2011 Number 3

The future of
marketing
What every executive needs to know
 2011 Number 3

This Quarter

Over the past two years, I’ve had the privilege of

meeting with several hundred leaders from institutions
in the private, public, and social sectors. Those
conversations have been an invaluable source of insight
about the issues that matter most today, and they
also have shaped my thinking about McKinsey’s oppor-
tunity to deliver ideas that will help global leaders.

One thing I’ve heard over and over is that leaders today, especially
business executives, need insight about the political, economic,
social, and technological context in which they operate. To help provide
that context in Japan, our Tokyo office recently invited more than
80 contributors to write essays about the future of the country. They
appear in a new book, Reimagining Japan: The Quest for a Future
That Works. In this issue of McKinsey Quarterly, you’ll find several
articles from that collection—three by outspoken Japanese CEOs
and two by McKinsey colleagues—that shed light on the road ahead
for companies in the world’s third-largest economy.
Regulation, whose scope has increased in the wake of the financial
crisis, is another critical area of context that’s top of mind for many
leaders I meet. My colleagues Andre Dua, Robin Nuttall, and Jon
Wilkins describe in this issue how the cognitive biases studied by
behavioral economists may be undermining corporate regulatory
strategies—and what to do about that. And in an interview, University
of Chicago behavioral scientist Richard Thaler suggests that busi-
ness leaders need to get ready for a world where regulators push for
even more transparency and free-flowing data than companies are
already accustomed to.

Marketers are on the leading edge of the trend toward more openness
as social media and other forms of digital engagement grow in
importance. One implication, according to McKinsey’s Tom French,
Laura LaBerge, and Paul Magill, is that companies no longer can
count on the marketing organization to do all their marketing. Accom-
panying the authors’ thinking is commentary from a trio of
practitioners—American Express chief marketing officer John Hayes,
Virgin Atlantic Airways CEO Steve Ridgway, and Duncan Watts,
director of the Human Social Dynamics group at Yahoo! Research—
whose professional diversity indicates the range of minds that will
be needed to master the new environment.

In addition to ref lecting some of the themes I’ve been hearing in

conversations with global leaders, this issue also contains one
of those discussions: an upbeat interview with Chile’s president,
Sebastián Piñera, that my colleague Alejandro Krell and I con-
ducted. President Piñera, who spent much of his career in the private
sector, has been bringing a businesslike approach to leading
Chile through its immediate crises and a series of longer-term
economic reforms. I hope you enjoy the interview—and this
issue of the Quarterly.

Dominic Barton
Global managing director,
McKinsey & Company
 On the cover
The future of marketing
What every executive needs to know
26 We’re all
marketers now
Tom French, Laura LaBerge,
and Paul Magill
Engaging customers today requires
commitment from the entire
company—and a redefined marketing
organization.
35 How we see it:
Three senior
executives on the
future of marketing
Virgin Atlantic Airways CEO Steve
Ridgway, American Express CMO John
Hayes, and Yahoo! Research scientist
Duncan Watts on staying ahead of the
changes rocking the world of marketing.
Features
46 How new Internet
standards will
finally deliver a
mobile revolution
Bengi Korkmaz, Richard Lee,
and Ickjin Park
As the Web experience evolves, smart-
phones may soon live up to their
name, and every business’s mobile
strategy will grow in importance.
54 Winning the Web standards
battle: History shows that the best
technology doesn’t always come
out on top. Building an ecosystem that
shares benefits widely is critical.
56 Remapping your
strategic mind-set
Pankaj Ghemawat
Shake up your thinking by looking
at the world from the perspective of
a particular country, industry,
or company. “Rooted” maps can help
you unearth hidden opportunities
and threats.
 Features

68 Nudging the
world toward
smarter public
policy: Special report
An interview with
80 Rediscovering
Richard Thaler
Japan’s
Public and private data alike will
become more transparent, says competitive edge
behavioral scientist Richard Thaler.
Three Japanese CEOs and two teams
That’s an opportunity for some
of McKinsey experts offer perspectives on
companies and a threat for others.
the road ahead for Japanese business.
All are drawn from a new book,
Reimagining Japan: The Quest for a
Future That Works.
74 Why good
82 Introduction: Toward a lasting
companies create recovery
Yasuchika Hasegawa
bad regulatory
strategies 83 Rebooting Japan’s high-tech
sector
Andre Dua, Robin Nuttall, and Ingo Beyer von Morgenstern,
Jon Wilkins Peter Kenevan, and Ulrich Naeher

Too few ask themselves, “Why would 86 Staying in the game

anyone agree with us?” Keiji Inafune

90 Japan’s globalization imperative

Naoyuki Iwatani, Gordon Orr, and Brian
Salsberg

93 Dare to err
Tadashi Yanai

Departments

7 McKinsey on 8 Idea Exchange 120 Extra Point

the Web Readers mix it up Resolving
Highlights from with authors of articles the centralization
our digital offerings from McKinsey Quarterly dilemma
2011 Number 2
 Leading Edge
12 U
nderstanding your
‘globalization penalty’
Martin Dewhurst, Jonathan Harris,
and Suzanne Heywood
Strong multinationals seem less healthy
than successful companies that
stick closer to home. How can that be?
16 Is there a right way to pay
back shareholders?
Bin Jiang and Tim Koller
New research shows that the choice
between paying dividends and
buying back shares doesn’t affect
corporate value.
20 Are your customers
becoming digital junkies?
Bertil Chappuis, Brendan Gaffey,
and Parviz Parvizi
Consumer behavior is shifting rapidly
as more people use digital devices
and platforms intensively.
Applied Insight
97 To centralize or not
to centralize?
Andrew Campbell, Sven Kunisch, and
Günter Müller-Stewens
It’s a hard call made harder by power
struggles. CEOs can force a more
thoughtful debate by asking three
critical questions.
103 When big acquisitions
pay off
Ankur Agrawal, Cristina Ferrer, and
Andy West
Some deals are quietly creating
value that doesn’t make the headlines.
Here’s how.
109 Preparing your organization
for growth
Martin Dewhurst, Suzanne Heywood,
and Kirk Rieckhoff
Companies that address their organi-
zational weaknesses as they implement
growth strategies give themselves
an advantage.
114 Managing crises and shaping
the future of Chile: An
interview with Sebastián Piñera
Chile’s president has taken a business-
like approach to recovering from
an earthquake, rescuing miners, and
rejuvenating his country’s economy.
Editorial
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 7

McKinsey on the Web

Highlights from our digital offerings

Now available on
mckinseyquarterly.com

Tapping China’s
luxury-goods market
By 2015, Chinese consumers will
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How is their behavior evolving?

© Gilles Sabrie

Other features:

Eric Schmidt on business culture,

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US passed peak productivity growth?
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 8

Idea Exchange
Readers mix it up with authors of articles from McKinsey Quarterly
2011 Number 2

Beyond expats: Better managers for

emerging markets
As more companies pursue growth in emerging markets, questions of talent—
who will lead these efforts and where will they come from?—become
a more pivotal part of strategy. In our last issue, Jeffrey A. Joerres, the chair-
man and CEO of ManpowerGroup (formerly Manpower), argued for
local leadership; here, he addresses a reader’s concern about related risks.

Carl Martin Faannessen

General manager, Himal Power Limited, Nepal

“Some risks are easier for expatriate managers to mitigate than locals. Local
employees can be more susceptible to local pressures from suppliers and
customers. It’s easier for expats to stick to signed contracts than it is for local
managers, since nonbusiness pressures are more easily brought to bear on
local employees. Also, local managers may—regardless of the indicators
being used to measure them—focus more on what’s good for their country
than what’s good for their company, unwittingly or not. Currying political
favors and goodwill are typically the drivers behind this kind of behavior,
especially in emerging markets. These issues need to be addressed clearly
and openly when discussing whether or not to localize a given position.”

Jeffrey Joerres responds:

“You certainly raise a valid point, but such risks exist everywhere and
companies must manage them closely—no matter who’s at the helm.
The benefits of selecting local leaders, among them the ability to most
effectively motivate local employees, outweighs the risks. Of course,
local leaders must align with the company’s goals and objectives (as expat
leaders must also do), and companies need to be vigilant of conflicts
of interest and nefarious behavior, but this is true regardless of where
the company operates.”
 9

Sparking creativity in teams:

An executive’s guide
In our last issue, McKinsey’s Marla M. Capozzi, Renée Dye, and Amy
Howe described four techniques for fostering the creativity and innovation
that companies need to grow. The conversation continued online at
mckinseyquarterly.com; featured here are two reader comments and the
authors’ subsequent responses.

Creating an innovative culture

Christina Ehrlich
Manager, Trianz, Santa Clara, California

“Your article shows some great exercises teams can use to force thinking
outside the box. But how do you ensure that the company’s culture is one of
innovation and risk taking?”

The authors respond:

“One way to improve risk taking in a culture is to encourage early experimentation.
Doing so allows employees to apply techniques like the ones we describe and also
to move the ideas those techniques generate onto the next steps of prototyping
and testing. A high-tech company we’ve studied offers prizes in its internal innovation
competitions for experiments that didn’t move forward as expected but that still
generated useful knowledge, and they give equal recognition to employees who win
these awards.

“Such efforts need to be reinforced by leaders and through performance management

and skill building. We’ve seen companies create incentive schemes that ‘paid back’
employees for bonuses they had forgone while working on special projects, so as to
not penalize them for taking risks. This all requires vigilance from senior managers:
in a world where companies focus on multitasking and maximizing productivity, leaders
need to create environments that help employees make time to innovate.”

The role leaders play

Tim Ayers
Vice president of services strategy–CTO Group, Tellabs, Chicago, Illinois

“Leaders are critical to the equation. If leaders say, ‘We highly value innovation,’
but in practice value and promote the status quo, discourage risk taking,
and send a message ‘not to rock the boat,’ real creative dialogue goes under-
ground. And then it goes out the door to venues where people with ideas
and passion to explore them can do so.”

The authors respond:

“We strongly agree, and believe that leadership is one of the greatest predictors of
innovation outcomes. Leaders need a vision for innovation and must also serve as role
models for the behaviors they wish to see. Many innovative companies we’ve seen
establish recognizable ‘guard rails’ to help employees understand acceptable levels of
risk. Public companies, for instance, may explicitly choose to take greater risks in
smaller, newer businesses—as opposed to the core businesses closely watched by
analysts. Such choices can help generate ideas that are more likely to be successful.”
10 2011 Number 3

Seven steps to better brainstorming

Also on the subject of generating better ideas for growth, McKinsey
alumni Kevin P. Coyne and Shawn T. Coyne, cofounders and managing
directors of The Coyne Partnership, a consulting firm, described an
approach that requires more focus and active participation than traditional
brainstorming. Here is an excerpt of their longer response to reader
comments on mckinseyquarterly.com.

The advantages of electronic brainstorming

Leonard Koningswijk
Owner, Quanteus Consultants and New Dialogues, Amsterdam, Netherlands

“The article does not mention the opportunities social media offer to take
brainstorming to the next level. My experiences with online tools have
been very positive: they allow for input from groups of all sizes, where partici-
pants can bring up ideas and discuss them in a very safe environment.
Since participants are anonymous, there is no distortion from rank or social
status, and they can contribute without having to travel to a single location.
It makes it very easy to involve participants from different backgrounds—for
example, different functional departments, ranks, regions, and beliefs—
which can improve the quality and quantity of the outcome enormously.”

Kevin Coyne and Shawn Coyne respond:

“We agree that social networks and electronic brainstorming are exciting tools
whose potential contributions to new idea generation are only beginning
to be understood fully. Among their many possible benefits, these tools
offer the potential to draw upon much greater numbers of individuals
for ideas and to allow people to express themselves thoughtfully and in
writing when they might not be comfortable speaking up ‘on the spot’
and/or in front of others in traditional brainstorming sessions. Provided
that these tools are used wisely as one part of a well-designed, com-
prehensive approach to idea generation, we believe both could become
game-changing additions to the ideation tool kit.”

One size does not fit all

Dom Ventura
Global ideation manager, British American Tobacco, London, United Kingdom

“The real creative articulation really starts, in my opinion, just after the
[brainstorming] event has finished. Whoever picks up the output of the ideation
session should be a creative group capable of capturing all the little thoughts,
even if they’re on Post-its or scrap paper, and consolidate them into bigger
‘creative clumps.’ After that, the iteration process can start, where you build on
the proposed clumps and start to structure the ideas into clear propositions,
benefits, and payoffs.”

Kevin Coyne and Shawn Coyne respond:

“We caution against thinking that the only effective means of generating ideas is via
large-group, single-session efforts. You can generate ideas by working in groups
and working alone, working in single sessions and working in multiple sessions over
time. The key in solving any given ideation challenge is to choose the tools that best
fit the specific demands of your situation and that best leverage the resources at
your disposal, whether they are inside or outside your organization.”
 Idea Exchange 11

Is your emerging-market strategy

local enough?
Emerging markets such as China, India, and Brazil present huge growth
opportunities for multinationals. McKinsey authors Yuval Atsmon, Ari
Kertesz, and Ireena Vittal made the case that companies should focus
on clusters of cities and on consumers with similar characteristics.
Here, Vittal responds to a reader comment on the sociolinguistic
boundaries that differentiate consumers in India.

Deepak Seth
Business intelligence solutions architect, HealthNow New York,
Buffalo, New York

“The ‘clustering’ in India cannot just be based on socioeconomic indices; it also

needs to factor in state and linguistic boundaries. For example, the cluster
around Delhi spans across the states of Haryana, Uttar Pradesh, Rajasthan,
Madhya Pradesh, and Uttarakhand, each with its own local laws that will
impact a marketer’s objective of achieving some kind of homogeneity across
the cluster. Similarly, the cluster around Kolkata spans across the Hindi-
Bengali sociolinguistic divides, while the one near Hyderabad is affected
by the political crisis around which states that area falls in.”

Ireena Vittal responds:

“Yes, getting granular in India requires understanding the market not only
geographically but also through other relevant lenses, including language
and community. Indeed, some of the best insights emerge at the ‘sweet
spots’ where all of these variables intersect. For example, one food retailer
has looked at Mumbai as a grouping of 32 separate wards, and then as
a mix of two or three cultural communities within each ward. The resulting
clusters are very revealing. For example, there are catchments within
Mumbai with food tastes that are similar to catchments in Chennai, and
others that more closely resemble Ahmedabad.”

Visit mckinseyquarterly.com to share your

own comments or see more from our readers on these
and other topics.
12 2011 Number 3 Research, trends, and emerging thinking

Leading Edge

12 16 20
Understanding Is there a Are your
your ‘globalization right way to customers
penalty’ pay back becoming
shareholders? digital junkies?

Understanding your
‘globalization penalty’
Martin Dewhurst, Jonathan Harris, and Suzanne Heywood

Strong multinationals seem less healthy than successful companies that stick closer
to home. How can that be?

The rapid growth of emerging global reach seems to threaten

markets is providing fresh impetus
for companies to become ever
more global in scope. Deep expe-
rience in other international
markets means that many companies
know globalization’s potential
benefits—which include accessing
new markets and talent pools
and capturing economies of scale—
as well as a number of risks:
creeping complexity, culture clashes,
and vigorous responses from
local competitors, to name just a few.
Less obvious is a challenge
identified by our latest research:
the underlying health of far-
flung organizations, even highly
successful ones. In particular,
we have found that high-performing
global companies consistently
score lower than more locally
focused ones on several critical
dimensions of organizational
health—direction setting, coordi-
nation and control, innovation,
and external orientation—that we
have been studying at hundreds
of companies over the past decade.
Understanding this threat, and
its causes, is a first step toward
diminishing its impact.

Weaknesses
The data to support this finding
come from McKinsey’s organizational-
health index database, which
contains the results of surveys of
more than 600,000 employees
who assessed the health of nearly
500 different corporations.
Within this database, we identified
20 “local champions,” which
had outperformed their industries
over the previous ten years,
and 18 “global champions,” which
had likewise outperformed their
industries and met our composite
criteria for full globalization.1
We then compared these
companies across the elements
of organizational health, which
we define as the ability to align
around a strategy or change
program, to execute, and to renew
a company faster than its com-
petitors can. 2 Highlights of this
analysis included the following:
• High-performing global organi-
zations are consistently less
effective at setting a shared vision
and engaging employees around
it than are their local counterparts.
13
• These global leaders also find
maintaining professional standards
and encouraging innovation of
all kinds more difficult.
• Because they do business in
multiple countries, they find it
more challenging than local
leaders do to build government
and community relationships and
business partnerships.
These findings are troubling. For
starters, the weaknesses touch
on all three major areas of organi-
zational health—alignment,
execution, and renewal. Since
related research from our
colleagues Scott Keller and Colin
Price indicates that at least
50 percent of an organization’s
long-term success is a function of
its health, this globalization
penalty should be a red flag
for high performers with a rapidly
expanding international reach.
What’s more, the global leaders
we studied represented the
cream of the crop—they not only
enjoyed strong financial per-
formance but also had significant
global scale and scope, which
 14 2011 Number 3

Q3 2011
Globalization
Exhibit 1 of 1

Do companies pay a penalty for being global?

Do companies pay a penalty for being global?
Local champions
Organizational-health index score, % Global champions1

Champions are companies that outperformed their peers in

10-year total returns to shareholders (TRS)
Factors in organizational health 0 50 70 85 100

Statistically significant difference Not effective Common Superior Distinctive

62
Alignment Direction
53

70
Leadership
69

59
Culture and climate
51

67
Execution Accountability
66

64
Coordination and control
54

77
Capabilities
66

59
Motivation
66

60
Renewal Innovation and learning
47

72
External orientation
59

1 Companies were defined as global based on proportion of sales outside of home geography, proportion of employees outside
of home region, geographic diversity of top management team, and proportion of shareholders that are outside of home region.
Source: Organizational-health index database; McKinsey analysis

is why we included them in the local adaption against global scale,

sample. If organizations like these
can’t stay healthy as they grow
globally, can any company?
Pain points
To understand what lies beneath
these findings, we interviewed
executives at 50 global companies.
Those interviews, while hardly
dispositive, suggested a relationship
between organizational health
and a familiar challenge: balancing
scope, and coordination.
Almost everyone we interviewed
seemed to struggle with this tension,
which often plays out in heated
internal debates. Which organizational
elements should be standardized?
To what extent does managing
high-potential emerging markets on
a country-by-country basis
make sense? When is it better, in
those markets, to leverage scale
Leading Edge
and synergies across business
units in managing governments,
regulators, partners, and
talent? One global company, hoping
to realize the benefits of scale
and, simultaneously, of focusing
intently on India and China, recently
started deploying business
unit “CEOs,” whose responsibilities
cut across both of those high-
growth markets.
Complicating matters further, our
interviews suggested that, for most
companies, about 30 to 40 per-
cent of existing internal networks
and linkages are ineffective for
managing global–local trade-offs
and instead just add costs and
complexity. Many companies, for
example, can’t identify trans-
ferable lessons about low-income
consumers in one high-growth
emerging market and apply them
in another. Some struggle to
1
coalesce rapidly around market-
specific responses when
local entrants undermine traditional
business models and disrupt
previously successful strategies.
Finally, many executives we inter-
viewed are clearly wrestling with
2
the corporate center’s role in their
“Organizational health: The ultimate
increasingly globalized institu-
tions. The feasibility of centralizing
three functions in particular—
human resources, finance, and
marketing (broadly defined
to include brand and reputation
management)—was a question a
number of leaders raised. In
fact, our interviews suggest that
it may be time for some companies
to reimagine what the corporate
center does, even to the extent of
considering whether a single
15
center is suited to the task of
effectively directing and
coordinating global operations.
It’s easy to see how organizations
working through such funda-
mental structural and operating
questions might also struggle
with activities—like setting a clear
direction, building alignment,
and maintaining innovative energy—
that contribute to organizational
health. Since even leading multina-
tionals appear to suffer this
globalization penalty, the impor-
tance of addressing it will
only grow larger in the years ahead.
For more and more companies,
the globalization imperative is
intensifying, and that could present
additional organizational and
leadership challenges that are not
yet fully understood.
 e compared the degree of globalization
W
using four metrics: the proportion of
sales originating outside a company’s home
geography, the proportion of employees
working outside a company’s home region,
the geographic diversity of a company’s
top management team, and the proportion
of shareholders residing outside a com-
pany’s home region. Of these, we weighted
the source of sales and the location of
management most heavily.
For more, see Scott Keller and Colin Price,
competitive advantage,” mckinseyquarterly
.com, May 2011.
Martin Dewhurst is a director
in McKinsey’s London office,
where Suzanne Heywood is a
principal; Jon Harris is a
director in the New York office.
Copyright © 2011 McKinsey & Company.
All rights reserved. We welcome your
comments on this article. Please send them
to quarterly_comments@mckinsey.com.
16 2011 Number 3
Is there a right way to pay
back shareholders?
Bin Jiang and Tim Koller
New research shows that the choice between paying dividends and buying back shares
doesn’t affect corporate value.
Successful companies
have piled up a mountain of cash
in recent years—$2 trillion in
the United States and Europe alone.
As the global economy’s pulse
quickens and companies start paying
out more of that cash to share-
holders, those companies will face
the perennial question of how
to distribute it: dividend payments,
share repurchases, or a mix of
both. Can fine-tuning these options
influence market perceptions
and increase corporate value?
In a word, no. Our research
shows that how the distributions are
made doesn’t affect value. We
found that no matter which method
companies use, the earnings
multiples of those that make similar
total payouts are essentially
identical.1 We also found that total
returns to shareholders (TRS)
are the same regardless of the mix
of dividends and share repur-
chases. 2 These results should not
be surprising. Ultimately, what
drives value is the cash flow that
operations generate. That cash
flow is a function of the growth rate
of a company and its returns on
capital—not the mix of how it pays
out excess cash.
These findings run counter to an
oft-stated argument for share
repurchases—that they increase
value because they increase
earnings per share. In truth, an
EPS rise of this nature is a simple
mathematical effect offset by a
decline in the price-to-earnings ratio,
since a company becomes more
risky as a result of higher leverage.
The net effect on share value is zero.
So how should a company
decide between repurchases and
dividends? It depends on how
confident management is about
future cash flows—and how
much flexibility it needs.3 Share
repurchases let companies
tailor how much cash they hold for
changing strategic demands—
unexpected investment opportunities
or shifts in an uncertain economic
environment. In contrast, companies
that pay dividends enjoy less
 Leading Edge 17
Q3 2011
Payback
Exhibit 1 of 3

Earnings multiples are not affected by the payout mix.

