Harvard Business Review 7 HBR.ORG Features November 2014

NOVEMBER 2014

47 The Big Idea The HBR List of Best-Performing CEOs 2014 edition 100 Spotlight The New Deal on Data An interview with Alex “Sandy” Pentland 133 Case Study Do Business and Politics Mix? Brian K. Richter

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Discover the new movie on cartier.us November 2014 Contents

SPOTLIGHT ON MANAGING THE INTERNET OF THINGS ABOVE Chris Labrooy 64 STRATEGY & COMPETITION 90 INFORMATION TECHNOLOGY 100 MANAGING TECHNOLOGY Shrinkwrap How Smart, Connected Digital Ubiquity: With Big Data Comes Stills, Hoover Products Are Transforming How Connections, Big Responsibility Competition Sensors, and Data Are Allowing people to control their Smart, connected products are Revolutionizing Business own data may actually beneﬁt changing how value is created The digitization of tasks and companies in the long run. The MIT for customers, how companies processes has become essential Media Lab’s Alex “Sandy” Pentland, compete, and the boundaries of to competition. Marco Iansiti and interviewed by Scott Berinato HBR.ORG competition itself. Michael E. Porter Karim R. Lakhani Big data and and James E. Heppelmann analytics, explained. hbr.org/ video/data

November 2014 Harvard Business Review 7 HBR.ORG Features November 2014

47 106 116 THE BIG IDEA INNOVATION HEALTH CARE The Best-Performing Turn Your Science How Not to Cut CEOs in the World into a Business Health Care Costs HBR looks at the 100 chief Inventors face a host of Five mistakes that keep executives who have delivered potentially fatal traps when treatment costs too high the highest returns to commercializing their innovations. Robert S. Kaplan and shareholders over the Here’s how to avoid them. Derek A. Haas long term. Reddi Kotha, Phillip H. Kim, and Oliver Alexy ANGUS GREIG ANGUS

8 Harvard Business Review November 2014

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“I never thought of the shows as groundbreaking, because every American understood what they Innovation is a were all about.” mindset. page 126

144 AUDIO IN EVERY ISSUE For Lear’s thoughts IDEA WATCH EXPERIENCE on managing egos, 14 From the Editor visit hbr.org/lear. 28 TALENT 126 MANAGING YOURSELF 22 Interaction How Companies Can Profit Where to Look for Insight 36 Vision Statement from a “Growth Mindset” The insights that feed innovation can be found through seven 38 Strategic Humor A key psychological concept applies to organizations, too. PLUS Why channels. Mohanbir Sawhney 141 Executive political ties don’t always pay off and Sanjay Khosla Summaries in China, the true cost of “patent trolls,” and more CASE STUDY 133 Playing cards depict Do Business and Politics Mix? the 1720 financial 34 DEFEND YOUR RESEARCH When the super PAC to which scandal. page 36 Cooks Make Tastier Food Natural Foods has contributed backs When They Can See Their a candidate with controversial views, consumer and employee protests roil Customers Does transparency the company. Brian K. Richter improve the customer experience?

HOW I DID IT 138 SYNTHESIS 41 Who’s responsible for your continued The U.S. Chairman of PwC on growth—you or your employer? Keeping Millennials Engaged Lisa Burrell Millennials want job ﬂexibility in the here and now, along with more- 144 LIFE’S WORK frequent feedback and rewards. Bob Moritz Norman Lear The man who reinvented American TV in the 1970s has been happy to stay behind the scenes. DAVE LAURIDSEN; MATT CHASE; COURTESY OF BAKER LIBRARY CHASE; COURTESY MATT LAURIDSEN; DAVE

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From the Editor On a Long-Term Roll

eople warn you about Jeff Bezos’s laugh. It’s a surprising, high-pitched out- burst (think Tom Hulce’s Mozart in Amadeus) that can throw off an interviewer. But Amazon’s CEO has earned the right to guffaw. Sure, authors have accused him of being a bully in the company’s battles with publishers, and the new Fire Phone has yet to catch on. But Bezos is still on a roll. He has Pconsistently defied skeptics and delivered for investors—to such an extent that he’s number one on HBR’s 2014 list of the world’s 100 best-performing CEOs. The list measures long-term performance according to a formula that tracks a company’s shareholder return over an executive’s tenure. Although the rankings can’t reliably take account of many hard-to-measure attributes that are critical to executive performance— customer satisfaction, employee engagement, community relations, and so on—they are a valuable guide to who is delivering results year after year. Amazon has produced a total See page 47 for our shareholder return (industry adjusted) of 14,917% in the 18 years since Bezos was officially best-performing-CEOs named CEO. package, which was Meanwhile, at HBR we’re taking steps of our own to enhance long-term performance. overseen by HBR senior We’re about to relaunch our website, hbr.org, to deliver a more premium reading experience editor Daniel McGinn. and better functionality. For example, subscribers and registrants can take advantage of It includes a proﬁle My Library, a new feature that will let them seamlessly save, organize, and share their of Jeﬀ Bezos and an interview with him at favorite articles. Amazon headquarters. We’re tweaking the magazine as well. The front and back sections have been redesigned to make things (we hope) cleaner, clearer, and more appealing. We will be routinely connecting newly published pieces to our archive of timeless ones, and we’re adding elements, often presented by business leaders on the front lines, that focus on how to put our ideas into practice. We’ve also introduced a contributors page, to let you know more about our authors and to supply some context for their research and ideas. Over the coming months we’ll be incorporating other changes online and in print. We look forward to hearing what you think of them.

Adi Ignatius, Editor in Chief JOHN VON PAMER JOHN VON

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An assistant professor at the University of Texas at Austin’s McCombs School, Brian Richter Chris Labrooy, the artist works to improve our whose work appears in this collective understanding month’s Spotlight section of companies’ interactions (p. 63), started out as a with governments and product designer in the UK, other nonmarket actors using computers to bring and institutions. He is his ideas for chandeliers the author of this month’s and other furnishings to Case Study (p. 133). life. He then lost interest in furniture and focused instead on creating images with digital tools.

The thinking behind this month’s cover story (p. 64) began well over a year ago,

during conversations between Michael Dave Lauridsen, who shot the portrait of Norman Porter and his coauthor, Jim Heppelmann, Lear for Life’s Work (p. 144), and they have been refining it ever since. learned quickly that the TV legend isn’t comfortable in They saw that the emergence of smart, front of the camera. “When I started shooting, his connected products was much more than Daniel McGinn has spent teenage daughter showed 20-plus years writing about up and announced that an incremental technological advance—it business at Inc., Newsweek, he hates all portraits of heralded fundamentally new technologies and now HBR—great himself,” Lauridsen says. preparation for overseeing “But when she saw the that would transform whole industries and HBR’s annual report on photos come up on the the best-performing CEOs computer screen, she said reshape competition and strategy. CEOs (p. 47) and for interviewing he’d be happy. Boy, was the best performer, I relieved.” around the world get this instantly when Amazon’s Jeff Bezos. Says McGinn, “He takes great they talk with Porter and Heppelmann: pride in his consistency, so Their first question is usually “How will he’s challenging.” this affect our strategy?” This article is the answer to that question. Porter) DAVID JOHNSON ( DAVID

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RECENTLY data available, and a myriad of TRENDING* other issues need to be considered ON HBR.ORG within their particular environments. 9 Habits That Lead to Terrible The bigger question is: What’s uni- Decisions versal? What’s context-specific? BY JACK ZENGER AND JOSEPH Loida Rosario, president, Into the Core FOLKMAN Consulting Why Women An organization’s contextual intel- Don’t Apply for Jobs Unless ligence quotient determines its They’re 100% success, especially in emerging Qualified BY TARA SOPHIA markets. The lack of such intel- MOHR ligence causes organizations to be The Most perplexed about why, for example, Productive Africa seems so full of opportuni- People Know Global Success ties, but market penetration is not Who to Ignore BY ED BATISTA as rapid as expected. Coca-Cola has 5 Tips for a high contextual IQ, which we can Depends on Context Off-the-Cuff learn from and emulate. Speaking HBR article by Tarun Khanna, September Brenda Thokozani Mangunda, strategy BY JOHN COLEMAN Despite what we’d like to believe, management and business development executive, The Industries Inard Africa Plagued by practices—even the most-effective ones— the Most Though we try to simplify matters Uncertainty don’t travel well across borders. Economic with one-size-fits-all thinking, ap- BY JEFF DYER, NATHAN FURR, AND development, education, language, and plying it often creates new complex- CURTIS LEFRANDT culture vary too widely from place to place. ity. When implemented like recipes, The Best Leaders management practices will produce Are Insatiable Khanna argues that international executives passable results but occasional flops. Learners BY BILL TAYLOR need “contextual intelligence,” the ability to We don’t focus enough on situa- tional responsiveness and contextual What People recognize the limits of their knowledge and Are Really intelligence. Recipes and process Doing When adapt it to different environments. adherence work in manufacturing, They’re on a Conference Call producing predictable repeatable BY GRETCHEN The problem with a practice like management is that while the “whats” results, but they don’t make for GAVETT (goals) are generic, the “hows” are specific to you and the organization you exceptional managers. are working with. Going from “what” to “how” is akin to trying to discover Derick Snyders, head of business detail in a lo-res digital picture from which the detail has been lost. In solution center, Metropolitan Health, South Africa *AT PRESS TIME management, the necessary detail has to be understood through guided trial and error—in other words, practice. I sometimes wonder if, to achieve a David K. Hurst, speaker, educator, and author of The New Ecology of Leadership highly illuminated state of contex- I’ve seen the importance of contextual intelligence in innovation manage- tual intelligence, one must abandon ment. In my research I’ve come across R&D centers and entrepreneurs that ethical prejudices. For example, used novel experimentation and testing practices that were based on local what if a company operates in institutional contexts. Those practices allowed them to rapidly and cheaply a country where women’s rights reduce uncertainties—a critical step in problem solving and design. As orga- are not valued or businesses are nizations become more aware of context, the way they think about locating expected to embrace religious and managing innovation efforts will change dramatically. practices? Would a multinational Budhaditya Gupta, doctoral candidate, Harvard Business School face consequences at home if it did? Seems like a lose-lose proposition. Contextual intelligence is also relevant in “hard” business model situations. Magda E. Ramos, director of product

Simple deﬁnitions of quality standards, performance measurement, timing, strategy, Worldpay CSA IMAGES

22 Harvard Business Review November 2014 HBR.ORG

The New Cyberthreat HBR article by David M. Upton and Sadie Creese, September More and more cyber- attacks involve people with authorized access to systems, like suppliers, contractors, and internal employees. The authors discuss why insider threats have grown and offer ways to detect and neutralize them. This article conflates risks from malicious insiders with risks from employees making mistakes. Both are problems, but the solutions are completely different. Malicious insiders are almost T:10” impossible to defend against. The steps suggested, such as background checks, are pretty dif- YOUR BUSINESS ficult to scale up and don’t help much. CHALLENGE IS THE Advanced monitoring SUBJECT. techniques and “big data” are starting to make headway, but so far the cost is out of reach for most companies. What can be fixed is acciden- tal behavior, but few companies do anything beyond boring 30-minute computer-based training and a few posters on the wall. Three things that will really help are (1) building training into work- EXECUTIVE EDUCATION flows, (2) making the secure way COMPREHENSIVE ."/"(&.&/5q-&"%&34)*1q453"5&(: the easy way to get things done, '*/"/$&q."3,&5*/(q40$*"-&/5&313*4& and (3) giving people incentives to do the right thing. Columbia Business School Executive Education offers over Jeremy Bergsman, practice manager, CEB 30 programs that prepare today’s leaders for tomorrow. Executives can bring their real-workplace challenges to collaborate on and solve. Meet your needs at gsb.columbia.edu/execed Interaction

HBR SURVEY Which of the following The author’s prescriptions seem factors do you give premature. While it’s critical to “rein in stock-based pay,” Lazonick largely greatest priority to ignores the econometric evidence. when making a senior It’s been reported that stock options appointment? exercised in the previous year by the top executives of 700 U.S. firms Experience increased share buybacks by 8% in the short run. Higher share buy- 57% backs lowered R&D expenditures by The Dirty Little Secret 1%. Options granted lowered the in- of Stock Buybacks Emotional intelligence creases in investment expenditures HBR article by William Lazonick, by 1%. The effects seem too small to September 38% merit overhauling corporate policies. Corporate profits are high, Alok Bhargava, professor of public policy, and the stock market is IQ University of Maryland booming. So why is America Reining in executive pay is no still suffering from unstable 5% cure, but it will have to happen. and underpaid jobs? The Otherwise, profits will eventually dry up, sales will fall, and employ- corporate obsession with SOURCE “HOW GOOD ARE YOU AT TALENT MANAGEMENT?” BY CLAUDIO FERNÁNDEZ-ARÁOZ, ees will either be forced to leave or stock buybacks deserves HBR.ORG (RESULTS AS OF PRESS TIME) much of the blame. Massive move on by choice. Richard Bannister, resources are being devoted a tax perspective, buybacks are still software test analyst to stock repurchases (which better than dividends because they boost share price and CEOs’ allow investors who’d like to have equity-based pay) rather cash and the corresponding tax obli- gation now to sell their shares, while What’s Your than growth investments. Language Strategy? Lazonick says it’s time other investors can keep their shares without generating a taxable event. HBR article by Tsedal Neeley and to bring buybacks under Also, many corporations have foreign Robert Steven Kaplan, September control. shareholders whose tax codes may Unrestricted multilingualism have much lower rates for capital One can also accuse corporations can create inefficiency, gains than for dividends. of not distributing enough earn- Oliver M. Haynold, principal, friction, and other problems ings and instead reinvesting them Promanthan in global organizations, say in unprofitable projects that build Neeley and Kaplan. But empires and create jobs but are This is a valiant effort to expose by crafting a language counterproductive socially and for flaws in the management of public strategy, factoring it into individual investors. The distribu- companies, but I believe it falls short. tion of cash to investors is not a bad talent decisions, and To imply that executives manipulate providing training, firms can thing, in my view, and is even a little stock prices simply to raise their pay heroic given that it’s a tacit admis- develop the best employees, is quite shortsighted. Walk through improve collaboration, and sion of a lack of attractive invest- any plant of a Fortune 500 company, ment opportunities at the company. and talk to the employees there. If build a stronger presence in Traditionally, the best justifica- the stock price is down, they will local markets. tion for share buybacks was the tax have some choice words for their code, which favored capital gains executives. Would anyone not think I used to think that a headquarters over dividend income. As the article executives feel that pressure? initiative could successfully imple- explains, that has been partially Mitchel Paddyaker, CEO, ment a single language across a alleviated, but only partially. From Rocket Science Labs global organization. Now I believe

24 Harvard Business Review November 2014 HBR.ORG

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that headquarters should support an organic approach by regional leaders. Requiring a local employee to function in a foreign language that is not necessary for his or her job is counterproductive and demotivating. To overcome language barriers, organizations should hire multilingual and multicultural leaders. Neil Barker, HR consultant Every company that wants to expand internationally must have a language strategy. Communicating with your customers in the right language is critical. Eighty-six percent of customers won’t buy goods and services if sales aren’t conducted in Where the next generation of innovative CIOs their own language. Many companies leave a massive source of revenue untapped because of this goes for answers. language barrier. Lucia Kash, director of business development, Language I/O At times communications are equally complicated among people Today’s CIOs confront unprecedented change. The Innovative who speak the same language. CIO program helps you gain a greater C-suite role as strategist, People with a common language leader, and innovator. You’ll learn firsthand from world-class but from different cultures can still faculty and leading edge technology entrepreneurs. No other conflict. Therefore, cultural training top program can leverage Silicon Valley innovation like this is also important in international distinctive, comprehensive, weeklong immersion. Come to management. the source. There’s only one. Stanford. Jay Wren, founder, SeeWhoIsHiring.com Enroll. Re-boot. Transform: CIO.StanfordToday.com Communication norms can differ even within one country. In Mexico, for example, people from the north get straight to the point. People from Mexico City never mention the point directly; you have to read THE INNOVATIVE CIO between the lines. They’ll never say no; they’ll tell you a story that you’ll May 31 – June 5, 2015 have to analyze to discover that they are saying no to you. Application Deadline: Salvador Quirarte, senior consultant May 1, 2015 and LatAm director, Quadmark Change lives. Change organizations. Change the world.

IDEA WATCH

and Laura Kray—have collaborated with TALENT the consulting firm Senn Delaney to answer those questions. HOW COMPANIES To explore company mindsets, the researchers asked a diverse sample of employees at seven Fortune 1000 companies about CAN PROFIT FROM A the extent to which they agreed with various statements—for example, “When it comes “GROWTH MINDSET” to being successful, this company seems to Stanford’s Carol Dweck explores how a key psychological believe that people have a certain amount concept applies to organizations, too. of talent, and they really can’t do much to change it.” High levels of agreement suggested that the organization had a predomi- nantly fixed mindset; low levels suggested hen Carol Dweck was a gradu- EMPLOYEES IN A a growth mindset. The researchers then ate student, in the early 1970s, “GROWTH MINDSET” conducted surveys to try to understand how W she began studying how chil- COMPANY ARE the prevailing organizational mindset in- dren cope with failure—and she quickly fluenced workers’ satisfaction, perceptions realized that “cope” was the wrong word. of the organizational culture, levels of col- “Some didn’t just cope—they relished it,” she laboration, innovation, and ethical behavior, says. “For some people, failure is the end of % and how it affected supervisors’ views of the world—but for others, it’s this exciting employees. new opportunity.” Dweck, now a psychol- “In broad strokes, we learned that in each ogy professor at Stanford, spent the next likelier47 to say that their company, there was a real consensus about several decades studying this dichotomy, colleagues are trustworthy, the mindset,” Dweck says. “We also learned which she originally described using the that a whole constellation of characteristics clunky academic monikers “fixed mindset went with each mindset.” For instance, em- entity theory” and “incremental theory.” ployees at companies with a fixed mindset By the early 2000s, while writing a mass- % often said that just a small handful of “star” market book on the topic, she’d come up workers were highly valued. The employees with more- appealing labels. She now refers who reported this were less committed than to people who view talent as a quality they likelier34 to feel a strong sense employees at growth-mindset companies either possess or lack as having a “fixed of ownership and commitment and didn’t think the company had their back. mindset.” People with a “growth mindset,” to the company, They worried about failing and so pursued in contrast, enjoy challenges, strive to learn, fewer innovative projects. They regularly and consistently see potential to develop kept secrets, cut corners, and cheated to try new skills. Dweck’s framework has had a to get ahead. significant impact: Her book Mindset, pub- % Supervisors in growth-mindset compa- lished in 2006, has sold more than 800,000 nies expressed significantly more positive copies, and the concept of a growth mindset views about their employees than supervi- has come to permeate fields such as educa- likelier65 to say that the company sors in fixed-mindset companies, rating them tion and sports training. supports risk taking, and as more innovative, collaborative, and com- Now Dweck is extending her work on mitted to learning and growing. They were mindset beyond individuals—and the exten- more likely to say that their employees had sion has important implications for manag- management potential. ers. Can an organization, like an individual, % Dweck’s team hasn’t yet looked at have a fixed or a growth mindset? If so, what whether growth-mindset organizations actu-

are the effects on the organization and its ally perform better, as measured by financial likelier to say that the company employees? Since 2010 Dweck and three col- 49 returns and other metrics. “That’s our burn- fosters innovation. leagues—Mary Murphy, Jennifer Chatman, ing question,” she says. But the findings so far

28 Harvard Business Review November 2014 HBR.ORG PUT AWAY THE KNICKKNACKS Asked about professional versus unprofessional oﬃce decor, research subjects suggested that unprofessional oﬃces contain nearly twice the proportion of holiday decorations and other “personal symbols.” “ACTING PROFESSIONAL: AN EXPLORATION OF CULTURALLY BOUNDED NORMS AGAINST NONWORK ROLE REFERENCING,” BY ERIC LUIS UHLMANN, EMILY HEAPHY, SUSAN J. ASHFORD, LUKE [LEI] ZHU, AND JEFFREY SANCHEZ-BURKS

suggest that at a minimum, growth-mindset THE IDEA IN PRACTICE firms have happier employees and a more in- “INSTEAD OF OUTPUT, THINK ABOUT EFFORT” novative, risk-taking culture. How can managers help organizations Timothy Perlick is the senior director of professional development at CME Group. He spoke with HBR about the organization’s use of Carol Dweck’s research. Edited excerpts: embrace a growth mindset? “It takes dedication and hard work,” Dweck says. Often top management must drive the change; for instance, a new CEO might focus on maximizing employees’ potential. Dweck points to GE’s Jack Welch as an emblematic growth-mindset CEO: He hired according to “runway,” not pedigree, preferring Big 10 graduates and military veterans to Ivy Leaguers, and spent thousands of hours grooming and coaching employees on his executive team— activities that demonstrate a recognition of people’s capacity for growth. As Welch’s example shows, one area in which mindset is especially important is hiring. Growth-mindset organizations are likely to hire from within their ranks, while fixed-mindset organizations reflexively look for outsiders. And whereas fixed-mindset organizations typically emphasize appli- How did you get started with “growth mindset”? In 2012 cants’ credentials and past accomplishments, Phupinder Gill became our CEO. He recognized how much growth-mindset firms value potential, capac- consolidation, technology, and globalization are changing our ity, and a passion for learning. “Focusing on industry and believed our employees needed a growth mindset to pedigree…is not as effective as looking for think about the business in new ways. We hired Carol to speak with people who love challenges, who want to senior leadership and then with all employees. We recorded the grow, and who want to collaborate,” Dweck says. Google appears to be making such a sessions, and all new employees watch the video. Gill emphasizes shift, she notes; the company has recently be- the idea of highlighting the growth mindset. Instead of focusing on gun hiring more people who lack college de- output, which can be seen as the result of talent (and emblematic grees but have proved that they are capable of a fixed mindset), we think about effort. Instead of celebrating independent learners. employee achievements, we say, “Thank you for your effort.” Despite the survey results, not all employees will be happier in growth-mindset Has this changed the way you hire? Yes. We’ve adopted behavioral organizations, Dweck acknowledges. For interviewing techniques using mindset-focused questions. For example, people who believe they are more example, “Describe a time you confronted a challenge. How did you talented than others may prefer an organiza- work through it to overcome your doubts?” We don’t hire specifically tion with a “star” system, where their talent for growth mindset, but we do look for that quality. will be better recognized (and compensated). In general, though, the early evidence suggests that organizations focused on employ- Do some employees dislike the shift? Definitely. Some find that ees’ capacity for growth will experience sig- they don’t fit, and some have left for other companies. nificant advantages. Has the cultural shift been successful? It’s too early to say it’s a HBR.ORG To hear Carol Dweck discuss her work on individuals and huge success. But it has allowed us to formalize and institutionalize growth mindset, visit the IdeaCast our innovation process and innovate more quickly.

) ( cat in frame LIAM BRAZIER ( Perlick ); ISTOCKPHOTO “The Right Mindset for Success.”

November 2014 Harvard Business Review 29 IDEA WATCH HBR.ORG FROM THE ARCHIVE: 1958 “Today pronouncements about social responsibility issue forth so abundantly from the corporations that it is hard for one to get a decent play in the press. Everybody is in on the act, and nearly all of them actually mean what they say!” “THE DANGERS OF SOCIAL RESPONSIBILITY,” BY THEODORE LEVITT (HBR, SEPTEMBER–OCTOBER 1958)

PRICING IS EXTRA LEGROOM WORTH FIGHTING FOR? Consumers pay more to get more, whether it’s beef by the pound, TVs by screen size, or game tickets courtside. But with economy class airfares there’s no correlation between price and comfort, including legroom. Even before recent incidents in which planes were diverted because of passenger ﬁghts over reclined seats, customers were demanding more comfort at reasonable prices. JetBlue and United now oﬀer “extra legroom” economy class seats for higher fares that are still well below the cost of business class seats. Expect more GLOBALIZATION airlines to experiment with pay-for-inches pricing models. IN CHINA THE RIGHT POLITICAL TIES COUNT

YOU’RE NOT PAYING FOR EXTRA INCHES o one who has done business in China will be surprised by the idea Average round-trip inter- 30 inches $2,077 national fare according to Nthat relationships with government 31 inches “seat pitch”—the distance $2,389 matter. But a new paper shows that in fact from a point on one seat 32 inches $2,087 they don’t always pay off. Yes, having politi- to the same point in the 33 inches $2,121 cal ties sometimes improves a firm’s chances row ahead. of success—but it turns out that some types of connection are more beneficial than others. Researchers led by Weiting Zheng, of the There’s no link between comfort rating and price paid for a seven- MONEY DOESN’T Hong Kong Polytechnic University, examined BUY COMFORT day round-trip ﬂight between New York and London booked a week in advance, judging from the “happiness scores” on Routehappy. the TV manufacturing industry from 1993 to 2003—a period of significant liberalization.

LOWEST COMFORT HIGHEST COMFORT They looked at whether firms had a former $2,000 government employee on their leadership HIGHER COST, HIGHER COST, LOWER COMFORT HIGHER COMFORT team and also whether they had had an executive who was now employed in government. They then looked at whether firms $1,800 subsequently survived and compared their annual revenues before and after their political connections were formed. Crucially, the researchers distinguished $1,600 AVERAGE TICKET PRICE between ties to local and to national officials. They found that local ties were associated with higher rates of firm survival and in some

$1,400 cases to increases in revenue. However, ties to national officials had no effect on either metric of success. These findings held even after controlling for firm size, age, degree of $1,200 state ownership, and level of diversification. The researchers also learned that local ties were most likely to boost the survival of LOWER COST, LOWER COST, LOWER COMFORT HIGHER COMFORT poorly performing firms. And the positive ef- $1,000 fect on revenue was seen only among firms that had already been performing well. These SOURCE MICHAEL SEGALLA AND DOMINIQUE ROUZIÈS, HEC PARIS;

CATALIN CIOBANU AND VINCENT LEBUNETEL, CARLSON WAGONLIT TRAVEL findings suggest that political ties are more DENIS CARRIER

30 Harvard Business Review November 2014

IDEA WATCH HBR.ORG FOLLOW THE LEADER Although laws and formal policies have a big impact on how many new fathers take paternity leave, peers play a role too: A study of small companies in Norway found that when an employee took paternity leave, the next male coworker of his to have a child was 11% likelier to do so.

“PEER EFFECTS IN PROGRAM PARTICIPATION,” BY GORDON B. DAHL, KATRINE V. LØKEN, AND MAGNE MOGSTAD effective at keeping struggling companies INNOVATION afloat than at helping them excel. THE REAL COST OF “PATENT TROLLS” The researchers offer several reasons why connections to local government would Much has been written recently about “patent trolls”—people or firms that obtain matter more than national ties. Local govern- patents and sue alleged infringers but do not make useful products of their own. U.S. ments directly experience the benefits and congressional leaders and the White House have called for reforms to fix the underlying costs of firms’ operations in their jurisdic- problems that give rise to patent troll lawsuits. Boston University’s James Bessen points to several new findings that show just how damaging these suits are to the economy. tions—for example, strong firm performance “A consistent picture is emerging about the effects of patent litigation,” Bessen says. increases employment and boosts tax rev- “It costs innovators money. Many innovators and venture capitalists report that it enue. They often have more discretion than significantly impacts their businesses. Innovators respond by investing less in R&D, the central government does, and they are while venture capitalists respond by investing less in start-ups.” He believes the more likely to focus on local issues and to mounting evidence should spur efforts toward reform. address the needs of local firms than are national government agencies, which must balance a much broader range of concerns and Suits brought by frequent litigators Small firms hit are less able to respond to the interests of any (largely patent trolls) caused a decline of with extensive one firm or even any one industry. lawsuits One caveat: It’s impossible to discuss political ties in China without noting the had previously widespread corruption of local govern- devoted, ment and the ensuing bribery scandals. And on average, so it’s conceivable that some of what the research captures is simply a proxy for that % corruption. Previous research by Harvard Business 20 School’s Lynn S. Paine sheds light on another $22 of their element firms should consider: Even the operating most carefully tended ties may not be enough expenditures to ensure success. “Executives often believe BILLION to R&D. that obtaining government support for big in venture investing over five years. business deals is just a matter of forging high- Afterward level connections or lining the right pockets,” they devoted Paine has written. “Connections are no doubt only about useful, but experienced leaders know that Unless suits were dismissed, firms they must also demonstrate their project’s subsequently reduced R&D spending by contribution to China’s development.” % The takeaways for firms looking to build leadership teams or partnerships in China are 15 clear. Not all political connections are equal; to time spent cultivating local ties may yield higher returns. At the national level, it’s im- $211 A 48% % portant that companies demonstrate a strong DROP . alignment between their corporate strategies MILLION. 17 and the Chinese state’s development priori- ties and goals. ABOUT THE RESEARCH Clockwise from top left: “The Effect of Patent Litigation and Patent Assertion Entities on Entrepreneurial Activity,” by Catherine Tucker; “Does Patent Litigation ABOUT THE RESEARCH “Buffering and Reduce Corporate R&D? An Analysis of US Public Firms,” by Roger Smeets; “Patent Trolls: Evidence Enabling: The Impact of Interlocking Political from Targeted Firms,” by Lauren Cohen, Umit G. Gurun, and Scott Duke Kominers Ties on Firm Survival and Sales Growth,” by Weiting Zheng, Kulwant Singh, and Will HBR Reprint F1411A Some of these articles previously appeared, in different form, on hbr.org.

Mitchell; “The China Rules,” by Lynn S. Paine DENIS CARRIER

32 Harvard Business Review November 2014 For the most critical questions.

No matter how complex your business questions, we have the capabilities and experience to deliver the answers you need to move forward. As the world’s largest consulting ﬁ rm, we can help you take decisive action and achieve sustainable results. www.deloitte.com/answers

DEFEND YOUR RESEARCH COOKS MAKE TASTIER FOOD WHEN THEY CAN SEE THEIR CUSTOMERS

The research: Ryan W. Buell, an assistant professor at Harvard Maybe seeing the customers just raises Business School; Tami Kim, a doctoral student at HBS; and the anxiety of the chefs, and they feel Chia-Jung Tsay, an assistant professor at University College they have to do better because they’re London, set up four scenarios in a real cafeteria for two weeks. being watched? Kim: We considered whether transparency In the ﬁrst, diners and cooks couldn’t view one another; in the could have unintended costs. We found that second, the diners could see the cooks; in the third, the cooks reciprocity plays a much bigger role than could see the diners; and in the fourth, both the diners and the stress or accountability. This is more about cooks were visible to one another. The researchers timed the gratitude—which is a powerful force. Cooks preparation and conducted surveys about the service and constantly said how much they loved seeing food. The results showed that when the cooks could see their their customers. Many wanted to keep the iPad setup. One said, “When the customers patrons, the food quality got higher ratings. can see the work, they appreciate it, and it makes me want to improve.” The challenge: Does the mere sight of a customer motivate Buell: Being appreciated makes work you to do your job better? Defend your research. meaningful. People feel what they do matters. Human connections seem to trigger that. Buell: The results were pretty compel- Why do you think that improved the Tsay: We did follow-up experiments in which ling: Customer satisfaction with the food perception of quality? chefs and customers watched videos of shot up 10% when the cooks could see the Buell: We’ve learned that seeing the service interactions. For customers, seeing customers, even though the customers customer can make employees feel more the chefs’ work increased their perceptions couldn’t see the cooks. In the opposite appreciated, more satisfied with their of effort and improved their opinions of the situation, there was no improvement in jobs, and more willing to exert effort. It’s service. But it didn’t matter to the chefs if satisfaction from the baseline condition important to note that it wasn’t just the the customers watched them make the meal. in which neither group could see the other. perception of quality that improved—the Just seeing the customers is what motivated But even more striking, when customers food objectively got better. During the them to do better. and cooks both could see one another, experiment we had an observer in the satisfaction went up 17.3%, and service kitchen taking notes and timing service. So, customers do want to see inside the was 13.2% faster. Transparency between Normally, chefs would make eggs on the sausage factory? customers and providers seems to really grill in advance, adding them to plates as Buell: Probably not. Sandwich making is an improve service. needed and often overcooking them. When appealing process. We’ve learned that the we turned on the screens and the chefs saw process has to be effective and the out- HBR: How did you rig it so that they could the customers, they started making eggs to come has to be favorable for the benefits of see one another? order more often. transparency to accrue. But in such settings Kim: We used iPads and set up a video- Tsay: We also tested these effects on transparency can change one’s whole out- conference between the dining area and a range of populations, from chefs to look on a service. In another study we did, the kitchen. There was no sound and no communities in remote parts of the world. customers preordered a sandwich and then interaction, but people on both sides could We consistently found that transparency either waited to pick it up in view of the sta- see each other. created value. tion where food was prepared or bypassed

34 Harvard Business Review November 2014 HBR.ORG

GREAT LEADERS Appreciation makes work NEVER STOP meaningful. People feel what EVOLVING they do matters. Join world-class faculty and a network of global Buell: It doesn’t seem to be about eye peers in our Executive contact. In earlier research, Michael Education programs. Norton and I found that when websites reveal the work they’re doing, customers appreciate and value their service more. Kim: It may extend beyond service. What the line and picked it up without waiting. about manufacturing transparency? What Leading Product Innovation The sandwiches weren’t any different, but if you could watch your car being made? 02–06 FEB 2015 customers who waited in line rated the Would it change how you felt about the com- service higher. Think about that: People who pany? Would it change how you took care of Finance for Senior observed the chef thought the service was the car? Would you get into fewer accidents? Executives better despite the line, because they could Buy more insurance? These are all questions 08–13 FEB 2015 see the effort being made. we’re asking. Tsay: What’s exciting is that these are often Real Estate Executive The output in knowledge work isn’t as subtle alterations. It’s not expensive or Seminar simple or as delicious as a sandwich. difficult to create transparency between con- Can this work in an oﬃce or with more- sumers and producers. Just by opening up 18–21 FEB 2015 complex transactions? the work environment, you could improve Kim: There are many examples in realms value and quality. Transparency becomes a Leading Professional where effort is hidden from customers. low-cost strategic advantage. Service Firms Decisions in health care. Prep work in educa- 22–28 MAR 2015 tion and online learning. Our findings sug- But maybe consumers would get used to gest that it’s not just about the final output it? This was a two-week study. What if Strategic Financial Analysis but about what goes into it. after three months, cooks and diners just for Business Evaluation Buell: Think about an office job where your started tuning it out? 29 MAR–01 APR 2015 head is down and you’re just processing pa- Buell: We’ll need to do more work to know perwork all the time and are separated from for sure. If you’re the employee, seeing the Building Businesses in the customer. If suddenly the beneficiary of customer may fundamentally change the your labor is visible to you, it could change way you look at your job and how you per- Emerging Markets how you feel about the work. form it daily. You’ll cook more eggs to order, 29 MAR–02 APR 2015 for example. And if you’re a customer, see- So if I had seen someone reading a Defend ing the person helping you may recast your Leadership Best Practices Your Research column before this interview, view of the exchange. This work highlights 06–10 APR 2015 it would be a better interview? the humanity of interactions, of service. Tsay: Possibly—if you’d seen that they There’s something refreshingly human appreciated your work. about the idea that just seeing each other can make us more appreciative and lead to The visual access here included eye contact. objectively better outcomes. Get started at What if that’s the connection at work? Interview by Scott Berinato www.exed.hbs.edu/pgm/hbr/

GETTY IMAGES; ISTOCKPHOTO Maybe I have to have that? HBR Reprint F1411B IDEA WATCH GAME OF FINANCE: THE SOUTH SEA BUBBLE

As far as economic disasters go, the South Sea Bubble of 1720 was a doozy, involving the British government, the South Sea Company, and lots of financial speculation. That bubble was arguably the first financial scandal to play out in the public eye. The company’s founder, Tory leader Robert Harley, was a shrewd propagandist who touted his venture tirelessly, enlisting Jona- than Swift and Daniel Defoe in the effort. But writing a century later, the journal- ist Charles Mackay also faulted speculators and ordinary investors, who were “no longer satisfied with the slow but sure profits of cautious industry.” It’s no surprise that greed and chicanery on such a scale gave rise to satire. These playing cards, dating from 1721, depict the various characters caught up in the speculative fever. HBR Reprint F1411Z

WILD CARDS The deck skewers high-rolling speculators and ordinary investors alike: the “men of fame” who ﬂee England rather than face scandal, and the ladies who snap up new china as fast as they can unload their shares. They’re all “fools” suﬀering from the “South Sea Plague.”

