How did Gillette, a razor blade company, justify spending $7 billion to buy battery maker Duracell? How has SAP, Europe’s leading software company, managed to sustain such high growth rates? And how has entrepreneur Li Ka-shing been able to pull off the kinds of deals in China about which others only dream?

The answer is capabilities: the skills, assets, and relationships that companies assemble to build competitive businesses. Our research into companies that succeed in sustaining growth for long periods reveals that they think broadly about capabilities. Naturally, some rely on operational skill, the narrow definition of capability. But a surprising number from our sample thrived by employing less obvious capabilities.

When businesspeople refer to organizational capa-bilities, they usually mean the skills embedded in a company’s people, processes, and institutional know-ledge. These are so basic to survival that they are often referred to as core competencies. In any competitive environment, a company must be good at what it does and possess skills that make it stand out. Distinctive competencies allow growth companies not only to make more money from existing businesses but also to extract greater value from new opportunities.

Important as operational skills or competencies are to a company’s success, too narrow a focus on them can stunt growth. A broader definition of capability — one that includes all resources useful in gaining competitive advantage — is required. In addition to operational skill, our definition of capability would include three other classes of resources: privileged assets, growth-enabling skills, and special relationships.

Privileged assets

Privileged assets are physical or intangible assets that are hard to replicate and confer competitive advantage on their owner. They include infrastructure, intellectual property, distribution networks, brands and reputations, and customer information.

Distribution networks. A business can use the scale of its distribution network to increase sales of its existing products and services or to reduce the cost of a new-product launch. For Gillette, the principal motive for its $7 billion acquisition of battery maker Duracell in late 1996 was synergy in distribution. The distribution network that gets Gillette’s razor blades into supermarkets and convenience stores—the same outlets where batteries are sold—was second to none. So big was this opportunity that investors added $4.1 billion to the companies’ combined capitalization in the two days following the announcement of the deal.

Gillette was able to help Duracell grow by taking it global. This strong domestic player had 50 percent of the US market, but little exposure in such emerging economies as China and India, where Gillette’s network was especially strong.

Brands and reputation. Strong brands can be extended to launch products without threatening the credibility of the current business. Gillette has used its brand to enter the market for men’s grooming products. The Gillette Series for Men includes products such as aftershave, shaving cream, and deodorant as well as razors and blades. Launched in 1990, the men’s Sensor razor achieved $2.9 billion in sales in 1997 alone, with over 60 million users worldwide. Gillette is seeking to beat this record with the MACH3, a three-blade multiangled razor.

Customer information. Detailed information of all kinds can be critical to maximizing sales. Some of the most valuable information involves customers’ buying habits and needs. Seven-Eleven Japan’s point-of-sale information system helps to ensure that the company has the right product mix for every customer who walks into its stores. It tries to extract a range of data from each sale, including the time of purchase and the sex and estimated age of the customer. The information is downloaded daily from store computer terminals to headquarters, where sales trends are analyzed.

Every day, managers can gain access to current and historical data to adjust and customize the product mix for their stores. About 70 percent of an average store’s 3,000 products is replaced annually in the never-ending quest for the optimal product mix.

Growth-enabling skills

Organizations that master such generic growth-enabling skills as acquisition, deal structuring, financing, risk management, and capital management have a big advantage in creating and sustaining growth. While operational skills tend to be specific to each of a company’s businesses, these growth-enabling skills are transferable from one market or business unit to another. Because of their broad applicability, they usually reside in the corporate center, from where they are made available to business units.

Acquisition and postmerger management skills. Poorly executed acquisitions can be expensive and risky. Acquisitions done well can accelerate growth and save costs. The ability to make and integrate acquisitions quickly and on attractive terms confers an obvious advantage.¹

The Sara Lee Corporation has relied on acquisitions to launch new businesses and promote growth. It made more than 80 purchases between 1981 and 1995 while simultaneously divesting underperforming and distracting businesses. Its planning and budgetary system often sets targets that cannot be reached through organic growth alone. To meet them, managers go to great lengths to keep the acquisition pipeline full. The company sometimes courts potential targets for as long as ten years so that it can be the first to know when one of them is ready to sell.

Financing and risk management skills. Highly developed financial and risk management skills enable some organizations to grow in ways that others cannot. By crafting elegant solutions to funding constraints, such companies can advance along promising growth paths that are too costly or risky for their competitors.

