to customers).

For instance, Nike Inc.’s success comes from an

understanding of its customers’ total experience with its

product, including intensive managerial experience with

the products and a special panel of athletes to provide

feedback on designs and trends. Leading-edge products

combine with powerful advertising campaigns using role

models to enhance the customer’s athletic shoe experi-

ence. Intel Corporation, on the other hand, creates value

from a focus on maintaining market leadership by usingtechnology to constantly improve physical product per-

formance. Before a new product is launched, a design

team is working on the next-generation technology that

will make the new product obsolete — bringing a con-

tinuous stream of higher-powered chips to the market.

In capital-intensive industries, driving value

through continual product innovation often requires

“new to the world” innovations that “bet the company.”

For the Boeing Company, the development of each new

aircraft is a major decision, one that could permanently

damage the company if it fails. For instance, from the

late 1980s to the early ’90s Boeing spent US$4.5 billion

to develop the 777 aircraft, at a time when the compa-ny’s equity was $8 billion. The success of this aircraft was

instrumental in helping the company turn its sales num-

bers around during the industry rebound of the late

1990s. Intel has to make similarly risky bets on each

next wave of microprocessor technology. Although mak-

ing these bets can be frightening for all involved, they

must enable the stream of continual product innovation

required to deliver 10X value. In addition, big bets cre-

ate a barrier to entry by less-experienced companies, and

this helps to maintain the product innovator’s superior

value over its competitors.

The Growth Superhighway

To earn superior returns for shareholders, a company

must effectively exploit its 10X value to sustain annual

top-line growth of 15 to 25 percent without mistakes

that negatively impact earnings. Whatever the source of

their 10X value, the companies that created the greatest

long-term value for their shareholders all created a

growth superhighway — that is, the capability to repli-

cate revenue growth along one targeted path. All companies seek growth through some mix of

market share gains within current segments, new seg-

ments, new geographies, and acquisitions. Most compa-

nies try to generate growth through most of these paths.

The companies that create the most long-term value for

their shareholders are unusual in that they focus on one

primary path. For example, Walmart and Home Depot

have grown primarily through geographic expansion,

the Shaw Group and WMX Technologies (formerly

Waste Management Inc.) expanded by acquisition;



Nucor and Rubbermaid pursued adjacent segments; and

Intel has primarily focused on rapid rollout within its

current segments.Global expansion is an increasingly important

growth superhighway. Coke’s ability to replicate its 10X

value proposition overseas — especially in developing

and supporting the local bottlers who sell and distribute

the product — has been the principal driver of its

growth. Similarly, Carrefour SA, the leading French

hypermarket retailer, has had tremendous success in

expanding its format in Latin America. In Carrefour’s

case, international expansion into less-developed mar-

kets has been especially effective because the hypermar-

ket value proposition is more than a 10X improvement

over the small local supermarkets and general merchan-

dise retailers.

The best-performing companies invest in routiniz-

ing expansion along the targeted growth path. For exam-

ple, Walmart has a standard, very efficient process to

build a new store, Home Depot excels in quickly pene-

trating a new metropolitan area with a critical mass of

stores, and Shaw and WMX learned to install their 10X

value-creating system quickly in the companies they

acquired. Once these companies stray from their growthsuperhighway, their performance can become highly

variable. For example, Home Depot’s entry into Canada

by acquisition and its formats targeted at other customer

segments (for example, Expo) have not really panned out.

It appears that more than one growth superhighway

may be viable in an industry. For example, between

1972 and 1985, WMX and Browning-Ferris Industries

each created 10X value for customers and top-decile

returns for their shareholders, even though WMX grew

primarily by acquisition and Browning-Ferris mainly by

geographic expansion. Hence, the imperative appears to

be less to select the correct growth path than to focus on

one path and invest in building the capability to make ita superhighway.

Implications for Management

Our findings demonstrate that creation of 10X value for

customers along a growth superhighway leads to superi-

or long-term value for shareholders. The four impera-

tives top management must heed to develop and exploit

a 10X value proposition are: challenge; focus; differenti-

ate your management approach; and lead, don’t follow.

• Challenge. Companies that create superior long-

term returns for their shareholders have financial per-

formance that is significantly — not incrementally —

better than average. Increasing the rate of growth in

earnings and revenue of an average company by two or

three points will not result in 80th or 90th percentile

returns to shareholders.

By setting the strategic long-term challenge of

achieving dramatically higher financial goals, a CEO can

help stimulate a fundamental rethinking of the business

that might yield 10X value for customers.

• Focus. The best-performing companies that wehave studied all prospered by creating 10X value for cus-

tomers in one business and by exploiting their advantage

down one growth superhighway. Focus enables a com-

pany to continue to innovate, to gain leverage from scale

as it grows, and to sustain its advantage over competi-

tors. Companies that lose their focus on one growth

superhighway often falter in creating superior long-term

returns to shareholders.

The multibusiness corporations like General

Electric Company and PepsiCo that have created 10X



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value have done so in only one business unit at a time

(specifically, GE Capital and Frito-Lay). In part, this fact

may merely reflect the inherent difficulty of creating10X value. However, we believe that it will be very

difficult for any corporation to create and exploit 10X

value in two distinct business units simultaneously.

10X value creation is simply too demanding in terms of

management talent, investment to finance rapid growth,

and the attention of the CEO.

One principal reason that large multibusiness com-

panies have been less likely to create 10X value than

single-business companies may have been an unwilling-

ness to focus on a single business unit as the driver of

superior long-term shareholder value creation.

The good news is that even in a corporation as large

and diverse as GE, one division that creates 10X value

and exploits the advantage along a growth superhighway

can yield excellent long-term results to shareholders. For

example, GE is an extremely well-managed company

with returns to shareholders in the 75th percentile

between 1985 and 1994. However, without GE

Capital’s 23 percent annual earnings growth, the corpo-

ration’s earnings would have grown at only 6 percent

instead of 9 percent, and returns to shareholders proba-bly would have been only average.

• Differentiate your management approach. Cre-

ation of 10X value for customers requires a distinctive

management model. This involves the rapid incorpora-

tion of feedback from customers into the evolving value

proposition; investment in rapid growth, often before a

compelling case can be made that the investment will pay

off; an entrepreneurial culture with rapid decision mak-

ing; and compensation heavily incentivized toward bot-

tom-line growth or superior returns to shareholders.

Although single-business companies can embrace

this model, multidivision corporations face a formidable

challenge. The usual multidivision corporate planningand budgeting processes, culture, and compensation sys-

tems are inconsistent with the 10X value creation

model. For example, traditional strategic planning usu-

ally focuses on what is and what has been, whereas 10X

value creation involves “new to the world” innovation.

An analytical demonstration that something that has

never been done will prove to be a superior investment

is very difficult.

The solution for a large multidivision company that

wants to create 10X value in a business is to differentiate

its management systems. That is, it can use different

planning, budgeting, and compensation systems in the

division targeting 10X value and allow that business’s

culture to diverge somewhat. More traditional planning

and budgeting systems are better adapted to businesses

that are not trying to create 10X value. These systems

can stimulate productivity improvements, target oppor-

tunities for profitability increases and market share

gains, quickly match successful initiatives by competi-

tors, and ensure that business units create and execute

near-term plans consistent with a long-term strategicdirection.

• Lead, don’t follow. 10X value creation requires

senior management leadership. There are two key roles

to be played: a senior champion who makes the refine-

ment and success of the 10X value innovation his or her

sole objective, and a CEO who decides which bets to

make and who creates the environment for success.

Creating 10X value starts with the conviction that a

market is ready for value innovation, like that shown by

Sam Walton in leaving Ben Franklin stores when that

It will be very difficult forany corporation to create and exploit

10X value in two distinctbusiness units simultaneously.



improve products significantly (its R&D spending is

about 4 percent of sales whereas Unilever’s is about 2percent) and has developed the ability to globalize the

products rapidly. Although P&G cannot claim every

breakthrough — indeed, it missed such product ideas

as pull-up diapers and peroxide and baking soda in

toothpaste — it creates a sufficient stream of global win-

ners, such as two-in-one shampoo and compact deter-

gents, to fuel returns to shareholders, as of 1997, in the

81st percentile.

CEOs of companies with successful 10X value cre-

ation strategies consider them to be low risk: As long asthey can sustain the 10X advantage, there is no need to

worry about the actions of competitors or the cyclicality

of the underlying market.

Superior long-term growth in shareholder value is

feasible only with creation of 10X value for customers

through strategic or product innovation, sharing part

of the value with customers and capturing part of the

value in attractive profitability. Ultimately, 10X value

creation is strategically liberating: Virtually all compa-

nies, even large corporations in mature industries, have

the potential of creating superior long-term returns for

their shareholders. +

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Resources

Paul Leinwand and Cesare Mainardi, “The Coherence Premium,”

Harvard Business Review, June 2010, Reprint R1006F,

www.booz.com/global/home/what_we_think/capabilities_driven_

strategy/hbr_article: Takes the concept of focus further by showing how

aligning strategy, capabilities, and products and services leads to a long-term “right to win” in the market.

Charles E. Lucier and Amy Asin, “Toward a New Theory of Growth,”

s+b, Winter 1996, www.strategy-business.com/article/8660: Paved the way

for this article by asserting that increasing revenue is not enough; 10X

shareholder-value growth requires strategic innovation.

Kenichi Ohmae, “The Godzilla of the New Economy,” s+b, First Quarter

2000, www.strategy-business.com/article/10401: A prescient look at the

rapidly growing 10X-value companies of the turn of the century: Amazon,

Nokia, eBay, Docomo, Cisco Systems, and more.


www.strategy-business.com/strategy_and_leadership.

company rejected the idea of a “Walmart” or by Gary

Wendt and Larry Bossidy in building GE Capital acqui-sition by acquisition during the 1990s. We are not say-

ing these leaders had a vision that popped fully formed

into their minds, but they did have the commitment to

refine the idea until it succeeded, the willingness to

make mid-course corrections, and the ruthless execution

to make the financials attractive while evolving along a

growth superhighway. Although the CEO usually plays

the champion’s role in small entrepreneurial companies,

in large companies the role does not have to be played

by the CEO (for example, at GE Capital it was playedby the head of the business).

The CEO plays three critical roles in the creation of

superior value for shareholders. He or she sets the objec-

tive of truly superior (top 10th or 20th percentile) long-

term returns to shareholders. He or she evaluates the

opportunities for 10X value creation across the business

units, betting on no more than one or two prospective

growth engines and adjusting the bets as new informa-

tion comes to light. Finally, the CEO ensures that man-

agement processes, incentives, and leadership of the tar-

geted bets support 10X value creation.

In our discussions with CEOs of large companies,

their major concern is risk: How likely is an innovative

growth strategy to succeed? What is the downside if it

fails? Our response is that if the CEO’s objective is top

10th or 20th percentile long-term returns to sharehold-

ers, then there is no real alternative to a 10X value cre-

ation strategy.

Because 10X value creation strategies typically

involve pilot programs to refine the concept, significant

financial commitments may not be required initially.The downside of the pursuit of an innovative strategy

that is ultimately unsuccessful is less the financial loss

than the loss of time and management attention that

would have been used more productively elsewhere.

Partially successful 10X value creation strategies can still

produce excellent returns for shareholders, albeit returns

sustained for a shorter period of time (because competi-

tors can match the innovation quickly) or fall “only” in

the 70th or 80th percentile. For example, Procter &

Gamble Company spends heavily on technology to



I l l u s t r a t i o n

b y

J o h n

H e r s e y

BY DON TAPSCOTT

Rethinking

(or Why Michael Porter Is Wrong about the Internet)

in a Netw



For decades, the starting point for strategic think-

ing has been the stand-alone, vertically integrated cor-

poration. These powerful companies do everything from

soup to nuts and dominate the competitive landscape. We

think of them as intrinsic to the economy, and they pro-

vide the context for theories about competitive strategy.

Companies prospered with this model of produc-

tion because it was cheaper and simpler for them to per-

form the maximum number of functions in-house,

rather than incurring the high cost, hassle, and risk of part-

nering with outsiders to execute vital business activities.

This is no longer true.

The CEO of Boeing Company says his company is

no longer an aircraft manufacturer; it has become a sys-

tems integrator. Mercedes-Benz doesn’t build its own

E-Class cars; the Magna Corporation does the work,

including final assembly. IBM has become a computer

company that doesn’t really make its computers; its part-

Strategy

The Harvard strategy guru errswhen he says partnerships erode competitive

advantage. Instead, they are now centralto business success.

orked World



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ner network does.

Indeed, we are seeing spectacular growth in contract

manufacturing — with companies such as Celestica,Flextronics, and Solectron partnering with computer

and telecommunications vendors to provide core elec-

tronics manufacturing services. Virtually overnight, the

top five contract manufacturing firms have achieved

aggregate revenues of more than US$50 billion, averag-

ing return on invested capital of more than 25 percent.

All of this is possible because of networking —

specifically, the Internet. This deep, rich, publicly avail-

able communications technology is enabling a new busi-

ness architecture that challenges the industrial-age cor-

porate structure as the basis for competitive strategy. My

colleagues at Digital 4Sight and I have studied hundreds

of different examples of this architecture, what we call a

business web, or b-web. We define it as any system com-

posed of suppliers, distributors, service providers, infra-

structure providers, and customers that uses the Internet

for business communications and transactions. B-webs

across industries, in which each business focuses on its

core competence, are proving to be more supple, inno-

vative, cost-efficient, and profitable than traditional ver-

tically integrated competitors.Established companies, not dot-coms, are the main

beneficiaries of b-web thinking. Successful businesses

such as Citibank, Herman Miller, Dow Chemical,

American Airlines, Nortel Networks, and Schwab are

now transforming themselves by partnering in areas that

were previously unthinkable. The performance advan-

tages of a b-web also explain why new Internet-based

companies such as eBay, Travelocity, E-Trade, and

Amazon are growing dramatically and competing well

despite volatility in their stock prices. And b-webs ex-

Don Tapscott

[email protected]

is president of the NewParadigm LearningCorporation and cofounder ofDigital 4Sight, a company thatdesigns and implements newbusiness models for corpora-tions. He is the coauthor, withDavid Ticoll and Alex Lowy, ofDigital Capital: Harnessing the

Power of Business Webs

(Harvard Business SchoolPress, 2000).

Originally published ThirdQuarter 2001.

plain why an upstart e-business entity like Napster is

wreaking havoc in the music industry, and why open

source software such as Linux poses a huge threat toMicrosoft.

Profound changes to the deep structures of the cor-

poration are under way. Yet most of this underlying

restructuring has been either unnoticed or underappre-

ciated by the financial media and business schools. They

remain shell-shocked at the rise and collapse of the

Nasdaq. And since “Nasdaq” and “New Economy” are

so frequently (but incorrectly) used interchangeably,

the Nasdaq collapse is often cited as proof that the New

Economy is a bogus notion. (See “Six Reasons There Is

a New Economy,” page 28.) As for eBay, Amazon,

Linux, Napster, and others, they are dismissed as

Internet aberrations.

Michael Porter’s obituary for the New Economy,

“Strategy and the Internet,” published in the March

2001 Harvard Business Review, is typical of this think-

ing. In it, Porter exhorts business leaders to “return to

fundamentals” and abandon thoughts of “new business

models” or “e-business strategies” that he says encourage

managers “to view their Internet operations in isolation

from the rest of the business.” When a politician makes a motherhood statement

that receives wide support, pollsters say it “resonates

with” the voters (i.e., it’s considered credible and is con-

sistent with citizens’ values). Such is the appeal of

Porter’s article. Profitability still counts. True economic

value, measured by sustained profits, is the arbiter of

business success — not eyeballs, stickiness, hits, or even

market share. To compete, companies must operate at a

lower cost and/or command a premium price, either

through operational effectiveness or by creating unique



value for customers. Being a first mover does not guaran-

tee competitive advantage over the long haul.

Unfortunately, he uses these truths to prop up a

false thesis. Because corporate objectives remain

unchanged by the Net, Porter argues, the best methods

of achieving these goals, including operating within a

vertically integrated structure, must be unchanged, too.

Porter sees the world as two warring camps: theInternet zealots and the defenders of tried-and-true

business thinking, such as himself. And it’s pretty clear

who’s winning. This gives him the basis on which to

assert that “the experiences companies have had with

the Internet thus far must be largely discounted and

…many of the lessons learned must be forgotten.” If

you were an industry leader prior to the Internet’s burst-

ing on the scene, continue your time-tested business

processes. Use the Net as a “complement to traditional

ways of competing,” he says, rather than “cannibalizing”a healthy company.

Regrettably, a much-needed return to fundamentals

has become a new fundamentalism that argues managers

should turn back the clock for business wisdom. Al-

though there is some merit in Porter’s view that “in our

quest to see how the Internet is different, we have failed

to see how the Internet is the same,” it is utter

folly to believe the Internet brings nothing fundamen-

tally new.

What Is the Internet?

Much of Porter’s reasoning stems from his misunder-

standing of the Internet itself. He concedes that the

Internet is important — it’s just not that important.

“But for all its power, the Internet does not represent

a break from the past; rather, it is the latest stage

in the ongoing evolution of information technology,”

he writes. Rather than viewing the Net as the emerging

infrastructure for economic activity, he puts the Internet

architecture on the same level as “complementary tech-

nological advances such as scanning, object-orientedprogramming, relational databases, and wireless com-

munications.”

It is wrong to trivialize the Net in this way. The Net

is much more than just another technology develop-

ment; the Net represents something qualitatively new

— an unprecedented, powerful, universal communica-

tions medium. Far surpassing radio and television, this

medium is digital, infinitely richer, and interactive. The

Net is becoming ubiquitous; it will soon connect every

business and business function and a majority of

humans on the planet. All other communications tech-

nologies, such as telephone, radio, television, and wire-

less, are being sucked into the Net’s maw.

Porter also makes an all-too-common mistake in

assuming that the Internet we see today — a network

that connects desktop PCs — is the same Internet we

will see tomorrow. This is nonsense. The Internet of

tomorrow will be as dramatic a change from the Internetof today as today’s Internet is from the unconnected, pro-

prietary computing networks of yesterday.

The Net continues to soar in reach, power, and

functionality. It is not only the means to link computers,

but the mechanism by which individuals and organiza-

tions exchange money, conduct transactions, communi-

cate facts, express insight and opinion, and collaborate

to develop new knowledge.

Mobile computing devices, broadband access, wire-

less networks, and computing power embedded ineverything from refrigerators to automobiles are con-

verging into a global network that will enable people to

use the Net just about anywhere and anytime. No facet

of human activity is untouched. The Net is a force of

social change penetrating homes, schools, offices, facto-

ries, hospitals, and governments. When an institution

such as the Massachusetts Institute of Technology says it

will post its entire curriculum on the Net — including

such items as lecture notes and course reading lists — it

is attempting to shape the nature of pedagogy and learn-

ing everywhere.

The 20th-century corporation was based on an

infrastructure that included the electric power grid,

roads, railroad tracks, and primitive analog networks

like the telephone. Rather than viewing the Net as com-

parable to “scanning,” Porter should see it as the new

infrastructure of the 21st century. Many strategists look

beyond individual corporations to think about the

structure of industries. However, the Internet precipi-

tates one of those rare occasions in economic history

when we must think even more broadly in order tounderstand how the entire infrastructure for wealth cre-

ation is changing.

What Is a New Business Model?

Porter believes there is no such thing as a “business

model,” let alone a new one, and I don’t fault him for

questioning the validity of the term. Analysts have used

it loosely, in reference to everything from selling rocks

online to a Vickery auction for financial services.

Often the term business model is used more or less



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synonymously with business strategy. For example, Adrian

Slywotzky describes it as “the totality of how a company

selects its customers, defines and differentiates its offerings

(or response), defines the tasks it will perform itself and

those it will outsource, configures its resources, goes to

market, creates utility for customers, and captures profits.

It is the entire system for delivering utility to customersand earning a profit from that activity.”

Our view is narrower than this. Quite simply, a

business model refers to the core architecture of a firm,

specifically how it deploys all relevant resources (not just

those within its corporate boundaries) to create differen-

tiated value for customers. Historically, strategists

weren’t particularly concerned with business models,

because each industry had a standard model, and strate-

gists assumed the model in that industry. Although the

auto manufacturer, the integrated steel company, the

insurance company, the retailer, the oil company, and

the bank were different, they shared the characteristic of

vertical integration.

Traditional business theorists like Michael Porter

favor vertical integration and argue against partnering.

In his seminal book, Competitive Strategy, he devotes an

entire chapter to a vigorous defense of the vertically inte-grated firm. Today he writes how the “myth” that “part-

nering is a win–win means to improve industry eco-

nomics” has “generated unfounded enthusiasm for the

Internet.” He cites a litany of reasons he believes it’s bet-

ter not to partner.

However, it is indisputable that the Net dramatical-

ly reduces search, coordination, contracting, and other

transaction costs between firms. Because of this, myriad

new business models have emerged that are different

from the industrial-age template, and there are hundreds

Six Reasons ThereIs a New Economy

here is nothing fundamentally

new about the way capitalism

works. In capitalist countries, there is

still private, not state, ownership of

wealth, and the economy is based on a

market. The traditional business cycle

(overproduction, inventory gluts, tight

employment markets, inflation) is

alive and well. Profits are still the ulti-

mate measure of success. Yet, there

are characteristics of 21st-centurycapitalism that make it entirely differ-

ent from its predecessors.

1. New infrastructure for wealth

creation. Networks, specifically the

Internet, are becoming the basis

of economic activity and progress.

This is not unlike how railroads, roads,

the power grid, and the telephone

supported the vertically integrated

corporation.

2. New business models. Instead of

thinking of New Economy companies

as Internet companies or dot-coms,

think about them as companies that

use the Internet infrastructure to cre-

ate effective b-web–based business

models. In this sense, the New

Economy can include steel compa-

nies, banks, gas distribution compa-

nies, and furniture manufacturers,

just as the old economy can include

high-technology firms.

3. New sources of value. In today’s

economy, value is created by brain,

not brawn, and most labor is knowl-

edge work. Knowledge infuses itself

throughout products and services.

Michael Porter is right to say that

intellectual capital has no intrinsicvalue. However, recent experiments in

measuring knowledge-based assets

suggest wealth contained in such

assets can outstrip the wealth con-

tained in physical assets and even

bank accounts.

4. New ownership of wealth. The

silk-hatted tycoons owned the most

wealth in industrial capitalism. Today

60 percent of Americans own stock,

and the biggest shareholders are

labor pension funds. Most economic

growth comes from small companies;

entrepreneurialism is everywhere.

5. New education models and insti-

tutions. As lifelong learning becomes

the norm, the services of private com-

panies, not public institutions, are

proliferating to meet growing de-

mand. The model of pedagogy is also

changing with the growth of interac-

tive, self-paced, student-focused

learning. Colleges are becoming

nodes on communications networks,

not just places where people go to

study.

6. New governance. Industrial-age

bureaucracies rose simultaneously

with the vertically integrated corpora-tion and mimicked its structure. New

Net-driven governance structures,

such as the Knowledge Network of

Los Angeles, enable Internet-based

cooperation between public and pri-

vate organizations to deliver services

for citizens. Expect to see similar

changes in the democratic procedure

(e.g., the voting processes) and the

relationship between citizens and the

state.

—D.T.

T



of old and new companies that are winning by focusing

on their core capabilities and letting partners do the rest.

For example, Siebel Systems Inc., one of the fastest-

growing software companies in America, has established

a vast and unique network of customer, supplier, and

employee relationships to deliver its products and ser-

vices. Tom Siebel claims his company’s b-web is the

most important element in its success: “We only have8,000 people on our payroll, but more than 30,000 peo-

ple work for us,” he says. The relatively small core com-

pany creates software products and orchestrates an

extensive b-web composed of consultants, technology

providers, system implementers, suppliers, and vendors

that take its products to the global marketplace. The

result: Siebel Systems’ revenues soared more than 1,400

percent in just three years, from $118 million in 1997 to

$1.8 billion in 2000.

Yesterday’s strategy orthodoxy blinds managers tothese unprecedented corporate opportunities. The busi-

ness strategist needs new tools, including strategic

concepts and analytical methods, to comprehend and

exploit business architectures, like b-webs, that are sud-

denly possible because of the Net. I call this “business

model innovation.”

When the superiority of the vertically integrated

industrial corporation was taken for granted, it was

assumed that most resources would be internal to the

company. A business’s human-resources strategy dealt

with people on the payroll. Accounting handled cus-

tomer payments. Simple.

But in the Internet era, we know firms can profit

enormously from resources that don’t belong to them.

This is much more than what we call outsourcing today.

In the future, strategists will no longer look at the inte-

grated corporation as the starting point for creating

value, assigning functions, and deciding what to manage

inside or outside a firm’s boundaries. Rather, strategists

will start with a customer value proposition and a blank

slate for the production and delivery system. There willbe nothing to “outsource” because, from the point of

view of strategy, there’s nothing “inside” to begin with.

Instead, managers, using new tools of strategic analysis,

can identify discrete activities that create value and par-

cel them out to the appropriate b-web partners. A lead

firm in a b-web (e.g., Siebel Systems) choreographs the

process, acting as a “context provider.”

Given the Internet’s power, a reasonable person

might ask: Why can’t corporate managers simply deploy

intranets to get at the resources they need and reap the

rewards? Economics 101 tells us why: Intra-corporate

solutions fail to capture the tonic of the marketplace.

Most of what companies do is not based on their

core competencies. Instead, firms attempt to make do

with some combination of in-house design, manufac-

turing, marketing, and other capabilities that are often

not best-of-breed. Now with the Net, business functions

and large projects can be reduced to smaller componentsand farmed out (often simultaneously) to more special-

ized companies around the world with virtually no

transaction costs. This captures the enormous benefits

brought on by the competitive environment. Suppliers

strive to reduce costs and increase quality and innova-

tion. They know there are other specialized workers and

companies around the world keen to replace them.

In this environment, the management of partner-

ing, corporate boundaries, distribution channels, indus-

try restructuring, and strategic repositioning is suddenly much more complex. And there are new issues, too. It

used to be that sellers simply established prices. No

longer. Transparency across the value chain, customer

power, and global real-time information make variable

pricing mechanisms far more important.

