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The New Leader’s Guide to Diagnosing the Business

by Mark Gottfredson, Steve Schaubert, and

Hernan Saenz

How can an incoming leader

lay the groundwork for

dramatic performance

improvement?

Reprint R0802C

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by Mark Gottfredson, Steve Schaubert, and

Hernan Saenz

harvard business review • february 2008 page 1

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How can an incoming leader lay the groundwork for dramatic

performance improvement?

From 1999 to 2006, the average tenure of de-parting chief executive officers in the UnitedStates declined from about 10 years to slightlymore than eight. Although some CEOs stay along time, a lot of them find that their stint inthe corner office is remarkably brief. In 2006,for instance, about 40% of CEOs who left theirjobs had lasted an average of just 1.8 years, ac-cording to the outplacement firm Challenger,Gray & Christmas. Tenure for the lower half ofthis group was only eight months. Some ofthese short-timers were simply a poor fit andleft of their own accord, but many others wereushered out the door because they appearedunable to improve the business’s perfor-mance. Nobody these days gets much time toshow what he or she can do.

So within a few months at most, incomingCEOs and general managers must identifyways to boost profitability, increase marketshare, overtake competitors—whatever thekey tasks may be. But they can’t map out spe-cific objectives and initiatives until they knowwhere they are starting from. Every organiza-

tion, after all, has its distinctive strengths andweaknesses and faces a unique combinationof threats and opportunities. Accurately as-sessing all these is the only way to determinewhat goals are reasonable and where a man-agement team should focus its performance-improvement efforts.

Embarking on this kind of diagnosis, how-ever, can be daunting because there are count-less possible points of entry. Your company’soperations may span the globe and involvemany thousands of employees and customers.Should you start by talking to those employ-ees and customers or by examining your pro-cesses? Should you focus on the effectivenessof your procurement or analyze your productlines? Managers often begin with whateverthey know best—customer segments, for ex-ample, or the supply chain. But that approachis not likely to produce either the thorough-ness or the accuracy that the managementteam and the business situation require.

What’s needed instead is a systematic diag-nostic template that can be tailored as neces-



sary to an individual business’s situation.Such a template has to meet at least threecriteria: It must reflect an understanding ofthe fundamentals of business performance—the basic constraints under which any com-pany must operate. The template must beboth comprehensive and focused—coveringall the critical bases of the business, but onlythose bases, without requiring any waste oftime or resources on less important matters.And it should lend itself to easy communica-tion and action.

This article presents a template that wethink meets these criteria. It is built on fourwidely accepted principles that define anysuccessful performance-improvement pro-gram. First, costs and prices almost alwaysdecline; second, your competitive positiondetermines your options; third, customersand profit pools don’t stand still; and fourth,simplicity gets results. Along with each princi-ple, we offer question sets and analytic toolsto help you determine your position andfuture actions.

We developed and refined this templateover our combined 50-plus years of workingwith clients, nearly all of whom have neededto perform an accurate diagnosis quickly. Wehave recently used it both with large corpora-tions and with private equity firms evaluatingthe potential of their portfolio companies. Wetested it through a series of research studiesand interviews that we conducted in prepara-tion for writing the book from which thisarticle is adapted. Our experience and re-search convinced us that the template is apowerful tool. Its four principles cover thecritical bases of virtually every business, pro-viding managers with the minimum informa-tion required for a comprehensive diagnosis.Of course each manager will have to decidewhich elements of the template to emphasize(or de-emphasize) based on his or her busi-ness situation.

A word of caution: As the article makesclear, you will need to gather a lot of dataquickly, ideally within the first three or fourmonths of your tenure. Ask your senior lead-ers to head up teams that take on as manyquestions relevant to their areas of responsi-bility as they can handle. Ask for short,focused presentations to facilitate discussionsabout the main threats and opportunities.That should enable you and your teams to

make quick, accurate decisions about the fewareas on which to concentrate your efforts.

This process not only will show you whereyou are starting from (your point of depar-ture, so to speak) but also will help you mapout your performance objectives (or desiredpoint of arrival) along with three to five criti-cal change initiatives that will take you whereyou want to go. Indeed, many companieshave used the template to create a set ofcharts showing exactly where and how thebusiness can improve. Incoming leaders findthat reaching a diagnosis within their firstthree to four months helps them lay a founda-tion for breakthrough performance—andavoid the pitfalls that other new leadersencounter all too frequently.