Earnings multiples are not affected by the payout mix.

Level of total payouts: average annual payouts (dividends +

share repurchases) as % of total net income,1 2002–07

0–65% 66–95% 96–130%

Payout mix: average share of dividends in Ratio of median enterprise value to EBITA multiple,
total payouts, 2002–07, % year-end 20072

0 5 10 15 20 25

0 (100% share repurchases)

>0 to 20%

>20 to 40%

>40 to 65%

>65 to 100%

1 Insufficient data for payout levels of 96–130% at payout mix of >65 to 100% dividends and for payout levels of >130% for all payout mixes.
Q3 2011
2For 279 nonfinancial companies that were in the S&P 500 at the end of 2009, were continuously in operation since 1999, and paid
dividends or repurchased shares. EBITA = earnings before interest, taxes, and amortization.
Payback
Exhibit 2 of 3

Returns to shareholders are unrelated to the payout mix.

Returns to shareholders are unrelated to the payout mix.

Level of total payouts: average annual payouts (dividends +

share repurchases) as % of total net income,1 2002–07

0–65% 66–95% 96–130% >130%

Payout mix: average share of dividends Median total returns to shareholders (TRS),
in total payouts, 2002–07, % CAGR, 2002–07,2 %

–5 0 5 10 15 20 25

0 (100% share repurchases)

>0 to 20%

>20 to 40%

>40 to 65%

>65 to 100%

1 Insufficient data for payout level of 66–95% at payout mix of zero dividends (100% share repurchase).
2For 293 nonfinancial companies that were in the S&P 500 at the end of 2009, were continuously in operation since
1999, and paid dividends or repurchased shares. CAGR = compound annual growth rate.
 18 2011 Number 3

Q3 2011
Payback
Exhibit 3 of 3

On average, US companies have returned about 60 percent

Ontheir
of average,
netUS companies
income have returned about 60 percent
to shareholders.
of their net income to shareholders.

Dividends as share of
total net income

Share repurchase as share

of total net income

Ratio not meaningful2

US net income payout ratio,1 %

130
120
110
100
90
80
70
60
50
40
30
20
10
0
1965 1970 1975 1980 1985 1990 1995 2000 2005 2008

1 Sample includes nonfinancial US companies with real revenue >$100 million in any year between 1989 and 2009.
2Data for 1991–92, 2001–02 are excluded because of abnormally low net incomes.

flexibility because the investment Share repurchases also signal

community has been conditioned to
expect that they will be cut only
in the most dire circumstances. Thus,
managers should use dividends
only when they are certain they can
continue to do so. A dividend
increase inevitably sends signals to
investors that managers are confi-
dent that they will be able to continue
paying at the new, higher level.
confidence but offer more flexibility
because they don’t create a tacit
commitment to additional purchases
in future years.4 That flexibility
seems to have become important
to a growing number of companies
in recent decades: share repur-
chases have increased from less
than 10 percent of distributions
in the early 1980s to 50 to 60 per-
 Leading Edge
cent today. Over that period,
the total share of earnings returned
to shareholders by US companies
in the form of dividends or share
repurchases has remained relatively
constant, as it has since 1965.
In theory, companies could
repurchase undervalued shares
for the benefit of shareholders
who hold onto them. We’ve seen
few companies with a good
track record of repurchasing shares
when they were undervalued,
however. Market timing is as hard
for companies as it is for individuals.
If it weren’t, share repurchases
surely would bring higher shareholder
returns than dividends, instead of
delivering the same results.
For more on payout strategies, see the full
version of this article, “Paying back your shareholders,”
on mckinseyquarterly.com.
19
1
 e also used statistical techniques and
W
found that the dividend or share repurchase
mix had no impact on the value of com-
panies once we adjusted for differences in
total payouts, growth, and returns on
invested capital.
2
A fter adjusting for differences in total
payouts.
3
See Marc H. Goedhart, Timothy Koller, and
Werner Rehm, “Making capital structure
support strategy,” mckinseyquarterly.com,
February 2006.
4
The academic research on whether dividend
increases or share repurchases send a
stronger signal to investors is not conclusive.
Bin Jiang is a consultant in
McKinsey’s New York office, where
Tim Koller is a principal.
Copyright © 2011 McKinsey & Company.
All rights reserved. We welcome your
comments on this article. Please send them
to quarterly_comments@mckinsey.com.
20 2011 Number 3
Are your customers
becoming digital junkies?
Bertil Chappuis, Brendan Gaffey, and Parviz Parvizi
Consumer behavior is shifting rapidly as more people use digital devices and
platforms intensively.
New McKinsey research
highlights a dramatic increase in
the intensity with which people
use digital devices and platforms.
Nearly 50 percent of US online
consumers are now advanced users
of smartphones, social networks,
and other emerging tools—up from
32 percent in 2008.
We have been tracking consumers’
digital habits through a series of
surveys covering more than 100,000
respondents across North America,
Europe, and Asia.1 Our 2010
US findings highlighted the growth
of advanced multidigital and
rich-media segments: the people
most likely to be early adopters
of new technologies (whom we label
“digital-media junkies”), often
younger men; those spending more
time on social networks (“digital
communicators”), often women; and
those more likely to consume
Internet-based video (“video digerati”).
Meanwhile, we have seen a
decline in segments focused primarily
on one kind of digital use (such
as e-mail or gaming), as well as late
adopters whose digital consumption
is superficial. Behind these
broad category shifts are meaningful
changes in how consumers use
core technologies.
Social networks as
communications gateways
Social networks, particularly Face-
book, are emerging as the
dominant digital-communications
channels. For people aged 34
and under, they already are
the preferred channel (by minutes
of use per day), displacing
e-mail, texting, and phone calls.
Social-network use, growing
swiftly among all segments of our
survey population, has doubled
among those over 55. Such networks
also are becoming information
portals for people seeking items
such as videos, photos, and
content posted by friends. In our
latest survey, 33 percent of the
respondents said they use social
networks to navigate content
on the Web, up from 13 percent in
2008. While search engines
continue to be the leading way
 Leading Edge
consumers access online content,
the use of social networks is
growing. As consumers spend more
time on them, decisions about
what to purchase often reflect inter-
actions with friends and other
influencers. In response, leading
marketers are adapting their
strategies to reach increasingly
networked consumers and placing
more stress on tactics such
as word-of-mouth marketing and
storytelling.
Smartphone as ‘Swiss
Army knife’
As the usage and processing
power of smartphones increase in
tandem with the rising speed of
3G and 4G data networks,2 mobile
devices are invading the domains
of single-purpose gear such as game
consoles and portable media
players, as well as PCs.
Advertisers must refine
marketing plans so
that they reflect new video-
viewing behavior, while
getting creative about
targeting users who are
time-shifting and
dividing their attention
among platforms.
21
Smartphones are also becoming
the device of choice for e-mail, Web
browsing, and product research.
A third of smartphone owners prefer
using it for Web browsing or
e-mail even when they are near PCs.
Over the past two years, iPhone
users have spent 45 percent more
time e-mailing on their smart-
phones and 15 percent less time
e-mailing on their PCs. More
than 60 percent of smartphone
users would consider buying goods
with it or have already done so.
As the power and functionality
of devices grow, the possibilities for
making money from mobile
platforms will continue to improve.
We found, for instance, that
smartphone users already are more
accustomed to paying for digital
content and services than traditional
online users are. Three-quarters
of iPhone users, for example, now
pay for one or more apps each
month, though most remain free.
As more products are distributed
over mobile channels, greater
competition will raise the importance
of design, ease of use, and
new mobile payment options. These
findings are good news for
content and service providers that
wonder if mobile solutions will
deliver real returns.
Internet video: Challenging
traditional TV
As digital platforms multiply,
consumer video-viewing habits
continue to change. Among
our survey respondents, 69 percent
now view videos on their PCs and
22 2011 Number 3

Q3 2011
iConsumer
Exhibit 1 of 1

Digital consumers fall into seven distinct groups characterized

by the consumers
Digital types of digital experiences
fall into they
seven distinct prefer.
groups characterized
by the types of digital experiences they prefer.
US example

Segment Size of segment, 2010, Absolute change in Behavior relative to

n = 16,839, % share, 2008–10, % survey average

Engaged with multiple digital platforms

Digital-media 3 times more likely to be early

19 +7
junkies adopters of new technologies

Digital Use social networking

16 +4
communicators 3.2 times more

Deeply involved with a single digital experience

View 2.6 times more videos

Video digerati 14 +6
across all platforms

Gamers 10 –6 Play video games 2.2 times more

Professionals 6 –8 Spend 44% more time on e-mail

Limited digital engagement

Spend 79% less time on

Traditionalists 24 0
social networking

On-the-go Use mobile phones for voice

11 –2
workers 3 times more

Source: 2008, 2009, and 2010 McKinsey surveys of ~20,000 US Internet users, aged 13–64

33 percent on their smartphones. That should open the door to new

Twenty-four percent view
Internet content on their TVs—a
percentage that has tripled
over the past two years as Internet-
enabled game consoles, DVD
players, DVRs, and TVs have prolif-
erated. Although these users
are 1.5 times more likely than the
general population to say that
they intend to cancel their pay-TV
service, only a quarter of them
are satisfied with the experience.
areas of competition and innovation;
pay-TV companies, for example,
are starting to offer their program-
ming across tablets and mobile
devices.
Web search and video providers,
meanwhile, see opportunities
for services that help consumers
navigate the fragmented domain
of online video, a role similar to that
of traditional TV-programming
Leading Edge
1
packagers. Advertisers must
refine marketing plans so that they
reflect this new video-viewing
behavior and get creative about
targeting users who are time-
2
shifting and dividing their attention
among platforms.
We have seen similar digital
disruptions in other key platforms,
such as gaming, e-publishing,
and music. The digital revolution,
still in its earliest days, will continue
to upend how we interact, entertain
ourselves, buy, and work.
23
 his article focuses on recent results
T
from our US research, covering 20,000
people since 2008. Respondents aged
13 to 64 with Internet access were asked
about their digital behavior in areas
including social interactions, e-commerce,
video preferences, and device ownership.
The term 3G, or third generation, refers to
a generation of multiple standards for
mobile phones and mobile telecommuni-
cations devices, while 4G is the fourth
generation of cellular wireless standards—
with higher speeds.
Bert Chappuis is a director
in McKinsey’s Silicon Valley office,
Brendan Gaffey is a principal in
the Dallas office, and Parviz
Parvizi is an associate principal
in the Boston office.
Copyright © 2011 McKinsey & Company.
All rights reserved. We welcome your
comments on this article. Please send them
to quarterly_comments@mckinsey.com.
The future of
marketing
What every executive needs to know

The rules of engagement for companies

and customers have changed
dramatically over the past decade as
the digital-marketing revolution has
accelerated. Few companies—and
even fewer executives from outside the
marketing organization—have kept pace.
They need to, because in this new era of
customer engagement, marketing must
become a company-wide responsibility.
The first article in this package provides
a blueprint for that transition. Then,
read more about where marketing is
headed from a CEO, a CMO, and a
global authority on the social dynamics
of human behavior.

26
We’re all marketers now
Tom French, Laura LaBerge,
and Paul Magill
Artwork by Keith Negley

35
How we see it:
Three senior executives on the
future of marketing
25
26

We’re all marketers now

Tom French, Laura LaBerge, and Paul Magill

Engaging customers today requires

commitment from the entire company—and
a redefined marketing organization.

For the past decade, marketers have been adjusting to a new era
of deep customer engagement. They’ve tacked on new functions,
such as social-media management; altered processes to better integrate
advertising campaigns online, on television, and in print; and added
staff with Web expertise to manage the explosion of digital customer
data. Yet in our experience, that’s not enough. To truly engage
customers for whom “push” advertising is increasingly irrelevant, com-
panies must do more outside the confines of the traditional marketing
organization. At the end of the day, customers no longer separate
marketing from the product—it is the product. They don’t separate
marketing from their in-store or online experience—it is the experi-
ence. In the era of engagement, marketing is the company.

This shift presents an obvious challenge: if everyone’s responsible for

marketing, who’s accountable? And what does this new reality
imply for the structure and charter of the marketing organization? It’s
a problem that parallels the one that emerged in the early days of
the quality movement, before it became embedded in the fabric of general
management. In a memorable anecdote, one of former Chrysler CEO
Lee Iacocca’s key hires, Hal Sperlich, arrived at the automaker in 1977 as
the new vice president of product planning. His first question: “Who
is in charge of quality?”
 27

“Everybody,” a confident executive replied.

“But who do you hold responsible when there are problems in quality?”
Sperlich pressed.

“Nobody.”

“Oh, shoot,” Sperlich thought. “We are in for it now.” 1

To avoid being “in for it,” companies of all stripes must not only recog-
nize that everyone is responsible for marketing but also impose
accountability by establishing a new set of relationships between the
function and the rest of the organization. In essence, companies
need to become marketing vehicles, and the marketing organization
itself needs to become the customer-engagement engine, responsible
for establishing priorities and stimulating dialogue throughout the
enterprise as it seeks to design, build, operate, and renew cutting-
edge customer-engagement approaches.

As that transformation happens, the marketing organization will look

different: there will be a greater distribution of existing marketing
tasks to other functions; more councils and informal alliances that
coordinate marketing activities across the company; deeper partner-
ships with external vendors, customers, and perhaps even competitors;
and a bigger role for data-driven customer insights. This article
provides some real-life examples of these kinds of changes.

Marketing’s cutting edge is being redefined every day. While there’s

no definitive map showing how companies can successfully navigate
the era of engagement, we hope to help senior executives—not just
marketers—start to draw one. (For a complementary set of practitioner
perspectives, read “How we see it: Three senior executives on the
future of marketing,” on page 35.)

The evolution of engagement

More than two years ago, our colleagues David Court, Dave Elzinga,
Susan Mulder, and Ole Jørgen Vetvik unveiled the results of a research
effort involving 20,000 customers across five industries and three
1 David Halberstam, The Reckoning, first edition, New York, NY: Avon Books, 1986.

In Halberstam’s telling of the tale, Sperlich used an expletive that rhymes with “hit.”
28 2011 Number 3

continents.2 Their work showed how collaborative the buying process

has become and how difficult it is to influence customers by relying
solely on one-way, push advertising. In the words of American Express
chief marketing officer John Hayes, “We went from a monologue
to a dialogue. Mass media will continue to play a role. But its role has
changed.” (For more from Hayes, see page 39.)

Over the past two years, that evolution has only accelerated. More
and more consumers are using digital video recorders to fast-forward
through TV commercials and are consuming video content on Web
sites such as YouTube and on mobile devices. Billboards alongside train
lines and bus routes struggle to capture the attention of people
absorbed by the screens of their smartphones. Meanwhile, today’s more
empowered, critical, demanding, and price-sensitive customers are
turning in ever-growing numbers to social networks, blogs, online review
forums, and other channels to quench their thirst for objective
advice about products and to identify brands that seem to care about
forming relationships with them. Individuals even are posting their
own commercials on YouTube. In short, the avenues (or touch points)
customers use to interact with companies have continued to multiply.

The problem for many companies is that the very things that make
push marketing effective—tight, relatively centralized operational con-
trol over a well-defined set of channels and touch points—hold it
back in the era of engagement. Many touch points, such as calls to cus-
tomer service centers and interactions between the sales force and
customers, sit outside the traditional marketing organization, which has
little or no permission to reach into other business functions or units.
Companies have traditionally divided responsibility for touch points
among functions. But a comprehensive strategy for engaging custom-
ers across them rarely emerges and, if one does, there’s often no system
for executing it or measuring its performance.

More pervasive marketing

To engage customers whenever and wherever they interact with a

company—in a store; on the phone; responding to an e-mail, a blog post,
or an online review—marketing must pervade the entire organization.
Companies such as Starbucks and Zappos, for which superior engage-
ment has been a critical source of competitive advantage from the
beginning, already exhibit some of these traits. But these companies
2 See David Court, Dave Elzinga, Susan Mulder, and Ole Jørgen Vetvik, “The consumer

decision journey,” mckinseyquarterly.com, June 2009.

We’re all marketers now 29

aren’t our focus, which instead is the kinds of actions everyone else
can take as they strive for world-class customer engagement.

The starting point is a mind-set shift around customer interaction

touch points. Companies typically think of them as being “owned” by a
given function: for instance, marketing owns brand management;
sales owns customer relationships; merchandising or retail operations
own the in-store experience. In today’s marketing environment,
companies will be better off if they stop viewing customer engagement
as a series of discrete interactions and instead think about it as cus-
tomers do: a set of related interactions that, added together, make up the
customer experience. That perspective should stimulate fresh dialogue
among members of the senior team about who should design the overall
system of touch points to create compelling customer engagement,
and who then builds, operates, and renews each touch point consistent
with that overall vision. There’s no need to worry about traditional
functional or business unit ownership: whoever is best placed to tackle
an activity should do so.

Design
Designing a great customer-engagement strategy and experience depends
on understanding exactly how people interact with a company through-
out their decision journey. That interaction could be with the product
itself or with service, marketing, sales, public relations, or any other
element of the business.

When the hotel group Starwood sought to enhance its engagement

with customers, for example, the company pored through data about
them and identified clear demographic groups staying at its more
than 1,000 properties. In 2006, the company unveiled a specific new
positioning for each part of its brand portfolio, ranging in afforda-
bility from Four Points by Sheraton to its Luxury Collection and
St. Regis properties.

Each brand seeks to deliver a different customer experience, on dimensions

ranging from how guests are greeted by staff to the kind of toiletries
offered in rooms. Crucially, for each type of property, Starwood sought
to design not only the desired experience but also how it would
actually be delivered. It therefore had to decide what coordination would
be necessary across functions, who would operationally control dif-
ferent touch points, and even what content customers wanted in the
company’s Web site, in loyalty program mailings, and other forms
of communication.
30 2011 Number 3

Starwood’s experience underscores the fact that, despite the growing

impact of digital touch points such as social media, effective customer
engagement must go beyond pure communication to include the
product or service experience itself. “At the end of the day,” says Virgin
Atlantic Airways chief executive Steve Ridgway, “we fly exactly the
same planes as everybody else. If we get our customers off the plane
happy, and they go on to talk about that and get others to come and
then come back again themselves—that’s a huge marketing tool.” (For
more from Ridgway, see page 36.)

Build
Once a company designs how it will engage with customers, it needs
the organizational capabilities to deliver: adding staff, building a social-
media network infrastructure, retooling customer care operations, or
altering reporting structures. Functions far removed from marketing
often have important roles to play, so one or more marketing teams
at the center may have to build skills in other parts of a company. A
global energy company took that approach and then largely dissolved
the group when those capabilities were in place.

Allocating responsibility for building touch points is increasingly

important because of the degree to which Web-based engagement is
requiring companies to create “broadcast” media.3 Some have built
publishing divisions to feed the ever-increasing demand for content
required by company Web sites, social media, internal and external
publications, multimedia sites, and coupons and other promotions. Many
luxury-goods companies, for example, have built editorial teams to
“socialize” their brands: they are transforming the customer relationship
by producing blogs, digital magazines, and other content that can
dramatically intensify both the frequency and depth of interactions.

Last year, LVMH Moët Hennessy–Louis Vuitton, for example, launched

an online magazine, NOWNESS, that offers what the company calls
“information reference” about its luxury brands. The site presents a daily
multimedia story with little pure advertising and (in conjunction with
LVMH’s efforts on Facebook, Twitter, and YouTube) seeks to deepen
the engagement customers have with the company’s brands. British
luxury brand Burberry has undertaken a similar venture with its Art of
the Trench site. France’s Chanel has for years used its own creative
and artistic directors to develop content, without any need for help
from external agencies.

3 For more on the marketing organization’s role as a publisher, see David C. Edelman’s articles

“Four ways to get more value from digital marketing,” mckinseyquarterly.com, March
2010; and “Branding in the digital age: You’re spending your money in all the wrong places,”
Harvard Business Review, December 2010, Volume 88, Number 12, pp. 62–69.
We’re all marketers now 31

Content-oriented strategies like these require creative employees who

can feed the customer’s ever-increasing need for timely, relevant,
and compelling content across a variety of media. They also provide an
opportunity for productive dialogue within companies about the role
of marketing versus other functions in building critical touch points that
drive engagement.

Operate and renew

For companies in industries as diverse as consumer packaged goods
and financial services, digital technology has upended the engagement
expectations of customers, who, for example, want one Web site to
visit and a relationship seamlessly integrated across touch points. Meeting
such expectations requires extraordinary operational coordination
and responsiveness in activities ranging from providing on-the-ground
service delivery to generating online content to staying on top of a
customer care issue blowing up on YouTube.

Behind the scenes, that new reality creates a need for coordination and
conflict resolution mechanisms within and across functions, as well
as budget procedures that allow f lexibility and rapid action should the
need arise. PepsiCo, for example, has sought to provide a single point
of contact for its digital-marketing efforts by creating the role of chief
digital officer: an executive without line responsibility who drives
the application of best practices across the beverage group’s global
digital efforts.

Companies also need a clear approach for monitoring touch points and
renewing them as needed. At one major hotel chain, for example,
a single group circumnavigates the globe acting as a “monitor and fix”
SWAT team. It meets with hotel licensees, educates them about
the company’s customer-engagement approach and management of key
touch points, demonstrates new behavior, and trains the staff in
new operational processes. Given the speed of information sharing today,
constant monitoring and adaptation—indeed, continuous improve-
ment of the sort that came to the operations world long ago—is bound to
infiltrate marketing and grow in importance.

