2012 Number 2

Put your
money where
your
strategy is
 2012 Number 2

This Quarter

In today’s volatile business environment, many

companies appear to be surprisingly slow at
rebalancing their corporate priorities and portfolios.
New research from McKinsey’s strategy practice
reveals that there is essentially no change in the amount
of capital that business units receive and deploy from
one year to the next (the mean year-to-year correlation
is 0.92). This isn’t just an interesting analytic finding;
it’s powerful evidence that many corporate strategies
are stagnant, despite the rigor with which most
companies plan for the future and review performance.

In “How to put your money where your strategy is,” my colleagues

Stephen Hall and Reinier Musters, along with University of Sydney
Business School professor Dan Lovallo, show just how costly this
strategic inertia can be, explore some of the reasons for it, and identify
remedies. In a related article, Hall teams with Bill Huyett and Tim
Koller, from McKinsey’s corporate finance practice, to propose ways
the corporate center can stimulate the reallocation of capital,
talent, and other scarce resources. Finally, two practitioners—the
CFO of Rio Tinto and the president of a major business unit at
Honeywell—offer suggestions for overcoming inertia.

One business function that couldn’t be less static these days is

marketing. The social-media revolution is forcing companies to
rethink their approach to bread-and-butter issues such as
advertising and customer engagement. In “Demystifying social
media,” Roxane Divol, David Edelman, and Hugo Sarrazin
argue that it’s time to move beyond experimentation. More specifically,
they offer a systematic approach for connecting social media with
the evolving “consumer decision journey” that several colleagues and
I introduced in these pages three years ago. This new approach
is an exciting step forward for any executive interested in riding the
social-media wave instead of being swamped by it.

Social technologies also hold powerful implications for the

way organizations operate internally. In “The social side of strategy,”
Arne Gast and Michele Zanini describe some intriguing ways
that companies are starting to use wikis, prediction markets, and
other crowdsourcing tools to catalyze more informed strategic
dialogue and decision making, while boosting organizational align-
ment. Challenges exist with such approaches, as Olivier Sibony
reminds us in a related commentary, but their potential is intriguing.

Leaders who can listen well are more likely to take on board new
insights generated by social technologies and to jump on opportunities
that require significant shifts in corporate resources. But listening
skills are seldom taught. Former McKinsey director Bernard Ferrari
tries to remedy that in “The executive’s guide to better listening,”
while Amgen CEO Kevin Sharer offers his own reflections on
the power of listening by recounting an epiphany that made him
start to hear what he’d been missing. We hope this issue of the
Quarterly strikes a similar chord with you.

David Court
Director, Dallas office
On the cover
Rethinking corporate strategy

28 How to put your

money where
your strategy is
Stephen Hall, Dan Lovallo,
and Reinier Musters

Most companies allocate the same

resources to the same business
units year after year. That makes it
difficult to realize strategic
goals and undermines performance.
Here’s how to overcome inertia.

39 The power of an independent

corporate center

Stephen Hall, Bill Huyett,

and Tim Koller

To develop a winning corporate

strategy, you may need more muscle
in your headquarters.

42
Breaking
strategic inertia:
Tips from two
leaders
Rio Tinto’s Guy Elliott and
Honeywell’s Andreas Kramvis explain
how they overcome the barriers
that all too often separate capital,
talent, and other resources from
vital strategic goals.
 Features

50 The executive’s 82 The social side

guide to better of strategy
listening Arne Gast and Michele Zanini

Bernard T. Ferrari Crowdsourcing your strategy may

Strong listening skills can make a
critical difference in the performance
of senior executives, but few actively
cultivate them.
sound crazy. But a few pioneering
companies are starting to do just that,
boosting organizational alignment
in the process. Should you join them?

94 Collaborative strategic
61 Why I’m a listener: planning: Three observations
Amgen CEO Kevin Sharer
Olivier Sibony
The biotech giant’s chief executive
describes the epiphany that made him
Social-strategy tools can provide
a better listener and explains why
real value to a company whose
listening is a survival skill for leaders
executives know how to use them.
and organizations.

66 Demystifying
social media Departments
Roxane Divol, David Edelman,
and Hugo Sarrazin

As the marketing power of social media 7 McKinsey on the Web

grows, it no longer makes sense to Highlights from our digital
treat it as an experiment. Here’s how offerings
senior leaders can harness social media
to shape consumer decision making
in predictable ways.
8 Idea Exchange
Readers mix it up with authors
78 Understanding social of articles from McKinsey Quarterly
2012 Number 1
media in China

Cindy Chiu, Chris Ip,

112 Extra Point
and Ari Silverman
A field guide to identifying bad
listeners
The world’s largest social-media market
is vastly different from its counterpart
in the West. Yet the ingredients
of a winning strategy are familiar.
 Leading Edge Applied Insight

10 A clearer-eyed view 99 Developing better change

of M&A leaders

Werner Rehm, Robert Uhlaner, Aaron De Smet, Johanne Lavoie,

and Andy West and Elizabeth Schwartz Hioe

Companies that do many small deals Putting leadership development at

can outperform their peers—if they the heart of a major operations-
have the right skills. But they need more improvement effort paid big dividends
than skill to succeed in large deals. for a global industrial company.

13 Is there a payoff from top-

team diversity?
Spotlight on India
Thomas Barta, Markus Kleiner,
and Tilo Neumann
105 How multinationals can
Between 2008 and 2010, companies
win in India
with more diverse top teams were
also top financial performers. That’s Vimal Choudhary, Alok Kshirsagar,
probably no coincidence. and Ananth Narayanan

Multinational companies must

16 How the role of equities
may shrink
Susan Lund and Charles Roxburgh
110 How Tata Group is raising
Emerging-market households are
becoming potent new global investors,
but so far they seem less inclined
than developed-country investors to
hold equities.
20 Does your CEO
adapt to Indian conditions in order
to thrive there.
its game
Rajat Dhawan, Gautam Swaroop,
and Adil Zainulbhai
Tata Group’s experience offers
clues for multinationals seeking to
“Indianize” their operations.

compensation plan provide

the right incentives?

David F. Larcker and Brian Tayan

Few boards look at how the CEO’s

total wealth invested in the company
changes as stock prices fluctuate.
They could—and they should.
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7
Now available on
mckinseyquarterly.com
The trouble with
travel distribution
It’s among the biggest e-commerce
markets, and maybe the most
turbulent. To compete, players must
define their place in travel’s next
wave. Explore the article’s interactive
exhibit to see how suppliers can
win customers.
Spotlight on China:
Meet the Chinese consumer of 2020
Evolving economic profiles will
continue to be the most important
trend shaping the market.
Stephen Roach on the consumer
opportunity in China
In this video interview, Morgan
Stanley’s former nonexecutive
chairman explains how focusing on
exports to the world’s second-
largest economy will help the United
States generate growth and jobs.
What’s in store for China in 2012?
Despite food price inflation and
a stagnant housing market,
China should maintain a rapid rate
of growth this year, argues
McKinsey director Gordon Orr.
Read his ten predictions for
the country.
 8

Idea Exchange
Readers mix it up with authors of articles from McKinsey Quarterly
2012 Number 1

How leaders kill meaning at work

In our previous issue, Teresa Amabile, a professor at Harvard Business
School, and Steven Kramer, an independent researcher, argued that
senior executives routinely undermine productivity and commitment by
damaging the inner work lives of their employees in four avoidable
ways. A discussion of those traps continued on mckinseyquarterly.com;
here, the authors respond to readers’ comments.

Share to win
Harold Lefkowitz
Regional director, DigitalDerm; New York City

“Another way to avoid a trap is to create a clear forum to share ideas,

improvements, and innovations from the bottom up. Top-level managers
have experience, insight, and the most information about their companies
to generate good ideas—and employee input makes the good ideas better.”

The authors respond:

“A forum for idea exchanges between people in the trenches and people at the top is a
terrific idea that could be especially useful for avoiding the corporate Keystone Kops trap
we discussed. Because frontline employees are likely to be affected by a consistent lack
of coordination, they can articulate useful solutions. This requires a high degree of trust on
the employees’ part that what they say won’t be used against them. Such a forum is
usually easier to create at small start-ups, but one large, well-established organization that
has done so is Zappos, with its culture book. Periodically, employees are asked to submit
their honest views of the Zappos culture—both positive and negative. Managers will often
take action to fix the problems the workforce perceives.”

Fostering ownership
Mitch McCrimmon
Managing partner, Self Renewal Group; Toronto

“A lot of companies would say they avoid these four traps. For me, a deeper
reason why executives disengage employees is the metaphor of the
organization as a person, which means that the ‘head’ thinks and the ‘hands’
do. A primary role of managers is to ask employees what they think, not
only about the problems they face but also about strategic issues in order to
engage them in the whole business and foster wider ownership for success.”

The authors respond:

“We agree completely about the need for two-way communication. Individual employees
need to communicate effectively with their bosses, but that can only happen if leaders
create an environment where all employees are heard and respected. In our research, sub-
ordinates often felt that they were ignored—or even worse, criticized—when they offered
ideas. Second, consider top-down communication: we have seen many cases in which top
management sent contradictory messages. One vice president would insist a project
was a top priority, only to have another say the opposite. We would hope that top manage-
ment would seek input from frontline workers, decide on priorities, and then communi-
cate them clearly and consistently. But when leaders fail in this basic way, a two-way
conversation—if it can even happen—would not lead to much clarity.”
 9

The human factor in service design

Companies can achieve greater impact from their services when they design
them to be more psychologically savvy, economic, and scalable, wrote
McKinsey’s John DeVine, Shyam Lal, and Michael Zea in our previous issue.
Readers on mckinseyquarterly.com offered additional filters through which
to view the task of service design.

What about gender?

Ann Lehman
Policy director, San Francisco Dept. on the Status of Women; San Francisco

“I would suggest that one component of ‘How human is our service?’ [one
of the three design factors explored in the article] is asking whether or not the
service takes gender issues into account.”

The authors respond:

“Good point. Gender is one potential dimension to consider in customer segmentation
and can be accounted for as companies work more broadly to identify and understand
the needs, attitudes, preferences, and behaviors of various customer groups. But
companies should never rely solely on gender, or any single demographic identifier, as a
factor in service design. One consumer electronics retailer we studied, for example,
uses outwardly observable shopping behaviors to inform the creation of simple guides—
heuristic ‘short cuts’—that help its employees identify and respond to different customer
segments and their needs by first asking basic questions, such as ‘What are you looking
for in your personal entertainment device?’ Based on the answer, the employee
pursues specific discussion paths, emphasizing different products and features, and
often sequencing the discussion differently depending on the customer.”

Don’t forget brand building

Melissa Kalish
Partner, MBLM; New York City

“Determining if services are human, economic, and scalable are three great
filters; another one is understanding and acting on customers’ brand-
based expectations for service when seeking to transform service gaps into
brand-building opportunities.”

The authors respond:

“Indeed! The companies that are best at designing customer service processes
also incorporate a very clear brand experience or value proposition. One company, for
example, made sure that a phrase tied into its brand (‘simplicity with a smile’) was a
fundamental piece of its customer service design. Other companies design services for
specific experiences that link closely to their brands, such as high levels of personal-
ization or technologically advanced features. One note: in the actual design process—the
establishment of the process steps and supporting technologies—companies must
make hundreds of small trade-offs. To create an excellent customer service experience,
the branded value proposition should drive the way these trade-offs are prioritized.”
10 2012 Number 2 Research, trends, and emerging thinking
Leading Edge
A clearer-eyed view
of M&A
Werner Rehm, Robert Uhlaner, and Andy West
Companies that do many small deals can outperform their peers—if they have the right skills. But
they need more than skill to succeed in large deals.
The appeal of big deals is perennial:
they can be transformative in stra-
tegic terms, add asset heft for future
competitive battles, and for large
companies may be one of the clear-
est paths to achieve material growth
rates. But leaders hoping to use
M&A to outperform their peers should
also be aware of the value that a
program of smaller, targeted deals
can create. On average, in fact,
our research suggests that more
programmatic M&A is likely to
generate stronger returns than the
occasional big deal.
Our analysis focused on the excess
total returns to shareholders (TRS)
10 13
A clearer-eyed Is there a payoff
view of M&A from top-team
diversity?
16 20
How the role Does your CEO
of equities may compensation
shrink plan provide
the right
incentives?
of the world’s top 1,000 nonbanking
companies, which completed
more than 15,000 M&A deals over
the past decade.1 We segmented
companies into five patterns of
deal making depending on the scope
of their M&A activities. A corre-
lation of these patterns with long-
term excess returns shows that
companies achieved positive total
returns over the last decade while
pursuing a range of approaches
(exhibit), including programmatic deal
making that involves frequent
smaller targets, tactical acquisitions
aimed at procuring specific capa-
bilities, and strategies driven primarily
by organic growth. Even though
 11

organic growth was positive, it’s delivering 4 percent in excess

worth noting that programmatic M&A
delivered higher excess returns.
While average returns were negative
for companies engaging in at
least one large deal (where the target
was worth more than 30 percent
of the acquirer’s market cap), closer
examination of the data reveals
that industry context is critical. Com- tors have been less successful,
panies doing larger deals in mature,
slow-growing industries, for
Q2 2012 example, generate higher returns,
2011 M&A
Exhibit 1 of 1
Exhibit
TRS in the five-year period after the
deal. For these big combinations,
there is value in reducing excess indu-
stry capacity, and a lengthy inte-
gration effort may be less disruptive
to performance.
On the other hand, companies
doing large deals in fast-growing sec-
with excess total returns around
–12 percent. In certain industries
that depend on rapid product

Companies using a programmatic strategy were the

most successful.
Companies using a programmatic strategy were the most success-
ful.
Global 1,000 nonbanking companies, %

Average 95% confidence interval

Median excess TRS,1 Probability Excess TRS,1 difference

Dec 1999–Dec 2010 of excess return between 25th and 75th
greater than zero percentile in percentage points

Programmatic 2.8 64 9

Selective 2.0 64 10

Organic 2.0 58 14

Tactical 1.3 61 8

Large deal –1.7 44 12

1 TRS = total returns to shareholders; median excess TRS = outperformance against global industry index for each company.

Source: Dealogic; McKinsey analysis

 12 2012 Number 2

1 We measure excess total returns to

development (such as high tech), we
shareholders (TRS) by assigning companies
found that managers tended to
to subsectors and tracking the difference
focus inwardly during the protracted between a company’s TRS and an index
integration required for large deals— that follows the sector. In this analysis, we
used 11-year excess TRS to avoid some
which led them to miss critical of the issues resulting from the collapse of
upgrades. Another factor depressing the high-tech bubble in the early 2000s.
returns: high-tech companies
often did larger deals when valua- The authors would like to thank
tions were high, and they chose Theresa Lorriman for her significant
targets in complementary businesses contribution to the research
where there often was limited supporting this article.
overlap in products and technology.
Werner Rehm is a senior expert
Small deals seem less subject to in McKinsey’s New York office,
these structural effects. We found Robert Uhlaner is a director in
that companies across many the San Francisco office, and
sectors were successful with small- Andy West is a principal in the
deal strategies. To be ready for Boston office.
such opportunities, companies need
M&A capabilities that allow them Copyright © 2012 McKinsey & Company.
to continually scan for sources All rights reserved. We welcome your
of portfolio renewal, while effectively comments on this article. Please send them
to quarterly_comments@mckinsey.com.
and routinely executing and
integrating acquisitions. Companies
with skills such as these may
wind up making more acquisitions,
reduce their reliance on the
occasional large deal, and be better
prepared to execute on attractive
ones that do arise. The good news
for senior executives is that it is
well within their power to build the
organizational muscle needed to
pull off an M&A program, regardless
of deal size.

For the full version of this article, see

“Taking a longer-term look at M&A value
creation,” on mckinseyquarterly.com.
 Leading Edge
Is there a payoff from
top-team diversity?
Thomas Barta, Markus Kleiner, and Tilo Neumann
Between 2008 and 2010, companies with more diverse top teams were also top financial
performers. That’s probably no coincidence.
There are many reasons companies
with more diverse executive
teams should outperform their peers:
fielding a team of top executives
with varied cultural backgrounds and
life experiences can broaden a
company’s strategic perspective, for
example. And relentless compe-
tition for the best people should
reward organizations that cast their
nets beyond traditional talent
pools for leadership.
To understand whether reality is con-
sistent with theory, we looked
at the executive board composition,1
returns on equity (ROE), and
margins on earnings before interest
and taxes (EBIT) of 180 publicly
traded companies in France,
Germany, the United Kingdom, and
the United States over the period
from 2008 to 2010. To score a com-
pany’s diversity, we focused on
two groups that can be measured
objectively from company data:
women and foreign nationals on
senior teams (the latter being
a proxy for cultural diversity).
13
Diversity and performance
The findings were startlingly
consistent: for companies ranking in
the top quartile of executive-board
diversity, ROEs were 53 percent
higher, on average, than they were
for those in the bottom quartile.
At the same time, EBIT margins at
the most diverse companies
were 14 percent higher, on average,
than those of the least diverse
companies (exhibit). The results were
similar across all but one of the
countries we studied; an exception
was ROE performance in France;
but even there, EBIT was 50 percent
higher for diverse companies.
The broad range of companies in
our sample makes us confident
that industry-specific distortions—
those arising, for instance, when
a particularly profitable industry has
high numbers of foreign executives—
are negligible. We did another
stress test as well, looking at a sub-
set of German companies for
the independent (as opposed to com-
bined) effects of gender and
 14 2012 Number 2

Q2 2012
Diversity
Exhibit 1 of 1

Exhibit

Companies with diverse executive boards enjoyed significantly

Companies
higher with diverse
earnings executive
and returns onboards enjoy significantly
equity.
higher earnings and returns on equity.
Average returns on equity (ROE) and margins on earnings before
interest and taxes (EBIT),1 2008–10, %
Diversity of the executive board2

Top quartile
Bottom quartile

Breakout by country

Overall France Germany United Kingdom United States

12.1 8.5 10.3 27.8 16.2

ROE
7.9 9.0 6.2 16.7 8.3
+53% –6% +66% +66% +95%

9.8 10.8 9.3 25.1 11.2

EBIT margin
8.6 7.2 5.1 19.5 7.1
+14% +50% +82% +29% +58%

1 Comparison of top quartile vs bottom quartile of DAX 30 (Deutscher Aktienindex), CAC 40 (Euronext Paris), the top 30 by market
cap of the FTSE 100, and the 80 Fortune 500 companies with the highest and lowest diversity levels; diversity analysis based on women
and foreign nationals/ethnic minorities on companies’ executive boards; adjusted for statistical outliers.
2 Our multivariate regression analysis of diversity with country-specific fixed effects gives a coefficient of +9.89 (significant at 1% level)
or +4.71 (significant at 10% level).
Source: Bloomberg; Thomson Reuters Datastream; McKinsey analysis

international diversity. Here, too, the tinue to explore these issues in

performance relationships were
strong. Research by our colleagues
that focuses on senior women
alone (and was conducted over time
frames different from ours) also
produces similar results.2
Diversity in action
We acknowledge that these findings,
though consistent, aren’t proof
of a direct relationship between diver-
sity and financial success. At high-
performing companies, the board or
CEO may simply have greater
latitude to pursue diversity initiatives,
and other management innova-
tions may contribute more directly
to superior results. We will con-
further research.
As a starting point, and to get
a reality check on the aggregate
data, we looked for evidence of
diversity’s influence on the actions
of individual companies during
the volatile 2008–10 time frame our
analysis covered. In a number
of cases, diversity appeared to play
a critical role. At adidas, one of
the companies that ranked in our
top quartile in diversity and
performance, senior leaders have
designated diversity as a stra-
tegic goal and started building it
into the guts of the organization.
To deepen the talent base, for
Leading Edge
instance, the company has set
hard targets for increasing the
number of women in management
ranks. Today, women account
for 30 percent of all managers,
up from 21 percent three years ago.
The company’s goal for 2015 is
35 percent. The effort is supported
by numerous policies, including
gender-balanced recruiting, child
care assistance, and flex- and
part-time work opportunities. To
spur innovation across global
markets, adidas is also ensuring
diversity in its design centers—
and has won a number of awards
for product creativity.
Among other top-ranking companies
in our research, senior-team diver-
sity appeared to support strategies
with a cross-cultural dimension.
One global food company that
ranked in the top quartile for diversity
completed a series of successful
international joint ventures between
2008 and 2010. These actions
advanced a strategic goal of geo-
graphic decentralization and
risk diversification, while ensuring
that its products fit the varying
preferences of local cultures and
markets. The more diverse foot-
print paid operational dividends as
well: at some of these joint ven-
tures’ plants, the company discov-
ered highly efficient manufacturing
processes, which it absorbed
and then disseminated across its
own manufacturing base. Simi-
larly, a leading telecommunications
company whose top team hailed
from a number of different nations
significantly expanded its global
network infrastructure and was able
15
to meet ambitious growth targets in
emerging markets.
While we can’t quantify the exact
relationship between diversity
and performance in such cases, we
offer them as part of a growing
body of best practices. These suc-
cessful companies are simulta-
neously pursuing top-team diversity,
ambitious global strategies,
and strong financial performance.
1 This group encompasses the senior leadership
of companies in the United Kingdom and
the United States, as well as management
board members in France and Germany
(Comités Exécutifs and Vorstand,
respectively).
2 For more on these results, see two studies
in McKinsey & Company’s Women Matter
series: Women at the top of corporations:
Making it happen (October 2010) and
Women Matter: Gender diversity,
a corporate performance driver (October
2007), available on mckinsey.com.
Thomas Barta is a principal in
McKinsey’s Cologne office, Markus
Kleiner is a consultant in the
Frankfurt office, and Tilo Neumann
is a consultant in the Berlin office.
Copyright © 2012 McKinsey & Company.
All rights reserved. We welcome your
comments on this article. Please send them
to quarterly_comments@mckinsey.com.
 16 2012 Number 2

How the role of

equities may shrink
Susan Lund and Charles Roxburgh

Investors in developed nations hold a dominant share of

Q2 2012
global financial assets, but emerging-market portfolios
Equity gap
are growing
Exhibit 1 of 4 four times as fast and should represent about
30 percent of global wealth by 2020.

