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Clouds, big data, and smart assets: Ten tech-enabled business trends to watch
Advancing technologies and their swift adoption are upending traditional business models. Senior executives need to think strategically about how to prepare their organizations for the challenging new environment.
AUGUST 2010 • Jacques Bughin, Michael Chui, and James Manyika
Two-and-a-half years ago, we described eight technology-enabled business trends that were profoundly reshaping strategy across a wide swath of industries.1 We showed how the combined effects of emerging Internet technologies, increased computing power, and fast, pervasive digital communications were spawning new ways to manage talent and assets as well as new thinking about organizational structures.
Since then, the technology landscape has continued to evolve rapidly. Facebook, in just over two short years, has quintupled in size to a network that touches more than 500 million users. More than 4 billion people around the world now use cell phones, and for 450 million of those people the Web is a fully mobile experience. The ways information technologies are deployed are changing too, as new developments such as virtualization and cloud computing reallocate technology costs and usage patterns while creating new ways for individuals to consume goods and services and for entrepreneurs and enterprises to dream up viable business models. The dizzying pace of change has affected our original eight trends, which have continued to spread (though often at a more rapid pace than we anticipated), morph in unexpected ways, and grow in number to an even ten.2
The rapidly shifting technology environment raises serious questions for executives about how to help their companies capitalize on the transformation under way. Exploiting these trends typically doesn’t fall to any one executive—and as change accelerates, the odds of missing a beat rise significantly. For senior executives, therefore, merely understanding the ten trends outlined here isn’t enough. They also need to think strategically about how to adapt management and organizational structures to meet these new demands.
For the first six trends, which can be applied across an enterprise, it will be important to assign the responsibility for identifying the specific implications of each issue to functional groups and business units. The impact of these six trends—distributed cocreation, networks as organizations, deeper collaboration, the Internet of Things, experimentation with big data, and wiring for a sustainable world—often will vary considerably in different parts of the organization and should be managed accordingly. But local accountability won’t be sufficient. Because some of the most powerful applications of these trends will cut across traditional organizational boundaries, senior leaders should catalyze regular collisions among teams in different corners of the company that are wrestling with similar issues.
Three of the trends—anything-as-a-service, multisided business models, and innovation from the bottom of the pyramid—augur far-reaching changes in the business environment that could require radical shifts in strategy. CEOs and their immediate senior teams need to grapple with these issues; otherwise it will be too difficult to generate the interdisciplinary, enterprise-wide insights needed to exploit these trends fully. Once opportunities start emerging, senior executives also need to turn their organizations into laboratories capable of quickly testing and learning on a small scale and then expand successes quickly. And finally the tenth trend, using technology to improve communities and generate societal benefits by linking citizens, requires action by not just senior business executives but also leaders in government, nongovernmental organizations, and citizens.
Across the board, the stakes are high. Consider the results of a recent McKinsey Quarterly survey of global executives on the impact of participatory Web 2.0 technologies (such as social networks, wikis, and microblogs) on management and performance. The survey found that deploying these technologies to create networked organizations that foster innovative collaboration among employees, customers, and business partners is highly correlated with market share gains. That’s just one example of how these trends transcend technology and provide a map of the terrain for creating value and competing effectively in these challenging and uncertain times.
1. Distributed cocreation moves into the mainstream
In the past few years, the ability to organize communities of Web participants to develop, market, and support products and services has moved from the margins of business practice to the mainstream. Wikipedia and a handful of open-source software developers were the pioneers. But in signs of the steady march forward, 70 percent of the executives we recently surveyed3 said that their companies regularly created value through Web communities. Similarly, more than 68 million bloggers post reviews and recommendations about products and services.
Intuit is among the companies that use the Web to extend their reach and lower the cost of serving customers. For example, it hosts customer support communities for its financial and tax return products, where more experienced customers give advice and support to those who need help. The most significant contributors become visible to the community by showing the number of questions they have answered and the number of “thanks” they have received from other users. By our estimates, when customer communities handle an issue, the per-contact cost can be as low as 10 percent of the cost to resolve the issue through traditional call centers.
Other companies are extending their reach by using the Web for word-of-mouth marketing. P&G’s Vocalpoint network of influential mothers is a leading example. Mothers share their experiences using P&G’s new products with members of their social circle, typically 20 to 25 moms. In markets where Vocalpoint influencers are active, product revenues have reached twice those without a Vocalpoint network.
Facebook has marshaled its community for product development. The leading social network recently recruited 300,000 users to translate its site into 70 languages—the translation for its French-language site took just one day. The community continues to translate updates and new modules.
Yet for every success in tapping communities to create value, there are still many failures. Some companies neglect the up-front research needed to identify potential participants who have the right skill sets and will be motivated to participate over the longer term. Since cocreation is a two-way process, companies must also provide feedback to stimulate continuing participation and commitment. Getting incentives right is important as well: cocreators often value reputation more than money. Finally, an organization must gain a high level of trust within a Web community to earn the engagement of top participants.
Further reading:
Jacques Bughin, Michael Chui, and Brad Johnson, “The next step in open innovation,” mckinseyquarterly.com, June 2008.
Michael Chui, Andy Miller, and Roger P. Roberts, “Six ways to make Web 2.0 work,” mckinseyquarterly.com, February 2009.
Josh Bernoff and Charlene Li, Groundswell: Winning in a World Transformed by Social Technologies, first edition, Cambridge, MA: Harvard Business School Press, 2008.
Clay Shirky, Here Comes Everybody: The Power of Organizing Without Organizations, reprint edition, New York, NY: Penguin, 2009.
2. Making the network the organization
In earlier research, we noted that the Web was starting to force open the boundaries of organizations, allowing nonemployees to offer their expertise in novel ways. We called this phenomenon “tapping into a world of talent.” Now many companies are pushing substantially beyond that starting point, building and managing flexible networks that extend across internal and often even external borders. The recession underscored the value of such flexibility in managing volatility. We believe that the more porous, networked organizations of the future will need to organize work around critical tasks rather than molding it to constraints imposed by corporate structures.
At one global energy services company, geographic and business unit boundaries prevented managers from accessing the best talent across the organization to solve clients’ technical problems. Help desks supported engineers, for example, but rarely provided creative solutions for the most difficult issues. Using social-network analysis, the company mapped information flows and knowledge resources among its worldwide staff. The analysis identified several bottlenecks but also pointed to a set of solutions. Using Web technologies to expand access to experts around the world, the company set up new innovation communities across siloed business units. These networks have helped speed up service delivery while improving quality by 48 percent, according to company surveys.
Dow Chemical set up its own social network to help managers identify the talent they need to execute projects across different business units and functions. To broaden the pool of talent, Dow has even extended the network to include former employees, such as retirees. Other companies are using networks to tap external talent pools. These networks include online labor markets (such as Amazon.com’s Mechanical Turk) and contest services (such as Innocentive and Zooppa) that help solve business problems.
Management orthodoxies still prevent most companies from leveraging talent beyond full-time employees who are tied to existing organizational structures. But adhering to these orthodoxies limits a company’s ability to tackle increasingly complex challenges. Pilot programs that connect individuals across organizational boundaries are a good way to experiment with new models, but incentive structures must be overhauled and role models established to make these programs succeed. In the longer term, networked organizations will focus on the orchestration of tasks rather than the “ownership” of workers.
Further reading:
Thomas W. Malone, The Future of Work: How the New Order of Business Will Shape Your Organization, Your Management Style, and Your Life, illustrated edition, Cambridge, MA: Harvard Business Press, 2004.
Lowell L. Bryan and Claudia I. Joyce, Mobilizing Minds: Creating Wealth from Talent in the 21st-Century Organization, New York, NY: McGraw-Hill, 2007.
Albert-Laszlo Barabasi, Linked: How Everything is Connected to Everything Else and What It Means for Business, Science, and Everyday Life, New York, NY: Plume, 2009.
Jacques Bughin, James Manyika, and Roger Roberts, “Beyond the Sloan Age,” What Matters, February 26, 2009.
3. Collaboration at scale
Across many economies, the number of people who undertake knowledge work has grown much more quickly than the number of production or transactions workers. Knowledge workers typically are paid more than others, so increasing their productivity is critical. As a result, there is broad interest in collaboration technologies that promise to improve these workers’ efficiency and effectiveness. While the body of knowledge around the best use of such technologies is still developing, a number of companies have conducted experiments, as we see in the rapid growth rates of video and Web conferencing, expected to top 20 percent annually during the next few years.
At one high-tech enterprise, the sales force became a crucible for testing collaboration tools. The company’s sales model relied on extensive travel, which had led to high costs, burned-out employees, and difficulty in scaling operations. The leadership therefore decided to deploy collaboration tools (including video conferencing and shared electronic workspaces, which allow people in different locations to work with the same document simultaneously), and it reinforced the changes with a sharp reduction in travel budgets. The savings on travel were four times the company’s technology investment. Customer contacts per salesperson rose by 45 percent, while 80 percent of the sales staff reported higher productivity and a better lifestyle.
In another instance, the US intelligence community made wikis, documents, and blogs available to analysts across agencies (with appropriate security controls, of course). The result was a greater exchange of information within and among agencies and faster access to expertise in the intelligence community. Engineering company Bechtel established a centralized, open-collaboration database of design and engineering information to support global projects. Engineers starting new ones found that the database, which contained up to 25 percent of the material they needed, lowered launch costs and sped up times to completion.
Despite such successes, many companies err in the belief that technology by itself will foster increased collaboration. For technology to be effective, organizations first need a better understanding of how knowledge work actually takes place. A good starting point is to map the informal pathways through which information travels, how employees interact, and where wasteful bottlenecks lie.
In the longer term, collaboration will be a vital component of what has been termed “organizational capital.”4 The next leap forward in the productivity of knowledge workers will come from interactive technologies combined with complementary investments in process innovations and training. Strategic choices, such as whether to extend collaboration networks to customers and suppliers, will be important.
Podcast: William Dutton, director of the Oxford Internet Institute at the University of Oxford, says collaboration technologies will revolutionize organizations, vastly expanding their reach and empowering their employees. Download the podcast or listen in the player below.
Further reading:
Andrew McAfee, Enterprise 2.0: New Collaborative Tools for Your Organization’s Toughest Challenges, first edition, Cambridge, MA: Harvard Business School Press, 2009.
Erik Brynjolfsson and Adam Saunders, Wired for Innovation: How Information Technology is Reshaping the Economy, Cambridge, MA: The MIT Press, 2009.
James Manyika, Kara Sprague, and Lareina Yee, “Using technology to improve workforce collaboration,” What Matters, October 27, 2009.
Wolf Richter, David Bray, and William Dutton, “Cultivating the value of networked individuals,” in Jonathan Foster, Collaborative Information Behavior: User Engagement and Communication Sharing, Hershey, PA: IGI Global.
4. The growing ‘Internet of Things’
The adoption of RFID (radio-frequency identification) and related technologies was the basis of a trend we first recognized as “expanding the frontiers of automation.” But these methods are rudimentary compared with what emerges when assets themselves become elements of an information system, with the ability to capture, compute, communicate, and collaborate around information—something that has come to be known as the “Internet of Things.” Embedded with sensors, actuators, and communications capabilities, such objects will soon be able to absorb and transmit information on a massive scale and, in some cases, to adapt and react to changes in the environment automatically. These “smart” assets can make processes more efficient, give products new capabilities, and spark novel business models. 5
Auto insurers in Europe and the United States are testing these waters with offers to install sensors in customers’ vehicles. The result is new pricing models that base charges for risk on driving behavior rather than on a driver’s demographic characteristics. Luxury-auto manufacturers are equipping vehicles with networked sensors that can automatically take evasive action when accidents are about to happen. In medicine, sensors embedded in or worn by patients continuously report changes in health conditions to physicians, who can adjust treatments when necessary. Sensors in manufacturing lines for products as diverse as computer chips and pulp and paper take detailed readings on process conditions and automatically make adjustments to reduce waste, downtime, and costly human interventions.
As standards for safety and interoperability begin to emerge, some core technologies for the Internet of Things are becoming more widely available. The range of possible applications and their business impact have yet to be fully explored, however. Applications that improve process and energy efficiency (see trend number six, “Wiring for a sustainable world,” later in this article) may be good starting points for trials, since the number of successful installations in these areas is growing. For more complex applications, however, laboratory experiments, small-scale pilots, and partnerships with early technology adopters may be more fruitful, less risky approaches.
Podcast: Kristopher Pister, professor of electrical engineering and computer sciences at the University of California, Berkeley, tells why a new generation of sensors and location technologies will endow the Internet of Things with much greater intelligence. Download the podcast or listen in the player below.
Further reading:
Michael Chui, Markus Löffler, and Roger Roberts, “The Internet of Things,” mckinseyquarterly.com, March 2010.
Hal R. Varian, Computer Mediated Transactions, Ely Lecture to the American Economics Association, Atlanta, GA, January 3, 2010.
Bernhard Boser, Joe Kahn, and Kris Pister, “Smart dust: Wireless networks of millimeter-scale sensor nodes,” Electronics Research Laboratory Research Summary, 1999.
Peter Lucas, “The trillion-node network,” Maya Design, March 1999.
5. Experimentation and big data
Could the enterprise become a full-time laboratory? What if you could analyze every transaction, capture insights from every customer interaction, and didn’t have to wait for months to get data from the field? What if . . . ? Data are flooding in at rates never seen before—doubling every 18 months—as a result of greater access to customer data from public, proprietary, and purchased sources, as well as new information gathered from Web communities and newly deployed smart assets. These trends are broadly known as “big data.” Technology for capturing and analyzing information is widely available at ever-lower price points. But many companies are taking data use to new levels, using IT to support rigorous, constant business experimentation that guides decisions and to test new products, business models, and innovations in customer experience. In some cases, the new approaches help companies make decisions in real time. This trend has the potential to drive a radical transformation in research, innovation, and marketing.
Web-based companies, such as Amazon.com, eBay, and Google, have been early leaders, testing factors that drive performance—from where to place buttons on a Web page to the sequence of content displayed—to determine what will increase sales and user engagement. Financial institutions are active experimenters as well. Capital One, which was early to the game, continues to refine its methods for segmenting credit card customers and for tailoring products to individual risk profiles. According to Nigel Morris, one of Capital One’s cofounders, the company’s multifunctional teams of financial analysts, IT specialists, and marketers conduct more than 65,000 tests each year, experimenting with combinations of market segments and new products.
Companies selling physical products are also using big data for rigorous experimentation. The ability to marshal customer data has kept Tesco, for example, in the ranks of leading UK grocers. This brick-and-mortar retailer gathers transaction data on its ten million customers through a loyalty card program. It then uses the information to analyze new business opportunities—for example, how to create the most effective promotions for specific customer segments—and to inform decisions on pricing, promotions, and shelf allocation. The online grocer Fresh Direct shrinks reaction times even further: it adjusts prices and promotions daily or even more frequently, based on data feeds from online transactions, visits by consumers to its Web site, and customer service interactions. Other companies too are mining data from social networks in real time. Ford Motor, PepsiCo, and Southwest Airlines, for instance, analyze consumer postings about them on social-media sites such as Facebook and Twitter to gauge the immediate impact of their marketing campaigns and to understand how consumer sentiment about their brands is changing.
Using experimentation and big data as essential components of management decision making requires new capabilities, as well as organizational and cultural change. Most companies are far from accessing all the available data. Some haven’t even mastered the technologies needed to capture and analyze the valuable information they can access. More commonly, they don’t have the right talent and processes to design experiments and extract business value from big data, which require changes in the way many executives now make decisions: trusting instincts and experience over experimentation and rigorous analysis. To get managers at all echelons to accept the value of experimentation, senior leaders must buy into a “test and learn” mind-set and then serve as role models for their teams.
Podcast: According to Hal Varian, Google’s chief economist, companies that take advantage of “big data” and the new opportunities for experimentation that technology affords will gain a significant competitive edge. Download the podcast or listen in the player below.
Further reading:
Stefan Thomke, “Enlightened experimentation: The new imperative for innovation,” Harvard Business Review, February 2001, Volume 79, Number 2, pp. 66–75.
Stephen Baker, The Numerati, reprint edition, New York, NY: Mariner Books, 2009.
Thomas H. Davenport, Jeanne G. Harris, and Robert Morison, Analytics at Work: Smarter Decisions, Better Results, Cambridge, MA: Harvard Business Press, 2010.
David Bollier, The Promise and Peril of Big Data, The Aspen Institute, 2010.
Janaki Akella, Timo Kubach, Markus Löffler, and Uwe Schmid, “Data-driven management: Bringing more science into management,” McKinsey Technology Initiative white paper.
“Economist special report: The data deluge,” the Economist, February 25, 2010.
6. Wiring for a sustainable world
Even as regulatory frameworks continue to evolve, environmental stewardship and sustainability clearly are C-level agenda topics. What’s more, sustainability is fast becoming an important corporate-performance metric—one that stakeholders, outside influencers, and even financial markets have begun to track. Information technology plays a dual role in this debate: it is both a significant source of environmental emissions and a key enabler of many strategies to mitigate environmental damage. At present, information technology’s share of the world’s environmental footprint is growing because of the ever-increasing demand for IT capacity and services. Electricity produced to power the world’s data centers generates greenhouse gases on the scale of countries such as Argentina or the Netherlands, and these emissions could increase fourfold by 2020. McKinsey research has shown, however, that the use of IT in areas such as smart power grids, efficient buildings, and better logistics planning could eliminate five times the carbon emissions that the IT industry produces.
Companies are now taking the first steps to reduce the environmental impact of their IT. For instance, businesses are adopting “green data center” technologies to reduce sharply the energy demand of the ever-multiplying numbers of servers needed to cope with data generated by trends such as distributed cocreation and the Internet of Things (described earlier in this article). Such technologies include virtualization software (which enables the more efficient allocation of software across servers) to decrease the number of servers needed for operations, the cooling of data centers with ambient air to cut energy consumption, and inexpensive, renewable hydroelectric power (which of course requires locating data centers in places where it is available). Meanwhile, IT manufacturers are organizing programs to collect and recycle hazardous electronics, diverting them from the waste stream.
