Building a Winning Business Model Portfolio 06-28

Many companies today are operating several business models at once. But despite the potential that business model diversification has for generating growth and profit, executives need to carefully assess the strategic contributions of each element of their business model portfolio.

Across many industries, companies are using innovative business models as a basis for competitive advantage. In recent years, for example, we have seen upstarts such as Uber Technologies Inc. and Airbnb Inc. use multisided business models to leverage ordinary resources against established competitors that rely on unique resources. Increasingly, organizations are adopting two or more business models at once. Multiple business models provide companies with a diversification vehicle that enables them to tap into resources and capabilities that aren’t available through other means. By definition, a company diversifies into a business model portfolio when it engages in at least two ways of creating and/or monetizing value. 

To illustrate how business model diversification can work, consider Netflix Inc. Netflix deployed two distinct business models (DVDs by mail and online streaming) to challenge Blockbuster and other movie rental incumbents. Although its rapid market penetration and growth are indisputable, Netflix did not initially depend on traditional approaches to diversification. In fact, the company offered U.S. customers essentially the same movies through both its DVD by mail and online streaming services, but it offered different subscription prices, a choice of physical versus digital rentals, and value-added services online, including tailored recommendations. Netflix’s business model diversification helped it to expand its U.S. market share, which provided a springboard for extensive international expansion as well as an expanded product portfolio that now includes original content.

Although Netflix’s success shows how multiple business models can work to make organizations more competitive, such success stories are, more often than not, specific to a particular company’s circumstances. However, there can also be industry-wide patterns. When we studied various business model configurations in the Formula One automobile racing industry, we found that certain configurations of business models were associated with higher performance than others. We concluded that the higher-performing business model configurations generally led to better results because there were complementarities between the two business models chosen that helped companies both learn faster and further develop key business capabilities.

As companies attempt to diversify into portfolios of business models that achieve higher performance than other configurations, they need to match their own resources and capabilities to the external opportunities they face. The goal is to establish a unique bundle of resources and capabilities that can deliver sustainable competitive advantage.

Despite the potential that business model diversification has for generating growth and profit, most companies lack the tools to assess the value of business models in their portfolio or their strategic contributions. In practice, different business models can be in direct conflict with one another, resulting in cannibalization and resource dilution. For example, they may provide offers that are mutually exclusive, or defocus resources from core activities that sustain competitive advantage.
For instance, beginning in the late 1980s, the direct-sales business model of Dell Computer Corp. (now Dell Technologies) fundamentally altered the structure of the personal computer industry.

Once Dell’s approach was seen as a success, competitors such as IBM, Hewlett-Packard, and Compaq tried to copy it. Unfortunately, the other companies found that pursuing two business models at once undermined their existing competitive advantages. Rather than offering synergies, the direct-sales business model required different assets and new capabilities (such as flexible fabrication lines and the ability to reorganize supply chains) and risked alienating distributors, who represented a core customer base.

The Case for Business Model Diversification

Harvard Business School professor Michael E. Porter has noted that strategic diversification is about combining activities that efficiently relate to and mutually reinforce one another, forming a system of activities, as opposed to a collection of isolated activities. In the process, the strategic fit may increase the value of the individual assets in addition to contributing to competitive advantage and superior profitability.

A business model is a system of interdependent organizational activities to create and capture value. Executives need to assess whether there is fit not only between the activities underpinning each business model but also across multiple business models. In fact, although the fit within a business model’s activities can reduce costs or enhance differentiation, the complementarities within a portfolio can further enhance individual activities and create unique and hard-to-imitate resources and capabilities. Indeed, diversified configurations of business models may offer unique opportunities for increased performance.

How can companies assess whether there are advantages to using multiple business models? And when might it make sense to focus on fewer business models rather than more? To develop our understanding of business models, we studied the Formula One auto racing industry, the various businesses operated by Amazon.com Inc., and nearly 50 other companies. (See “About the Research.”) In this article, we offer a framework built on three core questions:

• What should you consider when thinking about business model diversification?

• In deciding to add a new business model to your portfolio, how can you assess and optimize its value?

• How should you modify your business model portfolio over time? 

Question 1: What should you consider when thinking about business model diversification?

When contemplating model diversification, managers should begin by assessing the extent to which the business models in the company’s portfolio can share resources. By sharing physical assets across business models, companies can enjoy economies of scope and eliminate redundancies. This approach is particularly valuable in capital-intensive and technology-focused industries. Successful business model diversification can help companies reduce risk. Biopharmaceutical companies provide a good example. Because they operate in highly uncertain environments where the time lag between an investment and the returns can be extremely long, many companies try to limit the risk by tapping into different revenue streams (such as R&D services, royalties, patents, and health care products). What’s more, they try to share valuable assets such as financial and knowledge resources across business models in order to create cross-business synergies.

Another question to consider is whether the additional business model will provide access to valuable assets that can help an existing business. For example, Formula One teams that, in addition to racing, sell advanced components such as engines and gearboxes to competitors gain access to valuable data about how those components perform — an intangible resource that can provide insights that allow the teams that sell components to further develop their own technology, win more car races, and sell future engines at higher prices. In such cases, the two business models have positive complementarities.

Question 2: In deciding to add a new business model to your portfolio, how can you assess and optimize its value?

As attractive as “synergetic” business model diversification may seem, optimizing this approach entails challenges. How can a manager ensure that the company’s portfolio of business models will have synergies? Historically, management scholars thought that competitive advantage was mostly based on a company’s ability to control valuable, unique, and scarce resources. As a result, many organizations focused their efforts and capital on acquiring and safeguarding what they considered to be “extraordinary assets.”

When considering new business models, managers should start by looking for promising opportunities that would tap into existing company resources to achieve economies of scope and greater capacity utilization. The new business models should utilize resources and capabilities that are closely related to some employed by the existing business model or models. However, managers should be careful not to let the costs of acquiring new resources restrict their freedom to develop new products and services.

