Tuesday, April 16, 2013

The Agility Factor

A few large companies in every industry show consistently superior profitability relative to their peers, and they all have one thing in common: a highly developed capacity to adapt their business to change.

strategy+business magazine:

Everybody knows that big corporations, by nature, maneuver like battleships. Held back by their own inertia and current business strategies, they cannot turn quickly when the competitive environment changes. Everybody also knows that high performance, as measured by shareholder returns, is impossible to sustain over the long term; no company consistently beats the market.
But a recent in-depth study of long-term performance suggests an alternative point of view about business strategy. When the measure of performance is profitability, a few large companies in every industry consistently outperform their peers over extended periods. And they maintain this performance edge even in the face of significant business change in their competitive environments. The one factor they seem to have in common is agility. They adapt to business change more quickly and reliably than their competitors; they have found a way to turn as quickly as speedboats when necessary.
ExxonMobil is a good example. Throughout the 1980s, when it was still just Exxon, it was the largest, most profitable oil and gas company in the world. ...
Portrait of Lee Raymond
Portrait of Lee Raymond (Photo credit: Wikipedia)
hen in 1989, Exxon fell from grace. ... When Lee Raymond took over from Lawrence Rawl as chairman in April 1993, Exxon had dropped on Fortune’s list of most admired companies from number six to 110. As Raymond noted in a rare interview, a good day for him was one in which “Exxon” or his name did not appear in the papers.
Many companies would have reacted by putting in place short-term fixes and doing whatever they could to return to their old ways of operating. Instead, Exxon quietly moved to internalize the lessons of the Valdez spill and to build the capabilities required for future profitability. ... Recognizing that external upheavals could occur at any time, the company relentlessly drove for efficiency over the 1990s—a fortunate move because oil prices continued to fall throughout the decade. Exxon ... improved its exploration capability (where it had historically lagged behind its competitors), and pushed production efficiency even harder. Through all these measures, and by taking full advantage of the innate discipline for which it was known, Exxon halved its cost of finding oil and greatly improved its exploration success rate. In 1995, Lee Raymond was able to say, “Exxon is now much more efficient at getting on with it.”
Exxon’s focus on execution, technical excellence, and capital efficiency positioned the firm well to exploit the rise in oil prices that began in 1998. In 1999, Raymond, dubbed by Businessweek as the “anti-celebrity CEO,” engineered the largest acquisition in history to that point, and one of the most successful, with Exxon’s purchase of Mobil. In 2000, the combined company became the most profitable in history, a ranking it still holds today, and launched a new series of exploration initiatives to spur growth in oil and gas reserves.
The pattern of adaptation Exxon exhibited is not typical of most large companies. It represents an unusual ability to successfully respond to and learn from external events, to innovate technically and organizationally, and to plan and execute new courses of action. In short, Exxon demonstrated a rare and distinctive ability to continually and successfully adapt to changing circumstances. We call this “agility.” Today, when every industry faces turbulent change as a matter of course, a company’s agility becomes the difference between sustaining performance and falling behind.

Agility and Performance

A closer look at the record of Exxon and other large, public companies, from a variety of industries, supports this link between agility and consistent high performance. We studied the financial performance of 243 large firms in 17 industries over the 30-year period from 1979 to 2009.
Like others before us, we concluded that stock prices and shareholder returns cannot tell a story about sustained performance. ... Exxon and ExxonMobil stock languished through the 1990s, for instance, despite exemplary performance during the dot-com craze.
Thus, instead of relying on total shareholder return (TSR) or its even more misleading cousin, cumulative shareholder return, we looked at return on assets (ROA)—a meaningful proxy for profitability in many companies and a better indicator of management’s effectiveness. (Only one of the 17 industries we studied—financial services and insurance—lacked any kind of reasonable asset base. For this industry, we used return on equity as a more relevant proxy for profitability.) In every industry we studied, there were two or three “outperformers”: companies that achieved above-average industry ROA performance more than 80 percent of the time. Altogether, this group made up 16 percent of the sample. Exxon was a member; between 1979 and 2009, its ROA exceeded the industry average 97 percent of the time.
Among the other companies, we found two common performance patterns. About 18 percent of the sample were “underperformers,” whose profitability was below the industry average 80 percent or more of the time. The remaining 66 percent of the sample were “thrashers”; their profitability oscillated between underperformance and outperformance relative to the industry average.
Image representing IBM as depicted in CrunchBase
Image via CrunchBase
ExxonMobil is one of only two outperformers in the oil and gas industry. The other is Royal Dutch Shell PLC (see Exhibit 1). Outperformers in other industries include Campbell Soup, DaVita, GlaxoSmithKline, Honda, Johnson Controls, Limited Brands, Nike, Nokia, and Svenska Handelsbanken. Thrashers include BP, Procter & Gamble, IBM, Toyota, Pfizer, and Apple—all highly regarded companies that have received business accolades and spectacular press at times, but that tend to be admired for their peaks and forgiven for their valleys. Meanwhile, Exxon, Shell, and other outperformers, despite their occasional stumbles, more consistently deliver the goods.
To complete the link between agility and performance, we surveyed more than 4,700 directors and executives from 56 companies (including outperformers, underperformers, and thrashers), 34 of which were Fortune 500 firms included in the financial database. We asked about the way their organizations formulated strategy, designed their structures and processes, led their people, and changed and innovated. We also interviewed executives at 19 of the Fortune 500 firms.
When we compared our survey and interview data with the performance data, we observed a strong relationship between a company’s basic approach to management and its long-term profitability patterns. When markets and technologies changed rapidly and unpredictably—as they did in every industry over these 30 years—the outperformers had the capability to anticipate and respond to events, solve problems, and implement change better than thrashers. They successfully adapted. They were agile.

What Is Agility?

