Harvard Business Review

Executive Summaries

Cover Feature

Reverse Engineering Google's Innovation Machine

Bala Iyer and Thomas H. Davenport Reprint: R0804C

Even among internet companies, Google stands out as an enterprise designed with the explicit goal of succeeding at rapid, profuse innovation. Much of what the company does is rooted in its legendary IT infrastructure, but technology and strategy at Google are inseparable and mutually permeable--making it hard to say whether technology is the DNA of its strategy or the other way around. Whichever it is, Iyer and Davenport, of Babson College, believe Google may well be the internet-era heir to such companies as General Electric and IBM as an exemplar of management practice.

Google has spent billions of dollars creating its internet-based operating platform and developing proprietary technology that allows the company to rapidly develop and roll out new services of its own or its partners' devising. As owner and operator of its innovation "ecosystem," Google can control the platform's evolution and claim a disproportionate percentage of the value created within it. Because every transaction is performed through the platform, the company has perfect, continuous awareness of, and access to, the by-product information and is the hub of all germinal revenue streams.

In addition to technology explicitly designed and built for innovation, Google has a well-considered organizational and cultural strategy that helps the company attract the most talented people in the land--and keep them working hard. For instance, Google budgets innovation into job descriptions, eliminates friction from development processes, and cultivates a taste for failure and chaos.

While some elements of Google's success as an innovator would be very hard and very costly to emulate, others can be profitably adopted by almost any business. Forethought

The Tourism Time Bomb

Paul F. Nunes and Mark Spelman Reprint: F0804A

The number of international tourist visits will more than double in the next dozen years. As demand for access to hot spots outpaces capacity, some companies will profit by creating destinations. And all businesses will need to adopt strategies for claiming--or avoiding--prime turf.

So You Think You're a Good Listener

Patrick Barwise and Seán Meehan Reprint: F0804B

Managers are less receptive to bad news and contrary viewpoints than they think they are, and they often send subtle signals that discourage frank input. The solution: 360-degree surveys of peers and subordinates that generate feedback specific to individual managers.

The Rewards of Rewarding Change

Robert W. Gunn Reprint: F0804C

Change initiatives thrive in companies where the agents of reform are promoted and thereby retained, according to research from a change-leadership consultancy. Investors also notice and reward these businesses.

Distribution Lessons from Mom and Pop

Carlos Niezen and Julio Rodriguez Reprint: F0804D

Coca-Cola developed a distribution model for emerging markets by learning how its Peruvian bottler succeeded in the mom-and-pop channel. The tenets: Turn wholesalers into distributors, use IT to link and control distributors, and employ simple technology. PepsiCo has taken a page from the same playbook; other multinationals can, too.

The Best Advice I Ever Got

William S. Thompson, Jr. Reprint: F0804E

The managing director and CEO of PIMCO fondly remembers a boss who helped him find solace in failure. Bolstering your high performers when they fall short, he says, is the key to maximizing their potential.

What You Can Gain When You Lose Good People

Lori Rosenkopf and Rafael A. Corredoira Reprint: F0804F

When high-tech businesses lose a valued inventor, they often gain access to her new employer's intellectual capital. To take full advantage of the networking possibilities, technology companies should consider adopting alumni programs like those at consulting and law firms.

A Conversation with Jimmy Wales Reprint: F0804G

The founder of Wikipedia analyzes why wikis are becoming popular tools for sharing knowledge in the workplace. He encourages managers to provide institutional support for these highly practical forums but to be judicious about direct participation.

The Off-Line Impact of Online Ads

Magid Abraham Reprint: F0804H

Advertising on the internet increases sales in brick-and-mortar stores even more than it does online. Individually, search ads and display ads have the power to drive purchases, but they get the best results when used together in a single campaign.

Reviews

Featuring The Turnaround Kid: What I Learned Rescuing America's Most Troubled Companies, by Steve Miller. HBR Case Study

Open Source: Salvation or Suicide?

Scott Wilson and Ajit Kambil Reprint: R0804A

Amp Up, a wildly popular electronic-music game, is the brainchild of KMS's cherished programmers, who now spend their time trying to keep customers dazzled with upgrades. But a couple of start-ups have ripped off the idea using their own code--which is open source. Now they're demanding that KMS float with the rising tide and join the open-source community. How could the company make money without its IP? And why should it try? Four experts comment on this fictional case study.

Jonathan Schwartz, the CEO of Sun Microsystems, says that if KMS is confident it knows what its customers will want next--and if it's content with a small corner of the market--it should stay proprietary. But it will pay a reputational price.

Eric Levin, the executive vice president of Techno Source, suggests that KMS take a middle path: license its software to third-party companies and add features to promote community building. This approach could fund itself through royalties or fees and would allow KMS to approve or veto third-party products.

Gary P. Pisano, of Harvard Business School, points out that an open-source strategy could increase Amp Up's rate of improvement, enhance users' satisfaction with the game, and reduce KMS's development costs. But if the company stops competing on the basis of its code, it had better be sure of the strength of its downstream capabilities.

Michael J. Bevilacqua, of the law firm WilmerHale, warns that KMS risks greater liability for intellectual-property infringement if it joins the open-source community, where code carries no guarantee that it doesn't infringe on someone's IP rights and providers offer no indemnification. Features

Creativity Step by Step

A Conversation with Choreographer Twyla Tharp Reprint: R0804B

Most people believe that creative genius is a predetermined personality trait reserved for only a gifted few. Tharp--an award-winning choreographer who has revolutionized dance in our time--firmly rejects that notion. "Everyone can be creative," she says, "but you have to prepare for it with routine."

The winner of a MacArthur fellowship, a Tony award, and two Emmys, Tharp has been the artistic force behind her own dance company, Broadway shows, and TV productions, and has created choreography for movies (including Hair and Amadeus) and leading ballet companies around the world. In this conversation with senior editor Diane Coutu, Tharp shares her thoughts about what it takes to achieve creative breakthroughs: hardheaded practicality, discipline, and ruthlessness about the work. She is unsentimental in her advice to aspiring innovators who worry that they don't have the right stuff: Get over yourself. Get angry, throw a tantrum--just do whatever it takes to get moving, and stop wasting time. Creativity is the result of habit, hard work, and constantly pursuing new challenges. Don't get hung up on originality or on failure; if you never fail, you'll stagnate. Mentors may help guide you to your goals, but don't choose people who will hold your hand. Choose mentors who can teach you, and invent them if you have to.

In her no-nonsense way, Tharp also talks about her commitment to being uncompromising in her work, even when it exacted a price (such as forgone vacations and personal relationships) or was otherwise painful (when it involved firing extraordinary people). "It's a terrible analogy, but when it comes to your work, you have a war to win," she says. "Men are going to die."

The Four Things a Service Business Must Get Right

Frances X. Frei Reprint: R0804D

Many of the management tools and techniques used in service businesses were designed to tackle the challenges of product companies. Although they are valuable to service managers, they aren't sufficient for success. In this article, Harvard Business School's Frei explains why and urges companies to add some new ones to the mix. After years of extensive research and analysis, she offers an approach for crafting a profitable service business based on four critical elements: the design of the offering, employee management, customer management, and the funding mechanism.

Just like a product that's going to market, a service needs to be compellingly designed, and management must field a workforce capable of producing it at an attractive price. Additionally, however, service firms must manage their customers, who do not simply use the service but also can be integral to its production: Because customers' involvement as producers can wreak havoc on costs, companies must also develop creative ways to fund their distinctive offerings, by providing a self-service alternative, for example, or by offsetting expenses with operational savings.

A close look at successful service businesses--Wal-Mart, Commerce Bank, the Cleveland Clinic, and others--reveals that effective integration of the four elements is key. There is no "right" way to combine them; the appropriate design of one depends upon the other three. If managers don't get all four pulling together, they risk pulling the enterprise apart.

Incumbents can fend off attacks from highly focused upstarts by becoming multifocused--that is, by pursuing multiple niches through optimized service models rather than trying to cover the entire waterfront with one model. Shared services within a firm (functions such as HR and finance) can help, since they will enable it to generate economies of scale and experience across models.

Can You Say What Your Strategy Is?

David J. Collis and Michael G. Rukstad Reprint: R0804E

Can you summarize your company's strategy in 35 words or less? Would your colleagues express it the same way? Very few executives can honestly say yes to those simple questions. The thing is, companies with a clear, concise strategy statement--one that employees can easily internalize and use as a guiding light--often turn out to be industry stars. In this article, Harvard Business School's Collis and Rukstad provide a practical guide for crafting an effective strategy statement and include an in-depth example of how the St. Louis-based brokerage firm Edward Jones developed one that has generated success.

Any strategy statement must begin with a definition of the objective, or the goal that the strategy is designed to achieve. Since most firms compete in a more or less unbounded landscape, it is also crucial to define the scope, or domain, of the business. Perhaps most important, companies need to have a clear sense of advantage--that is, the means by which the business will achieve its stated objective.

Defining the objective, scope, and advantage requires trade-offs. If a firm pursues growth or size, profitability will take a backseat. If it chooses to serve institutional clients, it might ignore retail customers. If it derives its competitive advantage from scale economies, it will not be able to accommodate idiosyncratic customer needs.

Before developing your strategy and crafting your statement, you'll want to carefully evaluate the industry landscape. This includes segmenting customers and identifying unique ways of delivering value to the ones the firm targets. It also calls for an analysis of competitors' current strategies and a prediction of how they might change. The key is to find the sweet spot where the firm's capabilities and customers' needs align in a way that competitors cannot match.

The Right Way to Manage Unprofitable Customers

Vikas Mittal, Matthew Sarkees, and Feisal Murshed Reprint: R0804F

Problem customers can cost your business lots of money, but quickly ejecting them may not be the best way to relieve the burden. Mittal, of Rice University, Sarkees, of Penn State, and Murshed, of Towson University, explore the ins and outs of customer divestment.

Using real-world examples, the authors show how deciding to end a relationship with a customer segment or individual can increase profitability, improve employee morale, address capacity constraints, and bolster a business strategy. However, divestment also comes with potential downsides for various constituencies, including employees and remaining customers, both of whom may wonder whether they're next. In addition, ethical and legal consequences--and the risk of bad publicity--always loom.

Before you rush to action, say the authors, walk through their five-part customer divestment framework. First, reassess the context of present customer relationships, looking beyond simple profitability. You may find that the most productive option is to educate customers rather than drop them. In some cases, if you renegotiate the value proposition with them, both of you will win. In other instances, you'll want to migrate customers to other subsidiaries or providers, as long as the move is undertaken--and perceived to be conducted--in good faith. If it becomes necessary to terminate a customer relationship, use a direct, interpersonal approach.

No business can afford to squander its customer base, so divestment should not be boiled down to determining merely who is profitable and who is not--the strategic consequences are too weighty. In the end, the decision about whether to divest might prove to be the toughest customer of all.

