This piece was published before the May 2007 rebranding of , Mercer , and Mercer Delta Consulting as Oliver Wyman.

Oliver Wyman Oliver Wyman is building the leading global management consultancy, combining deep industry knowledge with specialized expertise in strategy, operations, risk management, organizational transformation, and leadership development. The firm works with clients across a range of industries to deliver sustained shareholder value growth. We help managers to anticipate changes in customer priorities and the competitive environment, and then design their businesses, improve their operations and risk profile, and accelerate their organizational performance to seize the most attractive opportunities. www.oliverwyman.com Performance Anxiety Is it me or my business design?

By Adrian Slywotzky, Richard Balaban, and Phyllis Rothschild

Globalization and complexity have made it tough to untangle whether your greatest leverage lies in strategy or execution. A process called the business design audit cuts through the fog by examining all the business design choic- es and performance drivers within a company to determine which are out of alignment and what the highest-priority moves should be––while there’s still time to act.

ow well do you know your business? Do This question of how to untangle strategy Hyour biggest problems and opportunities from execution does not surface in tradi- lie in the realm of strategy or execution? tional strategic planning exercises or process Virtually all large companies have faced the improvement programs, which tend to be challenges of flawed strategy and flawed exe- backward-looking, internally focused, and cution at some point. Some have faced both incremental in nature. As a result, managers at the same time. Yet few have a process to often wind up tackling the wrong problem. untangle how much their current challenges For example, WordPerfect (now owned by stem from one or the other and what their Corel) used to be one of the most successful highest-priority next moves should be. companies in software, paying close atten- Consider Sony and Gateway, which have tion to continuously improving customer been disappointing investors for years as service. Senior management did not antici- they struggle to maintain profit margins and pate the flaws in their business design as find new sources of growth in very competi- more and more customers bought PCs bun- tive PC and consumer electronics markets. dled with Microsoft Windows software. Even Their predicaments might seem similar, but the highest levels of customer service per- they’re actually quite different. formance could not stem the tide of Gateway had a good business design idea WordPerfect users shifting to Microsoft’s that emphasized capturing profit from the Word application, which was part of an services associated with owning the PC— “installed base” business design better suited leasing and financing, training classes, soft- to consumers’ actual purchasing behavior. ware and accessories, Internet access, and a Understanding one’s business has become trade-in program designed to keep customers more difficult in recent years, for several rea- coming back. But Gateway has had difficul- sons. Companies made many mergers and ties in executing this business design well. acquisitions starting in the 1990s not just to Sony, on the other hand, has demonstrated increase scale but also to acquire comple- excellent execution of a business design that mentary products, channels, and customer is becoming obsolete—introducing new con- segments. That created hard-to-digest incon- sumer electronics products with incremental sistencies within many firms. In addition, feature improvements that are sold through accelerated globalization has been destroying traditional retail channels. the assumptions on which many businesses

Adrian Slywotzky is a Boston-based director, Richard Balaban is a London-based director, and Phyllis Rothschild is a Boston-based director of Mercer Management Consulting. They can be reached at [email protected], [email protected], and [email protected].

Mercer Management Journal Performance Anxiety 19 are built, causing more mismatches between industries, from paper to energy, from food the design of the business and the require- products to , we have developed a ments of local markets and supply systems. process that cuts through the fog of complexity In short, large companies have become so by examining all the business design choices complex that few people understand how all and performance drivers within a company to the pieces work together. A global integrated determine which are out of alignment.We call this oil company might have 20 business designs, disciplined process a business design audit. (See including five or six that really matter in terms sidebar “The Components of Business Design.”) of revenues and profits. Some of the business designs need to be fixed and others are per- The business design audit addresses several forming well but are limited by their nature key questions for managers: and need to be reinvented. Senior managers may think they’re running one business design How many different business designs are when they actually have several and are co- we running? mingling resources in a way that has become dysfunctional. They need to get a clear line of Are these the right business designs, but sight into their business so that they can in need of performance improvement? understand which 20 moves they could make and which few moves they should make in Or are they obsolete and need reinvention order to grow profits on a sustained basis. to create a unique position? Having worked with executives in dozens of companies around the world and in many How far away is each business design from its performance frontier?

