Silencing The Critics: 10 Years Of Apple Retail Success

The last thing we need is another sermon on Apple’s success.  It is the most valuable brand in the world according to WPP’s BrandZ ranking, climbed 21 spots to #35 on the Fortune 500, and has now usurped Microsoft on every conceivable metric of financial performance.  But on the 10-year anniversary of the opening of Apple’s first two stores in Tysons Corner, Virginia and Glendale, California, I thought it would be worthwhile to explore the often-overlooked role of Apple’s pioneering retail experience in the brand’s resurgence and sustained momentum.

Legend has it that at the turn of the century, Steve Jobs hired McKinsey & Company – knowing full well they’d tell him retail stores were a terrible idea – just so he could prove them wrong.  Whether or not it was intentional, he did.  Apple now operates 324 stores in 11 countries, and in the 2010 holiday quarter alone, retail stores brought in 75 million visitors, nearly $4 billion in sales, and a $1 billion retail margin.  Apple’s stores consistently account for 15-20% of the company’s total revenue, in effect writing the business case for their own existence.

Yet as marketers we know that more often than not, it is a great brand that lies at the core of a thriving business, and so it is also important to understand Apple’s stores from a brand-building perspective.

The stores are closed-off physical spaces over which the brand has complete control – every Apple product is carefully displayed in an environment that reflects the simple, intuitive elegance of everything Apple does but on a massive scale.  Less a ‘touchpoint,’ the stores represent a kind of full-body acupuncture.  The consistency of the Apple experience – from the packaging to the devices to the giant glass cube on Fifth Avenue – makes the brand simultaneously familiar and unattainable, and explains its unique magnetism.

Yet for all of its pre-planned precision, it is the dynamic, unpredictable elements of the Apple retail experience that ultimately lure us in.  People are free to touch, hold, and use every product in the store, even if it’s to Google the nearest BlackBerry vendor.  This seemingly minor act of self-assuredness, and the altruism that comes with it, compels people to engage with Apple’s products and transmits a cool, positive vibe that carries over to everything else the brand does.

And then there is, of course, the human element – the tireless geniuses at their bar, the bubbly, all-knowing store representatives, and the special events and training sessions that manage to use the brand as a means to a greater end: the fostering of social connections.  The store thus becomes a place we go not to buy, but to discover, learn, play, interact, and, in the spirit of Apple’s brand ideal, to self-express.  The purchase is merely a byproduct, but with half of new Mac sales in retail locations going to Windows switchers, it is a profitable byproduct indeed.

As Apple celebrates today, what are other brands to do?  A quick look at the BrandZ ranking indicates that many brands are already on the right track, with nearly half of them operating dedicated physical retail spaces.  The challenge for the rest – the beer, soft drink, and personal care brands of the world – is figuring out how to build the ‘human element’ when you’re one of hundreds of brands on someone else’s shelf.  Procter & Gamble has found this human element in Mr. Clean carwashes and Tide Dry Cleaners, while Coca Cola has opened several successful pop-up stores around the world.  In time, we may find ourselves spending happy hour in a Budweiser bar or asking for a shave at a Gillette barbershop.

What is ultimately remarkable about Apple’s retail revolution is its astonishing success in a world transfixed by hits, tweets, and ‘likes.’  It shouldn’t be, though. Humans have survived for millennia thanks to our ability to see, touch, hear, manipulate, and interact with our environments and each other.  For brands in a crowded, competitive marketplace, the story of survival should not be much different.

Contributed to BSI by: Eric Tsytsylin, Millward Brown Optimor

What we can all learn from Apple’s retail success - Nigel Hollis Milward Brown

On Monday, I commented on Eric Tsytsylin’s post published on Branding Strategy Insider, on the power of the retail experience in a world transfixed by "hits," "tweets," and "likes."

As I was writing my post, another idea occurred to me. Maybe there is something else that we can learn fromApple’s retail success.

In the past, I have commented on the difference between Apple and Google in terms of their very different models. Google, the archetypal Internet brand with free services and open systems, and premium-priced Apple, which eschews the open model in favor of what Steve Jobs refers to as an “integrated” model.

The Apple products all exist within an Apple ecosystem that is very much under the company’s control. Sure, app developers have access to the code necessary for development, but what is accepted into the App Store is strongly controlled.

Eric’s post reminded me of this when, referencing Apple’s stores, he states:

The stores are closed-off physical spaces over which the brand has complete control – every Apple product is carefully displayed in an environment that reflects the simple, intuitive elegance of everything Apple does.

He goes on to say:

Yet for all of its pre-planned precision, is it the dynamic, unpredictable elements of the Apple retail experience that ultimately lures us in. People are free to touch, hold, and use every product in the store.

And then there is, of course, the human element – the tireless geniuses at their bar, the bubbly, all-knowing store representatives.

Readers will know that this model is precisely the model that I believe brands need to bring to social media. Control what your brand stands for, but be prepared to interact with your fans in an engaging and human manner.

Apple’s “controlling” business and brand model has helped to grow its company value over 800 percent in the last six years. Maybe there is a lesson for all of us in there. Know what it is your brand stands for, and make sure that it is reflected in everything it does.

Am I wrong?

Finding 'A Novel Match Between a Solution and a Need'

Soaking up oil spills with human hair, turning clunkers into hybrids and powering Tanzanian villages with rechargeable batteries are just a few of the ideas to come out of Knowledge@Wharton's second annual Innovation Tournament.

Sponsored jointly by K@W and Wipro Technologies, a global IT services company, the tournament challenged innovators from around the world to compete for a total of $40,000 in cash prizes. The tournament inspired more than 160 submissions from six continents. The 44 teams that made it to the semifinals were asked to submit video presentations. From those, the top 14 entrants were invited to Philadelphia on April 27 to present their ideas to a panel of judges made up of academics and industry leaders.

"I can't imagine a more diverse set of opportunities," Karl Ulrich, Wharton's vice dean of innovation and one of the judges, told the finalists at the end of the day's presentations. "We had [entries about] world peace and customer data and carbon credits.... It was incredibly diverse." (Listen to podcast interviews with the victors in each category as well as the grand prize winner here.)

The competition was inspired by the book, Innovation Tournaments: Creating and Selecting Exceptional Opportunities, co-authored by Ulrich and Wharton operations and information management professor Christian Terwiesch.Similar to contests likeAmerican Idol, innovation tournaments create a framework that can help identify the best ideas by whittling down a large pool of diverse notions through several rounds of vetting, the authors say.

"It's a departure from the previous world view ... that innovation is a random outcome, that sparks illuminate and something just happens," said Terwiesch.

Judges evaluated the entries based on the definition of innovation as "a novel match between a solution and a need that creates value," according to Terwiesch, who also served as a judge. Teams could submit innovations related either to sustainability or customer-centricity, categories that were further divided into "new" or "implemented" ideas. All four elements of the definition --- need, solution, novelty and value -- needed to be strong for a team to win.

Solutions didn't necessarily have to be high tech, and the value of the innovation didn't have to be monetary, Terwiesch pointed out. For example, in the sustainability category, the "Hair Twister" team from India proposed a mat filled with human hair to clean up oil spills. Unlike some chemical spill mats, hair mats would trap the oil without destroying it, the team said. The oil could then be harvested and the mat re-used again and again. The mats could also be used in farming to reduce the need for chemical fertilizers, since the hair was a natural product. Best of all, the product would cost very little in India because barbershops and temples (which sometimes collect human hair as offerings) would donate the hair for free.

Instead of coming up with a new technology, "the novelty was the match between the solution and the need," Terwiesch said. "It was so novel and yet so simple."

A team from the Eastern Caribbean proposed an unusual way for Haiti to rebuild its economy without foreign aid or charitable donations -- an innovation with social as well as economic value. Noting that 80% of Haitians are unemployed and that many of the problems plaguing the island nation demand solutions that are labor-intensive, the "Funding for Haiti" group proposed a mandatory national service program that would require every household to work four hours per week on projects such as planting trees, building roads or clearing earthquake rubble. Work projects would be administered by the government or approved charities, which would pay workers with community service receipts that could be freely earned, traded, bought or sold.

"The goal of the program would be to give anyone who wants a job a job," noted presenter Russell Huntley. By mandating that every household submit receipts and levying fines on those who did not comply, the government would indirectly create a secondary market for work receipts. People employed in the private sector could legally meet their obligations by purchasing others' receipts, pumping new money into the economy. Haiti's 3.8 million unemployed could work to earn as many receipts as they wanted, and the economy would slowly grow as receipts were traded and projects reached completion.

"I was intrigued by the idea for stimulating economic activity in Haiti by deploying the large number of unemployed Haitian workers," Ulrich said. "The key insight was quite interesting -- that many of Haiti's challenges could be addressed by the application of labor and that there was a lot of idle labor."

