Welcome to Our New Era of Management

A few days ago, I visited a friend who is pioneering a new course at the Berkeley’s Haas School of Business. The objective of the course is to train graduate students in critical thinking – framing difficult management problems in creative and innovative ways.

The course is designed to shift their thinking from “how to do it” to “why to do it.” It is only by thinking creatively about the “why to do it” that a manager can design powerful new solutions and approaches that transform management. She is focusing on the most important objective of business education – to move beyond teaching students how to do the things that others have already figured out, and instead to teach them how to create the next generation of innovations that others will study.

After our conversation, I reflected on a panel discussion in which I participated earlier in the week. The subject of the panel was managing supply chain transformations, and the panel also included top supply chain executives from P&G, Chiquita, and Pepsi.

These three leading companies shared the same strategic dynamic. They were creating important gains in market share and competitive positioning because they were capable of partnering with their best customers to jointly create more and more powerful supply chain efficiencies. These efficiencies increased the customers’ profitability, which in turn drove large revenue increases for the suppliers. At the same time, they dramatically improved their own supply chain productivity. They were rapidly increasing their market share and profitability, even in a stagnant economy.

The discussion quickly turned to the question of how they did it: How can a company’s supply chain managers shift their focus from inward-looking cost control to the critical task of creating a much broader host of financial benefits through supply chain integration with the best customers? I have been asked the same question in various forms in discussions with CFOs, CIOs, and top executives in every functional area, who wonder how to shift their managers’ attention from narrow technical issues to broader, high-payoff matters.

The underlying problem is that we are shifting from one era of business to another. A great guide to the management implications of this shift is the classic work on organizational design and management by Paul Lawrence and Jay Lorsh. They investigated the question of whether the best form of organization was for a company to be centralized, with separate functional “smokestacks” that only came together at the top of the company, or to be decentralized with a high degree of interdepartmental integration at the local level. To figure this out, they looked at high vs. low performing companies in a few different industries.

What did they find? They found that it depends – on whether the company was in a stable, homogeneous environment or a rapidly-changing heterogeneous environment.
I always picture two polar extremes: a brewery and a plastics company. A brewery (before the days of craft beers) is in a relatively stable environment. The objective is to carefully set the operating policies of each department – operations, advertising, distribution, etc. – and not let the departments interfere with each other. Hence, the wisdom of a centralized “smokestack” organization where important changes in operating policies are tightly controlled and coordinated at the top.

A plastics company is at the other extreme. Every customer is different, and every project is different. Here, the company needs to form relatively independent teams for each project or cluster of projects. Each team needs to have representation from sales, engineering, manufacturing, distribution, etc., and the locus of coordination must reside at the team level.

When I talk to the managers in a company about their organization, in the back of my mind is the question: Should it look more like a brewery or a plastics company?

Our whole economy has shifted from one era of business to another. In the prior era, the Age of Mass Markets, the fundamental objective of most companies was to drive down costs through economies of scale, and this involved distributing as broadly as possible through arm’s length relationships. The markets were relatively stable and homogeneous, and most companies correctly were organized like the brewery. In this context, most managers were focused on the rather technical tasks in their own department – the “how to do it” issues. Most of our management processes were formed in this earlier era.

Today, we have shifted to a new era, which I call the Age of Precision Markets. Leading companies form different relationships with different customers, each with very different operating characteristics and vastly different profitability. My new book, Islands of Profit in a Sea of Red Ink, describes this transition in detail. The most successful companies have learned to organize like a plastics company – account teams that are multi-functional and highly coordinated at the local level. This is exactly the solution that the leaders of P&G, Chiquita, and Pepsi described in detail, and credited with creating their stunning success. (Think about P&G’s account team at Wal-Mart: representation from sales, supply chain, IT, and finance.)

In today’s era, the essential management task has shifted from the narrow, inward-looking technical skills of a mass-market-era manager, to a new set of tasks. Today’s successful managers have to be broad-gauge creative thinkers that can work with colleagues across departmental boundaries in a rapidly-changing world.

Managing this transition is the most important management challenge today. More than anything, the key success factor is for managers to shift their focus from “how to do it” to “why to do it” – exactly the need that my colleague’s innovative new course is designed to address.

The managers who master this essential understanding will be the leaders who guide their companies to ever-greater success, while their competitors who remain mired in the past fall further and further behind.

Unlikely Sales Heroes – Supply Chain Managers

You finally landed your first orders from that really important high-potential account. When should you bring in your supply chain managers?

In most companies, the standard progression is for the sales rep to focus on ramping up the sales volume, with a courtesy call from the company’s local supply chain manager only when the account is “safe.” Wrong answer.

This “sales first, supply chain last” way of dealing with account development is an obsolete and counterproductive approach to customer management that stems from the past “Age of Mass Markets.”

