Convention and tradition may still have their (smaller) place in organizations today, but not in the company envisioned and described by one of the world’s leading and most respected management gurus, Gary Hamel. “In the years ahead,” he says in this extensive and provocative interview, “the challenge for every organization is going to be to begin to think about how to measure and support three newer kinds of capital, imagination capital, entrepreneurial capital and relationship capital.” From prescribing how a company can claim and sustain a competitive advantage to meeting the next imperative, developing “business concept innovation,” Mr. Hamel offers his observations and recommendations on how organizations in any business can win and stay on the leading edge.

Part visionary, part missionary and part revolutionary, Gary Hamel is first and foremost one of the world’s leading management thinkers and consultants. The Economist calls him “the world’s reigning strategy guru,” and the Financial Times recently ranked him as the fourth most influential management guru in the world.

The author of Competing for the Future, one of the most important business books of the ’90s, Mr. Hamel is the founder and chairman of Strategos, a Silicon Valley-based global consulting firm. His introduction of concepts such as “strategic intent,” “core competence” and “expeditionary marketing” into the vocabulary of managing have informed and influenced leaders in corporations everywhere.

Mr. Hamel is a Visiting Professor of Strategic and International Management at the London Business School. His latest book, Leading the Revolution (Harvard Business School Press), was published last year. He spoke with Ivey Business Journal during a recent visit to Toronto.

Journal: You’ve written that e-business is “rapidly becoming an information technology arms race.” What are the implications for managers and CEOs?

Hamel: The thing that kind of caught my attention when I began to focus on e-business was the following: The U.S. data suggest that in 1990, companies were spending 16 percent of their capital budgets on information technology. By the year 2000, that number was 59 percent. And of course that ramp-up in spending drove the valuations of Cisco and Oracle and all of those associated companies. But at the same time, if you looked at the average operating margins of the S&P500, they’ve been very stable, basically unchanging for the last six or seven years.

So I started scratching my head and saying, “Why is this, we’re spending more and more money on information technology. Clearly, it’s creating productivity and efficiency, but it’s not showing up on the bottom line in many companies. Why would that be?”

In a nutshell, I think there are two answers. First of all, in the same way that the Internet is helping a lot of companies reduce costs and gain efficiencies, it’s also giving customers a lot more power in the overall purchasing equation, in the sense that “e” is celebrated for its ability to reduce friction in commerce. But many companies owe a great percentage of their profits to friction. For example, most individuals could not tell you if they’re getting the lowest-possible interest rate on their credit card debt or their mortgage debt. So for many companies, customer ignorance was a profit centre. And of course the Internet begins to remove that source of friction—the cost of information as a source of friction. Search costs were high for customers—the ability to compare was a difficult thing in many cases. Historically, you also found asymmetries in bargaining power. This was another source of friction. For example, if I was a company selling to Wal-Mart, it would beat me down on my prices because of its enormous bargaining power. But luckily, I probably had some weaker customers as well. Now you look at all the hubs and exchanges where companies across industries are consolidating their purchasing power, and pretty soon, every buyer will have the power of Wal-Mart. So you think about a world in which there are no ignorant or weak customers, where transaction costs are going to zero, or knowledge arbitrage is more difficult because knowledge is more readily available. All of those things are going to attempt to reduce friction and, therefore, prices.

So the way I sometimes say it is this: For many companies, the efficiency-enhancing benefits of the Internet will be overwhelmed by the price-deflating impact of the Internet. That’s the first reason that all of this spending may not translate to the bottom line: Many of the efficiency gains will get back to the customers in the form of lower prices or more service for the same price.

The second reason I think these efficiency gains may not end up on the bottom line is that many companies have very similar e-strategies. Think about the major trends in information technology and you will see that most of those trends tend to drive strategies to be more alike rather than more different. Most companies are running the same platforms, whether it’s SAP or a small number of IT platforms. Most companies are working with the same handful of IT consultants—IBM Global Services or PWC or a couple of others. Most are outsourcing to the same set of companies. And increasingly, companies are combining with their competitors to form industry-wide exchanges.

