Blog | Islands of Profit in a Sea of Red Ink | New book by Jonathan Byrnes

Assessing Strategic Investments

Posted on February 10, 2013 by Jonathan Byrnes

Recently, I was involved in a discussion about a major strategic investment that a company was contemplating. This investment was a possible game-changer involving the development of an important new business capability.

The key question on the table was: Will the prospective benefits exceed the costs, yielding returns greater than the cost of capital? What could be more obvious?

Two critical questions

In fact, assessing investments using the cost of capital, often called capital budgeting, is not obvious at all. It is a process that seems like second nature to virtually all managers, but one which only a few use correctly.

And it is critically important. If you get it wrong, it can lock your company in place, block your most important initiatives, and prevent you from getting in front of competitors.

Two key questions lie at the heart of sound investment assessment: (1) What is the cost of capital? and (2) How should I assess the value of investments?

Not so obvious

Let’s start with the first question: What is the cost of capital? Just look it up in a Finance textbook. It is the weighted average of the company’s cost of debt and cost of equity (with a few minor adjustments). Obvious, right?

In fact, the answer is not so obvious.

This seems like a technical question, but in reality it is a very important management issue because it tacitly determines a company’s asset productivity.

The cost of capital is actually a composite. It is the weighted average of the risk/return profile of the company’s portfolio of investments (ranging from buying new machines to developing new product lines) that together constitute the existing business. This portfolio is comprised of some investments that have a very low risk and low return, other investments that have a very high risk and high return, and many in between.

Contrast an investment in a well-tested new machine to improve the efficiency of an existing process, with another investment to develop a new product line. The former investment has a low risk profile, and thus is a sensible investment even if it generates returns that are lower than the company’s composite (overall) cost of capital. The latter has a high risk profile, and thus requires a higher return than the company’s composite.

Here’s the key point: it is wrong to evaluate each investment by the standard of the company’s composite cost of capital – instead the right measure is how its risk-adjusted return compares with relevant investments, those with similar risk/return characteristics, in the company’s portfolio.

As a practical matter, I think of three levels of risk/return: low, medium, and high. This makes the task of specifying a hurdle rate (the appropriate cost of capital) much easier.

Strategic vs. tactical investments

The second question – How should I assess the value of investments? – is vitally important to a company’s competitive success. The bottom line is that assessing strategic initiatives is fundamentally different from assessing tactical investments.

Tactical investments, which produce incremental improvements to the business, are the appropriate domain for traditional capital budgeting, featuring net present value (NPV) and return on investment (ROI) analysis setting well-understood costs against benefits over time. (Remember that even here, most companies’ capital budgeting processes fail to differentiate between low risk/return investments that warrant a lower hurdle rate, from the high risk/return investments that require a higher hurdle rate.)

In the world of major strategic investments, a completely different financial assessment process is needed: one that goes beyond simply adding up costs and benefits to also reflect strategic relevance, the prospective cost of capital, and the payback period.

Bad profits

Should you make all investments that pass the cost of capital recovery test? I wrote a very popular blog about this: What are Bad Profits?

The heart of the blog was this illustration:

The essential point is that in assessing investments, profitability alone is not enough – and this is especially true of major strategic investments. The other critical dimension is whether the investment is strategically relevant.

For example, investing in offering a service that is demanded by only a few customers, but not most customers, probably is not strategically relevant and, if so, you should avoid it even if the investment is profitable. On the other hand, investing in a showcase project to discover an important new customer need in your main line of business may well be very worthy in the long run, even if it does not offer immediate returns.

Yet, a simple business case would favor the former investment and discourage the latter. How can this be right?

Consider a profitable investment that is not strategically relevant, which would indeed pass the cost of capital test. What’s really happening is that this situation has two hidden costs that typically do not appear in the business case calculation.

First, an investment in a new service almost always exponentially increases the complexity of the business in unforeseen ways, and this increases the cost structure of the whole business. (In general, increasing the volume of existing business creates arithmetically increasing costs, but increasing the complexity of the business creates geometrically increasing costs.)

