The Change Leader’s Toolbox…page 72 Biotech’s Failed Promise…page 114

www.hbr.org October 2006

60 Emerging Giants: Building World-Class Companies in Developing Countries Tarun Khanna and Krishna G. Palepu 72 The Tools of Cooperation and Change Clayton M. Christensen, Matt Marx, and Howard H. Stevenson 82 The HBR Interview Ideas as Art James G. March 92 Strategies for Two-Sided Markets Thomas Eisenmann, Geoffrey Parker, and Marshall W. Van Alstyne 102 Meeting the Challenge of Corporate Entrepreneurship David A. Garvin and Lynne C. Levesque

20 Forethought 37 HBR Case Study What Serves the Customer Best? Paul F.Nunes and Woodruff W. Driggs 53 Different Voice ON THE Sleep Deficit: The Performance Killer A Conversation with Harvard Medical School Professor Charles A. Czeisler 114 Big Picture Can Science Be a Business? RISE Lessons from Biotech …page 60 Gary P.Pisano 126 What Business Are You In? Classic Advice from Theodore Levitt 146 Executive Summaries 152 Panel Discussion In a business, ROI stands for Are your people ready?

Where do new products come from? How about new services? Or new and better ways of working? A people-ready business has the answer: It’s people, empowered by the right software. Software that streamlines the creative process, organizes the production process, and connects people who have ideas with people who can manufacture, distribute, and sell them. That’s the foundation of a successful business. A people-ready business. Microsoft.® Software for the people-ready business.SM microsoft.com/peopleready

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© 2006 Microsoft Corporation. All rights reserved. Microsoft and “Your potential. Our passion.” are either registered trademarks or trademarks of Microsoft Corporation in the United States and/or other countries.

102 Features

60 October 2006

60 Emerging Giants: Building World-Class Companies in Developing Countries 92 Tarun Khanna and Krishna G. Palepu Western, Japanese, and South Korean companies appear to hold near-insurmountable advantages over businesses in newly industrializing countries – primarily because of their access to vast reservoirs of finance and talent. But some emerging-market companies are turning perceived disadvantages into business opportunities and compet- ing successfully at home and abroad. Here’s how.

72 The Tools of Cooperation and Change Clayton M. Christensen, Matt Marx, and Howard H. Stevenson Employers can use all kinds of tools to get their employ- 92 Strategies for Two-Sided Markets ees to cooperate with a major change program, from vi- Thomas Eisenmann, Geoffrey Parker, and sion statements to financial incentives to threats. Choos- Marshall W. Van Alstyne ing the right cooperation tool starts with knowing to Many of the blockbuster products and services that have what extent employees agree on two crucial issues: what redefined the global business landscape tie together two they want out of the organization and how to get it. distinct groups of users in a network. Credit cards link consumers and merchants; search engines connect Web 82 THE HBR INTERVIEW users with advertisers. The distinct character of these Ideas as Art two-sided network businesses demands a new approach James G. March to strategy. Interviewed by Diane Coutu 102 Meeting the Challenge of Corporate Stanford University’s James March shares his thinking on Entrepreneurship aesthetics, leadership, the role of folly, and the irrelevance David A. Garvin and Lynne C. Levesque of relevance. To grow innovative emerging businesses, companies must effectively blend new traits with old ones. They can do that by performing balancing acts in three crucial 72 areas: strategy, operations, and organization.

continued on page 10

82 COVER ART: ALEX NABAUM ART: COVER

6 harvard business review | hbr.org The Cupped Hands logo is a registered service mark of Allstate Insurance Company. © 2006 Allstate Insurance Company, Northbrook , IL. getting teens to drive more safely. “Keep the Drive” Peers are some of the most important influences in passenger. a or driver a as — car a into get they time every smarter act and think teens help to influence peer of power the uses it And program. safe-driving new a designing in teens nationwide program: program: nationwide Drive.” the “Keep Foundation Allstate The new,So a developed has it’s timeforachange. roads anddecadesofsafe-drivingprograms.We think remain unacceptablyhigh,despitesafercars,better year. every another300,000 injure Theytakenearly6,000lives and teens inAmerica. Motor vehiclecrashesarethe to become safe-driving activists by involving them them involving by activists safe-driving become to The

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It mobilizes mobilizes It help, go to to go help, To to do can you what and issue more this learn about and their futures. keepingto their licenses, their cars, their friends can help them realize that on the road. the on make decisions and smarter limits driving set teen your Parent-Teen and you help to it Use contract. Driving Allstate the to link a find also parent, you’re you’ll a If It’s timetomaketheworldabetterplacedrive. That’s Allstate’s Stand Allstate.com/community . smart driving is the key

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12 COMPANY INDEX 90 STRATEGIC HUMOR

14 FROM THE EDITOR 14 114 BIG PICTURE Fair Business Is as Fair Can Science Be a Business? Business Does Lessons from Biotech Western companies expect to be treated Gary P.Pisano fairly as they expand into emerging The birth of biotechnology created high markets like China, India, and Brazil. hopes for a revolution in drug R&D. Staring them in the face at home, how- Three decades later, those hopes are ever, is the stock-option-dating scandal. largely unrealized. Can companies that Shouldn’t decency translate equally conduct basic scientific research as a across cultures and economies? core activity be profitable? Yes – with a different anatomy. 20 FORETHOUGHT 20 The nationality of firms is becoming 126 What Business Are You In? more, not less, clear…When so-called Classic Advice from Theodore Levitt best practices fail to deliver…Indians An early proponent of the need for com- are getting more materialistic…No one panies to focus on customers, Theodore likes a perfect brand…Sending consis- Levitt was one of business’s great minds. tent corporate messages…Online shop- Read excerpts from six of his most influ- ping in 3-D…Following in the footsteps ential HBR articles. of an icon…Is the globalization apoca- lypse upon us? 139 LETTERS TO THE EDITOR 37 HBR CASE STUDY 37 Consumer-directed health plans don’t What Serves the Customer Best? necessarily create any true savings for the U.S. health care system. They only Paul F.Nunes and Woodruff W. Driggs help employers shift the responsibil- Whiskey maker Glenmeadie is facing a ity and the cost of health care to their trade-off: Front-office innovations are in- employees. creasing sales and customer loyalty. But by siphoning money away from product EXECUTIVE SUMMARIES innovation, they might produce the op- 146 posite effect in the long term. 152 PANEL DISCUSSION 53 DIFFERENT VOICE On Stage Sleep Deficit: 114 Don Moyer The Performance Killer For a leader, there’s no such thing as a A Conversation with Harvard Medical casual conversation. School Professor Charles A. Czeisler Corporations try to protect employees with rules against workplace smoking, drinking, drugs, sexual harassment, and so on. Yet they keep asking people to work too hard, too long, and with too lit- tle sleep. The toll on morale and perfor- mance can be significant. So why are so few companies doing anything about it? 126

10 harvard business review | hbr.org

COMPANY INDEX • October 2006

Organizations in this issue are indexed to the first page of each article in which they are mentioned. Subsidiaries are listed under their own names.

AB Electrolux ...... 60 Guangdong Galanz Group ...... 60 RealNetworks ...... 92 Accenture ...... 60 Haier Group ...... 60 Roche...... 114 Adobe Systems ...... 92 Hangzhou Wahaha Group ...... 60 RR Donnelley ...... 102 Agora ...... 60 Harrods ...... 37 SABMiller ...... 60 Akbank...... 60 Hartmann Incorporated...... 37 S.A.C.I. Falabella ...... 60 Allied Domecq...... 37 Henkel ...... 102 Safeway ...... 126 American Apparel ...... 20 Hero Honda...... 20 Samsung ...... 20, 92 American Express ...... 92 Hewlett-Packard ...... 60, 72, 92 Sanofi-Aventis ...... 53 Amgen ...... 114 Home Depot ...... 60, 102 Satyam Computer Services ...... 60 Apple Computer ...... 72, 92 Hoover ...... 126 Shanghai Baosteel Group ...... 60 Ashland ...... 102 Huawei Technologies ...... 60 Shell Group...... 20, 92 AT&T ...... 114 Hutch ...... 20 Skype ...... 92 Autobytel ...... 92 IBM...... 72, 92, 102, 114 Sony ...... 92 Ayala Group ...... 60 InBev ...... 60 Southdale Center ...... 92 Bajaj Auto ...... 20 Infosys Technologies...... 20, 60 Southland...... 126 Bank One ...... 72 Intel ...... 72, 102 Sprint...... 92 BellSouth ...... 92 Interbrew ...... 60 Standard & Poor’s...... 20 Best Buy...... 60 Intuit ...... 102 Staples...... 102 Bharti Tele-Ventures...... 60 Inventec ...... 60 Starbucks...... 102 Bill & Melinda Gates Foundation ...... 114 ITC Limited...... 60 Sun Microsystems...... 92 Biogen Idec ...... 114 JD Power and Associates...... 60 Symbol Technologies...... 92 Bloomingdale’s...... 37 Johnson & Johnson ...... 20, 114 Takeda ...... 53 Boeing ...... 102 Jollibee Foods ...... 60 Tata Group ...... 20, 60 Broad Institute ...... 114 JPMorgan Chase ...... 72 Teva Pharmaceutical Industries ...... 60 Bunge ...... 60 Kaiser ...... 92 3M ...... 102 CareerBuilder ...... 92 KFC ...... 60 Time Warner ...... 92 Carrefour ...... 60 Koç Group...... 60 Toshiba ...... 60, 92 Cemex ...... 60 Kodak...... 102 Toyota...... 60, 92 Cephalon ...... 53 Lenovo Group ...... 60 Türkiye Garanti Bankasi ...... 60 Cetus ...... 114 Linksys...... 92 Unilever ...... 20 Chiron ...... 114 Livingston Healthcare Services ...... 102 UPS ...... 102 Cingular Wireless ...... 92 L.L. Bean ...... 102 Verizon ...... 92 Cisco Systems...... 92, 102 Lucent Technologies ...... 102 VF Corporation ...... 37 Citibank ...... 60, 82 Mahindra & Mahindra...... 60 Visa ...... 92 Companhia de Bebidas das Américas (AmBev) ...... 60 Mall of America ...... 92 Volvo ...... 53 Continental Airlines ...... 72 McDonald’s ...... 60 Wal-Mart ...... 20, 60 Covisint ...... 92 Menlo Worldwide Forwarding...... 102 WellPoint ...... 92 Cox Enterprises...... 60 Merck ...... 114 Whirlpool ...... 60 Craigslist ...... 92 Michael J. Fox Foundation Wipro ...... 60 DaimlerChrysler ...... 60 for Parkinson’s Research ...... 114 Xerox ...... 102, 114 Dell...... 20, 72, 92 Microsoft ...... 72, 92, 102 Yahoo...... 92 Do˘gu¸s Group ...... 60 Mitsukoshi Limited ...... 37 Dr. Reddy’s Laboratories...... 60 Monster ...... 92 AUTHOR AFFILIATIONS Dubai Ports World...... 20 Multiple Myeloma Research Foundation ...... 114 Accenture ...... 37 Dunkin’ Brands...... 37 Nandos...... 60 Annals of Improbable Research...... 20 DuPont ...... 102 National Institutes of Health...... 114 Boston Pops ...... 20 Eastern Air Lines ...... 72 NCR ...... 92 Boston University ...... 92 eBay...... 92 Netscape ...... 72, 92 Dartmouth’s Tuck School of Business ...... 20 Electronic Arts ...... 92 New York Stock Exchange ...... 82 Dunkin’ Brands...... 37 Electronic Data Systems ...... 60 New York Times Company ...... 20 Gallup Organization ...... 20 Eli Lilly ...... 114 NIIT Technologies ...... 60 Glen Avenue Communications ...... 20 Emerge Logistics ...... 60 Nokia ...... 20, 102 Hartmann Incorporated...... 37 Enron ...... 102 Novartis ...... 114 Harvard Business School ...... 20, 60, 72, 92, 102, 114 Exxon Mobil...... 92, 102 Old Mutual ...... 60 Harvard Medical School ...... 53 FedEx ...... 20 Overture ...... 92 IESE Business School ...... 20 Ford ...... 20, 53, 102 PayPal ...... 92 Marketspace...... 37 FreePC ...... 92 PepsiCo ...... 20 MIT...... 92 Genentech ...... 114 Philips ...... 20 Stanford University...... 82 General Electric...... 60, 72, 102, 114, 126 Polaroid ...... 102 Tulane University’s General Motors ...... 20, 60, 92, 102, 126 Pollo Campero ...... 60 A.B. Freeman School of Business ...... 92 Genzyme...... 114 Procter & Gamble ...... 72, 102 University of Massachusetts ...... 20 Godrej ...... 20 Prostate Cancer Foundation ...... 114 Utah Symphony...... 20 Google ...... 72, 92 Ranbaxy Laboratories ...... 60 VF Corporation ...... 37

12 harvard business review | hbr.org TRUST.

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© Copyright 2006 Perot Systems T nvriy indicates that nearly30 University, ofIndiana andRandall Heron, Iowa, oftheUniversity of professors ErikLie, Statistical analysisbyfinance store. seems thatare manyindictments in FROMEDITOR THE 14 Itshowsthat companies thefruitoftheirlabor. Countries”is ing Giants:BuildingWorld-Class Companies inDeveloping Palepu have studyingthat topic forsixyears.“Emerg- been vard professors Tarun Business School Khanna andKrishna notjust supplierstoestablished Westernfirms?Har- right, How can our companies becomeglobalplayers intheirown halfadozenbusinessleadersandacademics:from perhaps Iheard onequestion In Shanghaiacouple ofyearsago, cent are- Meanwhile, price. a lowerstock inorder toexploit were really issued, a date priortothedate onwhichthey tohavepear granted optionsasof thefirmsap- That is, dated options. companies mighthave back- of U.S. executives inAmerica can behave with similardecency. thensurely inemergingmuch toaskofpoliticians markets, Ifthat isn’t too treatedness shouldexpectistobe fairly. Theonlyfavor abusi- market counterpartswantthesame. Theiremerging- tween theletter ofthelaw anditsspirit. which istosay congruence be- and honestenforcement, They wantreasonable regulations some andlesscapricious. calling foraruleoflaw that issimultaneously lessburden- they’re andotheremerging markets, Brazil, India, China, AsWesterncompaniescapitalism invest in andkleptocracy. Russia hasexperienced anepicstrugglebetween Union, ambition? about andourcommunities?greed or Isitabout our customers, thevalue Orisitabout wecreate foroneanother, for me?” a great) reward forlegitimate work?Isitabout “what’s init ness isabout?earningalegitimate (even Orisitabout ofexecutives. sands, thou- perhaps nies were ladlingoutoptionstohundreds, ofAmerican compa- hundreds, perhaps scores, – Pentagon reeling from theattacks ontheWorldTrade Center andthe while theworldandmarket were – strated that2001 inlate September In thedecade andahalfsince thedemiseofSoviet Isthat what busi- Sleazeballs andprivateering ghouls. he scandal Wall Street Journal aigcniust ie.It dating continues towiden. arBsns Is Business Fair sFi uiesDoes Business Fair as about stock stock about study demon- • option % which shouldmanagersuseundercircumstances? domanagershave? And they ask, ple tochange.”What tools, comes much moretogetpeo- sowhenmanagersare trying gether inasystematic way.…a complicated job[that] be- tasktoworkto- primary ofmanagementistogetpeople Asthey write: “The lem that istheessence ofmanagement. wise andpracticaltheseeminglysimpleprob- about article a andHoward Stevenson, Matt Marx, by Clay Christensen, don’t miss Finally, Tools“The ofCooperation andChange” of mediacompanies that connect audiences withadvertisers. think – costs and revenues are foundinmultipledirections however, Inmanyindustries, (revenue) ontheright. puts imagine avalue chainwithinputs(costs) andout- ontheleft they Whenmoststrategists envisiontheirbusinesses, egy. isHBR’s at thehottest firstlook topicinstrat- Van Alstyne, Markets,”by Geoffrey Parker, andMarshall Tom Eisenmann, forTwo-Sided guru.“Strategies him businessgurus’favorite ofthefirmhasmade on decisionmakingandthetheory Stanford thelegendary professor whosework James March, aconversationDiane Coutu with presents “Ideas asArt,” Senioreditor hasn’t liveduptothepromise ofthescience. Pisano unravels theriddleofwhybusinessbiotech In “Can Science BeaBusiness? Lessons from Biotech,”Gary asacashew. isasgood Every article as we’ve ever published. hmsA Stewart Thomas A. strategist shouldseetheview. business andevery the otherside, through thewindowfrom ants”looks “Emerging Gi- Western incumbents. of written frombeen theperspective emerginglished about markets has Mostofwhat’s pub- been choices. but onlybymakingtoughstrategic structure andspottytalent markets)– caps (suchasweakdomesticinfra- markets) andovercome theirhandi- and privilegedaccess totheirhome advantagestheir (suchaslowcosts in emerging markets can exploit This isasinteresting anissueofHBR harvard business review|hbr.org •

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©2006 Citrix Systems, Inc. All rights reserved. Citrix® is a trademark of Citrix Systems, Inc. and/or one or more of its subsidiaries, and may be registered in the United States Patent and Trademark Office and in other countries. All other trademarks and registered trademarks are the property of their respective owners. editor and managing director Thomas A. Stewart deputy editor and assistant managing director Karen Dillon executive editor Sarah Cliffe art director Karen Player senior editors senior production David Champion manager Diane Coutu Bronwyn Fryer Dana Lissy Ben Gerson editorial Paul Hemp production Julia Kirby manager Gardiner Morse Christine Wilder M. Ellen Peebles senior designers Steven Prokesch Kaajal S. Asher Anand P.Raman Jill Manca senior editor, Annette Trivette hbr online production Eric Hellweg coordinators associate Josette Akresh- editor Gonzales Roberta A. Fusaro Tisha Clifford manuscript communications editors director Christina Bortz Cathy Olofson Lisa Burrell communications Margaret K. Hanshaw associate Andrew O’Connell Siobhan C. Ford Andrea Ovans editor for editorial business manager development Kassandra Duane John T. Landry editorial contributing coordinator staff Rasika Welankiwar Lilith Z.C. Fondulas executive editor Amy L. Halliday and director Amy N. Monaghan of derivative Annie Noonan products Martha Spaulding Jane Heifetz Suki Sporer Lindsay A. Sweeney a note to readers The views expressed in articles are the authors’ and not necessarily those of Harvard Business Review, Harvard Business School, or Harvard University. Authors may have consulting or other business relationships with the companies they discuss. submissions We encourage prospective authors to follow HBR’s “Guidelines for Authors” before submitting manuscripts. To obtain a copy, please go to our Web site at www.hbr.org; write to The Editor, Harvard Business Review, 60 Harvard Way, Boston, MA 02163; or send e-mail to [email protected]. Unsolicited manuscripts will be returned only if accompanied by a self-addressed stamped envelope. editorial offices 60 Harvard Way, Boston, MA 02163 617-783-7410; fax: 617-783-7493 www.harvardbusinessonline.org Volume 84, Number 10 October 2006 Printed in the U.S.A. publisher Cathryn Cronin Cranston consumer associate You can’t outrun change, marketing publisher director Alex Clemente but you can outthink it. John Titus worldwide circulation advertising director sales marketing Bruce W. Rhodes director business Marisa Maurer manager marketing and research Adrienne M. Spelker manager retention marketing Jennifer B. Henkus manager advertising production Christine Chapman manager circulation fulfillment Catharine-Mary manager Donovan Greg Daly marketing and promotions marketing coordinator manager Jackie D’Alessio Nicole Costa assistant fulfillment manager Danielle Weber worldwide advertising offices You can’t just wait for change. You have to confront it head on. New York Maria A. Beacom Michael J. Carroll Sharpen your skills in the Columbia Business School Executive Denise Clouse James H. Patten Education Programs. Together with the Columbia Business School 75 Rockefeller Plaza faculty and peers from around the globe, you’ll maximize your 15th Floor New York, NY 10019 effectiveness, enhance your managerial skills, and take on the issues 212-872-9280 fax: 212-956-0933 of our rapidly changing world. There’s no time to wait. Join us this fall. Atlanta 404-256-3800 Boston 978-287-5400 Chicago 312-575-1100 Executive Development Program: Dallas 214-521-6116 Detroit 248-524-9000 Transition to General Management Los Angeles 323-467-5906 October 15-27 San Francisco 415-986-7762 Australia 612-9252-3476 France 33-01-4643-0066 Leading Strategic Growth and Change Hong Kong 852-237-52311 October 22-27 India 912-2287-5717 Sweden 48-8-541-318-37 United Kingdom 44-20-7833-3733 Fundamentals of Management: Highlights of an MBA November 5-17 For all other inquiries, please call 212-872-9280. For advertising contact information, Pricing to Win: Strategy and Tactics please visit our Web site at November 6-9 www.hbradsales.com. subscription service information u.s. and canada Accounting Essentials for Corporate Directors: 800-274-3214; fax: 813-354-3467 Enhancing Financial Integrity Rates per year: U.S., $119; Canada, u.s.$139 November 13-15 international 31-20-4874465; fax: 31-20-4874412 Rates per year: u.s.$165; Mexico, u.s.$139 The Columbia Senior Executive Program subscribe online April 29-May 25 www.hbr.org reproduction To learn more: www.gsb.columbia.edu/execed/HBR Copyright © 2006 Harvard Business School or call (212) 854-0616 Publishing Corporation. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopy, recording, or any information storage and retrieval system, without written permission.

The ofCorporate Rise Nationality grist 20 side theirhomeeconomies thanwithin. andservicesout- and sellmore products of companies that employmore people and offshoringthegrowing number ened bytheacceleration of outsourcing strength- state hasgainedwidecurrency, are becomingdivorced from thenation- thenotionthat globalfirms recent years, In tionality wasincreasingly irrelevant. less globalwebsandthat corporate na- multinational firmswere becomingstate- ReichRobert forcefully argued that large thepolitical scientist Over adecade ago, uvyo da,ted,pol,andpractices onthebusiness horizon people, trends, A survey ofideas, c”tn ob ilaig because prod- misleading, tendtobe ica” suchas Labels “Made inAmer- opaque. nationality isoften individual products, At thelevel of of corporate nationality. decades. clearer inrecent andmore important companies may have actually become more plausible:Thenationality ofglobal conclusion theopposite seems firms, torical evidence onthe nationality of at thehis- withthefacts? Ifyoulook port thisperception com-But howwelldoes Bear inmindthat there’s nosingletest oto h prto,orthe country control the operation, nior managersortheshareholders who it’s thenationality ofthese- casionally, Oc- location ofitscentral administration. the – is determinedbythecompany’s seat nationality influenced bythosesystems, Continental andothercountries Europe inmostcivillaw systems in However, state ofincorporation is themaintest. the Inmanylegalsystems, more solid. zational definitionsofnationality can be Organi- from adozenormore countries. sourced may madeupofparts ucts be by harvard business review |hbr.org geoffrey g. jones

LEO ACADIA where most of the business is done, that As globalization, liberalization, and they would best fulfill the firm’s overall determines corporate nationality. deregulation took hold in the 1980s, sen- strategy. Such decisions continued to In the first surge of globalization, be- sitivities about being perceived as for- be made by top management, which, fore World War I, nationality was often eign lessened, although they certainly with relatively few exceptions, remained highly ambiguous. Although the nation- did not disappear. The autonomy of na- the preserve of nationals of the home alities of the pioneering giants of multi- tional subsidiaries was scaled back as country. national business, such as Singer Sewing U.S. corporations, followed, often reluc- The influence of nationality on multi- Machines, were evident, much interna- tantly, by their European counterparts, national corporations is still strong today. tional business did not look like this. began to seek efficiencies by integrating The composition of boards of directors Countless commercial and financial busi- geographically dispersed businesses. remains heavily biased toward home- nesses – owned by far-flung networks of These strategies reduced ambiguity sur- country nationals, despite the fact that ethnic Greeks, Scots, Chinese, Jews, and rounding the nationality of multination- equity ownership of large corporations others – crisscrossed national borders. als. The new, globally integrated corpora- is now widely dispersed among coun- Entrepreneurs moved between countries tions sought to locate functions wherever tries. In some cases, the pressure for with remarkable ease in a world without visas and passports. The vast London capital market was tapped by all and sundry, some of whom registered their studies show firms as “British” though little was Brit- ish about them. Business Lessons from Leeches The world wars concentrated peoples’ by marc abrahams minds on nationality. It became unwise, and sometimes fatal, to be ambiguous. Time-tested wisdom is invaluable–when it’s correct. But sometimes, revered Large multinational corporations such “best practices” turn out to be, at best, just practices. Consider, for instance, this as Ford and General Motors were the report by Anders Baerheim and Hogne Sandvik of the University of Bergen in dominant organizational form and tech- Norway, titled “Effect of Ale, Garlic, and Soured Cream on the Appetite of nological innovators in international Leeches.” business. Yet while Ford and GM may have seemed distinctly American from a “The medicinal leech has regained some of its lost popularity by its present use U.S. perspective, their overseas subsidi- in microsurgery,”the authors write in the British Medical Journal. “Sometimes, aries often had few links to them. The however, the leeches refuse to cooperate properly. To overcome this problem foreign subsidiaries of major corpora- doctors in the nineteenth century used to immerse leeches in strong beer before tions largely stood apart from their par- applying them to the patient.”German doctors–renowned at the time as the ents or other subsidiaries. Tariffs, foreign world’s best–also recommended garlic and sour cream as alternatives to beer. exchange controls, and the logistical dif- Baerheim and Sandvik realized that no one had ever actually tested whether ficulties of disaggregating value chains beer, garlic, or sour cream really does stimulate the appetite of a leech. So they meant that the level of intrafirm imports ran a simple experiment and discovered that the old advice didn’t hold up. Sour and exports was low. Local subsidiaries cream didn’t make leeches hungry for blood. Garlic killed them. And beer appar- typically manufactured distinctive prod- ently made them drunk. ucts for each market. European compa- When adopting a practice or a technology that’s new to you, do pay attention nies, such as Unilever, often gave affili- ates even more autonomy than their to the conventional wisdom about it. But also remember–whether you’re blood- U.S. equivalents, believing that respon- letting with leeches or motivating a workforce–that golden rule of thumb: Trust, siveness to local markets was a major but verify. source of competitive advantage. More- marc abrahams ([email protected]) is the editor and cofounder of the over, at least until the 1980s, govern- scientific humor magazine Annals of Improbable Research. In this regular Fore- ments and the public in many countries thought column, he unearths studies that shed the oblique light of multidisciplinary were distrustful of foreign companies, research on the science of management. and so subsidiaries often portrayed Reprint F0610B themselves as local firms.

october 2006 21 transparency in corporate governance culture has led to a reduction in ambiguities about nationality. For example, the The New Indian Consumer Shell Group, which had been owned by ashok gopal and rajesh srinivasan by dual British and Dutch holding companies since its formation in 1907, When India opened its economy to the Indians are more motivated than ever abolished this structure in 2005 and global marketplace in the early 1990s, by personal ambition and a desire for assumed a single British parent com- many multinational corporations rushed material success, and they put in the pany (albeit one with a head office in in to pursue its middle-class consumers – hours it takes to achieve those goals. A the Netherlands). And despite anxiety an estimated 200 million people – only recent Gallup poll of more than 30 coun- to confront low incomes, social and polit- tries showed that, with an average work- ical conservatism, and resistance to week of 50 hours, India ranks among change. It turned out that the Indian the hardest working nations globally. consumer was a tough one to figure out (The average in the United States is 42 and win over. hours; major European nations such as Things are changing. Although atti- Germany, France, and the UK have work- tudes remain complex, they have shifted weeks of fewer than 40 hours.) substantially toward consumerism, par- Consumerism is becoming a way of ticularly over the past decade. The coun- life in India. An analysis of Indians’ sav- try’s recent economic performance is a ings goals underscores the increase in about the outsourcing of knowledge factor, of course. For three years, GDP materialism. Although long-term plans work, the globalization of key func- growth has been strong and sustained, remain a high priority, life’s pleasures in tions such as R&D remains limited. % U.S. and Japanese firms, in particular, at an average annual rate of around 8 . the here and now have gained impor- prefer to conduct sophisticated R&D The population’s demographic profile tance over the past decade. Indians’ de- in their home markets. also plays a role: Indians constitute a sire to set money aside for electronics Recent developments in the United fifth of the world’s citizens below age 20. and durables has grown so dramatically States – including the peremptory ex- So a youthful, exuberant generation, that it has nearly caught up with their pulsion of foreign firms from the S&P weaned on success, is joining the ranks desire to save for their children’s educa- 500 in 2002 and the recent extraordi- of Indian consumers. tion. Travel and entertainment have also nary public outcry when Dubai Ports To examine the changes in attitude, gained ground. World acquired a British company that the Gallup Organization conducted two Interestingly, this trend does not apply operated ports in the United States – surveys of more than 2,000 respondents only to the young–it holds true for peo- underscore the rising relevance of cor- gauging the habits, hopes, plans, and evo- ple aged 15 to 55. And it is not merely a porate nationality. Today, technologi- lution of the Indian consumer in the de- large-city phenomenon; people in smaller cal advances may permit different parts of the value chain to operate in cade from 1996 to 2006. (For a similar towns espouse these values as well. different places, companies may hold look by Gallup at Chinese attitudes, see Among durable goods, high-tech lux- portfolios of brands with different William McEwen et al.,“Inside the Mind ury items are increasingly in demand. national heritages, and leaders, share- of the Chinese Consumer,”HBR March The number of Indians who own or use holders, and customers may be dis- 2006.) In collaboration with our col- mobile phones, for example, has grown persed. Still, the nationality of a firm leagues Raksha Arora and Prasun Basu, 1,600% – not surprising in a country that is rarely ambiguous. It usually has a we mined the data and emerged with is adding more than 3 million subscribers major influence on corporate strat- three key insights. a month. The number of people who egy, and it seems to be growing in po- Indians are getting more materialis- own or use computers or laptops is up litical importance. tic. Indians are often stereotyped as 100%, albeit from a very small base. Own- deeply spiritual people who reject mate- ership of music systems and televisions is geoffrey g. jones ([email protected]) rialistic values. Our research suggests also on the rise. is the Joseph C. Wilson Professor of Busi- ness Administration at Harvard Business that this stereotype no longer reflects re- Across products, a majority of the po- School in Boston. The working paper ality. For instance, almost half of India’s tential customers are entering the mar- on which this article is based can be urban population had adopted a “work ket for the first time. This is great news accessed at www.hbs.edu/research/pdf/ hard and get rich” ethos by 1996; another for marketers, since it signifies an ex- 06-052.pdf. Reprint F0610A 9% had done so by 2006. panding market, which will get even big-

22 harvard business review | hbr.org ger as current owners replace or upgrade only 34% of those surveyed expressed one thing, India is a diverse country, with what they have. confidence in Indian companies; in 2006, 23 official languages and more than A word of caution: Although incomes 56% did. Indians realize that not all for- 1,000 dialects. It’s also one of the world’s have risen over the past ten years, mid- eign goods are perfectly suited to their oldest civilizations, and rather than dis- dle- and lower-income groups are in- tastes and needs. They have become dis- pense with traditional values, it has creasingly dissatisfied with their earn- cerning consumers who want products wrapped modernity around its tradi- ings. It is essential to remember that 30% that are made in India and for Indians. tional core. For instance, 83% of Indians of Indians still live on less than one U.S. A look at the most respected brands in approve of women’s working outside the dollar a day. The highest-income groups India is telling. Of the top 20 named in a home, and 74% approve of women’s de- are delighted with what their income survey, eight are Indian, including names laying marriage to further their educa- can do for them; the middle and lower like Tata, Godrej, and Bajaj. Only five of tion or careers (both percentages are up groups are much less satisfied. In the the top 20 are new foreign brands. These substantially from ten years ago); yet short term, income constraints and rising have succeeded because they have cus- only 25% approve of marriage to some- costs could slow India’s transformation tomized technology to meet Indian one who is not an Indian, and only 5% ap- from a needs-based to a wants-based needs. Hutch, Nokia, and Samsung have prove of couples’ living together without market. However, a heightened desire to done this particularly well. Nokia modi- getting married. lead the good life might well intensify fied one of its mobile phones by adding To the outside world, the harmonious the middle- and lower-income groups’ ef- a built-in flashlight that truck drivers, for coexistence of seeming contradictions forts to make more money, thus fueling instance, find useful on poorly lit high- is one of the most confusing aspects of consumerism in the long run. ways.“Indianizing” also has to do with the Indian psyche – but it also signifies Foreign is passé; Indian is para- keeping prices at levels that are manage- the country’s openness to change and its mount. Indians long believed in the able for the average Indian consumer. ability to add new dimensions without overwhelming supremacy of all things Seven of the top brands come from losing old ones. The companies, domestic foreign. Antiquated products and tech- well-established MNCs that are either or foreign, that understand this complex- nologies, well past their “sell by”date in thoroughly indigenized or involved in a ity will be the most successful at working more developed nations, were once joint venture that gives them the advan- with and selling to Indians and stand to lapped up by Indian consumers. Now, tages of both worlds – customization of reap enormous benefits of scale. though, with Indians succeeding on the products for India with levels of quality ashok gopal ([email protected]) global economic stage,“Made in India” and technology associated with interna- is a principal at the Gallup Organization’s is no longer an apology. While Indians’ tional companies. Names such as Philips Singapore office, and rajesh srinivasan confidence in foreign companies has re- and Hero Honda fall into this group. ([email protected]) is a prin- mained essentially static, their faith in Trying to connect with consumers at cipal at Gallup’s Princeton, New Jersey, domestic companies has grown. In 1996, an “Indian” level is a mammoth task. For office. Reprint F0610C

Changes in Consumer Behavior 20 Most Respected Savings Goals Durable Goods Purchases Brands in India (percentage of Indians who identified (percentage of Indians who own or use) these as among their goals)

1996 63 62 60 2006 Domestic New foreign brands brands

41 40

29 21 22 18 17 13 12 12 7 8 6 7 1 2 1 Established MNC brands phone Music Mobile system Color TV Color durables machine Washing or laptop Land line Land Children’s education Computer Travel and Travel Refrigerator entertainment Electronics and Electronics

october 2006 23 pings of recruitment advertising. It didn’t promise an exciting career, valuable skills, or the respect of schoolchildren. Rather, it showed how difficult the job was. One ad featured Simon Weston, a badly scarred Falklands veteran whose artillery boat had been bombed. The war hero wept, asking viewers to imagine “going round to someone’s house…to tell a man that his wife and child have been killed in a car crash.”Another com- mercial asked viewers to envision how horrible it would be to have to respond to a call about a baby who had died in his sleep – to collect the child’s teddy bear in a plastic evidence bag as the incon- solable mother watched. These ads de- picted police work as distressing, and yet they attracted recruits. To gauge the effectiveness of the campaign, the ads marketing great success. A few years ago, I helped directed prospective applicants to a dedi- reposition Lipton Cup-a-Soup, one of cated phone number and Web site. More Embrace the Dark Side those brands whose history was filled than 100,000 inquiries flooded the re- by michael j. fanuele with saccharine moms and smiling kids. cruitment office, and from that eager Ivory soap has been bringing “good, We started by accepting the truth: The pool the police force selected 6,000 new clean fun” to families for more than 125 1970s are over. These days, no right- officers – a 50% increase over the previ- years. Along with other classic brands minded parent would serve something ous year, according to the British Home like Sears, Kraft, and Tropicana, Ivory has so high in sodium and low in nutritional Office. spent decades presenting a vision of life content as part of a family dinner. We Part of the appeal was that the ads is- that’s all sweetness and light. That vision promoted Cup-a-Soup as an office snack sued one big professional dare: Are you is also simplistic, cloying, and quickly los- instead, an alternative to a late-afternoon brave enough to be a police officer? But ing its draw. BrandZ, a global study con- Snickers or Coke. By locating a new, something deeper was at work. A survey ducted by the London-based marketing more beneficial context for the brand’s conducted by TNS Gallup found that services company WPP,categorizes these negative attributes, we increased sales people who had seen the ads were twice once-great brands as “fading stars.” every month the ads ran, delivering a as likely to “respect the police” as those They’ve lost the image-based advantage 60% cumulative spike on top of a price who hadn’t. The difficult part of polic- that once made them beloved. increase of 20%. ing – its dark and scary shadow – made Today’s consumers don’t trust the arti- I had a similar experience working the London police brand more authentic ficial, two-dimensional images that used with a marketing team on Ragú. For and thus more appealing. to work in ads. Sadly, many brand man- years, Ragú was in a pitched battle with The lesson here? Perfect purity is per- agers haven’t figured this out. They’re Prego over which sauce was thicker. We fectly dull. In our personal lives, we’re selling fairy tales in a reality-TV world. ended that fight by accepting Ragú’s hardly ever attracted to slick virtue; we They haven’t learned that imperfections shadow. Our brand wasn’t as rich and love people with all their faults and flaws can actually be a source of great appeal. chunky as Prego, but that could be an ad- and contradictions. Likewise with brands. It’s not that people are drawn to prod- vantage. Chunky sauce may be good for In acknowledging their shadows, brands ucts’ shortcomings; it’s that they’ve grown-ups, but it’s not for the typical ten- target the right people, and they do so grown suspicious of things that seem too year-old. Instead of trying to convince convincingly. Their shadows make them pure. To be strong, brands need authen- the world that Ragú was hearty, we cele- stronger. ticity, and that can be found in a brand’s brated what it truly was: a kid’s delight. shadows, or its darker attributes – what The strategy reversed a decadelong sales michael j. fanuele (michael.fanuele@ market researchers call “negative equity” decline. mac.com) is a marketing consultant based and brand managers try their hardest Perhaps the best example of “shadow in New York. He has spent the past ten to hide. branding” is the London police force’s years working at ad agencies on a wide The few brands that have searched for dramatic recruitment campaign in 2000. array of global brands. strength in their shadows have found The effort eschewed the traditional trap- Reprint F0610D

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© UBS 2006. All rights reserved. corporate communications combined their communications functions tion, the best companies we studied had into one organization, reporting up to one created and disseminated detailed com- Get Your Act Together senior executive. Not so. munications plans clarifying the goals by paul a. argenti and thea s. haley While some of our exemplar compa- being pursued, the tactics chosen to In October 2005, an internal Wal-Mart nies such as FedEx do group their com- reach them, and the metrics by which memo was leaked to the New York Times. munications functions under one senior success would be measured. At the same Sent to Wal-Mart’s board by the execu- officer, others, like Johnson & Johnson, time, they gave locally based communica- tive in charge of employee benefits, it nest their communications professionals tions professionals the latitude to calibrate proposed various ways to cut spending within individual business units. Often messaging for their markets. The goal, as on health care while minimizing dam- citing their scale and geographical dis- one executive put it, was “not to speak age to the retailer’s reputation. Among persion, they resist centralized reporting, with one voice but to speak in harmony.” the recommendations: Hire more part- considering it unwieldy and unnecessary. We suspect that the effectiveness of this time workers and discourage less-healthy Some companies combine aspects of strategy is linked to leadership skills of workers from applying to Wal-Mart. The both models. Dell, for example, has a core these at the head of the communications recommendations made sense from a corporate team supported by communi- functions in these companies – specifi- business perspective. But the memo cations professionals residing within the cally, strong business backgrounds, expe- came to light just a day after the com- firm’s many operating divisions. The rience navigating complex organizations, pany had touted its social responsibility New York Times Company has an infor- and the personal influence to move opin- in a briefing to reporters on reduced en- mal council of executives from various ions. Not surprisingly, the very best com- ergy use in stores. When the story ap- areas of the business. Other companies munications performance we observed peared on the front page of the Times create a position wholly focused on was in companies where the head of cor- business section, that irony did not go achieving consistent messaging across porate communications had that much unnoted. departments and audiences. coveted “seat at the table”– a presence It was a stumble that seriously under- Even in the absence of any formal and voice in the process of formulating cut the company’s two primary objec- mechanism, the right culture can drive a overall company strategy and direction. tives – to trim costs and burnish its repu- level of consistency that from the outside Today, it takes strong and clear signals tation – and it’s exactly the kind of thing looks carefully orchestrated. We saw this to penetrate the noise bombarding con- that happens when a company does not in “decentralized” companies where ro- sumers and to prevent distortions of your have an integrated approach toward its bust informal networks and information message by antagonists eager to exploit communications. sharing – often facilitated by sophisti- inconsistencies. Remember, what’s im- Yet integration is becoming harder to cated IT – were at work. portant is not how you align your com- achieve in corporate communications. In short, the idea that organizational munications but that you do. Just as constituency groups are becom- structure accounts for consistent commu- paul a. argenti (paul.argenti@dartmouth ing more complex and multilayered, so nications is false. What makes the differ- .edu) is professor of corporate communi- are many companies. Increasingly, we ence, we found, is a company’s approach cation at the Tuck School of Business at see organizations within organizations – to formulating a communications strat- Dartmouth in Hanover, New Hampshire. large companies made up of a collection egy. Organizations in which communica- thea s. haley ([email protected]) is of underlying operations that cut across tions strategy was aligned with overall the founder of Glen Avenue Communica- business lines, time zones, and cultures. corporate strategy sent the most consis- tions in New Canaan, Connecticut. Messages emanate from senior manage- tent and powerful signals. Without excep- Reprint F0610E ment and various communications func- tions (investor relations, media relations, internal communications, government relations, and so on) through both formal and informal mechanisms, and the in- tended audience for each has unprece- dented access to what has been said to the other audiences. To discover the internal structures, processes, and cultures behind consistent messaging, we interviewed more than 50 senior executives at exemplar firms in- cluding Dell, PepsiCo, FedEx, Infosys, and the New York Times Company. We ex- pected to find that these companies had

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NASDAQ makes no representation about the fi nancial condition of any company. Investors should evaluate companies carefully before investing. Logos are trademarks of their respective companies. ©2006 The Nasdaq Stock Market, Inc. All Rights Reserved. consumer behavior chandise and then, by clicking on an ies virtual human interactions. One can image of a particular item, purchase vir- envision a group of teenage girls arrang- Are You Ready tual clothing for their avatars – the char- ing to meet at a virtual store to try on acters that users create to represent clothes, comment on each other’s choices, for E-tailing 2.0? themselves in virtual worlds – or real- and ultimately choose something, real or by paul hemp world clothing for themselves. Other virtual, to buy. (Though the sales receipts E-commerce is poised for a fundamental companies have followed suit: For exam- from virtual items are small, getting peo- change – a shift from making online pur- ple, Adidas is slated to open a store in ple to sport branded items in a virtual chases (commercial transactions involv- Second Life this fall. world has its own benefits.) ing a single consumer interacting with The shopping experience in these on- But virtual shopping expeditions may a two-dimensional Web page) to going line worlds is still pretty rudimentary. At be driven more by the urge to chat than shopping online (a social experience in- the American Apparel store, virtual ver- the urge to buy. Virtual shopping “would volving groups of people interacting sions of the clothing are crude approxi- give friends something to do as they so- with one another in a three-dimensional mations (though they are also signifi- cialize online instead of simply sitting Web space). The difference between the cantly cheaper than the real article; most and IM-ing each other,”says Michael K. two is as great as the difference between of them sell for under $2), and you can’t Wilson, head of the company that runs sitting on your couch leafing through try on an item before buying it. In order There. Indeed, Raz Schionning, who over- a J. Crew catalog and heading off with to buy the real-world article, you click on sees Web marketing for American Ap- friends for an afternoon trip to the mall. an image of the product and are simply parel, says visitors to the Second Life store If virtual shopping takes off, it is likely to transported to the company’s regular Web often arrive in groups and seem to know unleash the next surge of e-commerce site, where you complete the purchase. one another. They typically talk about the growth. In fact, American Apparel currently sees clothes on display. They might buy some- The evolution is foreshadowed by the the store more as a brand-building than thing or watch the in-store videos. But growing popularity of online environ- as a revenue-generating venture. they often end up chatting about unre- ments in which thousands of people in- But virtual-world commerce is becom- lated topics, even as they continue to teract in real time in 3-D virtual worlds, ing ever more sophisticated, and people linger in the store – mirroring the activity places such as Second Life, Entropia Uni- will soon be able to replicate online the at popular virtual clothing stores in Sec- verse, and There. Although real-life prod- sort of buying experience they have in ond Life, such as Preen and Dazzle Haute ucts have occasionally been offered for the real world. Better technology is en- Couture. sale in these worlds, the May 2006 open- abling realistic representations of prod- The potential of online shopping goes ing of an American Apparel outlet in Sec- ucts and the ability to interact with them. far beyond clothing stores’ opening their ond Life was a milestone. At the store, American Apparel has experimented doors in existing virtual worlds. Develop- customers can browse through the mer- with the use of avatar clerks – controlled ers could create stand-alone online shop- by flesh-and-blood company employees – ping malls comprising dozens of retailers who can answer questions about clothing of all kinds, including music sellers. For items, both virtual and real. Avatars’ ca- instance, iTunes could create a virtual pabilities are also improving. You can store in which people would hang out create an avatar that mirrors your actual and listen to others’ playlists, dancing as appearance, thus enabling you to see they swapped opinions about the music. how an outfit would look on your real Even eBay, with its jumble-sale character, body. Avatars’ somewhat clunky gestures, might be transformed from a tool for typically activated by typing a word like finding a particular item to a world in “shrug” or by choosing from a drop-down which people could rummage together list, are likely to be replaced by realistic through piles of virtual stuff, the equiva- moves that, through the use of Webcams lent of an afternoon of real-world an- or other devices, capture and mimic tiquing in the country with friends – an the body motions of the person at the event that, even if no one is looking for keyboard. anything in particular, inevitably results As the experience becomes more real- in someone’s purchasing something. istic, there will be a return to the “social and recreational aspect of shopping,”a paul hemp ([email protected]) crucial element of bricks-and-mortar re- is a senior editor at Harvard Business tailing that was lost when retailers went Review and the author of “Avatar-Based online, says Bob Moore, a sociologist at Marketing” (HBR June 2006). the Palo Alto Research Center who stud- Reprint F0610F

28 harvard business review | hbr.org conductor keith lockhart on tradition and leadership Responsibility Junkie

s conductor of “America’s Orchestra,”the Boston in the violin section thought they’d be the one playing Pops, for the past 12 years, Keith Lockhart has the Tchaikovsky Concerto in front of the orchestra, lead- conducted more than 900 concerts in the ing it with their artistic impulses. Few of them dreamed United States and overseas, in addition to serv- about being a person who takes orders. But in any organi- ing as music director of the Utah Symphony. zation, if there are no people who are followers, you’ve Lockhart recently spoke with Glenn Mangurian, an execu- got a situation. tive in residence at the University of Massachusetts, as How does the conductor empower everybody while part of the university’s Uncommon Leadership breakfast still creating a musical collaboration that works? The key series. In this edited conversation, Lockhart discusses the in my experience is to make the musicians feel invested challenges of taking the helm of a century-old institution. in your decisions–so that they own them, too. That’s not always easy. For example, if a bassoonist has a solo in the You’ve been in this job for more than a decade, but middle of a piece and you say,“Well, I really don’t like people still often think of you as the new conductor. where that’s going”–how do you get that musician to buy When will that change? into your idea? Unlike most businesses, you don’t have the In Boston, it takes about 100 years not to be the new per- luxury of having a private office in which to talk these son. Seriously, the challenge is not so much in becoming things through. Rather, in real time, you’re criticizing this established as the conductor of the Boston Pops, but in person in front of 85 of his or her peers. It can be humili- following the legacy of a person whom people in Boston ating, and others can become defensive on their col- know of even if they were born after he died: Arthur league’s behalf. So, even though you have formal author- Fiedler. Fiedler died in his 50th year at the helm. When he ity as the conductor, if you haven’t built support from the died, his name was inextricably linked to the Pops. The ground up at the start, you’ll be in trouble. Pops knew that it would be difficult to appoint a new con- ductor without everyone saying,“Hah, but he’s not Arthur How do you build that sort of support? Fiedler.”So in 1980, after Fiedler died, they recruited That comes in part from being someone who can be ab- somebody whose fame was already established for doing solutely trusted and relied upon. I’ve had air-raid sirens go something completely different: John Williams, who was off during concerts, blackouts, rainstorms postponing out- famous for composing the Star Wars score three years ear- door televised performances. In situations like that, peo- lier. After 13 years of Maestro Williams’s tenure, the Pops ple ask,“What does Keith want to do?” And if I can take felt it was safe to bring in somebody whose name and charge and come through for them in a crisis, that goes a fame would be bound together with the institution’s. long way. Even when things are going smoothly, every player is relying on you. A violinist may seem buried in What did you do to make the Pops yours? the sheet music. But she knows exactly when she needs to The best advice about that actually came from John look up for guidance. I’d better be there, as I used to tell Williams. I had dinner with him the night before it was my students in my conducting classes: If you sometimes announced that I’d be the new conductor, February 5, think you’re peripheral, just make a mistake, because the 1995. He said,“People here love the Boston Pops, they love moment you do, you’ll get 80 pairs of eyes glaring at you. the institution. It’s not about you. Just be a caring steward People assume that when you become a conductor of the institution; show that you love the Pops and they you’re into some sort of a Napoleonic thing–that you will love you because of that. You don’t have to worry want to stand on that big box and wield your power. I’m about making it your own institution.” not a power junkie, I’m a responsibility junkie. If I were in it for the power, I don’t think I could get the orchestra to Leading musicians presents some unusual challenges. follow me anywhere.

