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by Charles F. Knight
When I meet with people outside Emerson, I’m often asked: What makes
Emerson tick? That question typically reflects an interest in the company’s
consistent financial performance over the past three-and-a-half decades—but my
answer deals with issues that go far beyond financial statements.
A third belief is that the “long term” consists of a sequence of “short terms.” Poor
performance in the short term makes it more difficult to achieve strong
performance in the long term. The basis of management is management from
minute to minute, day to day, week to week. Finally, it is crucial to “keep it
simple.” While effective management is simple in theory, it’s difficult in practice.
As Peter Drucker has noted, managers seem naturally inclined to get caught up
in complicated ideas and concepts—ideas that look great on paper but just don’t
work. A corporation has to work hard to have a simple plan, simple
communications, simple programs, and simple organizations. It takes real
discipline to keep things simple.
My answer, therefore, to those who ask what makes us tick is far-reaching in its
implications but uncomplicated in its substance: what we do at Emerson to
achieve consistent performance at high levels is just solid management,
rigorously executed. Interestingly enough, given our consistent performance, the
dynamic impact of Emerson’s approach to management is sometimes
overlooked. Wall Street analysts, for example, tend to portray our stock as a
good investment, but they also consider us a conservative and unchanging
company. Yet a close look at what Emerson has accomplished in recent years
reveals that we have changed a great deal.
For example, through our Best Cost Producer Strategy, we have spent more than
a quarter of a billion dollars on restructuring and now have best cost positions in
all of our major product lines. We’ve moved from an export-led to an investment-
led international strategy, resulting in a rise of international sales from about 20%
to about 40% in the past five years. As a result of a $1.6 billion investment in
technology during the 1980s, new products—those introduced in the past five
years—as a percent of sales have increased from 9% to 20%. All the while,
we’ve adhered to the discipline of constantly increasing earnings, earnings per
share, and dividends per share (see Emerson’s earnings and return on equity
charts).
The driving force behind all that change is a simple management process that
emphasizes setting targets, planning carefully, and following up closely. The
process is supported by a long-standing history of continuous cost reduction and
open communication and is fueled by annual dynamic planning and control
cycles. Finally, it is nourished by strongly reinforced cultural values and an
approach to organizational planning that is as rigorous as our approach to
business planning. It is an environment in which people at all levels can and do
make a difference.
The first step is to “set financial targets,” since almost everything we do is geared
toward reaching our financial objectives. When I came to Emerson in 1973, the
company was already a strong performer whose stock traded at a premium
relative to other industrial companies. We wanted to maintain this performance.
We analyzed Emerson’s historical record and the records of a set of “peer
companies” that the stock market valued highly over the long term for growth and
consistency. We concluded that, to maintain a premium stock price over long
periods of time, we needed to achieve growth and strong financial results on a
consistent basis—no swings of the pendulum, just constant improvement starting
from a high level.
Consistent high performance requires ambitious and dynamic targets. Every year
we reexamine our growth targets to see whether they remain valid, and we have
recalibrated our growth objectives several times because the business
environment has changed, or Emerson has changed, or we’ve learned
something that causes us to see the world a little differently. In the early 1970s,
for example, the general level of economic activity, plus the energy shocks and
their inflationary aftermath, forced us to rethink our nominal and real growth
rates. In recent years, we’ve targeted growth rates relative to economic growth
as a whole, based on revenue targets above and beyond economy-driven
expectations.
We have not modified our other financial goals, despite pressure to do so. During
the 1980s, for example, we were criticized because we refused to increase our
debt position. Given the then-prevailing attitudes toward leverage, our financial
position appeared unduly conservative. But we regard our finances strategically:
maintaining a conservative balance sheet is a powerful competitive weapon.
When we see an opportunity that we can finance only by borrowing, we have the
capacity. By the same token, we’re not encumbered by interest payments, which
are especially burdensome during economic downturns—as the experience of
the 1990s bears out so far.
Once we fix our goals, we do not consider it acceptable to miss them. These
targets drive our strategy and determine what we have to do: the kinds of
businesses we’re in, how we organize and manage them, and how we pay
management. At Emerson, this means planning. In the process of planning, we
focus on specific opportunities that will meet our criteria for growth and returns
and create value for our stockholders. In other words, we “identify business
investment opportunities.”