SOURCES “THE DAMN’D SOUTH SEA,” BY CHRISTOPHER REED, HARVARD MAGAZINE, MAY–JUNE 1999; EXTRAORDINARY POPULAR DELUSIONS AND THE MADNESS OF CROWDS, BY CHARLES MACKAY, 1841; BANCROFT COLLECTION, KRESS LIBRARY OF BUSINESS AND ECONOMICS, BAKER LIBRARY, HARVARD BUSINESS SCHOOL.

36 Harvard Business Review November 2014 HBR.ORG To see the full deck of playing cards, go to this article on hbr.org. You can visit Baker Library’s complete South Sea Bubble Collection at www.library.hbs.edu/hc/ssb/collection.html.

THE SOUTH SEA BUBBLE EXPLAINED In exchange for assuming the debt that England incurred in the War of the Spanish Succession, the South Sea Company won a monopoly on trade with Spain’s colonies in South America and the West Indies. Investors—thrilled at the prospect of capitalizing on the colonies’ gold, silver, and other rich resources— bid up the stock’s price nearly tenfold in less than a year. When the company failed to deliver on its promise, the stock collapsed.

1701–1714 The War of to make one voyage a exchange for stock, the Spanish Succession year to trade in slaves further exciting and British goods. investors. 1711 The South Sea Company is formed as 1717 The company makes JUNE 1720 The South a joint-stock venture in its first trade voyage. Sea Company receives England. Robert Harley a royal charter (a new suggests that to secure 1719 Parliament requirement imposed by peace, Spain’s king will authorizes the legislation the company allow the company a company to assume itself introduced to limit monopoly on trade with an additional portion competition). Investors his colonies. England’s of the national debt. initially see this as a vote debt is converted into of confidence—but the shares in the company. JAN 1720 To stir investor stock plummets in value interest, the company’s soon after. 1713 The Treaty of directors circulate false Utrecht confirms Spain’s claims of success. 1721 Formal sovereignty over its New investigations expose World colonies, limiting MARCH 1720 The a web of deceit and the company’s potential government endorses corruption that leads trade in raw materials. a company proposal to the prosecution of The company does to assume more of many company and secure a contract the national debt in government officials.

THE SOUTH SEA COMPANY’S STOCK PRICE, 1720 ₤1,000

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November 2014 Harvard Business Review 37 STRATEGIC HUMOR IDEA WATCH 38 Harvard Business Review this point. set isn’t evidentat Actually, no, hisskill November 2014 a simple yesorno. I wasjustlooking for “Introducing ournewest This month’s winningcaptionwassubmittedby CAPTION CONTEST of Seattle, Washington. the CH2O.” member ofthe board: go t go HBR.ORG To contributecaptions, o hbr.org/strategic-humoro Laren Hagen . HBR.ORG

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ometimes I wonder what my who are of the same generation. But As one Millennial in our study reaction would have been if, I didn’t realize how little I really knew put it, “The guys in my generation Sas a twentysomething starting about these young people in the want fast-growing careers. We want out at Price Waterhouse nearly three workforce until PwC collaborated everything now.” Another said, “I decades ago, I had been magically with researchers from the University think older generations think people transported to today’s PwC. of Southern California and London spend their whole lives in one com- I would have been stunned by how Business School in 2011–2012 on a pany, but younger generations do much had changed. During most of study of Millennials and their levels not think that way. If the work doesn’t my career at the firm, the rewards sys- of engagement. Although Millennials More from really interest you, you can quit in tem focused more on quantity than have a lot in common with their older HBR on what two years or three years. It doesn’t quality of work, although clients de- colleagues, the study quantified distinguishes really matter. You can change the manded standards just as high then as some very real generational differ- Millennials place you work—liking your work is the ones they do now. Bigger bonuses ences—differences that matter for any “Handing the more important.” and promotions went to those who company trying to devise an effective Keys to Gen Y” Millennials are less willing than by Vineet Nayar sacrificed more of their personal lives, people strategy. (See the exhibit “Not May 2013 Boomers to make their work lives an whereas our current HR policies pri- Your Father’s Firm.”) exclusive priority, even when offered marily reward quality and value the “Mentoring the prospect of substantial future com- work and life needs of every person. Mapping the Diﬀerences Millennials” pensation. They want job flexibility in by Jeanne C. The Millennials among my colleagues PwC’s workforce is strikingly young: Meister and the here and now, along with oppor- emphasize finding satisfaction in their Because we recruit approximately Karie Willyerd tunities for training and mobility and May 2010 jobs and are willing to be vocal about 8,000 graduates annually from col- better and more frequent feedback what they want from a career and lege and university campuses, two- “How Gen Y and and rewards. Another common re- a company. They’re also extremely thirds of our people are in their twen- Boomers Will sponse to the survey: “People from my Reshape Your globally oriented—they know and care ties and early thirties. We’ve always Agenda” generation [expect] their company to much more about what’s going on all employed large numbers of young by Sylvia Ann give them time to have a personal life.” over the world than I did at their age. people—historically, the assumption Hewlett, Laura This finding was particularly pertinent Sherbin, and And they’re adept at leveraging tech- has been that most hires will eventu- Karen Sumberg in the developed world. Although nological advances to be more flexible. ally move on to other firms or other July 2009 Millennials working in every PwC firm But most of all, I would have been careers, while a few will be promoted “Gen Y in the around the globe aspire to achieve a astonished that PwC’s Millennials all the way up to partner. Built into Workforce” greater balance between their work by Tamara J. don’t only demand to know the or- this model was another key assump- Erickson lives and their personal lives, the ganization’s purpose—its reason for tion: that our workforce accepted February 2009 survey showed that the issue has a being—but are prepared to leave the the notion of making partner as the stronger bearing on turnover, com- firm if that purpose doesn’t align with reward and justification for years of mitment, and job satisfaction in North their own values. long hours in service to clients. But America, Europe, and Asia than in When I was coming up, we knew our study revealed that the allure other parts of the world. what we were doing, but we didn’t ask of someday becoming partner is no PwC’s leaders saw that we had to why we did it. We didn’t give much longer enough to spark high levels respond to this research in a radical thought to our, or the firm’s, role in of engagement. way. So we’ve turned our traditional society. For me, that point crystallizes human-capital approach on its head, the generational issues that PwC and developing a system of evidence- many other organizations are fac- When I was coming based HR practices that address the ing as they hire greater numbers of up, we knew what we shifting needs of our workforce. A Millennials. were doing, but we greater emphasis on nontraditional Fortunately, my education in this career models sometimes gives our age cohort didn’t have to happen in- didn’t ask why we were clients pause, but we’ve learned the stantly. It was a gradual process that doing it. We didn’t give benefits of sticking to our people com- included spending time in our HR de- mitments. Over the past decade turn- partment, observing and talking with much thought to our over has decreased by about three Millennials, and raising my children, role in society. percentage points—while employee

42 Harvard Business Review November 2014 HBR.ORG

engagement has increased by three NOT YOUR travel for work. In a previous era she percentage points. FATHER’S FIRM might have faced a choice between accepting a no-advancement job and Meeting Millennials’ At PwC, Millennials place more leaving the firm. Instead, she was Expectations importance on being part of cohesive offered another role that required less We’ve instituted several initiatives teams—and less on pay—than non- travel. We also have a program called Millennials do. And they readily speak up in response to the results of our en- about their career goals and concerns. Full Circle for people who need to gagement study: stop working for a while for personal Greater input. Our research reasons; it enables them to stay con- showed that Millennials want every nected to the firm and reengage when More of them say that action the firm takes to represent they’re able. Our Flexibility2 Talent workplace demands interfere their values, and they are more eager with their personal lives. Network allows people to work for the than others to be asked for input on firm during our busiest few months 71% important issues. To respond to those MILLENNIALS (January through March) and then desires, we’ve implemented programs pursue other interests for the rest of to engage all our people, so they know the year. For example, one individ- what the firm is doing and why, and so ual left to attend medical school but they can have a voice in where it’s go- 63% returned to work for PwC during a ing. For example, we’ve asked them for NON-MILLENNIALS break between courses. ideas on how to invest in human capi- Appreciation. These young tal and what the firm’s next $100 mil- people have a greater expectation lion idea should be. Some of their sug- A greater number say they prefer than previous generations had that gestions were pretty compelling, but to be rewarded or recognized for they’ll be supported and appreciated, what was even more important to us their work at least monthly. and financial rewards don’t always fill was that 70% of the organization took 41% the bill. We’ve found that Millennials part in the ideation process. We’ve also tend to be looking for something expanded choice in many areas—in- instead of or in addition to money— cluding bonuses: People may receive rewards that will benefit them in their rewards as cash, gift cards, prod- 30% life- or career-enhancing ways. So uct packages, or even matched chari- we decided to implement a number table contributions. We’ve increased of nonmonetary rewards for staying transparency in our compensation with the firm. For example, after a They are more likely to say they program, and we’ve become more ex- would like overseas career certain number of years we’ll send plicit about what our people can look opportunities with PwC. someone to California for a few days to forward to as their careers progress. 37% receive life skills and leadership train- Career paths. Millennials are ing. After a few more years people are inclined to want and expect the free- eligible for a four-week sabbatical dur- dom to move from one career path to ing which they can pursue an interest, another. We think that’s laudable, and 28% travel, volunteer, or stay at home with we don’t want them to have to leave the family. us in order to make such moves. So Corporate values and respon- we’ve instituted a policy of breaking sibility. Businesses need to create an down artificial barriers within the or- More of them expect not to environment that allows people to ganization. After a member of our staff work at one place for nine give back and excel both at the of- has been on board a certain number of years or more. fice and outside it. At PwC we see years, opportunities to try new things 38% greater retention and higher perfor- increase dramatically. mance when people are engaged in For example, personal circum- corporate responsibility programs. stances limited the ability of one For example, those who participated 30% director in our consulting practice to in more than one CR activity had an

November 2014 Harvard Business Review 43 HOW I DID IT HBR.ORG

average tenure of 7.4 years, while Millennials are often stereotyped those who participated in none as self-absorbed, quick to shift their PwC Facts & stayed with the organization an loyalties, lazy, and uncommitted Financials average of 6.3 years. Our Project Belize to work. We’ve all heard these un- FOUNDED 1998 (through a program, which is part of Earn Your founded myths, and that’s exactly merger of Price Waterhouse Future, a $160 million commitment what they are. At PwC we’ve used and Coopers & Lybrand) to increasing the financial literacy of education to address assumptions HEADQUARTERS London students, provides another example. like these. We’ve helped Boomers WORKFORCE 184,235 Only 8% of the staff members who see that although Millennials may be Global revenue (in US$T) participated in Project Belize left the more aware of the ill effects of stress, 32.1 30.9 firm in the subsequent year, compared and may value nonwork interests 28.6 with 16% of nonparticipants. and activities more than Boomers do, 26.4 26.4 they’re every bit as committed to the Millennials are quick to success of the firm. They’re simply not prepared to sacrifice their health and react negatively to any well-being for it. perceived disconnect To reinforce the value of work/life flexibility, a year and a half ago we between the ﬁrm’s made a point of stressing it for managers. Before a manager starts a new job, words and its actions. FY09 FY10 FY11 FY12 FY13 he or she is asked how team members SOURCE PwC If they don’t believe us, will be enabled to shift work hours, they leave. for example, or to work remotely. We also want managers to model flexible That’s why it’s important for us behavior, which doesn’t come easily to explain to clients up front that Millennials are quick to react to some of them, and we make sure to although we understand their high negatively to any perceived discon- reward it in our compensation process. expectations, and we intend to re- nect between the firm’s words and its Last year we created a contest to solicit act quickly to their needs, we’ll pro- actions. If they don’t believe us, they ideas for a flexibility plan for our busy vide a team that’s going to be there leave. That’s a challenge for anyone in season. Submissions came in from 24/7—not an individual. We achieve a managerial position, and social me- more than 1,800 teams, engaging that by overstaffing our teams so dia have raised the stakes. I’m acutely more than half the partners and staff- that no one person has to be unduly aware that if I were to say something ers in the firm. burdened for the sake of a deal. that appeared to conflict with PwC’s Contests have proved to be a popu- Some observers might see a certain stated values, it could go viral, and my lar way to boost engagement as well as irony here: In an era when young peo- credibility would be shot. bring in new ideas. In another contest ple seem less team-oriented and more that was centered on work flexibility, individualistic than ever before, we Helping Managers Adapt a number of people suggested that we are protecting individuals by relying Another part of improving the work involve clients in our efforts. That was on a team approach. But Millennials experience for Millennials is chang- a great idea, because it often seems well understand the value of the team ing managers’ attitudes toward them. that the concept of work/life flexibil- and are just as committed to their It’s not uncommon for our longer- ity runs counter to clients’ interests. units and to the firm as previous gen- term partners and staff to believe that For example, a company that’s em- erations were. What has changed is working hard is, or should be, a badge broiled in a merger might well expect the definition of commitment. It no of honor. So if someone relieves stress the people it’s working with at PwC longer encompasses sacrificing health by getting up and walking around, go- to be available around the clock. But or throwing work/life flexibility out of ing out to grab some coffee, or tak- Bob Moritz deals can take weeks—even months. whack, but it still includes what really ing a yoga class in the afternoon, the is the U.S. Burnout has been an issue in the past, matters for business outcomes: a de- chairman and Boomer’s impulse might be to tell her a senior partner and we’ve had some tough conversa- votion to the missions of the client and to sit back down and keep working. of PwC. tions with clients about it. the firm. HBR Reprint R1411A

44 Harvard Business Review November 2014 “I’ve been banking with First Republic for several years now and they keep getting better.”

STEPHEN ROSS Executive Chairman and Founder Related Companies

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HBR.ORG THE BIG IDEA 100

The Best-Performing CEOs in the World The knock on most business leaders is that they don’t take the long view—that they’re ﬁxated on achieving short- term goals to lift their pay. So which global CEOs actually delivered solid results over the long run? Our 2014 list of top performers provides an objective answer.

November 2014 Harvard Business Review 47 100THE BIG IDEA THE BEST-PERFORMING CEOS IN THE WORLD Leaders for the Long Term A few years ago I sat down with Starbucks founder Howard Schultz in his Seattle oﬃce to discuss the challenges of being a CEO. At one stage I asked whether he felt there was a disconnect between the person he would like to be and the persona he needs to project while running a public company.

by Adi Ignatius Serving as a CEO, he said, “has been difficult—and The top CEOs have undeniably been effective. lonely.” Yet he’d found that it was indeed possible to The top 50, on average, have delivered total share- be values-driven while also winning Wall Street’s re- holder returns of 1,350% (adjusted for exchange-rate spect. “But the only ingredient that works in this en- movements) during their time on the job. That trans- vironment is performance—so we have to perform.” lates into an annual return of 26.2%. Adjusting for in- Schultz has delivered on both fronts. He has be- dustry effects, average total shareholder returns for come increasingly progressive, speaking out on top- the top 50 are 1,161%, and for country effects, 1,087%. ics ranging from presidential politics to gay marriage. We acknowledge, of course, that being a good CEO And though that might make some shareholders is about far more than just investment performance. cringe (and others applaud), he has resoundingly— Leading a company and creating value depend on and consistently—come through for investors. As many skills that are hard to measure—strategic vision, a result, Schultz has earned a spot (#54) on our list authenticity, long-term planning. And investors cer- of the 100 best-performing CEOs in the world. It’s tainly aren’t the only stakeholders that need tending a varied ranking, whose honorees represent 22 na- to; the best-run companies connect effectively with tionalities and countless personal values and styles. customers, employees, and the communities where Another Seattle-based CEO, Amazon founder Jeff they operate. Bezos, comes out as #1 (see “The Numbers in Jeff But we want this ranking to be as objective as pos- Bezos’s Head,” page 58). sible, so we’ve put a premium on what we can mea- How do you measure a CEO’s worth? We de- sure precisely. Someday, we hope that there will be cided to approach the task scientifically, basing the equally concrete ways to account for “intangibles”— ranking on hard data, not on reputation or anec- environmental impact, employee satisfaction, cus- dote. Specifically, we looked at the increase in total tomer engagement—so that we can confidently add shareholder return and market capitalization (see that data to the formula. Until then we can only sup- “How We Calculated the Rankings,” at right). We also plement this list with parallel data that tries to track focused on long-term—or at least longish-term— some of these “softer” attributes. results. Our rankings consider the performance of Along those lines, we asked the Reputation active CEOs over their entire stints, and we’ve in- Institute, a reputation management consultancy, to cluded only those who have been in their jobs for at rank our top 100 CEOs in terms of these other skills— least two years. (The median term for all the CEOs work environment, citizenship, governance, leader- we studied is seven years.) ship, and so on. The results (see the sidebar “Money

48 Harvard Business Review November 2014 HBR.ORG How We Calculated the Rankings To create the list of the best-performing CEOs in the world, HBR began with the companies that, at the end of 2013, were in the S&P Global 1200, an index covering 70% of the world’s stock market capitalization and comprising firms in North America, Europe, Asia, Latin America, and Australia. We Isn’t Everything”) suggest, I’m afraid, that doing identified each company’s current CEO. To make sure that we well doesn’t correlate much at this stage with doing had reliable data and focused on long-term performance, we good. That said, a few superstars scored high across excluded CEOs who had assumed their role before 1995 or the board, including Bezos, who, despite Amazon’s after April 30, 2012. We also excluded any executive who had well-publicized entanglements with publishers been convicted or arrested. All told, we ended up with 832 and authors, was #4 on the Reputation Institute list. current CEOs from 827 companies. (Several companies had (Schultz finished in the middle of the pack.) co-CEOs.) Those executives represented 43 nationalities and What else do we know about the CEOs on this ran enterprises based in 30 countries. list? Most are men—only two women, Debra Cafaro Our research team, headed by of the three rankings for every CEO of Ventas and Carol Meyrowitz of TJX, made the Nana von Bernuth and assisted to create the final overall ranking. top 100—and the median age is 59. (This is similar by statistician Hyunwoo Park and Using three metrics is a balanced to what we see in the entire group studied, in which coders Peggy Lam, Michelle Kossack, and robust approach: While the 3% of CEOs were female and the median age was 58.) and Phachareeya Ratchada, pulled first two risk being skewed toward Thirteen CEOs are of nationalities that differ from financial data from Datastream smaller companies (it’s easier to their companies’. (Though it’s still not a global market and Worldscope and calculated get large returns if you start from for CEOs, that figure is more than double what it was daily company returns (including a small base), the third is skewed in the 2013 version of this ranking.) And while the top reinvested dividends) for each CEO toward larger companies. 100 have each experienced their own unique jour- from the first day that he or she took We also collected biographical neys to success, there do seem to be two preferred office until April 30, 2014. From this data on each CEO and performed data we calculated three sets of regression analysis on the data set. pathways. Over a quarter of the CEOs have MBAs, numbers: country-adjusted returns This allowed us to “control” for some and nearly as many had studied engineering. (See the (which exclude any increases in factors and isolate the effect that sidebar “Why Engineers Make Great Leaders.”) returns that are attributable merely one factor (such as having an MBA We also looked at CEO pay, to see how that related to an improvement in the local stock or an engineering degree, or being to performance. To do so, we worked with Equilar, a market), industry-adjusted returns a company founder) had on a CEO’s company that collects information on compensation, (which exclude increases that result standing in the ranking. to tally the most recent pay packages for the top 100. from rising fortunes for the overall HBR’s list of the world’s best- These elite CEOs are very well paid, as are most CEOs. industry), and change in market performing CEOs was conceived by But on average the executives on our list receive capitalization (measured in inflation- Morten T. Hansen, Herminia Ibarra, more of every form of compensation than their peers adjusted U.S. dollars, using 2012 and Urs Peyer. Previous rankings do. (See the sidebar “How They Stack Up on Pay.”) exchange rates). were published in HBR’s January– We then ranked all CEOs for February 2010 and January–February Disney’s Bob Iger, #60 on our list, is the high- each metric—from 1 (best) to 832 2013 issues, but the methodology est paid among our 100, with a total package of (worst)—and calculated the average has been updated for the 2014 list. $34.3 million. That doesn’t make him the world’s best-paid CEO. In fact, according to Equilar, 13 CEOs earned more, led by Charif Souki of U.S. gas developer Cheniere Energy, whose 2013 compensation totaled $141.9 million. So what’s the ultimate takeaway from this ranking? In many ways, Bezos’s place atop the list says it all. Here’s a CEO who has frequently underperformed in the short term while continuing to make big bets on the future. Amazon often reports quarterly losses, even as sales continue to rise. And though the company is subject, like many firms, to dramatic share- price swings, Amazon and Bezos have a long-term track record of delivering shareholder value that is second to none.

November 2014 Harvard Business Review 49 THE BIG IDEA THE BEST-PERFORMING CEOS IN THE WORLD

The Rankings OVERALL RANK OVERALL RANK 1 2 3 4 5

Jeﬀrey Bezos John Martin John Chambers David Pyott David Simon

COMPANY UNITED STATES COMPANY UNITED STATES COMPANY UNITED STATES COMPANY UNITED STATES COMPANY UNITED STATES Amazon Gilead Sciences Cisco Systems Allergan Simon Property Group

START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER YEAR YEAR YEAR YEAR YEAR 1996 1996 1995 1998 1995 INDUSTRY INDUSTRY INDUSTRY INDUSTRY INDUSTRY Retail Health care Information technology Health care Financial services MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE

TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED 15,189% 14,917% 7,206% 6,919% 668% 1,102% 1,948% 1,929% 1,246% 1,605%

MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$140B +$128B +$168B +$50B +$63B

8 9 10 11 12

J. Michael Pearson Mark Donegan William Doyle Tadashi Yanai David Novak

COMPANY CANADA COMPANY UNITED STATES COMPANY CANADA COMPANY JAPAN COMPANY UNITED STATES Valeant Pharmaceuticals Precision Castparts PotashCorp Fast Retailing Yum Brands

START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER YEAR YEAR YEAR YEAR YEAR 2008 2002 1999 2002 2000 INDUSTRY INDUSTRY INDUSTRY INDUSTRY INDUSTRY Health care Industrials Materials Retail Consumer goods MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE

TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED 1,144% 1,100% 1,720% 1,622% 1,327% 1,163% 824% 862% 806% 670%

MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$44B +$34B +$37B +$39B +$38B

OVERALL RANK OVERALL RANK OVERALL RANK OVERALL RANK 15 16 17 18 19

Marc Benioﬀ Oscar Gonzalez Stephen Wynn James Taiclet Jr. Elmar Degenhart Rocha COMPANY UNITED STATES COMPANY MEXICO COMPANY UNITED STATES COMPANY UNITED STATES COMPANY GERMANY Salesforce.com Southern Copper Wynn Resorts American Tower Continental

START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER YEAR YEAR YEAR YEAR YEAR 2001 2004 2002 2003 2009 INDUSTRY INDUSTRY INDUSTRY INDUSTRY INDUSTRY Information technology Materials Consumer services Financial services Automobile MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE

TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED 1,002% 990% 576% 579% 2,164% 1,944% 646% 601% 591% 521%

MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$28B +$40B +$22B +$35B +$38B

50 Harvard Business Review November 2014 HBR.ORG

Why Engineers Make Great Leaders OVERALL RANK OVERALL RANK Twenty-four of HBR’s 100 best-performing CEOs have 6 7 undergraduate or graduate degrees in engineering, compared with 29 who have MBAs. (Eight CEOs have both degrees.) At technology or science-based companies, it’s not a big Lars Rebien Hugh Grant surprise to find an engineer at the helm. But engineers thrive S#rensen COMPANY DENMARK COMPANY UNITED STATES at the top of other kinds of firms, too: Examples include Novo Nordisk Monsanto Carlos Alves de Brito of brewing giant Anheuser-Busch InBev, START FOUNDER INSIDER START FOUNDER INSIDER Jeffrey Sprecher of the financial services firm Intercontinental YEAR YEAR 2000 2003 Exchange, and Kari Stadigh of the insurance company Sampo. INDUSTRY INDUSTRY Health care Materials What makes an engineering Executive recruiter James Citrin, MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE degree useful to people leading a after examining the list’s numbers,

business? “Studying engineering notes an interesting trend: CEOs TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN gives someone a practical, who were hired into firms as COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED 621% 1,214% 1,006% 827% pragmatic orientation,” says Nitin outsiders were more likely to have an Nohria, the dean of Harvard Business engineering degree than insiders who MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$101B +$59B School, who holds an undergraduate were promoted into the job. “That degree in chemical engineering from connects with my experience,” says the Indian Institute of Technology, Citrin, who leads Spencer Stuart’s Bombay. “Engineering is about North American CEO practice. “When 13 14 what works, and it breeds in you an boards are making decisions, and ethos of building things that work— they know it’s riskier going outside, whether it’s a machine or a structure it often gives them comfort if a Michael Wolf Pablo Isla Álvarez or an organization. Engineering candidate has studied engineering.” de Tejera also teaches you to try to do things Why? Citrin says engineers excel at COMPANY SWEDEN COMPANY SPAIN Swedbank Inditex efficiently and eloquently, with “architectural thinking” and logical reliable outcomes, and with a margin problem solving. The only downside START FOUNDER INSIDER START FOUNDER INSIDER of safety. It makes you think about of an engineering background, Citrin YEAR YEAR 2009 2005 costs versus performance. These says: It might be a small strike INDUSTRY INDUSTRY Financial services Retail are principles that can be deeply against a candidate who wants to important when you think about lead a company in a creative field MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE organizations.” such as fashion or advertising.

TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED 842% 1,269% 395% 442%

MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$29B +$72B

20 21 21 23 24

*TIE *TIE George Paz Tsai Ming-Kai Paolo Rocca Reed Hastings Ronald Havner Jr.

COMPANY UNITED STATES COMPANY TAIWAN COMPANY ARGENTINA COMPANY UNITED STATES COMPANY UNITED STATES Express Scripts MediaTek Tenaris Netﬂix Public Storage

START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER YEAR YEAR YEAR YEAR YEAR 2005 1997 2002 1998 2002 INDUSTRY INDUSTRY INDUSTRY INDUSTRY INDUSTRY Health care Information technology Energy Retail Financial services MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE

TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED 431% 419% 702% 989% 754% 1,205% 3,755% 3,158% 620% 536%

MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$52B +$28B +$26B +$19B +$31B

November 2014 Harvard Business Review 51 THE BIG IDEA THE BEST-PERFORMING CEOS IN THE WORLD How They Stack Up on Pay One of the downsides of a global CEO ranking is that it’s difficult to offer a comprehensive comparison of these leaders’ pay, 25 26 because countries require different levels of transparency with executive compensation. With help from the compensation analysis firm Equilar, we compiled pay data on 68 of our top Michael Balmuth Daniel Hajj Aboumrad 100 CEOs. (The remaining 32 are based in countries that lack COMPANY UNITED STATES COMPANY MEXICO public data on executive pay.) Ross Stores América Móvil The takeaways from our pay analysis: START FOUNDER INSIDER START FOUNDER INSIDER YEAR YEAR No surprise: American CEOs earn more. The median pay for U.S. CEOs on 1996 2000 INDUSTRY INDUSTRY HBR’s list is $12.1 million, compared with $6.4 million for non-U.S. CEOs for Retail Telecommunication whom we obtained data. All 10 of the highest earners lead U.S. companies. MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE “That’s consistent with what we’ve seen for years: that U.S. CEOs make more,” says Aaron Boyd, Equilar’s director of governance research. The pay TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED calculations incorporated each executive’s salary, cash bonus, equity awards, 2,827% 2,806% 262% 486% option awards, and “other,” and the biggest difference between U.S. and non- U.S. pay packages was the size of equity and option grants—components that MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE are particularly valuable when global markets are rising. Those components +$18B +$64B are also especially lucrative to CEOs who generate THE 10 TOP PERFORMERS WITH THE HIGHEST above-average total shareholder returns. TOTAL COMPENSATION High-performing CEOs earn more than the 32 32 1. ROBERT IGER average. Last year the median compensation for WALT DISNEY S&P 500 CEOs reached $10.1 million, breaking *TIE *TIE $34,321,055 into eight digits for the first time. That’s 20% Jon Fredrik Baksaas Renato Alves Vale 2. DAVID ZASLAV below the amount earned by the U.S. CEOs on DISCOVERY COMMUNICATIONS our list. Equilar’s analysis shows that, on average, COMPANY NORWAY COMPANY BRAZIL $33,349,798 they outearned other CEOs in every category— Telenor CCR 3. MARC BENIOFF including salary, bonus, equity awards, and START FOUNDER INSIDER START FOUNDER INSIDER YEAR YEAR SALESFORCE.COM options. And since our top 100 CEOs produce 2002 1999 $31,333,332 superior shareholder returns in the long term, INDUSTRY INDUSTRY 4. FABRIZIO FREDA their equity and options will obviously appreciate Telecommunication Transportation ESTÉE LAUDER with their stock. In addition, the top 100 tend MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE $31,069,648 to stay in their jobs longer than most CEOs, 5. JOHN HAMMERGREN increasing their lifetime earnings. TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN MCKESSON COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED $25,032,775 Family and founders sometimes “earn” less. 302% 652% 1,962% 2,338% It may seem ironic that Jeff Bezos, the #1 CEO 6. MONTY MORAN MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE CHIPOTLE MEXICAN GRILL in performance, comes in second-to-last in +$36B +$17B $24,397,054 compensation, earning a 2013 salary of $81,000 OVERALL RANK 7. ALEXANDER CUTLER and total compensation of $1.7 million (most of EATON which consists of company-provided security). $23,087,809 While Bezos’s annual comp is far below the CEO 39 40 8. BRIAN JELLISON average, Amazon’s founder holds an 18% stake ROPER INDUSTRIES $21,368,796 in the company, which means that for every $1 increase in Amazon’s share price, Bezos’s Charles Davidson George Scangos 9. JOHN CHAMBERS net worth rises by $84 million. It also makes CISCO SYSTEMS COMPANY UNITED STATES COMPANY UNITED STATES $21,049,501 him the world’s 20th richest person, by some Noble Energy Biogen Idec calculations. 10. CAROL MEYROWITZ START FOUNDER INSIDER START FOUNDER INSIDER TJX YEAR YEAR $20,720,802 2000 2010 INDUSTRY INDUSTRY SOURCE EQUILAR Energy Health care MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE

TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED 661% 493% 352% 223%

MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$24B +$55B

52 Harvard Business Review November 2014 HBR.ORG

OVERALL RANK OVERALL RANK OVERALL RANK 27 28 29 30 31

Debra Cafaro James Gallogly Christopher Djalma Bastos Paul Bisaro Connor de Morais COMPANY UNITED STATES COMPANY UNITED STATES COMPANY UNITED STATES COMPANY BRAZIL COMPANY UNITED STATES Ventas LyondellBasell Sherwin-Williams Cemig Actavis

START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER YEAR YEAR YEAR YEAR YEAR 1999 2009 1999 1999 2007 INDUSTRY INDUSTRY INDUSTRY INDUSTRY INDUSTRY Financial services Materials Materials Utilities Health care MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE

TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED 1,761% 1,636% 391% 400% 1,096% 936% 1,113% 1,624% 520% 475%

MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$20B +$48B +$22B +$19B +$32B

34 34 36 37 38

*TIE *TIE Alexander Cutler Stephen Luczo Gordon Nixon Kent Thiry H. Lawrence Culp Jr.

