Chapter Six:
The Transformation Zone

The transformation zone is the mechanism by which an enterprise can free its future from the pull of the past. Initiatives here focus on responding to an emerging wave of secular growth arising out of category disruption. When the disrupted category is adjacent to the core business, established corporations can play offense. When it is their own category that is getting disrupted, they must play defense. Either way, the goal is to undertake a transformational initiative to put the enterprise on a new trajectory, one significantly different from the current one.

This gives rise to the Horizon 2 dilemma. To effectively engage with the new wave, the enterprise must reallocate substantial resources to endeavors that dramatically underdeliver on Horizon 1 performance metrics. Worse, they must extract the bulk of these resources from the existing performance matrix, putting even more pressure on Horizon 1. Further complicating the challenge, every system in their company has evolved to reinforce the interests of the performance zone, not contravene them. The end result is that there is enormous inertial momentum around the current operations. This is a very good thing in normal times, allowing the company to generate attractive returns at low risk—indeed, the whole point of any new growth strategy is to someday achieve this state and sustain it for as long as possible.

But all that goes out the window when disruption strikes. Now staying the course is a path to going over the falls. To have a meaningful role in the new order, the enterprise will have to change its course and speed. The captain must take the helm. Leading this kind of transformation is the defining element in the CEO role, the one that sets it apart from the COO role. It is not something to undertake lightly or frequently, but when it must be undertaken, it trumps all other priorities.

Governance

Unlike the other three zones, the transformation zone is a transitory institution. It comes into existence to meet (or create) a crisis, and it passes out of existence once the crisis is resolved. Thus there is no independent, persistent body of governance. Instead, it organizes around the CEO’s executive staff and co-opts that group’s regular meeting cadence by claiming top priority on every agenda.

The role of the CEO itself changes dramatically in a time of disruptive innovation. During an era of sustaining innovation, the CEO is the most senior manager on the executive team, and the focus of executive activity is on good management. In an era of disruption, by contrast, CEOs must transfer the burden of managing the existing lines of business onto the rest of the executive team, with or without the help of a COO, and focus their own energies on leading the enterprise through a period of destabilizing change. In other words, sustaining initiatives demand good management; disruptive ones, extraordinary leadership.

Playing Offense in the Transformation Zone

The goal of zone offense is to leverage nonlinear growth from a category disruption to create a net new business of material size in the enterprise portfolio. To initiate this move, one takes an independent business unit from the incubation zone and repositions it as a line of business in the performance matrix, as illustrated in the following diagram:

The CEO’s first task here is to pick one—and only one—business to scale. As we have said repeatedly, allowing two or more entities into the transformation zone at the same time is a showstopper.

The CEO’s second task is to sponsor a dramatic reallocation of resources, one that will put everyone’s nose out of joint. That is, even though the disruptive business at present is an order of magnitude subscale, the GM of the IOU is nonetheless promoted to become a new row owner in the performance matrix. At the same time, all of the sales-focused column owners in the performance matrix are charged to deliver nonlinear growth against this new row even though the sales motion is less efficient than in the other, established lines of business. Moreover, the professional-services organization is charged to prioritize this row’s projects above all others, even though they are likely to be resource-intensive, unprofitable, and a bear to manage. Finally, to complete the arc of nonlinear growth, business development is charged to find one or more at-scale acquisitions that will be personally endorsed by the GM and shepherded through the M&A process by the CEO in light of the fact that their valuation multiples will be ludicrously high when compared with the acquiring enterprise. With the onboarding of these acquisitions, scaling commences in earnest, and the period from then on until the tipping point will be one of great sacrifice and stress.

Once that tipping point is reached, the organization can restabilize. The various line functions that previously took direction from the GM under the IOU model will now migrate into and integrate with the performance zone or productivity zone function that provides their service, and take their future direction from the appropriate line function manager. The business itself will have become a material row in the performance matrix and a high-growth provider as well. The goal now is to grow inertial momentum around the new position, something the performance matrix is inherently good at.