Leading from the Boardroom

Jay W. Lorsch and Robert C. Clark Reprint: R0804G

These days, boards are working overtime to comply with Sarbanes-Oxley and other governance requirements meant to protect shareholders from executive wrongdoing. But as directors have become more hands-on with compliance, they've become more hands-off with long-range planning. That exposes corporations and their shareholders to another--perhaps even greater--risk, say professors Lorsch, of Harvard Business School, and Clark, of Harvard Law School.

Boards are giving the long term short shrift for a number of reasons. Despite much heavier workloads, directors haven't rethought their patterns of operating--their meetings, committees, and other interactions. Compliance has changed their relationship with executives, however, turning directors into micromanagers who closely probe executives' actions instead of providing high-level guidance. Meanwhile, the pressure to meet quarterly expectations intensifies.

Directors need to do a better job of balancing compliance with forward thinking. Boardroom effectiveness hinges most on the quality of directors and their interactions, the authors' research shows. Directors must apply their wisdom broadly, handling compliance work more efficiently and staying out of the weeds on strategic issues. Using their power with management to evangelize for long-term planning, they must take the lead on discussions about financial infrastructure, talent development, and strategy. Reserving sacrosanct time for such discussions, as Philips Electronics' board does at annual retreats, is an effective practice: After one recent retreat, Philips decided to exit the semiconductor business, where it was losing ground. Individual directors also must not shy away from asking tough questions and acting as catalysts on critical issues, such as grooming a successor to the CEO. In short, directors must learn to lead from the boardroom.

Be a Better Leader, Have a Richer Life

Stewart D. Friedman Reprint: R0804H

Work fills most executives' lives to the brim, leaving insufficient time for their families, their communities, and themselves. But Wharton professor Friedman suggests that, rather than view the problem as a set of trade-offs, executives use their leadership talents to benefit all four domains at once. The idea is to design experiments--small, short-term adjustments to their daily routines--that incorporate and mutually benefit the various aspects of their lives. If an experiment works out, everyone wins--employer, employee, family, and community; if it doesn't, it simply becomes a low-cost learning opportunity. Over time, the combination of small gains and lessons learned can lead to larger-scale transformation.

The "Total Leadership" process involves identifying what's important to you, identifying what's important to everyone in your life, using those insights to creatively explore possibilities for experiments, and then selecting and implementing a few at a time. Drawing on decades of experience, Friedman has distilled nine categories of experiments that offer a manageable, systematic approach to the daunting task of conceiving projects with four-way benefits.

In one such experiment, an executive might raise money for a charity her company sponsors by running a marathon with her son, thus simultaneously gaining greater visibility at work, spending more time with her family, giving back to the community, and improving her health. To move toward the goal of becoming a CEO, another executive might join the board of a nonprofit agency in his neighborhood together with his wife.

Friedman suspects that there are far more opportunities for simultaneous benefits than people realize. They are there for the taking. You just have to know how to look for them and then find the support and courage to pursue them.

Managing Hypergrowth

Alexander V. Izosimov Reprint: R0804J

When a market or an industry goes into hypergrowth--that steep part of the S-curve where market share is usually determined--established companies may be at a disadvantage. Often they labor under organizational legacies that hamper their ability to respond to lightning-quick opportunities to increase their share. Izosimov, the CEO of VimpelCom, rode the hypergrowth wave in Russia's cell phone market and came out ahead. He offers five rules to help other companies survive a similar ride.

Sell first and ask questions later. This is the time to capture as many new customers as possible--while making sure that you can actually deliver the promised products and services. Your business model doesn't have to be perfect at the outset, though; you can refine it as you go along.

Don't try too hard to innovate. Of course you must understand the technological trends in your business, but your focus should be on the systems and solutions critical to your growing customer base, not on the strategic implications of future killer apps.

Organize like McDonald's. Standardized organizational structures, technologies, and business processes allow your people to hit the ground running in new markets. In VimpelCom's case it would have been cheaper to start by piggybacking on local systems--but customer satisfaction would have suffered.

Push decisions out to the front line. You simply can't afford decision paralysis during hypergrowth. Ceding operational decisions to those who have to deliver the performance saves time, triggers entrepreneurial behavior, and may even raise the quality of job candidates.

Foster a can-do culture. Action-oriented companies--where people move on quickly from solutions that aren't working, communicate freely, and don't fear failure--will do best during hypergrowth. To foster such a culture, reward people for their successes and for implementing new ideas.

Reverse Engineering Google's Innovation Machine

Every piece of the business plays a part, every part is indispensable, every failure breeds success, and every success demands improvement.

by Bala Iyer and Thomas H. Davenport

In the pantheon of internet-based companies, Google stands out as both particularly successful and particularly innovative. Not since Microsoft has a company had so much success so quickly. Google excels at IT and business architecture, experimentation, improvisation, analytical decision making, participative product development, and other relatively unusual forms of innovation. It balances an admittedly chaotic ideation process with a set of rigorous, data-driven methods for evaluating ideas. The company culture attracts the brightest technical talent, and despite its rapid employee growth Google still gets 100 applicants for every open position. It has developed or acquired a wide variety of new offerings to augment the core search product. Its growth, profitability, and shareholder equity are at unparalleled levels. This highly desirable situation may not last forever, but Google has clearly done something right.

Indeed, Google has been the creator or a leading exponent of new approaches to business and management innovation. Much of what the company does is rooted in its legendary IT infrastructure, but technology and strategy at Google are inseparable and mutually permeable--making it hard to say whether technology is the DNA of its strategy or the other way around. Whichever it is, Google seems to embody the decades-old, rarely fulfilled vision of IT pundits that technology should do more than just support the business; it should engender strategic opportunity and be architected with that purpose in mind. As such, Google may well be the internet-era heir to such companies as General Electric and IBM as an exemplar of management practice.

We haven't spent a lot of time in the Googleplex, and between us we've consumed only one of the company's tasty and free cafeteria meals. One of us impulsively tried to question Sergey Brin in the Googleplex courtyard, but he beat a hasty retreat and came close to calling security. Fortunately, however, the company is quite open (there are scores of official and unofficial blogs accessible through the company's website, for example), and non-insiders can find countless clues as to how the company approaches innovation. Many of those clues we unearthed, appropriately enough, through Google searches. Based on our years of observing how Google does what it does so well, we have identified a number of key innovation practices that others can profitably adopt. To be sure, some of Google's attributes--two are its category-killing search engine and a massive, scalable IT infrastructure--would be very hard and very costly to emulate. But others--technology explicitly architected for innovation coupled with a well-considered organizational and cultural strategy--can be applied diligently and successfully by businesses across many industries.

Practice Strategic Patience

Google's mission "to organize the world's information and make it universally accessible and useful" is so broad as to be imperial, yet Google clearly takes it seriously. Beyond its core search and advertising capabilities, the company has embarked on ventures involving online productivity, blogging, radio and television advertising, online payments, social networks, mobile phone operating systems, and many more information domains.

What information management tools the company hasn't developed it has acquired: Picasa for photo management; YouTube for online videos; DoubleClick for web ads; Keyhole for satellite photos (now Google Earth); Urchin for web analytics (now Google Analytics). Google seeks to master not only bits but also electrons: It recently announced an ambitious project to generate low-cost green electricity. While few of these ventures make money today, they are all bricks in the wall of its ambitious strategy, and few doubt Google's resolve or its ability to make progress toward the ultimate goal. Almost every day the company announces a new product or feature that chips away at information disorganization.

With such a farsighted mission, the short-term profitability of a new offering doesn't seem to matter as much to Google as it might to other businesses. The company's managers are strategically patient. CEO Eric Schmidt has estimated that it will take 300 years to achieve the mission of organizing the world's information. His 1,200-quarter forecast might invite smirking; still, it illustrates Google's long-term approach to building value and capability. Google, unlike many companies, can afford its broad mission and collection of innovations simply because its search-based advertising is a fantastically profitable product that provides cover for many unprofitable ones. The company certainly cares about accumulating customers, but its executives believe that over time the business model and the money will take care of themselves. At a 2007 Bear Stearns conference, Schmidt put it this way: "Ubiquity first, revenues later....If you can build a sustainable eyeball business, you can always find clever ways to monetize them."

In other words, not everything will take 300 years. If Google's expressed mission is to organize the world's information, it has a somewhat less exalted but equally important unexpressed commercial mission: to monetize consumers' intentions as revealed by their searches and other online behavior. Search-based advertising is the first highly successful instantiation of this mission.

What makes strategic patience work for Google are the company's clarity of purpose and attention to detail. Everything Google does extends its reach. It is informational kudzu, always putting down new roots based on the thoroughly internalized principle that information shall be organized by analyzing users' intentions. Companies aiming to learn from Google must first understand that clear, simple directives underlie the vast infrastructure and ostensible chaos that we'll describe here.

Exploit an Infrastructure "Built to Build"

Google has spent billions of dollars creating its internet-based operating platform and developing proprietary technology. The investment in infrastructure allows the company to guarantee specified service levels and sub-second response times. It also allows Google to rapidly develop and roll out new services of its own or its partners' devising. The proprietary technology gives the company unprecedented control over the design and evolution of its infrastructure (and emergent strategy). The main attributes of Google's infrastructure are these:

Scalability.

While the internet is of course available to every company, Google has made major investments to get more out of it and to construct a proprietary platform that supports new and growing online services. According to unofficial but widely reported statistics, Google owns a network infrastructure consisting of approximately one million computers; these run an operating system that allows new computer clusters to plug in and be globally recognized and instantly available for use. The operating software that performs this magic is a customized version of open source Linux (which itself is built to make it easy for third parties to add features of competitive value).

Another aspect of the infrastructure is that the internet platform is built to scale. For example, when Google needs more data centers, the proprietary operating system makes them easy to add. And the company can move data around the world seamlessly to meet changing user demand. Managing the petabytes of data Google accumulates requires special database-management tools. Because existing commercial systems couldn't efficiently support such large volumes of data, Google developed a proprietary database called Bigtable, which is tuned to work with Google's operating system to process growing volumes of data quickly and efficiently.

An accelerated product-development life cycle.

Google's infrastructure is well suited to executing an entire product-development life cycle rapidly and efficiently. Google engineers prototype new applications on the platform; if any of these begin to get users' attention, developers can launch beta versions to see whether the company's vast captive customer base responds enthusiastically. If one of the applications becomes a hit, Google's enormous "cloud" of computing capability can make room for it. In the process of moving products from the alpha to the beta phase, Google simultaneously tests and markets them to the user community. In fact, testing and marketing are virtually indistinguishable from one another. This creates a unique relationship with consumers, who become an essential part of the development team as new products take shape and grow. Google does more than just alpha and beta test applications--it can host them on its infrastructure. Google's customers then transition seamlessly from testing to using products as they would any other commercial offering.

