Capabilities-Driven Strategy

IMI Kolkata 22nd February 2012

RUDRA CHATTERJEE

Material has been developed for this class by

Welcoming the IMI class
About the students

About our style of interaction student participation, talk about

instances in your life professional, volunteer activities that
relate to the subjects we will discuss

About this class Coherence Premium in an environment of

strategy schizophrenia

About next class A simplified model of Porter and discussion

on how Strategies are defined by local markets

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Since were at the last leg of our course, let us ask: despite many
strategy frameworks why companies struggle with value creation?
Evolution of Strategy
Adaptation Future Position
Act quickly and creatively Exploit the high ground: create
in response to events Michael Porter and hold a distinctive position
(organizational warning) Competitive Strategy (market-back strategy)
1980
Henry Mintzberg W. Chan Kim &
The Rise and Fall of Rene Mauborgne
Strategic Planning Blue Ocean Strategy
1994 Bruce Henderson 2005
Essays
Tom Peters & 1966 Kenneth Andrews
Robert Waterman The Concept of
In Search of Excellence Corporate Strategy
1982 1971
Many Few
William Abernathy &
Robert Hayes Gary Hamel &
Managing Our way to C.K. Prahalad
W. Edwards Deming Economic Decline Competing for the Future
Out of the Crisis 1980 1994
1986 RamCharan & Chris Zook
Larry Bossidy Profit from the Core
Execution 2001
2002
Michael Hammer &
James Champy
Execution Reengineering the Corporation Concentration
Align people and processes 1993 Focus on your current
for operational excellence core business
(the quality movement) Present (private equity)
Source: The Right to Win, by Cesare Mainardi and Art Kleiner, published in strategy+business (issue 61)
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Why are companies drowning in blue oceans pursuing markets
that look appealing but are unreachable?
A recent Booz survey of 1800 senior executives identified the
problem:
More than half of the respondents dont think that they
have a winning strategy
2 out of 3 companies admit that they dont have the
capabilities needed to create value in the marketplace
Only 1 in 5 are fully confident they have a right to win
And, the vast majority agree that theyre chasing far too
many opportunities

We see many companies struggling to grow despite heavy

investment.
They grab hastily for what seems like the next answer to
growth
They dont have a solid framework to decide which
opportunities will lead to sustained success
They end up stretched thin
Note: Illustration from The Coherence Premium, by Paul Leinwand
and Cesare Mainardi, published in Harvard Business Review (June 2010)

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Companies are not asking the right question

They ask Where do we want to grow?

and What do we want to do?

They should be asking: Who do we want to be?

In other words: How should we be different to create value?

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Coherent companies consistently outperform their competitors a
Coherence Premium
Link between Coherence and Performance
22 Passenger Auto 32 Consumer Packaged Goods
20
18 28
* *
16
*
14
* * 24
12
10 *
* *
8 20
* *
6

*%
*%

* *
4 16 *
* *
2
* * *
0 *
-2 * * * 12
*
*
-4
-6 8 *
-8 Size of Bubble: Revenue Size of Bubble: Revenue
-10 4
20 30 *0 *0 *0 *0 *0 *0 *0 * * * * * *
Portfolio * Score *

Degree to which a company leverages a common set of capabilities across its different businesses
Sources: Booz & Company; Capital IQ; Bloomberg; Automotive analysis based on 2003-2007 financial data

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Resolving who we want to be entails making three strategic
choices when all three are in synch a company is coherent

How are we going to

create value for our
customers in this
market?

Right to
Win
What are we going to
What do we need to do sell in this market and
well to deliver that value to whom?
proposition?

Winning companies align their strategic direction to the capabilities that make them unique.
They make hard choices about differentiation and stick to them.
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Case study

Case 1: Pfizer Consumer Health Care

Pfizer Consumer Healthcare transformed into a premier OTC company consistently

Results
delivering industry-leading growth

Capabilities Product and

Way to Play
System Service Fit

Develop and market 1. Pharma-like innovation Reorganized to grow

advantaged molecules and Rx-to-OTC switches golden global brands at
and formulations able to above-market rates
2. Claims-based innovation
meet substantive
Decisions and NPD Rationalized the OTC and
therapeutic claims
and Actions CHC product portfolio
3. Claims-based marketing
Divested personal care
4. Ability to scale global
(Schick brand) to
brands and products
Energizer
5. Regulatory management
Sold confectionary
6. Effective retail execution (Bubblicious, Halls) to
Cadbury

Value Pfizer redeemed the value built by PCH when it sold the business to J&J for an
Capture unprecedented $16.6Bn or 20.6 times EBITDA in 2006

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Why do coherent choices create value?

