3

Translate the Strategic into the Everyday

Most large companies are hotbeds of execution. Everywhere you go, you see people installing enterprise resource planning (ERP), implementing processes to support digital marketing, or redesigning parts of the supply chain. But when you look more closely, you often see that this activity is not aligned with the company’s strategic intent.

Think back to the investments you’ve made in, say, upgrades to computer systems or new stage gate methodologies. Undoubtedly the new capabilities are urgently needed; a functional or business leader has approved the investment. If implemented successfully, a project of this sort will fulfill its stated goal: solving a significant problem, supporting income-generating products and services with some competence, or filling a gap in your company’s practices. But how will it support your overall value proposition or advance your distinctive capabilities system?

All too often, the leaders of a company, including the chief information officer, have not considered that question. If they had, they might define, plan, and roll out their new software, training, or process implementations very differently.

This lack of connection between strategy and execution stems in part from the ingrained habit of not taking strategic issues into account when planning new implementations. With such habits in place, it becomes very challenging to build and develop distinctive capabilities. You may have to unlearn the old ways you put capabilities together and learn new ones that are linked closely to your strategy from the very first moment. In other words, now that you have committed your company to an identity, as we discussed in chapter 2, you have to translate that identity into everyday practice. Hence the title of this chapter.

Your new approach to building capabilities will be your own approach: bespoke to your company. You will not benchmark or copy it from anyone else—at most, you will borrow details and practices and convert them to your own way of doing things. This approach may also be unfamiliar. For all their experience in functional excellence, most companies have rarely built truly distinctive cross-functional capabilities in their own way. They follow a program created with generic business in mind. They end up with functional activity similar to every other company’s functional activity.

The companies we studied, by contrast, have built their own bespoke capabilities, adapting best practices that suit their identity, inventing new practices of their own, and in the process learning to do something that no other enterprise has done before. One of the most compelling examples is Frito-Lay, the snack division of PepsiCo, with more than $14 billion in annual revenues.¹ For thirty-five years, this enterprise has defended its position as market leader by being better at what it does than any of its competitors. It introduces new varieties frequently and successfully and manages all of them in a way that meets the ever-changing tastes of snack consumers. The company also has consistently high quality, and, most importantly to a company whose products are often purchased on impulse, Frito-Lay “owns the streets.” It gets the right products to the right stores at the right time—all the time. As a result, the company currently owns seven $1 billion brands: Lays, Ruffles, Walkers, Fritos, Cheetos, Doritos, and Tostitos along with several other well-known snack brands such as Smartfood and Sun Chips.

Like many companies with remarkable capabilities systems, Frito-Lay makes what it does look easy. But its success is anything but an overnight story. The company has steadily invested its time, money, and—most importantly—executive and employee attention in building and improving its capabilities system.

Much has been published about this Frito-Lay story over the years, at least in technological circles, because the company revolutionized the way the entire consumer products industry thinks about its supply chain. As part of this process, the company invented the first handheld mobile computer, two decades before the smartphone. Frito-Lay remains on the leading edge today, incorporating robotics, analytics, location-tracking technologies, and a great deal of attention to staff recruiting and training. In effect, this system establishes Frito-Lay’s capabilities system as the underlying grid of a powerful companywide network, with marketers, trade program designers, manufacturing and delivery experts, and other decision makers all plugged in. Productivity improvements from this and other innovations at Frito-Lay have been credited with generating $1 billion per year in bottom-line gains since the mid-2010s.²

Let’s start by looking at Frito-Lay’s capability in direct store delivery. In the eyes of a typical grocer, the Frito-Lay system may look expensive and inefficient. Most other food companies send their merchandise through giant sorting and distribution centers, sharing the facilities with many other producers and using economies of scale to save costs. Frito-Lay, by contrast, has its own overarching distribution system tailored to serve every kind of retail outlet. Its giant distribution centers have a highly efficient way of prepacking the bins delivered there. It also maintains a fleet of large and small trucks, each staffed with one or two “sellers” (as they’re known in the company), who are recruited carefully, well trained, and well paid. They handle sales and merchandising as well as transportation and delivery.

The sellers’ jobs are highly structured, with a detailed execution framework based on the idea of a “perfect order”: an optimal product assortment for every store, oriented to consumer tastes. This is all reinforced by Frito-Lay’s carefully-designed IT infrastructure. The sellers’ handheld computers send sales and inventory data (including observations of how well competitors’ products are doing) instantaneously back to the home office, where the data is analyzed and translated into new sales forecasts and specs for the next day’s deliveries. The sellers, and the regional managers who supervise them, are thus equipped to make precisely the right moves in stocking the shelves.

This direct store delivery capability is just part of a larger capabilities system that Frito-Lay has parlayed into success. The delivery and sales information feeds directly into Frito-Lay’s powerful flavor innovation capability, enabling the company to rapidly introduce new products that meet consumer demand. This capability has been prodigious for years, but it was enhanced in the mid-2010s through crowdsourcing and social media. Frito-Lay’s “Do Us a Flavor” campaign, which started in the United Kingdom and migrated to the United States, invites consumers to suggest new chip flavors and vote on them, with a cash prize of $1 million for the creator of the winning entrant. The first year’s American winner, cheesy garlic bread, became a market favorite; the second year’s, wasabi ginger, heralded a new direction toward diverse and globally inspired flavors.³

Frito-Lay also has carefully developed capabilities in both quality production and local consumer marketing, with store displays and promotions tailored for each customer group. All of these capabilities together—flavor innovation, direct store delivery, manufacturing quality, and local consumer marketing—give the enterprise a tremendous advantage in launching new products. When Frito-Lay’s competitors introduce new products, these snack makers must pay significant slotting fees to grocers to feature them on the shelf. To reduce the risk of failure, other companies must test products carefully before launch—a process that adds cost and delays the launch. Frito-Lay avoids all these hurdles by managing the shelf itself. Using data analytics, the company can rapidly introduce a new product with confidence that it will sell reasonably well. Frito-Lay can further test a new product at low cost by introducing it in a few stores, then can roll it out rapidly across a region or a continent if customers like it. The power is in the capabilities system—in the way all of these strengths reinforce one another to give the company an unbeatable advantage. Indeed, this capabilities system has given Frito-Lay a 60 percent market share in US snack foods, a growing business in emerging markets, a productivity engine that gains savings of almost $1 billion per year, and an extremely high success rate in the introduction of new products.⁴

“The real benefit of this system is the energy it brings across the entire company,” said Charles Feld, one of the prominent architects of the approach, in a recent interview. “It really tightens the link between every function involved in making, distributing, and selling the products.”⁵

Building the Capabilities System at Frito-Lay

Now let’s look at what Frito-Lay went through to put this capabilities system into place. The company had always been a relatively coherent enterprise; it was formed in the 1950s and 1960s through a series of mergers among several companies known for their facility with snack foods. (One of the founders, Charles Elmer Doolin of Frito Corporation, invented the cheese puff and perfected the corn chip.) But it wasn’t until the early 1980s, about fifteen years after its merger with Pepsi Cola to form PepsiCo, that Frito-Lay’s capabilities system took its current form.

The starting point was a desire to streamline direct store delivery. Though Frito-Lay’s system outpaced the rest of the industry, the system was costly and inefficient. The paperwork used to track grocery shelf inventories, for example, was so complex that it took about ten days for the data to make it back to Frito-Lay headquarters.

In 1981, Frito-Lay recruited a new chief information officer away from the IBM team managing its account. Charles “Charlie” Feld had impressed Frito-Lay CEO Wayne Calloway with his view of IT as an enabler of company excellence, rather than as overhead. With Calloway’s support, Feld and other top executives mapped out a plan for linking all the truck drivers and the head office in constant communication. As they tested their ideas with local prototypes, it became clear how much investment, innovation, and intervention would be required to build out this capability across the United States. They would need to combine sales, merchandising, and delivery, revamp their back-office processes, and build new relationships between the distribution, innovation, and marketing functions to ensure that all these functions would work together. Frito-Lay also had to invest in route design: picking the best vehicle for each delivery route, with the right frequency of visits and the right seller training, and the ability to change routes rapidly when circumstances called for it. In short, this would go far beyond the handheld computer and beyond IT itself; it would effectively transform the entire enterprise.

