by: Michael Hammer
Breakthrough innovations in operations—not just steady improvement—can destroy competitors and shake up industries. Such advances don’t have to be as rare as they are.
In 1991, Progressive Insurance, an automobile insurer based in Mayfield Village, Ohio, had approximately $1.3 billion in sales. By 2002, that figure had grown to $9.5 billion. What fashionable strategies did Progressive employ to achieve sevenfold growth in just over a decade? Was it positioned in a high-growth industry? Hardly. Auto insurance is a mature, 100-year-old industry that grows with GDP. Did it diversify into new businesses? No, Progressive’s business was and is overwhelmingly concentrated in consumer auto insurance. Did it go global? Again, no. Progressive operates only in the United States. Neither did it grow through acquisitions or clever marketing schemes. For years, Progressive did little advertising, and some of its campaigns were notably unsuccessful. It didn’t unveil a slew of new products. Nor did it grow at the expense of its margins, even when it set low prices. The proof is Progressive’s combined ratio (expenses plus claims payouts, divided by premiums), the measure of financial performance in the insurance industry. Most auto insurers have combined ratios that fluctuate around 102%—that is, they run a 2% loss on their underwriting activities and recover the loss with investment income. By contrast, Progressive’s combined ratio fluctuates around 96%. The company’s growth has not only been dramatic—it is now the country’s third largest auto insurer—it has also been profitable.
In 1991, Progressive Insurance, an automobile insurer based in Mayfield Village, Ohio, had approximately $1.3 billion in sales. By 2002, that figure had grown to $9.5 billion. What fashionable strategies did Progressive employ to achieve sevenfold growth in just over a decade? Was it positioned in a high-growth industry? Hardly. Auto insurance is a mature, 100-year-old industry that grows with GDP. Did it diversify into new businesses? No, Progressive’s business was and is overwhelmingly concentrated in consumer auto insurance. Did it go global? Again, no. Progressive operates only in the United States. Neither did it grow through acquisitions or clever marketing schemes. For years, Progressive did little advertising, and some of its campaigns were notably unsuccessful. It didn’t unveil a slew of new products. Nor did it grow at the expense of its margins, even when it set low prices. The proof is Progressive’s combined ratio (expenses plus claims payouts, divided by premiums), the measure of financial performance in the insurance industry. Most auto insurers have combined ratios that fluctuate around 102%—that is, they run a 2% loss on their underwriting activities and recover the loss with investment income. By contrast, Progressive’s combined ratio fluctuates around 96%. The company’s growth has not only been dramatic—it is now the country’s third largest auto insurer—it has also been profitable.
The secret of Progressive’s success is maddeningly simple: It outoperated its competitors. By offering lower prices and better service than its rivals, it simply took their customers away. And what enabled Progressive to have better prices and service was operational innovation, the invention and deployment of new ways of doing work.
Operational innovation should not be confused with operational improvement or operational excellence. Those terms refer to achieving high performance via existing modes of operation: ensuring that work is done as it ought to be to reduce errors, costs, and delays but without fundamentally changing how that work gets accomplished. Operational innovation means coming up with entirely new ways of filling orders, developing products, providing customer service, or doing any other activity that an enterprise performs.
Operational innovation has been central to some of the greatest success stories in recent business history, including Wal-Mart, Toyota, and Dell. Wal-Mart is now the largest organization in the world, and it owns one of the world’s strongest brands. Between 1972 and 1992, Wal-Mart went from $44 million in sales to $44 billion, powering past Sears and Kmart with faster growth, higher profits, and lower prices. How did it score that hat trick? Wal-Mart pioneered a great many innovations in how it purchased and distributed goods. One of the best known of these is cross-docking, in which goods trucked to a distribution center from suppliers are immediately transferred to trucks bound for stores—without ever being placed into storage. Cross-docking and companion innovations led to lower inventory levels and lower operating costs, which Wal-Mart translated into lower prices. The rest is history. Although operational innovation wasn’t the sole ingredient in Wal-Mart’s success—its culture, strategy, human resource policies, and a host of other elements (including operational excellence) were also critical—it was the foundation on which the company was built.
Similar observations can be made about Dell and Toyota, organizations whose operational innovations have become proper nouns: the Dell Business Model and the Toyota Production System. Each of these three companies fundamentally rethought how to do work in its industry. Their operational innovations dislodged some of the mightiest corporations in the history of capitalism, including Sears, General Motors, and IBM. These stories are well known for two reasons. First, the stories are worth telling: Operational innovations fuel extraordinary results. But the stories are also repeated because there are, frankly, not many of them. Operational innovation is rare. By my estimate, no more than 10% of large enterprises have made a serious and successful effort at it. And that shouldn’t be. Executives who understand how operational innovation happens—and who also understand the cultural and organizational barriers that prevent it from happening more often—can add to their strategic arsenal one of the most powerful competitive weapons in existence.
The Payoffs
For most of its history, Progressive focused on high-risk drivers, a market that it served profitably through extremely precise pricing. But in the early 1990s, the insurer believed that much larger companies were about to enter this niche and emulate its approach to pricing; the company’s managers realized it couldn’t compete against larger players on a level playing field. So Progressive decided to win the game by changing the rules. It reinvented claims processing to lower its costs and boost customer satisfaction and retention.
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