Good to Great: Why Some Companies Make the Leap... and Others Don't, 1st Edition Hardcover - Jim Collins (2001)
Chapter 6. A Culture of Discipline
Freedom is only part of the story and half the truth.... That is why I recommend that the Statue of Liberty on the East Coast be supplanted by a Statue of Responsibility on the West Coast.
—VIKTOR E. FRANKL,
Man’s Search for Meaning1
In 1980, George Rathmann cofounded the biotechnology company Amgen. Over the next twenty years, Amgen grew from a struggling entrepreneurial enterprise into a $3.2 billion company with 6,400 employees, creating blood products to improve the lives of people suffering through chemotherapy and kidney dialysis.2 Under Rathmann, Amgen became one of the few biotechnology companies that delivered consistent profitability and growth. It became so consistently profitable, in fact, that its stock price multiplied over 150 times from its public offering in June 1983 to January 2000. An investor who bought as little as $7,000 of Amgen stock would have realized a capital gain of over $1 million, thirteen times better than the same investment in the general stock market.
Few successful start-ups become great companies, in large part because they respond to growth and success in the wrong way. Entrepreneurial success is fueled by creativity, imagination, bold moves into uncharted waters, and visionary zeal. As a company grows and becomes more complex, it begins to trip over its own success—too many new people, too many new customers, too many new orders, too many new products. What was once great fun becomes an unwieldy ball of disorganized stuff. Lack of planning, lack of accounting, lack of systems, and lack of hiring constraints create friction. Problems surface—with customers, with cash flow, with schedules.
In response, someone (often a board member) says, “It’s time to grow up. This place needs some professional management.” The company begins to hire MBAs and seasoned executives from blue-chip companies. Processes, procedures, checklists, and all the rest begin to sprout up like weeds. What was once an egalitarian environment gets replaced with a hierarchy. Chains of command appear for the first time. Reporting relationships become clear, and an executive class with special perks begins to appear. “We” and “they” segmentations appear—just like in a real company.
The professional managers finally rein in the mess. They create order out of chaos, but they also kill the entrepreneurial spirit. Members of the founding team begin to grumble, “This isn’t fun anymore. I used to be able to just get things done. Now I have to fill out these stupid forms and follow these stupid rules. Worst of all, I have to spend a horrendous amount of time in useless meetings.” The creative magic begins to wane as some of the most innovative people leave, disgusted by the burgeoning bureaucracy and hierarchy. The exciting start-up transforms into just another company, with nothing special to recommend it. The cancer of mediocrity begins to grow in earnest.
George Rathmann avoided this entrepreneurial death spiral. He understood that the purpose of bureaucracy is to compensate for incompetence and lack of discipline—a problem that largely goes away if you have the right people in the first place. Most companies build their bureaucratic rules to manage the small percentage of wrong people on the bus, which in turn drives away the right people on the bus, which then increases the percentage of wrong people on the bus, which increases the need for more bureaucracy to compensate for incompetence and lack of discipline, which then further drives the right people away, and so forth. Rathmann also understood an alternative exists: Avoid bureaucracy and hierarchy and instead create a culture of discipline. When you put these two complementary forces together—a culture of discipline with an ethic of entrepreneurship—you get a magical alchemy of superior performance and sustained results.
Why start this chapter with a biotechnology entrepreneur rather than one of our good-to-great companies? Because Rathmann credits much of his entrepreneurial success to what he learned while working at Abbott Laboratories before founding Amgen:
What I got from Abbott was the idea that when you set your objectives for the year, you record them in concrete. You can change your plans through the year, but you never change what you measure yourself against. You are rigorous at the end of the year, adhering exactly to what you said was going to happen. You don’t get a chance to editorialize. You don’t get a chance to adjust and finagle, and decide that you really didn’t intend to do that anyway, and readjust your objectives to make yourself look better. You never just focus on what you’ve accomplished for the year; you focus on what you’ve accomplished relative to exactly what you said you were going to accomplish—no matter how tough the measure. That was a discipline learned at Abbott, and that we carried into Amgen.3
Many of the Abbott disciplines trace back to 1968, when it hired a remarkable financial officer named Bernard H. Semler. Semler did not see his job as a traditional financial controller or accountant. Rather, he set out to invent mechanisms that would drive cultural change. He created a whole new framework of accounting that he called Responsibility Accounting, wherein every item of cost, income, and investment would be clearly identified with a single individual responsible for that item.4 The idea, radical for the 1960s, was to create a system wherein every Abbott manager in every type of job was responsible for his or her return on investment, with the same rigor that an investor holds an entrepreneur responsible. There would be no hiding behind traditional accounting allocations, no slopping funds about to cover up ineffective management, no opportunities for finger-pointing.5
But the beauty of the Abbott system lay not just in its rigor, but in how it used rigor and discipline to enable creativity and entrepreneurship. “Abbott developed a very disciplined organization, but not in a linear way of thinking,” said George Rathmann. “[It] was exemplary at having both financial discipline and the divergent thinking of creative work. We used financial discipline as a way to provide resources for the really creative work.”6 Abbott reduced its administrative costs as a percentage of sales to the lowest in the industry (by a significant margin) and at the same time became a new product innovation machine like 3M, deriving up to 65 percent of revenues from new products introduced in the previous four years.7
This creative duality ran through every aspect of Abbott during the transition era, woven into the very fabric of the corporate culture. On the one hand, Abbott recruited entrepreneurial leaders and gave them freedom to determine the best path to achieving their objectives. On the other hand, individuals had to commit fully to the Abbott system and were held rigorously accountable for their objectives. They had freedom, but freedom within a framework. Abbott instilled the entrepreneur’s zeal for opportunistic flexibility. (“We recognized that planning is priceless, but plans are useless,” said one Abbott executive.)8 But Abbott also had the discipline to say no to opportunities that failed the three circles test. While encouraging wide-ranging innovation within its divisions, Abbott simultaneously maintained fanatical adherence to its Hedgehog Concept of contributing to cost-effective health care.