The project was such a complex and audacious endeavor that the company scrapped it more than once, but reinstated it each time. Pulling all this together, with so many leaders and functions contributing in so many ways, took everything Frito-Lay had, for almost a decade. It also required the support of three successive CEOs: Calloway; his successor, Michael Jordan, in 1984; and Roger Enrico, who took the reins as chief executive in 1990. (Their support also played a major role in the company’s staying true to its evolving identity.) Jordan and Enrico, who were convinced of the project’s value only when they saw how the prototypes increased profitability, became the capability’s greatest champions. For example, when Jordan realized that the field sales organizations in each territory were resisting the new system, he required each organization to commit to a 1 percent reduction in the cost of sales each year. Like IKEA’s annual price reductions, this was a forcing function. Jordan knew the only way the groups could hit that goal was to embrace the new approach.⁶

Frito-Lay rolled out parts of the new system starting in the mid-1980s. By 1991, seven years after the work began, it was in place throughout the enterprise. By then, the investment had already demonstrated the payoff. Frito-Lay managers knew more about their competitors’ reach and costs than the competitors themselves knew about these factors. The company could also ask what-if questions about price cuts, advertising approaches, and other marketing initiatives, and simulations would calculate potential sales results. The managers could keep building each other’s knowledge and putting it to work in increasingly sophisticated ways.

As with many great capabilities, the industry tends to catch up; a company like Frito-Lay must continually stay ahead of competitors and customer expectations. One important innovation developed in the 2000s was the Geographic Enterprise Solution (GES)—an automated logistics system with distribution centers equipped with robotics and sensors to track the flow of merchandise. Combined with advanced analytics to discern merchandising patterns, these innovations reduce inventory and lower the company’s carbon footprint and energy use. (Environmental sustainability is a priority for PepsiCo.) These measures also help the sellers make the most of their limited time in each store, and ensure that the product on the shelf is fresh, often placed there just a day or two after manufacture. Much of the money saved through productivity gains is plowed back into further improvements.⁷

You can build similarly powerful capabilities in your own business. Like Frito-Lay, your company will start reaping benefits almost immediately—but the benefits multiply the more you keep improving your capabilities system. To get from here to there, you need to boil down your approach, as Frito-Lay did, to three main activities. First, create a blueprint of your capabilities system. Articulate the nature of the capabilities you need to develop: how they would interact and add value, what they would look like in action, and what would be required to make them work. Second, build the capabilities system you need. Use focused interventions, breakthrough innovation, continuous improvement, and, often enough, M&A to augment the capabilities you already have. Third: take it all to scale. This is a far more involved and participative process than many executives expect; it involves organizing activity across functions and finding ways to codify tacit understanding into explicit knowledge without losing the creativity of a small enterprise.

Blueprinting, building, and scaling capabilities may seem like familiar work, something that all companies manage to do all the time. But as we’ll see throughout this chapter, a great deal of innovation, attention, discipline, and creativity is needed to bring distinctive capabilities to life. Because they are closely aligned with your value proposition, there is no gap between strategy and execution in this process; the process of developing strategy is intimately connected to the process of building the relevant capabilities.

Blueprinting the Capabilities System

Your first step is deductive. You start with a desired outcome: the value proposition you outlined in chapter 2 and the three to six capabilities that will add up to deliver on the proposition better than anyone else can. Your blueprint is the detailed design and architecture of that capabilities system, explaining how and why it will deliver the promised value.

A capability, as noted in chapter 2, is the combination of people, processes, technologies, and organization that allows you to deliver your intended outcome. The blueprint covers all of those components, but not separately: it determines how they will fit together. There is also an accompanying plan that specifies the people who will build pieces of the capability, the targets and incentives that govern their actions, and a timetable for implementation.

The CEO and the team driving the strategy must lead this effort in a hands-on fashion. They don’t necessarily plan every detail themselves, but they generally handpick the people overseeing details, recruiting them from outside if necessary (as Wayne Calloway recruited Charlie Feld) and remaining closely involved themselves. Follow the example of Lego’s CEO Jørgen Vig Knudstorp, who continually checked in on the “war room” at Lego, effectively creating a blueprint for the company’s new supply chain and product development capabilities. You cannot simply delegate this job to functional leaders, especially given the numerous connections and trade-offs that have to be made.

Like an architectural blueprint, a blueprint of your capabilities system is not purely functional; it is artistic and it should evoke the identity of the company. It must meaningfully integrate diverse processes and technologies while preserving the strategic value of the enterprise. You may find yourself iterating these capabilities in detail in successive blueprints, each one a refinement of the previous version. At Apple, for example, the outsourcing of manufacturing processes is part of the company’s product design capabilities. According to writer Adam Lashinsky, this can involve extensive iteration of blueprints for operations at local facilities in China. Apple’s representative at the China factory will repeatedly “bring the latest beta version back to Cupertino for senior executives to see—and then get right back on a plane for China to repeat the process.” ⁸

You might benchmark what other companies are doing, because it’s helpful to know the best practices of your industry. But be skeptical. You risk being drawn into practices that are not right for your company. Don’t try to be great at everything, especially everything your competitors do. Don’t feel pressure to keep up with their IT systems or supply chains, unless there is reason to do so. Focus on building excellence in the areas that matter the most for your company’s success; be lean and merely “good enough” everywhere else.

Seek inspiration from companies that have successfully developed capabilities like the ones you’re trying to build, even (or especially) if the firms are not in your industry. Apple famously adapted its Genius Bar design from the Ritz-Carlton concierge desk. Lego, in rethinking its supply-chain capability, drew on the experience of the electronics industry and ended up outsourcing some production to Flextronics, a Singapore-based supplier to that sector.⁹ In the mid-2000s, Danaher developed its product innovation capability by looking beyond the boundaries of its tool and instrument sectors. “We sent a team of people to Procter & Gamble,” recalls Steven Simms, the executive vice president (since retired) who led the effort. “Their concepts on innovation stretched our thought process. We [also] went to Starbucks several times to look at customer management.”¹⁰

It is rare to see a company’s capabilities blueprint because they often involve closely held competitive secrets. But one that we mentioned in our previous book, The Essential Advantage, is a good example of how to lay out a blueprint in detail. The story took place in the 1990s at the Automotive Systems Group (ASG) within Johnson Controls Inc. (JCI). (It was later renamed the Automotive Experience Group.) Based in Milwaukee, Wisconsin, this group makes motor vehicle interior components, including car seats. (The parent company, which also makes batteries, energy efficiency-related products, and heating, ventilation and air conditioning systems, announced in mid-2015 that this group may be spun off into a separate company.)¹¹

Around 1991, the leaders of JCI-ASG began to recognize that their market had changed. During the previous few decades, car seats had become highly sophisticated appliances incorporating hundreds of components. The seats could adjust to drivers’ body shapes, protect the lumbar region during extended travel, keep track of preset positions, convey warmth and ventilation, and, perhaps most importantly, help shield against danger in a crash. With unionized labor wages driving up the costs of designing and building car seats, major automakers began looking for suppliers that could help produce these complex mechanisms less expensively. A core group of ASG executives saw an opportunity to leap ahead of their competitors. They would abandon their current practice of building seats to specifications and competing on price. They would no longer underbid competitors to win orders and then make up the difference with relentless cost-cutting. Instead, they would adopt a new value proposition as a solutions provider. They resolved that ASG would be a consummate champion of what seat engineers call the golden butt: the customer’s point of satisfaction. They would seek to understand the evolving needs of drivers and passengers; they would resolve automakers’ concerns about ergonomics, functionality, and consumer appeal; and as they did all this, they would keep moving the technology forward.

The senior team set up a cross-functional steering committee to oversee the development of a capabilities blueprint. The committee began with what we have come to call peeling the onion: an intensive, deductive analysis of the capabilities needed to make a value proposition work. Only one of the capabilities that JCI-ASG needed was fully in place: just-in-time manufacturing, which the company had learned as a supplier to Toyota. The team members concluded they would have to build up four other capabilities significantly, in some cases almost from scratch:

Each of the practices in these capabilities had to be simple enough that all of JCI-ASG’s business units could use them. They also had to be robust enough to make the company world-class.

