February, 2004

Hammer and Company 2004 All rights reserved.

Deep Change:
How Operational Innovation
Can Transform Your Company
In 1991, Progressive Insurance, an auto insurer based in Mayfield Heights, Ohio, had
approximately $1.3 billion in sales volume; in 2002, that figure had grown to $9.5 billion.
What fashionable strategies did Progressive employ to achieve seven-fold growth in just
over a decade? Positioning in a high-growth industry? Hardly; auto insurance is a mature,
hundred-year-old industry that grows with GDP. Diversification into new businesses? Both
then and now, Progressive's business is overwhelmingly concentrated in consumer auto
insurance; in the 1990s, the company did attempt a diversification into commercial truck
insurance, but abandoned it because of unsatisfactory results. Going global? Progressive
operates only in the United States. Acquisitions? Its growth was entirely organic. Clever
marketing? For much of the last decade, Progressive did little or no advertising, and some
of its early efforts in this area (such as its sponsorship of the 1999 Super Bowl halftime
show) were notably unsuccessful. New products? Auto insurance is pretty close to a
classical commodity. Did the company buy market share? Hardly. Progressives growth did
not come at the expense of its margins, even when it set low prices. The proof is
Progressives combined ratio (expenses plus claims payouts divided by premiums), the
measure of financial performance in the insurance industry. Most auto insurers have
combined ratios that fluctuate around 102%, recovering their underwriting losses with
investment income. By contrast, Progressive's combined ratio fluctuates around 96%.
The company's growth has not only been dramatic it is now Americas third largest auto
insurer it has also been profitable.
The secret of Progressive's success is maddeningly simple: the company succeeded
because it out-operated its competitors. By offering lower prices and better service than
others in its industry, it simply took their customers away. But what enabled Progressive to
have better prices and service? The root cause of Progressive's success was operational
innovation, the invention and deployment of new ways of doing work. This is not
innovation at the product level, but at the process and operations level. Progressive
deployed a series of operational innovations, large and small, throughout the 1990s.
These innovations lowered Progressives costs and improved the caliber of its service,
and profitable growth was the inevitable result. Operational innovation, as practiced by
Progressive and other firms, should not be confused with operational improvement
or operational excellence. These latter terms refer to achieving high performance of
existing modes of operation: assuring that work is done as it ought to be in order to
reduce errors, costs, and delays, but without making any fundamental changes in the
way that work is done. Operational innovation is altogether different. It means coming
up with fundamentally new ways of doing an organization's work. Operations is not
merely a synonym for the back office; it includes any and all of the work that an
enterprise performs. Operational innovation can include new ways of filling orders, of
developing products, of providing customer service, or of any other of a company's
activities and processes.
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Operational innovation has been central to some of the greatest success stories in recent
business history, including Wal-Mart, Toyota, and Dell. Wal-Mart is now the largest
enterprise in the world and the owner of one of the worlds strongest brands. But how
was Wal-Mart able to take on and vanquish much larger companies, both conventional
retailers like Sears and discounters like Kmart? To reply low price is but to beg the
question: what enabled Wal-Mart to offer lower prices than competitors? The answer is
that Wal-Mart pioneered a wide spectrum of innovations in how it purchased and
distributed goods; one of the best-known of these is cross-docking, in which goods come
into a distribution center on trucks from suppliers and are immediately transferred to
trucks bound for stores without first being placed into storage. Cross-docking and its
companion innovations led to lower inventory levels and lower operating costs, which
Wal-Mart translated into lower prices, and the rest is history. This is not to imply that
operational innovation was the sole ingredient in Wal-Marts success; its culture, its
strategy, its human resource policies, and a host of other elements including operational
excellence were also critical. But operational innovation was the foundation on which
the company was built.
A similar observation can be made about Dell. Dells rise to prominence did not come on
the back of distinctive products or creative marketing. Dell differentiated itself not on what
it made and sold, but in how it made and sold. Dell invented (and excelled at executing) a
new way of building computers: in response to customer orders rather than to forecast. It
also innovated in its supply chain operations, putting in place systems that minimized the
amount of inventory it had to keep on hand to support its build-to-order system. In the
aggregate, Dells operational innovations enabled it to simultaneously offer customers low
price and high service.
THE PAYOF FS OF I NNOVATI VE OPE RAT I O N S
Wal-Mart and Dell were start-ups when they introduced their operational innovations.
Progressive was not. Progressive was an established auto insurer that embarked on
operational innovation because it thought it was under attack. For most of its history, the
company's niche was high-risk drivers, a market that it was able to serve profitably
through extremely precise pricing. In the early 1990s, Progressive believed that much larger
firms were about to enter this niche and emulate its approach to pricing; the company's
managers realized it would be unable to compete against these larger players on a level
playing field. So Progressive decided to win the game by changing the rules. It reinvented
claims processing, with the twin goals of lowering its costs and boosting customer
satisfaction and retention. The company introduced what it calls Immediate Response
claims handling, in which a claimant is able to reach a Progressive representative by phone
any time of day or night; this representative then schedules a time when an adjuster will
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inspect the vehicle. The adjusters themselves no longer work out of offices from 9 to 5,
but out of mobile claims vans. Instead of taking 7-10 days for an adjuster to see the
vehicle, Progressive's target for getting it done is now 9 hours. Moreover, when the
adjuster appears, it is not merely to examine the vehicle. A Progressive adjuster prepares
an on-site estimate of the amount of the damage and if possible makes out a check on
the spot.
