Digital is driving major changes in how companies set and execute strategy. New survey results point to four elements that top performers include in their digital-strategy operating model.
For many companies, the process of building and executing strategy in the digital age seems to generate more questions than answers. Despite digital’s dramatic effects on global business—the disruptions that have upended industries and the radically increasing speed at which business is done—the latest McKinsey Global Survey on the topic suggests that companies are making little progress in their efforts to digitalize the business model.
The online survey was in the field from May 15 to May 25, 2018, and garnered responses from 1,542 C-level executives and senior managers representing the full range of regions, industries, company sizes, and functional specialties. Respondents who participated in this year’s and last year’s surveys report a roughly equal degree of digitalization as they did one year ago.
As measured by the shares of the organization’s sales from products, services, or both sold through digital channels; of core products, services, or both that are digital in nature (for instance, virtualized or digitally enhanced); and of core operations that are automated, digitized, or both, as well as the volume in the organization’s supply chain that is digitized or moves through digital interactions with suppliers.
The previous survey was in the field from June 20 to July 10, 2017, and garnered responses from 1,619 C-level executives and senior managers representing the full range of regions, industries, company sizes, and functional specialties. Of those who completed the survey in 2017, 345 also completed the 2018 survey. suggesting that companies are getting stuck in their efforts to digitally transform their business.
The need for an agile digital strategy is clear, yet it eludes many—and there are plenty of pitfalls that we know result in failure. We have looked at how some companies are reinventing themselves in response to digital, not only to avoid failure but also to thrive. In this survey, we explored which specific practices organizations must have in place to shape a winning strategy for digital—in essence, what the operating model looks like for a successful digital strategy of reinvention. Based on the responses, there are four areas of marked difference in how companies with the best economic performance approach digital strategy.
We define a top economic performer as one that has, according to respondents, a top-decile rate of organic revenue growth (that is, of 25 percent or more in the past three years), relative to other respondents. We also looked at respondents in the top decile for growth in earnings before interest and taxes (EBIT) and have made note of any practices for which the top-decile revenue and top-decile EBIT results correspond or differ. compared with all others:
- The best performers have increased the agility of their digital-strategy practices, which enables first-mover opportunities.
- They have taken advantage of digital platforms to access broader ecosystems and to innovate new digital products and business models.
- They have used M&A to build new digital capabilities and digital businesses.
- They have invested ahead of their peers in digital talent.
Increase the agility of creating, executing, and adjusting strategy
One of the biggest factors that differentiate the top economic performers from others is how quick and adaptable they are in setting, executing, and adjusting their digital strategies—in other words, the velocity and adaptability of their operating models for digital strategy. Both are necessary for companies to achieve first-mover (or very-fast-follower) status, which we know to be a source of significant economic advantage.
So how do they do it? We looked at the frequency with which companies follow 11 operational practices of digital strategy. With the exception of M&A—which typically requires a much longer time frame than the other ten, often due to regulatory reasons—respondents in the top revenue decile say their companies carry out each one more frequently than their peers (Exhibit 1). The link between frequency and performance also holds up when looking at earnings before interest and taxes (EBIT).5 5.In our analysis, we looked at the relationship between frequency and economic performance in multiple ways. The results indicate that when these digital strategy practices are carried out more frequently, revenue and earnings before interest and taxes (EBIT) are greater. The inverse also is true: when companies carry out these practices more slowly, their revenue and EBIT performance is worse. Exhibit 1
That speed in strategy links with financial outperformance is not surprising and is consistent with our other work on strategy planning. As the pace of digital-related changes continues to accelerate, companies are required to make larger bets and to reallocate capital and people more quickly. These tactical changes to the creation, execution, and continuous modification of digital strategy enables companies to apply a “fail fast” mentality and become better at both spotting emerging opportunities and cutting their losses in obsolescent ones, which enables greater profitability and higher revenue growth.
Invest in ecosystems, digital products, and operating models
The companies that outperform on revenue and EBIT also differ from the rest in their embrace of the economic changes that digital technologies have wrought. Based on the results, they have done so in three specific ways: taking advantage of new digital ecosystems, focusing product-development efforts on brand-new digital offerings, and innovating the business model. We know that digital platforms have enabled the creation of new marketplaces, the sharing of data, and the benefits of network effects at a scale that was impossible just a few years ago. As these factors have converged, the digital ecosystems created by these platforms are blurring industry boundaries and changing the ways that companies evaluate the economics of their business models, their customers’ needs, and who their competitors—and partners—are.
The top EBIT performers are taking better advantage of these ecosystem-based dynamics than other companies—namely, by using digital platforms much more often to access new partners and customers. Respondents at these companies are 39 percent more likely than others are to say they do so. And while the share of global sales that move through these ecosystems is still less than 10 percent, other McKinsey research predicts that this share will grow to nearly 30 percent by 2025, making platforms an ever more critical element of digital strategy. The needs of customers become broader and more integrated in an ecosystem-based world, and the companies that are already active in their respective ecosystems are better positioned to understand these needs and meet them (either on their own or with partners) before their peers do. It makes sense, then, that the top performers seem to be developing much more innovative offerings than their peers.
On average, companies’ digital innovations most often involve adjustments to existing products. Yet respondents at the top-performing companies say they focus on creating brand-new digital offerings (Exhibit 2). What’s more, these respondents are about 60 percent more likely than others are to agree that they are more advanced than peers in adopting digital technologies to help them do so. This result is consistent with our previous findings that first movers and early adopters of digital technologies and innovations also outperform their peers. Exhibit 2
Last, innovation of the business model is more common at the top-performing companies. In our past survey, only 8 percent of respondents said their companies’ current business models would remain economically viable without making any further digital-based changes. In the newest survey, we see that the companies that have embraced digital are well ahead of their peers in their preparation for digital’s new economic realities. At the top performers, respondents say they have invested more of their digital capital in new digital businesses, compared with all other respondents (Exhibit 3).
Our research also shows that companies overall invested a greater share in new digital businesses as the overall digital maturity of their sectors increased. The more successful companies appear to be the ones that made these moves earlier than their peers, rather than being forced into making such investments late in the game.Exhibit 3
Use M&A to build digital capabilities and businesses
According to the results, M&A is another differentiator between the top-performing companies and everyone else. Not only are they spending more than others on M&A, but they are also investing in different types of M&A activities (Exhibit 4). At the winners, respondents report spending more than twice as much on M&A, as a share of annual revenue, as their counterparts elsewhere.
Includes only respondents working at privately owned companies, n = 767. Respondents working at publicly owned companies (n = 318) were asked how much their organizations invested in M&A as a percentage of market capitalization over the past three years. The same is true of respondents reporting top-decile EBIT growth, relative to respondents at other organizations. Exhibit 4
Given the pace of digital-related changes and the challenges companies face to match that speed through organic growth alone, this isn’t so surprising. What is surprising, however, is that top economic performers take a different approach to their M&A activities. While top performers and their peers have used some part of their overall digital investments to acquire new digital businesses in recent years, the top performers are investing more in acquiring both new digital businesses and new capabilities. By contrast, other respondents say their companies focus most of their M&A spending on nondigital ventures—an area where lower-performing companies seem to be doubling down. Exhibit 5
Invest ahead of peers in digital talent
From earlier work, we know that getting the right digital talent is a key enabler for digital success—a point that our latest findings only reinforce. Talent is also a major pain point: qualified digital talent is a scarce commodity, as the pace of digital still outstrips the supply of people who can deliver it. But the top economic performers are making a greater effort to solve this problem. Compared with others, these respondents say their companies are dedicating much more of their workforce to digital initiatives (Exhibit 5).
It’s not just the degree of investment that distinguishes top performers, though. They are also much nimbler in their use of digital talent, reallocating these employees across the organization nearly twice as frequently as their peers do. This agility enables more rapid movement of resources to the highest-value digital efforts—or to clearing out a backlog of digital work—and a better alignment between resources and strategies.
- Make your strategy process more dynamic. By definition, a digital strategy must adapt to the digital-driven changes happening outside the company, as well as within it. Given the breakneck pace of these changes, such a strategy must keep up with the pace of digital and enable first-mover opportunities by being revisited, iterated upon, and adjusted much more frequently than strategies have been in the past. Companies need their digital strategies to act as a road map for ongoing transformation—a living organism that evolves along with the business landscape. In other work, we laid out the four main fights that companies must win to build truly dynamic digital strategies.
- Organizations must educate their business leaders on digital and foster an attacker’s perspective, so people are more likely to look at their business, industry, and the role of digital through the eyes of new competitors. They must galvanize senior executives to action by building top-team-effectiveness programs. Organizations also must leverage data-driven insights to test and learn—and correct course—quickly. And they must fight the diffusion of their efforts and resources—a constant challenge, given the simultaneous need to digitalize their core business and innovate with new business models. These steps will put companies in a better position to move first in delivering new products and meeting customers’ and partners’ evolving needs in the new ecosystems that platforms are creating.
