The End of Strategy? Our Faculty Discusses

Oh the irony! First introduced in 1979, Harvard Business School professor Michael Porter’s Five Forces analysis of competitiveness has continued to make its mark. The forces—which include the bargaining power of suppliers, the bargaining power of customers, the threat of new entrants, the threat of substitute products, and the competitive rivalry within the industry—have been widely used to understand the factors that affect profits in an industry. Yet in November of 2012, the Monitor Group, a strategy consulting firm co-founded by Porter, filed for bankruptcy.

This led Forbes contributor Steve Denning to ask, “Why didn’t the highly paid consultants of Monitor use Porter’s famous five-force analysis to save themselves?” In a widely read 3000-word article, Denning uses Monitor’s demise to lambast the Five Forces. In the process, he raises serious questions about the nature and future of strategy consulting. Denning attributes Monitor’s problem to a “conceptual error” on Porter’s part: “In the theoretical landscape that Porter invented,” he writes, “all strategy worthy of the name involves avoiding competition and seeking out above-average profits protected by structural barriers. Strategy is all about figuring out how to secure excess profits without having to make a better product or deliver a better service.” And this, he argues, is neither a boon for society nor, in the long-term, for a firm.

Denning’s is a harsh indictment. Yet the Five Forces are still widely taught at top business schools, including here at Kellogg. I have invited a number of Kellogg faculty members who teach strategy to consider Denning’s arguments. What follows are the thoughtful responses of professors Craig Garthwaite, Thomas Hubbard, David Dranove, David Besanko, Meghan Busse, Mike Mazzeo, and Justin Lenzo in the form of a written dialogue.

Craig Garthwaite

Craig Garthwaite, Assistant Professor of Management & Strategy

I must say that, in his attack on Michael Porter, Steve Denning constructs a fairly lengthy and pessimistic caricature of both the profession of management consulting and the academic field of the economics of strategy. After reading the article, one couldn’t help but think that strategy academics and consultants were just modern versions of historical snake-oil salesmen. Denning appears to believe that modern-day strategy is simply the search for industries whose basic characteristics lead to higher profits—an outcome he labels, or more accurately mislabels, a “sustainable competitive advantage.” He concludes that there are no (or very few) situations where these characteristics exist and therefore strategy practitioners are charlatans and frauds. While this straw man argument creates a compelling screed against Porter and his now defunct Monitor Group, it reflects an understanding of the current state of the economics of strategy that is far below that of even my worst first-year MBA student.

The reality is that analyzing an industry’s basic characteristics, often through a framework such as Michael Porter’s Five Forces, is only a starting point for firm strategy. As we teach at Kellogg, once you understand these basic economic characteristics, you can move on to considering firm-specific assets and activities that generate above-average economic profits over time. This is a far more conventional, and frankly useful, definition of a sustainable competitive advantage.

These above-average profits come not simply from high barriers to entry or favorable government regulations, but rather from a firm’s ability to effectively create and, importantly, capture value.   Firms must capture value through prices determined in competition with other firms.  However, at no point does this limit our analysis to a zero-sum contest for profits between firms in an industry.  Innovative firms, such as those cited in Denning’s article, are often those who more effectively create value, differentiate their products, and sustain high profits.

Thomas Hubbard

Thomas Hubbard, Elinor and H. Wendell Hobbs Professor of Management

Hammers are really useful tools. It is hard, if not impossible, to build a house without one.  But trying to build a house using only hammers won’t work. Denning’s main complaint is that strategists should not build houses using only hammers, and he accuses Monitor of trying to do so.

Denning’s piece contains lots of narrow statements with which I agree. The broad point that strategists who focus only on industry analysis and/or “value capture” elements of a firm’s strategy are unlikely to provide useful guidance is a good one. The pervasiveness of the Five Forces framework often leads students, as well as some practitioners, to attempt to apply it irrespective of the question at hand. (“Why is the sky blue?”  “It has few substitutes and few rivals, but it also has declining barriers to entry and little bargaining power versus its suppliers or customers.”) To a boy with a hammer, the world is a nail. This leads to all sorts of bad analysis and shortsighted/incomplete strategic prescriptions.

The piece falls apart when it condemns Porter’s work on this basis. The fact that a hammer isn’t all that one needs, and that hammers are sometimes used inappropriately, does not mean that hammers are not useful. The framework is a very useful way of organizing one’s analysis of the question of whether and why a representative firm in one industry is more or less profitable than one in another industry. This is often an important question, and having a framework around which to structure the analysis generally improves the analysis.

