Dynamic capabilities

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Dynamic Capabilities at IBM: Driving Strategy into Action
(White Paper Draft)
J. Bruce Harreld
Senior Vice President
IBM
Charles A. O’Reilly III
Graduate School of Business
Stanford University
Michael L. Tushman
Harvard Business School
Harvard University
August 10, 2006
Copying or posting is an infringement of copyright.

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Abstract
In the past 15 years, the IBM Company has undergone a remarkable transformation from
a struggling seller of hardware to a successful broad range solutions provider. Underlying
this change is a story of foresighted strategy and disciplined execution—of connecting
knowing to doing. In strategic terms, the IBM transformation illustrates the ideas behind
dynamic capabilities, showing how the company has been able to sense changes in the
marketplace and to seize these opportunities by reconfiguring existing assets and
competencies. We review the literature on dynamic capabilities and, using IBM as a case
example, show how their strategy process permits them to both explore new markets and
technologies (e.g., life sciences, pervasive computing) as well as to exploit mature
products and markets (e.g., mainframe computers, middleware).

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Dynamic Capabilities at IBM: Strategy in Action
In the early 1990s, many Wall Street analysts had written off IBM as a company; its
stock price was the lowest it had been since 1983. By 1992, more than 60,000 jobs had
been lost and, in spite of John Akers’ (the CEO until 1993) efforts at transformation, the
company was failing. When Lou Gerstner took over in 1993, the services unit was 27
percent of revenues and the software unit didn’t even exist. In 2001, services and
software were $35 billion and $13 billion businesses respectively and combined
represented 58 percent of total revenues. IBM’s market cap had increased from $30
billion in 1993 to $173 billion. The share price over that period increased 7X. Since then,
with Sam Palmisano as CEO, IBM has continued this remarkable transformation so that
today, IBM has revenues of $91 billion, more than 70% from software and services.
During the past decade, the company has transformed itself from primarily a provider of
computer hardware to a broad-based supplier of information technology services and
solutions. From an employer with more than 400,000 employees in 1986, IBM went to a
company of slightly more than 200,000 in 1994 and today has grown to 330,000. They
have gone from a laggard in the personal computer business in 1980 to a 40 percent
market share in 1985 to exiting from the business in 2005. From a company that provided
little in the way of consulting services in 1990, IBM has become the largest services
company with more than 190,000 employees in their Global Technical Services and
Global Business Services units. During a 20 year period, IBM has gone from success to
failure to success; from a technology company to a broad-based solutions provider to,
perhaps, an exemplar of the new world of open systems and on-demand capabilities.
Unlike other great technical companies such as Xerox, Philips and Polaroid that failed to

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capture the benefits of their innovation, IBM has been able to leverage their intellectual
capital into businesses as diverse as life sciences, automotive and banking—and make
healthy profits along the way.
How did this happen? While the broad story of IBM’s rise, fall, and transformation has
been well-documented elsewhere1
, there is a part of this story that is essential and not
widely appreciated—a story about strategy and execution and how the IBM strategy
process links the two. It is an illustration of how a current buzzword in strategy,
“dynamic capabilities,” is made real and used to help the company succeed in mature
businesses, like mainframe computers, as well as move into new ones, like digital media.
It is a lesson in how theory and practice combine to develop new insights that are useful
for business and generate new thinking about strategy.2
To illustrate how dynamic capabilities help IBM succeed, we first review briefly the
current thinking about strategy—and why dynamic capabilities are an improvement on
older strategy frameworks. We then describe how the company’s brush with failure led to
the evolution of the IBM Business Leadership Model and how a set of related strategic
processes, including deep dives, Emerging Business Opportunities, the Strategic
Leadership Forum, and the Corporate Investment Fund, are managed by IBM’s Strategy
Group and involve 25,000 executives to help identify and capture opportunities across
1
Louis V. Gerstner, Who Says Elephants Can’t Dance? Harper Business, 2002; Paul Carroll, Big Blues:
The Unmaking of IBM. Reed Business, 1993; Doug Garr, IBM Redux: Gerstner and the Business
Turnaround of the Decade, Harper Collins, 1999.
2
M. Tushman, C. O’Reilly, A. Fenelosa, A. Kleinbaum and D. McGrath, “Toward relevance and rigor:
Executive education as a lever shaping research and practice” Academy of Management Learning and
Education, 2006.

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140 geographies with constantly changing competitors and technologies. This process,
while hardly perfect, has, in the words of former CEO Gerstner, “helped the elephant to
dance.”
Strategy: Why it is so important—and often fails
We suspect that every regular reader of the business press has, in one way or another,
been steeped in the logic of strategy and competitive advantage. We have all been
exposed to the notions of the five forces, core competencies, SWOT, “coopetition,” and a
myriad of other frameworks for how leaders can help their firms prosper. For the few
who missed class that day, the essence of strategy is contained in a single question: “The
fundamental question in the field of strategic management is how firms achieve and
sustain competitive advantage.”3
This basic question has preoccupied managers and academics for the last century. The
extent of this preoccupation is underscored by the results of a search of the academic
literature using “strategy” as a keyword: More than four million citations were listed.4
Amazon lists more than 49,000 books with strategy in the title and a broad Google search
shows 800 million hits. Two obvious conclusions can be drawn from this interest: first,
strategy is clearly important; and second, given the disparate approaches, there does not
seem to be a consensus about “how” strategy works—in spite of the fact that there is
good consensus on the definition of the term itself.
3
Teece, D., Pisano, G. & Shuen, A. 1997. “Dynamic capabilities and strategic management.” Strategic
Management Journal, 18: 509-533. P. 1
4
Using the Google Scholar search function, a total of 4,170,000 cites were returned. A search on
“competitive advantage” returned 707,000 hits.