- Invest in talent and capabilities early and aggressively. Talent is already known as one of the hardest issues to solve as companies transform themselves in their pursuit of digitalization. The results confirm that companies need to embrace this reality and then look at how they can solve it best, whether through smarter, more dynamic allocation of these resources or the use of M&A to accelerate the building of new digital capabilities. Digital is driving an ever-faster pace of innovation, and companies can take advantage of the potential benefits only if they have the capabilities to harness it. For the survey’s top performers, one way forward is leveraging M&A to help build their digital capabilities, rather than trying to build them through a slower, organic approach. These companies are also getting the most from their digital capabilities and investments by deploying them in much more agile ways and creating a more flexible, responsive operating model.
- Redefine how you measure success. The digital era requires that companies move nimbly in order to succeed. Yet many are still measuring performance with the same metrics they used previously—which were designed for a slower pace of business and a rigid strategy-setting process. Companies must move away from old metrics (market share, for example) that are no longer meaningful indicators of economic success. With markets becoming ill-defined due to shifts in industry boundaries and shrinking economic pies within a given sector, market share is no longer a gold-standard metric or even relevant. Companies need to hold themselves to new standards that will indicate whether or not they are truly leading the pack on innovation, productivity, and the adoption of digital technologies. In our experience, outcomes such as being first to market with innovations, leading on productivity, and working with other businesses in the ecosystem (that is, moving from an “us versus them” mind-set on digital to one of partnership) are better indicators of future digital success.
About the author(s)
The survey content and analysis were developed by Jacques Bughin, a director of the McKinsey Global Institute and senior partner in McKinsey’s Brussels office; Tanguy Catlin, a senior partner in the Boston office; and Laura LaBerge, a senior expert in the Stamford office. They wish to thank Soyoko Umeno for her contributions to this work.MeasureMeasure
Oct 9, 2017: Weekly Curated Thought-Sharing on Digital Disruption, Applied Neuroscience and Other Interesting Related Matters.
By Bryan Walker and Sarah A. Soule
Curated by Helena M. Herrero Lamuedra
Culture is like the wind. It is invisible, yet its effect can be seen and felt. When it is blowing in your direction, it makes for smooth sailing. When it is blowing against you, everything is more difficult.
For organizations seeking to become more adaptive and innovative, culture change is often the most challenging part of the transformation. Innovation demands new behaviors from leaders and employees that are often antithetical to corporate cultures, which are historically focused on operational excellence and efficiency.
But culture change can’t be achieved through top-down mandate. It lives in the collective hearts and habits of people and their shared perception of “how things are done around here.” Someone with authority can demand compliance, but they can’t dictate optimism, trust, conviction, or creativity.
We believe that the most significant change often comes through social movements, and that despite the differences between private enterprises and society, leaders can learn from how these initiators engage and mobilize the masses to institutionalize new societal norms.
Dr. Reddy’s: A Movement-Minded Case Study
One leader who understands this well is G.V. Prasad, CEO of Dr. Reddy’s, a 33-year-old global pharmaceutical company headquartered in India that produces affordable generic medication. With the company’s more than seven distinct business units operating in 27 countries and more than 20,000 employees, decision making had grown more convoluted and branches of the organization had become misaligned. Over the years, Dr. Reddy’s had built in lots of procedures, and for many good reasons. But those procedures had also slowed the company down.
Prasad sought to evolve Dr. Reddy’s culture to be nimble, innovative, and patient-centered. He knew it required a journey to align and galvanize all employees. His leadership team began with a search for purpose. Over the course of several months, the Dr. Reddy’s team worked to learn about the needs of everyone, from shop floor workers to scientists, external partners, and investors. Together they defined and distilled the purpose of the company, paring it down to four simple words that center on the patient: “Good health can’t wait.”
But instead of plastering this new slogan on motivational posters and repeating it in all-hands meetings, the leadership team began by quietly using it to start guiding their own decisions. The goal was to demonstrate this idea in action, not talk about it. Projects were selected across channels to highlight agility, innovation, and customer centricity. Product packaging was redesigned to be more user-friendly and increase adherence. A comprehensive internal data platform was developed to help Dr. Reddy’s employees be proactive with their customer requests and solve any problems in an agile way.
At this point it was time to more broadly share the stated purpose — first internally with all employees, and then externally with the world. At the internal launch event, Dr. Reddy’s employees learned about their purpose and were invited to be part of realizing it. Everyone was asked to make a personal promise about how they, in their current role, would contribute to “good health can’t wait.” The following day Dr. Reddy’s unveiled a new brand identity and website that publicly stated its purpose. Soon after, the company established two new “innovation studios” in Hyderabad and Mumbai to offer additional structural support to creativity within the company.
Prasad saw a change in the company culture right away:
After we introduced the idea of “good health can’t wait,” one of the scientists told me he developed a product in 15 days and broke every rule there was in the company. He was proudly stating that! Normally, just getting the raw materials would take him months, not to mention the rest of the process for making the medication. But he was acting on that urgency. And now he’s taking this lesson of being lean and applying it to all our procedures.
What Does a Movement Look Like?
To draw parallels between the journey of Dr. Reddy’s and a movement, we need to better understand movements.
We often think of movements as starting with a call to action. But movement research suggests that they actually start with emotion — a diffuse dissatisfaction with the status quo and a broad sense that the current institutions and power structures of the society will not address the problem. This brewing discontent turns into a movement when a voice arises that provides a positive vision and a path forward that’s within the power of the crowd.
What’s more, social movements typically start small. They begin with a group of passionate enthusiasts who deliver a few modest wins. While these wins are small, they’re powerful in demonstrating efficacy to nonparticipants, and they help the movement gain steam. The movement really gathers force and scale once this group successfully co-opts existing networks and influencers. Eventually, in successful movements, leaders leverage their momentum and influence to institutionalize the change in the formal power structures and rules of society.
Practices for Leading a Cultural Movement
Leaders should not be too quick or simplistic in their translation of social movement dynamics into change management plans. That said, leaders can learn a lot from the practices of skillful movement makers.
Frame the issue. Successful leaders of movements are often masters of framing situations in terms that stir emotion and incite action. Framing can also apply social pressure to conform. For example, “Secondhand smoking kills. So shame on you for smoking around others.”
In terms of organizational culture change, simply explaining the need for change won’t cut it. Creating a sense of urgency is helpful, but can be short-lived. To harness people’s full, lasting commitment, they must feel a deep desire, and even responsibility, to change. A leader can do this by framing change within the organization’s purpose — the “why we exist” question. A good organizational purpose calls for the pursuit of greatness in service of others. It asks employees to be driven by more than personal gain. It gives meaning to work, conjures individual emotion, and incites collective action. Prasad framed Dr. Reddy’s transformation as the pursuit of “good health can’t wait.”
Demonstrate quick wins. Movement makers are very good at recognizing the power of celebrating small wins. Research has shown that demonstrating efficacy is one way that movements bring in people who are sympathetic but not yet mobilized to join.
When it comes to organizational culture change, leaders too often fall into the trap of declaring the culture shifts they hope to see. Instead, they need to spotlight examples of actions they hope to see more of within the culture. Sometimes, these examples already exist within the culture, but at a limited scale. Other times, they need to be created. When Prasad and his leadership team launched projects across key divisions, those projects served to demonstrate the efficacy of a nimble, innovative, and customer-centered way of working and of how pursuit of purpose could deliver outcomes the business cared about. Once these projects were far enough along, the Dr. Reddy’s leadership used them to help communicate their purpose and culture change ambitions.
Harness networks. Effective movement makers are extremely good at building coalitions, bridging disparate groups to form a larger and more diverse network that shares a common purpose. And effective movement makers know how to activate existing networks for their purposes. They also use social networks to spread ideas and broadcast their wins.
Leadership at Dr. Reddy’s did not hide in a back room and come up with their purpose. Over the course of several months, people from across the organization were engaged in the process. The approach was built on the belief that people are more apt to support what they have a stake in creating. And during the organization-wide launch event, Prasad invited all employees to make the purpose their own by defining how they personally would help deliver “good health can’t wait.”
Create safe havens. Movement makers are experts at creating or identifying spaces within which movement members can craft strategy and discuss tactics. These are spaces where the rules of engagement and behaviors of activists are different from those of the dominant culture. They’re microcosms of what the movement hopes will become the future.
