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“What Is Strategy?”

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Reinventing Your Business Model

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Using the Balanced Scorecard as a Strategic Management System

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Transforming Corner-Office Strategy into Frontline Action

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What Is Strategy?
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What Is Strategy?

The Idea in Brief The Idea in Practice

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The myriad activities that go into creating,
producing, selling, and delivering a product
service are the basic units of competitive
vantage. Operational effectiveness
eans performing these activities better—
at is, faster, or with fewer inputs and
fects—than rivals. Companies can reap
ormous advantages from operational ef-
tiveness, as Japanese firms demon-
ated in the 1970s and 1980s with such
actices as total quality management and
ntinuous improvement. But from a com-
titive standpoint, the problem with oper-
onal effectiveness is that best practices
easily emulated. As all competitors in an
ustry adopt them, the productivity
ntier—the maximum value a company
n deliver at a given cost, given the best
ailable technology, skills, and manage-
ent techniques—shifts outward, lowering
sts and improving value at the same
e. Such competition produces absolute
provement in operational effectiveness,
t relative improvement for no one. And
e more benchmarking that companies
, the more competitive convergence
u have—that is, the more indistinguish-
le companies are from one another.
rategic positioning attempts to achieve
stainable competitive advantage by
eserving what is distinctive about a com-
ny. It means performing different activi-
s from rivals, or performing similar activi-
s in different ways.
Three key principles underlie strategic positioning.
1. Strategy is the creation of a unique and
valuable position, involving a different set
of activities. Strategic position emerges from
three distinct sources:
• serving few needs of many customers (Jiffy
Lube provides only auto lubricants)
• serving broad needs of few customers
(Bessemer Trust targets only very high-
wealth clients)
• serving broad needs of many customers
in a narrow market (Carmike Cinemas op-
erates only in cities with a population
under 200,000)
2. Strategy requires you to make trade-offs
in competing—to choose what not to do.
Some competitive activities are incompatible;
thus, gains in one area can be achieved only
at the expense of another area. For example,
Neutrogena soap is positioned more as a me-
dicinal product than as a cleansing agent. The
company says “no” to sales based on deodor-
izing, gives up large volume, and sacrifices
manufacturing efficiencies. By contrast, Maytag’s
decision to extend its product line and ac-
quire other brands represented a failure to
make difficult trade-offs: the boost in reve-
nues came at the expense of return on sales.
3. Strategy involves creating “fit” among a
company’s activities. Fit has to do with the
ways a company’s activities interact and rein-
force one another. For example, Vanguard
Group aligns all of its activities with a low-cost
strategy; it distributes funds directly to con-
sumers and minimizes portfolio turnover. Fit
drives both competitive advantage and sus-
tainability: when activities mutually reinforce
each other, competitors can’t easily imitate
them. When Continental Lite tried to match a
few of Southwest Airlines’ activities, but not
the whole interlocking system, the results
were disastrous.
Employees need guidance about how to
deepen a strategic position rather than
broaden or compromise it. About how to ex-
tend the company’s uniqueness while
strengthening the fit among its activities. This
work of deciding which target group of cus-
tomers and needs to serve requires discipline,
the ability to set limits, and forthright commu-
nication. Clearly, strategy and leadership are
inextricably linked.
page 3

What Is Strategy?

by Michael E. Porter

C
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harvard business review • november–
I. Operational Effectiveness Is Not
Strategy
For almost two decades, managers have been
learning to play by a new set of rules. Compa-
nies must be flexible to respond rapidly to
competitive and market changes. They must
benchmark continuously to achieve best prac-
tice. They must outsource aggressively to gain
efficiencies. And they must nurture a few core
competencies in race to stay ahead of rivals.
Positioning—once the heart of strategy—is
rejected as too static for today’s dynamic mar-
kets and changing technologies. According to
the new dogma, rivals can quickly copy any
market position, and competitive advantage is,
at best, temporary.
But those beliefs are dangerous half-truths,
and they are leading more and more companies
down the path of mutually destructive compe-
tition. True, some barriers to competition are
falling as regulation eases and markets become
global. True, companies have properly invested
energy in becoming leaner and more nimble.
In many industries, however, what some call
hypercompetition is a self-inflicted wound, not
the inevitable outcome of a changing paradigm
of competition.
The root of the problem is the failure to dis-
tinguish between operational effectiveness and
strategy. The quest for productivity, quality, and
speed has spawned a remarkable number of
management tools and techniques: total quality
management, benchmarking, time-based com-
petition, outsourcing, partnering, reengineering,
change management. Although the resulting
operational improvements have often been
dramatic, many companies have been frustrated
by their inability to translate those gains into
sustainable profitability. And bit by bit, almost
imperceptibly, management tools have taken
the place of strategy. As managers push to im-
prove on all fronts, they move farther away
from viable competitive positions.
Operational Effectiveness: Necessary but Not
Sufficient. Operational effectiveness and strategy
are both essential to superior performance,
which, after all, is the primary goal of any en-
terprise. But they work in very different ways.
december 1996 page 4

What Is Strategy?

harvard business review • november–

Michael E. Porter

is the C. Roland
Christensen Professor of Business
Administration at the Harvard Business
School in Boston, Massachusetts.
This article has benefited greatly
from the assistance of many individuals
and companies. The author gives spe-
cial thanks to Jan Rivkin, the coauthor
of a related paper. Substantial research
contributions have been made by
Nicolaj Siggelkow, Dawn Sylvester, and
Lucia Marshall. Tarun Khanna, Roger
Martin, and Anita McGahan have pro-
vided especially extensive comments.
A company can outperform rivals only if it can
establish a difference that it can preserve. It must
deliver greater value to customers or create
comparable value at a lower cost, or do both.
The arithmetic of superior profitability then fol-
lows: delivering greater value allows a company
to charge higher average unit prices; greater
efficiency results in lower average unit costs.
Ultimately, all differences between companies
in cost or price derive from the hundreds of ac-
tivities required to create, produce, sell, and de-
liver their products or services, such as calling
on customers, assembling final products, and
training employees. Cost is generated by per-
forming activities, and cost advantage arises
from performing particular activities more effi-
ciently than competitors. Similarly, differentia-
tion arises from both the choice of activities and
how they are performed. Activities, then are the
basic units of competitive advantage. Overall ad-
vantage or disadvantage results from all a com-
pany’s activities, not only a few.1
Operational effectiveness (OE) means per-
forming similar activities better than rivals per-
form them. Operational effectiveness includes
but is not limited to efficiency. It refers to any
number of practices that allow a company to bet-
ter utilize its inputs by, for example, reducing de-
fects in products or developing better products
faster. In contrast, strategic positioning means
performing different activities from rivals’ or per-
forming similar activities in different ways.
Differences in operational effectiveness among
companies are pervasive. Some companies
are able to get more out of their inputs than
others because they eliminate wasted effort,
employ more advanced technology, motivate
employees better, or have greater insight into
managing particular activities or sets of activ-
ities. Such differences in operational effective-
ness are an important source of differences in
profitability among competitors because they
directly affect relative cost positions and
levels of differentiation.
Differences in operational effectiveness
were at the heart of the Japanese challenge to
Western companies in the 1980s. The Japa-
nese were so far ahead of rivals in operational
effectiveness that they could offer lower cost
and superior quality at the same time. It is
worth dwelling on this point, because so much
recent thinking about competition depends
on it. Imagine for a moment a productivity
frontier that constitutes the sum of all existing
best practices at any given time. Think of it as
the maximum value that a company deliver-
ing a particular product or service can create
at a given cost, using the best available tech-
nologies, skills, management techniques, and
purchased inputs. The productivity frontier
can apply to individual activities, to groups
of linked activities such as order processing
and manufacturing, and to an entire com-
pany’s activities. When a company improves
its operational effectiveness, it moves toward
the frontier. Doing so may require capital in-
vestment, different personnel, or simply new
ways of managing.
The productivity frontier is constantly shift-
ing outward as new technologies and man-
agement approaches are developed and as
new inputs become available. Laptop com-
puters, mobile communications, the Internet,
and software such as Lotus Notes, for exam-
ple, have redefined the productivity frontier
for sales-force operations and created rich
possibilities for linking sales with such activi-
ties as order processing and after-sales sup-
port. Similarly, lean production, which involves a
family of activities, has allowed substantial
improvements in manufacturing productivity
and asset utilization.
For at least the past decade, managers have
been preoccupied with improving operational
effectiveness. Through programs such as TQM,
time-based competition, and benchmarking,
they have changed how they perform activities
in order to eliminate inefficiencies, improve
customer satisfaction, and achieve best practice.
Hoping to keep up with shifts in the produc-
tivity frontier, managers have embraced con-
tinuous improvement, empowerment, change
management, and the so-called learning orga-
nization. The popularity of outsourcing and
the virtual corporation reflect the growing
recognition that it is difficult to perform all
activities as productively as specialists.
As companies move to the frontier, they can
often improve on multiple dimensions of per-
formance at the same time. For example, manu-
facturers that adopted the Japanese practice of
rapid changeovers in the 1980s were able to
lower cost and improve differentiation simul-
taneously. What were once believed to be
real trade-offs—between defects and costs, for
example—turned out to be illusions created by
poor operational effectiveness. Managers have
learned to reject such false trade-offs.
december 1996 page 5

What Is Strategy?

harvard business review • november–

Operatio
Versus S
dereviled eulav reyub ecirpno
N
low
high
high
Constant improvement in operational ef-
fectiveness is necessary to achieve superior
profitability. However, it is not usually suffi-
cient. Few companies have competed success-
fully on the basis of operational effectiveness
over an extended period, and staying ahead of
rivals gets harder every day. The most obvious
reason for that is the rapid diffusion of best
practices. Competitors can quickly imitate
management techniques, new technologies,
input improvements, and superior ways of
meeting customers’ needs. The most generic
solutions—those that can be used in multiple
settings—diffuse the fastest. Witness the pro-
liferation of OE techniques accelerated by
support from consultants.
OE competition shifts the productivity fron-
tier outward, effectively raising the bar for
everyone. But although such competition pro-
duces absolute improvement in operational ef-
fectiveness, it leads to relative improvement
for no one. Consider the $5 billion-plus U.S.
commercial-printing industry. The major players—
R.R. Donnelley & Sons Company, Quebecor,
World Color Press, and Big Flower Press—are
competing head to head, serving all types of
customers, offering the same array of printing
technologies (gravure and web offset), in-
vesting heavily in the same new equipment,
running their presses faster, and reducing crew
sizes. But the resulting major productivity
gains are being captured by customers and
equipment suppliers, not retained in superior
profitability. Even industry-leader Donnelley’s
profit margin, consistently higher than 7% in
the 1980s, fell to less than 4.6% in 1995. This
pattern is playing itself out in industry after
industry. Even the Japanese, pioneers of the
new competition, suffer from persistently low
profits. (See the insert “Japanese Companies
Rarely Have Strategies.”)
The second reason that improved opera-
tional effectiveness is insufficient—competitive
convergence—is more subtle and insidious. The
more benchmarking companies do, the more
they look alike. The more that rivals out-
source activities to efficient third parties,
often the same ones, the more generic those
activities become. As rivals imitate one an-
other’s improvements in quality, cycle times,
or supplier partnerships, strategies converge
and competition becomes a series of races
down identical paths that no one can win.
Competition based on operational effective-
ness alone is mutually destructive, leading
to wars of attrition that can be arrested only
by limiting competition.
The recent wave of industry consolidation
through mergers makes sense in the context of
OE competition. Driven by performance pres-
sures but lacking strategic vision, company
after company has had no better idea than to
buy up its rivals. The competitors left standing
are often those that outlasted others, not com-
panies with real advantage.
After a decade of impressive gains in opera-
tional effectiveness, many companies are facing
diminishing returns. Continuous improvement
has been etched on managers’ brains. But its
tools unwittingly draw companies toward imi-
tation and homogeneity. Gradually, managers
have let operational effectiveness supplant strat-
egy. The result is zero-sum competition, static or
declining prices, and pressures on costs that
compromise companies’ ability to invest in the
business for the long term.
II. Strategy Rests on Unique
Activities
Competitive strategy is about being different.
It means deliberately choosing a different set
of activities to deliver a unique mix of value.
Southwest Airlines Company, for example,
offers short-haul, low-cost, point-to-point service
between midsize cities and secondary airports
nal Effectiveness
trategic Positioning
Relative cost position
low
Productivity Frontier
(state of best practice)
december 1996 page 6

What Is Strategy?

harvard business review • november–

Japanese Companies

The Japanese triggered a global revol
tion in operational effectiveness in th
1970s and 1980s, pioneering practices
such as total quality management an
continuous improvement. As a result,
Japanese manufacturers enjoyed sub-
stantial cost and quality advantages fo
many years.
But Japanese companies rarely de
veloped distinct strategic positions
the kind discussed in this article.
Those that did—Sony, Canon, and Sega,
for example—were the exception rathe
than the rule. Most Japanese compa
nies imitate and emulate one anothe
All rivals offer most if not all produc
varieties, features, and services; the
employ all channels and match one
anothers’ plant configurations.
The dangers of Japanese-style comp
tition are now becoming easier to rec
ognize. In the 1980s, with rivals opera
ing far from the productivity frontier,
seemed possible to win on both cost
and quality indefinitely. Japanese com
panies were all able to grow in an ex-
panding domestic economy and by
penetrating global markets. They ap-

in large cities. Southwest avoids large airports
and does not fly great distances. Its customers
include business travelers, families, and stu-
dents. Southwest’s frequent departures and
low fares attract price-sensitive customers who
otherwise would travel by bus or car, and
convenience-oriented travelers who would
choose a full-service airline on other routes.
Most managers describe strategic position-
ing in terms of their customers: “Southwest
Airlines serves price- and convenience-sensitive
travelers,” for example. But the essence of strat-
egy is in the activities—choosing to perform
activities differently or to perform different ac-
tivities than rivals. Otherwise, a strategy is
nothing more than a marketing slogan that
will not withstand competition.
A full-service airline is configured to get
passengers from almost any point A to any point
B. To reach a large number of destinations and
serve passengers with connecting flights, full-
service airlines employ a hub-and-spoke system
centered on major airports. To attract passengers
who desire more comfort, they offer first-class
or business-class service. To accommodate
passengers who must change planes, they co-
ordinate schedules and check and transfer
baggage. Because some passengers will be
traveling for many hours, full-service airlines
serve meals.
Southwest, in contrast, tailors all its activities
to deliver low-cost, convenient service on its par-
ticular type of route. Through fast turnarounds at
the gate of only 15 minutes, Southwest is able to
keep planes flying longer hours than rivals and
provide frequent departures with fewer aircraft.
Southwest does not offer meals, assigned seats,
interline baggage checking, or premium classes
of service. Automated ticketing at the gate
encourages customers to bypass travel agents, al-
lowing Southwest to avoid their commissions.
A standardized fleet of 737 aircraft boosts the
efficiency of maintenance.
Southwest has staked out a unique and valu-
able strategic position based on a tailored set
of activities. On the routes served by South-
west, a full-service airline could never be as
convenient or as low cost.
Ikea, the global furniture retailer based in
Sweden, also has a clear strategic positioning.
Ikea targets young furniture buyers who want
style at low cost. What turns this marketing
concept into a strategic positioning is the tai-
lored set of activities that make it work. Like
Southwest, Ikea has chosen to perform activi-
ties differently from its rivals.
Consider the typical furniture store. Show-
rooms display samples of the merchandise.
One area might contain 25 sofas; another will
display five dining tables. But those items rep-
resent only a fraction of the choices available
to customers. Dozens of books displaying fabric
swatches or wood samples or alternate styles
offer customers thousands of product varieties
to choose from. Salespeople often escort cus-
tomers through the store, answering questions
and helping them navigate this maze of choices.
Once a customer makes a selection, the order
is relayed to a third-party manufacturer. With
luck, the furniture will be delivered to the cus-
tomer’s home within six to eight weeks. This is
a value chain that maximizes customization
and service but does so at high cost.
In contrast, Ikea serves customers who are
happy to trade off service for cost. Instead of
Rarely Have Strategies
u-
e

d

r
–
of
r
–
r.
t
y
e-
–
t-
it
–
peared unstoppable. But as the gap in
operational effectiveness narrows, Jap-
anese companies are increasingly
caught in a trap of their own making. If
they are to escape the mutually destruc-
tive battles now ravaging their perfor-
mance, Japanese companies will have
to learn strategy.
To do so, they may have to overcome
strong cultural barriers. Japan is noto-
riously consensus oriented, and com-
panies have a strong tendency to medi-
ate differences among individuals
rather than accentuate them. Strategy,
on the other hand, requires hard
choices. The Japanese also have a
deeply ingrained service tradition that
predisposes them to go to great
lengths to satisfy any need a customer
expresses. Companies that compete in
that way end up blurring their distinct
positioning, becoming all things to
all customers.
This discussion of Japan is drawn from
the author’s research with Hirotaka
Takeuchi, with help from Mariko
Sakakibara.
december 1996 page 7

What Is Strategy?

harvard business review • november–

Finding New Position

Strategic competition can be thought o
the process of perceiving new position
woo customers from established positi
draw new customers into the market. F
ample, superstores offering depth of m
chandise in a single product category t
market share from broad-line departm
stores offering a more limited selection
many categories. Mail-order catalogs p
customers who crave convenience. In p
ple, incumbents and entrepreneurs fac
same challenges in finding new strateg
sitions. In practice, new entrants often
the edge.
Strategic positionings are often not o
ous, and finding them requires creativit
insight. New entrants often discover un
having a sales associate trail customers around
the store, Ikea uses a self-service model based
on clear, in-store displays. Rather than rely
solely on third-party manufacturers, Ikea designs
its own low-cost, modular, ready-to-assemble
furniture to fit its positioning. In huge stores,
Ikea displays every product it sells in room-like
settings, so customers don’t need a decorator
to help them imagine how to put the pieces to-
gether. Adjacent to the furnished showrooms
is a warehouse section with the products in
boxes on pallets. Customers are expected to do
their own pickup and delivery, and Ikea will
even sell you a roof rack for your car that you
can return for a refund on your next visit.
Although much of its low-cost position comes
from having customers “do it themselves,” Ikea
offers a number of extra services that its com-
petitors do not. In-store child care is one. Ex-
tended hours are another. Those services are
uniquely aligned with the needs of its custom-
ers, who are young, not wealthy, likely to
have children (but no nanny), and, because
they work for a living, have a need to shop
at odd hours.
The Origins of Strategic Positions. Strategic
positions emerge from three distinct sources,
which are not mutually exclusive and often
overlap. First, positioning can be based on pro-
ducing a subset of an industry’s products or
services. I call this variety-based positioning
because it is based on the choice of product
or service varieties rather than customer
segments. Variety-based positioning makes
economic sense when a company can best
produce particular products or services using
distinctive sets of activities.
Jiffy Lube International, for instance, spe-
cializes in automotive lubricants and does not
offer other car repair or maintenance services.
Its value chain produces faster service at a
lower cost than broader line repair shops, a
combination so attractive that many customers
subdivide their purchases, buying oil changes
from the focused competitor, Jiffy Lube, and
going to rivals for other services.
The Vanguard Group, a leader in the mutual
fund industry, is another example of variety-
based positioning. Vanguard provides an
array of common stock, bond, and money
market funds that offer predictable perfor-
mance and rock-bottom expenses. The com-
pany’s investment approach deliberately
sacrifices the possibility of extraordinary per-
formance in any one year for good relative
performance in every year. Vanguard is known,
for example, for its index funds. It avoids mak-
ing bets on interest rates and steers clear of
narrow stock groups. Fund managers keep
trading levels low, which holds expenses
down; in addition, the company discourages
customers from rapid buying and selling be-
cause doing so drives up costs and can force a
fund manager to trade in order to deploy new
s: The Entrepreneurial Edge
f as
s that
ons or
or ex-
er-
ake
ent
in
ick off
rinci-
e the
ic po-
have
bvi-
y and
ique
positions that have been available but simply
overlooked by established competitors. Ikea,
for example, recognized a customer group
that had been ignored or served poorly. Cir-
cuit City Stores’ entry into used cars, CarMax,
is based on a new way of performing activities—
extensive refurbishing of cars, product guaran-
tees, no-haggle pricing, sophisticated use of in-
house customer financing—that has long
been open to incumbents.
New entrants can prosper by occupying a
position that a competitor once held but has
ceded through years of imitation and strad-
dling. And entrants coming from other indus-
tries can create new positions because of dis-
tinctive activities drawn from their other
businesses. CarMax borrows heavily from
Circuit City’s expertise in inventory manage-
ment, credit, and other activities in consumer
electronics retailing.
Most commonly, however, new positions
open up because of change. New customer
groups or purchase occasions arise; new
needs emerge as societies evolve; new distri-
bution channels appear; new technologies
are developed; new machinery or informa-
tion systems become available. When such
changes happen, new entrants, unencum-
bered by a long history in the industry, can
often more easily perceive the potential
for a new way of competing. Unlike incum-
bents, newcomers can be more flexible be-
cause they face no trade-offs with their
existing activities.
december 1996 page 8

What Is Strategy?

harvard business review • november–

A company can
outperform rivals only if
it can establish a
difference that it can
preserve.
capital and raise cash for redemptions.
Vanguard also takes a consistent low-cost ap-
proach to managing distribution, customer
service, and marketing. Many investors in-
clude one or more Vanguard funds in their
portfolio, while buying aggressively managed
or specialized funds from competitors.
The people who use Vanguard or Jiffy
Lube are responding to a superior value chain
for a particular type of service. A variety-based
positioning can serve a wide array of custom-
ers, but for most it will meet only a subset of
their needs.
A second basis for positioning is that of serv-
ing most or all the needs of a particular group
of customers. I call this needs-based positioning,
which comes closer to traditional thinking
about targeting a segment of customers. It arises
when there are groups of customers with dif-
fering needs, and when a tailored set of activi-
ties can serve those needs best. Some groups of
customers are more price sensitive than others,
demand different product features, and need
varying amounts of information, support, and
services. Ikea’s customers are a good example
of such a group. Ikea seeks to meet all the
home furnishing needs of its target customers,
not just a subset of them.
A variant of needs-based positioning arises
when the same customer has different needs
on different occasions or for different types of
transactions. The same person, for example,
may have different needs when traveling on
business than when traveling for pleasure with
the family. Buyers of cans—beverage compa-
nies, for example—will likely have different
needs from their primary supplier than from
their secondary source.
It is intuitive for most managers to conceive
of their business in terms of the customers’
needs they are meeting. But a critical element
of needs-based positioning is not at all intuitive
and is often overlooked. Differences in needs
will not translate into meaningful positions
unless the best set of activities to satisfy them
also differs. If that were not the case, every
competitor could meet those same needs, and
there would be nothing unique or valuable
about the positioning.
In private banking, for example, Bessemer
Trust Company targets families with a mini-
mum of $5 million in investable assets who
want capital preservation combined with
wealth accumulation. By assigning one sophis-
ticated account officer for every 14 families,
Bessemer has configured its activities for per-
sonalized service. Meetings, for example, are
more likely to be held at a client’s ranch or
yacht than in the office. Bessemer offers a wide
array of customized services, including invest-
ment management and estate administration,
oversight of oil and gas investments, and ac-
counting for racehorses and aircraft. Loans, a
staple of most private banks, are rarely needed
by Bessemer’s clients and make up a tiny frac-
tion of its client balances and income. Despite
the most generous compensation of account
officers and the highest personnel cost as a per-
centage of operating expenses, Bessemer’s dif-
ferentiation with its target families produces a
return on equity estimated to be the highest of
any private banking competitor.
Citibank’s private bank, on the other hand,
serves clients with minimum assets of about
$250,000 who, in contrast to Bessemer’s clients,
want convenient access to loans—from jumbo
mortgages to deal financing. Citibank’s account
managers are primarily lenders. When clients
need other services, their account manager re-
fers them to other Citibank specialists, each of
whom handles prepackaged products. Citibank’s
system is less customized than Bessemer’s and
allows it to have a lower manager-to-client
ratio of 1:125. Biannual office meetings are of-
fered only for the largest clients. Both Bessemer
and Citibank have tailored their activities to
meet the needs of a different group of private
banking customers. The same value chain can-
not profitably meet the needs of both groups.
The third basis for positioning is that of seg-
menting customers who are accessible in dif-
ferent ways. Although their needs are similar
to those of other customers, the best configu-
ration of activities to reach them is different. I
call this access-based positioning. Access can be
a function of customer geography or cus-
tomer scale—or of anything that requires a
different set of activities to reach customers
in the best way.
Segmenting by access is less common and
less well understood than the other two bases.
Carmike Cinemas, for example, operates movie
theaters exclusively in cities and towns with
populations under 200,000. How does Car-
mike make money in markets that are not only
small but also won’t support big-city ticket
prices? It does so through a set of activities
that result in a lean cost structure. Carmike’s
december 1996 page 9

What Is Strategy?

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The Connection with

In

Competitive Strategy

(The Free Press
1985), I introduced the concept of ge-
neric strategies—cost leadership, diffe
entiation, and focus—to represent the
alternative strategic positions in an in-
dustry. The generic strategies remain
useful to characterize strategic position
at the simplest and broadest level. Van
guard, for instance, is an example of a
cost leadership strategy, whereas Ikea,
with its narrow customer group, is an e
ample of cost-based focus. Neutrogena
is a focused differentiator. The bases fo
positioning—varieties, needs, and access—
carry the understanding of those gener
strategies to a greater level of specificit
small-town customers can be served through
standardized, low-cost theater complexes re-
quiring fewer screens and less sophisticated
projection technology than big-city theaters.
The company’s proprietary information system
and management process eliminate the need
for local administrative staff beyond a single
theater manager. Carmike also reaps advan-
tages from centralized purchasing, lower rent
and payroll costs (because of its locations), and
rock-bottom corporate overhead of 2% (the in-
dustry average is 5%). Operating in small com-
munities also allows Carmike to practice a
highly personal form of marketing in which
the theater manager knows patrons and pro-
motes attendance through personal contacts.
By being the dominant if not the only theater
in its markets—the main competition is often
the high school football team—Carmike is also
able to get its pick of films and negotiate better
terms with distributors.
Rural versus urban-based customers are
one example of access driving differences in
activities. Serving small rather than large cus-
tomers or densely rather than sparsely situ-
ated customers are other examples in which
the best way to configure marketing, order
processing, logistics, and after-sale service ac-
tivities to meet the similar needs of distinct
groups will often differ.
Positioning is not only about carving out a
niche. A position emerging from any of the
sources can be broad or narrow. A focused
competitor, such as Ikea, targets the special
needs of a subset of customers and designs its
activities accordingly. Focused competitors
thrive on groups of customers who are over-
served (and hence overpriced) by more broadly
targeted competitors, or underserved (and
hence underpriced). A broadly targeted com-
petitor—for example, Vanguard or Delta Air
Lines—serves a wide array of customers, per-
forming a set of activities designed to meet
their common needs. It ignores or meets only
partially the more idiosyncratic needs of par-
ticular customer customer groups.
Whatever the basis—variety, needs, access,
or some combination of the three—positioning
requires a tailored set of activities because it is
always a function of differences on the supply
side; that is, of differences in activities. How-
ever, positioning is not always a function of
differences on the demand, or customer,
side. Variety and access positionings, in partic-
ular, do not rely on any customer differences.
In practice, however, variety or access differ-
ences often accompany needs differences. The
tastes—that is, the needs—of Carmike’s small-
town customers, for instance, run more toward
comedies, Westerns, action films, and family
entertainment. Carmike does not run any films
rated NC-17.
Having defined positioning, we can now
begin to answer the question, “What is strategy?”
Strategy is the creation of a unique and valu-
able position, involving a different set of activi-
ties. If there were only one ideal position,
there would be no need for strategy. Compa-
nies would face a simple imperative—win the
race to discover and preempt it. The essence of
strategic positioning is to choose activities that
are different from rivals’. If the same set of ac-
tivities were best to produce all varieties, meet
all needs, and access all customers, companies
could easily shift among them and operational
effectiveness would determine performance.
III. A Sustainable Strategic Position
Requires Trade-offs
Choosing a unique position, however, is not
enough to guarantee a sustainable advantage.
A valuable position will attract imitation by in-
cumbents, who are likely to copy it in one of
two ways.
First, a competitor can reposition itself to
match the superior performer. J.C. Penney,
for instance, has been repositioning itself
Generic Strategies
,
r-

s
–
x-

r
ic
y.
Ikea and Southwest are both cost-based
focusers, for example, but Ikea’s focus is
based on the needs of a customer group,
and Southwest’s is based on offering a
particular service variety.
The generic strategies framework in-
troduced the need to choose in order
to avoid becoming caught between
what I then described as the inherent
contradictions of different strategies.
Trade-offs between the activities of in-
compatible positions explain those
contradictions. Witness Continental
Lite, which tried and failed to compete
in two ways at once.
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The essence of strategy is
choosing to perform
activities differently than
rivals do.
from a Sears clone to a more upscale, fashion-
oriented, soft-goods retailer. A second and
far more common type of imitation is strad-
dling. The straddler seeks to match the benefits
of a successful position while maintaining its
existing position. It grafts new features, ser-
vices, or technologies onto the activities it
already performs.
For those who argue that competitors can
copy any market position, the airline industry
is a perfect test case. It would seem that nearly
any competitor could imitate any other air-
line’s activities. Any airline can buy the same
planes, lease the gates, and match the menus
and ticketing and baggage handling services
offered by other airlines.
Continental Airlines saw how well South-
west was doing and decided to straddle. While
maintaining its position as a full-service air-
line, Continental also set out to match South-
west on a number of point-to-point routes.
The airline dubbed the new service Conti-
nental Lite. It eliminated meals and first-
class service, increased departure frequency,
lowered fares, and shortened turnaround
time at the gate. Because Continental remained
a full-service airline on other routes, it contin-
ued to use travel agents and its mixed fleet
of planes and to provide baggage checking
and seat assignments.
But a strategic position is not sustainable
unless there are trade-offs with other positions.
Trade-offs occur when activities are incom-
patible. Simply put, a trade-off means that
more of one thing necessitates less of another.
An airline can choose to serve meals—adding
cost and slowing turnaround time at the gate—
or it can choose not to, but it cannot do both
without bearing major inefficiencies.
Trade-offs create the need for choice and
protect against repositioners and straddlers.
Consider Neutrogena soap. Neutrogena Cor-
poration’s variety-based positioning is built on
a “kind to the skin,” residue-free soap formu-
lated for pH balance. With a large detail force
calling on dermatologists, Neutrogena’s mar-
keting strategy looks more like a drug com-
pany’s than a soap maker’s. It advertises in
medical journals, sends direct mail to doctors,
attends medical conferences, and performs re-
search at its own Skincare Institute. To rein-
force its positioning, Neutrogena originally
focused its distribution on drugstores and
avoided price promotions. Neutrogena uses a
slow, more expensive manufacturing process
to mold its fragile soap.
In choosing this position, Neutrogena said
no to the deodorants and skin softeners that
many customers desire in their soap. It gave up
the large-volume potential of selling through
supermarkets and using price promotions. It
sacrificed manufacturing efficiencies to achieve
the soap’s desired attributes. In its original po-
sitioning, Neutrogena made a whole raft of
trade-offs like those, trade-offs that protected
the company from imitators.
Trade-offs arise for three reasons. The first is
inconsistencies in image or reputation. A com-
pany known for delivering one kind of value
may lack credibility and confuse customers—or
even undermine its reputation—if it delivers an-
other kind of value or attempts to deliver two
inconsistent things at the same time. For exam-
ple, Ivory soap, with its position as a basic, inex-
pensive everyday soap, would have a hard time
reshaping its image to match Neutrogena’s pre-
mium “medical” reputation. Efforts to create a
new image typically cost tens or even hundreds
of millions of dollars in a major industry—a
powerful barrier to imitation.
Second, and more important, trade-offs arise
from activities themselves. Different positions
(with their tailored activities) require different
product configurations, different equipment,
different employee behavior, different skills,
and different management systems. Many
trade-offs reflect inflexibilities in machinery,
people, or systems. The more Ikea has config-
ured its activities to lower costs by having its
customers do their own assembly and delivery,
the less able it is to satisfy customers who re-
quire higher levels of service.
However, trade-offs can be even more basic.
In general, value is destroyed if an activity is
overdesigned or underdesigned for its use. For
example, even if a given salesperson were capa-
ble of providing a high level of assistance to
one customer and none to another, the sales-
person’s talent (and some of his or her cost)
would be wasted on the second customer.
Moreover, productivity can improve when vari-
ation of an activity is limited. By providing a
high level of assistance all the time, the sales-
person and the entire sales activity can often
achieve efficiencies of learning and scale.
Finally, trade-offs arise from limits on inter-
nal coordination and control. By clearly choos-
ing to compete in one way and not another,
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Strategic positions can be
based on customers’
needs, customers’
accessibility, or the
variety of a company’s
products or services.
senior management makes organizational
priorities clear. Companies that try to be all
things to all customers, in contrast, risk confu-
sion in the trenches as employees attempt to
make day-to-day operating decisions without a
clear framework.
Positioning trade-offs are pervasive in
competition and essential to strategy. They
create the need for choice and purposefully
limit what a company offers. They deter
straddling or repositioning, because competi-
tors that engage in those approaches under-
mine their strategies and degrade the value
of their existing activities.
Trade-offs ultimately grounded Continental
Lite. The airline lost hundreds of millions of
dollars, and the CEO lost his job. Its planes
were delayed leaving congested hub cities or
slowed at the gate by baggage transfers. Late
flights and cancellations generated a thousand
complaints a day. Continental Lite could not
afford to compete on price and still pay stan-
dard travel-agent commissions, but neither
could it do without agents for its full-service
business. The airline compromised by cutting
commissions for all Continental flights across
the board. Similarly, it could not afford to offer
the same frequent-flier benefits to travelers
paying the much lower ticket prices for Lite
service. It compromised again by lowering the
rewards of Continental’s entire frequent-flier
program. The results: angry travel agents and
full-service customers.
Continental tried to compete in two ways at
once. In trying to be low cost on some routes
and full service on others, Continental paid an
enormous straddling penalty. If there were no
trade-offs between the two positions, Conti-
nental could have succeeded. But the absence
of trade-offs is a dangerous half-truth that
managers must unlearn. Quality is not always
free. Southwest’s convenience, one kind of
high quality, happens to be consistent with low
costs because its frequent departures are facili-
tated by a number of low-cost practices—fast
gate turnarounds and automated ticketing, for
example. However, other dimensions of air-
line quality—an assigned seat, a meal, or bag-
gage transfer—require costs to provide.
In general, false trade-offs between cost and
quality occur primarily when there is redun-
dant or wasted effort, poor control or accuracy,
or weak coordination. Simultaneous improve-
ment of cost and differentiation is possible
only when a company begins far behind the
productivity frontier or when the frontier
shifts outward. At the frontier, where compa-
nies have achieved current best practice, the
trade-off between cost and differentiation is
very real indeed.
After a decade of enjoying productivity ad-
vantages, Honda Motor Company and Toyota
Motor Corporation recently bumped up
against the frontier. In 1995, faced with in-
creasing customer resistance to higher auto-
mobile prices, Honda found that the only way
to produce a less-expensive car was to skimp
on features. In the United States, it replaced
the rear disk brakes on the Civic with lower-
cost drum brakes and used cheaper fabric for
the back seat, hoping customers would not
notice. Toyota tried to sell a version of its best-
selling Corolla in Japan with unpainted
bumpers and cheaper seats. In Toyota’s case,
customers rebelled, and the company quickly
dropped the new model.
For the past decade, as managers have im-
proved operational effectiveness greatly, they
have internalized the idea that eliminating
trade-offs is a good thing. But if there are no
trade-offs companies will never achieve a sus-
tainable advantage. They will have to run
faster and faster just to stay in place.
As we return to the question, What is
strategy? we see that trade-offs add a new di-
mension to the answer. Strategy is making
trade-offs in competing. The essence of strat-
egy is choosing what not to do. Without trade-
offs, there would be no need for choice and
thus no need for strategy. Any good idea
could and would be quickly imitated. Again,
performance would once again depend
wholly on operational effectiveness.
IV. Fit Drives Both Competitive
Advantage and Sustainability
Positioning choices determine not only which
activities a company will perform and how it
will configure individual activities but also
how activities relate to one another. While op-
erational effectiveness is about achieving ex-
cellence in individual activities, or functions,
strategy is about combining activities.
Southwest’s rapid gate turnaround, which
allows frequent departures and greater use of
aircraft, is essential to its high-convenience,
low-cost positioning. But how does Southwest
achieve it? Part of the answer lies in the com-
december 1996 page 12

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harvard business review • november–

Trade-offs are essential
to strategy. They create
the need for choice and
purposefully limit what a
company offers.
pany’s well-paid gate and ground crews, whose
productivity in turnarounds is enhanced by
flexible union rules. But the bigger part of the
answer lies in how Southwest performs other
activities. With no meals, no seat assignment,
and no interline baggage transfers, Southwest
avoids having to perform activities that slow
down other airlines. It selects airports and
routes to avoid congestion that introduces de-
lays. Southwest’s strict limits on the type and
length of routes make standardized aircraft
possible: every aircraft Southwest turns is a
Boeing 737.
What is Southwest’s core competence? Its
key success factors? The correct answer is that
everything matters. Southwest’s strategy in-
volves a whole system of activities, not a col-
lection of parts. Its competitive advantage
comes from the way its activities fit and rein-
force one another.
Fit locks out imitators by creating a chain
that is as strong as its strongest link. As in most
companies with good strategies, Southwest’s
activities complement one another in ways
that create real economic value. One activity’s
cost, for example, is lowered because of the
way other activities are performed. Similarly,
one activity’s value to customers can be en-
hanced by a company’s other activities. That is
the way strategic fit creates competitive advan-
tage and superior profitability.
Types of Fit. The importance of fit among
functional policies is one of the oldest ideas in
strategy. Gradually, however, it has been sup-
planted on the management agenda. Rather
than seeing the company as a whole, manag-
ers have turned to “core” competencies, “criti-
cal” resources, and “key” success factors. In
fact, fit is a far more central component of
competitive advantage than most realize.
Fit is important because discrete activities
often affect one another. A sophisticated sales
force, for example, confers a greater advan-
tage when the company’s product embodies
premium technology and its marketing ap-
proach emphasizes customer assistance and
support. A production line with high levels of
model variety is more valuable when com-
bined with an inventory and order processing
system that minimizes the need for stocking
finished goods, a sales process equipped to ex-
plain and encourage customization, and an
advertising theme that stresses the benefits of
product variations that meet a customer’s
special needs. Such complementarities are
pervasive in strategy. Although some fit
among activities is generic and applies to
many companies, the most valuable fit is
strategy-specific because it enhances a posi-
tion’s uniqueness and amplifies trade-offs.2
There are three types of fit, although they
are not mutually exclusive. First-order fit is
simple consistency between each activity (func-
tion) and the overall strategy. Vanguard, for
example, aligns all activities with its low-cost
strategy. It minimizes portfolio turnover and
does not need highly compensated money
managers. The company distributes its funds
directly, avoiding commissions to brokers. It
also limits advertising, relying instead on pub-
lic relations and word-of-mouth recommenda-
tions. Vanguard ties its employees’ bonuses to
cost savings.
Consistency ensures that the competitive ad-
vantages of activities cumulate and do not
erode or cancel themselves out. It makes the
strategy easier to communicate to customers,
employees, and shareholders, and improves
implementation through single-mindedness in
the corporation.
Second-order fit occurs when activities are
reinforcing. Neutrogena, for example, mar-
kets to upscale hotels eager to offer their
guests a soap recommended by dermatolo-
gists. Hotels grant Neutrogena the privilege
of using its customary packaging while requir-
ing other soaps to feature the hotel’s name.
Once guests have tried Neutrogena in a lux-
ury hotel, they are more likely to purchase it
at the drugstore or ask their doctor about it.
Thus Neutrogena’s medical and hotel market-
ing activities reinforce one another, lowering
total marketing costs.
In another example, Bic Corporation sells a
narrow line of standard, low-priced pens to vir-
tually all major customer markets (retail, com-
mercial, promotional, and giveaway) through
virtually all available channels. As with any
variety-based positioning serving a broad
group of customers, Bic emphasizes a common
need (low price for an acceptable pen) and
uses marketing approaches with a broad reach
(a large sales force and heavy television adver-
tising). Bic gains the benefits of consistency
across nearly all activities, including product
design that emphasizes ease of manufacturing,
plants configured for low cost, aggressive
purchasing to minimize material costs, and
december 1996 page 13

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Explanatory
catalogues,
informative
displays and
labels
Se
by
Ease of
transport and
assembly
Se
by
“Knock-down”
kit packaging
Wide variety
with ease of
manufacturing
Mapping Act
Activity-system maps, such
company’s strategic positio
activities designed to delive
in-house parts production whenever the
economics dictate.
Yet Bic goes beyond simple consistency be-
cause its activities are reinforcing. For example,
the company uses point-of-sale displays and
frequent packaging changes to stimulate im-
pulse buying. To handle point-of-sale tasks, a
company needs a large sales force. Bic’s is the
largest in its industry, and it handles point-of-
sale activities better than its rivals do. More-
over, the combination of point-of-sale activity,
heavy television advertising, and packaging
changes yields far more impulse buying than
any activity in isolation could.
Third-order fit goes beyond activity rein-
forcement to what I call optimization of effort.
The Gap, a retailer of casual clothes, considers
product availability in its stores a critical ele-
ment of its strategy. The Gap could keep prod-
ucts either by holding store inventory or by re-
stocking from warehouses. The Gap has
optimized its effort across these activities by
restocking its selection of basic clothing almost
daily out of three warehouses, thereby mini-
mizing the need to carry large in-store invento-
ries. The emphasis is on restocking because the
Gap’s merchandising strategy sticks to basic
items in relatively few colors. While compara-
ble retailers achieve turns of three to four
times per year, the Gap turns its inventory
seven and a half times per year. Rapid restock-
ing, moreover, reduces the cost of implement-
ing the Gap’s short model cycle, which is six to
eight weeks long.3
Coordination and information exchange
across activities to eliminate redundancy and
minimize wasted effort are the most basic
types of effort optimization. But there are
lf-transport
customers
Limited
customer
service
Self-selection
by customers
Modular
furniture
design
Low
manufacturing
cost
Suburban
locations
with ample
parking
High-traffic
store layout More
impulse
buying
lf-assembly
customers
Limited sales
staffing
Increased
likelihood of
future
purchase
In-house
design focused
on cost of
manufacturing
Ample
inventory
on site
Most
items in
inventory
Year-round
stocking
100%
sourcing from
long-term
suppliers
ivity Systems
as this one for Ikea, show how a
n is contained in a set of tailored
r it. In companies with a clear
strategic position, a number of higher-order strategic themes (in
dark grey) can be identified and implemented through clusters of
tightly linked activities (in light grey).
december 1996 page 14

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harvard business review • november–

Very
expe
passed
clie
Dir
distrib
Employee
bonuses
tied to
cost savings
No
broker-dealer
relationships
No
commissions
to brokers or
distributors
Vanguard’s A
Activity-system maps can b
strengthening strategic fit. A
guide the process. First, is
overall positioning – the va
and the type of customers a
higher levels as well. Product design choices,
for example, can eliminate the need for after-
sale service or make it possible for customers
to perform service activities themselves. Simi-
larly, coordination with suppliers or distribu-
tion channels can eliminate the need for some
in-house activities, such as end-user training.
In all three types of fit, the whole matters
more than any individual part. Competitive ad-
vantage grows out of the entire system of activi-
ties. The fit among activities substantially re-
duces cost or increases differentiation. Beyond
that, the competitive value of individual activi-
ties—or the associated skills, competencies, or
resources—cannot be decoupled from the sys-
tem or the strategy. Thus in competitive com-
panies it can be misleading to explain success
by specifying individual strengths, core compe-
tencies, or critical resources. The list of
strengths cuts across many functions, and one
strength blends into others. It is more useful to
think in terms of themes that pervade many
activities, such as low cost, a particular notion
of customer service, or a particular conception
of the value delivered. These themes are em-
bodied in nests of tightly linked activities.
Fit and sustainability. Strategic fit among
many activities is fundamental not only to
competitive advantage but also to the sus-
tainability of that advantage. It is harder for
a rival to match an array of interlocked ac-
tivities than it is merely to imitate a particu-
lar sales-force approach, match a process
technology, or replicate a set of product fea-
tures. Positions built on systems of activities
are far more sustainable than those built on
individual activities.
Consider this simple exercise. The probabil-
Wary of
small growth
funds
low
nses
on to
nt
A broad array
of mutual funds
excluding some
fund categories
Strict cost
control
Efficient investment
management approach
offering good, consistent
performance
ect
ution
Straightforward
client communication
and education
Limited
international
funds due to
volatility and
high costs
Use of
redemption
fees to
discourage
trading
No marketing
changes
No-loads
Only three
retail
locations
In-house
management
for standard
funds
Limited
advertising
budget
Very low rate
of trading
No first-class
travel for
executives
Emphasis
on bonds
and equity
index funds
On-line
information
access
Shareholder
education
cautioning
about risk
Long-term
investment
encouraged
Vanguard
actively
spreads its
philosophy
Reliance
on word
of mouth
ctivity System
e useful for examining and
set of basic questions should
each activity consistent with the
rieties produced, the needs served,
ccessed? Ask those responsible for
each activity to identify how other activities within the company
improve or detract from their performance. Second, are there
ways to strengthen how activities and groups of activities
reinforce one another? Finally, could changes in one activity
eliminate the need to perform others?
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No
assig
Le
p
g
g
Frequent,
reliable
departures
Flexible
union
contracts
High
compensation
of employees
Southwest A
ity that competitors can match any activity is
often less than one. The probabilities then
quickly compound to make matching the en-
tire system highly unlikely (.9 x .9 = .81; .9 x .9 x
.9 x .9 = .66, and so on). Existing companies
that try to reposition or straddle will be forced
to reconfigure many activities. And even new
entrants, though they do not confront the
trade-offs facing established rivals, still face for-
midable barriers to imitation.
The more a company’s positioning rests on
activity systems with second- and third-order
fit, the more sustainable its advantage will be.
Such systems, by their very nature, are usually
difficult to untangle from outside the com-
pany and therefore hard to imitate. And even
if rivals can identify the relevant interconnec-
tions, they will have difficulty replicating
them. Achieving fit is difficult because it re-
quires the integration of decisions and actions
across many independent subunits.
A competitor seeking to match an activity
system gains little by imitating only some
activities and not matching the whole. Per-
formance does not improve; it can decline.
Recall Continental Lite’s disastrous attempt
to imitate Southwest.
Finally, fit among a company’s activities cre-
ates pressures and incentives to improve opera-
tional effectiveness, which makes imitation
even harder. Fit means that poor performance
in one activity will degrade the performance in
others, so that weaknesses are exposed and
more prone to get attention. Conversely, im-
provements in one activity will pay dividends
in others. Companies with strong fit among
their activities are rarely inviting targets. Their
superiority in strategy and in execution only
No meals
seat
nments
Limited
passenger
service
an, highly
roductive
round and
ate crews
Very low
ticket prices
Short-haul,
point-to-point
routes between
midsize cities
and secondary
airports
High
aircraft
utilization
No baggage
transfers
No
connections
with other
airlines
15-minute
gate
turnarounds
High level
of employee
stock
ownership
Limited use
of travel
agents
Automatic
ticketing
machines
Standardized
fleet of 737
aircraft
”Southwest,
the low-fare
airline”
irlines’ Activity System
december 1996 page 16

What Is Strategy?

harvard business review • november–

Alternative Views of

The Implicit Strategy Model of the
Past Decade
•

One ideal competitive position in
the industry

•

Benchmarking of all activities and
achieving best practice

•

Aggressive outsourcing and part-
nering to gain efficiencies

•

Advantages rest on a few key suc-
cess factors, critical resources, core
competencies

•

Flexibility and rapid responses to a
competitive and market changes

compounds their advantages and raises the
hurdle for imitators.
When activities complement one another, ri-
vals will get little benefit from imitation unless
they successfully match the whole system.
Such situations tend to promote winner-take-
all competition. The company that builds the
best activity system—Toys R Us, for instance—
wins, while rivals with similar strategies—
Child World and Lionel Leisure—fall behind.
Thus finding a new strategic position is often
preferable to being the second or third imita-
tor of an occupied position.
The most viable positions are those whose
activity systems are incompatible because of
tradeoffs. Strategic positioning sets the trade-
off rules that define how individual activities
will be configured and integrated. Seeing strat-
egy in terms of activity systems only makes it
clearer why organizational structure, systems,
and processes need to be strategy-specific.
Tailoring organization to strategy, in turn,
makes complementarities more achievable and
contributes to sustainability.
One implication is that strategic positions
should have a horizon of a decade or more,
not of a single planning cycle. Continuity fos-
ters improvements in individual activities
and the fit across activities, allowing an orga-
nization to build unique capabilities and
skills tailored to its strategy. Continuity also
reinforces a company’s identity.
Conversely, frequent shifts in positioning
are costly. Not only must a company reconfig-
ure individual activities, but it must also re-
align entire systems. Some activities may
never catch up to the vacillating strategy. The
inevitable result of frequent shifts in strategy,
or of failure to choose a distinct position in
the first place, is “me-too” or hedged activity
configurations, inconsistencies across func-
tions, and organizational dissonance.
What is strategy? We can now complete the
answer to this question. Strategy is creating fit
among a company’s activities. The success of a
strategy depends on doing many things well—
not just a few—and integrating among them.
If there is no fit among activities, there is no
distinctive strategy and little sustainability.
Management reverts to the simpler task of
overseeing independent functions, and opera-
tional effectiveness determines an organiza-
tion’s relative performance.
V. Rediscovering Strategy
The Failure to Choose. Why do so many com-
panies fail to have a strategy? Why do manag-
ers avoid making strategic choices? Or, having
made them in the past, why do managers so
often let strategies decay and blur?
Commonly, the threats to strategy are seen
to emanate from outside a company because
of changes in technology or the behavior of
competitors. Although external changes can be
the problem, the greater threat to strategy
often comes from within. A sound strategy is
undermined by a misguided view of competi-
tion, by organizational failures, and, especially,
by the desire to grow.
Managers have become confused about the
necessity of making choices. When many com-
panies operate far from the productivity fron-
tier, trade-offs appear unnecessary. It can seem
that a well-run company should be able to beat
its ineffective rivals on all dimensions simulta-
neously. Taught by popular management
thinkers that they do not have to make trade-
offs, managers have acquired a macho sense
that to do so is a sign of weakness.
Unnerved by forecasts of hypercompetition,
managers increase its likelihood by imitating
everything about their competitors. Exhorted
to think in terms of revolution, managers
chase every new technology for its own sake.
The pursuit of operational effectiveness is
seductive because it is concrete and actionable.
Over the past decade, managers have been
under increasing pressure to deliver tangible,
measurable performance improvements. Pro-
grams in operational effectiveness produce re-
Strategy

ll
Sustainable Competitive Advantage
• Unique competitive position for the
company
• Activities tailored to strategy
• Clear trade-offs and choices vis-à-vis
competitors
• Competitive advantage arises from
fit across activities
• Sustainability comes from the ac-
tivity system, not the parts
• Operational effectiveness a
given
december 1996 page 17

What Is Strategy?

