McKinsey Quarterly 2015 Number 4

2015 Number 4
Copyright 2015
McKinsey & Company.
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2015 Number 4
This Quarter
Its almost a truism these days to say that modern corporations

must be agile. The pace of industry disruption arising from the digital
revolution, combined with nimble, new competitorsincluding
many from emerging marketshave raised the cost of complacency
and rigidity.
But what does it mean to achieve agility? This issues cover package
tries to answer that question, starting with intriguing new
McKinsey research. Using data from McKinseys Organizational
Health Index, Michael Bazigos, Aaron De Smet, and Chris
Gagnon show how organizations that combine speed with stability
are far likelier to be healthy than companies that simply move fast.
The utility sector is a striking example of one industry that needs
to combine flexibility and stability. Although digital competitors,
new data-based business models, and renewable-energy sources are
changing the landscape in certain markets, the industrys sprawling base of heavy assets remains core to its future. Sven Heiligtag
and his colleagues Dominik Luczak and Eckart Windhagen describe
how a number of leading utilities are trying to straddle these
two worlds, suggesting some lessons for companies in other sectors.
The importance of balance in our agile age extends to individual
executives. Many are overwhelmed by information, and its not clear
they or their organizations are extracting as much value from it
as they could. London Business School professor Julian Birkinshaw
and his coauthor Jonas Ridderstrle suggest the answer may be to
create organizations that can maximize return on attention, which

they define as the quantity of focused action to generate a possible
solution divided by the time and effort spent analyzing the problem.
Such organizations, say the authors, are more likely to look like an
adhocracy than a traditional bureaucracy or meritocracy.
The forces at work in todays large organizations demand more than
agility, of course, and were using both this issue of the Quarterly
and the next to further explore what it means to organize for the
future. Youll find here, for example, new research from McKinsey
and Gallup on matrix organizations, as well as thinking from
Ashridge Business School professor and McKinsey alumnus Andrew
Campbell and his coauthor INSEAD professor Gabriel Szulanski,
on ways to deter the corporate center from inadvertently subtracting
value. Finally, our global managing director, Dominic Barton, along
with Sandrine Devillard and Judith Hazelwood, examine a critical
challenge for many organizations: achieving gender parity. Through
the lens of McKinseys experience, they explore why its been elusive,
and what we can do about it.
The leaders of Chinese organizationswhether local companies or
the local business units of multinationalshave had a challenging
year amid economic and financial-market headwinds. This issue
also presents new research about how they are responding. The
article featuring those insights, How China country heads are
coping, is part of a broader package that takes Chinas pulse. Despite
economic and financial-market difficulties in 2015, research from
the McKinsey Global Institute and our colleagues on the ground
detect a wellspring of innovation and significant resilience. Global
leaders shouldnt be writing China off anytime soonin part because
of the agility with which its companies and leaders are responding to
changing circumstances. We hope this issue of the Quarterly will
inspire agile responses to your biggest challenges, too.
Allen Webb
Editor in chief, Seattle office
On the cover
Agility
28
Why agility pays

Michael Bazigos, Aaron De Smet, and Chris Gagnon
36
New research shows that the trick for companies is to combine speed with stability.
Agility lessons from utilities

Sven Heiligtag, Dominik Luczak, and Eckart Windhagen
44
The industry faces pressure on its core businesses and unexpected digital
competition. Evaluating the external environment and making bets more quickly
will be decisive for incumbents.
Adhocracy for an agile age

Julian Birkinshaw and Jonas Ridderstrle
The agile organizational model gives primacy to action while improving the speed
and quality of the decisions that matter most.
Features
Taking Chinas pulse
60
Five myths about the Chinese economy

Jonathan Woetzel
66
Predictions of deepening economic woes are plentiful. Here are five arguments
against the pessimism.
Gauging the strength of Chinese innovation

Erik Roth, Jeongmin Seong, and Jonathan Woetzel
China does well in customer- and manufacturing-oriented innovation,
though not in the more advanced varieties. But the country will need them to
sustain growth.
74
Five keys to connecting with Chinas wired consumers

Cindy Chiu, Todd Guild, and Gordon Orr
China is the worlds largest and most dynamic e-commerce market. But being
successful requires understanding and embracing its unique digital landscape
and consumers.
82
How China country heads are coping

Wouter Baan and Christopher Thomas
As multinational companies face stronger headwinds, how are local leaders
dealing with the situation, and what would help them move faster?
Features
86 Gender equality: Taking stock of where we are

Dominic Barton, Sandrine Devillard, and Judith Hazlewood
Why are women still underrepresented at every level of todays corporations?
90
Digging into the numbers on gender equality

Highlights from recent research
92 An executives guide to the Internet of Things

Jacques Bughin, Michael Chui, and James Manyika
The rate of adoption is accelerating. Here are six things you need to know.
102
Knowing when corporate headquarters adds

rather than subtracts value
Andrew Campbell and Gabriel Szulanski
Reduce value destruction by applying three tests to initiatives from
the center.
Leading Edge
Michael Bazigos and James Harter

Matrices are often necessary, but
they may create uncomfortable
ambiguity for employees. Clarifying
roles can boost employee engagement
and organizational health.
14
Industry dynamics
Revisiting the matrix

organization
Why its still a world

of grow or go
Yuval Atsmon and Sven Smit
24
Consumer packaged goods:

When subpar operations threaten
margin growth
Closing View
111
In a challenging environment,
growth matters more than ever.
19
A quick look at research and analysis

from selected sectors
How should you tap into

Silicon Valley?
Alex Kazaks, Eric Kutcher, and
Michael Uhl
Not by sticking a toe in the water.
Get your management team aligned
and then commit.
Taking the measure of the

networked enterprise
Jacques Bughin
New research shows that power
users reap the greatest benefits
from social technologies.
Short takes
Perspectives on management today
23 Reflections on oil and gas
116
Extra Point
The global gender-parity landscape
McKinsey Quarterly editors

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Research, trends, and emerging thinking
Leading Edge
8
2015 Number 4
8 Revisiting the matrix

organization
14 Why its still a world
of grow or go
Short takes:
23 Reflections on
oil and gas
Industry dynamics:
24 C
onsumer
packaged goods
19 Taking the measure

of the networked
enterprise
Revisiting the matrix

organization
Michael Bazigos and James Harter
Matrices are often necessary, but they may create uncomfortable ambiguity for
employees. Clarifying roles can boost both the engagement of the workforce and a
companys organizational health.
Matrix organizations have been around
for decades, stimulating vigorous
debate between supporters and detractors for nearly as long.1 They remain
prevalent at the large number of
companies that need to bring functional
centers of excellence together with
business-specific people and processes.
Eighty-four percent of respondents
to a recent Gallup survey, for example,
were at least slightly matrixed.
That survey, covering nearly 4,000
workers in the United States, highlights
some benefits for employees in
matrices, particularly in areas related to
collaboration. At the same time, the
survey suggests that these employees
feel less clear about whats expected
of them than their nonmatrixed counterparts do. This problem has consequences: Gallup research indicates that
clarity of expectations is a foundation
for building an engaged workplace that
performs at high levels. Furthermore,
according to McKinseys Organizational
Health Index (OHI), clear and accountable roles are among the most important
drivers of organizational health. Taken
together, the Gallup and McKinsey
findings underscore how important it is
for executives and line managers to
address the role ambiguity thats all too
common in matrix organizations.
(For more on the research behind these
two studies, see sidebar, About
the research, on page 11.)
Leading Edge
Ubiquitous and unexceptional

Eighty-four percent of the US employees
Gallup surveyed were matrixed to
some extent. Forty-nine percent served
on multiple teams some days (we
categorized them as slightly matrixed),
and 18 percent served on multiple
teams every workday but with different
people, though mostly reporting to the
same manager (matrixed). The remaining
17 percent reported to different managers in their work with different teams
(supermatrixed).
Most employees in matrixed organizations, according to the survey, arent
terribly engaged with their jobs. (Gallup
defines employee engagement as
involvement in and enthusiasm for work.)
These figures are consistent with what
Gallup has found in the workplace at
large over a decade of study. They are
alarming, given the relationship between
worker engagement and vital business
outcomes, such as productivity, profitability, and customer perceptions of
service quality.2 The survey does suggest a modestly positive relationship
between the four categories of organization and employee engagement,
which rises slightly across them (exhibit).
Collaboration and clarity

Beneath the surface, we found some
areas (particularly collaboration) where
matrixed organizations performed
better than less matrixed ones and others
(related to role clarity) where they did
worse. The differences in engagement
at more and less matrixed organizations
suggest advantages and disadvantages

that may cancel one another out.
A key area of strength for matrixed
organizations lies in collaborationa
heartening discovery, since crosscompany teamwork is one of the chief
aims of many matrices. We asked
employees of slightly matrixed, matrixed,
and supermatrixed organizations
about the benefits of being on different
teams. Supermatrixed employees
were generally about twice as likely as
slightly matrixed ones to say that
their organizations not only helped them
collaborate more effectively with
coworkers, do their best work, and
serve customers well but also stimulated
bottom-up innovation. Supermatrixed
employees were also somewhat more
likely than those in the other categories
to say they had received recognition
or praise during the past seven days, that
their opinions counted, and that their
fellow employees were committed to
doing quality work. These are key
elements in the overall engagement of
employees and suggest that relationships
and collaboration among employees in
matrixed organizations and their peers
and superiors really are better.
On the other hand, only a minority of
the supermatrixed employees strongly
agreed with the statement, I know
what is expected of me at work, compared with 60 percent of the nonmatrixed.
This reflects a common complaint
about matrixed organizationsthat the
structure gives rise to a lack of clarity
about responsibilities, expectations, and
who reports to whom. Workers in the
three matrixed groups were more likely
10
2015 Number 4
Q4 2015
Matrix organization
Exhibit 1 of 1
Exhibit
Matrixed employees are slightly more engaged.
% of US employees1
Engaged
Nonmatrixed
28
Slightly matrixed
Work on multiple teams
on some days
29
Matrixed
every day, primarily
reporting to same manager
Supermatrixed2
every day, reporting to
different managers
31
34
Not engaged
Actively disengaged
56
16
57
14
55
56
14
11
1 Controlled for employment level. Data reflect merged responses from 2 surveys and are not weighted.
2 Figures do not sum to 100%, because of rounding.
Source: Gallup
than nonmatrixed ones to say that

they need clear direction from project
leaders and communication between
their managers and project leaders to
prioritize their work most effectively.
Also, employees in the matrixed categories were more likely than their
nonmatrixed counterparts to say they
spent their days responding to
coworkers requests and attending
internal meetings. Such responses are
not surprising in an environment
where employees receive instructions
and feedback from multiple managers
and work with a range of people to complete projects. These are also probably
factors in the critics assertions that the
matrix structure can slow decision
making, blur lines of communication,
stifle productivity, and hinder organizational responsiveness and agility.3
The link to organizational health

Interestingly, role clarity and related
accountability practices emerge as
among the most important drivers of
organizational health, and ultimately
Leading Edge
11
About the research

based on three capabilities: aligning around
strategies, executing them, and adapting
when necessary.1 The index includes data
from more than two million respondents and
over 2,000 unique surveys. Organizations
in the top quartile for health collectively
outpace organizations in the bottom quartile in total returns to shareholders (TRS):
they earned three times the annual TRS of
bottom-quartile organizations over the
nine-year period of the study.2
The findings of the study on matrixed

employees are based on a Gallup panel
web survey, completed by 3,956 full-time
employees aged 18 and older, that was
administered between April 8 and April 27,
2015. The Gallup panel is a probabilitybased longitudinal group of US adults
selected through random-digit-dial (RDD)
phone interviews over landlines and cell
phones. Address-based sampling methods
are also used to recruit panel members.
The Gallup panel is not an opt-in panel, and
members are not given incentives
for participating.
Our sample for this study, which used
Current Population Survey figures, was
weighted to be demographically representative of the US adult population. For
results based on this sample, the maximum margin of sampling error is plus or
minus two percentage points at the
95 percent confidence level. Margins of
error are higher for subsamples. In addition
to sampling error, the wording of questions and practical difficulties in conducting
surveys can introduce error and bias
into the findings of public-opinion polls.
The survey responses were matched
with those of a US workforce panel survey
administered in November 2014 to study
the engagement and other work-related
factors of matrixed employees. Separately,
Gallups meta-analysis of the relationship between employee engagement and
business outcomes included more than
49,000 business units across 49 industries.
The results of the organizational studies
are based on subsets of McKinseys global
database for the Organizational Health
Index (OHI). This index is a survey-based
assessment of organizational health,
defined as the ability to perform over the
long term. That kind of performance is
The study focusing on the accountability

practices of organizations was conducted
using data from 254 unique companies
and 781,224 respondents, collected in 2014
and 2015. This study determined the
rank order of practices structurally related
to organizational-health outcomes. The
order of the practices was based on the
magnitude and significance of the
standardized betas produced by regressing
the outcome on the direct practices.
To determine the rank order of the related
practices, we first regressed the outcome
on the direct practices and then (using
a stepwise regression) entered the remaining practices. Practices that explained
a minimum incremental 1 percent of the
variance were labeled related practices.
Their rank order (like our treatment of direct
practices) was based on the incremental
amount of variance explained.
1
Organizational health is operationally defined by

scores on nine organizational outcomes: direction,
leadership, culture and climate, accountability,
capabilities, coordination and control, innovation
and learning, motivation, and external orientation.
Unlike employee engagement, they are assessed
by survey questions about the organizations
effectiveness in these areas rather than their impact
on employees.
See Aaron De Smet, Bill Schaninger, and Matthew

Smith, The hidden value of organizational health
and how to capture it, McKinsey Quarterly, April
2014, on mckinsey.com.
12
2015 Number 4
performance, in McKinsey research

based on the Organizational Health
Index (OHI). McKinsey has consistently
found that improving role clarity improves
accountability, an outcome that is a
critical component of the overall healthindex score. In fact, organizations with
high accountability scores have a
76 percent probability of achieving topquartile organizational healthmore than
triple the expected rate. Whats more,
the independent effects of role clarity are
so powerful that they affect OHI scores
directly, one of only four management
practices (among 37) that do.4
organizational health: two management

practicesrecognition and employee
involvement in direction settingare
important drivers of two of the OHIs
outcomesmotivation and direction
which, along with accountability, are
meaningful components of the overall
OHI score.
Priorities for matrixed managers
These findings are consistent with work

by McKinseys Suzanne Heywood and
others showing that organizations can
mitigate the complexity associated
with matrices through clear accountability
and targets for individuals.5 Further
reinforcing these findings is the academic
literature suggesting that higher levels
of the ownership mentality predict higher
levels of collaboration, organizational
commitment, and corporate citizenship,
as well as reduced levels of behavior
that deviate from workplace norms.6
Given the importance of role clarity and

accountability to organizational health
and, ultimately, performance, addressing the role ambiguity that pervades
matrixed companies is a critical priority
for their leaders, who should help
employees by continually setting clear
expectations aligned with the direction of the business. This clarity should
cascade into frequent conversations between managers and their direct
reports about the specific role each
person plays in advancing the companys
objectives. Consultative (as opposed
to authoritarian) leadership practices can
contribute meaningfully to accountability,
according to McKinseys OHI research.
The Gallup survey does suggest that

role clarity takes a hit in matrixed organizations. Yet it also indicates that supermatrixed employees were more likely to
have received recognition or praise
in the previous seven days and to believe
that their opinions counted. McKinsey
research suggests that these features of
the employee experience in matrixed
companies have a positive impact on
It is also imperative to maintain dayto-day lines of communication to root

out and dispel ambiguity and ensure
that everyone is consistently on the
same page. This is true at the organizational as well as the team level: Gallup
research shows that managers should
not save critical conversations for
once-a-year performance reviews
engagement flourishes when employees
Leading Edge
receive regular, actionable feedback on

their progress.
Last, the matrix structure is notorious for
frequently obscuring lines of accountability, so leaders and managers should
ensure that all employees understand
whom they answer to and the duties for
which they are responsible. The importance of regular discussions to reclarify
expectations as work demands change
is compounded in matrix organizations.
And highly engaged employees thrive in
a system where everyone is accountable for his or her work.
1 For a classic critique, see Tom Peters, Beyond
the matrix organization, McKinsey Quarterly,

September 1979, on mckinsey.com.
2 James K. Harter et al., The relationship between
engagement at work and organizational

outcomes, Gallup, February 2013, gallup.com.
3 For more, see Billie Nordmeyer, Disadvantages
of organizations with the matrix approach,

Houston Chronicle, chron.com; and Eric Krell,
Managing the matrix, HR Magazine, Society
for Human Resource Management, April 1, 2011,
shrm.org.
4 Since the impact of these practices transcends
geography, industry sector, and company size,

we call them power practices. Besides role clarity,
personal ownership (another accountability
practice), strategic clarity, and competitive
insights are also in this select group. Overall, we
assessed the 37 management practices through
empirically derived survey items that were
independent of the outcomes they predicted. We
assessed the independent effect of role clarity
after statistically controlling for shared or
overlapping effects among the 37 practices.
13
5 See Suzanne Heywood, Jessica Spungin, and
David Turnbull, Cracking the complexity

code, McKinsey Quarterly, 2007 Number 2;
and Suzanne Heywood and Julian Birkinshaw,
Putting organizational complexity in its place,
McKinsey Quarterly, May 2010, on mckinsey.com.
6 James B. Avey, Bruce J. Avolio, Craig D. Crossley,
and Fred Luthans, Psychological ownership:

Theoretical extensions, measurement, and
relation to work outcomes, Journal of
Organizational Behavior, 2009, Volume 30,
Number 2, pp. 17391; doi 10.1002/job.583.
The authors wish to thank Gallups Sangeeta

Agrawal, Annamarie Mann, and Susan
Sorenson, as well as McKinseys Lili Duan,
Dominik Deja, Dinora Fitzgerald, and Yuan
Tian, for their contributions to this article.
Michael Bazigos, head of organizational
science at McKinsey, is based in McKinseys
New York office. Jim Harter is the chief
scientist of workplace management and wellbeing for Gallups Workplace Management
Practice in Omaha, Nebraska.
Copyright 2015 McKinsey & Company.
14
2015 Number 4
Why its still a world

of grow or go
Yuval Atsmon and Sven Smit
In a challenging environment, growth matters more than ever.

Growth is magic. It makes it easier
to fund new investments, attract great
talent, and acquire assets. But the
environment for growth has been difficult
since 2008, and while there are signs
that the Great Recession is at last receding, significant challenges remain.
Real-GDP growth in the United States
remains below historical averages;
the economies of most European countries are still sluggish; and growth in
emerging markets, particularly the BRICS
countriesBrazil, Russia, India, China,
and South Africais slowing down.
For more than a decade, weve been
building and mining a global-growth
database containing hundreds of the
largest US and European companies.
Recently, weve been revisiting some
of the core analyses in the 2008 book,
The Granularity of Growth,1 to see
if the challenging environment of recent
years has shifted the picture of fundamentals we painted before the financial
crisis. The answer is no, though the
economic context arguably has
increased the importance of an effective
growth strategy.
Survival rates
Healthy growth boosts corporate survival
rates, which was true in 2008 and
remains true in the United States and in
other developed markets. From 1983
to 2013, for instance, roughly 60 percent
of the nonfinancial companies then in
the S&P 500 were acquiredits grow or
go, and they have gone. Consider these
findings over that period:
Sixty of the 78 S&P 500 companies
that generated top-line growth and

improved or at least maintained their
margins outperformed the S&P 500.
Companies with deteriorating margins
performed less well, even if these

companies were growing; just 8 out of
30 outperformed the index.
A higher percentage (56 percent)
of companies that grew slowly, but

also aggressively distributed cash
to shareholders, outperformed the
S&P 500.
Leading Edge
15
Q4 2015
Grow or go
Exhibit 1 of 2
Exhibit 1
Not all growth opportunities are created equal, but growth is still a
critical driver of performance.
Number of S&P 500 companies,1 19832013
Outperformed the
S&P 500
267
Average
TRS,3 %
S&P 500, CAGR 3 = 10.3%

19832013
78
57
Acquired2
Growing with
steady or
improving
margins
Low growth,
with high
cash-flow
distribution
12
11
30
26
Growing with
declining
margins or
low ROIC3
Low growth,
low capital
returns
1 Analysis of S&P 500 companies in 1983, excluding financial-services companies; n = 458.