COMPANY UNITED STATES COMPANY UNITED STATES COMPANY CANADA COMPANY UNITED STATES COMPANY UNITED STATES Eaton Seagate Technology Royal Bank of Canada DaVita Danaher

START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER YEAR YEAR YEAR YEAR YEAR 2000 2009 2001 1999 2001 INDUSTRY INDUSTRY INDUSTRY INDUSTRY INDUSTRY Industrials Information technology Financial services Health care Industrials MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE

TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED 506% 503% 1,016% 958% 192% 431% 2,658% 2,390% 348% 412%

MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$31B +$20B +$92B +$16B +$39B

OVERALL RANK 41 42 43 44 45

Ulf Schneider Dan Dinges Simon Wolfson Michael Ward Fujio Mitarai

COMPANY GERMANY COMPANY UNITED STATES COMPANY UNITED KINGDOM COMPANY UNITED STATES COMPANY JAPAN Fresenius Cabot Oil & Gas Next CSX Canon

START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER START FOUNDER INSIDER YEAR YEAR YEAR YEAR YEAR 2003 2002 2001 2003 1995 INDUSTRY INDUSTRY INDUSTRY INDUSTRY INDUSTRY Health care Energy Retail Transportation Information technology MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE

TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED 532% 696% 1,687% 1,570% 856% 1,006% 459% 257% 275% 196%

MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$22B +$15B +$17B +$32B +$64B

November 2014 Harvard Business Review 53 THE BIG IDEA THE BEST-PERFORMING CEOS IN THE WORLD Money Isn’t Everything While HBR’s global CEO ranking takes a critical step forward by gauging CEOs on long-term, rather than short-term, gains, it 46 47 nevertheless looks at performance in purely financial terms. Yet a company’s greatness also depends on nonfinancial factors— *TIE like social responsibility and integrity. Though these are harder Carlos Alves Ed Clark de Brito to quantify, there are organizations that try to track such COMPANY BELGIUM COMPANY CANADA factors and compare how companies measure up on them. Anheuser-Busch InBev Toronto-Dominion Bank For a broader view of our top 100, we asked the Reputation Institute, which START FOUNDER INSIDER START FOUNDER INSIDER YEAR YEAR ranks global companies annually according to how positively they are regarded, 2006 2002 to reorder our list. Its RepTrak methodology has respondents rate companies INDUSTRY INDUSTRY Consumer goods Financial services on seven dimensions—products and services, innovation, workplace, governance, citizenship, leadership, and performance—and then calculates a MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE score of 0 to 100 for each. TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN Below are the 10 companies on our list whose reputations were rated COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED highest by respondents in their home countries. (The reranking of the entire 246% 155% 144% 409% list by company reputation can be found at hbr.org, in the online version of MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE this article.) When we looked at these 10 firms, a few things jumped out: +$139B +$84B Bezos wins again. We can probably chalk the dual achievement up to his constant pursuit of a clear vision: to be “the most customer-centric company in the world.” Still, it presents a marvelous irony. The leader most adamantly 47 49 ignoring Wall Street pressure creates the most value—and the company that spends next to nothing on advertising and PR ends up with a great reputation. *TIE There is really no correlation. The order of names on the two lists is Joseph Papa Philip Pascall utterly unrelated. While two of the top 10 CEOs from our ranking also lead companies that are in the top 10 reputation-wise, so does a CEO ranked 98th COMPANY UNITED STATES COMPANY CANADA on the original list. In fact these reputation winners are pretty evenly Perrigo First Quantum distributed in terms of their value creation. START FOUNDER INSIDER START FOUNDER INSIDER YEAR YEAR It’s fair to call it a CEO ranking. Sure, this 2006 1996 THE COMPANIES WITH is a ranking of company reputations, not the INDUSTRY INDUSTRY THE BEST REPUTATION reputations of the CEOs themselves—and what Health care Materials SCORES, AND THEIR CEOS: is being measured here is their current value, MBA ENGINEERING DEGREE MBA ENGINEERING DEGREE 1. VOLKSWAGEN MARTIN WINTERKORN rather than any change in value across the CEO’s 85.84 TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN tenure. We’re still comfortable with hanging these COUNTRY ADJUSTED INDUSTRY ADJUSTED COUNTRY ADJUSTED INDUSTRY ADJUSTED 2. NOVO NORDISK companies’ reputations on their leaders. First, LARS REBIEN SØRENSEN 701% 669% 2,195% 2,854% 83.92 because among these 10, the average tenure MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE 3. SWATCH in office is over 12 years—surely enough time to +$18B +$13B NICK HAYEK JR. 82.37 make a mark. Second, because no one is better 4. AMAZON positioned than the CEO to effect the changes that JEFFREY BEZOS improve (or ruin) a company’s image. 80.95 For longtime leaders, it might be personal. 50 5. ADIDAS HERBERT HAINER One of the CEOs of our reputational top 10 is 80.38 a founder (Bezos); one is the son of a founder FOR MORE 6. TIFFANY & COMPANY (Hayek), and two are close to that (Wolfson, whose John Wren ON THE CEOS MICHAEL KOWALSKI 79.11 father was chairman of the same company, and COMPANY UNITED STATES GO TO 7. NEXT Riboud, whose father spent many years in the Omnicom HBR.ORG SIMON WOLFSON same CEO seat before him). Nearly all the rest have 78.88 START FOUNDER INSIDER been with their companies a long while—as in 27 YEAR 8. WALT DISNEY 1997 ROBERT IGER to 35 years. At least two explanations are possible. 78.88 INDUSTRY Perhaps people outside the company respond well Consumer services 9. DANONE to long-term leaders, so reputation scores tend FRANCK RIBOUD MBA ENGINEERING DEGREE 78.29 to rise with tenures. Or it could be the other way

10. FRESENIUS around: Maybe leaders whose identities are so TOTAL SHAREHOLDER RETURN ULF SCHNEIDER COUNTRY ADJUSTED INDUSTRY ADJUSTED 77.99 thoroughly tied up with their companies’ are more 366% 469% attuned to leaving legacies that aren’t only about SOURCE THE REPUTATION MARKET CAPITALIZATION CHANGE INSTITUTE ﬁnancial value created. +$24B

54 Harvard Business Review November 2014 HBR.ORG

51 56 61 66 *TIE 70 *TIE CAROL MEYROWITZ FRANK HERMANCE BENOÎT POTIER TERRY LUNDGREN PAUL DESMARAIS JR. COMPANY TJX COMPANY Ametek COMPANY Air Liquide COMPANY Macy’s COMPANY Power Corporation United States United States France United States of Canada INDUSTRY Retail INDUSTRY Industrials INDUSTRY Materials INDUSTRY Retail Canada START YEAR 2007 START YEAR 1999 START YEAR 1997 START YEAR 2003 INDUSTRY Financial services FOUNDER No INSIDER Yes FOUNDER No INSIDER Yes FOUNDER No INSIDER Yes FOUNDER No INSIDER Yes START YEAR 1996 MBA No ENGINEERING No MBA No ENGINEERING Yes MBA No ENGINEERING Yes MBA No ENGINEERING No FOUNDER No INSIDER Yes TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN MBA Yes ENGINEERING No COUNTRY ADJUSTED 281% COUNTRY ADJUSTED 1,702% COUNTRY ADJUSTED 242% COUNTRY ADJUSTED 259% TOTAL SHAREHOLDER RETURN INDUSTRY ADJUSTED 261% INDUSTRY ADJUSTED 1,649% INDUSTRY ADJUSTED 202% INDUSTRY ADJUSTED 251% COUNTRY ADJUSTED 578% MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE INDUSTRY ADJUSTED 1,021% +$35B +$12B +$39B +$26B MARKET CAPITALIZATION CHANGE +$12B 52 57 62 66 *TIE 72 NICK HAYEK JR. BRUCE FLATT WILLIAM RHODES III BENJAMIN STEINBRUCH COMPANY Swatch COMPANY Brookﬁeld Asset COMPANY AutoZone COMPANY Companhia OLA ROLLÉN Switzerland Management United States Siderúrgica Nacional COMPANY Hexagon INDUSTRY Consumer goods Canada INDUSTRY Retail Brazil Sweden START YEAR 2003 INDUSTRY Financial services START YEAR 2005 INDUSTRY Materials INDUSTRY Information technology FOUNDER No INSIDER Yes START YEAR 2002 FOUNDER No INSIDER Yes START YEAR 2002 START YEAR 2000 MBA No ENGINEERING No FOUNDER No INSIDER Yes MBA Yes ENGINEERING No FOUNDER No INSIDER Yes FOUNDER No INSIDER No TOTAL SHAREHOLDER RETURN MBA No ENGINEERING No TOTAL SHAREHOLDER RETURN MBA No ENGINEERING No MBA No ENGINEERING No COUNTRY ADJUSTED 307% TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED 436% TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN INDUSTRY ADJUSTED 312% COUNTRY ADJUSTED 865% INDUSTRY ADJUSTED 419% COUNTRY ADJUSTED 613% COUNTRY ADJUSTED 2,302% MARKET CAPITALIZATION CHANGE INDUSTRY ADJUSTED 794% MARKET CAPITALIZATION CHANGE INDUSTRY ADJUSTED 938% INDUSTRY ADJUSTED 3,410% +$28B MARKET CAPITALIZATION CHANGE +$19B MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$14B +$13B +$9B 53 63 58 68 73 JOHN HAMMERGREN MONTY MORAN COMPANY McKesson JEFFREY SPRECHER COMPANY Chipotle Mexican Grill RANDALL HOGAN HERBERT HAINER United States COMPANY Intercontinental Exchange United States COMPANY Pentair COMPANY Adidas INDUSTRY Health care United States INDUSTRY Consumer goods United States Germany START YEAR 1999 INDUSTRY Financial services START YEAR 2009 INDUSTRY Industrials INDUSTRY Consumer goods FOUNDER No INSIDER Yes START YEAR 2000 FOUNDER No INSIDER Yes START YEAR 2001 START YEAR 2001 MBA Yes ENGINEERING No FOUNDER Yes INSIDER Yes MBA No ENGINEERING No FOUNDER No INSIDER Yes FOUNDER No INSIDER Yes TOTAL SHAREHOLDER RETURN MBA Yes ENGINEERING Yes TOTAL SHAREHOLDER RETURN MBA Yes ENGINEERING Yes MBA No ENGINEERING No COUNTRY ADJUSTED 367% TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED 571% TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN INDUSTRY ADJUSTED 200% COUNTRY ADJUSTED 343% INDUSTRY ADJUSTED 520% COUNTRY ADJUSTED 614% COUNTRY ADJUSTED 388% MARKET CAPITALIZATION CHANGE INDUSTRY ADJUSTED 441% MARKET CAPITALIZATION CHANGE INDUSTRY ADJUSTED 401% INDUSTRY ADJUSTED 334% +$35B MARKET CAPITALIZATION CHANGE +$15B MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$22B +$15B +$17B 54 64 *TIE 59 69 74 HOWARD SCHULTZ AJAYPAL BANGA COMPANY Starbucks WOLFGANG REITZLE COMPANY MasterCard GREGORY CASE LARS RASMUSSEN United States COMPANY Linde United States COMPANY Aon COMPANY Coloplast INDUSTRY Consumer goods Germany INDUSTRY Information technology United Kingdom Denmark START YEAR 2008 INDUSTRY Materials START YEAR 2010 INDUSTRY Financial services INDUSTRY Health care FOUNDER Yes INSIDER Yes START YEAR 2003 FOUNDER No INSIDER Yes START YEAR 2005 START YEAR 2008 MBA No ENGINEERING No FOUNDER No INSIDER Yes MBA No ENGINEERING No FOUNDER No INSIDER No FOUNDER No INSIDER Yes TOTAL SHAREHOLDER RETURN MBA No ENGINEERING Yes TOTAL SHAREHOLDER RETURN MBA Yes ENGINEERING No MBA Yes ENGINEERING Yes COUNTRY ADJUSTED 256% TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED 169% TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN INDUSTRY ADJUSTED 217% COUNTRY ADJUSTED 241% INDUSTRY ADJUSTED 165% COUNTRY ADJUSTED 237% COUNTRY ADJUSTED 413% MARKET CAPITALIZATION CHANGE INDUSTRY ADJUSTED 328% MARKET CAPITALIZATION CHANGE INDUSTRY ADJUSTED 276% INDUSTRY ADJUSTED 474% +$41B MARKET CAPITALIZATION CHANGE +$66B MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$29B +$25B +$15B 54 65 *TIE 60 70 75 BLAKE NORDSTROM RICHARD COUSINS *TIE COMPANY Nordstrom ROBERT IGER COMPANY Compass Group ANDRÉ DESMARAIS GEORGE WESTON United States COMPANY Walt Disney United Kingdom COMPANY Power Corporation COMPANY Associated British Foods INDUSTRY Retail United States INDUSTRY Consumer goods of Canada United Kingdom START YEAR 2000 INDUSTRY Consumer services START YEAR 2006 Canada INDUSTRY Consumer goods FOUNDER No INSIDER Yes START YEAR 2005 FOUNDER No INSIDER No INDUSTRY Financial services START YEAR 2005 MBA No ENGINEERING No FOUNDER No INSIDER Yes MBA No ENGINEERING No START YEAR 1996 FOUNDER No INSIDER Yes TOTAL SHAREHOLDER RETURN MBA No ENGINEERING No TOTAL SHAREHOLDER RETURN FOUNDER No INSIDER Yes MBA Yes ENGINEERING No COUNTRY ADJUSTED 749% TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED 363% MBA No ENGINEERING No TOTAL SHAREHOLDER RETURN INDUSTRY ADJUSTED 655% COUNTRY ADJUSTED 193% INDUSTRY ADJUSTED 260% TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED 292% MARKET CAPITALIZATION CHANGE INDUSTRY ADJUSTED 144% MARKET CAPITALIZATION CHANGE COUNTRY ADJUSTED 578% INDUSTRY ADJUSTED 159% +$15B MARKET CAPITALIZATION CHANGE +$23B INDUSTRY ADJUSTED 1,021% MARKET CAPITALIZATION CHANGE +$117B MARKET CAPITALIZATION CHANGE +$28B +$12B

November 2014 Harvard Business Review 55 THE BIG IDEA THE BEST-PERFORMING CEOS IN THE WORLD HBR.ORG

91 76 81 86 *TIE 96 MARK PARKER FABRIZIO FREDA GREGORY JOHNSON LARS RENSTRÖM EDWARD COMPANY Nike COMPANY Estée Lauder COMPANY Franklin Resources COMPANY Alfa Laval MATTHEW TRACY United States United States United States Sweden COMPANY Sands China INDUSTRY Consumer goods INDUSTRY Consumer goods INDUSTRY Financial services INDUSTRY Industrials Hong Kong START YEAR 2006 START YEAR 2009 START YEAR 2004 START YEAR 2004 INDUSTRY Consumer goods FOUNDER No INSIDER Yes FOUNDER No INSIDER Yes FOUNDER No INSIDER Yes FOUNDER No INSIDER No START YEAR 2011 MBA No ENGINEERING No MBA No ENGINEERING No MBA No ENGINEERING No MBA No ENGINEERING Yes FOUNDER No INSIDER Yes TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN MBA No ENGINEERING No COUNTRY ADJUSTED 217% COUNTRY ADJUSTED 234% COUNTRY ADJUSTED 155% COUNTRY ADJUSTED 559% TOTAL SHAREHOLDER RETURN INDUSTRY ADJUSTED 116% INDUSTRY ADJUSTED 255% INDUSTRY ADJUSTED 247% INDUSTRY ADJUSTED 631% COUNTRY ADJUSTED 161% MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE INDUSTRY ADJUSTED 123% +$50B +$23B +$28B +$10B MARKET CAPITALIZATION CHANGE +$36B 77 82 86 92 *TIE 97 DAVID ZASLAV SCOTT SAXBERG MICHAEL MUSSALLEM MICHAEL KOWALSKI COMPANY Discovery COMPANY Crescent Point Energy COMPANY Edwards Lifesciences COMPANY Tiﬀany & Company GREGORY GOODMAN Communications Canada United States United States COMPANY Goodman United States INDUSTRY Energy INDUSTRY Health care INDUSTRY Retail Australia INDUSTRY Consumer goods START YEAR 2004 START YEAR 2000 START YEAR 1999 INDUSTRY Financial services START YEAR 2007 FOUNDER Yes INSIDER Yes FOUNDER No INSIDER Yes FOUNDER No INSIDER Yes START YEAR 1995 FOUNDER No INSIDER No MBA No ENGINEERING Yes MBA No ENGINEERING Yes MBA Yes ENGINEERING No FOUNDER Yes INSIDER Yes MBA No ENGINEERING No TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN MBA n/a ENGINEERING n/a TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED 388% COUNTRY ADJUSTED 1,033% COUNTRY ADJUSTED 525% TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED 352% INDUSTRY ADJUSTED 427% INDUSTRY ADJUSTED 954% INDUSTRY ADJUSTED 513% COUNTRY ADJUSTED 15,707% INDUSTRY ADJUSTED 321% MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE INDUSTRY ADJUSTED 19,663% MARKET CAPITALIZATION CHANGE +$14B +$9B +$11B MARKET CAPITALIZATION CHANGE +$18B +$6B 83 88 93 78 98 TSAI ENG-MENG JEAN-PAUL CLOZEL JOHN FINNEGAN ED HEFFERNAN COMPANY Want Want China COMPANY Actelion COMPANY Chubb FRANCK RIBOUD COMPANY Alliance Data Systems Holdings Switzerland United States COMPANY Danone United States China INDUSTRY Health care INDUSTRY Financial services France INDUSTRY Information technology INDUSTRY Consumer goods START YEAR 2000 START YEAR 2002 INDUSTRY Consumer goods START YEAR 2009 START YEAR 2007 FOUNDER Yes INSIDER Yes FOUNDER No INSIDER No START YEAR 1996 FOUNDER No INSIDER Yes FOUNDER Yes INSIDER Yes MBA No ENGINEERING No MBA Yes ENGINEERING No FOUNDER No INSIDER Yes MBA Yes ENGINEERING No MBA n/a ENGINEERING n/a TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN MBA No ENGINEERING Yes TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED 535% COUNTRY ADJUSTED 167% TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED 578% COUNTRY ADJUSTED 372% INDUSTRY ADJUSTED 952% INDUSTRY ADJUSTED 219% COUNTRY ADJUSTED 195% INDUSTRY ADJUSTED 549% INDUSTRY ADJUSTED 318% MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE INDUSTRY ADJUSTED 89% MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$11B +$23B MARKET CAPITALIZATION CHANGE +$13B +$17B +$46B 89 94 79 84 99 MARTIN WINTERKORN JACQUES ASCHENBROICH PETER ROGERS ERIC WISEMAN COMPANY Volkswagen COMPANY Valeo BRIAN JELLISON COMPANY Babcock COMPANY VF Germany France COMPANY Roper Industries United Kingdom United States INDUSTRY Automobile INDUSTRY Automobile United States INDUSTRY Industrials INDUSTRY Consumer goods START YEAR 2007 START YEAR 2009 INDUSTRY Industrials START YEAR 2003 START YEAR 2008 FOUNDER No INSIDER Yes FOUNDER No INSIDER No START YEAR 2001 FOUNDER No INSIDER Yes FOUNDER No INSIDER Yes MBA No ENGINEERING No MBA No ENGINEERING Yes FOUNDER No INSIDER No MBA No ENGINEERING No MBA Yes ENGINEERING No TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN MBA No ENGINEERING No TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED 108% COUNTRY ADJUSTED 785% TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED 1,329% COUNTRY ADJUSTED 289% INDUSTRY ADJUSTED 123% INDUSTRY ADJUSTED 618% COUNTRY ADJUSTED 510% INDUSTRY ADJUSTED 1,463% INDUSTRY ADJUSTED 236% MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE INDUSTRY ADJUSTED 393% MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$70B +$9B MARKET CAPITALIZATION CHANGE +$10B +$21B +$12B 90 95 80 85 100 KARI HENRIK STADIGH JEAN-PAUL LUKSIC GREGORY HENSLEE HE GUANGBEI COMPANY Sampo COMPANY Antofagasta WILLARD OBERTON COMPANY O’Reilly Automotive COMPANY BOC Hong Kong Finland United Kingdom COMPANY Fastenal United States Hong Kong INDUSTRY Financial services INDUSTRY Materials United States INDUSTRY Retail INDUSTRY Financial services START YEAR 2009 START YEAR 2004 INDUSTRY Industrials START YEAR 2005 START YEAR 2003 FOUNDER No INSIDER Yes FOUNDER No INSIDER Yes START YEAR 2002 FOUNDER No INSIDER Yes FOUNDER No INSIDER Yes MBA No ENGINEERING Yes MBA No ENGINEERING No FOUNDER No INSIDER Yes MBA No ENGINEERING No MBA No ENGINEERING No TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN MBA No ENGINEERING No TOTAL SHAREHOLDER RETURN TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED 229% COUNTRY ADJUSTED 380% TOTAL SHAREHOLDER RETURN COUNTRY ADJUSTED 417% COUNTRY ADJUSTED 121% INDUSTRY ADJUSTED 202% INDUSTRY ADJUSTED 338% COUNTRY ADJUSTED 420% INDUSTRY ADJUSTED 402% INDUSTRY ADJUSTED 261% MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE INDUSTRY ADJUSTED 256% MARKET CAPITALIZATION CHANGE MARKET CAPITALIZATION CHANGE +$21B +$13B MARKET CAPITALIZATION CHANGE +$15B +$31B +$13B

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* *OWFTUNFOUBOEJOTVSBODFQSPEVDUT/05'%*$*OTVSFEt/0#BOL(VBSBOUFFt.":-PTF7BMVF 18FMMT'BSHP"TTFU.BOBHFNFOUJTBUSBEFOBNFVTFECZUIFBTTFUNBOBHFNFOUCVTJOFTTFTPG8FMMT'BSHP$PNQBOZ$FSUBJOJOWFTUNFOUTBSFEJTUSJCVUFECZ 8FMMT'BSHP'VOET%JTUSJCVUPS --$ .FNCFS'*/3"4*1$ BTVCTJEJBSZPG8FMMT'BSHP$PNQBOZ 2 *OTVSBODFQSPEVDUTBOETFSWJDFTBSFPòFSFEUISPVHIOPOCBOLBóMJBUFTPG8FMMT'BSHP$PNQBOZJODMVEJOH8FMMT'BSHP*OTVSBODF*ODBOE8FMMT'BSHP *OTVSBODF4FSWJDFT64" *OD 3 8FMMT'BSHP4FDVSJUJFTJTUIFUSBEFOBNFGPSUIFDBQJUBMNBSLFU TBOEJOWFTUNFOUCBOLJOHTFSWJDFTPG8FMMT'BSHP$PNQBOZBOEJUTTVCTJEJBSJFT JODMVEJOH8FMMT'BSHP 4FDVSJUJFT --$ BNFNCFSPG'*/3" /:4& /'"BOE4*1$ 8FMMT'BSHP*OTUJUVUJPOBM4FDVSJUJFT --$ BNFNCFSPG'*/3" /'"BOE4*1$BOE8FMMT'BSHP#BOL /" ª8FMMT'BSHP#BOL /""MMSJHIUTSFTFSWFE%FQPTJUQSPEVDUTPòFSFECZ8FMMT'BSHP#BOL /".FNCFS'%*$%FQPTJUTIFMEJOOPO64CSBODIFTBSFOPU'%*$ JOTVSFE8$4 THE BIGIDEA BEST-PERFORMING CEOSINTHEWORLD make iteven bigger. grows, he’s reinvesting to business. Even asAmazon philosophy forrunninga He’s inventedanew 58 Harvard Business Review 1 November 2014 The Numbers in The Numbers in Jeﬀ Bezos’s Head Vijay received Ravindran anunusualinvitation—to When theattendees arrived, told themhe’d Bezos display ofbusinessleadershipI’ve seeninmy career.” ders. That intuition proved justweeks correct later, of looking thecurrentbusiness,Jeff toprotect saw of losses,” says. Ravindran ignored theobjec Bezos on orders over $25—with anewoffer. Customers by DanielMcGinn cer at GrahamHoldings. “It wasthe mostimpressive would pay shipping an annualfeeforfree onmost who’d madeafewpurchasesyear previously were launched.Customerswhen theprogram,Prime, were peoplewhothought it wasanextremely bad waiving shipping charges would gutmargins. “There suddenly ordering multiple timesamonth. “Instead sternation. Amazon’s financeteamworried that ON AFRIDAY IN2004, AFTERNOON a Saturday morning meeting JeffBezos with at the received anemployee suggestion that Amazonsup meeting at thelake. products, regardlessproducts, oforder size. “Jeff wasex plement its existing shipping policy—free shipping the upside,” says now Ravindran, chiefdigital offi tions, convincedthat theoffer would spurmore or- tant,” Hence theurgent recalls. Ravindran weekend to build something that was going impor tobevery tremely energetic—he feltthiswasanopportunity idea—the spreadsheets uniformly painted pictures idea—the spreadsheetsuniformlypainted pictures boathouse adjoining theCEO’s lakefront home. The proposal sparked hushedconcernsandcon Amazon manager ------Apple, which boasts precisely how manyApple, whichboastsprecisely iPhones 1997 initial publicoffering hasbeensostrong that its core retail business,theygrindout incrementalim continually invest ingetting alittle bit better. Intheir of PowerPoint, with for instance.Butthefrequency Today pay tens ofmillionscustomers $99ayear ciples (outlinedciples inhis1997shareholder letter, which e-readers, and other devices—some seeacompany e-readers, andotherdevices—some growth. With 132,000 employees and$75 billion in grows, he’s onreinvesting focused tomake it even which he rejects spreadsheet-drivenwhich herejects mak decision while chipping away at prices.As Amazon continues would stillrankasHBR’s best- performing CEO. says BradStone,authorof The Everything Store, a sold—an opaquenessthat even fanssay Bezos hurts share pricecould have dropped to $250, andBezos 2014to ahighof$407inJanuary stock droppedfrom shrugging offinvestor concernseven asAmazon’s annual revenue, Amazon isa20-year-old corpora a seriousplayer incloudcomputing, onlinevideo, he stillsendsto investors year). every Instead of may top$800 million inthethird quarter.) Unlike incrementalsales. membership fees andincalculable no disputing hisability to generate shareholder re managing forthelong term—buthewalks thetalk, provements offerings indelivery speedandproduct tion that routinelypostslosses.(Its operating loss that’s pioneering anewmodel.“Insomeways he’s to move into completely newindustries—it’s now the stockprice.Like CEO, every talksabout Bezos turns: Thecompany’s stockperformancesinceits Street basicdata, suchashow many Kindlesit has focusing oncompetitorsshifts,they ortechnology for Bezos. Amazon’sfor Bezos. c for Prime, whichgeneratesfor Prime, morethan$1 billion in $307 inAugust. Over thelong haul,however, there’s ing hasprobablyplayed alarger roleinAmazon’s it’s selling, Amazonsteadfastlyrefusestogive Wall invented anewphilosophy for running abusiness,” ing steadfastly—even boringly—to afewkey prin- best-selling biography. Bezos “Even asAmazon Disregard fororthodox approachesisnotunusual He andhisteam have achieved that feat by stick ulture famously forbids the use forbidstheuse ulture famously - - - - -

KAREN MOSKOWITZ

THE BIG IDEA THE BEST-PERFORMING CEOS IN THE WORLD

bigger—and because that means it shows no profits, flat-screen TVs for a full refund with no questions he avoids paying dividends or corporate taxes.” asked—a costly policy meant to drive customer satis- While Amazon is younger than Walmart or Apple, faction. “Almost no one understood the potential for its creation story is becoming equally familiar. After the company, its business model, and its stock,” says graduating from Princeton with a computer science Blodget, who rose to fame for his seemingly outland- degree in 1986, Bezos spent eight years on Wall Street. ish 1998 prediction that Amazon shares, which were In 1994 he and his wife, MacKenzie—a Princeton grad trading around $200, would hit $400—which they and his former coworker—left New York for Seattle, did, three weeks later. (Blodget now runs Business setting up shop in their garage. Jeff and a few employ- Insider, a website in which Bezos is an investor.) ees began building a website that would sell books. Today Amazon is so successful that people often Amazon went live in July 1995 and, in its first month, assume it has enjoyed a linear rise—like a dominant sold books to customers in 50 states and in 45 coun- sports team cruising, as expected, to the champion- tries. It quickly expanded into CDs and other goods. ship. But for several years, Wall Street questioned While consumers gravitated to Amazon, some Amazon’s viability. “At analyst conferences dur- investors remained skeptical. Henry Blodget, then a ing the early 2000s, I saw fund managers openly Merrill Lynch analyst, recalls an investor conference laughing at him,” recalls Marc Andreessen, the in the late 1990s at which Bezos patiently explained entrepreneur- turned-venture-capitalist. “They’d why Amazon allowed customers to return huge say, ‘That guy is nuts, and that company is going

In early August Amazon’s founder and CEO spoke with HBR’s Adi Ignatius and Daniel McGinn at the company’s Seattle headquarters. Here are edited excerpts from that conversation:

HBR: How do you balance the new initiatives that in some selection, and fast, reliable establishment made against long term versus the short ways we’re still a start-up. delivery. We continually paperbacks—they’re devaluing term when thinking about Volatility is part and parcel of work on all three. We don’t books, publishers are not innovation? Bezos: I bet 70% being a start-up. know what technologies going to be able to invest in of the invention we do focuses might be invented or who our literature—are being made on slightly improving a process. You say you focus on competitors will be, so it’s about e-books, too. Today we That incremental invention customers, not competitors. hard to build strategies around know the arguments about is a huge part of what makes But how do you react to those uncertainties. But I do paperbacks were wrong, and Amazon tick. There’s a second Google’s teaming up with know that 10 years from now, they’re equally wrong about kind of invention, which is Barnes & Noble to offer nobody is going to say, “I love e-books. It will take a while more clean-sheet and larger same-day delivery? You Amazon, but I wish the prices for the incumbents to come to scale—things like the Kindle can’t insulate yourself were a little higher.” It’s the terms with e-books, but we’re or Amazon Web Services. We from competition by being same thing with fast delivery. determined to get e-books to have a culture that supports customer-obsessed. But if that be less expensive. the risk taking and time frames obsession leads to invention Has the backlash over your required for that. on behalf of customers, it dispute with Hachette about What other CEOs do you helps you stay ahead. e-book pricing surprised admire? I’m a huge fan of Your stock has taken some you? The publishing industry Jamie Dimon, Jeff Immelt, and hits this year. Does that affect You’re now making your own changes very slowly. The Bob Iger. They all have deep the way you manage? big investments in same-day paperback, which was keels. They have conviction Amazon’s stock has always delivery. How do you know developed before World War II, around certain business ideas. been somewhat volatile. Even customers want it? In our was the last radical invention Warren Buffett is another one. though we have significant retail business, there are three before the e-book. All the They can’t be blown around, revenues, we invest in so many big ideas: Low prices, vast arguments that the literary and I think that’s pretty rare.

60 Harvard Business Review November 2014 HBR.ORG

to go bankrupt.’ That’s one of the things I really ad- His willingness to go mire about him, and it’s what I talk to our founders about. It’s very easy to say you want to be Jeff Bezos today. It’s a lot harder to be Jeff Bezos during that through the valley of death ‘valley of death’ period. It was his willingness to go through that valley and to come out the other side and come out the other side that makes Wall Street give him the benefit of the doubt. A lot of people would have given up, but he makes Wall Street give him didn’t. That’s what I admire most about his story.” The other big misconception: that Bezos doesn’t the beneﬁt of the doubt. care about profitability. By all accounts Amazon’s mature businesses (such as online retail) are profitable; it’s his deep investments in new businesses that create accounting losses, which he regards as a false Over the past two years the company has drawn measure of performance. “He’s really focused on fire for its treatment of distribution-center workers cash flow and what kind of return on invested capi- and the hyperaggressive steps taken to weaken ri- tal is being created,” says Warren Jenson, Amazon’s val e-commerce players such as Zappos and Diapers. chief financial officer from 1999 to 2002. Bill Miller, a com. (It eventually acquired both.) Bezos’s personal fund manager at Legg Mason who has held shares in management style, which by some reports can be Amazon since it went public, says Bezos shows deep abusive and demeaning, has also been reproached. understanding of the point Clay Christensen made But Stone believes Bezos has mellowed with age. “In in his recent HBR article “The Capitalist’s Dilemma,” fairness, a lot of the examples in the book of him be- which argued that most managers focus on the wrong having that way are older ones, and I think he’s got- financial metrics. “Jeff really takes theory seriously— ten better over time,” Stone says. he started out wanting to be a theoretical physicist,” Even critics admit that Bezos has an unusually Miller says. “In terms of financial theory, he’s trying ambitious imagination—one likely to have an impact to get away from the behavioral problems that afflict far beyond online retailing. He founded Blue Origin, other companies” that try to maximize the wrong a company experimenting with space travel, and numbers. Other Bezos watchers go even further: At last year purchased the Washington Post, where he a time when many large companies (most notably spends one day a month in hopes of finding a viable Apple) are hoarding idle cash, shouldn’t we be laud- financial model for journalism. And at Amazon, his ing Amazon’s ability to continually find entirely new strategy of making bold moves into adjacent indus- industries to reinvest and innovate in, rather than tries could become a model for other managers. Scott criticizing the losses driven by those outlays? Cook, the Intuit founder and former Amazon director, Bezos is unperturbed by criticisms of his financial compares Amazon to companies such as P&G (which management. He says he’s always been transparent invented brand management) and Toyota (which in- about Amazon’s focus on long-term cash flow (invented lean manufacturing). “I think Amazon is one stead of net profit). “As far as investors go, our job of those—what they’re doing is inventing better ways is to be superclear about our approach, and then infor companies to operate,” Cook says. vestors get to self-select,” he says. He insists Amazon That spirit could continue for some time. Bezos discloses far more data about its business than is le- is 50—about the same age Bill Gates was when he gally required and is silent only about numbers that retired from Microsoft to pursue philanthropy at the could help competitors. Gates Foundation, whose offices are visible from Some criticism goes beyond his financial theo- the roof deck at Amazon’s headquarters. But Bezos ries, however. Like Walmart, Amazon has been con- seems unlikely to make that kind of transition. “I’ve demned for upending the economics of industries never gotten any vibe off of him that he wants to do in ways that destroy competitors and vaporize jobs. anything else,” says Andreessen. “He’s monomania- Since 2007, when its Kindle ignited the e-book busi- cally focused on Amazon. My sense is he’s going to be ness, Amazon has been at war with publishers for running it another 30 years—and shareholders will using its leverage to price e-books at discount levels. be lucky if he does.” HBR Reprint R1411B

November 2014 Harvard Business Review 61 Information is the key to protecting information. That’s why our security solutions are backed by world-class intelligence to help you identify threats in real time and keep your information safe. Learn more at symantec.com/security-intelligence When you can do it safely, you can do it all.

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Copyright © 2014 Symantec Corporation. All rights reserved. Symantec, the Symantec Logo, and the Checkmark Logo are trademarks or registered trademarks of Symantec Corporation or its afﬁ liates in the U.S. and other countries. HBR.ORG SPOTLIGHT 64 90 100 How Smart, Digital Ubiquity With Big Data Comes Connected Products by Marco Iansiti and Big Responsibility Are Transforming Karim R. Lakhani An interview with Competition Alex “Sandy” Pentland by Michael E. Porter and James E. Heppelmann Managing the Internet of Things

ARTWORK Chris Labrooy Shrinkwrap Stills, Factory

November 2014 Harvard Business Review 63 SPOTLIGHT ON MANAGING THE INTERNET OF THINGS ARTWORK Chris Labrooy SPOTLIGHT Braun, Toaster HBR.ORG

Michael E. Porter is the James E. Heppelmann Bishop William Lawrence is the president and CEO University Professor, based of PTC, a Massachusetts- at Harvard Business School. based software company that helps manufacturers create, operate, and service products.

How Smart, Connected Products Are Transforming Competition

by Michael E. Porter and James E. Heppelmann

November 2014 Harvard Business Review 65 SPOTLIGHT ON MANAGING THE INTERNET OF THINGS

nformation technology is revolutionizing products. Once composed solely of mechanical and electrical parts, products have become complex systems that combine hardware, sensors, data storage, microprocessors, software, and connectivity in myriad ways. These “smart, connected products”—made possibleI by vast improvements in processing power and device miniaturization and by the network beneﬁts of ubiquitous wireless connectivity—have unleashed a new era of competition.

Smart, connected products offer exponentially Companies must look beyond the technologies expanding opportunities for new functionality, far themselves to the competitive transformation tak- greater reliability, much higher product utilization, ing place. This article, and a companion piece to be and capabilities that cut across and transcend tra- published soon in HBR, will deconstruct the smart, ditional product boundaries. The changing nature connected products revolution and explore its stra- of products is also disrupting value chains, forcing tegic and operational implications. companies to rethink and retool nearly everything they do internally. The Third Wave of IT-Driven These new types of products alter industry struc- Competition ture and the nature of competition, exposing com- Twice before over the past 50 years, information panies to new competitive opportunities and threats. technology radically reshaped competition and They are reshaping industry boundaries and creating strategy; we now stand at the brink of a third trans- entirely new industries. In many companies, smart, formation. Before the advent of modern information connected products will force the fundamental technology, products were mechanical and activities question, “What business am I in?” in the value chain were performed using manual, pa- Smart, connected products raise a new set of stra- per processes and verbal communication. The first tegic choices related to how value is created and cap- wave of IT, during the 1960s and 1970s, automated tured, how the prodigious amount of new (and sensi- individual activities in the value chain, from order tive) data they generate is utilized and managed, how processing and bill paying to computer-aided design relationships with traditional business partners such and manufacturing resource planning. (See “How as channels are redefined, and what role companies Information Gives You Competitive Advantage,” by should play as industry boundaries are expanded. Michael Porter and Victor Millar, HBR, July 1985.) The phrase “internet of things” has arisen to The productivity of activities dramatically increased, reflect the growing number of smart, connected in part because huge amounts of new data could be products and highlight the new opportunities they captured and analyzed in each activity. This led to can represent. Yet this phrase is not very helpful in the standardization of processes across companies— understanding the phenomenon or its implications. and raised a dilemma for companies about how to The internet, whether involving people or things, is capture IT’s operational benefits while maintaining simply a mechanism for transmitting information. distinctive strategies. What makes smart, connected products fundamen- The rise of the internet, with its inexpensive and INSIGHT CENTER Find tally different is not the internet, but the changing ubiquitous connectivity, unleashed the second wave our monthlong series of nature of the “things.” It is the expanded capabilities of IT-driven transformation, in the 1980s and 1990s articles on the internet of things at hbr.org/ of smart, connected products and the data they gen- (see Michael Porter’s “Strategy and the Internet,” insights/iot. erate that are ushering in a new era of competition. HBR, March 2001). This enabled coordination and

66 Harvard Business Review November 2014 HOW SMART, CONNECTED PRODUCTS ARE TRANSFORMING COMPETITION HBR.ORG

Idea in Brief A CHANGING ENVIRONMENT they do, from how they THE NEW STRATEGIC CHOICES many ﬁrms, smart, connected Smart, connected products conceive, design, and Smart, connected products products will force the oﬀer exponentially expanding source products; to how raise a new set of strategic fundamental question, opportunities for new they manufacture, operate, choices about how value “What business am I in?” functionality and capabilities and service them; to how is created and captured, that transcend traditional they build and secure the how companies work with This article provides a product boundaries. necessary IT infrastructure. traditional and new partners, framework for developing The changing nature of and how they secure strategy and achieving products is disrupting value competitive advantage as competitive advantage chains and forcing companies the new capabilities reshape in a smart, connected world. to rethink nearly everything industry boundaries. For

integration across individual activities; with out- What Are Smart, side suppliers, channels, and customers; and across Connected Products? geography. It allowed firms, for example, to closely Smart, connected products have three core ele- integrate globally distributed supply chains. ments: physical components, “smart” components, The first two waves gave rise to huge productiv- and connectivity components. Smart components ity gains and growth across the economy. While the amplify the capabilities and value of the physical value chain was transformed, however, products components, while connectivity amplifies the ca- themselves were largely unaffected. pabilities and value of the smart components and Now, in the third wave, IT is becoming an integral enables some of them to exist outside the physical part of the product itself. Embedded sensors, proces- product itself. The result is a virtuous cycle of value sors, software, and connectivity in products (in effect, improvement. computers are being put inside products), coupled Physical components comprise the product’s with a product cloud in which product data is stored mechanical and electrical parts. In a car, for example, and analyzed and some applications are run, are driv- these include the engine block, tires, and batteries. ing dramatic improvements in product functionality Smart components comprise the sensors, mi- and performance. Massive amounts of new product- croprocessors, data storage, controls, software, and, usage data enable many of those improvements. typically, an embedded operating system and en- Another leap in productivity in the economy will hanced user interface. In a car, for example, smart be unleashed by these new and better products. In components include the engine control unit, anti- addition, producing them will reshape the value lock braking system, rain-sensing windshields with chain yet again, by changing product design, market- automated wipers, and touch screen displays. In ing, manufacturing, and after-sale service and by cre- many products, software replaces some hardware ating the need for new activities such as product data components or enables a single physical device to analytics and security. This will drive yet another perform at a variety of levels. wave of value-chain-based productivity improve- Connectivity components comprise the ports, ment. The third wave of IT-driven transformation antennae, and protocols enabling wired or wireless thus has the potential to be the biggest yet, triggering connections with the product. Connectivity takes even more innovation, productivity gains, and eco- three forms, which can be present together: nomic growth than the previous two. • One-to-one: An individual product connects to Some have suggested that the internet of things the user, the manufacturer, or another product “changes everything,” but that is a dangerous over- through a port or other interface—for example, simplification. As with the internet itself, smart, con- when a car is hooked up to a diagnostic machine. nected products reflect a whole new set of techno- • One-to-many: A central system is continuously or logical possibilities that have emerged. But the rules intermittently connected to many products simul- of competition and competitive advantage remain taneously. For example, many Tesla automobiles the same. Navigating the world of smart, connected are connected to a single manufacturer system products requires that companies understand these that monitors performance and accomplishes re- rules better than ever. mote service and upgrades.

