„In the middle of transition the whole company is in a very tough position“
Crisis of prioritization
Geoffrey, in your book „Zone to win“ you develop a new management model. What is it about?
In a large established enterprise there are a number of conflicts of priorities when you are trying to catch the next wave of new technology. Everybody wants to incubate this new technology, and everybody understands that eventually you want to bring it to scale. But they also realize that they have to run the existing business and therefore to invest in the existing business. And that creates what we call the crisis of prioritization. There is a critical moment when you’re trying to transition to that new technology when there really isn’t enough money to go around. And you have to make some critical choices.
The conflict between existing business and future business creates a crisis of prioritization.
The purpose of the management model in „Zone to win“ is first of all to understand these conflicting priorities by sorting your business out into separate zones. Each zone has its own agenda and its own governance model. So we talk about four zones. One is the Performance Zone, where you pursue your existing business, you make your money, and where your shareholders see your performance. This zone is very much results oriented. The Performance zone cannot operate without a lot of support from functions like finance, human resources, marketing, customer support, manufacturing etc. These organizations are in the Productivity Zone, and are very process oriented. In a stable market these are the two zones you worry about every year.
Disruptive vs. sustaining innovation
And where is the future business located?
When the next wave of technology comes in view, you can’t develop it in either of those first two zones. They are not designed to develop disruptive technology. They are designed to sustain existing technology. So the third zone is called the Incubation Zone. It should feel a lot like the venture capital world. This is where you put start-up ventures. You want to try out new things, you want fast failure, you want all those things that Silicon Valley is famous for. You want to do these things in that zone, not in the Performance Zone or the Productivity Zone. The Incubation Zone plays by very different rules and you govern that zone with a much more venture model: with milestones, doing it agile, win or learn as fast as you can.
You cannot catch the next wave of technology in your normal business. It's not designed for that. You need what we call the Incubation Zone, much more governed by a more venture model.
So the three zones all have very different governance models. They have different performance metrics and different operating models. It is of vital importance that the each zone respect the governance model of the other zones. If they do, then the three zones can work together and in a normal year you can find enough money to do all three zones.
So far that sounds quite easy …
The problem happens when it is time to transition the next generation technology to scale. You have to put a lot of money into what is still a money-losing effort because it is not at scale yet, and it is still a new technology that requires a lot of handholding. Your existing customers may not be happy with that because they do not necessarily want the new technology or the trouble they would have to go through to get it. At the same time, your existing business could be losing ground because it is being attacked by disruptive technology from outside of the company. It needs investment too. So, when it comes to allocate resources and you want to go through this change, the existing system cannot handle the challenges. That creates the need for a fourth zone, what we call the Transformation Zone.
The Transformation Zone is for when the CEO has to take control of the entire company to reallocate resources in an unpopular and risky way. They personally direct the transformation and push resources into the money losing business to get it to scale as fast as possible. And they make it very clear to every other member of the corporation that this is the most important thing anybody in the company can do this year. It all makes for a very tough year, but that’s what it takes to get through a transformation. Once you get through, then you can expect quite good growth. But in the middle of transition the whole company is in a very tough position.
Transition affects the entire company
It is very important, therefore, that the leaders act swiftly. That is not the time for being a democracy. You need to be a dictatorship to get through. Once that is done you can return to your normal governance model. This is a very challenging zone and some companies actually decide that they do not have the cuture to do that. In which case the rule must be: „You must not try to do a transformation.“
Only to get it right: Are you talking of the transformation of the entire corporation or just of the disruptive part of it?
The only thing that has to be brought to scale is the next-generation disruptive offering. We are not trying to transform the entire company. We are trying to bring that new technology to scale. However: To do that requires everybody in the company to put that objective above whatever other objectives they may have. For example, if I am in the Performance Zone, and I have a very good and reliable account, but that account is also a target for the new business, I have to put winning the new business ahead of winning my normal business in that account. If I am in customer supoort I have to put supporting the new business ahead of supporting the additional business. Same for engineering, and so on.
We have those two hemispheres of sustaining and disruptive innovation. What binds these hemispheres together?
Most of the time you are living in the sustaining hemisphere. And most of the systems you have in place and your partnerships and customer relationships etc. are all organized around the Performance and the Productivity Zone. The Performance Zone is where you deliver all your value to the world. So eventually everything has to be in the Performance Zone if you are going to fulfill your mission. The Productivity Zone gives support to the Performance Zone, so you want to fund that fully too.
In the middle of transition the whole company is in a very tough position. It is very important, therefore, that the leaders act swiftly. That is not the time for being a democracy.
In the other hemisphere, you have a small amount of resources for the Incubation Zone, so you don’t get surprised by the next wave of technology. You are doing some investing, you are learning, you’ve heard about Artificial Intelligence, you’ve heard about Internet of Things etc. But it is not expensive because it is a small R&D section relative to the size of the whole corporation. Sometimes when you work in the Incubation Zone you don’t want to scale the outcome but you want to incorporate the outcome in your existing Performance Zone business in a much less disruptive way. It’s not quite exactly what they were working on in the Incubation Zone but an existing line of business can take it and use it to modernize their traditional offers. And that is great. The customers will like it and the company does not have to go through one of those very difficult transformations. Sometimes the Incubation Zone comes up with technology that you will never sell to customers all, but you will still use inside your own company. That does not require a transformation either.
Disruptor or disruptee
But we do want to use the Transformation Zone for one of two reasons. One reason is you want to be the disruptor, and so you have to put a lot of investment around a disruptive, next-generation offering. If you were a venture capital backed company that is where all the venture capital were going to. The problem for the most companies is: They are not venture capital backed and so they have to take all the money for these investments out of the existing business. This is what creates what we call a crisis of prioritization that the transformation has to resolve.