harvard business review • november–

Reconnecting with S

Most companies owe their initial succ
a unique strategic position involving
trade-offs. Activities once were aligne
that position. The passage of time and
pressures of growth, however, led to c
promises that were, at first, almost im
ceptible. Through a succession of incr
tal changes that each seemed sensible
time, many established companies ha
compromised their way to homogene
with their rivals.
The issue here is not with the comp
whose historical position is no longer
their challenge is to start over, just a
new entrant would. At issue is a far m
common phenomenon: the establish
company achieving mediocre returns
lacking a clear strategy. Through incre
tal additions of product varieties, incr
tal efforts to serve new customer gro
and emulation of rivals’ activities, the
ing company loses its clear competi
position. Typically, the company has

assuring progress, although superior profitabil-
ity may remain elusive. Business publications
and consultants flood the market with infor-
mation about what other companies are doing,
reinforcing the best-practice mentality. Caught
up in the race for operational effectiveness,
many managers simply do not understand the
need to have a strategy.
Companies avoid or blur strategic choices for
other reasons as well. Conventional wisdom
within an industry is often strong, homogeniz-
ing competition. Some managers mistake “cus-
tomer focus” to mean they must serve all cus-
tomer needs or respond to every request from
distribution channels. Others cite the desire to
preserve flexibility.
Organizational realities also work against
strategy. Trade-offs are frightening, and mak-
ing no choice is sometimes preferred to risk-
ing blame for a bad choice. Companies imitate
one another in a type of herd behavior, each
assuming rivals know something they do not.
Newly empowered employees, who are urged
to seek every possible source of improve-
ment, often lack a vision of the whole and
the perspective to recognize trade-offs. The
failure to choose sometimes comes down to
the reluctance to disappoint valued managers
or employees.
The Growth Trap. Among all other influ-
ences, the desire to grow has perhaps the
most perverse effect on strategy. Trade-offs
and limits appear to constrain growth. Serv-
ing one group of customers and excluding
others, for instance, places a real or imag-
ined limit on revenue growth. Broadly tar-
geted strategies emphasizing low price result
in lost sales with customers sensitive to fea-
tures or service. Differentiators lose sales to
price-sensitive customers.
Managers are constantly tempted to take in-
cremental steps that surpass those limits but
blur a company’s strategic position. Eventually,
pressures to grow or apparent saturation of the
target market lead managers to broaden the
position by extending product lines, adding
new features, imitating competitors’ popular
services, matching processes, and even making
acquisitions. For years, Maytag Corporation’s
success was based on its focus on reliable, dura-
ble washers and dryers, later extended to include
dishwashers. However, conventional wisdom
emerging within the industry supported the
notion of selling a full line of products. Con-
trategy
ess to
clear
d with
the
om-
per-
emen-
at the
ve
ity
anies
viable;
s a
ore
ed
and
men-
emen-
ups,
exist-
tive
matched many of its competitors’ offerings
and practices and attempts to sell to most
customer groups.
A number of approaches can help a com-
pany reconnect with strategy. The first is a
careful look at what it already does. Within
most well-established companies is a core of
uniqueness. It is identified by answering
questions such as the following:
• Which of our product or service variet-
ies are the most distinctive?
• Which of our product or service variet-
ies are the most profitable?
• Which of our customers are the most
satisfied?
• Which customers, channels, or purchase
occasions are the most profitable?
• Which of the activities in our value chain
are the most different and effective?
Around this core of uniqueness are en-
crustations added incrementally over time.
Like barnacles, they must be removed to re-
veal the underlying strategic positioning. A
small percentage of varieties or customers
may well account for most of a company’s
sales and especially its profits. The chal-
lenge, then, is to refocus on the unique
core and realign the company’s activities
with it. Customers and product varieties at
the periphery can be sold or allowed
through inattention or price increases to
fade away.
A company’s history can also be instruc-
tive. What was the vision of the founder?
What were the products and customers that
made the company? Looking backward, one
can reexamine the original strategy to see if
it is still valid. Can the historical positioning
be implemented in a modern way, one con-
sistent with today’s technologies and prac-
tices? This sort of thinking may lead to a
commitment to renew the strategy and may
challenge the organization to recover its dis-
tinctiveness. Such a challenge can be galva-
nizing and can instill the confidence to
make the needed trade-offs.
december 1996 page 18

What Is Strategy?

harvard business review • november–

Emerging Industries

Developing a strategy in a newly
emerging industry or in a business un
dergoing revolutionary technological
changes is a daunting proposition. In
such cases, managers face a high leve
of uncertainty about the needs of cus
tomers, the products and services tha
will prove to be the most desired, and
the best configuration of activities an
technologies to deliver them. Because
of all this uncertainty, imitation and
hedging are rampant: unable to risk
being wrong or left behind, companie
match all features, offer all new ser-
vices, and explore all technologies.
During such periods in an industry’s
development, its basic productivity fron
tier is being established or reestablishe
Explosive growth can make such times
profitable for many companies, but pro
its will be temporary because imitation
and strategic convergence will ultimate
destroy industry profitability. The comp
nies that are enduringly successful will b
those that begin as early as possible to
define and embody in their activities a
cerned with slow industry growth and competi-
tion from broad-line appliance makers, Maytag
was pressured by dealers and encouraged by
customers to extend its line. Maytag expanded
into refrigerators and cooking products under
the Maytag brand and acquired other brands—
Jenn-Air, Hardwick Stove, Hoover, Admiral,
and Magic Chef—with disparate positions.
Maytag has grown substantially from $684 mil-
lion in 1985 to a peak of $3.4 billion in 1994,
but return on sales has declined from 8% to
12% in the 1970s and 1980s to an average of
less than 1% between 1989 and 1995. Cost
cutting will improve this performance, but
laundry and dishwasher products still anchor
Maytag’s profitability.
Neutrogena may have fallen into the same
trap. In the early 1990s, its U.S. distribution
broadened to include mass merchandisers
such as Wal-Mart Stores. Under the Neutro-
gena name, the company expanded into a wide
variety of products—eye-makeup remover and
shampoo, for example—in which it was not
unique and which diluted its image, and it
began turning to price promotions.
Compromises and inconsistencies in the pur-
suit of growth will erode the competitive advan-
tage a company had with its original varieties
or target customers. Attempts to compete in
several ways at once create confusion and un-
dermine organizational motivation and focus.
Profits fall, but more revenue is seen as the an-
swer. Managers are unable to make choices, so
the company embarks on a new round of broad-
ening and compromises. Often, rivals continue
to match each other until desperation breaks
the cycle, resulting in a merger or downsizing
to the original positioning.
Profitable Growth. Many companies, after a
decade of restructuring and cost-cutting, are
turning their attention to growth. Too often,
efforts to grow blur uniqueness, create com-
promises, reduce fit, and ultimately undermine
competitive advantage. In fact, the growth im-
perative is hazardous to strategy.
What approaches to growth preserve and re-
inforce strategy? Broadly, the prescription is to
concentrate on deepening a strategic position
rather than broadening and compromising it.
One approach is to look for extensions of the
strategy that leverage the existing activity sys-
tem by offering features or services that rivals
would find impossible or costly to match on a
stand-alone basis. In other words, managers
can ask themselves which activities, features,
or forms of competition are feasible or less
costly to them because of complementary ac-
tivities that their company performs.
Deepening a position involves making the
company’s activities more distinctive, strength-
ening fit, and communicating the strategy better
to those customers who should value it. But
many companies succumb to the temptation to
chase “easy” growth by adding hot features,
products, or services without screening them or
adapting them to their strategy. Or they target
new customers or markets in which the com-
pany has little special to offer. A company can
often grow faster—and far more profitably—by
better penetrating needs and varieties where it is
distinctive than by slugging it out in potentially
higher growth arenas in which the company
lacks uniqueness. Carmike, now the largest the-
ater chain in the United States, owes its rapid
growth to its disciplined concentration on small
markets. The company quickly sells any big-city
theaters that come to it as part of an acquisition.
and Technologies
–

l
–
t

d

s

–
d.
f-

ly
a-
e
unique competitive position. A period of
imitation may be inevitable in emerging
industries, but that period reflects the
level of uncertainty rather than a desired
state of affairs.
In high-tech industries, this imitation
phase often continues much longer
than it should. Enraptured by techno-
logical change itself, companies pack
more features—most of which are
never used—into their products while
slashing prices across the board. Rarely
are trade-offs even considered. The
drive for growth to satisfy market pres-
sures leads companies into every prod-
uct area. Although a few companies
with fundamental advantages prosper,
the majority are doomed to a rat race
no one can win.
Ironically, the popular business
press, focused on hot, emerging indus-
tries, is prone to presenting these spe-
cial cases as proof that we have entered
a new era of competition in which
none of the old rules are valid. In fact,
the opposite is true.
december 1996 page 19

What Is Strategy?

harvard business review • november–

Globalization often allows growth that is
consistent with strategy, opening up larger
markets for a focused strategy. Unlike broad-
ening domestically, expanding globally is
likely to leverage and reinforce a company’s
unique position and identity.
Companies seeking growth through broad-
ening within their industry can best contain
the risks to strategy by creating stand-alone
units, each with its own brand name and tai-
lored activities. Maytag has clearly struggled
with this issue. On the one hand, it has orga-
nized its premium and value brands into sepa-
rate units with different strategic positions. On
the other, it has created an umbrella appliance
company for all its brands to gain critical mass.
With shared design, manufacturing, distribu-
tion, and customer service, it will be hard to
avoid homogenization. If a given business unit
attempts to compete with different positions
for different products or customers, avoiding
compromise is nearly impossible.
The Role of Leadership. The challenge of de-
veloping or reestablishing a clear strategy is
often primarily an organizational one and de-
pends on leadership. With so many forces at
work against making choices and tradeoffs in
organizations, a clear intellectual framework
to guide strategy is a necessary counterweight.
Moreover, strong leaders willing to make
choices are essential.
In many companies, leadership has degen-
erated into orchestrating operational improve-
ments and making deals. But the leader’s role
is broader and far more important. General
management is more than the stewardship of
individual functions. Its core is strategy: defining
and communicating the company’s unique
position, making trade-offs, and forging fit
among activities. The leader must provide the
discipline to decide which industry changes
and customer needs the company will re-
spond to, while avoiding organizational dis-
tractions and maintaining the company’s
distinctiveness. Managers at lower levels lack
the perspective and the confidence to main-
tain a strategy. There will be constant pres-
sures to compromise, relax trade-offs, and
emulate rivals. One of the leader’s jobs is to
teach others in the organization about
strategy—and to say no.
Strategy renders choices about what not to
do as important as choices about what to do.
Indeed, setting limits is another function of
leadership. Deciding which target group of cus-
tomers, varieties, and needs the company
should serve is fundamental to developing a
strategy. But so is deciding not to serve other
customers or needs and not to offer certain
features or services. Thus strategy requires
constant discipline and clear communication.
Indeed, one of the most important functions
of an explicit, communicated strategy is to
guide employees in making choices that arise
because of trade-offs in their individual activi-
ties and in day-to-day decisions.
Improving operational effectiveness is a nec-
essary part of management, but it is not strategy.
In confusing the two, managers have uninten-
tionally backed into a way of thinking about
competition that is driving many industries to-
ward competitive convergence, which is in no
one’s best interest and is not inevitable.
Managers must clearly distinguish opera-
tional effectiveness from strategy. Both are es-
sential, but the two agendas are different.
The operational agenda involves continual
improvement everywhere there are no trade-
offs. Failure to do this creates vulnerability
even for companies with a good strategy. The
operational agenda is the proper place for con-
stant change, flexibility, and relentless efforts
to achieve best practice. In contrast, the strate-
gic agenda is the right place for defining a
unique position, making clear trade-offs, and
tightening fit. It involves the continual search
for ways to reinforce and extend the com-
pany’s position. The strategic agenda demands
discipline and continuity; its enemies are
distraction and compromise.
Strategic continuity does not imply a static
view of competition. A company must continu-
ally improve its operational effectiveness and
actively try to shift the productivity frontier; at
the same time, there needs to be ongoing ef-
fort to extend its uniqueness while strengthen-
ing the fit among its activities. Strategic conti-
nuity, in fact, should make an organization’s
continual improvement more effective.
A company may have to change its strategy
if there are major structural changes in its in-
dustry. In fact, new strategic positions often
arise because of industry changes, and new
entrants unencumbered by history often can
exploit them more easily. However, a com-
pany’s choice of a new position must be
driven by the ability to find new trade-offs
and leverage a new system of complemen-
december 1996 page 20

What Is Strategy?

harvard business review • november–

tary activities into a sustainable advantage.
1. I first described the concept of activities and its
use in understanding competitive advantage in
Competitive Advantage (New York: The Free
Press, 1985). The ideas in this article build on
and extend that thinking.
2. Paul Milgrom and John Roberts have begun
to explore the economics of systems of comple-
mentary functions, activities, and functions.
Their focus is on the emergence of “modern
manufacturing” as a new set of complemen-
tary activities, on the tendency of companies
to react to external changes with coherent
bundles of internal responses, and on the
need for central coordination—a strategy—to
align functional managers. In the latter case,
they model what has long been a bedrock princi-
ple of strategy. See Paul Milgrom and John Rob-
erts, “The Economics of Modern Manufactur-
ing: Technology, Strategy, and Organization,”
American Economic Review 80 (1990): 511–528;
Paul Milgrom, Yingyi Qian, and John Roberts,
“Complementarities, Momentum, and Evolu-
tion of Modern Manufacturing,” American
Economic Review 81 (1991) 84–88; and Paul
Milgrom and John Roberts, “Complementari-
ties and Fit: Strategy, Structure, and Organi-
zational Changes in Manufacturing,” Journal
of Accounting and Economics, vol. 19
(March–May 1995): 179–208.
3. Material on retail strategies is drawn in part
from Jan Rivkin, “The Rise of Retail Category
Killers,” unpublished working paper, January
1995. Nicolaj Siggelkow prepared the case study
on the Gap.
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Further Reading

A R T I C L E S
Clusters and the New Economics of
Competition
by Michael E. Porter
Harvard Business Review
November–December 1998
Product no. 98609
This article focuses on operational effective-
ness and the conditions that create it. In the-
ory, location should no longer be a source of
competitive advantage. Open global markets,
rapid transportation, and high-speed com-
munications should allow any company to
source any thing from any place at any time.
In practice, location remains central to com-
petition. This is true because companies in a
particular field, along with suppliers and other
related businesses, cluster in geographic con-
centrations where virtually all the important
information and technology in the field is
readily available.
How Competitive Forces Shape Strategy
by Michael E. Porter
Harvard Business Review
March–April 1979
Product no. 79208
In this McKinsey Award–winning article, Porter
discusses factors that determine the nature of
competition. Among them: rivals, the eco-
nomics of particular industries, new entrants,
the bargaining power of customers and sup-
pliers, and the threat of substitute services or
products. A strategic plan of action based on
such factors might include: positioning the
company so that its capabilities provide the
best defense against competitive forces, influ-
encing the balance of forces through strategic
moves, and anticipating shifts in the factors
underlying the competitive forces. Strategic
positioning requires looking both within the
company and at external factors when mak-
ing these decisions; in some cases, it means
choosing what not to do.
From Competitive Advantage to
Corporate Strategy
by Michael E. Porter
Harvard Business Review
May–June 1987
Product no. 87307
Despite some startling success stories,
diversification—whether through acquisi-
tion, joint venture, or start-up—has not typ-
ically brought the competitive advantages
or the profitability sought by executives.
Successful diversification strategies rely on
transferring skills and sharing activities to
capture the benefits of existing relation-
ships among business units. Therefore, cor-
porate leaders must examine closely any
acquisition candidate’s “fit” with the parent
company’s existing businesses.
B O O K
On Competition
by Michael E. Porter
Harvard Business School Press
1998
Product no. 7951
In this collection of articles on competition,
Porter addresses the core concepts of compe-
tition and strategy, the role of location in com-
petition, and the interrelation of competition
and social progress. Important business activi-
ties such as staking out and maintaining a dis-
tinctive competitive position in order to profit
and grow, and the continual improvement of
productivity in order to achieve prosperity, are
all intimately related to strategic positioning.
page 22

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The Five Competitive
Forces That Shape
Strategy

by Michael E. Porter

Included with this full-text

Harvard Business Review

article:
The Idea in Brief—the core idea
The Idea in Practice—putting the idea to work

24

Article Summary

25

The Five Competitive Forces That Shape Strategy
A list of related materials, with annotations to guide further
exploration of the article’s ideas and applications

41

Further Reading

Awareness of the five forces
can help a company
understand the structure of its
industry and stake out a
position that is more
profitable and less vulnerable
to attack.

Reprint R0801E
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The Five Competitive Forces That Shape
Strategy

The Idea in Brief The Idea in Practice

C
O
P
YR
IG
H
T
©
2
00
8
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A
R
V
A
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O
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B
LI
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IN
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O
R
A
T
IO
N
. A
LL
R
IG
H
T
S
R
E
SE
R
V
E
D
.

You know that to sustain long-term profit-
ability you must respond strategically to
competition. And you naturally keep tabs
on your

established rivals

. But as you scan
the competitive arena, are you also looking

beyond

your direct competitors? As Porter
explains in this update of his revolutionary
1979 HBR article, four additional competi-
tive forces can hurt your prospective profits:

•

Savvy

customers

can force down prices
by playing you and your rivals against
one another.

•

Powerful

suppliers

may constrain your
profits if they charge higher prices.

•

Aspiring

entrants

, armed with new ca-
pacity and hungry for market share, can
ratchet up the investment required for
you to stay in the game.

•

Substitute offerings

can lure customers
away.
Consider commercial aviation: It’s one of
the least profitable industries because all
five forces are strong.

Established rivals

compete intensely on price.

Customers

are
fickle, searching for the best deal regardless
of carrier.

Suppliers

—plane and engine
manufacturers, along with unionized labor
forces—bargain away the lion’s share of air-
lines’ profits.

New players

enter the indus-
try in a constant stream. And

substitutes

are readily available—such as train or car
travel.
By analyzing all five competitive forces, you
gain a complete picture of what’s influenc-
ing profitability in your industry. You iden-
tify game-changing trends early, so you can
swiftly exploit them. And you spot ways to
work around constraints on profitability—
or even reshape the forces in your favor.
By understanding how the five competitive forces influence profitability in your industry, you can
develop a strategy for enhancing your company’s long-term profits. Porter suggests the following:

POSITION YOUR COMPANY W HERE THE
FORCES ARE WEAKEST
Example:

In the heavy-truck industry, many buyers
operate large fleets and are highly moti-
vated to drive down truck prices. Trucks are
built to regulated standards and offer simi-
lar features, so price competition is stiff;
unions exercise considerable supplier
power; and buyers can use substitutes such
as cargo delivery by rail.
To create and sustain long-term profitability
within this industry, heavy-truck maker Pac-
car chose to focus on one customer group
where competitive forces are weakest: indi-
vidual drivers who own their trucks and
contract directly with suppliers. These oper-
ators have limited clout as buyers and are
less price sensitive because of their emo-
tional ties to and economic dependence
on their own trucks.
For these customers, Paccar has developed
such features as luxurious sleeper cabins,
plush leather seats, and sleek exterior styl-
ing. Buyers can select from thousands of
options to put their personal signature on
these built-to-order trucks.
Customers pay Paccar a 10% premium, and
the company has been profitable for 68
straight years and earned a long-run return
on equity above 20%.

EXPLOIT CHANGES IN THE FORCES
Example:

With the advent of the Internet and digital
distribution of music, unauthorized down-
loading created an illegal but potent substi-
tute for record companies’ services. The
record companies tried to develop technical
platforms for digital distribution themselves,
but major labels didn’t want to sell their
music through a platform owned by a rival.
Into this vacuum stepped Apple, with its
iTunes music store supporting its iPod music
player. The birth of this powerful new gate-
keeper has whittled down the number of
major labels from six in 1997 to four today.

RESHAPE THE FORCES IN YOUR FAVOR

Use tactics designed specifically to reduce
the share of profits leaking to other players.
For example:

•

To neutralize

supplier power

, standardize
specifications for parts so your company
can switch more easily among vendors.

•

To counter

customer power

, expand your
services so it’s harder for customers to leave
you for a rival.

•

To temper price wars initiated by

estab-
lished rivals

, invest more heavily in prod-
ucts that differ significantly from competi-
tors’ offerings.

•

To scare off

new entrants

, elevate the fixed
costs of competing; for instance, by escalat-
ing your R&D expenditures.

•

To limit the threat of

substitutes

, offer bet-
ter value through wider product accessibil-
ity. Soft-drink producers did this by intro-
ducing vending machines and
convenience store channels, which dramat-
ically improved the availability of soft drinks
relative to other beverages.
page 24

The Five Competitive
Forces That Shape
Strategy

by Michael E. Porter

harvard business review • january 2008

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Awareness of the five forces can help a company understand the
structure of its industry and stake out a position that is more profitable
and less vulnerable to attack.

Editor’s Note:

In 1979,

Harvard Business Review

published “How Competitive Forces Shape Strat-
egy” by a young economist and associate profes-
sor, Michael E. Porter. It was his first HBR article,
and it started a revolution in the strategy field. In
subsequent decades, Porter has brought his sig-
nature economic rigor to the study of competi-
tive strategy for corporations, regions, nations,
and, more recently, health care and philanthropy.
“Porter’s five forces” have shaped a generation of
academic research and business practice. With
prodding and assistance from Harvard Business
School Professor Jan Rivkin and longtime col-
league Joan Magretta, Porter here reaffirms, up-
dates, and extends the classic work. He also ad-
dresses common misunderstandings, provides
practical guidance for users of the framework,
and offers a deeper view of its implications for
strategy today.

In essence, the job of the strategist is to under-
stand and cope with competition. Often, how-
ever, managers define competition too nar-
rowly, as if it occurred only among today’s
direct competitors. Yet competition for profits
goes beyond established industry rivals to in-
clude four other competitive forces as well:
customers, suppliers, potential entrants, and
substitute products. The extended rivalry that
results from all five forces defines an industry’s
structure and shapes the nature of competi-
tive interaction within an industry.
As different from one another as industries
might appear on the surface, the underlying
drivers of profitability are the same. The glo-
bal auto industry, for instance, appears to
have nothing in common with the worldwide
market for art masterpieces or the heavily
regulated health-care delivery industry in Eu-
rope. But to understand industry competition
and profitability in each of those three cases,
one must analyze the industry’s underlying
structure in terms of the five forces. (See the
exhibit “The Five Forces That Shape Industry
Competition.”)
If the forces are intense, as they are in such
industries as airlines, textiles, and hotels, al-
most no company earns attractive returns on
page 25

The Five Competitive Forces That Shape Strategy

harvard business review • january 2008

investment. If the forces are benign, as they are
in industries such as software, soft drinks, and
toiletries, many companies are profitable. In-
dustry structure drives competition and profit-
ability, not whether an industry produces a
product or service, is emerging or mature, high
tech or low tech, regulated or unregulated.
While a myriad of factors can affect industry
profitability in the short run—including the
weather and the business cycle—industry
structure, manifested in the competitive forces,
sets industry profitability in the medium and
long run. (See the exhibit “Differences in In-
dustry Profitability.”)
Understanding the competitive forces, and
their underlying causes, reveals the roots of an
industry’s current profitability while providing
a framework for anticipating and influencing
competition (and profitability) over time. A
healthy industry structure should be as much a
competitive concern to strategists as their com-
pany’s own position. Understanding industry
structure is also essential to effective strategic
positioning. As we will see, defending against
the competitive forces and shaping them in a
company’s favor are crucial to strategy.

Forces That Shape Competition

The configuration of the five forces differs by
industry. In the market for commercial air-
craft, fierce rivalry between dominant produc-
ers Airbus and Boeing and the bargaining
power of the airlines that place huge orders
for aircraft are strong, while the threat of en-
try, the threat of substitutes, and the power of
suppliers are more benign. In the movie the-
ater industry, the proliferation of substitute
forms of entertainment and the power of the
movie producers and distributors who supply
movies, the critical input, are important.
The strongest competitive force or forces de-
termine the profitability of an industry and be-
come the most important to strategy formula-
tion. The most salient force, however, is not
always obvious.
For example, even though rivalry is often
fierce in commodity industries, it may not be
the factor limiting profitability. Low returns in
the photographic film industry, for instance,
are the result of a superior substitute prod-
uct—as Kodak and Fuji, the world’s leading
producers of photographic film, learned with
the advent of digital photography. In such a sit-
uation, coping with the substitute product be-
comes the number one strategic priority.
Industry structure grows out of a set of eco-
nomic and technical characteristics that deter-
mine the strength of each competitive force.
We will examine these drivers in the pages that
follow, taking the perspective of an incumbent,
or a company already present in the industry.
The analysis can be readily extended to under-
stand the challenges facing a potential entrant.

Threat of entry.

New entrants to an indus-
try bring new capacity and a desire to gain
market share that puts pressure on prices,
costs, and the rate of investment necessary to
compete. Particularly when new entrants are
diversifying from other markets, they can le-
verage existing capabilities and cash flows to
shake up competition, as Pepsi did when it en-
tered the bottled water industry, Microsoft did
when it began to offer internet browsers, and
Apple did when it entered the music distribu-
tion business.
The threat of entry, therefore, puts a cap on
the profit potential of an industry. When the
threat is high, incumbents must hold down
their prices or boost investment to deter new
competitors. In specialty coffee retailing, for
example, relatively low entry barriers mean
that Starbucks must invest aggressively in
modernizing stores and menus.
The threat of entry in an industry depends
on the height of entry barriers that are present
and on the reaction entrants can expect from
incumbents. If entry barriers are low and new-
comers expect little retaliation from the en-
trenched competitors, the threat of entry is
high and industry profitability is moderated. It
is the

threat

of entry, not whether entry actu-
ally occurs, that holds down profitability.

Barriers to entry.

Entry barriers are advan-
tages that incumbents have relative to new en-
trants. There are seven major sources:
1.

Supply-side economies of scale.

These econ-
omies arise when firms that produce at larger
volumes enjoy lower costs per unit because
they can spread fixed costs over more units,
employ more efficient technology, or com-
mand better terms from suppliers. Supply-
side scale economies deter entry by forcing
the aspiring entrant either to come into the
industry on a large scale, which requires dis-
lodging entrenched competitors, or to accept
a cost disadvantage.
Scale economies can be found in virtually
every activity in the value chain; which ones

Michael E. Porter

is the Bishop Will-
iam Lawrence University Professor at
Harvard University, based at Harvard
Business School in Boston. He is a six-
time McKinsey Award winner, includ-
ing for his most recent HBR article,
“Strategy and Society,” coauthored
with Mark R. Kramer (December 2006).
page 26

The Five Competitive Forces That Shape Strategy

harvard business review • january 2008

are most important varies by industry.

1

In mi-
croprocessors, incumbents such as Intel are
protected by scale economies in research, chip
fabrication, and consumer marketing. For lawn
care companies like Scotts Miracle-Gro, the
most important scale economies are found in
the supply chain and media advertising. In
small-package delivery, economies of scale
arise in national logistical systems and infor-
mation technology.
2.

Demand-side benefits of scale.

These bene-
fits, also known as network effects, arise in in-
dustries where a buyer’s willingness to pay for
a company’s product increases with the num-
ber of other buyers who also patronize the
company. Buyers may trust larger companies
more for a crucial product: Recall the old
adage that no one ever got fired for buying
from IBM (when it was the dominant com-
puter maker). Buyers may also value being in a
“network” with a larger number of fellow cus-
tomers. For instance, online auction partici-
pants are attracted to eBay because it offers
the most potential trading partners. Demand-
side benefits of scale discourage entry by limit-
ing the willingness of customers to buy from a
newcomer and by reducing the price the new-
comer can command until it builds up a large
base of customers.
3.

Customer switching costs.

Switching costs
are fixed costs that buyers face when they
change suppliers. Such costs may arise because
a buyer who switches vendors must, for exam-
ple, alter product specifications, retrain em-
ployees to use a new product, or modify pro-
cesses or information systems. The larger the
switching costs, the harder it will be for an en-
trant to gain customers. Enterprise resource
planning (ERP) software is an example of a
product with very high switching costs. Once a
company has installed SAP’s ERP system, for
example, the costs of moving to a new vendor
are astronomical because of embedded data,
the fact that internal processes have been
adapted to SAP, major retraining needs, and
the mission-critical nature of the applications.
4.

Capital requirements.

The need to invest
large financial resources in order to compete
can deter new entrants. Capital may be neces-
sary not only for fixed facilities but also to ex-
tend customer credit, build inventories, and
fund start-up losses. The barrier is particularly
great if the capital is required for unrecover-
able and therefore harder-to-finance expendi-
tures, such as up-front advertising or research
and development. While major corporations
have the financial resources to invade almost
any industry, the huge capital requirements in
certain fields limit the pool of likely entrants.
Conversely, in such fields as tax preparation
services or short-haul trucking, capital require-
ments are minimal and potential entrants
plentiful.
It is important not to overstate the degree to
which capital requirements alone deter entry.
If industry returns are attractive and are ex-
pected to remain so, and if capital markets are
efficient, investors will provide entrants with
the funds they need. For aspiring air carriers,
for instance, financing is available to purchase
expensive aircraft because of their high resale
value, one reason why there have been numer-
ous new airlines in almost every region.
5.

Incumbency advantages independent of
size.

No matter what their size, incumbents
may have cost or quality advantages not avail-
able to potential rivals. These advantages can
stem from such sources as proprietary technol-
ogy, preferential access to the best raw mate-
rial sources, preemption of the most favorable
geographic locations, established brand identi-
ties, or cumulative experience that has allowed
incumbents to learn how to produce more effi-
ciently. Entrants try to bypass such advantages.
Upstart discounters such as Target and Wal-
The Five Forces That Shape Industry Competition
Bargaining
Power of
Suppliers
Threat
of New
Entrants
Bargaining
Power of
Buyers
Threat of
Substitute
Products or
Services
Rivalry
Among
Existing
Competitors
page 27

The Five Competitive Forces That Shape Strategy

harvard business review • january 2008

Mart, for example, have located stores in free-
standing sites rather than regional shopping
centers where established department stores
were well entrenched.
6.

Unequal access to distribution channels.

The new entrant must, of course, secure distri-
bution of its product or service. A new food
item, for example, must displace others from
the supermarket shelf via price breaks, promo-
tions, intense selling efforts, or some other
means. The more limited the wholesale or re-
tail channels are and the more that existing
competitors have tied them up, the tougher
entry into an industry will be. Sometimes ac-
cess to distribution is so high a barrier that new
entrants must bypass distribution channels al-
together or create their own. Thus, upstart
low-cost airlines have avoided distribution
through travel agents (who tend to favor estab-
lished higher-fare carriers) and have encour-
aged passengers to book their own flights on
the internet.
7.

Restrictive government policy.

Government
policy can hinder or aid new entry directly, as
well as amplify (or nullify) the other entry bar-
riers. Government directly limits or even fore-
closes entry into industries through, for in-
stance, licensing requirements and restrictions
on foreign investment. Regulated industries
like liquor retailing, taxi services, and airlines
are visible examples. Government policy can
heighten other entry barriers through such
means as expansive patenting rules that pro-
tect proprietary technology from imitation or
environmental or safety regulations that raise
scale economies facing newcomers. Of course,
government policies may also make entry eas-
ier—directly through subsidies, for instance, or

Differences in Industry Profitability

The average return on invested capital varies markedly from industry to industry. Between 1992 and 2006, for example, average return on in-
vested capital in U.S. industries ranged as low as zero or even negative to more than 50%. At the high end are industries like soft drinks and pre-
packaged software, which have been almost six times more profitable than the airline industry over the period.
Profitability of Selected U.S. Industries
Average ROIC, 1992–2006
N
um
be
r
of
In
du
st
rie
s
ROIC
0% 5% 10% 15% 20% 25% 30% 35%
40
50
30
20
10
0
10th percentile
7.0%
25th
percentile
10.9%
Median:
14.3%
75th percentile
18.6%
90th percentile
25.3%
or higheror lower
Average Return on Invested Capital
in U.S. Industries, 1992–2006
Security Brokers and Dealers
Soft Drinks
Prepackaged Software
Pharmaceuticals
Perfume, Cosmetics, Toiletries
Advertising Agencies
Distilled Spirits
Semiconductors
Medical Instruments
Men’s and Boys’ Clothing
Tires
Household Appliances
Malt Beverages
Child Day Care Services
Household Furniture
Drug Stores
Grocery Stores
Iron and Steel Foundries
Cookies and Crackers
Mobile Homes
Wine and Brandy
Bakery Products
Engines and Turbines
Book Publishing
Laboratory Equipment
Oil and Gas Machinery
Soft Drink Bottling
Knitting Mills
Hotels
Catalog, Mail-Order Houses
Airlines
Return on invested capital (ROIC) is the appropriate measure
of profitability for strategy formulation, not to mention for equity
investors. Return on sales or the growth rate of profits fail to
account for the capital required to compete in the industry. Here,
we utilize earnings before interest and taxes divided by average
invested capital less excess cash as the measure of ROIC. This
measure controls for idiosyncratic differences in capital structure
and tax rates across companies and industries.
Source: Standard & Poor’s, Compustat, and author’s calculations
Average industry
ROIC in the U.S.
14.9%
40.9%
37.6%
37.6%
31.7%
28.6%
27.3%
26.4%
21.3%
21.0%
19.5%
19.5%
19.2%
19.0%
17.6%
17.0%
16.5%
16.0%
15.6%
15.4%
15.0%
13.9%
13.8%
13.7%
13.4%
13.4%
12.6%
11.7%
10.5%
10.4%
5
5.9%
.9%
page 28

The Five Competitive Forces That Shape Strategy

harvard business review • january 2008

indirectly by funding basic research and mak-
ing it available to all firms, new and old, reduc-
ing scale economies.
Entry barriers should be assessed relative to
the capabilities of potential entrants, which
may be start-ups, foreign firms, or companies
in related industries. And, as some of our ex-
amples illustrate, the strategist must be mind-
ful of the creative ways newcomers might find
to circumvent apparent barriers.

Expected retaliation.

How potential entrants
believe incumbents may react will also influ-
ence their decision to enter or stay out of an
industry. If reaction is vigorous and protracted
enough, the profit potential of participating in
the industry can fall below the cost of capital.
Incumbents often use public statements and
responses to one entrant to send a message to
other prospective entrants about their com-
mitment to defending market share.
Newcomers are likely to fear expected retali-
ation if:
• Incumbents have previously responded
vigorously to new entrants.
• Incumbents possess substantial resources
to fight back, including excess cash and unused
borrowing power, available productive capac-
ity, or clout with distribution channels and cus-
tomers.
• Incumbents seem likely to cut prices be-
cause they are committed to retaining market
share at all costs or because the industry has
high fixed costs, which create a strong motiva-
tion to drop prices to fill excess capacity.
• Industry growth is slow so newcomers can
gain volume only by taking it from incumbents.
An analysis of barriers to entry and expected
retaliation is obviously crucial for any com-
pany contemplating entry into a new industry.
The challenge is to find ways to surmount the
entry barriers without nullifying, through
heavy investment, the profitability of partici-
pating in the industry.

The power of suppliers.

Powerful suppliers
capture more of the value for themselves by
charging higher prices, limiting quality or ser-
vices, or shifting costs to industry participants.
Powerful suppliers, including suppliers of la-
bor, can squeeze profitability out of an indus-
try that is unable to pass on cost increases in
its own prices. Microsoft, for instance, has con-
tributed to the erosion of profitability among
personal computer makers by raising prices on
operating systems. PC makers, competing
fiercely for customers who can easily switch
among them, have limited freedom to raise
their prices accordingly.
Companies depend on a wide range of differ-
ent supplier groups for inputs. A supplier
group is powerful if:
• It is more concentrated than the industry it
sells to. Microsoft’s near monopoly in operating
systems, coupled with the fragmentation of PC
assemblers, exemplifies this situation.
• The supplier group does not depend
heavily on the industry for its revenues. Suppli-
ers serving many industries will not hesitate to

Industry Analysis in Practice

Good industry analysis looks rigor-
ously at the structural underpinnings
of profitability. A first step is to under-
stand the appropriate time horizon.

One of the essential tasks in industry
analysis is to distinguish temporary or
cyclical changes from structural
changes. A good guideline for the appro-
priate time horizon is the full business
cycle for the particular industry. For
most industries, a three-to-five-year hori-
zon is appropriate, although in some in-
dustries with long lead times, such as
mining, the appropriate horizon might
be a decade or more. It is average profit-
ability over this period, not profitability
in any particular year, that should be the
focus of analysis.

The point of industry analysis is not
to declare the industry attractive or un-
attractive but to understand the under-
pinnings of competition and the root
causes of profitability.

As much as possi-
ble, analysts should look at industry
structure quantitatively, rather than be
satisfied with lists of qualitative factors.
Many elements of the five forces can be
quantified: the percentage of the buyer’s
total cost accounted for by the industry’s
product (to understand buyer price sensi-
tivity); the percentage of industry sales
required to fill a plant or operate a logisti-
cal network of efficient scale (to help as-
sess barriers to entry); the buyer’s switch-
ing cost (determining the inducement an
entrant or rival must offer customers).

The strength of the competitive
forces affects prices, costs, and the in-
vestment required to compete; thus
the forces are directly tied to the in-
come statements and balance sheets of
industry participants.

Industry struc-
ture defines the gap between revenues
and costs. For example, intense rivalry
drives down prices or elevates the costs of
marketing, R&D, or customer service, re-
ducing margins. How much? Strong sup-
pliers drive up input costs. How much?
Buyer power lowers prices or elevates the
costs of meeting buyers’ demands, such
as the requirement to hold more inven-
tory or provide financing. How much?
Low barriers to entry or close substitutes
limit the level of sustainable prices. How
much? It is these economic relationships
that sharpen the strategist’s understand-
ing of industry competition.

Finally, good industry analysis does
not just list pluses and minuses but
sees an industry in overall, systemic
terms.

Which forces are underpinning
(or constraining) today’s profitability?
How might shifts in one competitive
force trigger reactions in others? Answer-
ing such questions is often the source of
true strategic insights.
page 29

The Five Competitive Forces That Shape Strategy

harvard business review • january 2008

extract maximum profits from each one. If a
particular industry accounts for a large portion
of a supplier group’s volume or profit, however,
suppliers will want to protect the industry
through reasonable pricing and assist in activi-
ties such as R&D and lobbying.
• Industry participants face switching costs
in changing suppliers. For example, shifting
suppliers is difficult if companies have invested
heavily in specialized ancillary equipment or in
learning how to operate a supplier’s equipment
(as with Bloomberg terminals used by financial
professionals). Or firms may have located their
production lines adjacent to a supplier’s manu-
facturing facilities (as in the case of some bever-
age companies and container manufacturers).
When switching costs are high, industry partic-
ipants find it hard to play suppliers off against
one another. (Note that suppliers may have
switching costs as well. This limits their power.)
• Suppliers offer products that are differen-
tiated. Pharmaceutical companies that offer
patented drugs with distinctive medical bene-
fits have more power over hospitals, health
maintenance organizations, and other drug
buyers, for example, than drug companies of-
fering me-too or generic products.
• There is no substitute for what the sup-
plier group provides. Pilots’ unions, for exam-
ple, exercise considerable supplier power over
airlines partly because there is no good alterna-
tive to a well-trained pilot in the cockpit.
• The supplier group can credibly threaten
to integrate forward into the industry. In that
case, if industry participants make too much
money relative to suppliers, they will induce
suppliers to enter the market.

The power of buyers.

Powerful customers—
the flip side of powerful suppliers—can cap-
ture more value by forcing down prices, de-
manding better quality or more service (thereby
driving up costs), and generally playing industry
participants off against one another, all at the ex-
pense of industry profitability. Buyers are power-
ful if they have negotiating leverage relative to
industry participants, especially if they are price
sensitive, using their clout primarily to pressure
price reductions.
As with suppliers, there may be distinct
groups of customers who differ in bargaining
power. A customer group has negotiating le-
verage if:
• There are few buyers, or each one pur-
chases in volumes that are large relative to the
size of a single vendor. Large-volume buyers are
particularly powerful in industries with high
fixed costs, such as telecommunications equip-
ment, offshore drilling, and bulk chemicals.
High fixed costs and low marginal costs amplify
the pressure on rivals to keep capacity filled
through discounting.
• The industry’s products are standardized
or undifferentiated. If buyers believe they can
always find an equivalent product, they tend to
play one vendor against another.
• Buyers face few switching costs in chang-
ing vendors.
• Buyers can credibly threaten to integrate
backward and produce the industry’s product
themselves if vendors are too profitable. Pro-
ducers of soft drinks and beer have long con-
trolled the power of packaging manufacturers
by threatening to make, and at times actually
making, packaging materials themselves.
A buyer group is price sensitive if:
• The product it purchases from the indus-
try represents a significant fraction of its cost
structure or procurement budget. Here buyers
are likely to shop around and bargain hard, as
consumers do for home mortgages. Where the
product sold by an industry is a small fraction
of buyers’ costs or expenditures, buyers are usu-
ally less price sensitive.
• The buyer group earns low profits, is
strapped for cash, or is otherwise under pres-
sure to trim its purchasing costs. Highly profit-
able or cash-rich customers, in contrast, are
generally less price sensitive (that is, of course,
if the item does not represent a large fraction of
their costs).
• The quality of buyers’ products or services
is little affected by the industry’s product.
Where quality is very much affected by the in-
dustry’s product, buyers are generally less price
sensitive. When purchasing or renting produc-
tion quality cameras, for instance, makers of
major motion pictures opt for highly reliable
equipment with the latest features. They pay
limited attention to price.
• The industry’s product has little effect on
the buyer’s other costs. Here, buyers focus on
price. Conversely, where an industry’s product
or service can pay for itself many times over by
improving performance or reducing labor, ma-
terial, or other costs, buyers are usually more
interested in quality than in price. Examples in-
clude products and services like tax accounting
or well logging (which measures below-ground
Industry structure drives
competition and
profitability, not whether
an industry is emerging
or mature, high tech or
low tech, regulated or
unregulated.
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The Five Competitive Forces That Shape Strategy

harvard business review • january 2008

conditions of oil wells) that can save or even
make the buyer money. Similarly, buyers tend
not to be price sensitive in services such as in-
vestment banking, where poor performance
can be costly and embarrassing.
Most sources of buyer power apply equally
to consumers and to business-to-business cus-
tomers. Like industrial customers, consumers
tend to be more price sensitive if they are pur-
chasing products that are undifferentiated, ex-
pensive relative to their incomes, and of a sort
where product performance has limited conse-
quences. The major difference with consum-
ers is that their needs can be more intangible
and harder to quantify.
Intermediate customers, or customers who
purchase the product but are not the end user
(such as assemblers or distribution channels),
can be analyzed the same way as other buyers,
with one important addition. Intermediate
customers gain significant bargaining power
when they can influence the purchasing deci-
sions of customers downstream. Consumer
electronics retailers, jewelry retailers, and agri-
cultural-equipment distributors are examples
of distribution channels that exert a strong in-
fluence on end customers.
Producers often attempt to diminish chan-
nel clout through exclusive arrangements with
particular distributors or retailers or by mar-
keting directly to end users. Component manu-
facturers seek to develop power over assem-
blers by creating preferences for their
components with downstream customers.
Such is the case with bicycle parts and with
sweeteners. DuPont has created enormous
clout by advertising its Stainmaster brand of
carpet fibers not only to the carpet manufac-
turers that actually buy them but also to down-
stream consumers. Many consumers request
Stainmaster carpet even though DuPont is not
a carpet manufacturer.

The threat of substitutes.

A substitute per-
forms the same or a similar function as an in-
dustry’s product by a different means. Video-
conferencing is a substitute for travel. Plastic is
a substitute for aluminum. E-mail is a substi-
tute for express mail. Sometimes, the threat of
substitution is downstream or indirect, when a
substitute replaces a buyer industry’s product.
For example, lawn-care products and services
are threatened when multifamily homes in
urban areas substitute for single-family homes
in the suburbs. Software sold to agents is
threatened when airline and travel websites
substitute for travel agents.
Substitutes are always present, but they are
easy to overlook because they may appear to
be very different from the industry’s product:
To someone searching for a Father’s Day gift,
neckties and power tools may be substitutes. It
is a substitute to do without, to purchase a
used product rather than a new one, or to do it
yourself (bring the service or product in-
house).
When the threat of substitutes is high, indus-
try profitability suffers. Substitute products or
services limit an industry’s profit potential by
placing a ceiling on prices. If an industry does
not distance itself from substitutes through
product performance, marketing, or other
means, it will suffer in terms of profitability—
and often growth potential.
Substitutes not only limit profits in normal
times, they also reduce the bonanza an indus-
try can reap in good times. In emerging econo-
mies, for example, the surge in demand for
wired telephone lines has been capped as
many consumers opt to make a mobile tele-
phone their first and only phone line.
The threat of a substitute is high if:
• It offers an attractive price-performance
trade-off to the industry’s product. The better
the relative value of the substitute, the tighter
is the lid on an industry’s profit potential. For
example, conventional providers of long-dis-
tance telephone service have suffered from the
advent of inexpensive internet-based phone
services such as Vonage and Skype. Similarly,
video rental outlets are struggling with the
emergence of cable and satellite video-on-de-
mand services, online video rental services such
as Netflix, and the rise of internet video sites
like Google’s YouTube.
• The buyer’s cost of switching to the substi-
tute is low. Switching from a proprietary,
branded drug to a generic drug usually involves
minimal costs, for example, which is why the
shift to generics (and the fall in prices) is so sub-
stantial and rapid.
Strategists should be particularly alert to
changes in other industries that may make
them attractive substitutes when they were not
before. Improvements in plastic materials, for
example, allowed them to substitute for steel
in many automobile components. In this way,
technological changes or competitive disconti-
nuities in seemingly unrelated businesses can
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have major impacts on industry profitability.
Of course the substitution threat can also shift
in favor of an industry, which bodes well for its
future profitability and growth potential.

Rivalry among existing competitors.

Rivalry
among existing competitors takes many famil-
iar forms, including price discounting, new
product introductions, advertising campaigns,
and service improvements. High rivalry limits
the profitability of an industry. The degree to
which rivalry drives down an industry’s profit
potential depends, first, on the

intensity

with
which companies compete and, second, on the

basis

on which they compete.
The intensity of rivalry is greatest if:
• Competitors are numerous or are roughly
equal in size and power. In such situations, ri-
vals find it hard to avoid poaching business.
Without an industry leader, practices desirable
for the industry as a whole go unenforced.
• Industry growth is slow. Slow growth pre-
cipitates fights for market share.
• Exit barriers are high. Exit barriers, the flip
side of entry barriers, arise because of such
things as highly specialized assets or manage-
ment’s devotion to a particular business. These
barriers keep companies in the market even
though they may be earning low or negative re-
turns. Excess capacity remains in use, and the
profitability of healthy competitors suffers as
the sick ones hang on.
• Rivals are highly committed to the busi-
ness and have aspirations for leadership, espe-
cially if they have goals that go beyond eco-
nomic performance in the particular industry.
High commitment to a business arises for a va-
riety of reasons. For example, state-owned com-
petitors may have goals that include employ-
ment or prestige. Units of larger companies
may participate in an industry for image rea-
sons or to offer a full line. Clashes of personality
and ego have sometimes exaggerated rivalry to
the detriment of profitability in fields such as
the media and high technology.
• Firms cannot read each other’s signals well
because of lack of familiarity with one another,
diverse approaches to competing, or differing
goals.
The strength of rivalry reflects not just the
intensity of competition but also the basis of
competition. The

dimensions

on which compe-
tition takes place, and whether rivals converge
to compete on the

same dimensions

, have a
major influence on profitability.
Rivalry is especially destructive to profitabil-
ity if it gravitates solely to price because price
competition transfers profits directly from an
industry to its customers. Price cuts are usually
easy for competitors to see and match, making
successive rounds of retaliation likely. Sus-
tained price competition also trains customers
to pay less attention to product features and
service.
Price competition is most liable to occur if:
• Products or services of rivals are nearly
identical and there are few switching costs for
buyers. This encourages competitors to cut
prices to win new customers. Years of airline
price wars reflect these circumstances in that
industry.
• Fixed costs are high and marginal costs are
low. This creates intense pressure for competi-
tors to cut prices below their average costs,
even close to their marginal costs, to steal incre-
mental customers while still making some con-
tribution to covering fixed costs. Many basic-
materials businesses, such as paper and alumi-
num, suffer from this problem, especially if de-
mand is not growing. So do delivery companies
with fixed networks of routes that must be
served regardless of volume.
• Capacity must be expanded in large incre-
ments to be efficient. The need for large capac-
ity expansions, as in the polyvinyl chloride busi-
ness, disrupts the industry’s supply-demand
balance and often leads to long and recurring
periods of overcapacity and price cutting.
• The product is perishable. Perishability
creates a strong temptation to cut prices and
sell a product while it still has value. More prod-
ucts and services are perishable than is com-
monly thought. Just as tomatoes are perishable
because they rot, models of computers are per-
ishable because they soon become obsolete,
and information may be perishable if it diffuses
rapidly or becomes outdated, thereby losing its
value. Services such as hotel accommodations
are perishable in the sense that unused capacity
can never be recovered.
Competition on dimensions other than
price—on product features, support services,
delivery time, or brand image, for instance—is
less likely to erode profitability because it im-
proves customer value and can support higher
prices. Also, rivalry focused on such dimen-
sions can improve value relative to substitutes
or raise the barriers facing new entrants. While
nonprice rivalry sometimes escalates to levels
Rivalry is especially
destructive to
profitability if it
gravitates solely to price
because price
competition transfers
profits directly from an
industry to its customers.
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that undermine industry profitability, this is
less likely to occur than it is with price rivalry.
As important as the dimensions of rivalry is
whether rivals compete on the

same

dimen-
sions. When all or many competitors aim to
meet the same needs or compete on the same
attributes, the result is zero-sum competition.
Here, one firm’s gain is often another’s loss,
driving down profitability. While price compe-
tition runs a stronger risk than nonprice com-
petition of becoming zero sum, this may not
happen if companies take care to segment
their markets, targeting their low-price offer-
ings to different customers.
Rivalry can be positive sum, or actually in-
crease the average profitability of an industry,
when each competitor aims to serve the needs
of different customer segments, with different
mixes of price, products, services, features, or
brand identities. Such competition can not
only support higher average profitability but
also expand the industry, as the needs of more
customer groups are better met. The opportu-
nity for positive-sum competition will be
greater in industries serving diverse customer
groups. With a clear understanding of the
structural underpinnings of rivalry, strategists
can sometimes take steps to shift the nature of
competition in a more positive direction.

Factors, Not Forces

Industry structure, as manifested in the
strength of the five competitive forces, deter-
mines the industry’s long-run profit potential
because it determines how the economic
value created by the industry is divided—how
much is retained by companies in the industry
versus bargained away by customers and sup-
pliers, limited by substitutes, or constrained by
potential new entrants. By considering all five
forces, a strategist keeps overall structure in
mind instead of gravitating to any one ele-
ment. In addition, the strategist’s attention re-
mains focused on structural conditions rather
than on fleeting factors.
It is especially important to avoid the com-
mon pitfall of mistaking certain visible at-
tributes of an industry for its underlying struc-
ture. Consider the following:

Industry growth rate.

A common mistake is
to assume that fast-growing industries are al-
ways attractive. Growth does tend to mute ri-
valry, because an expanding pie offers oppor-
tunities for all competitors. But fast growth
can put suppliers in a powerful position, and
high growth with low entry barriers will draw
in entrants. Even without new entrants, a high
growth rate will not guarantee profitability if
customers are powerful or substitutes are at-
tractive. Indeed, some fast-growth businesses,
such as personal computers, have been among
the least profitable industries in recent years.
A narrow focus on growth is one of the major
causes of bad strategy decisions.

Technology and innovation.

Advanced tech-
nology or innovations are not by themselves
enough to make an industry structurally at-
tractive (or unattractive). Mundane, low-tech-
nology industries with price-insensitive buy-
ers, high switching costs, or high entry barriers
arising from scale economies are often far
more profitable than sexy industries, such as
software and internet technologies, that at-
tract competitors.

2

Government.

Government is not best un-
derstood as a sixth force because government
involvement is neither inherently good nor
bad for industry profitability. The best way to
understand the influence of government on
competition is to analyze how specific govern-
ment policies affect the five competitive
forces. For instance, patents raise barriers to
entry, boosting industry profit potential. Con-
versely, government policies favoring unions
may raise supplier power and diminish profit
potential. Bankruptcy rules that allow failing
companies to reorganize rather than exit can
lead to excess capacity and intense rivalry.
Government operates at multiple levels and
through many different policies, each of
which will affect structure in different ways.

Complementary products and services.

Complements are products or services used to-
gether with an industry’s product. Comple-
ments arise when the customer benefit of two
products combined is greater than the sum of
each product’s value in isolation. Computer
hardware and software, for instance, are valu-
able together and worthless when separated.
In recent years, strategy researchers have
highlighted the role of complements, espe-
cially in high-technology industries where they
are most obvious.

3

By no means, however, do
complements appear only there. The value of a
car, for example, is greater when the driver also
has access to gasoline stations, roadside assis-
tance, and auto insurance.
Complements can be important when they
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affect the overall demand for an industry’s
product. However, like government policy,
complements are not a sixth force determining
industry profitability since the presence of
strong complements is not necessarily bad (or
good) for industry profitability. Complements
affect profitability through the way they influ-
ence the five forces.
The strategist must trace the positive or neg-
ative influence of complements on all five
forces to ascertain their impact on profitability.
The presence of complements can raise or
lower barriers to entry. In application software,
for example, barriers to entry were lowered
when producers of complementary operating
system software, notably Microsoft, provided
tool sets making it easier to write applications.
Conversely, the need to attract producers of
complements can raise barriers to entry, as it
does in video game hardware.
The presence of complements can also affect
the threat of substitutes. For instance, the need
for appropriate fueling stations makes it diffi-
cult for cars using alternative fuels to substi-
tute for conventional vehicles. But comple-
ments can also make substitution easier. For
example, Apple’s iTunes hastened the substitu-
tion from CDs to digital music.
Complements can factor into industry ri-
valry either positively (as when they raise
switching costs) or negatively (as when they
neutralize product differentiation). Similar
analyses can be done for buyer and supplier
power. Sometimes companies compete by al-
tering conditions in complementary industries
in their favor, such as when videocassette-re-
corder producer JVC persuaded movie studios
to favor its standard in issuing prerecorded
tapes even though rival Sony’s standard was
probably superior from a technical standpoint.
Identifying complements is part of the ana-
lyst’s work. As with government policies or im-
portant technologies, the strategic significance
of complements will be best understood
through the lens of the five forces.