It took months for the design teams—which included top management along with senior people from engineering, sourcing, manufacturing, legal (for contracts), and finance (for costing and pricing) working closely together—to build the blueprints. The teams articulated the processes, systems, skills, behaviors, and organizational changes that would need to be in place for each of those capabilities. For each capability, they developed a plan for reaching the desired goals, backed up with detailed databases of costs, design changes, supplier information, and insights about the automaker teams.

Together, the final blueprints laid out a detailed view of the company that JCI-ASG would become. Some new capabilities, like first-time design, required major investments in IT tools—for example, sophisticated computer-assisted design systems. Other capabilities required relocation or reorganization. To improve its just-in-time manufacturing capability, the company relocated the facilities that produced the seat frame and the foam padding, moving them closer together—while it offshored other activities, like the manufacturing of the trim covers. As part of the new extended-enterprise capability, JCI-ASG linked the procurement, research, and design functions more closely into product development. It also brought the list of regular suppliers down from hundreds to about thirty. This latter group were integrated into engineering and design, with dedicated communications links and new financing arrangements.

When bridging the strategy-to-execution gap in your own company you will need to build a similar blueprint. As you work through the details, you naturally test the concept you articulated in chapter 2. The first step is to bring together the right steering group: a cross-functional group of senior leaders with ties to every major line of business and function, ideally led by the chief executive of the enterprise. Then take a closer look at the capabilities system you identified at the end of chapter 2. For each distinctive capability in that system, ask yourself a series of questions. In the next few pages, we’ll lay out those questions and show you how the JCI-ASG committee answered them for one of its new capabilities: solution selling.

1.What is the capability? The simple discipline of defining each capability gives you a much clearer view of what you are trying to build, and why it matters. For solution selling, the stated definition was: “To build long-term strategic relationships.” They would communicate directly with the automakers’ technical specialists, instead of just the purchasing staff, and build their own financial models of the products, so they understood the costs and potential revenues, before signing the contract.

2.Why is it valuable? It’s important to understand what this capability does for your value proposition, and for your business in general. At JCI, this capability would enable a change that being a solutions provider required: from selling based on price to selling based on value. It would also minimize the risk of commoditization, eliminate high-cost transactions and conflicts stemming from forced partnerships with other suppliers, and protect the company’s proprietary technology from competitors. It would also be a major cost-saver, reducing the wasted time and expense of last-minute design changes or multiple alternative designs.

3.How would it be different from what we have today? Under conventional practices, suppliers were brought into platform development at too late a stage to influence the overall product. Now JCI-ASG would be part of its customers’ vehicle platform development cycles from the beginning. They would design to match an overall concept rather than to specs selected by automakers. They would select their own technologies, suppliers, and production methods, instead of those specified by their customers.

4.Describe a day in the life of this capability. What does it look like in action? Which functional groups are involved? What kinds of things do they do? The JCI-ASG team laid out the way the work would look and feel. The many scenarios they described included meetings to set joint targets; new ways of batching design changes; and a program schedule managed collaboratively with automakers rather than being dictated by either side.

5.What is required to make it work? What processes, systems, and tools will be used in making it happen? They broke the capability down into a long list of new measures. Some were processes: for example, new ways of developing product specifications, managing programs, and integrating warranty and product liability information into the designs. They would need new IT systems for performance and cost tracking, financial models, and inventories of previous solutions, along with a strategic sourcing supplier database. They would have to become more knowledgable in such areas as strategic sourcing, making performance trade-offs, calculating tolerances, and all the many aspects of developing mutually beneficial relationships with customers and their own vendors. And they would reorganize to be more effective solution sellers: strengthening support functions such as account, legal, and quality management.

6.For the capabilities system, what does the business case look like? Calculate the return on investment and other parameters that can help you justify this investment. The team estimated one-time costs and recurring expenses for each measure they had already specified: the IT systems, recruiting arrangements, payroll for new staff, and so on. They also estimated the value of recurring benefits: revenue from new customers, money saved by avoiding last-minute changes, and profits gleaned from more flexible value-based pricing.

7.How does this capability fit with the others in the capabilities system? Make sure that the logic holds: that every part of the capabilities system contributes to your strategy. Step back to think about how they fit together. Imagine metaphorical pipes, extending from one to the other. What would the outputs and inputs flowing through those pipes be? For example, one of the “outputs” of solution selling was JCI’s demand for more autonomy in choosing its own suppliers. This turned out to be a prerequisite for the extended enterprise capability. Think through what each capability contributes to the others, until you have the complete system mapped out. All the outputs, when they are fully realized, should add up to deliver your value proposition.

(For an online template that leads you through these questions, visit www.strategythatworks.com and see “Capabilities Visioning [Peeling the Onion].”)

Now consider the plan for creating that capabilities system. What steps do you need to take to bridge the gap between the capabilities you have and those you need? Strictly speaking, this is not part of the blueprint itself; it is more like the plan for building the house. But it is essential. Think about the types of people you need to recruit—especially for skills that are not normally associated with your industry. The earliest Apple Macintosh had a graphic artist and font designer on the core team. Some engineers belittled that talent at the start, but it turned out to be critical for the graphical user interface.

Which functional groups need to be involved? Who would be the right people to draw in from the various functions—first, to enhance what you have (or in some cases to design and build a new capability) and, second, to manage and maintain it?

You may face internal resistance. Some entrenched senior executives at JCI-ASG had to be convinced that building a new capabilities system was worth the trouble. Others questioned the investment—for example, the money spent on new computer-aided design to enable first-time design and shelf technology. But the steering committee persevered, addressing criticisms as they were raised, and gradually the company came around. As a forcing function, the committee tied all funding to these new capabilities, cutting costs in other parts of the business so that the company could grow stronger here. (We’ll explore this approach further in chapter 5.)

In the end, hundreds of people changed their ways of working, the five capabilities came together, and JCI-ASG became the premier manufacturer in the auto-seat sector. Following its acquisition of Prince, another automobile interior supplier, the enterprise deployed the same capabilities system for a broader group of interior components. Revenues rose accordingly; JCI went from earning about US$300 million in annual revenues in the mid-1980s to more than US$41 billion in 2014, with ASG making a large contribution.¹³

Building Distinctive Capabilities

At this point, you have a blueprint containing explicit descriptions of your distinctive capabilities, and a plan for building them. You may already have teams of people assigned to building each capability. Now you are ready to bring them to life.

Creating distinctive capabilities systems is a multifaceted process. While this process may seem familiar to you—after all, every company builds capabilities—few companies tackle it with the requisite focus and creativity. But you can do better. You do it the same way Lego, Apple, Starbucks, and the other companies we studied build distinctive capabilities. You put your best people on the job, you give them the resources they need (more on this in chapter 5), you involve your top leadership closely in the task, and you keep your outcome—your value proposition—clearly in mind.

The effort usually combines three basic activities:

All of these efforts are cross-functional. Small teams of people from each relevant function—typically including operations, sales, marketing, innovation, learning and development, IT, and procurement—must learn to speak each other’s language and work toward common goals. This cross-functionality will become even more important, as you’ll see, when you scale up capabilities to the entire enterprise. No function owns a distinctive capability: each distinctive capability belongs to the entire company.

Focused Interventions

To develop the level of proficiency you need, you’ll have to make meaningful changes to the capabilities you already have. Some of these changes will start at the core of the business. Others may seem to be on the periphery at first, and you’ll need to bring them into the mainstream. Some of these focused interventions will be identified in the blueprint stage; others will become clear later. Ideally, you’ll continue making focused interventions throughout the life of your enterprise.

