Lafley’s Law: If You Want to Win Become a Game-Changer

P&G's A.G. Lafley talks about making real innovation happen.

The best way to drive growth and win competitively is to innovate. Simple, but hard to do consistently. In June 2000, A.G. Lafley received a call from former Procter & Gamble CEO John Pepper asking him if he was prepared to accept the CEO position at the company. Stunned, Lafley had met with then CEO, Durk Jager, the day before and had no idea he had resigned. In the coming days and months, Lafley undertook a hard assessment of the company's predicament. P&G had already issued a profit warning in March. It would soon issue another that June. Too many products and organization initiatives were being pushed into the market before they were ready. While Lafley's business in North America was delivering, his other responsibility, global beauty care, was not going to make its numbers. Other businesses were in worse shape.

Humbled, Lafley and his team had to go back to first principles and re-organize the company around innovation to drive sustained organic growth. Together with Ram Charan, a prolific author and consultant, Lafley set forth how he did it in the recently published book, The Game-Changer. Freeof management cant and the usual platitudes that infuse most business tomes, the book is a lively and detailed account of what he learned "through many trials and too many errors" along the way. But it's not just about P&G. Charan provides case studies of similar innovation shifts at Nokia, GE, DuPont, HP and Dell, among others.

Not everyone can do what P&G does. (Who can spend $200 million a year-$1 billion since the beginning of the decade-on consumer research?) But anyone can create an organizing structure that nurtures and supports innovation. Even companies with their own innovation centers can learn from the multidisciplinary team approach of P&G's Future Works, which creates new businesses, or its use of innovation hot zones like Clay Street.

And here's the kicker: Today, Lafley gets more revenue and profit from new products and businesses while spending less each year on R&D as a percent of revenue. "Innovation now drives virtually all of P&G's per annum organic sales growth," he argues. "We now only count on 1 percent of our 5 to 7 percent sales growth to come from acquisition activity. From fiscal 2001 through 2007, even against a background of rising  energy and commodity costs, we have improved operatingmargins by more than four percentage points. Profits have more than tripled to $10 billion-plus, while free cash flow has totaled $50 billion over the same period."

Perhaps Lafley's most disarming idea, which he discussed when CE's J.P. Donlon caught up with him in New York, is the notion of "fearlessness when it comes to failure." Lafley, who was honored by this magazine as Chief Executive of the Year in 2006, even celebrates in his book 11 spectacular failures during his career-not something most CEOs feel comfortable talking about. 

What does a CEO most have to get right to drive game-changing innovation?

It depends on what industry you're in and what your goals and strategies are, but there are two basic principles. You have to innovate with the customer, involve the customer early in the innovation process and keep her involved, co-creating and co-designing with you throughout. The second critical piece is determining which of the innovation drivers are critical for your company. In our case, we reaffirmed purpose, clarified goals and narrowed our strategies. What really drove innovation at P&G were the changes in the innovation process, the culture and the changes in the leadership.

If Jeff [Immelt] were here talking about GE, you know he might tell you a different story. If Olli [-Pekka Kallasvuo] were here talking about Nokia, he might say that there were different innovation drivers that were critical for Nokia. I believe in the innovation-driver model where somewhere in that group of enablers or drivers are the keys to unlocking more consistent reliable innovation performance for your company and your industry. Much depends on your company's starting point and where the real leverage is. 

Yet P&G is known for developing new products. So what was wrong with the old way you went about it?

There were two issues for us. One is, at $40 billion in sales, to grow 5 percent organically, which is the midpoint of our 4 to 6 percent organic net sales growth-rate target, in an industry growing 2 to 3 percent. You had to create $2 billion of new innovation per year. At $80 billion-we'll be well above $80 billion this year-you have to do $4 billion a year. At $100 billion�� 

It's creating a new Fortune 500 company every year.

Yes, exactly. That was the magnitude of the growth challenge. And virtually all of our incremental sales growth each year comes from identifiable innovation that's going to market that year. The other issue is, at least in our industry, consumer staples, and for our company, the consistency, reliability and sustainability of the business and financial performance has always been important. So we wanted a system that didn't depend entirely on having only home runs. We needed a system where we could drive innovations that were singles, doubles, triples, as well as home runs, on a continuous basis.

