Brilliant strategy but can you execute it?

8/12/2019 Brilliant strategy but can you execute it?

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88 THE McKINSEY QUARTERLY 1999 NUMBER 1

MARC BURCKHARDT


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O FIND THE RIGHT STRATEGY for a business, its managers must under-stand such general considerations as its competitive situation, the latentneeds of customers, capital markets, the regulatory environment, new

technology, the structure of its industry, and the strengths and weaknessesof its rivals. Yet the formulation of a truly successful strategy requiresmanagers to ponder not only these primary determinants but also thecompanys ability to execute whatever strategy it chooses. Oten, however,

discussions on strategy ignore the execution factor because managers fail to seeit as part of the big picture. Such companies miss the opportunity to make aninformed choice between a second-best strategy that they can execute welland an ideal strategy that may demand capabilities they simply do not have.

We studied companies in a wide range of industries to learn if success issystematically associated with a strong alignment between the innate abilitiesof a company and the execution requirements of its strategy, and if failure issystematically associated with the absence of such an alignment. Our research

identified industries facing major strategic decisions about such issues ascomputers, telecommunications, electronics, and transportation. Within theseindustries, we examined the approaches to execution of 40 companies thatpursued fundamentally sound strategies; in other words, they did not rest onflawed assumptions about market realities (such as consumer demand) orthe basis of competition (such as the importance of cost positions).

STRATEGY

THE McKINSEY QUARTERLY 1999 NUMBER 1 89

Claudio Aspesi is a principal andDev Vardhan is a consultant in McKinseys Chicago ofice.Copyright 1999 McKinsey & Company. All rights reserved.

BRILLIANT STRATEGY,BUT CAN YOU EXECUTE?Claudio Aspesi and Dev Vardhan

The best strategy for any company is a strategy it can implement

Before you choose one, think about what your company already does well

The experience of two industries energy and pharmaceuticals illustrates anew way to assess the fit between corporate strategy and corporate strengths

T


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There were two basic kinds of strategies: transformational and operational. Astrategy is transformational when the company using it faces significantuncertainty, aims to change the game in the industry, and must addresssubstantial customer, channel, or competitive challenges. Strategies areoperational if companies face relatively low uncertainty and are mostlyattempting to play the same old game better than the competition does.

It takes vastly diferent skills to execute these two kinds of strategies. For theoperational approach, a company must focus doggedly on conventional

measures like capacity utilization or throughput and on such basics ascustomer service. Transformational strategies, by contrast, require a companyto use inadequate information to make timely options-based decisions aboutproduct or market priorities, investments in technology, the configuration ofbusiness systems, and industry partnerships.*

Neither kind of strategy will fly if a company lacks the skills needed toimplement it, from running a factory at world class levels to knowing how tochoose an acquisition target. Moreover, the skills needed to execute

operational and transformational strategies, while not mutually exclusive, arerarely present in a single company. Ater all, these strategies require topmanagement to focus on fundamentally diferent things: building exceptionalinternal capabilities in the case of operational strategies and gaining unusualinsight into the evolution of the industry and market-based opportunities in

the case of transformational ones. They alsocall for diferent kinds of organizationalsupport (distinctive front-line behavior orexcellent strategic decision making, respec-

tively), diferent approaches to imple-mentation (highly linear or options-based),and diferent ways of monitoring progress

(highly structured tracking of eficiency targets or event tracking andcontingency planning). More important, once a company has distinguisheditself in one set of skills or the other, they cannot be reversed overnight,because they are so dissimilar. This is why the alignment between a strategyand a companys real strengths is a critical, though oten neglected, factorin determining whether strategies succeed.

Of the 40 companies in our sample, for instance, 16 delivered poor results(bottom-quartile shareholder returns) even though their strategies werefundamentally sound in the sense defined above. Yet many other companies inthe sample had the skills needed to execute their chosen strategy. In fact, 24 ofthem delivered excellent results that is, top-quartile shareholder returns.

BRILLIANT STRATEGY, BUT CAN YOU EXECUTE?


* See Thomas E. Copeland and Philip T. Keenan, Making real options real, The McKinseyQuarterly, 1998 Number 3, pp. 12841; Kevin P. Coyne, Stephen J. D. Hall, and Patricia GormanCliford, Is your core competence a mirage? The McKinsey Quarterly, 1997 Number 1, pp. 4054.

The skills needed to execute bothoperational and transformational

strategies are rarely presentin a single company


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In this article, we draw on our study to describe the experiences of twocompanies in each of two industries: energy and pharmaceuticals. Despiterelying on quite diferent strategies, these four businesses managed to succeedat roughly the same time. All chose strategies closely tied to their basic skillsand could therefore execute those strategies extremely well.