November 2014 Harvard Business Review 67 SPOTLIGHT ON MANAGING THE INTERNET OF THINGS

• Many-to-many: Multiple products connect to adjustments that can prevent blackouts before they many other types of products and often also to occur. In consumer goods, Big Ass ceiling fans sense external data sources. An array of types of farm and engage automatically when a person enters a equipment are connected to one another, and to room, regulate speed on the basis of temperature geolocation data, to coordinate and optimize the and humidity, and recognize individual user prefer- farm system. For example, automated tillers inject ences and adjust accordingly. nitrogen fertilizer at precise depths and intervals, Why now? An array of innovations across the and seeders follow, placing corn seeds directly in technology landscape have converged to make the fertilized soil. smart, connected products technically and eco- nomically feasible. These include breakthroughs in the performance, miniaturization, and energy efficiency of sensors and batteries; highly compact, Some have suggested that the low-cost computer processing power and data storage, which make it feasible to put computers inside internet of things “changes products; cheap connectivity ports and ubiquitous, low-cost wireless connectivity; tools that enable everything,” but that is a rapid software development; big data analytics; and a new IPv6 internet registration system opening up dangerous oversimplification. 340 trillion trillion trillion potential new internet addresses for individual devices, with protocols that The rules of competition and support greater security, simplify handoffs as de- competitive advantage still apply. vices move across networks, and allow devices to request addresses autonomously without the need for IT support. Smart, connected products require that compa- Connectivity serves a dual purpose. First, it al- nies build an entirely new technology infrastructure, lows information to be exchanged between the consisting of a series of layers known as a “technol- product and its operating environment, its maker, its ogy stack” (see the exhibit “The New Technology users, and other products and systems. Second, con- Stack”). This includes modified hardware, software nectivity enables some functions of the product to applications, and an operating system embedded exist outside the physical device, in what is known in the product itself; network communications to as the product cloud. For example, in Bose’s new support connectivity; and a product cloud (soft- Wi-Fi system, a smartphone application running in ware running on the manufacturer’s or a third-party the product cloud streams music to the system from server) containing the product-data database, a the internet. To achieve high levels of functionality, platform for building software applications, a rules all three types of connectivity are necessary. engine and analytics platform, and smart product Smart, connected products are emerging across applications that are not embedded in the product. all manufacturing sectors. In heavy machinery, Cutting across all the layers is an identity and se- Schindler’s PORT Technology reduces elevator curity structure, a gateway for accessing external wait times by as much as 50% by predicting eleva- data, and tools that connect the data from smart, tor demand patterns, calculating the fastest time to connected products to other business systems (for destination, and assigning the appropriate elevator example, ERP and CRM systems). to move passengers quickly. In the energy sector, This technology enables not only rapid product ABB’s smart grid technology enables utilities to ana- application development and operation but the col- lyze huge amounts of real-time data across a wide lection, analysis, and sharing of the potentially huge range of generating, transforming, and distribution amounts of longitudinal data generated inside and equipment (manufactured by ABB as well as others), outside the products that has never been available such as changes in the temperature of transformers before. Building and supporting the technology and secondary substations. This alerts utility control stack for smart, connected products requires sub- centers to possible overload conditions, allowing stantial investment and a range of new skills—such

68 Harvard Business Review November 2014 HOW SMART, CONNECTED PRODUCTS ARE TRANSFORMING COMPETITION HBR.ORG THE NEW TECHNOLOGY STACK Smart, connected products require companies to build and support an entirely new technology infrastructure. This “technology stack” is made up of multiple layers, including new product hardware, embedded software, connectivity, a product cloud consisting of software running on remote servers, a suite of security tools, a gateway for external information sources, and integration with enterprise business systems. PRODUCT CLOUD Smart Product Applications Software applications running on remote servers that manage the monitoring, control, optimization, and autonomous operation of product functions

Rules/Analytics Engine The rules, business logic, and big data analytical capabilities that populate the algorithms involved in product operation and reveal new product insights

Identity and Application Platform External Integration Security An application development and execution environment enabling the rapid Information with Business Tools that creation of smart, connected business applications using data access, Sources Systems manage user visualization, and run-time tools A gateway for Tools that authentication information integrate data and system Product Data Database from external from smart, A big-data database system that enables aggregation, normalization, access, as connected and management of real-time and historical product data sources—such as well as secure weather, traﬃc, products with the product, commodity and core enterprise connectivity, and energy prices, business systems product cloud social media, such as ERP, CRM, layers and geo- and PLM mapping—that CONNECTIVITY informs product Network Communication capabilities The protocols that enable communications between the product and the cloud

PRODUCT Product Software An embedded operating system, onboard software applications, an enhanced user interface, and product control components

Product Hardware Embedded sensors, processors, and a connectivity port/antenna that supplement traditional mechanical and electrical components

as software development, systems engineering, data incorporate all four (see the exhibit “Capabilities of analytics, and online security expertise—that are Smart, Connected Products”). Each capability is rarely found in manufacturing companies. valuable in its own right and also sets the stage for the next level. For example, monitoring capabilities What Can Smart, are the foundation for product control, optimization, Connected Products Do? and autonomy. A company must choose the set of ca- Intelligence and connectivity enable an entirely new pabilities that deliver its customer value and define set of product functions and capabilities, which can its competitive positioning. be grouped into four areas: monitoring, control, op- Monitoring. Smart, connected products en- timization, and autonomy. A product can potentially able the comprehensive monitoring of a product’s

November 2014 Harvard Business Review 69 SPOTLIGHT ON MANAGING THE INTERNET OF THINGS

condition, operation, and external environment a patient reaches a threshold blood-glucose level, en- through sensors and external data sources. Using abling appropriate therapy adjustments. data, a product can alert users or others to changes Monitoring capabilities can span multiple prod- in circumstances or performance. Monitoring also al- ucts across distances. Joy Global, a leading mining lows companies and customers to track a product’s equipment manufacturer, monitors operating con- operating characteristics and history and to better un- ditions, safety parameters, and predictive service derstand how the product is actually used. This data indicators for entire fleets of equipment far under- has important implications for design (by reducing ground. Joy also monitors operating parameters overengineering, for example), market segmentation across multiple mines in different countries for (through the analysis of usage patterns by customer benchmarking purposes. type), and after-sale service (by allowing the dispatch Control. Smart, connected products can be con- of the right technician with the right part, thus im- trolled through remote commands or algorithms proving the first-time fix rate). Monitoring data may that are built into the device or reside in the product also reveal warranty compliance issues as well as new cloud. Algorithms are rules that direct the pro- sales opportunities, such as the need for additional duct to respond to specified changes in its condition product capacity because of high utilization. or environment (for example, “if pressure gets too In some cases, such as medical devices, monitor- high, shut off the valve” or “when traffic in a parking is the core element of value creation. Medtronic’s ing garage reaches a certain level, turn the overhead digital blood-glucose meter uses a sensor inserted lighting on or off”). under the patient’s skin to measure glucose levels in Control through software embedded in the prod- tissue fluid and connects wirelessly to a device that uct or the cloud allows the customization of product alerts patients and clinicians up to 30 minutes before performance to a degree that previously was not cost

CAPABILITIES OF SMART, CONNECTED PRODUCTS The capabilities of smart, connected products can be grouped into four areas: monitoring, control, optimization, and autonomy. Each builds on the preceding one; to have control capability, for example, a product must have monitoring capability. Autonomy Optimization Control Monitoring

12Sensors and external Software embedded in the 34Monitoring and control Combining monitoring, control, data sources enable the product or in the product capabilities enable algorithms and optimization allows: comprehensive monitoring of: cloud enables: that optimize product • Autonomous product • the product’s condition • Control of product functions operation and use in order to: operation • the external environment • Personalization of the user • Enhance product • Self-coordination of • the product’s operation experience performance operation with other and usage • Allow predictive diagnostics, products and systems Monitoring also enables alerts service, and repair • Autonomous product and notiﬁcations of changes enhancement and personalization • Self-diagnosis and service

70 Harvard Business Review November 2014 HOW SMART, CONNECTED PRODUCTS ARE TRANSFORMING COMPETITION HBR.ORG

Smart, connected products ultimately can function with complete autonomy. Human operators merely monitor performance or watch over the fleet or the system, rather than over individual units.

effective or often even possible. The same technol- parts. Finally, like many smart, connected products, ogy also enables users to control and personalize Diebold’s ATMs can be updated when they are due their interaction with the product in many new ways. for feature enhancements. Often these can occur re- For example, users can adjust their Philips Lighting motely, via software. hue lightbulbs via smartphone, turning them on and Autonomy. Monitoring, control, and optimiza- off, programming them to blink red if an intruder is tion capabilities combine to allow smart, connected detected, or dimming them slowly at night. Doorbot, products to achieve a previously unattainable level a smart, connected doorbell and lock, allows custom- of autonomy. At the simplest level is autonomous ers to give visitors access to the home remotely after product operation like that of the iRobot Roomba, a screening them on their smartphones. vacuum cleaner that uses sensors and software to Optimization. The rich flow of monitoring data scan and clean floors in rooms with different layouts. from smart, connected products, coupled with the More-sophisticated products are able to learn about capacity to control product operation, allows compa- their environment, self-diagnose their own service nies to optimize product performance in numerous needs, and adapt to users’ preferences. Autonomy ways, many of which have not been previously possi- not only can reduce the need for operators but can ble. Smart, connected products can apply algorithms improve safety in dangerous environments and fa- and analytics to in-use or historical data to dramati- cilitate operation in remote locations. cally improve output, utilization, and efficiency. In Autonomous products can also act in coordina- wind turbines, for instance, a local microcontroller tion with other products and systems. The value of can adjust each blade on every revolution to capture these capabilities can grow exponentially as more maximum wind energy. And each turbine can be ad- and more products become connected. For example, justed to not only improve its performance but mini- the energy efficiency of the electric grid increases as mize its impact on the efficiency of those nearby. more smart meters are connected, allowing the util- Real-time monitoring data on product condition ity to gain insight into and respond to demand pat- and product control capability enables firms to op- terns over time. timize service by performing preventative mainte- Ultimately, products can function with complete nance when failure is imminent and accomplishing autonomy, applying algorithms that utilize data repairs remotely, thereby reducing product down- about their performance and their environment— time and the need to dispatch repair personnel. Even including the activity of other products in the sys- when on-site repair is required, advance information tem—and leveraging their ability to communicate about what is broken, what parts are needed, and with other products. Human operators merely moni- how to accomplish the fix reduces service costs and tor performance or watch over the fleet or the system, improves first-time fix rates. Diebold, for example, rather than individual units. Joy Global’s Longwall monitors many of its automated teller machines for Mining System, for example, is able to operate au- early signs of trouble. After assessing a malfunction- tonomously far underground, overseen by a mine ing ATM’s status, the machine is repaired remotely if control center on the surface. Equipment is moni- possible, or the company deploys a technician who tored continuously for performance and faults, and has been given a detailed diagnosis of the problem, a technicians are dispatched underground to deal with recommended repair process, and, often, the needed issues requiring human intervention.

November 2014 Harvard Business Review 71 SPOTLIGHT ON MANAGING THE INTERNET OF THINGS THE FIVE FORCES THAT SHAPE INDUSTRY COMPETITION Smart, connected products will have a transformative effect on industry structure. The five THREAT forces that shape competition OF NEW ENTRANTS Reshaping Industry Structure provide the framework To understand the effects of smart, connected prod- necessary for understanding the ucts on industry competition and profitability, we significance of these changes. must examine their impact on industry structure. In any industry, competition is driven by five competitive forces: the bargaining power of buyers, the BARGAINING RIVALRY BARGAINING nature and intensity of the rivalry among existing POWER OF AMONG EXISTING POWER OF SUPPLIERS BUYERS competitors, the threat of new entrants, the threat of COMPETITORS substitute products or services, and the bargaining power of suppliers. The composition and strength of these forces collectively determine the nature of industry competition and the average profitability for incumbent competitors. Industry structure changes THREAT OF when new technology, customer needs, or other SUBSTITUTE PRODUCTS OR factors shift these five forces. Smart, connected SERVICES products will substantially affect structure in many industries, as did the previous wave of internet-enabled IT. The effects will be greatest in manufacturing industries. Bargaining power of buyers. Smart, connected However, smart, connected products can in- products dramatically expand opportunities for crease buyer power by giving buyers a better un- product differentiation, moving competition away HBR.ORG For a derstanding of true product performance, allowing from price alone. Knowing how customers actually full discussion of them to play one manufacturer off another. Buyers competitive strategy, use the products enhances a company’s ability to see Michael Porter’s may also find that having access to product usage segment customers, customize products, set prices article “The Five data can decrease their reliance on the manufac- to better capture value, and extend value-added ser- Competitive Forces That turer for advice and support. Finally, compared with Shape Strategy” (HBR, vices. Smart, connected products also allow compa- January 2008). ownership models, “product as a service” business nies to develop much closer customer relationships. models or product-sharing services (discussed be- Through capturing rich historical and product-usage low) can increase buyers’ power by reducing the cost data, buyers’ costs of switching to a new supplier of switching to a new manufacturer. increase. In addition, smart, connected products al- Rivalry among competitors. Smart, connected low firms to reduce their dependency on distribution products have the potential to shift rivalry, opening or service partners, or even disintermediate them, up numerous new avenues for differentiation and thereby capturing more profit. All of this serves to value-added services. These products also enable mitigate or reduce buyers’ bargaining power. firms to tailor offerings to more-specific segments of GE Aviation, for example, is now able to provide the market, and even customize products for indi- more services to end users directly—a move that vidual customers, further enhancing differentiation improves its power relative to its immediate cus- and price realization. tomers, the airframe manufacturers. Information Smart, connected products also create oppor- gathered from hundreds of engine sensors, for ex- tunities to broaden the value proposition beyond ample, allows GE and airlines to optimize engine products per se, to include valuable data and en- performance by identifying discrepancies between hanced service offerings. Babolat, for example, has expected and actual performance. GE’s analysis of produced tennis rackets and related equipment fuel-use data, for example, allowed the Italian air- for 140 years. With its new Babolat Play Pure Drive line Alitalia to identify changes to its flight proce- system, which puts sensors and connectivity in dures, such as the position of wing flaps during land- the racket handle, the company now offers a ser- ing, that reduced fuel use. GE’s deep relationship vice to help players improve their game through with the airlines serves to improve differentiation the tracking and analysis of ball speed, spin, and with them while improving its clout with airframe impact location, delivered through a smartphone manufacturers. application.

72 Harvard Business Review November 2014 HOW SMART, CONNECTED PRODUCTS ARE TRANSFORMING COMPETITION HBR.ORG

Offsetting this shift in rivalry away from price remotely monitor their patients’ devices and clini- is the migration of the cost structure of smart, con- cal status. nected products toward higher fixed costs and lower Barriers to entry also rise when agile incumbents variable costs. This results from the higher upfront capture critical first-mover advantages by collecting costs of software development, more-complex prod- and accumulating product data and using it to im- uct design, and high fixed costs of developing the prove products and services and to redefine after- technology stack, including reliable connectivity, ro- sale service. Smart, connected products can also bust data storage, analytics, and security (see again increase buyer loyalty and switching costs, further the exhibit “The New Technology Stack”). Industries raising barriers to entry. with high fixed cost structures are vulnerable to price Barriers to entry go down, however, when pressure as firms seek to spread their fixed costs smart, connected products leapfrog or invalidate across a larger number of units sold. the strengths and assets of incumbents. Moreover, The huge expansion of capabilities in smart, con- incumbents may hesitate to fully embrace the ca- nected products may also tempt companies to get pabilities of smart, connected products, preferring into a feature and function arms race with rivals and to protect hardware-based strengths and profitable give away too much of the improved product perfor- legacy parts and service businesses. This opens the mance, a dynamic that escalates costs and erodes door to new competitors, such as the “productless” industry profitability. OnFarm, which is successfully competing with tradi- Finally, rivalry among competitors can also in- tional agricultural equipment makers to provide ser- crease as smart, connected products become part vices to farmers through collecting data on multiple of broader product systems, a trend we will dis- types of farm equipment to help growers make bet- cuss further. For example, manufacturers of home ter decisions, avoiding the need to be an equipment lighting, audiovisual entertainment equipment, manufacturer at all. In home automation, Crestron, and climate control systems have not historically an integration solution provider, offers complex, competed with one another. Yet each is now vying dedicated home systems with rich user interfaces. for a place in the emerging “connected home” that Product companies are also facing challenges from integrates and adds intelligence to a wide array of other nontraditional competitors like Apple, which products in the home. recently launched a simpler, smartphone-based ap- Threat of new entrants. New entrants in a proach to managing the connected home. smart, connected world face significant new ob- Threat of substitutes. Smart, connected prod- stacles, starting with the high fixed costs of more- ucts can offer superior performance, customization, complex product design, embedded technology, and and customer value relative to traditional substitute multiple layers of new IT infrastructure. For example, products, reducing substitution threats and improv- Thermo Fisher’s TruDefender FTi chemical analyzer ing industry growth and profitability. However, in added connectivity to a product that already had many industries smart, connected products create smart functionality, to enable chemical analysis from new types of substitution threats, such as wider hazardous environments to be transmitted to users product capabilities that subsume conventional and mitigation to begin without having to wait for products. For example, Fitbit’s wearable fitness de- the machine and personnel to be decontaminated. vice, which captures multiple types of health-related Thermo Fisher needed to build a complete product data including activity levels and sleep patterns, is a cloud to securely capture, analyze, and store product substitute for conventional devices such as running data and distribute it both internally and to custom- watches and pedometers. ers, a substantial undertaking. New business models enabled by smart, con- Broadening product definitions can raise bar- nected products can create a substitute for product riers to entrants even higher. Biotronik, a medical ownership, reducing overall demand for a product. device company, initially manufactured stand- Product-as-a-service business models, for example, alone pacemakers, insulin pumps, and other de- allow users to have full access to a product but pay vices. Now it offers smart, connected devices, such only for the amount of product they use. as a home health-monitoring system that includes A variation of product-as-a-service is the a data processing center that allows physicians to shared-usage model. Zipcar, for example, provides

November 2014 Harvard Business Review 73 SPOTLIGHT ON MANAGING THE INTERNET OF THINGS REDEFINING INDUSTRY BOUNDARIES The increasing capabilities of smart, connected products not only reshape competition within industries but expand industry boundaries. This occurs as the basis of competition shifts from discrete products, to product systems consisting of closely related products, to systems of systems that link an array of product systems together. A tractor company, for example, may ﬁnd itself competing in a broader farm automation industry. 3. Smart, connected product 2. Smart product 1. Product

customers with real-time access to vehicles when commoditized or even replaced by software over and where they need them. This substitutes for car time. Software also reduces the need for physical tai- ownership and has led traditional automakers to loring and hence the number of physical component enter the car-sharing market with offerings such varieties. The importance of traditional suppliers to as RelayRides from GM, DriveNow from BMW, and total product cost will often decline, and their bar- Dash from Toyota. gaining power will fall. Another example is shared bike systems, which However, smart, connected products often in- are springing up in more and more cities. A smart- troduce powerful new suppliers that manufacturers phone application shows the location of docking have never needed before: providers of sensors, soft- stations where bikes can be picked up and returned, ware, connectivity, embedded operating systems, and users are monitored and charged for the amount and data storage, analytics, and other parts of the of time they use the bikes. Clearly, shared usage technology stack. Some of these, like Google, Apple, will reduce the need for urban residents to own and AT&T, are giants in their own industries. They bikes, but it may encourage more residents to use have talent and capabilities that most manufactur- bikes since they do not have to buy and store them. ing companies have not historically needed but that Convenient shared bikes will be a substitute not are becoming essential to product differentiation only for purchased bikes but potentially for cars and and cost. The bargaining power of those new sup- other forms of urban transportation. Smart, con- pliers can be high, allowing them to capture a bigger nected capabilities make such substitutions for full share of overall product value and reduce manufac- ownership possible. turers’ profitability. Bargaining power of suppliers. Smart, con- A good example of these new types of suppliers nected products are shaking up traditional sup- is the Open Automotive Alliance, in which General plier relationships and redistributing bargaining Motors, Honda, Audi, and Hyundai recently joined power. As the smart and connectivity components forces to utilize Google’s Android operating sys- of products deliver more value relative to physi- tem for their vehicles. The auto OEMs lacked the cal components, the physical components can be specialized capabilities needed to develop a robust

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SPOTLIGHT ON MANAGING THE INTERNET OF THINGS CHARTING THE IMPACT ON COMPETITION This article is the first 1 How does the move 3 What new types of In this article, we examine in a two-part series to smart, connected strategic choices will the effect of smart, con- products affect the smart, connected products nected products on indus- in which we examine structure of the industry require companies to try structure and industry how smart, connected and industry boundaries? make to achieve boundaries and discuss the products are shifting competitive advantage? new strategic choices fac- 2 How do smart, ing companies. In part two competition in many connected products 4 What are the (forthcoming), we examine industries. At the most affect the configuration organizational implications value chain impacts and fundamental level, of the value chain or of embracing these new organizational issues. the set of activities types of products and companies must (Disclosure: PTC does business with more than required to compete? the challenges that affect 28,000 companies worldwide, many of which ask four questions: implementation success? are mentioned in this article.)

farm performance. Smart homes, which involve nu- Smart, Connected Products and merous product systems including lighting, HVAC, Competitive Advantage entertainment, and security, are another example. How can companies achieve sustainable competi- Companies whose products and designs have the tive advantage in a shifting industry structure? The greatest impact on total system performance will be basic tenets of strategy still apply. To achieve com- in the best position to drive this process and capture petitive advantage, a company must be able to dif- disproportionate value. ferentiate itself and thus command a price premium, Some companies—like John Deere, AGCO, and operate at a lower cost than its rivals, or both. This Joy Global—are intentionally seeking to broaden allows for superior profitability and growth relative and redefine their industries. Others may find them- to the industry average. selves threatened by this development, which cre- The foundation for competitive advantage is op- ates new competitors, new bases for competition, erational effectiveness (OE). OE requires embracing and the need for entirely new and broader capabili- best practices across the value chain, including up- ties. Companies that fail to adapt may find their tra- to-date product technologies, the latest production ditional products becoming commoditized or may equipment, and state-of-the-art sales force meth- themselves be relegated to the role of OEM supplier, ods, IT solutions, and supply chain management with system integrators in control. approaches. The net effect of smart, connected products on OE is the table stakes of competition. If a company industry structure will vary across industries, but is not operationally effective and continually em- some tendencies seem clear. First, rising barriers to bracing new best practices, it will fall behind rivals in entry, coupled with first-mover advantages stem- cost and quality. Yet OE is rarely a source of sustain- ming from the early accumulation and analysis of able advantage, because competitors will implement product usage data, suggests that many industries the same best practices and catch up. may undergo consolidation. To move beyond OE, a company must define a dis- Second, consolidation pressures will be amplified tinctive strategic positioning. Whereas operational in industries whose boundaries are expanding. In effectiveness is about doing things well, strategic po- such cases, single product manufacturers will have sitioning is about doing things differently. A company difficulty competing with multiproduct compa- must choose how it will deliver unique value to the nies that can optimize product performance across set of customers it chooses to serve. Strategy requires broader systems. Third, important new entrants making trade-offs: deciding not only what to do but are likely to emerge, as companies unencumbered what not to do. by legacy product definitions and entrenched ways Smart, connected products are defining a new of competing, and with no historical profit pools to standard for operational effectiveness, dramatically protect, seize opportunities to leverage the full po- raising the bar in terms of best practices. Every prod- tential of smart, connected products to create value. uct company will have to decide how to incorporate Some of these strategies will be “productless”—that smart, connected capabilities into its products. But is, the system that connects products will be the core not only the product itself is being affected. As we advantage, not the products themselves. discussed earlier, the move to smart, connected

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products also creates new best practices across the In some cases, firms can decrease service costs by value chain. replacing physical parts with “software parts.” For ex- The implications of smart, connected products ample, glass cockpit LCD displays in modern aircraft, for the value chain will be discussed in detail in which can be repaired or upgraded via software, have the second article in this series (see the sidebar replaced electrical and mechanical dials and gauges. “Charting the Impact on Competition”). Here we Product usage data also enables firms to better “de- focus briefly on how smart, connected products sign for service”—that is, reduce the complexity or affect product design, service, marketing, human placement of parts that are prone to failure in order resources, and security, because these shifting inter- to simplify repairs. All these opportunities change nal activities often bear directly on strategy choices. the service activities in the value chain substantially. Design. Smart, connected products require a Marketing. Smart, connected products allow whole set of new design principles, such as designs companies to form new kinds of relationships with that achieve hardware standardization through customers, requiring new marketing practices and software-based customization, designs that enable skill sets. As companies accumulate and analyze personalization, designs that incorporate the ability product usage data, they gain new insights into how to support ongoing product upgrades, and designs products create value for customers, allowing better that enable predictive, enhanced, or remote service. positioning of offerings and more effective commu- Expertise in systems engineering and in agile soft- nication of product value to customers. Using data ware development is essential to integrate a prod- analytics tools, firms can segment their markets in uct’s hardware, electronics, software, operating more-sophisticated ways, tailor product and service system, and connectivity components—expertise bundles that deliver greater value to each segment, that is not well developed in many manufacturing and price those bundles to capture more of that companies. Product development processes will value. This approach works best when products can also need to accommodate more late-stage and post- be quickly and efficiently tailored at low marginal purchase design changes quickly and efficiently. cost through software (as opposed to hardware) Companies will need to synchronize the very differ- variation. For example, whereas John Deere used to ent “clock speeds” of hardware and software devel- manufacture multiple engines with different levels of opment; a software development team might create horsepower to serve different customer segments, it as many as 10 iterations of an application in the time now can modify the horsepower rating on the same it takes to generate a single new version of the hard- engine using software alone. ware on which it runs. Human resources. Smart, connected products After-sale service. Smart, connected products create major new human resource requirements offer major improvements in predictive maintenance and challenges. The most urgent of these is the need and service productivity. New service organizational to recruit new skill sets, many of which are in high structures and delivery processes are required to take demand. Engineering departments, traditionally advantage of product data that can reveal existing staffed with mechanical engineers, must add tal- and future problems and enable companies to make ent in software development, systems engineering, timely, and sometimes remote, repairs. Real-time product clouds, big data analytics, and other areas. product usage and performance data allows substan- Security. Smart, connected products create the tial reductions in field-service dispatch costs and ma- need for robust security management to protect the jor efficiencies in spare-parts inventory control. Early data flowing to, from, and between products; protect warnings about impending failure of parts or com- products against unauthorized use; and secure ac- ponents can reduce breakdowns and allow more ef- cess between the product technology stack and other ficient service scheduling. Data on product usage and Joy Global corporate systems. This will require new authentica- performance can feed insights back to product design, Smart, connected mining tion processes, secure storage of product data, pro- so that firms can reduce future product failures and machines such as this Joy tections against hackers for both product data and Global longwall shearer associated service required. Product usage data can autonomously coordinate customer data, definition and control of access privi- also be used to validate warranty claims and identify with other equipment to leges, and protections for products themselves from warranty agreement violations. improve mining eﬃciency. hackers and unauthorized use.

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Implications for Strategy segments it chooses to serve. Schneider Electric, for The path to competitive advantage ultimately rests example, makes building products as well as inte- on strategy. Our research reveals that in a smart, grated building management solutions that gather connected world companies face 10 new strategic volumes of data about energy consumption and choices. Each choice involves trade-offs, and each other building performance metrics. For one seg- must reflect a company’s unique circumstances. The ment of customers, Schneider’s solution involves choices are also interdependent. The company’s en- remote equipment monitoring, alerts, and advisory tire set of choices must reinforce one another and services in reducing energy use and other costs. For define a coherent and distinctive overall strategic po- the segment of customers that want a fully out- sitioning for the company. sourced solution, however, Schneider actually takes Tesla over remote control of equipment to minimize en- Which set of smart, connected product ergy consumption on customers’ behalf. A Tesla vehicle in need of 1 capabilities and features should the com- Third, a company should incorporate those ca- repairs can autonomously pany pursue? Smart, connected products dramati- call for a corrective software pabilities and features that reinforce its competitive cally expand the range of potential product capabili- download, or, if necessary, positioning. A company competing with a high-end ties and features. Companies may be tempted to add send a notiﬁcation to the strategy can often reinforce differentiation through as many new features as possible, especially given customer with an invitation extensive features, while a low-cost competitor may for a valet to pick up the the often low marginal cost of adding more sensors choose to include only the most basic features that car and deliver it to a Tesla and new software applications, and the largely fixed facility. affect core product performance and that lower costs of the product cloud and other infrastructure. the cost of operation. For example, A.O. Smith’s But just because a company can offer many new ca- Lochinvar boiler unit, which competes using a pabilities does not mean that their value to custom- highly differentiated strategy, has made extensive ers exceeds their cost. And when companies get into smart, connected product features standard on its a features and capabilities arms race, they end up core products. In contrast, Rolex, the luxury watch blurring strategic differences and creating zero-sum maker, has decided that smart, connected capabili- competition. ties are not an area in which it will compete. How should a company determine which smart, connected capabilities to offer? First, it must decide How much functionality should be em- which features will deliver real value to custom- 2 bedded in the product and how much in ers relative to their cost. In residential water heat- the cloud? Once a company has decided which ca- ers, A.O. Smith has developed capabilities for fault pabilities to offer, it must decide whether the en- monitoring and notification, but water heaters are abling technology for each feature should be embed- so long-lived and reliable that few households are ded in the product (raising the cost of every product), willing to pay enough for these features to justify delivered through the product cloud, or both. In ad- their current cost. Consequently, A.O. Smith offers dition to cost, a number of factors should be taken them as options on only a few models. In commer- into consideration. cial water heaters and boilers, however, adoption of Response time. A feature that requires quick re- such capabilities is high and rising. The value of response times, such as a safety shutdown in a nuclear mote monitoring and operation to commercial cus- power plant, requires that the software be embed- tomers that often cannot operate without heat and ded in the physical product. This also reduces the hot water is high relative to their cost, and so these risk that lost or degraded connectivity slows down features are becoming standard. Note that the cost response. of incorporating smart, connected product features Automation. Products that are fully automated, will tend to fall over time, as is the case in water such as antilock brakes, usually require that greater heaters and boilers. When deciding what features functionality be embedded into the device. to offer, then, companies must continually revisit Network availability, reliability, and security. the value equation. Embedding software in the product minimizes de- Second, the value of features or capabilities pendence on network availability and the amount will vary by market segment, and so the selection of data that must flow from the product to cloud- of features a company offers will depend on what based applications, lowering the risk that sensitive

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or confidential data will be compromised during products. A closed system approach aims to have transmission. customers purchase the entire smart, connected Location of product use. Companies that oper- product system from a single manufacturer. Key ate products in remote or hazardous locations can interfaces are proprietary, and only chosen parties mitigate the associated dangers and costs by host- gain access. The operating data that GE gathers ing functionality in the product cloud. As discussed from its aircraft engines, for example, is available above, Thermo Fisher’s chemical analyzers, used in only to the airlines operating the engines. An open hazardous or toxic environments, have cloud-based system, by contrast, enables the end customer to as- capabilities and connectivity that enable the instan- semble the parts of the solution—both the products taneous transmission of contamination data and al- involved and the platform that ties the system to- low the immediate initiation of mitigation efforts. gether—from different companies. Here, the inter- Nature of user interface. If the product’s user faces enabling access to each part of the system are Wind interface is complex and is changed frequently, the open or standardized, allowing outside players to Turbine interface may be best located in the cloud. The cloud create new applications. When smart wind turbines offers the ability to deliver a much richer user experi- Closed systems create competitive advantage by are networked, software ence and potentially to take advantage of an existing, allowing a company to control and optimize the de- can adjust the blades familiar, and robust user interface like a smartphone. sign of all parts of the system relative to one another. on each one to minimize impact on the eﬃciency Frequency of service or product upgrades. Cloud- The company maintains control over technology and of turbines nearby. based applications and interfaces allow companies data as well as the direction of development of the to make product changes and upgrades easily and product and the product cloud. Producers of system automatically. components are restricted from accessing a closed Home audio equipment maker Sonos, a smart, system or are required to license the right to integrate connected products pioneer, takes advantage of their products into it. A closed approach may result cloud-based capability to “reinvent home audio for in one manufacturer’s system becoming the de facto the digital age,” putting a premium on convenience, industry standard, enabling this company to capture variety of music, and ease of use. The company’s the maximum value. wireless systems place both the music source and A closed approach requires significant invest- the user interface in the cloud, enabling Sonos to ment and works best when a single manufacturer simplify its products’ physical design: The portable has a dominant position in the industry that can be device, which is controlled from a smartphone, con- leveraged to control the supply of all parts of the tains only the amplifier and speaker. With this offer- smart, connected product system. If either Philips ing, Sonos attempted to disrupt the home audio mar- Healthcare or GE Healthcare were the dominant ket. The trade-off? Wireless streamed audio systems manufacturer of medical imaging equipment, for do not deliver the level of sound quality that true example, it could drive a closed approach in which audiophiles demand. Competitors such as Bose will it could sell medical imaging management systems make different choices and trade-offs to secure their that included only its own or partners’ equipment to competitive differentiation. hospitals. However, neither company has the clout We believe that as smart, connected products to restrict hospitals’ choice of other manufacturers’ evolve, more human-machine interface capabilities equipment, so both companies’ imaging system plat- may well move out of the product and into the cloud. forms interface with other manufacturers’ machines. However, the complexity facing users in operating A fully open system enables any entity to partici- these interfaces will increase. User interfaces may of- pate in and interface with the system. When Philips ten overshoot in complexity, and user backlash may Lighting introduced the hue smart, connected drive firms to restore simpler, easy-to-use interfaces lightbulb, for example, it included a basic smart- for common functions, including on/off controls. phone application that allowed users to control the color and intensity of individual bulbs. Philips Should the company pursue an open or also published the application programming inter- 3 closed system? Smart, connected products face, which led independent software developers to involve multiple types of functionality and services, quickly release dozens of applications that extended and are often systems encompassing multiple the utility of the hue bulbs, boosting sales. The open

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approach enables a faster rate of applications devel- example, while software skills are not well development and system innovation as multiple entities oped in most manufacturing companies, Jeff Immelt contribute. It can also result in a de facto industry recently said that “every industrial company will be- standard, but one from which no company gains a come a software company.” The nature of technol- proprietary benefit. ogy for smart, connected products makes it clear While a closed system is possible for individual why that might well be true and why building inter- product systems, it is often impractical for systems nal software capability is crucial. of systems. Whirlpool, for example, realizes that its Early pioneers AGCO and Deere have both taken a strong position in home appliances will not be suffi- largely in-house route to develop smart farm equip- cient to become the leader in the “connected home,” ment solutions for those reasons. GE has created a Babolat which includes not only connected appliances but major software development center to build in-house also automated lighting, HVAC, entertainment, and capabilities it sees as strategic across business units. Babolat’s Play Pure Drive product system puts security. Therefore, Whirlpool designs its appliances However, as with the two previous IT waves, the sensors and connectivity to be readily connectable to the variety of home au- difficulty, skills, time, and cost involved in building in the tennis racket handle, tomation systems on the market, seeking to retain the entire technology stack for smart, connected allowing users to track and proprietary control only over its product features. A products is formidable and leads to specialization at analyze ball speed, spin, hybrid approach, in which a subset of functionality each layer. Just as Intel has specialized in micropro- and impact location to improve their game. is open but the company controls access to full ca- cessors and Oracle in databases, new firms that spe- pabilities, occurs in industries like medical devices, cialize in components of the smart, connected prod- where manufacturers support an industry standard ucts technology stack are already emerging, and their interface but offer greater functionality only to cus- technology investments are amortized over many tomers. Over time, closed approaches become more thousands of customers. Early movers that choose challenging as technology spreads and customers in-house development can overestimate their ability resist limits on choice. to stay ahead and end up slowing down their development time line. Should the company develop the full set But outsourcing can create new costs, as suppliers 4 of smart, connected product capabilities and partners demand a larger share of the value cre- and infrastructure internally or outsource to ated. Companies that rely on partners also compro- vendors and partners? Developing the technol- mise their ability to differentiate going forward, and ogy stack for smart, connected products requires their ability to build and retain the in-house expertise significant investment in specialized skills, technol- required to set overall product design strategy, man- ogies, and infrastructure that have not been typically age innovation, and choose vendors well. present in manufacturing companies. Many of these In making these build-versus-buy choices, com- skills are scarce and in high demand. panies should identify those technology layers that A company must choose which layers of technol- offer the greatest opportunitiesfor product insight, ogy to develop and maintain in-house and which future innovation, and competitive advantage, and to outsource to suppliers and partners. In utilizing outsource those that will become commoditized or outside partners, it must decide whether to pursue advance too quickly. For example, most companies custom development of tailored solutions or license should strive to maintain solid internal capabilities off-the-shelf, best-of-breed solutions at each level. in areas such as device design, the user interface, Our research suggests that the most successful com- systems engineering, data analytics, and rapid prod- panies choose a judicious combination of both. uct application development. Companies that develop smart, connected prod- These choices will evolve over time. In the early ucts in-house internalize key skills and infrastruc- stages of smart, connected products technology, the ture and retain greater control over features, func- number of capable and robust suppliers has been lim- tionality, and product data. They may also capture ited, and so companies have been faced with the im- first-mover advantages and the ability to influence perative of in-house or custom development. Already, the direction of technology development. The com- however, best-of-breed vendors with turnkey con- pany gets on its own, steeper learning curve, which nectivity solutions and product clouds, secure high- can help maintain its competitive advantage. For performance application platforms, and ready-to-use

