Authors: Henrique Ceotto, Juan Franco, Rami Goldfajn, and Fábio Stul
Executives are well versed in the importance of transformations. If they haven’t recently completed one, they are likely in the midst of one or are getting ready to embark on the journey. Yet despite their ubiquity, transformations are often poorly understood: Are they discrete efforts or ongoing journeys? Is digital and analytics at their core, or is it simply a critical enabler? One reason for this confusion is that the transformations have evolved—from mission-critical operations intended to turn around failing companies to sources of organizational renewal and innovation.
To get a glimpse of this broader version of transformation in action, one need look no further than Latin America. In part, the region has excelled at transformation because it is home to a fast-moving business environment with a high degree of volatility. The COVID-19 pandemic and the resulting severe economic and social shocks forced companies to continue to develop their ability to adapt. Companies across industries must regularly reimagine themselves or risk becoming obsolete.
Now, Latin American executives are seeking to build on their organizations’ hard-earned resilience to pursue emerging opportunities. New McKinsey analysis sheds light on the elements of a successful transformation. First, leaders must understand four archetypes of transformation and determine which one best fits their organization. In addition, an awareness of five foundational transformation actions can ensure that executives avoid pitfalls and position their companies for ongoing success.
Why Latin American companies are primed for transformation
Latin America boasts a dynamic business environment shaped by several factors: young populations, abundant resources, a growing consumer base, strong trade ties, and a burgeoning start-up scene. With a population twice as large as that of the United States and a GDP roughly half that of China, the region offers boundless opportunities to companies that can overcome barriers.
The COVID-19 pandemic has brought immense suffering to the region, but it has also accelerated digitalization and the adoption of new technologies at organizations across Latin America. For example, 40 million people opened bank accounts to receive digital payments in the first five months of the pandemic; the number of start-up unicorns has expanded from zero to 17 over the past three years; and internet penetration and venture capitalist (VC) investments are at all-time highs.
Our analysis found that transformations that focus on both growth and costs while seizing all opportunities in parallel typically achieve better outcomes than those with a narrower focus. This pattern holds especially true in Latin America. Our data show that 38 percent of transformation value is generated from growth initiatives, reaching 49 percent for Latin American companies. In fact, we found that reducing general and administrative expenses, including reductions in head count, accounted for just 9 percent of gross transformation targets on average. Yet this is typically where most companies start.
Latin American companies can choose from several different paths in their transformation journeys, depending on their starting points and aspirations. Our analysis defined four transformation archetypes:
Performance transformations (from good to great). These typically occur in companies that have solid fundamentals but that are not achieving maximum performance. Many of these organizations are leaders in their industries and engage in transformations to push their competitive advantages even further. For example, one of the region’s dairy players embraced a transformation that helped increase its earnings before interest, taxes, depreciation, and amortization (EBITDA) by close to 60 percent a year, positioning it as one of the best performers in the industry.
Operating-model transformations (reinventing the core). These are usually pursued by companies that are anticipating future disruptions in their businesses. As a result, they make preemptive moves to improve their resilience. These companies are typically incumbents that need to keep pace with nimbler, more agile disruptors. One of the region’s leading banks invested in digital capabilities to address the most pressing trends facing the industry. It developed a digital lab with more than ten agile cells, executing more than 200 growth and cost initiatives. This coordinated effort increased profits by more than $150 million within two years.
Portfolio shifts or growth transformations (igniting the engines). These involve significantly reshaping the company’s business scope. They will likely consist of selling a business, building new businesses (generally with a heavy digital-and-analytics component), entering new geographies, or developing new offerings (either organically or through M&A). The environment in which these transformations operate is constantly shifting, so speed and adaptability are critical, for example, to integrate an asset or to build a completely new direct-to-consumer channel. One supplier of production services for an extraction industry greatly increased its profitability and consolidated itself as the industry leader within a couple of years by embracing digital and analytics. It created a whole new set of businesses to provide digital-and-analytics services to its peers and to a broader set of capital-intensive industries.