Although the Barrick Gold Corporation’s core competency lies in the operation of gold mines, former chief financial officer Robert Wickham noted in 1992 that "Larger [gold companies] will need to know as much about financing as they do about metallurgy."² Barrick has used gold bonds that index interest to the gold price as a means of financing new mines. It has also conducted an extremely successful hedging program. Through financial engineering, it narrows the risk of developing new mines to operational and geological uncertainties.

Capital management skills. Exceptional capital productivity skills enable managers to make a commercial success of projects that other companies might reject as yielding poor returns. Stretching capital further increases the projected return from individual projects and frees up some of a company’s financial capacity for investments in other projects.

Hindustan Lever’s success in Indian consumer goods rests partly on its capital efficiency skills. The company generates tremendous sales per dollar of capital through its skill in designing manufacturing plants without any gold-plating and the outsourcing of selected manufacturing and distribution activities.

Special relationships

One of the most important yet least-discussed capabilities involves relation-ships. Ties with existing customers and suppliers can provide growth oppor-tunities and should be nurtured. Those with powerful individuals, businesses, and governments can unlock opportunities that would otherwise be shut off. In particular, relationships can facilitate entry into new industries and geographies, as well as bring deals to the table.

In Asia, special relationships have played a major role in the extraordinary success of groups founded by overseas Chinese families.³ The business empire of Li Ka-shing, one of the world’s richest men, is founded on special relationships. Li’s powerful web of contacts has granted him early access to restricted opportunities in fast-growing infrastructure businesses. His flagship company, Hutchison Whampoa, has moved rapidly from container terminals into electricity generation, retailing, and telecommunications, expanding from its Hong Kong base into China, the United Kingdom, and Canada. Through joint ventures, it now operates three of China’s largest container ports.

Li’s access to deals comes through a network of relationships he has been cultivating in Hong Kong and China since the late 1970s. It includes close ties with governments, state-owned enterprises, financial institutions, overseas Chinese entrepreneurs, and Western multinationals. Li has nurtured these relationships in dozens of ways. He sits on the board of the Hongkong and Shanghai Bank, well situated within the Asian deal flow. He sent early signals of his commitment by building the China Hotel in Guangdong in 1980, well before China opened up.

Australia’s Village Roadshow has grown from a drive-in theater operator to a global entertainment conglomerate

The relevance of special relationships extends far beyond the emerging markets of the Far East.⁴ Australia’s Village Roadshow has employed relationships to grow from a small drive-in theater operator to an inter-national entertainment company operating cinemas in Australia, Asia, and Europe, as well as theme parks, radio stations, film and music production, and film and video distribution. An integral part of its success has been active alliances or joint ventures with dozens of companies. To take one example, it married its expertise in cinema operation with the European cinema sites of Warner Bros. to accelerate both companies’ growth in Europe. At the same time, Village Roadshow’s knowledge of its home market and Warner’s theme park expertise led to the development of theme parks, resorts, and stores in Australia and New Zealand.

Barrick Gold offers another powerful example. Barrick opened its doors in Canada in 1983 under the entrepreneurial leadership of Peter Munk and has since become one of the world’s largest and most profitable gold-mining companies. But it has met obstacles along the way. Despite Barrick’s superior operational skills, investors became concerned in 1993 about the company’s lack of options on mines relative to competitors such as Placer Dome and Newmont Mining.

Barrick responded by augmenting its exploration program. But it went a step further: it also deployed its strength in relationships. In 1995, it formed an international advisory board that included former Canadian prime minister Brian Mulroney, former US president George Bush, and former president of the German central bank Karl Otto Pöhl. In assembling this group of heavyweights, Munk was sending a message to investors: we have access to international deals at the highest possible level.

In addition, Barrick formed relationships with many smaller exploration companies operating in Asia, Australia, and Latin America. These companies had innovative ideas, access to exploration acreage, and low overhead, but little money. As such, they complemented Barrick, with its ample capital, substantial mine development, and oper-ational expertise.

Relationships have mattered for as long as people have done business. But recent busi-ness history reveals many cases where the boundary between special relationships and corruption has been crossed. The issue becomes especially sensitive where the special relationship is with government officials. This makes reliance on special relationships as a capability more complicated than, say, the use of a brand or a distribution network. However, it is perfectly possible to derive strategic benefit from relationships without jettisoning ethical values. Companies that sustain growth find ways to do just that.