In the early 2000s, Pfizer’s consumer products division went through this exercise. (Then called Pfizer Consumer Healthcare, or PCH, it was sold to Johnson & Johnson in 2006. It is not the same as the current Pfizer Consumer Healthcare, which Pfizer acquired when it purchased Wyeth in 2009. We’ll refer to it in this chapter as Pfizer Consumer). At the time, Pfizer (the larger company) had several household-name brands in over-the-counter (nonprescription) medicines, confectionary, and personal care. The products included Listerine mouthwashes; Hall’s cough drops; shaving and hair care brands like Barbasol, Schick, and Rogaine; smoking cessation aids like Nicorette; Chiclets, and Trident chewing gum; and some common household medicines like Benadryl and Zyrtec for allergies, Zantac for heartburn, and Sudafed for cold and flu symptoms. Many of these brands had come to Pfizer through acquisitions; for example, Listerine and the chewing gums had been part of Warner-Lambert, a major manufacturer of pharmacy and grocery products that Pfizer had bought in 2000. Individually, many of these products were successful revenue generators, but because they had come together through various mergers and acquisitions, they were not coherent. No single value proposition or capabilities system applied to all of them, and together they were not nearly as profitable as they needed to be.

In The Essential Advantage we described how Pfizer Consumer developed its value proposition: to offer over-the-counter medications with clearly articulated claims of demonstrable health benefits. The company sold off the products that didn’t fit this value proposition (razors, shaving cream, and chewing gum among them) and concentrated on the products that did. For example, Pfizer Consumer reoriented Listerine toward mouth-related health care, advertising that it reduced 52 percent more plaque and 21 percent more gingivitis than did brushing and flossing alone.¹⁴ Nicorette, Sudafed, Zantac, Benadryl, Zyrtec, and Rogaine were marketed with proven, compelling claims. This approach worked. Within four years, the enterprise turned its scattered portfolio into a $4 billion business, which it sold to Johnson & Johnson for $16.6 billion in 2006. This number was a multiple of more than twenty times earnings, at a time when multiples averaged fifteen—a clear validation of the value of coherence to any company.

Pfizer Consumer could not have made this strategy work without its own strong capabilities system. The system was made up of six capabilities, each existing in some form within the company. Some were legacies of Pfizer’s pharmaceutical roots:

Others had been inherited from Warner-Lambert:

As part of the transformation program, each capability involved its own focused interventions to bring it fully in line with the new strategy. For example, to fully develop the innovation of forms and formulations, Pfizer Consumer redefined its stage-gate process (which approves investment at each stage of R&D) to prioritize claims-related projects. To build out the claims-based marketing capability, a global team developed a methodology for sifting through the masses of clinical data around products like Listerine and drawing out viable claims. This extraordinarily difficult task would never have been undertaken without the specific link to a critically important capability.

Another example was the regulatory management capability. It was already impressive, especially in mature economies. The regulatory team worked with governments around the world to negotiate and follow the rules governing what a pharmaceuticals company could say to consumers about its products. However, the capability was oriented to local governments, which made it difficult to scale to a global level. The division leaders reorganized its worldwide regulatory affairs staff members, connecting them in a virtual center of excellence. They now were set up to communicate regularly, advising each other on how to manage relationships with regulatory agencies. This focused intervention led to quick wins almost immediately. For example, Pfizer Consumer rapidly gained regulatory approval in Europe for its eye care and smoking cessation products. In addition, as one of the focused interventions, a regulatory group within the R&D function set out to develop the ability to influence policy in emerging markets. This meant recruiting and putting in place people who knew how to navigate the government’s requirements in precise detail, document by document.

Focused interventions are familiar activities in most companies. On any given day, you’ll find business people upgrading their IT systems, tweaking metrics, promoting people, implementing new training, or reorganizing a functional department. Continuous improvement, which is standard practice at most manufacturing companies these days, can be seen as one point intervention after another. But how many of these activities are tailored to helping the company realize its value proposition? If you set out to translate the strategic into the everyday—to bridge the strategy-to-execution gap—then every intervention should be aligned with your value proposition. If it’s not strategic, it’s not worth doing.

A good example of the power of a focused intervention occurred at McDonald’s in the early 1990s. Any fast-food restaurant must provide rapid, consistent service; it thus relies on its soft drink machines. Breakdowns can lead to long lines and angry customers, especially during hectic rush periods. Moreover, the burden of fixing broken machines typically falls on the local store manager, who must arrange service from local repair people—with inconsistent results. Unsatisfied with this piecemeal approach, McDonald’s operational leaders decided to augment their already-powerful capabilities in restaurant processes. They convened a group of franchise owners and operations experts, considered the problem, and ended up borrowing an idea from the emerging call-center business in the high-tech computer industry.

Today, in every McDonald’s restaurant in the United States, there is a single point of contact for soft-drink machine repair. When that phone number is dialed, the call is immediately answered by a trained professional equipped with a list of diagnostics. That first encounter solves the problem for 80 percent of the callers. The rest are quickly directed to a “level two” expert technician, who immediately takes accountability for fixing the problem and guides the manager through another set of diagnostics and tailored processes by phone. Should these efforts fail, a local, prequalified service technician, contracted and trained for rapid response, is dispatched. The technician can typically resolve most of these rare instances within a few hours of the initial call.

The solution saved so much expense (relying less on costly local repair people) that it changed the rest of the industry. Deciding that its primary beverage supplier, Coca-Cola, could manage this new beverage repair service more effectively than it could, McDonald’s turned the whole burden over to the beverage company. Coca-Cola then used it for competitive advantage with other restaurants.¹⁵

As digital technology advances, the “internet of things,” data analytics, cloud computing, and mobile devices will provide many new opportunities for point interventions. Industrial companies will follow the example of shared-economy start-ups like Uber and AirBnB, using digital technology to make their operations much more flexible and responsive; their products and services will be customized to a degree that was never possible before. In China, for example, the color and feature set of every appliance that Haier sells can be tailored to the specifications of its purchaser, who arranges this in advance on a Haier company website. The point intervention, in this case, was not the design of the website or the factory’s customization ability; those already existed. The intervention involved bringing these two activities together, making this level of customization standard for new sales, and incorporating them into Haier’s on-demand production and delivery capability.

These technological changes are happening so rapidly that most companies have not yet taken advantage of the opportunities they provide. Every company still has a great deal to learn through prototyping and experimentation. But when translating the strategic into the everyday, be careful not to experiment for its own sake. The most successful companies link their technologically driven interventions closely with their strategy. They apply technology in their own way to their own distinctive practices, instead of taking on the same technological solutions that everyone else is attempting.

One company that uses digital technology effectively this way is Under Armour. Founded in 1996 by Kevin Plank, a former college football captain who found cotton T-shirts too prone to getting wet and heavy during sports and exercise, the company sells athletic clothing made from a synthetic fabric that wicks moisture away from the skin and stays light and dry. Plank’s T-shirts first found a small following among other college athletes after he assiduously built up the capability of marketing to them and with them. Since then, the company has grown into a full athletic outfitter with over $3 billion in revenue in 2014.

The use of digital technology is embodied in the company’s athletics-oriented value proposition, where they continually claim their clothes add to an athlete’s comfort and performance. Under Armour has been a pioneer in computer-assisted fabric design, creating water-transmitting materials that allow people to feel dry instead of soggy and sweaty after a workout, and water-repellent sweatshirts that keep people as dry as a raincoat would. It was also one of the first companies to integrate its clothing with data from fitness trackers. In 2013 the company acquired MapMyFitness, a company that aggregates data from a range of fitness trackers and allows athletes to monitor their exercise and eating. The point in all this is not the improvement of any particular product, but the continuous improvement of Under Armour’s distinctive product development capability. Like Natura, Apple, and Qualcomm, it has developed a group of followers who expect innovative new products will emerge from the company on a regular basis.¹⁶

The next time you discuss the threat of technological disruption to your business, try turning it around. What technological changes can you make to your capabilities to ensure that you can advance your mission, and better deliver your value proposition? Don’t think of this as a request for more IT investment per se. Few IT infrastructure projects are designed to differentiate a company, instead, a certain amount of functional delivery is demanded against the cost. Think of your IT investment instead as a point intervention: a move to improve your current capabilities, working with other functions to do something better than you did it before, or to do it at a larger scale.