In the end, five prizes were awarded: $5,000 to the winners in each of the four categories, and $20,000 as a grand prize. The winners:

Best new customer-centric innovation: L3, for a new video encryption technology.

The need: Today, nearly anyone can make a video and post it on the Internet, but making money from those videos remains difficult. Piracy plagues the $1 trillion video industry. Producers, especially smaller ones, have little means to protect their work and struggle to profit from it.

The solution: The L3 technology allows a video producer to not only encrypt a video, but also include instructions about how it can be viewed and how much it will cost. For example, the producer could charge a single price per view, allow unlimited views within a certain number of days or insert advertisements into the content. Content owners can even modify price by location. To unlock the video and watch it, a customer would either have to pay a fee or watch the video with ads. &quoOur innovation will allow anyone to publish, distribute and monetize their video from anyone to anyone, from anywhere to anywhere, and most importantly, on any medium" according to Anil Gupte, who has patented the process and plans to market it through his company, K.E.E.N. &quoAll you have to do is download a piece of software in which you encrypt and package the content."

Once encrypted, the video can be transferred to any medium without losing its protection. The encryption process is unique because the content protection scheme keeps changing, making it difficult to hack, Gupte said. Fees from videos go directly back to the content producer, minus a small transaction fee to L3. "We've solved the major problems of the content owners and created major opportunities for them," Gupte added. " Bottom line: We help content owners make more money in less time and thereby create a bigger market."

Best new sustainability innovation: Welectricity, a social networking site that encourages energy savings.

The need: Household electricity use is a major source of carbon emissions around the world, and most consumers waste a lot of energy. But even though many households could save money by being more energy efficient, utilities often struggle to motivate their customers to scale back. Even well informed customers may not realize how much energy they are wasting because they don't know what the benchmark should be.

The solution: Bring electricity consumers together on a social networking site that helps them track and compare energy use with friends and neighbors. "Consumers need motivation, not information," said Herbert Samuel, founder of Welectricity, based in St. Vincent and the Grenadines. Scientists have found four factors that, when combined, provide motivation for behavioral change: feedback, information, goal setting and social proof, or the ability to compare oneself to others. "Welectricity packages these four motivating nudges into a free easy-to-use social network that people all over the world are already using to track, compare and reduce their energy consumption," Samuel noted.

Users log onto the site or connect from their Facebook accounts, enter basic information about location, house size, appliances and utility bills, and then connect to other people in the area. Users can see how their energy consumption compares to others, and have a forum to discuss the best ways to cut their bills. Ultimately, Samuel hopes to bring utility companies on board to make the process more automatic, and eventually plans to migrate to mobile devices. "The more people use it, the more powerful it becomes," he said.

Best implemented customer-centric innovation: WiseWindow, for a data service that collects, sorts and displays customized business intelligence in real time.

The need: Companies need quick insights into what customers think and want, but data from traditional market research, surveys and focus groups often comes weeks or months too late. More timely information is often anecdotal and scattered, and cannot be used to make decisions.

The solution: Irvine, Calif.-based WiseWindow has created a data service that culls information from online public comments, sorts it into categories, analyzes the sentiment behind it and delivers it to a company in real time. The product, Mass Opinion Business Intelligence (MOBI), begins with industry-specific sites and moves outward, scanning online articles, conversations, blogs, tweets and other online comments to "learn" what the product is, what type of vocabulary is used to describe it and how people are feeling about it. Then the program sorts the data into categories and relevant topics that a business can use to make decisions. "It turns natural language in conversations on the web into topical dimensions and sentiments," said Alex Costakis, WiseWindow's vice president of business development. "The initial seed process may have 12 sites but as the system learns, it [visits] other sites ... so the data set literally grows by tens of thousands per week."

The data is customized based on a client's industry and product. For example, a client from the auto industry might ask the computer to identify information related to a specific car's brakes, transmission, color or interior comfort. Clients can view the data in a number of ways -- through heat charts, graphs, reports, even a real-time ticker tape -- and may use the information to predict customer behavior, adjust manufacturing schedules or even design new products. Companies will likely still employ opinion surveys and traditional market research, Costakis added, but MOBI gives them a tool to see what is happening minute-to-minute. "Because you have this real-time data, you can react much more quickly."

Best implemented sustainability innovation: Revolo, from KPIT Cummins, for a process that converts old automobiles into hybrids.

The need: About 8% of the world's carbon emissions come from automobiles. While a number of hybrid products are on the horizon, they do nothing to curb emissions from existing vehicles on the road. In countries like India, most vehicles are 15 to 20 years old, and owners cannot afford to replace them.

The solution: Revolo, a parallel plug-in hybrid solution that converts old gas guzzlers into quasi-hybrid vehicles. A technological innovation by Bangalore-based IT firm KPIT Cummins, Revolo is a technology that retrofits older cars by adding an electric engine and rechargeable battery pack, cutting emissions and boosting performance. Revolo can be used on cars with standard batteries and simple motors and does not interfere with the existing engine, according to Rajeev Kulkarni, KPIT's associate vice president. "It takes from four to six hours to retrofit the car. The beauty of this is that [the vehicle] doesn't have to be electronic." That's good news for countries like India, where cars from the 1970s are still on the road. Revolo comes in a kit that costs about $2,000 in India, far cheaper than a new car. The patented technology can reduce emissions from a vehicle by 30%, improve its fuel efficiency by 35% and reduce the cost of travel by 25%, thus paying for itself in two to three years.

As a judge, Terwiesch said he was highly impressed with the Revolo innovation because it addressed the need to improve emissions of cars already on the road. "Everybody is talking about hybrid vehicles that will be launched in the future, but what do we do with all these carsnow?"

The GRAND PRIZE: EGG-energy, for their battery-swapping service in Tanzania.

The need: About 500 million people in Africa live without access to electricity. In Tanzania, 90% of the population has no electricity even though 80% live within three miles of the grid. High grid connection fees and lack of infrastructure funding makes access difficult. So to power lights and charge small devices like cell phones, most low-income households in Tanzania rely on kerosene, AA batteries or even car batteries -- methods that can be expensive, dangerous and bad for the environment.

The solution: EGG-energy solves Tanzania's electricity shortage by offering clean, rechargeable batteries that households can rent for an annual subscription fee. The 12-volt batteries, about the size of a brick, are enough to power the typical Tanzanian household for about a week. EGG, which stands for Engineering Global Growth, customizes the electrical system for each customer so the batteries can easily be plugged in and removed without hazard. "We install our customers' home electrical system, we charge the batteries, we swap batteries and we distribute batteries to swapping stations for more distant customers," said Rhonda Jordan, the company's U.S. representative. "We're like the Netflix of batteries."

The company also offers complementary appliances such as LED light bulbs, cell phone chargers and radio adapters. Over time, customers save up to 53% in energy costs. So far, the small for-profit company has brought electricity to 2,000 people with a single charging station and eight employees. The goal by 2015: 9,000 customers and $7.2 million in revenues, with sights set on other African markets.

Additional Reading

How Can You Find the Most Promising New Opportunities? Hold an Innovation Tournament

Wharton's 2011 Business Plan Competition: Babies, High Fashion and Fundraising

The Envelope, Please: From Eight Great Innovative Tools, Which Ones Are the Winners?

How Sustainable Is Groupon's Business Model?

What customer wouldn't want to score a deep discount on dinner, beauty treatments and other services, especially during a downturn? Barely three years old as an industry, online group buying sites are witnessing rapid growth, as more subscribers sign up, more partner businesses sign on, revenues climb and venture capitalists swarm to invest, further driving up business valuations as a result. 

The most prominent group buying site, Chicago-based Groupon, has 2011 revenues estimated at between $3 billion and $4 billion. Google last December offered to buy the firm for $6.4 billion. After the acquisition was unsuccessful, the search giant launched its own venture, Google Offers. Facebook, too, is entering the space, joining the roughly 500 group buying sites that have emerged worldwide.

But much of that "wild exuberance" is miscalculated and could bring ruin to investors, warns Wharton marketing professor David Reibstein in an interview with Knowledge@Wharton. Taking Groupon as a case in point, he says the industry's current growth rates are unsustainable. Also, he faults the site's business model, arguing that it will leave customers, suppliers and investors disenchanted.

An edited transcript of the conversation appears below:

Knowledge@Wharton: Online group buying sites are a growing industry. Competition is fierce. More than 500 group buying sites have sprung up even though the industry is in its infancy. What is driving all this action?

David Reibstein: Part of it is because the Internet has provided a lot of power to the customer. Group buying has provided the ability to pool customers together to give them much more collective bargaining power. There's been a long history of customers trying to pool resources so they can buy more. Often there would be resellers who pool together and form cooperatives or even franchises that would collect individuals, but now consumers are pooling their buying interests together. And so, it is turning a lot of power over to the customer. That's great.