2 TRS for acquired companies calculated up to year of acquisition.
3 CAGR = compound annual growth rate; ROIC = return on invested capital; TRS = total returns to shareholders.
As analysis of these companies total

returns to shareholders (TRS) suggests
(Exhibit 1), growth is only a means
to the ultimate end: creating value. Not
all growth opportunities are equal.
Still, theres no escaping the fact that
growth is a critical driver of performance
as measured by total returns to shareholders. And TRS underperformers are
far more likely to be acquired.
Growth can be sustained, but

thats not easy
Growth must be actively and continually
renewed. That may seem like common
sense, but sometimes, as Voltaire aptly
noted, common sense is very rare.
When we looked at several economic
cycles, we found that very few companies
managed to maintain strong growth
16
2015 Number 4
over time (Exhibit 2). Less than half of

the S&P companies that increased
their revenues faster than GDP from 1983
to 1993 managed to do so from 1993
to 2003. Fewer than 25 percent of the
outperformers of 1983 to 1993 remained
in that group through 2013. Similarly,
in the eurozone, only about one-third of
the nonfinancial companies whose
revenue growth outpaced GDP in 1993
also outpaced it through 2013. Nonetheless, some evidence suggests that
enduringly fast growth is not a fluke:
the rate at which long-term survivors in
the United States fell out of the growthleader category actually decreased over
the years. While 62 percent of the
companies that outpaced GDP growth
after one decade failed to do so after
two, only 36 percent of the surviving
companies fell away in the decade
that followed.
Rethinking where to compete and

which assets to buy
A consistent finding in our research is
that about 75 percent of all growth
is a function of the markets in which
businesses competeportfolio
momentumand the acquisitions they
initiate. In other words, just 25 percent of a companys growth typically
comes at the expense of competitors.
We highlighted this analysis before
the market downturn in 2008, and it has
continued to hold true since then.
Making good choices about where to
compete requires a truly granular
understanding of market dynamics and
of a companys business performance.
Opportunities will not always come in

traditional or even familiar locales; indeed,
from 2010 to 2025, almost 50 percent
of global GDP growth will take place in
approximately 440 small- and mediumsize cities in emerging markets.2
Nor do overall averages reliably indicate
where the opportunities lie. One company we know had a three-year growth
rate that averaged 13 percent across
12 key business units. A closer inspection, however, revealed that their median
growth rate was only 2.5 percent. The
top-performing unit had been growing at
a 62.4 percent clip, but only two others
topped the company-wide average of
13 percent. In fact, five of the business
units were growing at around 1 percent or less over the three-year period,
and the worst performer had been
contracting at a rate of close to 5 percent.
Companies can predict their growth
momentum by identifying the unique
factors that drive their sales and
how these factors connect to broader
economic developments. To that
end, another company we know employs
a robust set of tools that go beyond
reporting where growth exists at present
it aims to forecast where opportunities will probably arise over the coming
quarters. This company starts by feeding
its data to econometric models and
time-tested algorithms to predict
its momentum. Disaggregating the data
exposes its market momentum and
financial outcomes in the past. Analyzing
the data to look for patterns helps
to identify shifts, opportunities, and
threats indicating potential opportunities
in the future.
Leading Edge
17
Q4 2015
Grow or go
Exhibit 2 of 2
Exhibit 2
Few companies manage to maintain strong growth over time.

Number of companies1 that remained in S&P 500 and had revenue-growth rates outpacing GDP growth
In 1983
After 1st decade

198393
388
After 2nd decade

19932003
56
147
After 3rd decade

200313
36
1 Sample = 458 companies; financial-services companies are excluded.
You cant grow without

reallocating resources
Even the smartest where to compete
strategy will fail to bring results unless the
company that develops it follows through
with the strong resolve that can bring
it to life. This is among the most challenging aspects of growing in a slow-growth
environment. In such times, companies
dont have the benefit of a rising tide to
generate surpluses for new initiatives
pushing into new markets, acquiring existing businesses, or focusing on
promising products or services.
But while its easy to agree that growth

is imperative, its not always clear
how to achieve it. Managers are often
uncertain whether the answer lies in
expanding beyond the core. When we
surveyed more than 600 executives
from developed markets, fully 75 percent
believed that the share prices of their
organizations would increase over the
next five years if they pursued a new
activity outside their core business. At
the same time, though, more than half of
the respondents assumed that growth
would result from refining the corporate
focus. When we asked them what would
18
2015 Number 4
happen if their companies divested

a current noncore activity, for example,
54 percent predicted that share prices
would rise over the next five years.
Theres an element of truth to both perspectives. Businesses decay, and
yesterdays core may not be todays or
tomorrows. Getting free from a decaying business is different from investing in
one with a strong potential. But the two
perspectives may become linked through
the reallocation of scarce financial and
human resources. Companies must
often let go of businesses that were once
important and focus on up-and-comers.
But it can be hard to jettison businesses
that management grew up with or to
accept that they cant be turned around
enough to justify further investments.
Hard but important. A leading global
industrial manufacturer we know
assessed the profitability, growth, market
attractiveness, competitive positioning, and other dimensions of the products
and components produced by its
largest business group. This analysis
revealed opportunities to reallocate
tens of millions of dollars to business
areas that could deliver significantly
better returns than existing priorities did.
It also highlighted ways to raise the
bottom line quickly and thus to overcome
initial misgivings that these moves
might sabotage the companys shortterm performance.
Capital-market pressures and organizational dynamics can make it difficult for

companies to place big, long-term bets
on the growth opportunities of tomorrow.
And the bigger you are, the harder
it is to grow. That said, outperforming
the competition remains possible in
all industries, even in sluggish economic
times. But this takes discipline and a
relentlessly granular analysis, as well as
a commitment to seek the kind of
growth that generates real and sustainable valuethe most important
objective of all.
1 See Mehrdad Baghai, Sven Smit, and Patrick
Viguerie, The Granularity of Growth: How

to Identify the Sources of Growth and Drive
Enduring Company Performance, Hoboken:
Wiley, 2008.
2 See Urban world: Cities and the rise of the
consuming class, McKinsey Global Institute, June

The authors wish to thank McKinseys

Kate Armstrong and Ankit Mishra for their
contributions to this article.
Yuval Atsmon is a principal in McKinseys
London office, and Sven Smit is a director in
the Amsterdam office.
Leading Edge
19
Taking the measure of the

networked enterprise
Jacques Bughin
New research shows that power users reap the greatest benefits from social
technologies.
The adoption by companies of Enterprise

2.0 tools, a cluster of web-based
social technologies first popularized by
consumers, appears to be leveling
off after a decade of rapid growth. But
new research also suggests that
power usersbusinesses that deploy
the more advanced technologies
extensivelyachieve stronger results
than companies dabbling at the edge.
Our latest analysis

For nearly a decade, weve tracked the
adoption and diffusion of social technologieswikis, blogs, social technologies, and the likethrough a unique
database of 1,500 companies.1 Two
points stand out in our latest analysis.
1. An S-curve pattern of adoption
Levels of social-technology use, by our
estimates, were low in 2006. By 2008,
two-thirds of the companies in our database had adopted at least one such
technology, though internal diffusion was
narrow: only 20 percent of all employees
had used them, and no single technology
had gone mainstream. Thereafter, our
analysis shows, an S-curve dynamic

(Exhibit 1) spurred the wider diffusion
of these tools, particularly blogs and
social networks.
Strong evidence indicates that imitation
and innovation have been driving
the spread of Enterprise 2.0 tools. Using
modeling techniques, we found that
35 percent of the companies had adopted
social technologies in response to
their adoption by competitors. Copycat
behavior was also responsible for their
diffusion within organizations, though
at a slightly lower rate: 25 percent of all
employee usage. (Teams, for example,
typically tried to burnish their performance by imitating early users of social
networks and internal blogs.) As for
innovation, company policies designed
to encourage it sparked the adoption of
wikis. Within enterprises, social networks
help to spread innovative ideas.
According to our analysis, imitation and
innovation spread Enterprise 2.0
social technologies more quickly than
they did nonsocial web-based ones
such as email, as estimated by academic
researchers.2 But their effect seemed
20
2015 Number 4
to be weaker than others have found it

to be on the diffusion of consumer
technologies such as Facebook (social
networks) or Netflix (social recommendations).3 One reason for the difference
is that the adoption of Enterprise 2.0
tools requires two things that are not
always available: additional investment and management discipline to
spur integration.
2010 to 2015 as more companies

adopted these tools and broadened their
internal deployment (notably of wikis
and social networks). Our surveys also
asked specifically about the perceived
impact of Enterprise 2.0 tools on
revenues and operating costs.4 These
self-reported responses were combined
to calculate a measure of enterprise
value added.
2. Enterprise 2.0 tools follow power laws

Roughly a fifth of the companies we
studied will account for an estimated
50 percent of all social-technology usage
Q4 2015
in 2015. The steepness of the powerEnterprise 2.0
curve distribution diminishes slightly from
We found that the companies we

identified as power users reported an
incremental 5 percent in value added
in 2010 and of up to 6.5 percent in
2014. These findings were tested with
a traditional measure of statistical
Exhibit 1 of 2
Exhibit 1
Since 2006, corporate use of blogs and social networks grew most rapidly,
but growth is flattening.
Corporate adoption of Enterprise 2.0 technologies,1 %
Blogs
Social
networks
Video
sharing
70
60
50
Wikis
Podcasts
40
30
Prediction
markets
20
10
0
2006 2007
(estimated)
2008
2009
2010
2011
2012
2013
2014
2015
1 Companies that have ever adopted the social technologies, including those not using them now.
Source: 200715 McKinsey survey of 1,500 companies
2016
(forecast)
Leading Edge
21
significance which confirmed the correlation. We also used a more sophisticated technique that indicated a
causal relationship between usage and
performance.5 That seems plausible:
power laws should naturally skew performance benefits toward heavier users.
Its interesting that the incremental value
from social technologies appears
to be as large as it was from computers
Q4 2015
in the 1990s and, more recently, from
Enterprise 2.0
technologies linked to big data.6
In addition, we found significant returns

from the greater diffusion of Enterprise
2.0 within companies. The data allowed
us to estimate the returns for each
technology at several levels of penetration,
from 25 percent to 100 percent. We found
that even incremental use among
employees could significantly increase
the value added for each technology
(Exhibit 2). The highest usage level of
social networks, wikis, and blogs created
a self-reported added value of at least
Exhibit 2 of 2
Exhibit 2
The diffusion of Enterprise 2.0 technologies within companies offers

significant returns to scale.
Increase in value added, %
Level of penetration
100%
75%
50%
25%
Social networking
5.8
3.4
1.7
0.6
Wikis
5.7
3.1
1.5
0.5
Blogs
5.0
2.6
1.3
0.4
Video sharing
1.4
1.0
0.6
0.3
Prediction markets
0.6
0.4
0.3
0.1
Podcasts
0.6
0.4
0.2
0.1
Source: 200715 McKinsey survey of 1,500 companies
22
2015 Number 4
5 percent each, but the impact of other

social technologies was much smaller.
We also found returns to scope: using a
second social technology doubles the
value added at most levels of penetration.
New frontiers
Social technologies are approaching
the top of the S-curve. Adoption across
organizations started to taper in 2012,
and internal diffusion flattened out somewhat later. Yet the growing popularity of
mobile and cloud technologies,
as well as the Internet of Things (see
An executives guide to the Internet
of Things, on page 92), could alter the
pattern in the future. Companies
placing bets should consider how these
technologies will interact with
Enterprise 2.0 tools and potentially
multiply their impact.
Meanwhile, Facebook and other digital
players are developing a new generation
of social tools geared to enterprise use.
These providers, with their huge base of
consumers, may further increase the
adoption and diffusion of Enterprise 2.0
tools among and within companies. They
may also open up new sources of value,
both for heavy users and for companies
still sitting on the sidelines.
1 Our database includes 11,000 companies around
the world across industries. For this study, we

drew on a random sample of 1,500 companies
that had completed our Enterprise 2.0 survey
for each of the eight years from 2007 to 2014
and had a minimum of 50 data points for
each question on adoption and performance
to ensure statistical relevance. The research
comprised blogs, prediction markets, podcasts,
video sharing, social networking, and wikis.

The full range of early results can be found on
mckinsey.com. For example, see Transforming
the business through social tools, January
2015; Organizing for change through social
technologies: McKinsey Global Survey results,
November 2013; and Evolution of the networked
enterprise: McKinsey Global Survey results,
March 2013.
2 Nexhmi Rexha, Bradley Turner, David H. Wong,
and Kenneth B. Yap, Predicting the diffusion

pattern of Internet-based communication
applications using Bass model parameter estimates
for email, Journal of Internet Business, 2011,
Volume 9.
3 Bruno Ribeiro, Modeling and predicting the
growth and death of membership-based websites,

International World Wide Web Conference, Seoul,
South Korea, April 2014.
4 Regressions for both the adoption and diffusion
tests were statistically significant across variables

with high goodness fits. For details, see Ten years
of Enterprise 2.0: The power law of Enterprise
2.0 revisited, forthcoming later this year in the
Encyclopedia of E-Business Development and
Management in the Global Economy, IGI Global.
5 We used Granger tests to measure whether a
variance in performance is reduced when it depends

on a level of technology use. See C. W. J. Granger,
Investigating causal relations by econometric
models and cross-spectral methods, Econometrica,
1969, Volume 37, Number 3, pp. 42438.
6 Erik Brynjolfsson and Lorin M. Hitt, Computing
productivity: Firm-level evidence, Review of

Economics and Statistics, 2003, Volume 85, Number
4, pp. 793808; and Prasanna Tambe, Big data
investment, skills, and firm value, Management
Science, Volume 60, Number 6, pp. 145269.
Jacques Bughin is a director based in

McKinseys Brussels office.
Leading Edge
23
Short takes
Reflections on oil and gas

At a recent meeting of Prium, a CEO forum, three energy experts weighed in. Here are
some highlights.
65: a magic number for oil in the

United States
changes quickly enough to meet all their

needs, so theyre not putting all their eggs
in that basket. And I think thats because
they realized to replicate what has hapAs I was making my notes for this morning,
pened
in the United States requires massive
I realized I wrote down the number 65
reforms to their system. For instance,
more than once. First, 65 percent of
it requires price reforms. They have price
new production that came on in 2014 is
controls
on natural gas, and they are
profitable at $65. The other thing is that by
undertaking
some reforms; it will take time
the end of the year we expect that every
to generate effects.
dollar spent upstream in the US will be
Meghan OSullivan, Professor,
65 percent more productive than it would
Harvard University Kennedy School
have been in 2014.
Daniel Yergin, Vice Chairman, IHS
Still a ways off

China has, or is believed to have, more
shale gas than the United States. Three
years ago the Chinese were really bullish
about developing this gas and meeting a
lot of their energy needs domestically,
at least on the gas front. Thats still an
ambition of the Chinese, but its not at
all their top ambition.My guess is in 10,
20 years, well definitely see China being
a big producer of shale gas, but in the
short term I think the Chinese look out, they
see that there is this abundance of energy
that they can get cheaply from other
sources, and theyre contracting it from
Russia, from Turkmenistan, from Australia,
from Qatar, maybe even from the US.
And so theyre going to develop their own
industry, but theyre not confident that
theyre going to make the institutional
Relearning that what goes up can

also come down
I was talking to a group of one- to threeyear employees recently and I said,
This was, is, and it always will be, a very
volatile business. And one of them
raised their hand and said, We understand
its volatile, but we thought volatile
always meant up. So were teaching a
whole new generation about commodity
cycles and whats going on in our
business. And I think the fact is that at
$100 youre not bullet proof, and at
$50 you really shouldnt jump out of a
window. You want to structure your
business so that you prepare and that you
can run and power through this period
of time. Greg Garland, Chairman &
CEO, Phillips 66

24
2015 Number 4
Consumer packaged goods
When subpar operations

threaten margin growth
Mike Doheny, Jan Henrich, and Shruti Lal
Consumer-goods companies with weak cost management will struggle to increase the
bottom lineno matter how much they grow.
Companies can generally take two
paths to improve their margins: on the
revenue side, through innovation and
brand building to increase prices, and
on the cost side, through operational
efficiencies. We looked at 17 global
leaders in the food and beverage industry
over the period from 2009 to 2013 and
found that operational improvement was
the determining factor in margin growth.
By creating a baseline case that adjusts
for cost-growth momentum, we isolated
the impact of operational improvements
on the cost of goods sold (COGS)
for functions such as manufacturing,
purchasing, and the supply chain.1
We then plotted the performance of
companies against the COGS momentum case and compared that data
point with margin growth. As the exhibit
shows, none of the companies in
the sample improved margins through
revenue growth alone. But those in
the top-right quadrant (for instance, a
beverage business facing shrinking
revenues and fierce competition in
its premium segment) also managed
their bottom-line performance through

operational efficiencies.
By contrast, companies in the bottomleft quadrant (such as one that increased
its revenues quickly through acquisitions, new products, and new approaches
to distribution but also had subpar
operations) could not offset the higher
costs associated with growth and
therefore found their margins eroding.
Finally, for companies in the bottomright quadrant, dramatic revenue losses
were hard to overcome with only
middling operational performance.
1 We looked at large North American and
European companies, with a collective revenue

of approximately $200 billion in three categories:
packaged foods and snacks, beer, and spirits. For
the momentum (baseline) case, we excluded inputprice increases in labor and materials and adjusted
for scale and regional differences.
Mike Doheny is a principal in McKinseys

Atlanta office, and Jan Henrich is a director
in the Chicago office, where Shruti Lal is a
senior expert.
Leading Edge
25
Q4 2015
CPG OPs
Exhibit 1 of 1
Not one company managed to improve its margins without at least

maintaining cost parity with the baseline case.
Global leaders in consumer packaged goods,1
200913 (n = 17 companies)
Packaged foods
Growth
Beer
Growth via
revenue alone
Growth via
operations management
and revenues
Revenues
cannot cover cost
increases
Operations management
cannot cover
revenue shrinkage
Spirits
Overall gross
margin
Loss
Lagging
Equal
Leading
Cost of goods sold (COGS) per unit

vs momentum (baseline) case2
1 With revenues of $2 billion$13 billion and with compound annual growth rates of 314%.
2 Calculated as weighted average compound annual growth rate for price indices of materials and resources used by
given industry.
Copyright 2015 McKinsey & Company. All rights reserved.
Illustration by Vasava
26
27
Most companies are striving to

be more nimblebut whats
the prize for agility and the best
way to achieve it?
28
Why agility pays
Michael Bazigos,
Aaron De Smet, and
Chris Gagnon
44
Adhocracy for an
agile age
Julian Birkinshaw and
Jonas Ridderstrle
36
Agility lessons
from utilities
Sven Heiligtag,
Dominik Luczak, and
Eckart Windhagen
28
Why agility pays

Michael Bazigos, Aaron De Smet, and Chris Gagnon
New research shows that the trick for

companies is to combine speed with stability.
Over the past decade, weve studied the impact of a wide range
of management practices on different dimensions of organizational
health.1 This analysis, based on surveys of more than two million
respondents at over 1,000 companies, has become a stable baseline
for understanding the incremental contributions of specific
organizational and leadership characteristics to the health, positive
and negative, of the companies in our sample.
Weve long inquired into the processes and structures that reinforce
organizational stability. But from November 2013 to October 2014,
we added questions, for the first time, on speed and flexibility. Our
goal was to discover how often leaders and managers moved
quickly when challenged and how rapidly organizations adjusted to
changes and to new ways of doing things.
Taken together, these two sets of questions, old and new, provided
the foundation for a simple matrix, comprising a speed axis and
a stability axis. The matrix turns out to be a surprisingly strong
predictor of organizational health and, ultimately, of performance. We describe companies that combine speed and stability
as agile (see sidebar, A word on methodology, on page 34).
No one would expect sluggish companies to thrive. Its equally
reasonable to assume that success achieved through breakneck
speed, without stabilizing processes and structures underfoot,
will be hard to sustain over the long term. Yet some executives might
not only reasonably maintain that speed and stability pull in
opposite directions but also hypothesize that they may be negatively
correlated. Our latest research, however, confirms that the
opposite is true.
1 We

define health as an organizations ability to align, execute, and renew itself faster than
the competition does and thus to sustain exceptional performance over time.
29
Its significant that all 37 of the management practices we scrutinize,

when combined with speed and stability, generated better outcomes
in their respective dimensions of health, as well as better overall
health. In 4 of the 37financial management, financial incentives,
capturing external ideas, and involving employees in shaping a companys visionspeed and stability had a particularly striking impact.
Q4 2015
Why agility pays
Exhibit 1 of 3
Exhibit 1
Few companies excelled in either speed or stability58 percent
hovered near average.
Distribution of 161 companies by Organizational Health Index (OHI) scores1
Strong
Start-up2
8% of sample
Speed
index
Agile
12% of sample
58%
of sample
Average3
Trapped
14% of sample
Weak
Bureaucratic
8% of sample
Average3
Strong
Stability index
1 Scores have been adjusted to remove the portion of OHI variance shared by the factors of speed and stability,
to highlight the specific contribution of each factor (speed or stability) along its axis.
2 That is, companies with a mode of operating suited to a very small start-up (not actual start-ups).
3 Mean +/ 0.50 standard deviation on each axis of matrix.
30
2015 Number 4
When we divided the companies in our sample2 among different

groups based on their stability and speed scores, things got even more
interesting (Exhibit 1):
Relatively few companies stood out as being especially agile:
58 percent of them had speed scores, stability scores, or both that
hovered near average.
A n additional 22 percent of companies in our sample were
sloweither slow and unstable, a group we describe as trapped
(14 percent), or slow and stable, which we call bureaucratic (the
remaining 8 percent). These slow companies generally have poor
organizational health: in fact, they had the lowest percentage
of companies with top-quartile organizational-health scores in our
sample: only 5 percent for trapped companies and 17 percent
for bureaucratic ones.
Twenty percent of the companies in our sample were fast. Eight
percent were fast, pure and simplea group we describe as start-up.
(These companies were not start-ups, but resembled start-ups
in their speed, irrespective of size.) The rest (12 percent), which
we call agile, combined speed with stability. All of these fast
companies had better organizational-health scores than the other
80 percent did. Agile companies, however, enjoyed a far greater
premium: the odds that one of them would rank in the top quartile
for organizational health were 70 percent (Exhibit 2). Fewer
start-ups enjoyed top-quartile performance, but this quadrant
was our only nonagile category in which a majority of the
companies (52 percent) had health scores above the median.
Given the striking outperformance of the agile companies, we
conducted additional analyses to better understand the characteristics and benefits of agility. For example, we identified the ten
management practices that differentiated our samples most agile
companies from the least agile ones (Exhibit 3). This analysis
showed the following:
2 These

observations rest on a global study of 161 different companies around the world. In
this effort, we used our Organizational Health Index (OHI), including the new matrix, to
survey more than 365,000 individual employees.
Q4 2015 Why agility pays

Why agility pays
Exhibit 1 of 3
31
Exhibit 2
Seventy percent of agile companies rank in the top quartile of

organizational health.
% of organizations within each category, by quartile, for Organizational Health Index (OHI) scores1 (n = 161)
Top quartile
Second quartile
Third quartile
Bottom quartile
Strong
Start-up
100% = ~13 companies
Agile
23
70
38
15
23
10
15
Speed
index
Average2 (93 companies)

Trapped
Bureaucratic
17
27
8
36
17
32
58
Weak
Strong
Stability index
Note: Figures may not sum to 100%, because of rounding.

