Next-generation CIOs

Many chief information officers do an excellent job of overseeing IT operations, but very few lead their companies' efforts to get real business benefits from IT investments. A new style of leader is needed—one who can find ways for IT to change the company, not just run it. Are CIOs up to the challenge?

Case in point: The CIO of a large European bank instilled discipline and focus in the IT organization, reduced IT costs, streamlined and upgraded the infrastructure, and showed the business units that IT mattered. From an enterprise perspective, however, the CIO's performance was not so impressive. First, the IT budget focused on maintaining bank operations, not on innovating to add business value. Second, technology operations and investments were not aligned with the bank's business strategies.

The bank's CFO proposed an alliance. The two executives would involve business-unit leaders in defining the bank's IT agenda. They would begin, the CFO suggested, by helping the business leaders see the impact of their decisions on IT costs. At the CFO's behest, IT reports on operating costs and reliability were replaced with reports focusing on IT-driven business and financial metrics, such as business-process errors. The CFO also sold the bank on a new decision-making process for technology investments—one requiring greater business-unit involvement. Over time, persuaded by facts, influence, and deal making, the business-unit leaders became more deeply engaged in initiatives to reduce IT costs stemming from business complexity.1 Today these executives are making smarter decisions about IT investments and are more accountable for the outcomes.

Who was the real IT leader at the bank—the CIO or the CFO? The answer is obvious: the CFO drove efforts to take IT to the next level. While some CIOs may be content to manage their IT organizations efficiently, those who aspire to a greater role will need to make a choice in the next few years: step up to the new responsibilities required of an IT leader or watch as another executive does.

At many companies in Europe and North America, CIOs have been optimizing IT assets successfully. But at a growing number of these businesses, CEOs say they are disappointed that IT hasn't done more to improve corporate performance (see sidebar, "What CEOs really think about IT" ). CEOs and many CIOs agree on the components needed to manage IT for value—including more business-unit involvement in technology-investment decisions, greater business accountability for realizing the benefits of those investments, and an increased emphasis on using IT to change the company rather than just to run it. The missing ingredient is the leadership needed to make these changes real.

Let's be clear: this article is not suggesting—as many have, for many years—that CIOs should have a seat at the strategy-making table. That advice is good, but simplistic. There are CIOs who can provide savvy ideas about new business applications but can't drive the kind of business value that the European bank's CFO in our example did. Whether IT leadership ends up in the hands of the CIO or another executive depends on multiple factors, including ability, reputation, corporate culture, and a company's perception of the role of IT. In a recent survey,2 few senior executives placed a high degree of importance on guidance in IT matters from the CIO: their top priority was getting business value from IT.

Some CIOs have taken on the leadership mantle. From our ongoing research on CIO relationships in French companies—as well as discussions with other European and US CIOs, CEOs, and business-unit leaders3—it is clear that this transition requires a new focus plus new skills. CIOs need to direct their attention away from managing IT supply and toward managing IT demand, and they must fine-tune their executive-leadership skills.
From supply to demand

Think of supply and demand, in this context, as a clarifying analogy. CIO responsibilities span a spectrum of managerial tasks, with one end of the spectrum involving supply—the delivery of IT resources and services to support business functions. The other end of the spectrum is demand—the task of helping the business innovate through its use of technology. CIOs who accept the new responsibilities of IT leadership are delegating or even shedding some operational duties and spending more time helping business leaders identify and use technologies that matter. This challenge includes persuading business leaders to be better owners of the technology they leverage. To achieve this goal, CIOs are redefining their roles and changing the way they communicate and lead.

In truth, most CIOs struggle to balance the supply and demand roles. Managing IT supply—keeping the engine running cost-efficiently and reliably—is the heart of the job. Basic systems must be operating smoothly before the CIO can take on broader leadership responsibilities. Most CIOs also spend considerable time with business-unit leaders and other executives in the company and talk to customers, suppliers, and business partners.

But many CIOs admit that managing supply tends to trump shaping demand. Although in survey after survey they say that aligning IT and business strategies remains one of their most significant challenges, they don't have enough time for effective strategic planning.4 They feel demand-side pressures but are hard-pressed to meet them.

While CIOs do spend time with business-unit leaders, numerous executives say that the time is not well spent. They tell us that their CIOs aren't up to speed on issues confronting the businesses and can't think through the implications of systems trade-offs, on a business-unit level, for planned implementations or proposed IT investments. Moreover, business leaders often tell us that their CIOs are not proactively bringing them new ideas about how technology can help them compete more effectively.

Part of the problem stems from the inherent conflict of managing supply and shaping demand. CIOs often must meet requirements to reduce total IT spending, for instance, while making investments to support future scenarios—even though these upgrades will increase IT operating costs. By trying to be both a cost cutter and an innovator, the CIO sometimes compromises one role. At a financial-services company, the CIO slashed IT supply costs to meet corporate objectives, and now the organization's aging legacy systems fail to provide competitive functionality. The company's business leaders don't understand why IT spending must rise or why it will take a long time to implement needed new functionality.

CIOs who seek a broader demand role also face many organizational challenges. They alone can't drive change in parts of the organization that are under the control of other executives. Business-unit leaders want more IT leadership, but they are wary of CIOs who don't tread carefully along business leaders' boundaries.

Ironically, as business leaders have gained a greater understanding of technology's strategic impact—indeed, during the dot-com years, some even led Internet channel initiatives—they are more likely to engage in battles over ownership of and accountability for IT. Tempers can flare especially vividly during decisions about business-applications investments. At a US-based financial-services company, business-unit leaders went to war with the CIO, one of its top executives, when he attempted to take greater responsibility for IT applications and technology investments at the business-unit level and to make business leaders shoulder more accountability for getting returns from IT.
Leadership agenda

At a growing number of companies for which IT is part of the very fabric of the business, the next IT objective clearly is to make improvements on the demand side. Leadership in this area awaits CIOs or other executives who will step up to the challenge. What does demand-side leadership consist of? In companies where executives have begun to ensure that the organization captures greater value from IT investments, we see three critical hallmarks of success:

1. Key business executives in the organization—as well as the CIO—have a clear financial understanding of IT costs and potential investments. Business and IT managers who discuss IT in a common, business-focused language make smarter and faster decisions.

2. There is widespread business accountability for IT. Executives who possess a financial understanding of IT are more willing to take responsibility for generating value from IT investments.

3. Business and IT managers seriously study how new technology investments can help a company become more productive and competitive. In other words, they seek innovations that will help them change the business.

For a majority of companies, IT leadership is a vacuum. The CIO should view each of the three markers of success as an opportunity. By taking the lead in making improvements in any one—or all three—of these areas, a CIO can help the organization get significantly greater value out of its IT spending and, in the process, gain credibility to take on even more significant leadership tasks.
Financial language of IT

At companies where business executives are involved in technology-investment decisions, IT leaders aren't generating reports about how many person-days it will take to build functionality into a particular system. Instead they frame IT costs in financial terms. At one company, for instance, the CIO compared the IT capital expenditures of a proposed new system with ratios and returns on other kinds of capital outlays made by companies in the sector. Another CIO routinely groups costs or investments in tangible categories—such as equipment and people—and breaks out how specific changes in the business unit can lower costs or improve an investment's impact.

At a handful of companies, CFOs are starting to push aggressively for changes in the way IT and the business evaluate and measure information technology. Smart CIOs could forge alliances with their CFOs to sell these changes throughout the organization.
Business accountability

Most executives recognize that active involvement by business leaders in setting the agenda for IT investments improves the company's ability to get the greatest benefit from them.5 But involving business executives in investment decisions—much less getting them to take responsibility for realizing the benefits of new systems—has been difficult. There is considerable room for improvement. In a 2003 McKinsey survey, 64 percent of CIOs reported that their IT budgets were set at the beginning of the year and that they didn't have to compete with business units or other functions for resources. Also, 68 percent of these companies had no process for auditing the performance of their IT projects. An additional 14 percent said that while their companies did have a postimplementation audit process, outcomes weren't tied to budgets or bonuses (see "Tech spending is up, but who's doing the buying?" McKinsey on IT, Number 2, Spring 2004, pp. 9–12).

Despite these organizational constraints, CIOs can drive changes in accountability. At a basic level, many CIOs can do postimplementation audits themselves. More generally, a few CIOs have led broad change initiatives—restructuring global IT organizations, for example—that have prompted businesses to take on greater responsibility for IT decisions. (For a look at how one CIO achieved this result, see "Deutsche Bank's IT revolution," McKinsey on IT, Number 2, Spring 2004, pp. 18–22.)
Innovation

Business-unit leaders we spoke with worry that they don't have a good grasp of which new technologies to scrutinize and which to ignore. Are any emerging technologies potentially disruptive—that is, could they help a company change the competitive game? And how, specifically, might the business units take advantage of new technology?