Prior to reaching that point, however, there are deep challenges to overcome. As we discussed earlier, these include:

• Scarce Domain Expertise. Knowledge critical to winning sales in the new category is concentrated in the IOU sales team and virtually absent in the global sales force at large. There is a straightforward fix for this problem—implementing an overlay sales force model—but that leads to the next challenge.
• Out-of-Band Expense-to-Bookings Ratio. Overlay sales forces become victims of their own success, being expensive to deploy and becoming more so as they scale. Well before the materiality metric has been achieved, they will have a visibly negative impact on the operating margins of the enterprise as a whole. This normally causes the CFO to clamp down. But to cut back at this time is simply fatal: when the overlay layer is decommissioned before revenues reach the tipping point, sales momentum goes sideways, the initiative falters, and no new row appears in the performance matrix.
• Misaligned Compensation. Sales compensation is normally awarded for bookings productivity. Selling in Horizon 2, however, is inherently less productive than selling in Horizon 1 because first one must engage senior executives at the target customer to create budget, and then with the function managers to win the right to consume it. This fundamentally less-productive selling motion deters conventionally compensated members of the global sales team from engaging more actively with the transformational initiatives, diminishing their efforts just when they need to be maximized.
• Account Management Resistance. Misalignment surfaces here as well. Typically the incumbent account manager does not have a relationship with the new target customer who is often in a separate organization and who may be competing for budget with the existing customer’s organization. Meanwhile, sales cycles with the traditional customer can be disrupted by the new offer, causing delays and even outright losses.

None of these problems is insoluble, but all require substantial investments of time, talent, and management attention. That is why the CEO has to make the transformational initiative the first topic on the agenda at virtually every executive staff meeting. The focus of these sessions is on acceleration. Transformational initiatives are extremely risky and exceptionally painful, so the sooner they are completed the better. The operative question for every meeting, therefore, directed by the CEO to the GM of the emerging line of business, is: “What can any of us do right now to further accelerate your progress?”

Here are some of the levers the CEO and e-staff can and should pull:

• Make the new business the headline in corporate marketing and communications messaging.
• Double sales coverage in one or two vertical markets where the new line of business has particularly compelling use cases and is getting better-than-average traction.
• Grant special terms for contracts that get marquee customers over the line.
• Add professional-services capacity to accelerate customer implementation of the disruptive offering.
• Fund additional engineering capacity to accelerate the build-out of the “me-too” feature set that complements a highly differentiated core.
• Support special deals for supply chain partners to expedite their contributions to the offering.
• Grant special retention agreements for executives from the growth acceleration acquisition to ensure they double down to support this effort.

In parallel with these special dispensations, transformation zone initiatives also demand significant sacrifices from the other three operating zones, each of which has its own inertial momentum that will resist such changes. Specifically, here’s what is being asked of each:

• Performance Zone. Column owners in the performance matrix need to allocate up to 10 percent of their total go-to-market capacity to the transformational initiative while still achieving the metrics of the rest of the operating plan. Product row owners do not have to pay this big a tax directly—although they typically do have to curtail their hiring—but less sales capacity puts pressure on their numbers as well. In short, a single transformational initiative can and normally does consume all the contingency resources in the system and puts every cell in the performance matrix at risk.
• Productivity Zone. Leaders of shared-services functions need to find ways to reengineer, outsource, automate, or otherwise offload their existing workloads in order to free up program resources to help power the transformational change. This will likely include running a Six Levers project to extract resources trapped in legacy processes and could also include accelerating one or more EOL efforts. At the same time, they must continue to maintain the enterprise’s underlying systems to ensure compliance, quality, and reliability. It’s a bit of a “change the tires while the vehicle is still in motion” exercise, but it can’t be helped. The performance matrix cannot deliver on both its operational and its transformational commitments without a significant productivity boost.
• Incubation Zone. GMs from the remaining IOUs in the incubation zone cannot expect access to the transformation zone for the foreseeable future. In that context, each IOU must reevaluate its own exit strategy, choosing either to wait out the current initiative for the chance to be next in line or to reconfigure itself for one of the alternative exits mentioned in the prior chapter.

