Here is an excerpt from another in a series of conversations sponsored by Booz & Company. In this instance, with Paul Leinwand and Cesare Mainardi, co-authors of The Essential Advantage: How to Win with a Capabilities-Driven Strategy, published by Harvard Business Review Press (2011). In this interview, they point out that in this unpredictable economy, traditional approaches to strategy are a luxury most companies cannot afford. Instead they need to follow a Capabilities-Driven Strategy, starting by conducting a clear-eyed assessment of what they as a firm already do exceptionally well, and then doubling down on those differentiating capabilities. Further, they need to limit their focus to, at most, six capabilities, and make those capabilities work together as a mutually reinforcing system that perpetuates competitive advantage.

To download a PDF and read the complete conversation, please click here.

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Why did you write The Essential Advantage?

Turbulent markets demand focus and discipline. In this unpredictable economy, traditional approaches to strategy are a luxury most companies cannot afford. They cannot chart a future course based on a wide-eyed search for external growth: “There’s an attractive, adjacent market. Let’s go after it.” Rather, they need to conduct a clear-eyed assessment of what they as a firm already do exceptionally well, and then double down on those differentiating capabilities. Further, they need to limit their focus to, at most, six capabilities, and make those capabilities work together as a mutually reinforcing system that perpetuates competitive advantage.

What is the “coherence premium”?

Coherent companies—those that possess a capabilities system that aligns their strategy with their product/service portfolio—generate superior performance over time, which is what we call the coherence premium. For a company to be described as “coherent,” according to our definition, it must be resolute and clear-minded in three critical ways: in the way the company creates value in the market (its chosen “way to play”); in the system of capabilities it deploys; and in the products and services it provides to its customers. The goal is balance: A coherent company strikes a balance where the right product and service portfolio naturally thrives within a capabilities system consciously chosen and implemented to support a deliberate strategy or way to play. We believe coherence confers a substantial premium, and we’ve measured it. We’ve established a strong correlation between coherence, as we define it, and superior performance over time in a number of industries.

What does it mean to have a “right to win”?

The right to win is the confidence held by a company that its combination of way to play, system of capabilities, and products and services will outdeliver those of its competitors, drive sustained earnings growth, and thus give it an essential advantage in its market. The right to win is the ability to enter or participate in any competitive market with the reasonably justified belief that you will succeed and create value. That belief stems from having chosen a differentiated way to play that is supported by a strong system of mutually reinforcing capabilities. A right to win isn’t a guarantee that things will go your way, but it reflects your relative coherence: the fact that you are better prepared to attract and keep customers than any of your competitors. A right to win can be measured in having share or margin advantage relative to competitors who compete within the same market.

What is “capabilities-driven strategy”?

Capabilities-driven strategy (CDS) is a pragmatic series of choices designed to lead you to increasing levels of coherence and thus to gain an essential advantage for your company over time. CDS starts with what you as a company do best—better than anyone else—and builds from that internal base of strength in making market participation choices. Traditionally, the practice of strategy has moved in the opposite direction. Companies scan the market for attractive expansion opportunities and build capabilities to suit those opportunities. We think they have it backward. It’s much harder to build capabilities than to leverage what you already do exceptionally well in capturing value. Those companies that focus on building a system of three to six best-in-class, interlocking capabilities that support their way to play achieve a right to win in their industries. They exploit their strengths over and over again, becoming even better at what they already excel at.

We’ve established a strong correlation between coherence, as we define it, and superior performance over time in a number of industries.

Can you measure the success of a capabilities-driven strategy?

We have established a strong correlation between capabilities coherence and superior returns over time. In fact, we have devised a way to measure the success of a capabilities-driven strategy and applied it to a number of industries. We call this measure the “coherence premium.” To demonstrate it, we’ve examined a number of industries and mapped the level of capabilities coherence in the portfolio of each of the major players against their operating margins over the past five years. We have confirmed that coherence in capabilities correlates strongly with greater profitability (as measured by EBIT margin over a five-year period). Our approach to scoring coherence is similar across industries and can be distilled into three essential steps. First, we define the segments each company serves. Next, we identify the capabilities that drive value for the company in each segment. Finally, we determine the number of common capabilities across all the segments a company serves. The resulting score is then mapped against EBIT margin to determine the coherence premium. Our research shows that companies that invest mindfully in a capabilities system that supports their way to play and their product and service portfolio outperform the competition in their industry.

In a messy, incoherent world, those companies that can look through a capabilities lens set a straighter and more sustainable course and avoid costly missteps.

Why haven’t more companies adopted capabilities-driven strategy as “the” way to develop strategy?

It’s easier to accommodate incoherence than to fight for coherence.

Companies today operate in a business environment that encourages incoherence. Efforts to improve customer insight, for example, seem laudatory—but they can lead a business unit leader to propose bringing out a product line extension (“Consumers are asking for it”) without considering how it fits with the company’s capabilities system. Or a benchmarking exercise might lead a functional leader to argue for new investment in distribution networks (“Our competitors have them” or “We must be great at this”) without recognizing that your existing distribution network, while it may not be the best, is more than adequate for your way to play, and the investment is better made elsewhere. It’s easier, or certainly less risky, to focus on incremental improvement in specific areas than sweeping change across the board.
What many people don’t realize is that CDS can be implemented at any level—function, business unit, subsidiary, enterprise. The complete coherence we’ve described is an ultimate destination, but there is also value created in the journey, in staking and exploiting “pockets” of coherence. In an incoherent world, the relatively coherent company can prosper. In an incoherent company, the relatively coherent division can grow.

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To download a PDF and read the complete conversation, please click here.

Paul Leinwand is a Booz & Company partner based in Chicago. He works in the consumer, media, and digital practice and focuses on capabilities-driven strategy for consumer products companies.

Cesare Mainardi is managing director of Booz & Company’s North American business and a member of the firm’s executive committee. In his 23 years with the firm, he has worked with global Fortune 500 companies to help them achieve major business transformations.

Resources

Paul Leinwand and Cesare Mainardi, The Essential Advantage: How to Win with a Capabilities-Driven Strategy, Harvard Business Review Press, December 2010.

Paul Leinwand and Cesare Mainardi, “The Coherence Premium,” Harvard Business Review, June 2010. (Download free copy by clicking here.)

Shumeet Banerji, Paul Leinwand, and Cesare Mainardi, Cut Costs and Grow Stronger