Strategy Development Usually Starts at the Wrong Place — the Market, According to Booz & Company Research
Companies pay an "incoherence penalty" when strategy doesn't begin with internal capabilities; companies that use capabilities, in addition to market forces, to drive strategy, reap outsized returns.
NEW YORK (May 24, 2010) – Generally, strategy development follows a well-worn path from the market back to the boardroom, focusing first on external positioning and opportunity, as opposed to internal capabilities. The results are often disappointing, argue Booz & Company’s Paul Leinwand and Cesare Mainardi in their upcoming Harvard Business Review article “The Coherence Premium” (June 2010).
“Companies succumb to intense pressure for top-line growth and chase business in markets where they don’t have the capabilities to sustain success. Their attempts at growth emanate not from the core but from the acquisition of ‘adjacencies’ and the exploration of market opportunities that don’t align properly with their central strengths,” said Mr. Leinwand, a partner in Booz & Company’s Chicago office.
Many of the world’s market leaders – from Procter & Gamble to Coca-Cola to Mars and its Wrigley division – wind up benefiting from a “coherence premium,” which is measurable and proven. “Stand-out performers start from the opposite direction when it comes to strategy. They figure out what they’re really good at and then develop those three to six capabilities, which can involve anything from knowledge to processes to tools, until they’re interlocking and best in class – and thus form a powerful capabilities system. From there, strategy becomes a matter of aligning the distinctive capabilities system with the right marketplace opportunities,” said Mr. Mainardi, managing director of Booz & Company’s North American business.
“It sounds simple, but it’s extremely hard to internalize. Yet the rewards for this discipline are huge,” said Mr. Leinwand. “Unfortunately, many companies don't have a clear capability agenda at all. And those that do often pursue capabilities, or competencies, separately from the strategy itself. They then wind up with a long list of competing priorities – and aren’t able to support the business with the right capabilities system that is required to win.”
Mr. Leinwand and Mr. Mainardi are available to discuss the power of coherence and a capabilities-driven strategy; what they consist of; how companies can attain them; and what can happen when leaders put the market before coherence and capabilities. During a conversation, they can elaborate on:
Coherence in practice
- Wal-Mart isn’t successful simply because of impressive logistics and an ability to get vendors to fall in line. Underlying Wal-Mart’s competitive advantage is a system of mutually reinforcing capabilities that lowers total value chain costs in a differentiated way. The retailer achieves maximum efficiency by integrating four capabilities: aggressive vendor management, expert point-of-sale data analytics, superior logistics and rigorous working-capital management. “Every Wal-Mart product and service fits with the company’s ‘way to play’ – its ‘everyday low prices’ – and capabilities system. It’s coherence at its finest,” said Mr. Mainardi.
- In refining and fixing its consumer health care business in 2002, Pfizer identified six interlocking capabilities: science-based innovation around formulations; its ability to influence regulatory management and government policy; new-product development focusing on prescription to over-the-counter switch; claims-based marketing featuring a demonstrable health benefit; channel management in both general stores and pharmacies; focused portfolio management of aggressive and moderate growth brands; and geographies. With those capabilities at the core of its strategy, Pfizer sold its confectionary products and its shaving businesses, which enabled it to focus more attention on growing health care brands like Listerine, Zyrtec and Nicorette at above-market rates and acquiring new brands, like Purell, that could be differentiated based on claims. “Pfizer Consumer Healthcare became a premier company in its category, delivering a growth rate double the industry average,” said Mr. Leinwand. “As a result, when Pfizer decided to sell these businesses, it realized a huge profit.”
What coherence and capabilities really are – and the payoff
- “A capability is something you do well that customers value and competitors can’t beat. It’s more than an activity or a function: It’s the interconnection of people, knowledge, IT, tools and processes that enable a company to out-execute rivals on some important measure,” said Mr. Mainardi. A company becomes coherent when its system of three to six capabilities is consciously chosen and implemented to support a focused strategic purpose and is aligned with the right product and service portfolio. Coherent companies have no problem answering these questions: How are we going to face the market? What capabilities do we need? What are we going to sell, and to whom?
- Data show that coherence correlates strongly with greater profitability, as measured by EBIT margin; coherence thus leads to the so-called coherence premium. (The Booz & Company approach to scoring coherence is similar across industries and involves: defining the segments each company servers; identifying the capabilities that drive value for the company in each segment; determining the number of common capabilities across all the segments the company serves.)
- Coherent companies focus day in and day out on what they are best at, and thus continually improve their capabilities. Coherence also hones strategic investment on what matters: Companies make better organic growth decisions and pursue acquisitions that line up with their capabilities. Coherence also produces efficiencies of scale and creates alignment between strategic intent and day-to-day decision-making.
The coherence test
To determine how coherent or incoherent a company is, leaders should address these questions…
- Are we clear about how we choose to create value in the marketplace?
- Are we investing in the capabilities that really matter to our way to play?
- Can we articulate the three to six capabilities that describe what we do uniquely better than anyone else? Have we defined how they work together in a system?
- Do all our businesses draw on this superior capabilities system? Does our organizational structure and operating model support and exploit it? Does our performance management system reinforce it?
- Have we specified our product and service “sweet spot”? Do we understand how to leverage the capabilities system in new or unexpected areas?
- Do most of the products and services we sell fit with our capabilities system? Are new products and acquisitions evaluated on the basis of their fit with our way to play and capabilities system?
- To determine how coherent or incoherent a company is, leaders should address these questions…
The cost of incoherence
- ConAgra Foods created incoherence through an unfocused acquisition binge in the 1990s. By the mid-2000s, its portfolio spanned three segments that drew on distinctly different capability sets: prepared foods, which required superior merchandising and supply chain capabilities; snacks, which relied on strong product innovation; and staples, like flour and processed meat, which depended on efficient sourcing and production. As a result, the company suffered from sub-par performance between 2002 and 2007. (It has since begun moving toward coherence.)
- Similarly, Sara Lee operations were incoherent: Businesses ranged from bakery goods to Hanes underwear to Kiwi shoe polish – and financial performance was at the bottom of the pack. (Sara Lee has also taken steps to begin to tap into the coherence premium, having started to divest many non-core brands.)
- Incoherent companies struggle to make the right capability choices. Because they need to support diverse strategies with diverse capability requirements, incoherent companies wind up investing in too many capabilities and lack the focus to do any of them well.
The journey to coherence
- “Given the natural tendency of organizations to devolve into incoherence, it takes extraordinary leadership to pursue a capabilities-driven strategy,” said Mr. Leinwand.
- Added Mr. Mainardi, “Focusing on one way to compete and a system of differentiating, mutually reinforcing capabilities often requires hard choices, including divesting businesses, streamlining nonessential functions and paring down product and service lines. It also means resisting the temptation to leap into a hot new market where your capabilities system can’t help you or to pursue, in boom times, easy profits at the expense of strategic focus.”
About the authors
Paul Leinwand ([email protected]) is a partner in Booz & Company’s global consumer, media, and retail practice. Based in Chicago, he serves as chair of the firm’s Marketing Advisory Council. He supports clients undertaking significant strategic opportunities, and in building capability systems in marketing, innovation, and customer management.
Cesare R. Mainardi ([email protected]) is managing director of Booz & Company’s North American business and is a member of the firm’s Executive Committee. Based in Cleveland, he works with Fortune Global 500 companies to help them achieve major business transformations. He has served as global leader of Booz & Company’s functional practices and has led the firm’s global consumer products and health practices.