Strategy+Business Magazine Winter 2011

A Moore’s Law for Energy • Defeating Malware • Resetting Costs at Shell

strategy+business Published by Booz & Company

THE Global

Innovation 1000

WHY CULTURE IS KEY BARRY JARUZELSKI, JOHN LOEHR, AND RICHARD HOLMAN BY

Winter 2011 $12.95 Display until February 28, 2012

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Illustration by Lars Leetaru

Making the Case for Optimism As we bid an unfond farewell to 2011 — a year likely to be remem­ bered most for natural disasters, economic underperformance, and political upheaval — it’s tough to be optimistic about the future of the global economy and the corpo­ rate sector. But as the articles in this issue of strategy+business show, there are grounds for optimism in even the bleakest of times. Our cover story, “The Global Innovation 1000: Why Culture Is Key” (page 30), is a case in point. The main conclusion of our seventh annual study of R&D spending at the world’s largest companies seems, at first glance, to be depressing: The authors — Booz & Com­ pany experts Barry Jaruzelski, John Loehr, and Richard Holman — find that the innovation programs at nearly half the companies on the list are falling short of their poten­ tial, because the companies’ inno­ vation strategies are poorly aligned with their overall corporate strate­ gies, and their corporate cultures are unsupportive of their innova­ tion efforts. But the corollary is that the global corporate sector can vastly increase the volume and quality of

its overall innovation effort, which could in turn significantly boost technological advancement, finan­ cial returns, and prosperity. There’s every reason to think such improve­ ments will happen. Since Clayton Christensen wrote The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail (Harvard Business School Press) in 1997, innovation has become a fertile area in management science and lit­ erature, which has yielded real ad­ vances in our understanding of how to enable and improve innovation. This magazine has been a leader in that conversation, publishing articles such as Henry Chesbrough’s “R&D Through Open Innovation” (Summer 2003), C.K. Prahalad’s “The Innovation Sandbox” (Au­ tumn 2006), and A.G. Lafley’s “P&G’s Innovation Culture” (Au­ tumn 2008), as well as interviews with innovation thought leaders such as W. Chan Kim and Renée Mauborgne (First Quarter 2002), Gary Pisano (Summer 2007), and Tim Brown (Autumn 2009). Our Global Innovation 1000 study has also contributed significantly, show­ ing why innovation success is not a function of a company’s level of

spending (2005), how a company’s distinct capabilities sets enable in­ novation success (2010), and how strategy and culture can improve innovation (this year). Several other authors featured in this issue also find reasons for optimism in the current gloom. In “A Moore’s Law for Renewable En­ ergy” (page 6), consultant Andrew J. McKeon envisions a day when the energy industry embraces the kind of aspirational goals that have driven technological breakthroughs in Silicon Valley for more than half a century. And in “A Better Way to Battle Malware” (page 24), business professors Tim Laseter and Eric Johnson show how the current malware mess could be cleaned up for good. This issue also contains our popular best business books re­ views (page 46), featuring insight­ ful essays from, among others, the University of Denver’s James O’Toole, Harvard’s Barbara Keller­ man, IMD’s Phil Rosenzweig, and MIT’s Michael Schrage. Rob Norton Executive Editor [email protected]

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LEADING IDEAS

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A Moore’s Law for Renewable Energy Andrew J. McKeon Increasing capacity per dollar in computer technology has driven exponential growth for 50 years. The same could happen in the energy industry.

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China’s Auto Industry Responds to Record Growth Sheridan Prasso Dazong Wang, CEO of one of China’s largest automakers, discusses how auto companies will keep pace with Chinese consumers’ appetite for cars.

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The Right Side of Financial Services Gauthier Vincent Financial institutions need new strategies — to rethink portfolios, customer-centricity, and risk — for the neglected side of their balance sheets.

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Making Customer Segmentation Deliver

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Corey Yulinsky As the ability to gather sophisticated data grows, here’s a four-step process for making segmentation drive improved performance. DATA POINTS

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Winners in the New Digital Economy

STRATEGY & LEADERSHIP

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Resetting the Cost Structure at Shell Gerard Paulides A senior finance executive explains how a zero-based cost management effort is leading to significant performance improvements. TECHNOLOGY

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A Better Way to Battle Malware Tim Laseter and Eric Johnson Emulating the methods used to transform production quality could clean up the Internet — and might even pay for itself.

Correction, Issue 64: In “A Strategist’s Guide to Digital Fabrication,” by Tom Igoe and Catarina Mota, the caption for artwork on pages 44–45 misidentified the time frame of manufacture. It should have read “less than two hours.”

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features

conversation

Cover Story: Innovation

THOUGHT LEADER

The Global Innovation 1000: Why Culture Is Key

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Art Kleiner An expert on innovative leadership warns that too many companies are reverting to fear-driven management. Instead, executives should hold to their values and build healthy corporate communities.

Barry Jaruzelski, John Loehr, and Richard Holman Booz & Company’s annual study shows that spending more on R&D won’t drive results. The most crucial factors are strategic alignment and a culture that supports innovation. 34 Profiling the Global Innovation 1000 40 The 10 Most Innovative Companies 42 The Silicon Valley Advantage

Barry Jaruzelski and Matthew Le Merle

BEST business BOOKS 2011

48

Ethics and Aspirations

Meg Wheatley

END PAGE: RECENT RESEARCH

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Taming the “Bullwhip Effect” in Supply Chains Matt Palmquist How upstream companies can hedge the risks from demand cycles.

Cover illustration by Leandro Castelao

The Good Company Revisited

James O’Toole 53

Strategy

Asking the Right Questions

Phil Rosenzweig 57

Management

The Battle for Management’s Future

David K. Hurst 61

Economics A Dismal Outlook?

David Warsh 66

Marketing

Marketing Reenvisioned

Catharine P. Taylor 70

Leadership

Learning to Lead the Old-Fashioned Way

Barbara Kellerman 74

Technology

The Ecology of Technology

Michael Schrage

Published by Booz & Company

Issue 65, Winter 2011

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Increasing capacity per dollar in computer technology has driven exponential growth for 50 years. The same could happen in the energy industry. by Andrew J. McKeon

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il companies should think more like technology companies.” So said one of the world’s largest oil companies, the Chevron Corporation, as part of a 2011 public outreach campaign. This idea deserves to be taken seriously, and at a global, industry-wide scale. Since World War II, the computer industry has transformed the global economy and the patterns of everyday life in ways that would have been unimaginable before. Could energy companies — especially those developing renewable technologies such as solar and wind power — spark a similar transformation by emulating the kind of exponential technological improvement that brought about the digital age? Moore’s Law is well known as a description of the dramatic and continuing reduction in the size and cost of computer technology. In 1954, the average price of a transistor was about US$5. During the next half century, the price of computing power steadily dropped until an integrated circuit was worth about a billionth of a dollar. This dynamic was first described formally in 1965, when Gordon Moore — a pioneer in the semiconductor industry and cofounder of the Intel Corporation — published an article in Electronics,

observing that the number of components that could be mounted economically on a standard computer chip was doubling every year, and forecasting that this scaling effect would continue for at least 10 years. Moore’s position within the industry and his technical knowledge gave his words credibility and authority. His prediction, dubbed “Moore’s Law” in 1972, has held true for nearly five decades, guiding the development of a burgeoning and increasingly powerful industry. Many people believe that Moore’s Law is driven automatically by the inherent qualities of computer circuitry. Certainly, Moore himself recognized the innate pace of technological innovation. In 1975, he recalibrated his prediction in a speech to the Institute of Electrical and Electronics Engineers (IEEE), adjusting the rate of doubling from every year to every two years. However, even Gordon Moore could not see indefinitely into the future. Today’s computer evolution depends on breakthroughs in nanotechnology and semiconductor materials that were completely unknown and unpredicted in the 1970s, and that do not relate directly to the scaling effect at the heart of Moore’s original observation. Moore’s Law held true, however, at least in part, because of its own

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A Moore’s Law for Renewable Energy

Illustration by Opto

been about getting around the apparent barriers that are going to limit the rate at which the technology can expand.” Then, as an example of how Moore’s Law became pervasive, Moore talked about the International Technology Roadmap for Semiconductors (ITRS). This was an industry-led, ongoing collaborative effort, organized in 1993 to identify ways to sustain technological momentum. In a fiercely competitive industry, the ITRS brought leaders together to resolve common technological problems — always in service of continuing the track record of exponential growth through innovation. “The companies all recognize they have to stay on this curve,” he added, “or get a little ahead of it.” There are many reasons to be skeptical about generating a similar dynamic with energy. Power generation and oil and gas are old industries, laden with legacy infrastructure. Many energy technologies, including photovoltaics, date back to the 19th century or earlier. Innovation involves such diverse fields as hydraulic mechanics, geologic mon-

itoring and sensing, and wind energy design. The companies involved are scattered and diffuse, and their interests often conflict. Most daunting, the expectations that drive the majority of energy investment today — including the assumptions of all-important institutional investors — focus not on technological progress, but on such external factors as the price fluctuations of oil, reserve replacement ratios, and government regulations such as carbon taxes or NIMBY (“not in my backyard”) restrictions. Although some investors promote clean energy, their sense of urgency is easily dissipated. Hightech companies see Moore’s Law as an existential imperative; if they fail to keep up, they lose much of their relevance. By contrast, there is little perceived punishment in the energy industry for failing to innovate. Indeed, in the past, energy companies tended to support only the kind of innovation that would improve the margins of their current business models. Thus, in 2009, when it looked as though the U.S. might pass a climate bill, both coal and oil companies were squarely behind the technology called CCS (carbon capture and sequestration), largely because it supported their embedded investments in oil and coal plants. Yet changes in economic, environmental, and demographic trends could lend credibility to the idea of a Moore’s Law equivalent in energy. The first major trend is global demand. Over the next 40 years, according to Jim O’Neill, the chairman of Goldman Sachs Asset Management and the economist known for coining the acronym BRICs, worldwide annual productive economic growth will triple. As billions of people enter the consum-

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effect on the industry. As a clear, credible, and widely accepted metric, it created an expectation that the doubling of computer power every two years would generate huge financial opportunities. Engineers and entrepreneurs organized themselves to realize these gains, attracting capital investment, which in turn spurred innovation. As the costs and prices of these successful technologies dropped, this created even higher expectations, driving more investment in innovation, and bringing more cost reductions. Moore’s Law acted as a powerful organizing principle for the semiconductor industry. Gordon Moore recognized this power; in an interview with television host Charlie Rose in 2005, he said that his law had “kind of become a self-fulfilling prophecy.” When Rose asked if Moore’s Law would ever become obsolete, Moore replied, “Talking to the Intel technologists, they think they can still see reasonably clearly for the next four generations. That’s further than I’ve ever been able to see. It’s amazing how creative the people have

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new interest in investment. There are even signs of Moore’s Law–style cost decreases in several energy sectors, though the pace is not as fast as it is in high tech. One example is natural gas turbines, used to generate electricity in power plants. Between 1955 and 1980, 10 consecutive doublings of gas turbine capacity occurred, reducing the cost 10 to 20 percent each time. During those years, the cost of a natural gas–based kilowatt dropped to about one-fifth its original price, adjusted for inflation. The researchers

ful economics brought new investment from capital markets, which allowed SunEdison to offer more types of franchised installations. The industry is still waiting for its Gordon Moore: someone with the credibility and insight to establish viable expectations about energy sourcing and usage that will drive investment and foster innovation. One could imagine proposing, for example, a 4/7 Rule: Between 2010 and 2050, the share of global energy supplied by solar technologies will double every four years and the

In both solar and wind technologies, costs have dropped 20 percent with every doubling of deployed capacity. who charted this — Arnulf Grübler, Nebojša Naki´cenovi´c, and David Victor of the International Institute for Applied Systems Analysis — also looked at data on Japanese photovoltaics, and found more than a 90 percent decrease in the cost of a kilowatt between 1973 and 1995. Another example can be found in the economics of solar installation business models. Over the years, the owners and managers of many commercial buildings have put off installing solar energy systems because of their cost expectations: huge upfront capital expenditures and ongoing operation and maintenance expenses. In 2003, however, a U.S. photovoltaic company called SunEdison removed those barriers by providing solar energy as a service. Customers could sign up for longterm electricity contracts at guaranteed pricing per kilowatt-hour with no capital investment (other than roof space) required. These success-

share supplied by wind technologies will double every seven years. That would be consistent with the historical record. During the 30 years from 1979 to 2009, according to Cleantech Blog writer John Addison, solar power capacity worldwide grew at an annual rate of 33 percent, and it is forecast to exceed 40 percent growth by 2020. Wind energy capacity grew between 25 and 40 percent annually between 2000 and 2010, according to wind energy research group BTM Consult. In both technologies, costs have consistently dropped 20 percent with every doubling of deployed capacity. If such cost curves could prove reliable, then one would expect to see solar and wind power costs by 2050 drop to about one-tenth the current rates, and wind power costs to about onefifth, without reliance on government subsidies. This growth, of course, will not be easy. Both solar and wind are

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er economy, annual global energy use will rise sharply — according to some estimates, from about three cubic miles of oil (CMO) in 2009 to between six and nine. (CMO is a measure of usage developed by SRI International engineer Hewitt Crane to enable comparisons of diverse energy sources.) At the same time, the use of fossil fuels will be increasingly restricted because of greenhouse gas emissions, and nuclear energy, especially after the Fukushima disaster, will continue to face regulatory and cost hurdles. Renewables are not yet technologically advanced enough to provide more than a tiny fraction of the global energy used today — in 2009, wind and solar together accounted for less than 1 percent of global energy production. Without a continuous cycle of innovation, driven by a model such as Moore’s Law, all the forms of energy supply put together may not be able to meet demand. Another trend is the increasing reliance on technological innovation by the energy industry. Conventional oil reserves, which are estimated to be as low as 35 CMO, will likely be exhausted by mid-century, whereas unconventional reserves from shale and tar sands are estimated to be as much as 300 CMO. Hence the continuing huge investments in coal, natural gas, and unconventional oil production technologies. And as several observers have noted, the technologies of solar and wind generation are not yet risk free for investors, but they have become diverse and sophisticated enough to create new markets for energy generation. (See, for example, “Renewables at a Crossroads,” by Christopher Dann, Sartaz Ahmed, and Owen Ward, s+b, Autumn 2011.) That itself is sparking

Reprint No. 00087

Andrew J. McKeon [email protected] is the founder and principal of BusinessClimate, a consulting firm specializing in business strategies involving climate change and sustainability, and the founder of the annual BusinessClimate conference.

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very land-intensive technologies with their own environmental footprints. Their growth is not sustainable unless the infrastructure is developed to support them, such as the capabilities to feed locally generated power into the grid seamlessly or to improve energy storage technologies. If transformational change does come to the energy sector, it will not happen in a vacuum. Consistent and thoughtful public policies on energy and carbon could foster the constancy of purpose required for the transformation away from a fossil fuel–based economy. Yet even with minimal regulations against carbon emissions, and the current low baseload capacity of solar and wind, renewables may well have the most potential among energy technologies for rapid growth and innovation. Like Moore’s original law, a 4/7 Rule for energy might need adjusting over time as new knowledge emerges, but the overall aim will remain unchanged: creating a clean, affordable, and secure energy future with huge growth opportunities, in which continuous innovation supplants oil price fluctuations or the reserve replacement ratio as the source of urgency for the industry. A rule like this, as Gordon Moore showed, can be both an indicator and instigator of breakthrough innovation — just the sort that is needed for energy over the next 40 years. +

Dazong Wang, CEO of one of China’s largest automakers, discusses how auto companies will keep pace with Chinese consumers’ appetite for cars. 10 by Sheridan Prasso

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ince Dazong Wang took over as president and CEO of the state-owned Beijing Automotive Industry Holding Company (BAIC) in 2008, the automaker’s profits have increased 700 percent and annual production has more than doubled, to 1.5 million vehicles. By 2015, the company plans to manufacture 3.5 million to 4 million cars per year — 5 percent of which will be electric vehicles. Despite the fact that in April and May 2011, auto sales in China declined for the first time in more than two years, the overall trend in sales is still growth. Sales in China are forecast to top 20 million this year, compared to just 13 million in the United States, and Wang is positioning the company to meet this demand. BAIC is also starting to introduce vehicles under its own brand for the first time: A microvan, the Weiwang, launched in March 2011. In late 2009, BAIC bought some of Saab’s technologies from General Motors and used them to design its own high-end vehicles that will roll out by the end of 2011. Wang started his career with GM in Detroit in 1985 after receiving his Ph.D. in engineering from

Cornell University. He returned to his native China in the 1990s to run GM’s subsidiary, Delphi, then came back to the U.S. and GM before returning home in 2006 to serve as vice president at GM’s joint-venture partner Shanghai Automotive — and subsequently going on to head its archrival, BAIC. This global experience will be put to use as BAIC seeks partnerships at home and abroad (it already has joint ventures with Daimler AG and Hyundai) to continue to expand its capabilities and know-how. This form of innovation — buying up old technology around the world, modernizing it, and adapting it to the Chinese

MIKA: PLS PLACE SPECTRA’S HIRES WHEN AVAILABLE

Dazong Wang

S+B: What do you see as the key trends that characterize China’s auto industry today? WANG: I see five. The first is con-

solidation. We still have too many automakers in China. The government has identified the country’s top eight auto companies and it is encouraging them to consolidate the industry through M&A. [More than 100 automakers are currently operating in the country.] Last year, BAIC and other companies made acquisitions in different parts of the country. This is going to accelerate. But this consolidation is not forced; it’s not government matchmaking. It’s based on each company’s own initiative. The second trend is Chinese domestic brands further increasing market share and improving their quality. Right now they have around 30 to 35 percent market share. Recently a J.D. Power and Associates study suggested that there is a gap [between domestic and foreign brands] when it comes to quality, but also noted that this gap will decrease pretty rapidly, and will be eliminated sometime between 2015 and 2018. The domestic brands have always had a cost or price advantage,

Photograph by Kevin Ng for the Committee of 100

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China’s Auto Industry Responds to Record Growth

market — is important, Wang believes. But even more important is business model innovation, in which automakers share resources and ideas to improve the auto industry as a whole. On the margins of a conference organized by the Committee of 100 (a nonprofit focusing on U.S.China relations) in New York in May, Wang spoke with strategy+ business about the trends that will define China’s auto industry and what Chinese automakers need to do to capture the opportunities.

ies get wealthier, you’ll see the market shift toward these cities. The fifth trend is that Chinese auto companies are getting increasingly global. Through external acquisitions, you will see them become more integrated around the world. We also want to do cross-border M&A, including in the United States. That is an important tool. S+B: The news behind all these trends is that more and more Chinese are now able to afford cars. What are the short-term and longterm implications? WANG: We think that today 230

million Chinese families can afford a car. Compared to the U.S., car ownership is still low. China has only 50 or 60 cars per 1,000 people, whereas the United States has 870 cars per 1,000 people. Ownership in China is one-third of the world aver-

age. But there is rapid growth. The forecast this year is for 20 million car sales [in China], and 40 million in 10 years. Certainly in the long term, this is not sustainable, for the environment in particular. So what do we do? We have to find alternative solutions. That’s why we talk about electric vehicles. This is one of the ways to solve this problem. Meanwhile, we continue to improve the efficiency of our current, conventional vehicles — giving them smaller, better engines and better transmissions, and making them lighter. You have to push hard on both fronts. Pollution is a concern, but cars are getting cleaner and cleaner. China will soon adopt the same emissions standards as Europe, which will help reduce fuel consumption. In the short term, inflation is a concern. Recent inflation data sug-

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so if you further increase the quality, you should see their market share increase. If the price is low and the car is good, people will buy it. The third trend is the rise of new-energy vehicles. This is an important part of our product plan, so we have set up a new-energy vehicle division. Last year we sold 1,300 electric vehicles, mostly buses and light-duty delivery trucks. This year we will extend that to eight electric vehicle models, including passenger cars. We now have 50 electric taxis operating in Beijing. Our goal is that 5 percent of our vehicles sales will be electric vehicles by 2015, or around 150,000 annually. Overall, you will see more and more of these types of vehicles. The fourth trend is a shift toward the interior cities of China. As first-tier cities like Beijing get more and more congested and interior cit-

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That’s the universal best practice. We have diversified the ownership structure so that the company can have better governance and decision making. From the government

“We have had a sevenfold increase in profit, so I worry about how I can maintain this growth.” about 55 percent. We are heavy consumers of steel, iron ore, and rubber. Rising prices will impact our costs and impact the consumer. Over the long term, my concern is how to make the company sustainable. Since I became CEO three years ago, we have had a sevenfold increase in profit, so I worry about how I can maintain this growth. S+B: You are part of a government plan to reform state-owned enterprises. As the head of a state-owned enterprise, how do you see this reform working? WANG: Government policy has

made clear that public ownership is the right direction. How far to go and how fast to go must be decided case by case. In our case, we partitioned our assets into four major groups by product: commercial vehicles, called Beiqi Foton Motor Company; passenger cars, called BAIC Motor Company; BAIC components, called Beijing Hainachuan Automotive Parts Company; and finance and services, known as BAIC Penglong. We have already done an IPO for Foton. The idea is to do IPOs for the rest over time. So Foton is now a public company, and we have 40 percent ownership. It’s important to have this modern enterprise governance structure.

standpoint, it’s more flexible too. The government still has some shares, but it’s more liquid. A diversified ownership structure has many advantages, and is more compatible with how the rest of the world conducts business. S+B: There’s been a lot of debate about China’s true innovation capabilities. How do you see them? WANG: There are many kinds of in-

novation. We are doing several things: One is building a new technology center for innovation capability development. Then we need product innovation. We use an open approach. In other words, we don’t need to start everything from scratch. That’s what we did when we purchased Saab’s technology for [US] $200 million, and we also purchased some development know-how to help us increase our innovation capability. Some Saab engineers are now working with us to support our efforts. In technology innovation, we are focused on new-energy vehicles. We also need business model innovation — that’s probably the more important type of innovation. We need to explore new models with others. The automotive industry needs to do a better job of working together, sharing resources, and reducing costs. You don’t have to do

everything on your own. You can share parts, share market distribution, share product development, and share manufacturing. The business model is actually the core of innovation. S+B: Multinationals complain that it’s difficult to find quality engineering talent in China. Has that been your experience? WANG: We have difficulty getting

really qualified engineering talent and management talent. We are trying to do so many things, to build so many plants, to develop so many products, to become a global company. The shortage of talent is a big problem. That’s why I see a lot of synergy between China’s automotive industry and Western companies, particularly in the United States. Many companies are facing difficulty in the U.S., but not because they don’t have the technology or management skills. It’s the market that presents a challenge. In China it’s the opposite — it’s a growing market, and yet we have a shortage of technology and of managerial and technical talent. There are opportunities here. We can form strategic alliances and joint ventures. We are interested in talking to companies both big and small. Everybody has partners already, but they could have multiple partners. For example, look at Toyota, look at Volkswagen. And look at us. We have multiple partners — we are partnering with Mercedes and with Hyundai. As long as it enables us to continue to win, we should explore these opportunities. + Reprint No. 00084

Sheridan Prasso [email protected] is a longtime Asia specialist. A contributing editor to Fortune, she is an associate fellow at the Asia Society in New York.

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gests we are at a 37-month high. The weakening dollar is also a concern, because China imports a lot of raw material. Right now in China, energy dependence from imports is

Financial institutions need new strategies — to rethink portfolios, customer-centricity, and risk — for the neglected side of their balance sheets. by Gauthier Vincent

Illustration by Joyce Hesselbirth

T

he great financial meltdown of 2008 unmasked a truth that management teams at banks and financial institutions had clearly lost sight of: The right side of the balance sheet matters. For many years leading up to the crisis, the financial-services industry by and large dismissed the importance of the right side. This is the part of the ledger that lists customer liabilities (for example, bank deposits and insurance premiums), debt, and capital — the money on hand to fund loans and other assets (the left side). Without the proper blend of liabilities to fund their assets, banks and financial institutions are vulnerable to economic upheavals, during which fearful clients may withdraw their deposits or capital markets may suddenly become unwilling to roll over an institution’s debt — and they risk sharp declines in shareholder value or even total or near collapse. This was the fate of Lehman Brothers, Bear Stearns, AIG, Citigroup, and Bank of America. Right-side strategies aim to find an effective mix of sources of funding on the right side of the balance sheet, taking into account their cost and duration in good and bad times, to support asset growth on the left side and adequately cover losses in

asset values. Through much of the past couple of decades, financialservices firms tended to ignore the right side because they were under pressure both to aggressively grow assets to drive improvements in revenue and earnings and to release “excess” equity to boost returns and enhance valuations. Moreover, the lack of transparency in the valuation of certain complex financial instruments (such as mortgage-backed securities and derivatives) along with loopholes in regulatory capital frameworks — for example, in the treatment of off-balance-sheet exposures — made it easier to neglect right-side strategies. Over time, this approach created elevated risk levels at some firms. In today’s financialservices environment, it is clear that sustainable shareholder value cre-

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The Right Side of Financial Services

ation (and protection) has as much to do with the right side as with the left side of the balance sheet. In short, right-side strategies matter more now than they ever have mattered before. To be fair, since the onset of the recession and the subsequent bank bailouts, the financial-services industry has made progress in recalibrating the importance of the right side of the balance sheet. Overall, industry capital ratios have improved. Some firms have reduced their reliance on more unstable sources of funding and increased the stability and duration of their borrowings. Moreover, lending business models that depended almost exclusively on capital markets for funding have all but disappeared. But most of those changes came in the immediate wake of the worst of the great financial meltdown; the urgency to craft long-term right-side strategies has begun to recede in recent months. And as the crisis mentality wanes and short memories take over, one thing is becoming more and more apparent: If there is another dramatic shock to the financial system, the outcome is likely to be just as devastating to the industry as it was in 2008.

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Shifting the Portfolio

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A portfolio strategy involves changing the blend of the company’s holdings through acquisitions and divestitures, or through other types of organic growth across the company’s businesses. When there is a rightside focus, this means increasing the

strategy came under attack as concerns suddenly surfaced about the credit quality of some of its assets. Almost overnight, the company faced resistance in capital markets to rolling over its debt. Its share price fell abruptly by nearly 50 percent, as many investors feared that the company could not survive much longer as a stand-alone entity. This near-death experience, several years ahead of the credit and funding crisis of 2008, became a blessing in disguise. It forced Capital One’s senior management to rethink the right side of their balance

Pursuing client-centric strategies at the business unit level can go a long way toward stabilizing the right side. influence of businesses that are rich in client liabilities or that require less capital, as well as shrinking businesses that mostly generate assets and drive up capital requirements. Capital One’s tale of near demise and subsequent revival illustrates the value of this approach. Through the 1990s, Capital One aggressively grew its base of credit card assets on the back of superior credit and segmentation skills. The company demonstrated an industryleading ability to plumb databases of potential clients and offer segmented demographic groups a range of credit cards with various rates and rewards. By the early 2000s, Capital One had leveraged these capabilities across new asset classes such as auto loans. To fund these accounts, Capital One’s strategy was simple: Rely primarily on bond issuances to match asset growth. But in 2003, Capital One’s

sheet to regain the confidence of Wall Street and the bond markets. After this reappraisal, Capital One acquired two retail banks: Hibernia and North Fork (in 2005 and 2006, respectively), two retail operators with large portfolios of plain-vanilla savings and checking accounts. These sticky, low-cost, and stable funding pools were precisely what Capital One needed to alter its balance sheet mix and provide longterm funding for its asset base. Just a few years ago, few would have thought that Capital One could withstand a credit crunch of any magnitude. Yet not only did the company hold its own throughout the industry collapse, but its share price outperformed those of most financial stocks. In fact, this retail bank acquisition strategy has worked so well for Capital One that the company continues to embrace it today, recently anteing up US$9 bil-

lion to purchase the online bank ING Direct. Capital One’s experience shows how portfolio strategies can strike the appropriate balance between “client asset rich” and “client liability rich” businesses. Relying solely on wholesale markets and brokered deposits for funding is no longer a solution for many consumer or commercial banks. Instead, access to low-cost, stable funding, such as consumer or commercial deposits or even pools of insurance, is essential to long-term viability. Of course, Capital One is now operating with retail banking businesses that are quite different from its core card business. It must thus develop the right set of business capabilities to be successful at these new businesses, lest its financial performance be weighed down by poorly run retail banks with poorly differentiated business models. Becoming Client-Centric

Pursuing client-centric strategies at the business unit level can go a long way toward stabilizing the right side of diversified financial institutions. A client-centric strategy involves a transition from emphasizing individual products for all types of customers to serving a broad range of financial needs for a particular group of clients. These clients often require loans and have liquidities to park with their financial partner, for instance in the form of deposits; they could represent a desirable blend of left- and right-side contributions to the balance sheet. Silicon Valley Bank, a midsized commercial banking firm, provides a good example of this strategy. Most of the bank’s asset growth in the last five to 10 years has come from venture capital clients. Working with these entrepreneurs, the

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Financial-services firms should consider three types of right-side strategies. They are built, respectively, on changing the company’s portfolio, becoming more client-centric, and using economic capital to help rethink risk and capital strategies.