Abbott Laboratories exemplifies a key finding of our study: a culture of discipline. By its nature, “culture” is a somewhat unwieldy topic to discuss, less prone to clean frameworks like the three circles. The main points of this chapter, however, boil down to one central idea: Build a culture full of people who take disciplined action within the three circles, fanatically consistent with the Hedgehog Concept.
More precisely, this means the following:
1. Build a culture around the idea of freedom and responsibility, within a framework.
2. Fill that culture with self-disciplined people who are willing to go to extreme lengths to fulfill their responsibilities. They will “rinse their cottage cheese.”
3. Don’t confuse a culture of discipline with a tyrannical disciplinarian.
4. Adhere with great consistency to the Hedgehog Concept, exercising an almost religious focus on the intersection of the three circles. Equally important, create a “stop doing list” and systematically unplug anything extraneous.
FREEDOM (AND RESPONSIBILITY)
WITH IN A FRAMEWORK
Picture an airline pilot. She settles into the cockpit, surrounded by dozens of complicated switches and sophisticated gauges, sitting atop a massive $84 million piece of machinery. As passengers thump and stuff their bags into overhead bins and flight attendants scurry about trying to get everyone settled in, she begins her preflight checklist. Step by methodical step, she systematically moves through every required item.
Cleared for departure, she begins working with air traffic control, following precise instructions—which direction to take out of the gate, which way to taxi, which runway to use, which direction to take off. She doesn’t throttle up and hurtle the jet into the air until she’s cleared for takeoff. Once aloft, she communicates continually with flight-control centers and stays within the tight boundaries of the commercial air traffic system.
On approach, however, she hits a ferocious thunder-and-hail storm. Blasting winds, crossways and unpredictable, tilt the wings down to the left, then down to the right. Looking out the windows, passengers can’t see the ground, only the thinning and thickening globs of gray clouds and the spatter of rain on the windows. The flight attendants announce, “Ladies and gentlemen, we’ve been asked to remain seated for the remainder of the flight. Please put your seats in the upright and locked position and place all your carry-on baggage under the seat in front of you. We should be on the ground shortly.”
“Not too shortly, I hope,” think the less experienced travelers, unnerved by the roiling wind and momentary flashes of lightning. But the experienced travelers just go on reading magazines, chatting with seatmates, and preparing for their meetings on the ground. “I’ve been through all this before,” they think. “She’ll only land if it’s safe.”
Sure enough, on final approach—wheels down as a quarter of a million pounds of steel glides down at 130 miles per hour—passengers suddenly hear the engines whine and feel themselves thrust back into their seats. The plane accelerates back into the sky. It banks around in a big arc back toward the airport. The pilot takes a moment to click on the intercom: “Sorry, folks. We were getting some bad crosswinds there. We’re going to give it another try.” On the next go, the winds calm just enough and she brings the plane down, safely.
Now take a step back and think about the model here. The pilot operates within a very strict system, and she does not have freedom to go outside of that system. (You don’t want airline pilots saying, “Hey, I just read in a management book about the value of being empowered—freedom to experiment, to be creative, to be entrepreneurial, to try a lot of stuff and keep what works!”) Yet at the same time, the crucial decisions—whether to take off, whether to land, whether to abort, whether to land elsewhere—rest with the pilot. Regardless of the strictures of the system, one central fact stands out above all others: The pilot has ultimate responsibility for the airplane and the lives of the people on it.
The point here is not that a company should have a system as strict and inflexible as the air traffic system. After all, if a corporate system fails, people don’t die by the hundreds in burning, twisted hunks of steel. Customer service at the airlines might be terrible, but you are almost certain to get where you are going in one piece. The point of this analogy is that when we looked inside the good-to-great companies, we were reminded of the best part of the airline pilot model: freedom and responsibility within the framework of a highly developed system.
The good-to-great companies built a consistent system with clear constraints, but they also gave people freedom and responsibility within the framework of that system. They hired self-disciplined people who didn’t need to be managed, and then managed the system, not the people.
