Smart Organization

TH E SM A RT

ORG A N IZ AT ION

CREATING VALUE THROUGH STRATEGIC R&D

David Matheson and Jim Matheson

HARVARD BUSINESS SCHOOL PRESSBoston, Massachusetts

Matheson FM 9/16/98 4:26 PM Page iii

Copyright © 1998 by the President and Fellows of Harvard College

All rights reservedPrinted in the United States of America

02 01 00 99 98 5 4 3 2 1

Library of Congress Cataloging-in-Publication Data

Matheson, David, 1963–The smart organization : creating value through strategic R&D /

David Matheson and Jim Matheson.p. cm.

Includes bibliographical references and index.ISBN 0-87584-765-X (alk. paper)1. Research, Industrial—Management. 2. Strategic planning—

Decision making. 3. Value added. I. Matheson, James E.II. Title. III. Title: Creating value through strategic R&D. IV. Title:Creating value through strategic R & D.T175.5.M334 1998607.2—DC21 97–10776

CIP

The paper used in this publication meets the requirements of the American NationalStandard for Permanence of Paper for Printed Library Materials Z39.49-1984.

Matheson FM 9/16/98 4:26 PM Page iv

Preface ixAcknowledgments xi

Chapter 1 Being Smart 1

PA R T I D E C I S I O N Q U A L I T Y

Chapter 2 Decision Quality 17

Chapter 3 The Six Dimensions of Decision Quality 35

PA R T I I B E S T P R A C T I C E S

Chapter 4 Best Practices for R&D Decisions 63

Chapter 5 Implementing Best Practices 82

PA R T I I I P R I N C I P L E S

Chapter 6 Organizational Principles 95

Chapter 7 The Nine Principles of Smart R&D 110

Chapter 8 Organizational IQ 160

C O N T E N T S vii

C O N T E N T S

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PA R T I V P R O C E S S E S

Chapter 9 Technology Strategy 173

Chapter 10 R&D Portfolio Strategy 199

Chapter 11 Project Strategy 221

PA R T V B E YO N D R & D

Chapter 12 The Smart Organization 247

Appendix A 263

Appendix B 267

Notes 277

Index 285

About the Authors 292

viii C O N T E N T S

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S MART COMPANIES do great things. They develop world-beatingproducts and services on a continuing basis, and they deliver

them at prices that establish value leadership. Being smart and actingsmart may be the best guarantees of business success in this fast-changing and competitive world. We define being smart as makinggood strategic decisions. Acting smart is the activity of effectivelycarrying out those decisions. Peter Drucker proclaimed marketingand innovation as the two basic functions of the organization. Al-though he identified them as distinct functions, good strategy con-siders both. Successful innovation addresses strategically importantmarkets and in the process assures the renewal of the entire business.

This book focuses on what it takes to be smart in the business ac-tivity that, more than any other, determines the future of the organi-zation: research and development (R&D). We use the term R&D inthe broadest sense to mean any technologically related activity thathas the potential to renew or extend present businesses or generatenew ones, including core competency development, innovation, in-vention, product development, and process improvement. The chap-ters that follow provide an actionable approach to improving R&Ddecision making, which is based on decades of consulting to R&D-intensive organizations in Europe, Japan, and the United States, aswell as extensive work on strategic decisions of all kinds. In the courseof that work, we and our colleagues have collectively observed, super-vised, or led hundreds of R&D consulting activities. A number ofthose situations are used here to enrich the text, though they are

B E I N G S M A R T 1

Because its purpose is to createa customer, the business enter-prise has two—and only two—basic functions: marketing andinnovation. Peter Drucker, Peopleand Performance

C H A P T E R 1

B E I N G S M A R T

Matheson chs.1-5 9/26/97 12:23 PM Page 1

often disguised for purposes of confidentiality.1 While it is not a the-oretical work, the book is nevertheless based upon years of teachingdecision analysis at Stanford University, a leader in decision research,and upon studies conducted for the R&D Decision Quality Associa-tion. Although our focus is on “smart R&D” as an exemplar of strate-gic excellence, the principles generalize to the “smart organization”with implications for all functions and major business areas.