These are extraordinary requests that land across the entirety of the executive team, and unless they are managed with precision and grace, they can easily become showstoppers.

To secure this kind of alignment, the CEO, with the support of the board of directors, should revamp the executive compensation plan to give everyone on the team a significant stake in the transformational initiative’s success and a correspondingly painful consequence if it fails. If half of everyone’s annual bonus for the next two to three years depends on the success of this one venture, it will definitely get the attention and support it needs. Indeed, the great irony is that when everyone in the enterprise actually does row in the same direction, it is actually almost impossible not to succeed. Established enterprises have amazing throw-weight if they can coordinate it properly. The challenge is to ensure that compensation and management systems are appropriately modified to achieve precisely this kind of alignment.

One additional constituency you need to get aligned with the transformational initiative is your investor base. It is critical to prepare them for the upcoming changes before they impact the financial results and to control the ongoing narrative through which they are interpreted. You really are managing for shareholder value here, but because you are moving the fulcrum of value creation from steadily improving earnings to catching a new wave of growth, there is a nasty patch to go through before you can trumpet any success.

In this context your communication effort can be divided into three acts, as follows:

• Act One occurs before the new business has reached material size. Using the announcement of a major deal signed with a marquee customer, you call attention to the emerging category and the technology disruption that is driving it. Most of this narrative is about the impact the new paradigm can have in addressing important unmet needs and the early formation of an ecosystem of partners who will bring this value to market. There is no real financial news here; you are just giving the investment community a heads-up.
• Act Two is the one that does the heavy lifting. You must not hope to skate through a transformational initiative keeping your traditional performance numbers intact. That would take a miracle. But explanations as to why they are failing, no matter how compelling, will not head off investor angst. So you need to step up and make clear what you are up to and what people can expect for the next six to eight quarters. If you can time this with a major acquisition in the targeted category that resets the performance bar altogether, so much the better. Such an acquisition not only helps you achieve the material scale you need: it also buys you a grace period to put the new house in order, by the end of which you expect to show revenue performance metrics that growth investors can get excited about.
• Act Three represents the victory lap. The tipping point has been reached and passed. For the first time you will break out the financials for the new row in your performance matrix, allowing investors and analysts to revalue the company based on an additional earnings engine in a potentially uncorrelated category. Now it is critical not to keep things under wraps. Blending performance metrics from growth and value businesses is never a good idea—the sooner you can show each separately, the better for both.

The overall message here is that during a period of disruption, the numbers are not your friends, and you must not allow your corporate narrative to be dominated by operating ratios of any kind. Yes, those numbers will get calculated, and yes, you must be accountable to them, but they cannot be your story. That must be framed by a narrative of secular growth, a road map to a brighter future. Spreadsheets make lousy maps.

Playing Defense in the Transformation Zone

As challenging as it is to play offense in the transformation zone, it is even more difficult to play defense. Here’s why.

A company earns its keep by helping its customers release trapped value in their operations. But what if the value is being trapped by your own company’s offers? That is, what if the value you are delivering no longer warrants the profit margins you are extracting? It happens all the time as categories mature. It’s why disruptors target established franchises. Now what?

The first thing you must realize is that in cases like this your investors’ immediate interests are no longer aligned with your customers’. This is not a sustainable situation. The trapped value in your legacy model is going to get released one way or another. Customers have seen that there is a better way. Margins will deflate. Investors will be disappointed. There is no getting around it. Your only viable option now is to realign with your customer base by migrating your offers and your relationships onto a better footing.