Total financial assets,1 2010 exchange rates, %

Nominal GDP
growth rate, %

100% = $113 $198 $371 2000–10 2010–20

trillion trillion trillion forecast
3
10
4 14 China
12.0 10.8
11
Other emerging
16
markets

93
79
70 Developed nations 3.1 4.3

2000 2010 2020 consensus

growth scenario

1
Includes cash and deposits, fixed-income securities, listed equities, and alternative investments; excludes commodities, derivatives,
nonlisted equities, and real estate.
Source: National sources; McKinsey Global Institute analysis
 Leading Edge 17

As emerging-market households reach income levels that allow them to purchase

financial assets, they are becoming potent new global investors. So far, they
seem less inclined than developed-country investors to hold equities—a tendency that
could influence how businesses obtain capital, how investors fare, and how resilient
and stable some economies will be.

Emerging-market investors currently behave

differently than their counterparts in developed markets,
preferring bank deposits and cash instead of equities.

Emerging investors, asset allocation by investor, 2010,1 %

Equities Fixed income Cash and Other 100%,

deposits $ trillion

Sovereign-wealth funds 52 29 15 6 4.3

0
Developed Asian households2 32 13 54 3.6

Middle Eastern and North

18 14 65 3 2.7
African households

Latin American
households 14 24 54 8 3.5

0
Chinese households
14 5 81 6.5

Emerging Asian 0
households 10 13 77 1.8

0 0
Emerging-market
90 10 5.9
central banks

Equities, UK Equities, US
households and households and
pensions = 34% pensions = 47%

1
Figures may not sum to 100%, because of rounding.
2
Includes Hong Kong, Singapore, and Taiwan; excludes Japan, where households allocate 10% of their portfolio to equities.

Source: National sources; McKinsey Global Institute analysis

 18 2012 Number 2

Q2 2012
Equity gap
That could
Exhibit 3 of 4contributeto a shift away from equities in the
global asset allocation, which will be reinforced by
aging investors in developed nations whose retirement
needs dampen their appetite for equities.

Global asset allocation, consensus growth scenario (rounded figures), %

2020 forecast

Equities

22
2010

Equities
28

Other
Other 78
investments1 72 investments1

100% = $198 trillion 100% = $371 trillion

2
Factors in the projected 6% decrease in global equities, share by percentage point

Rising wealth in
2.6
emerging markets

Aging populations 1.7

Growth of alternative
1.3
investments

Shifting pension
0.4
portfolios

Changing regulations 0.3

1 Includes cash, deposits, and fixed-income securities.

2 Figures do not sum to total, because of rounding.

Source: McKinsey Global Institute analysis

This analysis is drawn from the McKinsey

Global Institute report The emerging
equity gap: Growth and stability in the new
investor landscape (December 2011),
available online at mckinsey.com/mgi.
 Leading Edge 19

012 Investor behavior is dynamic, however. In China, investors

Q2 2012
y gap Equity
in gap
wealthier cities are more likely to hold equities. Whether
bit 4 of Exhibit
4 4 of 4
and how that shift takes place in other emerging markets
will shape the evolution of their asset allocations.

nvestment patterns Investment patterns

% households
% after city name = % of after city name = % ofinhouseholds
investing investing
equities (also includes in equities
mutual (also includes mutual funds)
funds)

ities grouped by range ofCities groupedinvesting

households by rangeinofequities
households investing in equities

>25% 15–25% >25% <15% 15–25% <15%

ize of bubble represents Size of bubble

relative size of represents
deposits relative size of deposits

$59 billion (Beijing) $59 billion (Beijing)

$10 billion (Chengdu) $10 billion (Chengdu)

Beijing, 18% Beijing, 18%

Jinan, 8% Jinan, 8%
Kaifeng, 8% Kaifeng, 8%

Mianyang, 7% Mianyang, 7%
Chengdu, 8% Chengdu, 8%
Shanghai,
Shanghai, 38%
Xiamen, 2
Xiamen, 21%
Guangzhou,Guangzhou,
19% 19%
Shenzhen, 19%
Shenzhen, 19%

Exhibit
Source:
Source: 2011 McKinsey survey sources:
of 2011 McKinsey
20,000 National
survey
consumers in 13 sources;
of Asian
20,000 2011
consumers
markets; inMcKinsey
13 Asian
McKinsey survey
markets;
Global of 20,000
McKinsey
Institute analysis Globalconsumers in
Institute analysis
13 Asian markets; McKinsey Global Institute analysis

Susan Lund is director of research at the McKinsey Global Institute

(MGI) and a principal in the Washington, DC, office; Charles Roxburgh is
a director of MGI and a director in the London office.

Copyright © 2012 McKinsey & Company. All rights reserved. We welcome your comments
on this article. Please send them to quarterly_comments@mckinsey.com.
20 2012 Number 2
Does your CEO
compensation plan
provide the
right incentives?
David F. Larcker and Brian Tayan
Few boards look at how the CEO’s total wealth invested in the company changes as stock
prices fluctuate. They could—and they should.
Boards, shareholders, and journal-
ists often look at a chief executive’s
annual compensation plan to
determine whether the company is
offering the right incentives
to increase shareholder value. But
few consider another key question:
how does the compensation that
the CEO has already received over
the years in the form of stock and
stock options influence managerial
decision making? Our research
shows that for most CEOs in the
United States, accumulated wealth
effects are likely to swamp those
of year-to-year compensation—merit-
ing serious attention when boards
evaluate how risk structures and
incentives of executive pay packages
align with the company’s strategy.
Wealth effects
Since 2006, a wider array of data
on executive holdings of stock
and options has become available
in proxy statements filed with
the US Securities and Exchange
Commission. There is now enough
of it to permit serious research.
We began by taking the median
total annual compensation of chief
executives and comparing it
with their median total accumulated
wealth.1 For those at the largest
20 percent of publicly traded
companies, median accumulated
wealth was nine times CEO median
compensation. We also plotted
the percentage change in CEO
wealth against percentage changes
in stock price and found that
a 50 percent increase in stock price
would translate, at the median, to
an expected wealth gain of six times
annual compensation. For smaller
companies, total compensation lev-
els are lower. The ratios of accu-
mulated CEO wealth to income, as
well as those of wealth increases
to income resulting from significant
stock price gains, are also some-
what lower.2
 Leading Edge
These results, which in large part
reflect the leverage provided by stock
option grants that are part of pay
packages at many companies,
highlight the substantial monetary
incentives offered for CEOs to
make strategic and investment deci-
sions that increase shareholder
value. Our data further indicate that
wealth effects—and thus the lev-
els of risk that CEOs are encouraged
to take—vary widely, even among
direct competitors. It is not always
clear if this is intentional or simply
the inadvertent, cumulative impact
of grants made year after year at
varying price levels that are either
higher or lower than today’s
price—which could leave the chief
executive with a portfolio of shares
and options whose payoff function
is quite different from what the
board originally intended.
Our data further indicate
that wealth effects—
and thus the levels of
risk that CEOs are
encouraged to take—
vary widely, even among
direct competitors.
21
Comparing pay structures
via ‘convexity’
One practical way of making this
assessment is to plot changes
in CEO wealth against changes in
the company share price and
observe the shape (or “convexity”)
of this payoff curve. If the CEO’s
portfolio contains only shares, it will
tend to rise and fall one-for-one
with a change in stock price. We refer
to this as “low convexity.” If, how-
ever, the CEO’s portfolio contains
a large number of stock options,
and especially multiple tranches of
out-of-the-money stock options,
the payoff curve can become quite
steep (high convexity). Convex
payoff structures such as these pro-
vide more financial incentives for
CEOs to take on promising—albeit
risky—investments because
the CEO stands to earn very large
rewards if successful. By performing
this analysis, the board can bench-
mark the CEO’s payoff function
against those of direct competitors to
determine whether the incentive
structures are comparable to other
leaders in the industry.
Consider the experiences of two
CEOs from competing firms in the
fashion retailing industry (Exhibit 1).
Whereas a 100 percent increase
in stock price would lead to a
102 percent increase in wealth for the
CEO of one company, it would
lead to a 190 percent increase in
wealth for the second company—
a much more convex payoff as
a result of a richer mix of options.
Compensation at the latter com-
pany may thus encourage greater
risk taking. It might be the case
22 2012 Number 2

Q2 2012
Governance
Exhibit 1 of 2
Exhibit 1

The shape—or ‘convexity’—of a CEO’s payoff curve provides

a benchmark to determine whether the incentive
The shape—or ‘convexity’—of a CEO’s payoff curve provides
structures
a benchmarkare comparable
to determine to those
whether of other structures
the incentive industry leaders.
are comparable to those of other industry leaders.

Example of 2 fashion retailers

Increase in CEO’s
wealth from
Change in expected value of CEO’s stock and option 100% increase in
portfolio caused by change in stock price, % stock price

200 Curve is convex: 190%

portfolio contains
150 a large number of
stock options
Retailer B
100 Curve is not 102%
convex: portfolio
contains fewer
50
stock options
Retailer A
0

−50

−100
−100 −50 0 50 100
Change in stock price, %

Source: Calculations by David F. Larcker and Brian Tayan, based on compensation data provided in each company’s 2011 Form DEF-14A

that these are both appropriate
arrangements, because the
two firms face different strategic
opportunities and challenges. It
could also be the unintended
result of option grant timing and
market performance. Or it
might be the case that the market
opportunities for the companies
are similar and the boards of one or
both haven’t thought deeply about
whether incentives are appropriate.
Similarly, we found that the CEO
of one regulated public utility
has convexity in his compensation
of 1.00 (a 100 percent increase
in stock price leads to a 100 percent
increase in wealth), while the CEO
of another public utility has convexity
of 1.51. Here, too, having a clear
picture of the two compensation
contours can help board members
decide on whether risk levels are
appropriate for regulated utilities.
 Leading Edge 23

Volatility as a window on risk risky investments because the

We can take the analysis one
step further and plot the change in
expected CEO wealth against
changes in stock price volatility. This
additional detail can paint a stark
picture of the degree to which boards
are encouraging risk taking.
The foundation for this analysis
is the incentives associated
with stock options and grants: If a
CEO’s investment portfolio is
heavily weighted toward options, he
Q2 2012 or she is motivated to take on
Governance
Exhibit 2 of 2
Exhibit 2
present value of the options
package increases as volatility rises
in step with a more ambitious
and potentially uncertain strategy. If,
on the other hand, the investment
portfolio is composed entirely
of stock, the CEO is not rewarded
for volatility, creating an incentive
to take on safer projects with lower
risk and return.
This dynamic is illustrated by two
pharmaceutical companies shown
in Exhibit 2. The CEO of company

A significant share of compensation in stock options

causes a CEO’s payout to rise dramatically with a rise in
A significant share of compensation in stock options
stock
causesprice volatility.
a CEO’s payout to rise dramatically with a rise in
stock price volatility.

Example of 2 pharmaceutical companies

0 = current expected net

Change in expected value of CEO’s stock and option portfolio present value at company’s
caused by change in stock price volatility, % current volatility
50

40
Pharma company B
30

20

10

0
Pharma company A
−10

−20

−30

−40

−50
−100 −50 0 50 100

Change in stock price volatility, %

Source: Calculations by David F. Larcker and Brian Tayan, based on compensation data provided in each company’s 2011 Form DEF-14A
24 2012 Number 2
A holds only direct stock investments
and restricted shares, so the exec-
utive’s payout function is essentially
a flat line and is unaffected by a
volatile stock price. The CEO of com-
pany B, by contrast, receives a
significant share of compensation
in stock options, so the exec-
utive’s payout rises dramatically with
greater volatility, as shown by the
upwardly sloping line.
Which is the better approach? The
answer will depend on whether
the success of the company requires
innovation and risky investment or
whether it requires the steady devel-
opment of existing products. In
the pharmaceutical industry, it is not
hard to imagine that the board
should encourage at least some level
of risk. Risky projects that fail
are sure to destroy value, but failure
to innovate at all is also sure to
destroy value.
Evaluating your CEO’s payoff
structure
Since this analysis is relatively new,
and wealth effects aren’t routinely
calculated and reported, we suggest
boards do some benchmarking
against peers to see if it raises ques-
tions about the financial incentives
they have created for their CEO.
Is risk in line with industry peers, and,
more importantly, is it in line with
the company’s strategic objectives?
Have changes in the stock market
changed the convexity of the CEO’s
reward curve in a way that encour-
ages excessive risk? If so, should the
board change the mix of future
annual pay grants to get the curve
back in line with objectives? Should
it reprice existing options to reduce
convexity? If the CEO wants to
sell or hedge some of his or her
personal portfolio in order to reduce
personal-investment risk, how
will this change the incentives
to perform?
Boards should also be aware of how
the effects of tenure may misalign
CEO incentives and strategy over the
longer term. For long-standing
CEOs, convexity will often decline
as options vest and wealth in the
company shifts primarily to stock.
The board in this case may want
to amplify convexity to discourage
risk aversion. In a less frequent
occurrence, the time effects may
actually increase convexity,
when, for example, a company is
recovering from a long-term
decline in share price and an exec-
utive retains a substantial num-
ber of unexercised options that had
been deeply out of the money.
Here, appropriate action to dampen
convexity may be required.
Finally, it is useful in another way for
the board to understand the dollar
amount that the CEO can earn if “all
the stars align” for the firm and its
stock price rises sharply. Boards are
sometimes faced with the problem
of what to say to activist shareholders
and media when the CEO receives
very large payouts. The wrong
answer is, “We never looked at that,
because we did not think it would
happen.” Many boards will likely find
that the payout amounts for various
levels of stock price targets are
 Leading Edge 25

much different than they expected, David Larcker is the James Irvin
often encouraging too much or too Miller Professor of Accounting
little risk. That might also be true for at Stanford University, senior faculty
other senior executives, and boards member at Stanford’s Rock Center
could do well, as a second step, to for Corporate Governance, and
examine their payoff structures too. director of Stanford’s Corporate
Governance Research Program,
1 We define CEO wealth as the total value where Brian Tayan is a researcher.
and the expected value of stock options that They are coauthors of Corporate
an executive continues to hold at a company.
Governance Matters: A Closer Look
We exclude personal wealth outside company
stock (this is not typically disclosed). Stock at Organizational Choices and Their
options are valued using the Black–Scholes Consequences (FT Press, April 2011).
pricing model, with the remaining term
of the option reduced by 30 percent to com-
pensate for potential early exercise or Copyright © 2012 McKinsey & Company.
termination and volatility based on actual All rights reserved. We welcome your
results from the previous year.
2 For additional discussion of compensation comments on this article. Please send them
to quarterly_comments@mckinsey.com.
and wealth effects, see David F. Larcker and
Brian Tayan, Sensitivity of CEO Wealth to
Stock Price: A New Tool for Assessing Pay for
Performance, Stanford Graduate School of
Business, Closer Look Series Case No. CGRP-
10, September 2010.
On the cover

Rethinking corporate
strategy
The vast majority of companies provide their business
units with virtually the same amount of capital
and other scarce resources year after year. The lead
article in this package presents new McKinsey
research on the prevalence of strategic inertia, along
with its financial costs, causes, and potential
remedies. A strong, independent corporate center can
help counter the status quo, an idea we explore
in a companion piece. So can thoughtful processes and
decision rules. Learn here about approaches
that have worked for the CFO of Rio Tinto and for the
president of Honeywell’s Performance Materials
and Technologies business.

28 42
How to put your Breaking strategic
money where your inertia: Tips from
strategy is two leaders
Stephen Hall,
Guy Elliott
Dan Lovallo, and
Rio Tinto
Reinier Musters
Andreas C. Kramvis
Honeywell
39
The power of
an independent
corporate center
Stephen Hall,
Bill Huyett, and
Tim Koller
 27

Artwork by Neil Webb

28

How to put your

money where your
strategy is
Stephen Hall, Dan Lovallo, and Reinier Musters

Most companies allocate the same resources

to the same business units year after
year. That makes it difficult to realize strategic
goals and undermines performance.
Here’s how to overcome inertia.

Picture two global companies, each operating a range of

different businesses. Company A allocates capital, talent, and research
dollars consistently every year, making small changes but always
following the same broad investment pattern. Company B continually
evaluates the performance of business units, acquires and divests
assets, and adjusts resource allocations based on each division’s relative
market opportunities. Over time, which company will be worth more?

If you guessed company B, you’re right. In fact, our research suggests

that after 15 years, it will be worth an average of 40 percent more than
company A. We also found, though, that the vast majority of companies
resemble company A. Therein lies a major disconnect between the
aspirations of many corporate strategists to boldly jettison unattractive
businesses or double down on exciting new opportunities, and the
reality of how they invest capital, talent, and other scarce resources.

For the past two years, we’ve been systematically looking at corporate
resource allocation patterns, their relationship to performance, and the
implications for strategy. We found that while inertia reigns at most
 How to put your money where your strategy is 29

companies, in those where capital and other resources flow more readily
from one business opportunity to another, returns to shareholders
are higher and the risk of falling into bankruptcy or the hands of an
acquirer lower.

We’ve also reviewed the causes of inertia (such as cognitive biases and
politics) and identified a number of steps companies can take to
overcome them. These include introducing new decision rules and
processes to ensure that the allocation of resources is a top-of-mind
issue for executives, and remaking the corporate center so it can provide
more independent counsel to the CEO and other key decision makers.

We’re not suggesting that executives act as investment portfolio

managers. That implies a search for stand-alone returns at any cost
rather than purposeful decisions that enhance a corporation’s long-
term value and strategic coherence. But given the prevalence of stasis
today, most organizations are a long way from the headlong pursuit
of disconnected opportunities. Rather, many leaders face a stark choice:
shift resources among their businesses to realize strategic goals or
run the risk that the market will do it for them. Which would you prefer?

Weighing the evidence

Every year for the past quarter century, US capital markets have issued
about $85 billion of equity and $536 billion in associated corporate
debt. During the same period, the amount of capital allocated or reallo-
cated within multibusiness companies was approximately $640 billion
annually—more than equity and corporate debt combined.1 While most
perceive markets as the primary means of directing capital and
recycling assets across industries, companies with multiple businesses
actually play a bigger role in allocating capital and other resources
across a spectrum of economic opportunities.

To understand how effectively corporations are moving their resources,

we reviewed the performance of more than 1,600 US companies
between 1990 and 2005.2 The results were striking. For one-third of the

1 See Ilan Guedj, Jennifer Huang, and Johan Sulaeman, “Internal capital allocation and firm

performance,” working paper for the International Symposium on Risk Management and
Derivatives, October 2009 (revised in March 2010).
2 We used Compustat data on 1,616 US-listed companies with operations in a minimum of two

distinct four-digit Standard Industrial Classification (SIC) codes. Resource allocation

is measured as 1 minus the minimum percentage of capital expenditure received by distinct
business units over the 15-year period. This measure captures the relative amount of capital
that can flow across a business over time; the rest of the money is “stuck.” Similar results were
found with more sophisticated measures that control for sales and asset growth.
Q2
30 2012 2012 Number 2
Resource allocation
Exhibit 1 of 3

Exhibit 1
Capital allocations were essentially fixed for roughly one-third
of the business units in our sample.

Correlation index of business units’ capital expenditures,

year-over-year change,1990–2005 Companies’ degree of
capital reallocation
1.0 Low

0.9 Medium

0.8 High

0.7
The closer the correlation
0.6 index is to 1.0, the less the
year-over-year change in a
0.5 company’s capital allocation
across business units.
0
1991 1993 1995 1997 1999 2001 2003 2005

businesses in our sample, the amount of capital received in a given year

was almost exactly that received the year before—the mean correla-
tion was 0.99. For the economy as a whole, the mean correlation across
all industries was 0.92 (Exhibit 1).

In other words, the enormous amount of strategic planning in cor-

porations seems to result, on the whole, in only modest resource shifts.
Whether the relevant resource is capital expenditures, operating
expenditures, or human capital, this finding is consistent across indus-
tries as diverse as mining and consumer packaged goods. Given
the performance edge associated with higher levels of reallocation, such
static behavior is almost certainly not sensible. Our research showed
the following:

• Companies that reallocated more resources—the top third of our

sample, shifting an average of 56 percent of capital across business
units over the entire 15-year period—earned, on average, 30 percent
higher total returns to shareholders (TRS) annually than com-
panies in the bottom third of the sample. This result was surprisingly
consistent across all sectors of the economy. It seems that when
companies disproportionately invest in value-creating businesses,
they generate a mutually reinforcing cycle of growth and further
investment options (Exhibit 2).
How to put your money where your strategy is 31

• Consistent and incremental reallocation levels diminished the

variance of returns over the long term.

• A company in the top third of reallocators was, on average,

13 percent more likely to avoid acquisition or bankruptcy than low
reallocators.

• Over an average six-year tenure, chief executives who reallocated

less than their peers did in the first three years on the job were
significantly more likely than their more active peers to be removed
in years four through six. To paraphrase the philosopher Thomas
Hobbes, tenure for static CEOs is likely to be nasty, brutish, and,
above all, short.

We should note the importance of a long-term view: over time spans

of less than three years, companies that reallocated higher levels
of resources delivered lower shareholder returns than their more stable
peers did. One explanation for this pattern could be risk aversion on
the part of investors, who are initially cautious about major corporate
capital shifts and then recognize value only once the results become
visible. Another factor could be the deep interconnection of resource
allocation choices with corporate strategy. The goal isn’t to make
dramatic changes every year but to reallocate resources consistently
over the medium to long term in service of a clear corporate strategy.
That provides the time necessary for new investments to flourish, for
established businesses to maximize their potential, and for capital
from declining investments to be redeployed effectively. Given the rich-
Q2 2012
ness and complexity of the issues at play here, differences in the
Resource between
relationship allocation
short- and long-term resource shifts and finan-
Exhibit
cial 2 of 3 is likely to be a fruitful area for further research.
performance

Exhibit 2
Companies with higher levels of capital reallocation
experienced higher average shareholder returns.

Companies’ degree of Total returns to shareholders,

capital reallocation compound annual growth rate,
(n = 1,616 companies) 1990–2005, %

High 10.2

Medium 8.9

Low 7.8
32 2012 Number 2

Why companies get stuck

Why do so many companies undermine their strategic direction by

allocating the same levels of resources to business units year after year?
The reasons vary widely, from the very bad—companies operating on
autopilot—to the more sensible. After all, sometimes it’s wise to persist
with previously chosen resource allocations, especially if there are no
viable reallocation opportunities or if switching costs are too high. And
companies in capital-intensive sectors, for example, often have
to commit resources more than five years ahead of time to long-term
programs, leaving less discretionary capital to play with.

For the most part, however, the failure to pursue a more active allocation
agenda is a result of organizational inertia that has multiple causes. We’ll
focus here on cognitive biases and corporate politics, but regardless of
source, inertia’s gravitational pull is strong—and overcoming it is critical
to creating an effective corporate strategy. As author and Kleiner Perkins
Caufield & Byers partner Randy Komisar told us, “If corporations don’t
approach rebalancing as fiduciaries for long-term corporate value,
their life span will decline as creative destruction gets the better of them.”