Knowledge@Wharton: What are the strengths of this industry?

Reibstein: It continues to offer some value to customers in terms of pooling them together and providing them some strength. It has often been the case that businesses have been able to buy from suppliers and get quantity discounts. This is now allowing consumers to buy in groups and afford ... quantity discounts. That is fantastic. There's no reason why this notion of customers pooling interests to be able to do group buying should go away.

There is an advantage to the merchants as well. The advantage is, rather than sell one by one and customer to customer and doing the marketing effort one by one, it is really allowing businesses to be able to sell a significant amount of volume with more of it being channeled through one customer.

Knowledge@Wharton: What exactly do venture capital investors find attractive about this space?

Reibstein: Unlike the customer, the investors are attracted by the huge growth and the valuations that are going on in this industry. I firmly believe there's going to be a lot of money lost in some of these investments. What is it investors invest in? They invest in growth. They say, "Wow, this industry went from close to nothing [to] 500 suppliers." If you look at the total dollar volumes that are being passed through here, it looks like a tremendous amount -- and it is. But the question is will it continue to grow and particularly, will it continue to grow at the rate at which the number of suppliers is growing? The growth rate for [each] supplier will be negated by the number of suppliers. But investors are clearly attracted by the growth rate and the valuations.

Knowledge@Wharton: The biggest of these companies, Groupon, is estimated to post revenues exceeding $3 billion in 2011. What is it about Groupon's business model that is driving such growth?

Reibstein: The way this works is they go to merchants [and] say, "I am willing to sell some of your inventory and I am going to take a cut out of [the profit]. But you're going to have to give me a deep discount. If you don't give me a deep discount, we're not going to make it available to people." To some degree, they are operating just like a retailer. I am going to buy volume, I'm going to break that down and sell it to individual customers. And I'm going to sell it to those individual customers for more than what it cost me. That's exactly how every retailer operates. The difference is they are not buying any of the inventories. They are just a reseller.

Knowledge@Wharton: Why do you believe that business model will not support the current growth rates?

Reibstein: Let me talk about some of the fundamental weaknesses. Obviously, one is, however brilliant of an idea it is, there is also now a huge increase in competition. When Groupon had few competitors, it was more viable than it is now with 499 competitors.

But that is not the big weakness. The Groupon business model works better during a recession than it does during a vibrant economy. I will explain why, and this is where it gets intriguing. The reason some retailers might be willing to provide supply to Groupon is because they have excess inventory. That is particularly the case for services. One of the services I notice frequently [offered on group buying sites] is that of beauty salons. They have so many seats and so many beauticians. If I don't sell that 3 p.m. to 4 p.m. time slot on Thursday afternoon, I cannot carry that time slot in the inventory tomorrow. It perishes. It perishes in the same sense as an [unsold] airplane seat [once] a plane takes off down the runway. Because of the recession, there has been an abundance of people who are forgoing beauty salons and other sorts of luxury, discretionary services. Rather than let that airplane seat go [unfilled] and the beautician hour go with no revenue, [companies] would [rather] sell it for a little above whatever the incremental costs are. So there is a willingness to do deep discounting.

As the economy picks up and there is less excess inventory, the availability of supply will go down. The willingness of the merchant to offer deep discounts will go down. The business proposition to the customer will be less attractive if [the item or service being offered] doesn't have the same deep discount.

Knowledge@Wharton: A big chunk of Groupon's subscriber base is said to be made up of educated young women, and that is one reason why Groupon features many beauty and wellness offerings. How crucial is the makeup of the subscriber base for the success of the business model?

Reibstein: If you look at the nature of the customers who are buying from Groupon, they tend to be younger, more white-collar, they may be better educated and may be a similar profile to those who shop at [warehouse club chain] Costco. And so, they tend to be relatively savvy shoppers. Many of the merchants offer these deep discounts, not with the hope of perpetually offering them, but given that they have excess inventory right now, it would be nice to let people sample their product or service with the hope that they are going to like it and subsequently will come me back and buy it when it is not being offered on Groupon [and] is at its full retail price.

Unfortunately, the people Groupon is attracting are those who are referred to as "deal prone customers" -- who are, to put it differently, price-sensitive customers. These customers tend not to be the most loyal of customers. And because you have attracted them with a low price, you are more likely to lose them because somebody else offers a lower price. The merchant might say, "Well I am not making money on these customers, but hopefully I am building some future business." But there is the challenge of whether they are really building future business, because what they really getting is a fickle customer. Merchants are going to discover that the Groupon customer is not where you build your future business. Therefore, the savvy merchants are going to learn that this is not a good way for them to do business.

Knowledge@Wharton: How could this industry change customer expectations? What would that mean for retailers?

Reibstein: There is a real concern that [the model] takes regular customers and makes them more deal sensitive. Imagine the risk for a spa that has a set of customers who are willing to pay $120 each [for services]. Those customers either see or learn of a Groupon offering. It's one thing when [a Groupon deal attracts] an incremental customer who is paying $60 for what normally would have been $120, and [the business is] getting $60 it was not going to get [otherwise]. But it is disastrous when you take customers who were going to pay $120 and now you only get $60 from them.

You want [to attract] those customers who were not at all part of your existing customer base.... What would be really bad is if you make your Groupon offering frequently enough that the customer just sits around and waits, [thinking,] "Rather than getting my normal salon service, I am going to wait until they offer that 50% to 80% discount." [In that case,] the entire normal margin that the salon owner was going to make is totally gone.

Knowledge@Wharton: There have been cases where retailers have been swamped by customers with Groupon coupons and unable to cope. Also, there may be offers where Groupon does not attract the minimum required number of customers to "unlock" an offering. What are the downsides there?

Reibstein: Indeed, there have been some merchants that have been overwhelmed with the volume, and the correct solution is for retailers to be able to put a cap or a ceiling [on the discount]. That may create a little bit of frustration among customers, but that doesn't really hurt Groupon [because] it gets people to respond even quicker and buy it now before the deal closes. I think it works to Groupon's advantage to have a ceiling.

As for the floor, if you don't get a minimum number of people buying an offer, that makes sense, too. This is, again, in the same spirit of retailers buying from manufacturers; generally there is a minimum order that is required, and [group buying] is very similar to that.

Knowledge@Wharton: Wouldn't a supplier or retailer's existing client base feel shortchanged when others with coupons pay less?

Reibstein: The very loyal customer who is paying full retail price will start to resent [those who are using the Groupon discount], particularly if you go to a restaurant [and you are] willing to pay the full retail price. If everybody else who is walking in with a Groupon coupon is paying less, you will feel like an idiot. So retailers start developing some of that resentment in their best customers.

Knowledge@Wharton: How would customers paying full price respond?

Reibstein: This piggybacks on what I mentioned earlier. You could anticipate consumers will start saying, "I see you offering it to [Groupon users] at $50 off, and I expect you to give it to me. If you don't, then I am going to be more irritated." That has not happened as yet that we know of.

But I am sure there have been customers who were normally going to pay full retail price who now aren't because they were able to get a Groupon deal. A savvy customer could say, "I am not going to buy anything at Groupon that I wasn't normally going to buy. I'll just go online and look to see what is on there. If I see something that was already on my shopping list and now I can buy it at a cheaper price, then it's great."

Knowledge@Wharton: You said this model works best in a recession economy. We've heard the same thing being said about Walmart. Shouldn't group buying work just as well, or better, when the economy is stronger and people have more disposable income?

Reibstein: It is the case that Walmart's market share grew during the recession. Walmart still works well, but it works better in a recession. There's no question that during the recession, consumers were looking for bargains. Previously, they were not as inclined to look for bargains.... If the economy were to recover, then just looking for the bargain becomes not as much of a selling point. Everybody's fear is when the recession ends, that they have trained customers to be looking for bargains.

Knowledge@Wharton: The group buying market globally is largely underserved. These firms could enter huge untapped markets. Wouldn't that help them continue to grow at the current rate or even better?

Reibstein: The answer is yes. They still have opportunities to grow by going into untapped markets. But then the question is going to be, how long will their growth continue, and what's going to happen in those markets as more and more competitors enter?

Knowledge@Wharton: Groupon's valuation was last put at $6 billion. Do you see any parallels between what is happening in this industry and the dot-com boom and bust of 10 years ago?

Reibstein: That $6 billion is what Google offered them [in December 2010]. I think Google was foolish to make that offer, and the only thing worse was for Groupon to turn it down. [Groupon later raised $950 million in fresh financing, giving it a valuation of $6.4 billion.] Groupon's value will not persist if it stays in its current model. There is this wild exuberance, because of the growth, that has gotten everybody euphoric. But the question is, will it persist? Obviously, I don't believe that it will.

