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Jim Collins

KROGER, A&P, AND THE MARKET

Cumulative Value of $1 Invested,

1959- 1973

General Market

$3 42

Notes:

1. Kroger transition point occurred in 1973.

2 Chart shows value of $1 invested on January 1, 1959.

3. Cumulative returns, dividends reinvested, to January 1, 1973.

KROGER, A&P, AND THE MARKET

Cumulative Value of $1 Invested,

1973 - 1998

Kroger: $1 98.47

Notes:

1 Kroger transition point occurred in 1973

2 Chart shows value of $1 tnvested on January 1.1973

3. Cumulative returns, dividends reinvested, to January 1, 1998.

 

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A&P had a perfect model for the first half of the twentieth century, when two world wars and a depression imposed frugality upon Americans: cheap, plentiful groceries sold in utilitarian stores. But in the afflu-ent second half of the twentieth century, Americans changed. They wanted nicer stores, bigger stores, more choices in stores. They wanted fresh-baked bread, flowers, health foods, cold medicines, fresh produce, forty-five choices of cereal, and ten types of milk. They wanted offbeat items, like five different types of expensive sprouts and various concoc-tions of protein powder and Chinese healing herbs. O h , and they wanted to be able to do their banking and get their annual flu shots while shopping. In short, they no longer wanted grocery stores. They wanted Superstores, with a big block "S" on the chest-offering almost everything under one roof, with lots of parking, cheap prices, clean floors, and a gazillion checkout lines.

Now, right off the bat, you might be thinking: "Okay, so the story of A&P is one of an aging company that had a strategy that was right for the times, but the times changed and the world passed it by as younger, better-attuned companies gave customers more of what they wanted. What's so interesting about that?"

Here's what's interesting: Both Kroger and A&P were old companies (Kroger at 82 years, A&P at 11 1 years) heading into the 1970s; both companies had nearly all their assets invested in traditional grocery stores; both companies had strongholds outside the major growth areas of the United States; and both companies had knowledge of how the world around them was changing. Yet one of these two companies confronted the brutal facts of reality head-on and completely changed its entire system in response; the other stuck its head in the sand.

In 1958, Forbes magazine described A&P as "the Hermit Kingdom,"

run as an absolute monarchy by an aging

Ralph Burger, the suc-

cessor to the Hartford brothers who had built the A&P dynasty, sought to preserve two things above all else: cash dividends for the family foundation and the past glory of the Hartford brothers. According to one A&P

director, Burger "considered himself the reincarnation of old John Hartford, even to the point of wearing a flower in his lapel every day from Hartford's greenhouse. He tried to carry out, against all opposition, what he thought Mr. John [Hartford] would have

Burger instilled a

"what would Mr. Hartford do?" approach to decisions, living by the motto

"You can't argue with a hundred years of Indeed, through

 

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Jim Collins

Burger, Mr. Hartford continued to be the dominant force on the board for nearly twenty years. Never mind the fact that he was already As the brutal facts about the mismatch between its past model and the changing world began to pile up, A&P mounted an increasingly spirited defense against those facts. In one series of events, the company opened a new store called T h e Golden Key, a separate brand wherein it could experiment with new methods and models to learn what customers wanted.: It sold no A&P-branded products, it gave the store manager more freedom, it experimented with innovative new departments, and it began to evolve toward the modern superstore. Customers really liked it. Here, right under their noses, they began to discover the answer to the questions of why the! were losing market share and what they could do about it.

What did A&P executives do with T h e Golden Key?

They didn't like the answers that it gave, so they closed A&P then began a pattern of lurching from one strategy to another, always looking for a single-stroke solution to its problems. It held pep rallies, launched programs, grabbed fads, fired CEOs, hired CEOs, and fired them yet again. It launched what one industry observer called a "scorched earth policy," a radical price-cutting strategy to build market share, but never dealt with the basic fact that customers wanted not lower prices, but different

T h e price cutting led to cost cutting, which led to even drabber stores and poorer service, which in turn drove customers away, further driving down margins, resulting in even dirtier stores and worse service. "After a while the crud kept mounting," said one former A&P

manager. "We not only had dirt, we had dirty Meanwhile, over at Kroger, a completely different pattern arose. Kroger also conducted experiments in the 1960s to test the superstore By 1970, the Kroger executive team came to an inescapable conclusion: T h e old-model grocery store (which accounted for nearly 100 percent of Kroger's business) was going to become extinct. Unlike A&P, however, Kroger confronted this brutal truth and acted on it.

