Is your electric vehicle strategy shock-proof?

Bain & Company industry brief 02/09/11 by Bain's Global Utilities practice As the era of electric vehicles dawns, utility CEOs find themselves in the spotlight answering questions on how electric vehicles will impact their businesses. Most utility companies already know that their core business-generating, trading and selling powerwill hardly change, other than perhaps to shift to lower carbon emission sources of energy. However, the advent of e-mobility opens up a suite of opportunities for utility companies outside their immediate core. The question is: How to identify dependable, low-risk adjacencies to invest in? A good starting point is to consider the electric vehicle value chain, which combines links from the value chains of the automotive and utility industries. According to Bain & Company estimates, the total profit pool of each e-vehicle in Europe adds up to around 3,000 ($4,000) over its lifetime. That covers a number of business opportunities from one end of the value chain to the other: starting with vehicle sales and battery provision; going on to power management and value-added services; and ultimately, the resale of the vehicle or reuse of its components. Of these, the smallest slice of the profit pool goes to a utility's core business: electricity production. Predictions vary but most estimates agree that by 2020, as much as 50 percent of the new vehicles sold in the US and Europe could consist of some form of electric vehicles (battery electric, range extender or hybrid). Our research shows that at that level, electric vehicles have the power to shift profit pools substantially for the automobile industry-but only marginally for utilities. In a base scenario-a projected market penetration of battery electric vehicles of about 25 percent -electricity demand will increase by just 2 to 5 percent. Even if electric vehicles storm the market, with say a penetration of 50 percent, the additional increase in electricity demand would add up to just 5 to 10 percent. Most markets already have enough power capacity in reserve to meet this spike in future demand. To profit from electric vehicles, "power providers" like utilities and oil and gas companies must, therefore, look beyond electricity sales. But that gets tricky, as each link on the electric vehicle value chain also attracts competitors from other industries: "hardware providers" like auto original equipment manufacturers (OEMs) and battery manufacturers; "infrastructure providers" like service stations and parking garages; and "service providers" like banks, leasing companies, independent resellers and even infotech and infotainment companies. The six most promising bets Responding to market pressure, some utility companies moved fast to place bets on new business ideas centered on electric vehicles. Many announced initiatives that projected a clean, green image of the corporate brand. In Germany E.ON is partnering with Audi for a fleet trial in the Munich region. The New York Power Authority is working with Ford. In Italy, Enel and Daimler are working together, introducing electrically

powered vehicles in major cities. However, now companies find they can do more: they can find a new source of revenue for the business by investing in the right adjacency. Our research shows that six key nodes on the e-vehicle value chain appear particularly promising for utilities- even though each comes bundled with start-up issues. These include:
Power

management: Increasingly, managing the grid will present significant challenges. On the one hand, as the number of solar and wind power generation plants rises and more distributed generation installations come into play, supply volatility will increase. On the other hand, with the advent of more energy efficient options, such as electric vehicles and heat pumps, demand volatility will also rise. Utilities can provide an answer to volatility by offering intelligent load control services for e-vehicles. Options include starting or stopping the load in line with the level of power supply in the grid. They can also use the battery in the car, with the consent of the owner, to provide regulation energy for the grid as needed. Major utilities have started pilot programs to test this service offering, such as RWE's project "e-mobility Berlin" and E.ON Avacon's project, Harz.EE-mobility. Vattenfall is investigating how e-vehicle batteries can help store power in times of oversupply. In all these pilots, pricing models will need to take the additional wear and tear on the battery into account.
Installation

and operation of public charging infrastructure: The high cost of public charging points--in Germany, for example, they cost 8,000 to 10,000 ($10,800 to $13,400) each--means that the business model for installing public charging stations remains fragile. Most service providers see no way to earn the capital and operation costs with revenues of only 2-4 ($3-6) per charge. Consequently, most public charging infrastructure will depend on cross-subsidies. Either the regulator allows the utility to add the cost to the grid costs and charge grid users, or local communities pick up the tab, or the incumbent utility invests in a public charging infrastructure to run a pilot and promote its brand. Another option: partnering with local businesses such as supermarkets, fast-food chains and cinemas that can use charging stations to attract customers. In Stockholm, Elforsk is conducting a pilot by running charging stations at McDonald's restaurants. Germany's EnBW has installed a network of charging stations in the Stuttgart region. E.ON's pilot project in Munich provides test drivers a fleet of Mini E battery electric vehicles that can be charged at E.ON branded charging stations in the city center.
Installation

and operation of private charging points: Private charging points offer a quicker path to revenues. They require fewer security and safety features than public charging points and are often cheaper to install and maintain. Besides, anyone who buys an electric vehicle is likely to pay the extra money to install a charging point. Recognizing that, RWE is piloting a program to offer consumers across Germany a wall-box charging station at their homes. Electric vehicle owners can charge their car for a 100-140-km range in only one hour. In the US,

NRG now offers customers private charging stations. This option will require investments from the grid operators over time. Most local grids lack sufficient capacity to supply the growing number of private charging stations in a given residential area. Value-added services: Utilities providing charging infrastructure (public or private) can also pipe "content" into the car in the form of navigation maps, traffic updates, or even music or films for car entertainment systems. Other services offered: monitoring car electronics and providing remote car-diagnosis services. Some utilities might also consider the option of offering advisory services to communities. Sweden's Vattenfall recently initiated a project to develop userfriendly, value-added services and applications for cost-efficient charging of EVs at home and for fleet operators. Financing vehicle batteries: Utilities have the option to develop innovative financing schemes for the sale or lease of electric vehicles and batteries. Depending on the specific scheme, utilities can enter into agreements with the car user on the extent to which the battery can be used for providing (positive or negative) regulation energy or regulation energy reserve. Such contracts can also specify the terms and conditions for battery usage once the battery's useful life in the electric vehicle is over. E.ON recently announced a partnership with Athlon Car Lease in Germany for the provision and financing of fleet cars. Reuse of battery for power storage: Even after lifetime employment as a vehicle battery, electric vehicle batteries still retain 50-60 percent of their capacity. A utility could also build a business model around bundling used batteries for power storage at wind farms or large-scale solar power generators. According to Bain calculations, under current regulations and given the energy prices in Germany, a used car battery still has a net present value (NPV) of around 1,000 ($1,300) if used in a bundled storage facility. Drawn to the idea, General Motors is teaming up with the Swiss-based utility supplier ABB to conduct research on reusing spent Chevy Volt batteries for power storage. Prioritizing e-mobility business models Utilities face a plethora of choices but most of them currently represent high-risk and untested business models. CEOs must not only pick their battles carefully, they must look beyond their own industry to gauge their ability to win. Which e-mobility activities will suit their businesses best? Do they have the right assets and capabilities to venture into new areas? What impact will the new adjacencies have on the corporate brand and reputation? Leaders can make decisions more confidently if they develop a framework to weigh options-and shortlist those that make sense. In our experience, to get the best out of the e-vehicle opportunity, a utility can prioritize potential business ideas on two dimensions. The first criterion ranks business models on their attractiveness in terms of the projected market size, the expected rate of growth and their potential profitability. The second prioritizes business models on the utility's ability to win: the assets and capabilities that the utility can bring to the table by itself or through partnerships.

The attractiveness and ability to win approach also helps companies zero in to the capabilities they lack. Then, the company can identify potential partners that can help it build successful new business models. For example, one utility company found that it lacked skills in consumer lending know-how and inexpensive refinancing. As the company identified financing as an attractive adjacent business, it began seeking a bank or leasing partner. Another utility company saw itself as an "emobility enabler." It identified partners such as parking garages to install branded charging stations and began to build its own public charging station network. Such frameworks also highlight business areas where utilities can play the role of an investor. In this case, instead of new revenue streams, the utility seeks to maximize the return on investments. For example, when Delphi, a leading global supplier to the automotive industry, recognized that electric vehicles will require new components it began investing in equipment technology suppliers for components like EV inverters. Similarly, Comverge invested in developing vehicle-to-grid (V2G) technology for future applications in demand management. A critical issue in making the right decision is to consider timing. Utilities might not perceive a need for urgency if they consider only what competitors are doing within the industry. However, for most utility companies, the disruptive force will appear from other industries such as oil and gas, telecom, and component and infrastructure equipment providers: These companies will want to access a greater share of the profit pool by directly offering services to electric vehicle consumers. Utilities can preempt the threats by planning the right strategy and making the right investments early. For most utilities, electric vehicles hold plenty of promise--not just in green slogans, but also green-field ventures. Key contacts in Bain's Global Utility practice: Europe: Stephane Julian Frederic Berthold Arnaud Kim Roberto Nacho Rios Philip Kalervo Tortola in Helsinki Americas: Neil Stuart Alfredo Cherry in Levy in Pinto in So Charveriat in Critchlow in Debruyne in Hannes in Leroi in Petrick in Prioreschi in Calvo in Skold in Paris London Brussels Dsseldorf Paris Munich Rome Madrid Stockholm

San

Francisco Atlanta Paulo

Joseph Scalise in Andy Steinhubl in Houston Asia: Sharad Apte in Amit Sinha in New Delhi

San

Francisco

Southeast

Asia

Creating a new commercial model for the changing medtech market Bain & Company industry brief 02/09/11 by Bain's Global Healthcare practice For three decades the medtech industry generated consistent success based on one formula: sell innovative, clinically beneficial products to surgeons and "pull" these products through hospitals and other providers that ultimately pay for them. Now, that world is changing:
Economics

influence a much greater portion of the device-selection decision. CFOs, purchasing managers and even physicians now put greater emphasis on the price of devices and the total cost of treatment as they select medical devices for their patients. One factor aligning economic and clinical forces: in the US, the number of medical practices owned by hospitals grew from 26 percent in 2005 to 50 percent by 2008. Genuine clinical differentiation is diminishing in many product categories. At the same time, the hurdle for valued innovation is rising. That is especially true in product categories that represent the largest medtech profit pools: cardiac rhythm management, cardiovascular, orthopedics and spine-related devices. Customers no longer reward incremental improvements. The net result is that pricing and product margins face increasing pressure. In response to these market forces, we find many companies in the medtech sector wrestling to reconfigure their go-to-market approach. Their key issue: how to chart a successful course to a new commercial model? On the one hand, not responding to the new market dynamics can result in death by a thousand cuts, as margins and resources slowly get squeezed out. On the other hand, if a company moves too fast in certain segments, it could rapidly lose market share to competitors that continue to provide very high levels of bundled services. Our experience shows that medtech companies can steer through turbulent waters by following three important steps: segment the market; tailor the go-to-market approach; and align the organization. Segment the market Many medtech executives recognize that the market is no longer homogenous and that the one-size-fits-all commercial model no longer works. However, few have invested in truly segmenting their markets. A "dynamic" segmentation is critical because hospitals have significantly different needs and those needs constantly evolve. We believe the

most effective, actionable approach clusters customers on two very practical yet important dimensions:
Device

selection criteria. One of the most important points of differentiation between one account and another is the way in which hospitals choose devices. These criteria can range from the purely clinical to the purely economic. While some medtech accounts heavily court physicians and avoid exerting any type of influence over product selection, many others directly employ physicians or have been expanding the scope of "value analysis" committees to provide greater direction on device choices. Several factors contribute to an account's position on this spectrum, including physician employment model, payer mix, acuity mix, group purchasing organization (GPO) affiliation and the local competitive position. Account sophistication. Increasingly, medtech companies find that sophisticated buyers tend to use formal processes to assess clinical and economic efficacy. They also seek to optimize total cost-including inventory, administration, nursing time, training, OR and facility utilization-rather than product cost alone. Furthermore, sophisticated accounts perceive medtech manufacturers as potential partners that can help them manage total costs and improve patient outcomes. At the other end of the spectrum, less sophisticated buyers simply focus on reducing device cost through "all-play" bids and broad-based product tenders. Each dimension represents a relatively broad spectrum of customer behaviors, preferences and activities. In fact, while accounts vary significantly in their level of sophistication, we have not found any that would currently qualify as "highly sophisticated" on an absolute basis. Moreover, each product category will generate different segments. The world looks dramatically different to a spinal-device manufacturer than it does to a wound-care company. Segmentation also varies from country to country. In most markets, at least three broad segments exist. Traditional physician preference accounts: Their influence may wane over time, but surgeons and physicians still wield purchasing power in most medtech categories. These accounts view themselves as the quality leaders in their therapeutic space. They place a premium on attracting and retaining surgeons and not constraining clinical choice. Several academic medical centers fall in this category. Health systems in the Netherlands, Switzerland and Belgium broadly fall in this segment. Collaborative buyers: For many hospital systems-such as large integrated delivery networks (IDNs) like Kaiser Permanente Hospital or Hospital Corporation of Americathe solution to reducing healthcare delivery costs lies not so much in hunting for bargains on each product they buy, but reducing the total cost of doing business. An important tool in this segment is the use of "value analysis committees," consisting of physicians and procurement managers, to narrow the selection of device choices in a given product category. Over time, these committees are becoming more sophisticated in their definition of "cost" to include inventory, order processing, operating room (OR) utilization and nursing utilization. European healthcare systems such as those in France and the UK, as well as private hospital chains in Germany, fit in this segment.

Price negotiators: Constrained in their budgets, many city and country hospitals have no choice but to hunt for bargains-especially in products like defibrillators, orthopedic implants and coronary stents. Such customers seek the lowest price by often inviting all bidders and setting an "all play" price point at the lowest bid received. Health systems in Scandinavia and Germany are rapidly moving toward this model. Tailor the go-to-market approach Once a medtech company understands the distinct segments and how they are evolving, it can begin to tailor its commercial approach to each segment. Our work with medtech companies of different sizes and specializations leads us to believe that the most important components of a robust commercial model are: Channel investment: This is the overall amount of enterprise resources a medtech company commits to each channel. A high level of investment includes dedicated sales reps covering only a few accounts. These reps have the time to accompany a high percentage of surgeries in the OR and are supported by a robust infrastructure of product specialists, support personnel and technology. A moderate level of investment would represent broad geographic and account coverage for each direct sales rep, usually complemented by a network of non-exclusive distributors. Lower levels of investment include using distributors or agents and even some of the emerging direct ecommerce platforms. Call-point focus: Companies need to make choices on the relative amount of resources they direct toward clinical decision makers (surgeons, physicians, nurses and clinicians) versus economic influencers (material managers, OR managers and finance personnel). It's also critical for the medtech company to identify the appropriate level of call points: should it be the surgeon or the department head? The procurement managers or the CFO? Different call-point priorities require very different capabilities, for both marketing and sales. Value proposition: This component comprises several sub-elements: the product, services and pricing models.
The

primary component of a medtech company's value proposition is the product and the clinical outcomes the product can deliver. Companies need to offer surgeons a variety of clinical capabilities across a spectrum of price points, ranging from value products to premium products. Many companies implicitly bundle services along with their product in their overall value proposition for surgeons and hospitals. For example, for surgeons, reps typically provide product training, operating room support and educational materials. Many medtech manufacturers are just beginning to develop services that help hospitals control costs and improve profitability. These include inventory management and component tracking, consignment, training for nursing and other staff, and other capabilities that help providers understand and manage risk.

 Pricing,

perhaps the least understood component of the value proposition, plays a critical role. Most medtech companies price today with one all-in price for the product as well as any services implicitly bundled with it. However, in our experience, this is but one midpoint on a spectrum of pricing alternatives that range from completely unbundled products and la carte services at one end, to gain-sharing or even profit-sharing programs at the other. Medtech leaders can think creatively about how to price like a partner and not just as a vendor-especially for their major accounts. Should every medtech company adjust its commercial model to address the needs of every segment? Not necessarily. Smaller companies may be best served targeting either the traditional physician preference segment or the price negotiators (as Eastern European and Asian companies are doing in many categories). Larger companies need to make a strategic decision on whether they want to participate in the price negotiator segment. Winning across all three segments requires highly sophisticated internal processes, data access, metrics, scale and organizational effectiveness. Align the organization The practical implications of a new commercial strategy-and the organizational change required to execute it-are not trivial and are, in fact, too often underestimated. Such transformation means that many priorities, capabilities and tools need to change. In our experience, companies that are ready to evolve their commercial approach must act across several dimensions:
First

and foremost, invest in thorough market segmentation. This initial step is critical for a medtech company to optimize its investments in the new commercial approach and to align its management team around a path for transformation. While common and well understood in other industries like consumer products, rigorous market segmentation is still in its infancy in the world of medtech. To develop its new commercial model, the medtech company must first deeply understand the needs and behaviors of its customers-clinically as well as economically. The company should have the ability to quantify each segment size, profitability and rate of change. Realign the company's sales and marketing capabilities. That involves structure, incentives and process as well as the types of people a medtech company recruits and promotes. A clinical specialist who excels at providing real-time surgical support in the OR typically will not have the skills to partner with a CFO to share risk and help an account improve profitability. Similarly, marketing teams that understand how to communicate with surgeons aren't necessarily equipped to influence IDN and GPO buying groups. Add "science" to the "art" of salesforce management. A medtech company must continue to improve upon the art of relationship-building. But it must also add formal customer relationship management systems to monitor every customer at every stage in their buying process. Over time the medtech company will need to quantify best practices and analyze ideal sales team configurations.

 Invest

in competitor intelligence. As the market evolves rapidly, competitors will also change with it. A medtech company must understand its competitor's product costs and the costs of the services that company bundles with its product. Then it can drill further. Does it have a cost advantage in certain types of services? Which competitors are winning in which segments? How are competitors trying to win each customer? Improve tender and bid-management capabilities. For many medtech companies, large volume bids represent a major and growing portion of annual sales volume. Instead of treating such transactions as one-offs, medtech companies can manage the process holistically-from the pre- to the post-tender stage. To do this, they must develop robust pipeline management tools and put in place sophisticated pricing processes. For example, a medtech company should know how to quantify the marginal cost of bundling in a particular service with a particular product. A time for action Today's industry leaders have the extensive data access and scale to respond to new market forces and position themselves to win across multiple dimensions. However, they also face great coordination and change management challenges. Business history is replete with stories of companies that failed because they stuck to a tried and tested formula, while the world moved on. Over the next three to four years, the medtech industry can expect a significant shakeup in profitability and relative market share among participants in many categories. For medtech leaders, the challenge will be how to invest in significant change--and ensure that it is identifiable, measurable and manageable. Winning medtech companies will challenge their leadership teams to plot a course for effective, pragmatic transformation. Most important, leading medtech companies will identify their best capabilities and pick and choose the races they want to win. Key contacts in Bain's Global Healthcare practice: Americas: Jay Istvan in Matthew Collier in Dave Fleisch in Giovanni Fiorentino in Sao Paulo Europe: Dave Michels in Zurich Getting to the core of Bain & Company by Bain's Global Oil & Gas practice the right cleantech strategy industry brief 01/25/11 Chicago Francisco Chicago

San

Cleantech promises to change how we operate in the world we live in. Exciting new ideas and ways of thinking abound. Technologies are starting to evolve at a breathtaking pace. And governments, investors and individuals keep pumping money into cleantech to stoke innovation and find solutions to global issues such as the increasing demand for energy. According to one estimate, oil demand may peak as early as 2020 due to more stringent CO2 reduction policies, higher fossil fuel prices and declining "clean energy" investment costs. However, cleantech also suffers the shortcomings of all industries in their early stage of development. It lacks a clear pathway to success. Regulation remains inconsistent. And most cleantech investments seem fragmented and unable to deliver the consistent returns investors expect. Despite the evolving landscape, for the current generation of cleantech pioneers this is an opportune time to press ahead. If they map the right course through the turbulence, they can not only extract the full potential of cleantech's promise, they can strengthen their existing businesses and develop new adjacencies. The experience of a handful of leading companies shows that the right cleantech strategy generates revenues, spawns new business ideas and in small and big ways, transforms the way companies operate. GE's foray into "ecomagination" generated revenues of $18 billion in 2009, with a projected increase to $20 billion by 2010. Similarly, Siemens' environmental portfolio business added $38 billion in revenues in 2010. Investors who committed capital early to solar and wind companies with a distinct competitive edge, like First Solar and Hansen Transmissions, reaped handsome rewards. An evolving cleantech landscape More companies can deliver such results if they develop a well-defined game plan for coping with cleantech's current challenges. For one, even now, little clarity exists on what truly defines cleantech and that makes it hard to map the pathway to success. Recently, when Bain & Company conducted in-depth interviews with 15 global cleantech experts, no one could agree on a generic definition of cleantech. The fast pace of cleantech innovation means that companies continually have to contend with evolving new technologies-and often, global events and concerns result in creating the "hot" technology of the day, which in turn influences strategic thinking. For example, the 1980s saw the first wave of cleantech investments, when leading oil and gas companies focused investments on renewable energy generation for off-grid applications. Ten years later, a second wave emerged with companies concentrating on solar and wind energy for large-scale power generation. Later, companies exited many of these investments. In 2006, Shell sold its solar crystalline operations to SolarWorld. In the past two years, BP Solar closed its solar manufacturing plants in Spain and the US and withdrew plans to expand into wind energy in the UK. A third, more recent, wave saw companies and investors diversify their cleantech bets by backing a range of technologies, many untested and at different stages of maturity.

While a sense of urgency prompted many such investments, it became hard to sustain a broad portfolio in the absence of adequate returns. For example, many utilities invested in a number of power generation technologies early in the past decade, only to find that in practice, their capacity addition targets for clean energy ruled out all other technologies except on-shore wind. In a recent conversation, a senior technology officer at an oil field service company said, "We've pumped millions of dollars into cleantech because we think it's something we should be doing. But if you ask me what our investment criteria is or what our returns will be-I couldn't tell you." It's an oft-repeated pattern. In 2009, governments across the world allocated $400 billion, 40 percent of the global economic stimulus spending, to "green" initiatives. In the same year, venture capital and private equity pumped in $6.8 billion in cleantech investments. Corporations and government spent $15 billion on smart energy technology R&D, concentrating mostly on solar energy, which received the highest funding of around $3 billion. In most cases, the return on the capital deployed remained low. Take biofuels, for example. Companies invested heavily in the development of firstgeneration biofuel technology. However, despite commercial viability guaranteed by government subsidies, biofuels failed to reach the anticipated scale due to the impact the increased feedstock demand had on food prices. In Mexico, tortilla prices shot up by more than 400 percent when maize was diverted from food production to ethanol production for the US. Another challenge for developing a clear cleantech game plan: the evolving nature of regulations. Globally, governments recognize the need to support cleantech. They use a variety of instruments such as subsidies, grants and trading mechanisms to this end. However, as governments fine-tune regulations or introduce new instruments, they can impact investor confidence in the long term. The introduction of feed-in tariffs and tax breaks for renewable energy in Spain and Germany accelerated the development of the wind and solar sectors. A few years later, the momentum stalled when the incentive packages were reduced. Now, as companies make their next round of bets-call it the fourth wave-they want to target their cleantech investments with greater precision. Increasingly, they want to move away from an ad hoc, scattershot approach, which lacks direction and wastes resources. Instead, they seek to identify opportunities where they have the greatest ability to win. These leading companies first see how cleantech fits into their core activities and then pick and choose options based on the most attractive rate of return. Mapping cleantech's growth opportunities The foundation of sustained profitable growth starts with a clear definition of a company's core business. When considering if and where to play in cleantech, companies should first consider the opportunities in which they have a competitive advantage as well as those that complement their core business activities. The first step is to understand what constitutes the core, as well as identify adjacencies to the core,

by creating a detailed inventory of opportunities. This process not only reveals choices for growth, but also clarifies the tradeoffs required. Avoid: Far removed from a company's core business, these least-attractive opportunities represent the lowest ability to win. These initiatives offer low levels of profitability and come burdened with high investment costs. Companies should aim to exit or avoid these expansions before they take up significant investments or resources. For example, a wind turbine equipment manufacturer entering into the biomass boiler installation and maintenance market will soon discover the pitfalls of not having the right capabilities or experience within the organization. Screen out early: These are cleantech ideas or opportunities that may already form part of a company's R&D portfolio: they appear to be good investments but do not fit into the long-term strategic objective of the business. Companies should explore the opportunities to maximize the value of these forays without utilizing more funds and resources. Options include selling technology patents, capitalizing assets or spinning off ventures. A number of oil and gas operators and service providers have done just that with carbon capture technology. They are either selling patents or setting up new ventures. Maintain options: These are cleantech opportunities not immediately considered core, but could evolve close to the core or pose a threat to it in the future. Very often such opportunities entail a long lead time or come with high risk attached. Companies can choose to invest in these through R&D partnerships or act as an asset operator rather than owner. For example, even though the threat from advanced biofuels is many years away, leading oil and gas majors are placing early bets in this space to manage the risk to their minerals fuel business. ExxonMobil said if R&D milestones were met, it expected to invest a further $600 million in its algae biofuels R&D program, and BP committed $500 million to its Energy Biosciences Institute. Own or develop: These cleantech opportunities are at the core of a company's business and in these areas, it makes the most sense to double-down resources. Technologies that fit into this segment offer the most attractive returns and the greatest chance of success for a company. These technologies have attractive risk profiles (such as stable government subsidies or proven technology) and hold the promise of maximizing returns. One example is the wind power sector in Europe. As growth continues at a rapid pace, fueled by an increasingly competitive cost structure and strong incentives such as feed-in tariffs, the industry is maturing and at an inflection point: the focus is shifting from building new capacity to improving the operational efficiency of wind farms. Experienced asset operators and ISPs (Independent Service Providers) from other industries are now attracted to the growth in this sector as an adjacency to their core business. Their belief: as turbine guarantee periods come to an end, they can capture maintenance and service contracts from the original turbine manufacturers.

Companies and investors that follow a disciplined and objective process in evaluating how cleantech fits with their core business can better hone in on the right strategy in three key ways. One, it can counterbalance the false sense of urgency ("must play in the cleantech space") with a reality check. Two, it can help overcome the challenging aspects-lack of structure, clear pathways and consistent regulation-that characterize cleantech today. Finally, it can help identify the right portfolio of adjacencies to keep an eye on as they develop. As the cleantech industry matures, companies can consolidate further in areas of strength and exit early activities that are noncore to their business. They can create cleantech investment portfolios with dedicated budgets and resources. As the industry grows, these portfolio investments can evolve into standalone businesses. In the best scenario, some of the budding ideas can bloom and even redefine their future, by expanding their core business.

Key contacts in Bain & Company's Global Oil & Gas practice: Americas: Jorge Andy Jose Sa in So Paolo Asia-Pacific: Sharad Apte in Bangkok Europe: Luca Rob John Roberto Peter John Luis Uriza in London Caruso in Fisher, McCreery in Nava in Parry in Smith in Bain Moscow Advisor London Milan London London East: Leis in Steinhubl in Houston Houston

Middle Christophe de Mahieu in Dubai

Realize results: Busting three common myths of change management Bain Brief 01/12/11 by Patrick Litre, Alan Bird, Gib Carey and Paul Meehan The best of intentions are never enough. Your goal is to lose 10 pounds and get fit. You invest in the latest home gym device and install it in your basement. And there it sitswhile you lounge on the couch, wondering why you're not getting into better shape. By setting up the equipment, you've mastered the first of three important stages toward achieving a goal: installation. But the second stage-realization-requires taking steps you

hadn't really considered, drawing up an exercise plan, for instance, or enlisting a coach, or getting over the hump and spending eight or 12 weeks actually using the equipment. Of course, it doesn't end there. Once you've taken those steps and realized the results you were after, there's a third stage, one that will help you achieve other personal goals beyond weight loss and fitness: repeatability. You'll need to learn how to learn from your experience in a way that allows you to tackle the next challenge with the muscle memory that makes the process familiar and systematic. Executives in every industry will recognize this home fitness analogy. It's the same situation that occurs when a company sets a goal like fostering closer collaboration between engineers and salespeople. The company installs new collaboration software, but nothing changes because the effort stalls at the installation stage. There's no program in place to encourage engineers to post their product plans to the new system or to motivate product managers to provide feedback. Even when those steps have been taken, it may require a couple of years to get true collaboration humming-when the plan says it should happen now. The failure to achieve desired results is not new, of course, but it has become a major challenge for leaders who must manage under increased pressure. A seven-year study by Challenger, Gray & Christmas found that about 40 percent of new CEOs last an average of less than two years. Facing such odds, leaders often pursue the sort of sweeping transformational change that will give their companies a competitive edge, boost performance and ensure their own future at the helm. But the odds of implementing a successful change effort-whether it's a broad-ranging efficiency initiative or a shift in strategic focus-are even more daunting than that of CEO tenure. According to one well-quoted study that spanned industries and continents, more than 70 percent of change efforts fail. Why is it so difficult to make change take root? To learn more about the breakdowns, we analyzed the barriers to successful change management at 184 global companies. The study enabled us to identify predictable patterns of risks in a broad cross-section of change efforts. We found, for example, that about 65 percent of initiatives required significant behavioral change on the part of employees-something that managers often fail to consider and plan for in advance. Nearly 60 percent of the companies we analyzed lacked the right capabilities to deliver on their change plans. The same percentage of companies didn't have the appropriate individuals, structures and decision-making processes to drive the change initiatives. In addition, about 60 percent lacked the right metrics and incentives to make change efforts successful. And more than 63 percent of the companies faced high risks to their change efforts because of significant communications gaps between the leaders of the effort and the employees most affected by it. These findings reinforce what decades of experience with clients have shown us: companies usually fall prey to three common change management myths, which lead to a superficial approach to change initiatives. Many companies assume they can get it

done, for instance, with the right combination of strong incentives for their leaders and overlook the importance of building employee commitment during a change effort. The 30 percent of companies that succeed take a radically different course of action. They know that success requires leaders to learn and apply some counterintuitive strategies to change. Let's take a look at each one in turn. Myth #1: As long as the effect on people is minimized, change will succeed Reality: It's about helping people succeed despite their discomfort Everybody knows that change starts by aligning people around a vision. But many organizations fail to win broad support, from the C-suite to the frontline. The reason for that is fundamental: change disrupts what people expect from their jobs and many leaders don't bother to anticipate-and plan for-the reactions of the individuals who will feel the impact the most. When people experience loss of control, many will do anything, even remain in unsatisfying situations, to try to reestablish some form of predictability. Readjusting expectations to the changed environment consumes mental, emotional and physical energy. Distracted employees cannot meet productivity and quality standards. That puts the core business at risk, and leaves people with little or no capacity to change the way they do their jobs. Change leaders take four steps to help people succeed despite their discomfort.
They They

start by identifying the employees most affected; target those employees with early, effective communication that explains the reason for the change and creates a clear picture of the destination; They provide the dedicated leadership attention and support needed to manage the shock of change; They start by treating the leaders themselves as targets of the change. Co-creating the ambition builds leadership support In the earliest stage of a change effort, successful organizations ensure that the leaders who will lead the charge are on board. Workshops to co-create the ambition help the leadership team paint a clear picture of what the change will look like when it's finished. Senior leaders whose support and alignment are needed must be in the room when the vision takes shape. Co-creation enables them to adjust their expectations early and maintain some level of predictability even for radical change. Having taken part in the birthing process, they can brace themselves for what's coming and start projecting how they can succeed in this new reality. When Merck KGaA, the German healthcare company, acquired US biotech equipment supplier Millipore last year, one of the first moves in the post-merger integration process was a series of workshops for executives from both companies. In the first workshop, participants focused on creating a vision for the combined entity. In the second, they drew up a more concrete view of the company's future state: What would the firm look

like five years down the road? In the third, they defined the initiatives required to achieve full potential. When the vision, the future state and the firm's full potential are crafted with full participation by all members of the leadership team, the odds of success increase dramatically. During the workshops, leaders develop a visual description that will resonate with the rest of the organization, translating it from a leftbrain analytical concept to a story with emotional appeal. When a healthcare company launched a major change effort to improve customer satisfaction, it started with the hospital registration process. Gathered together in a workshop, the company's leaders jointly developed a metaphor for the vision: hotel registration. People reserve rooms at a hotel in advance; why not apply the same model to hospital registration? A powerful metaphor helps people to visualize the change and can also drive the speed of the change management process: project teams can make the vast majority of decisions without input from top leaders because they have a clear vision of the goal. Myth #2: So much about change is irrational and hard to predict Reality: The risks of change are predictable, measurable and manageable Most companies devote too little effort to predicting how the transformation will affect the organization. The leaders of a change effort tend to focus on limiting the risks by using the tools they most know about, such as incentives. But they leave a lot on the table by not using the full range of tools available to mitigate risks. And they often fail to distinguish when to use which risk mitigation tool. Conduct a risk assessment to find the right mitigation tools The fact is, every initiative has its own unique risk profile. Bain has identified 30 specific risks that threaten to disrupt change efforts, things like poor sponsorship and change overload. These risks tend to occur with predictable patterns over the life cycle of a change. But only a handful of these risks determine success or failure at each stage. At the beginning of a change initiative, for instance, if the senior sponsors are not aligned with a clear assessment of the organization's ability to deliver, they can't make an informed decision to move to the next stage. A risk assessment enables a company to understand its risk profile and identify the four or five risks that pose the biggest threats, the sequence in which they will arise and the tools that will be most effective for containing and managing each risk. A starting point for any risk assessment is understanding the failure modes of an organization-what it did well or poorly in executing past change initiatives. Building from there, leaders can identify the handful of risks that will be most relevant at each stage of the process for their organization, and the specific actions to mitigate them. That allows management teams to focus risk mitigation on the things that really matter.

Armed with a risk assessment, leaders can move to the next stage by creating a Heat Map to identify those people most affected at each stage of a change initiative and the potential trouble spots in the organization. A simple version of the heat map provided one key to the successful Merck-Millipore integration. Managers drew up a two-by-two chart representing all groups in the organization across two dimensions: their importance in achieving the integration goals and the degree of likely disruption they would experience from the upcoming change. That allowed the management team to focus on supporting the people most important to the future success of the firm who faced the greatest risk of serious dislocation. The management team set about clarifying roles, helping to set priorities and providing focused change management support for the integration to succeed. Myth #3: All you need is good leadership and day-to-day management Reality: Disruption changes the rules of the game-and the patterns for success are often counterintuitive When an organization experiences high levels of disruption, the management rules change. The practices and patterns that have proven effective for leading the organization break down when employees are struggling to understand what change means for them. In high-stress situations, for example, people typically can only process-hear, understand and retain-20 percent of the information they receive. Studies have shown that attention spans are compressed; in fact, full attention lasts 12 minutes or less in these conditions, instead of an hour under normal circumstances. That means the messages about important changes have to be shorter, crisper and simpler. And in situations where they must deal with change, employees want to know that you care about how it will affect them first, before they hear your message about the details of the impending change. Trouble is, companies typically fail to treat communication during times of high stress as anything out of the ordinary. They rely on institutional channels-webcasts, newsletters, companywide emails-when people want to hear directly from those in charge. Another common mistake: management teams often use language that people cannot understand and process in times of stress-dense, jargon-filled terms. They simply don't train their leaders in clear communication. "High-stress" communication allows those affected by the change to hear the messages Change leaders adjust communication methods in three ways to manage how a shaken workforce perceives the information. First, they keep the message concise, clear and brief, with a positive focus. Instead of seven points, they might boil the message down to just three key statements, and they speak for no more than 12 minutes. Second, they quickly establish themselves as trusted, credible and empathetic messengers before

they even launch into their key messages. Employees typically decide within the first 30 seconds if leaders are credible and trustworthy, based on their perceived level of caring and empathy rather than expertise and competence. Third, people must hear the information from managers they trust, one on one. Initially, Merck Millipore relied primarily on an emailed newsletter and website to communicate details of its merger and pending integration, instead of arming supervisors to communicate directly with reports. When it later polled 3,900 employees on the effectiveness of its integration strategy, less than half said they understood the specifics of the change-a threat to any integration effort. The company adjusted its approach and immediately saw improvements in employee perception. To change behavior, you need to change consequences Effective communication is just the start. For any transformational change to succeed, people ultimately have to think and work differently. We've found that organizations typically spend about 90 percent of their effort on activities to "push" the change down the organization: designing-and then implementing-processes, training programs, organizational structures and communications that detail the new ways to work. In contrast, they invest very little effort in creating "pull" among people who are trying out new work behaviors. Researchers in the field of applied behavioral science have found that consequences such as real-time feedback loops and positive reinforcement are four times more powerful in encouraging new behavior than antecedents, all the activities designed to prompt new behaviors-everything from newly installed processes to revised role descriptions to training programs. One bank invested heavily in a program for cross-selling products to customers. It implemented a system for alerting bank tellers about which customers would be suitable prospects, trained tellers how to sell and compensated tellers who successfully crosssold. But the bank lacked a plan for changing employee behavior to make the new program a success. When a teller would apply a new script to encourage cross-selling for a qualified customer, he or she would back away if the first customers were not receptive. The company realized it wasn't making progress, so it developed a thoughtful support plan. After witnessing an encounter with an impatient customer with no interest in the new product, a platform manager standing nearby would offer encouragement: "You handled that well. You were not defensive," she might say. "Remember, it's only one in five customers who will buy." That would encourage the teller to continue applying the script, and as he sold the new product to more clients, the rise in his performance metrics would motivate him further. Positive reinforcement that is immediate, relevant and consistent can be significantly more effective in changing employee behavior in the early stage than the lure of longer-term rewards. Enlist sponsors at every level with a Sponsorship Spine

The truth is, change depends on the effectiveness of those providing the consequences-the sponsors of the change. But sponsorship is a cascading process and a "black hole" anywhere along the line will stop the change process below it. That's why it's essential to build a Sponsorship Spine from the bottom up. You can't really appoint sponsors. You start by targeting the people who will need to change. Then look through their eyes one level up to the person they trust who can provide them with effective communication and meaningful consequences. That's their sponsor. Now do it again. Look up from that sponsor to the next level up, to the person who can provide effective communication and meaningful consequences. In this way, companies can create an unbroken chain, with every level from the frontline to the C-suite clear about their roles and ready to engage. Each sponsor in the spine needs to be trained, coached and familiar with their roles. It's critical that companies continually monitor the health of a Sponsorship Spine. People quickly revert to other priorities or stop taking a change initiative seriously. That creates black holes. When sponsors are proving ineffective, they should be coached or, if necessary, replaced. Introducing the Change Cascade One of the first applications of the Sponsorship Spine is a systematic Change Cascade. At each level of the organization, starting with the most senior people, management holds meetings to explain how leaders reached their decisions and to ask for input in areas where it is needed. The sponsor at each level leads the meeting, explains the change and requests feedback. Because this is done throughout the organization, it is important to ensure that everybody is touched-and that everybody hears about it from the person who matters to them most: the person with the standing to be their sponsor, typically their direct supervisor. The Change Cascade is the complete opposite of what typically happens when companies introduce a change effort: everybody in the organization tunes in for a video conference in which the CEO spells out far-reaching change plans, and when they turn to their supervisor to ask for clarification, the answer comes back: "I don't know. I just heard it at the same time as you did." As part of Merck Millipore's merger integration effort, each supervisor hosted a series of facilitated sessions with their direct reports. Starting from the highest levels of the organization, sponsors explained the vision for the combined company, spelling out details of the changes occurring and answering questions. They clarified roles, established priorities and, in the case of employees from Millipore, explained Merck's core values. Afterwards, that direct report-now a sponsor-conducted a similar one-onone dialogue with his or her direct reports. The process repeated itself throughout the entire organization. Such attention to detail has kept Merck Millipore focused on making its merger a success while protecting its core business, and maintaining the trust and credibility of its leadership to best-in-class levels. Change takes time, focus, determination and planning for a future where, even with the best of intentions, things are likely to veer off course. That's why change leaders start

with a clear understanding about the magnitude of the change and who will be affected. They have the discipline to conduct a thorough risk assessment, and they know how to apply the right mitigation tools at the right time. Success requires changes in behavior, and it takes courage and discipline. As anyone who has bought home gym equipment knows, the results don't happen by themselves. Five guiding principles of change management How can companies move from installation to realization and repeatability? Five guiding principles can help you realize results consistently and predictably. Balance ambition. Articulate a clear and compelling vision for where you're headingbut be realistic. Senior sponsors need to be aligned and committed to the vision, understand how disruptive the change is going to be and balance the ambition with the organization's capacity to absorb that change. Mobilize leaders. Clearly define change roles, build a healthy Sponsorship Spine and solid engagement plans to enroll people to deliver the desired outcomes. Change behaviors. Identify the few critical behaviors required to drive results; shift and reinforce behaviors by changing consequences and measuring progress. Shape execution. Shorten your time to realization with a decision drumbeat that plans, tracks and measures progress and mitigates ongoing implementation risks. Extend success. Create a new source of sustainable competitive advantage by investing in new capabilities that build a repeatable model for change. Build muscles that endure and get stronger through each cycle of change. Patrick Litre is a partner with Bain & Company in Atlanta. Alan Bird is a Bain partner based in London. Gib Carey is a Bain partner based in Chicago. Paul Meehan, a partner in Hong Kong, is Bain's managing director for Asia-Pacific. Reengineering medtech R&D Bain & Company industry brief 12/15/10 by Bain's Global Healthcare practice Innovation by medtech companies gave the world lifesaving devices such as dialysis machines, pacemakers and defibrillators. Now these companies need help of their own to address several disruptive changes in the market. Their R&D models can still achieve game-changing innovations-but only if they reengineer them to respond to two new market forces.

New customer buying behavior: In the past, a physician's preference greatly influenced which medical devices were bought and which were not. Today, individual physicians wield less and less influence due to structural changes. Many physicians now work for hospitals or group practices that are aligned with larger medical centers. In turn, hospitals-acting as "economic buyers"-are using their purchasing clout to drive down costs, particularly in high-end product segments such as knee implants and implantable cardioverter defibrillators. As a result, across multiple product categories, prices are starting to tumble. For example, annual price declines have reached double digits for drug-eluting stents for which hospitals perceive little product differentiation. A number of key medtech product categories suffer from the "generics effect": the performance difference between leading products just isn't evident. Changes in payment models will likely accelerate this price pressure. Bundled payments, for example, cover full episodes of care-including device costs and doctor's fees. The consequence: physicians are increasingly motivated to preserve their income by lowering the device costs. Rising regulatory hurdles: It's increasingly costly and complex to bring new medtech products to market. The US Food and Drug Administration (FDA) requires clinical trialsthe pre-market approval path-only for Class III medical devices, which have higher levels of complexity and patient risk. Now the FDA is revamping its regulatory pathways and applying greater scrutiny to a much larger set of products, including products classified as Class II. The FDA is also intensively investigating quality issues, as reflected in the industry's rising number of consent decrees and product recalls. In 2001, the FDA recalled just three devices. In 2009, the number jumped to 31. These regulatory headwinds pose a major challenge. Medtech companies must now plan and budget for longer, more stringent product development-with no guarantee of approval at the end. A stent clinical trial, for example, can cost tens of millions of dollars and stretch over several years. In effect, the cost of entering-and staying in-markets has gone up, so companies need to respond. Rethinking the "what" and "how" of R&D Increasingly, leading medtech companies tell us that they see the need to fix their R&D models. But their challenge is: where do they start? Do they focus externally on understanding the new customer needs? Or should they concentrate on revamping processes internally? Our belief is that to lean completely into the new medtech R&D opportunity, companies will need to do both. Start with what customers will pay for To thrive in this changing market, medtech companies must closely align their innovation with customer willingness to pay. For this, they must consider two steps.

The first involves a choice, as medtech companies have reached a fork in the road. One path is to step up innovation and develop products with greater value. These will not necessarily have the latest features and benefits. Rather, they'll differ in that they'll offer clinical evidence showing superior efficacy, safety and cost-effectiveness versus their competitors' products. Some will even have data demonstrating superior outcomes for patients. It's an approach similar to one taken by pharmaceutical companies. Faced with the acute threat of generic drugs at much lower prices, these companies are starting to prove-and price-the comparative effectiveness of new drugs. For example, Merck has a performance-based contract with CIGNA for its oral anti-diabetes medications Januvia and Janumet. Merck offers discounts to CIGNA's customers if the patients adhere to their physicians' prescriptions and their blood sugar levels improve. The other path is to step down innovation and develop products with fewer features but good-enough performance that sell at lower prices. Such value-based products are common in other industries, and they will arrive soon in medtech. Medtech companies must choose, as staying the course-that is, investing heavily in incremental innovation-is not an option. Going down both roads is possible, but only if the company has the resources and capabilities to win in both categories of breakthrough and good-enough innovation. What's most important is making the choice, and acting on it. The second step, a logical follow-on, is for a medtech company to X-ray its pipeline. Projects that don't fit the chosen path of innovation must be redefined or canceled. For example, some projects will be caught in the middle: derivative projects offering the promise of modest efficacy improvement, but requiring costly clinical trials to clear regulatory hurdles. They will arrive in the market as neither the innovation nor the lowcost leader. Another critical component of the pipeline X-ray is reviewing business development issues. The hard question must always be asked: Is the company better off making or buying the next technology? The answer lies in understanding the company's distinctive competence, plus the external landscape of innovation. When working in collaboration, R&D and business development can make an informed decision about where to spend the company's innovation dollars. Bain experience in helping medtech companies X-ray their pipelines indicates that up to 25 percent of projects typically must be reconfigured or stopped. These actions free up scarce funds to double down on projects that do survive the rigorous scrutiny. Rethink how to develop the product In our experience, five levers are key to reengineering R&D for major gains in efficiency and effectiveness:
Improve

the quality of decisions: Every medtech company has a PDP (product development plan) with major milestones and activities in place. But the PDP

doesn't drive success; good decision making does. What companies need are clear decision rights-who owns the inputs, who synthesizes the recommendations and who makes the decision-with processes that are well defined and adhered to. In the absence of these elements, decisions take too long or are made poorly. This leads to late project cancellations or "go" decisions for products that don't actually merit investment because they won't truly meet customer needs. Elevate project management: Large companies need to recapture the spirit of start-ups where everything rides on R&D success-and project managers are the heroes who get products over the finish line. As many R&D organizations have grown, they have tilted too much toward functional structures that focus on optimizing activities instead of project success. To rebalance, a medtech company can start by installing a senior head of project management and a team of highly skilled project managers who have leadership responsibility and budget authority. Next, the company can embed all the elements that make project management work, including committed cross-functional team members, metrics and incentives tied to project success, and a rigorous cadence of project reviews with the C-suite to drive accountability. Get more from existing resources: In most leading medtech companies, R&D organizations are well stocked with resources-people, assets and knowledge. Typically, in these companies, adding more resources isn't what's needed. Rather, the more common problem is over-management and overcapacity that can clog the pipeline with activity and delay progress. In our experience, companies can do more with less. They can expand spans and reduce layers of management; set tougher performance hurdles; utilize centers of excellence to promote IP sharing and new ideas for technology combinations; and capture and reuse knowledge so that teams start faster and avoid previous pitfalls. Form global strategic partnerships:Outsourcing vendors are maturing rapidly in the medtech space. Traditionally, clinical research organizations such as Quintiles, Parexel and PPD focused on biotech and pharmaceutical customers; now they are shifting attention to medtech as a new growth frontier. And hardware and software engineering vendors such as Infosys, HCL and Wipro that built competence serving the aerospace and automotive industries are investing in healthcare. This is an opportunity for medtech companies to form strategic partnerships, including expanding their reach into India and China. This move will broaden their access to new talent, increase productivity and lower costs, plus bring R&D in closer contact with new commercial growth opportunities, particularly value products in emerging markets. Fix the cross-functional pain points: R&D is always intertwined with marketing and regulatory, quality and manufacturing functions. Now companies need to find ways to strengthen these cross-functional linkages because opposing forces are straining the bonds. Marketing tries to capture the new "voice of customer" that comes from hospital procurement. The regulatory department responds to FDA pressure and new hurdles for approval. Quality control is busy trying to prevent warning letters and product recalls that immediately damage businesses. Manufacturing redesigns its plant network to take advantage of lower costs and higher tax benefits in emerging markets. Various forces tug at each function,

straining their ability and willingness to work seamlessly together on product development. Alignment is thus critical, or else all the hard gains made in R&D are washed away by the enormous time and cost burden of cross-functional breakdowns. Pulling these five levers means transformational change in R&D, and such change takes time. Most medtech companies can expect to realize the benefits from reengineering R&D only after several years. But companies need to make these fundamental changes to stretch their R&D dollars and meet the shifting needs of customers. For medtech leaders, it's a call to action. By showing vision and confidence, making tough choices and inspiring the organization, they can fix the "what" and the "how" of R&D. Key contacts in Bain & Company's Global Healthcare practice: Americas: Patrick Matthew Hernan Saenz in Dallas Europe: David Michels in Zurich Peak oil: Does it matter? Bain & Company industry brief 12/15/10 by Bain's Global Oil & Gas practice Peak oil--the point at which global petroleum extraction reaches its maximum rate--is a source of concern for some and celebration for others. Although this widely accepted definition appears simple enough, it masks some complex issues. Are we talking about oil alone, or oil and gas? Do we count both conventional and unconventional production? Do we include coal-bed methane, shale oil and tar sands? Most importantly, how significant is this event? We often hear that "the days of easy oil are over," but they never really occurred. They only appear so in retrospect. For example, shallow-water production in the North Sea today seems easy in comparison with production in deep-water offshore West Africa or tar-sands extraction in western Canada. Yet try telling project managers of the first North Sea gravity-based structures in the 1970s that their tasks were not so difficult. Significant cost overruns and multiyear delays were the norm. Likewise, today's methods for reaching the most difficult oil and gas deposits will someday be dismissed as easy. The point is that, even if we have already passed the point of peak oil, those who imply that the petroleum industry is dying greatly exaggerate the threat. Why? First, at today's consumption rates, we have approximately 120 years of recoverable oil reserves. That includes 40 years of conventional reserves and 80 years of O'Hagan in Collier in San Boston Francisco

"unconventional" reserves. While oil consumption increased over the past 25 years by more than 30 percent, those reserves have not only been replaced, the reserve base has grown by the same 30 percent. In other words, global reserves have remained approximately constant since the mid-1980s. Most of this has come not from "easy" oil, but--from a mid-1980s perspective--from "difficult" or even "impossible" oil. And the industry continues to increase reserves through new discoveries, new extractions from discovered resources, field optimizations and unconventional resources. All this comes despite geopolitical events restricting access to many of the world's most promising regions. It defies logic and experience to maintain that this trend will suddenly end. Second, we know that oil consumption swings on two primary factors: global demand for energy and petroleum's price relative to energy alternatives. Again, it sounds simple, but these hinge on multiple variables that are difficult to predict. For example, global energy demand rises with population growth and economic development, region by region and country by country. Yet relative price is affected by complex interactions among technology development, economic subsidies and the handicapping of other energy sources. Determining how these will develop is impossible, as evidenced by history's many erroneous predictions of petroleum demand and price. What we can know is that economic growth depends on a reliable supply of energy, provided at the lowest cost. Put another way, it is more useful to identify ongoing energy demand and source trends than the growth rate of new petroleum reserves. In our view, three trends are most important First, new technologies must continue to emerge. That will make production of evermore difficult petroleum reserves possible and economically feasible, and will reduce the cost of competing energy sources. Environmental concerns will focus technology development on fossil-fuel alternatives. New nuclear technology, with better wastedisposal methods, will boost growth of that industry. Improved battery technology will eventually provide a better transportation alternative to gasoline power. Wind and water power will grow too, although affected by financial subsidies more than the free market. The main constraint will be human. It requires scientists and engineers to achieve these technological developments. Companies that succeed will be those recruiting, developing and directing qualified personnel in research and technology. Second, flexibility is essential. That means that governments should not constrain any potential energy source. Each will likely be required at some stage. As things sort themselves out, we can expect winners and losers, with varying effects on the pace of countries' development. Governments that embrace market solutions to energy supply will ensure that their nations are best positioned to develop. They must also monitor scientifically and economically justified environmental developments, maintain stable commercial and fiscal environments in the energy sector, and prioritize the education of young people in the required disciplines.