IT’s bigger role, however, lies in its ability to reduce environmental stress from broader corporate and economic activities. In a significant push, for example, utilities around the world are deploying smart meters that can help customers shift electricity usage away from peak periods and thereby reduce the amount of power generated by inefficient and costly peak-load facilities. Smart grids can also improve the efficiency of the transmission and distribution of energy and, when coupled with energy storage facilities, could store electricity generated by renewable-energy technologies, such as solar and wind. Likewise, smart buildings embedded with IT that monitors and optimizes energy use could be one of the most important ways of reducing energy consumption in developed economies. And powerful analytic software that improves logistics and routing for planes, trains, and trucks is already reducing the transportation industry’s environmental footprint.
Within the enterprise, both leaders and key functional players must understand sustainability’s growing importance to broader goals. Management systems that build the constant improvement of resource use into an organization’s processes and strategies will raise its standing with external stakeholders while also helping the bottom line.
Podcast: Microsoft’s chief environmental strategist, Rob Bernard, says that existing technologies hold enormous, latent potential to boost energy efficiency—but not without substantial changes in human behavior. Download the podcast or listen in the player below.
Podcast: Collaboration across industry boundaries, says McKinsey’s Markus Löffler, is critical to forging the technology innovations needed for sustainable growth. Download the podcast or listen in the player below.
Further reading:
Smart 2020: Enabling the low carbon economy in the information age, The Climate Group, 2009.
Giulio Boccaletti, Markus Löffler, and Jeremy M. Oppenheim, “How IT can cut carbon emissions,” mckinseyquarterly.com, October 2008.
William Forrest, James M. Kaplan, and Noah Kindler, “Data centers: How to cut carbon emissions and costs,” mckinseyquarterly.com, November 2008.
7. Imagining anything as a service
Technology now enables companies to monitor, measure, customize, and bill for asset use at a much more fine-grained level than ever before. Asset owners can therefore create services around what have traditionally been sold as products. Business-to-business (B2B) customers like these service offerings because they allow companies to purchase units of a service and to account for them as a variable cost rather than undertake large capital investments. Consumers also like this “paying only for what you use” model, which helps them avoid large expenditures, as well as the hassles of buying and maintaining a product.
In the IT industry, the growth of “cloud computing” (accessing computer resources provided through networks rather than running software or storing data on a local computer) exemplifies this shift. Consumer acceptance of Web-based cloud services for everything from e-mail to video is of course becoming universal, and companies are following suit. Software as a service (SaaS), which enables organizations to access services such as customer relationship management, is growing at a 17 percent annual rate. The biotechnology company Genentech, for example, uses Google Apps for e-mail and to create documents and spreadsheets, bypassing capital investments in servers and software licenses. This development has created a wave of computing capabilities delivered as a service, including infrastructure, platform, applications, and content. And vendors are competing, with innovation and new business models, to match the needs of different customers.
Beyond the IT industry, many urban consumers are drawn to the idea of buying transportation services by the hour rather than purchasing autos. City CarShare and ZipCar were first movers in this market, but established car rental companies, spurred by annual growth rates of 25 percent, are also entering it. Similarly, jet engine manufacturers have made physical assets a platform for delivering units of thrust billed as a service.
A number of companies are employing technology to market salable services from business capabilities they first developed for their own purposes. That’s a trend we previously described as “unbundled production.” More deals are unfolding as companies move to disaggregate and make money from corporate value chains. British Airways and GE, for instance, have spun off their successful business-process-outsourcing businesses, based in India, as separate corporations.
Business leaders should be alert to opportunities for transforming product offerings into services, because their competitors will undoubtedly be exploring these avenues. In this disruptive view of assets, physical and intellectual capital combine to create platforms for a new array of service offerings. But innovating in services, where the end user is an integral part of the system, requires a mind-set fundamentally different from the one involved in designing products.
Further reading:
Nicholas Carr, The Big Switch: Rewiring the World, from Edison to Google, reprint edition, New York, NY: W. W. Norton & Company, 2009.
IBM and University of Cambridge, “Succeeding through service innovation: A service perspective for education, research, business and government,” Cambridge Service Science, Management, and Engineering Symposium, Cambridge, July 14–15, 2007.
Peter Mell and Tim Grance, “The NIST definition of cloud computing,” Version 15, October 7, 2009.
8. The age of the multisided business model
Multisided business models create value through interactions among multiple players rather than traditional one-on-one transactions or information exchanges. In the media industry, advertising is a classic example of how these models work. Newspapers, magazines, and television stations offer content to their audiences while generating a significant portion of their revenues from third parties: advertisers. Other revenue, often through subscriptions, comes directly from consumers. More recently, this advertising-supported model has proliferated on the Internet, underwriting Web content sites, as well as services such as search and e-mail (see trend number seven, “Imagining anything as a service,” earlier in this article). It is now spreading to new markets, such as enterprise software: Spiceworks offers IT-management applications to 950,000 users at no cost, while it collects advertising from B2B companies that want access to IT professionals.
Technology is propagating new, equally powerful forms of multisided business models. In some information businesses, for example, data gathered from one set of users generate revenue when the business charges a separate set of customers for information services based on that data. Take Sermo, an online community of physicians who join (free of charge) to pose questions to other members, participate in discussion groups, and read medical articles. Third parties such as pharmaceutical companies, health care organizations, financial institutions, and government bodies pay for access to the anonymous interactions and polls of Sermo’s members.
As more people migrate to online activities, network effects can magnify the value of multisided business models. The “freemium” model is a case in point: a group of customers gets free services supported by those who pay a premium for special use. Flickr (online storage of photos), Pandora (online music), and Skype (online communication) not only use this kind of cross-subsidization but also demonstrate the leveraging effect of networks—the greater the number of free users, the more valuable the service becomes for all customers. Pandora harnesses the massive amounts of data from its free users to refine its music recommendations. All Flickr users benefit from a larger photo-posting community, all Skype members from an expanded universe of people with whom to connect.
Other companies find that when their core business is part of a network, valuable data (sometimes called “exhaust data”) are generated as a by-product. MasterCard, for instance, has built an advisory unit based on data the company gathers from its core credit card business: it analyzes consumer purchasing patterns and sells aggregated findings to merchants and others that want a better reading on buying trends. CHEP, a logistics-services provider, captures data on a significant portion of the transportation volume of the fastest-moving consumer goods and is now building a transportation-management business to take advantage of this visibility.
Not all companies, of course, could benefit from multisided models. But for those that can, a good starting point for testing them is to take inventory of all the data in a company’s businesses (including data flowing from customer interactions) and then ask, “Who might find this information valuable?” Another provocative thought: “What would happen if we provided our product or service free of charge?” or—more important, perhaps—“What if a competitor did so?” The responses should provide indications of the opportunities for disruption, as well as of vulnerabilities.
Podcast: New Web technologies are expanding the scope and power of “free” business models, argues McKinsey’s Michael Chui. Download the podcast or listen in the player below.
Further reading:
Chris Anderson, Free: How Today’s Smartest Businesses Profit by Giving Something for Nothing, New York, NY: Hyperion, 2009.
Annabelle Gawer ed., Platforms, Markets and Innovation, Cheltenham, UK: Edward Elgar Publishing, 2010.
David S. Evans, Andrei Hagiu, and Richard Schmalensee, Invisible Engines: How Software Platforms Drive Innovation and Transform Industries, Cambridge, MA: The MIT Press, 2006.
9. Innovating from the bottom of the pyramid
The adoption of technology is a global phenomenon, and the intensity of its usage is particularly impressive in emerging markets. Our research has shown that disruptive business models arise when technology combines with extreme market conditions, such as customer demand for very low price points, poor infrastructure, hard-to-access suppliers, and low cost curves for talent. With an economic recovery beginning to take hold in some parts of the world, high rates of growth have resumed in many developing nations, and we’re seeing companies built around the new models emerging as global players. Many multinationals, meanwhile, are only starting to think about developing markets as wellsprings of technology-enabled innovation rather than as traditional manufacturing hubs.
In parts of rural Africa, for instance, traditional retail-banking models have difficulty taking root. Consumers have low incomes and often lack the standard documentation (such as ID cards or even addresses) required to open bank accounts. But Safaricom, a telecom provider, offers banking services to eight million Africans through its M-PESA mobile-phone service (M stands for “mobile,” pesa is Swahili for “money”). Safaricom allows a network of shops and gas stations that sell telecommunications airtime to load virtual cash onto cell phones as well.
In China, another technology-based model brings order to the vast, highly dispersed strata of smaller manufacturing facilities. Many small businesses around the world have difficulty finding Chinese manufacturers to meet specific needs. Some of these manufacturers are located in remote areas, and their capabilities can vary widely. Alibaba, China’s leading B2B exchange, with more than 30 million members, helps members share data on their manufacturing services with potential customers and handles online payments and other transactions. Its network, in effect, offers Chinese manufacturing capacity as a service, enabling small businesses anywhere in the world to identify suppliers quickly and scale up rapidly to meet demand.
Hundreds of companies are now appearing on the global scene from emerging markets, with offerings ranging from a low-cost bespoke tutoring service to the remote monitoring of sophisticated air-conditioning systems around the world. For most global incumbents, these represent a new type of competitor: they are not only challenging the dominant players’ growth plans in developing markets but also exporting their extreme models to developed ones. To respond, global players must plug into the local networks of entrepreneurs, fast-growing businesses, suppliers, investors, and influencers spawning such disruptions. Some global companies, such as GE, are locating research centers in these cauldrons of creativity to spur their own innovations there. Others, such as Philips and SAP, are now investing in local companies to nurture new, innovative products for export that complement their core businesses.
Podcast: Vijay Govindarajan, the Earl C. Daum 1924 Professor of International Business at Dartmouth’s Tuck School of Business, explains why innovative business models arising in emerging markets present both opportunities and perils for established global players. Download the podcast or listen in the player below.
Further reading:
Jeffrey R. Immelt, Vijay Govindarajan, and Chris Trimble, “How GE is disrupting itself,” Harvard Business Review, October 2009, Volume 87, Number 10, pp. 56–65.
“Special report on innovation in emerging markets: The world turned upside down,” the Economist, April 15, 2010.
C. K. Prahalad, The Fortune at the Bottom of the Pyramid: Eradicating Poverty Through Profits, fifth edition, Philadelphia, PA: Wharton School Publishing, July 2009.
10. Producing public good on the grid
The role of governments in shaping global economic policy will expand in coming years.6 Technology will be an important factor in this evolution by facilitating the creation of new types of public goods while helping to manage them more effectively. This last trend is broad in scope and draws upon many of the other trends described above.
Take the challenges of rising urbanization. About half of the world’s people now live in urban areas, and that share is projected to rise to 70 percent by 2050. Creative public policies that incorporate new technologies could help ease the economic and social strains of population density. “Wired” cities might be one approach. London, Singapore, and Stockholm have used smart assets to manage traffic congestion in their urban cores, and many cities throughout the world are deploying these technologies to improve the reliability and predictability of mass-transit systems. Sensors in buses and trains provide transportation planners with real-time status reports to optimize routing and give riders tools to adjust their commuting plans.
Similarly, networked smart water grids will be critical to address the need for clean water. Embedded sensors can not only ensure that the water flowing through systems is uncontaminated and safe to drink but also sense leaks. And effective metering and billing for water ensures that the appropriate incentives are in place for efficient usage.7
Technology can also improve the delivery and effectiveness of many public services. Law-enforcement agencies are using smart assets—video cameras and data analytics—to create maps that define high-crime zones and direct additional police resources to them. Cloud computing and collaboration technologies can improve educational services, giving young and adult students alike access to low-cost content, online instructors, and communities of fellow learners. Through the Web, governments are improving access to many other services, such as tax filing, vehicle registration, benefits administration, and employment services. Public policy also stands to become more transparent and effective thanks to a number of new open-data initiatives. At the UK Web site FixMyStreet.com, for example, citizens report, view, and discuss local problems, such as graffiti and the illegal dumping of waste, and interact with local officials who provide updates on actions to solve them.
Exploiting technology’s full potential in the public sphere means reimagining the way public goods are created, delivered, and managed. Setting out a bold vision for what a wired, smart community could accomplish is a starting point for setting strategy. Putting that vision in place requires forward-thinking yet prudent leadership that sets milestones, adopts flexible test-and-learn methods, and measures success. Inertia hobbles many public organizations, so leaders must craft incentives tailored to public projects and embrace novel, unfamiliar collaborations among governments, technology providers, other businesses, nongovernmental organizations, and citizens.
Further reading:
Jason Baumgarten and Michael Chui, “E-government 2.0,” mckinseyquarterly.com, July 2009.
Bas Boorsma and Wolfgang Wagner, “Connected urban development: Innovation for sustainability,” NATOA Journal, Winter 2007, Volume 15, Number 4, pp. 5–9.
O’Reilly Radar Government 2.0 (radar.oreilly.com)
Connected Urban Development (connectedurbandevelopment.org)
Building a smarter planet (asmarterplanet.com)
The pace of technology and business change will only accelerate, and the impact of the trends above will broaden and deepen. For some organizations, they will unlock significant competitive advantages; for others, dealing with the disruption they bring will be a major challenge. Our broad message is that organizations should incorporate an understanding of the trends into their strategic thinking to help identify new market opportunities, invent new ways of doing business, and compete with an ever-growing number of innovative rivals.
Join the conversation
Over the next five years, which of these trends will have the most impact on you personally or professionally, and why? Tell us what you think by submitting a comment below, or use the #McKTechTrends hashtag to respond on Twitter. We’ll be following your comments via our McKinsey Quarterly twitter account, @McKQuarterly.
About the Authors
Jacques Bughin is a director in McKinsey’s Brussels office; Michael Chui is a senior fellow of the McKinsey Global Institute; James Manyika is a director in the San Francisco office and a director of the McKinsey Global Institute.
The authors wish to acknowledge the important contributions of our colleague Angela Hung Byers.
Back to top
Notes
1 James M. Manyika, Roger P. Roberts, and Kara L. Sprague, “Eight business technology trends to watch,” mckinseyquarterly.com, December 2007.
2 Two of the original eight trends merged to form a megatrend around distributed cocreation. We also identified three additional trends centered on the relationship between technology and emerging markets, environmental sustainability, and public goods.
3 “How companies are benefiting from Web 2.0: McKinsey Global Survey Results,” mckinseyquarterly.com, September 2009.
4 Erik Brynjolfsson and Adam Saunders, Wired for Innovation: How Information Technology is Reshaping the Economy, Cambridge, MA: The MIT Press, 2009.
5 Hal Varian explores some of these themes, along with the effects associated with “experimentation and big data” (described later in this article), in his 2010 American Economics Association lecture cited in this section’s Further reading.
6 Peter Bisson, Elizabeth Stephenson, and S. Patrick Viguerie, “Global forces: An introduction,” mckinseyquarterly.com, June 2010.
7 Peter Bisson, Elizabeth Stephenson, and S. Patrick Viguerie, “Pricing the planet,” mckinseyquarterly.com, June 2010.
In this blog, teachers, students and all those who have some kind of interest in the English language will find useful, interesting, curious and funny things to be used in their classes or for their personal enjoyment.
Thursday, September 1, 2011
Leading change: An interview with the executive chairman of Telefónica de España
The following information is used for educational purposes only.
Leading change: An interview with the executive chairman of Telefónica de España
Julio Linares explains the design of the company's big turnaround program. Third in a series of interviews with leading executives on change management.
AUGUST 2005 • Josep Isern and Julie Shearn
In the late 1990s, Telefónica de España's position seemed parlous: the incumbent telecom operator's fixed-line business was declining and gross earnings had fallen for three consecutive years. From 1999 to 2000 alone, the company's earnings before interest, taxes, depreciation, and amortization (EBITDA) declined by 10 percent and its cash flow by 15 percent. At the same time, the sector was liberalizing, competition was intense, and growth opportunities were unclear. Consequently, employee morale was low and the future outlook gloomy.
Yet during the past four years, the organization has transformed itself: its cash flow keeps climbing, the declining earnings trend has been reversed and the workforce drastically reduced, and the return on invested capital (ROIC) has almost doubled. Telefónica de España is the only wireline operator among its peers that has grown in terms of revenues and EBITDA. And it is now a leading European broadband operator, with a stronger customer focus and a compelling vision.
Telefónica de España's turnaround was part of a wider change at the parent Telefónica Group, which over the past decade has expanded into 40 countries and achieved the highest shareholder returns among its industry peers. Telefónica de España experienced one of the biggest business transformations in the Telefónica Group. We talked about the issues regarding the importance of program design with the company's executive chairman Julio Linares.
The Quarterly: When you began, back in 2000, did you have any particular aspirations you wanted to realize?
Julio Linares: Rather than realize any specific aspiration for change, the company needed to change completely to survive. The market was very mature, and the forecasts for the company's economics, if we did not change, were particularly bad. I think we were fully convinced that change was absolutely necessary.
The Quarterly: How was the program designed?
Julio Linares: We designed the program around three modules—growth, competitiveness, and commitment—with midterm objectives and a series of "waves," each lasting a year. The top-management team would get together in November and design the wave for the next year, keeping the modules consistent over time. This wave was then communicated to the top 500 people in the organization at an event every January—at the same time we explained how we had delivered last year's wave. By having the waves as annual cycles, we were able to tie the waves into the budget cycle and to keep the transformation initiatives, budgets, and financial targets knitted together. A yearlong wave is enough time to have an impact, and that impact becomes very visible in the annual results.
The Quarterly: What were these waves?
Julio Linares: The waves were designed to meet the goals and priorities for the year. They were made up of three or four large blocks of work, which together would deliver the year's performance and transformation goals. Each of the smaller projects that formed part of the transformation found a home in one of the larger blocks or modules. We discovered that this approach is a useful communication device—it helped people understand how the project they were working on would contribute to that year's targets and, therefore, to the overall transformation program.
The Quarterly: Why did the waves need to change every year?
Julio Linares: They did not change radically—the initiatives that made up each wave were certainly recognizable and consistent with the three modules from one year to the next. What changed were the types of efforts within the different modules. However, I don't think you can succeed with a program that is very stable or rigid. People need to feel that the transformation effort is changing and moving forward; otherwise they will believe that there has been no progress and that they are not changing.
The Quarterly: Did the process of designing each wave of the transformation program involve a lot of people?