I see a lot of parallels with the dot-com boom, and that includes the enthusiasm of growth and everybody running to the same spot. It's like a school of kids on a soccer field ... where they are all going to where the ball is. There are too many people in one spot, but that's where the energy is....

Knowledge@Wharton: What can Groupon and the other group buying sites do to fix the flaws in their business model?

Reibstein: There are lots of things that can be done to make the model even better. Groupon just announced one, which I think is big. There is Groupon Mobile, which is really cool. Groupon Mobile knows if you are near a merchant that is on Groupon, and it will message you that the pizza shop you are walking in front of is offering a 50% coupon....

The next enhancement that would make sense is to get down to individual information and be able to know that John likes pizzas and we're going to offer that to John. Or that John bought a new sweater and maybe a blue shirt would go with that sweater. If they start customizing offerings individually, it will be all the more powerful.

Knowledge@Wharton: Could the explosive growth of group buying become too big to handle for Groupon?

Reibstein: I am not at all worried about that. When you have growth, it is hard to manage it. But when you get the kind of valuations that you have seen [for Groupon], they can afford to find people to handle that growth volume. Everybody wishes they had that problem.

Additional Reading

Another Tech Bubble: Separating the Froth from the Facts

Power to the People or Just a Fad: Forecasting the Future of Group Buying Sites

Drawn by Discounts, Latin American Buyers Fuel the Boom of Group Buying Sites

Managing Telecommuters and Office Workers

A five-prong effort to increase the effectiveness of a blended staff.

Title: Managing a Blended Workforce: Telecommuters and Non-Telecommuters

Authors: Brenda A. Lautsch (Simon Fraser University) and Ellen Ernst Kossek (Michigan State University)

Publisher: Organizational Dynamics, vol. 40, no. 1

Date Published: January 2011

Telecommuting has become more common worldwide, and researchers have identified several benefits to working remotely: It boosts employee performance and satisfaction and reduces turnover and office costs.

One of the downsides, however, is the challenge faced by supervisors in handling a workforce that consists of both remote and on-site employees. Tensions can arise when employees don’t see one another or understand their colleagues’ workloads, and some who must work in the office will feel resentment toward those who can work from home. According to this study, which builds on the researchers’ previous work on telecommuting, the solution is to treat the two groups as similarly as possible.

The researchers conducted 45-minute interviews with 90 sets of managers and workers at two Fortune 500 firms. They also conducted a thorough review of telecommuting policies at other leading corporations. The researchers argue that organizations should strive to create a culture of inclusiveness, which means understanding five key factors that shape a firm’s stance on telecommuting.

The first element is gatekeeping, or deciding who gets to work outside the office and why. Some companies, like Cisco and Hewlett-Packard, parcel out telecommuting assignments on a case-by-case basis, the researchers report. A better approach, they maintain, is to make sure that both teleworkers and office employees have a say in establishing the gatekeeping rules, ensuring more transparency in the decision-making process. A telecommuting assignment shouldn’t be permanent, either, they say, but subject to periodic review.

The second factor is monitoring telecommuters to make sure they’re working — but the oversight should be handled in a manner that isn’t burdensome. The study showed that the most successful supervisors monitored the workflows of their telecommuters and non-telecommuters in the same way. At the Travelers Companies, for example, the output of all employees is reviewed, and each employee and supervisor together agree on goals.

The third factor, social integration, requires supervisors to have frequent contact with telecommuters to make sure they feel they are “in the loop.” The Viack Corporation issues a written guide on telecommuting, urging supervisors to establish a “virtual watercooler” for the work team through an intranet or shared e-mail folder. This approach has a practical payoff: When on-site workers can communicate directly with those off-site, they contribute more to one another’s projects.

The fourth element, managing the work–life boundary, is especially important because child care is a huge driver of telecommuting. Supervisors are advised to meet the issue head-on, providing their telecommuting employees with information and options on implementing different approaches and schedules. An IBM handbook advises telecommuters to teach their children that “the parent is at work when he or she is sitting at the desk or in the office,” and recommends establishing a separate office and phone line as physical barriers against intrusions. Otherwise, as one telecommuter noted, if there is a screaming baby or barking dog in the background, “people get uncomfortable and irritated... and will tend to favor calling your peers or others for similar information.”

Finally, it’s important to maintain work-group culture. When employees have limited face-to-face contact, the researchers found, they are less likely to help their co-workers, especially in last-minute or emergency situations. Sending frequent departmental progress reports can be a good way to get employees to think beyond their own projects.

Bottom Line:
Implementing an effective telecommuting policy requires supervisors to understand how their decisions will affect both in-office and remote employees. The most successful managers take a similar approach to monitoring the workflows of the two groups and create a feeling of equity between them. Supervisors are urged to stay in frequent contact with their telecommuting employees to make them feel they are “in the loop” and a part of the office culture.

Raising Organizational Performance - Lessons from a Chef

Eat Your Peas: A Recipe for Culture Change

The methods used by celebrity chef Jamie Oliver to promote health in a West Virginia city can also be used to raise organizational performance.

by Rutger von Post

Illustration by Lars Leetaru

When the well-known British chef and television reality show host Jamie Oliver arrived in Huntington, W.Va., in early 2009, he had a daunting goal in mind: to alter eating habits. Just a year before, Huntington had been dubbed the unhealthiest city in the United States by the U.S. Centers for Disease Control and Prevention. The community of 50,000 led the nation in rates of heart disease and diabetes. Half of its adults were considered obese. Oliver had chosen this small city for an initiative (and subsequent TV program) branded Jamie Oliver’s Food Revolution, with the idea of having a broader impact. If people could make themselves healthier here, they could do it anywhere.

In any community, food is closely tied to culture. And for any leader interested in change, watching Jamie Oliver’s Food Revolution can provide an inviting and immediate sense of how cultural patterns can be altered in the real world. Of course, Oliver is not an expert in organizations or management, but before bringing his show to Huntington he had already completed a series of campaigns to improve eating habits in the U.K.; he had been named a member of the Order of the British Empire for this in 2003. The expert chef, now 36, first gained fame in 1999 as a young cook known as “The Naked Chef.” He is known for his optimistic, boyish television persona; his ardent declarations that food should be healthy (fresh; prepared close to its raw state; and uncompromised by processed ingredients, sugary flavoring, trans fats, or other additives); and the cheerfully confrontational style of his programs.

As portrayed on Food Revolution, Oliver’s success depended not just on a plan or on expertise, but on his willingness to experiment, learn, and intuitively shift gears on the fly. He began his West Virginia campaign the way many leaders of change begin: with exhortations and slogans about the new behaviors needed to eat and live in a healthy manner. “I’ve been in South Africa, in the townships,” he told a group of school cafeteria cooks at one point, “and they’re getting better food than your American kids.” But he soon discovered that he could not force or persuade people to change their minds. Instead, he made it easier for them to change their habits first, while keeping their own views and values. He did this by starting on a very small scale, with a tiny vegetable: the pea.

Learn the Local Culture

Oliver came to Huntington with confidence that the rightness of his goals, along with his charisma and the town’s opportunity for TV exposure, would be enough to carry the day. Almost immediately, however, he ran into opposition. One of his first efforts to seek support, at the popular radio show of local disc jockey Rod Willis, turned out to be a disaster. Willis leveled Oliver’s plan with one withering line: “We don’t want to eat lettuce all day.” As shown on the reality show, the disc jockey reduced Oliver to tears, questioning his ability to effect change and his motives — intimating that the former Naked Chef was presumptuous and glory-seeking.

This initial public relations disaster was followed by Oliver’s first trip to Central City Elementary School, where he wanted to shift the students’ lunch plan toward healthier foods. Here, he was waylaid by the cafeteria’s tough-minded head cook, Alice Gue — referred to on the show as “a lean, mean, processed-food cooking machine.” Oliver had assumed at first that Gue would naturally share his attitude toward the food she had been serving. But she was more antagonistic, and prouder of her existing menu, than Oliver had expected.

This first stage of change was most important, it turned out, not for what Oliver taught the town — but for what the town taught him. He assumed a great deal about the town’s receptivity and its nature, underestimating the cumulative power of inertia and collective attitudes. Once he realized that the resistance came from a culture, rather than from individuals, he set out to learn about that culture instead of trying to defeat it outright. As he said at the end of the first episode, Huntington “is not a statistic. It’s a town. It’s a community. It’s a family.”

In subsequent episodes, Oliver moved more deeply into the town’s culture, developing relationships and conducting listening sessions. He eventually opened a storefront called Jamie’s Kitchen in downtown Huntington, where he offered nutrition advice and cooking lessons at no charge.

If you are a CEO or other senior leader seeking to change behavior throughout your organization, you may feel you are on more familiar ground than Jamie Oliver was. You presumably know your company well; you may have grown up in it yourself. Yet your very familiarity with the culture can be as much of an obstacle as Oliver’s outsider status was. Both too much knowledge and too little can lead to incorrect assumptions about the reasons people do what they do.

