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Published: October 11, 2002

 
 

Best Business Books 2002: Strategy

What Jack Welch Learned from the Prussian Army

In August 1914, Germany committed virtually its entire army to the invasion of Belgium and France. Few German troops remained to defend East Prussia against the invasion of two huge Russian armies. Despite the numerical inferiority, Colonel Hoffmann, chief of the German Eighth Army staff, created an audacious strategy to surround and annihilate one of the Russian armies, and began detailed attack planning. At the same time, on a train traveling east, General Ludendorff, the incoming chief of staff of the reinforced German forces in East Prussia, identified the same opportunity and created exactly the same strategy. Paul von Hindenburg, the new commander of German forces in the east, implemented the Hoffmann/Ludendorff strategy. At the resulting Battle of Tannenberg, only 10,000 of the 150,000 soldiers in the Russian Second Army escaped.

Tannenberg was a triumph for the Prussian general staff — not only because of the decisive result, but also because two strategists independently and without coordination analyzed an unexpected situation the same way and created the same strategy. Both officers — building on years of study, debate, and participation in war games — saw the potential analogy with Hannibal’s destruction of the putatively superior Romans at Cannae, and adapted Hannibal’s strategy to the eastern front in 1914.

Military strategists use history — that is, the real-world experience of others, many of them long gone — to ground their contemporary analyses and decision making. The best business-strategy books similarly equip corporate leaders with the cases, analogies, sound ideas, practical recommendations, and thought-provoking hypotheses that enable them to achieve business success. Although not all victories are the equivalent of the Battle of Tannenberg, a company’s life is at stake in an increasingly volatile global economy in which public memory is fickle and shareholders pitiless. Four books published in 2001 and 2002 offer strategies, templates, frameworks, and tools that can help leaders thrive, even if, like Hannibal at Cannae, they’re short an elephant or two.

Jack: Straight from the Gut (written with Business Week’s John A. Byrne, Warner Business Books, 2001) is vintage Jack Welch. More than an autobiography or a history of General Electric, it’s a characteristically clear and memorable articulation of the philosophy and conclusions that made Welch one of the most successful corporate chief executives of the past 20 years. For Welch, “business strategy is less a function of grandiose predictions than it is a result of being able to respond rapidly to real changes as they occur. That’s why strategy has to be dynamic and anticipatory.” As he did in his first presentation to Wall Street analysts, Welch approvingly cites the approach of the Prussian general staff, which “set only the broadest of objectives and emphasized seizing opportunities as they arose.”

“Strategy,” Welch writes, “was not a lengthy action plan. It was the execution of a single idea through continually changing circumstances.”

The first “single idea” that Welch selected and championed, and which the GE business units had to apply and execute, was the requirement that each unit be No. 1 or No. 2 in its market. Subsequently, Welch backed a series of initiatives that aimed, as he writes, to “grab everyone.” These had to be “large enough, broad enough, and generic enough” that they could change “the fundamental nature of our organization.”

In Straight from the Gut, Welch makes clear that, in turning GE into one of the most respected and highly valued conglomerates of the modern era, he didn’t rely on improvisation by gifted amateurs. The Crotonville management development center provided world-class training to thousands of managers — the modern business equivalent of the training Ludendorff and Hoffmann received as they rose through the ranks of the Prussian military. Differentiating people’s performance and rigorously cutting the bottom 10 percent each year ensured that GE had the deepest bench of managers in the world.

Because much of the Welch saga is so well known to business executives, it’s fair to ask what use a strategist can make of Straight from the Gut. Very few companies, we hypothesize, can adopt GE’s evolutionary strategy approach. As Welch’s memoir makes clear, that methodology requires an extremely strong management team, world-class management development, and a succession of ideas that supercharge performance. The poor track records many ex-GE executives have registered as CEOs of other companies supports our hypothesis; even extraordinary managers have trouble adapting techniques that work in talent-rich organizations to more typical companies. The current poster child for corporate excess and failure, Enron, exemplifies the dangers of a bottom-up evolutionary strategy approach guided only by the financial results achieved, rather than the discipline of Welch’s “single idea” and his continual probing of each business unit. Many of Enron’s financial shenanigans were cover-ups for the failures of all the businesses it spawned.

However, almost any company can benefit from Welch’s four transformation initiatives, which have proven their efficacy across an extremely diverse portfolio of businesses in a company that was already an excellent performer. These are:

• Globalization.  During the 1980s, most GE businesses were U.S.-centric. Non-U.S. sales increased from $9 billion (19 percent of GE’s revenue) in 1987 to $53 billion (more than 40 percent of GE’s revenue) today. Although acquisitions and alliances were the vehicle for much of GE’s growth, Welch focused the businesses on deals in regions that were either in transition or out of favor, as Europe was in the early to mid-’90s. In addition to pursuing this contrarian investment strategy, GE committed some of its best people to global assignments — not as business-unit general managers, but in “looking for deals, building business contacts, and being a champion for” the region.

