3 Conceptual Map
CCRC4
ThenewLeader.2.pdf
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DIAGNOSING THE BUSINESS
by Mark Gottfredson, Steve Schaubert, and Hernan Saenz
How can an incoming leader lay the groundwork for dramatic performance improvement?
From 1999 to 2006, the average tenure of departing chief executive offi cers in the United States declined from about 10 years to slightly more than eight. Although some CEOs stay a long time, a lot of them fi nd that their stint in the corner offi ce is remarkably brief. In 2006, for instance, about 40% of CEOs who left their jobs had lasted an average of just 1.8 years, according to the outplacement fi rm Challenger, Gray & Christmas. Tenure for the lower half of this group was only eight months. Some of these short-timers were simply a poor fi t and left of their own accord, but many others were
THE NEW LEADER’S GUIDE TO
D av
id P
lu nk
er t
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64 Harvard Business Review | February 2008 | hbr.org
ushered out the door because they appeared unable to im-
prove the business’s performance. Nobody these days gets
much time to show what he or she can do.
So within a few months at most, incoming CEOs and
general managers must identify ways to boost profi tability,
increase market share, overtake competitors – whatever the
key tasks may be. But they can’t map out specifi c objec-
tives and initiatives until they know where they are starting
from. Every organization, after all, has its distinctive
strengths and weaknesses and faces a unique combination
of threats and opportunities. Accurately assessing all these
is the only way to determine what goals are reasonable and
where a management team should focus its performance-
improvement efforts.
Embarking on this kind of diagnosis, however, can be
daunting because there are countless possible points of en-
try. Your company’s operations may span the globe and in-
volve many thousands of employees and customers. Should
you start by talking to those employees and customers or by
examining your processes? Should you focus on the effec-
tiveness of your procurement or analyze your product lines?
Managers often begin with whatever they know best – cus-
tomer segments, for example, or the supply chain. But that
approach is not likely to produce either the thoroughness or
the accuracy that the management team and the business
situation require.
What’s needed instead is a systematic diagnostic template
that can be tailored as necessary to an individual business’s
situation. Such a template has to meet at least three crite-
ria: It must refl ect an understanding of the fundamentals of
business performance – the basic constraints under which
any company must operate. The template must be both
comprehensive and focused – covering all the critical bases
of the business, but only those bases, without requiring any
waste of time or resources on less important matters. And it
should lend itself to easy communication and action.
This article presents a template that we think meets these
criteria. It is built on four widely accepted principles that
defi ne any successful performance-improvement program.
First, costs and prices almost always decline; second, your
competitive position determines your options; third, cus-
tomers and profi t pools don’t stand still; and fourth, simplic-
ity gets results. Along with each principle, we offer question
sets and analytic tools to help you determine your position
and future actions.
We developed and refi ned this template over our com-
bined 50-plus years of working with clients, nearly all of
whom have needed to perform an accurate diagnosis quickly.
We have recently used it both with large corporations and
with private equity fi rms evaluating the potential of their
portfolio companies. We tested it through a series of re-
search studies and interviews that we conducted in prepara-
tion for writing the book from which this article is adapted.
Our experience and research convinced us that the template
is a powerful tool. Its four principles cover the critical bases
of virtually every business, providing managers with the
minimum information required for a comprehensive diag-
nosis. Of course each manager will have to decide which
elements of the template to emphasize (or de-emphasize)
based on his or her business situation.
A word of caution: As the article makes clear, you will
need to gather a lot of data quickly, ideally within the fi rst
three or four months of your tenure. Ask your senior lead-
ers to head up teams that take on as many questions rel-
evant to their areas of responsibility as they can handle.
Ask for short, focused presentations to facilitate discussions
about the main threats and opportunities. That should en-
able you and your teams to make quick, accurate decisions
about the few areas on which to concentrate your efforts.
This process not only will show you where you are start-
ing from (your point of departure, so to speak) but also will
help you map out your performance objectives (or desired
point of arrival) along with three to fi ve critical change
initiatives that will take you where you want to go. Indeed,
many companies have used the template to create a set of
charts showing exactly where and how the business can
improve. Incoming leaders fi nd that reaching a diagnosis
within their fi rst three to four months helps them lay a
foundation for breakthrough performance – and avoid the
pitfalls that other new leaders encounter all too frequently.
Analyze Costs and Prices The fi rst principle in our template is that costs and prices
almost always decline. This may seem counterintuitive: In-
fl ation often clouds the view, and special circumstances can
sometimes drive costs and prices upward. But it is a well-
established fact that infl ation-adjusted costs – and therefore
infl ation-adjusted prices – decline over time in nearly ev-
ery competitive industry. The analytic tool that best charts
this principle is the experience curve, a graph showing the
decline in a company’s or an industry’s costs or prices as
a function of accumulated experience. For example, you
might fi nd that for every doubling of total units produced in
your company, your per-unit cost in constant dollars drops
by 20%. (In this case your experience curve is said to have
a “slope” of 80%.) Because the same principle holds true for
Mark Gottfredson ([email protected]), a partner in the Dallas offi ce of Bain & Company, and Steve Schaubert (steve.schaubert@
bain.com), a partner in the Boston offi ce, are the authors of The Breakthrough Imperative: How the Best Managers Get Outstanding Results
(HarperCollins, forthcoming in March 2008), from which this article is adapted. Hernan Saenz ([email protected]) is a partner in Bain’s
Boston offi ce and a leader in the fi rm’s North American performance improvement practice.