Energy

In the United States and elsewhere, the gas and electric power industries

are passing through a time of rapid change.* The historical model of avertically integrated utility obliged to serve customers and thus protectedfrom competition is fading as regulators open up markets and giveconsumers new choices.

The pace and extent of this transition are unclear. As is usual when industriesundergo turmoil, competitive responses are diverse. In this environment,should a company choose to pursue an operational or a transformationalstrategy? The success of two major energy businesses Duke Energy and

Enron suggests that both approaches can work.

Over the past ten years, the two companies have generated top-quartileshareholder returns: 22 percent for Enron and 15 percent for Duke, whilethe energy (electric and gas) index stood at only 11 percent. Duke, with one ofthe countrys lowest costs of generation, is the No. 1 utility in customersatisfaction, according to the index compiled by the University of MichiganBusiness School and the American Society for Quality Control. Enron rankedNo. 1 for innovation among 431 companies inFortune magazines 1997 survey

of corporate reputations.

Since both the operational and the transformational strategies arefundamentally sound in themselves, it is not useful to speculate abstractlyabout which is smarter. The important lesson is that both Duke and Enronhave done well because they chose strategies they could execute well. Dukesoperational strategy reflects the companys ability to build and run powerplants eficiently. The transformational strategy of Enron fits well with itsskills in risk management, deal making, and finance.

Duke

Building and operating eficient generation plants and developing oracquiring related capabilities is Dukes core strength. In 1997, its cost ofgeneration 3.3 cents for each kilowatt-hour was 15 percent below the US



* See Richard Dobbs and Matthew Elson, Regulating utilities: Have we got the formula right? pp.13344; Peter Crawford, Kristen Johnsen, Jim Robb, and Peter Sidebottom, World Power &Light, pp. 12232.


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average. The company holds the world record for replacing a steam generator:25 days at Wisconsin Electric Powers Point Beach Nuclear Station.

So it is not surprising that Duke chose a strategy exploiting its historicalstrengths. As a result, it has succeeded in entering generation-related design,engineering, operational, and maintenance businesses. The companys globalexpansion, focusing on generation projects in international markets, alsobuilds on core capabilities. Indeed, Duke has consistently been reluctant tomove beyond them; it has chosen not to make major moves in the uncertain

US electric retail market, for example.

Dukes success shows the importance of getting the metrics right in oper-ational strategies. Costperformance measures, an important part of topmanagements agenda, preoccupy managers at all levels of the company, andmanagers of specific assets or organizational units are responsible formonitoring their performance. Such market-based measures as customersatisfaction and account management are systematically assigned andmonitored, as well.

Many other utilities are now attempting to provide integrated services:generation, trading, transmission pipes and wires, and energy retailing. Duke,however, decided to focus on supplying (through generation or trading) thepower that retailers sell to consumers. Its approach assumes that supplyingenergy is a practical stand-alone business that will not make Duke miss outon attractive retail opportunities in the future. Although these assumptionsmay be risky, Duke has the benefit of focused execution.

The companys three most recent chief executive oficers have all recognizedthe importance of building or acquiring technical and commercialcapabilities. Under Bill Lees leadership, in 1989 Duke formed a 5050partnership with Fluor Daniel, one of the largest construction companies inthe United States. This deal improved Dukes ability to design, construct,operate, and maintain fossil fuel and nuclear generating plants. Lee retired in1994, handing the reins to Bill Grigg, who continued to strengthen Dukesposition as a low-cost generator. Besides creating businesses that providedesign, engineering, project management, construction, operating, and

maintenance services to a wide range of customers, he got the companyinvolved in several international projects. In all of these cases, Grigg soughtto leverage Dukes core capabilities in building and operating eficientgeneration plants.

But the greatest accomplishment of Bill Grigg was the PanEnergy merger,in June 1997 another example of Dukes ability to identify and secureimportant complementary capabilities. PanEnergys gas pipeline businessgives Duke the ability to provide a broad range of products to its customers.




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Through access to PanEnergys partnership with Mobil, Duke also receivedimportant complements gas marketing, field services, and gas pipelines to its strengths in low-cost generation. Rick Priory, who became Dukes chiefexecutive oficer in 1997, has made several significant investments to buy anddevelop generating plants in the United States.

