The Business Foundation

All business or economic organizations (including nonprofits) are based upon a conceptual foundation, which is either explicitly defined or implicitly understood. The foundation consists of three related concepts: (1) the business concept or definition, (2) the strategic mission, and (3) the core strategy.

The Business Concept. A business concept is a statement of what the organization is in business to do. It defines an organization's identity and gives it strategic focus. It provides the raison d'etre of the business. For example, Coca-Cola is in the beverage business, Federal Express is in the package transportation business, and Disney is in the entertainment business.

The overriding key problem or challenge of creating a business concept is that it must be valid or validated by customers in the marketplace. This means that the business must provide something (tangible or intangible) that the market wants or will accept. Validation occurs when there are customers who purchase the enterprise's product or service, thereby enabling it to continue to operate and survive as a business entity. When a new business concept fails to achieve this, or an existing business concept no longer works in the market, the organization will suffer and ultimately fail or die. For example, many of the first dot-coms (such as Webvan, eToys, Pets.com, and many more) did not succeed in creating valid business concepts and ultimately perished. Similarly, RadioShack was once a successful enterprise, serving several generations of electronics hobbyists; but its business concept became outdated and muddled, leading to a long period of irrelevance in the market and decline that suggests its ultimate disappearance from the retail market space.¹

Another key strategic problem or challenge of creating a business concept is to strike a balance between one that is too narrow to facilitate future growth and one that is so broad as to be strategically meaningless. We shall deal with the development of a business concept in Chapter 6, when we address strategic planning. At this point, our primary concern is with the purpose or function of a business concept in the context of building a successful organization over the long term.

In brief, the identification and clear definition of a business concept provide the foundation on which all other aspects of the business are and should be built. The customers to be served, products offered, and the company's day-to-day systems are all built upon the foundation of the business concept, as explained below.

The Strategic Mission. While the business concept defines what an organization is, the strategic mission identifies what the enterprise wants to achieve or become. It is a statement of the strategic intent of the enterprise. It answers the question “What do we want to achieve or become?” over a defined time period. For example, in its early days (1994) Starbucks Coffee Company (now Starbucks) established the strategic mission of becoming “the leading brand of specialty coffee in North America by the year 2000.” It was an aspirational statement. Similarly, in 2014, Techcombank (then the eighth largest bank in Vietnam) established the strategic mission of becoming the leading bank in Vietnam. We will discuss the nature and development of strategic missions further in Chapter 6.

The Core Strategy. While a strategic mission identifies what the enterprise wants to achieve or become, a core strategy is a statement of how the organization will compete and achieve its strategic mission. Most organizations have several strategies, but relatively few have core strategies. Core strategies depend upon the type of business. For example, the core strategy for a commodity type of business (such as Walmart, a retailer, or Rio Tinto, a mining company) is to be the low-cost provider. The core strategy is the central theme around which all other strategies are created. We will discuss the nature and development of core strategies further in Chapter 6. However, it must be noted here that many companies do not have core strategies. They can have lots of strategies without a true core strategy that ties all strategies together.

Six Key Organizational Development Tasks

Once a company has identified its business foundation (either implicitly or explicitly), it begins the process of developing the organization that will support this foundation. Our research² and consulting experience suggests that there are six organizational development areas or tasks that are critical in determining whether an organization will be successful at any particular stage of growth. Taken together, these six key tasks make up the “Pyramid of Organizational Development,” shown in Figure 2.1. As can be seen in this figure, this pyramid is built upon the organization's business foundation. We will first identify and describe each key organizational development task individually and then examine the Pyramid of Organizational Development as a whole.

Identify and Define a Market and, if Possible, Create a Niche. The most fundamental prerequisite for developing a successful organization is the identification and definition of a market and, if feasible, the creation of a market niche. A market is made up of the present and potential buyers of the goods and/or services that a company intends to produce and sell. A market segment is simply a place in the market differentiated by products offered (e.g., luxury, mid-sized, compact, and used automobiles) or customers served (e.g., businesses, schools, homes, etc.). As used here, a market niche is a place within a market where a company has developed a sufficient number of sustainable competitive advantages so that it controls a market segment. Although this distinction will be discussed more fully in Chapter 6, which deals with strategic planning, it should be noted that, in contrast to popular usage and its implicit connotation, a market niche does not have to be small. A true market niche can be very large, as illustrated by Microsoft and its control over most of the operating system software in the PC market. Similarly, Amgen, a leading biotechnology-based pharmaceutical company, has a niche in the market for kidney dialysis with its product Epogen, which historically controlled about 95% of the market for this type of product. In both Microsoft's and Amgen's case, part of their niche is derived from patent protection. Another and more important contributing factor to the creation of the niche for both of these companies, however, is the focus they have placed on understanding and meeting their customers' needs.

