Enormous financial rewards in business are smoothly justified - especially by those who are pocketing the money. Unless people like those running giant investment portfolios are paid millions, goes the argument, these shining stars will move to where the wealth is. Chief executives are in the same luxurious boat: if you want the best, you must pay the most. But there's an insidious doubt. How do you prove that one portfolio manager, or one chief executive, would have outperformed any alternative candidate? What if anybody would have done just as well?
That can never be established, since history cannot be run backwards. The big-time corporate world's two stars are Jack Welch of General Electric and Roberto Goizueta of Coca-Cola, who between them have 'added' over $100 billion to the value of their corporate equities. The 'added' is in quotes because, while the two chief executives performed brilliantly, their success cannot be separated from the buoyancy of stock markets over their careers, the huge revaluation of corporate assets in general, and the stodgy ratings of both corporations when the new men took over. But while the possibility remains that other chief executives might have exploited the opportunities to even greater effect, that's very hard to believe.
Neither career, though, fits the conclusions of some interesting research by Nitin Nohria and Rakesh Khurana, both of Harvard Business School, on The Effects of CEO Turnover on Large Industrial Corporations. They studied 222 CEO successions from 1978 to 1994 and concluded, among other things, that 'Having an insider take the reins from a retiring CEO... had little effect on performance in the study.' Both Welch and Goizueta were promoted insiders. That kind of promotion does achieve 'slightly better than average performance' when the predecessor is fired (and you can argue that the two golden CEOs replaced men with whom the boards were dissatisfied). For above-average results, however, the incumbent not only had to be sacked, but the replacement had to be an outsider.
THE ABOVE-AVERAGE SCENARIO
The two authors are somewhat naive about this so-called 'clean-break' scenario. According to a report on their findings in the Harvard Business Review, the above-average results are easily explained: it's because clean breaks usually occur 'when a company is performing poorly'. In those circumstances 'the change gives employees optimism about the future, and their optimism can bolster their commitment to and performance at work.' The first half of that proposition is true, the second often doubtful. The poor performance is what gives the clean-breakers their great advantage: by raising awful results only to mediocre (like Lou Gerstner at IBM) they can achieve huge recoveries in profit and thus major upgrades in shareholder value.
It may well be that the crisis also concentrates minds throughout the organisation, generates abnormal levels of effort and gives the outsider carte blanche to sweep away bad managers, poor practices, loss-making businesses, superfluous assets and people - and all the other legacies of corporate ineptitude. There's a well-established formula which governs these turnround operations. They don't have to be entrusted to an outsider, but that is likely enough, given the ill-repute in which all the insiders - and not just the incumbent chief executive - will be wallowing. Whether the replacement comes from inside or outside, though, the pattern of reform will almost certainly include most of these Eight Clean-Break Principles:
1. Leadership is the fulcrum
2. Nothing is sacred
3. Decisions are taken decisively and rapidly
4. Necessary action is taken decisively and rapidly
5. What's being done and why is clearly communicated inside and outside the business
6. Change is facilitated and symbolised by actions
7. The basics of the business are got right
8. 'The future lies ahead' - the new management has a clear vision of where the business can find its new fortunes.
All Eight Principles are easier for the outsider to live by, and also easier for anybody specifically appointed to improve on poor or disastrous performance. That explains why the research found that, if the new boss comes from inside, but replaces a retired predecessor, 'company performance will show little effect.' But if an outsider arrives after the last man's comfortable retirement, the outcome tends to be even less dynamic. The insider will be expected to preserve the status quo, with which everybody is comfortable, however wrongly. In contrast, the arrival of an outsider in a settled situation sends out mixed and possibly unsettling signals.
But look at that list again. What's so special about the Eight Clean-Break Principles? Surely, they only represent basic good management. They actually provide a check-list for the health of any company, in or out of trouble:
1. Is there clear and firm leadership from the top?
2. Is everything and anything subject to challenge and replacement or improvement?
3. Are decisions taken quickly and surely?
4. And actions?
5. Are communications clear, continuous and consistent?
6. Do actions support words - and specifically sustain a change agenda?
7. Are the basics continuously revised and improved?
8. Is there a shared, reviewed and renewed vision of the future?
UNACCEPTABLE REALITY
Every answer should, of course, be a resounding Yes. The unacceptable reality, however, is very often as follows: (1) the leadership is erratic and uncertain; (2) 'the way we do things round here' dominates operations and decisions; (3) the latter are put off frequently and sometimes never taken at all; (4) the same applies to necessary action; (5) few people are told what is actually happening, even at the higher levels; (6) actions contradict high-flown words and ambitious change programmes; (7) waste and inefficiency infect the basics; and (8) the future is constantly sacrificed to irrelevant short-term considerations.
