Sera Keer ee EPRICE BI Iaacen eau ART b] Buca.) aN eS it) &STRATEGY Michael E. Porter Be eae ct Sea sCrTT CUM esi Cees ee ee ee Gabarro, and Robert J. Lees Meer nd eo cea Tee aa DSCC CeCe RUA} Poe wT RNIN aa) een Ce A rs ees a arena TEC) ecm OS UCSC Ce BESO LLCs Cea CCL Pa td Dec ta Management System Cn een) ena ncaias MMeThe Siemens answer: Efficient energy supply. Finding answers to climate change is one of the greatest challenges of the 21st century. And energy efficiency plays a key role. Our innovations efficiently generate, transmit and distribute the po we need while drastically reducing sustainable and affordabl for the environment and good for the 10 depend on it to \www.siemens.com/answers Answers for the environment.Features 54. Putting Leadership Back into Strategy Cynthia A. Montgomery Weteve ost sight of te fact that stsegy isnot st aptan rides; its company’s way of fe. As tate’ eiter nd Stewate, ne CEO ws choosing te companys tte. 62. Mastering the Managament System bert S. Keplan and David P. Norton Great strategy wor't succeed without strong operations ~ ‘and vice versa blueprint for Inking the twe can help you balance the tension between them. 78. The Five Competitive Forces That Shape Strategy MecaolE. Porter Pathape no remework has beens extersivaly fli ecto aetna ve eres” analysis ct tha facors hat determine {he long-run proftabity of at ndusties,inwoducedin these ‘2900 1979, Now, with he Benefit af ast 20 yous of research and appicaion ts author returns treatin ard extend -his case nok 98 Innovation Killers: How Financial Tools Destroy Your Capacity to Do New Things Cayton M, Chistense, Stephen P Kaufman, and Willy. Shin ina’ sifing novavon in your compery and many others? Suggetts abound, bat thee common franca tcl ar key aecompices 106. THE Han mvTERVIEW Giving Great Advice Bruce Wasserstein Interview by Thomas A. Stewart and Gerdiner Morse LLamare's CEO krovis now tomate and execute a ood eat Alter tee decades in mergers and acqusions, here's what he hes learned acwsing companies and helping to broker more han a thousand Gels 2 Harvard Business Review | January 2008 | hbv.oraINTRODUCING SINGAPORE AIRLINES SUITES ADepartments 8 COMPANY INDEX: 4 10 From THE EDITOR 115, Great Enterprise (One hundvod yours ago, Harvard University established a graduate business school withthe goal of tesching leaders not just the nuts and bolts of management but something move: courage, good judamen anda kindness of spirit that pusies both 6. ForeTHOuGHT Tolove or ofearthe modemleader..Why 47a. ol technologies improve wher now ones ative,.The aesthetics behind certain high: ‘margin goods, ..Social esponsibility end {good nara performance correlate cnly akt...Comoete more successtuly by us ing an expanded product portlet .Ex vas wha read tagather are betta prepared to lead... deliberate andresponsive as you 200k the bos strategy. .Heosing hedge fond demands doesn't pay unless your fren {gets acquied...Sharpen yout company's abiay to calaborate globally. Woo iaves: (1S ane analysts by fist courting the made, 130. 29 HoR case sTUOY How to Change the World Howard H, Stevenson \nar’s tne est areas choce tor somaona ribo wants to make difference ish ia ‘big company, becoming a zecia entropre eu, oF making Serious monay ta heage fund? Wath commentary by Laura Scher B ariel Varela, Barbare H. Frankin, ana Christina C. Jones. E 43. Transforming Giants Rosabeth Moss Kanter Some multnatoras, spite thir se, ‘manage tobe nim. innovative, anc con- nected with local communities. Iteomes tom placing grater emphasis on sharod and it teads 108 mote postive Imoact on the work Harvard Susingss Review | January 2008 | nbcora STRATEGIC HUMOR Why Mentoring Matters in a Hypercompetitive World Thomas J. DeLong, John J. Gabarro, ‘and Robert J Loos Competition among professional service ‘isis fierce, not just for business but {or talent. strong mentoring cuture can hep you attract and atsin the best, the brightest. and the most reliable Where Will We Find Tomorrow's Leaders? A Conversation with Linda A. Hil We went tnd ane dovolop new gbal Jeaders by looking n conventional paces for pacple whe actin the convon ‘inal take-charge way. Organzatons inereasingly need individuls who krow ho to ead fom barind. Leadershyp approaches emerging provide coms valuable insights fluential Articles from Harvard Business School Hervetd Business Schoo! faculty members have authored countiese HBR artcioe over he magazine's 86-year history '3¢ list of some of the most conse: quoma ones. EXECUTIVE SUMMARIES Pandemonium Inc. Don Mayer ‘When communication eats doven, chaos beaks outerence M ACM Sar ace CR me aed tended up challenging the conventions of our industry, ree a Reel RLM Le POSES ease ee So, who do you want on your side? Merrill Lynch worked as sole advisor to three barking Ce Ree Ran a ABN AMRO. With @ thorough understanding of Ce eee eee ees) parther in the transaction could augment their a aR ae creative strategy we developed with our clients to Ce eer eee een largest international equity issue at €13.4 billion, and the largest hybrid capital financing offering of €62 billion. To support the transaction for our Ce a a ou cae! totaling €51 billion. Our dedication tocompleting a superior transaction demonstrated a new level of partnership in the investment banking industry. eee eR historic deal in such a difficule credit market, visit weerm.wvinningsolutions.m. ‘nliciscnaeracci os) CE Ta) Global Markets & Investment BankingHBR.org—~ This month at hbr.org- > How to Change the World HBR wrersene scone ree Ian ambitious MBA wants to do well by doing good, Ramboparansioey Lnbioh of tivee atrative career options shausd he pursue? Tellus your opinion stmauldcase. bora. where you > Interviews with HBS Professors Moss Kanter, an Linda & NM conc sos conosy > The Moral Leader > HBR 2007 Reader's Guide = Atsucheerendings Nhr.org seo what Araadorsquide hr ava youcan cont ives ae eacingin The Moral quckiy find just what you need. Scan of yourtoa Lado, cass taught by Harare the aelas publchod in 2007 by Se Business Scnoot's Sandra Suche subjectereuthot eee) sunseniasn access PREMIUM SURSCRIPTON -MRIMLOTNERLANGUAGES —_MARANSWERS youareasubserber, you © Apremiumsubserption fo Viet “HBR n Other The editors of HBR have eve 12 montha worthct — Hanerd Business Review Langueqes” onthahome posted gia! back seus Sivesreaders eccess io@ page lor information about arog ‘sposel Cick on any Searchablearchive of more the 1 licensed versie bones: chaterges, along aciclewiha nex toit, than 2.700ariies Tosign —_ediionsof Harvard Business with selact 2 te ontor your subserbor Tecan the upper-nght an suggest questions ot [Dincrmaten ‘comer of tha hema page (opis by cleking on Ema Us" on the HER A age athens 6 Harvard usinase Review | January 2008 | _nbcocaThe Americans were the first to set foot on the moon. But it was IWC who brought it under control. IwC SCHAFFHAUSEN SINCE 1868 WG. Engineored torLEADERSHIP AND STRATEGY | COMPANY INDEX | January 2008 (rgprizations in the rag ‘Alsat tera ‘re fo fot Bap ne sty. eg Baton Crateg Ge Boca cibncsscispeteaeonud eames Cxtacamontr cave Dia om. Otto Canc his (vat Stn Moos, ages gta favpnart Din Seven Dae urrsty Dir. Sli union ny oon Festa Cine a rsBuses So HO Tenoapes aria, ae ene Ona. roaca rem nea ke Eee ek phckkEbkkbheeknkRhERbbeR bE t a7 indexed te tho first pago ofeach arte in which thoy ate mentionod. Subeica in Janet Coa ne anetaePats Kat it lye Mt attemera St ee erat Novge Sy. ot veces tn Anonea Ne Omen Pega ose Pratap Pct Gente Sebo Sea Niede Satu resnes ‘Sion Groep Senons See sey Site stan. Sere srseo Tate Tox ch Ua cLbkbhbbhEhREMEL beh bc jk cEkkekkeKRRE RRR 216 Setos under hoirown nome. en Us nese! ean Ween Se US Sector edexangeCmmison Us sta verse ‘atin bebEkbp hE Ree AUTHOR AFFILIATIONS ron treo Aner Fin ape. = ante Ut i Cpsstaniebnnese Sta Cah, Sie Bene Cedi. fmitvonc nrc ‘trey Fi ose. BEBRE EBL ul ress So arr Bowe Shel Pasig ara Sev ev. aa org Sey ess Patni SoeonBapes B bbb beth usm Wenn ela Soup Wate execores ss “It's him the one they call ‘El Auditoc” |@ Harvard Business Review | January 2008 | nbrora Themes Cheneyao CapLEADERSHIP AND STRATEGY | FROM THE EDITOR Great Enterprise IN MARCH 30, 1998, the Corpoxation of Harverd Uni versity voted to establish the Graduate School cf Business Administration, the university having con: ‘cluded, in the words of ta ther-president Charles W. Elo, that "business in its upper walks has become a highly imelectual caling” merting “professienal gracuete inerue tion.” The first dean of the school, Edwin F Gay, bult ton the prineipla that the men in hs eharge should learn not [ust the nuts end bolts of accounting, contracts, and market- ing but someting about how 10 be leaders: to possess cour- 20e. good judoment, and “e certain kindness of spirt which Unites the other two elaments, which purifies courage by romoving its grossor bolFgoreney and tornpors judgement by tho undorstanaing heart” ‘This year the schoo! our owner celebrates its centenary. From our offices three miles upriver from the HBS campus, Watching the preparations has been Porter tod us that he was embarking on a profound and ‘exciting revision, update, end reaffirmation of his classic “five forces” artcie, published 29 years ago, We wented to ive into the connection between strategy, leadership, and ‘change — thats, getting things done. Cisyton M1 Christensen, ‘Stephen P. Kaulman, and Will C. Shih respondad with a ovastating analysis of how management systems Robbe innovation, while Robert S. Kaplan and David P Norton gave us a magisterial article about how to bulld a management system that works. (Oniy haltjoking. around the office we've ‘called tthe only manegement article you'll ever need) Peoplecome tous -HBRand HBS-tolearn howto manage ‘gr0at enterprises in a global owironmont, and to become the kind of leaders who make a diferonco in the word, Pur those two purposes together anc you get Rosabeth Moss Kanter’s| article about global glans that are transforming themselves. rather like seeing a city appear in the middle of apraire:a crane here, a rood there, on accalerating chsos of ideas, ‘and then, somehow, the emergonce of 2 cohoront and incisputably splondis calobration. a aan aoe geen penne ‘AL HBR we decided to mark the ‘occasion in two ways: frst by serving our mission with re doubled ene-gy, to improve the practice of management by publishing the best work we can find, by whomever writen, that helps women and men inthe “upper walks" of business: become better leaders, see the future first, slve thet tough: fet problems, anc learn wat really works; and second by devoting both 2008 spacial issues exclusively to the work of Curent HBS faculty and alumni wihoare leaders of important enterprises ‘The first of these issues isin your hands. Ie wins out thet ‘a project we launcted to laud the school does 2 giorous job (of honoring the mission. It also happens that we couldn't have done a botter job of hiting Edwin Gay's targa if wo has firod port-biank ati. Ve dacwed from tho start that this issue should focus on leadership and stiatapy, betev- ing that mneye inseparable. Unbeknownst to us, Cynthia A. Montgomery had been working on an article that mates: that case with great eloquence arc expertise. We decided the issue should acknowledge HAS's legacy of schol- arship but focus on the future; lo and behold, Michao! E. 10 Harvard Businass Review | January 2008 | novora HR's senior ector Pau Hema, Linda A. Hil tes us who these funure leaders wil be. Thomas J DeLong, Jobn J. Gabarro, and Robert J. Lees add an impor tant dimension, describing the changing role of mentors, who hend!-shape leaders; and Howard H. Stevenson contributes 9 ‘cage thet brings ave the croiees leader face avout making ‘a diference, Senior odor Garciner Morse and! spent severe! ‘hours i the prasence of ene such leader, Lazard CEO (and HBS alumnus) Bruce Wasserstein, who has given more good ‘advice 10 more CEOs than arnast anyonealveand nov shares, some with you Editorial director Sarah Ciffe and senior editors Steve Prokesch and Arend Reman made this magnificent issue pecsibie, with help from our colleagues downriver, including ‘specially Debora Spar, senior associate dean for rosaarch ‘when wa put the issue together. Mf Thomas. StenortSRC eee eee UR ee cl) SR ett uO Cn ard can be used in bags and packaging. It's shelf stable for one full year, Cea ue ee RCA te a ee eed =F. Bea ger toed eg Te kecuet (028 aASt CaranIn five days, even Darwin would be shocked at how you’ve changed. ARESTY INSTITUTE OF | 4a), ctuTwecoucarion | We're all business® Introducing the Wharton Learning Continuum. From the pre-program coursework to the post-program follow-up, you will transform your career, For more insight, download our FREE article series “Wharton on Career Management” al executiveeducation,wharton,upenn.edu, For more x harton.upenn.edu. Cali 800.255.3932 (U.S. or Canada) or +1.215,898.1776 (norldwide), and relerence HBR. LEADING ORGANIZATIONAL CHANGE > May 4-7, 2008 ‘December 1~4, 2008 EXECUTIVE DEVELOPMENT PROGRAM > May 4-16, 2008 September 7-19, 2008 ‘THE LEADERSHIP JOURNEY: CREATING AND DEVELOPING YOUR LEADERSHIP > May 18-23, 2008 October 19-24, 2008 FULL-SPECTRUM INNOVATION: DRIVING ORGANIC GROWTH Sey Wharton Usaveniiny of Pen Nsvivanta ® Harvard Business Review pIron ano nAnacing 1RseTOR ‘Thormas a. Stewart erury eorror aNo ASSISTANT MANAGING DIRECTOR Keron Dilan EDITORIAL OIECTOR Seranch ART oRECTOR aren lave enton corrons Davis chsmoen Pons) Diane Couns Broneryn Fiver Peston sila Key Lew Mcdieary Gardner Werse MBton Peebles Stoven Protoech ‘nang amar Associarecorrons Roberts A. Fusaro. Anérow O'Come! consutrine corron Bemard Avene manuserirr Spacing Sohn erery prom nescancnt Kessane’a Cuan ooRDInATOR Festa Weloakiwat STAFF ASSISTANT huistre Cook [ANOTE TOREADERS szronreooveon ssa Satay ‘onoma mas Sei eau Senay Jantanes ‘esioneR Uindesy A. Swaanay sorroriat sroouerion ‘Eoonainaron ‘sete Abvesh- Gonzales commumicarions ineeroR, Cathy Olteon ‘commuwicarions SssoniaTe Siochane Fors tit 2¢: Fonaulas Ay Lady ‘Anmie Noonan Elen Roce Kerstin Marah Romens Dobbie White ‘Tha vines ecrassed martes ortho ‘audnot necessary those of Hand ‘Businoss Rowen, Harve Business School ‘orHerva'd Unversity, Authors may tev orsusing of other busreasraaionshins ‘with the comparies they dscoss, Weeenccurage xospectve authors t follow HBR: “Guasainas for Authors” belore ubriting meruscits. To oan « 207 lease gato ou website ‘wit e The Eat, Hard BusressFevew, (6 Harvord Way. Boston, WA 02163, 01 send ermal ‘ehh oditosal@htsa hcvad.edu, Unsolicited manuscripts wil be raturned rly if aseompanin by 9908 erosced ston oniepe. prroniaL ornces (6G Harvord Way, Coston, WA.02163 617.709°7810; ox 617 vier 7837489 Volume 86, Number 1 January 2008 Preteainthe USNOW | INVENT INSTEAD OF PREDICT. THE ADVANCED MANAGEMENT PROGRAM CREATING INNOVATORS June 1-July 4, 2008 | September 21-October 24, 2008 Today's business culture demands leaders who are true innovators. They challenge traditional thought. They are the most sought after executives in the world. And, after 5 weeks at Wharton's Advanced Management Program, you will be one too. To become a master of innovation, and to receive your information kit, call Robin Salaman at +1.218,898.1179 (worldwide) or 800.265.3932 (U.S. or Canada), or e-mail her at AMP@wharton.upenn.edu Be sure to visit our website and listen to Nine Stories of AMP innovators. _http://executiveeducation,wharton,upenn.edu ARESTY INSTITUTE OF Wharton EXECUTIVE EDUCATION | We're all business.° UUNivERsi1¥ of PENNSYLVANIAMIT SLOAN EXECUTIVE EDUCATION, Because Successful Managers Don't Grow On Trees. MIT Sloan is uniquely positioned 2t the intersection of technology and business practice, and participants in our programs gain access to MIT's distinctive blend of intellectual capital and practical, hands-on learning. With our world-renowned faculty and legacy of leading-edge research, we offer programs that turn high- potential managers into innovative leaders. Upcoming Programs: May4-9 Product Design, Development, and Management June 1-27 International Management Program june1-6 Leading Change in Complex Organizations June8-13 Corporate Strategy June 16-20 Business Dynamics: MIT's Approach to Diagnosing and Solving Complex Business Problems Phone: +1 617.253.7165 Email; sloanexeced@mit.edu innovationework PuRUSHER Henry Boye: inceron Sehntue cimcuanon bineeron. Bruce W Rhodes sucess ‘Rdnenne M, Speke: ee sen sae oe sa Gregst. Pere be! Harvard Business Review Ax iemente, ADVERTISING sates irameernainceron ‘sewon warwerina ANORESeARCH Michele Lin ES ay on ‘maraeTing AND CoonomaroR KexPavia ftir Danette Weber Maras: Bascom Usa Cart Craig Catalero (Orine See Drecto Dene Clouse DaneiCoher echo! Carper somos H. Paton Angie Ses Drectos Attante orton chicas ° Detrat Los angeles Santraneeee Austra France Nona Keng de depen UAE United Kingdom 75 Rocketeler Plaza {sm Foor Now York. NY 10019 212-8725928) ine 212. 956-0053 404-256-0004 978-269-5677 312876-1100 214-821-5116 248:574-8000 323-467-5906 415.886.7752 912.026.9476 93:01-4643-0065 952:207-52911 91-11-495-0031 B1-09.9541-4166 971-4228-7708 $4:20-7039:3733 Forallethor ston lease coll 212 672-9200 Forsovernsing comact aformation pease ‘si our website at unwannansies cam, ‘SUBSCRIPTION SERVICE INFORMATION Us. AND CANADA 200-274-2214; fon 619-954 0467 fetes por year INTERNATIONAL. ‘5, $119, Canods, US.$199 BY 2Dde74aC6: tax 31-20-4074410 Fetes per yoo: U5 165, Mexco 5.8199 ‘susscnioe one Seino, CCopyrort@ 2007 Harvars ausnass Seno Poblinng Corporation. Al “gnt esarvee apart of vs pubteaten may a9 reproduces forrarsmttedn any fom oF ey any means, lactone racharieal snsiting prec, ‘acailng. ot ary ivermaten storage and Foxe syst without wrttn permission.Poteet ey Oe et eee Ce ee | AYO) UAV, ara] 0 WAV, 26 eeteeatere eee New First Class private suites. Non-stop nightly from JFK to Dubai. Fly Emirates. Keep discovering.A survey of ideas, trends, people, and practices on the business horizon |Love and Fear and the Modern Bo$$ wes Five hundred years ago, Niccolé Machia- oll posed the question of whethar tis batter for lead tobe loved of feared, concluding that it you can’t be both (and few people car, baing feared is more eifective. Whie the complexities of hu: ‘man nature resist definition in such stark terms ~ behav lie elong a continuum ~ the question of faor versus love has bean 2 fundamental ono for loaders through: outhistery. Unti'a generation or so ago, fear was ‘the predominant model. In the 1960s and 1960s, corporal punishment was ‘commen even in public schools, and the ‘workplace was @ largely hierarchical and autocratic arena where leaders imposed rewards and punishments based on con- ‘orrty with the rules, Today, teachers in most ofthe developed world would instantly lose the'r obs for hitting @ tu- dont, andin the office, 100, acceptable ‘modals of loadarship havo shown thoir softer side. This shift in the predominant leadership model reflects the mova from, an industrial oan information economy. 