Recommended Resources – An Interview with Paul Leinwand and Cesare Mainardi, authors of The Essential Advantage

The Essential Advantage: How to Win with a Capabilities-Driven Strategy
by Paul Leinwand and Cesare Mainardi

The conventional wisdom about strategy may be leading your company astray. In The Essential Advantage: How to Win with a Capabilities-Driven Strategy, Booz & Company’s Paul Leinwand and Cesare Mainardi maintain that success in any market accrues to firms with a coherence premium – a tight match between their strategic direction and the capabilities that make them unique.

Achieving coherence requires a sharpness of focus that few companies have mastered. This book helps you identify your firm’s distinctive blend of strategic direction and differentiated capabilities that give you the ‘right to win’ in your chosen markets.

Based on extensive research and providing a wealth of exercises, tools, and company examples from many industries – including, Walmart, Pfizer, Inditex (Zara), Itaú Unibanco, and Procter & Gamble – The Essential Advantage helps you construct a strategically coherent company in which the pieces reinforce each other instead of working at cross-purposes.

Additional Insights… An Interview with Paul Leinwand and Cesare Mainardi, authors of The Essential Advantage

SD: Why did you write The Essential Advantage?

PL and CM: 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.

SD: What is the ‘coherence premium?’

PL and CM: 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.

SD: What does it mean to have a ‘right to win?’

PL and CM: 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.

SD: What is ‘capabilities-driven strategy?’

PL and CM: 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.

SD: What new ideas are you bringing to the table with capabilities-driven strategy?

PL and CM: Our take on capabilities and how they work in systems is new, as is our view of coherence as this three-part balanced system that confers a measurable premium.

While capabilities and competencies have been written about many times before, our firm’s perspective is that capabilities work together in systems and must be coherent with your way to play and the products and services you sell. Any one of these elements is not enough to gain the type of essential advantage that is sustainable over time. In addition, we believe that your starting point for strategy development is what you are already great at, rather than studying the industry and market for opportunities. This perspective is a shift from existing strategy perspectives as it affects nearly every major decision a company makes, from growth initiatives, portfolio strategy, and M&A opportunities to its approach to budgeting and cost cutting.

SD: Why now? Is it more important to consider capabilities when you develop a strategy now than it was, say, five years ago?

PL and CM: Economic downturns intensify the need for coherence and distinguish those who have achieved it.

CDS is not more important, but it’s certainly more timely, given the economic upheaval of the past couple of years. That creates an imperative for coherence. As a business, when you have a dramatic reduction in demand, you will be far less successful on the fringe. And you’re not going to be able to invest in those external market opportunities that traditional strategy would suggest. In a downturn, there is all the more reason to focus on what you already do well that your customers value and your competitors can’t beat. Finally, many industries are responding to the pressures of the last few years by differentiating themselves. The theoretical optimized industry is one with two or three players performing very different roles. Large downturns (such as this recession), technology disruptions, or regulatory shifts create discontinuities that simply accelerate the industry’s evolution toward this equilibrium state. The leading companies are getting out in front of this trend.

SD: It sounds logical to develop strategy by starting with one’s capabilities. What do most companies do instead?

PL and CM: Most companies look outside to adjacent markets for growth and invest in assets to exploit those opportunities.

The well-worn path to strategy in most industries is to seek growth outside your doors. You look at adjacent markets. You assess the attractiveness of the demand, the size and growth of the market, and the amount of profit that could be delivered, and you make participation choices and invest behind them. And, invariably, you invest in assets. You buy a company, invest in a brand, do R&D to meet that unmet need, expand into a new geography. These choices historically conferred advantage – first-mover, scale – but asset-based scale advantages have diminished in recent years, thanks to technology, cheap information, and outsourcing. Assets are important, but they are, increasingly, table stakes in most competitive industries; everyone in the game has them. Moreover, fixed assets are more difficult to leverage across diverse businesses than capabilities, and they tend to expire, become obsolete, or give way to related services. As the intrinsic value of assets diminishes, the competitive value of capabilities will only grow. In fact, we would assert that capabilities have already passed assets to become the primary means of creating value in most industries. They deserve at least equal weight in strategy setting.