This approach has many benefits. For the claimant, Immediate Response means faster
service and less hassle, which in turn mean that the claimant is less likely to abandon
Progressive because of an unsatisfactory claims experience. For Progressive, the reduced
cycle time of the new process has an enormous impact on costs. The costs of one day of
storage for a damaged vehicle or one day's rental car reimbursement is equivalent to the
expected underwriting profit on a six-month policy. For a company that handles over ten
thousand claims a day, the financial impact is dramatic. Other benefits for Progressive are
an improved ability to detect fraud, lower operating costs (because fewer people are
involved in handling the claim), and even a reduction in claims payout (because claimants
will often accept a smaller payout that comes earlier and with less travail).
No single advance conveys a lasting advantage. Dell, Wal-Mart, Progressive, and other
companies committed to operational innovation pursue it on a broad front. In addition to
Immediate Response, Progressive has also introduced a capability that allows customers to
call an 800 number (or access a web site) and by providing fifteen minutes of information
find out the cost of Progressive's coverage as well as that of three of Progressive's
competitors. (This is possible because insurance is a regulated industry and rates are on file
with state insurance commissioners.) This has attracted customers in droves, affording
Progressive the opportunity to present quotes to customers it would otherwise never have
encountered. The company has also came up with better ways of assessing an applicant's
risk profile in order to calculate the right rate to quote. Progressive realized that an
applicant's credit rating was a good proxy for responsible driving behavior and so changed
its application process so that the company's computer systems automatically contact
those of a credit agency and factor in the applicant's credit score into its pricing
calculation. More accurate pricing translates into increased underwriting profit. Put these
all together, and Progressives remarkable growth becomes comprehensible.
Operational innovation means that the new ways of operating are new in the particular
area of activity in the companys industry; the innovation may be based on principles used
in other areas or other industries. Dell did not invent the notion of build to order, but did
introduce it to the PC industry. Similarly, in 2002 Shell Lubricants applied an idea used by
other companies in order fulfillment: replacing a group of people who handle different
parts of an order with one individual who does it all. Under Shells old ways of handling
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orders, a customers order could bounce among as many as 7 different departments before
it was completed; now one account services coordinator does everything required. As a
result, Shell has cut the cycle time of turning an order into cash by 75%, reduced its
operating expenses by 45%, and boosted customer satisfaction 105% all by
introducing a new way of handling orders. In the mid-1990s, IBM came up with a new
process for developing products, one based on the principles of stage gates, portfolio
management, and cross-functional teams; the results included a 75% reduction in the
time to develop new products, a 45% reduction in development expenses, and a 26%
increase in customer satisfaction with these new products. Eastern Energy, a UK electric
power utility, created a new process for establishing electrical service for new customers,
which led to a 90% reduction in the time needed to install service and a two-thirds
reduction in the cost of doing so. Time, cost, and customer satisfaction all the
dimensions of performance shaped by operations can get major boosts from operational
innovation.
T HE CONUNDRUM
Other companies, including Air Products and Chemicals, Intel, Siemens, General Motors,
HarvardPilgrim Health Care, MetLife, General Mills, Bank of America, and Nestle, have also
made major innovations in how they do their work, and with similarly impressive payoffs.
Yet despite the extraordinary results these companies have achieved, relatively few other
companies have availed themselves of the power of operational innovation. By my
estimate, no more than 10% of large enterprises have made a serious and successful
effort at operational innovation. The very fact that Dell, Wal-Mart, Toyota, and Progressive
continue to set the benchmarks in their industries is a testament to the relative rarity of
what by all rights should be a widespread phenomenon. Compared to most of the other
ways that managers try to stimulate growth investment in technology, acquisitions,
major marketing campaigns, and the like operational innovation is relatively reliable and
low cost. What then impedes its wider adoption?
The question is particularly significant since operational innovation is more needed now
than ever before. Most industries today are struggling with low-growth, even stagnant,
markets. Overcapacity is rampant and competition, particularly global competition, is
fiercer than ever. Virtually all product or service offerings have become commodities,
almost no one has any pricing power, and none of this is likely to change in the near
future. In this environment, the only way to grow is to take market share from competitors
by out-executing them: by operating at lower costs that can be turned into lower prices,
and by providing extraordinary levels of quality and service. In other words, the game must
now be played on the field of operations. Yet operational improvement is not enough to
win the game. While once a plausible way of getting ahead of the competition,
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operational improvement has itself become widespread and commoditized. More and
more companies have learned how to achieve high performance execution of industry-
standard ways of operating. Operational execution can win a close game, but it cant
break a game wide open and turn it into a rout. The only way to get and stay ahead of
competitors is by executing in a totally different way that is, through operational
innovation.
Operational innovation is thus a proven effective technique that offers great opportunities
in a very difficult economic environment. So why dont more companies avail themselves
of it?
T HE BARRI E RS
Obviously, no single explanation can account for the dearth of successful operational
innovation. There are a great many different reasons for this phenomenon, some unique
to individual companies and some widespread. However, in my interactions with hundreds
of companies over the last decade, two stand out above all the rest: Senior executives are
not tuned into operational innovation because they are distracted by other issues, and
operational innovation has no home in the organization.
