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Published: November 24, 2009
 / Winter 2009 / Issue 57

 
 

Best Business Books 2009: Strategy

The Capable and the Failed


Mark Blaxill and Ralph Eckardt
The Invisible Edge: Taking Your Strategy to the Next Level Using Intellectual Property
(Portfolio, 2009)

David J. Teece
Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth
(Oxford University Press, 2009)

Malcolm S. Salter
Innovation Corrupted: The Origins and Legacy of Enron’s Collapse
(Harvard University Press, 2008)


In a year when the market value of the fortune 500 fell by 37 percent and profits plummeted by 85 percent, conventional strategy books seem beside the point. Keys to guaranteed success? If only there were such a thing. Delivering high performance? Not very likely. Effective strategic planning? JPMorgan Chase & Company’s CEO, Jamie Dimon, said that he didn’t know any company that was following its three-year strategic plan or even its one-year forecast; companies were operating strictly on a month-to-month basis.

Yet if the current crisis affords us one thing, it’s the chance to stand back and reflect on eternal questions of strategy: How should we lead companies in competitive arenas where success is relative, not absolute; where technologies change rapidly; where profits attained in one time period are eroded in the next? What’s the best way to drive companies forward when they have to run faster just to stay in the same place (a phenomenon described by William P. Barnett in last year’s best book on strategy as “Red Queen competition”)?

With these questions in mind, a few new strategy books stand out from the pack. They would be good in any year, but in the present environment they have the virtue of reminding us what it takes to achieve and sustain high performance.

Legal Monopolies

The year’s best strategy book is The Invisible Edge: Taking Your Strategy to the Next Level Using Intellectual Property, by Mark Blaxill and Ralph Eckardt, formerly of Boston Consulting Group and now running their own practice. Intellectual property (IP) often brings to mind patents and lawyers, but this notion is far too limited. In fact, IP is about much more than patents; it also encompasses trademarks, copyrights, and brands, as well as trade secrets, which are aspects of knowledge kept safely away from the eyes of competitors. Seen this way, the entire field of knowledge management is essentially the management of intellectual property. IP isn’t a legal issue but rather a business issue, and, as the authors point out, far too important to leave to the lawyers.

Blaxill and Eckardt  maintain that companies with the highest returns tend to have advantages that effectively limit competition. “As we know, when competitors smell profits they come running, so without some form of protection, those companies will quickly copy the innovations and drive the profits (for both the innovator and themselves) down to nothing.” The authors’ thinking is linked closely to the industry analysis framework pioneered by Harvard Business School professor Michael Porter, which emphasizes the importance of differentiation as a defense against rivals. “Intellectual property,” Blaxill and Eckardt write, “represents small monopolies.”

If the authors left matters there, they would add little to earlier discussions. Much of this terrain was covered by Hiroyuki Itami in Mobilizing Invisible Assets (with Thomas W. Roehl; Harvard University Press, 1987), and the ability to apply knowledge without loss was addressed by Carl Shapiro and Hal R. Varian back in Information Rules: A Strategic Guide to the Network Economy (Harvard Business Press, 1998). The Invisible Edge takes the discussion a step further by analyzing how companies can protect knowledge-based capabilities and retain the benefits for themselves.

The key argument is captured in a refrain that echoes throughout the book: Innovation without protection is corporate philanthropy. All too often, Blaxill and Eckardt argue, managers emphasize innovation without considering how to capture its benefits. They essentially make a unilateral donation to others. The authors explain: “Simply put, when businesses invest in intellectual assets they need to protect the fruits of their investment in the form of intellectual property. Only with the appropriation of ownership rights, and not the creation of the asset itself, does an investment provide competitive advantage.”