Charlie Feld, the former CIO of Frito-Lay, Delta Airlines, and First Data Resources, argues that CIOs must be able to cut through complex tangles of business and technology signals to see—as an innovator would—patterns and meaning and to distinguish opportunities from fads.6 That vision is one of the skills required for demand-side leadership.

The CIO of a large European construction company says that his role within the organization is to be the "chief innovation officer." He spends considerable time studying the use of technology by European and North American companies in order to find new solutions—for example, ways that technologies used in other sectors can be recast to pioneer trends in building and construction.
Making the transition

CIOs who drive improvements in one or all three of these areas will need to focus less on operational issues and more on becoming business leaders. In our discussions with CIOs, business-unit leaders, and executives, we have identified a few important practices that can help CIOs succeed at this challenge.
Ensure that IT is efficient and then make the transition to effectiveness

For some CIOs, the first step in the transition from supply-side to demand-side leadership is to verify that the IT department is in good financial and operational order. As a North American energy company CIO put it, "If you can't keep basic systems up and running, you can't talk about strategy."

The dilemma for CIOs is that ensuring efficiency requires one set of management approaches and focusing on effectiveness quite another, so new skills are needed and very different priorities must be set. In mastering efficiency, CIOs are often pushed to be project oriented and to concentrate on the short-term actions needed to make targeted improvements or to put out fires. Communication with business units often emphasizes action plans and progress.

When the IT engine is running smoothly and the CIO turns his or her attention from supply to demand, the required management capabilities change—from operational skills to strategic ones, from short-term horizons to longer-term ones, from IT communications to business communications. CIOs need to know not only what the differences are but also how to time the shift; move too soon or too late and credibility with business leaders will suffer.

To be sure, some CIOs won't make the transition successfully. Those who do will spend less time managing core operations, be better able to describe the performance of the infrastructure in business terms, and spend more time creating real business value from IT.
Reengineer relationships with business leaders

For CIOs who have efficiency in order, the first step toward effectiveness is to build strong relationships with business leaders. The current supply-side model of IT leadership doesn't help CIOs forge these connections. In many companies, IT staff undertake discussions with business units about their requirements while the CIO largely stays at home managing supply. The reverse needs to happen.

Even CIOs who spend time talking with business leaders often need to digest the experience. Each discussion is an opportunity to forge a common financial understanding of IT. Successful demand-side CIOs leave IT measures and operating reports at the door; they know that providing business leaders with unwanted information only reinforces negative opinions about IT. Instead they ask about the business—and they listen. Executives have different opinions about the level of information they want, and smart CIOs figure out how to accommodate these differences within a common financial language.

As part of these discussions, CIOs should provide insights about how technology can help the business develop new capabilities. A few CIOs who do this well sometimes frame these discussions around what their competitors are doing—they have become adept at business intelligence. The CIO at one bank, for instance, routinely interviewed managers who were newly hired from competing banks about technology and business issues.
Invest a business committee with technology oversight

A few leading companies have disbanded their technology committees—typically staffed by business managers and IT staff—and are asking senior-executive committees to take responsibility for IT-investment decisions. They found that technology committees had limited usefulness. Indeed, business managers often sent delegates in their place, thus undermining the group's continuity and typically shifting the perspective toward IT.

Instead these companies ask existing top-executive committees to add technology to their agendas. (At two such companies, the CIO has earned membership; at others, the CIO is an invitee.) Over the years, these executive committees have worked to make effective decisions quickly. As they learn about technology, they apply the same decision-making process. Executives at companies with such a committee don't send substitutes to meetings, and all decisions about IT projects go through it. Using this structure avoids the problems (such as encroaching on the space of other committees and making conflicting decisions about IT) that companies have when multiple committees are responsible for different aspects of technology investments.

Ultimately, some CIOs may need to shed—partly or wholly—their supply responsibilities. The CIO of a European industrial company is beginning to outsource most of its supply-side organization so that the remaining IT managers can focus on demand-side activities. One European insurance company recently replaced a supply-oriented CIO with a new one who sits on the company's executive committee and has no responsibility for supply.

The pressing need to get better business value from IT calls for technologically savvy business leaders. Now is the time for CIOs to step up to the role—the challenges are many, but the opportunity has never been more ripe.
What CEOs really think about IT

Most large companies in the United States and Europe have long struggled with the need for tighter relationships between IT and business managers. This perennial management problem is echoed once again in a recent study of how French CEOs and CIOs view the performance of information systems within their organizations.1 Insights from the study suggest that CEOs are growing keener to find a solution—and that both CIOs and the leaders of business units may soon be held more accountable for business ownership of IT.

In the survey, CEOs say that IT isn't meeting their (admittedly high) performance expectations, particularly in providing systems and tools to support managerial decision making and in gaining the scale advantages of deploying common systems and processes across business units. CEOs attribute the gap between expected and actual performance mainly to the insufficient involvement of business units in IT projects, to the weak oversight and management of these projects, and to IT's inadequate understanding of their business requirements. As one CEO commented, "Because the businesspeople are uninterested in information systems, the information systems people have the power."

CEOs have high expectations that business units will be strongly involved with information systems projects throughout their whole life cycle. Around 90 percent of the CEOs expect business units to identify the IT investments needed to implement their strategies; to support, monitor, and assess important IT projects; and to help make IT-investment and budget decisions as well as the process and organizational changes that technology implementations require. But the actual involvement of business units is far below expectations: fewer than 10 percent of the CEOs feel that businesses really assess the benefits of IT projects, for example (exhibit).
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enlarge exhibit

Moreover, CEOs acknowledge that the governance of IT emphasizes checks and balances more than the strategic use of IT to create value. In most of the companies questioned, the business units allocate resources to information systems on a case-by-case basis. Projects are often run by steering committees that oversee joint teams consisting of managers of business units and IT. Few business units have a permanent sense of responsibility for IT, and the interaction between CIOs and business units is often confined to a few strategic IT committee meetings a year. In half of the companies, the CIO isn't involved in drawing up business-unit strategies, and in most companies, information systems aren't discussed at the board level.

But the most important blind spot is the assessment and monitoring of IT's benefits. The survey reveals that only major projects are subjected to business-case assessments before launch, that only half of the companies monitor the expected benefits, and that the business units are not accountable for realizing them in nine companies out of ten.

The survey does, however, suggest that some CEOs are starting to make business managers more accountable for getting business value from IT. One approach is to give business units ambitious progress objectives, which encourage managers to seek ways of using information systems to meet them. A CEO said, "I try to empower the BUs [business units] and have them make commitments. We monitor them and apply pressure through benchmarks. For finance [the cost of financial processes], for example, the benchmark was set at 0.8 percent of total income and we gave them 18 months to achieve it....The division bosses weren't the least bit interested, but they realized that they couldn't achieve their continuous-progress objectives if their division wasn't equipped with performing information systems. In less than six months, we saw a genuine change."

Other approaches used by CEOs to get business managers more involved in IT decision making include putting information systems issues on the agendas of executive committees and initiating the development of master plans for integrating the strategies of information technology and business units.
Notes

1 The study—conducted jointly in 2002 by McKinsey and Club Informatique des Grandes Entreprises Françaises (Cigref), to which a majority of the largest companies in France belong—was based on interviews with or questionnaires from the CEOs and CIOs of more than 70 leading French corporations.

Return to reference
About the Authors

David Mark is a director in McKinsey's Silicon Valley office, and Eric Monnoyer is a principal in the Paris office.

This article was first published in the Spring 2004 issue of McKinsey on IT.
Notes

1 See Frank Mattern, Stephan Schönwälder, and Wolfram Stein, "Fighting complexity in IT," The McKinsey Quarterly, 2003 Number 1, pp. 56–65.

2 GartnerG2 and Forbes.com, "Key business issues survey: What keeps CEOs up at night?" The analysis of the survey, released in February 2004 on Forbes.com, focused on the responses of 462 senior business executives from large companies around the world.

3 In a follow-up to a 2002 survey by McKinsey and Club Informatique des Grandes Entreprises Françaises (Cigref) of CIOs and CEOs at more than 70 leading French companies, we are conducting in-depth interviews with business-unit leaders at a subset of these companies.

4 The most recent survey is "State of the CIO survey," CIO, April 1, 2003.

5 Dan Lohmeyer, Sofya Pogreb, and Scott Robinson, "Who's accountable for IT?" The McKinsey Quarterly, 2002 special edition: Technology after the bubble, pp. 38–47; and Jed Dempsey, Robert E. Dvorak, Endre Holen, David Mark, and William F. Meehan, "Escaping the IT abyss," The McKinsey Quarterly, 1997 Number 4, pp. 80–91.

