Ford and Dell
Read the following short case histories of Ford and Dell drawn from Joan Magretta's book. What messages can be inferred? How did these two enterprises link their objectives to their (financial and non-financial) performance measures and results? Can you see the difference between corporate purposes or objectives and results? Explain how these enterprises' objectives determined what results were meaningful and what measures were appropriate.
Case studies by Joan Magretta (excerpted with permission of the author from What management is, how it works, and why it's everyones' business, 2002, Free Press)
When Henry Ford started his company in 1903, his partners wanted him to make highpriced cars with high margins. Ford's co-owners were typical of early investors in the auto industry in thinking that profit per car was the best measure of performance. Ford balked at this. His purpose, his overriding goal was to ‘build a car for the great multitude,' to democratize the auto. Ford wanted to create a car so affordable that it would displace the horse; he wanted cars to be so common that one day, hard as it must have been to imagine at the time, they would be ‘taken for granted.'
By 1907, Ford had bought up enough shares in the company to assume a majority position. He used his new control to shift the company's direction. For him, the measure of success was the number of cars sold. Selling a lot of cars, at a ‘reasonably small profit' would allow him to satisfy his two chief aims in life: more people could buy and enjoy cars, and more men could have good jobs at good wages. Ford created the ‘people's car' by reducing prices by 58 percent from 1908 to 1916, at a time when he had more orders than he could fill, and could easily have raised them. Ford's shareholders responded by slapping him with a suit against the practice. At the same time, he instituted the five-dollar day for workers, double the industry's standard wage. The Wall Street Journal condemned Ford for injecting ‘spiritual principles into a field where they don't belong.'
With 20-20 hindsight (and a better understanding of value creation), we can understand why Ford's measure was the right one, the one that fitted his purpose, his business model and, for a time, the competitive realities of the nascent auto industry. It led Ford to make the right pricing decision, that is, the one that supported his overriding purpose. At a time when turnover in the industry was astronomically high and, therefore, a real threat to Ford's ability to churn out its unprecedented volume of cars, it also led him to make the right decision about wages, which was the key people decision of the day. (The five-dollar-per-day wage also turned workers into customers who could afford cars.)
Dell Computer's measures for translating its mission into performance are equally fine grained and altogether different. When Michael Dell founded his company in 1984, his purpose was simple: give customers a better deal by selling to them directly instead of going through a middleman, as the rest of the industry then did. Working as a one-man operation from his college dorm room, Michael Dell had no need to articulate this purpose or to explain how the business worked. To become the industry giant Dell is today, however, he had to make the organization's purpose concrete. This meant defining results and specifying measures of performance that would keep a large organization focused on the right things.
In Dell's case, one of the keys to success is speed. More specifically, ‘speed' refers to the elapsed time between the moment a computer's components are manufactured and the moment a fully assembled computer reaches the customer's desktop. Why does speed matter? In the computer business, new products are introduced so rapidly that if you have old components, even if they are just several months old, chances are those machines will be obsolete before they get to market. When that happens, the computer maker simply has to sell them at a deep discount and swallow the loss. The expense of obsolete inventory is a fact of life in any business where the product life cycle is short - whether the business is computers or fashion.
Very early on, Dell made the connection between its business model and its performance measures. Dell and his managers were able to translate what they were trying to do - give customers the best available technology at the lowest possible cost - into concrete metrics. For example, Dell discovered that the more often a component, a monitor, say, was touched by a Dell worker, the longer the assembly process took and the more likely it was that the final computer would have a quality problem.
So, Dell began to measure ‘touches,' and set about systematically to reduce the number. For its monitors, Dell ultimately drove this number to zero. Working with its supplier, Sony, whose quality rates are high, Dell was able to put its name on the monitors without ever taking them out of the box. As Michael Dell explains, ‘What's the point in having a monitor put on a truck to Austin, Texas and taken off the truck and sent on a little tour around the warehouse, only to be put back on another truck?'
The imperative of speed was translated into Dell's financial strategy as well. One problem that plagues most growing companies, even profitable ones, is that, if they're not careful, they can run out of cash. (This is why start-ups often worry about burn rates, which is a measure of how fast a company is using up its seed money.) Thomas J. Meredith, Dell's former CFO, was an architect of the company's effort to solve the problem of financing rapid growth.
The question is simple: How do you balance rapid growth with profitability and liquidity? Gross margin, which is revenue minus the cost of goods sold, is a traditional measure of profitability. It doesn't include, however, all the funds that have to be invested in growth (advertising to build your market, for example, and money invested in facilities and inventory). Meredith shifted Dell's financial focus from gross margin to return on invested capital, a measure that includes those funds, paving the way for Dell's focus on low-inventory manufacturing. In fact, his car's license plate was ROIC, which may seem silly, but is very telling. If you want thousands of people to march in the same direction, some symbolism and theatrics are usually required.
Dell wanted to grow fast and to do so without taking on a lot of debt to fund its working capital. To this end, one of the things they did was measure days inventory, a ratio that tells you how long it would take to draw the inventory you have. (It's the number of units on hand divided by the number of units sold per day.) Dell focused everyone in the organization on coming up with ideas to get that number lower and lower. Why? The less inventory a company has, the less money it ties up carrying it.