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Risky Business Pays Off

June 10, 2007
Risk/reward thinking is driving today's turnaround successes. Winning requires transitioning from risk takers to risk shapers.

It's time to update conventional wisdom.

For example, in the 1980s conventional wisdom said you could have high quality or low cost, but not both -- until Japanese makers of cars and electronics showed otherwise. Now, high quality and low cost are required just to enter the marketplace.

Today, a similar paradox involves the conventional wisdom on risks and rewards -- that bigger rewards always require bigger risks. The challenge is to recognize that risk and reward are not inextricably linked, says management guru and author Adrian J. Slywotzky, director, Oliver Wyman (formerly Mercer Management). "It is possible to reduce the risk you confront at the same time you improve the returns." His evidence: "The leaders of today's most successful companies aren't risk takers, they're risk shapers."

He says the risk shapers typically uncover growth breakthroughs as well as the means to counter the accelerating economic volatility from such things as globalization, technology, venture capital, private capital and deregulation. Evidence of the new thinking is growing and can be seen in the turnaround accomplishments of such companies as DuPont, Corning Inc. and Cummins Inc.

Slywotzky explores his thinking in the just-published, "The Upside, The 7 Strategies for Turning Big Threats into Growth Breakthroughs" (Crown Business, 2007). In the book Slywotzky explains how the revised thinking on risk and reward applies to the successes of companies ranging from Toyota, Apple, Continental AG and Samsung to retailers such as Target and Coach.

He says the inspiration for the book came from how those companies gain new business opportunity while reducing unnecessary risk exposure. Rather than shrink from the risk so integral to the tumultuous global economy, those companies regard risk as being the greatest source of growth and future business reward. To Slywotzky, as management consultant, the key phrase is "strategic risk management." The goal: a transformation process to increase business opportunity while lowering business risk.

How is it done? Automakers, for example, constantly face the costly risk of project failure when they develop a new product. For example, Toyota's hybrid Prius was a $2 billion risk with a 5% chance of success initially. By making a series of specific risk-reduction moves, Toyota (but not GM, Ford or DaimlerChrysler) came out with the next big thing, which has an upside in the neighborhood of $15 billion to $25 billion. The upside of risk reversed was 10 times greater than the downside, adds Slywotzky.

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He says the fashion industry faces another type of risk -- potential decimation of its customer base because of shifts in customer behavior, preferences and demographics. What's hot today can quickly become yesterday's sales rack.

Slywotzky says Coach, the New York-based retailer, turns that risk into an upside through the genius of knowing 5% more about customers than its competitors. Coach creates and applies continuous proprietary information about its customers, explains Slywotzky. The guiding principle: Risk is just an expensive substitute for information.

The urgency for a solution is growing, says Slywotzky, as the challenge spreads throughout the economy. "For example, banks had this problem 15 years ago when financial risk management was still crude and unsophisticated. Since solved, that was a big deal for banks since 70% of their total risk is financial [rather than hazard or strategic]."

In the manufacturing world the issue is strategic risk management -- the external changes in the customer, competition, brand collapse and such things as failing projects. Slywotzky finds fault with the common syndrome of corporate offices not sharing in divisional risk management. "Corporate leadership needs to realize what its exposure is. Too many companies delegate strategic risk management as just another routine cost of doing business and some downplay strategic risk management because they see it as defensive."

Slywotzky says the most surprising discovery from his research is the finding that just about all strategic risks can be anticipated. "All that's needed is an early warning system that can pick up the early warning signals." Even more surprising is his assertion that by being early and proactive virtually any risk can be turned into an upscale growth opportunity.

"If people understood that, they would be motivated to do [risk/reward analysis] not only for defensive reasons -- I don't want to suffer a value loss' -- but also because it is a dependable, albeit unconventional, pathway to find many of the big growth opportunities of the next 5 to 10 years."

Strategic Risks (AKA Opportunities)

Slywotzky tells IW that each of the following seven strategic risks could represent a moment of maximum opportunity in terms of growth and/or revenue:

  • Project Risk: Most companies overestimate their odds for success. A few know the true odds and invest appropriately. They take specific steps such as creating excess options or the stepping-stone technique to change them in their favor. Slywotzky notes that people usually talk of new projects in terms of taking risks, but he suggests another
    approach: "Let's ask a different question. Can we get good at estimating the odds of success at the outset of the project? The consequence of that is that we quickly learn that we tend to overestimate the odds of success by a factor of three or four. And as a result of that we under-invest in the project."

    He cites the Toyota Prius and Apple iPod as examples. "They significantly overinvested when they realized the game-changing potential after being very clear on the true odds of success -- 5% for the Prius and 10% for the iPod.

    Slywotzky says a change in thinking would result. "For example, they would realize that over-investing in many projects is not a path to success. Secondly, they would get better at calculating the odds and make the right investments in fewer projects." The third change involved not only getting the product right, but the business model, too.
  • Customer Risk: Today's smartest companies are able to see the next customer shift and respond before it happens. The key is knowledge intensity. Slywotzky says the intensity of strategic risk today is attributable to how easy it is for customers to change suppliers. Sporadic data on the market and customers equals high risk. Continuous data equals low risk. Proprietary customer knowledge is as important as knowledge involving your proprietary technology, says Slywotzky. He discovered that retailer Coach annually performs 60,000 customer interviews. On the b2b side, C-level contact is the goal.
  • Transition Risk: Virtually every industry will face a landscape-changing shift from one technology or business design to another. Historically, 70% to 80% of the companies don't make the transition, notes Slywotzky. Major economic changes can result. The key to survive is double betting. Major growth opportunities can be a result. Study the successes of IBM and Microsoft, he adds.
  • Unique Competitor Risk: One industry after another is being conquered by a seemingly unstoppable competitor. Slywotzky says Toyota is in the process of becoming one. The signs: The automaker's ever-increasing lead in manufacturing now has a counterpart in its own product development. His recommended counter-tactic: Don't fight the behemoth; play a different game instead.
  • Brand Risk: Once fortresses of value, today's brands are more vulnerable than ever. To defend and grow your brand, learn about the golden triangle of brand, product, and business design and invest accordingly. Samsung is an example of a current winner, says Slywotzky.
  • Industry Risk: Sometimes entire industries become no-profit zones. The key to thriving is knowing how and when to collaborate with rivals. Slywotzky describes the collaboration between Sony and Samsung as an outstanding example. He says they contrast with industries in distress that usually take this step seven to 10 years too late.
  • Stagnation Risk: When markets mature, growth often grinds to a halt. The best response: demand innovation, which opens up new avenues of growth that a company may already be primed to explore.