The Net and Competitive Advantage

Porter avers that “as all companies come to embrace

Internet technology…the Internet itself will be neutral-

ized as a source of [competitive] advantage.” The more

robust competitive advantages, he says, will arise instead

from traditional strengths such as unique products,

strong personal service, relationships, and sustainable

operational efficiencies.

This astonishing statement has two problems. First,

effectively implementing the Internet is not a binary

matter like turning a light switch on and off, buying a

T1 line, or installing an off-the-shelf application. As we

saw during the dot-com craze, there are 1,001 ways to

employ the Net, many of which make no sense whatso-

ever. Moreover, there is a continuum of business trans-formation that occurs, from setting up a website, to

implementing radical new business models, to trans-

forming an entire industry. The Net enables many new

applications, technologies, and business innovations.

Firms that understand strategy in today’s more complex

business environment will plumb deeper into the grow-

ing pool of possibilities.

Second, Porter doesn’t see how the Net is precipi-

tating profound changes to the structures and cultures of

successful businesses. In fact, these changes enable com-



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panies to compete better — precisely through deploying

resources that allow them to create better and unique

products, stronger personal service, relationships, andsustainable operational efficiencies. These three core

areas are ripe for business model innovation:

• Unique products. IBM has shifted its mentality

from vertically integrated fortress to b-web proponent

and player. In its earlier incarnation, it reaped huge prof-

its by locking customers on a treadmill of high-margin

proprietary hardware and software. Today IBM trum-

pets Linux. This year it will invest more than $1 billion

in the open source software, collaborating with its part-

ners on the Net to develop, enhance, and market Linux-

based applications and services. A typical initiative has

IBM joining 18 other companies, such as Hewlett-

Packard, Dell, and Intel, to underwrite a $24 million

Open Source Development Lab solely to support proj-

ects already under way in the open source community.

In 1997, IBM decided its customer relationship

management (CRM) software needed to be the best in

the world. It mothballed a massive internal development

effort and a $40 million revenue stream to partner with

Siebel Systems. Today IBM’s CRM business is over $2

billion and one of its most profitable.Critics of partnering, such as Michael Porter, con-

demn IBM’s decision to build a PC industry based on

the Microsoft standard. Allegedly, this depressed indus-

try profitability and hurt IBM. Not true. PCs became a

commodity, leading to a vast explosion in the use of

information technology and, ultimately, networking,

which is the foundation on which the 21st-century IBM

is based. Today [in 2001], the revenue and earnings

from IBM’s software and services dwarf all hardware

sales, not just the sales of PCs.

Compare this to Apple Computer Inc., which clung

to the vertically integrated approach of designing and

building everything from chips to applications. If it had

licensed the Macintosh operating system to partners,

Apple Computer would probably be more important

today than Microsoft.

Remember, in the early 1990s, that IBM’s rivals

included half a dozen vertically integrated minicomput-er companies such as the Digital Equipment

Corporation, Prime Computer, and Data General.

These companies failed to embrace partnering to deliv-

er the best products to their customers and exploit

industry standards. All but one, Hewlett-Packard, which

adopted the partner model, failed.

The power of business-model innovation is just as

evident in service companies. For example, eBay Inc.

doesn’t just compete well against flea markets, auction

houses, and classified ads. It has changed the rules of competition by creating a new type of service company

that has become a leader in applying auction-based

dynamic pricing. The most important contributors to

eBay are its customers, who create the primary value of

the business web; eBay is simply the provider of the

business context. This b-web also includes companies

such as Wells Fargo, Visa, SquareTrade.com, and others

providing ancillary services that make buyers and sellers

more confident and competent.

• Operational efficiencies. Around the world, the

Internet is allowing companies to wring out waste from

their operations, differentiate themselves, and reach new

suppliers and customers. Jack Welch calls e-business ini-

tiatives “a game changer for GE” that are expanding “far

beyond our original vision.” His company’s first step was

to imitate Amazon and sell goods and services online.

This initiative was an immediate success; the $8 billion

in goods and services GE sold online in 2000 is expect-

ed to soar to $20 billion for 2001.

In procurement, reverse auctions alone are antici-

pated to save GE $600 million this year. The company runs global auctions daily — $6 billion worth last year,

growing to an estimated $12 billion this year. The

rewards are so great that rather than cutting back on IT

spending because of the weak economy, the company

will increase spending this year by 10 to 15 percent.

• Customer service and relationships. When it

comes to customers, many pundits view the Net as sim-

ply another channel. Porter writes, “On the demand

side, most buyers will value a combination of on-line

services, personal services, and physical locations over



The years from 1997 to 2000 were the dog days of

strategy. A get-rich-quick mentality distorted the asser-

tion that “the Internet changes everything” (which is

true) into the hope that “all things done on the Internet

will prove lucrative” (which is rubbish). For a market

economy, it was a shameful period. We saw egregious

excesses and spectacular market capitalizations based on

absurd or nonexistent business models. Momentuminvesting set in and massive damage was inevitable.

Thankfully, those times are past, and sanity is returning.

But what’s important to understand is that the headline-

grabbing dot-com machinations, be they startups or

spin-offs, were largely a distraction and represented only

a sliver of the businesses trying to harness the power of

the Internet.

Today, in the broad space between yesterday’s irra-

tional exuberance and today’s equally irrational ortho-

doxy, there is a new frontier of business strategy. Thereare great new possibilities for creating economic value,

customer value, shareholder value, and community

value. Business strategy is an idea whose time has come

once again. But new rules for competing require some

fresh thinking. Business fundamentals, indeed.

Fundamentalism, no. +

Reprint No. 01304

stand-alone Web distribution. They will want a choice

of channels.” But the Net is more than a channel. It

changes all channels. Effective competitors equip sales

agents with Net-based information and tools in the cus-

tomer’s living room. Call-center personnel with superior

Net-based customer relationship management systems

containing complete customer records deliver better

customer service. And bricks-and-mortar stores thatexploit emerging location-based services will have more

customers who find them through the Net.

No to Fundamentalism

Regrettably, many, including Porter, lament the

increased knowledge and power that customers are

acquiring in this new world. In fact, much of the com-

petition theorists’ language has disdain for customers.

It’s best when customers are “locked in.” When they are

ignorant or have no choice, profitability in an industry can be maintained and advantages can be achieved.

Because the Net can undermine this, Porter concludes

this powerful communications technology “is not neces-

sarily a blessing.” Indeed, he writes “it tends to alter

industry structures in ways that dampen overall prof-

itability, and it has a leveling effect on business practices,

reducing the ability of any company to establish an

operational advantage that can be sustained.”

Of course the Net creates efficiencies through the

economy, intensifying rivalry between competitors and

lowering barriers to market entry. It can arm consumers

and suppliers with greater power because of their

increased access to information, enhanced ability to

communicate with each other, and greater freedom of

choice. It increases the metabolism of the economy and

reduces friction — as did, say, the telephone.

But would it have been sensible to judge the tele-

phone as “not necessarily a blessing?” Overall it

advanced the economy and benefited society enormous-

ly. It was a threat only to the firms that didn’t want to

change. This becomes even more important when youconsider that the telephone’s impact pales compared to

the Net’s.

It is good that customers will be smarter, more

active, and more powerful. Because of this, more real

value will come to the fore, and fewer businesses will try

to make garbage smell like roses. As businesses increas-

ingly deliver what their customers value, it may turn

out the capital businesses earn from customer relation-

ships will dwarf the value of physical assets or money in

the bank.

Resources

Lawrence M. Fisher, “From Vertical to Virtual: How Nortel’s Supplier

Alliances Extend the Enterprise,” s+b , First Quarter 2001,

www.strategy-business.com/casestudy/01113/.

Keith Oliver, Anne Chung, and Nick Samanich, “Beyond Utopia: The

Realist’s Guide to Internet-Enabled Supply Chain Management,”

s+b , Second Quarter 2001, www.strategy-business.com/special/01209/.

Michael E. Porter, “Strategy and the Internet,” Harvard Business Review ,

March 2001, www.hbsp.harvard.edu/hbr.

Don Tapscott, David Ticoll, and Alex Lowy, Digital Capital: Harnessing the

Power of Business Webs (Harvard Business School Press, 2000).

David Ticoll, “Strategy and the Internet,” Letters to the Editor, Harvard

Business Review, June 2001.





BY C.K. PRAHALAD AND STUART L. HART

I l l u s t r a t i o n b y M a r c o V e n t u r a

Low-income markets present a prodigiousopportunity for the world’s wealthiest

companies — to seek their fortunes and

bring prosperity to the aspiring poor.

With the end of the Cold War, the former Soviet

Union and its allies, as well as China, India, and Latin

America, opened their closed markets to foreign invest-

ment in a cascading fashion. Although this significant

economic and social transformation has offered vast new

growth opportunities for multinational corporations(MNCs), its promise has yet to be realized.

First, the prospect of millions of “middle-class” con-

sumers in developing countries, clamoring for products

from MNCs, was wildly oversold. To make matters

worse, the Asian and Latin American financial crises

have greatly diminished the attractiveness of emerging

markets. As a consequence, many MNCs worldwide

slowed investments and began to rethink risk–reward

structures for these markets. This retreat could become

even more pronounced in the wake of the terrorist

attacks in the United States last September.

The lackluster nature of most MNCs’ emerging-

market strategies over the past decade does not change

the magnitude of the opportunity, which is in reality

much larger than previously thought. The real source of

market promise is not the wealthy few in the developing world, or even the emerging middle-income consumers:

It is the billions of aspiring poor who are joining the

market economy for the first time.

This is a time for MNCs to look at globalization

strategies through a new lens of inclusive capitalism. For

companies with the resources and persistence to com-

pete at the bottom of the world economic pyramid, the

prospective rewards include growth, profits, and incal-

culable contributions to humankind. Countries that still

don’t have the modern infrastructure or products to

The Fortune

Pyramid

Bottomat the

of the





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meet basic human needs are an ideal testing ground for

developing environmentally sustainable technologies

and products for the entire world.Furthermore, MNC investment at “the bottom of

the pyramid” means lifting billions of people out of

poverty and desperation, averting the social decay, polit-

ical chaos, terrorism, and environmental meltdown that

is certain to continue if the gap between rich and poor

countries continues to widen.

Doing business with the world’s 4 billion poorest

people — two-thirds of the world’s population — will

require radical innovations in technology and business

models. It will require MNCs to reevaluate price–

performance relationships for products and services. It

will demand a new level of capital efficiency and new

ways of measuring financial success. Companies will be

forced to transform their understanding of scale, from a

“bigger is better” ideal to an ideal of highly distributed

small-scale operations married to world-scale capabilities.

In short, the poorest populations raise a prodigious

new managerial challenge for the world’s wealthiest

companies: selling to the poor and helping them

improve their lives by producing and distributing prod-

ucts and services in culturally sensitive, environmentally sustainable, and economically profitable ways.

Four Consumer Tiers

At the very top of the world economic pyramid are 75

to 100 million affluent Tier 1 consumers from around

the world. (See Exhibit 1.) This is a cosmopolitan group

composed of middle- and upper-income people in

developed countries and the few rich elites from the

developing world. In the middle of the pyramid, in Tiers

2 and 3, are poor customers in developed nations and

the rising middle classes in developing countries, the tar-

gets of MNCs’ past emerging-market strategies.

Now consider the 4 billion people in Tier 4, at thebottom of the pyramid. Their annual per capita income

— based on purchasing power parity in U.S. dollars —

is less than $1,500, the minimum considered necessary

to sustain a decent life. For well over a billion people —

roughly one-sixth of humanity — per capita income is

less than $1 per day.

Even more significant, the income gap between rich

and poor is growing. According to the United Nations,

the richest 20 percent in the world accounted for about

70 percent of total income in 1960. In 2000, that figure

reached 85 percent. Over the same period, the fraction

of income accruing to the poorest 20 percent in the

world fell from 2.3 percent to 1.1 percent.

This extreme inequity of wealth distribution re-

inforces the view that the poor cannot participate in the

global market economy, even though they constitute

the majority of the population. In fact, given its vast size,

Tier 4 represents a multitrillion-dollar market. Accord-

ing to World Bank projections, the population at the

bottom of the pyramid could swell to more than 6 bil-

lion people over the next 40 years, because the bulk of the world’s population growth occurs there.

The perception that the bottom of the pyramid is

not a viable market also fails to take into account the

growing importance of the informal economy among

the poorest of the poor, which by some estimates

accounts for 40 to 60 percent of all economic activity in

developing countries. Most Tier 4 people live in rural

villages, or urban slums and shantytowns, and they usu-

ally do not hold legal title or deed to their assets (e.g.,

dwellings, farms, businesses). They have little or no for-

C.K. Prahalad

passed away on April 16, 2010.He was the Paul and RuthMcCracken DistinguishedUniversity Professor ofStrategy at the University ofMichigan’s Stephen M. RossSchool of Business andcoauthor of several significantbooks, including The New Age

of Innovation (McGraw-Hill,2008) and The Fortune at the

Bottom of the Pyramid (WhartonSchool Publishing, 2005).

Stuart L. Hart

[email protected]

is a professor of strategicmanagement, Sarah GrahamKenan Distinguished Scholar,and codirector of the Centerfor Sustainable Enterprise atthe University of NorthCarolina’s Kenan–FlaglerBusiness School.

Originally published FirstQuarter 2002.



mal education and are hard to reach via conventional

distribution, credit, and communications. The quality

and quantity of products and services available in Tier 4

are generally low. Therefore, much like an iceberg with

only its tip in plain view, this massive segment of theglobal population — along with its massive market

opportunities — has remained largely invisible to the

corporate sector.

Fortunately, the Tier 4 market is wide open for

technological innovation. Among the many possibilities

for innovation, MNCs can be leaders in leapfrogging to

products that don’t repeat the environmental mistakes of

developed countries over the last 50 years. Today’s

MNCs evolved in an era of abundant natural resources

and thus tended to make products and services that were

resource-intensive and excessively polluting. The United

States’ 270 million people — only about 4 percent of

the world’s population — consume more than 25 per-

cent of the planet’s energy resources. To re-create those

types of consumption patterns in developing countries

would be disastrous.

We have seen how the disenfranchised in Tier 4 can

disrupt the way of life and safety of the rich in Tier 1 —

poverty breeds discontent and extremism. Although

complete income equality is an ideological pipe dream,

the use of commercial development to bring people outof poverty and give them the chance for a better life is

critical to the stability and health of the global economy

and the continued success of Western MNCs.

The Invisible Opportunity

Among the top 200 MNCs in the world, the over-

whelming majority are based in developed countries.

U.S. corporations dominate, with 82; Japanese firms,

with 41, are second, according to a list compiled in

December 2000 by the Washington, D.C.–based

Institute for Policy Studies. So it is not surprising that

MNCs’ views of business are conditioned by their

knowledge of and familiarity with Tier 1 consumers.

Perception of market opportunity is a function of the

way many managers are socialized to think and the ana-lytical tools they use. Most MNCs automatically dismiss

the bottom of the pyramid because they judge the mar-

ket based on income or selections of products and ser-

vices appropriate for developed countries.

To appreciate the market potential of Tier 4, MNCs

must come to terms with a set of core assumptions and

practices that influence their view of developing coun-

tries. We have identified the following as widely shared

orthodoxies that must be reexamined:

• Assumption #1. The poor are not our target con-

sumers because with our current cost structures, we can-

not profitably compete for that market.

• Assumption #2. The poor cannot afford and have

no use for the products and services sold in developed

markets.

• Assumption #3. Only developed markets appreci-

ate and will pay for new technology. The poor can use

the previous generation of technology.

• Assumption #4. The bottom of the pyramid is not

important to the long-term viability of our business. We

can leave Tier 4 to governments and nonprofits.• Assumption #5. Managers are not excited by busi-

ness challenges that have a humanitarian dimension.

• Assumption #6. Intellectual excitement is in de-

veloped markets. It is hard to find talented managers

who want to work at the bottom of the pyramid.

Each of these key assumptions obscures the value at

the bottom of the pyramid. It is like the story of the per-

son who finds a US$20 bill on the sidewalk. Conven-

tional economic wisdom suggests if the bill really exist-

ed, someone would already have picked it up! Like the

Exhibit 1: The World Economic Pyramid

* Based on purchasing power parity in U.S. dollars.

Source: U.N. World Development Reports

Annual per Capita Income*

More than $20,000

$1,500–$20,000

Less than $1,500

Population in Millions [2002]

75–100

4,000

Tiers

1

2 & 3

4

1,500–1,750



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$20 bill, the bottom of the pyramid defies conventional

managerial logic, but that doesn’t mean it isn’t a large

and unexplored territory for profitable growth. Con-sider the drivers of innovation and opportunities for

companies in Tier 4. (See Exhibit 2.) MNCs must rec-

ognize that this market poses a major new challenge:

how to combine low cost, good quality, sustainability,

and profitability.

Furthermore, MNCs cannot exploit these new

opportunities without radically rethinking how they go

to market. Exhibit 3 suggests some (but by no means all)

areas where an entirely new perspective is required to

create profitable markets in Tier 4.

Tier 4 Pioneers

Hindustan Lever Ltd. (HLL), a subsidiary of Great

Britain’s Unilever PLC and widely considered the best-

managed company in India, has been a pioneer among

MNCs exploring markets at the bottom of the pyramid.

For more than 50 years, HLL has served India’s small

elite who could afford to buy MNC products. In the

1990s, a local firm, Nirma Ltd., began offering deter-

gent products for poor consumers, mostly in rural areas.

In fact, Nirma created a new business system thatincluded a new product formulation, low-cost manufac-

turing process, wide distribution network, special pack-

aging for daily purchasing, and value pricing.

HLL, in typical MNC fashion, initially dismissed

Nirma’s strategy. However, as Nirma grew rapidly, HLL

could see its local competitor was winning in a market it

had disregarded. Ultimately, HLL saw its vulnerability

and its opportunity: In 1995, the company responded

with its own offering for this market, drastically altering

its traditional business model.

HLL’s new detergent, called Wheel, was formulated

to substantially reduce the ratio of oil to water in the

product, responding to the fact that the poor often washtheir clothes in rivers and other public water systems.

HLL decentralized the production, marketing, and dis-

tribution of the product to leverage the abundant labor

pool in rural India, quickly creating sales channels

through the thousands of small outlets where people at

the bottom of the pyramid shop. HLL also changed the

cost structure of its detergent business so it could intro-

duce Wheel at a low price point.

Today, Nirma and HLL are close competitors in the

detergent market, with 38 percent market share each,

according to IndiaInfoline.com, a business intelligence

and market research service. Unilever’s own analysis of

Nirma and HLL’s competition in the detergent business

reveals even more about the profit potential of the mar-

ketplace at the bottom of the pyramid. (See Exhibit 4.)

Contrary to popular assumptions, the poor can be a

very profitable market — especially if MNCs change

their business models. Specifically, Tier 4 is not a market

that allows for the traditional pursuit of high margins;

instead, profits are driven by volume and capital effi-

ciency. Margins are likely to be low (by current norms),but unit sales can be extremely high. Managers who

focus on gross margins will miss the opportunity at the

bottom of the pyramid; managers who innovate and

focus on economic profit will be rewarded.

Nirma has become one of the largest branded deter-

gent makers in the world. Meanwhile, HLL, stimulated

by its emergent rival and its changed business model,

registered a 20 percent growth in revenues per year and

a 25 percent growth in profits per year between 1995

and 2000. Over the same period, HLL’s market capital-

Exhibit 2: Innovation and MNC Implications in Tier 4

Increased access among the poor to TV and information Tier 4 is becoming aware of many products and servicesand is aspiring to share the benefits

Deregulation and the diminishing role of governments

and international aid

More hospitable investment climate for MNCs entering

developing countries and more cooperation fromnongovernmental organizations

Global overcapacity combined with intense competitionin Tiers 1, 2, and 3

Tier 4 represents a huge untapped market for profitablegrowth

The need to discourage migration to overcrowded urban centers MNCs must create products and services for rural populations

Drivers of Innovation Implications for MNCs



ization grew to $12 billion — a growth rate of 40 per-

cent per year. HLL’s parent company, Unilever, also has

benefited from its subsidiary’s experience in India.

Unilever transported HLL’s business principles (not the

product or the brand) to create a new detergent market

among the poor in Brazil, where the Ala brand has been

a big success. More important, Unilever has adopted the

bottom of the pyramid as a corporate strategic priority. As the Unilever example makes clear, the starting

assumption must be that serving Tier 4 involves bring-

ing together the best of technology and a global resource

base to address local market conditions. Cheap and low-

quality products are not the goal. The potential of Tier

4 cannot be realized without an entrepreneurial orienta-

tion: The real strategic challenge for managers is to visu-

alize an active market where only abject poverty exists

today. It takes tremendous imagination and creativity to

engineer a market infrastructure out of a completely unorganized sector.

Serving Tier 4 markets is not the same as serving

existing markets better or more efficiently. Managers

first must develop a commercial infrastructure tailored

to the needs and challenges of Tier 4. Creating such an

infrastructure must be seen as an investment, much like

the more familiar investments in plants, processes, prod-

ucts, and R&D.

Further, contrary to more conventional investment

strategies, no firm can do this alone. Multiple players

must be involved, including local governmental author-

ities, nongovernmental organizations (NGOs), commu-

nities, financial institutions, and other companies. Four

elements — creating buying power, shaping aspirations,

improving access, and tailoring local solutions — are the

keys to a thriving Tier 4 market. (See Exhibit 5.)

Each of these four elements demands innovation in

technology, business models, and management process-

es. And business leaders must be willing to experiment,

collaborate, empower locals, and create new sources of

competitive advantage and wealth.

Creating Buying Power

According to the International Labor Organization’s

World Employment Report 2001, nearly a billion people

— roughly one-third of the world’s workforce — are

either underemployed or have such low-paying jobs that

they cannot support themselves or their families.

Helping the world’s poor elevate themselves above this

desperation line is a business opportunity to do well and

do good. To do so effectively, two interventions are cru-

cial — providing access to credit, and increasing the

earning potential of the poor. A few farsighted compa-

nies have already begun to blaze this trail with startling-

ly positive results.

Commercial credit historically has been unavailable

to the very poor. Even if those living in poverty had

access to a bank, without collateral it is hard to get cred-

it from the traditional banking system. As Peruvianeconomist Hernando de Soto demonstrates in his path-

breaking work, The Mystery of Capital: Why Capitalism

Triumphs in the West and Fails Everywhere Else (Basic

Books, 2000), commercial credit is central to building a

market economy. Access to credit in the U.S. has

allowed people of modest means to systematically build

their equity and make major purchases, such as houses,

cars, and education.

The vast majority of the poor in developing coun-

tries operate in the “informal” or extralegal economy,since the time and cost involved in securing legal title for

their assets or incorporation of their microenterprises is

prohibitive. Developing countries have tried govern-

mental subsidies to free the poor from the cycle of

poverty, with little success. Even if the poor were able to

benefit from government support to start small busi-

nesses, their dependence on credit from local money-

lenders charging usurious rates makes it impossible to

succeed. Local moneylenders in Mumbai, India, charge

interest rates of up to 20 percent per day. This means

that a vegetable vendor who borrows Rs.100 ($2.08) in

the morning must return Rs.120 ($2.50) in the evening.

Extending credit to the poor so they can elevate

themselves economically is not a new idea. Consider

how I.M. Singer & Company, founded in 1851, pro-

vided credit as a way for millions of women to purchase

Exhibit 3: New Strategies for the Bottom of

the Pyramid

Price Performance

• Product development• Manufacturing• Distribution

Views of Quality

• New delivery formats• Creation of robust products

for harsh conditions(heat, dust, etc.)

Sustainability

• Reduction in resourceintensity

• Recyclability• Renewable energy

Profitability

• Investment intensity• Margins• Volume



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sewing machines. Very few of those women could have

afforded the steep $100 price tag, but most could afford

a payment of $5 per month.

The same logic applies on a much larger scale in

Tier 4. Consider the experience of the Grameen Bank

Ltd. in Bangladesh, one of the first in the world to apply

a microlending model in commercial banking. Started

just over 20 years ago by Muhammad Yunus, then a pro-fessor in the economics department at Chittagong

University in Bangladesh, Grameen Bank pioneered a

lending service for the poor that has inspired thousands

of microlenders, serving 25 million clients worldwide, in

developing countries and wealthy nations, including the

United States and the United Kingdom.

Grameen Bank’s program is designed to address the

problems of extending credit to lowest-income cus-

tomers — lack of collateral, high credit risk, and con-

tractual enforcement. Ninety-five percent of its 2.3million customers are women, who, as the traditional

breadwinners and entrepreneurs in rural communities,

are better credit risks than men. Candidates for loans

must have their proposals thoroughly evaluated and sup-

ported by five nonfamily members of the community.

The bank’s sales and service people visit the villages fre-

quently, getting to know the women who have loans and

the projects in which they are supposed to invest. In this

way, lending due diligence is accomplished without the

mountain of paperwork and arcane language common

in the West.

With 1,170 branches, Grameen Bank today pro-

vides microcredit services in more than 40,000 villages,

more than half the total number in Bangladesh. As of

1996, Grameen Bank had achieved a 95 percent repay-

ment rate, higher than any other bank in the Indian sub-

continent. However, the popularity of its services has

also spawned more local competitors, which has cut into

its portfolio and shrunk its profits over the past few years.

In addition, Grameen Bank’s rate of return is not

easy to assess. Historically, the bank was an entirely

manual, field-based operation, a structure that undercut

its efficiency. Today, spin-offs such as Grameen Telecom

(a provider of village phone service) and Grameen Shakti

(a developer of renewable energy sources) are helping

Grameen Bank build a technology infrastructure to

automate its processes. As the bank develops its onlinebusiness model, profitability should increase dramatical-

ly, highlighting the importance of information technol-

ogy in the acceleration of the microcredit revolution.