The first challenge to organizational survival or success, then, is identifying a market need for a product or service to which the company will seek to respond. This can be either a need that has not yet been recognized or that is not currently being satisfied by other companies. The chances for organizational success are enhanced if an organization identifies a need that is not being adequately fulfilled or that has little competition for its fulfillment. This challenge is faced by all new ventures; indeed, it is the challenge for a new venture to overcome. It has also been the critical test of growing concerns and has even brought many once proud and great companies to near ruin or total demise.

Many businesses have achieved great success merely because they were one of the first in a new market. For example, Apple Computer grew from a small entrepreneurship in a garage to a $1 billion firm in a few years because its founders identified the market for a personal computer. Dreyer's, a manufacturer of ice cream (which is a relatively undifferentiated product), went from sales of $14.4 million to sales of $55.8 million in just five years because the company saw and cultivated a market segment between the super-premium ice creams such as Häagen-Dazs and the generic (commodity) ice cream sold in most supermarkets. Many Internet companies (like Amazon.com, eBay, and Alibaba) have also experienced rapid growth as a result of developing ways to sell products leveraging this transformational technology.

The reverse side of this happy picture is seen in businesses that have experienced difficulties and even failed either because they did not clearly define their market or because they mistakenly abandoned their historical market for another. For example, a medium-sized national firm that manufactured and sold specialty clothing wished to upgrade its image and products and become a high-fashion boutique. However, it failed to recognize that its historical market was the medium market, and its efforts to rise out of this market were unsuccessful. Similarly, Custom Printing Corporation with more than $10 million in annual revenues found itself in difficulty after trying to upgrade its position in the medium-priced printing market. Attracted by the market segment where the highest-quality work was done (with accompanying high profit margins), the company purchased the best equipment available. It also hired a high-priced sales manager to recruit a sales force that could compete in the new market segment. However, the company had underestimated the strength of existing companies in that market segment, and it found itself unable to break into this higher-priced market as easily as managers had hoped. Moreover, the additional investments it had made and the related increases in its overhead made the company's cost structure higher than that of its former competitors, so it began losing business from its historical market. Thus, the company found itself in a cost-price squeeze.

The first task in developing a successful organization, then, is the definition of the market in which a business intends to compete and the development of a strategy to create a potential niche. This process involves the use of strategic market planning to identify potential customers, their needs, and so on. It also involves laying out the strategy through which the company plans to compete with others for its share of the intended market. The nature and methods of strategic planning will be described in Chapter 6.

Develop Products and Services. The second task of an entrepreneurial organization is “productization.” This is the process of analyzing the needs of present and potential customers in order to design products and/or services that will satisfy their needs. For example, the founders of Google, Larry Page and Sergey Brin, met in 1995 while they were PhD students at Stanford University. They saw the need for an Internet search engine “to organize a seemingly infinite amount of information on the web.”³ By 1996, they had built a search engine (initially called BackRub) that used links to determine the importance of individual webpages.

Although many organizations are able to correctly perceive a market need, they are not necessarily able to develop a product that is capable of sustainably satisfying that need adequately. For example, Myspace (an online social networking service) was one of the first of its kind. It was launched in July 2003 and by April 2004 it had 1 million unique U.S. visitors. It was later acquired by News Corporation; but over time it lost its cool image and was abandoned by users. Myspace was overtaken by Facebook in the number of unique U.S. and worldwide visitors in May 2009.

Similarly, there were many companies that developed coffee bars or cafes such as Peet's Coffee, Coffee Bean and Tea Leaf, Gloria Jeans, and others; but Starbucks has grown to dominate this market. Thus, being the first to recognize a need and the so-called “first mover advantage” can be useful but is not necessarily sufficient for sustainable success.

The productization process involves not only the ability to design a “product” (defined here to include services as well) but also the ability to produce it. For a service firm, the ability to “produce” a product involves the service delivery system, the mechanism through which services are provided to customers. For example, although coffee is nominally the core product of Starbucks, the real product is the coffee experience provided by Starbucks' cafés. The company called EAS (Experimental and Applied Sciences), founded by entrepreneur Bill Phillips, markets and sells performance nutrition products. However, the company is also committed to providing education and information (provided through articles that appear in their magazine Muscle Media and The Sports Supplement Review) on what people can do to become more physically fit.

The development of successful products depends to a great extent on effective innovation and strategic market planning. This involves understanding potential customers, their needs, how they buy, and what they perceive to be value in a product or service.

The success of productization depends, to a very great extent, on success in defining the company's market (i.e., its customers and their needs). The greater the degree to which a company understands the market's needs, the more likely that its productization process will be effective in satisfying those needs. Productization is the second key development task in building a successful organization.

These first two tasks of organizational development can be thought of as the entrepreneurial building blocks of the enterprise. They are required for proof of concept of the business; that is, whether the business has a valid market and product. Once they are established, the next tasks relate to organizational scale-up, which involves acquiring the resources required for growth and developing the operational systems needed for day-to-day functioning of the enterprise.