The Transforming Power of Strategic Decisions

A great deal is being written about “transforming” the organizationthrough horizontal management, through self-directed work teams,through visionary leadership, and so forth. To these we add the trans-forming power of strategic decisions that direct the enterprise toadopt the most appropriate technologies, to develop new productswith the greatest likelihood of success, and to rationally manage itsR&D portfolio. Imagine how your business would be transformed ifits R&D decisions were measurably better than they have been? R&Dexecutives estimate that they can improve the value creation poten-tial of R&D by 20 percent to more than 200 percent with better stra-tegic decision making, and these levels have been achieved in practice.The principles of a smart organization create an environment inwhich this improved value creation is possible and sustainable.

The good news is that this transformation can be achieved byalmost any organization. As individuals, we are only as smart as ourgenes and our environment allow us to be. But organizations can be-come “smarter.” Their decision-making IQs can be improved, andusually with the current personnel and within a fairly short time.We’ve seen it happen. All it takes is commitment and the right set of tools and attitudes. In this sense, getting smarter about strategicdecision making is no more mysterious than the organizational im-provements that companies have made in product and service qual-ity, customer service, and other business processes.

A Little History

Since the mid-1970s, companies have concentrated on acting smart,pursuing a long list of nontraditional management systems aimed at improving operating results. Many of these systems came fromJapan; others were home-grown. For the most part, improvement-

2 B E I N G S M A R T


oriented companies have focused on business processes, the activitiesthat turn inputs to outputs. Total quality management, benchmark-ing, just-in-time, quality functional deployment, cross-functionalteaming, reengineering, and other methods have shown organiza-tions how to “do things right,” that is, to operate more effectively.While many complain that their attempts to implement these pro-grams have produced mixed results, the larger legacy is one of sub-stantial improvements in product quality, cycle time, inventory man-agement, and customer service. By most measures, operationalimprovements in both manufacturing and services have raised thelevel of what customers and shareholders view as acceptable.

The number of prominent U.S. corporations that report benefitsfrom these programs during the past two decades is long and contin-ues to grow. Xerox Corporation was among the first. During the late1970s, this company found itself in a serious competitive situationwith a host of new Asian challengers that were profitably sellinghigh-quality photocopiers in the United States at prices belowXerox’s own cost of production. Stunned by this development, Xeroxadopted benchmarking as an organization-wide method of improv-ing a number of its then substandard operations. Xerox learnedmany quality improvements directly from its Japanese partner, FujiXerox. These initiatives resulted in major improvements and bottom-line results. At about the same time, Motorola adopted its now-famous “six sigma” approach to eliminating quality problems fromits products, which had dramatic bottom-line results. More recently,General Electric has announced a major program of quality improve-ment, with the goal of eliminating some $7 billion to $10 billion incosts (10 percent to 15 percent of revenues) over a period of a fewyears. In effect, North American companies, and many in Europe,have passed through a revolution in operational improvement, justas their counterparts in Japan did before them. They have learnedhow to “do things right.”

No amount of design excellence or manufacturing agility orknock-’em-dead customer service, however, can save a companywhose decision makers direct it to “do the wrong things,” that is, todevelop unwanted products or products that it has no capacity tomarket. For example, NCR was the very best producer of electro-mechanical cash registers during the 1960s and early 1970s, butneither product excellence, nor continuous improvement, nor the state-of-the-art facilities the company built to produce these



machines would save it from a near-death experience once computer-based electronic cash registers broke into the market. NCR had de-cided to dabble with computer technology at the time, but only as ameans of breaking into new lines of business. Its strategic thrust wasaimed at refining the electromechanical technology on which its corebusiness was based. When DTS, a small newcomer, introduced thefirst electronic cash register in 1971, the industry changed dramati-cally. Over the course of the next four years, the market share ofelectromechanical machines dropped 80 percent, and NCR’s rev-enues and profits plummeted with it.2