Cognitive biases
Biases such as anchoring and loss aversion, which are deeply rooted in the
workings of the human brain and have been much studied by behavioral
economists, are major contributors to the inertia that prevents more active
reallocation.3 Anchoring refers to the tendency to use any number, even
an irrelevant one, as an anchor for future choices. Judges asked to roll a
pair of dice before making a simulated sentencing decision, for example,
are influenced by the result of that roll, even though they deny they are.

Within a company, last year’s budget allocation often serves as a ready,

salient, and justifiable anchor during the planning process. We know
this to be true in practice, and it’s been reinforced for us recently as we’ve
played a business game with several groups of senior executives. The
game asked participants to allocate a capital budget across a fictitious
company’s businesses and provided players with identical growth
and return projections for the relevant markets. Half of the group also
received details of the previous year’s capital allocation. Those without
last year’s capital budget all allocated resources in a range that optimized
for the expected outlook in market growth and returns. The other
half aligned capital far more closely with last year’s pattern, which had
little to do with the potential for future returns. And this was a
game where the company was fictitious and no one’s career was at risk!
3 See Dan Lovallo and Olivier Sibony, “The case for behavioral strategy,” mckinseyquarterly.com,

March 2010.
 How to put your money where your strategy is 33

In reality, anchoring is reinforced by loss aversion: losses typically hurt

us at least twice as much as equivalent gains give us pleasure. That
reduces the appetite for taking risks and makes it painful for managers
to give up resources.

Corporate politics
A second major source of inertia is political. There’s often a tight align-
ment between the interests of senior executives and those of their
divisions or business units, whose ability to attract capital can signifi-
cantly influence the personal credibility of a leader. Indeed, because
executives are competing for resources, anyone who wins less than he
or she did last year is invariably seen as weak. At the extreme, leaders
of business units and divisions see themselves as playing for their own
“teams” rather than for the corporation as a whole, making it challeng-
ing to reallocate resources significantly. Even if a reduction in resources
to their division benefits the company as a whole, ambitious leaders
are unlikely to agree without a fight. As one CEO told us: “If you’re asking
Q2 2012
me to play Robin Hood, that’s not going to work.”
Resource allocation
Exhibit 3 of 3

Exhibit 3

Inertia may affect the distribution of other scarce resources,

such as advertising spending.

Correlation between each brand’s 2010 advertising budget and its average advertising
budget for previous 5 years at one consumer goods company (n = 40 brands)

Average advertising spending by brand

over 5 years, 2004–09, % of corporate total

5.0
r 2 = 0.87
4.5

4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0
0 0.5 1.0 1.5 2.0 2.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0
Average advertising spending by brand in 2010, % of corporate total

r2 is the measure of interdependence of 2 or more variables.

34 2012 Number 2

Overcoming inertia

Tempting as it is to believe that one’s own company avoids these traps,

our research suggests that’s unlikely. Our experience also suggests, though,
that taking steps such as those described below can materially improve
a company’s resource allocation and its connection to strategic priorities.
These imperatives apply not just to capital but also to other scarce
resources, such as talent, R&D dollars, and marketing expenditures (as
shown in Exhibit 3, for advertising spending by one consumer goods
company). All of these also are subject to the forces of inertia, which can
undermine an organization’s ability to achieve its strategic goals.
Consider one company we know that prioritized expanding in China. It
set an ambitious sales growth target for the country and planned to
meet it by supplementing organic growth with a series of acquisitions. Yet
it identified just three people to spearhead this strategic imperative—
a small fraction of the number required, which is typical of the problems
that arise when the link between corporate strategy and resource
allocation is weak. Here are four ideas for doing better.

1. Have a target corporate portfolio.

There’s a quote attributed to author Lewis Carroll: “If you don’t know
where you are going, any road will take you there.” When it comes to
developing an allocation agenda, it’s helpful to have a target portfolio in
mind. Most companies resist this, for understandable reasons: it requires
a lot of conviction to describe planned portfolio changes in anything
but the vaguest terms, and the right answers may change if the broader
business environment turns out to be different from the expected one.

In our experience, though, a target portfolio need not be slavish or mechan-

istic and can be a powerful forcing device to move beyond generic strategy
statements, such as “strengthen in Asian markets” or “continue to migrate
from products to services.” Identifying business opportunities where
your company wants to increase its exposure can create a foundation for
scrutinizing how it allocates capital, talent, and other resources.

Setting targets is just a starting point; companies also need mechanisms

for revisiting and adjusting them over time. For example, Google holds
a quarterly review process that examines the performance of all core
product and engineering areas against three measures: what each area did
in the previous 90 days and forecasts for the next 90 days, its medium-
term financial trajectory, and its strategic positioning. And the company
has ensured that it can allocate resources in an agile way by not
having business units, which diminishes the impact of corporate politics.4

4 For more, see James Manyika, “Google’s CFO on growth, capital structure, and leadership,”

mckinseyquarterly.com, August 2011.

How to put your money where your strategy is 35

Evaluating reallocation performance relative to peers also can help com-

panies set targets. From 1990 to 2009, for example, Honeywell
reallocated about 25 percent of its capital as it shifted away from some
existing business areas toward aerospace, air conditioning, and controls.
Honeywell’s competitor Danaher, which was in similar businesses
in 1990, moved 66 percent of its capital into new ones during the same
period. Both companies achieved returns above the industry average
in these years—TRS for Honeywell was 14 percent and for Danaher
25 percent. We’re not suggesting that companies adopt a mind-set of
“more is better, and if my competitor is making big moves, I should too.”
But differences in allocation levels among peer companies can serve
as valuable clues about contrasting business approaches—clues that
prompt questions yielding strategic insights.

2. Use all available resource reallocation tools.

Talking about resource allocation in broad terms oversimplifies the
choices facing senior executives. In reality, allocation comprises
four fundamental activities: seeding, nurturing, pruning, and harvesting.
Seeding is entering new business areas, whether through an acquisi-
tion or an organic start-up investment. Nurturing involves building up
an existing business through follow-on investments, including bolt-on
acquisitions. Pruning takes resources away from an existing business,
either by giving some of its annual capital allocation to others or by
putting a portion of the business up for sale. Finally, harvesting is selling
whole businesses that no longer fit a company’s portfolio or under-
taking equity spin-offs.

Our research found that there’s little overall difference between the
seeding and harvesting behavior of low and high reallocators. This should
come as little surprise: seeding involves giving money to new business
opportunities—something that’s rarely resisted. And while harvesting
is difficult, it most often occurs as a result of a business unit’s sus-
tained underperformance, which is difficult to ignore.

However, we found a 170 percent difference in activity levels between

high and low reallocators when it came to the combination of nurturing
and pruning existing businesses. Together, these two represent half of
all corporate reallocation activity. Both are difficult because they often
involve taking resources from one business unit and giving them to
another. What’s more, the better a company is at encouraging seeding,
the more important nurturing and pruning become—nurturing to
ensure the success of new initiatives and pruning to eliminate flowers
that won’t ever bloom.
36 2012 Number 2

Consider, for example, the efforts of Google CEO Larry Page, over the
past 12 months, to cope with the flowering of ideas brought forth by
the company’s well-known “20 percent rule,” which allows engineers
to spend at least one-fifth of their time on personal projects and has
resulted in products such as AdSense, Gmail, and Google News. These
successes notwithstanding, the 20 percent rule also has yielded many
peripheral projects, which Page has recently been pruning.5

3. Adopt simple rules to break the status quo.

Simple decision rules can help minimize political infighting because
they change the burden of proof from the typical default allocation
(“what we did last year”) to one that makes it impossible to maintain the
status quo. For example, a simple harvesting rule might involve put-
ting a certain percentage of an organization’s portfolio up for sale each
year to maintain vibrancy and to cull dead wood.

When Lee Raymond was CEO of Exxon Mobil, he required the

corporate-planning team to identify 3 to 5 percent of the company’s
assets for potential disposal every year. Exxon Mobil’s divisions
were allowed to retain assets placed in this group only if they could
demonstrate a tangible and compelling turnaround program. In
essence, the burden on the business units was to prove that an asset
should be retained, rather than the other way around. The net effect
was accelerated portfolio upgrading and healthy turnover in the face
of executives’ natural desire to hang on to underperforming assets.
Another approach we’ve observed involves placing existing businesses
into different categories—such as “grow,” “maintain,” and “dispose”—
and then following clearly differentiated resource-investment rules for
each. The purpose of having clear investment rules for each category
of business is to remove as much politics as possible from the resource
allocation process.

Sometimes, the CEO may want a way to shift resources directly, in

parallel with regular corporate processes. One natural-resources
company, for example, gave its CEO sole discretion to allocate 5 percent
of the company’s capital outside of the traditional bottom-up annual
capital allocation process. This provided an opportunity to move the
organization more quickly toward what the CEO believed were
exciting growth opportunities, without first having to go through a
“pruning” fight with the company’s executive-leadership committee.

5 See Claire Cain Miller, “In a quest for focus, Google purges small projects,” nytimes.com,

November 10, 2011.

 How to put your money where your strategy is 37

Of course, the CEO and other senior leaders will need to reinforce
discipline around such simple allocation rules; it’s not easy to hold the
line in the face of special pleading from less-favored businesses.
Developing that level of clarity—not to mention the courage to fight
tough battles that arise as a result—often requires support in the
form of a strong corporate center or a strategic-planning group that’s
independent of competing business interests and can provide objec-
tive information (for more on the importance of the corporate center
to resource reallocation, see “The power of an independent corporate
center,” on page 39).

4. Implement processes to mitigate inertia.

Systematic processes can strengthen allocation activities. One approach,
explored in detail by our colleagues Sven Smit and Patrick Viguerie, is
to create planning and management processes that generate a granular
view of product and market opportunities.6 The overwhelming ten-
dency is for corporate leaders to allocate resources at a level that is too
high—namely, by division or business unit. When senior management
doesn’t have a granular view, division leaders can use their information
advantage to average out allocations within their domains.

Another approach is to revisit a company’s businesses periodically and

engage in a process similar to the due diligence conducted for invest-
ments. Executives at one energy conglomerate annually ask whether
they would choose to invest in a business if they didn’t already own
it. If the answer is no, a discussion about whether and how to exit the
business begins.

Executives can further strengthen allocation decisions by creating

objectivity through re-anchoring—that is, giving the allocation an objec-
tive basis that is independent of both the numbers the business units
provide and the previous year’s allocation. There are numerous ways to
create such independent, fact-based anchors, including deriving
targets from market growth and market share data or leveraging bench-
marking analysis of competitors. The goal is to create an objective way
to ask business leaders this tough question: “If we were to triangulate
between these different approaches, we would expect your investments
and returns to lie within the following range. Why are your estimates
so much higher (or lower)?”

6 See three publications by Mehrdad Baghai, Sven Smit, and S. Patrick Viguerie: “The

granularity of growth,” mckinseyquarterly.com, May 2007; The Granularity of Growth: How

to Identify the Sources of Growth and Drive Enduring Company Performance, Hoboken,
NJ: Wiley, 2008; and “Is your growth strategy flying blind?,” Harvard Business Review, May
2009, Volume 87, Number 5, pp. 86–97.
38 2012 Number 2

Finally, it’s worth noting that technology is enabling strategy process

innovations that stir the pot through internal discussions and
“crowdsourcing.” For example, Rite-Solutions, a Rhode Island–based
company that builds advanced software for the US Navy, defense
contractors, and first responders, derives 20 percent of its revenue from
businesses identified through a “stock exchange” where employees
can propose and invest in new ideas (for more on this, see “The social
side of strategy,” on page 82).

Much of our advice for overcoming inertia within multibusiness

companies assumes that a corporation’s interests are not the same as
the cumulative resource demands of the underlying divisions and
businesses. As they say, turkeys do not vote for Christmas. Putting in
place some combination of the targets, rules, and processes proposed
here may require rethinking the role and inner workings of a company’s
strategic- and financial-planning teams. Although we recognize that
this is not a trivial endeavor, the rewards make the effort worthwhile. A
primary performance imperative for corporate-level executives should
be to escape the tyranny of inertia and create more dynamic portfolios.

The authors would like to acknowledge the contributions of Michael

Birshan, Marja Engel, Mladen Fruk, John Horn, Conor Kehoe, Devesh
Mittal, Olivier Sibony, and Sven Smit to this article.

Stephen Hall is a director in McKinsey’s London office, and Reinier

Musters is an associate principal in the Amsterdam office. Dan Lovallo is
a professor at the University of Sydney Business School, a senior research
fellow at the Institute for Business Innovation at the University of California,
Berkeley, and an adviser to McKinsey.
 39

The power of an
independent corporate
center
Stephen Hall, Bill Huyett, and Tim Koller

To develop a winning corporate

strategy, you may need more muscle
in your headquarters.

The independent, hard-nosed perspective that executives need to make

decisions about a corporation’s businesses is often elusive. It can’t be
delegated to the business units, whose managers have competing interests
and may lack a corporate-wide perspective. Nor can it be folded into the
existing strategy process, which is frequently a bottom-up, business unit–
oriented exercise that starts with the assumption that each unit’s claims
on capital and resources won’t differ significantly from year to year.

A corporate center does have the potential to cut through the tensions,
lobbying, and logrolling that often bedevil resource allocation discussions
and lead to inertia (for more on resource allocation challenges, see “How
to put your money where your strategy is,” on page 28). But few are well
organized to play this role. Some are little more than a collection of central
functions (such as treasury, legal, and human resources) that don’t fit
elsewhere in the organization. Some are more strategy focused but
primarily prepare board papers and support special initiatives for the CEO,
the chairman, or the board. At the opposite extreme, certain corporate
centers meddle in the tactics of business units. Others revolve around a
CFO who manages the balance sheet, aggregates financial report-
ing, courts investors, and provides tax and treasury services—but seldom
gets involved in strategy. Too often missing are the intense reviews,
debates, and challenges that lie at the core of value-creating corporate-
strategy decisions.

Changing this picture will sometimes require a reconfiguration of the

corporate center—including the addition of staff and capabilities—that is
beyond our scope here. (For ideas from a CFO and a business head,
see “Breaking strategic inertia: Tips from two leaders,” on page 42.)
However, a few more modest changes can help most corporate centers
stimulate better dialogue, tougher decision making, and more effective
resource reallocation. Here’s what that takes:
40 2012 Number 2

Executive ‘ownership.’ The architects of this work must be willing

to bring forward recommendations that are bold—not incremental—and
potentially unpopular with division or business unit heads, who in most
companies dominate the group that makes decisions to reallocate capital
and talent. So the effort must be led by a respected senior executive,
such as the chief financial or strategy officer, who can bring an outsider’s
point of view: challenging status-quo projections, establishing decision
rules, and proposing concrete portfolio changes. Personal attributes that
can help an executive shape these discussions are more important than
titles. The main point is that someone needs to be explicitly accountable for
the work. All too often, these responsibilities slip through the cracks.

The right kind of ownership can be extremely powerful. Take the case of
the “two Bobs” at the mining company Rio Tinto, in the early 1990s. Rio’s
chairman, Bob Wilson, saw an opportunity to reshape its portfolio and
build a series of new growth platforms through a combination of bold organic
and inorganic moves. Bob Adams, the executive director for planning and
development, generated many of the ideas that underpinned the company’s
repositioning and supported the corporate agenda by building a world-
class capability to evaluate and develop businesses. Armed with independent
analyses, the two Bobs helped counteract the forces of inertia.

A transparent mandate from the CEO. The corporate-strategy process

and the top team that drives it have an implicit contract with a company’s
shareholders to do two things: to change its portfolio of businesses (and
growth platforms) and to stimulate appropriate and occasionally signifi-
cant shifts in the resources devoted to each business—even well-performing
ones. Both the contract and the processes should be clear to division and
business unit leaders and visibly supported by the CEO.

The central team should not attempt to develop alternative strategic

plans or budgets for business units; it won’t have the detailed knowledge
to do so. It should focus instead on the arguments for and against mak-
ing significant changes in R&D spending, capital investments, or top-talent
assignments within the existing portfolio. It’s also important for the team
to identify—before shareholders do—businesses that should be divested.
In other words, the team should set up processes ensuring that the right
new businesses are seeded, nurtured, pruned, or weeded as objectively as
possible. To do so, the team must include people who can help it form its
own analytical views about the performance of business units. There will be
some duplication of effort in this new mandate, but it is the only way to
have a constructive debate.

An inquisitive posture. Stimulating a better dialogue requires a direct

challenge to what may be long-held assumptions. Business unit–planning
processes—and perhaps even “crowdsourced” strategy approaches
such as those described in “The social side of strategy,” on page 82—can
help leaders grapple with some of these issues. But sometimes the
focus of questions at the business unit level is more microlevel and less
Howpower
The to putof
your
an independent
money wherecorporate
your strategy
center
is 41

likely to uncover a need for wholesale shifts out of one business area and
into another. The corporate center is better positioned to wrestle with
questions on behalf of the organization as a whole—and to propose tough
solutions that business units would be unlikely to arrive at independently.

How are the macroeconomic, consumer, and technology trends that

drive growth and returns for our businesses likely to change in the next
two to five years?

In what ways do we expect our industry’s competitive dynamics to

change in the next several years? For example, will maturation lead
to overcapacity?

Are we starving nascent growth platforms by maintaining the flow of

resources to historical core businesses?

How does each business unit stack up against its traditional peers
and new attackers on performance measures such as product quality
and innovation, the effectiveness of distribution, and cost levels?

Could other companies extract more value from any of our businesses—
and acquire them for a premium that we could invest better elsewhere?

How do individual business units affect the performance, positively or

negatively, of other parts of our company?

Which units absorb more than their fair share of senior management’s
time and attention relative to their potential for creating value?

The corporate center is the logical owner of a company’s resource allocation

process. Even many centers that now lack the structure, organization, or
capabilities to play this role fully can materially boost their effectiveness with
a few modest changes.

The authors would like to acknowledge the contribution of Dan Lovallo to

the development of this article.

Stephen Hall is a director in McKinsey’s London office, Bill Huyett

is a director in the Boston office, and Tim Koller is a principal in the New
York office.
42

Breaking strategic inertia:

Tips from two leaders

Guy Elliott Frameworks abound for developing corporate

CFO strategy. But there’s no textbook or theory
Rio Tinto that explains how to deliver on that strategy by
shifting capital, talent, and other scarce
resources from one part of a business to another.
Andreas C. Kramvis One reason is that the moves each organiza-
President and CEO tion must make at any point in time are unique.
Honeywell Performance Another is that different senior executives
Materials and Technologies have different roles to play. But that’s not to say
companies can’t learn from one another—in
fact, understanding the broad range of reallocation
challenges faced by different executives sheds
valuable light on common pitfalls and the decision-
making processes for sidestepping them.

Featured here are perspectives from two different

industries and corners of the C-suite. Guy Elliott,
the CFO of Rio Tinto, one of the world’s biggest
mining companies, discusses how it decides when
and how to place its bets. And Andreas Kramvis,
who heads Honeywell Performance Materials and
Technologies, provides insight from a business
unit perspective and outlines his novel approach to
bringing strategy and resources into alignment.
 43

Guy Elliott
has been the CFO of Rio Tinto—one of the world’s most diversified
mining companies, with operations on six continents and net assets
of roughly $60 billion—since 2002.

Prioritizing projects and regions

We start from the proposition that we are not strategic capital allocators;
we are bottom-up capital allocators. We invest not by choosing the
commodity in which to put money but by choosing the project in which
to put money. For example, we observed that 80 percent of the money
in the copper world is made by 20 percent or less of the world’s copper
mines. Our objective is for all of our mines in all of our products to be
in that 20 percent because we think we’re particularly good at running
large, long-life, low-cost mines.

Historically, we have not been particularly worried about which product

is “in,” because in the short to medium run, copper mines may do
better than nickel, or iron ore may do worse than aluminum. But
on a 50-year horizon, it’s much less clear that one metal is better than
another. It’s certainly true that one may have higher demand than
another, but what really matters is the difference between supply and
demand, and supply can often overshoot demand. The point of
departure for us has been bottom-up: geologically and infrastructure
driven. Is this deposit capable of being, over a long period, a low-cost,
expandable operation in its industry? If it is, let’s allocate capital to it.

There’s another dimension to this, beyond just looking at our port-

folio in project terms. You can also look at it as a jurisdiction portfolio.
For example, a very high percentage of assets in our portfolio—
approaching half—are in Australia, and about 40 percent are in North
44 2012 Number 2

America and Europe, mostly in Canada. And then we have about

10 percent in emerging markets. As we look for new opportunities,
they’re mostly in emerging markets. So that 10 percent will enlarge over
time, but we need to think a bit more about the political risk and
the management challenge of emerging markets versus what we might
call “safer” jurisdictions.

Rebalancing the portfolio

In the middle of the last decade, we had a relatively diversified

portfolio. But we then started investing heavily in what looked to be
the most interesting business—iron ore, which had very high
margins that have since risen even more. We also made a very big
acquisition in aluminum and, as a consequence, ended up with a
very lopsided portfolio: skewed toward iron ore in terms of profit and
toward aluminum in terms of investment of capital. That’s caused
the beta of the company to rise.

The portfolio bias toward iron ore has been very beneficial, of course.
But it has unnerved investors a bit because they can’t believe the
good times are going to continue forever. So we are beginning to ask
ourselves questions about whether we should take action to “correct”
that portfolio bias. And it’s very difficult. We could stop further invest-
ments in iron ore. But if we did that, we would be turning our back
on some of the highest-return, lowest-risk investments we can make. So
that looks like a perverse course of action. We also could sell some
iron ore assets, but why would you sell some of your best businesses
unless you really were clever enough to know precisely when the
top of the cycle was? And even then, would you get the right price, given
present market conditions?

Related to this is an essential part of our strategy: we don’t like to hedge.

We think there are natural hedges within the portfolio. In simple
terms, when the iron ore price is high, the Australian dollar is high;
and when the iron ore price is low, the Australian dollar is low. Our
margins are protected to some extent by this natural hedge because
our costs are chiefly denominated in Australian dollars. However,
there is a new phenomenon that is of concern. As Europe struggles, the
currencies of countries such as Australia and Canada have become
safe havens and behave differently than they have in the past. So our
natural hedge may not be quite as secure as it used to be. The other
Breaking strategic inertia: Tips from two leaders 45

imperfection of a nonhedging strategy is that from time to time, you

have to make decisions about building something or buying or selling
something, and that’s implicitly a hedging decision.