Agility is ... a cultivated capability that enables an organization to respond in a timely, effective, and sustainable way when changing circumstances require it. The management literature increasingly refers to this ability as a “dynamic capability”: the potential to sense opportunities and threats, solve problems, and change the firm’s resource base. This allows outperformers to maintain or enhance their relative advantages in ways their competitors fail to see or do not fully implement. Agility is also strategically relevant: Although agile organizations often change, they do not pursue change for change’s sake. They pursue it for the sake of competitive advantage.
Four routines, summarized in Exhibit 2, below, distinguish the high-performing organizations from the thrashers and underperformers. These companies have the ability to strategize in dynamic ways; accurately perceive changes in their external environment; test possible responses; and implement changes in products, technology, operations, structures, systems, and capabilities as a whole. Importantly, it is the whole system of routines, not the possession of one or two of them, that confers agility. ...[The] hard work necessary to orchestrate them for consistent high performance is advanced and uncommon. By executing these routines in concert, over and over again, the outperformers consistently outpaced competitors.
Strategizing dynamically. ... [Agile] organizations don’t define strategy the way other firms do. For them, strategy has three explicit parts: a sense of shared purpose, a change-friendly identity that is nonetheless stable enough to ground the organization, and a robust strategic intent that clarifies how the firm differentiates itself.
The Capital One Financial Corporation, ... demonstrates all three elements of strategizing dynamically. It has a widely shared and well-understood sense of purpose that is codified in its mission statement and business model. ...
Capital One’s change-friendly identity is embodied in a phrase that its managers often use in conversation: “test and learn.” ...
The company’s ongoing business strategy—its strategic intent—also enables it to embrace continuous change. Capital One is known for its willingness to rapidly shift its operations (for example, the range of customer segments served, channels used, or products offered); to adjust the aggressiveness of its marketing, customer support, new product development, or R&D; and to modify the features it offers consumers. Capital One seeks its competitive advantage not through a single product line or approach, but through an ongoing series of temporary advantages that exploit current business conditions.
Perceiving environmental change. Agile companies take special care to accurately sense what is going on in the environment. Managers and employees are put into direct contact with customers, regulators, and other stakeholders through multiple touch points, structures, and practices, and they are expected to gather intelligence. They communicate their perceptions of the external world to company decision makers who have the support and knowledge they need to interpret those messages as important or unimportant, opportunity or threat. All three elements of perceiving environmental change are essential. Sensing without communicating is wasteful; communicating without interpreting is just noise.
DaVita HealthCare Partners Inc., a Fortune 500 kidney care organization with more than 1,840 dialysis centers, has an effective, institutionalized perceiving routine. To keep all employees focused on the external environment, DaVita abandoned the organization chart. ... DaVita’s management system orients each local dialysis center to the needs of patients, physicians, and the community. Meanwhile, central management concentrates on activities that deliver future value for the corporation—they charter teams to build leaders, research the implications of healthcare reform, identify M&A prospects, and develop new business. One of these teams identified and pursued a recent merger with HealthCare Partners. This process also identified international dialysis as a potential business opportunity.
This external focus is supported by a hard-and-fast rule that moves information up the hierarchy: “Whenever there is a director and three or more team members in a room, there’s a town hall meeting.” In these meetings, any question can be asked about any subject. If the director doesn’t have an answer, the question goes into his or her email and has to be answered within 48 hours.
All that information—from dialysis centers and initiative teams—gets funneled to top management for consideration. ... At DaVita, different top management teams are accountable for different purposes. That allows the company to assign people with the right expertise to various questions and issues, and improves their ability to interpret signals from their externally focused organization.
Thrashers and underperformers, with inward-looking and politicized management, find this level and intensity of communication congenitally difficult. They are too busy vying for turf, resources, and position to dispassionately consider the implications of outside signals. The external focus of agile companies enables them to face up to brutal facts and separate wheat from chaff.
Testing responses. Agile organizations refine their insights from the perceiving routine with a relatively high number of low-cost experiments. They encourage innovation and tolerate a good deal of failure. ... In most cases, there are explicit risk management processes—with valid success criteria so the plug can be pulled if the test fails—and continuous learning efforts so that the insights gained from the tests spread to all relevant parts of the company. Agile organizations invest significantly in learning and continuous improvement, never resting on their laurels or believing they have “cracked the code” once and for all.
The Limited Brands has both informal and formal testing routines that help the apparel retail chain keep pace with fashion trends and competition. Managers get in the habit of asking one another, “What’s new, what’s next?” This connects everyone in the organization, from senior managers to store merchants, to the observations and data they’ve gathered, ... and pushes them to consider what they are going to do about it. The “what’s new, what’s next” mantra keeps them on their toes. At the store level, small-scale testing procedures make it easy to try out new concepts, point-of-purchase displays, and product extensions. Consumer responses to small-scale tests are vetted by managers, and investment decisions follow successful ideas. Two of the Limited’s blockbuster retail brands—Victoria’s Secret and Bath and Body Works—got started this way. Their success as small experiments inside existing retail stores caught management’s attention and led to big commitments from CEO Les Wexner.
To enable these tests, agile organizations are not always and everywhere “lean and mean.” They must consciously build in extra organizational slack—investing in people, money, and time that don’t go directly to the bottom line, but allow the agile organization to rapidly deploy resources against opportunities that may or may not pay off, without jeopardizing day-to-day operations. The higher staffing levels also play an important role in capturing and disseminating learning that the organization can use later.
Implementing change. Agile companies have mastered the internal program management capabilities they need to convert successful tests and promising innovations into widespread practices. ... These companies have histories of successful transformations, restructurings, and merger integrations, and they also excel at the execution of new product rollouts, policy changes, and compliance mandates, as Exxon demonstrated after the Valdez spill.
The Swedish bank Svenska Handelsbanken is built on the principle of radical decentralization, and its record of financial success is unmatched; the recent financial crisis hardly dented performance. Guided by a change-friendly identity and the slogan “the branch is the bank,” branch managers are responsible for financial results and have the budget authority to take action. They control marketing decisions (except when a new product common to all branches is being launched), staffing levels, salaries, and property lease costs. In addition, on average, half of a branch’s staff has lending authority, permitting customers to receive answers very quickly. Branch managers are held accountable for results and continuous improvement by a “relative performance measurement system” that transparently compares all branches on a quarterly basis. At the end of the year, a performance-based profit-sharing system for all employees is triggered when the organization’s after-tax return on shareholders’ equity (excluding extraordinary items) is higher than the average for other Nordic banks. One-third of the excess amount is placed in an employee fund, and all employees, including the CEO, receive the same profit share.
Executives at Svenska’s headquarters are expected to support the decentralized approach through coaching, instead of through memos, instructions, and directives. If corporate managers disagree with a branch decision, they are expected to raise the issue through a short email or brief phone call, but the final decision ultimately remains with the local manager.
The implementation of change relies on managerial autonomy and shared leadership. ... Once a decision is made, managers charged with implementation are monitored, but not second-guessed. Strong-form performance management systems provide incentives for managers to follow through. Performance targets are objective and unambiguous; positive and negative consequences are real and transparent.
When we correlated the agility routine scores from the survey data with the firm performance results, a clear pattern emerged. Firms with high scores on three or four of the agility routines (strategizing, perceiving, testing, and implementing) are six times (18 percent vs. 3 percent) as likely to be outperformers in their industry. They are also twice as likely (30 percent vs. 15 percent) to have above-average ROAs between 51 and 79 percent of the time. Firms with only one or two of the agility routines, indicating an incomplete system, are much more likely to have below-average ROAs most of the time (see Exhibit 3). Although improving any one of these routines can make an organization more effective, agile companies, according to their own accounts, have at least three of these four traits in large supply.