Support for third-party development and mashups.

Google created its proprietary infrastructure to be a more efficient and reliable alternative to the internet, ensuring a better user experience and higher quality of service. These purposeful investments in hardware, operating systems, and database management enable the company to exert control from end to end and to enhance such services as Gmail, Maps, AdWords, and the advertising placement system AdSense. When Google creates an application, it pays attention to the way it will fit into the infrastructure. Google Maps was therefore architected as a service so that either the company's own engineers or those of third parties could use it as a module to enrich additional services.

Indeed, Google's flexible infrastructure acts as an innovation hub where third parties can share access and create new applications that incorporate elements of Google functionality. These outsiders can easily test and launch applications and have them hosted in the Google world, where there is an enormous target audience--132 million customers globally--and a practically unlimited capacity for customer interactions. This benefits both parties: Google gets its product widely adopted, and its partners can devote their energies to developing product functionality important to their customers. For instance, a real estate company like Zillow.com can focus on getting high-quality data on properties that have been bought and sold, and leave the maps and display elements to Google or Microsoft.

In exactly this way, third parties browsing Google's infrastructure began creating what are known as mashups--IT applications that combine data and program functionality from more than one external source into an integrated customer experience. For example, Housingmaps.com combines data from Craigslist with Google Maps to create an application that allows users to see apartments for rent or houses for sale plotted on a map of the local area. This notion of allowing useful services to be mixed and matched with relative ease across organizational boundaries has interesting implications for the competitive environment and for organizational efficiency, engendering a "just try it" class of lean innovation. (Technically, it is made possible by web protocols such as XML and industry standards such as RosettaNet; these allow for the level of interoperability among systems that IT users have long demanded.)

This model is attractive on several counts: The interactions provide continuous feedback for iteratively improving or adding features to Google's product offerings. Moreover, the operating platform furthers the goals of Google's advertisers by getting their messages in front of relevant customers whose interests are revealed through their search terms. The dynamic interplay of Google, its third-party innovators, users, and advertisers creates a virtuous circle with benefits for all--and especially for Google (see the exhibit "Google's Innovation Ecosystem").

While few organizations can match the magnitude of Google's infrastructure investments, many can achieve the kind of purposeful design that allows the company to roll out innovations very rapidly. For example, the engineers in Bangalore, India, who launched Google Finance combined preexisting components scavenged from the Google infrastructure to create their new product. Following this model, a company could create reusable software components, bake them into its infrastructure, and make them accessible to the enterprise--or to members of the extended enterprise who might be inspired to use them in building and delivering their own applications.

Rule Your Own Ecosystem

In the ecosystem we've just described, Google plays the role of a keystone--the component that holds all others in place, as Marco Iansiti and Roy Levien describe in their book The Keystone Advantage. As owner and operator, Google can control the evolution of its ecosystem and claim a disproportionate percentage of the value created within it. Because every transaction is performed through the Google platform, the company has perfect, continuous awareness of, and access to, by-product information and is the hub of all germinal revenue streams. There's no need for Google to do market surveys and statistical analyses to forecast trends in the ecosystem; the information is already in Google's database.

While the sheer scale of Google's platform and the dominance of its search technology are uniquely powerful assets, it's still possible to emulate a model built expressly to foster innovation. Other companies can provide platforms that facilitate interactions with the partners within their value systems, becoming the hub of exchanges between and among them. Li & Fung, founded in Guangzhou, China, in 1906, has done just that within the apparel industry. Once it understood its hub position, Li & Fung ceased to be a trading company and became an orchestrator of highly customized end-to-end supply chains. It now participates in myriad decisions ranging from sourcing raw materials to manufacturing garments and managing supply chain logistics for the delivery of finished goods. Li & Fung's global platform has created a standardized way for several thousand partners to instantaneously interact and coordinate activities.

Within the enterprise software market, Salesforce.com has used its AppExchange platform to build an ecosystem of individual developers, independent software vendors (ISVs), and end users. Its infrastructure hosts applications, integrates them, and supports users' database and data-center requirements. Because of its position as the hub of all activities within its application domain, Salesforce.com can sell more subscriptions to its product. Developers benefit from the AppExchange infrastructure and access to customers.

Exercise Architectural Control

Under the right conditions, a company can create and exercise architectural control. As we've discussed, Google has demonstrated the feasibility of tracking the performance of mashups--a testament to the strength of its infrastructure. However, even companies lacking such infrastructure can maintain a firm hand in managing their ecosystems.

In executing an ecosystem strategy, it's critical to negotiate relationships from a strong competitive position, particularly when using an internet-based operating platform. Consider Amazon, which allows third parties to bundle its capabilities into their branded services. Amazon benefits from the ease with which it can track web behavior and closely monitor the performance of those services. For example, it allows a third-party developer, Amazon Light 4.0, to affix a different user interface to Amazon's database of books. In addition, AL4 combines news from Yahoo, blogging from Google, tagging from del.icio.us, and search from eBay into the same service. When a user decides to buy a book, the service directs the request to Amazon. AL4 initially included links to Netflix and iTunes; but since Amazon was providing an important service resulting in transactions and revenues for AL4, it was able to exercise its power to remove those competitors from the ecosystem.

The promise of revenues for everyone fuels these opportunistic alliances. However, during the early phases of innovation, revenues are speculative. Neither Google nor the third party building an application knows whether customers will find it useful. Given this uncertainty, third parties may prefer to innovate and test the application without first engaging in contract and revenue-sharing negotiations (delaying complicated and potentially entangling discussions until a critical mass of users embraces a product appreciably reduces the risk of failure). Customers benefit from faster access to more profuse innovations; Google benefits because it creates additional options for driving incremental traffic to its platform; the developer benefits if one of its applications creates enough value to warrant negotiations with Google to arrange a revenue-sharing deal. In the end, though, architectural control resides in Google's ability to track the significance of any new service, its ability to choose to provide or not provide the service, and its role as a key contributor to the service's functional value.

But control and ambition are not things you flaunt. Ecosystem-oriented innovators strive to avoid the appearance of competition by claiming to help everyone. For example, Google executives seldom miss an opportunity to remind the world that they don't compete with media and content companies. Instead, they characterize media companies as their partners. Not everyone is so sure: Sir Martin Sorrell, chief executive of the advertising giant WPP Group, noted in the firm's 2006 annual report that it's not clear whether Google is friend or foe. The deals Google is doing suggest that its ambitions are far broader than just online advertising. Google hopes to use its platform, with applications relevant to ad buying, to help media companies track the effectiveness of campaigns and help advertisers allocate their marketing dollars effectively across print newspapers and magazines, radio, television, mobile devices, and the web. It is quite possible that what Google learns across various media as it solves problems for the ecosystem partners may position it to become the competitor that it now claims not to be.

This model has vulnerabilities, of course. As the infrastructure provider, Google has to prove itself constantly to keep its legions of users from being tempted by rivals. Otherwise, many might defect--and take Google's coveted advertisers with them. Likewise, if Google were to violate customers' trust by not properly securing their data or if its platform suffered significant downtime, those derelictions, too, could trigger a large-scale loss of customers. Innovation and continuous improvement are strategies to hedge against those prospects. And at Google, there's more to innovation than technology and infrastructure. Google's organizational culture plays a key role.

Build Innovation into Organizational Design

Companies wishing to emulate Google should also look to its organizational design. Many aspects are importable; let's take a look at the key ones.

Sidebar Icon Who Should Use Google as a Role Model? (Located at the end of this article)

Budget innovation into job descriptions.

One clear reason for Google's success at innovation is that the company does what many others do not: budgets for it in employee time. New ideas at Google are often generated by employees, from the bottom up, in a prescribed system of time allocation. Technical employees are required to spend 80% of their time on the core search and advertising businesses, and 20% on technical projects of their own choosing. As one new Google engineer put it in a blog: "This isn't a matter of doing something in your spare time, but more of actively making time for it. Heck, I don't have a good 20% project yet and I need one. If I don't come up with something I'm sure it could negatively impact my review."

Managers, too, are required to spend some of their time on innovation, dedicating 70% to the core business, 20% to related but different projects, and 10% to entirely new businesses and products. The company recently created a new position--"Director of Other"--to help manage the 10% time requirement. (Nontechnical, nonmanagerial employees have no discretionary time--a regrettable omission, we believe.) These percentages--particularly the 20% slice for engineers--are closely managed, although the allocation is not necessarily weekly or even monthly. For example, an engineer might spend six months on the core business, and work for a couple of months on a discretionary project. Even CEO Eric Schmidt and founders Sergey Brin and Larry Page try to adhere to the scheme. This explicit investment in innovation--supported by the management strategy--has produced streams of new products and features. During one six-month period, Marissa Mayer, Google's head of search products and user experience, explained at a talk at Stanford, more than 50 new products resulted from Google engineers' 20% time investments--accounting for half of all new products and features (including Gmail, AdSense, and Google News) developed during that period.

Eliminate friction at every turn.

Before becoming an authorized project, an idea must pass through a qualification process. It must be prototyped, piloted, and tested with actual users in a controlled experiment. Yet it would be a mistake to assume that Google's process is slow and bureaucratic. As another engineer-blogger put it, change can still happen quickly and efficiently:

In my first month at Google, I complained to a friend on the Gmail team about a couple of small things that I disliked about Gmail. I expected him to point me to the bug database. But he told me to fix it myself, pointing me to a document on how to bring up the Gmail development environment on my workstation. The next day my code was reviewed by Gmail engineers, and then I submitted it. A week later, my change was live. I was amazed by the freedom to work across teams, the ability to check in code

• to another project, the trust

  in engineers to work on the right thing, and the excitement and speed of getting things done for our users....I didn't have to ask for anyone's permission to work on this.

Google's approach to innovation is highly improvisational. Any engineer in the company has a chance to create a new product or feature. That individuals can have such influence has allowed Google not only to attract high-quality employees (including some of the world's best computer scientists, statisticians, and economists) but also to create a large volume of new ideas and products. A recent New York Times article, which explored Google's perceived assault on Microsoft's hegemony in business software applications, quoted former Microsoft engineer Vic Gundotra on what drew him to defect to Google: "It became obvious that Google was the place where I could have the biggest impact. For guys like me, who have a love affair with software, being able to ship a product in weeks--that's an irresistible draw." Google appears to be adept at stripping away nonessential process while still preserving important checks and balances for value, quality, and usability.

Let the market choose.

There is no grand design for how new offerings fit together. Instead, Google executives assume that users will determine the success of innovations and that the company's strategy will emerge as particular offerings prosper and build on each other--or else wither. In effect, Google has "crowdsourced" its product strategy.