The marketing organization’s new look

As the chief marketing officer collaborates with the chief executive and
other senior-team members to nail down a shared approach for
designing, building, operating, and renewing customer touch points,
he or she also will require a new kind of marketing organization.
32 2011 Number 3

For marketing to truly become the customer-engagement engine that

orchestrates the delivery of the end-to-end customer experience, it must
evolve along four critical dimensions.

Distribute more activities

As marketing becomes more pervasive, the marketing organization will
increasingly be defined by a core set of tightly held responsibilities,
such as branding and agency relationships, and a set of responsibilities
distributed among the functions and groups best placed to manage
and use the information generated by customer interactions. Procter
& Gamble, for instance, has created a group within the purchasing
function to buy digital-media advertising space. The group spans geo-
graphic boundaries, ref lecting the global nature of the medium,
and while it sits within purchasing, it is staffed by people with mar-
keting experience.

At companies where the marketing organization’s responsibilities will be

split between core and distributed activities, CMOs will increasingly
be held accountable for the performance of groups that don’t report solely
to them. When CEOs ask for the marketing-org chart, they will see
a complex web of solid- and dotted-line relationships showing the roles
that marketing plays in designing, building, or operating touch points
across the whole organization.

The chart will also show where marketing activities have been embedded
in other functions. One major logistics company, for example, puts
marketing resources within each sales district to adapt corporate-level
marketing initiatives to local circumstances. This approach mutes
complaints from sales reps who feel bombarded with marketing pushes
from the head office by giving them simple, customized ideas for
driving sales within their regions.

More councils and partnerships

While leading companies have long used marketing councils to
boost management coordination, the new marketing organization will
require many more of them, with greater representation from other
functions. One global financial institution, for example, has created
a digital-governance council with representatives from all customer-
facing business units. The company’s goal was to ensure that data and
analytics are shared, that customers receive the same experience
regardless of channel (such as Web sites, branches, call centers, or auto-
mated teller machines), and that IT systems meet the customer’s
digital-engagement needs.
We’re all marketers now 33

More robust formal and informal external partnerships will be critical

too. Customer forums, such as the one Virgin Atlantic Airways used
to create a taxi-sharing app for smartphones, are one example. More
structured relationships with distribution partners also can enhance
engagement. The consumer-packaged-goods company Nestlé, for example,
manages its relationship with retailer Wal-Mart Stores via what it
calls the Nestlé–Wal-Mart Team. This unified cross-business, cross-
functional group is responsible for everything from in-store activity
to promotion, logistics, innovation, and product design. As a result, Wal-
Mart has a single point of contact with one of its largest suppliers,
Nestlé enjoys a stronger relationship with the retailer, and, critically,
both companies gain a better understanding of, and engagement
with, packaged-goods consumers.

Elevate the role of customer insights

Generating rich customer insights, always central to effective marketing
efforts, is more challenging and important in today’s environment.
Companies must listen constantly to consumers across all touch points,
analyze and deduce patterns from their behavior, and respond quickly
to signs of changing needs.

One implication is that the types of talent required to derive such insights
will change. A premium will be placed on problem-solving and
strategic-marketing skills, rather than on traditional market research
capabilities such as designing surveys and commissioning focus
groups. Some organizations also may need help from external partners,
a pattern that’s already apparent at several insurers and health care
payers that have neither the time nor the budgets to build the necessary
data-gathering and -analysis capabilities in-house and at scale.

The insights group’s position in a company could even change. At one

high-end hospitality business, for example, responsibility for generating
customer insights has moved out of the marketing function entirely.
The group now reports directly to the head of strategy, who uses infor-
mation from it to redesign core business elements such as pricing,
sales targeting, and the selection of properties for development.

More data rich and analytically intense

Reinforcing the importance of all these changes is an exponential increase
in the volume of customer data and the intensity of the analysis
required to process and act on it effectively. Without cross-functional
collaboration and a clear delineation of roles, it will be impossible
to gather, collate, gain insights from, and disseminate data that streams
34 2011 Number 3

in from every customer interaction. The sheer volume of data is

extraordinary: social-media gaming company Zynga, for example, gene-
rates five terabytes (the equivalent of about 1.5 million song files) of
data on customer clicks every day.4 What’s more, “Marketing is going
to become a much more science-driven activity,” says Duncan Watts
of Yahoo! Research. (For more from Watts, see page 42.) In the trenches,
this change suggests a shift toward sophisticated data analytics sim-
ilar to the revolution that has already taken place in industries such as
financial services, as well as in airlines and other industries where
yield management is important. Some marketing organizations are
already making their moves: to send targeted e-mails to customers,
retailer Williams-Sonoma, for example, analyzes an integrated data-
base that tracks some 60 million households on metrics including
income, housing values, and number of children. These e-mails obtain
response rates 10 to 18 times as high as those sent randomly.5 Such
capabilities don’t necessarily have to be built in-house: many companies
will enter into creative arrangements with outside parties to exchange
data and run joint tests of alternative marketing tactics.

The major barrier to engagement is organizational rather than conceptual:

given the growing number of touch points where customers now
interact with companies, marketing often can’t do what’s needed all on
its own. CMOs and their C-suite colleagues must collaborate inten-
sively to adapt their organizations to the way customers now behave
and, in the process, redefine the traditional marketing organization.
If companies don’t make the transition, they run the risk of being over-
taken by competitors that have mastered the new era
of engagement.

4 See Brier Dudley, “Q&A: Zynga founder talks about Seattle hiring spree, Amazon,

Facebook,” Seattle Times, April 13, 2011.

5 For more, see the McKinsey Global Institute report Big data: The next frontier for

innovation, competition, and productivity, available free of charge on mckinsey.com/mgi.

The authors would like to offer special thanks to Roxane Divol and to
acknowledge the contributions of Whit Alexander, Jean-Baptiste
Coumau, Blair Crawford, Dave Edelman, Ben Fletcher, and Tariq Shaukat
to this article.

Tom French is a director in McKinsey’s Boston office; Laura LaBerge is

a senior expert in the Stamford office, where Paul Magill is a principal.

Copyright © 2011 McKinsey & Company. All rights reserved.

We welcome your comments on this article. Please send them to
quarterly_comments@mckinsey.com.
 35

How we see it:

Three senior executives on
the future of marketing

Steve Ridgway
CEO of Virgin
Atlantic Airways

John Hayes
CMO of American
Express
There is no quick path to success in the new
era of customer engagement. Progress is likely
Duncan Watts to come incrementally—by listening to customers,
Principal research making adjustments to engagement strategies,
scientist at Yahoo! and learning through trial and error. Since diverse
Research perspectives will be essential to mastering this
new landscape, McKinsey’s Luke Collins, Tom French,
and Paul Magill recently sought out three prac-
titioners with very different vantage points on mar-
keting’s future.

Virgin Atlantic Airways CEO Steve Ridgway talks

about how his company recently has been pushing
the boundaries of collaborating with customers,
while experiencing the pleasant surprise of a suc-
cessful mass-media campaign. American
Express CMO John Hayes discusses what today’s
“marketing revolution” means and describes some
of the organizational steps he has taken to get ahead
of it. Duncan Watts, principal research scien-
tist of the Human Social Dynamics group at Yahoo!
Research, explains how today’s data-rich envi-
ronment exposes the limits of intuition in marketing
and the need to take a scientific approach to
understanding consumers. A summary of those
conversations follows.
36 2011 Number 3

The CEO

“
Virgin Atlantic Airways’ Steve Ridgway

If we get our customers off the

plane happy, and they go

”
on to talk about it, that’s a huge
marketing tool for us.

Steve Ridgway has been the CEO of Virgin Atlantic Airways since
2001. A native of England, he joined Virgin in 1990. Previously,
he served as executive director of customer service and managed
the company’s frequent-flyer program. In 2006, Queen Elizabeth II
made Ridgway a Commander of the Order of the British Empire
(CBE) in recognition of his service to British industry.

Where mass media still matter

It’s popular these days to say that television and other traditional forms
of marketing don’t work—that it’s a fragmented world out there, and
marketing is henceforth all about the thousands of little things that
companies do in different constituencies, markets, and segments.

I’m not sure that’s altogether right. Focused, laser-like efforts are
certainly very valuable, but I worry that we might get all the “micro”
things right and miss the bigger picture. I don’t want to lose sight
of how important it is to have all of our marketing efforts somehow
embodied in something bigger—something iconic, even.

That lesson was driven home for me by the recent success of two of
our, what would be considered traditional, “above the line” television
campaigns.1 The first was in 2009, when Virgin Atlantic Airways
was celebrating its 25th birthday. At the time, everyone was depressed
about the world economy, and we just wanted to put a smile on our
customers’ faces and on our own faces. The result was “Still red hot,”
a TV campaign 2 that started in the UK, went viral, and had an

1 “Above the line” refers to marketing campaigns that use paid channels such as television,

newspapers, or magazines. Traditionally, in “below the line” marketing efforts no

commission is paid to an advertising agency, such as with direct mail or other promotions.
2 Released in January 2009, the 90-second “Still red hot” commercial was set in London’s

Heathrow Airport at the time of the airline’s launch, in June 1984. It featured a young busi-
nessman wearing suspenders and carrying a brick-sized mobile phone, who becomes
spellbound by a group of Virgin Atlantic flight attendants wearing flame-red uniforms. The
commercial is filled with other 1980s artifacts, including its soundtrack, Frankie Goes
to Hollywood’s “Relax.”
How we see it: Three senior executives on the future of marketing 37

absolutely massive effect in creating a positive halo for our brand not
only among our customers but among our staff and suppliers as well.
We’ve always focused heavily on brand and brand awareness, but this
campaign sparked something more—it energized and engaged a
whole new constituency out there before they’d even set foot on a plane.

Of course, beneath the traditional campaign sat a series of related,

“below the line” efforts in all the new mediums. But it was quite a revelation—
and a surprise, frankly—for us to see how powerful it can be to put
ourselves out there in the market with this really big, confident shop-
window, rather than concentrating on the fragmented world that
everybody is telling us we have to be in. We simply wanted to reinvigorate
our brand, to produce a powerful campaign to show that we were still
alive and kicking and that our brand still had spirit, and it suddenly
became more than that. The experience has spurred us to launch a
second TV campaign, “Your airline’s either got it or it hasn’t,” and its
success has taught us more still, while further convincing me of the need
to have a traditional, big-hitting, resonant presence in the marketplace.

Catalyzing social-media engagement

Social media hasn’t required a huge investment from us thus far, in
part because we’ve tried to build social networking into things that we
knew we had to do anyway. We’ve also done some interesting things
with outside “self-developer” groups, where we adopt the role of catalyst,
or pump primer.

VJAM is an open-innovation initiative we did with NESTA, the UK’s

National Endowment for Science, Technology, and the Arts. We provided
seed capital to support the development of an outside development
group that has gone on to create some very useful applications for our
customers. It created a taxi-sharing app, for example, that lets pas-
sengers on the same flight or on flights arriving at a similar time share
a taxi ride if they’re going the same way. This saves people money and
is better for the environment—and it was all done by developers who are
themselves our fans, followers, and customers. Our f light tracker
app was developed in a similar way and has also become very popular.

It’s been really fun working with this group; they’re very fired up. Of
course, we could have spent a fortune on a glitzier version of all this, but
it wouldn’t have been better. What they’ve done is very good, and
when you consider the speed at which it was done and the infectious
enthusiasm they bring to the table—and the pride they take in the
work—it’s just fantastic. And it’s all possible because there was sufficient
motivation and engagement out there to convince these people to want
to do this for us.
38 2011 Number 3

Customer experience as a marketing tool

Before we start marketing anything or talking about our brand
proposition, we ask ourselves, are we being brave enough to get ahead
of consumer expectations? One way we try to think ahead of our
customers is through creating a superior customer experience. If we
get our customers off the plane happy, and they go on to talk about
that and get others to come and then come back again themselves—
that’s a huge marketing tool for us.

Making that happen requires having the elements in place to help

the staff do their jobs and make our customer experience distinct from
what other airlines are offering. Those elements include things like
putting our clubhouses in a different design world than the other air-
lines’ lounges. Differentiation also is visible onboard the aircraft in
all the design work we did in our upper-class suites to get the best flat-
bed possible and in taking the fit and finish inside the aircraft to a
whole new standard.

But getting the tools right isn’t enough. We were the first airline to
put in-flight entertainment systems in our planes, for example, and now
everybody’s got them. And, frankly, there are some airlines out there
now—in the Middle East, for example—that have very deep pockets and
spend lots of money. So we need to go further.

The real key is people and developing the chemistry and the attitudes,
in our staff, that create the right experience for customers. We’re
constantly pushing this in our professional training because without
the human element, all the rest counts for nothing. There’s massive
complexity in doing this well because it extends from a customer’s first
phone call to saying, “Goodbye. Come back soon.”

When we get both things right—connecting the tools and the people—
then our staff can really engage customers with attitude and spirit.
They feel proud of what they’re doing; they like being winners. And at
the end of the day, that really matters. After all, we f ly exactly the
same planes as everybody else. We fly them under the same very strict
safety rules. Yet if you go on one of our planes and experience the
service, you’ll see it’s very different from many others.
 How we see it: Three senior executives on the future of marketing 39

The CMO

“
American Express’s John Hayes

I haven’t met anybody who

feels they have their

”
organization completely aligned
with this revolution.

John Hayes has been American Express’s chief marketing

officer since 2003. Previously, he was the company’s
executive vice president of global advertising and brand
management. Hayes joined American Express in 1995,
after holding senior positions at the advertising agencies
Lowe & Partners, of which he was the president; Ammirati &
Puris; and Saatchi & Saatchi Compton.

A marketing revolution
We’re going through a revolution a whole lot like the Industrial
Revolution. The change is that profound. I had a conversation recently
with an employee about this new age of marketing. Basically, it went
like this: “As we try to go to market with your idea,” I said, “the world
is going to decide whether or not this has real value, talk about it,
and then position it pretty much how they want to position it.” The
person responded, “OK, so we really have lost control?” I said, “Yes,
that’s right. I don’t get to control everything that’s said about us.” Then
I said to the person, “But understand, you’re still 100 percent
accountable for the outcome.”

The reaction to me was, “That’s not fair.” And it’s not. But it’s the world
we live in. It’s more exciting because if you really do have a great
product or a great program, it can catch fire in the marketplace. That’s
exciting. But the challenge for most people who are marketers today
is, “How do you hold me accountable for the success of this when I can’t
control what somebody might say about it or what somebody else
might contribute to this conversation?”
40 2011 Number 3

Meeting the organizational challenge

I haven’t met anybody—and I talk to a lot of my colleagues in the mar-
keting world—who feels they have the organization completely
aligned with where this revolution’s going, because it’s happening so
fast and so dramatically. Marketing is touching so many more parts
of the company now. It touches on service; it touches on product
development. We need to organize in a way that starts to break down
the traditional silos in the business.

We’re creating cross-business function groups and seeing how they

work. If you’re not experimenting, you’re not learning. So we’ve created
a marketing council with the key marketer from each business unit.
At first we wondered, “What is this marketing council really going to
do?” Well, when we got everybody together, it was clear that there
were issues that the whole group was having, and there were issues
that some parts of the group were having with other parts of the
group. Taking folks out of their business unit environment and putting
them in more of an enterprise-wide environment changes some
behaviors because it helps people understand more clearly that we have
shared customers. We need to talk about how to serve them better,
and we may have synergies between two or three of our business areas
around specific growth opportunities.

We’ve done this now in a variety of areas, not just on a general marketing
basis but also, for example, in areas that have to do with digital
transformation. The result of some of this work is that we’re not just
marketing and selling on Twitter and Facebook today, we’re servic-
ing customers as well. When you bring these cross-functional teams
together, people start to say, “Well, if people are asking questions
on Facebook and Twitter about how to redeem Membership Rewards
points, shouldn’t we be there answering them? Wouldn’t that help
our marketing efforts?” When you start to see things come together
like this, that’s when the light bulb goes on.

These cross-functional teams—some may be temporary and some may

be permanent—will play a very important role in creating more
f luidity, more enterprise-wide understanding, and more initiatives
that lead to a more cohesive outcome for our customer base.

Understanding and engaging customers

We’re fortunate to have a very passionate, action-oriented community
of cardmembers. For example, they know—almost to a person—
their “member since” date. Despite all those passwords and all the
other things people have to remember in life, they’ll immediately
 How we see it: Three senior executives on the future of marketing 41

tell you, “Oh, I’m a member since 1991.” I can’t think of too many brands
where people know their tenure as a customer.

The strength of that relationship manifests itself in many different ways.

Take the earthquake in Haiti that took place in January 2010. We
made one small piece of communication to our cardmembers about
what they could do to help relief efforts, and within eight weeks
our cardmembers had donated over $100 million and 87 million
Membership Rewards points.

When you understand that this is a group of people who really feel a
sense of belonging—that this brand matters to them—you start to
build your marketing plans around the sense of joining a community.
So if we find, based on your purchasing profile, that you love wine
or you love dining out or you love golf, we can further engage you in
the things you’ve already made clear are important to you as a person.
It’s really a dialogue, which isn’t just us sending out an e-mail and some-
body sending something back to us. The dialogue has to do with us
guarding your privacy at all times but doing appropriate things to under-
stand what interests you and then serving you better. That’s part of
the dialogue; that’s how we listen.

We also benefit from seeing what people are writing about us in blogs,
what’s being said in the social space, and understanding the buzz
out there. We’re at the point where we can actually monitor this pretty
carefully by just reading what people are saying on the Web, under-
standing whether there’s a positive or negative sentiment, and how it
compares with the buzz around our competitors. It’s become very
useful because we learn, for example, not to overreact to something that
is likely to dissipate very quickly. It has really helped to calibrate how
we respond in different circumstances.

We’ve created a group of measurements that are early indicators, which

tell us we’re on the right track. And then we have business measures
that give us the ultimate outcome. Consider a program like Small
Business Saturday.3 When we asked ourselves, “Did it work?” we
first measured the buzz—what were people saying about it in social
media? There were nearly 1.5 million people who liked this effort
on Facebook. That’s a lot of people and a positive early indicator. Then
that support materialized into business: among all retailers that
accepted our card on that day, sales increased 9 percent year on year.
Among small businesses that participated in Small Business Saturday,
sales rose 28 percent. Those are pretty strong numbers.
3 A US shopping promotion, created by American Express, that was first held on the Saturday

after Thanksgiving in 2010. It encourages consumers to shop at smaller, local retailers.

42 2011 Number 3

The Scientist

“
Yahoo! Research’s Duncan Watts

Once you accept that your intuition

about how people behave is
inherently flawed, then you really

”
need a different model for learning
about the world.

Duncan Watts is the principal research scientist at Yahoo!

Research and director of its Human Social Dynamics group,
which explores how information diffuses and how people
influence one another online. The Australia-born researcher
was a professor of sociology at Columbia University from
2000 to 2007. He is the author, most recently, of Everything
Is Obvious: Once You Know the Answer (Crown Business,
March 2011).

The data revolution

Marketing has long been data driven, with a lot of survey research
and polling. But the volume and kind of data that we are beginning
to acquire is vastly increasing, requiring better computing facilities
and greater knowledge to handle. The kinds of questions that we can
ask are much more sophisticated and require a whole new science.

The study of social networks, for example, has long been something
that sociologists and marketers have thought was important. But
there really wasn’t much we could do, because a lot of the data simply
was not available to us. Prior to a few years ago, you couldn’t have
observed the ties that existed between hundreds of millions of individ-
uals. Now we have Web services that provide exactly that kind
of data.

The limits of intuition

One consequence is that we now need to start suspecting our intuition.
We can’t help thinking that we know why people do what they do
or what they’re going to do. But whatever hypothesis or intuition you
How we see it: Three senior executives on the future of marketing 43

have, however self-evident it may seem, when you test it against the
data, it’s wrong—not every time, but very often.

So the marketing world is about to experience a shock. We have these

spontaneous intuitions about why people do certain things and
how we can make them do other things, whether it’s engaging with
our brand or buying our product or evangelizing our product to
other people. We tell ourselves plausible stories about how consumers
are going to behave if we do x, y, and z. But then when you actually
get the data, they don’t do that. They don’t do anything crazy; they just
do something different from what you expected.

A recent example of this strong intuition that seems to be wrong is

word-of-mouth influence. We imagine information or influence propa-
gating through a network in the manner of an infectious disease.
We talk about viral videos and viral media, and we really think things
spread this way. What we recently stumbled on is that almost
nothing spreads. Instead, the vast majority of all adoptions happen
within just one degree of the seed. This is shocking to people who
study diffusion, and it’s shocking to viral marketers because it completely
changes your premise of how things work in the social world.

Research suggests that when we do see big events—things that we call

viral—something other than word-of-mouth, peer-to-peer diffu-
sion is happening. Once you think about it, in fact, it’s clear that this
has to be true. If you consider the famous viral video of the little
baby penguin that suddenly got 100 million views or the subservient-
chicken campaign, which was one of the first to be labeled a viral
campaign, all of these benefited from tremendous mass-media cover-
age. Once you get your so-called viral video on the front page of
Yahoo!, 100 million people see that. So this is not about viral anymore.
This is mass media.

Measure and react

Once you accept that your intuition about how people behave is
inherently flawed, then you really need a different model for learning
about the world. Everything becomes data driven in a real-time,
reactive way. A classic example in the Web industry is what we call
bucket testing, where you might say, “I don’t know what to put on
the front page of Yahoo!. I have very good editors who have plenty of
ideas, and they can generate a pool of good candidates.” But if we
want to optimize this, we actually have to go and show these different
combinations of articles to buckets of people. Within a few minutes,
44 2011 Number 3

we’ve got a million clicks that we can use to tell us which articles are
getting clicked on more.

We can do the same thing for the display of advertisements, for the
design of pages. All sorts of design parameters and choices that were
once within the purview of intuition, of experts, are now tasks that
can be distributed to the user population and learned empirically in
real time.