Blaxill and Eckardt identify three ways to secure the benefits of IP: control, collaborate, and simplify. Control is the most obvious and easily understood. The success of the Gillette Company (a subsidiary of Procter & Gamble) is often ascribed to its business model: Give away the razors and make money on the blades. This strategy sounds clever, until we realize that it affords little protection from rivals and can hardly explain Gillette’s high performance over so many years. Yes, Gillette has been a relentless innovator, but more importantly, it has protected its innovations with a blizzard of patents. The Fusion and Fusion Power razors, to mention the most current examples, are protected by no fewer than 30 U.S. patents that cover the blade geometry, blade coating, blade guard, pivot mechanism, trimming blade, blade retaining clips, handle design, grip design, system design, cartridge design, cartridge connection, cartridge dispenser, and more. Several of these elements have multiple patents.

Beyond control, companies can capture the benefits of IP through collaboration with others. The Toyota Motor Corporation’s network of suppliers is a widely acknowledged source of competitive edge; less well known is its extensive array of complementary patents and cross-licensing deals that make the idea of imitation daunting to rivals. By dispersing IP among a network of firms with which it collaborates closely, Toyota gains a competitive superiority that is even more difficult for others to overcome. Far from yielding its IP advantage by working with other firms, Toyota cements its IP advantage through its network.

Finally, since complexity adds to unwieldy coordination tasks, the third approach, simplify, emphasizes the benefits of setting industry standards. Here the authors explore the trade-offs between open and closed architectures, showing how open architectures can bestow benefits on companies that set the rules for the interfaces and interdependencies among components in a product design. As a prime example, Blaxill and Eckardt describe IBM’s success with the System/360, which set a standard that other players in the industry were forced to follow. The paradox: Simplicity, far from leading to imitation and irrelevance, can lead to a profitable position of network centrality.

The Invisible Edge is not without shortcomings. The concept of IP can be made so broad as to explain anything that confers advantage, and any success can somehow be attributed to IP. Furthermore, too much space is devoted to Facebook, perhaps an appealing example given its recent success, but surely an atypical example given that it has yet to establish a clear business model able to produce a stream of profits. Yet on balance, Blaxill and Eckardt have produced a fine book that is both insightful and timely. It sets forth a strong intellectual premise but is aimed at a practitioner audience. If anything, the authors’ subtitle sells their book a bit short. The Invisible Edge isn’t merely about taking strategy to the next level. Intellectual property is central to the formulation and execution of a successful strategy at any level. And by the end of the book, it is hard to imagine a successful strategy that isn’t solidly backed up by the protection of intellectual property.

The Importance of What You Do

What enables companies to develop the innovations that are essential to protect? For that, we turn to a second book, Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth, by David J. Teece, longtime professor at the University of California at Berkeley. The book is not based on original research or empirical findings, and indeed has relatively few examples of specific companies. It is more a collection of articles, written over many years, capturing an evolution in thinking by one of the most accomplished academics in the field of strategic management.

To Teece, “the field of strategic management has been stranded for some time with a framework that implicitly assumes that industry structure (and product market share), mediated by enterprise behavior, determines enterprise performance.” The target of his concern is clear. Michael Porter’s framework, anchored in industrial organization economics, conceives of the firm as a black box and ignores its inner workings, neglecting the vital role of managerial decisions. Unsatisfied with this approach, Teece looks inside the firm and sees it as a set of distinctive capabilities. Companies are notable not for the positions they occupy in an industry landscape, but for the things they actually do: how they learn from their environment, how they combine ideas as they seek to develop new products, how they deliver services to customers, how they develop the talents of employees, and more. Further, these many capabilities differ from company to company because of the deliberate actions of managers. In Teece’s vision, understanding managers and the decisions they make is central to understanding company strategy and performance.

Moreover, in a competitive market economy, capabilities must be constantly reinvented and reapplied if firms are to maintain high performance. Last year’s capabilities are inadequate; new combinations are necessary. Thus, writes Teece, dynamic capabilities form the foundation of competitive advantage, for “the extent to which an enterprise develops and employs superior (nonimitable) dynamic capabilities will determine the nature and amount of intangible assets it will create.”