Analyze Costs and Prices

The first principle in our template is thatcosts and prices almost always decline.This may seem counterintuitive: Inflationoften clouds the view, and special circum-stances can sometimes drive costs and pricesupward. But it is a well-established factthat inflation-adjusted costs—and thereforeinflation-adjusted prices—decline over time innearly every competitive industry. The ana-lytic tool that best charts this principle is the

experience curve

, a graph showing the declinein a company’s or an industry’s costs or pricesas a function of accumulated experience. Forexample, you might find that for every dou-bling of total units produced in your company,your per-unit cost in constant dollars drops by20%. (In this case your experience curve is saidto have a “slope” of 80%.) Because the sameprinciple holds true for your competitors—and thus for your entire industry—the curveallows you to estimate where costs or pricesare likely to be in the future. By comparingyour company’s cost curve with your indus-try’s price curve, you can determine whetheryour costs are declining at the rate necessaryfor your company to remain competitive.

Construct cost and price experiencecurves.

The first diagnostic questions to askregarding this principle are “What is the slopeof price change in our industry right now forthe products or services we offer?” and “Howdoes our cost curve compare with the indus-try’s price curve and with our competitors’cost curves?” (See the exhibit “UnderstandingExperience Curves.”)

Mark Gottfredson

([email protected]), a partner in the Dallas office of Bain & Company, and

Steve Schaubert

([email protected]), a partner in the Boston office, are the authors of

The Breakthrough Imperative: How the Best Managers Get Outstanding Results

(HarperCollins, forthcoming in March 2008), from which this article is adapt-ed.

Hernan Saenz

([email protected]) is a partner in Bain’s Boston office and a leader in the firm’s North American performance improvement practice.

mailto:[email protected]








The relationship between prices and costsin any given business area will determinesome of your top priorities. If industry pricesare going down while your costs are going upor holding steady, for instance, cost improve-ment is likely to be your single most urgentchallenge. Your costs need to be decreasingover the long term regardless of what pricesare doing. An upward movement in prices isfrequently only temporary.

Understanding your overall cost trends, ofcourse, is just a preliminary step. You thenneed to examine every segment of costs todetermine where the central challenges andopportunities lie. Dig into the cost areas thatare most important for your organization:manufacturing, supply chain, service opera-tions, overhead—whatever they may be. Iden-tify the key cost components and the trendsin each one. Look specifically for instances offailure to manage to the experience curve,such as rising unit costs for labor or rising pro-curement costs. This kind of detailed analysiswill identify opportunities for improvementat the most granular level and will provide thebasis for a plan of action.

One CEO we spoke with reflected on whathe called his biggest mistake in his first few

months on the job. One of his company’s busi-ness units was the leader in an industrialmarket. It had been raising prices, so it wasquite profitable, and the new CEO decided toleave it alone for the time being. Then new,low-cost competitors from Asia entered themarket and found that this unit had estab-lished both a price umbrella and a cost um-brella. The competitors soon undermined theunit’s pricing power. The situation requiredurgent action to reduce costs by at least 15%,an initiative that is well under way. The lessonthat CEO drew from the experience was stark:Be sure to diagnose

every

business positioncarefully, particularly in units that seem to bedoing well.

Determine costs relative to competitors’.

After comparing your overall costs with indus-try prices and your competitors’ costs, youneed to take a more detailed look at yourcost position in your industry. How do youcompare with your key competitors in eachcost area? Which company is most efficientand effective in priority areas? Where can youimprove most relative to others? An analysisof cost position quantifies cost differencesbetween your business and your competitors’;it also shows which cost elements and specific

Questions That Will Lead You to Breakthrough Performance

1. 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 efficient 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?

2. Second Principle

Your competitive position determines

your options.

•

How do you and your competitors com-pare 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 busi-ness position?

•

How big is your market?

•

Which parts are growing fastest?

•

Where are you gaining or losing share?

•

What capabilities are creating a com-petitive advantage for you?

•

Which ones need to be strengthened or acquired?

3. Third Principle

Customers and profit pools don’t stand still.

•

Which are the biggest, fastest-growing, and most profitable 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 profit pool do you have today?

•

How is the pool likely to change in the future?

•

What are the opportunities and threats?

4. 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 prod-ucts stand out in customers’ minds?

•

How complex is your decision making and organization relative to competi-tors’?

