Chief executives are fascinated by the intellectual challenge of building a business. They know they have different tools such as technological innovation, leadership and customer focus. But in the final analysis, there is no one cookie-cutter approach to creating a great business, and success can’t be achieved purely by adhering to budget numbers. “All businesses are a combination of quantitative and qualitative issues and lots of industry-specific details, but there’s also no small amount of indescribable art in there,” FedEx CEO Fred Smith told fellow chief executives at a roundtable cosponsored by Chief Executive and Accenture in New York. “Successful businesses have it, and unsuccessful ones don’t.”
The margin of error is extremely thin, meaning that success can turn into failure in a hurry. “When companies lose it by making a wrong turn or putting in the wrong leadership at the top, it usually ends up being quite spectacular,” said Smith, who is the 2004 CEO of the Year and who built FedEx into a $25 billion business from scratch.
So the question is, what is the “secret sauce” that allows one company to respond to customers’ feedback and even anticipate their needs with the Next Big Thing when another company that tries virtually the same approach ends up with the Next Big Flop? The victors typically share a combination of elements fundamental to success, as well as the ability to bring those components in line when recognizing, developing and executing on market opportunities.
“The litmus test is combining the dots,” explained Bernd Beetz, CEO of the beauty-products firm Coty. “The ingredients€¦quot;technology, people, customers, leadership€¦quot; apply to all industries, although the weighting of those factors may be different. But on their own, none of those things will get you to the next innovation, to that next product you have to bring out. You have to find a mechanism to get that spring in your step because that is the lifeblood.” A full 20 percent of Coty’s products have been introduced within the past 12 months, and that drives Beetz’s organization to keep coming up with new perfumes and skin-care products. (See sidebar, page 56.)
For Donald Peterson, CEO of Avaya, an enterprise-focused telecom equipment provider that was spun off from Lucent Technologies, timing factors heavily in the mix. “There are moments when technology is an advantage,” he noted. “Then it becomes commoditized. To me, knowing how to move forward to the next value proposition is what distinguishes a lot of companies.”
Avaya has a track record of navigating the rapid swerves that characterize its industry. Responding to market shifts, over time the company moved away from manufacturing equipment such as circuit boards and processors toward purchasing them from lower-cost, specialized providers. Today, while Avaya designs, sells, distributes and services telecom equipment, all manufacturing is done by others. “We don’t have a single factory,” said Peterson. “We have people who make our plastics, circuit boards and every other component. Our value add, while it has always included system design, has now moved up the value chain. The same is happening in many businesses. As the things you did earlier become a given that everyone has, you have to move on to the next value proposition.”
For savvy companies, a single innovation can produce a daisy chain of products and services as modifications and new applications spawn additional sources of revenue. At FedEx, for example, the development of a laser bar-code tracking system providing visibility through the package transportation process has since enabled the company to offer its customers far more than shipment transactions. “I wish I could say that we understood all along that once we could do this, it would be migrated into customers’ offices and allow them to run their supply chains,” said Smith. “But it wasn’t until that system was in place that it dawned on us that if we could give that information to our customers, they could substitute information for inventory and take a lot of mass out of the business.” In the 1980s, FedEx did just that, providing customers with PCs and the ability to track packages and manage their inventory through access to its proprietary system.
In the decades since, FedEx reinforced its market position by continually adapting to address new market opportunities. “It’s been a reinforcing cycle,” Smith said, noting that the Internet brought the system to “nirvana”€¦quot;a standardized, low-cost, ubiquitous protocol. “As the technology curve came down, we put more and more utility in the software. And the better we got at getting the information, the better people were able to utilize our systems. So we went from that fundamental position in the marketplace and migrated it starboard and portside, broadening the portfolio through product extensions, geographic extensions and acquisitions to reach where we are today.”
The Customer Quotient
For many successful companies, customer needs play a pivotal part in identifying new markets or determining which product concepts are worthy of development. “Innovation and customer service are the key,” said Greg Owens, newly designated chairman of Manugistics, a supply chain software company. “You’ve got to make innovations that apply to where their pain points are, where the market is or where it’s going. Focusing on the customer is a big factor in which bets turn into winners.”
Often, it’s fledgling firms that can capitalize most quickly on market opportunities. United Capital Markets, for example, was founded five years ago on an unfulfilled customer need. Its founder and CEO, John Devaney, who’d been a bond trader for five years, spotted an opportunity in the financial market. “There wasn’t a mechanism in place to support a secondary market for trading mezzanine and subordinate bonds,” he explained. “Wall Street firms didn’t care to re-research the complex, subordinate instruments that bear all of the risk of principle loss in these transactions.”