Finally, the petroleum industry will face competition from alternative and potentially subsidized energy sources. The industry must continue to invest in the kind of research and people to develop its own new technologies. The task is not just to find and produce petroleum more effectively. As alternatives develop, the industry must ensure that every petroleum molecule adds the maximum economic value. No one knows how the last barrel of oil produced will be used. Whatever way it plays out, peak oil will occur one day. But it won't signal the demise of petroleum as a growth enabler. With sufficient investment in technology and people, the industry can look forward to continuing to fuel global economic development for decades to come. Key contacts in Bain & Company's Global Oil & Gas practice are: Americas: Jorge Jose Sa in Andy Steinhubl in Houston Europe: Luca Rob John Roberto Peter John Luis Uriza in London Asia-Pacific: Sharad Apte in Bangkok Middle Christophe de Mahieu in Dubai East: Leis in So Houston Paolo

Caruso in Fisher, McCreery in Nava in Parry in Smith in Bain

Moscow Advisor London Milan London London

What providers can do to make IT systems communicate better Bain IT capability brief 11/04/10 Payers and providers often complain about their inability to share data with each other due to incompatible, disconnected information technology (IT) systems. But for many healthcare providers, the bigger opportunity for improvement lies closer to home: fixing the interoperability issues within their own hospital IT systems. In a recent Bain & Company survey, hospital CIOs ranked their own hospital's IT interoperability as the most important strategic issue for their organizations. They found it an even more urgent priority than reducing IT operating costs. In fact, hospital CIOs say fixing the incompatibility problems within their own organizations is more pressing than finding solutions to the interoperability problems between providers, such as regional health information organizations (RHIOs) or health information exchanges (HIEs).

By now, most people in the industry recognize the root causes of a healthcare provider's IT woes. The IT infrastructure of a hospital usually comprises several disparate systems. Health data lie in silos. System A does not communicate with System B. Healthcare costs rise and healthcare delivery worsens. In our survey, hospital technology leaders identified the inability to move records, referrals or orders seamlessly among physicians or hospitals within their own network as their organization's real pain point. Yet, the interoperability gap remains large: While CIOs rate the importance of having IT systems that communicate well with each other as "very high," they rate the current integration and interoperability within their networks as "quite poor." Hospitals pay a high price due to siloed IT systems. Our survey shows that IT issues not only have a debilitating effect on a provider's service quality, they also erode the profitability of the organization.
Costs

proliferate. Clinicians order redundant tests or the wrong tests when they cannot readily access the results of previous tests. Patient satisfaction falls. Patients have to provide the same information multiple times to different clinicians, they shuttle their own records from provider to provider and they often wait longer due to data inaccessibility. Medical errors rise. Clinicians order a drug that they otherwise would not have if a fuller patient record was available to them. Physician and nurse productivity declines. Clinicians waste time switching from one application to another to review a chart, find lab results, make notes or enter new orders. Searching for information in other departments reduces productivity further. Revenue leaks. Often, communication gaps increase the cost and reduce the quality of the referral process. In the absence of closed-loop scheduling across the system, patients go outside the hospital system for the next episode of care. Rebooting healthcare IT The symptoms might vary, but in our experience a few chronic maladies cause the majority of interoperability problems in hospitals. For starters, providers tend to make decisions on information technology investments based on "best of breed" vendors for each IT application. Multiple IT vendors proliferate within a facility, sowing the seeds for future interoperability mismatches. Then healthcare innovations-such as the rise of consumer-driven health plans (CDHPs)-create the need for new information. As hospitals scramble to meet demands, interoperability gaps develop. Frequently, hospitals are trapped in legacy systems: The introduction of new technologies results in a constant cycle of software upgrades. Over the last decade, mergers and acquisitions among hospitals further compounded interoperability by bringing very different software infrastructure under the same roof. Finally, the fact that major healthcare software vendors have not aligned around a set of software standards further complicates matters.

Recently, the US government established a set of incentives designed to break down these silos. Currently, billions of dollars, funded in part by US tax revenues, is flowing toward IT solutions that enable disparate healthcare entities-payer to provider and provider to provider-to pass data seamlessly among one another.
The

Nationwide Health Information Network provides a framework for secure health information exchange over the Internet. In 2004, the Office of the National Coordinator (ONC) of Health Information Technology was chartered to oversee and coordinate the nationwide effort to "use the most advanced health information technology and the electronic exchange of health information." The American Recovery and Reinvestment Act allocated billions of dollars in the form of Medicare and Medicaid incentives to encourage providers to install electronic health records (EHR) technology. The act also set aside substantial funds to develop HIEs that allow payers and providers to share data and improve interoperability among healthcare systems. The US Department of Health and Human Services' recommendations on the meaningful use of EHRs place a strong emphasis on providers' ability to exchange information in order to receive incentives from the federal government. This period marks a new growth phase in healthcare IT, spurred to a large extent by government investment. These investments will allow providers that have remained out of the EHR conversation so far-smaller hospitals and physicians' groups, for example-to catch up with the state of the art in healthcare IT. These dollars will also benefit vendors of EHR, computerized physician order entry (CPOE), electronic prescribing and other solutions that qualify for stimulus funding. Not surprisingly, vendors are investing heavily to make their solutions easier to install and to integrate as seamlessly as possible with the client's existing systems. However, healthcare CIOs know that in the short term, installation of an EHR system will add a great deal of additional complexity and raise a new set of interoperability issues to conquer. In recent years a new category of software solutions-interoperability platforms-have grown at impressive rates. Designed to solve the incompatibility issues providers face, these solutions offer an alternative to the wholesale replacement of the patchwork quilt of systems from multiple vendors-a multiyear process that many hospital executives consider operationally risky as well as expensive. Instead, the integrated platforms from a single vendor offer flexible software architecture: They allow data from multiple systems to be mapped to an integration engine. That means hospital IT systems can easily aggregate and manipulate data across the various applications. Many of these solutions also allow Web-based viewers at the point of care to see a comprehensive view of the patient's medical history. Smart integration platforms don't replace the current architecture, but run in parallel with a hospital's core systems. They ensure that providers have all the data they need, when they need it, in the formats they prefer. The path to interoperability

Bain & Company estimates that hospital CIOs plan to double their spending on interoperability solutions over the next five years. Their big concern: understanding where value leaks away from their current IT architecture and how to plug the leaks. In follow-up interviews, many CIOs could not pinpoint where and why their systems fell short on performance. Even among those who had a long list of development projects to address interoperability issues, few felt they knew exactly how to extract greater value by getting systems to communicate effectively. In our experience, hospital CIOs and CFOs who want to identify the gaps and track them much more closely can begin by asking the following questions:
Can

referrals be scheduled easily across departments or sites of care? Are revenues lost because patients are expected to schedule follow-up and referral appointments on their own? Are all the relevant clinical data for any individual patient-including those from the referring physician-available to the appropriate clinicians? What data is missing, and why? How often are duplicate tests ordered? Why? Do clinicians complain about awkward work flows as a result of the chosen software solutions? Do they have to jump across multiple applications or interfaces to complete a task? Are Health Insurance Portability and Accountability Act (HIPAA) security concerns addressed without onerous processes or procedures? Can clinicians access the appropriate data with a single sign-on? Does the transfer of information from one department to another, or from one site of care to another, result in the denial of claims for some services, or delays in payment? When CIOs step back and review the costs of poor system interoperability, they get a better understanding of how to make all IT development projects more effective. While the specific approach depends on a hospital's IT systems and strategy, in our experience many hospitals can quickly take some clear, practical actions: Identify the root causes of interoperability and group the issues logically: A full accounting of interoperability issues may turn up dozens of root causes. But as long as these are treated as discrete, individual problems, few of them will be significant enough to rise to the top of the CIO's IT project list. A better approach: Group the issues into relevant buckets, either by the core business process that's impacted, the underlying software solutions most affected or (and this is rare) in terms of the department or entity impacted. Assess the costs of poor interoperability: Executives should make an effort to enumerate the costs of their poor system interoperability. The approach should be to identify the orders of magnitude, rather than pursue precision, which can be timeconsuming and tedious. At this stage, the objective is to identify root causes and to determine broadly how significant these issues are, rather than working on a detailed

return on investment (ROI). Once a CIO assigns values to each of the logical groups of issues identified, the priorities become clearer. For the highest-order issues, for example, the CIO would assess the options for fixing them and compute the ROI-or whatever metrics the organization uses to establish the IT project portfolio. Reassess the development portfolio: In our experience, interoperability fixes frequently offer very attractive ROIs. More often than not, we find that some of these logical groups rise to the very top of a CIO's IT project list. Instead of solving discrete interoperability issues as they surface, such an approach allows a CIO to see where value is leaking from the organization and focus resources on closing the gaps. When hospital senior executives get a full measure of the value they can generate, addressing interoperability gaps becomes not just a top strategic priority to offer patients better healthcare-but also a smart way to manage a hospital's financial health. Key contacts in Bain's Global Healthcare Americas: Dale Stafford in David Bellaire in Kara Murphy in Asia: Phil Leung in Hirotaka Yabuki in Europe: Michael Kunst in Munich Making change happen: Shaping the Women's Forum Global Meeting report 11/04/10 Executive summary future with practice are: Atlanta Atlanta Boston Shanghai Tokyo voices

women's

The first decade of the 21st century marked a period of historic change for the world economy. Globalization continued to tighten the linkages among markets around the world and, in some regions, challenged job security, while in others it helped improve living standards for billions of people. The contagion of the Great Recession spread across economies, but many businesses used the opportunity to clean house and emerge leaner. Countries came together to combat climate change, but struggled to make a substantial difference in reducing carbon emissions. In each instance, winners and losers emerged based on their propensity to embrace-or avoid-change. Bain & Company's experience shows that turbulence can translate into opportunity-if the right actions are taken to adjust to uncertainty. When the Women's Forum for the Economy and Society chose "Change: Make It Happen" as the theme of the sixth edition of its Global Meeting, it was only natural for the two organizations to come together on a common agenda. As a strategic partner, Bain supported the Women's Forum right from its inception. As a firm, Bain's top leadership remains committed to gender parity as a strategic imperative. This year, the Women's Forum convened more than 1,250 women and men leaders in Deauville, France, at the Global Meeting. From October 14-16, participants took stock of the forces of change and reconsidered the way the world shares power, wealth,

progress and resources. Reflecting Bain's bias toward action and results, this report compiles some of the most pragmatic ideas raised in 16 brainstorming sessions clustered around five pressing global issues: 1. Change in politics: In an era of growing mistrust, the forum attendees felt the world needs actors who will promote collective thinking and steer decision making in the right direction.
Are cities the best hope for active citizenship? E-politics: Power to the people or power over the What legitimacy for NGOs as change agents?

people?

2. Change in business: As the global economy climbs out of the recession, companies will turn once again to innovation to generate growth. The forum participants would like to see companies focus on what's good for the world along with what's good for business.
Future growth: Economic progress and well-being? Sustainable innovation: Success factors and pitfalls From Web 2.0 to 3.0: Is your mind, and your company,

ready?

3. Change in the environment: People talk about the green economy, but the delegates discussed that the world still awaits the "killer app" that will prove the business case for sustainability.
Sustainable life: How can cities better take the lead? If doomsday messages are not working, how to change mindsets and behaviors? Three clean renewable energies to fight for, and how to broaden their impact for

all? 4. Change in global health: In a world where malnutrition co-exists with obesity, participants felt only bold measures will help bridge the gap between the supply and demand of scarce resources.
How can Africa succeed in its Green Revolution? Preventing childhood obesity: What needs to happen? Facing water shortage and its consequences

5. Change through the woman factor:

Delegates agreed that the "woman factor," that is, women in leadership positions, can play an influential role in mentoring and sponsoring more women leaders in companies, NGOs and government.
Nurturing profitable diversity Women investing together: Is it proving worthwhile? Women on boards: Why not? Women's entrepreneurship: Breaking through to a level

playing field

Each brainstorming session yielded strong points of view-some converging, others conflicting. But one common thread bound all the discussion and debate together: these were the voices of women and men, today's leaders as well as tomorrow's rising talent. Uninhibited, excited and full of optimism, they expressed a common goal to work together to create a better, more sustainable, more equitable, more diverse world. In that spirit, this report seeks to chronicle the nuances of an issue as well as to document solutions for action that came from the forum. But above all, this report aspires to capture and broadcast women's voices on the world's most pressing problems. Pulling the right levers for a low-carbon energy mix in 2050 Bain Brief 11/01/10 by Arnaud Leroi, Stephane Charveriat and Joseph Scalise Four decades is a long time-except when the goal is to reduce carbon emissions by 80 percent. Over the next 10 years, utilities around the world will make significant investments to renew their generating capacity and meet the growing demand for power. These decisions will require tough choices due to several reasons: the pressure on the balance sheets of most utilities, the financial constraints of governments that will limit the potential for subsidies and the evolving regulatory environment that will mandate reduced CO2 targets. Bain & Company research shows that if governments use four levers to build a vision for the future supply and demand of power, they will not just help utilities make better investment choices in the short term-but also improve the country's competitiveness and emerge as flag bearers in the march toward a low CO2 era. Identifying the right criteria Given the scale of the issue, these investment decisions require a robust and realistic view of a low CO2 competitive energy mix by 2050. With global population increasing by almost two billion in the next 20 years, energy demand will balloon by 1.5 percent every year. For most planners, managing and controlling demand represents a top prioritybest pursued through energy efficiency goals. Bain & Company research shows that in Europe, a 10 percent reduction in power consumption by 2050 will reduce CO2 emissions by 18 percent and a 20 percent reduction in power consumption will reduce emissions by 48 percent. Yet measures to curb energy consumption can only go so far. In parallel, countries also need to develop a game plan to identify the right energy mix such that they minimize their carbon footprint as well as meet the growing hunger for energy.

The power sector offers the most scope for reducing CO2 emissions. In 2007, power generation accounted for 41 percent of the world's CO2 emissions, well ahead of transportation (26 percent) and all other sectors combined (33 percent). For most developed countries, achieving an 80 percent reduction in CO2 emissions by 2050 means "decarbonizing" the power sector by 90 percent-which clearly presents a major challenge. As other sectors like transportation try to reduce their carbon footprints-for example, through the use of electric cars-they will generate even greater demand for power. Yet the sooner countries shift their power generation to less carbon-intensive capacities, the better their odds of getting to the right competitive mix by 2050. Power generation represents 43 percent of all CO2 emissions in the United States and 37 percent in Europe. By identifying the right mix of power technologies that make their economies more competitive, the US and Europe can reduce emissions by 80 percent by 2050-if they make the right choices now. When we analyzed the installed capacity in the US in 2008, we found that the existing capacities still operating in 2050 will account for only about 5 percent of the demand at that time. The US will need to invest in new assets or renew existing ones to meet 95 percent of the demand in 2050. In the case of Europe, Bain estimates the EU-27 will need to invest to meet nearly 90 percent of the total demand in 2050. The scope might appear daunting at first, but currently available technologies offer plenty of options to invest in power infrastructure that can help meet demand at low CO2 levels by 2050. The power cost will clearly be higher-roughly ?30 per ton of CO2 avoided in Europe and $20 per ton in the US-but affordable as long as the target for reducing CO2 emissions remains below 90 percent. Eliminating the remaining 10 percent emissions will imply financial burdens that could jeopardize the competitiveness of the economy. Most governments and key decision makers can therefore start the process of meeting the 90 percent reduction right away. Their challenge: identifying the right affordable power mix for 2050. In our experience, when defining an energy policy, most governments make trade-offs between as many as five criteria. 1. 2. 3. 4. 5. Cost of the electricity Amount of CO2 emissions Security of supply Ability to capture the value created by power assets locally Public acceptance of the available technology

With no optimal mix, each country or region must define its own "potentially appropriate" combination based on the relative importance of each criterion for that country or region. Despite the growing pressure to reduce carbon emissions, for many countries criteria such as security and public acceptance gained greater importance in the last decade. In

many US states and in some European countries, citizen groups campaign to block new nuclear plants. Today, nuclear energy provides only 18 percent of US energy needsequivalent to 0.32 kilowatt (KW) per inhabitant. In contrast, in France, nuclear energy provides almost 75 percent of all electricity generated (equivalent to 1 KW per inhabitant), but wind energy struggles to gain wide acceptance. To be eligible for tariffs, wind farms can be built only in restricted Wind Power Development Zones. Meanwhile, in Germany, which is often at the cutting edge of experimenting with new low CO2 technologies, the pilot test for carbon capture and sequestering (CCS) faced public opposition. Vattenfall's Schwarze Pumpe project in Spremberg, Northern Germany, which was meant to be a global demonstration for the three key stages of trapping, transporting and burying greenhouse gases, was forced to release CO2 directly into the atmosphere when Germans protested "not under my backyard." Four levers to shift to lower CO2 emissions When we applied the framework of the five issues to the US and the EU-27, the Bain model for optimizing the energy mix showed that countries can choose between many different paths to get to a low-emissions competitive mix by 2050. We found that the energy mix decisions became simpler if countries focus on four main levers: "Decarbonization" of the base load: The demand for base load power generation accounts for 85 percent of current CO2 emissions from power generation in Europe and up to 92 percent in the US. Decarbonizing the base load production of electricity attacks the problem at scale, but raises the next challenge of finding the right technology. Currently, there are at least seven low CO2 technologies. Five of these are already operational: run of river hydraulic; geothermal; biomass; nuclear; and alternative energy sources like wind and solar. Two technologies are still maturing: concentrating solar power (CSP) with storage, and coal and gas with carbon capture and storage (CCS). Each source of power comes with its own constraints. Rivers, geothermal and biomass technologies will quickly reach the limits of available natural resources; technologies like CSP with storage and coal or gas with CCS are still to develop commercially to full potential. Given the existing installed capacity and technology constraints, the US and the EU-27 can take several paths to a low CO2 future by 2050, depending on the trade-offs they make. For example, countries can depend on low-cost renewable sources such as run of river, biomass and geothermal for their competitiveness and low CO2 emissions, but these natural resources have finite potential. Or, countries can bet on CCS, which shows promise as a low CO2 technology, but still needs to evolve as a viable financial model for business. Another option: Countries can use nuclear power to reduce the cost of electricity as well as CO2 emissions, but nuclear technology comes with a considerable time lag. Options such as nuclear power and CCS become even more complex due to the time and cost involved in these projects. Bain estimates show that if Europe and the US

completely ignore nuclear power in the mix, it would increase electricity costs by 30 percent in Europe and 28 percent in the US compared with a balanced mix that includes nuclear supply. However, given the issues around licensing, feasibility and construction, a nuclear project can mean a lead time of almost 10 years. Similarly, not including CCS development in the mix could increase electricity costs by 13 percent in Europe and 26 percent in the US compared with a balanced mix. However, the jury is still out on how long CCS technology will take to mature. Shifting high CO2-emitting power capacities to serve semi-base and peak load demand: When renewing semi-base and peak load capacities and reinvesting in new low CO2 infrastructure, countries can switch supply. They can use existing high CO2 emission base load power plants, fired by coal or gas, to service demand only at less frequent load levels. Displacing high CO2-emitting plants to meet less frequent demand has several benefits. Our model shows that under certain conditions, displacement could reduce the EU-27's cumulative carbon emissions by 15 percent over the next 40 years. In the US, an additional benefit is a potential drop in the cost of electricity: Redeploying older assets to meet demand at less frequent load levels and investing in cleaner base load production technologies could reduce the price of electricity from $69 per megawatthour (MWh) to $66 per MWh. However, to get the best from displacement, utilities will have to speed up substantial investments. For example, the US would need to invest $1,533 billion by 2020 versus $1,332 billion without displacement. Relying on wind and solar in the near term: Even with displacement, most of the power a country needs will still come from high carbon-emitting plants. In the US and in Europe, wind and solar power can play a critical role in immediately reducing dependence on high CO2-emitting power-generation technologies. Most countries will need a short-term plan based on these technologies to dovetail into the long-term goal of reducing carbon emissions by 2050. However, renewable energy sources have limitations, too. They can be volatile, as they depend on intermittent sources of energy: the wind and sun. Many countries worry that wind and solar energy are still not dependable enough to cover base load demand. Another deterrent: The cost of electricity storage seems likely to remain prohibitive for quite some time. Wind and solar also represent a high initial capital investment, with marginal operating costs once the infrastructure is up and running. If too widely deployed, they will reduce the ability to get the full benefit from low CO2 competitive base load infrastructure based on nuclear energy or coal with CCS. The Bain model estimates that in Europe, a competitive power mix where 240 gigawatts (GW) of power is generated by wind and solar capacities by 2050 will require ?1,408 billion in total investments over the period. Depending further on wind- and solar-generated power-say to meet 600 GW demandwill require additional investments of roughly ?250 billion and increase the total cost of electricity by nearly 10 percent.

Managing demand: An effective way for a country to reach its 2050 goal is by tackling the demand profile for power. By looking for innovative ways to transfer semi-base and peak demand to base load-which is cheaper to decarbonize-a country can dramatically reduce carbon emissions at a lower cost. In one projection, the EU 27 can reduce the required power capacity from 773 GW to 670 GW by shifting 13 percent of peak demand to a more average level of demand. However, managing demand comes with its own issues. A critical constraint in balancing energy demand across regions-and for that matter, across different sources of energy-is the state of the transmission and distribution networks. Such networks become even more complex when they cross national boundaries. It took almost 20 years, for example, to build the interconnection capacities between France and Spain. Moreover, the aggressive push to reduce CO2 emissions comes at a cost: To renew and develop these capacities, utilities in the US would need to invest 30 percent more and in Europe 25 percent more than "business as usual" between now and 2050. But the payoff would be higher, too. In Europe, for example, countries can choose the right low CO2 technology for themselves by prioritizing options that stimulate economic growth and create more jobs locally. The road ahead As countries choose their optimal energy mix, they must consider two factors that can stall- or accelerate-activity. The first is the role of capital. Most options for a competitive low CO2 mix in 2050 require higher capital investments today for lower operating costs tomorrow. That puts tremendous pressure on utilities to come up with the requisite cash in the short term. The private sector can play a crucial role in bridging the need for capital, but that raises the second issue: a stable, predictable environment for energy investments. The more the profit pool in energy depends on unclear and changing rules and regulations made by governments, the less likelihood of private capital shifting to the energy sector. Bold approaches require strong leadership and therefore, getting to the right energy mix by 2050 will test both the public and the private sectors. Government can play a key role in launching initiatives that steer the mix in the right direction, providing access to financing and creating an environment of stability and transparency that attracts investments. Private leadership will feature in an equally significant role. Investors will need to assess and allocate risks. Technology developers will need to speed up the rollout and development of new low CO2 technologies. Meanwhile, power generation companies will need to ramp up plans to renew old assets or build new low-carbon facilities. They can also play a role in educating both the public and private sectors on stimulating R&D and pushing for the development of common and competitive standards on these technologies: Smooth license processes and collaboration on standards could substantially reduce the cost of investments. Most of all, despite the flux in the regulatory environment, utilities can choose to embark swiftly

on their journey to 2050, by taking the first steps needed to develop a clear vision of the future. Arnaud Leroi and Stephane Charveriat are partners with Bain & Company and work in the Utilities practice in Paris. Joseph Scalise is a Bain partner in San Francisco and leads the US Utilities practice. Key contacts in Bain & Company's Global Utilities practice: Europe: Stephane Charveriat Julian Critchlow Frederic Debruyne Berthold Hannes Arnaud Leroi Roberto Prioreschi Nacho Rios Calvo Philip Skold Kalervo Turtola in Helsinki Americas: Neil Cherry Stuart Levy Alfredo Pinto Joseph Scalise Andy Steinhubl in Houston Asia: Sharad Apte Amit Sinha in New Delhi in in in in So San in in in in in in in in Paris London Brussels Dsseldorf Paris Rome Madrid Stockholm

San

Francisco Atlanta Paulo Francisco

in

Southeast

Asia

Getting bank competition right post-crisis Bain & Company industry brief 10/26/10 by UK Financial Services practice As the battle to contain the financial crisis winds down, the eagerness to return to more normal business conditions is palpable. But it is not just banks that yearn to put the crisis behind them. Bank regulators, too, are eager to pick up where they left off. For most of the past two decades, the predominant objective of regulatory action in the UK has been to spur competition and deliver value for bank customers. Now regulators want to refocus their energies on that goal, partly because through bank closures, government takeovers and forced mergers, concentration in the banking sector has increased significantly. The six biggest banks have increased their total holdings of retail deposits from 66 per cent to 77 per cent, raised their share of personal current accounts from 85 per cent to 91 per cent, and lifted the proportion of residential mortgages they underwrite from 64 per cent to 78 per cent. Continued consolidation,

regulators worry, can disadvantage savers and borrowers and leave taxpayers on the hook to bail out banks that grow too big to fail. But how regulators go about balancing stability and competition will have major implications for banks, their customers and the broader British public. Earlier this year, the government charged the Independent Commission on Banking with the job of threading the needle between minimising systemic risk and promoting competition. As the Commission itself acknowledges in an Issues Paper it released in late September that lays out reform options it is weighing, these are challenging objectives to reconcile. Measures that aim to increase stability could result in fewer large banks. Credit may become less available to borrowers as banks shrink their assets to reduce leverage and shore up their capital base. In the end, the pursuit of stability could cause banks to feel less pressure to innovate and improve the customer experience. But policies that promote competition by encouraging new entrants and even splitting up the big banks could compromise stability, leading to smaller and even weaker banks. As competition intensifies, history says that banks are more likely to misprice risk and increase their need for wholesale funding. They will also be disposed to rely on leverage to boost returns on equity. In our view, simple economics dictates that regulators, to the extent that a choice needs to be made, should focus on measures that reinforce stability. Bain & Company calculates that the cost borne by taxpayers from an unstable banking industry is more than 1,000 per annum per head-mainly as a result of reduced output and higher unemployment. By contrast, regulators inclined to view the UK banking market as insufficiently competitive would be hard pressed to identify the cost of this to customers as more than 200 per annum per head. Those taxpayers and customers are, broadly speaking, one and the same. The good news, however, is that it is possible to have both stability and competition without adding large numbers of players and fragmenting the market. Analysing banking markets in 30 countries, we discovered that the most stable outcome that best serves consumers is to foster competition among a smaller number of diversified banks, and that the incremental benefits to consumers from increasing the number of leading players diminish rapidly. The experience of Australia and Canada, both countries that weathered the global banking crisis without having to resort to government-financed bank rescues, is relevant to the UK. Both have concentrated banking markets that are closely monitored by regulators to ensure that banks meet adequate capital standards, maintain healthy reserves and steer clear of risky activity. Yet banks in both markets earn customer loyalty scores that equal or exceed those in the UK. In Canada particularly, banks have achieved profit growth by focusing on customer service and improving the customer experience.

Whichever course UK regulators choose, banks cannot afford to relent on competing aggressively to win more business from their customers. UK consumers are not willing to park their funds with just one bank, but make active financial product choices across a wide range of providers. Today the foundation for sustainable future growth is shifting to customer loyalty, higher customer-retention rates, relationship-based pricing and a richer customer experience. Key contacts in Bain's UK Financial Services practice: United Mike John Matt Symonds in London Baxter Ott in in Kingdom: London London

Publishing in the digital era A Bain & Company study for the Forum d'Avignon 10/20/10 by Patrick Bhar, Laurent Colombani and Sophie Krishnan Summary The written word-incised in clay, inked with a quill, printed on presses or transmitted as electronic bits in email-has always been at the heart of capturing and disseminating human knowledge. Now it is moving to dedicated e-readers, multipurpose tablets and other digital devices that could be in the hands of 15 percent to 20 percent of the developed world's population by 2015. This new format will trigger a profound change in the publishing ecosystem and spark new trends in content creation itself. At first glance, the publishing industry seems unlikely to suffer the same jolting upheaval as the music industry experienced when new technologies hit it. Several factors suggest a fairly smooth evolution toward the digital age, including most readers' continuing attachment to paper, the complementary nature of e-books and paper, and limited electronic piracy, at least to date. But the power of the word may actually increase: A survey of almost 3,000 consumers conducted by Bain & Company across six countries and three continents (United States, Japan, Germany, France, United Kingdom and South Korea) shows that readers tend to read more when equipped with digital readers. And that's not the only encouraging news for publishers: The vast majority of those readers will pay for their e-books. Nevertheless, with 15 percent to 25 percent of book sales shifting to digital format by 2015, the book industry is heading into wholly new territory. Authors, publishers, distributors and retailers all will need to rethink their business models and their relationships with one another. They will have to address several critical challenges: pricing policies that secure the industry's changing profit pools, redefined distribution networks that preserve format diversity and the reallocation of value among industry participants. Writers, in particular, may be able to carve out a new, direct role in consumer relationships.

In theory, the press should also benefit from the emergence of paid digital content. However, the newspaper and magazine industries continue to grapple with broader challenges. Our study shows that most online press readers want to continue to get information for free, whether on digital tablets or not. They will pay only for premium content-such as financial information, local news and deep analysis. Digital reading devices are thus an additional distribution channel for an industry that still needs to redesign its business model. Whatever the sector, the emergence of new reading devices suggests an interesting evolution in writing itself. Creating long-term value will not come from simply reformatting print content into digital words. Rather, the greatest opportunity lies in experimenting with such new formats as nonlinear, hybrid, interactive and social content, electronic modes that add motion, sound and direct reader interactions through technologies we will discuss below. Introduction Over the past 20 years, the digitization of content has shaken the economic foundations of industries like the press, music and video. The absence of convenient e-reading platforms had protected books from such a revolution until recently. However, the emergence of new massmarket devices, such as dedicated e-book readers or multipurpose tablets, has put an end to that reprieve. Critical questions arise: Is the publishing industry next in line to experience digital turbulence? Will new reading platforms provide the press with an opportunity to restore its economic equilibrium? Answers will take time. But the migration to digital publishing is happening, and managing the transition will be crucial for industry participants. Bain & Company conducted a survey of almost 3,000 consumers across the United States, Japan, Germany, France, United Kingdom and South Korea to evaluate the migration of printed books and press content to digital formats. The findings help to decode new reading behaviors and begin to assess their economic implications on the book publishing and press industries. More than that, our analysis provides some clues for the different segments of the "book ecosystem," including authors, publishers, distributors and retailers. Much is at stake: the redistribution of value among players, a redesign of their roles and, potentially, an evolution in the way content is created-all of which could produce significant new value for the industry in the long term. Tablets, e-readers: What are the perspectivesfor adoption? Technologies finally "ready for prime time"

Dedicated e-readers and multipurpose tablets are finally becoming commonplace. A prerequisite to the digital publishing era, adoption rates are projected to reach 15 percent to 20 percent of the population in developed countries. The penetration rate could reach higher levels if multipurpose tablets continue on their current trajectory. The United States and Korea are setting the pace and could see such penetration rates by 2015. Other countries, particularly those in Europe, will lag but eventually catch up. However long it takes, conditions are perfectly aligned for readers to embrace digital devices. Prices have sunk below consumers' purchasing thresholds, with some ereaders already less than $140. Meanwhile, the reading experience and ergonomic design keep improving. Which devices will be favored? The emerging scenario suggests a shifting balance between e-readers, such as Amazon's Kindle, and multipurpose tablets, such as Apple's iPad. Early on, e-readers could capture as much as a third of the market, based on a price advantage and a reading experience that closely matches that of paper. Multipurpose tablets, priced above most consumers' $300 psychological threshold, are still too expensive for mass-market adoption. Yet over time, they could predominate by capitalizing on multimedia capabilities that appeal to a broader audience and as their prices inevitably decline. Indeed, access to other media and valuable functions may open the gates on e-book penetration rates. Reaching the masses As our study found, early adopters of digital reading devices and multipurpose tablets mostly are already heavy readers. In numbers, they are more often men than women. They also describe themselves as more affluent than average and tend to be in their 20s and early 30s. This group values the flexibility of reading in different settings and the new devices' ease of use. Their reading behaviors suggest that digital formats are bound for a promising future and will initially be used as a complement to paper.The second wave of the digital migration should broaden the e-readers' market. Readers who told us they are considering purchasing digital devices in the near future are mostly women and are older than 35 years of age. Promising new reading habits: More reading? Books won't go away any time soon. Several indicators from the study show why. First, respondents who have adopted digital formats say they continue to read printed books. This attachment to paper formats also holds for younger generations, even though they were born in the digital era. Unlike the music industry, the book ecosystem also can rely on some near-term stabilizing factors: limited options to "unbundle" content and low piracy rates-at least for the first wave of users. Adoption rates show that the appetite for digital books has been strong, even by the standards of the media industry. Today, e-books account for approximately 5 percent of books sold in advanced markets like the United States. These rates are expected to quadruple, or even quintuple, over just five years, meaning the industry has little time to prepare. True, some countries, such as France, will migrate more gradually before

reaching about 15 percent of the market by 2015-in part due to the dense network of distributors making paper versions easily available. But make no mistake, the transition will be rapid and could trigger two positive trends. First, the shift to digital publishing could boost book consumption. More than 40 percent of readers equipped with a reading device say that they read more than before. Granted, the novelty of the experience may wear off. But users' creation of alternative "digital libraries" could be as much of a boon to book publishing as was the wide upgrading of audio collections to CD for the music industry. Furthermore, the study reveals that a majority of consumers are willing to pay for the ebooks they read. Close to 70 percent of those with devices stated that they purchase the majority of their e-books. In contrast, the widespread reading of e-books on computers has not triggered significant purchases to date. A story to each segment Emerging consumer behaviors will affect literary genres differentially. In other words, distinct adoption rates and business models will impact fiction and nonfiction works, guidebooks, illustrated books, children's literature or information. Reference books, such as encyclopedias and maps, have already migrated to digital formats. Almost all are now available free on the Internet, which has dramatically depressed print sales. Today, the static nature of first-generation electronic formats has made both publishers and consumers focus first on fiction and nonfiction. And through 2015, such works will likely remain the genre that is most widely read on digital formats. Digital offerings for other genres, such as lifestyle guides, illustrated books and children's books, remain limited today. But their production could accelerate to meet the strong consumer expectations that we discovered, particularly in Europe and Asia. Competition from today's magazine and Internet companies could limit this potential, but a strong new demand is there to be met. The press's business model has already been disrupted. Regardless of device, consumers today expect ubiquitous, instantaneous and free information. Nearly 90 percent of those we surveyed only read free news content online. For those with digital tablets, only 10 percent say they would pay for news. Except for subsegments like micropayments in South Korea, the demand for paid content seems to be confined to such areas as financial information, local news or investigative journalism. However, even those willing to pay say they would spend three times less for digital news than for the print version. A new equilibrium

The book industry will not benefit economically from a migration to digital formats without a fundamental evolution that entails a redistribution of value across all participants, including retailers, distributors, publishers and even authors. Vast change is in the wind, with digital formats representing 20 to 28 percent of industry profits in the medium to long term. How the new digital profit pool will be divided remains to be seen, but several players are taking positions. Powerful digital distribution platforms have already emerged, with select players predominating: Amazon, benefiting from its first-mover advantage with the Kindle; Apple, riding on the success of iTunes; and possibly Google in the near future. These platforms use data-mining algorithms to extract a new kind of consumer insight. In essence, they seek to step into the advisory role of the individual bookstore owner. More than that, virtual distributors could upend today's bookselling hierarchy, altering everything from its vast physical distribution networks to its emphasis on best-selling authors. They might even contribute to the emergence of truly global book publishing markets. Obviously, digital distribution will have an economic impact on traditional publishers, whose business models are based on economies of scale and will therefore suffer from a decrease in physical volumes. The digital migration could therefore accelerate the consolidation of distribution networks around the players with the greatest economies of scale, including in the physical world. Among retailers, a select few will be able to take advantage of their brand and scale to launch competitive digital distribution platforms. Among these are Barnes & Noble in the US. However, the digitization of 20 to 30 percent of today's printed volumes challenges the very nature of current physical distribution networks. Even more fundamentally, new technologies could loosen the control that publishers have over the entire value chain. To maintain their leading role, publishers must not only redeploy resources to digital channels, but also create new services for authors and readers alike. For authors, publishers must provide clear value. While best-selling authors might be able to manage their own distribution, emerging authors may value publishers that can provide online and physical marketing and distribution services. Publishers must also scramble to develop products and services for online readers. Current examples include Vook.com, which offers short videos that accompany novels. Another, Leezam.com, sells novellas and short stories for mobile devices. And, offering a complement of online offerings is the children's book Skulduggery Pleasant: Playing with Fire by Derek Landy, which was launched in conjunction with the viral game The Munchkin Army. This could be a harbinger of a whole new style of book club.

Indeed, the creation of websites and social networks for readers can not only stimulate demand for publishers, but also establish a direct link to consumers. Publishers now have an opportunity to become an even purer business-to-consumer business, selling products and services directly from their own platforms. Authors, in the meantime, are in an ideal position to benefit from the digital era. Bestselling authors in particular should gain more bargaining power with publishers and distributors, which could increase their share of the profit pool over the next five years. A number of authors have already unbundled the physical and digital rights of their works to increase their negotiation power. Paulo Coelho, for example, gave Amazon exclusive distribution rights for the international online sales of 17 of his books in 2010. Ian McEwan, winner of the Booker prize, signed an agreement with Rosetta Books, a specialized e-book publishing house. In France, Marc Levy uses Versilio, a company specialized in book marketing, to manage the digital rights of his books, rather than his traditional print publisher. Finally, newspaper publishers are living through a fundamental redefinition of their business. Expanding from the traditional role of news providers, they are now focusing on investigative journalism, editorials and opinion, and debate moderation-all while redefining the limits between free and paid content. In the medium term, the book and newspaper industries must reinforce the "perceived value" of digital formats to unlock profitable growth. What will consumers be willing to pay, and for what features and services? For books, in particular, the new economic model will rely on a pricing policy that remains within a reasonable range of paper pricing. This largely explains the reversal of Amazon's initial plan to retail e-books for $9.99, a practice that has since evolved to the industrywide agency model, adopted in 2010. Under it, publishers now set prices within a set of distributor guidelines. E-book prices have thus moved to an average 30 percent discount compared with printed book prices. But it's still unclear how the publishing world will handle its traditional pricing time lines, which used to entail new-release and paperback "windows." In the long run, generating and sustaining profitable pricing for ebooks will require providing additional services linked to new reading habits. More than just transitioning words to device screens, publishing's greatest opportunity lies with new formats, such as hybrid, nonlinear, interactive and social. Let's look at each. Since the advent of Gutenberg's movable-type print hundreds of years ago, advances in printing and distribution technology have fostered a continual stream of new formats that address the changing needs of societies. For today's book publishers and press companies, the digital shift is placing the reader even more at the center of inventiveness. From digital books to digital publishing

How do you improve on the printed page in a manner that people are willing to pay for? Among other ways, digital platforms can add videos, sound, music and various degrees of interactivity and collaboration to the reading experience. These forms of publishing go by various names. Hybrid. The digital era opens up books and written content to cross-breeding with other media. For instance, nonlinear reading becomes a multimedia experience. The "vook," for example, adds a set of high-definition visuals to the reading experience. ScrollMotion and Sesame Street created children's e-books that enhanced the text with audio tracks (Elmo's ABC Book). Random House has also developed applications that mix text, music and narration. Nonlinear. In new press services, websites such as Memorandum compile professional articles and political blogs, selected by an algorithm from among hundreds of sites from all ends of the opinion spectrum. The juxtaposition of such diverse content and sources offers a new reading experience, but also raises questions about the selection criteria and quality of the information. Interactive. The reader's participation in book publishing may seem incongruous in such a supply-driven industry. After all, the creative thinking usually stems from the author. Yet some experiments suggest that new formats may succeed in attracting younger, creation-hungry generations to the world of literature. In The Amanda Project, the reader is actively involved in writing a collaborative script. Given a starting point, the Internet user is prompted to continue the tale, and the best contributions are then published in paper format. On his "How to Change the World" blog, venture capitalist and business author Guy Kawasaki asks readers to help shape the theme and story of his next book. Social. Finally, digital publishing has created a feedback mechanism, whereby authors can communicate directly with their audience, and readers can communicate with one another. Authonomy.com, operated by HarperCollins, helps hopeful authors create their own webpage and upload their manuscript for all visitors to see. The readers can then vote and comment on a manuscript that, if successful, is then published in paper format. Amazon recently acquired Shelfari.com, which brings together a community of readers who share their favorite books through a virtual library-an initiative comparable to publisher Hachette Livre's website MyBoox. Tomorrow: new formats? The advent of digital publishing raises another set of questions: In the aftermath of the digital migration, how are tomorrow's electronic words to be preserved? Who will preserve them? Which ones in the increasing flood of electronic verbiage will be selected for preservation? Under which criteria?

That raises a business opportunity unto itself. Countless libraries, national or private, have already begun digitizing paper-based content to secure its preservation. It is a colossal task requiring equally large investments. And it is unclear how digitally born content will be sifted, particularly in nonlinear, hybrid and social formats. What is transient and what is heritage? The great classics of the digital publishing age have yet to be written. But from the past we know that the kinds of words that change people's lives have always lived on-in whatever format. Authors: Patrick Bhar is a partner in the Paris office of Bain & Company and heads the firm's Media and Entertainment Practice in Europe, the Middle East and Africa. He has served the industry for more than 18 years, on multiple continents and across the stakeholder spectrum of broadcasters, content producers, consumer and professional publishers, newspapers and magazines, music majors, movie studios, as well as new media. Laurent Colombani is a senior manager in the firm's Media and Entertainment Practice, managing its French activities. He has been working for the past ten years with leading players in the Media and Entertainment industries. Sophie Krishnan is a manager in the Media and Entertainment Practice. Contributors: Jennifer Binder-Le Pape, Caroline Detalle, Bertrand Escoffier, Piero Galli, Mathilde Haemmerle, Marc-Andr Kamel, Charlie Kim, Jean-Marc Le Roux, Pierre Morel-Fatio, Stamatia Nikolakakis, Dave Sanderson Media Caroline Detalle, Albane de la Flore Larger, Image 7 Bain Hitte, & Bain & contacts: Company Company

Bain & Company is a global business consulting firm with offices in all major cities. We help management make the big decisions: on strategy, operations, mergers & acquisitions, technology and organization. Bain was founded in 1973 on the principle that consultants must measure their success in terms of their clients' financial results. Companies that outperform the market like to work with us; we are as passionate about their results as they are. Avignon Laure Kaltenbach, Alexandre Joux, Director Flexible work models: How Bain by Julie Coffman and Russ Hagey to bring Managing sustainability to a Forum: Director 24/7 world Brief 10/18/10

Challenging times make most jobs more challenging. As companies reduce head count, surviving employees take up the slack. They shoulder more responsibility, work longer hours and travel more. When the economy picks up, attrition rates spike as employees act on pent-up frustrations and look for opportunities at other companies. In the constant war for talent-and especially when businesses start to grow again-flexible jobs can be a powerful tool to attract and retain top talent. When done right, flex jobs-defined as jobs that allow employees to contribute their skills outside the standard workweekoffer several benefits. They appeal to burned-out employees who are seeking sustainability. They allow employees, particularly women, to stay engaged and continue to advance during periods when they confront dilemmas such as caring for children or aging parents and managing 60-hour work weeks or extensive travel. However, so far very few companies have mastered the art of carefully designing and implementing effective flexible job models. While many companies offer flexible work models such as part-time, telecommuting and leaves of absence, the latest research from Bain & Company shows that is not enough. To be effective, companies need to ensure that two things happen: First, they must tailor flexible programs to meet specific employee needs. Individual employees are looking for many different things in such offerings and one size does not necessarily fit all. Second, companies need to give visible evidence that these models work and are supported by management. This means companies must promote enough top performers who've taken alternative career paths to convince the doubters as well as demonstrate that top leaders within the organization strongly support these opportunities. Only then do employees feel comfortable taking advantage of flex options, which, in turn, generate greater adoption and eventually lead to a shift in the firm's culture. The rewards can be huge: increased employee satisfaction, loyalty and retention. The Bain study investigates how to get this virtuous flywheel going. Retaining valuable employees who are under increasing stress We surveyed more than 3,300 people worldwide. Partnering with eight universities, a global search-firm association and a European professional women's organization, we surveyed managers and professionals in the US, Europe, Asia and India. Our respondents were split 61 percent to 38 percent between men and women. Nearly all, however, shared one similarity: They are in very challenging careers. For the purpose of this study, Bain adapted a list of the 10 hallmarks of a challenging job. They are:
Unpredictable work flow; Fast-paced work under tight deadlines; Inordinate scope of responsibility that amounts to more Work-related events outside regular work hours; Expected to be available to clients or customers 24/7; Responsibility for profit and loss; Responsibility for mentoring and recruiting; Large amount of travel; Large number of direct reports;

than one job;

 Physical

presence at workplace at least 10 hours a day.

A job with one or more of these characteristics can be onerous. But a job with five or more of the criteria fits the definition of a challenging job. Among our respondents, about half said they work more than 50 hours per week, while 40 percent said they struggle with five or more elements of a challenging career. Such careers are especially difficult for women. Over time, our survey found, they are nearly three times more likely than men to opt out of a career that has five or more stress-producing elements. In other words, women's retention rates fall precipitously as more challenging elements-such as increased hours and nights away per week-are heaped on to their job. This typically occurs right at the age when managers start to assume executive roles. Several studies have shown that the loss of female talent at this stage can be devastating to a company's performance. It also results in fewer female senior executives. Nevertheless, among women who push on to ages 56 to 65 (a winnowing process that leaves just 24 percent of females in this last age category in our survey), they become nearly equal to men in their willingness to take on challenging jobs. How can companies keep stressful jobs from overwhelming their most valuable managers-male and female alike? To get at that answer, we asked our survey respondents a simple question: "How likely are you to recommend your organization to a friend or a colleague?" This is no idle inquiry. Rather, it is the heart of a Bain customer loyalty tool called the Net Promoter Score (NPS). Originally devised to analyze the individual needs of a company's mostprofitable customers, NPS is equally powerful in understanding the work-life requirements of a company's employees. As opposed to standard "satisfaction inquiries," NPS reveals people's willingness to stake their personal reputation on the product, service or organization in question. As an indicator of future actions-such as making further purchases or staying employed-it is uniquely predictive. Here's how NPS works: Participants rate the "would recommend" question on a zero-to10 scale. Those who give a nine or 10 are "promoters"-people who are true advocates of the organization and drive positive outcomes, such as customers who create additional revenue or talent that helps to deliver great results for the organization. Those who rate a company from zero to six are "detractors"-they are liabilities who eviscerate growth and retention. Subtracting the percentage of detractors (liabilities) from the percentage of promoters (assets) yields the Net Promoter Score. In essence, the higher the NPS score, the better the outcomes for companies; the lower, the more corrective actions are needed. Focused on a company's pressured high performers, NPS tracking can not only help identify potential burnouts among the most valuable workers before they depart, but it can also help determine the best human resources strategies to keep them.

Not surprisingly, our NPS question showed that employees in companies who have used flexible models tend to be strong promoters of the company and are more satisfied with their jobs. What's more, employees who have used flex work models rate that experience positively-results showed an average successful experience rating of 4.2 out of a possible 5 across all flex work models. Most important for companies, however, was the finding that the availability of viable flexible job offerings-that fit the organization's culture-could increase retention in men by 25 percent and in women by a full 40 percent. uch options will become increasingly essential as the next generation of employees-called Millennials-grow in the workplace. Why? Some 86 percent of Millennials in our survey said they expect flexibility from their employer. Just what are the elements of satisfying and effective flexible work models? A key finding was that different employee segments prefer different models. Companies need to carefully study what their strong performers value most across options such as:
Maternity, paternity or parental leave; Leave of absence for less than a year; Extended leave of absence; Flexible hours within a full-time job, such

as going offline from 5 o'clock to 8 o'clock at night and on weekends; Part-time roles that amount to reduced hours and pay in a current role; Job sharing, in which two employees share the roles and responsibilities of one full-time employee; Temporarily stepping away from the "frontline" into a less demanding support function; Telecommuting from home. Unfortunately, most companies still have a long way to go to get this mix right. Our survey revealed two fundamental issues that companies need to address for flex work models to deliver the talent-preservation results they promise: tailored models that address key needs and top-management focus to ensure the models visibly work. Let's consider them in detail: I. One size does not fit all: Employees prefer a menu of flex options Just as companies customize options for different kinds of customers, our survey shows they also need to segment employees by their varying needs and then develop a meaningful set of flex work options from which employees can pick and choose. Feedback tools-such as NPS, employee focus groups, and other formal and informal channels-can help determine which options are most desirable and effective. Each organization will have its own unique segments, depending on the industry and the type of workforce. But there are some commonalities. When we looked at our survey respondents-who come from across industries, demographics and ranks-we

found four segments, each with distinct needs that respondents specified from a list of more than a dozen attributes associated with flexible work models. Beleaguered managers may share the same experience of working too hard. But, in terms of their desire for flexibility, they have differing ideas about what would provide them with relief. The four segments determined from our survey relate to both career stages and the need for predictability, yet they each reveal an overall population that is highly ambitious. In other words, they all want to advance as far as possible. But they are willing to take different routes and timetables to achieve various goals. Starting with "support seekers," we discovered a population that is looking for more leadership support in their flex journey, as well as more fellow travelers. Mattering a great deal to them, also, are challenging work and the ability to achieve demonstrable, high-value results. But today, they believe there are no alternative routes available to them at their companies. Split evenly between men and women, they represent potential mass defections. Next on the spectrum are "casual fans." They appreciate the availability of flexible work for others now-or for themselves later. But right now, they mostly want to move up. For the time being, therefore, they care little about such things as predictability, being on call constantly or heavy travel schedules. Primarily career driven, at least in the willingness to make sacrifices, they are divided at 60 percent men and 40 percent women. The next grouping is "pause-button pushers." They don't necessarily feel they have it made, nor are they ready to throttle back permanently. As a group, they still seek to grapple with challenging work in pursuit of commensurate pay and outstanding results. But these managers are also contemplating taking a brief respite in less-demanding roles or a short leave of absence to recharge their batteries. With leadership permission to take the necessary time off, they'll be back, stronger than ever. "Alternative career-path enthusiasts" are at the opposite end of the spectrum in their job flexibility requirements from "casual fans." They most definitely want two things: predictability in their work lives and, what is for them, a more reasonable number of hours on the job. In fact, they're willing to forgo a more rapid career trajectory to gain such assurance. For them, less is more. Fewer hours on call and on the road will keep them as contributors-eager ones-in their current companies. Across these population categories, deciding what to use among the current grab bag of flex options can be overwhelming. Companies need to understand the needs and then better tailor the menu for their targeted employees, just as they would alter their value propositions for target customers. Today, the most widely used options by our survey respondents were telecommuting, flex hours, parental leave and part-time work. Less commonly used are job sharing, extended leave of absence and a temporarily reduced role.