The dominant culture and structure of today’s organizations are perfectly designed to produce their current behaviors and outcomes, regardless of whether those outcomes are the ones you want. If your hope is for individuals to act differently, it helps to change their surrounding conditions to be more supportive of the new behaviors. Outposts and labs are often built as new environments that serve as a microcosm for change. Dr. Reddy’s established two innovation labs to explore the future of medicine and create a space where it’s easier for people to embrace new beliefs and perform new behaviors.
Embrace symbols. Movement makers are experts at constructing and deploying symbols and costumes that simultaneously create a feeling of solidarity and demarcate who they are and what they stand for to the outside world. Symbols and costumes of solidarity help define the boundary between “us” and “them” for movements. These symbols can be as simple as a T-shirt, bumper sticker, or button supporting a general cause.
Dr. Reddy’s linked its change in culture and purpose with a new corporate brand identity. Internally and externally, the act reinforced a message of unity and commitment. The entire company stands together in pursuit of this purpose.
The Challenge to Leadership
Unlike a movement maker, an enterprise leader is often in a position of authority. They can mandate changes to the organization — and at times they should. However, when it comes to culture change, they should do so sparingly. It’s easy to overuse one’s authority in the hopes of accelerating transformation.
It’s also easy for an enterprise leader to shy away from organizational friction. Harmony is generally a preferred state, after all. And the success of an organizational transition is often judged by its seamlessness.
In a movements-based approach to change, a moderate amount of friction is positive. A complete absence of friction probably means that little is actually changing. Look for the places where the movement faces resistance and experiences friction. They often indicate where the dominant organizational design and culture may need to evolve.
And remember that culture change only happens when people take action. So start there. While articulating a mission and changing company structures are important, it’s often a more successful approach to tackle those sorts of issues after you’ve been able to show people the change you want to see.
Sep 25, 2017: Weekly Curated Thought-Sharing on Digital Disruption, Applied Neuroscience and Other Interesting Related Matters.
By Klaus Schwab
Curated by Helena M. Herrero Lamuedra
We stand on the brink of a technological revolution that will fundamentally alter the way we live, work, and relate to one another. In its scale, scope, and complexity, the transformation will be unlike anything humankind has experienced before. We do not yet know just how it will unfold, but one thing is clear: the response to it must be integrated and comprehensive, involving all stakeholders of the global polity, from the public and private sectors to academia and civil society.
The First Industrial Revolution used water and steam power to mechanize production. The Second used electric power to create mass production. The Third used electronics and information technology to automate production. Now a Fourth Industrial Revolution is building on the Third, the digital revolution that has been occurring since the middle of the last century. It is characterized by a fusion of technologies that is blurring the lines between the physical, digital, and biological spheres.
There are three reasons why today’s transformations represent not merely a prolongation of the Third Industrial Revolution but rather the arrival of a Fourth and distinct one: velocity, scope, and systems impact. The speed of current breakthroughs has no historical precedent. When compared with previous industrial revolutions, the Fourth is evolving at an exponential rather than a linear pace. Moreover, it is disrupting almost every industry in every country. And the breadth and depth of these changes herald the transformation of entire systems of production, management, and governance.
The possibilities of billions of people connected by mobile devices, with unprecedented processing power, storage capacity, and access to knowledge, are unlimited. And these possibilities will be multiplied by emerging technology breakthroughs in fields such as artificial intelligence, robotics, the Internet of Things, autonomous vehicles, 3-D printing, nanotechnology, biotechnology, materials science, energy storage, and quantum computing.
Already, artificial intelligence is all around us, from self-driving cars and drones to virtual assistants and software that translate or invest. Impressive progress has been made in AI in recent years, driven by exponential increases in computing power and by the availability of vast amounts of data, from software used to discover new drugs to algorithms used to predict our cultural interests. Digital fabrication technologies, meanwhile, are interacting with the biological world on a daily basis. Engineers, designers, and architects are combining computational design, additive manufacturing, materials engineering, and synthetic biology to pioneer a symbiosis between microorganisms, our bodies, the products we consume, and even the buildings we inhabit.
Challenges and opportunities
Like the revolutions that preceded it, the Fourth Industrial Revolution has the potential to raise global income levels and improve the quality of life for populations around the world. To date, those who have gained the most from it have been consumers able to afford and access the digital world; technology has made possible new products and services that increase the efficiency and pleasure of our personal lives. Ordering a cab, booking a flight, buying a product, making a payment, listening to music, watching a film, or playing a game—any of these can now be done remotely.
In the future, technological innovation will also lead to a supply-side miracle, with long-term gains in efficiency and productivity. Transportation and communication costs will drop, logistics and global supply chains will become more effective, and the cost of trade will diminish, all of which will open new markets and drive economic growth.
At the same time, as the economists Erik Brynjolfsson and Andrew McAfee have pointed out, the revolution could yield greater inequality, particularly in its potential to disrupt labor markets. As automation substitutes for labor across the entire economy, the net displacement of workers by machines might exacerbate the gap between returns to capital and returns to labor. On the other hand, it is also possible that the displacement of workers by technology will, in aggregate, result in a net increase in safe and rewarding jobs.
We cannot foresee at this point which scenario is likely to emerge, and history suggests that the outcome is likely to be some combination of the two. However, I am convinced of one thing—that in the future, talent, more than capital, will represent the critical factor of production. This will give rise to a job market increasingly segregated into “low-skill/low-pay” and “high-skill/high-pay” segments, which in turn will lead to an increase in social tensions.
In addition to being a key economic concern, inequality represents the greatest societal concern associated with the Fourth Industrial Revolution. The largest beneficiaries of innovation tend to be the providers of intellectual and physical capital—the innovators, shareholders, and investors—which explains the rising gap in wealth between those dependent on capital versus labor. Technology is therefore one of the main reasons why incomes have stagnated, or even decreased, for a majority of the population in high-income countries: the demand for highly skilled workers has increased while the demand for workers with less education and lower skills has decreased. The result is a job market with a strong demand at the high and low ends, but a hollowing out of the middle.
This helps explain why so many workers are disillusioned and fearful that their own real incomes and those of their children will continue to stagnate. It also helps explain why middle classes around the world are increasingly experiencing a pervasive sense of dissatisfaction and unfairness. A winner-takes-all economy that offers only limited access to the middle class is a recipe for democratic malaise and dereliction.
Discontent can also be fueled by the pervasiveness of digital technologies and the dynamics of information sharing typified by social media. More than 30 percent of the global population now uses social media platforms to connect, learn, and share information. In an ideal world, these interactions would provide an opportunity for cross-cultural understanding and cohesion. However, they can also create and propagate unrealistic expectations as to what constitutes success for an individual or a group, as well as offer opportunities for extreme ideas and ideologies to spread.
The impact on business
An underlying theme in my conversations with global CEOs and senior business executives is that the acceleration of innovation and the velocity of disruption are hard to comprehend or anticipate and that these drivers constitute a source of constant surprise, even for the best connected and most well informed. Indeed, across all industries, there is clear evidence that the technologies that underpin the Fourth Industrial Revolution are having a major impact on businesses.
On the supply side, many industries are seeing the introduction of new technologies that create entirely new ways of serving existing needs and significantly disrupt existing industry value chains. Disruption is also flowing from agile, innovative competitors who, thanks to access to global digital platforms for research, development, marketing, sales, and distribution, can oust well-established incumbents faster than ever by improving the quality, speed, or price at which value is delivered.
Major shifts on the demand side are also occurring, as growing transparency, consumer engagement, and new patterns of consumer behavior (increasingly built upon access to mobile networks and data) force companies to adapt the way they design, market, and deliver products and services.
A key trend is the development of technology-enabled platforms that combine both demand and supply to disrupt existing industry structures, such as those we see within the “sharing” or “on demand” economy. These technology platforms, rendered easy to use by the smartphone, convene people, assets, and data—thus creating entirely new ways of consuming goods and services in the process. In addition, they lower the barriers for businesses and individuals to create wealth, altering the personal and professional environments of workers. These new platform businesses are rapidly multiplying into many new services, ranging from laundry to shopping, from chores to parking, from massages to travel.
On the whole, there are four main effects that the Fourth Industrial Revolution has on business—on customer expectations, on product enhancement, on collaborative innovation, and on organizational forms. Whether consumers or businesses, customers are increasingly at the epicenter of the economy, which is all about improving how customers are served. Physical products and services, moreover, can now be enhanced with digital capabilities that increase their value. New technologies make assets more durable and resilient, while data and analytics are transforming how they are maintained. A world of customer experiences, data-based services, and asset performance through analytics, meanwhile, requires new forms of collaboration, particularly given the speed at which innovation and disruption are taking place. And the emergence of global platforms and other new business models, finally, means that talent, culture, and organizational forms will have to be rethought.
Overall, the inexorable shift from simple digitization (the Third Industrial Revolution) to innovation based on combinations of technologies (the Fourth Industrial Revolution) is forcing companies to reexamine the way they do business. The bottom line, however, is the same: business leaders and senior executives need to understand their changing environment, challenge the assumptions of their operating teams, and relentlessly and continuously innovate.