The Components of Business Design

Customer selection. Which customers do you and should you serve? Which are the most profitable segments, now Customer and in the future? selection Value capture/ and value profit model proposition Value proposition. What is your unique value proposition, and how is it modified by segment?

Organizational Value capture. How do you make money in each customer architecture segment? Are there new profit models available? How many different profit models will you need to manage?

Strategic Scope Strategic control. What is the full repertoire of mechanisms control to protect your business position, customer relationships, and profits from being poached by competitors?

Scope. What activities should you do yourself? What should you outsource to others––and do you understand the hidden risks involved? When and why do you go offshore? Whom do you partner with? What collaborations do you want to join or catalyze?

Organizational architecture. How should you hire, train, and assemble the right mix of people? What elements of the organization (talent, leadership, systems, processes, structure, governance, and culture) will best drive the choices you have made? Which organization mechanisms will allow you to adapt to new developments in markets, technological innovation, and globalization? What new mechanisms are necessary?

20 Performance Anxiety Mercer Management Journal What are the major risks that our busi- Exhibit 1 X-raying the business ness designs face? Traditional process Business design audit improvement approach Like a financial audit, a business design • Inside out • Outside in audit is sequential and objective. What’s dif- -Start with the customer ferent is that the audit examines both design • Individual components • System (the choices for each component) and engi- • Single moves • Combinations and sequence neering (whether the components work • Cost reduction • Cost reduction and revenue growth orientation together as a finely tuned operating system), -Upward spiral and it looks ahead. It shows how misalign- -Functional role ment between or within the design and the • Strategy separate • Connects strategy engineering system erodes future value cre- and execution ation, and it helps set the agenda by showing executives the most fruitful course of action (Exhibit 1). is the retailer’s share of their wallet, and so Of course, improving the businesses you on. This database shows where value has have and building the businesses you need been and will be created and what trends will are linked activities. If you have poor oper- drive economic profit in the future. ating performance, it will be difficult to fund For each dimension of the business design growth with the necessary cash and earn- and operating system, ask: How well aligned is ings-per-share flexibility. And if you can’t that dimension with the overall design? How grow, it will be difficult to attract the talent, good is its relative performance? What is the resources, and customers that can improve breakthrough potential of that dimension? your performance. You can then map both the business design An audit thus should address both areas. and the operating performance dimensions Management needs to make design choices on a simple grid (Exhibit 2). In the upper right that are internally consistent, and it needs an or “northeast” quadrant of the grid, compa- operating system (composed of activities, nies such as IKEA, Tetra Pak, UPS, Tesco, and processes, and information) that will deliver Toyota have the best business designs in their on the design. (See sidebar “Tuning the industry and also have top-decile perform- Operating System” on page 23.) ance. But there is always room for improve- ment and these champions tend to audit Start with the Facts and the Homework themselves more frequently than most—well To see where the value is created, start by before their strong position begins to erode. identifying the data points that would be most valuable to track, an exercise that Exhibit 2 Charting the grid should combine quantitative and qualitative North Top decile measures. Even the relative strength or weak- • American Airlines • Dell • UPS ness of a business design can be tracked • Sony • Toyota • Tetra Pak • WordPerfect • Cemex • Tesco quantitatively by arraying the market-value- • IKEA • Target to-revenue ratio of all of the business designs in the industry. Performance West East • Ames • Saturn A retailer, for example, can track not just the • Bradlees • Gateway usual economic drivers such as inventory • Bethlehem Steel • Pan Am turns, but also what is happening to its cus- tomer base over time—which customers shop Bottom decile South exclusively in its stores, which customers Low relative market High relative market share their business with key competitors, value/revenues value/revenues who are the most profitable customers, what Business design choices