The structure and everyday operation of Emerson embodies this basic approach:
set tough targets, plan rigorously to meet them, and follow through on the plans.
The first of the two has correctly been described as a “religion” and “a way of life”
at Emerson. Every year for the past three-and-a-half decades (in good times and
bad), the company has set cost-reduction goals at every level and required plant
personnel to identify the specific measures necessary to achieve those
objectives. Over that period, Emerson’s cost-reduction programs have targeted
improvements of 6% to 7% a year, in terms of cost of sales. During the 1980s,
when fierce global competition challenged many of our businesses, we redoubled
our efforts, aiming for still higher levels of annual improvement. Our present cost-
reduction goals, developed by each division, average about 7% of the cost of
goods sold.
We identify the programs that will give us 70% to 80% of our cost-reduction
targets before the year starts. We know exactly what we’re going to do: we’ll
install this machine tool to streamline that process, saving two-and-a-half man-
years; we’ll change this design on that part, saving five ounces of aluminum per
unit at 75 cents a pound; and so on. Division and plant management report every
quarter on progress against these detailed targets. Although this entire saving
does not reach the bottom line, without this program combined with price
changes, we would not be able to stay ahead of the inflation that affects our
costs, and our margins would drop.
3. Have you met with your management in the past six months?
When I repeated to a business journalist the claim that every employee can
answer these questions, he put it to the test by randomly asking those questions
of different employees at one of our plants. Each employee provided clear and
direct answers, passing both the journalist’s test and ours.
Emerson’s Best Cost Producer Strategy (Located at the end of this article)
The Best Cost Producer Strategy begins with a recognition that our customers’
expectations for quality, broadly defined, are getting higher every day. To remain
competitive, we have to meet or exceed the highest standards in the world for
product performance, on-time delivery, and service after the sale. In this context,
for example, the ideal of “zero defects” is not some high-tech dream: we’ve
gotten to the point where defects are counted in parts per million—and I’m not
just referring to electronic products. For example, on one of our electric motor
lines, we have consistently reached fewer than 100 rejects per one million
motors.
Once we understand the needs of our customers and the plans of our
competitors, we develop a focused manufacturing strategy to produce more
competitively and to provide better service. Among other things, this strategy
means staying close to customers and vendors, helping them achieve their goals
as well as our own. It also means that we compete on process, not just product
design; that we focus strictly on manufacturing and aren’t afraid to say so; that
we address the issue of our installed manufacturing base and are willing to
relocate plants, invest in technology, and make other tough decisions when
necessary.
Finally, we support the elements of our Best Cost Producer Strategy through an
ongoing program of capital investments. This commitment to capital expenditures
is crucial: it’s the only way to improve process technology, increase productivity,
gain product leadership, and achieve critical mass regularly. This investment
program is made possible by our strong cash flow and balance sheet, which we
view as a major competitive asset; effective asset management plays a major
role in freeing up the needed cash.
These elements of strategy are not especially new or original. We think the key to
success is closely tracking performance along these dimensions and attacking
deviations immediately. Ten years ago, Emerson was not globally competitive in
all its major product lines. Today we are, thanks to the intensity of our
manufacturing approach and to the management process through which we
make it work.
Each fiscal year, from November through June, selected corporate officers, Al
Suter, and I meet with the management of every division for a one- or two-day
planning conference, usually held off-site. These division conferences are the
culmination of our planning cycle. The mood is confrontational—by design.
Though we’re not trying to put anyone on the spot, we do want to challenge
assumptions and conventional thinking and give ample time to every significant
issue. We want proof that a division is stretching to reach its goals, and we want
to see the details of the actions division management believes will yield improved
results. Our expectations are high, and the discussions are intense. A division
president who comes to a planning conference poorly prepared has made a
serious mistake.
Corporate management sets the stage. We require only a few standard exhibits,
including a “value measurement chart,” a “sales gap chart,” and a “5-back-by-5-
forward” P&L statement. (See the four corresponding exhibits, which are
reproductions of actual Emerson charts.) While the list is short, it takes
substantial planning and backup data to develop these exhibits. To prepare
properly requires that division presidents really understand their business. Every
piece of data we ask for is something division management needs to know itself.
The value measurement chart captures on a single page such vital data as long-
term sales and profit growth, capital investment, and expected return. The chart
displays the amount and type of investment and return on capital over the
preceding five years, allowing us to see quickly the return on incremental capital.