16 Herverd Business Review | January 2008 |_nbrore In factories, youneed strict les end you reward people besed on very simple and lear productivity metrics. Knowledge workers don't respond wall to such ngio- iy, and featfy sorvice employees would have trouble putting on a good face for ‘customers. In fields lice advertising, tight contiols stifle creativity and commitment. But even in the dovelopad world, plonty of leadors stil rly on foar, and ‘many people continve to put up with it. One reason is simply that people rationalize the fear model as “just taway things are done around here,” as isthe case with hazing, arguably a form of leadership among students. Another ‘reason is that some people feela sense ‘of pride and accomplishment in toughing ‘tout: they find eatsfacton in mesting the standards of a very demanding boss, Others simply prefer an autoerave style ‘over an empowering one: they don't want to decide how to do their work but ‘would rather just know the rules and follow them, Stil others actualy believe that they will utimately be mora suc- cessful with a strong boss, ona who wil push them beyond the limits to which they'd stratch thamsaives, It's justas well that we have people who can work under these bosses because some circumstances stil call for 2 fearbasod style of leadership -where you want to clscourage risky behavir, ‘such as in 3 nucear power plant. With the ‘tak so high on safety ight contol ~ not improvising is prudent. Employees ‘end 10 salf-setect into these companies, Leaders need to do the same ~find oes that match ther temperaments Indeed, if leader is atern and auto: cratic - even rudo and insulting -ho can Inspire great respect it ha is also authen: tic, and ithe genuinely cares about the people vrorking for him, Two of the most Successful coaches in the history of col lege basketball exemplify Machiavelli's two extremes ~ the feared Bobby Knight ‘at Texas Tech and Mike Krayzewski, Duke's beloved Coach K- and both have ‘wen devoted followings among players. Coach K, whose leadership style relies (on open communication and caring sup- port, wiore a book called Leading with ‘te Hert, Kright, on the other hand, bas hhad.a career marked by controversies bout his harshness, including alloga tions that he choked a playor during prectice. Despite his bullving, he inspires tremendous loyalty and even love. Texas Tech players know what they're getting into, anc they know that Knight’s temper {is integral to his being~ and thet he tiuly cares about them. ‘That's why, five centuries after it ‘was written, we can stl take lesson from The Prince. Leading by force and intmidation has its downsices - the potential for the leader's deraiment chief emong ther, Thanks to his violent ‘behavior and inability or unwilingness to adaot his dominant style to changing societal norms, Knight was eventually ‘fired from his ob at Indiana University (though quickly snapped up by Toxas “Tech). But hore are tmes when the solter approach to leadership is equally ineffective -or simply inauthentic ~and tule by fears the way to go. Successtul leaders teed the signels and adapt their styles accordingly, but they know their limite, A stretch assignment for aleador ‘might be a developmental opportunity that brings out previously unrecognized strengths —bur if the role requires a style beyond the leader's adaptability, the results often disastious. Scott A. Snook \ssaackAhhs acl an associate protescorin the organizational bbehaver unit t Harvacd Business Schoo! in Boston anda retteo U.S. Army coionel Reprint FoRO1A, PRODUCT TRANSITIONS Beware of Old Technolo: by Daniel. Snow ‘When superior technologies emerge, old ‘0nas usually don‘ simply face away. To the contrary, their performance often Jegps suddenly, thereby extencing their lives and slowing the adoption of tha ‘now tochnologies. This happaned with Hing ships when stoam-poweres vos- sels were developed. More recent exam piles of what | call “last gasps” include ‘manual versus computerized typesetting, CISC versus AISC architecture for com puter processors, steel versus aluminum bicycle frames, automobile co-buretors ‘versus olectronic fuol-injection eystoms, ‘and coronary artery bypass graft surgery versus angioplasty, For decades, the corentonal expia- nation ofthis phenomenon was behav ‘oral: When the oldktechnoiogy comm panies faced extinction, they worked hhardor to find ways to stave it off. When | started conducting research on last .g38ps, however, | found something ‘puzziing about this explanation, Most of the technologies that experienced a last gies’ Last Gasps asp were being sold in markets that \nere intensely competitive before the new technology arrived. So the exist- ing dayers already seemed to be doing everything they cauld to improve the old technoiogy, ealing into question the old assumptions, When | delved deoper, | found that two overlooked mechanisms were at work: A retreat to defensible ground. ‘most instances, the transition to the new technology is gradual. The oi¢ technology is initially displaced from the segmonts of the market (or eppkeations| to which its relatively poorly suited, leaving it in those where t can better compete. In some cases, the sults an im- provement in performance thet owes litte to changes in the technoloay itself, Salling ships cuickly coded short ferry routes to steam powored ships but continued to ply the longer routes, which ‘meant that, overall, sailing vessels wera Spending lass time ding the things hbvora | January 2008 | Harvard Business Review 17they were bad at (maneuvering around harbors with their confined speces and variable wind conditions) and more doing ‘what they were good at (moving across the open soa without having to carry fuel. As 2 result, their performance ~ as ‘measured by average speed anc cost per ton of cargo moved - jumoed In other cases, the focus on a market segment does spur an improvement in the oi technology. My research with Rob- ‘rt Huckman of Havvard Business School reveslod that this happened with coronary antary bypass graft surgery after angio- plasty was inocuced asa weatmnent for relaively heather patients with block forethought ‘The New Appears; the Old Improves When electronic fuel-injection (EF!) systems started to replace carburetors inthe early 1980s, the miles-per-gellon (MP6) performance of carburetors spiked dramatically Car Models with EFI vs. Carburotors ™ i a Son £00 g i 3 gates = i 5 Z| i BER ERE ES Carburetor Fuel Economy MPG above or below the average SERRE EE 18 Harverd Business Review | January 2008 |_nbrore ‘ages. Even though surgeons who perform bypasses were loft with sicker, hiaher-risk patients, outeomes after surgery actually Improved for such pationts.Itturns out thatthe concontration of dificult cases gave the surgeons better opportunities to lear how to hone thei techniques, Use of the new to improve the old, Existing technolovies often borrow ‘components of the new technology. ‘Carburetor manutacturers increased fuel ‘fficioncy by incorporating electronic ‘controls in the products they developed {or electronic tuel-injaction systems (see the exhibit "The New Appears; the Old Improves" Producers of CISC computer ‘chips increased the performance of their products by adopting features of RISC chips, such aa the lattar's design for con: ducting somo core processing operations. “Those insihts into the causes of last 2903 have major stratagic implications for firs in industries whore technology ‘transitions ate occurring. A danger for new-tachnology tims is underestimating how fong the last gasp wll dalay them from becoming profitable. Ina study of the semiconductor materials industry | ‘ound that this miscaleuletion caused humorous toch start ups to founder. For established playors that heve managed to breathe new ite into old echnowogias, a Ganget s mistaking the last gasp for sustainable improvement. This can lead them to overestimate the prospects of their products, overinvest in trying to en- hance them, and vait too lana to ewitch to the new technology. Digital Equipment ‘Corporation and two carburotor manu facturers, Holley and Carter, fellinto ths tap. From their axperiences and those ‘of others, it's clear that strategy can affect how transitions from old to new technologies occur and who wins and ‘sho loses, The path, pace, and outcome ‘are not preardeined. Danial C. Snow idsnawathhs edi is the Lumry Family Assistant Professor of Bus ress Administration in he technotogy and operations management unit at Harvard Business School in Boston Reprint FO8018 High Margins and the Quest for Aesthetic Coherence by Robert D. Austin Compenies squeezed by low-cost com petitars might be eble to learn something from a Danish maker of unscole waste: baskets and soap dispensers. ‘As globalization further erodes profits in daveloped counties, brands whose labor is based in low-cost economies may eventually have an insuimountable advantage over those from the devel- ‘oped world, Consumer product firms in Europe, the United States, and Japan wil nocd altornative businoss modois. One that has had striking success is soling ‘well-designed and well-crafted products thigh margins ~ but that strategy is: far trom simple. Executing it corectly requires that a compary and its products have whet I eal aesthetic coherence. Consider Vipp, maker of a select few high priced household items. Vipp is known throughout Europe for design, ‘workmanship, and a resonant back- story about founders Holger ané Marie Nielsen. The design of its trash bins, which sel for up to €500 each and are litle changed from the original that Holger invented in 1939 for Mario's hai- Grossing salon, has boon rocogrized by the Louvre as icone. Its products are bulit by European craftspeople, Its “mite edition” tolat brush is python ‘geen. a color inspired by a satin b ‘gown Marie wore in 1957, Every detal fits into a competing picture. The result ofthat eesthetic coherence is product profit margins that a mass matketar would envy. Three hundred percent (my rough estimate) looks pretty, ‘good 10 companies that typicaly get Single digits on items they produce for discount eizlers To succeed in seling high-end prod- cts, a company neadr't goto Vip ‘extremes, But ts story, products, part ners, and even sales chennels have to ‘ita coherent picture for customers. The Danish audio company Bang & Olufsen.much lerger than Vinp, has hed » distine- tive Bauhaus influenced style since the 1960s, solls state-of-the-art products, thas developed a car storeo syatarn with ‘Audi, and retails through B&O-cnly stores {nhigh-rent eeations oF in specially de- signed sections of larger stores. ‘Afevr comparies have managed 10 sea design-intensive approach to gat better then-discount margins while stil ‘mointaining reasonable prices ond high volume: Target, IKEA, ard the utensil ‘maker OXO Incernational, for example, hhave developed an aesthetic coher- fence that blands a style focus with cost ‘WalMart, on the other hand, didn’t hhave tho aesthetic coherence it nooded for erodibility with upscale customers \when it ted to market higher-end fash. fan ines. The company hadn't done its hhomewark it ain't have the necessary design and quaity reputation, Wal-Mart soon retreated from the stiategy, with chief executive H, Lee Scott, Jr, telling BusinessWeek, “We cen't wake up one ‘morning and say we're going to bs some thing different. and not earn it. My in-depth studies of Vipp, B&O, and other companies, ard my cbserva- tions of Wal-Mart's attempts 1 crack ‘@ high-mergin market, suggest that 2s companies try to create aesthetic cohe! ‘ence, they should avoid three dangerous tomotations: ‘Skipping the homework ov dosign, \weremanship, pubic rations, and story, thereby creating aesthetic incoherence Sacrificing margin potential for efficiency ~ don't go alter potential cost ‘savings that might reduce a produet’s at trastivanese and thereby ‘ower the prica thet customers are willing to pay. Th: price drep could even wipe out the entica benefit ofthe initial cost reduction Going after low-margin business, ‘which makes the product less distinc tive, Don't let short-term thinking driven by quertetly reporting push you 100 far down market mn search of greater volume, fr you'll wake Up one momning to realize you're seling commodities again. I've often wondered why some of the ‘companies that best exemplify aes- thetic coherence are Scandinavian, whether it’s at least partly because their high labor costs limit their ability to com- pete on orice. They've gotten very goad at dfforentiation instead. In that sence, the Scandinavian dosign-centorod players may represent the future for companies elsewhere in the developed ‘world, where the high-margin approach ‘may prove an extremely attractive ~ per hhaps the only ~alternative to competing fon cost. Robert D, Austin iaustin@hbs edu is ‘quest professor at Copenhagen Business Schoo! in Danmark and an associate rotes- sor at Harvaid Business School in Boston Heis2:coauthor, with Lee Devi, of Ret able Innovation forthcoming from Stanford University Press, Reprint FO801C SOCIAL RESPONSIBILITY Do Well by Doing Good? Don't Count on It by Joshua D, Margolis ond Hillary Anger Elfendoin It's alluring and very much in vogue to ‘connect social responsibilty with profit ability. you can make e business case for positive social action, everybody ‘wins ~ employees, shareholders, and s0- ciety at large. But for decades research- tars have labored to answer a nagging question: Is there, infact, a ink between corporate social performance end corpo- rate financial performance? Nota strong one, sccording to an analysis of 167 uch studios that wero conducted over 35 yoars, 2 project we undertook with James P. Walsh from the University of Michigan's Ress Scheol of Business While doing good doesn't appear 10 destroy shareholder value, we found ‘only a very small corvelation between corporate behavior and good financial results (the exception being public mis doods, which had a discernible nogative impact). Moreover, the minor correlation that does exist could well be explained by deep pockers ~2 history of sireng financial performance may simply give a company the wherewithal to contribute to society. Indeed, of the various forms social rpponsibllty can tako, cash contributions to charties have shown a stronger correlation with suecoss than have socially responsible corporate polices or community projects. Here is, a slightly more detalled summary of our findings Corporate misdeeds are costly to. companies -if people find out. ‘Anecdotal evidence about rocent scandals highlights just how grave the consequences of wrongcioing can be for companies and their executives, but it's dificult to estimate the ikatinocdl of being foure out Doing good is unlikely to cost shareholders. Porhaps the oasiest ‘way to communicate our findings is to:say thet only 2% of the studies we reviawed showed that managers who adicate corporate resources to social hnovorg | January 2008 | Harvatd Business Review 19forethought performance taking actions that con- sider the interests of society —imoose a direct cost to shareholders, Companies an 60 good and do well, even if they don't do wall by doing good, Profitability should not be the primary rationale for corporate social responsibility. None of tis s to suggest that companies should not engage in activites that generate social 900. However, they should not expect 10 bo handsomely rewarded. Socially responsible behavior may not cost you financially, but ifthe goal is return on investment, shere are many other ways to spenc money that can deliver a greater payoit. Analternative, and perhaps more cyni cal, way to interpret the mild correlation is to suggest that it pays to be good, but ‘ot t00 good. It could be that companies ‘that are demonstrating a payott are coing fenaugh nat 19 run afoul of regulators ‘and activists, but not so much that they offend analysts and investors. In the end, if the promise of an eco ‘nomic payott can persuede companies 10 clean up their questionable conduct or redress socal ils, society would benaft. However, framing a societal investment in terms of shareholder kneres: may be misguided. Invesimants need tobe judged solely on the merits, and leaders can end should explore thir own motives tions before buying into the hype. Doing 900d may bo its own reward Joshua D. Margolis imargols@hos edu) is an associate professor n he organization! bbehavier unit at Hervard Business Schoo in Bosion, Hillery Anger Elfenbein enger® has berkeley.edu] san assistant protesser in the organizational bohavir and ndusvial felations group atthe University of Califor. nia at Berkeloy’s Haas School of Business, Reprint FOBOID. STRATEGY AND TECHNOLOGY The Value of a Broader Product Portfolio by Bharat N. Anand With rapid technological change posing eve: more intense compettive chal- lenges, companies are often advised t0 scrutinize thei portfolios and siminate unprofitable products. Every product, the reasoning goes, ust stand on its own bottom tne, That, however, may ba ex ‘actly the wrong mantra for these times. {A broader portfolio of products ~ aven if some are, fora time, unprofitable —often can help a company capture move value To understand why breadth matters, ithelps to look at how today's strate- gic landscape is changing. New, less expansive production tochnologias and ‘93890 entry into some markets nave led to. proliferation of products and services; atthe same time, the cost of reproducing and distributing certain classes of cxoduets has dropped deamati- ‘cally, The result is @ heightening of two cote strategie challenges facing busi: 1ne8ses: getting noticed and getting paid. ow is brand to gat raticed when ‘there are some 13,000 US. mutual funds to select from and, 2s Barry ‘Schwartz notes in The Paradox of Choice, supermarkets