Indeed, there is a risk that a company’s prior investments in valuable resources and capabilities can inhibit its ability to adopt new business models. Consider the case of Nokia Corp., the Finnish technology company. In the early 2000s, Nokia was a global leader in mobile handset manufacturing. Yet its mobile strategy was heavily geared toward controlling strategic and costly resources, as exemplified by its $8.1 billion purchase of Navteq Co., which supplied advanced navigation data. In contrast to Apple Inc., whose versatile iPhone platform took the mobile phone market by storm, Nokia failed to respond well to emerging consumer trends or leverage high-priced acquisitions such as Navteq. Within a relatively short period, it lost its competitive edge in the mobile phone business. In 2012, Microsoft Corp. acquired Nokia’s phone and tablet business for less than the amount Nokia had paid to acquire Navteq five years earlier.

Business model diversification enables companies to maximize existing resources while developing capabilities that enhance their value across multiple activities. Therefore, managers should begin by asking: Does my proposed new business model help maximize the use of my current resource base while meeting an important need in the marketplace? If the answer to that question is yes, managers can expect their portfolio to generate cost efficiencies while also providing opportunities for risk reduction through cross-subsidization of the portfolio’s interrelated activities.

In 1994, Amazon, for example, started with a single business model: selling books online. By 2016, the company had grown so that it was achieving close to $136 billion in revenue and operated a number of business models. Along the way, Amazon invested heavily in powerful servers and the development of an automated web infrastructure whose sole objective initially was to power its own website’s massive traffic. Over the years, Amazon has acquired technological prowess and invaluable expertise in the development of web and data infrastructures; based on this expertise, it offers web services and infrastructure to thousands of companies (including Netflix, Siemens, and Vodafone) and has become one of the leading cloud-computing service providers.

Not only is the ownership of such resources of immense value for Amazon’s core e-business activities, it also has value as a stand-alone business model. Indeed, in 2016, Amazon Web Services brought in more than $12 billion in revenues and more than $3 billion in operating income. Although e-commerce still accounts for the majority of Amazon’s revenues, Amazon Web Services is a high-performing business unit.

By supporting a variety of business models and ensuring their survival, Amazon enjoys access to other critical resources. For example, with the Amazon Prime membership business model, the company gains access to important user data, promotes its brand, and fuels sales through the e-commerce platform. Resources and capabilities underpinning business models are often inextricably tied to one another, and thus not easily separable. For instance, Amazon Web Services used resource codeployment to create a new revenue stream. The technological infrastructures and expertise involved are woven into Amazon’s technology development capabilities.

When crafting new business models, managers also need to ensure that the models they create will be linked to the company’s existing distinctive capabilities and what it does best. For example, Apple leveraged its superior design and product development capabilities to serve product markets — going over and above PCs — but also capitalized on its exceptional management and marketing capabilities to develop a unique value proposition and customer engagement mechanism: in other words, a business model innovation. This enabled Apple to first disrupt the digital music industry (with iTunes and the iPod) and then reap the benefits of that disruption via the iPhone.

To translate capabilities beyond their current functional boundaries, managers should first delineate the structure of their individual business models’ activities. This isn’t always easy: Existing business models are often tightly intertwined and difficult to describe in isolation. Careful investigation can reveal potent and dynamic cross-business-model linkages, which might suggest new growth opportunities that transcend industry and product market boundaries.

As noted above, Amazon’s complementary business models work together in generating mutually reinforcing advantages. Amazon Web Services, for example, helps subsidize the Amazon Prime business model. Prime memberships, in turn, provide Amazon with more customer purchase data, which enhances customer service and the online retail experience. This, in turn, feeds buyer demand, which attracts more sellers, which ensures low-cost products, and so on.

Question 3: How should you modify your business model portfolio over time?

As appealing as the idea of cross-business-model synergies may seem, implementation is rarely straightforward. The same is true for intra-business-model portfolio complementarities. Therefore, we think it’s critical for managers to regularly examine portfolio synergies critically and granularly. (See “Analyzing a Business Model Portfolio.”)

Consider the logic behind Amazon’s technology products business (which has included devices such as the Kindle reader, Kindle Fire, Fire TV, Fire Phone, Dash Button, and Echo). These products are often bundled and sold with access to other Amazon products and services (such as its e-books and Prime subscriptions). However, among the company’s business models, some of Amazon’s technology products seem to have, in our analysis, the weakest synergies within the portfolio.

As its technological resources grew, Amazon thought it was gaining new capabilities it could apply to the development of technologies that complemented its online retail activities. In reality, though, Amazon’s business model diversification into electronics manufacturing only partially leverages the company’s distinctive capabilities in the areas of online platform and big-data management.

Those capabilities are, in fact, quite different from hardware technological development in consumer electronics, and hardware design needs to respond to changing consumer tastes and overcome established customer loyalties. Amazon products often compete directly with products offered by other suppliers, and some of Amazon’s products have fallen short of expectations. For example, Amazon launched its Fire Phone in 2014. But due to poor response from consumers, the company reduced the price to just 99 cents with a two-year contract, and it discontinued the product in 2015.

However, Amazon has recently taken steps to increase the synergies between its consumer products and the rest of its business. In launching Amazon AI, a set of cloud-based artificial intelligence services, in fall 2016, the company has sought to leverage the artificial intelligence technology behind its Echo devices and Alexa personal assistant software.

In general, executives need to examine the interrelationships across their business model portfolio rigorously and on a regular basis. Like other forms of corporate diversification, business model diversification does not always generate superior performance. In settings where a business model isn’t generating the synergies that were envisioned, managers shouldn’t be afraid to improve, streamline, or divest from business models in the portfolio, to focus on and bolster the activities that are strategically optimal.