I have spoken with thousands of managers from hundreds of companies about operational
innovation. Most of them immediately recognized its power and how it could be applied
in their companies. Most also found subsequently themselves stymied in trying to get
traction with it in their organizations. Overwhelmingly, the most common reason they gave
for this situation was that their senior executives did not understand, support, or
encourage operational innovation. As one of them put, Our top management doesnt see
operational innovation as part of their toolkit. Most managers that propose operational
innovation to their executive teams encounter a host of negative responses, from outright
dismissal of the notion, to claims that it wont work or is not relevant in their organization,
to requests for endless analyses and more data. Others receive lukewarm support,
insufficient resources, or no ongoing executive attention.
It should be self-evident that operational innovation will not succeed unless it is mandated
and managed from the top of the enterprise. Operational innovation entails a departure
from familiar norms and requires major changes in how departments conduct their work
and relate to one another. It is truly deep change, affecting the very essence of a
company: how its work is done. The effects of operational innovation ripple outward to all
aspects of the enterprise, from measurement and reward systems and job designs to
organizational structure and managerial roles. Thus, it will never get off the ground
without executive leadership. Yet senior managers rarely perceive operational innovation as
an important endeavor, nor do they enthusiastically embrace it when others present it to
them. Why not? The answers hinge on some unpleasant characteristics of contemporary
corporate leadership.
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Business culture undervalues operations. As one manager phrased it, In our company,
operations is not glamorous. Deals are. Making acquisitions, planning mergers, buying
and selling divisions all these will get the companys name and the CEOs picture in the
newspapers and business magazines. Redesigning procurement or transforming product
development will not, even though it might be much more important to the companys
performance. Deals are easily explained to and easily understood by boards, shareholders,
and the media; deals are relatively quickly consummated, offering the prospect of nearly
immediate gratification; and the bold stroke of a deal is consistent with the modern image
of the executive as someone who focuses on grand strategy, while leaving operational
details to others. The fact that the great majority of deals are unsuccessful does not deter
executives from pursuing them; hope apparently springs eternal.
Deals have high status; operations do not. Even business school students are aware of this.
One recently observed to me that, There seems to be a hierarchy in the business world.
Finance and strategy are at the top, marketing and sales occupy the middle tier, and
operations is at the bottom. An insurance CEO once quipped that managers work hard
at operations so that they can be promoted to the executive level where they can stop
worrying about operations. A journalist at a prominent business magazine, assigned to do
a story on operations, confessed that he thought it boring. This is the state of our
business culture. The core, value-creating work of enterprises has become low-status, out
of sight and out of mind of enterprise leaders.
Operations are out of sight (and out of mind-set). Many executives are uncomfortable with
operations and the style of thinking that operational innovation demands. At its heart,
operations is a branch of engineering. It requires a skill set and a mindset different from
those needed in most of an executives other activities. The days and minds of most senior
managers are taken up with strategic planning, budgeting, capital allocation, financial
management, mergers and acquisitions, personnel issues, regulatory concerns, and on and
on. These are macro issues, very different in kind from the design work that is the heart of
operational innovation.
To compound matters, many top managers are both ignorant of operations and
uninterested in it. Many general managers get to the senior most levels of the
organization without ever getting their hands dirty in the details of operations. They enter
the enterprise in finance, strategy, or marketing, and build their reputations on work in
these domains. When they move into their first general management role, they rely on
others plant managers, engineers, customer service leaders to tend to the details of
the actual work. Their role is one of oversight, resource allocation, and direction, all vital to
be sure, but all perched precariously on a foundation not grounded in the bedrock of the
organizations real work.
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At a major semiconductor maker, a group of middle managers, frustrated with the
complexity and poor performance of their order fulfillment process, decided to make a
case for change to executive management. They produced a two-page diagram illustrating
the endless series of steps that every order went through, the redundant moves of product
between factories and depots, the accumulations of inventory, and the enormous delays.
When they presented this diagram to the companys executive committee, the response
was an incredulous We do this?! The leaders of the company were in fact in the dark
regarding how its most basic value-creating work was being performed.
It should not be surprising that executives without experience in operations or a
background in it do not look to innovation in operations as a source of competitive
advantage. Even those who recognize the importance of operations and innovating in it
often feel awkward and ill-prepared to do so. With relatively little background in the area,
many senior managers are afraid of operations and lack the intuitive apparatus needed to
guide their decision-making.
The information that top managers receive also does little to focus their attention on the
mechanisms of operations. How many executives get data about order fulfillment cycle
time, or the accuracy of customer service responses, or the cost of each procurement
transaction, or the percentage of parts reuse in new products? Indeed, how many
organizations have such information anywhere in the organization? Financial data
dominates the discourse in the modern organization; yet operational performance is the
driver of financial results.
To be sure, despite these factors, some executives do embrace operational innovation.
Sometimes, this happens when the enterprise is in dire circumstances, and all other
options have been exhausted; leaders then stumble into operational innovation as a last
resort. Needless to say, this is not a strategy to be deliberately cultivated. Waiting until the
sheriff is at the door before rethinking operations is reminiscent of cold-war brinkmanship;
it also leaves open the distinct possibility that time will run out before the innovations pay
off. In other cases, a senior executive is blessed with a personal epiphany. For reasons
rooted in his or her background or situation, such an executive defies the stereotypes and
autonomously comes to recognize the criticality and the power of operational innovation.