This creates a problem, because if 50 or 60 percent of my capital budget is going into things that are essentially largely undifferentiated from what my competitors are doing, that’s not a good thing. And so I think the question that any executive needs to ask his or her CIO in a large company is this: What are we doing to build a unique industry competitive advantage?

There’s an interesting historical parallel. If you look at electrification 100 years ago, you will find that the companies that made money were the ones selling the generators and the lines and the power equipment—companies like GE and Siemens and Westinghouse. But the companies that were investing in electrifying their business processes saw their profits as a share of GNP decline over about 30 years during this process of electrification. So it’s going to be interesting to see whether the new “e” is any bigger boost for profits than the original “e.” I don’t think that that’s going to be the case.

What that suggests to me is that “e” without “i,” “e” without real innovation, is probably not going to buy a company very much.

It’s becoming harder and harder for a company to claim and sustain a competitive advantage. What does a company need to do in order to stake out a distinct position?

It is becoming more difficult to maintain a distinctive strategy for a variety of reasons. First, there are a lot more consultants out there in the world whose basic job is to transfer best practice from one company to another. Number two, you have a lot more employee mobility, so ideas flow more quickly across organizational boundaries. Number three, you have a lot of venture capital funding start-ups. And so the diffusion mechanisms for strategy insights are so much better today than they ever were before.

The only way of avoiding that is to create a capability for perpetual innovation in ways that are large and small. And here there’s actually a danger in thinking about innovation only as something that deeply changes the entire economics and structure of an industry. In some sense, I may even be guilty of perpetuating that rather grand view of innovation. The reality is that innovation comes in all sizes, and a company that wants to stay evergreen needs to be asking this question: How do I build a very deep and vibrant pipeline of smaller innovations that collectively have the power to continually transform what I’m doing?

I go back a few years for one example, British Airways in the ’80s and the early ’90s, when it was the most profitable airline in the world. It had deeply involved their employees in the process of creating competitive advantage, a host of small-scale innovations like the personal videos or seats that weren’t perfectly flat in First Class and then in Business Class, things that by themselves were not defining, but collectively made for a very diff e rent service experience.

Every company has to build an innovation pipeline because out of a thousand unconventional ideas, probably only a hundred are worth experimenting with. And out of those one hundred, only 10 have the power to transform a business, or maybe even less than that. The dilemma for many companies is that they don’t have enough variety, they don’t have enough experimentation in their strategies. Strategy unfortunately became a game of having a few really smart people at the top searching for the one great idea, rather than a question of how do we get a lot of unconventional, low-cost, low-risk experiments started, out of which we hope will emerge an idea or two that has the power to transform what we’re doing.

I’ve described this problem as having a low corporate sperm count. There’s a redundancy built in at conception, where you need a lot of these little swimmers to get the job done. Most large companies don’t yet understand that arithmetic of innovation. And so they actually believe that that kind of experimentation is wasteful when of course it is the very rhythm of life. By definition, innovation requires a certain amount of waste—it can be smart waste rather than stupid waste; you don’t experiment with ideas that are, on the face of it, ludicrous. But if you want to keep a strategy vibrant and continue to rebuild your competitive differentiation, you have to be continuously experimenting with a wide range of new rules.

What does a CEO need to do to make the process of innovation more bottom-up than top-down?

There are two fundamental answers to that question. The first is that you train people how to think and perceive in ways that increase the probability that they will see an unconventional opportunity. And that’s not as hard as it seems. I do think some people are just innately more creative than others. Some people are wired in ways that help them see patterns and relationships more quickly.

On the other hand, when we went and studied the process of innovation, we found that innovators shared not so much a common set of personal traits, but a common way of looking at the world. Number one, they were contrarians. And by definition the way you create a strategy differentiation means that you violate industry norms. Again, in smart ways and not in stupid ways. Number two, we found these people were, as I’ve described them, “novelty addicts,” people who loved to be out on the fringes of what was changing, to see what was new. They were the people who went to the new restaurants, who saw the new movies, who were the first to vacation in new places. And therefore they were constantly seeing and experiencing things that other people were not. And thirdly, they were deeply empathetic with customers, not in a “we need to be customer led” kind of a way, but in “I really understand the unarticulated frustrations and desires and anxieties of the people around me and I want to do something about that.”