Beginning with limited investment capital, Devaney bid one bond at a time and quickly expanded his firm in both size and reputation. A modest $4 million in transactions in its first year grew rapidly, with UCM’s total volume in 2003 weighing in at $15 billion. “I identified an opportunity,” said Devaney. “That’s what all of our jobs are about€¦quot;looking at the landscape of the marketplace, identifying an opportunity and acting on it.”
An Inside Track
Although new technologies are often the key to seizing new opportunities, CEOs also consciously try to shape the culture of their companies so that ideas flow. “It’s when a company takes care of its people that they want to work hard and be creative,” said John Edwardson, CEO of the computer products distributor CDW. “When employees spend time thinking about how we can do it better for the customer, that doesn’t happen by accident.”
For CDW, which develops the bulk of its technology applications internally, motivated employees are crucial. “We regularly reach into the company for good ideas,” explained Edwardson. “Several times a year I do lunches with the top salespeople and say, €˜Tell me what we need to make your jobs easier.’ If you can deliver those things, you can do well.”
But having good people who come up with great ideas is only part of the puzzle, says Pat Byrne, a global managing partner at Accenture, who pointed out that success hinges on collecting, evaluating and executing to bring the best new concepts to fruition. “With 100,000 employees worldwide, the big challenge at Accenture isn’t getting enough innovative ideas€¦quot;it’s having too many,” he said. “How do you identify, capture, package and then disseminate them? Sometimes you get the first three right, but you don’t do well on the dissemination. We’ve found that it’s about communicating it around the firm and having a structured approach to the process.”
Creating a balance where new ideas flow and some percentage of them are tested€¦quot;and the losers are eliminated€¦quot;seems to be one answer to the riddle of innovation. Technology companies, in particular, often need to temper internal enthusiasm for a new software or technology concept with customer feedback, noted James Goodnight, CEO of SAS Institute, a $1 billion software company. “There have been a few times in the past where I’ve been so enamored with some technology that I said, €˜All right, we’ve got to do this. Let’s spend a few million dollars and build this software,'” he said. “And then we discover there’s no market for it. So we have learned that it’s best to focus on what our customers want and find out first whether there’s a market.”
Just as internal enthusiasm can lead a company astray, customer needs, too, must be weighed against the other elements in the risk-reward equation. For Airbus, the world’s leading commercial aircraft maker, the cycle time for new product development and manufacturing can span years, with costs running into the billions of dollars, so innovations must be carefully scrutinized. “You cannot let customers design an airplane, but you cannot design an airplane without your customers,” said Airbus North America Holdings Chairman Allan McArtor. “It requires a little bit of crystal ball gazing. You have to know more about their requirements than they currently know.”
Airbus is making a calculated multibillion-dollar bet on its new jumbo A380 airliner, which will have two levels for passengers and one for cargo. (See sidebar, page 59.) Smith, whose FedEx is the first American company to place an order for the A380s, believes they will change the economics of importing goods from Asian manufacturing regions such as China. Cargo will no longer need to be sorted at a regional FedEx hub; it will be able to be shipped directly from where it is manufactured to North American markets.
Innovators and Their Dilemmas
For a large company with existing businesses, innovation can be particularly tricky because it might “cannibalize” an established product. That is the heart of the problem outlined in The Innovator’s Dilemma, by Clayton M. Christensen, and both Smith and Peterson noted that the book doesn’t offer a solution to that dilemma. It’s something that CEOs have to wrestle with every day. “Big companies come up with tremendous numbers of innovations, many of which they choose not to support because they don’t think the market’s big enough,” said Peterson. “We’ve all probably had people in our companies who said, €˜You’re missing a great bet,’ quit, started a company and made a bundle.”
A lost opportunity? Not necessarily, said Peterson, who points out that the new market in question could put existing businesses at risk or simply be too small for the firm. “It’s really a trade-off about where you make your money,” he asserted. “It doesn’t mean that somebody independent without those conflicts can’t do something with that idea.”
Internet telephony is just such a market. As startups like Skype and Vonnage pop up offering free phone service, Avaya passed on developing technology for that market. “Our existing customers, such as Verizon, would go ballistic,” Peterson explained. “So we would get 100 percent of a $5 million market and lose our 5 percent of a billion-dollar market. That is not a good trade-off.”
This is where a CEO’s instinct is so essential, because the numbers might argue against innovation. “Many, many times, with great business opportunities, you just can’t show the ROI on it,” said Smith. “You know it’s there, but you can’t be sophisticated enough in all of the assumptions to make the business case. That’s where you have the real gut checks.”
