Business Supermodels

Book Excerpt: Confronting Reality Business Supermodels

What should you change and what should you keep in your organization? The business model can guide you, helping managers uncover vulnerabilities and shore up strengths.

By Larry Bossidy and Ram Charan

From the book Confronting Reality: Doing What Matters to Get Things Right by Larry Bossidy and Ram Charan.

Copyright 2004 by Larry Bossidy and Ram Charan. Published by Crown Business, a member of the Crown Publishing Group, a division of Random House.

Reader ROI

• How global changes can quickly render business strategies obsolete
• A model for assessing an organization's strengths and weaknesses
• How to decide which improvements are right for your company

It's become commonplace to say that globalization has changed business, but the tectonic shifts run deeper than most businesses understand. These changes are permanent rather than cyclical; the fundamentals of how a business makes money have been altered by worldwide supply chains, instant communications and a surplus of readily available capital. More troubling to managers is the speed with which these factors can render products and processes obsolete, even endangering a business's survival. Larry Bossidy, the retired chairman and CEO of Honeywell International, and Ram Charan, acclaimed business guru and author, have followed up their 2002 bestseller, Execution: The Discipline of Getting Things Done. Their new book, Confronting Reality: Doing What Matters to Get Things Right, is a how-to guide for confronting change - how to spot vulnerabilities in your organization and scan for competitive threats, how to diagnose what needs to be changed and what to leave alone, and how to prepare your organization to cange rapidly. The authors' basic management tool is the business model. Though certainly not a new concept, this version of the business model is broken down into three components that leaders can act on: assessing the external environment that the organization inhabits, setting financial targets for profitability and gauging the adequacy of the company's internal processes and structures. Finally, say Bossidy and Charan, good leaders must regularly examine their business model and create new iterations as needed. This excerpt shows the business model in action. As a practical matter, virtually every business is now a player on the global stage. But it's still hard for most people to see the specific ways global forces affect their businesses. People tend to look at them in piecemeal or linear fashion, failing to see emerging patterns. What they see often looks bewildering: a chaos of volatile exchange rates, competitive dynamics that are hard to define and understand, and uncertainty about a host of other co mplexities. The result is that more and more business leaders are getting blindsided, with a speed that was almost unthinkable in the past . . .

The Linux operating system [that Linus Torvalds] designed as a college student in 1991 and posted online interested only geeks at first. But over the years, the free open-source software attracted more and more followers and developers. Now it's beginning to look like a genuine competitor to Microsoft's Windows . . .

The new rule is that almost any business activity is ever more likely to have a worldwide dimension. A new competitor can come from anywhere. The next Linus Torvalds - perhaps the one who could make life hard for your own business - may even now be developing his or her plans sitting at home in Bangalore, Shanghai or Prague. It doesn't matter if this person is operating on a shoestring; a good idea is increasingly likely to find financial backers. And once any new product or service hits the market, it can reach customers anywhere on the planet almost overnight.

The other side of the coin, of course, is that the new global game offers unparalleled opportunities for those savvy enough to find them. If you're the first to see a market opening or the implications of a shift in regulatory policies, you could be the new competitor who blindsides a complacent player.

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What's the reason for all of this? And will it continue? Understanding how the world business environment affects you starts with distinguishing between cyclical and structural change. Cyclical changes are part of business life's normal ups and downs, and any competent executive can deal with them. Structural changes are fundamental, long-term alterations in the basics of making money. They are usually hard to differentiate from cyclical changes in their early stages, which is when you really need to see them. By the time they're obvious, your odds of adjusting well to them are sharply lower.

Three structural changes are driving today's explosion of intensifying worldwide competition: One is the increasing integration of business activity across borders, accelerated by the Internet with its instant communications and vast repository of ideas and dialogues. Its most tangible aspect is the rapid growth of supply chains that stretch from the United States and Europe to all parts of the world - not only for goods, but now for services as well. The second structural change is worldwide overinvestment, fuelled by a vast credit expansion and immense free flow of risk capital. The third is a global buyers' market that has shifted power from the owners and managers of capital to consumers and giant retailers. There's also a wild card. Around the world, government regulators are getting more aggressive, and they are coming at different issues, in different times and places, without coordination or rationalization of their policies . . .

The business model brings rationality to the issue of change. It is the guide for when to change and when not to change, what to change and what not to change. If you link your assessment of the external environment to your financial targets and your internal capabilities, you will have a much clearer picture of the magnitude of change required: whether it's a change in strategy, a change in operations or people, or a change in the business model itself . . .

There is no one-size-fits-all plan of action. What's right depends on the particulars of your business environment, financial targets and internal activities - in short, a thorough assessment through the lens of the business model. Not every business model needs an overhaul. Sometimes a company is simply underperforming in a world of opportunity. That's when leaders have to think hard about how performance links with external realities and internal activities, and be judicious in the actions they recommend. The ability to zero in on precisely the parts of the business that need attention and leave the rest alone is just as much as sign of great leadership as is reinventing the business model when radical action is needed . . .