Making Organizations More Agile

Developing the agile capability is no small feat, but it has been done. IBM, DaVita, and Harley-Davidson have all demonstrated that transformation is possible by committing to a systematic approach and following through. Even within this group, Harley-Davidson (H-D) stands out. It is one of a handful of companies in our sample that made the transition to agility. Its story demonstrates how organizations can build strategizing, perceiving, testing, and implementing routines.
H-D’s performance has been consistently higher than auto industry norms for more than 20 years (see Exhibit 4). Yet in 1980, the company was as good as dead. Its corporate parent at the time, American Machinery and Foundry (AMF), had put Harley-Davidson up for sale and found no takers. Japanese competitors like Honda had not only encroached on America’s last domestic motorcycle brand, but opened up entirely new segments of commuter and recreational users.
In 1981, Vaughn Beals and 12 other executives took Harley-Davidson private, buying it back from AMF. In a desperate bid for survival, they shrank the company by one-third, rapidly implemented Toyota production system techniques to improve product quality and reduce costs, and successfully petitioned the Reagan administration for the “Harley Tariff” on imported motorcycles over 700cc to give them some breathing room. In 1983, they formed the Harley Owners Group (HOG), a stroke of marketing genius that created the largest factory-sponsored club of its kind and enabled direct communications between H-D and its most fervent customers.
When Rich Teerlink took over as CEO in 1987, he inherited a company that had been rescued from the brink through a strong form of “command and control” management. Naturally, there were questions about whether Harley-Davidson could sustain its success without a crisis to compel its employees. But instead of clinging to a top-down management style, Teerlink and his senior management team engineered a further transformation of H-D using a model of shared leadership and accountability, continuous improvement, and investments in learning and development—practices that are all typically linked with agility. The company’s managers and employees were asked to go from a “tell me what you want me to do” style of managing others to a “given where we’re going, I’ll figure out what’s best to do” approach. Said Teerlink at the time, “I believe fundamentally that people should have the opportunity to influence their lives and their workplace.”
Teerlink and his management team took the company through a series of initiatives, including a “joint vision process” involving the top 130 executives. They clarified and codified Harley-Davidson’s identity, synchronized their planning and performance management to it, and set up an integrated, cascading goal-setting process that provided lines of sight from executives to the worker on the floor. Personal and organizational goals were incorporated into appraisals and variable compensation. Leadership and accountability were distributed throughout the organization. Along the way, Teerlink and other senior leaders paid close attention to the four routines of agility:
Strategizing dynamically. Prior to the buyout, H-D’s reputation and style had been rough, oily, and arrogant. Through strategy and organization changes that consistently emphasized the importance of customers, quality, and accountability, a new identity evolved, summarized in the company vision: “We fulfill dreams inspired by the many roads of the world by providing remarkable motorcycles and extraordinary customer experiences. We fuel the passion for freedom in our customers to express their own identity.”
Perceiving environmental change. At H-D, every employee engages with the outside world—particularly with customers. Through HOG, employees (including current CEO Keith Wandell) ride with customers, attend HOG rallies, and participate in sponsored musical and sporting events. The Harley-Davidson Museum in Milwaukee is a shrine that attracts 300,000 visitors each year. There is also constant formal and informal contact with H-D dealer and supplier networks, and an expanded website where customers can interact directly with marketing and product development. To help communicate the ideas that come in, H-D has a shallow hierarchy and little cultural tolerance for gatekeepers and apparatchiks who would impede or filter information flow to executives.
Testing responses. Managers routinely vet the ideas coming from HOG and dealer connections for viability. These ideas include marketing programs, model customizations, new motorcycle models, new engines, new styling, new manufacturing methods, new ways of working with customers, and new markets. H-D also adopted the quality movement practice of “plan–do–check–act,” wherein activities, processes, and decisions are improved on the basis of collected data, and the military practice of “after action reviews,” wherein participants in a campaign meet in intensive sessions to analyze successes and failures.
Implementing change. Harley-Davidson has repeatedly demonstrated its capacity for ongoing change. Since the leveraged buyout, it has implemented operational restructurings, a new product development process, new management processes and personnel practices, and expansion into Europe and Asia. In 2011, for example, the company embarked on an ambitious program to develop a full-blown mass customization capability. H-D reorganized and scaled down its manufacturing footprint, streamlined R&D, marketed a wide variety of customization options through dealers and the Web, and restructured the manufacturing process to a flexible system that can produce any custom version of any bike in any plant on any day. To accomplish this, the company engaged its unionized workforce to dramatically change work rules and move from 62 job classifications to five.
By the time Rich Teerlink retired in 1999, his team had transformed Harley-Davidson from an inward-looking, marginal, command-and-control organization to an agile, dynamic market leader permeated with shared leadership and accountability. Curiosity, experimentation, and direct action are explicitly encouraged and rewarded. But it is a controlled chaos, held together by the centripetal forces of a strong identity and shared values.