Julio Linares: At the beginning, no. It was basically a top-down effort because of the need to change quickly. But I realized that it was very important to change that approach. When it is top down, it is very difficult to engage people, to convince them to make the effort. So we changed by involving different levels of the organization as much as possible, although I recognize that we haven't yet reached the kind of engagement we need.
The Quarterly: When did you realize that you needed to involve more people?
Julio Linares: I don't know exactly when, but my biggest effort has been to convince people of the need for the program and to involve people in it. That is, from my point of view, the biggest challenge in the whole process, the hardest part of the transformation. I think it is much easier to design the program than it is to involve and engage everybody in the transformation process.
The Quarterly: What have you done to involve people?
Julio Linares: Initially, we thought that it would be enough to use a cascaded communication program, but over time we realized that it wasn't enough. And although we increased participation in the cascaded communications every year, I would say that it is difficult to engage everybody just through communication. If people do not participate in the design of the program—if they feel it is something imposed by top management—then it is difficult to make them feel engaged.
But involving everybody in the design would take too long and be difficult to manage. Telefónica de España is a very large company and we have people located throughout the country. From my point of view, the real difficulty here is to try to find a balance in the whole process so as to give relevant people at different levels of the organization an opportunity to participate in the transformation program's design and then to complement that with a strong communication program. That way, we are more likely to reach 100 percent engagement, which is the objective we should have.
I think it is more important to involve people from the very beginning than to have a perfect design, because the result depends more on the engagement and commitment of people than on the design. So in the first waves of the program, I spent 90 percent of my time designing the program and 10 percent communicating it to people. And now I do exactly the opposite: 10 percent for the design of the program and 90 percent for involving people.
The Quarterly: Have any pockets of the organization been involved in the program in an especially productive way?
Julio Linares: I see a big difference in the involvement of people when they have a clear objective as compared with an objective that is complicated and difficult to understand. If the objective is clear, then everybody has a very good view of the progress made against it. I have come to believe that this is very important.
Take, for example, the objective of having one million ADSL1 subscribers by 2003, which we set at the end of 2000. This objective may seem obvious now, but it wasn't then. And, fortunately, the objective was very simple, very clear; it was recognized and understood by everybody. It was easy to track because everybody knew the number of ADSL subscribers we had, and so it was easy to share with the whole organization how well we were progressing. And, fortunately, at the same time this was an objective that required many people to be involved: salespeople, installation and maintenance people, technical people. Almost everybody seemed to have a part in attaining the objective. Also, it had a very clear connection with our view of the company's future.
But when we tried to set up the same kinds of objectives in other areas of the company, it was not so easy. It's very difficult to find objectives with such power, but it is necessary.
The Quarterly: When you had identified the objectives and the people to deliver them, how did you bring them to life?
Julio Linares: One issue was whether we should make a specific part of the organization responsible for achieving these objectives. We decided not to, so we kept the organization as it was and worked on the transformation efforts in parallel with day-to-day business. Each module was championed by a senior executive and had a full-time manager with high visibility in the organization. Apart from this manager, most participants in the different initiatives combined them with day-to-day work.
The Quarterly: Was this effective?
Julio Linares: Yes. For instance, I think people are more open and able to work on a project basis than they were before. Everything used to be regimented and organized by functions or business units, but today I see people more open to cooperating with people from different parts of the organization and more willing to work on a project basis. I think it's easier to share common objectives.
The Quarterly: How has management's behavior changed throughout the process?
Julio Linares: I believe we have changed a lot. Nowadays, the organization is more oriented to results. Also, we all have understood the need to balance the focus on short-term results with efforts to gradually change our capabilities and attitudes. Finally, I would highlight the fact that the organization has advanced significantly in its customer orientation and has also become really conscious of efficiency—critical requirements for our current and future success.
The Quarterly: You moved to another stage of the transformation after four years. Why?
Julio Linares: We had made small changes to the program every year as we launched each new wave. After four years, however, we thought that people were a little tired of the program. We believed that it was necessary to push further and to relaunch the program with more vigor and energy.
At the same time, we believed that this was a good moment to celebrate the results of the program so far and to recognize that it had been very good for the company, that we had reached many of the objectives we set forth at the beginning, and that we had made progress in the transformation.
But it was also necessary to recognize that a changing market and different conditions made it necessary to give more energy to the program. This was a difficult message to combine with the message of celebration, because you are in effect telling people that they have been working hard and that the program has been successful, but now they need to change how they work. Communicating this message needs to be done carefully if it is to be done well.
The Quarterly: So you needed to reinvigorate the program?
Julio Linares: Yes, summing up I would say that three things—the fact that people were a little tired with the program, that we needed to emphasize new things such as novel capabilities, and that more energy was required—made us make the decision to move into a new episode of our transformation. By this, I mean a set of new initiatives, also organized in waves, that will emphasize new change topics, such as integrated solutions for customers.
The Quarterly: So you have created a culture where people expect change every year?
Julio Linares: I see the process as something that will not end, ever. Because I don't think the market is going to stop changing. The market is going to change constantly, and because of that you need to make a constant effort to adapt your company to the market. Of course, some parts of the program will end, but new ones will come up. It's a never-ending journey.
About the Authors
Josep Isern is a director in McKinsey's Madrid office, and Julie Shearn is an associate principal in the London office.
Leading change: An interview with the executive chairman of Telefónica de España
Julio Linares explains the design of the company's big turnaround program. Third in a series of interviews with leading executives on change management.
AUGUST 2005 • Josep Isern and Julie Shearn
In the late 1990s, Telefónica de España's position seemed parlous: the incumbent telecom operator's fixed-line business was declining and gross earnings had fallen for three consecutive years. From 1999 to 2000 alone, the company's earnings before interest, taxes, depreciation, and amortization (EBITDA) declined by 10 percent and its cash flow by 15 percent. At the same time, the sector was liberalizing, competition was intense, and growth opportunities were unclear. Consequently, employee morale was low and the future outlook gloomy.
Yet during the past four years, the organization has transformed itself: its cash flow keeps climbing, the declining earnings trend has been reversed and the workforce drastically reduced, and the return on invested capital (ROIC) has almost doubled. Telefónica de España is the only wireline operator among its peers that has grown in terms of revenues and EBITDA. And it is now a leading European broadband operator, with a stronger customer focus and a compelling vision.
Telefónica de España's turnaround was part of a wider change at the parent Telefónica Group, which over the past decade has expanded into 40 countries and achieved the highest shareholder returns among its industry peers. Telefónica de España experienced one of the biggest business transformations in the Telefónica Group. We talked about the issues regarding the importance of program design with the company's executive chairman Julio Linares.
The Quarterly: When you began, back in 2000, did you have any particular aspirations you wanted to realize?
Julio Linares: Rather than realize any specific aspiration for change, the company needed to change completely to survive. The market was very mature, and the forecasts for the company's economics, if we did not change, were particularly bad. I think we were fully convinced that change was absolutely necessary.
The Quarterly: How was the program designed?
Julio Linares: We designed the program around three modules—growth, competitiveness, and commitment—with midterm objectives and a series of "waves," each lasting a year. The top-management team would get together in November and design the wave for the next year, keeping the modules consistent over time. This wave was then communicated to the top 500 people in the organization at an event every January—at the same time we explained how we had delivered last year's wave. By having the waves as annual cycles, we were able to tie the waves into the budget cycle and to keep the transformation initiatives, budgets, and financial targets knitted together. A yearlong wave is enough time to have an impact, and that impact becomes very visible in the annual results.
The Quarterly: What were these waves?
Julio Linares: The waves were designed to meet the goals and priorities for the year. They were made up of three or four large blocks of work, which together would deliver the year's performance and transformation goals. Each of the smaller projects that formed part of the transformation found a home in one of the larger blocks or modules. We discovered that this approach is a useful communication device—it helped people understand how the project they were working on would contribute to that year's targets and, therefore, to the overall transformation program.
The Quarterly: Why did the waves need to change every year?
Julio Linares: They did not change radically—the initiatives that made up each wave were certainly recognizable and consistent with the three modules from one year to the next. What changed were the types of efforts within the different modules. However, I don't think you can succeed with a program that is very stable or rigid. People need to feel that the transformation effort is changing and moving forward; otherwise they will believe that there has been no progress and that they are not changing.
The Quarterly: Did the process of designing each wave of the transformation program involve a lot of people?
Julio Linares: At the beginning, no. It was basically a top-down effort because of the need to change quickly. But I realized that it was very important to change that approach. When it is top down, it is very difficult to engage people, to convince them to make the effort. So we changed by involving different levels of the organization as much as possible, although I recognize that we haven't yet reached the kind of engagement we need.
The Quarterly: When did you realize that you needed to involve more people?
Julio Linares: I don't know exactly when, but my biggest effort has been to convince people of the need for the program and to involve people in it. That is, from my point of view, the biggest challenge in the whole process, the hardest part of the transformation. I think it is much easier to design the program than it is to involve and engage everybody in the transformation process.
The Quarterly: What have you done to involve people?
Julio Linares: Initially, we thought that it would be enough to use a cascaded communication program, but over time we realized that it wasn't enough. And although we increased participation in the cascaded communications every year, I would say that it is difficult to engage everybody just through communication. If people do not participate in the design of the program—if they feel it is something imposed by top management—then it is difficult to make them feel engaged.
But involving everybody in the design would take too long and be difficult to manage. Telefónica de España is a very large company and we have people located throughout the country. From my point of view, the real difficulty here is to try to find a balance in the whole process so as to give relevant people at different levels of the organization an opportunity to participate in the transformation program's design and then to complement that with a strong communication program. That way, we are more likely to reach 100 percent engagement, which is the objective we should have.
I think it is more important to involve people from the very beginning than to have a perfect design, because the result depends more on the engagement and commitment of people than on the design. So in the first waves of the program, I spent 90 percent of my time designing the program and 10 percent communicating it to people. And now I do exactly the opposite: 10 percent for the design of the program and 90 percent for involving people.
The Quarterly: Have any pockets of the organization been involved in the program in an especially productive way?
Julio Linares: I see a big difference in the involvement of people when they have a clear objective as compared with an objective that is complicated and difficult to understand. If the objective is clear, then everybody has a very good view of the progress made against it. I have come to believe that this is very important.
Take, for example, the objective of having one million ADSL1 subscribers by 2003, which we set at the end of 2000. This objective may seem obvious now, but it wasn't then. And, fortunately, the objective was very simple, very clear; it was recognized and understood by everybody. It was easy to track because everybody knew the number of ADSL subscribers we had, and so it was easy to share with the whole organization how well we were progressing. And, fortunately, at the same time this was an objective that required many people to be involved: salespeople, installation and maintenance people, technical people. Almost everybody seemed to have a part in attaining the objective. Also, it had a very clear connection with our view of the company's future.
But when we tried to set up the same kinds of objectives in other areas of the company, it was not so easy. It's very difficult to find objectives with such power, but it is necessary.
The Quarterly: When you had identified the objectives and the people to deliver them, how did you bring them to life?
Julio Linares: One issue was whether we should make a specific part of the organization responsible for achieving these objectives. We decided not to, so we kept the organization as it was and worked on the transformation efforts in parallel with day-to-day business. Each module was championed by a senior executive and had a full-time manager with high visibility in the organization. Apart from this manager, most participants in the different initiatives combined them with day-to-day work.
The Quarterly: Was this effective?
Julio Linares: Yes. For instance, I think people are more open and able to work on a project basis than they were before. Everything used to be regimented and organized by functions or business units, but today I see people more open to cooperating with people from different parts of the organization and more willing to work on a project basis. I think it's easier to share common objectives.
The Quarterly: How has management's behavior changed throughout the process?
Julio Linares: I believe we have changed a lot. Nowadays, the organization is more oriented to results. Also, we all have understood the need to balance the focus on short-term results with efforts to gradually change our capabilities and attitudes. Finally, I would highlight the fact that the organization has advanced significantly in its customer orientation and has also become really conscious of efficiency—critical requirements for our current and future success.
The Quarterly: You moved to another stage of the transformation after four years. Why?
Julio Linares: We had made small changes to the program every year as we launched each new wave. After four years, however, we thought that people were a little tired of the program. We believed that it was necessary to push further and to relaunch the program with more vigor and energy.
At the same time, we believed that this was a good moment to celebrate the results of the program so far and to recognize that it had been very good for the company, that we had reached many of the objectives we set forth at the beginning, and that we had made progress in the transformation.
But it was also necessary to recognize that a changing market and different conditions made it necessary to give more energy to the program. This was a difficult message to combine with the message of celebration, because you are in effect telling people that they have been working hard and that the program has been successful, but now they need to change how they work. Communicating this message needs to be done carefully if it is to be done well.
The Quarterly: So you needed to reinvigorate the program?
Julio Linares: Yes, summing up I would say that three things—the fact that people were a little tired with the program, that we needed to emphasize new things such as novel capabilities, and that more energy was required—made us make the decision to move into a new episode of our transformation. By this, I mean a set of new initiatives, also organized in waves, that will emphasize new change topics, such as integrated solutions for customers.
The Quarterly: So you have created a culture where people expect change every year?
Julio Linares: I see the process as something that will not end, ever. Because I don't think the market is going to stop changing. The market is going to change constantly, and because of that you need to make a constant effort to adapt your company to the market. Of course, some parts of the program will end, but new ones will come up. It's a never-ending journey.
About the Authors
Josep Isern is a director in McKinsey's Madrid office, and Julie Shearn is an associate principal in the London office.
BA/BM-Leading change: An interview with the CEO of P&G -McKinsey Q
The following information is used for educational purposes only.
Leading change: An interview with the CEO of P&G
Alan G. Lafley discusses how to stretch a company's aspirations without overpromising. Second in a series of interviews with leading executives on change management.
JULY 2005 • Rajat Gupta and Jim Wendler
Outrageously high targets for revenues, earnings, and market share; a bold vision based on a striking new business model or groundbreaking technology; major strategic moves, such as acquisitions or partnerships, that change the game in an industry; a new CEO, freshly arrived from the outside and committed to shaking things up. Such shocks to the corporate system are widely assumed to be necessary for transforming a company's performance.
Yet Alan G. Lafley's first five years as CEO of P&G show that none of these things is strictly necessary for achieving this sort of change. A large global company that has stumbled and lost some of its confidence can be led to new levels of performance through a more subtle form of leadership exercised by a long-term insider. Lafley's experience sheds particular light on two of the biggest challenges facing CEOs in this situation: the pace of change and the need for 'stretch' aspirations.
Lafley recalls vividly the market's initial disappointment when he took the helm, in June 2000. "I remember being in the basement of the television studio here in Cincinnati at 6 PM on the day [my appointment] was announced. I was the deer in the headlights, being grilled about the company and about why it was doing so badly. And the stock price had gone down a few bucks that day because I was a total unknown." The appointment of a prominent outsider, such as Robert Nardelli of Home Depot or James McNerney of 3M, might have pushed up the company's shares because the market assumed that an insider wouldn't drive the level of change required. Under his predecessor, the hard-driving insider Durk Jager, the company had issued three profit warnings in four months. On one momentous day, its shares fell by a full 30 percent. No wonder investors thought a more dramatic gesture was needed.
Five years later, the markets are looking at Lafley and P&G very differently. From fiscal years 2000 to 2004, the giant company's profits jumped by almost 70 percent, to $9.8 billion, and revenues increased by almost 30 percent, to $51 billion. Investors have embraced P&G's future thanks to new products ranging from Swiffer (a sweeper offering for hard floor surfaces) to Actonel (a prescription medication for osteoporosis), as well as innovations in a wide range of established brands. Lafley's announcement of the $54 billion acquisition of Gillette, in January 2005—by far the largest in P&G's history—has been well received by investors and analysts, who are generally skeptical about major deals.
Executing with excellence
The full story of P&G's turnaround is packed with complex, interlocking decisions about brands, personnel, technology, markets, facilities, and much else. One of the strongest patterns is Lafley's approach to raising aspirations: he agrees with Lou Gerstner that strategic visions can be a distraction, so he has never offered one. Lafley also seconds Lawrence Bossidy's belief that companies should aim to achieve great execution but insists that the real challenge is to "unpack" this idea. "Bossidy's right—in the end, it's about executing with excellence. But you can exhort all you want about excellent execution; you're not going to get it unless you have disciplined strategic choices, a structure that supports the strategy, systems that enable large organizations to work and execute together, a winning culture, and leadership that's inspirational. If you have all that, you'll get excellent execution."
Lafley emphasizes the key difference between a true transformation and incremental business building by describing the role he played during his first 15 years with the company: "That wasn't transformation. No, the game then was: take another half a share point and another half a margin point, build to a 50 percent market share, and take 85 percent of the profits and returns that are outsized in that industry. It was very much like classical military strategy, where you just keep putting on pressure, you just keep extending the lines, you just keep rolling up the weakest competitors, and so on."
Over time, however, the desire to compete in this way can erode into complacency, which Lafley has consciously tried to avoid. "You can get used to being a player without being a winner. There's a big difference between the two. So I became interested in transforming players into winners." Once a company's culture has changed so much that being a mere player is acceptable, Lafley argues, the culture must be transformed. At that stage, just trying to improve the numbers isn't enough. Deeper change is required.
Sometimes the need for a change is obvious from a company's competitive position. Lafley recalls his years heading P&G's Asian operations: "We were the last into Asia. We were a small player there in comparison with Unilever, which had been there at the time of the Raj, and Nestlé, which had been there since 1900." In such an environment, P&G had to transform its performance just to become a serious player. But in other parts of the company—such as beauty care, which Lafley ran during the year before he became CEO—P&G's performance, though lagging, was still thought to be respectable. Lafley set out to change that view.
Achievable aspirations
Lafley argues that although aspirations should stretch a company, it is counterproductive to overpromise. "As a new CEO, I took P&G company goals down to 4 to 6 percent top-line growth, which still required us to innovate to the tune of one to two points of new sales growth a year," as well as some market share growth and, on average, a point of growth from acquisitions. "And then I committed to stretching but achievable double-digit earnings-per-share growth." The share price went down again "because the first thing I did was to set lower, more realistic goals."
Nonetheless, these were indeed stretch goals, Lafley believes, because he had still publicly committed the company to growing faster than it had in recent years and faster than the industry as well. Moreover, he and his leadership team set internal goals higher than those announced externally.