T h e rise of Kroger is remarkably simple and straightforward, almost maddeningly so. During their interviews, Lyle Everingham and his predecessor Jim Herring (CEOs during the pivotal transition years) were polite and helpful, but a bit exasperated by our questions. To them, it just seemed so clear. When we asked Everingham to allocate one hundred points across the top five factors in the transition, he said: "I find your question a bit perplexing. Basically, we did extensive research, and the data came back loud and clear: T h e supercombination stores were the G o o d t o G r e a t

69

way of the future. We also learned that you had to be number one or number two in each market, or you had to exit.* Sure, there was some skepti-cism at first. But once we looked at the facts, there was really no question about what we had to do. So we just did

Kroger decided to eliminate, change, or replace every single store and depart every region that did not fit the new realities. T h e whole system would be turned inside out, store by store, block by block, city by city,

,

state by state. By the early 1990s, Kroger had rebuilt its entire system on the new model and was well on the way to becoming the number one grocery chain in America, a position it would attain in Meanwhile,

A&P still had over half its stores in the old 1950s size and had dwindled to a sad remnant of a once-great American

F A C T S A R E B E T T E R T H A N D R E A M S

O n e of the dominant themes from our research is that breakthrough results come about by a series of good decisions, diligently executed and accumulated one on top of another. Of course, the good-to-great companies did not have a perfect track record. But on the whole, they made many more good decisions than bad ones, and they made many more good decisions than the comparison companies. Even more important, on the really big choices, such as Kroger7s decision to throw all its resources into the task of converting its entire system to the superstore concept, they were remarkably on target.

This, of course, begs a question. Are we merely studying a set of companies that just happened by luck to stumble into the right set of decisions? O r was there something distinctive about their process that dramatically increased the likelihood of being right? T h e answer, it turns out, is that there was something quite distinctive about their process.

T h e good-to-great companies displayed two distinctive forms of disciplined thought. T h e first, and the topic of this chapter, is that they infused the entire process with the brutal facts of reality. (The second, which we

*Keep in mind, this was the early 1970s, a full decade before the "number one, number two, or exit" idea became mainstream. Kroger, like all good-to-great companies, developed its ideas by paying attention to the data right in front of it, not by following trends and fads set by others. Interestingly, over half the good-to-great companies had some version of the "number one, number two" concept in place years before it became a management fad.

 

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Collins

I

will discuss in the next chapter, is that they developed a simple, yet deeply insightful, frame of reference for all decisions.) When, as in the Kroger case, you start with an honest and diligent effort to determine the truth of the situation, the right decisions often become self-evident. Not always, of course, but often. And even if all decisions do not become self-evident, one thing is certain: You absolutely cannot make a series of good decisions without first confronting the brutal facts. T h e good-to-great companies operated in accordance with this principle, and the comparison companies generally did not.

Consider Pitney Bowes versus Addressograph. It would be hard to find two companies in more similar positions at a specific moment in history that then diverged so dramatically. Until 1973, they had similar revenues, profits, numbers of employees, and stock charts. Both companies held near-monopoly market positions with virtually the same customer base-Pitney Bowes in postage meters and Addressograph in address-duplicating machines-and both faced the imminent reality of losing their monopo-By 2000, however, Pitney Bowes had grown to over 30,000 employees and revenues in excess of $4 billion, compared to the sorry remnants of Addressograph, which had less than $100 million and only 670 employ-For the shareholder, Pitney Bowes outperformed Addressograph 3,581 to 1 (yes, three thousand five hundred and eighty-one times better).

In 1976, a charismatic visionary leader named Roy Ash became CEO

of Addressograph. A self-described "conglomerateur," Ash had previously built Litton by stacking acquisitions together that had since faltered.

According to Fortune, he sought to use Addressograph as a platform to reestablish his leadership prowess in the eyes of the Ash set forth a vision to dominate the likes of IBM, Xerox, and Kodak in the emerging field of office automation-a bold plan for a company that had previously only dominated the envelope-address-duplication busi-There is nothing wrong with a bold vision, but Ash became so wed-ded to his quixotic quest that, according to Business Week, he refused to confront the mounting evidence that his plan was doomed to fail and might take down the rest of the company with

He insisted on milking

cash from profitable arenas, eroding the core business while throwing money after a gambit that had little chance of

Later, after Ash was thrown out of office and the company had filed for bankruptcy (from which it did later emerge), he still refused to confront reality, saying: "We lost some battles, but we were winning the But

 

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PITNEY BOWES VERSUS ADDRESSOGRAPH

Annual Revenues, 1963-1 998

Constant 1998 Dollars, in Millions

Pitney Bowes

Addressograph was not even close to winning the war, and people throughout the company knew it at the time. Yet the truth went unheard until it was too

In fact, many of Addressograph's key people bailed out of the company, dispirited by their inability to get top management to deal with the

Perhaps we should give Mr. Ash some credit for being a visionary who tried to push his company to greater heights. (And, to be fair, the Addressograph board fired Ash before he had a chance to fully carry out his But the evidence from a slew of respectable articles written at the time suggests that Ash turned a blind eye to any reality inconsistent with his own vision of the world.