We needed to be able to do sustainable or incremental innovation and disruptive innovation at the same time. This meant creating a portfolio of innovations in various stages of development, a pipeline that we could see five, six or seven years out. We needed a process where we could take something from ideation, to prototyping, through development, and qualification, and finally, commercialization in the market. Our challenge was the magnitude of growth and the desire for a more consistent sustainable execution to deliver more consistent and sustainable results.

What specific metrics do you use that tell you where P&G is on the game-changing innovation meter?

We look at the estimated revenue size of the portfolio, the estimated net present value size of the portfolio and track our batting average-the percentage success rate. In our industry, only about 15 to 20 percent of new brands and products really succeed. That's what we were doing in 1999- 2000, the industry average. Today, we've raised that to about 50 percent. In a great period it may hit 60 percent.

But if you push the innovation success rate too high, then you're not taking risks. You're not doing enough big innovations. You're not going for the real disruptive ones, which have a higher failure rate. We track that by each business unit and for the whole company looking ahead five years.

I'll be the first to tell you that it's hard to predict the sales potential of an innovation project in its earliest stage. But as we get further along in the process, those estimates get tighter. By the time we finish our review we have tools and techniques that can predict pretty closely-plus or minus 20 percent- which is not bad. Every year, I do a deep dive innovation strategy review with every one of the 20 to 25 businesses. Early on we identify their target sustainable growth rate. Do they have a gap in their innovation portfolio, or do they have a surplus? The last thing we look at is innovating how we innovate- the tools, methods and techniques we develop that enable us to measure and predict better.

What is the percentage of your profits, or your revenues, that come from new products today, and how does this compare with the profits when you began as CEO?

Every year from 2000 through 2007-the last completed fiscal year virtually all of our incremental growth has come from innovation. For example, in color cosmetics or fine fragrances a high percentage of the total business is in new products and new-innovations every year. In a more stable staples business, like bath tissue or paper towels, this percentage would be considerably lower. But it's definitely higher than it was in 2000. One of the things we try to understand is not just how much of our sales and profit we're trying to drive from innovation, but what's the real pace of innovation that's right for the consumer, right for the retailer and right for us.

For example, Gillette concluded that about every seven or eight years they need to introduce a major new discontinuous men's shaving system. Atra, Sensor, Mac III, now Fusion, which will become a $1 billion brand this year, faster than any Gillette system in history. This doesn't mean they don't keep innovating in the interim. Every year or two we're developing incremental innovation. But at about seven or eight years, we will bring the next major change in male shaving systems. For color cosmetics the pace is seasonal. Fine fragrance has an annual pace of innovation. It depends on what the consumer can keep up with.

Lastly, one of our biggest opportunities is getting realistic trial targets on the innovations that we've already launched. We see at least $2 billion of available incremental sales out there, if we can just take the innovations we've launched in the last five to eight years and get them to modest trial targets. For example, we introduced the Swiffer Quick Clean lineup in 1998 in test markets. Ten years later we have a brand that does about $800 million in sales. The trial rate in the U.S. is only 10 to 14 percent. So 86 to 90 percent of U.S. households still have not tried the Swiffer Quick Cleaning system. We know if you try it, two-thirds of consumers claim they will convert to regular purchase and usage of Swiffer. So I don't need new-product innovation to get Swiffer going. I need new trial and sampling innovation. 

You argue that the customer is at the center of P&G's innovation model. Isn't this self-evident and doesn't every CEO say this?

Saying it is one thing, but really doing it is harder. It takes diligence, persistence and discipline to put her there and keep her there. Even across my businesses, we have a range. Without exception, the businesses closest to their customer do better than the businesses that say they're getting closer to their customer, but are not doing it, or doing it as well.

Second, we involve the consumer much earlier in the innovation process. In the past, you would have an idea, or a concept or a new technology. You would prototype it and get the prototype close to a manufacturable state, and then, and only then, would you start iterating with the consumer. Today, we'll involve some consumers as soon as we have the idea or the concept, and we'll expose them to a primitive prototype. It won't look anything like the finished product, but it will give them the idea of the functionality and the experience because we want them involved in the co-creation and co-design.

