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PART 1
Why 4+2?
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1
4+2 Equals Business Success
Business is full of mysteries, but none greater than this: What really works?
The grand illusion of the 1990s was that nothing from the Old Economy really mattered, provided you were blessed with a sexy IPO, cold nerve, and the magic carpet of momentum trading. If you looked and talked like a dot.com tycoon, reporters fawned, headwaiters beamed, your Porsche gleamed. The so-called New Economy was a dream world ruled by the arrogance of youth, the naivety of new money, the ignorance of alleged visionaries. Blind as bats at high noon, amateur robber barons declared the business cycle obsolete.
We know better now. Infinitely and painfully better. In the aftermath of a burst bubble, its hot air now frigid, we know anew that business is, was, and always will be hard, risky, insecure, and unpredictable. Optimism drives every entrepreneur, but dreams of success are more often a reality of failure. Businesspeople spend their best years in daily combat, fighting competitors, flattering customers, mollifying shareholders, cajoling employees, importuning bankers, and fending off landlords, tax collectors, and government regulators.
In short, todayâs sobered managers realize all too painfully that many, many things matter in achieving business success. But the galling fact is that few if any of the most successful managers can tell you much more than what worked for them.
For decades, one of the great puzzles of business life has been why a few companies thrive in the worst of times, contradicting all the bad numbers that afflict their industry peers. In the downturn of the early 1990s, for example, certain enterprises seemed immune to misfortuneâCampbell Soup in the food and snack industry, Conseco in life and health insurance, Gap in specialty retail, Duke Energy in electric utilities, Nucor in steel, Sony in consumer electronics, Walgreen in the pharmacy business. Yet, it wonât escape your notice that todayâs version of this list would not include all these namesâa sign that even the best managers may not fully know what they are doing right in good times, much less how to keep their companies booming in bad times.
Surely this canât be true, you say. Winners must know something that losers donât. And so, given our abiding faith in experts and how-to books, managers savor every word of wisdom from legendary chief executives like GEâs Jack Welch, AlliedSignalâs Larry Bossidy, and IBMâs Lou Gerstner, whose writings rivet businesspeople everywhere. These eminences offer actual answers: Gerstner, for example, largely attributed IBMâs resurrection as an industry leader to his overhaul of its ingrained, feudal corporate culture.
But such answers donât translate well. They derive from local conditions and unique situations. They arenât universal. Gerstnerâs work makes a great story, but your own company is unlikely to resemble the IBM he inherited, much less the one he reinvented. The same goes for silver-bullet cures prescribed by many management thinkers. The ultimate answer, they tell us, is to focus single-mindedly on some newly coined management buzzword or principle. Consider just a partial roster of these formulations: learning organizations, matrix management, management by objectives, peak performance, team-based management, total quality management.
These ideas are sometimes brilliant and often useful, but they have about as much staying power as the length of hemlines. For one thing, they become passing fads because managers are too busy to absorb or apply them as effectively as their inventors hope. Cynicism ensues, followed by irritation when the idea flops. Soon it is abandoned. Nothing is less enduring than yesterdayâs half-nibbled panacea.
So the great question remains, unanswered and not even well asked: What really works?
The truth is that managers have spent more than a century guessing at what really matters in businessâand guessing wrong. Managers have embraced fad after fad, all to their detriment. Like other stubborn mysteries, the puzzle of why some companies win and most lose has been reduced to blind faith or luck rather than hard investigation and solid proof. It is time for the first book identifying the fundamental practices that create business successâthe ones that do indeed really matter.
This is that bookâthe worldâs most systematic, large-scale study of the practices that create business winners. Instead of anecdotal evidence or personal intuition, it is based on a massive research project conducted with scientific rigor and verified by measured fact.
The Evergreen Project
The Evergreen Project, as we called it, was the first statistically rigorous search for the key to âevergreenâ business success. Evergreen mobilized more than fifty leading academics and consultants, who used well-accepted research tools and procedures to identify, collate, and analyze the experience of dozens of companies over a ten-year period (1986 to 1996). From that examination emerged the 4+2 formula that is at the heart of this book.
Essentially, we found eight management practicesâfour primary and four secondaryâthat directly correlated with superior corporate performance as measured by total return to shareholders (TRS). And we discovered that winning companies achieved excellence in all four of the primary practices, plus two of the secondary practicesâhence our 4+2 formula. Losing companies failed to do so.
For managers, the formula represents a proven guide to what really mattersâthe crucial practices that achieve lasting business success. In addition, the Evergreen Project revealed that each of the eight practices evokes certain behaviors typical of winning companies. These behaviorsâwe call them mandatesâgive managers practical benchmarks to help reinforce the practices.
What Doesnât Work
Before getting into the details of our formula and how it was derived, letâs consider some of the 200 management practices that didnât make the cut, highly touted practices that turned out to have no cause-and-effect connection to sustainable, superior returns.
Superb information technology, for example, is widely considered a sine qua non of business success. Our research found no correlation between a companyâs investment in technology and its total return to shareholders over the decade of our study.
The same absence of correlation marked corporate change programs. Despite their popularity, they were not the determining factors in achieving superior TRS. Neither were purchase and supply-chain management practices. They may, in the short run, increase profit margins and customer responsiveness, but they have no sustainable cause-and-effect relationship with TRS.
Another striking finding involved corporate governance. It is widely accepted that companies should attract high-quality outside directors. Indeed, winning companies in our study did better than losers in that respect. But there was no evidence that attracting better outside directors specifically improved TRS or sustainable business performance. The causality may actually run in reverse: perhaps being a winner helped a company upgrade its board.