 

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"When you turn over rocks and look at all the squiggly things under-neath, you can either put the rock down, or you can say, 'My job is to turn over rocks and look at the squiggly things,' even if what you see can scare the hell out of

That quote, from Pitney Bowes executive Fred Pur-due, could have come from any of the Pitney Bowes executives we interviewed. They all seemed a bit, well, to be blunt, neurotic and compulsive about Pitney's position in the world. "This is a culture that is very hostile to complacency," said one

"We have an itch that what we just

accomplished, no matter how great, is never going to be good enough to sustain us," said

Pitney's first management meeting of the new year typically consisted of about fifteen minutes discussing the previous year (almost always superb results) and two hours talking about the "scary squiggly things" that might impede future

Pitney Bowes sales meetings were quite dif-

ferent from the "aren't we great" rah-rah sales conferences typical at most companies: T h e entire management team would lay itself open to searing questions and challenges from salespeople who dealt directly with cust o m e r ~ . ~ ~

The

company created a long-standing tradition of forums where people could stand up and tell senior executives what the company was doing wrong, shoving rocks with squiggly things in their faces, and saying,

"Look! You'd better pay attention to

T h e Addressograph case, especially in contrast to Pitney Bowes, illustrates a vital point. Strong, charismatic leaders like Roy Ash can all too easily become the de facto reality driving a company. Throughout the study, we found comparison companies where the top leader led with such force or instilled such fear that people worried more about the leader-what he would say, what he would think, what he would do-than they worried about external reality and what it could do to the company. Recall the climate at Bank of America, described in the previous chapter, wherein managers would not even make a comment until they knew how the CEO felt. We did not find this pattern at companies like Wells Fargo and Pitney Bowes, where people were much more worried about the scary squiggly things than about the feelings of top management.

T h e moment a leader allows himself to become the primary reality people worry about, rather than reality being the primary reality, you have a recipe for mediocrity, or worse. This is one of the key reasons why less charismatic leaders often produce better long-term results than their more charismatic counterparts.

 

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Winston Churchill understood the liabilities of his strong personality, and he compensated for them beautifully during the Second World War.

Churchill, as you know, maintained a bold and unwavering vision that Britain would not just survive, but prevail as a great nation-despite the whole world wondering not if but when Britain would sue for peace. During the darkest days, with nearly all of Europe and North Africa under Nazi control, the United States hoping to stay out of the conflict, and Hitler fighting a one-front war (he had not yet turned on Russia), Churchill said: "We are resolved to destroy Hitler and every vestige of the Nazi regime. From this, nothing will turn us. Nothing! We will never par-ley. We will never negotiate with Hitler or any of his gang. We shall fight him by land. We shall fight him by sea. We shall fight him in the air.

Until, with God's help, we have rid the earth of his Armed with this bold vision, Churchill never failed, however, to confront the most brutal facts. He feared that his towering, charismatic personality might deter bad news from reaching him in its starkest form.

So, early in the war, he created an entirely separate department outside the normal chain of command, called the Statistical Office, with the principal function of feeding him-continuously updated and completely unfiltered-the most brutal facts of

He relied heavily on this spe-

cial unit throughout the war, repeatedly asking for facts, just the facts. As the Nazi panzers swept across Europe, Churchill went to bed and slept soundly: "I . . . had no need for cheering dreams," he wrote. "Facts are better than

A C L I M A T E W H E R E T H E T R U T H I S H E A R D

Now, you might be wondering, "How do you motivate people with brutal facts? Doesn't motivation flow chiefly from a compelling vision?" T h e

 

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answer, surprisingly, is, "No." Not because vision is unimportant, but because expending energy trying to motivate people is largely a waste of time. O n e of the dominant themes that runs throughout this book is that if you successfully implement its findings, you will not need to spend time and energy "motivating7' people. If you have the right people on the bus, they will be self-motivated. T h e real question then becomes: How do you manage in such a way as not to de-motivate people? And one of the single most de-motivating actions you can take is to hold out false hopes, soon to be swept away by events.