Capability Innovation

One of the great moments in IKEA’s history came in 1956. Gillis Lundgren, the designer of the three-legged, leaf-shaped Lövet end table, was trying to figure out how to fit it in the trunk of his car. He took the legs off and then figured out that the table could be sold that way and be reassembled by purchasers. He is credited as the creator of the IKEA flat pack, a critical element of the company’s price-conscious and stylish product design capability—and something that, to our knowledge, had not been done before with mass-manufactured furniture.¹⁷

This innovation paved the way for another: the creation of the IKEA self-service warehouse. It happened in 1970, after a fire nearly destroyed the flagship store, which was then located in Stockholm. During the reopening days, founder Ingvar Kamprad and a retail manager climbed up one of the warehouse racks to get a better view. “From that spot,” recalls Peter Agnefjäll, who like many IKEA senior executives has worked at the company for his entire career, “they could look into the shopping area which was completely crowded with people … [Then they looked] into the warehouse area, where there were four or five workers running around, trying to collect the products for the customers. They thought: What would happen if we take this wall away, and instead let the customers enter the warehouse?” ¹⁸ That was the origin, to our knowledge, of the first warehouse-style retail outlet. As a result, IKEA was not just a business with a capability in customer-focused retail design. It had transformed that capability into a new outlet-format approach, which engaged customers in picking the furniture off the shelves as a prelude to assembling it themselves.

The advantage that comes from an innovation of this sort is not limited to a product or service. It gives you a sustained capability applicable to everything you offer. The companies we looked at are all remarkable capability innovators. They push the boundaries of their own ability to do new things, and then they apply that new capability to a wide range of activity.

The impetus for innovation may start at the blueprint stage—when people consider the problems that need solving to create the capabilities they need. Often, however, innovation doesn’t stop there. All through the development of capabilities, the building of new processes, practices, and technologies becomes a way of life. “A lot of times we don’t yet know quite how we’re going to solve an engineering challenge,” said a senior Qualcomm leader we talked to. “But we told the customer we would provide it by a deadline. So the engineering teams have to figure out the answer as they go along. It’s typically a problem that no one has solved before, but that’s what inspires people.”

Some breakthrough innovations in capabilities are so powerful that they become entirely new ways of doing things, at the heart of a company’s identity. One of the best-known examples is Zara, the flagship brand of the global apparel company Inditex. Zara’s distinctive achievement was summed up eloquently by Amit Bagaria, the founder of the India-based fashion retail research group ASIPAC: “Zara comes up with 36,000 new designs every year, and it delivers new products as many as 2–6 times each week to its 1900+ stores around the world. Store orders are delivered in 24–48 hours. It takes the company only 10–15 days to go from the design stage to the sales floor.” ¹⁹ One part of Zara’s business model is a consistency grounded in changing fashion. Customers know that they will always find fashion-forward garments at Zara, at a reasonable price, usually within a few weeks after similar designs appeared on runways. They know that the clothing will be well manufactured and durable. And they know that if they don’t buy those clothes when they first appear, they may not ever find them again.²⁰

Inditex was founded in 1963 as a local dressmaking enterprise in La Coruna, a Galician port city on Spain’s northern coast. The company is now a global apparel industry leader with more than sixty-six hundred retail stores for all its brands.²¹ The roots of the company’s innovative capabilities system go back to 1975, when founder Amancio Ortega opened a complementary business—a women’s apparel shop—with the idea of selling affordable fashion that didn’t seem cheap. He realized that by making the garments himself, paying close attention to the items his customers selected, and then quickly adjusting his line to match, he and his family-owned company could produce clothing faster than anyone else did and sell it at relatively low cost. As the business grew, he used innovative technological and process design to take this capability to a larger scale, in a way that no one had done before. This capability makes Inditex relatively immune to the inventory problems of many apparel retailers, which buy from overseas, often months in advance, and therefore must guess what clothing will be popular. Inditex avoids the cost of storing and discounting clothing that didn’t sell and, more importantly, avoids the opportunity cost of missing trends.

Zara designers watch catwalk trends, fashion blogs, television shows, and the style choices of college students for early signs of customers’ next apparel choices. In parallel, the company’s retail employees are trained to serve as the company’s frontline eyes and ears, tracking data, observing customers, and gathering informal impressions. The stores compile information about the choices that customers make, their inquiries about missing items, and their conversations. Are shoppers looking for skirts or trousers? Bold or subtle colors? These impressions are sent directly to a group of designers and operational experts at headquarters, who are charged with translating them immediately into new products for the racks.²²

To make decisions based on all this data without being overwhelmed, Inditex created its own clear, and scalable, process for cross-functional communication. “We have a triangle of information,” chief communications officer Jesús Echevarría Hernández told a Harvard researcher. “The store managers, the [regional managers], and the commercials [who oversee sales figures for about forty stores each]. The commercials receive sales figures daily and communicate with the store managers and the [regional managers] every day to capture trends and interpret those figures. Store managers often ask to change a model (for example, changing colors and sizes), introduce variations (such as adapting short pants from long pants), or even design new clothes from scratch. If a lot of stores ask for similar changes, the commercials communicate these to the design team who will try to design the item and send it to all the stores.” ²³ Zara has successfully expanded its online sales and its global geographic footprint in recent years, always continuing to gather information about what customers look at and what they buy. Its net sales grow steadily year after year, putting it solidly among the category leaders in this sector.²⁴

Qualcomm has also built capabilities through breakthrough innovation. This includes the licensing proficiency which generates much of the company’s revenue. As journalist Dave Mock recounts in his history of the company, The Qualcomm Equation, this capability was oriented to “[help] licensees get up to speed fast on the technology and quickly introduce it to the market.” ²⁵ It goes beyond conventional licensing approaches, incorporating not just managing patents and intellectual property, but also in-depth consultation and building relationships with a broad group of telecommunications companies.²⁶ The pricing model was part of the breakthrough: the company steps up its fees when its licensees become successful.

The licensing capability was developed with as much intensive originality as any of Qualcomm’s technological innovations. The story began in the early 1990s, when the mobile phone industry was establishing itself in the United States. Qualcomm commercialized a mobile phone transmission format called code-division multiple access (CDMA). Unlike other mobile standards of the time, which relied on specific bands of radio frequency, CDMA could travel on any part of the available electromagnetic spectrum, providing higher capacity and stronger quality on the same transmission signals than had been previously available.

But Qualcomm faced an uphill battle; at first the company was the only purveyor of its technology, which required a great deal of innovation investment without a clear market. When the company first proposed CDMA, the technology was more of a concept than a deliverable technological platform. At the time, many technical challenges prevented telecoms from accepting CDMA. Most companies had already committed to other standards. “Nobody believed [CDMA] would work,” recalled former Qualcomm executive Bill Davidson, who had been active during that era. “[Others in the industry] absolutely disparaged the company. They said that we were selling vaporware. [Cofounder and then-chairman] Irwin Jacobs was called a crackpot.”

Qualcomm’s engineers and physicists were certain they were right. But to persevere, they had to simultaneously solve the technical challenges and figure out a viable business model for an emerging technology. This meant designing a fee structure low enough to attract business partners, but high enough that it would continue to subsidize Qualcomm’s innovation. They had to establish themselves as impartial honest brokers, attracting handset manufacturers and mobile network operators without giving any of them preferential treatment—a departure from many conventional industry practices. Unlike AT&T in the old Bell System, they had to do all this with no government-sanctioned monopoly, little experience in licensing, and comparatively few connections in the mobile phone industry.²⁷ Instead of delegating the design of this new licensing system to legal and finance departments. Qualcomm focused senior management attention to it and combined it with customer service: bringing together engineers, patent attorneys, license negotiators, and business-to-business marketers to design it.

Since the mid-1990s, of course, CDMA has been eclipsed by other technologies and Qualcomm has often found itself in a recurring role: investing in the next generation of mobile communications technology (such as 3G, 4G, and, most recently, 5G transmission standards) and then using its licensing model to attract the rest of the industry. As Davidson puts it, “While it didn’t feel fortunate at the time, it turned out to be fortunate that we were doubted in the beginning. It gave us a really scrappy culture.” Qualcomm’s technological audacity is unusual, but every company that has built distinctive capabilities has its own analogous structural innovations, enabling it to stand out in its field.