How do managers renew their firm’s capabilities? First by sensing new opportunities in a shifting landscape of competition and technology, and then by seizing opportunities through managerial initiatives, which in turn lead to reconfiguring capabilities. In all this, the manager plays a central role: Resources do not effortlessly combine and recombine to create new capabilities, but are manipulated by the actions of managers who function as internal entrepreneurs. Teece scolds those who build models of strategy on theoretical foundations that emphasize market structure but overlook the importance of managerial behavior: “The cavalier treatment of entrepreneurship and management in economics stems in part from a failure to understand the importance of managing organizations and the absence of well-developed and well-functioning markets for intangibles and other idiosyncratic assets.”

Dynamic Capabilities and Strategic Management is a succinct statement of what has come to be the prevailing academic school of thought in the field of strategy. It’s not hard to see why. In a world where profits erode thanks to increasingly intense competition, or so-called hypercompetition, only the ability to continually generate distinctive capabilities is likely to lead to success. Yet one of the criticisms that can be leveled against The Invisible Edge can be raised here, too. Viewed in retrospect, successful companies can always be said to have mastered dynamic capabilities, whereas failed companies can always be said to have been unable to satisfactorily sense, seize, or reconfigure. A second-order question of vital importance is not entirely resolved: What can be done to improve our ability to generate distinctive capabilities, not just once, but over and over — and defy gravity as long as possible?

Strategy Failed

The importance of managerial decisions in strategy brings us to Innovation Corrupted: The Origins and Legacy of Enron’s Collapse, by Malcolm S. Salter, the James J. Hill Professor of Business Administration Emeritus at Harvard Business School. On a superficial level, the demise of Enron is a story of dishonesty and reckless behavior, made possible by a lack of internal and external oversight. It’s tempting to blame Enron’s executives for arrogance, greed, and hubris — the same explanations offered for so many Wall Street failures in the past year. And to be sure, Jeffrey Skilling, Andy Fastow, and the late Ken Lay make excellent villains. But Salter, a veteran observer of the world of management, looks below the surface.

The tale of Enron is not a story about them, he writes, but about us. “After decades of studying the practice of management, I am convinced that very few of us who live in the world of competitive product markets and unforgiving capital markets have not encountered the management behavior and business policies that became so toxic at Enron,” he declares. “As self-interested individuals, we are also all susceptible to incentives that improve our economic well-being and tempt personal opportunism....”

Salter’s main interest is in probing the failures of governance at Enron, including the lack of strong board oversight and the dereliction of duty by watchdogs and auditors. Yet the collapse of Enron is also very much a story about strategy. It offers an object lesson in the possibilities and perils of extending success in one industry to others, and how managers respond when their strategies go awry.

Salter wisely notes that the executives involved did not set out to be dishonest or to defraud. In its early years, Enron was innovative and successful by any objective standard. During the early 1990s, Ken Lay and Jeffrey Skilling recognized the trading opportunity in the newly deregulated market for natural gas and devised a business model that was insightful and novel. The key insight was that Enron could play an intermediary role without owning physical assets, namely plants and pipelines. The result was an “asset-light” model for trading natural gas.

Building on this early success, Enron began to look for areas where it could replicate its business model. One Enron executive claimed, “Anything we want to intermediate, we can.” By that logic, the key to Enron’s success was not its knowledge of the gas trading industry or of any other particular industry, but rather a set of capabilities that could be applied in any trading domain — the more fluid and complex the better. As Enron reported in its SEC filings, it believed “skills developed in merchant energy services could yield operating efficiencies for Enron and other participants in the developing bandwidth market.” Finding this argument persuasive, investors and bankers were eager to provide abundant resources to finance Enron’s growth.