The Agility Challenge

Some business environments change faster and more profoundly than others, but it is a given that yours will change. The point of transformation is to adapt, and the point of pursuing agility is to become more adaptable. Executives in agile organizations make explicit, system-wide decisions that promote adaptability over stability and flexibility over inertia. Leaders and employees see the ability to change and adapt as the key to long-term success. They do not fear or avoid change; they embrace it because their ability to manage change well is their primary advantage.
Managing agile organizations means being willing to give up the activities that make you successful today but that won’t be appropriate tomorrow—over and over again. By contrast, thrashers often increase their commitment to successful courses of action but miss important inflection points in the market. BP, for instance, continued to emphasize cost performance over process safety and compliance for years, resulting in disasters like the 2005 Texas City refinery explosion that killed 15 and the 2010 Deepwater Horizon oil rig explosion and spill. Toyota was enamored with being the biggest auto company in the world and ignored important safety issues. Outperformers are not perfect, but they make fewer mistakes and, like Exxon, when they do stumble, they are quick to see the error and have the capabilities to correct it.
Perceiving the value of constant change is only the first step. Translating that perception into productive action requires know-how, processes, infrastructure, and resources. Leaders must commit the organization to a new course of action, mobilize resources, and implement changes. Niccolò Machiavelli’s insight is as relevant today as it was in the 15th century: “Whosoever desires constant success must change his conduct with the times.”


  • Thomas Williams is a senior executive advisor with Booz & Company. Based in Ridgway, Colo., he specializes in strategy, organization, and management systems for energy and industrial companies.
  • Christopher G. Worley is a senior research scientist at the Center for Effective Organizations at the University of Southern California in Los Angeles. He is the coauthor, with Edward Lawler, ofManagement Reset: Organizing for Sustainable Effectiveness (Jossey-Bass, 2011).
  • Edward E. Lawler III is the director of the Center for Effective Organizations at USC; the coauthor, with Chris Worley, of Management Reset; and the author of Talent: Making People Your Competitive Advantage (Jossey-Bass, 2008).
  • Also contributing to this article was Niko Canner, former senior partner of Booz & Company; and s+bcontributing editor Jim O’Toole.

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Reassessing the Impact of Interim CEOs

CEO (Photo credits:

Temporary appointments rarely result in poor firm performance

strategy+business magazine:

Southern Illinois University Carbondale
Southern Illinois University Carbondale (Photo credit: Wikipedia)
Authors: Vincent J. Intintoli (Southern Illinois University, Carbondale), Andrew Zhang (University of Nevada, Las Vegas), and Wallace N. Davidson III (Southern Illinois University, Carbondale)
University of Nevada, Las Vegas
University of Nevada, Las Vegas (Photo credit: Wikipedia)
Publisher: Journal of Management and Governance 
Date Published: December 2012 online; forthcoming in print
When a CEO steps down, most boards move quickly to hire a permanent replacement. But sometimes it makes more sense to name an interim successor, to give directors extra time to take stock of alternative candidates. It’s a risky move, though. Previous research has generally found that investors regard an interim appointment as a signal of failure by the board in its succession planning. Indeed, the few studies that have examined this scenario have suggested that firm performance is lower following an interim appointment than it is following a permanent hire.
However, it’s not quite as simple as that, according to this paper, which explores the reasons surrounding the predecessor’s decision to step down—specifically, whether it was a voluntary move, such as retirement, or whether the CEO was forced to depart as a result of board or shareholder pressure. Contrary to popular thought, the authors found that underperformance by interim CEOs was almost always restricted to cases involving a voluntary turnover—and that those cases were few in number.
In the study’s sample, nearly three out of four interim appointments came in the wake of forced CEO turnovers. In fact, interim successors were named in only 2.9 percent of the turnovers that involved a voluntary departure.
The authors based their findings on an analysis of turnovers from 1984 to 2007, using Forbes magazine’s annual compensation surveys of the largest 500 firms in the United States and information on S&P 1500 companies from the ExecuComp database. Consistent with prior research, the authors excluded turnovers related to mergers and acquisitions as well as interim successions that lasted less than 45 days. Overall, the sample consisted of 1,626 turnovers with 130 interim successions. Of the 1,626 turnovers, 1,275 were voluntary and 351 were forced; interim appointees were named in 37 voluntary cases and in 93 forced turnovers.
Accounts of departures were gleaned from database information and media reports. Voluntary turnovers were defined as those following a retirement or what the researchers called a surprise event—for example, when the CEO left to take another job, died, or stepped down for health reasons. Forced departures resulted from pressure applied by the board or founding family, or after the company was discovered to be involved in illegal activity or was embroiled in prolonged litigation.
After analyzing quarterly earnings reports, return on assets, and Tobin’s Q (the ratio of a company’s market value to the total value of its assets), the authors found almost no evidence of poor performance when boards hired interim CEOs following forced departures. What’s more, the poor performance of interim CEOs following voluntary departures was limited to operational metrics, and didn’t carry over to stock market returns.
Interim successions “do not necessarily signal a lack of strategic planning on the part of the board of directors and may represent an optimal response to the [departure] of the predecessor in cases of forced turnover,” the authors write.
Previous research has shown that forced departures are more likely to result in a power struggle among the top executives who remain at the firm, which can make it difficult for boards to identify and appoint a permanent successor immediately. An extended search process, therefore, could be beneficial in letting the executive suite settle down and in turning the firm around.
Bottom Line:
Interim CEOs’ reputation for presiding over declines in firm performance is undeserved. Companies fare worse only in the event that an interim replacement is named following a voluntary departure. However, the majority of interim appointments follow forced departures, and those CEOs appear to have a steady enough hand to afford the board time to find a suitable permanent replacement.