6 Charlie Feld, "IT leadership in 2010," CIO, December 15, 2003.

The Paris guide to IT architecture

The Paris guide to IT architecture

City planners try to preserve viable old assets, to replace outmoded assets, and to add new assets—all in the context of an infrastructure linking them coherently. IT developers have a good deal to learn from that approach.

Jürgen Laartz, Ernst Sonderegger, and Johan Vinckier

The McKinsey Quarterly, 2000 Number 3

Companies that want to gain a competitive edge, whether by being the first into a market with new products or by launching an electronic-commerce channel, know how much they depend on information technology architectures to achieve their aims. Usually, though, the architecture is a costly and aging maze of applications, hardware systems, and networks. Far from making it possible to achieve strategic goals, it can make a mockery of them. But by looking at the evolution of another complicated set of systems—those that make up a modern city—senior managers can begin to understand more fully how the controlled and rational development of an IT architecture can enhance the ability to compete.

Stories about companies that stumbled because their IT architectures couldn't accommodate rapid and drastic change are legion. Fast-growing companies are liable to hit a wall when their architectures fail to expand quickly enough to serve new customers cost-efficiently. Long-established companies can lose market share if their architectures lack the flexibility to move products to market as quickly as their competitors do.

A leading international bank discovered this problem the hard way. Its strategy involved launching an Internet channel that included an on-line securities brokerage, but its deadlines were so tight that there was no time to integrate the customer interface with the back-end systems where transactions were to be processed. The bank's back-office staff therefore had to input each one by hand, an error-prone process feasible only in the early days of e-brokerage, when volumes were tiny.

How could the bank's IT managers have allowed the systems they supervised to undermine rather than advance a strategic goal? The design decisions that had shaped the systems landscape over the years were, individually, sound. The people responsible had focused on delivering the required functionality on time and within budget. But no one had kept an eye on the big picture. The overall systems landscape thus became too complicated, extremely costly, hard to manage, and incapable of responding flexibly to the bank's business needs.

Whether chief executives wish to undertake new e-commerce or customer-relationship-management (CRM) initiatives or to replace existing IT systems, they can learn from the way modern cities adapt to the needs of residents and businesses. For, in the same way, a properly conceived and administered IT architecture adapts itself to the diverse and changing needs of the company that deploys it.

We could use several cities to make the analogy between city planning and IT architectures, but Paris seems particularly apt. When you walk around Paris, you see a wonderful variety of buildings dating from many centuries; a closer look reveals that a majority of these structures went up in the past hundred years. The infrastructure of Paris, such as its network of roads and bridges, unites these buildings, defining the cityscape and setting the terms in which it has evolved.

When Baron Georges-Eugène Haussmann was commissioned by Napoléon III to create a new plan for parts of Paris, in the 1850s, he cut boulevards through the existing pattern of streets to facilitate commerce and the movement of troops. Since then, Paris has carefully planned the redevelopment of sections of the city, so that neighborhoods and districts have distinctive social or economic roles. Most office towers, for example, are located outside the historic borders. As a result, the Paris of today, with its Beaubourg and La Défense, is a modern and highly efficient but unmistakable patchwork of many eras. City planners try to preserve and renovate those old assets that are still viable while replacing others and adding new ones in a coherent way. Finally, a city like Paris makes sure that a good infrastructure binds all these assets together for the long term.

This city-planning analogy can help established companies avoid IT architecture problems. A company might believe that major chunks of its applications are so unfit for current needs that they might as well have come from the Middle Ages. At the same time, IT departments are repeatedly asked to add new functions and to integrate business units and allied companies. This ceaseless growth in automation has made it less and less feasible to replace all systems completely. The challenge is to stay abreast of the different life cycles of a given IT system's components so that the architecture as a whole doesn't become obsolete (see sidebar, "Case study: A leading international bank").

The planning of cities like Paris has taught us four lessons that can help companies manage the evolution of their IT architectures to further their strategic initiatives.

1. Define a long-term plan

Most cities have zoning codes that designate some areas as residential, some as industrial, and some as parks. While mixed use (shops with apartments upstairs, for example) is permitted in some districts, certain functions are incompatible with each other: a responsible planning board would not, for example, permit a smelting plant to be located next to a hospital.

Similarly, good IT architectures break down complicated applications landscapes into coherent, manageable parts often known as domains. Typically, each domain performs a discrete function. An insurance company, for instance, would have domains such as product systems for life or automobile insurance and channel systems for call centers or physical branches.

This scheme permits IT functions to be built in one domain and then made available to other domains that need them. A product-pricing algorithm, for instance, could be built in the product domain and then made available to all channels. But a call center and an e-commerce channel that each built its own product-pricing algorithm would be needlessly duplicating each other's IT effort. There would also be a serious risk of inconsistencies—conflicting price quotations, for example—even if two channels sold the same product under the same brand.

IT architectures that are opaque and tangled should be broken down into clearer domains. Within a financial institution, this effort might involve disaggregating

a system providing both channel functions and product functions. By contrast, IT functions that are identical but dispersed across an architecture—databases containing different bits of information about the same customers, for example—should be grouped into a single domain. Exhibit 1 depicts one bank's vision of what its IT architecture ought to be.

2. Build a stable interface infrastructure

To offer neighborhoods standard services such as power and water, a city needs a stable infrastructure. The infrastructure must serve prospective as well as existing needs and have uniform interfaces—including the same types of outlets, plugs, and voltages—so that business can be carried out not just among neighborhoods but across an entire country.

Similarly, the interface infrastructure of an IT architecture makes it possible for domains to exchange information and instructions—what IT specialists refer to as "services"—with middleware functioning as the transporting technology. A customer information system, for example, should provide a standard service (name, address, customer number, birth date, and family members) regardless of whether it is requested by a salesperson's application or the company's Web site.

Ideally, all interfaces between domains pass through a limited set of stable and standard services. If they should lack stability, a change to any one of them would require all domains using it to go through a maintenance cycle. When a database of customers is migrated from an older mainframe to, say, a newer UNIX server, channel applications need not be affected as long as the customer's profile service hasn't changed.

Services also drastically limit the number of access routes to a domain. Once upon a time, all developers might have been able to blaze their own trails in search of the information they needed in other domains, but services force all developers to access domains in a standard way. Just as each city resident uses the same type of plug to draw a standard type of voltage, a channel system or a customer-billing system should retrieve a customer's profile with a standard service. Some financial institutions have set themselves the goal of gradually replacing the tens of thousands of differently tailored interfaces among their domains with a set of 500 or so services.

3. Appoint a zoning board

Many cities have created zoning boards to draw up and carry out long-term plans that both reflect and help shape evolving patterns of public use and the general preferences of elected officials. Similarly, a company needs its own zoning board, usually a separate group within the IT organization, to manage the evolution of an IT architecture.

The board's role is to define the discrete domains and the functionality belonging to each. Domains can be defined according to which kinds of functionality and data belong together, the de facto standards that software packages set for them, and which part of the business should manage them. To achieve IT efficiencies, the board should also identify the technologies and software development tools to be used in the domains. Finally, the board must ensure that the company builds and manages a strong and highly stable service infrastructure.

A bank's zoning board might, for example, decide that certain kinds of software belong in the call-center domain: the software that generates the scripts telephone operators read when customers call, the software that integrates the computers of those operators and their telephones, and the software that generates reports on call-center performance indicators. The board might also adopt UNIX as the system's platform and require all interfaces with software in domains other than the call center to pass through the standard services.

Occasionally, managers seek an exception to the rules—in city-planning jargon, a "variance." If, say, company X offered a delayed-payment function, which allows a bill to be paid on a specific date at the customer's direction, the managers of company Y, a competitor, might ask to have a similar function built into their own call-center application if the payments domain couldn't accommodate the new feature immediately.

Normally, deviations of this nature aren't allowed, since they deny other channels easy access to the function. But in specific cases, the zoning board, adopting an overall business perspective, will choose to weigh trade-offs: waiting until the payment domain can deliver the feature, allowing the call-center domain to deliver it temporarily, or delivering a quick fix by writing an add-on program in the payment domain. The last option is generally the preferable one, since the people in charge of the payment domain would then be responsible for turning an improvised solution into a well-engineered feature of that domain.

4. Make the most of what you have

Before making new investments, good municipal leaders ensure they have made the most of existing assets. Cities, for example, would generally try to add bandwidth to existing copper wire before submitting themselves to the disruptions of laying fiber-optic lines.