Perhaps the most pertinent measure of Grameen

Bank’s success is the global explosion of institutional

interest in microlending it has stimulated around the

world. In South Africa, where 73 percent of the popula-

tion earns less than R5,000 ($460) per month, accord-

ing to a 2001 World Bank study, retail banking services

for low-income customers are becoming one of the mostcompetitive and fast-growing mass markets. In 1994,

Standard Bank of South Africa Ltd., Africa’s leading

consumer bank, launched a low-cost, volume-driven

e-banking business, called AutoBank E, to grow revenue

by providing banking services to the poor. Through the

use of 2,500 ATMs and 98 AutoBank E-centres, Stan-

dard now has the largest presence in South Africa’s town-

ships and other under-serviced areas of any domestic

bank. As of April 2001, Standard served nearly 3 million

low-income customers and is adding roughly 60,000

customers per month, according to South Africa’s

Sunday Times .

Standard does not require a minimum income of

customers opening an AutoBank E account, although

they must have some regular income. People who have

never used a bank can open an account with a deposit

of as little as $8. Customers are issued an ATM card

and shown how to use it by staff who speak a variety

of African dialects. A small flat fee is charged for each

ATM transaction. An interest-

bearing “savings purse” is attachedto every account to encourage

poor customers to save. Interest

rates on deposits are low, but

superior to keeping cash in a jar.

The Sunday Times also reported

that Standard Bank is considering

a loan program for low-income

clients.

Computerization of micro-

lending services not only makes

Exhibit 4: Nirma vs. HLL in India’s Detergent Market (1999)

Source: Presentation by John Ripley, senior vice president, Unilever, at the Academy of Management Meeting,August 10, 1999

Total Sales (US$ Million) 150 100 180

Gross Margin (%) 18 18 25

ROCE (%) 121 93 22

Nirma HLL (Wheel) HLL (High-end Products)







humanity has yet to make a single phone call. However,

where telephones and Internet connections do exist, for

the first time in history, it is possible to imagine a single,

interconnected market uniting the world’s rich and poor

in the quest for truly sustainable economic develop-

ment. The process could transform the “digital divide”

into a “digital dividend.”

Ten years ago, Sam Pitroda, currently chairman andCEO of London-based Worldtel Ltd., a company creat-

ed by a telecommunications union to fund telecom

development in emerging markets, came to India with

the idea of “rural telephones.” His original concept was

to have a community telephone, operated by an entre-

preneur (usually a woman) who charged a fee for the use

of the telephone and kept a percentage as wages for

maintaining the telephone. Today, from most parts of

India, it is possible to call anyone in the world.

Other entrepreneurs have introduced fax services,and some are experimenting with low-cost e-mail and

Internet access. These communication links have dra-

matically altered the way villages function and how they

are connected to the rest of the country and the world.

With the emergence of global broadband connections,

opportunities for information-based business in Tier 4

will expand significantly.

New ventures such as CorDECT in India and

Celnicos Communications in Latin America are devel-

oping information technology and business models suit-

ed to the particular requirements of the bottom of the

pyramid. Through shared-access models (e.g., Internet

kiosks), wireless infrastructure, and focused technology

development, companies are dramatically reducing the

cost of being connected. For example, voice and data

connectivity typically costs companies $850 to $2,800

per line in the developed world; CorDECT has reduced

this cost to less than $400 per line, with a goal of $100

per line, which would bring telecommunications within

reach of virtually everyone in the developing world.

Recognizing an enormous business and develop-ment opportunity, Hewlett-Packard Company has artic-

ulated a vision of “world e-inclusion,” with a focus on

providing technology, products, and services appropriate

to the needs of the world’s poor. As part of this strategy,

HP has entered into a venture with the MIT Media Lab

and the Foundation for Sustainable Development of

Costa Rica — led by former President Jose Maria

Figueres Olsen — to develop and implement “telecen-

ters” for villages in remote areas. These digital town cen-

ters provide modern information technology equipment

with a high-speed Internet connection at a price that is

affordable, through credit vehicles, at the village level.

Bringing such technology to villages in Tier 4 makes

possible a number of applications, including tele-educa-

tion, telemedicine, microbanking, agricultural extension

services, and environmental monitoring, all of which

help to spur microenterprise, economic development,

and access to world markets. This project, namedLincos, is expected to spread from today’s pilot sites in

Central America and the Caribbean to Asia, Africa, and

central Europe.

Tailoring Local Solutions

As we enter the new century, the combined sales of the

world’s top 200 MNCs equal nearly 30 percent of total

world gross domestic product. Yet these same corpora-

tions employ less than 1 percent of the world’s labor

force. Of the world’s 100 largest economies, 51 areeconomies internal to corporations. Yet scores of Third

World countries have suffered absolute economic stag-

nation or decline.

If MNCs are to thrive in the 21st century, they must

broaden their economic base and share it more widely.

They must play a more active role in narrowing the gap

between rich and poor. This cannot be achieved if these

companies produce only so-called global products for

consumption primarily by Tier 1 consumers. They must

nurture local markets and cultures, leverage local solu-

tions, and generate wealth at the lowest levels on the

pyramid. Producing in, rather than extracting wealth

from, these countries will be the guiding principle.

To do this, MNCs must combine their advanced

technology with deep local insights. Consider packag-

ing. Consumers in Tier 1 countries have the disposable

income and the space to buy in bulk (e.g., 10-pound

boxes of detergent from superstores like Sam’s Club) and

shop less frequently. They use their spending money to

“inventory convenience.” Tier 4 consumers, strapped for

cash and with limited living space, shop every day, butnot for much. They can’t afford to stock up on house-

hold items or be highly selective about what they buy;

they look for single-serve packaging. But consumers

with small means also have the benefit of experimenta-

tion. Unburdened by large quantities of product, they

can switch brands every time they buy.

Already in India, 30 percent of personal care prod-

ucts and other consumables, such as shampoo, tea, and

cold medicines, are sold in single-serve packages. Most

are priced at Rs. 1 (about 1¢). Without innovation in



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packaging, however, this trend could result in a moun-

tain of solid waste. Dow Chemical Company and

Cargill Inc. are experimenting with an organic plastic

that would be totally biodegradable. Such packaging

clearly has advantages in Tier 4, but it could also revolu-

tionize markets at all four tiers of the world pyramid.

For MNCs, the best approach is to marry local capa-

bilities and market knowledge with global best practices.But whether an initiative involves an MNC entering

Tier 4 or an entrepreneur from Tier 4, the development

principles remain the same: New business models must

not disrupt the cultures and lifestyles of local people. An

effective combination of local and global knowledge is

needed, not a replication of the Western system.

The development of India’s milk industry has many

lessons for MNCs. The transformation began around

1946, when the Khira District Milk Cooperative, lo-

cated in the state of Gujarat, set up its own processingplant under the leadership of Verghese Kurien and cre-

ated the brand Amul, today one of the most recognized

in the country.

Unlike the large industrial dairy farms of the West,

in India, milk originates in many small villages. Villagers

may own only two to three buffaloes or cows each and

bring their milk twice a day to the village collection cen-

ter. They are paid every day for the milk they deliver,

based on fat content and volume. Refrigerated vans

transport the milk to central processing plants, where it

is pasteurized. Railroad cars then transport the milk to

major urban centers.

The entire value chain is carefully managed, from

the village-based milk production to the world-scale

processing facilities. The Khira District cooperative pro-

vides such services to the farmers as veterinary care and

cattle feed. The cooperative also manages the distribu-

tion of pasteurized milk, milk powder, butter, cheese,

baby food, and other products. The uniqueness of the

Amul cooperative is its blending of decentralized origi-

nation with the efficiencies of a modern processing anddistribution infrastructure. As a result, previously mar-

ginal village farmers are earning steady incomes and

being transformed into active market participants.

Twenty years ago, milk was in short supply in India.

Today, India is the world’s largest producer of milk.

According to India’s National Dairy Development

Board, the country’s dairy cooperative network now

claims 10.7 million individual farmer member–owners,

covers 96,000 village-level societies, includes 170 milk-

producer unions, and operates in more than 285 dis-

tricts. Milk production has increased 4.7 percent per

year since 1974. The per capita availability of milk in

India has grown from 107 grams to 213 grams per day

in 20 years.

Putting It All Together

Creating buying power, shaping aspirations, improving

access, and tailoring local solutions — the four elementsof the commercial infrastructure for the bottom of the

pyramid are intertwined. Innovation in one leverages

innovation in the others. Corporations are only one of

the actors; MNCs must work together with NGOs,

local and state governments, and communities.

Yet someone must take the lead to make this revo-

lution happen. The question is, Why should it be

MNCs?

Even if multinational managers are emotionally

persuaded, it is not obvious that large corporations havereal advantages over small, local organizations. MNCs

may never be able to beat the cost or responsiveness of

village entrepreneurs. Indeed, empowering local entre-

preneurs and enterprises is key to developing Tier 4 mar-

kets. Still, there are several compelling reasons for

MNCs to embark on this course:

• Resources. Building a complex commercial infra-

structure for the bottom of the pyramid is a resource-

and management-intensive task. Developing environ-

mentally sustainable products and services requires

significant research. Distribution channels and commu-

nication networks are expensive to develop and sustain.

Few local entrepreneurs have the managerial or technologi-

cal resources to create this infrastructure.

• Leverage. MNCs can transfer knowledge from

one market to another — from China to Brazil or India

— as Avon, Unilever, Citigroup, and others have

demonstrated. Although practices and products have to

be customized to serve local needs, MNCs, with their

unique global knowledge base, have an advantage that is

not easily accessible to local entrepreneurs.• Bridging. MNCs can be nodes for building the

commercial infrastructure, providing access to knowl-

edge, managerial imagination, and financial resources.

Without MNCs as catalysts, well-intentioned NGOs,

communities, local governments, entrepreneurs, and

even multilateral development agencies will continue to

flounder in their attempts to bring development to the

bottom. MNCs are best positioned to unite the range of

actors required to develop the Tier 4 market.

• Transfer. Not only can MNCs leverage learning



from the bottom of the pyramid, but they also have the

capacity to transfer innovations up-market all the way to

Tier 1. As we have seen, Tier 4 is a testing ground forsustainable living. Many of the innovations for the bottom

can be adapted for use in the resource- and energy-intensive

markets of the developed world.

It is imperative, however, that managers recognize

the nature of business leadership required in the Tier 4

arena. Creativity, imagination, tolerance for ambiguity,

stamina, passion, empathy, and courage may be as

important as analytical skill, intelligence, and knowl-

edge. Leaders need a deep understanding of the com-

plexities and subtleties of sustainable development in the

context of Tier 4. Finally, managers must have the inter-

personal and intercultural skills to work with a wide

range of organizations and people.

MNCs must build an organizational infrastructure

to address opportunity at the bottom of the pyramid.

This means building a local base of support, reorienting

R&D to focus on the needs of the poor, forming new

alliances, increasing employment intensity, and rein-

venting cost structures. These five organizational ele-

ments are clearly interrelated and mutually reinforcing.

•Build a local base of support. Empowering the

poor threatens the existing power structure. Local oppo-

sition can emerge very quickly, as Cargill Inc. found in

its sunflower-seed business in India. Cargill’s offices were

twice burned, and the local politicians accused the firm

of destroying locally based seed businesses. But Cargill

persisted. Through Cargill’s investments in farmer edu-

cation, training, and supply of farm inputs, farmers have

significantly improved their productivity per acre of

land. Today, Cargill is seen as the friend of the farmer.

Political opposition has vanished.

To overcome comparable problems, MNCs must

build a local base of political support. As Monsanto and

General Electric Company can attest, the establishmentof a coalition of NGOs, community leaders, and local

authorities that can counter entrenched interests is

essential. Forming such a coalition can be a very slow

process. Each player has a different agenda; MNCs have

to understand these agendas and create shared aspira-

tions. In China, this problem is less onerous: The local

bureaucrats are also the local entrepreneurs, so they can

easily see the benefits to their enterprise and their village,

town, or province. In countries such as India and Brazil,

such alignment does not exist. Significant discussion,

information sharing, the delineation of benefits to each

constituency, and sensitivity to local debates is necessary.

• Conduct R&D focused on the poor. It is necessary to

conduct R&D and market research focused on the

unique requirements of the poor, by region and by

country. In India, China, and North Africa, for example,

research on ways to provide safe water for drinking,

cooking, washing, and cleaning is a high priority.

Research must also seek to adapt foreign solutions to

local needs. For example, a daily dosage of vitamins can

be added to a wide variety of food and beverage prod-ucts. For corporations that have distribution and brand

presence throughout the developing world, such as

Coca-Cola Company, the bottom of the pyramid offers

a vast untapped market for such products as water and

nutritionals.

Finally, research must identify useful principles and

potential applications from local practices. In Tier 4, sig-

nificant knowledge is transmitted orally from one gen-

eration to the next. Being respectful of traditions but

willing to analyze them scientifically can lead to new

New business models must not disruptlocal cultures and lifestyles. An effective

combination of local and global knowledgeis needed, not a Western system.





machines can be placed in safe areas — police stations

and post offices. Iris recognition used as a security device

could substitute for the tedious personal-identification

number and card for identification.

Lowering cost structures also forces a debate on

ways to reduce investment costs. This will inevitably

lead to greater use of information technology to develop

production and distribution systems. As noted, village-based phones are already transforming the pattern of

communications throughout the developing world. Add

the Internet, and we have a whole new way of commu-

nicating and creating economic development in poor,

rural areas. Creative use of IT will emerge in these mar-

kets as a means to dramatically lower the costs associat-

ed with access to products and services, distribution, and

credit management.

A Common CauseThe emergence of the 4 billion people who make up the

Tier 4 market is a great opportunity for MNCs. It also

represents a chance for business, government, and civil

society to join together in a common cause. Indeed, we

believe that pursuing strategies for the bottom of the

pyramid dissolves the conflict between proponents of

free trade and global capitalism on one hand, and envi-

ronmental and social sustainability on the other.

Yet the products and services currently offered to

Tier 1 consumers are not appropriate for Tier 4, and

accessing this latter market will require approaches fun-

damentally different from those even in Tiers 2 and 3.

Changes in technology, credit, cost, and distribution are

critical prerequisites. Only large firms with global reach

have the technological, managerial, and financial

resources to dip into the well of innovations needed to

profit from this opportunity.

New commerce in Tier 4 will not be restricted to

businesses filling such basic needs as food, textiles, and

housing. The bottom of the pyramid is waiting for high-

tech businesses such as financial services, cellulartelecommunications, and low-end computers. In fact,

for many emerging disruptive technologies (e.g., fuel

cells, photovoltaics, satellite-based telecommunications,

biotechnology, thin-film microelectronics, and nano-

technology), the bottom of the pyramid may prove to be

the most attractive early market.

So far, three kinds of organizations have led the

way: local firms such as Amul and Grameen Bank;

NGOs such as the World Resources Institute, SELF,

The Rainforest Alliance, The Environmental Defense

Fund, and Conservation International, among others;

and a few MNCs such as Starbucks, Dow, Hewlett-

Packard, Unilever, Citigroup, DuPont, Johnson &

Johnson, Novartis, and ABB, and global business part-

nerships such as the World Business Council for

Sustainable Business Development. But to date, NGOs

and local businesses with far fewer resources than the

MNCs have been more innovative and have made moreprogress in developing these markets.

It is tragic that as Western capitalists we have

implicitly assumed that the rich will be served by the

corporate sector, while governments and NGOs will

protect the poor and the environment. This implicit

divide is stronger than most realize. Managers in MNCs,

public policymakers, and NGO activists all suffer from

this historical division of roles. A huge opportunity lies

in breaking this code — linking the poor and the rich

across the world in a seamless market organized aroundthe concept of sustainable growth and development.

Collectively, we have only begun to scratch the sur-

face of what is the biggest potential market opportunity

in the history of commerce. Those in the private sector

who commit their companies to a more inclusive capi-

talism have the opportunity to prosper and share their

prosperity with those who are less fortunate. In a very

real sense, the fortune at the bottom of the pyramid rep-

resents the loftiest of our global goals. +

Reprint No. 02106

Resources

Robert Chambers, Whose Reality Counts? Putting First Last (ITDG

Publishing, 1997).

Hernando de Soto, The Mystery of Capital: Why Capitalism Triumphs in

the West and Fails Everywhere Else (Basic Books, 2000).

Thomas L. Friedman, The Lexus and the Olive Tree: Understanding

Globalization (Farrar, Straus and Giroux, 1999).

Stuart Hart, “Beyond Greening: Strategies for a Sustainable World,”

Harvard Business Review , January–February 1997, www.hbsp.harvard.edu/

hbr/index.html.

“Is the Digital Divide a Problem or an Opportunity?” Business Week

Supplement, December 18, 2000.

C.K. Prahalad and Kenneth Lieberthal, “The End of Corporate

Imperialism,” Harvard Business Review , July–August 1998, www.hbsp

.harvard.edu/hbr/index.html.

Amartya Sen, Development as Freedom (Alfred A. Knopf, 1999).

For more thought leadership on this topic, see s+b ’s website at:

www.strategy-business.com/global_perspective.



Trait by trait, companiescan evolve their own

execution cultures.

I l l u s t r a t i o n

b y

B r i a n

C a i r n s

Every economic era has a theme. The 1960s are

still recalled as the “Go-Go” years, when Wall Street was

fueling mergers and conglomerations of unprecedented

scale. The 1990s were the “Internet Boom” years, when

a rising economic tide lifted the boat of just about any

company with a plausible business model tale to tell.The agonizingly slow recovery since the Internet bubble

burst has inspired the latest motif. Executives no longer

believe that a strategy — consolidation, transformation,

or breakaway — is enough. “We’ve made the right

strategic decision, but my organization isn’t motivated

or set up right to get on with it,” they are saying.

“Everyone says they understand the vision, but the

businesses and functions just aren’t working together to

get results.”

Welcome to the Era of Execution.

Execution has become the new mantra for this first

decade of the new millennium. Larry Bossidy, who led

AlliedSignal Inc.’s turnaround and its merger with

Honeywell International Inc., wrote a book with Ram

Charan, titled Execution: The Discipline of Getting Things

Done (Crown Business, 2002), that’s been on the busi-ness bestseller lists for more than a year. Former IBM

CEO Louis V. Gerstner Jr. put forth the same message

in his memoir, Who Says Elephants Can’t Dance? Inside

IBM’s Historic Turnaround (HarperBusiness, 2002). In

it, he says flatly that the revival of the computer giant

wasn’t due to vision. “Fixing IBM,” he wrote, “was all

about execution.”

Boards of directors, increasingly impatient with

CEOs who don’t deliver, have climbed on the execution

bandwagon too. Booz & Company’s annual study of

THEFourBases OF

Organizational

DNA

BY GARY NEILSON, BRUCE A. PASTERNACK, AND DECIO MENDES





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CEO succession trends showed that forced turnover of

underperforming CEOs at major corporations reached a

new high in 2002, rising a staggering 70 percent from2001 and accounting for 39 percent of all chief execu-

tive transitions.

But is execution simply a matter of firing the CEO

and bringing in a charismatic leader who can get on

with “getting things done”? Not at all. Underlying the

quest for an execution-driven enterprise is one central

question: How does a company design its organization

to execute the strategy — whatever the strategy is — and

successfully adapt when circumstances change?

Execution is woven deeply into the warp and woof

of organizations. It is embedded in the management

processes, relationships, measurements, incentives, and

beliefs that collectively define the “rules of the game” for

each company. Although we often think of companies as

monolithic entities, they’re not. They’re collections of

individuals who typically act in their own self-interest.

Superior and consistent corporate execution occurs only

when the actions of individuals within it are aligned

with one another, and with the overall strategic interests

and values of the company. Performance is the sum total

of the tens of thousands of actions and decisions that, atlarge companies, thousands of people, at every level,

make every day.

Because individual behaviors determine an organi-

zation’s success over time, the first step in resolving dys-

functions is to understand how the traits of an organiza-

tion influence each individual’s behavior and affect his

or her performance. We like to use the familiar meta-

phor of DNA to attempt to codify the idiosyncratic

characteristics of a company. Just as the double-stranded

DNA molecule is held together by bonds between base

pairs of four nucleotides, whose sequence spells out the

exact instructions required to create a unique organism,

we describe the DNA of a living organization as having

four bases that, combined in myriad ways, define an

organization’s unique traits. These bases are:

Structure. What does the organizational hierarchy look like? How are the lines and boxes in the organiza-

tion chart connected? How many layers are in the hier-

archy, and how many direct reports does each layer have?

Decision Rights. Who decides what? How many

people are involved in a decision process? Where does

one person’s decision-making authority end and

another’s begin?

Motivators. What objectives, incentives, and career

alternatives do people have? How are people rewarded,

financially and nonfinancially, for what they achieve?

Gary Neilson

[email protected]

is a senior partner with Booz

& Company in Chicago. He

works on the development of

new organizational models

and designs, restructuring,

and the leadership of major

change initiatives for

Fortune 500 companies

across industries.

Bruce A. Pasternack

is a former senior partner with

Booz & Company. He is now

an operating partner with

Venrock Associates.

Decio Mendes

is a former principal with Booz

& Company. He is now at the

Boston Consulting Group.

Originally published Winter

2003.

Exhibit 1: The Hourglass Organization

Source: Booz & Company

Vice President (8 to 9 direct reports)

Senior Director (6 to 8 direct reports)

Director (3 to 6 direct reports)

Lead Manager (4 to 6 direct reports)

Manager (5 to 7 direct reports)

Supervisor (8 to 14 direct reports)



What are they encouraged to care about, by whatever

means, explicit or implicit?

Information. What metrics are used to measure per-

formance? How are activities coordinated, and how is

knowledge transferred? How are expectations and

progress communicated? Who knows what? Who needs

to know what? How is information transferred from the

people who have it to the people who require it? Any metaphor can be pushed too far, of course.

Although the basic comparison of corporate and human

DNA is often invoked in general discussions of institu-

tional culture and conduct, we think it provides a practi-

cal framework senior executives can use to diagnose

problems, discover hidden strengths, and modify compa-

ny behavior. With a framework that examines all aspects

of a company’s architecture, resources, and relationships,

it is much easier to see what is working and what isn’t

deep inside a highly complex organization, to understandhow it got that way, and to determine how to change it.

(See “Focus: Testing Quest Diagnostics’ DNA,” page 50.)

Structure

In principle, companies make structural choices to sup-

port a strategy (for example, the decision to organize

business units around customers, products, or geogra-

phy). In practice, however, a company’s organizational

structure and strategic intent often are mismatched. The

variance can usually be exposed by, in effect, super-

imposing the organization chart — an efficient commu-

nicator of power and status in a firm — over a business

unit’s strategic plan.

A common structural problem impeding the execu-

tion of strategy is the existence of too many manage-

ment tiers (deep layers), with too many individuals at

each tier having too few direct reports (narrow spans).

Portrayed graphically, this structure resembles an hour-

glass. (See Exhibit 1.) Narrower spans in the middleoften result from unclear decision rights and the com-

pany’s mix of motivators. Generally, a structure shaped

this way indicates trouble.

There are many reasons a certain management posi-

tion may legitimately call for a narrower or wider span

than another position’s. Managers in complex jobs that

require them to create and maintain multiple informa-

tion linkages across individual units cannot handle the

same number of direct reports as managers with simpler

information aggregation roles. But it’s also easy for spansto become too narrow for no legitimate reason.

Consider the spans of control for three senior posi-

tions at one consumer goods company with which we

have worked. As shown in Exhibit 2, the catego-

ry/product line manager had five direct reports, com-

pared with seven and 10 reports for senior managers at

two best-practice companies. The vice president of sales

had six direct reports, versus eight and 10 at the other

companies. The manufacturing manager had only seven

direct reports; in other companies, similar managers had

11 or more. We have taken this measurement at more

Exhibit 2: Comparing Spans of Control

Source: Booz & Company

Best-practice Company

25

20

15

10

5

Consumer Goods CompanyConsumer Goods Company

Category/Product Line Manager

A v e r a g e N o . o f D i r e c t R e p o r t s

Vice President, Sales Manufacturing Manager

Co. A

10

75

108

6

23

12

11

7

Co. B CG Co. Co. A Co. B CG Co. Co. A Co. B Co. C CG Co.



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than 100 companies, and our data indicates that this

company fell well outside the range found at compara-

ble firms.

In our experience, numbers this far off the norm

provide strong evidence that a company’s spans are

narrower than they should be. Often this results in a

structure that has too many layers as well. This became

evident when we explored how senior managers at the

consumer goods company spent their time. About athird of it was devoted to making plans, ensuring target

corporate goals were met, and dealing with exceptions

and high-impact/high-risk decisions, all appropriate

roles for these managers. But they were spending far too

much time (roughly 40 percent) justifying and reporting

performance to senior executives above them and par-

ticipating in tactical, operational decisions with their

direct reports. In other words, too much of their time

was devoted to second-guessing the work of people

below them and preparing reports so that superiors

could second-guess their work. They should have been

giving more of their time to preparing action plans to

achieve the strategic and operational objectives of the

company.

This structure kept the consumer goods organiza-

tion from executing to its potential. Among specific dys-

functions we found:

• Because there were no clear standards that allowed

basic decisions to be made at lower levels, decisions re-garding such matters as authorization for PC purchases

and travel were decided too high in the organization.

• Managers and supervisors tended to discourage

their staffs from troubleshooting to resolve routine prob-

lems on their own.

• Managers rotated rapidly through jobs, reaching

senior positions without sufficient experience. Not only

did they require close supervision, but they continually

struggled to figure out what they needed to know.

• The company seemed to rapidly promote its best

Focus: TestingQuest Diagnostics’DNA

NA testing can be as valuable

to corporate health as it has

become to human healthcare. An

analysis of a company’s “genetic

material” can isolate the underlying

causes of and potential solutions to

organizational dysfunctions, and even

head off problems before they start.

Consider the case of the U.S.-based

medical laboratory testing companyQuest Diagnostics. Originally a divi-

sion of Corning Inc., Quest Diagnostics

grew in the 1990s through the acquisi-

tion of hundreds of small independent

testing laboratories. Spun off from

Corning in 1997, the company was los-

ing money and battling fines for billing

fraud and other abuses in a number of

the laboratories it had bought.