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In spite of variations in the definition, “strategy” is widely used to refer to the plans and
actions that firms take to achieve their objectives. It is simultaneously a process by which
plans for allocating resources are developed and the actions required to achieve their
goals are identified. It reflects management’s understanding of the firm’s assets and
position as well as the external forces it faces. At the most basic level, strategy is about
making quality decisions and executing well on those decisions. Unfortunately, what
seems so simple in theory is anything but in practice.
One of the things that makes this seemingly simple conceptual process so difficult is the
uncertainty and complexity of competition and change, particularly in fast moving
markets. To compete successfully managers need to be able to scan their environments,
identify relevant opportunities and threats, design responses that will satisfy customers in
ways that competitors can’t easily imitate and, finally, to ensure that these plans are
implemented, even as the firm competes across a variety of geographies and markets and
in mature businesses as well as emerging ones. Yet, capturing and distilling relevant
information isn’t a natural capability for most senior management teams. As David
Teece, who is both an academic strategist and a CEO, notes, “The skills that result in the
identification or development of an opportunity are not the same as those required to
profit from or ‘exploit’ the opportunity.”5
5
Teece, D. 2006. “Explicating dynamic capabilities: The nature and microfoundations of (long run)
enterprise performance.” Working Paper, P. 23

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Strategy is about understanding market and technology evolution and transformation as
well as the ability to execute against the plans. Interestingly, the striking evidence is that
some companies never see the threats or, more frequently, are unable to change quickly
enough to avoid them. For many years, the senior management at Sears refused to believe
that Wal-Mart was a competitor or a threat. Famously, in 1977 Ken Olsen, the founder
and CEO of DEC said “There is no reason for any individual to have a computer in his
home.” The irony here is that in 1998 a struggling DEC was sold to Compaq, a maker of
computers for people’s homes—which in turn was acquired by HP. Of course everything
looks clearer in hindsight, but the unfortunate fact is that we often can’t know ex ante
where to place bets. Strategy is partly a process of hypothesis testing in which firms
place bets and explore new technologies and markets and develop new competencies,
even as the firm continues to exploit existing competencies in mature businesses.
From “Five Forces” to “Dynamic Capabilities”: The Evolution of Strategic Thinking.
Theories of strategy abound and form the basis for the four million citations mentioned
earlier. Academics have developed four main paradigms for thinking about strategy.
First, there is the well-known competitive forces framework of Michael Porter in which
competitive advantage comes from actions taken by a firm to create defensible positions
against competitors—for example, by erecting strong barriers to entry.6
In this framing,
the strategic problem faced by managers is one of industry structure, entry deterrence,
and positioning. In a second framework, the resource-based view of strategy, competitive
advantage comes from difficult-to-imitate firm-specific assets that can be used to capture
rents—for instance through strong intellectual property, economies of scale, or a
6
Porter, M. 1980. Competitive Strategy. Free Press

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dominant brand.7
In this view, profits flow from having lower costs or higher quality
(e.g., through efficient supply chains or operational excellence), innovative products, or
customer insight that allows firms to understand and meet customer needs in the way
competitors cannot. A third distinct theoretical approach to strategy emphasizes a
strategic conflict approach which uses the tools of game theory to suggest how firms can
outsmart their rivals.8
The thrust of this approach emphasizes taking strategic moves,
such as irreversible investments in capacity, to influence the behavior of rivals. Intel, for
example, has been bold in exiting businesses such as semiconductor memory, demanding
to be a sole-source provider and refusing to license their designs, and announcing
capacity expansions to signal their commitment to would-be competitors.9
Similarly,
when Nokia chose to divest itself of all businesses other than telecom, it was signaling to
its competitors its commitment to a single industry.
Most recently, strategy research has begun to emphasize a fourth approach, dynamic
capabilities, which builds on the notion of core competencies but focuses on the role of
management in building and adapting these competencies to address rapidly changing
environments.10
This development was stimulated by the recognition that many
successful or dominant firms fail to sustain their performance as markets and
technologies shift (think DEC, RCA, Pan Am or Sears). In spite of having the resources,
7
Penrose, E. 1959. The Theory of the Growth of the Firm. Basil Blackwell; Rumelt, R. 1974. Strategy,
Structure and Economic Performance, Harvard University Press; Teece, D. 1984. Economic Analysis and
strategic management. California Management Review, 26: 87-110.
8
Brandenburger, A. & Nalebuff, B. 1996. Coopetition, Doubleday; Kreps, D. & Wilson, R. 1982.
Reputation and imperfect information. Journal of Economic Theory, 27: 253-279; Shapiro, C. 1989. The
theory of business strategy. Rand Journal of Economics, 20: 125-137.
9
Burgelman, R. 2002. Strategy Is Destiny: How Strategy-Making Shapes a Company’s Future. Free Press.
10
Teece, D. 2006, op cit.; Eisenhardt, K. & Martin, J. 2000. Dynamic capabilities: What are they? Strategic
Management Journal, 21: 1105-1121.

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these companies failed to adapt to changed circumstances. With dynamic capabilities,
sustained competitive advantage comes from the firm’s ability to leverage and
reconfigure its competencies and assets in ways that are valuable to the customer but
difficult for competitors to imitate. Dynamic capabilities help a firm sense opportunities
and then to seize them by successfully reallocating resources, often by adjusting existing
competencies or developing new ones. One example will illustrate this. In the early
1990s, Johnson Controls was primarily a maker of seats for U.S. automakers. Their
distinctive competencies were in manufacturing and their relationships with car
companies. Recognizing that this was an increasingly competitive market and one in
which they would be unlikely to dominate, they invested in design and partnering skills
that enabled them to move into higher margin businesses like design, engineering, and
electronics integration. They adapted and extended their competencies in the
manufacturing of seats and relationships with auto companies to transform the company.
Between 1995 and 2002 their shareholder return improved 400%.
Core competencies are generally defined as discrete business-level processes
fundamental to running the business which give it an advantage over competitors.11
For
instance, Southwest Airline’s advantage comes not from their planes, route structure, or
employees but from the combination of factors such as fast turnaround, high productivity,
and low costs. These result from a set of activities or core competencies that competitors
find difficult to replicate. Dell’s supply chain or Wal-Mart’s logistical prowess are other
examples. Competencies are necessary but not sufficient for sustained competitive
11
Leonard-Barton, D. 1995. Wellsprings of Knowledge. HBS Press; Stalk, G., Evans, P. & Shulman, L.
1992. Competing on capabilities: The new rules of corporate strategy. Harvard Business Review; Teece, D.
et al., 1997, op cit.