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We’re from Corporate and We’re Here to Help

Business Sign X
Business Sign X (Photo credits:

Understanding the real value of corporate strategy and the head office.

strategy+business magazine:

by Ken Favaro

Senior executives seeking to gauge the effectiveness of their company’s corporate strategy might look at any number of factors: the company’s shareholder returns, its growth rate, its market share, or its price-to-earnings multiple. ... In fact, they might lead executives to precisely the wrong conclusions.
The one true measure of a corporate strategy is the profitability of its head office. ... Of course, in strict accounting terms, corporate headquarters is a cost center because it has no revenues. ... In fact, a profitable corporate center is both literally and figuratively at the center of corporate profit itself.

Corporate Center Profitability

We define corporate center profitability as a company’s attributable performance delta—that is, the difference in financial performance that is attributable to the activities of the corporate center—less the costs of the center itself (see exhibit). By this definition, when the corporate center is profitable, the company is truly worth more than the sum of its parts ..., because the company’s business units (BUs) are outperforming ... in their markets. On the other hand, a company that has an unprofitable corporate center is sending a sure signal that it’s adding no real value to the individual BU strategies..., or worse, it’s a true hindrance to each BU being able to win in its own markets ... .
Research indicates that the performance delta is positive for 45 percent of all companies and negative for the rest. ... When your company’s performance delta is negative, neither your businesses nor your shareholders see much point in having a head office!

Drivers of Corporate Center Profitability

Corporate headquarters v2
Corporate headquarters v2 (Photo credit: Wikipedia)
Six key functions explain the difference between “profitable” and “unprofitable” corporate centers.
First, profitable corporate centers sparingly use centralized services such as receivables, payables, financial reporting, payroll, IT, legal, HR, R&D, manufacturing, sourcing, and sales. They know that centralization does not come free—it can slow responsiveness, increase bureaucracy, uncouple costs from the revenues they support, and dilute accountability for top- and bottom-line results—and they know that there are diminishing returns to scale economies. ...
A second key function is capital allocation. The corporate center adds value only if it can do a better job of allocating capital than the “invisible hand” of a vast, liquid, and ruthless capital market. A profitable corporate center does just that by attaining and using its inside knowledge, its ability to actively engage with the business units, its experience with the businesses that make up the company’s portfolio, and a highly disciplined process for funding business units. In these cases, businesses perform better than their peers because they have corporate leaders who are knowledgeable, informed, engaged, experienced, disciplined, and enterprising investors. Unprofitable corporate centers tend to think of capital allocation as rationing rather than investing. ... It is common to see 80 percent of a company’s value creation coming from only 20 percent of its capital base. This is usually the work of corporate doing more harm than good in substituting for the capital markets.
Developing and deploying human capital is corporate’s third key function. Profitable corporate centers use the full breadth of the company’s business portfolio to offer a variety of flexible and rich career paths that will attract and develop people who can make a real difference to the BUs. ... They actively match the company’s strongest talent to its most important priorities, whether these are specific to particular businesses, span multiple businesses, or transcend them. Deadweight corporate headquarters facilitate inbreeding, cultural silos, and hoarding of talent within units. They do worse than what the talent markets do on their own, and they often do it with an enormous and costly corporate HR function. Sooner or later they are forced to go outside the company and pay a premium for the business talent they need.
Business unit governance processes are a fourth key function of corporate headquarters. ... But profitable corporate centers ... work hard to shield the BUs from the worst of short-term behavior—be it from customers, employees, or, especially, shareholders—while also holding their feet to the fire when it comes to producing results. They challenge and help shape the strategies that underpin the BUs’ plans, rather than just sit back and wait until those plans are submitted for corporate’s review and approval. ... They continually ask themselves, “How can we ensure that we are governing the BUs in ways that enable them to outperform in their markets?” ...
Unprofitable headquarters have a completely different attitude. They tend to ask, “How can the BUs help us do our job in running the company?” Thus, they tend to think of their governance role primarily as one of control and compliance rather than as one of adding value. In fact, in our experience, they are more likely to suck the life out of the BUs.
Perhaps the most valuable—and difficult—of all functions is the fifth: incubating, nurturing, and disproportionately investing in the company’s enterprise capabilities. An enterprise capability is something a company is able to do better than any other company. ... Profitable head offices actively identify capabilities anywhere in their organizations that can benefit all their businesses. They stay on alert for acquisitions that would enhance their businesses’ most important capabilities. They organize centers of excellence to nurture certain essential capabilities. They manage costs and capital to ensure that they are investing more and more effectively in their capabilities than any other company. If done well, this can be the most valuable role a corporate center plays in delivering a positive bottom line to the company.
Finally, profitable corporate centers know that their ability to add value depends greatly on the nature and complexity of the company’s portfolio shape. ... Companies with profitable corporate centers tend to be made up of businesses that draw on the same few essential capabilities. This coherence in the company’s portfolio makes it easier to add value through the other five functions.

