Building Organisational Capability Part 1: What is it?

Episode #23 Building Organisational Capability Part 1: What is it?

Today’s podcast deals with a great question that came from one of our international listeners Radu, who’s based in Bucharest, Romania.

Radu asked about building organisational capability and this is a vast area, so I’ll split it into two episodes. This week, I’ll give you the context for what organisational capability is, how it fits with strategy, and where leaders most often put their focus. Next week in part 2, I’ll delve into what a leader should be doing at any level to build organisational capability through their people.

In the first part of our discussion on organisational capability, we’ll start by defining organisational capability. Then at the risk of over simplifying all of this, I’m going to take a quick fly over the top of business strategy because there’s years of study and learning in this area to be had. We’ll ask the question where does competitive advantage come from and I’ll let you in on some key findings on this subject from one of the world’s foremost thought leaders in strategy.

Then we’ll talk about where most leaders focus their energies and I’ll put forward my hypothesis as to why we aren’t necessarily good at building organisational capability.

what is organisational capability?

It’s the ability and capacity of an organisation expressed in terms of the resources it owns and has access to. It is all important in how we develop and execute strategy. When thinking through what capabilities your organisation might have, there are six key areas or categories that we like to focus upon and they’re really easy to remember because they form a nice little acronym called PROFIT, P-R-O-F-I-T.

PROFIT stands for physical, reputational, organisational, financial, intellectual and technological capabilities.

Physical resources are basically plant, equipment, machines, facilities, stuff you can touch.

Reputational capabilities are things like brand equity and recognition, respect and track record.

Organisational capability, which we’re going to focus most of these two episodes on, is about human resources and the inherent processes and methods inside the organisation that govern those.

Financial, fairly obvious, available funding and balance sheet capability.

Intellectual capabilities, copyrights, trade secrets. I also think market intelligence is very important here as an intellectual asset.

Technological, systems, equipment and information.

No matter what type of organisation you work for, strategy is important.

Why do we exist? What is our purpose? How do we what we do better and more effectively both in absolute and relative terms? How do we compete in our market? What are the sources of value for our customers? Now, don’t think that strategy doesn’t apply to you either at your level in an organisation or in your industry. You don’t have to be a bank or an airline or a telecommunications giant to be in a competitive industry driven by delivering customer value. It doesn’t matter what sector you’re working in. Your organisation is competing on a whole range of fronts.

If you’re in a traditional competitive business, you’ll be competing for customers and product or service margins. If you’re in an NGO delivering humanitarian services, you maybe competing for government funding to support your service delivery. If you’re in a registered charity, you’ll be competing for philanthropic donations. A private hospital, you compete for patients. Even if you’re a sub-scale business and want to compete beyond your place in the value chain, you maybe competing for partnerships and alliances. There are exceptions to the model of direct competition. For example, if you work in the service of the public for government body or in a regulated monopoly business.

These generally operate in a competition-free context. However, having a focus on value is still critical, so whether it’s delivering better services for customers or taxpayers, reducing the cost of compliance through a better policy or educating individuals and businesses on their legislative obligations. Let’s take a quick fly over the top of business strategy. Now, I normally wouldn’t delve into an area that’s more aligned with a specific technical discipline of management than the general leadership content that this podcast typically deals with. However, strategy and the ability to think strategically is a core skill for a leader as you rise through the levels.

It’s useful to understand where a leader’s imperative to build organisational capability fits in the scheme of the overall enterprise objectives. You need to know which levers to pull to give your organisation the biggest bang for buck. If you’re not yet on the top team in your organisation, this will help you in developing into a more senior role as you understand more about the demands and requirements of what senior leaders have to deal with. It will also help you ask the right questions, which will e-mark you as a leader of the future. My favourite strategy definition comes from Peter Drucker. He said, “Strategy is a set of principles around which to improvise.”

But for today’s discussion, I want to borrow a simple frame from my good friend and colleague Andrew McDonald, who’s undoubtedly one of the best competitive strategy people I’ve ever had the pleasure of working with. Business strategy, in its simplest form, seeks to address two questions.

Question one, is the market worth winning in? Question two, can we win?

Now, the first question examines industry attractiveness and it’s probably best viewed through the lens of Michael Porter’s Five Forces of Competitive Strategy Model. This has been around for a lot of years and it’s still holding up overtime.

The Power of Suppliers

How much power does a supplier have in your market? If you’re an airline and you’re trying to buy aircraft from someone, you’ve really only got two main choices, Boeing and Airbus. That’s it. These guys have a fair bit of power.

The Power of Buyers

How much choice does the customer actually have and what’s their knowledge of the products and services that you’re selling? Because the more knowledge they have, the less opportunity there is to extract a premium from them. In most B2C industries these days, the customer is getting more power through technology, cross comparisons online, the internationalisation of markets and so forth.

Barriers to Entry

How difficult is it for a new player to get into the market? Does it require large amounts of capital? If so, this is going to keep the smaller players away, which is why when governments deregulate industries like telecommunications, they have to try to create a level playing field for new entrants to stimulate competition. Another barrier to entry, how long would it take and how much would it cost to build a distribution network to rival the incumbents?

The Threat of Substitutes

For example, if you’re the manufacturer of aluminium cans, your product could be substituted for glass, steel and plastic bottles or cans. Same function, different properties. Now, it’s really worth listening to a podcast. It’s on the HBR IdeaCast. It’s an oldie. It’s been around for a year or two. Clay Christensen, the father of innovation theory, released a podcast called The “Jobs to be Done” Theory of Innovation.