I agree with Craig: where managers go wrong is in treating this part of the analysis as an ending point rather than a starting point. It is unfortunate they make this mistake as often as they do. One thing that we all try to do when teaching these concepts to students at Kellogg, or when helping practitioners with the problems that they face, is to not only impart the concepts themselves but illustrate how they should and should not be applied.

I also found other elements of Denning’s critique very strange. He writes that according to Porter, “[s]trategy is all about figuring out how to secure excess profits without having to make a better product or deliver a better service.” This makes me wonder whether he read Porter’s follow up book, “Competitive Advantage,” which is essentially about how firms can secure profits through better products and/or lower costs. This is an example of one of many very strange statements along these lines.

And so I share Denning’s concerns about indiscriminate, narrow applications of the Five Forces framework—perhaps at Monitor and certainly elsewhere—and agree with him that it has sometimes overshadowed other, more useful concepts. But the conclusion that he draws is silly.

David Dranove

David Dranove, Walter J. McNerney Professor of Health Industry Management and Professor of Management & Strategy

In addition to Craig’s and Tom’s excellent points, let me add my perspective from 25 years of teaching the Five Forces. Students often expect something from the Five Forces that just isn’t there. A good Five Forces analysis is not prescriptive; one does not walk away from the exercise with a strategic plan. So what is the point? One cannot develop or evaluate plans in a vacuum; one needs a solid empirical basis for analysis. But how does the strategist sift through the mountains of available information? The value of the Five Forces is that it uses economic theory to identify the most useful data. Doing strategy in the absence of theory can sometimes seem to be impossibly chaotic. Porter (and the economic theories he applies) brought method to the madness.

Economic theory has significantly evolved since Porter’s original work, so much so that the Five Forces we teach today bears only a partial resemblance to the Five Forces in Porter’s classic HBR article. As economic theory evolves, so too does our understanding of what we need to know to craft and evaluate strategy: when we assess internal rivalry to evaluate pricing strategies, we worry about our rival’s reputations and multimarket contacts; when we assess buyer power to evaluate vertical integration strategies, we consider asset specificity and worry about opportunities for vertical foreclosure.  By providing a framework that is systematic and adaptable, Michael Porter gave strategists something of enduring value.

In his misguided critique of Porter’s Five Forces, Denning joins a long list of non-academics who try to criticize economic approaches to strategy but do nothing more than tear down straw men of their own creation.

David Besanko

David Besanko, Alvin J. Huss Professor of Management & Strategy

Not yet commented upon is that Monitor’s failure almost certainly had nothing to do with an over-application of Porter’s Five Forces or any other framework found in Porter’s writings. In terms of its approach to client work, Monitor was not terribly different from the other major firms with whom it competed, such as McKinsey, BCG, or Bain. Consulting teams in these firms never start a strategy engagement by saying, “Let’s do a Five Forces analysis.” Do consulting teams assess a client’s industry conditions and competitive environment? Yes, of course. But they don’t do so using simplistic cookie cutter approaches. The approach is typically nuanced and deploys multiple analytical tools (of which an analysis of the structural conditions of the client’s markets might be one). To say this is not to deprecate the value of Porter’s framework; it is merely to say that it is but one lens that strategists have at their disposal for doing the careful situational analysis that is needed for formation and evaluation of strategic options.

All in all, Denning’s sophomoric article sheds no light on why Monitor failed, and it provides a grossly distorted picture of the state of modern strategic thinking. To paraphrase a line from the movie Billy Madison, you risk becoming dumber for having read it.

Meghan Busse

Meghan Busse, Associate Professor of Management & Strategy

I don’t have much to add to the excellent comments already made by my colleagues. Craig describes very well how we teach both industry analysis and sustainable competitive advantage (concepts that are not at all the same thing) in the core strategy course at Kellogg, and his description reflects my view as well.

I tell students in class that Five Force analysis is like the checklists that pilots use when they fly planes. The checklist isn’t what makes you a pilot, but it does keep you from making a stupid mistake because you missed something at the beginning. Similarly, the Five Forces is a checklist that makes sure you have thought about the most important elements that define the competitive and economic context in which the firm operates. But it is at this point that the heavy lifting begins: now having understood the context, the strategist must figure out what set of activities the firm should engage in in order to create a sustainable competitive advantage.