Most concert musicians had “the dream.”Most everyone Reprint F0610G STEINER CHRISTIAN

30 harvard business review | hbr.org 728 destinations. The whole world is within your reach.

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making the sky the best place on earth globalization cally. Levels of internationalization of How should managers incorporate na- phone calls, management research, chari- tional differences into their international Apocalypse Now? table giving, investment, and even trade strategies? by pankaj ghemawat (as a fraction of economic activity) clus- • Determine which of a range of na- To the ancient Greeks, an apocalypse ter much closer to 10% than to 100%. tional differences – cultural, administra- was the revelation to a privileged few (See the exhibit “The 10% Surprise” for tive, geographic, and economic – matter of something hidden from the masses. a closer look at the numbers.) the most in your industry. This will tell In biblical writings, the term came to The slow growth and limited extent of you which ones are particularly impor- denote an abrupt transition from the internationalization point up the sub- tant for your international strategy to present age to a future age, accompa- stantial national differences with which address. nied by great upheaval and extreme border-crossing strategies must still con- • Analyze differences within differ- outcomes. tend. Fascination with the globalization ences: Don’t just distinguish between Much of the classic literature about globalization was apocalyptic in both senses of the term. The notion of an Predictions of a globalization apocalypse are way off the apocalypse due to globalization can be traced at least as far back as 1983, to the mark: Most types of economic activity that might cross late Ted Levitt’s article “The Globaliza- tion of Markets” in Harvard Business Re- borders are still largely concentrated domestically. view. But with the profusion of new books on globalization – from 2000 to 2005, more than 5,000 were published, com- apocalypse is only one of the reasons home and abroad. Categorize foreign pared with fewer than 500 in the 1990s – such differences seem to be underplayed countries as similar to yours along the the apocalypse has become the stuff of in international strategy. Others include dimensions that matter most or as rela- best sellers. companies’ tendency to uncritically ac- tively different. This will help you decide Is the globalization apocalypse upon cept visions of borderlessness out of a where to compete. us? Visions of the apocalypse generally desire to seem to “get it”; incentives • Stretch your responses to differences evoke the disappearance of borders and that encourage headlong international beyond tweaking the domestic business the integration of markets and assume growth; the inability of most executives model – and also consider ways to profit or predict internationalization levels to grasp how different the conditions in from differences, rather than treating close to 100%. But such predictions of foreign countries truly are; and the fact them all as constraints on value creation. complete cross-border integration are that firms that are successful at home The objective here is to foster creativity way off the mark: Most types of eco- are disproportionately likely to venture in thinking about how to compete. nomic activity that might cross borders abroad – and to be overly enamored of If this simply sounds like additional are still largely concentrated domesti- their domestic business models. hard work with an uncertain payoff, re- member that at its core, the message here is an optimistic one. From a mana- The 10% Surprise gerial perspective, differences afford room for distinctively international stra- Many key measures of cross-border economic and other business activity fall within or close to the 5% to 15% tegic thinking – and the prospect of sig- range–far below what much of the writing on internationalization suggests. nificant improvements in performance. And from a social perspective, differences supply some reassurance that increas- Management Direct Private Stock Research Investment Charity Investment ing global integration will not inevitably lead to the triumph of the bigger and Telephone Trade blander. Calls pankaj ghemawat is the Jaime and Jose- fina Chua Tiampo Professor of Business Ad- 100 ministration at Harvard Business School in 0 5 10 15 20 25 50 Percent International Boston and professor of general manage- ment at IESE Business School in Barcelona, telephone calls = international revenues ÷ total global telecom service revenues; management research = percentage of management Spain. His book Global Strategy in a research published from 1996 to 2000 with a cross-border component; direct investment = foreign direct investment flows ÷ gross global World of Differences will be published by fixed capital formation; private charity = percentage of U.S. private giving that has an international component; stock investment = percentage of U.S. investors’stock holdings that has an international component; trade (to GDP) = global exports ÷ global GDP. For more Harvard Business School Press next spring. detail, go to hbr.org. Reprint F0610H

32 harvard business review | hbr.org some CEOs we interviewed wished to remain anonymous. read our report and you’ll understand why.

Let’s start with what we can tell you. We “We are at the critical point,” admitted one conducted interviews with a broad cross CEO, “where we should transform our business section of CEOs — 765 to be exact. They are model itself.” working in 20 different industries and 11 And some confessed, quite honestly, to a regions around the world. “gap” between the collaboration they’d like And they spoke with an honesty usually to do and the collaboration they’re actually reserved for the protected privacy of a doing. Said one respondent, “It has been boardroom. They revealed their plans, like Relationship 101 — we’re terrible their motivations, and in some cases, and we need to improve.” even their weaknesses. Other findings were equally Said one CEO,“Since 70 surprising. On page 21, for example, percent of our business is based you’ll discover which department on a service that will no longer was conspicuously low on the list exist as we know it, we need to when it comes to idea generation. adapt our enterprise to survive.” And you’ll learn that most CEOs have Given that level of candor, some tasked one person with bringing their chose not to reveal their names. innovation agenda to life. On page 29, While you don’t need to know you’ll find out who that person is. who they are, you do need to know Whichever page you turn to, one thing’s what they said. clear. CEOs are placing an enormous They talked quite openly about importance on innovation. a two-year window, in which 65% To them, it’s what will set them apart. of them expect to make fundamental And make them special. At IBM, we’ve changes to their businesses. helped businesses of all sizes innovate They spoke about devoting much their way to that goal. Want to be one of their innovation effort, a full 30%, of them? Start by downloading to revamping the sacrosanct The Global CEO Study 2006, at business model. ibm.com/special/ceo10

what makes you special?

IBM, the IBM logo, ibm.com, and What Makes You Special? are registered trademarks or trademarks of International Business Machines Corporation in the United States and/or other countries. Other company, product and service names may be trademarks or service marks of others. © Copyright IBM Corporation 2006. All Rights Reserved. The Bourgeois Virtues: Ethics for an Age of Commerce Deirdre N. McCloskey (University of Chicago Press, July 2006) The World’s Newest Profession Even ardent supporters usually concede Management Consulting in the Twentieth Century that capitalism has improved society only Christopher D. McKenna in material, not moral, ways. Not so, says (Cambridge University Press, 2006) McCloskey, a prominent economics histo- Christopher D. McKenna thinks consulting needs to grow up. After a nearly rian, who engagingly synthesizes a variety century-long fight to be seen as professional, the industry seems willing to em- of recent scholarship to build a broader brace the pleasures of professional status–healthy pay, intellectually challeng- case. Because they have always had a more ing work, respectful relationships with clients–but not the hassles of accredita- egalitarian outlook than the aristocrats tion, a code of ethics, or professional liability. Such trappings of adulthood may that previously dominated society, mer- not be so critical when you’re solving technical chants and industrialists have actually challenges like how to (literally) make a silk purse been the leading force for ethical improve- out of a sow’s ear, which kept Arthur D. Little busy ments such as the abolition of slavery. Cap- italists’ sins, the author suggests in this in 1921. But if you haven’t developed an adult con- conversational opus, have come more from science by the time you start consulting on strategy, governmental privileges than from purely McKenna claims, before you know it you’ll be ma- commercial acts. nipulating financial statements and shredding the evidence. Shopportunity! How to Be a Retail McKenna’s book lays out, in sometimes exhaust- Revolutionary ing and repetitive but nonetheless convincing de- Kate Newlin (Collins, September 2006) tail, the history of the business of consulting in the How much value does the shopping expe- United States. The book is academic in tone,1 a rience really provide? Newlin, a marketing scholarly wander that begins in the 1880s, when the second industrial revolu- consultant, insists that consumers seek tion created new opportunities for science-based businesses, and chemists, social significance not just in the products physicists, and more practical engineers took occasional consulting assign- themselves but in the environments in ments with the era’s emerging manufacturers. The business gained momentum which they buy them. Stores with harsh, in the 1930s when U.S. government regulators took actions to restrict the flow utilitarian designs and indifferent or non- of collusive information among companies. Executives could no longer share existent clerks can’t offer the personal best practices directly, so they turned to consultants as legal conduits of infor- coaching and meaningful experiences that mation. (In Japan and Germany, where companies were not so restricted, man- satisfy buyers’ deeper desires. Readers agement consultants never achieved the same degree of influence as they did who can get through a tedious paean to in the U.S.) brands will discover a provocative and well-illustrated warning to price-obsessed McKenna concludes with the explosion of consulting at the end of the twenti- department stores and other rivals to the eth century and the worldwide scandals in corporate governance that ushered in discounters. the twenty-first. He pins the Enron/Andersen collapse, among other debacles, on the consulting industry’s lack of professional standards and executives’ per- The Fable of the Keiretsu: Urban ception that their consultants and auditors would shield them from risk. Legends of the Japanese Economy Hence the call to professionalize. Executives have always questioned the Yoshiro Miwa and J. Mark Ramseyer (University of Chicago Press, July 2006) value of the consulting services they invest in; that they continue to use those According to the conventional wisdom, services suggests that the perceived benefits offset the lingering doubts. This keiretsu have long dominated Japan’s in- balance could easily shift the other way. Tom Watson wrote in his autobiogra- dustry and finance. These bank-centered phy of a consultant, John Burns, who took the CEO job at a competitor less corporate groups, the argument goes, pro- than three months after completing a project at IBM. McKenna leaves us with moted cooperative supply chains and a question: How often after that abuse did Watson (and his peers, for that mat- “patient” investment of capital that gave ter) avoid hiring consultants, or at least clip their wings? If the consulting firms the country a major competitive advan- themselves don’t see fit to straighten up and fly right, maybe it’s time for the tage. Now Miwa and Ramseyer, a Japanese CEOs who pay their fees to take a stand. economist and an American legal scholar, argue convincingly that these groups are 1. This reader, for one, found the profusion of footnotes a little distracting. –m. ellen peebles an academic fiction.

34 harvard business review | hbr.org THAT EDGE YOU’RE LOOKING FOR IS ACTUALLY QUITE WELL-ROUNDED.

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HBR CASE STUDY

What Serves the Customer Best? by Paul F. Nunes and Woodruff W. Driggs

Glenmeadie is investing lack-tied waiters circled with cide with a trip Bob was making to B coconut shrimp and crab cakes New York.Given that he had just joined heavily in the front end while a few dozen guests – mainly men the company three months earlier, it of its business, enhancing in their twenties and thirties – moved was a good opportunity to see his from station to station comparing notes CMO’s marketing approach up close its interactions with on the Scotch whiskies they were sam- and to take the pulse of a tier of cus- pling. Bob Littlefield beamed as he cir- tomers he wouldn’t ordinarily interact customers. But that’s culated through the crowd. But despite with. The guests were mostly bartenders drawing resources the appearance he’d given of taking from the city’s upscale bars, with a few regular sips, his glass still held the same club owners and liquor distributors away from the product four ounces poured for him an hour mixed in. innovation that might ago. It wasn’t that he didn’t like the Graciously exiting a conversation that taste; he loved it. It was his company’s threatened to monopolize him, Bob keep them happy in the best-selling product. Tonight, however, moved toward a group congregated long run. he was on the job. around the blind-tasting table. One of A division president wouldn’t nor- Glenmeadie’s apprentice distillers was mally be playing host at such a small- there helping guests appreciate the scale customer event–Glenmeadie had subtleties of different blends and single four of these Tastemakers gatherings malts. Working alongside a buyer from planned in each of 25 cities this year a big local distributor, the lad seemed alone – but this one happened to coin- enthusiastic and knowledgeable, if a bit

HBR’s cases, which are fictional, present common managerial dilemmas

DANIEL VASCONCELLOS DANIEL and offer concrete solutions from experts.

october 2006 37 HBR CASE STUDY • What Serves the Customer Best? unpolished. Whatever schooling he’d he wanted to thank the Newcastle kid the previous president, who’d hired him had to get to this point in his career for making the trip. two years ago, but he wasn’t sure exactly hadn’t been enough to rid him of a pro- He found the apprentice tidying up, what was being spent. nounced Geordie accent. For a New pulling the masks off the various bottles “Start by painting the worst possible York crowd, Bob supposed, that was part from the blind tasting.“Appreciate your picture for me,” Bob said. “What’s the of the charm. coming all this way to help out,” Bob damage, as they say.” Some time after eight, as the jazz trio said. Among the now revealed labels, he Ewan uncapped his pen and started finished its final set and the last of spotted Glenmeadie’s most expensive with the bills coming due for the Taste- Glenmeadie’s guests filtered out of the offering and poured two glasses. He makers program, which were more or less what Bob had expected. On top of A million and a half for the Tastemakers that, there had been an explosion of pilot initiatives aimed at making cus- program, plus management time. Suddenly tomers feel a more personal connection the moment seemed right to take a mouthful with the brand. “There’s the Web site overhaul, including all the new interac- of the spirits he’d been hand warming all night. tive capabilities. And there’s the soft- ware we’re handing out – mostly for lit- room, Paula Laughlin appeared at Bob’s tilted his in the young man’s direction. tle stuff like gift card printing and label side. She was the marketing director for “And now you’re off duty.” making, but it adds up. Then there’s the North America, reporting to CMO “Ta,” the apprentice said hoarsely. new customer information phone ser- Nevin Wallace. As the true force behind He lifted his glass in return, smiling vice. Nevin insisted on a local call center the event, she’d been attending to the broadly. “It’s a tough job, but some- to ‘ensure the authenticity of the voice.’ details. It occurred to Bob that having body’s gotta do it.” That means, despite what you might the new president in attendance could have heard, talk isn’t cheap.” Ewan only have added to her stress level. High Proof looked up from his growing column of “Well!” she sighed brightly. “I’d call Back in Inverness the following week, numbers. that a success.” Bob worked with his finance head, Bob acknowledged the quip with a “I had a wonderful time,”Bob assured Ewan McCallum, on the presentation thin smile. her. “And I’m sure our guests did, too.” he would give to the board of Glen- “We also need to add in the new loy- He smiled benevolently.“But you must meadie’s parent company, Worldwide alty card program,” Ewan continued, tell me what pleased you most about it. Spirits. Having already run a few small “and the new event-based program, Did it meet your, er, goals in terms of businesses for Worldwide, including a where we mail best wishes and coupons marketing?”It was a casual question but craft beer business in the States, he on birthdays and anniversaries. Then also an honest one. It had occurred to knew the drill well enough. But he also there’s the ongoing cost of the visitors Bob at various points throughout the knew that this time would be different. center and the quarterly newsletter evening how hard it would be to mea- Glenmeadie, a recently acquired “tuck mailing…” sure the ROI on this kind of expense. in” brand, was a much larger concern, He scribbled the total at the bottom, Paula grimaced. “Well, to be honest, with roughly $100 million in sales on underscored it twice, and turned the this one went over budget. But that’s nearly 2 million nine-liter cases sold. pad around for Bob to see. “Accounts New York for you. I’m sure we can make Plus, it was international, with sales in for over half our profits.” it up in the other cities, so we’ll still av- more than 180 countries. Bob’s perfor- “And you think the board will have erage $15,000 per event.” mance in the next few years would be questions about that, do you?”Bob said. Bob instantly did the math in his a key test of his ability to take on greater “Can’t imagine why.” head. Twenty-five cities times four responsibilities at Worldwide Spirits. “Ah,but it isn’t so catastrophic.”Ewan events. A million and a half for the It made sense to start by anticipating raised a finger to make his point.“We’ve Tastemakers program, plus manage- the questions the directors would have cut expenses in many other areas, es- ment time. Suddenly the moment on the financials. Ewan figured they pecially overhead. And R&D. And you seemed right to take a mouthful of the would zero in fast on the swollen mar- already know the really positive news– spirits he’d been hand warming all keting expenses. Bob knew that Nevin that sales have started to climb rather night. Then he excused himself, saying had been given quite a lot of latitude by dramatically. Market research says it’s mostly due to more repeat purchases, Paul F. Nunes ([email protected]) is an executive research fellow at Accen- higher individual buyer consumption, ture’s Institute for High Performance Business, based in Wellesley, Massachusetts. and greater share of wallet. Whatever Woodruff W. Driggs ([email protected]) is the global managing direc- the cause, if the trend continues, we’re at tor of Accenture’s Customer Relationship Management practice in Wellesley. risk of outselling our production.”

38 harvard business review | hbr.org What Serves the Customer Best? • HBR CASE STUDY

october 2006 39 HBR CASE STUDY • What Serves the Customer Best?

Bob knew this was a good problem to smaller business whose competing job Marketing struck a nerve.“All this spend- have. He could call on some of the other offer Ellis had turned down back in ing on so-called touch points,”Ellis spat. distillers to top off his supplies for blend- 1981. Bob inhaled from one of the tum- “It’s daft. Have we lost sight of the fact ing purposes. And he could hold the line blers and concentrated. The mixture of that we’re a distiller? At the end of the on prices at the wholesale level if there phenolic and aldehydic notes – smells day, customers only want us to make was strong pull from the retailers and that only weeks ago he would have rec- superior whiskey.” on-premises sellers. The only real prob- ognized simply as peaty and grassy – Ellis warmed to his subject rapidly. lem would be the single-batch and aged made a very pleasant bouquet. Ellis, al- “Bob, you now have a hand in the casks reserves, which would be harder to ready having sipped from both glasses, that will be opened 25, 26, 27 years from backfill, given their finite supply. launched into an evenhanded dissection now. Is the product still going to beat “So we can justify the marketing of their relative merits. the competition and please the connois- investment by showing the top-line Soon enough, Bob was convinced that seurs? We have a legacy to protect. And growth,” Ewan noted. “The question the Glenmeadie product was the supe- I need your help, because the time I can they’d be justified in asking, though, is rior one, but he also understood Ellis’s devote to the task is increasingly scarce. this: Will all these customer-facing ini- explanation of how the new wood fin- Do you know where I spent half the tiatives yield higher demand in the long ishes he’d been experimenting with morning? Not overseeing production. I term and make it stable enough that was in a studio taping video bits for the we can get the margins back up? Or “Sure, customers are Web site. Before I leave tonight, I’m sup- have we just made demand less consis- posed to have personally participated tent and predictable?” drinking more now – in our online forum. If Marketing gets “Well put,”Bob said.“But I know this but is it only because its way,I’ll be spending my whole day in crowd. They’ll ask it in simpler terms, ‘branded experiences.’ They’ll trot me as in ‘Sure, customers are drinking we’re buying?” out till I can’t trot anymore – and then more now–but is it only because we’re they’ll chisel it on my gravestone: ‘He buying?’ ” might have made it even better. By Was an Engaging Customer Interface.’” transferring the whiskey to sherry butts, Bob had heard his tutor hold forth on A Taste of History Madeira drums, and port barrels before this subject before–even using some of Of all the ways Bob had devised to get bottling, his group was achieving tastes the same phrases. There was nothing to up to speed in his first 100 days on the with new depth and complexity. The be done now but lean back and enjoy job, his favorite was the fortnightly tu- conversation turned to Ellis’s longtime the show. It occurred to Bob that blow- torial he’d arranged to get from Ellis dream of being able to do single-cask ing off steam this way was how Ellis Cameron, Glenmeadie’s master distiller. bottling at scale. came by his gift of gab. He rehearsed. At 53, Ellis was at the top of his game, “I won’t say it would be cheap,”Ellis His favorite debates found him con- and a treasure of tacit knowledge. He admitted. “It would take some new au- stantly reworking metaphors, experi- was a rare combination of traditional tomation of the line. But it’s actually menting with new grace notes, honing craftsperson and modern production possible now. Imagine it: Each cask sep- his delivery. It was a process not unlike engineer and beyond that, a born story- arately bottled, and each bottle given distilling. teller. In the midst of a primer on the a label that would detail all the rele- “Customer care is what you focus on merits of limestone spring water, Bob vant dates – when the whiskey was put when you can’t compete on product was likely to get an even more valuable down, tipped, bottled – as well as the superiority – and by Jove, we’ve not digression into company lore. It didn’t number of the cask and the number of reached that point yet.”Evidently, Ellis hurt that their meetings took place in bottles that came from that particular wasn’t finished. “There’s an old expres- Glenmeadie Castle, home of the com- cask. Each bottle would be a limited sion: Build a better mousetrap, and the pany’s distillation and storerooms for edition. Some would be collectible world will beat a path to your door. Say- nearly a century and a half. masterpieces.” ings like that become clichés because Today’s session marked a special occa- Bob hated to put him off.“Let’s revisit there’s truth in ’em. Yet we seem to be sion: Ellis’s 25th anniversary with the that subject in the next budget cycle,” forgetting these days that the customer company. In honor of it, he handed Bob he said.“Sales are up, you know, thanks has a basic need to be addressed. We’ve two glasses. One, he said, was the first to Marketing’s efforts. Now we just given up on redesigning his mousetrap taste of the 25-year-old special reserve need to get costs back in line, and then and are trying to trap him instead!” the company would release in a month: we can think about new investments in With that, the tirade ended. Bob, “The oldest batch around here I can production technology.” having weathered the storm, pressed claim to have had a hand in. Let’s hope As soon as the words left his lips, Bob his lips together and nodded sagely. it was clean.”The other was the equiva- knew they would not have their in- “Ellis, my friend, I hear you.”Then, ges- lent product from Hanshaw, a much tended effect. Instead, the reference to turing to the other bottle on the table,

40 harvard business review | hbr.org

HBR CASE STUDY • What Serves the Customer Best? he changed the subject. “What was it his order in the way he’d become accus- One More Round made you join Glenmeadie instead of tomed to back in Inverness: “Double “Passengers for Flight 126 to New York, Hanshaw, anyway?” shot enorme latte with a half shot of al- with continuing service to London – we Ellis glanced at him, then sat down mond syrup.”Bob was probably not the are about to begin boarding through with a sigh. After a moment, he chose first person to have noticed that Stubbs Gate 34.” to respond. “To tell you the honest was adhering to the rather downscale Bob and Nevin wrapped up their cell truth, the day I came in for my inter- strategy of fast-food chains – fairly un- phone calls and stood, anticipating the views, there was a lovely receptionist exceptional product quality delivered call for premier status frequent-fliers. who showed me some kindness…” He with incredible consistency. But no one Minutes later, Bob had a glass of paused and looked wistful. talked about that. Until a better option tomato juice and was fiddling with his There was no telling whether it was came along, wasn’t it best to preserve iStream. Opting for random selection, the honest truth or not, but Bob picked the fiction that your hangout was cool? he was treated to the opening strains of up the cue.“Well, there you have it, Ellis. Customers were complicit in such Dire Straits’“Sultans of Swing.”He closed Having the right interface sometimes things. Until the day they were not. his eyes and enjoyed the twang of Mark is the key to competitiveness.” Nevin interrupted Bob’s thoughts Knopfler’s guitar. He was even happier Ellis glanced at his boss slyly and con- by nudging his arm with a magazine. when the iStream shuffled to the classic tinued.“That evening, she had occasion “While we’re celebrating awards,”Nevin New Order tune “Blue Monday.” Talk to usher me into the tun room. Totally said,“I brought this along to show you. about a 25-year special reserve. It wasn’t off-limits. I couldn’t believe my eyes – In our own small way, Marketing is till the device moved on to a hip-hop the setup defined the state of the art. getting some recognition, too.” artist his son had recommended that I knew then I couldn’t work elsewhere.” The narrowness of trade journals was Bob pulled the earbuds loose. He lifted his drink to the light, studying always amusing to Bob when he en- What a phenomenon, the iStream, its color.“I daresay this has aged better countered them outside his field. This Bob thought. The margins the manu- than she.” one was called Corporate Events. With- facturer was earning on it were almost out thinking, he blurted out his sur- obscene, but people were happy to fork Choose Your Poison prise. “There’s an entire magazine over their money. Was that because it The superior quality of Glenmeadie’s about company shindigs?”Then he saw was a better mousetrap – or a better spirits was affirmed once again a few why Nevin had pulled it out of his customer trap? The question intrigued weeks later by the San Francisco World briefcase. Featured as a medalist in the him enough that he pulled out a note- Spirits Competition. Four gold medals came the company’s way, to be placed “Have we lost sight of the fact that we’re a alongside the three won earlier in the season in the International Wine and distiller? At the end of the day, customers only Spirits Competition. want us to make superior whiskey.” Bob and Nevin had attended the San Francisco event and were scheduled on magazine’s annual awards was Glen- pad to recall his last several interactions the same flight out. They took Nevin’s meadie’s Tastemakers program. The ac- as a customer. The airline. Stubbs. The rental car to the airport, allowing plenty companying text explained its goals, suc- rental car company. The hotel. A pur- of time for the Bay Area traffic. As it cess factors, and resource requirements. chase of some expensive chocolates. turned out, the roads were clear, and “Congratulations on the peer recog- He made a list of questions he would the rental car return was unbelievably nition,” Bob said as they sat down at a apply to each. Was he satisfied with the efficient. They found themselves on the table. He paused a moment to compose experience? Was he loyal to the seller? monorail heading toward their termi- his next thought.“At the same time, this Did it have a truly superior product? nal with two hours to spare. helps me see the challenge you face. Was the service more pleasing than They checked in at a kiosk and went I didn’t realize customer programs like what he got elsewhere? And if so, was through security. As the moving walk- ours were so plentiful that whole mag- that because it was solicitous or simply way took them toward their gate, Bob azines would be devoted to them. Our efficient? Bob started jotting down his spotted a Stubbs, the ubiquitous Amer- successful approach has now been pub- answers. With luck, a pattern would ican coffee chain.“I could use some caf- lished for the benefit of all. I’ve often emerge, and he would know how to feine,” he said to Nevin. “Just as com- heard you say that the front office is make his mark at Glenmeadie. fortable to sit here as at the gate.” the new basis for competitiveness, be- Entering the café, Bob was glad for cause product innovations are so easily What should be the priority for the aroma of espresso and for the decor matched. But here is our secret recipe in Glenmeadie’s innovation efforts? • that made Stubbs outlets nearly indis- print. Maybe a customer-facing advan- Four commentators offer expert advice tinguishable the world over. He stated tage isn’t so hard to copy after all.” beginning on page 44.

42 harvard business review | hbr.org Jess Jackson, Hawkeye Mountain Estate, Alexander Valley

The vine is a mountain animal. That’s not just my grapes will be of higher quality. This combination of opinion. It’s a fact of nature. A result of Darwinian elements produces tough little berries that are com- selection. In truth, growing grapes in high-elevation plex, intense and rich in character. vineyards is extremely difficult for both the farmer and Dry farming at high elevation is far more challeng- the vine. In the case of the vine, it’s a matter of survival. ing. But it always produces a better grape. The fact Our Hawkeye Mountain Estate vineyard sits at remains, you can’t have a world-class wine without a about 2,400 feet above sea level. At this elevation world-class grape. When you try our mountain-grown there is very little soil and, as a result of gravity, even Cabernet Sauvignon, I believe you’ll agree. less water. Grapes grown here are closer to the sun I have been told that many of you enjoy the taste and are exposed to more severe weather conditions. of our wines but you are not sure why. My goal is to In order to survive, the vines must put all their effort help with A Taste of the Truth. into the fruit. They will yield fewer grapes but the

kj.com/truth ©2006 Kendall-Jackson Wine Estates HBR CASE COMMENTARY • What Should Be the Priority for Glenmeadie’s Innovation Efforts?

s Bob Littlefield was sitting on the plane customers, I doubt all 25 of the targeted cities A listening to Mark Knopfler’s “Sultans of are created equal. In general, marketing’s Swing,” he would have heard the following “explosion of pilot initiatives” and “swollen” lyrics: “Too much competition, too many expense line signal a lack of focus, convic- other places / But not too many horns can tion, and discipline. make that sound.” Master distiller Ellis Cameron has come It’s a nice analogy for the business Bob is up with what sounds like the best way to leading. The category offers consumers many strengthen the personal relationship Glen- options, but Glenmeadie’s product is the one meadie’s most loyal consumers have with the being singled out for gold medals. Not too product. The single-cask bottling he envi- many scotches can make that sound. Now sions would deliver a customized product to Bob needs to decide how best to amplify it. the company’s preferred upscale consumer. The right strategy will be a careful balance This type of offering would command higher David Herman (dave_ between front-end initiatives and product de- margins, provide consumers with more indi- [email protected]) velopment. There’s no question that innova- vidual choices, and allow them to trade up. is the president of Lebanon, tion at the customer interface is important– Glenmeadie could also sell such limited edi- Tennessee–based Hartmann even for a company whose brand is rooted in tion products through appropriate third par- Incorporated, one of the oldest a heritage of product excellence. My own ties. There, it might take a page from Hart- luggage and leather goods company, Hartmann Incorporated, has been mann’s book. We have found much success in manufacturers in the United States. Hartmann is owned around since 1877 producing fine luggage offering our key retailer partners–like Bloom- by Brown-Forman Corpora- and leather goods for those who appreciate ingdale’s in the United States, Harrods in the tion, a consumer products luxury. But today, our fastest growing and United Kingdom, and Mitsukoshi in Japan – company known for Jack most profitable channel of distribution is their own exclusive patterns and pieces, help- Daniel’s, Southern Comfort, Hartmann.com. It’s also an incredible tool ing them differentiate themselves in a com- Fetzer wines, and other for communicating with loyal customers, petitive marketplace. Glenmeadie might brands. who tell us they want superb service along start with upscale steak house chains, hotel with high-quality products. chains, or casinos and later extend the offer Glenmeadie’s business differs from Hart- to private clubs, individual restaurants, and mann’s in some important respects. Due to even end consumers. Ellis implied that creat- legal restrictions, Glenmeadie has much less ing the product would entail a large invest- opportunity to sell direct to consumers. Be- ment in modern technology, and the nature tween that and the nature of the product, it’s of the supply chain is such that the results unlikely that quality of service is vital to the wouldn’t reach the marketplace for many consumption experience. So Glenmeadie years. For Bob, persuading his board and the might allocate its marketing funds differently skeptics on his team that the investment is needed will require real finesse – and that How many times must they hear will probably be the most important test of his capabilities. from the company in a single year? To secure the success of the product inno- vations, Marketing must ensure that Glen- between building lifetime relationships with meadie’s core brand remains strong. What- current customers and attracting new ones. ever differences in taste result from Ellis’s (Every company should explicitly make that port barrels, sherry butts, and so forth, any distinction.) I suspect Marketing could back new products need to draft off of that core off a bit on its efforts to cement relationships brand. In a way,the idea is like Mark Knopfler with current customers. How many times himself. Twenty-seven years after “Sultans of must they hear from the company in a single Swing”hit the pop charts, he’s still at it–only year? And is direct mail the most efficient now on the Americana charts, paired with vehicle? Likewise, while winning over local country music legend Emmylou Harris.

bartenders may be a good way to attract new Somehow, his guitar still has that sound. WENDY WRAY

44 harvard business review | hbr.org ©2006 Accenture. All rights reserved. ol’ otscesu opne.Fra in an For companies. successful most world’s to ourgroundbreaking research onover500ofthe accordingdefining characteristic ofhighperformers, Tiger. a executional diligence.Thatbalanceofcapabilities isa be to Outstanding strategic instinctsdrivenbyunrelenting takes it what know We visit accenture.com/research at ourstudyofandexperience withhighperformers, - et look depth HBR CASE COMMENTARY • What Should Be the Priority for Glenmeadie’s Innovation Efforts?

lenmeadie’s new initiatives – the Taste- shamelessly hyping itself into a hot consumer G makers program, the Web site en- brand; it is smart enough to address both hancements, the loyalty cards – are suscepti- end consumers and the trade with a broad- ble to fine-tuning. But if the goal was to build based program to expand the market of cer- more valuable customer relationships, then tifiable connoisseurs. the initiatives have proven an unalloyed suc- Bob’s problem isn’t that he has difficult cess. Bob may feel there’s a lot of activity trade-offs to make. The new approach is and expense to defend as he contemplates working. It’s the organization that’s not. Right his presentation to the board. But the real now, his people live in separate worlds and question he must address is this: Is the care about different things. Ellis resents what company seeing enough of a sales lift to jus- Marketing is doing (and spending), while the tify the several million extra marketing dol- marketing people probably see Ellis as a self- lars it’s spending on front-office programs? important diva who just doesn’t get what Though we don’t have many hard numbers matters to the business. As a result, the ques- Jeffrey F. Rayport (jrayport@ to work with, we know Glenmeadie is a busi- tions around resource allocation are political, marketspaceglobal.com) is the ness of scale, and we know that increased not practical. founder and chairman of Mar- demand may soon outstrip supply. Since no What the two groups have in common is ketspace, a digital strategy rational company would fail to forecast in- the demand side,the customer’s point of view. advisory company based in ventory, we can assume that the marketing Ellis’s notion of doing single-cask bottling Cambridge, Massachusetts, pushes have proven surprisingly effective – presents Bob with an ideal opportunity to that is affiliated with Monitor which, in turn, indicates a healthy ROI on the make peace. Start with the fact that Ellis’s Group. Prior to founding the company, Rayport was a faculty new marketing activities. idea is about as front end as a production in- member at Harvard Business Better yet, despite reported pressure on novation can get. Numbering barrels and School for nearly a decade. R&D budgets, the front office success does packaging their contents in limited-edition He is also the coauthor, with not seem to have come at the expense of batches represents more of a go-to-market Bernard J. Jaworski, of Best product innovation. Of course, Ellis doesn’t plan than a production strategy. Moreover, Face Forward: Why Compa- see it that way. He works in a fabulous castle what Ellis is really talking about is turning the nies Must Improve Their Ser- and pushes the envelope daily on distilling subtle distinctions of what industry insiders vice Interfaces with Custom- techniques, yet he thinks the company has and experts care about into something con- (Harvard Business School ers lost track of its priorities. If I were teaching sumer markets can value – and that kind of Press, 2005). this case, I’d enjoy the moment when the par- sleight of hand has reinvented industries in adox of Ellis’s argument dawned on the class: the past, especially in luxury goods. Con- For his innovations to be successful in the sider the impact on the high-end wristwatch marketplace, there must be an ever larger in- business when men started paying close at- stalled base of consumers capable of appreci- tention to mechanical movements and per- ating the artisanship involved. Without the petual calendars, inspiring many to build collections of timepieces. Consider what’s Bob’s problem isn’t that he happened in wine,what’s happened in cigars– and what’s already happened in Scotch has difficult trade-offs to make. whisky, where the elite market long ago The new approach is working. moved on from pricey blends like Chivas and Johnnie Walker to single malts. Ellis’s pro- It’s the organization that’s not. posal could push the trend to the nth degree. Bob should get all his stakeholders to think front office’s efforts to expand the market of together about how to capitalize on this po- aficionados by educating consumers on why tentially breakthrough marketing idea. Once Ellis’s offering is better than the hundreds of he’s set the organization’s sights on turning other single-malt options available, his “bet- the single-malt scotch industry on its head, ter mousetrap” would go nowhere. Ellis he can stop worrying so much about invest- should be thankful that the company isn’t ments and start thinking more about returns.

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Bartenders in discotheques are great for talking up new vodka drinks – but is that where someone interested in scotch goes for guidance?

lenmeadie’s marketing initiatives strike days, to introduce a new North Face shoe. In G me as great for launching a vodka our jeanswear business, the emphasis is on brand, but not so appropriate for fine increasing our share of voice in traditional whiskey.For one thing, Glenmeadie’s product media. Lee and Wrangler still have to inno- is in limited supply. A vodka maker has a vate around fit and style, but the marketing short production cycle and no end of pota- for both those brands aims to form an emo- toes to work with, so its emphasis can simply tional bond. Yet another model makes sense be on drumming up demand. Nevin Wallace for Vans, a casual shoe preferred by skate- and his team, however, have scarcity to their boarders. Here, we have a successful promo- advantage, and they should be more focused tion in the Vans Warped Tour, which links on leveraging it into higher prices. Scotch is the brand to the music and artists that the a luxury good – and no luxury good has ever community identifies with. survived ubiquity.If Glenmeadie’s greatly ex- The right marketing approach for a given panded marketing budget is evidence of brand is never obvious. It requires going out mass-market ambitions, the company is risk- and living with customers for a while, seeing ing real damage to the brand’s allure. I sus- how they get their information, and under- pect, too, that single malts appeal to a dif- standing the typical behavior path–from first ferent type of drinker than vodka does. awareness through to loyal purchasing. This Scotch is associated with quiet conversation is what I don’t see any evidence of at Glen- and is meant to be savored. It’s no surprise meadie. Who’s the category enthusiast for Stephen Dull (stephen_dull that Bob enjoys his tasting session at Glen- scotch? Who’s the brand enthusiast for Glen- @vfc.com) is the vice presi- meadie Castle so well; the history and ro- meadie? Who are the top 20% of customers dent of strategy at Greens- mance wrapped around the product captures who account for 80% of profits? How do those boro, North Carolina–based the very essence of the brand. What’s more, people become familiar with a scotch, and VF Corporation and a mem- a different type of consumer probably means what makes them place it in their considered ber of the company’s operat- different key influencers. Bartenders in dis- set? (That’s the step in the buying process ing committee. VF produces cotheques are great for talking up new Glenmeadie should be focusing on, more so branded apparel, including vodka drinks–but is that where someone in- than on promoting awareness and trial.) If jeanswear, intimate apparel, terested in scotch goes for guidance? the company’s marketers understood con- sportswear, outdoor products, That there could be so much variation in sumers’ behavior at a very deep level, they and workwear. the market realities of two types of liquor is could design a much more downscaled and not so surprising. VF’s various units all pro- efficient program. Rather than getting just duce apparel and are all focused on building anyone to try the product, Glenmeadie global lifestyle brands, yet we go about mar- would get the right people to try it and to keting those brands in very different ways. switch some part of their consumption. For the North Face brand, we target the true There doesn’t need to be a trade-off be- enthusiasts – the action-sports athletes who tween the front and back offices in this story. care most about technical innovation–know- Customer loyalty comes from the whole pack- ing that their choices deeply influence aspi- age, and Marketing’s job, in any company, rational users. Rather than blasting the air- is not simply to generate demand but to waves, we connect with that core group build brand strength and profitability over and how it interacts with the product. An the long haul. If Glenmeadie’s marketers do example is our sponsorship of ultrama- their job well, there will be plenty of margin rathoner Dean Karnazes, who set out to run to reinvest in the product that is central to 50 marathons in 50 states in 50 consecutive the total branded experience it offers.

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he good news is that Glenmeadie’s pres- efficiently. Our supply chain organization is T ident is deciding how – not whether – right there, too, anticipating costs and ways to invest in innovation. That innovation of to reduce them. Our value proposition to the some kind is required is not in doubt. Cer- customer – fresh, fast, and affordable – has tainly,we recognize the importance of invest- become a mantra that helps everyone con- ing in innovation at Dunkin’ Brands. If you verge on a clear vision. think about it, we are in a very perishable Putting these groups under one umbrella business. The coffee sale or other engage- allows us to achieve the right balance of ment with a consumer that we don’t cap- the three different forms innovation takes in ture today can never be captured again. So our business: the ambiance of the stores, it’s a constant quest to stay on consumers’ the quality of customer interactions, and the radar screens. If we aren’t somehow in their goods we sell. As we proceed down those faces on a weekly basis with something that three tracks simultaneously, we introduce can grab their attention, they will drift. new products very frequently while taking a The problem at Glenmeadie is that every- longer-cycle approach to the operating sys- one is seeing front- and back-office innova- tem and store environment. All three tracks tion as an either-or proposition. This is all come together in a major effort like our new too common in organizations, and it gets prototypical store, which we call 2015. The especially divisive when the argument esca- aim in this initiative has been to ensure that lates to the senior executive level. I think I re- the Dunkin’ Donuts concept is as relevant to call hearing some of the very phrases in this consumers in that year as it is today. Joe Scafido (joe.scafido@ story’s dialogue back when Dunkin’ Brands I’m not claiming that no one ever chafes at dunkinbrands.com) is a mem- was owned by Allied Domecq and the leader- the compromises we make with one another ber of the executive council at ship of the various brands would assemble along the way.Our head of R&D for donuts is Dunkin’ Brands, a Canton, for annual meetings. One gentleman in par- every bit as passionate about his craft as Ellis Massachusetts–headquar- ticular stands out in my memory. He was a Cameron and has just as little time for busi- tered company that franchises great winemaker,devoted to the stewardship ness model innovations that don’t center on restaurants under the Dunkin’ Donuts, Baskin-Robbins, and Togo’s brands. He is responsi- It’s a constant quest to stay on consumers’ radar ble for creating new product screens. If we aren’t somehow in their faces on and store concepts and over- sees channel development, re- a weekly basis, they will drift. tail operating systems, global supply chain management, of his casks and his fields, but it was always a his product. But in an organization devoted product development, and struggle for him to understand that the in- to change, it’s great to have his kind of talent quality assurance. vestments had to be balanced–that to stay in and dedication in the room, providing a bal- the business, we also had to have people ance to some of the more starry-eyed notions buying wine. The debate is hardly unique to and keeping us headed toward true north. wine and spirits makers. Most important, we know the debate is going This is partly why Dunkin’ Brands made on at the right level, among the people who the unusual move four years ago of pulling actually know what the implications will be. together our potentially competitive innova- With all due respect to senior managers like tion factions and housing them in one orga- Bob Littlefield and his CFO, when organiza- nization, which is the group I lead. Now, even tional problems get worked through below though our culinary team and our opera- their level, the solutions are usually better. tions specialists remain distinct, they collab- orate from the beginning on any change. Reprint R0610A When one of our culinary R&D folks creates Reprint R0610X: Case only a new product, the operating specialists are Reprint R0610Z: Commentary only right there, figuring out ways to deliver it To order, see page 151.