The impact on government
As the physical, digital, and biological worlds continue to converge, new technologies and platforms will increasingly enable citizens to engage with governments, voice their opinions, coordinate their efforts, and even circumvent the supervision of public authorities. Simultaneously, governments will gain new technological powers to increase their control over populations, based on pervasive surveillance systems and the ability to control digital infrastructure. On the whole, however, governments will increasingly face pressure to change their current approach to public engagement and policymaking, as their central role of conducting policy diminishes owing to new sources of competition and the redistribution and decentralization of power that new technologies make possible.
Ultimately, the ability of government systems and public authorities to adapt will determine their survival. If they prove capable of embracing a world of disruptive change, subjecting their structures to the levels of transparency and efficiency that will enable them to maintain their competitive edge, they will endure. If they cannot evolve, they will face increasing trouble.
This will be particularly true in the realm of regulation. Current systems of public policy and decision-making evolved alongside the Second Industrial Revolution, when decision-makers had time to study a specific issue and develop the necessary response or appropriate regulatory framework. The whole process was designed to be linear and mechanistic, following a strict “top down” approach.
But such an approach is no longer feasible. Given the Fourth Industrial Revolution’s rapid pace of change and broad impacts, legislators and regulators are being challenged to an unprecedented degree and for the most part are proving unable to cope.
How, then, can they preserve the interest of the consumers and the public at large while continuing to support innovation and technological development? By embracing “agile” governance, just as the private sector has increasingly adopted agile responses to software development and business operations more generally. This means regulators must continuously adapt to a new, fast-changing environment, reinventing themselves so they can truly understand what it is they are regulating. To do so, governments and regulatory agencies will need to collaborate closely with business and civil society.
The Fourth Industrial Revolution will also profoundly impact the nature of national and international security, affecting both the probability and the nature of conflict. The history of warfare and international security is the history of technological innovation, and today is no exception. Modern conflicts involving states are increasingly “hybrid” in nature, combining traditional battlefield techniques with elements previously associated with non-state actors. The distinction between war and peace, combatant and noncombatant, and even violence and nonviolence (think cyberwarfare) is becoming uncomfortably blurry.
As this process takes place and new technologies such as autonomous or biological weapons become easier to use, individuals and small groups will increasingly join states in being capable of causing mass harm. This new vulnerability will lead to new fears. But at the same time, advances in technology will create the potential to reduce the scale or impact of violence, through the development of new modes of protection, for example, or greater precision in targeting.
The impact on people
The Fourth Industrial Revolution, finally, will change not only what we do but also who we are. It will affect our identity and all the issues associated with it: our sense of privacy, our notions of ownership, our consumption patterns, the time we devote to work and leisure, and how we develop our careers, cultivate our skills, meet people, and nurture relationships. It is already changing our health and leading to a “quantified” self, and sooner than we think it may lead to human augmentation. The list is endless because it is bound only by our imagination.
I am a great enthusiast and early adopter of technology, but sometimes I wonder whether the inexorable integration of technology in our lives could diminish some of our quintessential human capacities, such as compassion and cooperation. Our relationship with our smartphones is a case in point. Constant connection may deprive us of one of life’s most important assets: the time to pause, reflect, and engage in meaningful conversation.
One of the greatest individual challenges posed by new information technologies is privacy. We instinctively understand why it is so essential, yet the tracking and sharing of information about us is a crucial part of the new connectivity. Debates about fundamental issues such as the impact on our inner lives of the loss of control over our data will only intensify in the years ahead. Similarly, the revolutions occurring in biotechnology and AI, which are redefining what it means to be human by pushing back the current thresholds of life span, health, cognition, and capabilities, will compel us to redefine our moral and ethical boundaries.
Shaping the future
Neither technology nor the disruption that comes with it is an exogenous force over which humans have no control. All of us are responsible for guiding its evolution, in the decisions we make on a daily basis as citizens, consumers, and investors. We should thus grasp the opportunity and power we have to shape the Fourth Industrial Revolution and direct it toward a future that reflects our common objectives and values.
To do this, however, we must develop a comprehensive and globally shared view of how technology is affecting our lives and reshaping our economic, social, cultural, and human environments. There has never been a time of greater promise, or one of greater potential peril. Today’s decision-makers, however, are too often trapped in traditional, linear thinking, or too absorbed by the multiple crises demanding their attention, to think strategically about the forces of disruption and innovation shaping our future.
In the end, it all comes down to people and values. We need to shape a future that works for all of us by putting people first and empowering them. In its most pessimistic, dehumanized form, the Fourth Industrial Revolution may indeed have the potential to “robotize” humanity and thus to deprive us of our heart and soul. But as a complement to the best parts of human nature—creativity, empathy, stewardship—it can also lift humanity into a new collective and moral consciousness based on a shared sense of destiny. It is incumbent on us all to make sure the latter prevails
Aug 1, 2017: Weekly Curated Thought-Sharing on Digital Disruption, Applied Neuroscience and Other Interesting Related Matters.
Curated by Helena M. Herrero Lamuedra
Executives put out the mandate: We need to be more innovative. We want great ideas. Innovation needs to be part of our core principles and everyday practice.
But even when great solutions are introduced to the organization, many remain best-kept secrets, failing to ever reach scale. More often than not, the problem is that the stakeholders who will make or break the idea’s execution aren’t ready, willing and able to support its success. They haven’t bought in to the change.
Here are four ways you can use design thinking as a powerful tool for change:
1. Involving Stakeholders
As great change leaders know, involvement creates ownership. Stakeholders who might otherwise block efforts become keener to support ideas that they have had an opportunity to influence. Even for stakeholders that would likely comply with a mandated change, involvement enhances their commitment to the success of the overall initiative.
Design thinking not only bakes involvement into the process by emphasizing the importance of collaboration and multiple perspectives, it also builds human connections that go deeper. You’re not just creating ownership, you’re creating two-way empathy, which helps people make better decisions.
Think strategically about who might resist your ultimate solution or who might be negatively affected by it, and find ways to involve those people in the process.
2. Reconnecting with Purpose
Organizations often struggle with mundane issues that never seem to get fully resolved. For example, a common one is getting people to submit their expenses in a timely manner. Here, too, design thinking, applied with intention, can be a great tool for changing the mindset behind the problem to help you reach a more effective outcome.
Design thinking looks at issues from a human-centered point of view, first empathizing with users and then building solutions that make their lives better. So you might ask, “How can we help people get their expenses in on time? What are they dealing with, and what would make it easier for them?”
By shifting your view to see this as an opportunity to help people, not impose process and rules on them, design thinking changes your perspective to something more meaningful. The attitudes became empathetic instead of oppositional. There is tremendous satisfaction created when the output of your work visibly improves the lives of others. When leading change, helping stakeholders connect to the purpose of their work can accelerate buy-in to a new way of doing things.
Throughout the process, find ways to share user stories, including challenges, opportunities and the impact of work, to help stakeholders reconnect to the organization’s work and how it genuinely helps users.
3. Generating Evidence
It happens all the time: people hear an idea, and they immediately say it won’t work. Without evidence, it won’t be easy to convince them otherwise. Design thinking’s process of quickly building and iterating on solutions is valuable for generating the evidence necessary to persuade leaders to fund and support a fledgling idea. Similar evidence should be used with other critical stakeholders as well.
Some evidence (metrics and validation data) will appeal to the head, but it’s more likely that early evidence (in the form of user stories) will appeal to the heart. And when a customer tells you the idea changed their life, that’s a pretty powerful argument for getting on board.
Collect data and identify various vehicles for sharing the material with stakeholder audiences. By including evidence in internal company presentations, newsletters and management meetings, you can continuously and powerfully establish the case for change.
4. Discovering Stakeholder Interests
If you don’t know what the stakeholders really care about, you could be spending your time and energy worrying about inconsequential factors—or overlooking critical ones. As a design team prototypes ideas and runs experiments, it learns about the opportunities for and barriers to ultimate success. As specific stakeholders and stakeholder groups come into contact with a nascent idea, their reactions speak to their interests.
Maybe that presumed barrier isn’t one after all, but you might discover another unanticipated obstacle that could derail success entirely. From a change management perspective, understanding and respecting these interests can help minimize resistance during implementation.
Leverage learning about stakeholder interests to both enhance the design of the solution and the design of the intervention that introduces the solution to the organization.
If you’re going to implement an innovative solution, you’re going to create change. There’s no getting around it. But in too many cases, leaders limit their focus to an either/or proposition: innovation or change.
