This blog post will mostly offer what I call a “fusing”: musings that fuse two or more recent topics that seem particularly useful or interesting to me. On this site, I already present many strategy execution and management innovation articles culled from my reading in the field, but these fusings are meant to go a little deeper by exploring a topic from a couple of different angles and giving you some takeaways, as well as my own two cents.
This post brings together articles from January 2021 on three different strategies that companies might consider to meet the challenges of a rapidly changing environment. Before we delve into those strategies, though, let me expand on some points from the last blog post, which was a primer on today’s dynamic business environments and the adaptive capabilities needed to thrive there.
Dynamic capabilities and VUCA (volatility, uncertainty, complexity, and ambiguity) environments
As I wrote, VUCA (volatility, uncertainty, complexity, ambiguity) is a convenient shorthand for the kind of quickly shifting, fog-shrouded terrain on which companies often find themselves these days, thanks to factors like digital technology and globalization that disrupt old certainties. Management experts recommend companies develop dynamic capabilities so as to be ready to shift along with their environment. These capacities are usually divided into three basic categories: sensing, seizing, and transforming.[i]
But what exactly are these dynamic capabilities that experts agree are so important? Well, there’s a growing and varied literature on the subject, which Rosabeth Moss Kanter, Matthew Bird, Ethan J. Bernstein, and Ryan Raffaelli do a good job of sifting through in an article from 2015. They see a commonality across scholars’ slightly differing definitions of dynamic capabilities: “the development of a routinized learning process at the organizational level—a focus on change as ‘something we know when and how to do.’” The authors later state that these “capabilities consist of processes, mechanisms, designs, models, structures, incentives, and knowledge.”[ii]
Clearly, there are many types and flavors of dynamic capabilities. To give just a few practical examples, they might include a corporate culture that welcomes experimentation by workers at different levels of the hierarchy; division of the company into semi-autonomous units that can reconfigure themselves as needed;[iii] a system by which frontline workers’ innovations can be quickly communicated to others and rewarded; a way to integrate customer feedback into the redesign of products; or a highly mobile and motivated network of employees from different parts of a company that can find new ways to efficiently capture value.[iv]
Having the right habitual processes and systems in place makes an organization readier to adapt to a turbulent market. The alternative is to keep to the same path that worked in stabler times, doggedly pursuing a course set years or decades ago—which could leave a company foundering on unforeseen rocks.
Strategies to navigate VUCA
This leads us to the three articles from last month that I want to highlight, which explain three very different strategies to help companies adapt to those choppy VUCA waters:
- building an Engine 2 as a new revenue source alongside the core business;
- coordinating an “ecosystem” to address an emerging market need; and
- investing outside the company with a corporate venture capital fund.
To be clear, these are not dynamic capabilities themselves. They are strategies that dynamic capabilities can help a company to first see a need for, and then to deploy and profit by. Remember also that these strategies are not one-size-fits-all; rather, one may be the right strategy for a particular firm depending on its industry, its position in that sector, its resources, and its own objectives. I’ll start by summarizing the three strategies, then connect them to the three categories of dynamic capabilities (sensing, seizing, and transforming).
Bain & Company’s Engine 2
The first article, “The Engine 2 imperative: New business innovation and profitable growth under turbulence,” by James Allen and Chris Zook of Bain & Company,[v] is probably the most intriguing of the three articles to me. It considered how a company operating in turbulent conditions might build a second (or eventually third or fourth) profitable “engine of growth.”
The authors begin by acknowledging that launching a whole new enterprise alongside your “core business” flies in the face of Bain’s traditional advice to maintain competitive advantage by honing what your company already does well. However, that advice was meant for less VUCA-ish times. Today, shifting environments present both threats and opportunities—either of which might demand an Engine 2. If technological changes, fast-moving competitors, or declining demand threaten your core business, a new source of revenue could hedge your company against sharp decline. On the other hand, awareness of an emerging technology or customer base could open new opportunities for growth on the peripheries of your business. In particular, Engine 2s require a substantial and growing market to be successful.
This gets to one of the most important points made by this article: most companies should probably consider an Engine 2 only if it will be somehow adjacent to their core business. Not only is a firm more in touch with trends and opportunities in its own sector, but adjacencies allow it to leverage its existing resources: its expertise with certain processes and technologies, its customer base and knowledge of their needs, its familiarity with government regulations, its relationships with suppliers and distributors, and so on.