Lafley reined in the company's aspirations in a second, more subtle way: he defined what he calls "the core"—core markets, categories, brands, technologies, and capabilities—and focused his near-term efforts entirely on that. P&G's markets and operations, he determined, were too vast and diverse to be turned around all at once. This decision meant, among other things, that only a fraction of the more than 100 countries where P&G operates would receive significant attention initially. "So we called out ten priority countries, and people said, 'Oh, I'm not on the list.' I just told them, 'Just keep doing a good job where you are.'"
While management literature has emphasized the necessity of defining the core, Lafley underscores the importance of actually communicating the definition clearly. Indeed, he says that the need to communicate at a Sesame Street level of simplicity was one of his most important discoveries as CEO:
"So if I'd stopped at 'We're going to refocus on the company's core businesses,' that wouldn't have been good enough. The core businesses are one, two, three, four. Fabric care, baby care, feminine care, and hair care. And then you get questions: 'Well, I'm in home care. Is that a core business?' 'No.' 'What does it have to do to become a core business?' 'It has to be global leader in its industry. It has to have the best structural economics in its industry. It has to be able to grow consistently at a certain rate. It has to be able to deliver a certain cash flow return on investment.' So then business leaders understand what it takes to become a core business."
Why is such excruciating repetition and clarity required? After all, as Lafley proudly notes, P&G attracts the best and brightest from the world's finest universities. One obvious reason is the sheer scale and diversity of the workforce. The company's 100,000 people come from more than 100 cultures, and for many of them English is a second language.
Another reason is the need to unclutter the thinking of employees so they can focus on the critical business of problem solving that Lafley can't do for them. "They have so many things going on in the operation of their daily businesses that they don't always take the time to stop, think, and internalize. They have to figure out what it all really means because I cannot call out the strategy for a business. I want them to use the same basic model and the same discipline to make the right choices for, say, the Philippines," where P&G has a half-billion-dollar business—a sizable operation but only 1 percent of the whole. "I want the manager there to think very consciously about what kind of culture is going to be a winner, what kind of capabilities are needed, and so on."
Coaching and coaxing
So Lafley insists that he can't babysit the businesses: to a large degree they must define their own future, while he plays the role of coach. But coaching at P&G doesn't mean coddling. On the contrary, Lafley demands that his managers take on the responsibility of making tough strategic choices. "Most human beings and most companies don't like to make choices. And they particularly don't like to make a few choices that they really have to live with. They argue, 'It's much better to have lots of options, right?'"
Those extraneous options have a way of reappearing on the table after they have been dismissed. Lafley therefore insists on a "not-do list" as an end product of the strategy process. "For example, when we chose our corporate-innovation programs, we cleared the deck of a lot of other stuff that we were then doing. So we'd have a list of all the things that we're not going to do. And if we caught people doing stuff that we said we were not going to do, we would pull the budget and the people and get them refocused on what we said we were going to do."
To help managers make these strategic choices, leaders must sometimes challenge deeply held assumptions. Lafley recalls a first meeting with his cosmetics managers in Japan after he took over Asian operations. He was known around the company for his work with the Tide brand, "so this guy said, 'You know, this is nothing like laundry detergent,' and smiled." Lafley spent much of the next month talking with consumers at sales counters and in their homes and then reported back to his team, "Do you know what I've learned after 30 days? Cosmetics is everything like laundry detergent! You need to know who your consumers are—intimately. You need to understand not just their habits and practices but their needs and wants, including those they can't articulate. Then you've got to delight them with your brands and your products." Lafley was determined not to allow the mystique of cosmetics to prevent the team from adopting classic P&G practices that had built the company and were fully applicable. A significant result of this process was the decision to promote the SK-II skin care line, which became one of the company's most successful in recent years.
Act as a role model
Being a role model is of course especially important when a CEO makes tough demands on managers. P&G's managers expect Lafley not only to make the same kinds of strategic choices he requires of them but also to act consistently on those choices. Lafley therefore recognizes that he must be ready for moments of truth that can alert the organization to his own deep commitment to P&G's aspirations.
Such moments came early in Lafley's tenure. He had to decide whether to go ahead with strong marketing support for the launch of several new brands (Actonel and Torengos in the United States, and Iams in Europe). "Profit pressure was severe. We had just missed earnings two quarters in a row, and the new brands would need strong, sustained support because they were going up against market-leading competitors. But innovation is P&G's lifeblood, and the businesses believed in their products—all of which tested better than those of competitors— and in their brands. So we locked arms and we went ahead. When I look back now on those early weeks, it's clear that I had to make choices like these to convince P&G managers we were going to go for winning."
One of the classic problems facing any CEO during a turnaround is the possibility that managers and employees become so overwhelmed by the breadth of the changes facing them that they can't achieve any change at all. The organization freezes, as though in shock. Lafley, after all, had taken over a 163-year-old company that was accustomed to leadership in most of its markets and had been famous for its cultural pride and self-confidence. "Then all of a sudden," he notes, "all that had been shattered." Although this slump wasn't P&G's worst in living memory—that came in 1984–85, when the company's earnings dipped below those of the previous 12 months for the first time in many years—it was perceived by outsiders as the worst. "Because of the role of the press, it was a more public failure."
Yet Lafley realized that P&G, though struggling, was in better shape than press reports suggested. In particular, he recognized that the company's culture, far from being a hindrance, was an asset that could be leveraged in a transformation. So he reversed his predecessor's sharp critique of the culture and affirmed its competitive value in discussions with managers and employees across the company.
"I started with P&G values and said, 'Here's what's not going to change. This is our purpose: to improve the everyday lives of people around the world with P&G brands and products that deliver better performance, quality, and value. That's not going to change. The value system—integrity, trust, ownership, leadership, and a passion for service and winning: not going to change. The six guiding principles, respect for the individual, and so on: not going to change. OK, so here's the stuff that will change. Any business that doesn't have a strategy is going to develop one; any business that has a strategy that's not winning in the marketplace is either going to change its strategy or improve its execution.' And so on. So I was very clear about what was safe and what wasn't."
This reassurance, like the intensive coaching about strategic choice and its consequences, was certainly a positive factor. Both helped the company raise its sights again.
Keep innovating
Ultimately, aspirations are energizing only when they are grounded in new ideas that can help a company win in the marketplace. Successful transformations always have a strong content dimension—particularly, of course, at companies like P&G, where constant product innovation is a central element of strategy. Lafley, however, believed that the pendulum had swung too far toward technology during the heady new-economy years. At one point, the annual budget for "skunk works" technology—experimental projects outside the mainstream businesses—had reached $200 million. "We were spending more than tech companies were on this kind of stuff," he observes. Thus P&G, which business schools treated as the classic example of a company that builds all of its processes around consumer "pull," was now "pushing" technology into the market. This was certainly one way to develop new ideas, but not necessarily winning ideas.
Durk Jager had excited P&G people with these investments. Lafley describes that approach as "forward to the future," which he contrasts with his own "back to the future" mind-set: "I wanted to put consumers front and center and get back to asking, 'Who are they and what do they want?' Find out what they want and give it to them. Delight them with P&G products. So I have this incredibly simple saying: 'The consumer is the boss.' And there are two moments of truth—when consumers make their purchase decision, and when they use the product. If they're delighted at the second moment of truth, they'll repurchase our brands and hopefully begin to use our products regularly."
When Jager left the company, news accounts cited his global reorganization as a major contributor to his departure. Lafley, however, not only supported the reorganization but had also served on the team that designed it. Rather than abandon Jager's new organizational structure, Lafley used it to support his own theme of returning to a stronger consumer orientation. The new market-development operations were charged with winning the first moment of truth, the new global business units with winning the second. The new structure, says Lafley, then "had a simple reason for being," and another apparent liability became an asset for the transformation.
More generally, Lafley strongly credits Jager with moving P&G toward a more external focus. Jager had begun to promote what the company calls "connect and develop"—that is, the pursuit of more externally sourced innovation. Currently, 25 percent of new products and technologies come from outside the company, but Lafley wants to raise that to 50 percent, so that "half would come out of P&G labs and half would come through P&G labs, from the outside."
Lafley is pushing for more exposure to the outside world in other ways as well—for example, by establishing strong relationships with external designers, distributing product development around the world to increase what P&G calls "consumer sensing," and even bringing John Osher, who invented the Crest SpinBrush electric rotating toothbrush, inside the company for a period to help make it more innovative. All of these moves have increased the flow of new ideas.
That flow should surge again with P&G's acquisition of Gillette. Like most major deals, this one is intended to create value in a number of ways, including relatively straightforward cost efficiencies. Lafley has concrete ideas for strengthening Gillette's brands too. He believes that increased innovation will be the most significant factor in the longer run, though he concedes that it is difficult to predict, at this early stage, exactly what form innovation will take:
"My aspiration is that this deal will accelerate the growth and development of our company by a decade or two. It's clear that Gillette and P&G are two of the strongest innovators in consumer products. Gillette's a company, like us, built on innovation in their core businesses. So I'm hopeful that we'll learn a lot from each other. They're mechanical engineers, we're chemical engineers. I'm very hopeful that this combination will open up new businesses to us. If you put mechanical and chemical engineers together, they're going to see things that we don't see today, because our view of the world is bounded."
Lafley clearly has strong faith in the transformative power of learning—a faith evident not only in his aspirations for the Gillette deal but also in the coaching role he regularly assumes with managers. It is clear, as well, in his initiatives to expand P&G's formal management and leadership training: for example, he founded the company's college for general managers and teaches leadership.
His coaching role has also shown him the importance of his own learning experiences. The first months after Lafley's appointment as CEO were particularly difficult in this respect: although he had experience selling the full range of P&G products during his stint as leader of the North American market-development operation, he lacked a deep understanding of about half of the company's businesses. Some things he learned during this period were bracing: "I discovered that the cupboard was bare on the technology side in one business, that we didn't have the leadership we needed in another business, and that we didn't know what the strategy was going to be in a third business." He was learning, in effect, what was needed to coach the organization.
Although Lafley needed a period of crash learning as CEO despite his 25 years as a P&G operating manager, he credits his experience with giving him insights into ways of transforming the company. "You need to understand how to enroll a leadership team and then an organization, how to operationalize the strategy, how to get the accountability that you want all the way down the organization. The more deeply you understand something, the more willing you are to take risks and the more intelligent those risks are." His deep knowledge of the company, he says, "meant I knew how and when we could take risks and stretch ourselves to go for peak performance—without breaking down."
Does a radical change agent lie behind the cultural conservatism? Lafley paused at the "radical" label because, at least until the Gillette deal, the transformation had been the cumulative effect of a series of small, interlocking changes. No single dramatic event during the past five years defines the period, just as no evocative vision statement served as its road map. "I guess I'm a serial change agent," Lafley says.
About the Authors
Rajat Gupta is a director in McKinsey's Stamford office, and Jim Wendler is an alumnus of the London office and an adviser to the firm.
Leading change: An interview with the CEO of P&G
Alan G. Lafley discusses how to stretch a company's aspirations without overpromising. Second in a series of interviews with leading executives on change management.
JULY 2005 • Rajat Gupta and Jim Wendler
Outrageously high targets for revenues, earnings, and market share; a bold vision based on a striking new business model or groundbreaking technology; major strategic moves, such as acquisitions or partnerships, that change the game in an industry; a new CEO, freshly arrived from the outside and committed to shaking things up. Such shocks to the corporate system are widely assumed to be necessary for transforming a company's performance.
Yet Alan G. Lafley's first five years as CEO of P&G show that none of these things is strictly necessary for achieving this sort of change. A large global company that has stumbled and lost some of its confidence can be led to new levels of performance through a more subtle form of leadership exercised by a long-term insider. Lafley's experience sheds particular light on two of the biggest challenges facing CEOs in this situation: the pace of change and the need for 'stretch' aspirations.
Lafley recalls vividly the market's initial disappointment when he took the helm, in June 2000. "I remember being in the basement of the television studio here in Cincinnati at 6 PM on the day [my appointment] was announced. I was the deer in the headlights, being grilled about the company and about why it was doing so badly. And the stock price had gone down a few bucks that day because I was a total unknown." The appointment of a prominent outsider, such as Robert Nardelli of Home Depot or James McNerney of 3M, might have pushed up the company's shares because the market assumed that an insider wouldn't drive the level of change required. Under his predecessor, the hard-driving insider Durk Jager, the company had issued three profit warnings in four months. On one momentous day, its shares fell by a full 30 percent. No wonder investors thought a more dramatic gesture was needed.
Five years later, the markets are looking at Lafley and P&G very differently. From fiscal years 2000 to 2004, the giant company's profits jumped by almost 70 percent, to $9.8 billion, and revenues increased by almost 30 percent, to $51 billion. Investors have embraced P&G's future thanks to new products ranging from Swiffer (a sweeper offering for hard floor surfaces) to Actonel (a prescription medication for osteoporosis), as well as innovations in a wide range of established brands. Lafley's announcement of the $54 billion acquisition of Gillette, in January 2005—by far the largest in P&G's history—has been well received by investors and analysts, who are generally skeptical about major deals.
Executing with excellence
The full story of P&G's turnaround is packed with complex, interlocking decisions about brands, personnel, technology, markets, facilities, and much else. One of the strongest patterns is Lafley's approach to raising aspirations: he agrees with Lou Gerstner that strategic visions can be a distraction, so he has never offered one. Lafley also seconds Lawrence Bossidy's belief that companies should aim to achieve great execution but insists that the real challenge is to "unpack" this idea. "Bossidy's right—in the end, it's about executing with excellence. But you can exhort all you want about excellent execution; you're not going to get it unless you have disciplined strategic choices, a structure that supports the strategy, systems that enable large organizations to work and execute together, a winning culture, and leadership that's inspirational. If you have all that, you'll get excellent execution."
Lafley emphasizes the key difference between a true transformation and incremental business building by describing the role he played during his first 15 years with the company: "That wasn't transformation. No, the game then was: take another half a share point and another half a margin point, build to a 50 percent market share, and take 85 percent of the profits and returns that are outsized in that industry. It was very much like classical military strategy, where you just keep putting on pressure, you just keep extending the lines, you just keep rolling up the weakest competitors, and so on."
Over time, however, the desire to compete in this way can erode into complacency, which Lafley has consciously tried to avoid. "You can get used to being a player without being a winner. There's a big difference between the two. So I became interested in transforming players into winners." Once a company's culture has changed so much that being a mere player is acceptable, Lafley argues, the culture must be transformed. At that stage, just trying to improve the numbers isn't enough. Deeper change is required.
Sometimes the need for a change is obvious from a company's competitive position. Lafley recalls his years heading P&G's Asian operations: "We were the last into Asia. We were a small player there in comparison with Unilever, which had been there at the time of the Raj, and Nestlé, which had been there since 1900." In such an environment, P&G had to transform its performance just to become a serious player. But in other parts of the company—such as beauty care, which Lafley ran during the year before he became CEO—P&G's performance, though lagging, was still thought to be respectable. Lafley set out to change that view.
Achievable aspirations
Lafley argues that although aspirations should stretch a company, it is counterproductive to overpromise. "As a new CEO, I took P&G company goals down to 4 to 6 percent top-line growth, which still required us to innovate to the tune of one to two points of new sales growth a year," as well as some market share growth and, on average, a point of growth from acquisitions. "And then I committed to stretching but achievable double-digit earnings-per-share growth." The share price went down again "because the first thing I did was to set lower, more realistic goals."
Nonetheless, these were indeed stretch goals, Lafley believes, because he had still publicly committed the company to growing faster than it had in recent years and faster than the industry as well. Moreover, he and his leadership team set internal goals higher than those announced externally.
Lafley reined in the company's aspirations in a second, more subtle way: he defined what he calls "the core"—core markets, categories, brands, technologies, and capabilities—and focused his near-term efforts entirely on that. P&G's markets and operations, he determined, were too vast and diverse to be turned around all at once. This decision meant, among other things, that only a fraction of the more than 100 countries where P&G operates would receive significant attention initially. "So we called out ten priority countries, and people said, 'Oh, I'm not on the list.' I just told them, 'Just keep doing a good job where you are.'"
While management literature has emphasized the necessity of defining the core, Lafley underscores the importance of actually communicating the definition clearly. Indeed, he says that the need to communicate at a Sesame Street level of simplicity was one of his most important discoveries as CEO:
"So if I'd stopped at 'We're going to refocus on the company's core businesses,' that wouldn't have been good enough. The core businesses are one, two, three, four. Fabric care, baby care, feminine care, and hair care. And then you get questions: 'Well, I'm in home care. Is that a core business?' 'No.' 'What does it have to do to become a core business?' 'It has to be global leader in its industry. It has to have the best structural economics in its industry. It has to be able to grow consistently at a certain rate. It has to be able to deliver a certain cash flow return on investment.' So then business leaders understand what it takes to become a core business."
Why is such excruciating repetition and clarity required? After all, as Lafley proudly notes, P&G attracts the best and brightest from the world's finest universities. One obvious reason is the sheer scale and diversity of the workforce. The company's 100,000 people come from more than 100 cultures, and for many of them English is a second language.
Another reason is the need to unclutter the thinking of employees so they can focus on the critical business of problem solving that Lafley can't do for them. "They have so many things going on in the operation of their daily businesses that they don't always take the time to stop, think, and internalize. They have to figure out what it all really means because I cannot call out the strategy for a business. I want them to use the same basic model and the same discipline to make the right choices for, say, the Philippines," where P&G has a half-billion-dollar business—a sizable operation but only 1 percent of the whole. "I want the manager there to think very consciously about what kind of culture is going to be a winner, what kind of capabilities are needed, and so on."
Coaching and coaxing
So Lafley insists that he can't babysit the businesses: to a large degree they must define their own future, while he plays the role of coach. But coaching at P&G doesn't mean coddling. On the contrary, Lafley demands that his managers take on the responsibility of making tough strategic choices. "Most human beings and most companies don't like to make choices. And they particularly don't like to make a few choices that they really have to live with. They argue, 'It's much better to have lots of options, right?'"
Those extraneous options have a way of reappearing on the table after they have been dismissed. Lafley therefore insists on a "not-do list" as an end product of the strategy process. "For example, when we chose our corporate-innovation programs, we cleared the deck of a lot of other stuff that we were then doing. So we'd have a list of all the things that we're not going to do. And if we caught people doing stuff that we said we were not going to do, we would pull the budget and the people and get them refocused on what we said we were going to do."