“This was the secret to how we were able to run stores from a great distance, by remote control,” said Bill Rivas of Circuit City. “It was the combination of great store managers who had ultimate responsibility for their individual stores, operating within a great system. You’ve got to have management and people who believe in the system and who do whatever is necessary to make the system work. But within the boundaries of that system, store managers had a lot of leeway, to coincide with their responsibility.”9 In a sense, Circuit City became to consumer electronics retailing what McDonald’s became to restaurants—not the most exquisite experience, but an enormously consistent one. The system evolved over time as Circuit City experimented by adding new items like computers and video players (just like McDonald’s added breakfast Egg McMuffins). But at any given moment, everyone operated within the framework of the system. “That’s one of the major differences between us and all the others who were in this same business in the early 1980s,” said Bill Zierden. “They just couldn’t roll it out further, and we could. We could stamp these stores out all over the country, with great consistency.”10 Therein lies one of the key reasons why Circuit City took off in the early 1980s and beat the general stock market by more than eighteen times over the next fifteen years.
In a sense, much of this book is about creating a culture of discipline. It all starts with disciplined people. The transition begins not by trying to discipline the wrong people into the right behaviors, but by getting self-disciplined people on the bus in the first place. Next we have disciplined thought. You need the discipline to confront the brutal facts of reality, while retaining resolute faith that you can and will create a path to greatness. Most importantly, you need the discipline to persist in the search for understanding until you get your Hedgehog Concept. Finally, we have disciplined action, the primary subject of this chapter. This order is important. The comparison companies often tried to jump right to disciplined action. But disciplined action without self-disciplined people is impossible to sustain, and disciplined action without disciplined thought is a recipe for disaster.
Indeed, discipline by itself will not produce great results. We find plenty of organizations in history that had tremendous discipline and that marched right into disaster, with precision and in nicely formed lines. No, the point is to first get self-disciplined people who engage in very rigorous thinking, who then take disciplined action within the framework of a consistent system designed around the Hedgehog Concept.
Throughout our research, we were struck by the continual use of words like disciplined, rigorous, dogged, determined, diligent, precise, fastidious, systematic, methodical, workmanlike, demanding, consistent, focused, accountable, and responsible. They peppered articles, interviews, and source materials on the good-to-great companies, and were strikingly absent from the materials on the direct comparison companies. People in the good-to-great companies became somewhat extreme in the fulfillment of their responsibilities, bordering in some cases on fanaticism.
We came to call this the “rinsing your cottage cheese” factor. The analogy comes from a disciplined world-class athlete named Dave Scott, who won the Hawaii Ironman Triathlon six times. In training, Scott would ride his bike 75 miles, swim 20,000 meters, and run 17 miles—on average, every single day. Dave Scott did not have a weight problem! Yet he believed that a low-fat, high-carbohydrate diet would give him an extra edge. So, Dave Scott—a man who burned at least 5,000 calories a day in training—would literally rinse his cottage cheese to get the extra fat off. Now, there is no evidence that he absolutely needed to rinse his cottage cheese to win the Ironman; that’s not the point of the story. The point is that rinsing his cottage cheese was simply one more small step that he believed would make him just that much better, one more small step added to all the other small steps to create a consistent program of superdiscipline. I’ve always pictured Dave Scott running the 26 miles of the marathon—hammering away in hundred-degree heat on the black, baked lava fields of the Kona coast after swimming 2.4 miles in the ocean and cycling 112 miles against ferocious crosswinds—and thinking to himself: “Compared to rinsing my cottage cheese every day, this just isn’t that bad.”
I realize that it’s a bizarre analogy. But in a sense, the good-to-great companies became like Dave Scott. Much of the answer to the question of “good to great” lies in the discipline to do whatever it takes to become the best within carefully selected arenas and then to seek continual improvement from there. It’s really just that simple. And it’s really just that difficult.
Everyone would like to be the best, but most organizations lack the discipline to figure out with egoless clarity what they can be the best at and the will to do whatever it takes to turn that potential into reality. They lack the discipline to rinse their cottage cheese.
Consider Wells Fargo in contrast to Bank of America. Carl Reichardt never doubted that Wells Fargo could emerge from bank deregulation as a stronger company, not a weaker one. He saw that the key to becoming a great company rested not with brilliant new strategies but with the sheer determination to rip a hundred years of banker mentality out of the system. “There’s too much waste in banking,” said Reichardt. “Getting rid of it takes tenacity, not brilliance.”11
Reichardt set a clear tone at the top: We’re not going to ask everyone else to suffer while we sit on high. We will start by rinsing our own cottage cheese, right here in the executive suite. He froze executive salaries for two years (despite the fact that Wells Fargo was enjoying some of the most profitable years in its history).12 He shut the executive dining room and replaced it with a college dorm food-service caterer.13 He closed the executive elevator, sold the corporate jets, and banned green plants from the executive suite as too expensive to water.14 He removed free coffee from the executive suite. He eliminated Christmas trees for management.15 He threw reports back at people who’d submitted them in fancy binders, with the admonishment: “Would you spend your own money this way? What does a binder add to anything?”16 Reichardt would sit through meetings with fellow executives, in a beat-up old chair with the stuffing hanging out. Sometimes he would just sit there and pick at the stuffing while listening to proposals to spend money, said one article, “[and] a lot of must-do projects just melted away.”17
Across the street at Bank of America, executives also faced deregulation and recognized the need to eliminate waste. However, unlike Wells Fargo, B of A executives didn’t have the discipline to rinse their own cottage cheese. They preserved their posh executive kingdom in its imposing tower in downtown San Francisco, the CEO’s office described in the book Breaking the Bank as “a northeast corner suite with a large attached conference room, oriental rugs, and floor-to-ceiling windows that offered a sweeping panorama of the San Francisco Bay from the Golden Gate to the Bay Bridge.”18 (We found no evidence of executive chairs with the stuffing hanging out.) The elevator made its last stop at the executive floor and descended all the way to the ground in one quiet whoosh, unfettered by the intrusions of lesser beings. The vast open space in the executive suite made the windows look even taller than they actually were, creating a sense of floating above the fog in an elevated city of alien elites who ruled the world from above.19 Why rinse our cottage cheese when life is so good?