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hbr.org | February 2008 | Harvard Business Review 65
Understanding Experience Curves
Experience curves show how much industry prices and your costs have fallen each time the industry’s cumulative experience (total units produced or services delivered) has doubled. They also allow you to predict how much infl ation- adjusted prices and costs are likely to decline in the future.
The “slope” is the percentage of original price or cost remaining after each doubling of experience: A 70% slope, for example, means that prices have dropped by 30%.
Mapping your industry’s price curve against your own cost curve can help pinpoint cost-reduction objectives. If you can reduce your costs faster than the previous CEO or general manager did, as in the graph below, you may be able to drive industry prices down faster as well, thereby putting pressure on your competitors’ margins.
your competitors – and thus for your entire industry – the
curve allows you to estimate where costs or prices are likely
to be in the future. By comparing your company’s cost curve
with your industry’s price curve, you can determine whether
your costs are declining at the rate necessary for your com-
pany to remain competitive.
Construct cost and price experience curves. The fi rst di-
agnostic questions to ask regarding this principle are “What
is the slope of price change in our industry right now for
the products or services we offer?” and “How does our cost
curve compare with the industry’s price curve and with our
competitors’ cost curves?” (See the exhibit “Understanding
Experience Curves.”)
The relationship between prices and costs in any given
business area will determine some of your top priorities. If
industry prices are going down while your costs are going
up or holding steady, for instance, cost improvement is likely
to be your single most urgent challenge. Your costs need to
be decreasing over the long term regardless of what prices
are doing. An upward movement in prices is frequently only
temporary.
Understanding your overall cost trends, of course, is just
a preliminary step. You then need to examine every seg-
ment of costs to determine where the central challenges
and opportunities lie. Dig into the cost areas that are most
important for your organization: manufacturing, supply
chain, service operations, overhead – whatever they may be.
Identify the key cost components and the trends in each
one. Look specifi cally for instances of failure to manage to
the experience curve, such as rising unit costs for labor or
rising procurement costs. This kind of detailed analysis will
identify opportunities for improvement at the most granular
level and will provide the basis for a plan of action.
One CEO we spoke with refl ected on what he called his
biggest mistake in his fi rst few months on the job. One of
his company’s business units was the leader in an industrial
ACCUMULATED EXPERIENCE
Performance goal
Industry price
Company cost
Prices tend to follow costs over time
Starting point for
new CEO
90% slope (10% DECLINE)
Industry Dates Price slope
Price decline
Microprocessors 1980–2005 60% 40%
LCDs 1997–2003 60% 40%
Brokerages 1990–2003 64% 36%
Wireless services 1991–1995 66% 34%
Butter 1970–2005 68% 32%
VCRs 1993–2004 71% 29%
Airlines 1988–2003 75% 25%
Crushed stone 1940–2004 75% 25%
Mobile phone services 1994–2000 76% 24%
Personal computers 1988–2004 77% 23%
DVD players/recorders 1997–2005 78% 22%
Cable set-top boxes 1998–2003 80% 20%
Cars* 1968–2004 81% 19%
Milk bottles 1990–2004 81% 19%
Plastics 1987–2004 81% 19%
Color TVs 1955–2005 83% 17%
DVDs 1997–2002 85% 15%
* Adjusted for changes in features and regulatory requirements
This chart shows the rate of price declines for every dou- bling of accumulated experience for a sample of both manufac- turing and service industries. (The time periods here refl ect a wide variety of studies conducted at different times.)
Source: Bain
70% slope (30% DECLINE)
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66 Harvard Business Review | February 2008 | hbr.org
market. It had been raising prices, so it was quite profi t-
able, and the new CEO decided to leave it alone for the time
being. Then new, low-cost competitors from Asia entered
the market and found that this unit had established both a
price umbrella and a cost umbrella. The competitors soon
undermined the unit’s pricing power. The situation required
urgent action to reduce costs by at least 15%, an initiative that
is well under way. The lesson that CEO drew from the experi-
ence was stark: Be sure to diagnose every business position
carefully, particularly in units that seem to be doing well.
Determine costs relative to competitors’. After compar-
ing your overall costs with industry prices and your com-
petitors’ costs, you need to take a more detailed look at your
cost position in your industry. How do you compare with
your key competitors in each cost area? Which company
is most effi cient and effective in priority areas? Where can
you improve most relative to others? An analysis of
cost position quantifi es cost differences between your
business and your competitors’; it also shows which
cost elements and specifi c practices are different. Drill
down until you understand where and how you differ,
and why. That, in turn, will help you fi gure out where you
can close cost gaps and gain or regain competitive advantage.