That's the opposite of Clean Break: Bad Continuity. Its prevalence is quite enough to explain what Nohria and Khurana describe as an irksome question. 'Why didn't the actions of the CEOs have more of an impact on company performance?' Their evidence suggests, remember, that only an emergency appointment made in an emergency achieves any results that differ significantly from the average. That's because 'in reality, CEOs are limited in what they can do by the very nature of their post. Their constraints are many: company values and procedures, pre-existing lines of business, currently accepted management practices, and bureaucracy.' In other words, they come into Bad Continuity situations and yet do nothing to achieve dynamic reform by following the Eight Clean-Break Principles. According to Noria, they want 'to do the right thing': but the right thing is usually defined as 'what other people in the industry are doing.'
The result isn't simply that, in his words, 'companies drift to the norm.' Worse, they damage their own strengths. There's a highly cautionary example from a top-class company, Procter & Gamble, which has been the temple of packaged goods marketing for many a decade. Yet this supposedly ultra-expert company was, among other obvious nonsenses, 'making 55 price changes a day across 110 brands, offering 440 promotions a year, tinkering with package size, colour and contents' - and all when the customer really wanted nothing but 'the same product, at the same price, in the same aisle, week after week.'
PLENTY OF HORRORS
The quotes are from the Wall Street Journal, which goes on to report plenty of other horrors: 27 superfluous kinds of promotion; product proliferation that produced 35 types of Bounce fabric softener just for North America; seven different sales reps (nicknamed the Seven Dwarfs) for seven different product lines, all calling at the same stores; a 25% error rate in filling orders that required 150 employees to correct 27,000 orders a month.
P&G paid only lip-service to the customer and the stores, because proper service to either would have rocked the beloved system. A clear example of mismanaging the customers is the 'bog-off', a promotional method popular in Europe: 'buy one, get one free'. When London Business School investigated the effect on washing powders, the researchers found that 70% of the bog-offs attracted only 14% of the customers. Far from becoming attached to the brand, these wealthier buyers went only for the discount. The brand was being devalued, and the discounts were being disbursed, for no good end.
That looks like Bad Continuity with a vengeance. What were the successive CEOs doing while these practices built up? Where was leadership? How could so many sacred cows (or Dwarfs) survive? How could hard but necessary decisions and actions be shelved so widely? What explains the cumulative neglect of basics?
Why did so successful a company not only perpetrate such errors in the past, but go on compounding them?
The explanation is cultural. Previous managers had earned their pay increases and promotions by launching new varieties, devising new promotions, and adding new lines: so successors piled on more of the same. Managers became adept at working the status quo - including patently absurd features like the Seven Dwarfs - so that their own careers could continue onwards and upwards. And all the mis-marketing and all the excess costs were easily absorbed within a torrent of cash and profit: earnings per share grew by no less than 14.6% annually from 1985-95 as net income topped $33 billion.
Continuity, though, can cut both ways. The present management has set to work vigorously to reform the bad habits. For example, thanks to information technology, orders on nearly two-thirds of P&G's products are now shipped automatically in response to electronic invoices; that has slashed four-fifths of the order mistakes and saved $25 million. Even that's a drop in the ocean of total savings - $1.35 billion over four years - that the giant expects to gain by similar reforms, wholesale axing of unwanted products and insignificant variations and much closer collaboration with retailers. These are Clean Break results, but achieved without turmoil in the executive suite. What's the secret?