Take something simple, like fragrances or flavors. We'd sort through all the fragrances or flavors, and then offer consumers the two that we thought in our testing were the best. We're now much more inclined to get the consumer involved when we're still formulating the flavors and fragrances. Same with packaging. We would show the consumer a package that was pretty well cooked. Now, we show a clearly primitive prototype. This is part of our immersion technique. You can't get this in a focus group or from quantitative research where you're having people fill out surveys. You can't get at what we call unarticulated needs. Consumers can't really tell us what they want, so we have to see them, and they have to be able to touch our prototypes and play with them, and we have to be able to watch them do tasks, watch them experience product prototypes so we can figure out, anthropologically, what's going on.

When I was working on the Tide brand in the laundry detergent category in the 1980s, every year we would get back the consumer research survey, and it would say women would rate our Tide package excellent on a five-point scale. But when you accompanied them down in their basement where they did laundry, eight out of ten women were taking out a screwdriver, or some other tool, and punching out the perforation on the side of the Tide box because maybe they had a manicure and they were not going to risk breaking a nail opening that Tide package-even though they rated the package excellent! As a result, we changed the package to make it easy to open just by pushing it with the soft side of your thumb and finger. 

In hindsight, it looks obvious.

It looks obvious, but if they don't tell you they're dissatisfied with it, you don't work on it. Same with liquid packages. Oh, yeah, consumers will say we love the liquid packages. But go into a typical home and you'll see containers with streams of gooey, blue liquid detergent running down the outside of the bottle. She just assumed that's the way it's always been. That's when we created the self-draining, easy-to-measure cap, like the one maple syrup makers now use.

Consumer immersion techniques are helpful even in business-to-business situations. We see this with our suppliers and retailers all the time. They can't tell you the root cause of what's making them unhappy. Sure, they can tell you that they are dissatisfied, but you have to probe deeper what caused and peel layer after layer of the onion to learn what caused the dissatisfaction. By the time you have peeled your way down, you get to the real opportunity.  

Why did you decide that 50 percent of your innovation would come from outside the company working with partners?

This was the most important decision that Gil Cloyd, who's our head of R&D, and I made back in 2000. At the time, we thought that we wouldn't achieve this in either his or my lifetime. But at that time, about 10 to 15 percent of new product initiatives that we brought to market had an outside partner, and most of the outside partners were in our supply chain.

We asked ourselves two questions. One, if we were to meet the challenge of creating a much bigger innovation portfolio and pipeline in order to deliver the growth target we'd set, how could we do this? We concluded that we needed more ideas, more inventions, more early prototypes because there's a big failure rate as one goes through prototyping, developing and qualification. Second, we decided we're probably not much better at creating the original-spark idea than many other potential outside partners are. But we're really good at connecting with consumers-finding the target market and developing and commercializing in our retail channels. So if we could find partners for the front end and then do the part that we do really well, we'd have a higher success rate. We were hoping to get to 50 percent by the end of the decade. We actually reached 50 percent in 2007. Half of our new products had at least one outside partner. Now we must sustain and improve it.  

Considering the it-must-be-invented- here Proctoid culture, this must have been a big change inside the company.

You go from a not-invented-here insular culture to a we-need-to-open-up- and-innovate-with-any-potential-partner culture. We're even innovating with competitors like Clorox. We joke that Glad is our 24th billion-dollar brand because we gave them the press-and- seal new bag technology, where you emboss and pattern the bag so you use less material and actually make it stronger. We worked with them on the container technology. We couldn't unlock the value and commercialize it. But they could with their brand. We're doing it in a new business area where we don't compete. We're the minority partners in a joint venture. They do what they do best. We do what we do best.  

As CEO, how do you develop innovation leaders? What do you look for?

