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(originally published by Booz & Company)


Cut Costs, Grow Stronger

Did Johnson Controls really need a crisis to figure out which costs were essential? Theoretically, of course, the answer is no. A company might choose to cut costs and grow stronger as way to realize its aspirations, not just to deal with a crisis. In reality, though, crises can provide powerful stimuli. To paraphrase Samuel Johnson, nothing focuses the mind quite like the prospect of your imminent removal from this world. Absent crises, companies often lose focus and habitually accept expenses that don’t really serve their interests.

Your opportunity — at all times, but especially during a crisis — is to grow stronger by building your critical capabilities, even as many of your competitors pursue a more incremental, across-the-board approach to cost cutting. Now is when you need to invest heavily in the capabilities that matter, and make the difficult choices that great companies make.

The Meaning of Capabilities

These days, any discussion about great companies and what they’ve done well usually turns to capabilities. “Procter & Gamble wins,” someone might say, “because it knows how to innovate.” Or “Renault has taken advantage of its ability to manage joint ventures.” Or “Haier is unmatched in customer service in China.” To a great extent, capabilities have bypassed assets (such as technology, capital, facilities, property rights, or brand names) as a means of creating value.

There are a few reasons for this. First, as industries mature, assets often become “table stakes”; everyone in the game has them. You and your competitors have long since caught up to one another with your brands, patents, and manufacturing. Second, in an era of outsourcing, the importance of asset scale (as achieved, for instance, through the economies of a broad-based manufacturing footprint) has faded. Thus, in many industries, the traditional role of large assets as barriers to entry by competitors has disappeared as well. Third, assets (such as patents, brands, land, facilities, and machinery) are often by their nature more difficult than capabilities to leverage across diverse portfolios. Finally, time has a way of eroding the value of assets. New technologies may come along and make old machinery obsolete, the value proposition may move away from the assets themselves toward related services, or the assets may be based on patents that eventually expire.

Capabilities, by contrast, need never expire; in total they represent an engine for creating assets. Consider the difference between an oil company strategy that relies on the oil fields the company already owns (its assets) and a strategy aimed at expanding the ability to discover and develop new fields (a capability). A strategy for building highly sophisticated capabilities — perhaps for extracting maximum value from assets or for conducting operations with a lower carbon emissions footprint — might be more valuable still.

When you think about your costs in terms of capabilities, it becomes much easier to create capabilities that will set you apart. A company with a concentrated cluster of capabilities is more likely to come up with blockbuster hits in the market. And the lack of focus on capabilities is probably the single biggest driver of strategic confusion — the ongoing, habitual way of thinking that makes prioritization painful and difficult.

One company that has shown how far a capabilities-driven cost initiative can go is Tata Steel Ltd., a division of India’s well-known Tata Group. Like all the other Tata companies, it had local origins, and it had worked hard to be a values-based corporation, balancing financial success and a commitment to employees, its community, and to India’s development. Tata Steel was also a leader in cost per ton of product; it was frequently cited as the lowest-cost steel producer in the world. Then in 1997, after several years of a very successful technology-modernization program, the senior leaders of Tata Steel realized that they were ready to expand around the globe. Indeed, if they didn’t expand, they might become vulnerable to competitors in their home market.

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  1. Cesare Mainardi, Paul Leinwand, and Steffen Lauster, “How to Win by Changing the Game,” s+b, Winter 2008: An overview of capabilities-driven strategy and its value in setting a company’s path.
  2. Zia Khan and Jon Katzenbach, “Are You Killing Enough Ideas?s+b, Autumn 2009: How to use the informal part of your organization to ensure that even your discontinued efforts aren’t wasted.
  3. DeAnne Aguirre, Laird Post, and Sylvia Ann Hewlett, “The Talent Innovation Imperative,” s+b, Autumn 2009: How to look strategically, not just mechanistically, at human capital and its expenses. 
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