The emphasis in this process is not on identifying the perfect offering, but rather on creating multiple potentially useful offerings and letting the market decide which are best. Even a modest fraction of Google's more than 132 million users constitutes a massive test bed and focus group for evaluating the potential of new products. Among the company's design principles are "ubiquity first, revenues later," and "usefulness first, usability later." When Google can't build ubiquity, it buys it--as seen in its enormous investments in YouTube and DoubleClick to acquire those already pervasive web franchises.

Cultivate a taste for failure and chaos.

Google is on the lookout for its third major commercial hit, after search and advertising. Its approach is to release many products and hope that some of them will become blockbusters. It's not entirely clear how many products Google currently supports (a Wikipedia entry lists 123 as of February 2008). Schmidt admitted in an interview that even he didn't know how many offerings Google had on the market; at another point, he conceded that the number of new products is "confusing to almost everyone." While more than 100 products might not impress executives at Procter & Gamble, it is a breakneck pace of technology innovation for an organization that's less than a decade old. (Indeed, Brin hopes to have Google launch fewer products with more features, lest customers have to use Google's own search engine to hunt down the company's offerings.)

Given the strategy to let a thousand flowers bloom, many products are bound to fail. However, Google executives appear to be undeterred by failure. In fact, Schmidt encourages it: "Please fail very quickly--so that you can try again" is how he described his outlook to the Economist. Similarly, Page told Fortune that he had praised an executive who made a several-million-dollar blunder: "`I'm so glad you made this mistake. Because I want to run a company where we are moving too quickly and doing too much, not being too cautious and doing too little. If we don't have any of these mistakes, we're just not taking enough risk.'" Needless to say, that level of risk tolerance is rare in corporations, despite the widespread belief that error and innovation go hand in hand.

The word "chaos" comes to mind when reflecting on innovation at Google. Shona Brown, before she became Google's senior vice president of business operations, coauthored a book that was subtitled "Strategy as Structured Chaos." Laszlo Bock, who reports to Brown as head of personnel, told the Economist, "We kind of like the chaos. Creativity comes out of people bumping into each other and not knowing where to go." This means that a revolutionary new product emerging from the Google soil might not get noticed for a while--but recall that Google is in no hurry.

It is too early to say whether this approach to innovation will be a demonstrably superior way of creating numerous highly successful products. It's not too early, however, to conclude that the strategy yields an impressive number of new products and product features. Google's commitment to budgeted innovation and a frenzied, low-friction product-development process is already worthy of emulation by firms that simply need more new products and services to offer the marketplace.

Support Inspiration with Data

Innovation need not be entirely chaotic, and it isn't at Google. A key ingredient of innovation at the company is the extensive, aggressive use of data and testing to support ideas. In a talk given at Stanford in 2006, Marissa Mayer stated that presentations about new products made to the executive team had better contain plenty of supporting data. This is not surprising in a company founded by two highly analytical Stanford computer-science graduate students. Google's focus on analytics and data goes far beyond that of most companies. Still, it's within the reach of most organizations to adopt an analytics-driven approach to evaluating innovation.

Google has a massive amount of data available. For example, insight gleaned from the vast clickstreams of its own and its partners' websites can be used to test and support any new idea or product offering (unless it relates to such offline ventures as the green-energy initiative). Google takes an analytical, fact-based approach not only to its core business of page-rank algorithms but also to making any change in its web pages and deciding what new services to offer. It's relatively easy to perform randomized experiments on the internet: Simply offer multiple versions of a page design, an ad, or a word choice. Every day Google does thousands of experiments for its own benefit. It also offers customers the ability to do them. For example, to help customers understand the value of their advertising with Google, the company bought a web analytics company, renamed it Google Analytics, and now offers customers free tools for assessing online ad effectiveness. Google is clearly competing through analytics.

Another order of analysis involves Google's use of nearly 300 prediction markets consisting of panels of employees. It uses the panels to assess customer demand for new products ("How many Gmail users will there be on January 1, 2009?"); company and product performance ("When will the first Android phone hit the market?"); competitor performance ("How many iPhones will Apple sell in the first year?"); and some just for fun ("Who will win the World Series?"). Prediction markets can be surprisingly accurate decision-support tools. One caveat, however: Senior executives who embrace their use should be prepared to hear the truth rather than the answers that will most gratify them.

Google also employs an idea management system whereby employees can e-mail ideas for new products, processes, and company improvements to a companywide suggestion box. Every employee can then comment on and rate the ideas. This, too, is a form of prediction market, though without the monetary bets (artificial currency, in Google's case). Google's founders and senior leadership seem to be saying, "We're smart, but we're not smart enough to ignore data. Nor are we smarter than thousands of our bright, motivated employees."

From a technological and data standpoint, most companies would face few obstacles in adopting the sorts of analytic and democratic approaches to innovation decision making that Google uses. What truly sets Google apart from most businesses in this regard is its culture.

Create a Culture Built to Build

Google has an unusual culture of which only some aspects are shared by other internet-based businesses. It is largely technocratic, in that individuals prosper based on the quality of their ideas and their technological acumen. Google's use of prediction markets suggests it places a high value on the intellect and opinions of employees. Likewise, giving them budgeted time for innovation shows high regard for their creativity. Google also attempts to provide plenty of intellectual stimulation, which, for a company founded on technology, can be the opportunity to learn from the best and brightest technologists. One employee told the "Google Jobs" website that his favorite perk was the series of regular "Tech Talks" given "by distinguished researchers from around the world....I've come to really appreciate the level of commitment Google has to continued learning and education for their engineers." That same employee, demonstrating that stimulation spans broader interests, told the website that the "most amazing experience" he'd had at Google was a single day during which "the chef Mario Batali came to give away copies of his new book and

• one of his menus for lunch. Then in the afternoon Thomas Friedman gave a talk about the flattening world, and Robin Williams gave an impromptu comedy sketch to close out the day."

If a company actually embraced--rather than merely paid lip service to--the idea that its people are its most important asset, it would treat employees in much the way Google does. Google's founders and executives have thought through many different aspects of the knowledge-work environment, including the design and occupancy of offices (jam-packed for better communication); the frequency of all-hands meetings (every Friday, with beer); and the approach to interviewing and hiring new employees (rigorous, with many interviews). None of these principles is rocket science, but in combination they suggest an unusually high level of recognition for the human dimensions of innovation. Brin, Page, and Schmidt have visited and appropriated ideas from other organizations--such as the software firm SAS Institute--that are celebrated for how they treat their knowledge workers.

In exchange for the privileged treatment, Google expects hard, almost obsessive, work. It therefore devotes considerable effort to identifying the best people, both before and after they are hired. Employees are scored on 25 performance metrics, from how frequently they host Tech Talks to the variability of their interview assessments for potential recruits (an interviewer with variable ratings is considered good, because all recruits are not equally strong). Management also systematically models the attributes of high-performing employees. It continually modifies its hiring approach based on an ongoing analysis of which employees perform best and most embody the qualities of "Googleness." Few organizations are both so paternalistic and so highly analytical in evaluating performance. Another enterprise might try to create such a culture, but that would require a rare degree of self-confidence on the part of its executives.

• o o

As Google grows, will it continue to attract such talented and highly motivated people? Can it retain its sheen? Newer startups like Facebook now compete for the same talent pool and may boast cooler technologies and trendier products. Furthermore, Google may need to find new financial incentives for employees, since its stock options are unlikely to keep growing at the rate that has held since its IPO.

Innovating on internet time requires dynamic capabilities to anticipate market changes and offer new products and functions quickly. Google has made substantive investments in developing the capacity to innovate successfully in this fast-changing business environment. The company is pioneering approaches to organizational culture and innovation processes that continue to attract high-quality employees. At the moment, Google sets the standard for twenty-first-century productivity and growth. If your company employs knowledge workers and needs to innovate, can you afford to wait and see whether Google's approaches pay off over the long term? We doubt it. Who Should Use Google as a Role Model?

If your company aims to improve innovation capacity, consider emulating these key attributes that have contributed to Google's success.

The Four Things a Service Business Must Get Right

Extensive study of the world's best service companies reveals the principles on which they're built.

by Frances X. Frei

As the world's major economies have matured, they have become dominated by service-focused businesses. But many of the management tools and techniques that service managers use were designed to tackle the challenges of product companies. Are these sufficient, or do we need new ones?

Let me submit that some new tools are necessary. When a business takes a product to market, whether it's a basic commodity like corn or a highly engineered offering like a digital camera, the company must make the product itself compelling and also field a workforce capable of producing it at an attractive price. To be sure, neither job is easy to do well; enormous amounts of management attention and academic research have been devoted to these challenges. But delivering a service entails something else as well: the management of customers, who are not simply consumers of the service but can also be integral to its production. And because customers' involvement as producers can wreak havoc on costs, service companies must also develop creative ways to fund their distinctive advantages.

Any of these four elements--the offering or its funding mechanism, the employee management system or the customer management system--can be the undoing of a service business. This is amply demonstrated by my analysis of service companies that have struggled over the past decade. What is just as clear, however, is that there is no "right" way to combine the elements. The appropriate design of any one of them depends upon the other three. When we look at service businesses that have grown and prospered--companies like Wal-Mart in retail, Commerce Bank in banking, and the Cleveland Clinic in health care--it is their effective integration of the elements that stands out more than the cleverness of any element in isolation.

This article outlines an approach for crafting a profitable service business based on these four critical elements (collectively called the "service model"). Developed as a core teaching module at Harvard Business School, this approach recognizes the differences between service businesses and product businesses. Students in my course learn to think about those differences and their implications for management practice. Above all, they learn that to build a great service business, managers must get the core elements of service design pulling together or else risk pulling the business apart.

1. The Offering

The challenge of service-business management begins with design. As with product companies, a service business can't last long if the offering itself is fatally flawed. It must effectively meet the needs and desires of an attractive group of customers. In thinking about the design of a service, however, managers must undergo an important shift in perspective: Whereas product designers focus on the characteristics buyers will value, service designers do better to focus on the experiences customers want to have. For example, customers may attribute convenience or friendly interaction to your service brand. They may compare your offering favorably with competitors' because of extended hours, closer proximity, greater scope, or lower prices. Your management team must be absolutely clear about which attributes of service the business will compete on.

Strategy is often defined as what a business chooses not to do. Similarly, service excellence can be defined as what a business chooses not to do well. If this sounds odd, it should. Rarely do we advise that the path to excellence is through inferior performance. But since service businesses usually don't have the luxury of simply failing to deliver some aspects of their service--every physical store must have employees on-site, for example, even if they're not particularly skilled or plentiful--most successful companies choose to deliver a subset of that package poorly. They don't make this choice casually. Instead, my research has shown, they perform badly at some things in order to excel at others. This can be considered a hard-coded trade-off. Think about the company that can afford to stay open for longer hours because it charges more than the competition. This business is excelling on convenience and has relatively inferior performance on price. The price dimension fuels the service dimension.

