Every new project is an infant and infants belong in the nursery.
Innovative efforts, especially those aimed at developing new businesses, products, or services, should normally report directly to the “executive in charge of innovation.” They should never report to line managers charged with responsibility for ongoing operations. Unfortunately, this is a common error.
The new project is an infant and will remain one for the foreseeable future, and infants belong in the nursery. The “adults,” that is, the executives in charge of existing businesses or products, will have neither time nor understanding for the infant project. The best-known practitioners of this approach are three American companies: Procter & Gamble, the soap, detergent, edible oil, and food producer; Johnson & Johnson, the hygiene and health-care supplier; and 3M, a major manufacturer of industrial and consumer products. These three companies differ in the details of practice, but essentially all three have the same policy. They set up the new venture as a separate business from the beginning and put a project manager in charge.
Growth that results only in volume and does not produce higher overall productivities is fat—it should be sweated.
Management needs to think through the minimum of growth that its company requires. What is the minimum of growth without which the company would actually lose strength, vigor, and ability to perform, if not to survive? A company needs a viable market standing. Otherwise it soon becomes marginal. It soon becomes, in effect, the wrong size. And if the market expands, whether domestically or worldwide, a company has to grow with the market to maintain its viability. At times a company therefore needs a very high minimum growth rate.
A business needs to distinguish between the wrong kind of growth and the right kind of growth, between muscle, fat, and cancer. The rules are simple: Any growth that, within a short period of time, results in an overall increase in the total productivities of the enterprise’s resources is healthy growth. It should be fed and supported. But growth that results only in volume and does not, within a fairly short period of time, produce higher overall productivities is fat. Any increase in volume that does not lead to higher overall productivity should be sweated off again. Finally, any increase in volume that leads to reduced productivities should be eliminated by radical surgery—fast.
A business that is the wrong size is a business that does not have the right niche to survive and prosper.
Being the wrong size is a chronic, debilitating, wasting—and a very common—disease. Being the wrong size is curable in the majority of cases. But the cure is neither easy nor pleasant. The symptoms are clear and are always the same. In a business that is the wrong size, there is always one area, activity, function, or effort—or at most a very few—that is out of all proportion and hypertrophied. This area has to be so big, requires so much effort, and imposes so much cost on the business as to make economic performance and results impossible. The old American Motors furnishes the example. American Motors announced successive plans to aggressively recruit new and strong dealers and push up its sales. In order to obtain the sales volume that would have given the business a viable size, the expenses that made the business nonviable had to be increased. And this is precisely what the business could not afford.
The most rewarding strategy to come to grips with the problem is to attempt to change the character of the business. A business that is the wrong size is a business that does not have the right niche to survive and prosper. A comparison between American Motors and Volkswagen shows the difference between being the wrong size as a result of lack of distinction, and being the right size by occupying a distinct niche.
The old cliche is still sound advice. The less diverse a business, the more manageable it is. Simplicity makes for clarity. People can understand their own job and see its relationship to results and to the performance of the whole. Efforts will tend to be concentrated. Expectations can be defined, and results can easily be appraised and measured. The less complex a business is, the fewer things can go wrong. And the more complex a business is, the more difficult it is to figure out what went wrong and to take the right action. Complexity creates problems of communications. The more complex a business, the more layers of management, the more forms and procedures, the more meetings, and the more delays in making decisions.
There are only two ways in which diversity can be harmonized into unity. A business can be highly diversified and yet have fundamental unity if its businesses and technologies, its products and product lines, and its activities are embraced within the unity of a common market. And a business can be highly diversified and have fundamental unity if its businesses, its markets, its products and product lines, and its activities are held together in a common technology.
Cost control is not a matter of cost cutting but of cost prevention.
What matters is not really the method. It is the realization that the cost-effectiveness of an activity depends on the way it is being structured. It depends heavily on accepting the premise that cost control is not a matter of cost cutting but of cost prevention. And costs never drift down, so cost prevention is a never-ending task. No matter how well structured the organization, its cost-effectiveness needs to be looked at again and again. No matter how carefully it controls its costs, its activities and processes need to be put on trial for their lives every few years.
This process also ensures that the entire workforce embraces and accepts cost control. It should actually see it as an opportunity and not a threat. If cost control is seen as cost cutting, the workforce will see it as a job threat and will refuse to support it. But if cost control is seen and practiced as cost prevention, then the workforce will actually see it as an opportunity, or at the very least it will support the cost control for the sake of better and more secure jobs.
Would the roof cave in if we stopped doing this work altogether?
No matter how well a business prevents cost inflation, it will still have to cut costs. This is because businesses are like people, and people often get sick no matter how carefully they exercise, control their diet, and avoid substance abuse. There is thus always the need for cost cutting. To start cost cutting, management usually asks: “How can we make this operation more efficient?” It is the wrong question. The question should be: “Would the roof cave in if we stopped doing this work altogether?” And if the answer is “probably not,” one eliminates the operation. It is always amazing how many of the things we do will never be missed. But businesses that actually succeed in cutting costs don’t wait until they have to cut costs. They build cost-cutting into normal operations. They build into their routine operations organized abandonment. Otherwise, eliminating activities and operations runs into extreme political resistance.
How much business can we expect in this new company if we are successful? And how much front-end investment is then justified?
To grow a business one has to put in front-end money. That money is invested in tomorrow’s profit makers, so those front-end investments will only be costs and no returns, and sometimes for a long time. How does one manage those to maintain cost control? The first thing is to budget these activities separately. I call it the opportunities budget. The second rule, therefore, is to think through what results we expect from these investments in the future and within what time period.
The best example I know is how Citibank became the world’s only successful transnational bank in the heady 1970s and 1980s. The reason was that Citi first thought through how much front-end investment in a new branch could be justified. It thought through what the minimum results in the new territory could and should be. Citibank asked: “How much business can we expect in this new country if we are successful and become a market leader? And how much front-end investment is then justified assuming that the front-end investment must not exceed a certain percentage of the potential results?” And then Citi knew from its own experience how long it should take before this new branch should reach break-even, that is, before it should begin to produce profits.
In cost control an ounce of prevention is worth a pound of cure.
All of us have learned that it is much harder to get rid of five extra pounds than it is not to put them on in the first place. In no other area is it as true as it is in cost control that an ounce of prevention is worth a pound of cure. An absolute necessity is to watch like a hawk to make sure that costs do not go up as fast as revenues; and, conversely, that they fall at least as fast as revenues if there is a recession and revenues go down.
One example of a follower of this rule is one of the world’s largest pharmaceutical companies, a company that grew almost eightfold, adjusted for inflation, between 1965 and 1995. During those thirty years, it held cost increase to a fixed percentage of its increase in revenues; a maximum 6 percent rise in costs for every 10 percent rise in revenues After five or six years of trying, it also learned how to make sure that costs go down in the same proportion as revenues go down in a down period. It took quite a few years to make this work; now it’s almost second nature in that company.