To help managers make these strategic choices, leaders must sometimes challenge deeply held assumptions. Lafley recalls a first meeting with his cosmetics managers in Japan after he took over Asian operations. He was known around the company for his work with the Tide brand, "so this guy said, 'You know, this is nothing like laundry detergent,' and smiled." Lafley spent much of the next month talking with consumers at sales counters and in their homes and then reported back to his team, "Do you know what I've learned after 30 days? Cosmetics is everything like laundry detergent! You need to know who your consumers are—intimately. You need to understand not just their habits and practices but their needs and wants, including those they can't articulate. Then you've got to delight them with your brands and your products." Lafley was determined not to allow the mystique of cosmetics to prevent the team from adopting classic P&G practices that had built the company and were fully applicable. A significant result of this process was the decision to promote the SK-II skin care line, which became one of the company's most successful in recent years.
Act as a role model
Being a role model is of course especially important when a CEO makes tough demands on managers. P&G's managers expect Lafley not only to make the same kinds of strategic choices he requires of them but also to act consistently on those choices. Lafley therefore recognizes that he must be ready for moments of truth that can alert the organization to his own deep commitment to P&G's aspirations.
Such moments came early in Lafley's tenure. He had to decide whether to go ahead with strong marketing support for the launch of several new brands (Actonel and Torengos in the United States, and Iams in Europe). "Profit pressure was severe. We had just missed earnings two quarters in a row, and the new brands would need strong, sustained support because they were going up against market-leading competitors. But innovation is P&G's lifeblood, and the businesses believed in their products—all of which tested better than those of competitors— and in their brands. So we locked arms and we went ahead. When I look back now on those early weeks, it's clear that I had to make choices like these to convince P&G managers we were going to go for winning."
One of the classic problems facing any CEO during a turnaround is the possibility that managers and employees become so overwhelmed by the breadth of the changes facing them that they can't achieve any change at all. The organization freezes, as though in shock. Lafley, after all, had taken over a 163-year-old company that was accustomed to leadership in most of its markets and had been famous for its cultural pride and self-confidence. "Then all of a sudden," he notes, "all that had been shattered." Although this slump wasn't P&G's worst in living memory—that came in 1984–85, when the company's earnings dipped below those of the previous 12 months for the first time in many years—it was perceived by outsiders as the worst. "Because of the role of the press, it was a more public failure."
Yet Lafley realized that P&G, though struggling, was in better shape than press reports suggested. In particular, he recognized that the company's culture, far from being a hindrance, was an asset that could be leveraged in a transformation. So he reversed his predecessor's sharp critique of the culture and affirmed its competitive value in discussions with managers and employees across the company.
"I started with P&G values and said, 'Here's what's not going to change. This is our purpose: to improve the everyday lives of people around the world with P&G brands and products that deliver better performance, quality, and value. That's not going to change. The value system—integrity, trust, ownership, leadership, and a passion for service and winning: not going to change. The six guiding principles, respect for the individual, and so on: not going to change. OK, so here's the stuff that will change. Any business that doesn't have a strategy is going to develop one; any business that has a strategy that's not winning in the marketplace is either going to change its strategy or improve its execution.' And so on. So I was very clear about what was safe and what wasn't."
This reassurance, like the intensive coaching about strategic choice and its consequences, was certainly a positive factor. Both helped the company raise its sights again.
Keep innovating
Ultimately, aspirations are energizing only when they are grounded in new ideas that can help a company win in the marketplace. Successful transformations always have a strong content dimension—particularly, of course, at companies like P&G, where constant product innovation is a central element of strategy. Lafley, however, believed that the pendulum had swung too far toward technology during the heady new-economy years. At one point, the annual budget for "skunk works" technology—experimental projects outside the mainstream businesses—had reached $200 million. "We were spending more than tech companies were on this kind of stuff," he observes. Thus P&G, which business schools treated as the classic example of a company that builds all of its processes around consumer "pull," was now "pushing" technology into the market. This was certainly one way to develop new ideas, but not necessarily winning ideas.
Durk Jager had excited P&G people with these investments. Lafley describes that approach as "forward to the future," which he contrasts with his own "back to the future" mind-set: "I wanted to put consumers front and center and get back to asking, 'Who are they and what do they want?' Find out what they want and give it to them. Delight them with P&G products. So I have this incredibly simple saying: 'The consumer is the boss.' And there are two moments of truth—when consumers make their purchase decision, and when they use the product. If they're delighted at the second moment of truth, they'll repurchase our brands and hopefully begin to use our products regularly."
When Jager left the company, news accounts cited his global reorganization as a major contributor to his departure. Lafley, however, not only supported the reorganization but had also served on the team that designed it. Rather than abandon Jager's new organizational structure, Lafley used it to support his own theme of returning to a stronger consumer orientation. The new market-development operations were charged with winning the first moment of truth, the new global business units with winning the second. The new structure, says Lafley, then "had a simple reason for being," and another apparent liability became an asset for the transformation.
More generally, Lafley strongly credits Jager with moving P&G toward a more external focus. Jager had begun to promote what the company calls "connect and develop"—that is, the pursuit of more externally sourced innovation. Currently, 25 percent of new products and technologies come from outside the company, but Lafley wants to raise that to 50 percent, so that "half would come out of P&G labs and half would come through P&G labs, from the outside."
Lafley is pushing for more exposure to the outside world in other ways as well—for example, by establishing strong relationships with external designers, distributing product development around the world to increase what P&G calls "consumer sensing," and even bringing John Osher, who invented the Crest SpinBrush electric rotating toothbrush, inside the company for a period to help make it more innovative. All of these moves have increased the flow of new ideas.
That flow should surge again with P&G's acquisition of Gillette. Like most major deals, this one is intended to create value in a number of ways, including relatively straightforward cost efficiencies. Lafley has concrete ideas for strengthening Gillette's brands too. He believes that increased innovation will be the most significant factor in the longer run, though he concedes that it is difficult to predict, at this early stage, exactly what form innovation will take:
"My aspiration is that this deal will accelerate the growth and development of our company by a decade or two. It's clear that Gillette and P&G are two of the strongest innovators in consumer products. Gillette's a company, like us, built on innovation in their core businesses. So I'm hopeful that we'll learn a lot from each other. They're mechanical engineers, we're chemical engineers. I'm very hopeful that this combination will open up new businesses to us. If you put mechanical and chemical engineers together, they're going to see things that we don't see today, because our view of the world is bounded."
Lafley clearly has strong faith in the transformative power of learning—a faith evident not only in his aspirations for the Gillette deal but also in the coaching role he regularly assumes with managers. It is clear, as well, in his initiatives to expand P&G's formal management and leadership training: for example, he founded the company's college for general managers and teaches leadership.
His coaching role has also shown him the importance of his own learning experiences. The first months after Lafley's appointment as CEO were particularly difficult in this respect: although he had experience selling the full range of P&G products during his stint as leader of the North American market-development operation, he lacked a deep understanding of about half of the company's businesses. Some things he learned during this period were bracing: "I discovered that the cupboard was bare on the technology side in one business, that we didn't have the leadership we needed in another business, and that we didn't know what the strategy was going to be in a third business." He was learning, in effect, what was needed to coach the organization.
Although Lafley needed a period of crash learning as CEO despite his 25 years as a P&G operating manager, he credits his experience with giving him insights into ways of transforming the company. "You need to understand how to enroll a leadership team and then an organization, how to operationalize the strategy, how to get the accountability that you want all the way down the organization. The more deeply you understand something, the more willing you are to take risks and the more intelligent those risks are." His deep knowledge of the company, he says, "meant I knew how and when we could take risks and stretch ourselves to go for peak performance—without breaking down."
Does a radical change agent lie behind the cultural conservatism? Lafley paused at the "radical" label because, at least until the Gillette deal, the transformation had been the cumulative effect of a series of small, interlocking changes. No single dramatic event during the past five years defines the period, just as no evocative vision statement served as its road map. "I guess I'm a serial change agent," Lafley says.
About the Authors
Rajat Gupta is a director in McKinsey's Stamford office, and Jim Wendler is an alumnus of the London office and an adviser to the firm.
BA/BM-The CEO’s role in leading transformation -McKinsey Quarterly
The following information is used for educational purposes only.
The CEO’s role in leading transformation
The CEO helps a transformation succeed by communicating its significance, modeling the desired changes, building a strong top team, and getting personally involved.
FEBRUARY 2007 • Carolyn B. Aiken and Scott P. Keller
In today’s business environment, companies cannot settle for incremental improvement; they must periodically undergo performance transformations to get, and stay, on top. But in the volumes of pages on how to go about implementing a transformation, surprisingly little addresses the role of one important person. What exactly should the CEO be doing, and how different is this role from that of the executive team or the initiative’s sponsors?
Based on a series of interviews we have conducted with nearly a dozen executives over the last couple of years—as well as our own experience working with companies—we believe there is no single model for success. Moreover, the exact nature of the CEO’s role will be influenced by the magnitude, urgency, and nature of the transformation; the capabilities and failings of the organization; and the personal style of the leader.
Despite these variations, our experience with scores of major transformation efforts, combined with research we have undertaken over the past decade, suggests that four key functions collectively define a successful role for the CEO in a transformation:
1.Making the transformation meaningful. People will go to extraordinary lengths for causes they believe in, and a powerful transformation story will create and reinforce their commitment. The ultimate impact of the story depends on the CEO’s willingness to make the transformation personal, to engage others openly, and to spotlight successes as they emerge.
2.Role-modeling desired mind-sets and behavior. Successful CEOs typically embark on their own personal transformation journey. Their actions encourage employees to support and practice the new types of behavior.
3.Building a strong and committed top team. To harness the transformative power of the top team, CEOs must make tough decisions about who has the ability and motivation to make the journey.
4.Relentlessly pursuing impact. There is no substitute for CEOs rolling up their sleeves and getting personally involved when significant financial and symbolic value is at stake.
Everyone has a role to play in a performance transformation. The role of CEOs is unique in that they stand at the top of the pyramid and all the other members of the organization take cues from them. CEOs who give only lip service to a transformation will find everyone else doing the same. Those who fail to model the desired mind-sets and behavior or who opt out of vital initiatives risk seeing the transformation lose focus. Only the boss of all bosses can ensure that the right people spend the right amount of time driving the necessary changes.
Making the transformation meaningful
Transformations require extraordinary energy: employees must fundamentally rethink and reshape the business while continuing to run it day to day. Where does this energy come from? A powerful transformation story helps employees believe in the effort by answering their big questions, which can range from how the transformation will affect the company down to how it will affect them. The story’s ultimate impact will depend on not just having compelling answers to these questions but also the CEO’s willingness and ability to make things personal, to engage others openly, and to spotlight successes as they emerge.
Adopt a personal approach
CEOs who take time to personalize the story of the transformation can unlock significantly more energy for it than those who dutifully present the PowerPoint slides that their working teams created for them. Personalizing the story forces CEOs to consider and share with others the answers to such questions as “Why are we changing?”; “How will we get there?”; and “How does this relate to me?”
Some leaders include experiences and anecdotes from their own lives to underline their determination and belief—and to demonstrate that obstacles can be overcome. Klaus Zumwinkel, the chairman and CEO of Deutsche Post, talked about his passion for mountain climbing, linking the experience of that sport and the effort it requires to the company’s transformation journey. In "Leading change: An interview with the CEO of Banca Intesa," Corrado Passera kicked off the communication effort by composing a short story, “written in human language,” about the transformation. In "Recovering from crisis: An interview with the CEO of McKesson," John Hammergren stressed the fact that every employee was or would be a patient in the health care system and that this “larger purpose” made a difference. “Had we been in the ball-bearing business, I’m not sure it would have been as easy to personalize it,” he acknowledges.
Openly engage others
When a CEO’s version of the transformation story is clear, success comes from taking it to employees, encouraging debate about it, reinforcing it, and prompting people to infuse it with their own personal meaning. Most CEOs invest great effort in visibly and vocally presenting the transformation story. In "Leading change: An interview with the executive chairman of Telefónica de España," Julio Linares says that, for him, the most important and hardest part of the transformation was “to convince people of the need for the program.” N. R. Narayana Murthy, chairman of the board and former chief executive of India’s Infosys, agrees and says, “The first responsibility of a leader is to create mental energy among people so that they enthusiastically embrace the transformation.” His view matches the experience of Banca Intesa’s Passera, who spearheaded communication efforts to get the story out to 60,000 employees by traveling the length and breadth of Italy. Passera says, “It is a long process, but you have to put your face in front of the people if you want them to follow you.”
Once the story is out, the CEO’s role becomes one of constant reinforcement. As P&G CEO Alan G. Lafley says, in "Leading change: An interview with the CEO of P&G," “Excruciating repetition and clarity are important—employees have so many things going on in the operation of their daily business that they don’t always take the time to stop, think, and internalize.” Paolo Scaroni, who has led three public companies through various chapters of change, likes to find three or four strategic concepts that sum up the right direction for the company and then to “repeat, repeat, and repeat them throughout the organization.”
‘Sharing success stories helps crystallize the meaning of the transformation and gives people confidence that it will actually work’
Reinforcement should come from outside as well. Passera notes, “If everyone keeps reading in the newspapers that the business is still a poor performer, not contributing to society, or is letting the country down, people will not believe you.”
Spotlight success
As the company’s transformation progresses, a powerful way to reinforce the story is to spotlight the successes. Sharing such stories helps crystallize the meaning of the transformation and gives people confidence that it will actually work. Murthy of Infosys describes how high-performing teams were invited to make presentations to larger audiences drawn from across the company, “to show other people that we value such behavior.”
Ravi Kant, the managing director of the integrated Indian auto business Tata Motors, deliberately identified people who would serve as examples to others. In "Leading change: An interview with the managing director of Tata Motors," he talks about how he highlighted the achievements of one young man whose success on a risky project and subsequent promotion showed colleagues that talented and determined people can rise through the hierarchy.
Emphasizing the positive, behavioral research shows, is especially important. In 1982, University of Wisconsin researchers who were conducting a study of the adult-learning process videotaped two bowling teams during several games. The members of each team then studied their efforts on video to improve their skills. But the two videos had been edited differently. One team received a video showing only its mistakes; the other team’s video, by contrast, showed only the good performances. After studying the videos, both teams improved their game, but the team that studied its successes improved its score twice as much as the one that studied its mistakes. Evidently, focusing on the errors can generate feelings of fatigue, blame, and resistance. Emphasizing what works well and discussing how to get more out of those strengths taps into creativity, passion, and the desire to succeed.
Role-modeling desired mind-sets and behavior
Whether leaders realize it or not, they seem to be in front of the cameras when they speak or act. “Every move you make, everything you say, is visible to all. Therefore the best approach is to lead by example,” advises Joseph M. Tucci, CEO of EMC, the US-based information storage equipment business, in "Leading change: An interview with the CEO of EMC." Ultimately, employees will weigh the actions of their CEO to determine whether they believe in the story.
Transform yourself
Employees expect the CEO to live up to Mahatma Gandhi’s famous edict, “For things to change, first I must change.” The CEO is the organization’s chief role model.
Typically, a personal transformation journey involves 360-degree feedback on leadership behavior specific to the program’s objectives, diary analysis to reveal how time is spent on transformation priorities, a commitment to a short list of personal transformation objectives, and professional coaching toward these ends. CEOs generally report that the process is most powerful when all members of an executive team pursue their transformation journeys individually but collectively discuss and reinforce their personal objectives in order to create an environment “of challenge and support.
Murthy’s 2002 decision to take on the job title of chief mentor at Infosys, for example, meant that he had to reinvent himself, because he laid aside his formal managerial (CEO) authority at the same time. He explains, “You have to sacrifice yourself first for a big cause before you can ask others to do the same,” adding, “A good leader knows how to retreat into the background gracefully while encouraging his successor to become more and more successful in the job.”
Take symbolic action
The quickest way to send shock waves through an organization is to conceive and execute a series of symbolic acts signaling to employees that they should behave in ways appropriate to a transformation and support these types of behavior in others. For instance, C. John Wilder, CEO of the Texas energy utility TXU, gave a large bonus to a woman who had taken a clear leadership role in a very important business initiative. “This leader’s contributions generated real economic value to the bottom line,” he explains. “Of course, news of that raced through the whole organization, but it helped employees understand that rewards will be based on contributions and that 'pay for performance’ could actually be put into practice.”
Building a strong and committed top team
The CEO’s team can and should be a valuable asset in leading any transformation. As Deutsche Post’s Zumwinkel suggests, “You need excellent individual players, but you also need players who are dedicated to playing as a team.” Sharing a meaningful story and modeling the right role will certainly increase the odds of getting the team on board, but it is also vital to invest time in building that team.
Assess and act
Successful CEOs take time to assess the abilities of individual members of the team and act swiftly on the result. In some cases, input from third parties (such as executive search firms) is sought to create a more objective fact base. Many CEOs find it useful to map team members on a matrix, with “business performance” on one axis and “role-modeling the desired behavior” on the other. Those in the top-right box (desired behavior, high performance) are the organization’s stars, and those in the bottom-left box (undesired behavior, low performance) should be motivated, developed, or dismissed. The greatest potential for sending signals involves the employees in the box of “undesired behavior, high performance.” When clear action is taken to improve or remove these managers, the team’s members know that role-modeling and teamwork matter. Banca Intesa’s Passera affirms that, “If necessary, you have to get rid of those individuals, even the talented ones, who quarrel and cannot work together.”
How do CEOs know when to intervene with the strugglers? They can reflect on the following questions:
•Do team members clearly understand what is expected of each of them in relation to the transformation?
•Is the CEO serving as a positive role model?
•Does everyone recognize the downside and upside of getting on board and doing what is required?
•Have struggling team members received a chance to build the needed skills?
If the answer to all of these questions is yes, decisive action is justified.