Second, an investment of this sort generates an inexorable future demand for more resources. Why? Because top managers generally do not really act for purely economic reasons – after all, how can you really estimate the costs and benefits of a service offering five years from now? Rather, at the executive level, they often act to ensure “fairness” – i.e. the executive in charge needs an opportunity to show what he or she can do with this new opportunity. And, it is much easier to start trying to grow an opportunity than to end it because the former is easy to measure, while the latter is difficult because turning it around is “just around the corner.”

These issues are central to growing profitability in a robust, lasting way.

Past or future cost of capital?

Let’s return to the question of the strategic investment at the opening of this blog. Here the investment was being judged by the current cost of capital, a measure that is backward-looking by definition since it reflects the current portfolio of investments made in prior periods. Yet the investment in question was being made to have a quantum effect on the company’s future.

For a strategic investment that will really change the business, the right measure really includes the prospective cost of capital, because it will change the basic shape of the company’s risk/return portfolio of investments into the future. It makes no sense to gauge it solely by a measure that doesn’t take into account what the strategic investment is designed to accomplish.

Consider a major strategic investment that promised to really change the company’s relationship with its key accounts – its islands of profit – accelerating major account profitability by increasing the value footprint, and growing high-potential underpenetrated accounts. In this situation the company would have a high likelihood of actually lowering its cost of capital, and a lower likelihood that the cost of capital would stay the same.

Viewed from this perspective, the proper cost of capital to use to evaluate the investment would be a blend of the current cost of capital with the prospective cost of capital – the cost after the strategic investment was made, and not solely the cost in the absence of the game-changing investment. After all, if the strategic investment has the effect of reducing the cost of future investments, shouldn’t this be counted as a major benefit?

This consideration is especially relevant for major strategic investments in public companies, where investment bank analysts’ views of a company’s prospects can have a major impact on the company’s stock price and multiple.

The practical-minded retort is that it is prohibitively difficult to estimate the prospective cost of capital for every possible investment. This is true and compelling. But, it certainly is possible, and indeed feasible, to estimate it for the occasional critical strategic investments that will really change the business.

Managing big risks

So, how do top managers actually assess major strategic investments? An important study conducted a number of years ago found that one of the most important measures actually used by top executives was the discredited measure, payback period.

Payback period is simply the number of years needed to recoup an investment. It is discredited relative to NPV and ROI because it fails to account for the time value of money: two investments may have the same payback period, while the first generates most of the benefits right away and the second generates most benefits at the end of the interval. Clearly, the first investment is superior, even though they both look the same by the payback measure.

So why do top managers pay so much attention to payback period in evaluating major strategic investments? Because a major strategic investment by definition changes the paradigm of the business, creating new value and often provoking competitive response. Therefore it is extremely difficult, if not impossible, to gauge the costs and benefits. It also may well absorb the company’s ability to undertake major change for some time. In this situation, a key top management question is: When will we able to make another major strategic move? Payback period provides an important insight into this critical question.

Cost of confusion

I remember working with a major telephone company in the early days of deregulation. The company served a broad area that included a major metropolitan area with a number of global companies clustered in a few dense locations. These companies were a prime target for new emerging competitors.

As the competitors entered the city and gobbled up the telephone company’s islands of profit customers by deploying fiber and offering new services, the incumbent was hobbled and couldn’t respond. It lost block after block of its most important business.

Why? Because its traditional business case process required an explicit estimate of costs and benefits for each investment (a holdover from the days of regulation). And, preventing a competitor from taking existing business – preventing the erosion of critical customers – was deemed by the finance group as not counting toward investment benefits because it was too “hard” to quantify.

Here, the erroneous use of a tactical investment evaluation process for evaluating strategic investments nearly cost the company its most lucrative business.

Profit maps into action

Thoughtful assessment of investments is the key to maximizing both asset productivity and strategic success.

