Operational agility at Toyota

Most managers (90% according to two recent surveys) agree that agility is important to succeed in turbulent markets. There is less agreement on precisely what agility is. My research on companies competing in turbulent markets reveals three distinct types of agility: operational, portfolio, and strategic. Operational agility is a company’s capacity, within a focused business model, to consistently identify and exploit opportunities to create economic value, and do so more quickly than rivals. Toyota, Wal-Mart, Southwest Airlines, and British grocery chain Tesco are good examples of operational agility.

Opportunities are not defined by their novelty, per se, but by their ability to create economic value. Economic value is the gap between a customer’s willingness to pay for a good or service, which can translate into higher price or increased sales volume, or by reducing the costs of necessary inputs (measured as opportunity cost of best alternative use including the risk-adjusted cost of capital).

The best firms exploit both types of opportunity with equal fervor. Most people attribute Toyota’s leadership in the global automotive market to the company’s production system, which systematically identifies activities that do not add value for customers, and weeds out this wasted effort to reduce costs. Toyota’s lean process discipline is an important part of the story, of course, but only part.

The company has consistently anticipated shifting consumer preferences and responded with new models that meet emerging needs. In the 1960s, Toyota began introducing a series of reliable vehicles including the Corona and Corolla, at a time when many customers were fed up with the quality problems endemic to Detroit’s vehicles. With the 1989 launch of the Lexus, Toyota filled a gap for a high-quality luxury vehicle, at a time  at a time when Cadillac and Chrysler were in decline. In the late 1990s, Toyota developed the Prius hybrid electric car, currently the most fuel-efficient car available in the according to the U.S. Environmental Protection Agency, just as concerns about environmental sustainability grew in salience for many customers.

Toyota illustrates another principle of operational agility–that firms should exploit revenue and cost opportunities with equal discipline and vigor throughout the economic cycle. Toyota introduced its lean system in the midst of a deep industry downturn after laying off nearly a third of its employees. This is common. Many firms institute cost reduction processes during hard times. Less common, however, is how Toyota continued to refine it’s production process long after demand picked up again. During downturns in the automotive market, Toyota continued to invest in market research and technology for cars that would meet emerging customer needs.

Many companies unfortunately veer between willy-nilly growth when markets are roaring and brutal cost cutting when the economy falls into recession. During a boom, executives put the gas pedal to the metal in undisciplined pursuit of new initiatives to grow revenues. When the economic cycle turns they slam on the brakes, abandoning growth to slash expenses. As the economy picks up again, they repeat the process, abandoning their new-found cost discipline to chase growth once again.

This stop-go approach causes organizational whiplash not operational agility. Companies should, like Toyota, maintain their cost discipline during economic booms, because that is when costs are most likely to sprout and spread throughout the organization. Conversely, they should stay alert for ways to raise revenues during a downturn, because the best opportunities often emerge in the worst of times as competitors retrench, customers’ preferences shift, and distressed sellers may offer resources on the cheap.

To embed operational agility, executives must ensure that their organization has the information systems to spot opportunities, processes to set priorities and translate these into objectives for individuals and teams, incentives that richly reward performance and punish the under-performance, and put in place a culture that supports agility. (Recent posts on Reckitt Benckiser describe how that consumer products maker has adopted a set of values that promote agility and put them into practice).

A recent survey on the enablers and obstacles to operational agility found that managers did a better job in building the “hardware” of agility in terms of processes to set and cascade corporate priorities. Respondents to the survey assessed their company as doing a good job of setting a small number of objectives for the organization, translating these into clear performance objectives throughout the organization, and allowing subordinates sufficient autonomy to execute on their objectives.

According to this same survey, managers struggle with the “software” required for agility, in terms of the right people and values. Respondents reported that their firms struggled to attract, retain, and reward entrepreneurial managers required to aggressively exploit new opportunities as they arose, and lacked effective processes to let go of under performing employees. They also struggled to maintain the urgency to exploit opportunities faster than rivals.

Leading in turbulent times

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Don Sull is professor of management practice in strategic and international management, and faculty director of executive education at London Business School. This blog is dedicated to helping entrepreneurs, managers, and outside directors to lead more effectively in a turbulent world.

Over the past decade, Prof Sull has studied volatile industries including telecommunications, airlines, fast fashion, and information technology, as well as turbulent countries including Brazil and China, and found specific behaviours that consistently differentiate more, and less, successful firms. His conclusion is that actions, not an individual’s traits, increase the odds of success in turbulent markets, and these actions can be learned.