Mercer Management Journal Performance Anxiety 21 In the upper left or northwest quadrant are purchasers and the value proposition is the companies that have great performance in lowest delivered price, guaranteed. The value terms of cost, cycle time, logistics, and other capture could be a long-term fixed contract or operating measures, but the nature of their busi- spot rates. Scope would include low-cost ness design severely limits their returns. operations and of non-critical American Airlines and other “legacy” air carriers functions to cheaper third parties. Strategic are good examples, with classic hub-and-spoke control would be the company’s low-cost sys- networks serving a wide variety of customer tems and processes or an advantaged input segments through a wide variety of assets. For source. Finally, the organization to support these companies, the pressing challenge is how this business design would be no-frills and to revise or reinvent their business designs. limited custom services. You might call this a Another set of companies, in the southeast “low-cost” business design. quadrant, have crafted At the same time, the superior business designs Large companies have company may also target that can be effective higher-value customers against tough competitors, become very complex. with an offer that aims to but their execution has solve their problems. The failed to raise performance More than ever, man- value capture here would to a level that can yield agers need a clear line be a function of the cus- great returns. Saturn and tomer’s enhanced eco- Gateway in the late 1990s of sight into all of nomics; higher levels of fit this profile. their business designs. service and customer Finally, the lower left or knowledge would be southwest quadrant of the required to make the offer grid might be called the “bankruptcy waiting credible. Switching costs would be high because room,” where the business design is weak and of the firm’s access to customer operations. the performance within the definition of that Organizationally, a skilled, high-touch sales force business design falls in the bottom decile of would be required to deliver on the value propo- the industry. Ames and Bradlees department sition. This is a “solutions” business design. stores, Bethlehem Steel, and Pan Am were all It’s important to determine which business in this position but did not act soon enough to designs drive the majority of revenue, which make the necessary moves. drive profitability and shareholder value, Companies that appear in each quadrant which represent future growth opportunities, might not stay there for longer than a year or which are threatened by their growing irrele- two, as the power of a business design and vance, and which new business designs have the quality of the operating system change yet to be developed. over time. The business design audit can catch movement westward or southward To the Northeast early enough to give a company options to Once the metrics are collected and the map of shift course. the company’s recent positions laid out, man- agement has to set its priorities for the best Sifting Through the Portfolio of Business next moves. Although the ultimate goal is to Designs reach the northeast quadrant, only a few com- Large companies typically operate many panies can make that happen in one effort. business designs, and each should be One that did advance north and east is mapped. For instance, one set of customers Samsung, the Korea-based conglomerate. buys on a pure commodity basis; for them, For many years, Samsung was a low-cost the driving factor is lowest price. In this case, producer of appliances and semiconductors, customer selection would be high-volume focused on Korean markets with export to

22 Performance Anxiety Mercer Management Journal Tuning the Operating System

Moving north to improve operational performance involves delving into a firm’s operating system. When diving into operations, it’s easy to focus on the traditional value chain and ask, “How do I make stuff cheaper?” But that’s just part of the equation. You should also ask, “What kind of system do I need to respond to customers’ priorities?” Start with customers, what they are willing to pay for, how they buy, how you service them, and work your way back to innovation and production. As shown in Exhibit 3, The operating system thus goes beyond the traditional value chain to include:

The proprietary information chain (information about customers, suppliers, competitors, and so on)

Processes that link different parts of the system (customer profitability system, integrated pricing system, etc.)

Policies that determine how decisions get made on resource allocation, outsourcing versus doing in-house, and so on. Is the resource policy “everyone shares” or “the jungle rules”?

Informal practices of “how we do things around here”

Exhibit 3 Every business design has a de facto operating system that supports its choices (or doesn’t)

Customer selection Value capture/ and value profit model proposition

Organizational architecture

Strategic Scope control

The customer’s Go-to-market Service Sales Marketing priorities mechanism

Customer Proprietary Integrated Shared profitability system information pricing system resource policy

Outsourcing Innovation process/ Production Supply chain Sourcing policies R&D

Keep in mind that the operating system is truly a system. Don’t get seduced by the appeal of a point solution to a narrowly defined problem. You may think you have a sales force productivity problem, but the real problem may well be a customer selection problem and a pricing problem. Looking simultaneously at the business design and how the operating system is engineered to sup- port it helps get quickly to the issue of whether there are anomalies or areas of disconnect. A sales force trained and given incentives as product sellers will not be able to execute a key account strategy; the company will have to change its organizational system and skill set through training, reorganiza- tion, new hires, compensation changes, and other relevant moves. Similarly, a just-in-time production system will not function if it relies on untrained suppliers.