For tactical investments, the key is developing a hurdle rate that reflects the right cost of capital for the risk/return profiles of the respective investments. As a practical matter, try bundling the candidate investments into three groups: high risk/return, medium risk/return, and low risk/return. Each group requires a different hurdle rate reflecting its different cost of capital. In this context, the traditional assessment measures, NPV and ROI, are very useful.

Strategic investments, however, are fundamentally different from tactical projects. They require a very different assessment process – one that goes beyond traditional cost/benefit analysis to reflect the strategic relevance, the prospective cost of capital, and the payback period.

The strategic relevance incorporates the important hidden costs of complexity and future opportunity costs, the prospective cost of capital embraces the possibility of game-changing gains that fundamentally alter the company’s risk/return profile, and the payback period speaks to the chess-like issue of when the company will be in a position to make its next major strategic move.

In the critical process of converting a profit map into results, wisely assessing investment opportunities is critical. And getting strategic investment assessments right makes all the difference between long-run success and failure.

Posted in Thinking for Profit Tagged cost of capital, hurdle rate, investment

Great Books for Winter Reading

Posted on January 18, 2013 by Jonathan Byrnes

In my prior blog post (Logistics Clusters – a terrific new book by Yossi Sheffi), I reviewed Yossi Sheffi’s terrific new book – Logistics Clusters – which explains how supply chain dynamics are transforming both company competitive advantage, and regional economies. This book is a must-read for all business managers, supply chain service providers, and government officials. It is fascinating, fast-paced, and packed with compelling factual examples.

Three other great books

For additional great reading, I suggest three other books: Reckless Endangerment, Turn Right at Machu Pichu, and The Seven Daughters of Eve.

Reckless Endangerment, by Gretchen Morgenson and Joshua Rosner is subtitled: “How Outsized Ambition, Greed, and Corruption Created the Worst Financial Crisis of our Time” – and the book certainly lives up to this description.

It is a gripping narration of the forces that led to the near-collapse of the US economy, complete with a blow-by-blow history and names. The really chilling issue is that most of these individuals are still in power, and history appears to be repeating itself in the current fiscal cliff and budgetary crisis.

Turn Right at Machu Pichu, by Mark Adams is a delightful tale. Adams interweaves the history of Pizzarro’s conquest of the Inca Empire, with the story of Hiram Bingham’s fascinating discovery of the ruins of Machu Pichu, with Adams’ own treks in the area tracing the respective histories and stories. The result is a wonderful amalgam by a great writer. By the way, Hiram Bingham is the Yale professor whose story reputedly formed the basis for the character, Indiana Jones.

The Seven Daughters of Eve, by Bryan Sykes, is an incredibly compelling scientific detective story. In this book, Sykes, a professor of molecular genetics at Oxford, describes his ground-breaking genetic investigations into human origins in a very understandable, compelling style that is hard to put down.

His investigations solve long-standing mysteries ranging from the origin of the polynesians, to the story of global human origins. He traces the development of his pioneering genetic techniques that enabled him to trace the lineage of all contemporary humans back through the shrouds of time to just seven women, whom he calls the “seven daughters of Eve.”

Posted in Thinking for Profit Tagged Reckless Endangerment, The Seven Daughters of Eve, Turn Right at Machu Pichu, winter reading

Logistics Clusters – a terrific new book by Yossi Sheffi

Posted on January 10, 2013 by Jonathan Byrnes

Logistics Clusters – Yossi Sheffi’s terrific new book – explains how supply chain dynamics are transforming both company competitive advantage, and regional economies.

Why did Singapore rise to international prominence? Why did Memphis outshine its regional neighbors? Why do competitors win by locating near each other and even sharing facilities? How will the transformed Panama Canal affect commerce on entire continents?

Sheffi answers these questions and more in his insightful and fast-paced book. The book’s focal point is an explanation, with multiple examples, of the power of clusters of supply-chain related businesses. These logistics clusters offer compelling advantages for carriers, for customers, and for regional economies.

The book is a must-read for all business managers involved in operations, supply chain management, and strategy – it systematically shows the decisive gains from locating in a logistics cluster.

The book is a must-read for all supply chain service providers – it details the powerful advantages from participating in a logistics cluster, and conversely the problems that result from failing to take advantage of this essential configuration.

