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Four Ways to Innovate in Operations

Innovation in operations—not to be confused with mere operational excellence or improvement—can yield competitive advantage. A Harvard Business Review excerpt.

In 1991, Progressive Insurance, an automobile insurer based in Mayfield Village, Ohio, had approximately $1.3 billion in sales. By 2002, that figure had grown to $9.5 billion. What fashionable strategies did Progressive employ to achieve sevenfold growth in just over a decade? Was it positioned in a high-growth industry? Hardly. Auto insurance is a mature, 100-year-old industry that grows with GDP. Did it diversify into new businesses? No, Progressive's business was and is overwhelmingly concentrated in consumer auto insurance. Did it go global? Again, no. Progressive operates only in the United States.

Neither did it grow through acquisitions or clever marketing schemes. For years, Progressive did little advertising, and some of its campaigns were notably unsuccessful. It didn't unveil a slew of new products. Nor did it grow at the expense of its margins, even when it set low prices. The proof is Progressive's combined ratio (expenses plus claims payouts, divided by premiums), the measure of financial performance in the insurance industry. Most auto insurers have combined ratios that fluctuate around 102 percent—that is, they run a 2 percent loss on their underwriting activities and recover the loss with investment income.

By contrast, Progressive's combined ratio fluctuates around 96 percent. The company's growth has not only been dramatic—it is now the country's third largest auto insurer—it has also been profitable.

The secret of Progressive's success is maddeningly simple: It outoperated its competitors. By offering lower prices and better service than its rivals, it simply took their customers away. And what enabled Progressive to have better prices and service was operational innovation, the invention and deployment of new ways of doing work.

At American Standard, the goal was to triple its inventory turns; at Progressive, to initiate claims within nine hours.

Operational innovation should not be confused with operational improvement or operational excellence. Those terms refer to achieving high performance via existing modes of operation: ensuring that work is done as it ought to be to reduce errors, costs, and delays but without fundamentally changing how that work gets accomplished. Operational innovation means coming up with entirely new ways of filling orders, developing products, providing customer service, or doing any other activity that an enterprise performs. [...]

Making it work
How do operational innovation efforts begin if no one is responsible for them and no formal channels for creating programs exist? Most often they start as grassroots movements, fostered by people sprinkled throughout organizations who are passionately committed to finding and exploiting opportunities for operational innovation. These catalysts take it upon themselves to find a leader who can grasp what they have in mind and then spearhead the innovation effort. The executive must have both the imagination and the charisma needed to drive major operational change.

Then the catalysts relentlessly campaign for the cause—confronting the executive with the inadequacies of existing operations and arranging for meetings with peers from other companies that have successfully implemented operational innovations. The campaign will be helped immensely if catalysts can tout existing pockets of operational innovation within their own organization. Maybe one plant implemented a new way of scheduling production, or a customer service center used a CRM system in a new way, or a sales team created a new way to support customers. Examples like these will help convince a leader that operational innovation can work.

Once the top executive is convinced that operational innovation is worth pursuing, the organization needs to focus its efforts. Because operational innovation is by nature disruptive, it should be concentrated in those activities with the greatest impact on an enterprise's strategic goals.

Progressive, for instance, realized that the key to its profitable growth is customer retention because acquiring new customers through commission-based agents is very expensive. And the key to customer retention is making sure customers have rewarding interactions with the company. That's why Progressive concentrated on streamlining claims; making it a more pleasant experience for customers would directly affect overall performance. Many auto insurers, by contrast, view claims as a nuisance at best because it entails paying claimants. They consider it to be a low-priority activity that doesn't deserve attention.

Or consider how American Standard, the diversified manufacturer, decided where to focus its innovation efforts in the early 1990s. It had just survived a hostile takeover bid by going through a leveraged buy-out, and leaders realized that servicing the debt would consume virtually all the company's available cash and starve product development efforts. Because a large amount of cash was tied up in inventories, the CEO mandated that the company would have to drive down its working capital and dramatically increase inventory turns. A program was instituted to transform manufacturing from a conventional push-based system to one pulled by actual demand using a system known as Demand Flow Manufacturing. The innovation paid off and led to a successful IPO a few years later.