For all these reasons, Bain’s research suggests expansion to an adjacent area is much likelier to be successful. The authors state that 49% of the thriving Engine 2s they studied were based on adjacency (as when industrial cleaning supplies manufacturer Ecolab got into industrial water purification). Meanwhile, 32% of the successful Engine 2s were next-generation versions of the company’s core business (e.g., Brazilian bank Bradesco moving into digital banking), while only 19% were based on business models that were totally new to the company.
While success often depended in part on existing familiarity with the Engine 2’s customers, distribution, or technology, the authors emphasized that another important factor was the creation of “entrepreneurial conditions” in the new offshoot, or what Bain refers to (and trademarks) as “Founder’s Mentality”—a startup-type devotion to innovation, agility, growth, and generally shaking things up, rather than doggedly pursuing the status quo. Of course, an Engine 2 has a great advantage over a startup: the ability to draw massively on an established company’s resources (financial, organizational, and human). The trick, according to this article, is to nonetheless grant the Engine 2 its own space, with its own culture, as it rapidly scales up.
BCG’s series on Ecosystems
A different strategy for turbulent times is creating an “ecosystem” around your company to seize an emerging market opportunity—the focus of a recent series of articles from Boston Consulting Group, coauthored by Ulrich Pidun, Martin Reeves, Maximilian Schüssler, and Niklas Knust. The latest in this series is on the governance of an ecosystem, but I want to focus on the first article, “Do you need a business ecosystem?”,[vi] which provides a better introduction to the concept.
The authors define an ecosystem as “a dynamic group of largely independent economic players that create products or services that together constitute a coherent solution,” and they divide ecosystems into two main categories:
- solution ecosystems organized around one core product or service, such as an iPhone, which is built by one company but populated with apps designed by third parties,
- and transaction ecosystems, which are platforms like Ebay, built to facilitate producers and consumers finding and transacting with one another.
The authors are at pains to say that ecosystems do not make sense for all companies in all contexts. Rather, they may be appropriate if your company occupies an “unpredictable but highly malleable business environment.” In fact, that’s what I found most fascinating about the article—the idea that an ecosystem can actually help you influence an emerging market, or shape an entirely new one—if you act quickly enough and attract the other players you need. (Think of the iPhone again, and how its apps and App Store have formed our concept of what a phone can be!)
Another benefit of ecosystems mirrors that of Engine 2s: the ability to scale a solution up rapidly. In this case, the ability to quickly grow to meet customer demand comes not solely from a company’s internal resources (as in Engine 2s), but from fruitful collaboration with outside partners. If the rewards are tempting enough, these third parties can bring their own ingenuity and resources to bear to develop offerings not possible from a single firm. (The article gives the example of Airbnb, a lodging platform with market penetration greater than even the largest hotel chain, despite not owning any hotels of its own.)
The authors point out that ecosystems are more flexible than either vertical integration within a company or hierarchical supply chains, while being more coordinated (by the core firm) than the open market’s free-for-all. As suggested by the latest article in the series, “How do you manage a business ecosystem?”,[vii] it can be difficult to choose the right governance model for an ecosystem (balancing flexibility with coordination while capturing sufficient value and distributing it equitably enough to all involved). In the right context, though, the benefits can be enormous.
Ernst & Young on CVC (corporate venture capital)
The last strategy I’ll discuss here is that of using corporate venture capital (CVC) to build what we might think of as an investigative portfolio, or what McKinsey’s Lowell Bryan called a “portfolio of initiatives.” This is the focus of the article “Why now may be the time to start a corporate venture fund,” by Peter Ulrich and Jeff Leach, from EY-Parthenon.[viii] In a nutshell, CVC operates much like an ordinary venture capital fund—setting aside money, sometimes from multiple parties, to invest in risky but intriguing opportunities—but for somewhat different purposes.
For ordinary venture capital funds, the intention is to eventually make money hand over fist—to reap the rewards that may come with greater risks. While a CVC fund certainly welcomes financial returns on its investments, this article emphasizes that it is better thought of as exploratory: using startups strategically to keep abreast of new technologies, trends, and markets, to outsource R&D, and to manage risk before undertaking mergers and acquisitions. In short, CVC is more about gaining insight than gaining monetary ROI.
As such, the authors recommend integration at every stage. First, CVC strategy should be integrated with a company’s larger objectives to ensure the investments are used to fill important gaps (in tech, products, market insight, strategic partnerships, etc.). In addition, there should be structured communication and collaboration between the investing company and the startups. Not only does this ensure that the corporation learns more from the startups, it also makes the CVC more attractive to founders. After all, startups are looking for more than just money—they are looking for the expertise, distribution channels, customer base, and brand reputation that established companies can lend to younger ones.