•

What is the impact of this complexity?

•

Where does complexity reside in your processes?

•

What is that costing you?



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 inflation-adjusted prices and costs are likely to decline in the future.

The “slope” is the percentage of original price or cost re-maining 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 gen-eral 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.

This chart shows the rate of price declines for every dou-bling of accumulated experience for a sample of both manu-facturing and service industries. (The time periods here reflect a wide variety of studies conducted at different times.)

ACCUMULATED EXPERIENCE

Performance

goal

Industry

price

Company

cost

Prices tend to follow costs over time

Starting

point for

new CEO

90% slope(10% DECLINE)

Source: Bain

70% slope(30% DECLINE)

Industry DatesPrice 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



practices are different. Drill down until youunderstand where and how you differ, andwhy. That, in turn, will help you figure outwhere you can close cost gaps and gain orregain competitive advantage. It will also helpyou formulate detailed plans to do so.

Not long after he took on the top job,David Weidman, CEO of the $6.7 billionchemical company Celanese, headquarteredin Dallas, asked his management team toconduct such a competitive assessment. “Theycame back and said, ‘Holy cow, our averageEBITDA to sales is seven or eight percentagepoints lower than the competition’s,’” he toldus. “And this was not in one business—thiswas across every organization.” Weidmanasked the team to identify specific areaswhere the company could improve relativeto the competition. He wanted to find out,for instance, what one key competitor wasdoing in maintenance, because that com-pany’s maintenance spending was far betterthan Celanese’s.

Understanding your cost position as well asyour experience curve enables you to setproper targets. You will know, for example,that your lower-cost competitors are on theirown experience curves and will have im-proved their own positions by the time youreach their current cost levels.

This kind of analysis presents a uniqueopportunity. Rather than simply comparingyourself with your top competitor, figure outwhich firm (including yours) is the best ineach area. Maybe one is world-class in supply-chain logistics practices, another in a particu-lar manufacturing step, and so on. You canthen construct a hypothetical competitorrepresenting the best of the best, or whatwe call best demonstrated practices. Thathypothetical company will have lower costsand better performance than any real-worldcompany; you can use it as a benchmark forimprovement, striving to leapfrog your com-petitors instead of just trying to catch up.

Assess the profitability of your productlines.

Your next job is to determine which ofyour products or services are making money(or not), and why. The goal is to calculate thetrue margins of your products or services.First, you need to figure out direct costs foreach product based on actual activities per-formed, rather than using standard costing.Then you must accurately allocate indirect

costs—logistics, selling expenses, general andadministrative expenses—to each product lineand customer segment. Activity-based costingwill give you a more accurate picture than youor your predecessor may have had in the past.The analysis should reveal the key cost andrevenue drivers you need to address: areaswhere the cost of goods sold, for instance, isout of line, or where your revenue perfor-mance is below benchmark levels.

When Warren Knowlton, until recentlythe CEO of the venerable British companyMorgan Crucible, agreed to take the top jobthere, he learned that Morgan had hundredsof products, ranging from crucibles andadvanced piezoceramics to body armor andstate-of-the-art superconductor magneticsystems. He needed to determine which weremaking money and which were dragging thecompany down, so he drew up a list of criticalquestions for the heads of his business units.For example, he asked them to delineate theirexpectations for operating profit during thecoming year and to explain expected changesfrom the preceding year. Then he asked fordetails. One question was “What percentageof your revenues represents sales to custom-ers you would consider to have significantleverage over you?” Another was “How muchof your revenue do you believe representsprice-sensitive, commodity-type products?”Other questions focused on the cost side,including matters such as purchasing proce-dures and performance compared with thatof rivals. The answers gave Knowlton a jump-start on his analysis of product-line profitabil-ity. He subsequently made major shifts inproduct lines to de-emphasize commodityproducts and unprofitable customers. Alongwith significant cost reductions, these movesenabled him to engineer a remarkable perfor-mance breakthrough, increasing the com-pany’s share price 10-fold in just three and ahalf years.

Evaluate Your Competitive Position

The second principle in our template is thatyour competitive position determines youroptions. Depending on your industry, therecan be different drivers of profit leadership, in-cluding customer loyalty and “premiumness”of the product. But in most industries, one ofthe strongest predictors of a company’s perfor-mance is its relative market share (RMS).

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.