Experienced CEOs attest to the positive impact this can have on the rest of the company. EMC’s Tucci says he had to take “public” action to tackle the “whiff of arrogance” that used to characterize certain parts of the company. TXU’s Wilder recalls that “When we did a cultural audit, we found that the number-one complaint was that management was not dealing with employees that everyone knew weren’t carrying their load.“
Invest team time
Even with the right team in place, it takes time for a group of highly intelligent, ambitious, and independent people to align themselves in a clear direction. Typically, the first order of business is for members to agree on what they can achieve as a team (not as individuals), how often the team should meet, what transformation issues should be discussed, and what behavior the team expects (and won’t tolerate). These agreements are often summarized in a “team charter” for leading the transformation, and the CEO can periodically use the charter to ensure that the team is on the right track.
Intesa’s Passera speaks of how he brought his team together regularly to “share almost everything,” to make it “clear to everyone who is doing what,” and to “keep the transformation initiatives, budgets, and financial targets knitted together.” P&G’s Lafley emphasizes the importance of spending the time together wisely: “You need to understand how to enroll the leadership team.” As a rule of thumb, 80 percent of the team’s time should be devoted to dialogue, with the remaining 20 percent invested in being “presented to.”
Effective dialogue requires a well-structured agenda, which typically ensures that ample time is spent in personal reflection (to ensure that each person forms an independent point of view from the outset), discussion in pairs or small groups (refining the thinking and exploring second- and third-level assumptions), and discussion by the full team before final decisions are made. In this process, little tolerance should be shown for minutiae (losing the forest for the trees) and for any lack of engagement. Face-to-face meetings, as opposed to conference calls, greatly enhance the effectiveness of team dialogue.
Relentlessly pursuing impact
Organizational energy—collective motivation, enthusiasm, and intense commitment—is a crucial ingredient of a successful transformation. There is no substitute for a CEO directing his or her personal energy toward ensuring that the company’s efforts have an impact.
Roll up your sleeves
Initiatives with a significant financial or symbolic value require the CEO’s personal involvement for maximum impact. There may be several beneficial effects, among them ensuring that important decisions are made quickly—without sacrificing the value of collective debate—and sowing the seeds of a culture of candor and decisiveness.
Leaders must be willing to leave the executive suite and help resolve difficult operational issues. Peter Gossas, president of Sandvik Materials Technology and a man with lifelong experience in the steel industry, observes, “If there’s a problem, it can be helpful if I come to the work floor, step up on a crate so that everyone can see me, and hold a discussion with a shift unit that may be negative to change.” He adds, “It’s hard for me to walk into a melt shop and not begin discussing ways to solve operational problems.”
Hold leaders accountable
Successful CEOs never lose sight of their management responsibility to chair review forums. Through these, they compare the results of the transformation program with the original plan, identify the root causes of any deviations, celebrate successes, help fix problems, and hold leaders accountable for keeping the transformation on track, both in activities (are people doing what they said they would?) and impact (will the program create the value we anticipated?). A central role for the CEO during these review forums is to ensure that decision making stays grounded in the facts. As Narayana Murthy wryly observes, “We have embraced the adage 'In God we trust; everyone else brings data to the table.’”
The CEO also plays a critical role in ensuring an appropriate balance between near-term profit initiatives (those that deliver performance today) and organizational-health initiatives (those that build the capacity to deliver tomorrow’s results). This is a lesson applied by John Varley, CEO of Barclays: “For several years, the focus on initiatives to improve financial performance dramatically crowded out attention on franchise health, leaving us with a set of issues in some businesses that needed urgent attention. We are addressing those issues.” During the transformation, some CEOs even choose to hold separate review meetings for short- and long-term objectives in order to ensure that companies maintain a balance between operational improvement (tactical strategies, wage management, productivity, and asset management) and long-term growth (revenue and volume growth through market share, new products, channels and marketing, M&A, talent, and capability management).
For CEOs leading a transformation, no single model guarantees success. But they can improve the odds by targeting leadership functions: making the transformation meaningful, modeling the desired mind-sets and behavior, building a strong and committed team, and relentlessly pursuing impact. Together, these can powerfully generate the energy needed to achieve a successful performance transformation.
About the Authors
Carolyn Aiken is a consultant in McKinsey’s Toronto office, and Scott Keller is a principal in the Chicago office.
The CEO’s role in leading transformation
The CEO helps a transformation succeed by communicating its significance, modeling the desired changes, building a strong top team, and getting personally involved.
FEBRUARY 2007 • Carolyn B. Aiken and Scott P. Keller
In today’s business environment, companies cannot settle for incremental improvement; they must periodically undergo performance transformations to get, and stay, on top. But in the volumes of pages on how to go about implementing a transformation, surprisingly little addresses the role of one important person. What exactly should the CEO be doing, and how different is this role from that of the executive team or the initiative’s sponsors?
Based on a series of interviews we have conducted with nearly a dozen executives over the last couple of years—as well as our own experience working with companies—we believe there is no single model for success. Moreover, the exact nature of the CEO’s role will be influenced by the magnitude, urgency, and nature of the transformation; the capabilities and failings of the organization; and the personal style of the leader.
Despite these variations, our experience with scores of major transformation efforts, combined with research we have undertaken over the past decade, suggests that four key functions collectively define a successful role for the CEO in a transformation:
1.Making the transformation meaningful. People will go to extraordinary lengths for causes they believe in, and a powerful transformation story will create and reinforce their commitment. The ultimate impact of the story depends on the CEO’s willingness to make the transformation personal, to engage others openly, and to spotlight successes as they emerge.
2.Role-modeling desired mind-sets and behavior. Successful CEOs typically embark on their own personal transformation journey. Their actions encourage employees to support and practice the new types of behavior.
3.Building a strong and committed top team. To harness the transformative power of the top team, CEOs must make tough decisions about who has the ability and motivation to make the journey.
4.Relentlessly pursuing impact. There is no substitute for CEOs rolling up their sleeves and getting personally involved when significant financial and symbolic value is at stake.
Everyone has a role to play in a performance transformation. The role of CEOs is unique in that they stand at the top of the pyramid and all the other members of the organization take cues from them. CEOs who give only lip service to a transformation will find everyone else doing the same. Those who fail to model the desired mind-sets and behavior or who opt out of vital initiatives risk seeing the transformation lose focus. Only the boss of all bosses can ensure that the right people spend the right amount of time driving the necessary changes.
Making the transformation meaningful
Transformations require extraordinary energy: employees must fundamentally rethink and reshape the business while continuing to run it day to day. Where does this energy come from? A powerful transformation story helps employees believe in the effort by answering their big questions, which can range from how the transformation will affect the company down to how it will affect them. The story’s ultimate impact will depend on not just having compelling answers to these questions but also the CEO’s willingness and ability to make things personal, to engage others openly, and to spotlight successes as they emerge.
Adopt a personal approach
CEOs who take time to personalize the story of the transformation can unlock significantly more energy for it than those who dutifully present the PowerPoint slides that their working teams created for them. Personalizing the story forces CEOs to consider and share with others the answers to such questions as “Why are we changing?”; “How will we get there?”; and “How does this relate to me?”
Some leaders include experiences and anecdotes from their own lives to underline their determination and belief—and to demonstrate that obstacles can be overcome. Klaus Zumwinkel, the chairman and CEO of Deutsche Post, talked about his passion for mountain climbing, linking the experience of that sport and the effort it requires to the company’s transformation journey. In "Leading change: An interview with the CEO of Banca Intesa," Corrado Passera kicked off the communication effort by composing a short story, “written in human language,” about the transformation. In "Recovering from crisis: An interview with the CEO of McKesson," John Hammergren stressed the fact that every employee was or would be a patient in the health care system and that this “larger purpose” made a difference. “Had we been in the ball-bearing business, I’m not sure it would have been as easy to personalize it,” he acknowledges.
Openly engage others
When a CEO’s version of the transformation story is clear, success comes from taking it to employees, encouraging debate about it, reinforcing it, and prompting people to infuse it with their own personal meaning. Most CEOs invest great effort in visibly and vocally presenting the transformation story. In "Leading change: An interview with the executive chairman of Telefónica de España," Julio Linares says that, for him, the most important and hardest part of the transformation was “to convince people of the need for the program.” N. R. Narayana Murthy, chairman of the board and former chief executive of India’s Infosys, agrees and says, “The first responsibility of a leader is to create mental energy among people so that they enthusiastically embrace the transformation.” His view matches the experience of Banca Intesa’s Passera, who spearheaded communication efforts to get the story out to 60,000 employees by traveling the length and breadth of Italy. Passera says, “It is a long process, but you have to put your face in front of the people if you want them to follow you.”
Once the story is out, the CEO’s role becomes one of constant reinforcement. As P&G CEO Alan G. Lafley says, in "Leading change: An interview with the CEO of P&G," “Excruciating repetition and clarity are important—employees have so many things going on in the operation of their daily business that they don’t always take the time to stop, think, and internalize.” Paolo Scaroni, who has led three public companies through various chapters of change, likes to find three or four strategic concepts that sum up the right direction for the company and then to “repeat, repeat, and repeat them throughout the organization.”
‘Sharing success stories helps crystallize the meaning of the transformation and gives people confidence that it will actually work’
Reinforcement should come from outside as well. Passera notes, “If everyone keeps reading in the newspapers that the business is still a poor performer, not contributing to society, or is letting the country down, people will not believe you.”
Spotlight success
As the company’s transformation progresses, a powerful way to reinforce the story is to spotlight the successes. Sharing such stories helps crystallize the meaning of the transformation and gives people confidence that it will actually work. Murthy of Infosys describes how high-performing teams were invited to make presentations to larger audiences drawn from across the company, “to show other people that we value such behavior.”
Ravi Kant, the managing director of the integrated Indian auto business Tata Motors, deliberately identified people who would serve as examples to others. In "Leading change: An interview with the managing director of Tata Motors," he talks about how he highlighted the achievements of one young man whose success on a risky project and subsequent promotion showed colleagues that talented and determined people can rise through the hierarchy.
Emphasizing the positive, behavioral research shows, is especially important. In 1982, University of Wisconsin researchers who were conducting a study of the adult-learning process videotaped two bowling teams during several games. The members of each team then studied their efforts on video to improve their skills. But the two videos had been edited differently. One team received a video showing only its mistakes; the other team’s video, by contrast, showed only the good performances. After studying the videos, both teams improved their game, but the team that studied its successes improved its score twice as much as the one that studied its mistakes. Evidently, focusing on the errors can generate feelings of fatigue, blame, and resistance. Emphasizing what works well and discussing how to get more out of those strengths taps into creativity, passion, and the desire to succeed.
Role-modeling desired mind-sets and behavior
Whether leaders realize it or not, they seem to be in front of the cameras when they speak or act. “Every move you make, everything you say, is visible to all. Therefore the best approach is to lead by example,” advises Joseph M. Tucci, CEO of EMC, the US-based information storage equipment business, in "Leading change: An interview with the CEO of EMC." Ultimately, employees will weigh the actions of their CEO to determine whether they believe in the story.
Transform yourself
Employees expect the CEO to live up to Mahatma Gandhi’s famous edict, “For things to change, first I must change.” The CEO is the organization’s chief role model.
Typically, a personal transformation journey involves 360-degree feedback on leadership behavior specific to the program’s objectives, diary analysis to reveal how time is spent on transformation priorities, a commitment to a short list of personal transformation objectives, and professional coaching toward these ends. CEOs generally report that the process is most powerful when all members of an executive team pursue their transformation journeys individually but collectively discuss and reinforce their personal objectives in order to create an environment “of challenge and support.
Murthy’s 2002 decision to take on the job title of chief mentor at Infosys, for example, meant that he had to reinvent himself, because he laid aside his formal managerial (CEO) authority at the same time. He explains, “You have to sacrifice yourself first for a big cause before you can ask others to do the same,” adding, “A good leader knows how to retreat into the background gracefully while encouraging his successor to become more and more successful in the job.”
Take symbolic action
The quickest way to send shock waves through an organization is to conceive and execute a series of symbolic acts signaling to employees that they should behave in ways appropriate to a transformation and support these types of behavior in others. For instance, C. John Wilder, CEO of the Texas energy utility TXU, gave a large bonus to a woman who had taken a clear leadership role in a very important business initiative. “This leader’s contributions generated real economic value to the bottom line,” he explains. “Of course, news of that raced through the whole organization, but it helped employees understand that rewards will be based on contributions and that 'pay for performance’ could actually be put into practice.”
Building a strong and committed top team
The CEO’s team can and should be a valuable asset in leading any transformation. As Deutsche Post’s Zumwinkel suggests, “You need excellent individual players, but you also need players who are dedicated to playing as a team.” Sharing a meaningful story and modeling the right role will certainly increase the odds of getting the team on board, but it is also vital to invest time in building that team.
Assess and act
Successful CEOs take time to assess the abilities of individual members of the team and act swiftly on the result. In some cases, input from third parties (such as executive search firms) is sought to create a more objective fact base. Many CEOs find it useful to map team members on a matrix, with “business performance” on one axis and “role-modeling the desired behavior” on the other. Those in the top-right box (desired behavior, high performance) are the organization’s stars, and those in the bottom-left box (undesired behavior, low performance) should be motivated, developed, or dismissed. The greatest potential for sending signals involves the employees in the box of “undesired behavior, high performance.” When clear action is taken to improve or remove these managers, the team’s members know that role-modeling and teamwork matter. Banca Intesa’s Passera affirms that, “If necessary, you have to get rid of those individuals, even the talented ones, who quarrel and cannot work together.”
How do CEOs know when to intervene with the strugglers? They can reflect on the following questions:
•Do team members clearly understand what is expected of each of them in relation to the transformation?
•Is the CEO serving as a positive role model?
•Does everyone recognize the downside and upside of getting on board and doing what is required?
•Have struggling team members received a chance to build the needed skills?
If the answer to all of these questions is yes, decisive action is justified.
Experienced CEOs attest to the positive impact this can have on the rest of the company. EMC’s Tucci says he had to take “public” action to tackle the “whiff of arrogance” that used to characterize certain parts of the company. TXU’s Wilder recalls that “When we did a cultural audit, we found that the number-one complaint was that management was not dealing with employees that everyone knew weren’t carrying their load.“
Invest team time
Even with the right team in place, it takes time for a group of highly intelligent, ambitious, and independent people to align themselves in a clear direction. Typically, the first order of business is for members to agree on what they can achieve as a team (not as individuals), how often the team should meet, what transformation issues should be discussed, and what behavior the team expects (and won’t tolerate). These agreements are often summarized in a “team charter” for leading the transformation, and the CEO can periodically use the charter to ensure that the team is on the right track.
Intesa’s Passera speaks of how he brought his team together regularly to “share almost everything,” to make it “clear to everyone who is doing what,” and to “keep the transformation initiatives, budgets, and financial targets knitted together.” P&G’s Lafley emphasizes the importance of spending the time together wisely: “You need to understand how to enroll the leadership team.” As a rule of thumb, 80 percent of the team’s time should be devoted to dialogue, with the remaining 20 percent invested in being “presented to.”
Effective dialogue requires a well-structured agenda, which typically ensures that ample time is spent in personal reflection (to ensure that each person forms an independent point of view from the outset), discussion in pairs or small groups (refining the thinking and exploring second- and third-level assumptions), and discussion by the full team before final decisions are made. In this process, little tolerance should be shown for minutiae (losing the forest for the trees) and for any lack of engagement. Face-to-face meetings, as opposed to conference calls, greatly enhance the effectiveness of team dialogue.
Relentlessly pursuing impact
Organizational energy—collective motivation, enthusiasm, and intense commitment—is a crucial ingredient of a successful transformation. There is no substitute for a CEO directing his or her personal energy toward ensuring that the company’s efforts have an impact.
Roll up your sleeves
Initiatives with a significant financial or symbolic value require the CEO’s personal involvement for maximum impact. There may be several beneficial effects, among them ensuring that important decisions are made quickly—without sacrificing the value of collective debate—and sowing the seeds of a culture of candor and decisiveness.
Leaders must be willing to leave the executive suite and help resolve difficult operational issues. Peter Gossas, president of Sandvik Materials Technology and a man with lifelong experience in the steel industry, observes, “If there’s a problem, it can be helpful if I come to the work floor, step up on a crate so that everyone can see me, and hold a discussion with a shift unit that may be negative to change.” He adds, “It’s hard for me to walk into a melt shop and not begin discussing ways to solve operational problems.”
Hold leaders accountable
Successful CEOs never lose sight of their management responsibility to chair review forums. Through these, they compare the results of the transformation program with the original plan, identify the root causes of any deviations, celebrate successes, help fix problems, and hold leaders accountable for keeping the transformation on track, both in activities (are people doing what they said they would?) and impact (will the program create the value we anticipated?). A central role for the CEO during these review forums is to ensure that decision making stays grounded in the facts. As Narayana Murthy wryly observes, “We have embraced the adage 'In God we trust; everyone else brings data to the table.’”
The CEO also plays a critical role in ensuring an appropriate balance between near-term profit initiatives (those that deliver performance today) and organizational-health initiatives (those that build the capacity to deliver tomorrow’s results). This is a lesson applied by John Varley, CEO of Barclays: “For several years, the focus on initiatives to improve financial performance dramatically crowded out attention on franchise health, leaving us with a set of issues in some businesses that needed urgent attention. We are addressing those issues.” During the transformation, some CEOs even choose to hold separate review meetings for short- and long-term objectives in order to ensure that companies maintain a balance between operational improvement (tactical strategies, wage management, productivity, and asset management) and long-term growth (revenue and volume growth through market share, new products, channels and marketing, M&A, talent, and capability management).
For CEOs leading a transformation, no single model guarantees success. But they can improve the odds by targeting leadership functions: making the transformation meaningful, modeling the desired mind-sets and behavior, building a strong and committed team, and relentlessly pursuing impact. Together, these can powerfully generate the energy needed to achieve a successful performance transformation.
About the Authors
Carolyn Aiken is a consultant in McKinsey’s Toronto office, and Scott Keller is a principal in the Chicago office.
BA/BM-When big acquisitions pay off -McKinsey Quarterly
The following information is used for educational purposes only.
When big acquisitions pay off
Some are quietly creating value that doesn’t make the headlines. Here’s how.
MAY 2011 • Ankur Agrawal, Cristina Ferrer, and Andy West
Big mergers and acquisitions make for splashy headlines, but do they make financial and strategic sense? Executives, board members, and investors are wise to be skeptical. Such deals—worth 30 percent or more of the acquirer’s market capitalization—are extremely complex. And as high-profile failures have demonstrated, big deals can destroy significant value for shareholders.
