Brilliant-strategy-but-can-you-execute

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 ph

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Title: BRILLIANT STRATEGY, BUT CAN YOU EXECUTE? , By: Aspesi, Claudio, Vardhan, Dev,

McKinsey Quarterly, 00475394, 1999, Issue 1

Database: Business Source Elite

Section: Strategy

BRILLIANT STRATEGY, BUT CAN YOU EXECUTE?

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 a new way to assess the fit between corporate

strategy and corporate strengths

To find the right strategy for a business, its managers must

understand such general considerations as its competitive situation, the latent needs of customers, capital markets, the regulatory environment, new technology, the structure of its industry, and the

strengths and weaknesses of its rivals Yet the formulation of a truly successful

strategy requires managers to ponder not only these primary determinants but also the

Contents

Energy

Duke

Enron

Pharmaceuticals

Pfizer

Eli Lilly

* * *

company's ability to execute whatever strategy it chooses Often, however,

discussions on strategy ignore the execution factor because managers fail to see it as

part of the big picture Such companies miss the opportunity to make an informed

choice between a "second-best" strategy that they can execute well and 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 is

systematically associated with a strong alignment between the innate abilities of a

company and the execution requirements of its strategy, and if failure is

systematically associated with the absence of such an alignment Our research

identified industries facing major strategic decisions about such issues as computers, telecommunications, electronics, and transportation Within these industries, we examined the approaches to execution of 40 companies that pursued fundamentally

sound strategies; in other words, they did not rest on flawed assumptions about

market realities (such as consumer demand) or the basis of competition (such as the importance of cost positions)

There were two basic kinds of strategies: transformational and operational A strategy

is transformational when the company using it faces significant uncertainty, aims to change the game in the industry, and must address substantial customer, channel, or

competitive challenges Strategies are operational if companies face relatively low

uncertainty and are mostly attempting to play the same old game better than the competition does

It takes vastly different skills to execute these two kinds of strategies For the

operational approach, a company must focus doggedly on conventional measures like capacity utilization or throughput and on such basics as customer service

Transformational strategies, by contrast, require a company to use inadequate

information to make timely options-based decisions about product or market

priorities, investments in technology, the configuration of business systems, and industry partnerships.[*]

Neither kind of strategy will fly if a company lacks the skills needed to implement it,

from running a factory at world class levels to knowing how to choose an acquisition

target Moreover, the skills needed to execute operational and transformational strategies, while not mutually exclusive, are rarely present in a single company After all, these strategies require top management to focus on fundamentally different things: building exceptional internal capabilities in the case of operational strategies

and gaining unusual insight into the evolution of the industry and market-based opportunities in the case of transformational ones They also call for different kinds of organizational support (distinctive front-line behavior or excellent strategic decision making, respectively), different approaches to implementation (highly linear or options-based), and different ways of monitoring progress (highly structured tracking

of efficiency targets or event tracking and contingency planning) More important, once a company has distinguished itself 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 strategy and a company's real strengths is a critical, though often neglected, factor in 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 were fundamentally sound

in the sense defined above Yet many other companies in the sample had the skills

needed to execute their chosen strategy In fact, 24 of them delivered excellent results

that is, top-quartile shareholder returns

In this article, we draw on our study to describe the experiences of two companies in each of two industries: energy and pharmaceuticals Despite relying on quite different

strategies, these four businesses managed to succeed at roughly the same time All chose strategies closely tied to their basic skills and 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 a vertically integrated utility obliged to serve customers and thus protected from competition is fading as regulators open up markets and give consumers new choices

The pace and extent of this transition are unclear As is usual when industries undergo turmoil, competitive responses are diverse In this environment, should a company

choose to pursue an operational or a transformational strategy? 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-quartile shareholder returns: 22 percent for Enron and 15 percent for Duke, while the energy (electric and gas) index stood at only 11 percent Duke, with one of the country's lowest costs of generation, is the No 1 utility in customer satisfaction, according to the index

compiled by the University of Michigan Business School and the American Society for Quality Control Enron ranked No 1 for innovation among 431 companies in Fortune magazine's 1997 survey of corporate reputations

Since both the operational and the transformational strategies are fundamentally

sound in themselves, it is not useful to speculate abstractly about which is smarter The important lesson is that both Duke and Enron have done well because they chose

strategies they could execute well Duke's operational strategy reflects the company's ability to build and run power plants efficiently The transformational strategy of

Enron fits well with its skills in risk management, deal making, and finance

Duke

Building and operating efficient generation plants and developing or acquiring related capabilities is Duke's core strength In 1997, its cost of generation 3.3 cents for each kilowatt-hour was 15 percent below the US average The company holds the world record for replacing a steam generator: 25 days at Wisconsin Electric Power's Point Beach Nuclear Station