Distressed turnarounds (recovering the path). These are cases in which the current business is severely challenged by high debt or industry or competitive headwinds, such as a shift in technology or in customer behavior. In these situations, the focus is mainly on generating cash in the short term, negotiating payment terms with debtors, and reshaping the portfolio to create a sustainable business model. This is the only archetype in which executives might have to sacrifice investments in the long term to ensure the survival of the business. For example, a mining-and-metals company in the midst of a ramp-up phase failed to meet its production targets. Through a holistic operational and cash-management intervention, it achieved break-even production within four months and attained an equilibrium for the business to continue to operate.
In many—if not most—situations, these archetypes overlap, so having all of them in mind can help executives understand the key drivers of value to be prioritized.
Five transformation boosters
Any sweeping initiative, especially one that has been heavily advocated for, can be vulnerable to misperceptions. For transformations, we have identified five boosters that can significantly improve overall outcomes.
- Aim for the moon
Companies commonly use two approaches to set goals: they embrace incremental targets with the hope of building momentum and of ensuring that the entire organization shares the burden, or—more typically—they establish low targets with an “underpromise to overdeliver” mindset. This approach is flawed for three main reasons. First, leaders risk alienating high-performing business units by asking them to deliver at the same level as low performers. Second, it unwittingly reinforces the behavior of low performers by suggesting they are better off maintaining the status quo until the next program, when they will be rewarded. Last, it neglects the fact that the effort required to improve performance in different areas can vary significantly. As Ken Robinson, a renowned British educator, said, “For most of us, the problem isn’t that we aim too high and fail. It’s just the opposite: we aim too low and succeed.”
As the COVID-19 pandemic grew in Latin America, the region’s economies collapsed. Discretionary customer spending fell precipitously, forcing companies to adapt. Many didn’t survive, but the ones that embraced transformation reaped significant benefits.
Successful transformations in the region focused on understanding the full opportunity in every relevant area. The best companies identified performance gaps through both analog and digital levers, corresponding barriers, and the efforts required to address them. This exercise defined a realistic but achievable target that companies could pursue to unlock real value. In the Latin American transformations we analyzed, the diligence process found, on average, 2.7 times more opportunity than senior executives thought possible. At one industrial company, the outcome was 4.7 times greater than the original aspiration.
A good example is one consumer-services company operating in a challenging market that embarked on a transformation not only to optimize its core businesses but also to branch out into new growth avenues. Within 18 months, it significantly improved the core business’s performance, expanded into adjacent areas, and launched a new business that has been growing at triple digits. At the same time, it has strengthened its internal capabilities by deploying agile at scale for many critical functions, creating an advanced analytics center of excellence, and fostering a culture of learning and innovation. It all started with a high aspiration.
- Mobilize the whole organization and build a pipeline of initiatives
Many people believe that an organization needs to concentrate on only a handful of initiatives to boost performance and that companies must devote significant time to developing a detailed plan before implementing it.
This approach has at least three challenges. First, while focus is critical, companies risk playing against the “law of large numbers”—the smaller the number of initiatives, the greater impact an underperforming initiative has on the overall outcome. Second, it assumes that a company can craft a perfect plan in advance, which is highly unlikely. And finally, it reflects a belief that tracking and performance dialogues will remove barriers to implementation, which they don’t.
The truth is that successful transformations have a portfolio of hundreds, if not thousands, of initiatives, each with an owner, a business case, key performance indicators (KPIs), and milestones to achieve the desired outcomes quickly. The best companies are also able to continually renew their pipeline of initiatives. Organizations compensate for the loss of the original plan by launching new initiatives, accelerating delivery, and exceeding expectations on existing ones. For Latin American companies, 31 percent of a transformation’s value after 18 months typically comes from different sources than originally planned. In addition, small initiatives (those costing less than $100,000) generated around 40 percent of the value in transformations, while large strategic initiatives (those costing more than $1 million) created just 16 percent of the value. For companies that achieved their target within 18 months, the value share of small initiatives was, on average, 13 percentage points higher than those that took longer to complete.