Chairman and CEO Ken Freeman,

then the newly appointed leader of

Quest Diagnostics, recognized that the

DNA of an enterprise formed by the

union of so many different entities,

each born in a different time and

place, with many different parents,

could readily become a monster. So he

was determined to focus his attention

on improving organizational DNA

across the entire company.

Immediately after the spin-off,

Freeman and his top management

team took control of key decision

rights to ensure that the company’s

turnaround effort was coherent and

driven hard. When the company

acquired SmithKline Beecham ClinicalLabs in August 1999, they again delib-

erately centralized decision rights

among a small senior team. A set of

integration teams headed by the lead-

ers of both companies methodically

worked through the long-term vision

and short-term tactics for each area

of the new company, again, to ensure

consistency across the enterprise.

The financial payoff was immediate:

Prior to the deal, revenues had typi-

cally declined upward of 20 percent

following a major acquisition. In this

case, Quest Diagnostics not only didn’t

lose business, revenues grew at or

above industry growth rates during

the integration process. This was the

first time such postmerger growth

occurred in the industry.

As Quest Diagnostics’ turnaround

progressed, decision rights were

decentralized gradually, first by plac-

ing supervisors into various units who

led change and taught employees new

behaviors, and then by empowering

frontline staff. Although many parts of

the Quest Diagnostics organizationare now high performers and largely

self-directed, it has taken seven years

to get there.

Today when Quest Diagnostics

acquires a company, Mr. Freeman and

his team concentrate on two of the

four organizational bases, motivators

and information, recognizing their

interdependency and combined influ-

ence on individual and organizational

D



and brightest just so it could retain them. This added

unnecessary layers to the hierarchy and created more

work at lower levels.

• Large cross-departmental meetings filled the

workday. The rationale was to have all parties “in one

room to resolve the issues.”

All of this activity is costly — these are managers

with salaries in the low six figures. Their compensation,

plus the actual cost of their activities, pushed the com-pany’s general and administrative costs to a level that was

20 percent higher than the average of our benchmark

companies. Because each of its many layers got involved

in almost every decision, the company’s speed to market

was slowing, and it was losing share to new, more nim-

ble competitors in several categories.

The obvious structural change was to reduce layers

and increase spans — that is, to add direct reports to

each manager. We recommended a new structure that

resulted in a reduction of 10 percent of the positions

in the management ranks across all six divisions.

Ultimately, with the elimination and repositioning of

managers and support staff, about 2,300 management

jobs were cut, which saved the company more than

US$250 million.

Still, simply cutting layers and extending spans

would have had little long-term effect if underlying

behaviors didn’t change. One way the company could

do this was by setting clear standards (e.g., which PC tobuy and which airline to fly) so high-level managers

would not need to review every transaction and provide

approvals. With a monthly report, they could easily

track exceptions to the standards. Another solution:

Reset promotion expectations to slow the upward move-

ment of managers and encourage more horizontal

moves — use promotions not just as a reward, but to

develop a manager’s breadth of experience. Long and

cumbersome reporting processes designed to satisfy the

information preferences of each layer and the tremen-

behavior. Among the first “gene thera-

pies” they perform is to introduce a

comprehensive and varied set of met-

rics that go well beyond the typical

financial performance measures that

most companies use. There are

measures for customer retention, the

time it takes to pick up a call in the call

center, the time it takes to process a

specimen in the labs, employee satis-

faction and attrition rates, and more.

The system is designed so that all

employees know how they can per-

sonally influence one or more core

performance measures.

The only way this information can

influence the day-to-day behavior anddecisions of employees throughout

the organization is if decision makers

have the information on hand when

they need it. Quest Diagnostics posts

various metrics on different time-

tables depending on the type of man-

agement issue: Customer retention

metrics are posted at least once a

month; specimen turnaround time is

posted every morning.

Finally, the company ties these

metrics to individuals’ bonus pay-

ments so that information not only

informs, but also motivates productive

behavior. Since virtually everyone in

the company can affect customer

retention in some way, Quest Diag-

nostics uses the customer retention

metric very broadly in its perform-

ance-based compensation programs.

Ultimately, the bonuses of all 37,000

Quest Diagnostics employees depend

in some way on meeting the customer

retention target.

“If we have a shared goal that says

we’re going to reduce customer attri-

tion, that doesn’t mean it is only forpeople in sales. It impacts people pick-

ing up the specimens, people who

draw and perform tests on the speci-

mens, and certainly people in billing. If

there are lots of complaints, the cus-

tomer is going to leave. By having

shared goals, you get speed and align-

ment,” says Freeman.

To make the motivators as specific

and powerful as possible, customer

retention metrics are measured not

just organization-wide. They are di-

vided up by region, so that people are

paid on the basis of customer reten-

tion performance in their own region,

where they can have the greatest

influence.

The aligning and motivating power

of bringing information and incentives

together is reflected in the firm’s

strong financial performance. Since

Quest Diagnostics was spun off from

Corning in 1997, the company’s stock

price has increased 730 percent, com-

pared with a 41 percent increase in the

S&P 500 Index during the same

period. Having successfully carriedout a classic turnaround and taken the

lead in consolidating the industry,

Quest Diagnostics is now driving

growth organically and has become

the clear leader in the U.S. medical

laboratory testing market. In 2002, the

company earned US$322 million on

$4.1 billion in revenues.

—G.N., B.A.P., and D.M.



Executives promoted to new positionsoften cling to their prior responsibilities,

burdening themselves with unnecessarytasks and disempowering their subordinates.

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dous desire for detail also had to go. In their place would

be a report on the key lagging and leading measures of

critical business activity, a top-down setting of targets,and the monitoring of variances. To further dissolve the

reflexive addition of layers, the company also had to do

more managerial training and communicate better

about the change in promotion principles. Following

the restructuring and changes in management, time to

market for product introductions shrank by months,

enabling the company to regain the first-to-market

advantage it had traditionally held.

Decision Rights

Decision rights specify who has the authority to make

which decisions. Clarifying these rights puts flesh on an

organization chart and makes crystal clear where respon-

sibility lies.

Clear decision rights enable wider spans and fewer

layers, which translates into lower costs and speedier exe-

cution. Unarticulated decision rights are more than a

time sink; they’re a central cause of substandard per-

formance — and even of nonperformance. An employee

at a financial-services company expressed this problem

quite concretely in a focus group we conducted, saying,“Responsibilities are blurred intentionally around here

so everyone has an excuse for not getting involved.”

At one industrial company, we found yet again that

senior executives were spending too much time review-

ing small projects. It turned out the company had not

reassessed managers’ spending-approval limits in more

than 10 years. We suggested the authorization process be

adjusted so that managers lower in the organization

could be accountable for the final approval of more proj-

ects. The capital expenditure amount requiring CEO

authorization was raised from $5 million to $15 million.

The objective was to free up senior management’s time

to focus on the longer-term issues associated with mar-ket growth and potential acquisitions. Based on histori-

cal analysis, it was determined that raising the level at

which projects required CEO authorization to $15 mil-

lion would reduce the number of projects crossing the

CEO’s desk by 49 percent. All large projects would still

come to the CEO, so the aggregate value of projects

approved at the top would decline by only 13 percent.

Decision rights become blurred for many reasons,

not all of them intentional. After a large industrial com-

pany completed a leveraged buyout, the management of

one of its business units became the new entity’s corpo-

rate management, charged with reviewing the operating

decisions of all business units. That change required

every level of management to take on greater decision-

making responsibility — an unnatural act for executives

accustomed to hands-on involvement in operating unit

decisions. Rather than allow their general managers to

make basic decisions about product design and resource

allocation, the CEO and COO still involved themselves

deeply in these activities. Meanwhile, they were neglect-

ing other areas where their attention was expected,notably strategic planning, long-range business portfolio

decisions, and the firm’s financial condition.

The solution was to create a process for corporate

officers to delegate decisions to the business unit’s gen-

eral managers. An executive committee was established

to review business unit decisions, and several general

managers were charged with integrating marketing,

product engineering, and manufacturing. These struc-

tures and processes made effective delegation possible.

It doesn’t take a leveraged buyout to distort a com-



pany’s decision-rights structure. People naturally lean

toward the familiar when faced with change. Executives

promoted to new positions often cling to their prior

responsibilities, burdening themselves with unnecessary

tasks and disempowering their subordinates. The press

of the urgent at the business unit level drives out the

important at the corporate level. The lesser decisions

seem concrete and knowable. Forward thinking and bigdecisions regarding long-term direction seem undefined,

amorphous, and tougher to tackle.

Often the process of assigning decision rights is a

response to a crisis or a shift in political power. When

this happens, decisions can fall between the cracks. Or

they can be made twice by different parties. Or they can

be reviewed repeatedly, becoming a Sisyphean exercise

in backsliding.

It is possible to assign decision rights systematically

and rationally. At a global industrial company, wehelped create an organizational matrix of functions,

products, and geographies. The structure was under-

girded by a set of specific organizational and decision-

making principles, among them: Responsibility does

not imply exclusive authority; different units should

have joint goals and performance measures; and certain

positions need to report upward to multiple managers.

Over several months, we worked with the company

to apply these and several other principles to more than

300 critical decisions. Because we undertook this effort

explicitly while also changing the structure, the com-

pany was able to execute its new strategy faster, and with

fewer missteps. The overall change process took two

years (one less than had been anticipated). The company

returned to profitability, reduced its net debt by the tar-

geted amount, and reached several other critical finan-

cial goals a year ahead of schedule.

Making decision rights explicit in companies in

which they are not requires management to set rules

for the most common business situations — and for

each position. In effect, the company is creating aconstitution that says who will decide what and under

what circumstances.

The decision rights of groups must also be clear. At

a consumer goods company, we saw large numbers of

executives meeting frequently to resolve conflicts among

functional units. It appeared that operations, finance,

and marketing were each doing an excellent job of ana-

lyzing new factories, new products, and new business

opportunities, but they weren’t talking to one another

along the way. Operations planned the perfect factory

— without guidance from finance on the cost. In

marathon meetings, managers from each function

brought their independent analyses together. Then they

struggled to reach a joint conclusion, because each unit,

by that time, was wedded to its own recommendation.

To solve this silo problem, one top executive was

made responsible for managing a cross-functional team,

so there would always be communication across dis-ciplines. As a result, only a few top executives were

needed to make routine decisions, and the company

reduced dedicated staff support for these efforts by more

than 30 percent.

Motivators

The third of the four bases in a company’s DNA-like

makeup involves motivation. Employees generally don’t

deliberately act counterproductively; they don’t try to

derail a company’s strategy. Rather, they respond quiterationally on the basis of what they see, what they

understand, and how they’re rewarded. An exhortation

to follow the vision and pursue the strategy is only so

much air if the organization’s incentives and information

flows make it difficult for employees to understand and

do what they’re supposed to do.

An organization can send confusing signals to indi-

viduals in many ways. Think about what happens when

an appraisal system inflates performance ratings. At a

consumer goods company we once worked with,

employees were appraised on a 1 to 10 scale. Eighty per-

cent received a rating of 9 or above, and everyone felt

good. But superior employees didn’t feel they needed to

do any better. Other workers thought their performance

was acceptable when it wasn’t. Appraisers were avoiding

the unpleasant task of delivering bad performance rat-

ings, and the organization wasn’t giving them any reason

to be tough. For every deficient employee who stayed at

the company because the organization said he or she was

competent, the company’s execution suffered. Because

of its unwillingness to differentiate people’s contributionsthrough performance assessments and raises, the com-

pany lost the opportunity to send important feedback to

employees on what was relevant to executing the strat-

egy — and where their performance was unsatisfactory.

Several years ago we worked with the new CEO of

a technology company who had been the head of a busi-

ness unit and had served for several years on the execu-

tive committee that made investment decisions. The

new CEO knew from experience that the committee

wasn’t tough enough on new investment requests. They



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were a collegial group; members supported their col-

leagues’ investment requests with the understandingtheir own requests would be supported in return.

The new CEO wanted a more discriminating

process that would judge investment proposals on their

merits. He also knew executive committee members

faced little downside from approving unsound invest-

ment requests. Future bonuses might suffer if company

performance wasn’t good, but that money wasn’t already

in their pockets.

So the CEO introduced a new system to change

this attitude: Each committee member was required totake out a personal loan of $1 million and invest it in

company stock (the loan was guaranteed by the com-

pany, so the individuals could borrow at good rates).

Unlike an outright stock grant, this scheme ensured that

the executives had existing wealth at risk, and that they

would lose money, and perhaps the ability to repay the

debt, if they permitted poor investment decisions. With

this new incentive to scrutinize investment requests, the

committee became much tougher and more effective.

And after a few sessions, teams began bringing better-

researched and smarter investment proposals to the table

because they knew if they didn’t, the committee was

likely to turn them down.

There are other market mechanisms that can be

used to send more accurate signals to managers about

the cost and value of certain activities. This approach

was used successfully at a large agribusiness company

that came to us for help in improving the services of its

human resources department. The HR department’s

performance had always been judged by how well it

stayed on budget. Internal customer satisfaction wasrarely measured. Each customer was allocated a share of

the HR budget, but these figures didn’t represent the

true cost of the services. Meanwhile, customers had lit-

tle influence on the kind and amount of services they

received. Neither HR nor its customers had an incentive

to offer or ask for services tailored to the specific needs

of a division.

Working with the company, we created a scorecard

to measure HR performance on such things as call cen-

ter response time and payroll errors. Achieving scorecard

targets became a significant component of management

incentives and rewards. HR’s internal customers were

given the right to negotiate service-level agreements with

HR. The true cost of services was established using out-

side benchmarks. Once HR’s customers understood

what they were paying for and could better manage their

costs, they had an incentive to use HR services more

wisely. Today, they often decline or reduce some servicesand request new ones. The market-based measurement

and incentive program improved the quality of the

company’s HR services and reduced costs by more than

15 percent.

Organizations that are ready to implement multiple

profit-and-loss statements and market-based motiva-

tional systems will find that these powerful new tools

can help them operate effectively with less command-

and-control oversight. But not all companies are ready

for these systems; it takes strong leadership, persistence,and patience to introduce them and overcome employ-

ee resistance to using them.

Information

Underlying a company’s ability to ensure clear decision

rights and to measure and motivate people to apply

them is one critical matter: information.

Making sure high-quality information is available

and flowing where it needs to go throughout a compa-

ny, all the time, is among the most challenging tasks of

the modern corporation, and one of the most under-

appreciated contributors to high performance and com-

petitive advantage. A 2002 study of the management

and financial performance of 113 Fortune 1000 compa-

nies over the five-year period 1996 to 2000, conducted

by Booz & Company and Ranjay Gulati of the Kellogg

School of Management at Northwestern University,

found that the companies with the highest shareholder

returns were more focused on managing and enhancing

communication with their customers, suppliers, and

employees than other firms in the study. We have seen this information–performance link-

age often in practice. A few years ago, the board of an

agricultural grower and processor became concerned

about the company’s operating efficiency. Among other

problems, farm managers were using equipment with-

out discipline — ordering a machine at will, driving it

hard, and returning it with an empty gas tank, all

because headquarters was responsible for maintenance

and replacement costs. Our benchmark data indicated

that this company’s expenses were far higher than those



of independent farms. We worked with corporate and

farm management to develop a new business model,

centered on turning each farm into an independent

business. For this to happen, farm managers needed new

information — specifically, individual farm P&Ls that

reflected, among many other things, the cost of the

equipment they used. The redesigned organization exe-

cuted more efficiently, as reflected in a 48 percent jumpin its imputed share price in the first year.

Better information flows did more than keep costs

down; they helped allocate scarce resources far more effi-

ciently than before. The company had a silo problem —

literally and figuratively. Any field ready for harvest had

a peak yield window of about 15 days. But there was

only so much mill capacity during the peak window.

Coordinating and timing the harvesting and milling

activities fell to a hapless employee at headquarters, a

central planner who relied on historical data that didn’treveal much about current conditions.

We showed in a simulation that if farm managers

could bid for use of the mill on particular dates, it would

strikingly improve the company’s efficiency. If a man-

ager saw that his highest-yielding acreage was ready to

harvest and couldn’t wait because rain was predicted, he

could bid more for mill time. No longer would someone

back at headquarters have to hunker down with a

spreadsheet, making educated guesses based on the pre-

vious year’s yield data and taking frantic phone calls

from farm managers. Market-based pricing of mill time

would allocate scarce resources better than a central

planner could. And with this new system, decisions

would reflect the real-time knowledge of the farmer in

the field observing the sky, testing the ripeness of the

crop, hour by hour, acre by acre.

Adaptive DNA

Although we have illustrated the four bases of organiza-

tional DNA separately to emphasize their distinct char-

acteristics, they clearly are intertwined. Changing struc-ture requires changing decision rights; to make effective

decisions, employees need new incentives and different

information. At the agricultural grower and processor,

the new structure touched each of these elements — the

individual farm as a business required new decision

authority for farm managers, new metrics by which to

measure their performance, and new rewards based on

their individual success. This interdependency is evident

in all of these company stories.

Considering — and changing — a company’s

DNA holistically means weaving intelligence, decision-

making capabilities, and a collective focus on common

goals widely and deeply into the fabric of the organiza-

tion so that each person and unit is working smartly —

and working together. It’s one thing to achieve well-

coordinated intelligence among senior executives. It’s

another thing entirely to touch every level of an organi-

zation all the way down to the loading dock. What every employee does every day, aggregated across the com-

pany, constitutes performance.

The best organizational designs are adaptive, are

self-correcting, and become more robust over time. But

creating such an organization doesn’t happen quickly; it

can take several years to get the basics right, and there is

always a need for fine-tuning. This may explain why

leaders of companies that are truly ailing — and who

need to reassure shareholders as fast as they can — often

don’t have the patience for changing decision rights,motivators, and information flows. They’re more likely

to cut the structure and see what happens than to take

time to ensure that structural changes actually result in

sustained productivity improvements and steady gains

in shareholder value. But neglecting this hard work may

also partly explain why some of these CEOs are no

longer in charge.

No company may ever totally master the enigma of

execution. But the most resilient and consistently suc-

cessful ones have discovered that the devil is in the

details of organization. For them, organizing to execute

has truly become a competitive edge. +

Reprint No. 03406

Resources

Jeffrey W. Bennett, Thomas E. Pernsteiner, Paul F. Kocourek, and Steven

B. Hedlund, “The Organization vs. the Strategy: Solving the Alignment

Paradox,” s+b, Fourth Quarter 2000, www.strategy-business.com/

press/article/14114.

Michael C. Jensen, Foundations of Organizational Strategy (Harvard

University Press, 1998).

Paul F. Kocourek, Steven Y. Chung, and Matthew G. McKenna,

“Strategic Rollups: Overhauling the Multi-Merger Machine,” s+b, Second

Quarter 2000, www.strategy-business.com/press/article/16858.

Chuck Lucier, Rob Schuyt, and Eric Spiegel, “CEO Succession 2002:

Deliver or Depart,” s+b, Summer 2003, www.strategy-business.com/

press/article/21700.

Gary Neilson, David Kletter, and John Jones, “Treating the Troubled

Corporation,” s+b enews, 03/28/03, www.strategy-business.com/press/

enewsarticle/22230.

Randall Rothenberg, “Larry Bossidy: The Thought Leader Interview,” s+b,

Third Quarter 2002, www.strategy-business.com/press/article/20642.



I l l u s t r a t i o n b y R o b e r t G o l d s t r o m

Leadership is not just for leaders anymore. Top

companies are beginning to understand that sustaining

peak performance requires a firm-wide commitment to

developing leaders that is tightly aligned to organiza-

tional objectives — a commitment much easier to

understand than to achieve. Organizations must find ways to cascade leadership from senior management to

men and women at all levels. As retired Harvard

Business School professor John P. Kotter eloquently

noted in a previous issue of strategy+business , this ulti-

mately means we must “create 100 million new leaders”

throughout our society. (See “Leading Witnesses,” s+b ,

Summer 2004.)

Organizational experts Paul Hersey and Kenneth

Blanchard have defined leadership as “working with and

through others to achieve objectives.” Many companies

are stepping up to the challenge of leadership develop-

ment and their results are quite tangible. In Leading the

Way: Three Truths from the Top Companies for Leaders

(John Wiley & Sons, 2004), a study of the top 20 com-

panies for leadership development, Marc Effron and

Robert Gandossy show that companies that excel atdeveloping leaders tend to achieve higher long-term

profitability.

But it sometimes seems there are as many approach-

es to leadership development as there are leadership

developers. One increasingly popular tool for developing

leaders is executive coaching. Hay Group, a human

resources consultancy, reported that half of 150 compa-

nies surveyed in 2002 said that they had increased their

use of executive coaching, and 16 percent reported using

coaches for the first time.

LeadershipIsaContact

SportThe “Follow-up Factor” in

Management Development

BY MARSHALL GOLDSMITH AND HOWARD MORGAN





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Yet even “executive coaching” is a broad category. In

reviewing a spate of books on coaching in 2003, Des

Dearlove and Stuart Crainer identified at least threetypes of coaching: behavioral change coaching, personal

productivity coaching, and “energy coaching.” (See “My

Coach and I,” s+b , Summer 2003.) Our own book, The

Art and Practice of Leadership Coaching: 50 Top Executive

Coaches Reveal Their Secrets (with Phil Harkins; John

Wiley & Sons, 2004), includes discussions about five

types of leadership coaching: strategic, organizational

change/execution, leadership development, personal/life

planning, and behavioral.

Given the increasingly competitive economic envi-

ronment and the significant human and financial capi-

tal expended on leadership development, it is not only

fair but necessary for those charged with running com-

panies to ask, “Does any of this work? And if so, how?”

What type of developmental activities will have the

greatest impact on increasing executives’ effectiveness?

How can leaders achieve positive long-term changes in

behavior? With admitted self-interest — our work was

described in the Crainer–Dearlove article, and is fre-

quently cited in reviews of and articles about leadership

coaching — we wanted to see if there were consistentprinciples of success underlying these different

approaches to leadership development.

We reviewed leadership development programs in

eight major corporations. Although all eight companies

had the same overarching goals — to determine the

desired behaviors for leaders in their organizations and

to help leaders increase their effectiveness by better

aligning actual practices with these desired behaviors —

they used different leadership development methodolo-

gies: off-site training versus on-site coaching, short

duration versus long duration, internal coaches versus

external coaches, and traditional classroom-based train-

ing versus on-the-job interaction.Rather than just evaluating “participant happiness”

at the end of a program, each of the eight companies

measured the participants’ perceived increase in leader-

ship effectiveness over time. “Increased effectiveness”

was not determined by the participants in the develop-

ment effort; it was assessed by preselected co-workers

and stakeholders.

Time and again, one variable emerged as central to

the achievement of positive long-term change: the par-

ticipants’ ongoing interaction and follow-up with col-

leagues. Leaders who discussed their own improvement

priorities with their co-workers, and then regularly fol-

lowed up with these co-workers, showed striking

improvement. Leaders who did not have ongoing dia-

logue with colleagues showed improvement that barely

exceeded random chance. This was true whether the

leader had an external coach, an internal coach, or no

coach. It was also true whether the participants went to

a training program for five days, went for one day, or did

not attend a training program at all.

The development of leaders, we have concluded, isa contact sport.

Eight Approaches

The eight companies whose leadership development

programs we studied were drawn from our own roster of

clients over a 16-year period. Although all are large cor-

porations, each company is in a different sector and each

faces very different competitive pressures.

Each company customized its leadership develop-

ment approach to its specific needs. Five of the eight

Marshall Goldsmith

marshall@

marshallgoldsmith.com

is a founder of MarshallGoldsmith Partners, a leader-ship coaching network. Hehas worked with more than70 major CEOs and theirmanagement teams and is theauthor or coauthor of manybooks on leadership andcoaching, including Mojo:

How to Get It, How to Keep It,

How to Get It Back if You Lose

It (with Mark Reiter; Hyperion,2009).

Howard Morgan

[email protected]

is the founder of 50 TopCoaches, a collective of manyof the world’s leading execu-tive advisors. He specializes inexecutive coaching as a strate-gic change-management tool.He is co-editor of The Art and

Practice of Leadership

Coaching: 50 Top Executive

Coaches Reveal Their Secrets

(John Wiley & Sons, 2004).

Originally published Fall 2004.



focused on the development of high-potential leaders,

and between 73 and 354 participants were involved in

their programs. The three other companies includedalmost all managers (above midlevel), and involved

between 1,528 and 6,748 managers. The degree of inter-

national representation varied among organizations. At

two companies, almost all of the participants were

American. Non-U.S. executives made up almost half of

the participants in one company’s program. The other

five had varying levels of international participation.

Some of the companies used traditional classroom-

based training in their development effort. In each of

these companies, participants would attend an off-site

program and receive instruction on what the desired

characteristics were for leaders in their organization, why

these characteristics were important, and how partici-

pants might better align their own leadership behavior

with the desired model. Some companies, by contrast,

used continuing coaching, a methodology that did not

necessarily involve off-site training, but did rely on reg-

ular interaction with a personal coach. Some companies

used both off-site training and coaching.

Along with differences, there were commonalities

among the programs. Each company had spent exten-sive time reviewing the challenges it believed its leaders

would uniquely face as its business evolved. Each had

developed a profile of desired leadership behaviors that

had been approved by upper management. After ensur-

ing that these desired leadership behaviors were aligned

with the company vision and values, each company

developed a 360-degree feedback process to help leaders

understand the extent to which their own behavior (as

perceived by co-workers) matched the desired behavior

for leaders in the corporation. All eight placed a set of

expectations upon participants. The developing leaders

were expected to:

• Review their 360-degree feedback with an inter-nal or external consultant.

• Identify one to three areas for improvement.

• Discuss their areas for improvement with key

co-workers.

• Ask colleagues for suggestions on how to increase

effectiveness in selected areas for change.

• Follow up with co-workers to get ideas for

improvement.

• Have co-worker respondents complete a confi-

dential custom-designed “mini-survey” three to 15

months after the start of their program.

