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Assignment 2: A New Best Practice

Write a one to two (1–2) page paper in which you describe a potential best practice for a company in Stage I, II, or III that is not discussed in the text. Please be as creative as you like.
The format of the paper is to be as follows:

APA

P A R T

A Framework for Developing
Successful Organizations

This firstpart of Growing Pains identifiesthe determinants of organizationalsuccessand providesa framework for understanding the key transitions that organizations and their leaders face asthey grow. It also focuses on helping the entrepreneur or company leader understand and
manage the personal transitions as well as organizational transitions that are required to support
the enterprise’s continued successful development.

The First Challenge for Entrepreneurs

The first challenge that entrepreneurs face is establishing a successful new venture. The basic skills
necessary to meet this challenge are the ability to recognize a market need and the ability to develop
(or to hire other people to develop) a product or service appropriate to satisfy that need.

If these two fundamental things are done well, a fledgling enterprise is likely to experience rapid
growth. At this point, whether the entrepreneur recognizes it or not, the game begins to change.
The organization’s success creates its next set of problems and challenges to survival.

As a result of expanding sales, resources become stretched very thin. A seemingly perpetual and
insatiable need arises for more inventory, space, equipment, people, funds, and so on. Day-to-day
activities are greatly sped up and may even take on a frenzied quality.

The business’s operational systems (those needed to facilitate day-to-day activities), such as mar-
keting, production or service delivery, accounting, credit, collections, and personnel, typically are
overwhelmed by the sudden surge of activity. There is little time to think, and little or no plan-
ning takes place because most plans quickly become obsolete. People become high on their own
adrenaline and merely react to the rush of activity.

2 A Framework for Developing Successful Organizations

At this point the organization usually begins to experience some, perhaps all, of the following
“organizational growing pains”:

• People feel that there are not enough hours in the day.
• People spend too much time “putting out fires.”
• Many people are not aware of what others are doing.
• People lack an understanding of the company’s ultimate goals.
• There are not enough good managers.
• People feel that “I have to do it myself if I want to get it done correctly.”
• Most people feel that the company’s meetings are a waste of time.
• Plans are seldom made and even more seldom followed upon, so things often do not get done.
• Some people feel insecure about their place in the company.
• The company has continued to grow in sales but not to the same extent in profits.

These growing pains are not merely problems in and of themselves, they are a symptom of the
underlying problem that there is an “organizational development gap” between the infrastructure
required by the organization and the infrastructure it actually has. An organization’s infrastructure
consists of the resources,operational support systems and management systems, and culture required
to enable the organization to function profitably on a short- and long-term basis. As described fur-
ther in Chapter 2, a company’s resourcesconsist of the human capital, financial capital, and physical
assets of an enterprise. Operational support systems consist of all the day-to-day systems required to
produce a product or deliver a service and to function on a day-to-day basis. Management systems
consist of the organization’s planning system, organization structure,management development sys-
tem, and performance management system. “Culture” refers to the values, beliefs, and norms that
drive the behavior of people in the enterprise as well as the “system” for culture management (what-
ever that might be). These are the systems required to manage the overall enterprise on a long-term
basis.

The Second Challenge for Entrepreneurs

Once an organization has identified a market and has begun to produce products or services to
meet the needs of customers within that market, it will begin to grow. As the business grows, it
will be faced with the need to make a fundamental transformation or metamorphosis from the
spontaneous, ad hoc, free-spirited enterprise that it has been to a more formally planned, organized,
and disciplined entity. The organizationmustmove from a situationin which there are only informal
plans and people simply react to events to one in which formal planning is a way of life; from one
in which jobs and responsibilities are to one in which there is some degree of definition
of responsibilities and mutually exclusive roles; from one in which there is no accountability or
control systems to one in which there are objectives,goals, measures,and related rewards specified in

Making an Organizational Transition 3

advance as well as formal performance appraisal systems; from one in which there is only on-the-job
training to one in which there are formal management development programs; from one in which
there is no budget to one in which there are budgets, reports, and variances; and, finally, from
a situation in which profit simply happens to one in which there is an explicit profit goal to be
achieved. In brief, the company must make the transition from an entrepreneurship to what we
term “an entrepreneurially oriented, professionally managed organization.”

As we will see in Chapter 1, this is a time when the very personality traits that initially made
the founder-entrepreneur so successful can lead to organizational demise. Most entrepreneurs have
either a sales or technical background, or they know a particular industry well. Entrepreneurs
typically want things done in their own way. They may be more intelligent or have better intuition
than their employees, who come to rely on their bosses’ omnipotence. Typical entrepreneurs tend
to be “doers” rather than managers, and most have not had formal management training, although
they may have read the current management best-sellers. They like to be free of “corporate
restraints.” They reject meetings, written plans, detailed organization of time, and budgets as the
trappings of bureaucracy. Most insidiously, they think, “We got here without these things, so why
do we need them?” Unfortunately, the nature of the organization has changed—and so must its
senior management.

There is no one pattern for a successful transition from an entrepreneurship to a professionally
managed enterprise.Whatever path is followed, the key to a successfulchange is for the entrepreneur
to recognize that a new stage in the organization’s life cycle has been reached and that the former
mode of operation will no longer be effective.

Making an Organizational Transition

As an organization grows, it will, in fact, face not just one but several significant transitions and
transformations that need to be managed. A key question for senior leaders (whether they are the
entrepreneur of a new company or the CEO of a billion-dollar-plus company), then, is, “What
should we do to take the organization successfully to the next stage of growth?” To answer this
question satisfactorily, it is necessary to understand that there are predictable stages of organiza-
tional growth, certain key developmental tasks that must be performed by the organization at each
growth stage, and certain critical problemsthat organizations typically face as they grow. This under-
standing, in turn, requires a framework within which the determinants of successful organizational
development may be placed.

Part One of this book focuses on identifying these determinants of success, on the identification
of the predictable stages of organizational growth (each requiring transitions), and on the personal
transitions that entrepreneurs and other leaders need to make to support the transitions from one
stage of growth to the next.

Chapter 1 deals with the personal and organizational transitions that are necessary during the
life cycle of a business enterprise. It examines a variety of personal and professional changes or
transitions that must be made by the chief executive officer or “CEO” as a company grows. These
individual transitions include the changing nature of the CEO’s role, changes in managerial style,

4 A Framework for Developing Successful Organizations

and the behavioral and attitudinal changes required to support successful organizational transitions.
It also examines the strategic and “architectural design” changes required for healthy organizational
development as a company grows over time.

Chapter 2 presents a holistic framework for successful organizational development. It deals with
the issue of what makes an organization successful and profitable. Drawing on research and expe-
rience from consulting with organizations of all sizes and types over nearly 40 years, it presents a
systematic approach to understanding the six critical variables that determine organizational effec-
tiveness. It examines these six critical tasks of organizational development and describes what must
be done to accomplish each. Chapter 2 presents a method for self-assessment of the strength of a
business in terms of these variables, which we call the Pyramid of Organizational Development. A
database is provided for the reader’s comparison of their company’s “strategic development scores”
with that of other businesses.

Chapters 3 and 4 together identify and examine the seven different stages of organizational
growth, from the inception of a new venture through the early maturity of an entrepreneurial orga-
nization, and to the ultimate decline and revitalization of a company. Chapter 3 focuses upon the
first four stages of growth from a new venture to scale-up, and from scale-up to professionalization
of the enterprise as well as consolidation. Taken together, the four stages described in Chapter 3
comprise the period or era from an entrepreneurial start-up through transformation to becoming an
entrepreneurially oriented professionally managed enterprise. Chapter 4 examines the remaining
three stages—diversification, integration, and decline-revitalization. These chapters also examine
the relative emphasis that must be placed on each of the six critical developmental tasks at each
stage of the organization’s growth.

Chapter 5 identifies and describes the growing pains that all developing organizations experi-
ence. It provides a method for assessing these growing pains and determining their severity. Senior
managers need to be able to recognize such growing pains as symptoms of the need to make changes
in their organizations. Chapter 5 also presents a method for self-assessment of the “growing pains”
being experienced by a business as well as for interpreting the degree of “risk” of problems (includ-
ing ultimate failure) facing the company. A database is provided for the reader’s comparison of their
company’s growing pains scores with that of other businesses.

Taken together, the ideas in Chapters 1 through 5 provide a conceptual map of the “tasks” that
must be focused upon to build a sustainably successful business. Part One also provides a guide for
analyzing and planning the transitions that must be made in moving a company from one develop-
mental stage to the next.

C H A P T E R

Transitions Required to Build
Sustainably Successful

Organizations®

It is well established that approximately 50% of all new ventures will fail within five years. Forevery Southwest Airlines that succeeds, there is a People Express that goes bankrupt. For everyFacebook, there is a Myspace that was once popular, but that is now an afterthought. For every
Starbucks, there is a Diedrich Coffee that failed. For every Dell, there is an Osborne Computer (who
very few people even remember—even though it reached $100 million in sales revenue in three
years before going bankrupt, and was a leader in personal computers prior to the founding of Dell).

It is a great achievement to create a successful start-up, given their 50% failure rate. It is an even
greater challenge to create a company that is sustainably successful over “the long run.” As we view
it, the long run relates to sustainable success over several decades. At a minimum, it involves success
over at least two generations of company leaders. In sports such as baseball, basketball, or football,
it is possible to have sustained success with a specific group of players and a single coach; but true
“sustainable success over the long run” exists only when leadership has passed from generation to
generation with sustained success. One company that has achieved this is General Electric (GE).
Founded in 1878, GE continues to be a global leader. Another is Heineken, the Netherlands-based
beer company. Heineken was founded in 1864, and also continues to be a world leader in its space.
A third is Toyota. Toyota, focused on the production of automobiles, was founded in 1933 as a
departmentof ToyodaAutomaticLoom Works,which itself traces its history to 1926.Toyota Motors
was created as a spinoff from the parent company as Toyota Motor Company in 1937.

6 Transitions Required to Build Sustainably Successful Organizations®

Sustainable success for a long period is very challenging, but possible, as shown by GE, Heineken,
and Toyota. It is difficult even over a relatively shorter period such as 15 years. A comparison of
companies listed on the Nasdaq stock exchange from 2000 to 2015 shows that there were significant
changes in the composition of the top listed companies by “market cap” (market capitalization, the
standard measure of a public company’s value).1 Only three companies were in the top 10 on both
dates: Microsoft, Intel, and Cisco. Several companies that were listed as among the top 10 in 2000
were no longer on the list in 2015, including Dell, Sun Microsystems (purchased by Oracle), JDS
Uniphase, and Yahoo!.

