09 Jan 2006  Research & Ideas

What Really Drives Your Strategy?

For better or worse, why do so many companies veer off their strategic plan? Look for a disconnect between strategy and how resources are allocated, say Harvard Business School’s Joseph L. Bower and Clark G. Gilbert.

 

"While companies might have an intended strategy, the strategy that actually emerges can be very different," says HBS professor Clark G. Gilbert. It is a topic that Gilbert and professor Joseph L. Bower have explored at length for a new book they have edited, From Resource Allocation to Strategy, published by Oxford University Press. Contributors to the book include Harvard Business School's Clayton M. Christensen, Walter Kuemmerle, and Thomas R. Eisenmann, as well as nine other scholars.

Bower and Gilbert recently sat down with HBS Working Knowledge to explain how internal and external factors play a surprising role in strategy formulation and execution. As Gilbert explains, "A lot of our book is about understanding (a) that realized strategy is often different from intended strategy, and (b) there are forces that shape strategy in unintended ways."

Martha Lagace: Professor Bower, since 1970 you have articulated views on the resource allocation process and how it fundamentally shapes corporate strategy. Could you give us a brief overview of the resource allocation process?

Bower: Organizations of any size are built around a series of building blocks, and the bigger the company the more responsibility in those building blocks. Today they are called SBUs—Strategic Business Units—or they are country organizations. The people who run them have a lot of responsibility. If you add up what those people actually do, which ideas they choose to bring forward, and which of those get funded, the consequences of that activity is what adds up to the strategy of the company, not words on paper.

And once you see that, you begin to ask questions such as: What determines which ideas get sponsored and funded? If I'm the top management, how can I shape that process, manage it, and give it direction?

That's what our new book, From Resource Allocation to Strategy, is about. People have studied the process in various ways, first to understand how it works and then to understand how it breaks down; and then to understand how it has worked in particular circumstances like high tech or in multinationals—and then how to manage it better. The answers to those "how" questions are the first four sections of the book.

Gilbert: The key is that what can be understood as the strategy of a company is more than the statement of strategy as presented in company documents or written plans, but is the actual aggregation of commitments and their relationship to the realized strategy of the firm.

If I'm the top management, how can I shape that process, manage it, and give it direction?
—Joseph L. Bower

While companies might have an intended strategy, the strategy that actually emerges can be very different. A lot of our book is about understanding (a) that realized strategy is often different from intended strategy, and (b) there are forces that shape strategy in unintended ways. This second point highlights that the structure of the resource allocation process itself can actually shape the realized strategy of the firm. This can include internal reporting structures and incentive systems, but it can also reflect external factors such as capital markets and customers.

One of the criticisms we would have of some of our colleagues who have studied strategy (and some consultants who advise on strategy) is that they assume that once you design strategy it gets executed. They don't look inside the process and realize that it's much more complicated.

Bower: It's almost as if they think strategy is like a software program: You pop it in the company and boot it up and all of a sudden it works. It's anything but that.

Q: In your preface, you explain that there has been less progress in the strategy field understanding the interaction between economic forces and organizational pressures than you have expected. Why is this so?

Bower: In the 1970s, economic growth in industrial countries began to slow down. All of a sudden companies found that they couldn't do everything. They had to make some choices and needed a way to think about it. The economics of strategy seems to be a very powerful way of making some sense, and it is; but I don't think they spent enough time understanding what it took to make sure that the specific plans—which products to make in which kind of facility, located where, using which technologies, selling to which customers—were lined up with more abstract notions about economic strategy.

It turns out that all those specifics are determined lower down in the organization. Even if you get the plan right, implementing it is a whole other project. Some of Clark's research in the book deals with the extent to which the operating organization also has to be converted so you can implement new ideas.

Gilbert: One of the frustrations that can emerge as we talk to people who work with or study strategy is they read these ideas and say, "OK, so the resource allocation is complicated and it can get in the way of the execution of our great strategy ideas."

They fail to recognize that it can also go the other way: that sometimes the content of strategy can come from the operating levels of the firm. So it's not just that resource allocation "gets in the way of implementation," it's that research allocation can lead firms in a whole new direction—and that direction might be the right way to go, or the wrong way. In either case, it needs to be understood and managed.

For people running or advising large organizations about strategy, the obvious implication is: Let's not understand the resource allocation process just so we can implement ideas, but let's also understand it because that's where the ideas often come from in the first place.

Q: What are the main findings of your research on the resource allocation process?

Gilbert: In certain settings, the resource allocation process is inherently a multi-level process in that the manager in the middle and the operating manager have just as big an impact on strategy as corporate-level managers.

One of the examples we use in the book is Intel. While the corporate office continued to conceive of Intel as a memory chip company, an operating rule in their manufacturing organization (to maximize gross margin per wafer of square inch) meant that the manufacturing floor was increasingly allocating more space to microprocessors. As that more profitable market grew, Intel became a microprocessor company, not a memory company. These operating level decisions changed the de facto strategy of the firm prior to the corporate office's conception of the company strategy. It's one of the more powerful examples of how operating managers can have a huge impact on the real-life strategy of the firm.

Bower: The other side of that is, they wouldn't have had the choice if Gordon Moore didn't buy back the technology. So essentially what we look at is the roles of the top, bottom, and middle, how they interact, and how the top can provide guidance.