This kind of measure-and-react strategy, as I call it, is particularly

powerful on the Web because the numbers are very large and the cost
of generating multiple versions is very low. But, in principle, this is
something that could be done in the offline world as well. We see it in
the fashion industry with Zara and in the casino industry with
Harrah’s or in retailing, where you can systematically rearrange product
positions on shelves in stores.

Making better predictions

Grasping the limits of your intuition is not the same thing as saying the
world is completely unpredictable. We have this irrepressible ten-
dency to make predictions about the future. We see it in the media all
the time—talking heads and experts and pundits constantly making
predictions. There are some things that we can predict and others that
we cannot. We need to be able to tell the difference between the two,
and if it turns out that certain things are hard to predict, it’s better to
know that.

Advertisers, for example, create elaborate stories about representative

consumers, and then they build a campaign around selling to this
person that they’ve created in their minds. That, to me, is deeply flawed
because what we’ve learned from many years of psychological
research—not to mention what we should have learned from actual
business experience—is that if any of these assumed factors that
you’re including in your simulation are wrong, then the person may do
something completely different. So this way of predicting behavior
by simulating it in our own brains is a problem.

But if you have data on billions of mouse clicks per day by hundreds
of millions of users, there are empirical regularities. They can be modeled.
They can be predicted—not deterministically, with 100 percent
accuracy, but that’s not the point. The point is that you can do better
than guessing. There are some things that are predictable. And we
should learn how to predict them.
 How we see it: Three senior executives on the future of marketing 45

So by all means, make predictions. But record them. Nobody ever keeps
track of the predictions they make. Our enthusiasm for making
predictions is matched only by our reluctance to be held accountable
for them. There’s a tremendous amount that can be learned—both
about your own ability and about your organization’s collective
ability to predict things—simply by measuring the track record over
time. This is something that is difficult to do. But it would have a
transformative effect on the way people think about their ability to
predict and plan.

Luke Collins is a member of McKinsey Publishing and is based in

McKinsey’s Chicago office, Tom French is a director in the Boston office,
and Paul Magill is a principal in the Stamford office. They would like to
thank Dieter Kiewell and Liz Hilton Segel for their help with these interviews.

Copyright © 2011 McKinsey & Company. All rights reserved.

We welcome your comments on this article. Please send them to
quarterly_comments@mckinsey.com.
 47

How new Internet

standards will
finally deliver a mobile
revolution
Bengi Korkmaz, Richard Lee, and Ickjin Park

As the Web experience evolves, smartphones

may soon live up to their name, and every business’s
mobile strategy will grow in importance.

The problem
A new Web standard known as HTML5
will allow the mobile Web to perform
much like the PC-based Internet, with
browsers—rather than applications—
doing the heavy lifting. That represents
a major departure from the situation
today, in which users must commit to a
particular technology or device.

Why it matters
As the range of content and services
provided by the mobile Web broadens
and the user experience improves,
companies that don’t have a mobile-Web
strategy will lose out to competitors
that do. Simultaneously, the economics
and competitive dynamics of mobile
devices, software, services, content
providers, and advertising markets will
shift dramatically.
Artwork by Lloyd Miller

What to do about it
Elevate the importance of mobile
customer engagement in overall business
strategy. Tailor marketing and adver-
tising approaches accordingly. Deter-
Read the accompanying mine how a more Web-centric mobile
article, “Winning the environment could change the way you
Web standards battle,” engage with employees. And be
on page 54. prepared for strategic investments in
supporting IT infrastructure.
48 2011 Number 3

An arcane-sounding change with potentially significant

implications for consumers and businesses is under way on the Web: the
shift to a new generation of HTML,1 the programming standard that
underpins the Internet. Senior executives, regardless of industry, should
take note; like the exponential growth of device-specific applications,
this evolution of HTML will further boost the power of mobile devices,
accelerating changes in the way people consume content and the
potential use of smartphones and tablets as both a marketing platform
and a productivity tool.

The next generation of the Internet standard essentially will allow

programs to run through a Web browser rather than a specific operating
system. That means consumers will be able to access the same programs
and cloud-based content from any device—personal computer, laptop,
smartphone, or tablet—because the browser is the common platform.
This ability to work seamlessly anytime, anywhere, on any device could
change consumer behavior and shift the balance of power in the mobile-
telecommunications, media, and technology industries. It will create
opportunities and present challenges. This article seeks to provide a
primer on these changes for senior executives, who may feel the effects
of the move toward “Web-centricity” much sooner than they think.

Web-centricity

In some ways, the evolution of mobile technology resembles the battle

among PC makers in the 1980s. While we today take it for granted
that Microsoft’s Windows operating system underpins hardware from
countless manufacturers, it wasn’t always that way. Remember the
operating systems that powered the Commodore 64, the biggest-selling
PC of all time, or the Apple II? Before the emergence of Microsoft’s
DOS and then Windows, PC users faced a tough decision about which
technology to adopt, because that determined the games and utilities
they could use, as well as the general usefulness of their computers. The
same occurs today with mobile devices. Users must weigh the hardware
and software merits and commit themselves to a technology, whether
it’s a device from manufacturers such as Apple or Research in Motion,
the ever-increasing array of tablets and smartphones running Google’s
Android operating system, or, soon, offerings from Nokia running on
Microsoft’s Windows Phone 7 operating system.

The next generation of HTML, known as HTML5, may narrow these

differences between mobile devices. HTML5, the most significant
1 Hypertext markup language.
 How new Internet standards will finally deliver a mobile revolution 49

evolution yet in Web standards, is designed to allow programs to run

through a Web browser, complete with video and other multimedia
content that today require plug-in software and other work-arounds. In
theory, this will make the browser a universal computing platform:
without leaving it, users could do everything from editing documents to
accessing social networks, watching movies, playing games, or listen-
ing to music. Not only would any device with a Web browser have these
capabilities, but consumers would also have access to all content
stored remotely “in the cloud,” independent of locations and devices.

That’s the first reason Web-centricity holds particular promise for

mobile devices. The second is that it helps overcome the relatively weak
processing power of smartphones and tablets compared with PCs and
laptops. It’s partly this lack of horsepower that has fuelled the explosive
growth in applications (or “apps”) to optimize the performance of spe-
cific devices: the average smartphone user now spends more than 11 hours
a month using apps, more time than either Web browsing or talking,
according to a March 2011 study by research firm Zokem. HTML5 has
the potential to improve the mobile experience—its specifications enable
browsers to locally store 1,000 times more data than they currently do,
so users can work when offline—writing e-mails, for example—and their
devices will automatically update when a network becomes available.
What’s more, programs and applications run faster because complex
processing tasks are handled by network servers, although mobile-
network capacity must go on growing to deal with heavier data demands.

Of course, not all programs are suited to running through browsers, nor
is HTML5 the first would-be universal platform to emerge: Sun
Microsystems (purchased by Oracle in 2010) promised that with its Java
language, programmers could “write once, run anywhere.” Things haven’t
worked out that way. And there’s never a guarantee that one kind of
standard will prevail. (For more on platform competition, see “Winning
the Web standards battle,” on page 54.) The rate at which developers
are writing apps and consumers buying them is dizzying, and ingrained
behavior can be hard to change. Web-centricity may raise security fears
among users because programs are no longer installed on specific devices
and because data are stored remotely. And there could be fragmentation
issues with both the standard and the browsers—after all, existing ones,
such as Google’s Chrome, Microsoft’s Internet Explorer, and Mozilla’s
Firefox, don’t all treat the current standard, HTML4, the same way.2

2 Various plug-in programs written for HTML4, such as those that run audio or video files,

often require multiple versions customized to specific browsers. As the complexity of Web
programs accelerates, those mismatches are increasing. To read more about how HTML5
may help the Web keep up with the pace of change, see Bobbie Johnson, “The Web is reborn,”
Technology Review, November/December 2010, Volume 113, Number 6, pp. 46–53.
50 2011 Number 3

Despite these possible headwinds, the number of HTML5 Web sites

is increasing by the day. Hardware manufacturers are lining up behind
HTML5, and the development community is undertaking efforts
to safeguard data in the cloud at a very fast pace. We therefore estimate
that more than 50 percent of all mobile applications will switch to
HTML5 within three to five years—and the rate of transition could be
considerably higher and faster. No matter how quickly the shift
occurs, it will affect both consumers and businesses significantly.

Consumer impact
Consider a simple task many consumers currently use mobile
devices for: reading news headlines. Today, that requires accessing
a specific Web site—often a sluggish exercise in frustration—or
separately installing an application on every device used and, for those
that charge a fee, paying each time. With Web-centricity, a single
application can theoretically be accessed from any device through a
browser—pay once and you’re done. And because all content is
stored in the cloud, billing information and preferences can be seam-
lessly shared and accessed, and all devices remain in sync. A con-
sumer can start reading an article on a tablet and then switch to a
laptop, picking up where she left off. In a more advanced example,
she could start an instant-messaging or video-chat conversation on
her desktop computer and continue it on her smartphone. The
bottom line for consumers: Web-centricity represents a major step
toward genuinely “smart” devices that offer the same simple,
relevant, and personalized experience everywhere.

Industry impact
These changes to consumer behavior may affect the economics of
industries ranging from telecommunications and media to technology
and even advertising. As Web stores selling applications that can
be used across devices proliferate, for example, cutthroat competition
may leave ad agencies reminiscing wistfully about the days when
they could claim up to 40 percent of every dollar of mobile-advertising
revenue. Consider, briefly, the implications for the following players
in a world where content is everywhere and the relative importance of
operating systems and Web browsers for creating and distributing
programs and applications is shifting.

Software developers. Application developers currently pay a fee

of up to 30 percent to device makers, telecommunications operators,
or operating-system developers whenever an application is sold
to a consumer. In a Web-centric world, developers can avoid these
intermediaries: not only can the same application be sold across
How new Internet standards will finally deliver a mobile revolution 51

all devices but anyone can set up a Web store and sell directly to
users. Google, for instance, is already charging application developers
a distribution fee of about 5 percent through its Chrome Web
store.3 In addition, the emergence of an open platform will probably
motivate bigger enterprise software companies to introduce—and
quickly—mobile-based programs for managing customer relationships,
marketing, and supply chains.

Telecom operators. Web-centricity may be a double-edged sword for

telecom players. On the one hand, it will spur demand for mobile-
Internet services, create opportunities for operators as consumers seek
applications that work across multiple devices, and loosen the
grip of native app stores. On the other hand, there’s no guarantee that
operators can make money with new apps, the likely surge in data
traffic will require significant investments in network infrastructure,
and operators may face increased competition from companies
offering Web-based mobile-voice and -video services.

Content providers. Web-centricity should provide revenue and savings

opportunities for content providers. On the revenue side, the ease
with which consumers can access Web-centric content on the go should
stimulate their interest in more relevant, timely material. Moreover,
the seamlessness with which consumers can access HTML5 content
across devices could create more opportunities for providers, such
as television studios, to offer consumers programming directly or to
work through aggregators such as Apple’s iTunes. Finally, adver-
tising could support additional mobile content. Fragmented mobile
platforms today make it hard for online publishers to manage ad
inventories across a broad range of users. Advanced features such as
consumer targeting and measurement may migrate to the mobile-
Web environment. Of course, this development will no doubt attract
entrants and intensify competition, making the new environment as
challenging as it is dynamic.

Savings, a secondary benefit, come from avoiding the cost of converting

an application from one platform to another (today, around 50 per-
cent of development cost). Newspapers and magazines, for example,
should be able to create content once and deliver it seamlessly
across multiple devices, lowering production costs and increasing reach.

Device makers. Web-centricity will probably make consumers

more “device agnostic,” and that will in turn reduce the ability of players
to control an ecosystem of developers and could accelerate the

3 See http://code.google.com/chrome/webstore/docs/index.html#builtin.
52 2011 Number 3

commoditization of mobile devices. The shift does, however, create

opportunities. Manufacturers will be able to more easily integrate
software and hardware experiences within and across devices. They
can try to develop compelling cross-device applications and make
synchronizing and storing data across devices easier. Finally, they have
some control (along with operators) in choosing the default set of
Web-centric services embedded in devices.

What it means for senior executives

Consumer uses propel many innovations associated with Web-centricity.

Yet it could ultimately provide a range of benefits for companies
as information technology moves to Web-centric platforms and away
from the current hard-wired infrastructure and applications. These
are enterprise-level issues, and any CEO who isn’t confident that the
organization is grappling with them should start pushing the senior
team to understand their importance.

The CMO
The emergence of the “m-dot revolution”4—the increasingly strong
tendency of consumers to use mobile devices to access company and
product information—will have its greatest impact on chief marketing
officers. Many companies are already experimenting with innova-
tive smartphone applications; Volkswagen, for instance, has released a
popular racing game for the iPhone. Companies will be able to take
advantage of the power of mobile Web browsers to create compelling
experiences for users. In addition, CMOs will need to push their
teams to develop compelling mobile-advertising strategies that go well
beyond merely inserting ads into applications, as many do today.
HTML5 should create opportunities to use video advertising more often,
for example, and the development of robust mobile capabilities
may spur the evolution of marketing tactics such as the monitoring of
shopping activity to deliver real-time, location-specific coupons.

The CIO
Web-centricity puts additional pressure on organizations to invest
in corporate cloud infrastructure. Chief information officers should,
for example, prepare for the day when consumers, employees,
and suppliers all communicate and interact through the use of mobile
devices that run Web applications. This phenomenon will not
only extend the reach of the enterprise but also place a premium on

4 “M-dot” refers to the URL of a Web site that is optimized for mobile phones. Many

of these sites include an “m.” at the beginning of the URL, such as “m.usatoday.com” or
“m.facebook.com.”
 How new Internet standards will finally deliver a mobile revolution 53

analytics and possibly improve the competitiveness of companies that

can exploit the new Web-centric information and interactions.

CIOs will have to decide whether costs can be cut and productivity
increased by introducing rich applications both horizontally, across
industries (for example, enterprise customer-relationship-management
systems such as Salesforce.com), and vertically, within industries
(say, mobile electronic medical records or smartphone-based claims
processing in insurance). Web-centricity also promises smaller
productivity improvements, such as allowing users to store content
locally for later uploading. Employees will therefore be able to
work without being connected to the Internet—for instance, when
they’re on airplanes.

The CEO
From the perspective of the chief executive officer, Web-centricity
should be part of a broader imperative to elevate the importance
of mobile marketing in corporate strategy. CEOs will need a response
when, as must inevitably happen, they are asked how their com-
panies are dealing with the m-dot revolution, which introduces a mobile
element into everything from commerce to advertising to public
relations. What’s needed is not just the coordination of mobile initia-
tives from functional offices, however. CEOs must take a big-picture
approach to the collective implications of Web-centricity, the way it
redefines a company’s interactions with employees and customers,
and the challenges and opportunities it presents.

Of course, Web-centricity will require spending money to make money.

Organizations will have to make IT investments, particularly for
cloud-based computing and mobile platforms. Employees, especially
in sales and operations, will need training in the art and science
of mobility if companies are to maximize cost savings and productivity
improvements. Yet Web-centricity also promises to make the mobile-
Internet experience more open, complex, and dynamic. It may change
the way consumers and enterprises behave. Even if companies don’t
understand the technical aspects of this transition, they must master
the technology’s potential and possible ramifications.

Bengi Korkmaz is an associate principal in McKinsey’s Istanbul office;

Richard Lee is a principal in the Seoul office, where Ickjin Park is an
associate principal.

Copyright © 2011 McKinsey & Company. All rights reserved.

We welcome your comments on this article. Please send them to
quarterly_comments@mckinsey.com.
54 2011 Number 3
Winning the
Web standards
battle
Jacques Bughin
HTML5 offers many advantages,
from a better video experience to
easy access to programs when
users are offline. But history tells
us that the better platform doesn’t
always win. Consider how Betamax
foundered during early efforts
to set a standard for home videos,
although it was considered to be
better technically than its rival, VHS.
The critical issue in platform com-
petition is whether a new technology
can create a vibrant ecosystem of
large and small players. With HTML5,
this means providing an environ-
ment that not only enables a better
user experience but also makes
it possible for innovative new Web
programs to scale rapidly and for
industry players to gain significant
benefits. Web companies that
rely on advertising revenues, for
example, may want to use HTML5
to help expand their reach, making
mobile devices and even TV screens
frictionless portals to the Web.
Apple and Nokia would want the new
platform to enhance the user experi-
ence in ways that stimulate sales
of their smartphones and tablets.
Recent research on standards-
based competition highlights four
issues, unrelated to the consumer
experience, that will help determine
the platform of the future.1 Execu-
tives should keep a careful watch on
them to find out whether HTML5
will reach its potential or be stymied
by the difficulties that sometimes
block the progress of new standards.
1. What developers do
A winning platform needs to cap-
ture the hearts and minds of the best
developers. HTML5’s flexibility
should be a strong selling point for
many, but sheer numbers aren’t
enough. To create compelling value,
a platform must also encourage
collaboration among talented pro-
grammers and content developers.
This leads to greater innovation and
to applications that excite a critical
mass of new users.
The preferences and goals of
developers will also affect the pace
of change. Some may be satisfied
with the returns they currently get
from app stores. For others, the
allure of wider reach, multiscreen
access, and, potentially, a more
significant distribution and marketing
platform could make HTML5’s open
standard more attractive.
2. How the economics evolve
The actions of developers and
companies will reflect the economics
of paid applications and advertis-
ing. Apple, through its App Store, has
demonstrated that the paid mobile-
content model can succeed. It’s also
clear that mobile advertising finally
has taken off as smartphones have
improved. Mobile Web search
now spins out revenues from paid
keyword advertising, much
as the PC-based Web does. Still,
analysts remain uncertain about
which of these two models will
gain ascendancy. How much will
customers be willing to pay for apps?
(If demand for paid ones hits a wall
as users resist paying for specialized,
“long tail” programs—which don’t
have mass appeal but seek to attract
niche users beyond the first wave
Winning the Web standards battle
of hits—that would be a boon for
HTML5.) Will advertising revenues
grow in line with rising numbers
of mobile users? (If not, Web-based
HTML5 applications might be less
attractive for developers than apps
they can charge for.)
The answers to such questions
will determine whether the mobile
Web looks more like today’s
PC-based market (advertising and
paid content are about equal
in importance) or today’s mobile-
Internet market (paid-content
revenues are more significant). They
also will have major second-order
effects: if the economics start tilting
one way or the other, developers
will probably steer ever more
of their innovative efforts toward the
winner—paid applications or
advertising-supported content. A
similar virtuous cycle could
affect the decisions of advertisers,
whose returns on mobile digital-
marketing investments will increase
along with the size of the audience
consuming ad-supported content.
3. How platforms fare
At present, the mission of Google’s
Android platform may simply
be to become a broadly accepted
mobile-Web operating system
that ensures the successful transition
of Google’s core search business
to smartphones. An open-source
model can help maximize reach,
with revenue coming not from tradi-
tional licensing deals but from
alternative sources such as mobile
advertising. But what if ad growth
hovers below expected targets?
Similarly, if the mobile environment
becomes more open—more like
today’s PC-based Internet—will
Apple and others continue to nurture
their walled-garden operating
platforms?
55
4. How the technical issues
play out
When hardware and software pro-
ducers, as well as service providers,
can easily incorporate elements
of a platform, momentum for the
standard increases. Interfaces—
the specifications that allow diverse
systems and hardware to interact
readily—are often the key. In the PC
world, a powerful impetus toward
standardization was BIOS, 2
which provides rules for how Intel
processors handle instructions
from software programs and com-
municate with other components
and devices. On today’s mobile
battlefield, complexity reigns.
Apple’s mobile interface ties the
iPhone’s operating system to
custom-built processors. Android
and Windows Mobile systems
interface with chips designed by
Intel, Qualcomm, and Samsung.
While this fragmentation could slow
down HTML5’s adoption, it could
also set up a healthy competi-
tion for a faster, more robust HTML5
interface that will enhance the
standard, leading to greater innova-
tion and, ultimately, to higher
sales of chips.
1See, among other sources, Carliss Y. Baldwin
and C. Jason Woodard, “The architecture
of platforms: A unified view,” Harvard
Business School working paper, Number
09-034, September 2008; Martin Kenny
and Bryan Pon, “Structuring the smartphone
mobile industry: Is the mobile Internet
OS platform the key?” ETLA working
paper, Number 1238, February 2011; and
Michael Cusumano, “Technology strategy
and management: The puzzle of Apple,”
Communications of the ACM, 2008, Volume
51, Number 9, pp. 22–24.
2Basic input/output system.
Jacques Bughin is a director in
McKinsey’s Brussels office.
68

Nudging the world

toward smarter
public policy: An interview
with Richard Thaler
 69

Public and private data alike will

become more transparent, says behavioral
scientist Richard Thaler. That’s an
opportunity for some companies and a
threat for others.

Richard Thaler is the rare academic whose ideas are being

translated directly into action. Since last year, the University of Chicago
professor has been advising the “Nudge Unit,” established by the
government of the United Kingdom to create policies that will enhance
the public welfare by helping citizens make better choices. The group
gets its name from Nudge: Improving Decisions about Health, Wealth,
and Happiness (Yale University Press, April 2008), the book Thaler
coauthored with Harvard Law School professor Cass Sunstein, which
applies the ideas of behavioral economics to public policy. Policy
makers can nudge people to save more, invest better, consume more
intelligently, use less energy, and live healthier lives, Thaler and
Sunstein argue, through greater sensitivity to human tendencies such
as “anchoring” on an initial value, using “mental accounting” to
compartmentalize different categories of expenditures, and being
biased toward the status quo.

In this interview with University of Sydney professor Dan Lovallo and

McKinsey’s Allen Webb, Thaler describes some of the Nudge Unit’s
early efforts to boost both organ donation rates and the volume of data
that governments and businesses share with individuals. The more
transparent data environment envisioned by Thaler holds profound
implications for business leaders. “Strategies that are based on
obscuring the consumer’s choice,” argues Thaler, will not be “good
long-term strategies.”