Despite Denning’s skepticism, I do think that there are firms that create a sustainable competitive advantage. By this, I don’t mean permanent, eternal, or inevitable profits, and I don’t mean (as Denning seems to understand the term) attractive industry characteristics. Instead, I mean the advantage obtained by firms who have chosen a set of activities that are well-suited to the economic context in which they operate, that are hard to imitate, that are mutually reinforcing, and which the firm has shown foresight in choosing. These firms do indeed tend to earn profits that are higher than those of their competitors, and profits that are durable rather than temporary or transitory. It is the superior profitability earned by firms who choose such a configuration of activities that I would term “sustainable competitive advantage.” Attractive industry characteristics are just a starting point.

David Besanko

Just a quick reaction to Meghan’s excellent post.

I agree that we can find examples of firms that can create sustainable competitive advantages. But I wonder whether a charitable interpretation of Denning is that he is not necessarily arguing against this broad point, but rather is suggesting that it is generally difficult for firms (or business units within firms) to achieve sustainable competitive advantage by exploiting favorable competitive forces in Porter’s framework. He seems to be saying that even if you are clever enough, or lucky enough, to have situated yourself in an industry with high entry barriers, sooner or later Clayton Christensen—like disruptive innovation will kick in, and you’ll be toast.

But even my charitable interpretation of Denning is problematic. It is not difficult to find examples of companies or business units that for years earn returns in excess of their costs of capital because they enjoy what Richard Rumelt calls positional advantages, competitive advantages that are rooted in the structural characteristics of industries, such as the confluence of economies of scale and market size that create room for just one or two big producers. We don’t often hear about these cases because many are in boring industrial backwaters that don’t get written about in Forbes. One of my favorite examples along these lines is U.S. Smokeless Tobacco Company, the dominant producer of smokeless tobacco products (like Skoal snuff), which, between 1982 and 2004, consistently earned positive economic profits and never earned a return on invested capital less than 24 percent! (I don’t have data before 1982 or after 2005, and in 2008, U.S. Smokeless Tobacco was purchased by Altria, but it is not unreasonable to conjecture that U.S. Smokeless Tobacco’s streak of positive economic profitability extended over an even longer horizon.) Over this period, U.S. Smokeless Tobacco did little, if any, of the continuous customer-centric innovation that Denning considers the sine qua non of corporate success. As Meghan notes, no competitive advantage is eternal, but achieving returns above cost of capital in excess for over 20 years is the sign of a pretty darn durable advantage, even if management’s most significant contribution to the advantage was to merely tend the position and not kill the golden goose. Continuous innovation may be one route to sustainable advantage, but it is not the only route, and one of the advantages of competitive analysis based on economics (analysis that, as David Dranove suggests, was rooted in Porter’s work) is that we have frameworks for identifying and assessing the power of these various approaches to competitive advantage.

Mike Mazzeo

Michael Mazzeo, Associate Professor of Management & Strategy

I agree with my colleagues’ main critique of Denning’s article: the notion that Porter’s framework for Industry Analysis is a strategy panacea is a straw man, trivial to rebut. No one who teaches Porter’s framework believes this and Porter never claimed it to be so. In fact, as Tom pointed out, in “Competitive Advantage,” Porter focuses on the intellectual foundations of how firms create value. As Craig and Meghan characterized, we teach our MBA students strategy by emphasizing value creation in tandem with value capture. Porter’s influence has come from tying these ideas to underlying economic theory and effectively communicating them to generations of students and managers.

On the topic of value creation, Porter’s contribution lies in his relentless insistence that firms acknowledge and incorporate the competition into strategic decision-making. Even if customers like the firm’s product, they have to like it better than what competing firms offer. Even if a process reduces a firm’s costs, it needs to be a process that competitors cannot replicate. Innovators who don’t ask themselves the question, “Why can’t another firm do this as well as we can?” will fail to profit from their initiatives, no matter how much value they create for consumers.

Allow me to close with one more retort to Denning’s initial thesis that the demise of Monitor is evidence of the uselessness of the Five Forces framework. One might argue that Monitor’s failure demonstrates just the opposite. Because Porter’s work on industry analysis is so persuasive, so easy to communicate and rings so true, it has become ingrained in managers’ thinking. When teaching executive students, I often remark that one benefit of learning strategy well is that you won’t need consultants to guide you or to fix your mistakes. It follows that firms need consultants’ help on industry analysis less because Porter’s framework is so ubiquitous and universally understood. So, let’s instead toast the end of Monitor as the culmination of a job well done.