To create a successful service offering, managers need to determine which attributes to target for excellence and which to target for inferior performance. These choices should be heavily informed by the needs of customers. Managers should discover the relative importance customers place on attributes and then match the investment in excellence with those priorities. At Wal-Mart, for example, ambience and sales help are least valued by its customers, low prices and wide selection are most valued, and several other attributes rank at points in between. (See the exhibit "Wal-Mart's Value Proposition" in David J. Collis and Michael G. Rukstad's article "Can You Say What Your Strategy Is?") The trade-offs Wal-Mart makes are deliberately informed by these preferences. The company optimizes specific aspects of its service offering to cater to its customers' priorities, and it refuses to overinvest in underappreciated attributes. The fact that it takes a drubbing from competitors on things its customers care less about drives its overall performance.

The phenomenon, of course, has a circular aspect. Shoppers whose preferences match Wal-Mart's strengths self-select into its customer base. Meanwhile, those who don't prefer Wal-Mart's attributes buy elsewhere. It is important therefore to identify customer segments in terms of attribute preferences--or as some marketers prefer, in terms of customer needs. Identifying what might be called customer operating segments is not the same exercise as traditional psychographic segmentation. Rather than stressing differences that enable increasingly targeted and potent messaging, this type of segmentation aims to find populations of customers who share a notion of what constitutes excellent service.

Once an attractive customer operating segment is found, the mission is clear: Management should design a new offering or tweak an existing one to line up with that segment's preferences. Look, for example, at the fit achieved by Commerce Bank, which has been able to grow its retail customer base dramatically even though its rates are among the worst in its markets and it has made limited acquisitions. Commerce Bank focuses on the set of customers who care about the experience of visiting a physical branch. These customers come in all shapes and sizes--from young, first-time banking clients to time-strapped urban professionals to elderly retirees. As an operating segment, however, they all believe that convenience is a bank's most important attribute and choose Commerce Bank because of its evening and weekend hours. Second most important to them is the friendliness of interactions with employees, and so the promise of a cheerful, familiar teller has become part of the bank's core offering. Commerce has added to its branch ambience with interior elements both lovely (high ceilings and natural light) and fun (an amusing contraption for redeeming loose change). When it comes to attributes less important to the bank's customers--price and product range--management is willing to cede the battle to competitors.

It is tempting to think, "If I'm a really good manager, then I don't have to cede anything to the competition." This well-intentioned logic can lead, ironically, to not excelling at anything. The only organizations I have seen that are superior at most service attributes demand a price premium of 50% over their competitors. Most industries don't support this type of premium, and so trade-offs are necessary. I like to tell managers that they are choosing between excellence paired with inferior performance on one hand and mediocrity across all dimensions on the other. When managers understand that inferior performance in one dimension fuels superior performance in another, the design of excellent service is not far behind.

2. The Funding Mechanism

All managers, and even most customers, agree that there is no such thing as a free lunch. Excellence comes at a cost, and the cost must ultimately be covered. With a tangible product, a company's mechanism for funding superior performance is usually relatively simple: the price tag. Only the customers who forfeit the extra cash can avail themselves of the premium offering. In a service business, developing a way to fund excellence can be more complicated. Many times, pricing is not transaction based but involves the bundling of various elements of value or entails some kind of subscription, such as a monthly fee. In these cases, buyers can extract uneven amounts of value for their money. Indeed, even nonbuyers may derive value in certain service environments. For example, a shopper might spend time learning from a knowledgeable salesperson, only to leave the store empty-handed.

In a service business, therefore, management must give careful thought to how excellence will be paid for. There must be a funding mechanism in place to allow the company to outshine competitors in the attributes it has chosen. In my study of successful service businesses, I've seen the funding mechanism take four basic forms. Two are ways of having the customer pay, and two cover the cost of excellence with operational savings.

Charge the customer in a palatable way.

The classic approach to funding something of value is simply to have the customer pay for it, but often it is possible to make the form that payment takes less objectionable to customers. Rarely is that done with à la carte pricing for the niceties. A large part of Starbucks's appeal is that a customer can linger almost indefinitely in a coffeehouse setting. It's unthinkable that Starbucks would place meters next to its overstuffed chairs; a better way to fund the atmosphere is to charge more for the coffee. Commerce Bank is open late and on weekends--earning it high marks on extended hours--and it pays for that service by giving a half percentage point less in interest on deposits. Could it fund the extra labor hours by charging for evening and weekend visits? Perhaps, but a slightly lower interest rate is more palatable. Management in any setting would do well to creatively consider what feels fair to its customers. Often, the least creative solution is to charge more for the particular service feature you are funding.

Create a win-win between operational savings and value-added services.

Very clever management teams discover ways to enhance the customer experience even while spending less (finding, in other words, that there can be such a thing as a free lunch). Many of these innovations provide only a temporary competitive advantage, as they are quickly recognized and copied. Some are surprisingly durable, however. An example is the immediate-response service provided by Progressive Casualty Insurance. When someone insured by Progressive is involved in an auto accident, the company immediately sends out a van to assist that person and to assess the damage on the spot--often arriving on the scene before the police or tow trucks. Customers love this level of responsiveness and give the company high marks for service. But in anticipation of such a need someday, would they pay more in insurance premiums? Unfortunately, no. People are pathologically price sensitive about car insurance and almost never select anything but the rock-bottom quote. The key to Progressive's ability to fund this service is the cost savings it ultimately yields. Normally insurance providers are subject to fraud, with criminals making claims for accidents that were staged or never happened. Because of these and other types of disputed claims, firms also incur high legal fees--which, combined with the other costs of fraud, add up to some $15 out of every $100 in insurance premiums across the industry. Since deploying its vans, Progressive has seen costs in both categories plummet. Sending a company representative to the scene pays for itself.

Progressive offers another customer convenience that many competitors have so far shied away from: giving quotes from other providers alongside its own when a potential buyer inquires about the cost of insurance. It's not that Progressive is determined to go one better than rivals to win the business. In fact, Progressive's is the lowest quote only about half the time. What Progressive does believe is that its quote is the right one given the probability of that person's getting into an accident--a probability that the insurer is best in class at determining. If indeed its quote is spot-on, then allowing a competitor to insure the customer at a lower rate is doubly effective: It frees Progressive from a money-losing proposition while burdening its competitor with the unprofitable account. Thus a level of service that looks downright altruistic to the customer actually benefits the company. This is an example of leveraging operations into a value-added service.

How can your management team find win-win solutions of its own? When I pose this question to managers, their impulse is to imagine what new value could be created for customers and then to ponder how that could be funded through cost savings. I suggest beginning instead by asking, "Where are our biggest cost buckets?" With these in mind, managers can then simultaneously determine how to reduce costs and create a value-added service. A good first place to look? Anywhere that time is a large component of cost. Removing time is often fruitful, since it can directly improve service even as it cuts costs.

Spend now to save later.

Often it is possible, if somewhat painful, to make operational investments that will pay off eventually by reducing customers' needs for auxiliary service in the future. A classic example is Intuit's decision to provide free customer support, in defiance of the software industry norm. Call centers are expensive to staff because of the combination of technical knowledge and sociability required to field inquiries effectively. Customers meanwhile are extremely uneven in their neediness vis-à-vis information technology. For most software makers this adds up to the obvious conclusion that customers should be charged for support.

Intuit founder Scott Cook sees the matter differently. Those needy calls, he believes, are a useful form of input to continued product development--the engine of future revenues--and that justifies an even greater expense outlay. Intuit has its higher salaried product-development people, not solely customer service people, fielding calls so that subsequent versions of its offerings will be informed by direct knowledge of what users are trying to accomplish and how they are being frustrated. This is part of a broader commitment to feedback-driven improvement that Cook refers to as "DIRST"--for "do it right the second time." The investment has paid off in better software, which means a lower call volume. "Our competition thinks we're crazy," Cook says, and he understands why. "If we got as many calls as they do, we'd be out of business."

Have the customer do the work.

One other type of funding mechanism for enhanced service puts the cost back in the customer's court, but in the form of labor. Offering self-service, from pump-your-own gas to self-managed brokerage accounts, is a well-established way to keep costs low. If the goal is service excellence, though, you must create a situation in which the customer will prefer the do-it-yourself capability over a readily available full-service alternative. Airlines have achieved this, at last, with flight check-in kiosks, although the value proposition they initially presented was dubious. At first, passengers felt compelled to use the relatively unappealing kiosks only because carriers had allowed the lines in front of manned desks to become intolerable. Today, however, frequent fliers prefer the kiosks because they provide readier access to useful tools like seat maps. Businesses looking to achieve service excellence in other settings should not take such an indirect route. They should set themselves the challenge of creating self-service capabilities that customers will welcome. Indeed, if a self-service option is truly preferable, customers should be willing to take on the work for nothing or even pay for the privilege. When managers designing self-service solutions are not permitted to add the inducement of price discounts, they are forced to focus on improving the customer experience.

Whatever funding mechanism is used to cover the costs of excellence, it is best thought out as thoroughly as possible prior to the launch of a new service, rather than amended in light of experience afterward. When a service that's been perceived as free suddenly has fees associated with it, customers tend to react with disproportionate displeasure. And since companies cannot thrive by offering service gratis, it is vital that they not set expectations that can't be sustained. With careful analysis and design, a company can offer and fund a better service experience than its customers would enjoy elsewhere.

3. The Employee Management System

Companies often live or die on the quality of their workforces, but because service businesses are typically people intensive, a relative advantage in employee management has all the more impact there. Top management must give careful attention to recruiting and selection processes, training, job design, performance management, and other components that make up the employee management system. More to the point, the decisions made in these areas should reflect the service attributes the company aims to be known for.

To design a well-integrated employee management system, start with two simple diagnostic questions. First: What makes our employees reasonably able to achieve excellence? And then: What makes our employees reasonably motivated to achieve excellence? Thoughtfully considered, the answers will translate into company-specific policies and programs. Companies that neglect to connect the dots between their employee management approaches and customers' service preferences will find it very hard to honor their service promises.

At one large international retail bank I studied, a senior manager had come to a depressing realization. "Our service stinks," she told me. Under her guidance the bank took various measures, mainly centering on incentives and training, but the problem persisted. Customer experience in the branch did not improve. Perplexed but determined, the executive decided to become a frontline employee herself for a month. She thought it would take that much time to experience a typical range of service interactions and see the roots of the problem. In fact, it took one day. "From the time the doors opened, customers were yelling at me," she reported. "By the end of the day, I was yelling back." What became clear was that employees were set up to fail. Recent cross-selling initiatives had created a set of customers with more complex needs and higher expectations for their relationship with the bank, but employees had not been equipped to respond. As a result of decisions made by the management team (all individually sensible), the typical employee did not have a reasonable chance of succeeding. The bank's employee management system was broken.