You must thus examine and explore the culture of your organization, as if seeing it for the first time — to make sure you are not blindsided, as Oliver was at the outset. You can accomplish this with your own counterparts to Oliver’s listening sessions: deep, structured interviews; workshops; and problem-solving groups. This type of inquiry can reveal the existing culture and the specific issues or themes that need to be addressed.

Demonstrate Success

As Oliver got to know the residents of Huntington, he realized he faced a formidable information and education barrier. One class of first graders could not identify a tomato. (They insisted it was a potato.) Others, including many adults, did not know how to use a knife or fork. After years of fast food like hamburgers and pizza, they didn’t have to. Nor did the school cafeteria provide knives or forks; the menu didn’t require them.

Oliver attempted to remake the eating habits of one household, the Edwards family, by talking with them at length about nutrition; he went food shopping with them, loading their home with recipes and fresh ingredients. But when he returned later to their house, he found many of the fresh ingredients uneaten; he also found milkshake containers and other telltale signs of unhealthy food. Providing information was not enough. Oliver had to lead the citizens of Huntington across a threshold of attitude change by addressing their behavior first. So he turned his focus from how they ate to what they ate — and making sure they ate differently.

He began with peas. Perhaps because of the British love for peas, Oliver was determined that the Central City schoolchildren should eat peas for lunch. To accomplish this, he dressed up in a green costume, racing around the school grounds trying to get the kids to engage with him as a pea. He was tireless in his banter and cajoling. He held up two fingers as a peace sign — which he referred to as a “peas” sign. Even if they didn’t quite get it, it made them laugh. He monitored their eating. He used rewards and recognition, handing out stickers after lunch that said “I’ve Tried Something New!” Not every child cooperated, but many peas were eaten — and Oliver had laid the groundwork for further and deeper changes.

For the kids who participated (and perhaps for some of their parents and the school staff), peas became a “proof point”: a bit of evidence, drawn from direct experience, of the possibility and value of change. Oliver had demonstrated that children could eat healthy food enthusiastically, that they could accept a change agent as a leader, that they could support one another without ridicule as pea-eating peers, and that all of this might actually be good for them.

Similarly, when you are a leader involved in change, success requires finding your own proof points in a few areas aligned with your agenda. Choose carefully the behaviors you target; they should match your organization’s strategic aspirations and convince specific subgroups and individuals in areas where change is most needed. Oliver’s strategic aspiration was better health; thus, he focused on improving diets. A company looking for cost efficiency might focus on eliminating unnecessary meetings and oversight reviews. Pick the people whose participation is most keenly needed (and who might be expected to resist), show that they can adopt new behaviors, draw a link between these new behaviors and higher performance, and develop the metrics you need to track the changes in results.

Identify Key Influencers

The more time Jamie Oliver spent in Huntington, the more success he enjoyed. Essential to this turnaround was his cultivation of allies within the community. For example, he sought out the most influential teachers — adults who already had the trust of the schoolchildren. Once they saw better health was possible, it became a genuine motivator. Gradually, they warmed to the idea of encouraging and even prodding the kids to make smarter choices during their lunch hour. Oliver’s persistent but respectful approach eventually earned the confidence of Alice Gue; this brought the entire kitchen (and many others in the school) over to his side. He even won over Rod Willis, the belligerent disc jockey, by betting him that in a single week Oliver could attract 1,000 townspeople to his storefront, Jamie’s Kitchen, to learn to cook healthfully. The DJ ended up broadcasting his show from the storefront on the last day of the bet. This episode marked a moment when many townspeople internalized the value of change; it was no longer simply “good for Jamie,” but also good for their community.

Then, as Oliver moved from the elementary school environment to Huntington High School, he changed his approach (and, not coincidentally, his demeanor, donning a leather jacket and toning down his children’s-talk-show-host speaking style). He explicitly recruited “ambassadors of change” — a group of students who met with him and signed on to promote his ideas.

By this point, Oliver had encountered three types of influencers, all of whom are important to any organizational culture change:

1. Culture carriers: visible figures, like Willis and Gue, who maintain the fabric of the community’s common beliefs and values. Culture carriers are not necessarily limited to people with hierarchical authority; they can include people who are well networked or popular, or who maintain an internal newsletter or blog. In any organizational change effort, it is important to identify who these visible figures are, and what they can do to enable or influence change. How can you enlist them as sources of positive energy, to spread insights virally across the organization?

2. Authority figures: those who are officially responsible for articulating the desired goals and the specific behaviors that will be needed to reach them. Often, different people have authority over different parts of the relevant workflow or social system. In Huntington, authority figures included the school principal, a local pastor, the West Virginia state inspector for school food, a businessman who donated US$150,000 to the nutrition effort, and then West Virginia governor Joe Manchin (now a U.S. senator). A sufficient number of these leaders must be seen as invested in the change they are promoting.

3. Pride builders: people who are respected as peers and are part of the groups where change is targeted. They embrace new behaviors as early adopters, and influence others in turn. The importance of pride builders has been evident in the work of other researchers, including University of Illinois psychologist Leann Lipps Birch (who convinced resistant children to eat peas in the late 1970s by seating them at tables with other kids who liked the vegetable) and Booz & Company Senior Partner Jon Katzenbach (whose book Why Pride Matters More Than Money: The Power of the World’s Greatest Motivational Force was published by Crown Business in 2003). In Huntington, some of the teenagers Oliver worked with became role models for their friends. In your organization, gaining the coopera-tion and support of such individuals will help instill the voice of the employees into every new approach and policy. Pride builders can also help refine your view of what changes are needed and how to implement them.

When they work in harmony, these three categories of individuals can accelerate the pace of change, and help one another see what is being accomplished. For example, in a customer service environment, the culture carriers can put forth an aspirational message of service excellence, explaining why it will attract customers. The authority figures can mandate new behaviors that demonstrate service excellence, and put in place the incentives, rewards, and metrics needed to track progress. The pride builders might include frontline service workers who are willing to embrace this new ethic, and who can show others how to translate the idea that “the customer is always right” into new types of behaviors. Every time you introduce a relevant change, all three types of influencers can be drawn in to reinforce it.

Formal and Informal Change

After several months in Huntington, Jamie Oliver managed to catalyze change among many groups of people — at the elementary school, the high school, and in the community at large. Jamie’s Kitchen is still operating; according to its website, it is funded by four local organizations, including a clinic and a not-for-profit hospital. There were other efforts in place to change attitudes about food, but Oliver’s energetic outreach brought many more people to embrace the idea that eating healthy gets easier over time and feels better.

Oliver’s West Virginia story can serve as a crash course in bringing about change. Some elements — defining the aspiration, finding key influencers, targeting behavior — are analogous to the informal elements of any organizational change initiative. Oliver’s success in Huntington came in part from his uncanny ability to energize and motivate the citizens, build informal networks, and help individuals experiment with new healthy eating behaviors.

But Oliver also deployed formal mechanisms — the same kind to which executives often turn when embarking on a transformation initiative in a corporate setting — such as redesigning reporting structures, setting goals, and communicating priorities to the whole organization. These top-down, rational activities are commonly seen as primary levers for aligning the organization in the same direction. For Oliver, these formal mechanisms included finding food suppliers for the school kitchens that could meet the budget criteria, working with the state inspector to modify policies concerning what counted as serving “a healthy meal,” training the kitchen staff in cooking healthy food from scratch, and ensuring that forks and knives were available in the school cafeteria. His attention to the formal side of change management appeared later in the series, as he clearly came to realize the importance of some of these less-showy organizational modifications.

To achieve sustainable success when implementing cultural change, you must integrate formal and informal efforts. For example, a new performance management system may require shifting the reporting structure of the HR function, alongside an agreement among key leaders to conduct appraisals differently. With both types of mechanisms working together, new, contagious ideas can reach the large scale necessary for impact in a global company.

Cultural interventions are difficult, but they can be successful. You need to clearly define your goals and have a plan for how to reach them — but you also need the willingness and ability to discard your preconceptions and adjust your plan when reality doesn’t line up with your expectations. You are likely to encounter resistance at first, as Oliver did, if you approach changing your organization’s culture in a heavy-handed, top-down way. But when you approach culture more thoughtfully, taking a holistic view of how the organization works in practice, you can make a real difference, even in parts of the culture that seemed intractable before.

Perhaps the most powerful aspect of culture change is the way goals expand after an early success. As Steve Willis, pastor of the city’s First Baptist Church, said to Oliver, “This isn’t going to change lives. This is going to save lives.” He meant literally that people would live longer, but also that the whole city would see its capabilities broaden. Of course, there are still overweight people in Huntington, W. Va., and if the community overcomes one challenge, there will be many more to follow (such as rebuilding the economy). Your own company will go on to face other problems as well. But once you learn how to change habits and get an organization to “eat its peas,” you’ll soon be ready to take on new challenges — whether that means eating tomatoes or eating the competition. 