In the '70s, as companies began to understand that they didn't have enough resources, they realized that to win in a competitive battle in one business they had to commit to enough resources to do whatever was necessary to gain scale and capture market share. They discovered that they generally didn't have enough to fund all the businesses in which they were trying to compete. So they had to get out of some businesses or at least harvest them.

And when they looked at the way they allocated resources, it had nothing to do with those imperatives. What they were doing was simply allocating resources to projects on the assumption that all the businesses were fine. So, one of the ways in which the ideas of our book really got implemented at that time was around what I would call strategic resource allocation systems. Consultants began to help companies see that they had to make fairly radical choices at the top, but to do so they needed a very different kind of planning from the bottom.

Operating managers often constrain strategy adaptation in ways that are very powerful.
—Clark G. Gilbert

Gilbert: The same problem exists today. We have just talked to a large financial services firm that has spent millions of dollars building a formal resource allocation system, yet all their efforts have been at the very senior levels of management. The decisions were made only in budgeting processes. As we walked through this research with them, they could see the impact that middle level and operating managers have on the process, both on its implementation and on the ideas that arise. I think they realized that they couldn't just hardwire their planning system into the budgeting process; all these other elements have an impact as well.

Q: What role do customers play?

Bower: In the ordinary course of events, when managers of business units make proposals for investments, they are almost always driven by opportunities to grow and the need for resources to do so.

When you are competing for resources with other business units, the most powerful argument you can make is that important customers want it and will commit. If you think about the mantras we have today such as "Get close to the customer" and "Fast to market," all of those kinds of ideas mean that the business unit is getting closer and closer to its best customers. And what the best customers want, the best customers get. There is detailed research in our book about how customers can almost capture the resource allocation process.

Gilbert: How customers capture the resource allocation process at every level happens in ways that are not always intuitive to people who think about strategy as a top-down planning process. For example, customers can capture what gets considered in a formal budgeting meeting because the pricing and margin implications that underlie a business model are linked to existing customer preferences.

But the challenge is not confined to formal budgeting meetings. Operating managers often constrain strategy adaptation in ways that are very powerful. We have seen this in the response of print media organizations to the Internet. For example, senior management at a U.S. newspaper company says, "We need to get into the Internet, we need to prioritize this and make a big investment." But then at the operating level of the firm you have a sales rep who is used to selling a display ad for $40,000. The new business has a lower gross margin, the customer who is buying it isn't the rep's traditional customer, and the price point isn't the same. And so that sale rep says, "Well, I can sell a $40,000 display ad, or I can go out and find one of these new customers and sell them a $2,000 banner ad." Every day as that sales rep comes into work he makes a resource allocation decision at the operating level—how to allocate his time and attention—which de facto keeps the investment from happening, even though financial resources have been procured.

So this is a case where the customers capture the resource allocation process not just in budgeting, but in the operating levels of the firm.

Bower: Other examples in our book are very different. The field of medical devices is one in which successful companies have their sales technicians literally in the operating room with the doctor. One of the biggest problems in the field of medical devices today is cost control. It turns out that the last thing the surgeon in the OR thinks about is how, on a total cost basis, to deliver a service in a lower cost way.

Gilbert: Especially if it doesn't include the doctor.

Bower: So a medical devices firm is going to have to rethink the whole way in which ideas are developed and funded in order to respond to something which the top can see clearly: that cost containment is a big issue.

Q: What role do capital markets play in the resource allocation process?

Bower: Capital markets play an important role in several ways. To begin, companies can write whatever they want about growth in their strategy or annual report, but top management responds to the capital market's need for quarterly earnings, and it turns out that quarterly earnings drive the resource allocation process. That takes the following form: It means that the projects and plans that get approved are the ones that deliver earnings in the short term. This is a very big problem, because it happens even when managers wish it didn't.

Another very interesting way the markets are influential is that when companies begin to run down, when the quality of their performance deteriorates, it's often true that the internal processes of the firm don't really respond. Management keeps saying, "What we need is to pour more money into these businesses because then we'll fix them." Quite often it's the bankers or bond holders or their representatives on the board of directors who exert pressure to really change failing companies.

Unfortunately, it often takes a crisis, which then leads to a new chief executive. One of the chapters in our book, by Donald Sull of London Business School, develops a brilliant example from the tire industry. During the 1970s, most of the tire companies were investing in old technology and in the technology that was making it obsolete—at the same time. Eventually the capital markets had their way.

Q: What are you both working on next?

Gilbert: Right now I am looking at a couple of new research areas. One is how what we've observed about the resource allocation process in large, complex organizations applies when considering small, emerging firms. And related to that, I am exploring how resource allocation patterns shape strategy redirection efforts in new venture settings.

We know that strategies in new ventures often require frequent redirection. What are the things that will help those redirections occur, both in large company settings as well as in new start-up settings? There are very interesting interactions in terms of how resources are allocated, both in the amounts and in the timing and sequencing of resource allocation.

Bower: One consequence of this research is that we have begun to get a picture of just how complex a job it is to manage a large corporation. And in this way, in a sense, we have gained a much better sense of how the corporate office adds value. So my work right now is trying to express what corporate value added is. Most business units think that "corporate adds overhead and that's about it." But in fact, great corporate offices do a number of very important things in driving a company.

I'm also writing a book right now on succession. Probably the most vital work of the corporate office is making sure that leadership continues over time.

About the authors

Joseph L. Bower is the Donald K. David Professor of Business Administration and Chair of The General Manager Program at Harvard Business School.

Clark Gilbert is an assistant professor in the Entrepreneurial Management unit at the Harvard Business School.