Acquire Resources. The third major task of developing an organization is acquiring and developing the additional resources it needs for its present and anticipated future growth. A company may have identified a market and created products but may not have sufficient resources to grow. For example, once Starbucks established proof of concept of its retail/café, it required resources to grow. Stated differently, “No bucks—no Starbucks!”

An enterprise's success in identifying a market and in productization creates increased demand for its products and/or services. This, in turn, stretches the organization's resources very thin. The organization may suddenly find that it requires additional physical resources (space, equipment, and so on), financial resources, and human resources. The need for human resources, especially in management, will become particularly acute. At this stage of development, the organization's very success ironically creates a new set of problems. These are the problems of organizational growth and scale-up.

The company must now not only acquire additional resources, but also become more adept at resource management, including the management of cash, inventories (if a manufacturing company), personnel, and so forth. It is at this stage that an entrepreneur must begin to think longer term about the company's future needs. Failure to do this can be costly. For example, one entrepreneur told how he kept purchasing equipment that became obsolete within six months because of the firm's rapid growth. Instead of purchasing a photocopying machine that would be adequate for the company's needs as it grew but was more than currently required, for example, he purchased a machine that was able to meet only current needs. The result was that he spent much more on equipment than he would have if he had purchased machinery that was adequate for potential future needs. Similarly, another entrepreneur found himself with insufficient space six months after moving into new offices that he had thought would be adequate for five years, because the company grew more rapidly than he had anticipated. Another entrepreneur described how he had had to unexpectedly move his offices every five years because, after five years it always seemed that he had run out of space.

Another resource-related dilemma facing entrepreneurial companies involves the people that they can hire. Often, entrepreneurs facing the need to hire people believe that they cannot afford to hire those with long-range potential to help them build their businesses and settle for those with lesser skills and abilities. Unfortunately, this may be a false economy. A few entrepreneurial firms do invest for the future and hire people who can grow with them. For example, one of the secrets to Starbucks' success was that they hired people who could help them build a billion-dollar-plus business from a very early stage. Starbucks' CEO, Howard Schultz, realized that human resources would be as much a key to Starbucks' long-term success as its now famous coffee. This insight helped Starbucks grow during a 10-year period from a small entrepreneurial company in Seattle with two retail stores to an institution with more than $1.4 billion in revenue and more than 1,400 stores. By 2014, Starbucks had become the largest café company in the world with more than 21,000 retail outlets/cafes in 63 countries and more than $15 billion in revenues.⁴

Develop Operational Systems. To function effectively, an organization must not only produce a product or service but also administer basic day-to-day operations reasonably well. These operations include accounting, billing, collections, advertising, personnel recruiting and training, sales, production (or service delivery), information systems, transportation, and related systems. The fourth task in building a successful organization is the development of the systems needed to facilitate these day-to-day operations—that is, operational systems. It is useful to think of a company's operational systems as part of its “organizational plumbing.” Just as plumbing is necessary for a house or building to function effectively, organizational plumbing is necessary for a business to function well. Thus, operational systems comprise part of an organization's infrastructure, and are necessary to facilitate growth.

Typically, businesses that are busy focusing upon their markets and products tend to neglect the development of their operational systems. As an organization increases in size, however, an increasing amount of strain is put on such systems because the company tends to outgrow the organizational plumbing or infrastructure available to operate it. For example, in one electrical components distribution firm with more than $200 million in annual revenues, salespeople were continually infuriated when they found deliveries of products they had sold could not be made because the company's inventory records were hopelessly incorrect. Similarly, a medium-sized residential real estate firm with annual revenues of about $10 million found that it required almost one year of effort and embarrassment to correct its accounting records after the firm's bookkeeper retired. A $100 million consumer products manufacturer had to return certain materials to vendors because it had insufficient warehouse space to house the purchases (a fact no one noticed until the deliveries were at the door). A $15 million industrial abrasives distributor found itself facing constant problems in keeping track of customer orders and in knowing what was in its inventory. The firm's inventory control system, which was fine when annual sales were $3 to $5 million, had simply become overloaded at the higher sales volume. One manager remarked that “nothing is ever stored around here where any intelligent person could reasonably expect to find it.” A $10 million professional service firm had no way of knowing if the services it provided to customers were, in fact, profitable. Their financial management system did not provide this type of data, so they continued to offer their package of services and to hope for the best. A $100 million distributor of consumer products had a computer system that was so antiquated that few, if any, important reports were prepared accurately or on time. Whatever information was available had to be collected and analyzed manually.

These are just a few of the types of problems that organizations encounter when they have not developed effective operational systems. A key reason for this neglect is that entrepreneurs are more interested in growth and deals than in the infrastructure needed to manage their companies.