In this context, your differentiating value proposition will be evolution, not revolution. In this context, the strategy for playing defense in the transformation zone is built around a three-step program: 1. Neutralize. 2. Optimize. 3. Differentiate.

The order is critical. Organizations that succumb to a disruptive challenger make one of two mistakes. Some continue with business as usual, denying or downplaying the disruption at first, and then as their market position erodes to the point where it can no longer be ignored, they launch a series of downsizing initiatives to rationalize their businesses through optimization. All they succeed in doing is convincing everyone that they just don’t get it. Alternatively, others panic and race to out-differentiate the disruptor, launching one or more half-baked incubation initiatives prematurely, meanwhile leaving their legacy in-market offerings unchanged. All this succeeds in doing is convincing everyone that they lack the mojo to win in the new market.

The winning response to disruption, by contrast, is as follows:

1. Neutralize first. Your first objective must be to blunt the disruptor’s attack. You do this by co-opting their most visible and attractive features and bolting them on, as best you can, to your current offerings, changing your operating model to accommodate these changes. It’s a kludge, to be sure, but the goal is to get to good enough, fast enough, any way you can.
        For example, at the time of this writing, to respond to the disruption of Uber, several San Francisco cab companies are adopting Flywheel, a mobile app that lets you summon one of their cabs, track your ride and pay by phone. You don’t rate the driver, and they haven’t changed their business model to match Uber’s. On the other hand, they have modernized their offering and updated their operating model in order to blunt Uber’s appeal by co-opting one of its most attractive and visible features. This puts them back in the game. If you fail to neutralize, you leave the playing field to the other team. That’s why “neutralize first” has to be your top priority.
2. Optimize second. Given the new value proposition in the market and your inability in the short term to match it, you have little choice but to reduce your prices. To do so and maintain a viable operating margin you are going to have to take cost out of your infrastructure model. Here is where the productivity zone needs to weigh in with its expertise in Six Sigma and the Six Levers. You have to act quickly, and the decisions you must make, while not difficult, are certainly not pleasant. In this context, the CEO needs to be both an active sponsor and a vigilant inspector, making sure the hard choices get made and get executed in a timely manner.
3. Differentiate third. This takes longer, often a lot longer. Having used neutralization to refurbish your operating model and used optimization to revamp your infrastructure model, you have bought yourself time—actually, quite a lot of time. Now, to stake out a sustainable position for the long term, you have to use differentiation to revitalize your business model. Your legacy business model is a sitting duck. It has been in the market forever, it is still a source of trapped value, and competitors know exactly how to attack it. You must reinvent yourself for a new world.
        The key to such reinvention is to reaffirm your legacy value proposition even as you revolutionize the way you fulfill it. Remember, you are the incumbent. If you can realign your firm with your customers’ future needs and interests, they would prefer to stick with you. And you have time. You don’t have to rip and replace the old business model. There are actually plenty of customers who want to stay with your old model for a while longer. But you do have to engineer a steady evolution to the new one, and you have to make clear from the outset where that evolution is headed.
        This is what Lou Gerstner did so well at IBM. When he took the helm, the mainframe model was not dead, but it was clearly dying. Nonetheless, a lot of people still wanted to stay on it, but they needed to see a different future. IBM’s legacy value proposition had always been to deliver enterprise productivity through information systems. Gerstner did not change this. But he did change IBM’s business model to rotate away from hardware to software and services. And that in turn gave IBM two very successful decades. Now it is time for the company to change again—never an easy thing—but at least it has a history of having been able to do so before.