The riches are part of the answer. Lesser companies, needless to say, lack this cushion of wealth and will not survive such prolonged and serious error without grave trauma. They don't have to be that much lesser, either. A study of corporate lifespans by Arie de Geus found that even major multinationals couldn't expect to last for more than 40 to 50 years. Moreover, only two-thirds of the 500 largest industrial companies in the US in 1970 were still extant a mere 13 years later. The findings are consistent with those of the chief executive survey. Whoever is boss, companies carry on under their own momentum, with results that oscillate around the average for their sectors. The danger is that the momentum will slow over time, until the performance cracks under the weight of accumulated error.
HARSH IMPLICATIONS
De Geus's conclusion has harsh implications for chief execuctives: 'in today's increasingly volatile business environment', most managers 'will find that their companies do not have the habits to accomplish what they hope to achieve.' There is an escape route, however, and it's demonstrated by the current P&G turnround. The way out is to adopt 'the priorities of the living company.' The chief executive's task is thus to orchestrate those priorities:
1. Sensitivity to the environment - is the company able to learn and adapt?
2. Cohesion and identity - is the company innately able to build a community and a persona for itself?
3. Tolerance and decentralisation - can the company build constructive relationships with other entities, within and outside itself?
4. Conservative financing - can the company govern its own growth and evolution effectively?
According to De Geus, these are the four key characteristics that best describe the company which can 'survive for very long periods in a changing world, because its managers [are] good at the management of change.' The quartet provide the framework which enables a P&G, or Coca-Cola, or GE to renew itself: note how P&G, kept wealthy by its conservative financing, was able to learn from its own mistakes when adapting to a new marketing environment, and to reform and improve its relationships with entities like the major store chains. In doing so, the sustained strength of the corporate brand and culture was invaluable.
When De Geus began his studies of corporate longevity, he was working for one of the business world's grandfathers: Royal Dutch-Shell. It's lately been proving his thesis by a massive effort, led by chairman Cor Herkstroeter, to change radically the culture at head office and the relationship between the centre and the operating companies. Like P&G's reforms, this wasn't in response to crisis, but in reaction to a changing environment. Managers were set new performance targets; employment for life was thrown out of the window and the culture; all the top 100 jobs were reconfigured; layers of management were cut away - and all this in a company with the highest profits in oil.
The Shell case features in a series of 'Lessons from the CEO' which Price Waterhouse Management Consulting presented to the World Economic Forum at Davos in January. The lessons from both sides of the Atlantic support the belief that the chief executive's role has changed. The boss who makes a genuine difference has become essential. To put that another way, the no-difference chief executive is a luxury that companies can no longer afford. The difference, however, has to operate in two dimensions: operational reform and organisational excellence, the Clean Break and the Good Continuity.
ORGANISATIONAL ADVANTAGE
Percy Barnevik, chairman of the electrical and engineering conglomerate ABB, told Price Waterhouse that 'you can build a lasting competitive edge through the excellence of your organisational structure', which he described as 'the most difficult competitive advantage to copy.' In automotive components, Woody Morcott of Dana Corporation advised other CEOs to consider 'creating an idea system that empowers your employees to think creatively.' Michael Dell talked of the management flexibility that enabled Dell Corporation to change strategies 'when things were not going right' in its PC business and of 'leadership that was strong enough to change things quickly.'
That's essentially the Clean Break approach, but Dell added an organisational lesson: 'Companies that learn to manage change are in the best position to continue to take the risks needed to stay out in front.' At Sky Chefs, Michael Z. Kay's 'core message' has the same combination of operations and culture:
1. Change culture and employee conduct by introducing new values plus high-stretch financial goals.
2. Create SWAT teams that are accountable for analysing and reconfiguring operations to yield dramatic transformations and economies.
3. Propagate the new values relentlessly and incorporate them into the accountability structure.
The propagated values need not, of course, be new. At Siemens, Heinrich von Pierer is striving to enhance overall operational effectiveness without sacrificing the broad-front technological innovation that has animated the group's past. His recipe is to reduce hierarchy, improve communications, change management style, and force an inward-looking company to focus on the customer. As at Shell, the recipe has yet to be proved by the results. But the management of culture holds one key: culture, says Melvin R. Goode of Warner-Lambert, is 'a living thing that should animate the hearts and minds of workers... and give them a more productive and rational environment.' Whatever the chief's route to the top, productivity and reason alike demand the hard Clean Break fist in the soft glove of Good Continuity.
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