At its heart, every operational innovation defies an assumption about how work should be done.

Using similar analyses, other companies have pinpointed procurement, order fulfillment, new product development, post-sales customer support, and even budgeting as the place where innovation would have the greatest effect on achieving key strategic goals. While operational innovation need not be confined to just one area, most companies find it prudent to limit their innovation programs to no more than two or three major efforts at a time. To undertake more would probably consume too many resources and create too much organizational disruption.

After selecting the area for innovation, the company must set stretch performance goals. At American Standard, the goal was to triple its inventory turns; at Progressive, to initiate claims within nine hours. Absent such specific targets, innovation efforts are likely to drift or degenerate into incremental improvement projects. Only a daunting target—clearly unattainable through existing modes of operation—will stimulate radical thinking and willingness to overturn tradition.

Inventing a new way of operating that achieves the target need not be simply a matter of crossing your fingers and hoping for inspiration. Following these suggestions should accelerate your efforts.

Look for role models outside your industry. Benchmarking within your own industry is unlikely to uncover breakthrough concepts. But techniques used in other industries with seemingly very different characteristics may turn out to be unexpectedly applicable. For instance, in the 1980s, Taco Bell transformed its restaurant operations by thinking about them in manufacturing rather than in fast-food terms. The restaurant chain reduced the amount of on-site food preparation by outsourcing to its suppliers, centralizing the production of key components, and concentrating on assembly rather than fabrication in the restaurants. The new approach lowered Taco Bell's costs and increased customer satisfaction by ensuring consistency and by allowing restaurant personnel to focus on customers rather than production. Harvard Pilgrim Health Care has applied techniques of market segmentation, common in consumer goods but not in health insurance, to identify patients most likely to have a medical crisis and to intervene before the crisis occurs.

Identify and defy a constraining assumption. At its heart, every operational innovation defies an assumption about how work should be done. Cross-docking negates the assumption that goods need to be stored in a warehouse, build-to-order that goods should be produced based on forecasts and destined for inventory. Zero in on the assumption that interferes with achieving a strategic goal, and then figure out how to get rid of it. A major hospital, for instance, recognized that to increase the number of patients admitted for (well-reimbursed) cardiac bypass graft operations, it needed to respond more quickly to physicians who wanted to refer a patient. The reason for the delay in response was the assumption that the hospital first had to assign a prospective patient a bed, a supposition that generated hours of delay and often led physicians to send their patients somewhere else. The solution? Send the patient to the hospital immediately, and assign the bed while the patient is in transit.

Make the special case into the norm. Companies often achieve extraordinary levels of performance under extraordinary conditions; their problem is performing extraordinarily in normal situations. One way to accomplish this is to turn the special-case process into the norm. A consumer packaged-goods maker, for instance, based its production scheduling on sales forecasts rather than on actual customer demand. When demand for a new product wildly exceeded forecasts, an ad hoc process was created that gave the manufacturing division real-time information about customer demand, which in turn allowed them to do production planning and product distribution much more efficiently. After the crisis had passed, the company decided to adopt this emergency mode of operation as its standard one. The results included a dramatic drop in inventory, an improvement in customer service, and a major reduction in the total cost of product deployment.

Rethink critical dimensions of work. Designing operations entails making choices in seven areas. It requires specifying what results are to be produced and deciding who should perform the necessary activities, where they should be performed, and when. It also involves determining under which circumstances (whether) each of the activities should or should not be performed, what information should be available to the performers, and how thoroughly or intensively each activity needs to be performed. Managers looking to innovate should consider changing one or more of these dimensions to create a new operational design that delivers better performance.

Excerpted with permission from "Deep Change: How Operational Innovation Can Transform Your Company," Harvard Business Review, Vol. 82, No. 4, April 2004.

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Michael Hammer is the founder of Hammer and Company, a management education firm based in Cambridge, Massachusetts.