It will also help you formulate detailed plans to do so.
Not long after he took on the top job, David Weidman,
CEO of the $6.7 billion chemical company Celanese, head-
quartered in Dallas, asked his management team to conduct
such a competitive assessment. “They came back and said,
‘Holy cow, our average EBITDA to sales is seven or eight
percentage points lower than the competition’s,’” he told us.
“And this was not in one business – this was across every orga-
nization.” Weidman asked the team to identify specifi c areas
where the company could improve relative to the competi-
tion. He wanted to fi nd out, for instance, what one key com-
petitor was doing in maintenance, because that company’s
maintenance spending was far better than Celanese’s.
Understanding your cost position as well as your experi-
ence curve enables you to set proper targets. You will know,
for example, that your lower-cost competitors are on their
own experience curves and will have improved their own
positions by the time you reach their current cost levels.
This kind of analysis presents a unique opportunity.
Rather than simply comparing yourself with your top com-
petitor, fi gure out which fi rm (including yours) is the best in
each area. Maybe one is world-class in supply-chain logistics
practices, another in a particular manufacturing step, and
so on. You can then construct a hypothetical competitor
representing the best of the best, or what we call best dem-
onstrated practices. That hypothetical company will have
lower costs and better performance than any real-world
company; you can use it as a benchmark for improvement,
striving to leapfrog your competitors instead of just trying
to catch up.
Assess the profi tability of your product lines. Your next
job is to determine which of your products or services are
making money (or not), and why. The goal is to calculate the
true margins of your products or services. First, you need to
fi gure out direct costs for each product based on actual ac-
tivities performed, rather than using standard costing. Then
you must accurately allocate indirect costs – logistics, sell-
ing expenses, general and administrative expenses – to each
product line and customer segment. Activity-based costing
will give you a more accurate picture than you or your pre-
decessor may have had in the past. The analysis should re-
veal the key cost and revenue drivers you need to address:
areas where the cost of goods sold, for instance, is out of
line, or where your revenue performance is below bench-
mark levels.
When Warren Knowlton, until recently the CEO of the
venerable British company Morgan Crucible, agreed to take
the top job there, he learned that Morgan had hundreds of
products, ranging from crucibles and advanced piezoceram-
ics to body armor and state-of-the-art superconductor mag-
netic systems. He needed to determine which were making
money and which were dragging the company down, so he
drew up a list of critical questions for the heads of his busi-
ness units. For example, he asked them to delineate their
expectations for operating profi t during the coming year and
to explain expected changes from the preceding year. Then
he asked for details. One question was “What percentage
of your revenues represents sales to customers you would
consider to have signifi cant leverage over you?” Another was
“How much of your revenue do you believe represents price-
sensitive, commodity-type products?” Other questions fo-
cused on the cost side, including matters such as purchasing
procedures and performance compared with that of rivals.
The answers gave Knowlton a jump-start on his analysis
of product-line profi tability. He subsequently made major
You can construct a hypothetical competitor
representing the best of the best
and then use it as a benchmark for improvement, striving to leapfrog your competitors.
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1 2 3 4
Questions That Will Lead You to Breakthrough Performance
FIRST PRINCIPLE
Costs and prices almost always decline.
■ How does your cost slope compare with your competitors’?
■ What is the slope of price change in your industry right now, and how does your cost curve compare?
■ What are your costs compared with competitors’?
■ Who is most effi cient and effective in priority areas?
■ Where can you improve most, relative to others?
■ Which of your products or services are making money (or not) and why?
SECOND PRINCIPLE
Your competitive position determines your options.
■ How do you and your competitors compare in terms of returns on assets and relative market share?
■ How are the leaders making money, and what is their approach? ■ What is the full potential of your business position? ■ How big is your market? ■ Which parts are growing fastest? ■ Where are you gaining or losing share? ■ What capabilities are creating a competitive advantage for you? ■ Which ones need to be strengthened or acquired?
THIRD PRINCIPLE
Customers and profi t pools don’t stand still.
■ Which are the biggest, fastest-growing, and most profi table customer segments?
■ How well do you meet customer needs relative to competitors and substitutes?
■ What proportion of customers are you retaining? ■ How does your Net Promoter Score track against competitors’? ■ How much of the profi t pool do you have today? ■ How is the pool likely to change in the future? ■ What are the opportunities and threats?
FOURTH PRINCIPLE
Simplicity gets results.
■ How complex are your product or service offerings, and what is that degree of complexity costing you?
■ Where is your innovation fulcrum? ■ What are the few critical ways your products stand out in
customers’ minds? ■ How complex is your decision making and organization
relative to competitors’? ■ What is the impact of this complexity? ■ Where does complexity reside in your processes? ■ What is that costing you?
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shifts in product lines to de-emphasize commodity products
and unprofi table customers. Along with signifi cant cost re-
ductions, these moves enabled him to engineer a remarkable
performance breakthrough, increasing the company’s share
price 10-fold in just three and a half years.