Organizational Success, Decline, and Failure

Why are some companies able to continue to manage growth successfully over the longer term (at
least 10 years) while others are not? Why are some company founders and leaders like Howard
Schultz at Starbucks and Richard Branson of Virgin Group able to continue to grow with their
companies, while other founders and leaders such as Donald Burr, who founded People Express
(and who had an MBA from Harvard!) or Adam Osborne, who founded Osborne Computer, fail to
make the required transitions as their businesses increase in size and complexity? What do successful
companies and their leaders do differently compared with those that are less successful or even those
that have failed? Is it simply chance or something that can be learned and managed?

Through rigorous research and analysis of organizations and their leaders over the past four
decades,2 we have answered these questions and have developed practical tools that can help lead-
ers of companies at all sizes increase their probability of long-term success. Why, for example, did
Starbucks Coffee (originally founded as a local roaster with stores in 1971 and later reconceived
in 1986–1987 as a “specialty retail/café” hybrid) become a global brand and industry leader,3 while
Diedrich Coffee (which was similarly founded in 1972 and later redefined like Starbucks as a cafe in
1983) has been broken into pieces (company stores and franchised stores) and sold to competitors
including Starbucks?4 How did Starbucks become the global leader in its space even though other
companies like Coffee Bean and Tea Leaf (founded 1963) and Peet’s (founded 1966) existed before
Starbucks was ever purchased and refocused? As we will see in the next chapter, Starbucks’ success
is not an accident, nor is it unique. The keys to Starbucks’ success were some critical transitions
made both by its founder and CEO, Howard Schultz, and by the organization itself. Starbucks devel-
oped and followed a plan, not just a classic strategic plan but one that focused upon organizational
development as well.

We shall describe this in some detail and distill the lessons for other company founders and their
organizations.

Lessons like these are not only important for the founders of entrepreneurial companies like
Howard Schultz, Steve Jobs (Apple Computer), or John Paul DeJoria (Paul Mitchell hair products
and Patron Spirits Company), they are important for venture capital and private equity investors,
boards of directors, banks that lend to such companies, managers of such companies, and students
of management who aspire to either start their own business or work in a company going through

Building Sustainably Successful Organizations® 7

such transitions over time. They are also of importance to society as a whole. Companies create jobs.
Successful companies create more and more jobs, while failing companies destroy jobs. For example,
successful companies such as Starbucks, Google, and Apple are job-creating machines! However,
when companies like Borders (retailer of books), Woolworths (specialty department store), Peo-
ple Express (airline) and Osborne Computer (computer manufacturer) fail, they destroy jobs and
people’s livelihood, and negatively impact lives.

Government programs to stimulate companies’ growth have been established in countries such
as Canada and Poland for just this reason. Canada created the Build in Canada Innovation Program
(BCIP) to kick-start businesses and get their innovative products from the lab to the marketplace.
The governmentof Poland has created the Polish Agency for EnterpriseDevelopment.It is a tragedy
when a companyfails after a promisingentrepreneurialstart becausethe entrepreneursdo not under-
stand how to build the organization.

Building Sustainably Successful Organizations®

The purpose of our research and really, what we might describe as our life’s work, is to help
entrepreneurs and others understand what must be done to build sustainably successful
organizations®. We have been helping organizational leaders plan for and implement the
transitions required to promote long-term success for almost 40 years. This book will summarize
our methods, tools, and insights in a practical and systematic way.

Two Types of Transitions Required for Sustainable Success
Our research and experience have shown that there are two different but related types of transitions
that must be made at different stages of growth in order for an organization to continue to flourish
and grow successfully.

One type of transition concerns the founder or ultimate leader of an organization—which is
typically the chief executive officer or CEO. This person must make a variety of personal and profes-
sional changes or transitions as their company grows. These include understanding and embracing
the changes in the CEO role that need to occur to effectively manage an increasingly larger and
more complex organization, developing new skills, adopting a new mindset (that supports, among
other things, having increasingly less direct control over results), and changing one’s managerial
style. For simplicity, we term these the “personal transitions.”

The second type of transition relates to the organization’s strategic and “architectural design.”
These organizational development transitions can include changes in the organization’s systems,
processes, or structure, as well as changes to what the company actually does (who its target cus-
tomers are and what it offers them).

If these two types of transitions are not made effectively, they will have a significant impact
on organizational effectiveness, efficiency, and success. In fact, the inability to make effective and
appropriate personal and organizational transitions is a key underlying reason why organizations
experience problems and, in some cases, fail. This chapter will focus on both types of transitions.

8 Transitions Required to Build Sustainably Successful Organizations®

The Personal Transitions Facing Founders and CEOs

As organizations grow and change, those in management and leadership roles also need to grow—in
their skills and capabilities—and change how they approach their roles. For example, the CEO of
a start-up needs to spend his or her time very differently from that of a $1 billion enterprise. We
will discuss tools and techniques for making these changes in Chapter 9. In this chapter, we focus
on the very specific challenges facing the founder or the entrepreneur as his or her business grows.

Unlike the CEOs of large, Fortune 500–type organizations, who are typically promoted through
the ranks over a period of many years, the CEO of an entrepreneurial company is typically some-
one who either was the founder of a company, was part of a founding group, or is the spouse or
child of the founder. Examples are legion and include not only those cited above but also some
other very familiar names such as Mark Zuckerberg (Facebook), Larry Ellison (Oracle), Jack Ma
(Alibaba, China), Anita Roddick (The Body Shop), Martha Stewart (Martha Stewart), as well
as some currently less familiar but equally significant names, including Ren Zhengfei (Huawei), Li
Ning (Li-Ning, China), Isaac Larian (MGA Entertainment), and Yerkin Tatishev (Kusto Holdings,
Singapore). To understand transitions that founders/entrepreneurs must make as their companies
grow, it is useful to first consider who they are as people and how they got to be CEOs.

Characteristics of Entrepreneurs
Although there are no precise demographic and psychological profiles available, our experience has
shown that CEOs of entrepreneurial companies tend to have certain things in common. About
90% of these people have one of three types of background: (1) a marketing background, (2) a
background in some technical area, such as engineering or computers, or (3) a background in a
particular industry. For example, an individual may have sold computer-related devices for a large
company before deciding to start his or her own company focused on developing and producing
similar products. Alternatively, a person may have been an engineer or other technical specialist
and become skilled at product development before deciding to establish a new business. Finally,
someone may have worked in a particular industry such as travel, executive search, construction,
real estate,garment manufacturing,or a varietyof technologyareas including software development,
computer chips, or telecommunications.

Most CEOs of entrepreneurial companies are enthusiastic about markets and products but are
not very interested in management or the “nuts and bolts” of day-to-day operations. Many of them
find accounting boring. They have no more interest in their own accounting system than the typical
homeowner has in the household’s plumbing: They want it to work, but they do not care to under-
stand how it works. Many tend to look at financial statements only to determine “the bottom line.”

Entrepreneurs are typically above average in intelligence, willing to take risks, uncomfortable in
environments in which they are told what to do, want things done quickly, and are fond of seeing
things done their way. Most, but not all, do not have good listening skills and many seem to have
ADD (attention deficit disorder). They are like butterflies flitting from one thing to the next, or like
Tennessee Williams’s proverbial “cat on a hot tin roof.”5 Anyone who has spent serious time with
many entrepreneurs will recognize the behavior that includes an inability to focus on one thing for

The Personal Transitions Facing Founders and CEOs 9

very long, an ingrained impatience, and an expectation of virtually instant results. One colleague
estimates that 90% of entrepreneurs have the ADD syndrome.

Most of these CEOs have made open-ended commitments to their business, which means that
business does not merely consume a great deal of their life; in most instances, their business is their
life. The pejorative term workaholic, however, would be a misleading description of such people;
rather, they view the business as a very complex, infinitely interesting game. It is a sourceof profound
personal pleasure.

Entrepreneurs are accustomed to being the dominant person in business situations. Above all,
entrepreneurs possess a strong desire to be independent of others’ ability to control their behavior.
They like to feel in control. The typical CEO of an entrepreneurial company either consciously or
unconsciously values control both as an end in itself and as a means to other ends. This personal
preference has most likely been reinforced in a variety of ways for a relatively long time.

The Impact of the Need for Control on Continued Successful Growth
In the early stagesof organizationalgrowth, the typical attributesof an entrepreneurialCEO are ben-
eficial and necessary for the company. Fledgling enterprises need strong direction and open-ended
commitment to make everything work properly. At this time, a compulsive CEO who knows about
everything that is going on and who pays attention to the smallest detail will have a tremendous
positive impact on operations.

As the organization increases in size, however, an entrepreneurial CEO’s typical way of doing
things (and personality) can begin to adversely affect success. Specifically, everyone in the company
(including the CEO) may have become used to the idea that almost every issue—whether major
or not—will be brought to the CEO’s attention for decision or final approval. In other words, the
CEO may have become an unwitting bottleneck in the organization. More insidiously, if the CEO
has not been extremely careful, an entire organization inadvertently may have been built on people
weaker than the CEO. Even though the business has grown in size and added many managers and
professional specialists, the CEO may remain the most skilled person in the company in most, if
not all, areas. This means that the CEO has not been able to increase the company’s capabilities
beyond his or her own admittedly considerable personal skills. Such a situation puts limits on the
organization’s capacity to grow and develop.

The CEO’s desire for personal control over everything done in the organization, which was a
considerable strength during the start-up stage, thus becomes a limitation or bind on the company
during later stages of growth. The CEO’s need to control everything can lead to an unintended
dysfunctional consequence of slowing an organization down to a bureaucratic pace.

Also, some CEOs consciously want to retain control at all costs and therefore do not want to
hire people who are better than they are at any particular task. Others are afraid that if they hire
someone to perform a task that they cannot do themselves, they will become too dependent on that
person. For example, the CEO of one service firm with $5 million in annual revenues was doing
most of the company’s computer programming work himself. When asked why he was spending his
time in this way, he replied, “If I had someone else do it, I would be vulnerable if he left me.”