Corning's Recovery: The Balancing Act

In Corning's 2001 annual report, the company indicated adjustments to market conditions that included the third- and fourth-quarter elimination of 12,000 jobs. Stock price, which had reached $100, declined to just over $1.

"A three-part balancing act followed," says Peter F. Volanakis, president and COO. "One was to protect our financial health. The second was to restore profitability and the third was to invest in the future. Next was the painful realization that we had too many people in our telecom operations, and the total employee numbers fell by half to around 21,000." Factory closings, divestitures and debt reductions (from $4.5 billion to $1.5 billion today) followed. "This was not a reinvention of the company," says Volanakis. "This was a continuation of . . . a better version of ourselves."

Although R&D was cut, most of the reductions were in the telecom area with minimal impacts in other areas with considerable growth programs underway. He emphasizes "that even at the peak of the telecom boom, we continued to invest very heavily in other non-telecom related businesses. LCD was just emerging, and we continued to spend heavily on that and our diesel initiative, and today LCD is very large, larger than telecom was at its peak and considerably more profitable, and now we're rapidly scaling up our diesel business."

Risks? "We grow from internal innovation of a long-term nature. The LCD business, for example, lost money between 1984 and 1998, turning a corner in 1999. So one of our greatest concerns during the downturn was not to damage a future growth area. And we do not allow discussions of today's financial performance when we're talking about growth programs. We completely separate them."

Lessons learned? "First, keep bets going in a number of different businesses and invest time understanding customers and their customers. Focus on understanding motivations and business models. Today, in our LCD business we maintain detailed financial understanding of our customers.

"Second, avoid straight-line thinking on sales and market projections. At Corning we constantly challenge projections to better understand markets and to be more aware of the sales volatility that could come from technological substitution." He says Corning's telecom results were entirely straight line -- except for dip at the industry's bust. "Also prepare a financial structure that is consistent with the nature of the business. We like to have more cash than debt, enough excess to take care of unexpected growth opportunities.

"We love our LCD business, but we're not happy that it is so dominant in our financial performance. We would prefer to have a wider array of businesses that march to different drummers at different points in their lifecycle. We try to do that by investing in more different things early on."

Turnaround results? In 2003 sales closed at $3.1 billion versus $5.2 billion in 2006. For 2006, Volanakis reports $1.9 billion in net profit after tax. The R&D spend was 10% of revenue.

"But in terms of revenue sources, we're still not balanced," notes Volanakis. "We went from a boom in telecommunications to a boom in LCDs." His consolation is that the LCD market is more predictable. "In addition, LCDs have made us more international by switching revenues to 70% offshore versus 90% North American during the telecom boom." He cites LCD growth rates of 30% to 40%.

A Six Sigma Turnaround

Cause and effect? In 2000 the implementation of Six Sigma began at Cummins. Today promotion to executive positions at the company requires Six Sigma certification, reports George Strodtbeck, executive director of corporate quality.

"We began those first launches of Six Sigma right before the biggest downturn in the history of the company. We did a launch every month through 2001, elevating 30 problems that became projects. That was the genesis of our quality improvement efforts."

The motivating factors: "Our warranty cost of coverage was too high and we had a rising number of dissatisfied customers in many of our markets, and we weren't seeing a return on sales that was adequate for a company like ours." Strodtbeck says the CEO's search for a solution culminated in Six Sigma. "It was the realization that we needed a common approach to problem solving and continuous improvement across the company. In addition to high warranty costs, our product introductions took way too long. We fell into a syndrome of introducing new products with a lot of problems that had to be solved in the application."

This resulted in growing resistance in the market. "We first applied Six Sigma to the manufacturing process followed by the concept of design for Six Sigma. We also use something called technology development for Six Sigma, which considers concepts and variations of invention." Strodtbeck says all aspects of business use some variant or form of Six Sigma.

The progress: "We went from a company that basically had almost zero return on sales to 10% pretax. Last year we made $1.1 billion in pretax profit on $11 billion in revenue." To properly evaluate Six Sigma, Strodtbeck recommends a long-term commitment. "It took us almost three years to see tangible evidence of Six Sigma's benefits. As a means of comparison, he notes that Toyota did not have its current reputation at the beginning of its 50-year presence in the United States. Remember that time is required to really change an organization. "Ongoing effort is the only thing that works."

Six Sigma also impacts the company's suppliers. "We have made Six Sigma or its equivalent a prerequisite for our key suppliers." Cummins also has customer-focused Six Sigma projects working on problems that they identify. Strodtbeck says the history of 7,500 projects has saved the company about $1.4 billion. He says Six Sigma forms the core of how Cummins does improvement across the company. In addition, Six Sigma became the leadership development program for the company. "It provides all the elements of what is necessary to become a good leader."

The toughest part of Six Sigma implementation? "Getting senior management to give Six Sigma enough time to demonstrate its capability. In addition to patience, evaluation requires a robust set of metrics."

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