Whatever the methods they offer, companies must get the cultural aspects of offering flex time right for it to work-and leaders must set the tone. Our survey revealed that cultural elements are in fact far more important than the actual tactics of providing alternative career paths. Overworked professionals are ambivalent about using flexible work models: In our survey, few interested employees actually used flex. Companies have to demonstrate genuine evidence of equal compensation, chances for advancement and overall retention of good talent that chooses to work part-time in order to increase usage and ultimately employee loyalty. II. Offering flex models isn't enough: They have to be seen to visibly work Despite all the benefits that flexible models have to offer in satisfaction and retention, a surprising survey result was that few managers in high-stress jobs take advantage of them. Less than one-third of interested men and only one-half of interested women have ever used flex. Across all age groups, the number of individuals who have used or currently use flex (46 percent of women and 25 percent of men) is significantly lower than their interest levels (94 percent of women and 78 percent of men). Why is that? Several reasons were offered, including a persistent perception that flex options signal a career dead end. As one North American woman said: "I don't see any role models or examples of managers, especially with children, at more senior levels who utilize these models." A European woman banker in the 56- to 65-year-old category elaborated: "As a senior leader, I feel management will take this as a sign that I am ready to be 'put out to pasture.'" There were other troubling factors. A male respondent raised a concern about how he would manage his time: "It's difficult to set boundaries in a flex-time arrangement. When am I on or off call?" A young professional woman mentioned guilt: "I may end up working more hours in flex than in a full-time 9-to-5 job." Many also cited a pervasively negative perception: "I think flexible work models are stereotyped as being for moms who are making others pick up the slack," said one young professional. With such perceptions widespread, it's easy to understand why most employees are wary of using flex models. Although 60 percent of companies in our survey offer flex options, they are widely used in only 18 percent of those companies. This statistical anomaly reflects a number of fears, according to respondents. Most said they worried about a loss of respect on three levels-not only by supervisors, but among peers and clients. Explained one female consultant who recently took a flexible job: "I don't think I get the same level of respect as my peers, since I am now in an internal role." Another fretted about maintaining client satisfaction: "How does a reduced-hour model work within client service when your client expects you to be available 24/7?" The inference for companies is unsettling: There is a pent-up demand in unhappy employees for flex options. Yet this population views today's choices as either unsatisfactory or culturally unacceptable. Confirmation of the latter view came when we asked employees about the relative importance of factors that might influence them to adopt a flexible work model. Fully 86 percent of respondents ranked leadership support

as the most important consideration for them. This key requirement was closely followed in ranking by challenging work and compensation. Way down the scale were specifics of particular flex job options. Put another way, many stressed workers seem to seek leadership's permission to take a much needed occasional break, yet not also lose their place in advancement. Today, many managers perceive that top-level support to be lacking. Yet they still yearn for it. As one male put it, "Seeing other respected executives using flexible work models would increase my perception of, one day, using it for my own situation." Such feelings represent more than a longing by the disaffected. Our survey findings conclusively show that the wide-scale use of flexible working models at companies with thoughtful HR policies is highly correlated with overall employee loyalty-and that an effective flexoption program makes employees who are thinking about leaving more likely to stay. Again, we found that retention rates jump by around 25 percent among men and nearly 40 percent among women in such companies. Creating more women leaders through viable flex work models The survey reveals that the single most important issue that stops women from staying in the workforce long enough to rise to senior leadership positions is the lack of flex work models that serve their specific needs. A very significant finding was that male and female workplace satisfaction diverges starting in the mid-40s age group-just when employees of both sexes start to move into leadership roles. The result: As noted in Bain's 2010 global gender parity study, women simply disappear from the higher echelons of organizational hierarchy. In 2009, for instance, only 3 percent of Fortune 500 companies had a female CEO. Our recent survey shows why: Women tend to opt out of challenging jobs at a much higher rate than men. The questions revealed that women become unhappy about longer hours sooner than men and seem to have less tolerance for extended travel commitments. Increasing work challenges push them first into company detractors and then into exiting the company. One important takeaway: Companies need to view segmentation through the male/female lens. Indeed, not only are women almost twice as likely as men to use flexible work models, they often place higher values on different options. More than that, companies that offer viable flex options can increase their female retention rates by as much as 40 percent. Fixing half the problem will be a good start. But as a company's flexible model evolves, it will also help meet the wider needs of a changing society, one where the promise of equal opportunities is blurring the traditional roles of men and women. In other words, with women paving the way, companies might solve the overriding concern of retaining their very best people in those challenging jobs where they are needed the most.

What companies can do to make flex work models more effective Two elements are paramount for success. One, a tailored set of options and two, demonstrable leadership support combined with visible evidence that the models are working. The last, which amounts to a full support system for flex-job employees to ensure their career aspirations are not jeopardized, begins with a commitment from the highest level of the organization. With this promise, companies can speedily build the right flex-job structure for their company by taking the following steps:
Gathering

input from employees to understand the needs of different segments for flexible models; Creating a thoughtful set of flex options to address the need of each employee segment in the most cost-effective way; Assigning a vocal and visible flex champion from senior leadership; Explicitly communicating the options and raising awareness; Developing a compelling career-management approach that helps workers navigate to the next level by understanding how different flex versus non-flex roles will allow them to develop the required skills for advancement; Providing supervisors with cultural training and arming them with best practices; Pairing new flex work users with experienced "mentors"; Highlighting success stories that encourage the use of flex options. For business leaders, one of their major tasks in a talent-starved global economy is to attract and promote outstanding performers. But leaders also worry about ways to retain top talent. By easing the burden on able employees who are overstressed and overworked, companies can not only get the best out of people in the short term, but also over the long term, through the ups and downs of their lives. Good flex work models start with carefully tailoring job requirements to the various age and career-goal segments of a company's talent pool. The result goes directly to the bottom line in tangible and intangible ways. The immediate payoff is increased employee satisfaction levels. Very soon, those translate into greater loyalty and ultimately into superior performance and better results. Julie Coffman is a partner in Bain & Company's Chicago office and chair of Bain's Global Women's Leadership Council. Russ Hagey is a partner in Bain & Company's Los Angeles and Amsterdam offices and also serves as the company's chief talent officer. Customer loyalty in retail banking: Bain & Company by Bain's Global Financial Services practice Key takeaways North America 2010 report 10/06/10

 Organic

growth rooted in strong customer relationships and the economic rewards they deliver will be the best path forward for retail banks in the years ahead. Bain & Company surveyed more than 89,000 bank customers across North America to determine which banks create the strongest customer relationships and how they do it. Direct banks earn the industry's highest levels of customer advocacy. Loyalty scores for community banks and credit unions also topped those for regional banks and national branch network banks by a wide margin, and their lead expanded since 2009. Why loyalty matters
Customers

who are promoters (defined as those whose survey rating identified them as their bank's most loyal advocates) stay longer with their banks than those who are not. They also buy more products, refer more new customers and cost less to serve. Among affluent US customers, a promoter is worth $9,500 more than a detractor over the tenure of his or her relationship with a bank. The Net Promoter Score (NPS) for direct banks exceeded those of national branch network banks by 69 percentage points. Direct bank customers cited a recommendation from a friend, colleague or family member as the principal reason they selected their bank nearly twice as often as did customers of national branch network or regional banks. Our analysis found that the banks that are loyalty leaders enjoy a growth rate that is 10 percent higher and a cost of funds that is 80 basis points lower than banks that are price leaders. The loyalty leaders
A

company's standing with customers can be measured meaningfully only in relation to that of other competitors with whom customers can reasonably choose to do business. In retail banking, the relevant basis for comparing customer loyalty is within geographic regions. The survey identified loyalty leaders among large, traditional banks in each market. In the US, TD Bank leads in the Northeast region; SunTrust is the leader in the South; Harris occupies the top spot in the Midwest; and Bank of the West is No. 1 in the West. In Canada, TD Canada Trust is the loyalty leader, and Ixe Banco leads in Mexico. The fact that some regional banks attained scores close to those of direct banks or local community banks and credit unions demonstrates that larger banks can earn the loyalty of their customers. What drives loyalty?

 Service

delivery clearly has the greatest potential to set a bank apart for good or for ill. Promoters cited "service" over six times more frequently than "rates and fees" or "branches" as their top reason for recommending their bank. Poor service delivery topped the list of factors named by detractors, with "rates and fees" not far behind. Banks underperform among prime, mid-career customers aged 25 to 55 years, earning scores much lower than those given by younger and older segments. Banks rated poorly with their most affluent customers. Among US banks, respondents from households with investable assets of $1 million or more gave an NPS averaging just 2 percent (versus 16 percent from those with assets between $100,000 and $500,000). What banks can do
Large

banks can put in place business systems and develop organizational cultures that enable them to behave much like their smaller, more-focused competitors. Loyalty leaders build their success on a common set of principles, embracing these six practices. They: - Measure their customer loyalty versus their competitors by segment. - Calculate the value of their promoters, passives and detractors to the business's bottom line. - Prioritize issues that have the greatest potential to create promoters or avoid detractors. - Close the loop by channeling customer feedback to frontline employees, who quickly follow up directly with customers for service recovery and learn how to better serve them in the future. - Engage employees by instilling loyalty disciplines through more effective hiring, training, listening, coaching and rewarding. - Act at every level of the organization to convert insights into learning and cultural change to improve steadily the customer experience. Many banks have adopted some of the elements. But true breakthroughs in customer loyalty and economic results come only when all six are in place, something very few banks have achieved. Bain has worked with organizations pursuing customer advocacy and has found ways to overcome many of the common roadblocks. 1. Introduction: Banks need a new playbook to achieve sustainable growth The near-collapse of the global financial system has left bankers searching for a profitable path forward in a permanently altered competitive landscape. Public trust in financial services companies has sunk to historic lows, underscoring the need for retail bankers to repair badly damaged customer relationships. To do this, however, banks need to rethink deeply entrenched business practices. Tough new financial-reform legislation in the US brings banks under tight scrutiny, restricts the businesses in which they will be permitted to operate, sets higher capital requirements, limits fees and

introduces a new layer of oversight in the form of a consumer financial protection watchdog. The turbulence has made it clear that the two principal growth strategies banks relied on for years mergers and acquisitions and ever-increasing fee income-have run their course. While smaller banks may continue to pursue consolidation, increased concentration among the big banks will no longer be an option, as regulators seek to limit the number of institutions that are "too big to fail." Gone, too, is the quick fix of raising fees, penalties and other charges, which ended with the credit crisis and deep recession-and the regulatory backlash they provoked. One measure of the sweeping changes: Earnings from fees and charges amounting to 40 percent of total checking account profits are now at risk and will not easily be replaced. In this challenge lies an opportunity for the industry to write a new, more solid and sustainable foundation for growth. For most retail banks, the best way forward will be organic growth rooted in strong customer relationships and the economic rewards they deliver. Like any organization that systematically sets out to convert customers into advocates, the most effective players put customer loyalty at the heart of their growth strategies. They embrace new management disciplines, apply new metrics to track customer sentiment and refocus their organizations from the executive suite to the frontlines on improving the customer experience. They also build the infrastructure, information systems and training programs that enable them to make customer feedback an integral part of how they operate. Some banks embarked on this journey years ago and are now showing the way forward and reaping the rewards. Several regional banks, community banks and credit unions have the principles of customer loyalty hard-wired into their business models and are now taking market share from the loyalty laggards. Fast growing direct banks, like USAA Federal Savings and ING Direct in the US and President's Choice Financial in Canada, manage to win some of the highest levels of customer advocacy achieved in any industry. But apart from a few super-regional banks, none of the biggest retail banks have yet to make much visible headway despite years of hit-or-miss customer initiatives. To make meaningful progress, they need to learn how to home in on the right actions that will boost loyalty among the right customers and produce attractive financial returns. Bain & Company is uniquely well positioned to help companies advance on their loyalty journeys. Pioneers in the field, we have been refining techniques that help companies become customer-focused organizations and realize bottom-line benefits for nearly two decades. Building on the work of Fred Reichheld, a Bain Fellow and director emeritus, we have developed a comprehensive set of disciplines for implanting a customer loyalty system into organizations' strategic outlook and operating rhythms. Using a simple, reliable metric for tracking loyalty called the Net Promoter Score (NPS), companies are able to channel a steady stream of real-time customer feedback from the boardroom to the frontlines, making the voice of the customer a presence at every level of the organization and a spur for continuous improvement where it matters most. Our work

helping more than 20 retail banking institutions design and implement customer loyalty programs around the globe has enabled us to co-develop many of the industry's best practices. Putting that experience to work in this report, we collaborated with e-Rewards, a leading market research firm, to poll more than 89,000 US, Canadian and Mexican customers of national branch networks, regional banks, direct banks, and hundreds of community banks and credit unions to measure their loyalty to their primary bank. We linked what respondents told us to their bank's financial performance. Probing deeper, we explore the root causes of their loyalty. We disaggregate the overall sample to understand the differences in customers' attitudes toward their banks by gender, age group, household income and assets. We demonstrate the substantial incremental profitability promoters deliver to the banks that treat them well. The report concludes by describing what banks that aspire to sustainable, organic customer-led growth can do, laying out the architecture of a top-to-bottom customer loyalty program. While there can and should be early wins that deliver measurable benefits and encourage the organization on the journey, there are no "quick fixes." The route to success is a long one, requiring the sustained commitment of senior management and active engagement of every employee. But as we will see in the pages of this report, the destination is well worth the trip. The rewards from customer loyalty for banks that stay the course can be substantial and, when fully implemented, they multiply and become self-reinforcing over the long run. 2. Why loyalty matters The power of customer loyalty is clear and compelling: It leads to more profitable growth. Loyal customers stay longer with banks that treat them well. They buy more of their products, and they cost less to serve. They recommend their bank to their friends and colleagues, becoming, in effect, a highly credible volunteer salesforce. Investing in loyalty can generate more attractive returns than rolling out an ambitious new marketing plan or building new branches. Far less simple is the "how": It is hard to marshal the data, insights and efforts needed to achieve customer loyalty and to tie those to economic outcomes. Most attempts to measure loyalty cannot clearly identify the organization's most loyal customers. They also fail to reveal what managers and frontline employees can learn from their customers' experiences, what actions the bank needs to take or how these initiatives will deliver bottom-line business results. An effective loyalty system needs to accomplish four things. First, it must make it possible for a bank to categorize individual customers by the intensity of their loyalty. Second, it needs to expose the root causes underlying customer loyalty that point the way to specific actions management and employees need to take that will steadily improve the customer experience. Third, it needs to be grounded in customer economics that enable a bank to calculate the lifetime value of a loyal customer-and what it would be worth to convert other customers like them into loyalists. Finally, it must

have the sustained commitment of the bank's senior leaders to propel customer-focused organizational change by using insights the loyalty system generates into policy, process and product improvements and daily frontline behaviors. Leadership engagement is the single most important ingredient to elevate loyalty from a marketing exercise into a core mission. Bain has found that the Net Promoter approach can help accomplish all of these objectives. By asking customers to rate on a scale from zero to 10 how likely they would be to recommend their bank to a friend or relative, companies can sort their customer base into promoters (those responding with scores of nine or 10), passives (who answer with a seven or eight) and detractors (giving scores from zero to six). Each grouppromoters, passives and detractors-exhibits different purchasing and referral behaviors, and understanding the motivations, needs, likes and dislikes of each can lead to actions and decisions that can grow the business. Subtracting the percentage of detractors from the promoters yields a bank's Net Promoter Score (NPS), a single simple number that, as we will see, yields powerful insights. NPS is a key that helps unlock organizational changes that most bankers would otherwise struggle to achieve. Used as a competitive benchmark, Net Promoter makes clear that winning customer loyalty is valuable not just because it is the "right" thing to do but because loyalty is inextricably tied to profitable growth. Indeed, it is striking how the relationship between loyalty scores and deposit growth rates plays out among the different banking business models we examined. Earning the highest NPS with an average of 63, the direct banks saw their deposits increase between 2007 and 2009 at a 13 percent annual rate compounded. Credit unions and community banks, which have long placed a premium on being customer friendly, have been rewarded with both high NPS and strong deposit growth averaging, respectively, 6.1 percent and 7.5 percent compounded annually. In contrast, deposit growth was essentially flat, overall, at the regional banks and national branch network banks, whose customers gave the lowest NPS (+5 percent and -6 percent, respectively). The gap between the customer loyalty of national and regional banks, on the one hand, and the community banks, credit unions and direct banks, on the other, is wide and increasing. Underpinning the correlation between loyalty and growth is the very different behavior of promoter, passive and detractor customers. Our analysis of customer attrition rates, for example, has found defections among promoters are only one-third those of detractors. Promoters also devote a greater share of wallet to and buy more products from their primary bank. Completing the virtuous cycle, promoters are also far more likely than detractors or passives to refer new customers to their banks. During the past year, the promoters in our sample made more than six times more referrals than detractors and more than twice as many as passives. Consistent with the higher NPS they gave, customers at direct banks provided more than twice as many referrals over the past year as did their counterparts at regional or national branch network banks. That higher propensity to refer is making a big impact on direct banks' new-customer recruitment. The proportion

of direct bank customers in our sample who told us that positive word of mouth from a friend, colleague or family member was the principal reason they selected their bank was nearly twice that of national branch network or regional bank customers. This result underscores that while the big retail banks invested heavily in their branch footprint and in marketing to bring in new customers, the loyalty leaders have their customers selling for them. The impact of promoters' lower attrition rates, commitment of a greater share of their spending, and greater likelihood to refer new customers flows directly to the bottom line and accumulates over time. Across our US sample of affluent customers, converting a passive customer into a promoter adds $6,700, on average, over their tenure as a customer, while creating a detractor destroys $2,800 of value-a total difference of $9,500. But even that fails to capture the full upside. The new customers that promoters refer are likelier to become promoters themselves-and generate a chain of secondary referrals that further boost each promoter's value. The value of customer loyalty is not limited only to the revenue side of the ledger. Our calculation does not include, for instance, the added benefits that accrue from the fact that promoters cost less to serve than detractors. They make fewer demands on call centers, raise fewer problems and conflicts that need to be resolved, and are more apt to rely on self-service tools to conduct transactions. Loyalty leaders also do not need to price as aggressively as their competitors. According to our analysis, banks that were price leaders (meaning those paying top rates on deposits in their markets in order to attract new business) enjoyed an annual deposit growth rate of 5 percent from 2002 through 2007 but faced a cost of funds of 265 basis points. In contrast, the loyalty leaders that paid only average rates turned in a 5.6 percent annual deposit growth rate but paid just 184 basis points for their funds. In other words, banks can choose to buy growth through pricing or they can earn an even higher rate of growth at lower cost through the loyalty advantage. 3. The loyalty leaders If the upheaval of the past three years has demonstrated anything it is that periods of economic and industry turmoil shake up banks' relationships with their account holders and open vast opportunities to win new customers or alienate existing ones. The pattern abundantly evident in the Bain survey is that customers are inclined to value banks that value them. Direct banks were the clear loyalty winners. With their simple, low-cost business model of providing just a few attractively priced products delivered and serviced online and through efficient call centers, they score high with respondents because they invest in serving them well. The power of customer loyalty to help a bank to weather economic and industry turbulence also shows up in the higher NPS of community banks and credit unions.

Find out what customers, both promoters and detractors, say about their banks. To be sure, bad publicity in the aftermath of the bank bailouts has been a major factor in the declining customer loyalty to the big banks, which fell dramatically as the crisis intensified in 2008. Overall, scores of the national branch network banks and regional banks recovered in 2009, but they dipped again this year even as the banking system further stabilized. Clearly, there is much ground the major banks, as a group, need to regain and important lessons they can learn from banks that pursue a more consumerfriendly business model. Our survey did find loyalty leaders among the large, traditional retail institutions in all three national markets we examined. Even as NPS at the regionals and nationals declined overall, survey respondents identified 11 banks as standouts that have earned their loyalty. The top-rated banks-among them TD Bank, TD Canada Trust (a subsidiary of TD Bank's Canadian parent), BB&T, Bank of the West, SunTrust Bank, Regions Bank and Mexico's Ixe Banco-all posted significantly higher scores than peers in their regional markets. The leadership of the regional banks in the overall US rankings reflects their stronger relationship to customers in the respective markets where they operate. Their superior standing relative to their local competitors is critical. Our work in industry after industry has found that having a high relative NPS (that is, "high" relative to that of competitors in a given market) is the best predictor of organic growth across industries and markets. The importance of relative NPS is especially striking in the Mexican bank rankings, where nearly all received scores that would put them among the leaders in the other markets but are relative laggards to top-scoring Ixe Banco. The high scores likely reflect cultural norms in rating standards among Mexican customers, who are less openly critical when asked to rate service providers. (In contract, Japanese consumers are tough graders.) For that reason, we have broken the rankings down by 1egion to

identify how the best stack up on the most relevant standard of comparison. One lesson in this for the large banks is that they should not benchmark themselves only against their national or super-regional rivals but also against the direct banks and nearby community banks and credit unions. Judged by that standard, what do the relative NPS rankings reveal? In the US Northeast region, TD Bank has grown to become the region's top-scoring bank through its commitment to understanding local customers and building an exceptional service model through extended hours, friendly service and community spiritedness. Other Northeast regionals, notably M&T Bank and PNC Bank, ranked high with NPS ratings of +13 percent and +12 percent, respectively. Contrary to the widely held view that the loyalty leaders earn customer plaudits at the expense of profits, these top-scoring regionals have recently produced profit margins that exceed the industry average. In the West, where the national branch network banks have a large market share and regional banks are less common, it is nevertheless a regional-Bank of the West-that tops the NPS ratings. Said one Bank of the West promoter, reflecting a sentiment expressed by many: "My bank gets to know their customers and makes you feel part of the family." Regional banks are well represented across the South, where SunTrust, Regions and BB&T were the NPS leaders. "The bank is great to work with, and the people are very caring and interested in helping in all facets," said one SunTrust promoter. "It's the friendliest bank I know," echoed another. Of Regions Bank, a promoter enthused: "They offer excellent customer service and are willing to work with you to resolve any banking needs." In the Midwest, another market with a strong regional bank tradition, Harris Bank and M&I Bank took the top two positions in the customer rankings. Describing what they liked about Harris Bank, customers said: "They don't nickel-and-dime with fees. It's easy to do business with them." M&I customers praised their bank as "consistent and reliable. They provide quality services with no surprises." Among Canadian banks, TD Canada Trust is the clear loyalty leader among the branch network banks. Its parent, TD Bank Financial Group, acquired customer-friendly Commerce Bank in the US in 2008 and worked hard to preserve and adopt most of the service features that made Commerce one of the most popular banks with its markets, as it rebranded it as TD Bank and integrated it post-merger. In Mexico, Ixe Banco stands far ahead of the competition with an NPS of 78 percent. A relatively small niche bank, Ixe Banco has earned its top ranking by focusing intently on an affluent customer base with highly personalized service. "They provide an exclusive and personal customer experience that makes me feel valued," said one promoter. The loyalty leaders' strong scores and superior relative rankings are merely the beginning of the story of what sets them apart from the laggards. As we will see in the

next section, the top performers rely on their customers to help them understand those aspects of service delivery that are critical for delighting promoters or alienating detractors. Then, using direct customer feedback as their guide, they mobilize the entire organization to continuously refine the skills, attitudes and behaviors that enable them to extend their lead. 4. What drives loyalty? Opportunities to create a promoter or a detractor accumulate transaction by transactionat teller windows, on the website, through call centers or via ATMs-over hundreds of interactions customers have with their banks. For most of these, customers have every reason to expect efficiency and accuracy. They can easily become detractors when their bank falls short, but they see no reason to reward their bank for delivering as promised. Relatively few interactions-quickly replacing a lost or stolen credit card, for example, or helping a bereaved family member transfer assets of a recently deceased loved one-have the potential to create promoters. In an attempt to get statistically valid feedback on customer interactions, many banks subject their customers to a battery of detailed questions about the service they received. The mountain of data they get back takes a long time to evaluate, can be hard to decipher, yet ends up revealing little about what really matters to customers. Gleaning the most important and actionable insights from customers requires a disciplined, and far simpler, approach. By soliciting customer input regularly through short surveys immediately following interactions, and then quickly sorting, analyzing and circulating results throughout the organization, a bank can use the feedback to identifyand act to improve-the experiences that have the greatest potential to delight or annoy. It is often the language customers use to describe how they feel about the service they received that crystallizes the most important issues. In the Bain survey, respondents were asked to describe in their own unprompted words the top-of-mind reason they gave their bank the Net Promoter Score they did. This lets customers-not the survey designers-determine what matters most. The importance respondents (whether promoters, passives or detractors) ascribed to any reason was a function of how frequently it was mentioned. One simple way to visualize this feedback is depicted on the inside covers of the report, where the size of the word is proportionate to how often it was mentioned-promoters' top issues inside the front cover and detractors' inside the back. Digging deeper, we sorted the thousands of comments we received into 10 categories that were broad, yet distinct. Thus, customers who spoke of their bank's "trustworthiness" had their comments clustered with those of others who mentioned its "size," "reliability" or "stability" in the umbrella category of "brand reputation." We gathered mentions touching on the banks' "friendliness," "problem resolution" skills, and "knowledgeable staff" and several other like attributes into a broader "service" category. (See the methodology appendix for details on the categorization of comments.)

What did the respondents say bank customers really want? "Service" was overwhelmingly the top reason promoters cited for recommending their bank. It was mentioned more than six times more often than "rates and fees" or "branches," which were second and third, respectively. Further underscoring the importance of service, detractors cited poor service delivery as the chief factor influencing the low scores they gave, although "rates and fees" was not far behind. Respondents' comments confirmed how much rates and fees can enhance or undermine customer loyalty. Promoters who are customers of community banks, credit unions or direct banks were about as likely to mention the service their bank offers as their counterparts who keep their accounts at a national or regional bank. Yet, they were four times more likely to praise their bank's rates and fees. Among detractors, customers at national and regional banks cited poor rates and high fees in their negative comments more than twice as often as other respondents. The power of service clearly provides the greatest potential to set a bank apart for good or for ill. Of course, banks have worked on service-improvement initiatives for decades, with inconsistent results, at least in terms of clearly demonstrable economic returns. Many banks suffer from what might be called "service-initiative fatigue," a sense that there are too many things to improve to make a difference or that delivering truly differentiated service is too expensive. It is true that systematically striving to deliver exceptional service requires hard work. But it often ends up saving money because it roots out defects that drive up costs from complaints, service calls and re-work. Moreover, delivering service that delights does not necessarily cost very much. For example, our analysis of the verbatims showed that respondents, by a factor of two, described simple "friendliness" is the service feature that is most important for winning their loyalty. Indeed, loyalty leaders drew the most consistent praise for going above and beyond for their "friendliness," "helpfulness" and "problem resolution." "They are friendly and helpful," said one respondent of her bank. "[There's] never a problem they can't solve." "They consistently exceed expectations," said another. "I love the bank's values, customer service and commitment," said a third. "They make me feel like they really look out for my best interest." "Friendly service" may not be easy to define or deliver, but it is far less expensive than investing in major systems upgrades. Delivering friendly services is inextricably linked to improved employee loyalty, stronger corporate culture and effective training. Getting the connection right can be highly profitable. (We will expand on this connection in Section 5.) Leading banks demonstrate that winning customer loyalty and advocacy is a big step beyond earning mere satisfaction. Delivering a satisfactory experience requires a company simply to meet customers' basic requirements competently with products that work as promised and by resolving problems as expected. Meriting customer loyalty demands much more. Loyalty leaders differentiate themselves by delivering ordinary services exceptionally well and by their ability to provide exceptional services and product features that the competition cannot match.

Among banks in the NPS survey, only direct banks like USAA, ING, President's Choice Financial and the best of the community banks and credit unions come close to meeting that exacting standard. The scores and the customer comments show that the bestscoring banks do a better job at delivering consistent, friendly service that wins promoters and eliminating the defects-notably high fees and poor rates-that breed detractors. For the direct-bank survey participants, nearly three-quarters identified themselves as promoters and fully three out of five gave their bank a perfect score of 10. The direct banks came by their high promoter scores by reinforcing customercentered cultures, operating systems and frontline engagement that focused relentlessly on serving account holders well. Further segmentation of the survey responses clearly showed that nearly all banks could earn greater loyalty from their customers-particularly those who present the greatest economic potential. Grouping the respondent population by age, for example, our analysis found banks are underperforming among their mid-career customers aged 25 to 55 years whose banking and borrowing needs are usually greatest. Customers in the prime age segments of 25 to 35 years and 36 to 55 years gave their banks an NPS of just 11 percent-well below the score that late-career and elderly respondents over age 56 gave. (We also cut the data by respondents' gender and found that, although women were somewhat likelier than men to be promoters, there were otherwise no major differences in their behavior.) Banks also could do a much better job serving groups that should be their most important targets, namely their wealthiest customers. US respondents from households with investable assets of $1 million or more gave their banks an NPS of just 2 percent. Among national branch network banks, the NPS for customers whose household investable assets top $1 million was -15 percent, nearly twice as bad as that given by customers with assets between $500,000 and $1 million. For regional banks, the NPS of the wealthiest customer segment drops to -5 percent from +5 percent for the next wealthiest customer group. Even the direct banks fall short in meeting the more discriminating needs of affluent customers. The NPS given by the highest-net-worth respondents, at +38 percent, was more than 20 percentage points lower than for the next wealthiest group. Across the board, the most affluent respondents reported negative experiences with their bank's service, fees and rates in numbers far greater than less-affluent respondents. The lower scores given by wealthier customers may be a reflection of the fact that their banks fail to meet their higher expectations set by their experience with other industries. Airlines and luxury hotels, for example, provide first-class accommodation and personalized concierge services. Private banks and asset management firms that cater to the affluent provide "white glove" attention to high-networth clients. Most retail banks, in contrast, have struggled to carve out an equivalent high-end service offering for affluent account holders. However, one bank in our survey, Mexico's Ixe Banco, has developed a service model that differentiates it along this important dimension. Ixe Banco executives make it a responsibility to know the bank's

affluent clients by name; track important personal events, like birthdays; and even deliver checks or currency exchange to customers' homes or offices. The consequences of banks' inability to win more affluent promoters and reduce their number of detractors are striking-and costly. Our analysis of the survey data found that promoters among every wealth segment purchased more products than detractors and that the gap between the average number of products promoters owned relative to detractors widened with income. For example, promoters with household assets below $100,000 owned an average 2.8 products versus 2.3 for detractors. However, promoters whose investable assets exceeded $1 million owned 3.7 products compared with just 2.8 for the detractors with equivalent wealth. By capitalizing on the more sophisticated needs and greater reliance of their well-heeled customers for advice and products that meet them, banks that set out to boost their NPS among the affluent stand to capture many times the premium earnings from this already highly valuable cohort. Across every wealth segment, affluent promoters showed a greater propensity to give positive referrals to their bank. Promoters from households with investable wealth below $100,000 said they recommended their bank to friends or relatives an average 3.8 times; the wealthiest promoters gave 4.1 referrals, on average. Major implications flow from these findings. Customers value good service and they know it when they experience it. For a start, banks need to cultivate an assurance that they offer fair pricing and reasonable fees. But delivering on customers' basic expectation of consistently reliable service is only a precondition for making loyalty possible. Banks need to provide service that goes well beyond the ordinary to reap the truly attractive rewards that come to those that understand, relentlessly pursue and merit the loyalty of the most attractive customer segments. Unfortunately, too many banks design their value propositions, service delivery processes and customer experiences around an average consumer. Banks that are content to hit the average should not be surprised when they reap mediocre results. The question is: What do banks need to do to excel? We turn to that topic next. 5. What banks can do The drill is familiar to most bank executives who have ever tried to spur customer-led organic growth. Implement training programs to help customer-facing employees project a "friendlier" image. Check. Develop incentives to increase product cross-selling. Check. Fine-tune processes to eliminate service defects. Check. Launch a rewards campaign to improve retention rates or encourage account holders who refer their friends. Check, check. What bank hasn't tried each of these approaches-many of them repeatedly? Most yield some short-term gains. But those usually dissipate in the next round of cost-cutting, or

when the "gamers" the bank paid to acquire as customers find a better deal elsewhere, or when senior management moves on to new priorities. It is no coincidence that loyalty leaders are very focused (like the direct banks) or small organizations (like the community banks and credit unions). Their business models allow them to concentrate obsessively on their customers and build their entire operating system around them. Of course, doing this is much harder for large, complicated organizations, and it takes years of sustained effort to achieve lasting results. But it would be a mistake to believe that sheer size is an impenetrable barrier to success. The solution lies in bridging the gap with customers by enabling the big organization to think and act like a nimble small one. The best practices we have codified from our work with banking loyalty leaders across the globe reveal a clear pattern. Effective loyalty systems enable these companies to get close to their customers and align the entire organization around the mission of earning their loyalty by addressing two related challenges simultaneously. First, senior leaders use the lens of customer input to chart the bank's strategic direction and better allocate resources. Their objective: to profitably meet the most important needs of attractive customer segments in ways that set their bank apart from its competitors. Second, and in parallel, it implants disciplines that channel a steady flow of customer feedback to frontline employees who use it to learn, act and improve every day. Both top-down strategy setting and bottom-up frontline activation are critical. Do only the first and the business will struggle to translate strategic insights into day-to-day actions. Do only the second and the organization can waste efforts on the wrong priorities. Loyalty leaders integrate the two by building capabilities around six key elements. 1. Measure The leaders begin by defining what competitive success built on customer loyalty means for their organization and determining how they will measure it. For many banks, Net Promoter Score (NPS) is the tool that underpins their loyalty system by providing a reliable metric for the health of their customer relationships. Central to its appeal is NPS's ability to allow a bank to use the "would you recommend" question to quickly sort its own and its competitors' customers into promoters, passives and detractors and assess its competitive position. When NPS is used as a benchmark of competitiveness, what matters most is not the bank's absolute score but how it stacks up relative to its direct competitors across relevant product markets and geographies. Thus, a bank that receives a low NPS yet ranks higher with customers than all of its direct competitors is indisputably best in class and likely to gain market share. By slicing the data by customer segment, a bank is able to zero in on how well it is able to serve the most attractive, highest-value customers.

The ability to capture competitive insights in a single, auditable metric makes NPS powerful because it is easy to communicate throughout the organization and it is actionable. It puts customer-focused decision making front and center at all levels, assigns accountability and can be linked to individual target customers. Through the understanding it provides about competitors' relative strengths and weaknesses, it also becomes a cornerstone for determining which customer segments to pursue, where to compete and in what products markets to play. This clarity, flexibility and reliability put NPS (or any other similarly clear, single measure that meets the needs described here) at the heart of a loyalty system based on direct customer feedback that reinforces organization-wide learning and continuous improvement. 2. Value Loyalty leaders ground the actions they take in the economics of their customer relationships. Identifying their most profitable customers, their finance teams calculate how much a promoter, passive and detractor is worth to the bank's bottom line. They also quantify the additional profit they stand to gain by converting a passive to promoter or reducing their number of detractors. Loyalty economics becomes a central pillar in their decision-making processes and a reference point when undertaking investments. Without this, investments in loyalty seldom last when budgets get tight. How this works in practice can be seen in the experience of a major North American retail bank. When the bank's marketers set out to use NPS to guide its new-customer recruitment initiatives, their analysis revealed that top-quartile customers accounted for more than 70 percent of total profits. Digging deeper the marketing team developed a demographic profile of these account holders by age, income and the products and services they bought. Based on this template, the team constructed its NPS initiative to focus on potential new customers who shared these prized characteristics. The factors that created promoters or detractors among this segment differed markedly from the factors driving loyalty among other, less attractive segments. An "on average" look at NPS among all customers would have resulted in suboptimal capital allocation. 3. Prioritize Not content to know only who their promoters and detractors are, loyalty leaders delve deeper to ferret out the root causes that lead customers to hold the opinions they do. They identify these by asking a follow up to the "would you recommend" question, inviting respondents to briefly describe in their own words the chief reason they gave the score they did. Gathering and sorting their answers, they then prioritize the "moments of truth" that matter most and formalize an ongoing process for addressing the issues they uncover. At a leading regional bank, for example, customer verbatims revealed that a significant number of detractors were annoyed that it took the bank anywhere from three to five business days to provide a replacement debit card. Tasking an operations team to work on the problem, the team discovered that service delays at this important touchpoint

were aggravating some of the bank's most active and profitable customers disproportionately. Recognizing that it risked jeopardizing its relations with this key segment, the bank quickened its card-replacement and shipment processes to put a new card in a customer's wallet within 24 hours. Seeing positive results from the new policy, the bank made the one-day replacement guarantee a part of its marketing pitch to attract new customers. Its NPS and new-account recruitment both climbed. 4. Close the loop Identifying those touchpoints where contacts have the biggest influence on shaping the customer experience and making them a priority is crucial, but it is only an important first step. Loyalty leaders go further by creating closed-loop learning processes that channel a regular flow of feedback customers provide to the frontline employees and their supervisors for direct follow-up. The two-way exchanges between customers willing to discuss their recent service experience and the employees who served them provide opportunities for employees to learn directly from the customer herself how they can refine their service skills. Equally important, the follow-up dialogue assures customers that someone is listening to what they have to say and is prepared to take steps to rectify a problem. Effective closed-loop feedback processes put protocols in place for employees to rapidly escalate issues customers raise to other parts of the organization where remedial action, a process change or a policy adjustment may be required. Brainstorming among members of a frontline work unit who meet regularly to review the customer feedback they receive can be a source of simple solutions that have a significant impact on improving the customer experience. Sometimes what they learn is surprisingly basic and simple to implement. For example, a local manager of a major bank discovered in the feedback that several customers found it a hassle to visit the branch because it was hard to maneuver their children's strollers through the office layout. They did not want to leave their young children unattended near the front entrance but were frustrated by the obstacles on the path to teller windows, ATMs or service desks. The manager relocated some of the obvious barriers that hindered movement in his branch and recommended that the bank make minor layout changes that ultimately eliminated the annoyance. Without the direct customer feedback, the bank would have been much slower to recognize the problem-or even failed to recognize that it had one. 5. Engage A loyalty system cannot be imposed from the top down but instead is a set of attitudes and behaviors deeply embedded in the metabolism of the organization. It is central to the job of all employees to strive to make promoters of their customers. Engaging employees in this mission requires the organization to instill loyalty disciplines by doing four things: First, develop training programs to introduce and reinforce customer loyalty. Employees need to understand what service skills they need to bring to the job to earn a top score of 10. Second, managers and supervisors need to provide ongoing, real-

time feedback and coaching on their customer-service skills. Verbatims on individual employee performance gathered from NPS surveys become indispensable tools for mentoring and guides for improvement. Third, employee engagement needs to be built in a work environment grounded in candor and trust. The organization needs to create forums and communications channels that allow employees' voices to be heard. Many banks that have adopted NPS to measure customer loyalty also use internal NPS surveys to assess whether employees would recommend their bank as a place to work. Finally, employees need to be inspired to continue to lift their performance. Positive customer feedback and testimonials from promoters provide countless stories to celebrate and share throughout the organization. 6. Act Net Promoter Scores and verbatim feedback provide the raw material that feed a loyalty system. But it is the capabilities of the organization at every level to absorb what customers are saying and convert insights into learning that result in action and improvement that achieves true organic growth. Banks that excel at these develop cross-functional teams to drive initiatives and facilitate the sharing of best practices. They embed active learning from customers and continuous improvement into the daily business rhythms of the organization. And they develop processes to ensure followthrough. The experience of the credit-card unit of a major North American bank illustrates how the spirit of learning, acting and improving takes root in a concrete way. Customer feedback from cardholders revealed very negative feedback around the process of collections calls for late payments. On the surface, this might not seem like an area to worry about loyalty; after all, these are customers who are delinquent and may ultimately lead to write-offs. The first priority, the unit's managers thought, should be the speedy collection of unpaid balances. But when they looked deeper into the profile of the customers who were on the receiving end of these calls, they discovered that a significant proportion were cardholders with high credit limits and included many in the bank's most profitable segment. As the team dug deeper into the data, they also found that agents with the best collection rates also had the highest NPS. Speaking to the agents and observing them as they worked, they discovered that these employees were more effective than their peers in conveying empathy and building trust in a way that made customers more willing to pay. The team overhauled call protocols, rewrote scripts for how the calls could be conducted in a more positive manner and retrained agents to take a friendlier and more sympathetic tone. When the new procedures were in place, the bank's followup NPS surveys confirmed that customers who were treated well paid off their balances faster and had much higher loyalty scores. The benefits did not end there. The encouragement to treat customers well and the improved results they saw from their efforts also lifted the morale and loyalty of the collectors, significantly reducing staff turnover.

Each of these six elements can help advance a company's customer focus, but their real power multiplies when they are brought together into an integrated loyalty system. Banks that adopt only the NPS metric but fail to embrace closed-loop feedback, prioritize the right touchpoints, or develop the cross-functional teaming to learn, adapt and improve miss out on its compounding benefits. Integrating the six elements to achieve truly transformational change requires organizational infrastructure, information technology support and appropriate tools for reporting and tracking the closed-loop feedback process. A true loyalty system can be built only by taking a holistic approach. Banks that adopt just the NPS measurement tool without embracing all of the disciplines that make the system robust capture only a small fraction of the gains. Perhaps the most important glue of all is effective leadership and communications. Senior executives who communicate the loyalty program's goals and progress internally and externally set the tone and example for its success. They demonstrate the organization's commitment to increasing the proportion of promoters by creating a customer leadership team to advance its objectives. They lead by example, participating directly in the customer feedback process and even personally fielding calls with promoters and detractors. They raise the goal of linking organic growth and customer loyalty by developing a loyalty "report card" and elevating its importance to that of hitting financial targets. Finally, they and their boards make the achievement of organic customer-led growth an integral part of their compensation. Accountability for building healthy, enduring customer relationships is every employee's mission, and that starts at the very top. Appendix: Methodology Bain & Company partnered with e-Rewards, the online global market research organization, to survey consumer panels in the United States, Canada and Mexico to gauge their loyalty to their principal bank and the underlying reasons they hold the views they do. Conducted in June and July 2010, the survey polled 89,025 customers of 90 national branch banks, regional banks, private banks and direct banks plus hundreds of community banks and credit unions in the United States, Canada and Mexico. We included in the individual bank analysis only those banks for which we received at least 170 valid responses. We grouped all community banks and credit unions together and evaluated the responses we received from their customers as a single business-model category. The respondent sample: To reflect that banking market and ensure robust, statistically valid results, the respondent sample included somewhat higher proportions of middle-aged and affluent households than the overall US population. By age, people between 36 and 55 years make up 22 percent of the total population but account for 43 percent of all respondents. By contrast, households headed by people in the age range 18 to 25 years are 13 percent of the population as a whole but 8 percent of the survey sample. Likewise, by income, households earning less than $49,000 annually comprise 55 percent of the total population but only 26 percent of our sample. Those earning more

than $100,000 a year are 14 percent of the population but 30 percent of the sample. Each region of the US is represented in the sample in approximately the same proportion as its population. Survey questions: The survey questionnaire consisted of 11 main questions. Once respondents identified their primary bank, they were asked the following three questions to assess their feelings of loyalty to that institution:
On

a scale of zero to 10, where zero represents not at all likely and 10 extremely likely, how likely are you to recommend your primary bank to a friend or relative? Tell us why you gave your primary bank that score. In the last year, how many times did you recommend your primary bank to a friend or relative? Respondents were then asked to identify the major reasons they initially chose to open an account with their primary bank and which of the bank's products they have. The remaining five questions elicited demographic profile information on age, gender, household income, investable assets and region of residence. Analysis of respondent comments: For each of the four bank categories whose customers we surveyed, we randomly sampled nearly 3,000 open-ended verbatim comments respondents offered as the chief reasons they gave their banks the score they did. We coded the comments into 66 categories. We then grouped related categories into the 10 meta-categories as listed below:
ATMs:

General ATM, location/quantity; ease of use; features/services offered; safety/security; international availability Banking processes: Proactive communication; account security/ID theft; secure systems; timely statements/bills; clear and accurate communications; serious error resolution Branches: General branch; quantity of locations; hours of operation; cleanliness/atmosphere; wait time in line Brand reputation: General reputation; trustworthy; size/stability; reliable Emotional: General emotional; sense of loyalty; there when needed; better than other providers Fees: General fees; ATM; CD; current/checking account; money market account; savings account; overdraft; wire transfer; international; online; added/changed/ hidden/transparent; credit cards Online banking: General online; bill pay; easy/user friendly; features/services offered Product: General product; CD; checking; investing; mobile banking; mortgage; savings; loan/line of credit; rewards; credit cards Rates: General rates; mortgage; CD; deposit; line of credit; loan Service: General service; friendliness; helpfulness; knowledgeable; feel valued; understand my needs; problem resolution; speed

State to region mapping: Banks in the 50 US states and District of Columbia were assigned to the following four regions:
Midwest: IA, IL, IN, KS, MI, MN, MO, ND, NE, OH, SD, WI Northeast: CT, MA, ME, NH, NJ, NY, PA, RI, VT South: AL, AR, DC, DE, FL, GA, KY, LA, MD, MS, NC, OK, SC, West: AK, AZ, CA, CO, HI, ID, MT, NM, NV, OR, UT, WA, WY

TN, TX, VA, WV

Statistical significance of findings: The results of our data analysis are robust both for the measurement of bank NPS by region and for respondent NPS for each demographic category. The NPS measured for each bank included in the regional rankings is statistically significant to an 80 percent confidence level, with a two-tailed test of the confidence interval ranging from plus or minus 1.5 percent (n > or = 4,500) to plus or minus 7.5 percent (n = 170). For the analysis of NPS by demographic subcategories of respondents' age, income, gender and investable assets, we again aimed for results that would be statistically significant at the 80 percent confidence level. Given the large size of our overall sample (n =74,840 in the US) and its overweighting in some age, income and affluence categories, the confidence interval for most demographic subgroups is plus or minus 0.4 percent. For the numerically smallest subcategory of respondents (those having investable assets greater than $1 million), the number in our survey sample was 2,600, yielding a confidence interval of plus or minus 2.1 percent that the NPS score they provided would be significant at the 80 percent level. Key contacts in Bain's Global Financial Services practice Global: Alan Colberg Americas: Andrew Schwedel Europe, Middle East and Africa: Paolo Bordogna Asia-Pacific: Edmund Lin; Gary Turner Acknowledgments This report was prepared by Gerard du Toit, leader of Bain's Banking practice in the Americas, Beth Johnson, leader of Bain's Customer Strategy & Marketing practice in the Americas; and a team lead by Maureen Burns, senior manager in the Americas Financial Services practice, and Christy deGooyer, Financial Services practice area manager. The authors thank Aaron Cheris, Rob Markey, Fred Reichheld, Antonio Rodrigues and Diego Santamaria for their contributions and Lou Richman for his editorial support.

We are grateful to e-Rewards for their valuable assistance conducting the NPS customer survey and their responsiveness to our special requests. Level the playing field: A call for action on gender parity in Australia Bain Brief 09/22/10 by Jayne Hrdlicka, Dale Cottrell and Melanie Sanders A "woman executive" is a rare sight in corporate Australia. According to government figures, women represent 45 percent of the workforce, but account for only 11 percent of executive managers in the private sector, 10 percent of board members and just 2 percent of ASX200 board chairpersons. What makes these numbers even more puzzling is that the vast majority of people-male and female, alike-say they're convinced of the benefits of equal opportunity in the workplace. How can most people want something that just doesn't happen? This lopsided outcome isn't due to a lack of able, ambitious women. Nor is it a result of government inattention; the Equal Opportunity for Women in the Workplace Agency (EOWA) requires companies to track and develop actions to address gender parity. But whatever the root causes of this mystery-from unintended cultural bias to simple inertia-one thing is clear: Promoting more talented women into senior roles isn't high enough on management's strategic agenda. Although it's discussed in most sectors, it appears to be more talk than action and outcomes. The evidence: When asked whether women have equal opportunities to be promoted to senior management or executive positions, only about 20 percent of women agreed, along with more than 50 percent of the men. These results are part of a recent Bain & Company study of Australian attitudes about workplace gender parity. Nearly 65 percent of both men and women see no evidence that their company has made gender parity a visible priority, while 70 percent of both sexes believe that their company has not committed meaningful resources to gender initiatives. To understand the female talent void at corporate Australia's upper levels, Bain surveyed more than 1,200 members of the Australian business community. The majority were women, but results included responses from more than 200 men. The survey covered senior executives to entry-level employees across a wide range of industries. It confirmed some suspicions, generated a few surprises and busted at least one major myth. As one would expect, 88 percent of female respondents believe that gender equality should be a strategic business imperative. However, only 67 percent of Australian men sampled agree. Still, Australian men are greater proponents of gender parity than North American and European men by a factor of 1.4 times, when compared with a global Bain & Company survey released in January 2010. One shattered stereotype was the idea that women don't desire a top job as much as men. Not so: The numbers of Australian men and women in our survey who had aspirations of becoming company leaders were within a few points of each other.

In other words, despite women's aspirations for senior leadership positions, there has been no real progress. Indeed, the low statistics haven't materially changed in more than a decade. And few Australian women believe their lot is improving. Roughly a third said they were more optimistic about progress than a year ago compared with 60 percent of men. Summarising for many, one woman wrote, "I think there is a lot of hype about gender equality at a senior level, but I think that the reality...is very different and the ability to provide equal pay for equal roles is limited." (A continuing male-female salary gap is something separately confirmed by a recent EOWA report.) Women's scepticism was linked to a lack of progress on several fronts. Partly, it stemmed from having too few flexible options to bring women back into the workforce after having children. And once back at work, women say there are not enough creative ways to allow them to balance family and work responsibilities. Though men and women equally say they're willing to make career sacrifices to support their spouse or raise a family, women are still much more likely to do so. Indeed, while some 76 percent of male respondents said they have spouses who would make sacrifices for them, only 48 percent of women felt similarly. How genuinely important is gender parity to top management? Some 59 percent of men believe their business leaders take it seriously, but only 35 percent of women say the same. Wrote one: "At our firm, we have programmatic excellence: best-in-class programs, practices and policies. But the reality is there is barely disguised disinterest at the senior leadership team level. There are no consequences, financial or otherwise, for poor performance in gender parity." Actually, there are consequences, serious ones. It begins with the wasted cost of continually hiring, training and developing talented women who ultimately leave the company. Which begs the question, if talent has no gender label, why do companies continue to unintentionally constrain the careers of their female employees? As the global economy picks up, executive teams will need to focus more on finding and keeping top performers-men and women-as a vital means for achieving competitive advantage. Beyond accessing a wider talent pool, gender parity acknowledges that businesses with greater diversity do far better financially because they more effectively meet the needs of an increasingly diverse customer base. In fact, according to one study of Fortune 500 companies, those with the highest representation of women in corporate officer positions had 35 percent higher financial performance than companies with the lowest representation of women in key posts. Further, according to the organisation Women's Network Australia, women make or influence 80 percent of all purchasing decisions. Women-friendly businesses also retain today's most creative and talented young employees of both sexes, who expect their employers to be leaders in social change.

In our view three major inhibitors block the way: not enough visible, committed leadership; unintended cultural barriers; and underinvestment in sustained change management. I. The need to show a real commitment Australian men may be nearly as convinced of the benefits of gender parity as women. But, when asked if gender parity needed to be a specific goal for their organisation, 88 percent of the women responded yes, while just 67 percent of men agreed. One male executive needing no convincing is David Thodey, CEO of telecom giant Telstra. Thodey, who is also chair of the Telstra Diversity Council, puts the case this way: "Having a diverse and talented team of people throughout Telstra is fundamental to our success. Diversity of ideas, gender, background, culture and age provides balance and generates innovation." As the company's website proclaims, "Our women are being challenged to step up and take control of their own development and career success" through a targeted mentoring program. The self-paced module explores such advancement issues as "personal brand," visibility, career planning, negotiation and work-life flexibility. This year Telstra became the first Australian company to win the Catalyst Award, an annual international award for initiatives that support and advance women in business. Among the reasons Telstra won: Over the past three years the percentage of women in management roles at Telstra increased from 29 percent to 41 percent. Meanwhile, the proportion of corporate officers among women grew from 31 percent to 35 percent. At the top of the pyramid, the percentage of women in senior leadership positions increased from a mere 6 percent to 31 percent. Such visible CEO commitment is essential. As one woman respondent expressed it: "I believe the senior leaders are beginning to intellectually get that gender parity is not just the nice thing to do, but that it can also generate business outcomes...but we have not yet won their hearts and minds. It is frustrating, but the noise seems to be getting louder and there is hope that soon we will reach a critical tipping point." Time will tell, but one hopeful Bain survey finding is that the higher men go in the organisation, the more convinced they become of the necessity of making gender parity a reality. While constant at nearly 90 percent for all levels of female respondents, it climbs from 56 percent of junior-level male employees to 58 percent of managers to 73 percent of male executives. This suggests that male leaders are beginning to see the necessity of gender parity for the good of the organisation. Put another way, male executives responsible for results become believers as they learn that gender parity really does deliver better corporate performance. The

implication for companies: They must do a better job of educating all employees on the bottom-line importance of gender equality as part of building leaders. II. Lowering the cultural barriers But as we explore the heart of the mystery of why the number of women in businesses drops sharply at higher ranks, we see persistently polarised beliefs. Today, women see the issue in sharp focus, but men generally less so. And maybe because most executive teams are predominantly male, the relative invisibility of the issues to them has the effect of making women practically invisible in top jobs. To create a culture that truly recognizes and takes advantage of the differences between men and women, male leaders need to send a clear message that gender parity matters to them. They must also halt the company behaviours that marginalise women and instill people practices that feel more like equal opportunity to employees. Based on the survey results, most companies still have a lot of work to do in these areas. We asked people to respond to the following statement: "Qualified men and women at my firm have equal opportunity to be recruited, promoted on the same timeline, and appointed to key leadership or governance roles." The answers not only diverged widely by gender, they were more pessimistic than in other parts of the world. In a nutshell, the perceptions were that the higher the title, the less likely women were to receive equal treatment in trying to achieve these positions. Interestingly, male and female respondents were both likely to perceive a level playing field for entry-level positions. This reflects not only the reality of Australia's employment statistics but a tacit agreement on the high quality of women's talent and ambition. But as job titles become more senior, the perception gap widens. It was a simple question: Are senior positions mostly out of reach for women? The survey highlights this widening gap. Just 21 percent of women surveyed believed they had equal opportunities to be promoted to senior management positions, and 53 percent of men agreed with them. Yet in career aspirations, the survey shows that Australian men and women are virtually the same in their desire for top jobs. Men and women also believe that either gender can be the primary income generator. However, a big variation showed up in perceptions around who can be the primary child caregiver. Only 68 percent of men believe that they can be equally good as caregivers-yet 85 percent of women believed men could be equally competent caregivers. The inference for companies is obvious. If they truly want women in senior positions, they must accept that women's careers often take a different trajectory, primarily due to children, and then build enough flexibility into both day-to-day work and career paths to ensure women can return after childbirth, and stay. Moreover, if we are evolving to a society where men and women share primary care-giving responsibilities, then companies need to ensure that flexible work options are just as appropriate and available for men.