Some CEOs are able to recognize their own limitations relative to their companies’ changing
needs. As one founder and CEO of an entrepreneurial company aptly stated, “I’m an entrepreneur.

10 Transitions Required to Build Sustainably Successful Organizations®

I’m very good at controlling things—making a decision and seeing it accomplished by sheer
willpower alone, if necessary. But our company has grown beyond that style. I’m not uncomfortable
with the company, but I’m not as effective.” Such CEOs realize that, for the good of the enterprise,
they need to make the transition from a manager who is used to controlling everything and
being the center of all that happens to someone who is still important but is not an omnipresent,
omnipotent figure.

Even when the need for it is recognized, however, this type of change can be stressful. For some
CEOs, whose identities are closely bound up with their companies, it represents a threat—a poten-
tial loss of perceived potency. Many CEOs are simply not able to give up control to any significant
degree and end up strangling their organizations.

Some CEOs go through the motions of giving up some degree of control because intellectu-
ally they know that this is essential; but emotionally they cannot really bring themselves to do it.
For example, one entrepreneur built an organization that achieved a billion dollars in revenues in
less than one decade. Recognizing that the size of the enterprise now made it impossible for him
to manage in the old way, he brought in two heavyweights—experienced professional managers
whom he had to pay high salaries to attract. One was a marketing manager, and the other was a
finance-oriented manager who would be responsible for day-to-day operations. The entrepreneur
himself moved up to chairperson. Unfortunately, he then proceeded to turn the professional man-
agers into managerial eunuchs. When the organization began to do poorly, he announced that he
had experimented with professional managers but, reluctantly, he had to reassume personal control
himself. Similarly, this was the root cause of Steve Jobs’ battles with John Sculley during his first
term at Apple (which ended in 1985). Steve Jobs was, in common parlance, a control freak.

The Tendency to Stick to a Success Formula
Another barrier to continued successful growth relates to the understandable human tendency to
repeat what has worked in the past. If a success formula has worked in the past, it is reinforced by
success, and tends to be repeated—even after the conditions that enabled it to be successful have
changed. For the founder and CEO, many factors reinforce the set of behaviors that has been suc-
cessful, including conventional wisdom that says, “If it ain’t broke, don’t fix it.” The problem is that
organizational success leads to changes in the key underlying determinant of future success—that is,
size. Size matters in business as well as in other areas of life. The greater the size of an organization,
the greater its complexity. This, in turn, means that managing and leading the business will also be
more complex. Like a rubber band that is stretched to its ultimate breaking point, an organization
will inevitably grow to a size where the success formula that created its success (including the way
that the CEO has managed and led the business and its development) will no longer function as
well and will require change.

The Core Dilemma Facing the CEO or Founder
All of the critical characteristicsof a founder or CEO of an entrepreneurialcompanycombine to cre-
ate what can be characterized as the core dilemma that must be resolved if an organization is going
to continue to grow successfully over time: The mindset, skills, and capabilities of entrepreneurial lead-
ership that led to initial success are no longer sufficient or appropriate for future success once an organization

The Personal Transitions Facing Founders and CEOs 11

reaches a certain critical size. Specifically, at some point, the significant or possibly total focus on mar-
kets and products, and the lack of interest in and subsequent neglect of management of the nuts
and bolts of day-to-day operations will turn strength into a limitation. Similarly, the willingness
and desire to personally “do whatever is necessary” (and, in turn, control everything) will also turn
from strength to a limitation. Taken together, this means that the entrepreneurial success formula
must inevitably change, if success is to continue.

Aligning the Entrepreneur’s Mindset to Support Continued Successful Growth
There are three key ideas that must be embraced by company leaders as their organizations grow.
First, a key notion that must be embraced is that past success is not a guarantee of future success. This
means that both the mode of operation and the way that a company is operated must inevitably
change. This also typically means that the founder or CEO and his or her team will need to develop
new skills and change the way that they execute their roles.

The second key idea that must be embraced is that infrastructure matters. When a company is
founded and begins to grow, the most important questions are: “Do we have market?” “Do we have
a product or service that is desired by the market?” and “Can we make a profit providing that prod-
uct or service to the market?” If these questions are answered in the affirmative, the company will
be successful and grow—at least for a while. At a certain point in this growth, however, significant
attention needs to be devoted to developing the infrastructure required to continue to grow and
operate successfully. As used here, “infrastructure” relates to the resources, systems, processes, struc-
ture, and organizational culture required to support effective and efficient day-to-day operations and
continued growth. Just as a city or nation requires an infrastructure to facilitate growth, so does an
economic organization like a company require an infrastructure.

The problem with focusing upon and developing organizational infrastructure is twofold.
Although it is not typically an objective that excites or energizes an entrepreneurial leader,
infrastructure is as critical to a business as to a house. In a house, when you turn on the lights or the
water tap, you want it to work flawlessly, but you might not really care about whether or not you
have certain types of wiring or copper pipes. You might well be much more concerned about the
decorations and furnishings of the house. You know that wiring and pipes are important, but the
details are not inherently interesting. With organizational infrastructure, the entrepreneur might
know that it is important, but not find it inherently interesting.

The third key notion that must be changed or managed is that developing infrastructure (sys-
tems, processes, etc.) means creating bureaucracy. Infrastructure implies process and systems; and
processes and systems (to many entrepreneurs) imply bureaucracy. Since bureaucracy is the mortal
enemy of innovation and entrepreneurship, an entrepreneurial leader might recoil at the thought
of embracing what seems to be tantamount to bureaucracy—just as he or she might not want to
embrace a poisonoussnake! Another challenge for the entrepreneurial leader, then, is to understand
that not only is infrastructure important, but that it does not necessarily mean creating bureaucracy.

The construct we use as the basis for the vision of the required transformation is making the
transition from an early stage entrepreneurship to an entrepreneurially oriented, professionally managed
organization. This means that the organization must develop the processes, systems, and capabilities
to manage the large, more complex enterprise it has (or will soon) become. Many entrepreneurs also

12 Transitions Required to Build Sustainably Successful Organizations®

equate professional management with bureaucracy, and reject that as an aspiration. For example,
Steve Jobs once referred to professional managers as “bozos,” and once said: “Why would anyone
respect professional managers? They can’t do anything.” This is a misunderstanding of the role and
function of professional management. It also explains why Jobs was once fired by his own firm.
When Jobs returned to Apple, he changed his perspective and approach and hired Tim Cook, a
quintessential professional manager, who became the company’s CEO in 2011.6

Alternatives for the CEO as the Organization Grows
Faced with the difficulties described above, what can a founder or entrepreneurial CEO do?

Four basic alternatives are available to the CEO who recognizes that the organization can no
longer be run in the old way. As described below, they are: (1) do nothing and hope for the best,
(2) sell the business and start over, (3) move up to chairperson and bring in a professional man-
ager to run the organization, or (4) make a systematic effort to change personal behavior to fit the
needs of the company at its new stage of development. Let us look more closely at each of these
alternatives.

Business as Usual. First, the CEO can do nothing—or, rather, do “business as usual”—and hope
for the best. This could be called the “ostrich strategy.” The strongest argument for this course of
action is that the company has been successful with its current style to date, and “If it’s not broken,
don’t fix it.” Unfortunately, corporate graveyards are littered with companies that had promising
starts but, because of this strategy, did not continue to develop.

Sell the Business and Start Over Again. A second strategy is for the entrepreneurial CEO to
sell the company when it gets too big to continue with an entrepreneurial style, and then set about
building a new company. A variation on this theme is merging with another company to bring in
new senior managers. This was the strategy of Steve Jobs, who began to develop a new company,
“Next,” after leaving Apple. This means the founder must become a serial entrepreneur. Some
founders are capable of doing this, while for others their business was a one-idea opportunity that
cannot be repeated.

Bring in a Professional Manager. The third strategy is for the CEO to become chairperson and
bring in a professional manager to run the business. When a founder has sufficient self-insight to
realize that he or she is really an entrepreneur or “creative person” and not really an executive, this
can be an attractive option. The founder can become the Chief Creative Officer (or whatever other
title seems appropriate) and turn over operation to others more capable of running an organization.
A great example of this is Mark Zuckerberg,founder of Facebook.As Zuckerberg has stated, “I’m not
an operator.”7 Some of our clients have also pursued this alternative—including a package delivery
business, where the founder realized he was “not CEO material” and hired a CEO to whom he
reported (as COO) on an operational level. The founder was, of course, the owner of the company
and had to approve the CEO’s recommended strategic plan and capital expenditure budgets. He
was also disciplined enough not to throw his weight around and overrule the CEO’s managerial
decisions and actions, even when long-term employees came complaining about something. As a
result, he did not undermine his CEO.

A variation on this theme is for the entrepreneur to turn over the CEO position to another indi-
vidual in the business who is better suited to handle the CEO position. This was done reasonably

The Personal Transitions Facing Founders and CEOs 13

successfully by Howard Schultz at Starbucks who turned the business over to Orin Smith. However,
after Smith retired from Starbucks, the next successor, Jim Donald, came from outside the organi-
zation and was later fired, with Schultz returning to the position of CEO. Schultz later stated that
Starbucks would never again hire someone in that position from outside the organization who did
not deeply understand the company’s distinctive culture.

Change Behavior, Skills, and Role. Finally, a CEO may choose to make the personal and
managerial style changes necessary to be able to take the organization to its next growth stage
successfully. This can also involve a redefinition of the CEO’s role. We will provide more detail
on the specifics of leadership transitions in the context of leadership development—the subject of
Chapter 9.

As described earlier in this chapter, a critical ingredient in the success of such an attempt is the
CEO’s willingness to live with less control over the organization and its activities. Our experience
in coaching CEOs through this transition is that it is possible, but it is not easy.

Cultural factors can play a role in a CEO’s willingness to give up a degree of control. In many
Asian counties, founders and CEOs (both men and women) are expected to be “strong” individuals,
as they typically are. The cultural expectation can lead to a situation where the CEO makes all of
the major (and probably many, if not most, of the minor) decisions. This can result in the CEO
being the only strong individual in the company, surrounded by “helpers” or people capable of
executing tasks and decisions, but not making them. This makes the company totally dependent
on the CEO and results in a self-fulfilling situation where the CEO does not expect others to be
capable of making decisions and therefore makes them himself or herself. Similar expectations and
behavior are also found in various Latin American countries, including Mexico.