Of course, we can’t avoid it, because we need to replenish our growth

pipeline continuously, as well as winnow our portfolio. But we don’t
do it with great enthusiasm, because it involves market timing and, if
we could do that well, we wouldn’t bother running a mining business;
we’d just be a trading business. We did major acquisitions in 1989, 1995,
and 2000 that have created many, many billions of dollars in value.
But of course we didn’t buy everything at the bottom or sell everything
at the top. One major acquisition—Alcan, in 2007—was strategically
in line with what we were trying to do, since it was a low-cost, long-life,
expandable business. But it was at the top of a cycle, which turned
down immediately after we bought it. With the benefit of hindsight, we
paid far too much for it in an auction.

Ensuring investment discipline

We institute checks and balances to manage internal lobbying. We have

something called the Investment Committee, which approves sizable
investments of any kind and consists of the chief executive, me, the head
of technology and innovation, and the head of business services. In
other words, it does not contain any of the divisional heads. The plan is
that this committee has enough data to have a dispassionate discus-
sion about an investment. Independence is essential: if it’s lost, we’re
lost. Separation of powers is important. Is the committee completely
immune to lobbying and strong characters? Of course it isn’t. But the
discipline and the checks and balances are there.

In addition to that, we have two other disciplines. One of them is the

information the committee gets. This committee receives three pieces
of paper. We get the recommendation of the project proponent. Then
we have an evaluation group that does a critique of the commercial
and financial stuff, and a technical and environmental critique. We try
to take the passion out of the debate.

The second discipline is a postinvestment review. After a period of

some years, we go back to the original proposal and calculate what the
return has been, which original estimates were wrong, which chal-
lenge was underestimated, what came out better than expected. From
46 2012 Number 2

numerous postinvestment reviews we learn what we tend to get

wrong and what we tend to get right. That’s an important discipline
in any capital-intensive company because otherwise you don’t learn
from your mistakes. For us it’s particularly important. We invest a few
billion dollars in year one, and that makes or breaks our returns on
that project for the next 50 years. The upfront decision is critical, since
there are endless people who in their enthusiasm say, “Well, there’s a
big strategic merit to this project that overrides the returns,” or “Don’t
worry about these risks—we must be big in Brazil,” or “We must be in
the nickel business,” or whatever it is.

Finally, our experience is that regular investments—as opposed to

one-offs—succeed better. That’s also true of divestments. It’s the same
principle as time–cost averaging. Successful investors don’t buy their
whole stake at once and sit on it. They move into it gradually and, when
they want to sell, move out of it gradually. In an ideal world, that’s
how I would like to invest, even though, of course, that’s not possible in
a big acquisition or disposal.

This commentary is based on an interview with Stephen Hall, a director

in McKinsey’s London office; and Dan Lovallo, a professor at the University
of Sydney Business School, a senior research fellow at the Institute
for Business Innovation at the University of California, Berkeley, and an
adviser to McKinsey.
 Breaking strategic inertia: Tips from two leaders 47

Andreas C. Kramvis
is the president and CEO of Honeywell Performance Materials and
Technologies, which has recorded double-digit margin improvements
for each of the past six years. He is the author of Transforming
the Corporation: Running a Successful Business in the 21st Century
(Randolph Publishing, September 2011).

Resource allocation at the business

unit level

When you are in a business unit, you are much closer to your markets
than the corporate entity is. Your knowledge of how to invest
should be much sharper as well. Through rapid reallocation of your
existing resources, you should be able to capitalize on opportunities
more quickly than if you needed to apply for funds through a corporate
capital process. The last thing you want to do is go hat in hand to
corporate asking for capital when your businesses are not running well.

What I emphasize to teams is that if a business performs well, it will

get all the capital it needs from the company, and then some. You
need to turn the problem on its head and say there really never is a
shortage of capital—there is a shortage of returns. If you achieve
high returns, money will chase you.

There are plenty of opportunities to reallocate resources and create

short-term opportunities to drive higher returns. You might have a plant
that is outdated or pockets of investment dollars in areas that are
no longer relevant. In one of my previous jobs, we had a very large plant
that was uncompetitive, but the company kept putting money into
it rather than pursuing the next technology. We stopped making those
investments and diverted those funds to the new technologies; in
a short period of time, we were able to supplant those operations with
48 2012 Number 2

a state-of-the-art plant that had better cycle times, less waste, lower
costs, and a greater ability to roll out innovative products. In other words,
we funded the new plant ourselves by using funds that were previously
being applied to areas without an upside.

Beyond capital

Most people think that reallocation only means the reallocation of

capital. Granted, this is important. At the same time, I also like to think
about the reallocation of people and mindshare. Believe it or not, the
latter type of reallocation has the biggest impact.

A company that fails to organize its people the right way is most likely
to require what you might call “hard reallocations,” such as divest-
ments or portfolio overhauls. Reorienting people is difficult, but that’s
what makes it so important to focus on. Moving your best managers,
researchers, salespeople, and so on from low-growth or failing busi-
nesses to areas with higher growth and profit potential can be one
of your most effective levers as a business leader.

Myriad issues stand in the way of achieving a dynamic reallocation. You

can throw the whole management book at this and it may not suffice.
Culture and organizational politics can stand in the way; so can sheer
inertia. Managers can be as slow to change as their organizations,
and misperceptions of what is important to them can linger for a long
time, despite strong evidence to the contrary. You could even have the
wrong business model in place, which means your processes are wrong
and your ability to make good decisions is seriously impaired.

Shifting resources one ‘decision week’

at a time

To ensure that your organization is constantly reallocating resources from

weak areas to promising ones, you need a systematic operating method.
Most companies have a rhythm of meetings and performance reviews but
spend much of their time looking in the rearview mirror: What was last
month’s performance? What was last year’s performance? I believe you
need to impose an operating mechanism that reallocates resources in real
time and that educates your organization and instills core capabilities.

One operating mechanism I’ve found helpful is something I call

“business decision week.” We run BDW ten times a year, and we take
 Breaking strategic inertia: Tips from two leaders 49

its name seriously: decisions are actually made on the spot in real
time. Attendance is mandatory for my direct-leadership team. Confi-
dentiality limits the number of people who can be in attendance
at some sessions, but for others there is no reason not to have a large
number of managers listen in. The discussions are lively, and
listening in can be a great learning opportunity.

I will not take a meeting outside BDW to discuss a project requiring

capital approvals. Similarly, I will not take a separate meeting
about resources for a new project involving research and development.
Having one-off meetings and decisions would waste a lot of time
and defeat the objective of this open system, in which all the key people
must be present and comment on the matter at hand.

Business decision week forces my leadership team to look out the

windshield. What are the biggest opportunities we should concentrate
on? What capabilities do we need in order to pursue them? Where
are our people wasting time, and where should they be spending more
time today? How about in six months? We try to place management
time and focus on areas where we can grow, rather than focusing on
firefighting and activities with low potential.

I often think of BDW as analogous to the processor of a computer:

the know-how it instills is the software. By building know-how,
business decision weeks grow increasingly productive, and they enhance
the organization’s ability to prepare for future challenges.

An example of how BDW helped my current business was in rethinking

the engineering processes to help us understand the costs and risks
involved in major capital projects. We started our discussions with a
desire to reach a common vocabulary and set of metrics, so that
each month, our business leaders could fully understand where our
engineering resources were being applied. With each passing month,
the discussion grew more sophisticated—we turned our attention toward
reallocation of these resources to achieve the most critical objectives
faster and discussion of which capabilities we will most need in the
future. Now we’re focusing our attention on the biggest projects: the
construction of new plants around the world. This is a significant under-
taking, and one we would not have been prepared for without having
both the processor and the software of business decision week in place.

Copyright © 2012 McKinsey & Company. All rights reserved.

We welcome your comments on this article. Please send them to
quarterly_comments@mckinsey.com.
50

The executive’s guide to

better listening
Bernard T. Ferrari

Artwork by Jon Krause

 51

Strong listening skills can make a critical difference in the

performance of senior executives, but few actively cultivate them.

The problem What to do about it

Many senior executives take By showing respect for
listening skills for granted and conversation partners, spending
focus instead on learning less time speaking, and
how to articulate and present their challenging the assumptions
own views more effectively. that inform conversations,
senior executives can improve
Why it matters their own listening skills
Listening is the surest, most and those of their organization.
efficient route to informing the
judgments that senior executives
must make. Good listening
can ultimately mean the difference
between a longer career and
a shorter one.

“I was an awful listener in almost every

possible way,” says Amgen CEO
Kevin Sharer. To read about the epiphany
that made him change, see “Why I’m
a listener,” on page 61.
52 2012 Number 2

A senior executive of a large consumer goods company had spotted

a bold partnership opportunity in an important developing market
and wanted to pull the trigger quickly to stay ahead of competitors. In
meetings on the topic with the leadership team, the CEO noted that
this trusted colleague was animated, adamant, and very persuasive about
the move’s game-changing potential for the company. The facts
behind the deal were solid.

The CEO also observed something troubling, however: his colleague

wasn’t listening. During conversations about the pros and cons of
the deal and its strategic rationale, for example, the senior executive
wasn’t open to avenues of conversation that challenged the move
or entertained other possibilities. What’s more, the tenor of these con-
versations appeared to make some colleagues uncomfortable. The
senior executive’s poor listening skills were short-circuiting what should
have been a healthy strategic debate.

Eventually, the CEO was able to use a combination of diplomacy, tactful

private conversation, and the bureaucratic rigor of the company’s
strategic-planning processes to convince the executive of the need to
listen more closely to his peers and engage with them more pro-
ductively about the proposal. The resulting conversations determined
that the original deal was sound but that a much better one was
available—a partnership in the same country. The new partnership
presented slightly less risk to the company than the original deal
but had an upside potential exceeding it by a factor of ten.

The situation facing the CEO will be familiar to many senior executives.
Listening is the front end of decision making. It’s the surest, most
efficient route to informing the judgments we need to make, yet many
of us have heard, at one point or other in our careers, that we could
be better listeners. Indeed, many executives take listening skills for
granted and focus instead on learning how to articulate and present
their own views more effectively.

This approach is misguided. Good listening—the active and disciplined

activity of probing and challenging the information garnered from
others to improve its quality and quantity—is the key to building a base
of knowledge that generates fresh insights and ideas. Put more
strongly, good listening, in my experience, can often mean the differ-
ence between success and failure in business ventures (and hence
between a longer career and a shorter one). Listening is a valuable skill
that most executives spend little time cultivating. (For more about
 The executive’s guide to better listening 53

one executive’s desire to be a better listener, see “Why I’m a listener:

Amgen CEO Kevin Sharer,” on page 61.)

The many great listeners I’ve encountered throughout my career

as a surgeon, a corporate executive, and a business consultant have
exhibited three kinds of behavior I’ll highlight in this article. By
recognizing—and practicing—them, you can begin improving your
own listening skills and even those of your organization.

1 Show respect

One of the best listeners I have ever observed was the chief operating
officer (COO) of a large medical institution. He once told me that he
couldn’t run an operation as complex as a hospital without seeking
input from people at all levels of the staff—from the chief of surgery to
the custodial crew. Part of what made him so effective, and so appealing
as a manager, was that he let everyone around him know he believed
each of them had something unique to contribute. The respect he showed
them was reciprocated, and it helped fuel an environment where good
ideas routinely came from throughout the institution.

The COO recognized something that many executives miss: our conver-
sation partners often have the know-how to develop good solutions,
and part of being a good listener is simply helping them to draw out
critical information and put it in a new light. To harness the power
of those ideas, senior executives must fight the urge to “help” more junior
colleagues by providing immediate solutions. Leaders should also
respect a colleague’s potential to provide insights in areas far afield
from his or her job description.

Here’s an example: I recall a meeting between a group of engineers and

the chief marketing officer (CMO) at a large industrial company. The
CMO was concerned about a new product introduction that had fallen
flat. The engineers were puzzled as well; the company was traditionally
dominated by engineers with strong product-development skills, and
this group had them too. As the CMO and I discussed the techno-
logical aspects of the product with the engineers, I was struck by their
passion and genuine excitement about the new device, which did
appear to be unique. Although we had to stop them several times to get
explanations for various technical terms, they soon conveyed the
reasons for their attitude—the product seemed to be not only more effi-
cient than comparable ones on the market but also easier to install,
use, and maintain.
54 2012 Number 2

The CMO didn’t cut the conversation short

by lecturing them on good marketing
techniques or belittling their approach; she
listened and asked pointed questions in
a respectful manner.

After a few minutes, the CMO, who had been listening intently, prompted
the engineers with a respectful leading question: “But we haven’t
sold as many as you thought we would in the first three months, right?”

“Well, actually, we haven’t sold any!” the team leader said. “We think
this product is a game changer, but it hasn’t been selling. And we’re not
sure why.”

After a pause to make sure the engineer was finished, the CMO said,
“Well, you guys sure seem certain that this is a great product. And you’ve
convinced the two of us pretty well. It seems that customers should
be tripping over themselves to place orders. So assuming it’s not the
product’s quality that’s off, what else are your customers telling you
about the product?”

“We haven’t spoken to any customers,” the engineer replied.

The CMO blanched. As the conversation continued, we learned that the

product had been developed under close wraps and that the engineers
had assumed its virtues would speak for themselves. “But maybe not,”
said the team leader. “Maybe we ought to push it a little more. I guess
its good traits aren’t so obvious if you don’t know a lot about it.”

That engineer had hit the nail on the head. The device was fine. Custo-
mers were wary about switching to something untested, and they
hadn’t been convinced by the specs the company’s sales team touted.
As soon as the engineers began phoning their counterparts in the
customers’ organizations (an idea suggested by the engineers them-
selves), the company started receiving orders.

Had the CMO looked at the problem by herself, she might have sus-
pected a shortcoming with the product. But after some good listening
and targeted follow-up questions, she helped to extract a much
 The executive’s guide to better listening 55

better solution from the engineers themselves. She didn’t cut the con-
versation short by lecturing them on good marketing techniques or
belittling their approach; she listened and asked pointed questions in
a respectful manner. The product ultimately ended up being a game
changer for the company.

Being respectful, it’s important to note, didn’t mean that the CMO
avoided asking tough questions—good listeners routinely ask them to
uncover the information they need to help make better decisions.
The goal is ensuring the free and open flow of information and ideas.

I was amused when John McLaughlin, the former deputy director of

the US Central Intelligence Agency, told me that when he had to
make tough decisions he often ended his conversations with colleagues
by asking, “Is there anything left that you haven’t told me . . . because
I don’t want you to leave this room and go down the hall to your
buddy’s office and tell him that I just didn’t get it.” With that question,
McLaughlin communicated the expectation that his colleagues
should be prepared; he demanded that everything come out on the table;
and he signaled genuine respect for what his colleagues had to say.

2 Keep quiet

I have developed my own variation on the 80/20 rule as it relates to

listening. My guideline is that a conversation partner should be speaking
80 percent of the time, while I speak only 20 percent of the time.1
Moreover, I seek to make my speaking time count by spending as much
of it as possible posing questions rather than trying to have my own say.

That’s easier said than done, of course—most executives are naturally

inclined to speak their minds. Still, you can’t really listen if you’re too
busy talking. Besides, we’ve all spent time with bad listeners who treat
conversations as opportunities to broadcast their own status or ideas,
or who spend more time formulating their next response than listening
to their conversation partners. Indeed, bad listening habits such as
these are ubiquitous (see “A field guide to identifying bad listeners,” on
page 112).

1Once, after I had explained this formula in a university lecture, a clever MBA student asked,

“What if the conversation is between two good listeners?” My answer: “Congratulations!

You folks will have have a productive—and short—conversation.” This response, while firmly
tongue in cheek, hints at an important truth about what the priority should always be
in conversations: to gather information. If more executives followed the 80/20 rule, I’m
convinced we’d have shorter, sharper, and more productive meetings.
56 2012 Number 2

I should know because I’ve fallen into these traps myself. One experience
in particular made me realize how counterproductive it is to focus
on your own ideas during a conversation. It was early in my career as
a consultant and I was meeting with an important client whom I was
eager to impress. My client was a no-nonsense, granite block of a man
from the American heartland, and he scrutinized me over the top of
his reading glasses before laying out the problem: “The budget for next
year just doesn’t work, and we are asking our employees to make some
tough changes.”

All I heard was his concern about the budget. Without missing a beat,
I responded to my client and his number-two man, who was seated
alongside him: “There are several ways to address your cost problem.”
I immediately began reeling off what I thought were excellent sug-
gestions for streamlining his business. My speech gained momentum
as I barreled ahead with my ideas. The executive listened silently—
and attentively, or so it seemed. Yet he didn’t even move, except to cock
his head from time to time. When he reached for a pen, I kept up
my oration but watched with some annoyance as he wrote on a small
notepad, tore off the sheet of paper, and handed it to his associate.
A smile flitted almost imperceptibly across that man’s face as he read
the note.

I was already becoming a bit peeved that the executive had displayed no
reaction to my ideas, but this little note, passed as though between
two schoolboys, was too much. I stopped talking and asked what was
written on the paper.

The executive nodded to his associate. “Show him.”

The man leaned across the table and handed me the note. My client
had written, “What the hell is this guy talking about?”

Fortunately, I was able to see the humor in the situation and to recognize
that I had been a fool. My ego had gotten in the way of listening. Had
I paid closer attention and probed more deeply, I would have learned
that the executive’s real concern was finding ways to keep his staff
motivated while his company was shrinking. I had failed to listen and
compounded the error by failing to keep quiet. Luckily for me, I was
able to get a second meeting with him.

It’s not easy to stif le your impulse to speak, but with patience and
practice you can learn to control the urge and improve the quality
The executive’s guide to better listening 57

and effectiveness of your conversations by weighing in at the right

time. Some people can intuitively grasp where to draw the line between
input and interruption, but the rest of us have to work at it. John
McLaughlin advises managers to think consciously about when to inter-
rupt and to be as neutral and emotionless as possible when listening,
always delaying the rebuttal and withholding the interruption. Still, he
acknowledges that interrupting with a question can be necessary
from time to time to speed up or redirect the conversation. He advises
managers not to be in a hurry, though—if a matter gets to your level,
he says, it is probably worth spending some of your time on it.

As you improve your ability to stay quiet, you’ll probably begin to use
silence more effectively. The CEO of an industrial company, for
example, used thoughtful moments of silence during a meeting with
his sales team as an invitation for its junior members to speak up
and talk through details of a new incentive program that the team’s
leader was proposing. As the junior teammates filled in these
moments with new information, the ensuing rich discussion helped
the group (including the team leader) to realize that the program
needed significant retooling. The CEO’s silence encouraged a more
meritocratic—and ultimately superior—solution.

When we remain silent, we also improve the odds that we’ll spot non-
verbal cues we might have missed otherwise. The medical institution’s
COO, who was such a respectful listener, had a particular knack for
this. I remember watching him in a conversation with a nurse manager,
who was normally articulate but on this occasion kept doubling back
and repeating herself. The COO realized from these cues that something
unusual was going on. During a pause, he surprised her by asking
gently, “You don’t quite agree with me on this one, do you? Why is that?”
She sighed in relief and explained what had actually been bugging her.
58 2012 Number 2

3 Challenge assumptions

Good listeners seek to understand—and challenge—the assumptions

that lie below the surface of every conversation. This point was
driven home to me the summer before I went to college, when I had
the opportunity to hang out with my best friend at a baseball park.
He had landed a job in the clubhouse of the Rochester Red Wings, then
a minor-league farm team for the Baltimore Orioles. That meant
I got to observe Red Wings manager Earl Weaver, who soon thereafter
was promoted to Baltimore, where he enjoyed legendary success,
including 15 consecutive winning seasons, four American League champ-
ionships, and one World Series victory. Weaver was considered fiery
and cantankerous, but also a baseball genius. To my 18-year-old eyes, he
was nothing short of terrifying—the meanest and most profane man
I’d ever met.

Weaver wasn’t really a listener; he seemed more of a screamer in a per-

petual state of rage. When a young player made an error, Weaver
would take him aside and demand an explanation. “Why did you throw
to second base when the runner was on his way to third?” He’d wait
to hear the player’s reasoning for the sole purpose of savagely tearing it
apart, usually in the foulest language imaginable and at the top of
his lungs.

But now and then, Weaver would be brought up short; he’d hear some-
thing in the player’s explanation that made him stop and reconsider.
“I’ve seen that guy take a big wide turn several times but then come back
to the bag. I thought maybe if I got the ball to second really fast, we
could catch him.” Weaver knew that the move the player described was
the wrong one. But as ornery as he was, he apparently could absorb
new information that temporarily upended his assumptions. And, in
doing so, the vociferous Weaver became a listener.

Weaver called his autobiography It’s What You Learn After You
Know It All That Counts. That Zen-like philosophy may clash with the
Weaver people thought they knew. But the title stuck with me
because it perfectly states one of the cornerstones of good listening: to
get what we need from our conversations, we must be prepared
to challenge long-held and cherished assumptions.

Many executives struggle as listeners because they never think to relax

their assumptions and open themselves to the possibilities that
can be drawn from conversations with others. As we’ve seen, entering
The executive’s guide to better listening 59

conversations with respect for your discussion partner boosts the odds
of productive dialogue. But many executives will have to undergo a
deeper mind-set shift—toward an embrace of ambiguity and a quest to
uncover “what we both need to get from this interaction so that we
can come out smarter.” Too many good executives, even exceptional ones
who are highly respectful of their colleagues, inadvertently act as if
they know it all, or at least what’s most important, and subsequently
remain closed to anything that undermines their beliefs.

Such tendencies are, of course, deeply rooted in human behavior.

So it takes real effort for executives to become better listeners by forcing
themselves to lay bare their assumptions for scrutiny and to shake up
their thinking with an eye to reevaluating what they know, don’t know,
and—an important point—can’t know.

Arne Duncan, the US Secretary of Education, is one such listener. He

believes that his listening improves when he has strong, tough people
around him who will challenge his thinking and question his reasoning.
If he’s in a meeting, he makes sure that everyone speaks, and he
doesn’t accept silence or complacency from anyone. Arne explained to
me that as a leader, he tries to make it clear to his colleagues that
they are not trying to reach a common viewpoint. The goal is common
action, not common thinking, and he expects the people on his team
to stand up to him whenever they disagree with his ideas.

Duncan uses a technique I find helpful in certain situations: he will

deliberately alter a single fact or assumption to see how that changes
his team’s approach to a problem. This technique can help senior
executives of all stripes step back and refresh their thinking. In a plan-
ning session, for example, you might ask, “We’re assuming a 10 per-
cent attrition rate in our customer base. What if that rate was 20 percent?
How would our strategy change? What if it was 50 percent?” Once
it’s understood that the discussion has moved into the realm of the hypo-
thetical, where people can challenge any underlying assumptions
without risk, the creative juices really begin to flow.