But lifting cultural barriers goes well beyond adopting new working models for parents. As several ASX100 human resources executives told us in response to this survey, change must also come to individual behaviours and people processes. Obviously, no company can tolerate aggressive, hypercritical and bullying styles, or inappropriate conduct. Less understood are the ramifications of current people processes-or the "way things are done around here." These require a thorough re-examination and a long-term commitment aimed at rooting out unintended cultural biases. The payoff is well worth it: to develop and promote high potential women into senior positions in numbers meaningful enough to boost the bottom line. By its very nature, this sort of undertaking must be led from the top. III. Persistent approach to change management So what will it take to put Australia's talented women in their rightful place? As with any other business opportunity requiring significant change, success requires five essentials: outstanding leadership; a fact-based diagnostic; initiatives that are realistic and achievable; adequate funding and resourcing; and the right measurements to track progress. Leadership trumps everything else. As one respondent wrote, "Visible support from the CEO and the team makes diversity a key strategic priority. You must ensure that you select people from the best talent available, all of them." Less than 40 percent of respondents-male and female alike-thought that their organisation's leadership team believes gender parity is an imperative. Similarly, less than 40 percent thought their workplaces had either made it a visible priority or committed sufficient resources to achieve it. When questioned about what actions demonstrate leadership commitment, the most common response from both men and women was "appointments of women" (84 percent and 86 percent, respectively). One action that leaders can take instantly is to make sure HR provides the names of the most talented man and woman for promotions and leadership roles. They can also require recruiters to include female candidates in all search responses. And, they can appoint women into highly visible special projects to improve their visibility and exposure. All send a powerful message about breaking down unintended barriers to the career development of talented women. To fix the problem long term, leaders need to understand root causes. This means direct engagement with employees. Our respondents say that very few companies today even ask employees for feedback on gender-parity solutions. Where are gender parity intentions falling apart? Why? How? Companies need to expend effort to get the facts and understand the specific nature of the problem. For instance, how can companies increase the loyalty of talented women? How can they help women navigate the changing circumstances in their lives and stay committed to their careers? The devil is in the details and it all starts with CEO commitment.

Companies need to track their gender mix over time to identify problem areas and predict how the proportion of women in leadership positions might change if these were specifically addressed. For example, Chief Executive Women (CEW), an organisation of nearly 200 leaders across Australia, offers The CEO Toolkit. Many ASX companies use the diagnostic to explore appointment and recruitment decisions, organisational culture, pay equity and talent management. The next step is to turn employee findings into meaningful metrics, targets, actions and time-specific goals. This goes well beyond tracking gender mix, or even gender mix for each management level-a head-counting exercise that 61 percent of respondents believe their company already does. Rather, companies need to delve deeply into such complex factors as the effects of pay equity on and the performance and career development of someone who is working part-time. Today, many companies' HR systems don't even allow tracking by gender, let alone complex metrics around promotion timelines or talent identification. Meaningful change can only happen if companies measure the right things. There is nothing new about what finally happens. Businesses already know how to run successful change-management programs. They do it all the time in make-or-break product launches. Their very success hinges on carrying out performance-driven initiatives. So the task now is to apply those same skills to gender parity-recognising that it is a vital ingredient for growth in a talent-constrained world. Getting an organisation through these stages takes constant leadership. As Carlos Ghosn, head of the Renault-Nissan Alliance, recently told a 2010 World Economic Forum panel discussion on putting parity into practice: "We need to explain why promoting gender diversity is good for business. We need to lead by example. And we need to entrench parity in the basic processes of hiring, appraisal and succession planning." Jayne Hrdlicka, a former partner with Bain & Company in Sydney and a founding member of Bain's Global Women's Leadership program, is an executive at Qantas Airlines and board member of Woolworths. Dale Cottrell is the managing partner for Bain & Company's Australian practice. Melanie Sanders is a partner with Bain & Company in Melbourne and leads the Australian Women at Bain program. Capability-driven IT Bain & Company capability brief 08/30/10 by Bain's Global IT practice In order to unleash an organization's full potential, IT needs to be anchored to clearly defined business capabilities. Information technology organizations and the business units they are meant to support do not occupy parallel universes, but most business leaders can be forgiven for thinking they might. A Bain & Company survey of more than 500 senior executives found that despite devoting enormous resources and energy trying to align their company's IT investments with their most important business needs and improving IT's effectiveness, fewer than one in five felt their efforts were succeeding.

Our work with organizations across a wide variety of manufacturing and service industries around the world has found that problems of misalignment share a common source. Trouble starts when business units typically hand off their strategy to IT at too high a level. The broad goals the business articulates are not concrete enough to be converted into well-informed IT decisions. But when it comes to specifying what the business expects IT to deliver, the proposals IT develops are defined at too low a leveloften in the form of a one-year operating plan rather than a comprehensive program to reach a strategic destination. As a result, IT ends up building its assets from the bottom up, a narrow approach to business needs that fosters a short-term investment mentality. Instead of developing approaches that serve broad business goals, IT solutions-and the budgets that support them-are typically siloed by product, sales or distribution channel, customer segment or market geography. This impedes flexibility and drives up both capital expenditures and operating costs. The consequences of misalignment are severe, showing up in four major lost opportunities:
Money squandered on the wrong IT investments; Delays encountered in bringing new products and initiatives to market; Opportunities missed to create loyal customers because of suboptimal

service,

and; Improvements deferred because IT lacks the fully engaged support of the business which, in turn, fails to achieve its most critical objectives. There is a better way. Effective alignment can occur only when IT and business strategy are anchored in clearly articulated business capabilities. Why capabilities? In the architecture of a business, capabilities are basic building blocks-the key enablers of mission success stemming directly from the organization's vision, strategy and business imperatives (see Figure 1). Business capabilities are the specific skills the organization must refine in order to achieve competitive leadership. They are dynamic and give the organization an ability to adapt to changing market conditions-as must the IT capabilities that support them. To better understand what this means, consider the critical business capability of customer segmentation, a key enabler of organic growth. A conventional static IT approach disconnected from broader business objectives would be able to serve the narrow needs of a business's current customer segmentation scheme. A dynamic IT organization built around capabilities, by contrast, enables the business to identify and pursue attractive new customer segments in an environment of changing products, prices and consumer tastes. Accomplishing the first objective requires the IT organization simply to respond when the business orders up new data. Meeting the

more challenging demands of the latter requires IT to build capabilities for integrated data storage; develop broad systems platforms to accommodate various channel, product and security requirements; and enable end-user computing. Supporting business capabilities puts IT and business on common ground, permitting IT to respond flexibly to critical business needs. It provides a common language between business operations and IT. It ensures that business priorities trigger key IT decisions. It provides a high-level, pragmatic approach for focusing IT investment where it is needed the most. Finally, it makes it easier for the organization to determine which capabilities need to be shared and which are specific to a given segment or geography. As IT becomes aligned with business capabilities, its relationship to the business matures and deepens over time. IT evolves from being simply an arm's-length service provider into a supplier that is fully engaged in business transactions, and then into a trusted business partner. The IT organization's ultimate goal: to function seamlessly as part of the business. Of course, the needs of the organization will change over time and its capabilities must keep pace with them. This requires constant coordination between IT and the business, frequent recalibration of IT priorities, and timely reallocation of IT spending. But because core capabilities remain relatively stable, the IT organization is able to build a platform of support that can warrant a sustained investment program. A five-step approach toward a capabilities-centered IT strategy Working with leading companies, we have developed and tested a five-step process for unlocking IT's full potential to deliver business value: 1. Define business imperatives and capabilities. Business imperatives are the organization's most urgent priorities flowing from the corporate vision and strategy. Alignment begins by defining these critical battlegrounds and identifying the key capabilities the business units need to master in order to support them. Then, executives need to weigh the strategic relevance of each capability based on the number of business imperatives it supports and group them into priority clusters. A clear business imperative might be to establish a customer-centric culture that allows the real-time ability to make special offers and set prices based on key customer relationships, and to adapt products accordingly. In a bank setting, for example, the business capability required is for all branch staff to have, or be able to quickly retrieve, timely and simple-to-understand online insights into their customers. Translated into an IT-enabled business capability, some of the features needed in this platform would include instantaneous responsiveness to deliver a full customer profile to a sales representative's desktop. From this, a sales rep would instantly know what other products the customer has purchased, past issues or complaints, and prompts related

to complementary offerings. In other words, the business capability is a complete profile linked to the ability to design and price custom products based on such important customer factors as segmentation, subgroups or change-of-life points. Such a frontline service point of view would empower a bank branch manager, financial adviser or credit-card company call-center representative to provide a better customer experience. 2. Identify IT capabilities that support business capabilities and plug gaps. Here, line executives and IT managers together determine the IT design required to satisfy the business capabilities. Their collaboration will likely reveal that the choices they make may not accommodate all business imperatives, requiring that they rank order them. To do this, managers need to assess the strategic relevance of the various IT capabilities, map them to the business capabilities they support and then group them into priority clusters. In the process, they will identify gaps between current IT capabilities and the target state, and they will need to determine which IT capabilities can be shared across different lines of business. To return to the financial services company example, IT needs to build a flexible customer-information platform based on a common customer database that enables the bank's financial advisers, call-center reps and credit product marketers to quickly offer the right products and service levels to each customer. The process of developing that platform may expose potential capability gaps, such as in a lack of data in the forms the business unit will require or insufficient IT skills to support data analytics. These will need to be addressed. 3. Design the operations and technology architecture. Rather than develop IT features in an ad hoc manner as requirements emerge, managers need to establish capabilitiesbased IT principles. These will guide and govern IT architecture, its evolving design, and the way features are built and operated. From a firm-wide perspective, companies must develop recommendations for a target-state technology solution that encompasses each IT capability. Here, the selection of systems architecture becomes critical to ensure flexibility and meet evolving business needs. As part of creating durable, multi-user capabilities, IT managers must carefully design specs for the final application, determine how the data are going to be manipulated and decide what overarching infrastructure will accommodate it. For example, in most organizations, master customer data are scattered over diverse applications and databases. To support the financial institution's business requirementsand to simplify the environment for the sales force-various customer systems will need to be integrated into one universal content-management system. In this way, branch and contact centers will be able to access a real-time, 360-degree customer view from one readily accessible place. This not only pushes data to customer-facing employees when they need it, it facilitates customer-focused service, segment-specific marketing and sales analytics. On a daily basis, for example, such a platform could push customer feedback gathered from surveys directly to a call-center representative to follow up and resolve problems.

When aggregated by the IT customer-interface system to reflect the experiences of the hundreds of customers who required call-center service, the feedback can be used by supervisors and managers for front-line training or to elevate issues that may need higher-level attention. Finally, the platform would also enable market analysts to sort the feedback by customer segment in order to identify opportunities to improve service delivery to high-value targets or spot opportunities to cross-sell other products. 4. Develop the IT strategy roadmap. Aligning IT with business objectives requires not only a capabilities-based goal, but a roadmap to get there. To create one, managers must work together to identify key IT investment needs that will close the alignment gaps, and then bundle them into IT investment themes. Following an acquisition, for example, a top priority will be to improve IT connectivity and efficiency across the merged companies. Thus, integrating the two organizations' systems ties into the business imperative to get a more granular view of all customers and how they rate the services they receive. Meanwhile, organizational capabilities needing an immediate upgrade might be to consolidate finance, data warehouse and human resources functions. In our experience, leading firms sequence their IT investments. They develop a threeor five-year transformation roadmap for IT initiatives based on their strategic relevance, urgency and ease of completion. They also build an investment plan based on the estimated cost to accomplish these IT initiatives and the return that investment is expected to yield. 5. Reallocate IT spending as business priorities evolve. Periodically, companies need to reassess whether their technology investments remain aligned to business priorities by applying a business lens to IT costs. Sometimes it is necessary to refocus the project portfolio on the most critical capabilities, reallocate IT budgets accordingly and capture the savings. Frequent assessment of all projects against the IT strategy can identify significant amounts of unaligned IT costs early on that can be reallocated to new business priorities. For instance, IT capabilities may need to be revised as business needs change, creating opportunities to serve new customer segments. Other capabilities might begin to rise in priority, as well, such as the need to accommodate high-volume customer surveys, develop a capacity to mine verbatim feedback, and begin channeling the feedback to front-line employees. Aligning the stars for success A business-capability approach delivers a payoff that can be dramatic in two important ways. First, it addresses and directly supports key business strategies, making the impact of IT on the business visible and easily understood by all. It also ensures that the IT implications of business strategy are well understood. And it helps the business set

priorities. In other words, this approach forces the business to make trade-offs across different strategic imperatives. Second, focusing on capabilities improves the effectiveness of IT spending. It greatly reduces waste by eliminating the misallocation of resources on lower-value IT initiatives. Centering IT investments on capabilities also fosters a more effective sharing of IT assets. The IT organization is better able to identify the common requirements that can be shared across business units or geographies. In other words, aligning IT strategy closely with business strategy and mobilizing the organization behind the effort causes those once-parallel universes to converge. Key contacts in Bain's Global Information Technology practice: Asia: Donie Lochan in New Delhi; Arpan Sheth in Mumbai Europe: Sachin Shah in London Americas: Jonathan Stern in San Francisco Using data as a hidden asset Bain & Company industry brief 08/16/10 In this era of pervasive networks, proliferation of sensors and devices, and increasingly information-intensive applications the amount of global data more than doubles every two years. With waves of data rushing over virtually every sector of the economy, organizations need a new game-plan to create value from data. Even data-savvy organizations find this massive surge outpaces their ability to extract the full potential of their data. While most companies struggle to harness energy from this tidal wave, a select few have crafted strategies to surf the swell. These leading companies see data as the new currency for building competitive advantage. They invest in new, innovative ways to aggregate and use the data that they own or that surrounds their company's customers and ecosystem. In the process, they strengthen their core business and find new avenues for adjacent growth. Their experiences point to ways in which today's data opens up new opportunities for growth for all sectors of the economy. Data as a source of innovation: Why now more than ever? New tools and capabilities harness data more effectively than ever before. Data and information now help make products and services more intelligent-which lets companies deliver more value. The growth in the business-intelligence tools market is outpacing the growth in the entire software market. Organizations now have access to many more powerful new

tools. Database technology, both hardware and software, now operates at an order of magnitude faster than just a short while ago. Capabilities to analyze new data types, like video images or gene sequences, are steadily becoming mainstream applications. Today, the ability to process and glean insights from data exists at a much greater depth and scale than projected a few years ago. Kaiser Permanente, for example, is taking advantage of such capabilities. The company made a multi-billion dollar investment to build its HealthConnect health information system. The system securely connects 8.6 million people to their healthcare teams, stores their personal information and provides the latest medical knowledge. In an industry known for chronic high costs and quality issues, the system allows Kaiser to not just identify and rollout best practices but it also gives the healthcare company a datadriven edge in providing lower-cost and higher-quality care. If companies don't lean into the data opportunity, they risk losing ground to the competition. The medical equipment divisions of companies such as Philips and GE Healthcare compete increasingly on the data and analytics generated and enabled by their equipment. They sell MRI equipment but also help customers with the speed and quality of their data assets through their electronic picture archiving and communication systems. These IT solutions allow health care providers to archive, store and display images speedily and offer superior diagnostic services to patients. The burgeoning variety of data-gathering devices and the masses of new data create a fertile ground for innovation across industries-both for new applications as well as unique businesses models. For example, CarMD uses a device-data combination to offer consumers a third-party service that monitors their vehicle's health. The company's hand-held tester plugs into a consumer's car to extract data from the on-board computer. The company then charges consumers a membership fee to upload the information onto CarMD's online database to diagnose issues, get a repair estimate, and even find a qualified mechanic. A fluid resource, data now moves across physical and organizational boundaries. New and unforeseen combinations of data can create new opportunities for companies across industries. At least one recent estimate projects that in the next 10 years, over 50 billion devices will connect to the Internet, many wirelessly. Most of these will not be cell phones or PCs but a wide variety of devices such as appliances, capital equipment, sensors and medical devices. The broad scope of these devices and the data they generate and share will bring about fundamental change across industries. For example, Boeing's use of data and devices could transform the company from an aircraft manufacturer to an aero-health service provider. To reduce its airline customer's total cost of ownership, Boeing offers customers a data-based Airplane Health Management service. Performance data can be wirelessly transmitted from each

Boeing aircraft directly to the fleet operator for real-time fault management, performance monitoring and customized alerts. The data service allows Boeing customers to make fix-or-fly decisions quickly, which in turn, helps the airline improve maintenance efficiency and reduce servicing costs. Or, consider the shift to "e-homes." It's easy to imagine a future where phones, PCs, lights, thermostats, air conditioners, security cameras, even draperies are all dataenabled and accessible from anywhere. Many new applications that save costs or enhance the customer experience in the home are emerging as intelligent data from disparate home devices are merged. Microsoft Hohm and Google PowerMeter plan to help consumers monitor their energy use, Cisco plans to provide intelligent home area network infrastructure. Emerging companies like GridPoint, EcoFactor, Control4 and Comverge now provide software that help consumers manage e-homes. Consumer electronics companies like Whirlpool are honing new skills in the installation, maintenance and repair of web-enabled appliances, while utility companies like Duke Energy and Direct Energy are exploring options for serving e-homes. A surfeit of data creates new services opportunities and pitches new competitors against old incumbents. Some companies believe so strongly in the power of their data that they are willing to share their assets to make them stronger: these companies open up their data to others in the hope that it becomes a platform for all to use. In an unprecedented move, GlaxoSmithKline went public with the structures behind 13,500 chemical compounds that may inhibit the malaria parasite. GSK hopes that by sharing information and working together, scientists will come up with a drug to fight the disease, faster than the company could on its own. Going even further, start up companies like BlueKai and eXelate are even creating data marketplaces where companies can sell and buy data. How to harness the power of data assets How can a company develop a strategy that unleashes the power of its hidden assetsand propel growth? A good starting point is to ask the following questions: What data exists within and around the company's processes and customer experience? To uncover its hidden assets, a company can start by creating an inventory of all the data that it generates from its business. Too often companies, even Internet companies, store petabytes of data that they never use or analyze, and, in the process, they overlook opportunities to capture valuable data created in their core processes. Once the inventory of internal data assets is complete, the company can next consider sources of accessible, valuable data outside the enterprise. In the darkest days of the residential mortgage crisis in the US, Experian Capital Markets, a credit bureau, spotted an opportunity to data-mine its existing assets and target a new customer segment: bond buyers on the secondary mortgage market. The company already provided detailed information on home loan applicants to investors in

residential, mortgage-backed investments-when the securities were first created. After the housing collapse, the company began offering equally detailed information on borrowers to investors buying the securities on the secondary market. Experian realized that in a shaky housing market, bond buyers would welcome data that let them track the credit-worthiness of borrowers every month and gave them early warning of defaults. Zillow.com created a new service and business model that provides publicly available mapping of individual home values across the US by combining existing data sources such as transactional history from public records and listings from real estate brokerages with new data from Microsoft-based maps. Its media-based business model continues to expand with nearly 12 million visitors per month and an increasing array of services as Zillow mines the data on visitor actions and continuously builds its data assets. What is unique about the data and are there ways to use it to create more value for customers? Data in and of itself is not valuable, unless it can be turned into a feature, product or service that creates value for customers. When performing a data review, companies need to critically assess where data truly adds value for their customers. More specifically, they should ask: Where can new data and information provide a meaningfully lower-cost or better product or service? Is there a customer pain point or unmet need that can be solved through data-enabled improvements of their experience? From advertising to logistics, companies across industries are applying global positioning systems (GPS) data to their business to develop innovative new services for customers. Star Navigation Systems recently launched a novel application for aircraft safety and monitoring. The company provides commercial airlines an in-flight data monitoring service that acts as a counterpart to an aircraft's "black-box." The Star Navigation service collects data from sensors and systems on board and passes the information to the pilot and ground controllers in realtime, defined intervals, via satellite. Now Star Navigation's Flight Tracker offers airlines the ability to use GPS tracking software to get a constant stream of accurate data on an aircraft's exact altitude, longitude, latitude, heading, airspeed and operations. The system allows airline executives to manage and track their fleet in real time, from the office-and even communicate with an aircraft en-route via two-way text messages. In the worst case, if a catastrophic event happens, the airline can also access flight data and location right up to the last minute-critical information that is lost when aircraft crash in inaccessible locations. What is required to mobilize around the new data opportunities? In order to use data to generate growth, an organization needs to build new muscles. In many cases, data and information businesses require different business models. Sometimes, they can even require the redefinition of existing customer relationships. Companies therefore often need different organizational and operational capabilities for data and information businesses, compared with their core product or service.

A few years ago, Yahoo realized that while its data was increasingly strategic, the company was not able to tap its full potential. The issue: The data resided in multiple stove-piped sub-organizations within Yahoo in different formats. To solve the problem, Yahoo created the new position of chief data officer and set up a team to centralize data strategy and analytics, and invested aggressively in people and technology like machine-learning. The change not only aligned taxonomy and policy across the business, it also pushed Yahoo to adopt an agenda that offered more value to its customers, both consumers and advertisers, through data and insight. The transition wasn't quick, however: Yahoo continues on a multi-year journey to capture the full potential of its data assets. In order to make that journey, companies often require new talent. The data surge is creating a tremendous need for people who understand data and how to collect, analyze and synthesize data on a large scale. Despite a moribund job-market, statisticians, data architects, and database analysts and administrators remain in high demand. In fields like healthcare informatics and statistics, new graduate programs have been created and grown dramatically in the US. As data gains importance, enterprises will be stretched to build their capabilities and find the right talent. Lastly, the pursuit of data-led growth requires thoughtful understanding and protection of customer and partner interests in the area of privacy. Increasing consumer and regulator scrutiny is being applied to privacy. Each company should carefully consider the relationship, brand, contractual and legal risks of any customer or partner data it uses. A company's core business can suffer significant negative impact if the company violates customer or partner trust. Companies that take a misstep on privacy issues will suffer the consequences: They may suddenly face stormy customer relationships or brand concerns if they press ahead in sensitive areas. Facebook quickly had to address its privacy policy when consumers raised a furor over the expanding use of their data. However, companies can manage and overcome privacy concerns too. For example, to comply with regulatory constraints the electronic medical records systems of leading health-plans protect the patient's identity from all except those permitted to see it. At the same time, these systems allow payers to use data in aggregate to derive insights and identify opportunities to improve performance. Many internet companies also aggregate data to make it anonymous and develop insights that do not violate individual privacy. A privacy strategy is an essential part of any plan for data-enabled growth. When properly conceived, it can actually help create data-led products and services that add tremendous value to the customer experience without destroying customer value. Data at the core of future growth Finding valuable data with the potential to generate growth is just the starting point. For most organizations, taking advantage of hidden data assets can be challenging. Dataled growth requires a company to invest in a concerted mobilization-across strategy, operations, customer relationships and fundamental organizational capabilities-before the company can realize data's full potential. As companies begin to harness data assets to enhance their customer experience and offer greater value, they get better at

spotting new opportunities. The tsunami of data will continue unabated. The faster companies fashion more valuable propositions for their customers with data that matters, the more likely they will be to catch the data wave and grow. Key contacts in Bain's Global Telecommunications, Media & Technology practice are: Americas: Chris Brahm and Josh Asia: Jean-Philippe Biragnet Europe: Michele Luzi in London Rutberg in in San Francisco Tokyo

Changing pharma's innovation DNA Bain Brief 08/13/10 by Nils Behnke and Norbert Hueltenschmidt It's no secret that Big Pharma's traditional research and development (R&D) engine needs a complete overhaul. What's surprising is how long the industry's taking to fix the problem. Despite a number of bold efforts to bring pharma R&D back to higher productivity levels, the pace of innovation remains anemic: the long-term average lags at one new molecular entity (NME) a year per company. Despite R&D spending at a high 18 percent of revenues, Big Pharma's R&D productivity declined by 20 percent between 2001 and 2007. The cost of bringing a new drug to market currently runs at more than $2 billion, clearly an unsustainable level. Mergers and acquisitions and the creation of mega-companies have not compensated for the slowdown in innovation. As a result, analysts lowered expectations and now hope the global pharma industry will at least eke out a compounded annual growth rate of 1 percent in revenues over the next five years. Faced with patent expirations, rising expenses, competition from generics and pressure on branded drug prices, Big Pharma's revenue gap could balloon to almost $100 billion by 2014. For the top 20 biopharma companies in the world, this represents an annual earnings decline of 8 percent. Most companies find that even shopping for innovation externally cannot help close the gap. Recent Bain analysis of 6,000 biotech projects, available for late-stage licensing, shows that only about 200 are likely candidates for a large pharma company. Of these, fewer than 100 show potential to become top-sellers and taken together, they account for only about $30 billion in potential revenue. Pharma companies are striving hard to stave off the R&D crisis through mergers and acquisitions, geographic expansion, and diversification into new areas like consumer health. But they recognize that while these efforts yield more predictable sales in the future, they have limited impact on the profit gap. The US, Japan and Western Europe still account for 80 percent of the global market and recent growth in emerging markets cannot replace lost revenues or profits. Diversification into other healthcare businesses does not help fill the profit gap either, as over-the-counter medications have much lower margins compared with prescription drugs.

With the innovation burden hanging heavy over the industry, many companies have started to experiment with new R&D models. GlaxoSmithKline (GSK) restructured its R&D centers to emulate biotech R&D principles. Still a work-in-progress, GSK hopes to replicate an entrepreneurial culture in a large pharma organization. Eli Lilly acquired ImClone to source innovation from outside the company and then left it as a stand-alone unit operating independently. Pfizer and GSK broke down corporate barriers to share intellectual property and assets to develop new drugs for diseases like HIV. Several pharma companies are partnering with leading academic institutions to promote innovation from basic research. However, the jury is still out on whether these efforts prime the innovation pump enough. Instead, our analysis as well as a survey by Bain & Company of 20 leading global innovators-responsible for some of the greatest breakthrough medicines in the last few decades-suggests that Big Pharma needs to do even more. The efforts made so far point the industry in the right direction; now companies must press ahead to go much further. They need to break through the barriers that currently hold them back. To raise innovation returns back to the level in the era of blockbusters, pharma companies need transformational change: change that renews R&D but also cuts across the entire company. Such radical change goes to the root of the problem and explores what holds back innovation-and identifies what can be done to create a vibrant new culture of innovation across the organization. It requires hard decisions to give up entrenched legacy behavior, but also it requires an openness to bring back what worked in the past. By nature, such change is difficult and takes time to implement. Inevitably, it presupposes strong leaders who persevere. In the following pages, we share the findings of our research, develop a new framework for radical change in pharma's R&D organization and decision making-and offer an approach on how to achieve the transformation. The innovators' perspective To understand what ails pharma we spoke to innovation leaders with a proven track record of creating breakthrough medicines. They brought to the discussions a deep knowledge of academia, venture capital and the current state of biopharma discovery and development capabilities. We conducted in-depth interviews to probe for what they considered key success factors for innovation. We then asked them to rate each factor on its importance. Finally, we asked them to identify the strengths and weaknesses of biopharma companies compared with these factors. First, the good news: These innovators strongly believe in the potential for future innovation. They see no set limit to how many new products biopharma companies can develop per year. Nor do they believe the industry has run out of technological advances required to develop new products. They identify two critical areas for the success of new product development, in which pharma excels: raising funds and providing access to technologies. They also credit Big Pharma with superior skills in

strategy and pipeline management-but herein lies the rub: They rank these two skills as least important for success in innovation. According to the innovators, the other pressing areas of improvement for pharma companies, in order of importance, are: increasing managerial autonomy; aligning research goals with incentives; attracting and retaining the right, creative talent; minimizing bureaucracy; and creating flexible organizations. In addition, when pressed to identify why in recent times pharma companies struggled to innovate successfully, the innovators identified some common themes.
Scale

crept into every aspect of the business. In the 1980s, when Big Pharma produced blockbusters with much greater frequency, internal champions often led innovation. These leaders could rally the troops across functions and shift the focus of R&D efforts nimbly. Then began the industry's quest for repeatability and efficiency-an industrial manufacturing approach focused on "throughput" and "risk mitigation." Repeatable processes delivered a host of benefits for Big Pharma. For example, the industry found a steady source of revenue in marginallydifferentiating products and making them "evergreen" through extended releases or co-formulations. But innovation suffered when eventually, pharma companies tried to industrialize even the non-scalable, truly creative steps in product generation. The vision of success in drug discovery and development got diffused by averages and probabilities. Investment decisions in pharma companies shifted to a "numbers game." As ideas for drug innovation funneled through several stages, pharma companies measured success in terms of progression from one gate to the next. At the level of the organization, increasingly, incentives got aligned with annual throughput. Subtly, that shifted the pressure on numerical outcomes: Getting the project to the next phase became as important as getting it right. As they grew more complex, pharma companies became risk-averse. As the stakes rose, at every gate, research projects got more input and feedback from various functions across the pharma company: The marketing department weighed in, the strategy team pitched in with a portfolio-management lens, and cross-functional committees became routine. Over time, this created a bias to minimize risk. Truly game-changing projects, with a perceived lower probability of success, struggled to survive the funnel. The more the system rewarded the same way of doing things, the more the odds stacked against rulebreakers. In a world of scientific breakthroughs, however, pharma companies needed more discontinuities and disruptive ideas for successful innovation. Many pharma companies grew too big to be effectively managed as one organizational unit for innovation. Today, pharma pursues scale on several dimensions: a global footprint, a diversified product portfolio, influencing new stakeholders and dealing with stricter regulatory requirements. Most of this requires building additional internal capabilities-and a large part of pharma's rising expenses now go to supporting scale, rather than innovation.

For most innovators, a "broken innovation culture" lies at the core of pharma's problems. The rest they cited as symptoms: the lack of dedication to deeply understand the disease biology; the inability to engage in "true" partnerships with academia and biotech; the substantial turnover at the R&D executive level; and a lack of passion to explore new ways to undertake R&D. A majority of the innovators believe that to stoke innovation, biopharma must rethink how to reward the right behaviors and create the required flexibility within the organization structure. Says a biopharma head of research, with two successful biotech ventures to his credit: "It all goes back to incentives. If you do that well, you wipe away the red tape." Another successful biotech entrepreneur adds: "Leaders in R&D should have the autonomy to make decisions on how to use funds and allocate resources between programs. They should be able to hire the right number of right people, and not have to staff research projects with whoever is available." New approach to innovation It goes without saying-but it also bears repeating-that only leaders can bring about transformational change. Over the next few years, Big Pharma leadership will face two tests: First, reigniting innovation such that it leads to the creation of new, discontinuous technologies. Second, morphing the current organization structures into new forms that nurture discovery and development-and result in new business models. Speed will be important as most leaders will not have the luxury of coming into an organization and learning how things are done. Successful leaders will need to recognize the right moment and grasp it to launch such radical change. In the case of one mid-sized European pharma company for example, the timing coincided with its acquisition of another European pharma company. The acquiring company used the integration process as a proxy to fully redesign its R&D approach. It set itself a new goal: to achieve an optimal balance between portfolio assets and fixed operating costs. Its new R&D approach was not just highly selectivethe company now only pursues opportunities with real medical differentiation-it was also purely priority-driven, so that only valuable projects got resources. To achieve these goals, the acquiring pharma company took nothing for granted while creating a lean, scalable and flexible organization. It retained in-house critical core capabilities in select areas of discovery, development and life-cycle management. In other areas it partnered with contract research organizations. Today, the combined company's fixed assets account for less than 50 percent of its total resource needs-which, compared with competitors, leaves much more available for research. Of course, no one innovation model will fit all pharma companies. However, we believe in the future, successful pharma innovators will share three common fundamental principles. 1. They will pursue medical differentiation As a generic standard-of-care settles in for many diseases, pharma companies will need a higher degree of medical differentiation to successfully introduce new products

into the market. This isn't a new idea. In the 1990s, the pipeline for cancer treatments got crowded with pharma companies developing new chemotherapies, most with little therapeutic difference. However, instead of becoming a "me too," Genentech concentrated on changing the way cancer is treated. With the help of PDL's humanization technology, it developed treatments based on humanized monoclonal antibodies-a technology that most pharma companies considered too complicated. The company's researchers focused on understanding tumor biology and set goals to take patient outcomes to a new level. Genentech's reward: Its innovative approach helped it gain market leadership. In addition, Genentech was able to price its therapies several times higher than pharma's marginally improved options. In today's market, differentiation is more important than ever. Now, increasingly, Big Pharma's customers are payers (very often government customers) and patients who care about two criteria: health outcomes and affordability. Further, it's a much more transparent marketplace. Government agencies develop cost-effectiveness studies; private payers invest in health technology assessments and analyzing real-life medical data; and most information is available on the Internet. This new reality has a number of implications for innovation in biopharma companies. First, servicing the new customer requires an innovation engine that produces cost-effective, tangible improvements in healthcare. That, in turn, requires a whole new decision-making process, especially in the early stages of R&D. For example, to ensure that a drug is priced right at the time of its launch, a pharma company might explicitly include early-stage hurdles to test for cost-effectiveness. Second, pharma companies will need to review portfolios to identify opportunities where they are better off collaborating versus investing in differentiation. Already, the market is less willing to pay pharma companies to develop similar, marginally different products that require a huge amount of competitive marketing spending for promotion. Some pharma companies have taken steps to pool resources-more such collaborative models will evolve in the future. And third, pharma companies will need new criteria and processes for evaluating their pipeline. As companies consciously shift a significant portion of their R&D budget to potential game-changers, by definition, they will take on more risk. To buffer against risk, companies will need to adapt their current approach of treating all projects in the pipeline as equals. Instead, they will move closer to the way investors manage a portfolio: balancing low-risk, low-return assets with high-risk, highreturn assets. 2. They will invest in building flexible organizations Leading pharma companies will be the first to admit that often, decisions suffer death by committee. The malaise is not uncommon: As organizations grow and expand, they adopt more complex structures and processes. Over time, complexity becomes a drag on the quality and speed of decision making. Ineffective decision making can stifle innovation. Pharma companies need to test early and consistently for what really matters in a drug-development project. For this, they need to have incentives in place to get to the right answer and set the right research goals. While killing a project early-

especially for mediocrity-is hard for most organizations, in pharma it's critical for continuous, successful innovation. In our survey, industry experts stressed that Big Pharma must develop incentives that reward rapid learning, testing and adaptation from pilot projects. But that requires delegation in decision making, which is hard to do if a pharma company is dependent on centralized processes. To get around the issue, a pharma company can view all projects through an investment lens: allocate resources based on pre-determined proofpoints; delegate authority down the line to people running the innovation processes; and increase autonomy in areas like outsourcing or staffing decisions. To make the approach work, a good first step will be to dismantle the pharma company's functional staffing model and replace it with a more flexible human resource model. Under such a structure, empowered project champions can freely use their budget to find the right skills and resources, which might come from within the organization or outside. Some companies like UK's Vernalis or Big Pharmabackedinitiatives like Chorus have established virtual development as a viable and often more effective and efficient development model. Such companies don't just manage costs better by limiting full-time employees, reducing fixed assets and clamping down on overheads; their flexibility and lean structure helps them hone in on successful innovation or quickly move on to the next promising idea. Chorus, which was set up by Eli Lilly as an autonomous division, advanced more than two dozen molecules through candidate identification and Phase I, at median cycle times that were 40 percent to 60 percent faster than the industry average. According to one innovator we surveyed, outsourcing became a learning tool for the organ- ization. Says he: "Large, readily available internal resource pools dull the mind and drive the decision to action rather than thought. With outsourcing, the process is reversed." 3. They will balance the use of scale While scale can be an enormous commercial advantage, it can be kryptonite for innovation. That raises a challenge for pharma: Where does a company draw the line? Clearly, scale has a place in pharma development in late stages of development, particularly for very large-scale trials, as well as manufacturing. In fact, any process innovation that is repeatable can be industrialized, not just in later-stage development, but even in early research or areas like medicinal chemistry. Where scale often doesn't work is in areas of true product innovation, where ingenuity matters. In such instances, pharma companies need milestone-based processes where progress in projects can be reviewed on an individual basis. To unleash innovation, Big Pharma will need to revisit its singular approach to R&D and differentiate between activities: One, activities that warrant process innovation and two, those that should not be over-engineered but allowed autonomy in order to fuel creativity. Some pharma companies such as Roche have already begun this process by separating research and early-stage development from later-stage development into two organizations. An emerging new R&D model

Seeking medical differentiation, building flexibility in an organization and revisiting processes to identify the ones best suited for scale versus creativity-each goal is challenging by itself. Taken together, they can radically transform a pharma organization. In practical terms, what would this degree of change entail? While each company will want to find its own unique solution, consider one hypothetical model for a large, innovation-led pharma company. At the core of this company's new innovation model are Innovation Centers (ICs) focused on specific therapeutic or disease areas. Depending on the stage of the innovation and the nature of their work, these ICs are based on different criteria such as more internal or external resources; unique milestone or success definitions. The ICs share only a few internal service technology platforms-those that are truly proprietary, like RNA interference-but they have some common characteristics:
The

ability to attract and retain the best talent, especially scientists and innovation managers (two very distinct roles that are often conjoined in today's pharma organizations); The expertise to identify and access the best science within their disease area, be it internal or external; The ability to conduct limited internal research for validation; The allocation of the IC budget among programs, such that there is an adequate balance between the internal and external sources of innovation; and The ability to flexibly hire the right staff for specific projects, and maintain very limited permanent staff, mostly functional management. In particular, this fluid organization structure should encourage the creation of more "dual staffing" roles, where academic researchers are invited to work full- or part-time on commercial pharma projects. The flexibility to create ICs at a regional or global level, based on ensuring that they attract the best talent, with the right cultural fit. To make the model work, the pharma company puts in place the right incentives for each IC team. While incentives vary substantially from IC to IC, they are always multiyear, aligned with the specific business plan and linked to milestones. Just as in biotech, key contributors get significantly rewarded for real success; but instead of being tied arbitrarily to the annual stage/gate processes, their success is measured in NDAs/BLAs or any other dollar-related exit criteria the company chooses. ICs are tested on their progress against business plans regularly in a peer review with external scientific advisory boards. The process goes beyond checking off metrics to a more qualitative assessment that asks questions like, "Is the scientific progress strong enough to meet unmet medical needs and is it sufficiently differentiated from alternatives?" The pharma company's business development team works closely with ICs to enable access to external science. The skill set required for business development requires substantial flexibility in contracting and deal-structuring abilities. Once again, this is

about making things happen rather than checking lists for in-licensing criteria. The team drills down on how to maximize the value of assets, identifies low-priority programs to be shed in disease areas that are no longer a priority, and actively nurtures its networks in academia and biotech. The role of the R&D chief is no longer to coordinate processes in a prescriptive manner for early-stage R&D, but to be a strategic architect and portfolio investor. In concrete terms, the R&D team becomes the organization's headquarters for innovation. It sets the R&D vision and provides strategic direction (which TA/DAs, underlying biologic mechanisms and new technologies should the pharma company invest in?), objectives (what are the right multi-year goals for the company?) and budget allocation (how do we allocate resources among the various ICs?). While these decisions need to support the overall R&D business case, this is no longer a one-size-fits-all approach with annual throughput (how many programs did you advance into the clinic?), but rather a process similar to venture capital investment in biotechs (in the next round, what are the proofpoints we need to continue investing?). Those innovation investment decisions are challenged regularly by an investment board that includes internal executives (except those, such as the heads of the ICs, who might have a conflict of interest) as well as outside members. This board provides more than scientific advice-and therefore, includes "customers" such as payers and healthcare providers. They review IC business plans with an eye on return on capital invested and set specific metrics and milestones. The model pre-supposes the separation of late-stage development (III and IV) into one development organization that spans all therapeutic areas and geographies: a veritable global "innovation marketplace." This organization takes into account the perspectives of the customer and the market and excels in providing the necessary regulatory proof for the molecules developed by the ICs as quickly and cost-efficiently as possible. The challenge ahead We believe Big Pharma can build just such an innovation-led organization-if its leaders have the appetite and patience to embrace change. Like all metamorphosis, transforming a large pharma company will be a slow, sometimes uncomfortable process. Leaders will need to probe deep before embarking on the mission. What are the concrete unmet medical needs the company can target? Which improvements in patient health will justify an attractive price point that governments, payers and patients are willing to pay for? How does the company's proposed solution compare with what is currently available in-house, what the competition is doing and what the R&D team believes is technically feasible in the near future? The burden will fall on Big Pharma leaders to personally set a new course-even as one hand steadies the helm. In order to be successful, leaders will have to rise above the competition and establish new rules of innovation-led productivity and then get down to the nitty-gritty of transforming the organization. It's a tall order for most organizations,

but not unprecedented. Apple reinvented itself by making a conscious decision to focus on discontinuous products, like the iPod, iPhone and iPad, versus investing in yet another update of the Apple operating system. The company repeatedly outsmarted the industry by successfully challenging the status quo and questioning "how things are done." Pharma also requires that level of decisive leadership in order to launch a new era of innovation. For once, the timing couldn't be better. Externally, investors realize pharma innovation needs to be fixed. Currently, they attach little value to discovery and earlystage development in their valuation-and therefore, even in the worst case, the potential negative impact of a new innovation strategy on price-to-earnings ratios is likely to be low. Internally, as in all organizations on the cusp of transformation, employees already know what's not working. They await bold leadership and an inspiring, energizing mission-or at least, for a start, a promise of change. As one executive vice president of R&D says: "The only thing I know for sure is that we can't keep doing the same thingand expect a better outcome." Nils Behnke is a partner with Bain & Company in San Francisco in the Global Healthcare practice. Norbert Hueltenschmidt is a partner in Bain's Zurich office and leads the Global Healthcare practice. Bain's business is helping make companies more valuable. Founded in 1973 on the principle that consultants must measure their success in terms of their clients' financial results, Bain works with top management teams to beat competitors and generate substantial, lasting financial impact. Our clients have historically outperformed the stock market by 4:1. Who we work with Our clients are typically bold, ambitious business leaders. They have the talent, the will and the open-mindedness required to succeed. They are not satisfied with the status quo. What we do We help companies find where to make their money, make more of it faster and sustain its growth longer. We help management make the big decisions: on strategy, operations, technology, mergers and acquisitions and organization. Where appropriate, we work with them to make it happen. How we do it We realize that helping an organization change requires more than just a recommendation. So we try to put ourselves in our clients' shoes and focus on practical actions. For more information, please visit www.bain.com

Private Equity in the Middle East Private Equity Industry Brief 08/03/10 After a promising start, investment in the region has fallen off sharply. PE firms need to raise their game. Private equity's expansion into fast-growing emerging markets helped redefine the business landscape of the past decade, and the Middle East and North Africa (MENA) rode this new wave of investor interest. Annual private equity (PE) investments in the region soared from just $148 million in 2004 to top out at $3.8 billion in 2007 before dropping steeply following the global recession, as they did nearly everywhere else. Now, with economic growth reviving, conditions look promising for PE to pick up where it left off and deepen its presence in emerging markets. But bucking the global trend, the industry's momentum in the MENA region appears to have stalled. In 2009, total deal value was just $521 million, an 86 percent decline from its 2007 peak to its lowest level in five years. Signs of inertia elsewhere in the deal pipeline suggest that new investment activity could remain subdued. One indicator is a lack of exits by PE firms from investments made across the region a few years ago. Last year, for example, PE firms arranged just six exits-a steep decline from the 17 exits valued at $2.9 billion in 2008. A slump in new fundraising is another sign of PE's loss of momentum in the region. New capital commitments to the Middle East dropped from 10 percent of the total allocated to emerging markets in 2008 to just 5 percent, or $1.1 billion, in 2009. More recently, firms active in the region have struggled to meet their funding targets. For example, Dubaibased Abraaj Capital announced that it would reduce the planned size for its fourth buyout fund to $2 billion, half of the original goal. In March, weak investor appetite led Invest AD, an Abu Dhabi state-owned investment firm, and its partner UBS Global Asset Management, a division of the big Swiss banking company, to liquidate a $250 million fund targeting regional infrastructure investments. Examining a sample of 10 regional funds, Bain & Company found that, on average, they were able to close at only 55 percent of their original targeted size. Bain's recent interviews with more than 25 limited partners (LPs) and family offices investing in PE in the region have found that they are becoming more sophisticated and selective about the fund investments they make-a phenomenon that is not confined only to the Middle East. Globally, investors are becoming much more discriminating about the funds in which they invest and fund managers with whom they work. They are also pushing back against the terms, conditions and fees PE firms try to impose. It is unlikely, for example, that "two-and-twenty" compensation arrangements, whereby PE firms collect a 2 percent fee on assets LPs invest and earn 20 percent carried interest on the fund's returns, will come back as the industry norm. For Middle East-focused funds that are unable to demonstrate a consistent track record of success in the region, it is becoming increasingly difficult to attract international investors who have a plethora of attractive options in other high-growth emerging markets from which to choose. In a recent ranking of the most attractive markets for PE

investment by the Emerging Markets Private Equity Association (EMPEA) and Coller Capital, the Middle East ranked only ninth out of the top ten, just ahead of Russia and the former Soviet republics. Even without new funds to deploy, PE firms active across MENA have their hands full trying to put to work the money they have already raised. Capital committed by limited partners in previous years' fundraising rounds has been accumulating and remains undeployed. Through the end of 2009, the cumulative capital raised since 2001 reached $20 billion, of which more than half has yet to be invested. Much of this "dry powder" has been idle for so long that many PE funds are now beyond their planned investment windows. Thus, unable to count on using capital gains from successful liquidations of earlier PE investments, anticipating depressed returns associated with more prolonged investment-holding periods, and facing their own liquidity constraints, investors may hold off on meeting future capital calls. A scarcity of attractive investment opportunities will continue to be a major challenge for the region's PE market. Local economies are dominated by family businesses and government-owned enterprises that have long spurned PE acquirers-and in some cases, have become competitors to PE firms. Many privately held companies are reaching the third generation of family ownership and face major business succession issues at a time when regional growth is brisk. However, PE investors have struggled to gain traction with these potentially attractive targets, which have been reluctant to sell them significant stakes or cede management control. Most deals are for small, minority positions that do not allow PE owners to exert the kind of influence to add value to their portfolio companies as they commonly do in other markets. This dynamic is unlikely to change over the short run, since the global economic downturn has left many families dubious about financial assets and preferring to hold on to businesses that generate cash flow. A second drag on deal-making activity has been the slow pace of privatization of stateowned companies, a trend that investors expected to spark opportunities for PE acquirers. The increased sale of government-owned assets by the emirate of Dubai that many had hoped for has yet to materialize. Finally, deep-pocketed government investment companies (GICs) and sovereign wealth funds (SWFs), including Mubadala Development Company, Emirates Investment Authority and Invest AD, have become potent new rivals to PE firms in the region. The big state-owned investment firms are beginning to target the same investments and buyout opportunities that have traditionally been the domain of PE firms. Their government connections, privileged access to potential deals, and longer time horizons will make them tough adversaries. This new challenge, on top of the other liabilities weighing on the industry in the region, is likely to jeopardize many firms' prospects for survival. Bain estimates that approximately one-third of PE firms will not bounce back from the downturn or successfully raise follow-on funds. PE needs to raise its game in MENA

The types of deals available in the region are unlikely to change anytime soon. Investments will mostly continue to be for minority stakes that restrict the ability of PE firms to manage their portfolio companies. Successful PE firms will be ones that can clearly define their investment "sweet spot" and differentiate themselves strategically from their competitors. They will also need to concentrate on four key areas: Sharpen their sector focus. Most PE firms in the MENA region position themselves as opportunistic investors of growth capital or as buyout generalists across a broad set of sectors and geographies. Even though many claim they enjoy privileged access to deals, this positioning suggests that they offer little that sets them apart from their rivals or equips them to add value to the companies with which they negotiate. Effective specialization in such growth sectors as healthcare, education, logistics, and oil and gas will be an increasing source of competitive advantage for sustaining strong deal flow. These industries boast increasing consumer demand and attractive profit margins, and they have proven to be resilient through the downturn. PE firms will need to build deal teams with geographic and industry specialization in order to demonstrate convincingly how they can add value to portfolio companies. Given the large amount of idle PE capital looking to land attractive deals, bringing capabilities to the table beyond being a financial partner will be a key factor separating winners from laggards. Some firms are already beginning to organize investments based on sector themes. Broaden the investment landscape. PE firms can significantly expand their deal flow by looking beyond conventional buyouts and growth-capital investments to consider a wider range of opportunities, including infrastructure, real estate, mezzanine lending and other debt financing. Given the region's large, unmet needs for transportation, electric power, and water and waste treatment, infrastructure projects alone represent vast, untapped potential for PE investors. Penetrating the infrastructure deal flow-and zeroing in on the relatively small number of deals that are open to PE investors-will require them to develop distinctive competencies for arranging deals and expertise in financing and managing large projects. But the opportunity for those that can do so will be large. Bain & Company estimates the value of infrastructure deals open to PE investors to reach between $6 billion and $10 billion annually-more than double what we estimate more conventional PE investments in growth capital, buyouts and venture capital will be. Some PE firms are widening their deal options by targeting companies earlier in the development cycle. To the extent that their involvement complements economic development initiatives in the region, they may find willing investors and partners in the public sector. Abraaj Capital recently added to its deal-making arsenal by acquiring Riyada Ventures, a Jordanian venture capital firm, to create Riyada Enterprise Development (RED), a new investment platform focused on small and medium-sized enterprises. Seeded with $50 million of Abraaj capital, RED has already attracted government co-investors. Abraaj teamed up with the Palestine Investment Fund to launch a RED-managed fund that will target Palestinian companies. More recently, the Overseas Private Investment Corporation, a US government agency, announced it

would commit $455 million to fund five technology-focused MENA funds. Up to $150 million of this total will go to RED, which Abraaj anticipates could ultimately grow to have $1 billion under management. Enhance due diligence and smarter ownership. PE firms need to hone their due diligence processes-disciplines that are especially important in the MENA region, where a high proportion of potential target companies are small, private and lacking in transparency. Once they close on a deal, PE firms need to work actively with management at their portfolio companies to identify two or three high-priority initiatives that create value. Lay the path for exits. PE leaders begin weighing how they will exit each investment well before the time comes to sell by continuously evaluating market conditions for initial public offerings (IPOs) and identifying potential strategic acquirers. Developing a sound exit strategy is particularly important for foreign PE firms operating in markets like Saudi Arabia, where IPOs are restricted to local investors, the secondary market is thin, and taxes on capital gains can be onerous. Despite recent headwinds, the MENA region's vast wealth, entrepreneurial talent and solid growth offers much that should continue to attract PE interest. But it will take greater focus and resourcefulness on the part of PE firms to convert those appealing attributes into winning returns. Key contacts in Bain's Middle East Private Equity practice: Dubai: Jochen Duelli, partner and regional Alexander DeMol, manager, regional PE practice PE practice leader

India Private Equity Report India Private Equity Report by Sri Rajan and Prashant Sarin 1. Indian business and private equity: A promising start