The second reason to go through a transformation is when you are not the disruptor but instead the disruptee. Amazon is destroying your retail business, Facebook is destroying your media business, Uber is destroying your transportation business. So you have to respond this disruption. To do so, you have to take an existing business out of the Performance Zone and bring it into the Transformation Zone in order to reengineer it. And when you do that, you are losing money because you do not make any of the normal sales because you are trying to get your customers to switch to the new platform. But the new platform is not as mature as the old one, and from a customer’s point of view it is not necessarily quite as good. So you give them lower prices, free trials etc. and all of this creates a financial downturn. Once again that’s why the transformation has to be fast.
In an interview with a german VC investor he told me that large corporates are not used to portfolio management. It’s easier to build a 300 million dollar factory in India than to get 30 million dollars very year over a ten year period to invest in initiatives of which nobody knows which will succeed and when …
I don’t agree with that interview. I would say that corporations will put a certain amount of money – maybe not 30 millions, but whatever it is – into venture oriented things. They will have a corporate lab, they will have minority investments in venture backed start-ups, they will run projects, they will run what we call „skunk works“, businesses that they run in a different city or building. At least in the USA that is not that challenging because the investments in this new world are about 1 or 2 percent of total revenue. It’s not 10 percent. You can do all this at 1 or 2 percent.
Why would a little start-up be able to beat a Siemens or an Ericsson or a Nokia? Because they are not conflicted.
The problem happens when you try to take anything at scale. Now you want to go from 1 or 2 percent to 10 or 15 percent of revenue – and it is not profitable. That´s when the traditional management says „I do not know how to do that.“ That is why the start-ups beat the incumbents. It is a total mismatch. Why would a little start-up be able to beat a Siemens or an Ericsson or a Nokia. Why is that possible? The answer is: They are not conflicted. Established enterprises are always conflicted when it comes to the transition to the next technology. They are not afraid of investing in the laboratory, but they are afraid of taking it to scale.
Those labs, the whole Incubation Zone: Can companies do that inside or do they have to outsource it?
Companies have a supply chain. That supply chain is on the old platform, they want to build a new platform. But they do not want to be a start-up. A start-up does not have the resources a big company has. Established enterprises have all the resources, but they have to redirect them. Redirection has a short-term financial implication that is very ugly. Traditional management has taught you never to do that, and so traditional business management teaches you never to go into the Transformation Zone. The problem with that is that you may have one great big ride like Nokia, but then you’re out of the next generation of the market. So you get one big run at things and then you’re gone. In the front of my book I list 54 companies that were market leaders in their days, and today they do not exist anymore – at least not in the business they were famous for.
Those disruptive innovations: Are they always about technology or can there be a disruptive change in the business model as well, for example?
Historically they were around technology. I am focused primarily on the Business to Business context, and I would say the tremendous changes in business models we have seen are more common in the Business to Consumer business. But whether in B2B or in B2C, all disruption has at least a technology dimension. Amazon has technology but also a very different business model with Amazon Prime. Uber has a very different business model. But it was enabled by technology. If there is no disruptive technology involved, it’s hard to see what makes the disruption possible.
The process of innovating in the sustaining hemisphere and in the disruptive one – are they totally different, are they similar?
In the beginning they are totally different. Sustaining innovation starts with respect for the last release. Basically it is about how to work down the new feature request list and pay down some technical debt, maybe refactoring a part of the existing platform. It is working within the existing establishment. You are working with your existing customer relationships, with the existing partner ecosystem. Just trying to do better and better. Sustaining innovation is about improvement of what already exists.
The principle of disruptive innovation is „We are going to attack a technological legacy“. Because it is old, because it has gone from being a productivity improvement to a productivity deterrent. Wireline telephones were a huge productivity improvement for my parents‘ generation. My chidren’s generation doesn’t even use them. To make that kind of disruption, you have to do a lot of engineering that attacks the legacy architecture, that exploits its vulnerabilities that does not protect or improve it. Disruptive technology creates a new ecosystem. That’s why it is so much easier for a start-up. It simply has no legacy. That is why we always talk about catching up, because most established companies do not attack their own business model if not being attacked by new start-up rivals.
That leads me to my last question. The astonishing revival of Microsoft since Satya Nadella took over – is it owed to sustaining or disruptive innovations?
It was disruptive. But this is interesting: The journey started 12 years ago. Back in 2007 Satya was in charge of they called the back office software business at Microsoft—the data bases and the different servers and anything they ran in a data center. They had hired in a guy named Ray Ozzie from Lotus Notes to be their new Chief Technology Officer. He was not part of the MS management legacy. He said that internet and cloud will totally disrupt Microsoft’s business and that MS had to get into cloud computing. But Microsoft had this incredibly profitable business based on on premise software and was naturally resistant to change.
Anyway, Satya, back in 2007, said he would not fund any future R&D unless it would be connected to cloud. That was a very dramatic action, backed by the former CEO Steve Ballmer. He supported Satya, but a lot other people did not, and a number of them had to leave the company becouse they would not. Microsoft then went through a period where they were substituting cloud computing contracts, with negative gross margins, for their very lucrative enterprise license agreements. So the enterprise license agreements actually became negative growth agreements. When a customer signed that agreement, Microsoft went from earning money to losing money in an instant. And not only that, they even gave special sales compensation to those who could sell cloud bigger and faster. They put an enormous amount of money in the disruptive technology of the cloud which is totally different from on premise. They had to learn all about SaaS business what they never had done. They had to create a subscription model, they had to reorganize sales, everything was new. On all levels: technology, business model, operating model. So I say: That was highly disruptive.