Mercer Management Journal Performance Anxiety 23 developing countries. That business design Samsung’s six-year makeover has paid off started to flag in the early 1990s because in several ways. Samsung is one of the Samsung faced competition from even lower- fastest-growing brands in the world and has cost producers and had limited consumer overtaken in brand value venerable giants awareness of its brand. such as Sony, Philips, and Motorola. From Starting in the late 1990s, Samsung set 2000 through 2005, annual revenues have about shifting away from the low-cost, low- more than doubled from $27 billion to $59 bil- value business design (Exhibit 4). In appli- lion, and on stock markets, Samsung has ances, consumer electronics, and mobile become the world's most valuable non-U.S. phones, the company targeted upwardly technology company. mobile consumers and corporate customers that valued leading tech- One Step at a Time nology. Innovation in The Samsung story, with product design, customer If you try to fix the concurrent moves both solutions, time-to-market, wrong problem, you north to improve perform- and branding would ance and east to change the become much more will. Avoiding the business design, is unusual. important, so the com- usual misdiagnoses Typically, a firm does best pany increased invest- to sequence its moves. ment in marketing, R&D, is half the battle. Sometimes, it becomes and design. obvious that the firm On the branding front, should first move east. Samsung trimmed the product portfolio and Apple Computer’s priority in the late 1990s switched to selling all remaining products was to refresh its business design, which had under the Samsung brand. It chose televi- focused primarily on offering an alternative, sions and mobile phones—central to con- proprietary computer to Wintel-based PCs. sumers’ daily lives—for its most stylish Apple decided to put a greater emphasis on designs and advanced technologies, backed appealing, sleek designs, which would res- by more marketing spend and non-tradi- onate with graphic artists and other users in tional approaches such as a product place- creative fields. Apple then branched out with ment agreement with New Line Cinema. its foray into consumer electronics and music Samsung also decided that the primary go- distribution through the iPod music player to-market mechanism, which relied heavily and iTunes digital music store, which reached on Wal-Mart, was not consistent with how a far broader set of customers and generated Samsung’s branding and value proposition interest for the core PC business as well. were evolving to a high-style, high-value, pre- For many companies, the most effective mium-priced brand. Samsung pulled all of its first move is to focus on improving opera- products out of Wal-Mart and moved to tions and head north. A business design retailers Best Buy and Circuit City—a tough where the components are a bit out of sync but necessary decision. but are well-executed can be more valuable Operational improvements supported this than an adventurous business design business design shift. Samsung outsourced poorly executed. Keeping promises you non-essential Korean jobs and sourced low have already made to investors and cus- value-added components or products from tomers is usually an absolute imperative, so low-cost countries, thus freeing up resources the decision to move north carries lower to focus on design and R&D. And it invested risk and is the most feasible option to gen- in more efficient merchandising and supply erate value quickly. In every industry where chain management practices that empha- we have worked, from pharmaceuticals to sized speed to market. mining to paper to steel, achieving top-

24 Performance Anxiety Mercer Management Journal Exhibit 4 Samsung’s business design reinvention starting in the late 1990s...

Value capture/ Customer profit model selection Organizational and value Strategic Scope architecture proposition control

• Low-cost, commodity • Low-cost business • Market share • Low manufacturing • Systems to support From seeking companies design • Price costs lowest-cost, mass • Price-focused manufacturing setup consumers

• Companies focused • Time profit • Global brand • Product innovation • Systems that promote To on leading technology • Customer solution • Advanced technolog- • Design innovation innovation • Upwardly mobile profit ical capabilities • Focused production consumers • Low-cost business • Cost-competitive design sourcing • Brand profit

…Was supported by shifts in the operating system…

Customer selection Value capture/ and value profit model proposition 1. 2. • Pull out of low-cost Organizational • Alternative/more architecture sales channels effective marketing – New channels Strategic Scope – Tie-ins control

The customer’s Go-to-market Service Sales Marketing 3. priorities mechanism • Increase designer 4. involvement • Lower produc- Customer Proprietary Integrated Shared and power in tion costs and product devel- increase profitability system information pricing system resource policy opment and investment in R&D marketing, • Invest in R&D R&D, design, Outsourcing Innovation process/ centers to and other Production Supply chain Sourcing policies R&D better capture areas trends

…Producing tremendous performance gains

Samsung revenue Samsung stock 275% $59 250 $55 225 200 175 $36 $billions $33 150 $27 125 $21 100 75 50 25 0 2000 2001 2002 2003 2004 2005E -25 Operating 1997 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 21.7%8.1% 18.7% 16.5% 20.8% 14.0% margin % Samsung S&P 500