SD: How does capabilities-driven strategy create value?

PL and CM: Capabilities-driven strategy creates value through four levers: effectiveness, focused investment, efficiency, and alignment.

First is an effectiveness benefit, which is realized simply in doing what you’re exceptionally good at over and over, day in and day out. Those companies that ‘sweat’ their capabilities continuously improve them and sustainably capture the top-line growth in their industries and, ultimately, market leadership. A coherent, focused, and aligned capabilities system creates not only value but a lock on value, as it is enormously difficult for competitors to replicate. Second, a coherent system focuses strategic investment on what matters. Coherent companies direct capital, time, and other resources with purpose to those activities, products, and businesses that will extend their lead. Third, there is the simple efficiency argument. Organizations that are clear-minded about where and how they participate in a market spend less on those capabilities that are not competitively differentiating. Finally, CDS forces alignment between strategic intent and day-to-day decision making. 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. These organizations move in lockstep, because everyone understands what’s important. They execute faster and with more force. And they attract, in turn, people who excel at the capabilities they wield with such mastery.

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

PL and CM: 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.

SD: Why haven’t more companies adopted capabilities-driven strategy as ‘the’ way to develop strategy?

PL and CM: 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.

SD: Can you name some companies that have earned the coherence premium?

PL and CM: Walmart and Pfizer’s former consumer healthcare division are a couple of great case studies in capabilities coherence.

Walmart wrings maximum efficiency from its supply chain by integrating four capabilities – aggressive vendor management, expert point-of-sale data analytics, superior logistics, and rigorous working-capital management – that together deliver ‘everyday low prices’ to consumers. It’s a ‘sharp pencil’ capabilities system rooted in superior information. Because of its world-class point-of-sale analytics, Walmart can rigorously tailor its assortment to local consumption trends and go to vendors with better information than the vendors themselves have. This, in turn, increases the company’s leverage with suppliers and allows it to be extraordinarily efficient in moving inventory and managing working capital.

Pfizer’s consumer healthcare (PCH) division offers a great start-to-finish case study of capabilities-driven strategy development and the returns it affords. After absorbing the much larger consumer healthcare divisions of Warner-Lambert and Pharmacia in the early 2000s, PCH was looking to develop a focused growth strategy. Based on the breakthrough insight that consumer healthcare was more a healthcare business than a consumer products business, PCH restructured its entire business and product portfolio around six healthcare-oriented capabilities: pharma-like innovation, regulatory management, new product development, claims-based marketing, channel management, and the ‘Rx-to-OTC switch’ (adapting prescription pharmaceuticals into over-the-counter products). It divested a number of personal care and confectionary lines (e.g., Schick razors and Trident) and acquired other products (e.g., Purell) consistent with its chosen way to play. In 2006, Pfizer directly redeemed the value built by PCH by selling the business to Johnson & Johnson for an unprecedented US$16.6 billion, or 20.6 times EBITDA (compared to average multiples of 15 at the time).

SD: How can capabilities-driven strategy be applied to cutting costs?

PL and CM: CDS and cost reduction go hand in hand, as you need to make explicit choices about what to cut and what to keep.

In the course of developing and implementing a capabilities-driven strategy, companies make definitive choices about what matters and what doesn’t. They spend less on those capabilities that are not competitively differentiating. They don’t invest in making accounts payable world-class. They don’t fund R&D projects that won’t enhance their way to play. And they don’t overspend on marketing campaigns that won’t move the needle on sales.

Strangely, cost reduction exercises in most companies – no matter how extensive – are almost always divorced from business strategy, which makes little sense. You’re never just cutting costs. You’re making a decision that something is no longer strategically relevant, and that other things are essential. In coherent companies, every discretionary expenditure enhances a company’s capabilities system and thus strengthens its competitiveness.