This technique proved useful during discussions with executives at a

company that was planning to ramp up its M&A activity. The company
had a lot of cash on hand and no shortage of opportunities to spend
it, but its M&A capabilities appeared to have gone rusty (it had not done
any deals in quite some time). During a meeting with the M&A team
and the head of business development, I asked, “Listen, I know this is
going to be a little bit shocking to the system, but let’s entertain the
60 2012 Number 2

idea that your team doesn’t exist. What kind of M&A function would
we build for this corporation now? What would be the skills and
the strategy?”

The question shook up the team a bit initially. You have to be respectful
of the emotions you can trigger with this kind of speculation. None-
theless, the experiment started a discussion that ultimately produced
notable results. They included the addition of talented new team mem-
bers who could provide additional skills that the group would need as
it went on to complete a set of multibillion-dollar deals over the
ensuing year.

Throughout my career, I’ve observed that good listeners tend to make

better decisions, based on better-informed judgments, than ordinary or
poor listeners do—and hence tend to be better leaders. By showing
respect to our conversation partners, remaining quiet so they can speak,
and actively opening ourselves up to facts that undermine our beliefs,
we can all better cultivate this valuable skill.

Bernard Ferrari is an alumnus of McKinsey’s Los Angeles and New York

offices, where he was a director; he is currently the chairman of Ferrari
Consultancy.

Elements of
this article
were adapted
from Bernard
Ferrari’s book,
Power Listening:
Mastering the
Most Critical
Business Skill
of All (Penguin,
March 2012).
 61

Why I’m a listener:

Amgen CEO Kevin Sharer

The biotech giant’s chief executive describes the epiphany

that made him a better listener and explains why listening is
a survival skill for leaders and organizations.

For most of my career, I was an awful listener in almost every pos-

sible way. I was arrogant throughout my 30s for sure—maybe into my
early 40s. My conversations were all about some concept of intellec-
tual winning and “I’m going to prove I’m smarter than you.” It wasn’t
an evil, megalomania-driven thing; it was mostly because I was a
striver, I wanted to get ahead, and getting ahead meant convincing
people of my point of view.

The best advice I ever heard about listening—advice that significantly

changed my own approach—came from Sam Palmisano,1 when he
was talking to our leadership team. Someone asked him why his experi-
ence working in Japan was so important to his leadership develop-
ment, and he said, “Because I learned to listen.” And I thought, “That’s
pretty amazing.” He also said, “I learned to listen by having only
one objective: comprehension. I was only trying to understand what
the person was trying to convey to me. I wasn’t listening to critique
or object or convince.”

That was an epiphany for me because as you become a senior leader,

it’s a lot less about convincing people and more about benefiting from
complex information and getting the best out of the people you work
with. Listening for comprehension helps you get that information, of
course, but it’s more than that: it’s also the greatest sign of respect
you can give someone. So I shifted, by necessity, to try to become more
relaxed in what I was doing and just to be more patient and open to
new ideas. And as I started focusing on comprehension, I found that my
bandwidth for listening increased in a very meaningful way.

1President and CEO of IBM from 2002 to 2011, and now chairman of the board.
62 2012 Number 2

The cultural environment, of course, is going to define every aspect of

communication. If you’re in a fear-driven, toxic environment, listening
is going to be almost impossible, and I’ve been in places like that.
Being the CEO, however, means that you can define the culture by whom
you pick for positions under you and by the standards you enforce.
I’ve always tried to emphasize an environment of partnership, teamwork,
trust, and respect—and anyone with a bullying tendency, we fire.
Of course, it’s not perfect; we’re human beings. But we try hard to have
every aspect of our culture and of the way we operate encourage the
sharing of information—to listen to the facts, listen to the logic, and
draw well-formed conclusions.

“Listening is a threshold skill: if you don’t

have it, you will fail, but having it doesn’t mean
you will necessarily succeed.”

Kevin Sharer has been Amgen’s CEO since 2000 and

chairman since 2001. He recently announced his plan to
retire from the company in May 2012. To see a video
interview of Sharer on the importance of listening, visit
this article on mckinseyquarterly.com.
Why I’m a listener: Amgen CEO Kevin Sharer 63

Strategic listening

As a senior executive—particularly if you’re responsible for a big

function or division—you operate in a very complicated ecosystem with
many sources of information that matter. In your mind, you need
a picture of what reality is right now, with the knowledge that the pic-
ture is dynamic and ambiguous. That’s why it’s important to focus
on what I call strategic listening: a purposeful, multifaceted, time-
sensitive listening system that helps you get the signals you need
from your ecosystem.

You’ve got to seek out these signals actively and use every possible
means to receive them. I imagine the individual signals as mosaic tiles
of information. No single tile paints the picture—and you never get
all the tiles—but by assembling them you get a good idea of what the pic-
ture is. My method of gathering the tiles involves regularly visiting
with, and listening to, people in the company who don’t necessarily report
to me. I also read as much as I possibly can: surveys, operating data,
analyst reports, regulatory reports, outside analyses, and so on. I meet
with our top ten investors twice a year to listen, and at shareholder
conferences I consider the Q&As very important. The key is making
yourself open to the possibility that information can and will come
from almost anywhere.

I also try to teach and model this behavior within our company. Often,
when I’m with an executive, I say, “Hey, tell me about your ecosystem.
Whose opinion matters to you? Let’s make a list of those people. How
do you hear from them, and how often? Where are you now with a
particular constituent? When’s the last time you got a particular piece
of data? And don’t tell me that no news is good news.”

Listen or fail

It’s terribly important to be able to hear danger, which is often a very

weak signal. If there’s a lag in your ability to hear it, you are going to be
in trouble because the rest of the world—the press, blogs—is a gigantic
amplification system for these signals. Listening is a threshold skill: if
you don’t have it, you will fail, but having it doesn’t mean you will
necessarily succeed. The failure may happen rapidly—the danger signal
came, you didn’t react, and it got you. Or it may occur in a more grad-
ual way, when an accumulation of all your bad listening practices erodes
personal relationships, causes you to make lower-quality decisions,
or leaves you unable to monitor implementation. Eventually, executives
64 2012 Number 2

who don’t listen lose the support of their teams and colleagues. And
once you’ve lost that support, it’s almost impossible to get it back. You
can’t be effective as an executive, and you’re going to get fired.

Similarly, organizations that don’t listen will fail, because they won’t
sense a changing environment or requirements or know whether their
customers or employees are happy. In an incredibly information-
intensive, dynamic environment, you have to listen or else—to mix
metaphors—you’re blind.

Changing behavior

Most people underappreciate the complexity of listening, the skills

needed, and the value of doing it well. Everybody says you need
to be a good listener, but in my experience it’s often more lip service
than conviction.

Listening can be learned, but to change your behavior on any important

dimension you’ve got to have deep self-awareness. You have to change,
and you have to want to change—and you can’t fake it. That’s what
my epiphany was about. I started thinking: I’d better change my style.
I was maybe 90 percent tell, 10 percent listen, and I knew I’d better try
to move closer to 50–50 and force myself to be more patient.

That was hard because arrogance would lead me to think, “I’m smarter
than you and I know what you’re going to tell me, so let’s make this
really efficient for both of us. I won’t have to listen, and we can get to the
really important part of the conversation: me telling you what to do.”
It hit me hard that I had to stop this. What was I doing? Saving three
minutes? We’ve all got three minutes to spare. There has to be a
certain humility to listen well.

Of course, at the other extreme, listening doesn’t mean being a wit-

less receiver of information or taking a monk-like “hear and say nothing”
posture. We have to process what we’re hearing, think about what it
means, and make decisions. Still, before you make a decision, you’ve got
to make sure the listening has happened so that you have sufficient
information.

At the level of very senior executives, this information includes under-

standing the psychology of the situation. Most of my job is not about
deciding on the right thing to do—that’s pretty easy. The hard part is
 Why I’m a listener: Amgen CEO Kevin Sharer 65

figuring out how to get it to happen, and that’s about understanding

the thinking and motivations of the people who help me achieve,
so I can help them to be more effective. And if I don’t listen enough to
understand their world, I can’t be a very good coach.

I recall one situation when we were developing a five-year resource

plan for a very large function. Our financial executive was worried that
the functional leader didn’t really have the conviction to manage the
costs and meet the financial targets the plan called for. This executive
felt that he had to go in with a pretty heavy hand. In listening to him
talk, I could tell right away that there would be resistance and that he
was going to fail. So I coached him on how to talk with the functional
executive and how to listen to the functional group’s concerns and put
them in a strategic context that would resonate for the group—not
just, “Hey, we’re going to miss the EPS2 for the quarter.” I was also implic-
itly giving him time to work all this through. In the end, he was able
to come together with the functional leader and succeed.
2Earnings per share.

This commentary is adapted from an interview with Thomas Fleming,

a member of McKinsey Publishing based in the Chicago office.

Copyright © 2012 McKinsey & Company. All rights reserved.

We welcome your comments on this article. Please send them to
quarterly_comments@mckinsey.com.
Artwork by Scott Bakal
 67

Demystifying
social media
Roxane Divol, David Edelman, and Hugo Sarrazin

As the marketing power of social media grows,

it no longer makes sense to treat it as an
experiment. Here’s how senior leaders can harness
social media to shape consumer decision
making in predictable ways.

The problem
Companies invest millions of dollars
in social media, with little understanding
of how it influences consumers to
favor their brands or buy their products.

Why it matters
Without knowing how social media
affects consumer behavior, companies
run the risk of aiming it at the wrong
targets, wasting time and money
on ineffective efforts, and generally
failing to harness its potential.

What to do about it
Understand social media’s core
functions: to monitor, respond, amplify,
and lead consumer behavior. Then
look for the best opportunities to carry
out those functions along the journey
that consumers embark upon when they
make purchasing decisions.
For insight into the world’s
largest social-media market,
see “Understanding social
media in China,” on page 78.
68 2012 Number 2

Executives certainly know what social media is. After all,

if Facebook users constituted a country, it would be the world’s third
largest, behind China and India. Executives can even claim to
know what makes social media so potent: its ability to amplify word-
of-mouth effects. Yet the vast majority of executives have no idea
how to harness social media’s power. Companies diligently establish
Twitter feeds and branded Facebook pages, but few have a deep
understanding of exactly how social media interacts with consumers
to expand product and brand recognition, drive sales and profitability,
and engender loyalty.

We believe there are two interrelated reasons why social media remains
an enigma wrapped in a riddle for many executives, particularly
nonmarketers. The first is its seemingly nebulous nature. It’s no secret
that consumers increasingly go online to discuss products and
brands, seek advice, and offer guidance. Yet it’s often difficult to see
where and how to influence these conversations, which take place
across an ever-growing variety of platforms, among diverse and
dispersed communities, and may occur either with lightning speed or
over the course of months. Second, there’s no single measure of
social media’s financial impact, and many companies find that it’s
difficult to justify devoting significant resources—financial
or human—to an activity whose precise effect remains unclear.

What we hope to do here is to demystify social media. We have identified

its four primary functions—to monitor, respond, amplify, and lead
consumer behavior—and linked them to the journey consumers under-
take when making purchasing decisions. Being able to identify
exactly how, when, and where social media influences consumers helps
executives to craft marketing strategies that take advantage of social
media’s unique ability to engage with customers. It should also help
leaders develop, launch, and demonstrate the financial impact of social-
media campaigns (for insight into the world’s biggest social-media
market, see “Understanding social media in China,” on page 78).

In short, today’s chief executive can no longer treat social media as

a side activity run solely by managers in marketing or public relations.
It’s much more than simply another form of paid marketing, and
it demands more too: a clear framework to help CEOs and other top
executives evaluate investments in it, a plan for building support
infrastructure, and performance-management systems to help leaders
smartly scale their social presence. Companies that have these three
elements in place can create critical new brand assets (such as content
from customers or insights from their feedback), open up new
 Demystifying social media 69

channels for interactions (Twitter-based customer service,

Facebook news feeds), and completely reposition a brand through the
way its employees interact with customers or other parties.

The social consumer decision journey

Companies have quickly learned that social media works: 39 percent of

companies we’ve surveyed already use social-media services as their
primary digital tool to reach customers, and that percentage is expected
to rise to 47 percent within the next four years.1 Fueling this growth
is a growing list of success stories from mainstream companies:

Creating buzz: Eighteen months before Ford reentered the US

subcompact-car market with its Fiesta model, it began a broad
marketing campaign called the Fiesta Movement. A major element
involved giving 100 social-media influencers a European model
of the car, having them complete “missions,” and asking them to docu-
ment their experiences on various social channels. Videos related to
the Fiesta campaign generated 6.5 million views on YouTube, and Ford
received 50,000 requests for information about the vehicle, primarily
from non-Ford drivers. When it finally became available to the public,
in late 2010, some 10,000 cars sold in the first six days.

Learning from customers: PepsiCo has used social networks

to gather customer insights via its DEWmocracy promotions, which have
led to the creation of new varieties of its Mountain Dew brand.
Since 2008, the company has sold more than 36 million cases of them.

Targeting customers: Levi Strauss has used social media to offer

location-specific deals. In one instance, direct interactions with
just 400 consumers led 1,600 people to turn up at the company’s stores—
an example of social media’s word-of-mouth effect.

Yet countless others have failed to match these successes: knowing

that something works and understanding how it works are very
different things. As the number of companies with Facebook pages,
Twitter feeds, or online communities continues to grow, we think
it’s time for leaders to remind themselves how social media connects
with an organization’s broader marketing mission.

1 See “What marketers say about working online: McKinsey Global Survey results,”

mckinseyquarterly.com, November 2011.

Q2 2012
70 2012 Number 2
Social media (CDJ)
Exhibit 1 of 2

Exhibit 1
Marketers can tailor their use of social media for each stage of the
consumer decision journey.

2 Consumer evaluates brand

Watches YouTube video posted
by enthusiastic owner showing the 3 Consumer buys
product’s innovative uses product
Photographs the product
Evaluate in store, posts it for
others to comment on,
1 Consumer considers and receives personal
purchase message with coupon
Bond
Views your brand from the brand
on retailer site and is
impressed by 6 Consumer bonds
enthusiastic user “Tips” friends on foursquare
reviews Consider after revisiting your store Buy
to purchase again

Advocate Experience

5 Consumer advocates 4 Consumer interacts

for brand with brand after purchase
Comments on your “Follows” your expert on
representative’s helpful advice Twitter to receive product
in a user forum, then “likes” updates; retweets to friends
your Facebook page

Marketing’s primary goal is to reach consumers at the moments, or

For more on touch points, that influence their purchasing behavior. Almost three
social media’s years ago, our colleagues proposed a framework—the “consumer
relationship to
the consumer decision journey”—for understanding how consumers interact with
decision journey, companies during purchase decisions.2 Expressing consumer behavior
see the interactive as a winding journey with multiple feedback loops, this new frame-
exhibit, narrated
by coauthor work was different from the traditional description of consumer
David Edelman, purchasing behavior as a linear march through a funnel. Social media
in this article on is a unique component of the consumer decision journey: it’s the only
mckinseyquarterly
.com. form of marketing that can touch consumers at each and every stage,
from when they’re pondering brands and products right through the
period after a purchase, as their experience influences the brands they
prefer and their potential advocacy influences others (Exhibit 1).

The fact that social media can influence customers at every stage
of the journey doesn’t mean that it should. Depending on the company
and industry, some touch points are more important to competitive

2 See David Court, Dave Elzinga, Susan Mulder, and Ole Jørgen Vetvik, “The consumer

decision journey,” mckinseyquarterly.com, June 2009.

 Demystifying social media 71

advantage than others.3 What’s more, our work with dozens of

companies adapting to the new marketing environment strongly
suggests that the most powerful social-media strategies focus on a
limited number of marketing responses closely related to individual
touch points along the consumer decision journey. Exhibit 2 depicts
the ten most important responses, range from providing customer
service to fostering online communities. One of those ten—monitoring
what people say about your brand—is so important that we see it
as a core function of social media, relevant across the entire consumer
decision journey. The remaining nine responses, organized in three
clusters in the exhibit, underpin efforts to use social media to respond
to consumer comments, to amplify positive sentiment and activity,
and to lead changes in the behavior and mind-sets of consumers.

1. Monitor
Gatorade, a sports drink manufactured by PepsiCo, has been diligently
working toward its goal of becoming the “largest participatory
brand in the world.”4 It has created a Chicago-based “war room” within
its marketing department to monitor the brand in real time across
social media. There are seats where team members can track custom-
built data visualizations and dashboards (including terms related
to the brand, sponsored athletes, and competitors) and run sentiment
analyses around product and campaign launches. Every day, all of
this feedback is integrated into products and marketing—for example,
by helping to optimize the landing page on the company’s Web site.
Since the war room’s creation, the average traffic to Gatorade’s online
properties, the length of visitor interactions, and viral sharing from
campaigns have all more than doubled.

Such brand monitoring—simply knowing what’s said online about

your products and services—should be a default social-media function,
taking place constantly. Even without engaging consumers directly,
companies can glean insights from an effective monitoring program that
informs everything from product design to marketing and provides
advance warning of potentially negative publicity. It’s also critical to
communicate such feedback within the business quickly: whoever
is charged with brand monitoring must ensure that information reaches
relevant functions, such as communications, design, marketing,
public relations, or risk.

3Readers interested in a detailed approach for understanding which touch points matter—based

on research techniques that reveal what consumers are seeing, saying, and doing—should
read David Edelman, “Branding in the digital age: You’re spending your money in all the wrong
places,” Harvard Business Review, December 2010, Volume 88, Number 12, pp. 62–69.
4 Comment by Carla Hassan, Gatorade’s senior marketing director, consumer and shopper

engagement. For more, see Adam Ostrow, “Inside Gatorade’s social media command center,”
mashable.com, June 15, 2010.
 Q2
72 2012 2012 Number 2
Social media (CDJ)
Exhibit 2 of 2

Exhibit 2

Social media enables targeted marketing responses at individual

touch points along the consumer decision journey.

1. Monitor 2. Respond 3. Amplify 4. Lead

social channels for to consumers’ current positive changes in sentiment
trends, insights comments activity/tone or behavior

Consider Brand monitoring Crisis Referrals and Brand content

management recommendations awareness

Evaluate Product launches

Steps in the consumer decision journey

Buy Targeted deals,

offers

Experience Customer service Fostering Customer input

communities

Advocate Brand advocacy

Bond

Source: Expert interviews; McKinsey analysis

2. Respond
Valuable though it is to learn how you are doing and what to improve,
broad and passive monitoring is only a start. Pinpointing conversations
for responding at a personal level is another form of social-media
engagement. This kind of response can certainly be positive if it’s done
to provide customer service or to uncover sales leads. Most often,
though, responding is a part of crisis management.

Last year, for example, a hoax photograph posted online claimed that
McDonald’s was charging African-Americans an additional service
fee. The hoax first appeared on Twitter, where the image rapidly went
viral just before the weekend as was retweeted with the hashtag
#seriouslymcdonalds. It turned out to be a working weekend for the
McDonald’s social-media team. On Saturday, the company’s director
of social media released a statement through Twitter declaring the
photograph to be a hoax and asking key influencers to “please let your
Demystifying social media 73

followers know.” The company continued to reinforce that message

throughout the weekend, even responding personally to concerned
Tweeters. By Sunday, the number of people who believed the image
to be authentic had dwindled, and McDonald’s stock price rose 5 per-
cent the following day.

Responding in order to counter negative comments and reinforce

positive ones will only increase in importance. The responsibility for
taking action may fall on functions outside marketing, and the
message will differ depending on the situation. No response can be
quick enough, and the ability to act rapidly requires the constant,
proactive monitoring of social media—on weekends too. By responding
rapidly, transparently, and honestly, companies can positively
influence consumer sentiment and behavior.

3. Amplify
“Amplification” involves designing your marketing activities to have an
inherently social motivator that spurs broader engagement and sharing.
This approach means more than merely reaching the end of planning
a marketing campaign and then thinking that “we should do something
social”—say, uploading a television commercial to YouTube. It means
that the core concepts for campaigns must invite customers into an
experience that they can choose to extend by joining a conversation
with the brand, product, fellow users, and other enthusiasts. It means
having ongoing programs that share new content with customers and
provide opportunities for sharing back. It means offering experiences
that customers will feel great about sharing, because they gain a
badge of honor by publicizing content that piques the interest of others.

In the initial phases of the consumer decision journey, when consumers

sift through brands and products to determine their preferred options,
referrals and recommendations are powerful social-media tools. A
simple example is the way online deal sites such as Groupon and Gilt
Groupe provide consumers with credit for each first-time purchaser
they refer. Our research shows that such direct recommendations from
peers generate engagement rates some 30 times higher than tradi-
tional online advertising does.

Once a consumer has decided which product to buy and makes a

purchase, companies can use social media to amplify their engagement
and foster loyalty. When Starbucks wanted to increase awareness of its
brand, for example, it launched a competition challenging users to
be the first to tweet a photograph of one of the new advertising posters
74 2012 Number 2

that the company had placed in six major US cities, providing winners
with a $20 gift card. This social-media brand advocacy effort
delivered a marketing punch that significantly outweighed its budget.
Starbucks said that the effort was “the difference between launching
with millions of dollars versus millions of fans.”5

Marketers also can foster communities around their brands and

products, both to reinforce the belief of consumers that they made a
smart decision and to provide guidance for getting the most from
a purchase. Software company Intuit, for example, launched customer
service forums for its Quicken and QuickBooks personal-finance
software so users could help one another with product issues. The result?
Users rather than Intuit employees answer about 80 percent of
the questions, and the company has employed user comments to make
dozens of significant changes to its software.

4. Lead
Social media can be used most proactively to lead consumers toward
long-term behavioral changes. In the early stages of the consumer
decision journey, this may involve boosting brand awareness by driving
Web traffic to content about existing products and services. When
grooming-products group Old Spice introduced its Old Spice Man
character to viewers, during the US National Football League’s 2010
Super Bowl, for example, the company’s ambition was to increase its
reach and relevance to both men and women. The commercial became
a phenomenon: starring former player Isaiah Mustafa, it got more
than 19 million hits across all platforms, and year-on-year sales for the
company’s products jumped by 27 percent within six months.