Likewise, companies that contemplate building new systems should first try to get what they can out of their current applications, however messy. Such companies might, for instance, be able to build adapters on to existing applications—a practice known as "wrapping"—so that they can be hooked up to a standardized service infrastructure. Wrapping permits a company to deliver a clean and stable customer profile service, for example, to an important new e-commerce domain even when the data are drawn from a variety of existing systems (Exhibit 2). A data warehouse that serves the purpose of supplying background for a CRM initiative could be added in the same way. Under this approach, new applications and domains such as e-commerce can be insulated from the problems of an existing IT architecture even while it is being renovated or replaced.

Companies reviewing their architectures will probably discover a multitude of past "city-planning" mistakes—the IT equivalent of putting a smelting plant next to a hospital. In general, companies can't justify correcting all of these mistakes, but new business initiatives can provide the occasion for doing so.

When an IT architecture embodies decades of ad hoc decisions and short-term projects, it can be no less disorderly than Bangkok or Mexico City. But even planners in those cities look for evolutionary ways to exploit important assets. Tearing them down and beginning again or building a brand-new city next door to the old one is rarely a serious possibility.

Instead, cities adopt change programs. They typically start by mapping the roles of existing zones and the capacity of the transportation infrastructure. Then they calculate how much growth to expect in particular areas within a given time frame and how much infrastructure must be added or restored to support that growth. Finally, public undertakings are put out to tender, and private proposals that are not "as of right'' are submitted to the approval process. Often, public-private partnerships—such as New York City's Lincoln Center, built in the 1960s on the site of slums—have a transforming effect on the surrounding neighborhood and beyond.

Similarly, an IT program starts by determining the extent of problems such as duplication. If the company's goal is to become a multiproduct, multichannel financial institution, for example, it must organize domains around those key areas of functionality. A first step toward implementing this architecture will usually be the construction of services that wrap current applications; these services can then offer the existing capabilities of legacy systems to new applications in a stable, standardized way. Once a service infrastructure of this type is established, applications can coexist with new kinds of functionality, such as e-commerce. Gradually, the IT architecture becomes an evolving asset, with applications in each domain—all bound together by a stable service infrastructure—added, enhanced, renovated, and replaced along different time lines.

Our four lessons from city planners have helped companies begin redesigning their IT architectures in order to get products and services to market more quickly and to improve their returns on IT assets. Even chief executives who believe that their companies' IT architectures resemble Mumbai rather than Paris are likely to find that an approach taking into account the existing fabric while laying the groundwork for growth will turn their IT assets into virtual cities of light.

Case study: A leading international bank

Senior managers of a large international bank developed a strategy to get products to market faster, offer more customized services, and reach larger numbers of customers through new channels. To execute the strategy, the bank had to redesign its information technology architecture, and it decided to do so with an approach incorporating lessons about how cities grow. Three possibilities were considered: a greenfield approach, with each division building a new platform tailored to its requirements; migration to a banking software package using a modern IT architecture; and the transformation of existing systems according to an IT architectural master plan—something akin to a long-term city plan. The third approach would have to permit the immediate addition of new kinds of functionality, such as electronic commerce, in parallel with a thoroughgoing renovation (or even replacement) of some core systems.

The first option was rejected because the costs of the new system and the time required to build it would have been excessive. The second option was tempting in theory, but banking packages capable of handling the bank's product breadth and high volumes were not available. The third option had three important advantages. It could be introduced gradually, starting with the existing application portfolio. It would continue to use existing applications as they evolved, thus reducing the payback period on the investment to a year. Finally, it would spare the bank the need to spend at least five years developing and maintaining the old and new architectures in parallel.

1. Define a long-term plan

The bank's IT architecture left much to be desired. The customer database held payment information—an arrangement resulting in unnecessary interactions between software engineers from the bank's customer side and software engineers from the product side. The deposits system was so closely woven into the securities and customer information system that several attempts to replace it with a more modern version had failed. And the Internet channel systems offered access to the back-office systems only through an aging interface, a problem that became a performance bottleneck delaying new software releases and jeopardizing levels of service.

To resolve these issues, management designed an IT architecture: the long-term city plan. It laid out the components—that is, the "city's" zones (the securities domain, the customer information domain, the credit domain, and so on), the data they should contain, and the way they were to communicate with other systems. This set of rules was intended to transform the systems landscape into a more modular environment where particular systems could be altered or exchanged to minimize the impact on other systems.

2. Build a stable interface infrastructure

Just as streets usually have a longer life than do individual buildings, so too the communications infrastructure and interfaces between systems tend to remain in place longer than the systems themselves. One challenge in making the bank's IT architecture work was to design and implement communications and data exchanges between the separate domains. To do so, the IT department had to master new technology and application design skills. Most difficult, groups of software developers pursuing the city-planning approach could no longer make private arrangements among themselves about how to integrate their applications.

3. Appoint a zoning board

Both to ensure that the systems developers adhered to the rules of the IT architecture and to get a long-term plan adopted, the bank's chief information officer created and chaired a steering committee. Every deviation from the rules had to be reported to the committee, which granted approval, at best, on a temporary basis—and then only on condition that there was a clear plan to make the system architecturally compliant.

4. Make the most of what you have

It was clear from the outset that the bank had no practical chance of eliminating its legacy systems in the near future and that, in any case, doing so would be uneconomical. On the positive side, so many functions had been built into the systems over the years that the bank could offer a wide array of customized services (such as tax statements for customers in different countries) and an extremely broad set of products. Even Russian government bonds from the pre-Communist era could be processed in securities accounts.

The bank thus began renovating its legacy systems to reduce their complexity while maintaining their broad functionality. To permit the almost round-the-clock use demanded by e-commerce applications, the bank overhauled applications monopolized at night by accounting batch runs. This approach extended the life of existing systems and in this way lowered the amount of new investment needed, while the systems' reduced complexity brought down IT operations costs.

Overall, the bank found that its evolutionary approach addressed its changing IT needs in an economical and low-risk way that enabled it to respond properly to urgent business priorities, such as e-commerce, while resolving fundamental problems in its systems. The bank expects the effectiveness of its IT architecture to improve so much that it will recoup the substantial investment it made—an average of 20 percent of its annual IT development budget for three years—within a year of finishing the project.

Return to reference

About the Authors

Jürgen Laartz is a principal in McKinsey's Frankfurt office; Ernst Sonderegger is a principal in the Zurich office; Johan Vinckier is a principal in the London office.