80 Harvard Business Review November 2014 HOW SMART, CONNECTED PRODUCTS ARE TRANSFORMING COMPETITION HBR.ORG

data analytics are emerging. This makes it increas- and energy cost, gathers extensive data on both ingly challenging for in-house efforts to keep up and product usage and peak demand across the energy can turn an early lead into a disadvantage. grid. This has enabled the Rush Hour Rewards program, which raises residential customers’ air condi- What data must the company capture, tioning thermostat temperature to reduce energy 5 secure, and analyze to maximize the use during peak demand periods and precools a value of its oﬀering? Product data is fundamental home before peak demand begins. By partnering to value creation and competitive advantage in with energy providers, securing the data they pro- smart, connected products. But collecting data re- vide, and integrating it with customer data, Nest quires sensors, which add cost to the product, as enables customers to earn discounts or credits from does transmitting, storing, securing, and analyzing Ralph their energy provider and to use less energy when this data. Companies may also need to obtain rights everyone else is using more. to the data, adding complexity and cost. To deter- Lauren mine which types of data provide sufficient value Ralph Lauren’s Polo Tech How does the company manage owner- relative to cost, the firm must consider questions Shirt, available in 2015, 6 ship and access rights to its product streams distance covered, such as: How does each type of data create tangible data? As a company chooses which data to gather calories burned, movement value for functionality? For efficiency in the value intensity, heart rate, and and analyze, it must determine how to secure rights chain? Will the data help the company understand other data to the wearer’s to the data and manage data access. The key is who and improve how the broader product system is per- mobile device. actually owns the data. The manufacturer may own forming over time? How often does the data need to the product, but product usage data potentially be- be collected to optimize its usefulness, and how longs to the customer. For example, who is the right- long should it be retained? ful owner of the data streaming from a smart, con- Companies must also consider the product integ- nected aircraft engine—the engine supplier, the rity, security, or privacy risks for each type of data airframe manufacturer, or the airline that owns and and the associated cost. The less sensitive data a operates the planes? company collects, the lower the risk of breaches and There is a range of options for establishing data transmission disruptions. When security require- rights for smart, connected products. Companies ments are high, companies will need capabilities to may pursue outright ownership of product data, or protect the data and limit transmission risk by stor- seek joint ownership. There are also various levels of ing data in the product itself. (We will discuss secu- usage rights, including NDAs, the right to share the rity more extensively in part two of this series.) data, or the right to sell it. Firms must determine their The types of data a company chooses to collect approach to transparency in data collection and use. and analyze also depend on its positioning. If the Rights to data can be laid out in an explicit agreement company’s strategy is focused on leading in prod- or buried in small print or hard-to-understand boil- uct performance or minimizing service cost, it must erplate documents. Although we are seeing the early usually capture extensive “immediate value” data stages of a movement toward more transparency in that can be leveraged in real time. This is especially data gathering across industries, data disclosure and important for complex, expensive products for ownership standards often have yet to be established. which downtime is costly, such as wind turbines or Another option for handling data rights and ac- jet engines. cess includes the establishment of a data-sharing For companies seeking leadership in the product framework with component suppliers for providing system, there is a need to invest in capturing and ana- information about the component’s condition and lyzing more-extensive data across multiple products performance but not about its location. Limiting sup- and the external environment, even for products the Medtronic pliers’ access to data, however, could reduce poten- company does not produce. For example a smart, Medtronic’s implanted tial benefits if the supplier lacks a full understanding connected product system might need to capture digital blood glucose meter of how products are being used, slowing innovation. connects wirelessly to a traffic data, weather conditions, and fuel prices at Customers and users want a say in these choices. monitoring and display different locations for an entire fleet of vehicles. device and can alert Some customers today are much more willing than Different strategies involve different data-capture patients to trends in glucose others to share data on their product use. For ex- choices. Nest, which aims to lead in energy efficiency levels requiring attention. ample, part of Fitbit’s value proposition is its ability

November 2014 Harvard Business Review 81 SPOTLIGHT ON MANAGING THE INTERNET OF THINGS HBR.ORG

to share via social media the personal fitness infor- revenue and boost margins. They can also improve mation it collects. But not every customer wants to their knowledge of customer needs, strengthen share this data. Likewise, cautious drivers may be brand awareness, and boost loyalty by educating willing to share data on their driving habits with in- customers more directly about product value. surance or rental car companies as a way to lower Tesla, for example, has disrupted the status quo premiums or fees, but others may resist. Firms will in the automotive industry by selling its cars directly need to provide a clear value proposition to cus- to consumers rather than through a traditional tomers to encourage them to share usage or other dealer network. This has simplified the firm’s pric- data. As consumers become more aware of the value ing—consumers pay full sticker price, avoiding the that data generates across the value chain, they will haggling common at dealerships—greatly improv- become more active and demanding participants ing customer satisfaction. By eliminating third-party in decisions about what data is collected, how it is involvement in repairs, Tesla captures revenue and used, and who benefits. deepens its relationship with customers. The firm Today it’s common to see “click through” agree- transmits software upgrades to its cars, continually ments giving broad consent to collect product data improving the customer experience and giving driv- the first time a smart, connected product is used. ers the equivalent of the “new car smell” with each This consent allows companies to indiscriminately update. When monitoring detects that a Tesla ve- collect product data and use it with few constraints. hicle is due for repairs, the car either autonomously In time we expect that more-stringent contractual calls for a remote repair via software or sends a noti- frameworks and mechanisms governing those rights fication to the customer with an invitation to request will emerge to define and protect intellectual prop- that a valet deliver it to the Tesla facility. The firm erty associated with smart, connected product data. was recently rated number one in customer satisfac- It behooves companies to get ahead of this trend, es- tion by Consumer Reports. pecially on the product data they truly need to collect While disintermediation has definite advantages, in order to drive value. some level of physical proximity to customers is still Careful stewardship of data will also be essential, required and desirable in most industries. Customers especially in highly regulated industries such as med- must take delivery of and sometimes install a physi- ical devices. Regulatory standards for data access cal product, and some types of service visits are still and security are already in place in many such fields. necessary. In addition, customers may have strong Biotronik has created infrastructure that allows it to relationships with resellers and channels that offer securely gather patient information, such as arrhyth- them a broader product line and deep and local field- mia events or pacemaker battery status, and share it based expertise. When manufacturers diminish the only with a specified audience—the patient’s physi- role of valuable channel partners, they risk losing cian. Regardless of the industry, however, steward- them to competitors whose strategy is to embrace ship of data will be an essential capability, and data partners. Also, assuming roles formerly handled by breaches will lead to serious consequences regard- partners—such as direct selling or service—can be less of who is at fault. Ongoing security risk is part of challenging, involving high start-up costs and major the business case for which data to collect and how new investments in value chain functions such as to manage it. sales, logistics, inventory, and infrastructure. The choice of whether or not to disintermediate Should the company fully or partially dis- a channel or service partner will depend in large 7 intermediate distribution channels or part on the type of partner network the firm man- service networks? Smart, connected products en- ages. Do partners simply distribute products, or are able firms to maintain direct and deep customer rela- they critical to delivering training and service in the tionships, which can reduce the need for distribu- field? What percentage of partner activities can be tion channel partners. Companies can also diagnose replaced through smart, connected product capa- product performance problems and failures and bilities? Do customers understand the value of elim- sometimes make repairs remotely, reducing reliance inating the middleman? Do customers understand on service partners. By minimizing the role of the that traditional relationships with established chan- middlemen, companies can potentially capture new nels are no longer necessary and involve extra cost?

82 Harvard Business Review November 2014 Smooth er operations. That’s Ryder.

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Ryder and the Ryder logo are registered trademarks of Ryder System, Inc. Copyright © 2014 Ryder System, Inc. Ever better is a trademark of Ryder System, Inc. SPOTLIGHT ON MANAGING THE INTERNET OF THINGS HBR.ORG MISTAKES TO AVOID Smart, connected products oﬀer a rich new set of value creation and growth opportunities. However,

eﬀorts to seize those opportunities will not be model in which the manufacturer retains ownership without challenges. Some of the greatest strategic and takes full responsibility for the costs of prod- risks include the following: uct operation and service in return for an ongoing charge. Customers pay as they go, not up front. Here, Adding functionality that customers don’t want to pay for. Just because a the value of product performance improvements feature is now possible does not mean there is a clear value proposition for that reduce operating cost (such as better energy ef- the customer. Adding enhanced capabilities and options can reach the point ficiency) and service efficiencies are captured by the of diminishing returns, due to the cost and complexity of use. manufacturer. Smart, connected products create a dilemma for Underestimating security and privacy risks. Smart, connected products manufacturers, particularly those that make com- open major new gateways to corporate systems and data, requiring stepped-up network security, device and sensor security, and information plex, long-lived products for which parts and service encryption. generate significant revenue and often disproportionate profit. Whirlpool, for example, currently has Failing to anticipate new competitive threats. New competitors oﬀering a healthy business selling spare parts and service products with smart, connected capabilities (such as connectivity and contracts—a model that can dull incentives to make embedded software) or performance- or service-based business models can products more reliable, more durable, and easier to emerge quickly and reshape competition and industry boundaries. fix. If, instead, Whirlpool moved to a product-as-a- service model, in which it maintained ownership of Waiting too long to get started. Moving slowly enables competitors and the product and the customer simply paid for the use new entrants to gain a foothold, begin capturing and analyzing data, and of the machine, the economic incentives would be start moving up the learning curve. turned upside down. Overestimating internal capabilities. The shift to smart, connected The profitability of product-as-a-service models products will demand new technologies, skills, and processes throughout depends on the pricing and terms of contracts, which the value chain (for example, big data analytics, systems engineering, and are a function of bargaining power. Product-as-a- software application development). A realistic assessment about which service models can increase buyers’ power, because capabilities should be developed in-house and which should be developed customers may be able to switch after the contract by new partners is crucial. period (if the product is not embedded as with an elevator), unlike with perpetual ownership. Product sharing, a variation of the product-as-a- service model, focuses on more efficient utilization of products that are used intermittently. Customers Should the company change its business pay for the use of the product (such as cars or bikes) 8 model? Manufacturers have traditionally fo- when they need it, and the company (such as Zipcar cused on producing a physical good and capturing or Hubway) is responsible for everything else. value by transferring ownership of the good to the Product sharing is spreading to non-mobile products customer through a sales transaction. The owner is such as houses. then responsible for the costs of servicing the prod- Companies can also pursue hybrid models be- uct and other costs of use, while bearing the risks of tween the extremes of product-as-a-service and con- downtime and other product failures and defects not ventional ownership, such as product sales bundled covered by warranties. with warranty or service contracts, or product sales Smart, connected products allow the radical al- bundled with performance-based contracts. Service teration of this long-standing business model. The contracts allow the manufacturer to keep service in- manufacturer, through access to product data and house and capture more of the value from service the ability to anticipate, reduce, and repair failures, efficiencies. In a performance-based contract, the has an unprecedented ability to affect product per- manufacturer sells the product along with a contract formance and optimize service. This opens up a that promises that the product will perform to cer- spectrum of new business models for capturing tain specifications (such as percentage of uptime). value, from a version of the traditional ownership Here, ownership is transferred, but the manufac- model where the customer benefits from the new turer maintains responsibility and bears the risk of service efficiencies to the product-as-a-service product performance.

84 Harvard Business Review November 2014 INSPIRE

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Should the company enter new businesses and the need for new capabilities. Companies must 9 by monetizing its product data through identify a clear value proposition before entering. selling it to outside parties? Companies may find Expanding product scope will be most attractive that the data they accumulate from smart, connected where there are major performance improvement products is valuable to entities besides traditional opportunities through co-designing the related customers. Companies may also discover that they products to optimize the system. Alternatively, if can capture additional data, beyond what they need optimization is not dependent on individual prod- to optimize product value, that is valuable to other uct designs, a company may be better off sticking to entities. In either case, this may lead to new services its knitting and providing open connectivity to re- or even new businesses. lated products produced by others. Success is less a Data about the performance of a product’s com- Sonos function of traditional product design than systems ponents, for example, could be valuable to suppliers engineering. The company’s wireless of those components. Data about driving conditions music systems place the Companies whose products (and associated tech- or delays gathered by a fleet of vehicles could be valu- user interface in the cloud, nological capabilities) are central to overall product able to other drivers, to the operators of logistical enabling users to control system operation and performance, such as Joy systems, or to road repair crews. Data about driving the portable device from Global’s mining machines, will be in the best posi- a smartphone. characteristics could be valuable to fleet operators or tion to enter related products and integrate the sys- insurance companies. tem. Manufacturers that produce less system-critical Again, in choosing how to capture new value from machines, such as the trucks that move the material product data, companies must consider the likely re- extracted from underground, will have less capabil- action of core customers. While some of them may not ity and credibility in customers’ eyes to take on a care how their data is used, others may feel strongly broader system provider role. about data privacy and reuse. Companies will need to The choice of whether or not to develop the tech- identify mechanisms to provide valuable data to third nology platform that connects a product system or parties without alienating customers. For example, a system of systems depends on some related ques- company might not sell individual customer data but tions. The first is whether the company can assemble rather blinded or aggregate data on purchasing pat- the necessary IT skills and technology, which are terns, driving habits, or energy usage. quite different from those required in product design and manufacturing. Another key question is where Should the company expand its scope? system optimization takes place. “Inside product” 10 Smart, connected products not only transform optimization involves integrating individual prod- existing products but often broaden industry bound- uct designs so that products work better together. aries. Products that have been separate and distinct “Outside product” optimization takes place through can become parts of optimized systems of related the algorithms that connect products and other in- products, or components of systems of systems. formation, where products themselves are modular. Shifting boundaries mean that companies that have Inside product optimization creates the strongest been industry leaders for decades may find them- rationale for expanding into related products and of- selves playing more of a supporting role in a broader fering a proprietary platform. Outside product opti- landscape. mization favors an open platform, and the platform The emergence of product systems and sys- may be offered by a company that does not produce tems of systems raises at least two types of strategic products at all. choices about company scope. The first is whether Philips Carrier Corporation offers an example of these a company should expand into related products or choices. It has a 100-year history of innovation in the other parts of the system of systems. The second is Lighting design of a full range of HVAC equipment such as fur- whether a company should seek to provide the plat- Users can control Philips naces, air conditioners, heat pumps, humidifiers, and form that connects the related products and informa- Lighting hue lightbulbs via ventilators. Carrier optimizes its HVAC product sys- tion, even if it does not make or control all the parts. smartphone, turning them tem performance by integrating individual designs on and oﬀ, programming Companies may be tempted to enter into related them to blink if they detect across products, and its smart Infinity heating and products in order to capture the big opportunity, an intruder, or dimming cooling system platform connects them. However, but entry into related products always involves risk them slowly at night. HVAC is part of a broader home automation system.

86 Harvard Business Review November 2014 Meeting productivity for senior leadership

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Smart, connected products will give rise to the next era of IT-driven productivity growth at a time when the impact of earlier waves of IT has largely played itself out.

Carrier has not entered other product areas within trajectory of the overall economy, giving rise to the home automation because of the need for very dif- next era of IT-driven productivity growth for com- ferent capabilities. Rather, its Infinity platform pro- panies, their customers, and the global economy at vides interfaces to allow the HVAC product family to a time when the impact of earlier waves of IT has be integrated into the system of systems. largely played itself out and productivity growth has Finally, as smart, connected products expand slowed down. industry scope and the boundaries of competition, This third wave of IT not only will create step many companies will need to rethink their corpo- function improvements in product capability and rate purpose. The focus is shifting to the broader performance but will radically improve our ability to need companies meet, rather than their traditional meet many business and human needs. Across many product definition. For example, Trane has moved fields, products will be far more efficient, effective, from seeing itself as an HVAC equipment producer to safe, reliable, and more fully utilized, while conserv- a company that makes high-performance buildings ing scarce natural resources such as energy, water, better for everyone inside. As products continue to and raw materials. communicate and collaborate in networks, which This opportunity to drive rapid innovation and are expanding both in number and diversity, many economic growth, and with it a return to prosperity companies will have to reexamine their core mission growth, comes none too soon. The past decade has and value proposition. been characterized by internal cost reduction, cautious investment, higher corporate profitability, ris- A company must make a clear choice in each of ing M&A, and muted innovation across large parts these dimensions of strategy but ensure that each of the economy. This path has resulted in slower job choice is consistent with and reinforces the others. growth, slower improvements in wages and living For example, a company pursuing product system standards for the average citizen, a diminished sense leadership will enter related product categories, pur- of economic opportunity, doubts about capitalism, sue inside product design integration, capture exten- and reduced public support for business. sive product usage data, and develop more intensive The era of smart, connected products can change internal capabilities across the technology stack. In this trajectory, provided that companies move ag- contrast, a company that focuses on a single part of gressively to embrace the opportunity. Business and a product system will need to become best-of-breed government together will need to equip workers in terms of features and functionality and provide across all groups with the skills to participate, and transparent and open interfaces so that its product agree on the rules and regulations needed to set stan- can be readily integrated into and becomes a valu- dards, enable innovation, protect data, and over- able part of other companies’ systems and platforms. come efforts to block progress (such as auto dealers’ Ultimately, competitive success will arise not by imi- political opposition to Tesla). tating rivals but by defining a distinctive value prop- The United States stands to lead and benefit osition that the company can realistically achieve. disproportionately in a smart, connected products world, given America’s strengths in the core un- The Larger Opportunity derlying technologies, many of the skills required, Smart, connected products are changing how value and key supporting industries. If this new wave of is created for customers, how companies compete, technology allows the U.S. to reinvigorate its capac- and the boundaries of competition itself. These ity as a technology leader in the global economy, it shifts will affect virtually every industry, directly or will breathe new life into the American dream while indirectly. But smart, connected products will have contributing to a better world. a broader impact even than this. They will affect the HBR Reprint R1411C

88 Harvard Business Review November 2014

SPOTLIGHT ON MANAGING THE INTERNET OF THINGS SPOTLIGHT HBR.ORG ARTWORK Chris Labrooy Shrinkwrap Stills, Steam Iron

Marco Iansiti is the Karim R. Lakhani is an David Sarnoﬀ Professor associate professor of of Business Administration business administration at Harvard Business at HBS and principal School, where he heads the investigator of the NASA Technology and Operations Tournament Lab at Harvard Management Unit and the University’s Institute for Digital Initiative. Quantitative Social Science.

Digital Ubiquity How Connections, Sensors, and Data Are Revolutionizing Business by Marco Iansiti and Karim R. Lakhani

OR MORE THAN A CENTURY General Electric made most of its revenue by selling industrial hardware and repair services. But in recent years GE was at increasing risk of losing many of its top customers to nontraditional competitors—IBM and SAP on the one hand, and big-data start-ups on the other. Those competitors aimed to shift the customer value proposition away from acquiring reliable industrial equipment to deriving newF efficiencies and other benefits through advanced analytics and algorithms based on the data generated by that equipment. The trend threatened to turn GE into a commodity equipment provider. In 2011 GE responded with a multibillion-dollar initiative focused on what it calls the industrial internet. The company is adding digital sensors to its machines, connecting them to a common, cloud-based software platform, investing in modern software development capabilities, building advanced analytics capabilities, and embracing

November 2014 Harvard Business Review 91 SPOTLIGHT ON MANAGING THE INTERNET OF THINGS

crowdsourced product development. All this is SAP, which used to make large profits by selling soft- transforming the company’s business model. Now ware licenses, are investing heavily in infrastructure revenue from its jet engines, for example, is tied not to support cloud software and analytics; switching to a simple sales transaction but to performance im- from product to service revenue; and experiment- provements: less downtime and more miles flown ing with outcomes-based business models in cases over the course of a year. Such digitally enabled, out- where revenue might be tied to the efficiencies deliv- comes-based approaches helped GE generate more ered by an enterprise application. Joining them are than $1.5 billion in incremental income in 2013; the newer players such as Salesforce, Workday, Google, company expects that number to double in 2014 and and Amazon Web Services, whose cloud-native ser- again in 2015. vices are already transforming enterprise software. GE’s industrial internet is based on the newfound But the trend reaches well beyond software compa- ubiquity of digital connectivity. Most information nies: The medical device maker Becton Dickinson work is already digitized through the use of con- is investing heavily in software and development nected laptops and mobile devices. Now, with the capabilities that will incorporate increased connec- growth of the “internet of things,” the pervasive tivity, intelligence, and platform functionality in its deployment of digital sensors is extending digitiza- diagnostics equipment. Companies in the invest- tion and connectivity to previously analog tasks, ment management sector, such as Wealthfront and processes, and machine and service operations. AltX, are assembling data platforms that optimize Moreover, virtually limitless computing power is and automate the investing process. Even Domino’s, available at very low cost through cloud computing. the pizza company, is building digital capabilities, The combined impact of all this is that both estab- mobile technologies, and analytics to enhance inno- lished and start-up players in every industry are be- vation and meet consumer expectations regarding ing forced to compete in new ways. (See the sidebar service, transparency, and speedy delivery. “What Makes Digital Technology Transformational?”) Adapting to ubiquitous digital connectivity is Digital ubiquity started with the transformation now essential to competitiveness in most sectors of software companies. For example, Microsoft and of our economy. We have examined transformation WHAT MAKES DIGITAL TECHNOLOGY TRANSFORMATIONAL? To understand why the internet the investment in network and old business processes of things is transforming infrastructure has been made, and connect industries and business models, it’s helpful to the page can be communicated communities to generate novel understand three fundamental to the incremental consumer opportunities. Facebook can properties of digital technology: at zero (or almost zero) connect any brand to any user (1) Unlike analog signals, digital marginal cost. And a digital community without incremental signals can be transmitted task performed at zero marginal expense. A sensor on a GE jet perfectly, without error. A cost will immediately supersede engine can transmit useful Facebook webpage will look any traditional analog task data predicting maintenance exactly the same when it’s completed at significant over long distances at zero generated in Palo Alto as it does marginal cost (which is why incremental cost; this data can when it’s shown to a consumer e-mail and social networks are in turn be communicated to in Bangalore. (2) Moreover, killing “snail mail”). GE’s maintenance organization digital signals can be replicated These properties (exact and third-party spare parts indefinitely—that same page replication infinite times at zero manufacturers. Thus these three can be shown to a billion marginal cost) improve the fundamental properties drive Facebook users—without scalability of operations and the transformation enabled by any degradation. (3) Once make it easy to combine new ubiquitous digital technology.

92 Harvard Business Review November 2014 DIGITAL UBIQUITY HBR.ORG

Idea in Brief THE FINDING THE IMPLICATION THE EXAMPLE Digital transformation—the To compete, companies will General Electric has invested digitization of previously have to rethink their business millions in its “industrial analog machine and service models, identifying new internet,” linking previously operations, organizational opportunities for creating and discrete tasks and equipment tasks, and managerial capturing value. to create more than $1.5 billion processes—is pushing both in incremental revenue in established and start-up 2013—an amount it expects players in many industries to will double in 2014 and again compete in new ways. in 2015.

across dozens of industries and companies—both turbine hardware, E.ON could meet demand with a traditional and born-digital. We have talked to hun- relatively modest purchase of equipment to connect dreds of executives in our effort to understand how all the turbines through software that allows for dy- traditional modes of innovation and operational ex- namic control and real-time analytics. ecution are changing. (Disclosure: We have consulted GE creates value by extracting useful data from with or have interests in several of the companies the sensors on its turbines and other wind energy mentioned in this article.) We have seen that digital equipment and using that information to optimize transformation is no traditional disruption scenario: equipment performance, utilization, and mainte- The paradigm is not displacement and replacement nance. It captures that value by charging a percent- but connectivity and recombination. Transactions age of the customer’s incremental revenue from are being digitized, data is being generated and improved performance. So although GE sells less analyzed in new ways, and previously discrete ob- hardware, it has developed a mutually profitable jects, people, and activities are being connected (see long-term partnership. the exhibit “An Explosion in Connected Devices”). Incumbents can use their existing assets, dramatically increase their value, and defend against (or partner with) entrants. Pacific Gas and Electric, for example, will be more valuable if it connects with AN EXPLOSION IN Nest, the digital thermostat that Google recently CONNECTED DEVICES NUMBER OF DEVICES IN USE (IN MILLIONS) bought for $3.2 billion. (See the sidebar “Why Nest 20,000 WEARABLES Matters.”) And Uber makes money by bringing drivers together with customers—not by replacing them. SMART TVS

Rethinking Value Creation Between now and 2018 we’ll see and Capture the number of smartphones, A business model is defined by two things: how the tablets, and other connected devices skyrocket. THE INTERNET organization creates value for its customers (the cus- OF THINGS tomer value proposition) and how it captures that value (how it makes money). Digital transformation changes both. Consider GE’s wind farm deal with the global en- TABLETS ergy giant E.ON. In the past, as the demand for power increased, GE would try to sell more turbines and as- SMARTPHONES sociated equipment to power-generation companies. In its partnership with E.ON, GE used E.ON’s exten- PERSONAL sive operational data to run advanced analytics and COMPUTERS simulations and come up with a different scenario: 2004 2018 SOURCE BI INTELLIGENCE ESTIMATES BASED ON DATA FROM GARTNER Instead of increasing capacity by adding more wind RESEARCH, IDC, STRATEGY ANALYTICS, MACHINA RESEARCH, AND OTHERS

November 2014 Harvard Business Review 93 SPOTLIGHT ON MANAGING THE INTERNET OF THINGS

GE’s Transformation out the new system was more evolutionary. By When Jeffrey Immelt became GE’s CEO, in 2001, he 2011, along with sensors and microprocessors, GE inherited a company that was efficient but facing had significant embedded software running power intense competition and falling prices for its top-tier plants, jet engines, hospitals and medical systems, GE’S INDUSTRIAL capital goods. Immelt accelerated the company’s INTERNET utility companies, oil rigs, rail, and other industrial movement toward contract service agreements infrastructure worldwide. Connecting the hundreds (CSAs), instituted under his predecessor, Jack Welch. Jet Engines of thousands of GE devices to one another and arm- CSAs guaranteed total operational management of an BENEFITS ing them with increasingly sophisticated sensors • Lower maintenance costs asset, including preventive maintenance and repairs. • Lower workforce costs seemed like a logical extension of the maintenance- They generated reliable high-margin income for GE • Fewer canceled ﬂights and-operations-driven business model, and one over the life of the equipment—often several decades. • Better on-time that would extend GE’s strategic advantages. “I By 2005 CSAs accounted for more than 75% of GE’s performance have a great deal of confidence in our core hard- revenue backlog and contributed the same propor- • Higher customer ware,” Immelt says. “We have the most stuff. It’s satisfaction tion to industrial earnings. hard to replicate. We started from a real position of “We have globalized the company while investing relative strength.” massive amounts in technology, products, and ser- Building software capabilities. As the scale vices,” Immelt told an industry group in 2009. “We and scope of the opportunity became clear, Immelt know we must change again.” That change was the and his team recognized that the company would industrial internet. GE’s initiative proposes an open have to build new capabilities. It would need a global global network of machines, data, and people to center to develop and support software applications generate a plethora of new business opportunities uniformly across the businesses, and it would need and outcomes-based business models. It focuses on new and innovative approaches to managing cus- providing data synthesis and analysis and designing tomer relationships—including how to sell and ser- real-time and predictive solutions to optimize the vice the new offerings. complex operations of its customers. GE is a world-beater in efficiency, productivity, The industrial internet is revolutionizing value and innovation. But it had never been known for creation and capture for GE. The decision to build the agility, responsiveness, and strategic coherence of its software development process. Indeed, when Immelt launched GE Software, in November 2011, the company’s IT efforts were scattered. Its various THE EVOLUTION OF business units employed more than 12,000 software professionals, who helped generate several bil- GE SERVICE MODELS lion dollars in revenue. But no overarching strategy guided their technical choices and commercial offerings. Each business unit—even each product leader— EXPANDED CUSTOMER made choices according to local conditions; the result OUTCOMES was wildly uneven technical and commercial perfor- Optimized assets & operations mance. “Every one of our products had a different underpinning platform, architecture, technology, Use data and analytics to provide decision support and set of vendors,” says William Ruh, whom Immelt

VALUE HIGH VALUE CONTRACTUAL brought in from Cisco to run the new operation. Ruh “CSAs” services and other GE senior leaders set out to get a handle on the scope of the company’s existing software opera- Share risk, reducing the tions globally; they found 136 products, of which only TRANSACTIONAL total cost of ownership 17 were actually profitable. “It was taking us years to Break/ﬁx build the software, and years to get it out the door,” Ruh says. “And customers’ needs were changing too Sell parts and repairs rapidly to keep up.”

LOW CUSTOMER CUSTOMER LOW Developer talent was also a concern. “Our soft- 1980 2014

ware engineers had experience in one of two ways,” DETWILER TODD

94 Harvard Business Review November 2014 DIGITAL UBIQUITY HBR.ORG WHY NEST MATTERS A year ago few Honeywell executives thermostats. Second, it can make saw Google as a competitor. That money from electric utilities on changed in January 2014, when the basis of outcomes: Google Google bought Nest, the digital can aggregate data on energy- Ruh says. “They were either mechanical engineers thermostat and smoke detector consumption patterns and oﬀer the or they were computer scientists. But most of them company, for $3.2 billion. The move utilities a service in return for a had experience with technologies that were last- is a clear indication that percentage of their savings. generation. They were very reliant on outside ven- digital transformation and Third, it can pass some of dors, sometimes for full development.” Furthermore, connection are reaching those savings back to GE’s software specialists were spread across the critical mass, spreading consumers. global businesses and had no common language. across even the most Thus Nest will not Ruh started assembling his own team and insisted traditional industrial only play in the $3 billion that its members all work together at GE Software segments. global thermostat headquarters, in San Ramon, California. “Co-location The Nest thermo- industry; it will help shape is everything,” he says. “New things are easier to cre- stat creates value by the $6 trillion energy sector. digitizing the entire home- It can also jump into other ate a team around when they are all in one place.” temperature-control process— sectors by opening up its By January 2013 Ruh had hired 62 people; that June from fuel purchase to temperature digital cloud platform to devices about 150 employees moved into the new offices. At setting to powering the heating, and services from other providers. the end of the year the team numbered 350, only 2% ventilation, and air-conditioning For example, the platform now of whom had transferred from other parts of the com- system—and connecting it to Nest’s connects with advanced Whirlpool pany. Ruh expects to have more than 1,000 software cloud data services. The thermostat laundry systems to schedule wash developers and data scientists working at the San aggregates its data on real-time and dry cycles during nonpeak Ramon facility by the end of 2014. energy consumption and shares that hours. It works with the wearable- Ruh set out to create a software platform that data with utilities, which can improve technology company Jawbone to would work across the entire enterprise. It would their energy consumption forecasts detect when someone has awakened make developing new applications more efficient and thus achieve greater eﬃciency. and then dynamically adjust the And Nest can push cost data back to home temperature. It can connect and allow for rapid cross-industry innovation. It customers (“Current demand is high, with home security (“Someone just would also enable independent developers to build so the price you pay is going up. We walked by your thermostat; I thought applications on GE’s platform. And Ruh insisted that will turn down your air conditioning for no one was home”) and consumer GE own all the intellectual property his team built. the next two hours”), reducing their electronics (“Since you’re now in the The team rolled out its first set of solutions un- energy bills. bedroom, do you really want to keep der the Predictivity brand, running on Predix, GE’s How does Nest capture the value the TV on in the den?”). The potential common software platform. Predix and Predictivity it creates? First, its retail prices are for new applications and services is promise to dramatically streamline monitoring and double or triple those of conventional astonishing. maintenance for all GE’s industrial technologies. Predix combines distributed computing and big-data analytics, asset management, machine-to-machine communication, security, and mobility. Predictivity Nest will not will eventually connect all GE’s machines to the cloud (no small feat, given that some business units, only play in the such as health care, have thousands of products, each with its own complex software needs and legacy $3 billion global systems), enabling them to talk to one another, learn from historical data, and provide predictive information to help eliminate unplanned downtime and oth- thermostat sector; erwise improve efficiency. Public Service Enterprise Group (PSEG), a New it will help shape York– and New Jersey–based utility, is using a Predictivity product to react to real-time changes in the $6 trillion power demand, grid conditions, and fuel supply. In the few months that the asset-optimization solu- energy sector. tion has been in place, PSEG has increased output by 6%, reduced fuel burn by more than 1.5%, and in-

COURTESY OF NEST COURTESY creased operational flexibility for its gas turbine fleet.