Changes in Industry Structure

So far, we have discussed the competitive
forces at a single point in time. Industry struc-
ture proves to be relatively stable, and indus-
try profitability differences are remarkably
persistent over time in practice. However, in-
dustry structure is constantly undergoing
modest adjustment—and occasionally it can
change abruptly.
Shifts in structure may emanate from out-
side an industry or from within. They can
boost the industry’s profit potential or reduce
it. They may be caused by changes in technol-
ogy, changes in customer needs, or other
events. The five competitive forces provide a
framework for identifying the most important
industry developments and for anticipating
their impact on industry attractiveness.

Shifting threat of new entry.

Changes to any
of the seven barriers described above can raise
or lower the threat of new entry. The expira-
tion of a patent, for instance, may unleash new
entrants. On the day that Merck’s patents for
the cholesterol reducer Zocor expired, three
pharmaceutical makers entered the market
for the drug. Conversely, the proliferation of
products in the ice cream industry has gradu-
ally filled up the limited freezer space in gro-
cery stores, making it harder for new ice cream
makers to gain access to distribution in North
America and Europe.
Strategic decisions of leading competitors
often have a major impact on the threat of en-
try. Starting in the 1970s, for example, retailers
such as Wal-Mart, Kmart, and Toys “R” Us
began to adopt new procurement, distribution,
and inventory control technologies with large
fixed costs, including automated distribution
centers, bar coding, and point-of-sale termi-
nals. These investments increased the econo-
mies of scale and made it more difficult for
small retailers to enter the business (and for ex-
isting small players to survive).

Changing supplier or buyer power.

As the
factors underlying the power of suppliers and
buyers change with time, their clout rises or
declines. In the global appliance industry, for
instance, competitors including Electrolux,
General Electric, and Whirlpool have been
squeezed by the consolidation of retail chan-
nels (the decline of appliance specialty stores,
for instance, and the rise of big-box retailers
like Best Buy and Home Depot in the United
States). Another example is travel agents, who
depend on airlines as a key supplier. When the
internet allowed airlines to sell tickets directly
to customers, this significantly increased their
power to bargain down agents’ commissions.

Shifting threat of substitution.

The most com-
mon reason substitutes become more or less
threatening over time is that advances in tech-
nology create new substitutes or shift price-
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performance comparisons in one direction or
the other. The earliest microwave ovens, for
example, were large and priced above $2,000,
making them poor substitutes for conven-
tional ovens. With technological advances,
they became serious substitutes. Flash com-
puter memory has improved enough recently
to become a meaningful substitute for low-ca-
pacity hard-disk drives. Trends in the availabil-
ity or performance of complementary produc-
ers also shift the threat of substitutes.

New bases of rivalry.

Rivalry often intensi-
fies naturally over time. As an industry ma-
tures, growth slows. Competitors become
more alike as industry conventions emerge,
technology diffuses, and consumer tastes con-
verge. Industry profitability falls, and weaker
competitors are driven from the business. This
story has played out in industry after industry;
televisions, snowmobiles, and telecommunica-
tions equipment are just a few examples.
A trend toward intensifying price competi-
tion and other forms of rivalry, however, is by
no means inevitable. For example, there has
been enormous competitive activity in the U.S.
casino industry in recent decades, but most of
it has been positive-sum competition directed
toward new niches and geographic segments
(such as riverboats, trophy properties, Native
American reservations, international expan-
sion, and novel customer groups like families).
Head-to-head rivalry that lowers prices or
boosts the payouts to winners has been lim-
ited.
The nature of rivalry in an industry is al-
tered by mergers and acquisitions that intro-
duce new capabilities and ways of competing.
Or, technological innovation can reshape ri-
valry. In the retail brokerage industry, the ad-
vent of the internet lowered marginal costs
and reduced differentiation, triggering far
more intense competition on commissions and
fees than in the past.
In some industries, companies turn to merg-
ers and consolidation not to improve cost and
quality but to attempt to stop intense competi-
tion. Eliminating rivals is a risky strategy, how-
ever. The five competitive forces tell us that a
profit windfall from removing today’s competi-
tors often attracts new competitors and back-
lash from customers and suppliers. In New
York banking, for example, the 1980s and 1990s
saw escalating consolidations of commercial
and savings banks, including Manufacturers
Hanover, Chemical, Chase, and Dime Savings.
But today the retail-banking landscape of Man-
hattan is as diverse as ever, as new entrants
such as Wachovia, Bank of America, and Wash-
ington Mutual have entered the market.

Implications for Strategy

Understanding the forces that shape industry
competition is the starting point for develop-
ing strategy. Every company should already
know what the average profitability of its in-
dustry is and how that has been changing over
time. The five forces reveal

why

industry prof-
itability is what it is. Only then can a company
incorporate industry conditions into strategy.
The forces reveal the most significant aspects
of the competitive environment. They also pro-
vide a baseline for sizing up a company’s
strengths and weaknesses: Where does the
company stand versus buyers, suppliers, en-
trants, rivals, and substitutes? Most impor-
tantly, an understanding of industry structure
guides managers toward fruitful possibilities
for strategic action, which may include any or
all of the following: positioning the company
to better cope with the current competitive
forces; anticipating and exploiting shifts in the
forces; and shaping the balance of forces to cre-
ate a new industry structure that is more favor-
able to the company. The best strategies ex-
ploit more than one of these possibilities.

Positioning the company.

Strategy can be
viewed as building defenses against the com-
petitive forces or finding a position in the in-
dustry where the forces are weakest. Consider,
for instance, the position of Paccar in the mar-
ket for heavy trucks. The heavy-truck industry
is structurally challenging. Many buyers oper-
ate large fleets or are large leasing companies,
with both the leverage and the motivation to
drive down the price of one of their largest
purchases. Most trucks are built to regulated
standards and offer similar features, so price
competition is rampant. Capital intensity
causes rivalry to be fierce, especially during
the recurring cyclical downturns. Unions exer-
cise considerable supplier power. Though
there are few direct substitutes for an 18-
wheeler, truck buyers face important substi-
tutes for their services, such as cargo delivery
by rail.
In this setting, Paccar, a Bellevue, Washing-
ton–based company with about 20% of the
North American heavy-truck market, has cho-
Eliminating rivals is a
risky strategy. A profit
windfall from removing
today’s competitors often
attracts new competitors
and backlash from
customers and suppliers.
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sen to focus on one group of customers: owner-
operators—drivers who own their trucks and
contract directly with shippers or serve as sub-
contractors to larger trucking companies. Such
small operators have limited clout as truck
buyers. They are also less price sensitive be-
cause of their strong emotional ties to and eco-
nomic dependence on the product. They take
great pride in their trucks, in which they spend
most of their time.
Paccar has invested heavily to develop an
array of features with owner-operators in
mind: luxurious sleeper cabins, plush leather
seats, noise-insulated cabins, sleek exterior styl-
ing, and so on. At the company’s extensive net-
work of dealers, prospective buyers use soft-
ware to select among thousands of options to
put their personal signature on their trucks.
These customized trucks are built to order, not
to stock, and delivered in six to eight weeks.
Paccar’s trucks also have aerodynamic designs
that reduce fuel consumption, and they main-
tain their resale value better than other trucks.
Paccar’s roadside assistance program and IT-
supported system for distributing spare parts
reduce the time a truck is out of service. All
these are crucial considerations for an owner-
operator. Customers pay Paccar a 10% pre-
mium, and its Kenworth and Peterbilt brands
are considered status symbols at truck stops.
Paccar illustrates the principles of position-
ing a company within a given industry struc-
ture. The firm has found a portion of its indus-
try where the competitive forces are weaker—
where it can avoid buyer power and price-
based rivalry. And it has tailored every single
part of the value chain to cope well with the
forces in its segment. As a result, Paccar has
been profitable for 68 years straight and has
earned a long-run return on equity above 20%.
In addition to revealing positioning opportu-
nities within an existing industry, the five
forces framework allows companies to rigor-
ously analyze entry and exit. Both depend on
answering the difficult question: “What is the
potential of this business?” Exit is indicated
when industry structure is poor or declining
and the company has no prospect of a superior
positioning. In considering entry into a new in-
dustry, creative strategists can use the frame-
work to spot an industry with a good future
before this good future is reflected in the
prices of acquisition candidates. Five forces
analysis may also reveal industries that are not
necessarily attractive for the average entrant
but in which a company has good reason to be-
lieve it can surmount entry barriers at lower
cost than most firms or has a unique ability to
cope with the industry’s competitive forces.

Exploiting industry change.

Industry changes
bring the opportunity to spot and claim prom-
ising new strategic positions if the strategist
has a sophisticated understanding of the com-
petitive forces and their underpinnings. Con-
sider, for instance, the evolution of the music
industry during the past decade. With the ad-
vent of the internet and the digital distribu-
tion of music, some analysts predicted the
birth of thousands of music labels (that is,
record companies that develop artists and
bring their music to market). This, the analysts
argued, would break a pattern that had held
since Edison invented the phonograph: Be-
tween three and six major record companies
had always dominated the industry. The inter-
net would, they predicted, remove distribu-
tion as a barrier to entry, unleashing a flood of
new players into the music industry.
A careful analysis, however, would have re-
vealed that physical distribution was not the
crucial barrier to entry. Rather, entry was
barred by other benefits that large music labels
enjoyed. Large labels could pool the risks of de-
veloping new artists over many bets, cushion-
ing the impact of inevitable failures. Even
more important, they had advantages in break-
ing through the clutter and getting their new
artists heard. To do so, they could promise
radio stations and record stores access to well-
known artists in exchange for promotion of
new artists. New labels would find this nearly
impossible to match. The major labels stayed
the course, and new music labels have been
rare.
This is not to say that the music industry is
structurally unchanged by digital distribution.
Unauthorized downloading created an illegal
but potent substitute. The labels tried for years
to develop technical platforms for digital distri-
bution themselves, but major companies hesi-
tated to sell their music through a platform
owned by a rival. Into this vacuum stepped
Apple with its iTunes music store, launched in
2003 to support its iPod music player. By per-
mitting the creation of a powerful new gate-
keeper, the major labels allowed industry
structure to shift against them. The number of
major record companies has actually de-
Using the five forces
framework, creative
strategists may be able to
spot an industry with a
good future before this
good future is reflected in
the prices of acquisition
candidates.
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The Five Competitive Forces That Shape Strategy

harvard business review • january 2008

clined—from six in 1997 to four today—as
companies struggled to cope with the digital
phenomenon.
When industry structure is in flux, new and
promising competitive positions may appear.
Structural changes open up new needs and
new ways to serve existing needs. Established
leaders may overlook these or be constrained
by past strategies from pursuing them. Smaller
competitors in the industry can capitalize on
such changes, or the void may well be filled by
new entrants.

Shaping industry structure.

When a com-
pany exploits structural change, it is recogniz-
ing, and reacting to, the inevitable. However,
companies also have the ability to shape in-
dustry structure. A firm can lead its industry
toward new ways of competing that alter the
five forces for the better. In reshaping struc-
ture, a company wants its competitors to fol-
low so that the entire industry will be trans-
formed. While many industry participants
may benefit in the process, the innovator can
benefit most if it can shift competition in di-
rections where it can excel.
An industry’s structure can be reshaped in
two ways: by redividing profitability in favor of
incumbents or by expanding the overall profit
pool. Redividing the industry pie aims to in-
crease the share of profits to industry competi-
tors instead of to suppliers, buyers, substitutes,
and keeping out potential entrants. Expanding
the profit pool involves increasing the overall
pool of economic value generated by the in-
dustry in which rivals, buyers, and suppliers
can all share.

Redividing profitability.

To capture more pro-
fits for industry rivals, the starting point is to

Defining the Relevant Industry

Defining the industry in which competition
actually takes place is important for good in-
dustry analysis, not to mention for develop-
ing strategy and setting business unit bound-
aries. Many strategy errors emanate from
mistaking the relevant industry, defining it
too broadly or too narrowly. Defining the in-
dustry too broadly obscures differences
among products, customers, or geographic
regions that are important to competition,
strategic positioning, and profitability. Defin-
ing the industry too narrowly overlooks com-
monalities and linkages across related prod-
ucts or geographic markets that are crucial to
competitive advantage. Also, strategists must
be sensitive to the possibility that industry
boundaries can shift.
The boundaries of an industry consist of
two primary dimensions. First is the

scope of
products or services

. For example, is motor oil
used in cars part of the same industry as
motor oil used in heavy trucks and stationary
engines, or are these different industries? The
second dimension is

geographic scope

. Most
industries are present in many parts of the
world. However, is competition contained
within each state, or is it national? Does com-
petition take place within regions such as Eu-
rope or North America, or is there a single glo-
bal industry?
The five forces are the basic tool to resolve
these questions. If industry structure for two
products is the same or very similar (that is, if
they have the same buyers, suppliers, barriers
to entry, and so forth), then the products are
best treated as being part of the same indus-
try. If industry structure differs markedly, how-
ever, the two products may be best under-
stood as separate industries.
In lubricants, the oil used in cars is similar
or even identical to the oil used in trucks, but
the similarity largely ends there. Automotive
motor oil is sold to fragmented, generally un-
sophisticated customers through numerous
and often powerful channels, using extensive
advertising. Products are packaged in small
containers and logistical costs are high, neces-
sitating local production. Truck and power
generation lubricants are sold to entirely dif-
ferent buyers in entirely different ways using a
separate supply chain. Industry structure
(buyer power, barriers to entry, and so forth) is
substantially different. Automotive oil is thus a
distinct industry from oil for truck and station-
ary engine uses. Industry profitability will dif-
fer in these two cases, and a lubricant com-
pany will need a separate strategy for
competing in each area.
Differences in the five competitive forces
also reveal the geographic scope of competi-
tion. If an industry has a similar structure in
every country (rivals, buyers, and so on), the
presumption is that competition is global, and
the five forces analyzed from a global perspec-
tive will set average profitability. A single glo-
bal strategy is needed. If an industry has quite
different structures in different geographic re-
gions, however, each region may well be a dis-
tinct industry. Otherwise, competition would
have leveled the differences. The five forces an-
alyzed for each region will set profitability
there.
The extent of differences in the five forces
for related products or across geographic
areas is a matter of degree, making industry
definition often a matter of judgment. A rule
of thumb is that where the differences in any
one force are large, and where the differences
involve more than one force, distinct indus-
tries may well be present.
Fortunately, however, even if industry
boundaries are drawn incorrectly, careful five
forces analysis should reveal important com-
petitive threats. A closely related product
omitted from the industry definition will show
up as a substitute, for example, or competitors
overlooked as rivals will be recognized as po-
tential entrants. At the same time, the five
forces analysis should reveal major differences
within overly broad industries that will indi-
cate the need to adjust industry boundaries or
strategies.
page 37

The Five Competitive Forces That Shape Strategy

harvard business review • january 2008

determine which force or forces are currently
constraining industry profitability and address
them. A company can potentially influence all
of the competitive forces. The strategist’s goal
here is to reduce the share of profits that leak
to suppliers, buyers, and substitutes or are sac-
rificed to deter entrants.
To neutralize supplier power, for example, a
firm can standardize specifications for parts to
make it easier to switch among suppliers. It
can cultivate additional vendors, or alter tech-
nology to avoid a powerful supplier group alto-
gether. To counter customer power, companies
may expand services that raise buyers’ switch-
ing costs or find alternative means of reaching
customers to neutralize powerful channels. To
temper profit-eroding price rivalry, companies
can invest more heavily in unique products, as
pharmaceutical firms have done, or expand
support services to customers. To scare off en-
trants, incumbents can elevate the fixed cost of
competing—for instance, by escalating their
R&D or marketing expenditures. To limit the
threat of substitutes, companies can offer bet-
ter value through new features or wider prod-
uct accessibility. When soft-drink producers in-
troduced vending machines and convenience
store channels, for example, they dramatically
improved the availability of soft drinks relative
to other beverages.
Sysco, the largest food-service distributor in
North America, offers a revealing example of
how an industry leader can change the struc-
ture of an industry for the better. Food-service
distributors purchase food and related items
from farmers and food processors. They then
warehouse and deliver these items to restau-
rants, hospitals, employer cafeterias, schools,
and other food-service institutions. Given low
barriers to entry, the food-service distribution
industry has historically been highly frag-
mented, with numerous local competitors.
While rivals try to cultivate customer relation-
ships, buyers are price sensitive because food
represents a large share of their costs. Buyers
can also choose the substitute approaches of
purchasing directly from manufacturers or
using retail sources, avoiding distributors alto-
gether. Suppliers wield bargaining power:
They are often large companies with strong
brand names that food preparers and consum-
ers recognize. Average profitability in the in-
dustry has been modest.
Sysco recognized that, given its size and na-
tional reach, it might change this state of af-
fairs. It led the move to introduce private-label
distributor brands with specifications tailored
to the food-service market, moderating sup-
plier power. Sysco emphasized value-added
services to buyers such as credit, menu plan-
ning, and inventory management to shift the
basis of competition away from just price.
These moves, together with stepped-up invest-
ments in information technology and regional
distribution centers, substantially raised the
bar for new entrants while making the substi-
tutes less attractive. Not surprisingly, the in-
dustry has been consolidating, and industry
profitability appears to be rising.
Industry leaders have a special responsibility
for improving industry structure. Doing so
often requires resources that only large players
possess. Moreover, an improved industry struc-
ture is a public good because it benefits every
firm in the industry, not just the company that
initiated the improvement. Often, it is more in
the interests of an industry leader than any
other participant to invest for the common
good because leaders will usually benefit the
most. Indeed, improving the industry may be a
leader’s most profitable strategic opportunity,
in part because attempts to gain further mar-
ket share can trigger strong reactions from ri-

Typical Steps in Industry Analysis

Define the relevant industry:
•

What products are in it? Which ones
are part of another distinct indus-
try?

•

What is the geographic scope of
competition?

Identify the participants and segment
them into groups, if appropriate:
Who are
•

the buyers and buyer groups?

•

the suppliers and supplier groups?

•

the competitors?

•

the substitutes?

•

the potential entrants?

Assess the underlying drivers of each
competitive force to determine which
forces are strong and which are weak
and why.
Determine overall industry structure,
and test the analysis for consistency:
•

Why

is the level of profitability what
it is?

•

Which are the

controlling

forces for
profitability?

•

Is the industry analysis consistent
with actual long-run profitability?

•

Are more-profitable players better
positioned in relation to the five
forces?

Analyze recent and likely future
changes in each force, both positive
and negative.
Identify aspects of industry structure that
might be influenced by competitors, by
new entrants, or by your company.
page 38

The Five Competitive Forces That Shape Strategy

harvard business review • january 2008

vals, customers, and even suppliers.
There is a dark side to shaping industry
structure that is equally important to under-
stand. Ill-advised changes in competitive posi-
tioning and operating practices can

undermine

industry structure. Faced with pressures to
gain market share or enamored with innova-
tion for its own sake, managers may trigger
new kinds of competition that no incumbent
can win. When taking actions to improve their
own company’s competitive advantage, then,
strategists should ask whether they are setting
in motion dynamics that will undermine indus-
try structure in the long run. In the early days
of the personal computer industry, for in-
stance, IBM tried to make up for its late entry
by offering an open architecture that would set
industry standards and attract complementary
makers of application software and peripher-
als. In the process, it ceded ownership of the
critical components of the PC—the operating
system and the microprocessor—to Microsoft
and Intel. By standardizing PCs, it encouraged
price-based rivalry and shifted power to suppli-
ers. Consequently, IBM became the tempo-
rarily dominant firm in an industry with an en-
duringly unattractive structure.

Expanding the profit pool.

When overall de-
mand grows, the industry’s quality level rises,
intrinsic costs are reduced, or waste is elimi-
nated, the pie expands. The total pool of value
available to competitors, suppliers, and buyers
grows. The total profit pool expands, for exam-
ple, when channels become more competitive
or when an industry discovers latent buyers
for its product that are not currently being
served. When soft-drink producers rational-
ized their independent bottler networks to
make them more efficient and effective, both
the soft-drink companies and the bottlers ben-
efited. Overall value can also expand when
firms work collaboratively with suppliers to
improve coordination and limit unnecessary
costs incurred in the supply chain. This lowers
the inherent cost structure of the industry, al-
lowing higher profit, greater demand through
lower prices, or both. Or, agreeing on quality
standards can bring up industrywide quality
and service levels, and hence prices, benefiting
rivals, suppliers, and customers.
Expanding the overall profit pool creates
win-win opportunities for multiple industry
participants. It can also reduce the risk of de-
structive rivalry that arises when incumbents
attempt to shift bargaining power or capture
more market share. However, expanding the
pie does not reduce the importance of industry
structure. How the expanded pie is divided will
ultimately be determined by the five forces.
The most successful companies are those that
expand the industry profit pool in ways that
allow them to share disproportionately in the
benefits.

Defining the industry.

The five competitive
forces also hold the key to defining the rele-
vant industry (or industries) in which a com-
pany competes. Drawing industry boundaries
correctly, around the arena in which competi-
tion actually takes place, will clarify the causes
of profitability and the appropriate unit for
setting strategy. A company needs a separate
strategy for each distinct industry. Mistakes in
industry definition made by competitors
present opportunities for staking out superior
strategic positions. (See the sidebar “Defining
the Relevant Industry.”)

Competition and Value
The competitive forces reveal the drivers of in-
dustry competition. A company strategist who
understands that competition extends well be-
yond existing rivals will detect wider competi-
tive threats and be better equipped to address
them. At the same time, thinking comprehen-
sively about an industry’s structure can un-
cover opportunities: differences in customers,
suppliers, substitutes, potential entrants, and
rivals that can become the basis for distinct
strategies yielding superior performance. In a
world of more open competition and relent-
less change, it is more important than ever to
think structurally about competition.
Understanding industry structure is equally
important for investors as for managers. The
five competitive forces reveal whether an in-
dustry is truly attractive, and they help inves-
tors anticipate positive or negative shifts in in-
dustry structure before they are obvious. The
five forces distinguish short-term blips from
structural changes and allow investors to take
advantage of undue pessimism or optimism.
Those companies whose strategies have indus-
try-transforming potential become far clearer.
This deeper thinking about competition is a
more powerful way to achieve genuine invest-
ment success than the financial projections
and trend extrapolation that dominate today’s
investment analysis.
Common Pitfalls
In conducting the analysis avoid
the following common mistakes:
• Defining the industry too
broadly or too narrowly.
• Making lists instead of engaging
in rigorous analysis.
• Paying equal attention to all of
the forces rather than digging
deeply into the most important
ones.
• Confusing effect (price sensitiv-
ity) with cause (buyer econom-
ics).
• Using static analysis that ignores
industry trends.
• Confusing cyclical or transient
changes with true structural
changes.
• Using the framework to declare
an industry attractive or unat-
tractive rather than using it to
guide strategic choices.
page 39

The Five Competitive Forces That Shape Strategy
harvard business review • january 2008
If both executives and investors looked at
competition this way, capital markets would be
a far more effective force for company success
and economic prosperity. Executives and inves-
tors would both be focused on the same funda-
mentals that drive sustained profitability. The
conversation between investors and execu-
tives would focus on the structural, not the
transient. Imagine the improvement in com-
pany performance—and in the economy as a
whole—if all the energy expended in “pleasing
the Street” were redirected toward the factors
that create true economic value.
1. For a discussion of the value chain framework, see
Michael E. Porter, Competitive Advantage: Creating and Sus-
taining Superior Performance (The Free Press, 1998).
2. For a discussion of how internet technology improves the
attractiveness of some industries while eroding the profit-
ability of others, see Michael E. Porter, “Strategy and the
Internet” (HBR, March 2001).
3. See, for instance, Adam M. Brandenburger and Barry J.
Nalebuff, Co-opetition (Currency Doubleday, 1996).
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Further Reading
A R T I C L E
What Is Strategy?
by Michael E. Porter
Harvard Business Review
February 2000
Product no. 4134
By analyzing the five competitive forces, you
uncover opportunities to position your com-
pany strategically; that is, to gain a sustainable
advantage over rivals by preserving what’s
distinctive about your company. Your strategic
position hinges on performing different activi-
ties from competitors or performing similar
activities, but in different ways. It emerges
from three sources: 1) serving few needs of
many customers (for example, Jiffy Lube pro-
vides only auto lubricants), 2) serving broad
needs of few customers (Bessemer Trust tar-
gets only very high-wealth clients), or 3) serv-
ing broad needs of many customers in a nar-
row market (Carmike Cinemas operates only
in cities with a population under 200,000).
B O O K S
Redefining Health Care: Creating Value-
Based Competition on Results
by Michael E. Porter and
Elizabeth Olmsted Teisberg
Harvard Business School Press
May 2006
Product no. 7782
In this book Porter and Teisberg analyze the
competitive forces responsible for the current
crisis in U.S. health care. The authors argue
that participants in the health care system
have competed to shift costs, accumulate bar-
gaining power, and restrict services rather
than create value for patients. This zero-sum
competition takes place at the wrong level—
among health plans, networks, and hospi-
tals—rather than where it matters most: in the
diagnosis, treatment, and prevention of spe-
cific health conditions. Redefining Health Care
lays out a breakthrough framework for rede-
fining health care competition based on pa-
tient value. With specific recommendations
for hospitals, doctors, health plans, employers,
and policy makers, this book shows how to
move to a positive-sum competition that will
unleash stunning improvements in quality
and efficiency.
On Competition
by Michael E. Porter
Harvard Business School Press
September 1998
Product no. 7951
Porter’s work, which began with his original
formulation of the five forces, has defined our
fundamental understanding of competition
and competitive strategy. This book is a com-
pilation of a dozen Porter articles: two new ar-
ticles and ten of his articles from Harvard Busi-
ness Review. Together, these essays provide a
complete picture of Porter’s perspective on
modern competition. Organized around three
primary categories: Competition and Strategy:
Core Concepts, The Competitiveness of Loca-
tion, and Competitive Solutions to Societal
Problems, these articles develop the building
blocks that define competitive strategy.
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Building Your
Company’s Vision

by James C. Collins and Jerry I. Porras

Included with this full-text

Harvard Business Review

article:
The Idea in Brief—the core idea
The Idea in Practice—putting the idea to work

43

Article Summary

44

Building Your Company’s Vision
A list of related materials, with annotations to guide further
exploration of the article’s ideas and applications

56

Further Reading

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Building Your Company’s Vision

The Idea in Brief The Idea in Practice

C
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Hewlett-Packard. 3M. Sony. Companies
with exceptionally durable visions that are
“built to last.” What distinguishes their vi-
sions from most others, those empty mud-
dles that get revised with every passing
business fad, but never prompt anything
more than a yawn? Enduring companies
have clear plans for how they will advance
into an uncertain future. But they are
equally clear about how they will remain
steadfast, about the values and purposes
they will always stand for. This

Harvard Busi-
ness Review

article describes the two com-
ponents of any lasting vision:

core ideology

and an

envisioned future

.
A company’s practices and strategies should
change continually; its core ideology should
not. Core ideology defines a company’s time-
less character. It’s the glue that holds the
enterprise together even when everything
else is up for grabs. Core ideology is some-
thing you

discover

—by looking inside. It’s not
something you can invent, much less fake.
A core ideology has two parts:

1. Core values are the handful of guiding
principles by which a company navigates.

They require no external justification. For ex-
ample, Disney’s core values of imagination
and wholesomeness stem from the founder’s
belief that these should be nurtured for their
own sake, not merely to capitalize on a busi-
ness opportunity. Instead of changing its
core values, a great company will change its
markets—seek out different customers—in
order to remain true to its core values.

2. Core purpose is an organization’s most
fundamental reason for being.

It should not
be confused with the company’s current
product lines or customer segments. Rather, it
reflects people’s idealistic motivations for
doing the company’s work. Disney’s core pur-
pose is to make people happy—not to build
theme parks and make cartoons.
An envisioned future, the second component
of an effective vision, has two elements:

1. Big, Hairy, Audacious Goals (BHAGs) are
ambitious plans that rev up the entire orga-
nization.

They typically require 10 to 30 years’
work to complete.

2. Vivid descriptions paint a picture of what
it will be like to achieve the BHAGs.

They
make the goals vibrant, engaging—and tangible.
Example:

In the 1950s, Sony’s goal was to “become
the company most known for changing
the worldwide poor-quality image of Japa-
nese products.” It made this BHAG vivid by
adding, “Fifty years from now, our brand
name will be as well known as any in the
world . . . and will signify innovation and
quality. . . .‘Made in Japan’ will mean some-
thing fine, not something shoddy.”
Don’t confuse your company’s core ideology
with its envisioned future—in particular, don’t
confuse a BHAG with a core purpose. A BHAG
is a clearly articulated goal that is reachable
within 10 to 30 years. But your core purpose
can never be completed.
page 43

Building Your
Company’s Vision

by James C. Collins and Jerry I. Porras

harvard business review • september–october 1996

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.

We shall not cease from exploration / And
the end of all our exploring / Will be to arrive
where we started / And know the place for
the first time.

T.S. Eliot,

Four Quartets

Companies that enjoy enduring success have
core values and a core purpose that remain
fixed while their business strategies and prac-
tices endlessly adapt to a changing world. The
dynamic of preserving the core while stimulat-
ing progress is the reason that companies such
as Hewlett-Packard, 3M, Johnson & Johnson,
Procter & Gamble, Merck, Sony, Motorola,
and Nordstrom became elite institutions able
to renew themselves and achieve superior
long-term performance. Hewlett-Packard em-
ployees have long known that radical change
in operating practices, cultural norms, and
business strategies does not mean losing the
spirit of the HP Way—the company’s core
principles. Johnson & Johnson continually
questions its structure and revamps its pro-
cesses while preserving the ideals embodied in
its credo. In 1996, 3M sold off several of its
large mature businesses—a dramatic move
that surprised the business press—to refocus
on its enduring core purpose of solving un-
solved problems innovatively. We studied
companies such as these in our research for

Built to Last: Successful Habits of Visionary Com-
panies

and found that they have outperformed
the general stock market by a factor of 12
since 1925.
Truly great companies understand the dif-
ference between what should never change
and what should be open for change, between
what is genuinely sacred and what is not.
This rare ability to manage continuity and
change—requiring a consciously practiced
discipline—is closely linked to the ability to
develop a vision. Vision provides guidance
about what core to preserve and what future
to stimulate progress toward. But

vision

has
become one of the most overused and least
understood words in the language, conjuring
up different images for different people: of
deeply held values, outstanding achievement,
societal bonds, exhilarating goals, motivating
page 44

Building Your Company’s Vision

harvard business review • september–october 1996

forces, or raisons d’être. We recommend a
conceptual framework to define vision, add
clarity and rigor to the vague and fuzzy con-
cepts swirling around that trendy term, and
give practical guidance for articulating a co-
herent vision within an organization. It is a
prescriptive framework rooted in six years of
research and refined and tested by our ongo-
ing work with executives from a great variety
of organizations around the world.
A well-conceived vision consists of two
major components:

core ideology

and

envi-
sioned future

. (See the exhibit “Articulating a
Vision.”) Core ideology, the yin in our scheme,
defines what we stand for and why we exist.
Yin is unchanging and complements yang, the
envisioned future. The envisioned future is
what we aspire to become, to achieve, to cre-
ate—something that will require significant
change and progress to attain.

Core Ideology

Core ideology defines the enduring character
of an organization—a consistent identity that
transcends product or market life cycles,
technological breakthroughs, management
fads, and individual leaders. In fact, the most
lasting and significant contribution of those
who build visionary companies is the core
ideology. As Bill Hewlett said about his
longtime friend and business partner David
Packard upon Packard’s death not long ago,
“As far as the company is concerned, the
greatest thing he left behind him was a code
of ethics known as the HP Way.” HP’s core
ideology, which has guided the company
since its inception more than 50 years ago,
includes a deep respect for the individual, a
dedication to affordable quality and reli-
ability, a commitment to community respon-
sibility (Packard himself bequeathed his $4.3
billion of Hewlett-Packard stock to a charita-
ble foundation), and a view that the company
exists to make technical contributions for the
advancement and welfare of humanity. Com-
pany builders such as David Packard, Masaru
Ibuka of Sony, George Merck of Merck, Will-
iam McKnight of 3M, and Paul Galvin of Mo-
torola understood that it is more important
to know who you are than where you are go-
ing, for where you are going will change as
the world around you changes. Leaders die,
products become obsolete, markets change,
new technologies emerge, and management
fads come and go, but core ideology in a great
company endures as a source of guidance
and inspiration.
Core ideology provides the glue that holds
an organization together as it grows, decen-
tralizes, diversifies, expands globally, and de-
velops workplace diversity. Think of it as
analogous to the principles of Judaism that
held the Jewish people together for centuries
without a homeland, even as they spread
throughout the Diaspora. Or think of the
truths held to be self-evident in the Declara-
tion of Independence, or the enduring ideals
and principles of the scientific community
that bond scientists from every nationality
together in the common purpose of advanc-
ing human knowledge. Any effective vision
must embody the core ideology of the orga-
nization, which in turn consists of two dis-
tinct parts: core values, a system of guiding
principles and tenets; and core purpose,
the organization’s most fundamental reason
for existence.

Core Values.

Core values are the essential
and enduring tenets of an organization. A
small set of timeless guiding principles, core
values require no external justification; they
have

intrinsic

value and importance to those
inside the organization. The Walt Disney
Company’s core values of imagination and
wholesomeness stem not from market re-
quirements but from the founder’s inner
belief that imagination and wholesomeness
should be nurtured for their own sake. Wil-
liam Procter and James Gamble didn’t instill
in P&G’s culture a focus on product excel-
lence merely as a strategy for success but as
an almost religious tenet. And that value has
been passed down for more than 15 decades
by P&G people. Service to the customer—
even to the point of subservience—is a way of
life at Nordstrom that traces its roots back to
1901, eight decades before customer service
programs became stylish. For Bill Hewlett
and David Packard, respect for the individual
was first and foremost a deep personal
value; they didn’t get it from a book or hear it
from a management guru. And Ralph S.
Larsen, CEO of Johnson & Johnson, puts it
this way: “The core values embodied in our
credo might be a competitive advantage, but
that is not

why

we have them. We have them
because they define for us what we stand
for, and we would hold them even if they

James C. Collins

is a management ed-
ucator and writer based in Boulder,
Colorado, where he operates a man-
agement learning laboratory for con-
ducting research and working with
executives. He is also a visiting profes-
sor of business administration at the
University of Virginia in Charlottesville.

Jerry I. Porras

is the Lane Professor of
Organizational Behavior and Change at
Stanford University’s Graduate School
of Business in Stanford, California,
where he is also the director of the Ex-
ecutive Program in Leading and Man-
aging Change. Collins and Porras are
coauthors of

Built to Last: Successful
Habits of Visionary Companies

(Harper-
Business, 1994).
page 45

Building Your Company’s Vision

harvard business review • september–october 1996

became a competitive

dis

advantage in cer-
tain situations.”
The point is that a great company decides
for itself what values it holds to be core, largely
independent of the current environment, com-
petitive requirements, or management fads.
Clearly, then, there is no universally right set
of core values. A company need not have as its
core value customer service (Sony doesn’t) or
respect for the individual (Disney doesn’t) or
quality (Wal-Mart Stores doesn’t) or market
focus (HP doesn’t) or teamwork (Nordstrom
doesn’t). A company might have operating
practices and business strategies around those
qualities without having them at the essence of
its being. Furthermore, great companies need
not have likable or humanistic core values,
although many do. The key is not

what

core
values an organization has but that it has core
values at all.
Companies tend to have only a few core val-
ues, usually between three and five. In fact,
we found that none of the visionary compa-
nies we studied in our book had more than
five: most had only three or four. (See the in-
sert “Core Values Are a Company’s Essential
Tenets.”) And, indeed, we should expect that.
Only a few values can be truly

core

—that is, so
fundamental and deeply held that they will
change seldom, if ever.
To identify the core values of your own
organization, push with relentless honesty to
define what values are truly central. If you
articulate more than five or six, chances are
that you are confusing core values (which do
not change) with operating practices, business
strategies, or cultural norms (which should be
open to change). Remember, the values must
stand the test of time. After you’ve drafted a
preliminary list of the core values, ask about
each one, If the circumstances changed and

penalized

us for holding this core value, would
we still keep it? If you can’t honestly answer
yes, then the value is not core and should be
dropped from consideration.
A high-technology company wondered
whether it should put quality on its list of core
values. The CEO asked, “Suppose in ten years
quality doesn’t make a hoot of difference in
our markets. Suppose the only thing that mat-
ters is sheer speed and horsepower but not
quality. Would we still want to put quality on
our list of core values?” The members of the
management team looked around at one an-
other and finally said no. Quality stayed in the

strategy

of the company, and quality-improvement
programs remained in place as a mechanism
for stimulating progress; but quality did not
make the list of core values.
The same group of executives then wres-
tled with leading-edge innovation as a core
value. The CEO asked, “Would we keep inno-
vation on the list as a core value, no matter
how the world around us changed?” This
time, the management team gave a resound-
ing yes. The managers’ outlook might be
summarized as, “We always want to do leading-
edge innovation. That’s who we are. It’s re-
ally important to us and always will be. No
matter what. And if our current markets
don’t value it, we will find markets that do.”
Leading-edge innovation went on the list
and will stay there. A company should not
change its core values in response to market
changes; rather, it should change markets, if
necessary, to remain true to its core values.
Who should be involved in articulating the
core values varies with the size, age, and geo-
graphic dispersion of the company, but in
many situations we have recommended what
we call a

Mars Group

. It works like this: Imag-
ine that you’ve been asked to re-create the
very best attributes of your organization on
another planet but you have seats on the
rocket ship for only five to seven people.
Whom should you send? Most likely, you’ll
choose the people who have a gut-level un-
derstanding of your core values, the highest
level of credibility with their peers, and the
Articulating a Vision
Core Ideology
Core values
Core purpose
Envisioned Future
10-to-30-year BHAG
(Big, Hairy, Audacious Goal)
Vivid description
page 46

Building Your Company’s Vision

harvard business review • september–october 1996

highest levels of competence. We’ll often ask
people brought together to work on core val-
ues to nominate a Mars Group of five to seven
individuals (not necessarily all from the as-
sembled group). Invariably, they end up se-
lecting highly credible representatives who do
a super job of articulating the core values
precisely because they are exemplars of those
values—a representative slice of the com-
pany’s genetic code.
Even global organizations composed of peo-
ple from widely diverse cultures can identify a
set of shared core values. The secret is to work
from the individual to the organization. People
involved in articulating the core values need to
answer several questions: What core values do
you personally bring to your work? (These
should be so fundamental that you would hold
them regardless of whether or not they were
rewarded.) What would you tell your children
are the core values that you hold at work and
that you hope

they

will hold when they be-
come working adults? If you awoke tomorrow
morning with enough money to retire for the
rest of your life, would you continue to live
those core values? Can you envision them
being as valid for you 100 years from now as
they are today? Would you want to hold those
core values, even if at some point one or more
of them became a competitive

dis

advantage? If
you were to start a new organization tomor-
row in a different line of work, what core val-
ues would you build into the new organization
regardless of its industry? The last three ques-
tions are particularly important because they
make the crucial distinction between enduring
core values that should not change and prac-
tices and strategies that should be changing all
the time.

Core Purpose.

Core purpose, the second
part of core ideology, is the organization’s rea-
son for being. An effective purpose reflects
people’s idealistic motivations for doing the
company’s work. It doesn’t just describe the
organization’s output or target customers; it
captures the soul of the organization. (See the
insert “Core Purpose Is a Company’s Reason
for Being.”) Purpose, as illustrated by a speech
David Packard gave to HP employees in 1960,
gets at the deeper reasons for an organiza-
tion’s existence beyond just making money.
Packard said,

I want to discuss why a company exists in
the first place. In other words, why are we here?
I think many people assume, wrongly, that a
company exists simply to make money. While
this is an important result of a company’s exist-
ence, we have to go deeper and find the real
reasons for our being. As we investigate this,
we inevitably come to the conclusion that a
group of people get together and exist as an
institution that we call a company so they are
able to accomplish something collectively that
they could not accomplish separately—they
make a contribution to society, a phrase which
sounds trite but is fundamental… You can look
around [in the general business world and] see
people who are interested in money and noth-
ing else, but the underlying drives come
largely from a desire to do something else: to
make a product, to give a service—generally
to do something which is of value.

1

Purpose (which should last at least 100
years) should not be confused with specific
goals or business strategies (which should
change many times in 100 years). Whereas
you might achieve a goal or complete a strat-
egy, you cannot fulfill a purpose; it is like a
guiding star on the horizon—forever pursued
but never reached. Yet although purpose it-
self does not change, it does inspire change.
The very fact that purpose can never be fully
realized means that an organization can
never stop stimulating change and progress.

Core Values Are a Company’s Essential Tenets

Merck
•

Corporate social responsibility

•

Unequivocal excellence in all as-
pects of the company

•

Science-based innovation

•

Honesty and integrity

•

Profit, but profit from work that
benefits humanity

Nordstrom
•

Service to the customer above all
else

•

Hard work and individual productivity

•

Never being satisfied

•

Excellence in reputation; being part
of something special

Philip Morris
•

The right to freedom of choice

•

Winning—beating others in a good
fight

•

Encouraging individual initiative

•

Opportunity based on merit; no one
is entitled to anything

•

Hard work and continuous self-
improvement

Sony
•

Elevation of the Japanese culture
and national status

•

Being a pioneer—not following
others; doing the impossible

•

Encouraging individual ability and
creativity

Walt Disney
•

No cynicism

•

Nurturing and promulgation of
“wholesome American values”

•

Creativity, dreams, and imagination

•

Fanatical attention to consistency
and detail

•

Preservation and control of the
Disney magic
page 47

Building Your Company’s Vision

harvard business review • september–october 1996

In identifying purpose, some companies
make the mistake of simply describing their
current product lines or customer segments.
We do not consider the following statement
to reflect an effective purpose: “We exist to
fulfill our government charter and partici-
pate in the secondary mortgage market by
packaging mortgages into investment securi-
ties.” The statement is merely descriptive. A
far more effective statement of purpose
would be that expressed by the executives of
the Federal National Mortgage Association,
Fannie Mae: “To strengthen the social fabric
by continually democratizing home owner-
ship.” The secondary mortgage market as we
know it might not even exist in 100 years,
but strengthening the social fabric by contin-
ually democratizing home ownership can be
an enduring purpose, no matter how much
the world changes. Guided and inspired by
this purpose, Fannie Mae launched in the
early 1990s a series of bold initiatives, includ-
ing a program to develop new systems for re-
ducing mortgage underwriting costs by 40%
in five years; programs to eliminate discrimi-
nation in the lending process (backed by
$5 billion in underwriting experiments); and
an audacious goal to provide, by the year
2000, $1 trillion targeted at 10 million fami-
lies that had traditionally been shut out of
home ownership—minorities, immigrants,
and low-income groups.
Similarly, 3M defines its purpose not in
terms of adhesives and abrasives but as the
perpetual quest to solve unsolved problems
innovatively—a purpose that is always leading
3M into new fields. McKinsey & Company’s
purpose is not to do management consulting
but to help corporations and governments be
more successful: in 100 years, it might involve
methods other than consulting. Hewlett-
Packard doesn’t exist to make electronic test
and measurement equipment but to make
technical contributions that improve people’s
lives—a purpose that has led the company far
afield from its origins in electronic instru-
ments. Imagine if Walt Disney had conceived
of his company’s purpose as to make cartoons,
rather than to make people happy; we proba-
bly wouldn’t have Mickey Mouse, Disneyland,
EPCOT Center, or the Anaheim Mighty Ducks
Hockey Team.
One powerful method for getting at purpose
is the

five whys

. Start with the descriptive state-
ment We make X products or We deliver X
services, and then ask, Why is that important?
five times. After a few whys, you’ll find that
you’re getting down to the fundamental pur-
pose of the organization.
We used this method to deepen and enrich a
discussion about purpose when we worked
with a certain market-research company. The
executive team first met for several hours and
generated the following statement of purpose
for their organization: To provide the best mar-
ket-research data available. We then asked the
following question: Why is it important to pro-
vide the best market-research data available?
After some discussion, the executives answered
in a way that reflected a deeper sense of their
organization’s purpose: To provide the best
market-research data available so that our cus-
tomers will understand their markets better
than they could otherwise. A further discus-
sion let team members realize that their sense
of self-worth came not just from helping cus-
tomers understand their markets better but
also from making a

contribution

to their cus-
tomers’ success. This introspection eventually
led the company to identify its purpose as: To
contribute to our customers’ success by help-
ing them understand their markets. With this
purpose in mind, the company now frames its
product decisions not with the question Will it

Core Purpose Is a Company’s Reason for
Being

3M:

To solve unsolved problems inno-
vatively

Cargill:

To improve the standard of liv-
ing around the world

Fannie Mae:

To strengthen the social
fabric by continually democratizing
home ownership

Hewlett-Packard:

To make technical
contributions for the advancement and
welfare of humanity

Lost Arrow Corporation:

To be a
role model and a tool for social
change

Pacific Theatres:

To provide a place
for people to flourish and to enhance the
community

Mary Kay Cosmetics:

To give unlim-
ited opportunity to women

McKinsey & Company:

To help lead-
ing corporations and governments be
more successful

Merck:

To preserve and improve
human life

Nike:

To experience the emotion of
competition, winning, and crushing
competitiors

Sony:

To experience the joy of advanc-
ing and applying technology for the
benefit of the public

Telecare Corporation:

To help people
with mental impairments realize their
full potential

Wal-Mart:

To give ordinary folk the
chance to buy the same things as rich
people

Walt Disney:

To make people happy
page 48

Building Your Company’s Vision

harvard business review • september–october 1996

sell? but with the question Will it make a con-
tribution to our customers’ success?
The five whys can help companies in any
industry frame their work in a more mean-
ingful way. An asphalt and gravel company
might begin by saying, We make gravel and
asphalt products. After a few whys, it could
conclude that making asphalt and gravel is
important because the quality of the infra-
structure plays a vital role in people’s safety
and experience; because driving on a pitted
road is annoying and dangerous; because
747s cannot land safely on runways built
with poor workmanship or inferior concrete;
because buildings with substandard materi-
als weaken with time and crumble in earth-
quakes. From such introspection may
emerge this purpose: To make people’s lives
better by improving the quality of man-
made structures. With a sense of purpose
very much along those lines, Granite Rock
Company of Watsonville, California, won the
Malcolm Baldrige National Quality Award—
not an easy feat for a small rock quarry and
asphalt company. And Granite Rock has
gone on to be one of the most progressive
and exciting companies we’ve encountered
in

any

industry.
Notice that none of the core purposes fall
into the category “maximize shareholder
wealth.” A primary role of core purpose is to
guide and inspire. Maximizing shareholder
wealth does not inspire people at all levels of
an organization, and it provides precious little
guidance. Maximizing shareholder wealth is
the standard off-the-shelf purpose for those or-
ganizations that have not yet identified their
true core purpose. It is a substitute—and a
weak one at that.
When people in great organizations talk
about their achievements, they say very little
about earnings per share. Motorola people
talk about impressive quality improvements
and the effect of the products they create on
the world. Hewlett-Packard people talk about
their technical contributions to the market-
place. Nordstrom people talk about heroic
customer service and remarkable individual
performance by star salespeople. When a Boe-
ing engineer talks about launching an excit-
ing and revolutionary new aircraft, she does
not say, “I put my heart and soul into this
project because it would add 37 cents to our
earnings per share.”
One way to get at the purpose that lies beyond
merely maximizing shareholder wealth is to
play the “Random Corporate Serial Killer”
game. It works like this: Suppose you could sell
the company to someone who would pay a
price that everyone inside and outside the
company agrees is more than fair (even with a
very generous set of assumptions about the ex-
pected future cash flows of the company). Sup-
pose further that this buyer would guarantee
stable employment for all employees at the
same pay scale after the purchase but with no
guarantee that those jobs would be in the
same industry. Finally, suppose the buyer plans
to kill the company after the purchase—its
products or services would be discontinued, its
operations would be shut down, its brand
names would be shelved forever, and so on.
The company would utterly and completely
cease to exist. Would you accept the offer?
Why or why not? What would be lost if the
company ceased to exist? Why is it important
that the company continue to exist? We’ve
found this exercise to be very powerful for
helping hard-nosed, financially focused execu-
tives reflect on their organization’s deeper
reasons for being.
Another approach is to ask each member of
the Mars Group, How could we frame the pur-
pose of this organization so that if you woke
up tomorrow morning with enough money in
the bank to retire, you would nevertheless
keep working here? What deeper sense of pur-
pose would motivate you to continue to dedi-
cate your precious creative energies to this
company’s efforts?
As they move into the twenty-first century,
companies will need to draw on the full creative
energy and talent of their people. But why
should people give full measure? As Peter
Drucker has pointed out, the best and most dedi-
cated people are ultimately volunteers, for they
have the opportunity to do something else with
their lives. Confronted with an increasingly mo-
bile society, cynicism about corporate life, and an
expanding entrepreneurial segment of the econ-
omy, companies more than ever need to have a
clear understanding of their purpose in order to
make work meaningful and thereby attract, mo-
tivate, and retain outstanding people.

Discovering Core Ideology

You do not create or set core ideology. You

dis-
cover

core ideology. You do not deduce it by
Listen to people in truly
great companies talk
about their
achievements—you will
hear little about earnings
per share.
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Building Your Company’s Vision

harvard business review • september–october 1996

looking at the external environment. You un-
derstand it by looking inside. Ideology has to
be authentic. You cannot fake it. Discovering
core ideology is not an intellectual exercise.
Do not ask, What core values should we hold?
Ask instead, What core values do we truly and
passionately hold? You should not confuse val-
ues that you think the organization ought to
have—but does not—with authentic core val-
ues. To do so would create cynicism through-
out the organization. (“Who’re they trying to
kid? We all know that isn’t a core value around
here!”) Aspirations are more appropriate as
part of your envisioned future or as part of
your strategy, not as part of the core ideology.
However, authentic core values that have
weakened over time can be considered a legit-
imate part of the core ideology—as long as
you acknowledge to the organization that you
must work hard to revive them.
Also be clear that the role of core ideology
is to guide and inspire, not to differentiate.
Two companies can have the same core values
or purpose. Many companies could have the
purpose to make technical contributions, but
few live it as passionately as Hewlett-Packard.
Many companies could have the purpose to
preserve and improve human life, but few
hold it as deeply as Merck. Many companies
could have the core value of heroic customer
service, but few create as intense a culture
around that value as Nordstrom. Many com-
panies could have the core value of innova-
tion, but few create the powerful alignment
mechanisms that stimulate the innovation we
see at 3M. The authenticity, the discipline,
and the consistency with which the ideology
is lived—not the content of the ideology—
differentiate visionary companies from the
rest of the pack.
Core ideology needs to be meaningful and
inspirational only to people inside the organi-
zation; it need not be exciting to outsiders.
Why not? Because it is the people inside the
organization who need to commit to the orga-
nizational ideology over the long term. Core
ideology can also play a role in determining
who

is

inside and who is not. A clear and well-
articulated ideology attracts to the company
people whose personal values are compatible
with the company’s core values; conversely, it
repels those whose personal values are incom-
patible. You cannot impose new core values
or purpose on people. Nor are core values and
purpose things people can buy into. Execu-
tives often ask, How do we get people to
share our core ideology? You don’t. You can’t.
Instead, find people who are predisposed to
share your core values and purpose; attract
and retain those people; and let those who do
not share your core values go elsewhere. In-
deed, the very process of articulating core ide-
ology may cause some people to leave when
they realize that they are not personally com-
patible with the organization’s core. Wel-
come that outcome. It is certainly desirable to
retain within the core ideology a diversity of
people and viewpoints. People who share the
same core values and purpose do not neces-
sarily all think or look the same.
Don’t confuse core ideology itself with
core-ideology statements. A company can
have a very strong core ideology without a
formal statement. For example, Nike has not
(to our knowledge) formally articulated a
statement of its core purpose. Yet, according
to our observations, Nike has a powerful core
purpose that permeates the entire organiza-
tion: to experience the emotion of competi-
tion, winning, and crushing competitors. Nike
has a campus that seems more like a shrine to
the competitive spirit than a corporate office
complex. Giant photos of Nike heroes cover
the walls, bronze plaques of Nike athletes hang
along the Nike Walk of Fame, statues of Nike
athletes stand alongside the running track
that rings the campus, and buildings honor
champions such as Olympic marathoner Joan
Benoit, basketball superstar Michael Jordan,
and tennis pro John McEnroe. Nike people
who do not feel stimulated by the competitive
spirit and the urge to be ferocious simply do
not last long in the culture. Even the com-
pany’s name reflects a sense of competition:
Nike is the Greek goddess of victory. Thus,
although Nike has not formally articulated its
purpose, it clearly has a strong one.
Identifying core values and purpose is
therefore not an exercise in wordsmithery. In-
deed, an organization will generate a variety
of statements over time to describe the core
ideology. In Hewlett-Packard‘s archives, we
found more than half a dozen distinct ver-
sions of the HP Way, drafted by David Pack-
ard between 1956 and 1972. All versions stated
the same principles, but the words used var-
ied depending on the era and the circum-
stances. Similarly, Sony’s core ideology has
You discover core ideology
by looking inside. It has to
be authentic. You can’t
fake it.
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Building Your Company’s Vision

harvard business review • september–october 1996

been stated many different ways over the
company’s history. At its founding, Masaru
Ibuka described two key elements of Sony’s
ideology: “We shall welcome technical diffi-
culties and focus on highly sophisticated tech-
nical products that have great usefulness for
society regardless of the quantity involved; we
shall place our main emphasis on ability, per-
formance, and personal character so that each
individual can show the best in ability and
skill.”