The Quarterly: What’s your sense of how the Nudge Unit came about
in the first place?
Artwork by Sandra Dionisi

Richard Thaler: I got to know David Cameron and George Osborne1

right after Nudge came out. One of their young staffers had read it
and passed it on to them. Mr. Cameron liked it and put it on a required
summer reading list for the Tory MPs. Gratifyingly, this turned out

1 David Cameron and George Osborne have been, respectively, the prime minister and

chancellor of the exchequer of the United Kingdom since May 2010.

70 2011 Number 3

not to be just a campaign gimmick. When they got in office they said,
“Let’s try to do something.”

People in Downing Street call it the Nudge Unit, but the official term
is the Behavioural Insight Team. A bunch of bright civil servants on the
team are going around trying to get agencies to think about how they
incorporate this tool kit into the things they do. It’s hard to know whether
this is early days of a new administration or people being polite to me.
But I’ve been very pleasantly surprised with the openness—almost the
eagerness—of people to talk to us. I’m sure that there are skeptics.
But they are keeping that skepticism to themselves, at least initially.

The Quarterly: What is the core message you try to deliver in

those meetings?

Richard Thaler: My number-one mantra from

Nudge is, “Make it easy.” When I say make it easy,
what I mean is, if you want to get somebody to do
something, make it easy. If you want to get people to
eat healthier foods, then put healthier foods in the
cafeteria, and make them easier to find, and make
them taste better. So in every meeting, I say, “Make
it easy.” It’s kind of obvious, but it’s also easy to miss.

The Quarterly: Which of your ideas seem to be

gaining the most ground?

Richard Thaler: Two things seem to have traction.

Richard Thaler is the Ralph and
Dorothy Keller Distinguished
Service Professor of Behavioral
Science and Economics at the
University of Chicago Booth
School of Business and is the
research associate and codirector
of the Behavioral Economics
Project at the National Bureau of
Economic Research.
One is building on the idea of changing defaults,
which is an idea that had already caught on. A big
pension reform that Adair Turner2 took on had
automatic enrollment built into it.
The Nudge Unit has an advisory committee, and
in the very first meeting with the committee we said,
“Let’s try to do something about organ donations.”
The idea I’ve been pushing on for that is something I
call “prompted choice” that we use in Illinois, where
I live. When you get your driver’s license renewed,
they ask, “Would you like to be an organ donor?” In
Illinois, that doubled the number of people on the
organ donation list. So a decision has been made

2 Adair Turner, an alumnus of McKinsey, served in 2002 as chairman

of the UK Pensions Commission. Currently, he is chairman of the

Financial Services Authority and the Committee on Climate Change.
Nudging the world toward smarter public policy 71

to do this in the UK, starting with motor vehicle registration and

possibly moving to the National Health Service, which could
make more sense in the UK, since everybody’s enrolled in that and not
everybody has a car.

The Quarterly: So defaults, which have already had an impact

on pensions in the UK, are now coming to organ donation. What’s the
second big priority?

Richard Thaler: The second thing that is getting traction is about

data. There’s a big report the Nudge Unit has written, and the interesting
thing here is they have gotten a big bunch of companies to agree to sit
at the table and help design this.

One general principle is that lots of good things can happen if the govern-
ment just releases data it already has in machine-readable, download-
able format. A good example of this is in San Francisco, where the Bay
Area Rapid Transit system has for years had GPS locators in all their
buses and trains. There was some big control room someplace where you
could see all these things moving around. They took that data that
they already had and put it online in real time in a format that app
designers could tap into. Now there’s an iPhone app that knows where
you are and will tell you when the next bus is coming.

So that’s one part: government releasing data. The second part is getting
firms to release data. One goal there is to get complete price transpar-
ency. Another initiative is getting companies that are collecting data on
your usage to share that data with you. When it comes time to renew
my smartphone calling plan, I’d like to be able to get a file that I could
upload to some Web site that would tell the search engine the way I
use the phone and, so, what features I should be looking for. It might even
be able to tell me, if I’m about to switch to some new model, how much
more my data usage is likely to jump based on past experiences.

The Quarterly: What are the business implications of the data policies
that the Nudge Unit advocates?

Richard Thaler: I firmly believe there’s a kind of regulation that can

improve competitive outcomes that some firms should be afraid of but
others should welcome. It’s clear that some companies’ explicit strategy
is obfuscation. Rather than “make it easy,” their goal is to make it hard:
They make the pricing strategy obscure. They make it easy for the con-
sumer to screw up. And then they make a lot of money.
 72 2011 Number 3

“There’s an opportunity for firms that want to

compete on the basis of fair dealing.”

Right now, it’s very easy to find what the best airfare is from Chicago to
San Francisco. It’s not so easy to find all the charges that might
come associated with that, especially if you have a big suitcase. And
there are plenty of stories of credit card companies that are making
all their money on late fees and increases in interest rates, and debit card
companies that will stick a big charge that puts you over the limit at
the head of the queue, so that the next six times you swipe your card for
a coffee, you get charged 25 bucks each time.

Now, in my dream world, through all these data release programs, we

make it easier for consumers to be smart shoppers, because the release
of the data spawns Web sites that offer shopping tools. It’s not that
we want consumers to spend any of their time poring through Excel
spreadsheets. We want them, with one click, to be able to go to a Web
site and be told, “Your credit card company is charging you hundreds
of dollars worth of fees, and if you switch to this other one that sends
you text messages when you are about to go over your limit, you could
cut your costs in half.”

Many firms view this with fear and trepidation, and some of them should.
But others should view this as an opportunity. There’s an opportunity
for firms that want to compete on the basis of fair dealing. If we really
succeeded with all these initiatives about transparency and making
it easier to shop, then we’re going to make it possible to compete on
a completely different level. Firms that honestly can say to themselves,
“We succeed by having the best products and treating our customers
fairly, and we’re getting screwed by the unscrupulous guys”—they
should welcome this initiative. The ones who are doing the opposite
should fight me tooth and nail.

The Quarterly: You described a more transparent environment

as your dream world. Can you point to places where it may become a
reality anytime soon?

Richard Thaler: The US Consumer Product Safety Commission has

created a national Web site where people can post complaints about
products, such as children’s cribs.3 This is an issue that’s near and dear

3 See www.saferproducts.gov.
 Nudging the world toward smarter public policy 73

to my heart because two of my good friends had an 18-month-old

son die in a crib accident at day care—in a crib that had been recalled,
but there was no way to find out about that.

Now, there are companies that are fighting this because, they say, some
of the information that will be posted will be malicious. While of
course it is true that some people may post bad reviews of products—
and even the greatest products have some detractors—a good prod-
uct will manage to overcome some bad-mouthing in the social media.
If you’re really proud of your product, then you won’t mind a complete
airing of people’s opinions.

What firms have to understand is, this sort of transparency initiative—

and, in fact, more generally, the whole Nudge approach to government—
is a middle ground. The alternative is having the government admin-
ister a two-year test of every product you make. That is much worse
from a producer’s point of view.

We’re all going to make some mistakes, and nobody builds a crib that’s
intended to strangle toddlers. But sometimes they’ll build a crib
that human parents will set up wrong. A crib’s got to be designed in a
way that nobody can possibly set it up wrong. And if somebody fig-
ures out how to set it up wrong so that it’s dangerous to kids, the manu-
facturer should want to know.

The strategy of dealing with these things by settling lawsuits with the
unlucky consumers, subject to nondisclosure, is not one that’s good
for the world. Strategies that are based on obscuring the consumer’s
choice are not good long-term strategies. And I would encourage
firms that are making their money that way to think long term and think
about how they can survive in a world where everything is trans-
parent and obvious.

Dan Lovallo is a professor at the University of Sydney; a senior

research fellow at the Institute for Business Innovation at
the University of California, Berkeley; and an adviser to McKinsey.
Allen Webb is a member of McKinsey Publishing and is based
in McKinsey’s Seattle office.

Copyright © 2011 McKinsey & Company. All rights reserved.

We welcome your comments on this article. Please send them to
quarterly_comments@mckinsey.com.
74

Why good companies

create bad regulatory
strategies
Andre Dua, Robin Nuttall, and Jon Wilkins
 75

Too few ask themselves, “Why would

anyone agree with us?”

As the preceding interview with Richard Thaler emphasizes,

the field of behavioral economics is rapidly making its way into the tool
kits of regulators. In stark contrast, we’ve rarely heard, in our work with
more than 300 companies over the past three years, a senior exec-
utive consider the impact that cognitive biases might be having on
his or her company’s regulatory posture. That’s understandable—people
don’t like to think about the mistakes they could be making—but it’s
also a missed opportunity. Our sense is that looking at regulatory strat-
egies through the lens of behavioral economics can help clarify the
missteps corporate leaders make and the corrective measures they
should pursue.

We’re not suggesting that leaders are downplaying the importance

of setting an effective regulatory strategy. On the contrary, in a survey
of roughly 1,400 global executives we conducted in January 2011,1
more than half of all respondents agreed that governments and regula-
tors will be among the stakeholders with the biggest economic
impact on their companies over the next three to five years (exhibit).
An even larger proportion expects governmental involvement in
their industries to increase over that period—all this despite recent
conservative shifts in the United States and the United Kingdom.
Artwork by Sandra Dionisi

Nonetheless, a surprising number of corporate leaders and companies

continue to take positions that may seem credible internally but are
totally incredible to outside observers and regulators. Simply put, there’s
a disconnect between external perceptions and internal beliefs that
often undermines efforts to engage productively with regulators. For

1 “Managing government relations for the future: McKinsey Global Survey results,”

mckinseyquarterly.com, February 2011.

 76 2011 Number 3

evidence of this disconnect, consider some other results from our

January 2011 survey. Seventy-six percent of global executives responding
said they believed that regulators would rate their companies’ repu-
tations as positive. Yet less than a quarter said that their companies
frequently succeeded in inf luencing regulatory decisions. These
executives think they’re doing right in the eyes of regulators, but their
own, self-reported results say otherwise.

Q3 2011
Biases in action
Regulatory strategy
Exhibit 1 of 1
The inflated view many executives hold of their companies’ reputations
with regulators is consistent with the well-known cognitive bias of
excessive optimism, which tracks with actions we see companies take

The economic impact of governments and regulators is

large and growing, according to global executives.

Expectations for the next 3–5 years, % of respondents1

Expected change in
Stakeholders expected to have the greatest effect on level of involvement with
economic value of respondent’s company respondent’s industry

Customers 74
Government

Government and/or Increase 61%

53
regulators2
Stay the same 27%

Employees 49 Decrease 12%

Investors 28 Regulators

Increase 64%
Suppliers 17
Stay the same 25%

Media 9 Decrease 9%

Nongovernmental
3
organizations (NGOs)

Organized labor 2

1 Respondents who answered “other” or “don’t know” are not shown.

2Respondents could select multiple stakeholders; 36% selected government, and 29% selected regulators, which were
distinct categories. Altogether, 53% of respondents selected government, regulators, or both.
Source: Jan 2011 McKinsey survey of 1,396 executives representing the full range of industries, regions, functional
specialties, tenures, and company sizes
Why good companies create bad regulatory strategies 77

all the time. For example, until recently most leading smartphone
software players seemed to be taking a “less said, best said” approach
to the thorny issue of tracking user locations over mobile networks.
They have adopted a posture similar to that of Internet companies,
which have remained confident that their services’ value to users
more than offsets privacy concerns. Observing positions like these,
it’s been natural for us to reflect on the experience of several European
airport operators, which were so convinced they would never
be broken up that they simply didn’t entertain the possibility—until
it happened.

A related challenge for companies in regulatory strategy is putting them-

selves into the shoes of policy makers. Consider the proposals many
companies made for grants, loan guarantees, or other government
funding as part of the American Recovery and Reinvestment Act
of 2009. A surprising number didn’t mention job creation! Similarly,
many companies fail to use the “budget math” of entities such as the
US Congressional Budget Office to discuss the impacts of proposed
legislative or regulatory changes. Others fail to take into account
how the cost–benefit functions of government agencies operate or the
best way to communicate with them.

Another issue for regulatory strategists is the prevalence of “stability”

biases that create a tendency toward inertia. The impact of such
biases is acute in regulatory settings because the typical career track
of successful executives in many industries—save highly regulated
ones, such as telecommunications or electric utilities—doesn’t involve
exposure to government issues. As a result, those executives often
are personally ill-prepared for shifting political winds that boost the
importance of regulatory issues and are prone to underinvest in
the regulatory skills of their organizations or to delegate without exer-
cising sufficient oversight. That’s one explanation for the frequency
with which companies must rapidly scale up their government-relations
function when they or their industries enter the crosshairs of
regulators—a phenomenon we saw during 2009 and 2010 as the US
health care reform debate heated up.

Countering biases

Addressing cognitive challenges like these is hard because executives

can’t change how their brains work. What they can do is put in
place processes for challenging entrenched beliefs and approaches.
 78 2011 Number 3

A good question for companies to ask is,

“Why would anyone listen to us?”
Leadership teams should subject themselves
to this question on a regular basis.

Drafting outside directors or a rotating group of senior managers from

inside the company to argue for contrary positions sometimes helps.
One European telecommunications company we know created, while
it was still a quasi monopoly, a process for generating contrarian
scenarios, such as complete breakup. These scenarios helped it recog-
nize the potential for, and successfully pitch to regulators, a milder
form of separation.

A good question to ask during sessions like these is, “Why would anyone
listen to us?” Leadership teams should subject themselves to this
question on a regular basis—perhaps by conducting war games in which
they explicitly put themselves in the shoes of other stakeholders or
“voice of the stakeholder” exercises in which they interview (and figure
out what is most important to) regulators, political actors, and the
public at large. Such initiatives boost the odds of taking positions that
are well received. Several companies we know used approaches like
these to frame their proposals for contracts related to the US stimulus
package, and they won five times the funding of counterparts that
did not.

There also are steps companies can take to ensure that regulatory
strategy is not ignored. One large European telecommunications com-
pany has a monthly “reg-watch,” led by the CEO, in which senior
managers review emerging issues and a wide range of plausible scenarios,
including their financial implications. Getting regulatory strategy
on a board’s agenda also helps. And to strengthen organizational muscle,
companies should build an exposure to government relations into
talent development and job rotation for high-potential managers.

The disciplined embrace of processes like these can help executives

avoid embarrassing themselves by taking positions that seem
 Why good companies create bad regulatory strategies 79

implausible to outsiders. It also may provide a common vocabulary

for communicating with regulators as they increasingly employ the
tools of behavioral economics. Most important, it should help leaders
navigate today’s choppy regulatory waters and achieve outcomes
that are sustainable and that serve as a source of competitive advantage
against less adroit—and self-aware—competitors.

Andre Dua is a director in McKinsey’s New York office, Robin Nuttall

is a principal in the London office, and Jon Wilkins is a director in the
Washington, DC, office.

Copyright © 2011 McKinsey & Company. All rights reserved.

We welcome your comments on this article. Please send them to
quarterly_comments@mckinsey.com.
80

Special report

Rediscovering Japan’s
competitive edge
Even before the massive earthquake
that shook Japan on March 11, 2011,
Japanese companies faced daunt-
ing competitive challenges. This pack-
age offers perspectives from three
Japanese CEOs and two teams of
McKinsey experts on the road
ahead for Japanese business—which
matters for executives everywhere.
Japan remains the world’s third- 82
Introduction:
largest economy and the country
Toward a lasting recovery
that revolutionized mass production Yasuchika Hasegawa
through lean manufacturing. A
new book, Reimagining Japan: The
83
Quest for a Future That Works Rebooting Japan’s high-tech
(Shogakukan, July 2011), is the source sector
Ingo Beyer von Morgenstern,
of these voices, and many more,
Peter Kenevan, and Ulrich Naeher
on the country’s future.
86
Staying in the game
Keiji Inafune
Artwork by Yuko Shimizu

90
Japan’s globalization
imperative
Naoyuki Iwatani, Gordon Orr, and
Brian Salsberg

93
Dare to err
Tadashi Yanai
81
82

Introduction:
Toward a lasting recovery

Yasuchika Hasegawa is the president and

CEO of Takeda Pharmaceutical Company,
Japan’s largest pharmaceutical manufacturer.

Japan, as every Japanese schoolchild learns, is a small, crowded

nation, perched atop shifting geological plates and surrounded by often
violent seas. For thousands of years, people living on this volatile archi-
pelago have coped with extraordinary natural calamities. When battered
by the elements, we endure. We grieve, we join together, we rebuild—
and we come back stronger than before. Indeed, our capacity to survive
and even thrive in the aftermath of shocks like those we suffered this
past March is part of what defines us as a nation and as a society. And
so, even as I mourn the victims of the Tohoku tragedies—the many
thousands of lives lost, the hundreds of thousands forced from their homes—
I also know Japan will recover from these terrible shocks as we have
recovered from shocks before.

At the same time, though, I am troubled. Despite our

In Reimagining Japan, 80 con-
tributors, including CEOs,
economists, Japan scholars,
foreign-policy experts,
authors, and journalists, as well
as stars from sports and
culture, share perspectives on
Japan in essays that are
insightful and thought provoking—
and sometimes contradictory.
The book, which was edited by
McKinsey’s Clay Chandler,
Heang Chhor, and Brian Salsberg,
will be published in English-
and Japanese-language editions
in July 2011.
long record of withstanding sudden external shocks,
we are less successful in combating gradual, long-
term challenges, especially when the origins of those
problems are homegrown. Before the earthquake struck
us, our nation struggled with many such long-term
challenges. As we recover from the disaster in Tohoku,
we must not neglect those long-term problems. The
scale of our nation’s challenge is therefore huge, and the
urgency for change is phenomenal. Business leaders,
politicians, government officials, and citizens—all of us
have to mobilize to produce the changes we need.
In the days before March 11, I felt our nation was in
deadlock. If one group proposed changes, then the other
parties were likely to oppose it. While the Tohoku
disaster has certainly brought us closer together, we
must maintain that sense of unity and purpose not
only in recovering from the earthquake and the tsunami
but also in comprehensively addressing all our longer-
term problems as well.
 83

Rebooting Japan’s
high-tech sector
Ingo Beyer von Morgenstern, Peter Kenevan,
and Ulrich Naeher

For many decades, Japan’s high-technology companies, nourished

by innovative products and prominent consumer electronics brands, were
the envy of the world. But that is rapidly changing. More recently, these
companies have been losing ground globally, undermined by a reluctance
to make the aggressive moves and hard choices necessary to compete
in new markets and against emboldened attackers.

Recent McKinsey research shows that Japanese high-tech companies

lost a decade between 2000 and 2010 (exhibit). On the current trajectory,
by 2013 their global market share will be 20 percent lower than it was
in 2008. That represents a cumulative loss of more than $30 billion in
potential revenue. Japanese companies have a global presence and
reputation, but most remain surprisingly dependent on Japan’s domestic
market for revenue, while struggling to capture a reasonable share of
dynamically growing emerging markets. Our analysis shows that Japanese
high-tech companies, as a group, still generate more than 50 percent
of their sales in the home market, growing by a mere 1 percent annually,
compared with growth of 5 to 10 percent in the developing world and
2 to 3 percent in other developed markets. As a result, Japanese companies
will see their global market share decline rapidly even if they success-
fully defend their current share in each market.

But the situation is potentially worse. Japanese companies are also

losing share in major products within key geographic markets. Between
2005 and 2009, these players’ share of LCD-TV unit shipments grew
to 100 percent, from 96 percent, in Japan but fell to 30 percent, from
40 percent, in North America. Also, total unit-volume growth in Japan
during this period was very small relative to growth in North America
and elsewhere. The pattern is similar for a number of other products,
such as servers—success in Japan but failure abroad. For PCs and mobile
phones, share declined even in the critical Japanese home market.

In addition, Japanese companies have almost no position in the critically

important software and IT services markets outside of Japan. As a
result, by 2013 these companies will probably have missed out on almost
 Q <_> <_>
<Article slug>
84 2011 Number 3
Exhibit <_> of <_>

Japanese high-tech players experienced a lost decade

between 2000 and 2010.

Revenue; index: revenue in 2000 = 100

300

260
Industry high
performers1
220

180

140

100
Japanese high-tech
companies2
60

0
2000 2002 2004 2006 2008 2009

Operating profit margin, %

11

10

9
Industry high
performers1
8

5
Japanese high-tech
companies2
4

0
2000 2002 2004 2006 2008 2009

1 Average of revenues for Acer, Apple, Cisco, HP, Lenovo, LG, and Samsung.
2Average of revenues for Canon, Fujitsu, NEC, Panasonic, Sharp, Sony, and Toshiba.

Source: Annual reports; Bloomberg; Nikkei Financial QUEST

Rediscovering Japan’s competitive edge 85

half of the absolute expansion in the global high-tech market since

2008. Most of the growth will come from the United States and Europe,
where Japanese companies have a limited presence. Market share
changes little in these incumbent-dominated geographies, and most
major movements that do occur reflect large-scale mergers and acqui-
sitions. Unless Japanese companies join the party, they will be locked out
of some of the most attractive growth and profit opportunities.

As a result of focusing on the wrong geographic markets and losing share

within many of them, Japanese companies are sliding down the ranks
of the leaders in units sold across a range of product sectors. In 2004,
these companies held the number-one and -two spots in LCD TVs, but
by 2009 their South Korean rivals Samsung and LG had taken a com-
manding lead. Similarly, Japanese companies occupied three of the
top five slots in the global PC market in 2004, but only one in 2008. This
rapid loss of leadership in important product categories in consumer
electronics may be disastrous in the context of the winner-takes-all
dynamic of the high-tech sector, where the top one or two players in
each submarket tend to capture all the value.

Breaking out of their current inertia will require the senior managers of
Japan’s high-tech giants to take bold steps. Some should pursue cross-
border deals—a form of shock therapy—or capability-building alliances.
Others will need to sharpen their focus by divesting underperforming
noncore assets such as white goods or semiconductors. The growing impor-
tance of emerging markets will make it imperative to become insiders
there by building up local distribution capabilities while improving local
R&D and product design to better address the preferences and eco-
nomic needs of local customers. In some cases, Japanese companies should
even consider offshoring the headquarters of business units to shorten
decision-making processes and expose senior managers to local mar-
ket conditions.