• Services. Services were an equally important element of GE’s growth. For example, in Medical Systems, service sales increased from 18 percent of a $600 million business in 1980 to 41 percent of a $7 billion business in 2000. Overall, Welch projects that services will grow into an $80 billion business for GE by 2010, 10 times the size it was in 1995. As with the globalization initiative, GE’s services success required the commitment of great people, alliances, and acquisitions. In addition, investment in technology for services enabled GE to sign long-term service agreements, deliver rapid payback to customers, increase customer intimacy, and increase service margins (e.g., tripling service margins in transportation).

• Six Sigma. Six Sigma — the quality management program pioneered by Motorola, and significantly improved by GE during Welch’s tenure — drove the increase in GE’s margins from 14.8 percent in 1996 to 18.9 percent in 2000. GE-style Six Sigma is much more than the Total Quality Management programs that many companies have launched. Like all major initiatives at GE, Six Sigma commanded GE’s best people (only Six Sigma “black belts” receive GE stock options) and was designed to have a measurable effect on earnings.

• E-business. Like Six Sigma, GE’s digitization initiative focused initially on cost reduction, on “taking out the low-value-added work in the guts of the company.” At first, digitization saved 5 to 10 percent on the $50 billion of goods and services GE purchases annually, and another $1 billion in its backroom operations, while increasing service levels to customers (online sales were $15 billion in 2001). Welch expects that eliminating “touch points” — the steps in a process when paper has to be handled by an employee — will reduce overhead costs by a total of 30 percent ($10 billion).

Gaining the benefits of these initiatives requires both a GE-like commitment to bringing improvements to the bottom line and a Welch-like championing of only one or two initiatives at a time in every internal forum for several years. That’s a formidable leadership challenge. But as GE has shown, it can be done.

Starting Point for Strategists
While Welch provides initiatives you can use, in The Art of Profitability (Warner Books, 2002), consultant Adrian Slywotzky offers 23 profit templates that can provide the skeleton for a business strategy — just as the battle of Cannae provided the skeleton that Hoffmann and Ludendorff fleshed out into the strategy for Tannenberg.

Strategists will recognize Slywotzky’s profit patterns — familiar concepts, new and old, including solutions, de facto standards, blockbusters, life cycle, relative market share, installed base profits, and even the experience curve. But familiarity doesn’t detract from The Art of Profitability’s value. Abstracted from the successful experience of many companies, the profit templates not only facilitate thinking “outside the box,” but also ground strategy in fundamental economics that have proven to yield superior profitability in other industries. Although 23 patterns don’t exhaust the universe of all possible strategies, they’re sufficiently comprehensive that they provide a useful checklist at the start of strategy formulation. One of our clients begins its strategy process by evaluating which three or four of the profit patterns might work in a business unit, fleshes out each of these patterns into a strategy, and then chooses among them.

We also liked the style and structure of The Art of Profitability. Slywotzky has adopted a novelistic approach to describing the development and application of corporate strategy. Telling an even simpler story than Eliyahu Goldratt’s The Goal: A Process of Ongoing Improvement (North River Press, 1992), he eavesdrops on the conversation between a strategy guru and a midlevel manager, drawing us into a dialogue about how companies make money. The format is surprisingly effective: People embrace stories, and economic logic communicated through dialogue is more engaging than the traditional didactic approach. The technique also enables Slywotzky to sidestep one of the perennial problems faced by consultant authors — how to cite examples of less successful companies without angering past or prospective clients — by using fictionalized stories of companies.

The Art of Profitability is weakest in helping managers move beyond the profit-pattern skeleton to flesh out real strategies. It’s not that the issue is ignored; the guru and the manager discuss the challenge of creating and implementing strategies several times. However, in contrast to the deep insights about profit skeletons, neither character understands mobilization of organizations around real strategies. As the guru concludes, “It’s a bit of a mystery.”

Mystery or not, strategy development receives an unusual and successful rendering in this book. Although the profit templates first appeared in 1999 in Profit Patterns (Times Business/Random House), written by Slywotzky, David J. Morrison, et al., Art has replaced Patterns on our bookshelf.