1 Scores have been adjusted to remove the portion of OHI variance shared by the factors of speed and stability,
to highlight the specific contribution of each factor (speed or stability) along its axis.
2 Mean +/ 0.50 standard deviation on each axis of matrix; these 93 companies were nearly evenly spread across
quartiles for organizational health.
Both role clarity and operational discipline are highly ranked

practices among agile organizations (those in the top quartile of
the Agility Index) but not among the least agile ones (the bottom
quartile). This is powerful evidence that part of what makes agile
companies special is their ability to balance fast action and rapid
Q4
32 2015 2015 Number 4
Why agility pays
Exhibit 3 of 3
Exhibit 3
Ten management practices differentiated the most from the least
agile companies.
Ranking of 161 companies based on OHI scores1
Rank for
most agile
Practice
Rank for
least agile
Difference
in rank
Associated
Outcome
Role clarity
35
34
Accountability
Top-down innovation
37
35
Innovation and
learning
Capturing external ideas
27
24
Innovation and
learning
Process-based
capabilities
19
15
Capabilities
Operationally disciplined
33
28
Culture and climate
Internally competitive
29
23
Culture and climate
Meaningful values
31
24
Motivation
Knowledge sharing
21
13
Innovation and
learning
Inspirational leaders
32
23
Motivation
People-performance
review
10
20
10
Coordination and
control
1 OHI = Organizational Health Index.
change, on the one hand, with organizational clarity, stability, and

structure, on the other.
Agile organizations appear to be powerful machines for innovation
and learning. Their performance stands out in three of the four
management practicestop-down innovation, capturing external
ideas, and knowledge sharingassociated with that outcome.
Why agility pays
33
A
gile companies seem to be strong at motivation. Five practices
on the Organizational Health Index promote it, and these
companies particularly excel at two of them: meaningful values
and inspirational leadership.
The achievements of one of the most agile organizations we studied,
a business-process-outsourcing company, emphasize the importance of balancing speed and stability. Financially successful and
growing, it has captured market share by rapidly entering new
geographical markets. But it is equally adept at exiting markets that
contract. In 2014, the company extricated itself from them so
effectively that it offset declining revenues by capturing new operational efficiencies in the most profitable markets. In this way, it
continued to increase earnings before interest, taxes, depreciation,
and amortization (EBITDA).
By way of contrast, lets look at a bureaucratic organization and
at a start-up organization we know. The former is a leading
professional-services firm specializing in audit, tax, and advisory
services. Its processes and structure are stable to a fault. Of course,
the industry is highly regulated by many government and judicial
entities. But while the firms competitors have found ways to act
quickly, this one is dogged by an obsession with compliance and a
blind determination to minimize litigation risk.
For example, it deliberately avoids storing assessments of its
employeesan unusual choice, since most other companies have
elaborate talent-management databases. (The compliance officers
rationale is that a dissatisfied client might start discovery proceedings in a future lawsuit and find out that the firm knew about a
relevant issue concerning the person at the center of such a case.)
A board composed entirely of senior partners, many of them
CEO aspirants, exacerbates the firms cumbersome decision making.
Not surprisingly, it has been trailing its competitors in major
performance categories each year.
The start-up organization was a joint venture between the
divisions of two large technology companies, one North American
and one from continental Europe, responsible for a similar range
of consumer offerings. The joint ventures main product line was
34
2015 Number 4
A word on methodology
We measured speed by asking survey respondents how often they observed
their leaders (and, separately, managers) making important decisions
quickly and their organizations adjusting rapidly to new ways of doing things.
We measured stability by asking respondents how often they observed
their organizations implementing clear operating goals and metrics, setting
clear standards and objectives for work, establishing structures that
promote accountability, designing jobs with clear objectives, and devising
processes to document knowledge and ideas.
The percentage of respondents who answered often or almost always
compared to all respondents was calculated for all companies, resulting in
the Agility Index.
communications equipment. It celebrated an early win, producing

an award-winning product that generated high demand. That device
was designed by just one person in record time, an achievement
showing exemplary speed and flexibility. But this persons three functional titlesall at the senior levelwere far from optimal for
the next stage of the joint ventures development. With little thought
given to designing replicable innovation processes, the joint
venture found it impossible to develop another winning product. The
speed that had been its hallmark began to wane as management
focused on the constant renegotiations between the two parties.
These unhealthy levels of internal competition caused leaders
to lose sight of external threats. The joint venture ended as a onehit wonder.
Why agility pays
35
Our earlier research consistently showed a strong relationship

between organizational health and the creation of value: the
healthiest companies far outpace those with moderate or low health
in long-term total returns to shareholders.3 Our new analyses
suggest that speed and stability are significant catalysts for
organizational health and performance.
3 See Aaron De Smet, Bill Schaninger, and Matthew Smith, The hidden value of
organizational healthand how to capture it, McKinsey Quarterly, April 2014,

mckinsey.com.
The authors wish to thank McKinseys Wouter Aghina, Lili Duan, Claudio Feser,
Dinora Fitzgerald, Bill Schaninger, Rob Theunissen, Kirsten Weerda, Abby Wurts,
and Cynthia Zhang for their contributions to this article.
Michael Bazigos, head of organizational science at McKinsey, is based in
McKinseys New York office; Aaron De Smet is a principal in the Houston
office; and Chris Gagnon is a principal in the New Jersey office.
gjp311/iStock/Getty Images Plus
36
37
Agility lessons
from utilities
Sven Heiligtag, Dominik Luczak, and Eckart Windhagen
The industry faces pressure on its core

businesses and unexpected digital
competition. Evaluating the external
environment and making bets more quickly
will be decisive for incumbents.
The utility industry offers a fascinating microcosm of the

challenges facing legacy companies today. Its sprawling base of
heavy assets amplifies the forces of inertia, while agile-bynature digital players nip at parts of the value chain once considered
immune to competition.
Utilities need a nimble strategic response to both of these challenges.

In the core businessesthe generation and distribution of energy
companies scramble to address the uncertainty and volatility manifested in sudden policy shifts on nuclear power, skyrocketing
demands to ramp up renewable energy, and the possibility of highstakes (and profit-draining) regulatory changes for carbon prices
and often dirty backup power plants. At the same time, new technology is steadily reshaping the energy sector: the falling cost
of solar power makes historical scale economies less valuable as
distributed generation becomes more feasible. And digitization
is disrupting traditional areas of business and enabling new ones
(see sidebar, Digital dilemma, on page 40).
Utilities arent alone, of course, in their need to manage both new
horizons and valuable legacies. In the automotive sector, capitalintensive value pools based on production expertise are yielding to
service offerings such as car sharing. Digital and communications
technologies are propelling innovation in connectivity for vehicles,
autonomous driving, in-car infotainment, and other areas.
In global banking, digitization has reached an inflection point: for
example, it is expected to penetrate a third to nearly a half of all
38
2015 Number 4
European revenue pools by the decades end, according to McKinsey

analysis. With legions of digital competitors emerging, traditional
banks are under pressure to match disruptive new business models
while maintaining valuable customer relationships.
In a companion piece (see Why agility pays, on page 28) our
colleagues present new research findings suggesting that agility
of the type needed by many industries that are now in flux calls
for a balance between speed and stability. They argue as well that
companies capable of striking this balance are dramatically
more likely to show strong performance and organizational health.
Independently, we have been working closely with a wide range
of utilities to explore how the sector can best adapt to its challenges.
What emerges not only demonstrates the wider case for agility
but also highlights the opportunities and challenges associated with
its pursuit.
This article describes how the more farsighted utility companies are
doing things differently in four critical areas: sensing opportunities,
seizing them across new and legacy businesses, going beyond traditional corporate boundaries, and creating an organizational
design and new ways of working to balance flexibility and stability
(see infographic).
Agile sensing
Many utilities have a fortress mentality that inhibits the adoption of
new ideas. Their information-seeking infrastructure is often
underdevelopedin an era of information networks and crowdsourcing, they rely on conventional (and often one-dimensional)
ways of gathering market intelligence.
Nimble information gathering produces a better foundation for
strategic decisions and a more diversified flow of ideas for
innovation. For this reason, first-mover utilities have established
outposts and venture-capital (VC) arms in Silicon Valley, where
they systematically test their own tech innovations, search for
new ideas, and tap information flows from energy start-upsoften
through their VC partnerships. (For more on this subject, see
How should you tap into Silicon Valley?, on page 111.)
Q4 2015
Agility EPNG
Exhibit 1 of1
39
Agile companies focus on three aspects of

strategyand the right organizational design.
Sensing
Seizing
Bursting company
boundaries
Mobilize the entire

organization
Reallocate resources
dynamically
Exploit complementary
skills across the value chain
Practice
Scale
up initiatives rapidly with

a fail fast, fail small mind-set
Engage
Employ
Create
nimble information
gathering
Exploit
new digital possibilities,

drawing on insights from
diverse and unexpected areas
of the organization
flexible financing
in open-source
collaborations
networks for sharing
complementary skills with
customers, suppliers, and
industry partners
Combining flexibility and stability in organizational design
As energy moves from a commodity to a product wrapped in information, building digital skills will be crucial to develop the value
of customer data. Ideas for exploiting new digital possibilities may
come from diverse and unexpected areas of your company.
Utilities and other traditional businesses should therefore follow
leading-edge open-innovation approaches, such as competitions
and hackathons to spark creativity and online platforms to manage
the flow of bottom-up ideas across the entire organization.
Seizing opportunities
Fresh ideas are just a starting point; companies must also seize
emerging opportunities. As in many sectors, utilities too often ground
their decision making and allocation of resources in static financial planning, which is hindered by the cumbersome dynamics of
existing businesses and a strong internal focus.
Yet a number of European and US renewable-energy players we
know with strong growth pipelines have used financial innovations
40
2015 Number 4
Digital dilemma
Like most of the economy, the energy sector faces huge challenges from
digital disrupters. Internet technologies are breaking open the traditional
value chain, driving down interaction and transaction costs. Customers
can now plug their consumption data directly into a utilitys computer system
and shift usage to lower-cost, nonpeak periods. These changes have
already triggered new business models characterized by customization and
a laser focus on the customer.
One cutting-edge shift is e-mobility, the electrification of cars. Another is
the range of power-to-heat technologies that can exploit the excess capacity
of cogeneration and of wind power. The hypergranular real-time metering
of home appliances could turn power consumption into a big data play,
opening vast new windows on the behavior and preferences of customers.
Meanwhile, digital natives with the technology and analytical firepower to
build a data-driven level of the energy economy are moving in to take
advantage. Can agile incumbents open up new vistas themselves and roll
with advances in technology?
The risk of missed opportunities is all too apparent from the example of the
telecom industry. Its incumbents, caught unawares by the rapid shift to
mobile speech and data beginning in the late 1990s, ceded a sizable share
of growing value pools to new entrantsthose, for example, that could
profit from the rapid growth of mobile apps.
In utilities, we see a similar potential for large (though still unknown) value
pools. Centralized, asset-heavy production of electricity wont disappear. But
legacy economies seem likely to change, creating possibilities to consolidate traditional assets and placing a premium on operational excellence.
Utilities must also explore new horizons in renewables; in downstream markets; and in digitally enabled, customer-centric business models.
to attract external funds on favorable terms. Some have established

so-called growth or return yieldcos, which bundle renewable assets
for sale to private and institutional investors, or forged partnerships
with investors such as pension funds for specific projects. Weve
also recently seen utilities rethinking their processes for pursuing
fast-moving opportunities:
41
ne utilitys standard top-down allocation process was tied to

O
internal incumbent stakeholders, so little was left for innovative
projects. This company found that reforming its budgeting
process was the best path to a more dynamic allocation of financial
resources. It now sets aside part of its budget for new projects
and has established a more rigorous funneling process to ensure
that the best ideas get fundingand that failed ideas die quickly.
nother large utility developed a framework for rating projects by
A
risk/return profile. It classified more than 150 of them, identifying those that had not only greater risk but also greater returns,
which could bolster the companys performance in slowergrowth scenarios. It balanced its overall level of risk by identifying
projects, suitable for more robust market conditions, with relatively moderate returns and dangers. The company can now respond
rapidly to different market developments by shuffling the pipeline,
using the rating system for guidance.
European utility established a committee, which included an
A
independent, financially savvy challenger, to reframe and debias
investment decisions and establish clear criteria for judging
priorities. At the operating level, the company shifted to more rapid
prototyping: a stage-gate process helped it to make go/no-go
decisions more quickly and to create speedboats. One of them
involved a quick, early-stage test of interactive videos for customers
whose power consumption had increased significantly and were
likely to experience bill shock. These explanatory videos helped
reduce customer churn by 80 percent from forecast levels. Building
on this success, the utility created a range of videos on customer
issues posing a risk of churn.
Bursting boundaries
An inward bias frequently makes utility leaders reluctant to
share talent and operating knowledge or to look beyond company
boundaries. These inhibitions hinder collaboration outside
traditional industry areasa sizable penalty at a time when utilities
should partner with players that understand the rising power
of customers.
42
2015 Number 4
Riding the sectors wave of change means engaging, in new ways,

with a broader ecosystem. Many companies will have to rethink
their boundaries and even what business theyre in. Although utility
leaders naturally fear the dilution of core strengths, company and
sector boundaries have been redrawn in some industries for years,
often through digital communications.1 Its time for incumbent
utilities to embrace these changes.
That could take the form of new open-source collaborations, partnerships, or minority investments with start-ups and innovative
niche players to take utilities out of familiar territory and provide
a range of possible outcomes rather than contracted goals. For
example, one utility we know partnered with a venture-capital fund
to get a window on energy-related start-ups and emerging ideas
that needed financing. It now gets preferential rights to invest in the
VCs portfolio companies, many built on digital platforms that
drive down the cost of transactions with customers.
Utilities should also create networks that help customers, suppliers,
and industry partners to share complementary skills. After all, they
have not only huge stores of information about market conditions
and customer needs and preferences but also big patent portfolios.
These are valuable assets to trade for knowledge and the right to
collaborate with start-ups.
Balanced organizational design

Underlying all this should be an organizational design that gives fast,
agile problem-solving teams a stable foundation of core functions.
To understand how this dynamic tension operates, consider the
experience of a utility we know that made an early move into large
renewable-energy sources.
The company began by setting up a renewables unit that operated
independently, with a culture and capabilities akin to those of a
start-up. Frontline teams ran hard to navigate an array of regulatory
demands, to assess potential project partnerships, and to model
tariff regimes for setting prices, but they had difficulty scaling up
1 For

an early description of these dynamics, see John Hagel III and Marc Singer, Unbundling
the corporation, McKinsey Quarterly, June 2000, on mckinsey.com.
43
this business amid so much change. Senior management then decided

to assess the renewables value chain to make its risks and volatile
returns (compared with those of the legacy business) more transparent.
Leaders addressed these issues in several areas:
Project finance. The companys central finance unit identified
institutional investors that were seeking returns in renewables and
would be willing to invest in individual projects.
Risk management and deal making. Specialists helped the new
renewables unit to forge partnerships that distributed financial
risk and satisfied government demands for local participation
and ownership.
Culture. The company started out with a linear, one-project-at-atime mentality, governed from the center. This has gradually given
way to a mind-set thats comfortable with locally made decisions
the project teams are now fully responsible for managing the performance of the team members (as well as the project) while the
business line focuses on capability building and the codifying and
sharing of best practices. Teams attuned to the regulatory and
competitive environments therefore have more control, while the
companys core valuestechnical excellence and high levels of
executionremain the guiding framework.
The hybrid organizational design thats now emerging isnt just

propelling the renewables business forward; its also rubbing off
on the core business.
The authors wish to thank McKinseys Florian Pollner, Jan Reichwald, Rob
Theunissen, Thomas Vahlenkamp, and Kirsten Weerda for their contributions to
this article.
Sven Heiligtag is a principal in McKinseys Hamburg office, Dominik Luczak is
an associate principal in the Munich office, and Eckart Windhagen is a director
in the Frankfurt office.
Andrew Bannecker
44
2015 Number 4
45
Adhocracy for an
agile age
Julian Birkinshaw and Jonas Ridderstrle
The agile organizational model gives primacy

to action while improving the speed and
quality of the decisions that matter most.
Even as companies from IBM to Caesars Entertainment to

American Express succeed through advanced analytics and big data,
a less visible side of the preoccupation with information may be
having the opposite effect.
Academic studies show that information overload at the individual

level leads to distractedness, confusion, and poor decision making.1
These problems beleaguer organizations, too, as we have seen from
working with many large companies and through many interviews and workshops with senior executives in a range of sectors
and geographies. Our experience reveals frequent cases of analysis
paralysis (gathering more and more information rather than making
a decision), endless debate, and a bias toward rational, scientific
evidence at the expense of intuition or gut feel. These pathologies
can have a deleterious impact on the functioning of companies.
They can lessen the quality and speed of decision making and
engender a sterile operating environment in which intuitive thinking
is quashed. As a result, many companies end up standing still,
even as the world around them is speeding up.
1 Two

influential books that summarize a lot of these studies are Nicholas Carr, The
Shallows: What the Internet Is Doing to Our Brains, New York: W.W. Norton, 2010; and
Daniel Kahneman, Thinking, Fast and Slow, New York: Farrar, Straus and Giroux, 2011.
For a management perspective on information overload, see Derek Dean and Caroline
Webb, Recovering from information overload, McKinsey Quarterly, January 2011,
mckinsey.com.
46
2015 Number 4
In short, the undeniable power of information brings the risk of

becoming overly reliant on or even obsessed with it. Whats more,
as the information age advances into an increasingly agile one,
something important is changing: information is less of a scarce
resource as it becomes ubiquitous and search costs plummet. In
such a world, as Herbert Simon speculated more than 40 years ago,
the scarce resource we have to manage is no longer information
it is attention.2 We believe that large companies today are poor
at managing what might be called their return on attention. Particularly at the executive level, attention is fragmented; people are
distracted; and even when the data are impeccable, decisions can be
unduly delayed or just plain bad.
Clearly, not everyone has fallen into this trap. At some companies,
executives understand both the power and the limits of information;
they know that at times, getting the right answer is imperative but
that at other times, being decisive and intuitive, and acting swiftly
and experimenting, can work better. As Amazons Jeff Bezos says,
there are decisions that can be made by analysis. These are the best
kinds of decisions! Theyre fact-based decisions. . . . Unfortunately,
theres this whole other set of decisions that you cant ultimately boil
down to a math problem,3 such as big bets on new businesses. Some
of Bezoss bets, like the Kindle and Amazon Web Services, have paid
off; others, such as Amazons mobile phone, have not. But that hasnt
dissuaded the company from continued experimentation and action.
Clearly, theres a need for balancefor a more nuanced understanding of when to dig deeper into the data, when to stimulate the
kind of extended debate that can help eliminate hasty or biased
decision making, and when to act fast. 4 In our experience, many
companies are more comfortable analyzing and debating than they
are acting decisively and intuitively. Their default orientation
2 Herbert