Competitive Rivalry

How many firms are competing? Is it a natural duopoly like coal rail haulage in Queensland? Is it an oligopoly, like the domestic airlines in Australia? Or is it a very fragmented market like retailers or fast moving consumer goods markets? Now, I like to think of this as the external view of strategy.

These are big powerful forces that generally drive business results with more impact and certainty than anything we might choose to do as an organisation. In fact, the world’s greatest investor Warren Buffett once said that when a management team with a reputation for brilliance tackles a business with a reputation for bad economics, it’s the reputation of the business that remains intact.

Let’s think about the second question, can we win?

This is all about organisation capability. Do we have the capability to compete in our chosen market more effectively than our competitors? The rest of this episode deals with the can we win question. I like to think of this as the internal viewer strategy.

Organisational capability supports what we call the resource-based view of competitive advantage. The object of the exercise is to assess your organisation’s perceived advantages and then to work out how effectively they could be leveraged. To do that, for each advantage that we identify in those six PROFIT categories, we have to ask ourselves the question, is that actually valuable? Is it rare? Is it hard to copy? Can it be substituted for another product? It’s your using the unique combination of these types of resources that organisations seek to compete and to gain advantage in the market. Where does competitive advantage really come from?

David Yoffie from Harvard Business School talks about the fact that competitive advantages are fleeting. The top performers in an industry at any given point in time will revert to the industry average within three to seven years. Now, the point is that industries and businesses constantly evolve. Just for sh!ts and giggles, check out some of the companies identified in Jim Collins seminal work, ‘Good to Great’. At the time the research was conducted, these companies were no doubt outliers with 15 year out performance of the indexes, but Fannie Mae blew up in 2008 as its exposure to the US mortgage market, broad and unstuck.

10 years later, they’re just talking about now getting it out of the conservatorship of the US government. Look at Circuit City. By 2000, which was not long after the publication of ‘Good to Great’, many Circuit City stores were outdated, in bad locations, and couldn’t compete with Best Buy. By 2008, Circuit City had to seek the sanctuary of Chapter 11 bankruptcy protection.

More recently though, the USA’s global behemoth General Electric was dumped from the Dow Jones Industrial Average Index, which they have been part of for over a hundred years. It broke the unwritten rule of its share price being worth less than 10% of the highest priced stock in the index. At the time it was dropped, its shared price was worth less than 5% of Boeing’s share price. Just remember people, in business and in life, quite often today’s rooster is tomorrow’s feather duster.

competitive advantage

Now, can you imagine then why the inherent capability in your organisation is so critical in creating a healthy growing and sustainable organisation. Let’s get back to Yoffie. In terms of the sources for competitive advantage, not all advantages are created equal. Yoffie’s research shows that an advantage in pricing over your competitors can be overhauled by them within two months. If you manage to establish a competitive advantage in advertising, it takes less than a year to overhaul.

In innovation, less than two years. Manufacturing processes, less than three years. If you manage to get an advantage in distribution, it will take up to four years for your competitors to overhaul that. But when it comes to human resources, the lag time for a competitor to replicate your advantage is greater than seven years. Now just think about that. We can pay a lot of smart people to help us with all of this stuff, strategy, operational improvement, marketing, customer and brand stuff, financial engineering, but this would ignore one of the richest sources of value, the organisational advantage that are hardest to create, people, process and methods are the most difficult to replicate.

They’re really hard to imitate and the payback is enormous. They’re the sources of long-term competitive advantage. But where do you think most executives focus their energies? Well, the really good ones try to focus on doing the things that deliver the most bang for buck. This naturally leads them to very tangible actions to improve short-term performance, so improving the balance sheet, inventory utilisation, debt to equity gearing ratio, profitability and liquidity ratios. They look for organic revenue growth and growth through acquisition. They look to acquire physical assets and they look to expand their operations.

They seek new sources of funding and they look at protecting or monetising the intellectual property that the organisation has. Of course, there’s the heck and old cost control and reduction, which everyone’s doing all the time, and then doing value or creative deals and partnerships. Now, most businesses focus first and foremost on financial value. This requires a profound understanding of the things you do in business that drive financial performance. This can be expressed in a value driver tree. For example, at CS Energy, we found that value is massively driven by the availability of our coal fired power plants.

Although that’s not to say that inventory management and reducing our total labour cost wasn’t important, the value derived from production at the top line of the business was an order of magnitude greater than could be achieved in our wildest dreams even if we were world class in those other areas. But many leaders ignore or struggle with one of the richest sources of value creation for business, improving the capability and performance of every individual in the organisation to deliver more, better, faster, smarter and cheaper. In next week’s episode, I’m going to go into more detail about how to build that sort of organisation capability.

Why aren’t we necessarily good at developing our people to create the human and organisational capability that leads to a more sustainable competitive advantage?

I mean the human capability is everything. It drives value into all other resource-based dimensions. It enables you to make better decisions inside a strong accountability culture, which improves virtually everything you want to do. It’ll drive performance of physical assets. It’ll uncover customer and market insights. It’ll lead to better knowledge of customers and of course, a better and more honest evaluation of your own capabilities. But building this capability requires you to undertake what I call the hard work of leadership, which many, many leaders shy away from.

It’s letting go of the need to be liked, the respect before popularity mantra. It’s having the difficult and uncomfortable conversations. It’s investing time in your people much of which doesn’t have any discernible impact and making tough decisions and being okay with that is a vital part of being a leader. That’s what I’m going to take you through next week as we look at building organisational capability through our people and leadership.