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advantage in changing markets. Recognizing that existing competencies may become less
valuable as competitors replicate them or markets shift, dynamic capabilities emphasize
the organization’s ability to sustain profitability by reconfiguring assets and competencies
to address changing market circumstances. It is this ability to adapt and extend existing
competencies that differentiates dynamic capabilities from competencies.
This ability places a premium on senior management’s ability to accomplish two critical
tasks. First, they must be able to accurately sense changes in their competitive
environment, including potential shifts in technology, competition, customers, and
regulation. Second, they must be able to act on these opportunities and threats; to be able
to seize them by reconfiguring both tangible and intangible assets to meet new
challenges.12
These two fundamental capabilities are at the core of a firm’s ability to
grow and survive over time and represent the essence of dynamic capabilities. “Winners
in the global marketplace have been firms that can demonstrate timely responsiveness
and rapid flexible product innovation, coupled with the management capability to
effectively coordinate and re-deploy internal and external competencies.”13
In IBM’s
language this requires that leaders possess both strategic insight and strategic execution.
One without the other is insufficient for long term success since the marketplace is ever
changing. If a firm has resources and competencies but lacks these dynamic capabilities,
it may make a competitive return in the short-term but is unlikely to sustain this in the
face of change.
12
Teece, D. 2006, op cit.
13
Teece, D. et al. 1997, op cit, P. 515.

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Each of these approaches to strategy attempts to solve the puzzle of how a firm can out-
compete its rivals by either developing useful firm-specific skills or positioning itself in
ways that customers value and are willing to pay for and that rivals cannot easily imitate.
While earlier approaches to strategy were largely static (e.g., develop a positional
advantage and protect it), dynamic capabilities call attention to the need for organizations
to change over time and compete in both emerging and mature businesses.14
While
conceptually reasonable, this is often difficult enough that successful firms fail. Lou
Gerstner acknowledged this, noting that “In most cases a company has a set of
competitive advantages in its base business. It may be hard—very hard—to redirect or
reenergize the existing enterprise.”15
How can leaders of organizations do this and avoid
being the subject of some business journalist’s account of a formerly great firm’s failure?
From Theory to Practice: Why Strategic Thinking Sometimes Fails.
Although theories of strategy can be elegant in their formulation, they are often less
helpful in practice. What passes for strategy in many organizations too often consists of
three-ring binders, power point slides, and annual meetings as carefully scripted as a
Kabuki drama—and, just as in the Japanese version, those who fail to play their roles
often suffer an organizational fate much like the villains in the play. Worse, many
strategists, especially academics who develop the theory, typically don’t want to get their
hands dirty with the myriad of details necessary for successful execution. As a result, in
many organizations a barrier exists between strategists and operational executives. The
failure of the conventional strategic planning group to devise executable plans has often
14
Tushman, M. & O’Reilly, C. 1996. The ambidextrous organization: Managing evolutionary and
revolutionary change. California Management Review, 38: 1-23.
15
Gerstner, 2002, op cit, P. 220.

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resulted in some firms giving up on strategic planning departments.16
Therefore, timely
strategic insights often go unrecognized by those line executives responsible for
execution.
Compounding this problem, many organizational strategic planning and review processes
take place annually—not an immutable time frame that technology, customer needs, or
competition adheres to. Firms that do annual planning in fast changing markets and
technologies are always behind. Worse, many operating managers in competitive markets
have little time for the reflection and analysis that good strategy requires. The IBM saga
over the past decade vividly illustrates these dangers—and offers a possible solution.
Success, Failure, and Success: Fixing Strategy at IBM
Through the mid-1980s IBM enjoyed 40 percent of the computer industry’s sales and 70
percent of its profit. In 1990 IBM sales were five times their nearest rival, but growth had
slowed to less than six percent. Analysts at the time described the company’s position as
a “dangerous mix of arrogance and complacency.”17
Even John Akers, the CEO, claimed
that “Everyone is too comfortable at a time when the business is in crisis.”18
By 1991
their stock price had reached the lowest point since 1983. From 1986 to 1993 IBM had
taken $28 billion in charges and cut 125,000 people from their payroll—after avoiding
layoffs for more than 70 years.
16
Rumelt, R., Schendel, D. & Teece, D. 1994, Fundamental Issues in Strategy, HBS Press
17
Business Week, June 17, 1991.
18
Business Week, op cit.

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On January 26, 1993, in the face of a looming disaster, CEO John Akers resigned. The
following day many of his direct reports also announced their departures and, after a
seven month search, Lou Gerstner was appointed as CEO—the first outsider to run IBM
in its history. Reflecting the company’s condition, a Business Week reporter described
Gerstner’s appointment as “the toughest job in Corporate America today.”19
After several months on the job, Gerstner’s diagnosis of the company’s problems was
clear: Costs were out of line, they had lost touch with customers, the firm was too
decentralized, and they had stayed with their old strategy too long. He summarized this
by saying, “We don’t move fast enough in this company. This is an industry in which
success goes to the swift more than the smart. We’ve got to become more nimble,
entrepreneurial, focused, cost driven…we’ve been too bureaucratic and preoccupied with
our own view of the world…The world is cynical about IBM’s promises. What I’m
trying to do is deliver results not promises, results not vision, results not concepts.”20
His
message to senior executives was equally blunt: “You should decide if you want to be
here. If you don’t, leave.”
Based on his understanding of customers’ needs, Gerstner recognized that the market was
shifting. The application of technology, not its invention, would become the growth
engine for IBM. This was a completely different approach than the old IBM business
model. These insights led to a transformation that subsequently led IBM to exit the
network hardware business, application software, storage, and personal computers and to
19
Business Week, October 4, 1993.
20
Financial Times, March 28, 1994.

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enter the services businesses and develop a freestanding software business. It also led to a
realistic evaluation of the firm’s core capabilities resulting in the decision to exit
consumer businesses which required skills very different from IBM’s enterprise focus.
However, Gerstner knew that having the strategic insight and accomplishing it were two
very different challenges. “I’m not saying that actually sticking to a strategic vision is as
easy as articulating it.”21
In analyzing why IBM had found itself failing, he noted that “What happened to this
company was not an act of God, some mysterious biblical plague sent down from on
high. It’s simple. People took our business away.”22
More startling, after reviewing
IBM’s strategies, he concluded that “The company didn’t lack for smart, talented people.
Its problems weren’t fundamentally technical in nature. It had file drawers full of winning
strategies. Yet the company was frozen in place…The fundamental issue in my view is
execution. Strategy is execution.”
To begin the transformation he emphasized focus, speed, customers, teamwork, and
getting the pain behind them. He did this by developing a few global core processes,
centralizing the company to leverage its strengths as a provider of solutions to customers,
fixing the core businesses, redesigning the metrics and reward systems, and relentlessly
driving the culture toward a focus on the marketplace. He began every meeting, including
budget and technology meetings, by asking participants what they had heard from
customers. He assigned customer responsibility to senior executives who acted as
21
22
New York Times, June 26, 1994.