Moves like these (which we describe in more detail in the full-length

version of this article, on mckinseyquarterly.com) may sound dramatic.
But competitors are moving very quickly. Although Japanese com-
panies still have many of the underlying assets and skills they need to
compete globally, the time for Japanese executives to set clear
strategic priorities and make hard, but necessary, decisions is now.

Ingo Beyer von Morgenstern is a director in McKinsey’s Shanghai

office; Peter Kenevan is a principal in the Tokyo office, where Ulrich Naeher
is a director.
86

Staying in the game

Keiji Inafune is CEO of Comcept and a

creator of video games. He is the former
head of global R&D at Capcom, an Osaka-
based video game developer.

Ten years ago, the Japanese game industry was number one in the
world: Japanese companies created over half of the 50 best-selling game
titles. In 2002, we claimed about a 50 percent share of global revenues.
Not any more. Nintendo continues to be wildly successful; otherwise,
there are now only a few Japanese games in the top 50, and Japan’s
share of the $60 billion global game industry has fallen to 10 percent.

We’ve forfeited our lead in technology; Japanese game technology is now

at least five years behind that of competitors in the United States.
And our approach to content has not changed much in the last decade.
The technical quality and the user interfaces have improved some,
but the ideas, the game play, and the design are basically the same.
There’s not enough originality.

Look at Dragon Quest, which was Japan’s best-selling game in 2009. The
content hasn’t changed that much from when it was introduced, in
1986; it even uses the same characters. Now compare Call of Duty, devel-
oped by California-based Activision and currently the world’s most
popular video game. The look and design are completely different from
the original version, released in 2003. The technology has raced ahead
and gives the player a real feeling of being in the middle of a battlefield.

So we—meaning Japanese game creators, company management, users,

all of us—have to admit that Japan has fallen behind. If we fail to
acknowledge this, we will not be motivated to learn from the United
States, the current leader, and to change.

Many factors have contributed to the Japanese game industry’s loss of

global leadership. But I think there are three big reasons: game creators
are like “salarymen,” the costs and risks of game creation are increasing,
 87

and Japan doesn’t know how to compete in overseas markets. One of

the most fundamental problems is the way Japanese game companies
are organized. They tend to be structured like any other big Japanese
company. The key managers join for life and advance by seniority. Even
the game creators think like salarymen, not that differently from
bureaucrats. These salarymen don’t have to take risks. They’re not inter-
ested in working hard. Month in and month out, they can count on
a steady paycheck as long as they avoid making mistakes. No one is moti-
vated to generate ideas or try new things.

In the West, game creators are often independent. They get evaluated
and rewarded according to their results. In-house game creators change
companies regularly. The model is similar to that of Hollywood, where
people jump from project to project depending on what talent is needed
where. A director will work with one set of actors or a certain team
of special-effects experts for one film and with a completely different
group for his next film. Japan’s game industry is more like the old
Hollywood system, where players were under exclusive contract to a par-
ticular studio. What’s interesting is that over time, the Japanese movie
industry is becoming more like the Hollywood of today. I believe the eco-
nomics of Japan’s game industry will eventually force it to follow that
pattern. But for now, we’re stuck in the past.

For game companies, retaining the traditional Japanese corporate orga-

nizational structure is a huge liability because such a structure restricts
the ability to hedge risk. In the past, creating a new game title cost
about 200 million yen,1 but these days, producing a successful game can
cost more than ten times that. The cost of failure has gone way up.
“Shooter” games like Call of Duty are hugely popular outside Japan. But
they’re expensive to develop, so Japanese game companies have shied
away from them. The obvious solution is for a Japanese game company
to team up with an experienced US game developer who knows how
to create a shooter game and thereby minimize the risk of failure. But
Japanese companies won’t do that; instead, they insist on working
only with their own in-house game creators.

So for now, the Japanese game industry is trapped in a vicious cycle.

The global industry is changing drastically. The technology, especially
from the United States, is racing ahead, and production costs are
soaring. But Japanese companies won’t adapt. They don’t know how to
collaborate with outside partners. They’re oblivious to what’s hap-
pening overseas. And they’re still trying to develop hit games on the
cheap; they are reluctant to invest the billions of yen required.

1 About $2.4 million, as of June 2011.

88 2011 Number 3

In the past, Japanese game makers could get away with ignoring
overseas competition because of the size of the domestic market and
because Japanese players weren’t all that interested in games from over-
seas. But now the Japanese market is shrinking. And the smaller
Japan’s home market, the less Japanese companies have to invest in games
that might be competitive outside Japan. In South Korea, where the
domestic market is smaller, the game industry recognized from the start
that it would have to go global to survive. Now they’re ahead of us in
many ways. So what first looked like an advantage for Japan’s game
industry—a large domestic market—has proved a handicap.

Of course, Americans still buy some Japanese games. There are many
fans of, say, Super Mario, guys in their 30s and 40s who like it
because they’ve been playing it since they were ten and it gives them a
feeling of nostalgia. But for young kids, who are just discovering
games, Japanese titles don’t have much to offer.

For the most part, games created for the Japanese market aren’t successful
outside Japan. There is a different sensibility between gamers in the
two countries. If you look at US games, the lead character is often non-
typical. He might be bald or some bearded old guy. In Japan, we would
never have a nonstandard lead character; we have a kind of cliché image
of a hero or heroine. Also, overseas games are often more aggressive,
with lots more violence and blood, than Japanese games.

Why? Because Japanese game developers aren’t familiar with other

cultures, and so far have had little incentive to learn. We find it difficult
to understand these nuances. At Capcom, I argued for years that we
should try to develop games tailored exclusively for Western markets.
One of our early efforts was Shadow of Rome, which was a game

Changing from gladiators to zombies made

all the difference. It was a subtle change—to the
extent that zombies can be subtle—but it
worked, because we took the time to figure out
what non-Japanese users would accept.
Rediscovering Japan’s competitive edge 89

involving battling gladiators. It was the right idea, but we went too far.
There was a lot of hacking off of limbs; it was just too bloody. What
we learned was that just adding a lot of violence is not enough to make
a successful game.

So we tried some variations. Eventually, I came up with Dead Rising,

which was the same concept but involved battles with zombies
instead of human gladiators. In some ways it’s even gorier than Shadow
of Rome: not only can you slice off zombie arms but, if need be, you
also can pick up a severed zombie arm and fight with it. But changing
from gladiators to zombies made all the difference. It was a subtle
change—to the extent that zombies can be subtle—but it worked. And
it worked because we took the time to figure out what non-Japanese
users would accept.

Mergers and acquisitions can help Japanese game companies to acquire

the technology and cultural know-how to thrive outside their home
market. But these factors are only part of the solution. You can’t just buy
a company and say, “OK, now we can make good games.” You need
to be able to retain and motivate people at the company after you’ve
acquired it. And you need to study how people in overseas markets
live, how they think, how they talk, how they play games, what motivates
them to improve their game skills.

In sum, for Japanese game companies to regain their global competi-

tiveness, they will need to invest more creatively, act less like bureaucrats,
and do a better job of understanding other cultures. But even in a
creative sector like games, it’s hard for large, established organizations
to change. Last year, after 23 years at Capcom, I decided to follow
my own advice about taking risks. I left the company and have decided
to strike out on my own. I want to try to change the industry. And
I felt that I didn’t want to end up being known only as “Capcom’s Inafune.”
Instead, I want to build my own brand. Think of Steven Spielberg.
He’s not “Universal’s Steven Spielberg.” He’s just Steven Spielberg, even
though he started with Universal.

It may be too late—or too hard—to tackle the US market at this

point. The next big market is China. There I see many opportunities.
My sights are on Asia.
90

Japan’s globalization
imperative
Naoyuki Iwatani, Gordon Orr, and Brian Salsberg

Many Japanese companies should be global leaders, given their

manufacturing and technological prowess and overall size and scale.
But they are not. We analyzed the ten largest Japanese companies
in each of 16 industries to better understand their global profiles. On
average, Japan’s ten largest companies in 15 of these industries—
automotive is a notable exception—are less global than their overseas
peers, as measured by the percentage of revenues, assets, and stock
ownership outside Japan. By those measures, Japanese companies made
no progress toward globalization from 2006 to 2009 (exhibit).

Simply put, the approaches that proved successful in the past—for

example, replicating practices from the Japanese market in foreign
operations—have outlived their usefulness. Recently, there’s been
an uptick in international mergers and acquisitions, a new sense of
urgency in boardroom discussions, and a few bold moves by Japan’s
more progressive companies to use English as a global corporate
language and to recruit talented non-Japanese executives. Still, the pace
is slow and the approach often opportunistic and confused rather
than strategic. To jump-start globalization efforts, Japanese executives
will need to think and act in new and unfamiliar ways, such as the
ones below (which we discuss in more detail in the full version of this
article, on mckinseyquarterly.com).

Make the case for globalization. Many Japanese companies understand

the benefits of globalization. But their executives may lack a compel-
ling “globalization story” for employees—global goals, aspirations, and
value propositions. Are these widely understood and properly com-
municated in a way that excites and energizes the organization while
addressing the anxiety that comes with big changes? Spending time
and effort developing such messages may seem trivial, but a globali-
zation effort won’t get far unless employees are on board.

Design an aggressive talent-management strategy. A 2010 govern-

ment survey of 263 senior Japanese executives found that the single
biggest hurdle for globalization was the “securing and training of human
resources in Japan.” That’s not surprising: few Japanese execu-
 91

tives have ever held an international assignment or worked outside

their companies or business units. Making progress will require many
Japanese companies to rethink HR’s role. Potential actions include
embracing diversity and setting aspirational targets for women, foreigners,
and Japanese managers from other companies and industries; creat-
ing a global rotation program that enables the top 100 to 200 executives
to work abroad in other parts of the company; and holding HR more
accountable for talent strategy and development rather than just internal
placement and recruiting.

Adopt English as the company language. The move to English is critical

for monocultural Japanese companies because it’s hard to get a rich
exchange of talented people across units and geographies without a lingua
franca. The decision to conduct most of the company’s business and
internal interactions in English was an important success factor for the
globalization efforts of multinational companies such as France’s
Danone and Israel’s Teva Pharmaceutical Industries. In Japan, companies
like Rakuten and Uniqlo have announced that they will make English
their corporate language by 2012, and Nissan and Takeda Pharmaceutical
conduct many meetings in English.

Q <_> <_> Build a global marketing function. In 2010, only five Japanese companies
<Article slug> made the WPP BrandZ Top 100, an annual ranking of global brands.
One reason: less than 1 percent of Japanese companies with revenue
Exhibit <_> of <_>
above $1 billion have a chief marketing officer (CMO), the executive

Japanese companies are less global than peers from other countries.

For the top 10 public companies by revenues across 16 selected industries,1 n=160

% external to home country, 2009–101

Japan
Rest of world n=

33 152
Revenues
52 131
24 160
Ownership
47 60

17 134
Assets
44 52
Management, top six 2 937
positions 9 829

1 Specifically, for Japan, the top 10 Japanese companies in each industry; for all others, the 10 largest non-Japanese companies by
revenues. To ensure a representative analysis, we categorized Japan’s public companies into the following 16 industries;
automobiles and parts, basic materials, construction and materials, consumer electronics and leisure goods, durable house
products, financial services, food and beverages, health care, industrial goods and services, media and telecommunications, oil
and gas, personal goods, retail, technology, travel and leisure, utilities.
Source: Bloomberg; McKinsey analysis
92 2011 Number 3

who, for many global companies, makes the final call on the balance
between global and local marketing, on trade-offs among distribution
channels, and on how much to invest in new advertising media. A crucial
step for many Japanese companies, as they consider the creation of
such a position, will be deciding which powers accrue to it and where it
should be in the organizational structure. At least until global brand-
equity thinking becomes second nature in a company, CMOs will need
disproportionate air time at key decision-making forums.

Experiment with new business models. We have observed some com-

panies trying to globalize by experimenting with business models that
are pointedly unlike those at their core. In one approach, the Japanese
company creates a “second home,” which offers freedom from the con-
straints of headquarters—meaning more room for across-the-board
experimentation and for decision making free of home market bias.
Executives can create one by acquiring a foreign business and using
it for pilots and experimentation, by moving a business unit to a foreign
country, or by reorganizing the company to eliminate the distinc-
tion between domestic and foreign markets (a step Panasonic announced
in 2010). Similarly, Komatsu, the world’s second-largest maker of
construction equipment (after Caterpillar), conducts annual reviews of its
business units’ operating plans not at the Tokyo headquarters but in
each of the company’s eight major markets, to signal their importance.

Globalization is a means to an end. The end is to create and sustain a

self-reinforcing cycle of profit growth and value creation, access to
a richer asset and talent pool, and a more compelling value proposition
for employees and investors. Getting there will be difficult for many
senior Japanese executives, figuratively standing on the shore and looking
across the ocean to a world whose languages many of them don’t speak
and whose habits and successful behavior seem radically different.

Nonetheless, most Japanese companies start the journey with considerable

advantages: scale, relative strength in the home market, formidable
quality standards and service, and experience working with an aging and
digitally sophisticated population—not to mention, at the time of this
writing, a strong currency for doing international deals. By ensuring that
faster globalization becomes a leading priority over the next few years,
Japanese executives can “get the boat pushed out into the current” and
start moving their organizations in new directions.

Naoyuki Iwatani and Brian Salsberg are principals in McKinsey’s

Tokyo office; Gordon Orr is a director in the Shanghai office and chairman
of McKinsey Asia.
 93

Dare to err

Tadashi Yanai is chairman, president, and

CEO of Fast Retailing, Asia’s largest publicly
traded clothing retailer.

Japan’s biggest problems are conservatism and cowardice. We

want stability, peace of mind, and safety. But the world keeps changing.
Other countries are growing, while we in Japan stick to our old ways.

One problem is that we look down on developing countries. We should

be willing to learn from companies in these countries if they are better
than us. But we lack the willingness to learn, because we have been
so successful before. That holds true for managers and employees alike.

Another problem is that Japanese business people and companies are

lacking in individuality. Too many people think that everyone must be
the same. That’s a basic fault.

Finally, Japanese companies seem to have their eyes in the rearview

mirror. They have become introspective. I think we should get back
to something more like we were at the end of World War II, when
Japan rose to prominence from a situation in which it had nothing. (It
was during this period that Fast Retailing got started, in 1949.)

We’ve lost that spirit, maybe because we are under the illusion that we
are rich and superior. But many countries are just as rich, and in
Japan income has stagnated for many people for a decade or more. Japan
is still very comfortable to live in, if you are Japanese. But there’s a
difference between being comfortable and being viable. We are gradually
losing our viability.

In short, Japan has been utterly defeated as an economy. We’re losing

the economic game. So why are we being so foolish? Or, more precisely,
why aren’t we learning from our mistakes?
94 2011 Number 3

Learning from mistakes is something that Uniqlo1 has had to do—

several times, unfortunately.

We opened our first store outside Japan in 2001, in London. And we

failed spectacularly. We quickly opened 21 outlets in Britain—and shut
down 16 of them by 2003. In retrospect, that was probably good
because we learned so much. Our big mistake was to try to do things
the British way. We never capitalized on our strengths.

For example, we let Uniqlo’s UK president create a compartmentalized

management team, with area managers, store managers, assistant
store managers, and then the sales staff. Store managers only spoke
with other store managers. We don’t have that kind of class system
in Japan. Our organizations are flat.

China, the second overseas market we entered, was a failure at first

too. We faltered in China because we went too far in adapting to China.
Per capita income is low—about 5 percent of Japan’s—so we figured
we should sell at much lower prices. That was a mistake. Uniqlo has a
Japanese identity; no one wanted a Chinese Uniqlo.

Vegetables were a disaster too. We saw food distribution as a backward

sector, so we went into partnership with a food group, Ryokuken,
in 2002. But vegetables are not an industrial product; you don’t know
exactly when they will be ready or in what volume. We eventually
understood that it would be impossible to succeed unless we ran our
own farms, and we did not want to be farmers. After two years,
we shut operations down.

The important thing is not so much that we failed in these instances

but that we learned and eventually succeeded. In Britain, we now have
more than a dozen stores, including a flagship on London’s Oxford
Street, and are doing well. China is our fastest-growing market, with
almost 100 stores. By 2020, we hope to have more stores in China
than in Japan (800 plus). Uniqlo’s international operations are growing
fast. We now have stores in ten countries, with Thailand, Brazil, and
India in our sights. By 2015, most of our Japanese employees could be
outside Japan.

Failures are always unpleasant; from the right perspective, though,

they can be useful. Our travails in Britain and China fostered resilience
and led us to understand three important things. First, to create the
best possible Uniqlo in other countries, we had to use the best aspects
1 A Fast Retailing company.
 Rediscovering Japan’s competitive edge 95

of our own organization. Second, while globalization is difficult,

it is also essential. And third, to succeed outside Japan requires under-
standing other markets on their own terms. In short, Uniqlo has to be
both Japanese and global. The analogy to Japan as a whole is obvious.

One thing Japan has to get rid of is the idea that things are one way here
and different everywhere else. The Japanese are really strong at
home and incredibly weak away from home. We need Japanese who are
strong away or who don’t distinguish between home and away. We’re
trying to build this idea into Uniqlo’s culture. For example, English is
spoken at business meetings with foreigners, and we want all e-mails
to be in English in a few years.

Most ordinary Japanese industries are bound up by government regu-

lation or by agreements (tacit or explicit) within the industry. The
idea is to create a union or association or something and then use it to
start imposing regulation and preventing competition. I hate that
sort of approach. We do our best to avoid the government–industrial
structures so typical of much of the Japanese economy. These are
meant to be safety nets; in fact, they are shackles on global competitiveness.

My advice for young Japanese is simple: get out of Japan. One of our
weaknesses as Japanese is our ineptness at communicating with other
cultures. Even people who speak English well are closed off psy-
chologically. They don’t speak frankly like I do. There’s this uniquely
Japanese standoffishness, this hesitancy to become too involved.
And it’s detrimental to globalization.

All this sounds pessimistic, but I don’t see this as the counsel of despair.
Japan has everything—people, goods, money, technology, information.
As a nation, we are honest, hard working, and serious. So why are we so
weak? Why don’t we use these strengths to take on the world?

If we give it everything we’ve got and start to move in the right direction,
I’m confident that we will succeed. Even if we experience failure, we can
pick ourselves up and try again. That’s what Uniqlo did—and that is
what Japan can do.

Copyright © 2011 McKinsey & Company. All rights reserved.

We welcome your comments on these articles. Please send them
to quarterly_comments@mckinsey.com.
Applied Insight
Tools, techniques, and frameworks for managers

97 109
To centralize or not Preparing your organization
to centralize? for growth

103 114
When big acquisitions Managing crises and shaping
pay off the future of Chile: An interview
with Sebastián Piñera

Artwork by Dan Page


To centralize or not
to centralize?
Andrew Campbell, Sven Kunisch, and Günter Müller-Stewens
It’s a hard call made harder by power struggles. CEOs can force a more
thoughtful debate by asking three critical questions.
The chief executive of a European
equipment manufacturer recently
faced a tough centralization decision:
should he combine product man-
agement for the company’s two busi-
ness units—cutting and welding—
which operated largely independently
of each other but shared the same
brand? His technical leader believed
that an integrated product range
would make the company’s offerings
more appealing to businesses that
bought both types of equipment.
These customers accounted for more
than 70 percent of the market but
less than 40 percent of the company’s
sales. “You cut before you weld,”
he explained. “You get a better weld
at lower cost if the cutting is done
with the welding in mind.” Managers
in both divisions, though, resisted
fiercely: product management, they
believed, was central to their busi-
ness, and they could not imagine
losing control of it.
The CEO’s dilemma—were the gains
of centralization worth the pain it
could cause?—is a perennial one.
Business leaders dating back at
least to Alfred Sloan, who laid out
GM’s influential philosophy of
decentralization in a series of memos
97
during the 1920s, have recognized
that badly judged centralization can
stifle initiative, constrain the ability
to tailor products and services locally,
and burden business divisions with
high costs and poor service.1 Insuf-
ficient centralization can deny busi-
ness units the economies of scale
or coordinated strategies needed
to win global customers or outper-
form rivals.
Timeless as the tug-of-war between
centralization and decentralization is,
it remains a dilemma for most com-
panies. We heard that point loud and
clear in some 50 interviews we con-
ducted recently with heads of group
functions at more than 30 global
companies. These managers had
found that the normal financial and
strategic analyses used for making
most business decisions do not
resolve disagreements about, for
example, whether to impose a
group-wide performance-manage-
ment system. What’s more, none of
the executives volunteered an
orderly, analytical approach for resolv-
ing centralization decisions. In its
absence, many managers fall back
on benchmarks, politics, fashion—
sometimes centralization is in vogue
98 2011 Number 3
and sometimes decentralization is—
or instinct. One head of IT, for
example, explained that in his expe-
rience the lowest-cost solution
was always decentralization. Another
argued the opposite.
To help senior managers make better
choices about what to centralize
Three questions
Each question defines a hurdle that
a centralization proposal must meet.
A decision to centralize requires a
yes to at least one of them. While the
questions set a high bar for central-
ization, they do not produce formu-
laic answers; considerable judg-
ment is still required. They benefit
companies by allowing advocates
and opponents of centralization to
conduct a debate in a way that
helps CEOs and their senior teams
make wiser choices. The questions
can be asked in any order, but the
one presented here is often natural
to follow.
1
Is centralization
mandated?
The first step is to ask whether the
company has a choice. A corpo-
ration’s annual report and consoli-
dated accounts, for example, are
required by law and must be signed
by the CEO, so it is impossible to
delegate this task to the business
divisions. In this case, the answer
is yes to centralization.
By contrast, centralization is not
essential for compliance with health
and safety laws; each division can
manage its own compliance. So a
and what to decentralize, we have
been refining a decision-making
framework based on our research
and experiences in the corporate
trenches. It is embodied in three ques-
tions that can help stimulate new
proposals, keep emerging ones prac-
tical, and turn political turf battles
into productive conversations.
proposal to appoint a head of group
health and safety would get a no
for this question and would need a
yes from question two or three.
2