SD: Does capabilities-driven strategy apply equally well to all industries and in all regions of the world?

PL and CM: We can’t imagine an industry or geography in which being good at what you do is not relevant or desirable.

The short answer is yes, CDS applies to all industries and all regions. Each company will come up with its own way to play based on its unique capabilities system – and in many cases, still, its advantaged assets. It’s true that different sectors and markets are at different stages of development and maturity. For example, in China, markets are still highly regulated, and domestic players protected. But even in such an environment, capabilities are essential – for example, working with the government to ensure distribution, or negotiating labor contracts to secure continued access to talent. Capabilities-driven strategy works in all contexts.

About the Authors

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. He works with global Fortune 500 companies to help them achieve major business transformations.


To learn more about Capabilities-Driven Strategy, click here.

Recommended Resources – An Interview with Jon Katzenbach and Zia Khan, authors of Leading Outside the Lines

Leading Outside the Lines: How to Mobilize the Informal Organization, Energize Your Team, and Get Better Results
by Jon Katzenbach and Zia Khan

Every enterprise has an informal as well as a formal organization. The formal is the side with which business people are usually most familiar. It consists of analyses, strategies, structures, processes and programs – all codified in memos, charts and Power-Point presentations. These tools are designed to align decisions and actions. The informal is generally less familiar. It consists of emerging ideas, social networks, working norms, values, peer relationships and communities of common interest – the elements that often hide beyond the boundaries of the formal. In Leading Outside the Lines, authors Jon Katzenbach and Zia Khan make the compelling case that it is in the less familiar informal world where magic happens… yet one without the other is unlikely to sustain peak performance over time.

Additional Insights… An Interview with Jon Katzenbach and Zia Khan, authors of Leading Outside The Lines

StrategyDriven Contributors recently interviewed Jon Katzenbach and Zia Khan, authors of Leading Outside the Lines; receiving many invaluable, beyond the scope of the book insights.

SD: Why did you write Leading Outside the Lines?

JK and ZK: To help leaders gain a powerful performance ‘boost’ from their informal organizations. In our years helping leading organizations improve performance, we’ve learned that leaders at all levels have a difficult time with, or don’t realize they need to address, a key avenue to success: balancing two distinct dimensions of human behavior and organizational performance – the formal and the informal elements. Learning how to mobilize the informal elements of an organization to accelerate the formal elements goes a long way in helping leaders fill the gap between intention and results. Further, the recession and slow recovery have forced many organizations to reduce headcount to a bare minimum, and have undermined employee motivation. Without making changes to headcount, systems of performance management and processes, leaders can tap into the informal elements of the organization to realize additional performance potential, and do so ‘for free.’

SD: What is the ‘informal organization?’ And what is the ‘formal?’

JK and ZK: The informal unlocks the emotional side of behavior; the formal is the rational side. The informal organization is a bundle of organizational elements that are often hidden from view, but exert strong influence on people’s decisions and behaviors. The informal includes values that drive decisions, networks that guide personal interactions and the spread of information and emotional feelings about the work that drives the amount of effort and commitment that people put into their jobs. The formal organization, on the other hand, includes the codified elements of organization that are usually disseminated on paper. They include strategies, structures, processes, metrics, etc. In other words, the informal organization is comprised of interpersonal connections, influences and “rituals” that happen beyond, around and beneath the formal rules; they are seldom codified or reference-able. The formal is the structural lines, boxes, rules, measures and processes that describe how things are supposed to work; they are almost always codified and reference-able.

SD: What do you mean by ‘Leading Outside the Lines?’

JK and ZK: Influencing results by using informal mechanisms beyond the hierarchy. The lines represent the formal organization – the usual elements of strategy, structure, hierarchy, metrics, etc. Most effective leaders are well trained in using those elements. However, the best leaders also learn how to mobilize the informal organization – the values, networks, and sources of pride that drive motivation and high performance. These elements are more responsive to leadership outside the lines, so to speak. So, leading outside the lines is really stepping outside of formal roles and responsibilities to influence emotions that accelerate behaviors that determine performance.