We could offer many other stories of capabilities system innovation. Apple, Lego, Amazon, and Starbucks—these companies are known for stepping outside the boundaries of conventional practice in highly successful ways. Some of their breakthrough innovations are small but telling. For example, Apple’s checkout practice, in which retail clerks rove through the store with portable computers taking care of the payment, ensures that no one in the store ever has to wait at a checkout counter. This practice is a bigger deal than it appears to be; it removes a nagging irritant that consumers may feel, and reinforces the store’s informal retail environment.

Just as with point interventions, the advent of digital technology will transform capabilities innovation in ways that have only begun to be imagined. For example, banks are just beginning to develop apps that play a much more active role in counseling and guiding people to financial health. In one future scenario recently developed by our firm, a young professional woman, after sending her monthly $1,650 rent payment, asks an app whether she should keep renting. “Great question,” the app replies. “Let’s discuss how to build equity over the next ten years.” This introduces her to a suite of programs and services that guide her to appropriate neighborhoods, estimate the costs of purchase, design a savings plan with her, prompt her every day to stick to that plan (for example, by bringing her lunch to work), and ultimately find the moving company that carts her belongings to the new address. The process takes years, and the bank is with her, in her pocket or on her wrist, every step of the way. The capabilities for accomplishing this are technologically enabled, but technology isn’t the critical innovation element. The bank must reimagine its business model and create an entirely new, cost-effective way to play the role of behavioral influence and guide, with the mobile device as its gateway. Few financial services firms have yet developed that kind of capability, or the trusted advisor identity, worthy of a customer’s loyalty, that is needed to go with it.²⁹

Capabilities-Oriented Acquisitions

Capabilities should be high on the strategic radar for dealmakers in companies. But all too often, they are treated as relatively minor factors, not as fundamental vehicles for creating value. Yet if you can look at prospective acquisitions as Starbucks, Danaher, and Amazon do, with an eye toward building capabilities, you are likely to be far more effective at M&A—and at value creation in general.

During the past few years, our firm has conducted a series of studies on the relative success of mergers and acquisitions (we referred briefly to the studies in chapter 1). The most recent iteration, conducted in 2015, analyzed more than 540 major transactions from around the world, all announced between 2001 and 2012. These were the 60 biggest deals in each of nine sectors: chemicals, consumer staples, electric and gas utilities, financial services, health care, industrials, information technology, media, and retail.

In the strategy-to-execution context, we have generally found that there are three types of deals. They can often be identified easily from the statements of intent that the acquirers make to investors, the press, and regulators. Leverage deals draw in products and services that make use of the acquirer’s capabilities system. Danaher is well known for these deals, buying companies that will thrive when its Danaher Business System is applied to them. Starbucks also has a history of leverage deals; it often expands by buying chains, like Seattle Coffee, which can be converted to the Starbucks brand. CEMEX is a third example: It acquired Mexican competitors such as Cementos Anáhuac and Cementos Tolteca in the 1980s, the Spanish cement makers Valenciana and Sanson in 1992, several South American cement companies in the later 1990s, and two US-based cement companies in the early-to-mid 2000s.³⁰ These companies were integrated into the CEMEX enterprise, sharing the solutions-provider value proposition and all the CEMEX capabilities.

Enhancement deals draw in companies that fill in gaps in the acquirer’s capabilities system. For example, when Starbucks paid $100 million for the La Boulange bakery chain in 2012, the acquisition was not just a matter of introducing high-quality breads and cakes. It raised the chain’s ability to serve distinctive foods (without a grill, which ruined the ambiance with its odors). Amazon’s 2009 purchase of the online shoe store Zappos brought expertise in customer service; its 2012 acquisition of Kiva Systems, known for its robot-driven warehouses, led to step-change improvements in its automated distribution logistics.³¹ Under Armour’s purchases of MapMyFitness in 2013 and Endomondo and MyFitnessPal in 2015 allowed it to build its digital capabilities in alignment with its core fitness-gear capabilities. Enhancement deals can be risky if they are not well managed; their success depends on a company’s ability to integrate the people and technologies that it is acquiring. Many of these deals involve a long buy-and-hold period, which gives the two companies time to figure out how to assimilate the incoming capabilities and set up an environment where the acquiring company can learn from the acquired one.

Limited-fit deals are typically oriented toward diversification, often for higher growth rates, and may have little to do with capabilities at all. These deals tend to be far less successful. Our firm’s studies have consistently found that the most immediately successful deals—as determined by total shareholder return in the two years after the deal was announced—are leverage deals. On average, they outperformed limited-fit deals by 14.2 percentage points. Enhancement deals also outperform limited-fit deals, by 12.4 percentage points. The return on the best enhancement deals is greater than that of leverage deals, but their success depends on the quality of postmerger integration. In all our studies, deals with a good capabilities fit outperform other deals by a significant and consistent margin.³²

Capabilities fit helps explain why the Danaher group of businesses, which was largely assembled through acquisitions, works so well. At first glance, the firms in the conglomerate barely seem to fit together. Danaher does business in a variety of categories, including industrial products (Kollmorgen, Pantone); test and measurement instruments (Fluke, Tektronix); dentists’ supplies (Kavo, Kerr); life sciences (Radiometer, HemoCue); environmental measurement and control (Hach Instruments, Gilbarco Veeder-Root); and science-focused enterprises (Leica, Beckmann Instruments, Pall, Videojet). This mix is not a coincidence. Danaher chose the companies it acquired carefully, sometimes spending years deciding to make an acquisition and following through. The rationale has always been the same: Danaher looks for companies that have a scientific or technological customer base, that have been languishing financially, and that could be revived with Danaher’s capabilities in operational and business discipline. The company’s pending 2016 split is being set up to enable the two new capabilites systems to be more tailored to each group of companies.

Our firm’s M&A team has analyzed Danaher as a serial acquirer. We found that the thirty-one transactions (worth 72 percent of its market capitalization) that the company conducted between 1995 and 2011 were almost all classifiable as leverage deals. In each of these acquisitions, the company applied its capabilities system to a new product or service area—often keeping the acquired company and its brand names intact, but always applying the Danaher Business system and other key practices. This highly focused M&A program helped raise the company’s share price fifteen-fold over that sixteen-year period, a performance far superior to that of the S&P 500 and many of Danaher’s competitors.

Once Danaher acquires a company, as we’ll see in chapter 5, it spends months onboarding the incoming executives. It also routinely moves top business leaders from one company to the other, making sure that the incisive, distinctive business knowledge inherent within Danaher is available to all the companies. And Danaher backs up these practices with other cross-platform and cross-boundary training. In this context, it shouldn’t be surprising that Danaher is so coherent or that its coherence extends into every business it enters. Moreover, while Danaher is known as a leverage-deal company, most of its deals are also oriented to enhancing its capabilities system at the same time. Some of its extraordinary success may well stem from its ability to use its deals for both leverage and capabilities enhancement—in a consistent way that routinely bridges the gap between strategy and execution.

“As we buy companies, we learn new things,” says Danaher executive vice president Jim Lico (who is slated to become CEO of the new industrial components spinoff company). “The dental businesses had great sales management practices that were new to us. When we acquired Fluke and Hach we learned better product management. When we bought Tektronix and some of the life sciences businesses, we learned more about technology development, advanced R&D, and software development. And those learnings were incorporated into all Danaher businesses. One of the most important things we can say about the Danaher Business System is that it improves and changes as our portfolio evolves.” ³³

In the long run, enhancement deals may even be more lucrative than leverage deals—if you invest the time, attention, and capital needed to integrate incoming capabilities with your system and apply them to your portfolio of products and services. You can either acquire an entire capability or acquire part of a capability that you combine with something else. Better still, any deal that leverages or enhances your capabilities can play a profound catalytic role; the right acquisition can jump-start your efforts to innovate, continuously improve, and make powerful, focused interventions.