Does centralization
add significant
value—10 percent?
If centralization is not mandated,
it should be adopted only if it adds
significant value. The problem,
however, as illustrated by the product-
management example, is how to
judge whether it will do so. This point
is particularly difficult because
corporate strategies rarely provide
clarity about the major sources
of additional value that underpin the
argument for bringing different
business activities together in a
group. The solution, we find, is to set
a hurdle high enough so that the
benefits of centralization will probably
far outweigh the disadvantages,
making the risks worth taking.
Specifically, we suggest asking:
“Does the proposed initiative add
10 percent to the market capital-
ization or profits of the corporation?”
This hurdle is sufficiently high to
make it difficult for advocates of
centralization to “game” the analy-
 Applied Insight
sis, and thus saves the top team’s
time by quickly eliminating small
opportunities from discussion. Start
by considering whether the activity
meets the 10 percent hurdle on its
own. If not, which is most often the
case, you should assess whether it
is a necessary part of some larger
initiative that will meet the 10 percent
hurdle. In practice, the answer to
the 10 percent question does not
require fine-grained calculations.
What is required are judgments about
the significance of the activity,
either on its own or as part of a
larger initiative.
3
Are the risks low?
Most centralization proposals will
not pass either of the two previous
hurdles: they will not be mandated
and will not represent major sources
of additional value. More often, the
prize will be smaller improvements in
costs or quality. In these cases, the
risks associated with centralization—
business rigidity, reduced motiva-
tion, bureaucracy, and distraction—
are often greater than the value
created. Hence, the proposals should
In practice:
European Automation’s product-management problem
Since centralized product manage-
ment was clearly not mandated, the
centralization proposal failed the
first test. The CEO then skipped to
the third test—is the risk of nega-
tive side effects low?—and quickly
concluded that it wasn’t. Central-
ization would reduce commercial flex-
ibility. Moreover, it could make
managers in the businesses less moti-
vated, since they would lose author-
99
go forward only if the risks of these
negative side effects are low.
An initiative to centralize payroll is
likely to get a yes on this hurdle.
Costs can clearly be saved through
economies of scale, and the risks
of negative side effects are low. Pay-
roll operations are not important
to the commercial flexibility of individ-
ual business units, nor are their
managers likely to feel less motivated
by losing control of payroll. More-
over, the risks of bureaucratic ineffi-
ciency and distraction can be
reduced to a minimum if the payroll
unit is led by a competent expert
who reports to the head of shared
services and doesn’t take up the
time of finance or HR leaders.
Any centralization proposal that does
not survive at least one of our three
questions should be abandoned or
redesigned. To see how our approach
works in practice, let’s look at two
companies that recently applied it—
starting with the automated cutting-
and welding-equipment manufacturer,
which we’ll call European Automation.
ity over an activity they considered
important. And if done badly, central-
ized product management could
lead to delays, additional costs, and
uncompetitive products.
So the proposal would succeed or
fail on the second question—the
10 percent hurdle. The CEO sat down
with the heads of the technical
function and the two businesses
100 2011 Number 3
(cutting and welding) to assess
whether centralized product manage-
ment could reasonably deliver an
additional 10 percent in value through
increased sales, higher prices, or
some combination of both. (It was
unlikely, in anyone’s estimation, to
yield major cost savings.)
After considerable discussion based
on estimates of likely profit margins
and on additional sales volumes from
customers who might be influenced
by an integrated product range, the
group judged that if the central-
ized product-management function
was properly managed it could
add 10 percent to the company’s per-
formance. In other words, the oppor-
tunity was big enough to surmount
the 10 percent hurdle.
Yet the business heads still resisted.
The downside of getting it wrong,
they argued, could make things worse
rather than better. But the CEO,
emboldened because the proposal
passed the 10 percent hurdle,
In practice:
Extreme Logistics’ performance-management issue
Sometimes, addressing the three
questions can spark meaningful
conversations that take managers
in unexpected—and beneficial—
directions. This happened at a com-
pany we’ll call Extreme Logistics,
a global provider of food services
to drilling, mining, and other oper-
ations in out-of-the-way locations.
Anticipating slower growth and lower
margins from increased competition,
the company’s CEO asked the HR
leader to consider imposing a single
performance-management system
on all of the five geographical divi-
responded: “Well, all the more reason
for us to work together to get it right.
At our next meeting, let’s have a
plan for how you are going to do this.”
Nearly two years later, European
Automation’s centralization of prod-
uct management has been largely
successful: market share is up, and
the product offerings of the cutting
and welding units are better aligned.
But this example also illustrates the
hard work and real risks involved. The
company had to replace some of its
original product managers because
they did not have the skills to under-
stand both cutting and welding prod-
ucts. Also, with product managers
reporting to the technical function
rather than to business units, some
new products have been technically
strong but less tailored to market
needs, and some product launches
have been delayed. To solve these
problems, the executive committee
is reviewing product-development
plans in more detail and asking for
regular progress reports.
sions. Historically, each had its
own. The CEO felt that a common
one might enable him to have
closer control of costs and manage-
ment quality.
The head of HR proposed a cen-
tralized system that would link a bal-
anced scorecard of metrics to
incentives. Knowing that the CEO
supported the initiative, skeptical
division heads nodded the proposal
through the concept stage. Once
HR began to work out the details,
however, vocal resistance emerged.
One division head said he was
 Applied Insight
Skeptical division heads nodded the proposal
through the concept stage. Once HR
began to work out the details, however, vocal
resistance emerged.
prepared to “play the game” of this
new system if he had to, but only
to ensure that his people got the
bonuses they deserved. Another
worried that the system would under-
mine her management style, which
was to “lead from the front rather
than to treat people as units of
accounting.”
To deal with the emerging political
impasse, the CEO and the head of
HR turned to the three questions.
The initiative clearly did not qualify
as a mandated item. It was also
hard to see it as a major contributor
to the key sources of value added
by the corporate center. Manage-
ment had recently identified these
as encouraging entrepreneurial ini-
tiative, coordinating global cus-
tomers, managing local governments,
and centralizing common oper-
ating activities.
So, if the proposal was to get a yes
to the second question, it would
have to clear the 10 percent hurdle
on its own. This, too, seemed
unlikely. True, the CEO and HR head
could imagine scenarios in which
the hurdle could be met: a 5 percent
cost reduction, plus a 10 percent
improvement in the quality of man-
agers, they reckoned, would suf-
fice. Yet the pair ultimately concluded
that a central performance-
management system would hardly
achieve such goals on its own.
101
Nonetheless, the discussion of sce-
narios prompted the CEO to con-
sider other ways of achieving a sig-
nificant cost reduction and an
increase in management quality. He
considered launching cost reduc-
tion projects and using existing busi-
ness review meetings to create
more demanding profit budgets and
to monitor cost reduction plans,
for example. With regard to manage-
ment quality, the head of HR sug-
gested developing a leadership pro-
gram and setting targets for the
businesses to improve or change
the bottom 20 percent of their
management talent.
Was a centralized performance-
management system, with a balanced
scorecard tied to incentives, essen-
tial to either a cost or management-
quality campaign of the type the
CEO and the head of HR were consid-
ering? They were inclined to think
it was. But in discussions with some
of the business presidents, the
CEO and the HR head became con-
vinced that most of what they
wanted could be achieved without
centralizing the performance-
management system.
That conclusion led to the third
question: how likely was a centralized
performance-management sys-
tem to cause negative side effects?
The proposal failed this hurdle
as well. Some of the business pres-
102 2011 Number 3
idents thought it would make their
managers less motivated. Moreover,
the head of HR, the CEO, and the
CFO all lacked experience running
a system of the type proposed.
Hence, it might become bureaucratic
and distract the corporate center
from the four areas that had previ-
1 
ously been identified as places
where it could add value, and from
the two new initiatives—cost
reduction and management-quality
improvements—both of which
are currently being evaluated to see
if they meet the 10 percent hurdle.
Is centralization mandated? Can it
add 10 percent to a corporation’s
value? Can it be implemented with-
out negative side effects? A pro-
posal to centralize only needs a yes
to one of these three questions.
Yet they provide a high hurdle that
helps managers avoid too much
centralization. Moreover, they stim-
ulate open and rational debate in
this highly politicized area. By giving
those in favor of centralization and
those opposed to it a level playing
field for building a case, these
questions help companies to strike
the right balance between cen-
tralization and decentralization
today and to evolve their organiza-
tions successfully as conditions
change over time.
For more on the evolution of Sloan’s
philosophy of decentralization and the
multidivisional structure, see Alfred Sloan,
My Years with General Motors, New York,
NY: Crown Business, 1990. For excerpts
from some of Sloan’s memorable internal
memoranda, see chapter 3, “Concept of the
organization.”
Andrew Campbell, an alumnus
of McKinsey’s London and Los
Angeles offices, is a director of the
London-based Ashridge
Strategic Management Centre of
Ashridge Business School;
Sven Kunisch is a PhD student
at the University of St. Gallen
Institute of Management and a
visiting fellow at Harvard
Business School; Günter Müller-
Stewens is professor of strategic
management at the University
of St. Gallen.
Copyright © 2011 McKinsey & Company.
All rights reserved. We welcome your
comments on this article. Please send them
to quarterly_comments@mckinsey.com.

When big acquisitions pay off
Ankur Agrawal, Cristina Ferrer, and Andy West
Some deals are quietly creating value that doesn’t make the headlines.
Here’s how.
Senior executives, board members,
and investors are wise to be skep-
tical about big mergers and acquisi-
tions. Indeed, as high-profile fail-
ures have demonstrated, big deals
can destroy significant value for
shareholders.
Yet big deals can create significant
value for the acquirer, even if suc-
cess takes time to unfold. We ana-
lyzed deals that were worth 30 per-
cent or more of the acquirer’s market
capitalization over the past decade
and found that half had created
excess returns to shareholders when
measured two years after the
deal’s completion.1
103
Artwork by Scott Bakal
While the difference between suc-
cess and failure often comes down
to strategy (and only a few situ-
ations give companies clear, compel-
ling reasons to take on the risks
of big acquisitions), successful deals
also result from strong execution.
In case studies of nine of the best-
and six of the worst-performing
deals in our dataset, we found that
successful acquirers employ
several approaches to execution and
integration that are different from
those used by unsuccessful ones—
and different from those typically
used by acquirers in smaller deals.
A closer look at how the success-
ful acquirers behave suggests
104 2011 Number 3
actions that CEOs and their senior
teams can take before, and after, con-
summating big acquisitions in
order to ensure a greater likelihood
of long-term success.
Aim higher than due
diligence
In the hectic pace of integration after
a deal closes, many integration
managers adopt the synergy esti-
mates calculated by the pre-
deal due-diligence team as perform-
ance targets.
Yet how much a company pays for a
deal isn’t necessarily the same as
what it’s worth. Even the best due-
diligence efforts can be only so
good. They’re often constrained by
time and access to data and typi-
cally focus on whether expected cost
synergies alone can justify a deal,
placing more emphasis on how much
could be saved by eliminating
redundant functions, facilities, people,
or products and much less on how
much can be gained through growth.
To compound the error, as indi-
vidual managers weigh the uncer-
tainty of due-diligence estimates
against their own performance risk,
they often translate synergy esti-
mates into even more conservative—
and easily achievable—cost and
revenue targets.
Our case studies suggest that if
companies reassess their synergy
targets after a deal closes, they
seem to achieve higher synergies
than those that don’t. These more
ambitious companies use pre-deal
estimates of synergies not as per-
formance targets but as performance
baselines—the minimum they
expect. What’s more, the successful
acquirers reset their aspirations by
identifying opportunities to trans-
form the business and then building
a fact base to support those
opportunities. Sometimes they came
from fundamental changes to
operations or from providing cus-
tomers with new products or ser-
vices that hadn’t come up in due dili-
gence or weren’t investigated,
as a result of limited time or informa-
tion access.
After a merger between two global
mining companies, for example,
the acquirer had more access to
details on the overlap between
its own and the target’s customer
base and suppliers. Access to
previously confidential information
on the terms and conditions of
sales agreements—and the needs
and expectations of customers—
led to unexpectedly high levels of
cross-selling and bundling between
the target’s and acquirer’s prod-
ucts, as well as unexpectedly lower
input costs, thanks to improved
supply chain management. While
these considerations were not a
large part of the original investment
thesis, they were a major part of
the deal’s success, improving the
combined company’s earnings
before interest, taxes, depreciation,
and amortization (EBITDA) by
more than 20 percent.
Similarly, when a North American
packaged-goods company reviewed
its synergy targets after a deal’s
close, managers learned that the
target company’s marketing
strategy was better than its own.
Importing those and other best
practices helped the company realize
synergies 75 percent above due-
diligence estimates.
Applied Insight
Setting such aggressive target
estimates requires individual leaders
to leave their comfort zones and
share aspirations. Workshops encour-
aging the joint exploration of oppor-
tunities can help. Senior managers
of one large deal in the pharma
industry, for example, summoned
teams from different backgrounds
to a three-day off-site event. It started
with an idea generation session
where each team compiled a list of
growth-related opportunities.
The group then assessed each of
the opportunities, ranking them
by size and priority, and eventually
developed a high-level imple-
mentation plan. In three days, the
group did not discuss the due-
diligence model or its synergy esti-
mates. In the end, the acquirer
uncovered upward of 40 percent
more synergies and rebalanced
its synergy expectations significantly
across teams. In addition, the
teams were motivated by their targets
and believed they were achievable—
a much better outcome than being
allocated a target based on a brief
due-diligence period.
Higher performance targets have
their challenges, of course, and
to meet those targets companies
must have the right kind of man-
agers. In a broad-based survey on
organizational health,2 managers
at the most successful acquirers
reported having a higher-than-
average sense of accountability, as
well as inspirational and author-
itative leadership. Developing those
traits requires companies to create
an environment that encourages
managers to take calculated risks
and gives them confidence to aim
beyond the original size and scope
of the synergy targets. Such an
105
environment includes clearly defined
managerial roles, strong links
between individual performance and
consequences (positive and neg-
ative), and attractive incentives for
high performers.
In one case study, for example,
a global bank in a large acquisition
actively encouraged managers
to develop ambitious business plans
and provided the resources to
pursue them. Managers were gener-
ously rewarded for meeting their
goals but also faced consequences
if they failed: those who missed
agreed-upon targets for a third time
were let go. All of these attributes
can—and, if possible, should—be
developed long before a large
deal is under way. In fact, in a sepa-
rate survey on corporate trans-
formations, respondents in compa-
nies that focused on building
capabilities before an acquisition
were twice as likely to describe
it as successful.3
Assert cultural
control
It’s not uncommon for an acquiring
company to assert control over
the culture of the acquired one—if it
is small. But many executives are
reluctant to do so with really large
deals, taking instead a merger-of-
equals posture or one purporting to
adopt the best of each company’s
culture. That approach, we find, typ-
ically leads to confusion and
reduces accountability, hindering
integration and lengthening the
time needed to get past integration
and on with running the business. In
fact, in our case studies’ exami-
nation of culture, the biggest differ-
ence between successful and
106 2011 Number 3
unsuccessful large deals was the rec-
ognition in the former that one
culture inevitably tends to dominate.
Unsuccessful acquirers typically
discovered that the emerging domi-
nant culture wasn’t always the
best fit for the deal’s strategic intent.
In successful deals, companies acted
more purposefully. They started
by building a fact base to identify
cultural differences, focusing on
extremely targeted improvements to
the acquiring company’s culture, if
needed. Then they spent the majority
of their time explaining the differ-
ences and helping acquired employ-
ees understand what they needed to
do to migrate toward the culture
of the new organization. Finally, they
aggressively managed that migra-
tion. This sounds intuitive but is quite
different from what happened
in many of our unsuccessful case
studies, where promises of “best
of both cultures” resulted in high
aspirations supported by little
transitional support and, ultimately,
an unfair playing field for acquired
employees.
Managers of a large international
media deal, for instance, started
with a survey of cultural perform-
In our transformation survey, respondents
were six times more likely to describe deals
as successful when the CEO was significantly
involved.
ance, management practices,
and outcomes. The survey identified
nine dimensions of culture, and
the data it generated gave managers
a benchmark of each company’s
position on performance. These man-
agers then used that data to
inform discussions with the integra-
tion leaders, so that everyone
understood the differences between
the cultures, and then to identify
very targeted improvements and
shape the language and messaging
to the merged company. Finally,
they created an “on-boarding”
program that helped acquired
employees understand what to
expect and how to succeed. The
topics included how the acquir-
ing company conducted perform-
ance reviews and financial plan-
ning, set and communicated goals,
and enforced accountability.
At some levels, the program even
included efforts to get people
comfortable with little things that
would feel very different, such
as the reimbursement of expenses,
laptop policies, and time and
expense reports.
There are exceptions when an
acquirer wants to leave cultural gaps
in specific areas, such as to pro-
Applied Insight
tect a specific capability. An acquirer
that relies on top-down innova-
tion, for example, may want to retain
the entrepreneurial culture of a
target’s R&D department. But this
approach should be restricted
to cases when the uniqueness of the
target’s culture creates value—
and the acquirer makes the needed
investment to keep a culture sepa-
rate by forming clear organizational
and operational boundaries.
When one North American high-tech
company acquired a target with
a potentially disruptive new technol-
ogy, for instance, it found that the
investment required to protect the
target’s culture was at least equal
to the cost of integrating it. The effort,
which lasted five years, required a
senior executive to manage all inter-
actions full time, changes to the
parent company’s HR policies and
systems to meet the target’s needs,
flexible financial reporting and bud-
geting that fit the target’s oper-
ating model, and forgoing almost all
cost synergies from redundant
operations. Yet the investment proved
to be very worthwhile; the asset
flourished under new ownership and
significantly exceeded expectations.
Balance CEO
involvement
Demands on the CEO’s time can be
overwhelming after a large deal
because of the magnitude,
complexity, and risk of integrating a
large company, typically of compa-
rable size. The CEO’s involvement is
critical for the deal team to main-
tain focus and energy; in our trans-
formation survey, respondents
were six times more likely to describe
107
deals as successful when the CEO
was significantly involved. Yet not
every decision or risk demands
the CEO’s attention, and in a large
deal the CEO cannot spend ade-
quate time on every issue that might
merit his or her attention in a
smaller deal.
The degree of focus may be sur-
prising: in our case studies, the
leaders of successful big deals typ-
ically focused in a meaningful
way on only one or two areas where
their involvement mattered most.
Everything else they delegated to
an empowered group of senior
leaders. The CEOs could therefore
focus on protecting the base
business even as they pushed the
organization to realize a deal’s
full potential.
In one global oil-and-gas merger, for
instance, the CEO met with his
acquired top team—the target com-
pany’s CFO and CEO—for several
hours every few weeks, with explicit
instructions that they bring only
the most challenging issues to the
table. All other integration updates
and process-related issues fell to
the integration leader, who esca-
lated them only if necessary. Dele-
gating this much authority and
responsibility requires CEOs to
encourage others to think and
act imaginatively without explicit
CEO input—an approach that
can boost the odds of uncovering
transformational synergies.
Nonetheless, the CEO’s interven-
tion is critical to overcome biases in
performance evaluation systems,
often structured toward short-term,
organic goals. To help organiza-
tions pursue higher aspirations,
108 2011 Number 3

CEOs should review their top- The authors wish to acknowledge

management incentive systems to Theresa Lorriman’s contribution to
make sure they reward people the development of this article.
who aim to realize long-term trans-
formational synergies that fre- Ankur Agrawal and Cristina
quently require otherwise-avoidable Ferrer are consultants in
short-term investments. McKinsey’s New York office, and
Andy West is a principal in the
1 
We looked at all 197 deals, from 2000 Boston office.
to 2009, completed by the largest 1,000
companies as of 2009 (by market cap) where
the value of the deal exceeded 50 percent of Copyright © 2011 McKinsey & Company.
the acquirer’s value. We then excluded deals All rights reserved. We welcome your
for which financial data were incomplete
comments on this article. Please send them
and deals done in the financial, energy,
to quarterly_comments@mckinsey.com.
or mining industries, where valuations
were excessively volatile. In selecting case
studies, we expanded the analysis to include
five deals worth 30 to 50 percent of the
acquirer’s value.
2 
This survey was completed by more than
600,000 employees of 500 organiza-
tions globally between 2003 and 2010; our
analysis focused on the nearly 4,000 res-
pondents in companies that had completed
a large acquisition. Complete results can
be found in Scott Keller and Colin Price,
Beyond Performance: How Great Organi-
zations Build Ultimate Competitive
Advantage (Wiley, June 2011).
3 
For more, see “What successful transfor-
mations share: McKinsey Global
Survey results,” mckinseyquarterly.com,
March 2010.

The full version of this article is available

on mckinseyquarterly.com.
 109

Artwork by Don Kilpatrick

Preparing your organization

for growth
Martin Dewhurst, Suzanne Heywood, and Kirk Rieckhoff

Companies that address their organizational weaknesses as they

implement growth strategies give themselves an advantage.