And, the book is a must-read for government officials seeking to turbo-charge their economies and upgrade their labor force in a recession-proof, outsourcing-proof, sustainable manner.

This book is written in a fast-paced style that draws the reader through the fascinating story of why logistics clusters are so important to so many top managers and government officials, what benefits they create for all participants, and how to participate to harvest the value.

This is a very important book that reads like a novel. After all, who else but Yossi Sheffi could tell this fascinating story that starts with Roman-era supply chains, continues with the rise of Singapore and the demise of the Erie Canal, and encompasses the founding of Federal Express, the just-in-time distribution of spinal surgical kits, and the economic transformation of the Spanish Province of Aragon?

Posted in Thinking for Profit Tagged Logistics Clusters, Yossi Sheffi

Three Cornerstones of Profitable Growth

Posted on December 10, 2012 by Jonathan Byrnes

What essential elements does a company’s top management team need to put in place to create years of strong, profitable growth?

Here’s my old family recipe: information, process, and value footprint.

These cornerstones formed the basis for a two-month series of workshops that I recently conducted with my colleague, Lisa Dolin, for the top 150 managers of an extremely effective global company.

All three elements are important and essential; without any of the three, the company will not reach its potential.

Information

A company’s core profitability information is contained in a profit map. I describe profit mapping in my award-winning book, Islands of Profit in a Sea of Red Ink. In essence, a profit map is built by developing a full P&L (including overheads) for every invoice line. Once this is accomplished, the profit map answers the critical question: What is the actual profitability of every product in every account?

It also answers a multitude of other critical questions about product and supplier profitability, as well as highly focused questions like: Are my low-volume unprofitable products largely consumed by my low-volume unprofitable customers (guess the answer…)?

Here are some important tips in developing and using profit maps:

Invoice-line information. Developing fully-costed information on every invoice line is absolutely essential. All too often, managers starting on the road to understanding and managing profitability focus on customers, with a rough invoice-level (as opposed to an invoice-line level) costing usually based on sales volume. These efforts give an inaccurate and incomplete picture. Even in your biggest, most obviously profitable customers, over 20-30% of the products are unprofitable by any measure – and without invoice line costing, this is completely hidden. Also, critically-important opportunities to work with suppliers are undiscovered.

Strategy first. One of the biggest surprises in profit mapping is how obvious the strategic opportunities and problems are. Many managers start the process with the assumption that they will focus on tactical issues like pricing and whether to take certain business. As soon as they see a profit map, they are struck by the fact that big portions of similar business are either very profitable, or very unprofitable. Immediately, they see what the company needs to do for really big improvements that put really big new profits on the table. Only later do they turn to the more tactical opportunities that need systematic grassroots mining.

Big opportunities early. Here’s what almost always happens when you give a profit map to a sales rep without guidance or training: He or she goes after small changes in small accounts (e.g. getting the customer to order three rather than five times per week), declares victory, and goes back to business as usual.

Instead, it is most productive to focus first on the big profitable customers, where you have the best relationships, the highest volume, and most often where you have a 20-30% fast profit upside.

To repeat: focus first on your big, profitable customers – your islands of profit – both because they offer the largest, fastest profit gains, and because securing these critical accounts is the absolute most important way to protect your business from fatal profit erosion.

After that, look at the large, low profit customers. These are more difficult to change because they often are unprofitable due to unfavorable pricing or contractual obligations. These take time to change. The lesson: if you really understand your profit map, your true net profit landscape, you can ensure that your customer relationships are profitable from the start.

Don’t forget your products and suppliers. Most companies have as much, or more, upside opportunities on the product and supplier sides of their business, yet most instinctively focus on their customers. With profit mapping, you can see which customers are buying which products, and it is not at all unusual for over 50% of a company’s products to be unprofitable (and often purchased by unprofitable small accounts).