The Business Model at Cisco Systems

Among the many players humbled in the stock market by the tech meltdown, Cisco stood out for the magnitude of its fall from grace. At its zenith in 2000, the maker of routers and switchgear briefly had the largest market capitalization in the world: At more than $US531 billion, it was greater than that of GE, which had six times Cisco's revenue. By mid-2001, Cisco's stock had fallen from its peak of $US82 to around $US20, eventually bottoming out at around $US8 in October 2002.

Cisco's revenue actually increased between 2000 and 2001, from about $US18.9 billion to $US22.3 billion, before dropping back to roughly $US19 billion in the next two years. But the financial markets were expecting continued blazing growth. And when CEO John Chambers appeared to be brushing off his problems, they weren't quick to forget their dashed hopes, and there was no question that Chambers had a problem on his hands. The evidence was clearest in [the external environment, which is] the first component of the business model. The telecom industry, which accounted for much of his sales, was crippled by overcapacity. Demand was evaporating as the telecoms underwent structural change, and Cisco's profits were evaporating with it.

The bleak prospects might have been enough to panic some leaders into trying to reinvent their business models. Indeed, that's what investors and the business press seemed to be expecting; they all but booed him when he argued that Cisco would weather what he called "a hundred year storm". But Chambers had looked carefully at his model. Though he recognized that Cisco was hurt, he had reason to maintain his famous optimism.

The model had long been admirable. The linkages between the external environment, the internal activity - particularly its strategy - and the financial targets had made the company a standout. Its highly desirable products were aimed at market segments that were exploding with growth, and while they were competitively priced, they earned attractive margins. Cisco kept up with demand through a strategy that relied heavily on subcontracting, and the low capital intensity in combination with reasonably good margins translated into lofty returns and huge cash generation . . .

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Determining the Solution for Cisco

What exactly had changed since then? In his root cause analysis, Chambers reasoned that the telecom business wouldn't disappear forever; it was just getting smaller. There was nothing ominous on the regulatory or competitive fronts, and Cisco's technology was still cutting-edge. So for Cisco, this was a nasty cyclical downturn, nothing more.

The financial targets were obviously in trouble at the moment: Profits were plunging; in 2001, the company lost more than $US1 billion. But Cisco's cash hoard allowed Chambers to take a bold and savvy $US2.5 billion inventory write-down without serious damage. As he continued to revisit the targets, he saw ways to improve margins at lower revenue levels, and to get ready for higher targets when the economy came back. The answer lay in improving cost performance and productivity.

Turning to the internal activities component, Chambers cut nearly 20,000 employees and slashed the numbers of suppliers and resellers. He rationalized his huge proliferation of products, reducing the lines from 50 to 40 and axing hundreds of models within them. Switches and routers were redesigned for lower cost, using fewer parts . . . Cisco had acquired hundreds of companies during the boom; Chambers reorganized to integrate the many that were still only half-digested . . .

Meantime Chambers was looking at the strategy element. He believed he could leverage Cisco's business model in new market segments, especially those where other well-established competitors had come close to bankruptcy. Identifying several markets and segments with high potential, he not only attacked markets for routers and switches, such as the cable industry, but also began increasing Cisco's offerings to include consumer products . . .

By 2003, still using its original business model, the company was making headway in six new product areas it called Advanced Technology markets: optical, network security, IP telephony, wireless LAN, storage networking and home networking. Each of these, Chambers has said, has "the potential to eventually create a $US1 billion revenue opportunity for Cisco." Regardless of how well or poorly Cisco capitalizes on them, they're opportunities that exist only because Chambers made the right decision when calamity struck. It's hard to know where the company would have been if he had misdiagnosed the change as structural and turned the whole business model upside down instead of focusing incisively on the key elements of the three components [of the business model].

EXTERNAL REALITIES: Demand plunged as customers cut back their purchases and confronted the mounting overcapacity in their industry. But Cisco's cutting-edge products were still desirable.

FINANCIAL TARGETS: Revenue growth stalled, margins shrank, and cash generation slowed.

INTERNAL ACTIVITIES: Cisco's operations and organizational processes were designed for high growth. Products proliferated, and controlling costs was not a high priority.

ITERATION: When he read the market downturn, Chambers correctly analyzed it for Cisco, it was cyclical, not structural. He kept his financial targets and strategy intact, and modelled ways to align them with the new and future marketplace realities. After establishing the likely volume of sales, he searched continually and repeatedly for ways to lower costs and get his desired margins. In subsequent iterations, Chambers saw opportunities to get into new markets and segments vacated by fallen competitors; with plenty of cash, he moved to exploit these opportunities.

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What's the Right Initiative for Your Organization?

In this new [business] environment, with its ever intensifying battles for razor-thin advantages, almost any edge you can gain looks attractive. And the list of tools and methodologies an organization can use to improve is endless. These days the most popular initiatives are moving operations to low-cost regions, streamlining the supply chain and Six Sigma. These initiatives are being widely adopted because they aim squarely at the challenges so many companies face: reducing cost, and improving productivity and quality.

Other initiatives range from a variety of process improvements to analytical tools such as the Balanced Scorecard, which augments traditional financial measures with criteria for things such as customer satisfaction and business process effectiveness. Companies continue to devote considerable time to integrating information technology functions through . . . ERP [systems] and the acquisition of facilitating software.

