Taking the Lead June 2008

An excerpt from the AMR Research article, "A Conversation With Procter & Gamble CEO A.G. Lafley," by AMR Research CEO and President Tony Friscia, April 2008

A.G. Lafley became CEO of The Procter & Gamble Company (P&G) at a rough time in the company's 171-year history. When Lafley took the helm in June 2000, profits were down, revenue was down and the stock price was hitting a low. By all accounts, the company had lost its way.

But that all changed under Lafley, who led one of the great turnaround case studies of our time: P&G is now one of the 10 most valuable companies in the United States. For example, on Lafley's watch, sales have grown to more than $80 billion from less than $40 billion when he took over, and earnings have tripled, topping $10 billion in 2007. The company has 24 brands generating more than $1 billion each, more than twice the number in 2000. And that number is likely to increase with close to 20 more brands with sales greater than $500 million and growing. P&G's stock, which was trading at about $28 per share before Lafley, now exceeds $70 per share.

I had the opportunity to talk to Lafley recently about the theme of his upcoming book, The Game-Changer: How You Can Drive Revenue and Profit Growth with Innovation (co-written with business consultant Ram Charan), and how he led P&G to its current leadership position. Here's a summary of our discussion:

Friscia: As widely reported, P&G wasn't doing very well when you took over. What were the problems you had to address?

Lafley: There were several core problems that were interrelated around our strategy, organization and structure.

Strategically, we were trying to do too many things. It wasn't clear what our core businesses were, and we had lost focus.

Organizationally, P&G was trying to do too much too fast, which was disruptive internally and affecting how we were doing in the marketplace. Organizational changes became internally focused, and we lost touch with our consumers. This had results like prices that were too high, which was a big negative to our consumers.

Structurally, we were putting all of our employees through change at the same time; 80 percent of the employees changed jobs, which was
very disruptive.

All of this combined caused us to lose focus and let our competition take market share from us. It was clear we had to address these issues quickly by making some hard choices on each.

Friscia: What were your first moves to address these challenges?

Lafley: The first lever we pulled was getting the company refocused on its purpose and values. The company's purpose has always been to create better brands and better products for a better everyday life for our consumer. We somehow lost that very simple sense of purpose and had to get it back by making sure that every employee understood it and lived it.

As we reinforced this core value across the company, we then decided to make what we called "How to Win" choices:

• Demonstrate a deep understanding of the consumer through brand leadership and an ability to drive innovation.
• Establish supply chain leadership through a deep connection with trading partners and customers.
• Really drive global learning and get the benefits of a scale company.

Friscia: Starting with the first goal, you evoked the mindset that the consumer is central to everything P&G does. How did you start, and how did you make the cultural changes necessary to recreate a consumer-driven company?

Lafley: We started to stress this core value by communicating everywhere that P&G is not doing its job unless we win with the consumer, and the boss is not P&G, the boss is our consumer. We had to get our people to invert the pyramid, turn what had become an "inside-out" focus into an "outside-in" focus.

I stressed the need for all of us to focus on two consumer "moments of truth." The first moment is when the consumer makes the decision to buy a product. P&G had to ensure that it won at this first moment of truth. The second moment is when the consumer uses the product. At that moment, they have to be satisfied and experience quality and value. This ensures they will buy the product again and become loyal consumers.

To strengthen our ability to deliver on these two moments of truth, we then had to establish and execute a strategy built around culture, values and principles. This meant getting focused and understanding all the changes that would be necessary to succeed. We knew that if we made all the changes necessary up front, we would not need to address them down the road, allowing us to execute and focus on results.

Developing a strategy meant deciding which industries, geographies, core capabilities and competencies to focus on. We also had to understand where growth was going to come from, having the right branded products and brand mix, and having the ability to drive into developing markets, which is where there was economic growth. As an example, we decided to shift the company's portfolio from two-thirds household products to one-half household and one-half personal, beauty and healthcare. This strategy and focus also drove our need to strengthen our innovation capability and our supply chain capability.

Friscia: Let's talk about innovation. You changed P&G's culture to tap outside sources for innovation, primarily through the Connect + Develop initiative. Tell us about how that came about.

Lafley: There are two routes to sustainable growth: acquire and/or innovate. We recognized that the innovation component would be critical to getting to $100 billion in sales this decade. We couldn't do it without bringing in new ideas and innovation.

This is not to discount the importance of our acquisitions. A big part of our growth has been through successful strategic acquisitions: Clairol, Wella and Gillette.

Beyond these acquisitions, innovation has made a considerable difference. We recognized that we had to achieve organic growth that exceeded overall industry growth, which meant seeking big ideas from both inside and outside the company. This was not easy to do because P&G was a "not invented here" culture, which was limiting. To really drive innovation, we knew we had to start working with outside partners: supply chain partners, inventors, research labs, or even, competitors.