Most senior managers pay close or make it impossible to meet them.

attention to the strategic side of
growth—the “wheres,” “whens,” and
“hows.” Yet many underestimate
the importance of organizational fac-
tors in translating a growth strat-
egy into reality. This oversight can
dampen a company’s growth
plans: organizational processes and
structures that are well suited to
today’s challenges may well buckle
under the strain of new demands
Likewise, key employees may
lack the skills needed to cope with
the additional complexity that
growth brings. By reviewing the expe-
riences of three organizations that
faced the stresses imposed by new
growth initiatives, this article seeks
to illustrate such “pain points” and
suggests some approaches for
coping with them.
110 2011 Number 3
1 Stifling structures: European retailer
Well-defined organizational struc-
tures establish the roles and norms
that enable large companies to
get things done. Therefore, when
growth plans call for doing things
that are entirely new—say, expanding
into new geographies or adding
products—it’s well worth the leader-
ship’s time to examine existing
organizational structures to see if
they’re flexible enough to support
the new initiatives. Sometimes they
won’t be.
A European retailer, for example,
decided to expand beyond its base
of small-format stores in urban
areas by including a number of large-
format stores in suburban ones.
To serve suburban customers, the
new stores would require a new
mix of products, including adult
clothing, larger housewares
(such as furniture), and additional
electrical appliances. The new
stores would also offer lower prices
than the old ones. All this meant
that the new stores would have spe-
cial supply chain requirements
and that the stores’ managers would
need to focus more intently on
price and cost than had been custom-
ary for the retailer.
As the company’s senior execu-
tives planned the new stores, they
began questioning whether to
operate them as part of the existing
organizational structure or at
arm’s length. Although launching
them within the existing struc-
ture would be simpler, the execu-
tives concluded that doing so
would deny the new stores the unique
resources needed to become a
meaningful growth platform. The
executives were concerned, for
example, that the company’s
existing team of store designers
would have difficulty making
the new format’s essential trade-
offs, such as working with unfa-
miliar, lower-cost flooring and lighting
products. Likewise, the execu-
tives were concerned that the existing
supply chain would not cope
easily with larger products, items
with a short shelf life (such as
adult fashion clothing), or the
demands of new suppliers.
So the company launched the large-
format stores as a separate busi-
ness unit, with its leader reporting
to the CEO. The new stores’ man-
agement team was independent of
the parent company and included
mostly newcomers who would not
seek to replicate its culture or pro-
cesses. Still, the retailer also set the
goal of bringing the new business
unit back into the original structure
once the first six new stores were
up and running and the new retail
concept was firmly established.
The new stores’ managers developed
their own local distribution cen-
ters and store designs, at a signifi-
cantly lower cost per square
meter than the company’s other
stores had achieved. They also
found new suppliers; modified some
existing systems, such as IT; and
created a different overall customer
experience that was more focused
on lower costs. The stores therefore
had fewer floor employees per
square meter, for example, and larger
shelves that needed to be refilled
less frequently.
 Applied Insight
Keeping the new stores separate
helped get them up and running
quickly but also made some pro-
cesses at the corporate level
more complex than they might have
been. The IT systems supporting
the new stores, for example, handled
a number of processes differently,
including store-level profit-and-loss
statements. It was therefore diffi-
cult to consolidate sales figures, cost
of goods sold, or wages across
both types of stores.
Nonetheless, in just two years, six
of the new-format stores were firmly
established and meeting their
financial targets. At this point, as
planned, the parent company
integrated all of the stores—large and
small—into a single business unit.
Because the new stores were past
the start-up phase, executives
determined that the benefits of using
common systems and processes
outweighed those of maintaining an
entrepreneurial subculture. There-
fore, many of the larger stores’ modi-
fied processes, such as the amended
financial and supply chain systems,
were replaced by those the parent
company used. The only remaining
operational difference was the local
distribution centers because the
company’s overall product mix was
easier to handle through them
even in the longer term.
For more on how to approach
customization decisions, see “The multilocal
challenge: Managing cross-border
functions,” on mckinseyquarterly.com.
111
In our experience, such separated
approaches work best when a
company can develop a convincing
business case showing that cur-
rent structures and processes will
make it very difficult to launch a
new undertaking. This can be true
when, for example, the new model
is inconsistent with the old one (as
with the European retailer) or if
the new model could cannibalize the
old one—say, if a high-tech firm
introduces a new generation of tech-
nology. Companies need to decide
how much, and when, local cus-
tomization should trump global stan-
dards and the benefits of scale,
taking into consideration factors
such as the product or service
being created, market conditions,
internal culture, and the skills
of the managers involved. In some
cases, the necessary customi-
zation can be as minor as enabling
people to work in a local lan-
guage; in others, as large as creating
a whole new business unit with
different suppliers and customers.
Deliberately making these approaches
temporary, as the European retailer
did, is critical. In our experience, two
to three years is usually enough
time for new operations to gain suffi-
cient maturity to hold their own
within the organization. It is also cru-
cial for companies to reintegrate
these innovative pockets before they
reach substantial scale, or they
will simply create an additional layer
of complexity that makes the
company as a whole harder to man-
age and could inhibit its next
growth spurt.
112 2011 Number 3
2 Unscalable processes: European biotech company
Business processes are another area
that companies often overlook, to
their detriment, when they are growing.
It’s important for a company to
determine which processes will come
under particular stress when it
grows. The case of a European bio-
tech company illustrates the dan-
gers of not addressing potential prob-
lems early.
Before the company began an ambi-
tious growth strategy, it used a
small group of ten key scientists to
make decisions about its product
portfolio. The group’s culture of colle-
giality, informality, and communal
decision making worked quite well,
and each scientist actively helped
to shape and refine every project.
Quarterly reviews of the research
portfolio took one or two days.
But as the company grew and the vol-
ume and diversity of its projects
increased, the number of scientists
involved in portfolio management
also had to expand. The meetings
grew in length, and no clear deci-
sions were made. By the time the com-
pany had 40 scientists involved,
the process had become unmanage-
able. The scientists—and business
leaders—were intensely frustrated, the
collegial culture was disintegrating,
and there was no agreement about
which projects should proceed or
what level of resources they required.
The scientists became defensive
and territorial, and the company was
saddled with a bloated, expensive,
and slow-moving set of projects.
For more on managing culture change,
see “The irrational side of change management,”
on mckinseyquarterly.com.
Fixing these problems required
formalizing the portfolio review pro-
cess. This move, in turn, meant
rethinking the scientists’ governance
processes—determining, for exam-
ple, who would attend, lead, and set
the agenda for meetings. Scien-
tists would now have to prepare and
distribute briefs in a standardized
format ahead of each meeting and
break into subgroups to make
decisions on related research pro-
jects. The company established
clear decision rights and decision-
making protocols, including for-
mal stage-gate mechanisms to deter-
mine, for example, if products
were ready to enter large-scale clini-
cal trials. It also worked to ensure
that there were clear, strong links
between portfolio decisions and
the way scientists and other resources
were assigned to projects.
Getting the large—and frustrated—
group of scientists to accept
these changes was much harder than
it would have been had the com-
pany addressed the issues before it
grew. This was particularly true
because the changes involved culture
and mind-sets, not simply different
documents or meeting formats. The
scientists had, for example, enjoyed
receiving and giving input on the
full set of research projects and ini-
tially found it difficult to accept
more defined responsibilities and a
sense of exclusion from important
discussions.It took two years to imple-
ment these changes, and not all
of the scientists were comfortable
with them. Within nine months,
however, most of them saw that the
projects with the greatest scientific
interest were getting more resources,
which boosted morale and corpo-
rate results.1
 Applied Insight
3 Unprepared people: Technology manufacturer
Growth naturally creates new
interactions and processes, expected
and unexpected, and often at
a fast pace. To manage them, the
employees who face the greatest
complexity—for example, those in
functions or businesses that will
see increased activity—must have
“ambidextrous” capabilities. These
enable people to take initiative beyond
the confines of their jobs, to coop-
erate and build linkages across the
organization, and to complete
many tasks in parallel.
Companies sometimes forget to
think about these capabilities in the
units immediately involved in
growth and very often don’t do so
beyond them. A manufacturer of
cutting-edge technology products
that was seeking to expand from
its domestic base, for example, found
The specific organizational chal-
lenges companies face as they grow
will differ according to their growth
strategies. By managing organiza-
tional complexity early, however,
any company can improve the odds
that its growth plans will succeed—
while making it less difficult than ever
to get things done.
1 
More broadly, we know from our research
and client work that only a few steps are
really critical to making it easy to get things
done within organizations: simplifying
processes, reducing duplications of
accountability, and building capabilities.
For more, see Julian Birkinshaw and
Suzanne Heywood, “Putting organizational
complexity in its place,” mckinseyquarterly
.com, May 2010; as well as Julian
Birkinshaw and Christina Gibson, “Building
ambidexterity into an organization,” MIT
Sloan Management Review, Summer 2004,
Volume 45, Number 4, pp. 47–55.
113
itself limited by the surge in complexity
associated with operating under
several different national regulatory
regimes. The company’s cautious
legal department rejected deviations
from home country procedures.
As a result, the department tended
to add new legal constraints in
each new jurisdiction but was unwill-
ing to remove constraints that
didn’t apply to it. The expansion plans
stagnated until senior executives
realized that the company’s legal
department needed new leaders
who felt comfortable assessing and
mitigating the risks in these new,
ambiguous environments. The com-
pany responded by hiring new
lawyers—a few in the home country,
as well as new legal leaders in the
markets where they were seeking
to expand.
Martin Dewhurst is a director in
McKinsey’s London office, where
Suzanne Heywood is a principal;
Kirk Rieckhoff is an associate
principal in the Washington, DC, office.
Copyright © 2011 McKinsey & Company.
All rights reserved. We welcome your
comments on this article. Please send them
to quarterly_comments@mckinsey.com.
114

© Cris Bouroncle/AFP/Getty Images

Managing crises and shaping

the future of Chile: An interview
with Sebastián Piñera
Chile’s president has taken a businesslike approach to
recovering from an earthquake, rescuing miners, and rejuvenating
his country’s economy.

Minutes before the inauguration of sive earthquake and to the accident,

Sebastián Piñera as president of
Chile, on March 11, 2010, an earth-
quake hit his country. While small
relative to the magnitude-8.8 quake
that had rocked Chile 12 days
before, it still underscored a key
theme of the president’s first
year in office: crisis management, in
response both to the earlier, mas-
later in 2010, that trapped 33 min-
ers some 2,300 feet underground for
69 days. In an interview with
McKinsey’s global managing director,
Dominic Barton, and Alejandro
Krell, a principal in the firm’s Santiago
office, President Piñera described
what he learned from those experi-
ences, how his background as
 Applied Insight
Sebastián Piñera
Career highlights
35th president of Chile (2010–present)
President of National Renewal political party
(2001–04)
Senator of Chile (1990–98)
Investor in organizations including Chilevisión,
Colo Colo soccer club, and LAN Airlines, where
he was also a board member
Founded Bancard, the company that introduced
credit cards to Chile
Consultant with the Inter-American
Development Bank (1974–76) and the
World Bank (1975–78)
a business leader influences
his governing approach, and some
of his dreams for Chile and
Latin America.
Editor’s note: this interview was
conducted prior to the March 2011
earthquake and tsunami in Japan.
The Quarterly: What did you learn
about crisis management from your
experiences with the earthquake and
the mining accident?
President Piñera: One thing I
saw is that you cannot lose a second.
Very often, especially in political
settings, the first hours or days or
even weeks are spent placing
blame and dealing with internal con-
flicts. With the oil spill1 in the US,
they lost two weeks arguing who was
to blame. Also, in the Katrina2 case,
they lost time arguing what to do.
115
Both in the earthquake and with
the miners, we acted immediately,
within the first few hours. The
earthquake happened a few days
before we took office, but when
we did we had already designed a
plan, which we of course enhanced
later, since it was based mainly
on an “outside-in” diagnostic, with
incomplete information. In the
case of the miners, we made a deci-
sion the very night of the accident:
we were going to take full respon-
sibility for the search-and-rescue
effort for every single person. The
private company that owned the
mine was not able to do it. There-
fore it was either us or nobody.
A second important factor for us
was concentrating our efforts
with the help of a clear, quick diag-
nostic and then assigning spe-
cific responsibilities for addressing
different needs simultaneously,
even though their urgency may have
been different. In the case of the
earthquake, one team dealt with the
most urgent challenges; another
team focused on providing, before
the onset of winter, shelter for
displaced people. A third team began
designing reconstruction plans
that required more time—for instance,
changing the design of the regu-
lation plans for cities. All these teams
started working right away. In
the case of the miners, we had sev-
eral rescue plans working simul-
taneously, and well before finding
them we had a team thinking
about how to address their imme-
diate needs if we did.
A third important factor was acknowl-
edging our limitations and the
complexity of the situation—and
requesting external help when it
might be useful and relevant. That
116 2011 Number 3
was of utter importance in the res-
cuing of the miners. Contrast
that with the case of the Russian
submarine, the Kursk,3 where
the Russian government didn’t ask
for help until it was too late. The
British and the Americans had the
technology to rescue them alive,
but the Russians didn’t ask for it.
The Quarterly: Could you speak
a little about your career and how
you wound up in this office?
President Piñera: In my life, I
have had three vocations. My first
was academic. I went to Harvard,
got a PhD in economics, and was a
professor in universities in Chile
and abroad for many years.
One day in the late 1970s, I remem-
ber saying, “Enough is enough,”
and decided to become an entre-
preneur. I created a number of
companies, including one that intro-
duced credit cards to Chile. That
was extremely successful and it gave
me the resources to invest in
other businesses—in construction,
in airlines, in TV, for example.
Finally, in the late 1980s, as we recov- international relations. He’s learning
ered our democratic system,
I decided to enter public service. I
ran as an independent and was
elected to be the senator representing
Santiago. After eight years, I
didn’t want to run again. For a time,
I focused on some foundations—
one that helps educate young women
with low incomes, one oriented
toward the environment, one seeking
to promote Chile’s embrace of
freedom and democracy—that I had
created along the way. It wasn’t
until 2005 that I got back into politics, new markets?”
first losing a very close race for
president to Michelle Bachelet4 and
then winning four years later.
The Quarterly: Did that back-
ground influence the way
you shaped your team as you
started governing?
President Piñera: We brought in
a lot of people from the private
sector and from universities. To some
extent, that was because our
party5 had been in opposition for
20 years, so our most experi-
enced people were already in Con-
gress, and we don’t have a par-
liamentary system, where members
of the House or Senate can easily
become ministers. In any event, just
about all our cabinet members
have PhDs from very well-known
universities or were extremely
successful in the private sector. Most
didn’t have much experience
in the public sector, so they had to
learn rapidly.
Our foreign-affairs minister, Alfredo
Moreno, is an interesting case
in point; basically, he was an entre-
preneur with strong interests in
rapidly, and he’s reforming our
Ministry of Foreign Affairs, which
was a very traditional one. He’s
asking tough questions about the
role of his office in advancing
Chile’s interests and suggesting that
“old diplomacy” doesn’t work now.
One example would be saying, “Our
exports have been stagnant for
the last two or three years. We want
our exports to grow by 10 or
15 percent this year. How do we sup-
port the process of looking for
 Applied Insight
© AFP/Getty Images
The Quarterly: Describe your
broader economic goals for Chile.
President Piñera: Chile had
12 magnificent years from 1986 until
1997. Fat cows. GDP was growing
more than 7 percent per year. We
were opening up the country to
the rest of the world, creating jobs,
and strengthening our macro-
economic balances.
But something happened in 1998
with the Asian financial crisis,
and starting then we lived through
12 years of lean cows. The growth
rate and the rate of employment
growth both went down by half.
We went from the Chilean miracle
to the Chilean nap.
Now we are trying to revive the
Chilean miracle by striving to become,
by the end of this decade, the
first Latin American country able to
117
Chile president
Sebastián Piñera
greets Florencio
Avalos, the
first of 33 miners
to be rescued
from a mine that
collapsed in
early August 2010.
overcome underdevelopment
and defeat poverty. And this is feasi-
ble. Chile is a country with a
$14,000 per capita income. If we can
grow at 6 percent per year for
the next eight years, we will achieve
$24,000 by 2018. That’s basically
the threshold between the underdevel-
oped and the developed world;
today, the average per capita income
of the OECD 6 is $26,000. We
want to become at least an average
member7 of the OECD and, hope-
fully, to go beyond that.
To defeat poverty, we must attack
its real causes. There are many, but
the most important ones in Chile,
according to our diagnosis, are the
lack of equality in education, our
weakness in creating good jobs, and
weaknesses in the family.
We are working on those three areas,
but that will take time. So we’ve
118 2011 Number 3
also created what we call the ethical
family income, which is something
similar to what has been known as a
negative income tax. Basically,
we will transfer enough income to
families to bring them up to the
extreme poverty line. In order to not
create perverse incentives, we
will ask something from those fami-
lies: their kids have to go to school;
if they are working age, they have
to be working or training—things
like that, to help our people to
help themselves.
The Quarterly: You’ve also set
aggressive goals for creating jobs.
President Piñera: Yes. We need
those jobs—because they will help
us defeat poverty, because we have
a very high unemployment rate,
and because we are expecting a huge
influx of women into the labor force.
Labor force participation by women
is currently very low, and it’s grow-
ing rapidly. So we have to create
jobs for them—as many as one
million over the next four years, to
help us equal the level of female
labor force participation in other
OECD countries.
The Quarterly: How are you going
to do that?
President Piñera: To answer that,
I need to say a little more about
my view of the role of government.
For a long time, I thought there
were three basic pillars for the govern-
ment: to have a stable, legitimate,
democratic system; to have a free,
open market economy, unencum-
bered by fiscal imbalances; and to
have a state that works. Those
pillars were very scarce during the
20th century in Latin America.
Chile was among the first to achieve
them, which helped us outperform
some of our neighbors.
But I don’t think that’s enough for
what’s coming now. In the society of
knowledge and information, we
need at least four new pillars: to give
a quality education to everyone,
to invest in technology, to promote
innovation and entrepreneurship,
and to have a very flexible society
and economy. This last one is
important because the only constant,
these days, is that the world is
changing, and we have to be ready
to adapt ourselves—to take advan-
tage of the opportunities and
to adjust to the changes that come
from abroad.
Basically, our government’s pro-
gram is designed to strengthen the
three traditional pillars while
creating these four new pillars. So
we are undertaking a huge edu-
cational reform—trying to fix a system
that hasn’t worked because it
was caught up by all kinds of inter-
est groups. We have a plan to
triple our investment in technology
as a percentage of GDP. We are
promoting innovation and entrepre-
neurship everywhere, including
within the public sector. And of
course we are trying to have a
more flexible and adaptive economy
and society. All of these things
should help with job creation over
time. In the shorter term, boosting
exports also will be a critical factor.
It’s challenging because we are
doing all this while facing the
huge costs of rebuilding what was
destroyed by the February 2010
earthquake and the tsunami that
came after. The earthquake
devastated us. We lost more than
500 lives. We also lost one-
Applied Insight
third of our schools and hospitals
and suffered enormous damage to
bridges, airports, and ports—all
adding up to $30 billion in losses,
which is roughly 18 percent of our
GDP. Just to give you a comparison,
the total cost of Hurricane Katrina
was less than one-tenth of 1 percent
of the US GDP.
The Quarterly: Looking beyond
Chile, to your region as a whole,
could you share any thoughts about
Latin America’s prospects?
President Piñera: Latin America
is incredible; it has everything: huge
natural resources, vast territory,
a common culture and language. We
haven’t had religious conflict or
the kind of internal wars that the
Europeans had into the 20th cen-
tury. So everything was here for us
to become a developed continent.
This didn’t happen—but I think that
now we are waking up and that
this will be a century when many
countries go in the right direction.
Mexico, Brazil, Colombia, Peru,
Chile—we all have reached a strong
consensus behind a real demo-
cracy with the rule of law, separation
of powers, and freedom of the
press. We all are creating open, free,
competitive market economies.
And we all are trying to achieve
more equality of opportunity.
There’s nothing limiting us. Not
only did the Iron Curtain and Berlin
Wall fall but another wall that
separated the developed countries
in the Northern Hemisphere
from the underdeveloped ones in
the Southern Hemisphere has
fallen away with globalization, the
Internet, and more freely flowing
knowledge. We have access to the
119
same opportunities as any other
person in any other part of the world.
Now it’s up to us to work harder,
be more innovative, invest more in
technology, and reform our edu-
cational system. It’s our time. And it’s
our responsibility—to history and
to the future—to do what our parents
and grandparents always wanted
to do but never achieved.
1 
The Deepwater Horizon oil spill (in the Gulf
of Mexico), after an explosion in April 2010.
2 
Hurricane Katrina, in August 2005.
3
 The Kursk sank in the Barents Sea
in August 2000, following an explosion.
4
 The first woman to serve as president of
Chile, from 2006 to 2010.
5
 President Piñera ran as the candidate of
the Coalition for Change (Coalición por el
Cambio), combining a number of center–
right parties.
6
 The Organisation for Economic
Co-operation and Development. The per
capita income metrics figures described
by President Piñera correspond with the
OECD’s GDP per capita rankings.
7
 Chile joined the OECD in May 2010.
Dominic Barton is McKinsey’s
global managing director and is
based in the London office;
Alejandro Krell is a principal in
the Santiago office.
Copyright © 2011 McKinsey & Company.
All rights reserved. We welcome your
comments on this article. Please send them
to quarterly_comments@mckinsey.com.
120

Extra Point

Resolving the centralization

dilemma
A common dilemma in large companies is knowing when to centralize
functions and operating activities, such as IT or product development, and
when to leave them in the business units. The prize—for example, econ-
omies of scale or better coordination—can be significant. But so are the
risks, which include bureaucracy and reduced flexibility.

Three questions can help senior executives focus the debate and
reduce political posturing. Each question sets a high bar for centralization,
with at least one yes answer needed to overcome the presumption of
decentralization. The questions can be asked in any order, but the sequence
presented here is often the natural one to follow.

1. Is it mandated? 2. Does it add 3. Are the risks low?

significant value?

Do external Does it add 10% to the Does it avoid risks

stakeholders or laws
require it?
If so, must it be done
at the group center?
market capitalization
or profits of the group?
No If not, is it a key part
of a larger initiative that
will add 10%?
of bureaucracy,
business rigidity,
reduced motivation,
No or distraction?

No to all three—don’t centralize

To read more about the framework,

see “To centralize or not to centralize?”
on page 97.

Copyright © 2011 McKinsey & Company. All rights reserved.

Copyright © 2011
McKinsey & Company.
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