So it is not surprising that Duke chose a strategy exploiting its historical strengths As

a result, it has succeeded in entering generation-related design, engineering,

operational, and maintenance businesses The company's global expansion, focusing

on generation projects in international markets, also builds on core capabilities Indeed, Duke has consistently been reluctant to move beyond them; it has chosen not

to make major moves in the uncertain US electric retail market, for example

Duke's success shows the importance of getting the metrics right in operational

strategies Cost/performance measures, an important part of top management's

agenda, preoccupy managers at all levels of the company, and managers of specific assets or organizational units are responsible for monitoring their performance Such market-based measures as customer satisfaction and account management are

systematically assigned and monitored, 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) the power that retailers sell to consumers Its approach assumes that supplying energy is a practical stand-alone business that will not make Duke miss out on attractive retail opportunities in the future Although these assumptions may be risky, Duke has the benefit of focused execution

The company's three most recent chief executive officers have all recognized the importance of building or acquiring technical and commercial capabilities Under Bill Lee's leadership, in 1989 Duke formed a 50-50 partnership with Fluor Daniel, one of the largest construction companies in the United States This deal improved Duke's ability to design, construct, operate, and maintain fossil fuel and nuclear generating plants Lee retired in 1994, handing the reins to Bill Grigg, who continued to

strengthen Duke's position as a low-cost generator Besides creating businesses that provide design, engineering, project management, construction, operating, and maintenance services to a wide range of customers, he got the company involved in several international projects In all of these cases, Grigg sought to leverage Duke's core capabilities in building and operating efficient generation plants

But the greatest accomplishment of Bill Grigg was the PanEnergy merger, in June

1997 another example of Duke's ability to identify and secure important

complementary capabilities PanEnergy's gas pipeline business gives Duke the ability

to provide a broad range of products to its customers.

Through access to PanEnergy's partnership with Mobil, Duke also received important complements gas marketing, field services, and gas pipelines to its strengths in low-cost generation Rick Priory, who became Duke's chief executive officer in 1997, has made several significant investments to buy and develop generating plants in the United States

Over the past five years, Duke has supplemented its technical and operational skills with the integrated marketing capabilities needed to make a significant impact on customers To achieve this sort of integration, the company has taken a national accounts approach mobilizing cross-functional teams to help large customers identify opportunities and to develop creative multiproduct solutions In 1997, for instance, Duke outbid 14 other players for a contract to manage the 175-megawatt generators

of the municipal utility of Dover, Delaware Duke's national accounts team gave the city a fixed ten-year price for electricity by integrating the technical and operational expertise of Duke and Fluor Daniel with the trading and risk management capabilities

of Duke's energy-trading arm

Enron

Unlike Duke, Enron has sought to transform its industry It began as a US gas pipeline company In the mid-1980s, when other natural-gas companies were trying to

preserve regulatory protection, Enron took the opposite approach Deregulation helped to create the wholesale gas-trading market, in which Enron has won a

dominant position In the early 1990s, the company used the same strategy in the

deregulating electric-trading market More recently, it placed a big bet in the retail electricity business, investing aggressively in infrastructure and brand building Enron has also expanded in Europe, India, and Latin America

Over the past ten years, Enron's chief executive officer, Kenneth Lay, has often tried

to change the rules of the energy business Realizing that new products and services would be needed to satisfy the delivery, risk management, and pricing needs of the industry's customers, Lay pushed for deregulation In the early 1990s, Enron created new gas markets outside the United States by building pipelines and power plants in countries with unmet energy needs At the same time, the company entered the wholesale electric market, beat the largest electric utilities, and created a large and successful electric-trading business

Recently, Enron has pushed hard for deregulation in the retail electricity business and started to invest aggressively in it even before this came to pass Once again, the company has seen an opportunity to change the game by offering highly competitive products and services Although lagging deregulation and unfavorable rate structures

in some deregulated markets (for example, California) have forced Enron to slow down temporarily, it continues to have a good position for changing the basis of

In July 1998, Enron's leadership team, believing that there was an unmet need for water and sewer systems in the developing world a market estimated at $300 billion announced that the company would try to build a global water business As a first step, Enron acquired Wessex Water PLC, a British water and water treatment

company

Enron supports its visionary, first-mover strategies by poaching talent from

investment banks, commercial banks, consulting firms, and top-tier business schools These managers know how to solve problems in creative ways and to make high-impact strategic decisions When the company entered the gas-marketing business, for example, it developed the innovative concept of a gas bank, which permitted it despite a highly uncertain environment to guarantee firm fixed-price contracts to independent power developers Enron did this by pooling contracts with different timing and risk characteristics to minimize the company's exposure Although the bank itself did not take off, the idea of pooling 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 one hand, and by selling them vigorously to physicians, on the other Patent protection decreased the level of price competition, and health insurance made consumers relatively insensitive

to prices Brands were chosen almost entirely at the discretion of physicians, whose preferences were greatly influenced by the sales coverage of the drug companies