The bottom line is that if these systems continue to remain underdeveloped, they can literally bring a business to a standstill. What is not well recognized by most entrepreneurs is that their companies are competing not just in products and markets, but in operational infrastructure as well. To illustrate this we will use an important historical example—Walmart versus Kmart and Sears. Walmart is the classic example of how a small entrepreneurial company grew larger and more successful than its giant competitors, and in turn became the dominant giant of its space. In the 1960s, Sears was the number one retailer in the United States and Kmart was the number two retailer overall but the number one discount retailer. Walmart was a small company headquartered in Bentonville, Arkansas. By analyzing his competition, Sam Walton understood that he could not compete head-to-head with Sears and Kmart but he could create some strengths for Walmart (which might even become competitive advantages) by developing his company's logistics and information systems. Today, Walmart has surpassed Sears and Kmart, and has developed unsurpassed logistics and information systems, because Sam Walton understood that he was competing not just in products but in operational systems as well. These infrastructure advantages led to a cost advantage in the operations of Walmart vis-à-vis Kmart and Sears. Since all sell the same products, the winner of the competition between Walmart, Sears, and Kmart is the company that has the lowest cost of operations. Since Walmart has the lowest cost of operations, it is the ultimate winner in the competition with Sears and Kmart. In 2015, Walmart had more than $500 billion in revenues, while Sears and Kmart continued to struggle.

Develop Management Systems. The fifth task required to build a successful organization is developing the management systems required for its long-term growth and development. There are four management systems: (1) planning, (2) organization structure, (3) management development, and (4) performance management systems. Management systems are another component of an organization's infrastructure, or organizational plumbing.

The planning system consists of how the company develops and implements its long-term plans for organizational development. It also includes operational planning, scheduling, budgeting, and contingency planning. An organization can create a plan and have a strategy, but still lack a planning system. The basic concepts and methods of strategic planning are presented in Chapter 6.

The organization structure of the business determines how people are organized, who reports to whom, and how activities are coordinated. All enterprises have some organizational structure (formal or informal), but they do not necessarily have the correct structure for their needs. The concepts and methods for design and evaluation of organization structure required at different stages of growth are presented in Chapter 7.

Performance management systems encompass the set of processes (budgeting, leadership, and goal setting) and mechanisms (performance appraisal) used to motivate employees to achieve organizational objectives. These systems include both formal control mechanisms, such as responsibility accounting, and informal processes, such as organizational leadership. Chapter 8 provides tools and techniques for designing and implementing effective performance management systems.

The management development system helps facilitate the planned development of the people needed to run the organization as it grows. Chapter 9 presents strategies for designing and delivering management and leadership development programs.

Until an organization reaches a certain critical size (which tends to differ for each organization), it typically can operate without formal management systems. Planning tends to be done in the head of the entrepreneur, frequently on an ad hoc basis. The organizational structure tends to be informal, with ill-defined roles and responsibilities for people that sometimes overlap. Management development tends to consist of “on-the-job training,” which basically means “You're on your own.” When performance management systems are used in such organizations, they tend to involve only the accounting system rather than a broader concept of management control.

The basic organizational growing pain (which is a symptom of the need for more developed management systems) is the decreasing ability of the original entrepreneur or senior executive to manage or control all that is happening. The organization simply becomes too large for senior managers to be personally involved in every aspect of it, and there is the gnawing feeling that things are out of control. This marks the need for the development or upgrading of the organization's management systems.

Manage the Corporate Culture. Just as all people have personalities, all organizations have a corporate personality or culture: a set of shared values, beliefs, and norms that govern the way people are expected to behave on a day-to-day basis. Values are what the organization believes are important with respect to product quality, customer service, treatment of people, and so on. Beliefs are assumptions that people in the corporation hold about themselves as individuals and about the firm as an entity. Norms are the unwritten rules that guide day-to-day interactions and behavior—including language, dress, and humor.

Organizational culture can have a profound impact on the behavior of people for better or for worse. Many companies, such as Starbucks, Johnson & Johnson, IBM, GE, Toyota, Southwest Airlines, Walmart, and Huawei have achieved greatness at least in part because of a strong corporate culture. Culture, then, is a critical factor in an enterprise's successful development and performance. It functions as an informal “control system,” because it prescribes how people are supposed to behave. It must be noted, however, that even companies with what can be generally characterized as a “great” culture (which we define as a strong “functional culture,” as explained in Chapter 10) can have cultural problems. IBM, Toyota, and Walmart all have generally strong functional cultures, but each has experienced cultural problems.⁵ On the contrary, other companies have experienced difficulties and even failure because of a dysfunctional culture, including once great companies such as GM, AIG, and Reuters.⁶

Some managers believe that what is espoused (stated) as their corporate culture is actually the culture that affects people's behavior. Unfortunately, this is often an illusion. For example, one rapidly growing entrepreneurship in a high-technology industry stated that its culture involved the production of high-quality products, concern for the quality of the working life of its employees, and encouragement of innovation. In reality, the firm's culture was less positive. Its true concerns were to avoid conflict among its managers, set unrealistic performance expectations, avoid accountability, and overestimate its performance capabilities. Moreover, the company saw itself as hard-driving and profit-oriented, but its real culture was sales-oriented regardless of profitability.