The primary purpose of a business is to drive growth and performance while generating value for customers. Although it’s common for managers to focus on financial performance, good managers seek to exploit new opportunities to create additional value, such as cross-selling, differentiation, reputation, user data, and capability development. Managed wisely, business model diversification can help executives improve performance and advance the purpose of the enterprise.

Business model portfolios encompass multiple activities that are sometimes difficult to disentangle and analyze. To maximize the complementarity across a business model portfolio, it is important to identify the relationships between the different business models’ resources and capabilities, and their impact on performance. We developed a visualization tool to map such critical connections. We used it when analyzing the business model complementarities of several companies in our research. The diagram above shows a sample analysis for a hypothetical company with four business models.

To visualize the complementarities in your own business model portfolio, follow these steps:

1. List your company’s business models in a column on the far left.

2. For each business model, identify the key resources it generates (for example, financial resources, user data, highly skilled human resources, or new technologies). Place them in the second column from the left. Label that column “Resources.”

3. For each business model, identify the key capabilities that stem from it (for example, technological capabilities, sales capabilities, new product development capabilities, or communication capabilities) and place them in a “Capabilities” column, to the right of the “Resources” column.

4. Identify one or more performance measures important to your organization. These can be financial measures (such as return on equity or return on investment), market-driven measures (such as market share or number of users), or other types of measures (such as product quality). Place them in a “Performance” column on the far right.

5. Now use arrows of one color (green in the diagram above) to connect each business model to its associated resources and capabilities and, ultimately, to performance. Think about the mechanisms that underpin such relationships. You can use thicker lines to identify the most strategic ones.

6. Resources are often bundled with other resources, as are capabilities. Use arrows of another color (orange in the diagram above) to identify such relationships. For example, amassing user data creates monetization opportunities and thus increases financial resources.

7. Then analyze: Which business models produce fewer (or less valuable) resources and capabilities? Which business models (as well as their resources and capabilities) display fewer synergies with the others? How strong is their relationship to performance measures? You might want to consider how to strengthen the weakest ties, create new synergies, or — if that is not doable — possibly drop less-embedded business models to focus on the more complementary ones.

8. Business model portfolios are as dynamic as the activities they underpin. Update your model portfolio chart periodically to make sure your business model portfolio is always maximized.

Reproduced from MITSloan Management Review

Managing Tensions Between New and Existing Business Models05-25

The search for new business models forces established companies to experiment with organizational designs — and leads to tensions that should be anticipated and carefully managed.

Image credit : Shyam's Imagination Library
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Exploring new business models is a recognized way for mature companies to renew their competitive advantage. Companies explore new value propositions, deploy value propositions in new segments, change the value chain, or experiment with alternative revenue models — all in a search for a different logic for value creation and capture. Sometimes this exploration goes far beyond the existing business model and requires the creation of a new business unit.

A sometimes unexpected consequence is the difficulty of fitting this new business unit into the existing organizational structure. While business model experimentation may be the raison d’être of many startup ventures, established companies typically face strong organizational rigidities that lead to tensions. Predicting these tensions and being open to experimentation with organizational structure can be the keys to a smoother business model exploration process. In this article, we report on a study of the European postal industry, in which we examined the organizational challenges that affect incumbent organizations in mature industries as they react to disruptive changes in their environment by seeking new business models.

Although the Romans had a type of postal service, the European postal industry as we know it today has existed for the past 500 years or so — one of the oldest, in Portugal, traces its history to 1520. For close to two centuries, established operators have been using essentially the same business model, pioneered in 1837 in the United Kingdom. In that model, senders pay a postal operator (usually through the purchase of a stamp) to bring a piece of mail or a parcel from A to B, with pricing dependent on some combination of distance, size, and weight. However, the postal industry has recently faced a rapid decline in physical mail as a result of digital substitution, while regulatory liberalization has boosted the level of competition in postal markets. Many postal operators have reacted by exploring new opportunities in the digital marketplace.

By interviewing managers and reviewing relevant information, we studied Danish, Portuguese, and Swiss postal operators to find out how they have dealt with the challenge of exploring new business models since the turn of the millennium. The organizations we studied strived to maintain their core business while at the same time incubating new ventures. Managers at all of the organizations felt there were potential new business models that they could benefit from developing, but when exploring the building blocks of these business models, they found that tensions emerged in their organizations. It required a separate process of organizational experimentation to find out how to organize for business model exploration.

Managing the Tensions

Our research points to three key areas of tension almost any existing business will face if it attempts to discover entirely new business models. Whether management succeeds in handling those tensions will determine their success in identifying and implementing new business models.

1. Don’t settle too quickly on structure. Top management is typically trained to see organizational structure as a means of executing strategy. As the business historian Alfred D. Chandler put it, “structure follows strategy.” In the case of business model exploration, however, our research suggests it’s a mistake for management to settle too quickly on a strategy and structure for the new business. In 2006, the Danish postal service, Post Danmark A/S, acquired Strålfors, an information logistics company, and subsequently positioned some of the company’s other innovative ventures within this subsidiary. It was thought there were possible synergies in merging products, but the fit was less than perfect, and as one manager put it, ultimately the business units “moved a bit around over the years.” The Danish and Swedish posts subsequently merged to form a new company, now called PostNord AB. PostNord at one point signaled to the market that Strålfors was for sale but then, in the fall of 2015, announced that it would retain ownership of Strålfors, after all. A manager from another postal operator offered a similar account of the struggle with how to fit a new venture into an old company, pointing out how that operator had to “constantly learn and modify … how we organize ourselves.”

The lesson for any organization wanting to explore new business models is to not settle too quickly on a structure for the new business. In fact, the organizational structure can more usefully be thought of as one of the essential building blocks of the business model — that is, as an aspect of the new business that needs to be fully explored and experimented with before you can learn what works best.