Like most companies, P&G does a good job recruiting, training and developing good operational leaders. These are people who can execute and manage budgets and costs. We need these people. But if you are to drive growth through innovation, you need leaders that are more ambidextrous. They must operate and lead innovation. So what are we trying to do? We have training programs where we help people focus on running an open architecture operation where you need to be truly open-minded in order to connect and collaborate. Innovation is a riskier game. Most innovations fail. You have to place big bets and manage your portfolio of bets. We try to teach innovation strategy where you put together a program that stretches over five, six, seven years. We put individuals through a series of experiences where they can learn to operate and innovate. We have innovation-specific assignments, such as Future Works, a corporate innovation fund. We have new business development groups in many of the established businesses. So we have lots of opportunities to move people across assignments and see who can develop these ambidextrous skills.

Everybody can't do this, so it helps to filter out some people. But the truth of the matter is that it's more difficult to do my job, or several of the top executive jobs in this company, if you can't do both. The important few who can do both will be real candidates for the future leadership of this company. 

You write in your book that one ought to promote someone who has failed. Have you actually done that?

Did you see the section where we list my 11 failures? (See sidebar.) If you add them up, it was a pretty costly education for A.G. Lafley. We are not a one strike and you're out company. Now, if you swing at the same pitch, and fail in a big way a second time, we start to wonder. That might be the end, but we're a two and three strikes and you're out company.

This innovation process is designed to fail faster or sooner, and, hopefully, fail cheaper. And most important, learn 10 times as much from the failure as you learn from the success. We don't always get it right; we still are bringing major new products to market that fail. Tempo failed in 2001. Torengos, fantastic snack, won every taste test versus Frito Lay, and failed in the marketplace. 

Did you ever sum-up the cost of all eleven of your failures?

No, but it's a big number. One of my personal favorites-I still believe it's a great idea-is the Natural Fruit and Vegetable Wash. I tried it twice. We tried it right before I left for Asia, and then when we came back. And Gil Cloyd and I still think it's one of our better products that hasn't made it. I honestly can't tell you why. For whatever reason, we couldn't get enough consumers to buy a special product, and then, on a regular basis, clean their fruits and vegetables. There's so much dirt and insecticide on them, and too many people still just rinse them under the faucet. I still buy the product. It's available at Kroger in Cincinnati. There's a little company, Dryel, trying to make a go of it.

Lemon Dash is another one of my favorite failures. Recently, I saw the kid who launched Lemon Dash with me at a P&G alumni event in New York. Consumers tried it, and most said, nah, I'll go back to my Tide and Cheer. Another one was Olay cosmetics. We had $100 million in sales on Olay Cosmetics in the first year. If we had gone out with a narrower line, on just the facial and lip products where we had great breakthroughs, and had not tried to do nails and the eyeliners and color, we might have had a success.

The other one that kills me is Physique. We did $100 million a year at retail, but couldn't hold the brand. Everybody copied our positioning, and genericized it. We couldn't move the brand quickly enough. That was a crime. We had a beautiful, unique package. We have a phenomenal line of hair care products. But we were just a little bit early because now the salonlike products are doing quite well.  

Wal-Mart represents 30 percent of your U.S. sales, and Target represents 7 percent of U.S. sales. Both are on a tear to increase their privatelabel business. For example, Target intends to raise its food business from 10 to 15 percent private label to 25 percent or higher. This overall push must be a huge challenge for a branded product firm like yours.

Yes. Their soft line business is virtually 100 percent private label as is the home fashion business. The electronics business, which has been very successful, is heavily private label. But knock on wood, they found that driving the leading brands, many of which are P&G's, in the consumer staples businesses, the household care and the personal care category, have been good for them. That's what they advertise in the Sunday circular, usually on the last page, sometimes on the front page, because it drives traffic.

One of Target's big opportunities is trips. They don't get enough trips. And another is price perception. Where they price very competitively with Wal-Mart is on our items. So, in order to improve Target's price perception among consumers, they do it on known-value brands, which we have. Having products like Tide, Crest, Pampers and Pantene in their weekly Sunday circular helps increase their trips.

So it's really a partnership. They can drive their private label participation in food. They've already driven it in soft lines and fashion items where they want to develop their own brands. But for them to build a detergent brand or an oral care brand against Colgate and Crest takes a lot of money and time; these are formulated products that need real R&D people to run them. They've been smart about it. They're doing it where food is more of a commodity product. They're doing it where they can get differentiation through the Target brand, not through the