If your business requires heroism of your employees to keep customers happy, then you have bad service by design. Employee self-sacrifice is rarely a sustainable resource. Instead, design a system that allows the average employee to thrive. This is part of Commerce Bank's competitive formula. Recall that the bank chooses to compete on extended hours and friendly interactions and not on low price and product breadth. Now think how that strategy could inform employee management; the implications are not hard to imagine. For instance, Commerce concluded that it didn't require straight-A students to master its limited product set; it could hire for attitude and train for service. In job interviews, its managers could use simple weed-out criteria--like "Does this person smile in a resting state?"--rather than trying to maximize across a wide range of positive characteristics. The bank's current employees could be deployed as talent scouts, on the principle that it takes one to know one. (When people from Commerce see someone providing great service in another setting, whether at a restaurant or at a gas station, they hand out a card printed with a compliment and a suggestion to consider working for Commerce.)

It's a simple reality that employees who are above average in both attitude and aptitude are expensive to employ. They are not only attractive to you but also attractive to your competitors, which drives up wages. A business that wants to maintain a competitive cost structure will probably need to compromise on one quality or the other (or, if it insists on having both, find a way to fund that luxury). If, as Commerce Bank does, you choose to hire for attitude, then you must engineer things so that even lower-aptitude employees will reliably deliver great service. Like managers who don't want to admit that their service is designed to be inferior on some attributes, many people are reluctant to acknowledge a trade-off between aptitude and attitude. But failure to accommodate this economic reality in the design of the employee management system is a common culprit in flawed service.

4. The Customer Management System

In a service environment, employees aren't the only people affecting the cost and quality of service delivered. The customers themselves can be involved in operational processes, sometimes to a very large extent, and their input influences their experiences (and often other customers' too). For example, an architectural firm's client may explain the purpose of a new facility well or poorly, and that will affect the efficiency of the design process and the quality of the end product. A customer who dithers at a fast-food counter makes the service less fast for everyone behind him.

Customer involvement in operations has profound implications for management because it alters the traditional role of the business in value creation. The classic product-based business buys materials and adds value to them in some way. The enhanced-value product is then delivered to customers, who pay to receive it. In a service business, however, employees and customers are both part of the value-creation process. A main benefit is that customer labor can be far less expensive than employee labor. It can also lead to better service experiences. When students participate more in a classroom environment, for example, they learn more. But there are challenges, as well. Designing a system that explicitly manages these challenges is essential to service success.

Consider the issue of customer selection. Service designs may call for customers to perform important tasks, but for the most part customers have no interview, no background check, and no personality profile. As a former senior executive from Nestlé now working in financial services put it, "I could control who was in my factory at Nestlé; I have no such control over the customers in my bank's branches."

In addition, despite many organizations' best efforts, customers are not as easy to train as employees. There are usually many times more customers than employees, and creating effective training materials for such a large, dispersed, unpaid, and often irrelevantly skilled workforce is difficult. When this holds true, firms must accommodate the limited training in the design of the service experience. If tasks are shifted from employees to customers--from higher-skilled to lower-skilled people--then they must be adjusted accordingly. Airlines seem to get this right. Recall (if you can) the last time you checked in with an agent at the full-service counter. Chances are you witnessed the agent complete a dizzying sequence of keystrokes. It would not seem reasonable to expect customers to perform these same steps, and so when the check-in role was transferred to customers, it was dramatically simplified. By contrast, think of the self-service supermarket checkout. Here customers are asked not only to do what trained employees have done previously but also to shoulder the additional responsibility of fraud prevention through a complicated process of weighing bags. Asking customers to perform more-complicated tasks than higher-skilled employees contributes to the disarray and anxiety that surrounds these checkout lines.

Customers also have a great deal of discretion in their operational activities, usually far more than employees. When a company introduces a new process that it wants employees to use, it can simply issue a mandate. When customers are involved, transitions like this can be significantly more complicated. Look at Zipcar, the popular car-sharing service. To keep costs low, its service model depends on customers to clean, refuel, and return cars in time for the next user. Motivating employees to perform these tasks would be routine; motivating customer-operators has required a complex, evolving mix of rewards and penalties.

In managing customers in your operations, then, you'll need to address a few key questions: Which customers are you focusing on? Which behaviors do you want? And which techniques will most effectively influence behavior? For example, a company whose business model depends on customers' timeliness--whether it's a dental office packing its appointment calendar or a video store circulating hit films--may use more- or less-heavy-handed tactics to ensure compliance. In a previous article for Harvard Business Review ("Breaking the Trade-Off Between Efficiency and Service," November 2006), I related lessons from several companies that have used a range of techniques to modify customer behavior. These techniques can be divided into two basic categories: instrumental (the carrots and sticks we commonly see play out as discounts and late fees) and normative (the use of shame, blame, and pride to motivate us to return shopping carts and pick up trash even when no one is looking). The important thing is to manage customers in a way that is consistent with the service attributes you've chosen to emphasize overall.

Integrating the Elements

Successful service companies have a working plan that incorporates all four elements of service design. Within each of those areas, however, it is hard to spot any best practice. This is because the whole business depends more on the interconnection of the four than on any one element.

A standout example of effective overall integration is the Cleveland Clinic, which is consistently ranked among America's most eminent hospitals and has been a leader in pioneering cardiac care for decades. It's hard to put a finger on the source of that advantage. The fact that the clinic has specialty centers focusing on diabetes, for example, or cardiac care is not exceptional in itself. Its refusal to attach financial rewards to doctors' productivity is unusual but might not be effective elsewhere. Step back from the details, however, and the bigger picture emerges. Attracting the highest-severity patients means that doctors will always face a challenging environment in need of innovative solutions. Organizing into disease centers rather than narrower, more traditional lines of specialization (such as kidneys or blood) sets the stage for cross-disciplinary collaboration--and thus for novel perspectives--within those centers. Removing productivity incentives gives doctors license to spend time on innovation, which is enhanced by their close work with specialists from other fields. The particular choices made on methods, processes, and personnel are the right ones for the Cleveland Clinic because they complement one another and come together in a smoothly operating system.

Any service company, no matter how long established, can benefit from a review of its operations using the framework laid out in this article. Bringing the four elements of service design into tighter alignment can be an ongoing process of small tweaks and experiments in change, inspired by the kinds of questions included in the sidebar "Diagnosing Service Design." A management team planning to launch a new service will find the framework particularly helpful. It flags the decisions that should be made early and in tandem so that they don't clash down the road. And at the highest level, it underscores two very important principles of service design. First, there is no such thing as a good idea in isolation; there is only a good idea in the context of a specific service model. Second, it is folly to attempt to be all things to all customers.

Sidebar Icon Diagnosing Service Design (Located at the end of this article)

The first point notes the importance of fit, mentioned earlier as a key strength of the Cleveland Clinic. At the clinic, management knows that extensions to its core business must be examined closely for their fit with its existing service model. The organization recently abandoned the concept of a high-end wellness and spa offering because it didn't build on the hospital's core operational strengths. In some ways this seems like an obvious point, but managers often stray into areas of relative weakness, particularly when they see a firm they consider to be a direct competitor succeeding with a service they don't yet offer. Progressive made this mistake when it decided to venture into the home insurance market. No question, there is money to be made in home insurance, as innumerable firms have shown. But Progressive failed in its attempt because the challenges of that business did not match up with the company's competitive strengths. Recall that Progressive is justifiably proud of its analytics advantage, which enables it to effectively size up the risk that a given policyholder will file a claim. Unfortunately, that kind of actuarial prowess is not as central to making a profit on insuring homes. Home insurers rise or fall on the management of their investment portfolios--and that is a relative weakness of Progressive. (Firms typically lose money on the insurance but make money investing prepaid premiums.) The fit, in retrospect, was a bad one. It should have been seen that way early on.

Just as common a failing is the misguided desire to be all things to all people. In today's service economy, it is nearly impossible to design a service model to cover a huge range of customers and remain competitive across them. Instead, firms should design their service models for more targeted excellence by being specific things to specific people.

Great service companies are, almost without exception, very clever about selecting their customers. We saw this in Progressive's highly informed choice of whom to do business with. Commerce Bank, from its beginnings in 1973, knew it should stake out its own claim on the market. "The world," its founder Vernon Hill said, "did not need another `me-too' bank. I had no capital, no brand name, and I had to search for a way to differentiate from the other players." Shouldice Hospital, a Canadian specialist in hernia operations, is highly selective about its customer base. Not only does it serve just patients experiencing a certain type of ailment, it has the luxury of operating on otherwise healthy people. It has skimmed the cream of the market.

Becoming a Multifocused Firm

Inevitably, companies that attempt to be all things to all people begin to struggle when upstart competitors like Shouldice start picking off profitable niches. Often, the decline is not taken seriously until it's too late. (See the sidebar "Coming to Terms with the Threat.")

Sidebar Icon Coming to Terms with the Threat (Located at the end of this article)

However, some incumbents have managed to compete effectively with their more-focused rivals, and there is much to learn from their experience. The common thread in their competitive responses to upstarts is the capacity to become "multifocused." In other words, they stopped trying to cover the entire waterfront with a single service model. Instead they pursued multiple niches with optimized service models--each designed to achieve excellence on some dimensions at the expense of inferior performance on others. The secret to success in a multifocused firm is the ability to benefit from having various service models under one house umbrella. This benefit often comes in the form of shared services (that is, internal service providers), which enable a firm to generate economies of scale and economies of experience across its service models. Effectiveness at utilizing shared services to the advantage of the individual service models can determine the success of a multifocused firm. (See the exhibit "Are Focused Competitors Nipping at Your Flanks?")

Sidebar Icon Are Focused Competitors Nipping at Your Flanks? (Located at the end of this article)

The shared services architecture can be seen in multifocused corporations across industries--from Yum Brands, a collection of five fast-food companies, to Omnicom, which consists of hundreds of companies in the interactive-marketing space, to GE, which seems to have no limit on the markets it can enter. Each corporation has created distinct service models for distinct customer operating segments and gauges the overall benefit of the models by assessing how much they gain from one another. What determines whether a company has assembled the right portfolio of service models? It comes down to a critical test: Is each of the firm's distinct service models better off as a result of the others? If the answer is no, it signals that performance is about to decline or that the company may want to spin off some service models. If the answer is yes, it's almost always thanks to superior management of shared services, and the incumbent thrives.

The services shared in multifocused companies typically include business functions like finance, purchasing, information technology, human resources, and executive training. The scale advantages they provide are straightforward and include pooled purchasing, preferred access to credit, and other cost-related benefits. Economies of experience are more difficult to realize but can also be more valuable. Here, the challenge is to use knowledge gained in one service model to strengthen the performance of the others. To a limited extent, this kind of knowledge transfer occurs informally; this has always been the hope and promise of diversified companies. The important difference in successful multifocused firms is that they formalize the process, designing very explicit ways of leveraging experience across service models. Knowledge transfer is facilitated by deliberate investments in such programs as formal best-practice sharing; centralized, dynamic employee training; and the rotation of managers among models.