These situations, however, tend to be sui generis, and organizations can not count on the
good fortune of having members of their executive team seeing the light on their own.
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Nobody owns i t . Even when a senior leader is committed to operational
innovation, it has a hard time finding a home in the organization. Operational innovation
does not fit in R and D, where product innovation is based, and line managers are too
focused on meeting plan by performing existing ways of operating to have time for or
interest in inventing new ways. There is no Vice President of Operational Innovation, there
is no budget line for it, it is not part of the normal planning process, and there is no ready-
made cadres of experts who define themselves in terms of it. It is very difficult for such an
unrooted program to gain traction in an organization.
Lack of a natural home and an associated advocate makes operational innovation
particularly susceptible to being confused with and overwhelmed by operational
improvement. It is all too common for enterprises today to have an slew of dozens even
hundreds of operational improvement programs under way at any point in time. Some
of these are technologically based, such as the implementation of enterprise resource
planning (ERP), customer relationship management (CRM), or supply chain management
(SCM) software systems. Others are centered on specific bodies of improvement
techniques, such as six sigma quality or lean enterprise programs. Still others are defined in
terms of outcomes they seek to achieve, such as accelerated time to market or
presentation of a single face to customers, or around improving a particular aspect of the
enterprise (e.g., procurement or customer service). Each of these projects typically has a
specific and usually narrow scope, a group of experts dedicated to it, and a sponsor whose
enthusiasm is usually tolerated by his or her peers as long as it is kept within bounds.
This situation can cripple operational innovation because an organization only has a limited
bandwidth for change; when juggling a great many improvement projects, it may
conclude that it cant handle an innovation effort as well. Indeed, in a company consumed
with improvement projects, the distinction between improvement and innovation may be
lost. Improvement projects can also get in the way of innovation efforts by appearing to
address similar issues. For instance, many companies implementing ERP or SCM systems
merely use them to enhance existing processes. Real innovations in order fulfillment or
supply chain are also likely to involve these technologies, but may be dismissed with the
observation that were already doing ERP.
OVERCOMI NG THE I MP E DI ME NTS
If, as is usually the case, a companys senior management does not recognize the
opportunity presented by operational innovation, all is not lost. In many companies, the
senior leader who instigated and drove a program of operational innovation was recruited
for the role by what may be called a catalyst. A catalyst is typically a mid-level manager
who is passionately committed to operational innovation and takes it upon himself or
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herself to find or create a leader who will make it happen. Catalysts are self-anointed.
Taking on this role entails career risk, since the catalyst is bearing a message that most
senior managers have not asked to hear and dont particularly want to. Moreover, should
the innovation effort encounter problems, the catalyst is likely to be blamed. Yet,
remarkably, there is no shortage of candidates for the catalyst role; every organization has
dozens of individuals with the requisite experience with operations, a bent towards
innovation, and a burning passion to combine the two in order to make a real difference.
Doug Mueller has played the role of catalyst at Schneider National, the largest full-load
trucking firm in the United States. In 2001, Doug was Director of Maintenance, and had
been responsible for a multi-year program that had reduced the cost per mile of
operations by 40%. He had an epiphany that the easiest way to continue to drive down
this key metric was to prevent trucks from moving at all! In other words, Doug realized
that persisting with traditional narrow-bore projects would not lead to the performance
improvements the company needed and that a larger scale and more ambitious approach
was called for despite the fact that the incremental approach was company policy at the
time. Doug identified Scott Arves, President of the Transportation Group, as a potential
leader of a broader gauge strategy. The two had worked closely together in the past, and
Doug thought Scotts background as an industrial engineer would make him eager to
embrace operational innovation. The two engaged in an extended series of discussions
and analyses, and Scott became passionate about a new approach and began to enlist
other members of the executive team. In early 2002, the company embarked on an effort
to redesign the process by means of which it bids for and acquires new business. The new
process entails a number of major innovations and departures for the company, including
integrating people from five functional departments into a single team, having a single
sales force sell all lines of business, and installing a dedicated group to managing the
overall trucking network. As a result, Schneider now responds to customer inquiries in a
third of the time that it used to and with much more effective proposals; in the first year
of the new process, the companys win rate on new business increased 80%.
T HI S E XP E RI E NCE I L LUS T RAT E S S OME OF T HE P RI NCI PLE S
OF SUCCES S FUL EXE CUT I VE CATA LY S I S :
Choos e a t a r ge t . Not every senior executive is a good candidate for the driver of
operational innovation. While the closer to the top the better, official position can not
compensate for a lack of critical personal characteristics.
First, someone who is to promote operational innovation must understand it; it is very
difficult to convince others of something one does not believe oneself. Some senior
managers simply lack the perspective needed to internalize an operational orientation.
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Second, the candidate must also have a personality congenial with major change;
operational innovation is, after all, innovation. Even some executives comfortable with
operations are not comfortable with making dramatic changes to it. At one aerospace
company, a team of catalysts concentrated on the CEO rather than the COO, because
despite the latters responsibilities and natural orientation towards operations, he did not
have the imagination, vision, and charisma needed to drive major operational change.
Ca mpa i gn. One presentation will not turn someone into an advocate for operational
innovation: a relentless campaign is needed. A key step is to bring the potential leader
face to face with existing operations and their inadequacies. In one company, a catalyst
arranged a simulation of a key process in the CEOs office. Another produced a videotape
of customers complaining bitterly about how hard the company was to do business with.