2. Balance top management support and experimentation. Exploring new business models is a strategic decision aimed at adapting the company’s activities to an evolving business landscape and discovering new revenue streams. At the postal operators we studied, this involved numerous initiatives. For example, the Swiss Post decided there might be an opportunity to expand its partnerships with online retail businesses beyond picking up and delivering parcels. The Swiss Post could leverage its established, trusted brand by selling secure sockets layer (SSL) certificates, digital signature solutions, and email certificates to online retailers and other businesses. However, setting up the new business unit involved the creation of new capabilities, both on the IT and the sales sides. It was recognized that this new business unit would be very different from the organization’s existing core business. The solution involved acquiring a startup that had developed some core solutions in this space and then building the business with a mix of management and staff hired from outside as well as transferred from the core business.

Management clearly identified a need to protect the fledgling business from above. The new business unit was a strategic initiative and as such needed to be shepherded by top management. As one manager told us, “We really managed to make sure that from the top … these organizations were protected. You need to have ownership by the CEO; otherwise, this is destroyed extremely quickly.” However, it was also gradually recognized that top management should not try to steer the new business unit. As one manager said, “It is clearly an advantage if people [in the new business unit] are a little bit remote of the headquarters. The headquarters has an existing way of doing business … you develop much more successfully if you give these people space and distance to the core.” This implies a balancing act for top management between protecting and coaching, on the one hand, and leaving the new business unit to experiment, on the other.

3. Expect a power struggle for resources. Any new business model has to grow and coexist with existing business models that may be stagnating but still provide the lion’s share of revenues for the company. Managers of such existing business models can be powerful and may have turf to protect in the internal struggle for resources. They and their employees may feel threatened if the new business unit becomes too successful. Furthermore, the new business model may not be profitable for a long time, leading to the risk that needed investments are diverted from more profitable parts of the business. One manager told us that this “has perhaps been the biggest barrier — that we are competing and working to get access to the same IT resources within the company.”

Top management needs to manage this potential competition for resources between the new business and the old core business. One way to achieve this is to accept multiple business logics, as well as multiple performance management and measurement systems. As one manager explained, “We quite successfully managed to convince the internal management that, for the moment, revenue streams shall not be the most important performance indicator.” Alternative metrics could include the estimated market potential, for example.

A point to consider is the importance of communicating across the company why it is engaging in business model exploration and how this will benefit the company in the long term. Conflicts for scarce resources within the organization cannot be avoided completely, but they can be softened if employees across business units build a shared understanding of the objectives of the business model exploration.

The Organizational Dimension

The business model canvas framework developed by Alexander Osterwalder and Yves Pigneur has become a very popular way to understand the potential building blocks of business models. The canvas highlights nine such building blocks: customer segments, value propositions, channels, customer relationships, revenue streams, key resources, key activities, key partnerships, and cost structure. However, organizational designs and the associated organizational tensions that emerge during the process of business model exploration are not well addressed by the existing tools. Companies exploring new business models may not fully recognize that these tensions will almost inevitably emerge and thus may be ill-prepared to manage them.

Understanding these tensions should help in managing the challenges of concurrent business models.
The tensions we highlight imply that the design of an organizational structure that accommodates both new and older business models needs to be considered an intricate part of business model innovation. Organizational design has to be questioned and experimented with as part of the exploration. A top management team that is prepared for such exploration and aware of the organizational dimension of business model exploration may well be more likely to succeed at business model innovation.

About the Author

Kristian J. Sund is an associate professor of strategy and organization at Roskilde University in Roskilde, Denmark. Marcel Bogers is an associate professor of innovation and entrepreneurship at the University of Copenhagen in Denmark. J. Andrei Villarroel is a professor of innovation and entrepreneurship at the School of Management Fribourg in Fribourg, Switzerland. Nicolai J. Foss is a professor of strategy and organization at Copenhagen Business School in Denmark.

Tags: Business Model Innovation, Change Management, Competitive Strategy, Organizational Change

Reproduced from MIT Sloan Management Review

Four Questions to Revolutionise Your Business Model 04-17

Four Questions to Revolutionise Your Business Model

Innovation is about more than groundbreaking technology. Rigorous, systematic questioning of risks in your business model can unleash opportunities for game changing performance improvements.

For a decade or more, listings website Craigslist seemed a rare exception to the Internet’s innovate-or-die rule. Very early in the new millennium, the San Francisco-based site nestled comfortably into the space once solely occupied by local newspapers’ classified sections, thanks to a singular, free-ad-based business model predicated on low operating costs. It has since expanded into more than 70 countries without making any major changes to either how it does business or its infamously drab design.

A recent spate of copyright-related legal actions, however, may reveal that Craigslist’s fountain of youth is at risk of running dry. In April 2013, a U.S. district court dismissed its claim that it held exclusive license to its listings. The year before, Craigslist added language to its terms of service asserting exclusive ownership of all user posts, prompting outcry from some consumer groups. (The language was deleted after just three weeks). At least to some, the company was starting to display a punitive side not in keeping with its stated mission to provide a public service.

It may be time for Craigslist to rethink its long-standing refusal to innovate, but this particular issue can’t be resolved with a raft of fancy new features. To satisfy its critics while keeping startups at bay, the company would have to turn a cold eye to what has been the unquestioned basis for its success: the vaunted Craigslist business model. In their new book The Risk-Driven Business Model: Four Questions That Will Define Your Company, Karan Girotra, INSEAD Professor of Technology and Operations Management, and Serguei Netessine, INSEAD Timken Chaired Professor of Global Technology and Innovation, make a forceful case for this sort of business model innovation (or “BMI”) and map out how Craigslist – or any company in danger of dulling its competitive edge – could use it to their advantage.

Four W’s to Manage Risk

The “four questions” of the book’s title -- Who, What, When, and Why – are hardly unique to the business world, but according to the authors, few firms subject their business model to such basic scrutiny frequently enough. There’s no substitute, Girotra and Netessine say, for the fundamental questions, such as “What should we sell?” and “When should we introduce our new products?”

