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Because its purpose is to create a customer, the business enter-prise has two-and only two-basic functions: marketing and innovation.
Peter Drucker, People and Performance
SMART COMPANIES do great things. They develop world-beating products and services on a continuing basis, and they deliver them at prices that establish value leadership. Being smart and acting smart may be the best guarantees of business success in this fast-changing and competitive world. We define being smart as making good strategic decisions. Acting smart is the activity of effectively carrying out those decisions. Peter Drucker proclaimed marketing and innovation as the two basic functions of the organization. Although he identified them as distinct functions, good strategy considers both. Successful innovation addresses strategically important markets and in the process assures the renewal of the entire business.
This book focuses on what it takes to be smart in the business activity that, more than any other, determines the future of the organization: research and development (R&D). We use the term R&D in the broadest sense to mean any technologically related activity that has the potential to renew or extend present businesses or generate new ones, including core competency development, innovation, invention, product development, and process improvement. The chapters that follow provide an actionable approach to improving R&D decision making, which is based on decades of consulting to R&D-intensive organizations in Europe, Japan, and the United States, as well as extensive work on strategic decisions of allkinds. In the course of that work, we and our colleagues have collectively observed, super-vised, or led hundreds of R&D consulting activities. A number of those situations are used here to enrich the text, though they are often disguised for purposes of confidentiality.' While it is not a theoretical work, the book is nevertheless based upon years of teaching decision analysis at Stanford University, a leader in decision research, and upon studies conducted for the R&D Decision Quality Association. Although our focus is on "smart R&D" as an exemplar of strategic excellence, the principles generalize to the "smart organization" with implications for all functions and major business areas.
A great deal is being written about "transforming" the organization through horizontal management, through self-directed work teams, through visionary leadership, and so forth. To these we add the transforming power of strategic decisions that direct the enterprise to adopt the most appropriate technologies, to develop new products with the greatest likelihood of success, and to rationally manage its R&D portfolio. Imagine how your business would be transformed if its R&D decisions were measurably better than they have been? R&D executives estimate that they can improve the value creation potential of R&D by 20 percent to more than 200 percent with better strategic decision making, and these levels have been achieved in practice. The principles of a smart organization create an environment in which this improved value creation is possible and sustainable.
The good news is that this transformation can be achieved by almost any organization. As individuals, we are only as smart as our genes and our environment allow us to be. But organizations can become "smarter." Their decision-making IQs can be improved, and usually with the current personnel and within a fairly short time. We've seen it happen. All it takes is commitment and the right set of tools and attitudes. In this sense, getting smarter about strategic decision making is no more mysterious than the organizational improvements that companies have made in product and service quality, customer service, and other business processes.
Since the mid-1970s, companies have concentrated on acting smart, pursuing a long list of nontraditional management systems aimed at improving operating results. Many of these systems came from Japan; others were home-grown. For the most part, improvement oriented companies have focused on business processes, the activities that turn inputs to outputs. Total quality management, benchmarking, just-in-time, quality functional deployment, cross-functional teaming, reengineering, and other methods have shown organizations how to "do things right," that is, to operate more effectively. While many complain that their attempts to implement these programs have produced mixed results, the larger legacy is one of substantial improvements in product quality, cycle time, inventory management, and customer service. By most measures, operational improvements in both manufacturing and services have raised the level of what customers and shareholders view as acceptable.
The number of prominent U.S. corporations that report benefits from these programs during the past two decades is long and continues to grow. Xerox Corporation was among the first. During the late 1970s, this company found itself in a serious competitive situation with a host of new Asian challengers that were profitably selling high-quality photocopiers in the United States at prices below Xerox's own cost of production. Stunned by this development, Xerox adopted benchmarking as an organization-wide method of improving a number of its then substandard operations. Xerox learned many quality improvements directly from its Japanese partner, Fuji Xerox. These initiatives resulted in major improvements and bottomline results. At about the same time, Motorola adopted its nowfamous "six sigma" approach to eliminating quality problems from its products, which had dramatic bottom-line results. More recently, General Electric has announced a major program of quality improvement, with the goal of eliminating some $7 billion to $10 billion in costs (10 percent to 15 percent of revenues) over a period of a few years. In effect, North American companies, and many in Europe, have passed through a revolution in operational improvement, just as their counterparts in Japan did before them. They have learned how to "do things right."
No amount of design excellence or manufacturing agility or knock-'em-dead customer service, however, can save a company whose decision makers direct it to "do the wrong things," that is, to develop unwanted products or products that it has no capacity to market. For example, NCR was the very best producer of electromechanical cash registers during the 1960s and early 1970s, but neither product excellence, nor continuous improvement, nor the state-of-the-art facilities the company built to produce these machines would save it from a near-death experience once computerbased electronic cash registers broke into the market. NCR had decided to dabble with computer technology at the time, but only as a means of breaking into new lines of business. Its strategic thrust was aimed at refining the electromechanical technology on which its core business was based. When DTS, a small newcomer, introduced the first electronic cash register in 1971, the industry changed dramatically. Over the course of the next four years, the market share of electromechanical machines dropped 80 percent, and NCR's revenues and profits plummeted with it.
The travails of NCR are not unique in the annals of industry. On that same note, it is not insignificant that several of the companies featured in the pages of In Search of Excellence-the book that prepared many American managers for the quality revolution-were on the slippery slope to crisis even as readers across the country were adopt ing their practices for operational excellence. Before long, many of the companies praised in the book-Atari, Digital Equipment, Eastman Kodak, Delta Airlines, Texas Instruments, and even Hewlett- Packard-were experiencing serious crises.' While these companies performed well on Peters and Waterman's measures of operational excellence, lack of excellence in strategic decision making may have accounted for some of their problems. Edwin Artzt, chairman and chief executive officer (CEO) of Procter & Gamble, said as much when he described his company's program of total quality management:
The limitation is in the area of strategy: total quality does not guarantee that companies will produce winning strategies. Winning strategies have to come from the minds of leaders and be augmented by input from the troops. Total quality ensures the success of a winning strategy and sustains success, but it doesn't automatically solve strategic problems.
More recently several Deming and Baldric prize winners-all masters of operational effectiveness-have experienced similar setbacks, and often for the same reason. For example, Florida Power and Light, winner of the Deming Prize in 1989 (the first non-Japanese company to do so), discovered that its quality efforts had barely translated into improved service to the customer. It had created an 85-member quality department, 1,900 quality teams, and a rigorous system of quality review. Very little of this had an impact on the way customers perceived the company's service. If anything, the details of the quality program shifted attention away from customers.
Florida Power and Light's experience is not an isolated case. An Arthur D. Little survey of 500 U.S. companies found that quality programs were having a significant impact on competitiveness for only one-third of the companies. A similar survey of 100 British firms by A.T. Kearney reached a more dismal conclusion. Only one-fifth of these firms could point to tangible results from their quality programs...