Tearing up the Jack Welch Playbook

The Six Sigma master was once the undisputed authority in management.

Today’s smart CEOs are following a different set of rules.

By Betsy Morris, Fortune senior writer

 

Even now, nearly five years after his retirement from General Electric, Jack Welch commands the spotlight. He is still making the gossip columns, still the charismatic embodiment of the star CEO. His books are automatic bestsellers. More than any other single figure, he stands as a model not just for the can-do American executive but for a way of doing business that revived the U.S. corporation in the 1980s and dominated the world’s economic landscape for a quarter century. What came to be known as Jack’s rules are now the business equivalent of holy writ that has been open to interpretation, perhaps, but not dispute.

But the time has come: Corporate America needs a new playbook The challenge facing U.S. business leaders is greater than ever before. The volatility of the markets is so unpredictable, the competition from China and India so intense, that the edicts of the past are starting to feel out of date.

If applied correctly, Welch contends, his rules can work forever. Sorry, Jack, but we don’t buy it. The practices that brought Welch and others such success were developed to battle problems specific to a time and place in history. And they worked. No one questions today that bloated bureaucracy can kill a business. No one forgets the shareholder – far from it. Yet those threats have receded. And they have been replaced by new ones. The risk we now face is applying old solutions to new problems.

Early on, Welch argued that lagging businesses – those not No.1 or No. 2 in their markets – should be fixed, sold, or closed. He talked about being the leanest and meanest and lowest-cost, and Corporate America got out its ax. Welch advocated ranking your players and weeding out your weakest, and HR departments turned Darwinian. As time went on, the mantra of shareholder value took on a life of its own.

But there is another model. In breathtakingly short order, the rock star of business is no longer the guy atop the FORTUNE 500, but the very guy those FORTUNE 500 types used to love to ridicule: Steve Jobs at Apple.

The biggest feat of the decade is not making the elephant dance, as Lou Gerstner famously did at IBM, but inventing the iPod and transforming an industry; yet few big companies paid close enough attention to see that new technologies and business models were negating the power of economies of scale in myriads of ways. Nobody has proved it more than Google.

That doesn’t mean everything about Welch’s era is wrong. Indeed, we named him “manager of the century” in1999. Were he at GE today, he might well be in the forefront of the current way of rethinking, as his successor, Jeffrey Immelt, surely is. Still, in the way of all good analogies, we must begin by tearing down the old so that we can really open ourselves to something different.

New rule: Agile is best; Being big can bite you.

Old rule: Big dogs own the street

Until the very end of the last century, big meant good in the business world. B-schools taugt the benefits of economies of scale. The greater your revenue, the more you could spread fixed costs across units sold. With size came dominance – of store shelves, supply chains, distributionchannels. Until mid-1990s, a company’s market value usually tracked its revenue.

Then strange things started to happen. Microsoft’s market cap passed IBM’s in 1993, even though Bill Gates’ $3 billion in revenue was one-twenty-second of IBM. Scale didn’t insulate GM from near-catastrophic decline. The big dogs seemed to hit a wall. Citygroup, built through acquisitions by Sandy Weill to deliver consistent earnings, suddenly found the market focused on whatever bad news emerged in City’s far-flung units instead of the smoothness of its overall performance.

Technological advances and changing business models have diminished the importance of scale, as outsourcing, partnering, and other alliances with specialty firms with their own economies of scale) have made it possible to convert fixed costs into variable ones. Dell, it turned out, was not an anomaly, it was just the beginning – a pioneer at all this, keeping its costs down by outsourcing disk drives, memory chips, monitors, and more, freeing itself to focus on direct selling and just-in-time assembly.

New rule: Find a niche, create something new.

Old rule: Be bo.1 or no. 2 in your market.

Nobody wants to be a laggard, of course, and there is much to be said for being the market leader, Nike, Wall-mart and Exxon certainly don’t wish they were anything else.

But more an more, market domination as no safety net. Disney stranglehold on animated films meant nothing once Pixar’s digital innovation hit the scene.

Look at Coca-Cola, whose still-strong No.1 position in cola turned out to be not an insurance policy but proof of what consulting firm McKinsey calls the “incumbent’s curse.” Coke’s archrivalry with Pepsi was always about market share – capturing it or defending it by tenths of a percentage point in grocery stores, restaurants, and faraway lands.

But eventually Coke’s monomaniacal focus backfired. When bottled waters like Evian and Poland Spring began to gain traction, Coke didn’t pay sufficient attention. Its board vetoed management’s proposal to buy Gatorade in 2000 (sending the sports drink into the arms of Pepsi). Such niche products were vied as low-volume distractions. Yet last year, in a turnabout that would have been inconceivable a decade ago, soda sales fell, and water, sport drinks, and energy drinks all soared. The jaw dropper: energy drinks – which boast a profit margin of 85 percent, according to Berstein research – are now expected to outteam every other category of soft drink within three years.

Coke has gotten religion. CEO Neville Isdel’s team is pushing an array of new drinks, including a half dozen of its own energy entries that have earned the company a significant stake in the US market. “We believe there is value in these niches,” Isdel told Fortune this spring. “It will not drive the volume number, but volume is something we’ve often chased to the detriment of the long-term business.”

New rule: Look out, not in.

Old rule: Be lean and mean.

In 1995, Jack Welch “went nuts”, as he later put it, over Six Sigma, a set of methods for improving quality – plus a powerful way to reduce costs – that had been developed by Motorola in the 80s. At GE’s annual managers’ meeting he told his troops that embracing Six Sigma would be the company’s most ambitious undertaking ever. GE’s “best and the brightest” were redeployed to put the methods into action. And it worked Welch would later write that Six Sigma helped drive operating margins to 18.9 percent in 2000 from 14.8 percent four years earlier. Many have followed suit. Yet not all firms were able to find the same magic.

In fact, of 58 large companies that have announced Six Sigma programs, 91 percent have trailed the S&P 500 since, according to an analysis by Charles Holland of consulting firm Qualpro (which espouses a competing quality-improvement process).

One of the chief problems of Six Sigma, say Holland and other critics, is that it is narrowly designed to fix an existing process, allowing little room for new ideas or an entirely different approach. All that talent – all those best and brightest – were devoted to, say driving defects down to 3.4 per million and not on coming up with new products or disruptive technologies.

Innovation is a “meta-stable entity”, says Vishva Dixit, vice-president for research of Genentech. “Nothing will kill it faster than trying to manage it, predict it, and put it on a timeline.”

No business can afford to focus its energies on its own naval in the new environment. “Getting outside is everything,” says GE’s Immelt (who still deploys Six Sigma). From the day he took over as CEO, he says, he knew the company would need to be “much more forward-facing in the future than we ever were in the past.”