Keep it simple. Ultimately, your profit information will be used by lower level sales reps, supplier managers, and others. These individuals almost always do best with relatively simple formats and standard ways of analyzing and acting on the information. The lesson: don’t design the information for a highly quantitative analyst who loves to explore data. Instead, design the right tool for the job.

Process

The second cornerstone is process. Without effective processes, even the best profit mapping information will not be converted to action. Here are some process tips.

Regularity and discipline. It is imperative that a company create a set of processes that are regular and disciplined, with clear accountability for results. These processes span strategy, market planning, account planning, product management, and supplier management. In my experience, the best combination is monthly planning and results tracking at the local level (e.g. account planning), and quarterly planning and results tracking at high levels (e.g. strategy, supplier management).

If possible, tie these processes into the company’s natural cadence of planning and control (e.g. profit mapping becomes the core of the planning and budgeting cycle).

Wade in. All too often, companies spend inordinate amounts of time developing information, very little time developing core processes to convert the information into results, and almost no time on training and organizational development. This is a big mistake.

Again, in my experience, the training and implementation process works best in four steps.

First, create custom workshops for the top managers. The objective is to expose them to the information and to help them create the processes to convert the information into results. Here, we have found that the best results come from a combination of teaching cases, custom cases that we write on the company’s own business units, and planning sessions. The custom cases are crucial, as they give teams of the company’s top managers actual hands-on experience in working with profit maps and planning processes.

Second, develop pilot processes. Here, try a few alternative ways to work with the profit maps in formal processes. I suggest using a few great managers and effective sales reps to try things in separate efforts; the same holds with other functional areas like supplier management. It is important to have a few independent initiatives going, so you can see what works, and ultimately develop a combination of the best practices.

Third, create a way to scale the process. Even the best process needs to be changed in order to operate at scale, especially when less capable individuals are involved. Do this over several months in a purposeful way.

Fourth, work the processes into the company’s DNA and muscle memory. It takes time to perfect the implementation and to make the processes a way of life. Without this, the company will fall back on comfortable old practices, even if much less effective.

My old family recipe for wading in is: 6/6/1 – six months for steps one and two, six months for step three, and one year for step 4.

Compensation. If you continue to compensate your sales reps on revenues and gross margin, and they “work their pay plan”, it is obvious that you won’t maximize your profitable growth. Your sales reps need to be carefully trained, and the compensation has to be modified as they develop the new understanding and skills. Compensation is a very sensitive and complex topic, but I suggest that a bonus overlay works well in the first year.

In parallel, we focus strongly on training the trainers (especially the sales managers and their counterparts). Here the relevant metaphor is to school excellence: it the principal of a school is great, the school will be great; but if the principal is mediocre, the school will underperform almost regardless of how talented the teachers are.

Value Footprint

Your value footprint, or value proposition, is critical. The value that you create for your customers and suppliers determines the value that you can harvest. Several chapters in Islands of Profit in a Sea of Red Ink explain how to create a powerful value footprint – for example, check out Chapter 17, “Profit from Customer Operating Partnerships.” Several of my blog posts also focus on how to be effective in creating a value footprint – and importantly, how to match a set of value footprints to sets of customers (necessary for creating big value without having your costs blow up).

Here are a few important aspects of creating a strong value footprint.

Islands of Profit. The absolute most important priority is to secure and grow your islands of profit – your high-volume, high-profit customers – both to gain large, fast profit growth and to protect your core profit source. This is where pushing the envelope on your value footprint is most important and productive. And, in the process you will lower your operating costs by 20% or more, and increase your share of wallet by over 35%, even in your most highly penetrated accounts.

Not just customers. You certainly have an opportunity to develop a decisive value footprint for your customers – indeed, this is where everyone focuses. But, you have an equally strong opportunity to create value for your suppliers. The latter is almost always overlooked.

Showcases. I have written at length in my book and in my blog posts about the importance of showcase projects. A showcase is a small exploratory project, often with a relatively small well-run customer or supplier, in which you can jointly embark on a journey of discovery to find inventive new ways to do business together.

Vendor-managed inventory, cross-docking, category management, and many other widespread innovations grew out of showcase projects.