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bank discovered that the venture capitalists were often at two distinctly different points in their funding cycles: Some had credit needs (for instance, before they could issue capital calls to their investors); others were flush with liquidity (for instance, after they had received investor funds and as they gradually put these funds to work). Recognizing the opportunity, Silicon Valley Bank implemented a client-centric strategy in which specialized sales and product teams pursued venture capital customers for both cash management and loan activity. The goal was to develop broader product development capabilities to serve both sides of the venture capital firms’ balance sheets, as opposed to merely trying to provide credit to them. By doing this, Silicon Valley Bank was able to fund its loans to venture capital customers with extremely low-cost and lowrisk deposits from other venture capital outfits. In choosing this client-centric strategy, the bank put itself in a strong position with stable, low-cost funding (two-thirds of its deposits are non-interest-bearing) and balanced growth in client assets and liabilities. This approach is also applicable to large, diversified financial firms, as long as they are willing to develop the appropriate new product and organizational capabilities. A good example of a major company that has begun to adopt a client-centric model in parts of its business is American Express. Long focused primarily on developing new charge and credit card products for its members, in recent years American Express has promoted a new brand called Open, which offers small businesses a wide range of services from credit cards to payments to social networking. By

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Rethinking Risk and Capital

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Observers outside the financialservices industry have long believed that banks and financial institutions were experts at managing risk and capital; it was generally accepted that their business model was driven by those skill sets. However, the credit collapse revealed that this was not the case. In the decade preceding the global crisis, risk and capital management had become more disconnected at many large banks and financial companies. Chief risk officers and their teams focused on managing risk exposures with little regard for the bank’s capital structure. Meanwhile, the chief financial officers and their teams exploited loopholes in regulatory capital frameworks to continually lower the cost of capital on hand and boost returns while largely ignoring increases in risk. A framework did (and does) in fact exist for tying risk closely to capital, but its importance was largely ignored. It is a concept known in the financial-services industry as economic capital. This set of algorithms and practices is used to translate a firm’s multiple risk exposures into the amount of equity capital that it needs to protect shareholders against insolvency. To minimize the chances of another financial-services meltdown — raising the specter of dozens of additional failed banks, big and small — boards and management

teams must take the lead and create a new risk culture in which economic capital is the organization’s currency of risk, right- and left-side capital strategies are tightly integrated, and the responsibility for managing risk and capital is broadly shared within the firm. For this to become a reality, several things need to happen: Boards and senior management must become more knowledgeable about right-side strategies and economic capital; economic capital algorithms and systems need to be upgraded to account for new sources of risk; economic capital must be an essential data point in all pricing and investment decisions at all levels of the organization; and performance assessments must factor in the cost of economic capital usage, not just profits. For many banks, this represents a difficult path; it entails a significant upgrade in their risk and capital management capabilities.

Because financial services is a highly leveraged industry, balance sheet management can never be neglected without dire consequences. The events of the last three years have reminded us that strong funding and capital positions are sources of long-term competitive advantage and value creation. They have clearly demonstrated that financial institutions can ignore right-side strategies only at their peril. The opposite is true as well. Banks that capably and actively manage both sides of the balance sheet will no doubt be the survivors — the industry leaders — well past the next global financial debacle. + Reprint No. 00089

Gauthier Vincent [email protected] is a senior executive advisor with Booz & Company’s financial-services practice in New York. He advises senior management at banks and financial companies on corporate strategy, managing for value, and business unit growth strategies.

Making Customer Segmentation Deliver As the ability to gather sophisticated data grows, here’s a four-step process for making segmentation drive improved performance. by Corey Yulinsky

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ew phrases have as much currency in today’s business-to-consumer (B2C) companies as the customer-centric organization. Although the particulars vary widely, most companies pursuing customer-centricity rely on some form of market segmenta-

tion. Segmentation provides insight into customer behavior, habits, and preferences, increasing the odds of success in marketing and experience management campaigns, and driving brand positioning and product development. For transaction-intensive industries, such as the airline, credit card, retail banking, retail, and telecommunications and wire-

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continuing to broaden its suite of offerings to small businesses, American Express may soon be in a position to access new pools of liquidity (for example, small-business deposit accounts) and greatly alter the corporation’s funding profile, perhaps relying less on capital markets.

Illustration by Heads of State

acquisition and retention. Crucially, they know how to manage the complexity that segmentation inevitably introduces to an organization, and how to capitalize on the insights it provides. We advise companies to take a four-step approach to segmentation: define the objectives of segmentation clearly, design the segmentation around those objectives, prepare a blueprint of the effects of the segmentation across the entire company’s decision processes, and carefully manage the necessary changes

that segmentation will demand of the organization. The goal is to ensure that segmentation leads to welldefined processes and actions that improve performance. 1. Define the objectives clearly.

The most important question for each company to ask: What is the purpose of segmentation? Understanding the purpose will enable decision makers to determine whether the segmentation effort is strategic, tactical, or both. Strategic segmentation is used for broad, enterprise-wide purposes — operating model design, branded customer experience, and overall value proposition development. It of-

ten becomes the basis for the design of the organization. Charles Schwab’s approach to segmenting investors by assets and desired relationship support level is one example. Many retail banks group their customers into income or asset classes such as affluent, mass affluent, and mass market, and others combine these classifications with insights relating to behaviors and channel usage. Tactical segmentation is used for a much more specific purpose, such as new customer acquisition, an upselling campaign, or channel migration. Among the successful implementers, the tactical segments map to the strategic segments in an explicit way. In fact, combining the strategic and tactical segments in campaign modeling produces substantial uplift; one bank was able to triple the profitability of a home equity line of credit (HELOC) crossselling campaign by tailoring its HELOC acquisition model and offer to a specific strategic segment. The notion of “horses for courses” — designing the segmentation around the specific business purpose — is apt here. Understand clearly which decision processes will be affected and which business partners need to be involved. 2. Design around the objectives.

The key to effective design is working back from the business decisions that need to be made. Once the objectives have been determined, the segmentation research itself must be rigorously designed to reflect them, and to ensure that the results will be insightful (they will tell us things we do not already know about customer behavior and needs), actionable (they will identify levers that will move behavior), and identifiable (they will be able to tag individual customers in the database with reliable segment

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less sectors, customer segmentation has become a critical capability in using the growing volumes of data on individual customer behavior to develop and implement successful go-to-market strategies. More B2C companies are striving to build customer-centric businesses, but will they be able to derive real value from their effort? A handful of companies — such as Charles Schwab in investments, Capital One in credit cards, and Caesars Entertainment in gaming — have had well-documented success. But other data-intensive companies feel their segmentation efforts have failed to deliver anything near the level of benefit they should. Even as they collect more information than ever before, these companies struggle with applying the insights afforded by segmentation to drive change and performance improvement. This paradox — that companies with the most data about their customers find it most difficult to use it — is likely to become more widespread as the digital transformation continues. Too often, companies develop segmentations that are based on conflicting business objectives, are not broadly understood or shared, or cannot be readily acted upon. Top managers must realize that a segment-based model requires rigorous execution. It will succeed only if it is embedded in the company’s overall strategy, crosses the boundaries of all business units and functional departments, and produces clear and actionable guidance. Companies that have implemented segmentation successfully tend to use it as a strategic context in designing their business models, as a touchstone for branding and value proposition development, and to guide processes such as customer

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it segmentation may not be very actionable, because in some industries, such as financial services, there are multiple routes to profitability. 3. Prepare a blueprint to operationalize the segmentation. Begin to

map out the decision processes by considering these questions: How is segmentation going to be used to influence the major value levers in your business? Will it underpin a redesign

view of the customer’s journey through the store. It is necessary to craft practical methods of delivering the required segmentation results that effectively conceal their analytic complexity from customer-facing staff, thus enabling productive faceto-face interactions with customers in real time. Subtle timing must be managed: Business partners need to be

Segmentation is more of a change management challenge than a technical or marketing challenge. of the brand and the value proposition or of frontline sales and service? Will it ultimately result in more tailored and dynamic online and direct marketing? How are the business and functional units responsible going to access the information and use it on a day-to-day basis? As soon as the outline of the segmentation permits, begin to define these process changes, share them with affected business partners, and formulate and discuss revised metrics that reflect the new capabilities. For instance, it is essential to work with the front line to define how it will modify today’s sales and service protocols to incorporate greater customer knowledge and targeted pitches. One large bank linked its strategic segments to targeted lead lists focused on explicit behaviors — crosssell leads, at-risk/retention leads, and acquisition leads — and instituted a new and more powerful sales pipeline management discipline. In another example, a major retailer redesigned the location, configuration, and staffing of its fitting rooms based on a target segment

engaged and prepared in advance, but not so far in advance that requisite changes are too theoretical or abstract. For executives at brokerages, for example, communicating the message that “We need to talk to segment X about 529s and Roths in the context of their families” is much more meaningful than “We need to be more segmented in how we are going to market.” Building on what’s tangible helps in configuring informed decision processes. 4. Manage the implementation process. Making segmentation de-

liver is ultimately more of a change management challenge than a technical or marketing challenge, but this point tends to be overlooked. The tools for managing change — targeted and tailored communications, sequenced to engender understanding, engagement, and acceptance — need to be deployed fully. Expectations must be managed from the start; too often these efforts begin with a “big bang” orientation that misstates the nature of the change required to capture the performance benefits of segmentation.

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membership). This implies that multiple dimensions — behaviors, attitudes, demographics, channel use and preferences, and profitability — must be incorporated to develop a full picture. In the past, difficult choices had to be made about which one or two dimensions drove segmentations, leading to, for example, heavily attitudinal segments that could not be identified or heavily behavioral segments that provided no insight into the causes of behaviors or the ways to influence them. New methodologies, such as the statistical modeling technique of latent class analysis, allow the synthesis of these different types of data — for example, transactional data, survey data, continuous variables, and discrete variables — into the same segmentation model. If designed properly, these methodologies yield identifiable segments that can be used to pursue new opportunities. Common examples include fast-food chains identifying their frequent users and wireless companies looking for “data hogs” who consume inordinate amounts of bandwidth. More sophisticated companies, such as some high-end retailers, add aspirational desires to the behavioral mix to identify and attract consumers who lust for the latest brand as soon as (or before) it hits the shelves. One detail to consider is how to approach customer profitability. Some companies use profitabilitybased segmentation, others incorporate profitability into the segmentation as a dimension, and still others use it as a criterion for choosing among potential segmentations based on their ability to discriminate among profitable customers. Each has its benefits and costs, but it is important to recognize that a pure prof-

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Corey Yulinsky [email protected] is a partner with Booz & Company based in New York. He has advised multiple leading providers of consumer financial services on customer-driven growth, analytics and capabilities development, and revenue improvement issues.

DATA POINT S

Winners in the New Digital Economy The balance of power in the digital economy has shifted. When Web 2.0 emerged after the dot-com bubble burst, service and content providers captured the lion’s share of profits. But between 2002 and 2010, according to a recent Booz & Company study, the digital players farthest from consumers — including telecom and publishing companies — lost profit share to those that are closest. Internet software and services companies that broadly aggregate and disseminate digital content, for example, lost money in 2002, but in 2010 took 4 percent of total profits (much of this attributable to Google); device producers claimed 11 percent in 2010 (up from 5 percent in 2002), thanks largely to Apple’s record growth. Companies across the digital value chain, the study concludes, will need to develop the right capabilities to bring them closer to the consumer. Total Profits in the Digital Economy, 2002 vs. 2010

2002 Total: US$498 billion

2010 Total: US$726 billion

Service Providers 76% Equipment Providers 1% Software Producers 4% Device Producers 5% Content Providers 13%

Service Providers 66% Internet Software and Services* 4% Equipment Providers 4% Software Producers 7% Device Producers 11% Content Providers 8%

* Sector operated at a loss in 2002. Note: Sums may not total 100 due to rounding. Source: “Profit Migration in the Digital Economy,” by David Standridge and Christopher Pencavel, Booz & Company white paper, August 2011, www.booz.com/profit-migration

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Most important, of course, is for leaders to lay out the business case for moving to a more segmentfocused set of processes. When employees ask, “What do you want me to do differently and why?” and “What’s in it for me?” leaders who respond with a clear message will dramatically enhance progress. In particular, painting a clear picture of how a segment-based strategy will enable frontline teams to deliver better customer experiences — and of the tools these teams will be provided to let them do so — has often proved a very powerful way to build buy-in and execution. This is usually best done by a combination of senior executives and field leaders on-site in stores and branches on a regular basis, serving as coaches and exemplars. At a time of increasing competition and the rise of new methods to capture immense amounts of data about customers, every company must raise its ability to anticipate and respond to customer needs and wants. Segmentation will be essential to the process of managing the complexity of continually evolving and fragmenting customer groups and their different demands. Creation of a company-wide operating model that can convert this flood of data to useful information in order to make better go-to-market decisions will be critical. Companies that achieve this will have a substantial advantage in making customercentricity more than a slogan. +

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Resetting the Cost Structure at Shell A senior finance executive explains how a zero-based cost management effort is leading to significant performance improvements. by Gerard Paulides

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or virtually every company, the need to manage costs is an imperative for sustained high performance. The need is especially acute now. After several recessionary years and a hesitant recovery, today’s business environment leaves no room for error. Indeed, in the oil and gas industry, recent and long-term trends suggest a period of continuing uncertainty. Demand for oil and gas is nearly impossible to predict, as industrialized economies revive in fits and starts and emerging economies mature, changing global trading patterns. Meanwhile, the supply side has its own question marks, as the impact of events like BP’s spill in the Gulf of Mexico, the post-earthquake

nuclear power plant accidents in Japan, climate change concerns, more stringent drilling regulations, and political turmoil in the Middle East add to the challenges and opportunities facing the oil and gas industry. Questions abound about where new energy sources and reserves will be found, and what the future energy mix will look like. Given these industry conditions, companies that fail to deftly manage revenue and costs will find themselves vulnerable to market and price fluctuations that are often out of their control. Consequently, in early 2010, Royal Dutch Shell PLC’s European Upstream leadership team decided to pursue a significant improvement in its cost structure, one that would have a substantial impact on the company.

We defined having a substantial impact as lowering the cost budget by 30 percent. In fact, the only aspect of our business that was off-limits was what we call HSE, or health, safety, and the environment; to achieve top performance in our industry, we must protect our workers and assets and the environment around them. Uncompromising HSE management is a prerequisite. It was obvious to me that traditional continuous improvement and lean efforts, many of them already widely adopted by Shell, would not be sufficient to meet the high expectations we had for our European business. I see continuous improvement in a big corporation as necessary in what I would call managing cost creep: reducing the 3 to 5 percent in additional costs or waste that most large companies seem to generate every two or three years. But continuous improvement alone wouldn’t do this time; we wanted a “hard reset” to make a significant difference. We wanted to achieve a real step change in cost levels and, more importantly, in the company’s approach to cost management. To establish the program, the executive vice president for Europe (equivalent to a CEO) and I (a CFO for exploration and production operations in Europe) put our full weight behind the initiative from Day One, by communicating the importance of resetting our cost base and spending behavior throughout the organization. We characterized it as a way to allow our teams to explore new revenue opportunities. We described cost reduction as a priority that was as important to our business as oil and gas production and hydrocarbon maturation. We articulated both the size of the cost management effort that we wanted and the

Illustration by Lars Leetaru

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mental reassessment of the entire business to answer these questions: Which activities and assets still fit with the company’s future goals and strategy, and which should be improved or eliminated? How much funding is required to support each necessary activity or asset at peak performance? And finally, which budgets must we alter to reach cost management targets? Simply put, in zero-based cost management, the budgets for assets, operations, functions, and departments are rewound to nil as a starting point so a fresh argument can be made for every funding and portfolio decision. The results of this focused cost management and reduction analysis were presented to the company’s leadership. After approval, a commitment session was held with the managers of each of upstream Europe’s functional groups that could challenge the findings. If those

Budgets are rewound to nil so a fresh argument can be made for every funding decision.

in fact it isn’t. We simply needed to have a series of pragmatic discussions among members of management, both upper level and midlevel, throughout the organization about where we thought the business was going in the next few years. The goal is to define a common reference point for everyone, a set of outcomes against which we can evaluate costs. Done well, this creates an environment for innovation and change by aligning people to a common goal. We didn’t conduct a wholesale reexamination of strategy. We simply asked, What are we trying to do as a company and which activities are needed to execute our plan? Stacked next to this was our new budget expectation or target of reducing costs by 30 percent. Also at this stage, we explored competitive repositioning of the portfolio. We ranked each of our assets by how well they were able to compete for capital and resource allocation within Shell at their current level of performance. This wasn’t an overly detailed exercise, but instead an effort to get an idea of where our best cost management opportunities would be found. Step 2. Zero-base the activi-

Often, when there is a special project, you go around the organization and ask, “Who is available to work on it?” But we felt that this effort was so critical to our success that we needed the best talent in the organization to oversee it and drive it to completion. This sent a message to everyone in the company that we were serious. The teams initially explored a series of cost-control frameworks, but the most powerful was a strategic approach known as zero-based cost management. This unique, holistic approach involves a funda-

groups did question the budget levels, a discussion ensued so they could reach a consensus. Ultimately, we obtained a commitment from these functional managers to meet the proposed cost limits, which were subsequently embedded in the business plan. A Three-Step Implementation

A zero-based cost management implementation can be broken down into three steps. Step 1. Reexamine the company’s goals and strategies. This

sounds dramatic and disruptive, but

ties. In this stage, we dove in deeply,

stripping all business areas down to zero and then going through the exercise of building them back up. To do this, we asked, What is the minimum resource required to run each part of our business — that is, to cover the cost of those activities necessary to comply with legal, corporate, and regulatory rules as well as to achieve production targets? These are the “must-haves”; all other activities are essentially discretionary and optional, or in the zero-based framework, “nice to have.” Given the risks and dangers of our business, HSE is

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timing (2011 through 2013). Moreover, we backed up our new cost estimates with benchmarks, such as unit cost of production, to illustrate our current performance, and where we could improve relative to our competitors and the top quartile in our industry. We and the wider leadership team involved in exploration and production of oil and gas in Europe put substantial resources behind this cost management campaign. We created two multifunctional teams made up of our most talented staffers — handpicked from a wide array of company functions, including technical, production, commercial, and finance — to identify cost opportunities and develop implementation plans. We freed these staff members from their day-to-day work for five weeks to spend 100 percent of their time identifying realistic cost management opportunities.

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Gerard Paulides [email protected] is the chief financial officer and vice president of strategy and finance for upstream in Europe at Royal Dutch Shell PLC. Also contributing to this article was Booz & Company principal Andrew Clark.

up centralized corporate standards centers that called on outside subject matter experts as needed. In our case at Shell, by canceling unused software licenses for the dozens of applications that we’d amassed over the years — such as geological imaging systems needed by only a small percentage of the people who had been given paid access to them — we were able to save millions of dollars without weakening operations in the least. Moreover, sunk costs can sometimes persuade corporate executives to keep projects alive, with the idea that shutting down a project essentially wastes the resources already invested in it. As appealing as this notion of avoiding waste may be, it is foolhardy if better value can be unearthed elsewhere, in another project or asset. Tough and intelligent choices must be made about all activities for the full long-term impact of zero-based cost management to be felt. Step 3. Adjust

budget

lines

for surviving activities. After the

“must-have” and “nice to have” activities were identified, we began the task of allocating the funding required to best manage our critical assets and projects. This means we actually lowered our budgets to match the expectations derived from the zero-based assessment. From this analysis, we could see whether after budgeting for all the activities core to our operations we could reach the 30 percent cost savings we envisioned. Had we failed to reach that goal, we would have had to pare back the discretionary activities and assets further. Clarity and Commitment

In undertaking this exercise, we learned relatively quickly that there

are many ways to challenge budgets for discretionary activities. For example, ask yourself, “Which activities can be simplified or aggregated?” Just because an activity is necessary doesn’t mean that it is being performed efficiently. In addition, similar activities may be duplicated across functions. Such cases may be widely known but remain unaddressed because changing them would be complicated, timeconsuming, or difficult politically within the organization. In the zerobased approach, these impediments should be circumvented, once and for all. For instance, we combined and reduced “nice to have” finance and services activities linked to oil well operations. At Shell, one of the key opportunities for cost efficiency was in rebalancing the work that we manage in-house and the work we contract out at our assets. We’ve increasingly embraced an outsourcing model for maintenance activities, but over time this has proven to be insufficiently flexible in reacting to market developments and business requirements and has resulted in additional costs. For instance, an integrated services contractor that performs a variety of tasks over numerous assets handles the frontline maintenance in our facilities. However, during our zero-based budget analysis, we realized that by bringing some of this work in-house, we could save on the cost of maintenance and reduce expenditures targeted for logistics and supervision. Particularly on offshore rigs, a tremendous amount of money is spent on moving contractors on and off the platforms and on coordinating their schedules. Consequently, at one offshore project, we found that by in-sourc-

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always a “must-have.” Much of what organizations do, however, involves an implicit choice about what to do above and beyond these “must-have” activities. Less imperative to operations, “nice to have” activities could in principle be eliminated without affecting the company’s license to operate. But the company’s competitive position may well be affected. As a result, “nice to have” activities must be separated into those that are needed to continue to support growth and marketplace performance and those that could be changed or even shelved completely. The ones we chose to maintain were certainly discretionary but were nonetheless considered distinctive and critical to our ultimate goal of being the most competitive and innovative energy company. In some ways, identifying the keepers is the easy part. Discerning which activities can be terminated demands a great deal of discipline and dispassion, and requires smart, diligent teams who can prepare the business argument for or against them. Often, certain activities are green-lighted and well funded year after year because that’s the way it has been done historically at the company, even though these activities may have outlived their usefulness. For instance, a business unit may have at one point established teams to adopt and implement global standards, but these groups may have been rendered essentially irrelevant when the company set

services, the routine back office– like operations, located in Shell operations centers in several locations globally. But using the zero-based lens, we were able to optimize our use of finance experts — who, among many other things, do costbenefit and appraisal analyses on assets and projects — by eliminating overlapping and redundant activities and spreading their work over multiple units. And we zero-based our nonoperated ventures, those in which

At one offshore project, by in-sourcing maintenance, and thus by simplifying logistics and supervision, we found real savings. forms dropped; hence, there was less worker exposure to potential health, safety, and environment risks. Once we brought more of our maintenance in-house, ancillary gains could be explored. We examined, for example, the frequency and nature of the shutdowns we scheduled for upkeep and repair. Inefficient patterns, like cost creep, tend to grow in an organization over time. We found cases in which an asset was shut down just prior to, say, a public holiday — which created an extended shutdown that wastefully added nonproductive days to the operations schedule and forced us to pay premium rates for workers and equipment. Besides the oil and gas production assets themselves, we found savings in each of the functions that provided support, such as finance, human resources, and IT. We already had shared financial

other companies manage oil and gas assets in which we have a stake. We interviewed the people in the companies running these joint ventures and asked, “When you look at Shell as a partner, what do you think we add to the operation? Are we efficient? Can we do better to help hold costs down? In what ways?” We also ranked these non-operated assets by five criteria: HSE risk, material value to Shell, Shell’s ability to influence operations, Shell’s confidence in the operator, and how well technology was applied. We then classified the non-operated assets into two categories: those in which we could have a real and lasting impact on the expense curve in a way that would improve Shell’s financial performance substantially and those in which we should basically be hands off. This allowed us to vary resource allocation, in both governance and activity budgets.

Implementing a Zero Base

Several critical attributes are necessary to make sure that a zero-based effort is embraced by the organization as an actual step-change tool. Among them: having visible management commitment; having clarity and transparency about specific expectations, deadlines, and savings; having dedicated resources to drive the program; and supplementing the effort with symbolic high-visibility interventions or events, including frequent management discussions that emphasize the importance of the opportunity to the company’s competitiveness. It may sound overly confident, but I was certain from Day One that our program would succeed, in part because I and the other managers were dedicated and committed to it and were not willing to accept failure or complacency. Not by being tough, but by being inclusive and committed, we created the environment for change and the motivation to deliver. It has taken 30 percent or more of my time to manage the process and to continually show that I am engaged, ready to communicate the appropriate management messages, and ready to direct the effort as needed. Because the program is being phased in over three years, the results are not yet in, but we are well on track to meet our goals. The zero-based approach is not a one-time event, nor is it self-propelling. But with the right mix of management support and diligent analysis, this approach will yield sustainable results that are impossible to achieve with even the most diligent continuous improvement campaign. + Reprint No. 11402

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ing maintenance typically handled by an outside contractor’s 30-person crew, we were able to improve costs materially. The Shell payroll and head count increased somewhat, but by fewer workers than the contractor employed because existing on-site teams could expand their responsibilities to handle some of the maintenance work. And thus by simplifying logistics and supervision, we found additional real savings. As importantly, the total number of workers spending time on drilling plat-

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A Better Way to Battle Malware Emulating the methods used to transform production quality could clean up the Internet — and might even pay for itself. by Tim Laseter and Eric Johnson

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undits proclaim the miraculous power of the Internet. It ushered in a “New Economy” and created a “flat world.” We even refer to our progeny as members of the “Net generation.” More than 5 billion devices are now connected to the Internet, accessing or serving up 500 billion gigabytes of information and transmitting 2 trillion e-mails per day. The decentralized structure of the Internet has ushered in a new level of worldwide connectivity, enabling product development teams to collaborate across the globe, banks to reach people in the developing world, and middle-aged divorcees to find their high school sweethearts. But this increasing connectiv-

ity has a dark side. Although spam recently dropped to its lowest levels in years, it still accounts for fully 75 percent of global e-mail traffic, 1.5 trillion messages per day. Every minute produces 42 new strains of malware — short for malicious software — including viruses, worms, and Trojans. An average of 8,600 new websites with malicious code are created each day, and 50 percent of results for the top 100 daily search terms lead to malicious sites. Until last year, 4.5 million computers were under the control of a single botnet that used these computers for nefarious means and disguised the malware presence by minimizing its impact on the computer’s performance and by eliminating other malware attempting to attack its network of computers. It was malware with its

own antivirus software. How then can we improve the safety and reliability of the Internet, an increasingly critical, shared global resource? As business leaders, managers, and individuals, we place our trust in the technical wizards in the back room who run the servers and write the code. We install antivirus software as directed and update other programs when told (at least when we have time to restart our computers). But the results suggest this isn’t enough. The best way to drive the kind of improvement in information security that would really clean up the Internet, we believe, is for corporate leaders and computer security professionals to reflect on the lessons of the manufacturing quality movement of the late 20th century. The methods employed by quality professionals — Six Sigma is an example — raised the visibility of the “cost of quality” and triggered a fundamental change in the philosophy of error prevention. Similarly, information security needs to be raised to the boardroom level, and the computer experts need to come out of the back rooms to engage all users to address the challenge. By doing this, we could collectively reduce malware to a level that does not put Internet-enabled advances at risk. A Short History of Malware

The origins of security concerns and computer malware are as old as the computer itself. In the earliest days, when computers were wired rather than programmed, companies generally secured these physical (albeit not virtual) behemoths in locked offices and buildings to prevent unauthorized access. In 1949, even before computers evolved to clearly separate

Illustration by Lars Leetaru

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technology

of the Internet — and the rising risk of information security — came with e-mail, the first sanctioned commercial use of the Internet. History credits Ray Tomlinson with inventing e-mail for Arpanet in 1971, but CompuServe, MCI Mail, and OnTyme first offered interconnected e-mail services to the masses in 1989. That same year marked the introduction of hypertext and the World Wide Web. Suddenly, the increasingly ubiquitous personal computers could share information through simple dialup services. By

fer productivity losses ranging from the minor intrusion of spam to the catastrophic malware-driven computer crash. Headlines make users increasingly wary of privacy risks as diverse as the relatively benign intrusion of cookies that track user behavior and the fear of identity theft through corporate hacking, such as the 46 million customer records breached in a 2007 incident involving retailer T.J. Maxx. Despite spending money on increasingly sophisticated tools, CIOs often feel like the Dutch boy

Corporate IT executives shop for literally thousands of security solutions. But individually, each provides little security. 1991, the number of host sites on the Internet stood at 600,000 — 10 times the number in existence three years before, when the Morris worm had wreaked its havoc. A year later, hosts passed the 1 million mark, and the number began doubling every three months. Over the following decade, distributed computing contributed to massive increases in productivity but also introduced a cybersecurity arms race. Empowered users added devices to the network while IT professionals sought to add firewalls and other forms of protection to block increasingly clever and malicious hackers. Today, corporate IT executives shop the aisles of the annual RSA conference in San Francisco for literally thousands of security solutions. But individually, each solution provides little real security. Similarly, individual users suf-

plugging the hole in the dike with his finger. Other senior executives rarely appreciate the magnitude of the risk or the amount of backroom work required to minimize that risk. Mostly, the CEO sees an evergrowing IT budget for a wide array of tools and patches, but no comprehensive solution. To change that dynamic, executives should reflect on the lessons of the quality revolution. While computer scientists were envisioning the opportunities of the Internet and the pending risks, quality professionals managed to recruit the executive suite and the masses to produce a sea change in attitudes about the importance of, and expectations for, product quality. Learning from Quality

Preventing the spread of malware presents a challenge similar to the elimination of errors in the opera-

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hardware and software, the leading theoretician of computing, John von Neumann, delivered a lecture on the “theory and organization of complicated automata,” which laid the foundation for both positive and negative impacts of software. His Theory of Self-Reproducing Automata (University of Illinois Press), published posthumously in 1966, explicitly addressed the idea of selfreplicating code. In fact, in 1980, Arpanet, the U.S. Department of Defense–sponsored predecessor of the Internet, shut down thanks to an accidentally propagated status message. In 1983, Fred Cohen intentionally developed a program that could “‘infect’ other programs by modifying them to include a possibly evolved copy of itself,” as he put it in his thesis, on the then-popular VAX family of minicomputers, which preceded the advent of personal computers. Drawing upon a biological analogy, he called the new program a virus. Taking a step beyond viruses, worms — the now-common term coined by John Brunner in his 1975 novel, The Shockwave Rider (Harper & Row) — began wriggling into the security landscape in the late 1980s. Whereas viruses simply infect a computer program (or files), worms go further by copying themselves between systems. Using security flaws known as back doors, worms propagate without the help of a careless user. The 1988 Morris worm penetrated and expanded on both DEC and Sun machines and infected about 6,000 of the 60,000 hosts on the nascent Arpanet. (Robert Morris, the worm’s creator, was the first person to be prosecuted and convicted under the 1986 Computer Fraud and Abuse Act.) A critical point in the evolution

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Tim Laseter [email protected] holds teaching appointments at an evolving mix of leading business schools, including the Darden School at the University of Virginia. He is the author or coauthor of four books, including Internet Retail Operations (Taylor & Francis, 2011) and The Portable MBA (Wiley, 2010). Formerly a partner with Booz & Company, he has more than 25 years of operations strategy experience. Eric Johnson [email protected] is professor of operations management at the Tuck School at Dartmouth College and director of its Glassmeyer/McNamee Center for Digital Strategies. He focuses on the impact of information technology on supply chain management and has published recent articles in the Financial Times, Sloan Management Review, Harvard Business Review, and CIO magazine.