The travails of NCR are not unique in the annals of industry. Onthat same note, it is not insignificant that several of the companiesfeatured in the pages of In Search of Excellence—the book that preparedmany American managers for the quality revolution—were on theslippery slope to crisis even as readers across the country were adopt-ing their practices for operational excellence. Before long, many ofthe companies praised in the book—Atari, Digital Equipment, East-man Kodak, Delta Airlines, Texas Instruments, and even Hewlett-Packard—were experiencing serious crises.3 While these companiesperformed well on Peters and Waterman’s measures of operationalexcellence, lack of excellence in strategic decision making may have accounted for some of their problems. Edwin Artzt, chairmanand chief executive officer (CEO) of Procter & Gamble, said as much when he described his company’s program of total qualitymanagement:

The limitation is in the area of strategy: total quality does notguarantee that companies will produce winning strategies.Winning strategies have to come from the minds of leadersand be augmented by input from the troops. Total quality en-sures the success of a winning strategy and sustains success,but it doesn’t automatically solve strategic problems.4

More recently, several Deming and Baldrige prizewinners—all mas-ters of operational effectiveness—have experienced similar setbacks,and often for the same reason. For example, Florida Power and Light,winner of the Deming Prize in 1989 (the first non-Japanese companyto do so), discovered that its quality efforts had barely translated into improved service to the customer. It had created an 85-memberquality department, 1,900 quality teams,5 and a rigorous system ofquality review. Very little of this had an impact on the way customers



perceived the company’s service. If anything, the details of the qualityprogram shifted attention away from customers.6

Florida Power and Light’s experience is not an isolated case. AnArthur D. Little survey of 500 U.S. companies found that quality pro-grams were having a significant impact on competitiveness for onlyone-third of the companies. A similar survey of 100 British firms by A.T. Kearney reached a more dismal conclusion. Only one-fifth of these firms could point to tangible results from their qualityprograms.7

The Next Quality Frontier

To fulfill the quality revolution requires a revolution in the quality ofdecision making, particularly at the level of strategy. Companies needto examine the processes through which they make strategic deci-sions and make them as effective as their operational processes. Deci-sion making is, after all, a process. Like manufacturing, customer ful-fillment, and countless others, this process converts inputs tooutputs. And this process can be improved.

Because of the impact of strategic decisions on the fortunes of thebusiness, we consider it a master process. Strangely, this critical processhas been ignored by the quality revolution. Unlike the ancient Athe-nians, who recognized the need to develop the body and the mind, ef-forts to develop and improve the modern organization have concen-trated on the body while ignoring the mind that directs it. Thefrequent result is misdirected effort and wasted accomplishment. Aclassic example of this occurred at Xerox’s Palo Alto Research Center(PARC) in the 1970s. Many of the inventions that have changed ourworld, in fact, came from this lab: the personal computer, the mouse,the user-friendly interface, the computer network, and laser printing.Yet Xerox was unable to take advantage of these technical break-throughs. As Robert X. Cringley describes it, “the captains of indus-try at Xerox headquarters in upstate New York were making toomuch money the old way—by making copiers—to remake Xerox intoa computer company. They took a couple of halfhearted stabs . . . butdid little to promote PARC technology.”8 By not investing strategi-cally in their commercialization, Xerox failed to capitalize on theexcellent work being done in its lab. Instead, Apple, Adobe, 3Comand others saw the potential of these technologies and reaped thebenefits.



The Leveraging Power of Strategic Decisions

Quality decision making has tremendous leveraging power, particu-larly at the strategic level. The bottom-line difference between a goodand a bad decision in mergers and acquisitions, R&D, capital budget-ing, and market selection is usually many millions of dollars. For ex-ample, Ford Motor Company was in a dismal state in the late 1970s.Its car models were uninspiring and of inconsistent quality, givingrise to the acronym FORD, Fix Or Repair Daily. A number of gooddecisions about design and organization, and the decision to adoptprocess quality measures, however, turned this situation around overa period of about five years. Following directions set through thesestrategic decisions, the same people who designed, built, and mar-keted some of America’s most unspectacular automobiles in the1970s launched the record-breaking Taurus in 1986 and, a few yearslater, the successful Explorer utility vehicle. Ford went from beingDetroit’s most troubled auto maker to the most profitable of the BigThree.