Big deals can create significant value for the acquirer, however, even if success takes time to unfold. Indeed, in our analysis of such deals over the past decade, half had created excess returns to shareholders when measured two years after the deal’s completion.1 In one-third, returns were significantly higher relative to the industry average.
The difference between success and failure often comes down to strategy. Only a few situations give companies a clear, compelling reason to take on a big deal’s risks and integration complexity. Companies with few options for organic growth, for example, can use a large deal to enter a new sector or market quickly. Those in consolidated industries, such as oil and gas or mining, can find success in big deals when other options are limited and major economies of scale exist. And on the rare occasion when a large target company is a very clear strategic fit with the prospective buyer, a big deal can improve an acquirer’s growth and performance rapidly.
But a successful deal also results from strong execution. In case studies of nine of the best-performing deals and six of the worst in our dataset, we found that successful acquirers employ several approaches to execution and integration that are different from those used by unsuccessful ones—and different from those typically used by acquirers in smaller deals. Successful acquirers set performance targets higher than due-diligence estimates of a merger’s value. They reject the common idea that an acquisition represents an opportunity to adopt the best of two companies’ cultures. Finally, their CEOs focus their involvement on a few most critical areas.
Aiming higher than due diligence
In the hectic pace of integration after a deal closes, many integration managers adopt the synergy estimates calculated by the pre-deal due-diligence team as performance targets. Yet how much a company pays for a deal isn’t necessarily the same as it’s worth. Even the best due-diligence efforts can be only so good. They’re often constrained by time and access to data. They typically focus on whether expected cost synergies alone can justify a deal, placing more emphasis on how much could be saved by eliminating redundant functions, facilities, people, or products and much less on how much can be gained through growth. To compound the error, as individual managers weigh the uncertainty of due-diligence estimates against their own performance risk, they often translate synergy estimates into even more conservative—and easily achievable—cost and revenue targets.
Yet, as our case studies suggest, companies that reassess their synergy targets after a deal closes seem to achieve higher synergies than those that don’t. These more ambitious companies use pre-deal estimates of synergies not as performance targets but as a performance baseline—the minimum they expect. In fact, in a survey on corporate transformations that included mergers and acquisitions, executives managing deals in which baseline aspirations were reset by a number of robust facts after a deal was reached were four times more likely to characterize those deals as very or extremely successful than executives whose baseline aspirations were not reset.2
The successful acquirers in our case studies reset their aspirations by identifying opportunities to transform the business and then building a fact base to support those opportunities. Sometimes they came from fundamental changes to operations or from providing customers with new products or services that hadn’t come up in due diligence—or weren’t investigated, as a result of limited time or information access.
After a merger between two global mining companies, for example, the acquirer had more access to details on the overlap between its own and the target’s customer base and suppliers. Previously confidential information on the terms and conditions of sales agreements—and the needs and expectations of customers—led to unexpectedly high levels of cross-selling and bundling between the target’s and acquirer’s products, as well as unexpectedly lower input costs, thanks to improved supply chain management. While these considerations were not a large part of the original investment thesis, they were a major part of the deal’s success, improving the combined company’s earnings before interest, taxes, depreciation, and amortization (EBITDA) by more than 20 percent.
Similarly, when a North American packaged-goods company reviewed its synergy targets after a deal’s close, managers learned that the target company’s marketing strategy was better than its own. Importing those and other best practices helped the company realize synergies 75 percent above due-diligence estimates.
Setting such aggressive target estimates requires individual leaders to leave their comfort zones and share aspirations. Workshops encouraging the joint exploration of opportunities can help. Senior managers of one large deal in the pharma industry, for example, summoned teams from different backgrounds to a three-day off-site event. It started with an idea generation session where each team compiled a list of growth-related opportunities. The group then assessed each of the opportunities, ranking them by size and priority, and eventually developed a high-level implementation plan. In three days, the group did not discuss the due-diligence model or its synergy estimates. In the end, the acquirer uncovered more than 40 percent more synergies and rebalanced its synergy expectations significantly across teams. In addition, the teams were motivated by their targets and believed they were achievable—a much better outcome than being allocated a target based on a brief due-diligence period.
Higher performance targets have their challenges, of course, and to meet those targets companies must have the right kind of managers. In a broad-based survey on organizational health,3 managers at the most successful acquirers reported having a higher-than-average sense of account-ability, as well as inspirational and authoritative leadership. Developing those traits requires companies to create an environment that encourages managers to take calculated risks and gives them confidence to aim beyond the original size and scope of the synergy targets. Such an environment includes clearly defined managerial roles, strong links between individual performance and consequences (positive and negative), and attractive incentives for high performers.
In one case study, for example, a global bank in a large acquisition actively encouraged managers to develop ambitious business plans and provided the resources to pursue them. Managers were generously rewarded for meeting their goals but also faced consequences if they failed: those who missed agreed-upon targets for a third time were let go. All of these attributes can—and, if possible, should—be developed long before a large deal is under way. In fact, in our transformations survey, respondents in companies that focused on building capabilities before an acquisition were twice as likely to describe it as successful.
Asserting cultural control
It’s not uncommon for an acquiring company to assert control over the culture of the acquired one—if it is small. But many executives have been reluctant to do so with really large deals, taking instead a merger-of-equals posture or one purporting to adopt the best of each company’s culture. That approach, we find, typically leads to confusion and reduces accountability, hindering integration and lengthening the time needed to get past integration and on with running the business. In fact, in our case studies’ examination of culture, the biggest difference between successful and unsuccessful large deals was the recognition in the former that one culture inevitably tends to dominate. Unsuccessful acquirers typically discovered that the emerging dominant culture wasn’t always the best fit for the deal’s strategic intent.
In successful deals, companies acted more purposefully. They started by building a fact base to identify cultural differences, focusing on extremely targeted improvements to the acquiring company’s culture, if needed. Then they spent the majority of their time explaining the differences and helping acquired employees understand what they needed to do to migrate to the culture of the new organization. Finally, they aggressively managed that migration. This sounds intuitive but is quite different than what happened in many of our unsuccessful case studies, where promises of “best of both cultures” resulted in high aspirations supported with little transitional support and, ultimately, an unfair playing field for acquired employees.
Managers of a large international media deal, for instance, started with a survey of cultural performance, management practices, and outcomes. The survey identified nine dimensions of culture, and the data it generated gave managers a benchmark of each company’s position on performance. These managers then used that data to inform discussions with the integration leaders, so that everyone understood the differences between the cultures, and then to identify very targeted improvements and shape the language and messaging to the merged company. Finally, they created an “on-boarding” program that helped acquired employees understand what to expect and how to succeed. The topics included how the acquiring company conducted performance reviews and financial planning, set and communicated goals, and enforced accountability. At some levels, the program even included getting people comfortable with little things that would “feel” very different, such as the reimbursement of expenses, laptop policies, and time and expense reports.
There are exceptions when an acquirer wants to leave cultural gaps in specific areas or to protect a specific capability by creating a distinct culture in parts of the business. An acquirer that relies on top-down innovation, for example, may want to retain the entrepreneurial culture of a target’s R&D department. But this approach should be restricted to cases when the uniqueness of the target’s culture creates value—and the acquirer makes the needed investment to keep a culture separate by forming clear organizational and operational boundaries.
When one North American high-tech company acquired a target with a potentially disruptive new technology, for instance, it found that the investment required to protect the target’s culture was at least equal to the cost of integrating it. The effort, which lasted five years, required a senior executive to manage all interactions full time, changes to the parent company’s HR policies and systems to meet the target’s needs, flexible financial reporting and budgeting that fit the target’s operating model, and forgoing almost all cost synergies from redundant operations. Yet the investment proved to be very worthwhile; the asset flourished under new ownership and significantly exceeded expectations.
Balancing CEO involvement
Demands on the CEO’s time can be overwhelming after a large deal because of the magnitude, complexity, and risk of integrating a large company, typically of comparable size. The CEO’s involvement is critical for the deal team to maintain focus and energy; transformation survey respondents were six times more likely to describe deals as successful when the CEO was significantly involved. Yet not every decision or risk demands the CEO’s attention, and in a large deal the CEO cannot spend adequate time on every issue that might merit his or her attention in a smaller deal.
The degree of focus may be surprising: in our case studies, the leaders of successful big deals typically focused in a meaningful way on only one or two areas where their involvement mattered most. Everything else, they delegated to an empowered group of senior leaders. The CEOs could therefore focus on protecting the base business even as they pushed the organization to realize the deal’s full potential. In one global oil-and-gas merger, for instance, the CEO met with his acquired top team—the target company’s CFO and the CEO—for several hours every few weeks, with explicit instructions that they bring only the most challenging issues to the table. All other integration updates and process-related issues fell to the integration leader, who escalated them only if necessary.
Delegating this much authority and responsibility requires CEOs to encourage others to think and act imaginatively without explicit CEO input. This approach is critical to uncovering transformational synergies. CEOs should thus create risk-free environments for generating and evaluating ideas and bring in outside experts (including academics, private-equity partners, and consultants) who can foster creativity. In the organizational-health survey, successful acquirers scored 1.5 times higher than average ones in the frequency with which they used external ideas or outsourced expertise.
The CEO’s intervention is critical to overcome biases in performance evaluation systems, often structured toward short-term, organic goals. To help organizations pursue higher aspirations, CEOs should review their top-management incentive systems to make sure they reward people who aim to realize long-term transformational synergies that frequently require otherwise-avoidable short-term investments.
About the Authors
Ankur Agrawal and Cristina Ferrer are consultants in McKinsey’s New York office, and Andy West is a partner in the Boston office.
The authors wish to acknowledge the contribution of Theresa Lorriman to the development of this article.
When big acquisitions pay off
Some are quietly creating value that doesn’t make the headlines. Here’s how.
MAY 2011 • Ankur Agrawal, Cristina Ferrer, and Andy West
Big mergers and acquisitions make for splashy headlines, but do they make financial and strategic sense? Executives, board members, and investors are wise to be skeptical. Such deals—worth 30 percent or more of the acquirer’s market capitalization—are extremely complex. And as high-profile failures have demonstrated, big deals can destroy significant value for shareholders.
Big deals can create significant value for the acquirer, however, even if success takes time to unfold. Indeed, in our analysis of such deals over the past decade, half had created excess returns to shareholders when measured two years after the deal’s completion.1 In one-third, returns were significantly higher relative to the industry average.
The difference between success and failure often comes down to strategy. Only a few situations give companies a clear, compelling reason to take on a big deal’s risks and integration complexity. Companies with few options for organic growth, for example, can use a large deal to enter a new sector or market quickly. Those in consolidated industries, such as oil and gas or mining, can find success in big deals when other options are limited and major economies of scale exist. And on the rare occasion when a large target company is a very clear strategic fit with the prospective buyer, a big deal can improve an acquirer’s growth and performance rapidly.
But a successful deal also results from strong execution. In case studies of nine of the best-performing deals and six of the worst in our dataset, we found that successful acquirers employ several approaches to execution and integration that are different from those used by unsuccessful ones—and different from those typically used by acquirers in smaller deals. Successful acquirers set performance targets higher than due-diligence estimates of a merger’s value. They reject the common idea that an acquisition represents an opportunity to adopt the best of two companies’ cultures. Finally, their CEOs focus their involvement on a few most critical areas.
Aiming higher than due diligence
In the hectic pace of integration after a deal closes, many integration managers adopt the synergy estimates calculated by the pre-deal due-diligence team as performance targets. Yet how much a company pays for a deal isn’t necessarily the same as it’s worth. Even the best due-diligence efforts can be only so good. They’re often constrained by time and access to data. They typically focus on whether expected cost synergies alone can justify a deal, placing more emphasis on how much could be saved by eliminating redundant functions, facilities, people, or products and much less on how much can be gained through growth. To compound the error, as individual managers weigh the uncertainty of due-diligence estimates against their own performance risk, they often translate synergy estimates into even more conservative—and easily achievable—cost and revenue targets.
Yet, as our case studies suggest, companies that reassess their synergy targets after a deal closes seem to achieve higher synergies than those that don’t. These more ambitious companies use pre-deal estimates of synergies not as performance targets but as a performance baseline—the minimum they expect. In fact, in a survey on corporate transformations that included mergers and acquisitions, executives managing deals in which baseline aspirations were reset by a number of robust facts after a deal was reached were four times more likely to characterize those deals as very or extremely successful than executives whose baseline aspirations were not reset.2
The successful acquirers in our case studies reset their aspirations by identifying opportunities to transform the business and then building a fact base to support those opportunities. Sometimes they came from fundamental changes to operations or from providing customers with new products or services that hadn’t come up in due diligence—or weren’t investigated, as a result of limited time or information access.
After a merger between two global mining companies, for example, the acquirer had more access to details on the overlap between its own and the target’s customer base and suppliers. Previously confidential information on the terms and conditions of sales agreements—and the needs and expectations of customers—led to unexpectedly high levels of cross-selling and bundling between the target’s and acquirer’s products, as well as unexpectedly lower input costs, thanks to improved supply chain management. While these considerations were not a large part of the original investment thesis, they were a major part of the deal’s success, improving the combined company’s earnings before interest, taxes, depreciation, and amortization (EBITDA) by more than 20 percent.
Similarly, when a North American packaged-goods company reviewed its synergy targets after a deal’s close, managers learned that the target company’s marketing strategy was better than its own. Importing those and other best practices helped the company realize synergies 75 percent above due-diligence estimates.
Setting such aggressive target estimates requires individual leaders to leave their comfort zones and share aspirations. Workshops encouraging the joint exploration of opportunities can help. Senior managers of one large deal in the pharma industry, for example, summoned teams from different backgrounds to a three-day off-site event. It started with an idea generation session where each team compiled a list of growth-related opportunities. The group then assessed each of the opportunities, ranking them by size and priority, and eventually developed a high-level implementation plan. In three days, the group did not discuss the due-diligence model or its synergy estimates. In the end, the acquirer uncovered more than 40 percent more synergies and rebalanced its synergy expectations significantly across teams. In addition, the teams were motivated by their targets and believed they were achievable—a much better outcome than being allocated a target based on a brief due-diligence period.
Higher performance targets have their challenges, of course, and to meet those targets companies must have the right kind of managers. In a broad-based survey on organizational health,3 managers at the most successful acquirers reported having a higher-than-average sense of account-ability, as well as inspirational and authoritative leadership. Developing those traits requires companies to create an environment that encourages managers to take calculated risks and gives them confidence to aim beyond the original size and scope of the synergy targets. Such an environment includes clearly defined managerial roles, strong links between individual performance and consequences (positive and negative), and attractive incentives for high performers.
In one case study, for example, a global bank in a large acquisition actively encouraged managers to develop ambitious business plans and provided the resources to pursue them. Managers were generously rewarded for meeting their goals but also faced consequences if they failed: those who missed agreed-upon targets for a third time were let go. All of these attributes can—and, if possible, should—be developed long before a large deal is under way. In fact, in our transformations survey, respondents in companies that focused on building capabilities before an acquisition were twice as likely to describe it as successful.
Asserting cultural control
It’s not uncommon for an acquiring company to assert control over the culture of the acquired one—if it is small. But many executives have been reluctant to do so with really large deals, taking instead a merger-of-equals posture or one purporting to adopt the best of each company’s culture. That approach, we find, typically leads to confusion and reduces accountability, hindering integration and lengthening the time needed to get past integration and on with running the business. In fact, in our case studies’ examination of culture, the biggest difference between successful and unsuccessful large deals was the recognition in the former that one culture inevitably tends to dominate. Unsuccessful acquirers typically discovered that the emerging dominant culture wasn’t always the best fit for the deal’s strategic intent.
In successful deals, companies acted more purposefully. They started by building a fact base to identify cultural differences, focusing on extremely targeted improvements to the acquiring company’s culture, if needed. Then they spent the majority of their time explaining the differences and helping acquired employees understand what they needed to do to migrate to the culture of the new organization. Finally, they aggressively managed that migration. This sounds intuitive but is quite different than what happened in many of our unsuccessful case studies, where promises of “best of both cultures” resulted in high aspirations supported with little transitional support and, ultimately, an unfair playing field for acquired employees.
Managers of a large international media deal, for instance, started with a survey of cultural performance, management practices, and outcomes. The survey identified nine dimensions of culture, and the data it generated gave managers a benchmark of each company’s position on performance. These managers then used that data to inform discussions with the integration leaders, so that everyone understood the differences between the cultures, and then to identify very targeted improvements and shape the language and messaging to the merged company. Finally, they created an “on-boarding” program that helped acquired employees understand what to expect and how to succeed. The topics included how the acquiring company conducted performance reviews and financial planning, set and communicated goals, and enforced accountability. At some levels, the program even included getting people comfortable with little things that would “feel” very different, such as the reimbursement of expenses, laptop policies, and time and expense reports.
There are exceptions when an acquirer wants to leave cultural gaps in specific areas or to protect a specific capability by creating a distinct culture in parts of the business. An acquirer that relies on top-down innovation, for example, may want to retain the entrepreneurial culture of a target’s R&D department. But this approach should be restricted to cases when the uniqueness of the target’s culture creates value—and the acquirer makes the needed investment to keep a culture separate by forming clear organizational and operational boundaries.
When one North American high-tech company acquired a target with a potentially disruptive new technology, for instance, it found that the investment required to protect the target’s culture was at least equal to the cost of integrating it. The effort, which lasted five years, required a senior executive to manage all interactions full time, changes to the parent company’s HR policies and systems to meet the target’s needs, flexible financial reporting and budgeting that fit the target’s operating model, and forgoing almost all cost synergies from redundant operations. Yet the investment proved to be very worthwhile; the asset flourished under new ownership and significantly exceeded expectations.
Balancing CEO involvement
Demands on the CEO’s time can be overwhelming after a large deal because of the magnitude, complexity, and risk of integrating a large company, typically of comparable size. The CEO’s involvement is critical for the deal team to maintain focus and energy; transformation survey respondents were six times more likely to describe deals as successful when the CEO was significantly involved. Yet not every decision or risk demands the CEO’s attention, and in a large deal the CEO cannot spend adequate time on every issue that might merit his or her attention in a smaller deal.