Regular conversations, shared news clippings, stories of progress at competitors all help to
wear away the disinclination to proceed. A particularly helpful tactic is to bring the
potential leader face to face with peers from other companies who have successfully
instigated and implemented operational innovation. This does more than any presentation
to make the candidate feel comfortable with what he or she is being asked to undertake.
Throughout, persistence should be the catalysts watchword. Doug Muellers motto is,
Connect with the vision, run until apprehended.
Bui l d on i nt e r na l e x pe r i e nc e . On the one hand, a catalyst can point to the
diminishing returns of conventional operational improvement efforts as an argument for a
more aggressive strategy. On the other, many companies, if they look hard enough, can
find isolated pockets of operational innovation. There may be one plant that implemented
a new way of scheduling production, a customer service center that used a CRM system in
a new way, a sales team that came up with a new way of supporting customers. A catalyst
should discover and exploit these internal experiences. They help convince candidate
leaders that operational innovation can not only work, it can work in this company. If such
pockets can not be found, then they will have to be created. The catalyst may need to
commission small-scale projects, working beneath the organizations radar, to illustrate the
power of the concept.
C re a t e pa s s i on. It is not enough for a leader to have a conceptual understanding
that operational innovation is an effective technique; he or she must have a deep belief
and commitment to it. Without such commitment, the leader will be hesitant to embark
on an unfamiliar path. Without it, he or she may not have the fortitude to continue the
effort despite inevitable problems and opposition. Passion can be contracted but it can not
be imposed. The style of the catalysts effort should therefore be one of shared discovery
and learning rather than didactic instruction. Executives become much more passionate
about ideas they develop themselves (even with assistance) than about those they are
force-fed.
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The campaign to develop a leader is over when the candidate takes control of the agenda
from the catalyst. But finding or creating the leader who will initiate and bless a program
of operational innovation is but the first step in making sure it succeeds. Line managers
must turn the concept into reality, despite the pressures of keeping the business going and
their own unfamiliarity with the idea and techniques of operational innovation. To focus
and support them, the initiating leader needs to designate an executive who will promote
and coordinate operational innovation across the organization. This individual will seed
and support rather than conduct projects; the latter is line managements responsibility.
The leader gives line managers targets to hit, while the operational innovation executive
provides them with the tools and resources they need, including the services of a cadre of
experts. The operational innovation executive also oversees the portfolio of innovation
projects, to ensure that energy and resources are focused on the biggest opportunities. In
many cases, the catalyst assumes this role. At Schneider National, Doug Mueller has
become Vice President of Process Redesign. He now has a small staff instead of an
organization of 1000 people, but his scope has expanded to encompass the entire
business.
The operational innovation executive must ensure that this work does not get lost in the
welter of other programs. The best way to do this is to have all operational change
initiatives, including operational innovation, be part of this executives purview. This
individual will need to make clear to the entire organization that operational improvement
and operational innovation are different but that both are necessary; senior leadership
needs to reinforce this message. The point must be made that the various tools and
techniques used in these efforts are not ends in themselves, but mechanisms in support of
larger, overarching goals. This executive helps line managers decide when and where
operational improvement is sufficient and when and where innovation is called for. The
right tool for the right problem should be his or her motto. At Johnson & Johnson, Susan
Lemons fills this role. She is Vice President of Process Excellence, and her portfolio includes
tools ranging from software systems and six sigma to process redesign and operational
innovation. She researches performance improvement methods and develops standard
methodologies that are deployed across J&J; her mission is to help line managers use these
tools to make both small and large changes in how J&J does business in pursuit of
improved performance.
F I NDI NG AND E XP L OI T I NG T HE OP P ORT U N I T I E S
Once a program of operational innovation gets under way, the company must decide on
where to focus the effort. As a rule, since operational innovation is by its nature disruptive,
it should be focused on the highest leveraged areas of activity, those with the greatest
impact on enterprise strategic goals.
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Progressive realized that in auto insurance, the key to profitable growth is customer
retention, since acquiring new customers through commission-based agents is very
expensive; in turn, the key to customer retention is providing customers with rewarding
experiences at the key junctures when they interact with the company. This led the
company to concentrate on streamlining claims, realizing that making this a more
pleasant experience for customers would have direct consequences on overall
performance. This was in stark contrast to many other auto insurers who saw claims as
a nuisance at best, since it entailed paying out money to claimants, and so viewed it as
a low-priority activity undeserving of energy or attention.
In the early 1990s, American Standard, the diversified manufacturer, had just survived a
hostile takeover effort by going through an LBO. Company leaders realized that
servicing the debt would consume virtually all the companys cash and starve product
development efforts; since a large amount of cash was tied up in inventories, the CEO
mandated that the company would have to drive down working capital and
dramatically increase inventory turns. This led to a program to transform manufacturing
from a conventional push-based system to one pulled by actual demand via a system
known as Demand Flow Manufacturing. The innovation paid off and led to a successful
IPO a few years later.
In the late 1990s, the U.S. unit of Siemens ICN (a major manufacturer of
telecommunications systems) embarked on a strategy that emphasized profitability over
growth. The companys leaders recognized that its existing customer engagement
process was oriented towards commodity sales and was insufficiently focused on
creating the high customer value that would yield higher margins. In response, they
created a new process, unprecedented in the telecommunications equipment industry,
which shifted away from indiscriminate equipment sales to focused consultative sales of
high-value integrated solutions. The results included both lower sales costs and higher
margins. As a consequence, Siemens ICN was able to remain profitable throughout
2000-2002, despite the crash in the telecommunications industry.