Reprint No. 11205

AUTHOR PROFILE:

• Rutger von Post is a principal with Booz & Company based in New York. He specializes in organizational change and leadership for the financial-services and healthcare industries and is a fellow of the Katzenbach Center.

CEO Succession 2010: The Four Types of CEOs

Booz & Company’s annual study of turnover among chief executives — now increasingly diverse, as the world’s largest companies migrate to emerging economies — suggests that the nature of the job varies with the role of the corporate core.

by Ken Favaro, Per-Ola Karlsson, and Gary L. Neilson

Illustration by Ross MacDonald

Every year, Booz & Company takes a long and penetrating look at CEO succession among the world’s top 2,500 public companies. Our research now goes back consecutively to 2000, giving us 11 years of perspective on the tenure and position of these global business leaders. Each year we consider a new dimension in our study of CEO succession. This year, we looked at the role of the CEO and its effect on tenure and turnover. How hands-on are the CEO and his or her senior team? How do they engage themselves with the businesses they lead? We found that these factors have a noticeable effect. The more involved headquarters is in operational decision making in any given company, the more tenuous the CEO’s tenure is likely to be.

We also found several noteworthy trends this year. There is a steep decline in CEO turnover worldwide: A higher proportion of chief executives are staying in office than we saw in 2009. (See Exhibit 1.) That doesn’t mean that governance is growing more relaxed; the rates of CEO turnover are still much higher in general than they were in the 1990s, and the pressure on performance remains as great as ever. But it does suggest that some basic trends in CEO hiring and oversight have solidified as standard practice. Last year, we referred to the 2000s as a “decade of convergence and compression,” and this pattern continued in 2010. Around the world, for example, fewer CEOs are also board chairmen this year than was the case the year before, and more CEOs are being appointed from inside companies, rather than from outside.

In one respect, however, the largest public companies are becoming more diverse: They are increasingly based in emerging economies, rather than in the mature economies of the United States, Canada, western Europe, and Japan. For years, in compiling our list of the 2,500 largest publicly held companies in the world (as ranked by their market capitalization), we have observed this gradual migration. (See Exhibit 2.) To explore the implications more closely this year, we divided our study sample over the past 11 years into mature and emerging economies (based on the United Nations’ Human Development Index for 2010), and then further broke out the BRIC countries (Brazil, Russia, India, and China). We found that the share of companies from emerging markets in our sample has grown at a compound annual growth rate of 14 percent over the past 11 years; BRIC representation has shot up 24 percent annually. China, in particular, shows staggering growth, accounting for one in five new entries in our sample this year (83 of the 415 new members of the world’s 2,500 largest companies).

For those who see North America and western Europe as the commercial centers of the world, the news is even more striking; for the first time, almost half the companies on the list are located outside those two regions. In fact, the number of the top 2,500 companies based in the U.S., Canada, and western Europe has fallen some 28 percent altogether since 2000.

Finally, a significant milestone was reached in 2010: More than one-quarter of the top 2,500 public companies now have their headquarters in emerging economies. Could this suggest that global enterprise is nearing a geographic tipping point? Within a few years, if this pattern continues, the companies in the world’s mature Western economies could represent a minority of our sample. Already, the Asian economies (China, Japan, rest of Asia) are the new center of gravity in terms of global market heft, with 895 companies in this year’s sample versus North America’s 772 companies and Europe’s 619 companies.

Global Turnover in 2010

This shift in the mix of companies in our global sample is already influencing CEO succession trends, as companies with new governance structures and different growth arcs come to the fore. (See “A Tipping Point for the Global Economy,” by Ivan de Souza and Edward Tse, below.)

For example, one can surmise that the growing presence of Chinese companies in our sample helped bring down the global rate of CEO turnover this year. Because of their high degree of government ownership, China’s biggest companies manifest extremely low CEO turnover — half the global average. In 2010, CEO succession worldwide hit a six-year low of 11.6 percent; Chinese companies’ turnover was only 5.2 percent.

However, the overall drop in turnover in 2010 is not solely China’s doing; in general, there was a sharp reduction in both forced and planned turnover at the top. There are several possible reasons for this. First, the global recession’s lingering effects influenced companies to keep a steady, seasoned hand at the helm. Second, boards have gotten better at selecting CEOs and ensuring their smooth succession. Finally, given the historically high rates of forced turnover in the last few years, there were fewer companies that hadn’t made a recent change in chief executives.

Global Governance Trends

We broke down the data to assess what it means for today’s boards as well as for sitting and aspiring CEOs. Many long-term trends in governance still hold. Boards around the world increasingly separate the roles of chairman and CEO, especially in North America, where only 14 percent of incoming CEOs were assigned both titles in 2010 (versus 52 percent in 2001). Related to this trend is the practice of appointing an outgoing CEO as board chairman, to apprentice the incoming CEO. We continue to see this model growing in prevalence — except in Japan, where it has long been the norm (it accounts for more than two-thirds of successions there).

Another Japanese tradition, appointing insiders, is also becoming a worldwide phenomenon. Among the 291 succession events we assessed in 2010, insiders ascended to the CEO spot 81 percent of the time. Insiders also last longer — in 2010, those insiders leaving office had lasted on average 7.1 years, versus 4.3 years for outsiders. This is not surprising; insiders have historically produced superior returns for their shareholders. Last year was no exception. Insider CEOs leaving office generated total shareholder returns on a regionally adjusted basis of 4.6 percent as compared with 0.1 percent among outsiders.

On average, compared with 10 years ago, CEOs are being appointed at a later age. The average appointment age among outgoing CEOs in 2010 was 52.2, versus 50.2 in 2000. This suggests that boards continue to value experience in selecting a CEO. In tracking outgoing CEOs, we found that the percentage of chief executives who had previously served as CEOs of a public company has risen markedly over the past 11 years, from 4.3 percent in 2000 to 15.2 percent in 2010. And in 2010’s incoming class, more than half (51 percent) of new outsider CEOs came from within the same industry — suggesting that boards are getting more particular about the type of candidates they are seeking.

CEOs are also staying in office for less time, compared with 11 years ago. For outgoing CEOs, the mean tenure was 18 months shorter: 6.6 years in 2010 versus 8.1 in 2000. In particular, the length of planned tenures — in which the CEO departs on a date that has been prearranged with the board — has dropped by 30 percent over the last 11 years, from 10 to seven years. These findings suggest that CEOs are finding the demands of the job more pressing than their predecessors did.

Four Models of Management

This year we applied an additional lens to our study of CEO succession events at the world’s largest companies by examining the impact of the corporate core. The corporate core is made up of the CEO, his or her senior team, and a defined set of support functions necessary for the entire corporation. Back when the senior management team of a typical large company could all have offices in one location, this was known as headquarters. All corporate cores provide leadership, create the context for growth, represent the corporation to the public and investment community, and provide essential services to the business units, which are consigned maximum responsibility for money-making activities. That’s where the similarities among companies end. As any CEO can tell you, each corporate core is a unique blend of skills, responsibilities, and personal management styles tailored to the nature of the businesses it oversees and the competitive environment in which it operates. On the basis of our in-depth experience with hundreds of corporations at Booz & Company, we have found that they fall along a spectrum of four different corporate models — defined by the way senior management and the corporate core engage with the rest of the business. (See Exhibit 5.)

The first model, at one extreme, is the highly diversified holding company — distinguished by its arm’s-length approach to managing its subsidiary operations. Holding companies add value through strong portfolio management. The second model is the strategic management company, which offers guidance and leadership on strategic direction and provides expectations of performance for its group of related businesses. The third model involves more active management. These corporate cores oversee more tightly linked businesses and advise on operational issues. The fourth corporate model is the highly operationally involved company, in which senior management plays an active role in day-to-day business decision making.

To briefly sum up each model from the point of view of a business unit leader: Holding companies want your results. Strategic management headquarters want to know what you will do. Active management corporate cores want to know how you will do it. And operationally involved executive teams want to work closely with you in running the business.

As part of our research on CEO succession and related issues, we have interviewed chief executives working within these models. Their experience sheds light on the operation of these models, the patterns of CEO succession that seem to follow the models, and the implications for business leaders.

Holding companies (Model 1) manage their businesses much as a financial fund manager oversees a portfolio of investments. The CEOs of this first group of companies have a minimal degree of involvement in operational decisions. They are primarily interested in results, not in how the results are generated. The corporate core establishes and ensures managerial and financial discipline. Holding company chief executives are a level removed — they focus on portfolio management while the second-tier executives run the businesses. If there is a problem, more often than not, its fallout is felt at that second management tier.