Good vs. Bad Corporate Centers

Headquarters (Photo credit: Miroslav Petrasko (
Our research and experience tell us that unprofitable corporate centers tend to overestimate the benefits of centralized services and underestimate their costs. They tend to politicize capital allocation and human capital such that they achieve less than what the market’s invisible hand would produce on its own. They also tend to manage their portfolios to engineer certain financial outcomes in terms of growth, profitability, and risk. (For example, they buy high-growth businesses in order to lift the company’s overall growth rate or sell low-margin businesses to lift its average margin.)
Profitable ones, on the other hand, tend to invest heavily in effective internal governance and enterprise capabilities, and then fill their portfolios with businesses that gain the most from their specific governance skills and enterprise capabilities. ... Berkshire Hathaway ... famously has a bare-bones corporate headquarters, with no centralized services, no corporate HR department, and no sharing of enterprise capabilities across its vast, diverse portfolio of businesses. Yet by and large, those businesses consistently outperform in their markets. ... Berkshire oversees a mix of highly capital-intensive businesses (such as trains, utilities, and retail) and substantially cash-generative businesses (such as insurance and reinsurance)—both of which benefit greatly from Berkshire’s undeniable investment prowess. It may not be big, but Berkshire’s corporate center is highly profitable.
Corporate center profitability is the key gauge of whether a company is an accelerator, hindrance, or nonfactor in how well its businesses are able to compete and perform in their respective markets; it is the acid test of whether corporate is truly adding value in excess of its costs; and it is the true measure of a company’s corporate strategy. Every strategist should know what it is and how to achieve it.


Ken Favaro is a senior partner with Booz & Company based in New York and global head of the firm’s enterprise strategy practice.

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Friday, April 12, 2013

Making great decisions

Stanford’s Chip Heath and McKinsey’s Olivier Sibony discuss new research, fresh frameworks, and practical tools for decision makers.

McKinsey Quarterly:

Every few years, Stanford University professor Chip Heath and his brother, Dan, a senior fellow at Duke University’s Center for the Advancement of Social Entrepreneurship (CASE), distill decades of academic research into a tool kit for practitioners. The bicoastal brothers offered advice on effective communications in Made to Stick, on change management inSwitch, and now, in their new book, Decisive, on making good decisions. It’s a topic that McKinsey’s Olivier Sibony has been exploring for years in his work with senior leaders of global companies and in a number of influential publications.1
Cover of
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Chip and Olivier recently sat down to compare notes on what matters most for senior leaders who are trying to boost their decision-making effectiveness. Topics included Heath’s new book, research Sibony and University of Sydney professor Dan Lovallo have under way on the styles of different decision makers, and practical tips that they’ve found make a big difference. The discussion, moderated by McKinsey’s Allen Webb, represents a state-of-the-art tour for senior executives hoping to help their organizations, and themselves, become more effective by benefiting from the core insight of behavioral economics: systematic tendencies to deviate from rationality influence all of our decision making.
The Quarterly: What’s the current state of play in real-world efforts to improve decision
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processes through behavioral economics?
Olivier Sibony: The point we haven’t conveyed effectively enough is that however aware you are of biases, you won’t necessarily be immune. ...
Chip Heath: The analogy I like is how we handle problems with memory. The solution isn’t to focus harder on remembering; it’s to use a system like a grocery-store list. ...
Olivier Sibony: We’re doing ourselves a disservice by calling it a decision-making process, because the word process, as you point out in your book—
Chip Heath: —It’s boring.
Olivier Sibony: It immediately conjures up images of bureaucracy and slowness and decisions by committee—all things associated with bad management.
Decision Making Chart
Decision Making Chart (Photo credit: West Virginia Blue)
Chip Heath: Early in the history of decision making, people were optimistic about a better process called decision analysis. But nobody ever used it, because very few people have the math chops to fold back probabilities in a three-layer decision tree. The process that we’re advocating runs away from decision analysis and bureaucracy. We wanted some tools that someone could use in five or ten minutes that may not make the decision perfect but will improve it substantially.
Olivier Sibony: There are individual solutions and organizational solutions. ... In an article you wrote long ago, Chip, you quote somebody who asks something like, “If people are so bad at making decisions, how did we make it to the moon?” Your answer was that individuals didn’t make it to the moon; NASA did.2 That insight has been translated into all sorts of operational decision making. It is the fundamental insight behind work in continuous improvement—for instance, when people are trained to go beyond the superficial, proximate cause of a problem by asking “five whys.”
But we don’t apply that insight when we move from shop floors to boardrooms. ... Partly, it’s because the further up the hierarchy you go, the harder it becomes to say, “My judgment is fallible.” Corporate cultures and incentives reward the kind of decision making where you take risks and show confidence and decisiveness, even if sometimes it’s really overconfidence. ...
Nancy Graphically Recording Chip Heath, "...
Nancy Graphically Recording Chip Heath, "Switch" (Photo credit: Choconancy1)
Chip Heath: Yes, but we’re never really sure when we’re being overconfident and when we’re being appropriately confident. That’s where we go back to processes.
Olivier Sibony: It’s a lot easier to say, “Let’s build a good process so your direct reports have better recommendations for you” than “Let’s come up with a process for you to be challenged by other people.”
Chip Heath:... We all tend to believe “I’m not subject to biases.” But we can easily believe thatothers are. I’m curious about your batting average, Olivier. Suppose you walk into an executive group and start talking about the behavioral research and how they could change their processes to overcome biases. Are a third of the people interested? Five percent?
Olivier Sibony: ...We don’t talk about biases, because no one wants to be told they’re biased; it’s a word with horrible, negative connotations. Instead, we observe that people typically make predictable mistakes in their planning process... We end up embedding this thinking into processes that generate better strategic plans, R&D choices, or M&A decisions.
Chip Heath: ... The number of alternatives that leadership teams consider in 70 percent of all important strategic decisions is exactly one. ...
One study at a medium-size technology firm investigated a group of leaders who had made a set of decisions ten years prior. They were asked to assess how many of those decisions turned out really well, and the percentage of “hits” was six times higher when the team considered two alternatives rather than just one.
Olivier Sibony: ...One thing we did, ... was to always ask people making an investment recommendation to present their second-best choice. ... Considering just one recommendation from every business unit will deprive you of many investment opportunities you’d get if you asked for two.
The Quarterly: Is the right approach to suggest a couple of simple things senior executives can do or to recommend that they take a step back and look at a whole checklist or framework to create a healthier process?
Chip Heath: I’m a fan of frameworks, but you don’t have to be 100 percent there to improve dramatically. One legitimate criticism of the decision-making field is that we have this overwhelming zoo of biases. In our most recent book, Decisive, we therefore came up with 4 intervention points in the decision process. ...
Olivier Sibony: ...When people ask me what will make a difference as they build decision processes, I emphasize three things. First, recognize that very few decisions are one of a kind. ...
Second, recognize uncertainty—have alternatives, prepare to be wrong, and have a range of outcomes where the worst case is real and not “best case minus 5 percent,” which is very common. Creating a setting where it’s OK to admit uncertainty is very difficult. But if you achieve that, you can make headway.
Third, create a debate where people speak up. ... If you’re the decision maker, when you get to the debate you’ve already got an idea of where you want it to lead. And if you’re an experienced executive, you’ve already influenced your people, consciously or unconsciously. A good intervention point, for instance, is to ask subordinates if anyone disagreed with them about a recommendation they bring to you. If everybody agreed, that’s a sign that there may have been “groupthink.”3
Chip Heath: All of the things you’ve highlighted are things we grappled with in designing the WRAP process we propose in our book (see sidebar, “Four principles for making better decisions”). A Wider set of options means you’re going to have more debate. By Reality-testing assumptions, you look at the reference class of events. ...Then there is the process of actually making a decision. It’s now slightly more complicated because instead of one option you’ve got two, and you’ve done some due diligence on both. When you find yourself agonizing about a choice, it’s important to step back and Attain some distance. Finally, you should be Preparing to be wrong at the end of the process—that’s about hard-to-acknowledge uncertainty.