Finally, some parts of your business may be worth selling to other companies that can make better use of those capabilities. For example, in 2013 Qualcomm divested Omnitracs, a maker of satellite-based tracking and messaging systems for transportation and logistics management. This business had been part of the company since its beginnings in 1985. Qualcomm sold Omnitracs to Vista Equity Partners in 2013, telling reporters that they believed the company would do better with a different corporate parent.³⁴

For most companies, an overall approach to building capabilities will include a mix of focused interventions, capability innovations, and capabilities-oriented acquisitions, all in sync. With each step, you’ll be making your capabilities stronger and your company more coherent. People will rehearse and repeat the new routines and practices you put in place, paying close attention to what works and what doesn’t work. Once your capabilities system is working effectively where you piloted it, or where it may have naturally existed, you’ll be ready to bring it to scale.

Scaling Up Your Capabilities System

Distinctive capabilities are expensive. They involve significant fixed costs and enormous managerial attention. To unlock the potential value from your investment in them, you must focus on only a few, and instill them throughout your enterprise, everywhere you do business.

Yet it is tempting to fall into a Skunk Works or special-forces mind-set. That’s when you think of distinctive capabilities as a kind of artistry performed by an elite corps of high-potential talent: the elite players work long hours and deliver unusual results, while the rest of the organization struggles along in its usual incoherent fashion. This approach rarely leads to success, especially if you have coherent competitors that have brought their capabilities to scale.

Thus, building scale for your distinctive capabilities must be at the top of the CEO agenda. The best approach will vary from one company to the next, but at its heart lie two common challenges. The first has to do with transcending functional boundaries—a difficult achievement in itself. The second has to do with balancing two forms of knowledge: tacit (held in peoples’ habits and behaviors) and explicit (codified and formal). This means centralizing and systematizing activity throughout your company while still fostering participation and experimentation. In the end, whatever your industry and whatever your enterprise’s size, scaling up your distinctive capabilities is one of the most difficult and yet essential things you can do.

Let’s explore these two challenges in more detail.

Transcending Functional Boundaries

When we began the research for this book, we expected to hear a lot about organizational design. We thought that creative, capability-rich companies would have paid a lot of attention to the way they organized and the value that restructuring gave them.

Instead, our interviews found a willingness to let organizational forms and structures evolve naturally, developing in line with the identity of the enterprise. This makes sense, given what we know about organizational design: the best designs, as our colleague Gary Neilson has pointed out, are those which are “fit for purpose”: designed to reinforce the distinctive capabilities of that particular company.³⁵

We only uncovered one recurring pattern in organizational design, and it was closely related to the ability to bring distinctive capabilities to scale. The companies we studied, each in its own way, had transcended the limits of functional boundaries.

In other more conventional companies, work on capabilities takes place within separate specialized departments. You’ll often find customer relationship management within marketing, budgeting within finance, supply-chain management within operations, outsourcing within procurement, training within HR, and new product development within R&D. You’ll find some capabilities sitting in multiple versions in parallel functions: IT, HR, and operations will all have their own version of an outsourcing capability, with people sometimes only dimly aware of their counterparts in other functions.

The functional model of organization dates back to the 1850s. Some of the first business functionaries were railroad telegraph operators who managed schedules. Then came sales forces, finance departments, and R&D labs—including the original labs of Thomas Edison and Alexander Graham Bell. As companies grew steadily, the “corporate staff” (as it was originally called) grew accordingly. The functional model has been ingrained ever since, so much so that it is rarely questioned. Business units come and go, but finance, HR, marketing, IT, legal, and R&D seem to last forever.

We are not proposing the elimination of functions. Their value is undeniable; no company could do without them. They perform the essential task of marshaling people with important skills to manage crucial activities. But functions as they exist in many companies, without a clear link to distinctive capabilities, tend to drive incoherence and widen the strategy-to-execution gap.

On one hand, functions are treated as sources of expertise within the enterprise, which gives them an incentive to emulate world-class functions in other companies—to whom they will inevitably be compared. On the other hand, they are set up as cost centers and service bureaus, mandated to meet the needs of all their constituents as rapidly as possible under the ceiling of their budget. As we’ll see in chapter 5, the entire budgeting process often facilitates and reinforces this—with functional leaders often incented and driven to protect and extend their functional reach just to maintain the resources they need. Meanwhile, as they juggle an endless list of (sometimes conflicting) demands from line units, they become skilled at solving the problems of the moment. They focus their attention on expedience, not on the most important distinctive capabilities. Aligning the functions to capabilities, which is often the only strategic way to resolve these pressures, may not even be considered.

The functional model of organizations is an important reason why so many companies struggle with the gap between strategy and execution. It makes a company good at many things, but great at nothing.³⁶ When functional boundaries prevail, there is no construct for managing capabilities. It isn’t clear who owns the capabilities, how to track spending on them, or how to connect them to the strategy or to each other.

Much of the task of scaling up capabilities depends on resolving this issue—on transcending the limits of functions. For distinctive capabilities are inherently cross-functional. The most important capabilities systems do not fall neatly into groupings designed many decades ago. Indeed, much of the distinction in a powerful capabilities system stems from the sparks created when people with different backgrounds, skills, technologies, and perspectives build practices and processes together. Frito-Lay’s direct-store delivery capability brings together IT, marketing, logistics and distribution, and financial analysis. The IKEA product design process involves design, sourcing, shipping, manufacturing, and customer insight. Apple’s distinctively intuitive product and user interface design similarly involves customer insight, engineering, manufacturing, marketing, and distribution. In all these cases, the teams work collaboratively rather than sequentially; they think together, rather than throwing projects “over the wall” to each other.

The most common organizational solution is the cross-functional team: a committee of people drawn from the relevant departments to solve particular problems. Unfortunately, many cross-functional teams fall far short of delivering effective and efficient solutions. They rarely have the time they need to resolve their different ways of thinking. They are also limited by their conflicting functional priorities and sometimes by a lack of clear accountability. What’s more, many of these teams are temporary; they will dissolve once the project is over, and their members may not work together again. There are also far too many of these teams, and the more there are, the more they tend to proliferate. When all cross-functional teams are temporary, an organization has little incentive to overcome these hurdles.

Permanent cross-functional teams tend to fare better. A growing number of long-standing innovation groups, for example, bring together disparate functional skills (typically R&D, marketing, customer insights, and IT) to facilitate the launch of new products or services. Some of these teams are relatively informal, whereas others involve major shifts to the organizational structure. In one case, to develop its portfolio management capability, Pfizer Consumer set up communities of practice: semi-formal ongoing networks that included lawyers, health professionals, and marketing experts. These communities helped spread key ideas and best practices to brand and product groups around the world.³⁷

From permanent cross-functional teams, it’s only a small step to having formal capabilities teams. These operate outside the functional structure entirely, led by top executives with newly created job descriptions: Chief Digital, Risk, or Innovation Officer. Members of these teams, no matter how specialized their skills, follow a cross-functional career, reporting to people who may not share their background but who have a common commitment to the capability and all the projects associated with it. The functional departments, instead of managing projects, focus on learning and development and specialized guidance for the relevant staff assigned to capabilities. Examples include the IKEA sustainability team and Natura’s supply-chain management council, whose purview includes sourcing, manufacturing, logistics, and aspects of the relationship with sales consultants. The capabilities team model can be likened to a symphony orchestra; the conductor is responsible for the whole work, but if a soloist needs help, he or she will turn to masters of the particular instrument for guidance.

The most farsighted functional leaders are not just waiting for these changes to affect them. They are taking the first step by helping evaluate the current state of their company’s capabilities system and suggesting ways to bring it closer to its potential. This is part of the functional leader’s new mandate as a strategic partner for the enterprise: delivering not what individual constituents demand, but what the whole enterprise needs.

Balancing Tacit and Explicit Knowledge

In their classic management book The Knowledge-Creating Company, management writers Ikujiro Nonaka and Hirotaka Takeuchi argue that the operating knowledge used to run distinctive capabilities in most companies is tacit.³⁸ In other words, it is held within the minds of people doing the work, is habitually followed, and is passed on through on-the-job training. This tacit knowledge is rarely written down in any systematic way. Because this knowledge is learned on the job, often within a function or business unit, it varies across different parts of the enterprise, often with some parts of the organization being far more capable than others.