can offer 175 varieties ‘of tea begs and 285 kinds of cookies? In information industries, the problem is particularly acute: US. publishors produce more than twice 2s many books today as they did a decade ago, anc the ‘volume of information our society gener- 20 Harvard Business Review | January 2008 | Noro%e ates is far outstripping curabiity toconsume ital. And how is, say, a music company to recover its invest ‘ments whan people can chaaly copy and distribute the products? Maia organizations are currently having the mest trouble getting paid ~ think of big metropolitan ‘newspapers end the competition from free dalies and free online content such as blogs. Othor types of businesses face similar problems —witness the chal- lenge to Microsoft by Linux. It's tempting for companies to tay to meat the twin challenges of getting noticed and getting aid by shedding product lines, but evecossful firms have shown thatthe Best approach is often ‘the opposite one: 0 expand anc ‘xtend the product portato. Expanding it increases not oni the chances for a big win but also the num ber of other products that can benefit froma hit's popularity, The porttolio approach has been used for years in the traditional supermarket — that brawling arena of product proliferation ~in such tacties as umbrella branding and loss- leader pricing, Indeed, the technique is shoving uo in arange of industries. Apple's expen- sion of its portili toinetude the iPod has not only Iaunchad.a whole economy (of "i" add-ons, including the iPhone, but also boostad sales of Apple's existing ‘computers. Tha Indian network Star TV ‘saw its prime-time viewer shate increase from lass than 5% to more than BO% in ‘one year aftera single hit show, Keun Banege Crorepati(the Indian version of Wino Wants to Be a Milioraie), helped allits productions become more popular. The benofits can euon extend to other firms. Author Dan Brown had written three books with mediocre sales prior to bis best seller The Da Vinci Code. When his former publishers then re- released the older works, they became best seliors as wall ‘The porttotio approach can also helps ‘company tackle the getting-paid problem. When there's price pressure in a coma:Conversation Harvard Business School's Sandra J. Sucher on the value of a book club for executives 0 20 years, Harvard Businass Schoo’ literature lass The Moral Laador has tapped a rich canon of fiction and nonfiction to offer executives deep and powerful lessons about leadership, Senor leturer ‘of business administration Sandie J. Sucher, who teaches the course and has had along career as a prectic= ing manager, argues that bringing executives together to ead and discuss iterary works can be a potent leadership davelopmert too ‘school may illuminate cocutives' reading and talking about books? Shouldn't those be off-duty pleasures? Life as an executive is replete with decisions that have moral or ethical dimensions ~and that usvally catch you off guard. You see a colleague being mistreated by your ‘boss do you speak up? You don't agree with a decision that comes down from senior management — how do you explain it to your subordinates? ‘Most people, when asked how they would approach. such decisions say that they would rely on their moral ode. But what does that really mean? Organizations provide few opportunities for executives to develop a nuanced understanding of moral challenges or to practice moral debate. The value of The Moral Leader {n't so much in what I or previous instructors have hhad to say during the course but in how the students reason through the moral challenges together and. debate the perspectives that the literature evokes, Managers responsible for developing other leaders can use this type of literary debate to spark very revealin conversations. Because the books we read are not about business, leas, executives can distance themselves from their biases and only later, upon reflection, see how their own choices might mirror ‘those in the narratives. For instance, ve read Kazuo Ishiguro’s novel, The Toviewa Fstot ‘econvmendad texts foranovscutve eck, iit sucherraadiags. Remains of the Day, about an English hoor butler relecting on a lite given ‘over toa single moral principle: loyalty to his boss. His sacrifices and their consequences. for him and others paint a terrifying picture of a moral code taken to extremes, even though the protagonist can understand this in only a limited way. 1° very hard not to read the novel at least in part as a cautionary tale ebout the limits of loyalty and the points at which we start to lose ourselves in our jobs. ‘A book can be a cautionary tale whether or not we discuss it. Why make it more than assigned indl- vidual reading? The Remains of the Day fine piece of literature no mat- terhow you read it, but you want to wrestle with your ‘own moral code, reading i in isolation isnt so diferent from the butle's lonely musings. He gains some perspec: into his actions and their consequences by reflecting ‘on his life, but be doesn't have the full story. People need! ‘thers’ points of view. {also have my students read an excerpt from Personal ‘story Katharine Graham's autobiograpsy, which ‘details her bold decisions about covering the Pentagon Papers and Watergate atthe Washington Post; and Alfred Lansing’s Eadurance, the tale of Sir Emest Shackleton’ disastrous Antarctic excursion. The moral question con- ‘cerns Shackleton’s motives for saving his entire crew ~ the stood to gan financially by sparing everyone, even. though supporting the weakest of them put the other crew members at risk. What valuo doos a book group offer individual lea ‘ors and, by extension, the firms that employ thom? It's in the exchange of ideas about these books that people come to understand how their ovmn moral codes ‘constrain them ~and how they might approach decisions ‘with a more nuanced understanding. Most of us believe that cur moral views are self-evident. Hearing people [present arguments you had never thought of fs one way to strengthen your own moral reasoning skis It also ‘can create a powerful bond within a group. Firms might ‘consider integrating discussions of texts into their leader ship development programs or even creating a book club for senior leaders ~or for any group that confronts moral decision making. Choose a few books, meet once a month ‘or so,rotate discussion leaders, and see what happens; you might be surprised atthe depeh of insight that emerges =M. Ellon Pesbles Reprint FOB01F ovorg | January 2008 | Harvare Businass Review 21forethought ny's core business, a product-oriented strateay would be to try to boost the return from each product by, for exerle, aiving up price-sensitive customers and, ppuréuing those who are willing to pay ‘more. With 9 portfolio approach, a com- ppany doesn't have to do that ~it can pro- tect itself by expanding into sectors that ‘make more money when prices of the company's core products fall. Record- ing studies were kicking themselves for ‘ot socing the opportunity in products such as MP3 players that were adjacent to easily dupicated CDs, Many media firms, such as the Norwegian company ‘Schibsted, have aggressively expanded into complernentary businesses such as free nevespapers and online classifieds With technology moving so quickly that vitualy no managor, engineer, or technologist can predict next year's ‘winning arc losing products, a porttotio approach presents greater opportunities {for creative solutions than does fighting with your competitors on a product-by- product level, Bharat N. Anand Jbananc@his edu) is a protessorin te strategy unit at Harvars Business Schoo! in Beston, eprint O301E COMPETITIVE ADVANTAGE Seek Strategy the Right Way at the Right Time by Giovanni Gavetti and Jan W. Rivkin ‘Among managers who make strategy and researchers who study it. fierce bates hhave been fought over the right way to diecover& strategy. In one corner stand advocates of analysis, deliberation, nd planning: Managers should study the competitive forces in their environment, deduce aset of choices that helps the fur confront those forces, an then implement the choices. Inthe opposite comer are those who support what's ‘termed an emergont approach Managars should try things out, loam from oxpor- fence, adjust, and gradually craft, a sustagy, urrecent esearch, en in-depth, multiyear study of firms searching for stratogies in tho internet portal industry, suggosts that both views are right - but Incomplete, Deliberation and emergence ‘work, just under diferent ercumstances andat different times inan industry's development, Early in the life of a typical industry, ‘competitive conditions are extremly i dofined. n the nascont portal industry of 1993 to 1995, for instanee, fundamental ‘eaturas of the market (who the custom: ‘es we'e, what they would pay for| ware ambiguous. It would have been futile for companies in this industry to search for ‘a strategy puroly by deliberate applica- tion of economic loge. Firms such as ‘Yahoo that thrived in those early days analyzed the environment to some degree but took a largely emergent, experiential approsc. Later, 2s the industy's features solidified, ithecame ‘effective for strategists to be more delib= erete. By 1997, for exemple, managers et Lycos could see that economies of scale and switching costs were rising, whieh meant the compary needed to be big and'o lock in customers. The managers reasoned that the company had to grow quickly and that acquisition was the test- est vay. Great stretegists can, firs, size Lup whether deliberate dectucton is afec: tive in an industry ata given point in time and, second, match how thay search for a strategy to current corsitions in their inaustry 22 Harverd Business Review | January 2008 | Mor oro Both the deliberate and emergent views are incomplete in that they miss important other ways to search for a stratogy, approaches that fo betwoon VACHERON CONSTANTIN Manufacture Horlogare. Gi Jepuis 1755Sta ot CO DEM rea Leto RE a) DRIVER SETTINGS. TECHNOLOGY IS THE NEW LUXURY. The Acura RL Advancing control.HBR CASE STUDY How to Change the World Alan Wilson has several career options but only one ambition ~ to make a difference. by Howard H. Stevenson LAN WILSON PEERED past his Atomics at the skiers ‘whizzing by 20 feet below the chairlift. The sky had darkened, and a light, wind-whipped snow was fall- ing, but the changing conditions certainly hadrrt de- terred the diehards. He watched a young woman hurtle down the steep slope, poles and ponder flying. He carefully adjusted his goggles. He hadn't said much to his, bestfriend, Karl, during their 1o-minute ride together. Alan vas feeling reflective, What was he going to do with his life now that some exciting new possibilities had opened up? People think it’s miserable to have no options, he thought, but in a way, it's more stressful to have too many. ‘Three-quartersof the way up the mountain, the strengthening nd gently rocked the chair. Karl pulled out the trail map and pointed a gloved finger at one of the black-diamond runs. “The HBRs cas ai which are fictional, present common managerial 1nap.ond offer concrete solutions from oxperts, ipcorg | January 2008 | Harvard Business Review 29LEADERSHIP AND STRATEGY | HBR CASE STUDY | How to Change the World Couloir Noir isthe one on the right!"he said. “What do you think?” Alan and Karl shared a passion for moguls. Alan had been a Division 1 skier in college, and Karl, who'd grown up in Kitzbiihel, Austria, had once en: tertained Olympic dreams. They had never explored this particular resort on any of their New Year's trips to the slopes of the Rockies. Alan looked up at the steep, narrow run snaking off through the pine trees, He nodded to- ward another one ~ the Dragon Chute, which started as a drop over a cliff and then spread out into a powdery bowl. “Tike the look of that one, too} he said. They still hadn't decided which course to take when they raised their ski tips at the top of the lift. Sliding off the chair, they stopped to look again at the map. Alan pointed to the Dragon Chute, which appeared to be closer. They skied to the brink of the cliff. Bending his knees and pushing in his poles, Alan launched himself into the swirling snow with Karl following hard behind. ‘Moguls in the Making AA few hours earlier, over bread bowls of steaming, fragrant chili in the noi lodge, Karl had asked Alan, a bit deli- cately, how things were going, “You mean at work?” Alan said “Well, yes, at work, And everything. How's your dad doing?" “A lot better now. It’ hard to believe it'sbeen five years since my mom died” He dug a spoon into the chilisoaked bread, fighting a lump in his throat. ‘The memory ofthe hospital room ~ the slant of the afternoon of the respirator, all that plastic tub: ing everywhere - was still searing. He thought how unfair his mother’s death Howard H. Stevenson (hstavenson@nns 2d) is the senior associate dean and the Serofim-Rock Bater Foundation Prolessor of Business Administration @t Harvard Busi ress School in Boston, and chair of the Harvard Business School Pubishing board, vas when she'd given so:much to oth- ers, not least by founding and running Help and Hope, now a wel/-established charity. He remembered the day they'd been tokt her cancer had spread; she had taken his hand,as ifto comfort him. Her fingers were ice-cold“Alan, darling, {you are my gift to the work she had! Said. “You will make a bigger difference initthan At the time, held been working flat out for the strategy consulting firm he'd joined out of business school ints Alan smiled. Good old Karl, ever the career counselor. He had gone a com- pletely different route. Deciding to sce how far his undergraduate degree in ‘math could take him, he had chosen to forgo an MBA. Now he was making ‘money hand over fist at a New York hedge fund, SM Investments. Alan had a vague sense of what was coming. “Well, the thing about M&A is that every deal is different, so I'm stil learn- inga lot? he said.*I've been working on some big possibilities, including some “You never struck me as a big-company guy. Are you really happy there? Challenged enough? And how about the money? Are they paying you what you're worth?” pharmaceutical industry practice. And although he firmly believed that work was the best therapy for griaf, he had also begun to regret the toll that travel ing 20 days a month was taking on. personal life. Not long after the memo- rialservice for hismother,a headhunter had called on behalf of Grepter,a New Jersey-based multinational pharme- ceutical firm, and dangled a vice presi- dency. Alan had decided to make the move. "Yeah I miss your mom, Karl said. “| still have that crazy hat she brought ‘me from Bangladesh.’ He grinned. “It always reminds me to send my check to Help and Hope. figure they're dedicat- Ing themselves to all those projects, the least I can do issupply some money? “Tell me about it” Alan said ruefully. “There's a fund-raiser coming up that | should be putting a lot more time into.” He took a sip of coffee, “But anywa fon the work front, I can’t complain. Grepter has been very good to me. The people are great” “V'mglad to hear it)'Karl said “Stock’s jing well, 00, which doesn't hurt. But it’s so corporate, isn't it? You never struck me as a big-company guy. Are you really happy there? Challenged enough?” 20 Harvard Busingss Revew | January 2008 | _po.0%a international ones. tf haf f them come through, 1 guess Il be on track for a promotion” “And how about the money?" Kart asked. “Are they paying you what you're worth?” Alan wasnt sure what he was worth ~ or, for that matter, how inflated his friend's idea of a decent income might have become. He offered an exagger- ated shrug. “How could they possibly?" Karl laughed and then dropped his voice."The reason Lask this: Theresan opportunity at LSM thet has your name written all over it? He rased hs hand slightly so that Alan would let him con tinue."You know in the fist few years ‘nas making close tohalfa million. With the fund size and performance on the rise, 'm now making~ you won't be liewe this ~almost 10” Alan took a deep breath. The figure stunned him. “Jeez, Karl’he responded. “That's amazing. But that’s you, and you're really good att. You love the risk. You've always been a maverick” “Don't kid me that you're afraid of risk? Karl replied. “ve watched you bom down mountains for years” His eyes glinted, “I mean, sure there’ risk, but it's mainly about being smarter than the average bear. You'd have noLEADERSHIP AND STRATEGY | HOR CASE STUDY | How to Change the World problem. And talk about Help and Hope —if you earn this kind of money, you'll be in a position to really make a difference. At some point down the line you could even cash in your chips, start the Jenny Wilson Memorial Foundation, and do that for the rest of your life” ‘Alan leaned back. Karl's proposal \wascertainly something to think about, But it was also complicating things. During a business trip to California the previous week, another friend had made Alan an offer, too. A Parallel Turn Shiori Masaki, resplendent ina crimson silk dress, had stood waiting for Alan near the host station of a 1o4osstyle restaurant in downtown San Francisco. “It's been too long)’ she said breezily, kissing his cheek. “Thank you for mak- ing the time for me!” “They settled into the comfortable booth. He ordered a draft beer, she a glass of pinot grigio. Alan admired her Jong, pale hand as she ran a finger down the stem of her wineglass Still no ring, he noticed. It was good to catch up. They'd dated a little in business school, but after graduating at the top of her class, Shiori hac moved to California. Very quickly she'd made a mint, first as the cofounder of a dot-com that sold out toa large software company, and then as a partner at a Silicon Valley-based ‘venture capital firm that was moving toward biotechnology. Most recently she'd decided to become a social en- trepreneur, She'd founded a com= pany that focused on getting lifesay- ing medical care to patients in Third World countries. Every time Alan talked to her, she sounded more pas- jonate about what her company was achieving. “We've just lined up some new inves- tors—which, let me tell you, is easier since the Gates Foundation came on board)’ Shiori said.