Both Welch and Slywotzky assert that digitization offers exciting opportunities, but John Hagel III, in Out of the Box: Strategies for Achieving Profits Today and Growth Tomorrow through Web Services (Harvard Business School Press, 2002), provides a much better — and more actionable — definition of its opportunities and challenges. Recent academic studies confirm what every manager knows from experience: Although information technology is an essential enabler of major changes in strategy, it slows implementation, requires major investment, and often forces compromises in execution. Hagel, former chief strategy officer of 12 Entrepreneuring Inc., believes that Web service technologies and distributed service architectures — such as the standards-based utilities that permit simple, flexible connections of heterogeneous platforms and businesses — will enable us to break out of the “box” of inflexible infrastructure and software.

Dell illustrates the power of the Web services approach. The company relies on third-party logistics companies (called “vendor-managed hubs”) to order and maintain inventory from its vast array of component suppliers. Each component supplier, vendor-managed hub, and assembly plant has its own set of legacy systems. To reduce inventory at its assembly plants, Dell shifted from a weekly demand forecast sent to its vendors to a new manufacturing schedule every two hours, published as a Web service on Dell’s extranet. The vendor-managed hubs automatically respond to the updated schedule — picking, packing, shipping, and delivering the required parts to the designated building within 90 minutes — reducing Dell’s inventory at the plants from 26 to 30 hours of production to three to five hours, while also freeing space at the plants for additional production lines. Dell is now deploying a Web service application to reduce inventory at the vendor-managed hubs: an extranet-based event-management system that automatically generates inquiries and confirmations of shipments from vendors to the hubs.

Web services offer the functionality of electronic data interchange (EDI) systems, with much lower investment. Rather than requiring a direct linkage to a vendor’s databases and applications (which compromises data confidentiality and requires costly custom programming), standards-based Web services provide a platform-independent linkage between Dell and its vendors. Because Web services leverage existing technology investments, incremental costs are low, supply chain partners have a greatly enhanced payback from participating, and additional functionality can be deployed incrementally.

Opportunities on the Edge
Despite the technical complexity, Out of the Box is an easy read for anyone with even basic familiarity with information technology. Most remarkable is Hagel’s ability to focus on the strategic forest and not get lost in the technology trees. He sees four major strategic opportunities created by Web services technology:

• Cost Reduction.  Web services offer all companies a low-cost, low-investment way to realize the digitization opportunity that Jack Welch describes. Whereas Welch sees the principal opportunities in the guts of the company, Hagel believes the opportunities are greatest at the boundaries of the enterprise, where the ability to link multiple hardware and software platforms is most powerful. Managers will welcome occasions to capture rapid reductions in costs as well as assets that can be pursued incrementally.

• Process Networks.  Collaboration creates economic value by enhancing the effectiveness of a key process across the supply chain, not just at a single stage in the chain, as business-to-business exchanges do. Hagel hypothesizes that process networks will be formed around three core processes: supply chain management, customer relationship management, and product innovation. At the center of each process network will be an “orchestrator” such as Cisco or Nike, which will define requirements to participate in the network, recruit participants, define standards for communication and coordination, and assume ultimate responsibility for the output of the business process. Although most orchestrators focus on selling their own products and services, some existing ones — like Li & Fung Ltd., the Hong Kong–based garment industry supply chain manager — focus entirely on linking large customers (apparel designers, in this case) to suppliers.

• Selling Web Services.  If Web services grow as fast and become as ubiquitous as Hagel expects, then selling such services is an exciting business opportunity. Although software providers and IT consultants are the obvious candidates, any innovator could choose to pursue the opportunity. For example, Citibank offered its payment-processing engine, CitiConnect, as a Web service.

• New Growth Avenues.  Hagel hypothesizes that Web services will accelerate the trend toward companies’ focusing on just one among three types of processes: customer relationships, infrastructure management, or innovation. Then, he believes, companies will grow through “rebundling,” in which economies of scope will drive customer relationship businesses to offer an increasingly broad variety of products and services, while economies of scale cause consolidation among infrastructure providers.

The wild exaggerations and failures of New Economy prophets have made all of us skeptical of predictions that a technology will transform business. For the most part, Hagel avoids dangerous overgeneralizations and extrapolations. However, we’re skeptical of the claim that Web services will result in an unbundling and rebundling of the value chain in the way that he hypothesizes. Outside the computer industry value chain, there’s little evidence either of the underlying economic advantage of rebundling or of examples of companies successfully pursuing the strategy.

Still, that leaves three useful strategies that we agree are enabled by Web services: Offer exciting cost reduction opportunities for all companies, stimulate the development of process networks that reshape opportunities for most companies, and provide profitable opportunities to sell services for a few companies. If Web services truly enable companies to break the constraints imposed by their technology infrastructure, most of Adrian Slywotzky’s mysterious gap between profit template and strategic reality may disappear.