Sophisticated managers understand that their companies compete as much with culture as with specific products and services. The CEO of a major New York Stock Exchange company once said that he could predict a division's organizational problems as soon as he had identified its culture. The sixth and final challenge in building a successful organization, then, is to manage corporate culture so that it supports the achievement of its long-term goals. The nature and management of corporate culture are examined in Chapter 10.

Implications of the Pyramid of Organizational Development

There are several important implications of the Pyramid of Organizational Development for management. First, the business foundation and the six key organizational development tasks comprise different phases of the business game. Just as the American game of football (the “business concept”—which is part of the business foundation) is comprised of six key phases (rushing offense, passing offense, rushing defense, passing defense, and kicking and receiving), there are six key phases of the “game” of business—markets, products, resources, operational systems, management systems, and culture management. If an organization is weak in any phase of its game, it will experience a variety of growth-related problems (discussed in Chapter 5).

Another implication is that all organizations compete with other enterprises at all levels of the pyramid. For example, Walmart and Kmart do not compete only with products, but with their operational and management systems and culture, as well. Walmart's logistics and information systems are a clear source of competitive advantage vis-à-vis Kmart and other discount retailers.

A third important implication is that, in the long term, the most sustainable competitive advantages are typically found at the top three levels of the pyramid (operational systems, management systems, and culture) rather than in products and markets. All markets can be entered by competitors, and all products can be copied or improved upon over time (even pharmaceuticals can have generic versions), but the top three levels of the pyramid take time and money to develop and are difficult to copy. Even if an attempt is made by a competitor to copy an enterprise's operational systems, management systems, and culture, their effort can be fruitless because of the unique aspects of each organization. In this sense, an organization's culture can be viewed as its ultimate strategic asset because it cannot be copied.⁷ We shall examine the strategic implications of the Pyramid of Organizational Development further in Chapter 6.

Winning with Infrastructure. The bottom line is that our research and experience indicate that an organization ultimately wins with infrastructure. It might superficially look as though a company is winning with products, but products (with the possible exception of an initial product at the start-up phase) are created by infrastructure. This is clear in certain types of industries such as pharmaceuticals, where research and development is the lifeblood of the industry. However, a closer look at virtually all industries will show that infrastructure is the “secret sauce” or secret weapon of companies.

Assessing the Degree of Strategic Organizational Development

The Pyramid of Organizational Development can and should be used as a template for assessing the degree or strength of an organization's strategic development both qualitatively and quantitatively. Strategic development refers to the extent to which an organization has successfully developed each of the six key strategic building blocks comprising the Pyramid of Organizational Development. Qualitative assessment involves identifying and describing a company's specific strengths and limitations (or “opportunities to improve”) of a business in qualitative terms. We will illustrate this in our discussion of strategic planning in Chapter 6.

Quantitative assessment involves using numerical ratings to assess the degree of strategic development—overall and at each level in the Pyramid of Organizational Development. We have developed and validated a 65-item survey, The Organizational Effectiveness Survey©, that can be used to provide this quantitative assessment. While this proprietary instrument is not included in this book (but is commercially available for readers' use),⁸ we have also created a “short-cut method” to get an approximation of an organization's strategic development scores that is provided here. This can be done by “rating” the strength of each key strategic building block using numbers from 1 to 5, where 5 is the highest number (greatest strength) and 1 is the lowest number (greatest opportunity to improve). This method provides a quick approximation of the actual situation of an organization. Readers can use the short-cut method to get an approximation of their strategic development score. This short survey can be administered to any number of managers and/or employees and a mean (average) score can be calculated for each pyramid level and for the overall pyramid. An example of an organization's mean strategic development scores is shown in Table 2.1.

Our use of the Organizational Effectiveness Survey© has led to the development of a set of standards for strategic development scores, as shown in Table 2.2. The higher its strategic development score, the greater is the likelihood that the organization will be successful over the long run. As seen in Table 2.2, a score of 4.5 or greater is required for a company to be a “Global Leader”; 4.0 or greater to be a “Superior” organization; and 3.5 or greater to be a “Sustainably Successful” organization. An organization with a score of 3.0 to 3.4 is classified as “Marginally Successful,” meaning that its success is not likely to be sustainable over the long term. An organization with a score of less than 3.0 is considered “At Risk/Unsuccessful.” An organization with a score of less than 2.5 is very likely to be in crisis.

As seen in Table 2.2, our research and experience indicate that organizations need to have a strategic development score above 3.5 to have the greatest chance of sustainable success over the long run. Research and experience also indicate that a company with a score of less than 3.0 has a 33% chance of great difficulties or even failure within two years.

Table 2.3 presents examples of well-known companies with our judgmental best guesses of the category into which each would fit, based upon the “Scores Required for Different Levels of Success” as shown previously in Table 2.2. We do not necessarily have empirical data for this classification.