Focus and dedication on creating a winning capabilities system in your way to play
Effectiveness Barriers for competitors who are less coherent, with less effective capabilities
Ongoing improvement engine for the few capabilities that matter

Highlighting of what is non-essential through clarity on way to play

Efficiency Less spend on those capabilities that are non-differentiating
Capability scale through focus and often ability to deploy more broadly

Provision of objective for the enterprise the value behind the portfolio
Focused
Direction of capital and attention to those opportunities that extend a capabilities lead
Investment Guide for both organic growth and M&A decisions

Alignment of strategic intent and day-to-day decision making thanks to capabilities

lens
Alignment Organization moving in lockstep and executing faster and with more force
Talent attraction to organizations that clearly value what they do

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There are many reasons for rampant incoherence

Pursuing growth
at all cost Basing portfolio
decisions on near-term
financial results

Prior experience guiding

future action (hubris) Mitigating managerial
risk at the expense of
shareholder returns

Not knowing what your

distinctive capabilities
are

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Case study
Case 2: A case study in incoherence Anheuser-Busch enters
snacks
Expansion into Snack Business
Anheuser-Busch in Early 1980s
Rolling in cash, having bested rival
Miller Brewing Co. in the beer wars of
the late 1970s
Famous for its brand management,
?
consumer insight, distribution
management, superior merchandising,
shelf management and navigation in
heavily regulated, state-based alcohol
market
Experiencing a stagnant market for
beer
Familiar with selling pretzels and
snacks to bars and restaurants
Booz & Company
US Snack Food Business
High growth market (~ 5% p.a.) worth $11 billion
with good profit levels (~8%)
Market strongly dominated by Frito-Lay, Inc., the
King Kong of the snack food aisle
Owned by PepsiCo
Famous for its direct-store delivery system
More than 40% market share
Although industry has some monopolistic elements
(aggressive pricing, distribution policies among chip
makers), regional presence of many large and small
manufacturers keeps it highly competitive
Key success factors in snack market include gaining
shelf space, in supermarkets, convenience markets,
gas stations, etc. and flavor innovation
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A chosen way to play must be well-defined and
differentiating
Example: Advantaged Ways to Play in PCs
Designs devices that intuitively fit
with how people work, play &
learn
Has premium offer based on
Experience
compelling experience Customizer Outsources manufacturing and
Provider
Has proprietary operating system
and puts emphasis on media
Sells devices as integrated
solutions, with direct link between
the device on a desk/ in a pocket
Solutions and the cloud of services that
Provider support it
Tries to become one-stop shop
for computers, systems, and
services
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Is consummate customizer of
computers for individuals matching
features to individual tastes
(configure-to-order)
assembly to reliable suppliers
Provides high-quality customer
service
Competes on low cost (leveraging
China base) and rapid fast-
follower-style innovation
Value Offers computers that have most
Player features that other computer
manufacturers provide but less
customer service
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Capabilities must be mutually reinforcing and integrated
into a system that best supports a chosen way to play
Example: The Pepsi-Frito Lay Capabilities System

Direct-store delivery (DSD)

allowing easy testing of new
products by introducing them in
a handful of stores

Continuous
innovation of new Skilful global consumer
products with store marketing to rapidly build
level response demand for initially
information going successful products
directly to R&D

Way to Play
Rapid innovation, distribution and marketing to stimulate and meet
customer snacking needs
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Products and services must fit a companys capabilities
system and way to play
Example: The Listerine Pocket Pack Story

Pocket Packs Pocket Packs

launched by achieve $160m in
Pfizer, inventing sales in the first
a new category full year of sales

2001 2002 2004

Wrigley enters market
Eclipse overtakes
with Eclipse,
Listerine (still one
marketing multiple
flavor) as #1 breath
flavors to Listerines
strip on the market
one

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Case study

Case 3: Three pure tone strategic alternatives

Market-back Pure-Tone Capabilities Essential Financial Resulting

Growth Avenues Strategic for Advantage Evaluation Enterprise Value
Where are our Alternatives What gives us
best opportunities? the Right to Win?
Revenue
Consumers Insights Growth
* *
and
Customers

Category
Leader Innovation Margin
Expansion

Supply
* x

Chain ROIC
Categories
Expansion
(158 reviewed)
Category
Innovator Marketing Organic
x
Invested Plays
Trends Capital
Wellness and
Nutrition
Geographic
Sales