Justin Lenzo

Justin Lenzo, Assistant Professor of Management & Strategy

My colleagues identify the major weaknesses in Mr. Denning’s rant against business strategy and the Five Forces framework. At the risk of sounding uncharitable, I cannot help but wonder whether Mr. Denning made the effort to really understand the ideas he condemns. Nevertheless, a couple of legitimate and important questions about strategy and its frameworks arise over the course of his article.

First, as several of my colleagues have discussed above, there is no “one tool” that should be thought to provide a universal answer to questions of strategy. In fact, as important as the Five Forces are to understanding industry context, our core business strategy course in the Kellogg MBA program focuses on the topic for roughly one week out of ten. In other words, there are nine other weeks in which we focus on other tools and ideas (of course, connections are frequently made back to the Five Forces). The Five Forces has a well-defined purpose in strategy analysis: it provides a disciplined approach to identifying the threats to profitability of firms in a particular industry. It is not, in itself, about “selecting a business strategy” or “building sustainable competitive advantage” or “defeating the competition.” Again, it is about identifying the threats to profitability for firms in a particular industry. To identify such threats is a crucial part of strategic analysis and planning, but only a part.

Second, the article raises a broader question of whether good strategy focuses on “coping with competition” or focuses instead on “adding value for customers and ultimately society” through experimentation and innovation. The straw man here is that there exists a trade-off between the two. Truly sustainable competitive advantage necessitates a complementary mix of both. Firms that experiment and innovate—organizationally, as well as in the products and services they provide—are better positioned to continue to thrive in the face of context disruptions (such as disruptive technological change) that dramatically change the industry’s structure. But experimentation and innovation require investable resources. Where do these resources come from? A firm that is isolated from price competition is likely better able to accumulate them.

Furthermore, and more critically, what happens when the experimentation and innovation are successful? In the absence of barriers to entry and imitation, competitors will rush in to capture a share of the profits. Mr. Denning suggests, “Unlike competition in sports, every company can choose to invent its own game.” Perhaps every company could invent its own game, but surely many would choose instead to pursue the low-hanging fruit of imitating successful strategies in industries with low entry barriers. Such imitation inhibits the innovative firm from recouping its investment, decreasing its incentive to innovate in the first place. Apple surely is, as Mr. Denning identifies, a continually innovating firm. However, Apple also relies on patent protection, trade secrets, brand reputation, easier access to financial capital, supplier capacity constraints, and other “structural barriers” to ensure that it captures value created by the risky investments it makes. Likewise, Mr. Denning’s other model firms necessarily employ “competition coping” alongside their innovation efforts. Come to think of it, the Five Forces is an especially helpful framework in understanding the non-obvious aspects of these firms’ strategies.

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Reading list: Blank checks and the marketing ideal

Over the last two months, some of our marketing faculty has published thought provoking articles in the Sloan Management Review and in strategy + business.

Most recently, Kellogg School Professors of Marketing Philip Kotler and Bobby Calder coauthored an article in the Sloan Management Review with Edward Malthouse (a Professor at the Medill School at Northwestern University) and Peter Korsten (IBM Institute for Business Value). In it, they discuss the results of the 2011 IBM Global CMO study,  focusing, in particular, on how close companies are to controlling the marketing mix, a key aspect of the vision set for marketing more than 60 years ago by Neil Borden, then president of the American Marketing Association. They find that average level of control of the marketing mix, across 1,700 CMOs, is a 3.5 in a scale from 1 (no control) to 5 (full control). According to the authors,

The CMO survey also suggests a crucial obstacle to achieving the vision of marketing: the role of the CMO vis-à-vis the CEO and other C-suite members.

[…]

A statistical analysis of the correlation between the Full-Scale Marketing Index and top management’s view of marketing […] suggests that top management’s evaluation of marketing is indeed a cause of marketing success and not a consequence.

The full article can be accessed from the link above, while the full IBM study requires a registering with IBM Institute for Business Value.

Meanwhile, early in August, Professor Mohan Sawhney co-authored an article in strategy + business with Sanjay Khosla (Kraft Foods) about a strategy used by Kraft Foods to boost organic growth. They dub this management technique “blank checks”:

What if resources were not a constraint? If managers were free to dream and act big without worrying about busting their budgets, they would be limited not by resources, but by their imagination.

The article elaborates on the concept, outlines the steps to implement it, provides some tips to manage the process and reviews case studies within Kraft.

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BASF plant-science leaves Europe for US

BASF announced last week that it was moving its genetically modified plant-science headquarters from Germany to the United States. The chemical firm said widespread resistance to GM crops in Europe prompted the move, one which mirrors a decision the company made two decades ago when it opened a biotech research lab in Boston.