You can teach people those things. You can teach people to deconstruct industry orthodoxies, you can teach people how to get out on the fringe and find out where change is happening. And you can teach people to develop a much deeper experiential sense of the frustrations and unspoken needs of customers. When you do that and you triangulate those perspectives—the heretic, the novelty addict and the individual who’s living inside of the customer’s skin—the juncture of those perspectives is where you’re going to see opportunities that other people don’t see.

We’re going to have to train people how to think this way, because by and large, Industrial Age thinking focused on continuous improvement and optimization. It wasn’t focused on “Let’s find something new.” An organization can also create internal markets for ideas, experimental capital and talent. Most organizations operate a bit like the former Soviet Union in that ideas have to fight their way up through many levels of hierarchy before somebody at the top makes an allocational decision. And yet, by and large, markets are more effective in getting the right resources behind the right ideas than are hierarchies, as even the Soviet Union has learned.

Silicon Valley isn’t based on resource allocation, it’s based on resource attraction, where somebody throws out an idea into this kind of marketplace for ideas. Either that idea attracts capital and talent or it doesn’t. But there’s no giant CEO brain making allocational decisions in Silicon Valley. There are many, many people making those decisions— it’s very distributed. If one venture capitalist doesn’t like it, you send it to another and another and another, and maybe you get funding and maybe you don’t. You have to create the expectation that the kind of ideas that could change the destiny of a company can emerge from anywhere, and you have to create a system whereby people can quickly share those ideas.

What do you see as the business models that are emerging from the dot-com meltdown?

That’s a hard question, because I don’t think there is such a thing as an “e-business business model” in a pure sense. “E” is just another technology that does a variety of things. It allows you to obviously distribute digital content extraordinarily efficiently, it allows you to answer customer queries more efficiently, it allows you to remove layers of bureaucracy and process in large organizations. But thinking about “e” as a pure-play business model is not the right way to look at it.

One of the biggest challenges a leader has today is reconciling strategy continuity and change. How does a leader do that?

I think in the following way. When we work in organizations and we work to dramatically expand the number of unconventional, strategic options that the company has, we are often confronted with a fear that this will splinter the company into many, many different, disconnected projects and initiatives.

The reason that does not happen is the following. First of all, the hard part in working with an organization is actually getting people to get far enough out of bounds. Most people are so stuck inside the existing paradigm that there’s little risk of them getting so far out on the fringe that they’re going to have an opportunity that is completely unrecognizable and tangential to what the company is doing already.

An employee who wants to succeed quickly in a large organization knows that he or she has to find opportunities that leverage what the company already has. And so there’s a natural tendency to want to work with the grain of what the company has rather than against it. Because if I have an idea for something in which the company has no starting advantage, I might as well leave the company and spend the next 10 years trying to build an Amazon, because we have no advantages here. So, for example, the young people I’ve met at Enron know that if they find an idea that exploits the competencies and assets of Enron, they will beat any start-up to the market, because the start-up has to assemble all these things from scratch.

The right kind of top-management oversight will find and reinforce the important patterns. I believe that scale and scope are all that’s going to matter. I believe that size can be an advantage. And obviously, if you want scale and scope advantages, you have to do things consistently over time and across projects. If you didn’t, you accumulate no scale and no scope advantages. And so to do things consistently over time means that you have to find patterns that you can replicate in some way.

For example, look at a company like Virgin, that has started more than 150 different businesses. At one level it’s completely diverse. And yet the thing that unites all of those businesses is a set of value propositions that are encased in its brand. So Virgin goes into businesses where they think the brand will imply customer value, funky and fun, aimed at kind of the younger folks, well, where that brand is going to have value.

