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Harvard Business School Professor: an architecture for business growth

Harvard Business School Professor: an architecture for business growth

IBM IBM
Photo credit:

Pablo Fernandez

IBM’s near failure in the early 90’s can be learnt from. From death’s shadow to unfathomable profitability, its turnaround was legendary.

Established businesses face intense pressures like globalization and digitization.

In many cases, the skill of managers and their organizations for navigating these choppy waters determines whether a company is average or excels; in other cases, survival is at stake.

To foster profitable growth, established firms must be able to pursue new opportunities. If a differentiated firm’s core products are rapidly flowing down the river towards commoditization, that firm must be able to get back upstream. Few firms enjoy yesterday’s sheltered industries, and competition is fierce. Look no further than Airbnb and the hotel industry to see how swiftly the currents can change.

This will not be the first column to note that remaining entrepreneurial is hard for a large company.

We have come a long way in understanding some of the root causes of the issue, including the unfortunate irony that many of the features and behaviors that make large companies successful in their mature businesses make starting a new internal organization harder.

But many business leaders still struggle with creating a playbook to fight back. Gone is the simplistic notion to just launch a skunkworks project in a remote facility. Instead, by chewing over IBM’s story (references below), we can see some of the challenges leaders face.

IBM’s turnaround in the early 1990s is a first-round inductee into the American business hall of fame. The downfall was steep: In the 1960s and 1970s, IBM controlled 70% of the market share for the computer mainframe industry, and by the 1980s, it was the most profitable company in the world.

However, by the end of the decade, the company was in decline, and by 1991, it was losing money. Between 1991 and 1993, IBM lost approximately $16 billion (!), and its market share plummeted to 26%. This decline was due to a toxic mixture of missed market trends, losing touch with customers, a culture incapable of change, and so on.

The next part of the story is also legendary. IBM hired Lou Gerstner, an outsider to the tech industry, in 1993 to be the new CEO, and many anticipated Gerstner would break-up the company for sale. While briefly entertaining this thought, Gerstner concluded Big Blue was more valuable as one business, provided it could renew its focus on the customer and overcome what Donald Sull termed “active inertia,” which is when a company’s set of assumptions about its core business become blinders to new ways of thinking that will promote growth.

Gerstner and his senior leaders established a sense of urgency to fix IBM’s broken infrastructure.

They cut $7 billion in annual costs, shut down underperforming departments, and established the “One IBM” philosophy, setting a vision for the company as a global information business and allowing them to strategize around new opportunities like the Internet.

It worked. By the mid 1990s IBM was back to profitability and out of death’s shadow. But do you know what happened next? In my mind, the second half of this story is just as important as the turnaround, and it provides insights for leaders today that should be resurfaced.

By the late 1990s, IBM was back on stable financial footing, but it was not growing as fast its peers in the industry.

Moreover, Gerstner became increasingly frustrated with the fact that IBM regularly missed out new industries that were emerging. Time and time again, they thought IBM would be well-placed for a first-mover advantage, but they would find themselves lagging once again. This came to a boil when Gerstner learned that funding for an important life sciences project—considered a major growth area for the firm—had been cut due to spending cuts as budget deadlines approached. Incensed, he demanded to know if this experience was pervasive…

The report back was not encouraging. An internal inquiry identified that many aspects of IBM’s business did not support the creation of new businesses, despite the firm’s overwhelming intentions otherwise. See if some items on this list sound familiar for your company: IBM was 1) overly focused on serving the needs of existing customers versus thinking about future ones, 2) concentrated on achieving strict short-term revenue and profit targets at the expense of long-run investment, 3) lacked a defined process to select, experiment, fund and terminate new ventures, and so on. In total, six core items were identified, with many sub-themes.

This list shows a core challenge for managers—many of the struggles for launching new ventures are closely coupled with the strengths that large companies develop for their core businesses.

In the IBM case, for example, Gerstner and his team had relentlessly focused on cost reductions to stabilize the ship—but those budget pressures were showing a less-desirable side in the cuts of innovative projects to hit short-term targets. Likewise, a critical element of the turnaround at IBM was restoring the customer to the central place of importance. But now that customer focus—along with the processes, mentalities, culture, incentive systems, etc. that rose to support and reinforce the customer focus—were weighing against the firm being able to think about where growth might happen tomorrow.