RMS is easy to calculate. If your company isa market leader, simply divide your share bythe share held by your closest competitor(30% divided by 20%, say, equals an RMS of1.5). If you’re a follower, divide your share bythat of the market leader (20% divided by30% equals 0.67 RMS). Now plot the compa-nies in your industry according to their RMSand their returns on assets (ROA). (See theexhibit “A Map of the Marketplace.”)

You are likely to find that for many firms,higher RMS corresponds to higher ROA, andvice versa. This reflects the fact that marketleaders typically outperform market followerson ROA; they have greater accumulated ex-perience, leading to lower costs and superiorcustomer insights, which in turn lead tohigher profits. They thus have a greater abilityto outinvest the competition in innovation,customer service, branding, and productsupport.

Compare your returns and market sharewith those of your rivals.

The ROA/RMS chartis an extraordinarily useful diagnostic tool be-cause it helps you narrow down your optionsfor performance improvement. There are fivegeneric positions on the ROA/RMS chart:

in-band leaders, in-band followers, distant orbelow-band followers, below-band leaders,and overperformers. Each has its own impera-tives. Typically, for instance, in-band leadersfind that they can raise the bar for competitorsby investing in still-greater market share andin product or service improvements. In-bandfollowers usually need to work hard just tokeep up; only occasionally can they jump intoa leadership role through heavy investmentin innovation, the way Sony Computer Enter-tainment’s PlayStation leapfrogged Nintendoin the video game industry in the 1990s. Over-performers, which earn returns well beyondwhat their relative market share wouldsuggest, typically need to maintain high levelsof investment in whatever has enabled themto escape the pull of the band (assuming theyaren’t simply capitalizing on a temporaryprice umbrella). That might be a trusted orprestigious brand, an innovative or patentedtechnology, exceptionally loyal customers, orsome other asset. Below-band companies, ofcourse, have probably not been managingtheir costs down the experience curve, whichwould be a primary reason for their underper-formance.

Whatever your company’s position, theband helps you understand its full potentialby showing both opportunities and con-straints. An in-band follower, for example,can’t expect to earn the returns of a leader un-less it moves up the band or escapes into theoverperformer category through one of thestrategies mentioned.

Band analysis can be used for two otherdiagnostic tasks: anticipating competitors’improvement strategies and assessing busi-nesses in a multiunit organization.

Mapping your company against competi-tors is the first step toward seeing how eachfirm is making money or where it is failingto do so. It allows you to spot potentialthreats to and opportunities for your busi-ness, and to assess the strategic options avail-able to others. For example, when we and ourcolleagues began compiling a band chart forcredit card companies, we could find no rela-tionship between market share and returns—a highly unusual situation. So we asked whatwas driving the returns of the most successfulplayers. The analysis showed us that in thisbusiness, customer loyalty was the single mostimportant factor in determining profitability.

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 com-petitors. Companies in a well-defined industry typically line up in a fairly narrow band, reflecting 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

RET

UR

N O

N A

SS

ETS

High

LowWeak

In-band leaders

dnab-woleB

leaders



If every company were equally skilled atretaining customers, then market share

would

be the principal driver—but that wasn’t thecase. Because of the high cost of customeracquisition and the tendency of customers toincrease their credit card use over time, so-phisticated techniques for retaining custom-ers could overcome advantages of pure scaleand allow successful companies to becomemore profitable than their competitors. Thatwould increase their RMS as well. Companiesthat had not developed such techniques wereoperating at a serious disadvantage.

Band analysis can also help the leader of amultiunit organization determine whethereach business is achieving close to its full-potential performance. This objective was atthe heart of Knowlton’s decision-making pro-cess regarding Morgan Crucible’s many busi-nesses. Placing Morgan’s business units on aband chart that compared their economicperformance with their region-weighted rela-tive market share, Knowlton could see at aglance that some units, such as the company’sindustrial rail and traction division, were inthe band: They were performing as expected.Others, such as thermal ceramics, were belowthe band and needed to be moved upward,typically through aggressive cost control andmeasures designed to grow revenue. Stillothers were laggards in the lower left of theband and were candidates for divestiture.

Measure your market size and trends.