My research convinces me that the best means of sustaining growth in a service business is to employ the multifocused model, yet it is also evident that this model requires concentrated effort to defend. Leaders of individual service models constantly assert that dedicated, rather than shared, resources would do more to strengthen their own businesses. Operations managers, meanwhile, raise a chorus of complaint that shared services require more-vigilant control "below the line" if they are to deliver the necessary economies of scope and experience. Given the perpetual assault on the model, it may not be surprising that another common characteristic of successful multifocused firms is directive (even autocratic) leadership. This leadership style accommodates different personalities, but it always relies on senior managers who are able and willing to exert strong influence on subordinates. They must be, in order to balance the competitive autonomy of individual service models with the collective value of shared services. Without strong, centralized leadership, revenue-generating line managers typically overrule shared-services managers, particularly in moments of strategic distress. Indeed, companies often stack the deck by placing stronger leaders in the service models than in the shared services, effectively undermining the performance of the system.

The Management-Practice Frontier

Management scholars, and not a few practitioners, have taken up an interesting debate in recent years: Is the discipline of management fundamentally different in service businesses than in product businesses? The way in which management is studied and taught in graduate business schools was forged in the context of the industrial economy. Are the approaches that worked for manufacturing companies equally applicable to services?

As service businesses continue to innovate, succeed, and be studied, the answers are becoming clearer. The framework presented here suggests why the traditional techniques have proved as durable as they have and why they still leave sophisticated managers wanting more. Much of what determines the health of a product business--the soundness of its offering and the management of its people--is just as indispensable in a service business and can be addressed with a similar tool kit. But whole new areas involving the roles of customers have opened up, and their tool kits are only now being assembled. Diagnosing Service Design

The success or failure of a service business comes down to whether it gets four things right or wrong--and whether it balances them effectively. Here are some questions that will sharpen managers' thinking along each dimension and help companies gauge how well their service models are integrated.

1. The Offering

Which service attributes (convenience? friendliness?) does the firm target for excellence?

Which ones does it compromise in order to achieve excellence in other areas?

How do its service attributes match up with targeted customers' priorities?

2. The Funding Mechanism

Are customers paying as palatably as possible?

Can operational benefits be reaped from service features?

Are there longer-term benefits to current service features?

Are customers happily choosing to perform work (without the lure of a discount) or just trying to avoid more-miserable alternatives?

3. The Employee Management System

What makes employees reasonably able to produce excellence?

What makes them reasonably motivated to produce excellence?

Have jobs been designed realistically, given employee selection, training, and motivation challenges?

4. The Customer Management System

Which customers are you incorporating into your operations?

What is their job design?

What have you done to ensure they have the skills to do the job?

What have you done to ensure they want to do the job?

How will you manage any gaps in their performance?

The Whole Service Model

Are the decisions you make in one dimension supported by those you've made in the others?

Does the service model create long-term value for customers, employees, and shareholders?

How well do extensions to your core business fit with your existing service model?

Are you trying to be all things to all people--or specific things to specific people? Coming to Terms with the Threat

How do incumbents react when a focused entrant appears on the scene? The usual response seems to follow four distinct stages of "strategic grief."

Dismissal. The incumbent perceives the entrant as a nonthreat. It is a deceptively easy assessment to make, given that the focused firm has optimized its service model to be deliberately good--and bad--at certain aspects of the incumbent's business.

Sadness. Next comes a sense of loss as profitable customers start to defect. They are willing, if not eager, to make the trade-offs inherent in the entrant's service model.

Relief. Sadness is replaced by relief as the realization dawns that only one of the incumbent's customer segments is being targeted by the focused entrant. The new competitor may win on a few dimensions of value and take certain customers away, but there are still many other segments to serve!

Dread. Finally, the larger threat reveals itself. The problem is not this single entrant; it's the inevitable attack of focused firms on other fronts.

Spotted in time, the threat of focused competitors can be met effectively. Is there a troubling area of competitive activity on your radar screen? If so, don't be lulled by its small scale and isolation. Move quickly to understand what's going on there. In particular, focus on the entrant's rate of improvement along critical measures like market share, share of wallet, and service quality. Benchmarks of absolute difference can fool managers into believing that the threat is not imminent. But when a new competitor improves faster than you do, the gap soon closes.

Once you learn the threat is real, explore your potential advantages. Can you compete effectively as a "multifocused" firm (one that targets multiple niches rather than trying to tackle everything)? The threat needs to be addressed with humility. The temptation will be great to believe that "our way" remains the better way. If anything, overstate the fact that it is not, and proceed from that assumption to craft a competitive response. Are Focused Competitors Nipping at Your Flanks?

Highly focused firms are the bane of big, established companies. Because they laser-target certain customer segments, they are able to optimize their service models. The service quality they provide, using specialized employees and a customized product set, is potent. By contrast, incumbent firms typically attract a mix of customers, hire and develop a variety of employees, and--as a result of excellent, well-intentioned suggestions from both groups--are rampant product proliferators.

Can You Say What Your Strategy Is?

It's a dirty little secret: Most executives cannot articulate the objective, scope, and advantage of their business in a simple statement. If they can't, neither can anyone else.

by David J. Collis and Michael G. Rukstad

Can you summarize your company's strategy in 35 words or less? If so, would your colleagues put it the same way?

It is our experience that very few executives can honestly answer these simple questions in the affirmative. And the companies that those executives work for are often the most successful in their industry. One is Edward Jones, a St. Louis-based brokerage firm with which one of us has been involved for more than 10 years. The fourth-largest brokerage in the United States, Jones has quadrupled its market share during the past two decades, has consistently outperformed its rivals in terms of ROI through bull and bear markets, and has been a fixture on Fortune's list of the top companies to work for. It's a safe bet that just about every one of its 37,000 employees could express the company's succinct strategy statement: Jones aims to "grow to 17,000 financial advisers by 2012

• by offering trusted and convenient face-to-face financial advice to conservative individual investors who delegate their financial decisions, through a national network of one-financial-adviser offices."

Conversely, companies that don't have a simple and clear statement of strategy are likely to fall into the sorry category of those that have failed to execute their strategy or, worse, those that never even had one. In an astonishing number of organizations, executives, frontline employees, and all those in between are frustrated because no clear strategy exists for the company or its lines of business. The kinds of complaints that abound in such firms include:

• "I try for months to get an initiative off the ground, and then it is shut down because `it doesn't fit the strategy.' Why didn't anyone tell me that at the beginning?"
• "I don't know whether I should be pursuing this market opportunity. I get mixed signals from the powers that be."
• "Why are we bidding on this customer's business again? We lost it last year, and I thought we agreed then not to waste our time chasing the contract!"
• "Should I cut the price for this customer? I don't know if we would be better off winning the deal at a lower price or just losing the business."

Leaders of firms are mystified when what they thought was a beautifully crafted strategy is never implemented. They assume that the initiatives described in the voluminous documentation that emerges from an annual budget or a strategic-planning process will ensure competitive success. They fail to appreciate the necessity of having a simple, clear, succinct strategy statement that everyone can internalize and use as a guiding light for making difficult choices.

Think of a major business as a mound of 10,000 iron filings, each one representing an employee. If you scoop up that many filings and drop them onto a piece of paper, they'll be pointing in every direction. It will be a big mess: 10,000 smart people working hard and making what they think are the right decisions for the company--but with the net result of confusion. Engineers in the R&D department are creating a product with "must have" features for which (as the marketing group could have told them) customers will not pay; the sales force is selling customers on quick turnaround times and customized offerings even though the manufacturing group has just invested in equipment designed for long production runs; and so on.

If you pass a magnet over those filings, what happens? They line up. Similarly, a well-understood statement of strategy aligns behavior within the business. It allows everyone in the organization to make individual choices that reinforce one another, rendering those 10,000 employees exponentially more effective.

What goes into a good statement of strategy? Michael Porter's seminal article "What Is Strategy?" (HBR November-December 1996) lays out the characteristics of strategy in a conceptual fashion, conveying the essence of strategic choices and distinguishing them from the relentless but competitively fruitless search for operational efficiency. However, we have found in our work both with executives and with students that Porter's article does not answer the more basic question of how to describe a particular firm's strategy.

It is a dirty little secret that most executives don't actually know what all the elements of a strategy statement are, which makes it impossible for them to develop one. With a clear definition, though, two things happen: First, formulation becomes infinitely easier because executives know what they are trying to create. Second, implementation becomes much simpler because the strategy's essence can be readily communicated and easily internalized by everyone in the organization.

Elements of a Strategy Statement

The late Mike Rukstad, who contributed enormously to this article, identified three critical components of a good strategy statement--objective, scope, and advantage--and rightly believed that executives should be forced to be crystal clear about them. These elements are a simple yet sufficient list for any strategy (whether business or military) that addresses competitive interaction over unbounded terrain.

Any strategy statement must begin with a definition of the ends that the strategy is designed to achieve. "If you don't know where you are going, any road will get you there" is the appropriate maxim here. If a nation has an unclear sense of what it seeks to achieve from a military campaign, how can it have a hope of attaining its goal? The definition of the objective should include not only an end point but also a time frame for reaching it. A strategy to get U.S. troops out of Iraq at some distant point in the future would be very different from a strategy to bring them home within two years.

Since most firms compete in a more or less unbounded landscape, it is also crucial to define the scope, or domain, of the business: the part of the landscape in which the firm will operate. What are the boundaries beyond which it will not venture? If you are planning to enter the restaurant business, will you provide sit-down or quick service? A casual or an upscale atmosphere? What type of food will you offer--French or Mexican? What geographic area will you serve--the Midwest or the East Coast?

Alone, these two aspects of strategy are insufficient. You could go into business tomorrow with the goal of becoming the world's largest hamburger chain within 10 years. But will anyone invest in your company if you have not explained how you are going to reach your objective? Your competitive advantage is the essence of your strategy: What your business will do differently from or better than others defines the all-important means by which you will achieve your stated objective. That advantage has complementary external and internal components: a value proposition that explains why the targeted customer should buy your product above all the alternatives, and a description of how internal activities must be aligned so that only your firm can deliver that value proposition.

Defining the objective, scope, and advantage requires trade-offs, which Porter identified as fundamental to strategy. If a firm chooses to pursue growth or size, it must accept that profitability will take a back seat. If it chooses to serve institutional clients, it may ignore retail customers. If the value proposition is lower prices, the company will not be able to compete on, for example, fashion or fit. Finally, if the advantage comes from scale economies, the firm will not be able to accommodate idiosyncratic customer needs. Such trade-offs are what distinguish individual companies strategically.