Simon originally offered this insight in an article, Designing organizations for
an information-rich world, in Martin Greenberger (ed.), Computers, Communication,

and the Public Interest, Baltimore, MD: Johns Hopkins Press, 1971. See also the academic
literature on managing attentionfor example, William Ocasio, Attention to attention,
Organization Science, 2010, Volume 22, Number 5, pp. 128696.
3 Alan

Deutschman, Inside the mind of Jeff Bezos, Fast Company, August 1, 2004,
fastcompany.com.
4 For more on cognitive bias and strategic decision making, see Dan Lovallo and Olivier
Sibony, The case for behavioral strategy, McKinsey Quarterly, March 2010, on
mckinsey.com.
47
toward more and better information binds and restricts their ability
to move surely and quickly.
The purpose of this article is to suggest a set of capabilitiesabout
how work is organized and people thinkto complement the default
orientation of companies and to help them manage their return
on attention in a more systematic way. These capabilities, we suggest,
are part of an organizational modeladhocracythat differs from
the bureaucratic and meritocratic organizational models currently in
favor. By clarifying the pros and cons of these three models, and the
conditions when each should be used, we aim to provide guidance on
how to get the right balance between information and attention.
Three organizational models

The concept of adhocracy was first proposed several decades ago,5
essentially as a flexible and informal alternative to bureaucracy.
Here were intending to redefine the concept in a way that further
distinguishes it not only from bureaucracy but also from the
meritocracy model of organization.
Adhocracys defining feature is that it privileges decisive (and often
intuitive) action rather than formal authority or knowledge. For
example, when bureaucracies face a difficult decision, the default is
to defer to a senior colleague. In a meritocracy, the default is to
collect more data, to debate vigorously, or both. The default in an
adhocracy is to experimentto try a course of action, receive
feedback, make changes, and review progress.
Adhocracies are also likely to use more flexible forms of governance,
so they can be created and closed down very quickly, according
to the nature of the opportunity. By emphasizing experimentation,
motivation, and urgency, adhocracy provides a necessary complement to progress in advanced analytics and in machine learning,
which automates decisions previously made through more
5 The term adhocracy has been used by several illustrious management thinkers, notably
Warren Bennis and Philip Slater, The Temporary Society, New York: Harper & Row, 1968;
Robert H. Waterman Jr., Adhocracy: The Power to Change, Knoxville, TN: Whittle Direct
Books, 1990; and Henry Mintzberg, Mintzberg on Management: Inside Our Strange
World of Organizations, New York: Free Press, 1989.
Q4
48 2015 2015 Number 4
Adhocracy
Exhibit 1 of 2
Exhibit
The right organizing model often varies according to the business
environment in which a company competes.
Three
organizing
models
Bureaucracy
Meritocracy
Adhocracy
Formal, positional
authority is
privileged
Individual
knowledge is
privileged
Action is
privileged
Under which
conditions is the
model appropriate?
Relatively stable
environment
High levels of
technological
progress
High levels of
unpredictability
How are activities

coordinated?
Rules and
procedures
Mutual adjustment
and the free flow
of ideas
Around a problem
or opportunity
How are
decisions made?
Through the
hierarchy
Via argument and

discussionthe
power of the idea
By experimentation,
trial and error
How are people

motivated?
Extrinsic
rewardspay
Personal mastery,
interesting work
Stretch goals and

recognition
for achieving them
Source: Julian Birkinshaw and Jonas Ridderstrle
bureaucratic approaches.6 Specifically, we view adhocracy as

an organizational model that maximizes a companys return on
attention, defined as the quantity of focused action taken
divided by the time and effort spent analyzing the problem.7
The exhibit summarizes the differences among bureaucracies, meritocracies, and adhocracies. The right organizational model, though,
often varies according to the business environment in which a
company (or a part of it) competes. Bureaucracy still has merit in
highly regulated and safety-first environments. Generally
speaking, meritocracy works well in, for example, professional6 See, for example, Dorian Pyle and Cristina San Jos, An executives guide to machine
learning, McKinsey Quarterly, June 2015, mckinsey.com.
7 This definition of return on attention builds on the ideas developed during the 1950s
and 1960s by James March and Herbert Simon, in which decision makers engage in
problemistic search to address opportunities. For instance, see James March and Herbert
Simon, Organizations, New York: John Wiley and Sons, 1958; and Richard Cyert and
James March (eds.), A Behavioral Theory of the Firm, Englewood Cliffs, NJ: PrenticeHall, 1963. Note that quality of action is omitted, since rapid experimentation is itself
aimed at separating good from bad ideas.
49
service environments, universities, and science-based companies.

Adhocracy is well aligned with the needs of start-ups and companies operating in fast-changing environments. The appropriate
model also varies by function, with compliance more likely
to be a bureaucracy, R&D a meritocracy, and sales an adhocracy.
That said, executives must carefully weigh their overall approach
and the extent to which any of these models should hold sway.
A professional-service firm, for example, might take an adhocratic
approach to organizing its teams so as to exploit opportunities,
even as its professional-development and strategic-planning groups
use more meritocratic approaches. The selective application of
all three models is a core executive task.
In the rest of this article, we describe adhocracy in more depth,
explaining its key features and comparing its pros and cons with
those of the bureaucratic and meritocratic models.
Three key features of adhocracy

An adhocracy can be readily observed in many organizational
settings. For example, if you go to a hospitals emergency room or
an investment banks trading floor, the focus on getting things
done rapidly is clear. Many companies have used skunkworks
operations: small project teams that tackle a one-off problem
outside the organizations formal processes at an accelerated pace.
Many small companies have adopted the lean start-up model, which
emphasizes early prototyping and pivoting rapidly to new business
models as circumstances change.8 In all these settings, informed,
decisive action matters more than formal authority or knowledge.
Three key features distinguish adhocracy from bureaucracy and
meritocracy. Each helps increase a companys return on attention.
1. Coordinating activities around opportunities

Bureaucracies coordinate their activities through rules, procedures,
and routines; meritocracies, through adjustments based on flows
8 See, for example, Eric Ries, The Lean Startup, New York: Crown Business, 2011; and
Steve Blank, Why the lean start-up changes everything, Harvard Business Review,
May 2013, pp. 310, hbr.org.
50
2015 Number 4
of information. In an adhocracy, by contrast, coordination coheres

around discrete opportunities. For example, many companies
have experimented with decentralized business units focused on
specific customers or projects. One such company is the UKbased pharmaceutical firm GlaxoSmithKline, which has broken its
drug-discovery operation into about 40 units that compete with
one another for funding.9
Valve, the gaming company (based in Bellevue, Washington) thats
behind such best sellers as Half-Life and Counter-Strike, has
developed an interesting version of adhocracy, though it doesnt
use the term. Valve claims to have no managers. Employees are
encouraged to initiate new projects and to choose which of them
to work on. Self-selected teams emerge spontaneously where the
most exciting opportunities appear to be rather than according to a
strategic plan or a product-development road map.10 As employee
Michael Abrash noted in his blog, this approach is appropriate
because most of the value [in gaming] is now in the initial creative
act. . . .What matters is being first and bootstrapping your product into
a positive feedback spiral . . . Hierarchical management doesnt help
with that. . . . 11 Nor, we might add, would the meritocratic model,
for speed to market could be sacrificed to disputes and debates.
A key feature of this form of coordination is the disbanding of project
teams once activities are complete. Opportunities are ephemeral by
nature, and work in an adhocracy should reflect this. Mundipharma
is a fast-growing midsize player in the pharmaceutical industry.
Traditional pharmaceutical companies make long-term commitments
to specific therapy areas. Mundipharma organizes its business
units around specific drug opportunities. When a business unit
successfully launches a new drug, that unit continues to operate,
but it shuts down if the launch fails, and the employees move over
to other, more promising areas. As a result, the company is quite
9 The GlaxoSmithKline, Mundipharma, and Costa Coffee examples are based on personal
interviews.
10SAPM: Course Blog, Management at Valve, as seen through the Valve Employee
Handbook, blog entry for course at School of Informatics, University of Edinburgh,

March 24, 2014, blog.inf.ed.ac.uk/sapm.
11 Ramblings

in Valve Time, Valve: How I got here, what its like, and what Im doing, blog
entry by Michael Abrash, April 13, 2012, blogs.valvesoftware.com.
51
market focusedits model resembles that of a venture capitalist:

it invests only when it sees a clear pathway toward a commercially
viable drug.
In sum, adhocracys ability to coordinate workers around tangible
external opportunities keeps them closer to the action and less
inclined to spend time deliberating. That, in turn, generates a higher
return on attention than the traditional coordination processes
of bureaucracies or meritocracies do.
2. Making decisions through experimentation

In a bureaucracy, decisions are made through the hierarchy: superiors
tell their subordinates what to do, and so on down the line. In a
meritocracy, decisions are made through argument and discussion,
and everyone is entitled to weigh in with a point of view. The
decision-making model in an adhocracy, in contrast, is experimental,
which means consciously cutting short internal deliberations and
trying things out with customers to gain rapid feedback. While this
concept has been around for many years, in our experience most
large companies still fall back on formal stage-gate processes and
committees rather than risk releasing unproven ideas in the market.
In 2012, Costa Coffee, the worlds second-largest coffee chain,
developed an ambitious plan, codenamed Project Marlow, to transform its vending-machine offering by creating an entirely new
self-serve coffee system that would engage all the five senses of the
customer. Project Marlow was agreed on with a handshake in
January 2012. The formal kick-off meeting, with 20 people, was held
on April 19th. The beta version was delivered, on time and on
budget, on September 20th of the same year. The pace of work was
uncomfortably high, recalled project leader Eric Achtmann,
the team was small and world-class without exception, and decisions
were made on a 24-hour cycle.
One key principle of Project Marlow was to base decisions on what
would move the effort forward. For example, potential partners that
required a legal agreement to be in place before starting work
were eschewed in favor of those prepared to get going on the basis of
a handshake. Project Marlows ground rules included rapid decision
making (less than 24 hours); a relentless focus on results, not
activities; and a preference for asking forgiveness, not permission.
52
2015 Number 4
In one instance, technical problems with a key subsystem threatened

to delay the project as a whole, so Achtmann created a parallel
team to find a way around them. Decisions were made by the person
closest to the action, whose proximity gave the company a betterinformed and more instinctive understanding of what had to be done.
On a project like this, observed Achtmann, people are making
decisions on the fly, very aggressively. But they are informed decisions. The purpose is always just to get to the next stage as effectively
as possible; and once there, the next target becomes visible.
This approach to decision making, by nature, has a strong intuitive component. While that can entail greater risk and doesnt work
out every time, it helps companies to avoid analysis paralysisan
increasingly costly pitfall in a world with more and more information but fewer and fewer clear answers. Adhocracy is extremely
well suited to help generate such intuitions.
In a meritocracy, employees gather information to persuade their
peers. In a bureaucracy, they pass information upward, often
in a bid to influence budget allocations. Decisions are passed down
from more senior levels, often in the form of budget distributions.
Adhocracy keeps decision makers more deeply immersed in the flow
of a project or a business rather than more removed from it. For
individuals, this place in the flow is a powerful position for inspiring
useful intuitions, although such a flow can be generated by various
means, including the collective activity that takes place in online
communities or internal social-media platforms.12
This experimental approach to decision making has already found
its way into some management processes. Agile techniques, for
example, have been shown to be a better way of developing software
in many settings than the traditional waterfall model.13 But many
other management processesfrom budgeting to capital allocation
to new-product development to project staffingcontinue to be
managed through the traditional bureaucratic or meritocratic models.
12See Arne Gast and Raul Lansink, Digital hives: Creating a surge around change,
McKinsey Quarterly, April 2015, mckinsey.com.
13 See,

for example, Jeff Sutherland, Scrum: A revolutionary approach to building
teams, beating deadlines, and boosting productivity, London: Random House Business
Books, 2014.
53
As the rapid experimentation characteristic of adhocracy gains sway,

a companys return on attention improves. The ratios numerator
rises with the quantity and quality of quick, experimental decisions,
even as less time is spent (or even available for) disputing data or
managing upward in a hierarchy.
3. Motivating people through achievement and

recognition
Generally speaking, bureaucracies motivate people primarily
through extrinsic rewardsabove all, money. Meritocracies and
adhocracies both motivate them through achievement and
recognition. But meritocracies also emphasize giving people interesting work and enabling them to achieve personal mastery
in a field of expertise. In adhocracies, motivation centers on giving
people a challenge and providing the resources and freedom they
need to surmount it.
Consider again Costa Coffees Project Marlow: Eric Achtmann deliberately built an elite team and gave its members an almost
impossible deadline. Of course, this doesnt mean that an adhocracy
cant offer financial rewards as well; the Marlow team members
all had a stake in the upside growth of the projectthe sale of lots
of machineswhich ensured an alignment of material interests.
Achtmann also spent a good deal of time working on team spirit,
coupling demanding standards and grueling milestones with
celebratory events every time a milestone was achieved. He also
created a plaque that would be permanently mounted inside every
production machine, with the names of all 38 key team members
who made an extraordinary and enduring contribution to Marlow,
above and beyond the call of duty.
Valve offers a slightly different proposition to its employees. Challenge is the starting point: the handbook for new employees says,
Valve has an incredibly unique way of doing things that will make
this the greatest professional experience of your life, but it can
take some getting used to. Employees have very high levels of
responsibility (You have the power to green-light projects. You have
the power to ship products.), and the company emphasizes that
hiring great colleagues is your most important role. There is also
a significant extrinsic component to motivation at Valveone that
Adhocracy
Exhibit 2a of 2
54
Adh
Exh
2015 Number 4
A questionnaire: Which management model does your company prefer?

Which is more appropriate?
Part 1
Your organization likely uses elements of all three models, but one may stand out. For each question,
choose the answer most typical of your function or businessit is usually more informative to answer at
this level rather than for a company as a whole.
Question 1. A frontline employee is dealing with an unhappy customer, who feels that the service the
company provided wasnt as good as expected. How does the employee typically respond?
Par
Que
exte
A. She pushes back, explaining that the company followed its formal policies. If the customer
pushes harder, the employee escalates the problem to her boss.
B. She seeks to understand what went wrongto get to the bottom of the problem, so that the
system can be improved in the future.
C. She realizes that the customer is upset and takes immediate action to placate him.
Que
Question 2. How does a manager typically conduct a meeting?

A. She chairs decisively, often seeking the views of others but making clear she is in charge. At
the end of the discussion of each item, she gives her decision.
B. She seeks debate, looking to get people involved. When appropriate, she puts forward her
own perspective, and she allows the weight of the arguments to drive decision making.
Que
C. She runs the meeting swiftlyif there is a meeting, since she brings things forward for
discussion only in exceptional circumstances. Whenever possible, she tries to push decision
making to a lower level.
Question 3. Where does the head of your function or business prefer to spend his time?
Que
train
A. At his desk; chairing reviews and board meetings; seeking input from his direct reports.
B. Debating strategic issues with his colleagues, reading up on the latest thinking, in the lab, or
talking to experts about developments in the industry.
C. Out in the field, meeting with customers and prospective customers; walking the corridors;
talking with frontline employees about their work and their challenges.
Que
or e
Question 4. A subsidiary requests 5 percent more than the amount previously allocated so that it can
invest in what it sees as an important new project. How does the boss at headquarters respond?
A. He says nothere is a well-established process for requesting funds, and the subsidiary
should wait until next year.
B. He asks the subsidiary for more information: What is the business case? Why does this
project merit special consideration? Depending on the answers, he may make an exception.
Que
cou
C. He tries to help the subsidiary by providing a small amount of money to test the idea with
limited funding. He adds that if the project seems successful, the subsidiary can ask for more
money later.
Question 5. Your company is exploring a strategic alliance with a competitor. Which approach do
people support?
Que
and
A. We have a very structured approach, are cautious about risk, and pay a lot of attention to the
terms of contracts.
B. We spend a lot of time getting to know the other party to see if there are complementarities
and how well we can work together.
C. We start very informally, trying out something low risk quickly and building up from there.
If your answers were mostly As, your organizations preferred management model is bureaucracy. If they were
mostly Bs, it is meritocracy. If they were mostly Cs, it is adhocracy.
Add
prob
Sour
Adhocracy
Exhibit 2b of 2
55
,
er at
Part 2
he
Question 1. What is the level of regulation and compliance imposed on your function or business by
external factors?
Now consider your organizations external business environment. Again, please focus on the specific
function or business you work in rather than the company as a whole. Your answers will indicate which
model your organization favors.
very low
Meritocracy or Adhocracy is favored
he
At
or
an
medium
low
high
very high
Bureaucracy is favored
Question 2. How significant are the downside risks (safety and costs) if something goes wrong?
very low
medium
low
Adhocracy is favored
Meritocracy is favored
high
very high
Question 3. What is the rate of technological or scientific change (or both) in your business area?
very low
medium
low
high
very high
Question 4. To what extent do people in your function or business require advanced professional
training to operate effectively?
very low
medium
low
Adhocracy or Bureaucracy is favored
high
very high
Question 5. How much volatility exists on the demand sidefor example, changing customer needs
or emerging new segments?
very low
medium
low
Meritocracy or Bureaucracy is favored
high
very high
Question 6. What is your operating environments level of ambiguitya lack of clarity about what
course of action is required for your organization to succeed?
n.
re
the
very low
medium
low
high
very high
Question 7. What is the degree of malleability in your operating environmentyour ability to influence
and shape it in your favor?
very low
medium
low
high
very high
Add up the number of times each model (bureaucracy, meritocracy, or adhocracy) is favored. Your answers
probably wont be entirely consistent, so choose your model according to which is favored more often.
Source: Julian Birkinshaw and Jonas Ridderstrle
56
2015 Number 4
would not be out of place at GE: employees rate their peers, and
a forced-ranking system gears discretionary pay toward those who
contribute the most. Valve is a competitive and challenging place
to work, and its founders believe that this makes it attractive to the
most talented game developers.
Again, this approach to motivation helps overcome analysis paralysis
and increases a companys return on attention. The heroes are
the people who make something happenfor example, completing
a pilot project quickly and ahead of budgetrather than those
who come up with the cleverest ideas (which would be celebrated
in a meritocracy) or who oversee the biggest budgets (the mark
of respect in a bureaucracy).
Choosing the right model

So which is the right model for your company? It is worth noting,
first of all, that bureaucracy, meritocracy, and adhocracy are all
about the relative emphasis on formal authority, knowledge, and
action. When we ask executives which model they prefer, they
typically say they want the benefits of all three: people who bring
their knowledge and formal authority to bear, take decisive action,
and act intuitively when necessary.
But we would argue that this is a hedge. Companies cant put
equal emphasis on all three dimensions at once; they have to make
it clear which one takes precedence, at least in specific business
environments and units. For example, if your company aspires to be
focused and action oriented but continues to operate on traditional
bureaucratic principles, dont be surprised when things move more
slowly than you expect. To get a better sense of your current
overall organizing modeland which parts of your organization
might be best suited for bureaucracy, meritocracy, or adhocracy
think about the descriptions in the exhibit and try out the simple
diagnostic on page 54.
57
The demands of the business world often change more quickly

than the organizations where we work. Many companies are still
moving from the traditional bureaucratic model, which has been
around for 100 years, toward a more meritocratic one built around
the primacy of information and knowledge. But our analysis
suggests that for many companies, this isnt enough. Meritocracy
has its benefits, but we believe adhocracy will become increasingly
important in the decades ahead. By understanding the benefits
of all three management models, you will have a better chance
of creating a style of working that positions your organization for
future success.
Julian Birkinshaw is a professor of strategy and entrepreneurship at London
Business School, and Jonas Ridderstrle is an author, most recently of
Re-energizing the Corporation: How Leaders Make Change Happen (Wiley, 2008).

pranodhm/iStock/Getty Images Plus
58
59
Taking
Chinas pulse
In 2015, China has had to navigate some unusually
choppy economic and financial rapids. McKinsey
authors assess the outlook.
60
Five myths about
the Chinese
economy
66
Gauging the
strength of Chinese
innovation
Jonathan Woetzel
Erik Roth, Jeongmin

Seong, and
Jonathan Woetzel
74
Five keys to
connecting with
Chinas wired
consumers
Cindy Chiu,
Todd Guild, and
Gordon Orr
82
How China country
heads are coping
Wouter Baan and
Christopher Thomas
60
Five myths about the

Chinese economy
Jonathan Woetzel
Predictions of deepening economic woes
are plentiful. Here are five arguments against
the pessimism.
A widely held Western view of China is that its stunning economic

success contains the seeds of imminent collapse. This is a kind
of anchoring bias,1 which colors academic and think-tank views of
the country, as well as stories in the media. In this analysis, China
appears to have an economy unlike othersthe normal rules of
development havent been followed, and behavior is irrational at best,
criminal at worst.
Theres no question, of course, that Chinas slowdown is both real

and important for the global economy. But news events like this
years stock-market plunge and the yuans devaluation versus the
dollar reinforce the refrain, among a chorus of China watchers,
that the countrys long flirtation with disaster has finally ended, as
predicted, in tears. Meanwhile, Chinese officials, worried about
political blowback, are said to ignore advice from outside experts on
heading off further turmoil and to be paranoid about criticism.
My experience working and living in China for the past three
decades suggests that this one-dimensional view is far from reality.
Doubts about Chinas future regularly ebb and flow. In what
follows, I challenge five common assumptions.
1. China has been faking it