Each participant received mini-survey summary

feedback from three to 16 co-workers. Colleagues were

asked to rate the participants’ increased effectiveness in

the specific selected behaviors as well as participants’

overall increase (or decrease) in leadership effectiveness.

Co-workers were also asked to measure the degree of

follow-up they had with the participant. In total, we col-

lected more than 86,000 mini-survey responses for the

11,480 managers who participated in leadership

development activities. This huge database gave us theopportunity to explore the points of commonality and

distinction among these eight very different leadership

development efforts.

Three of the organizations permitted their names to

be used in articles or conference presentations, enabling

us to reference them in this report; the rest have request-

ed anonymity, although we are able to describe their sec-

tor and activities. Two of the organizations also have

allowed their results to be published elsewhere, without

disclosure of the organization’s name. The companies





ship effectiveness, and a five-point scale to plot the

amount of follow-up, ranging from a low of “no follow-

up” to a high of “consistent or periodic follow-up.”They then compared the two sets of measurements by

plotting the effectiveness scores and the follow-up tallies

on charts.

The remaining three firms used slightly different

measurement criteria. The telecommunications compa-

ny used a “percentage improvement” scale to measure

perceived increases in leadership effectiveness, as judged

by co-workers. It then compared “percentage improve-

ment” on leadership effectiveness with each level of

follow-up. Johnson & Johnson and Agilent Technol-

ogies measured leadership improvement using the same

seven-point scale employed by the first five companies,

but they did not categorize the degree of follow-up be-

yond the simple “followed up” versus “did not follow up.”

As noted earlier, follow-up here refers to efforts that

leaders make to solicit continuing and updated ideas

for improvement from their co-workers. In the two

companies that compared “followed up” with “did not

follow up,” participants who followed up were viewed

by their colleagues as far more effective than the leaders

who did not. In the companies that measured the degreeof follow-up, leaders who had “frequent” or “periodic/

consistent” interaction with co-workers were reliably

seen as having improved their effectiveness far more

than the leaders who had “little” or “no” interaction with

co-workers.

Exhibit 1 shows the results among the first five

companies, which, despite their different leadership

development programs, used the same measurement

methodology. This apples-to-apples comparison shows

strong correlations across all five companies between the

degree of follow-up and the perceived change in leader-

ship effectiveness.

Leadership, it’s clear from this research, is a relationship . And the most important participants in this

relationship are not the coach and the “coachee.” They

are the leader and the colleague.

Most of the leaders in this study work in knowledge

environments — in companies where the value of the

product or service derives less and less from manufac-

turing scale and, to use Peter Drucker’s formulation,

more and more from the processing and creation of

information to define and solve problems. In discussing

leadership with knowledge workers, Drucker has said,

“The leader of the past was a person who knew how to

tell. The leader of the future will be a person who knows

how to ask.” Our studies show that leaders who regular-

ly ask for input are seen as increasing in effectiveness.

Leaders who don’t follow up are not necessarily bad

leaders; they are just not seen as getting better.

Ask and Receive

In a way, our work reinforces a key learning from the

Hawthorne studies. These classic observations of factory

workers at suburban Chicago’s Western ElectricHawthorne Works, which Harvard professor Elton

Mayo made nearly 80 years ago, showed that productiv-

ity tended to increase when workers perceived leadership

interest and involvement in their work, as evidenced by

purposeful change in the workplace environment. Our

studies show that when co-workers are involved in lead-

ership development, the leaders they are helping tend to

become more effective. Leaders who ask for input and

then follow up to see if progress is being made are seen

as people who care. Co-workers might well infer that

Leadership is a relationship, notbetween the coach and the “coachee,” but

between the leader and the colleague.



TYPE OF

FOLLOW-UP

MuchLess

MuchMore

SomewhatLess

SomewhatMore

SlightlyLess

Slightly moreNo change

PERCEIVED CHANGE IN LEADERSHIP EFFECTIVENESS

NONE

A LITTLE

FREQUENT

CONSISTENT

SOME

Distribution of respondents

Exhibit 1: The Impact of Follow-up

Combined results from five companies — with very different leadership development programs, but that measured leadership effectiveness the

same way — show how the perceived quality of leaders correlates to the frequency of their follow-up. Follow-up, here, means efforts by leadersto solicit ideas from their coworkers about their own improvement.

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leaders who don’t respond to feedback must not care

very much.

Historically, a great deal of leadership development

has focused on the importance of an event . This event

could be a training program, a motivational speech, oran off-site executive meeting. The experience of the eight

companies we studied indicates that real leadership de-

velopment involves a process that occurs over time, not an

inspiration or transformation that occurs in a meeting.

Physical exercise provides a useful analogy. Imagine

having out-of-shape people sit in a room and listen to a

speech on the importance of exercising, then watch

some tapes on how to exercise, and perhaps practice

exercising. Would you ever wonder why these people

were still unfit a year later? The source of physical fitness

is not understanding the theory of working out; it is

engaging in exercise. As Arnold Schwarzenegger has

said, “Nobody ever got muscles by watching me work

out!” So, too, with leadership development. As Drucker,

Hersey, and Blanchard have pointed out, leadershipinvolves a reliance on co-workers to achieve objectives.

Who better than these same co-workers to help the

leader increase effectiveness?

Indeed, the executive coach is, in many ways, like a

personal trainer. The trainer’s role is to “remind” the per-

son being trained to do what he or she knows should be

done. Good personal trainers spend far more time on

execution than on theory. The same seems to be true for

leadership development. Most leaders already know

what to do. They have read the same books and listened



to the same gurus giving the same speeches. Hence, our

core conclusion from this research: For most leaders, the

great challenge is not understanding the practice of leadership: It is practicing their understanding of leadership.

Beyond the basic finding — that follow-up matters

— several other conclusions arise from our research. For

example, the eight-program study indicates that the

follow-up factor correlates with improved leadership effec-

tiveness among both U.S. and non-U.S. executives.

As companies globalize, many executives have

begun to wrestle with issues of cultural differences

among their executives and employees. Recent research

involving high-potential leaders from around the world

has shown that cross-cultural understanding is seen as a

key to effectiveness for the global leader. (See, for exam-

ple, Marshall Goldsmith et al., Global Leadership: The

Next Generation , Financial Times Prentice Hall, 2003.)

Our study addressed this issue as it affects leader-

ship development programs. Nearly 10,000 of the

respondents in the eight companies whose programs we

reviewed — almost 12 percent of our mini-survey sam-

ple — were located outside the United States. We found

that the degree of follow-up was as critical to changing

perceived leadership effectiveness internationally as it was domestically. This was true for both training and

coaching initiatives.

At Johnson & Johnson, there were almost no dif-

ferences in scores among participants in Europe, Latin

America, and North America. The group seen as

improving the most was in Asia. In analyzing the find-

ings, J&J determined that the higher scores in Asia were

more a function of dedicated local management than of

cultural differences, again supporting the correlation

between a caring, contact-rich leadership and its per-

ceived effectiveness.

That follow-up works globally contravenes assump-

tions that different cultures will have differing levels of receptiveness to intimate conversations about workplace

behaviors. But the universality of the follow-up principle

doesn’t imply universality in its application. Leaders learn

from the people in their own environment, particularly

in a cross-cultural context. Indeed, research by the

Center for Creative Leadership in Greensboro, N.C., has

shown that “encouraging feedback” and “learning from

those around us” are both central to success for leaders in

cross-cultural environments. Companies with successful

leadership development programs encourage executives

to adapt the universal principle of follow-up and the fre-

quency of such conversations to fit the unique require-

ments of the culture in which they working. Despite

other cultural differences, there seems to be no country

in the world where co-workers think, “I love it when you

ask me for my feedback and then ignore me.”

Inside and Outside

Interaction between the developing leader and his or her

colleagues is not the sole connection that counts. Also

vital is the contact between the leader and the coach. Ourthird major finding concerns that relationship: Both

internal and external coaches can make a positive difference.

One reason coaching can be so effective is that it

may inspire leaders to follow up with their people.

Agilent, for one, found a strong positive correlation

between the number of times the coach followed up

with the client and the number of times the client fol-

lowed up with co-workers.

The coach, however, does not have to be part of the

company. This conclusion was readily apparent when



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we compared the two companies most distinct in the

composition of their coaching corps. Agilent used only

external coaches. GE Capital, by contrast, used only internal coaches from human resources. Yet both

approaches produced very positive long-term increases

in perceived leadership effectiveness.

Given the apparent ease of accessibility to internal

coaches, firms might naturally use this finding to justify

“going inside.” But there are at least three important

variables to consider in determining whether to use an

internal HR coach: time, credibility, and confidentiality.

In many organizations, internal coaches are not

given the time they need for ongoing interaction with

the people they are coaching. In some cases, they may

not seem as credible as trained development experts. In

other cases, especially those that involve human

resources personnel filling multiple roles, there may

appear to be a conflict of interest between a profes-

sional’s responsibilities as coach and as evaluator. If these

perceptions exist, then external coaches may well be

preferable to internal coaches.

But internal coaches can overcome these obstacles.

At GE Capital, the internal coaches were HR profes-

sionals who were given time to work with their“coachees.” Coaching was treated as an important part

of their responsibility to the company and was not seen

as an add-on “if they got around to it.” Moreover, the

coachees were given a choice of internal coaches and

picked coaches they saw as most credible. Finally, each

internal coach worked with a leader in a different part of

the business. They assured their coachees that this

process was for high-potential development, not evalua-

tion. As a result of this thorough screening process,

client satisfaction with internal coaches was high and

results achieved by internal coaches (as judged by co-

workers) were very positive.

Inside or outside, we discovered that the mechanicsof the coach–leader relationship were not a major limit-

ing factor. Our fourth finding was that feedback or

coaching by telephone works about as well as feedback or

coaching in person.

Intuitively, one might believe that feedback or

coaching is a very “personal” activity that is better done

face-to-face than by phone. However, the companies we

reviewed do not support this supposition. One company,

Johnson & Johnson, conducted almost all feedback by

telephone, yet produced “increased effectiveness” scores

almost identical to those of the aerospace/defense organ-

ization, which conducted all feedback in person.

Moreover, all the companies that used only external

coaches similarly found little difference between tele-

phone coaching and live coaching. These companies

made sure that each coach had at least two one-on-one

meetings with individual executive clients. Some coaches

did this in person, whereas others interacted mostly by

phone. There was no clear indication that either method

of coaching was more effective than the other.

Although sophisticated systems — involving somecombination of e-mail, intranets, extranets, and mobile

connectivity — are available, follow-up needn’t be

expensive. Internal coaches can make follow-up tele-

phone calls. New computerized systems can send

“reminder notes” and give ongoing suggestions.

However it’s done, follow-up is the sine qua non of effec-

tive leadership development. Too many companies

spend millions of dollars for the “program of the year”

but almost nothing on follow-up and reinforcement.

Companies should also take care to measure the



effectiveness of their leadership development initiatives,

and not just the employees’ satisfaction with them. Our

results indicate that when participants know that surveysor other methods of measuring program effectiveness are

slated to occur three to 15 months from the date of the

program, a higher level of commitment is created

among them. This follow-up measurement creates a

focus on long-term change and personal accountability.

Although measuring outcomes would seem to be

second nature for most companies, the success of lead-

ership development programs has conventionally been

assessed through the satisfaction of the participants. This

metric is of limited relevance. Among the companies in

our study that offered leadership development training,

virtually all participants came away highly satisfied. At

the aerospace/defense contractor and Johnson &

Johnson, the average satisfaction rating among more

than 3,500 participants was 4.7 out of a possible 5.0.

Executives loved the training, but that didn’t mean they

used the training or improved because of it.

Learning to Learn

Of even greater import is this: Continual contact with

colleagues regarding development issues is so effective itcan succeed even without a large, formal program.

Agilent, for example, produced excellent results, even

though its leaders received coaching that was completely

disconnected from any training. In fact, leaders who do

not have coaches can be coached broadly by their co-

workers. The key to changing behavior is “learning to

learn” from those around us, and then modifying

our behavior on the basis of their suggestions. The

aerospace/defense contractor and the telecommunica-

tions company used very streamlined and efficient train-

ing processes and “reminder notes” to help leaders

achieve a positive long-term change in effectiveness,

without using coaches at all.If the organization can teach the leader to reach out

to co-workers, to listen and learn, and to focus on

continuous development, both the leader and the organ-

ization will benefit. After all, by following up with col-

leagues, a leader demonstrates a commitment to self-

improvement — and a determination to get better. This

process does not have to take a lot of time or money.

There’s something far more valuable: contact. +

Reprint No. 04307

Resources

Diane Anderson, Brian Underhill, and Robert Silva, “The Agilent APEX

Case Study,” in Best Practices in Leadership Development — 2004 , edited

by Dave Ulrich, Louis Carter, and Marshall Goldsmith (Best Practices

Publications, 2004).

Des Dearlove and Stuart Crainer, “My Coach and I,” s+b , Summer 2003,

www.strategy-business.com/press/article/22062.

Marshall Goldsmith, “Ask, Learn, Follow Up, and Grow,” in The Leader of the Future: New Visions, Strategies, and Practices for the Next Era , edited

by Frances Hesselbein, Marshall Goldsmith, and Richard Beckhard (Peter

Drucker Foundation and Jossey-Bass, 1996).

Marshall Goldsmith et al., Global Leadership: The Next Generation (Financial Times Prentice Hall, 2003).

Linda Sharkey, “Leveraging HR: How to Develop Leaders in Real Time,”

in Human Resources in the 21st Century , edited by Marc Effron, Robert

Gandossy, and Marshall Goldsmith (John Wiley & Sons, 2003).

Elizabeth Thach, “The Impact of Executive Coaching and 360 Feedback

on Leadership Effectiveness,” Leadership & Organization Development Journal , vol. 23, no. 4, 2002; http://fiordiliji.emeraldinsight.com/

vl=2762214/cl=12/nw=1/rpsv/lodj.htm.



Continual contact with colleaguesis so effective it can succeed even

without a formal program.



During the past few decades, many industrial

companies have attempted to achieve manufacturing

excellence. They have had at their disposal any number

of methodologies and theories, quality initiatives, and

cost-reducing concepts. But few companies have made

much headway. Manufacturing strategies — decisionsrelated to siting, designing, and running factories — are

often the same as they were 10 or 20 years ago. Plants

often look and feel as they did then. Programs intended

to improve performance, such as “total quality manage-

ment,” “lean production,” and “Six Sigma,” seem to ebb

away, without producing the desired results. Sometimes

it seems as though the harder manufacturers try to

improve, the worse they perform.

Consider, for example, the bad news from the

Middle East that hit Household GmbH, a Europe-

based consumer goods manufacturer, in 2003. (The

company name is changed, but the details are accurate.)

Household’s market share in hygiene products, one of

its flagship divisions, had recently tumbled in such cities

as Cairo and Abu Dhabi. When Household’s regional

managers investigated, they discovered that a private-label producer based in Egypt had begun to aggressively

undercut the shelf price of Household’s products.

At first glance, it seemed as if Household could eas-

ily win a price war with any local private label. After all,

Household’s Middle Eastern manufacturing sites were

running at higher capacity than the competition’s sites,

with advanced proprietary technology and a highly pro-

ductive, well-trained staff. But the private-label manu-

facturer refused to go away, and its prices remained low

while its market share kept rising. I l l u s t r a t i o n b y P e t e r K r ä m e r

BY KAJ GRICHNIK, CONRAD WINKLER, AND PETER VON HOCHBERG

MyopiaMANUFACTURING

Instead of drifting intodecline and irrelevance,

producers of goods havea chance to seize the future.





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Household’s managers had assumed that their com-

petitor was selling under cost. But gradually it became

clear that despite Household’s scale and technologicaledge, the competitor spent less to make most hygiene

products, without any sacrifice in quality — at least as

perceived by customers. In short, Household’s ostensible

manufacturing advantage — its distinctive technology

— had become its biggest disadvantage. To make mat-

ters worse, Household had nearly completed a new fac-

tory in Ukraine, which had been intended, in part, to

add capacity to serve the Mideast, but which now would

simply add to Household’s manufacturing costs.

There are many such stories in manufacturing

today. Executives do all the right things to improve oper-

ations, but somehow get outperformed on cost, quality,

or delivery. They may turn to benchmarking exercises,

but those are rarely meaningful. Low-cost competitors

appear with prices that can’t be completely explained by

lower wages. Rising warranty costs or dramatic product

recall levels indicate the ongoing erosion of quality.

As a last resort, companies outsource production,

and thus erode their own company’s competence in it.

Gradually, manufacturing is treated more and more as an

outcast, and plant communities become disenfranchised. We call this condition “manufacturing myopia.” It

is akin to the “marketing myopia” that Harvard Business

School lecturer Theodore Levitt identified in the 1960s.

Levitt argued that companies made themselves vulnera-

ble when they defined their brands too narrowly.

Railroads are not in the passenger-train business, he

argued; they’re in transportation. Every business should

define itself through the interests of its market, not its

own production priorities.

Today, myopia is even more prevalent and danger-

ous in manufacturing than it was in marketing four

decades ago. Like marketing myopia, manufacturing

myopia is caused by isolation; it is the inevitable out-come of keeping manufacturing strategies contained to

the functional or even plant level, with little or no con-

nection to enterprise-wide strategies. As the factories

and supply chain oversight functions are cut off from

the rest of the executive decision makers, the manufac-

turing focus grows narrower, and overall competence can

atrophy. This compels companies to cut costs even more

blindly and irresponsibly, often by setting company-

wide targets determined by financial fiat rather than by

competitive or customer insights. (See Exhibit 1.)

Building Awareness

Surprisingly few major multinational or large-scale man-

ufacturing companies have been able to break free of this

trap. Household GmbH was one of them. The Middle

East episode prodded its senior executives into a multi-

year, systematic endeavor to rethink the company’s oper-

ations and to glean and use better information about its

manufacturing costs. Today, rather than a few state-of-

the-art plants, Household operates a variety of plants that

are designed for flexibility and can be moved or revampedas customer needs and the competitive climate change.

The cure for manufacturing myopia is 20/20 vision

— that is, the cultivation of awareness about manufac-

turing costs and means. Companies can sharpen their

own ability, as Household did, to see their operations

more clearly and redesign them more flexibly. For com-

panies that achieve this kind of manufacturing prowess,

the manufacturing function is no longer seen primarily

as a cost center, ripe for cutbacks or outsourcing. Instead,

the ability to produce higher-quality goods at lower

Kaj Grichnik

[email protected]

is a partner with Booz &

Company based in Paris and

a leader of research and

practice in manufacturing.

He focuses on the pharma-

ceutical, food, aerospace,

and automotive industries.

Conrad Winkler

[email protected]


Company based in Chicago. He

advises companies across

industries on supply chain

management improvement

and manufacturing strategies,

with a focus on the automotive

and aerospace sectors.

Peter von Hochberg

[email protected]


Company based in Düsseldorf.

He has extensive experience

in consulting with clients on

manufacturing and lean

production, focusing on

automotive OEMs and

suppliers, and industrial

goods manufacturers.

Also contributing to this article

were John Potter, a Booz &

Company partner based in

London, and Georgina Grenon,

a former Booz & Company

senior associate.

Originally published Spring

2006.



prices in a more flexible manner is a key component of

their long-term competitive strategy and a central,

dependable part of their identity.

This involves two major commitments: first, dedi-

cation of resources to building awareness. Leaders can

peel back the layers of their own manufacturing opera-

tions and those of their competitors so that processes,

advantages, and disadvantages can be viewed moreclearly. This means becoming more aware of a com-

pany’s unique technological capabilities, the unfulfilled

potentials of each plant (for reaching the appropriate

markets), and the specific drivers responsible for their

costs. Many manufacturers look at cost data primarily

as justification and leverage for continually trimming

expenses, rather than as a source of insights about scale,

capital spending, labor deployment, technology, logis-

tics, and supply chain efficiency — all critical factors in

measuring how well a company’s manufacturingprocesses stack up against the competition. Toyota’s

manufacturing competence, widely admired for many

years, stems in large part from the company’s insistence

on building fine-grained awareness of every facet of pro-

duction, at all levels of the company.

The second commitment is patience, demonstrated

by investing the time and resources to address manufac-

turing productivity as a long-term, organization-wide

strategic imperative and not as an isolated operational orfunctional issue. Plant managers are often expected to

show the same fast pace of change as marketing, finance,

and procurement, where six- to 18-month transforma-

tions are feasible. But those metrics don’t apply to man-

ufacturing efforts, where improving results requires a

very different set of time frames. A new manufacturing

program frequently involves motivating, as well as hiring

or moving, thousands of employees; new construction;

new technology deployment; and perhaps the closing of

a plant or two, which takes years rather than months.That time is well invested if it is used to develop an

“We need 10% costreduction across all

plants.”

“We need acomprehensivemanufacturing

strategy.”

Who chooses the costreductions?

What guides thedecision?

What are theresults?

Exhibit 1: The Anatomy of a Manufacturer’s Dilemma

Companies facing manufacturing pressure can seek to solve the problem in one of two ways: cost reduction, mandated from the top, or strategicrealignment of manufacturing resources. This diagram shows four possible decisions as they play out in the manufacturing system and thereal-world results they produce.

KPIs do not reflectleverage in reducingproduct complexity ordesigning cross-plantstrategies. Fewlong-term gains. Nostrategic shift inprocess or product.

Strategic changes(probably) lead to cost,quality, speed, andservice advantages.

2%–4% cost reduction;evolutionary changes;no strategic shift inprocess or product.

Targets consideredunfair; plants object.Excuses, “passive-aggressive” resistance.No strategic shift inprocess or product.

Option #3

Reduction is basedon selected keyperformance indicators,or KPIs (such localmetrics as costs, etc.).

Cost data (showsopportunities andlimitations in thesystem), strategicobjectives, competitiveposition.

Consultation with localteam, perhaps withshop floor workers.

Option #1

Locally controlled:Plant reduction targetsare voluntary.

Centrally controlled:Top executives andcentral staff establishthe process for a 10%cost reduction.

Option #4

Top executives andmanufacturingmanagers look at theconstellation of plantsand prioritiestogether.

Option #2

Company-wide rulesand uniform reductiontargets are applied toall plants.



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effective, flexible manufacturing capability, unique to

the business and its customers, as a platform for more

rapid change once it is established.How does one go about building this kind of aware-

ness? At most companies, there are four dimensions of

manufacturing in which highly visible data and analysis,

projected farther into the future, can yield both short-

term gains and long-term advantage: technological

distinctiveness, network sophistication, in-plant trans-

formation, and labor modernization.

Technological Distinctiveness

One of the first places to eliminate myopia is in the

design, engineering, or purchasing of manufacturing

technology. (We call this the “inherent” dimension of

manufacturing, because it involves the physical nature of

the products and the processes that create them.) There

is a staggering level of underinvestment in business

process innovation as compared with product innova-

tion. In 2004, according to Booz & Company analysis,

only 10.2 percent of the R&D budgets at the top 500

industrial companies was set aside for process innova-

tion, down from 15 percent in 1980. Because they’ve

neglected this essential activity, manufacturers tend torely on machine builders and other vendors to fill in the

gap. In most cases, this is counterproductive. Equip-

ment manufacturers do not generally have a strong track

record for innovation, particularly for the kinds of cre-

ative and customized solutions that would enable indi-

vidual companies to overcome their manufacturing

shortcomings. And even when equipment providers are

innovators, their technology is unlikely to give manufac-

turers a competitive edge, because it generally can be

freely purchased by any of their rivals.

Moreover, in many organizations, there is little

patience for process innovation, which in manufactur-

ing is by its very nature a long-term event. After the pro-duction technology is replaced, it could take two to

three years before the capital investment bears fruit in

the semiconductor sector, five years in major manufac-

turing, and as much as 20 years in process industries,

such as petrochemicals and electricity production.

Additionally, to improve processes, companies have to

train entire plant communities in dozens of different

tools and techniques and completely different ways of

working. All of that consumes time and resources.

Some extremely successful manufacturers, such as

packaging giant Tetra Pak, Procter & Gamble, and

Toyota, have bucked the trend and used in-house

machine development and internal process innovation

to protect their competitive advantages. P&G has long

been a pioneer of novel factory floor environments; for

example, letting shop floor employees not just lay out

the flow of machinery but design the machines them-

selves. This approach began at P&G in the early 1960s

and has developed in scope, efficiency, and sophistica-

tion ever since. In one celebrated example at a P&G

plant in Lima, Ohio, a team of shop floor “technicians,”as hourly workers were called, designed a machine for

placing detergent bottles into position on the assembly

line — a mechanical feat that P&G’s professional engi-

neers had said was impossible. The team commissioned

a machine-tool supplier to produce the device, and put

it successfully into operation.

But for every P&G, there are dozens of companies

faced with an equivalent to Household’s dilemma in the

Middle East: Their state-of-the-art factories, more capa-

ble than those of competitors on a worldwide basis, are

A manufacturer of air conditioningsupplies built its factories on freighter ships

that can be moved from port to port as theseasonal marketplace changes.



not flexible enough to respond to local conditions.

Sometimes, a promising process innovation effort is

disbanded because top management changes or becausethe sponsoring executives lose interest, even though they

have known all along about the nature of the investment

they’ve been making. As a result, outmoded technologi-

cal principles may endure for 30 or 40 years while the

company cycles through a series of half-realized quality-

improvement or plant-restructuring initiatives. Other

times, process innovation is consigned to the plant level

only. When approached in this way, companies become

little more than multiple small organizations with no

scale, unable to harness process technology as a compet-

itive advantage.

Myopia also afflicts efforts to modify existing man-

ufacturing processes. For example, there has been a lot

of excitement in the last 15 years about design for man-

ufacturing (DFM), an approach by which companies

engineer products not just for their intrinsic qualities

but also for how efficiently they can be manufactured.

But despite the allure of DFM, the relationship between

engineering and manufacturing groups at most compa-

nies is chilly or nonexistent. The shop floor community

is often excluded from direct communication aboutthe manufacturability of products with the engineering/

design function. Even if the two groups are allowed to

communicate, manufacturing companies may not have

the budget to cover the engineers’ internal rates and

therefore may lose contact.