2

Four decades later, this same concept
appeared in a statement of core ideology
called Sony Pioneer Spirit: “Sony is a pioneer
and never intends to follow others. Through
progress, Sony wants to serve the whole
world. It shall be always a seeker of the un-
known…. Sony has a principle of respecting
and encouraging one’s ability…and always
tries to bring out the best in a person. This is
the vital force of Sony.”

3

Same core values, dif-
ferent words.
You should therefore focus on getting the
content right—on capturing the essence of
the core values and purpose. The point is not
to create a perfect statement but to gain a
deep understanding of your organization’s
core values and purpose, which can then be
expressed in a multitude of ways. In fact, we
often suggest that once the core has been
identified, managers should generate their
own statements of the core values and pur-
pose to share with their groups.
Finally, don’t confuse core ideology with
the concept of core competence. Core com-
petence is a strategic concept that defines
your organization’s capabilities—what you
are particularly good at—whereas core ideol-
ogy captures what you stand for and why
you exist. Core competencies should be well
aligned with a company’s core ideology and
are often rooted in it; but they are not the
same thing. For example, Sony has a core
competence of miniaturization—a strength
that can be strategically applied to a wide
array of products and markets. But it does
not have a core

ideology

of miniaturization.
Sony might not even have miniaturization as
part of its strategy in 100 years, but to re-
main a great company, it will still have the
same core values described in the Sony Pi-
oneer Spirit and the same fundamental
reason for being—namely, to advance tech-
nology for the benefit of the general public.
In a visionary company like Sony, core com-
petencies change over the decades, whereas
core ideology does not.
Once you are clear about the core ideology,
you should feel free to change absolutely

any-
thing

that is not part of it. From then on, when-
ever someone says something should not
change because “it’s part of our culture” or
“we’ve always done it that way” or any such ex-
cuse, mention this simple rule: If it’s not core,
it’s up for change. The strong version of the
rule is,

If it’s not core, change it!

Articulating
core ideology is just a starting point, however.
You also must determine what type of progress
you want to stimulate.

Envisioned Future

The second primary component of the vision
framework is

envisioned future

. It consists of
two parts: a 10-to-30-year audacious goal plus
vivid descriptions of what it will be like to
achieve the goal. We recognize that the phrase

envisioned future

is somewhat paradoxical.
On the one hand, it conveys concreteness—
something visible, vivid, and real. On the
other hand, it involves a time yet unrealized—
with its dreams, hopes, and aspirations.

Vision-level BHAG.

We found in our re-
search that visionary companies often use bold
missions—or what we prefer to call

BHAGs

(pronounced BEE-hags and shorthand for Big,
Hairy, Audacious Goals)—as a powerful way to
stimulate progress. All companies have goals.
But there is a difference between merely hav-
ing a goal and becoming committed to a huge,
daunting challenge—such as climbing Mount
Everest. A true BHAG is clear and compelling,
serves as a unifying focal point of effort, and
acts as a catalyst for team spirit. It has a clear
finish line, so the organization can know when
it has achieved the goal; people like to shoot for
finish lines. A BHAG engages people—it
reaches out and grabs them. It is tangible, ener-
gizing, highly focused. People get it right away;
it takes little or no explanation. For example,
NASA’s 1960s moon mission didn’t need a com-
mittee of wordsmiths to spend endless hours
turning the goal into a verbose, impossible-to-
remember mission statement. The goal itself
was so easy to grasp—so compelling in its own
right—that it could be said 100 different ways
yet be easily understood by everyone. Most cor-
porate statements we’ve seen do little to spur
forward movement because they do not con-
tain the powerful mechanism of a BHAG.
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Building Your Company’s Vision

harvard business review • september–october 1996

Although organizations may have many
BHAGs at different levels operating at the
same time, vision requires a special type of
BHAG—a vision-level BHAG that applies to
the entire organization and requires 10 to 30
years of effort to complete. Setting the BHAG
that far into the future requires thinking be-
yond the current capabilities of the organization
and the current environment. Indeed, invent-
ing such a goal forces an executive team to be
visionary, rather than just strategic or tactical.
A BHAG should not be a sure bet—it will
have perhaps only a 50% to 70% probability of
success—but the organization must believe
that it can reach the goal anyway. A BHAG
should require extraordinary effort and per-
haps a little luck. We have helped companies
create a vision-level BHAG by advising them
to think in terms of four broad categories: tar-
get BHAGs, common-enemy BHAGs, role-
model BHAGs, and internal-transformation
BHAGs. (See the insert “Big, Hairy, Audacious
Goals Aid Long-Term Vision.”)

Vivid Description.

In addition to vision-
level BHAGs, an envisioned future needs what
we call vivid description—that is, a vibrant, en-
gaging, and specific description of what it will
be like to achieve the BHAG. Think of it as
translating the vision from words into pic-
tures, of creating an image that people can
carry around in their heads. It is a question of
painting a picture with your words. Picture
painting is essential for making the 10-to-30-
year BHAG tangible in people’s minds.
For example, Henry Ford brought to life the
goal of democratizing the automobile with this
vivid description: “I will build a motor car for
the great multitude…. It will be so low in price
that no man making a good salary will be un-
able to own one and enjoy with his family the
blessing of hours of pleasure in God’s great
open spaces…. When I’m through, everybody
will be able to afford one, and everyone will
have one. The horse will have disappeared
from our highways, the automobile will be
taken for granted…[and we will] give a large
number of men employment at good wages.”
The components-support division of a
computer-products company had a general
manager who was able to describe vividly the
goal of becoming one of the most sought-after
divisions in the company: “We will be re-
spected and admired by our peers…. Our solu-
tions will be actively sought by the end-prod-
uct divisions, who will achieve significant
product ‘hits’ in the marketplace largely be-
cause of our technical contribution…. We will
have pride in ourselves…. The best up-and-
coming people in the company will seek to
work in our division…. People will give unsolic-
ited feedback that they love what they are do-
ing…. [Our own] people will walk on the balls
of their feet…. [They] will willingly work hard
because they want to…. Both employees and
customers will feel that our division has con-
tributed to their life in a positive way.”
In the 1930s, Merck had the BHAG to trans-
form itself from a chemical manufacturer into
one of the preeminent drug-making compa-
nies in the world, with a research capability to
rival any major university. In describing this
envisioned future, George Merck said at the
opening of Merck’s research facility in 1933,

Big, Hairy, Audacious Goals Aid Long-Term
Vision

Target BHAGs can be quantitative or
qualitative
•

Become a $125 billion company
by the year 2000 (Wal-Mart,
1990)

•

Democratize the automobile (Ford
Motor Company, early 1900s)

•

Become the company most known
for changing the worldwide poor-
quality image of Japanese products
(Sony, early 1950s)

•

Become the most powerful, the
most serviceable, the most far-
reaching world financial institu-
tion that has ever been (City
Bank, predecessor to Citicorp,
1915)

•

Become the dominant player in
commercial aircraft and bring the
world into the jet age (Boeing,
1950)

Common-enemy BHAGs involve
David-versus-Goliath thinking
•

Knock off RJR as the number one to-
bacco company in the world (Philip
Morris, 1950s)
• Crush Adidas (Nike, 1960s)
• Yamaha wo tsubusu! We will destroy
Yamaha! (Honda, 1970s)
Role-model BHAGs suit up-and-coming
organizations
• Become the Nike of the cycling in-
dustry (Giro Sport Design, 1986)
• Become as respected in 20 years as
Hewlett-Packard is today (Watkins-
Johnson, 1996)
• Become the Harvard of the West
(Stanford University, 1940s)
Internal-transformation BHAGs suit
large, established organizations
• Become number one or number
two in every market we serve and
revolutionize this company to have
the strengths of a big company com-
bined with the leanness and agility
of a small company (General Elec-
tric Company, 1980s)
• Transform this company from a de-
fense contractor into the best diver-
sified high-technology company in
the world (Rockwell, 1995)
• Transform this division from a
poorly respected internal products
supplier to one of the most re-
spected, exciting, and sought-after
divisions in the company (Compo-
nents Support Division of a com-
puter products company, 1989)
page 52

Building Your Company’s Vision
harvard business review • september–october 1996
“We believe that research work carried on
with patience and persistence will bring to in-
dustry and commerce new life; and we have
faith that in this new laboratory, with the
tools we have supplied, science will be ad-
vanced, knowledge increased, and human life
win ever a greater freedom from suffering
and disease…. We pledge our every aid that
this enterprise shall merit the faith we have in
it. Let your light so shine—that those who
seek the Truth, that those who toil that this
world may be a better place to live in, that
those who hold aloft that torch of science and
knowledge through these social and eco-
nomic dark ages, shall take new courage and
feel their hands supported.”
Passion, emotion, and conviction are essen-
tial parts of the vivid description. Some man-
agers are uncomfortable expressing emotion
about their dreams, but that’s what motivates
others. Churchill understood that when he
described the BHAG facing Great Britain in
1940. He did not just say, “Beat Hitler.” He
said, “Hitler knows he will have to break us on
this island or lose the war. If we can stand up
to him, all Europe may be free, and the life of
the world may move forward into broad, sun-
lit uplands. But if we fail, the whole world, in-
cluding the United States, including all we
have known and cared for, will sink into the
abyss of a new Dark Age, made more sinister
and perhaps more protracted by the lights of
perverted science. Let us therefore brace our-
selves to our duties and so bear ourselves that
if the British Empire and its Commonwealth
last for a thousand years, men will still say,
‘This was their finest hour.’”
A Few Key Points. Don’t confuse core ideol-
ogy and envisioned future. In particular,
don’t confuse core purpose and BHAGs. Man-
agers often exchange one for the other, mix-
ing the two together or failing to articulate
both as distinct items. Core purpose—not
some specific goal—is the reason why the
organization exists. A BHAG is a clearly artic-
ulated goal. Core purpose can never be com-
pleted, whereas the BHAG is reachable in 10
to 30 years. Think of the core purpose as the
star on the horizon to be chased forever; the
BHAG is the mountain to be climbed. Once
you have reached its summit, you move on to
other mountains.
Identifying core ideology is a discovery pro-
cess, but setting the envisioned future is a cre-
ative process. We find that executives often
have a great deal of difficulty coming up with
an exciting BHAG. They want to analyze their
way into the future. We have found, there-
fore, that some executives make more
progress by starting first with the vivid de-
scription and backing from there into the
BHAG. This approach involves starting with
questions such as, We’re sitting here in 20
years; what would we love to see? What
should this company look like? What should
it feel like to employees? What should it have
achieved? If someone writes an article for a
major business magazine about this com-
pany in 20 years, what will it say? One bio-
technology company we worked with had
trouble envisioning its future. Said one mem-
ber of the executive team, “Every time we
come up with something for the entire com-
pany, it is just too generic to be exciting—
something banal like ‘advance biotechnology
worldwide.’” Asked to paint a picture of the
company in 20 years, the executives men-
tioned such things as “on the cover of Business
Week as a model success story…the Fortune
most admired top-ten list…the best science
and business graduates want to work
here…people on airplanes rave about one of
our products to seatmates…20 consecutive
years of profitable growth…an entrepreneur-
ial culture that has spawned half a dozen new
divisions from within…management gurus
use us as an example of excellent manage-
ment and progressive thinking,” and so on.
From this, they were able to set the goal of be-
coming as well respected as Merck or as
Johnson & Johnson in biotechnology.
It makes no sense to analyze whether an
envisioned future is the right one. With a cre-
ation—and the task is creation of a future,
not prediction—there can be no right answer.
Did Beethoven create the right Ninth Sym-
phony? Did Shakespeare create the right
Hamlet? We can’t answer these questions;
they’re nonsense. The envisioned future in-
volves such essential questions as Does it get
our juices flowing? Do we find it stimulating?
Does it spur forward momentum? Does it get
people going? The envisioned future should
be so exciting in its own right that it would
continue to keep the organization motivated
even if the leaders who set the goal disap-
peared. City Bank, the predecessor of Citi-
corp, had the BHAG “to become the most
You must translate the
vision from words to
pictures with a vivid
description of what it will
be like to achieve your
goal.
page 53

Building Your Company’s Vision
harvard business review • september–october 1996
powerful, the most serviceable, the most far-
reaching world financial institution that has
ever been”—a goal that generated excitement
through multiple generations until it was
achieved. Similarly, the NASA moon mission
continued to galvanize people even though
President John F. Kennedy (the leader associ-
ated with setting the goal) died years before
its completion.
To create an effective envisioned future re-
quires a certain level of unreasonable confi-
dence and commitment. Keep in mind that a
BHAG is not just a goal; it is a Big, Hairy, Auda-
cious Goal. It’s not reasonable for a small re-
gional bank to set the goal of becoming “the
most powerful, the most serviceable, the most
far-reaching world financial institution that
has ever been,” as City Bank did in 1915. It’s not
a tepid claim that “we will democratize the au-
tomobile,” as Henry Ford said. It was almost
laughable for Philip Morris—as the sixth-place
player with 9% market share in the 1950s—to
take on the goal of defeating Goliath RJ Rey-
nolds Tobacco Company and becoming num-
ber one. It was hardly modest for Sony, as a
small, cash-strapped venture, to proclaim the
goal of changing the poor-quality image of Jap-
anese products around the world. (See the in-
sert “Putting It All Together: Sony in the
1950s.”) Of course, it’s not only the audacity of
the goal but also the level of commitment to
the goal that counts. Boeing didn’t just envi-
sion a future dominated by its commercial jets;
it bet the company on the 707 and, later, on
the 747. Nike’s people didn’t just talk about the
idea of crushing Adidas; they went on a cru-
sade to fulfill the dream. Indeed, the envi-
sioned future should produce a bit of the “gulp
factor”: when it dawns on people what it will
take to achieve the goal, there should be an
almost audible gulp.
But what about failure to realize the envi-
sioned future? In our research, we found that
the visionary companies displayed a remarkable
ability to achieve even their most audacious
goals. Ford did democratize the automobile;
Citicorp did become the most far-reaching
bank in the world; Philip Morris did rise from
sixth to first and beat RJ Reynolds worldwide;
Boeing did become the dominant commercial
aircraft company; and it looks like Wal-Mart
will achieve its $125 billion goal, even without
Sam Walton. In contrast, the comparison
companies in our research frequently did not
achieve their BHAGs, if they set them at all.
The difference does not lie in setting easier
goals: the visionary companies tended to have
even more audacious ambitions. The differ-
ence does not lie in charismatic, visionary
leadership: the visionary companies often
achieved their BHAGs without such larger-
than-life leaders at the helm. Nor does the dif-
ference lie in better strategy: the visionary
companies often realized their goals more by
an organic process of “let’s try a lot of stuff
and keep what works” than by well-laid stra-
tegic plans. Rather, their success lies in build-
ing the strength of their organization as their
primary way of creating the future.
Why did Merck become the preeminent
drug-maker in the world? Because Merck’s ar-
chitects built the best pharmaceutical research
and development organization in the world.
Why did Boeing become the dominant com-
mercial aircraft company in the world? Be-
cause of its superb engineering and marketing
organization, which had the ability to make
projects like the 747 a reality. When asked to
name the most important decisions that have
contributed to the growth and success of
Hewlett-Packard, David Packard answered en-
tirely in terms of decisions to build the
strength of the organization and its people.
Finally, in thinking about the envisioned fu-
ture, beware of the We’ve Arrived Syndrome—a
complacent lethargy that arises once an organi-
Putting It All Together: Sony in the 1950s
Core Ideology
Core Values
• Elevation of the Japanese culture
and national status
• Being a pioneer—not following oth-
ers; doing the impossible
• Encouraging individual ability and
creativity
Purpose
To experience the sheer joy of innova-
tion and the application of technology
for the benefit and pleasure of the
general public
Envisioned Future
BHAG
Become the company most known for
changing the worldwide poor-quality
image of Japanese products
Vivid Description
We will create products that become
pervasive around the world…. We will
be the first Japanese company to go
into the U.S. market and distribute di-
rectly…. We will succeed with innova-
tions that U.S. companies have failed
at—such as the transistor radio….
Fifty years from now, our brand name
will be as well known as any in the
world…and will signify innovation
and quality that rival the most innova-
tive companies anywhere…. “Made in
Japan” will mean something fine, not
something shoddy.
page 54

Building Your Company’s Vision
harvard business review • september–october 1996
zation has achieved one BHAG and fails to re-
place it with another. NASA suffered from that
syndrome after the successful moon landings.
After you’ve landed on the moon, what do you
do for an encore? Ford suffered from the syn-
drome when, after it succeeded in democratizing
the automobile, it failed to set a new goal of
equal significance and gave General Motors the
opportunity to jump ahead in the 1930s. Apple
Computer suffered from the syndrome after
achieving the goal of creating a computer that
nontechies could use. Start-up companies fre-
quently suffer from the We’ve Arrived Syndrome
after going public or after reaching a stage in
which survival no longer seems in question. An
envisioned future helps an organization only as
long as it hasn’t yet been achieved. In our work
with companies, we frequently hear executives
say, “It’s just not as exciting around here as it used
to be; we seem to have lost our momentum.”
Usually, that kind of remark signals that the orga-
nization has climbed one mountain and not yet
picked a new one to climb.
Many executives thrash about with mis-
sion statements and vision statements. Unfor-
tunately, most of those statements turn out to
be a muddled stew of values, goals, purposes,
philosophies, beliefs, aspirations, norms, strat-
egies, practices, and descriptions. They are
usually a boring, confusing, structurally un-
sound stream of words that evoke the re-
sponse “True, but who cares?” Even more
problematic, seldom do these statements have
a direct link to the fundamental dynamic of
visionary companies: preserve the core and
stimulate progress. That dynamic, not vision
or mission statements, is the primary engine
of enduring companies. Vision simply pro-
vides the context for bringing this dynamic to
life. Building a visionary company requires 1%
vision and 99% alignment. When you have su-
perb alignment, a visitor could drop in from
outer space and infer your vision from the op-
erations and activities of the company with-
out ever reading it on paper or meeting a
single senior executive.
Creating alignment may be your most im-
portant work. But the first step will always be
to recast your vision or mission into an effec-
tive context for building a visionary company.
If you do it right, you shouldn’t have to do it
again for at least a decade.
1. David Packard, speech given to Hewlett-
Packard’s training group on March 8, 1960;
courtesy of Hewlett-Packard Archives.
2. See Nick Lyons, The Sony Vision (New York:
Crown Publishers, 1976). We also used a transla-
tion by our Japanese student Tsuneto Ikeda.
3. Akio Morita, Made in Japan (New York: E.P.
Dutton, 1986), p. 147.
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The basic dynamic of
visionary companies is to
preserve the core and
stimulate progress. It is
vision that provides the
context.
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Further Reading
A R T I C L E S
What Leaders Really Do
by John P. Kotter
Harvard Business Review
May–June 1990
Product no. 3820
This article sets the work of vision building
within the larger context of leadership. Effec-
tive management and leadership are both
necessary in order for a company to pros-
per—but they involve different tasks. Man-
agement copes with complexity; leadership
deals with change. The leader’s job is to set
the direction of change by communicating a
vibrant vision of the company’s future—and
the strategies to achieve it—in ways that will
inspire and energize employees.
Successful Change Programs Begin
with Results
by Robert H. Schaffer and Harvey A. Thomson
Harvard Business Review
January–February 1992
Product no. 92108
A compelling vision is not enough: senior
management must identify the crucial busi-
ness challenges that change programs will
meet and then link them to the vision. Most
corporate change programs have a negligible
impact on operational and financial perfor-
mance because management focuses on the
activities, not the results. By contrast, results-
driven improvement programs focus on
achieving specific, measurable improvements
within a few months.
Managing Change: The Art of Balancing
by Jeanie Daniel Duck
Harvard Business Review
November–December 1993
Product no. 5416
This article maintains that people issues are
at the heart of realizing a vision. Managing
change is like balancing a mobile. You have
to keep two conversations in balance: the
one between the people leading the change
effort and the one between those who are
expected to implement the new strategies.
You also have to manage emotional connec-
tions—even though they have traditionally
been banned from the workplace, they are
essential for a successful transformation. By
encouraging this activity, management com-
municates its understanding that transfor-
mation is difficult for everyone involved, and
that people issues are at the heart of change.
B O O K
Leading Change
by John P. Kotter
Harvard Business School Press
1996
Product no. 7471
A Big, Hairy, Audacious Goal (BHAG) isn’t real-
ized overnight—you have to carefully lay the
groundwork, and that can sometimes take
years. Kotter identifies eight errors common to
transformation efforts and offers an eight-step
process for overcoming them: establishing a
greater sense of urgency; creating the guiding
coalition; developing a vision and strategy;
communicating the change vision; empower-
ing others to act; creating short-term wins;
consolidating gains and producing even
more change; and institutionalizing new ap-
proaches in the future.
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Reinventing Your
Business Model

by Mark W. Johnson, Clayton M. Christensen, and
Henning Kagermann

Included with this full-text

Harvard Business Review

article:
The Idea in Brief—the core idea
The Idea in Practice—putting the idea to work

58

Article Summary

59

Reinventing Your Business Model
A list of related materials, with annotations to guide further
exploration of the article’s ideas and applications

68

Further Reading
One secret to maintaining a
thriving business is
recognizing when it needs a
fundamental change.

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Reinventing Your Business Model

The Idea in Brief The Idea in Practice

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When Apple introduced the iPod, it did
something far smarter than wrap a good
technology in a snazzy design. It wrapped a
good technology in a great business
model. Combining hardware, software,
and service, the model provided game-
changing convenience for consumers
and record-breaking profits for Apple.
Great business models can reshape in-
dustries and drive spectacular growth.
Yet many companies find business-model
innovation difficult. Managers don’t under-
stand their existing model well enough to
know when it needs changing—or how.
To determine whether your firm should
alter its business model, Johnson, Chris-
tensen, and Kagermann advise these
steps:
1. Articulate what makes your existing
model successful. For example, what cus-
tomer problem does it solve? How does
it make money for your firm?
2. Watch for signals that your model needs
changing, such as tough new competitors
on the horizon.
3. Decide whether reinventing your
model is worth the effort. The answer’s yes
only if the new model changes the industry
or market.
UNDERSTAND YOUR CURRENT BUSINESS
MODEL
A successful model has these components:
• Customer value proposition. The model
helps customers perform a specific “job”
that alternative offerings don’t address.
Example:
MinuteClinics enable people to visit a
doctor’s office without appointments by
making nurse practitioners available to
treat minor health issues.
• Profit formula. The model generates value
for your company through factors such as
revenue model, cost structure, margins, and
inventory turnover.
Example:
The Tata Group’s inexpensive car, the
Nano, is profitable because the company
has reduced many cost structure elements,
accepted lower-than-standard gross mar-
gins, and sold the Nano in large volumes to
its target market: first-time car buyers in
emerging markets.
• Key resources and processes. Your com-
pany has the people, technology, products,
facilities, equipment, and brand required
to deliver the value proposition to your
targeted customers. And it has processes
(training, manufacturing, service) to lever-
age those resources.
Example:

For Tata Motors to fulfill the requirements
of the Nano’s profit formula, it had to recon-
ceive how a car is designed, manufactured,
and distributed. It redefined its supplier
strategy, choosing to outsource a remark-
able 85% of the Nano’s components and to
use nearly 60% fewer vendors than normal
to reduce transaction costs.

IDENTIFY W HEN A NEW MODEL MAY BE NEEDED

These circumstances often require business model change:
An opportunity to . . . Example
Address needs of large groups
who find existing solutions
too expensive or complicated.
The Nano’s goal is to open car ownership to low-income consumers
in emerging markets.
Capitalize on new technology,
or leverage existing tech-
nologies in new markets.
A company develops a commercial application for a technology
originally developed for military use.
Bring a job-to-be-done focus
where it doesn’t exist.
FedEx focused on performing customers’ unmet “job”: Receive
packages faster and more reliably than any other service could.
A need to . . . Example
Fend off low-end disruptors. Mini-mills threatened the integrated steel mills a generation ago by
making steel at significantly lower prices.
Respond to shifts in
competition.
Power-tool maker Hilti switched from selling to renting its tools in
part because “good enough” low-end entrants had begun chipping
away at the market for selling high-quality tools.
page 58

Reinventing Your
Business Model

by Mark W. Johnson, Clayton M. Christensen, and
Henning Kagermann

harvard business review • december 2008

C
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One secret to maintaining a thriving business is recognizing when it
needs a fundamental change.

In 2003, Apple introduced the iPod with the
iTunes store, revolutionizing portable enter-
tainment, creating a new market, and trans-
forming the company. In just three years, the
iPod/iTunes combination became a nearly
$10 billion product, accounting for almost 50%
of Apple’s revenue. Apple’s market capitaliza-
tion catapulted from around $1 billion in early
2003 to over $150 billion by late 2007.
This success story is well known; what’s less
well known is that Apple was not the first to
bring digital music players to market. A com-
pany called Diamond Multimedia introduced
the Rio in 1998. Another firm, Best Data,
introduced the Cabo 64 in 2000. Both prod-
ucts worked well and were portable and
stylish. So why did the iPod, rather than the
Rio or Cabo, succeed?
Apple did something far smarter than take
a good technology and wrap it in a snazzy
design. It took a good technology and
wrapped it in a great business model. Apple’s
true innovation was to make downloading
digital music easy and convenient. To do
that, the company built a groundbreaking
business model that combined hardware, soft-
ware, and service. This approach worked like
Gillette’s famous blades-and-razor model in
reverse: Apple essentially gave away the
“blades” (low-margin iTunes music) to lock
in purchase of the “razor” (the high-margin
iPod). That model defined value in a new way
and provided game-changing convenience to
the consumer.
Business model innovations have reshaped
entire industries and redistributed billions of
dollars of value. Retail discounters such as Wal-
Mart and Target, which entered the market
with pioneering business models, now account
for 75% of the total valuation of the retail sec-
tor. Low-cost U.S. airlines grew from a blip on
the radar screen to 55% of the market value of
all carriers. Fully 11 of the 27 companies born in
the last quarter century that grew their way
into the Fortune 500 in the past 10 years did
so through business model innovation.
Stories of business model innovation
from well-established companies like Apple,
page 59

Reinventing Your Business Model

harvard business review • december 2008

however, are rare. An analysis of major in-
novations within existing corporations in
the past decade shows that precious few have
been business-model related. And a recent
American Management Association study
determined that no more than 10% of inno-
vation investment at global companies is
focused on developing new business models.
Yet everyone’s talking about it. A 2005
survey by the Economist Intelligence Unit
reported that over 50% of executives believe
business model innovation will become even
more important for success than product or
service innovation. A 2008 IBM survey of
corporate CEOs echoed these results. Nearly
all of the CEOs polled reported the need to
adapt their business models; more than two-
thirds said that extensive changes were re-
quired. And in these tough economic times,
some CEOs are already looking to business
model innovation to address permanent shifts
in their market landscapes.
Senior managers at incumbent companies
thus confront a frustrating question: Why is it
so difficult to pull off the new growth that
business model innovation can bring? Our
research suggests two problems. The first is a
lack of definition: Very little formal study has
been done into the dynamics and processes
of business model development. Second, few
companies understand their existing business
model well enough—the premise behind its
development, its natural interdependencies,
and its strengths and limitations. So they
don’t know when they can leverage their core
business and when success requires a new
business model.
After tackling these problems with dozens of
companies, we have found that new business
models often look unattractive to internal and
external stakeholders—at the outset. To see
past the borders of what is and into the land
of the new, companies need a road map.
Ours consists of three simple steps. The first
is to realize that success starts by not thinking
about business models at all. It starts with
thinking about the opportunity to satisfy a
real customer who needs a job done. The
second step is to construct a blueprint laying
out how your company will fulfill that need
at a profit. In our model, that plan has four
elements. The third is to compare that model
to your existing model to see how much you’d
have to change it to capture the opportunity.
Once you do, you will know if you can use
your existing model and organization or need
to separate out a new unit to execute a new
model. Every successful company is already
fulfilling a real customer need with an effec-
tive business model, whether that model is
explicitly understood or not. Let’s take a look
at what that entails.

Business Model: A Definition

A business model, from our point of view,
consists of four interlocking elements that,
taken together, create and deliver value. The
most important to get right, by far, is the first.
Customer value proposition (CVP). A suc-
cessful company is one that has found a way
to create value for customers—that is, a way to
help customers get an important job done. By
“job” we mean a fundamental problem in a
given situation that needs a solution. Once we
understand the job and all its dimensions,
including the full process for how to get it
done, we can design the offering. The more
important the job is to the customer, the
lower the level of customer satisfaction with
current options for getting the job done, and
the better your solution is than existing alter-
natives at getting the job done (and, of course,
the lower the price), the greater the CVP.
Opportunities for creating a CVP are at their
most potent, we have found, when alternative
products and services have not been designed
with the real job in mind and you can design
an offering that gets that job—and only
that job—done perfectly. We’ll come back to
that point later.
Profit formula. The profit formula is the
blueprint that defines how the company
creates value for itself while providing value
to the customer. It consists of the following:
• Revenue model: price x volume
• Cost structure: direct costs, indirect costs,
economies of scale. Cost structure will be
predominantly driven by the cost of the key
resources required by the business model.
• Margin model: given the expected volume
and cost structure, the contribution needed
from each transaction to achieve desired
profits.
• Resource velocity: how fast we need to
turn over inventory, fixed assets, and other
assets—and, overall, how well we need to
utilize resources—to support our expected
volume and achieve our anticipated profits.

Mark W. Johnson

(mjohnson@
innosight.com) is the chairman of
Innosight, an innovation and strategy-
consulting firm he cofounded in
2000 with Clayton M. Christensen
(cchristensen@hbs.edu), the Robert
and Jane Cizik Professor of Business
Administration at Harvard Business
School. They are both based in Boston.
Henning Kagermann (henning
.kagermann@sap.com) is the co-CEO
of SAP AG, in Walldorf, Germany.
Johnson is the author of Seizing the
White Space: Business Model Innovation
for Transformative Growth and Renewal,
forthcoming from Harvard Business
Press in 2009.
page 60

mailto:mjohnson@innosight.com

mailto:mjohnson@innosight.com

mailto:cchristensen@hbs.edu

mailto:henning.kagermann@sap.com

mailto:henning.kagermann@sap.com

Reinventing Your Business Model

harvard business review • december 2008

People often think the terms “profit formu-
las” and “business models” are interchange-
able. But how you make a profit is only one
piece of the model. We’ve found it most use-
ful to start by setting the price required to
deliver the CVP and then work backwards
from there to determine what the variable
costs and gross margins must be. This then de-
termines what the scale and resource velocity
needs to be to achieve the desired profits.
Key resources. The key resources are assets
such as the people, technology, products,
facilities, equipment, channels, and brand
required to deliver the value proposition to
the targeted customer. The focus here is on
the key elements that create value for the
customer and the company, and the way those
elements interact. (Every company also has
generic resources that do not create competi-
tive differentiation.)
Key processes. Successful companies have
operational and managerial processes that
allow them to deliver value in a way they
can successfully repeat and increase in scale.
These may include such recurrent tasks as
training, development, manufacturing, bud-
geting, planning, sales, and service. Key
processes also include a company’s rules,
metrics, and norms.
These four elements form the building
blocks of any business. The customer value
proposition and the profit formula define
value for the customer and the company,
respectively; key resources and key processes
describe how that value will be delivered to
both the customer and the company.
As simple as this framework may seem, its
power lies in the complex interdependencies
of its parts. Major changes to any of these
four elements affect the others and the
whole. Successful businesses devise a more
or less stable system in which these elements
bond to one another in consistent and com-
plementary ways.

How Great Models Are Built

To illustrate the elements of our business
model framework, we will look at what’s be-
hind two companies’ game-changing business
model innovations.
Creating a customer value proposition.
It’s not possible to invent or reinvent a busi-
ness model without first identifying a clear
customer value proposition. Often, it starts
as a quite simple realization. Imagine, for a
moment, that you are standing on a Mumbai
road on a rainy day. You notice the large
number of motor scooters snaking precari-
ously in and out around the cars. As you look
more closely, you see that most bear whole
families—both parents and several children.
Your first thought might be “That’s crazy!” or
“That’s the way it is in developing countries—
people get by as best they can.”
When Ratan Tata of Tata Group looked
out over this scene, he saw a critical job to be
done: providing a safer alternative for scooter
families. He understood that the cheapest car
available in India cost easily five times what a
scooter did and that many of these families
could not afford one. Offering an affordable,
safer, all-weather alternative for scooter fami-
lies was a powerful value proposition, one
with the potential to reach tens of millions
of people who were not yet part of the
car-buying market. Ratan Tata also recognized
that Tata Motors’ business model could not
be used to develop such a product at the
needed price point.
At the other end of the market spectrum,
Hilti, a Liechtenstein-based manufacturer of
high-end power tools for the construction in-
dustry, reconsidered the real job to be done
for many of its current customers. A contrac-
tor makes money by finishing projects; if the
required tools aren’t available and function-
ing properly, the job doesn’t get done. Con-
tractors don’t make money by owning tools;
they make it by using them as efficiently
as possible. Hilti could help contractors get
the job done by selling tool use instead of the
tools themselves—managing its customers’
tool inventory by providing the best tool at
the right time and quickly furnishing tool
repairs, replacements, and upgrades, all for a
monthly fee. To deliver on that value proposi-
tion, the company needed to create a fleet-
management program for tools and in the
process shift its focus from manufacturing
and distribution to service. That meant Hilti
had to construct a new profit formula and
develop new resources and new processes.
The most important attribute of a customer
value proposition is its precision: how per-
fectly it nails the customer job to be done—
and nothing else. But such precision is often
the most difficult thing to achieve. Companies
trying to create the new often neglect to focus
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The Elements of a Successful Business Model

Every successful company already operates according to an effective business model. By systematically identifying all of its
constituent parts, executives can understand how the model fulfills a potent value proposition in a profitable way using certain
key resources and key processes. With that understanding, they can then judge how well the same model could be used to fulfill
a radically different CVP—and what they’d need to do to construct a new one, if need be, to capitalize on that opportunity.
PROFIT FORMULA
■ Revenue model How much
money can be made: price x
volume. Volume can be thought of
in terms of market size, purchase
frequency, ancillary sales, etc.
■ Cost structure How costs are
allocated: includes cost of key
assets, direct costs, indirect costs,
economies of scale.
■ Margin model How much each
transaction should net to achieve
desired profit levels.
■ Resource velocity How quickly
resources need to be used to sup-
port target volume. Includes lead
times, throughput, inventory turns,
asset utilization, and so on.
KEY RESOURCES
needed to deliver the
customer value proposition
profitably. Might include:
■ People
■ Technology, products
■ Equipment
■ Information
■ Channels
■ Partnerships,
alliances
■ Brand
KEY PROCESSES, as well as
rules, metrics, and norms, that
make the profitable delivery of the
customer value proposition repeat-
able and scalable. Might include:
■ Processes: design, product
development, sourcing, manu-
facturing, marketing, hiring and
training, IT
■ Rules and metrics: margin re-
quirements for investment, credit
terms, lead times, supplier terms
■ Norms: opportunity size needed
for investment, approach to
customers and channels
Customer Value Proposition (CVP)
■ Target customer
■ Job to be done to solve an
important problem or fulfill an
important need for the target
customer
■ Offering, which satisfies the
problem or fulfills the need.
This is defined not only by what
is sold but also by how it’s sold.
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Reinventing Your Business Model

harvard business review • december 2008

on

one

job; they dilute their efforts by at-
tempting to do lots of things. In doing lots
of things, they do nothing

really

well.
One way to generate a precise customer
value proposition is to think about the four
most common barriers keeping people from
getting particular jobs done: insufficient
wealth, access, skill, or time. Software maker
Intuit devised QuickBooks to fulfill small-
business owners’ need to avoid running out of
cash. By fulfilling that job with greatly simpli-
fied accounting software, Intuit broke the skills
barrier that kept untrained small-business
owners from using more-complicated account-
ing packages. MinuteClinic, the drugstore-
based basic health care provider, broke the
time barrier that kept people from visiting
a doctor’s office with minor health issues by
making nurse practitioners available without
appointments.
Designing a profit formula. Ratan Tata
knew the only way to get families off their
scooters and into cars would be to break
the wealth barrier by drastically decreasing
the price of the car. “What if I can change the
game and make a car for one lakh?” Tata
wondered, envisioning a price point of around
US$2,500, less than half the price of the
cheapest car available. This, of course, had
dramatic ramifications for the profit formula:
It required both a significant drop in gross
margins and a radical reduction in many
elements of the cost structure. He knew,
however, he could still make money if he
could increase sales volume dramatically,
and he knew that his target base of consumers
was potentially huge.
For Hilti, moving to a contract management
program required shifting assets from custom-
ers’ balance sheets to its own and generating
revenue through a lease/subscription model.
For a monthly fee, customers could have a full
complement of tools at their fingertips, with
repair and maintenance included. This would
require a fundamental shift in all major com-
ponents of the profit formula: the revenue
stream (pricing, the staging of payments, and
how to think about volume), the cost structure
(including added sales development and con-
tract management costs), and the supporting
margins and transaction velocity.
Identifying key resources and processes.
Having articulated the value proposition for
both the customer and the business, compa-
nies must then consider the key resources and
processes needed to deliver that value. For a
professional services firm, for example, the key
resources are generally its people, and the
key processes are naturally people related
(training and development, for instance). For a
packaged goods company, strong brands and
well-selected channel retailers might be the
key resources, and associated brand-building
and channel-management processes among
the critical processes.
Oftentimes, it’s not the individual resources
and processes that make the difference but
their relationship to one another. Companies
will almost always need to integrate their
key resources and processes in a unique way
to get a job done perfectly for a set of custom-
ers. When they do, they almost always create
enduring competitive advantage. Focusing
first on the value proposition and the profit
formula makes clear how those resources and
processes need to interrelate. For example,
most general hospitals offer a value proposi-
tion that might be described as, “We’ll do
anything for anybody.” Being all things to
all people requires these hospitals to have
a vast collection of resources (specialists,
equipment, and so on) that can’t be knit

Hilti Sidesteps Commoditization

Hilti is capitalizing on a game-changing opportunity to increase profitability by
turning products into a service. Rather than sell tools (at lower and lower prices),
it’s selling a “just-the-tool-you-need-when-you-need-it, no-repair-or-storage-hassles”
service. Such a radical change in customer value proposition required a shift in all
parts of its business model.
Traditional
Power Tool Company
Hilti’s Tool Fleet
Management Service
Sales of industrial and
professional power tools and
accessories
Customer
value
proposition
Leasing a comprehensive
fleet of tools to increase con-
tractors’ on-site productivity
Low margins,
high inventory turnover
Profit formula
Higher margins; asset heavy;
monthly payments for tool
maintenance, repair, and
replacement
Distribution channel, low-cost
manufacturing plants in devel-
oping countries, R&D
Key resources
and processes
Strong direct-sales approach,
contract management, IT sys-
tems for inventory manage-
ment and repair, warehousing
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harvard business review • december 2008

together in any proprietary way. The result
is not just a lack of differentiation but dis-
satisfaction.
By contrast, a hospital that focuses on a
specific value proposition can integrate its
resources and processes in a unique way that
delights customers. National Jewish Health
in Denver, for example, is organized around a
focused value proposition we’d characterize
as, “If you have a disease of the pulmonary
system, bring it here. We’ll define its root
cause and prescribe an effective therapy.”
Narrowing its focus has allowed National
Jewish to develop processes that integrate the
ways in which its specialists and specialized
equipment work together.
For Tata Motors to fulfill the requirements
of its customer value proposition and profit
formula for the Nano, it had to reconceive
how a car is designed, manufactured, and
distributed. Tata built a small team of fairly
young engineers who would not, like the
company’s more-experienced designers, be
influenced and constrained in their thinking
by the automaker’s existing profit formulas.
This team dramatically minimized the num-
ber of parts in the vehicle, resulting in a sig-
nificant cost saving. Tata also reconceived its
supplier strategy, choosing to outsource a re-
markable 85% of the Nano’s components and
use nearly 60% fewer vendors than normal to
reduce transaction costs and achieve better
economies of scale.
At the other end of the manufacturing
line, Tata is envisioning an entirely new way
of assembling and distributing its cars. The
ultimate plan is to ship the modular com-
ponents of the vehicles to a combined net-
work of company-owned and independent
entrepreneur-owned assembly plants, which
will build them to order. The Nano will be
designed, built, distributed, and serviced in a
radically new way—one that could not be
accomplished without a new business model.
And while the jury is still out, Ratan Tata may
solve a traffic safety problem in the process.
For Hilti, the greatest challenge lay in train-
ing its sales representatives to do a thoroughly
new task. Fleet management is not a half-
hour sale; it takes days, weeks, even months of
meetings to persuade customers to buy a pro-
gram instead of a product. Suddenly, field reps
accustomed to dealing with crew leaders and
on-site purchasing managers in mobile trailers
found themselves staring down CEOs and
CFOs across conference tables.
Additionally, leasing required new re-
sources—new people, more robust IT sys-
tems, and other new technologies—to design
and develop the appropriate packages and
then come to an agreement on monthly
payments. Hilti needed a process for main-
taining large arsenals of tools more inexpen-
sively and effectively than its customers
had. This required warehousing, an inven-
tory management system, and a supply of
replacement tools. On the customer manage-
ment side, Hilti developed a website that
enabled construction managers to view all the
tools in their fleet and their usage rates. With
that information readily available, the manag-
ers could easily handle the cost accounting
associated with those assets.
Rules, norms, and metrics are often the last
element to emerge in a developing business
model. They may not be fully envisioned
until the new product or service has been
road tested. Nor should they be. Business
models need to have the flexibility to change
in their early years.

When a New Business Model Is
Needed

Established companies should not undertake
business-model innovation lightly. They
can often create new products that disrupt
competitors without fundamentally changing
their own business model. Procter & Gamble,
for example, developed a number of what
it calls “disruptive market innovations” with
such products as the Swiffer disposable mop
and duster and Febreze, a new kind of air
freshener. Both innovations built on P&G’s
existing business model and its established
dominance in household consumables.
There are clearly times, however, when cre-
ating new growth requires venturing not only
into unknown market territory but also into
unknown business model territory. When? The
short answer is “When significant changes are
needed to all four elements of your existing
model.” But it’s not always that simple. Man-
agement judgment is clearly required. That
said, we have observed five strategic circum-
stances that often require business model
change:
1. The opportunity to address through dis-
ruptive innovation the needs of large groups
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Reinventing Your Business Model

harvard business review • december 2008

of potential customers who are shut out of a
market entirely because existing solutions
are too expensive or complicated for them.
This includes the opportunity to democratize
products in emerging markets (or reach the
bottom of the pyramid), as Tata’s Nano does.
2. The opportunity to capitalize on a brand-
new technology by wrapping a new business
model around it (Apple and MP3 players)
or the opportunity to leverage a tested tech-
nology by bringing it to a whole new market
(say, by offering military technologies in the
commercial space or vice versa).
3. The opportunity to bring a job-to-be-
done focus where one does not yet exist.
That’s common in industries where compa-
nies focus on products or customer segments,
which leads them to refine existing products
more and more, increasing commoditization
over time. A jobs focus allows companies to
redefine industry profitability. For example,
when FedEx entered the package delivery
market, it did not try to compete through
lower prices or better marketing. Instead, it
concentrated on fulfilling an entirely unmet
customer need to receive packages far, far
faster, and more reliably, than any service
then could. To do so, it had to integrate its
key processes and resources in a vastly more
efficient way. The business model that re-
sulted from this job-to-be-done emphasis
gave FedEx a significant competitive advan-
tage that took UPS many years to copy.
4. The need to fend off low-end disrupters.
If the Nano is successful, it will threaten
other automobile makers, much as minimills
threatened the integrated steel mills a gener-
ation ago by making steel at significantly
lower cost.
5. The need to respond to a shifting basis
of competition. Inevitably, what defines an
acceptable solution in a market will change
over time, leading core market segments to
commoditize. Hilti needed to change its busi-
ness model in part because of lower global
manufacturing costs; “good enough” low-end
entrants had begun chipping away at the
market for high-quality power tools.
Of course, companies should not pursue
business model reinvention unless they are
confident that the opportunity is large enough
to warrant the effort. And, there’s really no
point in instituting a new business model
unless it’s not only new to the company but
in some way new or game-changing to the
industry or market. To do otherwise would be
a waste of time and money.
These questions will help you evaluate
whether the challenge of business model
innovation will yield acceptable results. An-
swering “yes” to all four greatly increases
the odds of successful execution:
• Can you nail the job with a focused,
compelling customer value proposition?
• Can you devise a model in which all the
elements—the customer value proposition,
the profit formula, the key resources, and the
key processes—work together to get the job
done in the most efficient way possible?
• Can you create a new business develop-
ment process unfettered by the often negative
influences of your core business?
• Will the new business model disrupt
competitors?
Creating a new model for a new business
does not mean the current model is threat-
ened or should be changed. A new model
often reinforces and complements the core
business, as Dow Corning discovered.

How Dow Corning Got Out of Its
Own Way

When business model innovation is clearly
called for, success lies not only in getting
the model right but also in making sure the

Dow Corning Embraces the Low End

Traditionally high-margin Dow Corning found new opportunities in low-margin
offerings by setting up a separate business unit that operates in an entirely different
way. By fundamentally differentiating its low-end and high-end offerings, the com-
pany avoided cannibalizing its traditional business even as it found new profits at
the low end.
Established Business New Business Unit
Customized solutions,
negotiated contracts
Customer value
proposition
No frills, bulk prices,
sold through the internet
High-margin, high-
overhead retail prices pay
for value-added services
Profit formula
Spot-market pricing, low
overhead to accommo-
date lower margins, high
throughput
R&D, sales, and service
orientation
Key resources
and processes
IT system, lowest-cost
processes, maximum
automation
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incumbent business doesn’t in some way pre-
vent the new model from creating value or
thriving. That was a problem for Dow Corning
when it built a new business unit—with a new
profit formula—from scratch.
For many years, Dow Corning had sold
thousands of silicone-based products and
provided sophisticated technical services to
an array of industries. After years of profitable
growth, however, a number of product areas
were stagnating. A strategic review uncovered
a critical insight: Its low-end product segment
was commoditizing. Many customers ex-
perienced in silicone application no longer
needed technical services; they needed basic
products at low prices. This shift created an
opportunity for growth, but to exploit that
opportunity Dow Corning had to figure out
a way to serve these customers with a lower-
priced product. The problem was that both
the business model and the culture were
built on high-priced, innovative product and
service packages. In 2002, in pursuit of what
was essentially a commodity business for
low-end customers, Dow Corning CEO Gary
Anderson asked executive Don Sheets to form
a team to start a new business.
The team began by formulating a customer
value proposition that it believed would ful-
fill the job to be done for these price-driven
customers. It determined that the price point
had to drop 15% (which for a commoditizing
material was a huge reduction). As the
team analyzed what that new customer value
proposition would require, it realized reach-
ing that point was going to take a lot more
than merely eliminating services. Dramatic
price reduction would call for a different
profit formula with a fundamentally lower
cost structure, which depended heavily on
developing a new IT system. To sell more
products faster, the company would need to
use the internet to automate processes and
reduce overhead as much as possible.
Breaking the rules. As a mature and suc-
cessful company, Dow Corning was full of
highly trained employees used to delivering
its high-touch, customized value proposition.
To automate, the new business would have to
be far more standardized, which meant insti-
tuting different and, overall, much stricter
rules. For example, order sizes would be
limited to a few, larger-volume options; order
lead times would fall between two and four
weeks (exceptions would cost extra); and
credit terms would be fixed. There would be
charges if a purchaser required customer
service. The writing was on the wall: The new
venture would be low-touch, self-service, and
standardized. To succeed, Dow Corning would
have to break the rules that had previously
guided its success.
Sheets next had to determine whether this
new venture, with its new rules, could succeed
within the confines of Dow Corning’s core
enterprise. He set up an experimental war
game to test how existing staff and systems
would react to the requirements of the new
customer value proposition. He got crushed
as entrenched habits and existing processes
thwarted any attempt to change the game. It
became clear that the corporate antibodies
would kill the initiative before it got off the
ground. The way forward was clear: The new
venture had to be free from existing rules
and free to decide what rules would be ap-
propriate in order for the new commodity
line of business to thrive. To nurture the
opportunity—and also protect the existing
model—a new business unit with a new brand
identity was needed. Xiameter was born.
Identifying new competencies. Following
the articulation of the new customer value
proposition and new profit formula, the
Xiameter team focused on the new competen-
cies it would need, its key resources and pro-
cesses. Information technology, just a small
part of Dow Corning’s core competencies
at that time, emerged as an essential part of
the now web-enabled business. Xiameter also
needed employees who could make smart
decisions very quickly and who would thrive
in a fast-changing environment, filled initially
with lots of ambiguity. Clearly, new abilities
would have to be brought into the business.
Although Xiameter would be established
and run as a separate business unit, Don
Sheets and the Xiameter team did not want to
give up the incumbency advantage that deep
knowledge of the industry and of their own
products gave them. The challenge was to
tap into the expertise without importing
the old-rules mind-set. Sheets conducted a
focused HR search within Dow Corning for
risk takers. During the interview process,
when he came across candidates with the
right skills, he asked them to take the job
on the spot, before they left the room. This

When the Old
Model Will Work

You don’t always need a new busi-
ness model to capitalize on a game-
changing opportunity. Sometimes,
as P&G did with its Swiffer, a com-
pany finds that its current model is
revolutionary in a new market.
When will the old model do? When
you can fulfill the new customer
value proposition:

•

With your current profit formula

•

Using most, if not all, of your cur-
rent key resources and processes

•

Using the same core metrics, rules,
and norms you now use to run your
business
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Reinventing Your Business Model

harvard business review • december 2008

approach allowed him to cherry-pick those
who could make snap decisions and take
big risks.

The secret sauce: patience.

Successful new
businesses typically revise their business
models four times or so on the road to profit-
ability. While a well-considered business-
model-innovation process can often shorten
this cycle, successful incumbents must tolerate
initial failure and grasp the need for course
correction. In effect, companies have to focus
on learning and adjusting as much as on ex-
ecuting. We recommend companies with new
business models be patient for growth (to
allow the market opportunity to unfold) but
impatient for profit (as an early validation that
the model works). A profitable business is the
best early indication of a viable model.
Accordingly, to allow for the trial and error
that naturally accompanies the creation of
the new while also constructing a develop-
ment cycle that would produce results and
demonstrate feasibility with minimal re-
source outlay, Dow Corning kept the scale
of Xiameter’s operation small but developed
an aggressive timetable for launch and set
the goal of becoming profitable by the end
of year one.
Xiameter paid back Dow Corning’s invest-
ment in just three months and went on to
become a major, transformative success. Be-
forehand, Dow Corning had had no online
sales component; now 30% of sales originate
online, nearly three times the industry aver-
age. Most of these customers are new to the
company. Far from cannibalizing existing cus-
tomers, Xiameter has actually supported the
main business, allowing Dow Corning’s sales-
people to more easily enforce premium pric-
ing for their core offerings while providing a
viable alternative for the price-conscious.

• • •

Established companies’ attempts at transfor-
mative growth typically spring from product
or technology innovations. Their efforts are
often characterized by prolonged develop-
ment cycles and fitful attempts to find a
market. As the Apple iPod story that opened
this article suggests, truly transformative
businesses are never exclusively about the
discovery and commercialization of a great
technology. Their success comes from envel-
oping the new technology in an appropriate,
powerful business model.
Bob Higgins, the founder and general part-
ner of Highland Capital Partners, has seen
his share of venture success and failure in
his 20 years in the industry. He sums up the
importance and power of business model
innovation this way: “I think historically
where we [venture capitalists] fail is when we
back technology. Where we succeed is when
we back new business models.”

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What Rules, Norms, and Metrics Are Standing in Your Way?

In any business, a fundamental understanding of the core model often fades into the mists of institutional memory, but it lives on in rules,
norms, and metrics put in place to protect the status quo (for example, “Gross margins must be at 40%”). They are the first line of defense
against any new model’s taking root in an existing enterprise.