How big is your market, exactly? Which partsare growing fastest? Where are you gainingor losing share? A simple way to map yourmarket’s size and dynamics is to draw a rectan-gle and then divide it into vertical segmentsrepresenting your most important submarketsor products. The width of the segments shouldbe set in proportion to the share of revenuesthey account for in the market. Next, divideeach of these vertical segments into boxesrepresenting the share held by each principalcompetitor. Create one chart for three to fiveyears ago and one for the present. The twocharts will show you the sectors and thecompetitors experiencing market growth.Depending on your situation, of course, youmay need to customize the basic chart. A com-pany selling telecommunications equipmentin Asia might first map the Asian telecommarket by country and by sector (wireline,wireless, and so on) and then break it down

into competitors’ market shares. Again, com-paring two or more points in time will showyou where, and how fast, the market isgrowing. Faster-growing markets attract morecompetitive interest, so you will need anaggressive plan to win your share.

Other tools may be useful as well. Aso-called S-curve chart, for instance, whichplots industry growth against time, can showthe inflection points where growth acceler-ates and then tapers off.

Assess your firm’s capabilities.

Your com-pany’s chances to achieve its full potential—toimprove its position on the band chart—depend significantly on its capabilities. Whichcritical capabilities are giving you a competi-tive advantage? Which do you lack? Whichneed to be strengthened or acquired? Theglobal technology and engineering companyEmerson, for example, knows how to manageits costs so aggressively that it can acquireother businesses and then add substantialamounts of value. Companies can also succeedif they can develop capabilities they don’tcurrently have. The iPod didn’t really takeoff until Apple developed the capabilities tomanage and sell digitized music through itsiTunes store.

Every company, of course, must make deci-sions about which capabilities it wants todevelop or maintain in house and which itwants to obtain from suppliers. The contextfor these decisions has changed dramaticallyin recent years. In many industries the pri-mary basis of competition has shifted fromownership of assets (stores, factories, andso on) to ownership of intangibles (expertisein supply chain or brand management, forexample). At the same time, a handful of van-guard companies have transformed what usedto be purely internal corporate functionsinto entirely new industries. Thus FedEx andUPS offer world-class logistics-managementservices, while Wipro and IBM offer numer-ous business and IT services.

The result of all this is that companies canno longer afford to make sourcing decisionson a piecemeal basis—nor can they be satis-fied with a “good enough” approach to select-ing and working with suppliers. Today, youmust assess every capability that you needin order to create or develop a product orservice. You should analyze every step of yourvalue chain, from design and engineering to



product or service delivery. You should com-pare yourself not only with competitors inyour industry at every step of the chain butalso with whatever companies are the best inthe world at performing each particular step.Are you the best? Or do you have some capa-bility that creates a sustainable competitiveadvantage in a given step? If the answer toboth questions is no, you should ask whetheryou can improve or acquire the relevant capa-bility, or whether you might be better offsourcing that part of your value chain to thebest supplier.

Understand Your Industry’s Profit Pool

The third principle in our template is thatcustomers and profit pools don’t stand still.Markets undergo massive changes all thetime, mostly because customers’ desires andneeds evolve. Companies repeatedly discoverthat the landscape they operate in has alteredsignificantly and that the plans and strategiesthat worked so well yesterday no longer worktoday. They find that the

profit pool

from

which they were drawing their earnings hasdried up or attracted new competitors, andthat deep new pools of profit have appearedelsewhere. (For more on profit pools, see OritGadiesh and James L. Gilbert, “Profit Pools: AFresh Look at Strategy,” HBR May–June 1998.)For these reasons, you’ll need to examine theprofit pools you currently draw on and thosethat might hold potential for the future.

Study customer needs and behavior bysegment.

Correctly segmenting customersand developing proprietary insights into theirpurchasing behavior is one of the most power-ful methods of building loyalty, increasinggrowth, gaining market share, and thus ex-panding your share of the profit pool. Whichare the biggest, fastest-growing, and mostprofitable segments? How well do you meetcustomers’ needs, compared with competitorsand substitutes? As you raise these questions,you will want more-specific answers, suchas how customers are segmented. On thebasis of needs? Behavior? Occasion of use?Demographics? What are each segment’s char-acteristics and spending habits? What share ofwallet is each one currently giving you, and isthere reason to think that you can increasethat share?

You can use many tools to delve deeply intocustomer needs and behavior. These rangefrom cluster analysis to sophisticated ethno-graphic research. It’s often worthwhile tolook at customers through many differentlenses because you may spot something thatcustomers themselves aren’t even aware of.While we don’t have space to discuss all suchtools in this article, we’ll mention a simpleone that has been remarkably effective evenin highly sophisticated industries. We call ita SNAP (segment needs and performance)chart. It can help you assess how well youare meeting the needs of the segments youare targeting.