The right passage to India

The right passage to India
Companies attracted to the country’s potential must do more than merely transplant products and systems that have succeeded elsewhere.
Kuldeep P. Jain, Nigel A. S. Manson, and Shirish Sankhe
The McKinsey Quarterly, Web exclusive, February 2005
The right passage to India ");
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India, for some time now the focal point of the global trend toward strategic offshoring, has simultaneously become appealing as a market in its own right. With GDP growth more than double that of the United States and the United Kingdom during the past decade, and with forecast continued real annual growth of almost 7 percent,1 India is one of the world's most promising and fastest-growing economies, and multinational companies are eagerly investing there.
Yet the performance of the multinationals that have tried to exploit this opportunity has been decidedly mixed. Many of those notable for their strong performance elsewhere have yet to achieve significant market positions (or even average industry profitability) in India, despite a significant investment of time and capital in its industries.2 Why? Perhaps because the market entry strategies that have worked so well for these companies elsewhere—bringing in tried and tested products and business models from other countries, leveraging capabilities and skills from core markets, and forming joint ventures to tap into local expertise and share start-up costs—are less successful in India. Our research3 suggests that the most successful multinationals in India have been those that did not merely tailor their existing strategy to an intriguing local market but instead cut a strategy from whole cloth. In short, they have resisted the instinct to transplant to India the best of what they do elsewhere, even going so far as to treat the country as a bottom-up development opportunity.
With less of a focus on the initial entry and with a longer-term view of what a thriving Indian business would look like, the more successful companies have invested time and resources to understand local consumers and business conditions: tailoring product offers to the entire market, from the high-end to the middle and lower-end segments; reengineering supply chains; and even skipping the joint-venture route. The reward for this effort? Of the 50-plus multinational companies with a significant presence in India, the 9 market leaders, including British American Tobacco (BAT), Hyundai Motor, Suzuki Motor, and Unilever, have an average return on capital employed of around 48 percent. Even the next 26 have an average ROCE of 36 percent (exhibit).
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Getting local in India
India's per capita income is half of China's and one-fourth of Brazil's, and as much as 80 percent of Indian demand for any industry's products will be in the middle or lower segments. As a result, multinationals must resist the temptation merely to replicate their global product offerings; the products and price points that are competitive in India are often considerably different from those that work well in other countries. In particular, in India companies must reach into the middle and lower-end segments or they may end up as niche high-end players, with insignificant revenues and profits.
Multinationals that understand the Indian consumer's expectations and price sensitivities can tap into what is often a large and promising market, but they shouldn't assume that the lowest price tag will always lead it. Indian consumers, even in the lower-end segments, will pay a premium if the value of superior features and quality is seen to far outweigh their cost. LG Electronics, for example, reengineered its TV product specifications in order to develop three offerings specifically for India, including a no-frills one to expand the market at the low end and a premium 21-inch flat TV for the middle segment. By keeping the price of the latter offering to within 10 percent of the price of TVs with conventional screens, LGE persuaded many consumers to buy it. These innovations have led the company to a top-three position in the country's consumer durable-goods and electronics market in a little over three years, with revenues of nearly a billion dollars in India. And Toyota Motor captured nearly a third of the multi-utility-vehicle (MUV) market by offering a significantly superior product at a limited price premium.
Very often, however, companies need to develop completely new products to compete at target price points set by local competitors, as Hindustan Lever Limited (HLL), a part of the multinational Unilever, did with its low-priced detergent brand, Wheel. Responding to local competition, HLL lowered the active detergent content of its existing product, decreased the oil-to-water ratio, and then launched the new detergent at a 30 percent discount to the price points of the company's more traditional detergents. Today, Wheel accounts for 45 percent of HLL's detergent business in India and for 8 percent of total HLL sales.
In other cases, companies must significantly localize their product offerings to meet Indian consumer preferences. Hyundai, for example, spent several months customizing its small-car offering, Santro. Because Indian consumers attach significant importance to lifetime ownership costs, Hyundai reduced the engine output of the Santro to keep its fuel efficiency high, priced its spare parts reasonably, and made more than a dozen changes to the product specifications to suit Indian market conditions. In contrast, other global automakers entered the market with vehicles that had low gas mileage and high repair rates and after-sales service costs.
Companies can bolster their profitability by reengineering their supply chains. Hyundai, for instance—in contrast to other global auto manufacturers in India, which source only about 60 to 70 percent4 of their components locally—buys 90 percent of its components from cheaper Indian suppliers rather than importing more expensive parts from its usual suppliers elsewhere. Multinational pharmaceutical companies outsource a large share of their production to third-party manufacturers within India—an uncommon practice for major pharma companies elsewhere in the world. And both Hyundai and LGE have built global-scale manufacturing facilities to capture economies, making India a global manufacturing hub that can serve other markets as the local market develops.
Using extensive third-party distribution also helps. In India, organized retail distribution systems reach less than 2 percent of the market, so there is considerable pressure to find innovative ways of reaching retail consumers. This third-party distribution system is crucial to capturing demand created by the superior price-to-value offerings available in smaller cities and rural areas, which make up a large share of the Indian market. In fact, successful multinationals—such as Castrol (acquired by BP in 2000), LG Electronics, and Unilever—have built deep third-party distribution networks that serve second-tier cities and villages. Here again, a local strategy is crucial. One multinational company, for instance, used to own its entire worldwide distribution infrastructure, including warehouses and trucks. Applying that business system in India, where large companies face high labor and overhead costs, made it impossible to attain nationwide reach. Moving to a third-party distribution system employing a network of dealers and agents proved very successful.
Finally, in contrast to companies that rotate expatriate managers in and out of the country every two or three years—often a recipe for failure—most successful multinationals, such as Citibank, GlaxoSmithKline, and Unilever, have an Indian CEO in their local operations. Given the need to tailor products, supply chains, and distribution systems to local markets, local managers tend to be more effective. If the CEO is an expatriate, combining longer postings with a strong local second in command, as in the case of the South Korean giant Hyundai, seems to be crucial to success. In addition, multinationals such as Castrol have benefited from strong local boards to counsel, challenge, and help local operations.
Skipping the joint venture
Multinationals entering new markets have traditionally struck up joint ventures with local partners for a variety of reasons, including their ability to influence public policy, to bring into the venture existing products as well as marketing and sales capabilities, and to comply with regulatory requirements when foreign participation was restricted to less than 50 percent of a business.
While joint ventures are still crucial to gaining access to privileged assets in some industries—metals and mining, for example, and oil and gas—our research shows that, where possible, multinationals are better off going it alone. Of the 25 major joint ventures established from 1993 to 2003, only 3 survive. Most foundered because the local partner couldn't invest enough resources to enlarge the business as quickly as the multinational had hoped. As a result, most of the multinationals that initially entered the market through joint ventures have exited them and pursued independent operations. Multinationals, such as Hyundai and LGE, that have achieved real success in India have bypassed joint ventures entirely, and newcomers are increasingly entering the market on their own. Even when a joint venture is unavoidable, successful multinationals ensure from the outset that they retain management control and have a clear path to eventual full ownership.
Participating in the regulatory process
Multinationals in deregulating industries often need to be flexible and patient during the natural process of regulatory evolution. Regulations governing the mobile-telephony sector, for example, have been amended several times since 1994 as it has grown; it had two licensed operators per region back then and now has as many as six. Although most multinationals left the sector when the regulations governing it changed, Hutchison Whampoa continued to invest in India. Ten years later, Hutchison Essar is one of the top three telcos in the country (as reckoned by market share), and interviews with industry experts suggest that the company enjoys strong profitability.5
If regulations are a crucial factor for an industry, the CEO needs to spend a lot of time managing them. The most successful multinationals haven't relied on third-party legislation managers or joint-venture partners to address regulatory issues; instead they have invested much time and energy to identify and understand the key policy makers, to formulate robust positions for investment, and even to suggest regulatory changes. In addition, these companies have garnered support from constituencies such as state governments, which compete for investments, and industry associations that lobby for similar regulatory changes.
Clearly, any entry into a new market requires a certain degree of tailoring to its specific needs and conditions. But for some companies, the entry into India has forced a fundamental rethinking of product offers, cost structures, distribution systems, and management teams. Companies that successfully tap into the promising Indian market often ignore conventional wisdom, including the need for joint ventures.
About the Authors
Kuldeep Jain is a consultant and Shirish Sankhe is a partner in McKinsey's Mumbai office, and Nigel Manson is an associate principal in the London office.
This article was first published in the Winter 2005 issue of McKinsey on Finance.
Notes
1The Economist Intelligence Unit forecasts 6.9 percent real GDP growth from 2003 to 2008.
2Based on McKinsey analysis of the Centre for Monitoring Indian Economy's Prowess financial database for average industry profitability. The database, built on CMIE's understanding of disclosures in India on around 8,000 companies, is highly normalized.
3We reviewed the performance in India of more than 100 multinationals, conducting detailed case studies of 15 that have had varying degrees of success and interviewing 30 experts, company managers, analysts, and current or retired CEOs of leading multinationals.
4The Automotive Components Manufacturers Association (ACMA) of India.
5Since it is unlisted, actual numbers aren't available.

Managing CEO transitions

Managing CEO transitions
A leader’s best chance to lock in new organizational norms is usually during the first few months on the job.

TSUN-YAN HSIEH AND STEPHEN BEAR

The McKinsey Quarterly, 1994 Number 2

A new manager brought in from the outside. A key retirement. An executive waiting in the wings who finally gets his or her chance. The splitting of the Chairman/CEO role into two separate positions. The departure of unsuccessful contenders. Beyond their obvious effects on individual careers, such changes are also opportunities—often not fully exploited—to bring about significant organizational change. Never more so than when the change takes place at the very top with the appearance of a new CEO. These "appearances" are becoming increasingly common as more industries face discontinuities and more stakeholders assert their rights. Indeed, nearly a quarter of the CEOs of Business Week's top 1,000 companies have turned over during the past two years. How can companies—and new incumbents—better leverage these stressful periods of transition to break out of the performance-limiting aspects of the established order?

Perhaps an oil company president put it best: "This place has had three presidents in five years. My predecessors all made the mistake of trying too hard to get things back to normal. The organization took it as an endorsement of business-as-usual when a lot had to be changed. When I came in, the place felt rudderless. They were watching me to see if I would break them out of this rut. I did." Appropriately so. CEO transitions offer a natural, albeit brief, opportunity to shake up the status quo and change it fundamentally.

Make no mistake, even in the most flexible organizations, an entrenched status quo rapidly develops. Everyone knows what is important; who has influence; what success really means; which roles have prestige; which protocol must be followed to get things done; what constitutes a career-limiting move. On the positive side, this shared knowledge, when replicated all the way down the line, promotes a certain efficiency. It is clear whom to call; how reports should be done; which meetings to attend; what is kosher to ask; and where the land mines really are.