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ombudsmen for the customer relationship. This forced senior managers to listen to
customers’ problems and complaints and created a sense of urgency about the
marketplace. Incentives were changed so that business unit heads were no longer
rewarded solely on the performance of their business but on how well they operated as a
team.
Since 2002, Gerstner’s successor as CEO, Sam Palmisano, has continued the
transformation of the company into an “on-demand business” using advanced computer
and software technologies to quicken the flow of knowledge within companies and help
executives respond instantly to changes This entails offering open architecture, integrated
processes, and self-managing systems—selling computing services, not computers23
. This
has required a transformation of the company around customer needs. For instance, in a
partnership with the U.S. Postal Service, IBM has developed software to optimize mail
handling and shipping while with Boeing they have partnered to create technologies for
network-centric warfare products. They have also partnered with the Mayo Clinic to do
breakthrough work on gene profiling and with Bang & Olufsen to develop an electronic
pill dispenser. Within IBM, this has required that the company re-integrate itself to bring
together experts to solve customer problems—not simply to sell products or services.
The most important element of this transformation, however, was the radical shift in
IBM’s approach to strategic insight and strategic execution and embodied in how the
company approaches strategy.
23
IBM, The New Agenda: IBM and the On-Demand Era.

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How IBM Does Strategy
Up until 1999, the strategy process at IBM looked pretty much like the process at any
large, complex organization. Developments in technology were monitored, there were
occasional projects to drill down into specific issues, and, most centrally, there was the
annual strategic review process in which business unit heads prepared and presented their
plans to the senior management group. This strategy document purported to describe
what was happening in the unit’s marketplace (e.g., competitor moves, technology
changes) and what the financial implications were for the business. These separate
documents would be rolled together for IBM in what was called “the Spring Plan.”
In 1999 things changed. In preparation for one of these review meetings, Gerstner read
one of the business unit’s strategic plans. Irritated by what he saw, he called Harreld, the
SVP of Strategy, into his office, threw the strategy paper across his desk, and asked, “Are
you supposed to be in charge of strategy around here? This thing isn’t worth the paper it’s
printed on.” Knowing Gerstner, he responded “With all due respect, this isn’t the way we
really do strategy. Surely you don’t think this document was actually written by the
business unit leader?” Gerstner stopped, reflected for a moment, and acknowledged that
in his time as a group executive, he didn’t write those documents either. They were
farmed out to a staff expert and did not reflect the reality of the competitive landscape.
For example, during the 1990s, there were more than 400 strategic planners within IBM
whose primary role was to poke holes in the thinking of general managers. The actual
planning process was a staff exercise undertaken to satisfy senior management, not an

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accurate reflection of what the business needed to do to be competitive and certainly not
a blueprint for action.
After a discussion of the weaknesses of the current strategic review process at IBM and
the realities of their markets, Gerstner told Harreld to go away and think about
engineering a dramatic step-change in how strategy could be made more relevant at
IBM—a process that would reflect the realities and complexities of their businesses and
involve the responsible general managers in a real process of sensing the environment
and seizing opportunities. What emerged came to be labeled the “IBM Business
Leadership Model” (see Figure 1) and encompassed a process of strategic insight
(strategic intent, marketplace insight, innovation focus, and business design) designed to
systematically identify opportunities and strategic execution (alignment of people,
structure, culture, and process) designed to seize opportunities by ensuring that every
strategic initiative also had an associated plan for execution. In this way, the IBM
Business Leadership Model reflects the two fundamental dynamic capabilities of sensing
and seizing opportunities.
From this perspective, strategy doesn’t matter unless it changes what the company does
in the marketplace. Otherwise it’s “chartware”. Strategy is not about how to beat the
competition but understanding the client’s needs and removing the barriers needed to
help them—beating the competition is secondary. It is the connection of knowing with
great accuracy what the opportunities are with the ability to do the things necessary to
accomplish these.

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Insert Figure 1 about here
In a company of the size, complexity and geographic reach of IBM it is unrealistic to
think about strategy as an annual, top-down process. To be successful, IBM believes that
the process must help line managers to be engaged and competent in the strategy- making
process. A central part of this process is to keep strategy making at the business unit
level with the people who best understand the local marketplace—but also have a process
where general managers are willing to blow the whistle and ask for help when they need
it. Under the old system, the strategy process created an us versus them mindset where
candor was not rewarded. Furthermore, in the strategic reviews, criticisms about other’s
deficiencies exacerbated the tendency for leaders to be conservative in their strategies.
Under the new system, the essence of strategy is “disciplined, fact-based conversations.”
This approach now involves more than 25,000 general managers at IBM in both the
formulation and execution of strategy.
The IBM Business Leadership Model24
As shown in Figure 1, the IBM Business Leadership Model emphasizes the role of the
general manager and the interdependence between strategy and execution. Strategy is
stimulated by leaders’ dissatisfaction, the perception of a gap between current and desired
performance. In the IBM model, this be either a performance gap (a shortfall between
expected and actual results), or an opportunity gap (a discrepancy between current
business results and those achievable with a new business design). General managers
24
IBM internal document, 2004.