Add to this a forecast of capital investment and returns over the next five years,
and we can see whether the division is earning, or expects to earn, a return on
total capital greater than our cost of capital. In other words, we can tell in a
glance whether the division is creating stockholder value.
The sales gap chart and sales gap line chart display current sales and make
projections for the next five years based on an analysis of the sources of growth:
the market’s natural growth rate, the division’s change in market penetration,
price changes, new products, product line extensions, and international growth.
Should the projected growth not meet or exceed our target, the division faces a
gap. Then it is management’s job to tell us the specific steps it will take to close
the gap.
Together, those four charts tell us basic information about the business, alert us
to any problems, and provide clues to the steps divisions must take to outperform
the competition and produce results for stockholders. Beyond the required
exhibits, the planning conference belongs to the division presidents. We’re there
to help them improve their plans and their results. We want to hear division
management’s views of customers and markets; its plans for new products; its
analysis of the competition; and the status of such manufacturing issues as
quality, capacity, productivity, inventory levels, and compensation.
We also believe in the logic of illogic. Often, a manager will give a logical
presentation on why we should approve a plan. We may challenge that logic by
questioning underlying assumptions illogically. The people who know their
strategies in detail are the ones who, after going through that, are able to stand
up for the merits of their proposal. In the end, the test of a good planning
conference is whether it results in managers taking actions that will have a
significant impact on the business.
Input from the divisions arrives in the form of their president’s operating reports
(PORs), monthly submissions that summarize the divisions’ results and
immediate prospects (see the president’s operating report chart). We view the
budget process used by many companies as static. In contrast, the POR is a
dynamic tool: we update expected annual results each month and make rolling
comparisons against historical and projected performance.
The divisions themselves are governed by their own boards of directors, with a
member of the OCE serving as chairman. Other members of the board include
the division president and the president’s direct reports. The division boards are
partly a legacy of Emerson’s growth through acquisition, but more important, they
are a reflection of the level at which we plan and control profits. The boards meet
monthly to review and monitor performance. In addition, the president and chief
financial officer of each division meet quarterly with corporate operating and
financial management to discuss short-term operating results and lock in on the
current quarter; we call these sessions “president’s councils.”
Each division president, along with appropriate staff, meets once a year with
senior corporate officers for separate financial reviews. These reviews occur late
in the fiscal year and are a review of performance against financial plan, with a
detailed financial plan of the coming year.
At the financial review, we push the divisions to think through different scenarios
and to plan and advance actions that different contingencies will require. We use
a technique called ABC budgeting: an A budget applies to the most likely
scenario, a B budget to a possible lower level of activity, and so on. As a result,
our managers know well ahead that, if their business environment changes, they
have a well-thought-through set of actions they can take to protect profitability.
This contingency planning is particularly helpful in an economic downturn; we are
not paralyzed by bad news because we’ve already planned for it.
Information generated for and during the division planning conferences and
financial reviews becomes raw material for the corporate planning conference.
We consolidate the data and take a fresh look at the aggregate at our corporate
“preplanning conference” about a month before the corporate planning
conference, which is held in late September near the start of each fiscal year.
For the preplanning conference, we combine input from the divisions with an
analysis of the macroeconomic environment. The annual planning conference
itself, which includes corporate management and the top officers of each division,
serves primarily as a vehicle for communication. Corporate officers share overall
results and communicate the financial plan for the coming year as well as the
strategic plan for the next five years. It is an ideal setting for sharing success
stories and for challenging conventional wisdom.
So the wheel turns full circle, and we do it all over again. This may sound
repetitive and boring. But paying attention to detail makes Emerson successful.
Management Development
We manage organizational needs with the same intensity as we manage our
businesses. Emerson’s approach to the development of people is founded on
two principles: first, the corporation has the obligation to create opportunities for
talented individuals; and second, these individuals have the obligation to create
their own careers. We provide the opportunities; it’s up to our people to take
advantage of them.
The first is the organization review, which is part of the annual planning and
control cycle for each division. This review is an annual half-day meeting
centering on basic human resource issues in a division. In preparation, a division
will evaluate all managers who are department heads or higher, assessing them
according to specific performance criteria. At the meeting, we talk about key
managers’ length of service in a particular assignment, their potential to move to
a more difficult job, and specific responsibilities they might assume.