Four principles for making better decisions

Authors (and brothers) Chip and Dan Heath propose four steps for improving decision making. Below is an overview of that process, whose initials spell “WRAP.” It’s elaborated in their new book, Decisive: How to Make Better Choices in Life and Business (Crown Business, March 2013).
For example:
Consider at least two robust options for every decision.
Important because:
Adding just one alternative makes very good strategic decision making more likely—six times more likely, according to one research study.
For example:
Enforce vigorous debate on both sides of an issue and resolve debates with data by running small experiments to test assumptions.
Important because:
We are two times more likely to consider information that tends to confirm our assumptions than information that tends to disconfirm them.
For example:
“Fire” yourself and ask what your successor would do. That’s how Andy Grove broke through Intel’s indecision in the mid-1980s about whether to divert resources from the company’s long-standing core business in memory chips and go full force into microprocessors.
Important because:
The status quo is powerful. Research shows that over time, even arbitrary choices are regarded as valuable and right.
For example:
Set a clear tripwire now: “If we don’t achieve a market share greater than 20 percent in the first year, we’ll revisit our idea of entering the Southern market.”
Important because:
Our predictions are often incorrect, even when made with high confidence. In one study, doctors who expressed complete certainty in a diagnosis were wrong 40 percent of the time.

Olivier Sibony: How do you envision people using your WRAP framework—as a checklist when they make decisions, or as a tool to coach other people making decisions?
Chip Heath: We’ve heard from people doing both. ... In many situations, you could work through the WRAP framework in 30 minutes. And you can also have it running in the back of your mind as you’re coaching others.
Olivier Sibony: I find people asking when to get the facts and figures for a decision. Usually, they assume that you get all the facts first and then discuss them, which is not the way to go. Only when you create a debate and identify what it would take to believe one option versus another will you look for facts that would disprove your initial hypothesis. Save time for fact finding at a later stage.
Chip Heath: That’s really important. The trick is collecting information in the context of actual experience. At Intuit, founder Scott Cook developed what they call a culture of experimentation. As he put it, most decisions are based on “politics, persuasion, and PowerPoint,” and none of these “three Ps” are fully trustworthy. So Intuit bases decisions on experiments.
For example, they had a team with an idea for a service that would let Indian farmers use their cell phones to get information about market prices in surrounding towns. The top-leadership team was unanimous in thinking it was a bad idea. ...
Nonetheless, Intuit has a culture of experimentation, and the leadership team said, “OK, run your experiment.” Twenty experiments later, they have 1.3 million Indian farmers using this service. It’s been tremendously successful. It has raised the income of typical farmers using it by 20 percent—enough to afford books and tuition fees for their kids.
Olivier Sibony: How did he create this culture?
Chip Heath: ... This tradition of testing, of collecting data that allows you to be surprised by the outcomes, helps cultures of debate evolve in certain firms. I don’t think it has to come from the very top of the organization. ... Any manager at any level can start. If you create that culture in your team and you get into a disagreement, somebody will eventually say, “Look, it’s an empirical question. We can run a test.” If more people at more levels of organizations said that, the culture would start to change.
Olivier Sibony: I want to go back to this notion of helping people see when they've been wrong and helping them get better at learning from their own experience. ... Rather than telling someone he’s hopelessly biased, you say, for example, “Look, you’re a certain kind of decision maker—a real visionary—so you make fast decisions breaking with convention. The downside is that you could be wrong, so when you make an unusual decision you might want to stop and listen a bit.” Whereas someone else will tend to fall into the opposite trap.
We’re trying to build a language that would help people see how to get better at making decisions. The hope is that it would make individuals more conscious of their own style and also enable debate. If you and I are around the same table, rather than telling you that you’re out of your mind, I can tell you, “We know that you’re a visionary, right? So you would see things in this way. Well, I’ve got a different style, so here’s how I think about it.” A bit like the Myers–Briggs Type Indicator.4 ...
Chip Heath: I think that’s very promising. I love the idea that you can create a language for helping people introspect about their decision process. People love personality approaches. Psychologists have always had this approach–avoidance relationship with them because we can’t get them to be as predictive as we want, but they provide this tremendous social language.