Such a situation does not exist only in Asian and Latin American countries; there are many
examplesof this behavior in the United Statesand Europeas well. For example,in one medium-sized
bank in which we worked as consultants, the founder was an exceptionally strong and dominating
individual, and had “trained” other managers not to challenge him. They simply waited for him to
make decisions, which they executed. After his retirement, when the next president took over, he
had different expectations, and wanted a true managerial team. It took about two years to change
this “obedience culture” in which people simply followed orders.

Still another factor that might limit a CEO’s willingness to reduce the degree of control exercised
over operations is personal experience. Some CEOs have tried to reduce their level of control, but
the results have been disappointing. Other CEOs have not tried to do it themselves, but have
observed others try with unsuccessful results. These are powerful barriers to changing leadership
practices. For example, one CEO, who headed a residential real-estate development company we
worked with for many years, had observed only negative results in decentralization of operations.
He was therefore very reluctant to follow the same organizational strategy in his firm. He ultimately
became convinced that a variation on this was a necessity for his company to facilitate further
growth, which, in turn led to positive results.

The CEO’s Existential Dilemma: What Do I Do Now?
The CEO who elects to stay with the company and delegate authority to managers now faces
another problem. As more than one CEO has asked us, “What do I do now? What is my role?” It

14 Transitions Required to Build Sustainably Successful Organizations®

is likely to be more than a little discomforting for a person who has been hyperactive and involved
in virtually all phases of an organization’s activities to find that all tangible roles have been dele-
gated and the only thing left is to be responsible for intangibles. These intangibles include ultimate
responsibility for the company’s vision, organizational development, and culture management.

The entrepreneurial CEO has become accustomed to being the most versatile person in the
orchestra: the individual who could play violin, bass, trombone, drums, or harp. He or she could
even be a one-person band. Now, however, the CEO’s job is more like that of an orchestra leader.
The CEO may not be at all sure that he or she likes or values this new and unfamiliar role. It does
not seem to be productive in a concrete way.

In fact, this new or redefined role is indispensable. The CEO needs to focus on ensuring that the
company has a clear and well-communicated vision. People need to know where the company is
going and, in this sense, the CEO is the person who is responsible for charting and then working
with his or her team of senior executives to keep the organization on course. The CEO is responsible
for championing a holistic view of the development of the entity to ensure that there is a focus on
creating strengths, overcoming limitations, and identifying areas for improvement. This function is
known as “strategic organizational development.” Again the CEO is not responsible for the specific
organizational developmentinitiatives; he or she is responsiblefor orchestrating the process. Finally,
the CEO needs to focus on ensuring that there is a clear definition of the corporate culture, as well
as a method for managing it. In all of these areas, the CEO is responsible for articulating the “what”
(is done), but not the “how” (it is being done).

A CEO may not be equipped to handle this new role because he or she does not adequately
understand this new role or have the skills required to effectively perform it, or both. Moreover,
many CEOs cannot admit weakness by letting anyone guess that they know neither what to do
next nor how to do it. Some try to bluff their way through by acting in an executive manner and
issuing peremptory edicts. Others try to cope by becoming hyperactive, burying themselves in their
work. Often, however, this is merely make-work or busy work, an attempt to fool themselves into
believing that they are still doing something valuable. A CEO who does not know what to do next
but is afraid to admit it and seek help is setting the stage for future organizational crises.

At this stage of the company’s development, the CEO’s role involves becoming a strategic leader.
The focus needs to be on the future direction of the enterprise and its long-term objectives, versus
doing work or managing day-to-day operations. There needs to be a focus on managing the organi-
zation’s culture and on serving as a role model for others. Each of these aspects of the CEO’s new
role requires the ability to think abstractly or conceptually about the business rather than merely
in terms of concrete products.

The Need for Organizational Transition

In addition to making personal changes, CEOs and other senior managers must face the challenge of
managing organizational transitions. It is obvious that a company with $100 million in annual rev-
enues is fundamentally different from one with annual sales of $1 million. It follows, then, that as an
organization grows, it needs to develop new systems, processes, structures, and ways of managing the

Transitions Required for Continuing Success: An Overview Case Example 15

business (that is, it needs a different infrastructure). Through our work and research, we have identi-
fied a specific progressionof infrastructuredevelopmentthat needs to occurto supportorganizational
success. This progression is embedded in a “stages of organizational growth” framework that will be
the subject of Chapter 3 and Chapter 4.

Building a sustainably successfulbusiness,then, involves understandingand effectively managing
these stages of growth. The remainder of this book is intended to provide CEOs and their leader-
ship teams with the information that they need to effectively develop and manage their company’s
infrastructure.

Transitions Required for Continuing Success: An Overview
Case Example

As an introduction to the remainder of this book and to illustrate the personal and organiza-
tional transitions that typically occur as a company grows, this section presents a case study of an
entrepreneur, Robert Mason and his company, Medco. Although the case selected is that of a medi-
cal productscompany, the issues faced by the entrepreneur and the company cited here are similar to
those faced by CEOs in diverse organizations with revenue ranging from $1 million to substantially
more than $1 billion. In brief, it has been selected as a prototype of a widespread phenomenon, not
one that is limited to certain companies or industries.

Medco’s Early History
Bob Mason, the founder of Medco, began his career as a salesman for a major medical products
manufacturing and marketing firm. He worked hard to learn all he could about the industry, and
discovered that the company for which he was working was not adequately meeting all of its cus-
tomers’ needs, and that there was an untapped market for medical products. So he decided to start
his own company, a medical products business.8

Apparently Bob’s belief about the demand for his products was accurate, because within a few
years, his business began to experience rapid growth. Within five years, the company had reached
more than $20 million in annual revenues, and it was estimated that within four more it would
achieve $50 million in yearly sales.

The Onset of “Growing Pains”
When Medco reached $20 million in sales, and Bob Mason was feeling good about that, he also
became aware that the business was beginning to experience certain organizational problems, which
are what we term “growing pains,” as described below:

Many People Were Not Aware of What Others Were Doing. A significant number of people did
not understand what their jobs were, what others’ jobs were, or what the relationships were between
their jobs and the jobs of others. This problem resulted, in part, from a tendency to add personnel
without developing formal descriptions of roles and responsibilities. Since employees were added
on an ad hoc basis whenever a staff shortage seemed imminent, there was often little time to orient
them to the organization’s operations or to train them adequately in what their own responsibilities
would be. Indeed, there was no formal training program.

16 Transitions Required to Build Sustainably Successful Organizations®

Some people were given job descriptions, but did not adhere to their specified roles. Others
were given a title, but no explicit responsibilities. Surprisingly, many individuals often did not
know to whom they were to report, and managers did not know for which employees and activ-
ities they would be held accountable. People learned what they were supposed to do on a daily
basis; long-range planning was nonexistent.

Interactions between Departments Was Also a Problem. Managers often did not understand
what their responsibilities were and how what they were doing fit in with the firm’s overall oper-
ations. New departments were created to meet Medco’s product and marketing needs, but many
managers were not aware of how these departments fit in with the rest of the organization. One
manager complained, “People sit outside my door, but I don’t even know what they do.” Another
new manager described his introduction to Medco as follows: “I was walked to an area and was told:
‘It’s your department. Run it.’”

This lack of formal roles and responsibilities made it easy for personnel to avoid responsibility
whenever a task was not completed or was completed unsatisfactorily. This also led to duplication
of effort between departments. Since no one knew precisely whose responsibility a particular task
was, two or more departments or people often would complete a task, only to find that it had already
been accomplished by someone else.

People Felt There Were Not Enough Hours in the Day. Most employees felt overloaded. They
commonly stayed after hours to complete their work. Department managers, in particular, felt that
their workload was too great and that deadlines were unrealistic.

This situation resulted, in part, from the lack of adequately developed day-to-day systems to sup-
port Medco employees’ work. The accounting, operational planning, and communication systems
were adequate for a small company, but quite inadequate for one as large as Medco had become.
Systems for purchasing, inventory control, and even distribution were either poorly developed or
nonexistent.

People Spent Too Much Time Putting Out Fires. Perhaps the best indication that Medco was
beginning to choke on its growth was that employees spent an increasing amount of time dealing
with short-term problems resulting from the lack of long-range planning. This was particularly evi-
dent in the constant lack of space within the company’s headquarters.It appeared to most employees
that as soon as the company increased its office space, the space already was filled, and it was time
to begin planning for another move. It seemed that there was never enough space or equipment
to support the company’s staff adequately. When they worked at the firm’s headquarters, salespeo-
ple usually arrived early to ensure they would be able to find a vacant desk from which to make
their calls. Employees who did not go out into the field attempted to handle the cramped space by
creating “schedules” for using phones, computers, and even desks.

Employees Began to Feel That Medco Never Planned, It Simply Reacted. A joke around the
company was: “At Medco, long-range planning means what I am going to do after lunch.” This was
caused partly by the changes in the marketplace and the new demands placed upon the company.
It also resulted from the tendency of entrepreneurial companies like Medco to spend most of their
time simply staying afloat without keeping an eye on the future.

Transitions Required for Continuing Success: An Overview Case Example 17

Employees began to think that, simply because crisis is the norm at the company, that is the way
they should operate. They began to call themselves “the fire fighters,” and even took pride in their
ability to deal with crises.

There Were Not Enough Good Managers. Most managers at Medco were promoted to their
positions in recognition of service. Some were good managers, but most were described by their
direct reports as “good technicians who lack people skills.” Further, they were seen as clones: Many
employees believed that management had one and only one way of doing things, and that to deviate
from the norm would result in adverse consequences.

Plenty of people had the title “manager,” but relatively few really behaved as managers. After
promotion, many people simply kept doing the things they had done in their former roles. They
were poor delegators, often doing the work themselves rather than assigning it to others. As a result,
employees came to believe that their managers did not trust them.