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DIFFERENT VOICE

Sleep Deficit: The Performance Killer A Conversation with Harvard Medical School Professor Charles A. Czeisler

Sleep is a stranger to many t 12:30 am on June 10, 2002, Israel tomobile accidents in the United A Lane Joubert and his family of States alone, according to the National managers. Research by seven set out for a long drive home fol- Highway Traffic Safety Administration. leading scientists shows lowing a family reunion in Beaumont, The general effect of sleep deprivation Texas. Joubert, who had hoped to reach on cognitive performance is well-known: just how dangerous that home in faraway Fort Worth in time to Stay awake longer than 18 consecutive get to work by 8 am, fell asleep at the hours, and your reaction speed, short- problem is. wheel, plowing the family’s Chevy Sub- term and long-term memory, ability urban into the rear of a parked 18- to focus, decision-making capacity, wheeler. He survived, but his wife and math processing, cognitive speed, and five of his six children were killed. spatial orientation all start to suffer. The Joubert tragedy underscores a Cut sleep back to five or six hours a problem of epidemic proportions among night for several days in a row, and the workers who get too little sleep. In the accumulated sleep deficit magnifies past five years, driver fatigue has ac- these negative effects. (Sleep depriva-

FRANK CURRAN counted for more than 1.35 million au- tion is implicated in all kinds of physical

october 2006 53 DIFFERENT VOICE • Sleep Deficit: The Performance Killer maladies, too, from high blood pressure leaders is simple: If you want to raise per- you have a sleep disorder or get less than to obesity.) formance – both your own and your or- that for several days, you start building Nevertheless, frenzied corporate cul- ganization’s–you need to pay attention a sleep deficit that makes it more diffi- tures still confuse sleeplessness with vi- to this fundamental biological issue. In cult for the brain to function. Executives tality and high performance. An ambi- this edited interview with senior editor I’ve observed tend to burn the candle at tious manager logs 80-hour work weeks, Bronwyn Fryer, Czeisler observes that both ends, with 7 am breakfast meet- surviving on five or six hours of sleep top executives now have a critical respon- ings and dinners that run late, for days a night and eight cups of coffee (the sibility to take sleeplessness seriously. and days. Most people can’t get to sleep world’s second-most widely sold com- without some wind-down time, even if modity, after oil) a day. A Wall Street What does the most recent research they are very tired, so these executives trader goes to bed at 11 or midnight and tell us about the physiology of sleep may not doze off until 2 in the morning. wakes to his BlackBerry buzz at 2:30 am and cognitive performance? If they average four hours of sleep a to track opening activity on the DAX. Four major sleep-related factors affect night for four or five days, they develop A road warrior lives out of a suitcase our cognitive performance. The kinds the same level of cognitive impairment while traveling to Tokyo, St. Louis, of work and travel schedules required of as if they’d been awake for 24 hours – equivalent to legal drunkenness. Within ten days, the level of impairment is the Putting yourself or others at risk while driving same as you’d have going 48 hours with- or working at an impaired level is bad enough; out sleep. This greatly lengthens reaction time, impedes judgment, and interferes expecting your employees to do the same is with problem solving. In such a state of just irresponsible. sleep deprivation, a single beer can have the same impact on our ability to sus- tain performance as a whole six-pack Miami, and Zurich, conducting busi- business executives today pose a severe can have on someone who’s well rested. ness in a cloud of caffeinated jet lag. A challenge to their ability to function The third factor has to do with circa- negotiator takes a red-eye flight, hops well, given each of these factors. dian phase – the time of day in the into a rental car, and zooms through The first has to do with the homeosta- human body that says “it’s midnight”or an unfamiliar city to make a delicate tic drive for sleep at night, determined “it’s dawn.”A neurological timing device M&A meeting at 8 in the morning. largely by the number of consecutive called the “circadian pacemaker” works People like this put themselves, their hours that we’ve been awake. Through- alongside but, paradoxically, in opposi- teams, their companies, and the gen- out the waking day,human beings build tion to the homeostatic drive for sleep. eral public in serious jeopardy, says Dr. up a stronger and stronger drive for This circadian pacemaker sends out its Charles A. Czeisler, the Baldino Profes- sleep. Most of us think we’re in control strongest drive for sleep just before we sor of Sleep Medicine at Harvard Med- of sleep – that we choose when to go to habitually wake up, and its strongest ical School.1 To him, encouraging a cul- sleep and when to wake up. The fact is drive for waking one to three hours be- ture of sleepless machismo is worse that when we are drowsy, the brain can fore we usually go to bed, just when the than nonsensical; it is downright dan- seize control involuntarily. When the homeostatic drive for sleep is peaking. gerous, and the antithesis of intelligent homeostatic pressure to sleep becomes We don’t know why it’s set up this way, management. He notes that while cor- high enough, a couple thousand neu- but we can speculate that it has to do porations have all kinds of policies de- rons in the brain’s “sleep switch” ignite, with the fact that, unlike other animals, signed to prevent employee endanger- as discovered by Dr. Clif Saper at Har- we don’t take frequent catnaps through- ment–rules against workplace smoking, vard Medical School. Once that happens, out the day. The circadian pacemaker drinking, drugs, sexual harassment, and sleep seizes the brain like a pilot grab- may help us to focus on that big project so on–they sometimes push employees bing the controls. If you’re behind the by enabling us to stay awake through- to the brink of self-destruction. Being wheel of a car at the time, it takes just out the day in one long interval and by “on” pretty much around the clock in- three or four seconds to be off the road. allowing us to consolidate sleep into duces a level of impairment every bit as The second major factor that deter- one long interval at night. risky as intoxication. mines our ability to sustain attention and In the midafternoon, when we’ve al- As one of the world’s leading author- maintain peak cognitive performance ready built up substantial homeostatic ities on human sleep cycles and the bi- has to do with the total amount of sleep sleep drive, the circadian system has not ology of sleep and wakefulness, Dr. Czeis- you manage to get over several days. If yet come to the rescue. That’s typically ler understands the physiological bases you get at least eight hours of sleep a the time when people are tempted to of the sleep imperative better than al- night, your level of alertness should re- take a nap or head for the closest Star- most anyone. His message to corporate main stable throughout the day, but if bucks or soda machine. The caffeine in

54 harvard business review | hbr.org Sleep Deficit: The Performance Killer • DIFFERENT VOICE the coffee temporarily blocks receptors in the brain that regulate sleep drive. Thereafter, the circadian pacemaker sends out a stronger and stronger drive for waking as the day progresses. Pro- vided you’re keeping a regular sched- ule, the rise in the sleep-facilitating hor- mone melatonin will then quiet the circadian pacemaker one to two hours before your habitual bedtime, enabling the homeostatic sleep drive to take over and allow you to get to sleep. As the homeostatic drive dissipates midway through the sleep episode, the circadian drive for sleep increases toward morn- ing, maintaining our ability to obtain a full night of sleep. After our usual wake time, the levels of melatonin begin to decline. Normally,the two mutually op- posing processes work well together, sustaining alertness throughout the day and promoting a solid night of sleep. The fourth factor affecting perfor- mance has to do with what’s called “sleep inertia,”the grogginess most peo- ple experience when they first wake up. Just like a car engine, the brain needs time to “warm up” when you awaken. The part of your brain responsible for memory consolidation doesn’t func- tion well for five to 20 minutes after you wake up and doesn’t reach its peak efficiency for a couple of hours. But if you sleep on the airplane and the flight attendant wakes you up suddenly upon landing, you may find yourself at the customs station before you realize you’ve left your laptop and your pass- port behind. There is a transitional pe- riod between the time you wake up and the time your brain becomes fully and from our own increasing aches and creases the production of the hormone functional. This is why you never want pains. Another thing that increases ghrelin, which makes people crave carbo- to make an important decision as soon with age is the risk of sleep disorders hydrates and sugars, so they get heavier, as you are suddenly awakened–ask any such as restless legs syndrome, insom- which in turn raises the risk of sleep nurse who’s had to awaken a physician nia, and sleep apnea – the cessation of apnea, creating a vicious cycle. Some re- at night about a patient. breathing during sleep, which can occur searchers speculate that the epidemic when the airway collapses many times of obesity in the U.S. and elsewhere may Most top executives are over 40. per hour and shuts off the flow of oxy- be related to chronic sleep loss. More- Isn’t it true that sleeping also gen to the heart and brain, leading to over, sleep-disordered breathing in- becomes more difficult with age? many brief awakenings. creases the risk of high blood pressure Yes, that’s true. When we’re past the age Many people gain weight as they age, and heart disease due to the strain of of 40, sleep is much more fragmented too. Interestingly, chronic sleep restric- starving the heart of oxygen many times than when we’re younger. We are more tion increases levels of appetite and per hour throughout the night. easily awakened by disturbances such stress hormones; it also reduces one’s As we age, the circadian window dur- as noise from the external environment ability to metabolize glucose and in- ing which we maintain consolidated october 2006 55 DIFFERENT VOICE • Sleep Deficit: The Performance Killer sleep also narrows. That’s why airline drunkenness is real because, like a as well. With too little sleep, people do travel across time zones can be so brutal drunk, a person who is sleep deprived things that no CEO in his or her right as we get older. Attempting to sleep at has no idea how functionally impaired mind would allow. All over the world, an adverse circadian phase – that is, he or she truly is. Moreover, their effi- people are running heavy and danger- during our biological daytime–becomes ciency at work will suffer substantially, ous machinery or guarding secure sites much more difficult. Thus, if you take contributing to the phenomenon of and buildings while they’re exhausted. a 7 pm flight from New York to London, “presenteeism,”which, as HBR has noted, Otherwise intelligent, well-mannered you typically land about midnight in exacts a large economic toll on busi- managers do all kinds of things they’d your home time zone, when the home- ness. [See Paul Hemp’s article “Presen- never do if they were rested – they may ostatic drive for sleep is very strong, but teeism: At Work–But Out of It,”HBR Oc- get angry at employees, make unsound the local time is 5 am. Exposure to day- tober 2004.] decisions that affect the future of their light – the principal circadian synchro- Sleep deprivation is not just an indi- companies, and give muddled presenta- nizer – at this time shifts you toward vidual health hazard; it’s a public one. tions before their colleagues, custom- Hawaiian time rather than toward Lon- Consider the risk of occupational injury ers, the press, or shareholders. don time. In this circumstance, the worst and driver fatigue. In a study our re- possible thing you can do is rent a car search team conducted of hospital in- What should companies be doing to and drive to a meeting where you have terns who had been scheduled to work address the sleep problem? to impress people with your mental for at least 24 consecutive hours, we People in executive positions should set behavioral expectations and de- velop corporate sleep policies, just as A company’s sleep policy should not permit they already have concerning behaviors anyone, under any circumstances, to take an like smoking or sexual harassment. It’s important to have a policy limiting overnight flight and then drive to a business scheduled work – ideally to no more meeting somewhere–period. than 12 hours a day, and exceptionally to no more than 16 consecutive hours. At least 11 consecutive hours of rest acuity at the equivalent of 3 or 4 in the found that their odds of stabbing them- should be provided every 24 hours. Fur- morning. You might not even make the selves with a needle or scalpel increased thermore, employees should not be meeting, because you very easily could 61%, their risk of crashing a motor vehi- scheduled to work more than 60 hours wrap your car around a tree. Fourteen cle increased 168%, and their risk of a a week and not be permitted to work or 15 hours later, if you’re trying to go near miss increased 460%. In the U.S., more than 80 hours a week. When work- to bed at 11 pm in the local time zone, drowsy drivers are responsible for a fifth ing at night or on extended shifts, em- you’ll have a more difficult time main- of all motor vehicle accidents and some ployees should not be scheduled to work taining a consolidated night’s sleep. 8,000 deaths annually. It is estimated more than four or five consecutive days, that 80,000 drivers fall asleep at the and certainly no more than six consecu- So sleep deprivation, in your opin- wheel every day, 10% of them run off tive days. People need at least one day ion, is a far more serious issue than the road, and every two minutes, one of off a week, and ideally two in a row, in most executives think it is. them crashes. Countless innocent peo- order to avoid building up a sleep deficit. Yes, indeed. Putting yourself or others at ple are hurt. There’s now a vehicular Now, managers will often rationalize risk while driving or working at an im- homicide law in New Jersey (and some overscheduling employees. I hear them paired level is bad enough; expecting pending in other states) that includes say that if their employees aren’t work- your employees to do the same is just driving without sleep for more than 24 ing, they will be out partying and not irresponsible. It amazes me that con- hours in its definition of recklessness. sleeping anyway. That may be true for temporary work and social culture glo- There’s a man in Florida who’s serving a some irresponsible individuals, but it rifies sleeplessness in the way we once 15-year prison term for vehicular homi- doesn’t justify scheduling employees to glorified people who could hold their cide – he’d been awake for 30-some work a hundred hours a week so that liquor. We now know that 24 hours hours when he crashed his company’s they can’t possibly get an adequate without sleep or a week of sleeping four truck into a group of cars waiting for a amount of sleep. Of course, some cir- or five hours a night induces an impair- light to change, killing three people. I cumstances may arise in which you ment equivalent to a blood alcohol level would not want to be the CEO of the need someone to remain at work for of .1%. We would never say,“This person company bearing responsibility for more than 16 consecutive hours. The is a great worker! He’s drunk all the those preventable deaths. night security guard, for example, can’t time!”yet we continue to celebrate peo- Sleep deprivation among employees just walk off the job if his replacement ple who sacrifice sleep. The analogy to poses other kinds of risks to companies isn’t there, so you will need to have a

56 harvard business review | hbr.org Sleep Deficit: The Performance Killer • DIFFERENT VOICE provision for exceptional circumstances, employees. Educational programs about are referred for evaluation and treat- such as offering transportation home sleep, health, and safety should be ment by a specialist accredited by the for a sleep-deprived worker. mandatory. Employees should learn to American Academy of Sleep Medicine. Companies also need executive poli- set aside an adequate amount of time [Accredited sleep centers may be found cies. For example, I would advise execu- for sleep each night and to keep their at www.sleepcenters.org.] tives to avoid taking red-eye flights, bedrooms dark and quiet and free of Finally, I would recommend that su- which severely disrupt sleep. If some- all electronic devices–televisions, Black- pervisors undergo training in sleep one must travel overnight internation- Berries, and so on. They should learn and fatigue management and that they ally, the policy should allow the execu- about the ways alcohol and caffeine in- promote good sleep behavior. People tive to take at least a day to adapt to terfere with sleep. When someone is should learn to treat sleep as a serious the sleep deprivation associated with sleep deprived, drinking alcohol only matter. Both the company and the em- the flight and the new time zone before makes things worse, further eroding ployees bear a shared responsibility to driving or conducting business. Such a performance and increasing the propen- ensure that everyone comes to work policy requires some good schedule sity to fall asleep while also interfering well rested. planning, but the time spent making with the ability to stay asleep. Addition- the adjustments will be worth it, for ally, companies should provide annual This corporate sleep policy of yours the traveler will be more functional be- screening for sleep disorders in order to sounds a little draconian, if not fore going into that important meeting. identify those who might be at risk. For impossible, given people’s crazy And the sleep policy should not permit example, this past year our team schedules. anyone, under any circumstances, to launched a Web-based screening survey I don’t think it’s draconian at all. Busi- take an overnight flight and then drive that any law enforcement officer in ness travelers expect that their pilots to a business meeting somewhere – pe- the U.S. can take to help identify won’t drink before flying an airplane, riod. He or she should at least be pro- whether he or she is suffering from and all of us expect that no driver on vided a taxi, car service, or shuttle. sleep apnea, restless legs syndrome, nar- the highway will have a blood alcohol Companies can do other things to colepsy, or other sleep disorders. Those level above the legal limit. Many execu- promote healthy sleep practices among whose answers place them at high risk tives already realize that the immediate Opportunity knocks.

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makers of business leaders DIFFERENT VOICE • Sleep Deficit: The Performance Killer effect of sleep loss on individuals and attention to her task for longer periods insomnia or excessive daytime sleepi- on overall corporate performance is of time and bring her whole intelli- ness. Patients too often think there’s a just as important. A good sleep policy gence and creativity to bear on the silver bullet for a problem like insom- is smart business strategy. People think project at hand. nia, and doctors too easily prescribe pills they’re saving time and being more as part of a knee-jerk reaction to patient productive by not sleeping, but in fact What do you think about the use of requests during the final minutes of an they are cutting their productivity dras- drugs that help people fall asleep or office visit. The causes of insomnia are tically. Someone who has adequate that shut off the urge to sleep? subtle and need to be carefully investi- sleep doesn’t nod off in an important These agents should be used only after gated. These can be from too much caf- meeting with a customer. She can pay a thorough evaluation of the causes of feine, an irregular schedule, anxiety or

What’s New in Sleep?

Sleep science is advancing on a number of frontiers that, people function well on very little sleep without suffering the over time, may cause us to rethink everything from our ill effects of common stimulants. Sold under the commercial personal habits to public policy. Here’s a short sampling of trade name Provigil in the U.S., modafinil was originally pre- these new developments. scribed to treat narcolepsy; it’s now used to promote wake- Sleep is power. Your mother was right – to perform at fulness among those who can’t afford to go to sleep (such as your best, you need sleep. Discoveries about sleep cycles field soldiers in war zones). Studies have shown that subjects have given researchers new insight into the specific roles taking modafinil are able to stay alert with only eight hours sleep plays in overall health and performance. For example, of sleep during an 88-hour period. While modafinil sounds there is growing evidence that sleep aids in immune func- like a dream drug, no one yet knows what effects may result tion, memory consolidation, learning, and organ function. from more than occasional use. “Some researchers now think sleep may be the missing link Car drowse alarms. By the end of the decade, automakers when it comes to overall health, safety, and productivity,” will offer cars outfitted with devices designed to keep drowsy says Darrel Drobnich, the senior director of government drivers from falling asleep at the wheel. Some may use cam- and transportation affairs for the National Sleep Founda- eras to scan drivers’ eyes for droopiness, or to sense when tion. One new field of study is looking at a specific corre- people are loosening their grip on the steering wheel, and lation between sleep and productivity, and the benefits of then sound an alarm. In 2005, Ford and Volvo announced what sleep researchers call a “power nap”– a 20-minute pe- that they were working on a system called Driver Alert, con- riod of sleep in the afternoon that heads off problems associ- sisting of a camera that measures the distance between the ated with cumulative sleep deficit. vehicle and the markings on the surface of the road. If the Move over, Ambien. Ambien, the sleep aid from drug- driver starts to swerve, an alarm goes off and a text warning maker Sanofi-Aventis, is now de rigueur for the sleepless, appears on the dashboard. Another approach under consid- ringing up $1.4 billion annually in U.S. sales alone. While Am- eration by the U.S. National Highway Traffic Safety Admin- bien has fewer side effects than most over-the-counter sleep istration is the development of “intelligent” highways aids, it’s still a blunt instrument, neurophysiologically speak- equipped with specialized sensors that continuously track ing.“All of the current products on the market, including vehicle trajectory and speed. Ambien, take a sledgehammer to specific receptors in the Tomorrow’s workforce needs sleep now. Businesses brain,”says Dr. Robert McCarley, the head of psychiatry at need an educated workforce; ironically, school is interfering. Boston VA Medical Center and a professor of psychiatry The current high school schedule in the U.S., which typically at Harvard Medical School.“They have several negative side begins around 7:20 AM, threatens the neurological develop- effects, ranging from disassociated states of consciousness to ment and health of adolescents, whose homeostatic drive potential addiction. They also tend to lose their effectiveness operates differently from adults’. Most teens experience a over time.”Researchers hope a new family of sleep-inducing delayed sleep phase, in which melatonin is released around drugs will function closer to the body’s natural sleep mecha- 11 PM – an hour later than in most adults. Students who nisms and so avoid problems associated with sedatives like finally go to sleep by midnight and wake at 6 experience Ambien. One such new drug–Rozerem, from Japanese drug a chronic sleep deficit, which disrupts their ability to learn giant Takeda–targets melatonin receptors in the brain. As re- and puts them and you at risk on the roads. In the U.S., searchers learn more about the body’s internal sleep mecha- researchers and sleep advocates are now working closely nisms, McCarley believes, sleep aids will inevitably improve. with school districts, communities, and educators to change On the other side of the equation, the pharmaceutical com- school start times so that students can get more sleep. pany Cephalon is now marketing modafinil, a drug that helps –bronwyn fryer

58 harvard business review | hbr.org Sleep Deficit: The Performance Killer • DIFFERENT VOICE depression, physical problems such as better over both the short and the long light is particularly effective in suppress- arthritis, use of other medications, and term than sleeping pills do. ing melatonin production, thereby al- so on–and only a careful evaluation by lowing us to stay awake during our bio- a doctor experienced in sleep medicine Sometimes executives simply have logical night. Photon for photon, can uncover the causes. I once saw a pro- to function without much sleep. What looking up at the blue sky, for example, fessor who complained of difficulty are some strategies they can use to is more effective in both resetting our sleeping at night, and only after taking get by until they can go to bed? biological clock and enhancing our a careful history did we find that he Though there is no known substitute alertness than looking down at the was drinking 20 cups of coffee a day.He for sleep, there are a few strategies you green grass. didn’t even realize he was drinking that can use to help sustain performance While all these things can help an much and didn’t think about the fact temporarily until you can get a good executive function in an emergency, I that so much caffeine, which has a six- to night’s sleep. Obviously, executives can must reiterate that he or she should still nine-hour half-life, would interfere with drink caffeine, which is the most widely not drive when sleep deprived, even if his ability to sleep. Prescribing a sleep- used wake-promoting therapeutic in a cup of coffee or a walk on a sunny day ing pill for his insomnia without identi- the world. Naps can be very effective seems to help for a little while. fying the underlying cause would have at restoring performance, and if they been a mistake. are brief–less than a half hour–they will Do you get enough sleep? There are non-pharmacological treat- induce less grogginess upon awaken- Like everyone else, I try to, but I don’t ments for insomnia that seem very ing. Being in a novel or engaging cir- always achieve it. promising, by the way. Cognitive be- cumstance will also help you stay alert. havioral therapy, or CBT, helps people Exercise, standing in an upright posi- 1. Dr. Czeisler is the incumbent of an endowed professorship donated to Harvard by Cephalon recognize and change thoughts and tion, and exposure to bright light are all and consults for a number of companies, including behaviors that might be keeping them very helpful. Human beings are amaz- Actelion, Cephalon, Coca-Cola, Hypnion, Pfizer, Respironics, Sanofi-Aventis, Takeda, and Vanda. awake at night. A researcher named ingly sensitive to light. In fact, the Dr. Gregg Jacobs at Harvard Medical color of light may also be important. Reprint R0610B School has reported that CBT works Exposure to shorter wavelength blue To order, see page 151.

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www.tuck.dartmouth.edu/exec Hanover, New Hampshire 603-646-2839 [email protected] Companies in emerging markets must choose among three kinds of strategies to compete successfully, both at home and abroad. by Tarun Khanna and Krishna G. Palepu Emerging Giants Building World-Class Companies in Developing Countries

N 2003, JUST MONTHS AFTER Mahindra & Mahindra launched I a smartly designed sport-utility vehicle called the Scorpio, CNBC India, BBC World’s Wheels program, and others were heaping Car of the Year awards on the SUV. That was no mean achievement: The made-in-India automobile won top honors ahead of global best sell- ers such as the Mercedes-Benz E-Class and Toyota Camry sedans. To M&M, which manufactures tractors in several countries as well as ve- hicles targeted at India’s semi-urban and rural markets, the awards sig- naled that it could finally take the world’s automakers head-on. Even as the Scorpio successfully battles multipurpose vehicles like Toyota’s Innova and GM’s Chevy Tavera at home, M&M has started marketing $ the SUV in South Africa and Spain. Clearly, the 1.73 billion Indian ALEX NABAUM

60 harvard business review | hbr.org

Building World-Class Companies in Developing Countries company is on the road to becoming a player in the global analyzed data on each company, from its strategies to its automobile industry. stock market performance. The patterns, you’ll find, are M&M isn’t the only company from an emerging mar- intriguing. ket that is making the world sit up and take notice. Over the past two-plus decades, waves of liberalization have all but washed away protectionist barriers in devel- Blunting the Multinationals’ Edge oping countries. As those nations integrated themselves At first glance, Western, Japanese, and South Korean com- into the world economy,multinational corporations from panies appear to hold near-insurmountable advantages North America, Western Europe, Japan, and South Korea over businesses in newly industrializing countries. They stormed in. Many local companies lost market share or not only possess well-known brand names, efficient inno- sold off businesses as a result, but some fought back. They vation processes and management systems, and sophisti- held their own against the onslaught, restructured their cated technologies but also have access to vast reservoirs businesses, exploited new opportunities, and built world- of finance and talent. Western European and American class companies that today are giving their global rivals companies, for instance, can raise large sums of money a run for their money. at a low cost because of their well-established financial Some emerging giants compete in several countries – markets. They can hire talent easily because the labor for instance, Brazil’s AmBev (which in 2004 merged with markets on both continents work well. Most developing Belgium’s Interbrew to form InBev); Chile’s S.A.C.I. Fala- countries lack the soft infrastructure that makes markets bella; China’s Baosteel, Galanz, and Lenovo groups and work efficiently, as we have pointed out in previous Har- Huawei Technologies; India’s Dr. Reddy’s Laboratories, vard Business Review articles. (See, for instance,“Why Fo- Infosys, NIIT, Ranbaxy, Satyam, Tata Group, and Wipro; cused Strategies May Be Wrong for Emerging Markets” Israel’s Teva Pharmaceuticals; Mexico’s Cemex; the Philip- July–August 1997.) Because of institutional voids – the pines’ Jollibee Foods; and South Africa’s SABMiller. Oth- absence of specialized intermediaries, regulatory sys- ers operate mainly at home–for example, China’s Wahaha tems, and contract-enforcing mechanisms – corporations Group; India’s Bharti Tele-Ventures and ITC Limited; and in emerging markets cannot access capital or talent as Turkey’s Koç and Do˘gu¸s business groups. easily or as inexpensively as European and American cor- What strategies did these globally competitive busi- porations can. That often makes it tough for businesses nesses deploy to overcome the myriad obstacles that their in developing countries to invest in R&D or to build home environments pose? Why and how did some of global brands. them move from their dominant positions at home to es- Nevertheless, these companies can overcome such dis- tablish an international presence? Must every emerging- advantages, for three reasons. First, when multinational market company follow suit? What sequence of steps companies from the developed world explore business op- should wannabe giants take to build stronger businesses portunities in emerging markets, they must confront the at home or to enter markets overseas? same institutional voids that local companies face. How- Six years ago, we decided to study several companies in ever, executives from multinational companies are used developing countries as they created global businesses to operating in economies with well-developed institu- and emerged on the world stage. Academics such as Har- tional infrastructures and are therefore ill equipped to vard Business School’s Louis T.Wells, Jr. (who in 1983 pop- deal with such voids. Western organizations, for instance, ularized the term “Third World multinationals”) and rely on data from market research firms to tailor their MIT’s Alice H. Amsden (who in 2000 called firms in emerg- products and marketing strategies to compete in different ing markets “companies that rise from the rest”) have markets. They also count on supply chain partners to studied similar businesses. Our focus, however, wasn’t on make and deliver products to customers inexpensively. the role that economic policy plays in creating globally When these companies attempt to move into countries competitive companies but on strategies and business that don’t have sophisticated market researchers or reli- models. That’s important; several countries have opened able supply chain partners, they find it difficult to deploy up to foreign competition over the years, which has recast their business models. By contrast, the managers at local the challenges companies in emerging markets face: Sur- companies know how to work around institutional voids vival is tougher, but the opportunities are more enticing because they’ve had years of experience doing so. Their than ever. We identified 134 major companies in ten familiarity with the local context allows them to identify emerging markets–Argentina, Brazil, Chile, China, India, and meet customers’ needs effectively. Moreover, busi- Indonesia, Mexico, Poland, South Africa, and Turkey–and ness groups such as India’s Tata Group, the Philippines’

Tarun Khanna ([email protected]) is the Jorge Paulo Lemann Professor at Harvard Business School in Boston. Krishna G. Palepu ([email protected]) is the Ross Graham Walker Professor of Business Administration at Harvard Business School. They are coauthors of three previous HBR articles, including “Strategies That Fit Emerging Markets” (June 2005).

62 harvard business review | hbr.org Building World-Class Companies in Developing Countries

Ayala Group, and Turkey’s Koç Group have created mechanisms for raising cap- ital and developing talent. They can, for instance, raise money from the local stock market by trading on their reputations. These groups can also spread the cost of training executives in-house by deploying their manag- ers across businesses. Such mechanisms allow many local companies to com- pete effectively with for- eign giants. Second, once companies from emerging markets have demonstrated a de- gree of success, they, too, can tap capital and talent markets in developed coun- tries. Like American and European companies, they can raise money by, say, list- ing themselves on the New York Stock Exchange or on Nasdaq. Emerging giants often become investors’ darlings, making it easy for them to sell equity shares or bonds. In the talent market, intermediaries from developed countries that are trying prove the quality of their products and services, they are to fill the gaps in the soft infrastructure in emerging mar- able to cater to customers at home as well as, if not better kets help local businesses become more competitive. In than, multinational companies. recent years, American and European business schools have launched education programs in developing coun- Market Structures tries. This has allowed emerging-market companies to re- train their existing managers and to hire people with the in Developing Countries same skills that executives in multinational companies The structure of markets in developing countries helps possess. local companies counter their multinational rivals. Most Third – and this is often downplayed by executives – product markets comprise four distinct tiers: a global cus- multinational companies are reluctant, sometimes rightly tomer segment that wants products of global quality and so, to tailor their strategies to every developing market in with global features–that is, offerings with the same qual- which they operate. They find it costly and cumbersome ity and attributes that goods in developed countries to modify their products, services, and communications to have – and is willing to pay global prices for them; a “glo- suit local tastes, especially since the opportunities in de- cal”segment that demands products of global quality but veloping countries tend to be relatively small and risky. with local features (and local soul) at less-than-global Further, their organizational processes and cost structures prices; a local segment that wants local products with local make it difficult for them to sell products and services at features at local prices; and a bottom-of-the-pyramid seg- optimal price points in emerging markets; they often end ment, as Michigan University’s C.K. Prahalad calls it, that up occupying small, superpremium niches. Local compa- can afford to buy only the most inexpensive products. nies don’t suffer from those constraints, particularly since (See C.K. Prahalad and Allen Hammond’s “Serving the they operate in just a few geographic markets. In fact, World’s Poor, Profitably” HBR September 2002.) The we’ve found that once emerging-market companies im- markets for talent and capital in developing countries are october 2006 63 Building World-Class Companies in Developing Countries usually structured along the same lines, as we explain in around distinctive national characteristics. For instance, the exhibit “The Four-Tiered Structure of Markets.” Jollibee Foods thrives because it realizes that Filipinos Because of the institutional voids in developing coun- like their burgers to have a particular soy and garlic taste; tries, multinational companies find it difficult to serve Nandos is growing in South Africa by providing cooked anything but the market’s global tier. In product markets, chicken that suits local palates; and Pollo Campero is the lack of market research makes it tough for multina- doing the same in Guatemala. Over the past ten years, tional companies to understand customers’tastes, and the these companies have profitably battled American giants paucity of distribution networks makes it impossible for like McDonald’s and KFC. They have also used their un- them to deliver products to customers in the hinterland. derstanding of local preferences to cater to the tastes of In talent markets, they don’t have enough knowledge the diaspora from their home markets. Jollibee serves Fil- about the local talent pool to design policies that will ipino communities in Hong Kong, the Middle East, and attract and motivate employees at the glocal, local, and California; Nandos has expanded into the United King- bottom-of-pyramid tiers. Therefore, when a developing dom and Malaysia; and Pollo Campero sells to Latino country opens up, multinational companies rush into the communities in Ecuador, El Salvador, Honduras, Mexico, global tier, and local companies dominate the local tier. Nicaragua, and Peru, as well as parts of the United States. There are immense opportunities in the bottom tier, but Haier became a leader in China’s white goods market, companies have to use radically different strategies to in the teeth of competition from GE, Electrolux, and crack it open. Over time, the glocal tier becomes the bat- Whirlpool, mainly because it was able to develop prod- tleground between local and foreign corporations. Since ucts tailored to the needs of Chinese consumers. For ex- glocal customers demand global products with local fea- ample, when Haier discovered that customers in rural tures, several emerging-market companies have used their China were using the company’s washing machines to

Many emerging-market companies have kept multinational rivals at bay by adapting to the special characteristics of customers and business ecosystems at home.

knowledge of local markets to serve customers better clean vegetables like sweet potatoes, the company modi- than multinational firms have been able to, as we shall see fied its product designs to accommodate that need. The in the following pages. humid weather in Chinese cities such as Shanghai and Companies’successes depend on their ability to exploit Shenzhen requires people to change clothes frequently, their competitive advantages. Since emerging giants both so Haier created a tiny washing machine that cleans a sin- circumvent institutional voids and tailor their strategies gle set of clothes. Because the model uses less electricity to local markets better than multinational companies do, and water than a regular washing machine does, it has be- they initially take on foreign competitors by capitalizing come an instant hit in China’s coastal cities. Haier’s strat- on their ability to navigate their home turf. They do that egy compels the company to manufacture a large variety by using one of three strategies. of products, but the company exploits its expert knowl- edge of the Chinese market – knowledge that is hard for Exploit Understanding multinational companies to obtain – by developing a product for every need. of Product Markets Haier has also painstakingly created a distribution and Many emerging-market companies have become world- service network that covers not only urban markets on class businesses by capitalizing on their knowledge of the east coast of China but also markets in semi-urban local product markets. They’ve kept multinational rivals and rural China. In a country where reliable after-sales at bay by judiciously adapting to the special characteris- service and national distribution aren’t common, Haier’s tics of customers and business ecosystems at home. These investments in those two areas have yielded formidable emerging giants have also exploited similarities between sources of competitive advantage. Product markets often geographically proximate developing markets to grow turn out to be hard to penetrate because companies need across borders. specialized infrastructures, distribution channels, or deliv- Product markets often turn out to be unique because ery systems to meet customers’needs. Most multinational customers’ needs and tastes are idiosyncratic. Local com- companies, we find, are ill equipped to pioneer the devel- panies are the first to realize that and to build businesses opment of such systems.

64 harvard business review | hbr.org Building World-Class Companies in Developing Countries

The Four-Tiered Structure of Markets In developing countries, the markets for finished goods (products) and raw materials (factors of production) can be broken up into four distinct components.

At the apex of the market pyramid is the global tier. In the product market, this section con- sists of consumers who want offerings to have the same attributes and quality that products in developed countries have and are willing to pay global prices for them. In the talent market, this tier consists of top-notch managers, such as newly minted graduates from the Indian In- stitutes of Management, who demand global-level salaries. Global

Immediately below that is the glocal tier. In the product market, this tier consists of con- sumers who demand customized products of near-global standard and are willing to pay a shade less than global consumers do. An example would be Chinese and Indian execu- Glocal tives who prefer to stay in a Shangri-La or Taj hotel rather than at a Four Seasons. In the talent market, this section consists of high-quality managers who will work only for local companies even if the pay is a little less than it would be at multinational corporations.

Consumers in the local tier are happy with products of local quality and at local Local prices. In the talent market, managers in this section will put up with less-than-world- class working conditions as long as they are paid higher-than-average salaries.

The bottom of the market consists of people who can afford only the least ex- Bottom pensive products.

PRODUCT MARKET

FACTOR MARKET

Multinational corporations typically compete for consumers and talent only in the global tier. Meanwhile, smart local companies, which dominate the local tier, move into the glocal tier and also create breakthrough products for the bottom segment as economies liberalize. These businesses often become emerging giants.

Interestingly, Haier took care to cement its leadership nerships with American retailers such as Best Buy, Home at home before venturing abroad. By 1991, the company Depot, and Wal-Mart. In 2005, research firm Euromonitor had become China’s biggest manufacturer of refrigera- International reported that Haier had a 26% share of the tors, but it wasn’t until 1995 that Haier set up its first joint U.S. market for compact refrigerators (the kind found in venture, in Indonesia. It then quickly moved into the college dormitories and hotel rooms) and a 50% share of Philippines, Malaysia, and Yugoslavia over the next two the market for low-end wine cellars. Haier’s ability to de- years. Germany became the first Western market for velop products for small segments has stood it in good Haier-branded refrigerators in 1997, and two years later, stead overseas: In July 2006, Wal-Mart’s Web site listed 59 Haier entered the United States, setting up a design cen- Haier products, many aimed at college students. ter in Boston, a marketing operation in New York, and Haier’s travels epitomize the globalization journey a manufacturing facility in South Carolina. In the U.S. that emerging giants make when they embrace opportu- market, the Chinese giant has focused on entering price- nities in product markets. They instinctively turn to other sensitive segments and on learning how to establish part- emerging markets when they initially venture abroad october 2006 65 Building World-Class Companies in Developing Countries

tal – thereby serving cus- tomers both at home and abroad in a cost-effective manner. Consider Indian infor- mation technology majors such as Tata Consultancy Services, Infosys Technol- ogies, Wipro, and Satyam Computer Services, all of which have excelled in re- cent years at catering to the global demand for software and services. This is partly because India’s education system pro- duces many engineers and technical graduates; local companies hire these peo- ple at salaries much lower than those that engineers in developed markets earn. Since institutional voids pervade the talent market in India, however, it is very difficult for foreign com- panies to capitalize on the same human resources. Multinational software ser- vice providers, such as Ac- centure and EDS, have a hard time sorting talent in because they have the capabilities to respond to opportu- a market where the level of people’s skills and the quality nities in such countries. Because of their knowledge of of educational institutions vary wildly.In fact, as talent be- products and cost bases, however, they aren’t content with comes scarcer in urban centers like Bangalore and Delhi, operating only in developing countries. When they enter Indian companies will maintain their advantage, because advanced markets, they tend to avoid head-to-head com- they know how to lure people from India’s second-tier petition with foreign companies; they focus on niche op- cities better than multinational companies do. portunities that allow them to capitalize on their existing Transnational giants also find it tough to operate in an strengths. This approach helps emerging giants gradually economy with a poor physical infrastructure and to cope stretch their capabilities even as they learn how to oper- with the Indian regulatory apparatus. India’s software ate in developed markets. The experience helps them en- companies recognized the possibility of providing services large their footprints in advanced countries and compete to overseas customers at least a decade before Western more effectively with multinational giants when their companies acknowledged the feasibility of hiring Indian home markets mature. For instance, Haier’s experience in software professionals. Consequently, the Indian firms Europe and the United States will benefit the company as gained experience early, which has kept them ahead of Western retailers such as Carrefour and Wal-Mart become their foreign rivals. Recently,some Indian companies have important distribution channels in China. also been able to tap the global capital and talent mar- kets, nullifying more of their overseas rivals’ inherent Build on Familiarity with advantages. Some companies have exploited their knowledge of Resource Markets local factors of production and supply chains to build Some emerging-market companies have gained competi- world-class businesses. Taiwan-based Inventec, for in- tive advantage by exploiting their knowledge about local stance, is among the world’s largest manufacturers of factors of production – the markets for talent and capi- notebook computers, PCs, and servers, many of which it

66 harvard business review | hbr.org Building World-Class Companies in Developing Countries makes in China and supplies to Hewlett-Packard and in those countries. They have also acquired small consult- Toshiba. It also makes cellular telephones and portable ing firms in the United States and Europe, thereby en- music players for other multinational companies. Inven- hancing their ability to develop high-end solutions for tec’s customers benefit from the low costs of manufac- customers. turing products in China without having to invest in fac- tories there. They are also able to use China’s talented Treat Institutional Voids as software and hardware professionals, who can design products quickly in an industry where product life cycles Business Opportunities are notoriously short. Inventec has mastered the chal- The third way to build emerging giants is for private sec- lenges associated with sourcing electronic components tor businesses to fill institutional voids. Only governments from around the world, assembling them into quality can set up certain institutions, but companies can own products at a low cost, and shipping them to multina- and profitably operate many kinds of intermediaries in tional companies in a reliable fashion. Recently, Inventec product and factor markets. started selling computers in Taiwan and China under its Many institutional intermediaries facilitate the flow of own brand name. The computers have a Chinese operat- information in markets; these include newspaper publish- ing system and software, so Inventec doesn’t compete di- ers and database vendors. Some intermediaries enhance rectly with its customers–yet. the credibility of the claims sellers make – for instance, Likewise, Bunge, the world’s largest processor of accounting firms, quality-certification firms, and accredi- oilseeds, has created a supply chain that links Brazil’s tation agencies. Others analyze information and advise farmers to consumers all over the world. Bunge’s savvy buyers and sellers; these include rating agencies, product- trading organization tracks the supply of and demand for rating companies such as JD Power and Associates, and oilseeds, which lets executives decide when to buy oil- publications that rank universities and professional seeds; when and where to crush them; and when and schools. Private sector institutions can also facilitate trans- where to transport oil and oil meal for consumer, agricul- actions, either by aggregating and distributing goods and tural, and industrial use. Bunge charters approximately services or by creating forums where buyers and sellers 100 ships; it leases warehouses and crushing plants all can conduct their own transactions. The aggregators – over the world; and it even takes equity positions in ports. venture capitalists, private-equity firms, and banks in the That infrastructure allows the company to respond financial market; retailers in the product market; and, to quickly to changes in customer requirements and helps it some extent, universities in the talent market – help buy- cope with logistics problems, such as those caused by Hur- ers and sellers find each other. Stock exchanges, online ricane Katrina in 2005. Finally, the $24 billion company auction sites, and job sites on the Internet serve as fo- feeds supply and demand data to Brazil’s farmers, along rums where transactions can take place in the financial, with advice about everything from fertilizers to harvest- product, and talent markets, respectively. (For more on ing techniques, so they can plant the most profitable kinds two-sided markets, see Thomas Eisenmann, Geoffrey of oilseeds. Bunge’s sales grew by 235% between 1997 and Parker, and Marshall W.Van Alstyne’s “Strategies for Two- 2004, from $7.4 billion to $25.1 billion. Its net income Sided Markets,”in this issue.) has risen by about 425% over the same period, from Multinational companies enjoy an edge in the interme- $83 million to $469 million. diaries business because they bring expertise, credibility, Businesses that are built around raw materials are usu- and experience to the table. However, emerging-market ally global from their inception, either because they serve companies can take them on for three reasons. First, many customers in advanced markets or because they are part intermediaries are people intensive, so running them re- of a global value chain. As they grow, these emerging gi- quires familiarity with the local language and culture. Sec- ants expand their footprints in three ways. First, they look ond, intermediaries are information intensive, and it takes for customers in advanced markets that they can serve local expertise to access scattered information and ana- from their home bases. Second, as factor markets at home lyze data of variable quality. Third, governments consider become saturated and thus more expensive, these busi- some institutions, such as media, banking, and financial nesses look for other developing countries that offer sim- services, to be of national importance. They often pro- ilar resources. Finally,these companies move up the value hibit multinational companies from setting up those insti- chain, selling branded products or offering solutions to tutions or force them to collaborate with local companies. niche segments. That’s exactly what India’s information Resource markets can be separated into the four tiers technology leaders are doing. After establishing them- we discussed earlier – one global and three local. Multi- selves as reliable providers of IT services in North Amer- national companies are suited to serve as intermediaries ica, they moved into Latin America and Asia. By setting up in the global tier, but local firms are better able to cater operations in developing countries such as China and Rus- to the other tiers. For example, multinational banks serve sia, they have started exploiting the large pools of talent large blue-chip customers in emerging markets because october 2006 67 Building World-Class Companies in Developing Countries evaluating those companies’creditworthiness is relatively China’s Emerge Logistics is another company that has straightforward. Those businesses produce high-quality fi- exploited an institutional void in an emerging market to nancial statements, get them audited by globally reputa- create a profitable business. Although China has plenty of ble accountants, and, if their shares are listed overseas, eight-lane highways, delivering goods isn’t easy because follow international accounting norms. However, evaluat- the transportation system is underdeveloped. No trucking ing the credit of small and medium enterprises is tough: firm operates nationally; in fact, the average Chinese There’s so little data on them. Domestic banks, with their trucking company owns only one or two vehicles. In addi- local knowledge and informal connections, cater to this tion, separate government bodies regulate air, rail, road, segment better than foreign banks do. In Turkey, for ex- and river transport, and several levels of government im- ample, the likes of Citibank skim the top of the corporate pose tolls on vehicles. These factors add to companies’ market whereas local banks, like Garanti Bank Turkey and costs and hinder them from distributing products. Emerge Akbank, cater to Turkish businesses better than the multi- Logistics, one of China’s few third-party logistics services national banks do. providers, helps multinational companies sell products all Several emerging giants have learned to play the role of over the country by capitalizing on its understanding of market institutions. Consider Old Mutual, an insurance the disjointed transportation system and the baffling bu- company that realized that South Africa lacked mutual reaucracy. Operating from a warehouse an hour away

Emerging giants tend to avoid head-to-head competition with foreign companies; they focus on niche opportunities that allow them to capitalize on their existing strengths.

funds and other long-term investment products. Old Mu- from Shanghai, Emerge Logistics takes foreign companies tual responded by creating insurance policies for poor all the way through the delivery process – from filing im- people that had the features of savings accounts. By mar- port applications before goods enter the country to col- keting the policies to millions of South Africans, the com- lecting payments from customers. The company coordi- pany became a large financial services firm. When the nates the transfer of goods among different modes of South African economy integrated itself with the world transportation and takes orders from Chinese customers market in the early 1990s, Old Mutual moved into other for its clients’products. By doing the billing itself, Emerge African countries, such as Botswana, Kenya, Malawi, Logistics also facilitates direct sales by Western multina- Namibia, and Zimbabwe, and listed itself on the Johan- tional companies to Chinese customers. nesburg and London stock exchanges. Exploiting institutional opportunities often doesn’t cre- To take another example, Agora is one of Poland’s most ate a launchpad for globalization. That doesn’t mean successful media companies. It publishes Poland’s biggest these businesses stay small, however. In markets such as newspaper, Gazeta Wyborcza (GW), which commands 43% Brazil, China, India, and Russia, institutional businesses of the national readership and has a 62% share of national can become quite large even if they focus only on the do- newspaper advertising revenues. The paper started in mestic market. In smaller emerging markets, companies April 1989 as an organ for the Solidarity political move- that try to fill institutional voids can grow by exploiting ment, but after Solidarity’s victory in Poland’s elections adjacent opportunities. A print media company, for in- in June 1989, Agora’s founders made the newspaper an in- stance, can expand into electronic media; a bank can di- dependent organization. Agora filled the information versify into asset management and investment banking; void in Poland by providing not only news coverage but and a privately owned business school can set up a med- also a vehicle for advertising. Since GW’s readers are ed- ical, law, or technology school. Doing so often paves the ucated, live in urban areas, and have plenty of disposable way for these businesses to go global at a later stage. income, the newspaper’s advertisers include travel agen- cies, automakers, cellular phone companies, pension The Importance of Execution funds, and so on. The company trades on the Warsaw and London stock exchanges, which has enabled it to raise and Governance capital to fund its growth. In 1993, the company sold ap- Identifying the right growth strategy is critical for build- proximately 20% of its shares to Cox Enterprises, an Amer- ing a world-class business, but execution and governance ican media company. The alliance enabled Agora to get determine whether companies in emerging markets can expertise and capital from Cox. realize their potential. While that may be true about

68 harvard business review | hbr.org Building World-Class Companies in Developing Countries

building great companies anywhere, our research sug- • • • gests that excellent execution and good governance are Is it better to be more global? The answer may appear to particularly valuable in newly industrializing countries. be yes. Well-managed companies do spread their wings Financial and talent resources in emerging markets are over time and enter many geographic markets. There is a scarce, but companies that can execute well end up get- correlation between global scope and performance. But ting more out of them. And since resource providers can- executives shouldn’t confuse that with a causal relation- not rely on the enforcement of contracts in emerging ship. What is important is whether global scope results in markets, good governance – organizational mechanisms competitive advantage rather than being the result of ad- that ensure that a company lives up to its commitments vantage derived in some other fashion. Our research to investors, customers, employees, and business part- shows that there’s more than one way to skin the prover- ners–allows an organization to acquire a reputation that bial cat: Some emerging giants operate in several coun- is invaluable in its dealings with constituents. It can, for in- tries, but others sell only at home. In fact, look at the stance, access the best resources at the lowest cost. United Nations Conference on Trade and Development’s The manner in which emerging-market companies list of top 50 emerging-market companies, and you’ll see achieve good governance varies greatly.Countries put dif- that the correlation between size and degree of globaliza- ferent weights on the extent to which a governance sys- tion in these businesses (as measured by market value) is, tem should protect shareholders, employees, and other at 0.4, low. Moreover, the financial performance of world- constituents. The laws regarding corporate governance class companies that have diversified across countries isn’t differ across nations, with greater similarities among superior to the performance of those that haven’t. Emerg- those that share economic links such as trading connec- ing giants can thus be successful even if they don’t have tions. Governance practices vary even more. However, only global footprints. companies that zealously protect the interests of share- holders and employees, and ensure that both receive com- Reprint R0610C; HBR OnPoint 1459 petitive returns on investment, become emerging giants. To order, see page 151.