Don’t let that revolutionary idea languish in a dusty corner (or get brought to life by someone else). Design Thinking provides tools and methods to help lead change more effectively as well and, as a result, achieve the desired impact from our innovation projects. We just have to apply it with purpose and intention.
May 22, 2017: Weekly Curated Thought-Sharing on Digital Disruption, Applied Neuroscience and Other Interesting Related Matters.
By Lewis Robinson and Dr. Travis Bradberry
Curated by Helena M. Herrero Lamuedra
On the surface, multitasking seems like a winning proposition. After all, if you work on two projects at once, then you’ll finish twice as quickly, right? It’s a perfect situation! How can you lose?
Unfortunately, it doesn’t work that way. When you try to focus on two different projects, you divide your attention, and your brain has to expend additional energy each time you switch from one task to the other. Often, it will actually end up taking you longer to get the work done.
Negative Effects of Multitasking
Multitasking is not only an inefficient use of your time; it can actually have a negative impact, both on your work and your personal well-being. Let’s take a look at a few of the problems it can bring about:
If you’re splitting your attention between two, or three, or even more tasks at once, that means that you’re not able to focus on any one of them. The brain is an incredible tool, but it can only go so far before it starts to experience diminishing returns. Guy Winch, a PhD and author of the book Emotional First Aid: Practical Strategies for Treating Failure, Rejection, Guilt, and Other Everyday Psychological Injuries posits than we’re not really “multitasking” at all. Instead, we’re “task-switching.”
“When it comes to attention and productivity, our brains have a finite amount,” says Winch. “It’s like a pie chart, and whatever we’re working on is going to take up the majority of that pie. There’s not a lot left over for other things, with the exception of automatic behaviors like walking or chewing gum.” You’re never really able to focus on one task enough to get “in the zone.”
This may seem counterintuitive, but the more tasks you work on at a time, the less work you will get done. Most people resort to multitasking as a way to get more done, not less. But working distracted can lead to slower performance and more mistakes. In fact, shifting back and forth between two or more tasks create mental blocks where your brain has to shift its focus. These blocks can cost as much as 40% of your regular productive time.
Multitasking increases stress, which isn’t always bad in the short-term, but can lead to serious complications if it goes on for too long. Chronic stress causes your body to produce more cortisol, which can bring on physical complications, such as heart issues, high blood pressure, and a diminished immune system.
What to Do About It
Even when you recognize the negative effects multitasking can have on your work, it’s still tempting to try to work on several jobs at once.
Delegate as Needed
Instead of splitting one mind among several tasks, try the opposite tactic. Spread the load out a bit and assign certain jobs to other team members who may be able to lend a hand. Put a work structure in place with the goal of keeping any particular employee’s queue from filling up too much.
Manage Your (and Your Team’s) Workflow
This is essentially just another way of saying, “Plan ahead.” Keep an eye on what projects you and your team have coming down the pipeline. If you know there will be a huge project that you will need to focus all of your attention on in the next month, do what you can to clear other tasks from that time. Prepare yourself and your team members for any eventuality.
This also means setting priorities. If everything you send to your team is marked “ASAP,” then they have no way to know which tasks to tackle first. This usually leads to employees bouncing back and forth between each task, trying to get them all done quickly. Eventually, instead of everything getting done immediately, nothing ends up getting done.
Take Regular Breaks
Oddly enough, taking breaks can actually lead to more getting done. If you are constantly working, with no end in sight, it’s easy to get burned out. Shorter bursts of work are more productive, so you and your team should take a break anywhere between every 50 minutes and every 90 minutes. This will give you the occasional moment to unwind from the constant focus, leading to better results over the long term.
The next time you tell yourself that you’ll sleep when you’re dead, realize that you’re making a decision that can make that day come much sooner. Pushing late into the night is a health and productivity killer.
According to the Division of Sleep Medicine at the Harvard Medical School, the short-term productivity gains from skipping sleep to work are quickly washed away by the detrimental effects of sleep deprivation on your mood, ability to focus, and access to higher-level brain functions for days to come. The negative effects of sleep deprivation are so great that people who are drunk outperform those lacking sleep.
Why You Need Adequate Sleep to Perform
We’ve always known that sleep is good for your brain, but new research from the University of Rochester provides the first direct evidence for why your brain cells need you to sleep (and sleep the right way—more on that later). The study found that when you sleep your brain removes toxic proteins from its neurons that are by-products of neural activity when you’re awake. Unfortunately, your brain can remove them adequately only while you’re asleep. So when you don’t get enough sleep, the toxic proteins remain in your brain cells, wreaking havoc by impairing your ability to think—something no amount of caffeine can fix.
Skipping sleep impairs your brain function across the board. It slows your ability to process information and problem solve, kills your creativity, and catapults your stress levels and emotional reactivity.
What Sleep Deprivation Does to Your Health
Sleep deprivation is linked to a variety of serious health problems, including heart attack, stroke, type 2 diabetes, and obesity. It stresses you out because your body overproduces the stress hormone cortisol when it’s sleep deprived. While excess cortisol has a host of negative health effects that come from the havoc it wreaks on your immune system, it also makes you look older, because cortisol breaks down skin collagen, the protein that keeps skin smooth and elastic. In men specifically, not sleeping enough reduces testosterone levels and lowers sperm count.
Too many studies to list have shown that people who get enough sleep live longer, healthier lives, but I understand that sometimes this isn’t motivation enough. So consider this—not sleeping enough makes you fat. Sleep deprivation compromises your body’s ability to metabolize carbohydrates and control food intake. When you sleep less you eat more and have more difficulty burning the calories you consume. Sleep deprivation makes you hungrier by increasing the appetite-stimulating hormone ghrelin and makes it harder for you to get full by reducing levels of the satiety-inducing hormone leptin. People who sleep less than 6 hours a night are 30% more likely to become obese than those who sleep 7 to 9 hours a night.
How Much Sleep Is Enough?
Most people need 7 to 9 hours of sleep a night to feel sufficiently rested. Few people are at their best with less than 7 hours, and few require more than 9 without an underlying health condition. And that’s a major problem, since more than half of Americans get less than the necessary 7 hours of sleep each night, according to the National Sleep Foundation.
A recent survey of Inc. 500 CEOs found that half of them are sleeping less than 6 hours a night. And the problem doesn’t stop at the top. According to the Centers for Disease Control and Prevention, a third of U.S. workers get less than 6 hours of sleep each night, and sleep deprivation costs U.S. businesses more than $63 billion annually in lost productivity.
Doing Something about It
Beyond the obvious sleep benefits of thinking clearly and staying healthy, the ability to manage your emotions and remain calm under pressure has a direct link to your performance.
When life gets in the way of getting the amount of sleep you need, it’s absolutely essential that you increase the quality of your sleep through good sleep hygiene. There are many hidden killers of quality sleep.
There are some strategies to help identify these killers and clean up your sleep hygiene.
Moderate Caffeine (at Least after Lunch)
You can sleep more and vastly improve the quality of the sleep you get by reducing your caffeine intake. Caffeine is a powerful stimulant that interferes with sleep by increasing adrenaline production and blocking sleep-inducing chemicals in the brain.
When you do finally fall asleep, the worst is yet to come. Caffeine disrupts the quality of your sleep by reducing rapid eye movement (REM) sleep, the deep sleep when your body recuperates most. When caffeine disrupts your sleep, you wake up the next day with a cognitive and emotional handicap. You’ll be naturally inclined to grab a cup of coffee or an energy drink to try to make yourself feel more alert, which very quickly creates a vicious cycle.
Avoid Blue Light at Night
Short-wavelength blue light plays an important role in your mood, energy level, and sleep quality. In the morning, sunlight contains high concentrations of this “blue” light. When your eyes are exposed to it directly (not through a window or while wearing sunglasses), the blue light halts production of the sleep-inducing hormone melatonin and makes you feel more alert. This is great, and exposure to a.m. sunlight can improve your mood and energy levels.
In the afternoon, the sun’s rays lose their blue light, which allows your body to produce melatonin and start making you sleepy. By the evening, your brain does not expect any blue light exposure and is very sensitive to it. The problem this creates for sleep is that most of our favorite evening devices—laptops, tablets, televisions, and mobile phones—emit short-wavelength blue light. This exposure impairs melatonin production and interferes with your ability to fall asleep as well as with the quality of your sleep once you do nod off. When you confuse your brain by exposing it in the evening to what it thinks is a.m. sunlight, this derails the entire process with effects that linger long after you power down.
When you work in the evening, it puts you into a stimulated, alert state when you should be winding down and relaxing in preparation for sleep. Recent surveys show that roughly 60% of people monitor their smartphones for work emails until they go to sleep. Staying off blue light-emitting devices (discussed above) after a certain time each evening is also a great way to avoid working so you can relax and prepare for sleep, but any type of work before bed should be avoided if you want quality sleep.