Bob Mason was a strong individual who wanted things done his way, and he wanted to control
almost everything. He recognized this, referring to himself as “someone who sticks his nose into
everything.” Few decisions were made without Bob’s approval or review. As a consequence, one of
two things tended to happen concerning managers: (1) the stronger managers tended to butt heads
with Bob and ultimately left; and (2) the remaining managers were slowly marginalized. Those
managers who decided not to leave Medco tended not to take Bob on, at least directly, and they
had little real authority and certainly no power. Inadvertently, Bob had created an organization of
“managerial pygmies.” In effect, Bob was a victim of his own need for control. This phenomenon is
part of what we have previously termed the “entrepreneur’s syndrome.”9

When Business Plans Were Made, There Was Very Little Follow-Up, and Things Did Not
Get Done. As is true of many small and growing firms, Medco had traditionally operated on an
ad hoc basis. No formal strategic planning system was needed, since Bob had provided all of the
organization’s direction. Further, the informal structurehad allowed Medco’s employees the freedom
to generate new product and marketing ideas.

As the company grew, however, Bob and his senior management team began to realize that they
needed to monitor its operations. Unfortunately, Medco had not developed the systems necessary
to have accountability.

There Was a Lack of Understanding About Where the Firm Was Going. Many Medco employ-
ees complained that not only did they not know what was expected of them; they could not under-
stand where the company was headed in the long term. This resulted from the inability of Medco’s
management to communicate its vision for the future to the company’s personnel. Employees were
aware that changes were being made, but were not always sure how these changes would affect
them or their departments. Consequently, employees experienced high levels of anxiety. When this
anxiety became too great, many left the firm.

Most People Felt Meetings Were a Waste of Time. Employees complained that too many meet-
ings were held among top managers and not enough among the lower levels of the organization. In
addition, those meetings that were held were often inefficient and did not result in resolutions to
problems. It was because few meetings had written agendas or minutes—many of those attending

18 Transitions Required to Build Sustainably Successful Organizations®

described them as “free-for-alls.” They were at best discussions, and at worst fights between depart-
ments or individuals. Worst of all, they went on interminably.

Moreover, people complained that most meetings were called on an ad hoc basis. Since these
meetings were unscheduled, people typically came to them without any sense of their purpose and
certainly with no preparation. Thus, they tended to have the atmosphere of bull sessions in which
people shot from the hip. In addition, people felt that they could not plan their work because they
were constantly interrupted for “crisis” meetings.

Some People Began to Feel Insecure About Their Places at the Firm. This problem grew out
of the many changes taking place and the large number of problems the firm was encountering as it
grew. Some original founding members were terminated and replaced. This caused people to wonder
who was next. Although many recognized that some employees had not grown as the company grew,
they worried about their jobs and their places within the firm. This, in turn, led people to spend an
increasing amount of their time covering their vested interests.

The Company Grew in Sales but Not in Profits. Medco, like many entrepreneurial firms, tradi-
tionally had been most concerned with increasing sales. It adopted the philosophy of many growing
firms: “If we’re selling more, we must be making more profits.” Unfortunately, this is not often the
case. The other side of the profit equation, costs, often increases along with sales, and if costs are not
contained, the firm soon may find itself in a position of losing, rather than making, money. Thus,
although Medco sales were increasing at a rapid rate, profits were remaining relatively constant.

Medco’s problems certainly are not unique. Indeed, these are the classic symptoms of what we
have termed “growing pains,” as will be described in detail in Chapter 5. It should be noted that
while these “symptoms” represent problems in and of themselves, they also suggest a deeper, more
systemic organizational problem. Specifically, they signal that the organization is coming precari-
ously close to choking on its own growth. This, in turn, indicates that the organization must change
its very nature; it must make a transition to a different kind of organization, a more professionally
managed firm with processes and systems to facilitate growth.

The Need for Transitions
Bob Mason recognized that his business was experiencing problems. He realized that the organiza-
tion had outgrown the current way it was being managed, and that both he and the organization
needed to make some serious changes in the way things were being done.

His first step was to get deeper insight into the kinds of problems he was facing at Medco. He
did a search for books that would help, and obtained a copy of an earlier edition of Growing Pains.
After reading the book, he initiated action to help his company overcome the problems associated
with growth. Specifically, he began a program of organizational development for Medco. The four
specific steps in the program were as follows:

STEP I: Conduct an organizational assessment.

STEP II: Formulate an organizational development plan.

STEP III: Implement the organizational development plan.

STEP IV: Monitor progress.

Transitions Required for Continuing Success: An Overview Case Example 19

Step I: Conduct an Organizational Assessment
An organizational assessment was performed to evaluate Medco’s current state of development and
future needs. The assessment involved collecting information from employees about their percep-
tions of Medco and its operations. One tool used in this process was the Growing Pains Survey©,
which will be presented and described in Chapter 5. This survey measures the extent to which an
organization is experiencing the 10 classic symptoms of growing pains.

At Medco, the scores on this survey ranged from 30 to 34, with an average score of 32. As
explained further in Chapter 5, this indicated that the company was experiencing some “very sig-
nificant problems,” which required immediate attention. Specifically, the assessment revealed that
the company needed to:

• Better define organizational roles and responsibilities and linkages between roles.
• Help employees plan and budget their time.
• Develop a long-range business plan and a system for monitoring it.
• Increase the number of qualified present and potential managers.
• Identify the direction the company should take in the future.
• Reduce employee and departmental feelings that they always “needed to do it themselves” if

a job was to get done correctly.

• Make meetings more efficient by developing written agendas and taking and distributingmeet-
ing minutes.

• Become profit oriented rather than strictly sales oriented.

Steps II–IV: Formulate and Implement an Organizational Development Plan
and Monitor Progress
Having identified its organizational problems and developmental needs, Medco proceeded to the
next step: designing and implementing a program that would resolve problems and help the com-
pany develop the infrastructure necessary to accommodate its rapid growth. Management met at
a retreat to design a plan for the firm. The plan included specific action steps to overcome its
problems.

Some of these steps were (1) acquisition of human resources and development of operational sys-
tems needed to support current operations and continued growth; (2) implementation of a strategic
plan that clearly defined where the company was going, and how it was going to get there; (3) imple-
mentation of performance management systems to motivate people to achieve the company’s goals;
(4) design of a management and leadership development program to help people become better
managers and overcome the “doer syndrome”; (5) development of a system to explicitly manage
the corporate culture. In addition, Bob began to focus on making some important changes in his
own role, behavior, and attitudes.

Acquisition of Resources and Development of Operational Systems. As the company grew,
so did its need for greater skills and sophistication in certain functional areas. A controller was
recruited to replace the firm’s bookkeeper. A national sales manager was appointed. Medco also

20 Transitions Required to Build Sustainably Successful Organizations®

hired a personnel director and a marketing manager. Moreover, Medco engaged a consultant to
serve as its adjunct management and organizational development adviser. In brief, the firm made a
significant investmentin its human resources.These people, in turn, were responsiblefor developing
the day-to-day operational systems required to manage growth in various areas.

Implementing Strategic Planning. One of the first steps Medco took to manage its growth was
to develop a strategic plan and begin implementing a formal strategic planning process. The major
goal of this process was to motivate the company’s managers to begin to take a longer-range view
than “what’s happening after lunch.” A related goal was to affect the corporate culture at Medco
and make planning a way of life.

The process began with a two-day strategic planning retreat that focused on some fundamental
issues necessary to guide the future development of the company, including:

1. What business is Medco in?

2. What are our competitive strengths and limitations?

3. Do we have a market niche?

4. What do we want to become in the long term?

5. What are the key factors responsible for our past success, and to what extent will they con-
tribute to our future success?

6. What should our objectives and goals be for developing Medco as an organization?

7. What should our action plans be, and who is responsible for each action plan?

In addition to these generic strategic planning issues, which are relevant to all organizations, the
company also examined certain company-specific strategic issues.

After the strategic planning retreat, a draft of a corporate strategic plan was prepared. This plan
clearly identified the business that the company was in, its long-term goals, and its competitive
strategy. The plan also included specific, measurable, time-dated, short-term goals—with each goal
being assigned to a specific memberof the senior leadership team. The plan was circulated among the
firm’s senior managers for their comments and input. It was revised and approved by Bob, and then
distributed to all senior managers. The plan provided a “blueprint” for future development, includ-
ing specific goals focused upon eliminating the problems leading to the company’s growing pains.

Medco then held quarterly meetings to review the company’s results, compare them with the
plan, and make required adjustments. This signaled that the plan was more than merely a “paper
plan”—it was a real management tool.

A key decision made by management during this retreat was to be more selective in accepting
new business until the firm had digested its present growth by building the required infrastructure.

Performance Management Systems. Medco developed and implemented a more formal perfor-
mance management system. A first step in this process was to develop a measurement system for
tracking progress against each goal in the firm’s strategic plan. These measurements were developed
as part of an organizational development team meeting in which all of Medco’s senior management
participated. Once the measurements had been decided upon, the next step was for Medco to revise
its information system so that the data required could be obtained. Some of the data came directly

Transitions Required for Continuing Success: An Overview Case Example 21

from the firm’s accounting information system. For example, information about sales, gross margins,
and net profitability came from this source. Other information had to be obtained separately. The
firm’s management team felt that one of the vital aspects of the business concerned the percentage
of merchandise that was being shipped to dealers as opposed to end users. This information began
to be monitored on a regular basis.

Management and Leadership Development. Bob and Medco’s other senior managers realized
that people were Medco’s true asset. The firm’s technology, products, and equipment were really not
proprietary; the true differentiating factor was the motivation and skills of its people.

Recognizing this, Medco believed the company had to make an investment in building its man-
agement and leadership capabilities for two reasons. First, there simply was not a sufficient number
of effective managers. Although many people had managerial titles and could recite the right buz-
zwords, relatively few were really behaving as managers. They were spending too much time as doers
rather than managers. There was little true delegation, and insufficient effort was given to planning,
organizing people, performance appraisal, and team training. Another need for management devel-
opment was more symbolic. Bob recognized that some of the people who had helped build Medco
to its current size were in jeopardy of becoming victims of the Peter Principle: They had been pro-
moted to their level of incompetence. Bob felt that the company owed its people a chance to grow
with it and he saw management development as a chance to provide them that opportunity. Quite
frankly, he felt that if people had this opportunity and failed to grow, the organization could feel it
had met its responsibilities to them.

To deal with these issues, Medco asked a consultant to design a management development pro-
gram for its personnel. Two programs were developed: one for top managers and one for middle
managers.

Corporate Culture. Although Bob Mason had been aware that his firm had a culture, he had
never taken any serious steps to manage it. He had always wanted the firm to be sales oriented,
aggressive, and profit oriented. He hadn’t realized that there were also a great many other facets to
the firm’s culture, which had been embedded since the earliest days of its operation.