Source: Samsung Source: BigCharts.com

Mercer Management Journal Performance Anxiety 25 decile performance can be worth a two- to as often as the industry average. Senior man- threefold improvement in profitability agement made sure that all levels of the (Exhibit 5). organization had a better understanding of The case of Nissan is instructive here. In how profitability worked for individual prod- the late 1990s, Nissan suffered from lack- ucts and businesses, and linked incentives luster financial results and weak processes in more closely to profitability. many areas. Labor productivity lagged com- The result: operating profit margins rose peting automakers, Nissan models were tired from less than 2% to more than 10%. and unappealing to consumers, and many Investors viewed the company in a new light operational decisions were out of alignment (Exhibit 6), and Nissan gained the flexibility with the business design; to cite just one and options to make further value-creating example, the entry-level Sentra compact moves in the future. model used the highest- steel. A move north can also set up a move east Within three years, Nissan had focused on (just as a move east creates new opportuni- a set of moves that improved performance ties to move north). We worked with a con- across the board within the limitations of the sumer product manufacturer whose traditional automotive OEM business design. strategic control was weakening because To raise productivity, Nissan cut the number powerful distributors had consolidated and of vehicle platforms in half to 12, closed three a focused competitor was taking market plants, and reduced staff by 21,000 from a share. One option was to go downstream base of 148,000. To invigorate the launch and get into distribution itself in order to process, Nissan moved aggressively to refresh regain control and visibility in the value its product line more frequently, with 30% of chain. But that move carried a high risk of the product range replaced annually—twice failure because of the firm’s inadequate cost

Exhibit 5 The value of performance

Individual companies 30%

25%

20%

Operating margin, 15% 2004

10%

5%

0% g s s o e c d oil c iles als cc teel c d b a S oo b itional g Minin

troni paper d euti rate c c To d c onsumer onsumer g e C C Tra g ele lassi Automo Inte ka C life insuran c Pharma pa

Variation within industry 1.5x1.5x 2.0x 2.0x 2.5x 2.5x3.5x 3.5x 3.5x 3.5x

Source: Mercer analysis

26 Performance Anxiety Mercer Management Journal Exhibit 6 Nissan roars

75% 60 45 30 15 0 -15 -30 -45 -60 -75 2001 ‘02 ‘03 ‘04 ‘05 ‘06 Nissan Dow Jones automobiles index Dow Jones U.S. total market index

Source: BigCharts.com

position and inexperience in distribution system and business design, “The difficulty is activities. The manufacturer chose to focus when you try to create the totality of what we first on operational performance moves, have.You might be able to copy our low prices, which entailed redesigning its supply chain but you need our volumes and global sourcing network, executing several major manufac- presence. You have to be able to copy our turing productivity initiatives, and reducing Scandinavian design, which is not easy its overhead to gain the financial strength without a Scandinavian heritage. You have to needed for a business design reinvention be able to copy our distribution concept with within 18 months. the flat-pack. And you have to be able to copy our interior competence––the way we set out Becoming Unique our stores and catalogues.” A smart, honest, and thorough business As with any successful value creation design audit can help drive truly breakthrough effort, keeping the process evergreen, with performance that goes well beyond catching regular monitoring, ensures that you can up with competitors. Ultimately, the goal is to anticipate shifts in the external environment build a unique system that is very difficult for and respond early. Apply at least the same competitors to imitate––to protect your posi- level of rigor to crafting your business design tion in the northeast quadrant. The Spanish audit as you do to your process improvement clothing retailer Zara, by sharply reducing the programs or your annual financial audits cycle time of its manufacturing, improved oper- (which, for clear reasons, are always done by ational performance through reduced capital, external parties), and the payoffs will follow. warehouse, and inventory costs. As importantly, It’s daunting to build and run a complex it created a unique value proposition (fast new enterprise with many businesses, geogra- fashion), a new profit model (sell more clothes at phies, and sources of value. But there is little a higher price), and stronger strategic control real choice, since that is how competition is (because it takes years for competitors to copy). evolving. A business design audit can help cut At IKEA, Anders Dahlvig, group president, through that complexity, improve operations notes that while many competitors could copy in the near term, and bolster your arsenal for one or two elements of the retailer’s operating leading the next stage of value growth.

Mercer Management Journal Performance Anxiety 27