Many people who learn to meditate report that it improves the quality of their sleep and that they can get the rest they need even if they aren’t able to significantly increase the number of hours they sleep. At the Stanford Medical Center, insomniacs participated in a 6-week mindfulness meditation and cognitive-behavioral therapy course. At the end of the study, participants’ average time to fall asleep was cut in half (from 40 to 20 minutes), and 60% of subjects no longer qualified as insomniacs. The subjects retained these gains upon follow-up a full year later. A similar study at the University of Massachusetts Medical School found that 91% of participants either reduced the amount of medication they needed to sleep or stopped taking medication entirely after a mindfulness and sleep therapy course. Give mindfulness a try. At minimum, you’ll fall asleep faster, as it will teach you how to relax and quiet your mind once you hit the pillow.
Bringing It All Together
We all know someone who is always up at all hours of the night working or socializing, and is the number one performer at. the office. Watch out: this person is underperforming, may be not yet. After all, the only thing worth catching up on at night is your sleep.
May 15, 2017: Weekly Curated Thought-Sharing on Digital Disruption, Applied Neuroscience and Other Interesting Related Matters.
By Scott Scalon, Hunt Scalon Media
Curated by Helena M. Herrero Lamuedra
Companies are facing a radically shifting context for the workforce, the workplace, and the world of work, and these shifts have already changed the rules for nearly every organizational people practice, from learning and management to executive recruiting and the definition of work itself. Every business leader, no matter their function or industry, has experienced some form of radical work transformation, whether it be digitally in the form of social media, for example, demographically, or in countless other ways. Old paradigms are out, new ways of thinking are in — and talent, that one ‘commodity’ we’re all after is caught up in the middle of it all.
Almost 90 percent of HR and business leaders rate building the organization of the future as their highest priority, according to Deloitte’s latest Global Human Capital Trends report, “Rewriting the Rules for the Digital Age.” In the report, Deloitte issues a call-to-action for companies to completely reconsider their organizational structure, talent and HR strategies to keep pace with the disruption.
A Networked World of Work
“Technology is advancing at an unprecedented rate and these innovations have completely transformed the way we live, work and communicate,” said Josh Bersin, principal and founder, Bersin by Deloitte, Deloitte Consulting. “Ultimately, the digital world of work has changed the rules of business. Organizations should shift their entire mind-set and behaviors to ensure they can lead, organize, motivate, manage and engage the 21st century workforce, or risk being left behind.”
With more than 10,000 HR and business leaders in 140 countries weighing in, this massive study reveals that business leaders are turning to new organization models, which highlight the networked nature of today’s world of work. However, as business productivity often fails to keep pace with tecnological progress, Deloitte finds that HR leaders are struggling to keep up, with only 35 percent of them rating their capabilities as ‘good’ or ‘excellent.’
“As technology, artificial intelligence, and robotics transform business models and work, companies should start to rethink their management practices and organizational models,” said Brett Walsh, global human capital leader for Deloitte Global. “The future of work is driving the development of a set of ‘new rules’ that organizations should follow if they want to remain competitive.”
Talent Acquisition: Biggest Issue Facing Companies
As the workforce evolves, organizations are focusing on networks of teams, and recruiting and developing the right people is more consequential than ever. However, while Deloitte finds that cognitive technologies have helped leaders bring talent acquisition into the digital world, only 22 percent of survey respondents describe their companies as ‘excellent’ at building a differentiated employee experience once talent is acquired. In fact, the gap between talent acquisition’s importance and the ability to meet the need increased over last year‘s survey.
How Else the World of Work Is Changing
It is, indeed, a landscape of shifting priorities, and nowhere are we seeing this unfold more than among the group that matters most: job candidates. Five years ago, benefits topped their list of preferences. Today it’s culture and flexibility. Organizations need talented employees to drive strategy and achieve goals, but finding, recruiting and retaining people is becoming more difficult. While the severity of the issue varies among organizations, industries and geographies, it’s clear that this new landscape has created new demands. And organizations are scrambling.
It is critical, according to the report, to take an integrated approach to building the employee experience, with a large part of it centering on ‘careers and learning,’ which rose to second place on HRs’ and business leaders’ priority lists, with 83 percent of those surveyed ranking it as ‘important’ or ‘very important.’ Deloitte finds that as organizations shed legacy systems and dismantle yesterday’s hierarchies, it’s important to place a higher premium on implementing immersive learning experiences to develop leaders who can thrive in today’s digital world and appeal to diverse workforce needs.
The importance of leadership as a driver of the employee experience remains strong, as the percentage of companies with experiential programs for leaders rose nearly 20 percentage points from 47 percent in 2015 to 64 percent this year. Deloitte believes there is still a crucial need, however, for stronger and different types of leaders, particularly as today’s business world demands those who demonstrate more agile and digital capabilities.
Time to Rewrite the Rules
As organizations become more digital, leaders should consider disruptive technologies for every aspect of their human capital needs. Deloitte finds that 56 percent of companies are redesigning their HR programs to leverage digital and mobile tools, and 33 percent are already using some form of artificial intelligence (AI) applications to deliver HR solutions.
“HR and other business leaders tell us that they are being asked to create a digital workplace in order to become an ‘organization of the future,’” said Erica Volini, a principal with Deloitte Consulting LLP, and national managing director of the firm’s U.S. human capital practice. “To rewrite the rules on a broad scale, HR should play a leading role in helping the company redesign the organization by bringing digital technologies to both the workforce and to the HR organization itself.”
Deloitte found that the HR function is in the middle of a wide-ranging identity shift. To position themselves effectively as a key business advisor to the organization, it is important for HR to focus on service delivery efficiency and excellence in talent programs, as well as the entire design of work using a digital lens.
How Jobs Are Being Reinvented
While many jobs are being reinvented through technology and some tasks are being automated, Deloitte’s research shows that the essentially human aspects of work – such as empathy, communication, and problem solving – are becoming more important than ever.
This shift is not only driving an increased focus on reskilling, but also on the importance of people analytics to help organizations gain even greater insights into the capabilities of their workforce on a global scale. However, organizations continue to fall short in this area, with only eight percent reporting they have usable data, and only nine percent believing they have a good understanding of the talent factors that drive performance in this new world of work.
One of the new rules for the digital age is to expand our vision of the workforce; think about jobs in the context of tasks that can be automated (or outsourced) and the new role of human skills; and focus even more heavily on the customer experience, employee experience, and employment value proposition for people.
This challenge requires major cross-functional attention, effort, and collaboration. It also represents one of the biggest opportunities for the HR organization. To be able to rewrite the rules, HR needs to prove it has the insights and capabilities to successfully play outside the lines.
May 1, 2017: Weekly Curated Thought-Sharing on Digital Disruption, Applied Neuroscience and Other Interesting Related Matters.
By Charles Roxburgh, McKinsey
Curated by Helena M. Herrero Lamuedra
After nearly 40 years, the theory of business strategy is well developed and widely disseminated. Pioneering work by academics such as Michael E. Porter and Henry Mintzberg has established a rich literature on good strategy. Most senior executives have been trained in its principles, and large corporations have their own skilled strategy departments.
Yet the business world remains littered with examples of bad strategies. Why? What makes chief executives back them when so much know-how is available? Flawed analysis, excessive ambition, greed, and other corporate vices are possible causes, but this article doesn’t attempt to explore all of them. Rather, it looks at one contributing factor that affects every strategist: the human brain.
The brain is a wondrous organ. As scientists uncover more of its inner workings through brain-mapping techniques. But the brain isn’t the rational calculating machine we sometimes imagine. Over the millennia of its evolution, it has developed shortcuts, simplifications, biases, and basic bad habits. Some of them may have helped early humans survive on the savannas of Africa (“if it looks like a wildebeest and everyone else is chasing it, it must be lunch”), but they create problems for us today. Equally, some of the brain’s flaws may result from education and socialization rather than nature. But whatever the root cause, the brain can be a deceptive guide for rational decision making.
These implications of the brain’s inadequacies have been rigorously studied by social scientists and particularly by behavioral economists, who have found that the underlying assumption behind modern economics—human beings as purely rational economic decision makers—doesn’t stack up against the evidence. As most of the theory underpinning business strategy is derived from the rational world of microeconomics, all strategists should be interested in behavioral economics.
Insights from behavioral economics have been used to explain bad decision making in the business world, and bad investment decision making in particular. Some private equity firms have successfully remodeled their investment processes to counteract the biases predicted by behavioral economics. Likewise, behavioral economics has been applied to personal finance, thereby providing an easier route to making money than any hot stock tip. However, the field hasn’t permeated the day-to-day world of strategy formulation.
This article aims to help rectify that omission by highlighting eight.This is far from a complete list of all the flaws in the way we make decisions.