Defining the Objective

The first element of a strategy statement is the one that most companies have in some form or other. Unfortunately, the form is usually wrong. Companies tend to confuse their statement of values or their mission with their strategic objective. A strategic objective is not, for example, the platitude of "maximizing shareholder wealth by exceeding customer expectations for _______

• and providing opportunities for our employees to lead fulfilling lives while respecting the environment and the communities in which we operate." Rather, it is the single precise objective that will drive the business over the next five years or so. (See the exhibit "A Hierarchy of Company Statements.") Many companies do have--and all firms should have--statements of their ultimate purpose and the ethical values under which they will operate, but neither of these is the strategic objective.

Sidebar Icon A Hierarchy of Company Statements (Located at the end of this article)

The mission statement spells out the underlying motivation for being in business in the first place--the contribution to society that the firm aspires to make. (An insurance company, for example, might define its mission as providing financial security to consumers.) Such statements, however, are not useful as strategic goals to drive today's business decisions. Similarly, it is good and proper that firms be clear with employees about ethical values. But principles such as respecting individual differences and sustaining the environment are not strategic. They govern how employees should behave ("doing things right"); they do not guide what the firm should do ("the right thing to do").

Firms in the same business often have the same mission. (Don't all insurance companies aspire to provide financial security to their customers?) They may also have the same values. They might even share a vision: an indeterminate future goal such as being the "recognized leader in the insurance field." However, it is unlikely that even two companies in the same business will have the same strategic objective. Indeed, if your firm's strategy can be applied to any other firm, you don't have a very good one.

It is always easy to claim that maximizing shareholder value is the company's objective. In some sense all strategies are designed to do this. However, the question to ask when creating an actionable strategic statement is, Which objective is most likely to maximize shareholder value over the next several years? (Growth? Achieving a certain market share? Becoming the market leader?) The strategic objective should be specific, measurable, and time bound. It should also be a single goal. It is not sufficient to say, "We seek to grow profitably." Which matters more--growth or profitability? A salesperson needs to know the answer when she's deciding how aggressive to be on price. There could well be a host of subordinate goals that follow from the strategic objective, and these might serve as metrics on a balanced scorecard that monitors progress for which individuals will be held accountable. Yet the ultimate objective that will drive the operation of the business over the next several years should always be clear.

The choice of objective has a profound impact on a firm. When Boeing shifted its primary goal from being the largest player in the aircraft industry to being the most profitable, it had to restructure the entire organization, from sales to manufacturing. For example, the company dropped its policy of competing with Airbus to the last cent on every deal and abandoned its commitment to maintain a manufacturing capacity that could deliver more than half a peak year's demand for planes.

Another company, after years of seeking to maximize profits at the expense of growth, issued a corporate mandate to generate at least 10% organic growth per year. The change in strategy forced the firm to switch its focus from shrinking to serve only its profitable core customers and competing on the basis of cost or efficiency to differentiating its products, which led to a host of new product features and services that appealed to a wider set of customers.

At Edward Jones, discussion among the partners about the firm's objective ignited a passionate exchange. One said, "Our ultimate objective has to be maximizing profit per partner." Another responded, "Not all financial advisers are partners--so if we maximize revenue per partner, we are ignoring the other 30,000-plus people who make the business work!" Another added, "Our ultimate customer is the client. We cannot just worry about partner profits. In fact, we should start by maximizing value for the customer and let the profits flow to us from there!" And so on. This intense debate not only drove alignment with the objective of healthy growth in the number of financial advisers but also ensured that every implication of that choice was fully explored. Setting an ambitious growth target at each point in its 85-year history, Edward Jones has continually increased its scale and market presence. Striving to achieve such growth has increased long-term profit per adviser and led the firm to its unique configuration: Its only profit center is the individual financial adviser. Other activities, even investment banking, serve as support functions and are not held accountable for generating profit.

Defining the Scope

A firm's scope encompasses three dimensions: customer or offering, geographic location, and vertical integration. Clearly defined boundaries in those areas should make it obvious to managers which activities they should concentrate on and, more important, which they should not do.

The three dimensions may vary in relevance. For Edward Jones, the most important is the customer. The firm is configured to meet the needs of one very specific type of client. Unlike just about every other brokerage in the business, Jones does not define its archetypal customer by net worth or income. Nor does it use demographics, profession, or spending habits. Rather, the definition is psychographic: The company's customers are long-term investors who have a conservative investment philosophy and are uncomfortable making serious financial decisions without the support of a trusted adviser. In the terminology of the business, Jones targets the "delegator," not the "validator" or the "do-it-yourselfer."

The scope of an enterprise does not prescribe exactly what should be done within the specified bounds. In fact, it encourages experimentation and initiative. But to ensure that the borders are clear to all employees, the scope should specify where the firm or business will not go. That will prevent managers from spending long hours on projects that get turned down by higher-ups because they do not fit the strategy.

For example, clarity about who the customer is and who it is not has kept Edward Jones from pursuing day traders. Even at the height of the internet bubble, the company chose not to introduce online trading (it is still not available to Jones customers). Unlike the many brokerages that committed hundreds of millions of dollars and endless executive hours to debates over whether to introduce online trading (and if so, how to price and position it in a way that did not cannibalize or conflict with traditional offerings), Jones wasted no money or time on that decision because it had set clear boundaries.

Similarly, Jones is not vertically integrated into proprietary mutual funds, so as not to violate the independence of its financial advisers and undermine clients' trust. Nor will the company offer penny stocks, shares from IPOs, commodities, or options--investment products that it believes are too risky for the conservative clients it chooses to serve. And it does not have metropolitan offices in business districts, because they would not allow for the convenient, face-to-face interactions in casual settings that the firm seeks to provide. Knowing not to extend its scope in these directions has allowed the firm to focus on doing what it does well and reap the benefits of simplicity, standardization, and deep experience.

Defining the Advantage

Given that a sustainable competitive advantage is the essence of strategy, it should be no surprise that advantage is the most critical aspect of a strategy statement. Clarity about what makes the firm distinctive is what most helps employees understand how they can contribute to successful execution of its strategy.

As mentioned above, the complete definition of a firm's competitive advantage consists of two parts. The first is a statement of the customer value proposition. Any strategy statement that cannot explain why customers should buy your product or service is doomed to failure. A simple graphic that maps your value proposition against those of rivals can be an extremely easy and useful way of identifying what makes yours distinctive. (See the exhibit "Wal-Mart's Value Proposition.")

Sidebar Icon Wal-Mart's Value Proposition (Located at the end of this article)

The second part of the statement of advantage captures the unique activities or the complex combination of activities allowing that firm alone to deliver the customer value proposition. This is where the strategy statement draws from Porter's definition of strategy as making consistent choices about the configuration of the firm's activities. It is also where the activity-system map that Porter describes in "What Is Strategy?" comes into play.

As the exhibit "Edward Jones's Activity-System Map" shows, the brokerage's value proposition is to provide convenient, trusted, personal service and advice. What is most distinctive about Jones is that it has only one financial adviser in an office, which allows it to have more offices (10,000 nationally) than competitors do. Merrill Lynch has about 15,000 brokers but only 1,000 offices. To make it easy for its targeted customers to visit at their convenience--and to provide a relaxed, personable, nonthreatening environment--Jones puts its offices in strip malls and the retail districts of rural areas and suburbs rather than high-rise buildings in the central business districts of big cities. These choices alone require Jones to differ radically from other brokerages in the configuration of its activities. With no branch-office management providing direction or support, each financial adviser must be an entrepreneur who delights in running his or her own operation. Since such people are an exception in the industry, Jones has to bring all its own financial advisers in from other industries or backgrounds and train them, at great expense. Until 2007, when it switched to an internet-based service, the firm had to have its own satellite network to provide its widely dispersed offices with real-time quotes and allow them to execute trades. Because the company has 10,000 separate offices, its real estate and communication costs are about 50% higher than the industry average. However, all those offices allow the financial advisers who run them to deliver convenient, trusted, personal service and advice.

Sidebar Icon Edward Jones's Activity-System Map (Located at the end of this article)

Other successful players in this industry also have distinctive value propositions and unique configurations of activities to support them.

Merrill Lynch.

During the five-year tenure of former CEO Stan O'Neal, who retired in October 2007, Merrill Lynch developed an effective strategy that it called "Total Merrill." The company's value proposition: to provide for all the financial needs of its high-net-worth customers--those with liquid financial assets of more than $250,000--through retirement. While a lot of brokerages cater to people with a high net worth, they focus on asset accumulation before retirement. Merrill's view is that as baby boomers age and move from the relatively simple phase of accumulating assets to the much more complex, higher-risk phase of drawing cash from their retirement accounts, their needs change. During this stage, they will want to consolidate their financial assets with a single trusted partner that can help them figure out how to optimize income over their remaining years by making the best decisions on everything from annuities to payout ratios to long-term-care insurance. Merrill offers coherent financial plans for such customers and provides access to a very wide range of sophisticated products based on a Monte Carlo simulation of the probabilities of running out of money according to different annual rates of return on different categories of assets.

How does Merrill intend to deliver this value to its chosen customers in a way that's unique among large firms? First, it is pushing brokers--especially new ones--to become certified financial planners and has raised internal training requirements to put them on that road. The certified financial planner license is more difficult for brokers to obtain than the standard Series 7 license, because it requires candidates to have a college degree and to master nearly 100 integrated financial-planning topics. Second, Merrill offers all forms of insurance, annuities, covered calls, hedge funds, banking services, and so on (unlike Edward Jones, which offers a much more limited menu of investment products). Since several of these products are technically complex, Merrill needs product specialists to support the client-facing broker. This "Team Merrill" organization poses very different HR and compensation issues from those posed by Edward Jones's single-adviser offices. Merrill's compensation system has to share income among the team members and reward referrals.

Wells Fargo.

This San Francisco bank competes in the brokerage business as part of its tactic to cross-sell services to its retail banking customers in order to boost profit per customer. (It aims to sell each customer at least eight different products.) Wells Fargo's objective for its brokerage arm, clearly stated in a recent annual report, is to triple its share of customers' financial assets. The brokerage's means for achieving this goal is the parent company's database of 23 million customers, many of them brought into the firm through one particular aspect of the banking relationship: the mortgage. Wells Fargo differs from Edward Jones and Merrill Lynch in its aim to offer personalized, rather than personal, service. For example, the firm's IT system allows a bank clerk to know a limited amount of information about a customer (name, birthday, and so on) and appear to be familiar with him or her, which is quite different from the ongoing individual relationships that Jones and Merrill brokers have with their clients.

LPL Financial.

Different again is LPL Financial, with offices in Boston, San Diego, and Charlotte, North Carolina. LPL sees its brokers (all of whom are independent financial advisers affiliated with the firm) rather than consumers as its clients and has c