Using similar analyses, other companies have pinpointed procurement, order fulfillment,
product development, post-sales customer support, and even budgeting as the most
highly leveraged aspects of their operations, where innovation would have the greatest
impact on achieving key strategic goals. Needless to say, operational innovation need not
be limited to just one area. Most companies, however, find it prudent to limit their
innovation programs to no more than two or three major efforts at a time. To undertake
more is likely to consume too many resources and create too much organizational
disruption. Once the initial areas have been addressed, the net can be cast again to
identify further opportunities.
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Merely targeting an area for innovation is not enough; specific stretch performance goals
for it need to be specified. At American Standard, for instance, the goal was to triple
inventory turns; at Progressive, to initiate claims within nine hours; at Duke Power, to
perform work when promised 98% of the time. Absent such specific targets, innovation
efforts are likely to drift or to degenerate into incremental improvement projects. Only a
daunting target, clearly unattainable through existing modes of operation, will stimulate
the radical thinking and willingness to overturn tradition that is the essence of innovation.
Once the target for innovation has been identified, the next challenge is to invent a new
way of operating that achieves the target. This need not be simply a matter of crossing
ones fingers and hoping for inspiration. There are several concrete ways to focus and
accelerate the search for innovative operational designs. Three of the most effective are
the following:
Look for role models in other industries and other areas of operations. Benchmarking
within ones own industry is unlikely to uncover breakthrough concepts. On the other
hand, techniques applied in other industries with seemingly very different characteristics
may have unexpected applicability. For instance, in the 1980s Taco Bell transformed its
restaurant operations by thinking about them in manufacturing rather than in fast food
terms. It reduced the amount of on-site food preparation by outsourcing to its
suppliers, centralizing the production of key components, and concentrating on
assembly rather than fabrication in the restaurants. This of course defied the
conventional wisdom in the fast food industry, but that is what innovation always does.
The new approach lowered Taco Bells costs and increased customer satisfaction by
ensuring consistency and by allowing restaurant personnel to focus on customers rather
than production. HarvardPilgrim Health Care has applied techniques of market
segmentation, common in consumer goods but not in health insurance, to identify
patients most likely to have a medical crisis and to intervene with them before the crisis
occurs.
Identify and defy a constraining assumption. At its heart, every operational innovation
defies a conventional assumption about how work should be done. Cross-docking
negates the assumption that goods need to be stored in a warehouse; build-to-order
that goods should be produced based on forecast and destined for inventory;
Immediate Response claims processing that the key resource is the claims adjusters
time. Zero in on the assumption that interferes with achieving a strategic goal, and
then focus on how to get rid of it. A major hospital, for instance, recognized that in
order to increase the number of patients being admitted for (well-reimbursed) cardiac
bypass graft operations, it needed to respond more quickly to physicians who wanted
to refer a patient. The reason for the delay in response was the assumption that the
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hospital first had to assign the prospective patient a bed, an assumption that generated
hours of delay and often led physicians to send their patients elsewhere. The solution
was to tell the physician to send the patient immediately and to perform the bed
assignment while the patient was in transit.
Make the special case into the norm. Often, companies are able to achieve
extraordinary levels of performance under extraordinary conditions; their problem is
achieving extraordinary performance in normal situations. One way to do so is to turn
the special case process into the norm. A maker of consumer packaged goods, for
instance, had a process for deploying products into distribution centers that was based
on the centers ordering products from manufacturing for their inventories; this forced
manufacturing to base production scheduling on sales forecasts rather than on actual
customer demand, which in turn led to inventory imbalances. When demand for a new
product wildly exceeded forecasts, an ad hoc process was put into place that provided
manufacturing with real-time information about customer demand, which in turn
allowed much more effective production planning and product distribution. After the
crisis had passed, the company decided to turn this emergency mode of operation into
the standard one; the results included a dramatic drop in inventory, an improvement in
customer service, and a major reduction in the total cost of product deployment.
Rethink critical dimensions of work. Designing operations entails making choices in
seven key areas that determine how work activities are combined into overall business
processes that produce desired results. First, it requires specifying what results are to be
produced and deciding who should perform the necessary activities, where they should
be performed, and in what sequence. It also involves determining under what
circumstances (whether) each of the activities should or should not be performed, what
information should be available to the performers, and how thoroughly or intensively
each activity is to be performed. Managers looking to innovate in operations should
examine each of these dimensions, looking for opportunities to change one or more of
them in order to create a new operational design that delivers better performance..
A word of caution. Innovation, whether in products or processes, is inherently risky and
does not always yield immediate success. Not every idea that seems good actually is good,
and even good ideas do not always pan out as hoped or expected. Companies must be
prepared to roll with the punches and learn as they go. An apparel manufacturer had to
regroup when the technology underlying its plans for a new approach to production
scheduling did not live up to expectations; a consumer goods maker had to scale back an
innovation in logistics when implementing it turned out to be more difficult than
expected. Even companies experienced with operational innovation can encounter
problems. For instance, Progressive recently undertook to rethink one of the most basic
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assumptions of auto insurance that customers should pay for insurance by the year.