November 2014 Harvard Business Review 95 SPOTLIGHT ON MANAGING THE INTERNET OF THINGS

St. Luke’s Medical Center, in Phoenix, uses another operating performance. “The transition we have to Predictivity solution to integrate bed assignments, make with our customers is going from agreements departmental workflow, patient flow, transporta- that are break/fix to agreements that guarantee out- tion, and equipment management, reducing bed- comes,” Immelt says. “Those will happen customer turnaround times by 51 minutes—a critical factor in by customer, and the outcome guarantees are going hospital capacity planning and patient satisfaction. to cannibalize the break/fix.” GE’S INDUSTRIAL And a railroad customer, Norfolk Southern, uses a GE is now rethinking and redeveloping its go-to- INTERNET Predictivity network-optimization solution to move market and commercialization strategies. To help Drilling more freight faster and more intelligently, achieving evolve its sales organization, Immelt brought in Kate Equipment a 10% increase in the overall speed of trains, a 50% Johnson as chief commercial officer, a new position reduction in losses due to “expired crews” (person- within the marketing function. Johnson had deep BENEFITS nel who have to meet time-off requirements), and experience in selling and servicing enterprise soft- • Maximized production significant on-time performance improvements. ware at Red Hat and Oracle; she worked to create • Predictable delivery • Lower maintenance costs Getting business-unit buy-in for GE Software was and expand GE’s outcomes-based sales capabilities. often a challenge. The business units were accus- She also oversaw a new commercial center of excel- tomed to operating autonomously, and some were lence that crystallized how GE would increase service more legacy-laden than others. Ruh did not try to revenue and margin growth. “This change is not just force anyone to comply. “I said, ‘We’re going to do about sales,” Johnson says. “It’s about product man- this; you can be on the train or not,’” he recalls. “A agement, marketing, sales and commercial opera- number wanted to, so we developed them at a very tions, delivery. It involves the whole life cycle, from fast pace and got them successful quickly. The per- invention to fulfillment. And that is the essence of formance gains and revenue enhancements were how we’re tackling the problem.” visible to other executives, who then asked their own To be sure, GE still needs salespeople and account businesses, ‘If you’re not doing this, why not?’ And executives who have deep relationships with their there was no good answer.” Before long all the busi- clients. However, what they sell, how they sell, and ness units were working with the initiative. to whom they sell is changing completely. The sales It helped that Ruh’s division was structured to team now includes solution architects, who combine encourage collaboration. Funded by the CEO’s of- exhaustive industrial knowledge with advanced an- fice, GE Software does not have its own P&L. “I don’t alytics to develop models for setting and achieving compete with the businesses,” Ruh says. “I don’t business outcomes. “Instead of a features list with get confused by trying to build my business versus pricing and discount caps,” Johnson says, “we’re theirs. I’m tied to and care about their P&L because shaping deals from the ground up that are based on I’m aligned with the question ‘Did we have business the value derived by the customer. It’s a completely impact?’” different set of economics that is very disruptive in While Ruh and his team pushed forward on the the industry.” common platform, Immelt and Beth Comstock, GE’s Customer engagement has become far more com- chief marketing officer, considered the new offer- plex. It requires an approach to solution develop- ings’ implications for the marketing and sales teams. ment that integrates technology, connectivity, and From the outset some managers argued that selling analytics products from GE with the client’s propri- analytics and other software offerings was beyond etary financial and operational data. “For this kind of GE’s scope, whereas others argued that licensing the sale, we need much more data to truly understand offerings was a cleaner model and therefore prefer- our customers’ business and financial situation, how able. The challenge is that “we’re trying to sell them they make money,” Johnson says. “Our sales team something they don’t know they need,” as Comstock now has to do a whole range of new spreadsheet cal- puts it. “And they can’t see when it works.” culations and modeling before we even approach a Learning to sell the new model. GE had to potential customer.” make a dramatic shift in approach. It had to abandon For example, the E.ON contract started off with its traditional “box seller” mentality in favor of solu- GE’s proposing two capital-expenditure deals and tion-based sales that focused not only on pain points one operational-expenditure deal to improve energy

but also on exactly how to enhance the customer’s performance on E.ON’s wind farms. Structuring the DETWILER TODD

96 Harvard Business Review November 2014 DIGITAL UBIQUITY HBR.ORG To join Marco Iansiti and Karim Lakhani for their webinar “The Internet of Things,” go to hbr.org/ webinar/iot at noon on Thursday, October 23.

three options required extensive familiarity with consumer product innovation platform and manu- the client’s balance sheet, financial strategies, and facturer with more than 744,000 members, to pro- approach to the market. The GE sales team had to pose, refine, select, fund, and build new products, manage E.ON’s procurement and accounting officers and has offered its relationships with suppliers and and also had to work closely with its technologists other support for products as they launch. The in- to address concerns about measuring performance. vestment helped get four products—a smartphone- It developed a complete methodology, shared it enabled power strip, a physical dashboard that dis- through white papers, and piloted the technology plays online information, a smart egg tray (which con- on selected E.ON turbines. The deal itself required nects with your mobile device to tell you how many layers of agreement within the client, from purchas- eggs you have and how fresh they are), and a multi- ing to asset management to finance and operations. function sensor (motion/sound/light/temperature/ In the end, the operational-expenditure model won humidity) for home use—onto the shelves at Home out. E.ON accepted the assessments and methodol- Depot and Best Buy before the 2013 holiday season. ogy and was pleased that very little capital had to be More recently GE announced a smartphone-powered spent to capture gains. window air conditioner for the home market. Building out the ecosystem. Immelt, Ruh, and GE Aviation partnered with Alaska Airlines in Comstock were aware that they could go only so far November 2012 to present Flight Quest, making two in developing offerings. They needed to strengthen months’ worth of FlightStats data available on an the loose network of suppliers, distributors, and de- open platform. Outsiders were challenged to come velopers of related products and services that enable up with algorithms that could better predict flight ar- and enhance GE’s offerings. It’s an approach that rival times, with a total of $250,000 awarded to the technology companies such as Apple and Microsoft top five entries. The winner, a doctor in Switzerland, have benefited from for years, as have Walmart and developed an algorithm that predicted arrival times other highly tech-dependent businesses. 40% more accurately than the existing technology. The challenge was especially tricky for GE. Each More recently, Local Motors, an Arizona-based com- of GE’s industry sectors was at a different stage of pany that has crowdsourced vehicle design since maturity, and each business unit had its own legacy 2007, partnered with GE to debut a manufacturing software issues that constrained product innovation. process and increase by an order of magnitude the “We have to face the limitations on the ecosystem,” number of products designed and market-tested in Immelt says. “We started from the idea of asset op- the appliances division. timization and no unplanned downtime, but in the GE has also partnered with potential competi- end, the maximum customer value is going to be in tors, including Intel for sensor technology, Cisco for the ecosystem. How open do we want this to be? How network hardware, Accenture for service delivery, far are we willing to go?” and Amazon Web Services for cloud delivery. As Ruh To build out its ecosystem, GE is experiment- notes, “One big fear when partnering with compa- ing with different types of partnerships. Joint ven- nies like these is the competitive risks.” Immelt says, tures, for example, let a smaller concern run with a “We partner with competitors. We know there’s going discrete idea, keeping it free of GE’s internal pres- to be tons of things we learn and share or give away. sures. Caradigm, a 50/50 joint venture formed by GE You can say on the outside, ‘You are opening up Healthcare and Microsoft in February 2012, devel- Pandora’s box. You’re going to lose some of the con- oped software to enable health systems and payers trol you have today.’ I think that’s part of the debate.” to drive continuous improvement in care. Taleris, a GE’S INDUSTRIAL The tremendous opportunities created by GE’s INTERNET joint venture between GE Aviation and Accenture digital transformation don’t come risk-free. As the that developed software and analytics capabilities Locomotives company continues on this path, it will need to keep to manage airline operations, recently signed its first BENEFITS building software capabilities and defining software multibillion-dollar deal with Etihad Airways, of the • Lower maintenance costs strategies that capture value without alienating United Arab Emirates, to predict maintenance issues • Improved availability and participants in the ecosystem. The choices it makes utilization about the openness of its platform will be crucial. and recommend preventive approaches. • Improved network velocity GE is also relying more on crowdsourcing for in- and capacity Moreover, GE’s business model will be increasingly novation. The company has invested in Quirky, a • Improved customer service tied to those of its customers.

November 2014 Harvard Business Review 97 SPOTLIGHT ON MANAGING THE INTERNET OF THINGS WHAT SMARTWOOL LEARNED FROM ITS DIGITAL CUSTOMERS Ubiquitous connectivity can reshape When executives at SmartWool, a maker to world-class athletes for guidance—an marketing and product innovation. of high-performance athletic apparel, old-school approach based on the view Digital networks, for example, can wanted to reach their core customers with that expert knowledge was scarce. V&S leverage user data and drive efficiency a new ad campaign, they went to Victors flipped the paradigm and, through in advertising and lead generation. & Spoils, an open digital advertising Facebook, recruited a community to test They can also connect manufacturers company. The V&S team quickly discovered SmartWool’s products. Six months after that the last thing SmartWool’s loyal the launch of the campaign, SmartWool directly to communities of product customers wanted was more traditional had signed up 2,500 field testers—more users and “fans”—making it possible advertising; instead these outdoorsy than 10% of its Facebook following. to crowdsource innovative ideas types were eager to participate more These enthusiastic fans bought the new with ease. meaningfully with the company. products and put them to rigorous use In thinking about product design and right away. But the real bonanza for marketing, SmartWool had always looked SmartWool was that the testers flooded

Beyond GE ValueAct is working with iMatchative to create inte- GE is just one of many companies being completely grated data platforms—from fund performance to reshaped by the new ubiquity of digital technology. novel investor and fund-manager psychometrics— Microsoft’s CEO, Satya Nadella, is trying to move his and more-streamlined, digitized decision processes. company past reliance on sales of its packaged soft- The list goes on. ware to remake it as a provider of cloud-enabled productivity services that operate on any platform or de- Approaching Digital Ubiquity vice. Microsoft’s transformation will recombine and Over time, digital technology and the internet of restructure every one of its products and businesses. things will transform virtually every sector and every And as core applications such as Outlook and Office business. Here’s how you can embrace them, using rapidly turn toward service-based business mod- lessons from the companies we studied: els (Outlook.com and Office 365), Nadella and his Apply the digital lens to existing prod- team are looking at new monetization approaches. ucts and services. We still live in an analog world. Revenue from packaged software is giving way to However, over the next five years many business value capture based on customer usage. components will be digitized to enable a new range Like GE, Ford is working in a variety of partner- of products, services, and business models. Consider ships to create information-based offerings and is how Uber has transformed transportation services by structuring new relationships with major Silicon digitizing all aspects of reservations, tracking, billing, Valley players. CEO Mark Fields is investing in the de- customer service, driver performance, and ratings. velopment of new business models: Ford and Zipcar What cumbersome processes in your business or have experimented with car-sharing on U.S. college industry are amenable to instrumentation and con- campuses, and Ford is piloting a Zipcar-like program nectivity? Which ones are most challenging to you or in Germany. In cooperation with other start-ups, your customers? Ford is working on services such as enabling drivers Connect your existing assets across com- to reserve parking spaces and enforcing residential panies. If you work in a traditional analog setting, parking rules. And it is looking to create on-demand examine your assets for new opportunities and look ride-sharing. Meanwhile, Daimler has established a at other industries and the start-up world for new car-sharing service, car2go, that operates in 26 cit- synergies. Your customer connections are especially ies in Europe and North America, and it recently ac- valuable, as are your knowledge of customers’ needs quired RideScout, an Uber rival that operates in 69 and the capabilities you built to meet them. Nest is cities in North America. connecting with public utilities to share data and op- Bank of America is investing in its relationship timize overall energy usage. If you work in a start-up, with the investment platform Wealthfront, bring- don’t just focus on driving the obsolescence of es- ing analytics and automation to consumer portfolio tablished companies. Look at how you can connect investing. The bank is now using Wealthfront’s ser- with and enhance their value and extract some of it vices to manage more than $1 billion in investments, for yourself. rather than relying on its traditional portfolio choice Examine new modes of value creation. What and optimization processes. In the hedge fund arena, new data could you accumulate, and where could

98 Harvard Business Review November 2014 DIGITAL UBIQUITY HBR.ORG SmartWool customers asked for more color choices in their socks. the company with novel insights about in ads featuring its field testers and their the products’ performance, suggested innovations. The campaign has performed improvements, and offered ideas for new well online and in print, improving both products. For example, fans requested brand message retention and e-commerce that SmartWool add thumbholes to conversion. Executives at V&S and its jacket sleeves so that they could SmartWool say they were surprised by function as mittens. They also wanted the customers’ passion and acknowledge lighter-weight running socks in a broader that they could never have tapped into it selection of colors. The company’s without the digital connection. Now that designers accommodated them. SmartWool has opened the channel to The whole process culminated in an fans, it’s finding new ways to bring them advertising campaign. V&S incorporated into every part of the product innovation SmartWool’s new embrace of its crowd and marketing development processes.

you derive value from new analytics? The industrial to the same economic trends and potential shocks and consumer printing company 3D Systems is cre- that affect them. GE is going to absorb a lot of busi- ating platform- and service-based business models ness risk for its customers, but it has the financial that go beyond selling hardware and consumables. understanding and capabilities to manage that risk. How would recombining the components of your Smaller players will need to reach out to the financial business give rise to new opportunities? How could sector for some carefully considered ways to cope the data you generate enable old and new customers with potential downsides. to add value? The new ubiquity of digital technology and Consider new value-capture modes. Chances connectivity will have profound implications for are that digitization will deflate some of your old the economy at large. The fortunes of Fairfield, models but will also create interesting new opportu- Connecticut, where GE is based, will increasingly be nities. SAP’s cloud efforts allow it to charge custom- tied to the weather at a wind farm in Germany, or to ers for only the features they use, enhancing its abil- the operating efficiency of an airline headquartered ity to acquire new customers. Could you do a better in Abu Dhabi. Pressure on regulatory bodies will in- job of tracking the actual value your business creates crease, and traditional institutions—from Fanny Mae for others? Could you do a better job of monetizing to the U.S. Food and Drug Administration—may be that value, through either value-based pricing or unable to keep up. Inadequate regulation and a lack outcomes-based models? of transparency in financial instruments and institu- Use software to extend the boundaries of tions drove the global economy off a cliff in 2007– what you do. Digital transformation does not mean 2008. In a world in which complex relationships that your company will only sell software, but it will across companies and industry segments may not shift the capability base so that expertise in software always be understood, let alone transparent, some- development becomes increasingly important. And thing similar could occur. Booms and busts may be- it won’t render all traditional skills obsolete. Your come sharper and more violent. Furthermore, risks existing capabilities and customer relationships are will be increasingly difficult to identify and manage, the foundations for new opportunities. Invest in making busts harder to predict. software-related skills that complement what you But no opportunity comes without risks, which have, but make sure you retain those critical foun- are best handled with awareness and transparency. dations. Don’t jettison your mechanical engineering Individual investors, companies, and institutions wizards—couple them with some bright software should work to understand new assets, new connec- developers so that you can do a better job of creating tions, and new dependencies. Institutions should and extracting value. ensure that connections are transparent and that the powerful are held accountable for the impact of their New Structure and New Risks decisions. Our hope is that this wave of opportunity Outcomes-based business models create new de- will couple enthusiasm with reason. If the potential pendencies and risks as well as revenue opportuni- downsides are managed well, the short- and long- ties. You will depend on the ability of your custom- term rewards will be dramatic.

COURTESY OF SMARTWOOL COURTESY ers to operate successfully, and you’ll be sensitive HBR Reprint R1411D

November 2014 Harvard Business Review 99 SPOTLIGHT ON MANAGING THE INTERNET OF THINGS SPOTLIGHT HBR.ORG ARTWORK Chris Labrooy Darty, Gadget Portrait (designed with Zeitguised)

With Big Data Comes Big Responsibility An interview with MIT Media Lab’s Alex “Sandy” Pentland

ig data and the “internet of things”— in which everyday objects can send and receive data—promise revolutionary change to management and society. But their success rests on an assumption: that all the dataB being generated by internet companies and devices scattered across the planet belongs to the organizations collecting it. What if it doesn’t?

Alex “Sandy” Pentland, the Toshiba Professor of senior editor Scott Berinato, Pentland talks about Media Arts and Sciences at MIT, suggests that com- how the New Deal is being received and how it’s panies don’t own the data, and that without rules already working—in a little town in the Italian Alps. defining who does, consumers will revolt, regulators will swoop down, and the internet of things will HBR: How did you come to be concerned about fail to reach its potential. To avoid this, Pentland has data collection and privacy? proposed a set of principles and practices to define Pentland: In my research at the Media Lab, I use the ownership of data and control its flow. He calls wearable sensor technology that measures tone of it the New Deal on Data. It’s no less ambitious than voice, movement, gesticulation—innate behaviors— it sounds. In this edited conversation with HBR to collect very personal data about how people

November 2014 Harvard Business Review 101 SPOTLIGHT ON MANAGING THE INTERNET OF THINGS

communicate with one another. When I started individual whose data is collected. People would that work, I was impressed by the power of the data have the same rights they now have over their being generated, but I also saw very quickly how it physical bodies and their money. could be abused. Collectively, we now have data that could help So it’s not just guidelines—you’re proposing rules green the environment, create transparent govern- under which people can control data about them- ment, deal with pandemics, and, of course, lead to selves? Yes. The New Deal would give people the better workers and better service for customers. But ability to see what’s being collected and opt out or obviously someone or some company can abuse that. opt in. Imagine you had a dashboard that showed what your house knows about you and what it And the internet of things exacerbates this con- shares, and you could turn it off or on. Maybe cern? I think so. Data is data, regardless of how it’s there’d be some best practices concerning that data. generated. If anything, the internet of things helps Then people wouldn’t get so flipped out, because people see what they’re actually doing. When you they’d know what was going on and why it was go- pick up the kids, how fast do you drive? How much ing on, and they could control it. food do you eat in a week? How much time do Transparency is key. The data being recorded you spend in your kitchen? In your bedroom? Data about you will form a fairly complete picture of your points like these make people feel invaded. As sen- life. You need somewhere to store and manage it, sors are built into more and more products, there’s because it’s very valuable when it’s together in one a sense of being increasingly spied on. place. Seeing all the patterns of your life allows you to personalize medicine, personalize insurance, per- So when consumers become aware of data collec- sonalize finances. The question is, Who’s going to tion, they start to ask, “Is it really okay that I’m hold the complete picture? Some credit-rating ser- letting a company collect information about my vice? I hope not. Google? No. Is it going to be the indi- workouts and heart rate?” Yes. And some consum- vidual? I hope that’s the way we end up going. ers may decide they’re fine with it. But right now there’s no notification that people are spying on you, Are companies afraid that if they’re transparent collecting data. It’s a big, ongoing battle among in- with customers, then customers will opt out? A lot dustry and regulators and consumer groups: Do you of companies are afraid that this kind of regulation have the right to know what people are collecting? will kill their business models, and in some cases they may be right. Many telecommunications com- You believe that people do have a right to know. panies, for instance, have tried to get permission How did the idea of the New Deal on Data form? from customers to share data. They’ve spent hun- I thought we needed to create a win for customers dreds of millions of dollars on it and have gotten ba- and citizens, a win for companies, and a win for sically nowhere. Look what happened when Do Not government. In 2008 I wrote a policy piece for the Call became an option. World Economic Forum, which continued as a se- So some businesses may disappear, but that’s ries of meetings and follow-up pieces. It laid out the probably good—the economy will be healthier if the power of this data, and the disaster scenarios, and relationship between companies and consumers is the idea of a total reset: the New Deal on Data. more respectful, more balanced. I think that’s much more sustainable and will prevent disasters. The term “New Deal” has historical resonance and connotes huge ambition. Was that deliberate? Yes— You mean real disasters, not your garden-variety that’s exactly why I chose it. The original New Deal data breach? I don’t mean just credit cards being in the United States was a reset, and it turned out to stolen. I mean people selling data out the back, and be a pretty good thing for at least 50 years. It really criminals using it for some enterprise that affects changed the way people thought. critical systems, and people dying as a result. If that kind of disaster happened, there would be an over- What, speciﬁcally, is the New Deal on Data? It’s a reaction: Shut it down. You’d see very strong regula- rebalancing of the ownership of data in favor of the tion passed overnight, and a lot of companies would

102 Harvard Business Review November 2014 WITH BIG DATA COMES BIG RESPONSIBILITY HBR.ORG

be in deep trouble. That’s what I’d like to avoid, because big data and the internet of things can create a lot of positive change. The New Deal gives customers a stake in the new data economy; that will bring first greater stability and then eventually greater profitability as people become more comfortable sharing data.

The internet of things seems to put data generation and collection into exponentially more mission- critical systems: supply chains, power grids, cars, food, health care. As the data gets closer to our physical selves… It already is. For example, something like two million people are running around with wireless pacemakers in them. Somebody can wirelessly look at your heart rate, and that’s already The New Deal rebalances the yielding great improvements in health care. I can also see terrible outcomes if the owner of the heart ownership of data in favor doesn’t control that data. of the individual whose data Businesses are investing billions in strategies that rely on unfettered access to data. Google bought is collected. Nest. Face book acquired WhatsApp. Wearable health tech is taking oﬀ. These companies want to own all the data about consumers’ health, location, preferences, and behaviors. Well, if you’re in the form of data breaches and damage to critical an internet company, you look at the New Deal on systems. Not only is it expensive to maintain secu- Data and you say, “This is nuts.” These companies rity, but breaches will become increasingly expen- are going to have to work hard to show their cus- sive. The FTC has made it very clear that it’s going tomers the value in collecting all this data. I was at to come down hard on them. And along with finan- a World Economic Forum meeting where Nest was cial risk, there’s brand risk. Target has really suf- explaining what it does, and there was practically fered from a breach that wasn’t even its fault. It just a revolution in the room. You mean Google is now failed to catch somebody who was inserting a little going to know the temperature in my kitchen and bit of software—accessed through an HVAC system, when I went into the living room? It was like “Over speaking of the internet of things. I think companies our dead bodies!” don’t realize that these strategies contain poison that People are OK about sharing data if they believe can come back and bite them. they’ll benefit from it and it’s not going to be shared Then again, if you’re in a regulated industry, such further in ways they don’t understand. That has as telco, or banking, or health care, you need a license shaped some of the legislation that’s coming out of to operate and you haven’t really been able to mon- six years of work on the New Deal on Data, such as etize your data. The regulator says you can’t get into the Consumer Privacy Bill of Rights proposed by the the data business; it’s not your data. Regulators are Obama administration and the EU’s data protection now beginning to say to these enterprises, you can directives. This kind of legislation is going to kill a get into the data business if you respect the New Deal lot of weird “Let’s collect everything about every- on Data. The key is that they have to abandon the body” strategies. trick-and-trap of internet companies’ EULAs [end- Those strategies may not be as good as the com- user license agreements] and complex terms and panies believe, either. I don’t think companies real- conditions, where we all have to click “I Agree.” The ize that the costs of a “grab all the data” strategy are New Deal actually engages customers, which could

DANA SMITH very high. They’re taking on huge amounts of risk be much more valuable in the long run, because

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you’re building trust. But I can see how for internet rest of Europe. In Trento, Italy, hundreds of families companies it’s a little scary to start down this road. are living with the New Deal on Data. They get notification and control of data generated about them. How do you answer the CEO who says, “Look, it’s It’s securely shared in an auditable way. And guess good you’re thinking about this, Sandy, but you’re what? These people share a lot more than people hampering innovation. We need to collect this data. who don’t live under New Deal rules, because they We’ll ﬁgure out how to make it secure and make trust the system and recognize the value in sharing. sure people are comfortable with what we’re col- Being confident about your personal data makes for lecting.” I think that’s exactly wrong. Look at the a better economy, not a worse one. financial industry, for instance. Starting in the 1800s, Trento is a collaboration with Telecom Italia and it was basically unregulated, and we had booms and Telefónica (disclosure: I sit on the advisory board of busts that destroyed huge swaths of the economy Telefónica), and it is a way of anticipating data pro- and ruined many families and communities. That’s tection regulation in the EU. We’ve used software called openPDS, developed by my group at MIT. It stands for “open personal data store,” and it allows Who’s going to hold the people to see what data companies have and to share data in a secure, safe way. The idea of the Trento experiment is to ask how people feel about this way of complete picture of your sharing data, how they use it. A big question is, Does an openPDS environment life? Some credit-rating generate more innovative services or fewer? The answer seems to be that you get more, because con- service? Google? sumers have explicitly trusted you with their data, so you can offer services you never would have been able to offer before because it wasn’t safe. A simple example is sharing financial data with peers. When where we are with personal data. People say per- anonymous sharing is safe, you get new sorts of ap- sonal data is the new oil of the internet. What they plications that rely on the trust and security of the mean is that it’s a new asset class, a new value, a openPDS platform. new money. And we don’t have the regulations to treat it like the value class it is. We need data banks. Can this scale? Absolutely. We’ve had extensive We need data auditing. We need them in order to discussions with companies that have hundreds of avert huge disasters from breaches and attacks and millions of customers, and yes, it can. class action suits. The FTC has said it’s going to go after data collection, and the only thing that limits Are you hopeful the New Deal will truly come into it is that it doesn’t have enough lawyers. But it may being? I’m quite hopeful, actually, because people get more lawyers if it collects a lot of big fines. are fed up. They’re cynical. If you ask what they What happened when finance was regulated? worry about, identity theft comes in ahead of nu- Less volatility, greater trust, and more-successful clear war. They don’t do much about it because they financial institutions. People will be more willing to don’t see that they can do much, but the New Deal is share data if they’re confident that it’s safe to do so. a good, plausible thing we can do today. Regulators Right now there’s lots of data you would never share. believe in it. Computer scientists believe in it. Smart You’d never share the location of your kids. You’d people who are the heads of tech companies think never share certain financial things you do. If this we can do this. They may not be in favor of it, but was a regulated industry, you might feel comfortable they think we can do it. It simply requires that cre- sharing personal data. ative businesspeople harness the will of consumers in order to construct a value proposition better than Is there any evidence that data is like money in this the current steal-all-your-data paradigm. We’ve just way? Yes. We’ve set up some safe-harbor areas in got to push on through. Europe—cities that run by different rules than the HBR Reprint R1411E

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Reddi Kotha is an assistant professor at Singapore Management University. Phillip H. Kim is an associate professor at Babson College. Oliver Alexy is a professor at Technische Universität München in Germany. ANGUS GRIEG ANGUS TURN YOUR SCIENCE INTO A BUSINESS

Allen-Hoffmann is now the CEO and chief scien- to sell the technology to Chrysler and Ford. He was tific officer of Stratatech, a company that develops turned down. Then in 1969, Ford introduced a car skin substitutes for therapeutic and research pur- with intermittent wipers, and other automakers poses. The firm holds over 20 U.S. and worldwide soon followed in the 1970s. Surprised to see the patents, and in July 2013 it received a $47 million wipers on even foreign cars, Kearns disassembled a contract from the U.S. Department of Health and wiper system that his son had bought from a local Human Services to complete the FDA approval pro- Mercedes dealer and discovered that it contained cess for its flagship StrataGraft skin tissue product. the very same technology that he had developed and The outlook for future burn victims treated with patented. So he sued. StrataGraft is promising: In one clinical trial, 19 of Despite his patent, Kearns had to fight hard to 20 patients avoided the need for painful follow-up recoup any financial reward from his invention. surgery after being treated with the new technology. Chrysler and Ford argued that he had not invented It’s a great story: A scientist makes a discov- any new components and that any expert could eas- ery and then forms a company to create a life- ily repeat the enhancements he had made. The in- saving product from it. But not all scientific en- vention was thus “obvious” in their view, meaning deavors progress so smoothly from discovery or that his patent was not valid. invention to commercial enterprise. Compare The courts ultimately sided with Kearns, who Allen-Hoffmann’s experience with that of Robert eventually received $30 million from Chrysler and Kearns, the inventor of the intermittent windshield $10 million from Ford, but the process took a huge wiper used on most cars today. Kearns struggled for amount of time and effort, and the rewards were far almost 30 years to receive recognition and financial lower than they should have been for a technology rewards for a technology that he designed, created, that is used in millions of motor vehicles. and patented in the 1960s. In this article, we’ll explore seven common in- At the outset, Kearns understood the commer- tellectual property traps and offer strategies for cial implications of his invention, and he attempted avoiding them.

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Idea in Brief THE PROBLEM WHY IT HAPPENS THE SOLUTION Many inventors struggle to commercialize Commercial success with a new technology To manage the tension, inventors must their inventions or discoveries successfully. depends on the exclusive ownership of a successfully avoid the following traps: All too often large companies, investors, critical asset or capability. But to create prematurely disclosing proprietary or others walk oﬀ with the fruits of a the technology, innovators draw on information; neglecting policeability; scientist’s work. knowledge from many diﬀerent sources. failing to demonstrate originality; Inventors who mismanage that tension overrelying on known science; failing often fail to successfully commercialize to stake out the best territory; their innovations. mismanaging attribution; and falling into funders’ clutches.

An Inherent Tension world. In the following pages, we’ll describe these The starting odds aren’t favorable. Kearns’s expe- traps and present proven strategies for avoiding rience is much more common. According to the them. The strategies are, of course, most relevant U.S. Patent and Trademark Office and the World to scientists, but innovators of all kinds will benefit Intellectual Property Organization, in 2013 about from a clearer understanding of how to manage in- 280,000 patents were issued in the United States tellectual property and improve their prospects for alone, and nearly a million were issued globally. But realizing gains from their discoveries. only about 10% of them will yield commercial benefits. And even if they do, it won’t be much: The aver- Public Disclosure age patent earns less money than it costs to obtain. Most inventors can’t wait to announce their discov- To a large extent, this dismal state of affairs eries to the world. Others are virtually compelled can be explained by an inherent tension between to do so—for academics, publication is central to commercial performance and scientific endeavor. the research process. Unfortunately, public disclo- Commercial success with a new technology usu- sure often prevents inventors from patenting their ally depends on the exclusive ownership of a criti- inventions, as Robert Perneczky, a professor at the cal asset or capability. Scientific breakthroughs, on Imperial College of London, learned the hard way. the other hand, depend upon the open exchange of In 2010 Perneczky isolated a protein in cere- ideas and the ability to draw knowledge from many brospinal fluid that could be used as a biomarker for sources. Unless this tension can be resolved, a break- Alzheimer’s disease. Perneczky’s protein promised through discovery will not get successfully commer- to substantially improve the accuracy of early diag- cialized and may not realize its full potential. nosis of the disease. When he approached his TTO To understand how to manage the tension, we with a view to commercializing his discovery, he was carried out a comprehensive analysis of more than surprised to learn that it was not interested. He had 1,000 inventions from the Wisconsin Alumni Re- already detailed exactly what he had hoped to patent search Foundation—the University of Wisconsin’s in a paper published in a leading academic journal. technology transfer office (TTO). Working with The discovery was now in the public domain, the the TTO’s senior leadership, Carl Gulbrandsen and TTO informed him. Michael Falk, we interviewed the organization’s IP Clearly, complete secrecy is not an option for managers, licensing managers, legal counsel, con- academically trained scientists who value and rely tract managers, and other staff. We attended meet- on the opinions and input of their peers. This is why ings to get firsthand knowledge of how inventions the common practice of managing IP solely through were evaluated for commercial potential. trade secrets is not a viable strategy for them. From this research we were able to identify seven To avoid this trap, inventors should limit dis- common IP traps that unwary inventors (individuals closure to the main result or to a description of the and firms alike) fall into. These traps are particularly problem and refrain from revealing information on troubling from a societal perspective: They routinely every step involved in the solution. Even these par- impede the diffusion of promising inventions that tial revelations may preclude IP protection in coun- could improve the well-being of people around the tries where disclosure requirements (such as grace

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suppliers. A crucial patent that Nestlé used to protect its popular Nespresso machine was invalidated in the UK, in part because the company had sent 40 test machines to exclusive customers in Belgium and Switzerland without requiring them to sign any confidentiality agreements. That oversight opened the door for knockoff coffee pods to enter the market. Apple also fell into this trap when the late Steve Jobs demonstrated the iPhone’s photo gallery bounce-back features in a 2007 product launch presentation. Apple did not file its patent application for this technology in Europe until five months after the presentation, and as a result, the German courts invalidated the patent in 2013.

Neglecting Policeability Process and method innovations are difficult to protect. Because most companies’ production operations occur behind closed doors, it is often impossible to tell whether a product was made using a particular process technology. That gives firms leeway to copy the new method or technology with impunity and avoid paying license fees. This was the periods, what details to disclose, and what consti- problem facing Robert Kearns and his windshield tutes an “inventive step”) are more stringent than in wiper technology. Had Robert Kearns been able to the United States. enforce his IP sooner, the outcome would most likely In all cases, we recommend filing a provisional have been much different. patent application before any form of disclosure Ideally, an inventor will build markers for a pro- takes place. To play it safe, some companies file duction technology or method into the product itself. provisional patent applications a few days (or even A case in point involves a new process for extracting hours) before any partial public disclosure. A pro- flavonoids (a compound found in red wine, purple visional patent application preserves an inventor’s grape juice, and other extracts that protects humans right to benefit from having the idea first, while al- and animals against heart attacks) from waste prod- lowing time to further develop the concept, produce uct discarded by wine growers. The inventors of the more results, and create a working prototype—in- process found a way to give their extracted flavo- formation that can be added to the full patent appli- noids a unique chemical thumbprint, so if anyone cation. If inadvertent disclosure does occur, taking used their process, a simple test of the final com- steps to file provisional patent applications immedi- pound would reveal it. ately can help to protect intellectual property. Bear Another way to protect the IP of a process innova- in mind that a full patent application must be filed tion is to turn the process into a product. One inven- within 12 months for a patent to be issued. tor team linked to our TTO came up with a method Scientists working in the context of corporate for studying stem cells in vitro while simulating con- R&D are less likely to make Perneczky’s mistake. ditions similar to those in vivo. Although the com- Large firms, at least, have standard vetting practices mercial applications for researchers and biotechnol- that legal counsel and IP managers have to approve, ogy firms were immediately apparent, it was equally formal processes for releasing information about clear that it would be hard to police unlicensed use of new inventions, and IP-related training for staff. the technology. The inventors’ solution was to turn But even then, the potential for inadvertent disclo- the method into a kit that could be sold as a product. sure remains, because firms often preview or demo With a diagnostic product readily available, users their wares to potential investors, customers, and would have little incentive to make their own devices.