CEO transitions disrupt the efficiencies of the "status quo" and sever the web of familiar practice
CEO transitions disrupt these efficiencies and sever the web of familiar practice. Connections are broken; intelligence flows stop; secure power bases are thrown up for grabs; uncertainty takes the place of continuity; and what was once an easy and standard route to follow becomes a voyage into uncharted waters. Within 100 days or so, however, a new order usually gets established and things settle down again. Or, in the absence of strong leadership, the old order reasserts itself. Either way, such periods of genuine transition—the time when all is in flux, nothing is fixed, the status quo is interrupted, and an organization buzzes with the expectation of change—are painfully short.

But they are also—if properly grasped and managed—a unique opportunity to reset a company's rhythms to the requirements of the future. The general readiness to listen, learn, and act is at its height. So is the willingness, during this honeymoon phase, to defer judgment and give new incumbents the benefit of the doubt. These are, then, times of fluidity during which new performance expectations can be established more easily and new organizational norms are cast. They are also when the foundation stones get laid upon which a CEO's legacy will be built.

From a series of discussions with CEOs who have undergone such periods of transition and from our and our colleagues' work with public- and private-sector leaders around the world, we have distilled six lessons about how to make the best use of these periods of fluidity.

1. Start with where you want to end up
Sprinters are trained to keep their eyes on the finish line, but it is easy to be distracted by all the excitement as a race gets under way. CEOs who are new to their jobs can also get distracted by the day-to-day urgencies of running their business and by their felt need to hit the ground running. Everyone tells them, "When in doubt, do something." But looking back years later, they often regret this peremptory action bias. As the CEO of one media company acknowledges, "I expended a lot of my—and my organization's—energy on areas that should not have been priorities."

In retrospect, many corporate leaders wish they had started with a much clearer sense of where they wanted to end up
In retrospect, many corporate leaders wish they had started with a much clearer sense of where they wanted to end up. The lesson is painful. "I've learned," one reports, "that you have to be very clear about your end goals because, without that clarity, you waste a lot of time, money, and goodwill taking detours, making mid-course corrections, and reversing your earlier decisions." Some do not survive such reversals or corrections. As a CEO who lost his job after only 18 months put it, "For a while, I thought I had traction by attacking the most urgent issues a couple at a time. But I was soon consumed by the fire that I was trying to put out."

A focus on legacy
Executives who do make the transition successfully often focus, from the very beginning, on the kind of legacy they want to leave behind as a way of setting their sights on the finish line. When they think about their potential legacy, many CEOs first look to business goals: "I want to have downsized the company and focused it more on the core business before I leave"; "I want to restore share prices to pre-1987 levels"; "I want to build a management team that can—and will—take this company forward." Others dwell on personal considerations: "I'd like to get invited to stay on for another three years"; "I'd like to have developed a second pursuit by the time I am 55."

All these aspirations are legitimate. By themselves, however, they—and many like them—do not go far enough, do not cover enough ground. They address underlying cultural issues much too infrequently. As one CEO reflected, "There is nothing more important than to leave behind an organization that feels confident of its future and feels like a winner."

A legacy goes well beyond aspirations for financial or market position. It deals with perceptions in the minds of the leader's many constituencies
We have found that an effective way of thinking about a legacy includes: the condition of the organization at the time a leader departs; the prevailing focus of its people; what the leader personally stood for; and the organizational climate that grew out of the leader's style and actions. Thus defined, a legacy goes well beyond aspirations for financial or market position. It deals, as well, with perceptions in the minds of the leader's many and varied constituencies. And like all issues of perception, it deals with things that are more black-and-white than reality.

The CEO of a large US industrial corporation had created a record of major improvements by concentrating primarily on downsizing and defending against further market share erosion. However, the company still lagged world-class industry leaders and the climate left behind was perceived as being riddled with uncertainty and shaken confidence. By contrast, when Sam Walton of Wal-Mart died in 1991, he left behind the most successful retail operation in the United States, a personal reputation for thrift and attention to detail, and an organization marked by high energy, a strong performance orientation, and great confidence in its continuing success.

A fair test of legacy-related aspirations is to ask, "What would be my number one regret if I had to leave without achieving it?"
A fair test of legacy-related aspirations is to ask, "What would be my number one regret if I had to leave without achieving it?" Due diligence, however, requires asking as well, "What is the number one thing that could derail what I hope to achieve?" Is there, for example, a capable next generation of leaders to carry on—and build on—the present leader's accomplishments?

At the same time, of course, a new CEO must take into account any personal considerations that will impinge on the time and energy available for business pursuits. Here the questions can get quite personal. At this stage of my life, how much sacrifice on the personal front am I willing to make? How much time must I carve out for personal health or physical conditioning? For specific family members? For community service? For outside activities like involvement in regional economic development forums, special government taskforces, or CEO roundtables that might also, even if indirectly, benefit the stakeholders of the corporation? The challenge is to make these personal aspirations explicit and think through how they interact with all the other elements of a hoped-for legacy.

2. Get clear on the lay of the land
There are many unwritten realities that add up to the unique landscape that characterizes each organization. Who belongs to the power cliques? Who has credibility and why? How do the subterranean communication channels really work? What do people hold dear? How do decisions really get made? Which are the constraining scarce resources? How do they get allocated?

Most new CEOs instinctively know they must explore the organizational terrain for unexploded land mines. Few, however, delve deeply enough into how the organization really works or how different people will react to different leadership actions. Even fewer develop the full range of insight needed to use all of an organization's dynamics to achieve greater impact.

"It is dangerous to just find out where the land mines used to be. That doesn't tell you where the new booby-traps are planted"
This, of course, can be treacherous ground. According to the new CEO of a manufacturing business, "It is dangerous just to find out what people's strengths and weaknesses are and where the land mines used to be. That doesn't tell you how things really work or where the new booby-traps are planted. I had to get a sense of whether—today—a particular move would trigger a dynamic chain reaction that might blow the place up."

Chain reactions, started by new leaders, can also have beneficial effects. Another new CEO, for example, went to work early every day during his first three weeks at a transportation company. His intent was to start the day early enough to read up on the company's business before staff members showed up at 9.00am. Coming in around 7.00am meant that he literally had to turn on the lights. By the second week, he noticed that more and more people were coming in early. By week 3, someone always arrived before he did and turned on all the lights.

These chains of influence mean that there are possible economies of effort in changing an organization's dynamics. When the new CEO of a large US railroad took over the reins, he wanted to move immediately to make the indulgent corporate culture far more people- and performance-centered. Among the first things he did was close the executive dining-room and kick executive offices out of their prime ground-floor space so they could be replaced with a fitness center. By the time he announced that one-third of corporate staff would be cut, the organization had already gotten the message: change was real and more was coming.

"You never find out where all the skeletons are from the inside"
Surprisingly, it is not difficult to build a good working model of these dynamics—if a new leader systematically explores the landscape, talks to a representative cross-section of people both inside and outside the organization, and asks the right questions. As a new division president of a paper company told us, "You never find out where all the skeletons are from the inside. I often get more insights into the culture and politics of an organization by talking to customers and suppliers."

An army major we know always made it a point to take a week of personal time to visit, unofficially, his next posting before he actually assumed command. That way, he found out in advance not only what the morale of the troops was, but also what they really held dear—things like better rations and avoidance of extra weekend duties. He also found out the strengths and weaknesses of all the officers in that command, as well as the one whom the troops respected the most. On the first day of his official command, he would ask for that officer to be his second-in-command. He would also promise his troops (and then deliver) better rations and duty-free weekends in return for playing by his rules. He got his following.

3. Select which expectations to change, which to honor, and which to defend
New CEOs face the daunting challenge of balancing multiple expectations. Every stakeholder group has expectations, and available time, money, and other resources seldom, if ever, match aggregate demands. These expectations, moreover, often clash, and conflicts of interests arise. Worse still is the discovery that promises have been made or special deals agreed to by predecessors. Never mind the fine print, there is the implicit spirit of the "contract" to contend with.

"The trouble I had was with expectations. They were there, they were real, and would have come back to haunt me if I had pretended that they were not"
"It was easy enough to see what the formal obligations were," said a CEO of his transition. "The trouble I had was with expectations. They were seldom written down, and my senior managers were not close enough to the troops to know what they were. Even when I ferreted them out, my managers would deny that they were legitimate. But believe me, they were there, they were real, and they would have come back to haunt me if I had pretended that they were not."

New CEOs often have a hard time separating legitimate obligations from ingrained but unbridled expectations
Somewhere along the line, these unchecked expectations can easily turn into obligations. Whether it is a promise of job security for employees, the promotion prospects or role definition of particular executives, or the size of this year's bonus packages, new CEOs often have a hard time separating legitimate obligations from ingrained but unbridled expectations. One CEO explained how hard this is. "The expectations that I was given by my predecessor and the board were terribly vague. 'You should be able to turn it around in a year or so,' they told me. And 'be sure not to give in to union demands.' I really had to dig hard to find out what caused them to believe that these expectations could be satisfied."