HARLEY SCHWADRON “Furgis, under our new performance-based pay system, you owe us $27,000.”

october 2006 69

by Clayton M. Christensen, Matt Marx, and Howard H. Stevenson

Managers can use a variety of carrots and sticks to encourage people to work together and accomplish change. Their ability to get results depends on selecting tools that match the circumstances they face.

the primary task of management is to get people to work together in a systematic way. Like orchestra con- ductors, managers direct the talents and actions of vari- Tous players to produce a desired result. It’s a complicated job, and it becomes much more so when managers are trying to get people to change, rather than continue with the status quo. Even the best CEOs can stumble in their attempts to encourage people to work together toward a new corporate goal. In 1999, for example, Procter & Gamble’s Durk Jager, a highly regarded insider who had recently been promoted

JIM FRAZIER to CEO, announced Organization 2005, a restructuring

october 2006 73 The Tools of Cooperation and Change program that promised to change P&G’s culture. However, not everyone at P&G agreed that such sweeping change The Agreement Matrix was necessary or that the way to achieve it was to reduce in- Leaders who want to move their organizations in a new vestments in the company’s core brands in order to fund direction must first understand the degree to which employ- radical, new products. The organization rebelled, and Jager ees agree on two dimensions: what they want out of working was forced to resign only 17 months after taking the helm. at the company and cause and effect, or how to achieve what The root cause of Jager’s very public failure was that they want. A high level of agreement on both dimensions, such he didn’t induce P&G employees to cooperate–a require- as exists at Apple Computer, requires a completely different ment of all change campaigns. To achieve such coopera- tion, managers have a wide variety of tools at their dis- set of change tools than leaders will need in, for instance, low- posal, such as financial incentives, motivational speeches, agreement environments. training programs, and outright threats. But although most competent managers have a good grasp of what co- operation tools are available, we’ve observed that they may be less sure about which to use. The effectiveness of a given tool depends on the organization’s situation. In Microsoft Apple in 1995 Computer this article, which employs some ideas from Do Lunch or want what they Be Lunch, by Howard Stevenson and Jeffrey Cruikshank, we explain how to choose the right tools and offer advice for managers contemplating change.

Assessing the Existing Level Companies Balkan employing of Agreement Peninsula independent contractors Over our many years observing management successes Extent to which people agree on Extent to which

and failures up close, we’ve found that the first step in any No consensus Broad consensus change initiative must be to assess the level of agreement No consensus Broad consensus in the organization along two critical dimensions. The Extent to which people agree on cause and effect first is the extent to which people agree on what they want: the results they seek from their participation in the enterprise; their values and priorities; and which trade- nization, even though each might have a different view offs they are willing to make in order to achieve those re- of what actions will be required to fulfill those hopes. sults. Employees at Microsoft, for instance, have histori- Microsoft found itself in this situation in 1995, when cally been united around a common goal: to dominate Netscape was threatening to become the primary “win- the desktop. While of course there will always be pockets dow” through which people would use their computers. of employees who are an exception, this theme has de- Everyone in the company wanted the same thing – to fined the company’s culture. The second dimension is preserve Microsoft’s domination of the desktop – but ini- the extent to which people agree on cause and effect: tially there was little consensus about how to do that. which actions will lead to the desired outcome. When Many companies that employ independent contractors people have a shared understanding of cause and effect, and unionized workers, in contrast, are in the lower-right they will probably agree about which processes to adopt– corner. These employees may have little passion for the an alignment that was clearly absent at P&G as Jager at- goals of the company but are willing to follow prescribed tempted to transform the company. procedures if they agree that those actions will produce The exhibit “The Agreement Matrix” depicts these di- the needed results. mensions. The vertical axis shows agreement by an orga- In the upper-right quadrant are companies whose em- nization’s members on what they want; the horizontal ployees agree on what they want and how to get there. axis shows their agreement on cause and effect. Employ- Clear consensus on both dimensions makes these orga- ees in organizations in the upper-left quadrant share nizations’ cultures highly resistant to change: People are hopes for what they will gain from being part of the orga- generally satisfied with what they get out of working in

Clayton M. Christensen ([email protected]) is the Robert and Jane Cizik Professor of Business Administration at Harvard Business School in Boston. Matt Marx ([email protected]) is a doctoral student at Harvard Business School. Howard H. Stevenson ([email protected]) is the Sarofim-Rock Professor of Business Administration at Harvard Business School and the vice provost for Harvard University Resources and Planning. He is also the chairman of the board for Harvard Busi- ness School Publishing.

74 harvard business review | hbr.org The Tools of Cooperation and Change the organization and agree strongly about how to main- CEO of JPMorgan Chase, used these tools during the tain that status quo. bank’s integration with his previous company, Bank One. The final scenario is the lower-left quadrant of the Convinced that pay had gotten out of control (the head agreement matrix, where participants do not agree ei- of HR at Bank One was paid more than $5 million), ther on what they want or on how the world works. The Dimon met with executives individually to tell them they perpetually warring nation-states of the Balkan Penin- were vastly overpaid and slashed hundreds of salaries sula exemplify this lack of agreement. We will return to by 20% to 50%. He drove a replacement of the firm’s myr- each situation in the following pages. iad IT systems with a single platform, threatening to It’s important to note that there is no “best” position make all the decisions himself if the IT staff didn’t reach for managers to aspire to in the agreement matrix. To any decisions in six weeks. He yanked hundreds of unvis- choose the right tools for fostering cooperation among ited small-to-midsize businesses from the investment employees, however, managers must assess where their bank’s “prospects” list so that the commercial bank could organization lies. The tools that will induce employees in have the chance to work with them. Dimon also reconfig- one quadrant to cooperate with a change program may ured control systems so that retail branch managers, well misfire with employees in a different quadrant. In who had received modest bonuses for meeting sales quo- fact, in any given situation, most tools for eliciting coop- tas on mortgages and other products, now stood to lose eration will not work. their jobs for missing quotas. We have included three tools in the exhibit – negotia- Moving from Agreement tion, strategic planning, and financial incentives–to make a point. These tools will work only when there is a mod- to Cooperation icum of agreement on both dimensions of the matrix. In The tools of cooperation can be grouped into four major environments of antagonistic disagreement – whether categories: power, management, leadership, and culture. in the Middle East or in the infamous clashes between In the exhibit “The Four Types of Cooperation Tools,” Eastern Air Lines’ management and its machinist union– we’ve matched each category with a quadrant of the negotiation generally doesn’t work. A leader might use agreement matrix. While the boundaries are not rigid, strategic planning to figure out where the organization the broad labels can give managers a sense of which tools ought to go next, but in the absence of the requisite de- are likely to be effective in various situations. gree of agreement on both dimensions, the strategic plan Power tools. When members of an organization share itself won’t elicit the cooperative behavior required to little consensus on either dimension of agreement, the get there. only tools that will elicit cooperation are “power tools” And using financial incentives – essentially paying em- such as fiat, force, coercion, and threats. Marshal Josip ployees to want what management wants – may backfire Broz Tito, the leader of Yugoslavia during most of the in an environment of low consensus. Consider, for exam- Cold War, wielded power tools effectively. He herded ple, the world of K-12 public education, which is decidedly the disparate and antagonistic ethnic groups of the in the lower-left quadrant of the agreement matrix.

A WISE MANAGER IN A LOW-CONSENSUS ENVIRONMENT would not agree to lead a change program without the authority to wield the right power tools.

Balkan Peninsula into a more or less artificial nation and Teachers, taxpayers, administrators, parents, students, said, in effect,“I don’t care whether you agree with me or and politicians have divergent priorities and disagree with one another about what you want out of life or about strongly about how to improve. Most pay-for-performance how to get it. What I want is for you to look down this gun schemes have failed miserably in producing enduring barrel and cooperate.” His approach worked, and the change in schools, because financial incentives are a tool Balkan nations lived in relative peace for several decades. that just won’t work in this situation. This is not to suggest, of course, that managers bring Power tools can be extremely effective in low-agreement firearms to the office. But when organizational factions situations. The key is having the authority to use them. can’t agree on what they want or what to do, power tools Managers sometimes find themselves in balkanized cir- are the only ones that work. Jamie Dimon, currently the cumstances without the power to wield the only tools october 2006 75 The Tools of Cooperation and Change that will induce cooperation under those conditions. If but not necessarily on what they want from their partici- managers are asked to lead a matrixed or “lightweight” pation in the organization. project team whose members’ loyalties are in conflict For example, in many companies the reasons unionized with the objectives of the project, for instance, the road manufacturing workers come to work are very different to success will be tortuous. Just as a carpenter would from the reasons senior marketing managers do. But if never undertake a job without having the requisite tools both groups agree that certain manufacturing procedures in his or her toolbox, a wise manager in a low-consensus will result in products with targeted levels of quality and environment would not agree to lead a change program cost, they will cooperate to follow those procedures. without the authority to wield the right power tools. Measurement systems can also elicit cooperation in Management tools. The tools of cooperation that such situations. During Intel’s first two decades, gross- drive change in the lower-right quadrant of the agree- margin-per-wafer-start was the widely agreed-upon met- ment matrix focus on coordination and processes. These ric for profitability.In the 1980s,the company’s DRAM prod- “management tools”include training, standard operating ucts, which had enjoyed high gross margins in the 1970s, procedures, and measurement systems. For such tools to were withering under Japanese competition. Focused on work, group members need to agree on cause and effect the accepted metric–and even without an explicit execu-

The Four Types of Cooperation Tools

When people in an organization disagree on what they want and on how to achieve desired results, the only tools that induce cooperation are “power tools,”which are essentially variations on coercion and fiat. If people want the same thing but disagree on how to achieve it,“leadership tools” such as role modeling and charisma can move them toward a consensus. If people agree strongly on cause and effect but little on what they want, leaders can employ “management tools” such as training and measurement systems. Companies where employees agree on both dimen- sions of the matrix, and so are generally happy with the status quo, have very strong cultures that are difficult to change. In such circumstances, it is possible only to tweak direction, using such “culture tools” as rituals and folklore. Managers do have other tools at their disposal – such as negotiation and financial incentives – but these will work only when there is a certain level of agreement on both dimensions of the matrix.

• Religion • Charisma • Folklore • Vision • Rituals

Broad consensus Leadership Culture • Salesmanship Tools

what they want what they Tools • Role modeling • Tradition • Democracy • Apprenticeship Strategic planning • Negotiation • • Role definition • Financial • Transfer pricing incentives • Measurement Power • Hiring Management systems Tools and promotion To o l s • Fiat • Control • Threats systems • Coercion • Training • Standard Extent to which people agree on Extent to which operating procedures No consensus No consensus Broad consensus

Extent to which people agree on cause and effect

76 harvard business review | hbr.org The Tools of Cooperation and Change tive mandate–middle managers in disparate parts of the organization cooperated to shift manufac- turing emphasis from DRAMs to microproces- sors, which had become higher-margin products. Leadership tools. The tools useful in the upper-left quadrant of the agreement matrix tend to be results oriented rather than process oriented. Such “leadership tools” can elicit coop- eration as long as there is a high level of consen- sus that a change is consistent with the reason employees have chosen to work in the enter- prise–even if consensus is low on how to achieve the change. Charismatic leaders respected by employees, for example, often do not address how to get things done. Instead, they motivate people to “just go out and do it.” Good sales managers employ these tools skillfully. Bill Gates used the leadership tool we call vision in his 1995 Internet Tidal Wave memo, which helped Microsoft’s employees see that maintain- ing the company’s dominance in the software in- dustry (what they wanted) required an aggres- sive acknowledgment that the nascent World Wide Web would become an integral part of computing rather than a sideshow to the then- dominant desktop applications–an acknowledg- ment that ran counter to most employees’deeply held beliefs. The fierce response of the company’s Internet Explorer team crippled Netscape and won Microsoft a more than 90% share of the browser market. Faced with stiff competition from Google in late 2005, Gates reemployed this technique in his memo regarding a “services wave,”call- to be considered valid and, therefore, to be taught to ing for a shift from sales of shrink-wrapped software to new members as the correct way to perceive, think, and sales of subscriptions. feel in relation to those problems.”In organizations with The same actions viewed as inspiring and visionary strong cultures, people instinctively prioritize similar among employees in the upper-left corner of the matrix options, and their common view of how the world works can be regarded with indifference or disdain by those in means that little debate is necessary about the best way the lower quadrants. Consider vision statements. When to achieve those priorities. Companies with strong cul- members of a group agree on what they want to achieve, tures in many ways can be self-managing. statements that articulate where the organization needs But this very strength can make such organizations to go can be energizing and inspiring. But if employees highly resistant to change. So-called culture tools–such as don’t agree about what they want, vision statements rituals and folklore – only facilitate cooperation to pre- won’t help much in changing their behavior – aside from serve the status quo; they are not tools of change. Leader- inducing a collective rolling of eyes. ship and management tools can also be used in this Culture tools. In organizations located in the upper- quadrant to foster cooperation, but only in order to rein- right quadrant of the matrix, employees will cooperate force or enhance the existing culture. A manager of such almost automatically to continue in the same direction. a company might see herself as a visionary leader want- Their deep consensus on priorities, and on what set of ac- ing to chart a new course for the organization. She may tions will allow the company to achieve those priorities, want to use a vision statement as a tool for analyzing and is the essence of a strong culture. As MIT’s Edgar Schein refining the vision in her mind. But as a tool of change? wrote in Organizational Culture and Leadership, culture is Employees in the upper-right strong-culture quadrant are “a pattern of shared basic assumptions that was learned unlikely to cooperate with any strategy that is at odds by a group as it solved its problems of external adaptation with their deeply shared beliefs about what they want and internal integration, that has worked well enough and what must be done. Hewlett-Packard’s Carly Fiorina october 2006 77 The Tools of Cooperation and Change learned this the hard way when she tried to challenge Crisis and failure, in contrast, can destroy that consensus, the so-called HP Way. Her very public clashes with HP’s plunging the organization toward the lower-left quadrant. employees and board led to her ouster in 2005, following Employees in crisis are no longer certain or unanimous in the company’s controversial merger with Compaq. Es- their beliefs about what actions are necessary. Managers sentially, as P&G’s Durk Jager needed to recognize, the who are able and willing to use power tools during crises only tools that can be wielded are those that are effec- can get employees to cooperate in a remedial course of tive in the domain where the employees are–and in strong action, provided those managers know where the organi- cultures, the tools in the upper-right quadrant lead to co- zation needs to go and what must be done to get there. operation in gradual change, at best. Indeed, scholars of organizational change frequently pre- scribe “creating a crisis” because it forces employees into a What Managers Can – situation where they can be compelled to cooperate. While there is merit to the create-a-crisis strategy,there’s and Cannot – Do a rub to this simple solution: What if the CEO sees the need We noted earlier that there is no “best” position in the to change direction while the business is still healthy – matrix of agreement; each quadrant carries its own chal- when the crisis is in the future, not the present? And what lenges. A company’s position may reflect where it is in if this healthy company also has an extremely strong its life cycle and is largely determined by how successful culture? That was the situation facing John Sculley, CEO it has been. Most organizations start at the left and often of Apple Computer from 1983 until 1993. Fresh from a tri- at the bottom of the matrix, where the founder’s fiats umphant career at PepsiCo, Sculley was an exceptional drive much of what gets prioritized and how it gets done. executive. During his first several years at Apple, the If employees develop effective methods that result in suc- company continued to prosper. By the late 1980s, how- cess, consensus will begin to coalesce on the horizontal ever, Sculley sensed trouble over the horizon and saw the dimension of agreement – what actions yield the desired need to change strategy in three specific ways. First, he results. As the company succeeds, employees who fit with saw fledgling low-cost computer makers, such as Dell, these ways of working, and who want what senior man- menacingly exploring how to make higher-performance agement wants, tend to be promoted. Those who don’t computers within their low-cost business models. Sculley tend to leave. Hence, success is the mechanism that builds declared that Apple needed to move down-market aggres- consensus around what people want and how they can sively, reducing its prices by as much as 75% in order to get it. Success shifts the organization toward the upper- blunt this disruptive attack. Second, before Microsoft right quadrant. introduced its Windows operating system, Sculley urged

The Tools of Politics

In institutions with well-established others – because even if the police don’t On occasion, Americans in particular cultures (those in the upper-right catch and punish them, they will be re- have tried to impose democracy on coun- portion of the exhibit “The Agreement warded or punished in some way in the tries whose populations are not in the Matrix”), democracy can be used as afterlife. The successful practice of these upper-right corner of the agreement a tool to encourage cooperation. An im- beliefs – together with a shared value matrix – where religious or other institu- portant insight from this model is that that every person should be allowed to tions have not built the type of cultural democracy will not work except where worship God in his or her own way – has consensus that is consistent with demo- people agree strongly on both dimen- created successful societies in places cratic principles. When America has es- sions of the matrix: what they want and such as India, Japan, the United States, sentially snapped its fingers at these the rules of cause and effect. The very and Western Europe. The practices have countries, ordering them to establish sta- functioning of democracy depends become so deeply embedded over so ble democracies–and quickly–chaos upon the existence of strong cultural many years that almost all people in typically has ensued. The crime, corrup- beliefs that are often rooted in the these societies, regardless of religious tion, and tax evasion that characterize teachings of certain religions. The reli- belief, now strongly share these values much of Russia; the collapse of civil gious institutions at the root of these and are ensconced in the upper-right order that torments Haiti; and the costly, cultures have taught that people are quadrant of the agreement matrix. The tragic dilemma that America now faces meant to be free and that they should vast majority of people living in these in Iraq–all are testaments to the fact voluntarily be honest and respect the cultures obey the law voluntarily – and, that democracy doesn’t work when the life, property, and equal opportunity of as a result, democracy works. enabling preconditions don’t exist.

78 harvard business review | hbr.org The Tools of Cooperation and Change

DEEP CONSENSUS ON PRIORITIES, and on what set of actions will allow the company to achieve those priorities, is the essence of a strong culture.

Apple to open its proprietary product architecture and unit to build a different consensus among its employees begin selling its vaunted operating system. Third, he saw regarding what they want and how to get there, while the that portable, handheld devices would become an impor- prior culture continues to thrive in the original unit. tant growth market. In retrospect, Sculley saw the future Disaggregation works by eliminating the need for co- of his industry with remarkable clarity. operation between groups with opposing goals. This is But being a visionary leader isn’t all it’s cracked up to how Hewlett-Packard succeeded in the disruptive ink-jet be. When leaders like Sculley conclude that their orga- printer business even while its laser-jet printer business nization’s course must change, they need to consider was prospering with a very different profit model. HP dis- where the rest of the employees are in the agreement ma- aggregated the printer business, leaving the laser-jet unit trix. At Apple, they were decidedly in the upper-right quad- in Boise, Idaho, and setting up the ink-jet unit in Vancouver, rant–some said that Apple put the “cult”in “culture.”Scul- Washington. Likewise, IBM stayed strong in computers ley tried reorganization, firings, control systems, financial for many years, whereas all its mainframe and minicom- incentives, training, measurement systems, standard puter rivals failed, because it used the tool of disaggrega- procedures, vision statements, salesmanship, strategic tion. When minicomputers began disrupting mainframes, planning, and many more tools to elicit cooperation be- IBM created a separate business unit in Rochester, Min- hind the changes he envisioned. But none worked. The nesota, to focus on minicomputers, which had to be de- Apple employees wouldn’t listen. signed, built, and sold within a very different economic Sculley gradually lost credibility with his board and em- model than mainframes. When personal computers dis- ployees as tool after tool failed to produce the changes he rupted minicomputers, IBM disaggregated again, setting desired, and he was ousted in 1993. Apple’s board then ap- up in Boca Raton, Florida, another freestanding unit, pointed Michael Spindler, head of the company’s success- which developed a business model tailored to PCs. Had ful European operations, as CEO. Spindler also found that IBM executives tried to convince the managers and em- the only tools of cooperation at his disposal were those ployees of the original computer business to cooperate on that reinforced Apple’s culture, and he was dismissed a strategy, economic model, and culture to succeed simul- after three years. The board then brought in Gil Amelio, taneously in mainframes, minicomputers, and PCs, the who had turned around the deeply troubled National company would have failed. Semiconductor – expecting that he could do the same at Apple. He couldn’t and was gone in 18 months. Mastering the Tools of Cooperation Unable to recruit another qualified CEO, Apple’s board turned in desperation to ousted Apple founder Steve Jobs at Continental Airlines as interim CEO. Jobs essentially stopped trying to change It would be rare, of course, for all employees in a company the company and instead encouraged the troops to re- to be in one place in the agreement matrix at a given time sume designing cool, innovative, high-end products such or across time. While the founding group of senior manag- as the iMac and iPod. Apple now dominates the digital ers may be in the upper-right quadrant, manufacturing music industry. But if there had been any tools to wield employees may be in the lower-right. Those in sales and within this strong culture to elicit cooperation behind creative design might be in the upper-left, sharing an un- the new direction Sculley foresaw, Apple might have derstanding of what is important but unwilling to subject captured much of the fruit that ultimately fell into the themselves to the sorts of standards and processes that hands of Compaq, Dell, and Microsoft. are effective in the lower-right quadrant. Most managers, unfortunately, have a limited tool kit and thus can suc- cessfully manage only in certain types of situations. One The Tool of Disaggregation of the rarest managerial skills is the ability to understand All is not lost for managers who see the need to change which tools will work in a given situation – and not to a successful company before the onset of a crisis. They waste energy or risk credibility using tools that won’t. can wield the tool of disaggregation–the separation of or- Gordon Bethune, CEO of Continental Airlines from 1994 ganizations into units. This allows managers at the new until 2004, was such a manager. Bethune was the airline’s october 2006 79 The Tools of Cooperation and Change tenth CEO in ten years, following a disastrous run includ- upper-right quadrant, working to reinforce what has be- ing industry worsts in lost baggage, customer complaints, come a very productive culture. overbooking, and on-time departures. Moreover, Conti- Bethune’s well-timed choice of tools mirrored that of nental had declared bankruptcy twice during the previous Jack Welch at General Electric, who started out as Neu- decade and was losing $55 million per month despite tron Jack, using power tools when the company was a col- years of cost cutting. lection of businesses with vastly different cultures, oper- Bethune turned down the top job twice even though he ating procedures, and expectations about growth and was already serving as Continental’s COO. The first offer profitability. As he oriented the company around the was to be acting CEO during the existing CEO’s six-month mantra of being first or second in each of the conglomer- leave of absence, and the second was to serve in the office ate’s businesses, GE moved from the lower-left corner of of the CEO after that executive decided to retire. Although the matrix toward the upper-right, and Welch shifted his board members respected Bethune, they believed that focus to culture-reinforcing activities, teaching up-and- the only way to restore profitability was through further coming managers at the company’s Crotonville campus.

ONE OF THE RAREST MANAGERIAL SKILLS is the ability to understand which tools will work in a given situation–and not to waste energy or risk credibility using tools that won’t. cost cutting–a path Bethune was convinced would lead to The success of Bethune and Welch, of course, is both disaster, not deliverance. Given the significant disagree- good news and bad news for their successors. As long as ment about how to restore profitability, Bethune knew he the shared purposes and unified view of how to achieve could do nothing without the full authority that came with them are appropriate for their companies’ challenges, the top job, without the qualifiers of “acting”or “office of.” Larry Kellner and Jeffrey Immelt ought to be able to pre- Even after the board approved Bethune as CEO, few side over continued success using the cooperation tools within the company agreed with his unconventional view handed to them on their arrival. However, if there are that Continental needed to be less restrictive of its em- shifts in the competitive environment that mandate sig- ployees and spend more in order to get out of bankruptcy. nificant changes either to what people want or to the re- As Bethune wrote in his book From Worst to First, when quired actions, the two CEOs may find that the tools their the operations staff rebuffed his instruction to repaint all predecessors used to turn their organizations around can- of the carrier’s more than 200 airplanes, he threatened to not be wielded effectively in the strong-culture quadrant. shoot them unless they complied.Concerned that customer- For example, much has been written about former CEO service employees were micromanaging customers by re- Lou Gerstner’s success in refashioning IBM from a “big lying too heavily on a very thick instruction manual, he iron”company to one built on services. Managing change set fire to a stack of manuals in the parking lot. is always hard. But our model suggests that because he took Having won some initial battles by sheer force, Bethune IBM’s helm when the company was in genuine crisis, losing achieved preliminary success and began to move the com- billions of dollars, Gerstner was fortunate. The situation pany out of the lower-left quadrant toward the upper- demanded power tools. As IBM’s service businesses ma- right. As the company started to recover, Bethune began ture, his successor, Sam Palmisano, may face the tougher employing more traditional management tools, includ- challenge. There is no current crisis that enables the effec- ing financial incentives. After he offered each employee tive use of power tools to marshal a cooperative march in a $65 bonus every month that Continental placed among a new direction. He faces a cultural challenge that will the top five for on-time departures, Continental jumped likely prove more difficult than the crisis Gerstner faced. to fourth the subsequent month and first thereafter. Bethune, Welch, and Gerstner were blessed with an in- Our model suggests that this incentive would not have stinct for choosing the right tools at the right time.Our hope worked in the environment of distrust and disagree- is that by making the instincts of effective managers more ment that characterized the company when Bethune explicit, even those of us who are not born knowing how to began his work. By 1998, the company had posted 11 manage change can learn to do so more effectively. straight quarters of improved profits and had won two consecutive J.D. Power and Associates’ awards. Bethune Reprint R0610D; HBR OnPoint 1458 spent the final years of his career using the tools in the To order, see page 151.

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THE HBR INTERVIEW | JAMES G. MARCH Stanford’s James March has become a leading business thinker of our time while arguing that the elegance of an idea may be more important than its relevance. IDEAS AS ART INTERVIEWED BY DIANE COUTU

IN THESE PAGES, three years ago, consultants Laurence Prusak and Thomas H. Davenport re- ported the findings of a survey of prominent man- agement writers who identified their own gurus. Although his is an unfamiliar name to most read- ers of this periodical, James G. March appeared on more lists than any other person except Peter Drucker. March is a writer to whom the experts turn when

STEVEN VOTE they want to engage new ideas. He is a polymath

october 2006 83 Ideas as Art: A Conversation with James G. March whose career over the past five decades has encompassed In a recent interview with HBR senior editor Diane numerous disciplines. A professor emeritus in manage- Coutu at his home in Portola Valley, California, March ment, sociology, political science, and education at Stan- shared his thinking on aesthetics, leadership, the useful- ford University, he has taught courses on subjects as ness of scholarship, the role of folly, and the irrelevance diverse as organizational psychology, behavioral eco- of relevance when it comes to the pursuit of ideas. The nomics, leadership, rules for killing people, friendship, following is an edited version of that interview. decision making, models in social science, revolutions, computer simulation, and statistics. How did you come to have such influence on management March is perhaps best known for his pioneering contri- thinking without being as public a figure as Peter butions to organization and management theory. He has Drucker? coauthored two classic books: Organizations (with Her- I don’t claim to have any notable impact, partly because bert A. Simon) and A Behavioral Theory of the Firm (with I question the methodology by which such an impact is Richard M. Cyert). Together with Cyert and Simon, assigned to me, and partly because I suspect it is easier March developed a theory of the firm that incorporates to infiltrate the idea consciousness of the business com- aspects of sociology, psychology, and economics to pro- munity if you do not worry about attribution, reputation vide an alternative to neoclassical theories. The underly- for significance, or direct communication. And even if ing idea is that although managers make decisions that that is not true, I fear that my own enjoyments come are intendedly rational, the rationality is “bounded” by more from playing with ideas than from selling them. human and organizational limitations. As a result, human I am a scholar; I do what scholars do. I think about things, behavior is not always what might be predicted when conduct research studies, and write up my thoughts and rationality is assumed. research in professional journals. The writing is proba- In addition to this work, March has been a leading bly more a way of understanding my thoughts than of contributor to the study of political institutions, particu- communicating them. larly through the books Rediscovering Institutions and That sounds more reclusive than I believe I am. I am Democratic Governance (both coauthored with Johan P. hardly so perverse as to resist having my writings read Olsen); the study of leadership, through Leadership and by others. The articles I write are accessible to any man- Ambiguity (with Michael D. Cohen) and On Leadership ager who chooses to read them. I don’t write obscurely – (with Thierry Weil); and the study of decision making, at least not deliberately–and the ideas are not exception- through his books A Primer on Decision Making and The ally arcane. Dull, maybe, but not arcane. Pursuit of Organizational Intelligence. March’s influence on students of organizations and You liked to begin your classes at Stanford each year saying, management and his accomplishments in other areas of “I am not now, nor have I ever been, relevant.” What did you social science have conferred on him an almost unprece- mean by that? dented reputation as a rigorous scholar and a deep It was a signal to students that it would not be fruitful source of wisdom. In the academic literature, it has be- to ask me about the immediate usefulness of what I had come de rigueur to cite his articles. Professor John Pad- to say. If there is relevance to my ideas, then it is for the gett of the University of Chicago wrote in the journal people who contemplate the ideas to see, not for the per- Contemporary Sociology that “Jim March is to organiza- son who produces them. For me, a feature of scholarship tion theory what Miles Davis is to jazz.…March’s influ- that is generally more significant than relevance is the ence, unlike that of any of his peers, is not limited to beauty of the ideas. I care that ideas have some form of any possible subset of the social science disciplines; it is elegance or grace or surprise – all the things that beauty pervasive.” gives you. The central limit theorem, for example, is one Despite his renown in the social sciences, March has of the more important theorems in classical statistics; it not confined his interests to those fields. Besides his pro- allows you to say things about sampling errors. But for fessional and scholarly articles and books, he has made me, the theorem is primarily a thing of extraordinary one film (Passion and Discipline: Don Quixote’s Lessons for beauty. I think that anyone who teaches the central limit Leadership), is currently working on another, and has theorem should try to communicate that aesthetic joy written seven books of poetry. His poetic sensibility can to students. be felt in the metaphors he has created over the years: Charlie Lave and I wrote Introduction to Models in the the “garbage can theory” of organizational choice, the Social Sciences. Among the books I’ve written, it is one “technology of foolishness,” the role of consultants as of my favorites. It introduces students to the rudiments “disease carriers,”and the “hot-stove effect.” of four very fundamental models in social science. It treats modeling as an art form. Scholarship will always Diane Coutu ([email protected]) is a senior editor have an element of aestheticism, because scholars are at HBR. obliged to advance beauty as well as truth and justice.

84 harvard business review | hbr.org Ideas as Art: A Conversation with James G. March

This seems to be your artistic sensibility. How do you leadership are more characteristic of amateurs than of justify such a sensibility in a world where business is so professionals. Unless and until a link to significant schol- desperately in need of practical solutions? arship can be made, the thinking on leadership will pro- No organization works if the toilets don’t work, but I duce more articles in popular journals than in professional don’t believe that finding solutions to business problems ones, more homilies and tautologies than powerful ideas. is my job. If a manager asks an academic consultant what In the meantime, in order for leadership scholarship to to do and that consultant answers, then the consultant generate some good ideas, it needs to build buffers to pro- should be fired. No academic has the experience to know tect itself from the temptations of immediate relevance. the context of a managerial problem well enough to give specific advice about a specific situation. What an aca- What kinds of questions do you think are important demic consultant can do is say some things that, in com- for leaders? bination with the manager’s knowledge of the context, In my course on leadership and literature, I ended up may lead to a better solution. It is the combination of ac- with a list of about ten topics–for example, power, domin- ademic and experiential knowledge, not the substitution ion, and subordination; ambiguity and coherence; gender of one for the other, that yields improvement. and sexuality; the relation between private and public lives. Not a unique list, and hardly a complete one. Each Have you ever consulted to businesses? of the topics can draw illumination from social science, When I was younger – younger and poorer, I suppose – but I think they often are more profoundly considered in I used to do some relatively technical consulting about great literature. One issue, which I used to talk about by things involving statistics or research methods. I don’t do looking at George Bernard Shaw’s Saint Joan, is how mad-

No organization works if the toilets don’t work, but I DON’T BELIEVE THAT FINDING SOLUTIONS TO BUSINESS PROBLEMS IS MY JOB.

that any longer. I still occasionally do something I humor- ness, heresy, and genius are related. We often describe ously call “consulting” but probably is better seen as get- great leaders as having the drive, vision, imagination, ting someone to buy lunch for me. If someone calls me and creativity to transform their organizations through up and says a manager would like to talk to me, I’m in- daring new ideas. Retrospectively, of course, we some- clined to respond that I almost certainly don’t have any- times find that such heresies have been the foundation thing useful to say.But if the answer is that it doesn’t mat- for bold and necessary change, but heresy is usually just ter, that the manager still wants to have lunch with me, crazy. Most daring new ideas are foolish or dangerous then I am happy to have lunch. I think that it would ordi- and appropriately rejected or ignored. So while it may be narily be difficult to discover any practical use for such true that great geniuses are usually heretics, heretics are conversations, but I may occasionally have a way of look- rarely great geniuses. If we could identify which heretics ing at things that is sufficiently different to help a man- would turn out to be geniuses, life would be easier than it ager in some marginal way.Usually,managers are sensible is. There is plenty of evidence that we cannot. enough not to ask me to lunch, and I end up paying for most of my lunches myself. In your film on Don Quixote and leadership, you say that if we trust only when trust is warranted, love only when love Leadership has become a big concern and a big industry is returned, and learn only when learning is valuable, then in recent years. What is happening in leadership research? we abandon an essential feature of our humanity. How do we I doubt that “leadership” is a useful concept for serious lose part of our humanity? scholarship. The idea of leadership is imposed on our in- We justify actions by their consequences. But providing terpretation of history by our human myths, or by the consequential justification is only a part of being human. way we think that history is supposed to be described. As It is an old issue, one with which Kant and Kierkegaard, a result, the fact that people talk about leaders and among many others, struggled. I once taught a course on attribute importance to them is neither surprising nor in- friendship that reinforced this idea for me. By the end formative. Although there is good work on several aspects of the course, a conspicuous difference had emerged be- of asymmetric relations in life, broad assertions about tween some of the students and me. They saw friendship october 2006 85 Ideas as Art: A Conversation with James G. March as an exchange relationship: My friend is my friend be- preting its definitions and constraints. I called the paper cause he or she is useful to me in one way or another. “The War Is Over, and the Victors Have Lost,”to note the By contrast, I saw friendship as an arbitrary relationship: way economics has tended to become so tautological as If you’re my friend, then there are various obligations that to “explain” everything at the cost of abandoning predic- I have toward you, which have nothing to do with your tive power. At times, economics as a theory threatens to behavior. We also talked about trust in that class. The stu- become economics as a faith. dents would say, “Well, how can you trust people unless they are trustworthy?” So I asked them why they called You’ve been unusually interdisciplinary in your life’s work. that trust. It sounded to me like a calculated exchange. Is there some overarching question that you’ve tried to For trust to be anything truly meaningful, you have to answer? trust somebody who isn’t trustworthy. Otherwise, it’s I don’t think it’s been that grand. It just happens that the just a standard rational transaction. The relationships disciplines are organized in ways that distribute my rather among leaders and those between leaders and their fol- narrow areas of research focus across standard disciplin- lowers certainly involve elements of simple exchange ary lines. I’ve studied problem solving and decision mak- and reciprocity, but humans are capable of, and often ex- ing, risk taking, information processing, innovation and hibit, more arbitrary sentiments of commitment to one change, learning, selection, and the creation and revision another. of rules and identities. In a very loose way, I think, you could say my main focus has been on the cognitive as- You’ve said that scholars and managers do fundamentally pects of organizations, as long as you include in the term different things. Can you elaborate on that? “cognitive” such things as conflict, bias, rule following, You need both academic knowledge and experiential and confusion. knowledge, but they are different. The scholar tries to figure out, What’s going on here? What are the underly- Much of your research has focused on learning in one way ing processes making the system go where it’s going? or another. How is this tied to the hot-stove effect? What is happening, or what might happen? Scholars talk That term comes from an article by Jerker Denrell and about ideas that describe the basic mechanisms shaping me, but it is stolen from some of Mark Twain’s wisdom. managerial history – bounded rationality, diffusion of le- Twain said that if a cat ever jumps on a hot stove, he will gitimate forms, loose coupling, liability of newness, com- never jump on a hot stove again. And that’s good. But he petency traps, absorptive capacity, and the like. In con- will also never jump on a cold stove again–and that may trast, experiential knowledge focuses on a particular not be good. context at a particular time and on the events of personal The hot-stove effect is a fundamental problem of learn- experience. It may or may not generalize to broader ing. Learning reduces your likelihood of repeating things things and longer time periods; it may or may not flow that got you in trouble, as you hope it will. But that means into a powerful theory; but it provides a lot of under- you know less about the domains where you’ve done standing of a particular situation. A scholar’s knowledge poorly than about the domains where you’ve done well. cannot address a concrete, highly specific context, except You might say,“Well, why should that cause problems?” crudely. Fundamental academic knowledge becomes It causes problems whenever your early experience with more useful in new or changing environments, when an alternative is, for whatever reason, not characteristic of managers are faced with the unexpected or the unknown. what subsequent experience would be. It clearly causes It provides alternative frames for looking at problems problems in domains where practice makes a difference. rather than solutions to them. For example, you are likely to abandon an approach or a technology prematurely. Along with Richard Cyert and Herb Simon, you laid One form of the hot-stove effect is the competency the groundwork for the field of behavioral economics. trap, where learning encourages people to stick to and im- Do you think you started a revolution? prove skills they have already honed to a fine degree Scholarship is a communal activity. No one comes first; rather than spend time gaining new ones. Some of my and no one stands alone. Insofar as there has been a be- grandchildren say to me,“We’re not very good at mathe- havioral economics “revolution,”it is a revolution started matics, so we’re not going to take any more mathematics.” by many. Nowadays, economists and others do talk a fair I say, “Wait a minute. Mathematics is a practice sport. If amount about bounded rationality. But the economists you’re not very good at it, you take more of it.” That’s are more inclined to see the limits on rationality as minor counterintuitive, and it goes against the main logic of perturbations, easily accommodated within some varia- experiential learning, not to mention grandchildren’s sen- tion of neoclassical economic theory, than as fundamen- timents about control over their own lives. It has also tal challenges. I once wrote a paper on the tendency of been demonstrated that the hot-stove effect leads experi- economists to maintain neoclassical theory by reinter- ential learners to be risk averse. It is possible to limit the

86 harvard business review | hbr.org Ideas as Art: A Conversation with James G. March hot-stove effect by slowing learning so that you increase the sample of alternatives that have poor results. That obviously has the cost of incur- ring short run losses and conse- quently is hard for an adaptive sys- tem to do.

You’ve written about the importance of a “technology of foolishness.” Could you tell us a little about it? That paper sometimes gets cited – by people who haven’t read it closely – as generic enthusiasm for silliness. Well, maybe it is, but the paper actually focused on a much narrower argument.It had to do with how you make interesting value sys- tems. It seemed to me that one of the important things for any person interested in understanding or im- proving behavior was to know where preferences come from rather than simply to take them as given. So, for example, I used to ask stu- dents to explain the factual anom- aly that there are more interesting women than interesting men in the world. They were not allowed to question the fact. The key notion was a developmental one: When a woman is born, she’s usually a girl, and girls are told that because they are girls they can do things for no good reason. They can be unpre- dictable, inconsistent, illogical. But then a girl goes to school, and she’s told she is an educated person. Be- cause she’s an educated person, a woman must do things consis- tently, analytically, and so on. So she goes through life why men are both less interesting and more predictable doing things for no good reason and then figuring out the than women. They do not combine their analysis with reasons, and in the process, she develops a very compli- foolishness. cated value system–one that adapts very much to context. It’s such a value system that permitted a woman who was How do you encourage people to be foolish? once sitting in a meeting I was chairing to look at the men Well, there are some obvious ways. Part of foolishness, or and say,“As nearly as I can tell, your assumptions are cor- what looks like foolishness, is stealing ideas from a differ- rect. And as nearly as I can tell, your conclusions follow ent domain. Someone in economics, for example, may from the assumptions. But your conclusions are wrong.” borrow ideas from evolutionary biology, imagining that And she was right. Men, though, are usually boys at birth. the ideas might be relevant to evolutionary economics. They are taught that, as boys, they are straightforward, A scholar who does so will often get the ideas wrong; he consistent, and analytic. Then they go to school and are may twist and strain them in applying them to his own told that they’re straightforward, consistent, and analytic. discipline. But this kind of cross-disciplinary stealing can So men go through life being straightforward, consistent, be very rich and productive. It’s a tricky thing, because and analytic–with the goals of a two-year-old. And that’s foolishness is usually that – foolishness. It can push you to october 2006 87 Ideas as Art: A Conversation with James G. March be very creative, but uselessly creative. The chance that my colleagues from Yugoslavia, now Croatia, came up and someone who knows no physics will be usefully creative said,“That was a great talk, but please, when you come to in physics must be so close to zero as to be indistinguish- Yugoslavia, don’t give that talk. We have enough foolish- able from it. Yet big jumps are likely to come in the form ness.”And I think he may have been right. of foolishness that, against long odds, turns out to be valu- able. So there’s a nice tension between how much foolish- You’re famous for your garbage can theory of organizational ness is good for knowledge and how much knowledge is choice. Can you sum up the theory for us? good for foolishness. The original article on the garbage can theory was writ- Another source of foolishness is coercion. That’s what ten jointly with Michael Cohen and Johan Olsen, so they parents often do. They say,“You’re going to take dance les- have to share in whatever fame or shame there is in it. A sons.” And their kid says, “I don’t want to be a dancer.” fair number of people took the organized-anarchy notion And the parents say,“I don’t care whether you want to that life is ambiguous and said,“The garbage can is really be a dancer. You’re going to take these lessons.”The use of a label for confusion.”That wasn’t quite what we meant. authority is one of the more powerful ways to encour- We were operating at two levels. On one level, we were age foolishness. Play is another. Play is disinhibiting. saying that choice is fundamentally ambiguous. There is a When you play, you are allowed to do things you would lot of uncertainty and confusion that isn’t well represented not be allowed to do otherwise. However, if you’re not by standard theories of decision making. Opportunities

Most daring new ideas are foolish or dangerous and appropriately rejected or ignored. So WHILE IT MAY BE TRUE THAT GREAT GENIUSES ARE USUALLY HERETICS, HERETICS ARE RARELY GREAT GENIUSES.

playing and you want to do those same things, you have for choice attract all sorts of unrelated but simultaneously to justify your behavior. Temporary foolishness gives available problems, solutions, goals, interests, and concerns. you experience with a possible new you – but before you So a meeting called to discuss parking lots may become can make the change permanent, you have to provide a discussion of research plans, sexual harassment, manage- reasons. rial compensation, and advertising policies. Time is scarce for decision makers, though, and what happens depends What role would there be for foolishness in business on how they allocate that time to choice opportunities. education? On the second level, we tried to describe the way in We have some foolishness already, though we dress it up which organizations deal with flows of problems, solu- as fairly serious activity. For example, we have students tions, and decision makers in garbage can situations. The play roles. We have them pretend they are the CEO of central ideas were that a link between a problem and a IBM, and that’s foolishness. They aren’t, and they can’t solution depends heavily on the simultaneity of their be, and they won’t be. But if you are encouraged to think “arrivals,”that choices depend on the ways in which deci- of yourself as somebody else, you start acting the way you sion makers allocate time and energy to choice opportu- imagine such a person ought to act and experimenting nities, that choice situations can easily become over- with who you might become. loaded with problems, and that choices often can be made On the whole, I think that American management ed- only after problems (and their sponsors) have moved to ucation is so deeply embedded in a rational mystique other decision arenas and thus typically are not resolved. that pressure toward foolishness often has to become ex- In our minds, the garbage can process is a very orderly treme in order to have even a minor effect. At the same process. It looks a little peculiar from some points of view, time, I don’t think any of us would want to live in a world but it isn’t terribly complex, and it isn’t terribly jumbled. of foolishness that ignored the fact that one of the major The good thing, I think, is that our perspective has opened glories of the human estate is the capability to practice up the possibility for people to say,“That’s a garbage can intelligent rationality. process” – meaning it’s an understandable process in It’s all a question of balance. Soon after I wrote my which things are connected by their simultaneous pres- paper on the technology of foolishness, I presented it at ence more than by anything else, even though they look a conference in Holland. This was around 1971. One of all mixed-up.