*Now that we're so flush, we can finally get started on a couple of projects I've been dying to launch. I wanted to pick your brain about one in particular.” She described a plan for partnering with big pharma- ceutical companies to get medications forcancer,pain,and infectious diseases topeople in Africa and indonesia more quickly and cheaply.“It's really exciting, stuf But have we made it appealing enough for an industry partner? That's what I need you to tell me’ ‘The waiter appeared to take their order: “Oysters Rockefeller for two, he said with a nod."An excellent choice” {As Alan looked over some materials Shiori had brought, she chatted about “We need a talented person with the right network to kick-start this thing - and you're the perfect fit.” how much she enjoyed living on the peninsula.“You know, it’s sunny most of the time-even in January?’ she said, “It seems like every time I've been in New Jersey, it's been freez~ ing” She leaned toward him."Do you remember when I took you to Half Moon Bay for surfing lessons? You were pretty good.” Alan laughed. “Oh, come on, Shior he said. “You forget. 1 managed to get up on the board, that's all” “Well, you did a lot better than | did; she replied. “Anyway, you seem to like California. Have you ever thought about moving out here?” Alan narrowed his eyes. “Why do yyou ask?" “We need a talented person with the right network to kickstart this thing —and you're the perfect ft. That's what | really wanted to talk t0 you about?” This was a once-in-alifetime oppor- tunity, Shiori said, Alan could get his en- trepreneurial hands ditty. They woul work directly together. “C’mon, don't ‘you want to meet Bill and Melinda?” she said teasingly. 32 Horvard Business Revew | January 2008 | No.0" Alan laughed. “I can see me nov, hob robbing with them and Bono” “In fact, that’s a distinct possibility?” Shiori said seriously.*But here's the real hhard sell You could help save a lot of people from dying of AIDS, Or cancer!” A View from the Top “Okay, let's take a 1o-minute breaky'said Gary Drcisinger, Grepter's longtime CEO, as the investment bankers, their work cover for the day gathered up ther bret cases and slowly filed out of the board- room."We'll meet back here at 4:5.” Alan felt grateful forthe respite, how ever slight. He wasstil a litle sore from his ski trip, and it had been a long meet- ing. Now the whole thing was finally, mercifully, nearly over. He stood up, stretched, and ambled over to the west windows to lower the blinds against the setting sun, Alone in the room, he had a chance ‘to review his position. This merger with Schweitzer was the biggest deal he'd ever worked on, and the final decision would be made in just a few minutes. In his mind he ticked off all the require: ments. The research stream had been thoroughly vetted. The team had care fully considered all the possible cost and revenue synergies. A thorough human resources map of both firms showed that Grepter and Schweitzer were highly complementary, so com: paratively few people (primarily on the administrative side) would have to be let go. Independent analysts had asked the tough questions. The lawyers and bankers had done all their due ailgence. ‘Alan felt exhausted. The deal had been a naibbiter, and he'd flown many times to and from Zurich, putting hundreds of hours into the negotia tions. Schveitzer’s board had rejected Grepter's initial offer of $39 a share, so Alan had negotiated an increase to $42. The plan was to invest simultaneously in Grepter's manufacturing capacity and Schweitzer’ very promising drug R&D, in order to expand Grepter’s pipe- line. The acquisition would positionGrepterto take aver the global vaccines market and compete toe-to-toe with a larger rival Soon Gary, carrying a fresh mug of coffee, re-entered the boardroom ac: companied by the CFO and the head Of strategic planning, Alans boss. The ‘moment of truth hacl arrived. *Gentle- men.’ Gary said, as the four of them took their seats, “it's decision time” He took a sip of coffee, setting the ‘mug down on the polished table with a sharp click."We all know this deal is about the R&D pipeline, and we agree that the financials look positive. I've read the reports?” He looked directly at Alan. “Alan, you've been in Zurich; you've seen what they're doing firsthand. Are you personally confident that everything is as good as they say itis?” “yes, 'm truly impressed? Alan said firmly. “I's exactly what the team said it would be. | think the pipeline is real. And the people are first-class” “All tight,’ Gary said, “We'll go for it. Let's get the paperwork ready?” The other two men left the room, but Gary stayed behind while Alan gathered up his notes. He shook A. an’ hand, smiling broadly. “So, young he said with a twinkle in his eye, “Sprechen Sie Deutsch? “Not really? Alan replied. “Well, you might want to leam some. ‘What would you think about spending alittle more time in Zurich?” ‘Alan stared at Gary. “What do you hhave in mind?” “The first order of business will be to integrate Schweitzer” Gaty said. "That ‘would give you an opportunity to get some experience in operations. Besides?” he said with a grin, “since you're a ski bufi, | thought you might appreciate the surroundings” “Ah... Alan began, not quite know: ing what to say. “after that ~ 1 figure in six months or so I'l consider promoting you to se- nior vice president in charge of global M&A, reporting directly to me. By then you'll be an exceptionally strong canci- date. With a few years of global experi- ‘ence under your belt, you'll be as well positioned in the company as anyone could possibly be.” The Big Jump Alan felt a little lightheaded as he drove to the house of his favorite cousin, Beth for dinner. He wasn't sure whether he was just hungry or reacting to the plethora of dizzying choices. As he pulled into the driveway, the front door opened. Eva and Kia, Beth's four- year-old twins, came tumbling down the steps to meet him, squealing with delight “Uncalan! Uncalant Uncalan’s here!" the girls cried, hugging his legs as he ‘closed the car door. He grinned. “Bry, it's cold out here!” he said cheer ily."Let's go inside, I brought presents.” ‘Alan had trained his litle cousins ‘well, Beth had pleaded with himto stop spoiling them, but he enjoyed it when they behaved like Pavlovian puppies, jumping and yipping in expectation of ‘the trinkets he always provided. His Visits had a bittersweet side, thoust He couldn't help wondering sometimes iF he'd missed the chance to have his ‘own Family Ashe ovins bounced into the house, Beth greeted him at the door, wiping hier hands on a cloth. She kissed his cheek as her husband, Eric, offered to take his coat. Alan reached into the Pockets and pulled out two brightly colored, silken: maned plastic horses for the girls. “Girl, say thank you!” Beth shouted as they ran off with their prizes. “Thankyuncalan!” Over a dinner of roast chicken and mashed potatoes with gravy, Alan re- ‘counted the events of the afternoon to Beth and Eri. “My goodness!” Beth said. ‘What an ‘offer! What did you tell him?" AS a schoolteacher, she had ambitions of a different kind, but she always seemed to be dazzled by the accomplishments of her cousin, who was as close to her as her own brother. “{told him I'd be glad to think about Alan said. “Think about it!” Beth cried.“What’s tothink about? I'm surprised you didn't just grab it right there and then.” “Hmmm, | get the feeling Alan's a little conflicted,’ Erie observed. ‘Alan told them about the offers from Karl and Shiori, and then started weighing his options aloud, “I I stay with Grepter, I not only have an oppor tunity to work directly with the CEO, but I can get both operational and ‘lobal experience. And if continue to ‘advance — well, let's just say that any- ‘one who gets to the top of a Fortune 100 company has a big platform for bringing about some positive changes in the world. But that's counting chick- fens. On the other hand, if 1 worked in the hedge fund, I'm sure I'd make more money in the short term so 1 could probably start making a differ- “Because you could support the ‘of work that Aunt Jenny did," Beth ventured. ‘Alan nodded. “And people like her probably do it better than | could any- way. That's my hesitation about the California opportunity, 'é be making a difference for some very unfortunate people right now, and that would be ‘gratifying, but. “And does that Shiori still appeal to you?” Beth interrupted with a smile. “she sure did once, as 1 remember. She's cute. Smart, too Eric rescued him by saying, "It sounds like the real question is not about money but about where you think you ‘can make the greatest impact on the world.” *You're right," Alan said.*That's what wish I knew? “Alan, you're such a superstar Beth, chimed in. "Just do what you love, and the impact will follow” Which career should Alan choose to make the biggest difference? Four commentators offer expert dvi. prorg | January 2008 | Harvard Business Raview 33LEADERSHIP AND STRATEGY | HER Case Commontary | Which Career Should Alan Choose? Laura Seheris a cofounder and tho cheirand CED of Credo Mobile oxracy Working Assets, a Sen Freneigeo-basad wireless hove service provider that has generated $66 milion for onprott groups since 1986, Te ALAN is single, k's clear that fam= ily Is important (0 him. A devoted son and cousin, he loves children and entertains ‘thoughts of fatherhood. The best way te honor bis mother’s wishes woud be to raise Nis fu- tute children —her grardchiléren with a good value systom. Therefore, tho overricing que: tions he shoud ask hse ar these: Wheredo | se0mysaifin years, when nave famiy ot ‘my own? How wil | teach my kids about mak- Ing @ connection between values and work? From this perspective it seems that any of his ‘career options wil work very well~as long as he brings his votes into the workslece, ‘Alan should also waigh each of his job ‘options on a five-point scala -monoy, fame, ‘power, personal values, and qualty of He. By they would probably judge him negatively, But the could choose to use his positon at LSM to ‘support his personal values and his qualty of fie: 1 he ved modestly, tried to get the fund te invest in socely valuable projects, set an ‘example of philanthropic promis, and made ‘0 to epond o io of tino with hie cileron, they would judge him diferent. Having imagined himself inthe future and considerad the various postions according to this fwespoint scale, Aan can begin 10 weigh the benefits against the possible risks, both personally and professionally. For instance, living in California or Zurich right make him focl 100 distant from his beloved cousins: 4 negative for quaity of lite, AS he weighs these considerations, however, he shoulda Alan should rely on a clearheaded, objective investigation of the facts. For example, is there a basis for believing that the CEO will really follow through on his promise? this measure, working in Shvor's social ontor- prise organization might well score high on ‘personal values and qualiy of life. Working 138 senior manager et Grepter would score very high en power: would undoubtedly 16> ward Alan with @ fine sslary, bonuses, snd stock; and if he poreueded his compary to ‘provide free medicine for the Foor - would ‘also score high on personal values. Furtner- ‘more, If he's chinking about his future farnty ‘and quail of life, the chance to raise his chil- ten in Zurich ~@ safe, clean, cosmopoitan ity where they could learn to speak multiple languages ~ might tempt him, too. ‘A person who puts 3 high premium on do- {ng goad in the wor might thnk that joining karl at SM investments would be the worst possivle choice, because he oF she might ‘assume that meking money is the only reel iver. Certainly, if Alan were @ hedge fund manager who flew around the world on a pri vate jot ond savr his kids two weeks yoar, 44 Harvard Businass Review | January 2008 | Abo. ‘not on hearsay and hunches but, rather, on a clearheaded, objecive Investigation of the fects. For example, is there a basi for belie: ing thet the CEO wit realy folow through on his promise? Or would Alan find himself too {or away from the corporate epicenter if he \workodin Zurich, and thus be passed over for {8 more advantegeous position? To find out, hho should look at the career paths of other managers at Grepter. And has the company demonstrated any interest in supporting or expanding his sociel egenda? [As for the hedge fund, he should fook at the makeup of the toord. Does he share the vision of is members? What isthe long-term plan? Tho same goes for Shion's compar. ‘Once Alan has evaluated his options tis ‘way, his choice willbe clearer. But regardless ofthe choice he makes, he should remember thet mary paths lead to the seme place, t's really a matter of approach ~ bringing your val- ues to work Wondy wayOverdue and over budget, over and over again? Execution is often the missing link between project aspirations and reality. That's why projects take too long and cost too much. That's why we created the first Execution Management system. Using our system, the US Air Force Warner Robins Air Logistics Center is finishing C-5 aircraft maintenance 33% faster, saving 2.37 billion dollars in the replacement value of aircraft. For this achievement, together we ‘won the 2006 Franz Edelman award, the super bowl of operations research. If projects are vital to your business, call us at 1-408-271-1711 to schedule an introductory call with our experts. It could be a very profitable telephone call for your organization, * Source: Ar Force Materiel Command pros eee 8/2006 If projects are vital to your business, call us at 1-408-271-1714 to schedule an introductory call with our experts. It could be a very profitable telephone call for your organization. * Source: Ar Force Materel Command ross ease 8/2000LEADERSHIP AND STRATEGY | HER Case Commentary | Which Car Denie! Vesellafofice.vasele® soup novsrtis con ie the ‘oirman and CEO of Novartis in Basel, Switzerond. PT iene centr sero ners fyster, but his metner's ghost is inerter Jing with his enjoyment of it. His confusion ‘sorngs, in prt from the fact shat he hs not vet frished with the grieving process. As she was passing oway, his mother burdened him with 2 heavy expectation. Har dying wish has {put Aen inthe unhagpy poston offing to ful erro fer him rather than choosing Fis ‘own cirection. By hinging Nis future on the f= filment of his mother's wishes, he may miss the opportunity to realize the full potent of tis oem fo ‘Alan must start by asking himself @ fow key questions: What i roaly driving me, ro fessionally and prvatay? Am I bving my own lite, folowing my ideas, am acting from ‘heavy conscience? What ate my cove skis, ‘and what satisfies me most? Some of An's personal predilections o- ‘ready indicate apeth. Consider the wey he sks. He takes calvlated risks. Instead of choosing thonorraw track, whorohe mighthitatroe, he (068 forthe wide-open run, By leaping before Kar, ha shows that he's aleadar, nota folowor. Algn’s skill with people makes the oppor tunity in Casforia mote appropriate, but he ‘needs to ask whether professional network ing ls really whet he wants to do, Another uestion arises: Does it make sense to go Into business witha friend? What wil happen ‘f Alo, 2 natural loador, ports to Shiori~or to Karl? It he competes with one of them fF if something goas wrong, can the frignd- ship survive? Grepier, however satisfies hisneed 10 work vith people and offers excellent prospects. ‘An international position abroad and respon sibility foron integration project wouldindoos {v0 Alan extroraly valuablo experiance, The CEO has hinted that he might mentor fim andhhas even intimated that Alan might be his suecessor. Alan should confide in Gary and ‘openly and honestly discuss h's options and ‘concerns; he might say thet he’ like to find ‘a vay to combine a career in big pharra with social entrepreneurship, Indood, it might bo strategically interesting for Graptar to grow a business baseden proviaingatfordable drugs 10 the world’s poor During this ascussion Does it make sense to go into business with a friend? What will happen if Alan, a natur ‘or to Karl? ‘Such hints suggest that working fora hedge fund might be the wrong choice. Instead of ‘broadening his competency level though a wide variety of experiences, he would be nar- rowing it by spending his days studying the movements stocks. Moreover, interpersonal ‘latorships areimportant to him, buthe prob bly wouldn't beinteracting much with people ‘at @ hedge fund, And money doesn't seem to Interest him as much as it does Karl ~at last not forts ownsske. {suspect tat Alan knows that money has an addictive quality: The more you earn, the mote you spend, and it doesn't ‘necessarily make you happy, 26 Harvard Businass Revew | January 2008 | _nocora. leader, reports to Shiori ~ ‘Alan eould lesen a lot adeut Gary's interest in ‘and insentions for him. In his oles amentor, the CEO might also help Alan discover that being useful to so- ciety has to do not just with work but with all aspects of life ~not just the charities to “which he contributes but also the products and services he helps produce, the relation ships he bulls, even the taxes he pays. By ‘be2ng open with his mentor and paying attan- tion to his own heart, Alsn may ciscover that he can follow his true self and at the same time de more for the world than his mother ever roamed ofNew York's Columbia Business School offers 16 Executive Education programs to help you succeed in a rapidly ‘THE COLUMBIA SENIOR EXECUTIVE PROGRAM, APR. 27-MAY 23 or OCT. 19-NOV.14, 2008: ‘ocused on providing the tools, insights, ging world, including: Our premier 4-week program for senior execut and skills to maximize your potential EXECUTIVE DEVELOPMENT PROGRAM: TRANSITION TO GENERAL MANAGEMENT, APR. 27-MAY 9 or OCT. 26-NOV.7, 200! For upper-level spe: eeking to develop the skills needed as a cross-functional ger anager. COLUMBIA ESSENTIALS OF MANAGEMENT, APR. 6-18, 2008: For high: intial managers eek to fur wi their leaders velopment and ena} Go to UPGRADEYOURCAREERWARE.COM or call 212.854.3395. Columbia Business SchoolLEADERSHIP AND STRATEGY | HER Case Commentary | Which Car Barbara H. Fronklin Ibhrsnklin@ohrerkin com) Is the president and CEO of Barbara Franklin Enterprise, an internation trade consult ing and investment fim ead quartered in Washirgten, DC, anda former US. secretary ot ‘commerce (1992-1993) Wass 1 dying mother tells ber son, “You ate my gift 10 the word,” those wards echo forever in the core of his being, ‘Alan