Financial

•

Gross margins

•

Opportunity size

•

Unit pricing

•

Unit margin

•

Time to breakeven

•

Net present value calculations

•

Fixed cost investment

•

Credit items

Operational

•

End-product quality

•

Supplier quality

•

Owned versus outsourced manufacturing

•

Customer service

•

Channels

•

Lead times

•

Throughput

Other

•

Pricing

•

Performance demands

•

Product-development life cycles

•

Basis for individuals’ rewards and
incentives

•

Brand parameters
page 67

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Further Reading

A R T I C L E S

Marketing Malpractice: The Cause and
the Cure

by Clayton M. Christensen, Scott Cook, and
Taddy Hall
Harvard Business Review
December 2005
Product no. R0512D
Ted Levitt used to tell his Harvard Business
School students, “People don’t want a quarter-
inch drill—they want a quarter-inch hole.”
But 35 years later, marketers are still thinking
in terms of products and ever-finer demo-
graphic segments. The structure of a market,
as seen from customers’ point of view, is very
simple. When people need to get a job done,
they hire a product or service to do it for
them. The marketer’s task is to understand
what jobs periodically arise in customers’
lives for which they might hire products the
company could make. New growth markets
are created when an innovative company
designs a product and then positions its
brand on a job for which no optimal product
yet exists. In fact, companies that historically
have segmented and measured markets by
product categories generally find that when
they instead segment by job, their market is
much larger (and their current share much
smaller) than they had thought. This is great
news for smart companies hungry for growth.
Meeting the Challenge of Disruptive
Change

by Clayton M. Christensen and
Michael Overdorf

Harvard Business Review

March 2000
Product no. R00202

Why can’t large companies capitalize on the
opportunities brought about by major, dis-
ruptive changes in their markets? It’s because
organizations, independent of the people in
them, have capabilities. And those capabilities
also define disabilities. As a company grows,
what it can and cannot do becomes more
sharply defined in certain predictable ways.
The authors have analyzed those patterns
to create a framework managers can use to
assess the abilities and disabilities of their or-
ganization as a whole. They also suggest
ways large companies can capitalize on op-
portunities that normally would not fit in with
their processes or values.
The Customer-Centered Innovation Map

by Lance A. Bettencourt and
Anthony W. Ulwick

Harvard Business Review

May 2008
Product no. R0805H

We all know that people “hire” products and
services to get a job done. Surgeons hire scal-
pels to dissect soft tissue. Janitors hire soap
dispensers and paper towels to remove grime
from their hands. To find ways to innovate, it’s
critical to deconstruct the job the customer is
trying to get done from beginning to end, to
gain a complete view of all the points at
which a customer might desire more help
from a product or service. A methodology
called job mapping helps companies analyze
the biggest drawbacks of the products and
services customers currently use and discover
opportunities for innovation. It begins with
breaking down the task the customer wants
to accomplish into the eight universal steps of
a job: 1) defining the objectives, 2) locating
the necessary inputs, 3) preparing the physical
environment, 4) confirming that everything is
ready, 5) executing the task, 6) monitoring its
progress, 7) making modifications as neces-
sary, and 8) concluding the job. Within each
step lies multiple opportunities for making
the job simpler, easier, or faster. By locating
those opportunities, companies can discover
new ways to differentiate their offerings.
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Blue Ocean Strategy

by W. Chan Kim and Renée Mauborgne

Included with this full-text

Harvard Business Review

article:
The Idea in Brief—the core idea
The Idea in Practice—putting the idea to work

70

Article Summary

71

Blue Ocean Strategy
A list of related materials, with annotations to guide further
exploration of the article’s ideas and applications

80

Further Reading

Competing in overcrowded
industries is no way to sustain
high performance. The real
opportunity is to create blue
oceans of uncontested market
space.

Reprint R0410D

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Blue Ocean Strategy

The Idea in Brief The Idea in Practice

C
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The best way to drive profitable growth?
Stop competing in overcrowded industries.
In those red oceans, companies try to out-
perform rivals to grab bigger slices of exist-
ing demand. As the space gets increasingly
crowded, profit and growth prospects
shrink. Products become commoditized.
Ever-more-intense competition turns the
water bloody.
How to avoid the fray? Kim and Mauborgne
recommend creating blue oceans—
uncontested market spaces where the
competition is irrelevant. In blue oceans,
you invent and capture new demand, and
you offer customers a leap in value while
also streamlining your costs. Results? Hand-
some profits, speedy growth—and brand
equity that lasts for decades while rivals
scramble to catch up.
Consider Cirque du Soleil—which invented
a new industry that combined elements
from traditional circus with elements
drawn from sophisticated theater. In just
20 years, Cirque raked in revenues that
Ringling Bros. and Barnum & Bailey—the
world’s leading circus—needed more
than a century to attain.
How to begin creating blue oceans? Kim and Mauborgne offer these suggestions:

UNDERSTAND THE LOGIC BEHIND BLUE
OCEAN STRATEGY
The logic behind blue ocean strategy is
counterintuitive:
• It’s not about technology innovation. Blue
oceans seldom result from technological
innovation. Often, the underlying technol-
ogy already exists—and blue ocean cre-
ators link it to what buyers value. Compaq,
for example, used existing technologies to
create its ProSignia server, which gave buy-
ers twice the file and print capability of the
minicomputer at one-third the price.
• You don’t have to venture into distant wa-
ters to create blue oceans. Most blue
oceans are created from within, not be-
yond, the red oceans of existing industries.
Incumbents often create blue oceans
within their core businesses. Consider
the megaplexes introduced by AMC—an
established player in the movie-theater
industry. Megaplexes provided movie-
goers spectacular viewing experiences in
stadium-size theater complexes at lower
costs to theater owners.

APPLY BLUE OCEAN STRATEGIC MOVES

To apply blue ocean strategic moves:

•

Never use the competition as a bench-
mark.

Instead, make the competition irrele-
vant by creating a leap in value for both
yourself and your customers. Ford did this
with the Model T. Ford could have tried be-
sting the fashionable, customized cars that
wealthy people bought for weekend jaunts
in the countryside. Instead, it offered a car
for everyday use that was far more afford-
able, durable, and easy to use and fix than
rivals’ offerings. Model T sales boomed, and
Ford’s market share surged from 9% in 1908
to 61% in 1921.
• Reduce your costs while also offering
customers more value. Cirque du Soleil
omitted costly elements of traditional cir-
cus, such as animal acts and aisle conces-
sions. Its reduced cost structure enabled it
to provide sophisticated elements from
theater that appealed to adult audiences—
such as themes, original scores, and en-
chanting sets, all of which change year to
year. The added value lured adults who had
not gone to a circus for years and enticed
them to come back more frequently—
thereby increasing revenues. By offering
the best of circus and theater, Cirque cre-
ated a market space that, as yet, has no
name—and no equals.
page 70

Blue Ocean Strategy

by W. Chan Kim and Renée Mauborgne

harvard business review • october 2004

C
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. A
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IG
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.

Competing in overcrowded industries is no way to sustain high
performance. The real opportunity is to create blue oceans of
uncontested market space.

A onetime accordion player, stilt walker, and
fire-eater, Guy Laliberté is now CEO of one of
Canada’s largest cultural exports, Cirque du
Soleil. Founded in 1984 by a group of street
performers, Cirque has staged dozens of pro-
ductions seen by some 40 million people in 90
cities around the world. In 20 years, Cirque
has achieved revenues that Ringling Bros. and
Barnum & Bailey—the world’s leading cir-
cus—took more than a century to attain.
Cirque’s rapid growth occurred in an un-
likely setting. The circus business was (and still
is) in long-term decline. Alternative forms of
entertainment—sporting events, TV, and video
games—were casting a growing shadow. Chil-
dren, the mainstay of the circus audience, pre-
ferred PlayStations to circus acts. There was
also rising sentiment, fueled by animal rights
groups, against the use of animals, tradition-
ally an integral part of the circus. On the sup-
ply side, the star performers that Ringling and
the other circuses relied on to draw in the
crowds could often name their own terms. As a
result, the industry was hit by steadily decreas-
ing audiences and increasing costs. What’s
more, any new entrant to this business would
be competing against a formidable incumbent
that for most of the last century had set the in-
dustry standard.
How did Cirque profitably increase revenues
by a factor of 22 over the last ten years in such
an unattractive environment? The tagline for
one of the first Cirque productions is revealing:
“We reinvent the circus.” Cirque did not make
its money by competing within the confines of
the existing industry or by stealing customers
from Ringling and the others. Instead it cre-
ated uncontested market space that made the
competition irrelevant. It pulled in a whole
new group of customers who were tradition-
ally noncustomers of the industry—adults and
corporate clients who had turned to theater,
opera, or ballet and were, therefore, prepared
to pay several times more than the price of a
conventional circus ticket for an unprece-
dented entertainment experience.
To understand the nature of Cirque’s
achievement, you have to realize that the busi-
page 71

Blue Ocean Strategy

harvard business review • october 2004

ness universe consists of two distinct kinds of
space, which we think of as red and blue
oceans. Red oceans represent all the industries
in existence today—the known market space.
In red oceans, industry boundaries are defined
and accepted, and the competitive rules of the
game are well understood. Here, companies
try to outperform their rivals in order to grab a
greater share of existing demand. As the space
gets more and more crowded, prospects for
profits and growth are reduced. Products turn
into commodities, and increasing competition
turns the water bloody.
Blue oceans denote all the industries not in
existence today—the unknown market space,
untainted by competition. In blue oceans, de-
mand is created rather than fought over. There
is ample opportunity for growth that is both
profitable and rapid. There are two ways to cre-
ate blue oceans. In a few cases, companies can
give rise to completely new industries, as eBay
did with the online auction industry. But in
most cases, a blue ocean is created from within
a red ocean when a company alters the bound-
aries of an existing industry. As will become ev-
ident later, this is what Cirque did. In breaking
through the boundary traditionally separating
circus and theater, it made a new and profit-
able blue ocean from within the red ocean of
the circus industry.
Cirque is just one of more than 150 blue
ocean creations that we have studied in over
30 industries, using data stretching back more
than 100 years. We analyzed companies that
created those blue oceans and their less suc-
cessful competitors, which were caught in red
oceans. In studying these data, we have ob-
served a consistent pattern of strategic think-
ing behind the creation of new markets and in-
dustries, what we call blue ocean strategy. The
logic behind blue ocean strategy parts with tra-
ditional models focused on competing in exist-
ing market space. Indeed, it can be argued that
managers’ failure to realize the differences be-
tween red and blue ocean strategy lies behind
the difficulties many companies encounter as
they try to break from the competition.
In this article, we present the concept of
blue ocean strategy and describe its defining
characteristics. We assess the profit and growth
consequences of blue oceans and discuss why
their creation is a rising imperative for compa-
nies in the future. We believe that an under-
standing of blue ocean strategy will help to-
day’s companies as they struggle to thrive in an
accelerating and expanding business universe.

Blue and Red Oceans

Although the term may be new, blue oceans
have always been with us. Look back 100 years
and ask yourself which industries known
today were then unknown. The answer: Indus-
tries as basic as automobiles, music recording,
aviation, petrochemicals, pharmaceuticals,
and management consulting were unheard-of
or had just begun to emerge. Now turn the
clock back only 30 years and ask yourself the
same question. Again, a plethora of multibil-
lion-dollar industries jump out: mutual funds,
cellular telephones, biotechnology, discount
retailing, express package delivery, snow-
boards, coffee bars, and home videos, to name
a few. Just three decades ago, none of these in-
dustries existed in a meaningful way.
This time, put the clock forward 20 years.
Ask yourself: How many industries that are un-
known today will exist then? If history is any
predictor of the future, the answer is many.
Companies have a huge capacity to create new
industries and re-create existing ones, a fact
that is reflected in the deep changes that have
been necessary in the way industries are classi-
fied. The half-century-old Standard Industrial
Classification (SIC) system was replaced in 1997
by the North American Industry Classification
System (NAICS). The new system expanded
the ten SIC industry sectors into 20 to reflect
the emerging realities of new industry territo-
ries—blue oceans. The services sector under
the old system, for example, is now seven sec-
tors ranging from information to health care
and social assistance. Given that these classifi-
cation systems are designed for standardization
and continuity, such a replacement shows how
significant a source of economic growth the
creation of blue oceans has been.
Looking forward, it seems clear to us that
blue oceans will remain the engine of growth.
Prospects in most established market spaces—
red oceans—are shrinking steadily. Technologi-
cal advances have substantially improved in-
dustrial productivity, permitting suppliers to
produce an unprecedented array of products
and services. And as trade barriers between na-
tions and regions fall and information on prod-
ucts and prices becomes instantly and globally
available, niche markets and monopoly havens
are continuing to disappear. At the same time,

W. Chan Kim

(chan.kim@insead.edu) is
the Boston Consulting Group Bruce D.
Henderson Chair Professor of Strategy
and International Management at In-
sead in Fontainebleau, France. Renée
Mauborgne (renee.mauborgne@
insead.edu) is the Insead Distinguished
Fellow and a professor of strategy and
management at Insead. This article is
adapted from their forthcoming book
Blue Ocean Strategy: How to Create Un-
contested Market Space and Make the
Competition Irrelevant (Harvard Business
School Press, 2005).
page 72

mailto:chan.kim@insead.edu

mailto:renee.mauborgne@insead.edu

mailto:renee.mauborgne@insead.edu

Blue Ocean Strategy

harvard business review • october 2004

there is little evidence of any increase in de-
mand, at least in the developed markets,
where recent United Nations statistics even
point to declining populations. The result is
that in more and more industries, supply is
overtaking demand.
This situation has inevitably hastened the
commoditization of products and services,
stoked price wars, and shrunk profit margins.
According to recent studies, major American
brands in a variety of product and service cat-
egories have become more and more alike.
And as brands become more similar, people
increasingly base purchase choices on price.
People no longer insist, as in the past, that
their laundry detergent be Tide. Nor do they
necessarily stick to Colgate when there is a
special promotion for Crest, and vice versa. In
overcrowded industries, differentiating
brands becomes harder both in economic up-
turns and in downturns.

The Paradox of Strategy

Unfortunately, most companies seem be-
calmed in their red oceans. In a study of busi-
ness launches in 108 companies, we found that
86% of those new ventures were line exten-
sions—incremental improvements to existing
industry offerings—and a mere 14% were
aimed at creating new markets or industries.
While line extensions did account for 62% of
the total revenues, they delivered only 39% of
the total profits. By contrast, the 14% invested
in creating new markets and industries deliv-
ered 38% of total revenues and a startling 61%
of total profits.
So why the dramatic imbalance in favor of
red oceans? Part of the explanation is that cor-
porate strategy is heavily influenced by its
roots in military strategy. The very language of
strategy is deeply imbued with military refer-
ences—chief executive “officers” in “headquar-
ters,” “troops” on the “front lines.” Described
this way, strategy is all about red ocean compe-
tition. It is about confronting an opponent and
driving him off a battlefield of limited terri-
tory. Blue ocean strategy, by contrast, is about
doing business where there is no competitor. It
is about creating new land, not dividing up ex-
isting land. Focusing on the red ocean there-
fore means accepting the key constraining fac-
tors of war—limited terrain and the need to
beat an enemy to succeed. And it means deny-
ing the distinctive strength of the business
world—the capacity to create new market
space that is uncontested.
The tendency of corporate strategy to focus
on winning against rivals was exacerbated by
the meteoric rise of Japanese companies in the
1970s and 1980s. For the first time in corporate
history, customers were deserting Western
companies in droves. As competition mounted
in the global marketplace, a slew of red ocean
strategies emerged, all arguing that competi-
tion was at the core of corporate success and
failure. Today, one hardly talks about strategy
without using the language of competition.
The term that best symbolizes this is “competi-
tive advantage.” In the competitive-advantage
worldview, companies are often driven to out-
perform rivals and capture greater shares of ex-
isting market space.
Of course competition matters. But by fo-
cusing on competition, scholars, companies,
and consultants have ignored two very impor-
tant—and, we would argue, far more lucra-
tive—aspects of strategy: One is to find and
develop markets where there is little or no
competition—blue oceans—and the other is
to exploit and protect blue oceans. These
challenges are very different from those to
which strategists have devoted most of their
attention.

Toward Blue Ocean Strategy

What kind of strategic logic is needed to guide
the creation of blue oceans? To answer that
question, we looked back over 100 years of
data on blue ocean creation to see what pat-
terns could be discerned. Some of our data are
presented in the exhibit “A Snapshot of Blue
Ocean Creation.” It shows an overview of key
blue ocean creations in three industries that
closely touch people’s lives: autos—how peo-
ple get to work; computers—what people use
at work; and movie theaters—where people

A Snapshot of Blue Ocean Creation

The table on the next page identifies the
strategic elements that were common to
blue ocean creations in three different
industries in different eras. It is not in-
tended to be comprehensive in coverage
or exhaustive in content. We chose to
show American industries because they
represented the largest and least-
regulated market during our study
period. The pattern of blue ocean
creations exemplified by these three
industries is consistent with what
we observed in the other industries
in our study.
page 73

Blue Ocean Strategy

harvard business review • october 2004

Key blue ocean creations
Was the blue ocean
created by a new
entrant or an
incumbent?
Was it driven by
technology pioneering
or value pioneering?
At the time of the blue
ocean creation, was
the industry attractive
or unattractive?
New entrant Value pioneering*
(mostly existing technologies)
UnattractiveFord Model T
Unveiled in 1908, the Model T was the first mass-produced
car, priced so that many Americans could afford it.
Incumbent Value pioneering
(some new technologies)
Attractive GM’s “car for every purse and purpose”
GM created a blue ocean in 1924 by injecting fun and
fashion into the car.
Incumbent Value pioneering
(some new technologies)
UnattractiveJapanese fuel-efficient autos
Japanese automakers created a blue ocean in the mid-1970s
with small, reliable lines of cars.
Incumbent Value pioneering
(mostly existing technologies)
UnattractiveChrysler minivan
With its 1984 minivan, Chrysler created a new class of auto-
mobile that was as easy to use as a car but had the passenger
space of a van.
Incumbent Value pioneering
(some new technologies)
UnattractiveCTR’s tabulating machine
In 1914, CTR created the business machine industry by
simplifying, modularizing, and leasing tabulating machines.
CTR later changed its name to IBM.
Incumbent Value pioneering
(650: mostly existing technologies)
Value and technology pioneering
(System/360: new and existing
technologies)
NonexistentIBM 650 electronic computer and System/360
In 1952, IBM created the business computer industry by simpli-
fying and reducing the power and price of existing technology.
And it exploded the blue ocean created by the 650 when in
1964 it unveiled the System/360, the first modularized com-
puter system.
New entrant Value pioneering
(mostly existing technologies)
UnattractiveApple personal computer
Although it was not the first home computer, the all-in-one,
simple-to-use Apple II was a blue ocean creation when it
appeared in 1978.
Incumbent Value pioneering
(mostly existing technologies)
NonexistentCompaq PC servers
Compaq created a blue ocean in 1992 with its ProSignia
server, which gave buyers twice the file and print capability
of the minicomputer at one-third the price.
New entrant Value pioneering
(mostly existing technologies)
UnattractiveDell built-to-order computers
In the mid-1990s, Dell created a blue ocean in a highly
competitive industry by creating a new purchase and delivery
experience for buyers.
New entrant Value pioneering
(mostly existing technologies)
NonexistentNickelodeon
The first Nickelodeon opened its doors in 1905, showing short
films around-the-clock to working-class audiences for five cents.
Incumbent Value pioneering
(mostly existing technologies)
Attractive Palace theaters
Created by Roxy Rothapfel in 1914, these theaters provided
an operalike environment for cinema viewing at an affordable
price.
Incumbent Value pioneering
(mostly existing technologies)
UnattractiveAMC multiplex
In the 1960s, the number of multiplexes in America’s subur-
ban shopping malls mushroomed. The multiplex gave viewers
greater choice while reducing owners’costs.
Incumbent Value pioneering
(mostly existing technologies)
UnattractiveAMC megaplex
Megaplexes, introduced in 1995, offered every current block-
buster and provided spectacular viewing experiences in
theater complexes as big as stadiums, at a lower cost to
theater owners.
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te
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the defining technologies used had largely been in existence, whether in that industry or elsewhere. Co
py
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page 74

Blue Ocean Strategy

harvard business review • october 2004

go after work for enjoyment. We found that:

Blue oceans are not about technology inno-
vation.

Leading-edge technology is sometimes
involved in the creation of blue oceans, but it
is not a defining feature of them. This is often
true even in industries that are technology in-
tensive. As the exhibit reveals, across all three
representative industries, blue oceans were
seldom the result of technological innovation
per se; the underlying technology was often
already in existence. Even Ford’s revolutionary
assembly line can be traced to the meatpack-
ing industry in America. Like those within the
auto industry, the blue oceans within the com-
puter industry did not come about through
technology innovations alone but by linking
technology to what buyers valued. As with the
IBM 650 and the Compaq PC server, this often
involved simplifying the technology.
Incumbents often create blue oceans—and
usually within their core businesses. GM, the
Japanese automakers, and Chrysler were es-
tablished players when they created blue
oceans in the auto industry. So were CTR and
its later incarnation, IBM, and Compaq in the
computer industry. And in the cinema indus-
try, the same can be said of palace theaters
and AMC. Of the companies listed here, only
Ford, Apple, Dell, and Nickelodeon were new
entrants in their industries; the first three
were start-ups, and the fourth was an estab-
lished player entering an industry that was
new to it. This suggests that incumbents are
not at a disadvantage in creating new market
spaces. Moreover, the blue oceans made by in-
cumbents were usually within their core busi-
nesses. In fact, as the exhibit shows, most blue
oceans are created from within, not beyond,
red oceans of existing industries. This chal-
lenges the view that new markets are in dis-
tant waters. Blue oceans are right next to you
in every industry.
Company and industry are the wrong units
of analysis. The traditional units of strategic
analysis—company and industry—have little
explanatory power when it comes to analyz-
ing how and why blue oceans are created.
There is no consistently excellent company;
the same company can be brilliant at one time
and wrongheaded at another. Every company
rises and falls over time. Likewise, there is no
perpetually excellent industry; relative attrac-
tiveness is driven largely by the creation of
blue oceans from within them.
The most appropriate unit of analysis for ex-
plaining the creation of blue oceans is the stra-
tegic move—the set of managerial actions and
decisions involved in making a major market-
creating business offering. Compaq, for exam-
ple, is considered by many people to be “unsuc-
cessful” because it was acquired by Hewlett-
Packard in 2001 and ceased to be a company.
But the firm’s ultimate fate does not invalidate
the smart strategic move Compaq made that led
to the creation of the multibillion-dollar market
in PC servers, a move that was a key cause of the
company’s powerful comeback in the 1990s.
Creating blue oceans builds brands. So pow-
erful is blue ocean strategy that a blue ocean
strategic move can create brand equity that
lasts for decades. Almost all of the companies
listed in the exhibit are remembered in no
small part for the blue oceans they created
long ago. Very few people alive today were
around when the first Model T rolled off
Henry Ford’s assembly line in 1908, but the
company’s brand still benefits from that blue
ocean move. IBM, too, is often regarded as an
“American institution” largely for the blue
oceans it created in computing; the 360 series
was its equivalent of the Model T.
Our findings are encouraging for executives
at the large, established corporations that are
traditionally seen as the victims of new market
space creation. For what they reveal is that
large R&D budgets are not the key to creating
new market space. The key is making the right
strategic moves. What’s more, companies that
understand what drives a good strategic move
will be well placed to create multiple blue
oceans over time, thereby continuing to de-
liver high growth and profits over a sustained
period. The creation of blue oceans, in other
words, is a product of strategy and as such is
very much a product of managerial action.

The Defining Characteristics

Our research shows several common charac-
teristics across strategic moves that create blue
oceans. We found that the creators of blue
oceans, in sharp contrast to companies playing
by traditional rules, never use the competition
as a benchmark. Instead they make it irrele-
vant by creating a leap in value for both buy-
ers and the company itself. (The exhibit “Red
Ocean Versus Blue Ocean Strategy” compares
the chief characteristics of these two strategy
models.)
In blue oceans, demand
is created rather than
fought over. There is
ample opportunity for
growth that is both
profitable and rapid.
page 75

Blue Ocean Strategy

harvard business review • october 2004

Perhaps the most important feature of blue
ocean strategy is that it rejects the fundamen-
tal tenet of conventional strategy: that a trade-
off exists between value and cost. According to
this thesis, companies can either create greater
value for customers at a higher cost or create
reasonable value at a lower cost. In other
words, strategy is essentially a choice between
differentiation and low cost. But when it
comes to creating blue oceans, the evidence
shows that successful companies pursue differ-
entiation and low cost simultaneously.
To see how this is done, let us go back to Cir-
que du Soleil. At the time of Cirque’s debut,
circuses focused on benchmarking one an-
other and maximizing their shares of shrinking
demand by tweaking traditional circus acts.
This included trying to secure more and better-
known clowns and lion tamers, efforts that
raised circuses’ cost structure without substan-
tially altering the circus experience. The result
was rising costs without rising revenues and a
downward spiral in overall circus demand.
Enter Cirque. Instead of following the conven-
tional logic of outpacing the competition by of-
fering a better solution to the given problem—
creating a circus with even greater fun and
thrills—it redefined the problem itself by offer-
ing people the fun and thrill of the circus and
the intellectual sophistication and artistic rich-
ness of the theater.
In designing performances that landed both
these punches, Cirque had to reevaluate the
components of the traditional circus offering.
What the company found was that many of
the elements considered essential to the fun
and thrill of the circus were unnecessary and
in many cases costly. For instance, most cir-
cuses offer animal acts. These are a heavy eco-
nomic burden, because circuses have to shell
out not only for the animals but also for their
training, medical care, housing, insurance, and
transportation. Yet Cirque found that the appe-
tite for animal shows was rapidly diminishing
because of rising public concern about the
treatment of circus animals and the ethics of
exhibiting them.
Similarly, although traditional circuses pro-
moted their performers as stars, Cirque real-
ized that the public no longer thought of circus
artists as stars, at least not in the movie star
sense. Cirque did away with traditional three-
ring shows, too. Not only did these create con-
fusion among spectators forced to switch their
attention from one ring to another, they also
increased the number of performers needed,
with obvious cost implications. And while aisle
concession sales appeared to be a good way to
generate revenue, the high prices discouraged
parents from making purchases and made
them feel they were being taken for a ride.
Cirque found that the lasting allure of the
traditional circus came down to just three fac-
tors: the clowns, the tent, and the classic acro-
batic acts. So Cirque kept the clowns, while
shifting their humor away from slapstick to a
more enchanting, sophisticated style. It glam-
orized the tent, which many circuses had aban-
doned in favor of rented venues. Realizing that
the tent, more than anything else, captured
the magic of the circus, Cirque designed this
classic symbol with a glorious external finish
and a high level of audience comfort. Gone
were the sawdust and hard benches. Acrobats
and other thrilling performers were retained,
but Cirque reduced their roles and made their
acts more elegant by adding artistic flair.
Even as Cirque stripped away some of the
traditional circus offerings, it injected new el-
ements drawn from the world of theater. For
instance, unlike traditional circuses featuring
a series of unrelated acts, each Cirque cre-
ation resembles a theater performance in that
it has a theme and story line. Although the
themes are intentionally vague, they bring
harmony and an intellectual element to the
acts. Cirque also borrows ideas from Broad-
way. For example, rather than putting on the
traditional “once and for all” show, Cirque
mounts multiple productions based on differ-

Red Ocean Versus Blue Ocean Strategy
The imperatives for red ocean and blue ocean
strategies are starkly different.
Red ocean strategy
Compete in existing market space.
Beat the competition.
Exploit existing demand.
Make the value/cost trade-off.
Align the whole system of a com-
pany’s activities with its strategic
choice of differentiation or low cost.
Blue ocean strategy
Create uncontested market space.
Make the competition irrelevant.
Create and capture new demand.
Break the value/cost trade-off.
Align the whole system of a company’s
activities in pursuit of differentiation
and low cost. Co
py
rig
ht
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page 76

Blue Ocean Strategy

harvard business review • october 2004

ent themes and story lines. As with Broadway
productions, too, each Cirque show has an
original musical score, which drives the per-
formance, lighting, and timing of the acts,
rather than the other way around. The pro-
ductions feature abstract and spiritual dance,
an idea derived from theater and ballet. By in-
troducing these factors, Cirque has created
highly sophisticated entertainments. And by
staging multiple productions, Cirque gives
people reason to come to the circus more of-
ten, thereby increasing revenues.
Cirque offers the best of both circus and
theater. And by eliminating many of the most
expensive elements of the circus, it has been
able to dramatically reduce its cost structure,
achieving both differentiation and low cost.
(For a depiction of the economics underpin-
ning blue ocean strategy, see the exhibit “The
Simultaneous Pursuit of Differentiation and
Low Cost.”)
By driving down costs while simultaneously
driving up value for buyers, a company can
achieve a leap in value for both itself and its
customers. Since buyer value comes from the
utility and price a company offers, and a com-
pany generates value for itself through cost
structure and price, blue ocean strategy is
achieved only when the whole system of a
company’s utility, price, and cost activities is
properly aligned. It is this whole-system ap-
proach that makes the creation of blue oceans
a sustainable strategy. Blue ocean strategy inte-
grates the range of a firm’s functional and op-
erational activities.
A rejection of the trade-off between low cost
and differentiation implies a fundamental
change in strategic mind-set—we cannot em-
phasize enough how fundamental a shift it is.
The red ocean assumption that industry struc-
tural conditions are a given and firms are
forced to compete within them is based on an
intellectual worldview that academics call the
structuralist view, or environmental determin-
ism. According to this view, companies and
managers are largely at the mercy of economic
forces greater than themselves. Blue ocean
strategies, by contrast, are based on a world-
view in which market boundaries and indus-
tries can be reconstructed by the actions and
beliefs of industry players. We call this the re-
constructionist view.
The founders of Cirque du Soleil clearly did
not feel constrained to act within the confines
of their industry. Indeed, is Cirque really a cir-
cus with all that it has eliminated, reduced,
raised, and created? Or is it theater? If it is the-
ater, then what genre—Broadway show, opera,
ballet? The magic of Cirque was created
through a reconstruction of elements drawn
from all of these alternatives. In the end, Cir-
que is none of them and a little of all of them.
From within the red oceans of theater and cir-
cus, Cirque has created a blue ocean of uncon-
tested market space that has, as yet, no name.

Barriers to Imitation

Companies that create blue oceans usually
reap the benefits without credible challenges
for ten to 15 years, as was the case with Cirque
du Soleil, Home Depot, Federal Express,
Southwest Airlines, and CNN, to name just a
few. The reason is that blue ocean strategy cre-
ates considerable economic and cognitive bar-

The Simultaneous Pursuit of Differentiation
and Low Cost

A blue ocean is created in the region
where a company’s actions favorably
affect both its cost structure and its
value proposition to buyers. Cost savings
are made from eliminating and reduc-
ing the factors an industry competes on.
Buyer value is lifted by raising and
creating elements the industry has
never offered. Over time, costs are re-
duced further as scale economies kick
in, due to the high sales volumes that
superior value generates.

Blue
Ocean
Buyer Value
Costs
Co
py
rig
ht
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ar
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.
page 77

Blue Ocean Strategy

harvard business review • october 2004

riers to imitation.
For a start, adopting a blue ocean creator’s
business model is easier to imagine than to
do. Because blue ocean creators immediately
attract customers in large volumes, they are
able to generate scale economies very rapidly,
putting would-be imitators at an immediate
and continuing cost disadvantage. The huge
economies of scale in purchasing that Wal-
Mart enjoys, for example, have significantly
discouraged other companies from imitating
its business model. The immediate attraction
of large numbers of customers can also create
network externalities. The more customers
eBay has online, the more attractive the auc-
tion site becomes for both sellers and buyers
of wares, giving users few incentives to go
elsewhere.
When imitation requires companies to make
changes to their whole system of activities, or-
ganizational politics may impede a would-be
competitor’s ability to switch to the divergent
business model of a blue ocean strategy. For in-
stance, airlines trying to follow Southwest’s ex-
ample of offering the speed of air travel with
the flexibility and cost of driving would have
faced major revisions in routing, training, mar-
keting, and pricing, not to mention culture.
Few established airlines had the flexibility to
make such extensive organizational and oper-
ating changes overnight. Imitating a whole-
system approach is not an easy feat.
The cognitive barriers can be just as effec-
tive. When a company offers a leap in value, it
rapidly earns brand buzz and a loyal following
in the marketplace. Experience shows that
even the most expensive marketing campaigns
struggle to unseat a blue ocean creator. Mi-
crosoft, for example, has been trying for more
than ten years to occupy the center of the blue
ocean that Intuit created with its financial soft-
ware product Quicken. Despite all of its efforts
and all of its investment, Microsoft has not
been able to unseat Intuit as the industry
leader.
In other situations, attempts to imitate a
blue ocean creator conflict with the imitator’s
existing brand image. The Body Shop, for ex-
ample, shuns top models and makes no prom-
ises of eternal youth and beauty. For the estab-
lished cosmetic brands like Estée Lauder and
L’Oréal, imitation was very difficult, because it
would have signaled a complete invalidation of
their current images, which are based on
promises of eternal youth and beauty.

A Consistent Pattern

While our conceptual articulation of the pat-
tern may be new, blue ocean strategy has al-
ways existed, whether or not companies have
been conscious of the fact. Just consider the
striking parallels between the Cirque du Soleil
theater-circus experience and Ford’s creation
of the Model T.
At the end of the nineteenth century, the au-
tomobile industry was small and unattractive.
More than 500 automakers in America com-
peted in turning out handmade luxury cars
that cost around $1,500 and were enormously
unpopular with all but the very rich. Anticar
activists tore up roads, ringed parked cars with
barbed wire, and organized boycotts of car-
driving businessmen and politicians. Woodrow
Wilson caught the spirit of the times when he
said in 1906 that “nothing has spread socialistic
feeling more than the automobile.” He called it
“a picture of the arrogance of wealth.”
Instead of trying to beat the competition
and steal a share of existing demand from
other automakers, Ford reconstructed the in-
dustry boundaries of cars and horse-drawn car-
riages to create a blue ocean. At the time,
horse-drawn carriages were the primary means
of local transportation across America. The car-
riage had two distinct advantages over cars.
Horses could easily negotiate the bumps and
mud that stymied cars—especially in rain and
snow—on the nation’s ubiquitous dirt roads.
And horses and carriages were much easier to
maintain than the luxurious autos of the time,
which frequently broke down, requiring expert
repairmen who were expensive and in short
supply. It was Henry Ford’s understanding of
these advantages that showed him how he
could break away from the competition and
unlock enormous untapped demand.
Ford called the Model T the car “for the
great multitude, constructed of the best mate-
rials.” Like Cirque, the Ford Motor Company
made the competition irrelevant. Instead of
creating fashionable, customized cars for
weekends in the countryside, a luxury few
could justify, Ford built a car that, like the
horse-drawn carriage, was for everyday use.
The Model T came in just one color, black,
and there were few optional extras. It was reli-
able and durable, designed to travel effort-
lessly over dirt roads in rain, snow, or sun-
page 78

Blue Ocean Strategy

harvard business review • october 2004

shine. It was easy to use and fix. People could
learn to drive it in a day. And like Cirque, Ford
went outside the industry for a price point,
looking at horse-drawn carriages ($400), not
other autos. In 1908, the first Model T cost
$850; in 1909, the price dropped to $609, and
by 1924 it was down to $290. In this way, Ford
converted buyers of horse-drawn carriages
into car buyers—just as Cirque turned the-
atergoers into circusgoers. Sales of the Model
T boomed. Ford’s market share surged from
9% in 1908 to 61% in 1921, and by 1923, a ma-
jority of American households had a car.
Even as Ford offered the mass of buyers a
leap in value, the company also achieved the
lowest cost structure in the industry, much as
Cirque did later. By keeping the cars highly
standardized with limited options and inter-
changeable parts, Ford was able to scrap the
prevailing manufacturing system in which cars
were constructed by skilled craftsmen who
swarmed around one workstation and built a
car piece by piece from start to finish. Ford’s
revolutionary assembly line replaced crafts-
men with unskilled laborers, each of whom
worked quickly and efficiently on one small
task. This allowed Ford to make a car in just
four days—21 days was the industry norm—
creating huge cost savings.

• • •

Blue and red oceans have always coexisted and
always will. Practical reality, therefore, de-
mands that companies understand the strate-
gic logic of both types of oceans. At present,
competing in red oceans dominates the field
of strategy in theory and in practice, even as
businesses’ need to create blue oceans intensi-
fies. It is time to even the scales in the field of
strategy with a better balance of efforts across
both oceans. For although blue ocean strate-
gists have always existed, for the most part
their strategies have been largely unconscious.
But once corporations realize that the strate-
gies for creating and capturing blue oceans
have a different underlying logic from red
ocean strategies, they will be able to create
many more blue oceans in the future.

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Further Reading

B O O K

Blue Ocean Strategy: How to Create
Uncontested Market Space and Make the
Competition Irrelevant

by W. Chan Kim and Renée Mauborgne

Harvard Business School Publishing

December 2004
Product no. 6190
The authors provide recent examples of busi-
nesses that have created blue oceans and
present a framework for crafting blue-ocean
strategies: 1) Eliminate factors in your industry
that no longer have value. For example, wine-
maker Yellow Tail eliminated fancy terminol-
ogy in its marketing communications. 2) Re-
duce factors that overserve customers and
increase cost structure for no gain. Yellow Tail
initially offered just two choices: red or white
wine. 3) Raise factors that remove compro-
mises buyers must make. Yellow Tail priced its
wines above the budget category of wines
but below those deemed “premium.” 4) Cre-
ate factors that add new sources of value. Yel-
low Tail provided ease of selection and the fun
and adventure of Australian branding. By late
2003, Yellow Tail had become the United
States’ best-selling red wine in a 750-ml bot-
tle—outstripping all California labels.
A R T I C L E
MarketBusting: Strategies for
Exceptional Business Growth

by Rita Gunther McGrath and
Ian C. MacMillan
Harvard Business Review
March 2005
Product no. 9408
The authors provide suggestions for creating
blue oceans within your existing business. 1)
Redefine your unit of business—what you
bill customers for—to reflect what customers
value. For example, Mexican cement company
Cemex shifted its unit of business from cubic
yards of cement to delivery window: the right
amount of concrete delivered when needed.
2) Boost your performance on key metrics.
Cemex reoriented its information systems, lo-
gistics, and delivery infrastructure to improve
truck utilization—a key metric for delivery
businesses. 3) Improve customers’ perfor-
mance. UPS handles shipping and repair for
laptop makers—freeing these customers from
employing expensive maintenance staff, and
getting laptops back in owners’ hands quickly.
The service enhances laptop makers’ produc-
tivity and lowers their costs.
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The Secrets to
Successful Strategy
Execution

by Gary L. Neilson, Karla L. Martin, and
Elizabeth Powers

Included with this full-text Harvard Business Review article:
The Idea in Brief—the core idea
The Idea in Practice—putting the idea to work

82

Article Summary

83

The Secrets to Successful Strategy Execution
A list of related materials, with annotations to guide further
exploration of the article’s ideas and applications

94

Further Reading

Research shows that
enterprises fail at execution
because they go straight to
structural reorganization and
neglect the most powerful
drivers of effectiveness—
decision rights and
information flow.

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The Secrets to Successful Strategy Execution

The Idea in Brief The Idea in Practice

C
O
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YR
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T
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V
A
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B
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S
C
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O
O
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U
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IN
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C
O
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A
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. A
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IG
H
T
S
R
E
SE
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V
E
D
.

A brilliant strategy may put you on the
competitive map. But only solid execution
keeps you there. Unfortunately, most com-
panies struggle with implementation.
That’s because they overrely on structural
changes, such as reorganization, to execute
their strategy.
Though structural change has its place in
execution, it produces only short-term
gains. For example, one company reduced
its management layers as part of a strategy
to address disappointing performance.
Costs plummeted initially, but the layers
soon crept back in.
Research by Neilson, Martin, and Powers
shows that execution exemplars focus their
efforts on two levers far more powerful
than structural change:

•

Clarifying decision rights—

for instance,
specifying who “owns” each decision and
who must provide input

•

Ensuring information flows where it’s
needed—

such as promoting managers
laterally so they build networks needed
for the cross-unit collaboration critical to
a new strategy
Tackle decision rights and information
flows first, and only then

alter organiza-
tional structures

and

realign incentives

to

support

those moves.
The following levers matter

most

for success-
ful strategy execution:

DECISION RIGHTS

•

Ensure that everyone in your company
knows which decisions and actions they’re
responsible for.
Example:

In one global consumer-goods company,
decisions made by divisional and geographic
leaders were overridden by corporate func-
tional leaders who controlled resource allo-
cations. Decisions stalled. Overhead costs
mounted as divisions added staff to create
bulletproof cases for challenging corporate
decisions. To support a new strategy hinging
on sharper customer focus, the CEO desig-
nated accountability for profits unambigu-
ously to the divisions.

•

Encourage higher-level managers to dele-
gate operational decisions.
Example:

At one global charitable organization,
country-level managers’ inability to dele-
gate led to decision paralysis. So the leader-
ship team encouraged country managers
to delegate standard operational tasks.
This freed these managers to focus on de-
veloping the strategies needed to fulfill the
organization’s mission.

INFORMATION FLOW

•

Make sure important information about the
competitive environment flows quickly to
corporate headquarters. That way, the top
team can identify patterns and promulgate
best practices throughout the company.
Example:

At one insurance company, accurate in-
formation about projects’ viability was
censored as it moved up the hierarchy. To
improve information flow to senior levels
of management, the company took steps
to create a more open, informal culture.
Top executives began mingling with unit
leaders during management meetings
and held regular brown-bag lunches
where people discussed the company’s
most pressing issues.

•

Facilitate information flow across organiza-
tional boundaries.
Example:

To better manage relationships with
large, cross-product customers, a B2B
company needed its units to talk with
one another. It charged its newly created
customer-focused marketing group with
encouraging cross-company communi-
cation. The group issued regular reports
showing performance against targets (by
product and geography) and supplied
root-cause analyses of performance gaps.
Quarterly performance-management
meetings further fostered the trust re-
quired for collaboration.

•

Help field and line employees understand
how their day-to-day choices affect your
company’s bottom line.
Example:

At a financial services firm, salespeople
routinely crafted customized one-off deals
with clients that cost the company more
than it made in revenues. Sales didn’t un-
derstand the cost and complexity implica-
tions of these transactions. Management
addressed the information misalignment
by adopting a “smart customization” ap-
proach to sales. For customized deals, it
established standardized back-office pro-
cesses (such as risk assessment). It also de-
veloped analytical support tools to arm
salespeople with accurate information on
the cost implications of their proposed
transactions. Profitability improved.
page 82

The Secrets to
Successful Strategy
Execution

by Gary L. Neilson, Karla L. Martin, and
Elizabeth Powers

harvard business review • june 2008

C
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T
©
2
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V
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D
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SS
S
C
H
O
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U
B
LI
SH
IN
G
C
O
R
P
O
R
A
T
IO
N
. A
LL
R
IG
H
T
S
R
E
SE
R
V
E
D
.

Research shows that enterprises fail at execution because they go
straight to structural reorganization and neglect the most powerful
drivers of effectiveness—decision rights and information flow.

A brilliant strategy, blockbuster product, or
breakthrough technology can put you on the
competitive map, but only solid execution can
keep you there. You have to be able to deliver
on your intent. Unfortunately, the majority of
companies aren’t very good at it, by their own
admission. Over the past five years, we have
invited many thousands of employees (about
25% of whom came from executive ranks) to
complete an online assessment of their organi-
zations’ capabilities, a process that’s generated
a database of 125,000 profiles representing
more than 1,000 companies, government
agencies, and not-for-profits in over 50 coun-
tries. Employees at three out of every five
companies rated their organization weak at
execution—that is, when asked if they agreed
with the statement “Important strategic and
operational decisions are quickly translated
into action,” the majority answered no.
Execution is the result of thousands of de-
cisions made every day by employees acting
according to the information they have and
their own self-interest. In our work helping
more than 250 companies learn to execute
more effectively, we’ve identified four funda-
mental building blocks executives can use to
influence those actions—clarifying decision
rights, designing information flows, aligning
motivators, and making changes to struc-
ture. (For simplicity’s sake we refer to them
as decision rights, information, motivators,
and structure.)
In efforts to improve performance, most or-
ganizations go right to structural measures
because moving lines around the org chart
seems the most obvious solution and the
changes are visible and concrete. Such steps
generally reap some short-term efficiencies
quickly, but in so doing address only the
symptoms of dysfunction, not its root causes.
Several years later, companies usually end up
in the same place they started. Structural
change can and should be part of the path to
improved execution, but it’s best to think of it
as the capstone, not the cornerstone, of any
organizational transformation. In fact, our
research shows that actions having to do with
page 83

The Secrets to Successful Strategy Execution

harvard business review • june 2008

decision rights and information are far more
important—about twice as effective—as im-
provements made to the other two building
blocks. (See the exhibit “What Matters Most
to Strategy Execution.”)
Take, for example, the case of a global con-
sumer packaged-goods company that lurched
down the reorganization path in the early
1990s. (We have altered identifying details
in this and other cases that follow.) Dis-
appointed with company performance, senior
management did what most companies were
doing at that time: They restructured. They
eliminated some layers of management and
broadened spans of control. Management-
staffing costs quickly fell by 18%. Eight years
later, however, it was déjà vu. The layers had
crept back in, and spans of control had once
again narrowed. In addressing only structure,
management had attacked the visible symp-
toms of poor performance but not the under-
lying cause—how people made decisions and
how they were held accountable.
This time, management looked beyond lines
and boxes to the mechanics of how work got
done. Instead of searching for ways to strip out
costs, they focused on improving execution—
and in the process discovered the true reasons
for the performance shortfall. Managers didn’t
have a clear sense of their respective roles and
responsibilities. They did not intuitively under-
stand which decisions were theirs to make.
Moreover, the link between performance and
rewards was weak. This was a company long
on micromanaging and second-guessing, and
short on accountability. Middle managers
spent 40% of their time justifying and report-
ing upward or questioning the tactical deci-
sions of their direct reports.
Armed with this understanding, the com-
pany designed a new management model that
established who was accountable for what and
made the connection between performance
and reward. For instance, the norm at this
company, not unusual in the industry, had
been to promote people quickly, within 18
months to two years, before they had a chance
to see their initiatives through. As a result,
managers at every level kept doing their old
jobs even after they had been promoted, peer-
ing over the shoulders of the direct reports
who were now in charge of their projects and,
all too frequently, taking over. Today, people
stay in their positions longer so they can follow
through on their own initiatives, and they’re
still around when the fruits of their labors start
to kick in. What’s more, results from those ini-
tiatives continue to count in their performance
reviews for some time after they’ve been
promoted, forcing managers to live with the
expectations they’d set in their previous jobs.
As a consequence, forecasting has become
more accurate and reliable. These actions did
yield a structure with fewer layers and greater
spans of control, but that was a side effect,
not the primary focus, of the changes.

The Elements of Strong Execution

Our conclusions arise out of decades of practi-
cal application and intensive research. Nearly
five years ago, we and our colleagues set out to
gather empirical data to identify the actions
that were most effective in enabling an organi-
zation to implement strategy. What particular
ways of restructuring, motivating, improving
information flows, and clarifying decision
rights mattered the most? We started by draw-
ing up a list of 17 traits, each corresponding to
one or more of the four building blocks we
knew could enable effective execution—traits
like the free flow of information across organi-
zational boundaries or the degree to which
senior leaders refrain from getting involved
in operating decisions. With these factors in
mind, we developed an online profiler that
allows individuals to assess the execution
capabilities of their organizations. Over the
next four years or so, we collected data from
many thousands of profiles, which in turn
allowed us to more precisely calibrate the im-
pact of each trait on an organization’s ability
to execute. That allowed us to rank all 17 traits
in order of their relative influence. (See the
exhibit “The 17 Fundamental Traits of Organi-
zational Effectiveness.)
Ranking the traits makes clear how impor-
tant decision rights and information are to ef-
fective strategy execution. The first eight traits
map directly to decision rights and informa-
tion. Only three of the 17 traits relate to struc-
ture, and none of those ranks higher than 13th.
We’ll walk through the top five traits here.

1. Everyone has a good idea of the deci-
sions and actions for which he or she is re-
sponsible.

In companies strong on execution,
71% of individuals agree with this statement;
that figure drops to 32% in organizations weak
on execution.

Gary L. Neilson

(gary.neilson@
booz.com) is a senior vice president in
the Chicago office of Booz & Company,
a management-consulting firm. He is a
coauthor of “The Passive-Aggressive
Organization” (HBR, October 2005).

Karla L. Martin

(karla.martin@booz
.com) is a principal in the firm’s San
Francisco office.

Elizabeth Powers

(elizabeth.powers@booz.com) is a
principal in the New York office.
page 84

mailto:gary.neilson@booz.com

mailto:gary.neilson@booz.com

mailto:karla.martin@booz.com

mailto:karla.martin@booz.com

mailto:elizabeth.powers@booz.com

The Secrets to Successful Strategy Execution

harvard business review • june 2008

Blurring of decision rights tends to occur as
a company matures. Young organizations are
generally too busy getting things done to de-
fine roles and responsibilities clearly at the
outset. And why should they? In a small com-
pany, it’s not so difficult to know what other
people are up to. So for a time, things work
out well enough. As the company grows,
however, executives come and go, bringing
in with them and taking away different expec-
tations, and over time the approval process
gets ever more convoluted and murky. It be-
comes increasingly unclear where one person’s
accountability begins and another’s ends.
One global consumer-durables company
found this out the hard way. It was so rife
with people making competing and conflict-
ing decisions that it was hard to find anyone
below the CEO who felt truly accountable for
profitability. The company was organized into
16 product divisions aggregated into three
geographic groups—North America, Europe,
and International. Each of the divisions was
charged with reaching explicit performance
targets, but functional staff at corporate
headquarters controlled spending targets—
how R&D dollars were allocated, for in-
stance. Decisions made by divisional and
geographic leaders were routinely overridden
by functional leaders. Overhead costs began
to mount as the divisions added staff to help
them create bulletproof cases to challenge
corporate decisions.
Decisions stalled while divisions negoti-
ated with functions, each layer weighing in
with questions. Functional staffers in the
divisions (financial analysts, for example)
often deferred to their higher-ups in corpo-
rate rather than their division vice president,
since functional leaders were responsible for
rewards and promotions. Only the CEO and
his executive team had the discretion to
resolve disputes. All of these symptoms fed
on one another and collectively hampered
execution—until a new CEO came in.
The new chief executive chose to focus
less on cost control and more on profitable
growth by redefining the divisions to focus on
consumers. As part of the new organizational
model, the CEO designated accountability for
profits unambiguously to the divisions and
also gave them the authority to draw on func-
tional activities to support their goals (as well
as more control of the budget). Corporate
functional roles and decision rights were re-
cast to better support the divisions’ needs and
also to build the cross-divisional links neces-
sary for developing the global capabilities of
the business as a whole. For the most part,
the functional leaders understood the mar-
ket realities—and that change entailed some
adjustments to the operating model of the
business. It helped that the CEO brought
them into the organizational redesign pro-
cess, so that the new model wasn’t something
imposed on them as much as it was some-
thing they engaged in and built together.

2. Important information about the com-
petitive environment gets to headquarters
quickly.

On average, 77% of individuals in
strong-execution organizations agree with
this statement, whereas only 45% of those
in weak-execution organizations do.
Headquarters can serve a powerful func-
tion in identifying patterns and promulgating
best practices throughout business segments
and geographic regions. But it can play this
coordinating role only if it has accurate and
up-to-date market intelligence. Otherwise, it
will tend to impose its own agenda and poli-
cies rather than defer to operations that are
much closer to the customer.
Consider the case of heavy-equipment man-
ufacturer Caterpillar.