The company said it will relocate 123 jobs from Limburgerhof, Germany, and other European facilities to Raleigh, North Carolina. BASF was the last company still pursuing regulatory approval for GM crops in Europe, according to a Nature News Blog article. Though it won approval for its Amflora potato, it was the first time in a decade that a new GM plant was allowed to be grown in the European Union.

That BASF has elected to shift research and development in both transgenic plants and biotech to the United States should come as no surprise. There are strong sentiments in Germany against both technologies. “The anti-GM movement is in large part an offspring of the broader anti-biotech movement in the 1980s,” said Klaus Weber, an associate professor of management and organizations who has studied BASF and other German chemical and pharma firms.

While the German anti-biotech movement is still skeptical about the safety and benefits of medical biotechnology, it is more strongly opposed to applications in the agricultural sector, Weber said. Medical—or “red”—biotech had “undeniable medical and health benefits,” he noted, which made it harder to contest. Plus, the industry became highly regulated. Agricultural—or “green”—biotech, on the other hand, hasn’t had the benefit of perceived indispensability. Many early GM crops showed only incremental improvements over non-GM versions, and “industrial agriculture as a whole became suspect in the wake of major scandals, such as mad cow disease,” Weber said.

BASF’s pharmaceutical division stumbled when it moved from Germany to the U.S. in the early 1990s, but Weber doesn’t think the same problems will repeat themselves with the GM crop division. In the short term, the move will be expensive and disruptive, but the current global reach of the company’s R&D efforts, coupled with its partnerships with other firms like Monsanto, will insulate it from long-term problems. “I see this move as less problematic for BASF,” Weber said. “It is more of a problem for German research institutes that worked with them.”

Other firms have been closely watching the BASF case, Weber said, especially Bayer CropScience. While Bayer conducts much of its R&D on GM crops outside of Europe, it retains the division’s headquarters there much like BASF had. “As long as it is hard to get approval for outdoor tests and commercial scale permits in the EU, companies won’t invest a lot there,” he said. “The bigger question is whether BASF, Bayer, and others will keep their crop science units or sell them at some point.”

“My impression is also that BASF was acting not only on its own interest with the potato case, but also was trying to set a regulatory precedence for the industry as a whole. A lot of other companies were closely watching this case and there was certainly industry lobbying going on in support of the larger issue.”

That BASF decided to move its GM crop headquarters to the U.S. is a win for the anti-biotech movement in Europe, Weber said, “not just because of BASF, but because of the signal it sends to the entire industry.”

Further reading:

“The Fall of German Biotech” on Kellogg Insight

Photo from BASF.

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Legal oddity in stock option taxation doesn’t hurt IRS

A few weeks ago, the New York Times published a piece about the tax benefits companies are deriving from stock options granted to executives just after the market collapsed in 2008. The story was succinctly summarized in these two lines:

Thanks to a quirk in tax law, companies can claim a tax deduction in future years that is much bigger than the value of the stock options when they were granted to executives. This tax break will deprive the federal government of tens of billions of dollars in revenue over the next decade.

Stock options are typically cashed in at higher prices than they were issued. The legal oddity to which they refer gives firms a tax deduction based on the price at which they were cashed in—the higher price—rather than the lower price at which it was issued.

Anup Srivastava, an assistant professor of accounting and information management, says it’s not as straightforward as the article makes it out to be. “Yes, firms will save taxes, but IRS will more than make up for it by collecting taxes from executives,” he said.

It’s well known that people pay at higher tax rates than corporations, sometimes much higher—GE, for example, didn’t pay any taxes last year. Yet the IRS won’t lose out because of most executives who cash in stock options sell their stock right away. This means they typically have to pay the normal income tax rate on the price difference between when the option was granted and when it was cashed in, Srivastava said. Since most executives are already in the highest tax bracked—35 percent—they will end up paying the full rate. And since many firms don’t pay taxes at the statutory rate, the income generated from taxing executives’ gains on options will likely be higher than the tax savings firms can obtain at their marginal rate, he said.

“In fact, the higher the difference between prices at which options are cashed in and prices at which options were granted, the higher the benefit IRS derives,” Srivastava said. “This difference increases as the grant price becomes lower. Thus, the lower the grant prices set during the recessionary periods, the higher the ‘net’ benefit IRS derives.”

Photo by Team Civil Air Patrol.

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A VC ponders, profits or growth?

Venture capitalist Mark Suster examines the trade-offs between chasing profits vs. pursuing growth.