will never be able to completely dis ‘gard the memory of his mother's voice, end itis bound to havo an influence on his future bohavior. However, his cousin is right: It he does What he loves, the impact wil flow. | would aadvse Alan not to worry that any decision he ‘makes nove might foreclose future opportuni- ties. At this early stage in his cereer it prob- ably won't. Instead he should sort through his thoughts by pulling out a yelow ped and writing things down. Specificaly, ho should make two ists. Ona shoulé noto the things he really loves to do: What turns him on? Wat sorts af work situations ard personal activities does he find fun? The other should ist the things he really doesn’t ke, Having done this, he should note the pros and.cons of ‘2ach job opportunity and then compare them with hie kos and cisikes, His goa! should be te discover vinich opportunity best matches what he loves coing. were advising Alan, | would caution him against either jing the nadge fund or ac c2ptingalonger tenure at Grepter. He doesn't thing for him, as his old fiend has pointed ‘out. Nor, again, would Alan be able to make ‘an impact for quite a while, especialy if he is working very hard as a senior manager, “There ae several reesons why Alan should seriously consider joining Shior's enterpi Fist, the ortroprenourial adventure of build ing 2 company, although it can be risky, is ‘energizing and fun ~and Alan soars capabia of tolerating the level of rsk involved. Shion! thas alieady shown that she knows how to ‘make money, so her new company’s chances ‘of success may be better than averoge. And if Alon has an equity stake in the company ‘and it goes public or is cold, he could make ‘some money in the process. Howover, work ing with Shion! could be a pitfall lan isn't claar about his romantic feelings for her. Second, the satisfaction that he derives ‘rom working on @ meaningful socal venture would be @ wonderful belm for the emo tional pain of losing the mother he loved and admires. ‘Thicd, he would gain experiance in socis! potcy. If he combined tn's with tna nigh level contacis that Shiori hints he could ‘make, he might find himself in a position ‘of greeter influence later. For examole, he Alan might be drawn to the public sector. Public service is often tough, and you can’t get rich doing it. But there is great satisfaction in making a contribution this way. ‘peer to be sufficiently driven by money 10 join Kai's team. The stress factor in that busi- ress might be high, and~ even assuming the fund does well and Alan makes @ lot of ‘monoy—nis satistaction quotient might be low. Moreover, he wouldn't be able to make the social impact he wants to for several vears. And although Gtepter seems to be @ fine place, and Alan has been happy in his career there £0 far, wading through a larce corporate bureaucracy might not be the best 28 Harvard Business Revew | January 2008 | _hocora ‘might be drawn to the public sector. There ‘are mary jobs in government - in the United ‘States and globally, in appointive or elective office ~ where he could have a vary positive impact on society. Not many MBAS choose the public-service path: Public service is of ten Tough, and you can't get rich doing it But there is great satisfaction in making a contribution this way. It is worth consicer- ing if Alan really wants to become a force forlarge-scslo chongo,CAN RELATE 10 Alan's situation, When I fine Ished my MBA at Harvard Business School in 2004, my possibilities seemed Fmitless |, to0, wanted 10 do something meeringful ‘but didn’t know what. | had experienced a rewarding career in software, having started two companias and takon ono puis botero landing at HBS; but | wanted 10 expand my hhotizons. So many other paths wore now ‘open tome. Would go into venture capital or private equity, viere | would be on the omer side of building businesses? Weuld | join & Fortune 100 firm for best-ofclass manage ‘ment training? Or would | make something fof tho business plan I'd writen during the ‘rogram (In the end that's what | did} frst (nad to understand my own character | roalizad that enjoy taking risks and charting myown course. Alanismore conservative and (900d use of his analytical skls, the only real draw appears 16 be money. Ifthe fund fal, howaver, he may be left with neither wealth nor @ persuasive career record. Likewise, working with Shiori does not make sense. ‘Alan could indoed make a lasting impact, but tho eccial enterprice ic already hor dream and vision. How could Alsn dovelop and demen- stata his expertise independent? Moreover, It's never'@ good idea to mix personal and professional ives. If Alan's romentc interest in Show reawakens and things don’t work out, itcould be disastrous. Alon is motivated to build something with lasting impect, he cannot continue analyzing his career trom the sdeines. He musteutivate his opevationaland management skits. Staying with Grepter and accepting the challenge of Imegrating the Zuxich fiery wil give him the f Alan wants eventually to run a social enterprise or a smaller company, the best way to get there is to develop his capabilities and network at a leading firm, analysis, Select messures scorecard meres Conduct strategy and targote ‘Strattx correlation analysis av: 3 > Operating 5 pen Improve tay processes Desert >) Lp itt stogy review Develop soles pion gets L Proforma perarmence >”) Hold operational eviews Plan restnce capecly ous ae ripaie ais - results Execute processes and initistives orora | January 2008 | Harvard Business Review 65LEADERSHIP AND STRATEGY | Mastering the Management System products to prevent and cure diseases, to ease suffering and to enhance the quality of life. We also want to provide a shareholder return thet reflects outstanding performance and to adequately renard those who inves ideas and work inourcompany.” ‘The vision isa concise statement that defines the mi-to long-term (three-to 16-year) goals ofthe organization. Cigna Property and Casualty, an insurance company division we worked with in the 1990s, stated its goal this way: "to be 4 top-quatile specialist within 5 years!” Though short, this Vision statement contained three vital components: + Stretch goals*top quartile" in profitability (t the time ‘Cigna P&C was atthe bottom of the fourth quartile) + Definition of market focus: “a specialist” not a general- purpose underwriter as it was ac the time +A time line for executions"5 years” (a heartbeat inthe slow-moving insurance industry) ‘The stretch goal in the vision statement should truly be a dificult reach for the company in ts present position. The ‘CEO has to take the lead here; indeed, one ofthe principal roles of an effective leader, as Jim Collins and Jerry Porras noted in But 0 Last, isto formulate “big, hairy, audacious {goal (BHAG)” that challenges even welkperforming orga- nizations to become much hetter. The classic example is Jack Welch's challenge for every GE business unit to become number one or two in its industry In determining a stretch 0a it pays to look atthe financial markets expectations as ‘ benchmark, since the company’s share price usually con- tains an implicit estimate of future profitable growth which can be well beyond that achievable through incremental improvements to existing businesses. ta company is setting a new goal, rather than reaffirming an established goal man- agersmay need to undertake pre-ofisiteresearchandengage inextensive discussion atthe meeting. Finally the values (often called core values) of a company prescribe the atitude, behavior, and character of an organi- zation. Value statements, which are often lengthy, describe the desirable atitudes and behavior the company wants to promote as well asthe forbidden conduct, such 2s bribery, harassment, and conflicts of interest, that employees should definitely avoid. These excerpts rom the value statement of| the internet service provider Earthlink illustrate the compo- nents of value statements + We respect the individual, and believe that individuals who are treated with respect and given responsibilty respond by giving ther best. + Weore frugal. We guard and conserve the company's resources with atleast the some vigilance that we would use to guard and conserve our awn personal + We are believers inthe Golden Rule In all our dealings sve will strive tobe friendly and courteous, as well as {fair anc compassionate. (66 Harvard Businass Review | January 2008 |_nocora + We eel a sense of urgency on any meters related 10 ‘ur customers. We own problems and we are always responsive. We are customerdriven, The reaffirmation of mission, vision, and values puts ex ecutives in the right mind-set for considering the rest ofthe ‘agenda and seting the company’s fundamental guidelines. ‘What are the key issuas we face in our business? With mission, vision, and values established, managers undertake 2 strategic analysis of the company’s external and internal situation. The management team stucles the industry’s eco- ‘nomics using frameworks such as Michael Porters ive forces ‘mode! (bargaining power of buyers; bargaining power of up- pliers; availabilty of substitutes; threat of new entrants; and industry rivalry). The team assesses the external macroeco- nomic environment of growth, interest rates, currency move- ments, input prices, regulations, and general expectations of the corporation's roe in society. Often this is described as @ PESTEL analysis, encompassing political, economic, social, technological environmental, and leea! factors, Managers can then dive into competitiveness data and consider the dynam: ics of the company’s financial, technological, and market performance relative to its industry and competitors. After the extemal analysis, managers should assess the company’s internal capabilities and performance. One ap- proach is to use Michael Porter's value chain model, catego- riring capabilities used in the processes that create markets; develop, produce, and deliver products and services; and sell to customers. Or the internal analysis could identify the dis: tinctive resources and capabilities that give the firm a com- petitive advantage. Finally, unless managers are introducing an entirely new strategy, they will want to assess the perfor: mance of the current strategy, atopic we discuss more later ‘The next step isto summarize the conclusions from the external and internal analyses in a classic SWOT matrix, as sessing the ability of internal attributes and external factors to help or hinder the company’s achievement of its vision. ‘The aim here is to ensure that the strategy leverages inter nal strengths to pursue external opportunites, while coun- tering weaknesses and threats (internal and external factors that undermine successful strategy execution). This analysis will reveal a series of issues that the strategy must adress: the best role for new products and services; whether new partners need to be acquired; what new market segments the company might enter; and which customer segments fare contracting, These issues will become the focus of the strategy formulation process, which often takes place at a subsequent meeting. How can we best compete? Finally, managers tackle the strategy formulation itself the statement describing the strategy and how the company proposes to achieve it. inthis step managers decide on a course of action that will create a sustainable competitive advantage by distinguishing the company’s offering from competitors’ and, ultimately, will‘A Management System Tool Kit [Where to leam mere about the concepts are frameworks described in this atc Develop the Strategy Competitive Strategy Michael €. Porter Competitive Advantage: Creating and Sustaining Superior Performance Free Pros, 1985 opubichod wth ‘ane ntoducton, 1998) Michae!€. Porter Competitive Strategy: Techniques for ‘Analyzing Industries and Competitors Fes Press. 1980 repubishes win ‘nen ntiecuction, 1998) Michao!€.Portor “what s Strategy? sarvard Business Roviow Nowoméer-Decomter 1906 ‘Chris Zook and Jamas Allen Proflt fom the Core: Growth Strteay Iman ra ot Turbulence Harvard Business School ress, 2001 Resource-Based Stratogy Jey 8. Bor Gaining ana Sustaining Competitive Advantage ard edition Prentoe-Hal, 2006 Jay B, Baroy end Doiwyn N, Clerk Resouree-Basea Theory: Creating Sustaining Competitive Advantage Otora Universiy Press, 2007 David J. Cols and Ccynthia’A. Menigomory ‘Competing on Resours Strategy in the 19905" harvard Business Revow July-August 1995 Gary Hamel and CX. Prahalad Competing forthe Future Harverd Business Schoo Pros 1904 Blue Ocean Strategy 'W.Chen Kim and Renée Meuborgre Biue Ocean Strategy: How to.Croate Uncontosted Market Space and Make the Competition relevant Harvard Business Schoo Press, 2008 Disruptive Strategy Clayton tA. Chrietoncon ane Michae!E. Raynor ‘Tho nnovater's Solution: Creating Sustaining Successful Growth Harvard Business Schoo Prass, 2003 Emergent Strategy Gary Hamel “Strategy Innovation and the Questor Value” Sloan Masapemont Revow Winter 1908 Honey Mintebore “crafting Strategy” Havard Business Review ‘ely-August 1867 Translate the Strategy RobortS. Kaplon and Davi P ‘The Strategy-Focused OF How Balanced Scorecard Companies Thrive in the New Business Environment Horverd Business Schee! Prose, 2000 Robert. Koplan and David P Norton Strategy Maps: Converting intangible [Assets into Tangible Outcomes Hanverd Business Schoo Prose, 2004 Robert S. Kaplan and David PN Te Execution Premium: Linking Strategy to Operstions for Competitive Advantage Harvard Business Schoo Pre 2008 Plan Operations Process Improvement Wyre W. Echorson Performance Dashivow Measuring, Monitoring, nd Moneging Your Business John Wily & Sons, 2008 ichoel Hammer Beyond Reengineering: How the Procere-Centored Organization ‘Changing Our Work and Our Lives HarperBusness, 1996 Peters. Pande, Robert P. Neuman, and Roland RCs “The Six Sigma Way: How GE, Motorola, and Other Top Com ‘Are Honing Their Performance Mecian-Hi, 2000 ‘Jemes P. Womack, Daniel T- Jones, and Danial Roos ‘The Machine That Changed the World: ‘The tory of Lean Production Mocmitan, 1996 Budgeting and Planning Resource Capacity ‘Jerory Hope and Robin Frasar Boyond Budgoting: How Manage ‘Can Break Free from the Annual Performance Trap Horverd Business Sheol Prose, 2008 Robart S. Kaplan and Steven R Anderson Time: Driven Aetivity-Based Costing: ASimplorané More Powerful Path to Higher Profits Harverd Business Scheel Fress, 2007 Test and Adapt Strategy Dennis Campbell, Sikant Doar, Susan. Kulp, and V.G. Narayanan “Tosting Strategy Formulation and Implementation Using Strateglca Linked Performance Meatures” HBS Working Papet, 2008 ‘Thomes H. Davenport and Jeanne G. Haris ‘Competing on Anayti “The New Science of Winning Harvera Business Shea Press, 2007 Anthony J. uc! Stovan Kin, ‘and Richard T Quinn “The Employee-Customer-Profit Chain a Sears” Harrd Business Roviow Janvary-Fobvvary 1988 horerg | January 2008 | Harvard Business Review 67LEADERSHIP AND STRATEGY | Mastering the Management System lead to superior financial performance. The strategy must respond, in some form, tothe following questions: Which customers or markets will we target? + What is the value proposition that distinguishes us? What key processes give us competitive advantage? What are the inrman capital capabilities required to excel a these key processes? What are the lechnolegy enablers of the strategy? “What are the organizational enables requited forthe strategy? ‘Managers can draw upon an abundance of models and frameworks as they formulate the strategy. Michael Porter's original competitive advantage framework, for example, pre- sented the strategy decision as a choice between whether to provide generic low-cost products and services or more differentiated and customized ones for speciie market and ‘customer segments. The Blue Ocean approach, popularized by W. Chan Kim and Renée Mauborgne, helps companies search for new market positions by creating new value prop- ositions for a large customer base. Resource-based strategists (including those in the core competencies schoo!) empha- size critical processes ~ such as innovation or continual cost reduction ~that the company does better than competitors and can leverage into multiple markets and segments. Clay Christensen has identified how new entrants can disrupt established markets by offering an initially lesseapable prod uct or service at a much lower price to attract 4 large cus~ tomer base not targeted by the market leaders. We are agnostic with respect to these frameworks; we have seen each one we've described be highly successful. Which among them isthe right choice probably depends ‘on a company’s circumstances and is competitive analysis. ‘The Porter and resource-based frameworks help companies leverage existing competitive positions or internal capabil- ‘ies, whereas the Blue Ocean and disruptive technology frameworks help them search for entirely new positions. & z Translate the Strategy (Once the strategy has been formulated, managers need to translate it into objectives and measures that can be clearly communicated to all units and employees. Our own work ‘on developing strategy maps and balanced scorecards has contributed to this translation stage. ‘The strategy map provides a powerful tool for visuali2- ing the strategy a8 a chain of cause-and-effect relationships among strategic objectives. The chain starts withthe com pany’ longterm financial objectives and then Tinks down to objectives for customer loyalty and the company’s value propositions. From there, it links to goals related to criti~ cal processes and, ultimately, to the people, the technology, and te organizational climate and culture required for suc. cesful strategy execution. Typically large corporation will (68 Harvard Businass Review | January 2008 |_no-ora create an overall corporate strategy map and then tink it to strategy maps for cach ofits operating and functional units. Even though a strategy map reduces a complex stratcey statement toa single page, we have learned that many man- ‘agers find the multiple objectives (typically, 15 to 25) on 2 ‘map, along with their corresponding measures and targets somewhat complex to understand and manage. Some of 2 map’s objectives relate to short-term cost reduction and quality improvements while others reflect long-term innova- tion and relationship goals. Managers often find itchalleng- ing to balance these myriad objectives. In