SD: Why is the ‘Leading Outside the Lines’ concept and call to action any more important now than it was, say, five years ago?

JK and ZK: The recessionary recovery challenge demands emotional as well as rational leadership capabilities. There are two reasons. First, managing the formal organization has become a widespread and broadly used discipline. In the past, optimized processes and fact-based strategies gave companies an advantage. Now, anyone can buy them off the shelf, so it’s hard to gain a competitive advantage through formal elements alone. The informal organization, however, is mostly uncharted territory. There’s lots of excitement about social networking and the like, but there aren’t many practical frameworks or approaches for using informal elements to gain performance advantages. And the advantages gained from the informal organization are very, very hard to copy. Second, as mentioned before, because of the recession and slow recovery, most companies are in much greater need of leadership capacity that both the formal and informal organizations provide.

SD: You say that if the informal isn’t working for you, it’s working against you. What do you mean by that?

JK and ZK: Informal forces are always at play – you cannot simply turn them on and off by command. The informal is working all the time: It’s not ‘stoppable or start-able;’ it’s only influence-able. It either resists and de-rails what the formal is trying to accomplish, or it supports and accelerates it. It is never ‘in neutral.’ So, the chances that the informal organization is working for you without any deliberate attempt to mobilize it in the right direction are fairly low. In many cases, when left unattended, the informal works against you even if you’re not trying to change anything. In fact, the informal organization can align itself in the opposite direction that leaders want to take the whole company if the informal organization hasn’t bought into the change.

SD: What are the results when leaders successfully balance the informal with the formal?

JK and ZK: Emotional commitment supplants rational compliance to optimize performance results. Overall, leaders can accelerate performance results by combining the best of both the informal and the formal, and do so without having to make trade-offs. They get the efficiency of the formal with the creativity of the informal; the focused execution of the formal with the responsiveness to new opportunities of the informal; the accountability of the formal with the emotional commitment of the informal. In other words, you get behavior change that yields higher performance results or faster results – and often BOTH!

SD: You tell a lot of stories in the book. What’s your favorite one?

JK and ZK: We don’t have a single favorite; it depends on the issue. We like all the stories, and there are different categories. Perhaps our favorite ‘informal miracle’ story is the one about the transformation of Aetna. Early in the decade, Aetna had been on a treadmill to nowhere – even though it had tried three different change programs. It continued to lose $1 million a day. But a new CEO, Dr. John Rowe, had a vision to turn it all around – by bringing the company’s pride back. He engaged all levels of the informal organization and created evangelists for formal change. The core of the program was known informally throughout the company as ‘restoring the pride.’

SD: You mention types of workers call ‘fast zebras.’ Who are they? What do you do with them?

JK and ZK: People who get important stuff done quicker by going down informal as well as formal paths. In the wild, the fast zebra gets to the watering hole quickly and escapes predators who might be waiting. Similarly, in organizations, there are those who can quickly find innovative ways to realize their objectives without getting bogged down by organizational predators like bureaucracy, politics, senseless policies, outdated rules, etc. They have learned how to get things done by using a dynamic variety of formal and informal mechanisms; they know when to follow the rules, when to bend the rules and when to change the rules. The best thing to do with them is to learn from them, and draw on those learnings to make changes to the organization so you can enable potential fast zebras. Give them room to interact, get them together to energize one another and listen to – and act on – their insights.

SD: What kinds of leaders are best at ‘Leading Outside the Lines?’

JK and ZK: Those who have learned the power of the informal through trial and error. They are very open to the informal – and realize they don’t have all the answers. They are willing to take personal risks by drawing on emotional intelligence as much as analytical intelligence. They spend time with people at any level, particularly the frontline, and not just with a select few at headquarters. Most importantly, they believe that while the informal organization may appear to be unruly chaos and resistant to control, they know it can be mobilized to generate real performance results.