2010 2010 06/30/10

Among developments having a far-reaching influence on the global economy, two have particular relevance to readers of this document. The first has been India's emergence as one of the world's most dynamic economies over the past two decades. The second is the expanding size and geographic reach of private equity (PE) and venture capital (VC) as one of the world's most powerful sources of value creation. Inevitably, India's capital-hungry businesses and opportunity-seeking private equity investors, both domestic and international, have discovered each other in recent years, and the impact has been profound. Between 2004 and 2009, as PE and VC firms began to acquire critical mass, PE investors invested nearly $50 billion in more than 1,400 Indian businesses-including nearly one-third of what are now India's 500 biggest enterprises. By providing a critical

new source of patient capital, management expertise and deep networks of connections, they helped catalyse the growth and international expansion of companies in which they invest. For their part, successful Indian companies have rewarded PE investors with superior financial returns. As we will see in the sections that follow, the past year marked an important turning point for private equity in India. The global credit crisis and economic turbulence led PE and VC investors to retrench. India's economy briefly cooled, and the public equity markets tumbled. Growth has since rebounded on all fronts, but the recovery of PE activity and resumption of cyclical growth for Indian industry make now a good time to take stock of the health and future direction of the still-young relationship of private equity and India. For all of the early indications of its promise, private equity is still viewed skeptically by wide swaths of the Indian business community. Government regulations continue to impose limitations on PE and VC investors' freedom to manoeuvre effectively. As a result, most PE investments have been limited to passive minority holdings rather than the active hands-on role these investors play in more mature markets. This report will explore the issues that stand in the way of private equity's relationship with India reaching its full potential. Conditions in place for the year ahead bode well for private equity in India to embark on that journey. Based on extensive interviews with industry experts and our own analysis, VC and PE fund flows could rebound to some $17 billion through the end of 2010. Indeed, the Confederation of Indian Industry estimates that if India meets the challenges of creating a more hospitable environment for PE investment, private equity has the potential to fund up to $100 billion over the next three years. Bain & Company is uniquely well positioned to undertake this evaluation. Since beginning operations in India, Bain has been an active and well-informed participant in India private equity, observing and helping to shape the new industry and serving as adviser to some of its biggest deals. Bain's growing presence in India has been a natural outgrowth of the firm's prominence in private equity in Asia and globally. It is the world's leading consultant to all players related to the industry. Addressing areas such as firm strategy and operations, deal generation, due diligence and post-close portfolio company value creation, Bain has led the global PE industry for more than 25 years, working with the world's most sophisticated investors. Combining world-class capabilities with dynamic industry expertise, its unique business model delivers customised insights to more PE investors than any other firm in the world. We estimate that Bain has advised on half of all buyout transactions valued at more than $500 million over the past decade. In creating this report, we benefitted from the indispensable collaboration of the Indian Venture Capital and Private Equity Association (IVCA). As India's leading PE and VC trade association, IVCA has created a forum for educating Indian business leaders and policy makers about the industry and serves as a clearinghouse for industry information

and viewpoints. IVCA generously made its members available to us to participate in the surveys and in-depth interviews that provide the data and perspectives that inform our findings. At Bain, the project was led by Sri Rajan, the partner who leads the firm's Indian Private Equity practice, and Prashant Sarin, a manager with Bain's New Delhi office. We hope you enjoy Bain's private equity report-the first in what will be an annual look at private equity and venture capital's continued development and maturation. We look forward to having you join us and other PE stakeholders in India and around the world in a continued dialogue about this important industry and the businesses it helps build. 2. About this report The vitality of India's economy over the past two decades has attracted investors from around the world looking to participate in-and profit from-its remarkable growth. Prominent among the new arrivals are two categories of investors-venture capitalists (VC) and private equity (PE) firms-that are especially well suited to further the ambitions of an economy that, like India's, is in start-up and rapid development mode. VC and PE investments have quickly sunk roots in India, growing at a 72 per cent annual rate to more than $14 billion in 2008, compounded from just $1.6 billion in total deal value in 2004. Yet, despite their rapid growth and heightened visibility, venture capital and private equity are still only beginning to be understood by Indian corporate leaders, entrepreneurs and public officials as an asset class for the distinctive value they can bring to India's development. Conventional sources of capital, such as mutual funds, hedge funds, commercial lenders and other individual and institutional investors in corporate equities and debentures, provide market liquidity and trade actively on companies' stock and bond price movements. They are generally not directly involved in shaping the strategy or setting the operational priorities of companies in which they invest. VC and PE firms, in contrast, are sources of patient capital that take a hands-on role grooming their portfolio companies across all phases of their life cycles. They tie their own success to their portfolio companies' financial performance. They help management of start-up enterprises formulate and execute their initial marketing and product development strategies. The working capital they provide helps management line up institutional financing and supports capital investment in new plants and equipment. They help reinvigorate their portfolio companies by restructuring operations, commercializing new products, acquiring or disposing of assets, or providing buyout capital that facilitates the transition to a new management and ownership team. Decades of refinement of these capabilities for helping companies grow, evolve and prosper have made private equity one of the world's most creative and successful investment vehicles. Since it first emerged as a major asset class in the 1980s in the US, private equity has experienced three major booms. Each expansion was a direct result of private equity's resourcefulness, adaptability and capacity for innovation in the face of fast-changing market realities. In the 1980s, the PE industry capitalised on the

sale of many poorly run public companies and corporate divestitures available at low cost and largely financed with junk bonds. During the 1990s, PE industry returns were driven mainly by gross domestic product (GDP) growth and expanding price-to-earnings multiples during the long economic expansion. Over the past decade, private equity rode a credit bubble inflated by low interest rates to record deal values. A global liquidity surge from investors hungry for returns fuelled private equity's "golden era". Leveraged lending grew larger and more complex than ever before, and investor demand for structured finance vehicles such as collateralized loan obligations (CLOs) powered the market for leveraged loans to new heights. Favourable debt-market and fundraising conditions provided the capital to finance multibilliondollar deals. Fuelled by strong GDP growth and rising equity markets in both developed and emerging markets, price-to-earnings multiples expanded steadily, creating a strong market for initial public offerings (IPOs) and highly profitable exits. An upswing in PE activity across Asia has been a distinctive feature of the industry's growth since 2000, with total deal value increasing from just $10 billion to a peak of $91 billion in 2007 before tumbling back to $23.7 billion last year in the aftermath of the global credit market meltdown. Even as private equity contracted globally between 2007 and 2009, the share of investment in the Asia-Pacific region more than tripled, from 7 per cent to around 25 per cent. As private equity enters the new decade, global deal activity has revived, with Asia and India leading the way. The very qualities that first attracted the interest of PE investorsstrong, sustained economic growth and dynamic young companies in need of the financing and expertise PE investors can provide-stand to make the region a leading destination of PE interest going forward. Indeed, PE funds have raised more than $300 billion earmarked for investment across the region over the past seven years, of which nearly $200 billion has yet to be invested. Certainly some of that capital will find attractive opportunities in India, but Bain analysis reveals that two factors in particular will influence how big the potential impact will be. The first is the attractiveness of the business environment as determined not solely by macroeconomic fundamentals, such as the current size and projected growth rate of national GDP, but also by conditions on the ground, such as the ease of investing in and exiting from portfolio companies. The second is how actively government policy encourages venture capital and private equity. In countries where financial sophistication is high and the regulatory environment is favourable, private equity flourishes. Conditions in India are only moderately attractive today. India has become more accommodating towards PE in recent years, but still has not achieved its full potential. The goal of this report is to shine a spotlight on conditions influencing the current state and future prospects of venture capital and private equity in India. Prepared by Bain & Company, in collaboration with the Indian Venture Capital and Private Equity

Association (IVCA), it is intended to help all the stakeholders better prepare for the growth India is likely to present. In particular, our objective is to help PE firms and promoters better understand each other's expectations and to highlight the opportunities, challenges and changes that will mark their evolving relationship in the period ahead. Additionally, we hope the report will be used to strengthen the partnership between policy makers and the PE and VC industries by drawing attention to some of the regulatory issues that funds operating in India face. We hope to focus attention on how this sector can do more to advance India's economic growth within appropriate regulatory constraints. After describing the current state of private equity and venture capital in India, we provide a comprehensive outlook for the industry in the coming year and beyond. Our forecast is based on extensive data, interviews and analysis. We have surveyed dozens of PE investors. To deepen our insights and add context to the survey findings, we also interviewed dozens of industry leaders, including general partners as well as promotersboth those who have accepted PE funding and those who have not. We hope the report will provide all industry participants with valuable insights into the role private equity and venture capital can fulfil as corporate India seeks new sources of funding to boost its strong growth momentum further. In particular, this report is an effort to reach out to promoters who have not engaged with PE and VC firms in the past to point out the role these investors can play in supporting the growth of family-owned companies, both as a source of capital and for their management expertise. 3. Private equity in India: Its context, impact and key challenges India's long economic expansion barely paused during the recent deep global downturn that still has a firm grip on the economies of many nations. At just 6.7 per cent in FY2008-2009, India's GDP growth rate declined from the torrid pace of better than 9 per cent at mid-decade. But it was well in line with the solid growth trend that has been in place since India embarked on its market-oriented economic liberalization in the early 1990s. It is clear that India's commitment to deregulation, privatisation, tax reform, sound monetary policies and openness to international trade and investment are reaping big dividends that continue to compound. India's forex assets (excluding gold)-$258 billion in 2009-have increased by 141 per cent since 2004, and are up nearly 100-fold since 1998. Today, India is well integrated into the global economy, with trade flows and capital flows as a percentage of GDP having risen to 53 per cent and 64 per cent, respectively, from just 20 per cent and 12 per cent over the past two decades. By nearly every important indicator, prospects for a continuation of these positive trends appear strong. Personal income per capita is forecast to increase at a better than 10 per cent rate compounded through 2012, and foreign currency reserves are expected to increase at an annual 16 per cent rate compounded to more than $390 billion. India's robust

macroeconomic performance and outlook are reflections of the dynamism of India's entrepreneurship and strong corporate growth. More than 400 Indian companies now book annual revenues exceeding $1 billion-up from just 250 in 2002. And many thousands of innovative Indian business leaders have taken their companies from startup to healthy concerns in cutting-edge sectors like information technology, telecom and healthcare, to industrial and consumer goods manufacturing, to retailing and transportation services. Looking beyond India's borders, conglomerates such as Tata, Aditya Birla and Bharti are making large acquisitions to diversify their portfolios and build new platforms for growth. Their success has made India a magnet for domestic and global investors and powered the equity markets' upward climb. Since 2002, the Sensex has increased from 3,000 to above 17,000, with fund inflows from foreign institutional investors a big factor in that rise. But the public equity markets have not been able to carry the full weight of the nation's capital formation needs. The debt market, too, clearly lags behind India's Asian counterparts. India will need to tap every potential source of new capital to continue to achieve its growth aspirations, and private equity has emerged as one of the most promising over the past several years. Over the past six years, the emergence of India both as a destination of interest to global PE investors and home to a vibrant domestic PE industry coincided with the most buoyant period in the history of private equity globally. The economic and business climate from early 2003 through the end of 2007 was extremely favourable in nearly all of the fundamentals that matter to PE investors. As capital flowed in to private equity over the course of the decade, PE funds broadened their geographic and industry reach. Broad economic forces, including robust GDP growth and rapid expansion in both manufacturing and service industries, have been major draws for PE interest. Though growing off a small base, PE deal value in India witnessed the greatest rate of expansion in Asia between 2004 and 2008, increasing at an annual 72 per cent compounded to $14.1 billion in 2008. The numbers tell the story of private equity's growing place in India's economy. From 2004 to 2008, PE and VC firms have invested nearly $43 billion in India. That money has helped fund approximately 1,400 companies-some 900 of these just in 2007 and 2008 alone, making India Asia's largest PE market for both years. Even in the harsh climate of 2009, 231 Indian companies accepted VC or PE funding. As much as India's fast-developing economy has been a lure to venture capital and private equity, VC and PE funds have contributed to India's growth. Many young Indian firms still have only limited access to capital through the public equity markets, and PE and VC investors have stepped in to fill the void. Growth capital has become a preferred source for mobilising funds in India, and many Indian companies have aggressive growth and investment plans. With large reserves entrusted to them by limited partners (LPs) on

hand but not yet drawn down for investment ("dry powder"), VC and PE funds can play an important role as financial backers of entrepreneurial Indian companies. Private equity and venture capital offer distinct benefits to the Indian companies in which they invest. In early-stage investments, for example, they foster entrepreneurship, providing capital and expertise to first-generation company founders. As companies row, PE and VC firms provide deep industry knowledge and operational expertise derived from their previous work in the industry and the experiences of other companies in their portfolios. By tapping their extensive networks of experts and international relationships, they help their portfolio companies expand internationally or facilitate crossborder mergers and joint ventures. And as a source of patient capital to finance growth, they have helped accelerate the dramatic growth of some of India's new corporate leaders. PE and VC firms have brought those qualities to the table over the life of several highprofile investment relationships in recent years. For example, successive investments of $290 million by Warburg Pincus in 1999, $210 million by CVC International in 2004 and $2 billion by Temasek Holdings in 2007 hastened the development of Bharti Airtel into India's premier wireless telecom company. With FY2010 revenues of $8.6 billion, Bharti had a recent market capitalisation of $24.5 billion-up nearly fivefold in the past six years. Likewise, it was an investment of $22 million by IDFC Private Equity in 2004 that helped propel the GMR Group into one of India's leading infrastructure development companies. In 2003, GMR was a relatively small company with a handful of road and power projects in its portfolio. Subsequently, IDFC Private Equity made its first investment in GMR, acquiring a reported 15 per cent stake. It was during this time that GMR decided to aggregate the power projects and created GMR Energy in 2004. The deal was the first in the Indian infrastructure sector based on an aggregation play instead of simply a project finance business. Partnering with IDFC Private Equity resulted in several benefits for GMR, including improved corporate governance; a sounding board for strategic decisions; assistance creating a joint venture with Fraport, the operator of Frankfurt airport; and subsequently, the pricing of GMR's initial public offering. IDFC Private Equity ultimately earned seven times its initial investment in GMR and has since invested two additional tranches in the group, including the construction of Delhi International Airport. PE funding has also had a powerful multiplier effect on SKS Microfinance. Investments by Sequoia Capital and other PE firms, in 2006 and 2007, catapulted SKS, a young lender to capital-starved small entrepreneurs, onto a rapid growth trajectory. SKS increased its number of branches from just 11 that served 25,000 loan clients by early 2004 to 276 that served 600,000 three years later. The wide variety of PE and VC firms now operating in India tend to be categorised by their national origin and breadth of geographic focus rather than their distinct investment style. Thus, along with domestic Indian PE and VC firms, there are global, regional and

India-focused international PE funds. India has also attracted the interest of sovereign wealth funds, representing the investment arms of asset-rich foreign governments. In more mature PE and VC markets like the US, EU and Japan, these funds would be viewed less by their national pedigree than by whether they target their investments towards large, midsize or small companies. It is not yet possible to do this in the Indian context because PE firms typically end up competing against one another in most deals. The intense pursuit of many deep-pocketed investors for every available opportunity has been a major force for driving up valuations. Still, PE and VC firms in India are taking on several distinctive characteristics shared across other emerging-market economies. For one, both Indian and internationally based PE firms draw principally on foreign capital to fund their investments. Respondents to our survey reported that nearly 80 per cent of the funds routed to India for investment were sourced internationally. They anticipate that proportion will increase slightly over the coming two years. Second, in contrast to the US and Europe where sector specialization is becoming a hallmark of PE firms' identities, PE and VC funds in India invest opportunistically across a broad spectrum of industries. Third, most PE and VC investments are small, typically averaging less than $25 million, a characteristic Indian private equity shares with private equity in China. Unlike in the more mature markets where buyouts prevail, PE investors in India are acquiring minority stakes, usually in the form of Private Investment in Public Equities (PIPEs) or as late-stage growth capital in private companies. Finally, while PE and VC investors are able to negotiate board representation, they take on a far less active role than in majority or buyout situations, and their participation is commonly limited by promoters to a broad corporate governance role. Private equity has also played a major role in helping to power the growth of several of India's best-known companies, which points to private equity's significant future potential. More than 30 per cent of PE investments in India have been made in companies that have since grown into the nation's 500 largest firms. For example, a $640 million infusion of growth capital from the PE firm Providence Equity Partners helped fuel the rapid expansion of Idea Cellular into a leader in wireless telecommunications. One of the largest PE investments in India to date, the Providence capital has helped finance the company's expansion into 13 service circles and extend its reach to more than 75 per cent of the nation's potential telephony market. Having come this far, what does the future hold for private equity in India? Over the near term, conditions in the global economy will be a major factor, as economies continue to absorb aftershocks of the turbulence that rocked credit markets in late 2008. The global credit crisis and deep recession in the US and Europe have had a profound effect on the PE and VC industry that has been felt in India. As we will explore in detail later in this report, the number of Indian companies accepting VC or PE capital, the total value of deal-making activity and average deal size all fell dramatically in 2009. But the falloff in deal making in India and other fast-growing emerging markets paralleled even

steeper declines in the developed markets. India's recovery has arrived sooner and has been stronger than elsewhere in the world. New PE deal activity has been picking up since the middle of last year and is gaining momentum in 2010. Another sign that a robust cyclical recovery is well under way: The number of PE firms-both domestic and foreign based-continues to grow. This increasing population of hungry deal makers is also wielding plenty of dry powder-capital committed by limited partners to invest in PE deals, but not yet allocated. Bain analysis estimates that current investment reserves are deep enough to finance between two and four years of PE deal making. Beyond the business-cycle turn, however, Bain's data analysis and interviews with leading industry participants reveal important structural shifts at work shaping Indian private equity at this critical juncture in the industry's development. Signs that Indian private equity may be reaching an important milestone in its path to a more mature phase of development are evident in investors' expectations that deal value will grow. Increasingly, the survey respondents told us, deals will no longer be financed solely with equity but will begin to be structured using convertible securities commonly used in the developed PE markets. They also anticipate more deals to be buyouts rather than small minority stakes, although scepticism about that prospect remains high among many experts. Finally, PE firms will be looking to take a more direct hands-on role in the operations and governance of companies in their portfolios. Rising acquisition costs and intense competition to land the best deals is turning up the pressure on PE fund managers to find creative ways to add value to their portfolio companies over the threeto five-year ownership period. They can no longer simply rely on buoyant economic growth and a rising equity market to power their returns. Private equity's coming of age is also tied to the attractive long-term fundamentals of the Indian society and economy. Nearly 60 per cent of India's population is less than 30 years old. Increasing incomes among India's large, educated workforce have given rise to an expanding consumer class. As India's population increases to 1.25 billion by 2015, the proportion of households earning more than $3,000 annually will nearly double. Consumer spending, meanwhile, is forecast to top $520 billion by 2015, an increase of more than 50 per cent over 2010. Even as the nation's people prosper, the Indian economy looks positioned to sustain its growth advantages for decades to come. For example, Bain analysis finds that India's high-tech labour cost advantage will persist over the next two decades or longer while productivity gains continue to outperform those of the US. Those competitive strengths will provide a sound foundation for the growth of an entrepreneurial Indian economy and ideal conditions for venture capital and private equity to flourish. The continued expansion and sophistication of Indian private equity bode well for the industry's outlook as the economy continues to accelerate out of last year's slump. Together with China, industry experts believe, India looks poised to lead the growth of private equity in Asia, powering it beyond the levels of the cyclical peak in 2007 by 2012.

Key challenges Before Indian private equity can fully realise its potential, our survey found, promoters seeking PE capital and regulators will need to address several major legal, cultural and business challenges that currently impede the industry's development. Respondents cited five barriers that they consider the most problematic over the next two years. Mismatched expectations: Reluctant to cede control over their companies at anything below a high premium price, Indian promoters have been cool to approaches from PE firms unwilling to meet their valuation expectations. The steep drop in Indian public equity values following the credit meltdown in late 2008 served only to lock those mismatched expectations in place. Deal making froze in 2009, as PE investors and company promoters tried to determine how low equity valuations would ultimately fall. But the quick recovery of the public equity markets since mid-2009 did not give expectations a chance to reset. In most situations, promoters and PE investors remain at odds over valuations. It will take a long, robust economic expansion and a leveling off in price-to-earnings multiples to bring the two sides closer together. Tough competitive environment: As the Indian economy rebounds from the downturn, promoters will be hungry for capital to finance growth. They have a variety of sources to tap for funds, including bank loans, Qualified Institutional Placements and initial and follow-on public stock offerings. Private equity is near the bottom of the list, because it comes with higher costs and more strings attached. The equity-market downturn and brief dip in economic activity in 2009 significantly reduced access to most of these capital sources, opening an opportunity for PE and VC investors to fill the breach. But with about 300 VC and PE funds operating in India today, competition among them for attractive deals is feverish. To succeed, it will be imperative for PE investors to position themselves as providers of expertise, besides just being a source of funds. They will also need to focus on helping the companies in which they invest meet, or exceed, earnings growth targets if they want to realise PE-type returns. Postdeal value creation will therefore take on increasing importance even in minorityholding situations. Non-supportive regulatory environment: A lack of clarity about rules and delays by agencies with overlapping responsibility to issue clearances to operate under the Foreign Venture Capital Investment regulations burden the industry. Onerous registration requirements on offshore VC investors dampen the flow of foreign capital into India. In April, however, new rules announced by the Department of Industrial Policy & Promotion now oblige foreign investors to obtain prior approval to invest in Indian investment funds and prohibit investments in unregistered trusts. Intended to safeguard against money laundering and restrict foreign ownership of real estate assets, the regulations have the unintended effect of constraining capital flows. PE and VC investors in India also face complex tax burdens. For example, investors face a shortterm capital gains rate of 15.8 per cent and a long-term rate of 10.6 per cent when they

profit from the sale of shares in a publicly traded company. But when the gain is on a sale of a stake in a privately listed enterprise, rates nearly double. India's opaque and idiosyncratic tax laws, in place since the early 1960s, have led some foreign PE firms to purchase tax-liability insurance to protect them from their vagaries. Investment managers also cite inconsistent tax pass-through rules as a source of confusion that clouds investment decisions. Tax-rule changes made in 2007 restricted advantaged tax treatment of investments made by domestic VC funds to sectors, including nanotechnology, biofuels, seed research, hotel and convention centre development, some infrastructure projects and a handful of other state-favoured initiatives. To improve the overall investment environment, these investment-distorting tax policies need to be reexamined. Promoters' reluctance to allow PE investors to exert direct management oversight: Promoters and CEOs are generally not comfortable selling large equity stakes to outside investors. The result: Most deals are minority stakes of less than 25 per cent. Finding the right company at the right valuation that recognises the value of a PE partnership remains a major task for fund managers. Moreover, PE funds are often seen as a source of capital and not as an added source of expertise and best business practices. With low stakes, many promoters expect PE firms to be passive investors rather than activist owners that can provide business guidance. Underdeveloped corporate governance: Many privately held Indian companies lack the transparent reporting and appropriate board oversight PE and VC general managers insist upon in the companies in which they invest. While having nothing to do with PE investments, the fraud and manipulation of accounts at Satyam Computer Services shook investor confidence and increased calls by shareholders for independent, tough governance standards. Most observers expect that pressure for additional measures to strengthen corporate oversight will continue. As we will see in the sections that follow, the long-term prospects for India's PE and VC industry will hinge on the ability of investors, promoters and government regulators to tackle the challenges that constrain its growth while, at the same time, ensuring that the industry operates with effective safeguards and efficient oversight. Key takeaways
India

will need to tap every potential source of capital to continue to achieve its growth aspirations, and private equity is an important asset class that can play a critical role in enterprise value creation. The emergence of India over the past six years both as a destination of interest to global PE investors and home of a vibrant domestic PE industry coincided with the most buoyant period in the history of private equity globally. From 2004 to 2008, PE and VC investors have invested nearly $43 billion in India, the fastest growth rate in Asia over that period.

 More

than 30 per cent of PE investments in India have been made in companies that have since grown into the nation's 500 largest firms. These investments have helped to power the growth of several of India's best-known companies. The continued expansion and sophistication of Indian private equity bode well for the industry's outlook as the economy continues to accelerate out of last year's slump. New PE deal activity has been picking up since the middle of last year and is gaining momentum in 2010. Together with China, India looks poised to lead the growth of private equity in Asia, powering it beyond the levels of the 2007 cyclical peak by 2012. Signs that Indian private equity may be reaching an important milestone in its path to a more mature phase of development are evident in investors' expectations that deal value will grow, and that the number of buyouts will increase faster than acquisitions of small minority stakes. Before Indian private equity can fully realise its potential, our survey found, promoters seeking PE capital as well as regulators will need to address several major legal, cultural and business challenges that currently impede the industry's development. 4. Outlook for the Indian PE market The worldwide financial crisis hurt the PE industry around the world, and India was no exception. From a peak of more than $500 billion in 2007, global PE deal value in 2009 shrunk to its lowest level in nearly a decade. In the developed markets of North America and Europe, the credit crisis severely crimped buyers' ability to finance transactions. Also, with economies in a slump of unknowable depth and severity, PE investors in the mature markets were reluctant to trust their valuation models at a time tinged with so much cyclical uncertainty. A somewhat different dynamic was at work in the major emerging markets last year. After years of consistently high growth, GDP growth slumped briefly in China, India, Russia and Brazil into 2009, casting a shadow on prospects for corporate growth. Although the falloff in deal activity in Asia was only about half as severe as in Europe and North America, deal value in India plunged more than 70 per cent, peak to trough, to just $4.5 billion in 2009. Not only were there fewer deals, but the ones that were completed were smaller, averaging less than $21 million in 2009. Indeed, India's young PE industry experienced the most dramatic swings in deal activity of any country in the Asia-Pacific region. Between 2004 and 2008, total annual deal value rose dramatically, to a peak of $17.1 billion in 2007 and an annual growth rate of 72 per cent compounded over the five-year period-the fastest in the region. But in the turbulence that followed the financial meltdown, India's PE deal activity was matched only by Taiwan in suffering the biggest decline. Now that signs of economic growth and less-turbulent credit conditions are restoring life to global PE activity, global forces at play suggest that India will be a major beneficiary. While it is far from clear how robust the worldwide PE recovery will be, it is all but certain that there will be no return to the near-ideal conditions of low real interest rates,

strong earnings growth and abundant credit that powered private equity's expansion in developed markets before the downturn. Today, powerful countervailing forces are at work that will both help fuel private equity's expansion and constrain it. Two factors, in particular, will act to hold a strong recovery in check. First, credit-market conditions are improving, but they remain strained. According to a recent survey of financial sponsors by Private Equity News, 70 per cent think the repercussions will linger for years, perhaps changing the industry forever. Second, bargains will be hard to find. The rapid decline and quick rebound of the major global stock market indexes off their cyclical lows in early 2009 did not allow sufficient time for would-be sellers' expectations to reset. Thus, high asset prices combined with relatively tepid GDP growth forecast for many of the major developed markets in Europe and North America are likely to hold down deal activity, at least over the near term. At the same time, PE firms have widened their search for attractive investment opportunities. Institutional investors, public pension funds, endowments and other limited partners that entrust capital to PE funds are looking for attractive returns. And PE funds have vast sums of dry powder to deploy. The current inauspicious investment climate in Europe and North America, where deal activity is only now slowly ramping up, has put Asia squarely in the sights of PE investors. As the two biggest and most dynamic emerging markets in the region, India and China will both be major targets of PE investors' heightened attention. The comparative experience of private equity in both nations over the past six years is instructive for how the competition for capital will play out. Whereas both countries saw their economies expand rapidly through 2008, PE activity in India has been far more erratic. In terms of annual deal value, private equity in China grew at a 39 per cent rate compounded between 2004 and 2008, about half the pace of India's growth rate. But the 68 per cent drop in India from 2008 to 2009 stands in stark contrast to the relatively modest 12 per cent decline China private equity registered in that same time. What do these differences portend for private equity in the expansion that has now taken firm hold in both markets? For one thing, India's more volatile experience reflects the vibrancy of its entrepreneurial business environment. In contrast with China's statedominated economy and bureaucratic top-down management style, India's freewheeling small-business culture fosters a deal-making environment that is conducive to private equity during boom times and is more precarious when the economy slumps. India's public equity markets, too, are more open to small enterprises, providing entrepreneurs access to capital and an outlet for companies to go public-or PE investors to unwind their positions-via initial public offerings during growth cycles but are less hospitable in downturns. Though still heavily regulated by state authorities compared with private equity in more mature economies, Indian private equity is driven by swings in investors' expectations. PE investors have not been immune to the boom-and-bust mentality. When the economy faltered in late 2008, for example, foreign institutional investors were quick to pull out of Indian stock markets, triggering a massive sell-off. Heavily exposed to the

crippled financial services sector, information technology companies, India's bellwether industry and a sector heavily favoured by PE investors, were hit hard. Pessimism was widespread as investors anticipated more bad news. In the end, however, India's economy proved resilient and has revived quickly. Today, with strong GDP growth resuming, stable economic fundamentals asserting themselves and PE deal activity on the upswing, the upheaval of 2009 is fading as a distant memory. The PE executives we interviewed see these positive trends as mutually reinforcing. "The level of investment by the VC and PE industry has been in sync with the public markets," said the chairman of one Asia-focused venture capital firm. "This trend will continue going forward." Our survey found that PE and VC investors expect to see their industry grow strongly over the next three years-though not at the torrid pace of the past several years preceding the 2009 slowdown. For the balance of 2010 into the early months of 2011, nearly two-thirds of survey respondents said they expect India's PE market to grow at a rate of between 10 per cent and 25 per cent as measured by total annual deal value. Less than one respondent in five expects the industry to grow at an annual rate of between 25 per cent and 50 per cent through early 2011. However, optimism about the prospects for private equity increases along with expectations that the economy will continue to gather momentum in 2012. The percentage of respondents forecasting that private equity will grow by between 25 per cent and 50 per cent increases to about 60 per cent; 6 per cent expect the industry will grow by more than 50 per cent. PE investors are prepared to put money behind their optimism. Asked how much their firm has targeted to invest annually in India over the next six to 12 months, about onethird of the respondents said less than $50 million. Another 60 per cent answered that their firms' investments would range between $50 million and $200 million. Only 7 per cent foresaw investing between $200 million and $500 million. Looking out beyond next year, however, the proportion of respondents anticipating making annual investments of $200 million to $500 million increased nearly fourfold, to 27 per cent. Another 13 per cent expect their firms will lift their annual investments above $500 million. Speaking for the optimists we interviewed, a managing director at a leading domestic PE firm said: "Assuming public markets continue to grow, approximately one-third of all investments will come from private equity over the next three to four years." Certainly, interest in India is high among the limited partners who scout out the most attractive PE opportunities. In a survey taken in late 2009 by Private Equity News, the PE research firm, a plurality of LPs identified Asia as the most attractive emerging market, with India second to China as a choice destination in the period ahead. Their willingness to commit capital to participate in the region's potential has already begun to make itself evident in Asia's increasing share of global deal value during the PE slump of 2009. While investment languished in the troubled North American and European markets, deal value in Asia grew to 25 per cent of the global total. Based on interviews, prominent PE fund managers expect foreign-based LPs' interest in India to remain high, but just how active they will be depends on the kinds of deals they are able to

participate in. Said a managing director for the Asian subsidiary of a European PE firm: "Most LPs and sovereign wealth funds are keen to invest in India, although they prefer buyouts to PIPE deals. PIPE deals are not popular since it is difficult to gain control over public companies." Another potentially important group of limited partners--domestic investors--may also become more active in private equity. According to the chairman of one PE firm we interviewed, the share of domestic LPs investing in India has increased, now that banks have been granted regulatory approval to make small investments in private equity. "As regulations ease, the [domestic] share will increase further, as pension funds and large corporate organisations start investing in private equity," he said. With deal-making activity on the increase through the first quarter of 2010, Indian companies are poised to continue to attract a growing share of global PE capital. However, the true test of whether Indian PE lives up to investors' expectations depends not on the absolute number of deals they complete or their total value but on the returns PE firms reap on their investments and remit to LPs as capital gains. Here, the outlook is cloudy. Like stock markets around the world, India's public equity markets-an important benchmark for what PE investors will pay-fell steeply in the aftermath of the late-2008 credit market meltdown. But following a short correction, the Sensex recovered nearly as quickly, regaining most of its paper losses since March 2009. As has been the case in other developed and emerging markets over the past 18 months, the quick drop and subsequent rebound in India's equity market did not allow time for promoters' expectations to reset. This stickiness over valuations made it hard for PE firms to find attractive investment opportunities at a time when potential target companies' economic growth and profit prospects were uncertain. With valuations high and promoters looking to attract steep premiums, the lofty price-to-earnings multiples PE investors would be required to pay on the initial investment appears to leave little room for those multiples to expand over the typical three- to five-year period of PE ownership. Whether high acquisition prices will put a damper on deal making or suppress returns is a major question that hangs over private equity's continued growth in India. Of course, the multiple PE firms earn and the profits they return to limited partners on deals made in 2010 and 2011 will not be known for several years when they sell off their investment stakes. The biggest factors that will influence how well those investments do will be the health of India's market for IPOs and, in the case of sales to strategic buyers, the environment for mergers and acquisitions (M&As). The following sections of this report will explore in greater depth the dynamics that will influence fundraising, deal making, portfolio management and exits in the period ahead. We will see that as India's economy continues its sustained growth, PE activity should increase commensurately from today's baseline situation. But as it does, PE and VC investors will continue to encounter scepticism from promoters, lukewarm support from regulators and intense competition from one another. Whether the PE and VC industry can break through to a new level of influence in India's development will depend on whether those barriers can be breached and challenges surmounted.

Key takeaways
The

falloff in deal activity in Asia was only about half as severe as in Europe and North America during last year's economic downturn, but deal value in India plunged more than 70 per cent, peak to trough, to just $4.5 billion in 2009. Not only were there fewer deals, but the ones that were completed were smaller, averaging less than $21 million in 2009. For the balance of 2010 into the early months of 2011, India's PE market is projected to grow at an annual rate of between 10 per cent and 25 per cent as measured by total annual deal value. A majority of PE investors surveyed look for growth to accelerate by between 25 per cent and 50 per cent annually over the next three years. PE investors are prepared to put money behind their optimism. Through 2013, 27 per cent of survey respondents said their firms would make annual investments of between $200 million and $500 million. Another 13 per cent expect their firms will lift their annual investments above $500 million. Stickiness over valuations has made it hard for PE firms to find attractive investment opportunities at a time when potential target companies' growth and profit prospects were uncertain. With valuations high and promoters looking to attract steep premiums, the lofty price-to-earnings multiples PE investors will be required to pay on the initial investment appears to leave little room for multiples to expand over the typical three- to five-year period of PE ownership. The most important factors that will influence how well those investments do will be the health of India's market for IPOs and, in the case of sales to strategic buyers, the environment for mergers and acquisitions. 5. The outlook in depth Fundraising Today's baseline As India's economic recovery gains momentum, both local and global PE firms find themselves well armed with capital to deploy against a wide spectrum of sector opportunities. Hoarding an immense amount of dry powder, global funds have a particularly keen interest in participating in India's forecast 8.5 per cent GDP growth for 2010-2011, which outpaces every Asian country except China. Some observers estimate the committed, but as yet unallocated, funds targeted for India at nearly $30 billion. Since global PE firms commingle funds earmarked for Asia, the exact figure is hard to pin down, and potentially far larger. Whether this vast supply of funding will match up with a strong demand is another question. It's true that India's companies may well need PE partners to finance their continuing internal growth projections of as much as 35 per cent-especially those young companies that have already gone public and cannot soon tap equity markets again for more financing. But, as has been noted, private equity traditionally has not been the first source of funding for Indian promoters. Rather, it has usually been the last they turn to because of its higher cost and cultural

issues around sharing ownership control. That will change only slowly as Indian entrepreneurs become fully convinced that private equity's expertise in management and operational improvements can indeed deliver the kind of rapid growth they seek. While there is a significant supply of dry powder waiting to be deployed in India, most originates from foreign sources. Under stringent regulations currently in effect, insurance and pension funds are not encouraged by their respective oversight bodiesthe Insurance Regulatory and Development Authority (IRDA) and the Pension Fund Regulatory and Development Authority (PFRDA)-from making major capital commitments to these alternative asset classes. The contrast with mature economies such as the US is stark. In those markets, insurance and pension funds play a major part as limited partners (LPs), contributing significantly to the pool of capital available with almost all bulge-bracket PE houses. In India today, the only domestic LPs are wealthy individual investors, and it appears unlikely that institutional investors will emerge as LPs for the next few years. Longer-term prospects: Beyond 2010 Where will funding come from over the coming 18 to 24 months? In the aftermath of India's brief six-month economic slowdown, our survey results show that foreign venture capital investments (FVCI) are expected to rise by 30 per cent over the coming two years. Factors cited include the renewed strength of India's economy and the government's intention to use these funds to spur innovation in India. These tax benefits, however, come with restrictions on the sectors that can be invested in and limits on the percentage amounts of stakes. Respondents also expect foreign institutional investment, made through such vehicles as pension and mutual funds, to rise by some 24 per cent in the same period. Industry experts are skeptical about whether this will actually take place. They expect that most PE funding will continue to come via FDI for the foreseeable future, even though foreign direct investment declines as a category as it increasingly becomes reclassified as FVCI. As the proportion of funds from foreign sources increases, survey participants anticipate that the share derived from domestic Indian sources will remain a secondary source of capital. As in the recent past, nearly half of the domestic funding for the surveyed firms will continue to come from Indian institutional investors, with the balance split almost evenly between Indian non-institutional investors and general partners of PE firms. The complex regulatory framework governing private equity will influence how this plays out, as regulations are more stringent for foreign investors. However, under current rules, domestic and foreign funds cannot be pooled into a single investment fund. That means the Indian PE industry needs to develop and tap its own network of domestic limited partners to create adequate scale. But the likeliest source of large amounts of LP money-funding from insurance companies and pension funds-cannot, for the most part, be invested in private equity under today's regulations. Meanwhile, the likelihood of high-net-worth individuals being able to make up the difference is low, as is true in most markets.

Put another way, barring a revision in the regulatory regime, the composition-and relative share-of domestic investor categories will not change over the next two years, our interview respondents told us. In the interim, India's budding PE industry will continue to vie for the largest source of capital. Or, as one respondent explained, "[As] the fund house gains [an] investment track record...institutional investments are likely to increase." Employing another tactic, some domestic PE funds invest in Indian companies through wholly owned offshore subsidiaries. Because several jurisdictions, including Singapore and Mauritius, have double-taxed treaties with India, PE funds can use Special Purpose Vehicles based there to avoid transferability restrictions when they eventually exit from an investment. Deal making Today's baseline Since private equity's arrival in India, deal making has taken on distinctive characteristic that mirror the state of the nation's economic development. As evidenced by its mostly passive, minority-stake equity investments, Indian private equity bears little resemblance to the kind of buyouts-based, value-added management practices of private equity in the US and Europe. To characterise the investments PE firms have made, they are small, opportunistic and numerous-as a matter of fact, they total the highest number throughout Asia. Indeed, the high frequency and small size of most Indian PE deals to date reflect both India's vast potential and need for the kinds of investments PE firms excel at, on the one hand, and the disorganised current state of many economic sectors that render deal making in India so challenging, on the other. India's retail sector is a good example of why significant PE deal making has yet to gain traction. Less than a decade old, modern retailing is a relatively new concept to India. The highly fragmented sector remains overwhelmingly dominated by tiny shopkeepers, leaving very few viable retailers of sufficient scale to attract the attention of PE investors. The competition PE funds face to acquire stakes in the handful of companies that are sufficiently large and dynamic to attract their interest is intense. Promoters at these companies have found that they can easily attract capital from the public debt and equity markets, leaving little scope for PE funds to make investments that would enable them to demonstrate their value-creation capabilities. The volume of deals slowed dramatically during the global recession of 2008 and the first half of 2009, which left PE firms sitting on reserves of dry powder. Yet the return of economic activity in the latter half of 2009 proved a mixed blessing to private equity. Private equity found itself in competition with a revived equity market as a source of low-cost funds for promoters. Large companies have many funding options. But for smaller companies, the choices are circumscribed. Thus, throughout 2009, the percentage of transactions PE firms completed relative to the far larger number of opportunities they were invited to look at remained at the same low rate. That reflects an ongoing mismatch between PE investors' aggressive hunt for value early in the period of reinvigorated economic expansion and promoters' expectations that they can continue to command top value.

Respondents told us that they considered around 3 per cent of the initial information memoranda (IMs) submitted to them by fund requesters. And, only one in a hundred went through the entire process of submitting a term sheet and doing due diligence to get to a deal closing. As a managing director at one of India's leading domestic PE funds explained, deal volume may be up, "however, valuation expectations are still rich." Another factor: Since the downturn was so short, most owners didn't feel pressured to go to alternative capital sources to supplement organic funding for growth. Just as the number of deals decreased, so did their size during 2009. Of the top 25 deals last year, for instance, more than half totalled less than $100 million, compared with all of the top 25 deals in 2008 being at least $100 million to $200 million in size. The average deal size for 2009 sank to $85 million, compared with $181 million in 2008 and an average of $238 million in the boom year of 2007. Over the past six years, more than 60 per cent of all PE deals involved a minority stake of less than 25 per cent. That overall trend remained the same over the past two years. But even as the total number of deals fell from 153 to 79 from 2007 to 2009, something did change among the top 25 deals in 2008 and 2009: In more than half of these transactions, stakes rose to between 26 per cent and 50 per cent. That likely reflects less the emergence of a trend than a lingering effect of the downturn. The smaller deals consummated in 2009 may reflect promoters' desire to wait out the slowdown to see if they might capture higher valuations once the market rebounds. For their part, PE funds were uncertain which direction the markets would turn and settled on doing smaller deals during this period. Of the few large transactions, most fell in the infrastructure-building sector. In 2009, many infrastructure-building companies were in the midst of multiyear projects and found themselves in need of funding. Traditionally, promoters have also been reluctant to take large PE investments throughout their companies' life cycle, though PIPE deals are an exception since they do not dilute the owners' stakes. This remained true for the top 25 deals that closed during 2000 and 2009 and totalled more than $10 billion. Indeed, more than half of these transactions came as either late-stage or PIPE deals. Longer-term prospects: Beyond 2010 Despite the ongoing hurdles private equity faces in India-including regulatory and cultural factors and increasing competition that will reduce returns-fully 60 per cent of the industry insiders we surveyed expect to see "a significant pickup in deal closure(s)" this year. Another 28 per cent anticipate a large increase in the first half of FY2011. These growth expectations taper off in the second half of 2011 and beyond, but the strong belief in this upsurge is underscored by the fact that there are more than 100 India-focused funds raising capital in anticipation of what many believe will be the sudden release of pent-up demand for funding PE investors will continue to be opportunistic across many industries, but perennial favourites have been technology companies. Along with deals involving energy and real estate, these amounted to 41 per cent of private equity's total investments in 2009, and will continue to offer attractive

opportunities going forward. PE funding has varied its focus as growth in specific sectors created demand for capital, following a path from IT in 2004 to real estate in 2005 to information technology and telecom the following year. By 2009, investment clustered in real estate, IT and energy. Real estate, in particular, attracted PE investor interest in 2009, given that many construction and development firms had overextended themselves in the boom period of 2005 to 2008. By 2009, their stock price valuations had plummeted amidst a number of ongoing projects-which meant they were very open to new sources of capital. As these frequent shifts make clear, VC and PE funds have been less concerned with sector specialisation than in seeking opportunities wherever conditions were most favourable. Thus, the anticipated large-scale growth in infrastructure and other new construction efforts linked to government spending, as well as new energy projects, will act as a powerful magnet for investors. Another influence on increasing deal volumes was touched on earlier: the need by smaller publicly listed companies for financing to hit their aggressive growth targets. In the heady Indian business environment earlier this decade, many entrepreneurial firms went public too soon, given a low revenue threshold needed to issue stock. But now, without a long-term track record of stellar growth, many companies find it difficult to make follow-on public offerings. Many of these companies that are no longer actively traded are under the radar of securities analysts' scrutiny, but represent opportunities for PE funding. They will provide not only a deal opening for PE investors, but an opportunity for investors to add significant value and to increase private equity's reputation among the community of small and midsize enterprises. With PE funding seeking an outlet in India's dynamic economy, the dollar size of the deals also is expected to increase significantly. Indeed, industry executives expect to see deals in the range of $50 million to $100 million increase by 62 per cent. And, among transactions totalling from $100 million to $500 million, they peg the increase at 45 per cent. What will enable this surge in deal activity? Clearly, the vast amounts of dry powder PE funds have amassed and are eager to put to work will be a major factor. A pickup in deal making will also hinge on promoters' increasing contact and experience with private equity. Indeed, the best source of proprietary, profitable deals, PE executives tell us, comes from direct contacts-such as personal relationships across business networks and portfolio companies-and, to a lesser degree, through banks. Most PE investors say they rely far less on intermediaries or introductions facilitated by their limited partners. These opinions reflect both what PE investors say were the most important sources of deals over the past two years as well as looking ahead. Survey respondents told us that PE investors' ability to win promoters' trust will continue to be an essential tool for accelerating deal flow. One executive explained, "As early stage investors, our focus is finding promoters with whom we can build a long-term relationship. Unfortunately, it's difficult to establish trust in a hurry and so we shy away from intermediated deals." Yet, as important as having the right personal chemistry between promoters and PE investors is to the success of a relationship, most industry experts see the role of intermediaries increasing significantly going forward.

Over the past two years, the number of buyout deals represented just 13 per cent of all deals completed. Our respondents foresee these kinds of transactions increasing by 53 per cent over the coming two years. Asked specifically how they expect the number of buyout deals in the market to change, 55 per cent said they expected them to increase, while 38 per cent anticipated they would stay the same and 7 per cent thought they would fall. If expectations are realised, then, nearly 20 per cent of all deals will involve buyouts. Again, survey respondents linked this outcome to promoters' increasing and positive experience with private equity. "As the market matures we will see more and more buyouts," is the way one put it. Moreover, private equity will itself gain in experience. Explained another executive: "There are also more funds...willing to take control and that have built their teams to have operational capabilities." While this optimism about an upsurge in buyouts is widespread, PE investors need to reckon with the inherent reluctance of promoters to sell off their holdings. It is also difficult to square with at least one structural impediment in Indian law: The prohibition on the use of leverage in such deals-a practice used widely elsewhere that inherently makes returns more attractive. Nevertheless, some increase in buyouts will occur when larger conglomerate organisations (particularly in the real estate and technology sectors) begin a process of portfolio rationalisation-pruning non-core assets and beginning a focus on carve-outs. But until there is a change in regulations, PE funders will be obliged to continue to create offshore entities to add debt to equity in such deals. And this adds a level of complexity and expense that must be managed. Also seen to be on at least a small uptick will be the size of stakes that PE investors will control, the survey respondents said. Although minority-stake deals will remain the norm, they see the number of deals involving a controlling interest of between 50 per cent and 100 per cent increasing to 13 per cent of all deals in the two years ahead, compared with just 8 per cent two years ago. Again, this could be a reflection of the sentiment flowing from the downturn and decreased funding choices, but respondents also anticipate that the number of deals that involve 26 per cent to 51 per cent stakes will rise from 17 per cent over the past two years to 24 per cent of all deals by 2013. As to financing options, straight equity purchases will remain the norm, but respondents anticipate that the use of convertible instruments will increase to 40 per cent of all deals over the next two years, compared with 30 per cent in the prior two years. PE investors prefer creating such an investment structure as an incentive platform. They appear willing to extend credit that will enable managers of their portfolio companies to finance new projects and convert that debt into equity stakes if the growth targets are met. In June, KKR India completed a $141 million structured credit transaction consisting of a mix of cash, fixed-income and equity through its investment in the JSW Group of Companies-the firm's second such hybrid deal in the past year. However, it remains to be seen whether PE funds will be effective in making this a widespread practice, as entrepreneurs are less keen on such instruments and would prefer a straight equity infusion. As discussed before, the level of competition for deals may prevent this from becoming the norm.

In the meantime, respondents say they will continue to employ standard shareholding controls-such as put/call options, drag-along rights, share-transfer restrictions and outright vetoes-in mostly the same proportions over the next two years. However, even if put/call options are a part of a shareholder purchase agreement, their enforceability may be problematic. Portfolio management Today's baseline In the US and Europe, where private equity was born, portfolio management is an active discipline. It involves tight management control-even selection of key senior executivesto ensure attractive returns. In India, in contrast, portfolio management entails an advisory role that, at its most effective, melds persuasion and a growing sense of mutual trust to bear the kind of fruit that private equity can offer and that promoters want. PE investors do sit on corporate boards and help develop better governance standards and management information systems, areas where company owners often know they need help. Yet promoters view private equity's working model as a bit like mutual funds picking stocks, especially in PIPE deals where shares are bought in public markets. But the story changes when fund managers acquire larger stakes. Here, they attain a higher level of influence that is literally spelled out in the investment agreement's legal language. Such deals, for instance, require management to get prior PE investor approval to make investments that would take the company in a different strategic direction from its core business. Indian PE firms believe their target companies need to unlock their full potential value. This includes a strong role in corporate governance and operational improvements that incorporate best industry practices. Equally important, survey respondents said, is the power to influence financing decisions and a voice in determining with whom they are made. Indeed, the help Indian target companies need, in the eyes of industry insiders, covers a gamut of issues: growth and M&A, management guidance and selections, vision and strategy, and, to a lesser degree, the formulation of 100-day post-close plans (sometimes called "blueprints"), and hiring decisions, among others. Promoters have their own needs from PE firms. For the most part, they seek expertise in handling the complex process of going public, such as guidance in meeting standards and listing norms. Many also realise they need to improve their governance practices and operations. And others understand that PE firms can provide excellent counsel in the development of strategy and tap a network of relationships for a company that has reached both a critical mass and a turning point in its growth trajectory. Longer-term prospects: Beyond 2010 Matching needs on both sides and alignment on the strategy going forward will be the key to success. To visualise what this will entail, think of a typical quadrant, with PE

investors on the horizontal axis and promoters on the vertical one. PE firms will be divided between active investors and passive investors. The promoters divide between those who simply are in the market for capital versus those who want active PE involvement. The degree of involvement may extend from offering industry expertise to introducing best practices in functions, operations and governance to bringing to bear the experience needed to ready a company for an initial public offering. The question for PE and VC funders will be: "What must we do to be the preferred partner-and in each category?" For promoters, the main concern will be: "Which partner will we choose-and why?" Today, promoters more often than not pick solely on the basis of getting the greatest value for the stake they give up in their firm, not on the kind of industry or operational savvy that's offered at a higher price. For instance, one promoter recently turned down a deal from a renowned international PE fund because other offers came in higherdespite the fact that the PE firm ran a highly profitable European portfolio company in exactly the same industry segment. In other words, PE firms today must still surmount the valuation threshold to secure a deal. But promoters also need to begin thinking longer term about who they are partnering with and about the real costs of spurning a firm with a proven track record that might well help their company grow even faster. Indeed, over the lifetime of a company, accepting a marginally "lower" offer could pay off in the long run. Ultimately, PE investors and their Indian portfolio companies will need to establish good working relationships within the context of India's familydominated business culture. That will take time. In the interim, their modes of interaction will remain roughly the same, the survey respondents reported-although PE firms' desire for more day-to-day involvement is on the rise. The trick for private equity is to maintain a style of interaction with portfolio companies that stops short of interference. The points of contact typically are: board participation, appointments to senior C-level positions, the sharing of monthly management information reports, broad industry expertise and counsel, and, increasingly, involvement in critical short-term issues, such as working-capital management. One PE firm managing director explained the delicate balance this way: "During interactions with portfolio companies, [the] role of PE investors is advisory, with no interference." Another managing director we interviewed agreed, saying that the "interests of both PE investors and promoters should be aligned, with the former playing an advisory role to the promoters." How does this work in practice? One example involved a global financial firm whose 24 per cent stake in an Indian technology provider went far beyond a mere board seat. This fund provided strategy and financing assistance in making a European acquisition that gave the portfolio company a global reach. Another example was when a global PE firm recently encouraged a controlling family to develop a detailed "blueprint" of the strategy going forward as part of the funding agreement, an exercise that allowed both firms to be aligned on the key issues facing the company and the path ahead. Indeed, reputations are already building about certain PE firms that work well with promoters, a group that desires a patient and collaborative approach. Yet by the very nature of the relationship, a certain tension will continue to exist between the longterm objectives of family owners and the short-term goals of the PE firms-as well as between

mismatched expectations around valuations. As family-owned companies gain experience working with PE investors, they will be better able to decide whether they really want the highest valuation up front or the longer-term results private equity offers, and whether they need to cede a certain amount of control to gain them. They will also be able to figure out which firms they can collaborate with to create longterm value. Exits Today's baseline Because venture capital and private equity are still relatively new to India, the deals investors undertook over the past several years have only begun to reach the full span of their ownership life cycle leading to successful exits. Thus, relative to the number and value of PE deals since 2004, the number of exits has been few. With notable exceptions, such as Warburg Pincus's sale of its large stake in Bharti Tele-Ventures in 2005, they have also been small, averaging well under $4 billion annually over the past six years. Investors' anticipation of the 2008 peak in the public equity markets and worries about the financial services sector specifically resulted in a flurry of exits in that year, but the brief economic slowdown in 2009 chilled the climate for exits as stock prices fell. Nevertheless, investors in all sectors of the Indian economy-from high-tech and health sciences to manufacturing, construction and transport-have tested the exit market. Despite an economy that started to strengthen in the second half of 2009, the number of 2009 exits-and their values-remained low. Coming off a total 2008 value of $3.5 billion, mostly among the banking, financial services and insurance industries, PE and VC investors cleared some $900 million last year in deals that covered a variety of industries. Among the top 2009 deals were Shriram Transport Finance at $213 million, XCEL Telecom at $154 million and Vetnex Animal Health at $75 million. Longer-term prospects: Beyond 2010 The strengthening economy appears to be opening up opportunities for PE investors to unwind positions they have been holding and shortening the duration of deals. Over the past two years, the average investment horizon of the deals our survey respondents made was preponderantly from three to five years, they reported. Nearly two-thirds were in this category, with 34 per cent having a deal horizon of five to seven years. While these trends are largely stable, respondents did say they expected an uptick in the shorter horizon over the next two years. That is a logical consequence of the recent downturn, which prevented deals with a 2006 and 2007 vintage from achieving an exit on schedule. A notable feature of 2009's exit activity was the dramatic rise in public-market sales, including IPOs-up more than six times over the previous year's low base, to a total of 44 exits. It may signal an upward trend in public-market sales, including IPOs, in the future, compared with the traditional exit mode of strategic sales. When asked whether they expected exits to increase, survey participants overwhelmingly responded in the affirmative. For the rest of 2010, they predicted exits would rise marginally and uniformly among the various categories comprising trade exits, secondary exits and IPOs. But for the period through FY2014, they were extremely bullish on the growth in exits,

particularly in IPOs. When asked to predict which mode would predominate over the near and longer term, the answer came back: mostly through IPOs. One explanation of this expected increase in IPOs goes back to last year's economic slowdown, which delayed the timing of some as growth rates slowed. That created something of an exit backlog as performance histories need to be boosted again in order to command attractive IPO prices. Key takeaways Fundraising
A

vast supply of capital-as much as $30 billion-is earmarked for investment in sectors throughout India's resurging economy. Owing to rule changes granting tax-free status to foreign venture capital investments, survey respondents believe FVCI funding could increase by some 30 per cent over the next two years. Domestic Indian funds will remain a secondary capital source. Domestic PE funds will continue to come mostly from institutional investors, but it will likely remain subscale due to rules discouraging insurance and pension-fund participation. Deal making Deal making will continue to be opportunistic and deals will remain small, reflecting both the fragmented state of most industries and promoters' limited familiarity with the kind of active PE practices employed in more mature markets. Deal volume and size slowed in 2008-2009, but the economic revival will not necessarily trigger an upsurge, as the valuation "mismatch" between funds and promoters continues. PE industry participants' expectations are high for a significant acceleration in deal activity this year, tapering off by the second half of 2011. The dollar size of the deals also is expected to increase significantly, with the number of deals in the range of $50 million to $100 million anticipated to increase by 62 per cent. Deal flow will hinge on a combination of PE firms' personal networks and thirdparty contacts, and promoters' growing trust and experience with private equity. Industry insiders foresee an upsurge in buyouts-to nearly 20 per cent of all dealsdespite the continuing prohibition of the use of leverage.