our recent work, we've found that companies can sim: pilfy the structure and use of a strategy map by chunking it into three to five strategic themes. A strategic theme, typically a vertical slice within the map, consists of a distinct set of related strategic objectives. (For an example, see “Mapy Strategic Themes} gener strategy map organized by three vertical strategic themes and a horizontal theme to cluster the leamming and growth objectives.) Strategic themes offer several advantages. At the busi: ‘ness unit level, the theme structure allows unit managers to customize each theme to their local conditions and prior- ties, creating focus for their competitive situation while still Keeping their objectives integrated with the overall strategy: Second, the vertical strategic themes typically deliver theit benefits over different time periods, helping companies si ‘multaneously manage short, intermediate, and long-term value-creating processes. Using themes, executives can plan ‘and manage the key elements of the strategy separately but still have them operate coherently. ‘Once managers have developed the strategy map, they link it to another too! of our design: a balanced scorecard of performance metricsand targets for each strategic objective. We believe that if you don’t measure progress toward an ‘objective, you cannot manage and improve it. The balanced scorecard metrics allow executives to make better decisions about the strategy and quantitatively assess its execution. A third step at Stage 2 involves identifying, and authoriz- ing resources for, a portfolio of strategic initiatives intended to help achieve the strategy’s objectives. A strategic initia tive isa discretionary project or program, of finite duration, designed to close a performance gap. It might focus on, say, developing a customer loyalty program of training all em ployees in Six Sigma quality management tools. In our original conception of the strategy map and the balanced scorecard, we encouraged companies to select ini tiatives independently for each objective. We came to real ize, however, that by doing so, companies would fail to ben efit from the integrated! and cumulative impact of multiple, related strategic initiatives. Achieving an objective in the «customer or financial realm generally requires complemen: tary initiatives from different parts of the organization, such {as human resources, information technology, marketing,Mapping Strategic Themes ‘This generic strategy map ilustrates how a corporate ststegy can be sized into four themes, each with its own cause-andveffect reletionshins Roatife maps wil be more complex but il shave the desirable property of mak: Ing strategy much easier to understand and ‘manage. The stietegic themes provide a ormon structure that unit managers ean {use to develop their own maps within tho big picture and a governance structure that assigns accountability for actions, VISION: By 2013, become the leading company in our industry Bea leader in quaity ‘and reliability Process Perspective a Improve supply chain efficiency end effectiveness Improve quality, cost, and flexbility of ‘operating processes Provide vaued service, | applications oxportso, end support | Optimize customer proftebity Pe cfstngy ant Bui andmaintan song | customer telationsnips D\ A Weresse reveruesin > x Francia \ Gen panes Imorovepocuetviy | ( exstog eogrents | om. ( ) CS) Gree Improve Operating Quality || Grow High-Valve Accolorato nd Eticlancy CustomerReletionshies || Productianovetion ey Porepoctive Inuoduee innovative, high-performance ‘products end solutions a. Exzo! at technology, product development, ‘and lite cycle managomont Identity next-generation ‘market opportuities, a Expand ard build strstagi stil, capable, and expertise fa», Create a High-Porformance Culture Develop leadership and an execution-driven cultura rN Enable end reauire continuous learning and | sharing of knowlodge orora | January 2008 | Harvard Business Review 69LEADERSHIP AND STRATEGY | Mastering the Management System distribution, and operations. Also, standalone crossunit ini- tiatives often have no clear owner or home in the organiza~ tion, Starved for resources and lacking clear accountability for execution, the strategic initiatives wither away, thwarting the strategy’s execution. ‘Companies with theme based strategy maps avoid these problems by assigning a senior executive to lead each strate- ‘ic theme. in this way, the company gains an accountability and reporting structure even for cross-business and cross- functionalunit objectives. The executive assigned to own each theme assumes the responsibility for devising and ex- ecuting an entire portfolio of initiatives selected to achieve the theme's performance targets. The executive team autho: Fizes the resources required for the various portfolios; we call the designated Funds strategic expenditures (or Stratx). Committing funds to Stratkx is similar to budgeting for re search and development: Both categories represent spending ‘on nearterm actions expected to deliver mid-to long-term performance, and both are separate from the operating and ‘capital expenditures (OpEx and CapEx, described in the next stage) that support current operations. 23 lan Operations ‘ith strategic metrics, targets, and initiative portfolios in place, he company next develops anoperational plan that lays ‘out the actions that wil accomplish is strategic objectives ‘This stage starts with setting priorities for process improve- ment projects followed by preparing a detailed sales plan, 2a resource capacity plan, and operating and capital budgets. Process improvements. The strategic initiatives devel ‘oped in Stage 2 consist of the shortterm projects (lating as Jong as 12 00 18 months) selected to help achieve the strat. egy maps objectives, However, o execute thei strategies, companies generally must also enhance the performance of their ongoing processes ~ measured, for example, by their What Resources Do You Need to Implement Your Strategy? {ts entica for companies to factor ther strategic goals into their operational planning. HeVe's how one Company broke its sales forecast Cown into figutes fr each of the activities fequred to achieve it and uso. those 195 10 estimate the personne! and computing resources it would need inthe next period Breaking Down the Sales Target Towerton Financial, a financial services compen, broke down a monthly elas target of about $79 milion into subtargets {or ts four product ines: stock trading, mutual fund trading, investment manegement, and financial planning. It then broke ‘each line's forecast down inte the volume and mx of transac- tons that the company's most expensive resources (people jock | Mutual fund in er ‘end computing) would be ‘expected to handle eech month ‘That information helped the company's managers caleulata the resources needed to acneve their sales goals, (ez ee] = a ee =e ales ele a el aaTane See Pores eae gre oe ee 70 Harvard Business Review | January 2008 | hoveresponsiveness, speed, quality, and cost. Companies will get the biggest bang for their buck when they focus their bust ness process management, total quality management, lean management, Six Sigma, and reengineering programs on processes directly related to the objectives on their strategy ‘maps and scorecards. The goal is to align near-term process provements with long-term strategic priorities. Managers need to deconstruct each strategic process to lentify the critical success factors and metrics that employ ‘eescan focus on in their daily activities Electronic and phy: ‘al dashboards displaying data on the key indicators of local process performance, will inform the actions of and provide feedback to employees attempting to achieve process per formance targets. For example, one large pharmaceutical ‘chain has a dashboard system that gives each store manager a customized, single page display of financial and operating metrics ~ those that a statistical analysis revealed have the highest correlation with aggregate store performance. The managers’ dashboards also display monthly quartile rank- ings among comparable stores for six key metrics. Sales plan. Managers elso must identify the resources required to implement their strategic plan. Before they ‘can do that, they need to deconstruct their overall sales target into the expected quantity, mix, and nature of indi vidual sales orders, production runs, and transactions. (For an illustration, see the example of Towerton Financial in “Breaking Down the Sales Target” Towverton is a compos- ite of various firms we've worked with.) Companies with well functioning ERP systems will have a historical record (of product and customer mix and transaction volumes they ‘can draw upon to do this. A company can start by simply grossing up last period's distribution of order sizes by the desired percentage change in sales. Using this baseline, the company’s planners can modify the distribution to re- flect expected changes in sales and ordering patterns such as an increase in minimum order sizes and the additional Translating the Sales Plan into Resource Requirements in this chart, Towerton Financial calculated the quantity of resources wquited to implement the sales plan at left using a ime-criven ABC model ‘The numbers uncer total hours show what Towerton would need from ‘28ch kind of porsonnol or T resource {Note that the capacity of computing rosouteesis measured by MIPS, not ‘hours ) Tha next column inekeates how many houts (er MIPS) are supplied ‘monthly by ona unk of each rasouree, ‘The numbers for resource units re Auired were obrained simply by civc- ipo the total demand for each resource by the quantity supplied monthly by ono unit of it. Ater examining the ‘resource roquiramonts under 9 ango of assumptions, Toworton authorized the level of resource supply to be car ‘led into the next pariod. In genersl ‘companies will want to supply some: what mere capacity than forecast, 36 shown in the column for resource units supplied sesource demands are not ‘uniform throughout a period. As the final olurm shows, Tewerten expects teoporate t close to full cepacity dur ing the upcoming period. Knowing the cost of aac rosourca unt, Towerton ‘ean quickly transite its cperating plan into an overal profit pan andinciviuel proce! ine P&L eae hbrora | January 2008 | Harvare Business Review 71sales from new lines of products or services or new markets. Finally, data-rich companies can easily embrace scenario planning to explore the sensitivity of their sales forecasts to alternative economic and competitive assumptions. Resource capacity plan. Armed with data about produc- tivity from process improvements and likely sales numbers, ‘companies can now estimate what resources they will need in the year ahead to execute on their strategic goals. Our preferred tool for this step is time-driven activity-based cost- ing (TDABC), Activity-based costing’s original use was to measure the cost and profitability of processes, products, and customers (as we will describe in Stage 5). The time- riven version of ABC adds a new capability, the ability to ‘easily translate future sales numbers into a forecast of re- ‘quired resource capacity. At the heart of the TDABC model is a set of equations, based on historical experience, that describe how various transactions anc! demands consume the capacity of resources such as people, equipment, and facilities. A company that has such a mode! in place can update these equations for any productivity gains that have ‘occurred or are anticipated from process improvements (ce- ‘termined during the first step in this stage), Managers then feed the new detailed sales plans (from the second step) into the updated model, to produce estimates of the demand for resources implied by the sales forecast. (See “Translating the Sales Plan into Resource Requirements" for a simplified ‘example.) The company, seeing the capacity required to de- liver on its strategic plan, can then authorize the quantity of people, equipment, and other resources to be supplied, including any butfer capacity to handle fluctuations or short- ‘erm spikes in demand. Dynamic operating and capital budgets. Once managers have determined the authorized level of resources for the future period, the financial implications become easy to cal- ‘culate. In the Towerton Financial case used in the resource ‘capacity exhibit, the company already knew the full monthly ‘cost of each kind of personnel ~ brokers, account managers, financial planners, customer service representatives, and IT ‘consultants -as well as the monthly cost for each server, ‘the unit of computing capacity. To obsain the budget figures for each of the resources needed to meet the sales forecasts, ‘Towerton’s planners simply multiply the cost of each type Of resource by the quantity it has decided to supply. Most of the resource capacity represents personnel costs and would be included in the OpEx budget. Increases in equipment resource capacity (such as Towerton’s servers) would be Te- fected in the CapEx budget. The process quickly and ana- Iytically generates operating and capital budgets that grow logically and dynamically out of the sales and operating plans, rather than being imposed by fiat or through power negotiations. Since the company started with detailed rev- ‘enue forecasts and now has the resource costs associated with delivering on them, simple subtraction will yield a de- 72 Harvard Businass Revew | January 2008 |_norora ing the Management System tailed P&L for each product, customer, channel, and region, ‘Companies that have shifted from an annual budgeting cycle to one iwith quarterly updates can use this process to obtain resource capacity plans for every period for which they have assales forecast. In a final budgeting step, the company authorizes the discretionary spending that does not have an immediate relationship with sales and operations, such as process im+ provement initiatives, advertising, promotion, research and development, training, and maintenance. The amount Of such spending remains a judgment call for experienced ‘executives and is not a decision that can yet be automated through an analytic model. “The company now has finished the integrated planning of strategy and operations, which encompasses the following steps: Formulate the strategy; translate it into linked objec- tives, measures, and targets; develop and fund the portfolio Of strategic initiatives; identify the process improvernent priorities; forecast sales consistent with the strategic plan; estimate the resource capacities required for those sales; authorize the spending on resources; and produce next period'’sproformaincome anddetailed P&L statements. From here on, itis up tothe managers to execute, leam, and adapt, ‘moving the management cycle into its fourth stage. 24 Monitor and Learn As companies implement ther strategic and operational plans they need to hold three types of meetings to moni tor and lam trom their results. Fist, managers should con- ‘ene meetings that review the performance of operating departments and business functions and address problems ‘that have arisen or persist. They also should hold strategy management meetings that review balanced scorecard per formance indicators and initiatives to assess progress and identify barriers to strategy execution. Those two meetings ‘make up Stage 4 ofthe system, n Stage 5, managers meet to 2628 the performance of the strategy itself and adapt if necessary. The three meetings have different subject mater, different frequences, and, often, different sets of attendees (Gee the enhibit"Management Meetings 101"fora compari son of the meetings) Operational review meetings. Management groups nocd! to meet frequently ~ perhaps weekly, twice weekly, or even daily to review their operating dashboards and reports ‘on sas, bookings, and shipments, and to solve shorterm issues that have recently arisen complaint from Important customers ate deliveries, defective production, mechani- cal breakdowns, the extended absence of a key employee, new sales opportunities. The speed at which new data are posted on operational dashboards is the central factor in determining meeting frequency: If the company has ashort operations cycle, with nev data posted hourly and dally,then a daily review promotes rapid learning and problem solving. But for a product development group, progress against milestones and stage gates may be better evaluated monthly. The people attending an operational review typically ‘come from within a single department, function, or pro: cess. A unit’ salespeople, for example, will meet (often via conference calls and webcasts) to discuss the sales pipeline, recent sales closings, and new customer opportunities and problems. Operations people review production problems, including defects, yields, bottlenecks, maintenance and re pair schedules, equipment breakdowns, downtime, schedul- ing, expediting, supplier concerns, and distribution. Finance personnel address short-term cash flow issues, including col lections on receivables, late payments to suppliers, treasury ‘operations, and banking relationships. The top manage- ment group may meet monthly to review overall financial performance, Smaller companies, without functional departments, may have only a single monthly operating meeting, correspond- ing to the frequency with which they close their books. In general, however, we recommend gearing operating review Management Meetings 101 It's important to distinguish clearly among the vatious kinds of meetings that form the feedback ‘and learning component ofthe management eystom. They require diferent frequencies and have very diferent agendas and informational MEETING TYPE requirements. Companies thet try 0 double uo these meetings in oder to accommodete the lability of senior staf run the rsk of having decussions of oporational cisos drive out con- siceration of strategie iesves. ey Sead SR) Information requirements Dashboards for key cerfor- mance indicators; weekly ard ‘monthly nancial summaries Strategy map and belanced Seotecerd report Strateay map, balanced scorecard ‘ABC profitability reports, analyte studies of strategy, external and ‘competitive analyses Frequency Daily, twice weekly, weekly, Monthly ‘Annually (perhaps quartety for ‘ormonthy, depending on fast-moving industries) businoss cyclo | Attendees Departmental and