For most of the past century, businesses operated in the Age of Mass Markets. In this era, companies sought economies of scale through mass production, and they distributed their products as widely as possible through arm’s-length relationships. Most of our current management processes were developed in this earlier era. During this period, managers correctly focused on aggregate revenues and aggregate costs, and the role of a logistics manager was to move and store products at the lowest possible cost.

Today, all that is changing. We are in a new era, which I call the “Age of Precision Markets.” In this new era, companies form very different relationships with different groups of customers, and these feature very different degrees of supply chain integration and coordination, with vastly different profitability. The big problem is that all too often supply chain managers are not systematically involved in creating and managing these relationships. Instead, many are still primarily focused on internal cost control – like the logistics managers of old.

The consequence of this deficiency is a pattern of profitability that I have seen in my research and consulting with leading companies in over a dozen industries over the past two decades. In virtually every company, 30-40% of the company is unprofitable by any measure, and 20-30% provides all the reported profits and subsidizes the losses.

How can a top manager change this? By making supply chain managers essential partners with sales and marketing at every stage of the account development cycle – and even before the sales cycle begins.

The key success factor is to get sales, marketing, and supply chain management on the same page in three key business processes:

Relationship structure. If your sales reps are free to agree to a wide variety of customer requests and demands, it places a huge cost burden on your supply chain. The answer is for sales, marketing, and supply chain management to agree on a set of perhaps 4-8 standard customer relationships – ranging from arm’s length to highly integrated. Each relationship should have measurable value for both parties, and a clear to-do list for each party. Then your supply chain managers can create a streamlined process to support each relationship.

Market mapping. This is the process of matching customers to relationships based on an assessment of where each customer should wind up. This assessment involves both sales and supply chain factors, like buyer behavior and capability to partner. This is very different from simply asking the customers what they want. Your sales process should be focused on moving customers to the right relationships.

Account management. In major account relationships, the account development process must involve both sales reps and supply chain manages from the start. In a well-integrated relationship, your supply chain managers can dramatically lower both your customer’s costs – and your own costs – by influencing your customers’ inventory levels, order patterns, and other key (mostly supply chain) factors. When you increase your customer’s profitability, it almost always drives sales increases of 35% or more, even in highly-penetrated accounts. As a top executive of P&G once noted at MIT, “Our customer is Wal-Mart’s CFO.”

The bottom line is that it is essential to bring your supply chain managers into your earliest sales efforts. They will naturally work with their customer counterparts to identify areas of cost reduction that will come from working together. In the process, your supply chain managers will identify and nurture allies within the customer, and together develop a strong business case for selecting you as the premier supplier-partner. Today, both supplier selection and revenue growth are rooted in the foundation of trust developed between your company’s supply chain managers and their customer counterparts.

In a few days, I’m giving a presentation on “The Coming Revolution in Supply Chain Finance” to a national conference of supply chain management professionals. Here’s my message:

In leading companies today, supply chain integration leads directly to sales increases of 35% or more, even in highly penetrated accounts. Supply chain management is the fastest and surest way to increase revenues.

At the same time, top companies that structure their sales processes to bring in revenues that fit their supply chain’s capabilities see cost reductions of 30-40% or more. All revenues are not equally profitable, and thoughtful sales discipline is the best way to create quantum increases in supply chain productivity and efficiency.

Welcome to the new world: supply chain management driving huge revenue gains; sales discipline creating massive new supply chain efficiencies. In the process, financial performance going through the roof.

The Power of Constant Strategic Innovation

Strategic innovation is the lifeblood of business growth and lasting profitability. It enables you to push the envelope of customer value creation, positioning your company as the strategic partner of choice. It also allows you to price higher, grow faster, and leave your competitors in the dust.

On the other hand, companies that fail to innovate get stale fast – and they get left in the dust. The action question is how to manage constant strategic innovation in an aggressive but careful way.

There are two basic approaches to strategic innovation – one more common but less effective, the other less common but very effective.

The first features big occasional projects. Everyone has seen these. The project starts with a big, formal study, often with extensive customer surveys and very high visibility. It moves through the usual stages of analysis, and approval. Once management decides to go forward, the company launches a pilot. The objective of the pilot is to work out the implementation details. The process is generally formal and time-consuming, so the company needs to catch its breath for some time, often years, before the process starts again.

The alternative is to approach strategic innovation as an ongoing process. At the center of this process is a constant stream of showcase projects. A showcase project is an opportunity to engage a customer or supplier in a very limited-scale “learn by doing” project. There may be some hypotheses about what will work, but the project should be undertaken in an extremely open-minded way. Showcase projects are very effective because there is virtually no downside risk, and they create a very valuable opportunity to discover new ways to do business. Because they don’t require extensive analysis and formal approval in advance, they let managers be very innovative and creative.