“I like to compare it to financial auditing, which every organisation does every year, many times,” Netessine said in an interview with INSEAD Knowledge. “Often, a public company will do it once a quarter. But then you ask the same company how often [it examines] its own business models, they’ll tell you, ‘Well, I don’t know. Twenty years ago? Thirty years ago?’”

When business models are allowed to gather dust, the authors contend, hidden risks accumulate that could unravel companies. Though these risks come in many varieties, the book concentrates on two main kinds: information risk and incentive alignment risk. As Girotra explains, information risk “arises out of not knowing something, for instance which colour of iPhone 5 will be popular.” Incentive alignment risk occurs when the best interests of stakeholders diverge. It was awareness of this risk, for example, that led entertainment rental company Blockbuster to change its contracts with movie studios in the 1990s so that stores could order more copies of the most valuable new releases. The result: a big boost in overall profits, and a new (if temporary) lease on life for Blockbuster.

Blockbuster’s more recent difficulties, the authors suggest, perhaps could have been avoided had the firm kept the “4W”s top of mind. “The 4Ws anchor our framework,” they write, “because they are the innovator’s focal point for reducing both of our characteristic types of risk. By changing models to address the effects of these risks, you can limit the inefficiencies they cause and thereby unlock new value.”

Model Innovators

Many companies have turned to BMI techniques in times of existential crisis, but Amazon stands out to Girotra and Netessine for prioritising proactive, rather than reactive, reinvention of its business model. The company underwent multiple shifts in its business model in its first 15 years, they say, taking it from a “sell all, carry few” system heavily dependent on book wholesalers and publishers to a major wholesaler in its own right with a far-flung, ever-expanding network of warehouses. “It is amazing, I think, how Amazon has kept far more discipline than almost any organisation you could think of,” Girotra said.

But BMI isn’t just for the big boys. To escape the deepening shadow of Amazon, for example, smaller online retail companies could use the 4Ws to carve out a niche for themselves. That was the case with Diapers.com, which launched in 2005 with a business model aimed squarely at new parents. “Diapers had one amazing thing going for them,” Netessine enthused. “Demand for them is extremely easy to predict…For the next two, three years, you know exactly how much your customers are going to buy, and that makes it very, very easy to manage at very, very low cost and much higher efficiency than, say, for Amazon.”

Small wonder, then, that when Amazon bought Diapers.com in 2010, it allowed the new acquisition to operate at a respectful distance from the parent brand. “Perhaps because they wanted to keep both business models separate, so that both strengths continue to be strengthened,” Girotra said.

Enter the “Insurgency”

Effective implementation of BMI comes in three phases, the authors said. “The first phase is generating ideas of what kind of innovations [a company] might be able to do. Next phase is selecting between these innovations. And the final phase is really refining and testing them out, seeing if they really work or not,” Girotra said.

When gathering ideas, the authors recommend including as much input as possible from throughout the organisation. But for efficiency’s sake, it may be best for top management to hand-pick a diverse team to spearhead the refinement and experimentation phases. Girotra explained, “You don’t really make war on the existing business model, you really have an insurgency of a few people sitting outside the traditional structure who start developing the model.”

But unlike insurgencies that overthrow governments, these would be focused on “evidence-based experiential evaluation” that “eliminates a lot of the ideology around the existing and the new,” the authors said. Ideological agnosticism as well as broad representation on the team will help soothe any sore spots within the organisation as thoroughgoing change commences.

Though it may appear risky to loosen attachments to business-as-usual, Netessine stressed that experimentation is a key driver of innovation, even when it yields short-term losses. “If you want to innovate, many of those innovations will fail. Many more will fail than succeed. The important thing is to keep the process running.”

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Why Strategy Execution Unravels—and What to Do About It 03-03

Why Strategy Execution Unravels—and What to Do About It

Since Michael Porter’s seminal work in the 1980s we have had a clear and widely accepted definition of what strategy is—but we know a lot less about translating a strategy into results. Books and articles on strategy outnumber those on execution by an order of magnitude. And what little has been written on execution tends to focus on tactics or generalize from a single case. So what do we know about strategy execution?

We know that it matters. A recent survey of more than 400 global CEOs found that executional excellence was the number one challenge facing corporate leaders in Asia, Europe, and the United States, heading a list of some 80 issues, including innovation, geopolitical instability, and top-line growth. We also know that execution is difficult. Studies have found that two-thirds to three-quarters of large organizations struggle to implement t to understand how complex organizations can execute their strategies more effectively.

 The research includes more than 40 experiments in which we made changes in companies and measured the impact on execution, along with a survey administered to nearly 8,000 managers in more than 250 companies. The study is ongoing but has already produced valuable insights. The most important one is this: Several widely held beliefs about how to implement strategy are just plain wrong. In this article we debunk five of the most pernicious myths and replace them with a more accurate perspective that will help managers effectively execute strategy.

Myth 1: Execution Equals Alignment

Over the past few years we have asked managers from hundreds of companies, before they take our survey, to describe how strategy is executed in their firms. Their accounts paint a remarkably consistent picture. The steps typically consist of translating strategy into objectives, cascading those objectives down the hierarchy, measuring progress, and rewarding performance. 

When asked how they would improve execution, the executives cite tools, such as management by objectives and the balanced scorecard, that are designed to increase alignment between activities and strategy up and down the chain of command. In the managers’ minds, execution equals alignment, so a failure to execute implies a breakdown in the processes to link strategy to action at every level in the organization.

Despite such perceptions, it turns out that in the vast majority of companies we have studied, those processes are sound. Research on strategic alignment began in the 1950s with Peter Drucker’s work on management by objectives, and by now we know a lot about achieving alignment. Our research shows that best practices are well established in today’s companies. More than 80% of managers say that their goals are limited in number, specific, and measurable and that they have the funds needed to achieve them. If most companies are doing everything right in terms of alignment, why are they struggling to execute their strategies?