After losing $1.8 billion across three years in the mid-1980s, B of A eventually made the necessary changes in response to deregulation (largely by hiring ex-Wells executives).20 But even in the darkest days, B of A could not bring itself to get rid of the perks that shielded its executives from the real world. At one board meeting during Bank of America’s crisis period, one member made sensible suggestions like “Sell the corporate jet.” Other directors listened to the recommendations, then passed them by.21
A CULTURE, NOT A TYRANT
We almost didn’t include this chapter in the book. On the one hand, the good-to-great companies became more disciplined than the direct comparison companies, as with Wells Fargo in contrast to Bank of America. On the other hand, the unsustained comparisons showed themselves to be just as disciplined as the good-to-great companies.
“Based on my analysis, I don’t think we can put discipline in the book as a finding,” said Eric Hagen, after he completed a special analysis unit looking at the leadership cultures across the companies. “It is absolutely clear that the unsustained comparison CEOs brought tremendous discipline to their companies, and that is why they got such great initial results. So, discipline just doesn’t pass muster as a distinguishing variable.”
Curious, we decided to look further into the issue, and Eric undertook a more in-depth analysis. As we further examined the evidence, it became clear that—despite surface appearances—there was indeed a huge difference between the two sets of companies in their approach to discipline.
Whereas the good-to-great companies had Level 5 leaders who built an enduring culture of discipline, the unsustained comparisons had Level 4 leaders who personally disciplined the organization through sheer force.
Consider Ray MacDonald, who took command of Burroughs in 1964. A brilliant but abrasive man, MacDonald controlled the conversations, told all the jokes, and criticized those not as smart as he (which was pretty much everyone around him). He got things done through sheer force of personality, using a form of pressure that came to be known as “The MacDonald Vise.”22 MacDonald produced remarkable results during his reign. Every dollar invested in 1964, the year he became president, and taken out at the end of 1977, when he retired, produced returns 6.6 times better than the general market.23 However, the company had no culture of discipline to endure beyond him. After he retired, his helper minions were frozen by indecision, leaving the company, according to Business Week, “with an inability to do anything.”24 Burroughs then began a long slide, with cumulative returns falling 93 percent below the market from the end of the MacDonald era to 2000.
We found a similar story at Rubbermaid under Stanley Gault. Recall from the Level 5 chapter that Gault quipped in response to the accusation of being a tyrant, “Yes, but I’m a sincere tyrant.” Gault brought strict disciplines to Rubbermaid—rigorous planning and competitor analysis, systematic market research, profit analysis, hard-nosed cost control, and so on. “This is an incredibly disciplined organization,” wrote one analyst. “There is an incredible thoroughness in Rubbermaid’s approach to life.”25 Precise and methodical, Gault arrived at work by 6:30 and routinely worked eighty-hour weeks, expecting his managers to do the same.26
As chief disciplinarian, Gault personally acted as the company’s number one quality control mechanism. Walking down the street in Manhattan, he noticed a doorman muttering and swearing as he swept dirt into a Rubber-maid dustpan. “Stan whirled around and starting grilling the man on why he was unhappy,” said Richard Gates, who told the story to Fortune. Gault, convinced that the lip of the dustpan was too thick, promptly issued a dictate to his engineers to redesign the product. “On quality, I’m a sonofabitch,” said Gault. His chief operating officer concurred: “He gets livid.”27
Rubbermaid rose dramatically under the tyranny of this singularly disciplined leader but then just as dramatically declined when he departed. Under Gault, Rubbermaid beat the market 3.6 to 1. After Gault, Rubber-maid lost 59 percent of its value relative to the market, before being bought out by Newell.
One particularly fascinating example of the disciplinarian syndrome was Chrysler under Lee Iacocca, whom Business Week described simply as, “The Man. The Dictator. Lee.”28 Iacocca became president of Chrysler in 1979 and imposed his towering personality to discipline the organization into shape. “Right away I knew the place was in a state of anarchy [and] needed a dose of order and discipline—and quick,” wrote Iacocca of his early days.29 In his first year, he entirely overhauled the management structure, instituted strict financial controls, improved quality control measures, rationalized the production schedule, and conducted mass layoffs to preserve cash.30 “I felt like an Army Surgeon.... We had to do radical surgery, saving what we could.”31 In dealing with the unions, he said, “If you don’t help me out, I’m going to blow your brains out. I’ll declare bankruptcy in the morning, and you’ll all be out of work.”32 Iacocca produced spectacular results and Chrysler became one of the most celebrated turnarounds in industrial history.