A key tenet of the China-meltdown thesis is that the country has
simply not established the basis for a sustainable economy. It is said
1 See

Charles Roxburgh, Hidden flaws in strategy, McKinsey Quarterly, May 2003,
mckinsey.com.
61
to lack a competitive, dynamic private-enterprise structure and to

have captured most of the value possible from cheap labor and heavy
foreign investment already.
Clearly, China lacks some elements of a modern market economy
for example, the legal system falls short of the support for property
rights in advanced countries.2 Nonetheless, as China-economy
scholar Nicholas Lardy recently pointed out, the private sector is
vibrant and tracing an upward trend line. The share of stateowned enterprises in industrial output continues to drop steadily,
from 78 percent in 1978 to 26 percent in 2011.3 Private industry
far outstrips the value added in the state sector, and lending to private
players is growing rapidly.
In fact, much of Chinas development model mirrors that of other
industrializing and urbanizing economies in Asia and elsewhere. The
high savings rate, initial investments in heavy industries and
manufacturing, and efforts to guide and stabilize a rapidly industrializing and urbanizing economy, for example, resemble the
policies that Japan, South Korea, and Taiwan followed at a similar
stage of their development. This investment-led model can lead
to its own problems, as Japans experience over the past 20 years
indicates. Still, a willingness to intervene pragmatically in the
market doesnt imply backwardness or economic management thats
heedless of its impact on neighboring economies and global partners.
Furthermore, Chinas reform initiatives4 since 2013 are direct
responses to the structural changes in the economy. The new policies
aim to spur higher-value exports, to target vibrant emerging
markets, to open many sectors for private investors, and to promote
consumption-led growth rooted in rising middle-class incomes.
Today, consumption continues to go up faster than GDP, and investors
have recently piled into sectors from water treatment to e-commerce.
These reforms are continuing at the same time China is stepping
2 See

Francesco Di Lorenzo, 2014 International Property Rights Index, Property Rights
Alliance, 2014, internationalpropertyrightsindex.org. China ranked 46th among

97 nations. The index has three components: the legal and political environment, rights to
physical property, and intellectual-property rights.
3 Nicholas

R. Lardy, Markets over Mao: The Rise of Private Business in China,
Washington, DC: Peterson Institute for International Economics, 2014.
4 Those emerging from the Third Plenary Session of the 18th National Congress of the
Communist Party of China.
62
2015 Number 4
up its anticorruption drive, and the government hasnt resorted

to massive investment spending (as it did in 2008). That shows just
how important the reforms are.
2. Chinas economy lacks the capacity

to innovate
Think tanks, academics, and journalists alike maintain that China
has, at best, a weak capacity to innovatethe lifeblood of a
modern economy. They usually argue as well that the educational
system stomps out creativity.
My work with multinationals keen on partnering with innovative
Chinese companies suggests that theres no shortage of local players
with a strong creative streak. A recent McKinsey Global Institute
(MGI) study describes areas where innovation is flourishing here.5
Process innovations are propelling competitive advantage and
growth for many manufacturers. Innovation is at the heart of the
success of companies in sectors adapting to fast-changing consumer needs, so digital leaders like Alibaba (e-commerce) and Xiaomi
(smartphones) are emerging as top global contenders. Heavy
investment in R&DChina ranks number two globally in overall
spendingand over a million science and engineering graduates a
year are helping to establish important beachheads in science- and
engineering-based innovation. (See Gauging the strength of
Chinese innovation, on page 66.)
3. Chinas environmental degradation is at

the point of no return
To believe this, you need to think that the Chinese are content with
a dirty environment and lack the financial muscle to clean things up.
OK, they got things wrong in the first place, but so did most
countries moving from an agrarian to an industrial economy.
In fact, a lot thats good is happening. Start with social activism.
A documentary on Chinas serious air-pollution problems (Under the
5 To download the full MGI report, The China effect on global innovation, see Gauging the
strength of Chinese innovation, October 2015, on mckinsey.com.
63
Dome), by Chai Jinga former journalist at China Central Television

(CCTV), the most important state-owned broadcasterwas viewed
over 150 million times in the three days after it was posted online, in
March 2015. True, the 140-minute video, which sharply criticizes
regulators, state-owned energy companies, and steel and coal producers,
was ultimately removed. But the Peoples Daily interviewed Chai
Jing, and she was praised by a top environmental minister.
China is spending heavily on abatement efforts, as well. The nations
Airborne Pollution Prevention and Control Action Plan, mandating
reductions in coal use and emissions, has earmarked an estimated
$277 billion to target regions with the heaviest pollution.6 Thats
just one of several policy efforts to limit coals dominance in the
economy and to encourage cleaner energy supplies. My interactions
with leaders of Chinese cities have shown me that many of them
incorporate strict environmental targets into their economic
master plans.
4. Unproductive investment and rising debt

fuels Chinas rapid growth
To believe this, you would have to think, as many skeptics do, that
the Chinese economy is fundamentally driven by overbuildingtoo
many roads, bridges, and buildings.7 In fact, as one economist has
noted, this is a misperception created by the fact that the country is
just very big. An eye-popping statistic is illustrative: in 2013, China
consumed 25 times more cement than the US economy did, on
average, from 1985 to 2010. But adjusted for per-capita consumption
and global construction patterns, Chinas use is pretty much in line
with that of South Korea and Taiwan during their economic booms.8
Chinas rising debt, of course, continues to raise alarms. In fact,
rather than deleveraging since the onset of the financial crisis, China
has seen its total debt quadruple, to $28.2 trillion last year, a recent
6 Sonal Patel, Chinas war on air pollution, Power Magazine, November 1, 2014,
powermag.com.
7 For a view on overcapacity in the power industry, see Li Wei, The Chinese economy
needs to break out of the overcapacity trap, CKGSB Knowledge, July 13, 2015,
knowledge.ckgsb.edu.cn.
8 Jonathan Anderson, China, cement, and the art of meaningless statistics, Emerging
Advisors Group, December 23, 2014.
64
2015 Number 4
MGI study found.9 Nearly half of the debt is directly or indirectly

related to real estate (prices have risen by 60 percent since 2008).
Local governments too have borrowed heavily in their rush to
finance major infrastructure projects.
While the borrowing does border on recklessness, Chinas government has plenty of financial capacity to weather a crisis. According
to MGI research, state debt hovers at only 55 percent of GDP,
substantially lower than it is in much of the West. A recent analysis
of Chinas financial sector shows that even in the worst caseif
credit write-offs reached unprecedented levelsonly a fairly narrow
segment of Chinese financial institutions would endure severe
damage. And while growth would surely slow, in all likelihood the
overall economy wouldnt seize up.10
Finally, the stock-market slide is less significant than the recent
global hysteria suggests. The government holds 60 percent of
the market cap of Chinese companies. Moreover, the stock market
represents only a small portion of their capital funding. And
remember, it went up by 150 percent before coming down by 40.
Rumors drive the volatility on Chinas stock exchange, often in
anticipation of trading by state entities. The upshot is that the direct
impact on the real economy will most likely be some reduction in
consumer demand from people who have lost money trading in shares.
5. Social inequities and disenfranchised

people threaten stability
On this one, I agree with the bears, but its not just China that must
worry about this problem. While economic growth has benefited the
vast majority of the population, the gap between the countryside
and the cities is increasing as urban wealth accelerates. Theres also
a widening breach within urban areasthe rich are growing richer.11
9 For more, see Debt and (not much) deleveraging, McKinsey Global Institute, February
10 See

Jonathan Anderson, Financial armageddon, China-style (2015), Emerging Advisors
Group, April 2, 2015.
11 Chinas

Gini coefficient, a measure of income disparity, has risen steadily and now stands
at 47.
65
Urban inequality and a lack of access to education and healthcare

are not problems unique to China. People here and in the West
may find fruitful opportunities to exchange ideas because the pattern
across Western economies is similar. Leaders of the central government have suggested policies to improve income distribution and
to create a fair and sustainable social-security system, though
implementation remains a matter for localities and varies greatly
among them.
In short, Chinas growth is slower, but weighing the evidence I have

seen, the sky isnt falling. Adjustment and reform are the hallmarks
of a stable and responsive economyparticularly in volatile times.
Jonathan Woetzel is a director in McKinseys Shanghai office, as well
as a director of the McKinsey Global Institute. A version of this article was
previously published on Forbes.com, on October 5, 2015.
66
Gauging the strength

of Chinese innovation
Erik Roth, Jeongmin Seong, and Jonathan Woetzel
China does well in customer- and manufacturingoriented innovation, though not in the more
advanced varieties. But the country will need
them to sustain growth.
The events of 2015 have shown that China is passing through

a challenging transition: the labor-force expansion and surging
investment that propelled three decades of growth are now weakening. This is a natural stage in the countrys economic development. Yet it raises questions such as how drastically the expansion
of GDP will slow down and whether the country can tap new
sources of growth.
New research1 by the McKinsey Global Institute (MGI) suggests that

to realize consensus growth forecasts5.5 to 6.5 percent a year
during the coming decade, China must generate two to three percentage points of annual GDP growth through innovation, broadly
defined. If it does, innovation could contribute an estimated $3 trillion to $5 trillion a year to GDP by 2025.2 China will have evolved
from an innovation sponge, absorbing and adapting existing technology and knowledge from around the world, into a global
innovation leader. Our analysis suggests that this transformation
is possible, though far from inevitable.
1 To
download the full MGI report, The China effect on global innovation, see Gauging the
strength of Chinese innovation, October 2015, on mckinsey.com.
2 The

estimated increase in total factor productivity is $3 trillion to $5 trillion. We use
this figure as a proxy for innovations macroeconomic impact. Total factor productivity
is growth that doesnt flow from factors of production such as labor and capital
investment. In our research, we found that about 40 percent of the increase in total factor
productivity could come from innovations in higher-level manufacturing and services
enabled by the Internet. Other innovations could come from catch-up activities that bring
Chinese enterprises up to global best practices as well as breakthroughs yet to emerge.
67
To date, when we have evaluated how well Chinese companies

commercialize new ideas and use them to raise market share and
profits and to compete around the world, the picture has been
decidedly mixed. China has become a strong innovator in areas such
as consumer electronics and construction equipment. Yet in others
creating new drugs or designing automobile engines, for example
the country still isnt globally competitive. Thats true even though
every year it spends more than $200 billion on research (second
only to the United States), turns out close to 30,000 PhDs in science
and engineering, and leads the world in patent applications (more
than 820,000 in 2013).
When we look ahead, though, we see broad swaths of opportunity.
Our analysis suggests that by 2025, such new innovation opportunities could contribute $1.0 trillion to $2.2 trillion a year to the
Chinese economyor equivalent to up to 24 percent of total GDP
growth. To achieve this goal, China must continue to transform the
manufacturing sector, particularly through digitization, and the
service sector, through rising connectivity and Internet enablement.
Additional productivity gains would come from progress in scienceand engineering-based innovation and improvements in the
operations of companies as they adopt modern business methods.
To develop a clearer view of this potential, we identified four innovation archetypes: customer focused, efficiency driven, engineering based, and science based. We then compared the actual global
revenues of individual industries with what we would expect them
to generate given Chinas share of global GDP (12 percent in 2013).
As the exhibit on the next page shows, Chinese companies that rely
on customer-focused and efficiency-driven innovationin industries
such as household appliances, Internet software and services, solar
panels, and construction machineryperform relatively well.
However, Chinese companies are not yet global leaders in any of
the science-based industries (such as branded pharmaceuticals)
that we analyzed. In engineering-based industries, the results are
inconsistent: China excels in high-speed trains but gets less than
its GDP-based share from auto manufacturing. In this article, well
describe the state of play and the outlook in these four categories,
starting with the two outperformers.
Q4
68 2015 2015 Number 4
China Innovation
Exhibit 1 of 1
Exhibit
Chinese companies in industries that rely on efficiency-driven
innovation perform well, science-based companies less so.
Chinese industries: actual vs expected performance in innovation
(based on Chinas share of global GDP1 ), number of industries = 31
9
Above fair
share
Below fair
share
Efficiency driven
Customer focused
Engineering based
Science based
Four innovation archetypes

1 Chinas share was 12% in 2013.
Source: IHS Global Insight; International Data Corporation; annual reports; McKinsey Global Institute analysis
1. Customer-focused innovation: The Chinese

commercialization machine
China benefits from the sheer size of its consumer market, which
helps companies to commercialize new ideas quickly and on a large
scale; even a relatively small market like online gaming is bigger
than the auto industry in Turkey or Thailand. Chinese companies
have learned how to read the requirements of their rapidly urbanizing country and to scale up new products and services quickly to
meet them.
Manufacturers of appliances and other household goods dominated
the first wave of customer-focused innovators in China. Their
innovations were good enough products such as refrigerators and
TV sets. But these offerings no longer suffice to gain a growing
share of consumers. Companies like smartphone manufacturer
Xiaomi are responding with cheaper and better products designed
to offer hardware features as good as those from global brands
69
but priced for the Chinese market. Like other customer-focused

innovators in China, Xiaomi also uses the massive consumer
market as a collaborator, rapidly refining its offerings through online
feedback. Internet service providers are another hotbed of
customer-focused innovation. Alibaba, Baidu, and Tencent have
become global leaders in online services, largely thanks to their
success in the enormous Chinese market. (See Five keys to connecting with Chinas wired consumers, on page 74.)
Customer-focused innovation could reshape large swaths of Chinas
service sector, where productivity lags behind that of its counterparts in developed economies. The government already is pushing to
modernize traditional businesses through its Internet Plus initiative, announced in early 2015. Innovations are needed to expand
access to services (for example, remotely monitoring the health
of rural patients), to improve the quality of offerings (greater choice
and customization in financial and educational products), and to
optimize operations (crowd-sourced logistics). Chinese companies
will also have opportunities to use their skills in customer-focused
innovation to take a lead in selling to other emerging markets.
2. Efficiency-driven innovation: The

ecosystem advantage
In manufacturing, Chinas extensive ecosystem has provided an
unmatched environment for efficiency-driven innovation. The
country has the worlds largest and most highly concentrated supplier
base, a massive manufacturing workforce, and a modern logistics
infrastructure. These advantages give Chinese manufacturers a lead
in some important knowledge-based manufacturing categories, such
as electrical equipment, construction equipment, and solar panels.
Today, Chinese companies improve their efficiency with a variety of
cutting-edge approaches, including agile manufacturing, modular
design, and flexible automation. The apparel manufacturer Everstar,
for example, uses automated equipment and online design and
e-commerce systems that help consumers to customize designs for
clothing and receive finished goods within 72 hours. China is also
pioneering the use of open manufacturing platforms.
70
2015 Number 4
The challenges are mounting, however. As wages rise, the country

becomes less competitive for the most labor-intensive work. At
the same time, a worldwide transition is under way toward a new
kind of manufacturing, sometimes called Industry 4.0: a much
more intense digital linkage of manufacturing components, processes,
and logistics. As a result, Chinese companies will face pressure to
improve their performance in utilizing assets, matching supply with
demand, and controlling quality. Success will depend on how well
China can exploit the scale of todays manufacturing ecosystems and
clusters to extend their benefits beyond individual factories through
digitally linked networks.
Some efforts are under way to mobilize rapid, flexible manufacturing. In Guangdong province, for example, manufacturers have
set up joint platforms to share the benefits of R&D and operations
among companies in the same clusters. Elsewhere, companies
are looking at ways to mass-customize products by combining flexible manufacturing with the aggregation of a huge Internet
consumer base. New manufacturing gains may also emerge from
the aggressive use of robots, which could make Chinas huge
pool of semiskilled factory workers more effective.
Entrepreneurs are poised to play a bigger role. In Shenzhen, a
rich ecosystem of component suppliers, design services, business
incubators, and outsourced assembly capacity has helped
start-ups prototype products and scale up global manufacturing
businesses quickly.
3. Engineering-based innovation in learning

industries
China has had mixed success with engineering-based innovation.
The best performers are found in Chinese markets where motivated
domestic industries are nurtured by national and local governments that create local demand, push for innovation, and facilitate
the transfer of knowledge from foreign players. China has used this
formula successfully in high-speed rail (Chinese companies have a
41 percent share of the global railroad-equipment revenues, according to
McKinsey estimates), wind power, and telecommunications equipment.
71
In 2008, the Ministry of Railways launched a major program to

develop a new generation of high-speed trainsa top-down, nationwide effort that has been Chinas equivalent of the Apollo space
program in scale and complexity. We estimate that the country has
accounted for 86 percent of global growth in this market since
then. Using technology transfers from overseas partners as a knowledge base, Chinese companies tailor their offerings to local
requirements, such as terrain and temperature conditions, through
incremental innovation.
Learning and innovation have been slower to come in automotive
manufacturing. To date, most domestic Chinese carmakers have
relied on platforms from their global partners or on designs from
outside firms to bring products to market quickly. Thanks to
exploding domestic demand and strong profit streams from joint
ventures, they have felt little pressure to innovate.
Deregulation, a rapid increase in Chinas base of engineering talent,
and continued high levels of government investment promise to
make engineering-based companies more motivated and effective
innovators in the future. In some sectors, such as nuclear power,
explicit state support will continue to be critical. China has an ambitious government plan to build nuclear plants resulting in a total
installed capacity of 58 gigawatts by 2020, which can support
its goal of obtaining 20 percent of its energy from nonfossil fuel
sources by 2030.
72
2015 Number 4
In other industries, such as medical equipment, the private sector

will drive innovation. Mindray, United Imaging Healthcare, and
other smaller new Chinese players will continue to make inroads in
market categories (for instance, CT scanners and MRI machines)
that foreign suppliers now dominate. Government programs to subsidize purchases of Chinese-made equipment by the countrys
hospitals are providing a boost even as a new generation of medical
entrepreneurs draws from global knowledge and partnerships.
4. Science-based innovation: Novel Chinese

approaches
A massive government push to raise R&D spending, train more
scientists, and file more patents has yet to give China a lead
in science-based innovation. The slow progress has a number of
explanationsnot least that this type of work takes a long time
to pay off and requires an effective regulator to protect intellectual
property. Huge investments by government and the private sector
to shepherd projects from the lab to commercial deployment are
needed, as well. Whats more, despite the large number of Chinese
students trained in scientific and technical fields, companies
struggle to find capable talent.
The government is addressing some of these obstacles. For example,
recently launched reforms to the drug-review process could reduce
the time to get a new drug to patients by two or more years. Efforts
such as the Thousand Talents program bring overseas Chinese
to the country to launch their own companies and work in scientific
organizations and universities.
Even as these reforms play out, Chinese innovators are adopting
novel approachesfor instance, using the countrys massive market
size and huge pool of low-cost researchers to industrialize and
speed up experimentation and data collection. One such innovator,
BeiGene, gained ground in the biotech industry by developing
drugs to treat cancers and other diseases. The company has
accelerated the drug-discovery process by deploying a large-scale
drug-testing team, testing compounds on human tissue (such
as cancerous tumor samples) during the preclinical phase to get
73
early indications of issues that might arise in human testing,

and capitalizing on access to Chinas large pool of patients. In
genomics research, another company, BGI, is deploying massive
scale (2,000 PhDs and more than 200 gene-sequencing machines)
to power its way through biotech problems.
The extent and speed of Chinas advances in innovation will have
significant implications for the countrys growth and competitiveness and for the types of jobs, products, and services available to
the Chinese people. They will also have powerful consequences
for multinationals (competing at home and abroad with Chinese
companies), some of which are now using China as an R&D base
for global innovation. Fortunately, that isnt a zero-sum game: a more
innovative China ought to be good for a global economy that seeks
new sources of growth.
The authors wish to thank McKinseys Jason Lee for his contributions to this article.
Erik Roth is a director in McKinseys Shanghai office; Jeongmin Seong is a
senior fellow of the McKinsey Global Institute; and Jonathan Woetzel is a director
in the Shanghai office, as well as a director of the McKinsey Global Institute.
74
Five keys to
connecting with
Chinas wired
consumers
Cindy Chiu, Todd Guild, and Gordon Orr
China is the worlds largest and most dynamic

e-commerce market. But being successful
requires understanding and embracing its
unique digital landscape and consumers.
Chinas annual online-retail sales passed those of the United States

in 2013. By 2018, they are estimated to reach about $610 billion
likely passing Europe and the United States combined (exhibit). Yet
though the market is vast, succeeding in China is far from easy.
While select leading Western companies have captured some of the
countrys explosive e-commerce growth, many make basic mistakes,
from equating Chinas e-commerce leaders with US companies
(Alibaba is Chinas Amazon!) to assuming selling and distribution
practices from home markets are transferable. The reality is that
China is simply different. As a point of comparison for consumer
and retail companies, we regard the combination of the size of
the prize and the degree of change needed to succeed as roughly
analogous to what consumer-packaged-goods companies experienced
in the late 1980s when Walmart changed the consumer game.
Understanding Chinas e-commerce market starts with knowing its

online consumers and companies. The countrys three most prominent players are Baidu, the largest search engine; Alibaba, proprietor
of the largest online shopping mall; and Tencent, the leader in
gaming and social networking (see sidebar, Understanding BAT,
75
on page 77). While each may appear as though it plays in a different

arena (search, e-commerce, and social, respectively), in reality, the
companies compete more directly with one another. Each is a crucial
partner, capable of connecting brands with hundreds of millions of
new customers, and each has a role throughout the online consumers
decision journey: generating demand, finding and comparing local
merchants, moving customers from consideration to making a purchase,
paying, and then reviewing or telling a friend and building loyalty.
But its not enough to understand these three digital powerhouses.
More than a dozen multibillion-dollar players shape parts of Chinas
digital marketplaces, ranging from JD.com (a cross-category
Q4 2015
e-tailer) to VIP.com (a fashion-focused discount e-tailer). EngagChina wired consumers
ing with just one of these important platforms isnt enoughthey
Exhibit 1 of 1
Exhibit
Chinas e-commerce market is likely to exceed that of Europe and the
United States combined within three years.
Online-retail gross merchandise value, $ billion
Europe
United States
China
610
380
298
259
226
230
210
166
146
2012
2013
Source: eMarketer; Forrester Research; iResearch Services; McKinsey analysis
2018 (estimated)
76
2015 Number 4
are interrelated, and you need to work with several. Finally, in our
experience, mastering the countrys e-commerce landscape is a
journey specific to an industry and a company. We recommend
strategies that incorporate the following five priorities.
1. Adopt an integrated platform strategy