SD: What are the biggest mistakes leaders make when trying to manage and maximize the informal organization?

JK and ZK: The biggest mistake is to try and manage the informal like the formal. It can’t be told what to do; it must be convinced, influenced and energized. We tell clients that they must mobilize the informal and manage the formal. Therefore, it’s a big mistake to think that top-down communication will keep the informal interactions positive. It’s also a mistake to believe that broad-based ‘engagement scores’ are indicative of informal support and to underestimate the importance of emotional commitment over rational compliance.

SD: Are you saying that strict ‘traditionalists’ will fail in this environment?

JK and ZK: Only if you define under-performance as failing. They won’t actually fail – and that’s part of the problem. Right now, any leader who can’t use the formal organization has a very short career. So they get weeded out quickly. However, those who don’t use the informal will usually accomplish good enough results, as there aren’t many who know how to use both and who achieve outstanding results. However, we expect that as the discipline of using the informal spreads, the pressure to be versed n it will increase. We do believe that those who only take advantage of one side of the “organizational brain” will fall short of their potential – and end up as mediocre guardians of the status quo.

SD: What happens if a leader backs off from the informal organization and just lets it grow organically?

JK and ZK: He competes with one hand tied behind his back. It would be the same as forgetting about marketing and hoping your customers buy your products by chance. It’s an asset that needs to be used with purpose. It may adapt to support you organically if you have effective and committed leaders down the line, but it can also align against you if you change the status quo to which it has evolved. Remember, the informal organization has a mind of its own, which may not be in sync with your priorities. More often than not, when left to evolve on its own, the informal organization works against you. Put another way, it would be analogous to letting ivy find its own home.

SD: Your book mentions ‘master motivators’ and ‘pride builders.’ Who are they, and what do you do with them?

JK and ZK: They are people in supervisory situations who know how to make others ‘feel good’ about the work that has to get done every day; they instill pride in the work itself. We use these terms inter-changeably. We urge leaders to listen and learn from them, and get them into networks and communities where they can spread motivational skills experientially among peers and colleagues. The people who work for them ‘never want to disappoint them’ and the people who work beside them want to learn their ‘secrets.’

SD: What can leaders do to get better at actively leveraging the informal and balancing it with the formal?

JK and ZK: Keep working at it; if at first you don’t succeed, try and try again. The first thing is to get an understanding of your current informal organization – the values, the networks and sources of pride. Front line leaders can seek out peers who are natural pride-builders; leaders at the top can find ways to connect with them, learn from them, and spread their behaviors; leaders in the middle can do both.

About the Authors

Jon Katzenbach is a senior partner at Booz & Company and leads The Katzenbach Center, where promising new approaches in leadership, culture and organization performance are developed for client application. His consulting career has been largely focused in these areas, and spans several decades across several different professional books, including The Wisdom of Teams, Peak Performance, Why Pride Matters More Than Money, and the new Leading Outside the Lines. He received his MBA from Harvard, where he was a Baker Scholar. Jon is a founding partner of Katzenbach Partners. To read Jon’s complete biography, click here.

Zia Khan, co-author of Leading Outside the Lines, is vice president for strategy and evaluation at the Rockefeller Foundation, which supports innovations that help people share globalization’s benefits more equitably and strengthens their resilience to social, economic, health and environmental challenges. Zia also advises leaders on the integration of strategy and organization as a senior fellow of the Katzenbach Center, which he co-founded with Jon Katzenbach, and as an individual consultant. Prior to joining the Rockefeller Foundation, Zia established and led Katzenbach Partners’ San Francisco office and West Coast Practice and pioneered the firm’s work on the informal organization. Zia hold a B.S. from Cornell University and an M.S. and Ph.D. from Stanford University. To read Zia’s complete biography, click here.