About midway through his tenure, however, Iacocca seemed to lose focus and the company began to decline once again. The Wall Street Journal wrote: “Mr. Iacocca headed the Statue of Liberty renovation, joined a congressional commission on budget reduction and wrote a second book. He began a syndicated newspaper column, bought an Italian villa where he started bottling his own wine and olive oil .... Critics contend it all distracted him, and was a root cause of Chrysler’s current problems .... Distracting or not, it’s clear that being a folk hero is a demanding sideline.”33
Worse than his moonlight career as a national hero, his lack of discipline to stay within the arenas in which Chrysler could be the best in the world led to a binge of highly undisciplined diversifications. In 1985, he was lured into the sexy aerospace business. Whereas most CEOs would be content with a single Gulfstream jet, Iacocca decided to buy the whole Gulfstream company!34 Also in the mid-1980s, he embarked on a costly and ultimately unsuccessful joint venture with Italian sports car maker Maserati. “Iacocca had a soft spot for Italians,” said one retired Chrysler executive. “Iacocca, who owns a modest estate in Tuscany, was so intent on an Italian alliance that commercial realities were ignored, suggest industry insiders,” wrote Business Week.35 Some estimates put the loss of the failed Maserati venture at $200 million, which, according to Forbes, was “an enormous sum to lose on a high-price, low-volume roadster. After all, no more than a few thousand will ever be built.”36
During the first half of his tenure, Iacocca produced remarkable results, taking the company from near bankruptcy to nearly three times the general market. During the second half of Iacocca’s tenure, the company slid 31 percent behind the market and faced another potential bankruptcy.37 “Like so many patients with a heart condition,” wrote a Chrysler executive, “we’d survived surgery several years before only to revert to our unhealthy lifestyle.”38
The above cases illustrate a pattern we found in every unsustained comparison: a spectacular rise under a tyrannical disciplinarian, followed by an equally spectacular decline when the disciplinarian stepped away, leaving behind no enduring culture of discipline, or when the disciplinarian himself became undisciplined and strayed wantonly outside the three circles. Yes, discipline is essential for great results, but disciplined action without disciplined understanding of the three circles cannot produce sustained great results.
FANATICAL ADHERENCE TO THE HEDGEHOG CONCEPT
For nearly forty years, Pitney Bowes lived inside the warm and protective cocoon of a monopoly. With its close relationship to the U.S. Postal Service and its patents on postage meter machines, Pitney attained 100 percent of the metered mail market.39 By the end of the 1950s, nearly half of all U.S. mail passed through Pitney Bowes machines.40 With gross profit margins in excess of 80 percent, no competition, a huge market, and a recession-proof business, Pitney Bowes wasn’t so much a great company as it was a company with a great monopoly.
Then, as almost always happens to monopolies when the protective cocoon is ripped away, Pitney Bowes began a long slide. First came a consent decree that required Pitney Bowes to license its patents to competitors, royalty free.41 Within six years, Pitney Bowes had sixteen competitors.42 Pitney fell into a reactionary “Chicken Little/the sky is falling” diversification frenzy, throwing cash after ill-fated acquisitions and joint ventures, including a $70 million bloodbath (54 percent of net stockholders’ equity at the time) from a computer retail foray. In 1973, the company lost money for the first time in its history. It was shaping up to be just another typical case of a monopoly-protected company gradually falling apart once confronted with the harsh reality of competition.
Fortunately, a Level 5 leader named Fred Allen stepped in and asked hard questions that led to deeper understanding of Pitney’s role in the world. Instead of viewing itself as a “postage meter” company, Pitney came to see that it could be the best in the world at servicing the back rooms of businesses within the broader concept of “messaging.” It also came to see that sophisticated back-office products, like high-end faxes and specialized copiers, played right into its economic engine of profit per customer, building off its extensive sales and service network.
Allen and his successor, George Harvey, instituted a model of disciplined diversification. For example, Pitney eventually attained 45 percent of the high-end fax market for large companies, a hugely profitable cash machine.43Harvey began a systematic process of investment in new technologies and products, such as the Paragon mail processor that seals and sends letters, and by the late 1980s, Pitney consistently derived over half its revenues from products introduced in the previous three years.44 Later, Pitney Bowes became a pioneer at linking backroom machines to the Internet, yet another opportunity for disciplined diversification. The key point is that every step of diversification and innovation stayed within the three circles.
After falling 77 percent behind the market from the consent decree to its darkest days in 1973, Pitney Bowes reversed course, eventually rising to over eleven times the market by the start of 1999. From 1973 to 2000, Pitney Bowes outperformed Coca-Cola, 3M, Johnson & Johnson, Merck, Motorola, Procter & Gamble, Hewlett-Packard, Walt Disney, and even General Electric. Can you think of any other company that emerged from the protective comfort of a monopoly cocoon to deliver this level of results? AT&T didn’t. Xerox didn’t. Even IBM didn’t.