Here, the key is to keep a completely open mind and to learn by doing.

Resist the strong temptation to work with a major customer or supplier, and instead work with a smaller partner who is well-run and innovative. Work where the conditions for success are highest, and the risks of failure are lowest. Great companies have a constant portfolio of showcase projects. That’s how they stay in the lead.

And, as with any process, creating and improving a value footprint must be a regular, disciplined process with responsibility, regular cadence, results tracking and clear accountability – not just an occasional one-off project.

Huge gains

All companies have an opportunity for huge, fast gains and sustained profitable growth. I have been personally involved in projects involving nine-figure profit gains.

The secret of success is to cement in place the three cornerstones of profitable growth – information, process, and value footprint. With these in place, the company will naturally accelerate its profitability, growth, and competitive advantage.

Posted in Thinking for Profit Tagged profit generation process, profitable growth, value proposition

August 23 Webcast – Managing for Profit: Five Building Blocks of Success

Posted on August 22, 2012 by Jonathan Byrnes

I will be presenting a live webcast, “Managing for Profit: Five Building Blocks of Success”, on Thursday, August 23 from 1-2 p.m. EDT, offered by Modern Distribution Management. There is no charge for this webcast.

Here is a link to register for this event:

http://www.mdm.com/event/111/Managing-for-Profit-How-to-Ensure-Your-Profit-Initiatives-Dont-Fall-Short/RPARAMS/eventId/48

You can also view the webcast at a later time by using this link:

http://www.mdm.com/events/archive

I hope you find it helpful.

Posted in Leading for Profit Tagged change management, leadership, organization

A Note to My Readers

Posted on August 1, 2012 by Jonathan Byrnes

Today I posted my first blog since May. In May, I found out that I needed hip replacement surgery, and I was repaired in mid-June. The procedure went very well, and I am recovering steadily.

I appreciate the thoughtful notes I received from many of you who knew about this at the time.

I hope you enjoy my new blog post, Changing Organization Silos, and I look forward to sharing my ideas regularly again.

Best wishes for a pleasant summer.

Jonathan

Posted in Uncategorized

Changing Organization Silos

Posted on August 1, 2012 by Jonathan Byrnes

What do you do when you have a great idea, and it hits the wall of “silo indifference?”

Silo indifference – my term – is the difficulty of engaging your company’s functional or regional groups in new business initiatives that offer the prospect of significant gain but disrupt their traditional operations. Here’s an illustration.

Several years ago, my group at MIT held a workshop on customer service for executives of our affiliated companies – companies that support our activities and host thesis research. About thirty top managers gathered in Cambridge for a full-day session.

We shared our latest research findings, and invited top managers from Ritz Carlton Hotels, Disney, and a few other customer service leaders to share their insights. At the end of the day, I led a session in which the executives discussed their thoughts and experiences in turbocharging customer service.

Turbocharging customer service

I started the session by asking “What is customer service?” My straightforward question drew a variety of more-or-less expected responses: line fill, case fill, answering the phone in 30 seconds, no telephone tag, fast order cycles, and others. The thread that linked these responses was that they all were operating measures.

More importantly, they all were internal operating measures. After all, what good does it do to have high fill rates if the customer has too much of the wrong inventory? Or if the customer is ordering twice as often as is economical? Or if the customer has a quickly answered phone call about a very disruptive service problem that should not have arisen?

The customer service measures that really count are those that reflect what the customer is actually experiencing, not what you are experiencing in your operations. It is a very common false assumption to simply equate the two. Not only that, but what counts even more is the customer’s perception of service, which again managers often simply, but falsely, assume reflects actual service.

In fact, customers’ perceptions of service are strongly determined by their worst experiences. Even if a customer’s really bad experiences are very rare, those will be the most memorable. Just think about the one time you had a really bad meal at a restaurant – did you go back? (For more on this see my blogs, Stumbling on Customer Service, and Demand Management Disney Style.)

Your worst nightmare

After the MIT workshop executives had developed a long list of internal operational measures, I asked a very different question: “What could your competitor do that would be your worst nightmare?”