To develop a SNAP chart, start by definingthe attributes of the products or services youoffer that may be important to the customersegments you want to target. Then conductresearch to determine how important each ofthese actually is to these customers. A bank,for instance, might study everything from itshours of business to its loan rates to the qualityof the advice it offers and the ease of access toits ATMs. Finally, assess where you stand oneach scale and where your competitors stand.

Segment Needs and Performance

This SNAP (segment needs and performance) chart displays data for a fitness machine company we’re calling FitEquipCo. The company exceeds customers’ re-quirements 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 first in importance, and significantly underperforming on cus-tomer service, which is third. FitEquipCo needs to take action to close those gaps.

Competitors’ Performance

Company’s Performance

Assortm

ent

IMPORTANCE OF

ATTRIBUTES TO

CUSTOMERS

5

4

3

2

1

Quality Price

Time to

market

Customer s

ervice

Innovation



This process will show how you measure upto the competition in the eyes of your key cus-tomer segments. You can use the SNAP chartto identify which gaps are most importantto close (if you’re behind) or widen (if you’reahead). You can also see where you mightbe overshooting the mark. (See the exhibit“Segment Needs and Performance.”)

Track customer retention and loyalty.

Whatproportion of customers are you retaining?Loyalty can be a critical factor in the econom-ics of a business, particularly when the cost ofacquiring a customer is high, switching costsare relatively low, or both. Accordingly, youneed to know your retention rates for eachsegment. Doing so not only will help youdetermine the profitability of the segment butalso will help you make plans to boost reten-tion rates where necessary.

A good indicator of loyalty and probableretention is the Net Promoter Score (NPS),developed by our colleague Fred Reichheld.This measures customers’ responses to thequestion “How likely is it that you would rec-ommend this company (or product or service)to a friend or colleague?” Respondents an-swer on a zero-to-10 scale, where a 10 means“Extremely likely” and a zero means “Not atall likely.” Those who give you a nine or a10 are your

promoters

. Research shows theyspend more with you, are likely to increasetheir spending in the future, and sing yourpraises to their friends and colleagues. Thosewho give you a seven or an eight are

passives

,and those who rank you zero to six are

detrac-tors

. Promoters are an engine of growth, butdetractors often cost your company morethan they are worth, and they bad-mouth youto anybody who will listen.

Your Net Promoter Score is simply thepercentage of promoters minus the percent-age of detractors. Measured relative to com-petitors, NPS has been shown to correlatewith growth rates and with other measuresof customer satisfaction. Properly imple-mented, NPS creates a closed learning loopamong customers, the front line, and manage-ment, and thus can be used as a basis formanagerial decisions, just as financial reportsare. American Express and many other com-panies use NPS-like metrics throughout theirorganizations to give them quick, regularreads on customers’ attitudes and potentialbehavior.

Segmentation and retention efforts are atthe opposite ends of a six-step chain of activ-ity that enables a company to earn moreprofits per customer than its competitors andthen to outinvest the competitors to generatefaster growth. The first steps are (1) identify-ing the most attractive target segments and(2) designing the best value propositions tomeet their needs. The next ones are (3) ac-quiring more customers in the target segmentand (4) delivering a superior customer experi-ence. That enables the company (5) to growits share of wallet and (6) to increase loyaltyand retention, with more promoters andfewer detractors.

Anticipate profit-pool shifts.

CEOs and gen-eral managers naturally need to assess howmuch of their industry’s profit pools theirfirms own today. But they must also gaugehow profit pools are likely to change in thefuture and what opportunities or threats theseshifts may create. One useful tool is a profit-pool map, which shows the channels, prod-ucts, or sequential value-chain activities in themarket and indicates the total profits availablefrom them. You can then locate your businessand its competitors on the map, showing howmuch each company takes from each partof the profit pool. It’s wise to do this for allcustomer segments and all sets of products.

A company we’ll call FitEquipCo mappedthe growth (historical and projected) of itsindustry. Then it gathered extensive dataabout customers’ intent to purchase or repur-chase and developed profit-pool projectionsby 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 mapshowed, for instance, that FitEquipCo neededto build up its distribution through sportsspecialty stores, which delivered highermargins. Through such measures, the com-pany projected, it could increase earnings by$86 million over a three-year period, morethan doubling operating profits. (See “A Mapof the Profit Pool.”)