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define their gaps in terms of a clear business owner, financial metrics that quantify the
gap, and a specific time frame for addressing it (Figure 2 provides several examples).
Closing the gap requires both strategic insight to assess the opportunities and threats and
strategic execution to build the capabilities to deliver market results.
Insert Figure 2 about here
Strategic Insight. As shown in the left-hand side of Figure 1, strategy formulation
emphasizes four interrelated disciplines:
• Strategic Intent sets the overall direction and goal for the organization. This
statement sets priorities for the achievement of strategic advantage. For example,
Palmisano’s 2002 declaration that IBM would become an “on-demand company”
led to the development by the software organization of services oriented
architecture (SOA) to make software more adaptable and the consulting
organization to emphasize component business modeling to help clients more
easily use IBM services.
• Market Insight involves a focus on understanding customer needs, competitor
moves, technology developments, and market economics. This is a fact-gathering
analytical effort the goal of which is to specify in detail what is happening in the
market, how profits are shifting, and the implications for the IBM business.
• Innovation Focus challenges general managers to actively experiment and
challenge their thinking in the design and implementation of strategy, including
taking ideas from a wide range of sources and creating pilots and experiments to
shape industry change. Creativity is encouraged not simply with new products
and services but also operational and business model innovations.
• Business Design is based on the three elements above and specifies how the
business will go to market. Business design involves answering five key
questions:
o Customer Selection. What customer segments do we choose to serve—
and what will we not serve?
o Value Proposition. What will we offer our customers and how will we be
differentiated from our competitors? Why should any customer prefer our
offering to anyone else’s?
o Value Capture. Given the answers to the first two, how will IBM make
money?
o Scope of Activities. What will we do internally and what activities will we
rely on our value net partners?

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o Sustainability. How will we defend the profitability of our offerings
against competitor responses?
Strategic Execution. The right hand side of Figure 1 illustrates the elements required by
general managers for the execution of their strategic plan. The strategy-making process
culminates in a clearly-communicated business design and the allocation of required
resources. Implementation begins with an honest appraisal of current organizational
alignment and capabilities—identifying misalignments and specifying the steps needed to
correct these. Based on the business design, execution focuses on aligning four key
organizational elements to ensure that the business can deliver on the strategic intent:
• Critical Tasks and Processes. These are the key activities or success factors
necessary to deliver on the value proposition and scope of activities specified in
the business design. They are the concrete tasks and interdependencies needed to
add value from the customer’s perspective.
• Formal Organization. These are the explicit structures, metrics, and rewards
required to direct, control, and motivate individuals and groups to perform the
unit’s critical tasks. The question asked is “does the current formal organization
facilitate the accomplishment of the required critical tasks and
interdependencies?”
• People and Skills. Does the unit have the requisite human resource characteristics,
capabilities, and competencies needed to execute the critical tasks? Are people
motivated and engaged?
• Culture. Does the existing culture (expectations about how people need to
behave) support the accomplishment of the critical tasks? Given the new business
design, are there new behaviors that will be required to deliver on the value
proposition?
Business unit performance is a function of having the right strategy and the alignment or
congruence among these four organizational elements.25
The successful execution of
strategy critically depends on this alignment. What is sometimes overlooked, however, is
that whenever a strategy is changed, it is almost always the case that the existing
organizational alignment will also need to be changed. The IBM Business Leadership
25
Tushman, M. & O’Reilly, C. 2002. Winning Through Innovation. HBS Press

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Model forces line managers to be explicit in diagnosing the current versus the needed
organizational alignment, and to ensure that these changes are made by the top
management team as a part of their new strategy. Existing organizational architectures
reflect old strategies. Unless management actively realigns their business to reflect the
new strategy, execution will suffer.
IBM’s Dynamic Capabilities
After stabilizing the company in the mid-1990s, Gerstner described IBM’s bet on the
future this way: “Our bet was this: Over the next decade, customers would increasingly
value companies that could provide solutions—solutions that integrated technology from
various suppliers and, more importantly, integrated technology into the processes of the
enterprise.”26
The core competence required to execute this strategy was the ability to
integrate—open middleware (the software that permits applications to be used across a
variety of platforms) and services were key to this. Commenting on whether IBM, a
traditional hardware company, could make this transition, Gerstner said, “Services is
entirely different. In services, you don’t make a product and sell it. You sell a
capability…this is the kind of capability you cannot acquire.”27
Competencies are embedded in organizational processes or routines around coordination,
learning and transformation. For IBM, this meant it would need to take its existing
competencies in technology and quality and add to them the capability to learn better how
to serve the customer, integrate the organization around the customer’s needs, and to
transform themselves from a great product company to one that solved customer’s
26
27
Op cit., P. 133

22
problems. In the old IBM, Gerstner observed that “All of [our] capabilities were of a
business model that had fallen wildly out of step with marketplace realities.”28
To change
meant walking away from the IBM history and the collapse of gross profit margins as
they moved into services, but he was also optimistic, “History shows that the truly great
and successful companies go through constant and sometimes difficult renewal of the
base business.”29
Palmisano’s “On Demand Business” campaign is taking the next step by transforming
IBM from a set of conventional silos (e.g., hardware, software, and services) to an
integrated structure oriented around providing solutions to customer needs. To make this
new approach work, the entire role of the corporate strategy group at IBM needed to
change. If all the group did was to manage an annual strategy process, they would be
largely irrelevant to line managers—just another staff function wasting valuable
resources. To be successful, the strategy group needed to help business leaders gain
strategic insight and to help act on these insights. General mangers needed to be involved
in the entire process.
This new approach also required transformation of the strategy department. Beforehand,
IBM’s strategy department was exclusively populated with strategic planning
professionals who had strong skills in formulating strategic insight. However, since few
of these professionals had run a business, their strategic executional capabilities were
limited. Today, two thirds of the strategy organization is composed of successful general
28
Op cit, P. 176
29
Op cit, P. 220.

23
managers who join the team for an 18 – 30 month period. These executives bring
invaluable operational skills to the strategy team. Their presence has transformed the
department’s formerly academic planning culture to one which is much more action-
oriented. In return, these general managers develop improved strategy skills thus better
preparing them for their next line management assignment.
To ensure that the strategy process provides the insight necessary to sense opportunities
and the execution required to seize them, a set of complementary mechanisms have
evolved. The specific mechanisms that underlie the two fundamental dynamic
capabilities of sensing and seizing opportunities are outlined in Figure 3. In this figure,
the above the line activities include those actions designed to both sense new
opportunities and threats and to seize them by reallocating resources and reconfiguring
the organization. In Jim March’s terms, these are activities that promote “exploration”
and learning.30
“Exploitation” is equally as important and accomplished through the
existing organization—sometimes referred to within the company as a “disciplined
machine.” What is notable about the IBM approach to strategy is less in what they do and
more in how they do it. Each of the elements shown in Figure 3 is replicable by
competitors. What is more difficult to copy is the integrated way in which these activities
are implemented. Figure 4 illustrates how the above the line activities map onto the
dynamic capabilities of sensing and seizing opportunities.
Insert Figures 3 and 4 about here
30
James G. March. (1991). Exploration and exploitation in organizational learning. Organizational
Science, 2: 71-87.