As the firm began to change, Bob became increasingly aware that he needed to manage the
firm’s corporate culture in order to reinforce the change. One of the unintended aspects of the firm’s
culture that had developed was that people felt that if they worked hard they should be rewarded
regardless of the results. Bob felt that people needed to learn that hard work was simply not enough
and that they had to be oriented toward bottom line results.

A second aspect of the firm’s culture had been that decisions would be pushed up to Bob. Since
Bob was acknowledged to be an entrepreneurial genius and since his personality had tended to lead
to nuclear explosions whenever someone made a mistake, people naturally pushed decisions to his
desk. Bob now wanted to reverse the culture, and push the decisions down to the lowest level of
responsibility in the firm where they could be meaningfully made. The firm also tried to emphasize
that under the new culture, mistakes would be examined, and corrected, but that people would not
feel the brunt of a nuclear explosion if a mistake was made.

A third aspect of the Medco culture had been that “we’re good crisis managers.” This meant that
Medco managers had to learn to turn on a dime and solve whatever crises came up. Mason now
wanted Medco to revise its culture to emphasize the importance of long-range planning. He wanted

22 Transitions Required to Build Sustainably Successful Organizations®

the culture to become one of “planning is a way of life at Medco.” A fourth aspect of the Medco
culture had been “we’re hands-on managers.” This needed to be revised so that managers stayed in
touch with operations, but delegated responsibility to the lowest level capable of performing the
required tasks.

One of the most important aspects of this change was that Bob, together with the senior man-
agers, now realized that the management of the corporate culture was an important part of the
strategic leadership function that they had to perform.

Changes in the CEO. Bob Mason realized that just as Medco had to change, so did he. His basic
skills were as a salesman and as an entrepreneur. He had worked hard, and he had built a successful
company. He had the title of president, but he realized he was not acting like a president.

In spite of the fact that he was the CEO of the company, Bob continued to spend too much time
dealing with the technical and marketing aspects of the business. This is what he knew how to do,
and this is what he enjoyed. He knew he was not devoting a sufficient amount of time to the broader
aspects of organizational development.

Bob also understood that there were certain other problems with his management style and
capabilities. In spite of the fact that his organization had grown substantially, he still wanted to
control too many details of the business. He knew he still poked his nose into too many areas of
the business. He began to understand that this was not only a problem that he was facing, but his
behavior was seen as a role model by other managers in the organization who, in turn, were doing
the same things at their level of responsibility.

The first change that Bob made was to decide to change. He then proceeded to redefine his con-
cept of his role. He decided to spend more time on the planning and organizational development
aspects of the business and less time in many of the technical areas. He made a decision to give
up control over the marketing area by delegating more responsibility than he had in the past. He
decided to change his leadership style from “making all decisions” to “involving the senior leader-
ship team” in many of the decisions that needed to be made. There were always going to be decisions
where he would, in effect, have to decide what was best for the company and then announce it
to the organization. However, he decided to significantly increase the extent to which his senior
managers were involved in planning overall organizational changes and in making day-to-day oper-
ational decisions.

Another aspect of Bob’s behavior that needed to be changed was the way he was dealing with
stress. Bob, like most entrepreneurs, was constantly under a great deal of pressure. Periodically he
would “explode” or as one of his managers put it, “go nuclear.” When Bob went nuclear, everybody
headed for the hills. If something went wrong, Bob might “nuke ’em” in a meeting. This had led,
over time, to people avoiding bringing Bob bad news. In turn, this had created serious problems for
the business because Bob was, at times, simply not in touch with information he and other senior
managers needed to have to make effective decisions. As people began to see Bob dealing with
conflict but not exploding, they became more open in discussing problems, and even disagreeing
with the direction that Bob was proposing. His management team began to be a team in the true
sense of the word.

Summary 23

Bob sent another signal to the organization abouthis willingness to change by participating in the
organization’s new management development program. As he stated: “If I want people to change,
I’ve got to lead by example as well as by word.”

Program Results
For 18 months, Medco implemented its new program of organizational development. After this
period, the organizational growing pains score decreased from an average score of 32, which put the
company in a red-flag danger zone, to a score of 21, which indicated some problems but nothing of
major concern. This improvement occurred despite the fact that the firm continued to grow. More-
over, the firm’s profitabilityincreased significantly during this period, as a wide variety of operational
inefficiencies were eliminated.

In brief, Medco had made a fundamental transformation. It had gone from a firm about to choke
on its own growth to one that was able to absorb growth and operate profitably and effectively. In
addition, Bob Mason had made the transition from an entrepreneur to a true CEO.

Summary

This chapter has examined the issues of success and failure typically facing organizations and their
leaders after promising entrepreneurial starts. We have identified the need for continued success,
and described the personal and organizational transitions to promote that continued success. We
have identified and discussed the changes that the CEO needs to make as his or her organization
grows, and we have examined the alternatives available to CEOs who face such transitions.

The chapter presents a comprehensive case example of the transitions required by Medco, which
faced classic growing pains and developed strategies for addressing them. The steps that Medco took
to identify its challenges and work to address them illustrate how an organization can build the
infrastructure needed to promote sustainably successful growth. The personal challenges faced by
Bob Mason, Medco’s CEO, and how he addressed them provide a good example of how to make the
personal transitions required to support an organization’s continued successful development.

There is no one way to make a successful transition from an early-stage entrepreneurship to a
future stage of growth. However, the key to making this change is for the entrepreneur to recognize
that the company’s former mode of operation will no longer be effective.

All change is accompanied by risk, and many of us feel uncomfortable during the process of
change. Unfortunately, the need for organizational transitions and their accompanying personal
changes is inevitable. Those who do not believe this are likely to increase the risk that their
organizations will experience significant difficulties. However, if knowledge is truly power, then
entrepreneurs and others who understand the need for the kind of transitions described in this
book will be set up for the possibility of continuing success.

The remainder of this book deals with how to make these required personal and organizational
transitions—beginning with the next chapter, which presents a framework (based upon research

24 Transitions Required to Build Sustainably Successful Organizations®

and experience) that identifies the key factors that must be focused upon in building a sustainably
successful organization.

Notes

1. Dean Starkman and Russ Mitchell, “Nasdaq: Déjà vu 15 Years Later,” Los Angeles Times,
March 3, 2015, B4.

2. We have published many articles presenting our models, testing them empirically. We have
also published case application articles showing how our frameworks and tools have actually
been used.

3. Starbucks was originally founded by a three-man group in Seattle as a “local roaster,” not a
café. Howard Schultz who had worked at Starbucks left to found Il Giornale Coffee in 1986,
and then purchased Starbucks and rebranded his company as Starbucks in 1987.

4. Diedrich Coffee was founded in 1983 by Martin Diedrich. It was an outgrowth of an earlier
family business begun as a coffee plantation and then a local roasting store that opened in 1972.
Diedrich Coffee went public in 1996. In September 2006, Diedrich Coffee announced its plans
to close its company-owned retail stores,40 of which were sold to Starbucksand reopened under
that brand. Diedrich’s franchisee-owned stores remained unchanged. The company continued
as a roaster and wholesaler of coffee beans, with a few independently owned and operated
Diedrich stores that remained open in California and Texas. On November 3, 2009, Peet’s
announced that it was buying Diedrich, but its offer was exceeded by Green Mountain Roasters,
Inc., which currently owns the company.

5. Cat on a Hot Tin Roof is a play by Tennessee Williams. It was winner of the Pulitzer Prize
for Drama in 1955. The use of this phrase here is not intended literally, but to suggest the
motivation “to movement” by the entrepreneur.

6. Timothy “Tim” Cook spent 12 years at IBM in its personal computer business. He ultimately
became the director of North American Fulfillment. Later, he served as COO of the computer
reseller division of Intelligent Electronics. Finally, before joining Apple, in 1998 he was Vice
President for Corporate Materials at Compaq for six months.

7. Ryan Knutson and Sam Schectner, “Zuckerberg Seeks Calm with Telecom Carriers,” Wall Street
Journal, March 4, 2015, B4.

8. This case is based upon an actual situation, but details have been changed and the company
has been disguised.

9. Eric Flamholtz and Yvonne Randle, The Inner Game of Management (New York: AMACOM,
1987).

C H A P T E R

Building Sustainably Successful
Organizations®

The Pyramid of Organizational Development

As a new venture begins to grow, the CEO and other members of senior management mustsimultaneously cope with endless day-to-day problems and keep an eye on the future. Makingthis even more difficult is that many managers of growing entrepreneurships are going through
the processof building an organizationfor the firsttime. This is aboutas easy as navigating uncharted
waters in a leaky rowboat with an inexperienced crew while surrounded by a school of sharks. The
sea is unfamiliar, the boat is clumsy, the skills needed are not readily apparent or not fully developed,
and there is a constant reminder of the high costs of an error in judgment.

Just as the crew of such a boat might wish urgently for a guide to help them with navigation,
training, and ship repair, the senior managers of a growing enterprise may frequently wish for a
guide to help them build their organization. The crew might also be glad to know that others before
them have made the voyage successfully and to hear some of the lessons that the other voyagers
learned in the process.

This chapter attempts to provide a guide for senior managers who are faced with the special chal-
lenge of building a sustainably successful company. It gives a framework or “lens” for understanding
and managing the critical tasks that an organization must perform at each stage of its growth. The
framework for organizational developmentthat is presented in this chapter is an outgrowth of nearly
four decadesof research and consulting experiencewith organizationswho have faced and dealt with
the need to make a transition from one stage of growth to the next.

26 Building Sustainably Successful Organizations®

The Nature of Organizational Development

Organizational development is the process of planning and implementing changes in the over-
all capabilities of an enterprise in order to increase its operating effectiveness and profitability. It
involves thinking about a business organization (or any organization, for that matter) as a whole
and planning necessary changes in certain key areas in order to help it progress successfully from
one stage of growth to the next. Based upon our empirical research and experience, the key areas
that require focus include the organization’s business foundation (the conceptual foundation on
which the rest of the company’s systems and processes are built), as well as six key organizational
development tasks.

The Business Foundation
All business or economic organizations (including nonprofits) are based upon a conceptual foun-
dation, 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 cus-
tomers 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 strate-
gically 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

http://Pets.com

The Nature of Organizational Development 27

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 Star-
bucks) 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 pre-
requisite 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 impor-
tant 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.