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Does it concern you that people sometimes misunderstand cruelty of the powerful in dealing with the weak is toler- your ideas? ated, even encouraged. Even so, most of the executives In a real sense, there is no such thing as “my”ideas. Schol- I’ve met seem to be trying to do as decent a job as they arship and notions of intellectual property are poor bed- can. Of contemporary figures, probably the one I know mates. I have often read things, both by critics and by best is John Reed, the longtime CEO of Citibank and re- enthusiasts, that seem to me to be based on a less than cently the supervisor of reforms in the New York Stock precise reading of what I have written; but once you pub- Exchange. I admire John. I think he has a sense of what it lish something, you lose special access to it. The inter- means to be a human being. pretations of others have as much legitimacy, if they can I think practicing managers are sometimes less reflec- be defended, as yours do. In the best of all worlds, others tive than they might be. The rhetoric of management re- will generate interpretations that are more interesting quires managers to pretend that things are clear, that than the ones you had in your mind. In fact, a basic goal everything is straightforward. Often they know that in writing is to choose words that can evoke beautiful managerial life is more ambiguous and contradictory and useful meanings that were not explicit in your own than that, but they can’t say it. They see their role as reliev- mind. Some very good writers resist that idea. They ing people of ambiguities and uncertainties. They need want to be their own interpreters. I think that is a mis- some way of speaking the rhetoric of managerial clarity take. The evocative ambiguities of language are sources while recognizing the reality of managerial confusion of creativity. and ambivalence. In a recent paper, I argued that reading poetry helps, but I fear that is a small response to a large You’ve said that the numbers of women coming into the problem. workforce have changed the sexual character of organizations but that many people will pine for the You are a poet yourself. Why do you write poetry? simplicity of the old order. I’m not sure why I write poetry. I’m not always sure that Oh, sure. But I’m also committed to the notion that a lot it is poetry. It has something to do with an affection for of happiness comes from dealing with complexity. We the beauties and grace of life, along with an affection may regret the passing of a simple life – a simple divi- for its efficiency or effectiveness. I think it is the beauty of sion of labor between the sexes or a work world without rationality, as well as its utility, that attracts me to it. It is heterosexuality – but we wouldn’t like it if that life were the beauty of emotions and feelings that makes them restored to us. I think the problems of wrestling with the compelling for me. Poetry is a way of contemplating and issues of gender and sexuality have been, for my genera- augmenting those beauties, as well as the absurdities of tion, very important. They’ve obviously been important their presence in the dustbins of life. Poetry celebrates the to women, and, as a result, they’ve been important to senses; it celebrates the feelings in ways that other things men. Many of the beauties we now see in people have don’t. It’s also a place where you can play with the splen- come out of that struggle, and the struggle is by no means dor, sound, and combinatorics of words. And you don’t over. Nor am I sure you would want to have it over. For usually do that in other genres. example, life might be much less interesting if you actu- ally took sex and sexuality out of management. It would You began your courses by denying claims to your relevance. be easier, and it might, in some ways, be less prone to How did you end them? atrocity–but it surely wouldn’t be as much fun. It depended on the course; but quite often I would end with a quote from a French writer, Étienne Pivert de Are there any practitioners you admire? Senancour. Even in English, it provided a patina of culture I guess I admire all of them, even the scoundrels. Modern to an otherwise midwestern sensibility: “Man is perish- organized life poses problems that are not trivial; and able. That may be; but let us perish resisting, and, if noth- anyone who is prepared to try to function meaningfully ingness is what awaits us, let us not act in such a way that in a modern organization has my respect. Dealing with it would be a just fate.” the simultaneous demands for self-respect, autonomy, In the end, you know, we are very minor blips in a cos- control, coordination, order, freedom, imagination, disci- mic story. Aspirations for importance or significance are pline, and effectiveness that are essential parts of modern the illusions of the ignorant. All our hopes are minor, ex- organizations seems to me worthy of respect, even when cept to us; but some things matter because we choose to it is done in a less than perfect way. I know there is some make them matter. What might make a difference to us, sense in the observation that hierarchies and competition I think, is whether in our tiny roles, in our brief time, we can make monsters out of ordinary, good people. They inhabit life gently and add more beauty than ugliness. often do, and I think we have an obligation to recognize that problem. The business firm is one of the few contem- Reprint R0610E porary institutions in which the arbitrary and gratuitous To order, see page 151. october 2006 89 STRATEGIC HUMOR

Workplace Woes

“Opportunity for advancement, feeling that one is respected by the company, believing that the company listens and responds, and sensing that the company treats one fairly can all satisfy esteem needs on the job….There is much room for improvement in these areas.”

Michael R. Cooper, Brian S. Morgan, Patricia Mortenson Foley, and Leon B. Kaplan “Changing Employee Values: Deepening Discontent?” Harvard Business Review January–February 1979

“They’re accusing you of nepotism, sir.” MIKE LYNCH, MASEAR, ARTHUR SCOTT VEY RAY, SAM AND P.C.

90 harvard business review | hbr.org “Mr. Ashport has looked through his peephole, and he doesn’t want to see you.”

“Sure it’s career suicide, but you have to go home once in a while.”

“The men don’t feel that you’re receptive to their needs, sir.” october 2006 91 Companies in industries such as banking, software, and media make money by linking markets from different sides of their customer networks – audiences and advertisers, for example. The distinct character of these businesses demands a new approach to strategy. STRATEGIES FOR TWO-SIDED MARKETS by Thomas Eisenmann, Geoffrey Parker, and Marshall W. Van Alstyne

f you listed the blockbuster products and services that have redefined the global business landscape, you’d find that many of them tie together two distinct groups of users in a network. Case in point: What has been the most important innovation in financial ser- Ivices since World War II? Answer: almost certainly the credit card, which links consumers and merchants. News- papers, HMOs, and computer operating systems also serve what economists call two-sided markets or two-sided networks. Newspapers, for instance, join subscribers and advertisers; HMOs link patients to a web of health care

92 harvard business review | hbr.org DAVID WEISMAN Strategies for Two-Sided Markets providers, and vice versa; operating systems connect Fueled by the promise of increasing returns, competi- computer users and application developers. tion in two-sided network industries can be fierce. Plat- Products and services that bring together groups of form leaders can leverage their higher margins to invest users in two-sided networks are platforms. They provide more in R&D or lower their prices, driving out weaker ri- infrastructure and rules that facilitate the two groups’ vals. As a result, mature two-sided network industries are transactions and can take many guises. In some cases, plat- usually dominated by a handful of large platforms, as is forms rely on physical products, as with consumers’credit the case in the credit card industry. In extreme situations, cards and merchants’ authorization terminals. In other such as PC operating systems, a single company emerges cases, they are places providing services, like shopping as the winner, taking almost all of the market. malls or Web sites such as Monster and eBay. Platforms serving two-sided networks are not a new Two-sided networks can be found in many industries, phenomenon. Energy companies and automakers, for ex- sharing the space with traditional product and service of- ample, link drivers of gasoline-powered cars and refueling ferings. However, two-sided networks differ from other stations in a well-established network. However, thanks offerings in a fundamental way. In the traditional value largely to technology,platforms have become more preva- chain, value moves from left to right: To the left of the lent in recent years. New platforms have been created company is cost; to the right is revenue. In two-sided net- (Google, for example, links advertisers and Web searchers) works, cost and revenue are both to the left and the right, and traditional businesses have been reconceived as plat- because the platform has a distinct group of users on each forms (for instance, retail electricity markets are evolving

In traditional value chains, value moves from left to right: To the left of the company is cost; to the right is revenue. In two-sided networks, COST AND REVENUE ARE BOTH TO THE LEFT AND THE RIGHT.

side. The platform incurs costs in serving both groups and into platforms that match consumers with specific power can collect revenue from each, although one side is often producers, allowing them to express their preferences for subsidized, as we’ll see. cheaper coal or more costly renewable power). Yet for all The two groups are attracted to each other–a phenom- the potential they’ve spotted, platform providers have enon that economists call the network effect. With two- struggled to establish and sustain their two-sided net- sided network effects, the platform’s value to any given works. Their failures are rooted in a common mistake. In user largely depends on the number of users on the net- creating strategies for two-sided networks, managers have work’s other side. Value grows as the platform matches typically relied on assumptions and paradigms that apply demand from both sides. For example, video game devel- to products without network effects. As a result, they have opers will create games only for platforms that have a made many decisions that are wholly inappropriate for critical mass of players, because developers need a large the economics of their industries. enough customer base to recover their upfront program- In the following pages, we draw on recent theoretical ming costs. In turn, players favor platforms with a greater work1 to guide executives in negotiating the challenges of variety of games. two-sided networks. We begin by looking at the factors Because of network effects, successful platforms enjoy that senior managers must consider in designing their increasing returns to scale. Users will pay more for access platforms’ business models. The key decision here is pric- to a bigger network, so margins improve as user bases grow. ing. As we’ve noted, providers of platforms for two-sided This sets network platforms apart from most traditional networks are able to draw revenue from both sides. In manufacturing and service businesses. In traditional busi- most cases, though, it makes sense to subsidize certain nesses, growth beyond some point usually leads to dimin- users. The crucial strategy question is, Which side should ishing returns: Acquiring new customers becomes harder you subsidize, and for how long? as fewer people, not more, find the firm’s value proposi- The next step is to figure out how to manage winner- tion appealing. take-all dynamics. Many two-sided network industries are

Thomas Eisenmann ([email protected]) is an associate professor at Harvard Business School in Boston. Geoffrey Parker ([email protected]) is an associate professor at Tulane University’s A. B. Freeman School of Business in New Orleans. Marshall W. Van Alstyne ([email protected]) is an associate professor at Boston University’s School of Management and a visit- ing scholar at MIT’s Center for eBusiness in Cambridge, Massachusetts.

94 harvard business review | hbr.org Strategies for Two-Sided Markets served almost entirely by a single platform. In some cases, Challenge: just one company controls that platform, as with eBay’s auctions or Microsoft’s Windows. In other cases, multiple 1 Pricing the Platform companies share the dominant platform, as with DVD In competitive industries, prices are largely determined and fax standards or, in real estate, a regional multiple list- by the marginal cost of producing an extra unit, and mar- ing service. (See the exhibit “Examples of Two-Sided Net- gins tend to be thin. In industries with high barriers to works.”) When a network industry is likely to be served by entry, the price ceiling is set by customers’ willingness a single platform, aspiring providers must make a “bet the to pay, and margins are more likely to be fat. company” decision. Should they fight to gain proprietary For two-sided networks, pricing is a more complicated control over the platform or share the spoils with rivals? affair. Platform providers have to choose a price for each Platform providers that have vanquished their imme- side, factoring in the impact on the other side’s growth diate rivals can’t rest on their laurels. Indeed, they face a and willingness to pay.Typically,two-sided networks have significant competitive threat from large companies oper- a “subsidy side,” that is, a group of users who, when at- ating in adjacent markets that have the ability to offer tracted in volume, are highly valued by the “money side,” a multiplatform bundle. In our final section, we explore the other user group. Because the number of subsidy- this challenge and offer prescriptions for firms that face it. side users is crucial to developing strong network ef- As we’ll see, moving first and getting big quickly aren’t fects, the platform provider sets prices for that side below necessarily the right answers. the level it would charge if it viewed the subsidy side as

EXAMPLES OF TWO-SIDED NETWORKS

Insights about the economics of two-sided networks apply Networks served by shared platforms tend to lack a subsidy to a variety of industries. In cases where platforms–the products side. It is hard for platform providers to recover subsidies if and sevices that bring together groups of users–are proprietary, rivals share the fees collected from the network’s money side. there invariably is a clear subsidy side and a clear money side. Real estate brokers avoid this free-rider problem by splitting For example, doctors–in exchange for access to a higher volume the seller’s fee 50/50. Subsidies also disappear when a shared of patients – agree to rates below those they could command if platform’s providers do not have pricing power on both sides of they were not affiliated with an HMO. the network, as in the case of gasoline-powered transportation.

NETWORKED MARKET SIDE 1 SIDE 2 PLATFORM PROVIDERS Rival Providers of Proprietary Platforms

PC operating systems Consumers Application developers* Windows, Macintosh Online recruitment Job seekers* Employers Monster, CareerBuilder Miami Yellow Pages Consumers* Advertisers BellSouth, Verizon Web search Searchers* Advertisers Google, Yahoo HMOs Patients* Doctors Kaiser, WellPoint Video games Players* Developers PlayStation, Xbox Minneapolis shopping malls Shoppers* Retailers Mall of America, Southdale Center Rival Providers of Shared Platforms

Linux application servers Enterprises Application developers IBM, Hewlett-Packard, Dell Wi-Fi equipment Laptop users Access points Linksys, Cisco, Dell DVD Consumers Studios Sony, Toshiba, Samsung Phoenix Realtors Association Home buyers* Home sellers 100+ real estate brokerage firms Gasoline-powered engines Auto owners Fueling stations GM, Toyota, Exxon, Shell Universal Product Code Product suppliers Retailers NCR, Symbol Technologies

*Denotes network’s subsidy side october 2006 95 Strategies for Two-Sided Markets

For two-sided networks, pricing is a complicated affair. Platform providers have to choose a price for each side, factoring in the impact on THE OTHER SIDE’S GROWTH AND WILLINGNESS TO PAY.

an independent market. Conversely, the money side pays User sensitivity to price. Generally, it makes sense to more than it would if it were viewed as an independent subsidize the network’s more price-sensitive side and market. The goal is to generate “cross-side” network ef- to charge the side that increases its demand more strongly fects: If the platform provider can attract enough subsidy- in response to the other side’s growth. Adobe’s Acrobat side users, money-side users will pay handsomely to reach software follows this pricing rule. Acrobat presents any them. Cross-side network effects also work in the reverse electronic document in Portable Document Format (PDF), direction. The presence of money-side users makes the a universal standard that can be printed or viewed exactly platform more attractive to subsidy-side users, so they as it appeared in its original application. The PDF net- will sign up in greater numbers. The challenge for the work consists of two sets of users–writers, who create doc- platform provider with pricing power on both sides is to uments, and readers, who view them–using different soft- determine the degree to which one group should be en- ware. Readers are very price sensitive; they pay nothing couraged to swell through subsidization and how much for their software. If readers were charged even a small of a premium the other side will pay for the privilege of amount, Adobe Reader’s 500-million-person user base gaining access to it. would be much smaller. Writers, who greatly value this Pricing is further complicated by “same-side” network huge audience, pay a fee for their software. If Adobe re- effects, which are created when drawing users to one side versed its approach, charging readers and subsidizing helps attract even more users to that side. For example, as more people buy PlayStation consoles, new users will find it easier to trade games with friends or find partners for online play. Economists call this snowballing pattern THE DYNAMICS OF TWO-SIDED a positive same-side network effect. (Same-side network effects can also be negative. For a more detailed explana- NETWORKS tion of how network effects attract or deter users, see the Transactions in two-sided networks always entail a trian- sidebar,“The Dynamics of Two-Sided Networks.”) gular set of relationships. Two user groups – the net- It is not always obvious which side–if either–the plat- work’s “sides”– interact with each other through one or form should subsidize and which it should charge. During more intermediaries called platform providers. A platform the dot-com boom, for example, nascent B2B exchanges embodies an architecture–a design for products, services, agonized over whether to charge fees to buyers, sellers, or and infrastructure facilitating network users’ interac- both, and how charges should be split between fixed tions–plus a set of rules; that is, the protocols, rights, and subscription payments and variable transaction fees. (See pricing terms that govern transactions. These platforms the sidebar “Similar Networks, Different Pricing” for an exhibit two types of network effects, which may be ei- illustration of how two seemingly similar networks may ther positive or negative: A same-side effect, in which in- require very different pricing strategies.) creasing the number of users on one side of the network To make the right decisions about pricing, executives of makes it either more or less valuable to users on the platform providers need to look closely at the following same side; and a cross-side effect, in which increasing factors: the number of users on one side of the network makes it Ability to capture cross-side network effects. Your either more or less valuable to the users on the other giveaway will be wasted if your network’s subsidy side can side. Cross-side network effects are typically positive, but transact with a rival platform provider’s money side. they can be negative (TV viewers preferring fewer ads). That’s what happened to Netscape, which subsidized its Same-side network effects are often negative (sellers browser to individuals in the hope of selling Web servers preferring fewer rivals in a B2B exchange), but they may to companies operating Web sites. However, Web site op- be positive (Microsoft Xbox owners valuing the fact that erators didn’t have to buy Netscape’s server in order to they can play games with friends). send pages to Netscape’s big base of users; they could buy a rival’s Web server instead.

96 harvard business review | hbr.org Strategies for Two-Sided Markets writers, its network would collapse. Writers are less price sensitive,so free software would not dramatically boost their numbers. More to the point, readers would not pay much for access to a bigger base of writers. User sensitivity to quality. High sensitivity to quality also marks the side you should subsidize. This pric- ing prescription can be counterin- tuitive: Rather than charge the side that strongly demands quality, you charge the side that must supply quality.Such a strategy is evident in video games. To deliver compelling quality, game developers incur enormous fixed costs. To amortize these costs, they must be assured that the platform has many users. Hence the need for a consumer sub- sidy. Platform providers make sure game developers meet high quality standards by imposing strict licens- ing terms and charging a high roy- alty.This “tax”is not passed through to consumers: Developers charge the highest prices the market will bear, regardless of the royalty rate. However, the royalty helps weed out games of marginal quality. Once the “tax” is added, titles with poor sales prospects cannot gener- ate enough contribution margin to cover their fixed costs, so they never get made in the first place. Output costs. Pricing decisions are more straightfor- the user base on either side, because it encourages growth ward when each new subsidy-side user costs the plat- on the other side. In addition to positive cross-side net- form provider essentially nothing. This will be the case work effects, however, platform managers must assess the when the giveaway takes the form of a digital good such possibility of negative same-side network effects, which as a software program or a cheap service such as other- can be quite strong. In most markets, sellers would be wise-idle computer time. However, when a giveaway happy to see fewer direct rivals; the same can be true for product has appreciable unit costs, as with tangible goods, buyers when goods are scarce. For example, many auto platform providers must be more careful. If a strong will- parts manufacturers, concerned about downward pricing ingness to pay does not materialize on the money side, pressure, refused to participate in Covisint, a B2B ex- a giveaway strategy with high variable costs can quickly change organized by auto manufacturers. Covisint stalled, rack up large losses. FreePC learned this lesson in 1999 as did many other B2B market makers that failed to re- when it provided computers and Internet access at no cruit enough sellers. In the face of strongly negative same- cost to consumers who agreed to view Internet-delivered side network effects, platform providers should consider ads that could not be minimized or hidden. Unfortu- granting exclusive rights to a single user in each transac- nately,few marketers were eager to target consumers who tion category – and extracting high rent for this conces- were so cost conscious. FreePC abandoned its offer after sion. The platform manager then must make sure that incurring $80 million in losses. sellers do not abuse their monopoly positions; otherwise, Same-side network effects. Surprisingly, sometimes it buyers will avoid the network. Online car-buying services makes sense to deliberately exclude some users from the like Autobytel, which forwards consumers’ queries to network. Platform providers normally welcome growth in a single dealer in any given geographic territory, have october 2006 97 Strategies for Two-Sided Markets succeeded with this strategy.Autobytel has earned a mod- Microsoft learned this when Electronic Arts (EA) – the est profit over the past three years; more to the point, it largest developer of video games and thus a major poten- survived the dot-com crash that extinguished many Inter- tial money-side user of Microsoft’s Xbox platform – re- net market makers with flawed strategies. fused to create online, multiplayer versions of its games Users’brand value. All users of two-sided networks are for the Xbox Live service. EA objected to Microsoft’s re- not created equal. The participation of “marquee users” fusal to share subscription fees from Xbox Live, among can be especially important for attracting participants to other issues. After an 18-month stalemate, EA finally the other side of the network. Marquee users may be ex- agreed to offer Xbox Live games. Terms of the agreement ceptionally big buyers, like the U.S. government. Or they were not made public, but at the time, Microsoft an- may be high profile suppliers, like anchor stores in malls. nounced that it would halt the in-house development A platform provider can accelerate its growth if it can se- of new games that would compete with EA’s flagship cure the exclusive participation of marquee users in the sports titles. form of a commitment from them not to join rival plat- Failing to recognize that two-sided network pricing forms. For many years, this kind of exclusive arrangement follows different rules than conventional businesses can was at the core of Visa’s marketing campaigns (“…and sink even the most attractive platforms. Apple provides they don’t take American Express”). Of course, it can be a cautionary tale about misapplied pricing logic. Apple’s expensive – especially for small platforms – to convince well-regarded Macintosh operating system has always marquee users to forfeit opportunities in other networks. commanded a price premium from consumers. When it When the participation of a few large users is crucial for launched the Mac, Apple also tried to extract rent from mobilizing a network, conflict over the division of value the other side of its network, charging third-party devel- between platform providers and large users is common. opers $10,000 for the software development kits (SDKs)

SIMILAR NETWORKS, DIFFERENT PRICING On first inspection, PC and video game networks look simi- and quality conscious than typical PC users. On average, lar. In both cases, end users on one side wishing to link to each console owner buys just eight games, which cost about software or games on the other side buy a platform consist- $50 apiece. Over the two- to three-year life of a console, these ing of an operating system (OS) bundled with hardware – precious titles are consumed sequentially in intense bursts; a PC or a game console. The two businesses exhibit similarly gamers spend a great deal of time – 40 to 100 hours – with positive cross-side network effects: End users favor platforms each title. that offer a wide variety of complements. Developers favor To deliver compelling quality,game developers incur enor- platforms with more end users because this improves the mous fixed costs. To amortize these costs, they must be as- odds that they will recover the fixed, upfront costs of creating sured that the console has many users: Hence the need for complements. a consumer subsidy. Console providers police quality by im- Notwithstanding these similarities, the PC and game in- posing strict licensing terms and charging a high royalty.This dustries use very different pricing models. In video games, “tax,”absorbed by the developers, helps weed out games of end users are subsidized. Platform providers like Sony marginal quality.Developers cannot afford to offer titles with PlayStation and Microsoft Xbox historically have priced weak sales prospects, once the tax is added to their price. consoles at or below cost. Game developers are on the net- By contrast, PCs are often purchased for work and are work’s money side; they pay a royalty to console manufactur- otherwise more likely viewed as household necessities than ers of as much as 20% of a game’s retail price. In the PC in- game consoles are, so price sensitivity is lower. Over their dustry, the money side and subsidy side are reversed. End lives, PCs accumulate scores of applications, ranging from users are the money side, paying well above cost for the the indispensable (such as word processing) to the disposable platform’s essential element–its OS–which comes bundled (for example, some casual games). Accordingly, we observe with PCs offered by OEMs like Gateway.Application develop- a huge range of price and quality levels for applications. ers are the subsidy side. They pay no royalties and receive It’s true that both PC users and gamers value variety and free software development kits from the OS vendors. quality and that developers in both networks value the abil- Why do these similar two-sided networks have fundamen- ity to reach a large installed base. However,gamers’need for tally different pricing structures? Video game consoles quality seems to be stronger, as does game developers’ need users–typically teenagers–are both far more price sensitive for large numbers of consumers.

98 harvard business review | hbr.org Strategies for Two-Sided Markets required to create Macintosh applications. By contrast, needs and carve out niches in a larger rival’s shadow. Microsoft gave Windows SDKs away for free. Tellingly, American Express, for example, earns high margins de- by the time of Microsoft’s antitrust trial, Windows had spite having issued only 5% as many credit cards as Visa. six times as many applications as Macintosh. This made American Express cards have no preset spending limit – Windows far more attractive to consumers, despite its a valuable feature for business travelers, made possible functional shortcomings. because cardholders must pay their full balance every month. Visa cannot match this feature, because the loans Challenge: it extends to cardholders put an upper limit on their spending. In cases where special features are not impor- 2 Winner-Take-All Dynamics tant, however, users will tend to converge on a single The prospect of increasing returns to scale in network platform. industries can lead to winner-take-all battles, so an as- The DVD industry meets these three conditions. First, piring platform provider must consider whether to multi-homing costs are high for consumers because it share its platform with rivals or fight to the death. Com- would be expensive to buy multiple players. Likewise, panies sometimes get this decision wrong, as with multi-homing costs are high for studios: Having to pro- Sony’s futile battle to establish its Betamax videocas- vide the same content in multiple incompatible formats sette standard. would increase inventories and distribution costs. Second, Coping with platform competition is a two-step cross-side network effects are strong for both sides of process. First, executives must determine whether their the network. Most consumers value access to a wide vari- networked market is destined to be served by a single ety of titles, and studios realize scale economies when platform. When this is the case, the second step–deciding they can sell to more consumers. Third, opportunities whether to fight or share the platform – is a bet-the- for technical differentiation are modest, because DVD company decision. The stakes are much higher when a players connect to TV sets, which are standardized in networked market has room for fewer rival platforms. ways that intrinsically limit DVD picture and sound Turning to the first step, a networked market is likely quality. to be served by a single platform when the following For these reasons, the DVD market was bound to be three conditions apply: served by a single platform. Potential platform provid- • Multi-homing costs are high for at least one user ers anticipated this outcome and faced a choice: They side. “Homing” costs comprise all the expenses network could fight for proprietary control of the platform or users incur – including adoption, operation, and the op- pool their technologies. Industry participants chose the portunity cost of time–in order to establish and maintain latter approach, jointly creating the DVD format in 1995 platform affiliation. When users make a “home”on multi- and avoiding a replay of the VHS-Betamax standards ple platforms, they increase their outlays accordingly. battle. For example, the vast majority of PC users rely on a sin- Why share a network when proprietary control prom- gle operating system – almost always Windows – because ises monopoly profits once rivals are vanquished? The an- using multiple operating systems is expensive in terms of swer seems clear enough if senior managers believe that the additional hardware, software, and training required. their company’s platform is not likely to prevail. How- Similarly, distance limits the number of shopping malls ever, even those firms that have a fighting chance of that consumers can visit at any one time, which in turn gaining proprietary control stand to realize benefits limits the number of malls. When multi-homing costs are from sharing. First, the total market size will be greater high, users need a good reason to affiliate with multiple with a shared platform. During a battle for dominance in platforms. a two-sided network, some users will delay adoption, • Network effects are positive and strong–at least for fearing that they will be stranded with obsolete invest- the users on the side of the network with high multi- ments – like a Betamax VCR – if they back the loser. Sec- homing costs. When cross-side network effects are posi- ond, since the stakes are so high in battles for network tive and strong, those network users will tend to converge dominance, firms spend enormous amounts on upfront on one platform. A small-scale platform will be of little in- marketing. Rivalry tends to be less intense with a shared terest to users unless it is the only way to reach certain platform, reducing marketing outlays. users on the other side. The odds of a single platform pre- Winning the battle. To fight successfully, you will vailing also increase when same-side network effects are need, at a minimum, cost or differentiation advantages. positive: for example, when users of a software program Three other assets are important in establishing propri- need to share files with one another. etary control: First, platform providers gain an edge when • Neither side’s users have a strong preference for they have preexisting relationships with prospective special features. If certain users have unique needs, then users – often in related businesses. Adobe, for example, smaller, differentiated platforms can focus on those leveraged its user base for PostScript printing products october 2006 99 Strategies for Two-Sided Markets when launching PDF.Second, high expectations generate Networked markets–especially those in which technol- momentum in platform wars, so a reputation for past ogy is evolving rapidly–are rich with envelopment oppor- prowess helps a great deal. Having vanquished rival PC tunities that can blur market boundaries. This blurring operating systems, Microsoft is feared and respected as is called “convergence.”For example, mobile phones now a ruthless and competent rival. Third, in a war of attrition, incorporate the functionality of music and video players, deep pockets matter. Again, just ask Microsoft! PCs, and even credit cards. Likewise, eBay – having ac- First-mover advantages can also be significant in plat- quired PayPal and the voice-over-Internet protocol (VoIP) form battles, but they are not always decisive. In fact, start-up Skype, as well as equity in Craigslist – is on a col- when the market evolves slowly, late mover advantages lision course with Google, which also offers a payment may be more salient. Late movers may, for example, avoid service (Google Checkout), VoIP (Google Talk),and a list- the pioneer’s positioning errors, be better placed to incor- ing service (Google Base). porate the latest technology into product designs, or be In many cases, a stand-alone business facing envelop- able to reverse engineer pioneers’products and beat them ment has little choice but to sell out to the attacker or on cost. Google, which lagged Web-search pioneers by exit the field. Some, however, manage to survive. Real- several years, avoided portals’ clutter in favor of a simple, Networks, the pioneer of streaming media software, is – fast-loading home page. It also copied and then improved at least so far–a case in point. on Overture’s paid-listing model for generating revenue Real’s original business model was ideally suited to from searches. the needs of its two-sided network: Consumers down- In a battle for platform control, first and late movers loaded its streaming media player for free, and content alike will feel strong pressure to amass users as quickly companies paid for its server software. As a result, the as possible. In most cases, this urgency is appropriate. company quickly dominated the new market and earned Positive word-of-mouth favors the early mover. But racing modest profits in 1999 and 2000. But as early as 1998, to acquire users can be a mistake under two circum- Real’s streaming media franchise was under attack from stances. First, executives must ask whether their business Microsoft. Like Real, Microsoft freely supplied its Win- is readily scalable. For example, platforms that must sup- dows Media Player (WMP) to consumers. But Microsoft port complex customer-service interactions–like stop-loss also bundled its streaming software at no additional cost orders or margin trades at an online brokerage firm – as a standard feature of its NT Server–a multipurpose op- typically require skilled professionals. The need to recruit erating system that also incorporated file, print, e-mail, and train such personnel can put the brakes on rapid and Web servers, among other functions. growth. Second, due to their explosive growth potential, Since content companies – Real’s money side – needed platform-mediated networks are prone to boom or bust a multipurpose server anyway, they could buy NT and valuation cycles. When they launch cash-draining “get big receive a “free” streaming media server. As content com- fast” strategies, therefore, top managers need to be sure panies embraced this attractive proposition, consumers that funding will be forthcoming should capital-market switched with them, because Microsoft’s streaming media sentiment turn negative. servers worked only with its own media players, and vice versa. By 2003, 42% of Internet users in North America Challenge: identified WMP as their primary media player, compared % 3 The Threat of Envelopment with 19 for Real’s player. Microsoft has not been the only threat. Real’s Rhap- You can do a great job addressing pricing and winner- sody subscription music service is now threatened with take-all challenges and establish a successful new plat- envelopment by Yahoo and ultimately by Apple. In 2005, form yet still face great danger. Why? Your platform may Yahoo introduced a subscription music service–including be “enveloped” by an adjacent platform provider that downloads to portable music players – for $5 per month. enters your market. Platforms frequently have overlap- Yahoo could afford to price aggressively, because ping user bases. Leveraging these shared relationships can bundling subscription music into its portal would in- make it easy and attractive for one platform provider to crease user retention rates and, through cross-marketing, swallow the network of another. The real damage comes boost revenue from its other services. Likewise, Apple when your new rival offers your platform’s functionality might choose to offer a subscription version of iTunes, as part of a multiplatform bundle. Such bundling hurts drawing on the very lucrative iPod – its money side – to the stand-alone platform provider when its money side subsidize an envelopment attack. Real cannot match it perceives that a rival’s bundle delivers more functionality rivals’ bundles because it does not own a portal or sell an at a lower total price. The stand-alone platform provider MP3 player. cannot respond to this value proposition because it can- But Real is not without options. Its defense against not afford to cut the price on its money side and it cannot Microsoft and, more recently, Yahoo and Apple shows assemble a comparable bundle. what a focused firm can do to survive envelopment.

100 harvard business review | hbr.org Strategies for Two-Sided Markets

During the dot-com boom, nascent B2B exchanges agonized over whether to CHARGE FEES TO BUYERS, SELLERS, OR BOTH.

Change business models. Real’s response to Micro- 2005 received a $760 million payment from Microsoft soft’s envelopment attack was to switch its money side. to end the lawsuit. Sun Microsystems and Time Warner– Ceding the streaming media business, Real leveraged ex- Netscape’s current owner – reaped similar bounties after isting relationships with consumers and music companies they challenged Microsoft’s anticompetitive behavior to launch Rhapsody in 2003, charging $10 per month for in court. unlimited streaming to any PC from a library of a half- The threat of envelopment means that vigilance is million songs. Real now profited from consumers, rather crucial for a focused platform provider. Formulating than subsidizing them. Another common way for special- strategy for platform-mediated networks is like playing ists like Real to reinvigorate their business models is to three-dimensional chess: When market boundaries blur, offer services as a systems integrator–helping enterprises envelopment attacks can come from any direction. How- knit together diverse systems and technologies. Indeed, ever, focused firms are not without advantages when Real was doing precisely that for a number of big music competing with large, diversified companies. Big firms can companies even before it launched Rhapsody. And it’s no be slow to recognize envelopment opportunities and accident that IBM–the dominant provider of computing even slower to mobilize resources to exploit them. Also, platforms through the mid-1980s – has more recently fo- envelopment requires cross-business-unit cooperation, a cused on systems integration. Facilitating transactions significant barrier in many diversified companies. Sony, across a two-sided network requires platform providers to for example, has struggled to coordinate strategy across its coordinate users’ activities. Hence, managing a platform consumer electronics, video game, movie, and music busi- builds system integration skills that can be exploited. nesses. Once the industry’s trailblazer with products like Find a “bigger brother.” When bullied on the play- the Walkman, Sony has seen Apple usurp this role. Mis- ground, a little guy needs a big friend. Real has found al- takes like this on the part of established companies are lies through partnerships with cable TV system operators precisely why former upstarts like Google, eBay, and and cellular phone companies. Subscription music – Yahoo have grown into giants. which requires a broadband connection – makes cable • • • modem service stickier: Once consumers commit to a Despite the ubiquity of network industries and the attrac- music service, they face switching costs. Changing ven- tions of owning a successful platform, the strategic impli- dors would force them to configure new music players cations of two-sided networks have gone largely unex- and recreate playlists. Real also bundles its Rhapsody plored. In the past, this lack of understanding was less Internet radio product with Sprint’s wireless phone ser- problematic because executives usually had the luxury of vice and streaming video with Cingular’s service. Cellular formulating strategies for two-sided networks through phone companies are attractive allies for Real, because trial and error. Markets today are less forgiving. Many op- they can mount their own envelopment attacks if Apple portunities for platform creation arise in high-tech sectors ever enters the subscription music market. Cellular carri- with short product life cycles. Opportunities also abound ers can afford to subsidize digital music playback on their in traditional industries reconceived as two-sided net- phones, since doing so would be likely to reduce cell works. And, thanks to the Internet, firms have easy access phone churn rates. That would present a big threat to to both sides of new markets. In this environment, if you Apple’s money side. draw attention to a platform opportunity and don’t get it Sue. Firms facing envelopment are wise to consider right the first time, someone else will. Thinking carefully legal remedies, because antitrust law for two-sided net- through the strategic issues we’ve outlined here will give works is still in dispute. Antitrust law was conceived to you a head start. constrain the behavior of traditional manufacturing firms and does not fully reflect the economic imperatives 1. See Geoffrey Parker and Marshall W. Van Alstyne,“Two-Sided Networks: A Theory of Information Product Design,”Management Science (2005) and Jean- of platform-mediated networks. For this reason, domi- Charles Rochet and Jean Tirole, “Platform Competition in Two-Sided Mar- nant platform providers that offer bundles or pursue kets,” Journal of the European Economic Association (2003). penetration pricing run the risk of being charged with illegal tying or predation. Exploiting this opportunity, Reprint R0610F; HBR OnPoint 1463 Real brought Microsoft to antitrust court and then in To order, see page 151. october 2006 101 When established companies try to spawn new businesses, cultural conflict usually dooms the effort. They can succeed by finding the right balance in setting strategy, operating the business, and designing the organization.

MEETING THE CHALLENGE OF CORPORATE Entrepreneurship by David A. Garvin and Lynne C. Levesque

or large companies, creating new businesses is Corporate entrepreneurship is, however, a risky propo- the challenge of the day. After years of downsizing sition. New ventures set up by existing companies face in- F and cost cutting, corporations have realized that numerable barriers, and research shows that most of they can’t shrink their way to success. They’ve also found them fail. Emerging businesses seldom mesh smoothly that they can’t grow rapidly by tweaking existing offer- with well-established systems, processes, and cultures. Yet ings, taking over rivals, or moving into developing coun- success requires a blend of old and new organizational tries. Because of maturing technologies and aging prod- traits, a subtle mix of characteristics achieved through uct portfolios, a new imperative is clear: Companies must what we call balancing acts. Unless companies keep those create, develop, and sustain innovative new businesses. opposing forces in equilibrium, emerging businesses will They must become Janus-like, looking in two directions at flounder. once, with one face focused on the old and the other seek- In this article, we first describe the management issues

ing out the new. facing companies that pursue new-business creation, as GREGORY NEMEC

102 harvard business review | hbr.org

Meeting the Challenge of Corporate Entrepreneurship well as the usual problematic responses. We then explore early-stage financial numbers SWAGs, short for “scientific a number of the most critical balancing acts companies wild-assed guesses.” must perform, the choices they entail, and the risks corpo- Second, new businesses require innovation, innovation rations face when they fail to get the balance right. We requires fresh ideas, and fresh ideas require mavericks. conclude with a look at the hybrid systems that are often We’ve heard too many stories of leaders trapped by con- needed to support these balancing acts, focusing in partic- ventional thinking: Microsoft’s wariness of open-source ular on IBM’s Emerging Business Opportunity manage- software, Polaroid’s grudging move into digital cameras, ment system because of its success in mastering several of GM’s and Ford’s reluctance to embrace hybrid cars, media them simultaneously. companies’ distaste for blogs, and so on. Some degree of unconventional thinking is essential for new businesses to take hold,but many radical ideas are foolish or un- The Two-Cultures Problem founded. Most mavericks, sadly, can’t tell the difference It’s no secret that corporations are designed to ensure the between good and bad ideas. They persist in defending success of their established businesses. Existing opera- pet themes, demand repeated hearings, and refuse to take tions, after all, account for the bulk of their revenues. no for an answer. The dilemma, says Home Depot CEO Finely tuned organizational systems support current cus- Robert Nardelli, is that “there’s only a fine line between tomers and technologies. The operating environments entrepreneurship and insubordination.” are predictable, and executives’ goals are stability, effi- The third challenge is the poor fit between new busi- ciency, and making the most of incremental growth. nesses and old systems. That’s particularly true of systems New businesses are quite different, with cultures all for budgeting and for human resource management. Cor- their own. Many are born on the periphery of companies’ porate budgeting systems favor established businesses

The dilemma, says Home Depot CEO Robert Nardelli, is that “there’s only a fine line between entrepreneurship and insubordination.”

established divisions; at times, they exist in the spaces in because incremental dollars usually provide higher finan- between. Their financial and operating models are sel- cial returns when invested in known markets rather than dom the same as those of existing businesses. In fact, most unknown ones. New businesses are therefore difficult to new business models aren’t fully defined in the begin- finance for long periods, and in times of austerity,they are ning; they become clearer as executives try new strategies, the first to face funding cuts. In a similar spirit, companies develop new applications, and pursue new customers. Be- design HR systems to develop executives whose opera- cause of the high levels of uncertainty associated with tional skills match the needs of mature businesses – not new ventures, they need adaptive organizational environ- the strategic, conceptual, and entrepreneurial skills that ments to succeed. start-ups require. In both cases, the answer isn’t to pro- The distinctive features of new businesses present ceed haphazardly but, as we shall explain later in this ar- three challenges. First, emerging businesses usually lack ticle, to modify systems so they are less biased against hard data. That’s particularly true when they offer cutting- new businesses. edge products or when their technologies aren’t widely diffused in the marketplace. The difficulty,as one technol- ogy strategist told us, is that “it’s hard to find marketplace Why Traditional Responses Fail insights for markets that don’t exist.” Financial forecasts Faced with these challenges, corporations respond with are also undependable. Large errors are common, a fact one of two approaches. Some disperse the task of new- that led one printing and publishing company to call its business creation, assigning it to existing divisions, while others centralize it, lodging it in special-purpose divisions David A. Garvin ([email protected]), the C. Roland Chris- or venture groups. Both approaches have delivered mixed tensen Professor of Business Administration at Harvard results. Business School in Boston, has authored or coauthored 11 Diffused responsibility fizzles out. In an organization previous articles in Harvard Business Review. Lynne C. where every executive shares responsibility for new- Levesque ([email protected]) is a Boston-based consul- business creation, the CEO expects employees to be as tant and researcher. committed to turning new ideas into new businesses

104 harvard business review | hbr.org Meeting the Challenge of Corporate Entrepreneurship as they are to expanding mature ones. Some companies 1980s, these efforts took the form of internal corporate impose aggressive targets to motivate managers – at 3M, venture divisions, special-purpose groups that companies the poster child for this approach, 30% of sales must come charged with launching and nurturing the lion’s share of from products developed in the last four years–and they new businesses. In the 1990s, many businesses launched link the achievement of those targets to every employee’s corporate venture capital groups that mimicked the oper- compensation. ation of venture capitalists by providing new businesses The main drawback of this approach is that it’s easy for with arm’s-length funding, disciplined oversight, and ad- traditional businesses to dominate new ones. Veteran em- vice. Boeing, DuPont, and Exxon were among those that ployees often choose to ignore incentives and suppress established corporate venture divisions, while companies new ideas, especially those that render existing skills ob- like Intel, Lucent, and Xerox set up corporate venture cap- solete or require new ways of working. RR Donnelley, the ital groups. U.S. printing giant, failed in its first attempt to make dig- Both approaches focus on nurturing new businesses in ital printing popular, largely because of internal resis- their formative stages. However, the challenges come tance. Its sales managers were accustomed to selling long- later, when it’s necessary to integrate fledgling businesses term contracts to customers’purchasing managers on the with the mainstream. Because centralized new-venture basis of personal relationships and the price per page. groups magnify the clash between the old and the new They were uncomfortable selling solutions to senior man- cultures, suspicion and fractious relationships are com- agers, which the digital business demanded, and wouldn’t mon, as are power struggles between new-business man- share expertise with the digital-printing division or send agers and division leaders. Over time, integration be- orders its way. Since they were able to make their num- comes more problematic, and companies must either spin bers the old-fashioned way, no one could point a finger at off the new businesses or shut them down. The result, as them. As one Donnelley executive observed, resistance to Norman D. Fast wrote in The Rise and Fall of Corporate the new business often took the form of the “Donnelley New Venture Divisions, is that centralized groups typically nod”–an apparently supportive shaking of the head but, have “a long-term mission but a short-term life span.”In in truth, a signal of lack of commitment. fact, corporate venture groups in the United States last, on For related reasons, a new business that doesn’t fit with average, only between four and five years, according to the company’s existing product lines or markets fre- Paul Gompers and Josh Lerner in The Venture Capital Cycle. quently has trouble finding an organizational home. Few general managers are willing to assume responsibility for projects they privately view as diversions. In some cases– Balancing Acts as with Home Depot’s Floor Store, which the retailer Companies should avoid either-or approaches to corpo- launched in July 2000 to sell flooring and carpeting prod- rate entrepreneurship because they place the old and new ucts–the fledgling business is shunted from district man- cultures in conflict with each other. A new approach is ager to district manager and from division to division, called for, one that melds those cultures while avoiding which doesn’t allow it to establish a foothold. The new extreme behavior. Lean too much in one direction, and venture fails to attract influential sponsors and so won’t the process drifts out of equilibrium; get the balance receive sufficient resources or attention to survive. right, and corporate entrepreneurship will flourish. With In other cases, the pressure to create new businesses be- apologies to F.Scott Fitzgerald, the test of a first-rate com- comes so dominating that it overwhelms the organiza- pany may well be its ability to hold two opposing ideas at tion. A cowboy culture results; in its wake comes a loss of the same time and still function. financial and operating discipline. The classic example Corporations must perform balancing acts in three of this problem was Enron in the late 1990s, which re- areas: strategy, operations, and organization. warded executives for their ability to launch new trading Develop strategy by trial and error. New businesses businesses in the mold of its successful natural gas busi- operate in highly ambiguous environments. Ambiguity ness. The result: an outpouring of trading businesses – isn’t the same as uncertainty, as executives are realizing coal, water, pulp and paper, broadband, and (later) media (see, for instance, Nitin Nohria and Thomas A. Stewart, services, freight services, data storage, and semiconduc- “Risk, Uncertainty, and Doubt,”HBR February 2006). In tors–that made less and less strategic and financial sense. uncertain environments, the options are reasonably clear, Very few of Enron’s second- and third-generation busi- and the likelihood of different outcomes can be assessed. nesses became profitable, which paved the way for the In ambiguous environments, the full range of alternatives company’s downfall. and outcomes isn’t known, leading to many possible di- Centralization isolates. Concerned by their poor track rections and evolutionary paths. The high levels of ambi- records of new-business creation, many companies de- guity in new businesses imply that corporate entrepre- cided that the wisest course was to completely separate neurs won’t get it right the first time. Because hard new ventures from existing divisions. In the 1970s and numbers are difficult to come by and strategic options are october 2006 105 Meeting the Challenge of Corporate Entrepreneurship difficult to identify, past practices, too, offer little guid- fied when using its laundry and home care products and ance. Experimentation is essential. Managers must begin if those needs suggested any new business ideas. Within with hypotheses about what will work and what won’t; 48 hours, top management received more than 1,000 pro- then, they should search for ways of validating or invali- posals by e-mail. It then set up a ten-person “invent team,” dating their preconceptions, knowing that first-cut strate- which rated each idea on a ten-point scale based on assess- gies will change over time. ments of market size, whether Henkel had the necessary When taken to extremes, however, this approach can be technical knowledge in-house, whether the proposal fit counterproductive. Countless studies have shown that the brand, and whether a launch was feasible within a technologies in search of a market rarely succeed. In fact, year. Over one weekend, the team managed to shrink the many new businesses struggle for years because top man- list to just 50 high-potential ideas. agement, hoping that one more trial will lead to success, Learn from small samples, closely observed. In ambiguous is unwilling to close them down. environments, the deepest learning comes from interac- Overcoming these problems requires a balancing act tion with a small number of customers, not from surveys that combines open-minded opportunism (“Let’s try it of many potential users. The latter have great statistical and see how customers react; we’ll make changes based power but seldom provide the formative insights that ex- on what we hear and keep at it until we get it right”) with ecutives gain from ethnographic approaches. That’s the disciplined planning (“Let’s think systematically about tack that P&G has taken under CEO A.G. Lafley,who insists the market and the proposed technology, formulate a that managers stop worrying about focus groups and

Existing companies will enjoy an advantage in new-business creation only if they build on their strengths; otherwise, they will be no better off than start-ups that must begin with a clean slate.

hypothesis about customer needs, design experiments to spend time in consumers’ homes, watching them cook test our hypothesis, and repeat the process until we’re and clean, before launching new products. In 2000, the sure we’ve got the right product, technology,and business typical P&G marketer spent less than four hours a month model”). Here are five ways in which executives can cou- with consumers; by 2004, that number had tripled. Intuit, ple trial and error with rigor and discipline. which makes tax-preparation software, relies on a process Narrow the playing field. Unguided searching is an inef- it calls “Follow Me Home.”The company sends employ- ficient way of finding new ideas. Companies need some ees to watch customers carry out accounting and tax- criteria to narrow the range of potential choices and to preparation tasks in their homes and offices, which helps judge whether a technology or market presents a desir- uncover pain points that can lead to new opportunities. able opportunity. The goal isn’t to be definitive but to Starbucks periodically takes product development teams scope out certain areas of promise. Smart companies iden- on “inspiration” trips to meet customers on their home tify sectors that may be worth pursuing, first by applying turf. For example, in early 2006, one team visited many screens based on the attractiveness of markets and tech- Starbucks outlets and other restaurants in Paris, Lon- nologies, and later by combining them with executives’ don, and Düsseldorf, Germany, to get a better sense of best judgments about promising industry trends. GE local cultures, behaviors, and trends. Nokia used the same evaluates new business ideas with an eye toward increas- approach in China, India, and Nepal, to study how people ing the scope of its operations: All new businesses must with low incomes would use cellular telephones. Based on take the company into new territory – a new line of busi- the research, the company’s developers created an icon- ness, region or country, or customer base – and also have based menu – consisting of pictures rather than letters the potential to generate at least $100 million in incre- and numbers – that allows semiliterate villagers to use mental sales in three years’ time. cell phones. The most effective companies combine brainstorming, Use prototypes to test business models. Without some tan- usually at the divisional level, with corporate criteria for gible basis for discussion, most people find it difficult to reducing the list of ideas. In the early 2000s, Henkel, the evaluate new ideas. Prototypes are invaluable: They give German consumer and commercial products company, life to emerging products and provide a basis for in- asked employees what consumer needs they had identi- formed responses from potential users. They should be