As with the market map, it’s wise to com-pare at least two points in time so that youcan see how the pool is evolving. Often asignificant threat to the profit pool comesfrom companies that don’t yet compete inyour industry or are still too small to benoticed. Yet these competitors can turn an



industry upside down. Think, for example, ofthe effects minimill companies such as Nucorhad on the U.S. steel industry.

Simplify, Simplify

The fourth principle in our template is thatsimplicity gets results. A couple of years ago,researchers from Bain & Company surveyedexecutives in 960 companies around theworld, asking them about complexity in theirorganizations. Nearly 70% of the respondentstold us that complexity was raising their com-panies’ costs and hindering growth. Anotherteam of researchers studied the impact ofcomplexity on the growth rates of 110 compa-

nies in 17 different industries. The researchersfound that the least complex companies grew30% to 50% faster than companies withaverage levels of complexity, and 80% to 100%faster than the most complex companies. Inone particularly dramatic example, a telecom-munications company that offered consumersonly about one-fifth the number of optionsoffered by a competitor was growing almost10 times as fast.

Gauge the complexity of your products orservices.

To diagnose your company’s level ofcomplexity, begin by asking how complex yourproduct or service offerings are and what thatdegree of complexity may be costing you.

A Map of the Profit Pool

A profit-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 profits. The column widths reflect the proportion of units sold (left) and operating profits earned (right) in each channel.

…but only about a 20% share of profits

FitEquipCo has about a 40% share of units sold…

FitEquipCo

CompetitorTotal units sold: 10M (disguised)Total operating profit: $200M (disguised)

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36%

Spor

ting

Goo

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16%

OPERATING PROFIT

Other

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Disc

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ehou

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26%

Mai

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Inte

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18

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Spec

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Spor

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19%

UNITS SOLD

Other

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80

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C 1

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C 2 C 8

C 7

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C 2

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C 8

100%

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C 9

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C 9

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Benchmark your line of products or servicesagainst the competition’s; try to identify your“innovation fulcrum,” the point at which thevariety of products or services you offer maxi-mizes your sales and profits. It will be helpfulto construct what we call a Model T chart,showing the costs when you add features tothe basic product or service. It’s valuable to dothis exercise not only with your own com-pany’s data but also with your competitors’.(For more on complexity and the Model Tchart, see Mark Gottfredson and Keith Aspi-nall, “Innovation Versus Complexity: What IsToo Much of a Good Thing?” HBR November2005.) Ask yourself which of your competitorshas the advantage as variety and complexityin the industry increase—and why. You canapply what you learned from your customersegmentation research to this assessment. Ifyou know what customers want now andwhat they are likely to want in the future,you can better judge what level of variety isappropriate for your marketplace.

The complexity test is a necessary counter-balance to tools such as customer segmenta-tion. The temptation, after all, is to divideyour customer base into finer and finer sub-categories and tailor your offerings to eachsegment, all in the name of giving customersexactly what they want. That was one wayCharles Schwab, the financial-services firm,got itself into a difficult situation in the early2000s. Schwab added a plethora of new offer-ings and divisions, including a firm specializ-ing in institutional investments and an EastCoast wealth-management company. In 2004,founder Charles Schwab returned to thefirm as CEO and promptly took steps toreduce the complexity. He sold off most of therecent acquisitions, reduced the number ofservice offerings, and streamlined internalroles and processes. These and other movesallowed him to take out some $600 millionin costs, reduce commissions, gain marketshare, and increase the firm’s operating in-come by 3%.

Assess the complexity of your organiza-tion.

Decision-making procedures and organi-zations grow complex over time as well. Youneed to know how your company stacks upagainst competitors on these dimensions andwhat the effects of undue complexity maybe. Our colleagues Paul Rogers and MarciaBlenko have developed what they call a

RAPID analysis, which allows managers toassess decision-making bottlenecks, assignclear decision roles to individuals in the orga-nization, and hold them accountable. (RAPIDis a loose acronym for the different roles peo-ple can take on:

recommend

;

agree

; give

input

;

decide

; and

perform

, or implement the deci-sion.) Another useful tool is a spans-and-layersanalysis, which shows the number of levels inan organization from the CEO to the frontlineworker, and the number of people reportingup to each level. Spans that are too narrow—meaning too few people report to individualbosses—are likely to lead to excess overheadcosts, slow decision making, and unnecessarymanagerial oversight.