To find out, we ask survey respondents how frequently they can count on others to deliver on promises—a reliable measure of whether things in an organization get done (see“Promise-Based Management: The Essence of Execution,” by Donald N. Sull and Charles Spinosa, HBR, April 2007). Fully 84% of managers say they can rely on their boss and their direct reports all or most of the time—a finding that would make Drucker proud but sheds little light on why execution fails. When we ask about commitments across functions and business units, the answer becomes clear. Only 9% of managers say they can rely on colleagues in other functions and units all the time, and just half say they can rely on them most of the time. Commitments from these colleagues are typically not much more reliable than promises made by external partners, such as distributors and suppliers.

When managers cannot rely on colleagues in other functions and units, they compensate with a host of dysfunctional behaviors that undermine execution: They duplicate effort, let promises to customers slip, delay their deliverables, or pass up attractive opportunities. The failure to coordinate also leads to conflicts between functions and units, and these are handled badly two times out of three—resolved after a significant delay (38% of the time), resolved quickly but poorly (14%), or simply left to fester (12%).

Even though, as we’ve seen, managers typically equate execution with alignment, they do recognize the importance of coordination when questioned about it directly. When asked to identify the single greatest challenge to executing their company’s strategy, 30% cite failure to coordinate across units, making that a close second to failure to align (40%). Managers also say they are three times more likely to miss performance commitments because of insufficient support from other units than because of their own teams’ failure to deliver.

Whereas companies have effective processes for cascading goals downward in the organization, their systems for managing horizontal performance commitments lack teeth. More than 80% of the companies we have studied have at least one formal system for managing commitments across silos, including cross-functional committees, service-level agreements, and centralized project-management offices—but only 20% of managers believe that these systems work well all or most of the time. More than half want more structure in the processes to coordinate activities across units—twice the number who want more structure in the management-by-objectives system.

Myth 2: Execution Means Sticking to the Plan

When crafting strategy, many executives create detailed road maps that specify who should do what, by when, and with what resources. The strategic-planning process has received more than its share of criticism, but, along with the budgeting process, it remains the backbone of execution in many organizations. Bain & Company, which regularly surveys large corporations around the world about their use of management tools, finds that strategic planning consistently heads the list. After investing enormous amounts of time and energy formulating a plan and its associated budget, executives view deviations as a lack of discipline that undercuts execution.

Unfortunately, no Gantt chart survives contact with reality. No plan can anticipate every event that might help or hinder a company trying to achieve its strategic objectives. Managers and employees at every level need to adapt to facts on the ground, surmount unexpected obstacles, and take advantage of fleeting opportunities. Strategy execution, as we define the term, consists of seizing opportunities that support the strategy while coordinating with other parts of the organization on an ongoing basis. When managers come up with creative solutions to unforeseen problems or run with unexpected opportunities, they are not undermining systematic implementation; they are demonstrating execution at its best.

Such real-time adjustments require firms to be agile. Yet a lack of agility is a major obstacle to effective execution among the companies we have studied. When asked to name the greatest challenge their companies will face in executing strategy over the next few years, nearly one-third of managers cite difficulties adapting to changing market circumstances. It’s not that companies fail to adapt at all: Only one manager in 10 saw that as the problem. But most organizations either react so slowly that they can’t seize fleeting opportunities or mitigate emerging threats (29%), or react quickly but lose sight of company strategy (24%). Just as managers want more structure in the processes to support coordination, they crave more structure in the processes used to adapt to changing circumstances.

A seemingly easy solution would be to do a better job of resource allocation. Although resource allocation is unquestionably critical to execution, the term itself is misleading. In volatile markets, the allotment of funds, people, and managerial attention is not a onetime decision; it requires ongoing adjustment. According to a study by McKinsey, firms that actively reallocatedcapital expenditures across business units achieved an average shareholder return 30% higher than the average return of companies that were slow to shift funds.

Instead of focusing on resource allocation, with its connotation of one-off choices, managers should concentrate on the fluid reallocation of funds, people, and attention. We have noticed a pattern among the companies in our sample: Resources are often trapped in unproductive uses. Fewer than one-third of managers believe that their organizations reallocate funds to the right places quickly enough to be effective. The reallocation of people is even worse. Only 20% of managers say their organizations do a good job of shifting people across units to support strategic priorities. The rest report that their companies rarely shift people across units (47%) or else make shifts in ways that disrupt other units (33%).

Companies also struggle to disinvest. Eight in 10 managers say their companies fail to exit declining businesses or to kill unsuccessful initiatives quickly enough. Failure to exit undermines execution in an obvious way, by wasting resources that could be redeployed. Slow exits impede execution in more-insidious ways as well: Top executives devote a disproportionate amount of time and attention to businesses with limited upside and send in talented managers who often burn themselves out trying to save businesses that should have been shut down or sold years earlier. The longer top executives drag their feet, the more likely they are to lose the confidence of their middle managers, whose ongoing support is critical for execution.

A word of warning: Managers should not invoke agility as an excuse to chase every opportunity that crosses their path. Many companies in our sample lack strategic discipline when deciding which new opportunities to pursue. Half the middle managers we have surveyed believe that they could secure significant resources to pursue attractive opportunities that fall outside their strategic objectives. This may sound like good news for any individual manager, but it spells trouble for a company as a whole, leading to the pursuit of more initiatives than resources can support. Only 11% of the managers we have surveyed believe that all their company’s strategic priorities have the financial and human resources needed for success. That’s a shocking statistic: It means that nine managers in 10 expect some of their organizations’ major initiatives to fail for lack of resources. Unless managers screen opportunities against company strategy, they will waste time and effort on peripheral initiatives and deprive the most promising ones of the resources they need to win big. Agility is critical to execution, but it must fit within strategic boundaries. In other words, agility must be balanced with alignment.