Convenience Solution
Value and (all markets) Risk
Provider * x
Premiumization M&A
Authenticity

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Case study
Case 3: Defining capabilities systems was the key
Core Category Leader
Understand consumer trends,
category dynamics and regulatory
Insights environment to determine how to
transform categories where possible
Focus innovation on core categories
meeting current consumer lifestyle
Innovation and demographic trends to increase
occasion consumption and to take
share
Secure advantaged manufacturing
economics by investing in leading
Supply Chain process technology, establishing
scale positions and unparalleled
executional effectiveness
Develop retailer and consumer value
Marketing and propositions able to deliver rapid
Sales share capture utilizing regional,
sharp pencil assortment, pricing
and promotion tactics; own the
refrigerated XXX section
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Category Innovator
Understand and leverage trends,
equities, and capabilities to provide
new XXX-based innovations
Rapidly define, develop and market
test new XXX-based innovations on
trend
Configure a flexible value chain able
to launch many varied products
rapidly and economically, while
ensuring ongoing cost effectiveness
in the core
Communicate new consumer value
propositions effectively while
ensuring appropriate retail
distribution and availability
Solution Provider
Understand the evolution of XXX
solutions and the technology
required for success
Open architecture innovation
focused on securing new product
and process technologies able to
outperform large CPG alternative
XXX solution offerings
Operate a flexible assembly
manufacturing capability able to
integrate new product technologies
across several temperature states
Market de novo categories and
consumer solutions securing new
retail space; secure positions in the
store perimeter
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Coherence is essential to all value creation choices

Value Creation Choices

& Coherences
Companies make many choices about value
creation on an almost daily basis

These decisions must be coherent with the Growth

intended strategy but often are not Choices

A company can chart a path towards relative Expense Capabilities M&A

coherence Choices System Choices

The starting point will, therefore, naturally be

Portfolio
unique, and often localised, for each company
Choices

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How would you prioritize growth choices?

Grow with a Capabilities Lens

Sell more of existing products to
existing customers with existing
capabilities system
Grow Core
Acquire new customers in same
market segment
Enhance depth of current offering
Extend Leverage capabilities system to
Capabilities expand into new, complementary
Core System products and services

Expand Take offerings, capabilities system, and

Geographic way to play to new geographies where
Footprint they can thrive
and exceptionally
Adjust capabilities system - only if
fundamentals of sales and profitability
Acquire New are changing
Capabilities Parsimoniously select new capabilities
and fill capability gaps, if large de
novo opportunities require to do so

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Should M&A choices be viewed through a capabilities
lens?
Capabilities-based M&A Creates Value
Winners and Losers in Healthcare Sector M&As

Capability building has been the most

successful strategy 38% more likely
to be a winner than a loser, despite
Empirically, diversification deals having paid the highest multiples for
fare the worst, ~40% more targets
likely to be a loser than a Capability-building deals accounted for
winner 22% of deal volume and 38% of deal Its all about
value being better,
Focus-oriented divestitures were 15%
more likely to be winners than losers
not bigger

Winners
Losers
# of Deals

N=169
N=169

-140% -70% 0% 70% 140% 210%

1 Year Excess Return
Sources: Capital IQ; Booz & Company analysis of 340 Healthcare sector mergers and acquisitions from 1995 - 2008, classified into four archetype strategies
(scale/consolidation, capability building, diversification, and focus

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What does this imply for a portfolio strategy?

Define the Boundaries of Your Portfolio

Improve
Performance
Above
Par
Divest

Align
Grow or
Grow acquire
and Grow
and Expand
Financial
potential

Selectively products and

services that
leverage
your
distinctive
capabilities
Manage to Divest/Discontinue Leverage
Coherence or Divest
Below
Par
Low High
Coherence with capabilities system

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Can you Cut Costs and Grow Stronger?

Booz & Company Lights-On Cost and Discretionary Investment Perspective

Starting Cost
Base Breakdown
Not Required Essential Capabilities
Non-essential 36 differentiating
capabilities capabilities that build
sustainable advantage Taking costs
20-30% out is a
Eliminate or be 30-50% May spend more than
parsimonious competitors strategic
opportunity
Lights-On Table Stakes to make clear
Activities required to Activities required to
focus
keep the lights 20-30% compete in a given decisions
on/operate (e.g., 10-20% sector
legal requirements,
etc.)
Aim for best-in-class Aim for best-in-class
cost levels cost levels

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A starting point: Is your strategy coherent?