Retailers know that e-commerce platforms can compensate for
limited physical-store networks. This is especially applicable in China,
where our research shows consistently that up to 70percent of
Internet users shop online regardless of the size of the cities in which
they live, despite significant differences in Internet penetration
(which averages 86 percent in Tier 1 cities, compared with 52 percent
in Tier 3 cities).1
Yet advanced consumer companies in China dont just sell online
through their own sites. They use a variety of digital platforms,
typically managing a flagship store on Tmall and selling through
cross-category players such as JD.com and category-specific sites
such as VIP.com. Its an approach international players have evolved
to adopt. Even British luxury brand Burberry now has a flagship
digital store on Tmall, giving it access to traffic beyond its usual customers by virtue of being on the broader platform.
2. Understand Chinas vast network

of distributors
Managing distributors in the digital space in China is different than
in the West. The countrys e-commerce market is filled with small
distributors who have opened online shops through Tmall or
Taobao, Alibabas consumer-to-consumer platform embraced by
millions of small businesses and entrepreneurs.
While consumer to consumer is declining as a percentage of Chinas
total e-commerce market, it still accounts for about 50 percent
of Chinas e-commerce sales. That makes it a critical platform for
1 Tiers

are defined by urban population and economic factors, such as GDP and GDP per
capita. In China, Tier 1 cities include Beijing, Guangzhou, Shanghai, and Shenzhen;
Tier 2 comprises about 40 cities; and Tier 3 is made up of about 170 cities.
Understanding BAT
hinas digital powerhousesBaidu, Alibaba, and Tencentare not
C
the countrys equivalents of Amazon, Google, or Facebook. In fact, direct
comparisons overlook the richness and depth of the capabilities and
business models of the three Chinese companies, often described by the
acronym BAT:
earch-engine-optimization strategies designed for Google rarely work

S
for Baidu, for example, since it places different emphases on ranking
algorithm variables, such as overindexing the frequency of content
updates.
Alibaba resembles Amazon only insofar as it runs a digital retail platform.

In reality, the Chinese company has multiple platforms, ranging from
its namesake business-to-business marketplace to Taobao, its consumerto-consumer marketplace, and to Tmall, its business-to-consumer site.
In addition, none of these platforms hold inventory or operate fulfillment
centers. Unlike Amazon, whose business primarily involves buying
products and taking a cut from on-selling them, Alibabas digital platforms
make money by collecting fees from the companies listing merchandise
on them and by charging for the search engine and digital advertising
placement. In addition, Jack Ma, the founder of Alibaba, established
Cainiao, a platform that rents facilities to logistics companies and sellers
so they can distribute products better.

Tencent
differs from Facebook in that its main source of revenue is not
advertising but selling value-added online services, such as avatars,
emoticons, games, and other virtual products. Tencent also moved far
earlier than Facebook into e-commerce and online payments: it
holds a 15 percent stake in JD.com, Chinas second-largest e-commerce
platform, with over 90 million active purchasing customers and gross
merchandise value of more than $40 billion. Tencents digital-payment
system, Tenpay, trails only Alibabas Alipay in third-party online
payments. And Tencent has integrated its original social and mobile
business with its newly established e-commerce and payment
operations, unlike any other player.
77
78
2015 Number 4
companies, even if sites such as Taobao present challenges for

global brands. Thats because brands have little control over how
products are presented or priced: anyone with a Chinese identification number can set up shop on Taobao, and the site has become
a haven for counterfeiters, as well as for parallel importerswho
purchase genuine foreign products meant for sale in other countries
but bring them back to China for resale (often without paying
import duties). In addition, excess inventory from large retailers or
their sales forces also serves as a major source of authentic products
on Taobao, sold at significant discounts.
While Alibaba has strengthened measures to purge pirates from
Taobao, weve also seen multinational corporations evolve their
approaches. At first, many battled rogue distributors with a variety
of get tough measures, ranging from lodging official trade
complaints to using computer chips and bar codes to track down
inventory leaks. Yet practices involving carrots as well as
sticks are more effective. Several large consumer companies,
including Kimberly-Clark, have instead proactively identified and
partnered with their largest local distributors on Taobao,
providing them with store certificates, stable product supply, and
select product prelaunch benefits. In return, Kimberly-Clark
asked distributors to comply with its branding and pricing guidelines, for example.
Two-thirds of Chinas consumers cite

recommendations from families and friends
as the critical factor influencing their
decision to buy, compared with only one-third
of consumers in the United States.
79
3. Harness the power of social media

Brands have found social media especially important in China.
Chinese consumers do not trust official sources, such as government
and big corporations, and as a result, their purchasing decisions
are influenced much more by word of mouth. In fact, two-thirds of
Chinas consumers cite recommendations from families and friends
as the critical factor influencing their decision to buy, compared
with only one-third of consumers in the United States. Whats more,
we regard Chinas social-media-platform leaders as more attuned
to commerce and opportunities to work with brands and retailers
than their US counterpartsnone more so than Chinas dominant
social-media player, Tencent, which evolved its WeChat messaging
service from a platform for social networking to one for customerrelationship management, commerce, and payments.
Xiaomi, for example, used WeChat to manage both product-launch
buzz and sales. And since Hanting Hotel, a local midprice hotel
chain, began providing virtual membership cards through WeChat,
it has recruited more than 500,000 members and realized 62,000
room bookings. In parallel, WeChat is rapidly evolving its commerce
services. Our recent iConsumer survey found that 15 percent of
WeChat users have made a purchase through the WeChat platform,
and 40 percent are interested in doing so in the near future. Many
brands are adding WeChat commerce functionality into their official
WeChat accounts.
4. Leverage Chinas growth in locationbased services

China already has more mobile Internet users than PC Internet
users. Our research shows that almost two-thirds of Chinese consumers have made mobile purchases, and mobile commerce
is predicted to surpass PC commerce in 2016. Not surprisingly, as
mobile grows exponentially, so will location-based services
that make online-to-offline transactions evermore important.
80
2015 Number 4
China is rapidly becoming a market where the consumer shopping

experience integrates social media, location-specific information,
and mobile-payment capabilities on smartphones. For example, mass
chain player Pudding Hotels uses WeChats people around me
function to proactively recommend its hotels to users based on their
locationa service that generated more than 10,000 WeChatenabled bookings within three months of launch.
We are finding that winning brand-building and e-commerce strategies increasingly require leading-edge capabilities to partner with
digital platforms in social media, location services, and mobile marketing (SoLoMo) and, ideally, mobile commerce and payments.
5. Work with platforms to understand Chinas

consumers
Need to know more about your potential customers? Brand owners
and retailers can uncover consumer insights by collaborating
with digital-platform businesses in China. Consider P&G, Chinas
biggest digital advertiser, which has partnered with Baidu to
develop multichannel advertising campaigns for its products. In
reviewing search patterns for P&Gs Olay skin-care products, for
example, Baidu analysts determined that many users were framing
their queries in ways that suggested a strong connection between
concerns about skin care and aging. P&G used those insights to
devise an advertising campaign built on the idea that Olay products
could help older women hold on to age 25, a message that
resonated strongly with Chinese consumers. Similarly, a diaper
player worked with business-to-consumer e-commerce player
Dangdang to identify pregnant women entering their third trimester
and issue relevant coupons.
Working with Chinas e-commerce providers to codevelop consumer insights can benefit brand owners, retailers, and platform
companiesand help strengthen a companys relationship with
Chinas e-commerce players beyond being purely transactional.
81
Global brands will not maximize their digital-commerce potential

in China solely with practices and formulas that have worked
for them at home. In fact, success may require unlearning what you
know to understand how to operate across Chinas multiplatform
e-commerce environment. Finally, the countrys landscape is still
evolving quickly. Aside from the principles above, being alert to
new channels and new business models and being ready to adapt
early is also essential to future success.
Cindy Chiu is an alumnus of McKinseys Shanghai office, where
Gordon Orr formerly served as a director; Todd Guild is a director emeritus
in the Tokyo office.
82
How China country

heads are coping
Wouter Baan and Christopher Thomas
As multinational companies face stronger

headwinds, how are local leaders dealing
with the situation, and what would help them
move faster?
Signs of weaker growth in China during 2015, including its
stock markets tumble, have commanded widespread attention
from economic policy makers, businesspeople, and investors. Not
surprisingly, the leaders of local operations of multinational
companies are feeling the pressure.
Earlier this year, we surveyed more than 70 such country heads, who,
for simplicitys sake, we call China CEOs. The companies they lead
cover a wide range of B2B and B2C businesses, generate more than
$200 billion in China-based revenue, and in many cases are among
the top five global players in their industries. Fifty-five percent tell
us that their companies are growing faster than the corresponding market segments in China. Nearly 40 percent of the China CEOs
were Chinese nationals; a similar proportion came from Europe
or North America, the rest primarily from other countries in Asia.
Roughly 90 percent work for companies based in the United States
or Europe. Nearly half had more than ten years of experience in
China before taking on their current roles, but roughly 30 percent
had less than two years experience there or were new to the region.
Regardless of background, these China CEOs are under severe
time constraints. Forty percent said they dont have time to respond
quickly enough to the rapid changes in the China market, and
another 40 percent admit that they are hard pressed to do so. Two
challenges that China CEOs say demand large amounts of their
time are hitting the numbers while they cope with the downturn in
demand, as well as building their local teams. Another major issue
83
is managing headquarters, including explaining the unique Chinese

context to senior management there. Thats particularly true for
the subset of the sample that can be characterized as headquarters
focused, who spend nearly 40 percent of their time at or dealing
with headquarters. Even locally focused China CEOs spend about
20 percent of their time at or speaking with the global HQ.
Most China CEOs have direct line control over go-to-market and
support functions, such as branding and corporate affairs,
but limited direct line reporting in upstream areas like product
development, operations, and supply-chain management. Less than
50 percent can make decisions about pricing and product strategy
independently of headquarters (Exhibit 1). Among those with
integrated control over country operations and commercial results,
Q4 2015 most must still involve HQ in overall China strategy, long-term
China CEOmultiyear plans, and annual budgeting.
Exhibit 1 of 2
Exhibit 1
Less than half of China CEOs can make decisions in key business areas
independently of headquarters.
% of respondents who report exercising over 90% of all decision-making authority
independently of headquarters
Strategy
Overall China strategy
Investment
Annual China budgets

and investments
Long-term, multiyear
China investment plan
Products and
pricing
35
24
Pricing
Product strategy
People and
functions
49
40
27
Hiring and firing

Government-affairs
strategy
Source: 2015 McKinsey survey of 73 China CEOs
71
56
2015 Number 4
84
Regional-reporting relationships complicated things for some.

Roughly two-fifths of China CEOs report to an Asia head, 20 percent to a global CEO (Exhibit 2). Many say its challenging, even
uncomfortable, for them to report to the Asia head, when their China
businesses account for a huge proportion of Asian results. Problems
include the risk that they will duplicate approaches to targeting and
reaching customers made at a regional level, along with lengthy
planning and decision cycles.
Time pressures and decision-making complexity are hampering
China CEOs as they seek to adapt to a changing country, to customize their business models and product offerings to Chinese
requirements,
to compete with local competitors, and to respond
Q4 2015
China CEOnimbly to opportunities and threats.
Exhibit 2 of 2
Exhibit 2
Approximately 40 percent of China CEOs report to an Asia headtwice
as many as report to the global CEO.
Share of China CEOs1 in
2015 who report to
20%
Global CEO
Decreased
since 2013
16%
41%
Asia
regional head
Global
functional head
13%
Business-unit
CEO
Increased since 2013

0
Regional
functional head
1 Leaders of multinational corporations who are local to China; titles include China chairperson, country general
manager, China president, China vice president, and China CEO. Figures do not sum to 100%, because the category
of Other is not shown.
Source: 2015 McKinsey survey of 73 China CEOs
How China country heads are coping
85
Despite these issues, the vast majority of respondents said that China
remains a top-priority growth engine for their companiesand
that experience as the China head is a rocket to advance their own
careers. However, on the whole, most dont see the business
environment in China getting any easier. Most also fear that the
policy environment for multinationals in the country will get more
challenging. Efforts to increase their agility by simplifying interactions with headquarters or by delayering and accelerating decisionmaking processes may therefore be a boon for many China CEOs
and the organizations they oversee.
Companies address these challenges in different ways. Some have
removed the regional structure and elevated China to a position
equal to that of the rest of Asia. Others have consolidated all activities
there under a China CEO with direct access to the global CEO.
Several companies have built up their organic capabilities by moving
full business units and global senior executives to the country.
One created a China advisory board of senior global executives who
coordinate and accelerate the local agenda.
Still others have taken people-based rather than structural
approachespromoting the China head to a global executive position,
so that China expertise enters the boardroom. Some CEOs are
addressing the slower-growth environment in todays China by
making personal commitments to remove barriers, in the cause of
creating an organization thats sufficiently nimble and responsive to the market. Efforts to attain that objective would seem to
be a sensible use of time not only for executives at headquarters
but also for those struggling on the front line.
The authors wish to thank McKinseys Yatu Ji and Rachel Jin for their
Wouter Baan is an associate principal in McKinseys Beijing office, where
Christopher Thomas is a principal.
86
Gender equality:
Taking stock of where
we are
Dominic Barton, Sandrine Devillard, and Judith Hazlewood
Why are women still underrepresented at every level of todays corporations?
There is a growing consensus among top
executives that gender diversity is both
an ethical and a business imperative. Yet
progress is painfully slow. Despite modest
improvements, women are underrepresented at every level of todays corporations, especially in senior positions.
toughest problems depends on attracting

and retaining the worlds best people,
who can offer the diverse perspectives
that enhance creative problem solving.
Although we are glad to be making
progress, including recently being named
one of Working Mother magazines top
ten companies for women,2 we know
we would be a better firm if we had more
Were quite cognizant of how difficult it
top female talent. Thats why we have
is to make progress. Despite the fact
that McKinsey has, for a number of years, committed publicly, through the United
Nations HeForShe initiative and the 30%
been conducting research that has
Club,3 to some ambitious gender goals
helped our firm and many other comfor our firm over the next five yearsones
panies improve their gender balance
that wont be trivial to achieve.
for example, through our Women Matter
initiative,1 led by Sandrine Devillard,
one of this essays coauthorswere not
The persistence of the gender gap
yet where we want to be. Women now
represent about 39 percent of McKinseys
We believe there are several reasons
entry-level hires, but occupy just 11 perthe gender gap so stubbornly persists.
cent of the senior-leadership roles
For one, in many organizations, senior
within the firm. There are currently four
leadership has only recently committed
women (including Judith Hazlewood,
itself to addressing this challenge.
another of this articles coauthors) on our
A Women Matter study showed that
30-member Shareholders Council.
gender diversity was a top-ten strategic
priority for only 28 percent of companies
These numbers are certainly up from a
in 2010and for a third of companies,
decade ago, but less than we would like.
it was not on the strategic agenda at all.
Our ability to help our clients with their
87
Its widely acknowledged that without

a commitment from the top, nearly any
major change program will fail.
Our experience has been that top-down
targets make a difference. We didnt
set explicit gender goals for McKinsey
until 2014, and in just one year after
doing so, our intake of female consultants has increased by five percentage
points. Were encouraged by this,
and by the fact that a growing number
of companies are recognizing the case
for gender parity and declaring their
determination to pursue and achieve it.
Our hope is that initiatives like HeForShe,
in which we are participating, are just
the start of a growing wave of increased
transparency and more ambitious goals.
A second reason for sluggish progress
has to do with the nature of the gender
inequality issue itself, which, like many
efforts to change organizational cultures,
requires companies to take action
across a broad range of factors and keep
their managers aligned with multiple
objectives for years at a time. Our
research shows that the focus in these
interventions must be to help women
better develop as leaders, and to design
the conditions in which this can take
place. Crucial aspects include sponsoring (not just mentoring), neutralizing the
effects of maternity leave and ongoing
parenting responsibilities on career
advancement and wage increases, and
evolving the criteria companies use
for promotions to include a diversity of
leadership styles.
The complex dynamics of the gender
issue create a variety of challenges.
Consider sponsorship: its easy to

say more is needed, but weve found that
women at McKinsey are disproportionately sponsored by other women, which
places a higher burden on our more
senior women relative to senior men. This
surely limits the sponsorship they
are able to provide. Similarly, while the
anytime-anywhere model that currently
prevails in the corporate world has
placed everyone under more pressure,
the weight surely is heavier for
women, who continue to shoulder a
disproportionate share of the responsibility for managing home and family
issues. These forces challenge women
at McKinseya recent internal
diagnostic confirmed the persistence
of gender-based roles at home for
many women at the firmand we believe
they are emblematic of those faced by
women in many organizations.
Addressing these interrelated gender
issues is difficult, which brings us to a
third reason change has been slow:
major transformation efforts require
steady, broad-based interventions over
time. After an initial commitment from
the top, significant changes can typically
take as many as eight or more years,
requiring the close and visible monitoring
of progress by the executive team. Its
never easy and its rarely quick.4
Beyond the factors weve mentioned
lies at least one other that is mostly exogenous to private-sector institutions.
Economic equality for women, to
no small degree, depends on achieving
a sweeping set of social-equality
reforms. Is it the business of executives
to help solve broader social issues?
88
2015 Number 4
The case for gender equality is strong.