In the 1990s, the emergence of managed health care, provided for a fixed fee by companies that contract with employers, threatened to end the party The business model began to change when pharmacy benefits-management companies, which help large corporations manage the cost of their pharmacy benefits programs, entered the fray by encouraging doctors to use low-cost alternatives to branded products These pharmacy benefits managers were putting downward pressure on the profitability of the drug industry by capturing part of its profits for themselves and their corporate customers In the early 1990s, this threat gained more steam when the Clinton

Administration publicly championed the managed-care model, and the shaft prices of drug companies declined significantly as a result

Two leading drug manufacturers, Pfizer and Eli Lilly, responded to the coming of

managed care with quite different strategies Pfizer, building on its traditional

strengths in research and sales, took the operational approach Lilly, by contrast, took the transformational one and tried to shape the industry by purchasing a large

pharmacy benefits manager From 1992 to 1997, both companies created enormous shareholder wealth: 40 percent a year for Lilly, 35 percent for Pfizer, as compared

with the pharmaceutical industry average of 28 percent Many industry experts believe that both companies 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: their

respective skill sets determined the strategy they chose and its success.

Pfizer

While Lilly and such other pharmaceutical giants as Merck and SmithKline Beecham placed big bets by investing in pharmacy benefits managers, Pfizer stuck with the industry's 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 company's research operation, an industry leader in productivity and time to market, has been remarkably successful A 1995 industry survey reported that Pfizer's "discovery teams need less than one-third the industry's average of 190 person-years of work to advance a compound from conception to clinical trials."[*]

Pfizer's chief executive officer William Steere, a former salesman who joined the company in 1959 and rose through its marketing ranks has committed himself to building one of the industry's best sales forces His own experience suggested to him that the merits of novel drugs do not register with busy doctors until they hear the story from well-versed sales representatives Bucking the industry trend, he increased Pfizer's US sales force from 1,500 in 1990 to 3,467 in 1997,[+] often hiring talent cast off from other companies The company now has one of the most formidable sales forces in the industry, as reckoned both by size and by talent The Pfizer sales force uses leading-edge information systems and technology to track the prescription histories of physicians and to respond with sales coverage that delivers the biggest bang for the sales effort The company's information systems 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 comarketing rights for several major drugs produced by other companies

When Steere took over as chief executive officer, in 1991, he inherited a decade of aggressive investment in research and development by his predecessor, Edmund Pratt Pfizer had hired many of the industry's most experienced and talented scientists by offering them attractive compensation and an unbeatable opportunity to conduct leading-edge research The research team developed efficient management processes, including provisions for early input from marketing and a ruthless commitment to delivering practical results

Many other pharmaceutical companies are reluctant to kill even dubious research efforts, but Pfizer exerts discipline in managing projects at every stage of the

development process Research teams use "step charts" that show how many

promising compounds should be on hand at each phase of the drug development

process to cover the attrition rate These charts, based on robust statistical models, help the scientists apply themselves to delivering good business results Management practices of this kind, coupled with research and development budgets that rise at a rate of 18 percent a year, as opposed to the industry average of 9 percent, have stuffed the product pipeline

Pfizer offers an excellent example of how executives can recognize what their

companies do well and use that understanding to build superior strategies The

company followed what for the pharmaceutical industry was the traditional approach,

emphasizing sales and research This operational strategy, 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 Lilly's chief executive officer since 1993, was an industry outsider The former vice chairman of AT&T, he had been an

independent member of Lilly's board since 1986 The transformational strategy he

chose for the company included an effort to rethink its business focus and a

willingness to make industry plays to reposition it for the 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 also serves on the operations committee, an arrangement that helps Tobias, who heads the policy committee, to stay abreast of daily operations while focusing on the strategic agenda and leading the process of transformation

Tobias spent $4 billion for PCS Health Systems, a major pharmacy benefits manager,

to leverage an emerging industry discontinuity to Lilly's advantage As this move

shows, transformational strategies are risky by nature, for the emergence of pharmacy

benefits managers did not reshape the drug industry as anticipated, in part because the

US Federal Trade Commission took a skeptical view of vertical integration by drug companies In addition, many hospitals and health care plans that were customers of pharmacy benefits managers regarded this vertical integration as a conflict of interest