There is a healthy tension between profits & growth. To grow faster businesses need resources in today’s financial period to fund growth that may not come for 6 months to a year. The most obvious way to explain this is with sales people.

If you hire 6 sales reps in January at $120,000 / year salary then you’ve taken on an extra $60,000 per month in costs yet these sales people might not close new business for 4-6 months. So your Q1 results will be $180,000 less profitable than if you hadn’t hired them.

I know this seems obvious but I promise you that even smart people forget this when talking about profitability.

Hiring more people isn’t always the right answer. You have to understand whether they’re likely to yield revenue growth in the near term OR whether you have access to cheap enough capital to fund your losses until your investments pay off.

Heard through professor of finance Yael Hochberg.

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Olympus CEO ouster highlights perils of cultural misfit

In six short months, Michael Woodford was promoted to president and CEO of Olympus and fired from those same positions. He was the first non-Japanese person to fill those roles, and his ouster reveals a culture clash between not only himself and the board of directors, but also older Japanese business practices and Western ones.

Woodford had been successful in turning Olympus’s European business around and was brought to Japan as president to shake things up a bit. Apparently he shook too hard for some people’s liking. After a Japanese magazine published an expose on some shady deals made under the watch of then-CEO Tsuyoshi Kikukawa, Woodford pushed for an investigation. Four deals were suspect—the purchase of medical device manufacturer Gyrus involved $687 million in payments to two now defunct advisory firms and the acquisition of three startup firms whose values were quickly written down. When Woodford again pressed his case in late September, he wasn’t punished. Instead, he was given the title of CEO to add to his position as president, according to the New York Times. But two weeks later, after continuing to push for an investigation, he was fired.

Times reporter Hiroko Tabuchi savvily recognized the culture clash that was at the root of the scuffle. Due diligence has not been well received by Japanese executives that hew to older business practices. Though the skepticism and number crunching involved in due diligence may seem like common sense to many, traditional Asian business deals often involve healthy doses of trust in individuals. It appears that Olympus board members forwent due diligence on the three startup purchases, preferring instead to trust the startups’ executives or the deals’ advisors. The exorbitant payments made in the case of the Gyrus buyout seem more suspect and may be a case of corporate corruption rather than just a clash of business cultures.

The decision to buy the three startup companies without due diligence highlights the difficulties some firms have in adopting new business practices, especially those from different cultures. Ed Zajac, a professor of management and organizations, recently laid out a framework for studying business practice diffusion. One proposition he and his colleagues lay out states,

When adopters experience low cultural fit between the characteristics of the practice and the organization, early adopters will implement more extensive versions whereas later adopters will implement less extensive versions of the practice.

Since due diligence has been around for quite some time—it was first codified in the Securities Act of 1933, though basic concept significantly predates that—it’s likely that Olympus falls into the late adopter category, meaning they have adopted a less extensive version of the practice. So while Olympus may have executed some semblance of due diligence in the deals, it was probably not very extensive. Olympus had not adopted the practice to the extent which Woodford thought they should. Unfortunately, he found out the hard way.

Related reading:

Dimensions of Diffusion: Company to company, business practices seldom remain the same

Photo by idua_japan.

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P.S. Merger waves give way to troughs in tough times

Abbott Laboratories announced today that it will split itself into two smaller companies. Shareholders would keep their shares in the main company while gaining ownership in the research division. It is but the latest firm to announce such a split, following McGraw-Hill, Kraft, and others.

Some details as reported by the New York Times.

Abbott’s plan would leave the company as one of the biggest makers of generic drugs, with about $22 billion in annual sales. But its products include a variety of other offerings, including Similac baby formula, stents and laser eye surgery products.

Among its chief attractions is the division’s fast international growth, deriving about 40 percent of its sales in emerging markets.

The research drug unit that is being spun off has about $18 billion in annual sales and is focused on developing specialty medicines to treat diseases like multiple sclerosis and cancer.

Its top-selling drug is Humira, a treatment for immune system diseases like rheumatoid arthritis that reaped $6.5 billion in sales last year.

Abbott is no stranger to mergers and sell-offs. It bought BASF’s pharmaceutical division Knoll in 2001, diabetes specialist TheraSense in 2004, and Solvay Pharmaceuticals in 2010 among others. The company has also sold off numerous brands over the years and spun off its hospital products division as Hospira in 2004.

The announced split continues a trend that counters the merger fever that swept many sectors of the economy during the 1990s and 2000s. Such waves often come to an end when markets take a turn for the worse, professor of management and strategy David Besanko told me in an earlier article. Companies may be looking to unload unprofitable divisions or bolster their reserves by selling the profitable ones.