Marketers also can use social media to generate buzz through product
launches, as Ford did in launching its Fiesta vehicle in the United
States. For example, social media played an integral role in the success
of “Small Business Saturday,” the US shopping promotion created
by American Express for the weekend immediately following Thanks-
giving (for American Express CMO John Hayes’s perspective on
that launch, see “How we see it: Three senior executives on the future
of marketing,” on mckinseyquarterly.com). In addition, when
consumers are ready to buy, companies can promote time-sensitive
targeted deals and offers through social media to generate traffic and
sales. Online menswear company Bonobos, for example, provided
an incentive for its Twitter followers by unlocking a discount code after
its messages were resent a certain number of times. As a result of

5 See Claire Cain Miller, “New Starbucks ads seek to recruit online fans,” nytimes.com,

May 18, 2009.

Demystifying social media 75

this effort, almost 100 consumers bought products from the site
for the first time. The campaign delivered a 1,200 percent return on
investment in just 24 hours.

Finally, social media can solicit consumer input after the purchase.
This ability to gain product-development insights from customers in a
relatively inexpensive way is emerging as one of social media’s most
significant advantages. Intuit, for example, has its community forums.
Starbucks uses MyStarbucksIdea.com to collect its customers’
views about improving the company’s products and services and then
aggregates submitted ideas and prominently displays them on a
dedicated Web site. That site groups ideas by product, experience, and
involvement; ranks user participation; and shows ideas actively under
consideration by the company and those that have been implemented.

Converting knowledge to action

Despite offering numerous opportunities to inf luence consumers,

social media still accounts for less than 1 percent of an average
marketing budget, in our experience. Many chief marketing officers
say that they want to increase that share to 5 percent. One problem
is that a lot of senior executives know little about social media. But the
main obstacle is the perception that the return on investment (ROI)
from such initiatives is uncertain.

Without a clear sense of the value social media creates, it’s perhaps
not surprising that so many CEOs and other senior executives don’t
feel comfortable when their companies go beyond mere “experiments”
with social-media strategy. Yet we can measure the impact of social
media well beyond straight volume and consumer-sentiment metrics;
in fact, we can precisely determine the buzz surrounding a product
or brand and then calculate how social media drives purchasing
behavior. To do so—and then ensure that social media complements
broader marketing strategies—companies must obviously coordinate
data, tools, technology, and talent across multiple functions. In
many cases, senior business leaders must open up their agendas and
recognize the importance of supporting and even undertaking
initiatives that may traditionally have been left to the chief marketing
officer. As our colleagues noted last year, “we’re all marketers now.”6

6 See Tom French, Laura LaBerge, and Paul Magill, “We’re all marketers now,”

mckinseyquarterly.com, July 2011.

76 2012 Number 2

Consider the experience of a telecommunications company that pro-

actively adopted social media but had no idea if its efforts were
working. The company had launched Twitter-based customer service
capabilities, several promotional campaigns built around social
contests, a fan page with discounts and tech tips, and an active response
program to engage with people speaking about the brand. In social-
media terms, the investment was relatively large, and the company’s
senior executives wanted more than anecdotal evidence that the
strategy was paying off. As a starting point, to ensure that the company
was doing a quality job designing and executing its social presence,
it benchmarked its efforts against approaches used by other companies
known to be successful in social media. It then advanced the
following hypotheses:

• I f all of these social-media activities improve general service per-

ceptions about the brand, that improvement should be reflected in a
higher volume of positive online posts.7

• If social sharing is effective, added clicks and traffic should result

in higher search placements.

• If both of these assumptions hold true, social-media activity should

help drive sales—ideally, at a rate even higher than the company
could achieve with its average gross rating point (GRP) of advertising
expenditures.8

The company then tested its options. At various times, it spent less
money on conventional advertising, especially as social-media activity
ramped up, and it modeled the rising positive sentiment and higher
search positions just as it would using traditional metrics. The company
concluded that social-media activity not only boosted sales but also
had higher ROIs than traditional marketing did. Thus, while the company
took a risk by shifting emphasis toward social-media efforts before it
had data confirming that this was the correct course, the bet paid off.
What’s more, the analytic baseline now in place has given the company
confidence to continue exploring a growing role for social media.

In other cases, social media may have a more specific role, such as
helping to launch a new product or to mitigate negative word of mouth.
Similar types of analyses can focus on mixing the impact of buzz,
search, and traffic; correlating that with sales or renewals (or whatever

7 There’s no shortage of methods purporting to measure social media’s presence and impact.

The company in this example used BuzzMetrics, a suite of tools developed by NM Incite
(a joint venture between Nielsen and McKinsey).
8 Gross rating points measure the size of the audience a specific media vehicle reaches. To

calculate them, multiply the percentage of the target audience an advertisement reaches by
the number of times it airs.
Demystifying social media 77

the key metric may be); and then gauging the result against total
costs. This approach can give executives the confidence and focus they
need to invest more money, time, and resources in social media.

As these social-media activities gain scale, the challenges center less

around justifying funding and more around organizational issues
such as developing the right processes and governance structure, iden-
tifying clear roles—for all involved in social-media strategy, from
marketing to customer service to product development—and bolstering
the talent base, and improving performance standards. New
capabilities abound, and social-media best practices are barely starting
to emerge. We do know this: because social-media influences every
element of the consumer decision journey, communication must take
place between as well as within functions. That complicates lines
of reporting and decision-making authority.

If insights from monitoring social media are relevant to nonmarketing

functions such as product development, for instance, how will you
identify and disseminate that information efficiently and effectively—
and then ensure that it gets used? If you spot an opportunity to have
a meaningful conversation with a key influencer, how will you quickly
engage the right senior executive to follow through? If you recog-
nize a fast-moving service concern, how will you respond rapidly and
openly—and when should you do so outside the traditional service
organization? Senior executives across the company must recognize
and begin to answer such questions.

Social media is extending the disruptive impact of the digital era

across a broad range of functions. Meanwhile, the perceived lack of
metrics, the fear, and the limited sense of what’s possible are
eroding. Executives can identify the functions, touch points, and goals
of social-media activities, as well as craft approaches to measure
their impact and manage their risks. The time is ripe for executive-
suite discussions on how to lead and to learn from people within your
company, marketers outside it, and, most of all, your customers.

The authors would like to acknowledge the contributions of Sirish

Chandrasekaran, Dianne Esber, Rebecca Millman, and Dan Singer to the
development of this article.

Roxane Divol is a principal in McKinsey’s San Francisco office,

David Edelman is a principal in the Boston office, and Hugo Sarrazin is
a director in the Silicon Valley office.
78

Understanding social
media in China

Cindy Chiu, Chris Ip, and Ari Silverman

The world’s largest social-media market is vastly different from its counter-
part in the West. Yet the ingredients of a winning strategy are familiar.

No Facebook. No Twitter. No YouTube. Listing the companies that

don’t have access to China’s exploding social-media space under-
scores just how different it is from those of many Western markets.
Understanding that space is vitally important for anyone trying to
engage Chinese consumers: social media is a larger phenomenon in
the world’s second-biggest economy than it is in other countries,
including the United States. And it’s not indecipherable. Chinese
consumers follow the same decision-making journey as their peers
in other countries, and the basic rules for engaging with them
effectively are reassuringly familiar.

Surveying the scene

In addition to having the world’s biggest Internet user base—

513 million people, more than double the 245 million users in the
United States1—China also has the world’s most active environment for
social media. More than 300 million people use it, from blogs to
social-networking sites to microblogs and other online communities.2
That’s roughly equivalent to the combined population of France,
Germany, Italy, Spain, and the United Kingdom. In addition, China’s
online users spend more than 40 percent of their time online on
social media, a figure that continues to rise rapidly.

This appetite for all things social has spawned a dizzying array
of companies, many with tools more advanced than those in the West:
for example, Chinese users were able to embed multimedia content

1 These figures are sourced from Internet World Stats data, as of December 2011 (US figures

from March 2011).

2 A forthcoming McKinsey survey on Chinese consumers also finds that 91 percent of Internet

users in Tier 1 to Tier 3 cities use social media. Tier 1 cities include Beijing, Guangzhou,
Shanghai, and Shenzhen. Tier 2 comprises about 40 cities, Tier 3 about 170. The tiers are
defined by urban population and by economic factors, such as GDP and GDP per capita.
 Understanding social media in China 79

in social media more than 18 months before Twitter users could do so

in the United States. Social media began in China in 1994 with online
forums and communities and migrated to instant messaging in 1999.
User review sites such as Dianping emerged around 2003. Blogging took
off in 2004, followed a year later by social-networking sites with
chatting capabilities such as Renren. Sina Weibo launched in 2009,
offering microblogging with multimedia. Location-based player
Jiepang appeared in 2010, offering services similar to foursquare’s.

This explosive growth shows few signs of abating, a trend that’s at

least partially attributable to the fact that it’s harder for the government
to censor social media than other information channels. That’s
one critical way the Chinese market is unique. As you shape your own
social-media strategy, it’s important to fully understand some
other nuances of the country’s consumers, content, and platforms.

Consumers
China’s social-media users not only are more active than those of any
other country but also, in more than 80 percent of all cases, have
multiple social-media accounts, primarily with local players (compared
with just 39 percent in Japan).3 The use of mobile technologies to
access social media is also increasingly popular in China: there were
more than 100 million mobile social users in 2010, a number that is
forecast to grow by about 30 percent annually.4 Finally, because many
Chinese are somewhat skeptical of formal institutions and authority,
users disproportionately value the advice of opinion leaders in social
networks. An independent survey of moisturizer purchasers, for
example, observed that 66 percent of Chinese consumers relied on
recommendations from friends and family, compared with 38 per-
cent of their US counterparts.

Content
The competition for consumers is fierce in China’s social-media space.
Many companies regularly employ “artificial writers” to seed positive
content about themselves online and attack competitors with negative
news they hope will go viral. In several instances, negative publicity
about companies—such as allegations of product contamination—has
prompted waves of microblog posts from competitors and disguised
users. Businesses trying to manage social-media crises should carefully
identify the source of negative posts and base countermeasures on
whether they came from competitors or real consumers. Companies
must also factor in the impact of artificial writers when mining for

3 Figures are sourced from a forthcoming McKinsey survey of Chinese consumers.

4 Figures are sourced from IDC and iResearch.
80 2012 Number 2

social-media consumer insights and comparing the performance of their

brands against that of competitors. Otherwise, they risk drawing
the wrong conclusions about consumer behavior and brand preferences.

Platforms
China’s social-media sector is very fragmented and local. Each social-
media and e-commerce platform has at least two major local players:
in microblogging (or weibo), for example, Sina Weibo and Tencent
Weibo; in social networking, a number of companies, including Renren
and Kaixin001. These players have different strengths, areas of focus,
and, often, geographic priorities. For marketers, this fragmentation
increases the complexity of the social-media landscape in China
and requires significant resources and expertise, including a network
of partners to help guide the way. Competition is evolving quickly—
marketers looking for partners should closely monitor development of
the sector’s platforms and players.

Crafting a winning strategy

While these unique Chinese market characteristics often create

challenging wrinkles for marketers to contend with, they don’t invali-
date the principles that underpin effective social-media strategy
elsewhere. The following few examples illustrate how companies are
applying some widespread social-media tenets in China.

Make content authentic and user oriented. Estée Lauder’s

Clinique brand launched a drama series, Sufei’s Diary, with 40 episodes
broadcast daily on a dedicated Web site. (Viewers also could watch
segments on monitors located on buses, trains, and airplanes.) While
skin care was part of the story line and products were prominently
featured, Sufei’s Diary was seen as entertainment—not a Clinique
advertisement—and has been viewed online more than 21 million
times. Clinique’s online brand awareness is now 27 percent higher than
that of its competitors, although social-media content costs signifi-
cantly less than a traditional advertising campaign.

Adopt a test-and-learn approach. When Dove China first

imported the Real Beauty social-media campaign to promote beauty
among women of all looks and body types, Chinese consumers
viewed the real women as overweight and unattractive. Dove switched
tack and partnered with Ugly Wudi, the Chinese adaptation of
the US television show Ugly Betty, to weave the Real Beauty message
into story lines and mount a number of initiatives, including a blog
 Understanding social media in China 81

by Wudi and live online chats. The effort generated millions of searches
and blog entries, increased uptake of Dove body wash by 21 percent
year over year after the show’s first season, and increased unaided
awareness of Dove’s Real Beauty by 44 percent among target consumers.
The estimated return on investment from this social-media campaign
was four times that of a traditional TV media investment.

Support overarching brand goals with sustained social-

media efforts. Starbucks China promotes the same message
of quality, social responsibility, and community building across all of
its social-media efforts, as well as in its stores. And Durex didn’t just
establish a corporate account on Sina Weibo: it built a marketing team
that both monitors online comments around the clock and collabo-
rates closely with agency partners to create original, funny content.
The company’s approach is designed to interact meaningfully with
fans, generate buzz, and deepen customer engagement with the brand.

The sheer number of the more than 300 million social-media users
in China creates unique challenges for effective consumer engagement.
People expect responses to each and every post, for example, so
companies must develop new models and processes for effectively
engaging individuals in a way that communicates brand identity
and values, satisfies consumer concerns, and doesn’t lead to a negative
viral spiral. Another problem is the difficulty of developing and
tracking reliable metrics to gauge a social-media strategy’s performance,
given the size of the user base, a lack of analytical tools (such as
those offered by Facebook and Google in other markets), and limited
transparency into leading platforms. Yet these challenges should
not deter companies. The similarity between the ingredients of success
in China and in other markets makes it easier—and well worth the
trouble—to cope with the country’s many peculiarities.

The authors would like to acknowledge the contributions of TC Chu,

Davis Lin, and Yael Taqqu to the development of this article.

Cindy Chiu is a consultant in McKinsey’s Shanghai office, where

Ari Silverman is a principal; Chris Ip is a director in the Singapore office.

Copyright © 2012 McKinsey & Company. All rights reserved.

We welcome your comments on this article. Please send them to
quarterly_comments@mckinsey.com.
The social side
of strategy
Arne Gast and Michele Zanini

Crowdsourcing your strategy may sound crazy.

But a few pioneering companies are starting
to do just that, boosting organizational alignment
in the process. Should you join them?

The problem
Strategy setting sometimes suffers
from insufficient diversity and expertise,
with leaders far removed from the
implications of their decisions and
hampered by experience-based biases.

Why it matters
Strategies developed by leaders
in isolation can be flawed and
sometimes aren’t embraced by the
people who must implement them.
Such misalignment can compromise
organizational health and financial
performance.

What to do about it
Pull in overlooked frontline perspectives
through the use of social technologies
such as wikis and internal idea markets.
Work overtime to bring on board
executives and middle managers.
Transparency, radical inclusion, and
peer review are powerful tools but
can be uncomfortable for leaders up
and down the line.

For more on social-strategy tools,

see “Collaborative strategic planning:
Three observations,” on page 94.
 83

Artwork by Andrew Bannecker

84 2012 Number 2

In 2009, Wikimedia1 launched a special wiki—one dedicated to

the organization’s own strategy. Over the next two years, more than
1,000 volunteers generated some 900 proposals for the company’s
future direction and then categorized, rationalized, and formed task
forces to elaborate on them. The result was a coherent strategic
plan detailing a set of beliefs, priorities, and related commitments that
together engendered among participants a deep sense of dedication
to Wikimedia’s future. Through the launch of several special projects
and the continued work of self-organizing teams dedicated to spe-
cific proposals, the vision laid out in the strategic plan is now unfolding.

Wikimedia’s effort to crowdsource its strategy probably sounds like

an outlier—after all, the company’s very existence rests on collaborative
content creation. Yet over the past few years, a growing number of
organizations have begun experimenting with opening up their strategy
processes to constituents who were previously frozen out of strategic
direction setting. Examples include 3M, Dutch insurer AEGON, global
IT services provider HCL Technologies, Red Hat (the leading provider
of Linux software), and defense contractor Rite-Solutions.

While such efforts are at different stages, executives at organiza-

tions that are experimenting with more participatory modes of strategy
development cite two major benefits. One is improving the quality
of strategy by pulling in diverse and detailed frontline perspectives that
are typically overlooked but can make the resulting plans more insight-
ful and actionable. The second is building enthusiasm and alignment
behind a company’s strategic direction—a critical component of long-
term organizational health, effective execution, and strong financial per-
formance that is all too rare, according to research we and our col-
leagues in McKinsey’s organization practice have conducted.

Our objective in this article isn’t to present a definitive road map for
opening up the strategy process; it’s simply too early for one to exist.
We’d also be the first to acknowledge that for most organizations, “social”
strategy setting represents a significant departure from the status
quo and should be experimented with carefully—whether that means
trying it out in a few areas or creating meaningful opportunities
for participation in the context of a more traditional strategy process.
(For more on intelligent experimentation, see “Collaborative stra-
tegic planning: Three observations,” on page 94.) Nonetheless, we hope
that by sketching a picture of some management innovations under

1 Wikimedia is the nonprofit foundation that operates Wikipedia, the Web-based encyclopedia

that’s created and curated in a collaborative fashion by thousands of volunteers.

The social side of strategy 85

way, we will stir the thinking of senior executives eager to benefit from
experimenting with such approaches. If you’ve ever wondered how
to inject more diversity and expertise into your strategy process, to get
leaders closer to the operational implications of their decisions, or
to avoid the experience-based biases and orthodoxies that inevitably
creep into small groups at the top, it may be time to try shaking
things up.

Lessons from the fringe

The best way to describe the possibilities of community-based strategy

approaches is to show them in action. Two examples demonstrate the
lengths to which some companies have already gone in broadening their
strategy processes, as well as the degree to which the executives who
participated are convinced of the benefits.

Rethinking planning at HCL Technologies

HCL Technologies, the Indian IT services and software-development
company, had enjoyed rapid growth since its founding, in 1998.
With growth, however, the company’s business-planning process had
become unwieldy. Vineet Nayar, HCL’s chairman and CEO, along
with his top team, were providing input to hundreds of business unit–
level plans each year. Nayar realized that he and his team had
neither the expertise nor the time to deliver all the detailed feedback
that each business plan deserved, so he challenged his colleagues
to use three key principles to revamp the planning process: make peer
review a core component of strategy evaluation, create radical trans-
parency across units, and open up the conversation to large cross-
sections of the company.

The solution was to turn the company’s existing business-planning

process—a live meeting called Blueprint, which involved a few hundred
top executives—into an online platform open to thousands of people.
The new process, dubbed My Blueprint, was launched in 2009, with
300 HCL managers posting their business plans, each coupled with
an audio presentation. More than 8,000 employees (including several
members of the teams that had submitted plans) were then invited
to review and provide input on the individual blueprints. A surge of
advice followed. The inclusive nature of the process helped identify
specific ideas for cross-unit collaboration and gave business leaders a
chance to obtain detailed and actionable feedback from interested
individuals across the company.
86 2012 Number 2

This exercise quickly began yielding business results. One HCL exec-
utive we spoke with credited the new process with a fivefold increase
in sales to an important client over two years. The key, the executive
explained, was the detailed comments—from more than 25 colleagues,
ranging from junior finance professionals to software engineers—
that together highlighted the need to reframe the business plan away
from an emphasis on commoditized application support and toward
a handful of new services where HCL had the edge over larger com-
petitors. The employees provided more than good ideas: several even
helped assemble the materials the executive needed to deliver the
successful proposal.

The high degree of transparency increased the quality of insights,

not just their volume. As Nayar notes, “Because the managers knew that
the plans would be reviewed by a large number of people, including
their own teams, the depth of their business analysis and the quality
of their planned strategy improved. They were more honest in their
assessment of current challenges and opportunities. They talked less
about what they hoped to accomplish and more about the actions
they intended to take to achieve specific results.” At the conclusion of
the inaugural My Blueprint process, there was broad consensus that
participatory business planning had been far more valuable than the
traditional top-down review process.2

Red Hat’s new road map

Red Hat is the leading provider of open-source software. In 2008, its
leadership team began taking a new approach to strategy development.
After defining an initial set of priorities for exploration, Red Hat’s
leaders formed teams devoted to each priority. To boost the odds they
would stretch toward new solutions, the company ensured that the
team leaders—all members of the company’s C-suite—were far removed
from their areas of responsibility. The company’s chief people officer,
for example, was tasked with analyzing its financial model, while the
CFO explored potential operational enhancements.

The teams used wikis and other online tools to generate and orga-
nize ideas and made these “open” so that any Red Hat employee could
respond with comments or suggestions. The idea generation phase
lasted five months and included company-wide updates and online chats
with the CEO. Over that period, the best ideas coalesced into nine
strategic priorities.

2 For more on the My Blueprint process and HCL’s management philosophy, see Vineet Nayar,

Employees First, Customer Second: Turning Conventional Management Wisdom Upside

Down, Cambridge, MA: Harvard Business School Press, June 2010.
 The social side of strategy 87

Because managers knew that the plans would

be reviewed by a large number of people,
the depth of their business analysis and the
quality of their planned strategy improved.

To ensure accountability for developing the priorities further and for

making them actionable, the company tasked a new group of exec-
utives to lead teams exploring each of the nine areas. These leaders were
senior functional ones whose responsibilities put them a level or
two below the C-suite. Each of their teams fleshed out one or two of
the most important strategic initiatives and was empowered to
execute the plans for them without further approvals.

This effort has reshaped the way Red Hat conducts strategic plan-
ning. Instead of refreshing strategy yearly on a fixed calendar, the com-
pany now updates and evaluates strategy on an ongoing basis. Ini-
tiative leaders use customized mailing lists and other tools to receive
input continuously from employees and communicate back to them
via town hall–style meetings, Internet chat sessions, and frequent blog
posts. The company maintains its annual budget process, which is
informed by the evolving funding needs of the initiatives.

The fresh perspectives generated by the new planning process have

been instrumental in spurring value-creating shifts in the company’s
direction. For example, a respected Red Hat engineer used the new
process to make the case for a significant change in the way the company
offers virtualization services for enterprise data centers and desktop
computer applications. The changes led to the acquisition of an external
technology provider—a move that would have been unlikely in the
days when the company used its old, less inclusive planning process.

Red Hat’s vice president of strategy and corporate marketing, Jackie

Yeaney, cites three key benefits of the company’s new approach: first,
the process generated “more creativity, accountability, and commitment.”
Second, “By not bubbling every decision up to the senior-executive
level, we avoided the typical 50,000-foot oversimplification” of issues.
And third, “We improved the f lexibility and adaptability of the
88 2012 Number 2

strategy.” With the responsibility for planning and execution now in

the hands of the same people doing the work, responsiveness to
new opportunities or shifts in the market has increased dramatically.3

Closer to home

Some leaders may wonder about borrowing approaches from Red Hat,
Wikimedia, or other companies that consider crowdsourcing a part
of their institutional DNA (and for which confidentiality issues may be
less pressing than they are for many organizations). For these exec-
utives, we would note the experiments of more traditional companies,
such as 3M, AEGON, and Rite-Solutions. A look at how these
organizations are introducing a social side to strategy can help senior
executives determine how much further they want to go in their
own companies.