Warren Buffett, CEO of Berkshire Hathaway Inc., typifies this type of management. As he noted in his letter to shareholders in the 2010 annual report, “At Berkshire, managers can focus on running their businesses: They are not subjected to meetings at headquarters nor financing worries nor Wall Street harassment. They simply get a letter from me every two years…and call me when they wish. And their wishes do differ. There are managers to whom I have not talked in the last year, while there is one with whom I talk almost daily. Our trust is in people rather than process. A ‘hire well, manage little’ code suits both them and me.”

Strategic management companies (Model 2) exercise a bit more oversight in managing their operations. The corporate core offers strategic guidance to its local businesses, but not the supervision of operational decision making. A good example is the Korea-based LG Corporation, a US$104 billion company originally known for its brand name Goldstar. (LG once stood for Lucky Goldstar.) At first glance, because of its global operations spanning consumer electronics, mobile communications, home appliances, chemicals, and more, LG might seem to fit the definition of a diversified holding company such as Berkshire Hathaway. But Juno Cho, president and CEO of LG Corporation, notes that the company’s corporate core has always operated more in a strategic management model.

Cho describes his role, and that of other senior management, as closely engaged in strategic goal development with executives of subsidiaries such as LG Chemical and LG Electronics, where central core team members often sit on the boards. “We effectively agree on strategic goals and targets with the businesses and give them accountability,” says Cho. Once each year the group chairman of LG Corporation conducts a consensus meeting with the presidents of all the business units to discuss, understand, and agree on their annual business plan. “This is the backbone of our communication,” says Cho. “Corporate executives chair the board of each business unit, so we have a real-time understanding of performance, but it would be impractical to get deeply involved in operational matters. Since LG is such a big organization, the corporate core limits its voice to brand-building, R&D expenditures, high-level human resources decisions, and capital investment.”

Active management companies (Model 3) have a corporate core that starts to share accountability with the business units for major operational decisions and adds value through close guidance and expertise. John H. Hammergren, chairman, president, and CEO of the McKesson Corporation, a leading pharmaceutical distributor and healthcare IT company based in North America, describes his corporate core as moving back and forth between the strategic and active management models.

“We want our businesses to drive the McKesson culture,” says Hammergren, “but the corporate executive team also wants to guide the businesses on how they do it. We follow a similar approach when it comes to leadership development — whereas with sales training, we expect the businesses to take the lead, because sales training is more specific to their business.”

Hammergren says that the corporate officer group at McKesson performs several key roles. “First, it sets the culture: the tone at the top — for example, what standards we are going to hold for ourselves, both at the executive committee level and in our interactions with the leaders of the business units. Second, corporate upholds a set of principles that ensure all of our business units put the customer at the center of everything we do. Third, we manage the cadence of the management team: in other words, how we plan our strategy; how we conduct our operating reviews; what we expect of the business units; and what processes, like Six Sigma and the corporate calendar, we use to drive results.” The top group also establishes the rules of engagement between the corporate core and the business units, determining when businesses should expect that headquarters will be involved, and when they can assume the authority and decision-making power to move forward on their own.

“We manage the corporation through two key management teams,” says Hammergren. “The first is the executive committee, comprising my direct reports; the second is an operating team that consists of the presidents of the major businesses. I inspect each major business at least quarterly, and I’m actively involved in the budget-setting process and leadership decisions at the business unit level. The executive committee meets every other week to take up performance within the various businesses, large M&A transactions, Wall Street expectations, deployment of capital, leadership development, succession planning, balance sheet management, board reporting, overall corporate strategy, and those kinds of issues.”

Hammergren notes that it would be extremely difficult to move McKesson to a model of full operational involvement. “Given the complexity of our company, it would be impossible for the CEO to call the orders every day on the execution side. I wouldn’t be close enough to the fight to know which way to send the troops; and the people who run these businesses would get disenchanted and disheartened, because I would probably not do their jobs as well as they do them.”

Operationally involved companies (Model 4) are enterprises in which the corporate core is involved in management more directly. This does not mean that the CEO and top team are involved in every aspect of day-to-day management; execution remains the business units’ domain. Rather, the corporate core adds value through the development of cross-company capabilities and functional expertise, and gets involved in strategic decision making for most or all business units. Because of the highly engaged nature of the corporate core in managing the business, these companies are typically focused within a single industry.

Ford Motor Company under CEO Alan Mulally is a good example of an operationally involved corporate core. According to an Economist article published December 9, 2010, Mulally began to convene weekly meetings of his senior team soon after he arrived in September 2006. He pushed the attendees to bring up operational problems and collaborate in solving them. When the head of Ford’s operations in the Americas admitted that his group had a serious problem with defective parts, instead of falling from grace, he was applauded by Mulally, who exclaimed, “Great visibility.”

To maintain a tighter rein on the carmaker’s fundamental business, Mulally and his key lieutenants decided to concentrate on the Ford brand and divest the Premier Automotive Group — a collection of high-end brands that had been acquired under previous regimes. The company quickly sold Aston Martin, Jaguar, Land Rover, and Volvo. Ford also decided to produce a much narrower range of cars built on a few core platforms, focusing on quality and flexibility. At one point, Ford produced nearly 100 different models around the world; now it is down to a third of that number and may go lower. For clarifying and simplifying the management challenges at Ford, “you cannot believe the difference this makes,” noted Mulally.

The Most Challenging Corporate Model

As part of this year’s study, we identified which of the four corporate core models applied most closely to each of the 291 companies that experienced a succession event in 2010. We based our analysis on such factors as the number and diversity of business units, the degree of activity sharing among those units, and the number and proportion of senior line and staff managers. We also called on our own firm’s industry expertise and our direct experience with many of these companies. The breakdown that emerged from this sample was broadly consistent with what we have observed in the general population of global corporations — 10 percent were holding companies, 20 percent were strategic management companies, 30 percent were active management companies, and the most numerous, at about 40 percent, were operationally involved companies.

The corporate core model clearly seems to influence the CEO’s experience in office. For the 291 succession events that occurred worldwide in 2010, the tenure of the CEO in the operationally involved companies was unquestionably shorter and riskier. In fact, the tenure of a holding company CEO is a third longer, on average, than that of an operationally involved CEO. (The median tenure of a holding company CEO departing office in 2010 was 6.5 years, whereas the median tenure of an operationally involved CEO was only 4.9 years.) Moreover, CEOs in Model 4 companies are much more likely to depart during their first four years than CEOs in the other three models. (See Exhibit 6.)

This departure rate at operationally involved companies was particularly high for outsider CEOs — those who were hired from another company. Outsiders are generally more pressured; in all categories except holding companies (in which only one outsider CEO left in 2010, a chief executive who had lasted for a statistically anomalous 17 years), they stayed in office for less time on average than their insider counterparts. Outsiders at Model 4 companies had the shortest tenure of all: on average, only 3.3 years in office. (See Exhibit 7.)

Why was CEO turnover higher in Model 4 companies? It wasn’t because of inexperience: The proportion of Model 4 outgoing CEOs who had prior CEO experience was higher than in any other model group. Nor was it a matter of a lack of coaching or support. The apprentice CEO model is more prevalent at operationally involved companies than at holding companies (38 percent as compared with 32 percent), and Model 4 headquarters organizations are much larger, as a rule. However, CEOs in Model 4 companies face some particular challenges:

1. Operationally involved companies are more likely to be acquired.M&A successions are most common among Model 4 firms (in 2010, they represented 52 percent of non-planned turnover, versus 40 percent at Model 1 companies and 26 percent at Model 2 companies). Because Model 4 companies typically focus on a single industry or business, they are often attractive targets for acquisition. And although Model 1 and 2 companies may engage in M&A activity more frequently, they typically buy and sell subsidiary units, not whole companies, so the CEO position is usually not affected.

2. Operationally involved CEOs more often succumb to board and power struggles. These struggles accounted for 57 percent of the forced (non-planned and non-M&A) turnover at Model 4 companies in 2010. By contrast, in Model 2 companies, poor financial or managerial performance was the main driver of forced succession. (See Exhibit 8.) In a single-line or closely related set of businesses, it is easier for the board to apply strict scrutiny to a CEO’s strategy, and power struggles with other knowledgeable insiders are more likely.

3. Operationally involved and active management CEOs are more likely to also hold the chairman title. This is twice as likely, on average, as it is in the other two models. Overall, only one in 10 CEOs has this dual role, but the more involved the corporate core is in the business operations, the more likely the double role is to appear. (See Exhibit 9.) The correlation between actively engaged corporate cores and “double-hatted” CEO/chairmen is particularly strong in Europe.

At first glance, this correlation seems puzzling. Double-hatted CEOs are subject to immense job demands in any company; they run both the board — which is charged with scrutinizing their strategy — and the business. In Model 3 and Model 4 companies, their roles would be even more demanding. One may surmise that this trend is either an anomaly (in which case we will probably see it diminish in future years) or a sign that some boards still believe that a single leader accountable for the entire company provides the most effective form of governance.