How do you create a climate where the truth is heard? We offer four basic practices:

1. Lead with questions, not answers.

In 1973, one year after he assumed C E O responsibility from his father, Alan Wurtzel's company stood at the brink of bankruptcy, dangerously close to violation of its loan agreements. At the time, the company (then named Wards, not to be confused with Montgomery Ward) was a hodgepodge of appliance and hi-fi stores with no unifying concept.

Over the next ten years, Wurtzel and his team not only turned the company around, but also created the Circuit City concept and laid the foundations for a stunning record of results, beating the market twenty-two times from its transition date in 1982 to January 1, 2000.

When Alan Wurtzel started the long traverse from near bankruptcy to these stellar results, he began with a remarkable answer to the question of where to take the company: I don't know. Unlike leaders such as Roy Ash of Addressograph, Wurtzel resisted the urge to walk in with

"the answer." Instead, once he put the right people on the bus, he began not with answers, but with questions. "Alan was a real spark,"

said a board member. "He had an ability to ask questions that were just

 

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marvelous. We had some wonderful debates in the boardroom. It was never just a dog and pony show, where you would just listen and then go to

Indeed, Wurtzel stands as one of the few C E O s in a large corporation who put more questions to his board members than they put to him.

He used the same approach with his executive team, constantly pushing and probing and prodding with questions. Each step along the way, Wurtzel would keep asking questions until he had a clear picture of reality and its implications. "They used to call me the prosecutor, because I would home in on a question," said Wurtzel. "You know, like a bulldog, I wouldn't let go until I understood. Why, why, why?"

Like Wurtzel, leaders in each of the good-to-great transitions operated with a somewhat Socratic style. Furthermore, they used questions for one and only one reason: to gain understanding. They didn't use questions as a form of manipulation ("Don't you agree with me on that? . . .") or as a way to blame or put down others ("Why did you mess this up? . . ."). When we asked the executives about their management team meetings during the transition era, they said that they spent much of the time "just trying to understand."

T h e good-to-great leaders made particularly good use of informal meetings where they'd meet with groups of managers and employees with no script, agenda, or set of action items to discuss. Instead, they would start with questions like: "So, what's on your mind?" "Can you tell m e about that?" "Can you help me understand?" "What should we be worried about?" These non-agenda meetings became a forum where current realities tended to bubble to the surface.

2. Engage in dialogue and debate, not coercion.

In 1965, you could hardly find a company more awful than Nucor. It had only one division that made money. Everything else drained cash.

It had no culture to be proud of. It had no consistent direction. It was

 

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on the verge of bankruptcy. At the time, Nucor was officially known as the Nuclear Corporation of America, reflecting its orientation to nuclear energy products, including the Scintillation Probe (yes, they really named it that), used for radiation measurement. It had acquired a series of unrelated businesses in such arenas as semiconductor supplies, rare earth materials, electrostatic office copiers, and roof joists. At the start of its transformation in 1965, Nucor did not manufacture one ounce of steel. Nor did it make a penny of profit. Thirty years later, Nucor stood as the fourth-largest steelmaker in the and by 1999

made greater annual profits than any other American steel How did Nucor transition from the utterly awful Nuclear Corporation of America into perhaps the best steel company in America? First, Nucor benefited from the emergence of a Level 5 leader, Ken Iverson, promoted to C E O from general manager of the joist division. Second, Iverson got the right people on the bus, building a remarkable team of people like Sam Siegel (described by one of his colleagues as "the best money manager in the world, a magician") and David Aycock, an operations

And then what?

Like Alan Wurtzel, Iverson dreamed of building a .great company, but refused to begin with "the answer" for how to get there. Instead, he played the role of Socratic moderator in a series of raging debates. "We established an ongoing series of general manager meetings, and my role was more as a mediator," commented Iverson. "They were chaos. We would stay there for hours, ironing out the issues, until we came to something. . . . At times, the meetings would get so violent that people almost went across the table at each other. . . . People yelled. They waved their arms around and pounded on tables. Faces would get red and veins bulged

Iverson's assistant tells of a scene repeated over the years, wherein colleagues would march into Iverson's office and yell and scream at each other, but then emerge with a

Argue and debate,

then sell the nuclear business; argue and debate, then focus on steel joists; argue and debate, then begin to manufacture their own steel; argue and debate, then invest in their own mini-mill; argue and debate, then build a second mini-mill, and so forth. Nearly all the Nucor executives we spoke with described a climate of debate, wherein the company's strategy "evolved through many agonizing arguments and

 

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3. Conduct autopsies, without blame.

In 1978, Philip Morris acquired the Seven-Up Company, only to sell it eight years later at a

T h e financial loss was relatively small

compared to Philip Morris's total assets, but it was a highly visible black eye that consumed thousands of hours of precious management time.