Why is progress so slow?
Get a quick overview or dive deeper into the issues with A CEOs guide to
gender equality, on mckinsey.com. It includes more of our recent research and video
interviews with Facebook COO Sheryl Sandberg and actress Geena Davis.
We would say yes, provided they

dont distract from the other very
real issues executives face in their
own organizations.
The road ahead

Is it, then, only a matter of time before
gender equality will be achieved?
Yes and no. To the extent that private
and public institutions have made
the necessary commitment from the top
and are working to intervene in the
ecosystem of change, we are confident
they will, given time, reach their goal.
Too many companies have yet to grasp
the case for change, however, and
still lack both commitment and a program of action. For these institutions,
gender parity will take longer to achieve.
As a member of the 30% Club, our
global managing director Dominic Barton
(also a coauthor here) is one of

47 US chairpersons and CEO members
who have publicly committed to
better gender equality at all levels. This
commitment reinforces efforts we
have under way to challenge fundamental
mind-sets and behaviors inside the
firm while setting (or continuing) in motion
a number of initiatives in support of
gender diversity. These range from new
flexibility programs, adjustments
to travel expectations, and upgrades to
maternity benefits, among others.
Were working also to improve the quality
of sponsorship women receive at the
firm. A new diagnostic were piloting, for
instance, aims to create transparency
in the sponsorship arrangements among
all our consultants, many of whom
we have found to be unsure what good
sponsorship entails or how to create
it when its lacking. To help make all this
happen, we now have a global team
of managers fully dedicated to this issue,
Gender equality: Taking stock of where we are
and a network of deeply passionate

leaders actively driving this topic
throughout the firm.
Were acutely aware that there will be
surprises along the way. Heres one: so
far, a higher percentage of men than
women have been taking advantage of
some of our flexibility programs. Do
some women at McKinsey, like their
counterparts at many companies, worry
that participating in such programs will
raise questions about how committed
they are to their careers? We hope
not, but we are exploring ways to dispel
any concernsfor example, by refining
our up or out promotion system to
ensure people can stay in the same roles
for longer periods of time with no impact
on their eventual advancement if they
are at a stage in life where they need that
flexibility. As a project-based organization, we think were reasonably well
positioned to pull this off.
Clearly, we dont have all the answers.
Gender inequality is a multifaceted,
entrenched global issue. But our commitment to diversity and inclusion
is an abiding part of our firms history
and daily practice. That we have
yet to achieve it only further strengthens
our determination to do so.
89
1 For

more about the research, visit McKinseys
Women Matter page, at mckinsey.com/features/

women_matter.
2 For

more, see McKinsey & Co., Working Mother,
September 9, 2015, on workingmother.com/

mckinsey-co.
3 For

more about the United Nations HeForShe
initiative, visit heforshe.org; for more about the

30% Club, visit 30percentclub.org.
4 See How to beat the transformation odds, April
Dominic Barton is McKinseys global

managing director; Sandrine Devillard is
a director in the Paris office and has helped
lead McKinseys research on gender diversity
for more than a decade; Judith Hazlewood
is a director in the New Jersey office and a
member of McKinseys Shareholders Council.
90
2015 Number 4
Digging into the

numbers on gender
equality
Highlights from recent research
The challenges and the opportunities
of enabling women to reach their
full economic potential have been highlighted in two major reports published
in 2015.
nongovernmental organizations in
bridging the gender gap, and lists six
types of intervention, including financial incentives, capability building, and
advocacy and shaping attitudes.
Analysis1 by the McKinsey Global

Institute (MGI) showed that world GDP
could jump by $12 trillion over the
next 10 years under a scenario whereby
all countries make the same rate of
progress toward gender equality as the
fastest-improving country in their
region (Exhibit 1). MGI found that 40 of
the 95 countries it mapped for the
study have high or extremely high levels
of gender inequality with respect to
at least half of the 15 indicators it used,
covering everything from the workplace and essential services to legal
protection and physical security.
The scale of that task, however, was

emphasized in a second report
a study undertaken by LeanIn.Org and
McKinseyshowing that women are
underrepresented at every level in the
corporate pipeline, are less likely to
advance than men, and face more barriers to senior leadership. Women in
the Workplace,2 a comprehensive survey
of the state of women in corporate
America, follows a similar initiative conducted by McKinsey alone in 2012.
While this is alarming, the potential, on

the other hand, is enormous: the
economic boost from a best in region
scenario would be equivalent in size
to the current GDP of Germany, Japan,
and the United Kingdom combined,
or twice the likely growth in global GDP
contributed by female workers
between 2014 and 2025 under businessas-usual conditions. MGI concludes
that businesses will need to play a more
active role with governments and
Exhibit 2 comprises employee-pipeline

data from 118 companies in the 2015
report and 60 companies in 2012.
If progress doesnt pick up from the
modest rate of the last three years,
the data suggest it will take decades to
reach parity in the C-suite.
1 For

more on the research, see The power of
parity: How advancing womens equality can add

$12 trillion to global growth, McKinsey Global
Institute, September 2015, on mckinsey.com.
2 For

more, see the full report, Women in the
Workplace, 2015, on womenintheworkplace.com.

Q4 2015 Digging into the numbers on gender equality

Gender Charticles
Exhibit 1 of 2
91
Exhibit 1
If every country matched the progress toward gender parity of its fastestmoving neighbor, global GDP could increase by up to $12 trillion in 2025.
Incremental global GDP over
business-as-usual scenario,1 %
$ trillion
India
16%
0.7
Latin America
14%
1.1
China
12%
2.5
Sub-Saharan Africa
12%
0.3
North America and Oceania
11%
3.1
World
11%
11.8
Middle East and North Africa
11%
0.6
South Asia (excl. India)
11%
0.1
Western Europe
9%
2.1
Eastern Europe and Central Asia
9%
0.4
0.9
8%
Q4 2015
1 Sample
Gender
Charticles
= 95 countries.
Source:
IHS;2
ILO;
Exhibit
ofOxford
2 Economics; World Input-Output Database; national statistical agencies; McKinsey Global
East and Southeast Asia (excl. China)
Institute analysis
Exhibit 2
Women are underrepresented at every level of the corporate pipeline.
Corporate-talent pipeline by gender
Entry-level
professional
Manager
Senior
manager/
director
Vice
president
Senior
vice
president
C-suite
Men
Women
Women in the pipeline, %

2012
42
33
28
23
20
16
2015
45
37
32
27
23
17
Source: Data for 2012 are from Unlocking the full potential of women at work, in which McKinsey examined the
employee pipeline of 60 US corporations. Data for 2015 are from Women in the Workplace, in which LeanIn.Org and
McKinsey examined the employee pipeline of 118 US corporations.
John Lund/DigitalVision/Getty Images
92
93
An executives
guide to the Internet
of Things
Jacques Bughin, Michael Chui, and James Manyika
The rate of adoption is accelerating. Here are

six things you need to know.
As the Internet of Things (IoT) has gained popular attention in

the five years since we first published on the topic,1 it has also
beguiled executives. When physical assets equipped with sensors give
an information system the ability to capture, communicate, and
process dataand even, in a sense, to collaboratethey create gamechanging opportunities: production efficiency, distribution, and
innovation all stand to benefit immensely. While the consumers
adoption of fitness bands and connected household appliances
might generate more media buzz, the potential for business usage
is much greater. Research from the McKinsey Global Institute
suggests that the operational efficiencies and greater market reach
IoT affords will create substantial value in many industries.2
There are many implications for senior leaders across this horizon
of change. In what follows, we identify three sets of opportunities: expanding pools of value in global B2B markets, new levers of
operational excellence, and possibilities for innovative business
models. In parallel, executives will need to deal with three sets of
challenges: organizational misalignment, technological interoperability and analytics hurdles, and heightened cybersecurity risks.
1 See

Michael Chui, Markus Lffler, and Roger Roberts, The Internet of Things, McKinsey
Quarterly, March 2010, mckinsey.com.
2 For

the full McKinsey Global Institute report, see The Internet of Things: Mapping the
value beyond the hype, June 2015, on mckinsey.com. We analyzed more than 150 IoT
use cases across the global economy. Using detailed bottom-up economic modeling, we
estimated the economic impact of these applications across a number of dimensions.
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2015 Number 4
Opportunities beckon . . .
IoTs impact is already extending beyond its early, most visible applications. A much greater potential remains to be tapped.
Creating B2B value globally

To make the Internet of Things more understandable, media coverage has often focused on consumer applications, such as wearable
health and fitness devices, as well as the automation products that
create smart homes. Our research reveals considerable value
in those areas. Yet the more visible manifestations of IoTs power
shouldnt distract executives from a core fact: business-to-business
applications will account for nearly 70 percent of the value that we
estimate will flow from IoT in the next ten years. We believe it could
create as much as $11.1 trillion a year globally in economic value in
nine different types of physical settings (Exhibit 1). Nearly $5 billion
would be generated almost exclusively in B2B settings: factories in
the extended sense, such as those in manufacturing, agriculture, and
even healthcare environments; work sites across mining, oil and
gas, and construction; and, finally, offices.
Theres also a global dimension to IoTs B2B potential. Over the next
ten years, the total economic impact from IoT will be greater in
advanced economies, given the possibility of larger cost savings and
higher adoption rates. However, emerging markets, whose
manufacturing-intensive economies often supply goods to final
manufacturers, will be prime areas for IoT adoption.
An estimated 38 percent of IoTs overall worldwide value will likely
be generated in developing economies, and eventually, the number
of IoT deployments in such markets could surpass those in developed
ones. In fact, deployments in developing economies are likely to
exceed the global average in work-site settings (such as mining, oil
and gas drilling, and construction) and in factories. For instance,
China, with its large and growing industrial and manufacturing base,
stands to reap major benefits not only on the factory floor but also
in product distribution. In fact, developing economies could leapfrog
the developed world in some IoT applications because there are
fewer legacy technologies to displace.
Q4 2015
An executives guide to the Internet of Things
Internet of Things
Exhibit 1 of 2
95
Exhibit 1
The Internet of Things offers a potential economic impact of $4 trillion
to $11 trillion a year in 2025.
Nine settings
where value may accrue
Size in 2025, $ trillion1

Low estimate
High estimate
Factorieseg, operations management,

predictive maintenance
1.23.7
Citieseg, public safety and health, traffic control,

resource management
0.91.7
Humaneg, monitoring and managing illness,

improving wellness
0.21.6
Retaileg, self-checkout, layout optimization,

smart customer-relationship management
0.41.2
Outsideeg, logistics routing, autonomous

(self-driving) vehicles, navigation
0.60.9
Work siteseg, operations management,

equipment maintenance, health and safety
0.20.9
Vehicleseg, condition-based maintenance,

reduced insurance
Homeseg, energy management, safety and
security, chore automation
Officeseg, organizational redesign and worker
monitoring, augmented reality for training
0.20.7
0.20.3
0.10.2
Total $4 trillion$11 trillion

1 Adjusted to 2015 dollars; for sized applications only; includes consumer surplus. Figures do not sum to total, because
of rounding.
Source: McKinsey Global Institute analysis
Optimizing operations
Investing in IoT hardwarefrom sensors embedded in manufacturing equipment and products to electronically tagged items along
the supply chainis only the starting point of the value equation.
The biggest competitive gains come when IoT data inform decisions.
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2015 Number 4
Our work shows that most of the new business value will arise from
optimizing operations. For example, in factories, sensors will
make processes more efficient, providing a constant flow of data to
optimize workflows and staffing:
Sensor data that are used to predict when equipment is wearing
down or needs repair can reduce maintenance costs by as much as
40 percent and cut unplanned downtime in half.
I nventory management could change radically, as well. At autoparts supplier Wurth USA, cameras measure the number
of components in iBins along production lines, and an inventorymanagement system automatically places supply orders to refill
the containers.
In mining, self-driving vehicles promise to raise productivity by
25 percent and output by 5 percent or more. They could also
cut health and safety costs as much as 20 percent by reducing the
number of workplace accidents.
IoT systems can also take the guesswork out of product development by gathering data about how products (including capital goods)
function, as well as how they are actually used. Using data from
equipment rather than information from customer focus groups or
surveys, manufacturers will be able to modify designs so that new
models perform better and to learn what features and functionality
arent used and should therefore be eliminated or redesigned. By
analyzing usage data, for example, a carmaker found that customers
were not using the seat heater as frequently as would be expected
from weather data. That information prompted a redesign to allow
easier access: the carmaker updated the software for the dashboard
touchscreen to include the seat-heater command. This illustrates
another capability of connected devices: with the ability to download
new features, these products can actually become more robust and
valuable while in service, rather than depreciate in value.
Despite this value, most data generated by existing IoT sensors are
ignored. In the oil-drilling industry, an early adopter, we found
97
that only 1 percent of the data from the 30,000 sensors on a typical
oil rig are used, and even this small fraction of data is not used
for optimization, prediction, and data-driven decision making, which
can drive large amounts of incremental value.
Creating innovative business models

IoT can also spur new business models that would shift competitive dynamics within industries. One example is using IoT data
and connectivity to transform the sale of industrial machinery and
other goods into a service. The pioneers of this trend were jetengine manufacturers that shifted their business model to selling
thrust and ancillary services rather than physical equipment.
Now these models are proliferating across industries and settings.
Transportation as a service, enabled by apps and geolocation
devices, is encroaching on vehicle sales and traditional distribution
alike. Manufacturers of products such as laser printers with IoT
capabilities are morphing into robust service businesses.
IoT makes these business models possible in a number of ways. First,
the ability to track when and how physical assets are actually used
allows providers to price and charge for use. Second, the combined
data from all these connected assets help a supplier to operate
equipment much more efficiently than its customers would, since its
customers would only have a limited view of their own equipment
if they purchased and ran it themselves. Furthermore, analysis of IoT
data can enable condition-based, predictive maintenance, which
minimizes unplanned downtime.
This business-model shift will require product companies to
develop and flex their service muscles. Product development, for
instance, becomes service development, where value is cocreated
with customers. It wont be enough to focus on the product features
customers will pay the most for. Developers will need to understand the business outcomes their customers seek and learn how to
shape offerings to facilitate those outcomes most effectively.
Service providers will also have to take on capacity-planning
functionsincluding planning for peak usage and utilizing IoT data
to forecast demand.
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2015 Number 4
. . . but challenges remain

As with any major technological shift, realizing IoTs potential will
require significant management attention not just to new technical
imperatives but also to organizational issues.
Aligning the organization

IoT will challenge traditional organizational roles as information
technology becomes widely embedded across assets, inventories,
and operations. One focal point will be the IT function, for the
Internet of Things requires it to assume a transformed role that
spans beyond computers, networks, mobile devices, and data centers.
Instead, IT will have to join with line managers to oversee IoT
systems that are essential to improve both the top and bottom lines.
In retailing, for instance, one of the largest sources of value could
be the sales lift that real-time, in-store personalized offers are
expected to deliver. This will require the sophisticated integration
of data across many sources: real-time location data (the shoppers
whereabouts in a store), which would link to data from sensors
in the building; customer-relationship-management data, including
the shoppers online-browsing history; and data from tags in the
items on display, telling the customer to enter a specific aisle, where
he or she could use an instant coupon sent to a phone to buy an
item previously viewed online. In short, information technology and
operations technology will converge, both technically and in
their metrics of success. As a result, companies will have to align
their IT and operational leadership tightly, though traditionally
these functions tended to work separately and, more often than not,
held each other at arms length.
Beyond expanding ITs role, IoT will challenge other notions
of organizational responsibilities. Chief financial, marketing, and
operating officers, as well as leaders of business units, will have
to be receptive to linking up their systems. Companies may need to
train employees in new skills, so the organization can become
more analytically rigorous and data driven. Analytics experts and
data scientists must be connected with executive decision
makers and (to optimize insights from the new data) with frontline
managers. In some cases, the decision makers will be algorithms.
When companies need large-scale real-time actionsuch as
99
optimizing the control of equipment across an entire factoryIoT

systems will make decisions automatically. Managers will monitor
metrics and set policy.
Overcoming interoperability and analytics hurdles

Strategies that use IoT data in an effective way often call for interoperability. We estimate that nearly 40 percent of the potential
value, on average, will require different IoT systems to communicate
with one another and to integrate data (Exhibit 2). Relatively little
of that is happening now. For example, on offshore oil platforms
today, components such as pumps are often installed as connected
devices, but in a limited fashion: devices individually connect
back to their manufacturers, which monitor and control machines
and can optimize their maintenance and performance individually.
However, data from multiple components and systems must be
combined to identify more than half of the predictable performance
issues that arise in day-to-day platform operations, including those
that could impact overall oil-production volumes.
Many large companies will have enough market power to specify that
their IoT vendors make systems interoperable. In some cases, this
will lead vendors to choose common standards that will ultimately
speed up adoption. In other cases, interoperability could also be
achieved with software platforms designed to combine data from
multiple systems. That will create new market opportunities
for companies capable of integrating data from diverse sources.
However, simply bringing data together from different IoT systems
wont be enough. Indeed, IoT may exacerbate many of the challenges
we have observed when companies use big data.3 In moving to a
world where IoT is used for prediction and optimization, companies
face an analytics challenge. Theyll need to develop or purchase,
to customize, and then to deploy analytical software that extracts
actionable insights from the torrent of data IoT will generate.
And in many cases, the algorithms embedded in this software will
have to analyze data streams in real timea task many traditional
analytical tools are not designed to do. This offers another potential
market opportunity for innovative software developers.
3 For

more, see Big data: The next frontier for innovation, competition, and productivity,
McKinsey Global Institute, May 2011, on mckinsey.com.
Q4
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2015 2015 Number 4

Internet of Things
Exhibit 2 of 2
Exhibit 2
IoTs interoperability could deliver over $4 trillion out of an $11 trillion

economic impact.
The Internet of Things (IoT): examples
of how interoperability enhances value
Potential economic
impact,1 2025, $ trillion
Factoriesdata from different types of

equipment used to improve line efficiency
% of total value
within setting
1.3
36
Citiesvideo, cell-phone data, and sensors

used to monitor traffic and optimize flow
0.7
43
Retailpayment and item-detection

systems linked for automatic checkout
0.7
57
Work sitesworker- and machinerylocation data used to avoid accidents
0.5
Vehiclesequipment-usage data used in

presales analytics and insurance underwriting
0.4
56
44
Agriculturemultiple sensor systems used

to improve farm management
0.3
20
Outsideinventory levels monitored at

various stages of the supply chain
0.3
29
Homesdata from household energy systems

used to track time usage
0.1
17
Officesdata from building systems and

other buildings used to improve security
<0.1
30
1 Includes sized applications only; includes consumer surplus.
Source: Expert interviews; McKinsey Global Institute analysis
Facing up to the security imperative

The prospect of implementing the Internet of Things should prompt
even greater concern about cybersecurity among executives.
IoT poses not only the normal risks associated with the increased
use of data but also the vastly greater risks of systemic breaches
as organizations connect to millions of embedded sensors and communications devices. Each is a potential entry point for malicious hackers, and the damage from a break-in can be literally life
threateningdisrupting machine-control systems on an oil rig
101
or in a hospital, for example. The same interoperability that creates

operational efficiency and effectiveness also exposes more of a
companys units to cyberrisks. Growing interconnections among
companies and links with consumer devices will create other
challenges to the integrity of corporate networks, too.
Companies will need to rely on the capabilities of vendors to
mitigate some of these risks. However, preparing for a revolutionary
change in distributed connectedness and computation will also
require a new strategic approach, which our colleagues have described
as digital resilience.4 In other words, companies need to embed
methods of protecting critical information into technology architectures, business-model-innovation processes, and interactions
with customers. They can start by assessing the full set of risks in an
integrated way and by creating an extensive system of defenses
that will be hard for hackers to penetrate. Companies also need to
tailor cybersecurity protections to the processes and information
assets of each of their businesses, which in an IoT world will increasingly be linked. Given the extent of the risks and the cross-functional
nature (and significant cost) of the solutions, progress will require
senior-level participation and input.
IoT will soon become a differentiating factor in competition. Senior

leaders and board members must take a systems approach to
address the organizational challenges and risks this expansion of the
digital domain will create. That will allow companies to capture the
full range of benefits promised by the Internet of Things.
4 See Tucker Bailey, James M. Kaplan, and Chris Rezek, Repelling the cyberattackers,
McKinsey Quarterly, July 2015, mckinsey.com.
The authors wish to thank McKinseys Dan Aharon and Mark Patel for their
Jacques Bughin is a director in McKinseys Brussels office; Michael Chui is a
partner at the McKinsey Global Institute, where James Manyika is a director.
samxmeg/E+/Getty Images
102
103
Knowing when corporate

headquarters adds rather
than subtracts value
Andrew Campbell and Gabriel Szulanski
Reduce value destruction by applying three

tests to initiatives from the center.
Its a familiar dilemma for managers in corporate headquarters

everywhere: how to add value to operating units without inadvertently
subtracting it through misguided influence, bureaucracy, delays,
and time wasting.
Consultants and academics, ourselves included, have wrestled with

this challenge for years. We know many head-office initiatives that
successfully exploited economies of scale, uncovered opportunities
to cross-sell products, or devised strategies to share valuable
knowledge. But the net impact of many others is negative. Why else,
after all, do spin-offs from large conglomerates often perform well
after being released from the warm embrace of the parent company?
Why do executives in divisions complain so frequently about
corporate functions and initiatives?
We have been experimenting with three simple tests that help
companies reduce the risks of unproductive interference by head
offices.1 They entail asking whether the project adds significant
value, whether there are risks of unintended value subtraction, and
whether the initiative will encounter barriers to implementation.
In this article, well describe the application of these tests to one
companys recent efforts to improve its websites, as well as another
companys initiative to make its sales force more effective (see
sidebar, Failing to surmount the barriers, on page 108). But
analytical tools alone are not enough, so we also reflect on how
1 The

first two tests evolved out of Andrew Campbells work on centralization. For more,
see Andrew Campbell, Sven Kunisch, and Gnter Mller-Stewens, To centralize or not to
centralize, McKinsey Quarterly, June 2011, on mckinsey.com.
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2015 Number 4
to improve the dialogue between business units and the center. That
interaction is critical to the effectiveness of the three tests.
The three tests in action

The project to improve websites was typical of many head-office
initiatives. The managers concerned wanted to go ahead with
an upgrade to make the sites more mobile friendly and improve their
search rankings, as well as integrate the sites across the companys
four businesses. The stakes may seem small, but its easy, even with
the best of intentions, to do more harm than good. Thats why
we believe that managers at headquarters and in the businesses need
rules of thumb to guide such decisions.
Some head-office initiativespreparing financial statements, paying
taxes, or conducting internal audits, for exampleare required
for external governance or compliance and form part of an organizations right to do business. But many others, such as the website
example, are discretionary and can be evaluated with our addedvalue, subtracted-value, and barriers-to-implementation tests.
1. The added-value test