1

Today it is a highly
successful $45 billion global company, but a
generation ago, Caterpillar’s organization was
so badly misaligned that its very existence was
threatened. Decision rights were hoarded at
the top by functional general offices located
at headquarters in Peoria, Illinois, while

What Matters Most to Strategy Execution

When a company fails to execute its strategy, the first thing managers often think
to do is restructure. But our research shows that the fundamentals of good execu-
tion start with clarifying decision rights and making sure information flows
where it needs to go. If you get those right, the correct structure and motivators
often become obvious.
54
50
26
25
Information
Decision Rights
Motivators
Structure
Relative Strength (out of 100)
page 85

The Secrets to Successful Strategy Execution

harvard business review • june 2008

The 17 Fundamental Traits of Organizational Effectiveness

From our survey research drawn from more than 26,000 people in 31 companies, we have distilled the traits that make organi-
zations effective at implementing strategy. Here they are, in order of importance.
RANK ORGANIZATION TRAIT
STRENGTH
INDEX
(OUT OF 100)
1 Everyone has a good idea of the decisions and actions for which he or she is responsible. 81
2 Important information about the competitive environment gets to headquarters quickly. 68
3 Once made, decisions are rarely second-guessed. 58
4 Information flows freely across organizational boundaries. 58
5
Field and line employees usually have the information
they need to understand the bottom-line impact of their
day-to-day choices.
55
6 Line managers have access to the metrics they need to measure the key drivers of their business. 48
7 Managers up the line get involved in operating decisions. 32
8 Conflicting messages are rarely sent to the market. 32
9 The individual performance-appraisal process differenti-ates among high, adequate, and low performers. 32
10
The ability to deliver on performance commitments
strongly influences career advancement and
compensation.
32
11
It is more accurate to describe the culture of this orga-
nization as “persuade and cajole” than “command and
control.”
29
12 The primary role of corporate staff here is to support the business units rather than to audit them. 29
13 Promotions can be lateral moves (from one position to another on the same level in the hierarchy). 29
14 Fast-track employees here can expect promotions more frequently than every three years. 23
15 On average, middle managers here have five or more direct reports. 19
16 If the firm has a bad year, but a particular division has a good year, the division head would still get a bonus. 13
17 Besides pay, many other things motivate individuals to do a good job. 10
BUILDING BLOCKS ■ Decision Rights ■ Information ■ Motivators ■ Structure
page 86

The Secrets to Successful Strategy Execution

harvard business review • june 2008

much of the information needed to make
those decisions resided in the field with sales
managers. “It just took a long time to get deci-
sions going up and down the functional silos,
and they really weren’t good business deci-
sions; they were more functional decisions,”
noted one field executive. Current CEO Jim
Owens, then a managing director in Indo-
nesia, told us that such information that did
make it to the top had been “whitewashed
and varnished several times over along the
way.” Cut off from information about the
external market, senior executives focused on
the organization’s internal workings, overana-
lyzing issues and second-guessing decisions
made at lower levels, costing the company
opportunities in fast-moving markets.
Pricing, for example, was based on cost and
determined not by market realities but by the
pricing general office in Peoria. Sales represen-
tatives across the world lost sale after sale to
Komatsu, whose competitive pricing consis-
tently beat Caterpillar’s. In 1982, the company
posted the first annual loss in its almost-60-
year history. In 1983 and 1984, it lost $1 million
a day, seven days a week. By the end of 1984,
Caterpillar had lost a billion dollars. By 1988,
then-CEO George Schaefer stood atop an en-
trenched bureaucracy that was, in his words,
“telling me what I wanted to hear, not what I
needed to know.” So, he convened a task force
of “renegade” middle managers and tasked
them with charting Caterpillar’s future.
Ironically, the way to ensure that the right
information flowed to headquarters was to
make sure the right decisions were made
much further down the organization. By dele-
gating operational responsibility to the peo-
ple closer to the action, top executives were
free to focus on more global strategic issues.
Accordingly, the company reorganized into
business units, making each accountable for
its own P&L statement. The functional gen-
eral offices that had been all-powerful ceased
to exist, literally overnight. Their talent and
expertise, including engineering, pricing, and
manufacturing, were parceled out to the new
business units, which could now design their
own products, develop their own manufactur-
ing processes and schedules, and set their own
prices. The move dramatically decentralized
decision rights, giving the units control over
market decisions. The business unit P&Ls were
now measured consistently across the enter-
prise, as return on assets became the univer-
sal measure of success. With this accurate,
up-to-date, and directly comparable informa-
tion, senior decision makers at headquarters
could make smart strategic choices and trade-
offs rather than use outdated sales data to
make ineffective, tactical marketing decisions.
Within 18 months, the company was work-
ing in the new model. “This was a revolution
that became a renaissance,” Owens recalls, “a
spectacular transformation of a kind of slug-
gish company into one that actually has en-
trepreneurial zeal. And that transition was
very quick because it was decisive and it was
complete; it was thorough; it was universal,
worldwide, all at one time.”

3. Once made, decisions are rarely
second-guessed.

Whether someone is second-
guessing depends on your vantage point. A
more senior and broader enterprise perspec-
tive can add value to a decision, but managers
up the line may not be adding incremental
value; instead, they may be stalling progress
by redoing their subordinates’ jobs while, in
effect, shirking their own. In our research, 71%
of respondents in weak-execution companies
thought that decisions were being second-
guessed, whereas only 45% of those from
strong-execution organizations felt that way.
Recently, we worked with a global charita-
ble organization dedicated to alleviating pov-
erty. It had a problem others might envy: It
was suffering from the strain brought on by a
rapid growth in donations and a correspond-
ing increase in the depth and breadth of its
program offerings. As you might expect, this
nonprofit was populated with people on a
mission who took intense personal ownership
of projects. It did not reward the delegation of
even the most mundane administrative tasks.
Country-level managers, for example, would
personally oversee copier repairs. Managers’
inability to delegate led to decision paralysis
and a lack of accountability as the organiza-
tion grew. Second-guessing was an art form.
When there was doubt over who was empow-
ered to make a decision, the default was
often to have a series of meetings in which no
decision was reached. When decisions were
finally made, they had generally been vetted
by so many parties that no one person could
be held accountable. An effort to expedite
decision-making through restructuring—by
collocating key leaders with subject-matter

About the Data

We tested organizational effective-
ness by having people fill out an on-
line diagnostic, a tool comprising 19
questions (17 that describe organiza-
tional traits and two that describe
outcomes).
To determine which of the 17 traits
in our profiler are most strongly asso-
ciated with excellence in execution,
we looked at 31 companies in our
database for which we had responses
from at least 150 individual (anony-
mously completed) profiles, for a total
of 26,743 responses. Applying regres-
sion analysis to each of the 31 data
sets, we correlated the 17 traits with
our measure of organizational effec-
tiveness, which we defined as an
affirmative response to the outcome
statement, “Important strategic and
operational decisions are quickly
translated into action.” Then we
ranked the traits in order, according
to the number of data sets in which
the trait exhibited a significant corre-
lation with our measure of success
within a 90% confidence interval.
Finally, we indexed the result to a
100-point scale. The top trait—
“Everyone has a good idea of the
decisions and actions for which he or
she is responsible”—exhibited a sig-
nificant positive correlation with our
success indicator in 25 of the 31 data
sets, for an index score of 81.
page 87

The Secrets to Successful Strategy Execution

harvard business review • june 2008

experts in newly established central and
regional centers of excellence—became in-
stead another logjam. Key managers still
weren’t sure of their right to take advantage
of these centers, so they didn’t.
The nonprofit’s management and directors
went back to the drawing board. We worked
with them to design a decision-making map, a
tool to help identify where different types of
decisions should be taken, and with it they
clarified and enhanced decision rights at all
levels of management. All managers were
then actively encouraged to delegate standard
operational tasks. Once people had a clear
idea of what decisions they should and should
not be making, holding them accountable for
decisions felt fair. What’s more, now they
could focus their energies on the organiza-
tion’s mission. Clarifying decision rights and
responsibilities also improved the organiza-
tion’s ability to track individual achievement,
which helped it chart new and appealing
career-advancement paths.

4. Information flows freely across organi-
zational boundaries.

When information does
not flow horizontally across different parts of
the company, units behave like silos, forfeiting
economies of scale and the transfer of best
practices. Moreover, the organization as a
whole loses the opportunity to develop a cadre
of up-and-coming managers well versed in all
aspects of the company’s operations. Our re-
search indicates that only 21% of respondents
from weak-execution companies thought in-
formation flowed freely across organizational
boundaries whereas 55% of those from strong-
execution firms did. Since scores for even the
strong companies are pretty low, though, this
is an issue that most companies can work on.
A cautionary tale comes from a business-
to-business company whose customer and
product teams failed to collaborate in serving
a key segment: large, cross-product customers.
To manage relationships with important
clients, the company had established a
customer-focused marketing group, which
developed customer outreach programs, inno-
vative pricing models, and tailored promo-
tions and discounts. But this group issued no
clear and consistent reports of its initiatives
and progress to the product units and had
difficulty securing time with the regular cross-
unit management to discuss key performance
issues. Each product unit communicated and
planned in its own way, and it took tremen-
dous energy for the customer group to under-
stand the units’ various priorities and tailor
communications to each one. So the units
were not aware, and had little faith, that this
new division was making constructive inroads
into a key customer segment. Conversely (and
predictably), the customer team felt the units
paid only perfunctory attention to its plans
and couldn’t get their cooperation on issues
critical to multiproduct customers, such as
potential trade-offs and volume discounts.
Historically, this lack of collaboration hadn’t
been a problem because the company had
been the dominant player in a high-margin
market. But as the market became more com-
petitive, customers began to view the firm as
unreliable and, generally, as a difficult supplier,
and they became increasingly reluctant to
enter into favorable relationships.
Once the issues became clear, though, the
solution wasn’t terribly complicated, involv-
ing little more than getting the groups to talk
to one another. The customer division be-
came responsible for issuing regular reports
to the product units showing performance
against targets, by product and geographic
region, and for supplying a supporting root-
cause analysis. A standing performance-
management meeting was placed on the
schedule every quarter, creating a forum for
exchanging information face-to-face and dis-
cussing outstanding issues. These moves bred
the broader organizational trust required
for collaboration.

5. Field and line employees usually have
the information they need to understand
the bottom-line impact of their day-to-day
choices.

Rational decisions are necessarily
bounded by the information available to em-
ployees. If managers don’t understand what it
will cost to capture an incremental dollar in
revenue, they will always pursue the incre-
mental revenue. They can hardly be faulted,
even if their decision is—in the light of full
information—wrong. Our research shows that
61% of individuals in strong-execution organi-
zations agree that field and line employees
have the information they need to understand
the bottom-line impact of their decisions. This
figure plummets to 28% in weak-execution
organizations.
We saw this unhealthy dynamic play out at
a large, diversified financial-services client,
Second-guessing was an
art form: When decisions
were finally made, they
had generally been vetted
by so many parties that
no one person could be
held accountable.
page 88

The Secrets to Successful Strategy Execution

harvard business review • june 2008

which had been built through a series of suc-
cessful mergers of small regional banks. In
combining operations, managers had chosen
to separate front-office bankers who sold
loans from back-office support groups who
did risk assessments, placing each in a differ-
ent reporting relationship and, in many cases,
in different locations. Unfortunately, they
failed to institute the necessary information
and motivation links to ensure smooth opera-
tions. As a result, each pursued different, and
often competing, goals.
For example, salespeople would routinely
enter into highly customized one-off deals
with clients that cost the company more than
they made in revenues. Sales did not have a
clear understanding of the cost and complexity
implications of these transactions. Without
sufficient information, sales staff believed
that the back-end people were sabotaging
their deals, while the support groups consid-
ered the front-end people to be cowboys. At
year’s end, when the data were finally recon-
ciled, management would bemoan the sharp
increase in operational costs, which often
erased the profit from these transactions.
Executives addressed this information mis-
alignment by adopting a “smart customiza-
tion” approach to sales. They standardized
the end-to-end processes used in the majority
of deals and allowed for customization only
in select circumstances. For these customized
deals, they established clear back-office pro-
cesses and analytical support tools to arm
salespeople with accurate information on the
cost implications of the proposed transac-
tions. At the same time, they rolled out com-
mon reporting standards and tools for both
the front- and back-office operations to ensure
that each group had access to the same data
and metrics when making decisions. Once
each side understood the business realities
confronted by the other, they cooperated
more effectively, acting in the whole com-
pany’s best interests—and there were no
more year-end surprises.

Creating a Transformation Program

The four building blocks that managers can
use to improve strategy execution—decision
rights, information, structure, and motivators—
are inextricably linked. Unclear decision rights
not only paralyze decision making but also
impede information flow, divorce perfor-
mance from rewards, and prompt work-
arounds that subvert formal reporting lines.
Blocking information results in poor deci-
sions, limited career development, and a rein-
forcement of structural silos. So what to do
about it?
Since each organization is different and
faces a unique set of internal and external
variables, there is no universal answer to that
question. The first step is to identify the
sources of the problem. In our work, we often
begin by having a company’s employees take
our profiling survey and consolidating the re-
sults. The more people in the organization
who take the survey, the better.
Once executives understand their company’s
areas of weakness, they can take any number
of actions. The exhibit, “Mapping Improve-
ments to the Building Blocks: Some Sample
Tactics” shows 15 possible steps that can have
an impact on performance. (The options
listed represent only a sampling of the dozens
of choices managers might make.) All of these
actions are geared toward strengthening one
or more of the 17 traits. For example, if you
were to take steps to “clarify and streamline
decision making” you could potentially
strengthen two traits: “Everyone has a good
idea of the decisions and actions for which
he or she is responsible,” and “Once made, de-
cisions are rarely second-guessed.”
You certainly wouldn’t want to put 15 initia-
tives in a single transformation program.
Most organizations don’t have the managerial
capacity or organizational appetite to take on
more than five or six at a time. And as we’ve
stressed, you should first take steps to address
decision rights and information, and then
design the necessary changes to motivators
and structure to support the new design.
To help companies understand their short-
comings and construct the improvement pro-
gram that will have the greatest impact,
we have developed an organizational-change
simulator. This interactive tool accompanies
the profiler, allowing you to try out different
elements of a change program virtually, to
see which ones will best target your com-
pany’s particular area of weakness. (For an
overview of the simulation process, see the
sidebar “Test Drive Your Organization’s
Transformation.”)
To get a sense of the process from beginning
to end—from taking the diagnostic profiler, to
To help companies
construct an
improvement program
with the greatest impact,
we’ve developed an
organizational-change
simulator.
page 89

The Secrets to Successful Strategy Execution

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formulating your strategy, to launching your
organizational transformation—consider the
experience of a leading insurance company
we’ll call Goodward Insurance. Goodward
was a successful company with strong capital
reserves and steady revenue and customer
growth. Still, its leadership wanted to further
enhance execution to deliver on an ambitious
five-year strategic agenda that included aggres-
sive targets in customer growth, revenue
increases, and cost reduction, which would re-
quire a new level of teamwork. While there
were pockets of cross-unit collaboration within
the company, it was far more common for each
unit to focus on its own goals, making it diffi-
cult to spare resources to support another
unit’s goals. In many cases there was little in-
centive to do so anyway: Unit A’s goals might
require the involvement of Unit B to succeed,
but Unit B’s goals might not include support-
ing Unit A’s effort.
The company had initiated a number of en-
terprisewide projects over the years, which
had been completed on time and on budget,
but these often had to be reworked because
stakeholder needs hadn’t been sufficiently
taken into account. After launching a shared-
services center, for example, the company had
to revisit its operating model and processes
when units began hiring shadow staff to focus
on priority work that the center wouldn’t ex-
pedite. The center might decide what technol-
ogy applications, for instance, to develop on
its own rather than set priorities according to
what was most important to the organization.
In a similar way, major product launches
were hindered by insufficient coordination
among departments. The marketing depart-
ment would develop new coverage options
without asking the claims-processing group
whether it had the ability to process the
claims. Since it didn’t, processors had to cre-
ate expensive manual work-arounds when the
new kinds of claims started pouring in. Nor
did marketing ask the actuarial department
how these products would affect the risk pro-
file and reimbursement expenses of the com-
pany, and for some of the new products, costs
did indeed increase.
To identify the greatest barriers to building
a stronger execution culture, Goodward In-
surance gave the diagnostic survey to all of its
7,000-plus employees and compared the orga-
nization’s scores on the 17 traits with those
from strong-execution companies. Numer-
ous previous surveys (employee-satisfaction,
among others) had elicited qualitative com-
ments identifying the barriers to execution
excellence. But the diagnostic survey gave
the company quantifiable data that it could
analyze by group and by management level
to determine which barriers were most hin-
dering the people actually charged with
execution. As it turned out, middle manage-
ment was far more pessimistic than the top
executives in their assessment of the organi-
zation’s execution ability. Their input became
especially critical to the change agenda ulti-
mately adopted.

Mapping Improvements to the Building
Blocks: Some Sample Tactics

Companies can take a host of steps to improve their ability to execute strategy. The
15 here are only some of the possible examples. Every one strengthens one or more
of the building blocks executives can use to improve their strategy-execution capabil-
ity: clarifying decision rights, improving information, establishing the right motiva-
tors, and restructuring the organization.
Focus corporate staff on supporting
business-unit decision making.
Clarify and streamline decision making at each
operating level.
Focus headquarters on important strategic
questions.
Create centers of excellence by consolidating simi-
lar functions into a single organizational unit.
Assign process owners to coordinate
activities that span organizational functions.
Establish individual performance measures.
Improve field-to-headquarters information flow.
Define and distribute daily operating metrics to the
field or line.
Create cross-functional teams.
Introduce differentiating performance awards.
Expand nonmonetary rewards to recognize
exceptional performers.
Increase position tenure.
Institute lateral moves and rotations.
Broaden spans of control.
BUILDING BLOCKS Decision Rights Information Motivators Structure
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harvard business review • june 2008

Through the survey, Goodward Insurance
uncovered impediments to execution in three
of the most influential organizational traits:

• Information did not flow freely across
organizational boundaries.

Sharing informa-
tion was never one of Goodward’s hall-
marks, but managers had always dismissed
the mounting anecdotal evidence of poor
cross-divisional information flow as “some
other group’s problem.” The organizational
diagnostic data, however, exposed such plau-
sible deniability as an inadequate excuse. In
fact, when the CEO reviewed the profiler
results with his direct reports, he held up the
chart on cross-group information flows and
declared, “We’ve been discussing this problem
for several years, and yet you always say that
it’s so-and-so’s problem, not mine. Sixty-seven
percent of [our] respondents said that they
do not think information flows freely across
divisions. This is not so-and-so’s problem—it’s
our problem. You just don’t get results that
low [unless it comes] from everywhere. We
are all on the hook for fixing this.”
Contributing to this lack of horizontal
information flow was a dearth of lateral pro-
motions. Because Goodward had always
promoted up rather than over and up, most
middle and senior managers remained within
a single group. They were not adequately
apprised of the activities of the other groups,
nor did they have a network of contacts across
the organization.

• Important information about the com-
petitive environment did not get to head-
quarters quickly.

The diagnostic data and

Test-Drive Your Organization’s Transformation

You know your organization could perform
better. You are faced with dozens of levers
you could conceivably pull if you had unlim-
ited time and resources. But you don’t. You
operate in the real world.
How, then, do you make the most-educated
and cost-efficient decisions about which
change initiatives to implement? We’ve de-
veloped a way to test the efficacy of specific
actions (such as clarifying decision rights,
forming cross-functional teams, or expanding
nonmonetary rewards) without risking sig-
nificant amounts of time and money. You can
go to www.simulator-orgeffectiveness.com
to assemble and try out various five-step
organizational-change programs and assess
which would be the most effective and effi-
cient in improving execution at your company.
You begin the simulation by selecting one
of seven organizational profiles that most
resembles the current state of your organiza-
tion. If you’re not sure, you can take a five-
minute diagnostic survey. This online survey
automatically generates an organizational
profile and baseline execution-effectiveness
score. (Although 100 is a perfect score, no-
body is perfect; even the most effective com-
panies often score in the 60s and 70s.)
Having established your baseline, you use
the simulator to chart a possible course you’d
like to take to improve your execution capa-
bilities by selecting five out of a possible 28
actions. Ideally, these moves should directly
address the weakest links in your organiza-
tional profile. To help you make the right
choices, the simulator offers insights that shed
further light on how a proposed action in-
fluences particular organizational elements.
Once you have made your selections, the
simulator executes the steps you’ve elected
and processes them through a web-based en-
gine that evaluates them using empirical
relationships identified from 31 companies
representing more than 26,000 data observa-
tions. It then generates a bar chart indicating
how much your organization’s execution score
has improved and where it now stands in re-
lation to the highest-performing companies
from our research and the scores of other peo-
ple like you who have used the simulator start-
ing from the same original profile you did. If
you wish, you may then advance to the next
round and pick another five actions. What
you will see is illustrated below.
The beauty of the simulator is its ability to
consider—consequence-free—the impact on
execution of endless combinations of possi-
ble actions. Each simulation includes only
two rounds, but you can run the simulation
as many times as you like. The simulator
has also been used for team competition
within organizations, and we’ve found that
it engenders very engaging and productive
dialogue among senior executives.
While the simulator cannot capture all of
the unique situations an organization might
face, it is a useful tool for assessing and build-
ing a targeted and effective organization-
transformation program. It serves as a
vehicle to stimulate thinking about the im-
pact of various changes, saving untold amounts
of time and resources in the process.
page 91

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The Secrets to Successful Strategy Execution

harvard business review • june 2008

subsequent surveys and interviews with mid-
dle management revealed that the wrong
information was moving up the org chart.
Mundane day-to-day decisions were esca-
lated to the executive level—the top team
had to approve midlevel hiring decisions, for
instance, and bonuses of $1,000—limiting
Goodward’s agility in responding to competi-
tors’ moves, customers’ needs, and changes in
the broader marketplace. Meanwhile, more
important information was so heavily filtered
as it moved up the hierarchy that it was all
but worthless for rendering key verdicts. Even
if lower-level managers knew that a certain
project could never work for highly valid
reasons, they would not communicate that
dim view to the top team. Nonstarters not
only started, they kept going. For instance,
the company had a project under way to
create new incentives for its brokers. Even
though this approach had been previously
tried without success, no one spoke up in meet-
ings or stopped the project because it was a
priority for one of the top-team members.

• No one had a good idea of the decisions
and actions for which he or she was respon-
sible.

The general lack of information flow
extended to decision rights, as few managers
understood where their authority ended and
another’s began. Accountability even for day-
to-day decisions was unclear, and managers
did not know whom to ask for clarification.
Naturally, confusion over decision rights
led to second-guessing. Fifty-five percent of
respondents felt that decisions were regularly
second-guessed at Goodward.
To Goodward’s credit, its top executives
immediately responded to the results of the
diagnostic by launching a change program
targeted at all three problem areas. The
program integrated early, often symbolic,
changes with longer-term initiatives, in an
effort to build momentum and galvanize par-
ticipation and ownership. Recognizing that
a passive-aggressive attitude toward people
perceived to be in power solely as a result of
their position in the hierarchy was hindering
information flow, they took immediate steps
to signal their intention to create a more
informal and open culture. One symbolic
change: the seating at management meetings
was rearranged. The top executives used to sit
in a separate section, the physical space
between them and the rest of the room
fraught with symbolism. Now they intermin-
gled, making themselves more accessible and
encouraging people to share information
informally. Regular brown-bag lunches were
established with members of the C-suite, where
people had a chance to discuss the overall
culture-change initiative, decision rights, new
mechanisms for communicating across the
units, and so forth. Seating at these events
was highly choreographed to ensure that a
mix of units was represented at each table.
Icebreaker activities were designed to encour-
age individuals to learn about other units’
work.
Meanwhile, senior managers commenced
the real work of remedying issues relating to
information flows and decision rights. They
assessed their own informal networks to
understand how people making key decisions
got their information, and they identified crit-
ical gaps. The outcome was a new framework
for making important decisions that clearly
specifies who owns each decision, who must
provide input, who is ultimately accountable
for the results, and how results are defined.
Other longer-term initiatives include:
• Pushing certain decisions down into the
organization to better align decision rights
with the best available information. Most
hiring and bonus decisions, for instance,
have been delegated to immediate managers,
so long as they are within preestablished
boundaries relating to numbers hired and
salary levels. Being clear about who needs
what information is encouraging cross-group
dialogue.
• Identifying and eliminating duplicative
committees.
• Pushing metrics and scorecards down to
the group level, so that rather than focus on
solving the mystery of

who

caused a problem,
management can get right to the root cause of

why

the problem occurred. A well-designed
scorecard captures not only outcomes (like
sales volume or revenue) but also leading
indicators of those outcomes (such as the
number of customer calls or completed
customer plans). As a result, the focus of man-
agement conversations has shifted from trying
to explain the past to charting the future—
anticipating and preventing problems.
• Making the planning process more inclu-
sive. Groups are explicitly mapping out the
ways their initiatives depend on and affect
page 92

The Secrets to Successful Strategy Execution

harvard business review • june 2008

one another; shared group goals are assigned
accordingly.
• Enhancing the middle management ca-
reer path to emphasize the importance of
lateral moves to career advancement.
Goodward Insurance has just embarked on
this journey. The insurer has distributed own-
ership of these initiatives among various
groups and management levels so that these
efforts don’t become silos in themselves.
Already, solid improvement in the company’s
execution is beginning to emerge. The early
evidence of success has come from employee-
satisfaction surveys: Middle management
responses to the questions about levels of
cross-unit collaboration and clarity of decision
making have improved as much as 20 to 25
percentage points. And high performers are
already reaching across boundaries to gain a
broader understanding of the full business,
even if it doesn’t mean a better title right
away.

• • •

Execution is a notorious and perennial chal-
lenge. Even at the companies that are best at
it—what we call “resilient organizations”—
just two-thirds of employees agree that impor-
tant strategic and operational decisions are
quickly translated into action. As long as com-
panies continue to attack their execution
problems primarily or solely with structural or
motivational initiatives, they will continue to
fail. As we’ve seen, they may enjoy short-term
results, but they will inevitably slip back into
old habits because they won’t have addressed
the root causes of failure. Such failures can
almost always be fixed by ensuring that people
truly understand what they are responsible for
and who makes which decisions—and then
giving them the information they need to
fulfill their responsibilities. With these two
building blocks in place, structural and moti-
vational elements will follow.

1. The details for this example have been taken from Gary L.
Neilson and Bruce A. Pasternack,

Results: Keep What’s Good,
Fix What’s Wrong, and Unlock Great Performance

(Random
House, 2005).

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Further Reading

A R T I C L E

Mastering the Management System

by Robert S. Kaplan and David P. Norton

Harvard Business Review

January 2008
Product no. R0801D

It’s hard to balance pressing operational con-
cerns with long-term strategic priorities. But
balance is critical: World-class processes won’t
produce success without the right strategic
direction, and the best strategy won’t get any-
where without strong operations to execute
it. To manage both strategy and operations,
companies must take five steps: 1) Develop
strategy, based on the company’s mission and
values and its strengths, weaknesses, and
competitive environment. 2) Translate the
strategy into objectives and initiatives linked
to performance metrics. 3) Create an opera-
tional plan to accomplish the objectives and
initiatives. 4) Put the plan into action, monitor-
ing its effectiveness. 5) Test the strategy by
analyzing cost, profitability, and correlations
between strategy and performance. Update
as necessary.

B O O K C H A P T E R

Build Execution into Strategy

by W. Chan Kim and Renée Mauborgne
Harvard Business School Press
October 2006
Product no. 1635BC

The authors identify an additional lever essen-
tial for strategy execution: the alignment of
people behind a strategy. Incentives don’t in
themselves create alignment. You also need a
culture of trust and commitment. This chapter,
from

Blue Ocean Strategy: How to Create Un-
contested Market Space and Make the Compe-
tition Irrelevant

, shows how to build such a
culture, particularly by establishing fair strategy-
formulation processes. When people perceive
a process as fair, they go beyond the call of
duty and take initiative in executing the
strategy. To create a fair strategy-formulation
process: 1) Involve people in the strategic de-
cisions that affect them, by asking for their
input. 2) Explain why final strategic decisions
were made. 3) Clearly state the new behaviors
you expect from people and what will happen
if they fail to fulfill them.
page 94

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Using the Balanced
Scorecard as a Strategic
Management System

by Robert S. Kaplan and David P. Norton

•

Included with this full-text

Harvard Business Review

article:
The Idea in Brief—the core idea
The Idea in Practice—putting the idea to work

96

Article Summary

97

Using the Balanced Scorecard as a Strategic Management System
A list of related materials, with annotations to guide further
exploration of the article’s ideas and applications

109

Further Reading

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H B R

Using the Balanced Scorecard as a Strategic
Management System

The Idea in Brief The Idea in Practice

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Why do budgets often bear little direct
relation to a company’s long-term strategic
objectives? Because they don’t take
enough into consideration. A balanced
scorecard augments traditional financial
measures with benchmarks for perfor-
mance in three key nonfinancial areas:
• a company’s relationship with its
customers
• its key internal processes
• its learning and growth.
When performance measures for these
areas are added to the financial metrics, the
result is not only a broader perspective on
the company’s health and activities, it’s also
a powerful organizing framework. A sophis-
ticated instrument panel for coordinating
and fine-tuning a company’s operations
and businesses so that all activities are
aligned with its strategy.
The balanced scorecard relies on four processes
to bind short-term activities to long-term
objectives:

1. TRANSLATING THE VISION.

By relying on measurement, the scorecard
forces managers to come to agreement on
the metrics they will use to operationalize
their lofty visions.
Example:

A bank had articulated its strategy as pro-
viding “superior service to targeted custom-
ers.” But the process of choosing operational
measures for the four areas of the scorecard
made executives realize that they first
needed to reconcile divergent views of
who the targeted customers were and
what constituted superior service.

2. COMMUNICATING AND LINKING.

When a scorecard is disseminated up and
down the organizational chart, strategy be-
comes a tool available to everyone. As the
high-level scorecard cascades down to indi-
vidual business units, overarching strategic
objectives and measures are translated into
objectives and measures appropriate to
each particular group. Tying these targets to
individual performance and compensation
systems yields “personal scorecards.” Thus,
individual employees understand how their
own productivity supports the overall strategy.

3. BUSINESS PLANNING.

Most companies have separate procedures
(and sometimes units) for strategic planning
and budgeting. Little wonder, then, that typi-
cal long-term planning is, in the words of one
executive, where “the rubber meets the sky.”
The discipline of creating a balanced score-
card forces companies to integrate the two
functions, thereby ensuring that financial
budgets do indeed support strategic goals.
After agreeing on performance measures for
the four scorecard perspectives, companies
identify the most influential “drivers” of the
desired outcomes and then set milestones
for gauging the progress they make with
these drivers.

4. FEEDBACK AND LEARNING.

By supplying a mechanism for strategic feed-
back and review, the balanced scorecard
helps an organization foster a kind of learning
often missing in companies: the ability to re-
flect on inferences and adjust theories about
cause-and-effect relationships.
Feedback about products and services. New
learning about key internal processes. Tech-
nological discoveries. All this information can
be fed into the scorecard, enabling strategic
refinements to be made continually. Thus, at
any point in the implementation, managers
can know whether the strategy is working—
and if not, why.
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harvard business review • managing for the long term • july–august 2007

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Editor’s Note:

In 1992, Robert S. Kaplan and
David P. Norton’s concept of the balanced score-
card revolutionized conventional thinking about
performance metrics. By going beyond tradi-
tional measures of financial performance, the
concept has given a generation of managers a
better understanding of how their companies are
really doing.
These nonfinancial metrics are so valuable
mainly because they predict future financial
performance rather than simply report what’s
already happened. This article, first published in
1996, describes how the balanced scorecard can
help senior managers systematically link current
actions with tomorrow’s goals, focusing on that
place where, in the words of the authors, “the
rubber meets the sky.”

As companies around the world transform
themselves for competition that is based on
information, their ability to exploit intangi-
ble assets has become far more decisive
than their ability to invest in and manage
physical assets. Several years ago, in recogni-
tion of this change, we introduced a concept
we called the balanced scorecard. The bal-
anced scorecard supplemented traditional
financial measures with criteria that mea-
sured performance from three additional
perspectives—those of customers, internal
business processes, and learning and growth.
(See the exhibit “Translating Vision and
Strategy: Four Perspectives.”) It therefore en-
abled companies to track financial results
while simultaneously monitoring progress
in building the capabilities and acquiring
the intangible assets they would need for
future growth. The scorecard wasn’t a re-
placement for financial measures; it was
their complement.
Recently, we have seen some companies
move beyond our early vision for the score-
card to discover its value as the cornerstone
of a new strategic management system. Used
this way, the scorecard addresses a serious
deficiency in traditional management systems:
their inability to link a company’s long-term
strategy with its short-term actions.
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Most companies’ operational and man-
agement control systems are built around fi-
nancial measures and targets, which bear
little relation to the company’s progress in
achieving long-term strategic objectives.
Thus the emphasis most companies place
on short-term financial measures leaves a
gap between the development of a strategy
and its implementation.
Managers using the balanced scorecard do
not have to rely on short-term financial mea-
sures as the sole indicators of the company’s
performance. The scorecard lets them intro-
duce four new management processes that,
separately and in combination, contribute to
linking long-term strategic objectives with
short-term actions. (See the exhibit “Manag-
ing Strategy: Four Processes.”)
The first new process—translating the vision—
helps managers build a consensus around
the organization’s vision and strategy. De-
spite the best intentions of those at the top,
lofty statements about becoming “best in
class,” “the number one supplier,” or an “em-
powered organization” don’t translate easily
into operational terms that provide useful
guides to action at the local level. For people
to act on the words in vision and strategy
statements, those statements must be expressed
as an integrated set of objectives and mea-
sures, agreed upon by all senior executives,
that describe the long-term drivers of success.
The second process—communicating and
linking—lets managers communicate their
strategy up and down the organization and
link it to departmental and individual objec-
tives. Traditionally, departments are evaluated
by their financial performance, and individual
incentives are tied to short-term financial
goals. The scorecard gives managers a way of
ensuring that all levels of the organization un-
derstand the long-term strategy and that both
departmental and individual objectives are
aligned with it.
The third process—business planning—
enables companies to integrate their business
and financial plans. Almost all organizations
today are implementing a variety of change
programs, each with its own champions,
gurus, and consultants, and each competing for
senior executives’ time, energy, and resources.
Managers find it difficult to integrate those
diverse initiatives to achieve their strategic
goals—a situation that leads to frequent disap-
pointments with the programs’ results. But
when managers use the ambitious goals set
for balanced scorecard measures as the basis
for allocating resources and setting priorities,
they can undertake and coordinate only those
initiatives that move them toward their long-
term strategic objectives.
The fourth process—feedback and learning—
gives companies the capacity for what we
call strategic learning. Existing feedback and
review processes focus on whether the com-
pany, its departments, or its individual em-
ployees have met their budgeted financial
goals. With the balanced scorecard at the
center of its management systems, a company
can monitor short-term results from the three
additional perspectives—customers, internal
business processes, and learning and growth—
and evaluate strategy in the light of recent
performance. The scorecard thus enables
companies to modify strategies to reflect
real-time learning.
None of the more than 100 organizations
that we have studied or with which we have
worked implemented their first balanced
scorecard with the intention of developing a
new strategic management system. But in
each one, the senior executives discovered
that the scorecard supplied a framework and
thus a focus for many critical management
processes: departmental and individual goal
setting, business planning, capital allocations,
strategic initiatives, and feedback and learn-
ing. Previously, those processes were uncoor-
dinated and often directed at short-term
operational goals. By building the scorecard,
the senior executives started a process of
change that has gone well beyond the origi-
nal idea of simply broadening the company’s
performance measures.
For example, one insurance company—let’s
call it National Insurance—developed its first
balanced scorecard to create a new vision for it-
self as an underwriting specialist. But once Na-
tional started to use it, the scorecard allowed
the CEO and the senior management team not
only to introduce a new strategy for the organi-
zation but also to overhaul the company’s
management system. The CEO subsequently
told employees in a letter addressed to the
whole organization that National would
thenceforth use the balanced scorecard and
the philosophy that it represented to manage
the business.

Robert S. Kaplan

is the Marvin Bower
Professor of Leadership Development
at Harvard Business School, in Boston,
and the chairman and a cofounder
of Balanced Scorecard Collaborative,
in Lincoln, Massachusetts. David P.
Norton is the CEO and a cofounder of
Balanced Scorecard Collaborative. They
are the coauthors of four books about
the balanced scorecard, the most re-
cent of which is Alignment: Using the
Balanced Scorecard to Create Corporate
Synergies (Harvard Business School
Publishing, 2006).
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Translating Vision and Strategy: Four Perspectives
Managing Strategy: Four Processes
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National built its new strategic management
system step-by-step over 30 months, with each
step representing an incremental improve-
ment. (See the exhibit “How One Company
Built a Strategic Management System…”) The
iterative sequence of actions enabled the
company to reconsider each of the four new
management processes two or three times
before the system stabilized and became
an established part of National’s overall man-
agement system. Thus the CEO was able to
transform the company so that everyone
could focus on achieving long-term strategic
objectives—something that no purely financial
framework could do.

Translating the Vision

The CEO of an engineering construction
company, after working with his senior man-
agement team for several months to develop
a mission statement, got a phone call from a
project manager in the field. “I want you to
know,” the distraught manager said, “that I
believe in the mission statement. I want to
act in accordance with the mission state-
ment. I’m here with my customer. What am
I supposed to do?”
The mission statement, like those of many
other organizations, had declared an intention
to “use high-quality employees to provide
services that surpass customers’ needs.” But
the project manager in the field with his em-
ployees and his customer did not know how
to translate those words into the appropriate
actions. The phone call convinced the CEO
that a large gap existed between the mission
statement and employees’ knowledge of how
their day-to-day actions could contribute to re-
alizing the company’s vision.
Metro Bank (not its real name), the result of
a merger of two competitors, encountered a
similar gap while building its balanced score-
card. The senior executive group thought it
had reached agreement on the new organiza-
tion’s overall strategy: “to provide superior
service to targeted customers.” Research had
revealed five basic market segments among
existing and potential customers, each with
different needs. While formulating the mea-
sures for the customer-perspective portion

How One Company Built a Strategic Management System…
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of their balanced scorecard, however, it be-
came apparent that although the 25 senior
executives agreed on the words of the strat-
egy, each one had a different definition of
superior service and a different image of
the targeted customers.
The exercise of developing operational
measures for the four perspectives on the
bank’s scorecard forced the 25 executives to
clarify the meaning of the strategy state-
ment. Ultimately, they agreed to stimulate
revenue growth through new products and
services and also agreed on the three most
desirable customer segments. They devel-
oped scorecard measures for the specific
products and services that should be deliv-
ered to customers in the targeted segments
as well as for the relationship the bank
should build with customers in each seg-
ment. The scorecard also highlighted gaps
in employees’ skills and in information sys-
tems that the bank would have to close in
order to deliver the selected value proposi-
tions to the targeted customers. Thus, creat-
ing a balanced scorecard forced the bank’s
senior managers to arrive at a consensus and
then to translate their vision into terms that
had meaning to the people who would real-
ize the vision.

Communicating and Linking

“The top ten people in the business now un-
derstand the strategy better than ever before.
It’s too bad,” a senior executive of a major oil
company complained, “that we can’t put this
in a bottle so that everyone could share it.”
With the balanced scorecard, he can.
One company we have worked with de-
liberately involved three layers of management
in the creation of its balanced scorecard.
The senior executive group formulated the
financial and customer objectives. It then
mobilized the talent and information in the
next two levels of managers by having them
formulate the internal-business-process
and learning-and-growth objectives that
would drive the achievement of the financial
and customer goals. For example, knowing
the importance of satisfying customers’ ex-
pectations of on-time delivery, the broader

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group identified several internal business
processes—such as order processing, sched-
uling, and fulfillment—in which the com-
pany had to excel. To do so, the company
would have to retrain frontline employees
and improve the information systems avail-
able to them. The group developed perfor-
mance measures for those critical processes
and for staff and systems capabilities.
Broad participation in creating a scorecard
takes longer, but it offers several advantages:
Information from a larger number of manag-
ers is incorporated into the internal objectives;
the managers gain a better understanding of
the company’s long-term strategic goals; and
such broad participation builds a stronger
commitment to achieving those goals. But
getting managers to buy into the scorecard is
only a first step in linking individual actions to
corporate goals.
The balanced scorecard signals to everyone
what the organization is trying to achieve for
shareholders and customers alike. But to
align employees’ individual performances
with the overall strategy, scorecard users gen-
erally engage in three activities: communicat-
ing and educating, setting goals, and linking
rewards to performance measures.
Communicating and educating. Implement-
ing a strategy begins with educating those
who have to execute it. Whereas some organi-
zations opt to hold their strategy close to
the vest, most believe that they should dis-
seminate it from top to bottom. A broad-based
communication program shares with all
employees the strategy and the critical objec-
tives they have to meet if the strategy is to
succeed. Onetime events such as the distribu-
tion of brochures or newsletters and the
holding of “town meetings” might kick off the
program. Some organizations post bulletin
boards that illustrate and explain the balanced
scorecard measures, then update them with
monthly results. Others use groupware and
electronic bulletin boards to distribute the
scorecard to the desktops of all employees
and to encourage dialogue about the mea-
sures. The same media allow employees to
make suggestions for achieving or exceeding
the targets.
The balanced scorecard, as the embodiment
of business unit strategy, should also be com-
…Around the Balanced Scorecard
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municated upward in the organization—to
corporate headquarters and to the corporate
board of directors. With the scorecard, business
units can quantify and communicate their
long-term strategies to senior executives using
a comprehensive set of linked financial and
nonfinancial measures. Such communication
informs the executives and the board in spe-
cific terms that long-term strategies designed
for competitive success are in place. The mea-
sures also provide the basis for feedback and
accountability. Meeting short-term financial
targets should not constitute satisfactory per-
formance when other measures indicate that
the long-term strategy is either not working or
not being implemented well.
Should the balanced scorecard be communi-
cated beyond the boardroom to external share-
holders? We believe that as senior executives
gain confidence in the ability of the scorecard
measures to monitor strategic performance
and predict future financial performance, they
will find ways to inform outside investors
about those measures without disclosing com-
petitively sensitive information.
Skandia, an insurance and financial services
company based in Sweden, issues a supple-
ment to its annual report called “The Busi-
ness Navigator”—“an instrument to help
us navigate into the future and thereby
stimulate renewal and development.” The
supplement describes Skandia’s strategy and
the strategic measures the company uses to
communicate and evaluate the strategy. It
also provides a report on the company’s per-
formance along those measures during the
year. The measures are customized for each
operating unit and include, for example,
market share, customer satisfaction and re-
tention, employee competence, employee
empowerment, and technology deployment.
Communicating the balanced scorecard
promotes commitment and accountability to
the business’s long-term strategy. As one exec-
utive at Metro Bank declared, “The balanced
scorecard is both motivating and obligating.”
Setting goals. Mere awareness of corporate
goals, however, is not enough to change many
people’s behavior. Somehow, the organiza-
tion’s high-level strategic objectives and mea-
sures must be translated into objectives and
measures for operating units and individuals.
The exploration group of a large oil com-
pany developed a technique to enable and
encourage individuals to set goals for them-
selves that were consistent with the organiza-
tion’s. It created a small, fold-up, personal
scorecard that people could carry in their
shirt pockets or wallets. (See the exhibit “The
Personal Scorecard.”) The scorecard contains
three levels of information. The first de-
scribes corporate objectives, measures, and
targets. The second leaves room for translating
corporate targets into targets for each busi-
ness unit. For the third level, the company
asks both individuals and teams to articulate
which of their own objectives would be con-
sistent with the business unit and corporate
objectives, as well as what initiatives they
would take to achieve their objectives. It also
asks them to define up to five performance
measures for their objectives and to set targets
for each measure. The personal scorecard
helps to communicate corporate and busi-
ness unit objectives to the people and teams
performing the work, enabling them to
translate the objectives into meaningful tasks
and targets for themselves. It also lets them
keep that information close at hand—in
their pockets.
Linking rewards to performance measures.
Should compensation systems be linked to
balanced scorecard measures? Some compa-
nies, believing that tying financial compensa-
tion to performance is a powerful lever, have
moved quickly to establish such a linkage.
For example, an oil company that we’ll call
Pioneer Petroleum uses its scorecard as the
sole basis for computing incentive compensa-
tion. The company ties 60% of its executives’
bonuses to their achievement of ambitious
targets for a weighted average of four financial
indicators: return on capital, profitability,
cash flow, and operating cost. It bases the
remaining 40% on indicators of customer
satisfaction, dealer satisfaction, employee sat-
isfaction, and environmental responsibility
(such as a percentage change in the level of
emissions to water and air). Pioneer’s CEO
says that linking compensation to the score-
card has helped to align the company with
its strategy. “I know of no competitor,” he
says, “who has this degree of alignment. It is
producing results for us.”
As attractive and as powerful as such linkage
is, it nonetheless carries risks. For instance,
does the company have the right measures on
the scorecard? Does it have valid and reliable
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data for the selected measures? Could unin-
tended or unexpected consequences arise from
the way the targets for the measures are
achieved? Those are questions that companies
should ask.
Furthermore, companies traditionally han-
dle multiple objectives in a compensation
formula by assigning weights to each objec-
tive and calculating incentive compensation
by the extent to which each weighted objec-
tive was achieved. This practice permits sub-
stantial incentive compensation to be paid if
the business unit overachieves on a few objec-
tives even if it falls far short on others. A bet-
ter approach would be to establish minimum
threshold levels for a critical subset of the
strategic measures. Individuals would earn
no incentive compensation if performance in
a given period fell short of any threshold.
This requirement should motivate people to
achieve a more balanced performance across
short- and long-term objectives.
Some organizations, however, have reduced
their emphasis on short-term, formula-based
incentive systems as a result of introducing the
balanced scorecard. They have discovered that
dialogue among executives and managers
about the scorecard—both the formulation of
the measures and objectives and the explana-
tion of actual versus targeted results—provides
a better opportunity to observe managers’
performance and abilities. Increased knowl-
edge of their managers’ abilities makes it
easier for executives to set incentive rewards
subjectively and to defend those subjective
evaluations—a process that is less susceptible
to the game playing and distortions associated
with explicit, formula-based rules.
One company we have studied takes an
intermediate position. It bases bonuses for
business unit managers on two equally
weighted criteria: their achievement of a
financial objective—economic value added—
over a three-year period and a subjective
assessment of their performance on measures
drawn from the customer, internal-business-
process, and learning-and-growth perspectives
of the balanced scorecard.
That the balanced scorecard has a role to
play in the determination of incentive com-
The Personal Scorecard
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pensation is not in doubt. Precisely what that
role should be will become clearer as more
companies experiment with linking rewards to
scorecard measures.

Business Planning

“Where the rubber meets the sky”: That’s
how one senior executive describes his
company’s long-range-planning process. He
might have said the same of many other
companies because their financially based
management systems fail to link change pro-
grams and resource allocation to long-term
strategic priorities.
The problem is that most organizations
have separate procedures and organizational
units for strategic planning and for resource
allocation and budgeting. To formulate their
strategic plans, senior executives go off-site
annually and engage for several days in
active discussions facilitated by senior plan-
ning and development managers or external
consultants. The outcome of this exercise is a
strategic plan articulating where the com-
pany expects (or hopes or prays) to be in
three, five, and ten years. Typically, such
plans then sit on executives’ bookshelves for
the next 12 months.
Meanwhile, a separate resource-allocation
and budgeting process run by the finance
staff sets financial targets for revenues, ex-
penses, profits, and investments for the next
fiscal year. The budget it produces consists
almost entirely of financial numbers that
generally bear little relation to the targets in
the strategic plan.
Which document do corporate managers
discuss in their monthly and quarterly meet-
ings during the following year? Usually only
the budget, because the periodic reviews
focus on a comparison of actual and budgeted
results for every line item. When is the strate-
gic plan next discussed? Probably during the
next annual off-site meeting, when the senior
managers draw up a new set of three-, five-,
and ten-year plans.
The very exercise of creating a balanced
scorecard forces companies to integrate their
strategic planning and budgeting processes
and therefore helps to ensure that their bud-
gets support their strategies. Scorecard users
select measures of progress from all four
scorecard perspectives and set targets for each
of them. Then they determine which actions
will drive them toward their targets, identify
the measures they will apply to those drivers
from the four perspectives, and establish the
short-term milestones that will mark their
progress along the strategic paths they have
selected. Building a scorecard thus enables a
company to link its financial budgets with its
strategic goals.
For example, one division of the Style Com-
pany (not its real name) committed to achiev-
ing a seemingly impossible goal articulated
by the CEO: to double revenues in five years.
The forecasts built into the organization’s
existing strategic plan fell $1 billion short of
this objective. The division’s managers, after
considering various scenarios, agreed to
specific increases in five different performance
drivers: the number of new stores opened,
the number of new customers attracted into
new and existing stores, the percentage of
shoppers in each store converted into actual
purchasers, the portion of existing customers
retained, and average sales per customer.
By helping to define the key drivers of rev-
enue growth and by committing to targets
for each of them, the division’s managers
eventually grew comfortable with the CEO’s
ambitious goal.
The process of building a balanced scorecard—
clarifying the strategic objectives and then
identifying the few critical drivers—also
creates a framework for managing an organi-
zation’s various change programs. These
initiatives—reengineering, employee empow-
erment, time-based management, and total
quality management, among others—promise
to deliver results but also compete with one
another for scarce resources, including the
scarcest resource of all: senior managers’ time
and attention.
Shortly after the merger that created it,
Metro Bank, for example, launched more
than 70 different initiatives. The initiatives
were intended to produce a more competitive
and successful institution, but they were inad-
equately integrated into the overall strategy.
After building their balanced scorecard,
Metro Bank’s managers dropped many of
those programs—such as a marketing effort
directed at individuals with very high net
worth—and consolidated others into initia-
tives that were better aligned with the com-
pany’s strategic objectives. For example, the
managers replaced a program aimed at en-
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hancing existing low-level selling skills with
a major initiative aimed at retraining sales-
persons to become trusted financial advisers,
capable of selling a broad range of newly
introduced products to the three selected
customer segments. The bank made both
changes because the scorecard enabled it to
gain a better understanding of the programs
required to achieve its strategic objectives.
Once the strategy is defined and the drivers
are identified, the scorecard influences man-
agers to concentrate on improving or reengi-
neering those processes most critical to the
organization’s strategic success. That is how
the scorecard most clearly links and aligns
action with strategy.
The final step in linking strategy to actions
is to establish specific short-term targets, or
milestones, for the balanced scorecard mea-
sures. Milestones are tangible expressions of
managers’ beliefs about when and to what
degree their current programs will affect
those measures.
In establishing milestones, managers are
expanding the traditional budgeting process
to incorporate strategic as well as financial
goals. Detailed financial planning remains
important, but financial goals taken by
themselves ignore the three other balanced
scorecard perspectives. In an integrated
planning and budgeting process, executives
continue to budget for short-term financial
performance, but they also introduce short-
term targets for measures in the customer,
internal-business-process, and learning-and-
growth perspectives. With those milestones
established, managers can continually test
both the theory underlying the strategy and
the strategy’s implementation.
At the end of the business-planning pro-
cess, managers should have set targets for the
long-term objectives they would like to
achieve in all four scorecard perspectives;
they should have identified the strategic initi-
atives required and allocated the necessary
resources to those initiatives; and they should
have established milestones for the measures
that mark progress toward achieving their
strategic goals.

Feedback and Learning

“With the balanced scorecard,” a CEO of an en-
gineering company told us, “I can continually
test my strategy. It’s like performing real-time
research.” That is exactly the capability that
the scorecard should give senior managers: the
ability to know at any point in its implementa-
tion whether the strategy they have formu-
lated is, in fact, working, and if not, why.
The first three management processes—
translating the vision, communicating and
linking, and business planning—are vital for
implementing strategy, but they are not suffi-
cient in an unpredictable world. Together
they form an important single-loop-learning
process—single-loop in the sense that the ob-
jective remains constant, and any departure
from the planned trajectory is seen as a defect
to be remedied. This single-loop process does
not require or even facilitate reexamination
of either the strategy or the techniques used
to implement it in light of current conditions.
Most companies today operate in a turbu-
lent environment with complex strategies that,
though valid when they were launched, may
lose their validity as business conditions
change. In this kind of environment, where
new threats and opportunities arise constantly,
companies must become capable of what Chris
Argyris calls double-loop learning—learning
that produces a change in people’s assump-
tions and theories about cause-and-effect rela-
tionships. (See “Teaching Smart People How to
Learn,” HBR May–June 1991.)
Budget reviews and other financially
based management tools cannot engage
senior executives in double-loop learning—
first, because these tools address perfor-
mance from only one perspective, and sec-
ond, because they don’t involve strategic
learning. Strategic learning consists of gath-
ering feedback, testing the hypotheses on
which strategy was based, and making the
necessary adjustments.
The balanced scorecard supplies three ele-
ments that are essential to strategic learning.
First, it articulates the company’s shared
vision, defining in clear and operational terms
the results that the company, as a team, is
trying to achieve. The scorecard communi-
cates a holistic model that links individual
efforts and accomplishments to business
unit objectives.
Second, the scorecard supplies the essential
strategic feedback system. A business strategy
can be viewed as a set of hypotheses about
cause-and-effect relationships. A strategic
feedback system should be able to test, vali-
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date, and modify the hypotheses embedded
in a business unit’s strategy. By establishing
short-term goals, or milestones, within the
business-planning process, executives are
forecasting the relationship between changes
in performance drivers and the associated
changes in one or more specified goals. For
example, executives at Metro Bank estimated
the amount of time it would take for improve-
ments in training and in the availability of
information systems before employees could
sell multiple financial products effectively
to existing and new customers. They also esti-
mated how great the effect of that selling
capability would be.
Another organization attempted to validate
its hypothesized cause-and-effect relation-
ships in the balanced scorecard by measuring
the strength of the linkages among measures
in the different perspectives. (See the exhibit
“How One Company Linked Measures from
the Four Perspectives.”) The company found
significant correlations between employees’
morale, a measure in the learning-and-growth
perspective, and customer satisfaction, an
important customer perspective measure.
Customer satisfaction, in turn, was correlated
with faster payment of invoices—a relation-
ship that led to a substantial reduction in
accounts receivable and hence a higher return
on capital employed. The company also found
correlations between employees’ morale and
the number of suggestions made by employ-
ees (two learning-and-growth measures) as
well as between an increased number of
suggestions and lower rework (an internal-
business-process measure). Evidence of such
strong correlations help to confirm the orga-
nization’s business strategy. If, however, the
expected correlations are not found over
time, it should be an indication to executives
that the theory underlying the unit’s strategy
may not be working as they had anticipated.
Especially in large organizations, accumu-
lating sufficient data to document significant
correlations and causation among balanced
scorecard measures can take a long time—
months or years. Over the short term, manag-
ers’ assessment of strategic impact may have
to rest on subjective and qualitative judg-
ments. Eventually, however, as more evidence
accumulates, organizations may be able to
provide more objectively grounded estimates
of cause-and-effect relationships. But just get-
ting managers to think systematically about
the assumptions underlying their strategy
is an improvement over the current practice
of making decisions based on short-term
operational results.
Third, the scorecard facilitates the strategy
review that is essential to strategic learning.
Traditionally, companies use the monthly or
quarterly meetings between corporate and
division executives to analyze the most recent
period’s financial results. Discussions focus on
past performance and on explanations of why
financial objectives were not achieved. The
balanced scorecard, with its specification of
How One Company Linked Measures
from the Four Perspectives
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the causal relationships between performance
drivers and objectives, allows corporate and
business unit executives to use their periodic
review sessions to evaluate the validity of the
unit’s strategy and the quality of its execution.
If the unit’s employees and managers have
delivered on the performance drivers (retrain-
ing of employees, availability of information
systems, and new financial products and ser-
vices, for instance), then their failure to
achieve the expected outcomes (higher sales
to targeted customers, for example) signals
that the theory underlying the strategy may
not be valid. The disappointing sales figures
are an early warning.
Managers should take such disconfirming
evidence seriously and reconsider their
shared conclusions about market conditions,
customer value propositions, competitors’
behavior, and internal capabilities. The result
of such a review may be a decision to reaffirm
their belief in the current strategy but to ad-
just the quantitative relationship among the
strategic measures on the balanced scorecard.
But they also might conclude that the unit
needs a different strategy (an example of
double-loop learning) in light of new knowl-
edge about market conditions and internal
capabilities. In any case, the scorecard will
have stimulated key executives to learn about
the viability of their strategy. This capacity
for enabling organizational learning at the
executive level—strategic learning—is what
distinguishes the balanced scorecard, making
it invaluable for those who wish to create a
strategic management system.