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Why Apple will be the same without Steve Jobs

Steve Jobs’s resignation has dominated technology and business news since it was announced last night, and there has been a lot of speculation about how Apple will navigate the coming years without their charismatic CEO. It’s not an unfair thing to do—Jobs has left his mark on the industry like no other chief executive in recent memory. But he has also left an indelible impression on the company he founded over 30 years ago. It will take a long time for Apple to lose that religion, if ever.

Tim Cook has taken over as CEO after essentially performing that role for the past seven months. In that time—and during two previous stints while Jobs was also out on medical leave—he has proven himself up to the task. Apple owes much of its current profitability to Cook’s operational genius— when he was first hired, he slashed Apple’s enormous inventories and since then has secured supplies of important parts in such high quantities and at such low prices that competitors can’t hope to beat Apple on price.

No one doubts Cook’s abilities as a day-to-day manager. What they fear is that Cook lacks Jobs’s vision. Really, we have no proof of that, and we’ll likely never know. Here’s why: Jonathan Ive, Apple’s senior vice president of industrial design and a large part of the genius behind the company’s most important products, including the iMac, iPod, iPhone, and iPad.

Ive was lured to Apple shortly after Jobs returned as interim CEO in 1997 and has followed Jobs lead ever since. Ive and Jobs have worked closely on product design, so closely that I would argue Ive can conceptualize a product as well as Jobs. Jobs has been tutoring Ive in the skill of product prognostication for years.

The design process of the original iMac G4—the “desk lamp” design—is a great example of Jobs’s tutelage. Ive had proposed a design not unlike the current iMac, with the computing guts hanging behind a flat panel LCD. At the time, LCDs were relatively small, and in my estimation would not have elegantly hidden all the necessary drives and circuit boards. Jobs probably saw this limitation, too. After Ive pitched the design, Jobs invited the designer over to his house for a more informal chat. The design wasn’t bad, Jobs said, but it wasn’t great. As the two were walking through Jobs garden discussing the design, they had this exchange, recounted in a Time Magazine article about the new computer:

“Each element has to be true to itself,” Jobs told Ive. “Why have a flat display if you’re going to glom all this stuff on its back? Why stand a computer on its side when it really wants to be horizontal and on the ground? Let each element be what it is, be true to itself.” Instead of looking like the old iMac, the thing should look more like the flowers in the garden. Jobs said, “It should look like a sunflower.”

Lessons like these are not easily learned but neither are they easily forgotten. Ive has not only proven himself a creative genius, but also an astute student.

Ive’s designs are successful not only for their artistic appeal, but also for the way they they take manufacturing and engineering into account. Witness the unibody MacBook Pro. Without the design team understanding the engineering opportunities and challenges of carving a laptop from a single piece of aluminum, the design would have flopped. Because of that attention to detail, their designs are both easy and profitable to manufacture. Anyone can design a stunning design, but not everyone can translate it into a shipping product.

Jonathan Ive is Apple’s right brain to Tim Cook’s left. That’s not to say Apple will adopt RIM’s co-CEO approach (nor should they—that’s turned out to be a complete disaster). Rather, the two seem to understand each other in ways many other designers, engineers, and managers do not. That synergy will prove invaluable in Jobs’s absence. Plus, they’re steeped in the Jobs way. Cook and Ive understand enough of what it takes to make an Apple product that I can see little reason for the company to stumble.

Photo by dotmotion.

Related posts:

Steve Jobs’ medical leave raises the issue of CEO succession

What will Apple do with its billions?

Apple: The world’s largest startup?

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The failings of News Corp’s board

News Corp and the Murdochs have had a rough couple of months, to say the least. The media conglomerate’s leadership has claimed innocence amidst growing evidence that the hacking of thousands of people’s phones by News of the World was discussed by the paper’s top editors. No matter how much the Rupert and James Murdoch knew of the practice, they are at least partially to blame for the company’s problems thanks to questionable appointments they made to News Corp’s board of directors.

NASDAQ, where the firm’s stock is listed, requires a majority of board members to be independent. Technically, News Corp complies with this requirement. But in reality, six of the nine claimed independent directors have close ties to the company and it’s CEO, according to the New York Times. Among them are three former chairmen of News Corp subsidiaries, a member of the Bancroft family who made a fortune off News Corp’s purchase of Dow Jones, and the godson of Lachlan Murdoch, Rupert Murdoch’s eldest son.