28 Building Sustainably Successful Organizations®

Figure 2.1 The Pyramid of Organizational Development

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 Computergrew 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.

http://Amazon.com

The Nature of Organizational Development 29

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 mistak-
enly 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 Cor-
poration 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 pur-
chased 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 “produc-
tization.” 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 neces-
sarily 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 “pro-
duce” a product involves the service delivery system, the mechanism through which services are

30 Building Sustainably Successful Organizations®

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 per-
formance 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 com-
pany’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 devel-
oping 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 com-
pany), personnel, and so forth. It is at this stage that an entrepreneurmust 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 equipmentthat becameobsoletewithin six months becauseof the firm’s
rapid growth. Instead of purchasing a photocopying machine that would be adequate for the com-
pany’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

The Nature of Organizational Development 31

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, pro-
duction (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 oper-
ational 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 increas-
ing 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 distri-
bution firm with more than $200 million in annual revenues,salespeoplewere 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 insuffi-
cient 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 keep-
ing 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

32 Building Sustainably Successful Organizations®

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 surpassedSears and Kmart, and has developed unsurpassedlogisticsand
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 opera-
tions. 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 devel-
oping 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 organi-
zation’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 plan-
ning 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

The Nature of Organizational Development 33

organizational objectives. These systems include both formal control mechanisms, such as respon-
sibility 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 man-
agers 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 Air-
lines, 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

34 Building Sustainably Successful Organizations®

avoid conflict among its managers, set unrealistic performance expectations, avoid accountability,
and overestimateits 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.

The Pyramid of Organizational Development

The six tasks of organizational development just described are critical to any business’s successful
functioning, not only individually but as an integrated system. They must harmonize and reinforce
rather than conflict with one another. An enterprise’s markets, products, resources, operational
systems, management systems, and corporate culture must be an integrated whole. Further, the
Pyramid of Organizational Development must support and be supported by the organization’s busi-
ness concept—the foundation on which the business is built. Stated differently, each variable in the
Pyramid of Organizational Development affects and, in turn, is affected by each of the other vari-
ables (including the organization’s business concept). Thus, although the foundation of the Pyramid
of Organizational Development is the market, the market is affected by and affects the company’s
culture. The management of an organization must learn to visualize this pyramid and evaluate their
organization in terms of the extent to which its pyramid has been successfully designed and built.

Implications of the Pyramid of Organizational Development
There are several important implications of the Pyramid of Organizational Development for man-
agement. First, the business foundation and the six key organizational development tasks com-
prise 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 oper-
ational 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 advan-
tages are typically found at the top three levels of the pyramid (operational systems, management sys-
tems, and culture) rather than in products and markets. All markets can be entered by competitors,

The Pyramid of Organizational Development 35

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 limi-
tations (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 stan-
dards 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

36 Building Sustainably Successful Organizations®

Table 2.1 Example of an Organization’s Strategic
Development Scores

Pyramid Level Sample

Mean

Markets 3.2
Products/Services 2.9
Resources 2.8
Operational Systems 2.7
Management Systems 3.0
Culture 3.0

Overall Strategic Development Score 2.9

Table 2.2 Strategic Development Scores Required for Different Levels of Success over the
Long Run

Level Success Required Overall Strategic Development Score

I Global Leader 4.50+
II Superior 4.00+
III Sustainably Successful 3.50+
IV Marginally Successful 3.00+
V At Risk/Unsuccessful <3.00 VI Likely to Be in Crisis <2.50

organization with a score of 3.0 to 3.4 is classified as “Marginally Successful,” meaning that its suc-
cess 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

The Pyramid and Financial Performance 37

Table 2.3 Examples of Companies with Different Levels of Strategic Development

Level Success Examples

I Global Leaders Starbucks, Microsoft, IBM, Caterpillar
II Superior Amgen, Nike, Walmart
III Successful Mövenpick, Komatsu, Li Ning
IV Marginally Successful Nokia, Ford, Sony
V At Risk/Unsuccessful Sears, Radio Shack, Kmart

Table 2.4 Distribution of Overall Strategic Development Scores per Management
Systems’ Database

Mean Score Percent of Companies with Mean Scores

4.5–5.0 Less than 1%
4.0–4.4 3%
3.5–3.9 26%
3.0–3.4 50%
<3.0 20%

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.

The Pyramid and Financial Performance

During the past few years, a growing body of research has provided empirical support for the validity
of the Pyramid of Organizational Development framework.10 This research has consistently indi-
cated that there is a statistically significant relationship between the variables contained in the
pyramid and the financial performance of companies. The six variables are hypothesized to account
for as much as 90% of financial performance, with the remaining 10% attributable to exogenous
factors. See Figure 2.2 for a graphic representation of these variables as drivers of financial results.
Empirical research to date has, in fact, indicated that as much as 80% of gross margin and 55% of
EBIT (earnings before interest and taxes) is explained by the variables in the model. Additional
research has indicated that the pyramid has a statistically significant relationship to ROI (return
on investment).

38 Building Sustainably Successful Organizations®

Figure 2.2 Six Key Drivers of Financial Results

The Pyramid as a Lens to Build and Evaluate Organizations

The pyramid framework can be used as a template for planning to build an organization and as a
strategic lens through which to evaluate the strengths and limitations (or areas for improvement)
of an existing enterprise. As such, it becomes the guide for planning to build a new business or to
strengthen an existing business. This topic is addressed more fully in Chapter 6, which deals with
strategic planning and organizational development.

Although an organization should focus on the six levels in the pyramid, the emphasis on the
components or subsystems of the pyramid must be somewhat different at different stages of organi-
zational growth. Before we can explore this idea further, we must examine the different stages of
growth through which all organizations develop. This topic is the focus of Chapters 3 and 4. First,
however, we illustrate how the pyramid can be used to build and/or improve a successful enterprise
by describing the examples of Guangzhou Construction (the disguised name of an actual company)
and Starbucks Coffee Company. Guangzhou Construction is an example of how the pyramid can
be used to improve an enterprise, while Starbucks is an example of how it can be used to build a
successful or even a dominant company.

Improving Strategic Organizational Development at Guangzhou
Construction, China

Guangzhou Construction was established in 1983 in the city of Guangzhou, China. Guangzhou’s
services include general contracting, project management, design, permitting, construction, pro-
curement, decoration, final inspection, and acceptance. Guangzhou Construction is qualified as a
Class I Design Institute and Class I General Contractor (highest level of construction licenses)
to do a wide range of design and construction through three regional branch companies in South
China, East China, and North China. The company also provides complete design-and-build.

Improving Strategic Organizational Development at Guangzhou Construction, China 39

Table 2.5 Revenue and Employees at Guangzhou Construction

2006 2007 2008 2009

Revenue (in millions of RMB) 570 1080 960 880
Number of employees 290 442 442 470

Over a 30-year period, the company grew rapidly and successfully, providing services to over
220 major projects. The company’s revenue and employee growth from 2006 to 2009 is shown in
Table 2.5.11

Origins of the Organizational Development Initiative
In 2009,Guangzhou Construction’sCEO, 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 Sur-
vey” (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 mea-
sure 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.)

Table 2.6 Guangzhou Construction Organizational Effectiveness Survey Results 2009
versus 2010

Mean

Pyramid Level Plus Financial Results 2009 2010 Change (+, −, 0)

Markets 3.5 3.8 +
Products/Services 3.1 3.6 +
Resources 3.2 3.8 +
Operational Systems 3.2 3.8 +
Management Systems 3.3 3.8 +
Culture 3.5 3.8 +
Financial Results Management 3.3 4.0 +
Overall 3.3 3.8 +

40 Building Sustainably Successful Organizations®

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 Con-
struction’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, pas-
sion, 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 man-
agement 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

Successfully Building the Pyramid: The Example of Starbucks 41

score improved from 3.3 (indicating a marginally successful organization) to 3.8, which indicates a
sustainably successfulentity. 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

Successfully Building the Pyramid: The Example of Starbucks

Starbucks (formerly “Starbucks Coffee Company”) is one of the truly great entrepreneurial success
stories of the past few decades. The scope and speed of its success are reminiscent of Apple, Nike,
Microsoft, Amgen, and Google.

Starbucks is a classic example of an organization that has been very successful because it was
effective in building the entire Pyramid of Organizational Development at a relatively early stage of
development. It has achieved success as an organization through its development of the six key
tasks of organizational development, not only each task individually but the effective develop-
ment of the pyramid as a whole. This section will use the development of Starbucks to illustrate
the process of building a sustainably successful organization by using the pyramid as a template, as
described below.

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, sometimesthe 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

42 Building Sustainably Successful Organizations®

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
atmosphereand experienceof the Starbucksstore. The store itself was part of the productexperience
for the customer,not just the place where the productwas 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), tech-
nological, and human resources. As he stated: “We could not have gotten where we are today if we
had not had the commitmentto 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 sec-
ond edition of this book and invited Eric Flamholtz to visit Starbucks and assist the firm with its

Successfully Building the Pyramid: The Example of Starbucks 43

“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 develop-
ment 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 man-
agement 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 addi-
tion, 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.

44 Building Sustainably Successful Organizations®

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 Pyra-
mid of Organizational Development and not merely focus upon productsand markets. Prior to 1994,
the company had done an excellent job of developing five of the levels of the Pyramid of Organi-
zational 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 devel-
opment 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 bot-
tom 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

Notes 45

costs of store build-outsand operations,Boston Market never got the economicsof 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 dis-
appeared. In brief, Boston Market simply did not effectively execute all of the six required tasks of
organizational development and ultimately paid the price.

This discussionis not intended to imply that Starbucksneither made no mistakesnor 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.

Summary

This chapter has presented a framework or lens for understanding what makes an organization suc-
cessful, effective, and profitable. The foundation of this framework is the organization’s business
foundation—that defines the nature of its business, what it is working to achieve, and how it will
compete. Building upon this foundation, an organization must focus on six areas if it is to succeed
over the long term. These are: (1) markets, (2) products or services, (3) resources, (4) operational
systems, (5) management systems, and (6) corporate culture. For organizations to be successful, they
must first identify their business foundation. Then they must deal not only with each of these six
areas individually and in sequence but also with the six as parts of a whole. We use the image of a
Pyramid of Organizational Development to describe this holistic approach.