A number of innovations that are now central to the way we do business grew out of showcase projects. For example, about twenty years ago, Baxter, the hospital supply company, entered into a “learn by doing” showcase project to discover whether there were new ways to partner with customers. It selected as a showcase partner a very small community hospital about a mile from its main distribution center. The hospital had just opened, and the hospital CEO was very interested in finding new and better ways to do things. Out of this showcase arose one of the first, and very widely followed, vendor-managed inventory systems.

Ironically, the more innovative the initiative, the less likely it would grow out of a big, formal study. Because Baxter’s showcase project had very low risk, it was possible to conceive, develop, and pilot the new vendor-managed inventory process – all without the need for formal review and prior approval. By the time executive approval was needed, the new system was already up and running on a demonstration basis, and the whole management team could come over and “kick the tires.” (Conversely, if the showcase had not yielded results, it would have simply and quietly ended.) At the time, this hospital became the most visited hospital in North America, as major hospital CEOs came to see the operation and talk to the hospital’s management.

Over the years, I’ve seen showcase projects produce amazing results in leading companies. Here are the key success factors:

  • Developing showcase projects should be an ongoing process, not an occasional event. Every company should have at least one showcase project at all times, although it is much better to have several. Because showcases are very limited scale, they do not create significant risk or require significant resources.
  • The definition of failure is not trying a showcase. A showcase offers the opportunity to see what works, and more importantly, to find out what doesn’t work. In virtually all cases, the original hypothesis won’t be the right one – but the process of exploring the initial thoughts will lead to the really powerful innovations. And these would not have been discovered had a showcase project not taken place.
  • Resist the strong temptation to engage your most important customer or supplier. The best partner for a showcase is a relatively small, but highly innovative, customer or supplier – where the risk is very low, and the conditions for success are highest.
  • Create a deliberate process to scale up the innovations that really work. Without an effective scaling process, a company winds up with a series of interesting innovations that sound good in a management interview – but that do not have a major impact on the company.

A management team that is adept at constant strategic innovation attracts the best customers and suppliers. They sprint ahead of the competition, and keep widening the gap. Showcase projects provide the building blocks of success.

The Problem with Accounting

What’s the difference between profits and profitability? In most companies, a net income deficiency of 30% or more. Let me explain.

Accounting information is at the core of virtually all of our business processes. It is axiomatic that accounting has two roles: providing financial information and providing management control information. The problem is that it is very good at the first role, and surprisingly poor at the second.

Financial accounting is critical to every business. The objective is to present an accurate picture of a company’s overall performance – its profits. It grew up in the time of quill pens and arm garters, and its role is to tell shareholders how much their company earned. This discipline is well perfected and highly regulated. Just ask the Audit Committee of any public company.

The management control role is another story altogether. Even with an accurate financial accounting picture of overall profits, nearly every company is 30-40% unprofitable by any measure, and 20–30% provides all the reported profits and subsidizes the losses. In years of writing about this, no one has disagreed. How can this be?

This situation is a legacy of the prior Age of Mass Markets, when companies sought the economies of scale of mass production, coupled with mass distribution using arm’s length customer relationships. In this context, more revenues really did mean more profits. Virtually all of our management information and processes were developed in this earlier era.

We now live in what I call “The Age of Precision Markets,” in which companies form a variety of relationships with their customers – some very profitable, many not. Traditional accounting information is much too aggregated and broad for profitability management today. This is the underlying reason why almost every company has so much embedded unprofitability and why so many managers fail to identify and build their sustainably profitable core of business.

Instead, a transaction-based approach to developing management control information gives you the granularity you need to understand your profit picture, and to develop sharply targeted initiatives. I call this profit mapping.

Start by extracting a three- to four-month sample that includes every transaction (order line). The next step is to create what is essentially an “income statement” for each transaction, subtracting distribution, sales, and other operating costs from gross margin. You can do this at “70% accuracy” using available information and rules of thumb. Avoid lengthy debates about cost allocations, and sharpen your pencil later in the few places where better accuracy will matter.

Once you have this information, input it into a database program. In a few weeks, you can figure out precisely which products and customers are profitable, and what concrete steps you can take to improve things. Even in profitable customers, there are many unprofitable products, and vice versa. My forthcoming book gives several concrete examples of this.

This is very different from traditional “top-down” profit analysis, which focuses on the aggregate profitability of broad groups of products and customers – a process that derives directly from traditional financial accounting approaches.

The problem with accounting is that most managers simply assume that they can use the same process to develop accurate financial information and useful management control information. This is a big mistake.

Instead, if you develop an appropriate transaction-based analysis for management control, you can identify your profitability landscape and create the sharply targeted initiatives that will quickly increase your company’s profitability – and profits – both this year and for years to come.

The Missing Element in Large-scale Change

Large-scale change. Most managers view it as the ultimate management challenge.