shift from inspection to prevention. Although initially ignored in the United States, W. Edwards Deming, a statistician who became a noted management guru, introduced his philosophy in Japan during the military-led nation building after World War II. Managers from leading companies such as Toyota, Canon, and Sony eagerly applied the new tools to control quality at the source — and in the process transformed the image of Japan from a producer of cheap knockoffs in the 1960s to the gold standard of manufacturing prowess and product quality by the mid-1980s. The shift to prevention also led to a focus on root-cause analysis and problem solving. Statistical quality control charts separated normal, random variation from “special cause” variation. But that was just the starting point. Knowing that a spike in a chart isn’t random doesn’t tell you what caused the spike. Engineers and quality specialists needed tools to determine the root cause of problems in order to fix them. Two engineers-turned-consultants, Genichi Taguchi and Dorian Shainin, proved instrumental in translating the statistical concepts into practical tools during the 1950s and ’60s. Employed at Nippon Telegraph and Telephone during the period when Japanese companies were aggressively adopting Deming’s philosophy, Taguchi developed a methodology for finding root causes. The Taguchi method built upon classic experimental design methods developed by R.A. Fisher before World War I, but offered a more userfriendly package. Although some questioned the rigor of Taguchi’s methods, he was able to make accessible the testing of multivariate hypotheses, which armed a host of

engineers with a practical problemsolving technique. Shainin pushed practicality even further by famously exclaiming, “Talk to the parts; they are smarter than the engineers.” Rather than hypothesize potential causes and then design an experiment to test them, Shainin encouraged hands-on problem solving. He employed a method of paired swaps between a faulty and functional product to identify the “red X,” the one part most likely to be causing the problem. He appreciated that statistical methods could tease out subtle relationships and interaction effects, but his pragmatic problem solving focused on identifying and fixing the biggest issues rapidly. Philip Crosby helped ignite the modern quality movement by framing the problem in managerial terms with his 1979 book, Quality Is Free: The Art of Making Quality Certain (McGraw-Hill). Crosby challenged senior managers to quantify the true cost of quality, using a framework developed by Armand Feigenbaum that deconstructed both the cost of ensuring good quality and the cost of poor quality into four categories: prevention, appraisal, internal failure, and external failure. Crosby asserted that the total cost of these four categories could easily add up to more then 30 percent of a com­pany’s revenues, but most senior managers missed this problem, focusing instead on balancing the money spent on appraisal versus the cost of external failure. Thus, by Crosby’s calculations, better quality was “free” because investments in prevention could be funded by reducing the vast amount of money spent reworking internal failures and fixing or replacing defective products. Although Crosby did not

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tions realm, and we propose that the evolution of thinking about product quality offers managers useful lessons about how to eliminate malware. Expectations about product quality have shifted dramatically over the past 40 years. In the 1970s, consumers had become accustomed to buying new products, whether toasters or automobiles, that had been designed, built, and shipped with inherent flaws, and companies commonly sorted through supplier shipments to ensure an “acceptable quality level” (often 95 to 99 percent), which was deemed good enough for the captive consumers of that time. Today, consumers expect new products to work flawlessly from the moment they buy them. Companies no longer inspect incoming goods but hold suppliers accountable to delivering “Six Sigma quality” measured in parts per million, with single-digit targets. The quality transition did not happen overnight, however. The first evolutionary stage occurred with the introduction of statistical process control and the accompanying

nalism, he preached his 14 points of management and maintained a travel schedule beyond the limits of many people half his age until his death at 93. Over time, management provided the needed training and the empowering environment to allow employees to address quality issues through small incremental improvements and simple tools such as Ishikawa (or “fishbone”) diagrams to identify possible root causes and Pareto charts to focus on the critical few. But as Deming had predicted,

Today, consumers expect new products to work flawlessly from the moment they buy them. could simply create teams and empower employees to reduce quality errors. However, without the proper support, these early efforts evolved into sloganeering with posters admonishing employees to “Do it right the first time!” while management washed its hands of responsibility. Fortunately, Deming’s 1986 book, Out of the Crisis (MIT, Center for Advanced Engineering Study), spoke to the real management task at hand, on the basis of his experience in Japan: “Long-term commitment to new learning and new philosophy is required of any management that seeks transformation. The timid and the fainthearted, and the people that expect quick results, are doomed to disappointment.” An octogenarian at the time, Deming admonished managers and corporate leaders to accept responsibility for creating an environment that encouraged poor quality. With a subtle mix of humor and pedantic pater-

many leading companies eventually concluded that simple tools and frontline employees were insufficient to the task. To push for step-function rather than incremental improvement, in the mid-1980s Motorola developed Six Sigma and trained a set of technical experts, known as black belts, to apply more sophisticated problem-solving tools. General Electric CEO Jack Welch learned of the power of the methods from Larry Bossidy, CEO of Allied-Signal (now Honeywell) in the early 1990s and helped popularize the Six Sigma approach by training thousands of GE managers as certified black belts. Although most of the tools had existed in previous quality system manifestations, Six Sigma added a clear focus on quantifying the benefits of solving problems and investing critical time in getting stakeholder buyin to implement proposed solutions. Most importantly, Six Sigma

raised the bar of expectations for quality performance and made it everyone’s job. The language of “acceptable levels” of poor quality had been permanently erased from the business lexicon. The philosophic mantra of “zero defects” was replaced by the goal of Six Sigma quality, precisely defined as defects of less than 3.4 parts per million. And building on the Japanese notions of quality circles and continuous improvement, Six Sigma engaged the entire organization. Problem-solving black belts led the way, but a host of green belts, from frontline employees to senior managers, also participated. Quality and Information Security

If today’s managers adopted the approach taken by the quality movement toward product flaws, they could revolutionize how we tackle online security problems. The goals of information security are simple but daunting: ensure the confidentiality, integrity, and availability of information. Unpacking those three words reveals that we want information to be limited to the owners and to those they grant access. We don’t want the information to be changed without the owner’s permission, and we want to be able to access our information anytime we want. Achieving these goals requires maintaining control over both logical systems and their physical environment. We are all familiar with physical security. At home, we install strong doors that we lock, giving keys only to our family and friends. We install intrusion alarms that monitor doors, windows, or movement in the house. We examine travelers’ identities and use metal detectors and body scanners at airport entries to watch for terrorists. We install surveillance cameras to

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push the science of quality forward, he accelerated the application by articulating the dynamics in bottomline terms, thus elevating the issue into the executive suite. However, initial efforts toward a quality revolution in Western economies struggled to take hold during the 1980s. Many companies mis­ attributed Japan’s success to the use of quality circles, where small groups of frontline employees worked to drive continuous improvement through incremental change. Western managers falsely assumed they

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one-upmanship. Increasingly, malware reflects clear goals such as financial gain or social protest. The intentionality of malware provides a clear distinction between the two movements, but the lessons of the quality revolution remain relevant to malware nonetheless. Crosby’s notions of cost map well onto security. Firms invest both in

negative effects of excessive controls. Tight policies limiting use of new devices or unapproved applications offer greater security, but they also stifle innovation — something hard to quantify. After quantifying the full costs of information security, companies need to focus on the root causes. Although “denial of service” attacks

To date, no one has made a compelling case to assert that “information security is free,” but that may, in fact, be correct. prevention (education) and ongoing appraisal (penetration testing). Likewise, security failures lead to both internal costs (lost productivity) and external costs (fines and damaged reputations). To date, no one has made a compelling case comparable to Crosby’s to assert that “information security is free,” but that may, in fact, be correct. Understanding all of these costs offers an important step toward improving security; however, in this case, the objective is not hard quantification but a change in executive and organizational mind-sets. To move from the back room to the boardroom, information security specialists should employ a common, rigorous framework for quantifying the bottom-line impact of security breaches. Too frequently, senior executives are aware only of the cost side of the equation. They see growing investments in software tools designed to catch problems but rarely see hard quantification of the benefits of these controls. Even more unusual is a quantification of the

and botnets grab the headlines, the root causes of many security breaches include both benign and malicious insiders with access to sensitive information. So, just as retail stores check departing employees for stolen merchandise, data loss prevention systems watch for data moving on a corporate network. If an employee deliberately (or accidentally) tries to e-mail a spreadsheet of credit card numbers or product release plans, the system bars the door. Related monitoring tools scrutinize employees’ use of company data, watching for suspicious frequency, unexplained volume, or a particular combination of data. Other security tools help users make good security decisions, such as warning them if a hyperlink in an e-mail message appears fraudulent. In the words of Dorian Shainin, IT security experts need to “talk to the parts” rather than stay in the back room running system diagnostics. Users — the parts in information networks — rarely understand the true vulnerability inherent in

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watch for suspicious behavior. Many of these analogies carry over to the digital world. Firewalls limit access through specific doors, called ports. As e-mail passes into a corporate network and then a user’s machine, it is examined to see if it contains malware. Besides watching the doors, antivirus software continues to monitor suspicious files and activity. Identity management and access control systems require users to identify themselves and ensure users see only information they are entitled to see. Intrusion detection systems watch for hackers who have found a way into the network. And encryption is used for both data at rest (in storage on a hard drive) and data that is moving on a network to make it impossible to read without the appropriate keys in case it is stolen or lost. The history of information security offers some interesting parallels to the evolution of quality thinking, but also some critical differences. Both the similarities and differences provide insight in thinking about the growing challenge of Internet malware. As was the case with the quality revolution, the early practitioners of information security were technical experts, laboring in obscurity even as they battled the enemy. The quality statisticians, however, waged war against innate waste and error to reduce unintentional variation; the infotech security wizards have been fighting in an escalating and increasingly nasty war against an enemy with destructive intent. Early viruses generally reflected benign, often humorous attempts to demonstrate the fallibility of both humans and computers. Later, more malicious efforts appeared as a way to demonstrate technical superiority in a game of

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the connectivity of the Internet. Rather than keeping users in the dark and assuming that malware protection programs such as Norton and McAfee have everything under control, we need to educate frontline employees. Following the lesson of Taguchi, companies must empower employees with user-friendly malware protection tools. Information security cannot be the sole domain of the technical team. Users need to understand the real threats, and technicians need to appreciate the loss of benefits that results from overly restrictive controls. Taking a lesson from Six Sigma, security specialists need to focus on stakeholder buy-in, and to recruit advocates in the user community. Cybersecurity is everyone’s job, not just that of the CIO or security specialist. The increased visibility for management as well as users should be accompanied by higher expectations. Just as the quality movement led managers and employees to expect Six Sigma performance — and led consumers to expect that products would work right the first time and every time — so too must our society admit that current levels of cybersecurity are unacceptable. Do we really believe that an e-mail network consisting of three-quarters spam is acceptable? If we fully understood the untold costs of both lost productivity and needless investment in storage and bandwidth, we would also come to the conclusion that security is free. Once we — as a society composed of individuals, institutions, businesses, and government — accept the challenge, then we can truly move down the road toward an open, but safe, global community. +

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features innovation

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The Global Innovation 1000

Why Culture Is Key features innovation

by Barry Jaruzelski, John Loehr, and Richard Holman

Booz & Company’s annual study shows that Spending more on R&D won’t drive results. The most crucial factors are strategic alignment and a culture that supports innovation.

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Illustration by Leandro Castelao

The elements that make up a truly innovative com-

pany are many: a focused innovation strategy, a winning overall business strategy, deep customer insight, great talent, and the right set of capabilities to achieve successful execution. More important than any of the individual elements, however, is the role played by corporate culture — the organization’s self-sustaining patterns of behaving, feeling, thinking, and believing — in tying them all together. Yet according to the results of this year’s Global Innovation 1000 study, only about half of all companies say their corporate culture robustly supports their innovation strategy. Moreover, about the same proportion say their innovation strategy is inadequately aligned with their overall corporate strategy. This disconnect, as the saying goes, is both a problem and an opportunity. Our data shows that com-

panies with unsupportive cultures and poor strategic alignment significantly underperform their competitors. Moreover, most executives understand what’s at stake and what matters, even if their companies don’t always seem to get it right. Across the board, for example, respondents identified “superior product performance” and “superior product quality” as their top strategic goals. And they asserted that their two most important cultural attributes were “strong identification with the consumer/customer experience” and a “passion/pride in products.” These assertions were confirmed by innovation executives we interviewed for the study. Fred Palensky, executive vice president of research and development and chief technology officer (CTO) at innovation leader 3M Company, for example, puts it this way: “Our goal is to

features innovation 32

John Loehr [email protected] is a Booz & Company partner based in the firm’s Chicago office. He specializes in helping automotive, industrial, and aerospace companies reach a position of product and market leadership through a combination of product strategy and functional restructuring.

include the voice of the customer at the basic research level and throughout the product development cycle, to enable our technical people to actually see how their technologies work in various market conditions.” If more companies could gain traction in closing both the strategic alignment and culture gaps to better realize these goals and attributes, not only would their financial performance improve, but the data suggests that the potential gains might be large enough to improve the overall growth rate of the global economy. To that end, we continue to emphasize the key finding that our Global Innovation 1000 study of the world’s biggest spenders on research and development has reaffirmed in each of the past seven years: There is no statistically significant relationship between financial performance and innovation spending, in terms of either total R&D dollars or R&D as a percentage of revenues. Many companies — notably, Apple — consistently underspend their peers on R&D investments while outperforming them on a broad range of measures of corporate success, such as revenue growth, profit growth, margins, and total shareholder return. Meanwhile, entire industries, such as pharmaceuticals, continue to devote relatively large shares of their resources to innovation, yet end up with much less to show for it than they — and their shareholders — might hope for. Last year, we looked at the innovation capability sets companies put together, how they vary by innovation strategy, and which groups of capabilities can best enable companies to outperform their peers. This year, we took a different vantage point, analyzing the ways that critical organizational systems and cultural attributes support those capability sets that are most likely to promote innovation success. The results suggest that

Richard Holman [email protected] is a principal with Booz & Company based in Florham Park, N.J. He is a leader of the firm’s innovation practice, specializing in fields with highly engineered products, such as aerospace, industrial, and high tech.

Also contributing to this article were s+b contributing editor Edward H. Baker and Booz & Company senior associate Marc Johnson.

the ways R&D managers and corporate decision makers think about their new products and services — and how they feel about intangibles such as risk, creativity, openness, and collaboration — are critical for success. As part of this year’s study, we surveyed almost 600 innovation leaders in companies around the world, large and small, in every major industry sector. As noted, almost half of the companies reported inadequate strategic alignment and poor cultural support for their innovation strategies. Possibly even more surprising, nearly 20 percent of companies said they didn’t have a welldefined innovation strategy at all. Understanding these issues is particularly important now that innovation spending is on the rise again. After last year’s 3.5 percent drop in global innovation spending, the first-ever decline shown in the data we have tracked for more than a decade, R&D outlays have recovered. Spending among the Global Innovation 1000 surged 9.3 percent in 2010, thanks in great part to the perception of a worldwide economic recovery. (See “Profiling the Global Innovation 1000,” page 34.) The Alignment Gap

Issues of culture have long been of great concern to corporate executives and management theorists alike, whether they apply to companies as a whole or to selected areas such as innovation. The reason is obvious: Culture matters, enormously. Studies have shown again and again that there may be no more critical source of business success or failure than a company’s culture — it trumps strategy and leadership. That isn’t to say that strategy doesn’t matter, but rather that the particular strategy a company employs will succeed only if it is supported by the appropriate cultural attributes. So when

strategy+business issue 65

Barry Jaruzelski [email protected] is a partner with Booz & Company in Florham Park, N.J., and is the global leader of the firm’s innovation practice and its engineered products and services business. He works with high-tech and industrial clients on corporate and product strategy, product development efficiency and effectiveness, and the transformation of core innovation processes.

Exhibit 1: The Alignment Advantage Only 44 percent of companies surveyed have both highly aligned cultures and highly aligned innovation strategies, and it pays off in performance: They outperform on growth in both profits and enterprise value.

HIGH

Innovation Strategy and Cultural Alignment Matrix

44%

MODERATE ALIGNMENT

HIGH ALIGNMENT

27%

20%

LOW

LOW ALIGNMENT

LOW

MODERATE ALIGNMENT

Alignment of Business Strategy to Innovation Strategy

HIGH

Gross Profit

Enterprise Value

Indexed mean of normalized 5-year CAGR

Indexed mean of normalized 5-year CAGR AVERAGE ACROSS ALL COMPANIES

AVERAGE ACROSS ALL COMPANIES

49

45

42

44

LOW MODERATE ALIGNMENT ALIGNMENT

Source: Booz & Company

48

56 51

43

HIGH ALIGNMENT

LOW MODERATE HIGH ALIGNMENT ALIGNMENT ALIGNMENT

we approached the topic of culture in the context of innovation for this year’s study, our primary goals were to determine which cultural attributes were most critical to underpinning the focused capability sets required for each distinct innovation strategy that we have previously identified. The results are clear — and may explain why many companies have difficulty making their substantial R&D investments pay off. Overall, 36 percent of all respondents to our survey admitted that their innovation strategy is not well aligned to their company’s overall strategy, and 47 percent said their company’s culture does not support their innovation strategy. Not surprisingly, companies saddled with both poor alignment and poor cultural support perform at a much lower level than well-aligned companies. In fact, companies with both highly aligned cultures and highly aligned innovation strategies have 30 percent higher enterprise value growth and 17 percent higher profit growth than companies with low degrees of alignment. (See Exhibit 1.) On the other hand, companies whose strategic goals are clear, and whose cultures strongly support those goals, possess a huge advantage. 3M is a case in point. Palensky articulates his company’s innovation strategy clearly: “We call it ‘customer-inspired innovation.’ Connect with the customer, find out their articulated and unarticulated needs, and then determine the capability at 3M that can be developed across the company that could solve that customer’s problem in a unique, proprietary, and sustainable way.” Culture plays a critical role in this strategy, says Palensky. “For over 100 years, 3M has had a culture of interdependence, collaboration, even codependence. Our businesses are all interdependent and collaborative-

innovation features features title of the article

Cultural Support for Innovation Strategy

9%

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Profiling the Global Innovation 1000

Exhibit A: R&D and Sales

increase in R&D spending in 2010,

R&D spending rose 9.3 percent in 2010, returning to its long-term trajectory after 2009’s recession-induced decline.

especially in certain industries and among larger companies, confirms these companies’ continued willing-

1997 base year = 1.0

ness to invest in new and improved

3.0 R&D Spending

R&D

products and services to respond

2.5

spending

among the Global Inno-

vation 1000 rose at an annual rate

to ever more competitive markets

Sales

2.0

around the world. Fully 68 percent of companies increased spending in

1.5

of 9.3 percent to US$550 billion in

2010, compared with just 41 percent

1.0

2010, rebounding strongly from its recession-induced decline in 2009

in 2009.

R&D Spending as a % of Sales

R&D spending grew in all nine

0.5

— which had been the first fall in the

sectors we track, but the comput-

more than 10 years of data we have

2000

studied. This year’s total spend-

’05

ing and electronics, healthcare, and automotive sectors contributed the

features innovation

ing was also 5.6 percent above the

Source: Booz & Company

vast majority of the increase — 77

pre-recession total of $521 billion in

crease in corporate revenues, but

percent, or $36.1 billion — of the

2008, marking a return to the long-

this difference was logical, given

total increase of $46.8 billion. (See

term growth trajectory for innova-

that most companies had not cut

Exhibit B.) The biggest absolute in-

tion spending. (See Exhibit A.)

innovation spending in 2009 to the

crease in R&D spending was in the

The 2010 increase in R&D

same extent that they suffered de-

computing and electronics sector,

spending was less than the Global

creases in revenues and cut other

which remained the top spender

Innovation 1000’s 15 percent in-

expense areas that year. Thus, the

among all industries, making up 28

ly connected to each other, across geographies, across businesses, and across industries. The key is culture.” Despite their differences in performance, most Exhibit 2: Top Innovation Goals 34

’10

Superior product performance and product quality were seen as the most important goals by a plurality of innovators, with much less priority for other goals, such as the success rate of new products.

Perceived Importance of Common Innovation Goals/Outcomes Superior product performance Superior product quality Products customized to local markets and geographies Advantaged products and services Developing low-cost products Products developed for multiple markets Speed-to-market of product developmentand introduction Number of breakthrough products Success rate of new-product introductions MEAN RANKING OF IMPORTANCE

Source: Booz & Company

0

0.1

0.2

0.3

0.4

0.5 0.6

companies strongly agree on the strategic goals that matter most in achieving innovation success: “Superior product performance” and “superior product quality” were ranked number one or two by a plurality of more than 40 percent of all respondents. Other goals, such as “developing low-cost products” and “speed-to-market,” were given much lower priority. (See Exhibit 2.) Similarly, companies agree strongly on the cultural attributes that are most prevalent at their companies. More than 60 percent cited “strong identification with the customer” as among the top two, and 50 percent chose “passion for and pride in products.” The lowest ranked was “tolerance for failure in the innovation process.” (See Exhibit 3.) This finding, which contradicts some of the academic research on the subject, raises serious questions about companies’ real appetite for risk taking in their innovation practices. In general, companies also continue to show a range of significant gaps in how their strategic goals and cultural attributes contribute to performance and support their innovation. Companies that underperform their peers have much to gain if they can close these gaps and achieve much higher degrees of cultural and

strategy+business issue 65

W

orldwide

Exhibit B: Change in R&D Spending by Industry, 2009–2010

percent of the total. With 2010 rev-

The strong growth in 2010 R&D spending was dominated by gains in computing and electronics, healthcare, and auto.

increased spending on innovation

enues up 14.2 percent, the industry by 6.1 percent — to $16.9 billion. For

Exhibit C: 2010 Spending by Industry Computing and electronics, healthcare, and auto continue to dominate R&D spending — making up 65 percent of the total.

the first time in the years we have

$US billions

Computing and Electronics 28%

studied, however, no high-technolo-

Healthcare 22%

gy company was among the world’s Computing and Electronics

top three spenders on R&D.

Other 1%

In healthcare, R&D expendi-

$16.9

tures increased $10.4 billion, or 9 percent. This was the fastest rate

NET SPENDING INCREASE

among the top three industries in

$46.8

Auto 15% Telecom 2%

Industrials 10%

2010, in line with its 9 percent in-

Consumer 3%

Healthcare

$10.4

crease in revenues. That kept health-

Aerospace and Defense 4%

Auto

$8.8

care in second place among all in-

Industrials

$4.5

dustries in terms of its share of total

Chemicals and Energy

$2.3

Exhibit C.) And thanks to that high

Software and Internet

$2.2

Telecom

$1.3

growth rate, healthcare companies

20. (See Exhibit D, page 36.) For the

Aerospace and Defense

— primarily pharmaceutical firms

second year in a row, Roche Hold-

$1.1

— captured four of the top five spots

ing Ltd. headed the list, spending

–$0.3

on the overall list of the Global Inno-

$9.6 billion of its $45.7 billion in 2010

vation 1000, and eight out of the top

(continued on page 37)

–$0.4

Software and Internet 8%

Source: Booz & Company

Source: Booz & Company

strategic alignment. We believe the way to do so lies in gaining a greater understanding of the cultural attriExhibit 3: Top Cultural Attributes Companies agreed strongly on the two most important cultural attributes. There was less unanimity on the importance of other attributes, with very few citing tolerance for failure in innovation as essential.

Perceived Importance of Cultural Attributes Strong identification with the customer and an overall orientation toward the customer experience Passion for and pride in the products and services offered

Three Strategies

Reverence and respect for technical talent and knowledge Openness to new ideas from customers, suppliers, competitors, and other industries Culture of collaboration across functions and geographies Sense of personal accountability for any and all contributions to the innovation and product development process Tolerance for failure in the innovation process MEAN RANKING OF IMPORTANCE

Source: Booz & Company

butes that any given company needs to foster, given its particular innovation strategy. Soma Somasundaram, executive vice president of the Fluid Management segment at the Dover Corporation, describes the challenge this way: “Poor innovation performance is usually not caused by a lack of ideas or lack of aspirations. What some companies lack is the structure needed to effectively dedicate resources to innovation. It’s the lack of will to develop a strategy that can balance today’s need versus tomorrow’s.”

0

0.1

0.2

0.3

0.4

0.5 0.6

As in previous years, this year we classified the companies that responded to our survey into the three core innovation strategies via our online Innovation Strategy Profiler. The profiler characterizes a company’s innovation strategy based on its approach to incremental versus breakthrough innovation and the role that end customers play in defining future product needs. • Need Seekers actively and directly engage both current and potential customers to help shape new products and services based on superior end-user understanding. These companies often address unarticulated needs

features innovation features title of the article

Consumer Other

R&D spending, at 22 percent. (See

Chemicals and Energy 7%

35

Exhibit D: The Innovation Top 20 Roche Holding claimed the number one spot among the top 20 spenders for the second year running, and, for the first time, four of the top five slots were held by pharmaceutical firms.

Rank

R&D Spending

Company

2010 2009

Headquarters Location

Industry

21.1%

Europe

Healthcare Healthcare

2010, $US Millions

Change from 2009

As a % of Sales

$9,646

1.5%

1

1

Roche Holding

2

5

Pfizer

$9,413

20.0%

13.9%

North America

3

6

Novartis

$9,070

21.4%

17.9%

Europe

Healthcare

4

2

Microsoft

$8,714

–3.3%

14.0%

North America

Software and Internet

5

14

Merck

$8,591

53.0%

18.7%

North America

Healthcare

6

4

Toyota

$8,546

0.7%

3.9%

Asia

Auto

7

10

Asia

Computing and Electronics

8

3

Europe

Computing and Electronics

features innovation

Samsung

$7,873

23.2%

5.9%

Nokia

$7,778

–0.8%

13.8%

General Motors

$6,962

16.0%

5.1%

North America

Auto

Johnson & Johnson

$6,844

–2.0%

11.1%

North America

Healthcare

$6,576

16.3%

15.1%

North America

Computing and Electronics

Asia

Computing and Electronics

9

11

10

7

11

13

Intel

12

18

Panasonic

$6,176

10.7%

6.1%

13

9

GlaxoSmithKline

$6,127

0.3%

14.0%

Europe

Healthcare

14

15

Volkswagen

$6,089

19.4%

3.6%

Europe

Auto

15

12

IBM

$6,026

3.5%

6.0%

North America

Computing and Electronics

Sanofi-Aventis

$5,838

–4.0%

14.5%

Europe

Healthcare

Asia

Auto

16

8

17

19

Honda

$5,704

5.2%

5.5%

18

22

AstraZeneca

$5,318

20.6%

16.0%

Europe

Healthcare

19

17

Cisco Systems

$5,273

1.3%

13.2%

North America

Computing and Electronics

20

16

Siemens

$5,217

–1.4%

5.1%

Europe

Industrials

TOP 20 TOTAL:

$141,781

10.1% Avg.

11.2% Avg.

Source: Bloomberg data, Booz & Company

and then work to be first to market with the resulting new products and services. • Market Readers closely monitor both their customers and competitors, but they maintain a more cautious approach. They focus largely on creating value through incremental innovations to their products and being “fast followers” in the marketplace. • Technology Drivers follow the direction suggested by their technological capabilities, leveraging their sustained investments in R&D to drive both breakthrough innovation and incremental change. They often seek to solve the unarticulated needs of their customers through leading-edge new technology. Just as companies following any of these three strategies can succeed, so any company can manifest strong strategic and cultural alignment, no matter which strat-

egy it follows. A closer look at the survey results, however, does suggest that companies perfecting one strategy — the Need Seekers — are relatively advantaged. They consistently demonstrate better achievement on a number of strategic and cultural variables. Additionally, Need Seekers are more likely to financially outperform their rivals than companies following one of the other two strategies. Overall, for example, Need Seekers are more than three times as likely to report that their innovation strategy is strongly aligned with their business strategy as other companies. And Need Seekers perceived their performance in carrying out the two most critical innovation goals — “superior product performance” and “superior product quality” — to be much higher than did companies using either of the other two strategies.

strategy+business issue 65

36

(continued from page 35) revenues on innovation. That works out to an R&D intensity rate of more than 21 percent, 11 percentage points

Exhibit E: Change in R&D Spending by Region, 2009–2010

the rest of the world — continued to

China and India, although they account for a small share of total R&D spending, had by far the fastest growth rate.

ter having increased spending more

above the industry average. Automotive companies were also absent

boom, albeit from a small base. Afthan 40 percent the year before, Indian and Chinese companies almost matched that rate again in 2010, up-

38.5%

from the top-spender slots: Toyota,

ping their investments in R&D more

which had been number one in R&D

than 38 percent. And companies

spending for several years before

from other regions around the world

the recession, fell to sixth place in

increased their spending almost 14

2010, having increased its spend-

percent. (See Exhibit E.)

ing less than 1 percent in 2010, after

AVERAGE GROWTH

13.9%

cutting it almost 20 percent in 2009.

10.5%

Overall, however, the auto sector boosted spending by $8.8 billion, or 8 percent, in 2010, after having cut

5.8% India/ China

Rest of World

North Europe America

1.8% Japan

Source: Bloomberg data, Booz & Company

That kept it in third place among

The downturn in innovation spending in 2009 was a clear indication of just how difficult the economic environment had been for many companies; it was both surprising and encouraging that R&D spending fell as little as it did. Similarly, the

all industries in terms of total R&D

— all cut back. The turnaround was

healthy increase in 2010 shows just

spending. Revenues for the automo-

cautious in both Europe and Ja-

how determined companies are to

tive sector in 2010 were up 16.5 per-

pan, which increased spending at

keep competing for market share. If

cent over 2009.

rates significantly below the aver-

there is a note of caution in this year’s

The geographical distribution of

age of 9.3 percent. North American

data, it is an entirely justifiable one,

innovation spending tells an equally

companies, however, which had cut

given the all-too-gradual pace of re-

varied story. Every region increased

R&D spending by almost 4 percent

covery in some regional markets and

R&D spending in 2010, a significant

in 2009, increased their spending in

general uncertainty about the global

turnaround from the previous year,

2010 by more than 10 percent.

economy, which calls into question

when the three regions that make

Innovation spending by compa-

up the lion’s share of innovators —

nies headquartered in China and In-

North America, Europe, and Japan

dia — and to a lesser extent those in

innovation features featurestitle of the article

R&D outlays by 14 percent in 2009.