When sizing up your company’s decisionmaking, turn to suppliers, distributors, andcustomers for feedback. They are often goodjudges of how quickly and effectively you canmake a decision compared with others in theindustry. Employees will be quick to tell youwhether they feel supported and empoweredby the organization’s management structureor whether it just gets in their way.

Determine where you can simplifyprocesses.

Where does complexity reside inyour processes? What is that costing you? St.George Bank, like others in Australia, experi-enced a slowdown in residential lending atone point and so was developing a growthstrategy for commercial banking. But thecomplexity of the bank’s commercial creditprocesses was a major constraint on growth.All loan applications, large or small, weretreated in a similar way. A sizable number ofapplications had to be sent up the ladder to acentral credit group. Then-CEO Gail Kelly andher management team determined that thislevel of complexity was not inevitable—forexample, they could create a fast-track systemfor applications from existing customers thatfell within certain risk boundaries. That aloneled to a 30% reduction in time spent by thelending officers. The bank also increased theamounts that a local lending officer couldapprove, resulting in a reduction of 50% ormore in deals sent to the central credit group.

How can you identify such opportunitiesfor process improvement? As at St. GeorgeBank, process complexity can show up inany number of areas: on the productionfloor, in distribution networks, in interactionswith customers, in back-office procedures.

When sizing up your

company’s decision

making, turn to

suppliers, distributors,

and customers for

feedback.



The key is to figure out where complexity isunavoidable—and where, by contrast, youcan put practices in place to reduce complex-ity while still delivering the products andservices that customers want. Process map-ping is a good way to get started. In a processmap, diagrams show the interactions amongdifferent steps in a process and the people ordepartments responsible for the steps. Thisenables the management team to visualizeand understand the whole process, spot prob-lems and opportunities for improvement, andaddress them through root-cause analysis.You want to map activities, inputs, and out-puts associated with each step, and the waittimes between steps.

Successful streamlining of the processesproduces several mutually reinforcing bene-fits. It increases efficiency, allowing a companyto reduce head count and its costs. Streamlin-ing also cuts down on errors and rework. Itreduces cycle time, enabling the company todeliver the product or service to the customersignificantly faster and enhancing customerloyalty. More-loyal customers are likely toorder more, generating growth and increasingthe possibilities for still greater economies inproduction or service delivery.

Many companies try to simplify their pro-cesses without simplifying any other aspect ofthe organization. This is a mistake. Processsimplification tends to be undermined by un-necessary complexity in the company’s prod-uct lines, organization, and decision-makingprocedures. So gather the data to addresscomplexity on all three fronts and then deter-mine the most fruitful points of attack.

• • •

A diagnostic template such as the one we’vedescribed here is powerful not because it con-tains any single new insight but because itcovers the ground a management team needsto cover. By answering the questions we’veprovided, you can pull together a comprehen-

sive set of data enabling you to understand thegap between your current performance andyour full potential. You can then set specificgoals and launch initiatives that will drivethe company to achieve that potential duringyour tenure and develop the performanceprofile that you are shooting for. A companythat has worked through such a diagnostictemplate might aim for objectives suchas these:

• Reduce costs by $200 million to moverelative cost position from 110% of best com-petitor to 90%.

• Increase relative market share from 0.9 to1.2; move share of high-profit segment A from40% to 60%, with a retention increase of sixpercentage points.

• Increase share of profit pool from 40% of$2 billion to 70% of $2.8 billion by expandinginto a downstream service business in themost profitable product segments.

• Cut SKUs from 100,000 to 2,000; reduceorganizational layers in SG&A from five tothree; outsource 20% of all G&A costs.

Objectives like these can translate intomarching orders for an entire organization.Because they stem from a comprehensivediagnosis, everyone can understand them andsee why they are important. Both managersand employees are more likely to buy in andput their shoulders to the wheel.

Diagnosis, of course, is only one part of aperformance-improvement program. You stillmust decide on where you want the companyto go, along with the three to five critical initi-atives that will get you there. But a thorough,accurate diagnosis is what makes the restpossible. It’s an indispensable first step to-ward breakthrough performance.

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Figure out where

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unavoidable—and

where, by contrast, you

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