Instead, Progressive wanted to be able to sell auto insurance by the mile, and to that end
developed a GPS-based system to be installed in customers vehicles. This system would
report to Progressive how much a car was being driven and at what speed, and based on
that information Progressive would invoice the customer. The company conducted a trial
of this system in Texas; customers who did not drive very much and did so at moderate
speeds saw it as a wonderful opportunity to be charged less for their auto insurance.
However, Progressive concluded that the technology was not yet cost-effective, and so has
postponed a wider rollout until a future date. When the technology does hit that point,
Progressive will be ready to roll while competitors will have to start from scratch.
GET T I NG I MPL E ME NTAT I ON RI GHT
Even good ideas can fail because of faulty implementation. Indeed, many firms fail at
operational innovation because they forget that operational innovation is in fact a form of
innovation and needs to be managed as such. Instead, they apply conventional project
management techniques and then are surprised and disappointed when their efforts run
aground. There is an analogy here to Clayton Christensens observation that conventional
market analysis tools lead organizations astray when applied to disruptive technologies.
Conventional implementation techniques lead to failure when applied to disruptive modes
of operation.
Companies that follow traditional implementation methodologies begin with a vision of
the new ways of operating, translate that vision into precise specifications of jobs and
procedures, and develop a plan for realizing these specifications, including building
information systems, installing new measurement and reward systems, adapting job
descriptions and facilities, and the like. They then proceed to execute this plan, and the
result is disaster.
One reason is that such big bang monolithic implementations inevitably have protracted
time-lines. There is so much to be done, and so much that must be integrated with
everything else, that years will pass before the innovation is implemented and its benefits
start to flow. But operational innovation that is deferred is operational innovation that
fails. Every proposed major change in operating procedures is inevitably greeted with a
chorus of it will never work and similar sentiments; the entrenched old guard holds to
the point of view that if this new idea were actually any good, we would already have
been doing things that way. A stretched-out big bang implementation gives these
opponents an extended opportunity to campaign against it. Even those not aggressively
opposed to the innovation will find the protracted transition unsettling and disquieting;
organizational support inevitably leaks away as more and more time passes and money is
spent, without the innovation or its payoffs seeing the light of day. Leadership then loses
heart and the denouement is inevitable.
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Another problem with conventional implementation is that it is based on the misguided
assumption that the initial specifications for an operational innovation will be accurate
and complete. In reality, they will be neither. Uncertainty is the essence of innovation.
When envisioning new ways of working, it is impossible to get everything right from the
outset. The initial version of a new idea is only a rough approximation to the real one.
Things that look good on paper have an unfortunate tendency not to work when put into
practice; it is only when a concept is actually tried that one learns what it should really
have been in the first place.
Making mistakes and learning from them is an essential part of innovation. Just as market
requirements for a truly innovative product can not be ascertained without building and
testing a version of the product in the marketplace, so too the details of a proposed
operational innovation can not be nailed down before it is actually tried out. All this is
obvious to anyone who has gotten his or hands dirty with any form of innovation,
whether in products or processes; unfortunately, many managers lack this experience.
Companies need to adopt a new approach to implementing operational innovations. This
alternative approach builds on an idea that is starting to gain traction in software product
development, an idea variously known as iterative, evolutionary, or spiral development. Its
premise is that product specifications will not be gotten right the first time out, but only
through a series of iterations. With iterative development, one begins with ones best
estimate as to the innovation, builds a trial version of it, and then tries it out (with
customers or users); the learnings of these tests are then fed back into a fast-cycle
iteration of the next version. Alan MacCormack, in a recent article in HBR, describes how
this approach has been successfully applied in the development of Internet browsers, an
innovative product category whose requirements were not determinable in detail prior to
implementation. Following this approach is crucial when attempting operational
innovation. Since the precise features of the innovation will only emerge by getting
experience with it, implementation must proceed through iterative development and
testing.
A companion technique is that the full innovation need not indeed, should not be
implemented all at once. To do so inevitably brings about unacceptable delays. Rather, the
innovation should be implemented in a series of releases, each of which has enough
novelty to deliver important performance improvements, but is sufficiently contained that
it can be implemented in a manageable amount of time.
MetLife, for instance, in implementing a new process for installing coverage of a new
customer, broke the implementation into two releases. The first centered on a new
process design that featured the new role of a case implementation leader, who is
responsible for collecting all the information to establish coverage, as well as the use of a
project management tool to control the process. The new process was implemented in a
matter of months and delivered substantial reductions in cycle time as well as a 15%
productivity gain. However, this first release continued to rely on old information systems
to support the process. This was addressed in the second release, which installed a new
information system that facilitated data collection, enabled the systematic generation of
customer-specific documentation, and provided enhanced reporting capabilities. This
second release delivered another 20% productivity improvement as well as a 20 point
increase in customer satisfaction.
Shell Lubricants followed a similar strategy in transforming its order fulfillment process.
The first release was modest; it involved bringing all the departments involved in the old
process under a single manager. This easy-to-implement change was effected quickly and
delivered a degree of performance improvement. The next release took people out of
these departments and put them into cross-functional teams; performance improved
further. The final release entailed cross-training members of these teams so that one
person could handle an entire order. This was the destination the company had in mind all
along, but it was reached through a series of interim waystations rather than all at once.