In our interviews with the Philip Morris executives, we were struck by how they all brought up the debacle on their own and discussed it openly. Instead of hiding their big, ugly mistake, they seemed to feel an almost therapeutic need to talk about it. In his book, I'm a Lucky Guy, Joe Cullman dedicates five pages to dissecting the 7UP disaster. He doesn't hold back the embarrassing truth about how flawed the decision was. It is a five-page clinical analysis of the mistake, its implications, and its lessons.

Hundreds, if not thousands, of people hours had been spent in autopsies of the 7UP case. Yet, as much as they talked about this conspicuous failure, no one pointed fingers to single out blame. There is only one exception to this pattern: Joe Cullman, standing in front of the mirror, pointing the finger right at himself. "[It] . . . became apparent that this was another Joe Cullman plan that didn't work," he He goes

even further, implying that if he'd only listened better to the people who challenged his idea at the time, the disaster might have been averted. He goes out of his way to give credit to those who were right in retrospect, naming those specific individuals who were more prescient than himself.

In an era when leaders go to great lengths to preserve the image of their own track record-stepping forth to claim credit about how they were visionary when their colleagues were not, but finding others to blame when their decisions go awry-it is quite refreshing to come

 

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across Cullman. He set the tone: "I will take responsibility for this bad decision. But we will all take responsibility for extracting the maximum learning from the tuition we've paid."

4. Build "red flag" mechanisms.

We live in an information age, when those with more and better information supposedly have an advantage. If you look across the rise and fall of organizations, however, you will rarely find companies stumbling because they lacked information.

Bethlehem Steel executives had known for years about the threat of mini-mill companies like Nucor. They paid little attention until they woke up one day to discover large chunks of market share taken Upjohn had plenty of information that indicated some of its forth-coming products would fail to deliver anticipated results or, worse, had potentially serious side effects. Yet it often ignored those problems. With Halcion, for example, an insider was quoted in Newsweek saying, "dis-missing safety concerns about Halcion had become virtual company policy." In another case when Upjohn found itself under fire, it framed its problems as "adverse publicity," rather than confronting the truth of its own

Executives at Bank of America had plenty of information about the realities of deregulation, yet they failed to confront the one big implication of those realities: In a deregulated world, banking would be a commodity, and the old perks and genteel traditions of banking would be gone forever. Not until it had lost $1.8 billion did Bank of America fully accept this fact. In contrast, Carl Reichardt of Wells Fargo, called the ultimate realist by his predecessor, hit the brutal facts of deregulation Sorry, fellow bankers, but we can preserve the banker class no more. We've got to be businessmen with as much attention to costs and effectiveness as McDonald's.

 

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O n e particularly powerful way to accomplish this is through red flag mechanisms. Allow me to use a personal example to illustrate the idea.

When teaching by the case method at Stanford Business School, I issued to each MBA student an 8.5" x 11" bright red sheet of paper, with the following instructions: "This is your red flag for the quarter. If you raise your hand with your red flag, the classroom will stop for you.

There are no restrictions on when and how to use your red flag; the decision rests entirely in your hands. You can use it to voice an observation, share a personal experience, present an analysis, disagree with the professor, challenge a C E O guest, respond to a fellow student, ask a question, make a suggestion, or whatever. There will be no penalty whatsoever for any use of a red flag. Your red flag can be used only once during the quarter. Your red flag is nontransferable; you cannot give or sell it to another student."

With the red flag, I had no idea precisely what would happen each day in class. In one situation, a student used her red flag to state, "Professor Collins, I think you are doing a particularly ineffective job of running class today. You are leading too much with your questions and stifling our independent thinking. Let us think for ourselves." The red flag confronted me with the brutal fact that my own questioning style stood in the way of people's learning. A student survey at the end of the quarter would have given me that same information. But the red flag-real time, in front of everyone in the classroom-turned information about the shortcomings of the class into information that I absolutely could not ignore.

I got the idea for red flag mechanisms from Bruce Woolpert, who instituted a particularly powerful device called short pay at his company Graniterock. Short pay gives the customer full discretionary power to decide whether and how much to pay on an invoice based upon his own subjective evaluation of how satisfied he feels with a product or service. Short pay is not a refund policy. The customer does not need to

 

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return the product, nor does he need to call Graniterock for permis-sion. He simply circles the offending item on the invoice, deducts it from the total, and sends a check for the balance. When I asked Woolpert his reasons for short pay, he said, "You can get a lot of information from customer surveys, but there are always ways of explaining away the data. With short pay, you absolutely have to pay attention to the data. You often don't know that a customer is upset until you lose that customer entirely. Short pay acts as an early warning system that forces us to adjust quickly, long before we would lose that customer."