Myth 3: Communication Equals Understanding

Many executives believe that relentlessly communicating strategy is a key to success. The CEO of one London-based professional services firm met with her management team the first week of every month and began each meeting by reciting the firm’s strategy and its key priorities for the year. She was delighted when an employee engagement survey (not ours) revealed that 84% of all staff members agreed with the statement “I am clear on our organization’s top priorities.” Her efforts seemed to be paying off.

Then her management team took our survey, which asks members to describe the firm’s strategy in their own words and to list the top five strategic priorities. Fewer than one-third could name even two. The CEO was dismayed—after all, she discussed those objectives in every management meeting. Unfortunately, she is not alone. Only 55% of the middle managers we have surveyed can name even one of their company’s top five priorities. In other words, when the leaders charged with explaining strategy to the troops are given five chances to list their company’s strategic objectives, nearly half fail to get even one right.

Not only are strategic objectives poorly understood, but they often seem unrelated to one another and disconnected from the overall strategy. Just over half of all top team members say they have a clear sense of how major priorities and initiatives fit together. It’s pretty dire when half the C-suite cannot connect the dots between strategic priorities, but matters are even worse elsewhere. Fewer than one-third of senior executives’ direct reports clearly understand the connections between corporate priorities, and the share plummets to 16% for frontline supervisors and team leaders.

Senior executives are often shocked to see how poorly their company’s strategy is understood throughout the organization. In their view, they invest huge amounts of time communicating strategy, in an unending stream of e-mails, management meetings, and town hall discussions. But the amount of communication is not the issue: Nearly 90% of middle managers believe that top leaders communicate the strategy frequently enough. How can so much communication yield so little understanding?

Part of the problem is that executives measure communication in terms of inputs (the number of e-mails sent or town halls hosted) rather than by the only metric that actually counts—how well key leaders understand what’s communicated. A related problem occurs when executives dilute their core messages with peripheral considerations. 

The executives at one tech company, for example, went to great pains to present their company’s strategy and objectives at the annual executive off-site. But they also introduced 11 corporate priorities (which were different from the strategic objectives), a list of core competencies (including one with nine templates), a set of corporate values, and a dictionary of 21 new strategic terms to be mastered. Not surprisingly, the assembled managers were baffled about what mattered most. 

When asked about obstacles to understanding the strategy, middle managers are four times more likely to cite a large number of corporate priorities and strategic initiatives than to mention a lack of clarity in communication. Top executives add to the confusion when they change their messages frequently—a problem flagged by nearly one-quarter of middle managers.

Myth 4: A Performance Culture Drives Execution

When their companies fail to translate strategy into results, many executives point to a weak performance culture as the root cause. The data tells a different story. It’s true that in most companies, the official culture—the core values posted on the company website, say—does not support execution. However, a company’s true values reveal themselves when managers make hard choices—and here we have found that a focus on performance does shape behavior on a day-to-day basis.

Few choices are tougher than personnel decisions. When we ask about factors that influence who gets hired, praised, promoted, and fired, we see that most companies do a good job of recognizing and rewarding performance. Past performance is by far the most frequently named factor in promotion decisions, cited by two-thirds of all managers. Although harder to assess when bringing in new employees, it ranks among the top three influences on who gets hired. 

One-third of managers believe that performance is also recognized all or most of the time with nonfinancial rewards, such as private praise, public acknowledgment, and access to training opportunities. To be sure, there is room for improvement, particularly when it comes to dealing with underperformers: A majority of the companies we have studied delay action (33%), address underperformance inconsistently (34%), or tolerate poor performance (11%). Overall, though, the companies in our sample have robust performance cultures—and yet they struggle to execute strategy. Why?

The answer is that a culture that supports execution must recognize and reward other things as well, such as agility, teamwork, and ambition. Many companies fall short in this respect. When making hiring or promotion decisions, for example, they place much less value on a manager’s ability to adapt to changing circumstances—an indication of the agility needed to execute strategy—than on whether she has hit her numbers in the past. Agility requires a willingness to experiment, and many managers avoid experimentation because they fear the consequences of failure.

 Half the managers we have surveyed believe that their careers would suffer if they pursued but failed at novel opportunities or innovations. Trying new things inevitably entails setbacks, and honestly discussing the challenges involved increases the odds of long-term success. But corporate cultures rarely support the candid discussions necessary for agility. Fewer than one-third of managers say they can have open and honest discussions about the most difficult issues, while one-third say that many important issues are considered taboo.

An excessive emphasis on performance can impair execution in another subtle but important way. If managers believe that hitting their numbers trumps all else, they tend to make conservative performance commitments. When asked what advice they would give to a new colleague, two-thirds say they would recommend making commitments that the colleague could be sure to meet; fewer than one-third would recommend stretching for ambitious goals. This tendency to play it safe may lead managers to favor surefire cost reductions over risky growth, for instance, or to milk an existing business rather than experiment with a new business model.

The most pressing problem with many corporate cultures, however, is that they fail to foster the coordination that, as we’ve discussed, is essential to execution. Companies consistently get this wrong. When it comes to hires, promotions, and nonfinancial recognition, past performance is two or three times more likely than a track record of collaboration to be rewarded. Performance is critical, of course, but if it comes at the expense of coordination, it can undermine execution. We ask respondents what would happen to a manager in their organization who achieved his objectives but failed to collaborate with colleagues in other units. Only 20% believe the behavior would be addressed promptly; 60% believe it would be addressed inconsistently or after a delay, and 20% believe it would be tolerated.