When we started this process, only 10 percent to 15 percent of our innovation included the ideas or technologies of outside partners. Today, more than half of our innovation includes at least one outside partner; we have really transformed the culture. This wasn't easy to achieve. Given the culture we started with, many in R&D initially saw this as a threat. The change happened slowly at first, but then accelerated as we started to achieve innovation success by connecting our researchers to outside players. And fortunately, we achieved this without a lot of turnover in R&D.

The end result is that we've achieved six percent organic growth in an industry that's growing at two percent to three percent. There's no doubt this was because we opened ourselves up to outside ideas and built a sense of urgency to innovate. We're not in a revolutionary business like high technology where you're constantly under pressure from new product lifecycles. That's a good and a bad thing, good because it bought us time, but bad because we had to create our own sense of urgency.

Friscia: AMR Research ranks the supply chain performance of the Global 500 annually in its report, "The AMR Research Supply Chain Top 25." P&G has consistently been at the top of this list, No. 2 and No. 3 the past two years, respectively. How did you develop this as a core competency?

(Note: To show the importance of this supply chain leadership, financial analysis shows that an investment in our Top 25 companies yielded an average return of 17.89% last year compared with returns of 6.43% for the Dow Jones Industrial Average and 3.53% for the S&OP 500)

Lafley: The reason P&G places a high value on its supply chain performance is that our business is intensely execution-oriented. We acquire raw materials, manufacture product and have complex systems to manage the flow of billions of units per year through a global system. If our supply chain doesn't perform, P&G does not have the right brand in the right place at the right time. This is the difference between winning and losing in the marketplace.

To develop this expertise, the company centralized product supply in the late 1980s and 1990s. This has continued to evolve. My goal has been to take this system to a new level by integrating the organization seamlessly to have a balance. Even though the organization was centralized, we were still looking at the pieces as independent organizations: engineering, manufacturing, purchasing and logistics. Our goal has been to operate these as one integrated network, which we've done with some success. The result is that our supply chain, today, gives us a competitive advantage, which has made a big difference in overall performance and in growth areas, like entering emerging markets.

Friscia: Let's talk about supply chain and emerging markets. You talked about entering these markets as a key part of your strategy. Can you share P&G's approach to this?

Lafley: In developing markets, supply chain and distribution capabilities are critical to success. These are typically the biggest challenges in penetrating and developing these markets. For example, we have had great success in China since we opened there because P&G was the first to establish a distribution system and create a supply chain, which consisted mostly of local manufacturing. This gave P&G an advantage in serving the Chinese consumer. Through supply chain capability, we established trade scale and cost advantages that allowed us to focus on innovating with new products to further develop that market.

In some developing markets, we face entrenched competition. In these cases, supply chain competence is critical to our ability to effectively enter the market. For example in India, Unilever has been there for 100 years; its supply chain exists there. To be successful in developing a position there, we had to find an innovative way to be different, a better way of doing things. We leveraged our global scale and brought partners in to help build the supply chain in India. This has been critically important to our success there.

Overall, through these competencies and our innovation success, sales in emerging markets have been up 18 percent per year since 2001. More than one-third of total company sales growth now comes from these developing markets.

Friscia: With regard to globalization, P&G faces significantly more risk. How do your culture and operational abilities allow you to outperform competitors in addressing the business risks of globalization (natural disasters, terrorism and global unrest, labor unrest, disease, etc.)?

Lafley: This is a high priority within our company. It is continuously assessed and reviewed. In fact, we devote an entire board meeting each year to discussing risk and assessing the company's ability to deal with it in the many forms it may take. Again, our supply chain capability is critical here.

Friscia: You talked about driving global learning within P&G's culture and also achieving the benefits of scale within the company. How did you accomplish this?

Lafley: We moved from a country structure to a global product structure. For example, we started to look at beauty care as a global profit center supported by a global shared service. This has given us the benefits of scale. It has allowed for more balance and allowed us to put an emphasis on productivity and be more attentive to cash and cost.

As a result, we've cut capital expenditures in half and have taken general and administrative costs down considerably. We've also built an organization in which we could attract the best talent and make our leadership more diverse to serve our more global market.

During this transition, we turned over more than half our leadership team. Today, about 40 percent of our top team carries non-U.S. passports.

Friscia: What role do you, as CEO, see information technology (IT) playing in these initiatives, and how do you assure the most value is gained from these investments for P&G?

Lafley: IT is huge for P&G and a core strategic advantage. We made the decision to outsource our data centers and information technology infrastructure globally to Hewlett-Packard in 2003. This freed up P&G people to be innovative in the technologies arena.

For example, we leverage new technology in our innovation process. What we used to do in the physical world, we're now trying to do in the virtual world.

We're working with social networking and other emerging technologies and platforms to work more closely with our consumers and partners to innovate.