Network Sophistication

Most companies organize their production and supply

operations on a project-by-project basis. As market

conditions change, they move plants from Detroit to

Mexico, and a few years later they shift subassembly to

Asia. They do not envision their manufacturing system

for what it must be: A global, flexible supply chain network that can be reconfigured anywhere in the world as

market conditions change. (We think of this dimension

as “structural,” because it involves such infrastructure-

oriented features as the location and size of plants and

the supply chain flow among them.)

Companies that realize this and design their plants

accordingly gain a tremendous time advantage. It can

take two years to close down a factory — and that’s typ-

ically after several years of wavering over the decision to

shutter it in the first place. It is far better to design the

configuration of individual plants so that it is easy to

enlarge, shrink, or reconfigure them based on the busi-

ness landscape. Then fewer factories ever have to be

abandoned and the manufacturing network needn’t be

completely overhauled. There’s also an expense advan-

tage as the one-time cost penalty of moving plants from

one place to another is reduced.

This approach, known as flexible footprints, is prac-

ticed with great success by a few dozen large organiza-

tions — among them, the U.S. Army, which constantly

and proactively reassigns military bases to fresh uses. Inan extremely novel implementation, a European manu-

facturer of specialized air conditioning supplies built its

factories on large freighter ships that can be moved from

port to port as the seasonal marketplace changes. The

company chooses not to broadcast this manufacturing

innovation publicly, perceiving it as a competitive

advantage. A Qatari company, Cement International,

has recently begun similar operations, putting a cement

factory onboard a ship that docks in ports around the

Persian Gulf, wherever building materials are needed.



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Unfortunately, we observe that there is little coop-

eration among companies within a supply chain to

jointly optimize plant networks, another potentially

lucrative example of flexible footprints. In the outdoor

equipment industry and in basic chemicals, some com-

panies have shared parts of their production capacity,

sometimes spinning off manufacturing. But capacity

pooling is a rarity outside those two industries.

In-plant Transformation

It is now more than 30 years since the notion of manu-

facturing excellence — variously attributed to theToyota production system, socio-technical systems,

quality management, lean manufacturing, and high-

performance systems — became widely known in

Europe and the United States. By now, practically every

manufacturing manager can tell you about pokayoke,

kanban, or self-steering teams. But plants that have suc-

cessfully implemented the manufacturing practices that

produce efficient and optimal operations are few and far

between. And most of these are greenfield sites: previ-

ously undeveloped locations where elite processes could

be designed into the factory from the beginning. The

competitive advantage of process optimization remains

high, in part, because of the woefully poor record of the

manufacturing industry in general.

We think of in-plant transformation as “systemic,”

because it takes place when people see the processes on

the shop floor as interrelated parts of a whole system.

Why has this kind of in-plant transformation lagged so

badly, even though its successes are so visible? Manu-

facturing myopia is the primary reason. Typically,

process improvement is seen by company executives as a

“go ahead, just do it” manufacturing issue managed sole-ly by the plants.

This isolation contributes to the lack of patience

among decision makers, who feel pressured to show

results before the systemic change is ready. By contrast,

a well-designed manufacturing change initiative is delib-

erately set up like a developmental path, with a menu of

results expected in the short term, medium term, and

long term. Some systemic drivers can have an effect on

costs almost instantly (e.g., changing maintenance con-

tractor purchasing procedures); some take a bit longer

The Roots of Myopia

ow did manufacturing myopia

become so prevalent? There

are several roots. Probably most per-

nicious was the separation of manu-

facturing, marketing, and finance in

corporate structures that date back to

the mid-20th century. “Turf wars”

often unconsciously reinforce those

divisions, particularly when the stakes

are high.

Here’s one typical story we recentlyencountered in a consumer products

company: The vice president of manu-

facturing stated at a meeting that his

factories could deliver at lower costs,

“but only if R&D can come up with a

better factory blueprint and reduce

the number of product parts.” Also, he

said, it would help if sales provided

reliable forecasts “and didn’t ask us

for last-minute changes for important

clients.” And finance would be less of

a hindrance if the CFO would finally

approve funding for new machines to

simplify operational bottlenecks.

The company’s vice president of

sales responded that manufacturing

needed to eliminate its oversized

workforce and sharply curtail labor

costs by shifting more of the produc-

tion to low-cost countries. Only then

could his team sell significantly more.

The vice president of R&D ex-

pressed the opinion that manufactur-

ing still had not managed to suffi-ciently operate the existing production

technology. “We’re simply not up to

world-class standards,” he said.

Later, the CEO said privately that he

was fed up with all these points of

view. None of them had much to do

with the problem as he saw it: an

unsustainable status quo of rising

fixed costs and a widening gap

between projected and actual profits.

Manufacturing companies are usu-

ally not set up with the kinds of incen-

tives and decision rights that would

encourage executives to review plant

operations with a full understanding

of the company’s competitive cost

drivers. Consequently, a narrow, self-

interested view of plant performance

tends to prevail, even when everyone

involved has the best interests of the

whole company at heart.

Business education reinforces the

division. Students interested in manu-

facturing are tracked into a “ghetto” inmany business schools; they don’t

share many classes or associate

much with their counterparts in

finance and strategy. Nor do they

expect to cross over to other positions

when they enter the working world.

“Once a plant manager, always a plant

H



(e.g., installing “pull” systems, in which the production

line sets its own pace, to replace the top-down controls

of a manufacturing resource planning approach). Even

in full-scale manufacturing transformation initiatives, it

should not take more than two years for the first visible

effects to appear. The leaders of many manufacturing

projects stop paying attention after that. But in a well-

designed initiative, those first results become a base for

continuous improvement.

In a so-called brownfield site (an established factory

with a long-standing workforce), one may often find

high fixed costs or blatant overstaffing. Installing “intel-ligent tools,” “lean solutions,” or “high-performance sys-

tems” will not solve these problems. If there are already

more workers than work to do, improving production

speed or throughput will not lead to higher levels of pro-

ductivity, in part because overcapacity breeds “process

creep,” in which workers and managers merely overlay

the new work rules and practices on top of their old rou-

tines. Despite knowing this, all too often, manufacturers

myopically push a “lean” program through plants that

are overstaffed and have a high share of non-value-added

work. We call this the fat ballerina syndrome: Only

slimmed-down organizations stand a chance of perform-

ing smart moves.

Companies also are often greedy or formulaic when

it comes to assigning improvement objectives to plants.

It’s not atypical for a factory manager to be told to save

10 percent of fixed costs, while improving output and

quality by 20 percent. Often a basic analysis will reveal

that enhancing a plant’s productivity dwarfs the value

of firing a group of maintenance technicians and engi-

neers, and more importantly that increasing productiv -

ity and cutting personnel are not mutually compatibleobjectives. For one thing, plant communities often resist

cooperating with management to alter their work

methods and increase output while their colleagues are

being let go.

Labor Modernization

Let’s face it: In most plants, industrial relations and

treatment of the workforce are reminiscent of the 19th

century. This statistic illustrates the point: From 1999

to 2004, there were more strikes in most western

manager,” people say. Manufacturing

functions consequently suffer in the

“war for talent”; they recruit from a

smaller pool. The result is often an

unnecessary tension between manu-

facturing and finance; manufacturing

executives may have far more contact

with, and feel more loyalty to, employ-

ees than shareholders. And finance

executives may not appreciate the

strategic importance of manufacturing

talent, particularly on the shop floor.

This tendency was exacerbated

during the service boom of the 1990s,

when it became fashionable to assert

that mere manufacturing was not

strategically important. Some compa-nies followed cost-cutting strategies

that downplayed the importance of

their long-standing manufacturing

knowledge, and then found them-

selves needing to rebuild it. This was

one of the key components of the

decline of the American manufacturer

Sunbeam. After being acquired by

Allegheny International in the early

1980s, the company’s manufacturing

division was “starved of capital to

update its factories and refresh its

product line,” as management writer

John Byrne put it. This ultimately

led the shareholders to appoint cost-

cutting turnaround artist Al Dunlap as

CEO in 1996; manufacturing capacity

suffered even more erosion during

Dunlap’s time as CEO. In his book

Chainsaw: The Notorious Career of Al

Dunlap in the Era of Profit-at-Any-Price

(HarperBusiness, 1999), Byrne de-

scribes how Sunbeam shut down a

high-quality, efficient hair-clipperplant in McMinnville, Tenn., and moved

production to a chaotic, money-losing,

poorly managed new facility near

Mexico City.

To counterbalance all these trends,

some companies now make deliber-

ate efforts to integrate manufacturing

with the rest of the enterprise. Toyota

sends manufacturing employees and

managers on sales calls — to areas

including those where their products

have low penetration. ASML, a Dutch

company that is a leading producer of

lithography and semiconductor man-

ufacturing equipment, went from a 10

percent to a 70 percent market share

in its product categories, in part by

bridging this gap. ASML’s head of

manufacturing started as an account-

ant, then led a finance function, and

only then moved into production. This

perspective recently helped the com-

pany reduce lead times and generally

improve the integration of manufac-turing with other functions.

—K.G., C.W., and P.V.H.



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European countries than occurred between 1950 and

1975. In one German aerospace plant, where three gen-

erations have worked on the shop floor, absenteeism andillness rates have risen a steady 3 percent per generation.

Overall, Western companies made few strides in align-

ing factory workers more closely to the companies that

employ them. Only 20 percent of production workers in

western Europe and the U.S. receive compensation

linked to performance, and more than 75 percent work

under a compensation system that is so rigid it uninten-

tionally drives people to take overtime.

We use the term realized because the modernization

of a labor force takes place only in the real-world dimen-

sion of the community around each manufacturing

location. The principles of effective workforce manage-

ment are universal: The improvement of labor practices

and customization of human resource policies are essen-

tial to developing creative, innovative, and motivated

employees. But the most appropriate methods for

accomplishing those things are decidedly local. Labor

issues vary significantly from one place to another.

Workforces in different locales have their own particular

cultures, holidays, workdays, family structures, commu-

nity resources, demographics, education levels, and as-sumptions about the type of work they will do. Pro-

ductivity can also deviate dramatically among regions.

Over the years, effective manufacturers have exper-

imented with a wide variety of means for engaging shop

floor employees. Some companies establish worker-

focused principles. At one Dutch chemical company,

the budget line for work space and plant maintenance

and modernization was sacrosanct and could not be cut.

This was important because workers perceived the com-

pany as a reliable protector of their safety. A cosmetics

manufacturer demonstrated the same kind of commit-

ment by installing an on-site health spa, free to employ-

ees. We have seen plants in which windows and skylightsare carefully placed to make the most of natural light,

the architecture fits local styles, and social spaces reflect

the way employees naturally interact.

These types of factories, which fit their social and

physical environment so well, are usually owned by

companies that realize the value of an inspired workforce

to the finished product. Such companies often make

concerted efforts to link employees with more in-depth

knowledge of the company and the product. Danone,

Procter & Gamble, Harley-Davidson, and Mercedes-

Benz are all known for plant communities that take part

in word-of-mouth and face-to-face sales campaigns and

provide testimonials for marketing and public relations

programs. Mercedes, for example, encourages customer-

to-factory interaction by suggesting that car buyers pick

up their new vehicles at, say, the Sindelfingen plant,

where they can talk to plant workers about quality and

other issues pertaining to the making of their automo-

biles. Very successful companies create products that

command an emotional premium, and they make cer-

tain that their manufacturing employees are among thefirst to emotionally promote them. Ultimately, how can

your product be loved by your customers if thousands of

your own employees who make the product don’t love

producing it?

In a brownfield site, labor modernization often rep-

resents a daunting challenge. Managers may believe that

they can employ greenfield policies (those applicable to

a new factory) in a brownfield plant, but this assump-

tion is flawed. The brownfield workforce is generally

older; they may have already lived through shutdowns,



layoffs, and closures. Moreover, unions don’t usually for-

get the bitter relations they had with the prior plant

management and are less willing to forge alliances with

the new factory team. In some locations, sophisticated

lean production concepts, implemented in a one-size-

fits-all pattern, have been viewed by the cynical, dispir-

ited workforce as micromanagement and paternalism.

For a brownfield renewal to succeed, the surround-

ing community has to be fundamentally remotivated

and more closely tied to the enterprise through new

compensation systems and governance roles. The

German agricultural equipment maker Claas demon-

strated the value that can be unlocked if the right formu-la is found. In the midst of substantial growth and as

part of a constant drive to improve flexibility, Claas spun

off a large part of the factory through a management

buyout and made the newly independent plant a pri-

mary supplier. The newly formed business unit was able

to secure quality standards and to better balance its

capacity, signing up additional customers besides Claas.

Meanwhile, employee motivation improved in the fac-

tory as managers used the space they had reclaimed to

fundamentally reengineer activities, aiming at a one-

piece-flow philosophy. The plant’s positive development

defied the long slump in commodity machining and

metalworking factories in the region.

Manifesto for Manufacturers

A company seeking to overcome its manufacturing

myopia may find the task daunting at first, but easier

over time. The goal is not to “fix” manufacturing, but to

build the capacity for long-term and medium-term

manufacturing management among engineers, suppli-

ers, and staff (including unionized staff), and to redesign

the technology to take advantage of these capabilities

and augment them.There are no universal rules for doing this because

each manufacturer has a unique combination of in-

house capabilities, labor histories, supply chain relation-

ships, market demands, and technological innovations.

A holistic manufacturing strategy emerges only from an

analysis that assesses the critical operational data buried

in the four dimensions of manufacturing design: inher-

ent, structural, systemic, and realized. (See Exhibit 2.)

Consider the recent case of a European auto manu-

facturer. The company was desperate for a way to cut

Exhibit 2: A Framework for Building Awareness

Technological distinction: the

machines and production

techniques that either allow for

unique combinations of features

or reduce costs.

Inherent Maintaining command over

technological adeptness;

continuing to improve and

increase quality; reducing

complexity.

Capital investment requires a

five- to 10-year outlook.

Network sophistication:

recognizing that a company’s

manufacturing competence

depends on its total supply and

production chain, not on individual

components of that chain.

Structural Continuing willingness to adapt

factory networks to new products

and markets as conditions

demand; design for flexible

footprints and capabilities.

Up-front investment in greenfields

may require slightly more time

than converting old plants to this

way of thinking; structural change

gradually becomes ingrained,

taking place on an ongoing basis.

In-plant transformation:

continuous improvement of

process quality and effectiveness.

Systemic The adoption of lean production

techniques, self-organizing teams,

and many of the other process

innovations of the past 30 years.

With comprehensive, long-term

initiatives, some initial results can

be seen within months. Efforts

begin to pay off in one to two years

and continue to produce gainsthereafter.

Labor modernization: recognition

of each plant’s unique community

and workforce needs, and the

ability to meet those needs more

than halfway.

Realized Policies and plant designs that

attract workers, engage local

governments, and enhance

communities; executive recruiting

and training practices oriented

toward these goals.

This requires immediate moves,

but it may be five years or more

before a cynical community is

willing to admit that the plant is

actually worthy of their respect

and commitment.

DefinitionDimension Commitment Time Frame





Resources

John A. Byrne, Chainsaw: The Notorious Career of Al Dunlap in the Era of

Profit-at-Any-Price (HarperBusiness, 1999): Myopia and its consequences

at the formerly competent manufacturer Sunbeam.

Neil Hopkinson, Richard Hague, and Philip Dickens, editors, Rapid

Manufacturing: An Industrial Revolution for the Digital Age (John Wiley &

Sons, 2006): Flexible and customized manufacturing, grounded in

computer-based prototyping techniques.

Bill Jackson and Conrad Winkler, “Building the Advantaged Supply

Network,” s+b , Fall 2004, www.strategy-business.com/press/article/04304:

Focused, flexible, and lower-cost manufacturing through supply chain

network innovations.

Art Kleiner, The Age of Heretics: Heroes, Outlaws, and the Forerunners of

Corporate Change (Doubleday, 1996): History of socio-technical systems

and Procter & Gamble’s manufacturing innovations.

Art Kleiner, “Leaning Toward Utopia,” s+b , Summer 2005, www.strategy-business.com/press/article/05208: Profile of “lean” experts James P.

Womack and Daniel T. Jones.

Jeffrey Liker, The Toyota Way: 14 Management Principles from the World’s

Greatest Manufacturer (McGraw-Hill, 2003): Comprehensive, accessible

look at a company with renowned production awareness.

Josh Whitford, The New Old Economy: Networks, Institutions, and the

Organizational Transformation of American Manufacturing (Oxford

University Press, 2005): Myopia in the U.S. Rust Belt.

James P. Womack and Daniel T. Jones, Lean Solutions: How Companies

and Customers Can Create Value and Wealth Together (Free Press, 2005):

Evokes a world of customer-oriented manufacturing foresight.

tion by how well employees responded to the new sys-

tem. As the plant matured and its capabilities grew, pro-

ductivity was expected to increase. Managementassumed that either head count would decrease or pro-

duction quality would increase during the first five

years, depending on the level of sales and scope of the

plant’s market. Indeed, as employees became more

familiar with the processes, the cost of production

dropped and quality stayed high.

This type of approach represents an alternative to

the prevailing despondent mood at many manufactur-

ing companies. Indeed, perhaps the most tragic result of

manufacturing myopia, for many companies, is the lost

opportunity for manufacturing leadership. Computer

technology, materials science, and energy innovation

have progressed dramatically over the past 20 years.

There are many futuristic manufacturing options avail-

able. They include “instant” and “inkjet” manufactur-

ing, where computer-based molding machines turn out

individually customized plastic components with the

speed of mass fabrication; biomimicry, in which indus-

trial processes reproduce the cell-by-cell process by

which, for example, a seashell is formed; and environ-

mentally friendly fermentation-based fabrication meth-ods that eschew toxic chemicals and reuse waste more

effectively. In many industries, there exists great unful-

filled potential for moving beyond commoditization by

rethinking manufacturing prowess as part of the com-

pany’s identity. Few companies today are trying to real-

ize that potential; there are few 21st-century equivalents

to the original Ford Motor Company, with its break-

throughs in assembly-line manufacturing, or even to the

1990s-era Intel. We believe that manufacturing myopia

helps explain why.

Over the past 20 years, manufacturing managers

have learned that even the most effective supply chain

management will not lead to results unless these capabil-ities are implemented — not just within the function,

but at the level of the executive suite. In a confrontation-

al, competitive environment, the choice is engaging in

manufacturing competence as the core of your corporate

identity — or continuing to pay the price of myopia. +

Reprint No. 06105

Computer technology, materialsscience, and energy innovation have progressed

dramatically, but few companies are trying torealize their potential.



I l l u s t r a t i o n s b y M i c h a e l K l e i n

P&G’SINNOVATION

CULTURE

As they lead to repeat purchases, these offeringsreshape the market, so that the company is playing an

entirely new (and profitable) game to which others must

adapt. A number of game-changing innovators are oper-

ating today, including such household-name enterprises

as Procter & Gamble, Nokia, the Lego Group, Apple,

Hewlett-Packard, Honeywell, DuPont, and General

Electric. Wherever you see a steady flow of noteworthy

innovations from one company, you can probably

assume that it is a game-changing innovator, with the

distinctive kinds of social connections, culture, and sup-

porting behaviors that enable it to play that role.Consider the case of Procter & Gamble

Company. Since A.G. Lafley became chief execu-tive officer in 2000, the leaders of P&G have

worked hard to make innovation part of the daily routine and to establish an innovation culture.Lafley and his team preserved the essential part of P&G’s research and development capability —

world-class technologists who are masters of thecore technologies critical to the household and

personal-care businesses — while also bringing

How we built a world-class

organic growth engineby investing in people.

THE HEART OF A COMPANY ’S BUSINESS MODEL should be game-changinginnovation. This is not just the invention of new products andservices, but the ability to systematically convert ideas into new offerings that alter the very context of the business.

BY A.G. LAFLEY, WITH AN INTRODUCTION BY RAM CHARAN





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more P&G employees outside R&D into the inno-vation game. They sought to create an enterprise-

wide social system that would harness the skills andinsights of people throughout the company andgive them one common focus: the consumer.

Without that kind of culture of innovation, a strat-egy of sustainable organic growth is far more diffi-cult to achieve.

A.G. Lafley and I coauthored The Game- Changer: How You Can Drive Revenue and Profit Growth with Innovation (Crown Business, 2008) toexplain how to make game-changing innovation

drive growth on a consistent, well-paced basis. Thecritical factors that we cover in the book includekeeping a laser-sharp focus on the customer; estab-lishing a disciplined, repeatable, and scalable inno-vation process; creating organizational and fundingmechanisms that support innovation; and demon-strating the kind of leadership necessary for prof-itable top-line growth as well as cost reduction.

One aspect of building an innovation culturedeserves more attention than we could give it inThe Game-Changer : designing a social system that

would spark new ideas and enable critical deci-sions. In the article that follows, A.G. explains thehuman factors that fostered innovation at Procter& Gamble. It could be thought of as the “missingchapter” to The Game-Changer ; a vital componentthat isn’t always obvious, even to experts, precisely because it is so fundamental.

—Ram Charan

hen I became CEO of Procter & Gamble

in 2000, we were introducing new brands

and products with a commercial success rateof 15 to 20 percent. In other words, for every six new

product introductions, one would return our invest-

ment. This had been the prevailing ratio in our industry,

consumer packaged goods, for a long time.

Today, our company’s success rate runs between 50

and 60 percent. About half of our new products suc-

ceed. That’s as high as we want the success rate to be. If

we try to make it any higher, we’ll be tempted to err on

the side of caution, playing it safe by focusing on inno-

vations with little game-changing potential.

The decision to focus on innovation as a core

strength throughout the company has had a direct influ-

ence on our performance. P&G has delivered, on aver-

age, 6 percent organic sales growth since the beginning

of the decade, virtually all of it driven by innovation.

Over the same period, we’ve reduced R&D spending as

a percentage of sales; it was about 4.5 percent in the late

1990s and only 2.8 percent in 2007. In that year, we

spent US$2.1 billion on innovation, and received $76.5

billion in revenues. We’re getting more value from every

dollar we invest in innovation today.The focus on innovation has also had a direct effect

on our portfolio of businesses. The Game-Changer de-

scribes how we sold off most of P&G’s food and bever-

age businesses so we could concentrate on products that

were driven by the kinds of innovation we knew best. As

it turns out, with this narrower mix of businesses, we can

more easily devote the resources and attention needed to

build a broad-scale innovation culture.

We also focused on creating a practice of open inno-

vation: taking advantage of the skills and interests of

A.G. Lafley

editors@

strategy-business.com

was the chairman and CEO ofProcter & Gamble Companywhen this article waspublished. He was namedExecutive of the Year by theAcademy of Management in2007. He is the coauthor, withRam Charan, of The Game-

Changer: How You Can Drive

Revenue and Profit Growth

with Innovation (CrownBusiness, 2008).

Ram Charan

www.ram-charan.com

is a Dallas-based advisor toboards and CEOs of Fortune500 companies and the authoror coauthor of 14 books,including the bestsellersExecution (with Larry Bossidy;Crown Business, 2002),Confronting Reality (with LarryBossidy; Crown Business,2004), and Know-How (CrownBusiness, 2007).

Also contributing to this articlewas Geoffrey Precourt.

Originally published Autumn2008.

W



people throughout the company and looking for part-

nerships outside P&G. This was important to us for sev-

eral reasons.First, we needed to broaden our capabilities. Each

of our businesses was already practicing some form of

innovation improvement, but they were not all improv-

ing at the same rate. As the CEO, I could lead and

inspire the company as a whole, but I could not substi-

tute my judgment for that of other leaders who knew

and understood their specific businesses far better than I

could. The decision makers in each business would have

to examine their competitive landscape and their own

capabilities to figure out what kinds of innovation

would work best and win with consumers.

Second, building an open innovation culture was

critical for realizing the essential growth opportunity

presented by emerging markets. During the next 10

years, between 1 billion and 2 billion people in Asia,

Latin America, eastern Europe, and the Middle East will

move from rural, subsistence living to relatively urban

and increasingly affluent lives. They will have more

choices, a greater connection with the global economy,

and the ability to realize more aspirations. Along the

way, they will become, for the first time, regular con-sumers of branded products in categories such as per-

sonal care, fabric care, and prepared food.

It would seem relatively simple to execute a strategy

for reaching these new consumers. But the days of

achieving automatic growth by entering new markets

are essentially over. Just as retailers often reach a level of

saturation — where it doesn’t make sense to open any

more stores in a particular market — many mature con-

sumer products companies are rapidly running out of

the so-called white space in new regions. P&G, for

example, already has a market presence in more than

160 countries, with large operations on the ground in

more than 80 of them. We can grow our business inthese countries only by consistently developing new

products, processes, and forms of community presence.

And to do that, we need to involve people, inside the

company and out, who are comfortable and familiar

with the values and needs of consumers in these parts of

the world.

A third reason for focusing on open innovation had

to do with fostering teams. The kinds of innovation

needed at Procter & Gamble must be realized through

teams. The idea for a new product may spring from the

mind of an individual, but only a collective effort can

carry that idea through prototyping and launch. If inno-

vation is to be integrated with both business strategy and

work processes, as we believe it should be, it requires a

broad network of social interactions.

Moreover, our experience suggests that many of the

failures of innovation are social failures. Promising ideas,

with real potential business value, often get left behind

during the development process. Some innovations are

timed too early for their market; others are lost in exe-

cution. Often, the root cause is poor social interaction;the right people simply don’t engage in productive dia-

logue frequently enough.

For all these reasons, we consciously set in place a

series of measures for building an open innovation cul-

ture at P&G.

“The Consumer Is Boss”

Procter & Gamble is known for its highly capable and

motivated workforce. But in the early 2000s, our people

were not oriented to any common strategic purpose. We

The days of achieving automatic growthby entering new markets are over. We can grow in

these countries only with new products,processes, and forms of community presence.