At first the group was silent. After a few minutes, the discussion gathered steam and moved in a very different direction. The answers varied in form and content, but they all had the same underlying message: “If my competitor could coordinate internally to really improve my customers’ profitability, business processes, and strategic positioning, I would be in deep trouble. If my competitor really could do this, my customers would abandon our relationship and run to the competition without looking back.”

This was the customer service prospect that really concerned and worried everyone in the group.

So I asked the logical next question, “If this is the ultimate win strategy, and we now know the secret to competitive success, why don’t we do it first? It seems we have a golden opportunity to secure our best customers and take away our competitors’ prime business.”

The answer to this query still echoes in my mind. In essence, everyone in the group said in so many words, “We can’t. We just can’t.”

Why not? “Because,” the conversation continued in essence, “we can’t get our functional departments to coordinate around really innovative customer initiatives. They are too focused on their own departmental objectives and metrics [like the internal operational measures the group focused on initially].” Certainly, managers can get limited cooperation, but all too often this is overshadowed by the momentum of the mainstream business.

Here we had a textbook definition of “silo indifference.” Not a malicious lack of cooperation – just counterpart managers in other departments naturally focusing on their traditional “mainstream” activities and measures.

And, in most cases, these counterpart managers in other silos are appropriately focusing on the objectives they were given by top management. They are responding to the measures top management has told them are most important, and for which they are being held responsible.

What’s at stake? Massive competitive success.

The Apple problem

I thought about this customer service workshop when I had an opportunity to work with a group of top marketing executives of major financial institutions a few months ago.

I led a session on market innovation, in which I showed how a number of very innovative companies, ranging from Southwest Airlines to Apple, had entered tradition-bound industries, and revolutionized them with powerful new value propositions and compelling new go-to-market strategies. In their wake, numerous strong incumbents wound up reeling and a surprising number simply went bankrupt.

As I discussed the innovators, and explained how the industry incumbents had failed to respond effectively, I heard a familiar frustration. The marketing executives saw the need for fundamentally new, innovative approaches to take advantage of the massive changes beginning to sweep through the financial services industry, but they felt an almost insurmountable roadblock in engaging their counterpart managers, who were too busy operating and improving their “traditional” business activities.

These managers hit the wall of silo indifference. Just like the MIT workshop executives.

But the financial services managers faced a problem much more pressing and troubling: the impending presence of world-class innovators like Apple, Google, and others – all with massive resources, far-reaching creativity, and powerful go-to-market machines – and all taking aim directly at the sweet spots in their industry.

If the incumbents failed to act quickly and decisively, they would be in severe danger of failing to use their natural first mover advantage to secure the most profitable portions of their market – their islands of profit – and being left with the unprofitable portions. Just like the incumbent firms in industry after industry that failed to act.

Yet, there was an almost irresistible temptation for some participants to shift the conversation to comfortable topics like how to tune up the on-premise customer experience.

Nevertheless, a number of participants continued to drill into the core question of how to be an effective innovator, how to overcome the roadblock of silo indifference. And this led to a very productive discussion.

Accelerating change

All companies face the problem of accelerating change, overcoming silo indifference. Most fail to act decisively and effectively, putting themselves in danger of being overtaken by more capable, focused competitors.

How do the most successful innovators do it?

Consider this recent New York Times article (July 26, 2012).

News Summary: Google’s Fast Internet for $70/mo.

FAST SERVICE: Google says it will charge $70 a month for its long-awaited, ultra-fast Internet service in Kansas City.

THE SIGNIFICANCE: The service is intended as a showcase for what’s technically possible and as a testbed for the development of new ways to use the Internet. Bypassing the local cable and phone companies, Google has spent months pulling its own optical fiber through the two-state Kansas City region.

OPTIONS: For another $50 per month, Google will provide cable-TV-like service, too. There’s also a free, slower option, though households have to pay a $300 installation fee.

What is Google doing?

Two things.

First, Google is learning by doing.