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If marking products and turning processes into Consider the approach taken by Jeffrey Percival products are not viable options, inventors can also and his research associates, who developed the Star approach a producer of a larger system to see if their Tracker 5000, a device affixed on the nose of a space new processes can be embedded under license into rocket that adjusts the rocket’s altitude during flight an existing tool or platform. This transfers respon- by keeping a star in the field of view. Because the sibility for policing to upstream producers that are tracker relied on off-the-shelf components and em- better equipped to monitor the use of a technology. ployed standard production techniques, the device This was the approach taken by Charles Mistretta was much less expensive than the only comparable and his research team, who in 2003 pioneered a 3-D alternative on the market—nearly one-hundredth imaging technology that captures multiple, real-time the price. But the use of standard components also images of an afflicted area of the body and displays made it susceptible to claims that the invention them dynamically. The new technology allows doc- lacked originality. To address that problem, Percival’s tors to view vascular obstructions in even the tiniest team also embedded in the device a proprietary algo- of blood vessels. To commercialize this breakthrough, rithm for rapid transmission of the digitized images it Mistretta licensed the technology to GE Healthcare, captured. Having secured a patent for this invention, which incorporated it into its MRI machines. the team’s technology transfer office successfully licensed the entire product to NASA, which has used Failing to Demonstrate Originality the Star Tracker 5000 on at least 30 space missions Inventors often build on commercially available and high-altitude balloon flights. tools and existing techniques to generate innova- Of course, combining commercially available tions that are much more efficient, cost-effective, components with proprietary ones is easier for and better at meeting end-user demands than cur- large firms, which usually have a greater selection rent offerings. But this approach can limit inventors’ to choose from. Small firms and universities don’t ability to profit from their work, since an innovation have this luxury and are, therefore, best advised must be “novel,” appear “nonobvious” to those to find a large licensing partner that can work with skilled in the art, and contain a significant “inventive them on the adaptation. step” in order to earn a patent. In 2010, Philip Wyers faced this predicament when his hopes for a $9 million award from Master Lock were dashed by a court ruling that his invention of a locking mechanism (using a simple recombination of existing designs) was obvious. His patent was invalidated on the basis of the “common sense” principle. Inventors can avoid this fate by building additional proprietary features into their innovations. If the modifications lead to significant end-user performance improvements, inventors will be able to make a stronger case that the innovations are Overrelying on Known Science nonobvious. When an innovation is developed in Few inventions depend on an advance in basic sci- the context of corporate R&D, the firm can bolster ence; most draw on well-known causal relationships IP protection by combining the standard tools and between a particular set of inputs and outputs. This techniques with existing proprietary artifacts, algo- fact often leads to accusations that a particular in- rithms, or knowledge. If the combination leads to vention lacks an “inventive step.” If IP claims are not superior performance compared with commercially dismissed at the outset, competitors will likely chal- available tools and techniques, the firm can argue for lenge the patent’s validity, drawing the inventor into ownership rights over its version of the innovation. time-consuming and costly enforcement battles. By addressing this originality trap proactively, inven- Inventors can answer such charges convincingly tors and companies lay the groundwork for a strong if they can demonstrate that an invention is a novel enforcement strategy down the road, should others application of the known science. A veterinary pro- mount IP challenges. fessor’s invention—a knife to cut and pare horse

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hooves—provides a case in point. The invention did some cases, these rivals erect patent fences around not introduce any new science, but it addressed a the most attractive applications of the breakthrough problem—carpal tunnel fatigue for farriers—that no idea, even though they had nothing to do with the other knife on the market was expressly designed R&D behind it. to solve. To prevent this, we urge inventors to stake out Scientists can also bolster claims of originality by the best IP territory early. If they carefully identify showing that an invention involves a novel applica- the most profitable potential applications of an in- tion of materials. Consider the work of one inven- vention and focus resources on developing them, tor we studied who focused on desalination. The they can improve the return on their company’s general principles of desalination using membrane R&D investment. They should also file a provisional processes and nanofiltration technology are well patent application to protect the development work. understood. But by combining those processes with This grants the company one year to complete the a unique material—an iron-modified silica mem- research and exploit the most beneficial applica- brane—the inventor was able to make a legitimate tions of the invention. The provisional application claim that her innovation constituted a quantum is a double-edged sword, however: If the firm can- leap in desalination efficiency. not complete its research within one year, then the knowledge contained in it becomes publicly available. Hence the strategy should be used judiciously— for example, when the results can be accurately predicted and the application is for a market large enough to be worth the risk. In considering what territory to mark out, inventors need to look beyond their own direct areas of expertise. Poultry scientist Mark Cook and micro- biologist Michael Pariza provide a good example. Although Cook studied chickens and Pariza anticar- cinogens, they were both looking at conjugated lin- oleic acid (CLA)—a fatty acid with a variety of favorable nutritional properties—whose most promising commercial application lay outside both men’s areas of research expertise. Cook and Pariza had discovered that CLA can act as an anticarcinogenic, can treat certain autoim- In another, particularly striking example, a team mune diseases, and can increase lean muscle while of scientists developed a tool to improve manipula- reducing body fat. It had the potential, therefore, to tions within a microfluidic device. The tool, which be a blockbuster fitness product. The inventors en- is based on traditional pipetting techniques, uses a tered initial licensing agreements with EAS, a lead- microvalve switch to regulate the flow of fluid, al- ing sports-training and dietary supplement manu- lowing users to extract single cells or move small facturer, and at the same time filed their provisional amounts of liquids more efficiently. The valve switch patent application. Soon thereafter, other nutritional itself is far from novel, but the idea of putting one manufacturers sought to license the technology for into a microfluidic device—tremendously enhancing its weight-loss properties. the value of the tool—had never been done before. Mismanaging Attribution Failing to Secure the Best Territory Research improves through conversations with and When inventors solve big problems, many new ap- feedback from specialists from a range of domains. plications can be envisioned for the core invention. That’s why scientists attend conferences and trade Potential competitors often use publicly available shows where state-of-the-art research is presented. information (such as articles in scientific journals In such forums, specialists learn about new ideas or patent filings) to create their own applications. In and research from scholars in and outside their

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discipline. Open-source platforms offer the same opportunity to share ideas and get feedback. But this partly crowdsourced process can make it hard to figure out whom to credit with what. To complicate matters, scientists are often too generous in sharing the credit. One inventor we know of who was working on insulin-resistant animals included his technician as a coinventor, saying that without her, the work would not have been accomplished. He also pursued his work in this area because of another professor’s suggestion at a conference, and he believed that the professor should also get a share of the income. The trouble is that investing in development of commercial applications becomes less attractive to companies when credit for the invention is widely dispersed. We advise inventors to make a clear distinction between inventive steps—the making of an original conjecture—and work done under supervision. While dedicated technicians should reap some monetary reward, they should not be credited with an invention unless they were instrumental in the inventive step. Of course, it is essential to give credit where it is due. Take the case of InBae Yoon, who designed a safety trocar, a device to reduce injuries to internal organs during endoscopic procedures. In 1985 he re- Companies are generally more likely to give too ceived a U.S. patent as a sole inventor for his device little credit than too much, because they start from and subsequently licensed the technology exclu- a position of power: Employee inventors have no au- sively to Ethicon. In 1989 Ethicon discovered that a tomatic right to share the rewards from the commer- competitor, U.S. Surgical, had infringed on the pat- cialization of their invention. But that doesn’t mean ent and filed a lawsuit. Breakthrough science rarely the firm can ignore the issue of sharing credit, even occurs as a lone endeavor, and the safety trocar for internally derived inventions, because research was no exception. To develop it, Yoon had collabo- scientists usually draw inspiration from a broad net- rated with Young Jae Choi, an electronic technician. work of colleagues, which often extends beyond the Although Choi contributed to the product develop- company. Firms that rotate their scientists among al- ment, Yoon did not pay him for this effort, and their liances and joint ventures need to be especially care- working relationship concluded prior to the project’s ful about crediting inventive steps and should share completion. Yoon filed for his patent as the sole in- rewards with all those involved. ventor without acknowledging Choi’s participation. What steps can be taken to avoid attribution As the court proceedings progressed, U.S. Surgi- problems? First, agreements regarding IP ownership cal learned of Choi’s prior involvement, contacted should be formalized prior to commencing commer- him, and in 1992 took steps to correct the inventor- cial development. Keep in mind that laws differ from ship on the original patent filed by Yoon. Having country to country regarding how such agreements secured Choi’s partial ownership of the technology, should be structured and what details they should U.S. Surgical entered into a separate exclusive licens- contain. For example, in many European countries, ing agreement with him. The court subsequently companies are legally obligated to reward employees ruled in 1998 that U.S. Surgical had, retroactively, for inventions they produce as part of their jobs. It’s used the patent legally; Ethicon lost the case, and essential to document how the invention was created the appeal was denied. and who took part in it—for example, with lab records,

November 2014 Harvard Business Review 113 TURN YOUR SCIENCE INTO A BUSINESS HBR.ORG ANTICIPATING THE TRAPS Inventors are most susceptible to traps at certain phases in the discovery and commercialization process. Here are some of the most common traps and how to avoid them. diaries, or log files. In the Ethicon case, Choi’s hand- PHASE CONCEIVING AND TESTING THE IDEA writing was found on the documents Yoon had sub- In conceptualizing innovations, inventors depend on input mitted when applying for the patent, supporting the from experts from different domains and financial resources claim that Choi was a coinventor. Such precautionary from early backers. steps can prevent complications when other inven- POTENTIAL TRAPS tors make claims over a promising discovery. PUBLIC DISCLOSURE Inventors may disclose proprietary information. • Before filing for patent protection, share only partial results, rather than Falling into Funders’ Clutches full solutions, in public forums. Although some concepts may be developed on a • Require contributors to sign nondisclosure covenants. shoestring budget, others require substantial invest- MISMANAGING ATTRIBUTIONS Experts may lay claims as coinventors. ment to be fully validated and positioned for com- • Clearly distinguish “inventive steps” from supporting work. mercialization. When outside funding is required, FALLING INTO FUNDERS’ CLUTCHES Inventors may compromise their ability innovators become highly dependent on their re- to profit from their work by accepting funding under unfavorable terms. source providers. • Structure funding arrangements to ensure that funders do not reap all the benefits from the invention. Funder capture—when investors stake a claim over IP—is especially a problem for small R&D firms that enter into alliances and equity partnerships PHASE DEVELOPING THE PRODUCT with large corporations. One research team we met Few innovations constitute advances in basic science. As developed a new means of in-line cracking of gaso- inventors transform concepts into prototypes, they often line and diesel fuels prior to fuel injection to achieve reach for familiar scientific tools. a higher burning efficiency. The inventors need POTENTIAL TRAPS funding to test the technology. A large automobile OVERRELYING ON KNOWN SCIENCE If IP claims are not dismissed at the company is interested in the technology, but the in- outset, competitors will challenge the patent’s validity. vestment may have IP strings attached. • Demonstrate a novel application of scientific principles. In this kind of situation, the inventor should • Demonstrate a novel application of materials. file a provisional patent application before apply- FAILING TO DEMONSTRATE ORIGINALITY ing for funding, as this will establish their claims to • Build proprietary features into the innovation. • Combine the innovation with proprietary artifacts, knowledge, or tools. the invention, making it clear that any funding is for generating data, results, and prototypes that have MISMANAGING ATTRIBUTIONS Inventors may crowdsource elements of the been outlined in the provisional application. This innovations or rely on the work of others to develop prototypes. • Grant partial credit to contributors. strengthens the inventor’s position in subsequent • Formalize IP ownership agreements prior to commencing development. commercialization decisions and has become es- NEGLECTING POLICEABILITY It may be difficult to monitor use of certain pecially pertinent because of recent changes in U.S. inventions, particularly new processes, and to enforce a patent. patent law. Of course, any negotiation requires give- • Engineer indelible marks of an invention into a product. and-take. Funders can be offered, for instance, bene- • Embed the process invention in a larger system. fits such as royalty-free access to the technology and • License the process invention to producers of a larger system. a small share of the income derived from licensing it. Structured this way, the agreement implicitly ac- PHASE GOING TO MARKET knowledges the inventors’ prior rights. As inventors commercialize their technologies, competitors may enter the fray, preemptively launching profitable FROM STEM CELLS to alternative energy production, applications. Funders may also lay claim to income benefits. we live in an era of technological innovation. But all POTENTIAL TRAPS too often, our scientific pioneers do not reap finan- FAILING TO SECURE THE BEST TERRITORY Pursue promising markets early. cial rewards from their discoveries and sometimes • Launch applications, or file provisional patents, in the most attractive fail to successfully commericalize innovations with domains concurrently with the invention. the potential for great societal benefit. Using the FALLING INTO FUNDERS’ CLUTCHES Take prudent steps to preserve strategies outlined here, scientific entrepreneurs can commercial rights. • Grant funders initial royalty-free access to the invention. take more control over the development and com- • Grant them a share of any licensing income. mericalization of their ideas. • File a provisional patent before applying for funding. HBR Reprint R1411F

114 Harvard Business Review November 2014 © 2014 Louisiana Economic Development “Louisiana’s custom-ﬁ“Louisiana’s t solutionsprovide applied globallyfor ourclients.” us accesstotalentandresources to develop IT innovation thatcanbe at out Find dofor your Louisiana business? can What clients. industry and government toits services IT high-quality willdeliver that center technology custom-ﬁ leader, IT Louisiana’s isutilizing aglobal CGI, OpportunityLouisiana.com/CustomFit CGI FEDERAL PRESIDENT FEDERAL |CGI PEAKE JAMES DR. to the Tax Foundation and KPMG and Tax Foundation the to according U.S., the in operations business new for taxes state/local Second-lowest CLIMATEPRO-BUSINESS Park Research Lafayette’s at Louisiana of University the at center Technology HIGH-TECH FACILITY Customized workforce recruitment assistance LED FASTSTART forcosts development software production and labor on incentive State COST35% SAVINGS annually in computer science awarded degrees ofundergraduate number the triple to aimed investment state Targeted UNIVERSITY PARTNERSHIP t solutions to establish a 400-job a400-job toestablish tsolutions ® . HOW NOT TO CUT HEALTH CARE COSTS

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Robert S. Kaplan is a senior fellow and the Marvin Bower Professor of Leadership Development, Emeritus, at Harvard Business School. Derek A. Haas is a project director and fellow at HBS and a founder of Avant-garde Health.

The missteps that keep us paying too much for treatment

GEORGE KROLL/DREAMSTIME.COM GEORGE by Robert S. Kaplan and Derek A. Haas

November 2014 Harvard Business Review 117 HOW NOT TO CUT HEALTH CARE COSTS

ealth care providers could both lower costs and improve care. Field research we are conducting with more than 50 health in the United States care provider organizations, most U.S.-based, suggests much better ways to reduce costs without jeop- and much of the ardizing care and often while improving outcomes. Let’s examine five common cost-cutting mis- rest of the world are takes in detail. trying to respond Hto the tremendous Mistake #1: pressure to reduce Cutting Back on Support Staﬀ costs. Many of their The first port of call in a cost-cutting exercise is often the payroll, which accounts for about two-thirds of a attempts, however, are typical provider organization’s costs. Most administrators begin by freezing salaries and new hires. Some counterproductive, take more-drastic action by reducing head count, starting with administrative and “backroom” sup- ultimately leading port personnel along with front-desk staff. Often the to higher costs and stated reason for targeting nonclinical staff is a desire not to impact patient care. A probable unstated rea- sometimes lower- son is that the work of clinical staff is directly reimbursable, whereas that of administrative staff is not. quality care. But disproportionately cutting support staff can What’s going on? Our findings show that to iden- be shortsighted when it lowers clinicians’ productiv- tify cost-cutting opportunities, hospital administra- ity and raises the cost of treating patients’ conditions. tors typically work from the information that is most One physician told us that her department had re- readily available to and trusted by them—namely, duced administrative support to fewer than one sec- the line-item expense categories on their P&L state- retary for every 10 doctors. After the cuts the doctors ments. Those categories, such as personnel, space, had to spend much more time on paperwork, which equipment, and supplies, are attractive targets: detracted from their revenue-generating work and Reducing spending on them appears to generate sometimes jeopardized patient care—for instance, immediate results. But the reductions are usually when messages about patients’ needs were not com- made without considering the best mix of resources municated to clinicians in a timely fashion. needed to deliver excellent patient outcomes in an Our research shows that specialists’ time is often efficient manner. an order of magnitude (10 times) more costly than Health care provider organizations also try to their assistants’ time. It makes no sense to have phy- optimize the number and mix of patients seen—for sicians and senior nurses perform tasks that could instance, by pushing physicians to spend less time be done just as well by far less expensive personnel. with each patient and on treatment processes that Indeed, we found that effectively integrating more are poorly reimbursed under fee-for-service mecha- nurses and physician assistants into patients’ care nisms. Fee-for-service payments encourage physi- frees up senior clinicians to work “at the top of their cians to increase their volume of reimbursable proce- license,” performing tasks that only they can per- dures and visits, not to deliver effective and efficient form, leading to higher-quality care at a much lower care for a patient’s condition. To make matters worse, cost per patient. clinical personnel—the people who actually treat pa- This approach allowed the Anesthesia Assess- tients—are seldom involved in decisions about how ment Center (AAC) at Houston’s MD Anderson to achieve savings, which means that providers lose Cancer Center, which evaluates patients prior to out on significant opportunities for benchmarking their procedures, to reduce per-patient spending and standardizing medical practices in ways that by 45% while seeing 19% percent more patients and

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Idea in Brief THE PROBLEM WHY IT HAPPENS THE SOLUTION Field research with more Administrators typically look Administrators, in than 50 health care provider to reduce line-item expenses collaboration with clinicians, organizations, most based in and increase the volume should examine all the costs the United States, suggests that of patients seen. This may incurred over the care cycle for many cost-cutting initiatives generate immediate ﬁnancial a medical condition. This will actually lead to higher costs gains, but if the cuts are made uncover multiple opportunities and lower-quality care. without considering what’s to benchmark, improve, and needed to deliver excellent standardize processes in ways patient outcomes, they lead to that lower total costs and larger bills in the long term. deliver better care.

maintaining the same quality of care. Patients with do just two or three—even though the duration of relatively simple conditions were seen by midlevel the actual surgical procedure does not vary greatly providers rather than attending physicians, which between the two groups. The difference in produc- enabled two of the four anesthesiologists to shift tivity results from the number of operating rooms from the AAC to the operating room. This is sustain- available: High-volume surgeons generally have two, able and value-increasing cost reduction. while low-volume surgeons have only one and must Top-down spending mandates are effective wait between surgeries for the room to be cleaned mainly in aggravating the margin-versus-mission and the next patient prepared. tension between financial and clinical professionals. Our analysis shows that the cost of a second Arbitrary constraints or cuts in personnel spending, operating room is far less than the cost of a skilled uninformed by an awareness of the underlying clini- surgeon and clinical team’s idle time. This is a vivid cal and staff resources needed to deliver high-quality example of the folly of attempting to cut costs by outcomes for a variety of medical conditions, can holding down spending in isolated categories. More lead to long treatment delays, worse care and out- often than not, much higher costs soon show up in comes, and overstressed, frustrated caregivers. another category. Only by measuring the costs of all the resources used to treat a patient’s condition can trade-offs be made that lower the total cost of care. (See “How to Solve the Cost Crisis in Health Care,” Mistake #2: HBR, September 2011.) Underinvesting in Space Similarly, increasing spending on equipment and Equipment can improve care and reduce overall costs. The In our cost analyses of dozens of medical conditions, emergency department of one hospital we studied space and equipment costs were consistently an or- had three X-ray machines (two standard and one der of magnitude smaller than personnel costs. This portable). During busy periods the patient and at- finding leads to the obvious conclusion that idle tending staff often had to wait for one to become space and equipment are much less expensive than available. A financial analysis showed that adding idle clinicians and technicians. Yet because hospi- another portable machine would be cost-effective: tal systems do not measure the costs of idle space, The savings from shorter staff waits and proce- equipment, and personnel, they often make poor dure times would exceed the annual cost of the trade-offs, underinvesting in space and equipment machine—even without counting the gains from and thereby lowering the productivity of their most faster diagnosis. Unfortunately, this type of oppor- expensive resources. tunity is seldom pursued, because providers do not Here’s a case in point: We are currently study- conduct the benefits analysis that would show that ing the surgical processes for joint replacements at increased spending on relatively inexpensive equip- more than 30 hospitals, as part of a program with ment could be paid for by the savings from reducing the Institute for Healthcare Improvement. We’ve the idle time of expensive staff members (and, just learned that some orthopedic surgeons perform as important, could also improve responsiveness to seven to 10 joint replacements a day while others the patient’s condition).

November 2014 Harvard Business Review 119 HOW NOT TO CUT HEALTH CARE COSTS

sensitive to the impact of these seemingly arbitrary Mistake #3: standards on patient outcomes. Focusing Narrowly on In fact, if you measure, as you should, a physi- Procurement Prices cian’s productivity not by inputs (number of pa- Recognizing the hazards of cuts in personnel, some tients seen) but by the quality of outcomes achieved, executives aim their reductions at materials and you’ll find that physicians can often achieve greater services from outside suppliers—enticing targets overall productivity by spending more time with because these items often account for 25% to 30% fewer patients. For example, many patients with of total costs, and reducing them lets administra- chronic kidney disease eventually need dialysis. tors avoid the potentially demoralizing impact and Extensive research shows that patients have better perhaps difficult union negotiations associated with outcomes (longer lives and fewer complications) eliminating personnel. when dialysis is started with a fistula (requiring a Providers typically try to lower the costs of pur- surgical procedure to connect an artery to a vein) or chased items by negotiating higher discounts from a graft rather than a catheter. Patients with optimal suppliers. Many providers join group-purchasing starts also cost tens of thousands of dollars less per organizations (GPOs) to gain the benefits of higher year. Yet more than half of U.S. dialysis patients to- volume in their negotiations. According to the day start dialysis suboptimally, with a catheter. Healthcare Supply Chain Association, 96% of all One nephrologist told us that if he could spend acute-care hospitals belong to at least one GPO. 30 minutes counseling each patient with advanc- Yet we found enormous variation in organiza- ing chronic kidney disease, he could significantly tions’ spending on supplies, owing to variations in increase the likelihood of that patient’s starting di- the quantity and mix of items clinicians use. For alysis with a fistula or a graft. We estimate that the in- example, in our multisite study of knee replace- cremental cost of such front-end counseling would ments, the cost of bone cement varied by more be less than 1% of the additional costs incurred when than a factor of 10 (for similar patient populations dialysis starts with a catheter, and it would produce and outcomes) across institutions. This variation much better outcomes. Even if only a small incre- was not due to a few outliers; costs at the 75th- and ment of patients initiated dialysis with a preferred the 25th- percentile institutions varied by a factor of method, the counseling time would yield a very high three. The differences had two main causes: Some return in terms of future costs avoided. The provider hospitals used expensive premixed antibiotic ce- organization would capture those savings, because it ment while others used hand-mixed or plain bone is financially accountable for the total cost of the pa- cement, and hospitals varied in the average quantity tient’s care. But because institutional standards limit of cement used in each procedure. the length of patient visits, the nephrologist has little These findings suggest that many hospitals focus opportunity for such counseling. too narrowly on negotiating price and fail to exam- As another example, the hospitals in our total ine how individual clinicians actually consume sup- joint replacement study focused much attention on plies. As a result, they miss potentially large oppor- managing the costs of postoperative inpatient stays. tunities to lower spending. But many missed a large and low-cost opportunity to devote more time before surgery to setting the patients’ and families’ expectations about the length of the stay and the place to which the patient was Mistake #4: likely to be discharged (whether to home, a skilled- Maximizing Patient Throughput nursing facility, or a specialized rehabilitation cen- It would be absurd to try to increase the productivity ter). Clinicians in hospitals in the lowest quartile of of musicians by having them play faster. Yet health total costs had learned to spend more time educat- care executives force an increase in the number of ing patients and their families about the postdis- patients seen by physicians each day by establishing charge plan of care: how to prepare their homes so productivity targets that limit office visits to fixed that patients could return directly there, and the time periods, such as 15 minutes or a half hour. This need to identify a family member or another person apparent increase in productivity, however, is not to pick up the patient and assist in home care. It was

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Where Is the Pressure Coming From? Cost-effectiveness has not historically been a competitive claims). Those perceived as doing so attract more patients, imperative in health care; virtually no provider offers a low-cost/ enabling them to negotiate higher payment rates from insurers. low-price strategy, because patients—who are usually insured— This industry dynamic has contributed to the price index for do not see any benefits from seeking out low-priced providers. hospital and related services’ having grown more than twice as Instead, they search for providers with a reputation for high- fast as the consumer price index over the past 30 years. quality care. Consequently, providers compete by claiming Several new factors, however, are encouraging providers to to offer better care (though few supply data to support their become much more cost-conscious:

NEW HEALTH INSURANCE NEW REIMBURSEMENT TOUGHER THE EMERGENCE OF PLAN DESIGNS MECHANISMS INSURERS LOW-COST, LOW-PRICED Many plans now require consumers Some providers now receive In response to increased price ALTERNATIVES to contribute higher co-pays to global payments that make them resistance from consumers, Walk-in clinics, such as access upper-tier providers (those accountable for the total cost employers, and the government, MinuteClinic and others in the insurer rates as the most of caring for a patient, including insurers are taking a harder line in pharmacies and retail stores, expensive). Some, including plans care delivered by other providers. negotiations with providers. Some are starting to provide much- offered under the Affordable Care The ACA authorized Medicare to no longer allow price increases lower-priced outpatient care. Act (ACA) exchanges, exclude expand global payment models in above inflation and are reducing They could become the high-priced providers. In addition, accountable care organizations, or eliminating payments used to Southwest Airlines and Walmart insurers have introduced higher- and many private payers are support research and education. of health care, disrupting the deductible plans, with deductibles pushing in this direction as well. Further, because of the aging of expensive supply of community as high as several thousand dollars, Insurers are also introducing the population and the ACA’s care by existing providers. to make consumers much more bundled, or episode-based, increased coverage of patients under price-sensitive. As these plans payments, under which they pay a Medicaid, a greater percentage of gain market share, high-priced single fixed amount to cover all the patients are now covered by much providers can anticipate lower costs associated with the full cycle less generously reimbursed public patient volumes. of care for a patient’s condition. insurance programs.

also important to set expectations about postsur- the sidebar “Where Is the Pressure Coming From?”), gical care among members of the patient’s profes- which have incentives to reduce the total costs of sional care team, from workers in the physician’s treating covered patients, including costs incurred office to the hospital staff. at other facilities. Patients whose providers invested more time communicating about these issues had much shorter postsurgical inpatient stays. Even more beneficial, a far higher percentage of them could Mistake #5: be discharged directly to their homes rather than to Failing to Benchmark nursing facilities or inpatient rehab centers, where and Standardize rehab costs are five to 10 times higher than at home. We have also found great variations in the costs and Here, too, a modest amount of increased front-end clinical and administrative processes involved in spending often led to an order-of-magnitude reduc- treating specific medical conditions among the mul- tion in downstream costs. tiple facilities within a provider organization and Clinicians in several of our other ongoing re- even among physicians within the same facility. At search projects, especially those treating patients a private hospital chain in Germany that performs with chronic conditions, such as diabetes and con- joint replacements at a half-dozen sites, the proce- gestive heart failure, tell us similar stories. If they dure’s cost differed by as much as 30% across facili- could spend more time and money educating and ties that treated the same patient mix and achieved monitoring their patients, the total spending on the comparable outcomes. In our joint replacement patients’ conditions would decline dramatically. study, the cost of implants at different facilities var- High-level administrators, however, focused solely ied by more than 100%; another study documented on line-item expense categories on their P&Ls, of- variations greater than 500% for implant costs across ten overlook these opportunities to reduce the to- different sites. tal costs of treating their patients while improving High variation in clinical practices can occur outcomes. Such opportunities should be highly rele- even with outstanding institutions and clinicians. vant for the new accountable care organizations (see For example, Dr. John Noseworthy, the CEO of Mayo

November 2014 Harvard Business Review 121 HOW NOT TO CUT HEALTH CARE COSTS HBR.ORG Participate in the HBR–New England Journal of Medicine online forum “Innovating for Value in Health Care,” November 4 to December 15. Visit hbr.org/insights/hcvalue.

Clinic, recounted a cardiac surgeon’s saying to his adopted. Transfusions fell by 50%, transfusion- group, “All five of us are very good at what we do, related kidney disease fell by 40%, and Mayo saved but we all do it differently. At least four of us must $15 million over three years. Boston Children’s be doing it wrong.” Another surgeon responded, Hospital achieved similarly impressive results af- “Actually, probably all five of us. Let’s try to do it ter implementing a program it calls Standardized right.” Individual clinicians’ practices tend to go un- Clinical Assessment and Management Plans questioned (current practice has been described as (SCAMPs). Its first six SCAMPs, addressing areas such “eminence based,” not “evidence based”). Despite as chest pain and heart valve abnormalities, lowered multiple attempts over the years, huge opportuni- costs per episode by 11% to 51% without decreasing ties—to improve patient outcomes and lower costs— the quality of care. remain to be realized from benchmarking and stan- Unfortunately, such success stories are rare. dardizing clinical practices. Physicians, nurses, and other caregivers often do Mayo set out to achieve the benefits of greater not know the costs associated with their treatment standardization. For instance, the cardiovascular protocols. And administrators rarely collaborate surgeons learned that they all used blood transfu- with them to develop outcome and cost measure- sions differently. They got together and within a year ments that would facilitate benchmarking and best- developed blood-products guidelines that everyone practice-sharing opportunities. Actively engaging clinicians in the cost- measurement-and-management process enables them to learn the true cost drivers of a full cycle of care, from diagnosis through treatment and recov- ery. Clinicians want to improve patient care. They also recognize the financial constraints under which health care systems around the world must operate even as demand from aging populations increases. They are more than willing to search for process improvements that lower costs while maintaining or improving the overall quality of care.

HIGH HEALTH CARE costs are the result of mismatched capacity, fragmented delivery, suboptimal outcomes, and inefficient use of highly skilled clinical and technical staff. The current practice of managing and cutting costs from a P&L statement does nothing to address those problems. The only sustainable way to reduce costs is to start with an in-depth analysis of the current processes used to treat each medical condition. Clinicians and administrators need to fully understand all the costs incurred over a full cycle of care, and the outcomes, for each treatment their facility provides. With that understanding they can work together to deliver the same or better outcomes with an overall lower-cost mix of personnel, purchased materials, and equipment. As the results from organizations such as MD Anderson, Mayo Clinic, and Boston Children’s Hospital show, this path can dra- “There isn’t one.” matically improve efficiency and lower costs while continuing to deliver exceptional care.

HBR Reprint R1411G SATZ CROWDEN

122 Harvard Business Review November 2014 DIGITAL TRANSFORMATION IS THE FUTURE

George Westerman, Didier Bonnet, and Andrew McAfee of MIT and Capgemini Consulting reveal that while changes in the digital realm to date have focused on niche industries, the next phase will cast a much wider net. It is rapidly impacting the other 94% of the economy. From Nike to Burberry, Leading Digital identiﬁ es the companies that have used digital most successfully to gain strategic advantage. It oﬀ ers practical, real-life tested frameworks that you can apply instantly to transform your enterprise.

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©2014 Citrix Systems, Inc. All rights reserved. CASE STUDY 133 SYNTHESIS 138 LIFE’S WORK 144 Should companies The challenge of TV’s Norman Lear on stay out of politics? lifelong learning a big career behind the scenes

Few people ﬁnd great ideas on a blank canvas PAGE 126 MATT CHASE MATT

November 2014 Harvard Business Review 125 EXPERIENCE

ear the word “innovation,” and you might think of an HR&D lab, a design group, or a start-up venture. But today innovators are in demand everywhere—from the factory floor to the salesroom, the IT help desk to the HR department, the employee cafeteria to the C-suite. Innovation isn’t a department. It’s a mindset that should permeate your entire enterprise. No matter the venue, the feed- stock for innovation is insight—an imaginative understanding of an internal or external opportunity that can be tapped to improve efficiency, generate revenue, or boost engagement. Insights can be about stakeholder needs, market dynamics, or even how your company works. Several Fortune 500 companies have been founded on a single insight about what customers want. Starbucks brought a little bit of Italy to coffee shops. Home Depot gave do-it-yourselfers access to professional supplies. The Body Shop was built on the notion that buyers of beauty products care about humane Managing animal-testing practices. Inside your company, insights can lead to more-efficient operations, simplified processes, or leaner structures. Yourself Insights can be powerful, but how do you find them? Should you brainstorm with colleagues? Sift through masses of data? Simply introspect? Where to Or carry on as usual and wait for the proverbial apple to fall on your head? In our combined half-century of working with innovators at start-ups Look for and within large corporations, we’ve found that the best insights tend to come from sources that can be Insight categorized. We recognize that many people arrive at great ideas more or less serendipitously, but we never- Seven places to search for new ideas theless believe that it’s possible for by Mohanbir Sawhney and Sanjay Khosla individuals to approach innovation in

a more systematic way. CHASE MATT

126 Harvard Business Review November 2014 HBR.ORG Health care employees who adopted fun versions of their job titles—such as “Minister of Dollars and Sense” (COO) and “Heralder of Happy News” (PR manager)—were less emotionally exhausted than their peers. “JOB TITLES AS IDENTITY BADGES: HOW SELF-REFLECTIVE TITLES CAN REDUCE EMOTIONAL EXHAUSTION,” BY ADAM GRANT, JUSTIN BERG, AND DAN CABLE

On the basis of our experiences providing an innovative experience happens and growing concerns over with and research into entrepre- that effectively brings the store, the privacy. People express themselves neurial ventures and product- style consultant, and the cash register spontaneously on Snapchat without development groups in varied to the customer’s front door, Lamoda worrying about self-censorship. industries around the world, we have built a very successful e-commerce New social habits, technologies, outlined seven “insight channels” business, uniquely suited to the and areas of interest are forming all that can be used by would-be innova- Russian market. (See also “The CEO the time across all facets of life. The tors in any function or role. They are of Ozon on Building an e-Commerce smart innovator looks at how they fit listed below. By periodically tuning Giant in a Cash-Only Economy,” HBR, together. Ask yourself: What are the in to these channels and methodi- July–August 2014.) major economic, demographic, and cally running through them, you can The smart innovator knows to no- technological trends affecting my focus your imagination, organize tice and then follow up on surprising organization, industry, or market? thinking, spur creativity, and find data. To look for anomalies, ask ques- How do those trends intersect? For valuable ideas for growth. tions such as: Is your market share or instance, if you combine an aging Anomalies. Businesses today are revenue abnormally low or high in a population (a demographic trend) awash in data. Innovators pore over geographical market? Are you hav- with mobile connectivity (a technol- this information looking for promising unusual success with a specific ogy trend) and rising health care costs ing ideas, but often they focus on customer segment? Are some of your (an economic trend), you can mine the intersection to create services such as remote health care monitor- Many people arrive at great ideas more or ing for seniors. Similarly, if you com- less serendipitously—but it’s possible for bine the rising costs and difficulty of individuals to approach innovation in a more sourcing talent with the widespread availability of mobile video, you can systematic way. see an opportunity to create a video- based recruitment application to screen a large number of candidates means and averages, which lead salespeople unusually productive? at a low cost. to broad conclusions. Sometimes Are some of your suppliers able to Frustrations. Life’s irritations the real opportunities lie in the deliver unusually quickly? Then dig are often a terrific source of ideas. In results that deviate from business deeper. The deviant numbers may be the late 1990s Mark Vadon, a young as usual. the tip of the iceberg, hiding a valu- consultant, went shopping for an Consider an anomaly in global able insight below. engagement ring and found the expe- e-commerce. One might think that Conﬂuence. When several trends rience intimidating and difficult. The Russia, with more than 100 million come together, their intersection can system for categorizing and valuing middle-class consumers and 75 mil- be fertile ground for insights. For diamonds is complicated, and eager lion internet subscribers, would be instance, the confluence of mobile salespeople only add to the pressure. an attractive market for online retail. telephony growth, social network- Vadon reasoned that many other men However, e-commerce accounts for ing, and increasingly short attention were equally put off—an insight that a paltry 1.5% of total retail sales in spans has spurred the creation of led him in 1999 to found Blue Nile, an the country. The entrepreneur Niels social media applications including online jewelry dealer that offers use- Tonsen recognized why: The Russian Vine, which allows the sharing of ful tutorials and information on gems. postal system is very unreliable, and short videos; Tinder, a GPS-linked Today the company is the largest few consumers have credit cards. matchmaker; and Snapchat, which online retailer of diamonds and sells This insight led Tonsen to create deletes anything sent through some $250 million worth of engage- an online clothing store, Lamoda, it from the receiver’s phone in a ment rings a year—more than 4% of which employs an army of couriers matter of seconds. Evan Spiegel total sales in the U.S. market. to deliver customers’ purchases to and his Snapchat cofounders built Vadon’s experience shows the their homes, pick up cash on delivery, on two more-specific social media value of paying attention to what and even offer fashion advice. By trends: the urge to broadcast life as it annoys people and then fixing the

November 2014 Harvard Business Review 127 EXPERIENCE

Seven AnomaliesA Confluence Frustrations ExamineE deviations Find macro trend Pinpoint deﬁciencies Insight ffrom the norm intersections in the system DDo you see unexpectedly high What key economic, behavioral, Where are customer pain points Channels oor low revenue or share in a technological, or demographic for your products, services, or mmarket or segment? Surprise trends do you see? How are solutions? Which organizational pperformance from a business they combining to create processes or practices annoy pprocess or a company unit? opportunities? you and your colleagues?

problem. Put yourself in the shoes targets. But at Raytheon (a company to overcome incredible odds or solve of customers, colleagues, or suppli- to which Mohanbir Sawhney has pro- seemingly intractable problems. ers and ask: What’s most frustrating vided consulting), the 25-year veteran In May 2014 the famous Harvard about your products, processes, or Steve Ignat and his team recently law professor and activist Larry workplace? What bothers you per- upended that status quo. Lessig created Mayday, a political ac- sonally about your business? What Knowing that the United States tion committee to address the issue of work-arounds do people use to get and its allies needed cheaper, stealth- corporate money in politics. The PAC their jobs done? How could they be ier missiles to effectively target small would use community- and internet- improved upon? Can you make cus- groups of terrorists on the ground, based “crowdfunding” to raise similar tomers’ lives easier or company meet- they created a low-cost manufactur- amounts of money directly from ings less painful? Can you reduce the ing facility (dubbed the Bike Shop) citizens. As of August 25, 2014, it had hassles your suppliers face? If you feel and, without even courting a single raised $7.92 million from more than people’s frustrations, you can find customer, used parts from existing 55,000 contributors. valuable innovation opportunities. production programs to assemble Positive deviants may be vision- Orthodoxies. When something exactly those sorts of weapons. One ary customers who can help you see has always been done the same way of the missiles they built, the Griffin, trends before they become main- on your team or in your organization is now in high demand. stream. They may be manic cowork- or industry, it’s worth asking if there’s Orthodoxies hide in every orga- ers who are passionate and don’t an alternative. Traditions often nization, industry, and market. To take no for an answer. They may be block potential innovations because uncover them, ask yourself: What enlightened shareholders who can people are reluctant to abandon the beliefs do we all hold sacred? Why help shape your company’s strategy. tried-and-true. But when conditions do things have to be this way? What Innovators must look at the fringes change, so must traditions. if the reverse were true? What op- of stakeholder groups and ask: What In the defense industry, for exam- portunities would be opened up if can we learn from those who are ple, manufacturers have long focused we abandoned those assumptions most intense in their complaints or on building expensive and sophis- and beliefs? enthusiasm that we could apply to ticated missiles, such as Raytheon’s Extremities. Businesses, our company or our role? Tomahawk, that sell for more than appropriately, spend most of their Voyages. When busi- a million dollars; even the cheapest time concerned with their ness turns stale, innovators offerings, such as Lockheed’s Hellfire, mainstream stakehold- get out of their own offices cost upward of $100,000. These mis- ers. But sometimes it is to visit “customers”—whether siles are developed with customer the “positive deviants,” as that means employees they funding (from the U.S. Department Oxford University’s Richard manage, colleagues who rely on of Defense) and are custom-designed Pascale calls them, who are a their work product, or the to be smart and powerful so that they rich source of ideas or insights, people who buy their can take out tanks and other large teaching us innovative ways goods and services.

128 Harvard Business Review November 2014 HBR.ORG

Orthodoxies Extremities Voyages Analogies Question conventional beliefs Exploit deviance Learn from immersion Borrow from other industries elsewhere or organizations

Are there assumptions or What can you learn from How are your stakeholders’ What successful innovations beliefs in your industry that go the behaviors and needs needs inﬂuenced by their do you see applied in other unexamined? Toxic behaviors of your leading-edge or sociocultural context? disciplines? Can you adapt or procedures at your company laggard customers, them for your own? that go unchallenged? employees, or suppliers?