We began by clearly and precisely defining the tar-

get consumer for each fragrance brand, and identifying

subgroups of consumers for some brands. We didn’t walk away from the traditional approaches of the fine

fragrance business. We still maintained partnerships

with established fashion houses, such as Dolce &

Gabbana, Gucci, and Lacoste. But we also made the

consumer our boss. We focused on a few big launches

and on innovation that was meaningful to consumers,

including fresh new scents, distinctive packaging,

provocative marketing, and delightful in-store experi-

ences. We also took advantage of our global scale and

supply chain to reduce complexity and enable a signifi-

cantly lower cost structure.

The result? Our team turned a small, underper-

forming business into a global leader. In 2007, P&G

became the largest fine fragrance company in the world,

with more than $2.5 billion in sales — a 25-fold

increase in 15 years.

Elsewhere in our company, we experimented with

new ways to build social connections through digital

media and other forms of direct interaction. We

designed websites to reinforce consumer connections, to

better understand consumers’ needs, and to experiment with prototypes. For example, we used to hand-make

baby diapers for a product test. Now, we show people

digitally created alternatives in an onscreen virtual

world. If the consumers we’re talking to have an idea, we

can redesign it immediately and ask them, “Do you like

that better? How would you use it?” It allows

us to iterate very quickly. In effect, we are building a

social system with the purchasers (and potential pur-

chasers) of our products, enabling them to codesign and

co-engineer our innovations.

Integrating Innovation

We are constantly innovating how we innovate. We keep

refining our product-launch model — from idea to pro-totype, to development, to qualification, to commercial-

ization. Applying this sequential practice on a large

scale, and making it replicable, does not mean eliminat-

ing judgment. In fact, there’s still a fair amount of judg-

ment that’s applied along the way. That’s why we need

active leaders and a strong innovation culture.

Scalability is critical at a company the size of Procter

& Gamble. If we can’t scale our processes, they don’t

have much value for us. In fact, scalability is often the

justification for our existence as a multinational, diversi-

fied company. Our innovation practices are thus

designed for deliberate learning, across all our functions,

product categories, and geographic locations. Once peo-

ple understand a particular process, they can replicate it

and train others. It soon becomes a part of normal deci-

sion making.

P&G had not treated innovation as scalable in the

past. We had always invested a great deal in research and

development. When I became CEO, we had about

8,000 R&D people and roughly 4,000 engineers, all

working on innovation. But we had not integrated theseinnovation programs with our business strategy, plan-

ning, or budgeting process well enough. At least 85 per-

cent of the people in our organization thought they

weren’t working on innovation. They were somewhere

else: in line management, marketing, operations, sales,

or administration. We had to redefine our social system

to get everybody into the innovation game.

Today, all P&G employees are expected to under-

stand the role they play in innovation. Even when you’re

operating, you’re always innovating — you’re making



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the cycles shorter, or developing new commercial ideas,

or working on new business models. And all innovation

is connected to the business strategy.

In fostering this approach and building the social

system to support it, the P&G leadership has had to

be very disciplined. For instance, we are now set up to

see many more new ideas. Our external business de-

velopment group is very small; all it does is meet with

individuals, groups, research labs, and other potential

collaborators, including (as we noted in The Game-

Changer ) P&G’s competitors on occasion. Any of these

may propose new technologies, new product prototypes,

or new ways to connect us to our consumer base. In2007, the business development group reviewed more

than 1,000 external ideas. In 2008, they saw 1,500. We

tend to act on about 5 to 7 percent of them.

We are also open to ideas from more regions than in

the past. Innovation used to travel primarily from devel-

oped markets to developing markets. When new tech-

nology appeared in Japan, Germany, or the U.S., it

flowed across the regions and down the hierarchy.

Today, more than 40 percent of our innovation comes

from outside the United States. People in India, China,

Latin America, and some African countries have become

part of our social system. Their presence has made us

more open, and this helps compensate for our natural

tendency to become more insular.

We maintain open work systems in a lot of places

around the world. Executives’ offices don’t have doors.

Leaders don’t have a secretary cordoning them off. All

the offices on the executive floor at Procter & Gamble

are open; the conference room is an open, round space.

We made it round as a small symbol of the new

approach. We’re seeing indications that this new social

process is catching on all over the world.

The Talent Component

P&G used to recruit for values, brains, accomplishment,

and leadership. We still look for these qualities, but we

also look for agility and flexibility. We believe the “soft”

skills of emotional intelligence — fundamental social

skills such as self-awareness, self-fulfillment, and empa-

thy — are needed to complement the traditional IQ

skills. (See “Tea and Empathy with Daniel Goleman,”

by Lawrence M. Fisher, s+b, Autumn 2008.) Maybe

“soft” isn’t the right word: These skills are every bit as

Becoming aGreat InnovationTeam Leader

s you read about Procter &

Gamble’s social system and

innovation culture, you may be think-

ing, “There are some good ideas

here…for someone else. In my shop,

we can barely keep the trains running

on time. How am I supposed to do all

this?”

Leaders of innovation take their

game to another level through a par-ticular set of practices:

• Establish clear criteria and don’t

hesitate to shift resources. Great

innovation leaders keep a sharp eye

on their short-term and long-term

business goals and think through how

and when various innovation projects

will contribute to them. They deter-

mine which projects to accelerate or

cut on the basis of resource consump-

tion as well as market potential. They

don’t hesitate to pull the plug on proj-

ects that don’t clear the hurdles or

that simply consume more time or

money than the business can afford.

• Concentrate on possibility. The

process of innovation is inherently

uncertain. Innovation leaders live with

ambiguity as ideas are shaped and

reimagined; they don’t let ideas die

before they’re fully formed or under-

stood. Once a project is selected,

these leaders inspire the team to keep

going even as they encounter obsta-cles and go through iterations. At the

same time, leaders are vigilant for

indications that the project’s market

potential has diminished.

• Cross boundaries and help oth-

ers do the same. Innovation becomes

riskier when there are gulfs between,

for example, technologists, marketing

people, and those responsible for

commercializing a new product.

Inevitably, trade-offs will be required

among these groups. Leaders thus

must ensure that communication

channels are open from the start and

that facts and sound judgment prevail.

They must be prepared to break dead-

locks and resolve conflicts by keeping

individuals focused on their common

goal: the customer.

• Reward effort and learning.

Failure is a fact of life for companies

that pursue innovation seriously, and a

leader’s response to it has a huge

effect on company culture and there-fore on future projects. Innovation

leaders know that failures represent

opportunities to learn. They keep peo-

ple energized by publicly recognizing

their earnest efforts and willingness to

venture from the tried and true.

—Ram Charan

A



hard to master as some tough analytical skills. People

just learn them in a different way.

Some people at Procter & Gamble have struggled with this new approach, but most of our best people

have done really well with it. Curiosity, collaboration,

and connectedness are easy to talk about but difficult to

develop in practice. We have tried to careful-

ly identify and ease out people who

are controlling or insecure, who

don’t want to share, open up,

or learn — who are not curi-

ous. And in the process, we

have discovered that most

of our people are natu-

rally collaborative.

We also try to de-

velop people by giving

them new stimulation

and greater challenges.

As they move through

their careers, we deliber-

ately increase the com-

plexity of their assign-

ments. That might meanentering a market that’s not

developed yet or a market with a

competitor already firmly established.

Whatever the challenge, it stretches them.

We give our most promising people time in both

functional and line positions, because we think our best

leaders are great operating leaders and great innovation

leaders. We also move people around geographically. We

bring people into our Cincinnati headquarters from

around the world, and we make a point of moving our

headquarters people to our global businesses. Almost all

of us have worked outside our home region. Almost all

of us have worked in developing or emerging markets. And almost all of us have worked across the businesses.

We track that progress very carefully.

We’ve been fortunate that some of this flexible,

multifaceted ethic exists in our heritage. For

example, Procter & Gamble pio-

neered a technician-based sys-

tem in its manufacturing

plants during the 1960s

and ’70s. In this system,

we avoided the ap-

proach in which one

person was assigned

to do only one job.

The technician sys-

tem still operates to-

day: To get the highest

evaluation rating in a

P&G factory, you learn

how to do all the jobs on

the line. And, once you have

that rating, we expect you tobe capable of problem identifi-

cation, problem solving, and in-

novation. This background has made it

easier for us to plug manufacturing and engineer-

ing into the innovation culture.

Once people have succeeded at innovation, you

can see the energy in the company changing. People

routinely say, “We can do this. This is feasible.” The atti-

tude changes are incredible to watch; once people see

the simplicity, durability, and sustainability of an inno-

Once people see the simplicity,durability, and sustainability of an innovation

mind-set, it continually reinforces itself.





people in a variety of functions and at least two regions.

It opened our team members’ eyes to other possibilities.

And it came to fruition because we were skilled at hav-ing the kinds of processes and conversations that would

lead people to synthesize their ideas.

Our long-standing middle managers, people who

have grown up in the P&G system (as I did), are start-

ing to recognize that better innovation processes can

expand their personal and leadership skills. They’ve all

been through cost-cutting and productivity exercises.

But that’s not the same as creating top-line opportuni-

ties that can earn kudos from consumers. Nobody is

telling them they have to be the geniuses who invent an

idea. They will get credit for turning ideas into replica-

ble processes and learning from their mistakes. In

operating cross-functionally, they are also moving away

naturally from the old silos.

The result of P&G’s focus on innovation has been

reliable, sustainable growth. Since the beginning of the

decade, P&G sales have more than doubled, from $39

billion to more than $80 billion; the number of billion-

dollar brands, those that generate $1 billion or more in

sales each year, has grown from 10 to 24; the number of

brands with sales between $500 million and $1 billionhas more than quadrupled, from four to 18. This

growth is being led by energized managers — innova-

tion leaders — who continually learn new ways to grow

revenues, improve margins, and avoid commoditization.

Our culture of innovation is helping P&G leaders be

more effective, and in the process, they’re renewing our

company every day.

Once people have succeeded at a game-changing

innovation, the level of energy in the company elevates.

Even people who weren’t directly involved are affected

through the social networks. It becomes easier for them

to expand their idea of what is feasible. Building this sort

of capability often has the rhythm of, say, skilled basket-ball practice: a group of people who gradually learn

seamless teamwork, reading one another’s intentions

and learning to complement other team members, ulti-

mately creating their own characteristic, effective, and

uncopyable style of successful play. +

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Resources

Daniel Goleman, Emotional Intelligence: Why It Can Matter More Than IQ

(Bantam Books, 1996): Developing individual maturity for an organiza-tional innovation culture.

Larry Huston and Nabil Sakkab, “P&G’s New Innovation Model,”Harvard Business Review, March 2006: Anatomy of an open approach forattracting ideas and consumer insights from around the world.

A.G. Lafley and Ram Charan, The Game-Changer: How You Can Drive

Revenue and Profit Growth with Innovation (Crown Business, 2008):Guide for giving large, mature companies the sustainable capacity forbreakthrough innovation.

Roger Martin, The Opposable Mind: How Successful Leaders Win through

Integrative Thinking (Harvard Business School Press, 2007): Gaining theability to overcome the limits of partisan thinking, to enhance innovationor anything else.

Steven Wheeler, Walter McFarland, and Art Kleiner, “A Blueprint for

Strategic Leadership,” s+b, Winter 2007, www.strategy-business.com/press/article/07405: Context for chief executives, drawing on A.G.Lafley’s example, among others.

Procter & Gamble website, www.pg.com: Includes Connect + Develop, aportal for engaging innovation partners, and Everyday Solutions, through

which the company connects with consumers.

For more thought leadership on this topic, see the s+b website:

www.strategy-business.com/innovation.



I l l u s t r a t i o n b y L e i g h W e l l s

BY DAVID ROCK

Naomi Eisenberger, a leading social neuroscience

researcher at the University of California at Los Angeles

(UCLA), wanted to understand what goes on in the

brain when people feel rejected by others. She designed

an experiment in which volunteers played a computer

game called Cyberball while having their brains scannedby a functional magnetic resonance imaging (fMRI)

machine. Cyberball harks back to the nastiness of the

school playground. “People thought they were playing a

ball-tossing game over the Internet with two other peo-

ple,” Eisenberger explains. “They could see an avatar

that represented themselves, and avatars [ostensibly] for

two other people. Then, about halfway through this

game of catch among the three of them, the subjects

stopped receiving the ball and the two other supposed

players threw the ball only to each other.” Even after

they learned that no other human players were involved,

the game players spoke of feeling angry, snubbed, or

judged, as if the other avatars excluded them because

they didn’t like something about them.

This reaction could be traced directly to the brain’s

responses. “When people felt excluded,” says Eisen-berger, “we saw activity in the dorsal portion of the ante-

rior cingulate cortex — the neural region involved in the

distressing component of pain, or what is sometimes

referred to as the ‘suffering’ component of pain. Those

people who felt the most rejected had the highest levels

of activity in this region.” In other words, the feeling of

being excluded provoked the same sort of reaction in the

brain that physical pain might cause. (See Exhibit 1.)

Eisenberger’s fellow researcher Matthew Lieberman,

also of UCLA, hypothesizes that human beings evolved

Neuroscience research is

revealing the social nature of thehigh-performance workplace.

Managingwith the Brain in Mind



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this link between social connection and physical dis-

comfort within the brain “because, to a mammal, being

socially connected to caregivers is necessary for survival.”This study and many others now emerging have made

one thing clear: The human brain is a social organ. Its

physiological and neurological reactions are directly and

profoundly shaped by social interaction. Indeed, as

Lieberman puts it, “Most processes operating in the

background when your brain is at rest are involved in

thinking about other people and yourself.”

This presents enormous challenges to managers.

Although a job is often regarded as a purely economic

transaction, in which people exchange their labor for

financial compensation, the brain experiences the work-

place first and foremost as a social system. Like the

experiment participants whose avatars were left out of

the game, people who feel betrayed or unrecognized at

work — for example, when they are reprimanded, given

an assignment that seems unworthy, or told to take a pay

cut — experience it as a neural impulse, as powerful and

painful as a blow to the head. Most people who work in

companies learn to rationalize or temper their reactions;

they “suck it up,” as the common parlance puts it. But

they also limit their commitment and engagement.They become purely transactional employees, reluctant

to give more of themselves to the company, because the

social context stands in their way.

Leaders who understand this dynamic can more

effectively engage their employees’ best talents, support

collaborative teams, and create an environment that fos-

ters productive change. Indeed, the ability to intention-

ally address the social brain in the service of optimal

performance will be a distinguishing leadership capabil-

ity in the years ahead.

David Rock

davidrock@

workplacecoaching.com

is the founding president ofthe NeuroLeadership Institute(www.neuroleadership.org). Heis also the CEO of ResultsCoaching Systems and theauthor of Your Brain at Work

(HarperBusiness, 2009) andQuiet Leadership: Six Steps to

Transforming Performance at

Work (Collins, 2006).

Originally published Autumn2009.

Triggering the Threat Response

One critical thread of research on the social brain starts

with the “threat and reward” response, a neurologicalmechanism that governs a great deal of human behavior.

When you encounter something unexpected — a

shadow seen from the corner of your eye or a new col-

league moving into the office next door — the limbic

system (a relatively primitive part of the brain, common

to many animals) is aroused. Neuroscientist Evian

Gordon refers to this as the “minimize danger, maximize

reward” response; he calls it “the fundamental organiz-

ing principle of the brain.” Neurons are activated and

hormones are released as you seek to learn whether this

new entity represents a chance for reward or a potential

danger. If the perception is danger, then the response

becomes a pure threat response — also known as the

fight or flight response, the avoid response, and, in its

extreme form, the amygdala hijack, named for a part of

the limbic system that can be aroused rapidly and in an

emotionally overwhelming way.

Recently, researchers have documented that the

threat response is often triggered in social situations, and

it tends to be more intense and longer-lasting than the

reward response. Data gathered through measures of brain activity — by using fMRI and electroencephalo-

graph (EEG) machines or by gauging hormonal secre-

tions — suggests that the same neural responses that

drive us toward food or away from predators are trig-

gered by our perception of the way we are treated by

other people. These findings are reframing the prevailing

view of the role that social drivers play in influencing

how humans behave. Matthew Lieberman notes that

Abraham Maslow’s “hierarchy of needs” theory may

have been wrong in this respect. Maslow proposed that





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makes it difficult to focus their attention. They are less

susceptible to burnout because they are able to manage

their stress. They feel intrinsically rewarded.Understanding the threat and reward response can

also help leaders who are trying to implement large-scale

change. The track record of failed efforts to spark

higher-perfomance behavior has led many managers to

conclude that human nature is simply intractable: “You

can’t teach an old dog new tricks.” Yet neuroscience has

also discovered that the human brain is highly plastic.

Neural connections can be reformed, new behaviors can

be learned, and even the most entrenched behaviors

can be modified at any age. The brain will make these

shifts only when it is engaged in mindful attention. This

is the state of thought associated with observing one’s

own mental processes (or, in an organization, stepping

back to observe the flow of a conversation as it is hap-

pening). Mindfulness requires both serenity and con-

centration; in a threatened state, people are much more

likely to be “mindless.” Their attention is diverted by the

threat, and they cannot easily move to self-discovery.

In a previous article (“The Neuroscience of

Leadership,” s+b, Summer 2006), brain scientist Jeffrey

Schwartz and I proposed that organizations could mar-shal mindful attention to create organizational change.

They could do this over time by putting in place regular

routines in which people would watch the patterns of

their thoughts and feelings as they worked and thus

develop greater self-awareness. We argued that this was

the only way to change organizational behavior; that the

“carrots and sticks” of incentives (and behavioral psy-

chology) did not work, and that the counseling and

empathy of much organizational development was not

efficient enough to make a difference.

Research into the social nature of the brain suggests

another piece of this puzzle. Five particular qualities

enable employees and executives alike to minimize thethreat response and instead enable the reward response.

These five social qualities are status, certainty, autono-

my, relatedness, and fairness: Because they can be

expressed with the acronym SCARF, I sometimes think of

them as a kind of headgear that an organization can

wear to prevent exposure to dysfunction. To understand

how the SCARF model works, let’s look at each charac-

teristic in turn.

Status and Its Discontents

As humans, we are constantly assessing how social

encounters either enhance or diminish our status. Re-

search published by Hidehiko Takahashi et al. in 2009

shows that when people realize that they might compare

unfavorably to someone else, the threat response kicks

in, releasing cortisol and other stress-related hormones.

(Cortisol is an accurate biological marker of the threat

response; within the brain, feelings of low status provoke

the kind of cortisol elevation associated with sleep dep-

rivation and chronic anxiety.)

Separately, researcher Michael Marmot, in his book The Status Syndrome: How Social Standing Affects Our

Health and Longevity (Times Books, 2004), has shown

that high status correlates with human longevity and

health, even when factors like income and education are

controlled for. In short, we are biologically programmed

to care about status because it favors our survival.

As anyone who has lived in a modest house in a

high-priced neighborhood knows, the feeling of status is

always comparative. And an executive with a salary of

US$500,000 may feel elevated. . .until he or she is

Neuroscience has discovered thatthe brain is highly plastic.

Even the most entrenched behaviorscan be modified.



assigned to work with an executive making $2.5 million.

A study by Joan Chiao in 2003 found that the neural

circuitry that assesses status is similar to that whichprocesses numbers; the circuitry operates even when the

stakes are meaningless, which is why winning a board

game or being the first off the mark at a green light feels

so satisfying. Competing against ourselves in games like

solitaire triggers the same circuitry, which may help

explain the phenomenal popularity of video games.

Understanding the role of status as a core concern

can help leaders avoid organizational practices that stir

counterproductive threat responses among employees.

For example, performance reviews often provoke a

threat response; people being reviewed feel that the ex-

ercise itself encroaches on their status. This makes

360-degree reviews, unless extremely participative and

well-designed, ineffective at generating positive behav-

ioral change. Another common status threat is the cus-

tom of offering feedback, a standard practice for both

managers and coaches. The mere phrase “Can I give you

some advice?” puts people on the defensive because they

perceive the person offering advice as claiming su-

periority. It is the cortisol equivalent of hearing footsteps

in the dark.Organizations often assume that the only way to

raise an employee’s status is to award a promotion. Yet

status can also be enhanced in less-costly ways. For

example, the perception of status increases when people

are given praise. Experiments conducted by Keise Izuma

in 2008 show that a programmed status-related stimu-

lus, in the form of a computer saying “good job,” lights

up the same reward regions of the brain as a financial

windfall. The perception of status also increases when

people master a new skill; paying employees more for

the skills they have acquired, rather than for their

seniority, is a status booster in itself.

Values have a strong impact on status. An organiza-

tion that appears to value money and rank more than a

basic sense of respect for all employees will stimulate

threat responses among employees who aren’t at the top

of the heap. Similarly, organizations that try to pit peo-

ple against one another on the theory that it will makethem work harder reinforce the idea that there are only

winners and losers, which undermines the standing of

people below the top 10 percent.

A Craving for Certainty

When an individual encounters a familiar situation, his

or her brain conserves its own energy by shifting into a

kind of automatic pilot: it relies on long-established

neural connections in the basal ganglia and motor cor-

tex that have, in effect, hardwired this situation and theindividual’s response to it. This makes it easy to do what

the person has done in the past, and it frees that person

to do two things at once; for example, to talk while driv-

ing. But the minute the brain registers ambiguity or

confusion — if, for example, the car ahead of the driver

slams on its brakes — the brain flashes an error signal.

With the threat response aroused and working memory

diminished, the driver must stop talking and shift full

attention to the road.

Uncertainty registers (in a part of the brain called

the anterior cingulate cortex) as an error, gap, or tension:

something that must be corrected before one can feel

comfortable again. That is why people crave certainty.

Not knowing what will happen next can be profoundly

debilitating because it requires extra neural energy. This

diminishes memory, undermines performance, and dis-

engages people from the present.

Of course, uncertainty is not necessarily debilitat-

ing. Mild uncertainty attracts interest and attention:

New and challenging situations create a mild threat

response, increasing levels of adrenalin and dopamine just enough to spark curiosity and energize people to

solve problems. Moreover, different people respond to

uncertainty in the world around them in different ways,

depending in part on their existing patterns of thought.

For example, when that car ahead stops suddenly, the

driver who thinks, “What should I do?” is likely to

be ineffective, whereas the driver who frames the inci-

dent as manageable — “I need to swerve left now

because there’s a car on the right” — is well equipped to

respond. All of life is uncertain; it is the perception of



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too much uncertainty that undercuts focus and per-

formance. When perceived uncertainty gets out of

hand, people panic and make bad decisions.

Leaders and managers must thus work to create a

perception of certainty to build confident and dedicated

teams. Sharing business plans, rationales for change, and

accurate maps of an organization’s structure promotes

this perception. Giving specifics about organizationalrestructuring helps people feel more confident about a

plan, and articulating how decisions are made increases

trust. Transparent practices are the foundation on which

the perception of certainty rests.

Breaking complex projects down into small steps

can also help create the feeling of certainty. Although it’s

highly unlikely everything will go as planned, people

function better because the project now seems less

ambiguous. Like the driver on the road who has enough

information to calculate his or her response, an employ-ee focused on a single, manageable aspect of a task is

unlikely to be overwhelmed by threat responses.

The Autonomy Factor

Studies by Steven Maier at the University of Boulder

show that the degree of control available to an animal

confronted by stressful situations determines whether or

not that stressor undermines the ability to function.

Similarly, in an organization, as long as people feel they

can execute their own decisions without much oversight,

stress remains under control. Because human brains

evolved in response to stressors over thousands of years,

they are constantly attuned, usually at a subconscious

level, to the ways in which social encounters threaten or

support the capacity for choice.

A perception of reduced autonomy — for example,

because of being micromanaged — can easily generate a

threat response. When an employee experiences a lack of

control, or agency, his or her perception of uncertainty

is also aroused, further raising stress levels. By contrast,

the perception of greater autonomy increases the feelingof certainty and reduces stress.

Leaders who want to support their people’s need for

autonomy must give them latitude to make choices,

especially when they are part of a team or working with

a supervisor. Presenting people with options, or allowing

them to organize their own work and set their own

hours, provokes a much less stressed response than forc-

ing them to follow rigid instructions and schedules. In

1977, a well-known study of nursing homes by Judith

Rodin and Ellen Langer found that residents who were

given more control over decision making lived longer

and healthier lives than residents in a control group who

had everything selected for them. The choices them-

selves were insignificant; it was the perception of auton-

omy that mattered.

Another study, this time of the franchise industry,

identified work–life balance as the number one reason

that people left corporations and moved into a franchise. Yet other data showed that franchise owners actually

worked far longer hours (often for less money) than they

had in corporate life. They nevertheless perceived them-

selves to have a better work–life balance because they

had greater scope to make their own choices. Leaders

who know how to satisfy the need for autonomy among

their people can reap substantial benefits — without los-

ing their best people to the entrepreneurial ranks.

Relating to RelatednessFruitful collaboration depends on healthy relationships,

which require trust and empathy. But in the brain, the

ability to feel trust and empathy about others is shaped

by whether they are perceived to be part of the same

social group. This pattern is visible in many domains: in

sports (“I hate the other team”), in organizational silos

(“the ‘suits’ are the problem”), and in communities

(“those people on the other side of town always mess

things up”).

Each time a person meets someone new, the brain

automatically makes quick friend-or-foe distinctions

and then experiences the friends and foes in ways that

are colored by those distinctions. When the new person

is perceived as different, the information travels along

neural pathways that are associated with uncomfortable

feelings (different from the neural pathways triggered by

people who are perceived as similar to oneself).

Leaders who understand this phenomenon will find

many ways to apply it in business. For example, teams of

diverse people cannot be thrown together. They must be

deliberately put together in a way that minimizes thepotential for threat responses. Trust cannot be assumed

or mandated, nor can empathy or even goodwill be

compelled. These qualities develop only when people’s

brains start to recognize former strangers as friends. This

requires time and repeated social interaction.

Once people make a stronger social connection,

their brains begin to secrete a hormone called oxytocin

in one another’s presence. This chemical, which has

been linked with affection, maternal behavior, sexual

arousal, and generosity, disarms the threat response and



The cognitive need for fairness is so strong that

some people are willing to fight and die for causes

they believe are just — or commit themselves whole-heartedly to an organization they recognize as fair. An

executive told me he had stayed with his company for 22

years simply because “they always did the right thing.”