Portfolio management
Portfolio

management practices are evolving gradually to a more activist role. Funds increasingly seek three things: a stronger role in corporate governance, the ability to improve operations and the power to influence financing decisions.

 Promoters

have their own expectations from their PE partners, including expertise in going public, access to best practices and strategy development. Alignment among private equity and promoters will entail deep understanding of each other's goals. Ultimately, promoters need to weigh carefully not only the short-term cost of capital but the longer-term advantages of working with private equity's proven business-growth expertise. Exits
Despite

an economy that started to strengthen in the second half of 2009, the number of 2009 exits-and their values-remained low. Coming off a total 2008 value of $3.5 billion, mostly among the banking, financial services and insurance industries, PE and VC investors cleared some $900 million last year in deals that covered a variety of industries. A notable feature of 2009's exit activity was the dramatic rise in public-market sales, including IPOs, which were up more than sixfold to a total of 44 exits, coming off the previous year's low base. For the rest of 2010, survey respondents predicted that exits would rise marginally and uniformly among the various categories comprising trade exits, secondary exits and public-market sales. But for the period through 2014, they were extremely bullish on the growth in exits, particularly in public-market sales and IPOs. 6. Implications The months ahead are shaping up as an important time of transition for private equity in India. Will the coming two to three years be a period when domestic and international PE firms and Indian entrepreneurs build on the foundation they established since 2004 to make private equity a more integral part of India's economic and corporate growth? Or will private equity continue to serve as a marginal additional source of capital to finance smaller deals and minority holdings? At this point the verdict is far from clear and will depend on the actions that PE firms, promoters and government regulators take-individually and together-to further their mutual objectives. What is clear is that PE activity has picked up following last year's brief downturn, and the path forward looks favourable for a quicker pace of deal making and exit activity. As reflected in the outlook expressed by the industry insiders who responded to our survey, sentiment about the future among PE investors is buoyant overall. Big global PE firms and well-endowed sovereign wealth funds that had been active in India before the 2009 slowdown are now stepping up their Indian commitments, and new firms are establishing a presence. Expectations among limited partners around the world about India private equity's future prospects are also high, and they are directing a greater proportion of their capital dedicated to private equity to funds that invest in Asia generally, and India specifically. Domestic Indian PE funds, too, are increasing in number, size and sophistication. Capitalising on their extensive networks of connections in industry, banking and government, they are absorbing the investment and portfolio management skills of their global counterparts. Leading Indian-headquartered firms like ChrysCapital, ICICI

Venture, TVS Capital and UTI Ventures are building high-quality capabilities that are attracting the attention of foreign investors looking to participate in the Indian PE and VC story. India's strong economic growth, of course, is a major factor propelling PE activity. But the rush to India is also fuelled, in large measure, by a somewhat slower pickup in deal activity in the mature markets of North America and Europe coming out of the recession. The favourable outlook still appears to be based more on India's vast potential than on concrete evidence that private equity in India is poised for a dramatic leap forward. Indeed, it is likely that absent some fundamental changes, private equity in India will fall short of achieving its full promise. PE investors will continue to compete for small deals, accepting passive roles in their portfolio companies rather than bringing their talents to bear to realise their growth opportunities. Promoters and entrepreneurs will continue to view private equity as just another source of capital, and a costly one with unattractive strings attached, at that. Add to this a regulatory environment that constrains deal making, and it is clear that private equity in India is still very much a work in progress. What will it take to unlock private equity's potential? The passage of time, the accumulation of trust and the achievement of a strong performance track record, of course, will be essential pre-conditions. Those key traits cannot be acquired quickly, but each of the major parties to private equity's fate-the PE firms themselves, promoters and regulators-can take steps today to put in place conditions that will ensure they are achieved. PE investors. As in other fast-developing emerging markets, India has presented PE investors with constraints that are at variance with their operating style in the mature economies. Perhaps chief among these are the rare opportunities to acquire control of target companies through buyouts. Having a dominant stake enables PE fund managers to put their imprint on the companies in their portfolios as activist owners. But operating as minority shareholders, PE investors need to exert influence to create value. Learning how to steer from a backseat position requires PE investors to adopt a different mind-set-one of quiet coaxing and coaching rather than command and control. They need to demonstrate to promoters and family owners of the companies in which they invest that they are not out simply to maximise short-term financial returns but are willing to work with them to achieve a common growth vision over the long haul. An example of this is the type of relationship TPG India Investments, the local subsidiary of TPG Capital, the US-based PE firm, has established with the Shriram Group, a diversified financial services holding company. Since its initial investment in Shriram Holdings (Madras) of $100 million to finance the growth of its transport finance subsidiary in 2006, TPG has provided successive capital infusions to help speed Shriram's growth. It acquired stakes in the group's retail holdings subsidiary and its consumer finance arm in 2008. Earlier this year, TPG lifted its stake yet again, investing an additional $100 million to back Shriram Group's new venture, Shriram Capital Limited, as it applies for a licence from Indian authorities to expand into retail banking. Working with Shriram on governance, providing operational advice and partnering to

develop Shriram management's vision, TPG has helped the group grow to serve 4 million customers through nearly 1,000 branches and assets totalling more than Rs. 13,500 crores ($2.7 billion). Commenting on the successful working relationship Shriram has established with PE investors, a senior executive with Shriram Capital said: "We believe in partnerships, and we go out of the way to build them." Even as they wait for the Indian market to mature, PE firms will need to prepare themselves by sharpening their capabilities along each phase of the investment life cycle, from deal sourcing to exit. In deal sourcing, for example, the leading firms are becoming specialists in industry sectors, enabling them to differentiate themselves from their peers in the eyes of promoters. Because very few VC and PE deals are proprietary, sector-specialised firms are better able than their peers to get an early read on the most attractive investment targets. Leading firms are also strengthening their due diligence disciplines, which are especially important in India where a high proportion of companies in which PE firms invest are small, private and lacking in transparency. PE firms need to work actively with owners to identify high-priority initiatives that create value. Finally, PE leaders begin weighing how they will exit from each investment well before the time comes to sell by continuously tracking market conditions for IPOs and identifying potential strategic acquirers. As competition among PE firms in India heats up, it will be those that can differentiate themselves on these dimensions that will be positioned to make the right investments at the right price. Businesses that accept PE investment. Promoters are deeply reluctant to cede significant management control to outside investors. Seeing private equity as little more than a last-resort source of capital to tap only after retained earnings, bank loans and issuances of new shares have been exhausted, most promoters have focused on getting top rupee for the sale of a stake in their business to a PE fund. Valuation becomes the overriding consideration in choosing a PE firm to work with to the exclusion of virtually any other. With so much PE money chasing deals in today's competitive market, the risks of fixating solely on value are likely to increase in the period ahead. That approach is shortsighted and potentially costly. Promoters can get far more value out of their relationship with PE investors by choosing partners who are aligned with their vision for the future of their business and have the expertise to help them realize it. The time to focus on this is not after the agreement of an investment stake has been arrived at but during the period of negotiation before the deal is completed. Once both sides are in agreement about the broad direction of the company's growth over a three to five-year period and have come to terms on the size and price of the PE investors' stake, they can transition smoothly as soon as the deal is consummated to develop a blueprint for how they will tackle the top-priority opportunities. On the margin, selecting PE partners based on their expertise and compatibility with a company's growth goals is worth far more than capturing the last 5 per cent in the original acquisition price. Businesses new to private equity. Indian businesses that have not yet worked with VC and PE investors-or have been reluctant to accept funding from these sources- may want to give private equity a fresh look. VC and PE capital can play a critical role in the

life cycle of any company. For start-up enterprises unable to secure bank financing or too untested to tap the public debt or equity markets, it can help management finance product development, bring a new product to market or scale up a distribution network. More mature companies weighing a decision to float an initial public offering may want to consider private equity before they seek a stock market listing. Many promising Indian businesses have learned from hard experience that rushing to the public equity markets prematurely can be a mistake. Although the capital they raise in an IPO can help finance an initial growth spurt and enrich the promoters, many newly public companies discover that their shares languish once they are listed. Lacking a strong track record for revenue and profit growth, their shares are thinly traded. Many discover that they cannot go back to the public markets for more capital without seriously diluting existing shareholders. Working with private equity backers, instead, enables these companies patiently to build their businesses outside of the public glare. They are better able to choose a more propitious timing of their IPOs when their balance sheets and income statements are strong enough to withstand public shareholder scrutiny. Public policy makers. As a complex new industry attracting vast sums of foreign capital and a mix of international and domestic firms looking to invest in India's most promising public and private companies, private equity presents a host of complex challenges to Indian regulatory authorities. In the context of India's young and dynamic PE markets, finding the right balance between efficiency and safety will take time. Two regulatory reforms, however, could significantly advance the development of private equity in India to the advantage both of PE investors and the companies that need growth capital-with virtually no risk to financial markets or the economy as a whole. The first would adjust the 15 per cent trigger rule. Under this regulation, PE investors who acquire at least 15 per cent of the outstanding shares in an Indian company must extend an open offer at an equal, or higher, price to the company's other shareholders and be willing to accept up to an additional 20 per cent stake in the company. Intended to protect the interests of third-party shareholders in a firm selling a significant equity stake, this requirement inhibits PE capital formation in two ways. First, it puts promoters and entrepreneurs at risk of having to give up a far bigger stake in their businesses than they may be willing to cede. Second, it leaves PE investors exposed to the likelihood of having to commit more money to a business than they planned and tying their potential returns too closely to the fate of an individual company than they may think is warranted. Raising the trigger, which the Securities and Exchange Board of India is reportedly weighing, would greatly reduce that uncertainty and increase investment flow. An initial increase of the trigger to 26 per cent would be beneficial to all parties and still protect the rights of minority shareholders. A second reform that would facilitate better-informed deal making would be to ease disclosure rules that make it difficult for PE firms to conduct effective due diligence before investing in publicly listed companies. Under current law, any information a company shares with one potential investor must be disclosed to others without

exception. That lack of confidentiality prevents prospective PE investors from making an accurate assessment of a target company's true condition, with the result that no investment will likely be made. Because so many Indian companies with listed shares are thinly capitalised and are unable to float new shares through public offerings, the inability to share critical information with PE firms can deprive them of an important source of funding at a key juncture in their development. A better solution would be to make it possible for company boards to approve the restricted release of internal data subject to the recipient of the information signing an appropriate nondisclosure agreement that is effective for a certain period of time. As we have seen throughout this report, the long-term prospects for private equity to prosper in India appear to be excellent. The nation's strong, self-sustaining economic growth, talented workforce and creative entrepreneurs have created a fertile environment for PE and VC investment to take root. Conditions over the next year or two look especially promising. With credit markets and the economic outlook in Europe and the US problematic, interest among global PE firms and limited partners in opportunities in Asia and the region's two most dynamic markets, China and India, is for the moment very high. VC and PE fund flows could rebound to some $17 billion through the end of 2010. Given the right economic conditions and a more favourable regulatory environment, private equity has the potential to fund up to $100 billion over the next three years, according to a Confederation of Indian Industry estimate. But international investors' attention can just as quickly shift back to the far bigger, more familiar and more welcoming terrain of their home economies as recoveries there show signs of taking hold. To ensure that they capture this unique moment when all eyes are on India, Indian businesses and regulators will need to take visible steps towards removing the barrierslegal, cultural and attitudinal-that continue to block this promising source of growth capital from delivering its full potential. If they do, they will find that VC and PE investors will be enthusiastic partners in an effort from which all of India stands to benefit. Key takeaways
Strong

market fundamentals make India an attractive destination for PE investment. However, the rush to India is also fuelled to some extent by a lack of attractive investment opportunities in the mature markets of North America and Europe, where deal activity remains sluggish and credit conditions are tight. India's PE market will continue to grow at a healthy double-digit rate over the next few years. But absent some fundamental changes on the part of promoters and regulators, its long-term growth potential could be constrained. Each of the major parties to private equity's fate-PE firms, promoters and regulators- can take steps today to put in place conditions that will ensure that the benefits of private equity's potential are achieved. PE firms need to sharpen their capabilities along each phase of the investment life cycle, from deal sourcing to exit. As competition among PE firms in India heats up, it will be those that can differentiate themselves through sector specialisation,

enhanced due diligence and an ability to identify value-creating opportunities that will be positioned to make the right investments at the right price. Learning how to steer from a backseat position requires PE investors to adopt a different mind-set-one of quiet coaxing and coaching rather than command and control. Promoters can get far more value out of their relationship with PE investors by choosing partners who are aligned with their vision for the future of their business and have the expertise to help them realise it. Indian businesses that have not yet worked with VC and PE investors-or have been reluctant to accept funding from these sources-may want to give private equity a fresh look. Regulators can have a major influence in advancing the potential benefits of private equity in India by lifting the cap on the open-offer rule and liberalising disclosure norms when potential investors need confidential information to conduct their appropriate due diligence. Overall, Indian businesses and regulators need to take visible steps towards removing the barriers-legal, cultural and attitudinal-that continue to block private equity from delivering its full potential. About Indian Venture Capital and Private Equity Association Indian Venture Capital and Private Equity Association (IVCA) is the oldest, most influential and largest member-based national organisation of its kind. It represents venture capital and private equity firms, promotes the industry within India and throughout the world and encourages investment in high-growth companies. It seeks to create a more favourable environment for equity investment and entrepreneurship, representing the industry to governmental bodies and public authorities. IVCA members include leading venture capital and private equity firms, institutional investors, banks, incubators, angel groups, corporate advisers, accountants, lawyers, government bodies, academic institutions and other service providers to the venture capital and private equity industry. These firms provide capital for seed ventures, earlystage companies, later-stage expansion and growth finance for management buyouts/ buy-ins of established companies. IVCA's purpose is to support the examination and discussion of management and investment issues in private equity and venture capital in India. It aims to support entrepreneurial activity and innovation as well as the development and maintenance of a private equity and venture capital industry that provides equity finance. It helps establish high standards of ethics, business conduct and professional competence. IVCA also serves as a powerful platform for investment funds to interact with each other. The Association stimulates the promotion, research and analysis of private equity and venture capital in India, and facilitates contact with policy makers, research institutions, universities, trade associations and other relevant organisations. IVCA collects, circulates and disseminates commercial statistics and information related to the venture

capital industry. It also encourages the formation, development and use of equity markets and funding structures appropriate to the needs of private equity and venture capital investors and investees. IVCA organises symposia and seminars directly related to its purpose as well as training seminars and courses for private equity and venture capital industry practitioners. It publishes newspapers, periodicals, books and leaflets to promote its objectives. IVCA has established a partnership with the European Venture Capital Association (EVCA), founded in 1987 and focused exclusively on the professional development of investment professionals. About Bain & Company's Private Equity business Bain & Company is the leading consulting partner to the private equity industry and its stakeholders. Private equity consulting at Bain has grown 13-fold since 1997 and now represents about 25 per cent of the firm's global business. We maintain a global network of more than 400 experienced professionals serving private equity clients. In the past decade, we estimate that Bain & Company has advised on half of all buyout transactions valued at more than $500 million globally. Our work with buyout funds represents 75 per cent of global equity capital. Our practice is more than three times larger than the next-largest consulting firm serving buyout funds. Bain's work with private equity does not stop with buyouts. We work across asset classes, including infrastructure, real estate, debt and hedge funds. We also work for many of the most prominent limited partners to private equity firms, including sovereign wealth funds, pension funds, financial institutions, endowments and family investment offices. We have deep experience working in all regions of the world across all major sectors-from consumer products and financial services to technology and industrial goods. We support our clients across a broad range of objectives for our private equity clients: Deal generation: We help private equity funds develop the right investment thesis and enhance deal flow, profiling industries, screening targets and devising a plan to approach targets. Due diligence: We help funds make better deal decisions by performing diligence, assessing performance improvement opportunities and providing a post-acquisition agenda. Immediate post-acquisition: We support the drive for rapid returns by developing a strategic blueprint for the acquired company, leading workshops that align management with strategic priorities and direct focused initiatives. Ongoing value addition: We help increase company value by supporting leveraged efforts in revenue enhancement and cost reduction, and by refreshing strategy.

Exit: We help ensure funds consummate deals with a maximum return by preparing for exits, identifying the optimal exit strategy, preparing the selling documents and prequalifying buyers. Firm strategy and operations: We work with private equity firms to develop their own strategy for continued excellence. Topics include asset-class and geographic diversification, sector specialisation, fundraising, organisational design and decision making, winning the war for talent and maximising investment capabilities. Key contacts in Bain's Global Private Equity practice Global: Hugh Europe: Graham Americas: Bill Asia-Pacific: Suvir India: Sri Rajan; David Mountain Please direct questions to: bainPEreport@bain.com Acknowledgments This report was prepared by Sri Rajan, who leads Bain & Company's Private Equity practice in India, and a team led by Prashant Sarin, a manager in Bain's New Delhi office. The authors thank the following for their support: Bain consulting staff: Abhinav Sharma, Akash Bhargava, Ankit Bhargava, Arvind Chandrasekhar, Nidhi Agarwal, Rachana Kedilaya Bain Global Editorial: Lou Richman, Bob Gilbert, Kamil Zaheer, Elaine Cummings, Maggie Locher, Jitendra Pant, Erika Hayden Bain Global Design: Dawn Briggs, Tracy Lotz, Kelley Choi Private equity in Southeast Asia Industry Brief 06/10/10 by Bain's Global Private Equity practice Private equity's expanding global scope and influence-particularly in the big emerging markets of China and India-has been one of the leading financial stories of the past decade. Less visible, although no less significant, has been private equity's increasing role in speeding the growth of companies across the dynamic economies of Southeast Asia-from Singapore, Malaysia and the Philippines to Indonesia, Thailand and Vietnam. The PE industry has sunk deep roots in the region. From peak to peak across the business cycle, the number of deals financed by PE investors rose from 40 in 2000 to and comments about this report MacArthur Elton Halloran Varma via email

60 in 2007, a 50 percent increase. Even though the deal count in the region dropped to just 23 during the recent downturn, 2009 was still the fourth-best year for transactions in the past decade. The value of those deals, meanwhile, soared six-fold, to $12.3 billion in 2007. Deal value dropped by nearly half, in 2009, to $6.3 billion; but even at that depressed level, the total value of PE transactions last year was nearly eight times higher than in 2001, when the region began to pull out of the last recession. From 2006 through the end of last year, buyouts comprised less than one-third of all deals, but they accounted for between one-half and three-fourths of total deal value. With the return of strong GDP growth across the region since the second half of 2009, PE in Southeast Asia looks poised to resume its ascent. Deal flow has continued to increase into 2010, along with average deal size. A wide array of large-cap, mid-cap, sovereign wealth funds and Asia-focused funds wielding sizable amounts of "dry powder"-capital targeted for investment but not yet allocated-are scouting the region for opportunities. Credit markets have stabilized, laying a foundation for a cautious return of both buyouts and growth capital. This constellation of favorable conditions makes now a good time to take stock of how the industry will evolve over the balance of 2010 and beyond. To find out, Bain & Company, with the cooperation of the Singapore Venture Capital & Private Equity Association (SVCA), surveyed general partners at many of the leading PE and venture capital funds in the region. The picture that emerges is of a dynamic young industry ready to move into a phase that will require PE firms active in the region to acquire new skills. Let's look at the specifics: PE is now a major asset class in Southeast Asia Many factors point to a deepening of PE investor commitment to the region. Half of all respondents look for the number of funds active in Southeast Asia to increase over the next two to three years. The funds will also be bringing a new focus and deeper expertise to the region. Nearly two-thirds of the respondents expect that new funds will be regional specialists, and another 13 percent will specialize by industry sector. Overwhelmingly, PE general partners expect limited partners' interest in investing in the region to remain high, with nearly nine out of 10 looking for them to maintain or increase their asset allocations to PE and venture capital. PE firms are increasing their physical and financial commitment Among funds already active in Southeast Asia, just 20 percent are local specialists, and nearly half of those concentrate on Singapore. The remainder are about evenly split between funds that invest broadly across Asia and global funds that have established a local presence. Continuing to target mainly small and mid-cap companies, the survey respondents anticipate that 50 percent of funds' annual investments in the region over the coming two to three years will be more than $100 million. They expect that only about one-quarter will invest more than $200 million a year. Competition will heat up

The influx of new funds wielding large amounts of dry powder to invest will bring a new intensity to the competition for deals across Southeast Asia. But survey respondents report that incumbent funds that have an established presence in the region's fragmented markets have distinct deal-sourcing advantages. About half of all deals completed over the past two to three years were sourced, in about equal proportion, through networks of industry relationships and advisers or by direct approaches to the target companies themselves. Brokers and other intermediaries were the sources for the balance of deal introductions. Those early leads have kept a lid on competition. Nearly 40 percent of deals completed across the region since 2007 and 2008 were proprietary. In another 30 percent, winning bidders faced just one or two bidding rivals. New skills required As competition to identify attractive deals and to win the best ones ramps up, PE firms will need to sharpen their capabilities along each phase of the investment life cycle, from deal sourcing to exit.
In

deal sourcing, for example, the leading firms are strengthening their skills as geographic and industry sector specialists, enabling them to differentiate themselves from their peers as the preferred partner to owners of the companies they target. Greater specialization will be an increasing source of competitive advantage for sustaining a strong deal flow. Leading firms are honing their due-diligence disciplines, skills that are especially important in Southeast Asia, where a high proportion of potential target companies are small, private and lacking in transparency. PE firms increasingly recognize that they need to work actively with owners to identify high-priority initiatives that create value. They monitor performance by tracking a few key metrics that provide an early warning system to alert management to take fast corrective action if the program begins to drift off course. Finally, PE leaders begin weighing how they will exit from each investment well before the time comes to sell by continuously evaluating market conditions for initial public offerings (IPOs) and identifying potential strategic acquirers. Strong regional growth, dynamic entrepreneurs and increasingly knowledgeable and seasoned investors add up to a promising period ahead for private equity investment in Southeast Asia. Growing beyond China: Five things Chinese companies need to know about global expansion Bain Brief 06/08/10 by Phil Leung and Larry Zhu China is becoming a key player in a game that it's just beginning to learn how to play. The country's explosive economic growth has spurred a corresponding boom in mainland companies pursuing expansion opportunities overseas through mergers and acquisitions (M&A), joint ventures, partnerships or organic growth. Chinese firms seeking access to other markets are discovering that a global expansion strategy is just

as critical as it is for foreign companies trying to win in China. Even as the financial crisis hit in 2009, the value of deals involving Chinese companies making overseas acquisitions totaled $35.9 billion. As recently as 2004 it was $3.5 billion. Cash-rich Chinese firms are in a strong competitive position to make inroads into foreign markets. They've been relatively insulated from the financial crisis while many hard-hit Western companies are trying to unload struggling businesses and assets that have lost value. Mining, telecom, utilities and financial services topped the list for outbound M&A deals in 2008 and 2009. Typically, the deals are small, with minority stakes totaling just $50 million or less. But several multibillion-dollar deals are in the works or completed, including the $7.7 billion acquisition last year of Canada-based Addax Petroleum by Sinopec International Petroleum Exploration and Production Corporation (SIPC), a subsidiary of China Petrochemical Corp., and Zhejiang Geely Holding's $1.8 billion purchase of Ford Motor's Volvo division. With growing demand for raw materials and energy, these sectors will continue to pursue M&A deal making. But Chinese companies are discovering that expanding into foreign markets is tricky. And they aren't alone. Worldwide, we've found that M&A efforts often fail to deliver the intended value-and the stakes are even higher for companies that lack experience in M&A. A Bain & Company global survey of 750 companies showed that 55 percent-more than half-of the acquiring companies' stock failed to outperform the market one year after deals were announced. When Shanghai Automotive Industry Corporation (SAIC) won a heated takeover battle in 2004 for a nearly 50 percent stake of Ssangyong, it was the first acquisition by a mainland company of a foreign car manufacturer, with the potential of SAIC and Ssangyong complementing each other's businesses. But SAIC encountered a number of challenges, including an inability to get control of Ssangyong's operations and labor unions. However, some seasoned acquirers are getting it right. We've found that they start slow and small, gaining experience and confidence with domestic acquisitions before expanding globally. Winners often monitor the growth of acquisition targets for years before making an offer. They focus on how the deal could take full advantage of synergies for both parties. Winning acquirers understand that to excel, they have to attract and retain top talent. ChemChina (China National Chemical Corp.) became the mainland's No. 1 chemical conglomerate by following that path. After more than 100 domestic acquisitions, ChemChina, on its own or through its Blue Star subsidiary, then targeted three major foreign firms-Adisseo and Rhodia in France and Qenos in Australia. The deals helped catapult ChemChina onto the global stage, giving it the technology, management skills, capital and market access required to become a multinational player.

As the pace of global expansion by mainland firms accelerates, Chinese businesses need to learn quickly several important lessons to replicate the success of companies like ChemChina. Rule #1: Know which approach works best for you Don't assume conventional M&As are your only options. While M&As are the major growth strategy, companies often learn the ropes by forming partnerships and joint ventures in foreign markets. That approach gives them insights into the difficulties of foreign expansion and crucial experience without as large a financial commitment. Advantages include using a partner's manufacturing facilities, piggy-backing off their already well-established brands, sales and distribution networks and talent. While joint ventures are less risky than acquisitions, they involve their own special hurdles. The challenge is to know why you want a partner, what the "win-wins" are for both companies and how to tackle the cross-cultural challenges. Take Haier, now a leading global white-goods manufacturer. It is learning how to use partnerships with US players such as General Electric for joint product development and reciprocating by providing regional access in the Chinese market through Haier's distribution partners. Since 2008, Alibaba.com, the global leader in e-commerce for small business, has used a joint venture with Japan's telecommunications giant, Softbank, to open up new opportunities in the Japanese marketplace. It gave Alibaba.com access to Softbank's talent and sophisticated knowledge of the Japanese market. Now the two companies are in talks to form a partnership that would jointly promote e-commerce between China and Japan. Rule #2: Know why you're acquiring Understand the basis of competition, then create an investment thesis. One of the best ways to avoid disastrous acquisitions is to articulate clearly why buying a business will make your company more valuable. Even in good times, many companies don't understand the importance of an investment thesis. When we surveyed successful acquirers, we found that about 80 percent of successful transactions were based on a clear investment thesis. For failed deals, it was about 40 percent. Too often, companies haven't pinpointed the best opportunities for value creation as well as assessed the risks. In good times and bad, a winning acquisition strengthens a company's basis of competition such as its cost position, brand strength or customer access and loyalty. All were goals of the IBM acquisition, which helped Lenovo achieve global scale, build a

global brand and gain access to leading-edge technology in what was the fastest growth segment of the time. Amid economic turbulence outside of China, it's especially important to keep updating the valuations of potential targets. Many companies are relatively cheap in a downturn because their shares have plunged. But some companies are cheap for good reason, and the adage that you get what you pay for often applies. And update the target list based on changing market variables. The future business climate is likely to be more tightly regulated, less leveraged and more risk averse. Oncesuccessful business models may no longer work. Onetime market leaders may be permanently compromised. Yet you may want to add businesses that you think are likely to thrive in a different environment. Rule #3: Know which deals you should close Ask and answer the few questions that test your investment thesis. Identifying potential acquisition targets and winnowing them to one or two best choices requires discipline. Instead of hastily reacting to acquisition targets as they come on the market, seasoned deal makers know their basis of competition and are constantly thinking about the types of deals they should pursue. Their M&A teams create a pipeline of priority targets, each with a customized investment thesis and then cultivate a relationship with each one. As a result, they can quickly close a deal. Because they know what they want to achieve with the acquisition, they're often willing to pay a premium or act faster than rivals. China's three major commercial banks, the Industrial and Commercial Bank of China, Bank of China and China Construction Bank, all have developed lists of potential acquisition targets. The targets are linked to the government's strategic priorities in specific markets like Southeast Asia, Africa and Australia, where Chinese companies are significantly enhancing their trade activities or even acquiring assets, like natural resources. But before closing a deal, winners overinvest in due diligence. In cross-border deals, rigorous due diligence is even more critical to head off problems before a purchase is completed and requires extra attention. The process should start by zeroing in on potential roadblocks such as regulatory or political issues. To develop an insider's point of view, companies can tap their existing networks or customers and dispatch an advance team to review the target firm thoroughly. Rule # 4: Know where you need to integrate first Prioritize getting at the key sources of value quickly.

Our research shows that cross-border deals carry a similar rate of success as domestic deals, but integration typically is more complex. The unique challenges include tailoring the integration thesis to each region's circumstances, tackling actual and perceived cultural differences, considering geographically dispersed operations and stakeholders as well as complex legal and regulatory requirements that can derail the integration. To boost the odds of success, acquirers need to:
Identify the best sources of synergies and prioritize them Ensure that the integration process isn't overly complex Be able to make decisions quickly so that critical milestones Provide strong leadership of the integration process

aren't missed

Understanding whether deals are to boost "scope" or "scale" is vital. Chinese apparel maker Youngor Group Ltd.'s acquisition of US based Kellwood Co.'s Smart Shirts business is largely a scale deal designed to expand a core business, as opposed to a scope deal aimed at expanding into adjacent lines of business. Scope deals require a different approach to integration than scale deals, with the goal of fostering some of the capabilities of the acquired company and integrating where it matters most, rather than combining two similar companies for maximum efficiency. Meanwhile, when it comes to people issues, many companies wait too long on organizational and leadership decisions. Poor performance in the base business frequently occurs when integration soaks up too much energy or drags on, distracting managers from the core business. As a rule of thumb, at least 90 percent of the organization should be focused on the base business, and these people should have clear targets and incentives to keep those businesses humming. Rule #5: Know what to do if the deal goes off track Set up an early warning system and act quickly. No deal goes exactly as planned. The best deal makers expect to hit a few potholes. They install early-warning systems to detect problems and tackle them as soon as they emerge. They distinguish between the inevitable glitches and those that signal something far more serious. Here, the need for unsentimental discipline reaches its peak: Acquirers must let go of the past, admit errors and take decisive action to put their deals back on track-or not. Ultimately, to improve the odds of a successful global expansion, knowing when to pull out of a deal is just as critical as the other four guiding principles: knowing the best approach for your situation, knowing why you're acquiring, knowing the best deals to go after and knowing where to integrate. The more Chinese companies look for growth overseas, the more they need to be guided by these principles. Phil Leung is a partner with Bain & Company's Shanghai office and leads the firm's

Greater China Mergers & Acquisitions practice. Larry Zhu is a partner with Bain & Company's Shanghai office. The e-mobility era: Winning the race for electric cars Bain Brief 06/08/10 by Dr. Gregor Matthies, Dr. Klaus Stricker and Dr. Jan Traenckner By the year 2020, one in two new cars will be either partly or fully powered by electricity. That may surprise many market observers, who regard the current hype and numerous battery-powered prototypes as a knee-jerk reaction by an automotive industry under stress. But e-mobility is no marketing fancy. Bain & Company presents seven reasons that explain why an industry switch to electric cars in their various forms constitutes a fundamental and irreversible change: 1. In 10 years, at the latest, the e-car will be a mass-market product 2. E-cars are being launched as today's new lifestyle product 3. The electric car is not just a product variant-it represents a fundamental system change 4. E-cars do not need an expensive infrastructure to succeed 5. The available e-car technology today is already "good enough" 6. Battery costs will be at a mass-production level by 2015 7. The electrification of the automobile is compelling and inevitable. There is no alternative to the e-car In July 2006, the newly established auto company Tesla presented an exclusively electric-powered sports car at a sticker price of more than $100,000. A host of celebrities ordered one on the spot, and suddenly e-cars were hot. Within a few years, what had been a sideline became an image platform on which the industry's hopes for the future rested. Though virtually none of the carmakers had an e-car to offer for daily use, from that point on, the media landscape, the political scene and the motor shows were dominated by battery-powered vehicles. Since then, every major car manufacturer has joined the e-mobility bandwagon. German premium automakers were quick off the mark: The past year has seen a crop of pilot and concept cars, with two e-Tron prototypes from Audi, the E-Mini and the ActiveE from BMW, and the Smart Electric Drive (ED) and BlueZERO from MercedesBenz. Japanese companies like Toyota and Honda and US companies such as General Motors and Ford are in the fray, along with Chinese brands like BYD, Cheery and Geely. By 2012, there will be more than 100 partial or fully electric vehicle brands in the market. But when and how will the e-car genuinely become a mass-market product? What justification is there-economically as well as ecologically-for consumers to turn to electric vehicles? And how quickly will these vehicles catch on? In this report, Bain & Company looks at the market opportunities, the ecological case for the e-car, the

economic feasibility of electrification and the challenges facing the automotive industry today. 1. In 10 years, at the latest, the e-car will be a mass-market product A recent worldwide study by Bain & Company demonstrates that customers genuinely want e-cars. They are excited by the image, the technology, the environmental advantages and- for those who have already been able to drive one-the sheer driving experience. In addition to this customer-led "pull," the trend toward e-mobility is also accelerated by numerous and sustainable "push" factors. First among them is cost. The more battery prices fall to a level of economic viability while fuel prices rise, the more economical e-cars become compared with conventional vehicles. Second, consumers and governments in densely populated urban areas eagerly await e-cars as a means to reduce their local emissions. Third, national governments are trying to meet their climate protection targets and at the same time promote homegrown industry. Finally, car manufacturers must dramatically reduce the [CO2 levels their cars emit and, sooner or later, will put their design emphasis on vehicles with electric propulsion. These four factors will create huge growth potential for electrification technology before the end of this decade-and they present a unique opportunity for the auto industry. In this scenario, we estimate that, by the year 2020, half of all new cars registered worldwide will have an electric drivetrain, even if the majority are also likely to be fitted with a combustion engine-either as a backup "range extender" or as a full or plug-in hybrid. And 10 percent of all new cars in 2020 will be entirely battery-powered e-cars, pure and simple. These cars will primarily be used for daily driving and commuting, and drivers will be accustomed to their limitations. For longer trips, consumers will either use another vehicle with greater range or turn to car-sharing or public transportation. Again, costs will be a major factor. Not only will e-cars offer a good environmental image, but by 2020 they will be no more expensive than conventional vehicles-in fact, their overall cost of ownership will be far cheaper. What about those consumers who cannot manage with the current range of purely battery-powered cars that run 100 to 150 kilometers (about 60 to 90 miles) on a full charge? Or those who cannot afford a second car? Even for those traveling longer distances in and from the suburbs, there is still no need to forgo e-mobility. Their option will be to use a car with a smaller battery and an additional combustion engine as an emergency power plant. In that way, most driving can still be done in electric modewhich will soon be an essential requirement to enter the environmentally restricted zones that many cities are planning to create. Indeed, in the inner core, cities will offer concessions for e-cars-such as free parking, use of taxi lanes or exemption from urban center tolls-if they do not restrict entry to emission-free vehicles altogether. 2. E-cars are being launched as today's new lifestyle product An extensive global market survey by Bain in 2008 and 2009 identified an annual potential of 350,000 e-car customers worldwide, including 100,000 in Europe alone.

Those surveyed said they would buy an electric car even at twice the price of the comparative conventional city car, used as a baseline in the survey. These customers are predominantly high-earning, environmentally aware city dwellers who already own a premium vehicle. They said they would use the e-car mainly as a second or third car, mostly for short trips. This group of customers, which we call the "Premium 2.0" segment, is not price sensitive in that by buying an environmentally friendly e-car they can be seen to be green. The example of the Tesla Roadster shows that these early adopters are also motivated by an enthusiasm for technology and by the desire to stand out-the same buying criteria that apply to other innovative high-tech products. The e-car brings an added awareness that their drivers are doing something good for the environment. What's more, this group feels a need to pioneer ecological trends, and to be seen as doing so. To date, only a few people worldwide have driven the various e-cars that have been built as prototypes or in small lots. BMW, for example, is conducting field trials in Berlin and Los Angeles with 600 E-Mini prototypes. Daimler has 100 Smart Electric Drive cars on the streets of London and has just started another field trial with 1,000 newgeneration vehicles in various major cities. Tesla customers are testing some 1,000 cars-including 150 in Europe, and the feedback from drivers, after a brief period of familiarization, is positive. Their verdict: "We want to buy these cars. They are already technically good enough; they're fun to drive and environmentally friendly." Drivers' new feelings of satisfaction have little to do with conventional premium attributes, such as luxury, size or power. On the contrary, with an e-car, the Premium 2.0 consumers want to express a new attitude. Their motives for doing so vary: Some are eager to be seen as technological pioneers; others want to get away from conventional models that are more and more alike; still others see the e-car as a political statement. One telling comment from a US driver was: "We want to make our country more independent from oil." Broadly speaking, this growing customer segment is trying to live a more ecologically sound life. With such undercurrents, the e-car provides a personal-values platform for a new lifestyle that combines ecological awareness with individual mobility in urban centers. The Chevrolet Volt, slated to launch later this year, shows how stylish e-cars can stimulate enthusiasm. The Volt will be powered exclusively by an electric drive that will primarily draw power from a battery charged by an electric outlet. However, the car will also have a small combustion engine that can generate power for longer trips. This ecar concept is called a range extender. Thousands of potential customers in the United States are eagerly awaiting the vehicle's launch. They are even discussing on Internet forums how to optimize their daily routes so that the car can be driven exclusively in emode. E-car communities are springing up, and the media is stoking patriotic feelings by exhorting people to "buy American high-tech." The Volt has everything it takes to be a market success-not the least of which is the $7,500 tax incentive the US government is offering every buyer. So beyond its "curb appeal," the car is also an attractive cost proposition, even given the current comparatively lower gas prices in the United States.

3. The electric car is not just a product variant-it represents a fundamental system change The electric car will be the automotive industry's equivalent to the iPhone. When Apple presented its new product to the world in 2007, cell phone manufacturers scoffed.The iPhone did not have a removable battery and required recharging almost daily because of its high power consumption. In contrast, one could use another manufacturer's phone for a week without having to recharge it. Despite these apparent drawbacks, to date more than 35 million people worldwide have bought an iPhone. The fact is, the iPhone is not a new mobile phone, but an entirely new product that allows its customers to enter a previously unimaginable world of applications, turning one of the previous paradigms of the telecommunications industry on its head. The electric car has the same kind of potential. Customers who buy an e-car are not just buying a new car. They are changing to a new system. Suddenly, the car no longer uses gasoline, it uses electricity. The ride is whisper-silent but dynamic beyond accustomed standards. There are no flat spots or jerky gear changes, and the car is extremely nimble in the city. It also produces no local hazardous emissions, with a corresponding positive effect on the user's personal CO2 balance. The related infrastructure problems now shift to the power generators. But with today's energy mix in Europe, e-cars such as the Smart Electric Drive have a CO2 output of just 75 g/km. Drivers will also benefit-immediately, and for the entire life of the vehicle-from lower carbon emissions from the power station network and from the move toward greater use of renewable energy for power generation. That also represents a genuine paradigm shift. For many emotional reasons, rationally supported arguments and data comparing the combustion engine and the electric drive will fail. When a systemic change takes place, customers no longer perceive product attributes they have come to expect in the past (such as an 800-kilometer or nearly 500-mile range on a tank of fuel, for instance) as quite so important anymore. Customers want the new product because it offers new opportunities. Customers switched to the iPhone-like system because of the new apps, not because of how long the battery lasted on standby. Some governments have already gotten the message that the development of the electric car heralds a systemic change. Both China and the United States have adopted policy positions that their domestic auto industries must be supported in the development of electric vehicles and that e-car sales must be significantly subsidized with tax dollars. In both countries, this policy shift is also being hastened by the realization that global competition is overpowering their domestic auto manufacturers. Consequently, they are seizing the e-car opportunity and substantially investing in new technologies. The declared aim is to develop massproduced e-cars and bring them to market as rapidly as possible. In Europe, France is alone in adopting a clear stance in support of its domestic auto industry. Every French customer will receive a $6,000 government subsidy per French car, and the manufacturers PSA and Renault are receiving generous funding.

Are such subsidies justified in industrial policy terms? History says yes, as governments have played a role in the introduction of every significant new, transformational technology. For example, today's individual mobility is only possible because governments have made considerable investments in roads and infrastructures. The global telephone and data network, too, would not exist were it not for major funding from the public coffers. The huge investment in the first transatlantic cable could certainly not have been paid for by the few international telephone customers of the day. Based on that historical basis, there would be little justification in leaving the first buyers of e-cars to finance the still very high cost of batteries on their own. Only when sufficient numbers of batteries are made and sold will the production costs fall, allowing the development cost to be amortized across large volumes. Practically speaking, of course, people no longer question if e-cars will be subsidized, but merely where and to what extent. The coming systemic change will arrive sooner in regions with high e-car subsidies, and their local industry will have a head start. So this sea change in technology will also be a contest among regions. 4. E-cars do not need an expensive infrastructure to succeed The debate on e-mobility frequently revolves around infrastructure: public recharging stations, plug standardization and systems for swapping rechargeable batteries. However, Bain's analyses show that the success of e-mobility is not dependent on the development of a costly public backbone for the switch to any large extent. Most potential customers simply do not need anything new; they would use their own electric outlet or one provided by their employer. The standard charging process is accomplished using domestic electric power via a 110- or 220-volt outlet, with between six to eight hours required for charging. Bain surveyed consumers, who were asked about their personal charging options for a future electric car, and three typical user profiles emerged: Type 1: "The independents" Some 50 percent to 80 percent of e-car users have their own garage or a parking space close to their home (in the United States, the proportion is 80 percent to 100 percent). When finished driving for the day, these users would connect their e-car to a normal electrical outlet. The time needed for a full charge overnight is more than enough for their daily energy needs. All that is required is to equip the parking space or garage with a standard electrical outlet. Around 50 percent of interviewees already had one. The investment needed would be minimal, and the customer would expect to pay for it. Some e-car manufacturers are likely to offer special charging services and products (socalled wall boxes, including an electricity supply contract) for these "independents." Automakers would sell the wall box under their own brand, coincidentally providing an opportunity for an electricity supply partner to acquire new retail customers.

Type 2: "The office chargers" Approximately 40 percent to 70 percent of all drivers use a company parking space. Many employers could provide staff with charging facilities at the office. For example, Google has already installed company parking spaces with solar-powered charging facilities at many of its locations. Here too, the eight-hour workday is enough to charge an electric car with more than enough energy for daily needs. For companies the investment cost is manageable and can be partially integrated into an already existing infrastructure (lighting, for example) and billed at simple flat rates with no need for costly meters. A new law in France actually requires new office buildings to have such infrastructure. Type 3: "The street parkers" Just 15 percent of drivers have no opportunity to charge an e-car either at home or at work. This relatively small group is the only one currently excluded from using an electric car, at least until public charging facilities become available. The development of public charging stations (for example, using ordinary on-street parking spaces) or charging stations available for public use (for example, in parking garages or shopping malls) will be dependent on political will rather than actual demand. Again, most e-car users would not be reliant on such new infrastructure. What's more, electric charging stations with integrated, intelligent billing technology would be expensive and viable only as a marketing tool, if at all. In the midterm, the standard electrical outlet will remain the norm in most cases. For "emergencies," quick-charging stations will likely develop. That is, in fact, an emerging business opportunity for gas stations. With a relatively low-cost modification to the current infrastructure they already have, they could allow customers to top off with an 80 percent charge in just 15 to 20 minutes. During this time, the gas station could provide coffee and convenience shopping-a win-win situation. To supply such a fleet of e-cars, most experts do not see the need to build new power plants or massively invest in the existing electricity grid. Even if e-cars accounted for 20 percent of the vehicles on the road, power consumption would rise by only around 4 percent. E-cars would also be charged predominantly overnight when the generators have unused capacity. Nevertheless, demand from suburbs with a high e-car penetration would probably require some investments in higher-transformer station capacity or intelligent demand control in peak periods. Yet, with more future electric power being generated decentrally-solar panels on house roofs, for example-these costs should be limited. 5. The available e-car technology today is already "good enough" One issue for the immediate acceptance of the e-car is whether it is already "good enough" for consumers. Two aspects of e-car technology might argue against this idea: The batteries required make e-cars as much as 50 percent more expensive than

conventional cars today, and their range is limited to around 150 kilometers (93 miles) on a full charge. The extra-cost issue may not be as daunting as it seems. It is ultimately a matter of the economies of scale in battery production and of government subsidies, topics discussed in more detail later. However, the range required of a battery is solely a matter of customer acceptance. The field trials of the Smart Electric Drive and the E-Mini are being accompanied by extensive market research. In both cases, customer surveys show that the drivers were predominantly satisfied with the cars. Indeed, for a substantial majority of the users, these e-cars-despite their so-called handicaps-are already good enough for day-to-day mobility needs. Likewise, in numerous projects and studies, Bain determined that an attractive market exists both for e-cars charged exclusively via an electrical outlet as well as for vehicles with an auxiliary combustion engine. Let's look at each type of e-car: Market opportunity #1: "Battery only" E-cars powered solely by batteries for daily commuting, bought by users mainly as a second car, are definitely a competitive prospect. Today in Germany, there are around 10 million second cars. Research by the German Federal Ministry of Transport has shown that Germans travel an average of 37 kilometers (almost 23 miles) per day, 61 percent of which is by car. In the United States, the distance is around 60 kilometers (37 miles), with cars accounting for 86 percent of this distance. For electric cars, that means 80 percent of drivers can park their e-car at home to recharge in the evening with well over half the battery charge still remaining. For vacations and special trips that exceed the battery range, drivers of purely battery-powered e-cars either will use their conventional car or rent a vehicle. Market opportunity #2: "Battery plus" For drivers unwilling to forgo the range of a gasoline-powered car, plug-in hybrids are ideal. They can be used predominantly for city driving (such as the Toyota Plug-in Prius announced for 2014), or as range-extender hybrids (for example, the Chevrolet Volt). Operated in electric mode for daily driving in the city (20 to 60 kilometers or 12 to 37 miles), they can also be used like conventional cars (with a range of more than 600 kilometers or 370 miles). Lower-priced batteries that are substantially smaller than those used in pure e-cars compensate for the costs of the dual drives. Here is an opening for the auto industry's capacity to innovate-a traditional strength. Indeed, the large number of innovations embodied in the range-extender concept for the Chevrolet Volt is remarkable. In combination with an intelligent control system, it provides an entirely new driving experience-one that's on a par with an eight-cylinder engine but with the gas consumption of a three cylinder. 6. Battery costs will be at a mass-production level by 2015

To convert a Smart car into an electric car, the production costs of the necessary 16 kWh lithium-ion battery-which supports a range of about 130 kilometers (80 miles)would currently fall between $8,000 and $10,000. Some 75 percent of that price would be the result of small-scale production using largely manual processes. The raw materials would account for only 25 percent of the costs. In all other respects, an e-car is about as expensive to build as a conventional car with a combustion engine. The electric drivetrain roughly equates to the cost of the traditional components such as the engine, transmission, fuel tank and exhaust. The battery is the central economic impediment to the widespread rollout of the e-car today. But what would a battery cost if production were running at 100,000 units per year? Or, to put it another way: When will batteries for electric cars be affordable? In an extensive process of reverse-engineering and by applying benchmark analyses, Bain made some calculations based on comparable industrial cost curves. On the basis of those calculations, it appears that from 2015 and beyond, batteries will be available that can make the electric car a viable massmarket product. Bain expects to see manufacturing costs of $250 to $350 per kWh by 2015, and $150 to $250 per kWh by 2020. Besides the necessary automation of processes and assembly, this also assumes that other, lower-cost basic chemicals and simplified testing and inspection procedures will be introduced. Given the number of engineering hours and the amount of research funding currently devoted to that technology worldwide, the scenario appears entirely achievable. By 2015, the battery for a Smart Electric Drive or a Chevrolet Volt is likely to cost only around $4,000; the battery for a Toyota Plug-in Prius, just $2,500. Assuming the battery will have a residual value of $800 to $1,200 at the end of its lifecycle, one of these vehicles would have to amortize $1,700 to $3,400 in battery costs over 10 years before interest. At current fuel and electricity prices, a Smart Electric Drive covering around 10,000 kilometers (6,200 miles) per year would represent a cost saving of around $500 per year a gasoline-powered model. What's more, if in 2015 the government were to subsidize one of these cars to the tune of $2,400, buying an e-car would pay for itself in just two and a half years. Historically, that is equivalent to the proliferation of diesel engines that initially struggled to compete with gasoline models and became widespread only thanks to subsidies-either through taxation or the price of diesel. 7. The electrification of the automobile is compelling and inevitable Automakers are already grappling with ever more stringent global CO2 and environmental legislation. The recent announcement by US President Barack Obama that carmakers will be compelled to reduce drastically the fuel consumption of their engines is a case in point. Some manufacturers will have to slash the CO2 emitted by their vehicles by 20 percent to 30 percent by 2015 or face substantial penalties. And that is just the beginning. By 2020 at the latest, for example, all car manufacturers in Europe will have to comply with a CO2 limit of 95 g/km. For some, that will mean a reduction of up to 50 percent compared with today. In the case of larger vehicles, this

reduction will barely be achievable by such conventional means as the downsizing or turbo-charging of combustion engines. Automakers have a variety of technological means to meet these climate protection goals. For example, they can cut fuel consumption by 3 percent to 5 percent by decoupling ancillary modules such as air-conditioning, power brakes and power steering. Through extensive simulations, Bain has analyzed the potential savings yielded by all the available means. Yet it is clear that the goals for 2020 can be achieved only if electric cars account for a high percentage of the vehicles sold. That means that many manufacturers will need to convert their large vehicles to hybrids and electrify their smaller ones on a large scale to reach the across-the range target of 95 g/km CO2. Alternative technologies, such as hydrogen fuel cells, for example, are still some 10 years away from serious production. What's more, the efficient production of hydrogen as well as transport, storage and the development of H2-filling stations are still unresolved. Nevertheless, it remains important to invest in that technology, since it appears to offer the only alternative in the commercial-vehicle sector. Given the great weight of such vehicles and their loads, it is unlikely that battery power alone can offer a universal solution for trucks. Ultimately, a fuel-cell car is still an electric car, but with its own "power plant." That power plant could also be a high-efficiency combustion engine running on biofuels. With the right vehicle design, the power plant would be needed only on rare occasions to provide energy- for example, on trips exceeding 60 kilometers (37 miles). Ambitious local and regional climate targets are here to stay-and inevitably, pave the way for greater e-mobility. A substantial proportion of the cars of the future will come equipped with an electric drivetrain, and will be powered either by a battery, combustion engine, fuel cell or a mixture of these. Conclusion: The race for the e-car has already begun. Those that wait too long will lose! The race for leadership in e-cars goes beyond auto manufacturers-it encompasses regions, nations and governments. The new technology promises a transformational shift in the auto industry: With e-cars, once again, every manufacturer in every country is at the same starting line. As in all races, the first to accelerate is likely to lead the pack. Recognizing that, governments across the globe are developing an e-mobility agenda to ensure the competitiveness of their e-car industry. Japan, one of the first countries to commit to the development of electric cars, has long followed a collaborative approach. The government works with industry players in areas like policy and setting standards and encourages industry players to invest in technology and infrastructure development. The government has also invested about $330 million in R&D to develop battery technology.