This is because the large number of initiatives and the involvement of many people allow companies to accomplish more than they think they can. This mobilization of the workforce also helps to disseminate the ownership mindsets and behaviors needed for change. Perpetual renewal requires that companies designate chief transformation officers supported by small, specialized teams, allowing for smooth execution.
- Reinforce talent and focus on organizational health
An organization’s talent and culture are the main factors in successful transformations. In most cases, a company must focus from the beginning on developing capabilities across the enterprise and on ensuring people and culture have the foundational elements (in dimensions and practices) to support the organization’s new metabolic rate.
To achieve this focus on talent and culture, three actions have proved to be successful in transformations in Latin America: developing both soft and hard capabilities in leaders at all levels; reinforcing the skills of the management team to operate as a high-performance team; and taking actions to foster alignment, execution, and renewal.
In developing these capabilities, companies must identify (or bring in from outside if the current talent pool is not enough) the sponsors and leaders of the transformation, as well as the initiative owners.
Often, a training plan is needed to provide them with the tools to support a transformation, which include the ability to generate ideas, to solve problems, to communicate in a structured way, to have difficult conversations, and to mobilize the team. The transformation should orchestrate this skill development.
To have a high-performing leadership team, organizations must evaluate how teams work together and how activities are carried out compared with best-in-class teams—and change as needed. This evaluation should assess the configuration, alignment, execution, and renewal of a given team, strengthening the ability of its members to trust one other and helping them develop their credibility, reliability, and collaborative skills. As an example, one company’s executive team went through a process of self-evaluation that helped team members build trust, have difficult conversations, improve their orientation toward a common goal, and increase accountability.
Last, to improve organizational health, companies should start by measuring their current state of affairs to identify potential gaps in mindsets, behaviors, and management practices. McKinsey’s Organizational Health Index evaluates nine dimensions (what the organization is) and 37 management practices (what the organization does). This diagnostic allows companies to pinpoint areas with major gaps and to build plans to fill them. The initiatives from this diagnostic also become part of the inventory of the transformation and should be pursued with the same rigor as those coming from the other areas of the organization.
- Embrace ‘business back,’ not ‘technology forward’
Most companies are now investing in digital and analytics, but with mixed results. Some CEOs and CFOs even believe their companies have placed too much importance on technology and anticipate a course correction.
We understand why they feel that way. Many companies have significantly increased their spending in digital and analytics but have little to show for it. Although McKinsey research indicates that 90 percent of companies classify this area as being of average or high importance, our survey also shows that approximately 70 percent are stuck with pilots and are unable to scale. Conversely, digital and analytics has been a core element of 80 percent of McKinsey-supported transformations since 2019, delivering a significant portion of value. So what is the catch?
One of the most common mistakes companies make is taking a technology-forward approach, trying to find use cases for selected technologies. This typically leads to pilot purgatory. Companies that were able to significantly deliver value have been “business back,” rather than “technology forward”—that is, they clearly understand the business gaps and are looking for the best technologies to address them. Another recurring flaw is when companies outsource the responsibility for digital and analytics to consultants or third parties rather than create the capabilities internally. Partners are extremely important, but the core capabilities need to reside within the organization.
Companies that have excelled in the deployment of digital and analytics have made it a core part of their strategy, operating model, and competencies. Executives can then invest to significantly upskill their organization’s capabilities.
- Approach the transformation as an ongoing effort
Too many executives view transformations as one-time events with clear beginnings and ends. Our data show that Latin American companies that have made their transformations ongoing efforts—essentially incorporating them as the new way of working—have identified up to three times the value originally planned for capture.
These organizations have caught what we call the “transformation bug”—they are constantly creating and completing initiatives to improve their performance and to identify and seize new opportunities. Imagine how much easier the budgeting process would be if targets were based on a thorough evaluation of gaps and a robust pipeline of initiatives.
The stronger the transformation becomes, the more likely companies are to see their archetypes evolve and intertwine. A good example is the Brazilian subsidiary of a multinational company in a capital-intensive industry that has been on a multiyear journey. It began with a performance transformation that almost doubled its profitability; now, the subsidiary is using its internal transformation engine to embed digital and analytics into its operations and supply chain, further distancing itself from competitors.