We try to identify young people who look like “high potentials” and develop plans
to offer them a series of assignments that will enhance and augment their skills.
Finally, we try to ensure that the division has—or knows how to get—the specific
human resource skills it will need to implement its strategy. If a business plans to
open an operation in Eastern Europe, for example, we want a demonstration that
it has the organization and personnel capacity to succeed there.
Third, every year we recruit 10 to 20 high-potential young people and put them in
jobs for which they are not yet qualified. The best make it; the others don’t. It’s
that simple. We carefully track these people, and we retain a majority of them;
some have become division presidents and corporate officers. Finally, we hire
experienced people for certain jobs because we believe that occasionally
bringing in new thinking is very important. We also hire from the outside when we
need specialized experience that we do not have internally.
To keep people motivated and involved, we’ve tried to avoid problems that can
paralyze corporations—things like organization charts and large headquarters
staffs. We don’t have a published corporate organization chart at Emerson. No
such piece of paper exists because we want people communicating around
plans, projects, and problems, not along organization lines.
There are two lessons to be learned from this story. The first is, don’t
underestimate the capacity of well-managed organizations to get important things
done—less important things probably will not get done, but important things will.
And the second is, don’t burden very talented staff people with a lot of
administrative responsibility; the loss of their productivity is rarely worth the extra
capacity the additional people provide.
Emerson’s compensation policies help involve and motivate our people. Simply,
we pay for results. Each executive in a division earns a base salary and is
eligible for a year-end “extra salary,” which is based on the performance of the
division according to measurable objectives. This extra compensation is
calculated as a multiple of an extra salary “centerpoint,” which we establish as
part of the total compensation target at the beginning of each year. Depending on
how well the division performs, the multiplier applied to the centerpoint ranges
from 0.35 to 2.0. If the division hits its forecasted target for performance—
numbers based on commitments that were mutually agreed on during the annual
financial review—the multiplier is 1, and members of the management team will
receive their centerpoint extra salary. Doing better increases the multiplier, and
doing worse lowers it.
The formula for computing compensation targets changes over time, depending
on the needs of the business. At present, sales and margin have a 50%
weighting, with inventory turnover, international sales, new product introductions,
DSOs (a measure of accounts receivable), and individual management
objectives accounting for most of the rest. Other factors that may be included in
the formula are geared to the economics of a particular division. In addition, stock
options and a five-year performance share plan make up an important part of the
total compensation package.
The most important benefit, of course, is the bottom line. The proof lies in
constantly improving results and long-term, high levels of total return to
stockholders. We are opportunists, constantly on the lookout for new
management techniques. When a new idea surfaces—such as a method of
measuring value creation or focusing factories or a statistical process control
technique—we take a hard look. If we think the idea has merit, we’ll adapt it into
our management process and operations.
The process cannot be installed all at once, nor is it necessarily appropriate for
all other companies. But nothing we do has a geographic or national basis; the
sources of competitive success are the same in Japan, Germany, the United
States, or any other strong manufacturing economy. A company that puts the
pieces in place will see progress and results. We believe that planning will pay off
if management implements it aggressively, that the results of the process will
reward the intensity of the effort, and that people will respect and respond to
tough challenges.
One final, basic point: never underestimate the cumulative impact of incremental
change and the gathering forces of momentum. When you grind it out a yard at a
time, you are in fact moving ahead. I can’t say it will work for everybody, but at
Emerson we view it as the only way to manage.
Author’s note: This article was written with substantial input from the three senior
members of Emerson’s office of the chief executive: Albert E. Suter, president
and chief operating officer; Robert W. Staley, vice chairman and chief
administrative officer; and Jan K. Ver Hagen, vice chairman.
Emerson’s Record
During the past several decades, St. Louis, Missouri-based Emerson Electric Co.
has posted an enviable record for a U.S. manufacturing company. In 1991,
Emerson marked its thirty-fourth consecutive year of improved earnings and
earnings per share and its thirty-fifth consecutive year of increased dividends per
share—a performance matched by only a handful of manufacturing companies in
the world and unmatched by any U.S. company that makes comparable products
or serves similar markets.
The Editors
In recent years, the Best Cost Producer Strategy has been fundamental to
Emerson’s profitability and its success in global markets. Developed in the early
1980s, the strategy consists of six elements:
• Commitment to total quality and customer satisfaction.