Pitney Bowes illustrates what can happen when a company lacks the discipline to stay within the three circles and, conversely, what can happen when it regains that discipline.
The good-to-great companies at their best followed a simple mantra: “Anything that does not fit with our Hedgehog Concept, we will not do. We will not launch unrelated businesses. We will not make unrelated acquisitions. We will not do unrelated joint ventures. If it doesn’t fit, we don’t do it. Period.”
In contrast, we found a lack of discipline to stay within the three circles as a key factor in the demise of nearly all the comparison companies. Every comparison either (1) lacked the discipline to understand its three circles or (2) lacked the discipline to stay within the three circles.
R. J. Reynolds is a classic case. Until the 1960s, R. J. Reynolds had a simple and clear concept, built around being the best tobacco company in the United States—a position it had held for at least twenty-five years.45 Then in 1964, the Surgeon General’s Office issued its report that linked cigarettes with cancer, and R. J. Reynolds began to diversify away from tobacco as a defensive measure. Of course, all tobacco companies began to diversify at that time for the same reason, including Philip Morris. But R. J. Reynolds’ wanderings outside its three circles defied all logic.
R. J. Reynolds spent nearly a third of total corporate assets in 1970 to buy a shipping container company and an oil company (Sea-Land and Aminoil), the idea being to make money by shipping its own oil.46 Okay, not a terrible idea on its own. But what on earth did it have to do with R. J. Reynolds’ Hedgehog Concept? It was a wholly undisciplined acquisition that came about in part because Sea-Land’s founder was a close friend of R. J. Reynolds’ chairman.47
After pouring more than $2 billion into Sea-Land, the total investment nearly equaled the entire amount of net stockholders’ equity.48 Finally, after years of starving the tobacco business to funnel funds into the sinking ship business, RJR acknowledged failure and sold Sea-Land.49 One Reynolds grandson complained: “Look, these guys are the world’s best at making and selling tobacco products, but what do they know about ships or oil? I’m not worried about them going broke, but they look like country boys with too much cash in their pockets.”50
To be fair, Philip Morris did not have a perfect diversification record either, as evidenced by its failed purchase of 7UP. However, in stark contrast to R. J. Reynolds, Philip Morris displayed greater discipline in response to the 1964 surgeon general’s report. Instead of abandoning its Hedgehog Concept, Philip Morris redefined its Hedgehog Concept in terms of building global brands in not-so-healthy consumables (tobacco, beer, soft drinks, coffee, chocolate, processed cheese, etc.). Philip Morris’ superior discipline to stay within the three circles is one key reason why the results of the two companies diverged so dramatically after the 1964 report, despite the fact that they both faced the exact same industry opportunities and threats. From 1964 to 1989 (when R. J. Reynolds disappeared from public trading in a leveraged buyout), $1 invested in Philip Morris beat $1 invested in R. J. Reynolds by over four times.
Few companies have the discipline to discover their Hedgehog Concept, much less the discipline to build consistently within it. They fail to grasp a simple paradox: The more an organization has the discipline to stay within its three circles, the more it will have attractive opportunities for growth. Indeed, a great company is much more likely to die of indigestion from too much opportunity than starvation from too little. The challenge becomes not opportunity creation, but opportunity selection.
It takes discipline to say “No, thank you” to big opportunities. The fact that something is a “once-in-a-lifetime opportunity” is irrelevant if it doesn’t fit within the three circles.