This is very common, extending well beyond IBM. In joint work Ufuk Akcigit, we formalize a theoretical model that embodies this difference in innovation capabilities for large and small companies. When estimating the model across all U.S. firms that file patents, a stark conclusion emerges—the capacity to produce new external and exploratory innovations scales up more slowly with firm size compared to the capacity to make internal innovations that build on existing product lines.

Over small changes in firm size, say moving from 5000 to 7000 employees, this shift in innovation capabilities is minor. But when comparing entrepreneurial start-ups to a Fortune 50 giant, the difference becomes quite substantial. Moreover, these differences in innovation choices can explain some of the difference in growth rates between small and large companies, suggesting this is not “six of one, half a dozen of the other”. It matters for the company, and it matters for the economy.

How did IBM break free from this predicament? IBM started by recognizing its strengths and weaknesses, being candid about the problems it was having and seeking solutions.

An important step to its renewal was to develop a language for innovation and growth, adopting a Horizons model originally developed in Alchemy of Growth. This model helped the company articulate the timeframes over which growth efforts would develop and mature, their potential impact for IBM, and the uncertainty that the initiatives faced.

Why is this important? Well, without a language to tag initiatives, organizations mash everything into one bin. This is usually to the detriment of long-horizon growth opportunities that are not yet ready for the rigors that we place on existing businesses like quarterly performance targets—it’s like asking our two-year-old children to walk the dog (someday soon, but not yet). A proper language does not ensure success, but it is a necessary condition. The language about time horizons to innovations is just a starting point—organizations also need to parse top-down vs. bottom-up innovations, have a proper framework for aligning innovation and strategy, and so on.

This language enabled IBM to work towards becoming an ambidextrous organization.

The leadership at Big Blue worked hard to establish proper organizational homes for initiatives—placing incremental improvements to mature businesses in the standard business lines, but creating protected spaces for long-horizon Emerging Business Opportunity (EBO) initiatives.

The leadership worked to prepare the appropriate talent, cultures, performance metrics, incentive schemes, and so on to lead EBOs. These and other changes at IBM were the key to Act 2: becoming good at simultaneously executing for short-term performance in established businesses … while also providing the important spaces for longer-term exploratory innovation to be undertaken that would yield platforms necessary for the company’s sustained success. In total, about 20% of IBM’s top-line growth over the next decade came from new EBOs initiatives launched under the program.

In my work with large companies on these topics, I have found the IBM story to indispensable.

Of course, few companies are Big Blue’s size, and so any lessons must be applied to the context of each firm in question. But walking through these trade-offs and the many follow-on questions that emerge (e.g., what risk-reward profile should your company pursue in new initiatives) is critical for business leaders today. Competitive pressures from digitization and globalization demand companies be able to adapt and experiment to find new spaces. Leaving this haphazardly to the organization to figure out rarely works, but top management can make the right alignments.


 

Akcigit, Ufuk and Kerr, William. “Growth through Heterogeneous Innovations,” Harvard Business School Working Paper (2015).

Applegate, Lynda, Austin, Robert, and Collins, Elizabeth. “IBM’s Decade of Transformation: Turnaround to Growth,” Harvard Business School Case No. 9-805-130. Boston, MA: Harvard Business School Publishing, 2008.

Applegate, Lynda and Kerr, William. “Launching New Ventures in Established Organizations,” Working paper.

Baghai, Mehrdad, Coley, Stephen and White, David. The Alchemy of Growth. New York: Basic Books, 1999.

Garvin, David and Levesque, Lynne. “Emerging Business Opportunities at IBM (A),” Harvard Business School Case No. 9-304-075. Boston, MA: Harvard Business School Publishing, 2004.

Kerr, William, Nanda, Ramana and Rhodes-Kropf, Matthew. “Entrepreneurship as Experimentation,” Journal of Economic Perspectives 28:3 (2014), 25-48

Sull, Donald. “Why Good Companies Go Bad,” Harvard Business Review, July-August, 1999.

Tushman, Michael, Smith, Wendy, and Binns, Andy. “The Ambidextrous CEO,” Harvard Business Review, June 2011.

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