For managers of large corporations, these are uncertain times. They have a poor track record of dealing with significant, disruptive change even before the Internet and globalization. For instance, only one department store—Dayton Hudson—became a pioneer in cheap retailing out of hundreds of others. In the personal computer industry, none of the minicomputer businesses were successful. It is difficult for medical and business schools to adapt their curricula quickly enough to produce the managers and doctors that the markets want. The list might continue.
Not that management at large corporations are blind to impending disruptive shifts. Ordinarily, they can. They also have the means to fight back. The majority of large businesses have highly skilled managers and specialists, robust product lines, top-notch technological know-how, and substantial financial resources. The practice of carefully considering the capabilities of their organization as well as the talents of specific individuals is what managers lack.
Finding the ideal individual for the position and training staff to excel in their assignments are two qualities that distinguish exceptional managers. Unfortunately, most managers make the assumption that if every employee on a project is well-suited to their position, then the company they work for would be as well. That is not always the case. Even if two groups of equally qualified individuals worked in different organizations, the results would be very different. This is due to the fact that organizations possess capacities independent of the people and other resources they include. Good managers need to be proficient at evaluating people’s talents and impairments as well as their general abilities in order to constantly succeed.
This article provides managers with a framework to aid them in comprehending the potential of their enterprises. They will see how, even as their company’s core competencies expand, its limitations become more clearly defined. They will be able to identify various types of change and formulate sensible organizational responses to the opportunities that each type of change presents. And it will provide some practical advice that goes against a lot of what is presumed in our can-do corporate culture: the worst course of action may be to make significant changes to the current organization if an organization is facing huge change, such as a disruptive invention. Managers risk destroying the fundamental capabilities that support an enterprise in their attempts to transform it.
Managers need to know exactly what kinds of change the current organization can and cannot handle before jumping into the fray. We’ll first take a methodical look at how to identify a company’s fundamental skills on an organizational level, and then we’ll look at how those capabilities migrate as organizations develop and mature in order to assist them in doing that.
Where Capabilities Reside
Our research suggests that three factors affect what an organization can and cannot do: its resources, its processes, and its values. When thinking about what sorts of innovations their organization will be able to embrace, managers need to assess how each of these factors might affect their organization’s capacity to change.
Resources.
When they ask the question, “What can this company do?” the place most managers look for the answer is in its resources—both the tangible ones like people, equipment, technologies, and cash, and the less tangible ones like product designs, information, brands, and relationships with suppliers, distributors, and customers. Without doubt, access to abundant, high-quality resources increases an organization’s chances of coping with change. But resource analysis doesn’t come close to telling the whole story.
Processes.
The second factor that affects what a company can and cannot do is its processes. By processes, we mean the patterns of interaction, coordination, communication, and decision making employees use to transform resources into products and services of greater worth. Such examples as the processes that govern product development, manufacturing, and budgeting come immediately to mind. Some processes are formal, in the sense that they are explicitly defined and documented. Others are informal: they are routines or ways of working that evolve over time. The former tend to be more visible, the latter less visible.
One of the dilemmas of management is that processes, by their very nature, are set up so that employees perform tasks in a consistent way, time after time. They are meant not to change or, if they must change, to change through tightly controlled procedures. When people use a process to do the task it was designed for, it is likely to perform efficiently. But when the same process is used to tackle a very different task, it is likely to perform sluggishly. Companies focused on developing and winning FDA approval for new drug compounds, for example, often prove inept at developing and winning approval for medical devices because the second task entails very different ways of working. In fact, a process that creates the capability to execute one task concurrently defines disabilities in executing other tasks.1
The most important capabilities and concurrent disabilities aren’t necessarily embodied in the most visible processes, like logistics, development, manufacturing, or customer service. In fact, they are more likely to be in the less visible, background processes that support decisions about where to invest resources—those that define how market research is habitually done, how such analysis is translated into financial projections, how plans and budgets are negotiated internally, and so on. It is in those processes that many organizations’ most serious disabilities in coping with change reside.
Values.