Evaluate Your Competitive Position The second principle in our template is that your competi-
tive position determines your options. Depending on your
industry, there can be different drivers of profi t leadership,
including customer loyalty and “premiumness” of the prod-
uct. But in most industries, one of the strongest predictors of
a company’s performance is its relative market share (RMS).
RMS is easy to calculate. If your company is a market
leader, simply divide your share by the share held by your
closest competitor (30% divided by 20%, say, equals an RMS
of 1.5). If you’re a follower, divide your share by that of the
market leader (20% divided by 30% equals 0.67 RMS). Now
plot the companies in your industry according to their RMS
and their returns on assets (ROA). (See the exhibit “A Map of
the Marketplace.”)
You are likely to fi nd that for many fi rms,
higher RMS corresponds to higher ROA, and vice
versa. This refl ects the fact that market leaders
typically outperform market followers on ROA;
they have greater accumulated experience, lead-
ing to lower costs and superior customer insights,
which in turn lead to higher profi ts. They thus
have a greater ability to outinvest the competi-
tion in innovation, customer service, branding,
and product support.
Compare your returns and market share with those of your rivals. The ROA/RMS chart is an extraordinarily useful
diagnostic tool because it helps you narrow down your op-
tions for performance improvement. There are fi ve generic
positions on the ROA/RMS chart: in-band leaders, in-band
followers, distant or below-band followers, below-band lead-
ers, and overperformers. Each has its own imperatives. Typi-
cally, for instance, in-band leaders fi nd that they can raise
the bar for competitors by investing in still-greater market
share and in product or service improvements. In-band fol-
lowers usually need to work hard just to keep up; only occa-
sionally can they jump into a leadership role through heavy
investment in innovation, the way Sony Computer Enter-
tainment’s PlayStation leapfrogged Nintendo in the video
game industry in the 1990s. Overperformers, which earn
returns well beyond what their relative market share would
suggest, typically need to maintain high levels of investment
in whatever has enabled them to escape the pull of the band
(assuming they aren’t simply capitalizing on a temporary
price umbrella). That might be a trusted or prestigious brand,
an innovative or patented technology, exceptionally loyal
customers, or some other asset. Below-band companies, of
course, have probably not been managing their costs down
the experience curve, which would be a primary reason for
their underperformance.
Whatever your company’s position, the band helps you
understand its full potential by showing both opportuni-
ties and constraints. An in-band follower, for example, can’t
expect to earn the returns of a leader unless it moves up the
band or escapes into the overperformer category through
one of the strategies mentioned.
Band analysis can be used for two other diagnostic tasks:
anticipating competitors’ improvement strategies and assess-
ing businesses in a multiunit organization.
Mapping your company against competitors is the fi rst
step toward seeing how each fi rm is making money or
where it is failing to do so. It allows you to spot potential
threats to and opportunities for your business, and to as-
sess the strategic options available to others. For example,
when we and our colleagues began compiling a band chart
for credit card companies, we could fi nd no relationship be-
tween market share and returns – a highly unusual situa-
tion. So we asked what was driving the returns of the most
successful players. The analysis showed us that in this busi-
ness, customer loyalty was the single most important factor
in determining profi tability. If every company were equally
skilled at retaining customers, then market share would
be the principal driver – but that wasn’t the case. Because
of the high cost of customer acquisition and the tendency
of customers to increase their credit card use over time, so-
phisticated techniques for retaining customers could over-
come advantages of pure scale and allow successful com-
panies to become more profi table than their competitors.
That would increase their RMS as well. Companies that had
not developed such techniques were operating at a serious
disadvantage.
Band analysis can also help the leader of a multiunit or-
ganization determine whether each business is achieving
close to its full-potential performance. This objective was at
the heart of Knowlton’s decision-making process regarding
Morgan Crucible’s many businesses. Placing Morgan’s busi-
ness units on a band chart that compared their economic
performance with their region-weighted relative market
share, Knowlton could see at a glance that some units, such
as the company’s industrial rail and traction division, were
When sizing up your company’s decision making, turn to suppliers, distributors, and customers for feedback.
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A Map of the Marketplace
One method of assessing your position in the marketplace is to plot the company’s relative market share against its return on assets, and to do the same for your competitors. Companies in a well-defi ned industry typically line up in a fairly narrow band, refl ecting the fact that market leaders usually outperform market followers on ROA. But a handful of companies (“overperformers”) earn above- band returns while having a midrange or low market share, and others languish below the band with low ROA – often because they have not managed their costs down the experience curve. RELATIVE MARKET SHARE
Overperformers
In-band followers
Distant or below- band followers
Strong
R ET
U R
N O
N A
S S
ET S
High
Low Weak
In-band leaders
Below-band leaders
in the band: They were performing as expected. Others, such
as thermal ceramics, were below the band and needed to
be moved upward, typically through aggressive cost control
and measures designed to grow revenue. Still others were
laggards in the lower left of the band and were candidates
for divestiture.