9.3%

whether this pace of R&D investment growth will continue in 2011. — B.J., J.L., and R.H. 37

As for innovation culture, more than 41 percent of Need Seekers said theirs strongly supported their innovation strategy, compared with just 7 percent of Market Readers and 14 percent of Tech Drivers. (See Exhibit 4, page 38.) These important distinctions were borne out in other ways as well. But the most notable was financial performance. Overall, Need Seekers were 30 percent more likely to report their overall financial performance as being superior to that of their peers than the other two models, and, on average, they appear to have a much better chance of outperforming the competition than either of the other innovation models. Our previous studies have consistently shown that companies using any one of these strategies can regularly outperform their peers, and that, although top per-

formers had an overlapping set of capabilities critical to success no matter which strategy they followed, those top performers also had developed a unique, focused set of capabilities essential to their strategy. In this year’s study, we viewed those strategic models through a different lens: which strategic goals and cultural attributes led to the greatest success within a given strategy, and how those goals and attributes contributed to the capabilities needed to achieve that success. Thus, for instance, whereas companies following any of the three strategic models have a common set of strategic goals and cultural attributes, Need Seekers ranked as their highest innovation goal the creation of “advantaged products and services,” and their number one cultural attribute as “openness to ideas from external sources.” These characteristics clearly lead to

Exhibit 4: Alignment by Strategy Model

features innovation

Companies following the Need Seeker model are more aligned than others, with 30 percent reporting high alignment of innovation and business strategy, and 41 percent saying their culture strongly supports innovation. How Closely Is Your Innovation Strategy Aligned with Your Business Strategy? HIGHLY ALIGNED

8%

How Well Does Your Company Culture Support Your Innovation Strategy?

8%

30%

7%

14%

31%

29%

34%

34%

STRONGLY SUPPORTS

41% 34%

33%

35%

38%

15%

20%

17%

16%

21%

18%

4%

3%

4%

4%

7%

6%

51%

39%

38 NOT ALIGNED

NEED MARKET TECH SEEKER READER DRIVER

NEED MARKET SEEKER READER

DOES NOT SUPPORT

TECH DRIVER

Note: Sums may not total 100 due to rounding. Source: Booz & Company

creating truly differentiated products by leveraging all potential sources of good ideas. Each of the other two models has its own corresponding distinct innovation goals and cultural attributes. (See Exhibit 5.) How do those key goals and attributes aid and abet the efforts of companies in each strategy to develop the capabilities they need to succeed? driving Technology

Over the four years since we began our analysis of the three models of innovation, the Technology Drivers

strategy has been the most frequently employed around the globe and across industries. And this year it continues to be the most common model among the world’s 10 largest spenders on innovation. Successful Tech Drivers can no longer depend solely on the ability of their researchers to develop ingenious products that consumers are dying to have. Now, in order to succeed, Tech Drivers must strike the proper balance between the pure R&D efforts that in the past led to high-tech breakthrough innovations, and the more market-oriented activities of their less tech-centered brethren. That’s why the most successful Tech Drivers, like Google, have developed both the capabilities shared by all outperforming innovators, such as the ability to translate consumer and customer needs into product development and engagement with customers, and the capabilities specific to their own strategy: a deep understanding of emerging technologies and trends, and the capacity to manage the life cycle of their products and projects. Few companies exemplify both the long history of technology innovation and the new, more customer-centric demands better than Hewlett-Packard Company. Famed for its critical role in the founding of Silicon Valley and its long history as a pioneer in a variety of technologies, HP has made a conscious effort to integrate its innovation efforts more tightly with the business, and to ensure that both its strategic goals and the innovation culture that supports those goals are aligned with that overall strategy. And although the company’s overall strategy may change as a result of the recent arrival of Meg Whitman as chief executive officer, the tight link with the innovation culture is likely to continue. The close alignment of innovation with the business

strategy+business issue 65

suCCessful TeCh drIvers musT sTrIke The proper balanCe beTween The pure r&d ThaT In The pasT led To hIGh-TeCh breakThrouGh InnovaTIons, and more markeTorIenTed aCTIvITIes.

agenda is very basic research looking 10 years into the future. Another third is tied to current products, so it looks maybe six to 18 months into the future. And the remaining third is in the middle — what we call applied research — which looks two to five years into the future and is tied to some applications, but not products.” That is entirely in keeping with the strategic goals of Tech Drivers: to ensure superior product performance and quality, at the lowest cost possible. And it goes without saying that the entire effort must be imbued with a stronger spirit of respect for technical talent and knowledge, as well as openness to ideas from external sources, including academic researchers from universities around the world. HP Labs makes a concerted effort to involve the company’s customers: It invites more than 500 customers a year in to see what its researchers are working

Exhibit 5: Top Goals and Attributes by Strategy All companies following any of the three innovation models share some of the most important innovation goals and cultural attributes. Each model, however, also has distinct goals and attributes.

Top Innovation Goals and Cultural Attributes

MARKET READERS Distinct innovation goal • Products customized to local markets and geographies Distinct cultural attribute • Culture of collaboration across functions and geographies

NEED SEEKERS

ALL THREE STRATEGIES

Distinct innovation goal • Advantaged products and services

Common innovation goals • Superior product performance • Superior product quality

Distinct cultural attribute • Openness to new ideas from customers, suppliers, competitors, and other industries

Common cultural attributes • Strong identification with the customer and overall orientation toward the customer experience • Passion for and pride in the products and services offered

TECHNOLOGY DRIVERS Distinct innovation goal • Developing low-cost products Distinct cultural attribute • Reverence and respect for technical talent and knowledge Source: Booz & Company

features title features innovation of the article

can be seen clearly at HP Labs, the company’s central research organization. Prith Banerjee is HP’s senior vice president of research and director of HP Labs, which has seven locations around the world. In this capacity, he both oversees the company’s researchers and works with its five major business units — each of which has its own R&D unit — to ensure the transfer of ideas and innovations into products and services. “[The] mission of HP Labs,” says Banerjee, “is fourfold. One is to create absolutely breakthrough technologies. The second one is around creating new business opportunities for HP. The third one is to advance the state of the art in whatever we do. And the fourth one is to engage with customers and partners.” To that end, says Banerjee, “We take a portfolio approach within HP Labs: A third of our research

39

Exhibit F: The 10 Most Innovative Companies

19 percent of respondents includ-

Innovation executives we surveyed again chose Apple as most innovative. Facebook edged onto the list at number 10.

spectively. (See Exhibit F.) This year,

Company

T

features innovation 40

R&D Spending 2010 $US Mil. Rank

his year, we again asked our

as % of Sales (intensity)

ing them among the top three, reFacebook entered the list for the first time, suggesting the growing power of social media as a rich source of innovation on the Internet. (Because

survey respondents to choose

1

Apple

$1,782

70

2.7%

Facebook is still private, however,

the companies they thought were the

2

Google

$3,762

34

12.8%

reliable financial data is not avail-

most innovative. And again, Apple Inc.

3

3M

$1,434

86

5.4%

able.) Altogether, the 10 most inno-

came out on top. Seventy percent of

4

GE

$3,939

32

2.6%

vative companies boasted signifi-

respondents named it one of the three

5

Microsoft

$8,714

4

14.0%

cantly better financial results over the

most innovative companies, and more

6

IBM

$6,026

15

6.0%

past five years than did the top 10

than half voted it number one — no

7

Samsung

$7,873

7

5.9%

spenders on R&D, especially when

surprise, given the company’s strong

8

P&G

$1,950

61

2.5%

results are considered in terms of

performance this year. The iPad con-

9

Toyota

$8,546

6

3.9%

earnings as a percentage of revenues.

n/a

Not reported

tinues to define the market for tablet

10

Facebook

Not reported

computers, and Apple has been vying

(See Exhibit G.) This year, we also looked at the

with the Exxon Mobil Corporation as

Source: Bloomberg data, Booz & Company

innovation strategies followed by the

most valuable company in the U.S. by

Chairman and CEO Steve Jobs.

top innovators. The results are strik-

market capitalization — a testament

Following Apple, again, were

ing, especially in comparison with

to the innovative vision of the late

Google and 3M, with 44 percent and

the results of the top spenders. The

on, and works directly with some customers on “customer co-innovation” projects at the farthest reaches of its research vision. This structure inevitably causes some tension with the business units — indeed, it’s designed that way. “We are intentionally trying to create trouble for our business units,” says Banerjee. “The businesses are looking in the short term for the next six months, next year. That’s why a third of our activity involves assisting them with their current problems. But two-thirds of our activity is to create disruptive technologies.” Because the business units continue to benefit from the short-term research, and are involved through the lab’s advisory board in developing what Banerjee calls “the wacky, crazy ideas,” they continue to support those ideas as potential breakthroughs. reading the market

The automotive supplier sector, hard hit by the recession and the problems plaguing the auto industry in general, has only recently begun to recover. Among the companies at the center of the upswing is the Visteon Corporation, which produces a variety of systems, including climate electronics, interiors, and lighting solutions, for the

world’s leading car manufacturers. Its business depends heavily on working with its customers to determine exactly what they need and then building those products as cost-effectively as possible. That puts Visteon squarely in the camp of the Market Readers, those companies that carefully monitor markets and listen to their customers in order to gauge what the market is looking for, and then work closely with suppliers and partners to provide it. As Tim Yerdon, Visteon’s global director of innovation and design, says, “Most people think about innovation as just adding technology products. But it’s more than that. What we’re doing is taking a step back, looking at our industry, and asking ourselves, ‘How do we enhance life on board the car?’ A lot of the innovation involved in that is now being done in collaboration both with our supply base and with our customers.” This approach is in line with the innovation goals we have identified among Market Readers, including customizing products for markets and making sure those products have a clear advantage in the market, in terms of both quality and cost. That, in turn, is supported at top-performing Market Readers by a culture that fosters collaboration across functions and geogra-

strategy+business issue 65

The 10 Most Innovative Companies

four most innovative companies, and six of the top 10, all follow the Need Seeker strategy (and Apple is the classic example). In comparison, only

Exhibit G: Top 10 Innovators vs. Top 10 R&D Spenders

Exhibit H: Need Seekers in the Top 10

The top 10 innovators outperformed on all three performance measures, especially on EBITDA as a percentage of revenues.

Companies following the Need Seeker model accounted for six of the top 10 innovators slots, but only two of the top 10 spenders.

Performance of Top 10 Innovators vs. Top 10 R&D Spenders Compared to Their Industry Peers in the Global Innovation 1000

Proportion of Strategy Models

two of the top 10 spenders are Need Seekers. (See Exhibit H.) We rather expected these results, given our findings that companies pursuing a Need Seeker strategy have a greater

TOP 10 INNOVATORS

HIGHEST POSSIBLE SCORE: 100

likelihood of success, thanks to their NORMALIZED PERFORMANCE OF INDUSTRY PEERS: 50

performance.

vative. Indeed, only three companies

40

Revenue Growth, 5-Yr. CAGR

EBITDA as % of Revenue, 5-Yr. Avg.

Market Cap Growth, 5-Yr. CAGR

results show, as we have been saying for years now, that success in innovation isn’t about how much you

Source: Booz & Company

spend, but rather how you spend it.

appear on both top 10 lists: Microsoft,

— b.J., J.l., and r.h.

Toyota, and Samsung. Overall, the

phies, and openness to external ideas. Together, these goals and cultural elements help sustain the set of capabilities that enable these companies to succeed. These capabilities include not just a willingness to pay attention to the market and work with customers but also to run a very tight product development ship, using capabilities such as product platform and resource requirement management. Says Yerdon, “In product development, we have a phase-gate process that goes through four different gates to achieve what we feel is an appropriate level of robustness in products and technologies that are developed for sale to a customer. It’s very highly governed and metricized.” But it is the effort to instill a culture of collaboration that has most transformed Visteon’s innovation efforts. Behind all the company’s innovation efforts — whether they be concept prototypes or new climate control systems — lies a big increase in the amount of collaboration that takes place, across functions, geographies, and joint-venture partners. It used to be, says Yerdon, that groups would work in the same building and never talk to one another. But Visteon teams have been working hard to change that aspect of their culture, in part because collaboration has become a necessary ca-

Source: Booz & Company

pability now that the various systems that make up cars have become so integrated.

features of the article featurestitle innovation

voted onto the list of the most inno-

LOWEST POSSIBLE SCORE: 0

52

SPENDERS

though six of the top 10 spenders are single pharmaceutical company was

54

51 40

It is also worth noting that alpharmaceutical companies, not a

20%

76

INNOVATORS

culture needed to achieve superior

TOP 10 R&D SPENDERS

60%

advantage at assembling the optimal set of capabilities and creating the

Need Seekers Others

seeking needs

As successful as many Market Readers and Technology Drivers are, there is something different about Need Seekers. It has to do with their strategy — working closely with customers to develop products and get them to market first. It has to do with their innovation goals — ensuring that those products have a distinct advantage in the market. And the best Need Seekers have put together a winning set of capabilities, including the judicious use of technology, a disciplined approach to product development, and the ability to generate deep insights directly from regular contact with end-users of their product. But what really sets the best Need Seekers apart is their ability to execute on their strategy — to combine all these elements into a coherent whole. As we have seen, the innovation strategy that Need Seekers follow is significantly more aligned than either of the other models, on average, and their culture is most likely to support their innovation efforts. Such companies are more profitable and boast higher enterprise value, and a

41

The Silicon Valley Advantage by barry Jaruzelski and

almost three times as likely to say their innovation strategies are tightly

ilicon Valley is famous for its

all companies. When asked whether

long history of leadership in

their corporate cultures supported

semiconductors,

Exhibit I: Strategy and Culture in Silicon Valley Silicon Valley companies are much more likely to have strong strategic alignment and cultural support.

soft-

their strategies, 46 percent of Silicon

ware, biotech, and other innovation-

Valley companies strongly agreed

based industries. But beyond its tal-

that they did, compared with only 19

ent base and access to capital, what

percent of all companies, more than

makes Silicon Valley unique? What

double the general population. (See

exactly is the celebrated “West Coast

Exhibit I.)

features innovation

culture of innovation”? In conjunc-

It may come as something of a

tion with this year’s Global Innovation

surprise that Silicon Valley compa-

1000, we worked with the Bay Area

nies are no more likely to follow a

Council, a pro-business consortium

Technology Driver innovation model

How Closely Is Your Innovation Strategy Aligned with Your Business Strategy? HIGHLY ALIGNED

How Well Does Your Company Culture Support Your Innovation Strategy? STRONGLY SUPPORTS

14%

19%

46%

54% 38%

30%

32%

29%

21%

29%

11%

11% 15%

of more than 275 companies in the

than other companies are. But that,

San Francisco Bay area, to identify

in our view, only strengthens our ar-

the strategic, cultural, and organiza-

gument: Like many other top inno-

tional attributes that have led to the

vators, Silicon Valley companies not

sustained success of this region. That

only have found success in creating

included segmenting the survey re-

pathbreaking new technologies, but

sults we received from Silicon Valley

are almost twice as likely as average

value propositions that will win those

companies in hopes of better under-

companies to have developed capa-

customers’ business.

standing what cultural and organiza-

bilities that provide a superior under-

tional elements make them different.

standing of the stated and unstated

matthew le merle

Silicon Valley companies do in-

needs of their end customers. It isn’t

[email protected]

deed stand out. We determined that

just about how many transistors you

is a partner with Booz & Company

they are almost twice as likely to fol-

can fit on a chip, but also about how

based in San Francisco. He works

low a Need Seeker innovation model,

such advances can lead to products

with leading technology, media, and

compared to the general population

and services that gain unprecedented

consumer companies, focusing on

of companies in our global survey

traction in the marketplace through

strategy,

— 46 percent versus 28 percent —

superior insight into customers, as

marketing and sales, organization,

whereas the proportion of Tech Driv-

well as the development of practical

operations, and innovation.

disproportionate number of these highly aligned companies are following the Need Seeker model. Need Seekers are different in other ways as well. Our study shows that significantly more of the technical leads at companies classified as Need Seekers report directly to the CEO, and that their innovation agendas are much more likely to be developed and clearly communicated from the top down. In the survey, they were nearly twice as likely to point to product development

14% NOT ALIGNED

14%

3%

DOES NOT SUPPORT

ALL COMPANIES

BAY AREA COMPANIES

5%

7% 7%

ALL COMPANIES

BAY AREA COMPANIES

Note: Sums may not total 100 due to rounding. Source: Booz & Company

corporate

development,

as the function with the most influence in their company’s power structure. And Need Seekers even outperformed in terms of the management of the innovation process: They rated their portfolio management processes highest for both consistency and rigor. The advantage of the Need Seeker model is evident when the biggest R&D spenders are compared with the most innovative companies. Just two of the top 10 spenders are Need Seekers, whereas six of the 10 most

strategy+business issue 65

business strategies — 54 percent, compared with just 14 percent among

computing,

42

the overall population. And they are

aligned with their overall corporate

matthew le merle

S

ers is almost exactly the same as in

Although their innovation strategies may differ, companies like Agilent, HP, and Visteon understand what it takes to excel at developing new products that will succeed in the market.

is evident in how the company gathers insights from customers and outside innovators alike. Researchers at the lab reach out regularly not just to academics, but also to customers like government labs, to help acquire a better understanding of the future of technology and its customers’ needs. Meanwhile, capturing insights on what customers need now is the responsibility of not just business unit researchers but all customer-facing employees. When asked what holds all this activity together, Solomon turns the discussion to culture. “There’s a very strong innovation culture throughout the com­ pany, and a culture of teamwork. Agilent really encourages that. Innovation is not just R&D in Agilent,” she says. “We’ve really tried to make clear that it’s about everybody questioning the status quo and looking to do something better than what’s been done before. Each year, we recognize and reward innovation through the Agilent Innovates program, with innovation categories ranging from customer satisfaction to employee- and market-centered contributions.” In many ways, Agilent’s innovation culture stems from its history as part of HP, but Solomon notes that the company has defined its own values. Now, she says, “the cultural areas we’ve really tried to strengthen are speed to opportunity, customer focus, and accountability. Innovation itself has always been a strength; but to really address customer needs more swiftly and to focus on the things that matter most are where the culture of this company is today.” The Cultural Imperative

Although their innovation strategies, and their relative performance, may differ, companies like Agilent,

features title features innovation of the article

innovative are: Apple, Facebook, 3M, GE, IBM, and Procter & Gamble. (See “The 10 Most Innovative Companies,” page 40.) Moreover, Silicon Valley companies are often viewed as Technology Drivers, but in fact almost half of the companies we surveyed that hail from the Bay Area are actually Need Seekers. (See “The Silicon Valley Advantage,” at left.) Agilent Technologies Inc. is one of those Silicon Valley Need Seekers. Formed as a spin-off from HP in 1999, the company concentrates on instrumentation and measurement solutions for the communications, electronics, life sciences, and chemical industries. CTO Darlene Solomon puts the distinction this way: “Agilent definitely has the technology focus in our roots, and we want to continue to be a technology leader, not a follower. But to succeed, you need to be balanced in terms of focusing on the customer and understanding the market. There is a lot of great technology we can work on, and no shortage of technical challenges. But we need to choose the areas where, if we make a contribution, the customer and business value that can result is clear.” The trick for Agilent, as for many other companies, is to balance short-term R&D with long-term thinking about the kinds of things that will need to be measured in five or 10 years. Says Solomon: “It’s really about making sure that we’re at the leading edge of where our customers are going in the near term, and more than 90 percent of that work takes place in the businesses. In Agilent’s research laboratories, we have to make sure that we are placing the right bets now so that we have the right technologies in the future, at the right time, when they’re needed.” This is a balancing act at which Agilent excels. It

43

the most successful innovators ensure that their culture not only supports innovation, but actually accelerates its execution.

features innovation 44

As has been the case in the past six editions of the Global Innovation 1000, this year Booz & Company identified the 1,000 public companies around the world that spent the most on research and development in 2010. To be included, a company’s data on its R&D spending had to be public; all data is based on the most recent fiscal year, as of June 30, 2011. Subsidiaries that were more than 50 percent owned by a single corporate parent were excluded if their financial results were included in the parent company’s reporting. For each of the top 1,000 companies, we obtained the key financial metrics for 2001 through 2010, including sales, gross profit, operating profit, net profit, historical R&D expenditures, and market capitalization. All sales in foreign currencies and R&D expenditure figures prior to 2010 were translated into U.S. dollars according to the average exchange rate in 2010. In addition, figures for total shareholder return were gathered and adjusted to reflect each company’s total shareholder return in its local market. All companies were coded into one of

nine industry sectors (or “other”) according to Bloomberg’s industry designations, and into one of five regional designations, as determined by their reported headquarters locations. To enable meaningful comparisons within industries, we indexed the R&D spending levels and financial performance metrics of each company against the median values in its industry. Global expenditures on research and development were estimated using data from the World Bank, the Organisation for Economic Cooperation and Development, the International Monetary Fund, and government research reports. To understand how innovation strategy, culture, and organization affect performance, we conducted a Web-based survey of nearly 600 senior managers and R&D professionals from more than 400 companies around the globe. The companies participating represented more than US$182 billion in R&D spending, or one-third of the Global Innovation 1000’s total R&D spending for 2010, all nine of the industry sectors, and all five geographic regions.

Each company was classified into one of our three innovation strategy models — Need Seeker, Market Reader, or Technology Driver — based on survey respondents’ answers to four profiling questions. We then asked respondents to rank their company’s most important innovation goals, cultural attributes, and organizational factors, as well as their perception of their company’s performance on each. We analyzed their responses using a variety of statistical methods that allowed us to distinguish the cultural and organizational attributes most prevalent among companies, depending on which of the three innovation strategy models they followed. Company names and responses were kept confidential (unless permission to use them was explicitly granted), but respondents were asked to identify themselves to allow the association of survey answers with financial metrics. We then conducted interviews with a subset of respondents, in order to gain a deeper understanding of the links among strategy, culture, and organization.

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Booz & Company Global Innovation 1000: Methodology

in converting innovation spending into marketplace results and superior long-term financial performance. + reprint no. 11404

online Innovation strategy profiler For an assessment tool from Booz & Company designed to help evaluate your company’s R&D strategy and the capabilities required, visit: www.booz.com/innovation-profiler.

resources Soumitra Dutta, “The Global Innovation Index 2011: Accelerating Growth and Development,” INSEAD, 2011, www.globalinnovationindex.org/gii: A report on the conditions and qualities that allow innovation to thrive, and the role it can play in a nation’s economic and social development. Barry Jaruzelski and Kevin Dehoff, “The Global Innovation 1000: How the Top Innovators Keep Winning,” s+b, Winter 2010, www .strategy-business.com/article/10408: Last year’s study showed how highly innovative companies outperform by focusing on critical capabilities and aligning them with their overall business strategy.

features title features innovation of the article

HP, and Visteon understand what it takes to excel at developing new products that will succeed in the market: an innovation strategy that’s tightly aligned with their overall strategy, a prioritized set of capabilities that match the strategy, and a supportive culture. Our analysis shows that a well-executed Need Seeker model, although it may be the hardest model to create, is also the most likely to deliver superior differentiation, profitability, and growth in enterprise value. That’s because it is the model most able to get to market first with products that address unarticulated customer needs through superior customer understanding, and the most likely to have the cultural attributes and cross-organizational alignment that can sustain its success. Yet even the most successful companies concede the difficulty of maintaining the cultures that led to their success. Palensky of 3M, certainly one of the most consistently innovative companies ever to exist, describes the challenge: “That’s the thing about cultures — they’re built up a brick at a time, a point at a time, over decades. You need consistency; you need persistence; and you need gentle, behind-the-scenes encouragement in addition to top-down support. And you can lose it very quickly.” The larger lesson for companies that struggle to convert their R&D expenditures into successful products, solid financial returns, and unassailable market positions is that it may not just be traditional factors like the innovation pipeline that need rethinking. Instead, companies should follow the lead of the most successful innovators in ensuring that the company’s culture not only supports innovation, but actually accelerates its execution. First, make sure that the innovation strategy is clearly articulated, and communicated throughout the organization from the top all the way down to the lab bench. Second, align the technical community with top management, and give the technical leaders a real seat at the executive table. Third, ensure that the innovation agenda translates into a tangible action plan, clearly linked to a short, focused list of capabilities that will allow you to stand out in the marketplace. The tighter the connections between strategy, culture, and innovation, the more leverage your company will bring to bear

Barry Jaruzelski and Kevin Dehoff, “The Customer Connection: The Global Innovation 1000,” s+b, Winter 2007, www.strategy-business.com/ article/07407: This study identified the three distinct innovation strategies: Need Seekers, Market Readers, and Technology Drivers. Barry Jaruzelski and Richard Holman, “Casting a Wide Net: Building the Capabilities for Open Innovation,” Ivey Business Journal, March/ April 2011: Why many organizations are unable to make open innovation work, and what they need to do to succeed. Zia Khan and Jon Katzenbach, “Are You Killing Enough Ideas?” s+b, Autumn 2009, www.strategy-business.com/article/09303: How companies can improve their innovation performance by getting their formal and informal organizations in sync. Paul Leinwand and Cesare Mainardi, The Essential Advantage: How to Win with a Capabilities-Driven Strategy (Harvard Business Review Press, 2011): How to construct a strategically coherent company in which the pieces reinforce one another instead of working at cross-purposes. Randall Stross, “The Auteur vs. the Committee,” New York Times, July 23, 2011: Why Apple’s leadership structure, with decisions reflecting the sensibility of Steve Jobs, is more conducive to innovation than the conventional approach of companies like Google. Booz & Company’s Product and Service Innovation practice: www.booz.com/global/home/what_we_do/services/innovation. For more thought leadership on this topic, see the s+b website at: www.strategy-business.com/innovation.

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loosely translated epigram of French novelist JeanBaptiste Alphonse Karr: The more things change, the more they stay the same. Although they cover a wide variety of topics and fields, just about all of the books featured in the seven essays ahead are rife with dissatisfaction. Many of their authors have tracked down root causes of the destruction of economic value and prescribed radical solutions for them. Judging by the fact that the expert essayists we recruited to cull this year’s stack of business books chose these particular titles, it’s fair to assume that they too would welcome change that alters the status quo. Professor of business ethics James O’Toole, who has contributed an unbroken chain of insightful annual essays since 2001, leads off with books that illuminate the social role of business. Karr-like, he finds that for all the change we experience, the defining characteristics of “good” companies remain the same over time — as does the inability of leaders to sustain them. Next, IMD professor Phil Rosenzweig brings his sharp eye for flaws in business logic to his survey of this year’s books on strategy. He chooses three books that eschew formulaic strategic approaches to focus on the fundamental questions executives must consider as they decide the direction of their company. David K. Hurst, author and our regular Books in Brief reviewer, takes on the always-packed shelves of new books on management. His picks illuminate the struggle for the future of Western management practice and thought — and suggest the kinds of changes, and their magnitude, that may be needed to ensure that we move beyond business as usual. Award-winning financial journalist David Warsh

picks the year’s best books on economics. He discovers many worthy forward-looking books, and focuses on one in particular that describes the oncoming mash-up of national economies, providing what may prove to be a durable framework for making sense of a global economy that will soon be four times its current size. Journalist Catharine P. Taylor brings two decades of perspective to her roundup of the year’s best books on marketing. She finds a trio of compelling books that reject conventional marketing “window dressing” for more socially responsible and engaging approaches, but adopting such approaches would clearly require some corporate reinvention. We placed this year’s choices for best leadership books in the capable hands of Barbara Kellerman, a professor at Harvard University’s John F. Kennedy School of Government. In her first best business books essay, Kellerman bypasses leadership theory for leaders’ lives, picking two biographies of American presidents and a presidential memoir that illuminate four lessons for better understanding executive effectiveness. Finally, strategy+business contributing editor Michael Schrage of MIT’s Sloan School of Management and London’s Imperial College returns to our pages with an essay on the best books on technology. His choices broaden our understanding of how people and technology interact and coevolve, creating innovation ecosystems in the process. Here are the year’s best business books. I hope you find them as worthy as we do and take some of their ideas to heart. If you do, we might not be reliving this same cyclical chaos 10 years hence.

— Theodore Kinni

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In 2001, when strategy+business published its first Best Business Books section, an irrationally exuberant investment bubble had recently popped and the business world was coping with a global recession. Now, as this feature enters its second decade, another irrationally exuberant investment bubble has popped and the global recession is back with greater ferocity. Apparently there is some truth to the

S BOOKS 2011 s +b’s TOP SHELF

Contents

Ethics and Aspirations Howard Schultz with Joanne Gordon, Onward: How Starbucks Fought for Its Life without Losing Its Soul (Rodale, 2011)

Ethics and Aspirations The Good Company Revisited James O’Toole

Strategy Richard P. Rumelt, Good Strategy, Bad Strategy: The Difference and Why It Matters (Crown Business, 2011)

Strategy Asking the Right Questions Phil Rosenzweig

Economics Michael Spence, The Next Convergence: The Future of Economic Growth in a Multispeed World (Farrar, Straus and Giroux, 2011) Marketing Simon Mainwaring, We First: How Brands and Consumers Use Social Media to Build a Better World (Palgrave Macmillan, 2011) Leadership Ron Chernow, Washington: A Life (Penguin Press, 2010) Technology Kevin Kelly, What Technology Wants (Viking, 2010)

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Management The Battle for Management’s Future David K. Hurst

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Economics A Dismal Outlook? David Warsh

best books 2011 introduction

Management Roger L. Martin, Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL (Harvard Business Review Press, 2011)

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Marketing Marketing Reenvisioned Catharine P. Taylor

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Leadership Learning to Lead the Old-Fashioned Way Barbara Kellerman

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Technology The Ecology of Technology Michael Schrage

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Illustrations by Peter Hoey

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Howard Schultz with Joanne Gordon, Onward: How Starbucks Fought for Its Life without Losing Its Soul (Rodale, 2011)

Michael Beer, Russell A. Eisenstat, Nathaniel Foote, Tobias Fredberg, and Flemming Norrgren, Higher Ambition: How Great Leaders Create Economic and Social Value (Harvard Business Review Press, 2011)

ETHICS + ASPIRATIONS The Good Company Revisited by James O’Toole Not since the 1980s has so much been written about the social role of business enterprises. An Internet search of such key terms as business purpose, values, ethics, responsibility, and sustainability yields page after page of references to recent articles in business journals, of both the popular and scholarly persuasions. This renaissance of interest in the topic is also reflected in a bumper crop of books published during the last year, the quality of which runs the gamut from the sublimely inspiring to the patently ridiculous.