To be clear, we did not generally find red flag mechanisms as vivid and dramatic as short pay in the good-to-great companies. Nonetheless, I've decided to include this idea here, at the urging of research assistant Lane Hornung. Hornung, who helped me systematically research and collate mechanisms across companies for a different research project, makes the compelling argument that if you're a fully developed Level 5

leader, you might not need red flag mechanisms. But if you are not yet a Level 5 leader, or if you suffer the liability of charisma, red flag mechanisms give you a practical and useful tool for turning information into information that cannot be ignored and for creating a climate where the truth is heard.*

U N W A V E R I N G F A I T H A M I D T H E B R U T A L F A C T S

When Procter & Gamble invaded the paper-based consumer business in the late 1960s, Scott Paper (then the leader) simply resigned itself to second place without a fight and began looking for ways to

"The

company had a meeting for analysts in 1971 that was one of the most depressing I've ever attended," said one analyst. "Management essentially threw in the towel and said, 'We've been had.'

T h e once-proud com-

pany began to look at its competition and say, "Here's how we stack u p against the best," and sigh, "Oh, well . . . at least there are people in the business worse than we

Instead of figuring out how to get back on

the offensive and win, Scott just tried to protect what it had. Conceding the top end of the market to P&G, Scott hoped that, by hiding away in

"For a more complete discussion of mechanisms, see the article "Turning Goals into Results: The Power of Catalytic Mechanisms,"

Business Review, July-August,

1999.

 

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the B category, it would be left alone by the big monster that had invaded its

Kimberly-Clark, on the other hand, viewed competing against Procter

& Gamble not as a liability, but as an asset. Darwin Smith and his team felt exhilarated by the idea of going up against the best, seeing it as an opportunity to make Kimberly-Clark better and stronger. They also viewed it as a way to stimulate the competitive juices of Kimberly people at all levels. At one internal gathering, Darwin Smith stood u p and started his talk by saying, "Okay, I want everyone to rise in a moment of silence."

Everyone looked around, wondering what Darwin was up to. Did someone die? And so, after a moment of confusion, they all stood up and stared at their shoes in reverent silence. After an appropriate pause, Smith looked out at the group and said in a somber tone, "That was a moment of silence for P&G."

T h e place went bananas. Blair White, a director who witnessed the incident, said, "He had everyone wound up in this thing, all up and down the company, right down to the plant floor. We were taking on Later, Wayne Sanders (Smith's successor) described to us the incredible benefit of competing against the best: "Could we have a better adversary than P&G? Not a chance. I say that because we respect them so much.

They are bigger than we are. They are very talented. They are great at marketing. They beat the hell out of every one of their competitors, except one, Kimberly-Clark. That is one of the things that makes us so Robert Aders of Kroger summed this up nicely at the end of his interview, describing the psychology of the Kroger team as it faced the daunting twenty-year task of methodically turning over the entire Kroger system.

"There was a certain Churchillian character to what we were doing. We had a very strong will to live, the sense that we are Kroger, Kroger was here before and will be here long after we are gone, and, by god, we are going

 

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to win this thing. It might take us a hundred years, but we will persist for a hundred years, if that's what it

Throughout our research, we were continually reminded of the "hardiness" research studies done by the International Committee for the Study of Victimization. These studies looked at people who had suffered serious adversity-cancer patients, prisoners of war, accident victims, and so forth-and survived. They found that people fell generally into three categories: those who were permanently dispirited by the event, those who got their life back to normal, and those who used the experience as a defining event that made them

T h e good-to-great companies

were like those in the third group, with the "hardiness factor."

When Fannie Mae began its transition in the early 1980s, almost no one gave it high odds for success, much less for greatness. Fannie Mae had $56 billion of loans that were losing money. It received about 9 percent interest on its mortgage portfolio but had to pay up to 15 percent on the debt it issued. Multiply that difference times $56 billion, and you get a very large negative number! Furthermore, by charter, Fannie Mae could not diversify outside the mortgage finance business. Most people viewed Fannie Mae as totally beholden to shifts in the direction of interest rates-they go up and Fannie Mae loses, they go down and Fannie Mae wins-and many believed that Fannie Mae could succeed only if the government stepped in to clamp down on interest

"That's their only

hope," said one

But that's not the way David Maxwell and his newly assembled team viewed the situation. They never wavered in their faith, consistently emphasizing in their interviews with us that they never had the goal to merely survive but to prevail in the end as a great company. Yes, the interest spread was a brutal fact that was not going to magically disappear. Fannie Mae had no choice but to become the best capital markets player in the world at managing mortgage interest risk. Maxwell and his team set out to create a new business model that would depend much less on interest rates, involving the invention of very sophisticated mortgage finance instruments. Most analysts responded with derision. "When you've got $56 billion worth of loans in place and underwater, talking about new programs is a joke," said one. "That's like Chrysler [then asking for federal loan guarantees to stave off bankruptcy] going into the aircraft After completing my interview with David Maxwell, I asked how he and his team dealt with the naysayers during those dark days. "It was never an issue internally," he said. "Of course, we had to stop doing a lot of stu-

 

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pid things, and we had to invent a completely new set of financial devices.