I got to be at a dinner one time when I was in graduate school, where Danny Kahneman and Amos Tversky listened to a group of consultants telling them about the Myers–Briggs. The consultants didn’t know they were talking to two Nobel-caliber psychologists, so they were a little condescending as they explained MyersBriggs to their dinner companions, who should have known about it already. Kahneman and Tversky listened. And they weren’t telling the consultants, “Decades of social-psychology research says that it’s really hard to design a personality test that predicts anything useful about behavior.” Danny Kahneman walked out of the room and turned to Amos Tversky and said, “You know, that was a brilliant feat of social engineering. Instead of saying, ‘So-and-so is a jerk,’ they say, ‘Oh, he’s an INTP.’”5
The Quarterly: Let’s talk about points in the business system where people can attack these problems. Start with budgeting and planning.
Olivier Sibony: Clearly, the dominant bias is inertia—doing a budget that’s too close to last year’s, largely because of anchoring.6 You can re-anchor the budget around something different, typically a vision of the future, like where the growth will be. ... Instead, start with something like, “Your budget last year was 100. My model says it should be 375. Let’s discuss why 105 is better than 375.”
The Quarterly: What about M&A?
Chip Heath: M&A is a classic confirmation-bias situation. Something becomes available or draws you to a target. You’ll start gathering data to confirm or deny that choice, but on average you’ll be tempted to confirm it because you were interested in the first place.
Olivier Sibony: We tried to address that in one large company by adding something to the existing routine, which was superb. A month before the anticipated time of the final decision, when everyone still has a cool head, we suggested that the M&A team write a memo to the CEO entitled “Reasons you would say no to this deal.” The CEO will look at the memo in a month and ask whether these questions have been fully addressed. In effect, you have a dialogue between yourself a month ago and yourself now.
Chip Heath: I’ve seen procedures for getting distance by picturing yourself in the future looking back on a decision. Your idea is to have a present self look back at a past one. I love that.
The Quarterly: Let’s move to personnel choices for the senior team.
Chip Heath: A headhunting firm that had done 20,000 executive placements at the C-suite level went over its records and found that about 40 percent are pushed out, fail, or quit within 18 months. ... Lots of confirmation biases kick in here. People who are taller or more attractive do exceptionally well in interviews. Those qualities have little to do with the job.
The research says you can improve the interview process by treating it less like a conversation and more like a job sample. You can ask CFO candidates, say, to grapple with the financial decisions you’ve made over the last five years—what they would have thought about, what information they would have collected, what they would have done.
The Quarterly: What about new-product launches?
Chip Heath: Saras Sarasvathy, a professor at the Darden School, at the University of Virginia, has researched the differences between how entrepreneurs and very good senior managers at Fortune 500 firms think. She gives them a scenario about a new-product introduction. The typical Fortune 500 manager will run projections from the market data. But the entrepreneur says, “I don’t trust the data. I’d find a customer and try to sell the product.” The entrepreneur’s reaction is, “I’m gonna experiment. I’ll find my way into the market as opposed to project my way into it.” The entrepreneurs’ impulse to experiment is right. We don’t breed that enough in corporate America.
The Quarterly: Last question—there hasn’t been much work done on decision making and organizational structure. The classical view is that structure rationally follows strategy. Yet we know that’s not always the case. Should we be applying behavioral economics to this realm?
Chip Heath: Dan and I are actually thinking about it. I think there’s a systematic set of biases. For example, we favor division of labor over thinking about coordination. That underemphasizes the difficulty of coordinating across specialists that speak different business languages. I think that’s a really interesting set of questions.

About the Author
This discussion was moderated by Allen Webb, editor in chief of McKinsey Quarterly, who is based in McKinsey’s Seattle office.
1 See, for example, Dan Lovallo and Olivier Sibony, “The case for behavioral strategy,”, March 2010; and Daniel Kahneman, Dan Lovallo, and Olivier Sibony, “Before you make that big decision,” Harvard Business Review, June 2011, Volume 89, Number 6, pp. 50–60.
2 See Chip Heath, Richard Larrick, and Joshua Klayman, “Cognitive repairs: How organizational practices can compensate for individual shortcomings,” Research in Organizational Behavior, 1998, Volume 20, pp. 1–37.
3 For more on this, and 11 other useful questions senior executives can ask, see Daniel Kahneman, Dan Lovallo, and Olivier Sibony, “Before you make that big decision,” Harvard Business Review, June 2011, Volume 89, Number 6, pp. 50–60.
4 The Myers–Briggs Type Indicator (MBTI) is a personality-assessment questionnaire that probes how individuals perceive the world. MBTI describes a personality type for an individual based on his or her expressed preferences.
5 INTP is one of the 16 personality types expressed by the Myers–Briggs Type Indicator. I refers to “Introversion,” N to “Intuition,” T to “Thinking,” and P to “Perceiving.”
6 For more on the problem of strategic inertia, see Stephen Hall, Dan Lovallo, and Reinier Musters, “How to put your money where your strategy is,”, March 2012.

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