The third factor that affects what an organization can and cannot do is its values. Sometimes the phrase “corporate values” carries an ethical connotation: one thinks of the principles that ensure patient well-being for Johnson & Johnson or that guide decisions about employee safety at Alcoa. But within our framework, “values” has a broader meaning. We define an organization’s values as the standards by which employees set priorities that enable them to judge whether an order is attractive or unattractive, whether a customer is more important or less important, whether an idea for a new product is attractive or marginal, and so on. Prioritization decisions are made by employees at every level. Among salespeople, they consist of on-the-spot, day-to-day decisions about which products to push with customers and which to de-emphasize. At the executive tiers, they often take the form of decisions to invest, or not, in new products, services, and processes.
The larger and more complex a company becomes, the more important it is for senior managers to train employees throughout the organization to make independent decisions about priorities that are consistent with the strategic direction and the business model of the company. A key metric of good management, in fact, is whether such clear, consistent values have permeated the organization.
But consistent, broadly understood values also define what an organization cannot do. A company’s values reflect its cost structure or its business model because those define the rules its employees must follow for the company to prosper. If, for example, a company’s overhead costs require it to achieve gross profit margins of 40%, then a value or decision rule will have evolved that encourages middle managers to kill ideas that promise gross margins below 40%. Such an organization would be incapable of commercializing projects targeting low-margin markets—such as those in e-commerce—even though another organization’s values, driven by a very different cost structure, might facilitate the success of the same project.
Different companies, of course, embody different values. But we want to focus on two sets of values in particular that tend to evolve in most companies in very predictable ways. The inexorable evolution of these two values is what makes companies progressively less capable of addressing disruptive change successfully.
As in the previous example, the first value dictates the way the company judges acceptable gross margins. As companies add features and functions to their products and services, trying to capture more attractive customers in premium tiers of their markets, they often add overhead cost. As a result, gross margins that were once attractive become unattractive. For instance, Toyota entered the North American market with the Corona model, which targeted the lower end of the market. As that segment became crowded with look-alike models from Honda, Mazda, and Nissan, competition drove down profit margins. To improve its margins, Toyota then developed more sophisticated cars targeted at higher tiers. The process of developing cars like the Camry and the Lexus added costs to Toyota’s operation. It subsequently decided to exit the lower end of the market; the margins had become unacceptable because the company’s cost structure, and consequently its values, had changed.
In a departure from that pattern, Toyota recently introduced the Echo model, hoping to rejoin the entry-level tier with a $10,000 car. It is one thing for Toyota’s senior management to decide to launch this new model. It’s another for the many people in the Toyota system—including its dealers—to agree that selling more cars at lower margins is a better way to boost profits and equity values than selling more Camrys, Avalons, and Lexuses. Only time will tell whether Toyota can manage this down-market move. To be successful with the Echo, Toyota’s management will have to swim against a very strong current—the current of its own corporate values.
The second value relates to how big a business opportunity has to be before it can be interesting. Because a company’s stock price represents the discounted present value of its projected earnings stream, most managers feel compelled not just to maintain growth but to maintain a constant rate of growth. For a $40 million company to grow 25%, for instance, it needs to find $10 million in new business the next year. But a $40 billion company needs to find $10 billion in new business the next year to grow at that same rate. It follows that an opportunity that excites a small company isn’t big enough to be interesting to a large company. One of the bittersweet results of success, in fact, is that as companies become large, they lose the ability to enter small, emerging markets. This disability is not caused by a change in the resources within the companies—their resources typically are vast. Rather, it’s caused by an evolution in values.
The problem is magnified when companies suddenly become much bigger through mergers or acquisitions. Executives and Wall Street financiers who engineer megamergers between already-huge pharmaceutical companies, for example, need to take this effect into account. Although their merged research organizations might have more resources to throw at new product development, their commercial organizations will probably have lost their appetites for all but the biggest blockbuster drugs. This constitutes a very real disability in managing innovation. The same problem crops up in high-tech industries as well. In many ways, Hewlett-Packard’s recent decision to split itself into two companies is rooted in its recognition of this problem.
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