Market-based strategy at Rite-Solutions

One way of experimenting with more open strategic direction setting
is to create internal markets where legacy programs and new per-
spectives compete on an equal footing for talent and cash. Rite-Solutions,
a Rhode Island–based software provider for the US Navy, defense
contractors, and first responders (such as fire departments), is pio-
neering a game-based strategy process whose foundation is an internal
stock exchange it calls Mutual Fun.

Would-be entrepreneurs at Rite-Solutions can launch “IPOs” by

preparing an Expect-Us (rather than a prospectus)—a document that
outlines the value creation potential of the new idea—as well as a

3 To read more about Red Hat’s open approach to strategy development, see Jackie Yeaney,

“Democratizing the corporate strategy process at Red Hat,” managementexchange.com,

November 2011.
 The social side of strategy 89

Budge-It list that articulates the short-term steps needed to move the
idea forward. Each new stock debuts at $10, and every employee
gets $10,000 in play money to invest in the virtual idea market and
thereby establish a personal intellectual portfolio. The money flows
to ideas that are attracting volunteer effort and moving steadily from
germination toward commercialization. A value algorithm revalues
each stock, based on the number of Budge-It items completed, inflows
and outflows of employee money, and opinions about the stocks
expressed in an online discussion board. When an IPO gains momentum
and breaks into the company’s Top 20, the initiative is funded with
seed money; more is awarded depending on the ability to meet various
stage gate milestones. What’s more, when ideas help Rite-Solutions
make or save money, those who have invested intellectual capital and
contributed to the idea’s realization receive a share of the benefits
through bonuses or real stock options.

The internal market for ideas has bolstered the company’s pipeline of
new products, and the 15 ideas the company has thus far launched
as a result now account for one-fifth of Rite-Solutions’ revenues. Some
of the blockbusters were generated in unexpected places—including
Win/Play/Learn, a Web-based educational tool licensed by toy maker
Hasbro. The source of the idea: an administrative assistant.4

Improving market analysis at 3M

In April 2009, 3M decided to reinvigorate its Markets of the Future
process—a critical input to the company’s strategic planning. Previously,
says Barry Dayton, the company’s knowledge-management strategist,
this process had “consisted of a small group of analysts doing research
[about] megatrends and resulting markets of the future.”5 The com-
pany invited all of its sales, marketing, and R&D employees to a Web-
based forum called InnovationLive, which over a two-week period
attracted more than 1,200 participants from over 40 countries and
generated more than 700 ideas. The end result was the identifi-
cation of nine new future markets with an aggregate revenue potential
in the tens of billions of dollars. Since then, 3M has held several
additional InnovationLive events, and more are on the way.

4To read more about Rite-Solutions’ internal market for ideas, see Jim Lavoie, “Nobody’s

as smart as everybody—Unleashing individual brilliance and aligning collective genius,”

managementexchange.com, September 2011.
5 To read Dayton’s full description of the experience, see “InnovationLive: Engaging 3M’s

global employees in creating an exciting, growth-focused future,” managementexchange

.com, September 2011.
90 2012 Number 2

Many organizations struggle with strategic

alignment: even at the healthiest
companies, about 25 percent of employees are
unclear about their company’s direction.

The alignment advantage

Spend a few minutes talking with the senior executives involved in any
of the initiatives described earlier, and it’s immediately apparent
how powerful it is when thousands of people are deeply engaged with a
company’s strategy. Those employees not only understand the strat-
egy better but are also more motivated to help execute it effectively and
more likely to spot emerging opportunities or threats that require
quick adjustments.

Reviewing the data

Research we’ve conducted using McKinsey’s organizational-health
index database suggests that none of this should be surprising. That
database, which contains the results of surveys collected over more
than a decade from upward of 765,000 employees at some 600 com-
panies, facilitates analysis of the nature of organizational health, the
factors contributing to it, and its relationship with financial perform-
ance. One thing we and our colleagues have seen over and over again
through our work is that many organizations struggle with strategic
alignment: even at the healthiest companies, about 25 percent of
employees are unclear about their company’s direction. That figure
rises to nearly 60 percent for companies with poor organizational-
health scores.6

Similarly, we’ve found that the actions companies can take that are
most helpful in aligning individuals with the organization’s direction
are moves like “making the vision meaningful to employees at
a personal level” and “soliciting employee involvement in setting the
company’s direction.” If that’s right, it suggests that making more

6 For more, see Scott Keller and Colin Price, Beyond Performance: How Great Organizations

Build Ultimate Competitive Advantage, Hoboken, NJ: Wiley, June 2011; Scott Keller
and Colin Price, “Organizational health: The ultimate competitive advantage,”
mckinseyquarterly.com, June 2011; and Aaron De Smet, Mark Loch, and Bill Schaninger,
“Anatomy of a healthy corporation,” mckinseyquarterly.com, May 2007.
The social side of strategy 91

employees part of the strategy process should be a powerful means of

aligning them more closely with the company’s overall direction.
The payoff for such cohesion is significant: companies with a top-quartile
score in directional alignment are twice as likely as others to have
above-median financial performance.

Mobilizing middle management

Of course, adopting social-strategy tools doesn’t automatically create
alignment. Companies must create it actively, particularly among
middle managers, who as the guardians of everyday operations bear
the brunt of making any company’s strategy work.

One airline saw its efforts to mobilize the workforce impaired by the
silent noncooperation of middle management in several departments.
Closer inspection revealed that middle managers didn’t disagree with
the discussion that was under way but felt they deserved a bigger voice
in it—and should have been included earlier. They also felt uneasy
with the level of transparency in a dialogue involving some 2,000 people,
accustomed as they were to managing on a need-to-know basis.

The Dutch insurer AEGON sidestepped problems such as these by

breaking its strategy discussion into manageable topics related to every-
day operational practices. That allowed middle managers to assume
responsibility for the discussion and contribute their expertise. In the
words of Marco Keim, CEO of AEGON The Netherlands, “We started
a digital-networking platform called AEGON Square and got the
conversation going. People gathered in communities of practice and
started sharing ideas on how to make the new strategy work.
Dialogue really helped in fostering organization-wide alignment.”

Ultimately, middle managers were among the effort’s most enthusi-

astic supporters—both as contributors themselves and as active
recruiters of participants. (In the end, 3,000 employees, 85 percent
of the total, participated over 12 months.) Keim acknowledged,
though, that building this alignment required a significant cultural
change toward more openness, which took time to take hold and
required regular reaffirmation by senior executives.

The evolution of strategic leadership

It takes courage to bring more people and ideas into strategic direction
setting. Senior executives who launch such initiatives are essentially
92 2012 Number 2

using their positional authority to distribute power. They’re also

embracing the underlying principles—transparency, radical inclusion,
egalitarianism, and peer review—of the Web-based social technol-
ogies that make it possible to open up direction setting.

Taking these principles to their logical conclusion suggests a shift

in the strategic-leadership role of the CEO and other members of the
C-suite: from “all-knowing decision makers,” who are expected to
know everything and tell others what to do, to “social architects,” who
spend a lot of time thinking about how to create the processes and
incentives that unearth the best thinking and unleash the full potential
of all who work at a company.7 Making this shift doesn’t imply an
abdication of strategic leadership. The CEO and other top executives
still have the right—indeed, the responsibility—to step in if things
go awry, and of course they continue to be responsible for making the
difficult trade-offs that are the essence of good strategy.

But it also may be increasingly important for strategists to lead in

different ways. For example, to convey the message that the contribution
of employees is of vital importance, top executives should constantly
confirm that it is and set the example themselves. This approach requires
a more direct, personal, and empathetic exchange than a traditional
town hall meeting allows. For a mass digital dialogue to succeed, people
need to express themselves openly, which may leave some partici-
pants feeling exposed. Leaders can help by demonstrating vulnerability
as well—peeling off the layers of formal composure.

Another important element of social-strategy leadership is honestly

assessing the readiness of the organization to open up and, in light
of that, determining the best way to stimulate engagement. This sounds
simple, but overlooking it can be costly. As part of a new strategy
dialogue, the leaders of one mutual insurance company enthusiastically
called upon its workforce to share reflections on an innovative, soon-
to-be-launched life insurance product. Despite the leaders’ expectation
that the open call would generate a torrent of endorsements, it was
met with a deafening silence. Closer inspection revealed that people
were acutely aware of the strategic importance that senior manage-
ment attached to this innovation. And nobody wanted to wreck the party
by openly sharing the prevailing doubts, which were widespread.
The doubts proved well founded: within a few months of being launched,
the new product was declared a failure and shelved.

7For more about the changing role of senior leaders, see Gary Hamel, What Matters Now,

San Francisco, CA: Jossey-Bass, February 2012.

 The social side of strategy 93

This cautionary tale points to a final element of strategic leadership:

figuring out ways to encourage dissenting voices. Enabling employees
to communicate through ambient signals instead of relying on
words and elaborated opinions is an effective way to lower the threshold
and still catch the prevailing mood. Familiar examples of ambient
dialogue include polls, “liking,” 8 and voting—simple functions that allow
participants to express an opinion without being exposed. More power-
ful and sophisticated forms of ambient dialogue include prediction
markets (small-scale electronic markets that tie payoffs to measurable
future events) and swarming (the visually aggregated representation
of the emergent mood or motion within an organization).9

Consider how a prediction market might have helped the mutual insurer.
The opening market quotation for the new life insurance product
would probably have taken a steep dive, revealing the negative assess-
ment of the internal market. This would have immediately alerted
managers to potential weaknesses, without exposing the employees
who had the courage to reveal the problems.

While these are still early days for social strategy, its potential to
enhance the quality of dialogue, improve decision making, and boost
organizational alignment is alluring. Realizing that potential will
require strategic leaders to flex new muscles and display real courage.

8 Users of a Web site—Facebook, for example—click on a button to say that they “like” something

on it (“John Smith and five others like this”).

9 For more on prediction markets, see Renée Dye, “The promise of prediction markets:

A roundtable,” mckinseyquarterly.com, April 2008.

The authors would like to offer special thanks to Raul Lansink for his advice
on and contributions to this article.

Arne Gast is a principal in McKinsey’s Amsterdam office; Michele Zanini

is a consultant in the Boston office and cofounder of the Management
Innovation eXchange (MIX), a Web-based open-innovation project dedicated
to reinventing management. McKinsey is a knowledge partner of the MIX.
94

Collaborative strategic
planning: Three observations

Olivier Sibony

Social-strategy tools can provide real value to a company

whose executives know how to use them.

There are some fascinating interdependencies between the

experiments described in “The social side of strategy” (see page 82), the
challenges inherent to strategic planning, and the impact that cogni-
tive biases have on decision making. Because the latter two issues are
central to my own research and work,1 I would like to hazard three
observations about the role that community-oriented strategy tools
can play.

1. Rounding out the strategist’s tool kit

Social-strategy initiatives represent valuable tools, but they’re not a

replacement for the entire strategic-planning edifice. As the examples
in the previous article show, the crowdsourcing of strategy can be
particularly useful for activities such as generating ideas, prioritizing
them (through prediction markets, for example), and challenging
operational plans. On the other hand, social-strategy tools are less
likely to help the strategist identify the need for radical shifts in
direction, wrestle through difficult trade-offs between options that
seem similarly attractive, or develop plans for working through
intensely competitive circumstances. Most importantly, a strategist—
not a tool—should decide, at the end of the day, what to do.

One of the main gripes people have with strategic plans is that they are
not strategic enough. In the words of one chief strategy officer I know,
Collaborative strategic planning: Three observations 95

“Our strategic sessions are budget meetings with the word ‘strategic’
thrown in here and there to add emphasis.” There are also significant
confidentiality issues around strategy—most companies believe that
keeping a plan shrouded in secrecy until it gets implemented is critical
to its success. Consider the implications these two issues have for
social-strategy tools: leaders concerned about confidentiality might well
limit the use of these tools to more operational planning—which in
turn could reduce the likelihood of their leading to real strategic break-
throughs and breed disenchantment with them. The wise leader
will look for steps in the strategic-planning process that can be tackled
in unconventional ways, without pretending that taking those steps
implies wholesale replacement of the process or that it will magically
transform their strategy.

2. Killing bad ideas

The old brainstorming adage “There are no bad ideas” does not
apply to strategy. Terrible ideas abound for new markets to explore,
acquisitions to make, products to invest in, and the like. Prediction
markets and other similar mechanisms hold the alluring promise of
pinpointing bad ideas before companies invest too much in them.

The objection I have heard most often to prediction markets is that they
place sponsoring executives in a very difficult position. Asking large
numbers of employees for their input on strategy ideas already requires
a healthy measure of humility. Doing so by asking them to vote
through a public mechanism that will price ideas and make transparent—
perhaps even amplify—collective sentiment about them calls for extra-
ordinary courage. Simply put, it is extremely embarrassing to float the
stock of an idea (a new product launch, for instance) and see its price
fall to zero. One company I know had exactly this experience and sub-
sequently recognized that prediction markets were the best pre-
diction mechanism they had—but decided to drop them for that reason!

That decision may seem irrational: if a product is going to fail, wouldn’t

you want to know sooner rather than later? But the CEO believed
that success does not depend solely on the product’s intrinsic appeal; it
is also a function of how convincingly people will sell it—which in
turn requires them to believe in it. This point of view may sound oddly
paternalistic (“let some people fail trying to sell something they don’t
believe in, because making that disbelief transparent would demoralize
others who are foolish enough to believe in it and who will try harder
96 2012 Number 2

You are either mobilizing people toward

something a large majority will agree
on, or asking them to generate new ideas and
challenge existing ones.

based on that belief”). But it is widespread, and, at least in industries

where the sales process plays a key part, it can be justified. What this
experience suggests to me is that strategists hoping to embrace
market-based mechanisms should investigate not just the mechanics of
those approaches but also how the leaders employing them muster
the courage to do so.

3. Avoiding anchoring and groupthink

An important problem to keep in mind for leaders considering the appli-

cation of social-strategy tools is how to improve the odds of generating
productive debate instead of groupthink. Certainly, these approaches
hold the potential to promote dissent. For example, it’s easy to imagine
them helping to overcome one of the trickiest problems in strategic
planning: the inertia that often keeps capital, people, and other resources
“stuck” in similar allocation patterns year after year (for more on this
problem, see “How to put your money where your strategy is,” on page 28).
On a small scale, I have seen executives break such inertia by using
poker chips to simulate reallocation across businesses. The same should
be possible—arguably even easier—on a larger, more anonymous basis.

But one could also argue that crowd-based mechanisms are a powerful
engine to produce groupthink on a grand scale, encouraging people
to stick to predefined anchors that become more and more powerful as
other contributors appear to confirm them. Consider, for instance, a
couple of the most common crowd-based feedback mechanisms: reader
comments on online articles and product reviews on e-commerce Web
sites. Empirically, some turn into heated debates, while others result in
massive agreement. The explanation for this could simply lie with the
facts of each case: some articles and products are universally liked or
hated; others are polarizing. But the outcome could also be influenced
by the way you orchestrate the debate. Amazon.com, for instance,
 Collaborative strategic planning: Three observations 97

highlights the “most helpful favorable” and “most helpful critical”

reviews. Intuitively, that seems like a sensible way to stimulate debate
and dissent rather than conformity.

More broadly, for each mechanism that would-be social strategists

consider employing, I suggest they think carefully about whether
the intent is to generate dissent or build alignment. You are either mobi-
lizing people toward something a large majority will agree on, or
asking them to generate new ideas and challenge existing ones. Most
companies, in their strategy process, aim to build consensus and
to shake up the status quo. But at any given time, it should be one or
the other.

1For more on behavioral economics, decision making, and strategic planning, see Daniel

Kahneman, Dan Lovallo, and Olivier Sibony, “Before you make that big decision,” Harvard
Business Review, June 2011, Volume 89, Number 6, pp. 50–60; Dan Lovallo and Olivier
Sibony, “The case for behavioral strategy,” mckinseyquarterly.com, March 2010; and Renée
Dye and Olivier Sibony, “How to improve strategic planning,” mckinseyquarterly.com,
August 2007.

Olivier Sibony is a director in McKinsey’s Paris office.

Copyright © 2012 McKinsey & Company. All rights reserved.

We welcome your comments on this article. Please send them to
quarterly_comments@mckinsey.com.
Applied Insight
Tools, techniques, and frameworks for managers

Spotlight on India
99 105
Developing better How multinationals can
change leaders win in India