To bring that knowledge to scale, you must take it beyond the purview of the elite “special forces.” It must become explicit. It must be captured systemically, with clear instructions—like recipes and routines—or must be embedded in processes and technological setups, like algorithms and blueprints, that anyone could use to execute well. These codified routines and practices must be treated as standard practice: repeated at every level, in every location. Otherwise, the company loses its consistent value, and its distinctive capabilities are lost.

(Codifying the capabilities is not the same as creating a blueprint. The blueprint describes the capability and how it works, including the need for codification. The codification is embedded instructions: knowledge used to put it into practice throughout the company.)

Tacit knowledge should be gathered selectively. You must consciously focus on the knowledge that makes you distinctive. When people are asked what they do at work or what others should learn from them, the first things they say are probably not the most important. You need to probe more deeply, to get past their ordinary perceptions, and to codify not just what people consciously recognize as their work knowledge, but what has been ingrained into unconscious habit. You may end up discarding 75 to 80 percent of what people think is important, because it doesn’t quite get to the heart of what makes you distinctive.

You must also resist the temptation to codify too mechanistically. You want to create step-by-step recipes and routines, often embedded in technology, that make it possible for a wide number of people to learn to do things the same way. Yet your goal is not to standardize everything or hamstring creativity. Rather, as people get used to these recipes and routines, they adapt them to their own circumstances while remaining true to the identity and capabilities that the entire organization needs. You want to promote ownership of the knowledge embedded in the capability, to encourage innovation while operating at scale. Give your recipe-followers opportunities to become master chefs, practicing the steps until they no longer need the recipes; the knowledge has become tacit again and second nature. If you can make it work, you have a whole enterprise of people who are skilled enough to make their own valuable variations; who understand how they fit the value proposition, see their place in the capabilities system, and continually learn from each other.

Or as organizational learning specialist Robert Putnam puts it, “The learning of skills begins with recipes. Without practice, the concept won’t be second nature. But until it’s second nature, you can’t practice with it effectively. So you short-cut the dilemma by following a set of rules”—at least at first, until you don’t need the rules anymore.³⁹

Having a capabilities-oriented structure (a chief capability officer) can make it easier to balance explicit knowledge (centralized codification) and tacit knowledge (decentralized creativity). Whatever the structure, there needs to be a process for continually improving the work of your distinctive capabilities. People need to feel free to comment on the recipes, routines, and other standardized practices they are following. They need to know that their comments will be heard, and that the recipes and routines will rapidly be adjusted if the suggestions are right. They need opportunities to share information and learn from each other. And this needs to be tied to every aspect of codification, including the metrics that have been agreed upon to determine if a project is successful. Then they need the autonomy to act on what they have learned.

Frito-Lay, for example, has strict routines and metrics built into its direct store delivery capability. There are clear routes, and required steps in sending back data from the field. But regional managers are continuously involved in improving those routines and metrics, and in making sure the company continues to learn from its experience in the field. Danaher has regular review sessions at every level, and a culture in which anyone is encouraged to raise questions about the effectiveness of the Danaher Business System or any metric, practice, or rubric associated with it.

Once you have a capability that is codified and brought to scale, it will be available to you thereafter—even if you lose your way. In the mid-1980s, the sports apparel manufacturer Adidas learned this in a very striking way, and recovered a nearly bankrupt business as a result. Based in a small Bavarian town near Nuremberg, Germany, the company had been led since its founding in 1949 by the original managing director, Adolf (“Adi”) Dassler, a dedicated designer of athletic shoes for high performance. For example, he designed football shoes (or, as they’re called in the United States, soccer shoes) that were only two-thirds as heavy as those of his rivals. The company became famous after the 1954 World Cup, which its shoes were credited with helping the West German team win. Drawing on Dassler’s direct contact with athletes and insights about their needs, Adidas became known for its expertise in developing shoes tailored to competitive sports.

While little of that knowledge was written down in instructions or processes, it was codified in artifacts: a small museum of shoe prototypes and other design experiments. But after Dassler died in 1978, the company lost interest. Instead, according to management researchers Nicholas Ind, Oriol Iglesias, and Majken Schultz, Adidas tried to compete against Nike and Puma on fashion and price. The subsequent decline in profits led to near bankruptcy and a takeover in 1989. René Jäggi, a judo enthusiast and marketer from Duracell, was hired to turn the company around. He in turn hired two former Nike managers, Peter Moore and Rob Strasser, to visit its operations. “It only took about five minutes in the museum,” Moore recalls, “before I realized that these people had a gold mine in their hands, and that they really had no idea what they had had.”⁴⁰

The tacit knowledge from the past, brought back to life as the old shoe prototypes were unearthed, rejuvenated the company. “[Adidas] started to rebuild its archive,” Ind, Iglesias, and Schultz explain, “buying back shoes and clothes from collectors and asking for donations [of old Adidas items]. Managers were also asked to think about their current work and what they wanted to save and document. They re-created the company’s archive—which [as of 2014] had 90,000 items and 10,000 images,” along with many of Dassler’s notes.

It wasn’t enough to capture the old experiments, of course; Moore and Strasser had to encourage and support a new group of researchers to carry on, building a broad-based capability for athlete-friendly design rather than just a winning product or two. Adidas soon began producing new shoes in the Dassler tradition of experimentation in collaboration with athletes. One such line, called Equipment, focused on lightweight design and authenticity. Later renamed Performance, the line represents more than 75 percent of the company’s current sales. Another shoe produced through this revitalized innovation capability, the Stan Smith tennis shoe, has sold more than sixty million pairs.

Your company may not have what Adidas had: a founder’s forgotten museum linked to your value proposition. But your organization no doubt has a body of tacit knowledge highly relevant to your business. Much of it is probably not yet captured; it takes the form of conversations or behavior: “how we do things around here,” conveyed to newcomers when they join the enterprise. Your goal is to find this knowledge—often sitting behind your most successful businesses—and scale it so that hundreds or thousands of people are thinking together, as if they are all owners and not just following instructions. As you’ll see later in the book, this way of operating—collective mastery—becomes an inherent part of a coherent company’s culture.

If you can balance tacit and explicit knowledge successfully, the result is a paradoxical, but very effective, combination of people marching in step but thinking for themselves. Starbucks masters this balance. Its codification of practices and methods, from its retail store design principles to its use of reward cards and mobile-phone payments, has allowed it to scale up its distinctive look and feel around the world. Yet there is always enough local autonomy to cater to local tastes and interests. No two stores are exactly the same; they have varied menus and prices, depending on their location. Their promotions often involve community action, which is managed by the local store leaders.

The IKEA organization is similarly good at managing the balance between explicit and tacit knowledge. Every IKEA staffer around the world follows the same basic guidelines, almost to the letter—because the employees are convinced that it is the right thing to do in service of their value proposition and capabilities system. Even so, everyone is encouraged to speak out when they see a reason to change, and they know their insights will be heeded.

“One of our core values,” says Torbjörn Lööf, the CEO of Inter IKEA Systems B.V., “is to be entrepreneurial. Everyone takes initiative to improve the IKEA concept. But of course there are areas where we’re very strict and structured. If you look at the description of our concept, [you’ll see] what a store should look like, how it should be built, where people come in, how the flow goes, where they exit, where the restaurant should be and how it should be, what range we offer, what style we should have, what the price ladders are. A lot is almost set in stone. People don’t resist it. They know it’s been extensively tested [and] they know we’re constantly trying out new things, and if they prove out to work, they’ll become part of the concept.”⁴¹

Beyond Business as Usual

Though the specifics may vary from one company to another, the three activities described in this chapter—creating a blueprint of a capabilities system, building those capabilities, and bringing the capabilities to scale—are relevant to all enterprises. The activities require a disciplined focus that goes beyond business as usual.

When you follow this path, then people who work with you will internalize their capability-building activity as a form of engagement and creativity. People see themselves as what they do, so as they see their direct connection to the capabilities of your company, and as these capabilities become ingrained in day-to-day activities and habits, you will tap into a great deal of emotional energy. Indeed, the essentials of your capabilities system, as we’ll see in the next chapter, will become core elements of the culture of your company.