The project is framed specifically as a “showcase” and as a “testbed for the development of new ways to use the Internet.” Since this involves changes in consumer behavior, Google couldn’t just survey the public. The cardinal rule in market research is that you can’t do market research for a product that doesn’t exist because the customers have no experience of it. The services driving Internet usage today weren’t even conceived in the early days of the internet. The only way to find out what will happen when Google offers service speeds that are 100 times faster than today’s service at comparable prices is to prime the pump and learn by doing.

Second, and very importantly, Google is wisely laying the foundation for a frontal attack on silo indifference. The best way to overcome this pervasive roadblock is to develop a showcase project that demonstrates clear, compelling value. With a clear, practical pathway to clearly superior new value, the counterpart managers throughout the company will migrate to the new value proposition. The wonderful thing about a successful showcase is that the managers throughout the company can actually come see it. They can “kick the tires,” and actually talk to the customers.

This is the fastest and surest way to accelerate change, to overcome silo indifference.

Why the phone company failed

Contrast this with the case of a regional Bell phone company about twenty years ago. This very strong, successful company was a regional powerhouse with ample resources. It was deciding whether to deploy broadband/video capabilities, and if so, how to deploy them.

The obvious path was to conduct a study, which naturally showed that the customers were generally interested, but not enough to pay a compensatory price.

At the same time, however, an alternative proposal was offered to conduct a limited showcase project by wiring a small upscale community of about 30,000 with video, and linking the community’s “communities of interest” (i.e. schools, sports, clubs, etc.) through the network. This would give the customers an opportunity to forge new communications pathways and to develop first-hand a sense of the potential value.

In essence, this could have been a forerunner for many of the Internet-based services we now take for granted, and would have catapulted this company far in front of its competitors.

The company had ample resources. But the innovators in the company failed to gather support from their counterpart managers. In the end, the Finance Department killed the project, noting that it could not convince them that it offered returns comparable to those that flowed from the existing operational program of replacing old switches. Silo indifference in action.

What happened to the company, at the time a very well-respected industry giant? It languished and ultimately disappeared, merged into another regional Bell, then both into another.

Effective Showcases

How can an innovative management team create effective showcase projects that overcome silo indifference? Here is an old family recipe that really works.

Just do it. The cost will be very low, often trivial – frequently involving a few well-selected customers or suppliers – and the results can be transformative. There is no downside.

Do it all the time. Set up showcase projects in all areas of your company, especially those that are involved in customer and supplier relationships. What do you have to lose? A minute fraction of your revenues and resources are involved, and the upside is enormous.

Keep doing it. Very often the most important findings only emerge after the showcase evolves over time (perhaps a year or so). The second- and third-order changes are the most powerful. Remember that very few successful business ventures wind up pursuing their original business plans, but rather the key to success is to learn from experience and to evolve rapidly. The most successful venture investors understand this well.

Select the most favorable conditions for innovation. Many companies select important customers or suppliers for showcases. Big mistake. There is too much at stake and the innovations necessarily will be incremental and tactical. Instead, look for a relatively small customer or supplier that is very innovative, where the CEO has “fire in the belly” to do new things, the company knows how to partner, and the operational match is great.

Involve your counterparts early. Get your functional counterparts from the other silos involved from the beginning. Let them help shape the project, and in the process they will become champions. The project will almost certainly benefit from their perspective and capability, and the outcome will have the highest likelihood of being adopted.

Compelling results

Showcase projects offer the shortest distance between you and effective change. They are limited in scope, so you often don’t even have to ask permission, but the results are compelling. They are the ultimate change accelerators.

Why not try it?

Posted in Leading for Profit Tagged Apple, change management, Google, showcase, silo

May 10 Webcast – Selling for Profit: Turbocharge Your Profit Growth Through Market Development and Sales Management

Posted on May 6, 2012 by Jonathan Byrnes

I will be presenting a live webcast, “Selling for Profit: Turbocharge Your Profit Growth Through Market Development and Sales Management”, on Thursday, May 10 from noon to 1 p.m. EDT, offered by Modern Distribution Management. There is no charge for this event.