I remember when I wrote my Harvard Business School Working Knowledge column, “The Challenges of Paradigmatic Change.” The column went out on the Web on a Monday morning, and by noon I received a flood of emails from my readers describing their experiences and asking questions.

Managing large-scale change certainly is a big challenge, and it requires a different set of building-block actions than improving the day-to-day business. Most of the change management literature focuses on this.

But, the most important thing I’ve learned from years of involvement in change management is that more often than not, the need for large-scale change is avoidable. And many large-scale change projects really are evidence of a prior failure to keep the organization on track in a changing world.

Certainly, from time to time a big abrupt change takes place in an industry – a change in technology, a new regulation, a major new competitor – and these require a strong, thoughtful response.

I remember talking to the head of a major telecom company, now one of the world’s most successful, during the early days of deregulation. Aggressive new competitors were taking market share in the most lucrative markets, and the company’s culture was rooted in the days of cost-plus regulation. I remember the questions clearly: How can I get our managers to understand that they need to manage differently? What do I do? Send them a memo?

I wrote “The Challenges of Paradigmatic Change” as a guide to managers facing this type of situation.

Most companies, however, have a very different situation. The world around them is changing, often at an accelerating rate, and yet they tend to do things in more or less the same way. They may get better and better at it, but nevertheless, it is more or less the same approach. Over time, they become more and more disconnected from their customers and markets, until eventually someone rings the fire bell for a big, disruptive change.

What can a manager do? The answer is obvious: Develop ongoing processes that keep the company on track all along.

But how can a manager do this? The answer to this question is not obvious at all.

In my experience, many managers make two big mistakes in change management:

  • They fail to realize that managing change is not necessarily more difficult than day-to-day management, but it is very different;
  • They fail to see that there are three very different types of change and that each requires a completely different change-management process – and they almost always prioritize them incorrectly.

Most managers focus on the first problem – how managing change is different from making day-to-day tactical improvements.

But the second is the real source of lasting management effectiveness and great financial performance.

There are three very different types of change: (a) constant weeding – tuning up the way you do things in fundamental ways; (b) new strategic initiatives – trying out new things and scaling them up if they work; and (c) large-scale change – fundamentally changing the way everyone does things.

Which is the most important? Judging from the literature and my own observations, most managers probably would rank large-scale change as most important, new strategic initiatives second, and constant weeding as the last priority – if it’s a priority at all.

For most companies, this ranking is backwards.

Constant weeding. In most companies, the failure to institute an effective process for constant weeding is the biggest cause of suboptimal performance.

For example, in my research and consulting in over a dozen industries, I’ve found that even in the best-known leading companies, 30–40% of the business is unprofitable by any measure, and 20–30% provides all the reported profits and subsidizes the losses. Moreover, a lot of the marginal business can be turned around in a surprisingly easy way, and can become sustainably profitable.

In years of writing about this, no one has disagreed. Successful profit generation and profitability management requires four elements: (1) the right information – rarely available from accounting systems; (2) the right priorities – a strong focus on securing your best business and turning around high-potential underpenetrated accounts; (3) the right processes – almost always involving ongoing coordination of Sales, Marketing, and Operations; and (4) the right compensation – not assuming that all revenue dollars are equally profitable.

Yet how many companies have really focused on perfecting these four elements – successfully making profitability management (not budgeting and operating reviews) a core business process?

New strategic initiatives. This is the second change management priority. A vibrant, successful company should always be trying showcase projects – low risk experiments that enable it to try new things and “learn by doing.” Unfortunately, the business case process (capital budgeting) discourages this – because, by definition, a showcase project has uncertain returns. This is a huge mistake.

The companion issue in managing new strategic initiatives is developing an effective process to scale up those that are successful.

I recently spent time with the management team of a very successful international service company. The company had a number of great showcase projects. But, after discussion, the managers realized that they lacked a strong, explicit process to scale them up, transforming the company’s core business to incorporate these new ways of doing business. Without this, they remained isolated pockets of interesting innovation.

Large-scale change. This is the prime focus of most managers and writers. Yet in the absence of truly extraordinary circumstances, painful transformations should be only rarely be needed. If a company has an effective process for constant weeding, it will stay highly profitable even in the presence of rapidly changing markets. And if it has an effective process for developing and scaling new strategic initiatives, it will carve out a lucrative competitive positioning as the market leader and as strategic partner to the most important customers.

If a company succeeds in these two critical change management areas, it will have accomplished the essential goal of large-scale change: repositioning the company for the future. But, without the need for abrupt, painful large-scale change.

When a company is in trouble, it is easy to get everyone’s focus and attention. But the real missing piece in the jigsaw puzzle of change is an understanding of how important and feasible it is to avoid the need for abrupt large-scale change in the first place.

Doing the right things all the time through constant weeding and new strategic initiatives – this is the real missing element in large-scale change.