A Practical Tool Kit
After Welch, Slywotzky, and Hagel help you create alternative strategies, use Martha Amram’s Value Sweep: Mapping Corporate Growth Opportunities (Harvard Business School Press, 2002) to shape and select the best strategy. Value Sweep aims to provide “a practical, rigorous, and transparent valuation method for growth opportunities.” Even though — possibly because — Net Present Value (NPV) analysis is widely used and computationally easy, most companies grossly misapply NPV and misestimate the relative attractiveness of alternative strategies. Amram offers sound, realistic valuation methodologies that demonstrate the need to overcome the inertia of yesterday’s strategy and allow companies to assess their growth opportunities on an apples-to-apples basis. We appreciated Value Sweep for four reasons. First, Amram provides tools you can use. Although most valuation books offer frameworks, examples, and “dos” and “don’ts,” real-world problems always seem more difficult than the books’. Amram, the president of Glaze Creek Partners, a consulting firm in Palo Alto, Calif., goes further than others, equipping the reader with templates, tables, and (on her Web site, www.valuesweep.com) downloadable spreadsheets. And she explicitly addresses many of the most difficult valuation situations, such as intellectual property and new ventures.

Second, the Value Sweep “mark to market” approach produces valuations consistent with those of the public markets. Of course, “consistent” doesn’t mean identical to the stock market’s valuation of an individual company; market valuation isn’t always correct, and the analyst often has inside information that’s not yet impounded in the stock price. In Amram’s approach, “consistent” means that a variety of market-based measures — for example, interest rates, risk premiums, volatility, futures prices of key commodities, and typical industry valuations — discipline the valuations and help ground them in reality. As the markets change, so will the Value Sweep valuations.

Some analysts don’t like this dependence on the public markets. They believe that they can do better by analyzing the fundamentals. The crazy public market valuations during the dot-com stock market bubble reinforce their point. However, we believe that everyone, including the analysts most committed to fundamental valuations, will find the Value Sweep methodology helpful. Right or wrong, public markets are the place that investments are predominantly valued and traded, and they are becoming ever more ubiquitous. The market’s valuations are real, and have real consequences; however excessive AOL’s January 2001 valuation proved to be, the company still managed to purchase Time Warner.

Moreover, in our experience, it’s always helpful to know how the public market would value an investment if it had the information available to the analyst, whether or not that valuation is considered “correct.” If the public market’s valuation is significantly higher, it might be better to sell the investment (and in today’s markets, in which singer David Bowie can issue bonds on his future license revenue, virtually any investment can be sold!). The strategic implications are significant; public market valuations show how an investment will affect a company’s stock price, or the stock price of its competitors if they make a similar investment.

The third benefit of Value Sweep is that it highlights the proactive questioning that an analyst should do to probe the reality of a valuation, to test the critical risks, and to restructure the sequence of investments to increase value. Too often valuation is viewed as a calculation. In her examples, Amram scrutinizes the questions that equity investors and good CFOs ask. The Value Sweep templates include qualitative evaluation; in a section called “The Story,” the author challenges the analyst to write two sentences — one with the key argument in favor of the investment and the other with the key argument against.

Finally, Amram provides consistent, but differentiated, valuation. One of the principal challenges in valuation is that different investments require different methodologies. Traditional discounted cash flow works fine if there is a single decision point and fairly predictable cash flows. But a lease for an offshore oil field or for 3G spectrum requires options-based valuation, because of the series of decisions and the significant market price uncertainty involved; venture capitalists use yet a different valuation method. One problem with most valuation books is that they try to use a single valuation method for these very different investments. Amram honors the differences by offering several methods and provides a simple logic to decide which method to use, yet ensures that all the methods use a common philosophy so that a firm’s full sweep of opportunities can be valued consistently. For valuation, Value Sweep is the book to use.

Will these four books equip you to strategize a Battle of Tannenberg? Probably not on their own. But with their combination of stories, tools, and frameworks, they will equip the modern strategist to build a profitable enterprise — even without the help of the Prussian army.  

Reprint No. 02407


Authors
Chuck Lucier, chuck@chucklucier.com
Chuck Lucier is senior vice president emeritus of Booz Allen Hamilton. He is currently writing a book and consulting on strategy and knowledge issues with selected clients. For Mr. Lucier’s latest publications, see www.chucklucier.com.

Jan Dyer, janet.dyer@ptsem.edu
Jan Dyer spent the last 11 years at Booz Allen Hamilton, where she served as the firm’s director of intellectual capital and worked with corporations in a variety of industries. She specializes in the strategic application of knowledge and learning.
 
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