Toward a New Strategic
Management System

Many companies adopted early balanced
scorecard concepts to improve their perfor-
mance measurement systems. They achieved
tangible but narrow results. Adopting those
concepts provided clarification, consensus,
and focus on the desired improvements in
performance. More recently, we have seen
companies expand their use of the balanced
scorecard, employing it as the foundation of an
integrated and iterative strategic management
system. Companies are using the scorecard to
• clarify and update strategy;
• communicate strategy throughout the
company;
• align unit and individual goals with the
strategy;
• link strategic objectives to long-term tar-
gets and annual budgets;
• identify and align strategic initiatives;
and
• conduct periodic performance reviews to
learn about and improve strategy.
The balanced scorecard enables a com-
pany to align its management processes and
focuses the entire organization on imple-
menting long-term strategy. At National In-
surance, the scorecard provided the CEO and
his managers with a central framework
around which they could redesign each piece
of the company’s management system. And
because of the cause-and-effect linkages in-
herent in the scorecard framework, changes
in one component of the system reinforced
earlier changes made elsewhere. Therefore,
every change made over the 30-month pe-
riod added to the momentum that kept the
organization moving forward in the agreed-
upon direction.
Without a balanced scorecard, most organi-
zations are unable to achieve a similar consis-
tency of vision and action as they attempt to
change direction and introduce new strategies
and processes. The balanced scorecard pro-
vides a framework for managing the imple-
mentation of strategy while also allowing the
strategy itself to evolve in response to
changes in the company’s competitive, mar-
ket, and technological environments.

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Further Reading

A R T I C L E S

Putting the Balanced Scorecard to Work

by Robert S. Kaplan and David P. Norton

Harvard Business Review

September–October 1993
Product no. 4118

In this article, the authors argue that the bal-
anced scorecard is more than a measurement
system. Four characteristics make it distinctive:
It is a top-down reflection of the company’s
mission and strategy; it is forward-looking; it
integrates external and internal measures; and
it helps a company focus. Together, these char-
acteristics enable a scorecard to serve as a
means for motivating and implementing
breakthrough performance.
Profit Priorities from Activity-Based
Costing

by Robin Cooper and Robert S. Kaplan

Harvard Business Review

May–June 1991
Product no. 3588
When used as the financial metric of a bal-
anced scorecard, activity-based costing (ABC)
can help managers find the places in their or-
ganizations where improvement is likely to
have the greatest payoff. Any way you slice it—
by product, customer, distribution channel, or
reading—ABC helps you see how an activity
generates revenue and consumes resources.
Once you understand these relationships,
you’re better positioned to take the actions that
will increase your selling margins and reduce
operating expenses.
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www.hbr.org

Transforming Corner-
Office Strategy into
Frontline Action

by Orit Gadiesh and James L. Gilbert

Included with this full-text Harvard Business Review article:
The Idea in Brief—the core idea
The Idea in Practice—putting the idea to work

111

Article Summary

112

Transforming Corner-Office Strategy into Frontline Action
A list of related materials, with annotations to guide further
exploration of the article’s ideas and applications

120

Further Reading
It’s a challenge that confronts
every company, large and
small: how do you give
employees clear strategic
direction but also inspire
flexibility and risk taking?
One answer is to create and
broadcast a “strategic
principle”—a pithy,
memorable distillation of
strategy that guides employees
as it empowers them.

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Transforming Corner-Office Strategy into
Frontline Action

The Idea in Brief The Idea in Practice

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Southwest Airlines keeps soaring. Its
stock price rose a compounded 21,000%
between 1972 and 1992 and leapt 300%
between 1995 and 2000.
Why does Southwest succeed while so
many other airlines fail? Because it sticks
to its powerful strategic principle: “Meet
customers’ short-haul travel needs at fares
competitive with the cost of automobile
travel.” This pithy, memorable, action-
oriented phrase distills Southwest’s unique
strategy and communicates it throughout
the company.
An effective strategic principle lets a com-
pany simultaneously:
• maintain strategic focus,
• empower workers to innovate and
take risks,
• seize fleeting opportunities,
• create products and services that meet
subtle shifts in customers’ needs.
In today’s rapidly changing world, compa-
nies must integrate decentralized decision
making with coherent, strategic action. A
well-crafted, skillfully implemented strate-
gic principle lets them strike that delicate
balance.
HALLMARKS OF POWERFUL STRATEGIC
PRINCIPLES
A successful strategic principle:
• Forces trade-offs between competing
resources.
Example:

Southwest Airlines’ 1983 expansion to the
high-traffic Denver area seemed sensible.
But unusually long delays there due to bad
weather and taxi time would have forced
Southwest to increase ticket prices—
preventing it from adhering to its strategic
principle of offering air fares competitive
with the cost of auto travel. The company
pulled out of Denver.
• Tests the strategic soundness of particular
decisions by linking leaders’ strategic in-
sights with line operators’ pragmatic sense.
Example:

AOL’s strategic principle,“Consumer con-
nectivity first—anytime, anywhere,” tested
the wisdom of a powerful business deci-
sion: expanding AOL’s global network
through alliances with local partners, rather
than using its own technology everywhere.
Partners’ understanding of local culture
greatly increased customers’ connectivity.
• Sets clear boundaries within which employ-
ees operate and experiment.
Example:

At mutual-fund giant The Vanguard Group,
frontline employees conceived a potent
idea: Let customers access their accounts
on-line, but limit on-line trading. This move
kept Vanguard’s costs low, enabling the
company to stick to its strategic principle:
creating “unmatchable value for investors/
owners.”
CREATING AND COMMUNICATING YOUR
STRATEGIC PRINCIPLE
Capturing and communicating the essence
of your company’s strategy in a simple, mem-
orable, actionable phrase isn’t easy. These
steps can help:
1. Draft a working strategic principle. Sum-
marize your corporate strategy—your plan to
allocate scarce resources in order to create
value that distinguishes you from competi-
tors—in a brief phrase. That phrase becomes
your working strategic principle.
2. Test its endurance. A good strategic princi-
ple endures. Ask: Does our working strategic
principle capture the timeless essence of our
company’s unique competitive value?
3. Test its communicative power. Ask: Is the
phrase clear, concise, memorable? Would you
feel proud to paint it on the side of your firm’s
trucks, as Wal-Mart does?
4. Test its ability to promote and guide ac-
tion. Ask: Does the principle exhibit the three
essential attributes: forcing trade-offs, testing
the wisdom of business moves, setting
boundaries for employees’ experimentation?
5. Communicate it. Communicate your
strategic principle consistently, simply, and
repeatedly. You’ll know you’ve succeeded
when employees—as well as business writers,
MBA students, and competitors—all “chant
the rant.”
page 111

Transforming Corner-
Office Strategy into
Frontline Action

by Orit Gadiesh and James L. Gilbert

harvard business review • may 2001

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It’s a challenge that confronts every company, large and small: how do
you give employees clear strategic direction but also inspire flexibility
and risk taking? One answer is to create and broadcast a “strategic
principle”—a pithy, memorable distillation of strategy that guides
employees as it empowers them.

We all know the benefits of pushing decision
making from the CEO’s office out to the far
reaches of an organization. Fleeting business
opportunities can be seized quickly. Products
and services better reflect subtle shifts in cus-
tomers’ preferences. Empowered workers are
motivated to innovate and take risks.
But while the value of such an approach is
clear, particularly in a volatile business environ-
ment, there is also a built-in risk: an organiza-
tion in which everyone is a decision maker has
the potential to spin out of control. Within a
single company, it’s tricky to achieve both de-
centralized decision making and coherent stra-
tegic action. Still, some companies—think Gen-
eral Electric, America Online, Vanguard, Dell,
Wal-Mart, Southwest Airlines, and eBay—have
done just that.
These companies employ what we call a stra-
tegic principle, a memorable and actionable
phrase that distills a company’s corporate strat-
egy into its unique essence and communicates
it throughout the organization. (For a list of
companies’ strategic principles, see the exhibit
“It’s All in a Phrase.”)
This tool—which we have observed in use at
about a dozen companies, even though they
don’t label it as such—would always serve a
company well. But it has become particularly
useful in today’s rapidly and constantly chang-
ing business environment. Indeed, in our con-
versations and work with more than 50 CEOs
over the past two years, we have come to ap-
preciate the strategic principle’s power—its
ability to help companies maintain strategic
focus while fostering the flexibility among em-
ployees that permits innovation and a rapid re-
sponse to opportunities. Strategic principles
are likely to become even more crucial to cor-
porate success in the years ahead.

Distillation and Communication

To better understand what a strategic princi-
ple is and how it can be used, it may be helpful
to look at a military analogy: the rules of en-
gagement for battle. For example, Admiral
Lord Nelson’s crews in Britain’s eighteenth-
century wars against the French were guided
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by a simple strategic principle: whatever you
do, get alongside an enemy ship.
The Royal Navy’s seamanship, training, and
experience gave it the advantage every time it
engaged one-on-one against any of Europe’s
lesser fleets. So Nelson rejected as impractical
the common practice of an admiral attempting
to control a fleet through the use of flag sig-
nals. Instead, he gave his captains strategic pa-
rameters—they knew they had to battle rival
ships one-on-one—leaving them to determine
exactly how to engage in such combat. By
using a strategic principle instead of explicit
signals to direct his forces, Nelson consistently
defeated the French, including a great victory
in the dark of night, when signals would have
been useless. Nelson’s rule of engagement was
simple enough for every one of his officers and
sailors to know by heart. And it was enduring,
a valid directive that was good until the rela-
tive naval capabilities of Britain and its rivals
changed.
The distillation of a company’s strategy into
a pithy, memorable, and prescriptive phrase is
important because a brilliant business strat-
egy, like an insightful approach to warfare, is
of little use unless people understand it well
enough to apply it—both to anticipated deci-
sions and unforeseen opportunities. In our
work, we often see evidence of what we call
the 80-100 rule: you’re better off with a strat-
egy that is 80% right and 100% implemented
than one that is 100% right but doesn’t drive
consistent action throughout the company. A
strategic principle can help a company bal-
ance that ratio.
The beauty of having a corporate strategic
principle—a company should have only one—
is that everyone in an organization, the execu-
tives in the front office as well as people in the
operating units, can knowingly work toward
the same strategic objective without being
rigid about how they do so. Decisions don’t al-
ways have to make the slow trip to and from
the executive suite. When a strategic principle
is well crafted and effectively communicated,
managers at all levels can be trusted to make
decisions that advance rather than undermine
company strategy.
Given what we’ve said so far, a strategic prin-
ciple might seem to be a mission statement by
another name. But while both help employees
understand a company’s direction, the two are
different tools that communicate different
things. A mission statement informs a com-
pany’s culture. A strategic principle drives a
company’s strategy. A mission statement is as-
pirational: it gives people something to strive
for. A strategic principle is action oriented: it
enables people to do something now. A mis-
sion statement is meant to inspire frontline
workers. A strategic principle enables them to
act quickly by giving them explicit guidance to
make strategically consistent choices.
Consider the difference between GE’s mis-
sion statement and its strategic principle. The
company’s mission statement exhorts GE’s
leaders—“always with unyielding integrity”—
to be “passionately focused on driving cus-
tomer success” and to “create an environment
of ‘stretch,’ excitement, informality, and trust,”
among other things. The language is aspira-
tional and emotional. By contrast, GE’s well-
known strategic principle—“Be number one or
number two in every industry in which we
compete, or get out”—is action oriented. The
first part of the phrase is an explicit strategic
challenge, and the second part leaves no ques-
tion in line managers’ minds about what they
should do.

Three Defining Attributes

A strategic principle, as the distillation of a
company’s strategy, should guide a company’s
allocation of scarce resources—capital, time,
management’s attention, labor, and brand—in
order to build a sustainable competitive ad-
vantage. It should tell a company what to do
and, just as important, what not to do. More
specifically, an effective strategic principle
does the following:
• It forces trade-offs between competing re-
source demands;
• It tests the strategic soundness of a particu-
lar action;
• It sets clear boundaries within which em-
ployees must operate while granting them free-
dom to experiment within those constraints.
These three qualities can be seen in America
Online’s strategic principle. CEO Steve Case
says personal interaction on-line is the soul of
the Internet, and he has positioned AOL to cre-
ate that interaction. Thus, AOL’s strategic prin-
ciple in the years leading up to its recent
merger with Time Warner has been “Con-
sumer connectivity first—anytime, anywhere.”
This strategic principle has helped AOL
make tough choices when allocating its re-

Orit Gadiesh

is chairman of the board
and

James L. Gilbert

is a director of
Bain & Company, a consulting firm
based in Boston.
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harvard business review • may 2001

sources. For example, in 1997, the company
needed cash to grow, so it sold off its network
infrastructure and outsourced that capability—
a risky move at a time when it appeared that
network ownership might be the key to success
on the Internet. In keeping with its strategic
principle, AOL instead spent its time and cash
on improving connectivity at its Web site, fo-
cusing particularly on access, navigation, and
interaction. As a result, it avoided investing
capital in what turned out to be a relatively
low-return business.
Its strategic principle has also helped AOL
test whether a given business move makes stra-
tegic sense. For instance, the Internet company
has chosen to expand its global network
through alliances with local partners, even
though that approach can take longer than
simply transplanting AOL’s own technology
and know-how. AOL acknowledges that a local
partner better understands the native culture
and community, which is essential for connect-
ing with customers.
Finally, AOL’s strategic principle has spurred
focused experimentation in the field by clearly
defining employees’ latitude for making moves.
For example, AOL’s former vice president of
marketing, Jan Brandt, mailed more than 250
million AOL diskettes to consumers nation-
wide. The innovative campaign turned the
company into one of the best-known names in
cyberspace—all because Brandt, now AOL’s
vice chair and chief marketing officer, guided
by the principle of connecting consumers, put
her resources into empowering AOL’s target
community rather than sinking time and
money into slick advertising.
As AOL’s experience illustrates, a strong stra-
tegic principle can inform high-level corporate
decisions—those involving divestitures, for ex-
ample—as well as decisions made by depart-
ment heads or others further down in an orga-
nization. It also frees up CEOs from constant
involvement in the implementation of their
strategic mandates. “The genius of a great
leader is to leave behind him a situation that
common sense, without the grace of genius,
can deal with successfully,” said journalist and
political thinker Walter Lippman. Scratch the
surface of a number of high-performing com-
panies, and you’ll find that strategic principles
are connecting the strategic insights—if not al-
ways the genius—of leaders with the prag-
matic sense of line operators.

Now More Than Ever

In the past, a strategic principle was nice to
have but was hardly required, unless a com-
pany found itself in a trying business situation.
Today, many companies simultaneously face
four situations that make a strategic principle
crucial for success: decentralization, rapid
growth, technological change, and institu-
tional turmoil.
For the reasons mentioned above, decentrali-
zation is becoming common at companies of all
stripes; thus, there is a corresponding need for a
mechanism to ensure coherent strategic action.
Especially in the case of diversified conglomer-
ates, where strategy is formed in each of the
business units, a strategic principle can help ex-
ecutives maintain consistency while giving unit
managers the freedom to tailor their strategies
to meet their own needs. It can also clarify the
value of the center at such far-flung companies.
For example, GE’s long-standing strategic prin-
ciple of always being number one or number
two in an industry offers a powerful rationale
for how a conglomerate can create value but
still give individual units considerable strategic
freedom.
A strategic principle is also crucial when a
company is experiencing rapid growth. During
such times, it’s increasingly the case that less-
experienced managers are forced to make deci-

It’s All in a Phrase
A handful of companies have distilled their strategy
into a phrase and have used it to drive consistent
strategic action throughout their organizations.
Company Strategic Principle
America Online Consumer connectivity first—
anytime, anywhere
Dell Be direct
eBay Focus on trading communities
General Electric Be number one or number two in every
industry in which we compete, or get out
Southwest Airlines Meet customers’ short-haul travel needs
at fares competitive with the cost of
automobile travel
Vanguard Unmatchable value for the investor-owner
Wal-Mart Low prices, every day
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harvard business review • may 2001

sions about nettlesome issues for which there
may be no precedent. A clear and precise stra-
tegic principle can help counteract this short-
age of experience. This is particularly true
when a start-up company is growing rapidly in
an established industry. For instance, as South-
west Airlines began to grow quickly, it might
have been tempted to mimic its rivals’ ulti-
mately unsuccessful strategies if it hadn’t had
its own strategic principle to follow: “Meet cus-
tomers’ short-haul travel needs at fares compet-
itive with the cost of automobile travel.” Like-
wise, eBay, whose principle is “Focus on trading
communities,” might have been tempted, like
many Internet marketplaces, to diversify into
all sorts of services. But eBay has chosen to out-
source certain services—for instance, manage-
ment of the photos that sellers post on the site
to illustrate the items they put up for bid—
while it continues to invest in services like Bill-
point, which lets sellers accept credit-card pay-
ments from bidders. EBay’s strategic principle
has ensured that the entire company stays fo-
cused on the core trading business.
The staggering pace of technological change
over the past decade has been costly for com-
panies that don’t have a strategic principle.
Never before in business has there been more
uncertainty combined with so great an empha-
sis on speed. Managers in high-tech industries
in particular must react immediately to sud-
den and unexpected developments. Often, the
sum of the reactions across the organization
ends up defining the company’s strategic
course. A strategic principle—for example,
Dell’s mandate to sell direct to end users—
helps ensure that the decisions made by front-
line managers in such circumstances add up to
a consistent, coherent strategy.
Finally, a strategic principle can help provide
continuity during periods of organizational tur-
moil. An increasingly common example of tur-
moil in this era of short-term CEOs is leader-
ship succession. A new CEO can bring with him
or her a new strategy—but not necessarily a
new strategic principle. For instance, when

Bain & Company: Case Study of a Strategic Principle

I learned the most about strategic principles
in the trenches at Bain & Company when, a
decade ago, we almost went bankrupt.
Bill Bain founded Bain & Company nearly
30 years ago on the basis of a simple but pow-
erful notion: “The product of a consultant
should be results for clients—not reports.”
Over time, this mandate to deliver
results through strategy became Bain’s strate-
gic principle. It remains so today.
This directive fosters specific action, as an
effective strategic principle should. It means
that, from the very beginning of an assign-
ment, you are constantly thinking about how
a recommendation will get implemented. It
also requires you to tell clients the truth, even
if it’s difficult, because you can’t achieve re-
sults by whitewashing problems. And this stra-
tegic principle has teeth: Bain has always mea-
sured partners’ performance according to the
results they achieve for their clients, not just
on billings to the firm.
That was the company I joined. And for
many years it grew rapidly, all the time guided
by its strategic principle. Then, just over a de-
cade ago, the founding partners decided to get
their money out and sold 30% of the firm to an
employee stock-option plan. This saddled us
with hundreds of millions of dollars of debt
and tens of millions of dollars of interest pay-
ments. The move, whose details initially were
not disclosed to the rest of us, was based on
the assumption that the company would con-
tinue its historic growth rate of 50% a year,
which couldn’t be sustained at the size we had
become. When growth slowed, the details
came to light.
The nonfounding partners faced a critical
choice. Everybody had attractive offers. Com-
petitors and the press predicted we wouldn’t
survive. Recruits and clients were watchful. To
make a long story short, we sat down around a
conference table and resolved to turn the com-
pany around. The key to doing that, we de-
cided, was to stick with our strategic principle.
What followed was a couple of years during
which adhering to that goal was achingly diffi-
cult. But doing so forced important trade-offs.
In one case, right in the middle of the crisis,
we pulled out of a major assignment that was
inconsistent with our principle. We believed
the projects that the client was determined to
undertake could not produce significant re-
sults for the company. Today, we all believe
that had we veered from our principle in that
instance, we would not be around.
More recently, our strategic principle has
freed us to explore other ventures. Seven years
ago, for instance, we became interested in pri-
vate equity consulting, quite a different busi-
ness from serving corporate clients. We ini-
tially struggled with the notion but quickly
realized that it fit our strategic principle of de-
livering results through strategy, only to a new
client segment. We knew that we could trust
our colleagues forming the practice area to act
consistently with the company’s broader goals
because the strategic principle was fundamen-
tal to their perspective. The strength of our
shared principle permitted us to experiment
and ultimately develop a successful new prac-
tice area.
Our principle continues to let partners de-
velop new practices, markets, and interests
quickly and without splintering the firm. It has
given us the capacity to evolve and endure.
—

Orit Gadiesh
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harvard business review • may 2001

Jack Brennan took over as chairman and CEO
at Vanguard five years ago, the strategic transi-
tion was seamless, despite some tension
around the leadership transition. He main-
tained the mutual fund company’s strategic
principle—“Unmatchable value for the inves-
tor-owner”—thereby allowing managers to
pursue their strategic objectives without many
of the distractions so often associated with
leadership changes. (For our own experience
with organizational turmoil and strategic prin-
ciples, see the sidebar “Bain & Company: Case
Study of a Strategic Principle.”)

Strategic Principles in Action

Strategic principles and their benefits can best
be understood by seeing the results they create.
Forcing Trade-Offs at Southwest Airlines.
Southwest Airlines is one of the air-travel in-
dustry’s great success stories. It is the only air-
line that hasn’t lost money in the past 25 years.
Its stock price rose a compounded 21,000% be-
tween 1972 and 1992, and it is up 300% over
the past five years, which have been difficult
ones in the airline industry. For most compa-
nies, such rapid growth would cause problems:
legions of frontline employees taking up the
mantle of decision making from core execu-
tives and, inevitably, stumbling. But in South-
west’s case, employees have consistently made
trade-offs in keeping with the company’s stra-
tegic principle.
The process for making important and com-
plicated decisions about things like network
design, service offerings, route selection and
pricing, cabin design, and ticketing procedures
is straightforward. That’s because the trade-
offs required by the strategic principle are
clear. For instance, in 1983, Southwest initiated
service to Denver, a potentially high-traffic des-
tination and a seemingly sensible expansion of
the company’s presence in the Southwestern
United States. However, the airline experi-
enced longer and more consistent delays at
Denver’s Stapleton airport than it did any-
where else. These delays were caused not by
slow turnaround at the gate but by increased
taxi time on the runway and planes circling in
the air because of bad weather. Southwest had
to decide whether the potential growth from
serving the Denver market was worth the
higher costs associated with the delays, which
would ultimately be reflected in higher ticket
prices. The company turned to its strategic
principle: would the airline be able to main-
tain fares competitive with the cost of automo-
bile travel? Clearly, in Denver at least, it
couldn’t. Southwest pulled out of Stapleton
three years after inaugurating the service there
and has not returned.
Testing Action at AOL. A large part of
AOL’s ability to move so far and so fast across
untrod ground lies in its practice of testing po-
tential moves against its strategic principle.
Employees who see attractive opportunities
can ask themselves whether seizing one or sev-
eral will lead to deeper consumer connectivity
or broader distribution. Take, for example,
line manager Katherine Borescnik, now presi-
dent of programming at AOL. Several years
ago she noticed increased activity—call it con-
sumer connectivity—around the bulletin-
board folders created on the site by two irrev-
erent stock analysts and AOL subscribers. She
offered the analysts the chance to create their
own financial site, which became Motley Fool,
a point of connection and information for do-
it-yourself investors.
And AOL’s strategic principle reaches even
deeper into the organization. The hundreds of
acquisitions and deals that AOL has made in
the past few years have involved numerous
employees. While top officers make final deci-
sions, employees on the ground first screen op-
portunities against the company’s strategic
principle. Furthermore, the integration efforts
following acquisitions, while choreographed at
the top, are executed by a coterie of managers
who ensure that the plans comply with the
company’s strategic principle. “We have suc-
ceeded, both in our deal making and in our in-
tegration, because our acquisitions have all
been driven by our focus on how our custom-
ers communicate and connect,” says Ken No-
vack, AOL Time Warner’s vice chairman.
AOL’s massive merger with Time Warner
clearly furthers AOL’s strategic principle of en-
abling consumer connections “anytime, any-
where” by adding TV and cable access to the
Internet company’s current dial-up access on
the personal computer. But integrating this
merger, which will involve hundreds of em-
ployees making and executing thousands of de-
cisions, may be the ultimate test of AOL’s stra-
tegic principle.
Experimenting Within Boundaries at Van-
guard. The Vanguard Group, with $565 billion
in assets under management, has quietly be-
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come a giant in the mutual fund industry. The
company’s strategy is a response to the inabil-
ity of most mutual funds to beat the market,
often because of the cost of their marketing
activities, overhead, and frequent transac-
tions. To counter this, Vanguard discourages
investors from making frequent trades and
keeps its own overhead and advertising costs
far below the industry average. It passes the
savings directly to investors, who, because
Vanguard is a mutual rather than a public
company, are the fund’s owners.
While this was Vanguard’s founding strategy,
for years the company didn’t communicate it
widely to employees. As a result, they often
suggested initiatives that were out of sync with
the company’s core strategy. “Midlevel manag-
ers would walk in holding the newspaper say-
ing, ‘Look at what Fidelity just did. How about
if we do that?’” Jack Brennan says. It wasn’t ap-
parent to them that Vanguard’s strategy was
very different from that of its rival, which has
higher costs and isn’t mutually owned. Over
the years, Vanguard has invested considerable
energy in crafting a strategic principle and
using it to disseminate the company’s strategy.
Now, because employees understand the strat-
egy, top management trusts them to initiate
moves on their own.
Consider Vanguard’s response to a major
trend in retail fund distribution: the emer-
gence of the on-line channel. Industry surveys
indicated that most investors wanted Internet
access to their accounts and that on-line trad-
ers were more active than off-line traders. So
Vanguard chose to integrate the Internet into
its service in a way that furthered its strategy
of keeping costs low: basically, it lets custom-
ers access their accounts on-line, but it limits
Web-based trading. It should be noted that
the original ideas for Vanguard’s on-line initi-
atives, including early ventures with AOL,
were conceived by frontline employees, not
senior executives.
Brennan says the company’s strategic princi-
ple affects the entire management process, in-
cluding hiring, training, performance measure-
ment, and incentives. He points to a hidden
benefit of having a strong strategic principle:
“You’re more efficient and can run with a
leaner management team because everyone is
on the same page.”

Creating a Strategic Principle

Many of the best and most conspicuous exam-
ples of strategic principles come from compa-
nies that were founded on them, companies
such as eBay, Dell, Vanguard, Southwest Air-
lines, and Wal-Mart (“Low prices, every day”).
The founders of those companies espoused a
clear guiding principle that summarized the
essence of what would become a full-blown
business strategy. They attracted investors
who believed it, hired employees who bought
into it, and targeted customers who wanted it.
Leaders of long-standing multinationals, like
GE, crafted their strategic principles at a criti-
cal juncture: when increasing corporate com-
plexity threatened to confuse priorities on the
front line and obscure the essence that truly
differentiated their strategy from that of their
rivals.
Companies in this second category, which
represents most of the companies that are
likely to contemplate creating a strategic prin-
ciple, face a demanding exercise. It probably
comes as no surprise that identifying the es-
sence of your strategy so it can be translated
into a simple, memorable phrase is no easy
task. It’s a bit like corporate genomics: the prin-
ciple must isolate and capture the corporate
equivalent of the genetic code that differenti-
ates your company from its competitors. This
is somewhat like identifying the 2% of DNA
that separates man from monkey—or, even
more difficult and more apt, the .1% of DNA
that differentiates each human being.
There are different ways to identify the ele-
ments that must be captured in a strategic
principle, but keep in mind that a corporate
strategy represents a plan to effectively allo-
cate scarce resources to achieve sustainable
competitive advantage. Managers need to ask
themselves: how does my company allocate
those resources to create value in a unique
way, one that differentiates my company from
competitors? Try to summarize the answer in a
brief phrase that captures the essence of your
company’s point of differentiation.
Once that idea has been expressed in a
phrase, test the strategic principle for its endur-
ing nature. Does it capture what you intend to
do for only the next three to five years, or does
it capture a more timeless essence: the genetic
code of your company’s competitive differenti-
ation? Then test the strategic principle for its
communicative power. Is it clear, concise, and
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memorable? Would you feel proud to paint it
on the side of a truck, as Wal-Mart does?
Finally, test the principle for its ability to
promote and guide action. In particular, assess
whether it exhibits the three attributes of an
effective strategic principle. Will it force trade-
offs? Will it serve as a test for the wisdom of a
particular business move, especially one that
might promote short-term profits at the ex-
pense of long-term strategy? Does it set bound-
aries within which people will nonetheless be
free to experiment?
Given the importance of getting your strate-
gic principle right, it is wise to gather feedback
on these questions from executives and other
employees during an incubation period. Once
you are satisfied that the statement is accurate
and compelling, disseminate it throughout the
organization.
Of course, just as a brilliant strategy is
worthless unless it is implemented, a powerful
strategic principle is of no use unless it is com-
municated effectively. When CEO Jack Welch
talks about aligning employees around GE’s
strategy and values, he emphasizes the need
for consistency, simplicity, and repetition. The
approach is neither flashy nor complicated, but
it takes enormous discipline and could scarcely
be more important. Welch has so broadly evan-
gelized GE’s “Be number one or number two”
strategic principle that employees are not the
only ones to chant the rant. So can most busi-
ness writers, MBA students, and managers at
other companies.

When Rethinking Is Required

No strategy is eternal, nor is any strategic prin-
ciple. But even if the elements of your strategy
change, the very essence of it is likely to re-
main the same. Thus, your strategy may shift
substantially as your customers’ demograph-
ics and needs change. It may have to be modi-
fied in light of your company’s changing costs
and assets compared with those of competi-
tors. Strategic half-lives are shortening, and, in
general, strategy should be reviewed every
quarter and updated every year. But while it’s
worth revisiting your strategic principle every
time you reexamine your strategy, it is likely to
change only when there is a significant shift in
the basic economics and opportunities of your
market caused by, say, legislation or a com-
pletely new technology or business model.
Even then, your strategic principle may need
only refining or expanding. GE’s strategic prin-
ciple has been enhanced, but not replaced,
since Welch articulated it in 1981. Similarly,
AOL’s strategic principle will need to be broad-
ened, but not necessarily jettisoned, following
its merger with Time Warner. Ultimately, the
merged company’s strategic principle will also
need to embody the importance of high-quality
and relevant content, Time Warner’s hallmark.
Vanguard takes explicit steps to ensure that
the direction provided by its strategic principle
remains current. For example, as part of an in-
ternal “devil’s advocacy” process, managers are
divided into groups to critique and defend past
decisions and current policies. Recently, the
group reconsidered two major strategic poli-
cies: the prohibitions against opening branch
offices and against acquiring money manage-
ment firms. After considerable discussion, the
policies remained in place. According to CEO
Brennan, “Sometimes the greatest value [of re-
visiting our strategic principle] is reconfirming
what we’re already doing.” At the same time,
Vanguard has the process to identify when
change is needed.

Fundamental Principles

Respondents to Bain’s annual survey of execu-
tives on the usefulness of management tools
repeatedly cite the key role a mission state-
ment can play in a company’s success. We
agree that a mission statement is crucial for
promulgating a company’s values and build-
ing a robust corporate culture. But it still
leaves a large gap in a company’s management
communications portfolio. At least as impor-
tant as a mission statement is something that
promulgates a company’s strategy—that is, a
strategic principle.
The ability of frontline employees to execute
a company’s strategy without close central
oversight is vital as the pace of technological
change accelerates and as companies grow rap-
idly and become increasingly decentralized. To
drive such behavior, a company needs to give
employees a mandate broad enough to encour-
age enterprising behavior but specific enough
to align employees’ initiatives with company
strategy.
While not a perfect analogy, the U.S. Consti-
tution is in some ways like a strategic principle.
It articulates and embodies the essence of the
country’s “strategy”—to guarantee liberty and
justice for all of its citizens—while providing
page 118

Transforming Corner-Office Strategy into Frontline Action

harvard business review • may 2001

direction to those drafting the laws and regula-
tions that implement the strategy. While no
corporate strategy has liberty and justice at its
heart, the elements of an effective strategy are
just as central to the success of a company as
those concepts are to the prosperity of the
United States. And in neither case will success
be realized unless the core strategy is commu-
nicated broadly and effectively.

Bain consultant Coleman Mark assisted with this
article.

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Further Reading

A R T I C L E S

What Is Strategy?

by Michael E. Porter

Harvard Business Review

November–December 1996
Product no. 96608

An effective strategic principle helps a com-
pany to maintain strategic focus, including forc-
ing trade-offs and creating carefully integrated
systems. In this article, Porter expands on those
points within his definition of strategy. As he
explains, operational effectiveness—produc-
ing, selling, and delivering offerings faster than
rivals—can reap advantages. However, rivals
can quickly copy these “best practices.” There-
fore, companies need to hone their strategic
positioning, enabling them to achieve sustain-
able competitive advantage through 1) pre-
serving their distinctive qualities, 2) performing
different activities from rivals, or 3) performing
similar activities in different ways. Effectively im-
plementing strategy requires trade-offs (“what
we won’t do”) and reinforcing “fit” among com-
pany activities.
E-Loyalty: Your Secret Weapon on the
Web

by Frederick F. Reichheld and Phil Schefter

Harvard Business Review

July–August 2000
Product no. R00410
This article applies Gadiesh and Gilbert’s in-
sights about strategy to the special challenges
of e-commerce. Using several of the same
company examples cited in “Transforming
Corner-Office Strategy,” including The Van-
guard Group, AOL, and Dell, Reichheld and
Schefter emphasize the importance of mak-
ing trade-offs and the dangers of “trying to be
all things to all people.” They also stress the
importance of maintaining strategic focus and
integrating all operations, including on-line
activities.
Speed, Simplicity, Self-Confidence:
An Interview with Jack Welch

by Noel Tichy and Ram Charan

Harvard Business Review

September–October 1989
Product no. 89513
This interview with General Electric CEO Jack
Welch examines in greater depth the every-
day ramifications of GE’s strategic principle:
“Be number one or number two in every in-
dustry in which we compete, or get out.” As
Welch makes clear, this principle translates
into five “keys” that unlock the energy of GE’s
people: 1) candor (seeing the world as it is),
2) simplicity, 3) self-confidence in communi-
cating objectives, 4) two-way communication
between leaders and followers, and 5) evalua-
tion of and reward for agility and candor.
page 120

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Turning Great Strategy
into Great Performance

by Michael C. Mankins and Richard Steele

Included with this full-text Harvard Business Review article:
The Idea in Brief—the core idea
The Idea in Practice—putting the idea to work

122

Article Summary

123

Turning Great Strategy into Great Performance
A list of related materials, with annotations to guide further
exploration of the article’s ideas and applications

132

Further Reading
Companies typically realize
only about 60% of their
strategies’ potential value
because of defects and
breakdowns in planning and
execution. By strictly
following seven simple rules,
you can get a lot more than
that.

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Turning Great Strategy into Great Performance

The Idea in Brief The Idea in Practice

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Most companies’ strategies deliver only
63% of their promised financial value. Why?
Leaders press for better execution when
they really need a sounder strategy. Or they
craft a new strategy when execution is the
true weak spot.
How to avoid these errors? View strategic
planning and execution as inextricably
linked—then raise the bar for both simulta-
neously. Start by applying seven decep-
tively straightforward rules, including: keep-
ing your strategy simple and concrete,
making resource-allocation decisions early
in the planning process, and continuously
monitoring performance as you roll out
your strategic plan.
By following these rules, you reduce the
likelihood of performance shortfalls. And
even if your strategy still stumbles, you
quickly determine whether the fault lies
with the strategy itself, your plan for pursu-
ing it, or the execution process. The payoff?
You make the right midcourse correc-
tions—promptly. And as high-performing
companies like Cisco Systems, Dow Chemi-
cal, and 3M have discovered, you boost
your company’s financial performance 60%
to 100%.
Seven rules for successful strategy execution:
• Keep it simple. Avoid drawn-out descrip-
tions of lofty goals. Instead, clearly describe
what your company will and won’t do.
Example:
Executives at European investment-bank-
ing giant Barclays Capital stated they
wouldn’t compete with large U.S. invest-
ment banks or in unprofitable equity-
market segments. Instead, they’d position
Barclays for investors’ burgeoning need for
fixed income.
• Challenge assumptions. Ensure that the
assumptions underlying your long-term
strategic plans reflect real market econom-
ics and your organization’s actual perfor-
mance relative to rivals’.
Example:

Struggling conglomerate Tyco commis-
sioned cross-functional teams in each busi-
ness unit to continuously analyze their mar-
kets’ profitability and their offerings, costs,
and price positioning relative to competi-
tors’. Teams met with corporate executives
biweekly to discuss their findings. The re-
vamped process generated more realistic
plans and contributed to Tyco’s dramatic
turnaround.
• Speak the same language. Unit leaders
and corporate strategy, marketing, and fi-
nance teams must agree on a common
framework for assessing performance. For
example, some high-performing compa-
nies use benchmarking to estimate the size
of the profit pool available in each market
their company serves, the pool’s potential
growth, and the company’s likely portion of
that pool, given its market share and profit-
ability. By using the shared approach, exec-
utives easily agree on financial projections.
• Discuss resource deployments early. Chal-
lenge business units about when they’ll
need new resources to execute their strat-
egy. By asking questions such as, “How fast
can you deploy the new sales force?” and
“How quickly will competitors respond?”
you create more feasible forecasts and
plans.
• Identify priorities. Delivering planned per-
formance requires a few key actions taken
at the right time, in the right way. Make
strategic priorities explicit, so everyone
knows what to focus on.
• Continuously monitor performance. Track
real-time results against your plan, resetting
planning assumptions and reallocating re-
sources as needed. You’ll remedy flaws in
your plan and its execution—and avoid
confusing the two.
• Develop execution ability. No strategy can
be better than the people who must imple-
ment it. Make selection and development
of managers a priority.
Example:

Barclays’ top executive team takes responsi-
bility for all hiring. Members vet each oth-
ers’ potential hires and reward talented
newcomers for superior execution. And
stars aren’t penalized if their business enters
new markets with lower initial returns.
page 122page 122

Turning Great Strategy
into Great Performance

by Michael C. Mankins and Richard Steele

harvard business review • july–august 2005

C
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Companies typically realize only about 60% of their strategies’
potential value because of defects and breakdowns in planning and
execution. By strictly following seven simple rules, you can get a lot
more than that.

Three years ago, the leadership team at a
major manufacturer spent months developing
a new strategy for its European business. Over
the prior half-decade, six new competitors had
entered the market, each deploying the latest
in low-cost manufacturing technology and
slashing prices to gain market share. The per-
formance of the European unit—once the
crown jewel of the company’s portfolio—had
deteriorated to the point that top manage-
ment was seriously considering divesting it.
To turn around the operation, the unit’s
leadership team had recommended a bold
new “solutions strategy”—one that would le-
verage the business’s installed base to fuel
growth in after-market services and equip-
ment financing. The financial forecasts were
exciting—the strategy promised to restore
the business’s industry-leading returns and
growth. Impressed, top management quickly
approved the plan, agreeing to provide the
unit with all the resources it needed to make
the turnaround a reality.
Today, however, the unit’s performance is
nowhere near what its management team
had projected. Returns, while better than be-
fore, remain well below the company’s cost of
capital. The revenues and profits that manag-
ers had expected from services and financing
have not materialized, and the business’s cost
position still lags behind that of its major
competitors.
At the conclusion of a recent half-day review
of the business’s strategy and performance, the
unit’s general manager remained steadfast and
vowed to press on. “It’s all about execution,”
she declared. “The strategy we’re pursuing is
the right one. We’re just not delivering the
numbers. All we need to do is work harder,
work smarter.”
The parent company’s CEO was not so sure.
He wondered: Could the unit’s lackluster per-
formance have more to do with a mistaken
strategy than poor execution? More impor-
tant, what should he do to get better perfor-
mance out of the unit? Should he do as the
general manager insisted and stay the course—
focusing the organization more intensely on
page 123

Turning Great Strategy into Great Performance

harvard business review • july–august 2005

execution—or should he encourage the leader-
ship team to investigate new strategy options?
If execution was the issue, what should he do
to help the business improve its game? Or
should he just cut his losses and sell the busi-
ness? He left the operating review frustrated
and confused—not at all confident that the
business would ever deliver the performance
its managers had forecast in its strategic plan.
Talk to almost any CEO, and you’re likely to
hear similar frustrations. For despite the enor-
mous time and energy that goes into strategy
development at most companies, many have
little to show for the effort. Our research sug-
gests that companies on average deliver only
63% of the financial performance their strate-
gies promise. Even worse, the causes of this
strategy-to-performance gap are all but invisi-
ble to top management. Leaders then pull the
wrong levers in their attempts to turn around
performance—pressing for better execution
when they actually need a better strategy, or
opting to change direction when they really
should focus the organization on execution.
The result: wasted energy, lost time, and con-
tinued underperformance.
But, as our research also shows, a select
group of high-performing companies have
managed to close the strategy-to-performance
gap through better planning and execution.
These companies—Barclays, Cisco Systems,
Dow Chemical, 3M, and Roche, to name a
few—develop realistic plans that are solidly
grounded in the underlying economics of their
markets and then use the plans to drive execu-
tion. Their disciplined planning and execution
processes make it far less likely that they will
face a shortfall in actual performance. And, if
they do fall short, their processes enable them
to discern the cause quickly and take corrective
action. While these companies’ practices are
broad in scope—ranging from unique forms of
planning to integrated processes for deploying
and tracking resources—our experience sug-
gests that they can be applied by any business
to help craft great plans and turn them into
great performance.

The Strategy-to-Performance Gap

In the fall of 2004, our firm, Marakon Associ-
ates, in collaboration with the Economist Intel-
ligence Unit, surveyed senior executives from
197 companies worldwide with sales exceeding
$500 million. We wanted to see how successful
companies are at translating their strategies
into performance. Specifically, how effective
are they at meeting the financial projections set
forth in their strategic plans? And when they
fall short, what are the most common causes,
and what actions are most effective in closing
the strategy-to-performance gap? Our findings
were revealing—and troubling.
While the executives we surveyed compete
in very different product markets and geogra-
phies, they share many concerns about plan-
ning and execution. Virtually all of them strug-
gle to produce the financial performance
forecasts in their long-range plans. Further-
more, the processes they use to develop plans
and monitor performance make it difficult to
discern whether the strategy-to-performance
gap stems from poor planning, poor execution,
both, or neither. Specifically, we discovered:
Companies rarely track performance against
long-term plans. In our experience, less than
15% of companies make it a regular practice to
go back and compare the business’s results
with the performance forecast for each unit in
its prior years’ strategic plans. As a result, top
managers can’t easily know whether the pro-
jections that underlie their capital-investment
and portfolio-strategy decisions are in any way
predictive of actual performance. More im-
portant, they risk embedding the same discon-
nect between results and forecasts in their fu-
ture investment decisions. Indeed, the fact
that so few companies routinely monitor ac-
tual versus planned performance may help ex-
plain why so many companies seem to pour
good money after bad—continuing to fund
losing strategies rather than searching for new
and better options.
Multiyear results rarely meet projections.
When companies do track performance rela-
tive to projections over a number of years,
what commonly emerges is a picture one of
our clients recently described as a series of “di-
agonal venetian blinds,” where each year’s per-
formance projections, when viewed side by
side, resemble venetian blinds hung diago-
nally. (See the exhibit “The Venetian Blinds of
Business.”) If things are going reasonably well,
the starting point for each year’s new “blind”
may be a bit higher than the prior year’s start-
ing point, but rarely does performance match
the prior year’s projection. The obvious impli-
cation: year after year of underperformance
relative to plan.

Michael C. Mankins

(mmankins@
marakon.com) is a managing partner
in the San Francisco office of Marakon
Associates, an international strategy-
consulting firm. He is also a coauthor
of The Value Imperative: Managing
for Superior Shareholder Returns
(Free Press, 1994). Richard Steele
(rsteele@marakon.com) is a partner
in the firm’s New York office.
page 124

mailto:mmankins@marakon.com

mailto:mmankins@marakon.com

mailto:rsteele@marakon.com

Turning Great Strategy into Great Performance

harvard business review • july–august 2005

The venetian blinds phenomenon creates a
number of related problems. First, because
the plan’s financial forecasts are unreliable,
senior management cannot confidently tie
capital approval to strategic planning. Conse-
quently, strategy development and resource
allocation become decoupled, and the an-
nual operating plan (or budget) ends up driv-
ing the company’s long-term investments and
strategy. Second, portfolio management gets
derailed. Without credible financial forecasts,
top management cannot know whether a par-
ticular business is worth more to the com-
pany and its shareholders than to potential
buyers. As a result, businesses that destroy
shareholder value stay in the portfolio too
long (in the hope that their performance will
eventually turn around), and value-creating
businesses are starved for capital and other re-
sources. Third, poor financial forecasts com-
plicate communications with the investment
community. Indeed, to avoid coming up short
at the end of the quarter, the CFO and head
of investor relations frequently impose a
“contingency” or “safety margin” on top of
the forecast produced by consolidating the
business-unit plans. Because this top-down
contingency is wrong just as often as it is
right, poor financial forecasts run the risk of
damaging a company’s reputation with ana-
lysts and investors.
A lot of value is lost in translation. Given the
poor quality of financial forecasts in most stra-
tegic plans, it is probably not surprising that
most companies fail to realize their strategies’
potential value. As we’ve mentioned, our sur-
vey indicates that, on average, most strategies
deliver only 63% of their potential financial
performance. And more than one-third of the
executives surveyed placed the figure at less
than 50%. Put differently, if management
were to realize the full potential of its current
strategy, the increase in value could be as
much as 60% to 100%!
As illustrated in the exhibit “Where the Per-
formance Goes,” the strategy-to-performance
gap can be attributed to a combination of fac-
tors, such as poorly formulated plans, misap-
plied resources, breakdowns in communica-
tion, and limited accountability for results. To

Where the Performance Goes

This chart shows the average performance loss implied by the importance ratings that managers in our
survey gave to specific breakdowns in the planning and execution process.

Inadequate or unavailable
resources
Poorly communicated
strategy
Actions required to execute
not clearly defined
Unclear accountabilities for
execution
Organizational silos and culture
blocking execution
Inadequate performance
monitoring
Inadequate consequences or
rewards for failure or success
Poor senior leadership
Uncommitted leadership
Unapproved strategy
Other obstacles (including inadequate
skills and capabilities)
Average
Performance Loss
Average Realized
Performance
37%
63%
7.5%
5.2%
4.5%
4.1%
3.7%
3.0%
3.0%
2.6%
1.9%
0.7%
0.7%
Co
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page 125

Turning Great Strategy into Great Performance

harvard business review • july–august 2005

elaborate, management starts with a strategy
it believes will generate a certain level of fi-
nancial performance and value over time
(100%, as noted in the exhibit). But, according
to the executives we surveyed, the failure to
have the right resources in the right place at
the right time strips away some 7.5% of the
strategy’s potential value. Some 5.2% is lost to
poor communications, 4.5% to poor action
planning, 4.1% to blurred accountabilities,
and so on. Of course, these estimates reflect
the average experience of the executives we
surveyed and may not be representative of
every company or every strategy. Nonethe-
less, they do highlight the issues managers
need to focus on as they review their compa-
nies’ processes for planning and executing
strategies.
What emerges from our survey results is a
sequence of events that goes something like
this: Strategies are approved but poorly com-
municated. This, in turn, makes the transla-
tion of strategy into specific actions and re-
source plans all but impossible. Lower levels
in the organization don’t know what they
need to do, when they need to do it, or what
resources will be required to deliver the per-
formance senior management expects. Conse-
quently, the expected results never material-
ize. And because no one is held responsible
for the shortfall, the cycle of underperfor-
mance gets repeated, often for many years.
Performance bottlenecks are frequently
invisible to top management. The processes
most companies use to develop plans, allocate
resources, and track performance make it diffi-
cult for top management to discern whether
the strategy-to-performance gap stems from
poor planning, poor execution, both, or nei-
ther. Because so many plans incorporate
overly ambitious projections, companies fre-
quently write off performance shortfalls as
“just another hockey-stick forecast.” And when
plans are realistic and performance falls short,
executives have few early-warning signals.
They often have no way of knowing whether
critical actions were carried out as expected,
resources were deployed on schedule, compet-
itors responded as anticipated, and so on. Un-
fortunately, without clear information on how
and why performance is falling short, it is vir-
tually impossible for top management to take
appropriate corrective action.
The strategy-to-performance gap fosters a
culture of underperformance. In many com-
panies, planning and execution breakdowns are
reinforced—even magnified—by an insidious
shift in culture. In our experience, this change
occurs subtly but quickly, and once it has taken
root it is very hard to reverse. First, unrealistic
plans create the expectation throughout the or-
ganization that plans simply will not be ful-
filled. Then, as the expectation becomes experi-
ence, it becomes the norm that performance
commitments won’t be kept. So commitments
cease to be binding promises with real conse-
quences. Rather than stretching to ensure that
commitments are kept, managers, expecting
failure, seek to protect themselves from the
eventual fallout. They spend time covering their
tracks rather than identifying actions to en-
hance performance. The organization becomes

The Venetian Blinds of Business

This graphic illustrates a dynamic com-
mon to many companies. In January
2001, management approves a strategic
plan (Plan 2001) that projects modest
performance for the first year and a high
rate of performance thereafter, as shown
in the first solid line. For beating the first
year’s projection, the unit management
is both commended and handsomely re-
warded. A new plan is then prepared,
projecting uninspiring results for the first
year and once again promising a fast rate
of performance improvement thereafter,
as shown by the second solid line (Plan
2002). This, too, succeeds only partially,
so another plan is drawn up, and so on.
The actual rate of performance improve-
ment can be seen by joining the start
points of each plan (the dotted line).

30%
25%
20%
15%
10%
5%
0%
2000 2001 2002
Plan
2001
actual
performance
Performance
(return on capital)
2003 2004 2005 2006
Plan
2002
Plan
2003
Plan
2004
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harvard business review • july–august 2005

less self-critical and less intellectually honest
about its shortcomings. Consequently, it loses its
capacity to perform.