106 harvard business review | hbr.org Meeting the Challenge of Corporate Entrepreneurship detailed enough for users to evaluate form, content, and desirability, and companies should couple them with forums for con- sumer debriefings, discussions, and reviews. Prototypes are particularly useful for testing assumptions about customer needs. UPS ex- perimented with a grocery delivery business partly to determine whether it could tie that in with residential delivery of other goods such as consumer electronics products. Be- cause the prototype locations showed that even loyal users ordered groceries only once every ten to 14 days–a frequency that didn’t justify a larger residential delivery infra- structure – UPS quickly dropped the idea. Track progress through nonfinancial mea- sures. Trial-and-error strategy formulation shouldn’t be entirely unguided–that would make it little more than guesswork. Con- crete goals are essential, but in ambiguous environments, goals must take the form of project-based milestones, such as “We will conduct five customer trials in these two in- dustries in the next three months.”At times, companies can assess new businesses’ prog- ress by using leading indicators such as pub- licity or incorporation of product specifica- tions into industry standards. The targets must be measurable: “We will receive three positive mentions in trade journals and three favorable comments from industry analysts in the next two months.” Suspend judgment, but not indefinitely. The biggest risk when companies develop strat- egies through trial and error is that the process will con- ation only if they build on their strengths; otherwise, they tinue for too long. Failures are common in new-business will be no better off than start-ups that must begin with creation, and corporations need to be clear on when–and a clean slate. Novelty for novelty’s sake is seldom a source how–they will decide to pull the plug. New venture teams of competitive advantage. At the same time, if new busi- and top management must agree about the standards nesses make operating choices only by drawing on their that will be applied to a project, the length of time it will parents’ strengths, reusability and efficiency become the be allowed to continue, and who decides whether to shut driving values, and time-tested but inappropriate people, it down. There are many criteria for making the call–time processes, and systems will be the result. How do execu- elapsed, dollars spent, pace of technological progress, cus- tives avoid these unhealthy extremes? tomer enthusiasm, confirmed orders, financial perfor- In most cases, the best combination of the old and the mance, competitors’ success, and so on – but most critical new entails a blend of experience and invention. Selling is senior managers’ willingness to make timely go or no- to preexisting customers, staffing with seasoned person- go decisions. Kodak’s corporate entrepreneurship pro- nel, drawing on established distribution channels, and gram failed in the 1990s largely because of senior manag- working with proven processes will improve the odds of ers’ unwillingness to close several poorly performing creating profitable and sustainable operations. Differenti- new ventures, such as a copier services business, a floppy ation, however, requires fresh thinking and innovative ap- disks business, and a bioscience and pharmaceuticals busi- proaches to operations. To get the best of both worlds, ness. That wasted resources and destroyed the program’s companies should do the following: credibility. Staff new ventures with “mature turks.” Companies often Operate with something old, something new. Existing put young, hard-charging mavericks in command of start- companies will enjoy an advantage in new-business cre- up ventures. Frequently, those executives are new to the october 2006 107 Meeting the Challenge of Corporate Entrepreneurship company or haven’t grown up in the business. Such peo- tomers and representatives of multimodal transportation ple, runs the argument, are less constrained by compa- services. In contrast, internal development was UPS’s ap- nies’ current ways of working. Unfortunately, they’re also proach to developing mission-critical, customer-facing less likely to know which corporate resources are avail- capabilities such as tracking and shipping systems, espe- able or have the credibility to draw upon them. A better cially when the skills touched many parts of the busi- strategy, common at GE and 3M, is to put “mature ness, involved legacy systems, and presented integration turks”– managers who are already successful at running challenges. larger businesses but are also known for their willingness Share responsibility for operating decisions. New busi- to challenge convention–in charge of new businesses. An nesses prefer complete control over their destinies. How- observer described one such executive as “a 60-year-old ever, it’s easy to lose perspective. Stanford’s Robert Bur- with beads and a ponytail–a maverick but a through-and- gelman, in Strategy Is Destiny, quotes the head of one of through Xerox person with the credibility to get new busi- Intel’s start-up businesses as saying: “We created a very en- nesses off the ground.” trepreneurial culture that prided itself on being different At times, top management must handpick leaders from from the rest of Intel. Some of this was justified. We have a list of high-potential executives; at other times, it can a different business model….However, when we really find candidates by looking at annual personnel evalua- looked at it, we found that we were being different for dif- tions and identifying managers with high scores on entre- ference’s sake.” preneurship, innovativeness, and risk taking. In 1999, When corporations force new and old businesses to when L.L. Bean launched Freeport Studio, a brand of share responsibility for critical choices, the former be- women’s clothing, it selected employees for the new busi- come more accepting of established practices and more ness from within the organization partly on the basis of successful at leveraging existing strengths. For many how they answered one question: “How did you feel when years, Expo Design Center operated independently of you took a risk?” parent Home Depot, although the two businesses sold re- Change veterans’ thinking. Employees will seldom em- lated products and could realize synergies in merchan- brace a new business unless companies presell them the dising and procurement. Their buyers were brought to- idea. Smart companies place division chiefs and group gether to improve efficiency when Robert Nardelli became heads on the oversight committees or boards of promis- CEO; they now sit on the same floor of an office building, ing start-up efforts. They expect familiarity to lead to un- at adjacent desks, and jointly make decisions on common derstanding, and understanding to breed acceptance. purchases. That has led to large savings from the 25% of Companies can also foster shared understanding by get- vendors that Home Depot and Expo Design share. ting executives to envisage the future through exercises Integrate with autonomy. A new business needs help such as scenario planning. For years, Bill Gates took from the parent company as it strives to develop an inde- Microsoft’s senior team on weeklong retreats, where dis- pendent identity.That assistance usually takes the form of cussion revolved around emerging technological trends protection, sponsorship, and other types of support from and competitive threats. To reinforce the message, compa- the corporation’s senior-most executives. Organization- nies may sometimes need to alter incentives and promo- ally, the company gives the new business a direct report- tion criteria, particularly when existing values are deeply ing line to a respected leader, who becomes responsible rooted in organizations. for providing oversight, allocating resources, offering Develop some capabilities, but acquire others. Leaders of strategic guidance, and ensuring that its managers aren’t new businesses often feel that they must build every capa- hog-tied by the parent’s rules. The leader treats the new bility from the ground up. Not all skills are best developed business as an exception, free from the usual controls, from scratch, though; some can be purchased. The make- performance standards, and review processes demanded or-buy decision hinges on the availability of skills in the of the company’s mature businesses. open market, the time needed for internal development, This approach works well – until it becomes necessary and the ease with which outside capabilities can be inte- to hand the new business, which has outgrown the grated into the organization. UPS preferred to make ac- leader’s ability to manage it as an exception, over to an ex- quisitions when it needed specialized skills, as it did in isting business group. That’s when resistance sets in and 2000 with its purchase of Livingston, a Canadian logistics battles break out. Some conflict is predictable–there may firm specializing in the unique documentation and tech- be a knee-jerk “not nurtured here”response from existing nology systems required for the delivery of health care businesses. Yet it does reflect some legitimate concerns. products, and its sister company Livingston Healthcare New businesses are rarely designed in ways that ensure a Services, in the United States. It also acquired companies comfortable transition to the established organization, when they had built relationships that would take UPS and the division managers who inherit them are not years to cultivate; that’s why,in 2004, UPS bought Menlo, schooled in the requirements for successful handoffs. a freight forwarder that had 20-year ties with both cus- Those managers have good reason to worry that the in-

108 harvard business review | hbr.org Meeting the Challenge of Corporate Entrepreneurship fant businesses will fail and that top management will to serve as models for the rest of the organization. How- hold them responsible. ever, by 2004, GM had reannexed Saturn, tightly linking Too much independence leads to a related problem: the business to its established factories, marketing pro- a lack of organizational learning. At times, new busi- grams, and labor contracts, partly because the company’s nesses develop strategic and operational innovations that, other divisions had no desire to be “Saturn-ized.” should they succeed, are expected to be passed on to other For these reasons, we find, integration works best parts of the company. That’s why these businesses need when it begins early in the life of a new business. Manag- considerable independence and protection in their youth. ers are more amenable to inheriting organizations that But if they are held too far apart from the mainstream or they have had a hand in shaping from infancy. The chal- are regarded as threats to the existing order, the new ideas lenge is to get the balance right between identity and in- they embody will never take hold in the company. GM tegration, and to make the shift at the proper time. Too launched Saturn in 1990 to be a “different kind of car much integration in the early days or a rushed handoff, company,”with innovative advertising, labor practices, op- and the new business will never differentiate itself. Too erational processes, and sales strategies that were meant much early independence or corporate dominance, and established divisions will resist the integration of the new business. Companies can achieve the proper balance if they follow a few simple principles. Assign corporate and operating sponsors. Cor- Entrepreneurial Equilibrium porate sponsors, who can be either line or staff executives, bring credibility and clout to new Corporations can grow new businesses by performing ventures, while operating sponsors, who are three kinds of balancing acts: drawn from particular businesses, divisions, or groups, contribute organizational savvy and Balance trial-and-error strategy formulation foster acceptance. Together, they are likely to with rigor and discipline. give the right mix of freedom and discipline > Narrow the range of choices before diving deep. to new businesses, and to balance identity with > Closely observe small groups of consumers to integration. In 2006, Staples launched ten pro- identify their needs. totype rural stores. Each store reported simul- > Use prototypes to test assumptions about products, taneously to the local district manager and to services, and business models. the company’s vice president for strategic mar- > Use nonfinancial milestones to measure progress. kets, who was responsible for the initiative. > Know when – and on what basis – to pull the plug Such dual sponsorship helps overcome the on infant businesses. problem of long and uncertain gestation pe- riods. Few employees will sign up for a new Balance operational experience with invention. business if they believe that resources will dis- > Appoint “mature turks” as leaders of emerging appear when it becomes an independent busi- businesses. ness or if they sense that senior leaders are dis- > Win veterans over by asking them to serve on new busi- playing on-again, off-again enthusiasm. With nesses’ oversight bodies. dual sponsorship, companies signal that the > Consider acquiring select capabilities instead of develop- new business is a long-term commitment and ing everything from scratch. that they have already given thought to its > Force old and new businesses to share operational transition to maturity. responsibilities. Establish criteria for handoffs. Unless there Balance new businesses’ identity with integration. are preestablished standards for handoffs from corporate oversight to divisional ownership, > Assign both corporate executives and managers from divisions as sponsors of new ventures. companies will make those shifts very slowly. Most new businesses prefer to stay under the > Stipulate criteria for handing new businesses over to existing businesses. protective corporate umbrella, where they > Mix formal oversight with informal support by creatively enjoy privileged treatment and special status, combining dotted- and solid-line reporting relationships. controls are frequently looser, and resources are easier to obtain. The criteria for handoffs can be quantitative (revenue or size thresh- olds, number of customers, market share tar- gets) or qualitative (clarity of strategy,stability october 2006 109 Meeting the Challenge of Corporate Entrepreneurship and experience of the leadership team, competitive supe- To overcome these obstacles, the task force recom- riority), but everyone in the company must know and mended that IBM’s senior executives devote more time agree to them in advance. and attention to developing emerging businesses; that the Employ hybrid organizational forms. Companies must company identify and support promising opportunities; also balance identity and integration by using innovative and that every business group and division develop its organizational structures. Such structures often consist own sets of new businesses. Most important, executives of creative combinations of dotted-line and solid-line re- recommended that IBM build a distinct Emerging Busi- porting relationships that mix formal authority with in- ness Opportunity (EBO) management system to comple- formal oversight. Councils and oversight committees are ment its existing systems.1 particularly useful. To support its shift from the commod- After several months, Gerstner remained concerned ity chemical business to specialty chemicals, Ashland about the extent of the organization’s acceptance of the Chemical created its Strategic Expansion Project Board, task force’s recommendations; the ability of IBM’s existing consisting of the CEO and all the group vice presidents. processes to catch problems as new businesses grew; and The board identified and funded projects that had signif- the possibility that division managers might game the icant commercial potential but cut across traditional system. As one senior executive recalled, that led Gerstner business boundaries. The composition of the board en- to observe at one of the team meetings devoted to the sured that representatives from multiple functions, busi- topic: “Somebody around this table has to shepherd these nesses, and staff and line groups sat down together, com- efforts forward, someone who knows the culture well bined perspectives, and worked out differences. Once enough to kick the system. It can’t be just some staff guy. projects became operational, they moved to the Commer- It has to be someone with really big shoes.” On July 24, cial Development Group, whose head reported directly to 2000, Gerstner announced that he was promoting John the CEO. Thompson, leader of the software group, to vice chairman and putting him in charge of the new-business effort. Thompson, a 34-year IBM veteran, had managed several How IBM Strikes a Balance product groups and had also led many cross-business One company that has applied these principles is IBM. initiatives, such as the pervasive-computing and life sci- The starting point was September 12, 1999, when then- ences programs. The appointment had an immediate im- CEO Lou Gerstner learned that division managers had pact. As one task force member put it: “When Gerstner killed a promising project that focused on the explosive made Thompson, the most respected group executive, growth in biotechnology and life sciences computing. He vice chairman, the program got huge credibility.We knew fired off a scathing memo to his senior team, demanding then that Gerstner was serious.” to know why IBM kept missing the emergence of new in- Thompson moved immediately on several fronts. Ini- dustries. Executives quickly formed a task force to gather tially, he told us, he saw his role as that of an evangelist, information by interviewing members of several strug- selling the company’s commitment to emerging busi- gling or unsuccessful start-ups within IBM, reviewing the nesses “by preaching the story and occasionally making academic literature on innovation and business creation, an example by putting someone in the doghouse.”At the and benchmarking IBM’s new-business development ef- same time, he consolidated responsibility, bringing in forts against those of Cisco, Intel, Microsoft, and other the corporate strategy and technology groups for staff large companies, as well as those of venture capitalists support. He insisted, as one of the conditions for taking and entrepreneurs. the job, that he control a pool of funds to support EBOs, The team concluded that IBM’s difficulties in starting and IBM set aside $100 million for the purpose. Most im- new businesses could be traced to six root causes: a man- portant, Thompson started creating the development, agement system that rewarded execution and short-term oversight, and review processes that would form the core results rather than strategic business building; a preoccu- of IBM’s Emerging Business Opportunity management pation with IBM’s current markets and existing offerings; system. In the process, Thompson and his successor, Bruce a business model that emphasized sustained profits and Harreld, artfully managed a series of balancing acts. improvement in earnings per share rather than actions to Leadership. Because many EBOs were in danger of fall- drive higher price-earnings ratios; a financial, data driven ing between the cracks of established businesses, success approach to gathering and using market insights that was hinged on their leaders’ability to navigate IBM’s complex inadequate for embryonic markets; an absence of pro- matrix organization to secure cooperation and support. cesses suitable for selecting, developing, funding, and The typical EBO leader had only four or five direct reports terminating new growth businesses; and a lack of entre- and otherwise relied on part-time assistance from other preneurial skills. In essence, the team discovered that parts of the company, so each had to find ways to manage IBM, like many other companies, suffered from the two- the activities of dozens or, occasionally, hundreds of IBM cultures problem that we described earlier. employees in different countries and business groups.

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ness’s marketplace, set of customers to be pursued, value proposition, existing and needed capabilities, and steps to be taken next. Unlike IBM’s traditional planning processes, the EBOs’ development process was exploratory, with frequent changes in direction. According to Thompson: “Some- times it would take a year to a year and a half to get to a strategy we were happy with. You just kept iterating and iterating and iterating.” To resolve strategy issues, IBM encour- aged EBO teams to engage with the market- place. In the earliest days of a new business, when product designs and industry stan- dards were still in flux, that often required selling a point of view to the outside world. Public relations and media communications were essential tasks, and EBO teams often worked directly with analysts, thought lead- ers, and technical columnists to gain posi- tive coverage in the press. Eventually, how- ever, mind share had to translate into market share. To that end, IBM expected teams to work with customers on in-market experiments, where they executed some el- ements of their business plans. The first step was to test the proposed product as a pilot or to persuade a few customers to allow IBM to incorporate the product or service into a new design (called a design-in). The EBO teams had to set targets that they Thompson therefore decided to choose EBO leaders for hoped to achieve through the experiments, partly to their experience and skill in working the system, as well as acknowledge to themselves that failure was a distinct for their entrepreneurial, business-building, and creative possibility. talents. As the results of the experiments came in, EBOs had to Not surprisingly, many experienced managers had revise their strategies and business designs. Much of that doubts about becoming EBO leaders. They perceived the work took place in monthly review meetings that in- move to be a step down; it was like, one of them said, cluded the EBO leader, the overseeing IBM business “being asked to join a minor-league team after being a group or division head, representatives from finance and player in the major leagues.”For this reason, and because research, and the EBOs’ czar (Thompson, then Harreld). the competencies they needed were difficult to find, At these meetings, Thompson and Harreld took care to IBM’s senior-most executives handpicked the first EBO establish ownership of the business development pro- leaders. The top brass was involved in the process, Thomp- cess: They set the agenda, asked the tough questions, and son pointed out, partly because “the line really didn’t even held these meetings in their own offices. The reviews want to give those people up.” were rigorous and lasted several hours; one participant EBO leaders reported to the relevant business group described them to us as “root canals.” They were funda- heads, who also assumed primary responsibility for their mentally different from IBM’s traditional business re- performance reviews. However, IBM’s mature turks also views, which focused on financial performance versus had a strong dotted-line relationship with Thompson and plan targets. EBO reviews were much more developmen- Harreld, who took over as IBM’s EBO czar after Thomp- tal; they were designed to refine business plans rather son retired in September 2002. than review the numbers. Strategy development. Thompson charged EBO lead- Many EBO teams needed help defining their strategic ers with arriving at “strategic clarity” – which, at IBM, intent; they found it difficult to set boundaries around means having a deep understanding of the new busi- what they wanted to accomplish. Assumptions about october 2006 111 Meeting the Challenge of Corporate Entrepreneurship market needs and the business’s ability to deliver were a color-coded scoring system. It rated each EBO in three often wildly optimistic. Many teams had trouble identify- areas: developing a clear strategy, defining an executable ing opportunities, sources of value, target customers, and model, and winning in the marketplace. Red identified the bases of sustainable competitive advantage. They concerns or problems, yellow signaled limited progress had little experience with poorly defined marketplaces and unresolved issues, and green indicated sustained suc- and had to learn the rudiments of strategic analysis. Be- cess. The strategy team summarized the results of these cause collaborative brainstorming and joint problem solv- assessments in monthly and quarterly reports to senior ing were the primary goals of these meetings, the process management. These ratings also helped executives deter- was contentious by design. A crisp presentation didn’t mine when the new businesses were ready to be trans- matter. In fact, Harreld pointed out, most EBO leaders ferred out of the EBO management system. had to learn a new set of behaviors.“They were trained to The true measure of any system is its results. Of the answer every question and to have everything under con- 25 business bets that IBM has made in the past five trol. I told them,‘Put it aside. The worse you look, the bet- years, three have failed, and the remainder are a mix of ter this meeting is going to go.’” evolving and successful businesses. In 2002, these busi- Monitoring. Along with IBM’s finance and corporate nesses contributed more than $6 billion in additional strategy staffs, Thompson and Harreld periodically evalu- revenues; in 2003, more than $10 billion; and in 2004, ated each EBO using three parameters: project-based $15 billion. milestones, financials, and assessments of business ma- Most of the new businesses are now in the hands of turity. Together, those metrics satisfied IBM’s numbers- IBM’s business groups. That transition occurred quite oriented executives even as they encouraged the EBOs to suddenly. Gerstner’s successor, Sam Palmisano, triggered innovate and grow. the shift when he suggested to Harreld in August 2003 The project-based milestones were the primary basis that “maybe we’re hugging the EBOs too closely.”Harreld on which EBOs were evaluated. IBM used many kinds of responded by deciding, almost overnight, to move 14 milestones: marketplace acceptance (for instance, num- EBOs out of the corporate system and into IBM’s busi- ber of customer pilots, customer references, and design- ness groups. In each case, he based his decision on two ins), external perception (IBM’s public image versus the simple tests of sustainability: Did the business have clear competition’s, mentions by key technology columnists, leadership? And did it have a clear strategy? Any op- presentations at industry conferences), ecosystem devel- erational issues, he felt, were better addressed by the opment (number of software vendor partnerships and business group leaders than by the corporate strategy technology alliances), internal execution (significant department. product development checkpoints and announcements), The handoffs were accompanied by tightened monitor- and resource building (additions of solution and brand ing and reporting. IBM made the business groups’ quar- specialists to the staff, creation of an advisory committee, terly reviews more rigorous, with corporate strategy exec- outreach to other parts of the organization). As one par- utives attending to monitor the progress of the EBOs. ticipant observed, IBM’s executives expected milestones Each group’s monthly letter to the chairman had to de- to indicate progress toward a goal: “They had to be more scribe the status of its EBOs. In addition, Harreld met than just [any] nonfinancial measures that were easy twice a year with every business group head to review the to count.” EBOs’ progress and to ensure that IBM’s traditional cul- The EBOs were not, however, completely free from fi- ture wasn’t choking their performance. nancial scrutiny. Once a new business was up and run- • • • ning, IBM’s finance group calculated its revenues and di- For companies that wish to succeed with corporate rect expenses. The reports provided the basis for monthly entrepreneurship, the lesson is simple: Success is not an reviews that the finance group conducted with each either-or proposition. New businesses should be nurtured EBO’s executives. Meetings were often brief, but they through a series of balancing acts that combine entrepre- served a dual purpose. They prepared emerging busi- neurship and disciplined management, short- and long- nesses for the financial reviews that would be required of term thinking, and established and new processes. As them as they matured. In addition, they provided a check: IBM’s EBO management system shows, when companies If the expenses of an EBO were below budget but it wasn’t must choose between black and white, the best response meeting its milestones, that often meant that the IBM di- is often gray. vision funding the new venture was cutting back on in- 1. For more details, see David A. Garvin and Lynne C. Levesque, “Emerging vestments.“That’s a foul,”an IBM corporate finance exec- Business Opportunities at IBM” (A, B, and C), Harvard Business School case utive told us. “And you can only find it by looking at nos. 9-304-075, 9-304-076, and 9-304-077. expenses and milestones in the same meeting.” Finally, to track how well all the EBOs were progress- Reprint R0610G; HBR OnPoint 1462 ing, IBM’s corporate strategy department developed To order, see page 151.

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BIG PICTURE

Biotech has not delivered on its promise because the industry’s structure–much of it borrowed from Silicon Valley–is flawed. Businesses engaged in advancing basic science as a core activity need a new design.

Can Science Be a Business? Lessons from Biotech by Gary P. Pisano

n its 30 years of life, the biotech- focused, science-based businesses would Inology industry has attracted more break down the wall between basic and than $300 billion in capital. Much of applied science and produce a trove of this investment has been based on the new drugs; the drugs would generate belief that biotech could transform vast profits; and, of course, investors health care. The original promise was would be handsomely rewarded. that this new science, harnessed to So far, the promise remains largely new forms of entrepreneurial busi- that. Financially, biotech still looks like nesses that were deeply involved in ad- an emerging sector. Despite the com- vancing basic science, would produce mercial success of companies such as a revolution in drug therapy. Unencum- Amgen and Genentech and the stun- bered by the traditional technologies ning growth in revenues for the industry and organizations of the established as a whole, most biotechnology firms pharmaceutical giants, these nimble, earn no profit. Nor is there evidence

114 harvard business review | hbr.org that they are significantly more produc- thereby slowing scientific advance. But biotech sector – much of it borrowed tive at drug R&D than the much ma- the question of whether science can be from models that worked quite well in ligned behemoths of the pharmaceuti- a profitable business has largely been software, computers, semiconductors, cal industry. ignored. and similar industries – is fundamen- This disappointing performance raises As always, the prevailing outlook in tally flawed and therefore cannot serve a question: Can organizations motivated the industry itself is that the revolution the needs of both basic science and by the need to make profits and please in drug creation will succeed; it will just business. Unless that anatomy changes shareholders successfully conduct basic take a little longer than anticipated. dramatically, biotech won’t be able to scientific research as a core activity? For That may be wishful thinking. Over the attract the investments and talent re- 30 years, debate has been intense about past 20 years, I have conducted exten- quired to realize its potential for trans- whether business’s invasion of basic sive research on the strategies, structure, forming health care. science–long the domain of universities performance, and evolution of the bio- By “anatomy,”I mean the sector’s di- and other nonprofit research institu- technology and pharmaceutical sec- rect participants (start-ups, established

JOE MAGEE JOE MAGEE tions – is limiting access to discoveries, tors. I learned that the “anatomy”of the companies, not-for-profit laboratories,

october 2006 115 BIG PICTURE • Can Science Be a Business? universities, investors, customers); the emerging industries engaged in basic seek commercial partners to license the institutional arrangements that connect science, and the U.S. economy. The pur- patents; and they partner with venture these players (markets for capital, intel- pose of this article is to provide a frame- capitalists in spawning firms to commer- lectual property,and products); and the work for such an undertaking and to cialize the science emanating from aca- rules that govern and influence how offer some ideas about the new organi- demic laboratories. these institutional arrangements work zational forms, institutional arrange- In numerous instances, the bound- (regulations, corporate governance, in- ments, and rules that will be required. ary between a university and a biotech tellectual property rights). For biotech- firm is blurred. The founders of a sub- nology to fully succeed, its anatomy The Biotech Experiment stantial number of biotech firms include must help the players collectively to Science-based business is a relatively the professors (many of them world- excel in three ways: managing risk and recent phenomenon. By “science-based,” renowned scientists) who invented the rewarding risk taking, integrating the I mean that it attempts not only to use technologies that the start-ups licensed skills and capabilities that reside in a existing science but also to advance sci- from the universities, often in return for range of disciplines and functions, and entific knowledge and capture the value an equity stake. These companies fre- advancing critical knowledge at the or- of the knowledge it creates. A signifi- quently maintain their links with the ganizational and industry levels. cant portion of the economic value of universities, working closely with fac- The parts of an industry’s anatomy such an enterprise is ultimately deter- ulty members and postdoctoral candi- should support one another in meet- mined by the quality of its science. dates on research projects, and some- ing these challenges. In biotech, they Before the emergence of biotech, sci- times using the university laboratories. work at cross-purposes. For example, the ence and business largely operated in In many instances, the founding scien- way the industry manages and rewards separate spheres. Conducting research tists even retain their faculty posts. risks – how businesses are funded – con- flicts with the long R&D timetable needed to create new drugs. The frag- Despite the commercial success of several mented nature of the industry, with companies and the stunning growth in revenues scores of small, specialized players across far-flung disciplines, is a potentially use- for the industry as a whole, most biotechnology ful model for managing and rewarding firms earn no profit. risk, but it has created islands of exper- tise that impede the integration of crit- ical knowledge. And biotech’s market to expand basic scientific knowledge The science business was born in for intellectual property, which allows was the province of universities, gov- 1976, when the first biotech company, individual firms to lock up the rights to ernment laboratories, and nonprofit Genentech, was created to exploit re- basic scientific knowledge, limits the institutes. Commercializing basic sci- combinant DNA technology, a tech- number of scientists who can advance ence – using it to develop products and nique for engineering cells to produce that knowledge by learning through services, thus capturing its value – was human proteins. It was founded by trial and error. the domain of for-profit companies. His- Robert Swanson, a young venture capi- While all this sounds pretty gloomy, torically,a handful of companies, includ- talist, and Herbert Boyer, a professor at it does not mean that the industry is ing AT&T (the parent of Bell Labs), the University of California at San Fran- doomed. It does not mean that science IBM, Xerox (the parent of the Palo Alto cisco who had coinvented the technol- cannot be a business. It does mean that Research Center), and GE, did some re- ogy. In addition to demonstrating that biotech’s anatomy needs to change–an markable research, but they were the biotechnology could be used to develop undertaking that would have a major exception. By and large, businesses did drugs, Genentech created a model for impact not only on drug R&D and health not engage in basic science, and scientific monetizing intellectual property that care but also on university- and govern- institutions did not try to do business. has proved remarkably powerful in shap- ment-funded scientific research, other The biotech sector fused these two ing the way the biotech industry looks domains, creating a science-business and performs. This model consists of Gary P. Pisano ([email protected]) is the model that nanotechnology, advanced three interrelated elements: Harry E. Figgie, Jr., Professor of Business materials, and other industries have • technology transfer from universi- Administration at Harvard Business School adopted. For-profit enterprises now ties to the private sector through cre- in Boston. This article was adapted from often carry out basic scientific research ating new firms rather than selling Science Business: The Promise, the Re- themselves, and universities have be- to existing companies; ality, and the Future of Biotech, to be come active participants in the business • venture capital and public equity published by Harvard Business School of science. They patent their discoveries; markets that provide funding at criti- Press in November 2006. their technology-transfer offices actively cal stages and reward the founders–

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investors, scientists, and universities– pensate for the major drugs that were they would have a much lower failure for the risks they have taken; losing their patent protection, financial rate than conventional, chemical-based • a market for know-how in which analysts questioned the sustainability of drugs. The lower technological risks young companies provide their intel- the industry’s profits. Biotech’s champi- would mean lower business risks. The lectual property to established enter- ons in the scientific and investment- initial success of a few genetically engi- prises in exchange for funding. banking communities believed that its neered replacement hormones–insulin, In 1978, Genentech struck an agree- technologies would create an avalanche human growth hormone, and clotting ment with Eli Lilly, a major pharma- of profitable new drugs. They argued factor VIII to treat hemophilia among ceutical company.In return for the man- that small, specialized biotech compa- them–seemed to validate this view. ufacturing and marketing rights to nies had a comparative advantage in The sequencing of the human genome recombinant insulin, Lilly would fund research over bureaucratic, vertically in- and the invention of so-called industri- development of the product and pay tegrated pharmaceutical giants; Big alized R&D techniques further bol- Genentech royalties on its sales. This Pharma should therefore focus on mar- stered predictions that biotech would agreement knocked down one of the keting and leave innovative R&D to generate breakthrough therapies and chief barriers to new firms’ entering nimble biotech firms that were closer tremendous gains in R&D productivity. the pharmaceutical business: the huge to the science. Even some executives at The reasoning was that the massive cost ($800 million to $1 billion in today’s major pharmaceutical companies ap- amount of biological data produced dollars) over the long time (ten to 12 peared to believe this, as evidenced by would help enormously in identifying years) generally required to develop their decisions to aggressively pursue the precise causes of diseases, and that a drug. This was also the first time a alliances with biotech firms. techniques such as combinatorial chem- pharmaceutical company had essen- Because the products of the first istry (for creating new compounds), tially outsourced a proprietary R&D wave of biotech companies – including high-throughput screening (for testing program to a for-profit enterprise. Since Amgen, Biogen Idec, Cetus, Chiron, the compounds’ medicinal potential), then, virtually every new biotech firm Genentech, and Genzyme – were pro- and computational chemistry (for “ra- has formed at least one contractual re- teins found in the human body, scien- tionally designing” drugs to have spe- lationship with an established pharma- tists, managers, and investment bank- cific effects) would greatly increase the ceutical or chemical company,and most ers involved in the sector argued that quantity and quality of drug candidates. have formed several. This market for know-how has en- couraged venture capitalists to provide seed money for start-ups. It has also helped biotech companies tap public equity markets for capital by providing investors with an alternative to profits and revenues as a gauge of value. Gen- entech’s wildly successful initial public offering in 1980 demonstrated that a firm with no product revenues or in- come could go public–which made the sector even more attractive to venture capitalists. The Promise The rise of this system for monetizing intellectual property was intertwined with high hopes for biotech. Through the 1980s and into the 1990s, the sector seemed to offer a solution to the loom- ing crisis in R&D productivity that threatened established pharmaceutical companies. Facing a shortage of poten- tial blockbuster drugs in their pipelines, these companies had dramatically in- creased their R&D spending, but to no avail. With new drugs unable to com- october 2006 117 BIG PICTURE • Can Science Be a Business?

The days of inefficient, trial-and-error, market. (See the exhibit “Industrialized That said, the change in strategies raises craft-based, one-molecule-at-a-time ap- R&D Has Yet to Deliver for Biotech.”) a major concern: If young biotech firms proaches to drug discovery were deemed There is no conclusive proof that the are not pursuing cutting-edge science, to be numbered. unexceptional productivity of biotech who will focus on the higher-risk long- firms is due to the complexity and risk of term projects that offer potential med- Progress to Date the projects they undertake. ical breakthroughs? Excitement about these emerging tech- Nor is there reason to believe that People involved in biotechnology nologies, the exploding number of bio- biotech’s productivity will improve with have long contended that the sector tech start-ups (some 4,000 over three time. Optimists point out that biotech will flourish eventually. Some still say decades), and the sector’s soaring an- firms account for a growing percentage it’s just a matter of time and money.Oth- nual revenues (now about $40 billion) of drugs in clinical development. This ers insist that technology will save the only reinforced this optimism. But if suggests that we should expect a great day.Genomics, proteomics, systems biol- the industry’s success is measured by number of drugs to emerge from the ogy, and other advances will make it profitability and progress in revolu- possible to identify promising drug can- tionizing R&D to generate an ava- didates with a high degree of precision lanche of breakthrough drugs, a trou- The way the industry at extremely early stages of the R&D bling picture emerges. manages and rewards process, which should lead to a dramatic First, only a tiny fraction of biotech reduction in failure rates, cycle times, companies have ever been profitable or risks–how businesses and costs. generated positive cash flows, and the are funded–conflicts Such optimism assumes that the sector as a whole has lost money. (See underlying structure of the sector is the exhibit “Profitless Growth for Bio- with the long R&D healthy and the strategies of the play- tech.”) Of the firms that have been prof- timetable needed ers make sense. My research suggests itable, only an elite handful of the old- otherwise. This structure and these est – including Amgen, Biogen Idec, to create new drugs. strategies cannot solve the fundamental Genentech, and Genzyme–have gener- business and scientific challenges facing ated substantial profits. Only Amgen biotech pipeline in the future. But while the sector. and Genentech have broken into the industry spending on R&D continues to league of established pharmaceutical increase substantially, the attrition rate A Flawed Anatomy companies. It’s especially noteworthy of biotech drugs in development has Like living things, industries are not that Genentech, after pioneering the also grown over time. Thus it is doubtful “designed” but they have designs. In system for monetizing intellectual prop- that biotech’s output per dollar invested living things, these designs are called erty, then took a different path: along in R&D will improve significantly. anatomies. Anatomy helps us under- with Amgen, Genzyme, and a few oth- Finally – and perhaps not surpris- stand what a given species is capable of ers, it vertically integrated by investing ingly – the biotech sector appears to be and why certain species can thrive in heavily in manufacturing and market- retreating from its distinctive position at some environments but not others. ing even as it continued to build internal the radical and risky end of the R&D Anatomy explains why a cheetah can scientific capabilities. In addition, Gen- spectrum. Since 2001, when the ge- run 65 mph and a turtle can’t. The fit be- entech forged a long-term relationship nomics bubble burst, the strategies of tween anatomy and environment mat- with Roche, the Swiss pharmaceutical start-ups and the preferences of venture ters in economics, too. giant, which owns 56% of its shares. capitalists have undergone a marked The anatomy of the biotechnology in- Second, there is no sign that biotech- change. Rather than forming so-called dustry looks quite similar to those of nology has revolutionized the produc- molecule-to-market companies, whose other high-tech sectors, such as soft- tivity of pharmaceutical R&D, despite first product revenues might be more ware and semiconductors. It involves many claims to the contrary. The aver- than a decade away, entrepreneurs and university-spawned start-ups that focus age R&D cost per new drug launched investors have begun to look for lower- on specific pieces of the R&D value by a biotech firm is not significantly risk, faster-payback models, such as li- chain; a role for the venture capital and different from the average cost per new censing existing projects and products public equity markets; and a market for drug launched by a major pharmaceu- from other companies and then refin- know-how. What some might call the tical company. (See the exhibit “Bio- ing them. Silicon Valley anatomy has worked won- tech Has Produced No Breakthrough in Refinements such as new formula- derfully well in these other sectors. R&D Productivity.”) Nor has industrial- tions, including new technologies for de- Biotech’s anatomy was based on the ized R&D dramatically increased the livery, are certainly valuable. They can premise that it would be a lot like them. number of compounds that make it to lead to significant therapeutic improve- But when it comes to R&D, biotech dif- human clinical testing, let alone into the ments and expanded treatment options. fers radically in three ways:

118 harvard business review | hbr.org Can Science Be a Business? • BIG PICTURE

• Profound and persistent uncertainty, the number of targets (possible causes risks and to diversify them by building rooted in the limited knowledge of of diseases), weapons (therapies) with portfolios of firms. A closer examina- human biological systems and pro- which to attack them, and novel ap- tion, however, suggests that hidden cesses, makes drug R&D highly risky. proaches for identifying new potential flaws in the system have impeded the • The process of drug R&D cannot be causes and cures has exploded, knowl- overall business performance of the broken neatly into pieces, meaning edge about many of these options re- sector. that the disciplines involved must mains superficial, forcing scientists to Venture capitalists have a time hori- work in an integrated fashion. engage in more trial and error, not less. zon of about three years for a particular • Much of the knowledge in the diverse So even though biotechnological ad- investment–nowhere near the ten or 12 disciplines that make up the biophar- vances may eventually reduce the tech- years most companies take to get their maceutical sector is intuitive or tacit, nical risks in R&D, they have to date first drug on the market. In addition, be- rendering the task of harnessing col- had the opposite effect. cause they need to spread their risks, lective learning especially daunting. Profound, persistent uncertainty trans- not even the largest funds can afford to Contending with profound uncer- lates into high, long-term risks. At first sink a vast sum into any one start-up. Ac- tainty and risk. The basic feasibility of glance, biotech’s system for monetizing cording to data from the National Ven- technologies is not an issue for R&D in intellectual property seems to have ture Capital Association on fund invest- most industries, where the effort and functioned fairly well in managing such ment policies, the average investment in resources go primarily into developing risks. The rapid formation of new firms a biotech firm is about $3 million. The concepts already known to be techni- has given rise to a plethora of experi- average maximum is $20 million – far cally feasible. Car designers may grapple ments. The allure of equity ownership less than the $800 million to $1 billion with engineering problems concerning has encouraged scientific entrepreneurs typically required to develop a success- a vehicle’s various parts and worry to take the risks inherent in starting new ful drug. about whether the design can be man- firms. And venture capitalists have had Biotech firms rely on public equity ufactured and whether customers will the wherewithal to manage early-stage and strategic alliances to close the gap. buy the vehicle. But they can be virtu- ally certain that at the end of the pro- cess the vehicle will work. Even in high- tech industries such as semiconductors, Profitless Growth for Biotech high-performance computers, and air- craft, it is usually fairly clear which com- The revenues of publicly held biotech companies have grown dramatically but their prof- mercial R&D projects are scientifically its have hovered close to zero. Excluding Amgen, the largest and most profitable firm, the feasible and which are not. industry has been consistently in the red. Its losses would be even greater if private com- This is not the case with drug R&D. panies were included in the data pool. Whether a drug candidate is safe and effective can be determined only through a lengthy process of trial and Revenue and operating income before depreciation ($ billions 2004) error. Despite extraordinary progress in genetics and molecular biology over $35.8 the past few decades, scientists still find All public companies it extremely difficult to predict how a REVENUE particular new molecule will work in All public humans. Even today, they can assume companies except $25.2 that the most likely outcome of a proj- Amgen ect, after years of effort, will be failure. Historically,only one out of about 6,000 synthesized compounds has ever made it to market, and only 10% to 20% of drug candidates beginning clinical trials have ultimately been approved for commer- All public $2.5 cial sale. companies OPERATING $0 INCOME Advances in basic science may even- ($2.1) tually improve these odds. But so far All public (and contrary to expectations), bio- companies except Amgen technology has actually increased the 1980 2004 uncertainties in drug R&D. Although october 2006 119 BIG PICTURE • Can Science Be a Business?

These solutions, however, create other typically don’t require companies to dis- ent ways. Even if they interpret them problems. close their R&D projects, and although similarly, they may make different deci- Public equity markets are not de- biotech and pharmaceutical firms must sions about whether to proceed to the signed to deal with the challenges of en- disclose information on the state of next stage, based on their differing ap- terprises engaged in R&D only, which their development pipelines, the re- petites for risk. compose most of the biotech sector. quirements are vague. For example, Public investors have looked to the These companies cannot be valued on companies have discretion over how market for know-how to fill this infor- the basis of earnings; most of them much detail to provide about possible mation gap. With their years of experi- don’t have any. Their value hinges al- therapeutic uses of a given product, clin- ence and armies of scientists, the big most exclusively on their ongoing R&D ical trial results and progress, and future pharmaceutical companies that have projects. But trying to value them on development plans. Without adequate struck deals with biotech firms surely the basis of projects that face years of information, even the most sophisti- have the knowledge to assess projects’ great technical and commercial uncer- cated valuation techniques, such as real technical and commercial prospects. So tainty is next to impossible. Information options and Monte Carlo simulation, the willingness of Merck or Novartis or is simply inadequate. No clear disclo- are of limited use. Eli Lilly to invest in a biotech company’s sure and valuation standards exist for The other challenge for investors is project should signal that its prospects intangible assets in general and R&D interpreting the publicly announced re- are good, right? Not necessarily. Phar- projects in particular. Generally ac- sults of clinical trials. Companies can maceutical companies often make alli- cepted accounting principles (GAAP) and do interpret these results in differ- ances in precisely those areas where they lack expertise. Moreover, in many cases they have spent lavishly on alli- ances and reaped little in return – or Biotech Has Produced No Breakthrough have walked away from licensing early- in R&D Productivity stage drugs that eventually became blockbusters. As the graph below indicates, the average R&D cost per new drug launched by biotech Further evidence that the system for firms is not significantly different from the average cost per new drug launched by monetizing intellectual property is major pharmaceutical companies. flawed is that, on the whole, the long- term returns on investments in biotech have not been commensurate with the R&D spending per new drug launched ($ billions 2004) substantial risks. While venture capital funds have enjoyed some stellar years, $4.3 and individual biotech stocks have per- formed spectacularly, average returns overall have been disappointing rela- PHARMACEUTICAL tive to the risks. From 1986 through 2002, venture capital funds generated an average annual internal rate of re- turn of 16.6%. And an analysis con- ducted by Burrill, a San Francisco– based merchant bank, found that an investor who bought all 340 biotech $2.0 BIOTECH IPOs from 1979 through 2000 and held on to those shares until January 2001 (or until a company was acquired) $1.3 would have realized an average annual $1.2 return of 15%. All this may explain why biotech 1985 2004 start-ups appear to be retreating from the riskiest projects. Although it is The sample of biotech companies includes all publicly held companies that tried to develop new drugs. The sample of phar- maceutical companies includes the top 20 companies in the world according to their R&D spending. The drugs do not hard to know conclusively, indications include line extensions, reformulations, or approvals for new uses. Every annual data point represents the cumulative R&D are that investors are becoming more expenditures from 1985 through the given year divided by the cumulative number of drugs launched during the same pe- cautious. riod. The first four and last four years of data were adjusted to account for the lag between R&D spending and the resultant output. Credit for a jointly developed new drug was divided equally between the biotech firm and its partner,the established Integrating diverse disciplines. pharmaceutical company. Thanks largely to the emergence of the

120 harvard business review | hbr.org Can Science Be a Business? • BIG PICTURE biotech industry, the tool kit of drug narily multifaceted. What is the path- ferent kinds of scientists repeatedly ex- R&D has become much bigger and way? What genes might be at work? change huge amounts of information. much more diverse. In the mid-1970s, it How do they interact? What are the In other words, they must work together was dominated by a single discipline: proteins those genes express, and what in a highly integrated fashion. medicinal chemistry. Today it includes do they do? What is their structure? There are two basic ways of achieving molecular biology, cell biology, genet- How likely is one or more of them to integration. One is by having individual ics, bioinformatics, computational chem- be a “druggable” target? Answering firms own all the requisite pieces of istry, protein chemistry, combinatorial these questions requires insights from the puzzle (vertical integration). The chemistry, genetic engineering, high- different disciplines – including struc- other is with market-reliant networks, in throughput screening, and many oth- tural genomics, functional genomics, which independent specialists integrate ers. These new tools are opening up new cell biology, molecular biology, and their work through alliances, licensing opportunities, but each sheds light on protein chemistry – and also a broad arrangements, and collaboration. The only one piece of a very complex puzzle. range of approaches, including compu- traditional pharmaceutical business em- Discovering and developing drugs effec- tational methods, high-throughput ex- ploys the former, and the biotech indus- tively requires that all the pieces come perimentation, and traditional “wet” try the latter. together. Therefore, integration across biology. Most biotech firms were formed to diverse scientific, technical, and func- The same kind of integration must allow small teams of highly dedicated tional domains is more important than also occur further downstream in devel- scientists to focus on exploiting a specific ever if the scientific promise of biotech opment but with still other disciplines, finding or body of work initiated at a is to be realized. such as toxicology, process develop- university.The result was hundreds of is- The challenge of integration is not ment, formulation design, clinical re- lands of specialized expertise. The bio- unique to drugs. Virtually all R&D in- search, biostatistics, regulatory affairs, tech sector has relied heavily on the mar- volves solving multiple types of prob- and marketing. It is difficult, if not ket for know-how to link these islands. lems. Not only must the many problems downright impossible, to successfully There are indications, however, that this be solved, but the solutions must ulti- develop a drug by solving problems in- market can’t facilitate the flow of infor- mately work together as a whole. dividually in isolation, because each mation and the collective problem solv- In some cases–including highly com- technical choice (the target you pursue, ing needed to develop new drugs. plex systems such as electronics equip- the molecule you develop, the formula- To function in a highly efficient fash- ment, automobiles, software, and air- tion, the design of the clinical trial, the ion, a market for any property–whether planes – a big R&D problem can be choice of the target patient population, real estate or intellectual property – broken down into a set of relatively in- and the choice of manufacturing pro- requires well-defined, well-protected dependent subproblems, to be solved cess) has implications for the others. rights. Strong IP protection generally independently and then put together. Arriving at a solution requires that dif- exists in software and semiconductors. Modularity makes possible the division of labor among different organizations specializing in different parts of the Industrialized R&D Has Yet to Deliver for Biotech system, but it generally requires well- defined interfaces and standards that Since the mid-1990s, a combination of genomics, combinatorial chemistry, high- specify how different components of throughput screening, and IT has been used to create new drugs and to identify pos- the system are supposed to fit and func- sible targets in the body for attacking diseases. Despite this industrialization of R&D, tion together. In addition, modularity however, the number of compounds developed by commercial organizations that have requires that intellectual property be progressed at least to human clinical testing has not increased significantly. codified and the rights to it be clearly defined and protected. Drug R&D lacks these requirements. Number of compounds in human clinical trials Most of the numerous functional and technical activities involved in drug Industrialization of R&D begins R&D tend to be highly interdependent. A case in point is identifying a target for 500 drug discovery. The big questions to be resolved are what the underlying mech- anism of the disease is and where drug 0 therapy might intervene in it. Because 1986 2003 human biology is extraordinarily com- plex, target identification is extraordi- Source: www.fda.gov/cder/rdmt/Cyindrec.htm october 2006 121 BIG PICTURE • Can Science Be a Business?

