A true capabilities-driven strategy is the most reliable way for a company to thrive when the rules of the game for its industry are in flux. Instead of looking inward at the capabilities you already have and trying to discern your strengths, start by looking outward at the capabilities you need. What must you be able to do to reach the customers you fundamentally want to attract? By designing a portfolio of skills and tools needed to win customers, you can end up changing the game instead of playing by the rules.
The Case for Capabilities
As we write this article, in October 2008, much of the global financial-services industry is in crisis, and it is not clear how wide or deep the economic fallout will be. At the same time, many economic fundamentals remain unchanged. Emerging markets are still growing; an enormous amount of financial capital is still looking for investment vehicles; and productivity in many parts of the world continues to increase. Some industries, such as energy and heavy construction, are doing very well right now; even in the most “difficult” industries, such as manufacturing and financial services, some companies are thriving even as others collapse.
As the crisis unfolds, it is becoming more important to distinguish the companies that are managed effectively from those that have just managed to get by in good times. Those that seem positioned to win — P&G, Toyota, Wal-Mart, and Southwest, along with other well-regarded companies — have spent the past years explicitly building up a coherent portfolio of capabilities as the center of their strategy. When situated in a well-designed portfolio, capabilities naturally drive value for a company; they also drive decisions about mergers, acquisitions, high-level executive talent, divestitures, alliances, and other strategic concerns.
Capabilities have been ignored by many companies over the years, because many leaders don’t have experience in building them and because they are often regarded as nonessential. Strategies based on scale used to be sufficient in most operations-oriented enterprises. As a senior executive, if you gained enough heft in your industry (through aggressive M&A or cost cutting to drop prices), you could capitalize on economies of scale that ensured both production efficiencies and market clout. Leverage over retailers gave you better access to customers; leverage over advertising agencies gave you enhanced access to marketing media; and a larger amount of innovation investment gave you (or so it seemed) a greater likelihood of developing breakthrough products.
But the ability to establish competitive differentiation through scale has begun to erode. The rise of outsourcing and offshoring, along with more sophisticated telecommunications and the use of strategic alliances, allows smaller and newer firms to punch beyond their weight, competing with larger or more established companies. In marketing, one-on-one customer processes and more differentiated digital media have similarly leveled the playing field. And in many larger companies, economies of scale are often undermined by higher overhead costs or entrenched bureaucracy.
There’s no such thing as free capabilities; they require concerted investment. But they become far more cost-effective when they help corporate leaders decide where to expand and where to cut back. For example, Honda Motor Company has built much of its profitable growth around expertise in designing and manufacturing small high-performance engines. From motorcycles and lawn mowers, the company moved up to automobiles and light sport-utility vehicles. But it has drawn the line at larger V-8 engines that it believes lie outside its core business. “We kept asking ourselves what value Honda would bring to the customer [in] that category [of engine]. There was just no benefit for us,” noted Dan Bonawitz, head of corporate planning in the United States, in an August 2008 New York Times article.