Closing the Strategy-to-
Performance Gap

As significant as the strategy-to-performance
gap is at most companies, management can
close it. A number of high-performing compa-
nies have found ways to realize more of their
strategies’ potential. Rather than focus on im-
proving their planning and execution pro-
cesses separately to close the gap, these com-
panies work both sides of the equation, raising
standards for both planning and execution si-
multaneously and creating clear links be-
tween them.
Our research and experience in working
with many of these companies suggests they
follow seven rules that apply to planning and
execution. Living by these rules enables them
to objectively assess any performance shortfall
and determine whether it stems from the strat-
egy, the plan, the execution, or employees’ ca-
pabilities. And the same rules that allow them
to spot problems early also help them prevent
performance shortfalls in the first place. These
rules may seem simple—even obvious—but
when strictly and collectively observed, they
can transform both the quality of a company’s
strategy and its ability to deliver results.
Rule 1: Keep it simple, make it concrete.
At most companies, strategy is a highly ab-
stract concept—often confused with vision or
aspiration—and is not something that can be
easily communicated or translated into action.
But without a clear sense of where the com-
pany is headed and why, lower levels in the or-
ganization cannot put in place executable
plans. In short, the link between strategy and
performance can’t be drawn because the strat-
egy itself is not sufficiently concrete.
To start off the planning and execution pro-
cess on the right track, high-performing compa-
nies avoid long, drawn-out descriptions of lofty
goals and instead stick to clear language de-
scribing their course of action. Bob Diamond,
CEO of Barclays Capital, one of the fastest-
growing and best-performing investment bank-
ing operations in Europe, puts it this way:
“We’ve been very clear about what we will and
will not do. We knew we weren’t going to go
head-to-head with U.S. bulge bracket firms. We
communicated that we wouldn’t compete in
this way and that we wouldn’t play in unprofit-
able segments within the equity markets but in-
stead would invest to position ourselves for the
euro, the burgeoning need for fixed income,
and the end of Glass-Steigel. By ensuring every-
one knew the strategy and how it was different,
we’ve been able to spend more time on tasks
that are key to executing this strategy.”
By being clear about what the strategy is
and isn’t, companies like Barclays keep every-
one headed in the same direction. More im-
portant, they safeguard the performance their
counterparts lose to ineffective communica-
tions; their resource and action planning be-
comes more effective; and accountabilities are
easier to specify.
Rule 2: Debate assumptions, not forecasts.
At many companies, a business unit’s strategic
plan is little more than a negotiated settle-
ment—the result of careful bargaining with
the corporate center over performance targets
and financial forecasts. Planning, therefore, is
largely a political process—with unit manage-
ment arguing for lower near-term profit pro-
jections (to secure higher annual bonuses) and
top management pressing for more long-term
stretch (to satisfy the board of directors and
other external constituents). Not surprisingly,
the forecasts that emerge from these negotia-
tions almost always understate what each
business unit can deliver in the near term and
overstate what can realistically be expected in
the long-term—the hockey-stick charts with
which CEOs are all too familiar.
Even at companies where the planning
process is isolated from the political concerns
of performance evaluation and compensa-
tion, the approach used to generate financial
projections often has built-in biases. Indeed,
financial forecasting frequently takes place in
complete isolation from the marketing or
strategy functions. A business unit’s finance
function prepares a highly detailed line-item
forecast whose short-term assumptions may
be realistic, if conservative, but whose long-
term assumptions are largely uninformed. For
example, revenue forecasts are typically based
on crude estimates about average pricing,
market growth, and market share. Projections
of long-term costs and working capital re-
quirements are based on an assumption
about annual productivity gains—expedi-
ently tied, perhaps, to some companywide ef-
ficiency program. These forecasts are difficult
page 127

Turning Great Strategy into Great Performance

harvard business review • july–august 2005

for top management to pick apart. Each line
item may be completely defensible, but the
overall plan and projections embed a clear
upward bias—rendering them useless for
driving strategy execution.
High-performing companies view planning
altogether differently. They want their fore-
casts to drive the work they actually do. To
make this possible, they have to ensure that
the assumptions underlying their long-term
plans reflect both the real economics of their
markets and the performance experience of
the company relative to competitors. Tyco CEO
Ed Breen, brought in to turn the company
around in July 2002, credits a revamped plan-
building process for contributing to Tyco’s dra-
matic recovery. When Breen joined the com-
pany, Tyco was a labyrinth of 42 business units
and several hundred profit centers, built up
over many years through countless acquisi-
tions. Few of Tyco’s businesses had complete
plans, and virtually none had reliable financial
forecasts.
To get a grip on the conglomerate’s complex
operations, Breen assigned cross-functional
teams at each unit, drawn from strategy, mar-
keting, and finance, to develop detailed infor-
mation on the profitability of Tyco’s primary
markets as well as the product or service offer-
ings, costs, and price positioning relative to the
competition. The teams met with corporate ex-
ecutives biweekly during Breen’s first six
months to review and discuss the findings.
These discussions focused on the assumptions
that would drive each unit’s long-term finan-
cial performance, not on the financial forecasts
themselves. In fact, once assumptions about
market trends were agreed on, it was relatively
easy for Tyco’s central finance function to pre-
pare externally oriented and internally consis-
tent forecasts for each unit.
Separating the process of building assump-
tions from that of preparing financial projec-
tions helps to ground the business unit–cor-
porate center dialogue in economic reality.
Units can’t hide behind specious details, and
corporate center executives can’t push for un-
realistic goals. What’s more, the fact-based
discussion resulting from this kind of ap-
proach builds trust between the top team
and each unit and removes barriers to fast
and effective execution. “When you under-
stand the fundamentals and performance
drivers in a detailed way,” says Bob Diamond,
“you can then step back, and you don’t have
to manage the details. The team knows
which issues it can get on with, which it
needs to flag to me, and which issues we re-
ally need to work out together.”
Rule 3: Use a rigorous framework, speak a
common language. To be productive, the dia-
logue between the corporate center and the
business units about market trends and as-
sumptions must be conducted within a rigor-
ous framework. Many of the companies we ad-
vise use the concept of profit pools, which
draws on the competition theories of Michael
Porter and others. In this framework, a busi-
ness’s long-term financial performance is tied
to the total profit pool available in each of the
markets it serves and its share of each profit
pool—which, in turn, is tied to the business’s
market share and relative profitability versus
competitors in each market.
In this approach, the first step is for the cor-
porate center and the unit team to agree on
the size and growth of each profit pool.
Fiercely competitive markets, such as pulp and
paper or commercial airlines, have small (or
negative) total profit pools. Less competitive
markets, like soft drinks or pharmaceuticals,
have large total profit pools. We find it helpful
to estimate the size of each profit pool di-
rectly—through detailed benchmarking—and
then forecast changes in the pool’s size and
growth. Each business unit then assesses what
share of the total profit pool it can realistically
capture over time, given its business model
and positioning. Competitively advantaged
businesses can capture a large share of the
profit pool—by gaining or sustaining a high
market share, generating above-average profit-
ability, or both. Competitively disadvantaged
businesses, by contrast, typically capture a neg-
ligible share of the profit pool. Once the unit
and the corporate center agree on the likely
share of the pool the business will capture over
time, the corporate center can easily create the
financial projections that will serve as the
unit’s road map.
In our view, the specific framework a com-
pany uses to ground its strategic plans isn’t all
that important. What is critical is that the
framework establish a common language for
the dialogue between the corporate center and
the units—one that the strategy, marketing,
and finance teams all understand and use.
Without a rigorous framework to link a busi-
page 128page 128

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harvard business review • july–august 2005

ness’s performance in the product markets
with its financial performance over time, it is
very difficult for top management to ascertain
whether the financial projections that accom-
pany a business unit’s strategic plan are reason-
able and realistically achievable. As a result,
management can’t know with confidence
whether a performance shortfall stems from
poor execution or an unrealistic and un-
grounded plan.
Rule 4: Discuss resource deployments early.
Companies can create more realistic forecasts
and more executable plans if they discuss up
front the level and timing of critical resource
deployments. At Cisco Systems, for example, a
cross-functional team reviews the level and
timing of resource deployments early in the
planning stage. These teams regularly meet
with John Chambers (CEO), Dennis Powell
(CFO), Randy Pond (VP of operations), and
the other members of Cisco’s executive team
to discuss their findings and make recommen-
dations. Once agreement is reached on re-
source allocation and timing at the unit level,
those elements are factored into the com-
pany’s two-year plan. Cisco then monitors
each unit’s actual resource deployments on a
monthly basis (as well as its performance) to
make sure things are going according to plan
and that the plan is generating the expected
results.
Challenging business units about when new
resources need to be in place focuses the plan-
ning dialogue on what actually needs to hap-
pen across the company in order to execute
each unit’s strategy. Critical questions invari-
ably surface, such as: How long will it take us
to change customers’ purchase patterns? How
fast can we deploy our new sales force? How
quickly will competitors respond? These are
tough questions. But answering them makes
the forecasts and the plans they accompany
more feasible.
What’s more, an early assessment of re-
source needs also informs discussions about
market trends and drivers, improving the qual-
ity of the strategic plan and making it far more
executable. In the course of talking about the
resources needed to expand in the rapidly
growing cable market, for example, Cisco came
to realize that additional growth would require
more trained engineers to improve existing
products and develop new features. So, rather
than relying on the functions to provide these
resources from the bottom up, corporate man-
agement earmarked a specific number of
trained engineers to support growth in cable.
Cisco’s financial-planning organization care-
fully monitors the engineering head count, the
pace of feature development, and revenues
generated by the business to make sure the
strategy stays on track.
Rule 5: Clearly identify priorities. To deliver
any strategy successfully, managers must
make thousands of tactical decisions and put
them into action. But not all tactics are
equally important. In most instances, a few
key steps must be taken—at the right time and
in the right way—to meet planned perfor-
mance. Leading companies make these priori-
ties explicit so that each executive has a clear
sense of where to direct his or her efforts.
At Textron, a $10 billion multi-industrial
conglomerate, each business unit identifies
“improvement priorities” that it must act
upon to realize the performance outlined in
its strategic plan. Each improvement priority
is translated into action items with clearly de-
fined accountabilities, timetables, and key per-
formance indicators (KPIs) that allow execu-
tives to tell how a unit is delivering on a
priority. Improvement priorities and action
items cascade to every level at the company—
from the management committee (consisting
of Textron’s top five executives) down to the
lowest levels in each of the company’s ten
business units. Lewis Campbell, Textron’s CEO,
summarizes the company’s approach this way:
“Everyone needs to know: ‘If I have only one
hour to work, here’s what I’m going to focus
on.’ Our goal deployment process makes each
individual’s accountabilities and priorities
clear.”
The Swiss pharmaceutical giant Roche goes
as far as to turn its business plans into detailed
performance contracts that clearly specify the
steps needed and the risks that must be man-
aged to achieve the plans. These contracts all
include a “delivery agenda” that lists the five to
ten critical priorities with the greatest impact
on performance. By maintaining a delivery
agenda at each level of the company, Chair-
man and CEO Franz Humer and his leadership
team make sure “everyone at Roche under-
stands exactly what we have agreed to do at a
strategic level and that our strategy gets trans-
lated into clear execution priorities. Our deliv-
ery agenda helps us stay the course with the
page 129

Turning Great Strategy into Great Performance

harvard business review • july–august 2005

strategy decisions we have made so that execu-
tion is actually allowed to happen. We cannot
control implementation from HQ, but we can
agree on the priorities, communicate relent-
lessly, and hold managers accountable for exe-
cuting against their commitments.”
Rule 6: Continuously monitor performance.
Seasoned executives know almost instinc-
tively whether a business has asked for too
much, too little, or just enough resources to
deliver the goods. They develop this capability
over time—essentially through trial and error.
High-performing companies use real-time per-
formance tracking to help accelerate this trial-
and-error process. They continuously monitor
their resource deployment patterns and their
results against plan, using continuous feed-
back to reset planning assumptions and reallo-
cate resources. This real-time information al-
lows management to spot and remedy flaws in
the plan and shortfalls in execution—and to
avoid confusing one with the other.
At Textron, for example, each KPI is care-
fully monitored, and regular operating reviews
percolate performance shortfalls—or “red
light” events—up through the management
ranks. This provides CEO Lewis Campbell, CFO
Ted French, and the other members of Tex-
tron’s management committee with the infor-
mation they need to spot and fix breakdowns
in execution.
A similar approach has played an important
role in the dramatic revival of Dow Chemical’s
fortunes. In December 2001, with performance
in a free fall, Dow’s board of directors asked
Bill Stavropoulos (Dow’s CEO from 1993 to
1999) to return to the helm. Stavropoulos and
Andrew Liveris (the current CEO, then COO)
immediately focused Dow’s entire top leader-
ship team on execution through a project they
called the Performance Improvement Drive.
They began by defining clear performance
metrics for each of Dow’s 79 business units.
Performance on these key metrics was tracked
against plans on a weekly basis, and the entire
leadership team discussed any serious discrep-
ancies first thing every Monday morning. As
Liveris told us, the weekly monitoring sessions
“forced everyone to live the details of execu-
tion” and let “the entire organization know
how we were performing.”
Continuous monitoring of performance is
particularly important in highly volatile indus-
tries, where events outside anyone’s control
can render a plan irrelevant. Under CEO Alan
Mulally, Boeing Commercial Airplanes’ leader-
ship team holds weekly business performance
reviews to track the division’s results against its
multiyear plan. By tracking the deployment of
resources as a leading indicator of whether a
plan is being executed effectively, BCA’s leader-
ship team can make course corrections each
week rather than waiting for quarterly results
to roll in.
Furthermore, by proactively monitoring the
primary drivers of performance (such as pas-
senger traffic patterns, airline yields and load
factors, and new aircraft orders), BCA is better
able to develop and deploy effective counter-
measures when events throw its plans off
course. During the SARS epidemic in late
2002, for example, BCA’s leadership team took
action to mitigate the adverse consequences of
the illness on the business’s operating plan
within a week of the initial outbreak. The
abrupt decline in air traffic to Hong Kong, Sin-
gapore, and other Asian business centers sig-
naled that the number of future aircraft deliv-
eries to the region would fall—perhaps
precipitously. Accordingly, BCA scaled back its
medium-term production plans (delaying the
scheduled ramp-up of some programs and ac-
celerating the shutdown of others) and ad-
justed its multiyear operating plan to reflect
the anticipated financial impact.
Rule 7: Reward and develop execution ca-
pabilities. No list of rules on this topic would
be complete without a reminder that compa-
nies have to motivate and develop their staffs;
at the end of the day, no process can be better
than the people who have to make it work.
Unsurprisingly, therefore, nearly all of the
companies we studied insisted that the selec-
tion and development of management was an
essential ingredient in their success. And while
improving the capabilities of a company’s
workforce is no easy task—often taking many
years—these capabilities, once built, can drive
superior planning and execution for decades.
For Barclays’ Bob Diamond, nothing is more
important than “ensuring that [the company]
hires only A players.” In his view, “the hidden
costs of bad hiring decisions are enormous, so
despite the fact that we are doubling in size,
we insist that as a top team we take responsi-
bility for all hiring. The jury of your peers is
the toughest judgment, so we vet each others’
potential hires and challenge each other to
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Turning Great Strategy into Great Performance

harvard business review • july–august 2005

keep raising the bar.” It’s equally important to
make sure that talented hires are rewarded for
superior execution. To reinforce its core values
of “client,” “meritocracy,” “team,” and “integ-
rity,” Barclays Capital has innovative pay
schemes that “ring fence” rewards. Stars don’t
lose out just because the business is entering
new markets with lower returns during the
growth phase. Says Diamond: “It’s so bad for
the culture if you don’t deliver what you prom-
ised to people who have delivered…. You’ve
got to make sure you are consistent and fair,
unless you want to lose your most productive
people.”
Companies that are strong on execution also
emphasize development. Soon after he be-
came CEO of 3M, Jim McNerney and his top
team spent 18 months hashing out a new lead-
ership model for the company. Challenging de-
bates among members of the top team led to
agreement on six “leadership attributes”—
namely, the ability to “chart the course,” “ener-
gize and inspire others,” “demonstrate ethics,
integrity, and compliance,” “deliver results,”
“raise the bar,” and “innovate resourcefully.”
3M’s leadership agreed that these six attributes
were essential for the company to become
skilled at execution and known for account-
ability. Today, the leaders credit this model
with helping 3M to sustain and even improve
its consistently strong performance.

• • •

The prize for closing the strategy-to-performance
gap is huge—an increase in performance of
anywhere from 60% to 100% for most compa-
nies. But this almost certainly understates the
true benefits. Companies that create tight
links between their strategies, their plans, and,
ultimately, their performance often experi-
ence a cultural multiplier effect. Over time, as
they turn their strategies into great perfor-
mance, leaders in these organizations become
much more confident in their own capabilities
and much more willing to make the stretch
commitments that inspire and transform large
companies. In turn, individual managers who
keep their commitments are rewarded—with
faster progression and fatter paychecks—rein-
forcing the behaviors needed to drive any
company forward.
Eventually, a culture of overperformance
emerges. Investors start giving management
the benefit of the doubt when it comes to bold
moves and performance delivery. The result is
a performance premium on the company’s
stock—one that further rewards stretch com-
mitments and performance delivery. Before
long, the company’s reputation among poten-
tial recruits rises, and a virtuous circle is cre-
ated in which talent begets performance, per-
formance begets rewards, and rewards beget
even more talent. In short, closing the strategy-
to-performance gap is not only a source of im-
mediate performance improvement but also
an important driver of cultural change with a
large and lasting impact on the organization’s
capabilities, strategies, and competitiveness.

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Further Reading

A R T I C L E S

Why Good Companies Go Bad

by Donald N. Sull

Harvard Business Review

July–August 1999
Product no. 99410

Sull identifies another important cause of stra-
tegic underperformance: active inertia.
Through active inertia, executives cling to stra-
tegic formulas that brought success in the
past—even though emerging business reali-
ties call for new formulas. The strategic frames
of the past become blinders; processes harden
into routines; relationships become shackles;
and values turn into dogmas. Sull offers addi-
tional advice for avoiding active inertia. Rather
than asking, “What should we do?” ask, “What’s
hindering us?” You’ll focus leaders’ attention on
the strategic frames, processes, relationships,
and values that must change if your company
hopes to define a new direction.
Having Trouble with Your Strategy?
Then Map It

by Robert S. Kaplan and David P. Norton

Harvard Business Review

September–October 2000
Product no. R00509
A strategy map—a Balanced Scorecard tool
developed by Robert Kaplan and David
Norton—can help you apply the seven rules
Mankins and Steele define. The map enables
you to graphically depict the cause-and-effect
assumptions underlying your company’s strat-
egy. In clear, concrete language, it shows the
objectives you must achieve to execute your
strategy, the performance measures you’ll use,
and the targets you’ve set for each measure.
Using Mobil North American Marketing and
Refining Company as an example, Kaplan and
Norton explain how to create your strategy
map and develop themes for its four “per-
spectives”: financial, customer, internal pro-
cesses, and learning and growth. The Mobil
division used a strategy map to transform it-
self from a centrally controlled manufacturer
of commodity products to a decentralized,
customer-driven organization.
Execution Without Excuses: An Interview
with Michael Dell and Kevin Rollins

by Michael Dell, Kevin Rollins,
Thomas A. Stewart, and Louise O’Brien

Harvard Business Review

March 2005
Product no. R0503G

This article describes how Dell Computer
constantly identifies strategic priorities—
Mankins’s and Steele’s rule #5—as new busi-
ness realities emerge. For example, top execu-
tives realized that Dell had a very visible group
of employees who’d gotten rich from stock
options. But as CEO Kevin Rollins maintains,
“You can’t build a great company on employ-
ees who say, ‘If you pay me enough, I’ll stay.’”
To reignite the company’s spirit, Dell imple-
mented an employee survey whose results
spurred the creation of the Winning Culture
initiative, now a top operating priority. The
company also defined the highly motivating
Soul of Dell: Focus on the customer, be open
and direct in communications, be a good glo-
bal citizen, have fun in winning. Now people
stay at Dell for reasons other than money.
page 132

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Who Has the D?

How Clear Decision Roles Enhance
Organizational Performance

by Paul Rogers and Marcia Blenko

Included with this full-text

Harvard Business Review

article:
The Idea in Brief—the core idea
The Idea in Practice—putting the idea to work

134

Article Summary

135

Who Has the D?: How Clear Decision Roles Enhance Organizational
Performance
A list of related materials, with annotations to guide further
exploration of the article’s ideas and applications

143

Further Reading

Your organization can
become more decisive—and
can implement strategy more
quickly—if you know where
the bottlenecks are and who’s
empowered to break through
them.

Reprint R0601D
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Who Has the D?

How Clear Decision Roles Enhance Organizational Performance

The Idea in Brief The Idea in Practice

C
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Decisions are the coin of the realm in busi-
ness. Every success, every mishap, every op-
portunity seized or missed stems from a de-
cision someone made—or failed to make.
Yet in many firms, decisions routinely stall
inside the organization—hurting the entire
company’s performance.
The culprit? Ambiguity over who’s account-
able for which decisions. In one auto manu-
facturer that was missing milestones for
rolling out new models, marketers

and

product developers each thought they
were responsible for deciding new models’
standard features and colors. Result? Con-
flict over who had final say, endless revisit-
ing of decisions—and missed deadlines
that led to lost sales.
How to clarify decision accountability? As-
sign clear roles for the decisions that most
affect your firm’s performance—such as
which markets to enter, where to allocate
capital, and how to drive product innova-
tion. Think “RAPID”: Who should

r

ecom-
mend a course of action on a key decision?
Who must

a

gree to a recommendation be-
fore it can move forward? Who will

p

erform
the actions needed to implement the deci-
sion? Whose

i

nput is needed to determine
the proposal’s feasibility? Who

d

ecides—
brings the decision to closure and commits
the organization to implement it?
When you clarify decision roles, you make
the

right

choices—swiftly and effectively.

The RAPID Decision Model

For every strategic decision, assign the following roles and responsibilities:

Decision-Role Pitfalls

In assigning decision roles:

•

Ensure that only one person “has the D.” If
two or more people think they’re in charge
of a particular decision, a tug-of-war results.

•

Watch for a proliferation of “A’s.” Too many
people with veto power can paralyze rec-
ommenders. If many people must agree,
you probably haven’t pushed decisions
down far enough in your organization.

•

Avoid assigning too many “I’s.” When many
people give input, at least some of them
aren’t making meaningful contributions.

The RAPID Model in Action
Example:

At British department-store chain John
Lewis, company buyers wanted to increase
sales and reduce complexity by offering
fewer salt and pepper mill models. The
company launched the streamlined prod-
uct set without involving the sales staff.
And sales fell. Upon visiting the stores, buy-
ers saw that salespeople (not understand-
ing the strategy behind the recommenda-
tion) had halved shelf space to match the
reduction in product range, rather than
maintaining the same space but stocking
more of the products.
To fix the problem, the company “gave buy-
ers the D” on how much space product cat-
egories would have. Sales staff “had the A”:
If space allocations didn’t make sense to
them, they could force additional negotia-
tions. They also “had the P,” implementing
product layouts in stores.
Once decision roles were clarified, sales of salt
and pepper mills exceeded original levels.

PEOPLE WHO… ARE RESPONSIBLE FOR…

R

ecommend

• Making a proposal on a key decision, gathering input, and providing data and
analysis to make a sensible choice in a timely fashion
• Consulting with input providers—hearing and incorporating their views, and
winning their buy-in

A

gree

• Negotiating a modified proposal with the recommender if they have concerns
about the original proposal
• Escalating unresolved issues to the decider if the “A” and “R” can’t resolve
differences
• If necessary, exercising veto power over the recommendation

P

erform

• Executing a decision once it’s made
• Seeing that the decision is implemented promptly and effectively

I

nput • Providing relevant facts to the recommender that shed light on the proposal’s
feasibility and practical implications

D

ecide

• Serving as the single point of accountability
• Bringing the decision to closure by resolving any impasse in the decision-making
process
• Committing the organization to implementing the decision
page 134

Who Has the D?

How Clear Decision Roles Enhance
Organizational Performance

by Paul Rogers and Marcia Blenko

harvard business review • january 2006

C
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A
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IG
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E
D
.

Your organization can become more decisive—and can implement
strategy more quickly—if you know where the bottlenecks are and who’s
empowered to break through them.

Decisions are the coin of the realm in business.
Every success, every mishap, every opportu-
nity seized or missed is the result of a decision
that someone made or failed to make. At
many companies, decisions routinely get stuck
inside the organization like loose change. But
it’s more than loose change that’s at stake, of
course; it’s the performance of the entire orga-
nization. Never mind what industry you’re in,
how big and well known your company may
be, or how clever your strategy is. If you can’t
make the right decisions quickly and effec-
tively, and execute those decisions consis-
tently, your business will lose ground.
Indeed, making good decisions and making
them happen quickly are the hallmarks of
high-performing organizations. When we sur-
veyed executives at 350 global companies
about their organizational effectiveness, only
15% said that they have an organization that
helps the business outperform competitors.
What sets those top performers apart is the
quality, speed, and execution of their decision
making. The most effective organizations score
well on the major strategic decisions—which
markets to enter or exit, which businesses to
buy or sell, where to allocate capital and talent.
But they truly shine when it comes to the criti-
cal operating decisions requiring consistency
and speed—how to drive product innovation,
the best way to position brands, how to man-
age channel partners.
Even in companies respected for their deci-
siveness, however, there can be ambiguity over
who is accountable for which decisions. As a re-
sult, the entire decision-making process can
stall, usually at one of four bottlenecks: global
versus local, center versus business unit, func-
tion versus function, and inside versus outside
partners.
The first of these bottlenecks,

global versus
local

decision making, can occur in nearly
every major business process and function. De-
cisions about brand building and product de-
velopment frequently get snared here, when
companies wrestle over how much authority
local businesses should have to tailor products
for their markets. Marketing is another classic
page 135

Who Has the D?

harvard business review • january 2006

global versus local issue—should local markets
have the power to determine pricing and ad-
vertising?
The second bottleneck,

center versus business
unit

decision making, tends to afflict parent
companies and their subsidiaries. Business
units are on the front line, close to the cus-
tomer; the center sees the big picture, sets
broad goals, and keeps the organization fo-
cused on winning. Where should the decision-
making power lie? Should a major capital in-
vestment, for example, depend on the approval
of the business unit that will own it, or should
headquarters make the final call?

Function versus function

decision making is
perhaps the most common bottleneck. Every
manufacturer, for instance, faces a balancing
act between product development and market-
ing during the design of a new product. Who
should decide what? Cross-functional decisions
too often result in ineffective compromise so-
lutions, which frequently need to be revisited
because the right people were not involved at
the outset.
The fourth decision-making bottleneck,

in-
side versus outside partners,

has become famil-
iar with the rise of outsourcing, joint ventures,
strategic alliances, and franchising. In such ar-
rangements, companies need to be absolutely
clear about which decisions can be owned by
the external partner (usually those about the
execution of strategy) and which must con-
tinue to be made internally (decisions about
the strategy itself). In the case of outsourcing,
for instance, brand-name apparel and foot-
wear marketers once assumed that overseas
suppliers could be responsible for decisions
about plant employees’ wages and working
conditions. Big mistake.

Clearing the Bottlenecks

The most important step in unclogging decision-
making bottlenecks is assigning clear roles and
responsibilities. Good decision makers recog-
nize which decisions really matter to perfor-
mance. They think through who should recom-
mend a particular path, who needs to agree,
who should have input, who has ultimate re-
sponsibility for making the decision, and who is
accountable for follow-through. They make the
process routine. The result: better coordination
and quicker response times.
Companies have devised a number of meth-
ods to clarify decision roles and assign respon-
sibilities. We have used an approach called
RAPID, which has evolved over the years, to
help hundreds of companies develop clear de-
cision-making guidelines. It is, for sure, not a
panacea (an indecisive decision maker, for ex-
ample, can ruin any good system), but it’s an
important start. The letters in RAPID stand for
the primary roles in any decision-making pro-
cess, although these roles are not performed
exactly in this order: recommend, agree, per-
form, input, and decide—the “D.” (See the side-
bar “A Decision-Making Primer.”)
The people who

recommend

a course of ac-
tion are responsible for making a proposal or
offering alternatives. They need data and anal-
ysis to support their recommendations, as well
as common sense about what’s reasonable,
practical, and effective.
The people who

agree

to a recommendation
are those who need to sign off on it before it
can move forward. If they veto a proposal, they
must either work with the recommender to
come up with an alternative or elevate the issue
to the person with the D. For decision making
to function smoothly, only a few people should
have such veto power. They may be executives
responsible for legal or regulatory compliance
or the heads of units whose operations will be
significantly affected by the decision.
People with

input

responsibilities are con-
sulted about the recommendation. Their role
is to provide the relevant facts that are the
basis of any good decision: How practical is the
proposal? Can manufacturing accommodate
the design change? Where there’s dissent or
contrasting views, it’s important to get these
people to the table at the right time. The rec-
ommender has no obligation to act on the
input he or she receives but is expected to take
it into account—particularly since the people
who provide input are generally among those
who must implement a decision. Consensus is
a worthy goal, but as a decision-making stan-
dard, it can be an obstacle to action or a recipe
for lowest-common-denominator compro-
mise. A more practical objective is to get every-
one involved to buy in to the decision.
Eventually, one person will

decide

. The deci-
sion maker is the single point of accountability
who must bring the decision to closure and
commit the organization to act on it. To be
strong and effective, the person with the D
needs good business judgment, a grasp of the
relevant trade-offs, a bias for action, and a keen

Paul Rogers

(paul.rogers@bain.com)
is a partner with Bain & Company in
London and leads Bain’s global organi-
zation practice.

Marcia Blenko

(marcia.blenko@bain.com) is a Bain
partner in Boston and the leader of
Bain’s North American organization
practice.
page 136

mailto:paul.rogers@bain.com

mailto:marcia.blenko@bain.com

Who Has the D?

harvard business review • january 2006

awareness of the organization that will execute
the decision.
The final role in the process involves the peo-
ple who will

perform

the decision. They see to it
that the decision is implemented promptly and
effectively. It’s a crucial role. Very often, a good
decision executed quickly beats a brilliant deci-
sion implemented slowly or poorly.
RAPID can be used to help redesign the way
an organization works or to target a single bot-
tleneck. Some companies use the approach for
the top ten to 20 decisions, or just for the CEO
and his or her direct reports. Other companies
use it throughout the organization—to improve
customer service by clarifying decision roles on
the front line, for instance. When people see an
effective process for making decisions, they
spread the word. For example, after senior man-
agers at a major U.S. retailer used RAPID to sort
out a particularly thorny set of corporate deci-
sions, they promptly built the process into their
own functional organizations.
To see the process in action, let’s look at the
way four companies have worked through their
decision-making bottlenecks.

Global Versus Local

Every major company today operates in global
markets, buying raw materials in one place,
shipping them somewhere else, and selling fin-
ished products all over the world. Most are try-
ing simultaneously to build local presence and
expertise, and to achieve economies of scale.
Decision making in this environment is far
from straightforward. Frequently, decisions
cut across the boundaries between global and
local managers, and sometimes across a re-
gional layer in between: What investments
will streamline our supply chain? How far
should we go in standardizing products or tai-
loring them for local markets?
The trick in decision making is to avoid be-
coming either mindlessly global or hopelessly
local. If decision-making authority tilts too far
toward global executives, local customers’ pref-
erences can easily be overlooked, undermining

A Decision-Making Primer

Good decision making depends on assigning
clear and specific roles. This sounds simple
enough, but many companies struggle to
make decisions because lots of people feel ac-
countable—or no one does. RAPID and other
tools used to analyze decision making give
senior management teams a method for as-
signing roles and involving the relevant peo-
ple. The key is to be clear who has input, who
gets to decide, and who gets it done.
The five letters in RAPID correspond to the
five critical decision-making roles: recom-
mend, agree, perform, input, and decide. As
you’ll see, the roles are not carried out lock-
step in this order—we took some liberties for
the sake of creating a useful acronym.

Recommend.

People in this role are re-
sponsible for making a proposal, gathering
input, and providing the right data and anal-
ysis to make a sensible decision in a timely
fashion. In the course of developing a pro-
posal, recommenders consult with the people
who provide input, not just hearing and in-
corporating their views but also building buy
in along the way. Recommenders must have
analytical skills, common sense, and organi-
zational smarts.

Agree.

Individuals in this role have veto
power—yes or no—over the recommenda-
tion. Exercising the veto triggers a debate be-
tween themselves and the recommenders,
which should lead to a modified proposal. If
that takes too long, or if the two parties sim-
ply can’t agree, they can escalate the issue to
the person who has the D.

Input.

These people are consulted on the
decision. Because the people who provide
input are typically involved in implementa-
tion, recommenders have a strong interest in
taking their advice seriously. No input is
binding, but this shouldn’t undermine its im-
portance. If the right people are not involved
and motivated, the decision is far more likely
to falter during execution.

Decide.

The person with the D is the for-
mal decision maker. He or she is ultimately
accountable for the decision, for better or
worse, and has the authority to resolve any
impasse in the decision-making process and
to commit the organization to action.

Perform.

Once a decision is made, a per-
son or group of people will be responsible for
executing it. In some instances, the people re-
sponsible for implementing a decision are
the same people who recommended it.
Writing down the roles and assigning ac-
countability are essential steps, but good de-
cision making also requires the right process.
Too many rules can cause the process to col-
lapse under its own weight. The most effec-
tive process is grounded in specifics but sim-
ple enough to adapt if necessary.
When the process gets slowed down, the
problem can often be traced back to one of
three trouble spots. First is a lack of clarity
about who has the D. If more than one per-
son think they have it for a particular deci-
sion, that decision will get caught up in a tug-
of-war. The flip side can be equally damaging:
No one is accountable for crucial decisions,
and the business suffers. Second, a prolifera-
tion of people who have veto power can make
life tough for recommenders. If a company
has too many people in the “agree” role, it
usually means that decisions are not pushed
down far enough in the organization. Third,
if there are a lot of people giving input, it’s a
signal that at least some of them aren’t mak-
ing a meaningful contribution.
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Who Has the D?

harvard business review • january 2006

the efficiency and agility of local operations.
But with too much local authority, a company
is likely to miss out on crucial economies of
scale or opportunities with global clients.
To strike the right balance, a company must
recognize its most important sources of value
and make sure that decision roles line up with
them. This was the challenge facing Martin
Broughton, the former CEO and chairman of
British American Tobacco, the second-largest
tobacco company in the world. In 1993, when
Broughton was appointed chief executive, BAT
was losing ground to its nearest competitor.
Broughton knew that the company needed to
take better advantage of its global scale, but
decision roles and responsibilities were at odds
with this goal. Four geographic operating units
ran themselves autonomously, rarely collabo-
rating and sometimes even competing. Achiev-
ing consistency across global brands proved dif-
ficult, and cost synergies across the operating
units were elusive. Industry insiders joked that
“there are seven major tobacco companies in
the world—and four of them are British Amer-
ican Tobacco.” Broughton vowed to change the
punch line.
The chief executive envisioned an organiza-
tion that could take advantage of the opportu-
nities a global business offers—global brands
that could compete with established winners
such as Altria Group’s Marlboro; global pur-
chasing of important raw materials, including
tobacco; and more consistency in innovation
and customer management. But Broughton
didn’t want the company to lose its nimbleness
and competitive hunger in local markets by
shifting too much decision-making power to
global executives.
The first step was to clarify roles for the most
important decisions. Procurement became a
proving ground. Previously, each operating
unit had identified its own suppliers and nego-
tiated contracts for all materials. Under
Broughton, a global procurement team was set
up in headquarters and given authority to
choose suppliers and negotiate pricing and
quality for global materials, including bulk to-
bacco and certain types of packaging. Regional
procurement teams were now given input into
global materials strategies but ultimately had
to implement the team’s decision. As soon as
the global team signed contracts with suppli-
ers, responsibility shifted to the regional teams,
who worked out the details of delivery and ser-
vice with the suppliers in their regions. For ma-
terials that did not offer global economies of
scale (mentholated filters for the North Ameri-
can market, for example), the regional teams
retained their decision-making authority.
As the effort to revamp decision making in
procurement gained momentum, the com-
pany set out to clarify roles in all its major deci-
sions. The process wasn’t easy. A company the
size of British American Tobacco has a huge
number of moving parts, and developing a
practical system for making decisions requires
sweating lots of details. What’s more, decision-
making authority is power, and people are
often reluctant to give it up.
It’s crucial for the people who will live with
the new system to help design it. At BAT,
Broughton created working groups led by peo-
ple earmarked, implicitly or explicitly, for lead-
ership roles in the future. For example, Paul
Adams, who ultimately succeeded Broughton
as chief executive, was asked to lead the group
charged with redesigning decision making for
brand and customer management. At the time,
Adams was a regional head within one of the
operating units. With other senior executives,
including some of his own direct reports,
Broughton specified that their role was to pro-
vide input, not to veto recommendations.
Broughton didn’t make the common mistake
of seeking consensus, which is often an obsta-
cle to action. Instead, he made it clear that the
objective was not deciding whether to change
the decision-making process but achieving buy
in about how to do so as effectively as possible.
The new decision roles provided the founda-
tion the company needed to operate success-
fully on a global basis while retaining flexibility
at the local level. The focus and efficiency of its
decision making were reflected in the com-
pany’s results: After the decision-making over-
haul, British American Tobacco experienced
nearly ten years of growth well above the lev-
els of its competitors in sales, profits, and mar-
ket value. The company has gone on to have
one of the best-performing stocks on the UK
market and has reemerged as a major global
player in the tobacco industry.

Center Versus Business Unit

The first rule for making good decisions is to
involve the right people at the right level of
the organization. For BAT, capturing econo-
mies of scale required its global team to appro-
A good decision executed
quickly beats a brilliant
decision implemented
slowly.
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Who Has the D?

harvard business review • january 2006

priate some decision-making powers from re-
gional divisions. For many companies, a
similar balancing act takes place between ex-
ecutives at the center and managers in the
business units. If too many decisions flow to
the center, decision making can grind to a halt.
The problem is different but no less critical if
the decisions that are elevated to senior execu-
tives are the wrong ones.
Companies often grow into this type of prob-
lem. In small and midsize organizations, a sin-
gle management team—sometimes a single
leader—effectively handles every major deci-
sion. As a company grows and its operations
become more complex, however, senior execu-
tives can no longer master the details required
to make decisions in every business.
A change in management style, often trig-
gered by the arrival of a new CEO, can create
similar tensions. At a large British retailer, for
example, the senior team was accustomed to
the founder making all critical decisions. When
his successor began seeking consensus on im-
portant issues, the team was suddenly unsure
of its role, and many decisions stalled. It’s a
common scenario, yet most management
teams and boards of directors don’t specify
how decision-making authority should change
as the company does.
A growth opportunity highlighted that issue
for Wyeth (then known as American Home
Products) in late 2000. Through organic
growth, acquisitions, and partnerships, Wyeth’s
pharmaceutical division had developed three
sizable businesses: biotech, vaccines, and tradi-
tional pharmaceutical products. Even though
each business had its own market dynamics,
operating requirements, and research focus,
most important decisions were pushed up to
one group of senior executives. “We were using
generalists across all issues,” said Joseph M.
Mahady, president of North American and glo-
bal businesses for Wyeth Pharmaceuticals. “It
was a signal that we weren’t getting our best
decision making.”
The problem crystallized for Wyeth when
managers in the biotech business saw a vital—
but perishable—opportunity to establish a
leading position with Enbrel, a promising
rheumatoid arthritis drug. Competitors were
working on the same class of drug, so Wyeth
needed to move quickly. This meant expanding
production capacity by building a new plant,
which would be located at the Grange Castle
Business Park in Dublin, Ireland.
The decision, by any standard, was a com-
plex one. Once approved by regulators, the fa-
cility would be the biggest biotech plant in the
world—and the largest capital investment
Wyeth had ever undertaken. Yet peak demand
for the drug was not easy to determine. What’s
more, Wyeth planned to market Enbrel in part-
nership with Immunex (now a part of Amgen).
In its deliberations about the plant, therefore,
Wyeth needed to factor in the requirements of
building up its technical expertise, technology
transfer issues, and an uncertain competitive
environment.
Input on the decision filtered up slowly
through a gauze of overlapping committees,
leaving senior executives hungry for a more de-
tailed grasp of the issues. Given the narrow
window of opportunity, Wyeth acted quickly,
moving from a first look at the Grange Castle
project to implementation in six months. But
in the midst of this process, Wyeth Pharmaceu-
ticals’ executives saw the larger issue: The com-
pany needed a system that would push more
decisions down to the business units, where
operational knowledge was greatest, and ele-
vate the decisions that required the senior
team’s input, such as marketing strategy and
manufacturing capacity.
In short order, Wyeth gave authority for
many decisions to business unit managers,
leaving senior executives with veto power over
some of the more sensitive issues related to
Grange Castle. But after that investment deci-
sion was made, the D for many subsequent de-
cisions about the Enbrel business lay with
Cavan Redmond, the executive vice president
and general manager of Wyeth’s biotech divi-
sion, and his new management team. Red-
mond gathered input from managers in bio-
tech manufacturing, marketing, forecasting,
finance, and R&D, and quickly set up the com-
plex schedules needed to collaborate with Im-
munex. Responsibility for execution rested
firmly with the business unit, as always. But
now Redmond, supported by his team, also
had authority to make important decisions.
Grange Castle is paying off so far. Enbrel is
among the leading brands for rheumatoid ar-
thritis, with sales of $1.7 billion through the
first half of 2005. And Wyeth’s metabolism for
making decisions has increased. Recently,
when the U.S. Food and Drug Administration
granted priority review status to another new
The trick in decision
making is to avoid
becoming either
mindlessly global or
hopelessly local.
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Who Has the D?

harvard business review • january 2006

drug, Tygacil, because of the antibiotic’s effi-
cacy against drug-resistant infections, Wyeth
displayed its new reflexes. To keep Tygacil on a
fast track, the company had to orchestrate a
host of critical steps—refining the process tech-
nology, lining up supplies, ensuring quality
control, allocating manufacturing capacity.
The vital decisions were made one or two
levels down in the biotech organization,
where the expertise resided. “Instead of de-
bating whether you can move your product
into my shop, we had the decision systems in
place to run it up and down the business
units and move ahead rapidly with Tygacil,”
said Mahady. The drug was approved by the
FDA in June 2005 and moved into volume
production a mere three days later.

Function Versus Function

Decisions that cut across functions are some
of the most important a company faces. In-
deed, cross-functional collaboration has be-
come an axiom of business, essential for ar-
riving at the best answers for the company
and its customers. But fluid decision making
across functional teams remains a constant
challenge, even for companies known for
doing it well, like Toyota and Dell. For in-
stance, a team that thinks it’s more efficient
to make a decision without consulting other
functions may wind up missing out on rele-
vant input or being overruled by another
team that believes—rightly or wrongly—it
should have been included in the process.
Many of the most important cross-functional
decisions are, by their very nature, the most
difficult to orchestrate, and that can string
out the process and lead to sparring between
fiefdoms and costly indecision.
The theme here is a lack of clarity about
who has the D. For example, at a global auto
manufacturer that was missing its mile-
stones for rolling out new models—and was
paying the price in falling sales—it turned
out that marketers and product developers
were confused about which function was re-
sponsible for making decisions about stan-
dard features and color ranges for new mod-
els. When we asked the marketing team who
had the D about which features should be
standard, 83% said the marketers did. When
we posed the same question to product de-
velopers, 64% said the responsibility rested
with them. (See the exhibit “A Recipe for a
Decision-Making Bottleneck.”)
The practical difficulty of connecting func-
tions through smooth decision making crops
up frequently at retailers. John Lewis, the lead-
ing department store chain in the United King-
dom, might reasonably expect to overcome
this sort of challenge more readily than other
retailers. Spedan Lewis, who built the business
in the early twentieth century, was a pioneer in
employee ownership. A strong connection be-
tween managers and employees permeated
every aspect of the store’s operations and re-
mained vital to the company as it grew into the
largest employee-owned business in the
United Kingdom, with 59,600 employees and
more than £5 billion in revenues in 2004.
Even at John Lewis, however, with its heritage
of cooperation and teamwork, cross-functional
decision making can be hard to sustain. Take
salt and pepper mills, for instance. John Lewis,
which prides itself on having great selection,
stocked nearly 50 SKUs of salt and pepper
mills, while most competitors stocked around
20. The company’s buyers saw an opportunity
to increase sales and reduce complexity by of-
fering a smaller number of popular and well-
chosen products in each price point and style.
When John Lewis launched the new range,
sales fell. This made no sense to the buyers
until they visited the stores and saw how the
merchandise was displayed. The buyers had
made their decision without fully involving the
sales staff, who therefore did not understand
the strategy behind the new selection. As a re-
sult, the sellers had cut shelf space in half to
match the reduction in range, rather than de-
voting the same amount of shelf space to
stocking more of each product.
To fix the communication problem, John
Lewis needed to clarify decision roles. The buy-

A Recipe for a Decision-Making Bottleneck

At one automaker we studied, marketers and product developers were confused
about who was responsible for making decisions about new models.

When we asked, “Who has the right to
decide which features will be standard?”
64%

of product developers said, “We
do.”

83%

of marketers said, “We do.”

When we asked, “Who has the right
to decide which colors will be offered?”
77%

of product developers said, “We
do.”

61%

of marketers said, “We do.”

Not surprisingly, the new models were delayed.
page 140

Who Has the D?

harvard business review • january 2006

ers were given the D on how much space to al-
locate to each product category. If the space al-
location didn’t make sense to the sales staff,
however, they had the authority to raise their
concerns and force a new round of negotia-
tions. They also had responsibility for imple-
menting product layouts in the stores. When
the communication was sorted out and shelf
space was restored, sales of the salt and pepper
mills climbed well above original levels.
Crafting a decision-making process that con-
nected the buying and selling functions for salt
and pepper mills was relatively easy; rolling it
out across the entire business was more chal-
lenging. Salt and pepper mills are just one of
several hundred product categories for John
Lewis. This element of scale is one reason why
cross-functional bottlenecks are not easy to un-
clog. Different functions have different incen-
tives and goals, which are often in conflict.
When it comes down to a struggle between
two functions, there may be good reasons to
locate the D in either place—buying or selling,
marketing or product development.
Here, as elsewhere, someone needs to think
objectively about where value is created and
assign decision roles accordingly. Eliminating
cross-functional bottlenecks actually has less to
do with shifting decision-making responsibili-
ties between departments and more to do with
ensuring that the people with relevant infor-
mation are allowed to share it. The decision
maker is important, of course, but more impor-
tant is designing a system that aligns decision
making and makes it routine.

Inside Versus Outside Partners

Decision making within an organization is hard
enough. Trying to make decisions between sep-
arate organizations on different continents
adds layers of complexity that can scuttle the
best strategy. Companies that outsource capa-
bilities in pursuit of cost and quality advantages
face this very challenge. Which decisions
should be made internally? Which can be dele-
gated to outsourcing partners?
These questions are also relevant for strate-
gic partners—a global bank working with an
IT contractor on a systems development
project, for example, or a media company that
acquires content from a studio—and for com-
panies conducting part of their business
through franchisees. There is no right answer
to who should have the power to decide what.
But the wrong approach is to assume that con-
tractual arrangements can provide the answer.
An outdoor-equipment company based in
the United States discovered this recently
when it decided to scale up production of gas
patio heaters for the lower end of the market.
The company had some success manufacturing
high-end products in China. But with the ad-
vent of superdiscounters like Wal-Mart, Tar-
get, and Home Depot, the company realized it
needed to move more of its production over-
seas to feed these retailers with lower-cost of-

The Decision-Driven Organization

The defining characteristic of high-performing
organizations is their ability to make good
decisions and to make them happen quickly.
The companies that succeed tend to follow a
few clear principles.

Some decisions matter more than others.

The decisions that are crucial to building
value in the business are the ones that matter
most. Some of them will be the big strategic
decisions, but just as important are the criti-
cal operating decisions that drive the busi-
ness day to day and are vital to effective exe-
cution.

Action is the goal.

Good decision making
doesn’t end with a decision; it ends with im-
plementation. The objective shouldn’t be
consensus, which often becomes an obstacle
to action, but buy in.

Ambiguity is the enemy.

Clear account-
ability is essential: Who contributes input,
who makes the decision, and who carries it
out? Without clarity, gridlock and delay are
the most likely outcomes. Clarity doesn’t nec-
essarily mean concentrating authority in a
few people; it means defining who has re-
sponsibility to make decisions, who has in-
put, and who is charged with putting them
into action.

Speed and adaptability are crucial.

A
company that makes good decisions quickly
has a higher metabolism, which allows it to
act on opportunities and overcome obstacles.
The best decision makers create an environ-
ment where people can come together
quickly and efficiently to make the most im-
portant decisions.

Decision roles trump the organizational
chart.

No decision-making structure will be
perfect for every decision. The key is to in-
volve the right people at the right level in the
right part of the organization at the right
time.

A well-aligned organization reinforces
roles.

Clear decision roles are critical, but
they are not enough. If an organization does
not reinforce the right approach to decision
making through its measures and incentives,
information flows, and culture, the behavior
won’t become routine.

Practicing beats preaching.

Involve the
people who will live with the new decision
roles in designing them. The very process of
thinking about new decision behaviors moti-
vates people to adopt them.
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Who Has the D?

harvard business review • january 2006

ferings. The timetable left little margin for er-
ror: The company started tooling up factories
in April and June of 2004, hoping to be ready
for the Christmas season.
Right away, there were problems. Although
the Chinese manufacturing partners under-
stood costs, they had little idea what American
consumers wanted. When expensive designs
arrived from the head office in the United
States, Chinese plant managers made compro-
mises to meet contracted cost targets. They
used a lower grade material, which discolored.
They placed the power switch in a spot that
was inconvenient for the user but easier to
build. Instead of making certain parts from a
single casting, they welded materials together,
which looked terrible.
To fix these problems, the U.S. executives
had to draw clear lines around which decisions
should be made on which side of the ocean.
The company broke down the design and man-
ufacturing process into five steps and analyzed
how decisions were made at each step. The
company was also much more explicit about
what the manufacturing specs would include
and what the manufacturer was expected to do
with them. The objective was not simply to
clarify decision roles but to make sure those
roles corresponded directly to the sources of
value in the business. If a decision would affect
the look and feel of the finished product, head-
quarters would have to sign off on it. But if a
decision would not affect the customer’s expe-
rience, it could be made in China. If, for exam-
ple, Chinese engineers found a less expensive
material that didn’t compromise the product’s
look, feel, and functionality, they could make
that change on their own.
To help with the transition to this system,
the company put a team of engineers on-site in
China to ensure a smooth handoff of the specs
and to make decisions on issues that would be-
come complex and time-consuming if elevated
to the home office. Marketing executives in the
home office insisted that it should take a cus-
tomer ten minutes and no more than six steps
to assemble the product at home. The com-
pany’s engineers in China, along with the Chi-
nese manufacturing team, had input into this
assembly requirement and were responsible
for execution. But the D resided with head-
quarters, and the requirement became a major
design factor. Decisions about logistics, how-
ever, became the province of the engineering
team in China: It would figure out how to
package the heaters so that one-third more
boxes would fit into a container, which re-
duced shipping costs substantially.

• • •

If managers suddenly realize that they’re
spending less time sitting through meetings
wondering why they are there, that’s an early
signal that companies have become better at
making decisions. When meetings start with a
common understanding about who is respon-
sible for providing valuable input and who has
the D, an organization’s decision-making me-
tabolism will get a boost.
No single lever turns a decision-challenged
organization into a decision-driven one, of
course, and no blueprint can provide for all the
contingencies and business shifts a company is
bound to encounter. The most successful com-
panies use simple tools that help them recog-
nize potential bottlenecks and think through
decision roles and responsibilities with each
change in the business environment. That’s dif-
ficult to do—and even more difficult for com-
petitors to copy. But by taking some very prac-
tical steps, any company can become more
effective, beginning with its next decision.

Reprint R0601D

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A Decision Diagnostic

Consider the last three meaningful decisions you’ve been involved in and ask your-
self the following questions.

1.

Were the decisions right?

2.

Were they made with appropriate speed?

3.

Were they executed well?

4.

Were the right people involved, in the right way?

5.

Was it clear for each decision
• who would recommend a solution?
• who would provide input?
• who had the final say?
• who would be responsible for following through?

6.

Were the decision roles, process, and time frame respected?

7.

Were the decisions based on appropriate facts?

8.

To the extent that there were divergent facts or opinions, was it clear who had the D?

9.

Were the decision makers at the appropriate level in the company?

10.

Did the organization’s measures and incentives encourage the people involved to
make the right decisions?
page 142

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Who Has the D?

How Clear Decision Roles Enhance Organizational Performance

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Further Reading

A R T I C L E S

Want Collaboration? Accept—and
Actively Manage—Conflict

by Jeff Weiss and Jonathan Hughes

Harvard Business Review

March 2005
Product no. R0503F

Even if you’ve clearly defined roles, decision
makers can experience conflict—for example,
disagreements among people who must
“Agree.” The authors present

six strategies for
managing conflict

in a way that promotes
smart decisions: 1) Devise and implement a
common method for resolving conflict.
2) Provide people with criteria for making
trade-offs. 3) Use escalation of conflict as an
opportunity for coaching. 4) Establish and
enforce a requirement of joint escalation—
sharing a disagreement’s escalation up the
management chain. 5) Ensure that managers
resolve escalated conflicts directly with their
counterparts. 6) Make the process for esca-
lated conflict-resolution transparent. By apply-
ing these strategies, you integrate conflict res-
olution into day-to-day decision-making—
removing barriers to cross-organizational
collaboration.

What You Don’t Know About Making
Decisions

by David A. Garvin and Michael A. Roberto

Harvard Business Review

November 2003
Product no. R0108G

The authors provide guidelines to help “Rec-
ommenders” gather high-quality input. The
key?

Inquiry

—carefully considering a variety
of opinions, working with others to discover
the best ideas, and stimulating creative think-
ing rather than suppressing disagreement. To
use inquiry, master these “three C’s”: 1)

Con-
flict:

Ask tough questions and invite people to
play devil’s advocate while evaluating your
recommendation. 2)

Consideration:

Ensure
that input providers perceive your decision
process as fair—by conveying openness to
new ideas, listening attentively, and explain-
ing the rationale behind your decisions.
3)

Closure:

Resist any temptation to decide
too early so as to avoid extensive disagree-
ment among input providers. But don’t delay
decision making too long, either, just because
you think you must resolve every last issue or
concern before making any decision.
page 143

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http://harvardbusinessonline.hbsp.harvard.edu/relay.jhtml?name=itemdetail&referral=4320&id=R0503F

http://harvardbusinessonline.hbsp.harvard.edu/relay.jhtml?name=itemdetail&referral=4320&id=R0108G

http://harvardbusinessonline.hbsp.harvard.edu/relay.jhtml?name=itemdetail&referral=4320&id=R0108G

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