Further, transitions inevitably give rise to new expectations as well as to questions about existing ones. "Profits are down and they just fired the CEO. Is my job secure with the new CEO?" "He brought in a new VP Marketing from the outside. When is the next shoe going to drop on the rest of the marketing department?" "This guy [the in-coming CEO] is notorious for cost-cutting. What will happen to our tradition of paying workers at the 75th percentile of the industry?"

Recognizing the uncertainties created by the fact of transition at the top, many CEOs feel compelled to move quickly to clarify and address the expectations people have of them. At times like these, however, they need to be aware of two kinds of problems that can haunt the rest of their tenure, if not damage their legacy altogether.

The first has to do with the indiscriminate upholding of expectations. In the perfectly understandable interest of assuaging fears and removing uncertainty, some new CEOs treat all existing expectations as obligations and vow to uphold them across the board. In so doing, however, they squander a unique opportunity to reset expectations at a point when employee anticipation of—and likely acceptance of—change is highest. This, of course, locks in the status quo.

The CEO of a medium-size enterprise with three related businesses lamented about the missed opportunity to reset expectations when he was first appointed. The old order was that divisional presidents were left alone to run the business. Synergies across the businesses were rarely exploited because the three divisions operated as fiefdoms. Without thinking through future needs, the new CEO reaffirmed the divisions' independence. Two years later, he was still trying to get divisional managers to focus on potential synergies—long after competitors had pulled ahead by dint of their integrated strategies.

CEOs in transition often feel compelled to make early promises on which they ultimately cannot deliver
The second problem, which often follows the first, is unkept promises. CEOs in transition often feel compelled to make early promises on which they ultimately cannot deliver. Why? They bow to the sentiment of the people around them at the time. Wanting to be liked and accepted, they let good intentions cloud their business judgment.

The CEO of a North American company felt it was urgent to allay employee anxieties following a merger with a major competitor. He quickly announced that no one from either company would lose a job as a result of the merger—a promise that was irreconcilable with harsh industry realities and, therefore, clearly unrealistic. Three recessionary years later, he had to face up to two years of downsizing that eliminated thousands of jobs. Employees who had lived with an expectation of "life-long" employment, which was strongly reenforced by the CEO's promise of no firing, were traumatized. The CEO retired shortly after without ever recovering from the stigma of his "broken contract."

4. Get your real team together
Every new leader has to start with inherited players and their hidden agendas, uncertain aspirations, possible mistrust, and questionable loyalty
Each transition begins with an inherited team. Like it or not, a new leader has to start with inherited players and their hidden agendas, uncertain aspirations, possible mistrust, and questionable loyalty, as well as the history of relations among them and between each of them and the rest of the organization. Sorting out these dynamics early is never easy but always essential. As one CEO observed, "People knew that I had to get board approval to change the top team and that the board was going to question why we had to move so quickly. So my power to institute a new agenda was limited until I had key board members on my side. That took me damn near six months."

Assessing the players and the team
Naturally, the first challenge is to gather a perspective on each of the players and on overall team dynamics. Beyond probing for each person's competence, aspiration, credibility, and the like, a new leader must assess the personal impact each has on the team and on the rest of the organization. Is she a positive influence on the people she works with? Is his concern for self-interest in balance with his concern for the collective good? Does she nourish or merely exploit her peers and subordinates? Do his actions, not just his words, uphold the values I hold dear? Is she a good role model for the kind of leadership this company needs?

Questions also need to be asked about the team and the way it works. Does it provide the complementary skills I need? Is it small enough to function effectively? Does it have common aspirations about performance? How does it work together? Beyond the immediate group, who else is very much a part of the team? Who should be?

Making people choices
People choices are often the most dramatic—and arguably the most important—decisions a leader in transition has to make. Though full of difficult tradeoffs and rife with emotions, even the toughest calls are better made during the transition, when the situation is still fluid, than later. Much better to start with the right slate: the opportunity costs of having to change horses in mid-journey are too high.

All leaders have their own approaches to making people judgments. The raw ingredients, however, are similar: the person's strengths and weaknesses, the impact of each choice on the team and the organization, and the requirements of the business. There is no magic here, just a series of three basic questions: Which configuration comes closest to putting the right people in the right places? Combining which roles into which leadership positions will maximize the company's leadership capacity? And, of course, what personal role should I play?

Effective new CEOs concentrate on roles that leverage their proven strengths. Otherwise, they can silently fall prey to the roles that others expect them to play. "I need to cover government relations," said one newly-appointed CEO, "because my predecessor has always done it." This sounds logical, but his predecessor had had the savvy and stature to be an industry statesman. Not him. New leaders may find it difficult to define what their true strengths are for a role to which they have not previously been exposed. It may be easier to ask: What am I not good at doing? This kind of soul-searching can also help them put in place managers able to compensate for their particular weaknesses.

New CEOs seldom have the luxury to move as many people as they want as quickly as they would like
Although the freedom they enjoy to carry out major people and role changes will vary by situation, new CEOs seldom have the luxury to move as many people as they want as quickly as they would like. In the short term at least, they often have to make compromises on which people ought to go in which places. This is tolerable—as long as these compromises boost overall leadership capacity. The only caveat is that these compromises should not be forgotten down the road as lower-level talent matures and outside candidates become available.

A newly-installed CEO at a financial services firm responded to this problem by privately classifying his executive team, through careful assessment, into three categories: keepers, watchers, and goners. "Keepers" were clearly major assets whom he quickly informed of their status even before their formal roles were decided. This reduced their anxiety and minimized the risk of losing them. "Goners" were major liabilities, who subtracted from the overall leadership capacity. Though painful, visibly—and quickly—removing them would unleash frustrated energy in the organization. Finally, "watchers" were people who could become major assets if they could address one or two deficiencies within a reasonable time, say 12 to 18 months. Meanwhile, they represented a net addition to the overall capacity of the team.

But what if a new CEO has no flexibility to move on the problem cases? What if the team is still too large and unwieldy? In such cases, leaders often underestimate the power of informal devices like the use of forums and teams to improve overall effectiveness. It may help, for example, to change the established practice on when and with whom the CEO meets one-on-one, what the agenda is when the whole group meets, and when subgroups of two or three get asked to address specific issues.

This latter point may be especially valuable if a new CEO wants to avoid the appearance of setting up an exclusive inner circle. This is most likely to happen when there are only two circles: either you are part of the preferred inner circle, or you are not. Using multiple, issue-specific teams—each made up of different permutations and combinations of the larger group—circumvents this problem and boosts the whole group's effective capacity. A CEO who got really excited by this approach went a step further: "Mix them up and throw in a few young tigers and whipper-snappers as chasers. Then get out of the way and watch it go."

Communicating people choices
As important as making tough people choices is the decision about when and how to communicate them. Should I do it sooner rather than later? Should I leave people to read the tea leaves and figure it out? Should I have explicit, face-to-face conversations with the individuals affected?

"Explicit and sooner" is usually better than "implicit and later"
Again, there is no one right answer. One CEO even told us, "Sure, you've got to think quickly about your people. But that doesn't mean you have to act immediately on everyone. The most urgent need is to move on those you'll need to bring in." Our experience, however, is that "explicit and sooner" is usually better than "implicit and later." Anxious people during transitions are quick to read meanings, often not intended, into subtle shifts in role or resource allocation. Who is in favor? Who is down and on the way out? Left fuzzy, these signals will evoke political jockeying, whip the rumor mill into a frenzy, and tie up a lot of otherwise productive energy in an endless guessing game.

The financial services CEO described above moved swiftly—within 30 days of his appointment—to reassure the "keepers." He acted on all the "goners," as individual decisions got made, within the first 60 days. At the same time, he told all the "watchers" why they were on probation and what they had to work on and by when. Each had the chance to buy into the challenge or take an exit package instead. At first blush, his approach may appear blunt, almost brutal. But even those executives who were terminated thought he was firm but fair and actually appreciated his explicitness.

5. Focus on a few themes
"If everything is a priority, then nothing is a priority. It may sound trite. But we do it to ourselves all the time. At times, there seemed to be 200 'critical' things to do. Even when I pared the list down to 30, I still felt swamped." The sentiment is familiar. But so is the appropriate response, even during the hectic days of a corporate transition: the best directions are simple directions. When things get overly complicated, it is easy to get lost—and to lose others.