functional Sanior management team, Senior management team, strategic Personnel senior manage- strategic theme owners, theme owners, functional ond Ment for inancal eviews _stfategy management officer planning specialsts, business unit reads Focus Ideniily and solve operational plement strategy ‘Test and arian strategy based on problems (ales dectines, late causal analytes, product-line and deliveries, equipment down channel profitabilty, charging time, suppliorproolems) extornal envronmant, emergent stategios, and now technology developments Goal Respond toshortterm orob- Fine-tune ststegy: make _Incrementally improve ox transform lems and promote continuous improvomonte ‘midcourse aceptations svateoy; establish straregic and porational plans sot statoaie targels: authorize spending for strategic intistves and other major iscrotionary expenditures prorg | January 2008 | Harvard Business Review 73LEADERSHIP AND STRATEGY | Mastering the Management System meeting frequency to the operating cycle of the department and business, so management can respond to sales and op- crating data and to myriad other tactical issues in the most timely manner. Ideally, operational meetings are short, highly focused, {data driven, and action oriented. One company we've ad: vised holds its operational reviews in a small room filled with whiteboards and flip charts but no chairs. Attenclees post agenda topics and look over dashboards before the meet- ing, which lasts only as long as needed to discuss each issue, develop an action plan, and assign responsibility for carrying One company holds its operational reviews it the same people attend both. If that’s the situation, its es sential to set distinctly different agendas for the two meet- ings. Otherwise, as in our opening example of the Conner Corporation, short-term operational and tactical issues will rive out discussions of strategy implementation, Like operational reviews strategy management meetings should not be spent listening to report presentations. Man- agers should come to the meetings already familiar with the data to be discussed, thinking about the issues that the gaps in recent performance raise, and formulating solutions to problems. At the meetings themselves, executive committee aroom with no chairs. Forcing everyone to stand signals that the meeting is not about passive listening; it's about active and brisk problem solving. it out. Forcing everyone to stand signals that the meeting's purpose is not to spend time together, passively listening. It is to engage managers in active and brisk problem-solving discussions on the most pressing issues ofthe day. ‘Strategy review meetings. The leadership team of a busl- ness unit must meet periodically to review the progress of Strategy. Operational issues, unless they are particularly significant and cross-functional, should not be discussed at this meeting. Attendance at strategy reviews should be com pubory for the unit's CEO and all members of its executive ‘committee. “There's no clear consensus around the optimal frequency for these meetings, though most companies hold a monthly ‘two- to three-hour strategy review meeting, to ensure that strategy remains top of mind. That works well when a man agement team works in one central location. Some com- panies, especially those with dispersed teams, hold their strategy review meetings quarterly. Strategy is a long-term commitment, and strategic initiatives such as developing new workforce competencies, redefining the brand, innovat- ing new products, building new customer relationships, and reengineering key business processes typically take more than a month to yield measurable results. Quarterly meet- ings will probably require at least an entire day for active Aiscussion of all strategic objectives and themes. ‘Many company units hold their monthly operational f- ‘nancial review on the same day as the strategy review, since 74 Harvard Businass Review | January 2008 | houorg ‘members should discuss the issues, explore their implica: tions, and propose action pians. Executives have to make a trade-off between breadth ‘and depth at these reviews. In the early years of balanced scorecard implementations, we encouraged a full discussion ‘of BSC measures at each strategy management meeting. It soon became apparent that the normal time reserved for a monthly meeting did not permit a full discussion of all the objectives, measures, and initiatives on a strategy map ‘and scorecard. The solution, we discovered, came ftom the practice of using strategic themes to organize strategy maps: devote most of the meeting to a deep dive into one or two of the strategic themes. “That is precisely what happens at HSBC Rail, an operating unit of the HSBC Group, which purchases, leases, and main tains the locomotives and ears for the UK and other nations’ road systems. Its monthly two-end-s-halfhour meeting brings together its strategy council, consisting of the CEO, the head of Finance,the head of Customer Service-Operations,the head of Customer Relationship Management-Sales the head Cf Learning and Development, and the strategy management officer, win coordinates the data on the strategic measures ‘and initiatives for each strategic theme in advance ofthe meet- ing, The data go into a monthly report that has a section for each strategic theme. The section containsthe theme's strategy ‘map, objectives, targets, and initiatives, with each component color coded green (ifthe objective’s target has been achieved),yellow (progress i loner than expected bt doesn't require immediate senior management attention), oF ed (progress is off track and requires management attention to resolve criti- ‘cal issues). Each theme's section also contains evaluations and ‘commentary from the theme owner about any performance gaps and proposed actions for addressing ther. ‘The monthly meeting focuses on one (or at most two) strategic themes in depth. The agenda also allos time for ‘one operational orstrategic"hot topic" to ensure that urgent issues that fall outside the theme under discussion will be addressed, The February 2007 strategy council meeting was a typicel HSBC Rail strategy review. (See the exhibit "A Model Strategy Review Agenda.) The stratesy management officer started with an update on the action items from the previous month, indicating which had been accomplished and sehich were still under way. The CEO followed with a quick review of the unit's color-coded strategy map and of- feted his perspective on the business. Then, the attendees gave in-depth consideration for about 60 minutes to the ‘Customer Relationship Management strategic theme, For the remaining themes, the council spent about five min utes each on any issues that had to be resolved before the scheduled deep dive on that theme. The meeting partii- pnts, who were already familia withthe data and ready t0 discuss the implications and to propose action plans, built constructively on the ideas presented during the meeting. ‘The CEO questioned and probed, kept the meeting focused ‘on the key issues, encouraged dialogue and debate, and en- sured that the meeting stayed on schedule. The strategy management officer recorded each approved action item and the designated manager who would be accountable for following up on it. HSBC's meetings like all excellent strategy reviews ~ focuson whether strategy execution ison track, where prob- lems are occurring in the implementation, hy they're hap- pening, what actions will correct them, and who will have responsibility for achieving targets. These meetings take the strategy as a given. They are not used, except in unusual cir ‘cumstances, to question or adapt the strategy. That is what takes place in the final stage. 25 ‘Test and Adapt the Strategy From time to time managers will discover that some of the assumptions underlying their strategy are flawed or obsolete. When that happens, managers need to rigorously reexam- ine their strategy and adapr it, deciding whether incremen- tal improvements will suffice or whether they need a new, transformational strategy. This process closes the loop of the management system I generally occurs at the strategy A Model Strategy Review Agenda Time item Derait Duration Rasponsinaity TOO Acton Log Review State Srrinutes Poul Stategy Maragsment fet) 1015 Overviow oview Statogy Map YOminctes Peter (CEO) gnight Key Issues Fevew laitaives ovew Measurae YoX ——ThemeAscsswert Guster Pestorhin —GOvivtes Bob edt CHS 128 Break Smnies 1130 _Theme-Summary Learning and Growth Sminutes Nick ead ot Learingand Devweiopment) 136 ThemeSummery Capt Effewency Sminutes Dave Head of Finance) 1180 _‘ThemeSunmery __OperaionalEcolonse _—_—‘Sminutes Robert lead ol Customer Service- Operations) Teas Hot Tone TResoureingChalonge so mnnies avd head af France) 1215 MeatingRewew __Communieston Summary 10mmutet Peter (CE) 1225 Mesting Revie Feedback Smntes 1280 Aston Loa evew of New ers Smirutes _ Pover (CEO) 1255 Any Other Sutnese Paul Stit6ay Warapement Ofcer ard Mecting Closa Next Mesting 18/04/07 - Theme Assessment Cpiol Eifcerey ororg | January 2008 | Harvard Businass Roview 75development offsite described under Stage 1 but could occur uring the year if the company experiences a major dis- ruption or a new strategic opportunity. The strategy testing and adapting process introduces new inputs to the offsite: an analysis of the current economics of existing products and customers, statistical analyses of correlations among the strategy’s performance measures, and consideration of new strategy options that have emerged since the previous strategy development meeting. Cost and profitability reports. Anytime a company re Views its strategy, it should first understand the current eco- nomics of its existing strategy by examining activity-based ‘costing reports that show the profit and loss of each product line, customer, market segment, channel, and region. Execu- tives will then see where the existing strategy has succeeded and failed, and can formulate approaches to turning around loss operations and expanding the scope and scale of profit- able operations. ‘Consider the experience of a large New York City bank: with an overall profitable product line of demand and time deposits, Information from its aggregate profitability mes: surement system showed that all customers with balances ‘greater than $25,000 were profitable, so the bank launched a ‘major initiative to retain those clients. During the initiative, ring the Management System or product, however, In our experience, companies find multiple ways ~ process improvements, repricing, and tede- fining relationships ~ to reduce or eliminate the losses from ‘unprofitable products and customers,once a credible costing system has identified them, Statistical analyses. Companies, especially those with large numbers of similar operating units, can use statisti cal analysis to estimate correlations among strategy per formance numbers. Such analysis will usually validate and ‘quantify links between investments in, for example, em- ployee skills or IT support systems, and customer loyalty and financial performance. Occasionally, however, the analysis ‘can reveal that assumed linkages are not occurring, which should cause the executive team to question of reject atleast part of the existing strategy. Companies that consistently measure strategy performance through tools such as the strategy map and balanced scorecard have ready access to the data needed for strategy validation and testing. Take Store 24, one of New England’s largest conve: rience store chains (now owned by Tedeschi Food Shops), ‘S¥ which in 1998 implemented a now customer strategy called “Ban Boredom.” Store 24's CEO believed that providing an entertaining shopping atmosphere, including frequent themes and promotions, would differentiate the shopping UNPROFITABILITY DOESN’T MEAN that a company should simply drop a customer or product. Companies can find multiple ways to reduce or eliminate losses, once a credible costing system has identified them. fi» however, the bank conducted a more detailed ABC study to calculate the cost to serve and the profitability of all ac- ‘counts. It learned that 35% of the households targeted for etention were unprofitable, with cumulative losses total- ing more than $2 million. Unprofitable customers could be found in every balance tier up to $1 million, in fact. Manag- cers at first could not believe that high-deposit individuals could be unprofitable. Further analysis revealed that unprof- itable customers did a large number of transactions in the branches, the most expensive service channel, and kept most Of their deposits in accounts that yielded low margins to the bank, Fortunately, the bank discovered this. error in its strategy before it was too far along inits client retention initiative. Unprofitability doesn’t mean that a ‘company should simply drop a customer 76 Harva’d Business Revew | January 2008 |_noro-a ‘experience at the chain from its competitors'.The company created a strategy map and balanced scorecard to commu- nicate and help implement the new strategy. two years, however, Store 24’s executive team learned that the strategy was not working. Feedback from individual cus: tomers and focus groups led the chain to abandon the Ban Boredom strategy and repiace it with an updated version Of its previous strategy, which featured fast and efficient service. ‘A Harvard Business School faculty team (Dennis Camp- bell, Srikant Datar, Susan Kulp, and VG. Naray- anan) yaiined access to quarterly data from ‘Store 24’S85 retail outletsand performed statistical analysis to see whether the company’s executives could have recognized the flaws in the Bantte Lyne Boresiom strategy earlier. Looking at data from the sirst year ofthe strategy, the study found that better implemen- tation of the Ban Boredom program was indeed negatively correlated with store performance, exactly the opposite of ‘what the strategy had intended. The data also shored that differences in profits were best explained by variables not related to the strategy, including store managers’ skis, local population, and local competition. By uncovering those (and several other) simple correlations, Store 24 management «ould have learned one year earlier than it actually dd that the new strategy was not working, The managers woul! also have seen that the strategy would be successful only if all stores raised ther crew skills to high levels something that wasn’t feasible given the 200% annual employee tumover rate typical of reall stores. Emergent strategies. The strategy offsite, beyond ex amining the performance of existing strategy, provides ‘executives with a great opportunity to consider new strat ey proposals that managers and employees throughout the enterprise may have suggested. Henry Mintzberg and Gary Hamel, in fact, argue against top-down strat egy implementation, contending that the most innova: tive strategies emerge from within the ‘organization. Not all such strategies are worth pursuing, however, and even several seem promising, the executive team still needs to decide which, if any, toadopt. If the executive team decides, based ‘on analyses of the internal data, the competitive environment, and emerg- ing strategy ideas, to alter the existing strategy, it should follow up by modity- ing the organization's strategy map and scorecard. That will launch another cycle of strategy translation and opera- tional execution, with new targets, new initiatives, a new sales and operating plan, revised process improvement p ‘orities, changed resource capacity re quirements, and an updated financial plan, The new strategic and operational plansset the stage and establish the in- formation requirements for next peri- ‘d's schedule of operational reviews, strategy reviews, and strategy testing and adaptation meetings. Managers have always found it hard to balance near-term operational concerns with long-term strategic priorities. But sucha balancingact comes with the job; it {san inherent tension that managers can- not avoid and must continually address. As a senior strategic planner ata Fortone 20 company told us,*You can have the best processes in the world, but if your governance processes ‘don’t provide the direction and course correction required to achieve yourgoalssuccssisamaterofluck"Atthesametime, 4 company can have the best strategy in the world, but i will ct nowhere if managers cannot translate that strat «gy into operational plans and then execute the plans and achieve the performance targets. Managers that carefully follow the recommendations we have laid out in this article will have a complete management system that helps them set clear strategic ‘goals, allocate resources consistent with those goals, set Priorities for operational action, quickly recognize the ‘operational and strategic impact of those decisions, and, necessary, update ther strategic goals. The closed-loop management system enables executives to manage both strategy and operations, and to balance the tensions be tween them, 0 Reprint ROBOTD To order see page.1aa. ororg | January 2008 | Harvard Business Review 77Pec eel ater korea \wareness of the five forces can help a company understand the structure of its Sakura: Teeter ete) G\ ii é THE FIVE COMPETITIVE FORCES THAT SHAPE STRATEG by Michael E. Porter Editor's Note: In 1979, Harvard Business Review published “How Competitive Forces Shape Strat- 297" by @ young esonomist and associate professor. Michaol E. Porter. twas his first HBR article, ond it started a revolution in the strategy field. n eubsequent decadas, Porter has brought his signature economic rigor to the study of competitive strategy for corpora- tions, ragions, nations, and, more recently, Neath care and philanthropy. “Porter's five forees” have shaped 8 ‘generation of acaclemic rasearch and business practice. With prodding and assistance from Harvard Business ‘Schoo! Professor Jan Rivkin and longtime colleague Joan Mogretta, Portor here reatfirms, updates, end ‘extends tho classic work. He also addresses common ‘misuncerstandings, provides practical guidanes for users of the framework, and offers a deeper view of its implications for strategy today. IN ESSENCE, the job of the strategist is to under- ‘stand and cope with competition. Often, however, ‘Managers define competition too narrowly, as if ft occurred only among today’s direst competi- tors. Yet