A Perfect Brew The pick of the 2011 harvest is Howard Schultz’s Onward: How Starbucks Fought for Its Life without Losing Its Soul, the renowned coffee purveyor’s tale of how he resuscitated the global chain after it nearly expired during the recent recession. Most business readers will be familiar with the story: Over 37 short years, Seattle’s little coffee shop expands around the world, growing to some 17,000 outlets, seemingly two on every block in major cities. During this time, Starbucks can apparently

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Edward E. Lawler III and Christopher G. Worley, with David Creelman, Management Reset: Organizing for Sustainable Effectiveness (Jossey-Bass, 2011)

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when things go awry. Schultz is far from perfect: He acknowledges making egregious product decisions against the advice of his management team, and although he tries hard to show humility, delegate authority, and be patient with subordinates, it’s clear he doesn’t always succeed in these endeavors. Nonetheless, he’s about as humble as American top executives get. Of course, the measure of corporate leaders is not what they say, not how nice they are, not even the extent to which they have their egos under control. What matters is how they act, and by that metric Schultz shines. Consider a few things he did in the midst of his company’s financial crisis — and while stockholders, Wall Street analysts, and business journalists were carping about his every move. He started by being honest with everyone about what the company’s problem really was: Starbucks had lost sight of its values and, thus, was shortchanging its customers. In the past, the company’s goal had been to make “the perfect cup of coffee” for every customer, but Schultz acknowledged that its focus had shifted to generating growth at all costs to satisfy “the Street.” To show he was serious about restoring the quality of Starbucks coffee, Schultz shut down all the company’s 7,100 North American stores for a barista video training session one Tuesday afternoon in February 2008. And to ensure that “the romance of coffee” would once again be central to the company’s culture, he brought Starbucks’s 11,000 store managers to New Orleans (at a cost of $35.5 million) for a week of discussions about the firm’s values, problems, and potential. Because one of those prime values was balancing profitability with a social conscience, the managers spent a day in the city’s Hurricane Katrina–devastated neighborhoods, where they donated 50,000 hours of community service. And, even as Starbucks’s team worked to cut costs and boost profits, the company redoubled its efforts with regard to the ethical sourcing of coffee beans and its complementary microfinancing and community development programs in impoverished rural areas. That’s all impressive stuff, but to my mind, Schultz’s actions have been most admirable in the are-

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do no wrong. The chain becomes so successful that its founder and CEO, Howard Schultz, feels comfortable enough to kick himself upstairs to the chairman’s office and turn the company’s operating reins over to his chosen successor. All seems right in Schultz’s world until 2007, when suddenly everything goes wrong. Just as the global financial crisis looms, Starbucks hits the wall, suffering from over-expansion and a widely perceived decline in the quality of its products. Customers disappear, the stock price drops from US$26 to $7 a share, and about $21 billion in market value evaporates in 10 months. With Wall Street bears predicting the company will go belly-up (one rumor has McDonald’s acquiring it in a fire sale), Schultz does exactly what the experts counsel against: He un-retires as CEO and moves back into the corner office. On one level, Onward is Schultz’s explanation of why he chose to return to his old post and a chronicle of what he did to get Starbucks back on track. He reports in considerable detail the pain of terminating some 6,700 jobs, closing 800 stores, and bidding adieu to the CEO he had recruited to succeed him. He then describes the managerial steps he initiated to restore the company to its former, profitable self. But that turns out to be the least interesting part of the book, particularly for those familiar with the efforts of other CEOs who have had even greater managerial obstacles to conquer, such as the transformational challenge Louis Gerstner faced at IBM, which was, comparatively speaking, a colossal wreck when he assumed command in Armonk in 1993. Doubtless, Schultz’s task felt overwhelming to him, and he deserves much credit for leading a fast and full business turnaround, but that’s not the main reason to read his book. What is special about Onward is that Schultz comes across as an authentic avatar of socially responsible capitalism. He seems to be a business leader of great conscience who tries always to do the right thing, practice what he believes in, and stick to his high principles in bad times as well as good. He is also that most unusual of celebrity CEOs — one who admits his mistakes, says he is sorry, and takes personal responsibility

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widely recognized for their social commitments and ethical practices. Today, only a half dozen of the companies — Johnson & Johnson (J&J), Dayton-Hudson (now Target), Cummins, Xerox, W.L. Gore, and Herman Miller — are still in existence, still financially successful, and still practicing something like their original virtuous behaviors. Of those companies, J&J and Herman Miller had their commitment to virtue severely tested over the years, and Cummins and Xerox saw that commitment considerably weakened by new CEOs. More recently, three of yesterday’s exemplars of corporate virtue — Toyota, BP, and Goldman Sachs — have had their once-sterling reputations badly tarnished, and two of the most radically progressive models of social responsibility — Ben & Jerry’s and the Body Shop —

Schultz’s actions seem focused on institutionalizing Starbucks’s culture, so it will live on long after he leaves the C-suite. lost much of their uniqueness when they were acquired by companies with more conventional business philosophies. Hard as it is to do good, it seems harder still to sustain that behavior.

Nuts and Bolts The practical challenge of making good business practices endure is usefully addressed by Edward E. Lawler III and Christopher G. Worley in Management Reset: Organizing for Sustainable Effectiveness. Unlike most “eco-groovy” books published this year, Reset is research based, is realistic, and deals with the nuts and bolts of organizational management. And unlike other sustainability texts, this one doesn’t argue why companies should be economically, socially, and environmentally responsible; instead, it deals with how a company should be managed to achieve those ends. In effect, the authors’ starting point is where Schultz leaves off: They are seeking to overcome the tendency of good companies to fail because they are not as strategically and organizationally agile as they are socially responsible. The authors group evidence for the sustainable management practices they advocate into four core business components: the way value is created (the formu-

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na of employee relations. Schultz, we recall, grew up in Brooklyn’s housing projects, the son of a blue-collar worker who never made more than $20,000 a year. As a direct witness to the psychological injuries that too often result from low-level employment — as well as the physical injuries and the absence of health insurance and workers’ compensation to pay for them — Schultz vowed he would become the “good employer” his father never had. From Day One, Starbucks has offered the highest pay and most generous benefits (for part-timers, too) in the fast-food industry. Even when the company was hemorrhaging red ink, Schultz announced that Starbucks’s employee stock ownership and health insurance programs were sacrosanct. Now that the company stock is trading near its all-time high, Schultz continues to engage in some rather unusual CEO behavior: He keeps reminding his 200,000 employees about the lessons Starbucks learned from its near-death experience. He says they must never forget that complacency and hubris are dangerous by-products of success; success must be re-earned every day by exceeding customer expectations; it is necessary to stay, and think, small even in a big corporation; growth needs to be disciplined and not subject to irrational exuberance; having passionate people is more important than having a robust strategy, ergo, treating employees with respect must be the company’s first order of business; and, although strategy, products, and policies need to be continually reexamined, Starbucks’s commitment to its basic values must be constant. Nothing original there, perhaps, but unusual in that Schultz’s actions seem to match his words. That’s called integrity, and Schultz sees that ethical virtue as a wellspring of the trust that motivates employees to make that little extra effort to prepare the perfect cup of coffee. Although he doesn’t explicitly say so, Schultz’s ongoing leadership actions seem focused on institutionalizing Starbucks’s culture, so it will live on long after he vacates the C-suite. Schultz has good reason to be concerned: Not only were Starbucks’s values quickly diluted after he stepped down as CEO, but history shows that few companies are able to sustain highly responsible cultures after their founders step down. In the 1980s, I undertook a study of some two dozen firms

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The Leader’s Role Curiously, there no longer seems to be much discussion about whether or not business should play a social, as well as an economic, role. Indeed, leaders of major global companies today feel compelled to at least lay claim to a “socially conscious” mantle. That’s probably why esteemed Harvard Business School professor Michael Beer (along with no fewer than four coauthors) skips the “why” foreplay and jumps directly into descriptions of the leadership practices of 36 current and past CEOs in Higher Ambition: How Great Leaders Create Economic and Social Value. The authors offer breezy reports of their interviews with this “sample” of executives from a mixed bag of

companies, including a few widely recognized for their social contributions (Tata, Cummins, Herman Miller); many better known for their managerial excellence than their social practices (Southwest, Medtronic, Asda); and one or two, like Nestlé, with records of questionable social performance. The book is significant, I suggest, because it accurately reflects the way that many leaders of large multinationals demonstrate their social consciousness: They assert it. Neither the executives interviewed nor Beer and his colleagues make direct reference to specific social programs, practices, or policies at their 36 exemplar companies (with the notable exception of Tata’s well-documented attempts to alleviate poverty in India). (See “Too Good to Fail,” by Ann Graham, s+b, Spring 2010.) Instead, what they document is that leaders of these companies create great places to work and engage in most of the familiar progressive management practices described in detail elsewhere by the likes of Tom Peters, Jim Collins, and Beer himself. The authors take the 36 leaders at their word when they say they engage diligently in developing the leadership capacities of their organizations, use values as the glue in their corporate cultures, hold subordinates accountable for their actions, focus on execution and implementation, spend inordinate amounts of time in two-way communication with associates, and exercise team leadership. The executives also claim to listen to their associates, show them respect, and involve them in managerial decisions. And readers are assured that these leaders share the admirable character traits of humility and ethical integrity, all while being “uncompromising” (differentiating them, of course, from “rigid and inflexible” executives). Most important, the leaders confess to having well-developed stakeholder orientations and deep dedication to some higher social purpose that serves to motivate their troops and generate institutional loyalty (creating, in the words of Nokia’s Jorma Ollila, “a feeling that, gee, we can do something really good”). I doubt none of this, and would have been surprised only had the authors found otherwise. Indeed, it is useful to reinforce the importance of such familiar

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lation of strategy and competitive advantage), the way work is organized (the design of structure and systems), the way people are treated (how employees are recruited, developed, and rewarded), and the way behavior is guided (the role of leadership and corporate culture). They then disaggregate those categories by examining what social scientists have discovered about such practical tasks as strategy creation, board governance, organizational design, and management systems and rewards. I am no fan of how-to books, but this one overcomes the main weaknesses of the genre by offering a balance of rigorous intellectual theory along with concrete examples (from companies including Procter & Gamble, W.L. Gore, Patagonia, Southwest, UPS, and DaVita) to illustrate the practicality of the authors’ ideas. Nonetheless, there is much to be said about this subject that Lawler and Worley (incidentally, my former university faculty colleagues) omit or overlook, and more than a few points they make are debatable. For instance, to my mind, they define high-involvement management so narrowly that they miss the potential contribution employees can make to the ends they advocate, and they ignore the value of employee stock ownership in creating company sustainability. So although Management Reset should not be seen as the final word on this important subject, it is an essential starting point for further thought, research, experimentation, and discussion.

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social scientists call dependent variables). Instead, I am now inclined to believe that having a dedicated, courageous leader is the key factor in determining the extent to which a company has a social conscience. And, since leaders come and go, the questions to address then become: (1) what motivates executives to create ethical, socially responsible corporate cultures; and (2) how can such behavior be encouraged among greater numbers of leaders? Beer and his colleagues eventually come around to addressing those questions in their penultimate chapter, but they don’t really develop the answers, which remain rather sketchy. Seems a shame that they didn’t focus their book on those ripe subjects. Missing, in general, from most books in the stillemerging “good business” genre is a recognition of such

Having a dedicated courageous leader is the key factor in determining the extent to which a company has a social conscience. harsh facts of business life as the managerial necessity to make painful trade-offs between competing claims of stakeholders, for example, those of environmentalists on one side and employees on the other. Too many sustainability authors deal with such complex, unpleasant issues simply by ignoring them, but, fortunately, they don’t all have their heads in the clouds. There’s no eco gee-whiz and no promises of a utopia in which capitalists all get rich simply by being virtuous in any of the best books on ethics and aspirations this year. I found them to be the most inspiring of the current lot because they demonstrate that there are practical, better ways to manage, even given the real-world constraints of capitalism as it is and the tough, daily slog that is the salient fact of organizational life. +

James O’Toole [email protected] is the Daniels Distinguished Professor of Business Ethics at the University of Denver’s Daniels College of Business and coauthor, with Warren Bennis and Daniel Goleman, of Transparency: How Leaders Create a Culture of Candor (Jossey-Bass, 2008).

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practices because, as Beer and his colleagues aptly note, these are devilishly hard behaviors to engage in consistently. Yet the book misses golden opportunities to offer meaningful analysis of what these leaders actually do to create social value, and to provide an objective evaluation of the extent to which they actually add that value. Since most of these leaders, in fact, have truly impressive records, we could have learned a lot from a critical analysis and assessment of their behaviors. For example, one of them, Allan Leighton, has been widely acclaimed for his brilliant transformation of Britain’s Asda in the 1990s, and tried to accomplish the same as head of the U.K.’s Royal Mail. Hence, the curious reader might want to learn the extent to which his successful practices at the discount retailer worked at the nonprofit postal service, and how creating social value fit with his tasks at the post. Alas, we are told none of that and, instead, are treated to recitations of the leaders’ management-speak aphorisms: “Keep it simple,” “Commit, yet adapt,” “Stay the course.” All good advice, but as Yogi Berra said, it’s déjà vu all over again, and it’s unclear how it all relates to creating social value. It must be said that Higher Ambition makes a deeper analytical contribution than most other recent books purporting to show that corporations can do well by doing good. The message of most others of that genre boils down to a hyperventilated exhortation to “save the world while getting rich!” Higher Ambition’s authors at least make an attempt to distill the wisdom gleaned from their interviews, basically concluding that good companies share such general characteristics as a stakeholder orientation, a dedication to some higher purpose, a commitment to continuous learning that leads to flexibility, and the pursuit of excellence across the board. It is worth noting that these are roughly the same characteristics of the good companies that I studied in the 1980s — and significantly, only two of those make the grade on Higher Ambition’s contemporary roster. How to explain that manifest lack of sustainability in corporate virtue? From reading Higher Ambition, my guess is that organizational traits may not be the most relevant factor in determining why or how some profitable companies do good things while others don’t (instead, such traits may be a result of doing good, what

Paul Leinwand and Cesare Mainardi, The Essential Advantage: How to Win with a Capabilities-Driven Strategy (Harvard Business Review Press, 2011)

Michael A. Cusumano, Staying Power: Six Enduring Principles for Managing Strategy and Innovation in an Uncertain World (Oxford University Press, 2010)

Richard P. Rumelt, Good Strategy, Bad Strategy: The Difference and Why It Matters (Crown Business, 2011)

STRATEGY best books 2011 strategy

Asking the Right Questions by Phil Rosenzweig This year’s best business books on strategy are notable primarily for what they’re not. They’re not one more treatment of global strategy, with particular attention to the BRIC countries (Brazil, Russia, India, and China). They’re not about finding the next new thing, thriving in turbulent times, or some new technological frontier, like social media. Nor do they claim to reveal the secret of corporate success, guaranteeing breakthrough performance or market leadership if we follow this or that formula. Instead, the best strategy books of the year emphasize basic principles that should never be far from the mind of the practitioner. Although they differ in scope and tone as well as perspective — two are written by academics and one by consultants — they converge on a handful of timeless themes. If each is a valuable addition to the strategy bookshelf, in combination they offer even more, helping to remind us of the most important questions in the discipline.

Premium on Coherence The Essential Advantage: How to Win with a Capabilities-Driven Strategy, by Paul Leinwand and Cesare Mainardi, partners at Booz & Company (the publisher of this magazine), provides a solid overview of current strategic thinking. The two consultants open the book by introducing the intriguing concept of “the right to win.” (See “The Right to Win,” by Cesare Mainardi

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with Art Kleiner, s+b, Winter 2010.) At first glance, the phrase makes no sense: A company may have a right to compete, yes, but surely not a right to win. Success is earned; it’s not an entitlement. But that’s the point. The phrase forces us to ask: Does our strategy, along with the resources and capabilities that back it up, give us a reasonable chance of success? Are we just playing the game, or do we have what it takes to win? When Leinwand and Mainardi write, “The essential advantage in business is coherence. Our insight is that simple,” they take their place in the line of strategic thought that stresses not a single part of the organization, but how all the parts work together — a notion sometimes called fit or alignment. Coherence, they say, means that a company must be focused and clear-

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they are aligned with the necessary resources, The Essential Advantage is a solid and practical book. It provides managers with a framework to follow, while always keeping in mind the question, Do we have the right to win?

Patterns of Success Michael A. Cusumano, a veteran researcher at MIT, looks for patterns of lasting success in his latest book, Staying Power: Six Enduring Principles for Managing Strategy and Innovation in an Uncertain World. In it, he reviews the companies he has studied in depth during his career — first, Toyota and the broader Japanese auto industry in the late 1980s, and then Microsoft, Intel, and other information technology companies in the 1990s — to identify “the big ideas that create staying power and superior performance.” These are the principles that should have enormous value for managers in all industries. (See “The Enduring Principles of HighTech Success,” by David K. Hurst, s+b, Autumn 2011.) As the book’s title indicates, Cusumano is concerned with success over the long term. He writes, “I concluded that a handful of principles — I have chosen six — appear to have been essential to the effective management of strategy and innovation over long periods of time.” It’s worth noting his use of words like appear and I concluded, which admit subjective judgment, rather than claiming a measure of truth or scientific precision. Indeed, there’s no pretense of conducting quantitative analysis in this book; rather, it represents an effort to seek patterns from in-depth case studies. The first two principles describe fundamentally different ways of thinking about strategy and business models. Platforms, not just products draws on the successes of Toyota and Microsoft to illustrate the power of a strategy that generates complementary products, builds positive feedback, and makes incumbents harder to dislodge. In both companies, global leadership was based on the ability to create platforms, not just standalone products. Services, not just products (or platforms), the second principle, stresses the importance of offering services as an effective way to avoid the commoditization of products. Not only do services add revenue, often at a higher profit margin, but they are also harder to replace. The next four principles are all related to agility — to sensing and responding quickly and flexibly. Capabilities, not just strategy stresses the need to develop capabilities over time, rather than rely on any single strategic

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minded about three elements: its market positioning (or “way to play”), its most distinctive capabilities, and its product and service portfolio. “In a coherent company,” they argue, “the right lineup of products and services naturally results from conscious choices about the capabilities needed for a deliberate way to play.” The authors ground their argument by showing a correlation between recent financial performance and coherence in the consumer packaged goods industry, and claim that the same relationship holds true across industries, whether financial services, telecommunications, healthcare, or something else. They contend that a premium “accrues to any company that moves along the continuum to align its way to play, capabilities system, and product and service fit.” Perhaps so, yet even if there is a correlation, the direction of causality isn’t clear. Are coherent firms more successful than others, or do successful firms remain coherent? (One of the books the authors cite, Profit from the Core [Harvard Business School Press, 2001] by Chris Zook, a partner at Bain & Company, has the same problem: Are focused companies the most profitable, or do profitable firms remain focused while less-profitable ones feel compelled to diversify?) These questions, although fundamental in any empirical examination of company performance, remain unanswered. To capture the benefits of coherence, the authors advise the reader to take a series of deliberate steps “to reconsider your current strategy, overcome the conventional separation between outward-facing and inwardfacing activities, and bring your organization into focus.” The Essential Advantage goes on to examine each of these steps in some depth, beginning with an exploration of external forces, and then shifting toward a consideration of internal resources and capabilities. Along the way, the authors set forth the notion of the “capabilities-driven portfolio,” which is evaluated on two dimensions, financial value (from attractive to unattractive) and strategic value (which considers the portfolio’s alignment with the organization’s capabilities system). The implication is that we should think of a portfolio of activities not merely in terms of growth and profit, but in terms of how they fit together and contribute to the overall performance of the company. The final section addresses the process of developing a strategy that is based on “what you do, not what you have,” and the organization design and people issues that accompany it. For the practitioner who wishes to take concrete steps toward sound strategic decisions and ensure that

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Strategy Plain and Simple The year’s best and most original addition to the strategy bookshelf is Richard P. Rumelt’s Good Strategy, Bad Strategy: The Difference and Why It Matters. Rumelt is a longtime strategy professor at UCLA, and before that at Harvard Business School, where he wrote a landmark work of scholarship and empirical rigor, Strategy, Structure, and Economic Performance (Harvard University Press, 1974), which was based on his prize-winning doctoral dissertation. This book, however, takes a decidedly different tone. It is informal and personal, sprinkled with anecdotes and opinions, which are often contrarian. It is as if Rumelt decided, after years of scholarly restraint, to write a book that laid out exactly what he has learned

and observed over the last four decades. It is also a wideranging exploration, moving from business to politics to aerospace to the military, from the ancient to the modern, from diversified public corporations to family businesses, that places strategy in a broad context. Unlike the many authors of business books and articles who use elaborate phrases and neologisms, Rumelt prefers candor and simplicity at every turn — beginning with the title. Duke Ellington was once asked to define jazz, and he famously replied: “There are only two kinds of music. Good music, and the other kind.” He felt no need to complicate matters with lots of theory and abstract concepts, and Rumelt clearly feels the same way about corporate strategy. Rumelt urges us to set aside fine-grained distinctions and unnecessary complications, in order to focus on the simplest distinction of all — good and bad. He has seen so much bad thinking about strategy that this basic dichotomy is important. It’s a way to remind us that for all the efforts we make to complicate things, good strategy is not all that complicated. If we can just avoid bad thinking and foolishness, we’re much of the way there. What are the elements of bad strategy? Rumelt points to four: the failure to face the challenge, mistaking goals for strategy, bad strategic objectives, and “fluff.” At its root, bad strategy reflects an inability to think clearly and to make sound choices based on analysis. The author dismisses those who would substitute wishful thinking for careful analysis, epitomized in his opinion of the New Thought movement, which goes back to the 1800s, but more recently has surfaced as the power of positive thinking and banishing negative thoughts. Shared visions of success cannot be the basis of strategy, says Rumelt, because “all analysis starts with the consideration of what may happen, including unwelcome events. I would not care to fly in an airplane designed by people who focused only on an image of a flying airplane and never considered models of failure.” Regarding vision and mission statements, Rumelt finds that they represent a “class of verbiage [that] is the mutant offspring of charismatic, then transformational, leadership. In reality, these are the flat-

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decision. Pull, not just push is associated with Japanese manufacturing methods, but, according to Cusumano, it goes far beyond that application. It pertains to product design, for example, because the ability to draw on customer preferences and ideas early in the process can confer an advantage. Scope, not just scale reminds us that in addition to the benefits of scale, which can lead to lower per-unit cost, successful companies seek out economies across activities such as research, product development, engineering, and more, sharing ideas and applying novel insights from one part of the company to others, allowing the whole to be greater than the sum of its parts and often more robust and better able to withstand downturns. Finally, flexibility, not just efficiency stresses the importance of pursuing efficiency while also remaining able to adapt to changes in the marketplace as well as seeking advantages of innovation. These six principles represent a set of guidelines that executives in any company or industry should consider in order to achieve high performance over the long term. Take them together, and instead of a conventional strategy aimed at pushing scale-efficient products, for example, we would think of developing capabilities that enable us to offer flexible platforms of services and products. For Cusumano, staying power comes not just from discrete strategic moves but ultimately from a mind-set of agility and responsiveness.

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crowd, substituting popular slogans for insights.” Many of the ideas in Rumelt’s book reinforce key points in The Essential Advantage and Staying Power. Like Paul Leinwand and Cesare Mainardi, he stresses the need for coherence. Like Michael Cusumano, he emphasizes strategic thinking as a process — a hypothesis to be answered with openness to new ideas. Each of these books reminds us of the basic elements of strategy: the need for clear-eyed analysis, courage to make specific choices, action in support of those decisions, and alignment throughout the organization. They are all about coherence, about developing capabilities not once but in a dynamic manner, and ultimately, about the agility needed to succeed over time. None of these books guarantee success — not

“A good strategy is...a hypothesis about what will work,” concludes Rumelt. “Not a wild theory, but an educated judgment.” Rumelt’s good strategy, not Cusumano’s six principles, not Leinwand and Mainardi’s essential advantage. In an uncertain and intensely competitive business world, even the best of actions don’t lead predictably to desired outcomes. Strategy is necessarily about competition, where performance is inherently relative, not absolute — a message driven home by the cover of The Essential Advantage, which shows a race among five runners, suggesting that success isn’t about being fast but about being faster than your competitors. Each of these authors knows that fundamental truth and doesn’t try to tell readers otherwise. Their books do an important service by keeping us focused on the most important questions about strategy. +

Phil Rosenzweig [email protected] is a professor at IMD in Lausanne, Switzerland, where he works with leading companies on questions of strategy and organization. He is the author of The Halo Effect...and the Eight Other Business Delusions That Deceive Managers (Free Press, 2007).

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footed attempts of organization men to turn the magic of personal charisma into a bureaucratic concept — charisma-in-a-can.” So what is good strategy? It requires three things: a diagnosis that defines the challenge; a guiding policy for dealing with the challenge, and a set of coherent actions designed to carry out that policy. To help navigate the way forward, Rumelt offers numerous “guideposts”: vigilance about escalating fixed costs, awareness of transitions caused by deregulation, predictable biases in forecasting that draw on behavioral economics, and anticipation of incumbent responses. Sound strategic decisions are not enough, however; execution is essential, too. “Strategy is about action, about doing something. The kernel of a strategy must contain action,” writes Rumelt. “To have punch, actions should coordinate and build upon one another, focusing organizational energy.” Good strategy calls for effective management and concerted efforts to combat entropy. It calls for the discipline needed to identify low performers and raise the level of overall performance. One “cannot fully understand the value of the daily work of managers unless one accepts the general tendency of unmanaged human structures to become less ordered, less focused, and more blurred around the edges,” writes Rumelt. He admires Alfred P. Sloan of General Motors Company, who insisted on a rigorous review to analyze performance and take action, writing, “Sloan’s product policy is an example of design, of order imposed on chaos. Making such a policy work takes more than a plan on a piece of paper. Each quarter, each year, each decade, corporate leadership must work to maintain the coherence of the design.” Anyone hoping for a simple formula for strategic success will be disappointed. But in fact the message of Good Strategy, Bad Strategy is liberating. It reminds us that strategy need not be complicated. It’s not rocket science. And furthermore, you can spot the nonsense, simplify, and clarify. “A good strategy is, in the end, a hypothesis about what will work. Not a wild theory, but an educated judgment,” concludes Rumelt. “Good strategy grows out of an independent and careful assessment of the situation, harnessing individual insight to carefully crafted purpose. Bad strategy follows the

Bob Lutz, Car Guys vs. Bean Counters: The Battle for the Soul of American Business (Portfolio/Penguin, 2011)

Roger L. Martin, Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL (Harvard Business Review Press, 2011)

Tim Harford, Adapt: Why Success Always Starts with Failure (Farrar, Straus and Giroux, 2011)

MANAGEMENT The Battle for Management’s Future best books 2011 management

by David K. Hurst As the tumultuous decade of the “noughties” fades into history, the battle lines for the future of Western management practice and thought are becoming clearer. Each of the best business books on the topic of management reviewed this year sheds some light on where and why we went off the rails, and what we should do about it. One book’s author is a respected U.S. auto company executive, another is the dean of a Canadian business school, and another is a British journalist. They come at their subjects from very different perspectives, but all their views are insightful, and the overlaps among them are intriguing.

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A Detroit Swashbuckler In Car Guys vs. Bean Counters: The Battle for the Soul of American Business, veteran auto company executive Bob Lutz uses his varied experience in Detroit, particularly his nine years as vice chairman of General Motors Company, to show how the U.S. auto industry lost its soul and is trying to recover it. Lutz is a former fighter pilot and a self-confessed “right-brained car guy” with a multicultural background unusual in Detroit (he was born in Switzerland and worked extensively in Europe). He has been described as an opinionated swashbuckler, and he lives up to that reputation in this book, with his outspoken views and entertaining turns of phrase. Lutz dates the decline of GM to the 1960s, when, in the interests of volume and cost efficiency, the design function was progressively subordinated to the “empire”

of finance and accounting, eventually ending up under the auspices of product planning. Instead of producing cars that were objects of passion, he says, “the system created research-driven, focus-group-guided, customeroptimized transportation devices, hamstrung in countless ways.” Lutz’s firsthand description of the charisma-challenged, nitpicking, customer-distant “culture of excellence” that GM developed makes for painful reading. He reports how attempts to adopt brand management practices from the consumer packaged goods sector failed because of the much larger scale and longer time frames in the auto industry. Worse still, according to Lutz, GM’s elaborate Management by Objectives– based Performance Management Process (PMP) was a

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industry and the champion of car guys everywhere. In the book’s next-to-last chapter, he speculates on what he would have done had he become CEO of GM, although he points out that boards of directors typically don’t appoint “creative right-brainers” to that post. He would have focused on products first and foremost, creating joint ventures for R&D, and done everything possible to eliminate superfluous activities, scrapping the hallowed PMP and reducing the power of product planning. GM’s current leaders may agree. Lutz was retained by the company on a part-time consultancy basis a few months after the book was published. Lutz wouldn’t have acquired many of the car companies that GM actually purchased, but he says he would have bought Chrysler for the significant savings the two companies could have realized in scale and scope. As for trimming the too-numerous GM brands and the inefficiency of GM’s sprawling dealership network, he acknowledges that Chapter 11 was a huge enabler in this regard, allowing reductions in both. Lutz also contends that in the car business, a knowledgeable, autocratic management style is much more effective than the bland “‘respect other people’s emotional equity’ approach that so long characterized GM.” But he places the emphasis on knowledgeable; executives must be steeped in the business and have almost infallible “taste, skill, intuition, and sense for the customer.” He may be right for the car business, although the constraints on unilateral action, even by the CEO, in pre-bankruptcy GM must have been formidable. Lutz’s broader recommendation that U.S. companies need to throw out the intellectuals and get back to business will probably not be heeded, but his pragmatic warning that schemes that appear sound in theory often fail in practice is bolstered by many of the findings from behavioral economics, and managers will ignore them at their peril.

