It might seem that companies in the same sectors would need the same capabilities to win in the market, but that is rarely the case. Apple and Dell both compete in the computer market, but their capability sets are completely different. Apple’s success depends on continued product and service innovation combined with a deep understanding of the way in which people interact with technology; Dell’s success depends on rapid delivery, low-priced customization, and high-quality customer service. Something similar is true for automakers BMW and Lexus (Toyota): same markets, different points of attack. Fashion company Zara International Inc. furnishes yet another example of winning in a unique way. This division of Spain’s Inditex does most of its production in-house, distributes in small batches, and does not hesitate to build up excess capacity at the right point in production. It does these things — all of them taboo from a traditional cost perspective — to execute its strategy of delivering the right trends at the right time. As a result, Zara has consistently sold almost 85 percent of its goods at full price (versus the industry average of 60 to 70 percent), with gross margins about 55 percent higher than those of its competitors.
These examples make clear that it’s not just the dynamics of a market, but how a particular company chooses to play in that market, that determines the required capabilities. This point is important in a cost discussion because it’s not at all uncommon for companies to tie up resources in capabilities that their competitors have, and that they covet but may not need. All too often, functional leaders ask, “What are my competitors doing?” and request funding for initiatives to build capabilities in perceived gaps. However, if all you ever try to do is match your competitors’ capabilities, you can never create or sustain a real right to win.
Cutting costs while growing stronger thus requires that you understand not just the dynamics of the market you’re competing in — where it is now and where it’s heading — but how you will play in that market. Hence the importance of a coherent capability system. Your company’s most important capabilities generally come in groups (or systems) that logically fit together and reinforce one another. They match up well against the markets you’re facing, the assets you’re supporting, and the customers you’re dealing with. On its own, for example, PepsiCo’s high-performing capability for launching new food and drink products might not amount to much. But PepsiCo also has a related capability: a world-class skill at retail outlet distribution. That capability has made PepsiCo one of the most successful food companies in the world.
Stock market analysts and company managers typically measure portfolio strength financially. If a company has a group of high-performing business units, these analysts are likely to say, “There’s a strong portfolio.” If it has poorly performing businesses, the analysts label these units “fix” or “exit.” This view of portfolios is incomplete; it has only one important metric: relatively short-term financial performance.
Our view of strong portfolios is quite different. Instead of measuring only the financial performance of each business, we ask why these businesses are in the same portfolio to begin with, and we judge their potential according to the coherence of the capabilities that are required to manage them all together. We see leaders at the most successful companies doing the same. This explains, for example, why a company like Procter & Gamble can be successful with so many different brands that compete in seemingly unrelated consumer product segments, such as cosmetics, cleaning products, and disposable diapers. The brands all take advantage of P&G’s formidable capabilities in the areas of consumer insight, breakthrough innovation, and merchandising. At Procter & Gamble, the pieces of a winning portfolio are coherent. They benefit from the same capabilities. The job of the strategist, therefore, not just at P&G but everywhere, is to achieve capability coherence: to assemble a portfolio of businesses that benefit from having a coherent “winning set” of capabilities. Accomplishing this goal means classifying each part of the business not just through financial metrics, but also through its alignment with the overall strategic direction of the enterprise. (See Exhibit 2.) This view of the corporate portfolio makes the task of cost cutting infinitely easier. It becomes much more obvious which capabilities to select for investment. No longer do you have disparate needs that all require some investment to sustain, leading to spending spread evenly across functions and businesses. Now you can focus.