Measure your market size and trends. How big is your
market, exactly? Which parts are growing fastest? Where
are you gaining or losing share? A simple way to map your
market’s size and dynamics is to draw a rectangle and then
divide it into vertical segments representing your most im-
portant submarkets or products. The width of the segments
should be set in proportion to the share of revenues they
account for in the market. Next, divide each of these vertical
segments into boxes representing the share held by each
principal competitor. Create one chart for three to fi ve years
ago and one for the present. The two charts will show you
the sectors and the competitors experiencing market growth.
Depending on your situation, of course, you may need to
customize the basic chart. A company selling telecommuni-
cations equipment in Asia might fi rst map the Asian telecom
market by country and by sector (wireline, wireless, and so
on) and then break it down into competitors’ market shares.
Again, comparing two or more points in time will show you
where, and how fast, the market is growing. Faster-growing
markets attract more competitive interest, so you will need
an aggressive plan to win your share.
Other tools may be useful as well. A so-called S-curve
chart, for instance, which plots industry growth against time,
can show the infl ection points where growth accelerates and
then tapers off.
Assess your fi rm’s capabilities. Your company’s chances
to achieve its full potential – to improve its position on the
band chart – depend signifi cantly on its capabilities. Which
critical capabilities are giving you a competitive advantage?
Which do you lack? Which need to be strengthened or ac-
quired? The global technology and engineering company
Emerson, for example, knows how to manage its costs so
aggressively that it can acquire other businesses and then
add substantial amounts of value. Companies can also suc-
ceed if they can develop capabilities they don’t currently
have. The iPod didn’t really take off until Apple developed
the capabilities to manage and sell digitized music through
its iTunes store.
Every company, of course, must make decisions about
which capabilities it wants to develop or maintain in house
and which it wants to obtain from suppliers. The context
for these decisions has changed dramatically in recent years.
In many industries the primary basis of competition has
shifted from ownership of assets (stores, factories, and so
on) to ownership of intangibles (expertise in supply chain
or brand management, for example). At the same time,
a handful of vanguard companies have transformed what
used to be purely internal corporate functions into en-
tirely new industries. Thus FedEx and UPS offer world-class
logistics-management services, while Wipro and IBM offer
numerous business and IT services.
The result of all this is that companies can no longer
afford to make sourcing decisions on a piecemeal basis –
nor can they be satisfi ed with a “good enough” approach
to selecting and working with suppliers. Today, you must
assess every capability that you need in order to create or
develop a product or service. You should analyze every step
of your value chain, from design and engineering to product
or service delivery. You should compare yourself not only
with competitors in your industry at every step of the chain
but also with whatever companies are the best in the world
at performing each particular step. Are you the best? Or do
you have some capability that creates a sustainable com-
petitive advantage in a given step? If the answer to both
questions is no, you should ask whether you can improve
or acquire the relevant capability, or whether you might be
better off sourcing that part of your value chain to the best
supplier.
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Understand Your Industry’s Profi t Pool The third principle in our template is that customers and
profi t pools don’t stand still. Markets undergo massive
changes all the time, mostly because customers’ desires and
needs evolve. Companies repeatedly discover that the land-
scape they operate in has altered signifi cantly and that the
plans and strategies that worked so well yesterday no lon-
ger work today. They fi nd that the profi t pool from which
they were drawing their earnings has dried up or attracted
new competitors, and that deep new pools of profi t have
appeared elsewhere. (For more on profi t pools, see Orit
Gadiesh and James L. Gilbert, “Profi t Pools: A Fresh Look
at Strategy,” HBR May–June 1998.) For these reasons, you’ll
need to examine the profi t pools you currently draw on and
those that might hold potential for the future.
Study customer needs and behavior by segment. Cor-
rectly segmenting customers and developing proprietary in-
sights into their purchasing behavior is one of the most pow-
erful methods of building loyalty, increasing growth, gaining
market share, and thus expanding your share of the profi t
pool. Which are the biggest, fastest-growing, and most prof-
itable segments? How well do you meet customers’ needs,
compared with competitors and substitutes? As you raise
these questions, you will want more-specifi c answers, such
as how customers are segmented. On the basis of needs?
Behavior? Occasion of use? Demographics? What are each
segment’s characteristics and spending habits? What share
of wallet is each one currently giving you, and is there reason
to think that you can increase that share?
You can use many tools to delve deeply into customer
needs and behavior. These range from cluster analysis to
sophisticated ethnographic research. It’s often worthwhile
to look at customers through many different lenses because
you may spot something that customers themselves aren’t
even aware of. While we don’t have space to discuss all such
tools in this article, we’ll mention a simple one that has been
remarkably effective even in highly sophisticated industries.
We call it a SNAP (segment needs and performance) chart.
It can help you assess how well you are meeting the needs of
the segments you are targeting.
