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.

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.

A Malaysian Perspective on Managing Mergers

One of the great pleasures of writing this blog is the opportunity to stay in touch with friends and former students. I received a nice note from Tenglum Low, who is a top executive in Malaysia. Tenglum took my course when he was in an executive program at Harvard.

Tenglum wrote that over the last 25 years, a significant amount of his time was spent in reorganizing two publicly listed Malaysian companies, serving as COO and CFO.

The first was a steel company which he helped grow from 200 to 2,000 employees over 15 years. He started his career in this company when it had 200 employees, and he had a key role in selecting and developing the employees during its growth period. He noted that once the company’s vision and values were aligned, it grew quickly. While the company did not have the financial resources to hire experienced people, the commitment of the employees and the strength of the culture permitted them to succeed.

However, as they expanded through acquisitions, they were not able to integrate the cultures of the newly-acquired companies with that of the “original mothership.” The management team was reluctant to divert management resources to the newly-acquired subsidiaries because they were so important to the strategic and financial performance of the main business. Tenglum noted, “The acquired subsidiaries continued to be a sore thumb in terms of financial performance.”

The second company Tenglum managed was a mature brewing company, formed through the merger of two breweries. These entities had a similar history and heritage, but were competing in the marketplace prior to the merger. After the merger, the shareholders of the respective companies, through their representative directors, were acting more as brand owners than as owners of the whole enterprise. They were suspicious of each other, and this caused further problems. The company did not reduce the workforce and wound up with two separate organizational cultures, which were continually fighting with each other.

When Tenglum joined this company as a top manager, he initiated the following changes:

  1. Elevated the responsibilities of the independent directors over those of the representatives of the two former companies in order to align the board members around a common vision for the whole enterprise;
  2. Aligned the management team with this new integrated vision, and formed a culture around it;
  3. Reduced the layers of senior staff who were not contributing directly to the company’s operations;
  4. Raised management expectations in order to identify those managers who were both committed to the new vision and capable of achieving it;
  5. Allowed about 1/3 of the management team, who were committed but less talented, to retire over time with dignity – and replaced them with committed, capable younger managers.

Tenglum noted that this is a painful exercise, “but the results were great, a continuous 9 years of growth to become the market leader.” He also noted, as a bottom line, that without a massive reorganization, it is very difficult to merge companies, and quickly improve their management skills and allegiance to a viable new strategic vision.

I have had the privilege of staying close to Tenglum Low for over ten years. He is a manager who combines great capability with deep compassion. He was able to learn from his experience at Malaysian Steel, and to apply those lessons to successfully turning around a major brewery and guiding it to industry leadership.

Why Do Mergers and Reorganizations Fail?

I’ll always remember the immortal words of Murray Smyth, at the time CFO of one of the largest subsidiaries of a major distribution and manufacturing company, “If we haven’t reorganized in the last six months, it’s because someone missed a deadline.”

Why do reorganizations fail, and what is most critical for success? Strategic clarity and followthough.

I’ve been involved in a number of major mergers and reorganizations. In my experience the most important differentiator between success and failure is whether the company’s top management creates a new strategy that would not have been possible without the merger or reorganization. In the absence of this, the company’s factions simply focus on squabbling about “who wins.”

Companies reorganize or merge because a significant market opportunity arises that could not be fully met under the former structure. The company must change its organization and structure to meet the new opportunity, and to realize the profitability, growth, and strategic advantage it offers. The new organization necessarily must draw parts of the old organization or merged company that fit the new strategy, drop parts that don’t fit, and combine them in a new way to do critical new things.

Success requires three essential elements: (1) clarity about why the merger or reorganization is needed and what specific new advantage will result; (2) a VERY SHORT LIST of the things that the new organization must get right to accomplish the new strategy; and (3) relentless topmanagement follow-though with a clear focus (repeated message) on the reasons for the new strategy and a series of “report cards” on the organization’s progress toward implementing the very short list of things that must be done right – coupled with significant compensation behind it (not just “retention bonuses”).

Here are two instances of successful reorganizations/mergers. In the 1980s, Baxter developed a new business, called ValueLink (now part of Cardinal Health) that was a role-model for the vendor-managed systems that followed. In it, Baxter developed a way to control the movement of its products not just to the hospital loading dock, but all the way to the patient-care areas. This created great savings both for the hospitals and for Baxter, and high barriers to entry as well. When Baxter’s top managers saw the power of this relationship, they acquired American Hospital Supply in large part to have a much broader set of products to pump through the new channel.

For the new strategy to work, Baxter had to reorganize the old companies to service its focus accounts in a new way. For example, a question arose as to whether Baxter should distribute competitors’ products through its new system. The product managers argued strenuously against this, claiming correctly that it would hurt their product sales. The responsible General Manager wisely overruled them, seeing that the new strategy of developing the dominant channel was more important keeping the old strategy of simply maximizing the sales of each product manager’s products. New opportunity – new strategy – new policies and organization – rigorous follow-through – huge lasting success.

In a similar situation, when P&G developed its now-famous partnership with Wal-Mart, in which P&G drives sales and profit growth by developing supply chain and marketing efficiencies that give Wal-Mart higher returns on its sales of P&G profits, it had to radically change its account management process. In a novel move, P&G changed the structure of its account teams to feature four co-equal functions: (1) sales/marketing; (2) supply chain management; (3) IT; and (4) finance. This reorganization enabled P&G to create critical new efficiencies both for Wal- Mart and for its own business – and in the process both P&G and Wal-Mart achieved lasting success.

In both of these examples, numerous other companies, including direct competitors, tried to replicate the innovator’s success. But they faltered because they did not successfully reorganize to create the necessary foundation for success. The top managers of these companies lacked the clarity and follow-through that makes all the difference.