24
Sensing New Opportunities -- Strategic Insight
• The Technology Team meets monthly and assesses the market readiness and
potential of emerging technologies. This team draws on the deep expertise of IBM
Fellows and Distinguished Engineers. Decisions can result in accelerated funding
for a project or in its demise.
• The Strategy Team also meets monthly to examine the market results of existing
unit strategies as well as to explore new growth areas. Decisions can result in
new market entry, adjustments to existing business plans, or complete exit from a
business. This team is composed of a cross section of general managers, strategy
executives, and other key functional leaders.
• The Integration & Values Team is a group of 300 key leaders, selected annually
by the CEO and senior executives who are considered responsible for integrating
IBM through company-wide initiatives. These initiatives, known as Winning
Plays, are corporate-wide strategic efforts (e.g., issues that require cross-
organization interdependence). Each initiative has assigned leaders and, often,
uses the “deep dive” process. Results are reported quarterly to the entire I&VT
and, in abridged form, to the entire company.
• A Deep Dive is a structured process, typically requested by a general manager
confronting a performance or opportunity gap and staffed jointly by the operating
unit and the strategy group. This is an intensive, focused process where a topic
(e.g., a new technology or change in competition) is scrutinized in great detail.
This process is highly analytical and fact-based. It typically results in a strategic
decision to either pursue a market or technology, to change strategy, or to exit a
market. Intentionally these efforts are not run to a preset time line; the work
continues until all questions are answered, the decisions are clear, and the
necessary adjustments to the organizational model are clearly delineated.
Each of these processes helps ensure continuous scrutiny of the competitive environment
and involves line managers in this effort. The deep dives, for example, are routinely
called out by business managers facing problems. The technology team offers a way to
link technological advances with business needs. The strategy team ensures dynamic
adjustments to strategy and execution are made in a timely manner. The winning plays
provide a way of communicating and focusing the organization on company-wide

25
initiatives. The primary capability in sensing opportunities is the ability to make high
quality unbiased investment decisions under conditions of high uncertainty. These four
mechanisms provide a multifaceted way of continually monitoring and assessing
changes, a clear decision process for making timely decisions, and the ability to allocate
resources in support of these decisions.
Seizing New Opportunities -- Strategic Execution
In addition to these mechanisms that help identify opportunities, the IBM strategic
process also has a set of mechanisms to help seize these by reallocating resources and,
when needed, reconfiguring the organization. The key here is the ability to recombine
and reconfigure assets and structures as markets and technologies change. In addition to
the I&VT and Winning Plays described above, which also have elements that help seize
opportunities, three powerful mechanisms help ensure what Teece refers to as “asset
orchestration.”31
• Emerging Business Opportunities (EBOs) are an integrated set of processes,
incentives and structures designed explicitly to enable IBM to address new
business opportunities. The EBO process begins with the recognition that mature,
well-established businesses need to operate differently from new, exploratory
ones. To succeed, emerging businesses have different key success factors and
require a different style of leadership and different alignments of people, formal
organizations and culture. IBM recognized that the current management system
rewarded short-term execution aimed at current markets. Trying to operate new
business within a mature one can be exceedingly difficult, with the result that the
new business is often killed. Further, the company lacked the disciplines for
selecting, experimenting, funding, and terminating new businesses. This led to
the development of a process to identify new growth opportunities and to
establish separate new organizations with their own leadership, alignment, and
funding—all with senior management oversight to ensure that the new businesses
got the resources needed to explore the opportunity. Under the new system, these
aren’t product upgrades or just technical opportunities; they’re business
31
Teece, 2006, op cit., P. 46

26
opportunities—ones we believe we can commercialize and turn into revenue-
producing businesses.
The EBO process begins when growth opportunities are identified that require significant
cross-organization integration to be successful. Each EBO is typically characterized by a
new value proposition—which may cannibalize existing offerings, involves multiple
groups within the company, is in a high growth domain but with offerings that may not
be well-defined, and requires evangelism to develop successfully. From 1999 - 2005, 18
opportunities were identified, including autonomic computing, blade servers, digital
media, and network processing. Some of these succeeded and were subsequently folded
into existing businesses, others failed, and new ones have been added. Life Sciences for
example was predicated on the potential opportunities offered by the needs for new
hardware, software, and services demanded by pharmaceutical firms involved in
proteomics and the promise of personalized medicine. A number of earlier efforts within
the company to address these emerging markets had failed. However, since its founding
as an EBO in 1999, its leader, Carol Kovac, has grown this business to more than $2B in
revenues and begun new businesses to address emerging opportunities and evolved other
startup businesses to a mature category.
• The Strategic Leadership Forums (SLFs) are 3 ½ day team-based workshops
built around specific performance or opportunity gaps that bring extended teams
together for intensive work on problems or opportunities. These workshops begin
with work on refining the gap statement, challenging the strategy, a deep root
cause analysis of the specific underlying causes of the performance or
opportunity gap, and the development of an action plan. Teams are selected to
include all those responsible for the issue to be addressed. During the SLF groups
are supported by members of the strategy group and facilitation is provided by
members of IBM’s Global Executive and Organizational Capability group. This
process helps line managers to have a structured, candid conversation with a
common language—and to explicitly link strategic insight to execution in a
disciplined way.