To develop a SNAP chart, start by defi ning the attributes
of the products or services you offer that may be important
to the customer segments you want to target. Then con-
duct research to determine how important each of these
actually is to these customers. A bank, for instance, might
study everything from its hours of business to its loan rates
to the quality of the advice it offers and the ease of access
to its ATMs. Finally, assess where you stand on each scale and
where your competitors stand.
This process will show how you measure up to the compe-
tition in the eyes of your key customer segments. You can use
the SNAP chart to identify which gaps are most important
to close (if you’re behind) or widen (if you’re ahead). You can
also see where you might be overshooting the mark. (See the
exhibit “Segment Needs and Performance.”)
Track customer retention and loyalty. What proportion of
customers are you retaining? Loyalty can be a critical factor
in the economics of a business, particularly when the cost of
acquiring a customer is high, switching costs are relatively
low, or both. Accordingly, you need to know your retention
rates for each segment. Doing so not only will help you deter-
mine the profi tability of the segment but also will help you
make plans to boost retention rates where necessary.
A good indicator of loyalty and probable retention is the
Net Promoter Score (NPS), developed by our colleague
Fred Reichheld. This measures customers’ responses to the
question “How likely is it that you would recommend this
company (or product or service) to a friend or colleague?”
Respondents answer on a zero-to-10 scale, where a 10 means
“Extremely likely” and a zero means “Not at all likely.” Those
who give you a nine or a 10 are your promoters. Research
shows they spend more with you, are likely to increase their
Segment Needs and Performance
This SNAP (segment needs and performance) chart dis- plays data for a fi tness machine company we’re calling FitEquipCo. The company exceeds customers’ require- ments on innovation and assortment, the attributes that rank fourth and sixth, respectively, in importance to customers. It is thus incurring costs that may not earn a return in the marketplace. Meanwhile, it is slightly underperforming competitors on quality, which is fi rst in importance, and signifi cantly underperforming on customer service, which is third. FitEquipCo needs to take action to close those gaps.
Competitors’ Performance
Company’s Performance
Asso rtm
ent
IMPORTANCE OF ATTRIBUTES TO
CUSTOMERS
5
4
3
2
1
Quality Pric e
Tim e to
m arket
Custo mer s
ervice
Innovatio n
1872 Gottfredson.indd 701872 Gottfredson.indd 70 1/8/08 10:41:30 AM1/8/08 10:41:30 AM
hbr.org | February 2008 | Harvard Business Review 71
A Map of the Profi t Pool
A profi t-pool map for FitEquipCo revealed some telling market developments. Although the company was shipping almost 40% of all units in the marketplace, it had only about 20% of the profi ts. The column widths refl ect the proportion of units sold (left) and operating profi ts earned (right) in each channel.
spending in the future, and sing your praises to their friends
and colleagues. Those who give you a seven or an eight are
passives, and those who rank you zero to six are detractors.
Promoters are an engine of growth, but detractors often
cost your company more than they are worth, and they bad-
mouth you to anybody who will listen.
Your Net Promoter Score is simply the percentage of pro-
moters minus the percentage of detractors. Measured rela-
tive to competitors, NPS has been shown to correlate with
growth rates and with other measures of customer satisfac-
tion. Properly implemented, NPS creates a closed learning
loop among customers, the front line, and management, and
thus can be used as a basis for managerial decisions, just as fi -
nancial reports are. American Express and many other com-
panies use NPS-like metrics throughout their organizations
to give them quick, regular reads on customers’ attitudes and
potential behavior.
Segmentation and retention efforts are at the opposite
ends of a six-step chain of activity that enables a company
to earn more profi ts per customer than its competitors and
then to outinvest the competitors to generate faster growth.
The fi rst steps are (1) identifying the most attractive target
segments and (2) designing the best value propositions to
meet their needs. The next ones are (3) acquiring more cus-
tomers in the target segment and (4) delivering a superior
customer experience. That enables the company (5) to grow
its share of wallet and (6) to increase loyalty and retention,
with more promoters and fewer detractors.