These “voyages” into different work, and behave. Ask yourself: What groups and industries to look for worlds are necessary because all are the social, cultural, and envi- analogies that they can adapt to their behavior takes place within a rich ronmental factors that affect their domains. After all, innovation is not sociocultural context; it’s impos- preferences and behaviors? How can about bringing something new into sible to understand what others are we create solutions that respond to the world. It’s about usefully applying thinking when you’re sitting alone at those factors? something that is new to the situation, your desk. Designers and product de- Analogies. Sometimes other no matter the purpose for which it velopers have long understood how teams, business units, companies, or was invented. important it is to take this anthropo- industries have adopted useful ideas logical approach. or systems that haven’t crossed the OUR LIST of insight channels has A few years ago, Jennifer border, so to speak. Can you import evolved over the years and will no Hargreaves, a manager at the finan- innovation—even from a place that doubt continue to change and grow. cial software company Intuit, was seems far removed or exotic? Other observers could probably add a tasked with creating a new version of Greg Lambrecht came up with few categories of their own. But we’ve the company’s popular QuickBooks his Coravin Wine Access System by consistently found in our research product for nonprofit organizations. co-opting ideas from the world of and work that these seven are power- Her first step was to volunteer at a surgery. An MIT-trained engineer ful drivers of innovation. Although local charity. After immersing herself and an oenophile, he grew tired of they’re most commonly used by en- in the new context—helping to man- uncorking bottles that he didn’t want trepreneurs, developers, and design- age the organization’s accounts for to finish in one night, only to have ers, they can help you in any role and a few months—she noticed sharp the fine wine start to oxidize and any context where new thinking is differences between for-profit and deteriorate. Wouldn’t it be wonder- required. Few people find great ideas nonprofit financial management ful to be able to drink just one glass on a blank canvas. Most of us need processes. The focus was fundraising, while leaving the rest perfectly our imaginations channeled. not sales, and donors, not customers. preserved? He knew that surgeons HBR Reprint R1411H This on-the-ground research helped had started using extra-fine needles her brainstorm extra features—such to ensure minimally invasive surgery Mohanbir Sawhney is the as the ability to track donations, and wondered if the same type McCormick Foundation Chair of Technology and the director of the pledges, and grants separately and of needles could be used to draw Center for Research in Technology & to allocate expenses to particular wine from a bottle. He tested and Innovation at Northwestern University’s initiatives or programs—for the developed the idea over more than a Kellogg School of Management. Sanjay Khosla is a senior fellow at Kellogg and new QuickBooks Premier Nonprofit, decade, and despite a few setbacks, was formerly the president of developing which she later launched to positive Coravin has been well reviewed and markets for Kraft Foods (now Mondelēz reviews and sales. is now widely available. International). They are the coauthors of Fewer, Bigger, Bolder: From Mindless Anyone can make similar voyages. We advise innovators to study a Expansion to Focused Growth Learn how your stakeholders live, wide range of unrelated functional (Portfolio, 2014).

November 2014 Harvard Business Review 129 SPONSORED SECTION

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When Harold had approved the super-PAC donation a few months before, he hadn’t thought to question Case Study how Minnesota Business First vetted candidates on social issues. And even when Erikson shifted to his hard- line stance on gay marriage, Harold Do Business hadn’t anticipated how big the rami- fications would be for Natural Foods. Customers had staged protests at several of the company’s larger and stores in San Francisco, Los Angeles, and Minneapolis, and many of its 10,000 employees had signed a letter to Harold asking that Natural Politics Mıx? Foods explain its support of Erikson. Several senior executives privately A CEO struggles with the fallout from a controversial expressed concern that their gay and campaign donation. by Brian K. Richter lesbian team members were feeling alienated. With the help of Betty Martin, Natural Foods’ head of gov- s soon as Harold Leeson, the super PAC called Minnesota Business ernment relations, Harold had issued CEO of Natural Foods, pulled First. The company had chosen to an internal statement saying that A into the parking lot of his support the group because of its the chain’s donation did not mean company’s headquarters, his phone plan to fund ads promoting political that Natural Foods endorsed all the rang. It was Kenneth King, one of candidates who had strong pro- views of the candidates Minnesota his board members. Harold braced business platforms in the upcoming Business First supported and that the himself before answering. elections. However, in a last-minute executive committee and the board “This is a total mess,” Ken said push to court conservative voters would be reviewing its policy on immediately. in a tight race, one of those candi- campaign donations. “I know,” Harold replied, exhaus- dates, Pat Erikson, a rising star in “I saw your letter to the employ- tion creeping into his voice. “But our the Minnesota Republican Party, ees, and that was the right message,” publicity team is telling me it’s going had taken a strong stance against Ken said. “Make it clear that Erikson’s to calm down soon—people will gay marriage, saying that he’d vote position is not what Natural Foods forget about it.” against any bill to legalize it. Much to stands for; we’re a socially progres- “Which people? The media? Our Harold’s dismay, Natural Foods was sive organization.” The company was employees? Our customers? Because now equated with that position. known for being a generous donor to a lot of people are upset with us “I’m not happy about it either,” nonprofits, both in Minnesota and right now. And personally, I think Harold told Ken. “You in other states where it had stores; it they have a right to be.” know more than anyone gave 5% of its pretax operating profits The trouble had started how much I don’t want to charity each year. several weeks earlier, the word ‘antigay’ associated “But we need to take it a step fur- when the StarTribune ran with Natural Foods.” The two ther,” Ken continued. “As someone a story about the donation men had discovered early on who gets paid to think about risks that Natural Foods, a mid- in their 10-year working rela- that you and your team don’t see, size chain of organic grocery stores tionship that each of them had this is where I need to advise you to based in Minneapolis, had made to a a gay son. avoid making the same mistake again.

HBR’s ﬁctionalized case studies present dilemmas faced by leaders in real companies and oﬀer solutions from experts. This one is based on the Ivey Publishing Case Study “Rethinking Political Activity at Target” (case no. W12350-PDF-ENG),

KYLE HILTON by Brian K. Richter and Anisha George, which is available at hbr.org.

November 2014 Harvard Business Review 133 EXPERIENCE

Natural Foods should get but politics is getting too give it more time, not make any rash out of politics.” dangerous,” Ken retorted. decisions. I know you’ve been hesi- Harold had known that this “I’m not even sure we’re getting tant about our super-PAC donations. would be Ken’s take on the situa- the results we want from these But we need to do everything we can tion. Ken had always argued that the donations.” to get access to politicians who are world of campaign donations and “We’ve gone over this before,” potentially sympathetic to us.” lobbying was a minefield that sooner Harold said. “Betty has made it clear “Right. But I just spoke to Ken, or later would result in a crisis, just that supporting these PACs isn’t and you won’t be surprised to hear like this one. But he was outnum- about buying legislation or votes, but that he thinks this is a sign. Perhaps bered by fellow directors who it does give us a voice. Do you think we do need to rethink what we’re thought that ignoring politics was I would have gotten a meeting with doing in politics—though I know that even riskier. There were many policy the governor on 24-hour notice if would have big implications for you.” issues, from taxes to food regula- we hadn’t been a donor?” The year “This isn’t about me,” Betty said tions, in which the company needed before, the Minnesota legislature curtly. “It’s about what’s best for a say if it was to remain a successful, had taken up a GMO-labeling bill Natural Foods. It’s absurd to think profitable business and realize its that, if passed as written, would have that a company our size doesn’t mission of getting healthful food into imposed requirements inconsistent need influence in Saint Paul and the hands of more people. with those in other states, forcing Washington. How would you feel “Everyone likes to say it’s im- the company to change its label- not having a voice in the debate on possible,” Ken said now. “But look ing system and costing it millions the definition of ‘organic,’ or in the at Starbucks, Costco. They don’t of dollars. Harold had secured the conversation on import tariffs for the make federal campaign donations. governor’s word that he would veto specialty products our customers They don’t lobby Congress. And the it and encourage state lawmakers to demand? When the farm bill comes Supreme Court’s decision in Citizens focus on rules more consistent with up in Congress this year, do you want United hasn’t changed their position those in place elsewhere. a say or not? These are things that on that.” “Please. We’re one of the biggest affect our business model. We’d be “Come on, Ken. That’s all true, employers in Minnesota. We’d silly not to give ourselves access to but those companies are in politics. have that access even if we decision makers, especially since They’re just involved in ways that didn’t make donations.” our positions on all these issues don’t leave obvious ‘receipts’ lying “That’s not what Betty are subtle. We can’t explain around for the national media to find. says,” Harold replied. them with philanthropy or We’ve built our reputation on doing “Let’s talk to her about reduce them to marketing the right thing for people—our cus- this at the board meeting.” sound bites.” tomers, our employees, the environ- “You know what her posi- Harold knew she had a point, ment—and most of the issues we get tion is going to be,” Ken said. “She but he wasn’t fully convinced. involved in put those stakeholders doesn’t want to jeopardize her job.” “The StarTribune article said that only first. Think about how we support 10% of publicly traded companies the expansion of federal food educa- No Way Out? lobby at the federal level, and only tion and safety programs. We need Harold was opening his car door half the S&P companies make cam- political clout to make those things when the phone rang again. It was paign contributions. I didn’t believe happen. And it doesn’t cost us much; Betty. He was sure the conversation those numbers at first, but I checked it’s a tiny percentage of our revenue.” would be one he didn’t want to have them. Even in a post–Citizens United Brian K. Richter Harold looked out his car window walking the halls, so he closed the world, it seems we’re the outlier here.” is an assistant and saw several employees wave at door and leaned back again. “But we’re already in the game— professor in him on their way into the office. “Listen, Harold. I hope you’re not and playing it successfully, in spite the Business, Government, He was usually one of the first to panicking this morning.” of this situation with Erikson,” Betty and Society enter the building, but this call was “Is there a reason I should be? said. She explained that Starbucks Department at holding him up. More protests?” and other companies had adopted the University of Texas at Austin’s “We can maintain that reputation “No, no. Like I said last night, it’s policies against campaign contribu- McCombs School. by giving to charities and nonprofits, already dying down. We just need to tions early on. And although Howard

134 Harvard Business Review November 2014

EXPERIENCE The Experts Respond

consequence should be actively Campaigns generate controversy engaged in the political process, and debate, which the media will and that includes political giving. cover. It’s how you handle yourself Once in office, candidates are likely in such situations that matters. to give reasonable access to those As long as Harold and his team who helped them. are clear on what the company In today’s world, where busi- stands for, Natural Foods can ness is highly regulated, corporate survive those storms and retain leaders who insist on staying out the access to government decision of politics may be neglecting their makers that gives it a place at the Ken Cohen is the vice fiduciary responsibilities. Not only table in policy debates relevant president of public and is Ken King’s stance unrealistic to its business. government affairs for for Natural Foods, but it could damage shareholder value over Exxon Mobil Corporation. the long term, leaving the company at the mercy of too many external Answers from the IN MY VIEW, the heart of this players. At Exxon Mobil, where hbr.org community controversy is actually manage- I head up our company’s PAC, we ment’s reaction to the accusations see campaign donations as an Go with a lobbyist of discrimination. The company’s important way to stay involved in The company should allocate all first priority should be to clarify its political discussions. After all, few its campaign contributions to a position on the issue of gay mar- industries are more closely regu- lobbyist or a lobbying firm, which riage and thus change the percep- lated than energy. would advance Natural Foods’ tion that Natural Foods shares the When making contributions, we interests but without the exposure. candidate’s view. As it is, events are seek out candidates who have a The lobbyist would also use the defining the company’s stance. history of supporting open markets, money more effectively, targeting An internal statement from the understand business, and have specific issues that are important CEO, especially one that sounded demonstrated a willingness to hear to Natural Foods, such as import as defensive as his did, is not the facts involved in a particular tariffs or farm bills. enough. Harold (or a designated debate. We certainly don’t expect Alex Chang, consultant, spokesperson) must say that a candidate we’ve supported to Cerner Corporation vote in our favor 100% of the time, Natural Foods but we do seek to have a voice in Align actions with values the debate. Camilla, the general What are the company’s values, shouldn’t give up its counsel, suggested better vetting of and how do its actions align with role in the political candidates, but of course that’s not them? As an employee, a customer, always possible. We focus on the or an investor, I would want to know process because of candidate’s positions on issues that the answers to those questions long this one incident. are core to our business. before a crisis occurred. Recently we’ve had some inves- John Calia, CEO group chair, tors who shared Ken King’s views Vistage International Natural Foods opposes discrimina- and introduced proxy proposals tion of any kind—period. Then his that would impact our ability to Protect the brand team needs to get that message influence policy making. To date, Natural Foods should withdraw, out in a variety of venues—blog however, these initiatives have for three reasons: (1) Issue advocacy posts, in-store displays, a CEO not gained much support from can be done without direct political interview or two. other shareholders. contributions; (2) election out- That said, Natural Foods should Natural Foods shouldn’t give comes and popular thinking create not stop making campaign dona- up its role in the political pro- risks that lobbying cannot manage tions. Any company of size and cess because of this one incident. well; and (3) the other positions

136 Harvard Business Review November 2014 HBR.ORG

of candidates that aren’t directly their company’s future—a neces- In my view, lobbying is a far bet- relevant to the business may create sity if they want to be engaged in ter use of corporate funds. Although risk for the overall brand. the political process and to secure I have reservations about how it is Robert J. Choi, principal, RJC & Co. beneficial tax legislation and busi- done, at least it’s issue-specific, you ness contracts. But this argument have more control over where the Stay away from PACs has many flaws. money goes and how it’s used, and Political endorsement is very For one, when a company gives you get more-specific and docu- different from issue alignment, money to a PAC (or a super PAC), mented results. and getting behind a PAC that it has no control over how the Wasted money is one risk. A supports a slate of candidates is money is ultimately spent, as the damaged reputation is another. always a high-risk proposition. Natural Foods case makes clear. The more corporations dominate I would never advise a client to get involved with a PAC; too many of them have dubious practices Lobbying is a far better use of that go unchecked. If you favor corporate funds. You have more what the PAC advocates, align with a legacy organization in the issue control over where the money goes. sector that is publicly accountable. Art Stewart, vice president for corporate development, Maine Pointe Even if your donation goes the political system, the greater directly to a campaign, you the chance of public backlash. can’t ensure that your candidate, Natural Foods customers have if elected, will feel beholden to you reacted to a particular contribution, on every issue. Elected officials and that is certainly a danger. But decide on hundreds, if not thou- a growing number of Americans sands, of pieces of legislation each see the issue more broadly: They year, and because of the way the don’t want to support companies system works, they have to make that try to “buy” politicians and deals and trade votes, which corrupt the system. can work against your interests. To protect Natural Foods from Politicians have also been known this future, Harold should tell the to pass some of their own cam- board he wants the company to paign money on to others to secure stop making campaign contribu- a vote, a committee assignment, tions. I introduced shareholder John Harrington is the or a leadership position. Your resolutions to this effect at president and CEO of influence as a corporate donor is Starbucks and at the health care Harrington Investments, extremely limited, and your dona- provider WellPoint. They were tion may actually be put to work voted down, because executives a registered management against you. and other investors wanted to advisory firm. There is another problem, which reserve the right to make donations Betty Martin touches on: Who at some point in the future. This KEN KING is mostly right when he decides which political action com- was shortsighted and will come says that Natural Foods needs to mittees or candidates to support— back to haunt management. get out of politics. Political dona- a board committee, the CEO, or If Natural Foods continues to tions are not a good use of the someone else? And how can you be make political donations, it will see company’s money and, as the cur- sure that the decision maker isn’t more and more controversies like rent situation demonstrates, can be favoring donations that enhance the one it’s facing now. harmful to its reputation. his or her personal power but not HBR Reprint R1411J Executives often frame campaign necessarily the standing of the firm? Reprint Case only R1411X contributions as investments in Some CEOs do this. Reprint Commentary only R1411Z

November 2014 Harvard Business Review 137 EXPERIENCE Have aLife Learning How toKeep by Lisa Burrell 138 Harvard Business Review Synthesis and Still and Still November 2014

A quality barlower thanshe’d like. organizations, creating new reasons contributions andmanage others, edges ofmy wonderful jobandmy courses areyou taking?” It’ll bethe we grow andadapt,sodoour worries me a little—but not because worries mealittle—but notbecause school—most ofusare.At work we’re sive openonlinecourses) aroundthe soon startasking oneanother, “What I don’t like learning. Ilike it somuch not onlyallowed butexpectedtobe new “What are you reading?” perpetual students. Aswe make our life asaparent whoalready setsthe that I’d have stayed inschoolfora few decades ifIcould havefew decades paidmy bunch ofseminarsandMOOCs(mas bills. I’m justnotsurehow I’d tucka He’s probablyright, andthat In a sense, though, I am still in In asense,though,Iamstillin colleague ofminerecently who work together will who work together will made this prediction: People made thisprediction: - While it’s notquiteit that precise, draws onalarge bodyof research directed—something that peopletake on inaddition totheirregularduties zations, families,andcommunities. stronger learning environments. as invested membersoftheirorgani But there’s abigdifferencebetween and ways em- for ustostretch.Some offers what orDie,offerswhat new book,Learn mentoring, coaching, andnetworking. provides usefulguidance.Hess plentiful resourceshave corporate professional development andstruc ployers helpby providing venues for to assumeagreater shareofit. His to view continuingto view asself- education tured learning. Andalthoughsome universities, mostcompaniesseem forward-thinking employers with he calls a“blueprint”for building he calls ity lie? EdwardD. Hess, aDarden business professor, urges companies Where should theresponsibil - - -

MALINA OMUT HBR.ORG WHAT I’M READING The Better Angels of Our Nature, by Steven Pinker (Penguin Books, 2012) “Steven Pinker’s book is a perfect example of data and history; and the data is all good. Society is safer, people live longer, and culture is deeper than ever before.” ERIC SCHMIDT IS THE EXECUTIVE CHAIRMAN OF GOOGLE AND A COAUTHOR, WITH JONATHAN ROSENBERG, OF HOW GOOGLE WORKS (GRAND CENTRAL PUBLISHING, 2014).

on the cognitive, emotional, and more seasoned colleagues, who may from people, sparking creativity, and behavioral factors that promote be encumbered by what they know so on) as various needs arise. And the learning and on the kinds of leaders, and assume. In her new book, Rookie exercises are fun, in small doses. cultures, and policies that enable Smarts, Wiseman says rookies close Reading them reminded me of my businesses to change and survive. their knowledge and skills gaps by nine-year-old’s “pre-homework”— And he holds up several exem- scanning the landscape for informa- palpating her collarbone with one plars—describing in some detail, for tion, marshaling as many experts hand and her belly with the other. instance, how the investment firm as they can, listening carefully, and It’s a trick she picked up in Brain Learn or Die: Bridgewater Associates structures making connections. When facing Gym, a program used by schools and Using Science internal conversations as debates, brand-new challenges, they work organizations since 1987 to promote to Build a Leading-Edge exploratory discussions, or teaching their way toward mastery incremen- “learning readiness” through move- Learning moments. (For more on Bridgewater, tally but quickly, conducting small ment. (“Gets your right side talkin’ to Organization see “Making Business Personal,” HBR, experiments and frequently checking your left side,” she explained when Edward D. Hess Columbia University April 2014.) in with stakeholders to mitigate risk. she caught me staring.) Brain Gym’s Press, 2014 Learning efforts can easily fall Wiseman, like Dweck, argues that creators, Paul and Gail Dennison, flat without institutional muscle working and living on a continual say that 26 activities dramatically behind them. Sure, leaders may learning curve serves people well in a improve concentration, organization, encourage employees to sign up for extra training and courses—but how “An emotionally positive environment many people will find time to engage encourages learning by mitigating the big properly, or at all, if their workloads remain the same and their studying learning inhibitors: fears, ego defenses, must be done after hours? How many complacency, and arrogance.” Rookie Smarts: will even feel safe seeking support Edward D. Hess, Learn or Die Why Learning in areas where they have “room for Beats Knowing in the New Game growth” if learning isn’t integral to of Work their organizations? fast-moving world. But what academic performance, and relation- Liz Wiseman The solution, Hess suggests, is to if that outlook doesn’t come ships, “even though it is not clear HarperCollins, 2014 create a workplace where people’s naturally to you? The consultants yet ‘why.’” Critics take issue with jobs become their classes—“where Sebastian Bailey and Octavius Black the Dennisons’ research and their learners experience a combination say you can develop it with the many claims that the program “builds, of positive support and positive chal- mental exercises they offer in Mind enhances or restores natural neural lenges.” That includes providing good Gym (recently released in the United pathways in the body and brain to role models, granting sufficient -au States, after gaining a UK following). assist natural learning.” tonomy, measuring progress through Their book is meant to help you think Dubious neuroscience aside, Brain 360s, and giving rewards such as more positively and creatively, exert Gym has something going for it: It’s promotions and stock ownership to more influence, and in general make designed to make education feel Mind Gym: fuel engagement. the most of what you’ve got upstairs. both fun and doable. That’s a real Achieve More Meanwhile, of course, individuals Despite the care that Bailey and need, given the emerging mandate to by Thinking Diﬀerently still need to do their part by honing Black take to tether their advice to sustain our learning indefinitely. Sebastian Bailey their learning skills—and adopting scholarship, their book feels a little If my colleague’s prediction comes and Octavius Black the “growth mindset” that Stanford light, maybe because the overarching true, we’ll be scouting for many of HarperOne, 2014 University’s Carol Dweck famously goals are vague (to improve “perfor- our own growth opportunities—as identified as a self-fulfilling prophecy mance” and achieve “success”). But we should, and as we’ve done all (see “How Companies Can Profit it includes some interesting tools— along. But even the hungriest of us from a ‘Growth Mindset,’” page 28). such as a brief self-assessment to will make much more progress if our Brain Gym Liz Wiseman, a leadership adviser, identify why you’re procrastinating. organizations set us up for success. www.braingym.org even makes the case that a predis- I can’t imagine plowing through all They’ll reap the benefits, too. position to learning often gives inex- of them, though you might dip into Lisa Burrell is a senior editor

IAN LANGSDON/EPA perienced people an edge over their certain chapters (on getting more at Harvard Business Review.

November 2014 Harvard Business Review 139 YOU HAVE ALL THE MANAGERS YOU NEED. CAN YOU TURN THEM INTO LEADERS?

On the front lines, new opportunities emerge quickly and competitive threats arise overnight. You need people who can anticipate and act on these challenges. You need leaders, not just managers.

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SPOTLIGHT ON MANAGING THE INTERNET OF THINGS

HBR.ORG SPOTLIGHT 64 90 100 How Smart, Digital Ubiquity With Big Data Comes Products and services of every kind are evolving Connected Products by Marco Iansiti and Big Responsibility Are Transforming Karim R. Lakhani An interview with Competition Alex “Sandy” Pentland by Michael E. Porter and James E. Heppelmann into complex, software-enabled systems that can Managing the Internet of Things connect their makers, users, and third parties with one another. The business opportunities are potentially limitless, but they will require radically new strategies and structures.

ARTWORK Chris Labrooy Shrinkwrap Stills, Factory

November 2014 Harvard Business Review 63

STRATEGY & COMPETITION INFORMATION TECHNOLOGY MANAGING TECHNOLOGY How Smart, Digital Ubiquity: With Big Data Comes Connected Products How Connections, Big Responsibility Are Transforming Sensors, and Data Are Alex “Sandy” Pentland, Competition Revolutionizing Business interviewed by Scott Berinato page 100 Michael E. Porter and James E. Marco Iansiti and Karim R. Heppelmann | page 64 Lakhani | page 90 Information technology is revolu- When Google bought Nest, a Big data and the “internet of things” tionizing products, from appli- maker of digital thermostats, for promise revolutionary change to ances to cars to mining equipment. $3.2 billion just a few months ago, management and society. But their Products once composed solely it was a clear indication that digital success rests on the assumption of mechanical and electrical parts transformation and connection are that all the data being generated have become complex systems spreading across even the most by internet companies and devices combining hardware, sensors, elec- traditional industrial segments scattered across the planet belongs tronics, and software that connect and creating a staggering array of to the organizations collecting it. through the internet in myriad ways. business opportunities and threats. Pentland suggests that compa- These “smart, connected products” The digitization of tasks and nies don’t own the data, and that offer exponentially expanding op- processes has become essential without rules defining who does, portunities for new functionality, far to competition. General Electric, consumers will revolt, regulators greater reliability, and capabilities for example, was at risk of losing will swoop down, and the internet that cut across and transcend tradi- many of its top customers to of things will fail to reach its poten- tional product boundaries. nontraditional competitors—IBM tial. To avoid this, he has proposed The changing nature of products and SAP on the one hand, big data a set of principles and practices to is disrupting value chains, argue start-ups on the other—offering define the ownership of data and Michael Porter and PTC CEO data-intensive, analytics-based control its flow. He calls it the New James Heppelmann, and forcing services that could connect to any Deal on Data. companies to rethink nearly industrial device. So GE launched a The New Deal is “rebalancing everything they do, from how they multibillion-dollar initiative focused the ownership of data in favor of conceive, design, and source their on what it calls the industrial the individual whose data was products; to how they manufacture, internet: adding digital sensors to collected,” Pentland says. “People operate, and service them; to how its machines; connecting them to would have the same rights they they build and secure the necessary a common, cloud-based software now have over their physical bodies IT infrastructure. platform; investing in software and their money.” They could see Smart, connected products raise development capabilities; building what was being collected and then a broad set of new strategic choices advanced analytics capabilities; opt out or opt in. Many companies for companies about how value is and embracing crowd-based are afraid that the regulation created and captured, how to work product development. With all this, of data collection will kill their with traditional partners and what GE is evolving its business model. business models, he says. But he new partnerships will be required, Now, for example, revenue from believes that it will make for a and how to secure competitive its jet engines is tied to reduced healthier economy—and that it advantage as the new capabilities downtime and miles flown over the will prevent disasters such as the reshape industry boundaries. For course of a year. After just three criminal use of data in a way that many firms, smart, connected years, GE is generating more than affects critical systems and causes products will force the fundamental $1.5 billion in incremental income deaths. “If that kind of disaster question: “What business am I in?” with digitally enabled, outcomes- happened,” Pentland says, “there This article provides a framework based business models. The would be an overreaction: Shut for developing strategy and achiev- company expects that number to it down. You’d see very strong ing competitive advantage in a double in 2014 and again in 2015. regulation passed overnight, and a smart, connected world. HBR Reprint R1411D lot of companies would be in deep HBR Reprint R1411C trouble.” HBR Reprint R1411E

November 2014 Harvard Business Review 141 EXECUTIVE SUMMARIES The Big IdeaThe Idea Features

LEADERSHIP INNOVATION HEALTH CARE The Best-Performing CEOs Turn Your Science into a Business How Not to Cut in the World Reddi Kotha, Phillip H. Kim, and Oliver Alexy Health Care Costs page 47 page 106 Robert S. Kaplan and Derek A. Haas | page 116

HBR.ORG THE BIG IDEA TURN YOUR SCIENCE 100 INTO A BUSINESS WHEN COMMERCIALIZING SCIENTIFIC DISCOVERIESES, The Best-Performing INVENTORSANS ANDFID FIRMS FACEC SSEVERAL POTO ENTIALLY CEOs in the World FATALTRL TRAPSAPS. HERE’SES HOW TO The knock on most business leaders is that they don’t take AVOIDFAD FALLINGING INTO T HEMHEM. the long view—that they’re ﬁxated on achieving short- term goals to lift their pay. So which global CEOs actually BY REDDI KOTHAOTHA, PHILLIP HH. KIM, AND OLIVER ALEXY HOW NOT delivered solid results over the long run? Our 2014 list of top performers provides an objective answer. TO CUT HEALTH The missteps that keep us paying too much for treatment CARE COSTS by Robert S. Kaplan and Derek A. Haas

The knock on most CEOs is that their focus is Inventors should carefully Health care providers in much of the world are too myopic—that they’re fixated on achieving trying to respond to the tremendous pressure short-term goals to increase their pay. If identify and protect the to reduce costs—but evidence suggests that you studied results produced over the long many of their attempts are counterproductive, term, which leaders would truly show strong most profitable potential raising costs and sometimes decreasing the performance? HBR’s ranking of the 100 best applications of an invention quality of care. CEOs provides an answer. Kaplan and Haas reached this conclusion To compile our list, we examined how before competitors enter after conducting field research with more active CEOs of global public companies than 50 health care provider organizations. performed over their entire tenures. We the fray. Administrators looking for cuts typically work took a scientific, objective approach, from the line-item expense categories on their basing our evaluation on hard data, rather P&Ls, they found. This may appear to generate than on reputation or anecdote. For each Commercial success with a new technology immediate results, but it usually does not reflect executive, we looked at three metrics: the usually depends on the exclusive ownership of the optimal mix of resources needed to efficiently total industry-adjusted shareholder returns a critical asset or capability. But to create the deliver excellent care. produced, the total country-adjusted technology, an innovator draws on knowledge The authors describe five common mistakes: shareholder returns, and the total increase in from many different sources. Inventors who (1) Reducing support staff. This often lowers market capitalization. mismanage that tension often fail to successfully the productivity of clinicians, whose time is far The CEOs who made the 2014 list have commercialize their innovations. more expensive. (2) Underinvesting in space and undeniably been effective. On average, the To understand how to manage the tension, the equipment. The costs of these are consistently top 50 have delivered total shareholder authors carried out a comprehensive analysis of an order of magnitude smaller than personnel returns of 1,350% during their time on the more than 1,000 inventions from the University costs, so cuts here are short-sighted if they lower job. That translates into an annual return of of Wisconsin’s Technology Transfer Office. They people’s productivity. (3) Focusing narrowly on 26.2%. Adjusting for industry effects, average interviewed the TTO’s senior leadership, IP procurement prices and neglecting to examine total shareholder returns for the top 50 are managers, licensing and contract managers, how individual clinicians actually consume 1,161%, and for country effects, 1,087%. But legal counsel, and other staff to get firsthand supplies. (4) Maximizing patient throughput. the results turned in by the #1 CEO on our list, knowledge of how inventions were evaluated for Physicians achieve greater overall productivity Jeff Bezos, were especially impressive. Under commercial potential. by spending more time with fewer patients. his leadership, Amazon produced country- From this research they identified seven IP (5) Failing to benchmark and standardize. adjusted returns of 15,189% and industry- traps that unwary inventors (individuals and Administrators, in collaboration with clinicians, adjusted returns of 14,917% and grew its companies alike) fall into when developing should examine all the costs of treating market capitalization by $140 billion. scientific discoveries and inventions for the patients’ conditions. This will uncover multiple We also collected biographical and commercial market. The traps include publicly opportunities to improve processes in ways that compensation data on the CEOs to see if we disclosing information prematurely, neglecting lower total costs and deliver better care. could identify what they had in common and to enforce patent infringements, failing to HBR Reprint R1411G whether there was any correlation between demonstrate sufficient originality, overrelying performance and pay. While the top 100 have on known science, failing to stake out the best each had unique journeys to success, there territory for applications of the technology, do seem to be two preferred pathways: Over mismanaging attribution of contributors, and a quarter of the CEOs have MBAs, and nearly ceding too much control over IP to funders. as many studied engineering. But in some Drawing on examples encountered in their ways, Bezos’s place at the top says it all: The research, the authors describe these traps and best CEO in the long haul turned out to be offer advice on how to avoid them. one who frequently underperformed in the HBR Reprint R1411F short term—while continuing to make big bets on the future. HBR Reprint R1411B

142 Harvard Business Review November 2014 HBR.ORG How I Did It Managing Yourself

LEADERSHIP The U.S. Chairman of PwC on Where to Look for Insight Keeping Millennials Engaged Mohanbir Sawhney and Sanjay Khosla | page 126 Bob Moritz | page 41

HBR.ORG HOW I DID IT… PwC’s workforce In today’s organizations, technological trends come THE U.S. CHAIRMAN OF PWC ON KEEPING MILLENNIALS ENGAGED by Bob Moritz is strikingly young: H innovators are in demand together; (3) frustrations, which Two-thirds of its everywhere—from the factory lead to innovative work-arounds; employees are in their floor to the salesroom, the IT (4) orthodoxies, which can twenties and early help desk to the HR department, spark a search for alternatives; thirties. In the past, Managing the employee cafeteria to (5) extremities, such as fringe Yourself the assumption has Where to the C-suite. Innovation isn’t a members of stakeholder Look for The Idea been that most hires department, the authors say; it’s groups who push for solutions; Young staffers don’t Insight make work their main priority. Moritz Seven places to search for new ideas explains how his by Mohanbir Sawhney and Sanjay Khosla firm motivates them. will eventually move a mindset that should permeate (6) voyages, whereby innovators on to other firms or your entire enterprise. And what leave their offices to visit other careers, while fuels it is insight—an imaginative colleagues or customers; and a few will be promoted all the way up to understanding of an internal or (7) analogies, useful ideas or partner—rewarding and justifying years of external opportunity that can systems in other teams, business long hours in service to clients. But a recent be tapped to improve efficiency, units, companies, or industries. study done by the company revealed that generate revenue, or boost HBR Reprint R1411H the allure of becoming partner someday is engagement. no longer enough to generate high levels Sawhney and Khosla outline of engagement. Millennials are less willing seven “insight channels” that than Boomers to make their work lives an would-be innovators in any exclusive priority, even when offered the function or role can use: prospect of substantial future compensation. (1) anomalies, or data that They want job flexibility in the here and now, deviates from business as along with opportunities for training and usual; (2) confluence, when mobility and more frequent feedback and economic, demographic, and rewards. PwC has instituted several initiatives in response to the results of the study: Employees are asked for their ideas on how to invest in human capital and given choices about what form their bonuses will take. Career paths have become far more flexible. Life skills and leadership training Got the Right Stuff? and sabbaticals demonstrate appreciation in nonmonetary ways. Participation in corporate responsibility programs has improved retention and engagement. HBR Reprint R1411A

Make winning decisions by harnessing the power of the world’s largest library of business book summaries. Five page abstracts that can be read in ten POSTMASTER minutes or less. Send domestic address changes, orders, and inquiries to: Harvard Business Review, Subscription Service, P.O. Box 62270, Tampa, FL 33662. GST Registration No. 1247384345. Periodical postage paid at Boston, Massachusetts, and additional mailing offices. Printed in the U.S.A. Harvard Business Review (ISSN 0017-8012; USPS 0236-520), published monthly with combined issues in January–February and July–August for professional managers, is an education program of Harvard Business School, Harvard University; Try it today. Nitin Nohria, dean. www.getabstract.com/hbr Published by Harvard Business School Publishing Corporation, 60 Harvard Way, Boston, MA 02163. EXPERIENCE HBR.ORG Life’s Work reasonable questions, but with the ones that were silly, I stood my ground. They used to tell me, “It won’t fly in Des Moines.” But one thing that played well for me is that I spent months in Iowa, making the film Cold Turkey. So I was able to say, “Don’t tell me about Des Moines. I know Des Moines.” How did you bring out the best in writers and actors? We were all pointed in the same direction. We paid close attention to what was happening around us. We wanted to deal honestly with story and character. And when that was working, everybody took succor from it. We knew we were doing good work and an audience was appreciat- ing it on a different level from just laughing. Why have you always worked oﬀstage? I was, I’ve learned, both running from my father and wanting to make good in his name. He was an out- in-front guy but disappointed himself and left the rest of us high and dry. But I had characters that represented me. What I didn’t say, I found them saying. You’ve had many creative partners. How do you manage those relationships? If somebody HBR: Did you set out to disrupt gives 90% and somebody gives Norman Lear, 92, reinvented American 10%, but the 90 can’t get along TV’s status quo? without the 10, then you might television in the 1970s with All in the Lear: I never thought of the as well call it 50/50. You don’t shows as groundbreaking, Family and a string of other true-to-life think about the figures any because every American under- other way. sitcoms. As a publicist for Broadway stood what they were all about. stars, a writer for top comedians, a The issues were around their What lessons do you try to dinner tables, in their school pass on to others? “Every man Hollywood producer and director, and yards. I sold All in the Family to is my superior in that I may an ardent political activist, he’s relished ABC and made the pilot. They learn from him” is a great one. asked me to make another a “Happiness is the exercise of a career spent behind the scenes. year later, and I did—exactly the vital powers, along lines of His autobiography is out this month. same. This would be my first excellence, in a life affording show whenever it aired, which them scope”—that’s Aristotle. Interviewed by Alison Beard was three years later, for CBS. And this: “At the moment of commitment, the entire uni- From there, how did you negoti- verse conspires to assure HBR.ORG For Lear’s thoughts on managing egos, ate with network bosses? There your success.”

visit hbr.org/lear. were times when they raised HBR Reprint R1411K LAURIDSEN DAVE

144 Harvard Business Review November 2014 baml.com/healthygrowth

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