Faults and Fixes

When CEOs falter in leading a transformational initiative, here are the most common mistakes they make:

• Undertaking two or more transformations at the same time. This is a mistake on offense. It happens most often when two or more businesses in the incubation zone are needing to scale at the same time. Both are allowed to proceed because executive teams, well aware of the odds against any particular transformation succeeding, do not want to put all their eggs in one basket, and no CEO wants to disappoint EVPs who are deeply committed to their next big thing. Regardless of motive, given the exceptional demands even one initiative makes on the rest of the enterprise, executing two or more at the same time is simply not possible, and the consequence is certain failure.
• Delegating the task when playing offense. Transformations focused on adding a net new row to the performance matrix alter the very structure of the enterprise. By reason of the size of the effort, the breadth of involvement required, and the risk of the undertaking, only the CEO can sponsor these efforts. Indeed, transformation is the signature accomplishment of a CEO’s tenure and should take precedence over all other tasks. To delegate this responsibility to anyone else implies that the system as a whole should be able to absorb a transformation as business as usual. If that were true, this playbook would not have needed to be written.
• Delegating the task when playing defense. Here the challenge is to fend off an attack on the performance zone by coordinating a complex transformational response across all three of the other zones—the incubation zone to supply the technology to support the neutralization effort, the productivity zone to support the optimization effort, and the transformation zone to support the differentiation effort. The whole company must be interdependently engaged, and no one other than the CEO can control all these reins at the same time. If you leave the ball in the performance zone’s court, its only option is to optimize, and thus begins your long, slow decline into obscurity.
• Trying to play offense and defense in the transformation zone at the same time. You cannot simultaneously play both the disruptor and the disruptee roles. Or, to put it another way, you cannot disrupt your way out of a disrupted category. It simply puts too much stress on both the company and the partner ecosystem. When both roles are called for, you must elect to play defense first, get your house in order, and then go on offense.
• Competing priorities. There are always competing priorities, many of which are truly compelling. But transformations can never be put on hold. Time is always the scarcest resource, followed by talent and management attention. The transformational initiative must be first in line for all three.
• Incomplete alignment at the executive level. In this scenario one or more senior executives simply choose not to suit up, preferring instead to direct their energies toward efforts more specific to their own interests. This creates just enough contention for scarce reserves to cause the effort to fail, not to mention occasioning the passive-aggressive response, “I told you so.” Such lack of alignment must be rooted out early and eliminated swiftly and utterly.

Concluding Remarks

The transformation zone is the CEO zone. On offense, there is the opportunity to springboard the enterprise into a whole new dimension, the way cloud computing has reset the trajectory for Amazon, the way that music and smartphones reset it for Apple, the way that Pixar reset it for Disney, the way The Sopranos reset it for HBO, the way the Prius did for Toyota. On defense, there is the opportunity to reposition the franchise to give it a new lease on life, the way committing to wireless helped to reposition Verizon, the way committing to software as a service helped to reposition Adobe, the way acquiring TurboTax helped to reposition Intuit, the way acquiring WebLogic helped to reposition BEA, the way committing to web content management helped to reposition Documentum.

Twenty years after the publication of The Innovator’s Dilemma, we must recognize that these results are still not the norm, but frankly, it is time to stop lamenting that fact and do something about it. That is the job of the transformation zone. To succeed here, CEOs must embrace a handful of principles that run counter to conventional wisdom. Let us close this chapter by reminding ourselves of what they are:

1. It is more important to complete the transformation than to make the number. When your business portfolio is undisrupted and your company power intact, performance can and should be the top priority. But when both have been destabilized, either by you betting big to enter a new category or some other company betting big to take one of yours away, your entire future is at risk, and you must make securing it your number-one objective. That means transformation takes precedence.
2. When you undertake two transformations at the same time, it is impossible to succeed with either. There is no such thing as two top priorities. There can only be one. And when just one has the power to capsize your entire operation all by itself, it is folly to consider adding a second. You are not reducing risk—you are guaranteeing failure.
3. To complete a transformation, every leader and function must make its success their top priority—period! This is a matter of cadence and alignment. If anyone in the boat is rowing the wrong way at the wrong time, it throws the entire operation off. When that person is a leader, it signals to the troops that alignment is not mandatory. In times of disruption, alignment is mandatory. No exceptions.

If you can secure these three principles, your next transformation should succeed.