The degree of focus may be surprising: in our case studies, the leaders of successful big deals typically focused in a meaningful way on only one or two areas where their involvement mattered most. Everything else, they delegated to an empowered group of senior leaders. The CEOs could therefore focus on protecting the base business even as they pushed the organization to realize the deal’s full potential. In one global oil-and-gas merger, for instance, the CEO met with his acquired top team—the target company’s CFO and the CEO—for several hours every few weeks, with explicit instructions that they bring only the most challenging issues to the table. All other integration updates and process-related issues fell to the integration leader, who escalated them only if necessary.
Delegating this much authority and responsibility requires CEOs to encourage others to think and act imaginatively without explicit CEO input. This approach is critical to uncovering transformational synergies. CEOs should thus create risk-free environments for generating and evaluating ideas and bring in outside experts (including academics, private-equity partners, and consultants) who can foster creativity. In the organizational-health survey, successful acquirers scored 1.5 times higher than average ones in the frequency with which they used external ideas or outsourced expertise.
The CEO’s intervention is critical to overcome biases in performance evaluation systems, often structured toward short-term, organic goals. To help organizations pursue higher aspirations, CEOs should review their top-management incentive systems to make sure they reward people who aim to realize long-term transformational synergies that frequently require otherwise-avoidable short-term investments.
About the Authors
Ankur Agrawal and Cristina Ferrer are consultants in McKinsey’s New York office, and Andy West is a partner in the Boston office.
The authors wish to acknowledge the contribution of Theresa Lorriman to the development of this article.
BA/BM-Finding the courage to shrink -McKinsey Quarterly
The following information is used for educational purposes only.
Finding the courage to shrink
Spinning off businesses can have real advantages in creating value—if executives understand how.
AUGUST 2011 • Bill Huyett and Tim Koller
It takes courage to break up a company. CEOs and boards of directors often fear that investors will view asset divestitures as admissions of failed strategy—that having certain businesses under the same corporate umbrella never made sense. Many worry that shedding assets will cost a company the benefits of scale, cut into the advantages of analyst coverage, or even damage employee morale. Spin-offs in particular draw scrutiny because they shrink the size of the parent company but, unlike sales, don’t generate cash to reinvest.
We don’t believe these arguments hold up. What’s more, they may lead executives to pass up value-creating opportunities. A fundamental principle of corporate finance holds that a business creates the most value for shareholders and the economy as a whole when it is owned by the best—or, at least, a better—owner.1 So it makes sense that companies should continually reallocate their resources as circumstances change. Moreover, the benefits of being part of a large company come at a cost; in fact, many spun-off companies can make substantial cuts in overhead costs once they are independent. Investors typically don’t care about a company being too small once it reaches a threshold of about $500 million in market capitalization.2 And in our experience, executives and employees of spun-off companies often feel liberated and quite happy to be on their own.
So it’s a good sign that there’s been something of a revival in spin-off activity this year. According to Bloomberg, as of August 25, 174 companies had announced spin-offs of all sizes—quickly approaching the previous global record of 230, in 2006. Among the notable deals: Kraft Foods’s spin-off of its North American grocery unit and ConocoPhillips’s spin-offs of its downstream businesses.
The trick to executing a spin-off strategy—and to overcoming predictable objections to it—is to understand where the value is created. Markets typically respond favorably to spin-offs, but savvy managers understand that such deals create value not from some mechanical market reaction but from the sharpened strategic vision that comes with restructuring or the tax advantages relative to a sale.
Spin-offs: A brief history
Company breakups through spin-offs date back at least a hundred years. Many of the earliest and best-known ones were mandated by courts to split up monopolies, including the 1911 breakup of Standard Oil into 34 separate companies, as well as the 1984 breakup of AT&T into 8 companies.
After the AT&T breakup, spin-offs became a more common way for companies to change their strategic direction. American Express, for example, spun off Lehman Brothers in 1994, ending its strategy of becoming a financial supermarket. In 1993, as the historical links between chemical and pharmaceutical businesses became less relevant, the British chemical company Imperial Chemical Industries3 (ICI) spun off its pharmaceutical business as Zeneca.4 Recent spin-offs have reflected similar shifts. In 2008, when the integration of the production and delivery of media content didn’t lead to the anticipated benefits, Time Warner announced that it would spin off its cable television business.
Some of the major conglomerates built in the 1960s and ’70s used spin-offs to break themselves up. ITT, one of the best-known conglomerates of that era, used a double spin-off in 1995 to split itself into three companies, ITT Sheraton (now part of Starwood Hotels and Resorts), Hartford Financial Services, and the remaining industrial businesses, which kept the ITT name. In January 2011, ITT announced that it was further splitting up into three companies: ITT Corporation (industrial process and flow control), Zylem (water and waste water), and ITT Exelis (defense). In an even more extreme example, the company that was Dun & Bradstreet in 1995 has spun out businesses four times (1996, 1998, 1999, and 2000) and now exists as seven different companies.
Understanding the benefits
One common misperception about spin-offs is that they are quick fixes for low valuations. Managers see the typically favorable response that markets have to a spin-off announcement as confirmation that a spin-off itself mechanically illuminates value that investors previously overlooked. But that belief is misleading.
Such assumptions rest errantly on a “sum of the parts” calculation. For each of a company’s businesses, analysts add up an assumed earnings multiple based on the multiples of industry peers. If they find that the sum of the parts is greater than the market value of the company as currently traded, they assume the market hasn’t valued the business properly.
Unfortunately, these analyses often are flawed—usually because the selected peers are not actually comparable in industry, performance, or both. Once truly comparable businesses are identified, the undervaluation typically disappears (exhibit).
The real reason spin-offs are so valuable is tied to expected performance: increased valuations reflect the market’s expectation that performance will improve at both the parent company and the spun-off business once each has the freedom to change its strategies, people, and organization. Indeed, of the 85 spin-offs associated with a major restructuring5 of a company globally since 1992, spun-off businesses nearly doubled their growth rates and increased their operating profit margins by a median of 1.6 percent over five years. Among parent companies, profit margins increased 11 percent in the first year after the spin-off and an additional 3.5 percent by the fifth year.6 Also, one academic study concluded that spin-offs improve the allocation of capital, because researchers observed changes in strategy among spun-off businesses.7 They found that higher-profit businesses tended to increase their investment spending, while lower-profit ones tended to cut it.
This ability to change strategic direction is the biggest source of performance improvements. Consider, for example, Bristol-Myers Squibb, which spun off its Zimmer orthopedic-devices business in 2001 with an initial market value of $5.4 billion. Under Bristol-Myers Squibb, Zimmer relied on pricing to drive revenue growth. The separation allowed Zimmer to invest in developing new technologies, launch new products, and grow in new geographies. The company also more aggressively reduced costs by, for example, improving the efficiency of its manufacturing plants.
Another source of improvement is eliminating conflicts and potential conflicts between the parent and the spun-off company. The pharmaceutical company Merck, for example, spun off Medco, its pharmacy benefits manager, in 2003, with an initial market value of $6.6 billion. Because the parent company was an important supplier to Medco, there were long-standing questions about whether Medco gave preference to Merck drugs over those of other pharmaceutical companies. The separation eliminated that concern in Medco’s negotiations with customers and helped Medco accelerate its growth by shifting clients to generic drugs and a mail-order pharmacy.
Spun-off companies may also attract more desirable management talent. In 2007, Tyco International split itself into three companies: Covidien, Tyco Electronics, and the original Tyco International. Shortly after the spin-off, then-CFO Chris Coughlin described the advantages, reporting that the health care business, Covidien, had made significant strides in attracting new talent that would probably not have been attracted to the old Tyco.8 In a health care company with a clearly defined strategy, employees and prospective employees could see themselves advancing professionally while remaining in health care and playing a significant role in the business.
Sell or spin?
When executives decide to dispose of a business unit because their company is no longer a better owner of it, their first inclination is usually to sell it outright. Yet spinning off these units may have tax advantages over selling them. In fact, most early spin-offs were completed by UK- or US-based companies partly because the tax laws of those two countries treated most spin-offs as tax-free transactions. Several continental-European countries changed their tax laws, beginning in the late 1990s, to facilitate spin-offs. Since the 1998 breakup of Dutch telecommunications company KPN and TNT Post, more continental-European businesses have used spin-offs to break up their companies.
Tax benefits can make a spin-off preferable even if a potential buyer is willing to pay a sizable premium. In the United States today, for example, a company must pay income tax of 35 percent on any gain from the sale of a business but a spin-off can be structured as a tax-free transaction.
Consider a hypothetical example. ParentCo has decided to divest one of its business units, which—if spun off—would have a market capitalization of $1 billion. It also has a $1.3 billion offer from another company to buy the unit outright, reflecting a typical acquisition premium. Since ParentCo’s book value for the unit is $300 million, the outright sale would carry a tax liability of $350 million on a $1 billion gain on the sale, reducing after-tax proceeds to $950 million, less than the unit’s expected market capitalization. From a shareholder value perspective, taxes alone should make ParentCo seriously consider a spin-off rather than a sale.
Three factors determine the breakeven point: the tax rate, the premium from the sale, and the tax book value of the business relative to the sale price. Because of the tax dynamics, companies are more likely to spin off highly profitable businesses and sell less profitable ones. The ratio of the tax book value to the selling price is a good proxy for how profitable a business is. A highly profitable business may have a tax basis that is only 10 percent of the selling price. To break even between selling and spinning off, the company would need to receive a 46 percent premium on the sale. On the other hand, a low-profit business with a tax book value of 80 percent of the selling price would need to receive only an 8 percent premium to break even.9
In many cases, understanding the shareholder benefits that spinning off assets can have should provide executives with the dose of courage they may need to overcome resistance to this type of value-creating divestiture.
About the Authors
Bill Huyett is a partner in McKinsey’s Boston office, and Tim Koller is a partner in the New York office.
The authors wish to acknowledge the contributions of Katherine Boas, Mauricio Jaramillo, Mike Rosenbluth, and Joy Sun.
Finding the courage to shrink
Spinning off businesses can have real advantages in creating value—if executives understand how.
AUGUST 2011 • Bill Huyett and Tim Koller
It takes courage to break up a company. CEOs and boards of directors often fear that investors will view asset divestitures as admissions of failed strategy—that having certain businesses under the same corporate umbrella never made sense. Many worry that shedding assets will cost a company the benefits of scale, cut into the advantages of analyst coverage, or even damage employee morale. Spin-offs in particular draw scrutiny because they shrink the size of the parent company but, unlike sales, don’t generate cash to reinvest.
We don’t believe these arguments hold up. What’s more, they may lead executives to pass up value-creating opportunities. A fundamental principle of corporate finance holds that a business creates the most value for shareholders and the economy as a whole when it is owned by the best—or, at least, a better—owner.1 So it makes sense that companies should continually reallocate their resources as circumstances change. Moreover, the benefits of being part of a large company come at a cost; in fact, many spun-off companies can make substantial cuts in overhead costs once they are independent. Investors typically don’t care about a company being too small once it reaches a threshold of about $500 million in market capitalization.2 And in our experience, executives and employees of spun-off companies often feel liberated and quite happy to be on their own.
So it’s a good sign that there’s been something of a revival in spin-off activity this year. According to Bloomberg, as of August 25, 174 companies had announced spin-offs of all sizes—quickly approaching the previous global record of 230, in 2006. Among the notable deals: Kraft Foods’s spin-off of its North American grocery unit and ConocoPhillips’s spin-offs of its downstream businesses.
The trick to executing a spin-off strategy—and to overcoming predictable objections to it—is to understand where the value is created. Markets typically respond favorably to spin-offs, but savvy managers understand that such deals create value not from some mechanical market reaction but from the sharpened strategic vision that comes with restructuring or the tax advantages relative to a sale.
Spin-offs: A brief history
Company breakups through spin-offs date back at least a hundred years. Many of the earliest and best-known ones were mandated by courts to split up monopolies, including the 1911 breakup of Standard Oil into 34 separate companies, as well as the 1984 breakup of AT&T into 8 companies.
After the AT&T breakup, spin-offs became a more common way for companies to change their strategic direction. American Express, for example, spun off Lehman Brothers in 1994, ending its strategy of becoming a financial supermarket. In 1993, as the historical links between chemical and pharmaceutical businesses became less relevant, the British chemical company Imperial Chemical Industries3 (ICI) spun off its pharmaceutical business as Zeneca.4 Recent spin-offs have reflected similar shifts. In 2008, when the integration of the production and delivery of media content didn’t lead to the anticipated benefits, Time Warner announced that it would spin off its cable television business.
Some of the major conglomerates built in the 1960s and ’70s used spin-offs to break themselves up. ITT, one of the best-known conglomerates of that era, used a double spin-off in 1995 to split itself into three companies, ITT Sheraton (now part of Starwood Hotels and Resorts), Hartford Financial Services, and the remaining industrial businesses, which kept the ITT name. In January 2011, ITT announced that it was further splitting up into three companies: ITT Corporation (industrial process and flow control), Zylem (water and waste water), and ITT Exelis (defense). In an even more extreme example, the company that was Dun & Bradstreet in 1995 has spun out businesses four times (1996, 1998, 1999, and 2000) and now exists as seven different companies.
Understanding the benefits
One common misperception about spin-offs is that they are quick fixes for low valuations. Managers see the typically favorable response that markets have to a spin-off announcement as confirmation that a spin-off itself mechanically illuminates value that investors previously overlooked. But that belief is misleading.
Such assumptions rest errantly on a “sum of the parts” calculation. For each of a company’s businesses, analysts add up an assumed earnings multiple based on the multiples of industry peers. If they find that the sum of the parts is greater than the market value of the company as currently traded, they assume the market hasn’t valued the business properly.
Unfortunately, these analyses often are flawed—usually because the selected peers are not actually comparable in industry, performance, or both. Once truly comparable businesses are identified, the undervaluation typically disappears (exhibit).
The real reason spin-offs are so valuable is tied to expected performance: increased valuations reflect the market’s expectation that performance will improve at both the parent company and the spun-off business once each has the freedom to change its strategies, people, and organization. Indeed, of the 85 spin-offs associated with a major restructuring5 of a company globally since 1992, spun-off businesses nearly doubled their growth rates and increased their operating profit margins by a median of 1.6 percent over five years. Among parent companies, profit margins increased 11 percent in the first year after the spin-off and an additional 3.5 percent by the fifth year.6 Also, one academic study concluded that spin-offs improve the allocation of capital, because researchers observed changes in strategy among spun-off businesses.7 They found that higher-profit businesses tended to increase their investment spending, while lower-profit ones tended to cut it.
This ability to change strategic direction is the biggest source of performance improvements. Consider, for example, Bristol-Myers Squibb, which spun off its Zimmer orthopedic-devices business in 2001 with an initial market value of $5.4 billion. Under Bristol-Myers Squibb, Zimmer relied on pricing to drive revenue growth. The separation allowed Zimmer to invest in developing new technologies, launch new products, and grow in new geographies. The company also more aggressively reduced costs by, for example, improving the efficiency of its manufacturing plants.
Another source of improvement is eliminating conflicts and potential conflicts between the parent and the spun-off company. The pharmaceutical company Merck, for example, spun off Medco, its pharmacy benefits manager, in 2003, with an initial market value of $6.6 billion. Because the parent company was an important supplier to Medco, there were long-standing questions about whether Medco gave preference to Merck drugs over those of other pharmaceutical companies. The separation eliminated that concern in Medco’s negotiations with customers and helped Medco accelerate its growth by shifting clients to generic drugs and a mail-order pharmacy.
Spun-off companies may also attract more desirable management talent. In 2007, Tyco International split itself into three companies: Covidien, Tyco Electronics, and the original Tyco International. Shortly after the spin-off, then-CFO Chris Coughlin described the advantages, reporting that the health care business, Covidien, had made significant strides in attracting new talent that would probably not have been attracted to the old Tyco.8 In a health care company with a clearly defined strategy, employees and prospective employees could see themselves advancing professionally while remaining in health care and playing a significant role in the business.
Sell or spin?
When executives decide to dispose of a business unit because their company is no longer a better owner of it, their first inclination is usually to sell it outright. Yet spinning off these units may have tax advantages over selling them. In fact, most early spin-offs were completed by UK- or US-based companies partly because the tax laws of those two countries treated most spin-offs as tax-free transactions. Several continental-European countries changed their tax laws, beginning in the late 1990s, to facilitate spin-offs. Since the 1998 breakup of Dutch telecommunications company KPN and TNT Post, more continental-European businesses have used spin-offs to break up their companies.
Tax benefits can make a spin-off preferable even if a potential buyer is willing to pay a sizable premium. In the United States today, for example, a company must pay income tax of 35 percent on any gain from the sale of a business but a spin-off can be structured as a tax-free transaction.
Consider a hypothetical example. ParentCo has decided to divest one of its business units, which—if spun off—would have a market capitalization of $1 billion. It also has a $1.3 billion offer from another company to buy the unit outright, reflecting a typical acquisition premium. Since ParentCo’s book value for the unit is $300 million, the outright sale would carry a tax liability of $350 million on a $1 billion gain on the sale, reducing after-tax proceeds to $950 million, less than the unit’s expected market capitalization. From a shareholder value perspective, taxes alone should make ParentCo seriously consider a spin-off rather than a sale.
Three factors determine the breakeven point: the tax rate, the premium from the sale, and the tax book value of the business relative to the sale price. Because of the tax dynamics, companies are more likely to spin off highly profitable businesses and sell less profitable ones. The ratio of the tax book value to the selling price is a good proxy for how profitable a business is. A highly profitable business may have a tax basis that is only 10 percent of the selling price. To break even between selling and spinning off, the company would need to receive a 46 percent premium on the sale. On the other hand, a low-profit business with a tax book value of 80 percent of the selling price would need to receive only an 8 percent premium to break even.9
In many cases, understanding the shareholder benefits that spinning off assets can have should provide executives with the dose of courage they may need to overcome resistance to this type of value-creating divestiture.
About the Authors
Bill Huyett is a partner in McKinsey’s Boston office, and Tim Koller is a partner in the New York office.
The authors wish to acknowledge the contributions of Katherine Boas, Mauricio Jaramillo, Mike Rosenbluth, and Joy Sun.
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