Here is an excerpt from an article written by Paul Leinwand and Cesare Mainardi for Harvard Business Review and the HBR Blog Network. To read the complete article, check out the wealth of free resources, and sign up for a subscription to HBR email alerts, please click here.
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Sustainable, superior returns accrue to companies that focus on what they do best. The truth is that simple, and yet it’s incredibly hard to internalize. It is the rare company indeed that focuses on “what we do better than anyone” in making every operating decision across every business unit and product line. Rarer still is the company that has aligned its differentiating internal capabilities with the right external market position. We call such companies “coherent.”
Most companies don’t pass the coherence test because they pay too much attention to external positioning and not enough to internal capabilities. They succumb to intense pressure for top-line growth and chase business in markets where they don’t have the capabilities to sustain success. Their growth emanates not from the core but from the acquisition of apparent “adjacencies” that are often anything but and the exploration of “blue oceans” that turn out to be unswimmable. Even in contraction mode, when companies hunker down and try to wring more out of execution, most strategies fail to pay sufficient attention to capabilities. Cost-cutting, for example, is usually an across-the-board exercise, rather than a considered reallocation of resources. In most companies, strategy and capabilities are treated as separate topics. Strategy development follows the well-worn path from the market back to the boardroom.
We’re not suggesting that companies disregard market signals; all strategy is set within that vital context. We are suggesting, however, that companies start from the opposite direction, figuring out what they’re really good at and then developing those capabilities (three to six at most) until they’re best-in-class and interlocking. From there, strategy becomes a matter of aligning that distinctive capabilities system with the right marketplace opportunities—and the market rewards them with outsize returns. We call this the “coherence premium,” and we’ve measured it.
Specifically, we propose that coherence yields a consistent premium in performance derived from four sources of value:
o Effectiveness. Day in and day out, you become more effective where it matters most. You “sweat” your capabilities, refining and developing your methods and processes. Because your capabilities reinforce one another in a system, they improve more rapidly than the capabilities of your less-coherent competitors. Your people become more skilled; your systems grow more adept; your profitability improves. As you advance, other companies find it more and more difficult to catch up.
o Efficiency. As you apply your capabilities more broadly across more products and services, your investment in each of them goes further and you can build them up with more power. Small parts of your business, those that could never afford, say, a highly distinctive merchandising system on their own, can take advantage of this capability along with the rest of your company.
o Focused investment. By allocating capital and expense more deliberately and effectively, you focus more on the capabilities that differentiate your company competitively and less on what Gary Hamel and C.K. Prahalad called table stakes — the necessary competencies and skills that every competitor brings to this market. You don’t fund unnecessary R&D projects or marketing campaigns. You invest in depth where depth is needed, and go light where you should go light.
o Alignment. When you commit to a strategy and articulate it clearly, everyone has a common basis for the day-to-day decisions they make. Throughout your company, people in different businesses and different geographic areas are more likely to understand one another, and to make decisions independently that are nevertheless in sync. More-coherent decision making becomes part of your company’s culture. The advantage this gives you over less-coherent competitors is palpable.
We are hardly the first to write about the importance of capabilities to strategy. C.K. Prahalad and Gary Hamel’s seminal article, “The Core Competence of the Corporation” (HBR May 1990), was the first in a long line of articles and books to explore this idea. But a capability in isolation is not enough to produce the coherence premium. We believe that a capabilities system creates value in a differentiated way.
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To read the complete article, please click here.
Paul Leinwand (paul.leinwand@booz.com) is a partner at Booz & Company in Chicago. Cesare Mainardi (cesare.mainardi@booz.com) is managing director of Booz & Company’s North American business and is a member of the firm’s executive committee.