When organizations are provided with a clear and simple road-map, they can move with purpose and focus, leaving room for individual imagination and experience to fill in the details. But when they are deluged with long lists of priorities and complex tactics dressed up in fancy words, people's eyes glaze over and confusion reigns. It does not have to be this way. "I gave up a lot of important-looking things and erred on the side of being brutally simple," observed the paper company president. "I focused on only two themes—quality and throughput. Everyone knew what was important, and that made our energy productive and kept us in the game."

Moving quickly to articulate a few simple themes feeds an organization's hunger for a sense of what the new order might entail
During transitions, moving quickly to articulate a few simple themes feeds an organization's hunger for a sense of what the new order might entail, which frees it to respond positively to the new direction. It also provides an overall context so that people can come to grips with everything that is going on. In short, it provides a beacon of stability in a sea of change.

But what makes a good theme? How is it different from a slogan? First, of course, it must convey the essence of the rational case for the new order. But it must also be emotionally compelling. If it is not, it will not last both through the transition period and through the three to five years it will take to reach the implied organizational goals. The life of a slogan, by contrast, can be measured in days or months, not years.

Effective themes meet the "rule of 3 and 300": three simple but compelling themes can legitimize and sustain up to 300 organizational initiatives
More importantly, a theme finds its richest meaning as it energizes—and gets enriched and energized by—the ongoing, day-to-day actions of a broad cross-section of people. In fact, one CEO described effective themes as meeting the "rule of 3 and 300": three simple but compelling themes can legitimize and sustain up to 300 separate but consistent organizational initiatives.

Not surprisingly, the themes best able to mobilize large numbers of people tend to be value-laden. The new CEO of a natural resources company, for example, captured the imagination of his people when he enunciated the dual themes of "velocity" and "business-like thinking." Both readily developed personal meaning for everyone in the organization. Front-line people recognized in them an endorsement of rapid decisions that sensibly tried to balance economic gains among employees, shareholders, and the communities in which the company operated. Staffers recognized a clarion call to cut red tape and move with greater and more purposeful speed. The essence of the new order became clear: we must become fast-moving, tough-minded, and responsible businesspeople to stay ahead of the game.

Within 60 days of his appointment, the new CEO of an industrial company called on his people to become more "performance-oriented, bottom-line accountable people" who relied on "simplified business processes" and "strong implementation skills." They responded well initially, but never broke out of their old ways of doing things. The reason? Key initiatives were underled, and expectations remained unclear on how far or how fast to change. As a result, promising themes soon turned into hollow slogans.

6. Balance between short and long term
Transitions are always hectic, challenging times. The pace is intense. Everything demands attention. Daily calendars are filled with countless urgent and immediate tasks. In such an environment, it is not surprising that important long-term priorities often slip out of focus. Even with the best intentions in the world, it is not always easy to tell what must be done now and what can be done later. It is hard to strike the right balance. Indeed, a common refrain from many new CEOs is "There were so many opportunities to add value, that my biggest mistake was immediately to turn the place upside down based on flawed knowledge."

Most new CEOs gravitate to near-term urgencies, soaking up precious time trying to keep the wheels from falling off
Few new CEOs get the balance right. Most gravitate to near-term urgencies, soaking up precious time trying to keep the wheels from falling off. This is perfectly understandable. A few deliberately take off for the mountains to ruminate on paths to the future, leaving the organization to wonder what might eventually come down on them. This is understandable, too. As is the focus of still others, who embark on cost-cutting campaigns, believing that the organization should do—and think about—nothing else before it takes out a big chunk of costs. This, of course, leaves everyone to worry about what will be at the end of the rainbow once the raging storm of downsizing has finally subsided.

Balance, however, is important—and possible. Two simple principles might help. First, people will be more enthusiastic about near-term sacrifices if they know that a better future lies ahead. New leaders must take the time to spell out, even if only thematically, what constitutes that better future. If they are clear about the kinds of capabilities required in the new order, their people will be better able to avoid cutting out muscle along with the fat. The previously mentioned financial services CEO, for example, employed three themes during his transition: "Low-cost producer," "Best marketer of financial services for selected target customers," and "Superior branch network." The first signalled the need for retrenchment and aggressive cost reduction in those businesses in which they could be the low-cost producer. The second and third provided the uplift, the redeployment opportunity for people's energy.

The second principle is that movement creates opportunity. Some CEOs focus on a single cost or restructuring theme because they cannot see any other controllable actions they can take. Even in this unfortunate circumstance, however, it is vital for them to communicate the future-building experiments being undertaken. No guarantees are needed, just openness about what is being explored. Investigating a strategic alliance, contemplating an industry restructuring, or reexamining fundamentals of a business generates movement forward that, in turn, may open new possibilities not imagined before. This is not an argument in favor of movement for the sake of movement. Only a reminder that there is an upside to living in a turbulent world: there are always new possibilities—and new opportunities—to explore.

"We may our ends by our beginnings know," wrote Sir John Denham nearly four centuries ago. He might just as easily have been writing about today's CEO transition.

About the Authors
Tsun-yan Hsieh is a director and Steve Bear is a principal in McKinsey's Toronto office.

How private equity firms can play in China

Given the difficulties of doing business there, direct investment in Chinese companies isn’t always the best option.
Gordon Orr
The McKinsey Quarterly, Web exclusive, February 2005
International private equity houses are stepping up their efforts to invest in China in the next few years, reflecting a gold rush mentality that could leave some investors disappointed.
Private equity funds with good connections and deep insights account for the bulk of recent investments. But some new entrants have relatively untested China investment teams.
The influx of new money reflects the pulling power of the "China story," which suggests that there are opportunities that investors cannot afford to miss. Supporters of this contention point to a handful of pioneers who have made big profits by listing their portfolio companies on overseas stock exchanges such as the Nasdaq.
In practice, however, most investors will continue to struggle to pull off successful deals in China as investment conditions worsen. Many private equity investors might be better served by investing their funds in overseas companies that will benefit from China's economic boom. Those who are willing to make a bet on the growing pool of Chinese companies will face a number of challenges.
First, an oversupply of capital is placing more negotiating power in the hands of the target companies, possibly limiting potential investment returns. It could also be increasingly difficult for investors to conduct due diligence, as companies may feel able to withhold information.
Second, inexperienced investment teams might find it hard to keep tabs on the management of Chinese portfolio companies. For example, we recently saw a fund that has been seriously hit by its "remote-controlled" approach to investing in China. The fund's local representative—a junior staff member—was so intimidated by his US-based partners that he simply told them what he thought they wanted to hear and disregarded the underlying downward spiral. And it did not help that the local representative was seen as a lightweight by the Chinese portfolio company, which chose to ignore his presence.
Third, some private equity investors may struggle to secure domestic debt financing because many local banks remain wary of what they regard as foreign predators. In general, private equity companies can expect little help from the Chinese operations of international banks, which have limited capacity for lending local currency. Some funds have opted for a partial solution: obtaining specific guarantees of bank financing before the investment.
Access to financing is particularly tricky for portfolio companies seeking to expand overseas through mergers and acquisitions. While big companies—such as state-owned China Netcom and the privately held computer manufacturer Lenovo—can readily get access to foreign currency, smaller private companies may find it much harder to build up a war chest for foreign expansion.
The average time needed to line up foreign currency has fallen dramatically—from years to months. The precise timing, however, remains unpredictable, creating uncertainty among investors over their ability to pursue a strategy.
Finally, the path to a profitable exit remains uncertain. Despite China's decision to lift a six-month moratorium on initial public offerings, there is no guarantee of getting a timely spot in the IPO queue.
Trade sales, which are another potential exit, are likely to become less common, because foreign multinational groups increasingly focus on organic growth rather than acquisitions.
Given these challenges, we believe a number of private equity funds can find better China-related opportunities closer to home. For example, although Fortune 500 companies have the scale and international scope to move operations and sourcing to China, many midsize US companies have yet to follow suit. Some of these companies are held back by their lack of expertise in the region, while others are reluctant to change their traditional way of working.
There may be an opportunity for private equity groups to invest in these midsize US manufacturing companies because, while they are struggling to keep up with the Chinese competition, they retain substantial brand value, sales channels, and intellectual property. Through investment, private equity funds can inject the management talent to help a company shift operations and sourcing to China—which can lead to substantial cost reductions. Our experience suggests that there is tremendous room for such deals because there is little competition to invest in midsize US manufacturing companies.
The key is to develop a management team that can repeat these restructurings. To recoup their investment, private equity firms might want to sell these companies to Chinese rivals looking to expand overseas. Given the relative inexperience of the potential Chinese trade buyers, astute sellers may well be able to strike a very attractive deal.
About the Authors
Gordon Orr is a director in McKinsey's Shanghai office. This article was published as "Gold rush may be a mirage" in the Financial Times on February 23, 2005.