Myth 5: Execution Should Be Driven from the Top

In his best-selling book Execution, Larry Bossidy describes how, as the CEO of AlliedSignal, he personally negotiated performance objectives with managers several levels below him and monitored their progress. Accounts like this reinforce the common image of a heroic CEO perched atop the org chart, driving execution. That approach can work—for a while. AlliedSignal’s stock outperformed the market under Bossidy’s leadership. However, as Bossidy writes, shortly after he retired “the discipline of execution…unraveled,” and the company gave up its gains relative to the S&P 500.

Top-down execution has drawbacks in addition to the risk of unraveling after the departure of a strong CEO. To understand why, it helps to remember that effective execution in large, complex organizations emerges from countless decisions and actions at all levels. Many of those involve hard trade-offs: For example, synching up with colleagues in another unit can slow down a team that’s trying to seize a fleeting opportunity, and screening customer requests against strategy often means turning away lucrative business. The leaders who are closest to the situation and can respond most quickly are best positioned to make the tough calls.

Concentrating power at the top may boost performance in the short term, but it degrades an organization’s capacity to execute over the long run. Frequent and direct intervention from on high encourages middle managers to escalate conflicts rather than resolve them, and over time they lose the ability to work things out with colleagues in other units. Moreover, if top executives insist on making the important calls themselves, they diminish middle managers’ decision-making skills, initiative, and ownership of results.

In large, complex organizations, execution lives and dies with a group we call “distributed leaders,” which includes not only middle managers who run critical businesses and functions but also technical and domain experts who occupy key spots in the informal networks that get things done. The vast majority of these leaders try to do the right thing. Eight out of 10 in our sample say they are committed to doing their best to execute the strategy, even when they would like more clarity on what the strategy is.

Distributed leaders, not senior executives, represent “management” to most employees, partners, and customers. Their day-to-day actions, particularly how they handle difficult decisions and what behaviors they tolerate, go a long way toward supporting or undermining the corporate culture. In this regard, most distributed leaders shine. As assessed by their direct reports, more than 90% of middle managers live up to the organization’s values all or most of the time. They do an especially good job of reinforcing performance, with nearly nine in 10 consistently holding team members accountable for results.

But although execution should be driven from the middle, it needs to be guided from the top. And our data suggests that many top executive teams could provide much more support. Distributed leaders are hamstrung in their efforts to translate overall company strategy into terms meaningful for their teams or units when top executives fail to ensure that they clearly understand that strategy. And as we’ve seen, such failure is not the exception but the rule.

Conflicts inevitably arise in any organization where different units pursue their own objectives. Distributed leaders are asked to shoulder much of the burden of working across silos, and many appear to be buckling under the load. A minority of middle managers consistently anticipate and avoid problems (15%) or resolve conflicts quickly and well (26%). Most resolve issues only after a significant delay (37%), try but fail to resolve them (10%), or don’t address them at all (12%). Top executives could help by adding structured processes to facilitate coordination. In many cases they could also do a better job of modeling teamwork. One-third of distributed leaders believe that factions exist within the C-suite and that executives there focus on their own agendas rather than on what is best for the company.

Many executives try to solve the problem of execution by reducing it to a single dimension. They focus on tightening alignment up and down the chain of command—by improving existing processes, such as strategic planning and performance management, or adopting new tools, such as the balanced scorecard. These are useful measures, to be sure, but relying on them as the sole means of driving execution ignores the need for coordination and agility in volatile markets. If managers focus too narrowly on improving alignment, they risk developing ever more refined answers to the wrong question.

In the worst cases, companies slip into a dynamic we call the alignment trap. When execution stalls, managers respond by tightening the screws on alignment—tracking more performance metrics, for example, or demanding more-frequent meetings to monitor progress and recommend what to do. This kind of top-down scrutiny often deteriorates into micromanagement, which stifles the experimentation required for agility and the peer-to-peer interactions that drive coordination. Seeing execution suffer but not knowing why, managers turn once more to the tool they know best and further tighten alignment. The end result: Companies are trapped in a downward spiral in which more alignment leads to worse results.

If common beliefs about execution are incomplete at best and dangerous at worst, what should take their place? The starting point is a fundamental redefinition of execution as the ability to seize opportunities aligned with strategy while coordinating with other parts of the organization on an ongoing basis. Reframing execution in those terms can help managers pinpoint why it is stalling. Armed with a more comprehensive understanding, they can avoid pitfalls such as the alignment trap and focus on the factors that matter most for translating strategy into results.

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Why Large Companies Can't Innovate 12-13

Why Large Companies Can't Innovate

Large companies are trimmed to execute established business models. The demise of e.g. Eastman Kodak, Nokia, or Blockbuster illustrate that this is insufficient in the 21st century. Companies that want to escape this fate need to excel at execution AND the creation of new growth engines at the same time.

There is nothing wrong with being good at execution. It allows companies to get the most out of a known and successful business model. The challenge is to improve one's existing business models while creating an organizational space to invent business models for the future at the same time. The reason this is so difficult is because both require very different cultures, skills, processes, and incentives. Watch the video below to understand how they differ.

I often hear people say companies need to create an agile innovation culture. That's nonsense and even dangerous. It's great to have an outstanding execution engine as long as you are able to build an innovation engine as well. That's where you will experiment with new growth engines by relentlessly testing business models and value propositions.

There are a couple of great thinkers on this topic. In The Other Side of InnovationGovindarajan and Trimble show that the execution and innovation engines need to work in partnership. In The End of Competitive Advantage Rita McGrath shows that the urge to hold on to one’s established competitive advantage is a vicious trap. She establishes the factors central to building the dynamic enterprise of tomorrow.

Another favorite of mine is John Kotter. In the video below he shows that the organizational structure predominant today is over 100 years old. It was not built to be fast and agile, but to meet the daily demands of running an enterprise.  Kotter advocates a new system that he calls the "dual operating system" in which execution and innovation operate in concert.

Dr. John Kotter on what he calls the "Dual Operating System"

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