Anticipate profi t-pool shifts. CEOs and general managers
naturally need to assess how much of their industry’s profi t
…but only about a 20% share of profi ts
FitEquipCo has about a 40% share of units sold…
FitEquipCo
Competitor Total units sold: 10M (disguised) Total operating profi t: $200M (disguised)
De pa
rtm en
t S to
re 12
%
Di sc
ou nt
/W ar
eh ou
se 6%
M ai
l/T V/
In te
rn et
29 %
Sp ec
ia lty
/F itn
es s
36 %
Sp or
tin g
G oo
ds 16
%
OPERATING PROFIT
Other
De pa
rtm en
t S to
re 20
%
Di sc
ou nt
/W ar
eh ou
se
26 %
M ai
l/T V/
In te
rn et
18
%
Sp ec
ia lty
/F itn
es s
12 %
Sp or
tin g
G oo
ds 19
% UNITS SOLD
Other
Other
Other
Other
O th
er 5
%
100%
80
60
40
20
0
C 1
C 5
C 2 C 8
C 7
C 6
C 1
C 10
C 7
C 2
C 2
C 1
C 4
C 8
100%
80
60
40
20
0
Other
Other Other
Other
C 9
C 8
C 9
C 10
C 2
C 1
C 8
C 10
C 6
C 2
C 1
C 8
C 1
C 7
C 1
C 2
C 1
C 2
O th
er 1
%
O th
er
= C
C 8
1872 Gottfredson.indd 711872 Gottfredson.indd 71 1/8/08 10:41:36 AM1/8/08 10:41:36 AM
The New Leader’s Guide to Diagnosing the Business
72 Harvard Business Review | February 2008 | hbr.org
pools their fi rms own today. But they must also gauge how
profi t pools are likely to change in the future and what op-
portunities or threats these shifts may create. One useful
tool is a profi t-pool map, which shows the channels, prod-
ucts, or sequential value-chain activities in the market and
indicates the total profi ts available from them. You can then
locate your business and its competitors on the map, show-
ing how much each company takes from each part of the
profi t pool. It’s wise to do this for all customer segments and
all sets of products.
A company we’ll call FitEquipCo mapped the growth
(historical and projected) of its industry. Then it gathered
extensive data about customers’ intent to purchase or re-
purchase and developed profi t-pool projections by product
(treadmills, elliptical machines, and so on), by sales channel
(mass merchants, specialty stores, and so on), and by price
point (entry-level, value, and premium). The map showed,
for instance, that FitEquipCo needed to build up its distribu-
tion through sports specialty stores, which delivered higher
margins. Through such measures, the company projected,
it could increase earnings by $86 million over a three-year
period, more than doubling operating profi ts. (See “A Map
of the Profi t Pool.”)
As with the market map, it’s wise to compare at least two
points in time so that you can see how the pool is evolving.
Often a signifi cant threat to the profi t pool comes from com-
panies that don’t yet compete in your industry or are still too
small to be noticed. Yet these competitors can turn an indus-
try upside down. Think, for example, of the effects minimill
companies such as Nucor had on the U.S. steel industry.
Simplify, Simplify The fourth principle in our template is that simplicity gets
results. A couple of years ago, researchers from Bain & Com-
pany surveyed executives in 960 companies around the
world, asking them about complexity in their organizations.
Nearly 70% of the respondents told us that complexity was
raising their companies’ costs and hindering growth. An-
other team of researchers studied the impact of complexity
on the growth rates of 110 companies in 17 different indus-
tries. The researchers found that the least complex compa-
nies grew 30% to 50% faster than companies with average
levels of complexity, and 80% to 100% faster than the most
complex companies. In one particularly dramatic example,
a telecommunications company that offered consumers
only about one-fi fth the number of options offered by a
competitor was growing almost 10 times as fast.
Gauge the complexity of your products or services. To di-
agnose your company’s level of complexity, begin by asking
how complex your product or service offerings are and what
that degree of complexity may be costing you. Benchmark
your line of products or services against the competition’s;
try to identify your “innovation fulcrum,” the point at which
the variety of products or services you offer maximizes your
sales and profi ts. It will be helpful to construct what we
call a Model T chart, showing the costs when you add fea-
tures to the basic product or service. It’s valuable to do this
exercise not only with your own company’s data but also
with your competitors’. (For more on complexity and the
Model T chart, see Mark Gottfredson and Keith Aspinall,
“Innovation Versus Complexity: What Is Too Much of a Good
Thing?” HBR November 2005.) Ask yourself which of your
competitors has the advantage as variety and complexity in
the industry increase – and why. You can apply what you
learned from your customer segmentation research to this
assessment. If you know what customers want now and what
they are likely to want in the future, you can better judge
what level of variety is appropriate for your marketplace.
The complexity test is a necessary counterbalance to tools
such as customer segmentation. The temptation, after all,
is to divide your customer base into fi ner and fi ner subcat-
egories and tailor your offerings to each segment, all in the
name of giving customers exactly what they want. That was
one way Charles Schwab, the fi nancial-services fi rm, got
itself into a diffi cult situation in the early 2000s. Schwab
added a plethora of new offerings and divisions, includ-
ing a fi rm specializing in institutional investments and an
East Coast wealth-management company. In 2004, founder
Charles Schwab returned to the fi rm as CEO and promptly
took steps to reduce the complexity. He sold off most of the
recent acquisitions, reduced the number of service offer-
ings, and streamlined internal roles and processes. These and
other moves allowed him to take out some $600 million in
costs, reduce commissions, gain market share, and increase
the fi rm’s operating income by 3%.
Assess the complexity of your organization. Decision-
making procedures and organizations grow complex over
time as well. You need to know how your company stacks
up against competitors on these dimensions and what the
effects of undue complexity may be. Our colleagues Paul
Rogers and Marcia Blenko have developed what they call a
RAPID analysis, which allows managers to assess decision-
making bottlenecks, assign clear decision roles to individuals
in the organization, and hold them accountable. (RAPID is
a loose acronym for the different roles people can take on:
recommend; agree; give input; decide; and perform, or imple-
ment the decision.) Another useful tool is a spans-and-layers
analysis, which shows the number of levels in an organiza-
tion from the CEO to the frontline worker, and the number
of people reporting up to each level. Spans that are too nar-
row – meaning too few people report to individual bosses –
are likely to lead to excess overhead costs, slow decision mak-
ing, and unnecessary managerial oversight.