A fusing on strategies to survive VUCA
Now that I’ve sketched out these three very different strategies for turbulent times (Engine 2s, business ecosystems, and CVC), let’s think of them in terms of the three categories of dynamic capabilities: sensing, seizing, and transforming. Or to put it in evolutionary terms, what kind of adaptation to the environment does each of these strategies represent?
The first category of dynamic capability is sensing, which means staying alert to both threats and opportunities outside a company (as well as remaining open to innovations that originate internally). This idea aligns well with CVC, which after all is about learning. If CVC is an evolutionary strategy for a changing environment, we might compare it to a shark’s electroreception—its ability to detect faint electrical fields and thus prey, even when hidden by complete darkness or under the sand. Remember that the A in VUCA stands for ambiguity: Is that a fish hidden under the sand, or a rock? Is a new technology a flash in the pan, or something that will upend an industry? CVC can help a company make fine distinctions in a confusing situation.
The next two kinds of dynamic capability involve seizing, or innovating new products, services, and systems to exploit opportunities, and transforming, or reconfiguring an organization’s assets and structure.[ix] (Doing this well, of course, necessitates first sensing the moves and changes necessary to your context.) Building a business ecosystem involves both seizing (insofar as a company must design a new platform or core product that will bring together collaborators) and, often, transforming (when the ecosystem creation involves structural changes, as when Apple began to invest substantial resources in its App Store, or Airbnb acquired other companies to increase its presence outside the US). As an evolutionary strategy, ecosystem creation is a kind of symbiosis, like a bee that harvests life-sustaining pollen from flowers while simultaneously fertilizing the flowers. Hopefully, all involved benefit.
Finally, the Engine 2 strategy also involves both seizing and transforming. Building a second engine of growth obviously requires innovation (seizing), since entirely new products or services are offered to take advantage of a new opportunity. But transformation is just as necessary, since an Engine 2 amounts to spawning a second company alongside the core. Space and resources must be set aside for the new business to grow quickly, with a strong measure of independence from the core business (which must also be maintained, despite the new drains on resources). Since an Engine 2 acts as a hedge against stagnating revenue in a shifting environment, we might imagine it as the evolution of a second vital organ, even as the first continues to function. (This resiliency is one possible reason for vertebrates’ development of two kidneys, when one is enough to keep us alive.)
The article on Engine 2s made one other point I want to draw attention to, about supercompetitors. Such industry-shaping companies as Amazon, Reliance (an Indian conglomerate), and Ping An (a Chinese insurance-cum-financial services company) are the exemplars of using the Engine 2 strategy to maintain competitive advantage. The authors suggest it is no coincidence that the top eight supercompetitors, which “create[d] 15% of the positive market value generated by 3,000 of the top public companies over the past 10 years,” also “have become serial builders of Engine 2 businesses at scale.”[x] These are companies that have and use their dynamic capabilities to great advantage: to stay agile, to intuit changes in the marketplace, to innovate, and to reshape themselves as well as their industries. Of course, such megacorporations are also able to allocate massive resources to their new initiatives. For ordinary mortals (and businesses) on the outside looking in, the supercompetitors’ capabilities may inspire both awe and a bit of fear.
Anyway, I wanted to bring these three articles together in order to consider just a few of the adaptations companies can choose among when they face volatile, uncertain, complex, and ambiguous environments. If any of these strategies—Engine 2s, business ecosystems, or corporate venture capital—seems like it might be right for your circumstances, check out the source article to go a little deeper.
[i] “Dynamic capabilities and strategic management” by David Teece, Gary Pisano, and Amy Shuen
[ii] “How leaders use values-based guidance systems to create dynamic capabilities” by Rosabeth Moss Kanter, Matthew Bird, Ethan J. Bernstein, and Ryan Raffaelli
[iii] “Management innovation made in China: Haier’s rendanheyi” by Jedrzej George Frynas, Michael J. Mol, and Kamel Mellahi
[iv] “Accelerate!” by John P. Kotter
[v] “The Engine 2 imperative: New business innovation and profitable growth under turbulence” by James Allen and Chris Zook
[vi] “Do you need a business ecosystem?” by Ulrich Pidun, Martin Reeves, and Maximilian Schüssler
[vii] “How do you manage a business ecosystem?” by Ulrich Pidun, Martin Reeves, and Niklas Knust
[viii] “Why now may be the time to start a corporate venture fund” by Peter Ulrich and Jeff Leach
[ix] Dynamic Capabilities, from David Teece’s website: https://www.davidjteece.com/dynamic-capabilities
[x] “The Engine 2 imperative: New business innovation and profitable growth under turbulence” by James Allen and Chris Zook