The Parasite Hunter Roger L. Martin, dean of the Rotman School of Business at the University of Toronto, is fighting to change the way we think about and teach management. His newest book, Fixing the Game: Bubbles, Crashes, and

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“ritualistic time suck” without “a smidgen of customer value.” PMP allowed senior managers to hit all their numeric targets and earn bonuses, even as GM steadily lost market share. “[A] senior executive who needs a quantified list of objectives to know what he or she should be working on should not be a senior executive in the first place,” he writes. Not all GM’s wounds were self-inflicted. Lutz is highly critical of the government’s CAFE (corporate average fuel economy) regulations, which warped the market toward trucks. He also accuses U.S. politicians of failing to bite the bullet and impose a gas tax, which would have raised domestic gas prices to world levels and encouraged drivers to switch to more economical vehicles. Although he is a climate-change skeptic, Lutz says he would raise gas taxes by 25 cents per gallon annually until parity with other countries was reached, just to reduce the country’s dependence on foreign oil. In addition, he blames the U.S. government for allowing Japan to maintain an undervalued yen for many years, granting its auto companies a strong foothold for exports before they established U.S. manufacturing operations. Lutz is equally scathing in his denunciation of the media for what he considers its knee-jerk badmouthing of domestic cars. And notwithstanding his own MBA, he reserves his heaviest salvos for business schools. He argues that their sense of academic inferiority has led to the “needless intellectualization” of business — an economics-influenced perspective from which the customer is never discussed. As a result, the customer has become a “hapless victim” of “MBA bean counters”; any successful products are likely to be value engineered (read: cheapened) to generate short-term gains and longterm disasters. “Rather than bask in the false belief of the superiority of American business education, the big business schools should be asking themselves how and why it all went wrong,” he declares. “They have produced generations of number-crunching, alternate-scenario-loving, spreadsheet-addicted idiots-savants. They should be ashamed.” Bob Lutz’s charisma comes through in his writing, and it’s easy to see how he became an icon in the

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order to satisfy the desires of an unhealthy, insatiable community of gamblers and speculators. Martin would restore authenticity by having executives focus on creating customer value, a worthy, challenging goal that includes providing a fair return for shareholders. Many readers will consider Martin’s battle plan radical. One of his immediate recommendations is the repeal of “safe harbor” provisions that protect company executives from accepting accountability for their forecasts. He also suggests that accounting rules such as FASB 142 (which mandates goodwill write-downs if share prices fall) be amended to focus only on changes in real markets, removing the need to manage expectations to avoid write-downs. He also wants to outlaw stock-based compensation except for long-term grants that would vest only several years after the recipient’s retirement. Anything less, Martin writes, will lead to bubbles and crashes, more corporate scandals, and lower shareholder returns. Martin turns his attention to corporate governance by contrasting the murky state of governance in Major League Baseball (MLB) — where the commissioner is also an owner — with that in the NFL. He finds that the NFL has shown continuity, purpose, and diligence in the provision of a compelling customer experience. In contrast, MLB has not focused on its customers, running the league for the benefit of the owners and players rather than the fans. As a result, growth in the popularity of football has outpaced that of baseball over the past three decades. The problem with corporate directors, who Martin likens to the MLB governors, is that they lack both the capability and the incentive to serve outside stakeholders. This leaves them susceptible to the same temptations as executives — perquisites, compensation, prestige, and so on — all of which makes it highly unlikely that they will oppose the CEO on behalf of outsiders. He would have the job descriptions of directors changed so that they focused on customer value and public service, with directors acting like judges, protecting the long-run interests of the community at large, rather than the narrow interests of shareholders. However, the mechanism for this change is unclear.

best books 2011 management

What Capitalism Can Learn from the NFL, has its origins in a fine, prescient article he wrote for Barron’s in 2003 and is one of the very few business books that is better for the expanded treatment. Martin sets out to show why capitalism in America has gotten into trouble over the past few decades. He argues that agency theory, derived from neoclassical economics, together with the gospel of shareholder value, has led to managers being compensated for doing the wrong things. Stock-based compensation, for example, focuses executives on expectations markets rather than real markets, where customer value is created. It is this focus on maximizing what should be an ancillary goal that has led to the marginalizing of customers as “marks” to be exploited. Martin says that executives fix the game of business and try to manage expectations in much the same ways professional athletes would, if they were allowed to bet on games in which they play. Executives indulge in the business equivalents of “point shaving” (sacrificing a few points of advantage to win a game by a lower margin than expected) and “tanking” (making results appear worse than they are to lower expectations and make beating them easier). The unintended consequence of agency theory, according to the author, has been the creation of a business environment that is akin to a casino, with zero-sum gambling games in which executives win and everyone else loses. Hence the lessons that capitalism (presumably in the guise of regulators) can learn from the National Football League (NFL): Keep real and expectations markets separate (players are banned from gambling), and focus on creating customer value, continually adjusting the playing field to ensure that the players concentrate on improving their performance in the real game. This real game should be a positive-sum one that has meaning and motivation. Martin thinks that transactional communities have largely replaced the communities of long-term interest, with which public company executives once identified and to which their companies once catered. This has forced executives to lead inauthentic lives, becoming people that they are not, in

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A Resurrected Russian In Adapt: Why Success Always Starts with Failure, Tim Harford, an economics columnist for the Financial Times, describes the economy as “an evolutionary environment in which a huge variety of ingenious profit-seeking strategies emerge through a decentralized process of trial and error.” His key conclusion is that evolution is much smarter than we are; therefore, to be successful we must use evolutionary methods. An evolutionary perspective means, as the book’s subtitle states, that success invariably begins with failure. Harford devotes his book to exploring the implications of this idea for organizations and individuals, illustrating his conclusions à la Malcolm Gladwell, with a wide-ranging collection of anecdotes that are often drawn from studies of dysfunctional economies and organizations. The hero of the book, to whom the author continually returns, is Peter Palchinsky, a brilliant, stubborn, opinionated Russian engineer who was an economic advisor to the tsar and then to the Soviet government, before being executed by the Communists in 1929. His crime was that he saw too clearly that centralized control over economic development could not work, because it did not permit variation and selection — the critical processes of evolutionary adaptation. Harford identifies three Palchinsky-esque principles for success: “first, seek out new ideas and try new things; second, when trying something new, do it on a scale where failure is survivable; third, seek out feedback

and learn from your mistakes.” This sounds simple, but applying these principles is more difficult than it seems, as the author shows by tackling some of today’s major political, economic, and social challenges. For instance, Harford uses the invasion of Iraq to demonstrate how a refusal to learn from mistakes and adapt led to a failure in the city of Tal Afar — a nearrout that was rescued from disaster only through an improvised experiment. The conductor of this experiment, which harnessed the efforts of the locals to expel the terrorists, was Colonel H.R. McMaster, another of Harford’s heroes and a veteran of the Vietnam War. McMaster wrote a definitive examination of the failures of leadership in Vietnam, which showed how Lyndon Johnson and Robert McNamara had enforced a rigid hierarchy, insisted on unanimity, and put too much faith in the centralization of data and the use of quantitative methods for analysis. (Their story sounds eerily like the actions of the senior executives at GM that Bob Lutz describes.) It’s instructive, too, that in the process of winning over the local insurgents in Tal Afar, McMaster makes enemies of his superiors and is repeatedly passed over for promotion to brigadier general, an omission that was recently remedied by McMaster’s like-minded boss, General David Petraeus. A short review cannot do justice to all the perspectives that Harford uses to illustrate the application of Palchinsky’s principles. He discusses how new ideas can be created, how to conduct experiments to tease out the webs of cause and effect, and the multiple ways in which leaders can profit by admitting failure and learning from experience. My only criticism is that at times Harford appears to regard variation as the opposite of standardization, with the implication that “uniformly high standards are not only impossible but undesirable.” Certainly this is true of mindless standardization for the sake of uniformity, but it is not true of the rigid but mindful standardization of approaches like the Toyota production system, where standards form the foundation of the controlled experiments that take place on the factory floor every hour of every day. Without such standardization, there can be no helpful variation. One feels sure that Peter Palchinsky would agree.

An Exciting Future For much of the 20th century, American management was preoccupied with managing growth and the burgeoning scale of corporate operations. By and large, organizational solutions such as decentralization, func-

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In the book’s penultimate chapter, the author attacks the hedge fund industry and its 2/20 fee formula (2 percent of assets under management and 20 percent of any gains), which he characterizes as predatory. In venture capital and leveraged buyout contexts, the formula is acceptable; any upticks can come only from an increase in real value. In the zero-sum world of hedge funds, however, gains come only if others lose. Thus, Martin believes that hedge funds perform no socially useful function, promote market volatility, and are parasitic. He recommends that they be outlawed or, failing that, taxed to suck excess profitability out of the industry and compensate the community at large for the damage they cause. It’s bold recommendations like these, backed by reasoned arguments — together with Martin’s call for collective action to protect capitalist society’s civil foundations — that make Fixing the Game my pick for the best management book of the year.

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tional specialization, and hierarchy were successful in meeting the challenge. Now that challenge has changed, and management, especially in the West, is engaged in a struggle to reinvent itself and its institutions. Neoclassical economics, which provided managerial logic and legitimacy in the last century, is less and less relevant. It doesn’t answer questions about how to create value, for instance, and its assumptions of market equilibrium are unhelpful. In fact, for many companies, market failure is no longer an aberration, but a starting point and a source of opportunities. The actions taken to exploit these opportunities will not necessarily benefit the community as a whole. Indeed, as we have seen throughout history, market failures can be fertile ground for antisocial and even criminal enterprises. So, along with the field of innovation, the whole philosophy and practice of regulation will

David K. Hurst [email protected] is a contributing editor to strategy+business and author of its Books in Brief column. His writing has also appeared in the Harvard Business Review, the Financial Times, and other leading business publications. Hurst’s next book, The New Ecology of Leadership, will be published by Columbia University Press in the spring of 2012.

Jeff Madrick, Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present (Knopf, 2011)

Sylvia Nasar, Grand Pursuit: The Story of Economic Genius (Simon & Schuster, 2011)

ECONOMICS A Dismal Outlook? by David Warsh It’s been a good year for economics books. Autopsies on the economic crisis of 2008 continued to tumble out in 2011, some of them quite compelling. But it is clearly time to look to the future, and a spate of notable books describing the changing profile of the global economy did just that, including World 3.0: Global Prosperity and How to Achieve It, by Pankaj Ghemawat (Harvard Business Review Press, 2011); The Post-American World: Release 2.0, by Fareed Zakaria (W.W. Norton, 2011); and The Globalization Paradox: Democracy and the Future of the World Economy, by Dani Rodrik (W.W. Norton, 2011).

best books 2011 economics

Michael Spence, The Next Convergence: The Future of Economic Growth in a Multispeed World (Farrar, Straus and Giroux, 2011)

have to be rewritten. These tasks will require evolutionary and behavioral perspectives that enable us to better understand the origins and actions of institutions, markets, and firms. Management scientists may even become a little more humble, with a renewed respect for and interest in entrepreneurs and their practical wisdom. This year’s best business books on management lay out the battle lines. +

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From G-7 to G-20

ing its agenda, Wolfowitz turned to Spence as an honest, independent broker of ideas whose views would be of interest to leaders of nations all around the world. Thus began the Commission on Growth and Development, an ambitious project designed to bring senior political leaders and policymakers from 18 nations (such as Zhou Xiaochuan, governor of China’s central bank, and Montek Singh Ahluwalia, deputy director of India’s planning commission) together with the world’s leading economists (Robert Solow and Robert Lucas, for example). For four years, the commissioners traded visits to one another’s countries and elicited expert testimony, building a cautious case for openness and trade. Unfortunately, their report fizzled after Wolfowitz was forced to step down over an impropriety. Spence,

Economic growth has always occurred in parallel with the development of new political, legal, and regulatory institutions.

Spence’s The Next Convergence, my choice for the year’s best business book on economics, starts with simple arithmetic: China and India represent about 40 percent of the world’s population. Their combined GDP is growing at an annual rate of 7 percent or more; India is perhaps 14 years behind China on the curve. Their growth will slow in another two or three decades, as they finish the process of converging with the presentday industrial countries. By then, they will have become economic giants. Indeed, Spence calculates that the world will have a global GDP that is four times as great as what it is now. But what kind of a world will a US$240 trillion global economy create? That is the question Spence seeks to answer in this book. A considerable deepening of economics has taken place during these last 40 years, a process in which Spence has been an active participant. In 2001, he shared a Nobel Prize for contributions to the economics of information. By then he’d been drawn off into university administration — including nine years as dean of the Graduate School of Business at Stanford University. In the middle years of George W. Bush’s presidency, when Deputy Defense Secretary Paul Wolfowitz was posted to the World Bank with the goal of rethink-

however, soldiered on and produced this compelling tour d’ horizon based on his experiences as chair of the commission — a view more or less from the quarterdeck of the global economic system. Except, Spence says, that there is no proper quarterdeck — at least not yet. It used to be so simple. At the end of World War II, there were the industrial countries with 750 million people — 15 percent of the earth’s population — and there were another 4 billion people living in poverty, divided about equally among the Communist nations, a Second World determined to catch up, and the Third World, whose very name implied a bleak distance from the others. Yet already in 1945, the seeds of change had been planted. For 30 years Japan led the way; then, soon after the death of Mao Zedong in 1976, China abandoned autarky and set out to join the world economy. It was not long before underdeveloped countries gradually became less underdeveloped and emerging nations became newly industrializing ones, until, suddenly, there were the BRICs (Brazil, Russia, India, China). The latest phase of global growth and development accelerated dramatically after 1980, but why? Certainly, shorter lines of communication had something to do with it. Spence devotes a chapter to the advent of the

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Other books, which were partially eclipsed in the rush to reset our horizons, explored interesting topics outside the center ring, including The Price of Everything: Solving the Mystery of Why We Pay What We Do, by Eduardo Porter (Portfolio/Penguin, 2011), and The Economics of Enough: How to Run the Economy as if the Future Matters, by Diane Coyle (Princeton University Press, 2011). All are worthy books. But three of this year’s economics books are especially good. One — The Next Convergence: The Future of Economic Growth in a Multispeed World, by Michael Spence — looks forward, providing what is likely to be a durable framework for thinking about the global economy. The other two — Jeff Madrick’s Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present, and Sylvia Nasar’s Grand Pursuit: The Story of Economic Genius — look backward, in compelling, insightful, and highly readable ways.

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finance ministers and central bankers of 19 nations and the European Union. There’s nothing especially controversial about that: Economic growth in the past has always occurred in parallel with the development of new political, legal, and regulatory institutions, and mostly through trial and error. Whether the evolution of governance will keep pace remains to be seen. Lapsing into the sparse lingo of game theory (which helped him win his Nobel Prize), Spence ends The Next Convergence by writing, “This is a cooperative game on a giant scale we are trying to learn how to play, a complex one because of the asymmetries among the players. The chances that asynchronous moves and separate agreements on distinct issues will lead to a fully cooperative outcome are very low. More likely is a noncooperative outcome with attendant suboptimal results and instability. A bumpy road to a new and not very attractive normal.” His superior description and analysis of those high stakes are the main reasons to read this book.

A Rorschach Test Whereas The Next Convergence peers 40 years into the future, Age of Greed looks back over 40 years of the American past. It is a pageturner that, through a series of profiles of financiers, politicians, economists, and central bankers, presents a powerful polemical history. And it’s all true, as far as it goes. In this, Age of Greed resembles a famous issue of Institutional Investor published in 1987 that contained capsule stories of 50 celebrated financial entrepreneurs. Yet Jeff Madrick, the book’s author, like the editors of the glossy money manager fan mag, keeps you on your toes, asking yourself what he’s leaving out. Like liquor and candy, strongly emotional presentations take you only so far, but that is no reason to eschew them altogether. Madrick’s proposition is that an age of greed began in 1970, when various Roosevelt haters, John Birchers, devotees of Ayn Rand, and economic ideologues of the Mont Pelerin Society (chiefly Milton Friedman and Friedrich Hayek) began to gain influence. Their movement gathered force until, with the election of Ronald Reagan, the gates burst open and the barbarians flooded through to put the nation on “an unfortunate, tragic

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computer, spawned during World War II, and the Internet. By 2011, he writes, 4.5 billion people — two-thirds of the world’s population — had cell phones. Many problems arise from these different growth rates. Some have already become clear, as Spence outlines in a series of chapters: financial imbalances, pressure on resources and the environment, the continuing attenuation of middle-class jobs and incomes in Europe and the United States. These problems lead to major questions: Can Western economies continue to find new sources of growth? Can the environment stand a fourfold increase in the ranks of the wealthy? Will there be enough food and fuel? What about climate change? Are there other kinds of social and cultural brakes that may slow or even fracture the prospects for global growth? What if every important nation feels it must have its own banking, agricultural export, automotive, and aerospace industries? If everyone tries to do the same thing, it won’t work. Spence has something interesting to say about each of these questions; offers additional observations on the internal dynamics of China, India, and Brazil; and still devotes a quarter of the book to an examination of the financial crisis and its aftermath. The fact that The Next Convergence covers so much ground means that it has little time for the folksiness and redundancy that make for easy reading. The payoff is coherence — the argument of the book fits together as tightly as the formal models that Spence once built for a living. As for globalization, Spence thinks that the benefits of open trade have been oversold, and its potentially adverse distributional impacts too easily brushed aside. So for the next few years, expect a volatile world, he says, especially given the magnitude of recent economic shocks. Once the advanced countries regain their confidence, however, he predicts that the dynamism of the developing countries should produce a strong new wave of expansion — and bring us back to the problems of multispeed growth. None of the associated problems will be satisfactorily solved without the advent of new forms of cooperation, says Spence, starting with the Group of 20, the

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House Speaker Newt Gingrich. It’s commonplace for political sentiment in the U.S. to swing back and forth between private involvements and public purposes, but Madrick doesn’t give much credence to that view. He thinks events covered in the book may be irreversible. But my hunch is that political change is already in the works and that Age of Greed could impart roughly the same kind of momentum to that change as Gustavus Myers’s History of the Great American Fortunes did in the muckraker movement a century ago. In any event, Madrick has created a wonderful economic Rorschach test.

Lords of Economics A couple of years ago, Liaquat Ahamed’s Lords of Finance: The Bankers Who Broke the World (Penguin Press, 2009) became a resounding bestseller. If you liked that story — about four central bankers whose efforts to maintain the gold standard dominated the years after World War I until their efforts finally came undone in the Great Depression — you’ll love Grand Pursuit, for Sylvia Nasar has done something similar. (See “Sylvia Nasar: The Thought Leader Interview,” by Rob Norton, s+b, Autumn 2011.) In Nasar’s first book since A Beautiful Mind (Simon & Schuster, 1998), the best-selling biography of math genius John Nash, she turns a long-ago adventure into a compelling story for the present day. It is about a handful of economists who, in the long century between 1848 and 1960, transformed the discipline from a counsel of despair into “an instrument of mastery.” The story’s heroes are Alfred Marshall, Irving Fisher, John Maynard Keynes, Friedrich Hayek, and Joseph Schumpeter; its villains are Thomas Robert Malthus and Karl Marx. The story unfolds in three acts of economic narrative that Nasar labels Hope (1843–1911), Fear (1914– 1939), and Confidence (1945–2007). In 1848, Europe tottered on the brink of revolution. Malthusian reasoning about the tendency of the human population to outstrip its food supply dictated harsh terms for relief of the poor. Charles Dickens is a surprising entrant here; his much-loved A Christmas Carol, from 1843,

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path from which it may not be possible to turn back.” Thus, the book is divided into two parts, “Revolution,” up to 1980, and “The New Guard,” about those who took over after the barriers had been battered down. What makes the book so entertaining is that each life Madrick offers is highly interesting on its own. Who knew that Walter Wriston’s father had been president of Brown University, or recognized that the young banker had drawn a bead on the Glass-Steagall Act practically from the beginning of his career at First National City Bank, today’s Citi Group? (He was 28 when he began lending to Aristotle Onassis.) Who understood the utter centrality to the 1980s of lawyer Joe Flom, to whom Madrick assigns a riveting chapter? Or the common denominator — scale as strategy — that Ted Turner, Sam Walton, and Steve Ross employed to build their businesses? Tom Peters, Jack Welch, Michael Milken, Alan Greenspan, George Soros, John Meriwether, Sandy Weill, Ken Lay, Jack Grubman, Angelo Mozilo, Jimmy Cayne, and Richard Fuld — they’re all here. And to Madrick, they are all undeniably greedy, for something or other. Yet, as readable as the book is, there is something unsatisfying about it. Madrick is, after all, a paleo-liberal. He edits Challenge magazine and writes regularly for the New York Review of Books. Perhaps that’s why you won’t find President Barack Obama’s famous acknowledgment of Reagan’s role as a transformational president anywhere in this book. And there’s no Cold War. Madrick notes that the American mistrust of major institutions — government, religious, business, and educational — accelerated during the Vietnam War, but says nothing about the rhetorical and ideological effects of the United States’ successful competition with the former Soviet Union. Nor does the rise of China figure in the story. There’s no Bill Gates, either — no sense of the pervasive technological change that has been the background to so much institutional and social turbulence. And several characters whose careers would have lent fiber to his account are missing: Bruce Henderson of the Boston Consulting Group, Ronald Coase of the University of Chicago, Michael Jensen of Harvard Business School, and, for that matter, former

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with its images of plenty, turns out to be a tract against economic pessimism. Journalist Henry Mayhew wages a spirited campaign in London’s Morning Chronicle to persuade political economy to “take some little notice of the claims of labour” and provide higher pay and better working conditions. But not until Alfred Marshall (and others) took up the cudgels was new life breathed into a faltering discipline. “Before 1870 economics was mostly about what you couldn’t do,” Nasar writes. “After 1870, it was mostly about what you could.” World War I, with its shocking carnage and cruel aftermath, leading 15 short years after its outbreak to the Great Depression, cast the world into despair — but not Keynes or his great rival, Hayek, who in the 1930s both experienced periods of intense creativity. In their very different ways,

“Before 1870 economics was mostly about what you couldn’t do,” Nasar writes. “After 1870, it was mostly about what you could.” they led the developed nations into the sunlit uplands of postwar prosperity. (Brief chapters on Paul Samuelson, Joan Robinson, and Amartya Sen conclude the book.) Grand Pursuit is clearly meant to buttress Keynes’s famous claim that “the ideas of economists and political philosophers…are more powerful than is commonly supposed; indeed the world is ruled by little else,” but I am not so sure Nasar makes the case. Her worldly philosophers often look more like rubberneckers sallying forth periodically to observe and rationalize the concrete achievements of the world’s more practical sorts. The rising living standards that Marshall sought to explain owed more to the makers of the Industrial Revolution and the public health movement than to readers of his Principles of Economics. Lloyd George surely derived more inspiration from Otto von Bismarck, who invented the modern welfare state in the process of unifying Germany, than from Fabian Socialists Beatrice and Sidney Webb, who cofounded the London School of Economics. Recovery from the Great Depression stemmed more from preparations for World War II than from any deliberate application of Keynesian principles. And the Marshall Plan that helped Western Europe clamber back to its feet had more to do with

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President Harry Truman’s experience in World War I and Soviet Communism than with any reading of Hayek or Keynes. That doesn’t mean economists were useless, rather that it took somewhat longer for their investments to pay off. A grand pursuit indeed! Nasar’s book is unlikely to become a movie (A Beautiful Mind did). But, in her telling, the lives and times of economists make awfully interesting reading. There are books you read for work and books you read for pleasure, and there is a world of difference between the two. Work books are those you feel you have to muscle through in order to understand the changing world, and you do the reading when you can. Pleasure books are slower, longer reads, to be savored during summer vacations or night after night before bed in the winter. Spence is the work reading; save Madrick and Nasar for your leisure hours. +

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David Warsh [email protected] is the proprietor of EconomicPrincipals.com, an independent economics journalism site. He covered economics for the Boston Globe for 22 years and is a two-time winner of financial journalism’s Gerald Loeb Award.

Simon Mainwaring, We first: How Brands and consumers Use social Media to Build a Better World (Palgrave Macmillan, 2011)

David A. Aaker, Brand Relevance: Making competitors Irrelevant (Jossey-Bass, 2011)

Gary Vaynerchuk, The Thank You Economy (Harper Business, 2011)

MARKETING Marketing Reenvisioned AT fIRsT GlANcE, the three best business books of 2011 on marketing seem to go in very different directions. However, they do share one trait: They pay only lip service to marketing. A couple of decades ago that might have disqualified them from consideration, but these days, a surprising number of marketing books aren’t all that high on marketing. Most of those books’ authors say that marketing, as it’s been practiced since the dawn of paid media, doesn’t really get to the heart of the challenges that brands face today. In fact, although it’s still true that most major marketers spend tons of money on advertising — U.S. advertisers spent about US$9 billion in this year’s network TV “up-front” — the references these books make to advertisements, if they appear at all, are almost entirely incidental. The real action is in the much tougher arena of rethinking the companies that sell the brands. So, in We First: How Brands and Consumers Use Social Media to Build a Better World, brand consultant Simon Mainwaring ponders the role of the corporation in addressing the world’s ills, tackling such topics as charitable giving, environmentalism, and sustainability. In Brand Relevance: Making Competitors Irrelevant, David A. Aaker, professor emeritus at the University of California at Berkeley’s Haas School of Business, looks at how companies can build brands that aren’t just new and improved, but unequaled. And in The Thank You Economy, wine-selling social media guru Gary Vayner-

chuk advocates that marketers build a culture in which “good intent” is paramount. In each case, the authors emphasize that making these things happen requires fundamental shifts in corporate culture, not just marketing window dressing. Yes, marketing is no longer about simple brand repositioning, but about corporate reinvention. Thus, it’s more than coincidence that all three books have something else in common: They chastise marketers about their focus on the short term at the expense of the long term — not surprising given that the kind of corporate reinvention these authors describe could take years, courage, and, in many cases, substantial investment. And not just in the marketing budget.

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Marketing Ideals

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We First is that rare marketing book that is truly visionary. It is also sure to be controversial, because Simon Mainwaring takes trends such as green marketing, cause marketing, and corporate social responsibility and pushes them to their farthest extreme, urging corporations to stop pursuing profit for profit’s sake and instead refocus their efforts on pursuing profit by benefiting the world. (This, of course, flies in the face of one of the basic beliefs of certain economists, perhaps summed up most succinctly in Milton Friedman’s provocative 1970 essay titled “The Social Responsibility of Business Is to Increase Its Profits.”) If it sounds like Mainwaring is making a plea for environmental sustainability, that’s just the tip of his very large iceberg. He is also questioning whether it’s time for corporations to rethink employee compensation, including that of the CEO, to reconsider the impact of using tax havens to shield profits, and even to think about how they might help put shoes on children in poor countries, as Toms Shoes has done with its “One for One” program. Mainwaring is calling for a “We First” economy (an interesting bit of branding given that it is also the name of his consulting firm), and he proposes it as a response to Bill Gates’s call for “creative capitalism” at the 2008 World Economic Forum. Unlike the current economy, the We First economy “is a comprehensive system of mindful consumerism in which every single transaction for products and services would include a contribution toward building a better world,” writes Mainwaring. “Profit for profit’s sake is a mindset that drives too many investors, businesses, and corporations to neglect three critical issues that We First capitalism seeks to change: one, the methods of producing profits; two, the consequences of profits, and three, the social implications of profits.” Yes, that shouting you hear in the background is coming from people at a certain end of the political spectrum, crying: “Socialist!” (Or maybe even “Communist!”) But to jump to that conclusion about Mainwaring, and his book, would be to fundamentally misunderstand what he’s talking about. A former creative

director at Ogilvy & Mather on the Motorola account, and also on the Nike account at the revered ad agency Wieden + Kennedy, Mainwaring hasn’t abandoned capitalism. Instead, he contends that a We First approach is needed to save capitalism, if for no other reason than that humanity is consuming the earth’s resources faster than they can be regenerated. Rethinking compensation, as another example, is not about redistributing wealth but making sure that people have money to buy things. “The basis for this principle is less a moral argument than an economic reality: without a reasonably prosperous middle class in any society, the engine of capitalism falters,” asserts Mainwaring. Fortunately, once Mainwaring abandons some of the preachiness that occasionally drags down We First, he offers plenty of examples of companies that are already practicing We First capitalism. Like many other observers, he lauds Wal-Mart Stores Inc. for embracing rigorous environmental values — such as using 100 percent renewable energy — and pushing those standards down through its vast supply chain. But the retailer’s environmental initiatives mean it is meeting the mark on only one of Mainwaring’s five domains of sustainability. His broad definition of the term also encompasses economic, moral, ethical, and social values. To meet those standards, Walmart would have to, among other things, pay its associates more and offer them more reasonably priced health benefits. By now, you’re probably wondering what all this has to do with marketing, or with the social media–driven consumers referred to in the book’s subtitle. Mainwaring says that We First capitalism is what they demand. In reaching this conclusion, he relies heavily on the 2009 “goodpurpose” survey from public relations firm Edelman. According to the survey results, 83 percent of consumers are willing to change how they consume to make the world better and 64 percent wouldn’t mind recommending brands that support good causes. If that’s the case, the role of social media is an obvious amplifier of word of mouth. But Mainwaring’s bigger point about social media lies in how consumers are using it to push companies to-

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Brand Power Redefined

plenty of smartphones besides the iPhone, MP3 players besides the iPod, and tablets besides the iPad, but Apple’s products are also part of the larger iTunes ecosystem of audio, video, and apps. That’s quite a barrier. As Aaker points out, each Apple innovation also builds on existing ones, to make the company a “moving target,” which is a core component of ensuring that a brand is continually relevant. Aaker also writes extensively about other breakout brands, such as Toyota’s Prius, but many of his example products are decidedly more prosaic. If you market toothpaste, you will be able to read this book and get ideas for how to break out of the mold. (In fact, Aaker devotes specific attention to the toothpaste category.) Additionally, the book offers a comprehensive look

Zipcar “provides a way to cope with urban living.” It’s hard to see how an Avis or a Hertz could capture the same magic.