When sizing up your company’s decision making, turn
to suppliers, distributors, and customers for feedback. They
are often good judges of how quickly and effectively you
1872 Gottfredson.indd 721872 Gottfredson.indd 72 1/8/08 10:41:45 AM1/8/08 10:41:45 AM
hbr.org | February 2008 | Harvard Business Review 73
can make a decision compared with others in the industry.
Employees will be quick to tell you whether they feel sup-
ported and empowered by the organization’s management
structure or whether it just gets in their way.
Determine where you can simplify processes. Where
does complexity reside in your processes? What is that cost-
ing you? St. George Bank, like others in Australia, experienced
a slowdown in residential lending at one point and so was
developing a growth strategy for commercial banking. But
the complexity of the bank’s commercial credit processes was
a major constraint on growth. All loan applications, large
or small, were treated in a similar way. A sizable
number of applications had to be sent up the ladder
to a central credit group. Then-CEO Gail Kelly and her
management team determined that this level of com-
plexity was not inevitable – for example, they could cre-
ate a fast-track system for applications from existing cus-
tomers that fell within certain risk boundaries. That alone led
to a 30% reduction in time spent by the lending offi cers. The
bank also increased the amounts that a local lending offi cer
could approve, resulting in a reduction of 50% or more in deals
sent to the central credit group.
How can you identify such opportunities for process im-
provement? As at St. George Bank, process complexity can
show up in any number of areas: on the production fl oor,
in distribution networks, in interactions with customers, in
back-offi ce procedures. The key is to fi gure out where com-
plexity is unavoidable – and where, by contrast, you can put
practices in place to reduce complexity while still delivering
the products and services that customers want. Process map-
ping is a good way to get started. In a process map, diagrams
show the interactions among different steps in a process and
the people or departments responsible for the steps. This
enables the management team to visualize and understand
the whole process, spot problems and opportunities for im-
provement, and address them through root-cause analysis.
You want to map activities, inputs, and outputs associated
with each step, and the wait times between steps.
Successful streamlining of the processes produces several
mutually reinforcing benefi ts. It increases effi ciency, allow-
ing a company to reduce head count and its costs. Stream-
lining also cuts down on errors and rework. It reduces cycle
time, enabling the company to deliver the product or service
to the customer signifi cantly faster and enhancing customer
loyalty. More-loyal customers are likely to order more, gener-
ating growth and increasing the possibilities for still greater
economies in production or service delivery.
Many companies try to simplify their processes without
simplifying any other aspect of the organization. This is a
mistake. Process simplifi cation tends to be undermined by
unnecessary complexity in the company’s product lines, or-
ganization, and decision-making procedures. So gather the
data to address complexity on all three fronts and then de-
termine the most fruitful points of attack.
• • •
A diagnostic template such as the one we’ve described here
is powerful not because it contains any single new insight
but because it covers the ground a management team needs
to cover. By answering the questions we’ve provided, you
can pull together a comprehensive set of data enabling
you to understand the gap between your current perfor-
mance and your full potential. You can then set specifi c goals
and launch initiatives that will drive the company to achieve
that potential during your tenure and develop the perfor-
mance profi le that you are shooting for. A company that has
worked through such a diagnostic template might aim for
objectives such as these:
Reduce costs by $200 million to move relative cost posi-
tion from 110% of best competitor to 90%.
Increase relative market share from 0.9 to 1.2; move share
of high-profi t segment A from 40% to 60%, with a reten-
tion increase of six percentage points.
Increase share of profi t pool from 40% of $2 billion to 70%
of $2.8 billion by expanding into a downstream service
business in the most profi table product segments.
Cut SKUs from 100,000 to 2,000; reduce organizational
layers in SG&A from fi ve to three; outsource 20% of all
G&A costs.
Objectives like these can translate into marching orders for
an entire organization. Because they stem from a comprehen-
sive diagnosis, everyone can understand them and see why
they are important. Both managers and employees are more
likely to buy in and put their shoulders to the wheel.
Diagnosis, of course, is only one part of a performance-
improvement program. You still must decide on where you
want the company to go, along with the three to fi ve critical
initiatives that will get you there. But a thorough, accurate
diagnosis is what makes the rest possible. It’s an indispens-
able fi rst step toward breakthrough performance.
Reprint R0802C
To order, see page 139.
•
•
•
•
Figure out where complexity is unavoidable –
and where, by contrast, you can put processes in place to reduce it.
1872 Gottfredson.indd 731872 Gottfredson.indd 73 1/8/08 10:41:51 AM1/8/08 10:41:51 AM
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