In the early days of Federal Express, as it used to be called, Chief Financial Officer Alan Graf recalled he and others took plenty of risks. “We made a lot of leaps,” recounted Graf. “My very first day at the company, Fred called me into his office and said, €˜I need you to go down to Continental and buy some DC10s.’ I went home and told my wife, €˜This guy is nuts. He thinks he’s going to fill up these wide-body airplanes with packages. There’s no marketing forecast, no infrastructure, no pilots.’ That was a leap.”
It was obviously a leap that paid off. But while being willing to roll the dice on a venture is essential, so is knowing when to walk away. “You’ve got to make your mistakes faster than your competition,” noted McArtor. “When you go up a blind alley, you’ve got to recognize it, back up, keep moving and never look back.”
“You should be brave enough to walk away,” agreed Goodnight. “Because it’s a lot cheaper to start a new hole than to keep digging a big one.”
SAS did just that when the company’s promising entry into the game business threatened to spiral out of control. Operating under the brand name South Peak, it developed into the sixth-largest game company in the country€¦quot;but that healthy market share came at a hefty price tag. “We sold it when revenues were about $55 million a year because the expenses were $85 million,” reported Goodnight. “I kept thinking, if this gets any bigger, we’re in trouble. That’s when you’ve got to learn to say, €˜All right, I’m going to get rid of my pride here. We’re just going to move onto something else.'”
Ultimately, it may be when to roll the dice€¦quot;and for how long€¦quot;that decides a company’s future. “At the end of the day, it’s a balance once you reach a certain size,” said Smith, who pointed out that only startups have the luxury of taking all-or-nothing risks. “You have to be willing in any large organization to make some entrepreneurial bets. Because if you’re not willing to do that, then you’re going to be a dinosaur at some point. Just don’t bet the company once you get to a certain size.”
The Scent of a Winner
Coty must keep pace in a fast-changing industry.
At Coty, the 100-year-old beauty products firm, 20 percent of each year’s revenues come from new products. Bernd Beetz, German-born CEO of the $1.95 billion company, shared some insights on how the company engages in continual innovation.
How many new product concepts do you consider per year?
How does customer research factor into new product development?
You noted that department stores were initially reluctant to carry the perfume. How did you overcome that?
How did your tenure at Procter & Gamble and LVMH influence the way you develop products at Coty?
What distinguishes your development process from that of competitors?
Having that kind of system in place is critical because in our business you have to essentially reinvent your entire portfolio every five years. Ultimately, it’s the responsibility of the CEO to have a mechanism in place that nourishes the business with enough innovations so you can survive.
The Plane Truth
Airbus continuously modifies design to please customers.
The much-heralded Airbus A380 jetliner, due to hit runways in 2008, is already winning anticipatory raves from its potential customers. “For about a 25 to 30 percent increase in cost, we double our capacity,” enthused Alan Graf, CFO of FedEx, to roundtable participants. “So the leverage on filling up that airplane is unbelievable.
“In fact,” he added, turning to Airbus North America Holdings Chairman Allan McArtor,”we could use them today. Could you speed up that 2008 [deadline]?”
That glowing endorsement is no accident. “In developing the A380, Airbus carefully balanced customer input with design expertise,” said McArtor. Meetings between the design teams and its carrier and airline customers began in early 1996 and continued throughout the process, with customer-initiated changes made along the way. “We modified many, many things as a result of our own R&D and discussions with customers,” said McArtor. “For example, we reconfigured the original design of the cargo hold and made the engines quieter.”
The result? “Extremely long range at very efficient payloads,” he explained. “You can overfly what used to be typical stopping points and bring packages straight off the Pacific Rim into the United States nonstop. That’s a huge deal when you’re in a time-sensitive business.”
Interior space design changes were also made for the passenger craft version of the A380, due to enter service in 2006. Airbus’s customers were interested in “one-passenger spaces,” or private seating in the upper-class sections. “So we worked to offer them flexibility,” explained McArtor. “Ultimately, the airline decides on its interior; we offer them the space and flexibility of design to do what they want.”
This customized approach is a pricey endeavor. In an industry where 5 percent is the norm, Airbus spends a whopping 9 percent of annual revenue on R&D. With 1.7 billion euros spent on R&D in 2002 alone, Airbus has a great deal staked upon the A380’s success. But along with market research, taking calculated risks is essential for any company, noted McArtor. In the end, he said, “you have to have the courage to bet on your own ideas.”