Our use of the Organizational Effectiveness Survey© has also led to the development of a database that can be used as the basis for identifying the percentage of companies that fall into each level of strategic development.⁹ This set of percentile scores is shown in Table 2.4.

As seen in Table 2.4, fewer than 1% of the organizations in our database (which includes both for-profit businesses and nonprofits) have achieved scores greater than 4.5. Similarly, 3% of companies have achieved scores between 4.0 and 4.4. Most companies (about 76%) have scores in the range of 3.0 to 3.9, and about 20% have scores less than 3.0.

Readers can use the short-cut method described earlier to get an approximation of their strategic development score. They can then compare that score with both the Scores Required for Different Levels of Success shown in Table 2.2 and the database of percentiles of companies with each level of scores shown in Table 2.4 in order to self-assess their overall strength. Our data suggest that organizations with scores less than 3.0 are at serious risk of difficulties and possible failure.

Origins of the Organizational Development Initiative

In 2009, Guangzhou Construction's CEO, George Li, attended the CEO Leadership Program offered by Cheung Kong Graduate School of Business (CKGSB). Eric Flamholtz, one of the instructors for this program, was engaged by CKGSB to coach approximately 40 CEOs in China and to help them enhance their leadership and organizational effectiveness during a nine-month program. As part of his sessions, Dr. Flamholtz had the program's participants (along with their senior management teams) complete two proprietary organizational effectiveness surveys: (1) “The Growing Pains Survey” (to be described in Chapter 5) and (2) the “Organizational Effectiveness Survey,” described earlier in this chapter. Both surveys have been validated and have demonstrated predictive validity to financial performance.¹²

The surveys were administered twice—first in 2009 and again in 2010. This was done to measure the progress made after an organizational development program had been implemented. The strategic development scores for Guangzhou Construction are shown in Table 2.6. (Guangzhou Construction's Growing Pains Scores are shown and discussed in Chapter 5.)

Implementing a Program of Organizational Development

The results of these two surveys—with the Organizational Effectiveness Survey indicating that the company was only “marginally successful” and the Growing Pains Survey indicating that the company had a high level of growth-related problems—served as the catalyst for Guangzhou Construction's CEO to embark on a program of organizational development. George Li planned on a one-year timeframe in which he would do the following:

• Initiate a process to create a new vision for the business
• Initiate a culture management program to emphasize new values for the organization

As an initial step, the CEO articulated a mission for the company: “Guangzhou Construction's mission is to improve human beings' living and working environment.” However, workers at Guangzhou found that to be too abstract and not directly relevant to their work, so the CEO took steps to explain the company's mission in terms that could be understood by all workers. As he stated: “First line managers thought it was too intangible and far from their current work. As a result, I spent time with them in illustrating what we meant by this and how it was relevant to their daily work. I explained to them that even trivial things like ‘spit’ or leaving trash in workplace are against our mission of improving people's living and working environment and that this should be prevented. Those are all very tangible.”

The next step for George Li was to redefine the mission into a strategic mission for Guangzhou Construction. As he stated: “We set our strategic mission as ‘to be the most reliable construction company in China.’”

The next step was to articulate a set of core values for Guangzhou Construction: integrity, passion, initiative, good quality, teamwork, and continued improvement. In order to make these values real and operational in the company, George Li spent a great deal of time communicating with people. As he stated, “I spent much time in communicating and getting mid-level and senior management aligned with our mission, vision, and core values.”

He worked hard to translate those values into specific norms of behavior that could be understood by all employees. He wanted to emphasize integrity, but realized that people might be unwilling to be criticized for mistakes. His solution was clever: “We emphasize ‘forgiveness for honest mistakes’ in order to promote taking initiative while retaining a high level of integrity. We have demonstrated to our employees that we actually did not punish people if they made mistakes with good intention; at the same time, some people were fired for being dishonest and doing harm to the company's integrity.” George Li went on to explain the difference between an honest mistake, which can be forgiven, and a dishonest mistake, for which there can be no forgiveness: For example, if someone takes or gives a bribe, they will be fired. However, honest mistakes are forgiven. As George Li explains, “One day my secretary forgot to bring me something I had asked for. I said it was ‘no problem.’ Everyone makes mistakes.”

Program Results and Impact

As seen in Table 2.6, the strategic development scores for Guangzhou Construction improved very significantly from 2009 to 2010—a very short timeframe for such dramatic change. The overall score improved from 3.3 (indicating a marginally successful organization) to 3.8, which indicates a sustainably successful entity. All of the individual scores for each level of the pyramid improved. The sign test or the Wilcoxon signed-rank test for nonparametric statistics indicates that this difference is statistically significant and is unlikely to have occurred by chance alone.¹³

Formulate the Business Foundation

The original Starbucks began as a local roaster of coffee. In 1972, the company had two retail stores that sold coffee beans: one opened in 1971 near Seattle's Pike Place Market, and the other, opened in 1972, was located in a shopping center across from the University of Washington's campus. This original Starbucks did not sell coffee beverages. It sold fresh-roasted coffee beans, teas, and spices. However, sometimes the individual behind the counter would brew some coffee and serve it in paper cups as samples.