Over the past five years, Duke has supplemented its technical and operationalskills with the integrated marketing capabilities needed to make a significantimpact on customers. To achieve this sort of integration, the company has

taken a national accounts approach mobilizing cross-functional teams to helplarge customers identify opportunities and todevelop creative multiproduct solutions. In1997, for instance, Duke outbid 14 otherplayers for a contract to manage the 175-megawatt generators of the municipal utilityof Dover, Delaware. Dukes national accountsteam gave the city a fixed ten-year price for electricity by integrating thetechnical and operational expertise of Duke and Fluor Daniel with the

trading and risk management capabilities of Dukes energy-trading arm.

Enron

Unlike Duke, Enron has sought to transform its industry. It began as a US gaspipeline company. In the mid-1980s, when other natural-gas companies weretrying to preserve regulatory protection, Enron took the opposite approach.Deregulation helped to create the wholesale gas-trading market, in whichEnron has won a dominant position. In the early 1990s, the company usedthe same strategy in the deregulating electric-trading market. More recently,

it placed a big bet in the retail electricity business, investing aggressively ininfrastructure and brand building. Enron has also expanded in Europe, India,and Latin America.

Over the past ten years, Enrons chief executive oficer, Kenneth Lay, hasoten tried to change the rules of the energy business. Realizing that newproducts and services would be needed to satisfy the delivery, riskmanagement, and pricing needs of the industrys customers, Lay pushed forderegulation. In the early 1990s, Enron created new gas markets outside the

United States by building pipelines and power plants in countries with unmetenergy needs. At the same time, the company entered the wholesale electricmarket, beat the largest electric utilities, and created a large and successfulelectric-trading business.

Recently, Enron has pushed hard for deregulation in the retail electricitybusiness and started to invest aggressively in it even before this came topass. Once again, the company has seen an opportunity to change the gameby ofering highly competitive products and services. Although lagging



Getting the metricsright is absolutely essentialfor operational strategies


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deregulation and unfavorable rate structures in some deregulated markets(for example, California) have forced Enron to slow down temporarily, itcontinues to have a good position for changing the basis of competition.

In July 1998, Enrons leadership team, believing that there was an unmetneed for water and sewer systems in the developing world a marketestimated at $300 billion announced that the company would try to builda global water business. As a first step, Enron acquired Wessex Water PLC, aBritish water and water treatment company.

Enron supports its visionary, first-mover strategies by poaching talent frominvestment banks, commercial banks, consulting firms, and top-tier businessschools. These managers know how to solve problems in creative ways and

to make high-impact strategic decisions. Whenthe company entered the gas-marketingbusiness, for example, it developed theinnovative concept of a gas bank, whichpermitted it despite a highly uncertain

environment to guarantee firm fixed-pricecontracts to independent power developers. Enron did this by poolingcontracts with diferent timing and risk characteristics to minimize thecompanys exposure. Although the bank itself did not take of, the idea ofpooling contracts allowed Enron to convert them into financial contracts.

Pharmaceuticals

Before the present decade, drug makers generated attractive returns by

investing heavily in the discovery and development of new drugs, on the onehand, and by selling them vigorously to physicians, on the other. Patentprotection decreased the level of price competition, and health insurancemade consumers relatively insensitive to prices. Brands were chosen almostentirely at the discretion of physicians, whose preferences were greatlyinfluenced by the sales coverage of the drug companies.

In the 1990s, the emergence of managed health care, provided for a fixed feeby companies that contract with employers, threatened to end the party. The

business model began to change when pharmacy benefits-managementcompanies, which help large corporations manage the cost of their pharmacybenefits programs, entered the fray by encouraging doctors to use low-costalternatives to branded products. These pharmacy benefits managers wereputting downward pressure on the profitability of the drug industry bycapturing part of its profits for themselves and their corporate customers. Inthe early 1990s, this threat gained more steam when the ClintonAdministration publicly championed the managed-care model, and the shareprices of drug companies declined significantly as a result.



Poaching talent from othercompanies helps Enron support

its visionary strategies


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Two leading drug manufacturers, Pfizer and Eli Lilly, responded to thecoming of managed care with quite diferent strategies. Pfizer, building onits traditional strengths in research and sales, took the operational approach.Lilly, by contrast, took the transformational one and tried to shape theindustry by purchasing a large pharmacy benefits manager. From 1992 to1997, both companies created enormous shareholder wealth: 40 percent ayear for Lilly, 35 percent for Pfizer, as compared with the pharmaceuticalindustry average of 28 percent. Many industry experts believe that bothcompanies have built good positions for the future. If there is one lesson to be

learned from the experience of these companies, it is simply this: theirrespective skill sets determined the strategy they chose and its success.