A piece of software code, for instance, is R&D in general means that what is As a result, sharing experiences over a fairly distinct entity that can be pro- known pales in comparison to what re- an extended period matters enormously tected by legal mechanisms, and its theft mains to be discovered. New hypotheses in such endeavors, and the breadth of can be detected quite easily. In biotech- and findings must constantly be evalu- the sharing is extremely important. For nology, the IP regime is more complex ated, and decisions must be made about the science to advance, each of the dis- and murkier. It is often not clear what is which options to pursue and which to ciplines with expertise needed to solve patentable and what is not. Moreover, discard. These decisions must occur in a problem must be able to leverage the the most valuable IP is often not a spe- the fog of limited knowledge and expe- collective wisdom. cific molecule but data, understanding, rience. Mistakes are common, not be- Unfortunately, the biotech industry and insights relating to how that mole- cause people or firms are incompetent is not organized to learn from experi- cule behaves, what it can do, what its po- but because they are constantly dancing ence over time. Once again, its system tential problems are, and how it might on the edge of knowledge. for monetizing intellectual property is be developed. Such knowledge can be When, as in the case of drug R&D, to blame. By fueling the proliferation much more difficult to patent. failure is far more common than suc- of start-ups, the system has helped cre- Murky IP creates two problems: It cess, the ability to learn from failure is ate a sector of relatively inexperienced makes its owners think twice about critical to making progress. Learning can firms. The typical young firm in bio- sharing it in the first place, and it pro- occur at multiple levels in a system or tech simply lacks the capabilities that vides fertile ground for contract dis- an industry. A scientist who has spent Genentech, for example, accumulated putes over what will be shared. Biotech decades doing research on cell growth in the course of conducting R&D for 30 has suffered both. Suits between former years. Nor can newer ventures afford to partners and collaborators have been Far from being dead, learn through experience. They have fairly common. Indeed, Genentech and limited financial resources, and inves- Lilly, whose recombinant-insulin deal vertical integration has tors aren’t willing to give them the time became a template for the industry in an important role to to perfect their craft. many ways, wound up in a legal contest Finally, the market for know-how over rights to use genetic-engineering play in the future drug hinders companies from forming long- technology to produce human growth industry. term learning relationships. The lack of hormone. After codeveloping recombi- well-delineated intellectual property nant human erythropoietin, a synthetic rights is one problem; the short-term protein that stimulates the body’s pro- factors, for instance, will have accumu- focus of alliances is another. All too duction of red blood cells, Amgen and lated quite a lot of knowledge, and the often, priority is given to the deal, not Johnson & Johnson fought a bitter legal lab in which he worked will have to building joint long-term capabilities. battle over the division of marketing learned many new things from his re- As a result, most alliances are at arm’s rights. Years after that, they had another search as well as from that of others in length and fairly brief. According to re- dispute about whether a later version of the lab. This learning will be not only search by Harvard Business School’s Josh the drug was a completely new product the aggregate of what individuals know Lerner and Stanford Business School’s or an improved form of the original. but also the insights shared by the com- Ulrike Malmendier, the length of a typ- Another formidable barrier to shar- munity. Some of this knowledge will be ical contract is just short of four years – ing information is the tacit nature of formalized in organizational procedures much less than the amount of time much of the knowledge critical to drug and methods, but much of it will prob- needed to develop a drug. In addition, R&D. Such knowledge cannot be fully ably be tacit. the relationship is often centered on described in writing, because the cause- Despite scientific advances, there is reaching specific, short-term milestones; and-effect principles behind the tech- still an art to drug discovery that relies if one is missed, the alliance may be niques or know-how have not been com- on judgment, instinct, and experience. terminated. pletely identified. This is common in For example, what individual scientists All in all, the obstacles to integration emerging fields, but the magnitude of know about a molecule, or a biological and learning in the industry are enor- tacit knowledge in biotech impedes target for attacking a disease, or the mous. Given these impediments, it’s the pace of learning in the sector, as we behavior of a drug inside the body can- hardly surprising that biotech suffers shall see. not be codified or reduced to precise from productivity problems. Promoting cumulative learning. It rules – if X, then Y. Data from experi- would be hard to overstate the impor- ments are subject to a wide range of in- A More Suitable Anatomy tance of learning to the long-term terpretation and opinion. What consti- To deal with profound uncertainty and health of science-based sectors. The pro- tutes a strong signal of potential efficacy high risks, allow closely interdependent found and persistent uncertainty en- for one researcher may give pause to problem solving, and harness the collec- veloping biotech in particular and drug another. tive experience of disciplines through-

122 harvard business review | hbr.org Can Science Be a Business? • BIG PICTURE out the sector, biotech needs a new integrators, they will need new internal ample, a collaboration might focus on anatomy–one that involves a variety of structures, systems, and processes to specific therapeutic areas or target fam- business models, organizational forms, connect technical and functional do- ilies. Such relationships would poten- and institutional arrangements. The ap- mains of expertise. tially result in much more sharing of proaches needed to develop more inno- Fewer,closer,longer-term collabora- proprietary information, greater joint vative drugs differ enormously from tions. Alliances will continue to be a learning, and larger, more productive those required to develop less innova- critical complement to internal R&D. investments. We simply cannot expect tive drugs. One size does not fit all. A Given the breadth and rate of techno- independent enterprises to share knowl- more suitable anatomy might include logical change, not even the largest edge and engage in true collaboration the following elements. companies can explore all facets of the within a business-development frame- More vertical integration. Far from R&D landscape without help from out- work that focuses on short-term goals being dead, vertical integration has an side parties – universities and smaller, and emphasizes the law of large num- important role to play in the pharma- specialized biotech firms. Their collab- bers over commitment. ceutical industry’s future. It will be most orative relationships, however, will dif- Fewer independent biotech firms. useful in the pursuit of the most scien- fer substantially in form and number Small entrepreneurial biotech firms will tifically innovative drugs. Vertical inte- from those that currently dominate the continue to be an important element of gration requires a degree of scale, which sector. the landscape. But there will be far means that established pharmaceutical For projects that are scientifically or fewer independent public companies. companies are well positioned to be in- technologically novel, forging fewer, The publicly held model will work only tegrators. But that will require change. deeper relationships makes sense. In- for companies that have earnings, allow- Most major pharmaceutical companies stead of signing 40 deals in one year, a ing investors to judge their prospects; have created their own islands of exper- pharmaceutical company might be bet- under existing disclosure practices, pure tise inside their own corporate bound- ter off involving itself at any one time in R&D enterprises do not belong in the aries, a deeply problematic practice that only five or six that last five to ten years public equity space. probably explains their poor R&D pro- and are broad in scope. Instead of con- Quasi-public corporations. A possi- ductivity. To realize their potential as centrating on a given molecule, for ex- ble alternative to the public company is Real World Real Learning www.imd.ch IMD, world leader in executive education*. Look forward, broaden your thinking, tackle your business problems, prepare for tomorrow. Need a career boost? A competitive edge? Visit our website today.

* IMD was ranked first in Europe and second overall world-wide in the May 2006 Financial Times Global survey of Executive Education, and first in the Wall Street Journal/Harris Interactive survey of international corporate recruiters, September 2005. BIG PICTURE • Can Science Be a Business? the quasi-public corporation. Its shares gle firm. Granting an exclusive license to is one example. Such collaborations are are publicly traded, but a large company an existing firm is necessary when the a step in the right direction. with a long-term strategic interest in the technology in question is specific and More translational research. As the biotech firm’s success owns a majority further downstream in its development, name implies, this kind of research stake. Such a relationship would pro- its value declines as access to it grows, translates basic scientific findings and vide a firm with much more intensive and certain complementary assets and concepts into specific product opportu- oversight than is possible with a normal capabilities are needed to fully exploit it. nities. It connects early basic research public corporation, as well as a longer- For example, a novel cancer therapy with clinical testing, encompassing ac- term perspective and assured fund- might be more fully exploited if licensed tivities such as target identification and ing – all of which are crucial for drug to an organization with experience in validation, in vitro and in vivo screen- R&D. It would also allow the firm to op- both developing cancer drugs and de- ing, and perhaps some early-stage erate with a significant degree of inde- signing and managing clinical trials. But human clinical trials. Working to under- pendence and to offer stock options and that firm would be less inclined to invest stand how stem cells divide and special- other incentives to attract and retain in development if the therapy were also ize is an example of basic scientific re- entrepreneurs. Genentech, which is licensed to competitors. Granting an ex- search. Developing hypotheses and majority-owned by Roche, is one of the clusive license to a start-up makes sense insights about using stem cells to treat few existing examples. Genentech has only when the technology is so radically diabetes is an example of translational been highly profitable; its R&D pro- different that existing firms lack the ca- research. Historically, the problem with grams have been among the most pro- pabilities essential to developing it. For translational research has been that the ductive in the industry; and despite its instance, it would probably make sense National Institutes of Health and other growth it has maintained an entrepre- to incubate a highly novel technique government agencies that fund basic re- neurial and science-based culture. such as tissue engineering inside a new search view it as applied science, and A new priority for universities. A firm that could build the essential capa- private venture capitalists view it as too shift in the mentality and policies of uni- bilities from scratch. risky and too long-term. Moreover, to versities is needed. They should focus More cross-disciplinary academic undertake translational research re- primarily on maximizing their contri- research. In commercial drug R&D, the quires investments in intellectual assets, butions to the scientific community,not fragmentation of the knowledge base such as novel animal models, that may maximizing their licensing revenues into highly specialized niches is a major be difficult to commercialize or even and equity returns. barrier to integration. There is deep protect. Much of the debate about university knowledge within, say, chemistry and Translational research may be funded activity in the business of science has genomics, but much less knowledge in two ways. The first is by extending focused on the impact of patents and about the connections between them. the reach of government funding fur- has asked the wrong question: Should This is partly because each academic dis- ther downstream. This is already start- universities patent their discoveries? cipline has its own focal problems, lan- ing to happen with the NIH Roadmap The central issue is the extent to which guage, intellectual goals, theories, ac- for Medical Research, an initiative universities make available the knowl- cepted methods, publication outlets, launched by the agency’s director to edge embedded in their patents. They and criteria for evaluating research. identify and address major opportuni- should be much more cautious about Some of the difficulty may be in the ties and gaps in biomedical research. granting exclusive licenses to basic sci- peer-review process that universities use The second is through more private entific discoveries and supporting the to award research grants. The process funding. The largest pharmaceutical creation of new firms. Putting the sci- does an excellent job of ensuring that companies could increase their sup- ence into the hands of more explorers is decisions are based on scientific merit, port for the translational research they likely to accelerate the pace of advance. but reviewers tend to award grants to conduct on their own or in collabora- “Open” licensing that makes an up- projects within their own disciplines. tion with universities. Novartis, for one, stream discovery widely available on To address this problem, some univer- has been pursuing both strategies. Ven- reasonable economic terms works best sities have in the past decade launched ture philanthropies, too, hold promise. when the technologies in question are interdisciplinary institutes to bring to- These organizations tend to be pri- broadly applicable tools, techniques, or gether scientists from biology, chem- vately funded, not-for-profit entities that concepts with many potential (but un- istry, mathematics, computer science, focus on advancing treatments for spe- certain) paths for development. The ad- physics, engineering, and medicine. The cific diseases. Some examples are the vance of biotechnology would have Broad Institute, a research collaboration Bill & Melinda Gates Foundation (for been slowed considerably had recombi- involving faculty, professional staff, and research on AIDS and infectious dis- nant DNA, monoclonal antibodies, and students from the academic and med- eases in developing countries), the other basic genetic-engineering tech- ical communities of Harvard and the Michael J. Fox Foundation for Parkin- niques been exclusively licensed to a sin- Massachusetts Institute of Technology, son’s Research, the Multiple Myeloma

124 harvard business review | hbr.org Research Foundation, and the Prostate Cancer Foundation. These organiza- NOW MY RIGHT BRAIN tions approach funding and manage- ment much the way traditional for- profit venture capitalists do, with a KNOWS WHAT couple of big differences: They have long time horizons, and their goal is to make a therapeutic difference, not to re- THE LEFT IS DOING. turn a profit to limited partners within three to five years. • • • I AM GLOBAL. With such organizational forms and in- stitutional arrangements, science can be a business. Is it realistic to think that the anatomy of biotech could change so rad- ically? Yes, for two reasons. One is that many of the elements I have listed al- ready exist, even if they are still the ex- ception, and their success will undoubt- edly attract a following. The other is that evolution is the norm in business. Epochs of major technological innova- tion have been accompanied by trans- formational innovations in industry de- sign. For example, the development of the rail and telegraph systems, which re- quired enormous investments and the management of vast operational com- plexity,gave rise to the modern corpora- tion, which separated ownership (share- holders) from management (salaried professionals). Throughout the past cen- tury, the modern corporation has con- tinued to evolve. Venture capital’s emer- gence in the United States in the latter half of the twentieth century, for in- stance, helped produce entrepreneurial organizations that played a crucial role THE ADVANCED MANAGEMENT PROGRAM. in semiconductors, software, computers, and communications. CREATING INNOVATORS. June 3–July 6, 2007 We can hope that biotech will simi- September 23–October 26, 2007 larly evolve and create a model for emerging science-based businesses like Today’s business culture demands leaders who are true innovators. They nanotechnology. After 30 years of ex- challenge traditional thought. They use both sides of their brain. They are perimentation, it is clear that biotech is the most sought after executives in the world because they build cultures of not just another high-tech industry. It creativity. After five weeks at Wharton’s Advanced Management Program, you needs a distinctive anatomy – one that will be one too. will serve the demands of both science and business. Only then can it deliver on To become a master of innovation, and to receive your information kit, call its promise to revolutionize drug R&D, Robin Salaman at +1.215.898.1179 (worldwide) or 800.255.3932 (U.S. or conquer the most intractable diseases, Canada), or e-mail her at [email protected]. Visit our website at and create vast economic wealth. executiveeducation.wharton.upenn.edu.

Reprint R0610H Wharton Executive Education. To order, see page 151. We’re all business.™ october 2006 HOOELVT,1925–2006 THEODORE LEVITT,

DAVID JOHNSON What business are you in? Classic Advice from Theodore Levitt

Ted Levitt exhorted executives to put their customers at the center of all they do–and to put marketing at the center of strategy. Here are some of his wide-ranging insights.

DITORS’ NOTE: For all the talk about management as a Escience, experienced executives know that strategic decisions and tactics depend heavily on context. No one understood this bet- ter than Theodore Levitt. A scholar renowned as a founder of mod- ern marketing, he sought above all to use his insights to serve the needs of businesspeople. In a series of powerfully insightful–and delightfully written – essays in Harvard Business Review, he pro- voked readers to reexamine their settled thinking about vital issues so that they could better meet the needs of customers. Theodore Levitt was born in Vollmerz, Germany, in 1925. Ten years later, like an older émigré named Peter Drucker, he and his family fled the rise of Nazism and immigrated to the United States. They settled in Dayton, Ohio, where they became U.S. citizens in 1940. After earning a doctorate in economics in 1951, Levitt even- tually joined the faculty of Harvard Business School, where he remained a professor until retiring in 1990. His early work was fairly conventional scholarship. That had changed by 1960, when HBR published his best-known article, “Marketing Myopia.”It was not so much an article as a manifesto. Picking up threads that he and others had prepared, Levitt wove a powerful argument that companies should stop defining them- selves by what they produced and instead reorient themselves toward customer needs. No one before had so aggressively and

october 2006 127 THEODORE LEVITT, 1925–2006 • What Business Are You In?

practically made the case for centering companies on customers, Marketing Myopia and his ideas continue to shape marketing practices even today, Excerpted from July–August 1960 as Clay Christensen acknowledged last December in his HBR ar- very major industry was once a ticle “Marketing Malpractice.” growth industry. But some that Levitt intended “Marketing Myopia” to be a challenge to busi- Eare now riding a wave of growth nesses as a whole, not just to their marketing departments. enthusiasm are very much in the Twenty-three years later, his article “The Globalization of Mar- shadow of decline. Others that are kets” told a similar story on a grander scale. To take advantage of thought of as seasoned growth indus- globalization, he wrote, companies should standardize as much as tries have actually stopped growing. In every case, the reason growth is possible, because what people most desire are the low prices and threatened, slowed, or stopped is not quality made possible by standardization. The marketing evange- because the market is saturated. It is list was now praising engineering-oriented companies that lacked because there has been a failure of marketing departments but whose businesses understood the management…. strategic opportunity globalization presented. Once again, his The railroads did not stop growing take-no-prisoners prose attracted wide attention and discussion, because the need for passenger and as well as criticism fixated on his over-the-top pronouncements. freight transportation declined. That The critics missed the larger message about what consumers grew. The railroads are in trouble today really seek and therefore missed the point. not because that need was filled by oth- Levitt had the gifts of provocation and generalization, offering ers (cars, trucks, airplanes, and even tele- ideas that startled readers but compelled them to think more cre- phones) but because it was not filled by atively, and more intelligently, about their businesses. Writing at the railroads themselves. They let others take customers away from them be- a time when business was held in far less esteem, he rejected the cause they assumed themselves to be in easy contempt that many intellectuals had for managers and con- the railroad business rather than in the sumers. He celebrated the material achievements of corporations transportation business. The reason and presciently saw their long-term power.He became one of this they defined their industry incorrectly magazine’s most prolific authors, publishing 26 articles – a num- was that they were railroad oriented in- ber exceeded only by Peter Drucker. stead of transportation oriented; they Levitt carried his practical approach to his tenure as Harvard were product oriented instead of cus- Business Review’s eighth chief editor, from 1985 to 1989. He was at tomer oriented…. the same time one of HBR’s most intellectual and most populist The belief that profits are assured by editors. He understood that the magazine’s main purpose was to an expanding and more affluent popu- serve as a kind of sophisticated translation, clarifying authors’ lation is dear to the heart of every indus- raw – and sometimes rough – ideas for impatient, time-pressed try. It takes the edge off the apprehen- sions everybody understandably feels readers. In both his writing and his editing, he epitomized HBR’s about the future. If consumers are mul- standard of tireless practical engagement with ideas. tiplying and also buying more of your Levitt’s ideal businessperson was someone who, amid the product or service, you can face the fu- clamor of meetings, phone calls, stock-market updates, daily pa- ture with considerably more comfort pers, weekly magazines, and consultants’presentations, was fed up than if the market were shrinking. An with hype and showed an insatiable appetite for expertise. In a expanding market keeps the manufac- 1987 editor’s letter, Levitt wrote, “Harvard Business Review enters turer from having to think very hard or with the authoritative well-reasoned sounds of solidly profes- imaginatively. If thinking is an intellec- sional thought and sense – with articles written by experienced tual response to a problem, then the ab- specialists and professionals addressing important people who sence of a problem leads to the absence make important decisions about important matters in the world of thinking. If your product has an auto- of affairs. That’s what we think thoughtful businesspeople need matically expanding market, then you will not give much thought to how to ex- and want in this unstable world of slick popularizing and celebrity pand it…. hype.”In that ideal, he was his own best exemplar. The profit lure of mass production obviously has a place in the plans and strategy of business management, but it

128 harvard business review | hbr.org What Business Are You In? • THEODORE LEVITT, 1925–2006 must always follow hard thinking about ucts but as providing customer-creating This is the basis for the notion that a the customer. This is one of the most value satisfactions. It must push this salesperson needs charisma, because it important lessons we can learn from the idea (and everything it means and re- is charisma rather than the product’s contradictory behavior of Henry Ford. quires) into every nook and cranny of qualities that makes the sale. In a sense, Ford was both the most bril- the organization. It has to do this con- Consider, by contrast, marketing. Here liant and the most senseless marketer in tinuously and with the kind of flair the seller, being physically close to buy- American history. He was senseless be- that excites and stimulates the people ers, penetrates their domain to learn cause he refused to give the customer in it. Otherwise, the company will be about their needs, desires, and fears and anything but a black car. He was bril- merely a series of pigeonholed parts, then designs and supplies the product liant because he fashioned a production with no consolidating sense of purpose with those considerations in mind. In- system designed to fit market needs. We or direction. stead of trying to get buyers to want habitually celebrate him for the wrong what the seller has, the seller tries to reason: for his production genius. His have what they want. The “product” is real genius was marketing. We think he no longer merely an item but a whole was able to cut his selling price and bundle of values that satisfy buyers–an therefore sell millions of $500 cars be- After the Sale “augmented” product. cause his invention of the assembly line Is Over… Thanks to increasing interdepen- had reduced the costs. Actually, he in- dence, more and more of the world’s Excerpted from September–October 1983 vented the assembly line because he economic work gets done through long- had concluded that at $500 he could sell he relationship between a term relationships between sellers and millions of cars. Mass production was seller and a buyer seldom ends buyers. It is not a matter of just getting the result, not the cause, of his low Twhen a sale is made. Increas- and then holding on to customers. It is prices…. ingly,the relationship intensifies more a matter of giving the buyers what …Let us start at the beginning: the after the sale and helps determine the they want. Buyers want vendors who customer. It can be shown that mo- buyer’s choice the next time around. keep promises, who’ll keep supplying torists strongly dislike the bother, delay, Such dynamics are found particularly and standing behind what they prom- and experience of buying gasoline. Peo- with services and products dealt in a ised. The era of the one-night stand is ple actually do not buy gasoline. They stream of transactions between seller gone. Marriage is both necessary and cannot see it, taste it, feel it, appreciate and buyer – financial services, consult- more convenient. Products are too com- it, or really test it. What they buy is the ing, general contracting, military and plicated, repeat negotiations too much right to continue driving their cars. space equipment, and capital goods. of a hassle and too costly. Under these The gas station is like a tax collector to The sale, then, merely consummates conditions, success in marketing is whom people are compelled to pay a the courtship, at which point the mar- transformed into the inescapability of periodic toll as the price of using their riage begins. How good the marriage is a relationship. Interface becomes inter- cars. This makes the gas station a basi- depends on how well the seller man- dependence…. cally unpopular institution. It can never ages the relationship. The quality of the During the era we are entering the be made popular or pleasant, only less marriage determines whether there emphasis will be on systems contracts, unpopular, less unpleasant. Reducing its unpopularity completely means eliminating it. Nobody likes a One of the surest signs of a bad or declining tax collector, not even a pleasantly relationship is the absence of complaints from cheerful one. Nobody likes to interrupt that a trip to buy a phantom product, not the customer. Nobody is ever satisfied. even from a handsome Adonis or a se- ductive Venus. Hence, companies that will be continued or expanded busi- and buyer-seller relationships will be are working on exotic fuel substitutes ness, or troubles and divorce. In some characterized by continuous contact that will eliminate the need for fre- cases divorce is impossible, as when a and evolving relationships to effect the quent refueling are heading directly major construction or installation proj- systems. The “sale”will be not just a sys- into the outstretched arms of the irri- ect is under way. If the marriage that tem but a system over time. The value at tated motorist…. remains is burdened, it tarnishes the stake will be the advantages of that In order to produce these customers, seller’s reputation…. total system over time. As the customer the entire corporation must be viewed …In the [traditional] selling scheme gains experience, the technology will as a customer-creating and customer- the seller is located at a distance from decline in importance relative to the sys- satisfying organism. Management must buyers and reaches out with a sales de- tem that enables the buyer to realize think of itself not as producing prod- partment to unload products on them. the benefits of the technology.Services, october 2006 129 THEODORE LEVITT, 1925–2006 • What Business Are You In? delivery, reliability, responsiveness, and but we seldom account for our actions appearance contradicted the intended the quality of the human and organiza- and almost never manage them. Yet a offering of his carefully prepared pre- tional interactions between seller and company’s most precious asset is its re- sentation. No wonder that Thomas Wat- buyer will be more important than the lationships with its customers. What son the elder insisted so uncompromis- technology itself…. matters is not whom you know but how ingly that his salespeople be attired in …It is reasonable for a customer who you are known to them. their famous IBM “uniforms.” While has been promised the moon to expect clothes may not make the person, they it to be delivered. But if those who make may help make the sale. the promises are paid commissions be- The usual presumption about so- fore the customer gets everything he or called undifferentiated commodities is she bargained for, they’re not likely to Marketing that they are exceedingly price sensi- feel compelled to ensure that the cus- Success Through tive. A fractionally lower price gets the tomer gets fully satisfied later. After the business. That is seldom true except in sale, they’ll rush off to pursue other Differentiation – the imagined world of economics text- prey. If marketing plans the sale, sales of Anything books. In the actual world of markets, makes it, manufacturing fulfills it, and nothing is exempt from other consider- Excerpted from January–February 1980 service services it, who’s in charge and ations, even when price competition who takes responsibility for the whole here is no such thing as a com- rages. process? modity. All goods and services During periods of sustained surplus, Problems arise not only because those Tare differentiable. Though the excess capacity, and unrelieved price who do the selling, the marketing, the usual presumption is that this is war, when the attention of all seems riv- manufacturing, and the servicing have more true of consumer goods than of in- eted on nothing save price, it is pre- varying incentives and views of the cus- dustrial goods and services, the oppo- cisely because price is visible and meas- tomer but also because organizations site is the actual case…. urable, and potentially devastating in its are one-dimensional. With the excep- …On the commodities exchanges, for effects, that price deflects attention tion of those who work in sales or mar- example, dealers in metals, grains, and from the possibilities of extricating the keting, people seldom see beyond their pork bellies trade in totally undifferen- product from ravaging price competi- company’s walls. For those inside those tiated generic products. But what they tion. These possibilities, even in the walls, inside is where the work gets “sell” is the claimed distinction of their short run, are not confined simply to done, where the penalties and incen- execution–the efficiency of their trans- nonprice competition, such as harder tives are doled out, where the budgets actions in their clients’ behalf, their re- personal selling, intensified advertising, and plans get made, where engineering sponsiveness to inquiries, the clarity and or what’s loosely called more or better and manufacturing are done, where speed of their confirmations, and the “services.”… performance is measured, where one’s friends and associates gather, where Customers attach value to a product in proportion things are managed and manageable. Outside “has nothing to do with me”and to its perceived ability to help solve their problems is where “you can’t change things.”… or meet their needs. All else is derivative. One of the surest signs of a bad or de- clining relationship is the absence of complaints from the customer. Nobody like. In short, the offered product is dif- Customers attach value to a product is ever that satisfied, especially not over ferentiated, though the generic product in proportion to its perceived ability to an extended period of time. The cus- is identical. help solve their problems or meet their tomer is either not being candid or not When the generic product is undif- needs. All else is derivative…. being contacted – probably both. The ferentiated, the offered product makes Customers never just buy the “ge- absence of candor reflects the decline the difference in getting customers and neric” product like steel, or wheat, or of trust and the deterioration of the re- the delivered product in keeping them. subassemblies, or investment banking, lationship. Bad things accumulate. Im- When the knowledgeable senior part- or aspirin, or engineering consultancy,or paired communication is both a symp- ner of a well-known Chicago brokerage golf balls, or industrial maintenance, tom and a cause of trouble. Things fester firm appeared at a New York City bank or newsprint, or cosmetics, or even 99% inside. When they finally erupt, it’s usu- in a tight-fitting, lime green polyester pure isopropyl alcohol. They buy some- ally too late or too costly to correct the suit and Gucci shoes to solicit business thing that transcends these designa- situation. in financial instrument futures, the out- tions – and what that “something” is We can invest in relationships, and we come was predictably poor. The unin- helps determine from whom they’ll buy, can borrow from them. We all do both, tended offering implied by his sartorial what they’ll pay, and whether, in the

130 harvard business review | hbr.org What Business Are You In? • THEODORE LEVITT, 1925–2006

view of the seller, they’re “loyal” or “fickle.” What that something is in its customer- getting and customer-satisfying entirety can be managed…. …All this may be well known, but the underlying principles encompass much more. The failure to fulfill certain more subtle expectations may reflect unfavor- ably on the generic product. A shabby brokerage office may cost a realtor ac- cess to customers for his or her proper- ties. Even though the lawyer performed brilliantly in the bar exam and occupies offices of prudential elegance, his or her personality may clash with a potential client’s. A manufacturer’s competitively priced machine tools might have the most sophisticated of numerical con- trols tucked tightly behind an impres- sive panel, but certain customers may refuse to buy because output tolerances competition alone. The best way to test availability of its accompanying cus- are more precise than necessary or us- a customer’s assumption that he or she tomer services (e.g., display rooms, deliv- able. The customer may actually expect no longer needs or wants all or any part ery, repairs and maintenance, applica- and want less…. of the augmented product is to consider tion aids, operator training, installation As a rule, the more a seller expands what’s possible to offer that customer. advice, warranty fulfillment). In this the market by teaching and helping cus- sense, General Motors is probably more tomers to use his or her product, the service-intensive than manufacturing- more vulnerable that seller becomes to intensive. Without its services its sales losing them. A customer who no longer would shrivel…. needs help gains the flexibility to shop Production-Line People think of service as quite differ- for things he or she values more – such Approach to Service ent from manufacturing. Service is pre- as price. sumed to be performed by individuals Excerpted from September–October 1972 At this point, it makes sense to embark for other individuals, generally on a one- on a systematic program of customer- he service sector of the econ- to-one basis. Manufacturing is pre- benefiting, and therefore customer- omy is growing in size but sumed to be performed by machines, keeping, product augmentation. The Tshrinking in quality. So say a lot generally tended by large clusters of in- seller should also, of course, focus on of people. Purveyors of service, dividuals whose sizes and configurations cost and price reduction. And that’s for their part, think that they and their are themselves dictated by the ma- the irony of product maturity: Pre- problems are fundamentally different chines’ requirements. Service (whether cisely when price competition height- from other businesses and their prob- customer service or the services of ser- ens, and therefore when cost reduction lems. They feel that service is people- vice industries) is performed “out there becomes more important, is when the intensive, while the rest of the economy in the field”by distant and loosely super- seller is also likely to benefit by incur- is capital-intensive. But these distinc- vised people working under highly vari- ring the additional costs of new product tions are largely spurious. There are no able, and often volatile, conditions. Man- augmentation. such things as service industries. There ufacturing occurs “here in the factory” The augmented product is a condi- are only industries whose service com- under highly centralized, carefully or- tion of a mature market or of relatively ponents are greater or less than those ganized, tightly controlled, and elabo- experienced or sophisticated customers. of other industries. Everybody is in rately engineered conditions. Not that they could not benefit from or service. People assume, and rightly so, that would not respond to extra services; but Often the less there seems, the more these differences largely explain why when customers know or think they there is. The more technologically so- products produced in the factory are know everything and can do anything, phisticated the generic product (e.g., generally more uniform in features the seller must test that assumption or cars and computers), the more depen- and quality than the services produced

PHOTOS COURTESY OF HARVARD BUSINESS SCHOOL BUSINESS OF HARVARD COURTESY PHOTOS be condemned to the purgatory of price dent are its sales on the quality and (e.g., life insurance policies, machine

october 2006 131 THEODORE LEVITT, 1925–2006 • What Business Are You In?

vice industries or in the customer-service sectors of manufacturing and retailing companies – is that one almost inescap- ably embraces ancient, pre-industrial modes of thinking. Worse still, one gets caught up in rigid attitudes that can have a profoundly paralyzing effect on even the most resolute of rationalists. The concept of “service”evokes, from the opaque recesses of the mind, time- worn images of personal ministration and attendance. It refers generally to deeds one individual performs person- ally for another. It carries historical con- notations of charity, gallantry, and self- lessness, or of obedience, subordination, and subjugation. In these contexts, peo- ple serve because they want to (as in the priestly and political professions) or they serve because they are com- pelled to (as in slavery and such occupa- tions of attendance as waiter, maid, bell- boy, cleaning lady). In the higher-status service occupa- tions, such as in the church and the army, one customarily behaves ritualis- tically,not rationally.In the lower-status service occupations, one simply obeys. In neither is independent thinking pre- sumed to be a requisite of holding a job. The most that can therefore be expected from service improvements is that, like Avis, a person will try harder. He will just exert more animal effort to do bet- ter what he is already doing. So it was in ancient times, and so it is today. The only difference is that where ancient masters invoked the will of God or the whip of the foreman to spur per- formance, modern industry uses train- ing programs and motivation sessions. We have not in all these years come very far in either our methods or our results. In short, service thinks humanistically, and that explains its failures. repairs) or delivered (e.g., spare parts, Yet it is doubtful that things need be Now consider manufacturing. Here milk) in the field. One cannot as easily all that bad. Once conditions in the field the orientation is toward the efficient control one’s agents or their perfor- get the same kind of attention that con- production of results, not toward atten- mance out there in the field. Besides, dif- ditions inside the factory generally get, dance on others. Relationships are ferent customers want different things. a lot of new opportunities become pos- strictly businesslike, devoid of invidious The result is that service and service sible. But first management will have to connotations of rank or self. industries, in comparison with manu- revise its thinking about what service is When we think about how to im- facturing industries, are widely and cor- and what it implies. prove manufacturing, we seldom focus rectly viewed as being primitive, slug- The trouble with thinking of oneself on ways to improve our personal perfor- gish, and inefficient. as providing services – either in the ser- mance of present tasks; rather, it is axi-

132 harvard business review | hbr.org omatic that we try to find entirely new ways of performing present tasks and, better yet, of actually changing the tasks themselves. We do not think of greater exertion of our animal energies (work- ing physically harder, as the slave), of greater expansion of our commitment Come to Stanford (being more devout or loyal, as the priest), or of greater assertion of our de- pendence (being more obsequious, as Explore the latest ideas the butler)…. and concepts on traditional …Until we think of service in more positive and encompassing terms, until business practices. it is enthusiastically viewed as manufac- Directed by world-renowned Stanford turing in the field, receptive to the same faculty, our executive programs will kinds of technological approaches that provide you with management research, are used in the factory, the results are innovative leadership insights, and likely to be just as costly and idiosyn- entrepreneurial perspectives that you cratic as the results of the lonely jour- need to maximize value creation for neyman carving things laboriously by your business. hand at home.

UPCOMING The Globalization 2007 PROGRAMS of Markets Influence and Excerpted from May–June 1983 Negotiation powerful force drives the world Strategies Program toward a converging common- April15–20 Aality,and that force is technol- ogy. It has proletarianized Finance and communication, transport, and travel. It Accounting for the has made isolated places and impover- Nonfinancial Manager ished peoples eager for modernity’s April29–May4 allurements. Almost everyone every- where wants all the things they have Strategic heard about, seen, or experienced via Uses of Information the new technologies. Technology The result is a new commercial real- April22–27 ity – the emergence of global markets for standardized consumer products on Financial www.gsb.stanford.edu/exed a previously unimagined scale of magni- Management Program tude. Corporations geared to this new May6–11 reality benefit from enormous econo- mies of scale in production, distribution, marketing, and management. By trans- lating these benefits into reduced world prices, they can decimate competitors that still live in the disabling grip of old assumptions about how the world Change lives. Change organizations. Change the world. works…. Who can forget the televised scenes during the 1979 Iranian uprisings of Phone: 866.542.2205 (toll free, U.S. and Canada only) or 650.723.3341 Email: [email protected] october 2006 THEODORE LEVITT, 1925–2006 • What Business Are You In? young men in fashionable French-cut trousers and silky body shirts thirsting The global competitor will seek constantly for blood with raised modern weapons to standardize its offering everywhere. in the name of Islamic fundamental- ism?… It will digress from this standardization only after The most effective world competitors exhausting all possibilities to retain it. incorporate superior quality and relia- bility into their cost structures. They sell in all national markets the same kind of globally identical with respect to design, steel, cars, motorcycles, hi-fi equipment, products sold at home or in their largest function, and even fashion. farm machinery, robots, microproces- export market. They compete on the That, and little else, explains the sors, carbon fibers, and now even tex- basis of appropriate value – the best surging success of Japanese companies tiles, and intangibles like banking, ship- combinations of price, quality, reliabil- dealing worldwide in a vast variety of ping, general contracting, and soon ity, and delivery for products that are products – both tangible products like computer software. Nor are high-quality

Theodore Levitt’s HBR Articles

Advertising: “The Poetry Marketing Tactics in Exploit the Product Life Cycle of Becoming” a Time of Shortages November–December 1965 March–April 1993 November–December 1974 When Science Supplants The Case of the Migrating The Managerial Merry-Go-Round Technology… Markets July–August 1974 July–August 1963 July–August 1990 Production-Line Approach Creativity Is Not Enough After the Sale Is Over… to Service May–June 1963, September–October 1983 September–October 1972 republished August 2002

The Globalization of Markets The Morality (?) of Advertising M-R Snake Dance May–June 1983 July–August 1970 November–December 1960

Marketing Intangible Products The New Markets – Think Marketing Myopia and Product Intangibles Before You Leap July–August 1960, May–June 1981 May–June 1969 republished September–October 1975 and July–August 2004 Marketing Success Through Why Business Always Loses Differentiation – of Anything March–April 1968 Cold-War Thaw January–February 1980 January–February 1960 The Johnson Treatment Marketing When Things Change January–February 1967 The Dangers of Social November–December 1977 Responsibility Innovative Imitation September–October 1958 The Industrialization of Service September–October 1966 September–October 1976 The Changing Character Branding on Trial of Capitalism Dinosaurs Among the Bears March–April 1966 July–August 1956 and Bulls January–February 1975

134 harvard business review | hbr.org and low-cost operations incompatible, as a host of consulting organizations Leaders are made, not born, and data engineers argue with vigorous vacuity. The reported data are incom- through experience plete, wrongly analyzed, and contradic- tory. The truth is that low-cost opera- tions are the hallmark of corporate and education cultures that require and produce qual- ity in all that they do. High quality and low costs are not opposing postures. They are compatible, twin identities of superior practice. To say that Japan’s companies are not global because they export cars with left-side drives to the United States and the European continent, while those in Japan have right-side drives, or because they sell office machines through dis- tributors in the United States but di- rectly at home, or speak Portuguese in Brazil is to mistake a difference for a dis- tinction. The same is true of Safeway and Southland retail chains operating The Stanford Sloan Master’s Program effectively in the Middle East, and to not only native but also imported pop- The Stanford Sloan Master’s Program is a demanding ten-month ulations from Korea, the Philippines, experience that builds on the demonstrated ability of mid-career Pakistan, India, Thailand, Britain, and executives by opening minds and stretching capacities. Stanford Sloan the United States. National rules of the Fellows gain mastery of advanced management expertise, acquire a road differ, and so do distribution chan- global strategic perspective, develop team-building skills and deepen nels and languages. Japan’s distinction is personal leadership strengths, in the dynamic setting of Silicon Valley. its unrelenting push for economy and Corporate sponsors benefit from the accelerated development of prom- value enhancement. That translates into ising leaders who return ready to take on increased responsibilities. a drive for standardization at high qual- ity levels…. Self-sponsored Fellows gain the skills and entrepreneurial spirit The global competitor will seek con- essential to launch a new enterprise. stantly to standardize its offering every- where. It will digress from this stan- “The Stanford Sloan Master’s Program is one dardization only after exhausting all of the most interesting and creative programmes possibilities to retain it, and will push for in the whole field of management education — reinstatement of standardization when- linking ideas and practicality, analysis and ever digression and divergence have oc- action. I recommend it unreservedly”. curred. It will never assume that the — Lord Browne of Madingley, Group Chief Executive of BP plc customer is a king who knows his own Stanford Sloan ’81 wishes…. The Hoover case illustrates how the perverse practice of the marketing con- Developing Leaders for a cept and the absence of any kind of mar- keting imagination let multinational Changing Global Environment attitudes survive when customers actu- ally want the benefits of global stan- dardization. The whole project got off on the wrong foot. It asked people what features they wanted in a washing ma- chine rather than what they wanted For more information phone +1 (650) 723-2149 or visit us online at: out of life. Selling a line of products www.gsb.stanford.edu/sloanmasters october 2006 Open up to individually tailored to each nation is markets is to make a valid point. Eco- great ideas thoughtless. Managers who took pride nomic nationalism does have a power- in practicing the marketing concept to ful persistence. But, as with the present the fullest did not, in fact, practice it at almost totally smooth international- all. Hoover asked the wrong questions, ization of investment capital, the past then applied neither thought nor imag- alone does not shape or predict the ination to the answers. Such compa- future…. nies are like the ethnocentricists in the Reality is not a fixed paradigm, dom- Middle Ages who saw with everyday inated by immemorial customs and de- clarity the sun revolving around the rived attitudes, heedless of powerful earth and offered it as Truth. With no and abundant new forces. The world is additional data but a more searching becoming increasingly informed about mind, Copernicus, like the hedgehog, in- the liberating and enhancing possibili- terpreted a more compelling and accu- ties of modernity.The persistence of the rate reality. Data do not yield informa- inherited varieties of national prefer- tion except with the intervention of ences rests uneasily on increasing evi- the mind. Information does not yield dence of, and restlessness regarding, “A must-read, fille d with important insights that leaders of all types will find meaning except with the intervention their inefficiency, costliness, and con- extremely valuable.” of imagination. finement. The historic past, and the na- Larry Lucchino, President/CEO, Boston Red Sox The global corporation accepts for tional differences respecting commerce better or for worse that technology and industry it spawned and fostered drives consumers relentlessly toward everywhere, is now subject to relatively the same common goals–alleviation of easy transformation. life’s burdens and the expansion of dis- Cosmopolitanism is no longer the mo- cretionary time and spending power…. nopoly of the intellectual and leisure Significantly,Japanese companies op- classes; it is becoming the established erate almost entirely without market- property and defining characteristic of ing departments or market research of all sectors everywhere in the world. the kind so prevalent in the West. Yet Gradually and irresistibly it breaks in the colorful words of General Elec- down the walls of economic insularity, tric’s chairman John F. Welch, Jr., the nationalism, and chauvinism. What we Japanese, coming from a small cluster of see today as escalating commercial na- resource-poor islands, with an entirely tionalism is simply the last violent death “An incredible story about an outdoor industry alien culture and an almost impenetra- rattle of an obsolete institution…. icon, L.L.Bean, that became a national treasure.” bly complex language, have cracked the The earth is round, but for most pur- Jim Whittaker, former President and CEO of REI code of Western markets. They have poses it’s sensible to treat it as flat. done it not by looking with mechanistic thoroughness at the way markets are different but rather by searching for meaning with a deeper wisdom. They have discovered the one great thing all Creativity Is Not markets have in common – an over- Enough whelming desire for dependable, world- Excerpted from May–June 1963 standard modernity in all things, at ag- gressively low prices. In response, they reativity” is not the miracu- deliver irresistible value everywhere, lous road to business growth attracting people with products that “C and affluence that is so market-research technocrats described abundantly claimed these with superficial certainty as being un- days. And for the line manager, particu- “Drop what you are doing and read it!” suitable and uncompetitive…. larly,it may be more of a millstone than Gil Amelio, former Chairmanand CEO, Apple Computer To refer to the persistence of eco- a milestone. Those who extol the liber-

Available wherever books are sold, including: nomic nationalism (protective and sub- ating virtues of corporate creativity over www.amazon.com/hbspfall06 sidized trade practices, special tax aids, the somnambulistic vices of corporate or restrictions for home market produc- conformity may actually be giving ad- ers) as a barrier to the globalization of vice that in the end will reduce the cre- www.HBSPress.org harvard business review | hbr.org ative animation of business. This is be- workers of America, the U.S. Army or cause they tend to confuse the getting of the Salvation Army, the United States ideas with their implementation – that or the U.S.S.R., the purpose of organiza- is, confuse creativity in the abstract with tion is to achieve the kind and degree of practical innovation; not understand the order and conformity necessary to do a operating executive’s day-to-day prob- particular job. The organization exists to lems; and underestimate the intricate restrict and channel the range of indi- complexity of business organizations…. vidual actions and behavior into a pre- The fact that you can put a dozen in- dictable and knowable routine. Without experienced people into a room and organization there would be chaos and 2006 conduct a brainstorming session that decay. Organization exists in order to produces exciting new ideas shows how create that amount and kind of inflexi- Medical little relative importance ideas them- bility that are necessary to get the most selves actually have. Almost anybody pressingly intended job done efficiently Innovation with the intelligence of the average busi- and on time…. nessman can produce them, given a All this raises a seemingly frightening Summit halfway decent environment and stim- question. If conformity and rigidity are ulus. The scarce people are those who necessary requisites of organization, Neurosciences InterContinental Hotel & MBNA For the line manager, particularly, creativity Conference Center I Cleveland, Ohio may be more of a millstone than a milestone. have the know-how, energy, daring, and and if these in turn help stifle creativity, REGISTER NOW staying power to implement ideas…. and furthermore if the creative man November 6-8, 2006 The reason the executive so often re- might indeed be stifled if he is required jects new ideas is that he is a busy man to spell out the details needed to con- Join Jeff Immelt, GE; Jim Tobin, whose chief day-in, day-out task is to vert his ideas into effective innovations, Boston Scientific; Larry Glasscock, handle an ongoing stream of problems. does all this mean that modern organi- Wellpoint; Ron Williams, Aetna, He receives an unending flow of ques- zations have evolved into such invo- and many other top CEOs, venture tions on which decisions must be made. luted monsters that they must suffer the investors, medical leaders and Constantly he is forced to deal with fearful fate of the dinosaur–too big and journalists as they highlight new problems to which solutions are more unwieldy to survive? technologies and trends in the or less urgent and the answers to which The answer to this is no. First, it is neurosciences. Also featured will are far from clear-cut. It may seem questionable whether the creative im- be the Cleveland Clinic’s selection splendid to a subordinate to supply his pulse would automatically dry up if the boss with a lot of brilliant new ideas to idea man is required to take some re- of the year’s “Top 10” health help him in his job. But advocates of sponsibility for follow-through. The peo- care innovations, live, interactive creativity must once and for all under- ple who so resolutely proclaim their surgeries and in-depth debates stand the pressing facts of the execu- own creative energy will scarcely assert on industry challenges. 800 top-level tive’s life: Every time an idea is submit- that they need a hothouse for its flower- senior industry executives, entrepre- ted to him, it creates more problems for ing. Secondly,the large organization has neurs, investors and clinicians will him–and he already has enough…. some important attributes that actually attend the 4th annual Medical …Advocacy of a “permissive environ- facilitate innovation. Its capacity to dis- Innovation Summit on the Cleveland ment”for creativity in an organization is tribute risk over its broad economic base Clinic campus. Members of the world often a veiled attack on the idea of the and among the many individuals in- renowned Cleveland Orchestra will organization itself. This quickly be- volved in implementing newness is sig- perform at the opening night gala. comes clear when one recognizes this nificant. They make it both economi- inescapable fact: One of the collateral cally and, for the individuals involved, purposes of an organization is to be in- personally easier to break untried To register now or for more hospitable to a great and constant flow ground. information visit of ideas and creativity. www.clevelandclinic.org/innovations Whether we are talking about the U.S. Reprint R0610J Steel Corporation or the United Steel- To order, see page 151. or call 216.932.3448. Limited seating. october 2006 BOSTON September 16 WASHINGTON, D.C. September 30 CHICAGO October 14 SAN FRANCISCO October 28 NEW YORK November 18

Celebrating 150 years of publishing, The Atlantic will host a national tour, convening prominent writers, commentators, and public figures for conversation and a celebration of ideas.