The first thing a reader notices about Brand Relevance is how many of today’s power brands have already made good on its central concept: Brand preference has long ceased to be a powerful driver of marketing success. Brand success, therefore, requires something more. That something, according to David Aaker, now vice chairman of Prophet, a marketing consulting firm, “is to redefine the market in such a way that the competitor is irrelevant or less relevant, possibly by making the competitor’s strengths actually become weaknesses.” This requires creating brand relevance by carving out a new category or subcategory for your offering that has these key characteristics: a weak or nonexistent competitor set, a distinctive definition, a value proposition, a loyal customer base, and, perhaps most importantly, barriers to competition. In defining the characteristics that enable some brands to surge past others, Aaker brings an academic’s eye to the question of why some brands transcend their markets, and the result is a book thick with examples and lessons. One of the prime examples that Aaker uses to describe brand relevance is, of course, Apple Inc., particularly its roster of “i” products. Not only are they great products in and of themselves, he writes, but they also create substantial barriers to entry that keep other brands from competing directly. Nowadays, there are

at the kinds of factors that can make a brand relevant, which sometimes means looking at an established category such as car rentals in an entirely new way. Aaker cites Zipcar Inc., whose founders recognized that sharing a car makes more sense than owning one for some people, as probably the brightest example of the brand relevance concept. Started in 2000 in Boston, Zipcar had 350,000 members and 6,500 vehicles by 2010, focused mainly in urban centers and on college campuses. Members can reserve cars minutes before they need them, anytime, day or night. Although Aaker points out that the rest of the industry has responded by developing “more flexible” ways to rent, Zipcar has maintained its relevance not only because of its service, but because “rather than being about renting cars, [Zipcar is] about urban life and the freedom of not owning and maintaining a car but still having access to one. In that spirit it provides a way to cope with urban living in a fun, upbeat, and environmentally sensitive way.” It’s hard to see how an Avis or a Hertz could capture the same magic, even if it had programs that offered identical benefits. Other ways that brands can be relevant include providing a unique customer experience (Starbucks), being

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ward more responsible practices. Consumers and Greenpeace, he explains, successfully used social channels to pressure Nestlé and Cadbury to stop buying palm oil — a key ingredient in chocolate bars — from suppliers that were involved in deforestation. When the initial actions taken by the two companies weren’t enough, social media helped push both of them further. Although Nestlé and Cadbury were playing defense in this case, it’s easy to see how a company could proactively change its practices to better align with the We First philosophy and use that as a marketing differentiator. The vision presented in We First is huge and probably too idealistic for most companies to fully implement. But that doesn’t matter. It’s the best marketing book of the year because anyone who reads it will begin to question how his or her company does business, and that’s the initial step to change.

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a brand that offers “over-the-top service” (Zappos), and, in an unintended tip of the hat to We First, aligning themselves with some greater good. It’s clear from these examples that the ability to make brands relevant involves much more than the marketing department. Thus, Aaker devotes the book’s last chapter to dissecting cultures of innovation, such as General Electric’s. Among other initiatives, the company inaugurated an Imagination Breakthrough program in 2003, which charges every GE business with proposing new products and services that could make $100 million within three to five years. “The rude fact is that not all organizations allow ideas to emerge, nurture those ideas, and implement them in the marketplace,” he explains. Brand relevance may be a relatively simple concept; building it is not.

If you decide to read all three of this year’s best marketing books, Gary Vaynerchuk’s The Thank You Economy would be a good palate cleanser between We First and Brand Relevance. The other two books can be ponderous at times, but this book is anything but — as befits something written by a self-made social media superstar. Vaynerchuk’s personal Twitter account, @garyvee, has almost 900,000 followers. The charismatic Vaynerchuk also has the requisite YouTube channel, made 1,000 video posts on his now-inactive Wine Library TV blog, and is a frequent and popular speaker at digital conferences. Vaynerchuk’s book is as conversational as his various feeds. Explaining the now-famous Old Spice Man social media campaign, in which former NFL player Isaiah Mustafa interacted directly via social media channels with individual people, he enthuses: “With this campaign, Procter & Gamble…showed the world how a brand can play a kick-ass game of media PingPong.” (More on what he thought were the campaign’s shortcomings in a minute.) So what is the Thank You Economy? It’s today’s consumer-driven, social media–enabled economy, in which Vaynerchuk declares, “Only the companies that can figure out how to mind their manners in a very oldfashioned way — and do it authentically — are going to

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Mind Your Manners

have a prayer of competing.” Whereas We First argues that consumers are demanding more accountability from corporations in how they operate within the world at large, Vaynerchuk turns the premise inward. No matter how large the business, he says, companies can and should delight individual customers, who are becoming ever more discerning about how corporations should treat them. Drawing from his own experience, he asks: “How else do you think I outsell Costco locally and Wine.com nationally?… The real success of Wine Library wasn’t due to the videos I posted, but to the hours I spent talking to people online afterward, making connections and building relationships.” Which points directly to Vaynerchuk’s disappointment with the Old Spice Man campaign, even though it is viewed in the ad industry as one of the most successful social media campaigns to date. As far as the Thank You Economy is concerned, he says P&G dropped the ball because the brand didn’t use its new following in social channels to build an ongoing dialogue. “Every one of those people should have received an email, thanking the followers for watching the videos and offering them a reason to keep checking in,” Vaynerchuk says. He’s right. If building longterm relationships is the key to sustaining a brand, than P&G missed a major opportunity. “They turned what had all the markings of a superb social media campaign into a one-shot tactic,” he complains. In fact, although The Thank You Economy is full of anecdotes about how brands delight customers using tactics, Vaynerchuk goes to great lengths to explain that tactics work only as part of an ongoing engagement, an engagement that has to be more than superficial. As Aaker says in Brand Relevance, in order to differentiate a brand or a company, the employees have to live it. For Vaynerchuk, that comes down to intent: “If you’ve ever considered embarking on a social media campaign, or even tried an initiative or two, what was your intent? Was your goal to get someone to click through or click the ‘Like’ button? Or was it to build your online identity and foster a connection between

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yourself and the consumer?” You know the right answer. Vaynerchuk’s book is full of commonsense advice, but it has a big flaw: It promises that building individual customer connections is scalable, but it doesn’t really explain how the biggest brands can build those connections. It could have used more case studies involving a Ford, or a Microsoft, or a Kraft. That said, Vaynerchuk is inspirational. We First and Brand Relevance are food for thought, but The Thank You Economy is food for the soul of marketers who aim to build long-term relationships with their customers. In a world cluttered with brands and the media they support, traditional ways of messaging and targeting just aren’t getting the job done. And throwing money at the problem isn’t working. But as this year’s best marketing books show, companies can succeed if they market their brands in other ways — through the

Catharine P. Taylor [email protected] has covered advertising and marketing for more than 20 years, focusing on the impact of digital media since 1994 and writing for publications including Adweek, Advertising Age, and Wired. Founder of Adweek ’s AdFreak blog, she currently posts about advertising on her own blog, Adverganza.com; writes the weekly Social Media Insider column for Mediapost; and is a frequent speaker on the impact of social media on advertising, media, and behavior.

Edmund Morris, Colonel Roosevelt (Random House, 2010)

George W. Bush, Decision Points (Crown Publishers, 2010)

LEADERSHIP Learning to Lead the Old-Fashioned Way by Barbara Kellerman Once upon a time, long, long ago but not so far away, leadership was learned by learning about leaders. More precisely, we learned to lead by reading about great men (nearly always they were men) and their exploits. As Plutarch’s Lives was the first to attest, the assumption was instruction — life history as a template for what leaders ought and ought not do. The practice persisted for hundreds, even thousands of years; autobiography and, especially, biography were used as pedagogy. But some 30 or 40 years ago, the

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Ron Chernow, Washington: A Life (Penguin Press, 2010)

“media” of buzz-worthy products, excellent consumer experiences, and outstanding customer service. Since that’s the case, these books contend, it’s time to reframe the discipline and move forward. +

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Two of these authors are among the most distinguished of living American biographers: Chernow won the Pulitzer Prize for biography in 2011, for Washington; Morris won it in 1980, for the first volume of the trilogy, The Rise of Theodore Roosevelt. Chernow’s is a doorstop of a book, but, again, he tells the tale in full, from Washington’s birth to his death, and transforms him in the process from bland and boring icon into flesh and blood — a complex, commanding, and charismatic man who willed himself a hero. Morris’s book is almost as thick, but less compelling, not because it is less well written or researched than Chernow’s, but because in focusing on Roosevelt’s post-presidency we are, by definition, deprived of the leader at the height of his powers. Still, the Colonel had one helluva post-presidency, and the book’s value lies in its examination of how a great man winds down, or does not. Bush’s book is different. First, it is a political memoir, with all the subjectivity that this implies, not an objective biography. Second, it was written (with assistance) by an amateur who is famous for not being particularly literate. Finally, it is by and about a man who well into adulthood took more pride in being a good ol’ boy than he did in being anything else. So, it is no surprise that Decision Points is prosaic in its construction, plain in its prose, and notably lacking in self-reflection. But whatever its defects as a work of literature and critical analysis, Bush’s book does give voice to the man we know: the ordinary Joe, the uber-Texan who, for reasons even he cannot artfully articulate, ended up spending eight years in Washington — as president of the United States.

History and Context Assuming life stories are valuable sources of instruction, what leadership lessons do these three books provide? First, history matters. All leaders ought to have some sense of what transpired in the past, of context (both immediate and distal), of who their followers are, and of how the leaders who preceded them played their parts. In reading these three books, I was struck by how Washington and Roosevelt profited from their liberal learning (much of it undertaken of their own volition),

best books 2011 leadership

age-old tradition nearly came to a grinding halt. Since the burgeoning of the leadership industry with its now countless centers, institutes, programs, courses, seminars, workshops, experiences, teachers, trainers, books, blogs, articles, websites, webinars, videos, conferences, consultants, and coaches, which all claim to teach people how to lead, biography as pedagogy has gone out of fashion. Replaced now by readings on leadership development, training, and education, the life histories of great leaders are decidedly old hat. The present essay is unapologetically old-fashioned. It’s about the best new books on leadership all right, but it omits from the discourse books explicitly about leadership, in favor of books implicitly about leadership: two biographies and a memoir. Furthermore, although this essay is intended for an audience composed primarily of private-sector leaders, it considers public-sector leaders — three American presidents who left legacies that, whether proud or problematic, endure. In other words, the books under discussion mark a return to leadership learning as a liberal art, a form of instruction as multifaceted and richly textured as it is deeply human. Collectively, the books follow two trajectories. The first is chronological. The subject of Ron Chernow’s Washington: A Life is the first president of the United States. The subject of Edmund Morris’s Colonel Roosevelt is Theodore Roosevelt, who served as the 26th president, at about the midpoint in American history thus far. And in Decision Points, George W. Bush, the most recent ex-president of the United States, makes himself the book’s subject. The second trajectory is life span. Although Chernow’s book is, as its title implies, about George Washington’s entire life, the biographer is smitten with the start of the story, with Washington before he became president. Bush’s focus is on his time in the White House, on what he perceives to be the key crucibles of his performance as president. Finally, Morris’s book, the third in his magisterial three-volume biography of Theodore Roosevelt, is not only about the illustrious post-presidency of “the Colonel” (as he preferred to be addressed in those years), but also, inevitably, about his decline.

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that Washington had, in comparison with his peers, “superior presence, infinitely better judgment, more political cunning, and unmatched gravitas.… He had the perfect temperament for leadership.” At the same time, however, consider the context in which he lived. For more than a quarter century, Washington played a leading role in each of several different dramas: in the French and Indian War, where he honed his military prowess while acquiring the political and diplomatic skills for which he later became renowned; during the First and Second Continental Congresses, where he nurtured personal and political alignments with members of the colonial elite; during the Revolutionary War, where, as commander in chief of the Continental army, he sealed his fame forevermore; during the Constitutional Convention, over which he famously presided with dignity and restraint; and, finally, as first president of the United States, a position to which he was unanimously elected by the just-established Electoral College.

Lust for Life The third leadership lesson is that sometimes — not often, but sometimes — a single individual is unstoppable, a force of nature. Even past his prime, Theodore Roosevelt was such a man, a man of such brilliance and vitality, such stunning contradiction, such fierceness in his love of life, that everyone else seemed to shrink in comparison, becoming pygmies in contrast to this giant of a figure. Since Colonel Roosevelt constitutes the final chapter in Theodore Roosevelt’s life, it is more about his ostensible failures than his many successes. The biggest of these failures was his unsuccessful run for president on the ticket of the Progressive or Bull Moose Party, which he had founded for various reasons, not least to reclaim the pinnacle of power. As a result of his combativeness, he also became alienated from leading figures of the day, particularly political opponents, including his two immediate successors as president, William Howard Taft and Woodrow Wilson. But it’s hard to read this book and dwell on what TR did not accomplish, when he accomplished so much. His lust for life was so great that only death could quell it — first the death, in World War I, of the

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and by how Bush was diminished by his relative lack of it, by his lack of information and ideas and, worse, by his lifelong lack of curiosity about people and places other than those with whom and with which he was already familiar. Second, context matters. In fact, my own model of leadership is in the shape of a triangle with three equal sides: leader, followers, and context. Life stories of leaders are not merely life stories. They are, equally, stories about the times within which leaders lived. It does not belittle Washington to say his greatness was as much a product of his context as it was of anything else. Notwithstanding Chernow’s thoroughly chronicled description of Washington as a man of great derring-do, who by dint of self-construction ascended beyond his own earliest imaginings, and who among his other gifts was an extraordinary physical specimen, this president also had the great good fortune of being born at the right time. To consider Washington in context is to be reminded of that old chestnut: Great leadership is the result of great fit — between the person and the moment. Although Chernow’s book has justly been praised for infusing its subject with a measure of passion, it is impossible to be indifferent to the multiple upheavals that constituted his subject’s situation. This is not, in other words, a story of only a single struggle — by the Americans against the British — but of several struggles that began in the early 1750s and ended only in the late 1780s. What’s more, because each of these conflicts had military as well as political components, it mattered a great deal that Washington was as brilliantly accomplished a military leader as he was a political one. In fact, his political leadership depended absolutely on the glory he achieved in the military. Chernow, whose biography of Alexander Hamilton was chosen as an s+b best business book in this category in 2004, does not shy from what leadership theorists call the trait approach: Leaders become leaders because they possess in relative abundance certain traits, or characteristics, that propel them to the fore. George Washington had drive, courage, energy, integrity, and a high level of contextual intelligence. Chernow writes

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Tradition as a Starting Point The fourth and final lesson is that the ruling class is anything other than dead and gone. In 1921, German sociologist Max Weber published a seminal analysis of three types of leaders, one of which was the traditional leader. Traditional leaders are assumed by their followers to have the right to lead because they are legitimate heirs to legitimate traditions, as, for example, when the prince inherits the throne from his father. It is impossible to read Decision Points, in some ways a modest book by in some ways a modest man, and not conclude that in a million years George W. Bush would never have been elected president had he not been perceived on some level as a legitimate heir to a legitimate tradition. To be sure, before becoming chief executive, this son of President George Herbert Walker Bush, grandson of Senator Prescott Bush, and, for that matter, brother of Florida Governor Jeb Bush, had twice been elected governor of Texas. But by Bush’s own reckoning, his initial decision to run for governor, even to enter politics, was anything but obvious. Why? Because to understate it, his resume was thin, consisting of little more than brief (nepotistic) political experience, and light (nepotistic) managerial experience. Here is this particular “decision point” — to become a politician — in his own words: “My experiences on Dad’s campaigns and running the Rangers had sharpened my political,

management, and communications skills. Marriage and family had broadened my perspective. And Dad was now out of politics. My initial disappointment at his loss gave way to a sense of liberation.… I was free to run on my own.” Much has been made of George W. Bush’s overweening need to separate from, and prove himself to, George H.W. Bush. As the line “I was free to run on my own” seems to testify, this book does nothing to dispel the impression. Quite the opposite. The reader senses that on September 11, 2001, Bush the younger was further freed, however tragically, to make his own way, however tortured, and establish his own identity, however controversial. Bush himself writes as if his presidential life, his life as a man of consequence, began on that fateful day: “After 9/11, I developed a strategy to protect the country that came to be known as the Bush Doctrine.” It consisted of what he refers to as several “prongs,” of which the fourth and final is what he would have his legacy be. He calls it his “freedom agenda,” which was to “advance liberty and hope as an alternative to the enemy’s ideology of repression and fear.” For a man who begins his memoir with the story of his quitting drinking — he writes of being prodded by his wife, Laura, who asked in a “calm, soothing voice” if he could remember the last day he didn’t have a drink — Bush came far, albeit with a mighty, mandatory assist from his fabled family. I divide the leadership industry into two parts. One concerns learning about leadership, or leadership as an area of intellectual inquiry. And the other concerns learning how to lead, or leadership as a skill we should aspire to acquire. Life histories satisfy on both counts: They educate and elucidate, and they provide exemplars. Ron Chernow’s Washington: A Life is my candidate for the best book on leadership this year. But it is much more than that. It is an evergreen instruction on American history, a painterly portrait of a great man, and, to boot, a first-rate read. +

Barbara Kellerman [email protected] is the James MacGregor Burns Lecturer in Public Leadership at Harvard University’s John F. Kennedy School of Government. She is the author and editor of many books, including Followership: How Followers Are Creating Change and Changing Leaders (Harvard Business School Press, 2008) and The End of Leadership, which will be published in 2012 by HarperCollins.

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youngest and brightest of his well-loved children, son Quentin, and then his own, when he was just 60. What stands out most about Roosevelt is his intellectual voraciousness. Most of us know about his hunger for adventure, which took him, famously, to distant continents (Africa and South America) where he, equally famously, and, given his prescient preoccupation with conservation, paradoxically, slaughtered animals in large numbers. What we are less likely to know is that Theodore Roosevelt authored some 40 books, and cultivated an early expertise on a range of subjects, many, but by no means all, related to the natural world. A small example: Morris describes the former president seeking unaccustomed silence and solace at his home on Long Island, and witnessing 42 species of birds — thrashers and herons, bobolinks and catbirds, meadowlarks and red-tailed hawks. “All of them,” Morris writes, “were listed in the catalogue, Notes on Some of the Birds of Oyster Bay, Long Island. He had no need to consult that authoritative work, having written and published it himself, at age twenty.”

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Kevin Kelly, What Technology Wants (Viking, 2010)

Steven Levy, In the Plex: How Google Thinks, Works, and Shapes Our Lives (Simon & Schuster, 2011)

Stephen Baker, Final Jeopardy: Man vs. Machine and the Quest to Know Everything (Houghton Mifflin Harcourt, 2011)

TECHNOLOGY The Ecology of Technology To understand the future of innovation and entrepreneurship, listen to the technology. Don’t talk. Listen. Carefully. “Listen to the technology” is Carver Mead’s mantra. The eccentrically brilliant Caltech engineer is an apostle of and evangelist for Moore’s Law, which states that chip circuit density reliably doubles every one to two years. Mead thinks that Moore’s Law is more about belief systems than technology. “When people believe in something,” he observes, “they’ll put energy behind it to make it come to pass.” Belief systems that inspire great faith and even greater investment are powerful. Technologies and technical challenges that evoke such passion and commitment deserve to have their stories told. This year’s best technology books are well-crafted tales of what happens when people really listen to technology and believe what they hear. At their core, these books describe how people and technology successfully coevolve to compete. The heroes here aren’t technologies, technologists, or entrepreneurs; they’re the innovation ecosystems that create transformative value and growth. That’s why Kevin Kelly’s What Technology Wants, in which Mead is featured, reads like technology’s The Origin of Species. This sprawling compendium of argument and analysis asserts that technology is best understood not as materialized tools or actionable artifacts

but as what he calls a technium — an ever-evolving system driven by the interaction of technology and people. By contrast, In the Plex: How Google Thinks, Works, and Shapes Our Lives is Steven Levy’s superb, surprisingly comprehensive Baedeker of what makes Google Google. Levy captures the accelerating evolution of a global innovation juggernaut and quirky collective of entrepreneurial talent. And Stephen Baker’s Final Jeopardy: Man vs. Machine and the Quest to Know Everything updates the behind-the-scenes sensibility of Tracy Kidder’s classic The Soul of a New Machine (Little, Brown, 1981) by observing how and why IBM committed itself to creating an artificial intelligence that could win on Jeopardy. The resulting computer, named

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by Michael Schrage

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Technology Lives For Kelly, What Technology Wants amplifies and expands upon Out of Control: The Rise of Neo-Biological Civilization (Perseus, 1994), his exploration of emergent behavior and complex systems. A complexity junkie, Kelly is a cofounder and former executive editor of Wired magazine. He is always on the rhetorical prowl for underappreciated systems interrelationships. He listens diligently to people and technology alike. What Technology Wants, this year’s best technology book, fully commits to Kelly’s conceit that humans and their technologies coevolve. One is practically meaningless — or inert — without the other. Like the bacterial flora and fauna digesting food in our gut, he says, technology is a life force. The book is studded with biological metaphors and analogies. The suspension of disbelief that Kelly asks of his readership is the willingness to see technologies as living things.

With no apologies to Darwin, Kelly’s take on technology is more rooted in ecology than biology. Darwin’s great epiphany was that the Galapagos Islands mattered as much as the finch’s beak. Similarly, Kelly says that it’s intellectually and economically misleading to appreciate a technology outside its (un)natural habitat. Trying to grasp technology by studying its underlying physics, chemistry, and engineering design is too reductionist, Kelly argues. Real understanding demands insight into the web of user beliefs — tacit and explicit — around the fitness and perceived evolvability of tools and processes. In other words, what can the technology become? What does it want? Kelly’s imperative goes beyond evolutionary biologist Richard Dawkins’s vivid metaphor of the “selfish gene” to his lesser-known but comparably influential notion of the extended phenotype. Dawkins’s crucial insight is that successful birds are successful technologists. Nests, like the eggs they shelter, are essential to how birds perpetuate themselves. Poorly placed or shoddily constructed nests reduce the chances for reproductive success. Conversely, well-built nests dramatically improve the evolutionary odds. “Nest tech” — the twigs, leaves, hair strands, and so on — inarguably shapes both individual and species fitness. Divorcing bird biology from nest technology (and vice versa) fundamentally misrepresents bird reality. Technology is an extended phenotype, something external and transcendent that transforms the bio- and ecosystems of living things. No species on earth better extends its phenotype than human beings. Human habitats and personal relationships are mediated and managed by all manner of evolving technologies. This has been true for millennia. In What Technology Wants, Kelly maintains that it’s becoming ever more crucial. We are, he insists, committed to coevolve with the living artifacts of our creation: “Technology is simply the further evolution of evolution. The technium is a continuation of a four-billion-year-old force that pursues more ability to evolve. The technium has discovered entirely new forms in the universe, such as ball bearings, radios, and lasers that organic evolution could never

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Watson, dispassionately but definitively defeated humans and Ken Jennings, who had won US$2.52 million in 74 consecutive appearances on the show. With eyes and ears wide open for detail, the authors of these three books are exceptional reporters. They artfully balance their insight into innovative people with their insight into innovative technologies. Their books position technology as pop culture and pop culture as technology. Just as important, the books benefit from their living-in-the-moment narrative; they avoid the “Neugebauer dilemma” that plagues most high-tech histories. “The common belief that we gain ‘historical perspective’ with increasing distance seems to me to utterly misrepresent the actual situation,” observed the historian of mathematics and science Otto Neugebauer. “What we gain is merely confidence in generalization that we would never dare to make if we had access to the real wealth of contemporary evidence.” These contemporaneous accounts of technical transformation possess that wealth. In these books, telling details don’t defer to facile “big think” generalizations. Executive readers desiring the big picture with meaningful technical detail will find these works useful.

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tion ecosystem par excellence. Google cofounders Larry Page and Sergey Brin do more than just listen to the technology; they’ve turned their company into a most fluent translator of its every hiccup, whisper, and utterance. Even bats must envy their flair for echolocation. They’ll hire the world’s best specialists, deploy microphones anywhere and everywhere, and do whatever it takes to ensure maximum technological intelligibility. But the genius of Page and Brin lies not in their own acuity, but with their ability to evoke it in others. They hunger for techno talent that listens even better than they do. In the Plex flawlessly describes Google’s unique culture, which is dedicated to getting the world’s greatest technologists to innovate beyond disciplinary bound-

Google’s founders thoroughly grasped that they had launched not a company but a global innovation ecosystem.

Google’s Hive Mind Arguably no company on earth better embodies Kelly’s thesis than Google. With its global reach, driverless automobiles, plethora of digital platforms, dizzying arrays of real-time algorithms, and density of computational expertise and server farms — not to mention its great and growing wealth — Google is a coevolving innova-

aries. Although Steven Levy does not quite offer — or create — fully rounded views of the many Googlers mentioned in his pages, his descriptions of their design sensibilities and innovation ethos are without peer. This is the best book about Google yet written, because Levy gets the “push the envelope until it rips” intellectual extremism that defines Google’s most effective intrapreneurs. Sure, they’re very smart. But their drive and ambition have to get Page and Brin hot and bothered, or they will not have much impact. “Page once said that anyone hired at Google should be capable of engaging him in a fascinating discussion should he be stuck at an airport with the employee on a business trip,” Levy writes. “The implication was that every Googler should converse at the level of Jared Diamond or the ghost of Alan Turing. The idea was to create a charged intellectual atmosphere that makes people want to come to work. It was something that Joe Kraus [a top-tier Google hire] realized six months after he arrived, when he took a mental survey and couldn’t name a single dumb person he’d met at Google. ‘There were no bozos,’ he says. ‘In a company this size? That was awesome.’” Serious readers will come away from In the Plex

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invent. Likewise, the technium has discovered entirely new ways to evolve, methods that were unreachable by biology. And just as evolution did with life, technological evolution uses its fecundity to evolve more widely and faster. The ‘selfish’ technium generates millions of species of gadgets, techniques, products, and contraptions in order to give it sufficient material and room to keep evolving its power to evolve.” That relentless and remorseless coevolution spawns a theme and thesis inhabiting the entire book: “the evolvability of evolvability.” In other words, how does evolution itself evolve? “As evolution rises, ‘choicefulness’ increases,” Kelly writes. “A mind, of course, is a choice factory….” Different technologies appeal to different minds. Choices change as technologies evolve. Technologies evolve — and mutate — as those choices shift. But human minds won’t be the only “choice factories” in this emerging ecosystem. Kelly’s technology wants choicefulness. Technologies are becoming smarter; they’re evolving with silicon and software-enabled situational awareness. They’ll be inventing, and evolving, new ways to choose, not just in cooperation with people, but also in competition with them. Does anyone doubt that tomorrow’s smartphone will recommend what pictures to take or phone calls to make? Whose choicefulness will exert greater influence over a typical day: the growing menagerie of your evolving devices or your mind, which (supposedly) tells them what to do? The upshot is that almost everything people think they understand about intelligence, innovation, and choice needs to evolve as technology evolves. What Technology Wants is explicit acknowledgment that, now and tomorrow, trying to understand these three things distinct from our coevolving technologies is not merely self-deceptive but a denial of human potential.

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videos, Google literally and figuratively enjoyed an embarrassment of digitized riches. What a fantastic innovation environment. Network effects meant that the innovation paradigm could shift away from linear research and development to more iterative experimentation and scale. Business experimentation soon converged and coevolved with technical and computational experimentation. Google’s ecosystem became an economy. So the company hired innovative Berkeley professor Hal Varian as its chief economist; Varian has proved adept at designing market mechanisms for monetization and using Google searches as forecasting tools for the global economy. (See “To Hal Varian, the Price Is Always Right,” by Michael Schrage, s+b, First Quarter, 2000.) Levy holistically captures Google as a global business; a data-driven, experimentation-oriented innovation culture; a cutting-edge technologist; a pop culture icon; and the living extension of its founders’ vision. He strikes these balances remarkably well, although he is, perhaps, a little too generous to a company that clearly offered terrific access. That said, Levy doesn’t flinch in describing Google’s difficult moments, such as the souring of relations with Apple’s late CEO Steve Jobs, who felt betrayed by the top management at Google when that company introduced the Android phone. Indeed, Levy’s earlier books on Apple — The Perfect Thing: How the iPod Shuffles Commerce, Culture, and Coolness (Simon & Schuster, 2006) and Insanely Great: The Life and Times of Macintosh, the Computer That Changed Everything (Viking, 1994) — give him great insight into and context for writing about idiosyncratic technical geniuses worth billions of dollars. Levy also points to the struggle of retaining exceptionally talented people who invariably chafe at the technical and business conflicts that emerge in every fast-growing global enterprise. As dominant and influential as Google may be now (wasn’t that true of Microsoft barely a decade ago?), Schumpeterian reality suggests that today’s Googlers may be the firm’s most serious rivals tomorrow. To its credit, Google recognizes this. It knows that some of its best people may listen to

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knowing in their heart of hearts that their own organizations aren’t as passionately committed to technology, technologists, and their creative coevolution as Google. Recruiting the very best quants and software jocks was simply the most obvious element in the coevolutionary equation. What really made the difference was the founders’ relentless emphasis on creating the fastest possible and best user experience. Milliseconds mattered. The fastest search had to be the best; the best search had to be the fastest. That is an innovation imperative requiring exquisite skills in listening to technology. But Google’s founders — intuitively, analytically, or alchemically — thoroughly grasped that they had launched not a company but a global innovation ecosystem that technologically transformed value creation. The company’s culture evolved around the interaction of brilliant people with brilliant technology. It wasn’t just that smart Googlers made innovative technology; innovative technology made Googlers smarter. Google was as much a hive mind as an innovation ecosystem. In the words of publisher and digital entrepreneur Tim O’Reilly, Google was the first real Web 2.0 enterprise: “The real heart of Web 2.0 is harnessing collective intelligence.” This was Google’s transcendental essence. Google understood and exploited the innovation ecosystem of network effects faster, better, and cheaper than anyone else. Virtually every successful investment the company made was based on the belief that the economics of network effects ensured that great innovation would be great business. This proved true. From Page’s PageRank (pun intended) algorithm that made links the center of search to Google’s expropriation of rival GoTo’s auction business model for keyword search, Levy observes, everything was engineered around exponential expectations. To succeed, Google would ultimately have to manage billions of queries and petabytes of data. To sustain success and growth, Google would inherently need to think not just big but huge. The firm would need to listen for and exploit network effects wherever it could find or create them. As Levy documents with relish, from Android mobile phones to Gmail to YouTube

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What Is “Watson”?