Pfizer

While Lilly and such other pharmaceutical giants as Merck and SmithKlineBeecham placed big bets by investing in pharmacy benefits managers, Pfizerstuck with the industrys traditional model: excelling at sales and research.Throughout the history of the company, it has been known for its hard-driving, pragmatic style. Its salespeople are thought to wield considerable

influence over the prescription choices of many physicians, and the companysresearch operation, an industry leader in productivity and time to market, hasbeen remarkably successful. A 1995 industry survey reported that Pfizersdiscovery teams need less than one-third the industrys average of 190 person-years of work to advance a compound from conception to clinical trials.*

Pfizers chief executive oficer William Steere, a former salesman whojoined the company in 1959 and rose through its marketing ranks hascommitted himself to building one of the industrys best sales forces. His own

experience suggested to him that the merits of novel drugs do not registerwith busy doctors until they hear the story from well-versed sales represen-tatives. Bucking the industry trend, heincreased Pfizers US sales force from 1,500in 1990 to 3,467 in 1997, oten hiring talentcast of from other companies. The companynow has one of the most formidable salesforces in the industry, as reckoned both by size and by talent. The Pfizer salesforce uses leading-edge information systems and technology to track the

prescription histories of physicians and to respond with sales coverage thatdelivers the biggest bang for the sales efort. The companys informationsystems also allow top management to plan the expansion of the sales force,to track its performance, and to link that performance with compensation.This strong sales capability, a major asset for Pfizer, won the company co-marketing rights for several major drugs produced by other companies.



* Fortune, Why Pfizer is so hot, May 11, 1998.

POV Reports andMedAd News.

Both Pfizer and Lilly createdvast shareholder wealth


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When Steere took over as chief executive oficer, in 1991, he inherited adecade of aggressive investment in research and development by hispredecessor, Edmund Pratt. Pfizer had hired many of the industrys mostexperienced and talented scientists by ofering them attractive compensationand an unbeatable opportunity to conduct leading-edge research. Theresearch team developed eficient management processes, includingprovisions for early input from marketing and a ruthless commitment todelivering practical results.

Many other pharmaceutical companies are reluctant to kill even dubiousresearch eforts, but Pfizer exerts discipline in managing projects at everystage of the development process. Research teams use step charts that showhow many promising compounds should be on hand at each phase of the drugdevelopment process to cover the attrition rate. These charts, based on robuststatistical models, help the scientists apply themselves to delivering goodbusiness results. Management practices of this kind, coupled with researchand development budgets that rise at a rate of 18 percent a year, as opposed tothe industry average of 9 percent, have stufed the product pipeline.

Pfizer ofers an excellent example of how executives can recognize what theircompanies do well and use that understanding to build superior strategies.The company followed what for the pharmaceutical industry was thetraditional approach, emphasizing sales and research. This operationalstrategy, though no doubt less sexy than trying to shake up the industry,produced enviable returns all the same.

Eli Lilly

Unlike William Steere, Randall Tobias, Eli Lillys chief executive oficersince 1993, was an industry outsider. The former vice chairman of AT&T,he had been an independent member of Lillys board since 1986. The trans-formational strategy he chose for the company included an efort to rethinkits business focus and a willingness to make industry plays to reposition it forthe future. This became the strength of his top management team.

Explicitly acknowledging the specific challenges of a transformational strategy,Tobias created two committees to govern Lilly. One is responsible for

operations and day-to-day management, the other the policy committee for high-level strategic direction. Every member of the policy committee alsoserves on the operations committee, an arrangement that helps Tobias, whoheads the policy committee, to stay abreast of daily operations while focusingon the strategic agenda and leading the process of transformation.

Tobias spent $4 billion for PCS Health Systems, a major pharmacy benefitsmanager, to leverage an emerging industry discontinuity to Lillys advantage.As this move shows, transformational strategies are risky by nature, for the




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emergence of pharmacy benefits managers did not reshape the drug industryas anticipated, in part because the US Federal Trade Commission took askeptical view of vertical integration by drug companies. In addition, manyhospitals and health care plans that were customers of pharmacy benefitsmanagers regarded this vertical integration as a conflict of interest. It is stillan open question whether it makes strategic sense for drug companies toown pharmacy benefits managers, and this uncertainty forced Lilly to take asubstantial write-of on the PCS deal in 1997. Yet Lillys outstanding financialperformance over the past five years shows the soundness of the CEOs

strategy, which has many other dimensions.