Advice for the New CEO

Few CEOs would interpret these findings as a suggestion to adopt the holding company model. After all, most companies have developed their corporate core structure over time, to match their unique portfolio of businesses and their competitive strategy. No one model is inherently better than another, and it is neither practical nor desirable to move your corporate model away from what the business requires.

However, if you are the CEO in a Model 4 company, you should recognize the especially demanding nature of this job. It requires hands-on management and greater accountability, and your exposure to disruption is therefore higher. More than one-third of operationally involved CEOs are replaced within four years; indeed, your role may involve quietly building value to become an acquisition target. Model 4 boards tend to be more informed and engaged in monitoring strategy, and the competition for the chief executive position can be more intense — there are often several candidates well versed in the business vying for the position. These challenges will be all the more formidable if you are hired from outside.

Of course, CEOs at companies with other core models also face great pressures. As we noted earlier, planned-succession tenures, overall, have dropped from 10 years to seven since 2000. In a large company, seven years can be a very short time to set an agenda and execute it. Nonetheless, as an incoming CEO, you should adjust your expectations accordingly, and be prepared to demonstrate early wins in the first few years to solidify your position.

If you are a board member or senior executive in search of a long-term CEO, you face a different, but equally immense, challenge. As they develop through their careers, very few candidates will automatically receive the breadth of general management experience and functional expertise needed to oversee a large global enterprise. In a Model 1 company, up-and-coming executives have the early opportunity to run a P&L, but they may not get a broader sense of the whole portfolio or develop strong functional skills. By contrast, in a typical Model 4 company, there will be a cadre of executives with high levels of functional expertise and strong industry knowledge, but their general management experience may be less robust.

It is the responsibility of sitting CEOs and boards to plan for succession by building a bench of well-rounded candidates that transcends any management development limits in their corporate core model. Model 1 and 2 companies need to help their general managers cultivate functional and portfolio management skills. Model 3 and 4 companies need to give their functional specialists general management experience. Thoughtful executives planning their own careers would do well to take on roles that help fill the gaps.

If you are a new CEO, awareness of your corporate core model can help you establish a better position. For example, a new CEO coming from the outside into a company with an active management model can lay the groundwork for success early by appointing well-regarded insiders to one or two top jobs, to engage the organization more effectively. Similarly, in last year’s study, we highlighted the growing importance of regarding the board of directors as a strategic partner. This advice is crucial if you are the CEO of an operationally involved company, especially given the fact that skirmishes with the board account for most CEO dismissals in those companies. The more effective your engagement is with the board, the more likely your succession is to be a planned one.

In general, chief executives need to adapt their personal management style to the company’s corporate core model. This may be particularly challenging if you are a new CEO in a Model 1 or Model 2 company. More likely than not, you were an operationally involved business unit head before taking the top job. Now, you will have to deliberately learn to delegate accountability for running the businesses so you can focus on adding value to the larger organization.

No matter where you sit on the corporate core spectrum, the challenges of being the CEO of a major corporation are considerable and growing, while the window you have to address and overcome those challenges continues to narrow. Never has the job been more exciting…or more daunting.  

A TIPPING POINT FOR THE GLOBAL ECONOMY
by Ivan de Souza and Edward Tse

The changing composition of this year’s sample of the world’s top 2,500 public companies by market capitalization is, in and of itself, a significant portent of a profound shift about to occur in the global economy. The center of gravity among global corporations is moving from mature Western economies to emerging markets. (See Exhibit 3.) The details vary by country and industry, but some general truths broadly apply.

Companies in emerging economies — not only in Brazil, Russia, India, and China (the BRIC countries), but also in the “next 11” countries named by Goldman Sachs: Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, South Korea, Turkey, and Vietnam — are in hyper-growth mode. They are on the early and steep side of what we at Booz & Company call the arc of growth: the natural evolutionary cycle of any country or region as it enters the industrialized economy. Meanwhile, the mature economies of North America and western Europe are confronting challenges in generating further growth — challenges that have only been exacerbated by the economic turmoil of the past few years. The global recession has exaggerated the dichotomy between rapidly growing BRIC and next 11 countries on the one hand, and those in the Organisation for Economic Co-operation and Development on the other.

Furthermore, companies based in these emerging economies have far greater access to capital markets than they did even five years ago. Investors now perceive these economies more favorably, and the senior management of these companies have become more worldly in their outlook. Companies can now capitalize through IPOs, finance additional activity, and fund acquisitions in their own geographies as well as abroad (including in North America and western Europe).

Finally, companies in the world’s emerging economies enjoy significant resource advantages. It’s little wonder that demographically advantaged countries, such as India and China, and countries endowed with natural resources, such as Russia and Brazil, have seized the lion’s share of the growth in global GDP over the past several years.

Although these general truths apply to all emerging economies, China’s story has some unique elements. First, despite being publicly listed, the largest Chinese companies in our sample are still controlled by the state, which retains a substantial ownership stake. (Of the 232 Chinese companies on our global list of 2,500, the state owns all of the top 10.) The Communist Party appoints the chairman and the CEO of these enterprises from a roster it maintains of industry experts. (That said, the Chinese government has installed Western-style boards of directors in the top government-owned enterprises in China, and these boards exercise a good deal of authority.) Finally, given the high degree of government oversight, companies in China often enjoy distinct positional advantages, at least domestically, and M&A activity is rare. These factors all help explain why China’s CEO turnover is so low compared with that of other countries. (See Exhibit 4.)

In the coming years, we should see Chinese companies and their emerging-market peers open up more and more to the rest of the world, in terms of both mind-set and footprint. Chinese business leaders, by necessity, will maintain a more international outlook; this will undoubtedly have an impact on CEO succession in years to come.

• Ivan de Souza is a senior partner with Booz & Company based in Sao Paolo and is managing director of the firm’s global markets business.
• Edward Tse is a senior partner with Booz & Company based in Shanghai and Hong Kong, and is the firm’s chairman for Greater China.

METHODOLOGY

The 2010 CEO Succession study identified the world’s 2,500 largest public companies as measured by their market capitalization (per Bloomberg) on January 1, 2010. Booz & Company research team members based in India, China, Romania, Chile, the United Arab Emirates, Italy, France, and the United States then identified the companies among the top 2,500 that had experienced a chief executive succession event and cross-checked data using a wide variety of printed and electronic sources in multiple languages. For a listing of companies that had been acquired or merged in 2010, we again used Bloomberg. In considering relative market capitalization, we did not adjust for currency exchange rate fluctuations, which have an insignificant effect over time because they quickly adjust to market reality. (We also note that China’s currency is pegged to the U.S. dollar.)

We investigated each company that appeared to have changed its CEO to confirm that a succession event occurred in 2010, and for the 291 confirmed companies, we compiled demographic, career, and governance structure details on both outgoing and incoming CEOs (as well as any interim chief executives), including age, tenure, title, career path, prior experience, education, and chairmanship, among others. In the analysis of CEO succession by tenure of outgoing CEO (Exhibit 6), insider/outsider status (Exhibit 7), and CEO background (Exhibit 9), we excluded turnover events involving interim-appointed CEOs, and those resulting from mergers and acquisitions.

We accepted company-provided information for all data elements except for the reason for the succession. For that, we consulted outside press reports and other independent sources.

Total shareholder return data for a CEO’s tenure was sourced from Bloomberg and includes reinvestment of dividends, if any. Company return data was then regionally market-adjusted (against the return of the local regional index over the same time period) and annualized.

Corporate core classification of each of the 291 companies experiencing a succession event in 2010 was based on multiple factors (e.g., number and diversity of business units, degree of shared activities, number and percentage of top-line versus functional managers), as well as Booz & Company expertise on industry and geographic operating models.

To distinguish between mature and emerging economies, we followed the United Nations’ Human Development Index 2010 ranking, which classifies countries with a score above 0.788 as “very high.” Mature economies include South Korea, Australia, the Czech Republic, Poland, and Hong Kong; emerging economies include Turkey, Saudi Arabia, Mexico, and South Africa. For the purposes of this study, Hong Kong and Macau are classified as separate from China.

Reprint No. 11207

AUTHOR PROFILES:

• Ken Favaro is a senior partner with Booz & Company based in New York. He leads the firm’s work in enterprise strategy and finance.
• Per-Ola Karlsson is a senior partner with Booz & Company based in Stockholm. He is managing director of the firm’s European business.
• Gary L. Neilson is a senior partner with Booz & Company based in Chicago. He focuses on operating models and organizational transformation and is a leader of the firm’s work on organizational DNA.
• Also contributing to this article were Booz & Company Senior Associates Alexis Bour and Kenji Chikada and s+b contributing writer Tara A. Owen.