One caveat: the lack of a significant relationship between a given practice and superior returns doesnât indicate that the practice is irrelevant or can be ignored. It simply means that these practices are unlikely to yield sustainable superior returns, and they deserve less attention than the practices our study highlighted.
The 4+2 formula casts a new light on the managerâs role, making it clear why winning is so hard to sustain. Winning managers tend to be master jugglers, keeping six balls in the air at the same time. Sporadic victories, however spectacular, arenât enough. A consistently successful company never stops pursuing success. More tortoise than hare, it keeps working at all the small wins that ensure repeated big wins.
All companies, successful or not, have days when the stock market hates them; equally, winners are no more likely than losers to have days when their stock moves up sharply. Winners simply have more days when their stock inches upward. As in football, winning is the difference between averaging three yards per carry and four yards per carry. And to do that, you must consistently outdo your competition on all the fundamentalsâblocking and tackling, giving the passer extra protection, holding down turnovers, converting on third down. The 4+2 formula is a lesson in life.
How Do We Know What Really Works?
âWhy is our formula valid? Because the methodology we used in developing it was appropriate, honest, and effectiveâin short, as reliable as many good minds could make it. Letâs now examine our procedures here in some detail.
We began by selecting hundreds of enterprises that varied in terms of their total return to shareholders. We chose TRS as our standard even though many managers are uncomfortable with its use as a primary metric of managerial performance. They prefer to be judged by their operating results, and they view TRS as an âirrationalâ measure, driven by the vagaries of the markets.
This makes good sense if you view investors as lemmings swayed by momentum buying and panic selling. Our hunch, though, was that the markets as a whole reflect astute analysis of corporate performance. If it is true that some bad companies were oversold in the roaring 1990s, it is also true that good companies ultimately prevail and command high share prices accordingly.
To test our hypothesis, we asked Dr. Harvey Wagner, a professor at the University of North Carolina, Chapel Hill, to conduct a rigorous analysis of the financial statements of all the companies in our study. He found that the winning organizations as measured by their TRS were also winners by almost every other meaningful measure of operating performance.
In all cases, the Evergreen Project compared a companyâs TRS results to those of its peers within the same industry. We understood, from our years of academic research, and from our common sense, that an individual organizationâs TRS sometimes reflects not its own performance so much as the state of its industry.
From the initial list of companies, we selected 160 for detailed study and divided them into groups, each comprising four enterprises representing one of forty narrowly defined industries. To keep the playing field level, we made sure that as of 1986, the start of our ten-year study period, the four companies in each industry group were reasonably equivalentâmeaning similar to each other in scale, scope, financial numbers, TRS, and future prospects. We left out failing enterprises as well as big conglomerates with diverse businesses that could not be meaningfully compared with each other.
The vast majority of corporations in our study had market capitalizations between $100 million and $6 billion. And though they began the Evergreen decade as peer enterprises in their own industries, they didnât remain that way. They parted company during the decadeâs two five-year periods (see Exhibit 1.1), just as people do in responding to career challenges.
As the companies evolved differently over the decade, we classified the four in each industry to represent four archetypes: Winners, Climbers, Tumblers, and Losers. Winners outperformed their peers in TRS during both the first and second five-year periods. Climbers lagged behind their peers in the first period, but moved up in the second. Tumblers outdid their peers during the first period, and faltered in the second. Losers were bested by their peers through both five-year periods.
The decision to choose four matched companies (we called them âquadsâ) whose performance trajectories differed over time distinguished our study from all others. It also ensured results that would have greater validity than previous efforts to identify winning management practices.
Some studies, such as In Search of Excellence, identify best practices by studying a sample of successful organizations. But using winning companies alone limits your analysis. You canât tell whether or not losers are pursuing similar practices. And when successful businesses falter, as they often do, you canât be sure why. Did they falter because they stopped doing things that once made them successful, or did they go on doing those things and falter nonetheless?
1.1 Total Return to Shareholders*
for Winners, Losers, Climbers, and Tumblers
Sources: Compustat, Evergreen team analysis.
Other studies, such as Built to Last, identify best practices by comparing winning companiesâ behavior with a control group of average performers or with losing organizations. This approach is better than studying successful organizations alone, but it leaves out distinctions between cause and effect. You canât tell whether a winnerâs practice is actually a key reason for its superior performance. For example, does an organizationâs ability to attract highly talented employees play a major role in its superior performance, or has its superior performance attracted those talented employees?
Our research design was unique in that we not only compared Winners to Losers; we also looked at Climbers and Tumblers. By simultaneously studying companies whose performance changed (for better or worse), we were able to separate cause and effect. We could truly identify which management practices actually work. In other words, we could now say that improving upon specific practices virtually guarantees a companyâs superior performance. Equally important, fumbling at those practices is bound to worsen performance.
Our study was also special in its use of three distinct methodologies to determine management practices that truly influence company performance:
1. We began with a survey methodology. Using broadly accepted industry guidelines and our own research, we identified more than 200 management practices that were thought to influence business success, ranging from broad areas such as strategy, innovation, and business processes, to specific practices, including 360-degree performance reviews, supply-chain management, and the use of intranets. All publicly available information on the 160 companies was collected and read by coders trained to score each organization on all 200 practices on a scale of 1 (poor relative to peers) to 5 (excellent relative to peers). We verified the reliability of the survey by obtaining additional information from dozens of people familiar with each company, among them knowledgeable outsiders, senior executives, and former executives who had been present during the study period. Their perspectives helped us cross-check the codersâ analyses.
2. We also pursued in-depth studies of a number of the management practices that we had concluded were potentially major factors in company performance. This second set of studies, many of which were done at our request by academic experts, allowed us to verify and extend the larger survey findings. In each case, though, the experts had to test their ideas on the same 160 companies that comprised our st...