It is still an open question whether it makes strategic sense for drug companies to own pharmacy benefits managers, and this uncertainty forced Lilly to take a substantial write-off on the PCS deal in 1997 Yet Lilly's outstanding financial performance over

the past five years shows the soundness of the CEO's strategy, which has many other

dimensions

Tobias built a strong leadership team by elevating stellar performers within the company and by hiring people from the outside He also evaluated Lilly's business portfolio When he took over the company, it was involved not only in its core

pharmaceutical business but also in animal health, cosmetics, and medical devices Tobias divested a majority of these noncore entities most significantly, the medical device businesses, which were creatively spun off, 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 public offering to establish a share price Six months later, Lilly made the other 80 percent of Guidant's stock available to Lilly's

shareholders in exchange for Lilly stock This proved to be a masterly strategic move, giving Guidant a strong start, generating cash for Lilly's core business, and freeing management time 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 off for $120 million; and IVAC (medical and surgical instruments), for $200 million Meanwhile, the company made acquisitions to strengthen its core business: a 13.5 percent stake in Somatogen (for $20 million) as part of a strategic alliance to develop and market a blood substitute product, 100 percent ownership of Sphinx (for $72 million), and an 18 percent stake in Millennium BioTherapeutics (for $20 million), intended to give Lilly access to leading-edge capabilities for identifying auspicious chemicals for testing In 1997, the company accelerated the pace of its technology deals by creating a web of relationships to secure access to promising products and technologies

Lilly's organization excelled at making timely portfolio decisions of this sort All

transformational strategies require companies to make tough strategic choices

about first-mover investments to enter nascent markets, investments in technology, make-versus-buy problems, and so forth Although the jury is out on several of Lilly's investments, positive results from earlier deals suggest that the company, relying on strategic alliances and relationships, is creating a powerful drug portfolio

Tobias reorganized Lilly's functional structure around five therapeutic areas infectious diseases, cancer, cardiovascular products, endocrinology, and neuroscience in which the company had a strong presence, as well as unmet medical needs During the course of this reorganization, he also reevaluated Lilly's overall cost

competitiveness, reducing the workforce by 4,000 through an early-retirement

program that had two primary goals: to shed surplus employees and to give an "out"

to those who were not prepared for the transformational strategy The program was

driven from the top downward, carried out quickly, and designed to reveal and

promote high performers who would not have advanced under normal circumstances

These personnel decisions jump-started the transformational strategy.

* * *

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

organization, pursued his industry's traditional business strategy Randall Tobias,

supplying a successful vision of innovation and change, leveraged the adventurous

mentality of an organization that was willing to take steps outside its own walls The success of these two leaders shows the power an organization gains when it focuses

on doing what it does well In many industries, there is no one right course; a strategy cannot be assessed apart from the skills of the company trying to execute it The cases

of Duke and Enron in energy and of Pfizer and Lilly in pharmaceuticals show that

both operational and transformational strategies can yield outstanding results in the

same industry and at the same time

Yet this is not to say that there is never a single right strategy During the 1980s and

early 1990s, for example, Wal-Mart turned the discount-retailing business into a pure

game of operational strategy by excelling in information technology, logistics

infrastructure, and front-line execution Companies that pursued transformational

strategies failed across the board Conversely, in biotechnology and electronic

commerce, transformational strategies are the only way to succeed, at least in the next

few years while the industry structure is so volatile

Finally, sometimes the senior management of a company must push for exceptional performance and rethink its entire business at the same time that is, executive both

organizational and transformational strategies Companies rarely seem to accomplish

this, but Ford and British Airways have recently done so Such exceptional situations always involve the replacement of top management, including the CEO (British Airways), or the induction into top management of significant additional talent (Ford) The new leaders usually pursue programs for implementing change over a number of years

Despite these counter-examples, we believe that most companies can benefit from

thinking of strategy as the art of what is possible for them A capably executed

strategy will deliver better results than one that may be more elegant in principle but does not reflect an organization's strengths It makes sense to choose the strategy that

is sound for a particular company, meets its financial aspirations, and provides the best fit with the abilities of its top managers, its organizational skills, its approach to risk management, and its monitoring system

• See Thomas E Copeland and Philip T Keenan, "Making real options real,"

The McKinsey Quarterly, 1998 Number 3, pp 128-41; Kevin P Coyne,

Stephen J D Hall, and Patricia Gorman Clifford, "Is your core competence a

mirage?" The McKinsey Quarterly, 1997 Number 1, pp 40-54

• See Richard Dobbs and Matthew Elson, "Regulating utilities: Have we got the formula right?" pp 133-44; Peter Crawford, Kristen Johnsen, Jim Robb, and Peter Sidebottom, "World Power & Light," pp 122-32

• Fortune, "Why Pfizer is so hot," May 11, 1998

• POV Reports and MedAd News

• See Patricia L Anslinger, Steven J Klepper, and Somu Subramaniam,

"Breaking up is good to do," pp 16-27