Howard Schultz was not the original founder of Starbucks. He joined the company as Director of Retail Operations and Marketing in 1982. About one year later, Schultz visited Milan, Italy, to attend a trade show. While strolling on Milan's streets, he was struck by the ubiquity of the Italian coffee bars. He was drawn into them, and realized that the coffee bars were an extension of people's homes and a part of the Italian culture. He saw the opportunity to develop something like what he had seen in Milan back in the United States. In April, 1984 Starbucks tested Schultz's idea by opening a coffee bar inside a Starbucks retail store, and it was an instant success. Despite the experiment's success, the original founders of Starbucks decided not to adapt it to Schultz's vision: an American version of an Italian coffee bar. Schultz left to create his own company called Il Giornale, which was founded in 1985. In August 1987, Schultz went back to Starbucks with a buyout offer and a vision of taking the company national. Il Giornale acquired the assets and name of Starbucks, and changed its name to Starbucks Corporation.

In brief, Schultz's business concept for Starbucks was of a national specialty retailer/café, or, as noted above, an American version of an Italian coffee bar. During its very early years, there was not an explicit strategic mission in the way it has been defined here. Implicitly, the strategic mission was to establish the company. Similarly, there was not an explicit core strategy. However, the core strategy was to change the nature of the coffee café to an experience. Both the strategic mission and core strategy were developed later, as discussed in Chapter 6.

Identify a Market and Develop a Product

In terms of the Pyramid of Organizational Development, Schultz perceived the market not for coffee per se but for a different kind of retail/café experience. Thus the product was not just coffee but the atmosphere and experience of the Starbucks store. The store itself was part of the product experience for the customer, not just the place where the product was purchased. It was part of the coffee-related experience. Schultz also realized that customer service was part of the overall product or experience to be delivered in a Starbucks store. As a result, Starbucks emphasized its unique brand of customer service from the beginning.

Neither coffee nor cafés were new products, but Starbucks had redefined them in some magical way. Schultz had, indeed, solved the first two challenges of building a successful enterprise: he had identified a market and developed a product. This, in turn, led to the rapid growth of Starbucks, and created the next set of challenges: resources and operational systems.

Acquire Resources and Develop Operational Systems

Unlike many entrepreneurial companies, Starbucks paid a great deal of attention to the acquisition of resources and the development of operational systems. From the beginning, Schultz believed that he had a big opportunity, and he thought that Starbucks had the potential to become an enterprise with one billion dollars in sales.

He realized that if the company was going to fulfill its potential, he would need all of the resources and systems required of a large company, including financial, physical (plant and equipment), technological, and human resources. As he stated: “We could not have gotten where we are today if we had not had the commitment to build a national company with a national brand from the beginning. If you are going to build a 100-story building, you've got to build a foundation for 100 stories.”¹⁴

The first step was to raise money, and this became a continuing challenge as Starbucks rapidly grew. Schultz spent considerable time finding investors, and without the “bucks” there would be no Starbucks! The financial resources were used to hire people capable of building Starbucks into a national brand and a national company. This was not only true of a strong senior management team, but also the acquisition of people at the operating levels, such as real estate, finance, and retail operations. Funds were also used to upgrade the company's roasting plant, its logistics and manufacturing systems, and its overall day-to-day operating systems.

Starbucks' investment in a strong operating team as well as the related aspects of infrastructure paid off for the company in many ways. The strong real estate team led the company to choose solid locations and avoid the real estate problems of other similar organizations such as Boston Market and Koo Koo Roo. The company's investment in developing strong financial systems led to a deeper understanding of store economics, and, in turn, a healthy business from a financial standpoint.

Development of Management Systems

In 1994, Howard Schultz and Orin Smith (then CFO and later COO of Starbucks) read the second edition of this book and invited Eric Flamholtz to visit Starbucks and assist the firm with its “growing pains.” ¹⁵ This, in turn, led to the development of a more sophisticated set of management systems for Starbucks, including a strategic planning system similar to that described in Chapter 6, and a revised organizational structure. In 1995, Starbucks also developed its management development and performance management systems. Before that, there was a strategy and plan but not a formal, integrated planning system. There was training for customer service personnel but no management development. In addition, there was an incentive system for people but no well-developed performance management system.

Taken together, these things (planning, structure, management development, and performance management systems) all comprised the overall management systems for Starbucks, and completed the development (at least for this stage of the company's growth) of the fifth level of the Pyramid of Organizational Development.