From capability to advantage

How well a company assembles the capabilities that a new business requires determines how successful it is at gaining and keeping positional advantage. Some capabilities are more important than others, and combinations are generally harder to imitate than individual capabilities. The business builder’s challenge begins with the need to assemble the capabilities most critical to making money in the business. Lasting competitive advantage comes only when companies assemble difficult-to-imitate combinations of capabilities into bundles.

Competitive advantage may not call for superior capabilities in every business

Competitive advantage may not call for superior capabilities in every area of a business. But control of the most important capabilities can determine how much of the value of a growing business will flow to its owner. For every opportunity, it is important to distinguish the capabilities that influence competitive success from those that are merely necessary to play the game. Capabilities that are less critical can be outsourced or controlled by others.

Enron’s success in power generation is a case in point. As the company built or acquired power plants between 1988 and 1990, it viewed the business in a different way from its utility competitors. It recognized that economic value accrued disproportionately to those who structured the deals, not those who con-structed and operated the plants.

In the early years, Enron was not distinctive at building and operating power stations, but it didn’t matter; these skills could be contracted out. Rather, it was good at negotiating long-term fuel supply contracts, electricity sales agreements, construction contracts, financing, and government guarantees—precisely the skills that distinguished successful players from also-rans. By con-centrating on these skills, Enron built a strong global position in less than a decade.

Bundling capabilities for enduring advantage

Harvard Business School professors David Collis and Cynthia Montgomery argue that a capability or resource becomes a source of sustainable compet-itive advantage only if it passes several tests.⁵ First, it must be competitively superior and valuable in the product market. Second, it must be difficult to imitate. Third, it must not be easy to replace by an alternative capability. Fourth, it must be durable. Fifth, it must be difficult to trade. If the capability can walk out the door with an employee, it is the employee, not the cor-poration, that will appropriate the value.

Not many individual capabilities are totally unassailable

Some individual capabilities may pass the tests. A world class brand, for example, will continue to confer advantage on its owner. But few individual capabilities are unassailable, and even a first-mover advantage can fade away without proper support. The key to sustaining competitive advantage as a business grows is to assemble a bundle of distinctive capabilities that together satisfy the criteria.

The capabilities in the bundle can be built in house, borrowed by means of alliances, or acquired outright. As each new capability is added to the bundle, greater competitive advantage accrues because the combination becomes more difficult for competitors to imitate or substitute, and more difficult for employees to appropriate from the company.

SAP’s skill lies not in developing new technologies but in continually refining products

SAP, Europe’s leading software company, has achieved remarkable growth by assembling a distinctive bundle of capabilities: great operational skills, a set of privileged assets, and a web of special relationships. It has made its mark with its enterprise resource-planning software R/3, which is designed to help companies manage the torrent of information that pours in daily. But SAP’s operational skills lie not in the development of radically new techno-logies, but in continually refining and enhancing its products.

SAP achieves constant product improvement by systematically funneling its responses to customer suggestions and requirements into each release of a product. In-depth dialogue with customers and formal meetings with user groups have enabled SAP to convert its customers’ specialist knowledge into industry-specific solutions.

Two types of privileged assets contribute to the distinctiveness of SAP’s capability bun-dle: the first is the intellectual property represented by the programming code in R/3 software; the second, the power of SAP’s reputation or brand for its 6,000-strong customer base. The commitment of many industry leaders to SAP products has helped build momentum toward further growth.

Also at the heart of the growth formula pursued by SAP is a web of complementary relationships. The complexity of the company’s products calls for technical expertise at every stage of implementation. Rather than provide this itself, SAP uses partnerships: with the manufacturers whose hardware runs its software, with the vendors that sell the product and provide technical support, with the systems consultants that install the product, and with the software developers that provide complementary business- or industry-specific functions. It is in the interests of all of these partners to increase SAP’s sales.

All the same, SAP is not immune from competitive threats. To maintain its growth trajectory, the company may well have to work at making its software easier to implement. But its hard-to-duplicate bundle of skills, assets, and relationships would seem to give it the ammunition it needs to fend off challenges from rivals.

For any company with an expansive mindset, today’s business world is teeming with opportunities for growth. But however attractive these opportunities may be, no company will be able to profit from them unless it can marshal the necessary capabilities. Operational excellence is a necessary but not sufficient ingredient. What counts in the end is the set of privileged assets, growth-enabling skills, and special relationships that each competitor brings to bear in pursuing opportunities. The competitor that has assembled the strongest bundle of distinctive capabilities has the best chance of emerging as the winner.