110
How Tata Group is
raising its game

Developing better
change leaders
Aaron De Smet, Johanne Lavoie, and
Elizabeth Schwartz Hioe
Putting leadership development at the heart of a
major operations-improvement effort paid big dividends for
a global industrial company.
Few companies can avoid big,
periodic changes in the guts of their
business. Whatever the cause—
market maturation, a tough macro-
economic environment, creeping
costs, competitive struggles, or just
a desire to improve—the potential
responses are familiar: restructure
supply chains; rethink relation-
ships among sales, marketing, and
other functions; boost the effi-
ciency of manufacturing or service
operations (or sometimes close
them). Such changes start at the top
and demand a relentless focus
on nitty-gritty business details from
leaders up and down the line.
Too often, however, senior executives
overlook the “softer” skills their
leaders will need to disseminate
changes throughout the organi-
zation and make them stick. These
skills include the ability to keep
managers and workers inspired when
they feel overwhelmed, to promote
collaboration across organizational
boundaries, or to help managers
Artwork by Ken Orvidas
99
embrace change programs through
dialogue, not dictation.
One global industrial company
tackled these challenges by
placing leadership development at
the center of a major operational-
improvement program that involved
deploying a new production sys-
tem across 200 plants around
the world. While the need for oper-
ational change was clear—the
performance of the company’s fac-
tories was inconsistent and in
many cases far below that of com-
petitors in terms of efficiency,
productivity, and cost—so too were
the organizational obstacles.
Drives for improvement, for example,
carried a stigma of incompetence;
current performance was considered
“good enough”; conflict tended
to be passive-aggressive or was
avoided entirely; and shop floor
employees felt that they were treated
as cogs and that their supervisors
were enforcers. The effect of all this
on employees was disengagement,
100 2012 Number 2
a lack of trust in senior management,
and a pervasive fear of making
mistakes—a worry reinforced by the
company’s strong culture of safety
and of risk aversion.
These challenges were impossible to
ignore, and that was probably a
blessing in disguise: the senior team
had to look beyond technical
improvements and focus on helping
the company’s leaders to master the
personal behavioral changes
needed to support the operational
ones. To that end, the company
mounted an intense, immersive, and
individualized leadership program.1
The results are still unfolding, but
after three years the company esti-
mates that the improvement pro-
gram has already boosted annual
pretax operating income by about
$1.5 billion a year. Furthermore, exec-
utives see the new leadership
behavior as crucial to that ongoing
success. Indeed, the senior exec-
utive who launched the program
believes that without the inclusion of
leadership development, it would
have made only half the impact it
actually did. She adds that the
company has seen a tenfold return
on its investment in each of the
dozens of leaders trained thus far.
Scenes from the front
lines of change
In this article, we’ll share the stories
of three such leaders and examine
how the changes they made in their
leadership styles contributed to
improved business results. Then we’ll
step back and offer a few general
leadership-development principles
that we hope will be useful to other
organizations contemplating large-
scale, transformational changes.
Making sourcing more efficient
An executive we’ll call Annie is the
company’s director of sourcing and
logistics. Her charge: to help the
sourcing operation improve its per-
formance, from the mid- to the
first quartile, without additional
resources. Annie and her supervisor
(the group’s vice president) con-
cluded that the way to achieve this
goal was to create a single global
sourcing system instead of relying on
the existing patchwork of regional
and divisional ones. This approach
would improve efficiency, take
advantage of cheaper sources, and
cut interaction costs.
But that meant engaging a global
group of stakeholders, many
of whom preferred acting indepen-
dently. Some even mistrusted
one another. The vice president knew
that this problem would be very
difficult for Annie; as he put it, “she
used to move too fast, and peo-
ple would miss her train.” Somehow,
Annie had to build the skills—and
quickly—to engage her colleagues
on a journey where turning back
was not an option.
Annie realized she needed to engage
them not just intellectually but also
emotionally, so they would become
committed to the new approach
and understand why it was better,
even though many saw it as threat-
ening to their autonomy and their
ability to tailor services to local needs.
Annie also recognized that she had
a strong tendency to do all the work
herself to ensure that it was done
quickly and correctly. Learning to
overcome that inclination would
 Applied Insight
help her to articulate a more inspiring
vision and bring more people on
board. Along with a colleague who
was going through leadership
training at the same time, Annie
worked on a number of skills, such
as how to keep discussions
focused on solutions and how to
build on existing strengths to
overcome resistance. She also devel-
oped 20 coaching vignettes, which
helped her bring to life the mind-sets
and behavior that had to change.
These moves helped Annie establish
the new vocabulary she needed
to encourage colleagues to identify
and eliminate issues that were
getting in the way of the new sourc-
ing approach.
As more than 1,000 employees
across four regions adopted the new
system, operational efficiencies
quickly started to appear. What’s
more, the effort encouraged
interpersonal interactions that helped
some employees overcome long-
standing barriers to collaboration.
The vice president highlighted
the way the effort had encouraged
North American employees to
begin openly addressing issues they
had with colleagues at a logistics
service center in India, for example,
and to move beyond mistrusting
the workers there and resenting them
for holding “exported jobs.” Such
engagement skills spread across
the network and began to take hold.
Too often, senior executives overlook
the “softer” skills their leaders will
need to disseminate changes throughout
the organization and make them stick.
101
As collaboration improved, the cost
savings grew: within 18 months,
the sourcing group had eliminated
the need for 50 positions (and
helped the workers who held them
to get new jobs elsewhere in the
company). In the same time period,
benchmarking suggested that
the group as a whole had achieved
first-quartile performance levels.
What’s more, the experience strength-
ened Annie as a manager. “My
answer might have been right before,”
she says, “but it got richer. . . . I feel
more confident. It is not about
needing to prove myself anymore.
I have much greater range and
depth of influence.”
Boosting yields at a factory
Conor, as we’ll call one European
plant manager, needed to boost
yields using the company’s new pro-
duction system. In the past, the
industrial giant would have assigned
engineers steeped in lean pro-
duction or Six Sigma to observe the
shop floor, gather data, and pre-
sent a series of improvements. Conor
would then have told plant employ-
ees to implement the changes, while
he gauged the results—a method
consistent with his own instinctive
command-and-control approach
to leadership. But Conor and his
superiors quickly realized that the
old way wouldn’t succeed: only
employees who actually did the work
could identify the full range of
102 2012 Number 2
efficiency improvements necessary
to meet the operational targets, and
no attempt to get them to do
so would be taken seriously unless
Conor and his line leaders were
more collaborative.
Workers were skeptical. A survey
taken at about this time (in 2009)
showed that plant workers
saw Conor and his team as distant
and untrustworthy. Moreover,
the company couldn’t use salary
increases or overtime to boost
morale, because of the ongoing
global economic crisis.
Conor’s leadership training gave him
an opportunity to reflect on the
situation and provided simple steps
he could take to improve it. He
began by getting out of his office,
visiting the shop floor, and really
listening to the workers talk about
their day-to-day experiences,
their workflows, how their machines
functioned, and where things
went wrong. They’d kept all this infor-
mation from him before. He made
a point of starting meetings by invit-
ing those present to speak, in
part to encourage the group to find
collective solutions to its problems.
Conor explained: “As I shared
what I thought and felt more openly,
I started to notice things I had
not been aware of, as other people
became more open. We’d had
the lean tools and good technology
for a long time. Transparency
and openness were the real break-
through.” As the new atmosphere
took hold, workers began pointing
out minor problems and addi-
tional areas for improvement specific
to their corners of the plant; within
just a few months its yields increased
to 91 percent, from 87 percent.
Today, yields run at 93 percent.
Closing a plant
Pierre, as we’ll call him, was
managing a plant in France during
the darkest days of the global
financial crisis. His plant was soon
to close as demand from several of
its core customers went into a
massive and seemingly irreversible
tailspin. The company was in a
tricky spot: it needed the know-how
of its French workers to help
transfer operations to a new produc-
tion location in another country,
and despite its customers’ problems
it still had €20 million worth of
orders to fulfill before the plant closed.
Meanwhile, tensions were running
high in France: other companies’
plant closures had sparked protests
that in some cases led to violent
reactions from employees. Given the
charged situation, most companies
were not telling workers about plant
closures until the last minute.
Pierre was understandably nervous
as he went through leadership
training, where he focused intently
on topics such as finding the
courage to use honesty when having
difficult conversations, as well
as the value of empathic engagement.
After a lengthy debate among
company executives, Pierre decided
to approach the situation with
those values in mind. He announced
the plant closing nine months
before it would take place and was
open with employees about his
own fears. Pierre’s authenticity struck
a chord by giving voice to every-
one’s thoughts and feelings. More-
over, throughout the process of
closing the plant, Pierre recounts,
he spent some 60 percent of
his time on personal issues, most
notably working with his subor-
dinates to assist the displaced work-
ers in finding new jobs and providing
them with individual support and
 Applied Insight
mentoring (something other com-
panies weren’t doing). He spent
only about 40 percent on business
issues related to the closure.
This honest engagement worked.
Over the next nine months, the plant
stayed open and fulfilled its orders,
even as its workers ensured that their
replacements in the new plant had
the information they needed to carry
on. It was the only plant in the indus-
try to avoid violence and lockouts.
Lessons observed
While every change program is
unique, the experiences of the indus-
trial company’s managers offer
insights into many of the factors that,
we find, make it possible to sus-
tain a profound transformation. Far
too often, leaders ask everyone
else to change, but in reality this
usually isn’t possible until they
first change themselves.
Tie training to business goals.
Leadership training can seem
vaporous when not applied to actual
problems in the workplace. The
industrial company’s focus on teach-
ing Pierre to have courageous
conversations just as the ability to
do so would be useful, for instance,
was crucial as Pierre made
arrangements to close his plant. In
the words of another senior
executive we spoke with, “If this were
just a social experiment, it would
be a waste of time. People need a
For more on the role of sponsorship in careers,
see “Changing companies’ minds about women,”
on mckinseyquarterly.com.
103
‘big, hairy goal’ and a context to
apply these ideas.”
Build on strengths. The company
chose to train managers who
were influential in areas crucial to
the overall transformation and
already had some of the desired
behavior—in essence, “positive
deviants.” The training itself focused
on personal mastery, such
as learning to recognize and shift
limiting mind-sets, turning diffi-
cult conversations into learning
opportunities, and building on
existing interpersonal strengths and
managerial optimism to help
broadly engage the organization.
Ensure sponsorship. Giving
training participants access to formal
senior-executive sponsors who
can tell them hard truths is vital in
helping participants to change
how they lead. Moreover, the relation-
ship often benefits the sponsor
too. The operations vice president
who encouraged Annie, for exam-
ple, later asked her to teach him and
his executive team some of the
skills she had learned during
her training.
Create networks of change
leaders. Change programs
falter when early successes remain
isolated in organizational silos.
To combat this problem, the indus-
trial company deployed its
leadership-development program
globally to create a critical mass
of leaders who shared the same
vocabulary and could collaborate
across geographic and organi-
zational boundaries more effectively.
When Annie ran into trouble
implementing the changes in some
of the company’s locations in Asia,
the personal network she’d created
104 2012 Number 2
came to her rescue. A plant
manager from Brazil, who had gone
through the training with Annie,
didn’t hesitate to get on a plane and
spend a week helping the Asian
supply chain leaders work through
their problems. The company
allowed him to do so even though
this visit had nothing to do with
his formal job responsibilities, thus
sending an important signal that
these changes were important.
Another tactic the company
employed was the creation of formal
“mini-advisory boards”: groups
of six executives, with diverse cul-
tural and business perspectives,
who went through leadership training
together. The mutual trust these
teammates developed made them
good coaches for one another.
Pierre, for example, reported getting
useful advice from his board as
he finalized his plans to talk with his
plant employees. The boards also
provide much-needed emotional
support: “The hardest part of being
at the forefront of change is just
putting your shoes on every day,”
noted one manager we talked to.
“Getting together helps me do that.”
1 For each participant, the program took four
months, including two week-long off-site
training programs, along with ongoing
coaching on the application of what they
had learned to the workplace.
Aaron De Smet is a principal in
McKinsey’s Houston office,
Johanne Lavoie is a senior expert
in the Calgary office, and
Elizabeth Schwartz Hioe is an
associate principal in the New
Jersey office.
Copyright © 2012 McKinsey & Company.
All rights reserved. We welcome your
comments on this article. Please send them
to quarterly_comments@mckinsey.com.
 105

Spotlight on India

Artwork by Darren Diss

How multinationals
can win in India
Vimal Choudhary, Alok Kshirsagar, and Ananth Narayanan

Multinational companies must adapt to Indian conditions in order

to thrive there.

Over the past 20 years, multinational Indian revenues have grown by

companies have made considerable
inroads into the Indian market, yet
many haven’t realized its potential—
succeeding only in niches, for
instance, or failing to maximize econ-
omies of scale or to tap India’s
breadth of talent. All too common
is the experience of a leading
consumer goods company whose
7 percent annually over the past
seven years, almost twice the rate of
the parent company during the
same period but only about half that
of the sector in India.
For multinationals, the key to
reaching the next level will be to
adapt to Indian conditions rather
106 2012 Number 2
than to impose global business
models and practices on the local
market. It’s a lesson many
companies are already learning in
China, which more and more
multinationals treat as a second
home market.1 In India, this
trend has been slower to pick up
steam, though promising exam-
ples have begun to emerge.
For example, a big global auto-
mobile company became one of
India’s largest manufacturers—
growing at 40 percent a year since
its inception more than a decade
ago—by building a local factory, set-
ting up an Indian R&D facility to
better understand local customers,
and hiring a well-known Indian
figure as its “brand ambassador.”
By contrast, a leading beverage
company initially entered India with
a typical global business model—
sole ownership of distribution. This
approach resulted in high costs
and low market penetration, and the
company’s managers quickly
1 Organize for India
Many multinationals struggled in
the early going, some because they
gave local management too little
autonomy, others because of insuf-
ficient attention and investment
from headquarters. Many of today’s
leaders have already solved these
problems: removing bureaucratic
roadblocks imposed by the head
office helped one multinational power-
and-automation-technology com-
pany we studied to unleash rapid
identified two other big challenges:
India’s labor laws make organized
distribution operations very
expensive, and the country’s frag-
mented market demands multiple
channel handoffs. In response, the
company contracted out distri-
bution to entrepreneurs. As a result,
market penetration rose and
costs fell. Today, the company uses
the India unit’s P&L as a bench-
mark to help normalize costs for its
operations in other regions.
Such focused efforts will be
increasingly valuable: India’s econ-
omy is expected to grow as
much as 7 percent a year over
the next few years, among the
highest rates of any big emerging
market. In several product and
market categories—mobile handsets,
for example—the country could
account for more than 20 percent of
global revenue growth in the next
decade. In this article, we’ll highlight
three principles that forward-
looking multinationals are embracing
to achieve their potential in India.2
growth in its previously sluggish
Indian operation. Similarly, a global
electronics manufacturer revived
its Indian efforts by shutting down a
foundering joint venture, estab-
lishing a stand-alone Indian business
with a high degree of local empower-
ment to customize products to
suit local needs, financing an aggres-
sive local marketing campaign,
and bringing costs down by helping
to source components. Today,
that company is one of India’s
leading electronics manufacturers.
Applied Insight
The bar is now rising for multi-
nationals, whose long-term success
will depend on building country-
specific operations and management
systems. Some are rethinking their
organizational models, making India
a business unit in its own right
instead of managing it along the axis
of global products or functional
areas. The benefits include the
sharper development and execution
of strategy and a more accountable
on-the-ground leadership.
A global conglomerate faced with
declining sales in India recently
consolidated its business units there
under one country head with direct
P&L responsibilities. That executive
makes all major decisions (including
headcounts, pricing, and product
customization), and all heads of local
business units now report to him
rather than to their global business
unit leaders, as they did before.
This new approach has helped the
company to concentrate its
resources and to speed up decision
making, so it can now serve local
customers more effectively and
achieve faster growth.
Moves like this create a serious
talent imperative: the head of the
local unit must be experienced
and knowledgeable about India’s
market and culture; able to make
decisions on capital spending,
products, and pricing; and ready to
manage a direct line of communi-
cation with the global company’s
CEO. The talent imperative extends
to lower-level managers, whose
empowerment can likewise stimulate
innovation and entrepreneurialism
on the ground, while decreasing
times to market for new products.
107
Given the many opportunities
available and the relative shortage
of skilled and experienced
managers in India, multinationals
have had to revise their talent
models significantly to compete with
domestic players. The most
progressive global companies are
moving in three directions:
• Local roles with global
visibility. Such roles for local
managers may include represen-
tation on corporate executive
committees and will emphasize
entrepreneurialism, confer more
authority than most managers
enjoy, and typically offer higher
compensation.
• Meritocratic culture. Leading
companies offer accelerated
career tracks to high performers,
fair and transparent advancement
processes, the absence of
a “glass ceiling” for locals, a
performance-based system
that motivates self-starters, and
differentiated incentives for
high performers.
• Mobility and tailored
leadership programs.
Structured global rotations for
strong performers and leadership-
development courses (especially
those offering certification) are
proving to be effective recruiting
and retention tools.
Approaches like these are satis-
fying the multinationals’ need for
strong local leaders and the desire
of Indian managers for autonomy
and career growth.
108 2012 Number 2
2 Customize for India
Big differences between haves and
have-nots, languages, literacy rates,
and geography (including the urban–
rural divide) make it difficult for a
global brand to satisfy all Indian
consumers. Marketing something as
straightforward as, say, a television
presents challenges in rural India.
Some consumers may be able to
afford a TV, for example, but cannot
speak or read English. Some might
use the TV primarily for listening
to music.
One way to strike the right balance
between global brands and local
positioning is to introduce
subbrands or models with features
suited to Indian needs. A leading
global electronics manufacturer now
offers television models with menus
in Hindi and five other regional
languages. It has also enhanced the
sound systems of some models to
provide a better listening experience.
As multinationals move deeper
into the Indian market, they also run
into low-cost local competitors.
Meeting that challenge requires work-
ing with local suppliers to reduce
costs—without compromising the
brand attributes that set the multi-
nationals apart. In our experience,
when they aim for game-changing
local customization—say, a 60 to
80 percent cut in costs with just a
30 percent reduction in features—
they boost the odds of navigating
these tricky waters. This approach
isn’t new, but it’s not easy to
pull off, which may explain why
multinationals have been slow
to embrace it.
One example of successful local
customization comes from a
multinational equipment manu-
facturer that builds and sells relatively
low-cost, no-frills tractors in India.
These are far less elaborate than the
kind of machines the company
markets in more developed markets.
As a side benefit of developing
the new lightweight models, it
started selling a version of them in
its home market to small-scale
farmers and others looking for
a relatively inexpensive yet sophisti-
cated product.
Another company moving in this
direction is a consumer electronics
business that routinely uses
conjoint analysis across its markets
to learn more about Indian con-
sumer’s willingness to pay for
specific product features. Further, it
challenges its design team by
undertaking competitive teardowns
not just of comparable products
but also of products from adjacent
industries and of very low-cost,
nonbranded offerings. The company
has set a target: a 30 to 50 per-
cent cost reduction for every new
generation of its products,
without any impact on features.
Similarly, a leading global car manu-
facturer in India dedicated a team
to the task of understanding
customer requirements so that it
could make better trade-offs
between features and costs. (Some
multinationals devote more than
10 percent of their product-
development resources in India to
such efforts.) Leading companies
also take talented employees
from India and rotate them through
their product-development
organizations globally to embed
“frugal engineering” in the cor-
porate culture.
 Applied Insight
3 Partnering in India
Multinationals that entered India by
themselves have generally fared
better than those that created joint
ventures with Indian partners,
our experience shows. Indeed, most
multinationals that opted for joint
ventures have exited the Indian
market, while a handful have bought
out their partners or established
themselves as majority shareholders.
One global consumer goods
company, for example, bought out
its Indian partner because of
differences over product marketing
and brand positioning. The multi-
national is now doing well in all the
segments it competes in.
1 See Jeff Galvin, Jimmy Hexter, and Martin
Yet partnerships with Indian
companies need not be limited to
2 Of course, multinationals must also
joint ventures. A strategic alliance
between an international technology
manufacturer and an Indian com-
pany, for instance, set up a local
manufacturing plant that doubled its
production volumes in 18 months
and became one of the world’s
lowest-cost producers. The alliance’s
success encouraged the multi-
national to upgrade India from a “nice
to have” market to an essential
part of its international operations.
Similarly, a global pharmaceutical
company developed alliances (rather
than a joint venture) with Indian
manufacturers to license and market
those manufacturers’ generics and
The full version of this article is
available on mckinseyquarterly.com.
109
off-patent segments. The agreement
helped the multinational to enter
the fast-growing Indian market for
branded generics and off-patent
medicines, thereby responding to its
demand for low-cost, easily
accessible products.
Success in India will be increasingly
important to multinational com-
panies. To thrive there, they must
empower the local organization,
adapt to the Indian consumer’s
needs, and consider engaging the
country’s companies in relation-
ships that extend beyond traditional
joint ventures.
Hirt, “Building a second home in
China,” mckinseyquarterly.com, June 2010.
carefully consider the needs of local stake-
holders, such as regulators and activists,
when creating localized business models.
Although the topic is beyond the scope of
this article, our experience suggests that
companies neglect this issue at their peril.
Vimal Choudhary is a consultant
in McKinsey’s New Delhi office,
Alok Kshirsagar is a director in
the Mumbai office, and Ananth
Narayanan is a principal in the
Chennai office; all are coleaders of
McKinsey’s Asia Center.
Copyright © 2012 McKinsey & Company.
All rights reserved. We welcome your
comments on this article. Please send them
to quarterly_comments@mckinsey.com.
110
Spotlight on India
How Tata Group is raising
its game
Rajat Dhawan, Gautam Swaroop, and Adil Zainulbhai
Tata Group’s experience offers clues for multinationals seeking
to “Indianize” their operations.
Buffered by trade barriers and
decades of industrial protection, few
Indian manufacturers have ranked
among the world’s leaders. But
on factory floors across Tata Group—
India’s leading conglomerate—
a countertrend is emerging as
productivity surges. Global exec-
utives who study Tata’s ground-
level experience may find them-
selves reassessing the potential of
their own operations in India, as
well as stretching their ideas about
how to localize activities in other
emerging markets.
Artwork by Darren Diss
At center stage is Tata Steel, the
world’s seventh-largest producer.
Output per worker has soared
eightfold in little more than a decade
as the company became one of
the world’s lowest-cost producers.
In large part, that’s the result
of its success in adapting global
operational and management
best practices to India’s unique
conditions. One basic but telling
example: Tata Steel engineers
dramatically improved the production
of blast furnaces by learning to
adjust them continually for incoming
 Applied Insight
coal blends. Today, the furnaces
burn Indian high-ash coal much
more efficiently than they did earlier.
Significant organizational changes
support the operational moves. The
steel unit reduced the number of
management layers from 13 to 5, for
instance, to increase employee
accountability. To ensure access to
scarce talent, Tata Steel has
invested heavily to create a group of
frontline managers and staff who
have both analytical skills and
interpersonal ones. The company’s
Shavak Nanavati Technical Institute
trains more than 2,000 employees a
year. These moves helped Tata
Steel to focus more on continuous
improvement (it won the coveted
Deming Prize in 2008 for its pro-
cesses and quality).
Similarly, Tata Power has lowered its
capital expenditures to identify
relatively inexpensive designs and
specifications for big projects.
During the planning stages of a new
4,000-megawatt facility, for example,
the company brought together
customers, suppliers, and Tata
engineers to make Indianized design
decisions. These included using
cheaper welded tubes instead of
seamless ones in feedwater heaters
1 Of course, local companies will play an
and redesigning the layout of the
turbine-generator building to make it
more compact. Trade-offs of this
kind saved the company more than
$100 million in capital outlays while
preserving the plant’s core capa-
bilities and meeting standards for
safety and reliability.
For the full version Tata Motors borrowed from the suc-
of this article, see cessful public–private training
“Fulfilling the model of India’s IT service industry.
promise of India’s
Requiring an ample supply of skilled
manufacturing
sector,” on workers for an advanced auto-
mckinseyquarterly motive plant, Tata partnered with
.com. Gujarat State to hire more than
111
1,000 local people and trained them
to assemble the Nano car. The move
also helped ameliorate concerns
about displacing residents to build
the plant.
For multinationals, Tata’s experiences
in India should reinforce the
importance of tailoring operations in
emerging markets to local con-
ditions. Such adaptations will be
increasingly important as demand
for manufactured goods from
low-cost countries more than
doubles, to nearly $8 trillion a year,
by 2015. China will capture a sizable
share, but up to $5 trillion annually
will be up for grabs as companies
look to diversify production to
include other low-cost countries.
Similarly, multinationals that can
adapt to local conditions in
developing markets will have an
advantage in capturing their
demand as incomes rise. For India,
the opportunity is huge.1 Our
research finds that many of India’s
consumption sectors—including
apparel, automotive, electrical equip-
ment and machinery, and food and
beverages—are poised to grow from
12 to 20 percent annually over the
next 15 years.
important role. Our analysis finds that the
combination of rising demand in India and
the desire of multinationals to diversify
their global production could help India’s
manufacturing sector grow sixfold by
decade’s end, to $1 trillion, while creating
up to 90 million domestic jobs.
Rajat Dhawan is a director in,
and Gautam Swaroop is an
alumnus of, McKinsey’s Delhi office;
Adil Zainulbhai is a director
in the Mumbai office.
Copyright © 2012 McKinsey & Company.
All rights reserved. We welcome your
comments on this article. Please send them
to quarterly_comments@mckinsey.com.
112

Extra Point

A field guide to identifying

bad listeners
To improve your listening skills, you must learn why you don’t get the
information you need. Below are six common archetypes of bad listeners.
Any individual can demonstrate all of them at different times.

The Opinionator The Grouch

Listens primarily to Is sure you are
determine whether wrong.
or not the ideas
of others conform Approaches
to what he or she conversations as a
believes. necessary evil.

Appears to listen Through

closely, but not with perseverance,
an open mind. people can get
through to him
May have good or her, but many
intentions yet don’t have
routinely squelches enough energy.
“You’re a fool. Why did
other colleagues’
you think I’d be interested
ideas.
in this?”

The Preambler The Perseverator

Epitomizes one-way Talks a lot without
communication. saying anything—his
or her comments
Windy lead-ins and questions
and questions are don’t advance the
really speeches, conversation.
often intended to
box conversation Uses the thoughts of
partners into a conversation partners
corner. to support his or
her own prejudices,
Uses questions to biases, or ideas.
steer discussion,
send warnings, or When talking to
generate a desired one, you may feel
answer. the two of you are
having different
conversations.

The Answer Man The Pretender

Spouts solutions Feigns engagement
before there is even and agreement but
a consensus on the isn’t really interested
challenge—a clear in what you are
signal that input from saying.
others isn’t needed.
Gives conversation
You are speaking to partners every
Answer Man if your indication that he
conversation partner or she agrees with
can’t stop providing them, but doesn’t
solutions and has act on anything
ready answers for they’d said or, worse,
any flaws you note. doesn’t have that
information when
“I agree with you.” making decisions.

Are you a bad listener? To help improve your skills, read “The executive’s guide to
better listening,” on page 50.

Artwork by Serge Bloch. Copyright © 2012 McKinsey & Company. All rights reserved.
Copyright © 2012
McKinsey & Company.
All rights reserved.

Published since 1964

by McKinsey & Company,
55 East 52nd Street,
New York, New York 10022.

ISSN: 0047-5394
ISBN: 978-0-9829260-3-1

Cover illustration by Neil Webb

McKinsey Quarterly meets

the Forest Steward-
ship Council (FSC) chain
of custody standards.

The paper used in the

Quarterly is certified as being
produced in an environ-
mentally responsible, socially
beneficial, and economi-
cally viable way.

Printed in the United States

of America.
Highlights:
New McKinsey research on the
prevalence of strategic inertia, plus
tips for breaking the logjam
and rethinking the corporate center

Demystifying social media

The executive’s guide to better

listening, including Amgen CEO Kevin
Sharer’s ‘Why I’m a listener’

Does top-team diversity pay off?

How multinationals can win in India

Developing better change leaders

CEO compensation and decision making

Time to crowdsource your strategy?

ISBN: 978-0-9829260-3-1 mckinseyquarterly.com • china.mckinseyquarterly.com