This notion of fanatical consistency relative to the Hedgehog Concept doesn’t just concern the portfolio of strategic activities. It can relate to the entire way you manage and build an organization. Nucor built its success around the Hedgehog Concept of harnessing culture and technology to produce steel. Central to the Nucor concept was the idea of aligning worker interests with management and shareholder interests through an egalitarian meritocracy largely devoid of class distinctions. Wrote Ken Iverson, in his 1998 book Plain Talk:
Inequality still runs rampant in most business corporations. I’m referring now to hierarchical inequality which legitimizes and institutionalizes the principle of “We” vs. “They.”... The people at the top of the corporate hierarchy grant themselves privilege after privilege, flaunt those privileges before the men and women who do the real work, then wonder why employees are unmoved by management’s invocations to cut costs and boost profitability.... When I think of the millions of dollars spent by people at the top of the management hierarchy on efforts to motivate people who are continually put down by that hierarchy, I can only shake my head in wonder.51
When we interviewed Ken Iverson, he told us that nearly 100 percent of the success of Nucor was due to its ability to translate its simple concept into disciplined action consistent with that concept. It grew into a $3.5 billion Fortune 500 company with only four layers of management and a corporate headquarters staff of fewer than twenty-five people—executive, financial, secretarial, the whole shebang—crammed into a rented office the size of a small dental practice.52 Cheap veneer furniture adorned the lobby, which itself was not much larger than a closet. Instead of a corporate dining room, executives hosted visiting dignitaries at Phil’s Diner, a strip mall sandwich shop across the street.53
Executives did not receive better benefits than frontline workers. In fact, executives had fewer perks. For example, all workers (but not executives) were eligible to receive $2,000 per year for each child for up to four years of post-high school education.54 In one incident, a man came to Marvin Pohlman and said, “I have nine kids. Are you telling me that you’ll pay for four years of school—college, trade school, whatever—for every single one of my kids?” Pohlman acknowledged that, yes, that’s exactly what would happen. “The man just sat there and cried,” said Pohlman. “I’ll never forget it. It just captures in one moment so much of what we were trying to do.”55
When Nucor had a highly profitable year, everyone in the company would have a very profitable year. Nucor workers became so well paid that one woman told her husband, “If you get fired from Nucor, I’ll divorce you.”56But when Nucor faced difficult times, everyone from top to bottom suffered. But people at the top suffered more. In the 1982 recession, for example, worker pay went down 25 percent, officer pay went down 60 percent, and the CEO’s pay went down 75 percent.57
Nucor took extraordinary steps to keep at bay the class distinctions that eventually encroach on most organizations. All 7,000 employees’ names appeared in the annual report, not just officers’ and executives’.58 Everyone except safety supervisors and visitors wore the same color hard hats. The color of hard hats might sound trivial, but it caused quite a stir. Some foremen complained that special-colored hard hats identified them as higher in the chain, an important status symbol that they could put on the back shelves of their cars or trucks. Nucor responded by organizing a series of forums to address the point that your status and authority in Nucor come from your leadership capabilities, not your position. If you don’t like it—if you really feel you need that class distinction—well, then, Nucor is just not the right place for you.59
In contrast to Nucor’s dental suite-sized headquarters, Bethlehem Steel built a twenty-one-story office complex to house its executive staff. At extra expense, it designed the building more like a cross than a rectangle—a design that accommodated the large number of vice presidents who needed corner offices. “The vice presidents... [had to have] windows in two directions, so it was out of that desire that we came up with the design,” explained a Bethlehem executive.60 In his book Crisis in Bethlehem, John Strohmeyer details a culture as far to the other end of the continuum from Nucor as you can imagine. He describes a fleet of corporate aircraft, used even for taking executives’ children to college and flitting away to weekend hideaways. He describes a world-class eighteen-hole executive golf course, an executive country club renovated with Bethlehem corporate funds, and even how executive rank determined shower priority at the club.61
We came to the conclusion that Bethlehem executives saw the very purpose of their activities as the perpetuation of a class system that elevated them to elite status. Bethlehem did not decline in the 1970s and 1980s primarily because of imports or technology—Bethlehem declined first and foremost because it was a culture wherein people focused their efforts on negotiating the nuances of an intricate social hierarchy, not on customers, competitors, or changes in the external world.
From 1966 (at the start of its buildup) to 1999, Nucor posted thirty-four consecutive years of positive profitability, while over those same thirty-four years, Bethlehem lost money twelve times and its cumulative profitability added up to less than zero. By the 1990s, Nucor’s profitability beat Bethlehem’s every single year, and at the end of the century, Nucor—which had been less than a third the size of Bethlehem only a decade earlier— finally surpassed Bethlehem in total revenues.62 Even more astounding, Nucor’s average five-year profit per employee exceeded Bethlehem by almost ten times.63 And for the investor, $1 invested in Nucor beat $1 invested in Bethlehem Steel by over 200 times.
To be fair, Bethlehem had one giant problem not faced by Nucor: adversarial labor relations and entrenched unions. Nucor had no union and enjoyed remarkably good relations with its workers. In fact, when union organizers visited one plant, workers felt so ferociously loyal to Nucor that management had to protect the union organizers from workers who began shouting and throwing sand at them.64
But the union argument begs a crucial question: Why did Nucor have such a better relationship with its workers in the first place? Because Ken Iverson and his team had a simple, crystalline Hedgehog Concept about aligning worker interests with management interests and—most importantly—because they were willing to go to almost extreme lengths to build the entire enterprise consistent with that concept. Call them a bit fanatical if you want, but to create great results requires a nearly fanatical dedication to the idea of consistency within the Hedgehog Concept.
START A “STOP DOING” LIST
Do you have a “to do” list?
Do you also have a “stop doing” list?
Most of us lead busy but undisciplined lives. We have ever-expanding “to do” lists, trying to build momentum by doing, doing, doing—and doing more. And it rarely works. Those who built the good-to-great companies, however, made as much use of “stop doing” lists as “to do” lists. They displayed a remarkable discipline to unplug all sorts of extraneous junk.