In the UK, government sees electric vehicles as a means to an end of aggressively cutting CO2 emissions. In the last few years, the UK government provided funding support to industry-led demonstration and collaborative R&D projects. And from 2011, UK consumers of electric vehicles can take advantage of subsidies of $3,000 to $7,000. London is leading the charge in e-cars; it provides free parking in many areas for evehicles, is aggressively switching the city fleet to electric autos and is building a comprehensive network of charging stations across the city. Another aggressive player is Israel, where the government has "authorized" a private electric vehicle service provider to build and operate the infrastructure and ensure the growth of a vibrant e-car industry in the country. In China, too, the government is actively promoting the development and rollout of e-vehicles. The goal: to ensure that at least 5 percent of all passenger car sales in 2011 come from new energy cars. With governments pushing the accelerator on e-vehicles, automakers realize they must change gears fast to service the growing demand for e-mobility. Joining the fray are major players with well-known global brands-as well as new entrants who are fast gaining ground with new offerings, in this suddenly level playing field. The Chevrolet Volt from General Motors, the Nissan Leaf and the Mitsubishi i-MiEv will all be launched before the end of this year-the first e-cars developed and manufactured using genuine mass-production processes. The Chevrolet Volt is a true electric car, which also has a small combustion engine to extend its range. It is based on the concept of an e-car with its own on-board power plant (a "range extender"). From 2011, the Volt will also be marketed in Europe as the Opel Ampera. Mitsubishi has already begun selling its purely battery-powered i-MiEV e-car-with a quoted electric range of around 160 kilometers-in Japan and England. PSA plans to market the e-car versions of the Peugeot and Citroen based on the i-MiEV while Renault will launch four different models before the end of this year. German auto companies are readying their offerings. Daimler's Smart Electric Drive is due to go on sale in 2012 and Volkswagen is expected to make its e-car debut with its ultra-compact Up model in 2014. BMW plans to launch a two-seater city car codenamed Project I in 2013. Sensing the opportunity to emerge as leading players in an evolving e-car global market, China's auto manufacturers are taking aggressive steps to make their mark. China already hosts some of the world's leading battery manufacturers. Battery and automaker BYD is expected to launch an e-car for the US market this year. At the recent Geneva Motor Show, Daimler announced that it is embarking on an extensive venture with BYD for the joint development and production of e-cars. Many more such collaborations will be the norm as the market for e-vehicles matures. Established auto manufacturers with leading auto brands will find consumers have a new notion of "premium." New entrants in electric vehicles will bring innovative technology to the table, but over time will need to develop brands and distribution channels. All auto manufacturers will have to rethink strategy based on the consumer's

emerging needs. Increasingly, for example, while buying cars people will not ask for mileage, but charging time-how far a car goes on a full tank will matter less to e-car owners than how quickly it recharges. The e-car presents the automotive industry with the most important technological change in its 100-plus-year history. As established auto brands line up with new e-car companies, the field is once again open. The market for e-vehicles may seem small right now-but it is slated to increase exponentially as e-mobility gathers momentum with better infrastructure, more government support and steadily increasing consumer demand. For automakers, parts suppliers or automobile manufacturing nations, the lights are flashing green. Those that are quick off the mark, change gears fast and ride over obstacles are likely to win the most ground. Glossary Electric car (e-car): An electric car has a drive system comprising a battery and one or more electric motors as the key elements. In principle, the battery is charged with electricity from an electrical outlet. Provided the battery is large enough (depending on the weight and size of the car), an electric car has a range of 150 to 200 kilometers (93 to 124 miles) before it has to be plugged back in. An electric car can be charged via any normal electrical outlet. Dependent on the residual charge and the size of the battery, the charging process takes between 15 minutes (for a heavy current charge) and eight hours (for a normal charge). Range extender: To extend their range, some electric cars have their own "power plant" on board. These vehicles are called range extenders or serial hybrids. The power plant provides the electricity required to keep driving when the battery has been discharged. As a result, the vehicle is not dependent on lengthy charging times and is more flexible in range. The power plant may be a small gasoline or diesel engine that drives an electrical generator. Fuel cells that generate electricity directly from hydrogen can also be used as the power source. Plug-in hybrids: Vehicles that can be driven both directly via a combustion engine and by an electric motor are called hybrids. If the battery of the independent on-board electric drive system is large enough, the car can also be charged from an electrical outlet-referred to as a plug-in hybrid, which also ranks as an electric vehicle since it can travel a certain distance entirely under electric power and without producing emissions. Today's plug-in hybrids have a purely electrical range of up to 30 kilometers (18.5 miles). Full/mild hybrids: Classic full or mild hybrid cars cannot be charged from an electrical outlet. Therefore, they do not rank as electric cars, and are not a form of e-mobility. Nevertheless, this technology, in which the combustion engine is supported by one or more electric motors in specific driving conditions, does provide alternatives. The electric motors are powered exclusively by surplus energy released during braking, for example, and stored in a comparatively small battery. Particularly in the case of large,

heavy or high-performance vehicles, some substantial savings can be made in fuel consumption and CO2 emissions. This technology can also be seen as a transitional solution on the way to electro-mobility. Dr. Gregor Matthies is a partner at Bain & Company in Munich and leads the European Automotive practice. His clients are primarily companies in the automobile and aerospace industries as well as private equity fund portfolio companies. He advises on issues of strategy development, organization and restructuring. After studying aviation and space technology in Munich, Gregor Matthies was awarded a doctorate in electrical engineering at the University of Duisburg. Dr. Klaus Stricker is a partner at Bain & Company in Frankfurt. His clients include companies in industry and the automotive business. He advises on issues of strategic reorientation, restructuring and reorganization. He also assists corporate clients in developing and implementing operational improvement programs. Klaus Stricker studied industrial engineering at the Technical University in Wien and was awarded a doctorate in production engineering. Dr. Jan Traenckner is an electro-mobility expert. After completing studies in electrical engineering and obtaining a doctorate as an engineer, he went on to work as a corporate consultant. As an expert in technology and innovation, he has been active since 1997 as an independent investor and strategy consultant. For the past two years he intensively studied e-mobility and also has experience in the strategic exploitation of technologically driven megatrends. Dr. Traenckner helps industrial companies better understand the new megatrend of e-mobility and position themselves accordingly. Reenergizing Japan, Inc.'s growth, company by company Bain Brief 06/08/10 by Vernon Altman, Toshihiko Hiura, Jim Verbeeten and Shintaro Okuno "Japan, Inc.," considered worldwide in the late 1980s as a leader in business expertise, has within it the seeds of a profound regeneration that could restore Japan's economy and businesses to their former prominence. Despite two decades of economic stagnation, the problems that Japanese business leaders face today are not rooted in some inherent societal or economic inhibitors, although elements of both have played a major role. Rather, the main barrier to new growth, as we see it, is structural; a situation that can be remedied-company by company-by a strategic reexamination and pruning of individual business portfolios to enable the generation of strong new platforms for superior performance. The essence of such a transformation begins with an understanding of core competencies within a company and its available profit pools. According to Bain & Company research, the majority of consolidated sales for many Japanese companies comes from areas of both low growth and low relative market share.

What's needed is an alternative vision-one that is growth oriented and will energize Japan's companies. Such a vision must inevitably focus on growing market segments, sometimes those that are adjacent to-or hidden inside-their current core. Where are those major new segments for growth? Geographically, they're largely in the emerging markets of the East-places ideally suited to allow Japanese companies to manage their structural transformations by aiming new strategies, and in many cases old technologies, at customers who are only now moving up the consumption curve. Japanese companies also need to look within their own competencies for "hidden assets," out of which they can create strong new core businesses. We will explain these processes in depth. The larger point is that, as Japanese companies make that transition, reallocating resources for robust new growth, they will produce funding and allow time to find answers to the challenges in their existing portfolios of businesses. Using a framework for transformation, we estimate that by increasing the current average sales growth rate of 2 percent to 5 percent and earnings before interest and taxes (EBIT) margins from 4.5 percent to 7 percent-along with improving the level of capital efficiencies by 10 percent-Japan's market cap could triple its current level. Japan can attain the peak it reached in the boom years, but without a bubble economy. What follows is Bain's thinking on where Japan is today-the starting point-and our recommendations for a methodology of transformation to bring the country into a brighter future-the point of arrival. Here, as we see it, are the logical steps along the way. The primacy of relative market share (RMS) Today, Japanese companies are at a turning point. Having endured a 20-year recession, hit by the recent global credit crisis and facing future systemic socioeconomic issues such as an aging population and a declining birth rate, they understand the need for change. And while it's true that some positive signs are emerging, many Japanese companies are still underperforming. A global economic slowdown, of course, would seem to be beyond individual companies' control. However, we argue that the root cause of this lingering underperformance lies in the structural problems that Japanese firms have been facing since the 1990s; indeed, the economic slowdown only accelerated and deepened existing issues. In other words, even before today's recession began, many Japanese companies had been experiencing low growth in sales and profits for a decade, and today Japan's labor productivity has become less competitive. While unit labor costs have been higher than the US since the early 1990s, Japanese companies have not been able to keep up their competiveness in terms of productivity. In the past decade, Japan's productivity improvements have lagged not only the emerging Asian nations but also most Western ones. Japanese businesses have also fallen behind emerging Asian nations and the

West in operational improvement initiatives, an area where Japanese companies traditionally excelled. Beyond those factors, though, the key reason for low sales and low profit growth lies in the decrease in global market share by Japanese players. Since 1996, the share of Japanese firms within the global top 50 companies involved in manufacturing, retail, healthcare and financial services industries has been cut in half or even more. Why is that significant? It is because relative market share (RMS) is the single most important profit driver in most industries; any decrease automatically widens the gap in profitability between Japanese companies and their global competitors. Global RMS leaders use cash generated from profits to nurture new products and technologies; and they invest in strategic mergers and acquisitions (M&A) to increase their relative market share with new capabilities and offerings that support and expand their cores. The consequences of a continued decline in relative market share of Japanese firms are stark: We estimate that, at the current rates of market share erosion, the value destroyed three years from now could equal 50 percent of current market capitalization. Simply put, Japanese firms need to look beyond near-term initiatives to thrive. What Japan, Inc. collectively needs is to stage a massive transformation of its business practices. Time is critical and change will be difficult. Yet at least the means for achieving such a national economic transformation is no mystery. Methods have been proven in other developed nations by companies facing similar systemic erosion in their markets. These firms have decreased in size to grow-exiting from and divesting businesses that are better suited to other players' core competencies-to enable significant new growth in segments where they have distinct advantages. Can Japan, Inc. learn from transformation examples elsewhere? In the past, one of the greatest strengths of Japanese firms has been to adopt and perfect business practices from anywhere in the world. Bain & Company has supported numerous successful corporate transformation projects in Europe, the US and Asia. One might think that Japanese firms could simply apply the best practices that have worked in the rest of the world. But, from Bain's long experience supporting numerous restructuring initiatives in Japan, we have learned that, although the strategic framework for transformation can be imported, one needs to apply a Japan-specific methodology. Nevertheless, examples from other countries are useful. Consider a large US manufacturer that truly shrank to grow. US Heavy Industry Co.: A dramatic turnaround through divesting 70 percent of its businesses In the 1980s, a company we'll call US Heavy Industry Co. was a world-class manufacturer in multiple technology and defense-related businesses, with more than $10 billion in sales. It had enjoyed expansion across almost all its major businesses. At

the peak of its growth, however, as the Cold War was ending, sales orders from its biggest client, the US government, suddenly fell. As a result, US Heavy Industry Co. posted a large loss in 1990. In a crisis atmosphere, a new CEO was appointed, and the company began its transformation for survival. Among its first steps, US Heavy Industry Co. closed down production facilities to avoid overcapacity and began instituting major cuts in its cost structure. The cuts included substantial reductions in its research and development (R&D) spending and bold moves to slash overhead. It also took aggressive action to reduce its working capital. These restructuring moves were combined with a strategic analysis of its core capabilities. After carefully examining its profitability, technological competitive advantage and market growth in each of its lines of business, the company's senior leaders decided to focus on a small number of truly core businesses. They divested 70 percent of the company's other businesses in just two years. The company could have held on to them, since they were not all unprofitable, but it found purchasers with a better strategic fit that were willing to pay for those units. As an immediate result, its $10 billion in sales fell to just $3 billion, while employee levels dropped by 70 percent, with most workers following their units to new owners. On the positive side, EBIT improved-going from in the red to $300 million. US Heavy Industry Co. then went on to increase scale in its core and adjacent businesses, acquiring nine businesses in seven years. The results were genuinely transformative. Sales rebounded from $3 billion to close to $20 billion (which was an annual 15 percent increase); EBIT increased from $300 million to $1.9 billion (an annual 18 percent increase); and market cap increased at an annual 20 percent rate. By shrinking to grow, US Heavy Industry Co. became the market leader in more than 75 percent of its new businesses. US Heavy Industry Co. is an example of a company that quickly reacted to a collapse in its profit structure; it reinvented itself by divesting non-core businesses and concentrated its investments in promising businesses in which it already had significant core advantages. Consider, now, how another firm handled a similar challenge. European Chemical Co.: A recovery based on building regional scale while focusing on profitable customers and products European Chemical Co., a European-based longtime market leader, lost significant market share due to a series of acquisitions made by competitors and the emergence of Middle East firms that had an overwhelming cost advantage. As the situation worsened, for the first time European Chemical Co. recorded a net loss, combined with an unsustainably high debt load. By 2004, it was close to breaching debt covenants and declaring bankruptcy. Rather than simply conceding that it had to find a way to struggle in a mature market, European Chemical Co. decided to narrow its focus on its most

profitable products and customer segments. It launched a series of innovations to differentiate its products and pursued an aggressive M&A strategy to increase its share in key core segments. Simultaneously, European Chemical Co. undertook a number of operational improvements to build profitability and generate cash quickly. More than $100 million in savings were realized by cutting overhead, rationalizing sourcing procedures and reducing redundant headcount. European Chemical Co. also honed its sales management strategies to increase its share of wallet among key customer segments. As part of this effort, it reviewed pricing strategies and launched initiatives to improve salesforce effectiveness. For instance, it found that its salesforce spent only 20 percent of their time face to face with customers, and little of it with new customers. Among other remedies, European Chemical Co. created administrative procedures to keep its salespeople in the field, and trained them in different skill sets for different key sales segments. It also began linking bonuses to specific performance indicators. The salesforce's efficiency and sales improved dramatically. European Chemical Co. also streamlined its organizational structure, clarified its decision-making processes and accountability, and defined the role of the corporate center in determining M&A strategies. In its narrowed customer segments, European Chemical Co. was able to generate a profit in the first year after the launch of its transformation and has improved its profit record ever since. Closer to Japan, Korean Financial Services Co. represents another core transformation. Korean Financial Services Co.: Creating major profit improvements by focusing on core customers Korean Financial Services Co. is one of Korea's insurance giants, which covers 70 percent of that nation's market. In 2002, it experienced large losses after a series of missteps stemming from unclear strategies and internal company turmoil. With its brand image suffering, it also suddenly found itself facing the entrance of foreign competitors into the Korean market. Inheriting this crisis, the newly appointed CEO began by enforcing strategies aimed at going back to the basics. Chief among those was to provide the right product to the right customers with the right sales strategies. How? Korean Financial Services Co. started by conducting customer segmentation analysis based on customers' purchase behaviors; it prioritized key customer segments, and identified the types of products and sales approaches it needed to attract those customers. Based on that work, Korean Financial Services Co. optimized its operations by serving certain segments with call centers. That freed its top sales teams to concentrate on the most profitable customers. And that wasn't all. Korean Financial Services Co. also moved to strengthen its product-design capabilities, improve service quality and optimize its overall financial structure.

Korean Financial Services Co. completed its transformation in just two years. The result: The company recorded a profit in the very first year after its transformation. Today, it has the highest profit level of any company in the Korean financial services industry. Criteria for transformation Successful transformations don't just happen. While a theme of fewer-but-better lines of business emerges in these examples, there is a set of specific practices that each company pursued. In our experience, leaders set four key priorities to create change.
They They They They

establish a winning strategy pursue best-in-class operational excellence build a high-performance organization to execute the strategy thoroughly look for financial optimization to support the strategy execution

Successful transformations do not need to take a long time. They can be executed in a comprehensive and coherent manner within two to three years. But they must be driven by strong leadership. Each of these three companies gained extraordinary results in a very short time. However, they paid a price, one that employees and other stakeholders shouldered, at least in the short term. The price-lost jobs and abandoned lines of business-is precisely the reason why Japanese managers have been reluctant to commit to such drastic measures. But Japanese firms' market share in the global arena has been declining even as the domestic market continues to shrink-all of which requires structural changes to survive. Japanese companies' senior managers often perceive the ability to change as limited by their responsibilities to employees and regional economies. As a result, they tend to focus on the two least disruptive techniques for a successful transformation: operational excellence and financial optimization. A methodology for transformation that is not based on reform Many Japanese companies-such as Nissan Motors, Canon, Mitsubishi Electronic, Toshiba and Panasonic-have restructured their management styles and dramatically improved their operations during the long economic downturn that began in the early 1990s. For example, Canon improved its EBIT margins from 9 percent in 1995 to 16 percent in 2005 while continuing to show sales growth throughout the period. It defined printers and digital cameras as its core businesses. It also strengthened cash flow management

and introduced its well-known cell production system. Through these performanceimprovement tactics, Canon's stock price increased five times faster than the Nikkei Stock Exchange average. Likewise, Nissan Motors improved its EBIT margins from 1 percent in 1999 to 10 percent in 2004, and also increased sales volume with a 7 percent annual growth rate. And Mitsubishi Electric succeeded in restructuring its portfolio and improved its EBIT margins from a negative 2 percent in 2001 to nearly 4 percent in 2004, all without a significant reduction in sales. These successes involved many of the key elements of a transformation. However, even these laudable efforts by leading companies fall short of what we'd call a full-fledged transformation, particularly when analyzing their actual long-term growth in sales and profits. Moreover, similar reforms enacted by other Japanese companies have been even less effective over the long run. Why? Some may argue that ineffective leadership is the root cause. However, even the best leaders cannot overcome deep structural problems by avoiding them. A look at the market for beer allows for a deeper examination of such core problems. 1. Larger relative market share is even more important in global competition The beer market reveals some compelling data: We traced the relationship between global relative market share and EBIT margins in the beer market over nearly a decade. EBIT margins ranged between 4 percent and nearly 9 percent during the 2001 to 2008 period for major Japanese beer companies such as Kirin and Asahi, each with less than 0.2 RMS. They managed to improve profitability by 5 percent through various operational initiatives, such as inventory reductions and logistical improvements. That alone is a tremendous achievement. However, EBIT margins of global market leaders with more than 0.5 RMS ranged between 11 percent and 29 percent during the same period. The ramifications of that difference in profitability are unavoidable: Even after a series of painful cost reductions and profitability improvement initiatives, companies with insignificant RMS will never be able to achieve the profit margins of players with marketleading positions. In contrast, companies with significant RMS positions can garner higher margins-often without such extraordinary efforts-while taking advantage of their scale when they conduct margin improvement initiatives. This hard-and-fast rule is applicable not only to the worldwide beer market. The gap has grown larger in RMS and profitability among top companies and the rest of the players over 10 years. Traditional Japanese companies have boosted performance mainly through "full potential" operational improvement initiatives. Yet, try as they might, the data clearly

indicates that even the most efficient companies can never overtake global leaders just by operational improvements. 2. The link between core competence and leadership position There is no substitute for RMS in determining leadership and profitability. The way to begin gaining a higher RMS is by establishing a "winning strategy." Such a strategy is based on creating a replicable formula for honing and expanding the core business to generate cash for further investments in those areas in which a company is uniquely suited to compete. That also implies that companies must cut investments in businesses with no leadership prospects. The importance of concentrating on core competencies is clear. For instance, our research shows that those Japanese companies that exited from unrelated businesses, on average, realized 3 percent higher shareholder returns compared with those that did not exit any businesses. That's not all. These businesses also grew employment faster than others, suggesting that, in the long run, making such hard decisions pays off for shareholders and employees alike. In other words, one of the biggest reasons for underperformance by Japanese firms is their inability to refocus their proven leadership in operational excellence for new strategies that fit their changed circumstances. That is not to say that Japanese businesses are not trying to make structural changes. The difference lies in defining business limits clearly and making hard choices of what is within and outside of those limits. For example, one major Japanese company defined three of its business domains as its "core" businesses. But the nature of its definition was flawed. The company selected the three based on the size of sales within the existing company. It didn't understand that even cash cows do not necessarily make a core business. Instead, a core business needs to be narrowly based on a clear business definition, prospects for growth in a current market's profit pool and the company's ability to achieve market leadership. In this case, there were some units within its core business domains that actually were just that, when based on properly defined criteria. But they were mixed in among the rest, severely limiting the company's ability to focus the human and capital resources they needed to achieve market leadership. By holding on to too many non-core businesses, the company diluted the potential of the units that had the brightest prospects. Indeed, the company's non-core businesses accounted for fully 80 percent of total consolidated sales. That is all too typical. Another major Japanese manufacturer restructured its traditional divisional system, and consolidated business units to address various inefficiencies. However, it did not undertake a radical restructuring of its business portfolio. It

maintained a host of businesses unlikely ever to achieve leadership positions. Having defined its core too broadly, its financial performance and stock price have continued to slump. 3. Finding the seeds of growth is the key challenge Why do Japanese firms have such a hard time concentrating their efforts on core competencies and businesses? Some believe the reason lies in traditional Japanese business logic, which focuses on the "reasons to keep" rather than the "logic to exit," when companies are considering downsizing or withdrawing from unprofitable businesses. While many Japanese executives understand that evaluation criteria like profitability, market share and growth opportunity would dictate an exit, still very often we hear imperatives such as "keeping the manufacturing know-how and technologies for future growth," or "maintaining employment to meet the social norms." Alternatives are to "utilize what we have accumulated in the past," or "to pursue a step-up with existing strengths, without denying the past." Sometimes such imperatives can be overriding arguments to maintain a business-for instance, if the company believes that products or technologies may converge so that what now looks like an orphan business may end up being a key differentiating factor in a new product. However, all too often, these "imperatives" are excuses for not having made difficult and unpopular decisions. That is understandable if management cannot offer an alternative ambitious vision for the future that can energize management, employees and stakeholders alike. Imagine the situation of NEC and Fujitsu versus that of IBM, shown below. NEC and Fujitsu would not be able simply to exit markets in which they have limited relative market share, for there would be virtually nothing left. So how can management develop such a vision from a typical portfolio of businesses in which 60 percent to 80 percent of sales come from low-growth and low-RMS businesses? The answer starts with a thorough diagnosis of profit pools, relative market share and unique core capabilities. Obviously, companies need to find new and growing markets, with new profit pools, to pursue. But where are they? Bain's research shows that companies with a history of sustainable growth-those that have grown revenues as well as earnings at more than 5 percent annually while also generating returns for equity holders above their cost of equity for 10 years-always generate that performance by doing three things related to their core business over time. First, they invest in their core. Second, they seek growth opportunities around the core by expanding into nearby adjacencies. Finally, they redefine their core as profit pools shift. Note, however, that they neither abandon the core nor stick with dwindling cores. The first and second steps are precisely what Japanese companies need to take now to revamp their core business for new growth. As to the last-redefining the core-Bain's study of hundreds of companies shows that their odds for success increase as much as

four to eight times when they utilize "hidden assets" that are overlooked, undervalued or underutilized within the firm. Most hidden assets fall into three categories: untapped customer insights, undervalued business platforms and underexploited capabilities. Each can provide the foundation on which a company can redefine its core. Let's look at cases involving each. Harman International, a leading company in the high-end audio segment, built its automotive "infotainment" systems business by harnessing its abundant amount of data about its high-end customers' needs. In the case of undervalued business platforms, IBM redefined its core as a services company by using its existing customer services support organization, which it had built to support its hardware sales. Finally, Apple is a good example of underutilized capabilities, as it extended its design and software capabilities honed in the personal computer business to generate a new core music business with its iPod models. 4. Japan, Inc.'s greatest growth potential lies nearby-in Asia Where should Japanese firms develop and expand their new core businesses? As many executives have already decided, the geographic locus should be in Asia. Not only is it the fastest-growing market, but it is also nearby and has cultural affinities. Indeed, even before the Lehman Brothers shock, the center of global economic growth had been shifting from the developed countries to the emerging markets, many of them in Asia. The annual real-GDP growth rate in Asia, excluding Japan, was 8.5 percent in the 2004 through 2008 period. Those in the European Union, US and Japan were below the world average of 3.6 percent. Yet developing nations, most of which are Asian, could account for about a half of the world gross domestic product (GDP) in 20 years, assuming all regions continue to grow at the same rate. However, with the exception of automotive companies, most Japanese companies have not captured the growth potential that Asia provides. The average annual regional sales growth in Asia, excluding Japan, for 11 major Japanese companies was 6.1 percent. That figure lagged annual GDP of the region by almost 2.5 percent. Who are the global winners in Asia? According to market share rankings, Japanese companies have relatively small market share. Interestingly, European and Korean companies have achieved dominance in particular geographic areas and industries. These overseas businesses provide not only substantial profits, they lead the overall growth for these European and Korean companies. Volkswagen in China and LG Electronics in India are telling examples of such successful non-Japanese companies. Suzuki's India business is one good example of a Japanese company. How do these companies succeed?

LG in India, for example, sells color televisions, refrigerators, microwave ovens and other appliances. The company's products have penetrated the nation during its rapid economic growth period. Today, it is a major player in the "mainstream segment," which represents some 90 percent of the Indian market. LG succeeded by mining its core for hidden assets. Today, it sells less-expensive products developed for the Indian market in addition to premium products that were originally developed for the Korean and other developed markets. LG has pursued a local strategy by building sales networks across India, by developing products in three Indian R&D facilities and by hiring in-country managers who are trained in India. By meeting target customer needs combined with competitive pricing, LG has gained and maintained a high market share of 20 percent to 32 percent, depending on specific consumer electronics products. Significantly, these "good enough" products are based on legacy technologies that prevailed 30 years ago in Japan. In other words, that hidden asset needed little development to become the right technology at the right price for the right market. In contrast, many Japanese companies have focused on premium segments. An executive at a major consumer electronic company explained that his company not only aims solely at the high-end segment, it also does not care about the entire market share. That attitude seems shortsighted. The strategy certainly works well in markets where the proportion of profits held by the premium segment is relatively large-such as Thailand, Malaysia, Indonesia and some industries in Vietnam. However, population segments with low disposable income cover the majority of the market in the largest of the rapidly growing markets, China and India. Numerous cases show that substantial profits are possible in low-income segments, once players achieve overwhelming market share. For example, while LG India's profit margin has declined somewhat in recent years, it remains near the same level as its corporate average. Suzuki does even better. Its profit margin in India reached nearly 13 percent in fiscal year 2007, three times higher than its consolidated EBIT margins of more than 4 percent. Japanese firms need to abandon their typical overseas entry method of simply exporting their Japanese products. While that may have worked in the past when penetrating equally affluent European and North American markets, in emerging Asia, the largest opportunity is in a different segment. There, Japanese firms must pursue a strategy of serving less affluent customers. And like LG, that may involve revisiting underappreciated, even dated, assets. 5. Leadership and organizational perspectives Organizationally, companies must begin this journey from Japan-centric to internationally oriented organizations. Such a transformation starts from within and requires leadership that is both strong and broad. Ultimately, it will also take a transformation of traditional ways of doing business.

Three things are needed:

The

internationalization of company talent, to increase effectiveness in both the local and global spheres An attitudinal change at all levels, to reflect a sense of business "ownership" rather than being a representative of line organization and Fresh perspectives from the top None of these changes will be easy, nor can they simply be mandated by current leadership. Some understanding of each is necessary. The need for an international talent base grows from an understanding of Japanese companies' difficulties, going back to the 1980s, in capturing the full value from overseas acquisitions. Time and again, senior managers were dispatched from headquarters to run these operations to ensure control over this far-away subsidiary. As a consequence, a valuable local knowledge network-of everything from sourcing to customer desires-was often underutilized. That also meant a limited career path for nonJapanese managers, who tended to feel they had little influence on decision making or were limited in their progression to management levels. This has proven an extremely difficult situation to solve. How can headquarters control far-flung operations through guidance, training and support functions-without stifling ambition and innovation? There are no easy answers. But a strong and flexible model, one that enhances rather than restricts foreign operations, is the goal. Today, attitudes and responsibility roles in traditional Japanese firms dictate a consensus style of management. Outspoken opinions in open meetings are considered challenging and rude. In such a setting, there is no clear understanding about who has the final authority to make a decision. Everyone may appear to agree on a decision, yet none has really been made. Nor, is any particular person responsible for carrying it out. In this situation, "consensus" for one person may not necessarily be the consensus for the other management leaders, and the risk of such miscommunication will grow as the company becomes more global. That is not to advocate an American decision style, where each person in a meeting tries to assert his or her opinion. The point, rather, is that bringing ownership and clear responsibility to the management team in Japanese companies will strengthen the "real" consensus-based management style in the current business environment. Fresh perspectives from the top are necessary to make that happen. Indeed, high level openness to new thinking is essential to create a marketplace for competing ideas that will help return Japan, Inc. to its former preeminence. Yet of 15 recent CEO hires for top technology and industrial companies, all came from within their corporations. A closed system of promotion doesn't necessarily mean a lack of openness. But externally hired managers, by definition, bring with them an ability to "think outside the box." Terumo is a good example. In the early 1990s, Terumo had stuck with its origins as a clinical thermometer manufacturer. It posted deficits for three consecutive fiscal

years, primarily caused by competition from imports. Their inroads rapidly commoditized medical devices, such as injectors and transfusion device, which accounted for 70 percent of Terumo's sales. But then Takashi Waji, originally a banker at Fuji Bank (now Mizuho Bank), was named CEO in 1995. Looking at the business with what some might call "intelligent ignorance," he discovered profitable hidden assets in Terumo's technical superiority in medical device manufacturing and in its strong connections with doctors. Under his leadership, Terumo decided to focus on therapeutic devices, as opposed to medical technology, as its new core business. It was a stunning insight. At the time, no Japanese companies focused on that core. Terumo set the cardiac-vascular product group as the main pillar of its medium-term business plan, which started in 1999. To ensure success, it collaborated with doctors and researchers to develop the new product line. Aggressively executing M&A strategies, Terumo acquired an artificial heart-lung machine business from 3M to expand that new core. By March 2007, that product group had grown to encompass 40 percent of the company's overall sales and 50 percent of EBIT. In the process, Terumo increased its EBIT margins to 21 percent, with its new core business contributing to gain top market share. Externally hired CEOs are rare in Japan. But fresh thinking may also come in the form of company executives with atypical career paths-"insiders" who also bring intelligence and creativity to areas in which they have no deep-seated expertise or vested interest. For example, Fujio Mitarai, former president of Canon, spent 23 years-indeed, most of his career-in the United States. Tamotsu Nomakuchi, former president of Mitsubishi Electric, may have brought a more inquisitive viewpoint to the company because his background was in R&D. The lesson is that agents for transformation, even though they are often regarded as mavericks within a company, are able to bring an objective, even outsider perspective to key decisions facing the company. The rewards from a successful transformation The rewards of a company's successful transformation of its business practices and focus will be truly enormous. By aligning growth, profitability and level of capital efficiencies to the average of global corporations, it is possible to dramatically expand Japanese companies' value-and break out of the economic slump. That would mean increasing their current average sales growth rate of 2 percent to 5 percent and EBIT margins from 4.5 percent to 7 percent-along with improving the level of capital efficiencies by 10 percent. The result would be more than a threefold increase in Japan's market cap.

Tripling the current market cap would return Japan's stock price average to the level attained in the era of "Japan as No. 1"-but without the bubble economy. After two decades of economic stagnation in Japan, one might think that another decade or so would be needed to secure such a wholesale transformation. However, for any individual company-based on Bain's experience-we believe the initial phase of establishing new strategies can be completed within half a year. And it would take from two to three years to implement fully, with initial results showing up as early as six to 12 months into the program. What Bain proposes is indeed achievable, and represents a point of arrival certainly well worth the structural changes needed to get there. Japan, Inc. can indeed be reborn by redefining its companies' cores, by developing focused growth strategies that exploit "hidden assets" and by fully participating in Asia's growth dynamic. Ultimately, what's needed is a series of bold decisions by CEOs-leaders who can both question and learn from tradition-who will start their companies, and the nation, down the necessary path of transformation. Getting started Business leaders have the responsibility of creating a vision for their companies' futures and then making the critical decisions that will ensure it happens. The process begins with a thorough and honest analysis of a point of departure. To help in that determination, CEOs should consider three key questions: 1. Is my company a candidate for transformation? In other words, are some of the structural and performance observations discussed applicable to my situation? 2. Are my management team and I prepared to step up to the challenge and drive the necessary approach and discipline in order to make a difference? 3. Are my team and I committed to do what it takes over a period of two to three years to get to meaningful results and change in the organization? If the answers are yes to these questions, then the process has already begun. Vernon Altman is a director of Bain & Company and founder of the company's Japanese practice. He leads Bain's full-potential transformation practice. Toshihiko Hiura is a director in Bain's Tokyo office. Jim Verbeeten and Shintaro Okuno are managers in Bain's Tokyo office. Six ways to make healthcare deals work Industry Brief 06/03/10 by Bain Global Healthcare practice Conventional wisdom says mergers and acquisitions (M&A) in healthcare are like rolling dice: It's hard to guarantee success due to the technical, regulatory and commercial risk involved. In reality, if companies follow a tried and tested approach to managing deals,

they dramatically improve the odds in their favor.1 Healthcare companies that excel in the art of the merger outperform acquirers in many other industries. According to the Bain & Company Healthcare Manufacturer Merger and Acquisition Database, consisting of pharmaceutical, biotech, medical device and diagnostics transactions, almost 60 percent of the healthcare deals between 1995 and 2008 generated higher returns compared with peers. Consider the six factors that contribute to the success of topperforming acquirers: They maintain a regular pace of M&A activity.Companies that execute more than one deal every two years steadily build distinctive competencies. Bain's research on "frequent acquirers" shows such companies improve their skills in integrating assets over time.2 That allows them to extract more value and achieve higher returns than the market average. Frequent acquirers in healthcare outperform the market comfortably. In the last two decades, companies like Abbott Laboratories, Medtronic, Pfizer and Roche successfully invested in more than two dozen deals each. Over time, they built their organizations' "muscles" to execute deals well. Before the transaction, they invest in adequate due diligence and identify potential areas of value realistically. Post-deal, they effectively combine assets and integrate the businesses as quickly as possible. Most important, they ensure that the merger or acquisition does not distract from their core business. They focus on smaller "tuck-in" acquisitions. Smaller, frequent deals tend to support a more comprehensive growth strategy and can often deliver substantially higher returns. Large deals initiated from a position of weakness-for example, after exhausting all other growth avenues-seldom deliver excess returns. A comparison of 13 industries in Bain's Acquisition Success Study shows that, on average, large acquisitions in the healthcare sector eroded value for acquirers and performed below the industry index. Only three sectors-industrials, transportation and technology-did worse. Companies that pursue a "string of pearls" strategy by frequently acquiring smaller assets deliver sustainable, higher returns. For example, between December 2008 and January 2009, Johnson & Johnson's Ethicon unit successfully acquired three companies-Omrix (biosurgicals), Mentor (aesthetic medtech) and Acclarent (ENT devices)-to fill out its portfolio. Generally, such healthcare acquirers post excess returns close to 3.5 percent, compared with less than 1 percent for those that pursue only larger deals.3 They value internal and external sources of innovation. In order to access the best innovative ideas, industry leaders increasingly apply the same analytical rigor to products and technologies whether they come from internal or external sources. That is particularly critical in healthcare, where market leaders rarely command a majority share of the market, and mergers and acquisitions don't necessarily solve the problem of stimulating innovation.

Following the Wyeth acquisition in 2009, Pfizer's market share grew, but only to 11 percent of the total global market. Assuming a fairly consistent level of research and development (R&D) productivity across the industry, the combined company can generate only a fraction of the innovation needed to drive sustainable growth. The company therefore must remain open to innovation outside its walls. They invest when others don't. The economic downturn substantially reduced the number of deals in the healthcare sector. Despite several large, high-profile pharma deals such as Roche-Genentech, Pfizer's acquisition of Wyeth and Merck's acquisition of Schering-Plough, the total number of healthcare deals (globally) in 2009 fell to just over half of the average number of deals per year between 2006 and 2008. Nevertheless, experience shows that the more broad based and extended the downturn, the greater the opportunity for the right pharma or medtech company to create significant value through acquisitions. In the 2001 downturn, healthcare acquirers created higher shareholder returns compared with all other industries except telecom and energy. It pays to play the odds for several reasons. First, slower economic cycles make it easier for acquirers to deliver outsized returns compared with peers. In the relatively mild downturn of 2001-2003, for example, healthcare acquirers outperformed the industry indexes by 17 percent, compared with the preceding period of "irrational exuberance" between 1998 and 2000, when they outperformed indexes by just 6 percent. As the economy recovered between 2004 and 2007, returns posted by acquirers regressed to just 4 percent higher than the industry average. Second, down cycles help buffer the risk for acquirers. While on average 40 to 50 percent of deals fail to create value, the "failure rate" decreases to 30 percent during a downturn. When valuations fall, healthcare companies with strong cash positions can confidently accelerate merger and acquisition activity. They invest close to the core. Deal success is a function of how the acquired asset relates to the core business.4 Acquisitions that capitalize on existing customer relationships or capability platforms succeed more often. Johnson & Johnson's Omrix, Mentor and Acclarent deals added value because each acquisition found a place in the company's existing product and technology portfolio. In recent years, several leading pharmaceutical and medical technology companies have turned to acquisitions as a strategy to spur growth. Companies shopped for products, technology and even competitors to supplement their R&D pipelines and boost the bottom line. The ones most likely to succeed: those that acquired assets and skills that strengthened the core. They approach large deals selectively. Some healthcare sectors score better than others when it comes to the size of the deal. Between 1995 and 2008, pharma deals yielded 2.1 percent above their sector index, but medtech acquirers did three times better, with excess returns of 7.7 percent. Within pharma, larger-scale acquisitions tended to post substantially higher excess returns. Often, acquirers saved costs by

consolidating the commercial and administrative functions of the two pharma companies. Smaller pharma transactions such as product tuck-ins or co-marketing deals posted lower returns (2 percent), reflecting the increasingly competitive licensing and acquisitions market for such deals. In the medtech industry, large and small deals showed comparable results, as these acquisitions focused on the less risky strategy of product- and technology-platform expansion. Large or small, acquirers capture the full value of the deal only when they avoid the three most common pitfalls of post-merger integration. First, missed targets: Companies fail to define clearly and succinctly the deal's primary sources of value and its key risks, so they don't set clear priorities for integration. For pharma companies, the issue becomes complex when R&D pipelines need integration. Second, the loss of key people often derails efficient integration. Many companies wait too long to put new organizational structures and leadership in place; in the meantime, talented executives and key researchers leave. Pharma companies flounder if they don't address cultural matters-the "soft" issues that determine how people in key areas like R&D and marketing and sales feel about the new environment. Third, the larger the deal, the more the acquiring pharma company has to guard against poor performance in the base business. Often integration soaks up too much energy and attention, or worse, drags on too long. Uncoordinated actions, contradictory communications to customers, or poorly managed systems migrations buffet the business and weaken the core. Competitors quickly step in to take advantage of the confusion. Despite these challenges, most healthcare companies cannot afford to ignore deals as a path to growth. Bain research on the annual excess returns of companies across industries that had done more than 100 deals over a 10-year period shows they outperformed companies that did no deals at all. The frequent acquirers posted an annual excess return of 3 percent, while inactive companies lost 0.2 percent. Moreover, the right deal can offset the headwinds pharma and medtech companies face due to increasing regulatory hurdles, price pressures, rising competition, decreasing physician influence and stagnation in innovation. If adequate care is taken pre- and post-transaction and the merger or acquisition results in a robust pipeline of innovative, clinically differentiated products, a pharma company can confidentially hunt for targets. Such deals hit the jackpot when they create value for all stakeholders: employees, payers, physicians, distributors, patients and investors.

1 David Harding and Sam Rovit, Mastering the merger: Four critical decisions that make or break the deal (Harvard Business Press, 2004). 2 Bain Long-term Acquirer Performance Study. 3 A company's annualized total shareholder return minus its cost of equity. 4 Chris Zook and James Allen, Profit from the core: A return to growth in turbulent times (Harvard Business Press, 2010).

Key contacts in Bain & Company's Global Healthcare practice: Americas: Tim van Biesen Europe: Norbert Hueltenschmidt Asia: Hirotaka Yabuki in Tokyo in in New York Zurich

Key contacts in Bain & Company's Corporate M&A practice: Americas: David Harding Europe: Axel Seemann Asia: John Sequeira in Hong Kong For additional information, please visit www.bain.com Right-sizing the balance sheet Bain Brief 05/10/10 by Michael C. Mankins, David Sweig and Mike Baxter When performance is an issue, executives focus mainly on the income statement and cut costs. But tight management of the balance sheet often liberates more cash, preserves options and drives value for shareholders. When the pressure builds to improve performance, most business leaders adopt measures that affect the income statement They cut discretionary spending. They centralize support functions. They lop off unnecessary layers of management, eliminate low-value projects and so on, all with an eye to "rightsizing" the cost structure. And of course they do what they can to increase profitable sales. While all these efforts can boost results, they overlook one of the largest sources of value: the balance sheet. Companies often hold far more working capital than they need to. They make ill-timed or ill-advised capital investments. They own unnecessary or unproductive fixed assets. When management teams focus disproportionately on the P&L, they often miss those issues. In fact, some measures designed to manage costs can actually inflate the balance sheet, consuming cash and destroying value. But a handful of high-performing companies pursue a more evenhanded approach to financial management. They manage the balance sheet as tightly and as assiduously as they manage the profit and loss statement (P&L), and they reap outsized rewards for their efforts. While these companies approach it differently, they usually have six common imperatives. The companies: 1. Track precisely where capital is currently deployed 2. Actively manage working capital in in Boston Frankfurt

3. 4. 5. 6.

Zero-base the capital budget Liberate fixed capital Employ alternative ownership models Create processes and systems to prevent "capital creep"

Measures like these typically free up significant amounts of cash, which can then be redeployed to generate the greatest returns. The result is increased shareholder value at a lower cost than efforts focusing on the P&L alone. There is no magic here, just a different frame of reference and a series of practical, well-honed disciplines-disciplines that any company can use to improve its performance. 1. Track the current deployment of capital, mapping capital to each business, product, customer, geography and activity. Few companies track balance sheet information deeper than the company level. In our experience, fewer than 15 percent of CFOs from companies in North America and Western Europe have routine visibility into the balance sheet of any unit or area below a division. It seems the vast majority of CFOs have only a limited understanding of where their capital is currently invested. And their managers can't know the true economic profitability of the products and services for which they are responsible. John Deere is different. The big-equipment manufacturer compiles detailed balance sheet information business by business, product by product and plant by plant. "Granularity is essential," says former CFO Mike Mack, now president of the company's worldwide construction and forestry division. So, he adds, are transparency and consistency. "We use the same measures for every business everywhere in the world." Once capital use is measured at that level, executives can manage it closely. At Deere, every division, product and plant in the company has what's known as an "OROA line"an annual target for operating return on assets. Managers have quickly learned what actions are required to hit their targets and have been remarkably successful in boosting Deere's performance. Companywide, Deere's return on invested capital (ROIC) rose from negative 5 percent in 2001 to nearly 40 percent in 2008. Without a visible balance sheet, operating managers are encouraged to play the game of making the best case for their business's allocation of capital-because once the allocation is made, the resources will carry no costs. Companies with granular balance sheet information, in contrast, can assign appropriate capital costs to each unit and product, assess true performance and take appropriate action. When Northrop Grumman began compiling detailed balance sheet data and assessing return on net assets (RONA) results, for instance, it found that some areas of the company were "capital hogs" with low RONA. Senior executives were then able reduce capital use, drive profit improvements and de-emphasize units that weren't able to generate adequate return on capital.

2. Actively manage working capital, limiting the resources tied up in funding other people's businesses and using others' money where possible to fund your own. Beginning in 2001, Deere mounted a multipronged attack on working capital. First it honed its information technology systems, to the point where it had good, easily accessible data on fill rates for each product by week and by SKU (stock-keeping unit). That allowed it to shorten terms for dealers while giving them confidence that the company could replace inventories fast enough to avoid lost sales. Between 1998 and 2008, Deere tripled its sales but kept trade receivables flat, avoiding a $7 billion increase in working capital. The company also took bold measures to reduce work-inprocess inventory. One drive-train assembly line, for instance, cut production time over a four-year period from 44 days to just 6 days by modernizing production facilities and introducing lean manufacturing techniques. Cisco Systems is another company that focused intensely on working capital. Earlier in the decade, the company improved days sales outstanding every year for three years-"We were maniacal about collections," says one executive. Inventory turns also improved, and the company began tracking purchase commitments closely to keep payables under tight control. Cisco even began examining its customers' working capital levels. Bottlenecks in a customer's operations, the company found, often led to slow collections on the customer's part and slow receivables for Cisco. Helping customers fix their problems benefited both parties. 3. Zero-base your capital budgets, setting an implicit (or explicit) limit on capital expenditures based on the performance of the business. At most companies, of course, working capital represents a relatively small percentage of total capital requirements. For the average company in the Standard & Poor's 500, investments in fixed assets account for more than 40 percent of total investments. Therefore, right-sizing the balance sheet requires companies to challenge conventional assumptions about fixed capital. ITT is a prime example of a company that does just that. ITT develops detailed capital budgets by value center and by group. The company's rule of thumb is that any business should be able to sustain its position by investing at a rate equal to 70 percent of depreciation. But ITT doesn't assume that every business is entitled to that much. And it doesn't spread capital like peanut butter across its various units, giving each a proportionately equal amount. Instead it analyzes the strategic position of each business-its market attractiveness and its ability to win-and applies differential targets for investment. Thus highly advantaged businesses, those with high ROIC and good growth prospects, might receive investment at 90 percent or more of depreciation while disadvantaged businesses might get only 50 percent. The process allows the company to fuel its growth without overinvesting in unattractive businesses. ITT also stretches out its capital plan when appropriate. During the recent downturn, the company asked several of its businesses to reschedule their facilities and slow down orders to prevent the buildup of excess inventory. ITT corporate management then held back half of the capital it had budgeted in order to ensure sufficient liquidity, pay down

debt and reduce borrowing costs. Thanks to such measures, the company wound up with a stronger liquidity position than many of its peers and was able to make more strategic investments. One key to effective capital budgeting is to set targets for asset productivity. Like individuals, capital should become more productive over time. Yet many companies don't have explicit capital productivity targets, and so they spend more capital without requiring more output. Companies such as Deere, in contrast, set explicit, granular productivity targets for their assets and use these targets to reverse-engineer the appropriate level of capital expenditures for each business. 4. Liberate fixed capital, identifying low-hanging fruit and redeploying your capital accordingly. Many companies have paid so little attention to their balance sheets that 20 percent of their invested capital accounts for 100 percent or more of the company's value. Even better-managed companies typically have their share of unprofitable products, customers and businesses. The capital devoted to those areas is essentially wasted, and liberating it can lead to significant value creation. That's why many companies-particularly those with new owners or those facing a cash crunch-go on "liquidity hunts" to identify underutilized capital that can be converted into cash. Meatpacker Swift & Co. is an example. Beef gross margins were negative at points during 2005 and 2006 due to declining herd sizes and the continued closure of foreign markets as a result of the mad cow scare. With close to $1 billion in debt and declining free cash flow, management became concerned about future liquidity squeezes and launched a balance sheet review to find "trapped" capital that could be redeployed. It sold its cow division, liquidated excess real estate, sold water rights in Colorado, tightened working capital and divested a distribution business in Hawaii. Raising $60 million through these and other measures, the company got out in front of a possible liquidity crunch, avoided problems and maintained flexibility. Its owners eventually sold the company in 2007 for a 20 percent return. In companies that have never managed capital, such as Yahoo! until just recently, executives may be unfamiliar with the balance sheet or the cost of holding unnecessary assets. Freeing up capital can entail a substantial change in mindset-executives must rethink the way they run their business. Assets that previously were considered essential for the company to own, such as data centers, can be outsourced, liberating significant amounts of cash and reducing long-term costs. Sometimes entire segments of the business can be outsourced-the search business to Microsoft, for example. That can simultaneously reduce future capital investments and provide customers with a more appealing offer. 5. Explore new ownership models, pursuing strategies that allow your business to own fewer assets or seeking third parties to own your assets for you.