Keeping in mind that you're as interested in conditioning your organization for dealing with change as you are in achieving specific improvements, we see a number of additional noteworthy initiatives coming down the road.

One is achieving uniform IT [systems] and software. Far too much money is being lost as companies try to cobble together different systems. Unifying them leads to enormous savings and productivity improvements. You might think this is strictly an IT issue rather than a driver of broad cultural adaptation, but it isn't. It takes enormous cooperation across the business for people to give up their familiar software and adapt to new systems. The same is true for adapting to outsourced computing power versus owning your own machines - something more companies are doing in order to increase flexibility and lower capital needs.

Another is keeping talent within the organization. Anything you can do to create more job freedom will yield real gains in morale and performance. The workplace keeps getting more demanding as companies ratchet up productivity, and leaders need to give more time and attention to mitigating the burdens. For example, managers need to be more creative in helping people find ways to divide work between office and home. This is particularly important for those with young children . . .

What's important is to pick the initiative that's right for your business. A lot of corporate energy is expended on initiatives and "improvements" because they're the formula du jour - the latest fad or buzz - concept. We're talking not just about the obvious misfires (remember quality circles and zero defects?), but about anything that's suddenly popular that may not necessarily be a top priority given your circumstances at the moment. "I saw a company with a great supply chain," a leader will say. "Let's put that in." Or, "We have to do Six Sigma because everybody else is." Often as not, the organizational energy and resources end up being wasted. When the next initiative comes along, people groan and say: "Here we go again."

The improvements you choose must be guided by the priorities in your business model. The critical areas are the operating strengths and weaknesses that affect the business's ability to generate cash earnings over time - things such as cost, productivity, profitable revenue growth, differentiation, speed and quality. For example, if you need to raise cash flow, look to things such as improving inventory turns or a process improvement that speeds the collection of receivables.

Whatever the choice, always be sure the initiative is something your people can handle. Remember that you're not only aiming for a specific improvement, but also training the organization for adaptation, and trying to build unity and alignment. If it takes an easy or uncomplicated task to get people ready, suppress your impatience and make sure you lay the groundwork.

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Interview: Larry Bossidy on Competitiveness

CIO (US) interviewed Bossidy, the former chairman and CEO of Honeywell International, for insights into how IT changes corporate competitiveness and how CIOs can make use of the business model

CIO Magazine: Your book paints a picture of an ever-more competitive global marketplace. What is IT's role in that?

Larry Bossidy: The reason for what's happened [with global competitiveness] is the explosion of telecommunications and the Internet. The problem is that the more you have a global environment, the more data you have - and the more data you have, the harder it is to figure out what's important. You need a systems capability to be able to process that information.

CIO:From your perspective as a former CEO, what kinds of IT systems are most useful?

Bossidy:One of the ways to improve internal operations is to capture data - for instance, in the Six Sigma method. More broadly, companies without an advantage of some information systems data will fall behind those that do. If you take a look at company cultures that are progressive, they embrace data and [data-gathering] systems.

I'm not a whacko about being out in front on IT systems. You don't need the latest thing, because that can be very expensive, but you need contemporary systems. Contemporary means capable of meeting your information needs and consistently providing direction in a way that's up to speed [with competitors].

IT systems have to be an inherent part of strategy. They're sometimes done on an ad-hoc basis. For instance, we've got too many knowledge management systems being offered without a proper assessment of need. From what I've seen, knowledge management systems can make a major impact, but too often they're installed without a sense of how they're going to be used.

CIO:How can CIOs contribute to a good business model?

Bossidy:What I would do if I were the CIO is focus on external and internal realities [which are two components of the business model].

External realities include the industry you're in, who's doing well in it, and regulations that affect it. A CIO has to get more involved in the assessment of competition. There are cases out there where a competitor's supply chain or just a superior system is a competitive advantage. For instance, with Wal-Mart, its supply chain is not talked about very much as its source of competitive advantage. But CIOs recognize that importance [of the supply chain].

Then a CIO should devote more time to what the company's [IT] systems need to be - that's the internal realities piece. For instance, SAP has been popular in many companies, and rightly so, but what's the next system that you need? It's been proven that if you lag, you're going to pay the price.

CIO:What's your view of the trend toward outsourced jobs?

Bossidy:I know it's controversial, but it's here to stay. A lot of jobs that were previously done in the United States simply aren't competitive any more. [Outsourcing] is part of the increased global competitiveness. Sending jobs to India: You can only do that if you have [IT] systems in place. Outsourcing increases the need for systems.

But there's not a clear trend [with outsourcing]. You look at JP Morgan Chase (I'm on the board, by the way). They outsourced most of their IT to IBM. IBM did a good job with it. But when the merger with Bank One occurred [last January], the Bank One CIO [Austin Adams, who became the CIO for the merged entity] felt it was a competitive advantage to have IT in-house, especially for a huge consumer franchise. Outsourcing made sense for a commercial bank, but keeping the jobs in-house makes sense for a consumer bank.