Head-office projects should focus on significant opportunities. A
corporate headquarters, after all, only has a limited amount of executive capacity, and the business units themselves can only cope
with a limited number of initiatives from the center. So what is a significant opportunity? Our rule of thumb is that such projects should
have the potential to improve a companys overall performance
sales, profits, return on assets, or value to beneficiariesby a number
that is large enough to make the risk of subtracting value worth
taking. As a starting point, we suggest 10 percent. The exact number
isnt important; it could be 5 percent or 20 percent, as long as it is
large enough to command the attention of HQ executives.
In the case of the company that wanted to improve its websites,
the upgrade was likely to deliver a considerable increase in sales: the
number of mobile users was increasing and search rankings were
becoming significant. A 10 percent impact was not impossible. So the
project, at least on the overall level, appeared to pass this test. But
Knowing when corporate headquarters adds rather than subtracts value
105
we have learned from experience that good evaluation calls for

disaggregating projects into their component parts and applying the
added-value test to each part.
It was clear that all of the websites in question needed an upgrade. But
the issue was whether to manage the project from the center or
in a more decentralized way. A center-led project would not generate
sales 10 percent higher than a decentralized project would. Also,
the second goal of more fully integrating the four websites would, on
its own, not have passed the 10 percent test.
The analysis would have been speculative, and managers might
have disagreed. But it would have been hard to argue that centralized project management of the upgrade or greater integration
of the websites would deliver significantly more than a decentralized,
nonintegrated approach.
This suggests that the head-office project should not go ahead unless
the results of the other two tests were favorable. It is OK to pursue
small sources of added value if the risk of subtracted value is low and
there are few barriers to execution.
2. The subtracted-value test

This test may seem obvious, but companies rarely apply it in a formal
way. Managers in business divisions may be more sensitive to the
risk of subtracted value than managers at headquarters, who may be
overoptimistic, but neither side is wholly unbiased. Anecdotes from
previous company initiatives and an analysis of possible downsides
can help uncover areas where value could be subtracted.
For the upgrade objective, a plan to centrally manage the project
appeared to involve relatively few risks of subtracting value. One risk
was timing. Separately managed projects would let each unit
choose the moment most suited to its business needs. Another risk
was complexity. It might have proved harder to upgrade all sites
simultaneously. But neither risk seemed large. However, raising the
issue of subtracted value can suggest ways to manage projects
with a view to reducing even these small risks.
The risks were greater for the integration objective. Integration would
require some control of standardization from the center, which
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2015 Number 4
might reduce initiative in the businesses or their willingness to

experiment. So the subtracted-value test suggests that centralizing
the upgrade could be sensible, but the integration objective might
be risky.
3. The barriers-to-implementation test

The barriers test allows executives to assess the likelihood that a
project will be well implemented. Academic research on initiatives
to transfer skills and good practices has helped us distill a list
of nine barriers to successful implementation. Weve observed that
projects facing more than three of these barriers are so unlikely
to be implemented successfully that they are not worth pursuing
(see exhibit).
In upgrading the websites, the company faced only one barrier: the
project leader had not led a similar project before and therefore
wasnt fully credible. But he was well supported by outside advisers.
As for the integration part of the project, there were a number of
barriers. Neither the project leader nor the consultants had the
necessary skills. It wasnt clear what should be integrated to achieve
a good outcome. There was little evidence that integration would
increase sales or cut costs. Moreover, some of the businesses were
lukewarm about integration and thus not likely to embrace it fully.
There was little contextual pressure for integrationno burning
platform. With at least five barriers to implementation, this part of
the project would have failed the implementation test.
The verdict
Generally, if the opportunity to add value is big, it may be worth
trying to manage subtracted value, to look for ways around the implementation barriers, or both. But if the opportunity to add value
is small, problems with either of the other two tests should suffice to
deter the initiative.
In the case of the website project, the three tests support managements instinct to centralize the upgrade part of the project. But
107
the integration part should only move forward if ways could be

found to reduce the risks of subtracted value and to remove barriers
to implementation.
In reality, the company launched a project to achieve both objectives, with unfortunate results. While the upgrade was successful,
integration delivered few benefits at a high cost. The project ran
over budget and was late, which was damaging to one business with
a summer sales peak. Moreover, after the project was complete,
the policies put in place to protect standardization discouraged the
businesses from experimenting with ways to upgrade their sites.
Looking back, the business heads doubt that the project in total added
Q4 2015 much net value. They would have preferred to have kept control
Corporate of
HQ
their own sites.
Exhibit 1 of 1
Exhibit
Initiatives facing more than three of the following barriers to
implementation are less likely to succeed.
The actions
needed for a good
outcome are poorly
understood
There is little
evidence that a
proposed change
will yield improved
results
The designated
change agent is
not motivated to
lead the project
The change agent

does not have
credibility
People whose
contributions to the
project will be
needed arent
motivated
People who will

have to change
their behavior will
probably find it
hard to do so
Few spare
resources are
available to
help those who
need to change
There is little
contextual
pressure to
motivate change
The managers
concerned have
a history of poor
relationships
Source: Adapted from Gabriel Szulanski, Sticky Knowledge: Barriers to Knowing in the Firm, London: SAGE
Publications, 2003
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2015 Number 4
Failing to surmount the barriers

A technology company we know
launched an initiative to identify
strong sales-force practices within
its international division and to
transfer them across the divisions
country-based units. The project
was called Wave II, stimulated by a
successful projectWave Ithat
had focused on revenue-growth
opportunities.
Wave II involved identifying good
practices in the sales processes of
the different country units. These
processes were then to be
consolidated into a best-practice
template for a set of software
modules that the entire sales force
could use.
The project passed the added-value
test: managers knew that the
performance of the sales force in
different countries varied by as
much as 25 percent. If the company
could reduce this variation and the
country-based units with the
best-performing sales forces could
improve their current levels, the
payoff would be well above 10 percent.
In addition, the project passed the
subtracted-value test. The sales
task in each country was similar, so
it wasnt likely that standardized
processes would harm any of the

country-based units. Moreover,
the project team contained people
from different countries, so its
members would probably know
which ideas were universally
applicable and which would work
only in some places.
However, unlike Wave I, Wave II
faced several barriers to implementation. First, there was no urgency
for change. As one manager
explained, we had an excellent
year . . . outperforming the US part of
the group, so why make changes?
There is no crisis. Second, there
was no hard evidence to convince
skeptics that a good practice in
one country would work in another.
Third, changes in each country
would need to happen in quick
succession because the changes
were linked. This would make it hard
for the country units to implement
them. Fourth, few extra resources
were available to support countries
making changes.
Unfortunately, managers
implemented the project without
considering the barriers. Not
surprisingly, after six months, the
initiative was not showing results
and was cancelled.
Process supports
The three tests are not simple calculations. Judgment is required, and
we are not suggesting that the judgments are trivial. Moreover,
the tests are easier to apply in hindsight than before a project starts.
We also know that analysis alone is not sufficient. Good decisions
109
come from a dialogue between headquarters managers and business managers based on mutual respect. Each side has something
to offer. Because they have access to the big picture, managers
at headquarters may see opportunities to add value that business
managers miss. Business managers, on the other hand, are better
positioned to detect subtracted value and implementation barriers.
Organizational clarity
A clear understanding of the division of responsibilities between
headquarters and business units is always helpful. Franchise
organizations provide an extreme but instructive metaphor. The
franchisees (that is, the business divisions) are clearly less powerful than the franchisor (headquarters). But all parties understand
that the relationship will work only if the franchisor provides
value for the franchisees and if the franchisees have autonomy in
all areas not covered by the franchise agreement. Both sides
should evaluate any new initiative by the franchisor to test the likely
impact on added and subtracted value.
Without clarity, power struggles and competing agendas can
emerge when companies fail to communicate the different roles that
headquarters, functions, and businesses should play.
Measuring perceived added value

Although the value that headquarters adds cant always be measured
in financial terms, companies can gauge perceptions. One approach
is to ask senior managers in business divisions, every three or
six months, to assess the net added value of different headquarters
functions, processes, policies, and projects on a simple scale of
one to ten. A low score typically sparks a dialogue.
The main argument against such an evaluation process is that
headquarters sometimes needs to use tough love and hard-to-take
medicine, and that the business units may therefore rate headoffice performance unfairly. But our experience suggests that managers in the businesses understand the benefits of tough love.
And headquarters, of course, can always choose how to react to a bad
score after engaging in the appropriate dialogue.
Blowing the bureaucracy whistle

Our final suggestion is to give all managers, especially those in the
business divisions, a notional bureaucracy whistle. Like the
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2015 Number 4
famous andon cord, the emergency cable once strung above Toyota
production lines that brought managers and engineers running to
pinpoint the problem so as to minimize downtime, the bureaucracy
whistle should trigger a similarly focused dialogue.
Every month or every quarter, an appropriate management committee can review the reported bureaucracy issues. Of course, such a
committee runs the risk of becoming a bureaucracy in its own right.
But at the very least, it will show the organization the importance of
keeping an eye on subtracted value.
Andrew Campbell, an alumnus of McKinseys London and Los Angeles offices,
is a director of the Ashridge Business Schools Strategic Management Centre
in the United Kingdom. Gabriel Szulanski is a professor of strategy at INSEAD
in Singapore.
111
Closing View
How should you tap into

Silicon Valley?
Not by sticking a toe in the water. Get your
management team aligned and then commit.
Alex Kazaks is a
principal in McKinseys
San Francisco office.
Eric Kutcher is a
director in the Silicon
Valley office.
Michael Uhl is a
principal in the Silicon
Valley office.
The roughly 1,800-square-mile area commonly known

as Silicon Valley, southeast of San Francisco Bay, is home
to just three million peopleslightly less than 1 percent
of the US population. Yet the Valley, seat of several worldclass universities and numerous cutting-edge enterprises,
has become an economic and innovation powerhouse whose
importance is hugely disproportionate to its small physical
size. If it were a country, it would rank among the worlds
50 largest economies, larger than those of Hungary, Vietnam,
and New Zealand, among others. In 2013, Silicon Valley
generated over 12 percent of US patent registrations and
produced about 11 percent of new US-company IPOs, and the
greater Bay Area attracted almost 40 percent of US venturecapital (VC) investment.1 More than a few ideas hatched
in the Bay Area have paid off handsomely. Thirty-two of the
50 private start-ups with valuations at or exceeding $1 billion are based there. This is not a new phenomenon, of course.
Bay Area enterprises have been creating new markets and
disrupting a wide swath of industries for decades.
As companies everywhere strive to stay ahead of the digital
revolution, the payoff from engaging with Silicon Valley can be
substantial. BMW, which first arrived there almost 20 years
ago, linked up with Apple to become the first carmaker to integrate the iPod into its vehiclesan initiative that likely would
not have been possible without a physical presence in the area.
BMWs development of its i3 electric vehicle also benefited
from collaboration with other Valley companies.2
No silver bullet
But for every success, companies launch many haphazard
Valley initiatives that yield little and end in disappointment.
Consider, for example, the Bay Area networking offices
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2015 Number 4
beloved of many outsiders. These attempts to get a foot in the

door typically involve establishing a small outpost charged
with responsibility for networking with VC funds, leading area
businesses, and promising Valley start-ups. Many companies
find it difficult to make this model work. Even if employees in
these offices can identify winning ideasno sure thing, of
coursetheir potential tends to get watered down or lost as
the news is passed back to corporate headquarters and up
the chain of command. Often, opportunities are squandered,
and frustrated employees at the satellite office leave to join
some fast-growing Valley employer.
Companies that set up their own venture-capital funds or corporate-investment arms often report disappointing results,
too. In the Bay Area, after all, money is generally less important
than good connections; well-established entrepreneurs and
VCs there tend to stick together and pick winners cooperatively.
Even corporate-backed entities flush with money struggle
to embed themselves in the local network. Intel Capital
launched by one of the Valleys original corporate pillarsis
a notable exception, but many more fail to make meaningful
contributions to their corporate parents or dont follow a
coherent corporate strategy in training their sights on target
companies. For many big businesses looking in from the
outside, creating a venture fund is a difficult way to channel the
Valleys entrepreneurial spirit and generate fresh ideas.
A practical playbook
In our experience, there are three proven ways to engage with
Silicon Valley and tap into its zeitgeist.
The innovation boot camp
One option is a visit to Silicon Valley, typically for a few days
and often undertaken by an organizations board or highest
executives. Consider it an innovation boot camp. The goal is
to immerse company leaders in the Valleys entrepreneurial
approach, which can be an invaluable means of galvanizing
members of a top team to act.
The board of a large North American bank, for example,
recently visited Silicon Valley because that institution, like
How should you tap into Silicon Valley?
113
other financial playersand indeed like companies in many

other industrieswas beginning to foresee a future in which
unprecedented technological change would disrupt its
business model. What the board found most valuable from its
boot-camp experience wasnt learning about specific digital
platforms or uncovering new fintech systems but getting to
know the culture of innovation and grasping the importance
of accelerating the banks digitization program. The boards
perspective shifted as it considered how the Valleys
companies approach challenges entrepreneurially, with an
eye to industry transformation; what kind of talent these
companies require; and how the banks model had to become
more customer focused. Indeed, one board member described
the experience as the banks highest ROI project; another
said, We saw more change and urgency introduced in
the board in the last two days than in the entire last two years.
Other companies we know have benefited similarly, using
visits to Silicon Valley to help craft a digital strategy and develop
valuable relationships with senior Bay Area executives.
Targeted strategic partnerships

Properly executed, partnerships with a Silicon Valley enterprise
can hit the sweet spot, especially for companies that sense
a closing window of time before technology disrupts their core
business. Broadly, these combinations tend to take one of two
forms. In the first, two large companiesone in Silicon Valley,
the other based elsewhereagree to collaborate on a new
technology. Such combinations between local and nonlocal
giants can succeed. For example, the initiative between Google
and the Swiss pharmaceutical company Novartis to develop
contact lenses that can, among other uses, monitor the
glucose levels of diabetes patients is showing early progress.
Yet the partnership of equals approach can encounter
significant barriers; two large enterprises often find it difficult to
work together and frequently get bogged down in logistics.
By contrast, large non-Valley companies that partner with
Valley-based start-ups tend to move quickly: the smaller, more
nimble company pilots leading-edge ideas and technologies, while the big-branded partner helps refine and scale the
product. Done properlywith C-level strategic urgency on
both sidesthese can be winwin partnerships. Case in point:
114
2015 Number 4
the arrangement between the major hotel chain Four Seasons

and start-up Medallia, developer of a digital platform that
captures customer feedback and helps manage customer
experiences across properties. The relationship not only
helped make the smaller company an industry leader but also
enabled the large hotelier to become world class at anticipating its guests needs.
Bigger bets
More ambitious but potentially fruitful endeavors include
opening technology centers in Silicon Valley and using acquisitions to access local talent and cultivate a more innovative
culture away from legacy operations. These initiatives immerse
companies in Silicon Valleys culture more fully than toe in
the water networking offices do and have more credibility. A
classic example is GEs San Ramonbased Software Center,
which the company launched in 2012 after concluding that the
Internet of Things would significantly affect several of its core
businesses and that it still had time to build an IoT capability
from the ground up. GE attracted local talent from industry
leaders and start-ups alike and made substantial investments to achieve the needed scale. Currently, annual revenues
generated by the initiative have reached about $1 billion
annuallyand are growing.
Walmarts experience is another example. After several false
starts, and under pressure from large Internet retailers, its
e-commerce business relocated to Silicon Valley, where it has
become one of the three largest e-commerce enterprises
in the United States, with more than two thousand employees.
Ultimately, Silicon Valleys sauce is no secret. Its ecosystem

benefits from a highly educated workforce and a critical mass of
excellence drawn from across the globein 2011, college
graduates born outside the United States held 60 percent of
the areas science and engineering jobs. This talent can thrive
in a culture where personal networks run deep, noncompete
agreements are restricted, disruption is celebrated, and failure
is considered a rite of passage.
The three models weve highlighted for tapping into that ecosystem are points on a spectrum. The applicability of any of
these models depends on how well aligned a top-management
How should you tap into Silicon Valley?
115
team is about the challenges on the horizon, the time a company

has before they become real, and their potential impact.
GEs big bet on the Internet of Things, for example, reflected
the strong alignment of its management team, as well as
an understanding of the coming disruption and a belief that
the company had enough time to act itself. For others, the
ship may already have sailed, leaving them no choice but to
buy their way in or to go in a different direction entirely. The
key for most companies in a rapidly digitizing world is
to take stock of what Silicon Valley has to offer for their own
circumstances and then to chart a course accordingly.
1 S
ee 2015 Silicon Valley Index, Silicon Valley Institute for Regional Studies,
February 2015, jointventure.org.
2 R achael King and Steven Rosenbush, Mining Silicon Valleys culture,
Wall Street Journal, July 24, 2013, wsj.com.
The authors wish to thank McKinseys Deepika Chauhan for her

contribution to this article.
116
Extra Point
The global gender-parity landscape

Q4
The 2015
McKinsey Global Institute has analyzed gender issues in 95 countries, using 15 indicators
Extra
Point:
Gender
to measure
the MGI
cumulative
global extent of gender inequality. These indicators encompass
Exhibit
1
of
1
its physical, social, political, and legal dimensions, in addition to workforce participation. Six
out of the 15 stand out for their high levels of gender inequality.
% of countries1
Gender inequality
Low
Medium
High
Extremely high
100%
1
4
13
25
38
42
47
67
23
84
68
58
42
35
26
Political
Unpaid work
representation
Perceived
wage gap for
similar work
Leadership
positions
Legal
protection
Violence
against
women
1 Total number of countries per indicator varies, based on availability of data.
For more, see Digging into the numbers on gender equality, on page 90.
For the full report, see The power of parity: How advancing womens equality can add $12 trillion
to global growth, McKinsey Global Institute, September 2015, on mckinsey.com.
Highlights:
Competing in an agile age:
New research on how to combine
speed with stability; lessons
from the utility industry
Adhocracy: A model for moving
quickly and acting decisively
Spotlight on China: Perspectives
on Chinese innovation, online
auto sales, leadership challenges,
and the future of the economy
An executives guide to the Internet
of Things
Networked enterprises: Tracking
corporate use of social media
How to engage with Silicon Valley
Revisiting the matrix organization
Taking stock of gender equality
in todays corporations: New data
from McKinsey and LeanIn.org,
plus commentary from global
managing director Dominic Barton
and two women leading McKinseys
gender-diversity efforts
mckinsey.com/quarterly

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2015 Number 4

Its almost a truism these days to say that modern corporations

create organizations that can maximize return on attention, which

Why agility pays

Agility lessons from utilities

Adhocracy for an agile age

Five myths about the Chinese economy

Gauging the strength of Chinese innovation

Five keys to connecting with Chinas wired consumers

How China country heads are coping

86 Gender equality: Taking stock of where we are

Digging into the numbers on gender equality

92 An executives guide to the Internet of Things

Knowing when corporate headquarters adds

Michael Bazigos and James Harter

Revisiting the matrix

Why its still a world

Consumer packaged goods:

A quick look at research and analysis

How should you tap into

Taking the measure of the

23 Reflections on oil and gas

McKinsey Quarterly editors

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Research, trends, and emerging thinking

8 Revisiting the matrix

19 Taking the measure

Revisiting the matrix

Ubiquitous and unexceptional

Collaboration and clarity

suggest advantages and disadvantages

than nonmatrixed ones to say that

The link to organizational health

About the research

The findings of the study on matrixed

The study focusing on the accountability

Organizational health is operationally defined by

See Aaron De Smet, Bill Schaninger, and Matthew

performance, in McKinsey research

organizational health: two management

Priorities for matrixed managers

These findings are consistent with work

Given the importance of role clarity and

The Gallup survey does suggest that

It is also imperative to maintain dayto-day lines of communication to root

receive regular, actionable feedback on

the matrix organization, McKinsey Quarterly,

2 James K. Harter et al., The relationship between

engagement at work and organizational

3 For more, see Billie Nordmeyer, Disadvantages

8 Revisiting the matrix

19 Taking the measure

Organizational health is operationally defined by

See Aaron De Smet, Bill Schaninger, and Matthew

2 James K. Harter et al., The relationship between

3 For more, see Billie Nordmeyer, Disadvantages

4 Since the impact of these practices transcends

5 See Suzanne Heywood, Jessica Spungin, and

6 James B. Avey, Bruce J. Avolio, Craig D. Crossley,

2 See Urban world: Cities and the rise of the

3 Bruno Ribeiro, Modeling and predicting the

4 Regressions for both the adoption and diffusion

5 We used Granger tests to measure whether a

6 Erik Brynjolfsson and Lorin M. Hitt, Computing