Manage the Corporate Culture

The highest level in the Pyramid of Organizational Development, and the sixth task required to develop a successful enterprise involves culture management. From the beginning, Schultz and Starbucks had a clear idea that culture was important in building a successful enterprise. In addition, Howard Schultz had a well-defined concept of the kind of organization he wanted to build. Accordingly, Schultz articulated a set of “Five Guiding Principles” that was intended to serve as the foundation for Starbucks' culture. Subsequently, a sixth guiding principle was added: “Embrace diversity as an essential component in the way we do business.” The six guiding principles which comprised the core of Starbucks' stated culture are presented below:

Starbucks Corporation Six Guiding Principles

1. Provide a great work environment and treat each other with respect and dignity.
2. Apply the highest standards of excellence to the purchasing, roasting, and fresh delivery of our coffee.
3. Develop enthusiastically satisfied customers all of the time.
4. Contribute positively to our communities and our environment.
5. Recognize that profitability is essential to our future success.
6. Embrace diversity as an essential component in the way we do business.

In addition to the stated guiding principles of Starbucks, there are also some other facets of its culture that are important. Schultz believed that the kind of organization that Starbucks was, and, in turn, the way it did business would become a source of sustainable competitive advantage. In effect, Schultz understood the role of culture as a building block of organizational success. Although he was not then familiar with the concept of “corporate culture” per se, he understood it intuitively. This led Starbucks to be concerned about the treatment of people employed by the firm. Ideally, he wanted everyone employed by Starbucks to behave like “owners.” The notion was: The way we treat our people will influence the way they treat our customers, and, in turn, our overall success. This led Starbucks to a number of different personnel practices, including providing full benefits for all people working more than 20 hours each week, and providing opportunities for stock ownership. In other words, the company developed ways to manage its culture so that it would be embraced by its employees.

The Pyramid as a Whole

Starbucks is an illustration of a very successful entrepreneurial organization. The discussion above shows that Starbucks understood the need to develop all aspects of what we have termed the Pyramid of Organizational Development and not merely focus upon products and markets. Prior to 1994, the company had done an excellent job of developing five of the levels of the Pyramid of Organizational Development; that is, everything except management systems. As we shall see later in this book, this is the classic pattern of successful entrepreneurial companies. Beginning in 1994, at about $175 million in sales, Starbucks began to develop the management systems that were required to facilitate its continued successful development. This completed the developmental work prescribed by the Pyramid of Organizational Development.

What happened to Starbucks? By the end of its fiscal year 2014, Starbucks had grown to more than to $15 billion in net revenue and more than 21,000 stores worldwide. Clearly, successful development of the Pyramid of Organizational Development pays off.

The Secret to Starbucks' Success

Starbucks did not invent or develop coffee. Starbucks was not even the first to create the American version of a café/specialty retail company. Starbucks grew out of Peet's Coffee. Starbucks did not have the advantage of a proprietary product like Microsoft or Amgen, or even the first mover's advantage. So how did Starbucks become Starbucks—the leading brand and world-class company? The answer comes directly from Howard Behar, who joined Starbucks as a Senior Executive in 1989 when the company had just 28 stores and over his tenure with the company served as President of Starbucks International, President of Starbucks North America, and also as a Board member. In 2007, Behar published a book titled. It's Not the Coffee: Leadership Principles from a Life at Starbucks.¹⁶ As the books title suggests, the secret to Starbucks' success is not the coffee per se; it is the way Starbucks has been managed.

Boston Market: A Contrast with Starbucks

In the 1990s “Boston Chicken” (later renamed Boston Market) had people's mouths watering for more than just their food. The company was supposed to become “The McDonalds of the '90s.” It never happened. Instead, Boston Market filed for Chapter 11 reorganization under the bankruptcy law. While Starbucks was earning quite a few bucks for its investors, Boston Market was costing its investors and franchisees lots of money.

What was different about the two companies? While Starbucks successfully focused upon all of the six key aspects of the Pyramid of Organizational Development, Boston Market did not. Boston Market did identify a market and had developed a good product, but the emphasis was upon selling area franchises rather than truly building a solid business. In other words, the focus was on the bottom two layers of the Pyramid of Organizational Development versus the pyramid as a whole. While Starbucks' skilled real estate team identified good locations and negotiated sensible deals, Boston Market was perceived as overpaying for real estate. While Starbucks' financial people were analyzing costs of store build-outs and operations, Boston Market never got the economics of their stores under control. Their stores were expensive to build and operate, and they were not profitable. Although the restaurants were losing money, Boston Market was showing a profit for a period because of the heavy franchise fees charged. But the firm's reported profitability was a mirage, which finally disappeared. In brief, Boston Market simply did not effectively execute all of the six required tasks of organizational development and ultimately paid the price.

This discussion is not intended to imply that Starbucks neither made no mistakes nor was without problems, but simply that it did a significantly better job in performing the required tasks to build a successful organization. Boston Market failed to focus on several of the key tasks of organizational development, and went bankrupt. In 1998, Boston Markets was sold to McDonald's and in 2007 was acquired by Sun Capital Partners. Some of the stores continue to operate, but it never became anything close to what Starbucks has achieved.