The Coherence Test

Can We State It? Do We Live It?

Are we clear about how we choose to create value in the Are we investing in the capabilities that really matter to
Way to Play
marketplace? our way to play?
Do all our businesses draw on this superior capabilities
Can we articulate the three to six capabilities that
system?
describe what we do uniquely better than anyone else?
Capabilities
Do our organizational structure and operating model
System Have we defined how they work together in a system?
support and leverage it?
Do our strategy documents reflect this?
Does our performance management system reinforce it?
Do most of the products and services we sell fit with our
Have we specified our product and service sweet
capabilities system?
Product & spot?
Service Fit Are new products and acquisitions evaluated on the
Do we understand how to leverage the capabilities
basis of their fit with the way to play and capabilities
system in new or unexpected arenas?
system?

Can everyone in the organization articulate our

Do we have a right to win in our chosen market?
differentiating capabilities?
Coherence Do all of our decisions add to our coherence, or do
Is our companys leadership reinforcing these
some of them push us toward incoherence?
capabilities?

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 The process to develop and execute a Capabilities-Driven Strategy
follows five simple phases
The Capabilities-Driven Strategy Process
Discover Assess Choose Transform Evolve

Articulate current way Assess way to play Choose the future way Detail specific Track progress and
to play, capabilities, options: ability to to play and associated implications for growth monitor ongoing
Activities

products & services succeed, risk, and capabilities system plays, cost & portfolio choices
and their coherence headroom/financials most likely to provide a Communicate vision Drive continuous
Establish viable Evaluate hypotheses right to win Identify needed improvement of the
alternative future ways based on value and operating model capabilities system -
to play and their success probability changes live coherence every
required capabilities Begin implementation day

Right to Win Exercise Headroom Framework

CDS Tools

Coherence Test
Example

Market Dynamics Test Portfolio Review Tool

History Mapping Capabilities-Related
Puretone Exercise Cost Assessment
Senior Management Workshops

Status quo Assessment of value Decided upon way to Prioritized growth Delivery of strategic
self-assessment created by & risk of play opportunities roadmap
Deliverables

Current market adopting each way to Roadmap to re-align Ongoing activity and
landscape including play option costs and products/ continued commitment
competitors ways to In-depth evaluation of services in support of the new
play & capabilities each hypothesis Action plan to fill way to play and
Key market trends including related critical capability gaps capabilities system
Initial hypotheses on capabilities, effect on Communication &
future ways to play products & services, implementation plan
and feasibility
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We have identified the power of coherence in many leading
companies
Examples of Coherent Companies

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and our concept is receiving strong endorsements from
academics and business leaders SELECTION

Just because a company can doesnt mean it should. Their
books key insightthe idea of coherenceis of particular
importance as companies face pressure to increase their
comparable sales year over year and begin to turn outside of
their core business to build revenue.
Michael Roberts,
Former President & COO, McDonalds Corporation
A refreshingly new approach. Water naturally flows
downhilland companies naturally slide into an incoherent
strategy. This book teaches how to pump water uphill by
orchestrating three elements for coherence: the way to play,
distinctive capabilities, and the portfolio.
R. Gopalakrishnan,
Executive director, Tata Sons

For at least thirty years people have been trying to figure out
Here, at last, is a book that helps a CEO sort through the
how to build corporate strategy around a company's
many conflicting demands on him. The framework that
capabilities. Leinwand and Mainardi offer an elegant solution,
intrinsically links capabilities to strategy is clear; it makes
one that demonstrates the power of having all the pieces fit
sense; its practical; and, I know from experience; it works.
together into a coherent, focused way forward.
Saud Al Daweesh,
Walter Kiechel,
Group CEO of Saudi Telecom
Author, The Lords of Strategy

The Essential Advantage should be essential reading.

Companies have many strategic options, especially in fast-
Leinwands and Mainardis unique approach of assessing
growing markets and industries. The Essential Advantage is a
internal strengths firstthen ones product or services
powerful reminder that capabilities should play the central
portfoliois a fresh way forward that should be part of every
role in sorting through them.
CEOs and business leaders playbook.
Ahmad Abdulkarim Julfar,
Eric Spiegel,
Group Chief Operating Officer, Etisalat Group
President & CEO, Siemens Corporation

Sources: Endorsements for The Essential Advantage by Paul Leinwand and Cesare Mainardi, to be published in December 2009 by Harvard Business Review Press

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