When top management hones its strategic decision-making skillseven slightly, the leverage at the end of the value chain can be huge.And if a company achieves quality decisions in all functions and at alllevels, tremendous improvements in performance can be made. Thisis particularly true of R&D decisions, since they sit at the beginningof the entire value chain. Participants in our R&D briefings usuallyestimate that better strategic R&D decisions would easily generatebillions of dollars of greater value for the ten to fifteen companiestypically represented. What could your company accomplish if thequality of its major decisions improved by only 25 percent?

What We Mean by Smart R&D

Smart R&D is about making quality decisions, which we define asthose that produce the best prospects for creating value. Smart orga-nizations make these decisions routinely. Quality decisions proceedfrom facts and logical analysis, not from “how we do things” or fromcontests between contending factions or product champions. Con-sider the result of one company’s habit of letting its product champi-ons determine its R&D direction.

In the late 1970s, the R&D lab of a company we know well devel-oped a demonstration microwave clothes dryer. The head of the labo-



ratory liked the technology and pushed it aggressively, justifying iton technical merits and on the ability of microwaves to dry clothesefficiently. “It will save the customer a bundle,” he assured dubiouscolleagues. The company’s marketing representatives were not soconfident. They had concerns about customers’ perceptions aboutmicrowaves, but the company had no meaningful process for incor-porating these concerns. Aggressive lobbying by the laboratory man-ager simply closed off discussion of these concerns and ignored theneed to develop more complete market information.

The laboratory manager won the battle. The microwave dryer wasdeveloped and eventually launched with great fanfare. But the com-pany lost the war in the retail market. Despite substantial invest-ments in marketing and product launch, the microwave dryer was ahuge flop. A project postmortem revealed the reason: prospectivecustomers were generally afraid of microwaves. Some thought thatmicrowaves would contaminate their clothes with radiation. Othersthought that microwaves should not be used on metal zippers andsnaps; to them, the microwave dryer had limited use, even though themicrowave dryer in fact did not share this limitation with its cousin,the microwave oven.

Simply stated, the quality of the company’s decision was terrible.In its enthusiasm to launch the product, it had not adequately gath-ered or considered information on customers’ perceptions. The com-pany’s marketing representatives had articulated concerns aboutthese and “product acceptability,” but the company’s decision mak-ers had no meaningful process for incorporating these concerns.Confidence in the technical capabilities of the product and aggressivelobbying by the laboratory manager closed off discussion of theseconcerns and development of more market information. The resultwas a low-quality decision, which led to a bad outcome.

To prevent a recurrence of this type of mistake, the company wiselyadopted an information checklist as part of its decision-makingprocess. This checklist included the items of information on cus-tomers’ perceptions, competing products, and so forth that wouldhave eliminated the blind spot that was allowed to exist in themicrowave dryer situation. Future decisions routinely followed thischecklist. This new practice alone, however, resulted in only limitedimprovement in decision quality. Although the information compo-nent of this company’s R&D decisions was greatly improved, its pow-erful managers continued to push through decisions that favored



their projects. They simply overpowered objections and biased or dis-regarded information contrary to their views.

Quality decisions, in contrast, are outcomes of a process, not of acontest. Instead of the too-familiar “winner-take-all” contest that pitsopposing viewpoints against each other, decision quality takes thebest ideas from many parts and levels of the organization and in sodoing creates alternatives that are often superior to those of any sin-gle advocate.

The Unique Challenges of R&D Decision Making

While all strategic decisions are important to the future of the enter-prise, those involving R&D are difficult because they are usuallymade in the face of many uncertainties:

▲ the time between the decision point and the point at which the cashregister starts ringing is typically long and filled with unknowns;

▲ the R&D process is inherently uncertain (without uncertainty therewould be no R&D); no one knows whether and when R&D will suc-ceed, nor the level of that success;

▲ the markets to be served are most uncertain at the time R&D pro-jects are commissioned; and

▲ successful R&D often takes a company into unfamiliar areas requir-ing partnerships, alliances or acquisitions, and new ways of doingbusiness.