competition for profits goes beyond es- tablished industry rivals to include four other competitive forces as well: customers, suppliers, Potential entrants, and substitute products. The ‘extended rivalry that results from alll five forces defines an industry's structure and shapes the ‘ature of competitive interaction within an industry, As different from one another as industries. might appear on the surface, the underlying driv- 18 of profitability are the same. The global auto industry, for instance, appears to have nothing in common with the worldwide market for art ‘Masterpieces or the heavily regulated health-care ororg | January 2008 | Harvard Business Review 79LEADERSHIP AND STRATEGY | Tho Five Competitive For delivery industry in Europe, But to under- stand industry competition and profitabil- ity in each of those three cases, one must analyze the industry's underlying struc ture in terms of the five forces, (See the ex- hibit “The Five Forces That Shape Industry Competition’) If the forces are intense, as they are in such industries as airlines, textiles, and ho- tels, almost no company earns attractive re- tums on investment Ifthe forces are benign, That Shape Strategy The Five Forces That Shape Industry Competition as they are in industries such as software, soft drinks, and toiletries, many companies are profitable. Industry structure drives competition and profitability, not whether an industry produces a product or service, fs emerging or mature, high tech or low tech, regulated or unregulated. While a myriad of factors can affect industry profitability in the short run— including the weather and the business cycle ~industry structure, ‘manifested in the competitive forces, sets industry profitability in the medium and long run. (See the exhibit “Differences in Industry Profitability” Understanding the competitive forces, and their under- Iying causes, reveals the roots of an industry's current profit: ability while providing a framework for anticipating and influencing competition (and profitability) over time. A healthy industry structure should be asmuch a competitive concern to strategists as their company’s own position, Un- derstanding industry structure is also essential to effective strategic positioning. As we will see, defending against the competitive forces and shaping them in a company’s favor are crucial to strategy. Forces That Shape Competition "The configuration of the five forces differs by industry. In the market for commercial aircraft flerce rivalry between, dominant producers Airbus and Boeing and the bargain- ing power of the airlines that place huge orders for aircraft are strong, while the threat of entry, the threat of substi- tutes, and the poner of suppliers are more benign. In the ‘movie theater industry, the proliferation of substitute forms of entertainment and the power of the movie producers and distributors who supply movies, the critical input, are important. ‘Michael E. Porter is the Bishop Wiliam Lawrence Uriversiy Pro: fessor at Harvard Unversity, based at Harvard Business Scat in Boston, He isa siriime MaKinsey Award winner, including fortis most recent HBR artele, "Strategy and Society,” coauthored wih Mark R. Kramer (Decomiber 2008), 180 Harvard Businass Revew | January 2008 |_nocorg ‘The strongest competitive force or forces determine the profitability of an industry and become the most important to strategy formulation, The most salient force, however, is, not always obvious. For example, even though rivalry is often fierce in com- modity industries, it may not be the factor limiting profit. ability. Low returns in the photographic film industry, for instance, are the result of a superior substitute product ~as Kodak and Fuji, the world’s leading producers of photo- sraphic film, learned with the advent of digital photography. In such a situation, coping with the substitute product be- ‘comes the number one strategic priority. Industry structure grows out of a set of economic and technical characteristics that determine the strength of each competitive force. We will examine these drivers in the pages that follow, taking the perspective of an incumbent, (0r 4 company already present in the industry. The analysis, can be readily extended to understand the challenges facing, potential entrant. THREAT OF ENTRY. New entrants to an industry bring new capacity and a desire to gain market share that puts pressure on prices, costs, and the rate of investment nec: essary to compete. Particularly when new entrants are liversifying from other markets, they can leverage exist ing capabilities and cash flows to shake up competition, as, Pepsi did when it entered the boitled water industry, Micro: soft did when it began to offer internet browsers,and Apple «did when it entered the music distribution business.‘The threat of entry, therefore, puts a cap on the profit po- tential of an industry. When the threat is high, incumbents ‘must hold down their prices or boost investment to deter new competitors. In specialty coffee retailing, for example, relatively low entry barriers mean that Starbucks must in- ‘vest aggressively in modernizing stores and menus. ‘The threat of entry in an industry depends on the height of entry bartiers that are present and on the reaction en- tants can expect from incumbents. Ifentry barriers are low and newcomers expect little retaliation from the entrenched competitors, the threat of entry is high and industry profit- ability is moderated. It is the threat of entry, not whether entry actually occurs, that holds down profitability. entry by limiting the willingness of customers to buy froma newcomer and by reducing the price the newcomer can com ‘mand until it builds up a large base of customers. +3 Customer switching costs. Switching costs are fixed costs that buyers face when they change suppliers. Such costs may arise because a buyer who switches vendors must, for ex ample, alter product specifications, retrain employees to use a new product, or modify processes or information systems. ‘The larger the switching cost, the harder it will be For an en= trant to gain customers. Enterprise resource planning (ERP) software isan example of a product with very high switching, costs. Once @ company has installed SAP's ERP system, for ex- ample, the costs of moving to.a nev vendor are astronomical Industry structure drives competition and profitability, not whether an industry is emerging or mature, high tech or low tech, regulated or unregulated Barriers to entry Entry barriers are advantages that incum- bents have relative to new entrants. There are seven major 1. Supply-side economies of scale. These economies arise when firms that produce at larger volumes enjoy lower costs per unit because they can spread fixed costs over more units, employ more efficient technology, or command better terms from suppliers. Supply-side scale economies deter entry by forcing the aspiring entrant either to come into the industry ona large scale, which requires dislodging entrenched com- petitors, or to accept a cost disadvantage. Scale economies can be found in virtually every activity in the value chain which ones are most important varies by industry. In microprocessors, incumbents such as Intel are protected by scale economies in research, chip fabrica ton, and consumer marketing, For lawn care companies like Scotts Miracle-Gro, the most important scale economies are found in the supply chain and media advertising. In small- package delivery, economies of scale arise in national logisti> cal systems and information technology. 2. Demand side benefits of scale. These benefits also known as network effects arise in industries where a buyer's willing: ‘ness to pay for a company's product increases with the num- ber of other buyers who also patronize the company. Buyers ‘may trust larger companies more for a crucial product: Re~ call the old adage that no one ever got fired for buying from, IBM (when it was the dominant computer maker). Buyers may also value being in a*network” with a larger number of fellow customers. For instance, online auction participants are attracted to eBay because it offers the most potential trading partners. Demand-side benefits of scale discourage because of embedded! data, the fact that internal processes have been adapted to SAP, major retraining needs, and the mission-critical nature of the applications. 4. Capital requirements. The need to invest large finan cial resources in order to compete can deter new entrants. Capital may be necessary not only for fixed facilities but also. to extend customer credit, build inventories, and fund start up losses. The barter is particularly great if the capital is required for unrecoverable and therefore harderto-finance expenditures, such as up-front advertising or research and development. While major corporations have the financial resources to invade almost any industry, the huge capital requirements in certain fields limit the poo! of likely en: trants. Conversely, in such fields as tax preparation services or short-haul trucking, capital requirements are minimal and potential entrants plentiful. Itis important not to overstate the degree to which capital requirements alone deter entry. If industry returns are at tractive and are expected to remain so, and ifcapital markets are efficient, investors will provide entrants with the funds they need. For aspiring air carriers, for instance, financing. is available to purchase expensive aircraft because of their high resale value, one reason why there have been numer ‘ous new airlines in almost every region. 5. Incumbency advantages independent of size. No matter what their size, incumbents may have cost or quality advan= tages not available to potential rivals. These advantages can stem from such sources as proprietary technology, preferen- tial access to the best raw material sources, preemption of the most favorable geographic locations, established brand ‘identities, or cumulative experience that has allowed incum- hnovorg | January 2008 | Harvard Business Review 81LEADERSHIP AND STRATEGY | Tho Five Competitive For bbents to leam how to produce more efficiently. Entrants try to bypass such advantages. Upstart discounters such as Tar- get and Wal-Mart, for example, have located stores in free- standing sites rather than regional shopping centers where established department stores were well entrenched. 6. Unequal access to distribution channels. The new en- trant must, of course, secure distribution of its product or service. A new food item, for example, must displace others. from the supermarket shelf via price breaks, promotions, intense selling efforts, or some other means. The more lim ited the wholesale or retail channels are and the more that existing competitors have tied them up, the tougher entry into an industry will be. Sometimes access to distribution, is so high a barrier that new entrants must bypass distribu- tion channels altogether or create their own. Thus, upstart low-cost airlines have avoided distribution through travel agents (who tend to favor established higherfare carriers) and have encouraged passengers to book their own flights, ‘onthe internet. 7. Restrictive government policy. Government policy ean hinder or aid new entry directly, as well as amplify (or nul: lity) the other entry barriers, Government directly limits or even forecloses entry into industries through, for Instance, licensing requirements and restrictions on foreign invest- ‘ment, Regulated industries like liquor retailing, taxiservices, and airlines are visible examples. Goverment policy can heighten other entry barriers through such means as ¢x- pansive patenting rules that protect proprietary technol ‘ogy from imitation or environmental or safety regulations that raise scale economies facing newcomers, OF course, ‘government policies may also make entry easier — directly, through subsidies, for instance, or indirectly by funding ba- sicresearch and making it available toall firms, new and old, reducing scale economies. Entry barriers should be assessed relative to the capa bilities of potential entrants, which may be start-ups, foreign firms, or companies in related industries. And, as some of ‘our examples illustrate the strategist must be mindtul of the creative ways newcomers might find to circumvent appar- ent barriers. Expected retaliation. How potential entrants believe in- cumbents may react will also influence their decision to. enter or stay out of an industry. I reaction is vigorous and. protracted enough, the profit potential of perticipating in the industry can fall below the cost of capital. Incumbents, often use public statements and responses to one entrant to send a message to other prospective entrants about their commitment to defending market share. Newcomers are likely to fear expected retaliation if “Incumbents have previously responded vigorously to new entrants, = Incumbents possess substantial resources to fight back, including excess cash and unused borrowing power, avail 182 Harvard Businass Review | January 2008 |_nocora That Shape Strategy Differences in Industry Profitability ‘The average return on invested capital varies markedly trom industry to industry, Betweon 1992 and 2006, for exemple, average return on invested capital in US. industries ranged as owas 10 oF evan negative to more than 50%. At the high lend ar inkustios Ike soit drinks and prepackagod software, ‘which have been almost sx times more profitable than the: airine industry over the period, able productive capacity, or clout with districution channels, and customers. + Incumbents seem likely to cut prices because they are ‘committed to retaining market share at all costs or because. the industry has high fixed costs, which create a strong mo: tivation to drop prices to fill excess capacity. = Industry growth is slow so newcomers can gain volume only by taking it from incumbents, ‘An analysis of barriers toentry and expected retaliation is ‘obviously crucial for any company contemplating entry into, a new industry. The challenge is to find ways to surmount the entry barriers without nullifying, through heavy invest- ‘ment, the profitability of participating in the industry. ‘THE POWER OF SUPPLIERS. Powerful suppliers capture ‘more of the value for themselves by charging higher prices, limiting quality or services, or shifting costs to industry par ticipants. Powerful suppliers, including suppliers of labor, can squeeze profitability out of an industry that is unable to pass on cost increases in its own prices. Microsoft, fo in stance, has contributed to the eresion of profitability among, personal computer makers by raising prices on operating, systems, PC makers, competing fiercely for customers who, can easily switch among them, have limited freedom to raise their prices accordingly. ‘Companies depend on a wide range of different supplier {groups for inputs. A supplier group is powerful if +It is more concentrated than the industry it sells to. icrosoft’s near monopoly in operating systems, coupled ith the fragmentation of PC assemblers, exemplifies th situation. +The supplier group does not depend heavily on the in: dustry for its revenues. Suppliers serving many industries will not hesitate to extract maximum profits from each one. Ifa particular industry accounts fora large portion of asup: plier group's volume or profit, however, suppliers will want to protect the industry through reasonable pricing and as- sist in activities such as R&D and lobbying. + Industry participants face switching costs in changing suppliers, For example, shifting supplies is difficult if com. panies have invested heavily in specialized ancillary equip:Avorage Return on Invested Capital in U.S. Industries, 1992-2008 ‘ment or in learning how to operate a supplier's equipment (@s with Bloomberg terminals used by financial profession- als) Or firms may have located their production lines adja cent to a supplier’s manufacturing facilities (as in the case of some beverage companies and container manufacturers). ‘When switching costs are high, industry participants find it hard to play suppliers off against one another: (Note that suppliers may have switching costs as well. This limits their power.) + Suppliers offer products that are differentiated. Phar- maceutical companies that offer patented drugs with dis- tinctive medical benefits have more power over hos health maintenance organizations, and other drug buyers, for example, than drug companies offering metoo or ge neric products. + There is no substitute for what the supplier group pro- vides. Pilots’ unions, for example, exercise considerable sup- plier power over airlines partly because there is no good alternative to a well-trained pilot in the cockpit +The supplier group can credibly threaten to integrate for- ward into the industry. In that case, if industry participants ‘make too much money relative to suppliers, they will induce suppliers to enter the market. Profitability of Selected U.S. industries Average ROK Patan. cosets Fes 28.6% ‘Reversing Aone ModieHome: mam 180% [fapson iy Ree ‘THE POWER OF BUYERS. Powerful customers ~the flip, side of powerful suppliers ~can capture more value by fore ing down prices, demanding better quality or more service (thereby driving up costs), and generally playing industry participants off against one another, all at the expense of industry profitability. Buyers are powerful if they have nego- tiating leverage relative to industry participants, especially if they are price sensitive, using their clout primarily to pres sure price reductions. ‘As with suppliers, chere may be distinct groups af custam= crs who differ in bargaining power. A customer group has negotiating leverage if + There are few buyers, or each one purchases in volumes that are large relative to the size of a single vendor. Large- volume buyers are particularly powerful in industries with high fixed costs, such as telecommunications equipment, off shore drilling, and bulk chemicals. High fixed costs and low ‘marginal costs amplify the pressure on rivals to keep capac lay filed through discounting. + The industry's products are standardized or undifferenti= ated. 1f buyers believe they can always find an equivalent product, they tend to play one vendor against another. + Buyers face few switching costs in changing vendors. nocorg | January 2008 | Harvard Business Raview 83