When Darwin Smith became CEO of Kimberly-Clark, he made great use of “stop doing” lists. He saw that playing the annual forecast game with Wall Street focused people too much on the short term, so he just stopped doing it. “On balance, I see no net advantage to our stockholders when we annually forecast future earnings,” said Smith. “We will not do it.”65 He saw “title creep” as a sign of class-consciousness and bureaucratic layering, so he simply unplugged titles. No one at the company would have a title, unless it was for a position where the outside world demanded a title. He saw increasing layers as the natural result of empire building. So he simply unplugged a huge stack of layers with a simple elegant mechanism: If you couldn’t justify to your peers the need for at least fifteen people reporting to you to fulfill your responsibilities, then you would have zero people reporting to you.66 (Keep in mind that he did this in the 1970s, long before it became fashionable.) To reinforce the idea that Kimberly-Clark should begin thinking of itself as a consumer company, not a paper company, he unplugged Kimberly from all paper industry trade associations.67
The good-to-great companies institutionalized the discipline of “stop doing” through the use of a unique budget mechanism. Stop and think for a moment: What is the purpose of budgeting? Most answer that budgeting exists to decide how much to apportion to each activity, or to manage costs, or both. From a good-to-great perspective, both of these answers are wrong.
In a good-to-great transformation, budgeting is a discipline to decide which arenas should be fully funded and which should not be funded at all. In other words, the budget process is not about figuring out how much each activity gets, but about determining which activities best support the Hedgehog Concept and should be fully strengthened and which should be eliminated entirely.
Kimberly-Clark didn’t just reallocate resources from the paper business to the consumer business. It completely eliminated the paper business, sold the mills, and invested all the money into the emerging consumer business.
I had an interesting conversation with some executives from a company in the paper business. It’s a good company, not yet a great one, and they had competed directly with Kimberly-Clark before Kimberly transformed itself into a consumer company. Out of curiosity, I asked them what they thought of Kimberly-Clark. “What Kimberly did is not fair,” they said.
“Not fair?” I looked quizzical.
“Oh, sure, they’ve become a much more successful company. But, you know, if we’d sold our paper business and become a powerful consumer company, we could have been great, too. But we just have too much invested in it, and we couldn’t have brought ourselves to do it.”
If you look back on the good-to-great companies, they displayed remarkable courage to channel their resources into only one or a few arenas. Once they understood their three circles, they rarely hedged their bets. Recall Kroger’s commitment to overturn its entire system to create superstores, while A&P clung to the “safety” of its older stores. Recall Abbott’s commitment to put the bulk of its resources into becoming number one in diagnostics and hospital nutritionals, while Upjohn clung to its core pharmaceutical business (where it could never be the best in the world). Recall how Walgreens exited the profitable food-service business and focused all its might into one idea: the best, most convenient drugstores. Recall Gillette and Sensor, Nucor and the mini-mills, Kimberly-Clark and selling the mills to channel all its resources into the consumer business. They all had the guts to make huge investments, once they understood their Hedgehog Concept.
The most effective investment strategy is a highly undiversified portfolio when you are right. As facetious as that sounds, that’s essentially the approach the good-to-great companies took. “Being right” means getting the Hedgehog Concept; “highly undiversified” means investing fully in those things that fit squarely within the three circles and getting rid of everything else.
Of course, the key here is the little caveat, “When you are right.” But how do you know when you’re right? In studying the companies, we learned that “being right” just isn’t that hard if you have all the pieces in place. If you have Level 5 leaders who get the right people on the bus, if you confront the brutal facts of reality, if you create a climate where the truth is heard, if you have a Council and work within the three circles, if you frame all decisions in the context of a crystalline Hedgehog Concept, if you act from understanding, not bravado—if you do all these things, then you are likely to be right on the big decisions. The real question is, once you know the right thing, do you have the discipline to do the right thing and, equally important, to stop doing the wrong things?
A Culture Of Discipline
✵ Sustained great results depend upon building a culture full of self-disciplined people who take disciplined action, fanatically consistent with the three circles.
✵ Bureaucratic cultures arise to compensate for incompetence and lack of discipline, which arise from having the wrong people on the bus in the first place. If you get the right people on the bus, and the wrong people off, you don’t need stultifying bureaucracy.
✵ A culture of discipline involves a duality. On the one hand, it requires people who adhere to a consistent system; yet, on the other hand, it gives people freedom and responsibility within the framework of that system.
✵ A culture of discipline is not just about action. It is about getting disciplined people who engage in disciplined thought and who then take disciplined action.
✵ The good-to-great companies appear boring and pedestrian looking in from the outside, but upon closer inspection, they’re full of people who display extreme diligence and a stunning intensity (they “rinse their cottage cheese”).
✵ Do not confuse a culture of discipline with a tyrant who disciplines—they are very different concepts, one highly functional, the other highly dysfunctional. Savior CEOs who personally discipline through sheer force of personality usually fail to produce sustained results.
✵ The single most important form of discipline for sustained results is fanatical adherence to the Hedgehog Concept and the willingness to shun opportunities that fall outside the three circles.
✵ The more an organization has the discipline to stay within its three circles, with almost religious consistency, the more it will have opportunities for growth.
✵ The fact that something is a “once-in-a-lifetime opportunity” is irrelevant, unless it fits within the three circles. A great company will have many once-in-a-lifetime opportunities.
✵ The purpose of budgeting in a good-to-great company is not to decide how much each activity gets, but to decide which arenas best fit with the Hedgehog Concept and should be fully funded and which should not be funded at all.
✵ “Stop doing” lists are more important than “to do” lists.