The goal is not to just let employees go off and do anything, but to stimulate them. You help them understand that the ideas that leverage what we have are going to be the ones that create the most success. Top management should be sitting there and saying, “Gee, over the last few months we’ve seen 20 to 30 new ideas that kind of all are going in this direction. Let’s reinforce those, let’s bring those people together, let’s make that a vector.” The goal is not to turn a large company into a collection of small angel investments.

Is that what you mean when you say that a company should define itself by its competencies instead of what it actually does?

Yes. One of the assumptions we had from the Industrial Age was that a company was synonymous with its existing business model. That’s a pretty dangerous thing in a world where business models don’t have long lives.

I’ll give you a couple of examples. Despite the fact that Xerox has long described itself as a “document company,” it missed the opportunity for printers. Today, if you want another copy you send it to the printer, you don’t walk down to the copying room. It’s more or less the same technology sold to more or less the same customers. How does that happen? Because a company, even though it might talk about itself in broad terms, really is devoted to a single business model, in this case, copiers.

I saw the same thing at Coca-Cola, which has been late to most of the new beverage trends over the last 10 years. It was late to these fruit-flavoured teas…that was Snapple, and it was late to the sports drinks…that was Gatorade. It was also late to the New Age beverages like Red Bull. You can say, “But how could this be? After all, this is the greatest beverage company in the world.” I got the hint when I was talking to Roberto Goizuetta, the former chairman, shortly before he died. I asked him what his dream was for Coca-Cola. He said: “My dream is that anywhere in the world, if somebody turns on a tap, out comes Coca-Cola.” And I thought to myself, “That guy has imprisoned all the talent, the passion, the imagination, the competencies, the infrastructure of this company in a definition that comes down to brown fizzy liquid.”

Today, you have to think even more broadly, because the question is not, “How do I leverage my core competencies?” but, “How do I look at all the competencies that are out there in the world and think about the possibilities of putting those things together?” For example, if I put the Harvard Business School together with Cisco, I get a global cyber-business school, which no organization could do on its own.

But there is a great risk still of companies becoming imprisoned inside of a very narrow definition of who they are. And so my definition of a company has changed a lot even over the past year or so. A company today is made up of six kinds of capital. There’s the financial capital, the structural capital and the intellectual capital, all of which we understand pretty well. Yet I don’t believe those things by themselves create wealth. Those are actually almost inanimate. And it’s a complete mistake to say that knowledge is the most critical resource in the New Economy. Knowledge today is a commodity. You can buy it by the yard from just about anywhere.

It seems to me there’s three diff e rent kinds of capital that animate the traditional sources of capital, that serve as the catalyst that translate the traditional sources of capital into wealth. Those new sources of capital are imagination capital, the ability that people have to imagine entirely new uses for their traditional capital; entre p reneurial capital, the courage and the guts of people to actually experiment and try new things; and relationship capital, the connections that people in the organization have with each other, and with organizations and individuals outside of the company. Because one of the things we know is that innovation comes more and more at the juncture of organizations and individuals that had previously isolated skill sets and competencies, but that when put together, give you new things.

In the years ahead, the challenge for every organization is going to be to begin to think about how to measure and support the development of these three, newer kinds of capital. Unfortunately, most companies took a big detour over the last few years. A lot of them mixed “e” with innovation. But “e” is just an enabling technology. Of course a lot of the most interesting innovations have nothing to do with technology anyway. They’re examples of conceptual innovation. What does Ikea have to do with IT or The Body Shop or Starbucks?

The second mistake companies made was that they essentially assumed that you couldn’t innovate the core business. So they would assign the task of innovating to an incubator or a venture fund. They ghettoized innovation. They put a couple of 20-year-olds with a bit of money into an incubator and said, “Go find us a cool e-thing to do.” Of course all of those fail, because most of the talent and competence that you need to do new things were still sitting back in the old organization. But innovation cannot be something that is out on the periphery of the organization. I absolutely do not accept the fact that you have to isolate new things for them to take root. We have to change the culture of the old things so innovation is not seen as an unnatural act, rather than saying that this won’t survive unless we put it in some kind of a dedicated unit somewhere.