Several examples come from the dot-com era, a particularly rich period for students of bad strategy. But don’t make the mistake of thinking that this was an era of unrepeatable strategic madness. Behavioral economics tells us that the mistakes made in the late 1990s were exactly the sorts of errors our brains are programmed to make—and will probably make again.
Flaw 1: Overconfidence
Our brains are programmed to make us feel overconfident. This can be a good thing; for instance, it requires great confidence to launch a new business. Only a few start-ups will become highly successful. The world would be duller and poorer if our brains didn’t inspire great confidence in our own abilities. But there is a downside when it comes to formulating and judging strategy.
The brain is particularly overconfident of its ability to make accurate estimates. Behavioral economists often illustrate this point with simple quizzes: guess the weight of a fully laden jumbo jet or the length of the River Nile, say. Participants are asked to offer not a precise figure but rather a range in which they feel 90 percent confidence—for example, the Nile is between 2,000 and 10,000 miles long. Time and again, participants walk into the same trap: rather than playing safe with a wide range, they give a narrow one and miss the right answer. Most of us are unwilling and, in fact, unable to reveal our ignorance by specifying a very wide range. Unlike John Maynard Keynes, most of us prefer being precisely wrong rather than vaguely right.
We also tend to be overconfident of our own abilities. In a 1981 survey, for example, 90 percent of Swedes described themselves as above-average drivers. This is a particular problem for strategies based on assessments of core capabilities. Almost all financial institutions, for instance, believe their brands to be of “above-average” value.
Related to overconfidence is the problem of over-optimism. Other than professional pessimists such as financial regulators, we all tend to be optimistic, and our forecasts tend toward the rosier end of the spectrum. The twin problems of overconfidence and overoptimism can have dangerous consequences when it comes to developing strategies, as most of them are based on estimates of what may happen—too often on unrealistically precise and overoptimistic estimates of uncertainties.
One leading investment bank sensibly tested its strategy against a pessimistic scenario—the market conditions of 1994, when a downturn lasted about nine months—and built in some extra downturn. But this wasn’t enough. The 1994 scenario looks rosy compared with current conditions, and the bank, along with its peers, is struggling to make dramatic cuts to its cost base. Other sectors, such as banking services for the affluent and on-line brokerages, are grappling with the same problem.
There are ways to counter the brain’s overconfidence:
- Test strategies under a much wider range of scenarios. But don’t give managers a choice of three, as they are likely to play safe and pick the central one. For this reason, the pioneers of scenario planning at Royal Dutch/Shell always insisted on a final choice of two or four options.
- Add 20 to 25 percent more downside to the most pessimistic scenario. Given our optimism, the risk of getting pessimistic scenarios wrong is greater than that of getting the upside wrong. The Lloyd’s of London insurance market—which has learned these lessons the hard, expensive way—makes a point of testing the market’s solvency under a series of extreme disasters, such as two 747 aircraft colliding over central London. Testing the resilience of Lloyd’s to these conditions helped it build its reserves and reinsurance to cope with the September 11 disaster.
- Build more flexibility and options into your strategy to allow the company to scale up or retrench as uncertainties are resolved. Be skeptical of strategies premised on certainty.
Flaw 2: Mental accounting
Richard Thaler, a pioneer of behavioral economics, coined the term “mental accounting,” defined as “the inclination to categorize and treat money differently depending on where it comes from, where it is kept, and how it is spent.” Gamblers who lose their winnings, for example, typically feel that they haven’t really lost anything, though they would have been richer had they stopped while they were ahead.
Mental accounting pervades the boardrooms of even the most conservative and otherwise rational corporations. Some examples of this flaw include the following:
- being less concerned with value for money on expenses booked against a restructuring charge than on those taken through the P&L
- imposing cost caps on a core business while spending freely on a start-up
- creating new categories of spending, such as “revenue-investment spend” or “strategic investment”
All are examples of spending that tends to be less scrutinized because of the way it is categorized, but all represent real costs.
These delusions can have serious strategic implications. Take cost caps. In some UK financial institutions during the dot-com era, core retail businesses faced stringent constraints on their ability to invest, however sound the proposal, while start-up Internet businesses spent with abandon. These banks have now written off much of their loss from dot-com investment and must reverse their underinvestment in core businesses.
Avoiding mental accounting traps should be easier if you adhere to a basic rule: that every pound (or dollar or euro) is worth exactly that, whatever the category. In this way, you will make sure that all investments are judged on consistent criteria and be wary of spending that has been reclassified. Be particularly skeptical of any investment labeled “strategic.”
Flaw 3: The status quo bias
In one classic experiment, students were asked how they would invest a hypothetical inheritance. Some received several million dollars in low-risk, low-return bonds and typically chose to leave most of the money alone. The rest received higher-risk securities—and also left most of the money alone. What determined the students’ allocation in this experiment was the initial allocation, not their risk preference. People would rather leave things as they are. One explanation for the status quo bias is aversion to loss—people are more concerned about the risk of loss than they are excited by the prospect of gain. The students’ fear of switching into securities that might end up losing value prevented them from making the rational choice: rebalancing their portfolios.
A similar bias, the endowment effect, gives people a strong desire to hang on to what they own; the very fact of owning something makes it more valuable to the owner. Richard Thaler tested this effect with coffee mugs imprinted with the Cornell University logo. Students given one of them wouldn’t part with it for less than $5.25, on average, but students without a mug wouldn’t pay more than $2.75 to acquire it. The gap implies an incremental value of $2.50 from owning the mug.
The status quo bias, the aversion to loss, and the endowment effect contribute to poor strategy decisions in several ways. First, they make CEOs reluctant to sell businesses. McKinsey research shows that divestments are a major potential source of value creation but a largely neglected one. CEOs are prone to ask, “What if we sell for too little—how stupid will we look when this turns out to be a great buy for the acquirer?”
These phenomena also make it hard for companies to shift their asset allocations. Before the recent market downturn, the UK insurer Prudential decided that equities were overvalued and made the bold decision to rebalance its fund toward bonds. Many other UK life insurers, unwilling to break with the status quo, stuck with their high equity weightings and have suffered more severe reductions in their solvency ratios.
This isn’t to say that the status quo is always wrong. Many investment advisers would argue that the best long-term strategy is to buy and hold equities (and, behavioral economists would add, not to check their value for many years, to avoid feeling bad when prices fall). In financial services, too, caution and conservatism can be strategic assets. The challenge for strategists is to distinguish between a status quo option that is genuinely the right course and one that feels deceptively safe because of an innate bias.
To make this distinction, strategists should take two approaches:
- Adopt a radical view of all portfolio decisions. View all businesses as “up for sale.” Is the company the natural parent, capable of extracting the most value from a subsidiary? View divestment not as a failure but as a healthy renewal of the corporate portfolio.
- Subject status quo options to a risk analysis as rigorous as change options receive. Most strategists are good at identifying the risks of new strategies but less good at seeing the risks of failing to change.
Flaw 4: Anchoring
One of the more peculiar wiring flaws in the brain is called anchoring. Present the brain with a number and then ask it to make an estimate of something completely unrelated, and it will anchor its estimate on that first number. The classic illustration is the Genghis Khan date test. Ask a group of people to write down the last three digits of their phone numbers, and then ask them to estimate the date of Genghis Khan’s death. Time and again, the results show a correlation between the two numbers; people assume that he lived in the first millennium, when in fact he lived from 1162 to 1227.
Anchoring can be a powerful tool for strategists. In negotiations, naming a high sale price for a business can help secure an attractive outcome for the seller, as the buyer’s offer will be anchored around that figure. Anchoring works well in advertising too. Most retail-fund managers advertise their funds on the basis of past performance. Repeated studies have failed to show any statistical correlation between good past performance and future performance. By citing the past-performance record, though, the manager anchors the notion of future top-quartile performance to it in the consumer’s mind.
However, anchoring—particularly becoming anchored to the past—can be dangerous. Most of us have long believed that equities offer high real returns over the long term, an idea anchored in the experience of the past two decades. But in the 1960s and 1970s, UK equities achieved real annual returns of only 3.3 and 0.4 percent, respectively. Indeed, they achieved double-digit real annual returns during only 4 of the past 13 decades. Our expectations about equity returns have been seriously distorted by recent experience.
Besides remaining unswayed by the anchoring tactics of others, strategists should take a long historical perspective. Put trends in the context of the past 20 or 30 years, not the past 2 or 3; for certain economic indicators, such as equity returns or interest rates, use a very long time series of 50 or 75 years. Some commentators who spotted the dot-com bubble early did so by drawing comparisons with previous technology bubbles—for example, the uncannily close parallels between radio stocks in the 1920s and Internet stocks in the 1990s.