People often engage in volunteer work for similar rea-

sons: They perceive their actions as increasing the fair-

ness quotient in the world.

In organizations, the perception of unfairness cre-

ates an environment in which trust and collaboration

cannot flourish. Leaders who play favorites or who

appear to reserve privileges for people who are like them

arouse a threat response in employees who are outside

their circle. The old boys’ network provides an egregious

example; those who are not a part of it always perceive

their organizations as fundamentally unfair, no matter

how many mentoring programs are put in place.

Like certainty, fairness is served by transparency.

Leaders who share information in a timely manner can

keep people engaged and motivated, even during staff

reductions. Morale remains relatively high when people

perceive that cutbacks are being handled fairly — that

no one group is treated with preference and that there isa rationale for every cut.

Putting on the SCARF

If you are a leader, every action you take and every

decision you make either supports or undermines the

perceived levels of status, certainty, autonomy, related-

ness, and fairness in your enterprise. In fact, this is why

leading is so difficult. Your every word and glance is

freighted with social meaning. Your sentences and

gestures are noticed and interpreted, magnified and

further activates the neural networks that permit us to

perceive someone as “just like us.” Research by Michael

Kosfeld et al. in 2005 shows that a shot of oxytocindelivered by means of a nasal spray decreases threat

arousal. But so may a handshake and a shared glance

over something funny.

Conversely, the human threat response is aroused

when people feel cut off from social interaction.

Loneliness and isolation are profoundly stressful. John T.

Cacioppo and William Patrick showed in 2008 that

loneliness is itself a threat response to lack of social con-

tact, activating the same neurochemicals that flood the

system when one is subjected to physical pain. Leaders

who strive for inclusion and minimize situations in

which people feel rejected create an environment that

supports maximum performance. This of course raises a

challenge for organizations: How can they foster relat-

edness among people who are competing with one

another or who may be laid off?

Playing for Fairness

The perception that an event has been unfair generates

a strong response in the limbic system, stirring hostility

and undermining trust. As with status, people perceivefairness in relative terms, feeling more satisfied with a

fair exchange that offers a minimal reward than an

unfair exchange in which the reward is substantial.

Studies conducted by Matthew Lieberman and Golnaz

Tabibnia found that people respond more positively to

being given 50 cents from a dollar split between them

and another person than to receiving $8 out of a total of

$25. Another study found that the experience of fairness

produces reward responses in the brain similar to those

that occur from eating chocolate.

We now have reason to believethat economic incentives are effective

only when people perceivethem as supporting their social needs.



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combed for meanings you may never have intended.

The SCARF model provides a means of bringingconscious awareness to all these potentially fraught

interactions. It helps alert you to people’s core concerns

(which they may not even understand themselves) and

shows you how to calibrate your words and actions to

better effect.

Start by reducing the threats inherent in your com-

pany and in its leaders’ behavior. Just as the animal brain

is wired to respond to a predator before it can focus

attention on the hunt for food, so is the social brain

wired to respond to dangers that threaten its core con-cerns before it can perform other functions. Threat

always trumps reward because the threat response is

strong, immediate, and hard to ignore. Once aroused,

it is hard to displace, which is why an unpleasant

encounter in traffic on the morning drive to work can

distract attention and impair performance all day.

Humans cannot think creatively, work well with others,

or make informed decisions when their threat responses

are on high alert. Skilled leaders understand this and

act accordingly.

A business reorganization provides a good example.

Reorganizations generate massive amounts of uncertain-

ty, which can paralyze people’s ability to perform. A

leader attuned to SCARF principles therefore makes

reducing the threat of uncertainty the first order of busi-

ness. For example, a leader might kick off the process by

sharing as much information as possible about the rea-

sons for the reorganization, painting a picture of the

future company and explaining what the specific impli-

cations will be for the people who work there. Much will

be unknown, but being clear about what is known and willing to acknowledge what is not goes a long way

toward ameliorating uncertainty threats.

Reorganizations also stir up threats to autonomy,

because people feel they lack control over their future.

An astute leader will address these threats by giving peo-

ple latitude to make as many of their own decisions as

possible — for example, when the budget must be cut,

involving the people closest to the work in deciding

what must go. Because many reorganizations entail

information technology upgrades that undermine peo-

ple’s perception of autonomy by foisting new systems on

them without their consent, it is essential to provide

continuous support and solicit employees’ participation

in the design of new systems.

Top-down strategic planning is often inimical to

SCARF-related reactions. Having a few key leaders come

up with a plan and then expecting people to buy into it

is a recipe for failure, because it does not take the threatresponse into account. People rarely support initiatives

they had no part in designing; doing so would under-

mine both autonomy and status. Proactively addressing

these concerns by adopting an inclusive planning

process can prevent the kind of unconscious sabotage

that results when people feel they have played no part in

a change that affects them every day.

Leaders often underestimate the importance of

addressing threats to fairness. This is especially true

when it comes to compensation. Although most peopleare not motivated primarily by money, they are pro-

foundly de-motivated when they believe they are

being unfairly paid or that others are overpaid by com-

parison. Leaders who recognize fairness as a core con-

cern understand that disproportionately increasing

compensation at the top makes it impossible to fully

engage people at the middle or lower end of the pay

scale. Declaring that a highly paid executive is “doing a

great job” is counterproductive in this situation because

those who are paid less will interpret it to mean that they

are perceived to be poor performers.

For years, economists have argued that people will

change their behavior if they have sufficient incentives.

But these economists have defined incentives almost

exclusively in economic terms. We now have reason to

believe that economic incentives are effective only when

people perceive them as supporting their social needs.

Status can also be enhanced by giving an employee

greater scope to plan his or her schedule or the chance

to develop meaningful relationships with those at differ-

ent levels in the organization. The SCARF model thusprovides leaders with more nuanced and cost-effective

ways to expand the definition of reward. In doing so,

SCARF principles also provide a more granular under-

standing of the state of engagement, in which employ-

ees give their best performance. Engagement can be

induced when people working toward objectives feel

rewarded by their efforts, with a manageable level of

threat: in short, when the brain is generating rewards in

several SCARF-related dimensions.

Leaders themselves are not immune to the SCARF



dynamic; like everyone else, they react when they feel

their status, certainty, autonomy, relatedness, and fair

treatment are threatened. However, their reactions have

more impact, because they are picked up and amplified

by others throughout the company. (If a company’s

executive salaries are excessive, it may be because others

are following the leader’s intuitive emphasis, driven by

subconscious cognition, on anything that adds status.)If you are an executive leader, the more practiced

you are at reading yourself, the more effective you will

be. For example, if you understand that micromanaging

threatens status and autonomy, you will resist your own

impulse to gain certainty by dictating every detail.

Instead, you’ll seek to disarm people by giving them lat-

itude to make their own mistakes. If you have felt the

hairs on the back of your own neck rise when someone

says, “Can I offer you some feedback?” you will know it’s

best to create opportunities for people to do the hard work of self-assessment rather than insisting they

depend on performance reviews.

When a leader is self-aware, it gives others a feeling

of safety even in uncertain environments. It makes it eas-

ier for employees to focus on their work, which leads to

improved performance. The same principle is evident in

other groups of mammals, where a skilled pack leader

keeps members at peace so they can perform their func-

tions. A self-aware leader modulates his or her behavior

to alleviate organizational stress and creates an environ-

ment in which motivation and creativity flourish. One

great advantage of neuroscience is that it provides hard

data to vouch for the efficacy and value of so-called soft

skills. It also shows the danger of being a hard-charging

leader whose best efforts to move people along also set

up a threat response that puts others on guard.

Similarly, many leaders try to repress their emotions

in order to enhance their leadership presence, but this

only confuses people and undermines morale. Exper-

iments by Kevin Ochsner and James Gross show that

when someone tries not to let other people see what heor she is feeling, the other party tends to experience a

threat response. That’s why being spontaneous is key to

creating an authentic leadership presence. This approach

is likely to minimize status threats, increase certainty,

and create a sense of relatedness and fairness.

Finally, the SCARF model helps explain why intelli-

gence, in itself, isn’t sufficient for a good leader. Matthew

Lieberman’s research suggests that high intelligence

often corresponds with low self-awareness. The neural

networks involved in information holding, planning,

and cognitive problem solving reside in the lateral, or

outer, portions of the brain, whereas the middle regions

support self-awareness, social skills, and empathy. These

regions are inversely correlated. As Lieberman notes, “If

you spend a lot of time in cognitive tasks, your ability to

have empathy for people is reduced simply because that

part of your circuitry doesn’t get much use.”

Perhaps the greatest challenge facing leaders of busi-ness or government is to create the kind of atmosphere

that promotes status, certainty, autonomy, relatedness,

and fairness. When historians look back, their judgment

of this period in time may rise or fall on how organiza-

tions, and society as a whole, operated. Did they treat

people fairly, draw people together to solve problems,

promote entrepreneurship and autonomy, foster certain-

ty wherever possible, and find ways to raise the perceived

status of everyone? If so, the brains of the future will

salute them.+

Reprint No. 09306

Resources

John T. Cacioppo and William Patrick, Loneliness: Human Nature and the

Need for Social Connection (W.W. Norton, 2008): A scientific look at the

causes and effects of emotional isolation.

Naomi Eisenberger and Matthew Lieberman, “The Pains and Pleasures of

Social Life,” Science, vol. 323, no. 5916, February 2009, 890–891:

Explication of social pain and social pleasure, and the impact of fairness,

status, and autonomy on brain response.

Naomi Eisenberger and Matthew Lieberman, with K.D. Williams, “Does

Rejection Hurt? An fMRI Study of Social Exclusion,” Science, vol. 302,

no. 5643, October 2003, 290–292: Covers the Cyberball experiment.

Michael Marmot, The Status Syndrome: How Social Standing Affects Our

Health and Longevity (Times Books, 2004): An epidemiologist shows that

people live longer when they have status, autonomy, and relatedness, even

if they lack money.

David Rock, “SCARF: A Brain-based Model for Collaborating with and

Influencing Others,” NeuroLeadership Journal, vol. 1, no. 1, December

2008, 44: Overview of research on the five factors described in this article,

and contains bibliographic references for research quoted in this article.

David Rock, Your Brain at Work: Strategies for Overcoming Distraction,

Regaining Focus, and Working Smarter All Day Long (HarperBusiness,2009): Neuroscience explanations for workplace challenges and dilemmas,

and strategies for managing them.

David Rock and Jeffrey Schwartz, “The Neuroscience of Leadership,” s+b,

Summer 2006, www.strategy-business.com/press/article/06207: Applying

breakthroughs in brain research, this article explains the value of neuro-

plasticity in organizational change.

NeuroLeadership Institute website, www.neuroleadership.org: Institute

bringing together research scientists and management experts to explore

the transformation of organizational development and performance.





I l l u s t r a t i o n b

y

C r a i g

F r a z i e r

In its premier issue in 1995, strategy +business

reviewed five books. One of them was the fifth anniver-

sary edition of Peter M. Senge’s The Fifth Discipline:

The Art and Practice of the Learning Organization

(Doubleday Currency, 1990), which introduced the

concept of the learning organization to a broader audi-ence. This book remains as relevant today as it was when

it was first published. That’s no mean feat, given the

changes that have occurred in the past 20 years.

Some of the most far-reaching of these changes have

occurred in publishing, which has become digital and

migrated online. This has created a sea change in the

ways that ideas are communicated, the likes of which

hasn’t been seen since Johannes Gutenberg invented the

printing press 550 years ago.

Some observers are concerned that this change is

fundamentally altering not only how we write and read,

but how we think — and not altering it for the better.

In his new book, a polemic titled The Shallows: What the

Internet Is Doing to Our Brains (W.W. Norton, 2010),

Nicholas Carr describes how the skimming and skipping

that characterize online information gathering actually reroute the neural pathways in our brains. Carr warns

that this could cause us to lose the capacity for the kind

of mind-focusing “deep reading” that books engender,

and the reflection and creativity that result from it.

Whatever the prevailing trend in reading may turn

out to be, it is clear from 15 years of book coverage in

s+b, written by a host of distinguished reviewers, that

there is much to be thoughtful about. Executives who go

back to the best books that s+b has covered over the

years would gain a valuable source of information and

BY THEODORE KINNI

15YearsA select shelf of books that not only

expanded the corporate lexicon, but stillhave the power to change the way

we see the world and do business.

ESSENTIAL READING

HIGHLIGHTS FROM

OF S

+B

BOOK REVIEWS





0

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a u t u m n 2 0 1 0

insight. These are the rare books that have expanded the

corporate lexicon and changed the way we do business.

Seminal Ideas

Peter M. Senge’s The Fifth Discipline is surely one of the

most influential management works of the past two

decades. Senge, who founded the Center for Organiza-

tional Learning at MIT’s Sloan School of Management,

pegged the problems that companies commonly en-

counter to the inability to adapt to changing circum-

stances — in his words, to learning disabilities. He

asserted (borrowing a theme from Arie de Geus) that

organizations that are capable of learning possess a valu-

able competitive advantage, and went on, in the core

chapters of the book, to lay out the now-familiar five

components necessary to create such organizations: sys-

tems thinking, personal mastery, mental models, shared

visions, and team learning.

Paul Idzik, then a Booz & Company partner,

reviewed The Fifth Discipline on the occasion of the

book’s fifth anniversary. “Senior executives are devoting

more of their time these days to fostering a culture of

learning within their organizations,” wrote Idzik. “They

realize that many of the recurring problems they deal with would be more quickly and productively resolved if

they managed and belonged to a learning organization.”

That is still true; the organizational learning disabilities

that Senge noticed (such as a fixation on short-term

events that obscures the big picture) are still very much

with us, and the learning disciplines still provide a rem-

edy when practiced.

The list of seminal books that s+b reviewed must

also include The Fortune at the Bottom of the Pyramid:

Eradicating Poverty through Profits (Wharton School

Publishing, 2005), a paean to the uplifting effect of

capitalism on the human condition, by the late

University of Michigan professor C.K. Prahalad. (Seepage 32 for his article on the same theme.) This book is

so compelling that it was featured as one of the year’s

best business books in 2005 in two categories, strategy

and globalization.

Prahalad tallied up the 4 billion people who lived

on incomes of less than US$1,400 per year, and posited

the original idea that they make up a largely untapped

market valued at trillions of dollars in aggregate. In their

essay on the best business books on strategy, former

Booz & Company Partners Chuck Lucier and Jan Dyer

picked the book as “essential reading” for four reasons:

the emerging market business models it described; the

crucial new source of corporate growth it identified; the

competitive threat that companies serving the bottom of

the pyramid represented; and the likelihood that the

low-cost, high-volume models would eventually migrate

to developed markets. The Fortune at the Bottom of the

Pyramid, they wrote, provided “a rare glimpse into the

future — for those with eyes to see — of the extraordi-

nary opportunities waiting in uncharted and seemingly

impassable waters.” A third seminal book covered in s+b ’s pages is one

whose relevance grows along with the ecological impact

of our industrial society. In Cradle to Cradle: Remaking

the Way We Make Things (North Point Press, 2002),

William McDonough and Michael Braungart, an archi-

tect and chemist, respectively, identified the convention-

al “take, make, and waste” product cycle as a major con-

tributor to our environmental problems. They proposed

that human industry be redesigned to echo nature, in

which every major nutrient is endlessly recycled.

Theodore Kinni

[email protected]

is senior editor for books at

strategy +business. He has

written or collaborated on 13

business books.



“Consider this thought experiment, which appears

in [the book]: What would it take to run your company

the way the Menominee tribe of Michigan runs theirforest?” wrote Joe Flower, a regular s+b contributor, who

reviewed Cradle to Cradle in his Knowledge Review essay

on sustainability in the Spring 2009 issue. “In 1870, the

Menominee counted 1.3 billion board feet of standing

timber on their 235,000 acres of land. Over the last 138

years, they have harvested 2.3 billion board feet, and

now they have 1.7 billion board feet. Neat trick. Maybe

you’re not in a resource-extraction industry; maybe your

capital doesn’t grow on trees. But isn’t there an equiva-

lent potential achievement in your sector?”

A Global Trend

If books were to morph into shallow, short-form online

works, we would miss those titles that take deep dives

into the new trends that are shaping and reshaping our

world. One of the most far-reaching and implication-

laden of these trends has been globalization, and during

s+b ’s publishing tenure, a library’s worth of books on the

topic have appeared. Among the most influential and

widely read of them was Thomas L. Friedman’s The

World Is Flat: A Brief History of the Twenty-First Century (Farrar, Straus and Giroux, 2005), which Howard

Rheingold, a leading observer of the social changes stim-

ulated by technology, chose as the best business book of

2005 in the future category.

Friedman, the foreign affairs columnist for the New

York Times, argued that globalization entered a new

phase around the turn of the millennium. Whereas

Globalization 1.0 was fueled by the drive for empire by

nation-states beginning in 1492 and Globalization 2.0

was driven by the international expansion of enterprises

starting around 1800, Globalization 3.0 was driven by

“the newfound power of individuals to collaborate and

compete globally.” This power derived from 10 “flatten-ers,” according to Friedman, which were all directly

related to digital technologies and networks.

Friedman’s flat world explained many of the chal-

lenges that companies were facing in a global economy,

but business readers had to wait for the publication of

Pankaj Ghemawat’s Redefining Global Strategy: Crossing

Borders in a World Where Differences Still Matter

(Harvard Business School Press, 2007) for a measured,

strategic response. In it, the author, a professor of global

strategy at IESE business school in Barcelona, takes issue

with Friedman’s boundaryless “flat” world. Ghemawat

points out that there are still plenty of speed bumps for

companies that rush into the global fray with a one-

world strategy that doesn’t account for the myriad dif-

ferences between nations.

The core of the book is devoted to Ghemawat’s

CAGE framework, a means of understanding the cul-

tural, administrative, geographic, and economic dimen-

sions of nations and making sure they are reflected in

companies’ business strategies. “With its combination of

solid data, illuminating case studies, and helpful con-cepts, this book is an effective antidote to both millen-

nial and apocalyptic visions of globalization,” wrote

s+b ’s longtime Books in Brief reviewer David Hurst in

the Spring 2008 issue.

Managerial Art and Craft

Although many management books might benefit from

a shorter format, we wouldn’t want to lose a word of the

best of them. The books of Henry Mintzberg, McGill

University’s iconoclastic professor of management stud-

If books were to morph into shallow,short-form online works, we would miss those

titles that take deep dives into the new trendsthat are shaping and reshaping our world.





second issue. “The HP Way should be kept in a corner of

every office and den. It’s good just to know it’s there.”

Louis V. Gerstner Jr. is another leader who famous-

ly eschewed the “vision thing” for pragmatic manage-

ment — and saved IBM in the process. In Who Says

Elephants Can’t Dance? Inside IBM’s Historic Turnaround

(HarperBusiness, 2002), Gerstner explains in detail how

to restructure a massive organization — radically chang-ing its business model, cutting costs, and reengineering

its processes — and remake its culture without flying it

into an unrecoverable tailspin.

“There are a few good leaders, and a few good new

leadership books,” wrote Pasternack and O’Toole on

naming Who Says Elephants Can’t Dance? one of 2003’s

best business books in the leadership category. “Louis V.

Gerstner Jr. gets the nod on both counts.”

And finally, there is Alice Schroeder’s monumental

biography of Warren Buffett, The Snowball: Warren Buffett and the Business of Life (Bantam, 2008), which

successfully undertook the delicate task of ferreting out

what makes the Oracle of Omaha tick, with his permis-

sion. Schroeder’s portrait is especially compelling

because she never sidesteps the real Buffett for easy

answers. Instead, wrote O’Toole, who selected the book

as one of 2009’s best business books in biography,

“Schroeder offers us a nuanced portrait of a surprisingly

complex and insecure man whose life is full of paradox-

es and contradictions.” It’s good to know that even the

most successful businessperson of our time is more man

than mogul.

Disruptive Technologies

For greater insight into how technology will change

publishing in the years to come, Clayton Christensen’s

The Innovator’s Dilemma: When New Technologies Cause

Great Firms to Fail (Harvard Business School Press,

1997) is a good place to turn. The book, which David

Hurst reviewed in the spring of 2001, introduced

Christensen’s seminal theory of disruptive technologiesand described their cyclical effect on industries.

Christensen, a professor at Harvard Business

School, says that successful companies in a given indus-

try are almost always focused on improving their prod-

ucts and the technologies that underlie them. This cre-

ates innovation races in which the industry’s offerings

outpace the needs and desires of customers. New com-

petitors inevitably arise, deploying disruptive technolo-

gies to serve customers in more effective ways, but the

incumbent industry leaders ignore them as inconse-

quential. Eventually, the new competitors eclipse the

industry leaders, and the cycle starts again. How does

this relate to publishing? Well, one hint comes from

Amazon, which announced that its e-book sales had

overtaken hardcover sales as I wrote this article.

Disruptive technologies bring us full circle to

Nicholas Carr. Before the publication of his current vol-

ume, Carr generated controversy with Does IT Matter? Information Technology and the Corrosion of Competitive

Advantage (Harvard Business School Press, 2004). In it

Carr suggested that IT was well on its way to becoming

a “commodity technology.” The idea that IT had

become merely an ante in the game of business, rather

than a winning hand, understandably outraged many

denizens within this sector. They were, after all, still reel-

ing from the tech-led recession in 2001 and 2002 when

the book arrived.

When Steve Lohr, a technology reporter for theNew York Times, looked at the book in his Knowledge

Review in the Summer 2004 issue, he found flaws, say-

ing that “Carr’s desire to fit everything neatly into his

thesis leads him astray” and his “thesis is often the same

kind of straitjacket of standardization that packaged

software, as he says, is for companies.” But Lohr found

Carr’s indictment of “faith-based investment in technol-

ogy” spot on. “The value is not in the bits and bytes,”

concluded Lohr, “but up a few levels in the minds of the

skilled businesspeople using the tools. Large chunks of

the technology may be commoditizing, but how you use

it isn’t. That is where competitive advantage resides.”

The same can be said for books. Books probably

won’t disappear anytime soon, but their real value is not

in their pages. It is in the minds of managers and how

they put what they read to use. The best insights being

codified in the best business books and then deployed

thoughtfully is the way that management knowledge

develops these days — and books are therefore one of

the great vehicles of progress in our world. +



BY ART KLEINER

Of strategy +business’s many classic articles over the years,here are a few of the editor’s favorites.

How to Manage Creative People: The Case of IndustrialLight and MagicLawrence Fisher, Second Quarter 1997, www.strategy-business.com/article/15151: The special effects shop that George Lucasfounded builds its success on good relationships.

Are There Limits to Total Quality Management?Arthur M. Schneiderman, Second Quarter 1998, www.strategy-business.com/article/16188: Yes, as you go up the hierarchy,problems grow too complex for continuous improvement.

The Last Mile to Nowhere: Flaws and Fallacies in InternetHome-Delivery SchemesTim Laseter, Pat Houston, Martha Turner, et al., Third Quarter2000, www.strategy-business.com/article/19594: The failure ofWebvan shows the trade-off between delivery speed and variety.

Money Isn’t Everything: Innovation’s Big SpendersBarry Jaruzelski, Kevin Dehoff, and Rakesh Bordia, Winter 2005,

www.strategy-business.com/article/05406: First of our ongoingstudies of global corporate R&D spending — and its complexlink to performance.

Love Your “Dogs”Harry Quarls, Thomas Pernsteiner, and Kasturi Rangan, Spring2006, www.strategy-business.com/article/06107: Theconventional wisdom about portfolio management is wrong;foster poor performers to gain value.

City PlanetStewart Brand, Spring 2006, www.strategy-business.com/article/06109: Suddenly, half the world’s human population isurban. Get ready for cosmopolitan, thriving new cities.

The Future of Advertising Is NowChristopher Vollmer, John Frelinghuysen, and Randall

Rothenberg, Summer 2006, www.strategy-business.com/article/06204: After years of overhype, the digital revolutionfinally came — and marketers learned to adapt.

The Neuroscience of LeadershipDavid Rock and Jeffrey Schwartz, Summer 2006, www.strategy-business.com/article/06207: Change is pain, behaviorismdoesn’t work, focus is power, and attention changes the brain.

The Flatbread FactorAlonso Martinez and Ronald Haddock, Spring 2007, www.strategy-business.com/article/07106: Emerging markets, fromChina to Brazil, have strikingly similar life cycles.

Lights! Water! Motion!Viren Doshi, Gary Schulman, and Daniel Gabaldon, Spring 2007,www.strategy-business.com/article/07104: The world’s energy,

water, and transportation infrastructure needs a US$40 trillionmakeover.

The Empty BoardroomThomas Neff and Julie Hembrock Daum, Summer 2007,www.strategy-business.com/article/07206: Corporate boardrecruits with CEO experience are in short supply — and that’sgood news.

Oasis EconomiesJoe Saddi, Karim Sabbagh, and Richard Shediac, Spring 2008,www.strategy-business.com/article/08105: Open, diversifiedeconomics is a new force for stability in the Middle East.

The Next Industrial ImperativePeter Senge, Bryan Smith, and Nina Kruschwitz, Summer 2008,www.strategy-business.com/article/08205: The industrial era isbursting like a bubble; climate change is just the advance signal.

The Library RebootedScott Corwin, Elisabeth Hartley, and Harry Hawkes, Spring 2009,www.strategy-business.com/article/09108: These criticallyimportant institutions are redesigning their business models forthe digital age.

The Best Years of the Auto Industry Are Still to ComeRonald Haddock and John Jullens, Summer 2009, www.strategy-business.com/article/09204: Millions of newautomobiles will be sold in emerging markets.

Too Good to FailAnn Graham, Spring 2010, www.strategy-business.com/article/10106: India’s Tata, a giant and diverse conglomerate,bases its global strategy on social entrepreneurship.

Why We Hate the Oil CompaniesJohn Hofmeister, Summer 2010, www.strategy-business.com/article/10207: How corporate leaders create their reputations forarrogance, by a former CEO of Shell Oil.

Articles of Significance





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Strategy Business Magazine-Special 2010