Breaking a large-scale implementation into a series of limited releases, as MetLife and Shell
did, creates momentum, dispels skepticism and anxiety, and delivers a powerful rejoinder
to the carping of critics.
I S OP ERAT I ONAL I NNOVAT I ON S USTA I N A B L E ?
The barriers to operational innovation can be overcome; nonetheless, some executives may
wonder if it is worth the effort to do so. After all, the notion of first mover advantage
has of late lost some of its luster, and the alternative approach of close follower has
gained in the marketplace of business ideas. Why bother to be the first on the block to
develop and deploy a new way of working? Why go through the agony and the learning
curve? Why not let a competitor break that ground and then capitalize on their
experiences, doing an even better job at it than they? Indeed, where is the real strategic
advantage in operational innovation at all? Once one company introduces a new way of
doing things, all competitors can follow, and before long all are back on the same level
playing field having endured cost and travail to get there.
In theory, this is a powerful argument; in practice, it is not. In the real world, operational
innovations turn out to have legs. Even today, not all auto insurers offer immediate claims
response, not all retailers employ cross-docking in their distribution centers, and other
automakers are still struggling to imitate the Toyota Production System. Despite Dells
success, build-to-order has not swept the PC industry. At one major PC maker, an effort to
do so was suppressed by both the head of manufacturing (who was concerned that it
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would lead to outsourcing) and the head of marketing (who was afraid of alienating the
retail channel), and senior most leadership was preoccupied with other matters; eventually,
they largely exited the business.
There are many reasons why theoretically imitable operational innovations have staying
power. Some companies, even when confronted by a competitors innovations, will not
rush to emulate them. Denial of competitor superiority and executive disinclination to
truck with operations are powerful forces of nature, as are organizational momentum and
inertia. Even some who attempt to imitate the innovation will not understand it and others
will lack the capabilities to implement it. Some of those who do not (quickly) follow the
leader will vanish from the scene, and the rest will lose share; even those who do follow
will be at a disadvantage until they catch up. The innovator can harvest their customers in
the interim. For those who manage to overcome the barriers to operational innovation,
the difficulty of doing so represents a powerful obstacle for followers.
Over the long term, the sustainable power of operational innovation lies not in any single
concept, but in a continuing stream of them. Companies should strive to make operational
innovation not an extraordinary project but a way of life. Even areas of the business that
have already been rethought can benefit from subsequent rethinking, as new technologies
and new customer needs make the old innovations pass. The long-term winning firms
will be those that bake operational innovation into their culture. No sooner do such firms
upset the operational applecart for their competitors than they proceed to do it again.
Their competitors must continually scramble to catch up with the changing rules, but
never quite manage to do so. The innovator can even develop a reputation with customers
for relentlessly improving performance, a brand promise of extraordinary value.
Progressive has created such a culture; leaving well enough alone is a principle with which
the company is systemically uncomfortable. Progressive continues to rethink its operations
in order to stay ahead of competitors and to develop new capabilities that will represent
ever higher barriers to imitation. Recently, the company revised its very successful
Immediate Response claims process. In the latest approach, a Progressive representative no
longer attempts to assign an adjuster as soon as the claimant calls. Rather, the
representative guarantees to call the claimant back within two hours with specifics about
when an adjuster will see the vehicle. This two-hour window gives the company the
opportunity to assign just the right kind of adjuster to the specifics of the case, so that a
junior adjuster is not confronted with a complex accident beyond his level of expertise.
Progressive is also deploying in select markets what it calls a concierge approach to claims
handling. Here, a claimant simply brings the car to a Progressive claims facility at a
convenient time and leaves it there, picking up a loaner at the same time. Progressive then
takes responsibility for getting the car fixed by finding an appropriate body shop and
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inspecting the repairs made there. Under this system, the claimant is spared the hassle of
dealing with body shops, the Progressive adjuster works in a climate-controlled
environment that allows more careful inspection, and the body shop doesnt have to get
between Progressive and its customers. By the time its competitors become aware of and
imitate this latest innovation, Progressive will no doubt have done something else.
Operational innovation may feel unglamorous or unfamiliar to many executives, but it is in
fact the essence of business and the only lasting basis for superior performance. In an
economy that has overdosed on hype and high concept, and in which customers rule as
never before, operational innovation offers a meaningful and sustainable way to get ahead
and stay ahead of the pack.
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DR. MI CHAE L HAMME R
Dr. Michael Hammer is one of the worlds foremost business thinkers. He is the originator
of both reengineering and the process enterprise, ideas that have transformed the modern
business world. Organizations around the globe have achieved unparalleled performance
improvements by applying his principles to their operations and structure.
A highly sought-after lecturer, Dr. Hammer also serves as an advisor to leaders of the
worlds most progressive companies. His public seminars are attended by thousands of
people annually. He is the author of numerous articles and books, including the
international bestseller, Reengineering the Corporation: A Manifesto for Business
Revolution (HarperBusiness, 1993), and his latest book, The agenda: What Every Business
Must Do to Dominate the Decade (Crown Business, 2001).
Dr. Hammer was formerly a professor of computer science at the Massachusetts Institute
of Technology, and he is a founder and director of several high-technology firms. He was
named by BusinessWeek in 1992 as one of the four preeminent management thinkers of
the 1990s, and in 1996 he was named by Time magazine to its first list of Americas
twenty-five most influential individuals.
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