Actively managing working capital, zero-basing capital budgets and liberating fixed capital are just a few of the steps superior capital managers use to streamline the balance sheet. Over time, the obsession with a lean and efficient balance sheet encourages many executives to explore entirely new approaches to their business. They essentially create a new business model, disaggregating the value chain and shifting fixed capital from their own balance sheets to those of advantaged owners. The classic example is Marriott, which recognized in the mid-1980s that its core business was managing hotels, not owning real estate. As a result, it began divesting its hotel properties, creating limited partnership arrangements and selling them to taxadvantaged investors. Companies in semiconductors, transportation and other industries have taken similar measures more recently. A logistics company today, for example, may own few warehouses or trucks, and instead contract with companies or individuals who do. Such tactics enable businesses that would otherwise be capitalintensive to generate higher returns and grow more profitably. 6. Establish processes and systems to avoid "capital creep," putting procedures and protocols in place to reinforce prudent balance sheet management. If you talk to executives at companies known for their balance sheet management, you immediately hear a different way of thinking. People regularly discuss balance sheet measures. They're aware of the cost of capital. That kind of culture is typically reinforced by a host of policies and systems that encourage managers to continue taking the balance sheet into account in their day-to-day running of the business. One such policy-a powerful one-is to reward managers for hitting balance sheet targets, just as most are already rewarded for hitting income statement targets. Deere ties compensation to performance against the OROA line. Northrop Grumman establishes long-term incentives for improvement in RONA; it has also created formal training programs to help executives get comfortable with balance sheet measures. ITT ties compensation to performance against all of its "premier metrics," one of which is return on invested capital. Some astute balance sheet managers, such as Dow Chemical, create two-way performance contracts. The corporate center agrees to provide a certain level of resources to the businesses; and business-unit leaders commit to a certain level of performance. That is an essential policy for any investment requiring a long-time horizon. Most balance sheet investments represent multiyear commitments-the corporation invests now and may not see a return until much later. Without some form of contract, good money can be poured after bad and losing projects will never be cut short. Ultimately, of course, managing the balance sheet is all about freeing up cash and redeploying it in the best way possible. Most companies that successfully manage their assets find themselves developing cultures that emphasize not just the balance sheet but cash as well. Cash is "in the water here," says Steve Loranger of ITT. An executive

at Ford Motor Co. says, "We've changed the culture at Ford from one focused almost exclusively on the P&L to one focused on the P&L and cash." (See sidebar, "The 'Cash Lens' at Ford," next page.)Managers thus learn to take into account the cash implications of whatever they do-and they strengthen the balance sheet accordingly. Conclusion Right-sizing the balance sheet offers most companies an enormous opportunity to create shareholder value, in both good times and bad. Granular measures show where capital is currently being deployed. Aggressive management of both working and fixed capital frees up large amounts of cash. New ownership models enable once capitalintensive businesses to prosper with fewer assets. And processes and incentives that encourage careful balance sheet management help ensure sustainable gains. Over time, right-sizing the balance sheet becomes part of a company's culture-a culture where managers at every level of the company see the importance of carefully managing assets and liabilities and act accordingly. The "Cash Lens" at Ford "Everyone understands cash in their personal lives," says Lewis Booth, chief financial officer of Ford Motor Co. "But we didn't begin to focus on it at Ford until just the last few years. The reason? We had to." Facing a liquidity crunch in 2006, Ford executives under new CEO Alan Mulally rediscovered the balance sheet-and the importance of cash. Today, say Booth and other top executives, the company tracks cash balances every day instead of every month or every quarter. And the cash implications of nearly every action are clearly laid out before any decision is made. A company that focuses on cash, such as Ford, essentially learns to view its business through a different lens. For example:
People

begin to understand the "physicals" of cash. When vehicles are on hold, for instance, rather than being put into production, that creates a cash problem as well as a profit problem for Ford. Therefore, managers do everything possible to avoid putting a model on hold. They come up with new and better ideas for running the business. Ford's focus on cash led to a greater focus on the fastest-selling models, enabling dealers to reduce inventories without hurting sales. The company can communicate differently with investors. When Ford talked to investors almost exclusively about the P&L, some decided that the company wasn't watching its cash carefully. Today, regular communication about cash levels reassures investors and helps ensure that the stock is fairly valued. Executives approach the capital budget differently. "When we were capital constrained in the past," one executive says, "we'd just slash capex. Now we

recognize capex is our future." Instead of cutting capital expenditures, the company emphasizes efficiencies in the way it spends capital, thus doing more with less. How important is the cash lens? "This industry is going through a revolution," says Booth. "We wouldn't have been able to survive had we not gone through this process and improved the company's focus on cash." Michael C. Mankins is a partner in Bain & Company's San Francisco office and leads the firm's Organization practice in the Americas. David Sweig is a Bain partner in Chicago and a leader in Bain's Corporate Renewal Group. Mike Baxter is a partner in London and member of the firm's Global Financial Services practice. Deal making: Using strategic due diligence to beat the odds Bain & Company capability brief 04/21/10 It may come as a surprise in an M&A landscape struggling to recover, but executives are getting better at deal making. From 1995 to 1998, only one out of every four acquirers beat their peer index by more than 10 percentage points, according to Bain & Company research. From 2002 to 2005, the success rate had nearly doubled, to 45 percent or about one out of every two acquirers. What's behind the improvement? In our view, shaped by working on more than 1,800 M&A projects worldwide with corporate acquirers and more than 4,000 due diligence engagements for PE investors, the most salient factors are increased discipline at opposite ends of the deal value chain: Companies are completing deals with sounder strategic rationales, and they are executing more effectively on merger integration. Even with these improvements, however, about half of deals larger than $250 million fail to deliver the promised returns. The problem lies in the middle of the deal value chain: commercial due diligence. Only one in three business development executives we surveyed said they are satisfied with how their firms manage deal diligence. Too many executives treat diligence as an audit to confirm what they think they know, rather than a solution to the problem of "I don't know what I don't know." The focus on getting the deal done leads to reliance on conventional wisdom that flows from off-the-shelf information or standard industry research. In fact, diligence is a critical step to test and quantify what seems like a good idea. The key to effective diligence is recognizing that you are making an over/under bet versus the conventional wisdom. The most successful acquirers consistently uncover a deal's hidden upside, which allows them to bet the "over." But they are also careful to fully anticipate the downside, making sure potential risks are well understood. With that understanding, they can calculate when to bet the "under." The leading private equity firms are among the best practitioners of strategic diligence in the world. Their business models are built on identifying the hidden value in assets that are being thoroughly shopped. The top-tier firms know when to reach and outbid rivals and when to walk away.

Corporate deal makers face a different set of diligence challenges. Most private equity transactions are set up as auctions, complete with data rooms and well-defined processes for selling the assets. Corporate deals are more often private, requiring the bidder to make educated guesses about the asset they are buying. Yet, while the deal processes are different, the diligence tools used by private equity firms are equally valuable in both settings. In all cases, it's essential to formulate a strong, well-articulated deal thesis in advance and to concentrate analysis on proving it from the bottom up. All deal theses should answer the question: "How will buying this business make my existing business more valuable?" If a potential transaction has strategic value, the assertion needs to be backed up with customer input, competitor insight, new industry data and analysis about how profit pools are likely to evolve. In many corporate cultures, incentive systems that bias individual managers to make, not avoid, investments create additional deal risk. The best defense is a truth-seeking culture fostered by a rigorous deal-review process. It helps to set a walk-away price and make a concrete list of strategic benefits up front as part of the broader deal logic. Efficacy flows from asking the big questions about a deal from conception and focusing analysis on the few things that truly drive value. What factors result in superior performance and competitive advantage, and are these forces likely to stay in place during the foreseeable future? How dependent is the earnings stream on the existing management team, and what happens if they leave or their incentives change? Has the asset been dressed up for sale? What is the potential exit strategy if things go wrong? An essential part of this process is knowing what you don't know about a target and being diligent in understanding why a business is, or isn't, attractive. Predicting financial outcomes, especially over the long term, is inherently stochastic and frequently depends on assumptions that are foreign to an executive's past experience. One trap, however, is relying on the target for intelligence. Forecasts supplied by management and secondary sources should be viewed with circumspection. Selling executives and many industry analysts have their own natural inclination to put the best spin on information. Build your own proprietary view from the bottom-up and outside-in by spending time in the field interviewing customers, suppliers and competitors. No single element of business diligence is more important than plumbing these sources for business intelligence about the target. Beware also the allure of expected synergies. Executives tend to have strongly held views on their industry and often bias their thinking by imagining how much cost can be wrung from rationalizing duplicate operations. Extracting value from combining complementary businesses is more elusive than most people think, both in terms of the actual potential and the work required to achieve it. The key is to ensure synergies work for you, not against you. Remember, research shows that 90 percent of merged firms lose market share in the first year after a deal closes.

That said, the first day of due diligence is really the start of merger integration. It is an opportunity to chart a course early and set a plan to capture as much value in the business combination as possible. Especially if you are targeting a competitor, due diligence can be the first inside view of a company, shining a light on where synergies exist and where they don't. Above all, diligence should confirm whether a deal is truly scale or scope. The answer to that question will guide the subsequent merger integration and management of the acquired business, which follows a very different course, depending on whether it is a scale deal or a scope deal. Finally, be prepared to walk away at any point if that's what makes business sense. In our experience, successful deal makers turn down many more opportunities than they pursue. There's nothing glamorous about stepping on a landmine. Key contacts in Bain's Global Mergers & Acquisitions practice are: Global: David Harding in Boston, Ted Rouse in Chicago Europe: Axel Seemann in Frankfurt, Arnaud Leroi in Paris Asia-Pacific: John Sequeira in Hong Kong Key contacts in Bain's Private Equity practice are: Global: Hugh MacArthur in Boston Americas: Bill Halloran in San Francisco Europe: Graham Elton in London, Christophe DeVusser in Brussels Asia-Pacific: Suvir Varma in Singapore For additional information, please visit www.bain.com In search of a premium alternative: an action plan for online brand advertising Bain Brief 04/20/10 by John Frelinghuysen and Aditya Joshi As online advertising approaches maturity, it faces a major crossroads. The industry can continue down the path of commoditization driven by direct response, with its promise of high volumes but little room for differentiation. Or it can reinvent itself around brand advertiser needs and deliver more premium offerings. Making the right choice will not just ensure sustainable growth-it will redefine the industry's future winners. On the surface, online advertising appears to be in good shape. It has weathered the downturn better than other media: Online advertising revenues fell by just 3 percent in 2009, while print and television advertising saw double-digit declines. Moreover, future growth prospects appear robust: Bain & Company forecasts that online advertising revenues will grow at an average annual rate of 12 percent between 2010 and 2014. Spending on online advertising will overtake print in 2010. Dig a little deeper, however, and some worrying trends emerge. Consider:
Much

of the projected growth will come from direct-response advertising-in particular, search. This suits advertisers seeking an immediate, measurable return on investment (ROI), usually in the form of website traffic and sales transactions.

However, response advertising is not geared to building long-term brand affinity for marketers and does not fully value the content and "premium environment" of specific sites on which ads are placed. For example, two sites offering comparable response rates (that is, click-throughs or transactions) become increasingly interchangeable-even if one is a top-tier content site such as FT.com (Financial Times), and the other is a relatively unknown financial blog. Implication: Premium rates on "premium" publisher sites will be difficult to sustain. Display advertising is increasingly commoditizing due to excess inventory, lack of high-impact creative and the proliferation of low-cost ad networks. These developments have been devastating for online publishers. Their ability to charge for premium display advertising, measured in CPMs (cost per thousand impressions), has deteriorated-and shows no sign of a turnaround. Despite the potential for lower rates in the short term, brand marketers also have cause for concern. As sites grow more cluttered, marketers have less control over placement, the other advertisers adjacent to their ads, and the overall quality of the impressions generated. Implication: As audiences shift online, advertisers and media companies face serious constraints in their ability to deeply engage consumers and build brands. Little wonder that marketers seeking to build brands online have become disappointed with the medium. A recent survey of marketers conducted by Bain and the Interactive Advertising Bureau (IAB) highlighted brand-focused marketers' preferences: They spend about 75 percent of their advertising budgets on TV and print media, nearly three to four times as much as they advertise online. In our survey, marketers recognized that the Web is inherently more interactive and can address a broader set of marketing needs. But despite the immense potential for online advertising, the current reality falls short. So, what will it take in this environment to build brands online? A first step is to recognize the obstacles. Barriers to building brands online Through our survey, as well as interviews with brand marketers, agencies and media companies, we identified five major gaps that hold online back as a medium for premium brand engagement: #1: Ad formats and creative execution are not evolving with the medium Brand marketers are disenchanted that the online medium has not lived up to its potential for storytelling. Static display "banners," originally inspired by newspaper and magazine ad formats, are still the primary unit of online inventory, and with surprisingly little innovation over the past 15 years. Banners are inherently limited for brand advertising, with marketers preferring more engaging, even interruptive, ads with sound and motion. The typical website is cluttered with too many banner ads, and the placement of low-cost response ads (for example, mortgage ads) alongside imageoriented brand ads is often jarring. Despite the early promise of online video and largerformat ads, marketers still perceive a lack of innovative, new creative ideas from

agencies and media companies. Many marketers with whom we spoke believe that agencies are holding online back by not committing their best creative talent to the medium. #2: The Internet is awash with undifferentiated, low-cost inventory The recent exponential growth in online advertising inventory has not been matched by a proportional increase in demand. Without truly differentiated, premium offerings, the massive oversupply has forced content publishers to aggressively monetize "remnant" inventory and depend even more on less-premium, response-driven advertising and ad networks. In fact, Bain's 2008 digital pricing study, conducted with the IAB, highlighted that leading publishers were releasing excess inventory to ad networks at one-sixth to one-tenth the price of direct sales. This behavior further reduces the attractiveness of the online medium for premium brand marketers, worsens the supply-demand imbalance and conditions buyers to shift dollars to ad networks. Airlines typically create a premium experience for first-class passengers; they don't place them in the same seats as budget travelers paying a fraction of the cost. But this is essentially what online media companies have been doing, with costly results. #3: Too many metrics, too few that brand marketers really need Marketers are inundated with online tracking measures, from click-throughs to page views to unique visitors, and many more. These can be valuable metrics for direct response advertising, but marketers can't use them to answer branding questions, such as: What is the impact of the campaign on increasing brand awareness in my target audience? Does it influence purchase intent? While various survey-based alternatives (such as, Dynamic Logic, comScore, Brand.net) exist to track such measures, marketers indicate they are too expensive and don't allow for effective comparison across media. Also, as different vendors are often used, there is no standard "currency" on which buyers and sellers can agree. This limits marketers from comparing online with other media, and thus from making the decision online media companies want most: shifting more brand spending to the Web. A leading consumer packaged goods marketer summed up the problem: "What we need to see is: If we move 10 percent of our TV dollars to online, are we better off? There's no way to measure that today." #4: Online offers unreliable targeting-especially on a large scale Brand marketers struggle to target specific consumer segments online, at a scale that is comparable to traditional offline brand campaigns. While network TV can deliver a large audience watching a specific show in a specific time slot, websites have the much harder task of gathering traffic from across their pages and across different points in time. Consequently, marketers have difficulty accurately assessing the unduplicated reach of their ad, the frequency with which it is viewed and the gross rating points (GRPs) across multiple sites. Large marketers (such as consumer goods companies) told us that the complexity and uncertainty associated with targeting at scale on premium sites actually makes them recognize the value of mass reach with ad networks

and portals. At least, these non-premium options can offer high unduplicated reach and delivery metrics which can be measured with a single cookie. #5: Support from agency and media partners is underwhelming for premium brand campaigns Marketers indicated in our survey that they want media and agency partners who understand their industries, develop innovative ideas, and help them execute consistent and integrated campaigns across media platforms. Instead, agencies are hindered by silos, both within individual agencies and among different agencies serving the same account. Online media companies also fall short in brand marketers' perceptions. Today, many sales teams use a selling approach that, unintentionally, further commoditizes their inventory: They focus on buying agencies, respond almost solely to requests for proposals (RFPs) and provide limited customization or innovation in offerings. In addition, online sales teams often lack industry vertical expertise, interact with marketers too late in the media planning process and do not have the caliber of talent required to advise senior decision makers. Media companies with both online and offline operations often struggle to deliver integrated cross-platform ad campaigns; their respective sales teams tend to work in silos, too. Making brand marketing work online In the battle for advertising dollars, online publishers, portals and other sellers of premium-priced inventory face the most significant challenges. To better meet the needs of brand marketers and enhance the prospects for premium CPMs, we suggest the following action plan: 1. Develop "triple play" capabilities Online media companies must develop and effectively deliver three distinct product and service models that address different marketer objectives. At the same time, they need to determine which model, out of the three, will be their "core" business. Strengthen direct-response offerings. This is the proven "killer app" of online marketing today. It focuses on specific customer actions and satisfies a marketer's critical need for immediate "transactions" and "traffic," both on the Web and in the bricks-and-mortar world. The Web as a medium for direct-response marketing is becoming more cost-effective than ever before, and continues to grow rapidly. While search captures the majority of this spending, billions of dollars are still up for grabs in direct-response display and other formats. Determine the right "brand reach" strategy. Recently, brand marketers have seen the opportunity to "scale up" investments in high-cost campaigns on premium content sites, as well as increase impressions through a broader swath of lower-priced online advertising opportunities. Mercedes-Benz, for example, supported its premium ads in

top-tier newspaper websites with low-cost placement through ad networks to expand the reach of its E-Class launch campaign. The difference from direct-response ads is that brand reach advertising still values the brand "environment" and is focused on impressions as opposed to click-throughs. It's an opportunity for online publishers to extend their offerings, but can be a double-edged sword if not managed carefully. Online publishers can sell less desirable inventory at $3-$5 CPMs for brand-reach applications, but if they cannibalize other brand sales, they can quickly erode a publisher's ability to charge $8-$12 CPMs for premium units and services. Develop premium engagement skills. The third leg of the triple play-and the one with the most growth potential-is to create emotionally compelling online brand advertising that builds long-term brand affinity. Today, that remains largely the domain of television and magazines. But it's a huge untapped opportunity for online media companies, as the vast majority of national advertising dollars reside with large, brand-oriented advertisers seeking deeper engagement with consumers. To make that happen, online media must recognize that a transformation of their current offerings and sales approach will be required. 2. Re-commit to delivering a "premium" offer Online publishers who want to increase their share of premium-priced brand advertising dollars must put their house in order and build a truly premium value proposition for brand marketers. They must: "Wall off" premium ad inventory. In our survey, marketers consistently expressed frustration with clutter, unreliable context and seeing their full-priced ads alongside heavily discounted remnant ads. Sites must clearly designate their premium placements, limit the clutter around them and restrict access solely to brand-oriented ads. Bottom line: premium means offering fewer, but better, inventory units. Manage "non-premium" inventory better. While not all ad placements offer the equivalent of NBC TV's Thursday primetime position, the key is having a clear definition for what isn't premium and creating disciplined processes to manage that inventory. One online publisher we interviewed created packages of second-tier "run-of-site" ad inventory that sells at a 30 percent to 50 percent discount compared to the CPMs of higher-end inventory on the site. These less expensive packages are clearly separated from more premium placements and are sold with minimal sales support. Net result: the publisher cost-effectively monetizes less premium inventory, minimizes cannibalization and maintains the premium positioning of the website. Invest in ad-format innovation. Protecting premium ad inventory is good, but rejuvenating the ad units themselves is even better. In our survey, brand-oriented marketers identified formats utilizing video, sponsorship and social media as exciting options that go far beyond typical display ads. Apple's "Mac vs. PC" campaign on the New York Times, Yahoo! and Wall Street Journal sites showed a willingness to experiment with new formats-using video as well as custom ad units that interact across

the page. Similarly, the creative for Nintendo's "Wario's Land: Shake It!" on YouTube was a sophisticated execution that appeared to break apart the actual page. The ad hooked visitors and eventually generated several millions of views through word-ofmouth publicity. Today, such custom efforts are expensive, but by developing more standards and tools in the future, the online ad industry can increase this type of business. 3. Become a strategic partner for marketers Brand marketers are accustomed to receiving a high level of support from television and other offline media providers. In the future, online media sales teams too will feel the pressure to meet and exceed the emerging needs of brand marketers for "partnership" and consultative selling. But this will require different selling and serving models-ones that offer more senior client contact and more value-added support throughout the media planning process. Key requirements include: Delivering new ideas and category expertise. The number one capability marketers want in a partner is category-specific knowledge. Just as with their agencies, marketers expect media companies to understand their businesses and bring innovative ideas to the table. Says one CMO, "We want to sit down once or twice a year with our key media partners and hear their best thinking on how to improve what we do. But we'll only have time to do that with a handful of partners." While this raises significant change management challenges, we believe change is critical. Developing "category-focused" sales teams will help media companies in several ways. Sales teams with higher-caliber talent and category expertise interact directly with marketers earlier in the planning process, are able to offer more custom solutions and influence the creative aspects of the campaign. For these reasons, Google invested in a multi-year effort to develop category expertise in selling and services, and hired from the ranks of traditional marketers. Similarly, the New York Times integrated its online and offline sales organizations to offer advertisers a category-focused, custom and cross-platform approach. Such efforts have raised the bar for media sellers and are delivering substantial benefits for brand marketers. Make cross-platform the norm, not the exception. Over the next three years, brand marketers expect nearly 40 percent of their ad budget to be spent on integrated, crossplatform campaigns-with another 25 percent on advertising that is at least coordinated across platforms. Media companies that have both online and offline properties can develop fully-integrated packages with online and offline components, often providing customization of inventory units and creative input. For pure-play online media companies such as portals, cross-platform can involve developing ways to extend offline campaigns to online and link them to their sites. While such cross-platform solutions are still far from the norm, they are growing in popularity among all the publishers we spoke to. And while online might represent as little as 5 percent to 10 percent of the overall deal value with brand marketers, it might account for half of the sales discussion and most of the customization and creative support. In other words,

online capabilities are increasingly the key differentiator in gaining share of offline brand ad dollars. How might the typical sales structure change to make all this a reality? We believe it requires a fundamental shift from an online-versus offline model to one organized around the customer's needs, offering brand-focused and direct response-focused sales teams with deeper category expertise. 4. Speak the marketer's language For online advertising to mesh seamlessly into the brand planning process, content sites need to go beyond "hits," "clicks" and "gross impressions" as the primary means to measure impact. Talk GRPs. Brand marketers plan their advertising around gross rating points (GRPs)reaching a certain target audience with a certain frequency within a defined time period. In the online world, that audience is typically shared across multiple sites, making measurement even more challenging. At the non-premium end of the online advertising market, ad networks are able to track overall consumer reach by using common cookies. For premium sites, however, the challenge is complex: their approach of a separate cookie for each site complicates the evaluation of the reach and frequency of an ad served to consumers across multiple sites. "De-duplicating" the audience across multiple sites is difficult and will likely require new industry standards and publisher collaboration. Larger online publishers and the IAB can use their influence to lead this industry-level collaboration. Measure what matters. Marketers are clear that traditional brand metrics-especially brand awareness, favorability and purchase intent-will help guide their decision to shift dollars online from other channels. Today, these metrics are delivered in part by custom service providers like Dynamic Logic and Nielsen IAG. But the lack of an ongoing, syndicated common "currency" and standards means that marketers are unable to compare across campaigns and across media platforms; nor can they assess impact over extended periods of time. Industry forums such as the Association of National Advertisers and the IAB have a leading role to play in defining specifications for such metrics-and helping move existing players toward a more comprehensive, crossplatform offering. 5. Gain scale Traditional brand campaigns often need to reach what are, by online standards, very large audiences. For example, a leading women's magazine might reach 30 million to 40 million readers monthly. In contrast, the website for the same title might deliver only 5 million to 10 million unique visitors a month. And a marketer would need to place numerous ads on that website to reach any significant number of those unique users. Marketers and agencies therefore often find it inefficient to try to reach a large number of consumers across many small websites.

If you've got scale, use it. Scale represents a major advantage for large media companies and online pure-plays. But it is surprising how few online content companies utilize their full potential to offer scale. We believe many online publishers can offer more consumer insight, creative services and innovation/experimentation than they currently do. That will require them to bring their existing capabilities closer together when pitching to marketers and be involved much earlier in the campaign planning process. Recognizing this, larger players are increasingly bringing smaller sites together to create branded "networks." In some cases, publishers are integrating their own subbrands into packages that offer marketers more scale. MTV Generation Tribe, for example, targets young adult consumers. Similarly, Meredith's online BHG Network integrates cooking, home improvement, gardening and beauty content from Better Homes and Gardens and other related Meredith brands. If you don't have scale, get it. As online advertising continues to mature, brand marketers and ad agencies are becoming more selective-and ad networks allow them to efficiently place their ad on many sites with a single buy. Large brand marketers therefore have a diminishing interest in dealing directly with small content sites-unless these sites bring a distinctive audience or are truly a perfect fit for their brands. This does not mean, however, that smaller sites are running out of options. Instead, we believe that at the one end, they should double-down on serving their base of "naturalfit" advertisers and at the other, forge links with compatible media companies to gain scale and broaden the base of advertisers they can attract. One such approach is to create premium "mininetworks" with exclusive membership. Another is to establish a relationship with a larger media company for sales representation. As an example, the Rubicon Project helps smaller content publishers gain scale and better monetize their unsold inventory. Online advertising as we know it is long overdue for change. As direct-response advertising continues to commoditize inventory and erode pricing, media companies are under pressure to provide more value and transform the sales model. Those who are first to deliver more compelling and integrated brand campaigns, offering the full "triple play," are likely to build premium portfolios and pull away from the rest of the industry. The change won't be easy or quick. But for those who lead in online marketing innovation, there are billions of brand advertising dollars waiting to move online.

The

role

marketers

can

play

Advertisers also have a significant stake in cracking the code for building brands online. Brands such as Apple and Unilever's Axe are beginning to point the way forward. Their experience, and that of other progressive online brand advertisers, suggests some practical steps for marketers: Develop and utilize more innovative ad formats Marketers who have been successful in driving online brand engagement challenge the

constraints imposed by "standard" display advertising formats and instead push for larger, innovative formats that incorporate video and sound. The goal: mirror the attention-grabbing potential of traditional television advertising. Cast a wider net for creative ideas The most progressive online marketers actively collaborate with media companies to create custom ads that best utilize the layout and capabilities of their specific media properties-and resonate closely with the site's target audience. Clearly, there are limits to how many online media companies a marketer can deal with directly, but these are increasingly valuable endeavors to pursue with their most important media suppliers. Drive cross-platform campaign integration Marketers are increasingly aspiring to integrate campaigns across different media platforms in order to create "surround sound" effects for the consumer, stretch more expensive advertising investments in certain platforms such as network TV across multiple platforms, and better maintain brand consistency regardless of the platform being utilized. Further, pointing to the importance of cross-platform integration, we found that brand marketers who use the same creative agency for online and offline work were 40 percent more likely to be satisfied with the results than those using separate agencies for online and offline. Whether through a single agency or coordinating efforts through an interagency team (IAT), cross-platform integration is increasingly becoming the norm for effective brand advertising campaigns.

John Frelinghuysen is a partner with Bain & Company and a leader in the firm's Global Media practice. Aditya Joshi is a partner with Bain and a leader in the firm's Customer Strategy and Marketing practice. The authors would like to thank Jason Wiethe and Chris Sims, managers with Bain & Company, for their contributions to this Bain Brief. About this study The authors would like to acknowledge the support and collaboration of the Interactive Advertising Bureau (www.iab.net ) and its members in the development of this Bain Brief. The IAB is comprised of more than 460 leading media and technology companies who are responsible for selling 86 percent of online advertising in the United States. Seizing the strategic high ground in capability sourcing Bain Brief 04/19/10 by Michael Heric and Bhanu Singh How companies can realize the full potential of outsourcing and offshoring to leapfrog the competition

Wage inflation in traditional offshoring destinations, evolving government regulations and recent high-profile instances of back sourcing have led some companies to question the value and sustainability of capability sourcing-getting the right capabilities from the right partners at the right price from the right location. Others, however, see it as even more critical than ever. Many companies are not satisfied with their current capability sourcing efforts, which include outsourcing and offshoring. Bain & Company's global Management Tools and Trends 2009 survey of 1,430 executives showed that 63 percent of respondents used outsourcing as a business tool, but they ranked it in the lower third of 25 business tools in terms of satisfaction. Despite widespread dissatisfaction, many companies are expanding their use of capability sourcing. Why? Are these companies misguidedly buying into the hype surrounding outsourcing and offshoring, or are they on to something that others have yet to grasp? What many companies are realizing is that capability sourcing can be used for more than just cost cutting. When done right, capability sourcing can help companies achieve strategic objectives. Companies that successfully create and sustain value over time are rare. A recent Bain study of more than 2,000 companies across 10 years revealed that, while many companies aspire to outgrow their market, only 1 in 10 companies achieve sustained, profitable growth. Not surprising, these Sustained Value Creators often make use of capability sourcing in more innovative ways. We found that 85 percent of these highestperforming companies use capability sourcing to fix either broad structural cost or quality disadvantages, or for strategic purposes such as accelerating time to market or breaking into new markets. Another 10 percent transformed their business models through capability sourcing. Only 5 percent used outsourcing and offshoring less strategically, for purely opportunistic reasons or tactical cost reduction. How winners win Our experience with hundreds of clients has helped us identify five key ways in which winners capture the strategic high ground by using capability sourcing. Let's look at each of the five opportunities. 1. Tap global talent pool The war for top talent has become intense. To win the war, companies must tap into sources of talent more broadly. Historically, companies have pursued offshoring as a means to access low-cost resources to substitute for more expensive onshore talent. In doing so, companies focused on lower-skilled work that could be safely performed from remote locations. In the past, few companies used offshoring to recruit top talent or develop innovation outside their home countries.

Companies that seize the strategic high ground do exactly that: frame the war for talent in global terms and rely on offshoring and outsourcing to access the best global talent. For example, Texas Instruments offshores not only to tap new sources of talent, but also to broaden the climate for innovation in new global locations. In 1985, Texas Instruments became one of the first global technology companies to establish a research and development center in India. The world's largest maker of chips for mobile phones looked to India for more than cost savings and has nurtured a rich Indian talent pool over the course of two decades. Texas Instruments India developed the first digital signal processor designed in India for control applications in 1996 and supported the development of LoCosto, the semiconductor industry's first single-chip solution for low-cost handsets. Today, Texas Instruments India has the highest number of US patents granted to any organization in India. 2. Build ecosystems The stakes in capability sourcing are getting higher. As the sourcing market has matured, companies have become more comfortable increasing the scale and scope of what they outsource and offshore. Rather than focusing on a single location, they have expanded their sourcing network to include multiple countries-and often multiple locations within a country. While companies historically outsourced and offshored lowrisk activities, today they are increasingly outsourcing and offshoring more missioncritical activities, such as final assembly and product development, adding complexity to their supply chains. The trouble is, while sourcing risks have increased over time, most companies continue to manage their sourcing relationships in much the same way they did when they first started-as arm's-length vendor interactions overseen by the procurement department. Offshore captive centers are often managed as independent delivery units of a particular function, such as IT or finance. Companies that seize the strategic high ground view their external relationships and offshore centers as strategic partners, part of a broader ecosystem tightly integrated with their owned or domestic operations. The result of companies failing to keep pace with the changing requirements of relationship management can be painful. This was nowhere more apparent than during the toy industry's lead paint crisis in 2007. Toy companies with more sophisticated systems and processes for managing their partners were relatively unscathed by the lead paint controversy. McDonald's Corp., one of the largest purchasers of toys, anticipated the growing challenges from partner management before the crisis erupted. The fast food giant implemented superior design and manufacturing standards, placed trained observers at supplier factories and conducted rigorous testing. Most important, McDonald's realized the lead paint problem in China was pervasive, and it monitored the source of the paint on its toys all the way back to the suppliers. Due

to its vigilance, McDonald's ensured that its outsourced toy manufacturers only used approved paint suppliers. As a result, McDonald's was largely unaffected by the crisis. 3. Seize new market opportunities Strategic companies outsource and offshore to tap into local market opportunities and build presence in new markets. AstraZeneca's experience in China is an example of offshoring more strategically to penetrate a fast-growing emerging market. It did not simply build a local factory offshore to serve the Chinese market. AstraZeneca made large-scale, multiyear investments in research and development, manufacturing and sales, and partnered with local universities, government organizations and domestic companies. AstraZeneca increased its market share by focusing on largely underserved rural hospitals and physicians. By 2008, the Anglo-Swedish pharmaceutical giant became the largest pharmaceutical multinational in the Chinese prescription drugs market, with leading market share across eleven drug brands. 4. Accelerate and innovate Leading companies use capability sourcing to accelerate time to market and develop new sources of innovation. Traditionally, while the promise of cost savings and improved service quality from capability sourcing was appealing, many companies became disillusioned with the time it took to start realizing those benefits, often many years. However, companies are now reaping benefits faster by sourcing capabilities in more targeted ways. Consider Procter & Gamble's innovation networks. The world's largest consumer products maker turned the innovation paradigm on its head a decade ago by developing strategic alliances and partnerships. Realizing its internal capacity for innovation was flagging and its competitors were gaining ground, P&G created the Connect + DevelopSM strategy that welcomed outside innovation through open networks. That was revolutionary for an industry in which R&D was considered a core competitive competency. By outsourcing elements of R&D, especially for accessing technology, Procter & Gamble boosted innovation productivity by 60 percent and generated more than $10 billion in revenue from over 400 new products. Today, about half of P&G's innovation is the result of external collaboration. Other companies are following P&G's example. Bain's Management Tools and Trends 2009 survey showed that nearly six in 10 managers believe their companies could dramatically boost innovation by collaborating outside with other companies. 5. Disrupt the industry business model

In some instances, capability sourcing can help companies to leapfrog the competition. It can fundamentally disrupt an industry's economics by changing the traditional basis of competition; however, only a few companies have achieved that objective. Taiwan-based personal computer maker Acer is one rare success story. Starting with the spin off of its contract manufacturing operations in 2000, Acer sought to focus exclusively on branding and marketing. Its virtual model allows Acer to maintain a strikingly lean and flexible operation. Its nearly 6,800 employees represent a workforce less than one-tenth the size of its largest competitor. Capability sourcing played a critical role in helping Acer to neutralize the historical cost advantage of the PC direct model and become the world's second largest PC manufacturer. Using experience as a guide As more companies seek to replicate the success of leaders in capability sourcing, they first need to consider their capability sourcing experience when drawing up a game plan. Their strategy will depend on whether they are first-time users, testing the waters or experienced practitioners. Let's look at each category. First-time users: Learn from others' mistakes-and successes 1. Establish a clear mission with strong executive support Strong corporate sponsorship and on-site leadership are critical to successful offshoring programs. Many companies fall into the trap of using offshore locations as body shops: Most innovation occurs onshore and then work is handed off to the offshore center for lower-value activities. This makes it difficult to attract and retain the best talent offshore as well as to scale a company's offshore capability over time. Developing a local team offshore with an independent charter and autonomy improves the long-term odds of success. General Electric has successfully done this over its long history of offshoring. One example is how GE has used offshoring to develop a multidisciplinary R&D hub in India that supports the company globally and, in the process, has built up a large and deep Indian talent pool and strong onsite leadership. The John F. Welch Technology Center in Bangalore is the largest, integrated multi-disciplinary R&D center for GE, and is the first located outside the US. 2. Develop a comprehensive capability sourcing blueprint Companies can achieve full potential value from their capability sourcing efforts by developing and then implementing a sourcing blueprint. The starting point is a comprehensive assessment of a company's activities across the value chain to determine what should be kept in house, what should be outsourced and what should be offshored. No area should be off limits in this assessment phase. Then, every

company should develop a multiyear roadmap of both short- and long-term actions, linked to financial and service quality improvement metrics, to track progress over time. This blueprint should be drafted in collaboration with the corporate center, with the CEO's involvement if possible. 3. Consider emerging capability sourcing models Not surprising, most first-time users pick up the playbooks used by companies already outsourcing and offshoring. They assume that, given their experience, those companies must be model examples. However, that's rarely the case. As we saw in our tools and trends survey, satisfaction with outsourcing was less than the overall average of the 25 tools studied. Most companies are not achieving their expected return on investment: That's why first-time users should be very careful about assessing the lessons they learn from other companies. New capability sourcing models such as equity investments and managed captives are emerging to help companies avoid the mistakes made by other companies or to address the specific strategic, operational or organizational challenges that have historically prevented companies from outsourcing or offshoring. The pharmaceutical industry, for example, has historically been slow to adopt outsourcing and offshoring. However, with escalating costs and longer cycle times in drug discovery, development and launch, pharmaceutical companies are increasingly turning to outsourcing and offshoring. While traditional forms of outsourcing and offshoring like active pharmaceutical ingredients (API) and dosage-form manufacturing still dominate, some large pharmas are experimenting with new models. Alternative drug development models such as Chorus, an autonomous early phase drug development division within Eli Lilly that operates a fully outsourced model, is one example. Testing the waters: Achieve full potential from existing efforts and take a stand 1. Maximize return on investment from existing sourcing programs Rather than achieving full value from existing capability sourcing programs, companies often move on to the next outsourcing or offshoring project. Our client experience suggests that companies should be getting at least 25 percent return on investment on their sourcing programs. If companies are not on a path to achieve that level of return, they should carefully review, and if needed, fix their current programs before moving on to new projects. Companies often underestimate the value that can still be un-locked from their current sourcing programs. 2. Build a repeatable formula

As companies outsource and offshore more complex activities, it is critical for them to apply what they have learned. One way of doing that is to build an internal organization with capability sourcing experience to manage partner relationships and transfer experience from one project to the next. Another way is to institute a systematic approach to partner evaluation and selection. One company that continuously applies what it learns from its capability sourcing programs is Cisco Systems. The global leader in IP-based networking equipment aggressively turned to outsourcing production in the early 1990s to manage its rapid growth. Despite supply chain challenges in the early 2000s recession, Cisco recovered. Today, Cisco may face more complexity and change than ever before. The pace of technology change remains relentless, but Cisco continues to expand globally and diversify its product and services portfolio. Due in part to its ability to carry out supply chain innovation, Cisco continues to apply successfully its outsourcing model to new products and services with remarkable efficiency and effectiveness. 3. Take a stand on the role of capability sourcing Companies rarely understand the implications of starting down the path of capability sourcing. Though outsourcing can fundamentally change a company's operations and economics, many companies testing the waters approach it as a series of one-time, contractual events where responsibilities are often delegated to functional leaders or to the procurement department. The inevitable result is often a disparate collection of outsourcing contracts. Since these various contracts are not part of an integrated effort, they often fail to achieve the promised benefits. Companies testing the waters need to decide quickly on the strategic role of capability sourcing in their operations and take a stand on which programs to keep and which to unwind; which to expand or which to shrink; which new areas to outsource or keep in house; and which to keep onshore and which to offshore. Experienced practitioners: Avoid complacency and look to change the game 1. Challenge the status quo Just as first-time users should not on faith pick up the playbook of experienced practitioners to execute their plans, experienced practitioners should avoid becoming complacent about even their most successful sourcing programs. Similar to companies testing the waters, many experienced practitioners fail to achieve full value from their sourcing programs. Experienced practitioners should regularly undertake a comprehensive review of their capability sourcing programs. For example, while an offshore captive may have been the best approach years ago, conditions may have changed and outsourcing may now be the more attractive solution. Experienced practitioners should continuously evaluate

their capability sourcing strategy and operational approach. They may want to consider changes including modifying scope, converting captive operations into independent profit centers, diversifying or changing their low-cost country footprint or rationalizing and changing outsourcing partners. The recent meltdown in financial services, an industry with some of the longest and deepest experience in capability sourcing, has caused many companies in the industry to reevaluate their outsourcing and offshoring programs. In the new economic climate, the relative benefits of owning and operating captive offshore centers has declined, even for pioneering financial services firms such as Citibank and American Express. That has led to a wave of activity aimed at extracting more value from existing captive operations, which, in some cases, includes selling them. Citibank sold its offshore captive to Tata Consultancy Services at the end of 2008, and American Express divested its offshore travel center to Nasdaq-listed Indian company ExlService in November 2009. 2. Create innovative collaboration models with partners Companies that seize the strategic high ground by building partner ecosystems rather than managing their outsourced vendors at arm's length invest in developing innovative approaches to collaboration. Experienced practitioners are often best positioned to make such investments. Collaboration can take several forms and extend across the entire value chain. Cisco is pioneering innovative collaboration models with its Electronic Manufacturing Services (EMS) partners. After the recession of the early 2000s, the company focused on fewer partners to enable more collaborative relationships, and aggressively invested in new approaches. The company and its partners jointly develop technology roadmaps in Commodity Councils and rely on a collaborative network that captures real-time data from partner facilities. This network provides Cisco a unified view of its entire production network. The company also developed and expanded standards- based partner interfaces in ordering, logistics and transportation that require shared goals and processes. 3. Use capability sourcing to change the game in your industry Outsourcing and offshoring can change the game, freeing up scarce resources that allow companies to invest successfully in new and more sustainable areas of differentiation. The semiconductor industry was disrupted by the change that outsourcing brings. With the industry's birth in the 1960s, semiconductor manufacturers felt the need to be highly integrated, given the complexity of the manufacturing process. In the 1980s, however, outsourced foundry manufacturing changed the game. Companies that outsourced production to low-cost Asian foundries took off, as they were free to focus on research and development rather than investing in fabrication and its associated operating costs.

Fabless companies like Qualcomm and graphics-chip maker NVIDIA quickly gained market share. Today, outsourced semiconductor foundries make up close to 25 percent of total semiconductor manufacturing capacity. Capability sourcing creates real value, but companies will need to adapt to the shifts taking place. High-performing companies are moving from using capability sourcing narrowly and tactically to using it more broadly and strategically. The results will depend on whether a company is just getting started, testing the waters or is an experienced practitioner. In today's uncertain business climate, a strategic view of capability sourcing isn't an option, it's an imperative. Undergo a capability sourcing health check A company looking to understand whether it is achieving full potential from its current outsourcing and offshoring programs should undergo a health check. Answering the following questions will help a company understand the opportunities to improve the efficiency and effectiveness of its capability sourcing programs.
Is

your sourcing strategy aligned with shifts taking place in your industry? Is outsourcing and offshoring on the CEO's agenda? - Has capability sourcing improved competitive differentiation-in cost, service quality, time to market and flexibility? - How is the competition approaching outsourcing and offshoring, and could your competitors' actions potentially affect your position? Are you implementing sourcing programs effectively? - Do you have a repeatable formula for implementing outsourcing and offshoring programs? - Have past transitions to outsourcing or offshoring been on time, on budget and without disruption to your organization? Are you achieving the benefits you were expecting? - Are you achieving at least 25 percent return on investment? - Are you achieving the non-financial benefits you were expecting? For more information, please visit www.bain.com Michael Heric is a member of Bain & Company's Global Capability Sourcing practice and is based in New York. Bhanu Singh is the co-leader of the firm's Global Capability Sourcing practice and is based in Palo Alto and New Delhi, India. Copyright 2010 Content: Layout: Global Design Bain & Company, Editorial Inc. All rights reserved. team

Franchise network health Industry Brief 04/07/10 Even in the best of times, franchisors of everything from restaurants to muffler shops have little insight into how well or how poorly their franchisees are doing. But in a downturn, the risks of working in the dark are multiplied: There can be a cumulative effect as franchisees across the network struggle for survival. Franchise failures can hurt the brand, scare off potential new franchisees and end up in costly litigation. For their part, franchisees may worry that their franchises could be pulled if they get behind in royalty payments. Based on our experience, both parties opt to ignore the possibility of franchisee distress until it's too late. In addition to not knowing fundamentals such as the health of the franchisee's operations, their cash situation or the strength of their balance sheet, franchisors don't know when a franchisee who appeals for help really needs it. Some franchisees approach the franchisor for help long before making tough choices such as reducing their owner distributions or closing underperforming operations. Harder still for the franchisor is determining whether operations improvements or royalty relief will be enough to help the franchisee. Consider the situation facing one major franchisor. The company knew that many of its franchisees were in trouble-60 percent were either not paying royalties or were asking for relief. Because of legal responsibilities to treat all franchisees equally, the franchisor could not just pick and choose where to provide assistance. What the franchisor needed, before taking any action, was a clear view into the seriousness of each franchisee's situation. Only then could the franchisor determine which requests for royalty relief were legitimate. Bain & Company worked with the brand to take a proactive approach-one that helps both franchisors and franchisees gauge their situation and identify opportunities to improve performance in good times and bad. By conducting a detailed assessment of the financial and operational health of its franchisees, the franchisor discovered a startling statistic: 30 percent to 40 percent of its franchisees were at risk of default within a year, a situation that had a potentially significant impact on the viability of the brand. Recent Bain experience suggests the brand is not alone. For franchisors whose revenues have declined during the downturn, we have observed that between 20 and 50 percent of their franchisees could be in financial distress. Why do it? A franchise health check-up, performed with the full participation of franchisees, provides a holistic view of everything from operating metrics to capital structure. One company that recently conducted such a check-up was able to help almost all of its atrisk franchisees develop strategies to weather the storm. Despite franchisees' requests for relief that totaled many millions of dollars, the franchisor invested less than 5 percent of that sum to save almost all of its troubled franchises.

One of the key success factors of a franchise health checkup is that, when done cooperatively, it deepens a franchisor's relationship with franchisees. Also, the analysis helps identify opportunities where a franchisee could improve operations. In one meeting, a restaurant franchisor determined it could help a franchise improve its margin by 2 percent overnight through a simple change in how it ordered its poultry. That level of insight is not something franchisors can typically provide when they know only the revenue performance of the business. A check-up also uncovers the challenges franchises face due to their cash positions or capital structures, bringing a rigor that all but the most sophisticated franchisees are not able to bring on their own. We've found that most franchisees feel that going through the process helps better align the interests of both sides and that the franchisor better understands their situation. Another practical benefit of a franchise health check-up is that it enables a franchisor to evaluate whether financial assistance is needed. In our experience, franchisees who ask for relief can typically be segmented into three groups:
Those

who either don't need it or can be helped with operations improvement

support. Those who need help, but for whom relief alone won't be enough to avoid default over the long term due to misaligned capital structures. These franchisees should be encouraged to develop a plan to restructure their debt. Those who cannot be saved and are likely to lose control in bankruptcy or face liquidation. The franchisor should demonstrate the seriousness of their situation, and encourage them to develop an exit strategy to minimize the impact on their own financial situation. Helping franchisees shape up Bain has developed a three-step process for maintaining the health of a franchise brand. 1) Conduct an annual holistic check-up. Franchise operations work best when both franchisors and franchisees work collaboratively for their common benefit. Franchisors can encourage franchisees to take part in such a check-up as a requirement for participation in any current or future royalty abatement programs. A holistic check-up should look at a franchise's capital structure, cash flow and other indications that it could be at risk of default. For example, a check-up could evaluate contingent liabilities that might be draining a franchisee's finances in tough times. It's not uncommon for a franchisee to use the cash flow from one successful business to fund troubled holdings. 2) Prioritize your investments. Franchisors seldom are able to satisfy all the requests for financial assistance from franchisees, nor should they. Franchisors need to make hard choices about how to invest their limited funds to have the most impact while

treating all franchisees with equal consideration. That means prioritizing investments based on the depth of need and the potential impact on the network. 3) Design a playbook to improve network health.Franchisors need a decisionmaking framework for taking action that reflects both franchisor and franchisee priorities, including guidelines that ensure that any actions taken by the franchisor represent fair and equal treatment. In one case, a franchisor is using its new understanding of each franchisee's cost structure to identify the level of same store sales performance at which each franchisee is likely to encounter trouble. By monitoring each franchise's revenue, the franchisor can proactively identify and respond to any risk of distress. This three-step approach has helped franchisors overcome serious threats to the health of their network. Empowered with information, they can better prioritize resources and collaborate with franchisees. Some franchisors have used this as a basis for transforming their approach to working with franchisees-not just to stem the risk of default but also to position the healthiest franchises to grow at their full potential as the economy improves. Sidebar: Signs your network could be in trouble
Falling same-store sales for franchises Declining franchise revenues due to store closures Concentration of more than 30% of the brand's franchise

outlets in the hands of

relatively few franchisees Rising requests from franchisees for royalty relief or other assistance Sale-leaseback transactions among your franchisees between 2004 and 2008 Franchisee exposure to risk from their other holdings Franchisees grappling with capital structure issues Key contacts in Bain's Global Retail industry practice are: North America: Neil Cherry in San Francisco, David Sweig in Chicago and Eric Anderson in San Francisco Streamlining spans and layers Bain & Company capability brief 03/16/10 Most companies start out lean, but over time they find complexity creeps in-especially in spans and layers. Teams proliferate, with each manager having only a few direct reports. Layers accumulate, increasing the distance between the company's leadership and the frontline. Soon, costs pile up and ideas and decisions-the life force of a strong company-stop flowing smoothly up and down and across the organization. Even the best-performing companies with strong HR practices find that they are not as lean as they'd like to be and need to reduce layers and increase spans. A few years ago, AT&T cut management layers by half to just seven. In 2006, Intel increased the

span of managers from six or seven, to eight or nine. The reality is that, while spans narrow and layers build up insidiously over time-at all levels of the organization-it's very difficult to lose the bloat. In our experience, there are four potential objectives for tackling spans and layers (see Figure 1): Cost cutting: This is often the most immediate return from a spans-and-layers effort. When a global technology company was faced with declining margins, it used spans and layers to trim payroll costs. The CEO led the top-down effort with the full commitment of the leadership team and quickly executed the hard decisions needed to fix spans and layers. The results: $50 million a year in savings. Organizational effectiveness: This approach couples a spans-and-layers exercise with efforts to eliminate low-value-added or duplicative activities. By stripping out excessive data tracking, frequent re-forecasting and ad hoc reporting, one white goods company reduced its layers from 11 to eight and increased spans from around seven to more than 11. Decision effectiveness: Companies adopting this approach combine spans and layers with other tools such as RAPID to clarify decision rights so that the newly lean organization can make decisions faster and execute them better. When a leading telecom equipment company found decision making slow and inefficient, it thinned the management ranks and clarified accountability. Holistic organization simplification: Often, when organizations become complex, a more comprehensive approach is needed. An integrated petroleum company started out in 1994 with just a handful of geographic and customer units. As it expanded, its organization grew more complex. The company used spans and layers as a guideline while designing leaner functions and new business areas-and reduced its head count by 15 percent. Finding the right span-and-layer mix Bain & Company has helped hundreds of clients tackle these issues. In the process, we have built a detailed spans-and-layers database that includes more than 125 global companies. Our analysis shows that in an average company, a manager has a span of six to seven direct reports and the organization has eight to nine layers between the top leadership and the frontline employee. Best-in-class companies in the database have average spans ranging between 10 and 15 direct reports and no more than seven layers. Of course, much depends on the type of job: "skills-based" jobs such as brand managers or engineers are usually well served with a span of six to eight, while "taskbased" jobs such as shop-floor or call-center supervisors have higher spans of 15 or more. In our experience, bringing spans and layers back under control requires four steps: Establish the baseline: This can be difficult because the data on spans and layers is usually scattered around the organization; people use different definitions; and the

organization evolves as people get hired, fired or transferred. But arriving at a common baseline is the first step, as it reveals the extent of the company's problem-as well as the potential rewards for fixing it. Taking a consistent approach across the organization is important: How to handle contractual or parttime employees? How to count spans when someone has multiple reporting lines? At one bank we worked with, it took considerable effort to sort through the snarled reporting lines. But once the work was done, the process identified savings of $25 million a year. Set stretch targets: No magic number exists for all organizations or job types when it comes to setting targets for spans and layers. But benchmarking against best-in-class companies helps get to the right goal. In our experience, it is best first to understand the mix of employees and job types (skills-based versus taskbased), set targets by function or business area and work top-down-but constantly check that in practice, targets are realistic and feasible. In the case of the bank, for example, after the initial estimates of $25 million, best-in-class benchmarking showed the potential to double those savings. Make it happen: Agreement on the right level of spans and layers doesn't always translate into action. Managers protect people or move employees to other areas of the business. Very often excuses mount. ("It's not a good time.") At this stage, senior management reviews, where people are held accountable for the targets, can give momentum to the change. It also helps to link the targets for spans and layers to key performance metrics-and ultimately, the compensation- of top executives. Many companies first focus on targets that can be achieved in 12 months, which typically require making easy span changes and eliminating low-value-added activities. To reach world-class benchmarks, they then target more fundamental changes to processes and systems, for example, automating manual activities. At one global technology company, management set the short-term goal of increasing each manager's span from below five to six. When that brought in savings of $50 million a year, management spurred the organization to move to 6.5, then seven direct reports. Keep out the fat: Companies need to invest in management processes and systems that prevent the organization from sliding back to its old size. Some smart preventive tactics include setting up an HR dashboard that allows the organization to track the right metrics; holding managers accountable for spans in their departments; and ensuring that HR does a span check before a new job is posted. If managers revisit remaining lean as an issue at reviews, controlling spans and layers becomes a habit. It also helps to recall the success that comes from running a leaner, more nimble organization. At the white goods company, the decision to increase spans from eight to 11 saved more than $200 million a year. At an airline company, restructuring led to head-count reductions, which generated more than $150 million in savings-nearly a third of which came from spans and layers. The companies in our database improved spans by 24 percent and reduced layers by 14 percent, on average. In all cases, the impact was considerable: Costs declined, decision making improved and the organization emerged leaner and more competitive.

Key contacts in Bain's Global Organization Capability practice are: Americas: Marcia Blenko in Boston, Jeff Denneen in Atlanta, Lori Flees in Los Angeles, Mark Kovac in Dallas, Michael Mankins in San Francisco, Marcial Rapela in So Paulo and Hernan Saenz in Dallas Asia-Pacific: Kevin Meehan in Singapore, David Mountain in Mumbai, James Root in Hong Kong and Peter Stumbles in Sydney Europe: Frederic Debruyne in Brussels, Arnaud Leroi in Paris, Carsten Prussog in Munich and Paul Rogers in London