But we never entertained the possibility that we would fail. We were going to use the calamity as an opportunity to remake Fannie Mae into a great During a research meeting, a team member commented that Fannie Mae reminded her of an old television show, The Six Million Dollar Man with Lee Majors. T h e pretext of the series is that an astronaut suffers a serious crash while testing a moon landing craft over a southwestern desert.

Instead of just trying to save the patient, doctors completely redesign him into a superhuman cyborg, installing atomic-powered robotic devices such as a powerful left eye and mechanical

Similarly, David Maxwell

and his team didn't use the fact that Fannie Mae was bleeding and near death as a pretext to merely restructure the company. They used it as an opportunity to create something much stronger and more powerful. Step by step, day by day, month by month, the Fannie Mae team rebuilt the entire business model around risk management and reshaped the corporate culture into a high-performance machine that rivaled anything on Wall Street, eventually generating stock returns nearly eight times the market over fifteen years.

T H E S T O C K D A L E P A R A D O X

Of course, not all good-to-great companies faced a dire crisis like Fannie Mae; fewer than half did. But every good-to-great company faced significant adversity along the way to greatness, of one sort or another-Gillette and the takeover battles, Nucor and imports, Wells Fargo and deregulation, Pitney Bowes losing its monopoly, Abbott Labs and a huge product recall, Kroger and the need to replace nearly 100 percent of its stores, and so forth. In every case, the management team responded with a powerful psychological duality. O n the one hand, they stoically accepted the brutal facts of reality. O n the other hand, they maintained an unwavering faith in the endgame, and a commitment to prevail as a great company despite the brutal facts. We came to call this duality the Stockdale Paradox.

T h e name refers to Admiral Jim Stockdale, who was the highest-ranking United States military officer in the "Hanoi Hilton" prisoner-of-war camp during the height of the Vietnam War. Tortured over twenty times during his eight-year imprisonment from 1965 to 1973, Stockdale lived out the war without any prisoner's rights, no set release date, and no

 

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certainty as to whether he would even survive to see his family again. He shouldered the burden of command, doing everything he could to create conditions that would increase the number of prisoners who would survive unbroken, while fighting an internal war against his captors and their attempts to use the prisoners for propaganda. At one point, he beat himself with a stool and cut himself with a razor, deliberately disfiguring himself, so that he could not be put on videotape as an example of a "well-treated prisoner." He exchanged secret intelligence information with his wife through their letters, knowing that discovery would mean more torture and perhaps death. He instituted rules that would help people to deal with torture (no one can resist torture indefinitely, so he created a step-wise system-after x minutes, you can say certain things-that gave the men milestones to survive toward). He instituted an elaborate internal communications system to reduce the sense of isolation that their captors tried to create, which used a five-by-five matrix of tap codes for alpha characters. (Tap-tap equals the letter a, tap-pause-tap-tap equals the letter b, tap-tap-pause-tap equals the letter f; and so forth, for twenty-five letters, c doubling in for k.) At one point, during an imposed silence, the prisoners mopped and swept the central yard using the code, swish-swashing out

"We love you" to Stockdale, on the third anniversary of his being shot down. After his release, Stockdale became the first three-star officer in the history of the navy to wear both aviator wings and the Congressional Medal of

You can understand, then, my anticipation at the prospect of spending part of an afternoon with Stockdale. One of my students had written his paper on Stockdale, who happened to be a senior research fellow studying the Stoic philosophers at the Hoover Institution right across the street from my office, and Stockdale invited the two of us for lunch. In preparation, I read In Love and War, the book Stockdale and his wife had written in alternating chapters, chronicling their experiences during those eight years.

As I moved through the book, I found myself getting depressed. It just seemed so bleak-the uncertainty of his fate, the brutality of his captors, and so forth. And then, it dawned on me: "Here I a m sitting in my warm and comfortable office, looking out over the beautiful Stanford campus on a beautiful Saturday afternoon. I'm getting depressed reading this, and I know the end of the story! I know that he gets out, reunites with his family, becomes a national hero, and gets to spend the later years of his life studying philosophy on this same beautiful campus. If it feels depressing

 

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for me, how on earth did he deal with it when he was actually there and did not know the end of the story?"