Featuring leading voices, such as: MARK BOWDEN CARL CANNON CLIVE CROOK JAMES FALLOWS CORBY KUMMER SANDRA TSING LOH BEN MEZRICH VIRGINIA POSTREL DANA ADAM SHAPIRO CURTIS SITTENFELD and newly appointed Editor JAMES BENNET

To purchase tickets, visit www.theatlantic.com/ideastour. Letters to the Editor

Why Innovation in Health Care Is used properly by consumers–can affect So Hard the type of health care services that peo- ple demand. In the short term, however, After reading Regina E. Herzlinger’s CDHPs have only helped employers May 2006 article, “Why Innovation in shift the responsibility for, and the cost Health Care Is So Hard” (May 2006), I of health care to their employees. And am increasingly doubtful about whether this shifting of costs hasn’t necessarily the consumer-driven approach to health created any true savings for the U.S. care that she espouses can improve the health care system. system. Our current health care system Another critical aspect of consumer- doesn’t lack for innovation; it lacks for directed health plans is the notion of implementation. finances – in particular, deductibles. As In the past few years, consumer- part of these plans, consumers must pay directed health plans (CDHPs) and their for designated services out of pocket be- fore catastrophic coverage kicks in. As a result, people with low incomes tend to avoid seeking some of these basic health care services, even preventive care, for fear they may not be able to af- ford them. Meanwhile, people with higher incomes are assuming some of the added costs of health care, but this increase, while bothersome, still may not prompt them to change their health care consumption. (The person who will pay $2,000 to get his teeth whitened by lasers may not be the best person to drive efficiency in the U.S.health care sys- tem.) Unless those in the upper-middle associated health savings accounts income bracket can cause some kind of have been thrust into the limelight. Cen- health care tipping point, it is unlikely tral to the success of these plans is the that CDHPs, as they are currently con- notion of transparent information. Con- figured, will be able to positively affect sumers have greater access to the met- the health care system in the long term. rics that providers and payers use to de- Even before the new Medicare drug termine the cost of services and to plan came into being, taxpayers already measure the quality of care and out- were funding more than half of all health comes. With these data, which were pre- care costs. Taxpayers will probably end up viously hidden somewhere inside orga- paying even more as the demographics nizational databases, consumers can change and as fewer employers fund make more-informed health care deci- health care for their employees. While sions. The idea is that this increased in- we do not have a single-payer system, we formation – if it can be absorbed and have already moved to a situation in

We welcome letters from all readers wishing to comment on articles in this issue. Early responses have the best chance of being published. Please be concise and include your title, company affiliation, lo- cation, and phone number. E-mail us at [email protected]; send faxes to 617-783-7493; or write to The Editor, Harvard Business Review, 60 Harvard Way,Boston, MA 02163. HBR reserves the right to solicit and edit letters and to republish letters as reprints. october 2006 139 LETTERS TO THE EDITOR

which the government–if it could coor- niors, but it also calls for, among other more innovations in health care. Rather, dinate all its health care programs – things, improvements in chronic care the U.S. government should compel could create a single-buyer system. services; the establishment of special- the dissemination of the innovations he Herzlinger makes the point that we needs plans, health savings accounts, claims already exist, such as electronic need more health care models, and that and medication therapy management; medical records. Like others who favor is clearly true. Some existing and de- pay-for-performance pilot programs; increased government control of health veloping models hold promise. For in- and technology upgrades that will care, he deprecates consumers’ability to stance, the health care system of the U.S. allow for electronic prescriptions and spur helpful innovation; but if consum- Department of Veterans Affairs 20 years medical records. These concepts aren’t ers are as stupid and vain as Walker ago was downright scary. Today, the VA necessarily new; EMRs have been thinks, how did they cause complicated is becoming a model of care and effi- around since the 1960s. They just need products like cars and computers to be- ciency. It has improved by focusing its a buyer to push them toward wider come better and cheaper? efforts in just a few important areas: adoption and implementation. When it comes to health care, Walker’s treating whole patients, for example, Substantial improvements in the U.S. assertions about the effects of con- not just specific diseases or body parts; health care system are possible if we can sumer control are simply wrong, as my implementing an electronic system for effectively implement the innovations book Consumer-Driven Health Care its medical records (EMR); and setting we’ve already created. And the U.S. gov- demonstrates. The consumer-driven clear performance metrics for the en- ernment, as buyer, will need to push for health care system in Switzerland is tire system. Other new models are grow- that to happen. both better and cheaper than the U.S. ing out of the Medicare Prescription Albert Walker health care system – and it is unlike the Drug, Improvement, and Moderniza- Partner government-controlled systems in the tion Act of 2003 (MMA), which recog- Pelorus Management Consultants UK and Canada, which save money by nizes the major role government plays Livingston, New Jersey denying care to the sick. His assertion as a buyer of health care services. The about the lack of preventive care in MMA is best known for establishing Herzlinger responds: Albert Walker ap- consumer-driven systems is also wrong. a new prescription drug benefit for se- pears to believe that we do not need any A recent McKinsey survey found that

Energizing People for Performance november 12–17

A program where the business world’s most courageous minds tackle its most challenging issues. execed.kellogg.northwestern.edu 847-491-3100 Merger Week: those people enrolled in high-deductible agency’s mission is a relatively straight- plans, virtually all of which offer com- forward task when everyone agrees on Creating Value through plete coverage of preventive care, prac- the desired outcomes. However, such Strategic Acquisitions ticed more self-care than they did improvements are much more difficult and Alliances when they were fully insured. Equally to achieve when objectives clash, as they november 12–17, 2006 wrong is Walker’s claim about the cur- often do in government. It is perhaps rent feasibility of EMRs. The U.S. health significant that the three organizations Supply Chain Finance: care system lacks even the uniform data cited in the article mainly have com- Integrating Financial and standards needed to make them hap- plementary objectives or work on a pen – largely because of the govern- project basis. Even in the OSHA exam- Customer Information ment’s micromanaged pricing system, ple, though, distinguishing the mission december 3–6, 3006 which strangles innovation. from the change effort will reveal the Walker wants to send U.S. health care possible tension between establishing Negotiation Strategies back to the USSR – back to a system in safety measures and levying compliance for Managers which government wisdom and innova- costs on American businesses. december 3–6, 2006 tion compensate for consumers’frivolity Second, performance against mission and ignorance. This is not a trip most is hard to demonstrate when the mis- Factory Physics: Americans – or most former citizens of sion is preventive; it may not be imme- the Soviet Union–would favor. diately clear how many negative out- The Science of comes the agency averted. An agency Lean Manufacturing may experience a high number of fail- february 11–13, 2007 Change Management ures yet demonstrate outstanding over- in Government all performance. Managing New Products Third, public sector leadership is dif- and Services for Strategic Frank Ostroff’s May 2006 article,“Change ferent from private sector leadership. Competitive Advantage Management in Government,” tackles Public sector leaders may be either po- february 11–14, 2007 important questions about whether litical appointees or career administra- best practices from the private sector can tors who are responsible for carrying cross over into the public sector. “What out others’ policies. The appointee may Supply Chain lessons can we take from business?”has struggle to build effective working rela- Management: been a challenge to government leaders tionships with staffers who are operat- Strategy and Planning for at least 30 years, and the results have ing in a different context from his or her for Effective Operations been mixed. Either the implanted busi- own. The career administrator, who may february 13–16, 2007 ness practice flounders in an unfamiliar work with a series of politicians during political environment, or the host his or her professional life, may be wary agency’s immune system rejects the im- of becoming too closely identified with Accelerating Sales plant. Business implants have failed, in the rhetoric and programs of any one Force Performance part, because agencies’ capacity to politician. february 25–march 1, 2007 change their methods of delivering ser- The danger in promoting lessons vices has been modest. For instance, it’s from another sector (or even another Advanced extremely difficult for government industry) is that it is all too easy for the Executive Program agencies to switch financial or human opponents of change to deny the leader march 4–30, 2007 resources from low-return areas to that last crucial 10% of effort because higher-return areas if citizens have no they haven’t seen the best practices effective choice of supply. Additionally, work in their own environment. Last- public sector organizations find it diffi- ing reform is most likely to come from Upcoming programs where the business cult to experiment with change because internal reform. world’s most courageous minds tackle the political process looks for instant Ian B. Beesley its most challenging issues. scalability and has a low tolerance for Chairman execed.kellogg.northwestern.edu varying levels of service in different Wisdom of the Ancients Consulting parts of the sector. London 847-491-3100 I can see three possible complica- tions in Ostroff’s methods for enacting Ostroff responds: The three U.S. govern- change at government organizations. ment agencies I discuss in the article First, improving performance against an provide the strongest evidence for my october 2006 LETTERS TO THE EDITOR response to Ian Beesley. The organiza- The Unexpected Benefits of collected quickly enough. Using these tions are quite different from one an- Sarbanes-Oxley data, senior management can take other: The Occupational Safety and measures to improve the operational Health Administration (OSHA) is a reg- Stephen Wagner and Lee Dittmar’s and financial efficiency of the organiza- ulatory agency with enforcement re- April 2006 article, “The Unexpected tion. In some cases, a detailed perusal of sponsibilities. Its mission is to ensure Benefits of Sarbanes-Oxley,” suggests the financial data may uncover fraud. the safety and health of American work- that the biggest advantages of imple- The controls required by Sarbanes- ers. The Government Accountability Of- menting controls under Sarbanes-Oxley Oxley are necessary if the accounting fice (GAO) is the investigatory arm of are mostly administrative. That is, as data are to be correct and useful. But ac- the U.S. Congress. Its mission is to sup- a result of SOX, we have more-efficient counting procedures and data aren’t port Congress and help improve per- accounting procedures, less duplica- there just for administrative purposes; formance and accountability in the tion of data entry and checking, they’re also there to improve the com- federal government. The U.S. Special clearer definitions of the content of pany’s net earnings. Operations Command is an elite mili- reports, more standardization of func- Peter Van der Heyden tary force. Its mission is to conduct tions across different divisions or geo- Consultant global operations against terrorist graphic locations, and so on. All of these Asesoria Más + networks. changes obviously create organizational Puebla, Mexico All three organizations utilized best improvements. practices from wherever they could But Accounting is not there just to Wagner and Dittmar respond: Peter Van find them – private sector, the public show the numbers. If Sales says it sold der Heyden is correct in stating that sector, or within themselves. At OSHA, one million widgets at $10 each, we “Accounting is not there just to show for example, a cross-functional, multi- don’t learn anything new when Ac- the numbers.”Indeed, at top-performing level employee change team with exter- counting reports that the total amount firms, the role of corporate finance has nal support identified the relevant and broadened from retrospective (produc- BEST PRACTICE highest-impact best practices and then ing financial statements) to prospec- tailored their application to OSHA’s par- A few smart companies have stopped complaining tive (producing insights into the busi- about Sarbanes-Oxley, the investor-protection law, and turned it to their advantage–bringing operations under ticular situation and environment. The better control while driving down compliance costs. ness). Forward-thinking accounting and employees’ extensive involvement in corporate finance departments are par- all phases of the overall change effort The Unexpected Benefits ticipating in their companies’ strategic generated an extraordinarily high de- of Sarbanes-Oxley planning processes; they’re improving gree of internal “ownership”of the rec- by Stephen Wagner and Lee Dittmar executives’ decision making and con- ommendations that were made and the hen Congress hurriedly passed a small subset who approached the new tributing to the bottom line. Wthe Sarbanes-Oxley Act of 2002,it law with something like gratitude. For had in mind combating fraud, improv- years, and especially when financial re- ing the reliability of financial reporting, porting had become fast and loose and changes that were implemented. By and restoring investor confidence. Un- criminal conduct entrenched at places But there is a serious issue that derstandably,most executives wondered like WorldCom and Enron, these execu- why they should be subjected to the tives had secretly wished that some of same compliance burdens as those the resources absorbed by their compa- choosing a proactive, problem-solving who had been negligent or dishonest. nies’ profit centers could have been di- Sarbanes-Oxley initiatives helped to Smaller companies in particular com- verted to improving financial manage- plained about the monopolization of ment processes and capabilities. They executives’ time and costs running into were thinking not only of protecting enforcement strategy and developing the millions of dollars. stakeholders and shielding their compa- expose and that companies are starting Perhaps SOX’s most burdensome ele- nies from lawsuits but of developing ment was Section 404, which says that it better information about company op- is management’s responsibility to main- erations in order to avoid making bad the organizational capacity to execute tain a sound internal-control structure decisions. to address: Before the advent of SOX, for financial reporting and to assess its However, the burdens of implement- own effectiveness, and that it is the au- ing SOX for the first time, in 2004, were ditors’ responsibility to attest to the so great that this more forward-thinking it, OSHA’s developed a highly effective soundness of management’s assessment group could give little time to develop- the quality of information that finance and report on the state of the overall fi- ing and adopting policies and practices nancial control system. (See the sidebar that went beyond literal compliance. “Taking Control of Controls.”) Some spoke of putting their planned “third way” of improving performance Yet in the course of providing compli- initiatives in a “parking lot,’’ with the executives received was often insuffi-

TIM ELLIS ance advice to executives, we discovered hope of pursuing them the following while avoiding the traditional zero- april 2006 133 cient for them to draw meaningful sum trade-off of safety versus compli- conclusions. Supporting this observa- ance costs. of sales invoiced was $10 million. The ac- tion is a 2005 survey sponsored by De- Despite their differences, all three counting group’s broader function is (or loitte Consulting (www.deloitte.com/us/ organizations successfully applied the should be) helping senior management IQmatters) in which fewer than half the five principles described in the article to see where income is too low and how it respondents believed they had achieved implement deep changes throughout can be increased, or where costs are too their information-quality objectives. their systems – including leadership ap- high and how they can be decreased. Thus, while we agree that “administra- proach, structure, processes, infrastruc- Maybe the company gave its custom- tive”benefits should not be the sole out- ture (including technology), people, and ers too many discounts; maybe there come of Sarbanes-Oxley, we also note performance management – and to were too many product returns. The ac- that these gains are a necessary an- achieve significant, sustained improve- counting group can compare the ratio tecedent to operational and bottom-line ment in performance against their mis- of administrative expenses to sales improvements. That is, it’s tough to sions. Their clear success suggests that across divisions and determine where make good decisions when you have a wide range of other government agen- to make improvements. It can identify bad data. cies could use the five principles to do obsolete materials in inventory. It can Many benefits can be extracted from the same. check whether the receivables are being the compliance process; space constraints

142 harvard business review | hbr.org LETTERS TO THE EDITOR allowed us to present only a few case and churn rates in each cluster. They make no such claim and agree with him studies. Leaders at world-class compa- also can include each new salesperson’s that “the relation between sales force nies will discover their own opportuni- expected ramp-up time, predict the ef- importance and a business’s life cycle ties for improvement rather than get- fect that transferring current accounts depends, finally, on the environment.” ting bogged down in the minutiae of into new territories may have on attri- Our focus is on what issues sales leaders documentation and testing. tion, and determine whether any sales should concentrate on at each stage in uplift or erosion may occur in the terri- the life cycle. In maturity, most compa- tories from which the accounts were nies benefit more by enhancing the ef- Match Your Sales Force Structure transferred. fectiveness of the selling organization to Your Business Life Cycle The relation between sales force im- than by worrying about size. The same portance and a business’s life cycle de- marginal approach that is used for siz- In “Match Your Sales Force Structure to pends, finally, on the environment in ing can be used to enhance effective- Your Business Life Cycle” (July–August which a product or service is being sold. ness by better allocating sales resources 2006), Andris A. Zoltners, Prabhakant If the market is savvy and the vendor to customers, markets, products, or sales Sinha, and Sally E. Lorimer remind us of has established strong coverage and force activities. the importance of dynamically aligning credibility, a business may rely less on It is impossible to draw general con- sales resource levels with the life-cycle selling during the growth phase than it clusions about sales force sizing and stage of a business. However, with a few once did. But as long as products and go-to-market strategy. There are always exceptions, sales force sizing cannot be feature-benefit sets continue to change, situations that break the rules. However, reliably carried out using aggregate or a company’s competitive position re- valuable processes are available to help metrics of central tendency, such as mains challenged as competitors match companies with these decisions. overall sales force averages for costs, rev- the firm’s internal competencies, sales On a slightly different note, in “The enues, and profit margins. Only in high- force importance will remain high in Sales Learning Curve” (July–August density, highly engineered territories the overall marketing mix, even into 2006), Mark Leslie and Charles A. Hol- such as the pharmaceutical industry, market maturity. loway propose that high-tech start-ups consumer packaged goods, and call Edward A. Francisco can mistakenly scale their sales organi- centers can these methods and metrics Managing Partner zations too fast. We find this to be a valu- yield good estimates of optimal sales CRMlogics Consulting able insight that runs counter to the force size. Dallas suggestion in our article that start-ups Most business-to-business sales forces tend to undersize. Perhaps the mediator are more complex and fluid, perform- Zoltners, Sinha, and Lorimer respond: for the two differing conclusions is un- ing multiple sales roles across multiple Edward Francisco asserts that “with a certainty. In low market- or product- job titles, product sets, market segments, few exceptions, sales force sizing cannot uncertainty environments, the under- competitive settings, and account ma- be reliably carried out using aggregate sizing error tends to be more frequent, turities. These complexities mean that metrics of central tendency,”and, there- but in high-uncertainty environments sales planners need to know what their fore, companies should focus on “mar- with strong learning-curve effects, get- marginal costs, revenues, and gross mar- ginal metrics of sales response.”But he ting it right first and then scaling the gins will be if the sales head count is is mistaken when he interprets our arti- organization is the best approach. changed. For example, when large sales cle to mean that we suggest aggregate forces respond to competition by seek- measures can be used for sales force siz- ing to increase market share, marginal ing. In fact, we specifically advocate Building the Green Way as well as total selling costs per transac- using marginal metrics in our sizing tion tend to climb because transaction table. Marginal metrics have been the If creating and operating a green build- expenses and head counts are increased. preferred way of sizing for many years. ing were as easy as Charles Lockwood Once marginal costs and revenues start That’s what incremental sales are all suggests in “Building the Green Way” behaving differently,historical averages about, even in “high-density, highly en- (June 2006), no one would build any become poor predictors. gineered territories.”What we propose other type. While there are benefits to By focusing on marginal metrics of is that companies take this idea of incre- going green, getting there is not always sales response, a company can model mental sales even further and assess easy. For example, the author cites pre- the unique characteristics of each in- carryover, the future impact of current sumed experts who warn of supposed ternally clustered type of sales job or selling efforts. health risks from vinyl flooring, but he territory. These models can lead to Francisco also challenges a perceived should also note that all materials have sharpened rate-of-change decision tools premise of our article: that sales force environmental impacts. for predicting selling costs, close rates, resource levels should be low when Polyvinyl chloride (PVC) is regu- account loads, product mix, margins, companies are in a mature stage. We lated for safety by the Food and Drug october 2006 143 LETTERS TO THE EDITOR

Administration as the material of choice ton found that “the common practice of on this type of crutch than in exploring for blood bags and medical tubing. It is storing blood and drug formulations in alternate motivation methods. Sales or- widely used in pipes to deliver safe PVC bags causes phthalates to leach ganizations, which have typically con- drinking water, and it passes muster into the contents of the bag…. New- centrated performance management with the Consumer Product Safety born infants that receive a single blood solely on revenue-generating activities, Commission for use in toys. Many prod- transfusion have been found to have are not communicating clearly or com- ucts made of vinyl (and other materials) extremely high levels of phthalates in pensating based on the changing job can meet standards for low emissions their systems.” responsibilities and skills now required of volatile organic compounds. The One goal of green building is to re- in the field. draft report of the PVC Task Group of move the negative environmental and To adopt SFA successfully, a com- the U.S. Green Building Council and the human health impacts associated with pany needs to integrate it beyond the final report on vinyl’s life cycle from building materials. Rather than trying to level of the user, the sales unit leader, the European Commission both found justify the status quo, the Vinyl Insti- and the IT department. SFA has to be- vinyl products as acceptable as – and in tute should learn from paint manufac- come part of the overall corporate cul- some cases preferable to – products turers. Forty years ago, they sold lead ture. Companies can achieve that end made of competing materials. paint across the country.Today,they are not by mandating usage but by making Tim Burns producing lead-free low- and zero-VOC sure human-capital management ex- President and CEO paints. Challenging the status quo and perts assess training programs and offer- The Vinyl Institute doing things differently, and better, is ing compensation alternatives to im- Arlington, Virginia how we improve the world. prove compliance. Barbara McCormack Lockwood responds: Tim Burns’s insis- Vice President, Sales tence that widespread use of a product Selling the Sales Force on Whitney International denotes safety is absurd. Burns draws Automation Boston his claims about the PVC Task Group from a 2004 draft report, marked “do Mark Cotteleer, Edward Inderrieden, Cotteleer, Inderrieden, and Lee respond: not cite or quote,”that does not vindi- and Felissa Lee, the authors of “Selling We are delighted that Barbara McCor- cate PVC as a building material. The the Sales Force on Automation” (Fore- mack agrees with our central thesis that U.S. Green Building Council is still thought, July–August 2006), merely re- it is only when a company figures out gathering research and reviewing state what those in the field have how to embed the automation system more than 2,000 comments it received known for some time: Sales force au- into its culture that the change pays off. on that draft. It will not make a final tomation tools produce internal effi- Certainly,those who have already strug- determination about awarding credits ciencies, and often the value proposi- gled to deploy SFA have learned some to buildings that do not use PVC prod- tion for the end user can become lost in of these lessons. Our intent is to provide ucts until it issues its final report later translation. What they fail to point out insight to those who have yet to embark this year. is that the most commonly used SFA on such efforts. Hundreds of studies have identified products also fall short of providing an In our view, mandatory use puts many hazards inherent in the manufac- action-based training platform that en- more pressure on the firm than on the ture, use, and disposal of PVC (vinyl) gages sales professionals. Early on, it be- individual. The reality is that many products. Kaiser Permanente has stated came clear that the “What’s in it for sales representatives do derive a large that “no less than four PBTs (persistent me?” model was losing ground to com- percentage of their pay from compensa- bioaccumulative toxins) are directly plex and less-than-motivating systems- tion plans, and managers do need to associated with PVC manufacturing, training methods, such as computer- balance their SFA plans with the well- use, and disposal: cadmium, lead, mer- based models and Web site replays. So documented tendency of performance cury, and dioxins and furans.” The Fire before you call for mandatory compli- to dip following implementation and Brigades Union of Great Britain has ance, I would suggest a review of the with sales representatives’reluctance to urged eliminating PVC products in training delivery process to see whether take time from core field activities for buildings because “the combustion of it passes the snooze test! training. Avoiding excessive turnover PVC…in a fire leads to the release of I agree that “ramp” and ease of tran- demands that SFA be a well-supported dioxins and furans, which may then be sition are essential to the overall success and effectively taught part of company spread over a wide area by the smoke of adaptation. However,“excusing tem- culture. plume.”In his briefing report,“Environ- porary drops in performance and giv- Harris Interactive provides an out- mental Impacts of Polyvinyl Chloride ing breaks on quotas” seems like an standing example of these principles in (PVC) Building Materials,” Columbia academic’s approach to a complex busi- action. Having struggled with earlier ef- University research scientist Joe Thorn- ness issue. There is more risk in relying forts, it incorporated multiple perspec-

144 harvard business review | hbr.org LETTERS TO THE EDITOR tives and deployed a system that the Top Line,” Schering-Plough CEO Fred For the past five years, the focus has whole firm, including sales, research, Hassan talks about the power of philoso- been on cost-cutting your way to profit and finance, saw value in using. Harris phies, attitudes, and trust building in growth as opposed to tackling the also supported the rollout by assisting in sales: pure popular-camp material. tougher challenge of growing the top the conversion of sales representatives By contrast, with a 30-year trove of line organically. I wonder when more to SFA. Through the company’s integra- classic sales articles from which to leaders will discover that minimizing tion with finance, it effectively made the choose, HBR’s editors decided to reprint the variation in performance across system’s use mandatory, promoting three (again, my subjective count) on the sales organization is probably one long-term assimilation. the “popular” subject of humans en- of their biggest growth opportunities gaged in commerce and only one on in the short to medium term. There is “management.” generally a ten-to-one range in perfor- Special Double Issue on Sales An article on the world’s greatest fi- mance across sales organizations, indi- nancier, manufacturer, strategist, or cating something akin to a 75/25 rule at HBR Editor Thomas A. Stewart finds it marketer would probably read like work in most companies, where 25% of “puzzling” that A-list business schools something from the academic camp. the organization is generating 75% don’t offer much of a sales curriculum. of the overall results. By improving per- The reason, Stewart says in the maga- THE WORLD’S GREATEST SALESMAN…page 16 formance in the middle 50% of your zine’s excellent sales issue (July–August sales organization to even one-third www.hbr.org July–August 2006 PLUS: Best of HBR 2006), is that students of sales are split Benson P. Shapiro the level of the most productive sales- Ronald S. Posner SPECIAL DOUBLE ISSUE Edward C. Bursk David Mayer into two camps. Herbert M. Greenberg persons, you can generate something Thomas V. Bonoma The academic camp attempts to em- approaching a 30% improvement in ulate the hard sciences through data revenue over a one- to three-year hori- analysis, process description, and con- zon. Most firms, however, continue to ceptual models. It sees sales mainly as 58 How Right Should the Customer Be? concentrate their energies on eliminat- Erin Anderson and Vincent Onyemah an issue of process management and 68 Ending the War Between Sales ing the lowest performers, rather than and Marketing Philip Kotler, Neil Rackham, and couches human interactions in behav- Suj Krishnaswamy improving the performance of those 80 Match Your Sales Force Structure to Your Business Life Cycle ioral terms. This scientific approach Andris A. Zoltners, Prabhakant Sinha, and in the middle. Sally E. Lorimer

The HBR Interview may have worked well for finance, 90 Leading Change from the Top Line Randy Hull Fred Hassan of Schering-Plough

102 Better Sales Networks marketing, production, and strategy, Tuba Üstüner and David Godes Managing Director

114 The Sales Learning Curve but it does not work well for sales, Mark Leslie and Charles A. Holloway Prime Resource Group 124 The Ultimately Accountable Job: Leading Today’s Sales Organization where close encounters of the human Jerome A. Colletti and Mary S. Fiss Minneapolis kind are essential. The other camp – people writing the When I was passing through the Mon- so-called popular sales literature – is Yet Joe Girard, whom HBR calls “the treal airport, a newsstand clerk told me frequently soft, preachy, motivational, world’s greatest salesperson,” advises, your special double issue on sales cost and not rigorous. Marketers, financiers, simply,love your customer. Girard is not $25 Canadian. I figured it would be and strategists buy books by Harvard exaggerating or being metaphorical – worth the price. I was wrong. Business School professors; salespeople he’s being real. Save for the excellent contributions buy “wisdom” books from Jeffrey Gito- MBA courses that teach sales as love of Joe Girard, Neil Rackham, and Fred mer and Zig Ziglar. Those in the aca- are in short supply today. That’s hardly Hassan; the helpful numbers by CSO demic camp may look down their noses, puzzling; B schools have chosen to feed Insights; and Mark Leslie and Charles A. but popular-camp authors do seem bet- the head and not the heart. They don’t Holloway’s “The Sales Learning Curve,” ter at selling. know what to do with a “heart” topic the issue would have been a bust at One camp offers the rigor of science; when it comes along – so they ignore it. half the price. I had expected to hear one speaks to people. Each disdains the HBR faces the same dilemma. But to its from mostly billion-dollar-plus CROs. other. The dichotomy is unfortunate be- credit, even though it lies solidly within Instead, I found only the boring theo- cause data and wisdom work better to- the academic camp, the magazine high- retical musings of 11 professors, nine gether than apart. The special issue re- lights a few articles that speak to the consultants, four editors, and one self- flects the split, and HBR seems to have humanity at the heart of selling. Good aggrandizing weirdo sociologist who a foot in both camps. for you; maybe some curriculum design- I doubt has ever known a chief reve- By my subjective reading, six of your ers are listening. nue officer. seven cover articles deal with managing Charles H. Green Frank Robinson sales – classic B-school stuff. The note- President CEO worthy exception is your centerpiece in- Trusted Advisor Associates Product & Market Development terview. In “Leading Change from the Morristown, New Jersey Santa Barbara, California october 2006 145 STRATEGY & COMPETITION

COVER STORY 60 | Emerging Giants: Building World- Class Companies in Developing Countries Tarun Khanna and Krishna G. Palepu Executive Summaries Over the past 20 years, waves of liberalization have all but washed away protectionist barriers in devel- oping countries. As multinational corporations from North America, Western Europe, Japan, and South Korea stormed into the emerging markets, many October 2006 local companies lost market share or sold off busi- nesses – but some fought back. India’s Mahindra & Mahindra, China’s Haier Group, and many other cor- porations in developing countries have held their own against the onslaught, restructured their busi- nesses, exploited new opportunities, and built world- class companies that are today giving their global rivals a run for their money. In this article, the authors, citing the results of their six-year study of “emerging giants,”describe the three strategies these businesses used to become effective global competitors – despite facing finan- cial and bureaucratic disadvantages in their home markets. Some capitalized on their knowledge of local prod- uct markets. The Philippines’ Jollibee Foods, for in- stance, has profitably battled McDonald’s because it realizes that Filipinos like their burgers to have a particular soy and garlic taste. Some have exploited their knowledge of local talent and capital markets, thereby serving customers both at home and abroad in a cost-effective manner. India’s software companies, for instance, recognized the possibility of providing services to overseas custom- ers at least a decade before Western companies even considered hiring Indian software professionals. Emerging-market And some emerging giants have exploited institu- businesses both tional voids to create profitable businesses. China’s Emerge Logistics, for instance, helps foreign compa- “ circumvent institutional nies navigate the country’s disjointed transportation voids and tailor their system and baffling bureaucracy, guiding them all the way from ports to retail outlets. strategies to local The authors’ research indicates there’s more than markets better than one way to skin the proverbial cat: Some emerging- market companies compete in several countries, multinational but others sell only at home. Emerging giants can be companies do. successful even if they don’t have global footprints, Khanna and Palepu conclude. – page 60 Reprint R0610C; HBR OnPoint 1459; OnPoint collection “Winning in the World’s ” Emerging Markets” 1455

146 harvard business review | hbr.org IDEAS & TRENDS MARKETING

FORETHOUGHT HBR CASE STUDY 20 | The Rise of Corporate Nation- 37 | What Serves the Customer ality The nationality of global companies Best? has become less ambiguous and more Paul F. Nunes and Woodruff W. Driggs strategically important in recent decades. Reprint F0610A As president of Scotch whisky maker Glen- meadie, Bob Littlefield is pleased to see Business Lessons from Leeches The the results of his CMO’s recent marketing editor of the Annals of Improbable Research initiatives. There are new interactive capa- observes that leeches have a thing or two to teach us about so-called best practices. bilities on the company’s Web site, a prod- Reprint F0610B uct information call center, and numerous other customer interfaces designed to The New Indian Consumer According deepen consumers’ connection to the brand. to the Gallup Organization, consumerism Thanks to these front-end innovations, is becoming a way of life in India. sales are up – and largely because of more Reprint F0610C loyal purchasing behavior, research shows. Embrace the Dark Side Consumers But not all the news is good. Glen- these days prefer authenticity to purity, so meadie’s CFO says the marketing pro- brands should capitalize on their flaws, or grams account for half the company’s “shadow” attributes. Reprint F0610D costs. Meanwhile, Glenmeadie’s master Get Your Act Together Consistent cor- distiller, Ellis Cameron, resents the fact porate communications depend less on that, with so much money going toward specific organizational structures than on enhancing customer relations, there isn’t carefully designed strategy. Reprint F0610E enough left for his R&D efforts. In a meet- Are You Ready for E-tailing 2.0? ing with Bob, he launches into a tirade E-commerce is shifting – from making pur- about priorities.“There’s an old expres- chases online to going shopping online, a sion,”Ellis says.“Build a better mousetrap, social experience in which people interact and the world will beat a path to your in a 3-D Web space. Reprint F0610F door.”Glenmeadie, he says, is neglecting Responsibility Junkie Boston Pops con- the customer’s basic need.“We’ve given up ductor Keith Lockhart discusses the chal- on redesigning his mousetrap and are try- lenges of filling big shoes and managing a ing to trap him instead!” team whose members all aspire to be num- Four commentators on this fictional ber one. Reprint F0610G case study provide varying perspectives. Apocalypse Now? Predictions of global David Herman, president of luggage maker economic integration are at odds with the Hartmann, criticizes Glenmeadie’s mar- facts: Most types of economic activity that keting for its lack of focus and notes that might cross borders are still largely fo- Ellis’s product innovation idea – single-cask cused at home. Reprint F0610H bottling – offers the best way to connect with upscale customers. Marketspace’s Book Reviews Featuring The World’s president, Jeffrey Rayport, disagrees that Newest Profession: Management Consulting in the Twentieth Century, by Christopher D. Glenmeadie’s marketing to date has been McKenna, and reviews of three other books. anything but an unalloyed success. Stephen Dull, vice president of strategy at VF,ex- plains why Glenmeadie needs to do more to understand its consumers on a deeper level. And Joe Scafido, who leads innova- tion at Dunkin’ Brands, outlines the organi- zational solution his company devised to get potentially competitive factions work- ing together. Reprint R0610A Reprint R0610X: Case only Reprint R0610Z: Commentary only

october 2006 HUMAN RESOURCES ORGANIZATION & CULTURE ORGANIZATION & CULTURE

53 | Sleep Deficit: The 72 | The Tools of Cooperation THE HBR INTERVIEW Performance Killer and Change 82 | Ideas as Art A Conversation with Harvard Medical Clayton M. Christensen, Matt Marx, and James G. March School Professor Charles A. Czeisler Howard H. Stevenson Interviewed by Diane Coutu Companies today glorify the executive who Employers can choose from lots of tools Three years ago, consultants Laurence logs 100-hour workweeks, the road warrior when they want to encourage employees Prusak and Thomas H. Davenport asked who lives out of a suitcase in multiple time to work together toward a new corporate prominent management thinkers to name zones, and the negotiator who takes a goal. One of the rarest managerial skills is their gurus and reported the results in red-eye to make an 8 AM meeting. But to the ability to understand which tools will HBR. James G. March appeared on more Dr. Charles A. Czeisler, the Baldino Profes- work in a given situation and which will lists than any other person except Peter sor of Sleep Medicine at Harvard Medical misfire. Drucker. School, this kind of corporate behavior is Cooperation tools fall into four major A professor emeritus in management, the antithesis of high performance. In fact, categories: power, management, leader- sociology, political science, and education he says, it endangers employees and puts ship, and culture. Choosing the right tool, at Stanford University, March has taught their companies at risk. say the authors, requires assessing the or- courses in subjects as diverse as organiza- In this interview, Czeisler describes four ganization along two critical dimensions: tional psychology, behavioral economics, neurobiological functions that affect sleep the extent to which people agree on what leadership, rules for killing people, friend- duration and quality as well as individual they want and the extent to which they ship, computer simulation, and statistics. performance. When these functions fall agree on cause and effect, or how to get He is perhaps best known for his pioneer- out of alignment because of sleep depriva- what they want. The authors plot on a ma- ing contributions to organization and tion, people operate at a far lower level of trix where various organizations fall along management theory. March’s accomplish- performance than they would if they were these two dimensions. Employees repre- ments in that field, and in many others, well rested. Czeisler goes on to observe sented in the lower-left quadrant of the have conferred on him an almost unprece- that corporations have all kinds of policies model, for example, disagree strongly dented reputation as a rigorous scholar designed to protect employees – rules both about what they want and on what and a deep source of wisdom. As Univer- against smoking, sexual harassment, and actions will produce which results. Those sity of Chicago professor John Padgett so on – but they push people to the brink in the upper-right quadrant agree on both wrote in the journal Contemporary Sociol- of self-destruction by expecting them to dimensions. ogy, “March’s influence, unlike that of any work too hard, too long, and with too little Different quadrants call for different of his peers, is not limited to any possible sleep. The negative effects on cognitive tools. When employees share little consen- subset of the social science disciplines; it is performance, Czeisler says, can be similar sus on either dimension, for instance, the pervasive.” to those that occur after drinking too only methods that will elicit cooperation March approaches thought aestheti- much alcohol: “We now know that 24 are “power tools” such as fiat, force, and cally; he cares that ideas have “some form hours without sleep or a week of sleeping threats. Yugoslavia’s Josip Broz Tito wielded of elegance or grace or surprise.”His poetic four or five hours a night induces an im- such devices effectively. So did Jamie sensibility can be felt in the metaphors he pairment equivalent to a blood alcohol Dimon, current CEO of JPMorgan Chase, has created over the years – the “garbage level of .1%. We would never say,‘This per- during the bank’s integration with Bank can theory” of organizational choice, for in- son is a great worker! He’s drunk all the One. For employees who agree on what stance, and the “hot-stove effect”in learning. time!’ yet we continue to celebrate people they want but not on how to get it – think In this edited interview with HBR senior who sacrifice sleep for work.” of Microsoft in 1995 – leadership tools, such editor Diane Coutu, March shares his think- Czeisler recommends that companies as vision statements, are more appropriate. ing on aesthetics, leadership, the role of institute corporate sleep policies that dis- Some leaders are blessed with an in- folly, and the irrelevance of relevance when courage scheduled work beyond 16 consec- stinct for choosing the right tools – Conti- it comes to the pursuit of ideas. He also utive hours as well as working or driving nental Airlines’ Gordon Bethune, General comments on the fundamental differences immediately after late-night or overnight Electric’s Jack Welch, and IBM’s Lou Gerst- between academic and experiential knowl- flights. A sidebar to this article summarizes ner are all examples. Others can use this edge, underscoring the need for both. the latest developments in sleep research. framework to help select the most appro- Reprint R0610E Reprint R0610B priate tools for their circumstances. Reprint R0610D; HBR OnPoint 1458; OnPoint collection “What You Really Need to Know About Change” 1454

148 harvard business review | hbr.org STRATEGY & COMPETITION

92 | Strategies for Two-Sided Markets Thomas Eisenmann, Geoffrey Parker, and Marshall W. Van Alstyne If you listed the blockbuster products and services that have redefined the global business landscape, you’d find that many of them tie together two distinct groups of users in a network. Case in point: The most important innovation in financial services since World War II is almost certainly the credit card, which links consumers and merchants. The list would also include newspapers, HMOs, and computer operat- ing systems – all of which serve what econ- omists call two-sided markets or networks. Newspapers, for instance, bring together subscribers and advertisers; HMOs link pa- tients to a web of health care providers and vice versa; operating systems connect com- puter users and application developers. Two-sided networks differ from tradi- tional value chains in a fundamental way. In the traditional system, value moves from left to right: To the left of the com- pany is cost; to the right is revenue. In two- sided networks, cost and revenue are both to the left and to the right, because the “platform” has a distinct group of users on each side. The platform product or service incurs costs in serving both groups and can collect revenue from each, although one side is often subsidized. Because of what economists call “net- work effects,”these platform products enjoy increasing returns to scale, which explains their extraordinary impact. Yet most firms still struggle to establish and sustain their platforms. Their failures are rooted in a common mistake: In creating strategies for two-sided networks, managers typically rely on assumptions and paradigms that apply to products without network effects. As a result, they make many decisions that are wholly inappropriate for the economics of their industries. In this article, the au- thors draw on recent theoretical work to guide executives negotiating the chal- lenges of two-sided networks. Reprint R0610F; HBR OnPoint 1463

october 2006 STRATEGY & COMPETITION STRATEGY & COMPETITION GENERAL MANAGEMENT

102 | Meeting the Challenge of 114 | Can Science Be a 126 | What Business Are Corporate Entrepreneurship Business? Lessons from Biotech You In? David A. Garvin and Lynne C. Levesque Gary P.Pisano Classic Advice from Theodore Levitt To be competitive, companies must grow In 1976, Genentech, the first biotechnology For all the talk about management as a innovative new businesses. Corporate en- company, was founded by a young venture science, experienced executives know that trepreneurship, however, isn’t easy. New capitalist and a university professor to ex- strategic decisions and tactics depend ventures face innumerable barriers and sel- ploit recombinant DNA technology. Thirty heavily on context. No one understood this dom mesh smoothly with well-established years and more than $300 billion in invest- better than Theodore Levitt (1925–2006). systems, processes, and cultures. Nonethe- ments later, only a handful of biotech firms A Harvard Business School professor less, success requires a balance of old and have matched Genentech’s success or even renowned as a founder of modern market- new organizational traits – and unless com- shown a profit. No avalanche of new drugs ing, he sought above all to use his knowl- panies keep those opposing forces in equi- has hit the market, and the long-awaited edge to serve the needs of businesspeople. librium, their new businesses will flounder. breakthrough in R&D productivity has yet In a series of powerfully insightful – and The authors describe the challenges to materialize. delightfully written – essays in Harvard companies face when they pursue new This disappointing performance raises Business Review, he provoked readers to re- businesses, as well as the usual problem- a question: Can organizations motivated examine their settled thinking about vital atic responses to those challenges. Such by the need to make profits and please issues so that they could better meet the companies, they say, must perform three shareholders successfully conduct basic needs of customers. balancing acts: scientific research as a core activity? The Levitt had the gifts of provocation and • Develop strategy by trial and error, question has largely been ignored, despite generalization, offering ideas that startled which includes narrowing potential choices, intense debate over whether business’s in- readers but compelled them to think cre- learning from small samples, using proto- vasion of basic science – long the domain atively and intelligently about their compa- types to test business models, tracking of universities and nonprofit research insti- nies. Writing in a period when business was progress through nonfinancial measures, tutions – is limiting access to discoveries, held in far less esteem than it is today, he and knowing how and when to pull the thereby slowing advances in science. rejected the easy contempt that many intel- plug on a new venture. Biotech has not lived up to its promise, lectuals had for managers and consumers. • Find the best combination of old and says the author, because its anatomy, Levitt carried that practical approach to new operational processes by staffing new which has worked well in other high-tech his tenure at Harvard Business Review from ventures with “mature turks,”changing vet- sectors, can’t handle the fundamental chal- 1985 to 1989. As one of HBR’s most intel- erans’ thinking, knowing which capabilities lenges facing drug R&D: profound, persis- lectual and most populist chief editors, he to develop and which to acquire, and hav- tent uncertainty and high risks rooted in understood that the magazine’s main pur- ing old and new businesses share responsi- the limited knowledge of human biology; pose was to serve as a kind of sophisticated bility for operating decisions. the need for the diverse disciplines in- translation, clarifying authors’ raw – and • Strike the right balance of integration volved in drug discovery to work together sometimes rough – ideas for impatient, and autonomy by assigning both corporate in an integrated fashion; and barriers to time-pressed readers. and operating sponsors to new ventures, learning, including tacit knowledge and This tribute, a look into one of business’s establishing criteria for handoffs to exist- murky intellectual property rights, which great minds, offers excerpts from six of ing divisions, and using creative organiza- can slow the pace of scientific advance. Levitt’s most influential HBR articles: tional structures. A more suitable anatomy would include “Marketing Myopia” (July–August 1960) The authors provide a detailed look at increased vertical integration; a smaller “After the Sale Is Over…” (September– IBM’s Emerging Business Opportunity sys- number of closer, longer collaborations; an October 1983) tem, which manages all these balancing emphasis by universities on sharing rather “Marketing Success Through Differentia- acts simultaneously. than patenting scientific discoveries; more tion–of Anything” (January–February 1980) Reprint R0610G; HBR OnPoint 1462; cross-disciplinary academic research; and “Production-Line Approach to Service” OnPoint collection “Building Break- more federal and private funding for trans- (September–October 1972) through Businesses in Established lational research, which bridges basic and “The Globalization of Markets” Companies, 2nd Edition,”1456 applied science. With such modifications, (May–June 1983) science can be a business. “Creativity Is Not Enough” Reprint R0610H (May–June 1963) Reprint R0610J

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october 2006 151 PANEL DISCUSSION by Don Moyer

Employees are ever alert for signs of competence, vision, and trustworthiness in their leaders. On Stage When they see these positive signs, they work harder, contribute better ideas, and stay with the company longer. When they pick up unsettling signals, their performance and loyalty deteriorate. Because the scrutiny and interpretation are relentless, even trivial things that you say or do have an impact, write Robert Galford and Anne Seibold Drapeau in “The Enemies of Trust” (HBR February 2003). For a leader, there’s “no such thing as a casual conversation.” You can’t totally manage the signals you send. Even if your intentions are pure and your per- formance flawless, the authors say, don’t be surprised when your most innocuous statements are assigned deep, sinister meaning – or are assigned very different meanings by different people. But if you communicate consistently and clearly, especially in times of crisis, and don’t shy away from the tough issues, you’ll engender the trust and confidence that you need to succeed. Don Moyer can be reached at [email protected].

152 harvard business review | hbr.org