27
For example, over a 3 ½ year period, there were 23 Strategic Leadership Forums that
hosted 113 teams and more than 1700 executives, including a significant majority of the
Integration & Values Team. These forums were used to address significant strategic
initiatives such as accelerating the development of Emerging Business Opportunities like
Life Sciences, Pervasive Computing, and Technology Services, addressing performance
gaps within mature businesses, linking IBM Fellows and Distinguished Engineers to the
on-demand effort, and even resolving significant organizational conflicts across lines of
business. A typical SLF would begin when either senior executives called out a strategic
initiative or a general manager surfaced the need for a focused intervention. Once
identified, the strategy group would help identify team leaders, build a fact base, and
convene the SLF. At the SLF, there would be disciplined conversations about the
strategy, a root cause analysis of the gap, the development of an implementation plan,
and senior management follow-up to ensure execution. Given the importance of the
topics addressed in these events, the SLFs were not typical corporate off-sites but
intensely focused, often emotional debates about the future of the business. As Palmisano
said in his introduction to one SLF, “I want you to argue and fight but leave in
agreement…the strategy is ‘IBM first.’”
The SLF is not simply education but a mechanism to solve major strategic problems.
Based on the success of this effort, the strategy group now supports “mini-SLFs”
throughout the company. This process, driven by the IBM Business Leadership Model,
provides a powerful common methodology and language which is used throughout IBM
and facilitates a common systematic approach to strategic initiatives.

28
• The Corporate Investment Fund was developed as a way of providing funding
for new initiatives identified by the I&VT or EBOs. This $500M fund was taken
from existing units and specifically designed to provide the resources to start new
initiatives. Funding decisions were made once a quarter. However, as Gerstner
noted, “We worked very hard at the process of starving the losers and investing
in the big bets…The new ventures had to be protected from the normal budgetary
cycle because if things get tight, more often than not, profit-center managers
would be tempted to starve the future oriented projects.”32
The Corporate Investment Fund is not the conventional internal venture fund found in
many companies. Rather, it is designed with the recognition that the annual budgeting
process may not be sufficiently responsive to fund new initiatives as they emerge during
the year—especially those that cut across business units and may not be attractive enough
for any specific business to fund by itself. Funds can be used to support Winning Play
initiatives or other projects that aren’t included in the annual budgeting process. For
example, after committing to the on-demand transformation, the fund was used to support
services oriented architecture in the software group and the development of enabling
technology in the consulting organization. Funds have also been allocated to permit the
accelerated development of executive talent in China and India.
Taken together, these processes emphasize strategic insight and execution and general
management leadership responsibility. While many organizations have several of these
elements as a part of their strategy process, what is different about the IBM approach is
that they have an integrated set of mechanisms to both sense and seize opportunities. This
allows the firm to consider trends in markets and technology, identify issues that are
relevant to customers, examine them in detail, and to reconfigure assets to address these.
32
Gerstner, 2002, op cit., P. 227

29
Once these decisions are made, this allows the new initiatives to be embedded into the
disciplined machine that characterizes IBM’s more mature businesses.
The Strategy Group at IBM
Strategy, and the role of the strategy group at IBM, has a very different profile than
conventional approaches. In the IBM context, strategy is an ongoing, disciplined
conversation between general managers and senior executives about the future of the
corporation—not an annual process or the work of a group of internal consultants. As
mentioned earlier, the strategy team itself is comprised largely of line managers who
spend an 18-30 month stint deepening their strategic skills. These individuals are
assigned by IBM’s senior executives without the strategy unit’s input. This not only
broadens the perspective of the strategy group but is a valuable developmental tool for
ensuring that the future senior managers of the company have deep strategic skills.
One of the enablers of IBM’s strategy process is that the career strategists within the
strategy department have no designs on any other jobs within the company; they have no
personal or political agenda, so their role is to facilitate difficult or critical conversations
with a focus on the facts and not some larger but hidden agenda. Further, if the input
from the strategy group is to be effective, this team needs to be in place through several
investment cycles in order to ensure consistency of strategic choice over time. Without
this continuity, the aggregate effects of investments are unlikely to give the strategy a
chance to succeed.

30
The IBM Business Leadership Model explicitly makes three important points. First,
leadership by general managers requires both strategic insight and execution. Second, this
is anchored on either a performance or opportunity gap as manifest in hard performance
outcomes such as market share gain, margins, growth, or profit. The metrics used to
assess the success of strategy implementation are always grounded in business
outcomes—and where the business is gaining or losing traction. In the end, it is about
only two things: customer satisfaction and shareholder return..
Third, this process highlights the importance of alignment or complementarities among
the components. For example, strategic execution occurs not from attention to people or
incentives or culture but from the alignment of all of these with the critical tasks
necessary to execute the chosen strategy. Effective strategy is not simply the articulation
of a strategic intent but the linking of this to innovation, solid marketplace insight, and an
appropriate business design. The overarching challenge is to ensure general management
involvement and ownership in this process—and not to let it become a staff function. As
useful as the IBM Leadership Model is in framing the strategic challenge, the risk is that
it becomes “chartware”—and lower level managers become cynical about it.
Dynamic Capabilities: Driving Strategy Into Action
Harreld is the first to acknowledge that the IBM approach to strategy is imperfect.
Amidst all the praise he received for transforming IBM, Gerstner was suitably modest
and noted that when he left in 2002, IBM was in the same businesses that it had been
when he arrived (e.g., hardware, software, and even services). The real change required

31
was for the company to reconfigure itself to be able to compete in a different way. It
meant walking away from its history and long-standing business model. This required
seeing the marketplace differently—but Gerstner claimed that IBM already had the right
strategies. More importantly, it required a cultural transformation that allowed the
company to reconfigure itself and to reallocate resources so that they could execute these
strategies. As Gerstner noted at his last annual shareholder meeting, “In the new IBM
we’ve always believed that our ability to execute is as important as the strength of our
strategies.”33
This is the essence of dynamic capabilities--the ability of a firm to sense
new opportunities and to seize them.
What the transformation of IBM illustrates is that while organizations are often
characterized by strong inertial forces that limit change, it is by no means impossible.
Teece argues this in saying that “Genetic engineering is possible with organizations; but
it is not easy…The key to sustained profitable growth is the ability to recombine and
reconfigure assets and organizational structures as markets and technologies change.”34
To accomplish such change, however, requires that senior managers be able to not only
sense the changes needed by their firms but also to be able to seize these by allocating
resources and reconfiguring the organization to address these. This involves seeing things
realistically, being willing to cannibalize existing businesses when necessary for survival,
and being ambidextrous or able to manage both mature and emerging businesses.35
33
Lou Gerstner, Annual Meeting, Savannah, Georgia
34
Teece, 2006, op cit, P. 21
35
O’Reilly, C. and Tushman, M. 2004, The ambidextrous Organization. Harvard Business Review, April,
PP. 74-83