"I never lost faith in the end of the story," he said, when I asked him. "I never doubted not only that I would get out, but also that I would prevail in the end and turn the experience into the defining event of my life, which, in retrospect, I would not trade."

I didn't say anything for many minutes, and we continued the slow walk toward the faculty club, Stockdale limping and arc-swinging his stiff leg that had never fully recovered from repeated torture. Finally, after about a hundred meters of silence, I asked, "Who didn't make it out?"

"Oh, that's easy," he said. "The optimists."

"The optimists? I don't understand," I said, now completely confused, given what he'd said a hundred meters earlier.

"The optimists. Oh, they were the ones who said, 'We're going to be out by Christmas.' And Christmas would come, and Christmas would go.

Then they'd say, 'We're going to be out by Easter.' And Easter would come, and Easter would go. And then Thanksgiving, and then it would be Christmas again. And they died of a broken heart."

Another long pause, and more walking. Then he turned to me and said,

"This is a very important lesson. You must never confuse faith that you will prevail in the end- which you can never afford to lose-with the discipline to confront the most brutal facts of your current reality, whatever they might be."

To this day, I carry a mental image of Stockdale admonishing the optimists: "We're not getting out by Christmas; deal with it!"

That conversation with Admiral Stockdale stayed with me, and in fact had a profound influence on my own development. Life is unfair-sometimes to our advantage, sometimes to our disadvantage. We will all experience disappointments and crushing events somewhere along the way, setbacks for which there is no "reason," no one to blame. It might be disease; it might be injury; it might be an accident; it might be losing a loved one; it might be getting swept away in a political shake-up; it might be getting shot down over Vietnam and thrown into a P O W camp for eight years.

What separates people, Stockdale taught me, is not the presence or

 

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absence of difficulty, but how they deal with the inevitable difficulties of life. In wrestling with life's challenges, the Stockdale Paradox (you must retain faith that you will prevail in the end and you must also confront the most brutal facts of your current reality) has proved powerful for coming back from difficulties not weakened, but stronger-not just for me, but for all those who've learned the lesson and tried to apply it.

I never really considered my walk with Stockdale as part of my research into great companies, categorizing it more as a personal rather than corporate lesson. But as we unraveled the research evidence, I kept coming back to it in my own mind. Finally, one day during a research-team meeting, I shared the Stockdale story. There was silence around the table when I finished, and I thought, "They must think I'm really out in left field."

Then Duane Duffy, a quiet and thoughtful team member who had done the A&P versus Kroger analysis, said, "That's exactly what I've been struggling with. I've been trying to get my hands around the essential difference between A&P and Kroger. And that's it. Kroger was like Stockdale, and A&P was like the optimists who always thought they'd be out by Christmas."

Then other team members began to chime in, noting the same difference between their comparison sets-Wells Fargo versus Bank of America both facing deregulation, Kimberly-Clark versus Scott Paper both facing the terrible might of Procter & Gamble, Pitney Bowes versus Addressograph both facing the loss of their monopolies, Nucor versus Bethlehem Steel both facing imports, and so forth. They all demonstrated this paradoxical psychological pattern, and we dubbed it the Stockdale Paradox.

The Stockdale Paradox is a signature of all those who create greatness, be it in leading their own lives or in leading others. Churchill had it during the Second World War. Admiral Stockdale, like Viktor Frankl before him, lived it in a prison camp. And while our good-to-great companies cannot claim to have experienced either the grandeur of saving the free Good to Great

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world or the depth of personal experience of living in a P O W camp, they all embraced the Stockdale Paradox. It didn't matter how bleak the situation or how stultifying their mediocrity, they all maintained unwavering faith that they would not just survive, but prevail as a great company. And yet, at the same time, they became relentlessly disciplined at confronting the most brutal facts of their current reality.

Like much of what we found in our research, the key elements of greatness are deceptively simple and straightforward. T h e good-to-great leaders were able to strip away so much noise and clutter and just focus on the few things that would have the greatest impact. They were able to do so in large part because they operated from both sides of the Stockdale Paradox, never letting one side overshadow the other. If you are able to adopt this dual pattern, you will dramatically increase the odds of making a series of good decisions and ultimately discovering a simple, yet deeply insightful, concept for making the really big choices. And once you have that simple, unifying concept, you will be very close to making a sustained transition to breakthrough results. It is to the creation of that concept that we now turn.

 

 

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