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That “listen different” sensibility reverberates throughout Final Jeopardy. This book is more an hors d’oeuvre than a gourmet banquet. But it serves a tasty slice of the larger themes addressed by What Technology Wants and In the Plex. Sometimes the technology simply says, “What the heck.” Sometimes the seemingly trivial provokes serendipitous and significant leaps of innovation. The sheer quixotic nature of the quest is silly but irresistible. Could IBM build a machine that could do for Jeopardy what Deep Blue did for chess? Could Ken Jennings — the ubergeek who captured the hearts, minds, and Nielsen ratings of America’s longest-lived TV game show as its most dominant champion — be turned into a 21st-century Gary Kasparov, the world’s top chess player who was defeated by IBM’s Deep Blue in 1997? Could creating a Jeopardy machine generate publicity for IBM even as it pushed the boundaries of real-time artificial intelligence research? As a successful Jeopardy contestant would answer, “What is yes, Alex?” Although his prose is more serviceable than sparkling, Stephen Baker chronicles what happens when IBM’s serious researchers confront a high-risk/highstakes challenge at the intersection of humiliation and breakthrough. Given the immature mix of artificial intelligence techniques and technologies, the Jeopardy challenge was far more difficult than that presented by chess. After all, chess — the royal game — had been the lab rat of artificial intelligence research for decades. Jeopardy — the game show of the upper middlebrow — sometimes involved more competitive, interpretive, and open-ended interplay than chess. The task of recognizing, evaluating, and processing puns, pop culture references, and subtle wordplay in less than two seconds is a nightmarish programming proposition. But David Ferrucci, the stressed-out researcher tasked with bringing Watson to life and Baker’s chosen hero, is fully committed. Money plays only a minimal role in this narrative. IBM supported the Jeopardy challenge both as a publicity stunt and as a forcing mechanism to integrate nonaligned strands of its artificial intelligence and analytics research efforts. I’m comfortable arguing, as Baker is not, that a decade hence, Watson’s triumph in Jeopardy will be regarded as a far more technically and economically significant event in computing history than Deep Blue’s victory.

Why? Because the way people interact with machines around seemingly simple questions and answers represents a profound shift in the coevolution of technology. It’s not an accident that one of IBM’s most important prototyping tools in Watson development was Google. Just observing how IBM modeled, simulated, and evaluated what it takes to win at Jeopardy is an anecdotal treat. Knowledge is not the same as understanding. “This led to an early conclusion about a Jeopardy machine,” Baker writes. “It didn’t need to know books, plays, symphonies, or TV sitcoms in great depth. It only needed to know about them.… Ken Jennings, Ferrucci’s team learned, didn’t prepare for Jeopardy by plowing through books. In Brainiac [Jennings’s pop autobiography], he described endless practice with flash cards. The conclusion was clear: The IBM team didn’t need a genius. They had to build the world’s most impressive dilettante.” Designing for dilettantism across the breadth and range of Jeopardy categories was enormously difficult. But Google- and Wikipedia-type technologies — combined with computationally intensive statistical learning algorithms — ultimately gave Watson the power to win. When Ken Jennings lost to Watson, he noted on his (correct) final Jeopardy answer the mock ironic line from a famous Simpsons cartoon: “I for one welcome our new computer overlords.” This was a passing of the pop trivia torch from the most successful human player to his silicon successor. When Jennings completed his run of Jeopardy wins in 2004, no one in computer science — including the Googlers —would have predicted a Watson-like triumph within a decade. Francis Bacon, the founding philosopher of science to whom the famous phrase “Knowledge is power” is attributed, also observed in 1620 that “we cannot command nature except by obeying her.” In this later observation, he anticipated Carver Mead’s aphorism by roughly 375 years. The essential truth of that prescient insight hasn’t changed a bit. But the technologies have evolved, in every meaning of the word. Their ongoing evolution, these three books agree, is also our own. +

Michael Schrage [email protected] is a contributing editor to strategy+business and holds appointments at MIT’s Sloan School of Management and London’s Imperial College. He was previously a Washington Post reporter and a columnist for Fortune and the Los Angeles Times. Reprint No. 11405

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the technology in a different way — and choose to do their translating elsewhere.

thought leader

The Thought Leader Interview: Meg Wheatley An expert on innovative leadership warns that too many companies are reverting to fear-driven management. Instead, executives should hold to their values and build healthy corporate communities.

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ith her first book, Leadership and the New Science: Learning about Organization from an Orderly Universe (Berrett-Koehler, 1992), Margaret J. (Meg) Wheatley began developing a body of work around the links between organizational learning, innovative leadership, and such fields of thought as chaos theory, quantum physics, and neuroscience. Around the same time, she cofounded the Berkana Institute, a U.S.-based not-for-profit organization, dedicated to experimental ef-

forts to build healthy communities around the world, often in highly impoverished areas with many serious challenges. During the next 15 years, Wheatley’s views on communities, and her experience with innovative management practice, made her a central figure in a wide network of pioneers in organizational learning and change. Then, starting in the mid-2000s and accelerating with the economic crisis of 2008, Wheatley noticed new levels of anxiety among her friends, clients, and business ac-

quaintances. Even the most performance-oriented innovative leaders, when confronted with the harshness of global competition or other severe business pressures, felt compelled to cut back their participative management practices — often at the expense of profitability and growth. Wheatley responded by turning simultaneously inward and outward. During a 15-month period, she produced two very different books. The first, Perseverance (Berrett-Koehler, 2010), is a small, personal book, a meditation on tenacity in the face of adversity. It is written explicitly for people dedicated to organizational change, who have suddenly found their work much more difficult, and who are looking for ways to sustain their effort and their peace of mind. Walk Out Walk On, coauthored with Deborah Frieze (a former copresident of the Berkana Institute), is subtitled A Learning Journey into Communities Daring to Live the Future Now (Berrett-Koehler, 2011). It describes seven innovative leadership and community-building initiatives: a self-organizing university in a highland Mexican village, where students build small-scale technologies such as bicycle-pow-

Photograph by Joshua Heath

by Art Kleiner

whom face the challenge of managing high-commitment, high-performance enterprises in the face of intensive competitive pressure and rising uncertainty. S+B: Why is perseverance important right now? WHEATLEY: Because so many inno-

vative leaders are struggling to do good, meaningful work in a time of overbearing bureaucracy and failing solutions. Everyone is working harder, and in most cases, in greater isolation. The current pace of work and life, along with increasing fear and anxiety, make it more difficult to have the energy and enthusiasm to keep going. Years of good efforts have been swept away by events beyond anyone’s control, such as the economic crisis or the natural disasters of the past decade. And decisions made by politicians and senior executives have been very damaging to those longterm efforts: They capriciously eliminate or withdraw funding for programs and processes that have proven successful. It is a very difficult time for innovative leaders. I notice that when I ask people how much time they spend thinking together with colleagues, reflecting

on what they’ve learned from their most recent efforts, they just stare back blankly at me. It’s getting hard to remember what it felt like to manage reflectively — to take time to figure things out together and to learn from experience. With our frantic pace, we’re screaming past one another (and more easily provoked and angered by each other), so we’re losing the one resource, community, that gets humans through hard times. For me, community — people working together and knowing that others are there to support them — is a critically important but largely invisible resource. In most situations (think of natural disasters, family crises, wars, and dislocations), community is the only thing that gets us through. In a time like this, of economic and emotional distress, every organization needs leaders who can help people regain their capacity, energy, and desire to contribute. And this is only accomplished when people work together in community, not in isolation. But community is hard to find in most organizations. Not only do many leaders deny that this capacity is important, but they’re actually destroying it through their current management approaches.

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ered water pumps as a means of local empowerment; a Brazilian institute that sets up “30-day games” in which players come together to improve conditions in debilitated neighborhoods; a Zimbabwean village dedicated to self-sustaining agriculture in the midst of politically created famine; a remarkable network of people transforming healthcare, education, and social service institutions in Columbus, Ohio; and similarly groundbreaking initiatives in South Africa, India, and Greece. The organizers of all these endeavors walked out of restrictive or confining ways of thinking, and Wheatley argues that anyone can do the same — which might mean changing jobs in some cases, but always means shifting perspective within one’s current situation. We conducted this interview on several occasions in 2011: first by telephone, then at the annual summer workshops of the Authentic Leadership in Action (ALIA) Institute (where we both teach), and finally at the Cape Cod Institute (where Wheatley leads a seminar each summer). Wheatley’s theme, the value of conscious perseverance, may particularly resonate with strategy+business readers — many of

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S+B: For example. . .? WHEATLEY: I have worked with

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many forward-thinking business leaders over the years. Now, I notice they’re increasingly frustrated. They can no longer motivate people in ways that they know will work. Instead, they’re being driven by imperatives from their boards and bosses. They find themselves doing things that feel meaningless or that waste time — or that they know from experience won’t lead anywhere good. They have to implement continuous cutbacks, and to produce more results with fewer resources. They feel terribly pressured yet believe they have no choice but to respond to these demands. One of my good friends led the turnaround of his company, one of the world’s top brands. He did it by engaging people: inculcating a strong sense of values, giving people latitude to make decisions and design projects, ensuring that learning was prevalent. Now that he’s retired, that’s all been destroyed. The new leadership is highly restrictive and controlling, using fear as a primary motivator. As a result, the company has been struggling in this current economic climate. And of course it becomes a reinforcing cy-

cle: The worse the financials, the stricter the controls become. In most companies, we do not have (and I believe won’t have for the foreseeable future) the money to fund the work that we have to do. Leaders have two choices. One, they can tap the invisible resource of people who become self-motivated when invited to engage together. This approach has well-documented results in higher productivity, innovation, and motivation, but it requires a shift from a fear-based approach to a belief in the capacity of most people to contribute, to be creative, and to be motivated internally. Alternatively, they can continue to slash and burn, tightening controls, and using coercive methods to enforce the cuts. This destroys capac­ ity, yet it is the more common approach these days. S+B: Some might argue that these cuts are reshaping the organization back down to what it should have been in the first place. WHEATLEY: I would love it if that

were true. Executives could be using this turbulence to shift their business models, redesign their HR systems, change how they motivate people, and rethink their own lead-

ership. But I don’t see that happening. Instead, too many people report that mean-spiritedness is on the rise in their companies. And there seems to be a growing climate of disrespect for individual experience and competence — hiring and firing decisions are made on the basis of finding the cheapest source of labor (and I include executives here). If someone can be found to do the job for less money, because they have less experience and fewer skills, that person gets hired. What makes one salesperson more successful than another? It’s not the reward and motivation system. It has much more to do with complex factors, like the relationships each person has, the ways they listen, their ability to be selfmotivated. Instead of paying attention to these factors, companies are simplifying the criteria and acting as if anybody can do any job, that people are easily replaceable. If you look at job satisfaction surveys, or you listen to people talk, you realize how this business climate has affected most organizations. Management has gone backward from the 1980s and ’90s, when people routinely talked about workforce engagement and intrinsic

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Art Kleiner kleiner_art@ strategy-business.com is editor-in-chief of strategy+business.

motivators. Instead, people are demoralized, disaffected, disillusioned. They’re afraid to talk openly about how they feel, because they want to hold on to their jobs. There’s a

ronment. Nothing is working as it should. A friend of mine quoted a highly placed oil executive, who whispered to her after the Gulf of Mexico oil spill: “None of us can figure out how this happened.” And I often hear descriptions of complex problems and crises described as, “We’re in new territory here. We’ve never been here before.” Around the time I began writing Perseverance, I read a book by Laurence Gonzales called Deep Survival: Who Lives, Who Dies, and

“People are anxious because these times warrant anxiety. Leaders are afraid that they don’t know how to solve the problems they face.” lot less freedom to walk out in this economy.

are anxious because these times warrant anxiety. They feel pushed aside and powerless. And then there’s a more personal fear, not as easy to name. Leaders are afraid that they don’t know how to solve the problems they face. The old models of command and control — budgeting, strategy setting, forecasting, incentives, evaluations — are not effective in a changing, volatile envi-

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S+B: Where does the fear and anxiety come from? Does it have to do with uncertainty, fear of failure, losing jobs? WHEATLEY: It’s all of that. People

Why: True Stories of Miraculous Endurance and Sudden Death [W.W. Norton, 2003]. Gonzalez says that when people are truly lost in the wilderness, they go through predictable stages. First, they deny they’re lost; they keep doing what they’ve always done but with a greater sense of urgency. Then, when they begin to realize that they’re lost, they search frantically for any shred of evidence that would indicate that they’re not. Next they deteriorate, both physically and mentally. Their frantic search for the familiar, and their inability to recognize that their current maps aren’t working, leads to the ultimate moment when they realize they are close to death. If

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group and comment about the number of reports people have to write today, or the number of measures they have to track, the audience members roll their eyes and groan. In addition, the opportunity is lost to cultivate the intelligence, contribution, and engagement of people throughout the organization. When the next crisis comes, people will be less prepared; they’ll leave it to the leader to solve it. When that doesn’t happen, they’ll kick out the leader for not being heroic enough as an individual. This pattern is visible in the statistics on CEO churn that strategy+business publishes. Over the

that it’s their job to keep things in control, but when they use fear as a motivator, they shut down people’s brains and, as leaders, create the conditions for everyone to fail. S+B: What’s the alternative? WHEATLEY: When you’re lost in the

wilderness, the only way to survive is to admit that you’re lost — and to stop looking for signs that might confirm that you know where you are. Your old ways of doing things won’t get you out of this situation. Once you realize this, you can look clearly around you, and seek information that will help you rethink

“When leaders use fear as a motivator, they shut down people’s brains and create the conditions for everyone to fail.” past 10 years, the average tenure of CEOs has gotten shorter. [See “CEO Succession 2010: The Four Types of CEOs,” by Ken Favaro, Per-Ola Karlsson, and Gary L. Neilson, s+b, Summer 2011.] I have a lot of sympathy for leaders who think

what to do. You don’t have to change the situation you’re in; you have to change your mind about it. For any situation where the old maps are failing, you need to call together everyone who might have information that’s needed to construct

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they don’t acknowledge that they’re lost and that they need new information to construct an accurate read on their situation, they will die. When I read this, I thought, “That’s exactly what I see in organizations (and in our political leaders).” Too many leaders fail to realize that the old ways, their mental maps, aren’t giving them the information they need. But instead of acknowledging that, they push on more frantically, desperate to have the old ways work. When human beings work from fear and panic, we lose nearly all of our best reasoning capacities. We can’t see patterns, think about the future, or make moral judgments. This leads to a terrible cycle, a death spiral. People in fear look for someone to blame; so leaders blame their staff, and staff blame their leaders. A climate of blame leads to self-protective behaviors. People take fewer risks; creativity and participation disappear. New rules and regulations appear, with unintended but predictable consequences: more staff disengagement, more wasted time, more chaos. People spend all their time trying to cope or writing reports to confirm that they aren’t to blame. When I’m speaking with a

S+B: Isn’t this problem limited to the U.S., Europe, and Japan? WHEATLEY: Even in other coun-

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tries, uncertainty is rearing its ugly head. A colleague in Australia invited me to speak at a forum for CEOs, built around reflection and longterm issues. I said, “You know, in the U.S., you wouldn’t get anyone to attend.” He said that Australia was different; they had survived the global financial crisis pretty well and didn’t share our despair or cynicism. Then came the floods, hurricanes, fires, and more economic turbulence. He wrote me back and canceled, saying that in this new, crisisstricken environment, none of the CEOs he knew had any time for reflection, either. They were now

in panic mode and resorting to command-and-control-style management. A very forward-thinking Australian CEO told me that he’s never experienced such fear-based

century Sufi mystic Rumi: “Sit down and be quiet. You are drunk, and this is the edge of the roof.” There are always choices. Everything in our world — what we

“We are at a turning point. Either we continue to descend into incompetence or we see new ways of thinking and acting.” and risk-averse behaviors as those that now characterize Australian leadership, in both business and government. S+B: If the situation is this grim and pressured, how can you expect people to rethink the way they operate? WHEATLEY: It’s more interesting to

reverse that question. Because the situation is so grim and pressured, why aren’t we rethinking how we operate? We are at a turning point. Either we continue to descend into incompetence and failing solutions or we realize where we are and see new ways of thinking and acting. One of my favorite quotes, applicable to this moment, is from the 13th

do, who we like, what we dislike — is a choice. When we realize this, and start to act on it, we regain our freedom and control. That doesn’t mean quitting your job out of frustration. It means thinking more deeply about the choices you have made, the choices you will make in the future, what you stand for, and your choice to persevere. Months after Hurricane Ike devastated Houston in September 2008, I received a text message from a friend who is CEO of a large nonprofit there. She was sitting in a meeting with government officials from FEMA [the Federal Emergency Management Agency]. The level of bureaucracy was heartbreaking

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a new map. This includes people at all levels of the system — anyone who plays a role that’s relevant. Especially as you face increasingly complex problems that have no easy answers, you need to be brave enough to seek out perspectives from all parts of the system. It takes a lot of courage for a leader to say, “Our problems were caused by complex interactions. I don’t know what to do, but I know we can figure it out together.”

S+B: If Perseverance is about being lost, then Walk Out Walk On is about being found — the communitybuilding efforts that you and your coauthor, Deborah Frieze, have worked with. Where did the title come from?

WHEATLEY: It was coined by a

group of students who left high school in India. The school officials had called them “dropouts.” They responded, “No, we’re not failures. The education system is the failure. We know we can contribute more and learn more if we leave this school.” They called themselves “walk-outs.” A bit later, they added “walk on” — meaning that after you walk out, you have to move forward and find a place where you can make a difference. The full phrase is a declaration of commitment to your own potential. Often, when people walk out of a difficult job or position, they’re full of fear. They don’t know where they’re going. But they know that if they stay, they’ll continue to lose their self-confidence; they’ll con­ tinue to shrink and wither. I met a woman who worked for one of the large pharma companies; they’d been through three major mergers during her 12-year tenure. One day she noticed that her job title was now listed as “income-generating unit” on a budget sheet. In other words, she was regarded as a commodity. She thought, “This isn’t the same company I was working for before the mergers.” When she re-

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and infuriating; people whose homes had been hit hard by the storm were still living with nothing, and nobody knew when the aid that was promised would come (it didn’t arrive for 16 months). Her text message said: “Every day I make a choice not to give up.” For me, that’s the essence of perseverance. Day by day, situation by situation, you become more conscious of your choices. Sometimes the best response is to keep going, as my friend did. Other times the best choice is to withdraw for a while, reassess the complexity of the situation, and see what will serve your cause, your people, and yourself. You don’t persevere by constantly pushing your head against a wall or by burning out. It’s also comforting to remember that perseverance is the story of humankind. We all come from ancestors who persevered. We wouldn’t be here without them. It’s our turn now.

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S+B: Can you give an example? WHEATLEY: In Columbus, Ohio,

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several years ago, a group of leaders of local healthcare institutions came together, along with some community members, with the idea that they could rethink their purpose — from the zero-sum game of treating the sick, to a system that would promote optimal health. The convener was Phil Cass, the CEO of the Columbus Medical Association, which is a physicians’ professional group that includes a medical foundation and a free clinic. To bring all these people together, he had to shift his own internal construct of what it meant to be an effective leader. He was already a skilled, traditional heroic leader; now he became the kind

of leader whose first responsibility is not to command others, but to ensure that they feel invited and welcome, so they can participate in making something happen that none of them could do alone. Under his leadership, more and more people in Columbus became trained in productive conversational processes that include all relevant stakeholders in figuring out problems and solutions. This form of leadership continued to spread into many types of institutions — the Ohio Food Bank, hospitals, Ohio State University, even to a federal initiative on homelessness. Another example is the “Warriors Without Weapons” program that the Elos Institute initiated in Brazil and has spread around the world. In most aid efforts for people on the margins of society, there’s an assumption that their poverty includes a lack of capacity to help themselves. But Elos gathers people together to “play a game,” as they call it. The game is actually an experience of people coming together for days or weeks, outsiders working side by side with residents, to do extraordinarily difficult work, such as cleaning up and rebuilding neighborhoods. They invoke the spirit of

play (which is different from fun) to get people past their fear and preconceptions. The participants take risks because it’s “just a game”; they compete with one another; there’s an engaged quality to their relationships. In this way, very difficult work gets done that would otherwise be overwhelming. In Walk Out Walk On we tell the story of the cleanup of a large, waste-ridden, abandoned warehouse that people in the neighborhood wanted to convert to a community space. Those engaged in the cleanup could spend only 15 minutes each day inside this hellhole; they had no idea if that would be enough to accomplish their goal, but they did realize that had they worked any longer in such terrible conditions, they would have been overwhelmed and given up. And they did accomplish their goal within 30 days! S+B: These sound like glimpses of a very engaged way of taking initiative and conducting work. But you would be unlikely to see it within the walls of, say, a major consumer products or energy company. WHEATLEY: No, I disagree. Good

leadership can be found in pockets within any large organization. I’ve

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signed, she told her boss that these transactional values were the reason. He responded, “Don’t leave; we’ll pay you more.” Walking out of a limiting situation doesn’t necessarily mean leaving the company — or even leaving your position. It means discarding some of the prevailing beliefs that blind you to the capacity that’s in yourself and other people. And opening yourself up to more contribution, intelligence, and capability.

couraged, challenged, and supported, to become stronger and more capable as they do their work. The descriptions are always the same: “The leader thought about me and trusted me (just as I trusted him or her). He or she believed that I was capable and supported and encouraged me to stretch and excel; the leader was not focused on making himself or herself look good.” I’ve heard this in so many different cultures that it’s convinced me that there’s only one type of leadership that people respond to positively. If we want people to contribute; if we want them to get smarter as they solve each problem or go through each crisis; if we want to develop our organizations to be responsive, smart, and enduring, then we have to change the way we lead. We cannot continue to lead from fear and control. People will step up to today’s challenges only if they are led with encouragement and support, and trusted to contribute. Islands of possibility are important because leaders have to intentionally create places where people can contribute. Part of a leader’s work is to create firewalls to keep out the bureaucratic, change-resistant forces of the larger organization, so that staff feels free enough to innovate and create. It’s no surprise to me that inside these islands, people meet plan, become more intelligent and responsive to demands and crises, and generally become more capable. And sadly, it’s no longer surprising to me that the larger organiza-

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dubbed them islands of possibility in some of my past work. The leaders of these pockets routinely meet goals, motivate employees, and achieve high levels of safety and productivity. But, ironically, they never change the behavior of the majority of the organization — even though these few islands reach or exceed the goals set by senior management. There’s a lot of evidence that innovators get pushed to the margins. You’d expect that they would be rewarded, promoted, and given the responsibility of teaching everyone else how to do the same. But instead, they’re ignored or invisible. Sometimes their bosses acknowledge their success, but offhandedly say: “I don’t know how you got these results.” And they don’t show any interest in learning about it. I think of this as an autoimmune response. Bosses don’t want to know how you achieved your results if it’s contrary to the way the system works (or doesn’t work). If they became genuinely interested in these innovative approaches, they’d have to change themselves. At the same time, most of us know from our own experience what kind of leadership works best. I’ve asked people of many ages, in many cultures, to talk about a leader they were happy to follow and what made that leader memorable. Several factors, such as integrity, a sense of humor, and a clear direction and vision, often come up. But the most common characteristic of good, memorable leaders is that they create the conditions for people to be en-

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S+B: In a talk at the ALIA Institute last summer, you said that the only leaders who succeed are those who have some kind of personal spiritual discipline. WHEATLEY: Yes, I’m convinced of

this. By discipline, I don’t mean meaningless, repetitive, boring practice. That disables people. Nor do I mean religious practice per se. I mean some regular activity that leads you to reflect on your struggles and challenges in a larger context. For one of my friends, Alcoholics Anonymous serves that role. For others, it can be prayer, meditation,

or time in nature. I’m not sure about running or other physical exercise, because I think a practice has to connect you to the rest of life — to take you out of the false perception that you are the center of the universe. Without that discipline, I don’t see how leaders can maintain their integrity and focus. The prevailing mass culture has schooled a lot of people to follow their passion, find their calling in life, and do what they love. Then they encounter setbacks, failures, disappointments, and very subtle impediments — for instance, their loved ones say, “Why are you working so hard here?” Many people quit. That’s what’s essential about discipline. You do it day after day, even when it’s boring, because you believe ultimately it will lead to a good outcome. The fruit of all this effort becomes apparent only after a long time when it seems not to be going anywhere. Work can begin with passion, but it’s only through discipline that people can persevere. Brain research is also clear on why we need quiet time, especially when under stress. This spring, I went on a long, solo retreat. I didn’t interact with anyone except my teacher. I witnessed my own mental capacities coming back in full flower. I regained great powers of mem­ ory and concentration. I could understand complex ancient texts. I was so mentally alive. Now that I’ve returned to my overly distracted life, I am back to old ways; I’ll walk across a room and not remember

what I went looking for. But now I know that my memory loss isn’t caused by aging or deterioration. The cause is distraction, and working in an anxious world. I can regain my mental capacities if I regularly take the time to slow down and focus. S+B: Not everyone is willing to make that kind of commitment. WHEATLEY: One question I ask ev-

eryone is, Who do you choose to be as a leader? What is the contribution you hope to make? It turns out that very few people answer that they care most about success and personal survival. They talk about doing the right thing for the people around them and helping them get through this time. This question, Who do we choose to be as leaders? is important because it acknowledges the historical moment we’re in. We have to become conscious and make choices about what we value; is it just our quarterly P&L or short-term results? It would be easier to articulate the more noble contributions we want to make if we were in a more dramatic crisis, like another world war. But in this crisis, we have to find the deeper meaning ourselves. I am finding that many people want to be called on to contribute to something larger than themselves right now, to walk out of fear-based leadership practices — and for me, that’s the best motivation possible. + Reprint No. 11406

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tion ignores these islands of possibility. It’s a terrible waste but it’s just the way it is. I wrote Perseverance so people who are doing things right and making a real contribution could keep going in the face of this dynamic of being pushed to the margins, ignored, or misunderstood. Those of us who are in that position have to expect that we will encounter a lot of difficulties. We’ll feel a lot of strong emotions such as anger or grief; our good work will go unrewarded. Once we know that these things will happen, we can more consciously choose our responses. We can choose to keep going, to influence where we can, to make a difference in the lives of our staff, and to be the kind of leader that people remember with gratitude. We can become skilled at negotiating within those large, frightened bureaucracies so that people can still do good, meaningful work inside them.

Taming the “Bullwhip Effect” in Supply Chains How upstream companies can hedge the risks from demand cycles. by matt palmquist

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Big shifts in demand are the bugaboo of any supply chain. All players do their best to avoid gluts and shortages in inventory, and companies higher up the chain are particularly wary of the sting that comes from the bullwhip effect: the amplified impact of a big increase or falloff in orders as it moves upstream from the consumer to the original supplier. This paper identifies another pressure point affecting upstream companies, but also a way to lessen the pain. Two components determine variations in demand, the authors note. One, systematic risk, consists of factors that affect the broad economy, for example, interest-rate spikes and recessions. The other, idiosyncratic noise, is specific to an industry or a company, and includes sudden shifts in consumer taste and ship-

ment delays. Idiosyncratic noise can generally be addressed by operational hedging in everything from product diversification to building factories with flexible capacity. But in times like the recent Great Recession, operational hedging loses much of its effectiveness. Thus, financial hedging (offsetting risks using traded instruments) is also needed. How much of each form of hedging is appropriate? The authors provide a broad answer: “The degree of systematic risk increases substantially from retailers to wholesalers to manufacturers.” Put another way, the more upstream a company is, the more likely it is to face shifts in demand that can be offset, in part, through financial hedging. The researchers analyzed monthly sales numbers from the U.S. Census Bureau from 1992 through 2007, combined with priceadjusted data from the Bureau of Economic Analysis and market returns from the Center for Research in Security Prices. They used sales as a proxy for demand, defining systematic risk in terms of the relationship between sales uncertainty and broad stock market performance.

The authors attribute the increase in upstream systematic risk to the fact that supply chains are really supply webs. The higher up the chain a company is, the more customers it serves and the more orders it receives. As the size of the aggregate order increases, so does its correlation with market performance. Order aggregation is analogous to the bullwhip effect, the researchers say, and reinforces the whip’s impact as it, too, travels up the chain. Although uncertainty about demand is highest for manufacturers, the authors write, “our results imply that manufacturers have a way out because they also have the highest ability to hedge their risk using financial instruments.” Bottom Line: The degree of risk related to demand variance increases upstream along the supply chain. To reduce their exposure, firms at the upper level are advised to engage in financial hedging. +

s+b Recent Research Online See more coverage of research papers — including our complete archive — at www.strategy-business.com/recent_research.

Illustration by Daniel Pelavin

Title: Systematic Risk and the Bullwhip Effect in Supply Chains Authors: Nikolay Osadchiy (Emory University), Vishal Gaur (Cornell University), and Sridhar Seshadri (University of Texas at Austin) Publisher: Self-published Date Published: July 2011

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