I once described the situation this way: The problem with the incubators and venture funds is that they’re a little bit like putting a bellybutton ring on granny. It’s kind of an interesting adornment, but what granny needs is a liver transplant not a bellybutton ring. And companies are now getting that. They have to build the constituent pieces of an innovation solution. And that means the training we’re going to have to provide people. It means the new metrics we’re going to have to use to get people focused on creating new wealth rather than cutting costs. It means re-engineering not only our business processes but our management processes so they become less toxic to innovation. It means instilling new values in people. So it’s making innovation a deep capability, not having 20 people brainstorm for a week at the Four Seasons Hotel.

You’ve said that developing “business concept innovation” [BCI] is the next imperative—and critical advantage—for a company. What is BCI and why is it the next critical advantage?

If you look at the companies that have created new wealth over the last decade, almost all of them had more than just a new product or a new technology. They had a completely diff e rent conception of the entire business. There are at least a dozen major design variables in a business. How you go to market, which competencies you use, how you put together your value web, what is your core mission, where do you look for differentiation, and so on. And most people don’t see those as design variables after a while. They just start accepting them for what they are. So if I’m a product person, I might think about product innovation but I don’t think about innovation in pricing or channel or a value Web. I’m trying to get people to think about the entire business concept as being malleable and open to redesign. When I look at a company like Ikea, it’s not about a diff e rent kind of furniture. It was a different retailing concept, a different manufacturing concept, a diff e rent value proposition altogether. It’s the same when I look at Starbucks, the same when I look at what Microsoft is now trying to do with Microsoft.net, and moving from software as a shrink-wrapped product sold on a shelf to software as a service that is bought on a subscription basis. These are deep shifts in the entire business concept, rather than incremental shifts in a single element of the business concept.

I believe that business concepts can be changed all at once in a big way and I believe they can be changed more slowly over time. But I think the challenge for organizations is to recognize that all of those design variables need to be open to question all the time. Because if they’re not, someone else is going to come along and take some dimension of that that you never regarded as important, and they’re going to use it in a very interesting way.

One of the examples I talked about in my book [Leading the Revolution] is this notion of a cyber business school. I don’t know whether it will happen one day or not…I’m pretty sure it will. But a traditional business school has a model that has several characteristics. All of the faculty has to live within 50 miles of the campus, more or less. It’s a very egalitarian structure because the economics tend to be similar. Whether you’re the best professor or the worst, you’re talking to 60 or 70 students. There’s the assumption that because you only have a limited number of seats, you have to have a very high hurdle for admittance. But all of this works against delivering your product in new ways. So I ask, is it possible that someone could come along and say, “We’ll take the 30 best business professors in the world, we’ll cherry-pick them out of Harvard, Ivey and so on. We will pay them a couple of million a year because we can now reach 100,000 or a million students at a time. We’ll have no admission requirements, only an exit requirement that you have to take a test to get the degree—we’ll let anybody in because…you know…that is a completely different business concept.” A business school that cannot look at every assumption it has made about its business model, and question it, is not going to be able to do that. They’ll get halfway. But I find it interesting that a lot of business schools are beginning to say, “We need to be in e-space, we need to be able to deliver courses over the Internet.” I don’t know of a single one though that has challenged the fundamental assumption that we should be able to use the best faculty wherever they are. So what they essentially have is what a film studio in London did when it decided that it will use only actors that live in London. “If you live in New York or you live in Paris or somewhere else, we can’t use you.” What a ridiculous thing to say.

How does a manger sell an innovative idea up through the organization?

You have to have your own point of view. There’s a lot of winging that goes on in organizations, by people who actually don’t have anything to say. If you haven’t made the investment in trying to build your own point about where and how your company should be innovating, then shut up and don’t bother people.

You also have to build a coalition. And that means you start not by asking your boss. You start by going horizontally, to your peers and seeing whether anybody is willing to sign up. Do they care about this? Do they agree? Are they willing to help you do something about it. I find that it is very easy for top management to say “No” to an individual, but it’s very difficult to say “No” once you have 15 or 20 people who say, “Let’s go, we need to try.”

Thank you very much.