32
In this regard, a key leadership element is the importance of fit or complementarity
among strategy, structure, culture, and process. As Michael Porter observed “Strategic fit
among activities is fundamental not only to competitive advantage but also to the
sustainability of competitive advantage. It is harder for a rival to match an array of
interlocked activities than it is merely to imitate a particular sales approach, match a
process technology, or replicate a set of product features.”36
In this sense, dynamic
capabilities comprised of complementary processes—like the ability to reallocate and
reconfigure assets—form the basis of a difficult to imitate competitive advantage. The
fact that such “soft” capabilities cannot be easily purchased but must be developed over
time only enhances their value.
At IBM these dynamic capabilities have been developed over time as an integral part of
how the company does strategy. It is the combination and complementarities among
those processes that promote strategic insight (e.g., deep dives, winning plays, ownership
by general managers in the strategy making process) and those that link this insight to
execution (e.g., EBOs, the Strategic leadership Forum, the Corporate Investment Fund)
that permits the firm to compete simultaneously in emerging and mature markets. This
approach permits the company to make small, frequent investments and to learn from
these. To use a buzzword, it encourages organizational learning—not solely by making
smart decisions from the top down but through an evolutionary process of variation-
selection-retention.
Conclusion
36
Porter, M. 1996, What is strategy? Harvard Business Review, November-December, P. 73

33
Helping organizations develop dynamic capabilities is, we believe, the fundamental and
enduring task of executive leadership. As Alfred Chandler has shown, organizations,
especially successful ones, can stagnate over time.37
Pursuing the same strategy and
sticking with the same core competencies may make a firm successful in the short-term
but is likely to be fatal in the long-term. Senior leaders are responsible for ensuring that
this does not happen. Unfortunately, the evidence is that too often firms get trapped by
their own success. The only way out of this trap is for senior leaders to help their firms
develop the dynamic capabilities that promote sustained competitive advantage.
In the past decade, IBM has undergone a remarkable transformation. While there are
many reasons for this success, at least part of it has been in their ability to both sense and
seize opportunities and to reconfigure the company’s structure and competencies to
address these. In strategic terms, these dynamic capabilities have been made real through
an ongoing process of disciplined, fact-based conversations, a common language and
problem solving methodology as manifest in the IBM Business Leadership Model, and a
clear commitment by leaders to compete in mature as well as emerging markets. This
language and process is employed throughout the company—from the senior executive
levels to first level managers. It is an integrated way to focus on both the formulation of
strategy and its implementation.
Unlike other piecemeal approaches to strategy, the IBM process is one driven by line
management based on the realities of the marketplace as seen in performance and
opportunity gaps, not a staff exercise or slide deck. This has moved the strategy-making
37
Chandler, A. 1990. Scale and Scope. Belknap Press.

34
process from an annual ritual to a continual process, from an emphasis on planning to one
on action, from a staff function to one that line managers own, and from a concern with
strategy only to a focus on both strategy and execution. It has changed the role of the
strategy group from that of a critic to a partner in fixing problems—and one that is
aligned with general managers in identifying future problems and opportunities for the
company.
Dynamic capabilities are not abstract academic concepts but a concrete set of
mechanisms that help managers address the fundamental question of strategy—to
develop a truly sustainable competitive advantage. Interestingly, we are beginning to
realize that sustainability is fleeting unless it is aligned with capabilities to continually
sense how the marketplace is changing and seize these changes through dynamic
organizational realignment.

35
Figure 1
The IBM Business Leadership Model
Formal
Organization
People &
Skills
Climate &
Culture
Brand Elements
Critical Tasks
Strategy Execution
Market
Results
Performance
Opportunity
GAP
Business
Design
Marketplace
Insight
Innovation
Focus
Strategic
Intent
Closing the gap requires both strategy to assess the opportunities
and design the business to address them—and execution to assess
and build the organizational capabilities to deliver market results.
Strategic Insight Strategic Execution

36
Figure 2
Performance and Opportunity Gaps
Performance Gap: Our revenue growth over the past 10 years has lagged the market
(4% vs. 8%). Our goal is to break out of this pattern of low growth and achieve 10%
profitable revenue growth in the next 24 months. Achieving this result will result in an
estimated $5 billion in top line growth.
Business Owner: VP of Line of Business
Performance Gap: The business has grown dramatically over the past 5 years. During
this period the quality of our products has declined. Our attempts at introducing six
sigma have failed and we have lost 5 points in market share in the past 12 months. Each
point lost represents roughly $500 million in revenue. Our intent is to regain this market
share over the next 24 months.
Business Owner: VP Quality
Performance Gap: The goal of our 2003 merger was to dramatically reduce costs (esti-
mated savings of $1 billion) and improve product development times (reduce times from
12 months to 6). In spite of a reorganization we have failed to achieve our time, quality or
cost targets. We need to achieve our time-to-market of 6 months within the next year.
Business Owner: VP Product Development
Opportunity Gap: Current revenue growth per customer in our existing markets is
is growing only slowly (5% per annum) and customer expectations are increasing. If
we are able to move up the stack and provide solutions rather than point products, we
should be able to increase revenues and profits by 20% over the next 3 years.
Business Owner: Division GM
Opportunity Gap: Our R&D group has developed a new technology platform which
represents a potential disruptive technology in our industry. At present, we anticipate a
first-mover opportunity of about 12-18 months if we can introduce this technology within
the next 6 months. Our current product development cycle takes 18-24 months. To
succeed, we must shorten this cycle to 6 months.
Business Owner: VP Technology and Manufacturing

37
Figure 3
The Strategy Process at IBM
Technology
Team
Strategy
Team
Corporate
Investment
Fund
Strategic
Leadership
Forums
I&VT /
Winning Plays
Deep Dives
IBM Business Leadership Model
The IBM Company: “A Disciplined Machine”
• Metrics
• Structure
• Leader Behavior
Exploit existing capabilities and processes:
Explore into new spaces:
Emerging
Business
Opportunities

38
Figure 4
Dynamic Capabilities at IBM
Strategic Elements Sensing Seizing
Technology Team X
Strategy Team X
Integration & Values Team /
Winning Plays
X X
Deep Dives X
Emerging Business Opportunities
(EBOs)
X
Strategic Leadership Forums
(SLFs)
X
Corporate Investment Fund X

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