“They have nothing that looks like arms length,” professor of finance Kathleen Hagerty said of News Corp’s board. “If you go to the board of GE, they have people like the president of MIT and CEOs of other major corporations. They have a lot of other things going, so they don’t really owe GE anything.” GE’s wealth of independent directors brings different perspectives to the board, allowing the firm to tap talent and ideas it may not have internally.

News Corp’s board, on the other hand, is stacked with internal directors and people who are indebted to Rupert Murdoch to some extent. That so many are currently or were previously employed by the firm means they are steeped in the News Corp “way”. “They’re not providing much outside perspective,” Hagerty said. On top of that, most directors have something to thank Rupert Murdoch for, whether that be a job, a tidy fortune, or both. “They owe him,” she added, “so it’s a little harder to be honest.”

Poor governance is apparent in the way the company has handled the hacking scandal, Hagerty said. “I don’t know how much attention the phone hacking got at the board level, but the way that they’ve handled it with internal people investigating it suggests poor judgement. They’re not getting enough outside advice,” she said. “If they had somebody else on the board who was a bit more independent, that would have helped them.”

Photo by World Economic Forum.

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The good and bad of Google’s Motorola Mobility purchase

Google’s Android platform has been a success with consumers, but the mobile operating system has attracted dozens lawsuits alleging patent infringement. Google announced this morning that it was hoping to turn a page on those troubles with its $12.5 billion purchase of Motorola Mobility, the recently spun-off portable device division of the venerable technology company.

The Motorola purchase bequeaths Google with some 17,000 patents and 7,500 filed patent applications. That should help the company fend off dozens lawsuits related to Android from myriad tech companies ranging from Microsoft to Apple to Oracle. While Google itself hasn’t been on the receiving end of many of these lawsuits—plaintiffs have been targeting manufacturers that use the OS instead—the legal challenges have been making the supposedly free operating system a more and more expensive proposition.

“The problem with this litigation for Google is since they are relatively young, they don’t have many patents they can countersue the giants with,” said James Conley, a clinical professor of technology who teaches Intellectual Capital Management (MGMT441 for interested Kellogg School students). “They are not able to play the game of volley and fire with what I call superior counter-battery strength. They just don’t have any counter-batteries,” he added. The Motorola Mobility purchase may change that. “Motorola really knows how to play the IP game.”

Hardware manufacturers that use the Android OS have been seeking reassurance that Google will help them fight patent suits brought by Apple, Microsoft, and others. With Google’s purchase, they got what they wanted, but they also gained a new competitor, one that could have an insider’s advantage. Google claims it will run Motorola as a separate division without any special treatment, but that promise will be hard to back up, said professor of management and strategy Shane Greenstein. It’s “an interesting managerial issue,” he said. “How does Google implement their promise not to play favorites? It is not hard to promise, but how do they guarantee the future?”

Google will have paid around $500,000 per patent if all of Motorola’s pending patents are awarded. That’s quite a deal, given that Google would have had to pay more than $750,000 per patent to top the winning bid for the 6,000 patents from defunct telecom firm Nortel. But with the Motorola deal, the search engine company gets hardware assets and engineering knowhow, too. Those could be a real asset, but Greenstein said that Motorola’s “hardware, organization, employee issues are quite different than anything Google has had to deal with up until this point.”

Beyond the usual integration woes, Google may have a tough time operating as both the Android OS licenser and a maker of Android devices. A number of companies have tried to both license their software while also building their own hardware. Apple was the first that came to my mind. After the success of Windows 3.1 and their own rash of unstable hardware releases, Apple decided to license its Mac OS while continuing to make Macintosh computers. The results were disastrous. The company didn’t make much money on the licensing agreements but lost significant hardware marketshare to the Mac clone makers, who sold their computers on thinner margins. Mac OS licensing was one of the first things Steve Jobs killed when he returned to the company.

Apple wasn’t alone in experimenting with licensing and building, Greenstein noted, nor are they alone in failing to succeed at the enterprise. IBM licensed its early PCs and AS minicomputers, Sun Microsystems tried its hand the late 1980s and early 1990s, and Palm tried the same when it licensed its OS to Handspring. None of these efforts were regarded as successful. “The issue is not with implementation or design, or having them under one roof. That can be done and has been done. The harder issue is managing open systems with multiple assets pushing and pulling in various directions,” Greenstein said.

In the end, we’ll have to wait and see if Google bit off more than it can chew. The patents are a windfall and gives Google a good chance to defend the Android OS market. But buying Motorola Mobility also brings with it a number of challenges that will certainly test the young company.

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