Decisions about research and development are complicated by thefact that they affect just about everything else that matters in thebusiness. Managers cannot prudently make R&D choices withoutthinking through the implications for marketing, service and sup-port, manufacturing, and finance. R&D decisions might includeacquisitions to gain technology or market access. There is hardly astrategic management issue that does not arise in the context ofR&D. As a consequence, any process that successfully addresses stra-tegic R&D decision making must address business strategy as well.

This last point is underscored by the experience of DuPont, whichhas moved to a system that brings R&D and business decisionstogether. “In the past,” according to one company R&D director,“research always drove the innovation process.” The result was thefamiliar hand-off of completed R&D projects to business units,which were not prepared to deal with them. DuPont’s new system




requires that the corporate business functions get involved from the beginning. “When R&D is finished with its work, the businesshas already decided to sell it, so we’ve cut some 40 percent to 60 per-cent off the time of getting new products to market, because thestrategic thinking and commercialization decisions have been madeahead of time. Innovation becomes a business process, not a researchprocess.”9

Indeed, the unity of R&D and other strategic decisions cannot beoverstated. Since everything R&D does should aim to create value forcustomers, owners, and other stakeholders, its activities must becoordinated with other goals and activities. To help managers appre-ciate the relationship between R&D and other strategic decisions, werefer them to the strategic decision hierarchy, shown in Figure 1-1.

For the corporation, the top level of strategy is organizational iden-tity, its statement of mission and values. Decisions at this level gener-ally focus on the types of businesses the organization will conductand what it will learn to be good at. Organizational identity is often agiven, changing slowly or in response to crises as old paradigms breakdown.

The next level, corporate strategy, involves decisions on what busi-nesses the enterprise will be in, given the enterprise’s higher level

R&DTechnology

Strategy

R&D Portfolio Strategy

R&D Project Strategy

(Other Functional D

ecision Areas)

Organizational Identity(Mission, values, . . .)

Corporate Strategy(Business areas, financial structure, . . .)

Business Strategy

Portfolio Strategy

Project Strategy

Strategic Decision Hierarchy

Figure 1-1. R&D and the Strategic Decision Hierarchy


charter. Corporate strategy is a matter of both desire and capability.The business strategy level, in turn, determines how the company willcompete in each area. The top of R&D’s hierarchy of strategic deci-sions quite naturally begins within these two levels.

Three Levels of Smart R&D

Three levels of R&D decision making overlap the organizational deci-sions just described: those that relate to technology strategy, thosethat determine the content of R&D portfolios, and those that shapeindividual R&D projects. To be smart, companies must make gooddecisions at all three levels. R&D technology strategy logically over-laps both the corporate-level and the business-level domains, sincetechnology is a factor in where and how the enterprise competes.R&D portfolio and project decisions are found at lower levels, takingtheir places alongside the many other decisions that every organiza-tion must make.

Technology Strategy

Technology strategy is a vital component of corporate and businessstrategy that designates the role technology will play in the future.Every business must determine how it will create new value and howit will renew its current products and services. How will it supportexisting products, generate new ones, and develop entirely new prod-uct lines? How will it develop or acquire the necessary manufacturingtechnologies? Which technology will it develop internally and whichwill it obtain from outside? What, if any, technological competencieswill it rely on to differentiate itself from the competition, and whichones must it excel in just to keep up? Where do technology alliancesmake sense? How will it shape the R&D organization? Which func-tions should be centralized or decentralized? How should these func-tions be spread globally? And what mix of skills is needed in eachlocation?

These questions cannot be answered in the abstract or by the R&Dorganization alone. They are questions that the CEO and generalmanagers must address as part of business strategy. For example,Xerox PARC, described earlier, was making very good decisions aboutits portfolio and individual projects. Its teams of researchers and en-gineers were successfully inventing the computing and communicat-



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