Flaw 5: The sunk-cost effect
A familiar problem with investments is called the sunk-cost effect, otherwise known as “throwing good money after bad.” When large projects overrun their schedules and budgets, the original economic case no longer holds, but companies still keep investing to complete them.
Financial institutions often face this dilemma over large-scale IT projects. There are numerous examples, most of which remain private. One of the more public cases was the London Stock Exchange’s automated-settlement system, Taurus. It took the intervention of the Bank of England to force a cancellation, write off the expenses, and take control of building a replacement.
Executives making strategic-investment decisions can also fall into the sunk-cost trap. Certain European banks spent fortunes building up large equities businesses to compete with the global investment-banking firms. It then proved extraordinarily hard for some of these banks to face up to the strategic reality that they had no prospect of ever competing successfully against the likes of Goldman Sachs, Merrill Lynch, and Morgan Stanley in the equities business. Some banks in the United Kingdom took the agonizing decision to write off their investments; other European institutions are still caught in the trap.
Why is it so hard to avoid? One explanation is based on loss aversion: we would rather spend an additional $10 million completing an uneconomic $110 million project than write off $100 million. Another explanation relies on anchoring: once the brain has been anchored at $100 million, an additional $10 million doesn’t seem so bad.
What should strategists do to avoid the trap?
- Apply the full rigor of investment analysis to incremental investments, looking only at incremental prospective costs and revenues. This is the textbook response to the sunk-cost fallacy, and it is right.
- Be prepared to kill strategic experiments early. In an increasingly uncertain world, companies will often pursue several strategic options. Successfully managing a portfolio of them entails jettisoning the losers. The more quickly you get out, the lower the sunk costs and the easier the exit.
- Use “gated funding” for strategic investments, much as pharmaceutical companies do for drug development: release follow-on funding only once strategic experiments have met previously agreed targets.
Flaw 6: The herding instinct
The banking industry, like many others, shows a strong herding instinct. It tends to lend too much money to the same kinds of borrowers at the same time—to UK property developers in the 1970s, less-developed countries in the 1980s, and technology, media, and telecommunications companies more recently. And banks tend to pursue the same strategies, be it creating Internet banks with strange-sounding names during the dot-com boom or building integrated investment banks at the time of the “big bang,” when the London stock market was liberalized.
This desire to conform to the behavior and opinions of others is a fundamental human trait and an accepted principle of psychology. Warren Buffett put his finger on this flaw when he wrote, “Failing conventionally is the route to go; as a group, lemmings may have a rotten image, but no individual lemming has ever received bad press.” For most CEOs, only one thing is worse than making a huge strategic mistake: being the only person in the industry to make it.
We all felt the tug of the herd during the dot-com era. It was lonely being a Luddite, arguing the case against setting up a stand-alone Internet bank or an on-line brokerage. At times of mass enthusiasm for a strategic trend, pressure to follow the herd rather than rely on one’s own information and analysis is almost irresistible. Yet the best strategies break away from the trend. Some actions may be necessary to match the competition—imagine a bank without ATMs or a good on-line banking offer. But these are not unique sources of strategic advantage, and finding such sources is what strategy is all about. “Me-too” strategies are often simply bad ones. Seeking out the new and the unusual should therefore be the strategist’s aim. Rather than copying what your most established competitors are doing, look to the periphery for innovative ideas, and look outside your own industry.
Initially, an innovative strategy might draw skepticism from industry experts. They may be right, but as long as you kill a failing strategy early, your losses will be limited, and when they are wrong, the rewards will be great.
Flaw 7: Misestimating future hedonic states
What does it mean, in plain English, to misestimate future hedonic states? Simply that people are bad at estimating how much pleasure or pain they will feel if their circumstances change dramatically. Social scientists have shown that when people undergo major changes in circumstances, their lives typically are neither as bad nor as good as they had expected—another case of how bad we are at estimating. People adjust surprisingly quickly, and their level of pleasure (hedonic state) ends up, broadly, where it was before.
This research strikes a chord with anyone who has studied compensation trends in the investment-banking industry. Ever-higher compensation during the 1990s led only to ever-higher expectations—not to a marked change in the general level of happiness on the Street. According to Tom Wolfe’s Sherman McCoy, in Bonfire of the Vanities, it was hard to make ends meet in New York on $1 million a year in 1987. Back then, that was shocking hubris from a (fictional) top bond salesman. By 2000, even adjusted for inflation, it would have seemed a perfectly reasonable lament from a relatively junior managing director.
Another illustration of our poor ability to judge future hedonic states in the business world is the way we deal with a loss of independence. More often than not, takeovers are seen as the corporate equivalent of death, to be avoided at all costs. Yet sometimes they are the right move.
Often, top management is blamed for resisting any loss of independence. Certainly part of the problem is the desire of managements and boards to hang on to the status quo. That said, frontline staff members often resist a takeover or merger however much they are frustrated with the existing top management. Some deeper psychological factor appears to be at work. We do seem very bad at estimating how we would feel if our circumstances changed dramatically—changes in corporate control, like changes in our personal health or wealth.
How can the strategist avoid this pitfall?
- In takeovers, adopt a dispassionate and unemotional view. Easier said than done—especially for a management team with years of committed service to an institution and a personal stake in the status quo. Nonexecutives, however, should find it easier to maintain a detached view.
- Keep things in perspective. Don’t overreact to apparently deadly strategic threats or get too excited by good news. During the high and low points of the crisis at Lloyd’s of London in the mid-1990s, the chairman used to quote Field Marshall Slim—”In battle nothing is ever as good or as bad as the first reports of excited men would have it.” This is a good guide for every strategist trying to navigate a crisis, with the inevitable swings in emotion and morale.
Flaw 8: False consensus
- People tend to overestimate the extent to which others share their views, beliefs, and experiences—the false-consensus effect. Research shows many causes, including these:
- confirmation bias, the tendency to seek out opinions and facts that support our own beliefs and hypotheses
- selective recall, the habit of remembering only facts and experiences that reinforce our assumptions
- biased evaluation, the quick acceptance of evidence that supports our hypotheses, while contradictory evidence is subjected to rigorous evaluation and almost certain rejection; we often, for example, impute hostile motives to critics or question their competence
- groupthink, the pressure to agree with others in team-based cultures
Consider how many times you may have heard a CEO say something like, “the executive team is 100 percent behind the new strategy” (groupthink); “the chairman and the board are fully supportive and they all agree with our strategy” (false consensus); “I’ve heard only good things from dealers and customers about our new product range” (selective recall); “OK, so some analysts are still negative, but those ’teenage scribblers’ don’t understand our business—their latest reports were superficial and full of errors” (biased evaluation). This hypothetical CEO might be right but more likely is heading for trouble. The role of any strategic adviser should be to provide a counterbalance to this tendency toward false consensus. CEOs should welcome the challenge.
False consensus, which ranks among the brain’s most pernicious flaws, can lead strategists to miss important threats to their companies and to persist with doomed strategies. But it can be extremely difficult to uncover—especially if those proposing a strategy are strong role models. We are easily influenced by dominant individuals and seek to emulate them. This can be a force for good if the role models are positive. But negative ones can prove an irresistible source of strategic error.
Many of the worst financial-services strategies can be attributed to over-dominant individuals. Their behavior set the tone and created a culture of noncompliance.
The dangers of false consensus can be minimized in several ways:
- Create a culture of challenge. As part of the strategic debate, management teams should value open and constructive criticism. Criticizing a fellow director’s strategy should be seen as a helpful, not a hostile, act. CEOs and strategic advisers should understand criticisms of their strategies, seek contrary views on industry trends, and, if in doubt, take steps to assure themselves that opposing views have been well researched. They shouldn’t automatically ascribe to critics bad intentions or a lack of understanding.
- Ensure that strong checks and balances control the dominant role models. A CEO should be particularly wary of dominant individuals who dismiss challenges to their own strategic proposals; the CEO should insist that these proposals undergo an independent review by respected experts. The board should be equally wary of a domineering CEO.
- Don’t “lead the witness.” Instead of asking for a validation of your strategy, ask for a detailed refutation. When setting up hypotheses at the start of a strategic analysis, impose contrarian hypotheses or require the team to set up equal and opposite hypotheses for each key analysis. Establish a “challenger team” to identify the flaws in the strategy being proposed by the strategy team.
An awareness of the brain’s “flaws” can help strategists and culture designers steer around them. All strategists should understand the insights of behavioral economics just as much as they understand those of other fields of the “dismal science.” Such an understanding won’t put an end to bad strategy; greed, arrogance, and sloppy analysis will continue to provide plenty of textbook cases of it. Understanding some of the flaws built into our thinking processes, however, may help reduce the chances of good executives backing bad strategies.
About the author(s)
Charles Roxburgh is a director in McKinsey’s London office