Tobias built a strong leadership team by elevating stellar performers withinthe company and by hiring people from the outside. He also evaluated Lillysbusiness portfolio. When he took over the company, it was involved not onlyin its core pharmaceutical business but also in animal health, cosmetics, andmedical devices. Tobias divested a majority of these noncore entities mostsignificantly, the medical device businesses, which were creatively spun of,generating more than $1 billion in cash. First, Lilly formed a wholly owned

subsidiary called Guidant and sold 20 percent of its stock in an initial publicofering to establish a share price. Six months later, Lilly made the other 80percent of Guidants stock available to Lillys shareholders in exchange forLilly stock. This proved to be a masterly strategic move, giving Guidant astrong start, generating cash for Lillys core business, and freeing managementtime and attention that were being diverted to marginal operations.*

The other divested entities include a 50 percent stake in Japan Elanco(agricultural products and empty capsules); the Eli Lilly Hard Gelatin capsule

business, spun of for $120 million; and IVAC (medical and surgicalinstruments), for $200 million. Meanwhile, the company made acquisitions tostrengthen its core business: a 13.5 percent stake in Somatogen (for $20million) as part of a strategic alliance to develop and market a bloodsubstitute product, 100 percent ownership of Sphinx (for $72 million), and an18 percent stake in Millennium BioTherapeutics (for $20 million), intendedto give Lilly access to leading-edge capabilities for identifying auspiciouschemicals for testing. In 1997, the company accelerated the pace of its tech-nology deals by creating a web of relationships to secure access to promising

products and technologies.

Lillys organization excelled at making timely portfolio decisions of this sort.All transformational strategies require companies to make tough strategicchoices about first-mover investments to enter nascent markets,investments in technology, make-versus-buy problems, and so forth. Althoughthe jury is out on several of Lillys investments, positive results from earlier



* See Patricia L. Anslinger, Steven J. Klepper, and Somu Subramaniam, Breaking up is good todo, pp. 1627.


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deals suggest that the company, relying on strategic alliances and relation-ships, is creating a powerful drug portfolio.

Tobias reorganized Lillys functional structure around five therapeutic areas infectious diseases, cancer, cardiovascular products, endocrinology, andneuroscience in which the company had a strong presence, as well as unmetmedical needs. During the course of this reorganization, he also reevaluatedLillys overall cost competitiveness, reducing the workforce by 4,000 throughan early-retirement program that had two primary goals: to shed surplus

employees and to give an out to those who were not prepared for thetransformational strategy. The program was driven from the top downward,carried out quickly, and designed to reveal and promote high performers whowould not have advanced under normal circumstances. These personneldecisions jump-started the transformational strategy.

William Steere, capitalizing on the legacy of a highly focused and pragmatic

organization, pursued his industrys traditional business strategy. RandallTobias, supplying a successful vision of innovation and change, leveraged theadventurous mentality of an organization that was willing to take steps

outside its own walls. The success of thesetwo leaders shows the power an organizationgains when it focuses on doing what it doeswell. In many industries, there is no one rightcourse; a strategy cannot be assessed apartfrom the skills of the company trying to

execute it. The cases of Duke and Enron inenergy and of Pfizer and Lilly in pharmaceuticals show that both operationaland transformational strategies can yield outstanding results in the sameindustry and at the same time.

Yet this is not to say that there is never a single right strategy. During the1980s and early 1990s, for example, Wal-Mart turned the discount-retailingbusiness into a pure game of operational strategy by excelling in informationtechnology, logistics infrastructure, and front-line execution. Companies that

pursued transformational strategies failed across the board. Conversely, inbiotechnology and electronic commerce, transformational strategies are theonly way to succeed, at least in the next few years while the industry structureis so volatile.

Finally, sometimes the senior management of a company must push forexceptional performance and rethink its entire business at the same time that is, execute both organizational and transformational strategies.Companies rarely seem to accomplish this, but Ford and British Airways



Both operational andtransformational strategies

can succeed in the sameindustry at the same time


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have recently done so. Such exceptional situations always involve thereplacement of top management, including the CEO (British Airways), orthe induction into top management of significant additional talent (Ford).The new leaders usually pursue programs for implementing change over anumber of years.

Despite these counterexamples, we believe that most companies can benefitfrom thinking of strategy as the art of what is possible for them. A capablyexecuted strategy will deliver better results than one that may be more

elegant in principle but does not reflect an organizations strengths. It makessense to choose the strategy that is sound for a particular company, meets itsfinancial aspirations, and provides the best fit with the abilities of its topmanagers, its organizational skills, its approach to risk management, and itsmonitoring system.



Brilliant strategy but can you execute it?

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