Over the next years, Enron made repeated attempts to apply its business model of intermediation in new domains, including electricity trading, broadband trading, electricity generation, and water. Yet every attempt to extend the model into new domains turned out to be a failure. Salter’s conclusion, based on an extensive reading of Enron finances, is that it is doubtful the company earned its cost of capital in any of these new businesses. “In retrospect, both the strategic and economic logic of EES [Enron Energy Services] look highly questionable,” he writes. “Neither fundamental economics nor managerial capabilities could support Skilling’s hopes of extending his energy-based business model down the value chain from sales to utilities, to sales to consumers. Skilling’s big bet on retail energy did not come close to being viable.” Yet with massive incentives to show ever-increasing top-line and bottom-line growth, Enron executives devised questionable, and eventually illegal, ways to maintain an illusion of success. The end was inevitable, and it came swiftly in 2001.

With the benefit of hindsight, it’s easy to say that trading electricity and broadband is fundamentally different from trading natural gas, and that Enron’s business model could not bring value to new industries. But that’s in retrospect. Whether the limitations should have been visible at the time is by no means certain. For corporate strategists, the most difficult questions are, To what extent can existing capabilities be applied in new domains? How certain should we be before committing resources to move ahead? What are the warning signs that a strategy is not working successfully? And perhaps most troubling, in the event of poor returns, what are the consequences — to the firm and to the manager — of admitting failure?

Toward this end, Salter seeks to distinguish between optimism, which can help performance and have “survival-enhancing effects in business,” and hubris, which has “survival-destroying effects.” But in our daily lives, optimism and hubris are terms we bestow after knowing the outcomes. If a firm performs well, we infer that healthy optimism was present; in the event of failure, we infer hubris. For the strategist, such ex post facto attributions are insufficient. Salter tries to offer a few guidelines: “Certainly, investments in new gas pipelines, gas trading, and even electricity trading — areas in which Enron had operating experience — should be considered intelligent gambles, which are well accepted as normal activities in business. However, investments pursued without relevant operating experience; without deep, specific knowledge on the part of project overseers at corporate headquarters; and without effective risk controls — such as the aforementioned electric power projects and the excursions into water and broadband businesses — crossed the line into the zone of reckless gambles.” Fair enough, but perhaps it still prompts the deeper question, How much relevant experience and how much specific knowledge is needed before we undertake a new strategic initiative? Strategy always involves making commitments in conditions of uncertainty, and risks can never be fully obviated.

One legacy of the Enron disaster is a spate of new rules concerning corporate oversight, governance, and the independence of auditors. Such rules are important, but Salter argues that “the irony of that legacy is that the new rules cannot — by themselves — prevent Enron-style debacles, because they do not address many of the causes of the company’s breakdown.” For a cure, he points us not in the direction of greater regulation, but to principles of responsible leadership found in Philip Selznick’s 1957 classic, Leadership in Administration: A Sociological Interpretation (Row, Peterson), and its emphasis on principle and a sense of ultimate consequence. Perhaps, despite our fondest hopes to engineer superior results with strategic formulas, we are best off reading a 50-year-old leadership book.

Which brings us back to the current crisis. In the financial meltdown, it’s tempting to search for books that promise to create profits amid turbulence or turn adversity into advantage. The three books reviewed here remind us of timeless themes in strategy, yet each offers something new. The Invisible Edge addresses IP as a core issue of differentiation, but emphasizes the need to protect what we create, whether through control, collaboration, or simplification. Dynamic Capabilities reminds us of the need to look within the firm and examine the ways that organizations sense changes, seize opportunities, and reconfigure capabilities, all in response to the actions of managers. And the story of Enron in Innovation Corrupted makes clear how hard it is to know how far we can extend core capabilities and warns us that the impulse for high performance can be perverted without proper oversight. Strategic decisions can never be reduced to exact formulas. They require a sense of balance and perspective to guide choices under uncertainty. 

Author Profile:

  • Phil Rosenzweig is a professor at IMD in Lausanne, Switzerland, where he works with leading companies on questions of strategy and organization. He is the author of The Halo Effect...and the Eight Other Business Delusions That Deceive Managers (Free Press, 2007).
 
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