The chapter has also presented a tool for assessing the extent of strategic development of a com-
pany in terms of the pyramid. It has provided a data set for readers to assess their organization
vis-à-vis other companies in quantitative terms.

Starbucks Coffee Company (“Starbucks”) illustrates the power of developing a company in a way
that is consistent with the Pyramid of Organizational Development—that is, an organization that
is positioned to be sustainably successful. In the next chapter, we examine the different stages of
growth and the different emphasis on each part of the pyramid that is required at each stage for an
organization to be successful over the long term.

Notes

1. Michael Hiltzik, “A Chain that Lost Its Concept,” Los Angeles Times, December 3, 2014,
B1–2.

2. Eric G. Flamholtz, “Towards an Integrative Theory of Organizational Success and Failure:
Previous Research and Future Issues,” International Journal of Entrepreneurship Education 1,
no. 3 (2002–2003): 297–319.

46 Building Sustainably Successful Organizations®

3. Google website/Company Overview/ Our History in Depth, 2015. http://www.google.com/
about/company/.

4. Spencer Jakab, “Starbucks Still a Coffee Achiever,” Wall Street Journal, January 22, 2015, C1.
5. Eric Flamholtz and Yvonne Randle, Corporate Culture: The Ultimate Strategic Asset (Stanford,

CA: Stanford University Press, 2011).
6. Ibid.
7. Ibid.
8. For information about the Organizational Effectiveness Survey, see www.mgtsystems.com/

surveys.
9. At the time of publication of this book, the database consisted of almost 2,000 organizations.

10. Eric Flamholtz and Stanford Kurland, “Strategic Organizational Development, Infras-
tructure and Financial Performance: An Empirical Investigation,” International Journal of
Entrepreneurial Education 3, no. 2 (2005): 117–142.

11. The exchange rate between Chinese currency RMB (renminbi) and U.S. dollars is approxi-
mately 6.1 yuan (RMB) to $1.

12. Both surveys, developed by Eric Flamholtz, have been validated and have demonstrated pre-
dictive validity to financial performance.

13. Sidney Siegel, Nonparametric Statistics for the Behavioral Sciences (New York: McGraw-Hill,
1956), 68–83.

14. Howard Schultz and Dori Jones Yang, Pour Your Heart Into It: How Starbucks Built a Company
One Cup at a Time (New York: Hyperion, 1997), 140.

15. Ibid., 161, 201–202.
16. Howard Behar with Janet Goldstein, It’s Not About the Coffee: Leadership Principles from a Life

at Starbucks (New York: Portfolio, 2007).

http://www.google.com/about/company/

http://www.mgtsystems.com/surveys

C H A P T E R

Managing the Advanced Stages
of Growth

The previous chapter dealt with the issues encountered by growing entrepreneurial organiza-tions as they move through the first four stages of growth: from a new venture (Stage I) toconsolidation of an established business (Stage IV). If management has accomplished the
developmental tasks described, then on completing Stage IV, the enterprise will have become a
professionally managed organization. This chapter continues the discussion of the organizational
life cycle and presents a framework for identifying and managing the advanced stages of growth:
Stages V to VII.

Some businesses will have the opportunity to grow in size beyond Stage IV, and this growth will
present a new set of organizational development problems that are quite different from those during
Stages I through IV. This chapter is intended to assist the senior managers of such organizations
in planning for the future development of their enterprises by examining the stages of growth that
occur beyond Stage IV. It can also help senior managers of organizations that have already reached
those stages of growth and are either encountering certain developmental problems or wish to avoid
the classic problems at each stage.

We first describe the nature of each of the advanced stages of growth and then examine the key
problems and challenges that organizations must confront as they advance to each of them.

Nature of Problems beyond Stage IV

Prior to Stage V, the organization’s management problems all center around the issues of locating
an initial market, developing a product, and building the operational infrastructure, management
systems, and corporate culture needed to run a business that has reached approximately $100 to

72 Managing the Advanced Stages of Growth

$500 million in annual revenue (for manufacturing firms) or approximately one-third of this for
service firms. On reaching Stage V, the firm’s problems change in nature. The entity must now
reestablish itself as a different type of entrepreneurial company—one that is professionalized, but at
the same time is entrepreneurial and focused on finding new markets and/or developing and offering
new products or services to support its continued growth. Ideally, the business will have retained its
entrepreneurial orientation throughout Stages I through IV. In some cases, however, organizations
may have lost their entrepreneurial spirit to some degree and must now seek to reestablish it. Once
the challenge of developing new productsor services has been met, the organization must then focus
on developing an infrastructure capable of supporting the now-diversified company it has become.

For most organizations, growth beyond Stage IV will involve or require diversification. The core
business might reach limits in terms of available market share, or the core business might sim-
ply provide opportunities for expansion into new areas. For example, Starbucks has continued its
growth of retail cafés, but has also expanded into selling coffee in groceries, and creating joint ven-
tures to sell its café concept in different venues such as airports. It has also expanded into other
products like juices and bakery items (through, in some instances, purchasing existing companies).
Google has diversified into many different areas from its core business in search. The company now
offers software including Gmail, social networking, cloud storage, and even Google Glasses, an eye-
wear device for accessing the Internet. Microsoft has diversified from the Windows PC platform to
web-based services.

Growth beyond Stage IV

In this section, we describe, in depth, the stages of growth beyond Stage IV: Stages V, VI, and VII.
They represent the transitions that must be made by all entrepreneurially oriented, professionally
managed organizations if they are to continue growing successfully. The advanced stages of organi-
zational growth, the critical development areas for each stage, and the approximate size (measured
in dollars of sales revenue or budget for nonprofits) at which an organization should pass through
each stage are shown in Table 4.1.

Stage V: Diversification
After an organization has completed the consolidation stage, the next developmental challenge it
faces is to diversify. This can occur either because the organization’s product life cycle has reached
the mature part of the S-curve, or because the core product has simply created new opportunities.

Diversification Attributable to Product Maturation and Competition. If the company’s original
product or product line has become relatively mature and will not facilitate sufficient future growth
to sustain the organization at its current rate of growth, its historical rate of growth, or its immediate
future growth expectations, the solution is diversification. This problem is simply a result of the
phenomenon of market saturation.

When a business initially introduces a product as a new venture, the market is typically unsatu-
rated, and there is relatively little competition. As the organization becomes successful, it inevitably
attracts competitors. A classic example was Apple Computer and the development of the personal

Growth beyond Stage IV 73

Table 4.1 Advanced Stages of Organizational Growth

Approximate Organizational
Size (in Sales)

Stage Description Critical Development Area
Manufacturing
Firms

Service
Firms

V Diversification New products for existing market, new
markets for existing products, or both

$500 million
to $1 billion

$167 to
$333 million

VI Integration Integration of different business
units through developing a new
infrastructure to support them
(managing resources, developing
appropriate operational and
management systems, and creating a
culture consistent with the needs of
the “new company”)

$1 billion plus $333 million
plus

VII Decline and
Revitalization

Revitalization of organization
at all levels of the Pyramid of
Organizational Development

Varies Varies

computer. Apple Computer found and developed the market for the personal computer (they were
the first to offer a product that required little assembly) but attracted a host of competitors, includ-
ing IBM. The presence of competition decreases the firm’s profit margins and erodes its market share
over time. Similarly, Google developed Google Glass, and then Microsoft developed the HoloLens.

Sometimes a company can have the market or playing field to itself, with limited competition,for
a very long time. For example, Mattel dominated the market for dolls for young girls for many years
with its iconic doll, Barbie. Since 2001, MGA Entertainment has taken away a significant portion
of Mattel’s market share with its edgier, multiethnic Bratz dolls. Another example of how a company
can have the market to itself is in the biotechnology business. Companies such as Amgen or those
specializing in orphan drugs can patent their drugs (or molecules) and create a virtual monopoly
for the products, at least for a limited period of time. Amgen owns patents for its products such as
Epogen and Neupogen, and has an army of lawyers to protect its intellectual property. While the
patent remains valid, Amgen has a market protected from competition and can earn high profit
margins. The same is true for so-called orphan drugs, which are drugs that treat relatively rare but
serious diseases. Such diseases would not be profitable for investment and development by pharma-
ceutical companies if competition were permitted. Once a drug has been patented, it has special
status and is relatively protected.

As the market for the new product becomes increasingly saturated, the new venture’s rate
of growth cannot be sustained for its given product vehicle. A classic historical example of this

74 Managing the Advanced Stages of Growth

phenomenon was the highly successful dBASE II—one of the first software products for database
management, marketed by Ashton-Tate, a company that no longer exists. As the potential users
of dBASE II were reached, and as new competitors entered the marketplace, it was necessary for
Ashton-Tate to identify new products to continue its growth. Ultimately, the company was unsuc-
cessful in accomplishing this task and was, as a result, sold to Borland, which in turn was ultimately
purchased by another company. In contrast, Oracle Corporation, which is itself built on a platform
of database management software, has been able to deal successfully with the challenge of product
diversification through software applications to become a dominant multibillion-dollar company.

One way of thinking about the difference between the issues faced by a company during Stages
I through IV and the issues faced in Stage V is to consider the analogy of a product as an oil field.
The central problem in petroleum exploration is finding new oil fields. Once an organization has
found an oil field, it builds up an infrastructure to tap the oil well and convert it into marketable
products. As the size of the business increases, the firm has to build its business around that oil well.
The central issues here are developing the capability to tap the oil well and marketing its products.
From this standpoint, the oil well is essentially a resource that the firm is drawing on. However, this
resource has a finite life, which means it will not last forever—only until all of the oil has been
pumped out.

Most consumer and industrial markets are very much like oil wells, in that they will not last
forever. They may produce a gusher that leads to very rapid growth for an organization, but over
time the oil wells inevitably play themselves out. When a company builds up its organizational and
management infrastructure to tap an oil well, it usually does so with the intention of remaining a
going concern. This means that if the organization is to continue to exist, it must find other oil fields
that it can begin to extract resources from. Accordingly, if the company is to become more than
a one-time venture, it must use some of the resources earned from tapping the oil well to invest
in exploration of other oil fields. It should be hiring geologists to search for additional oil fields,
spending additional resources in drilling test wells, and so forth.

Companies in totally different businesses from petroleum explorationand refining will find it use-
ful to think of their businessin termsof the oil well analogy just described.A company’s entrepreneur
identifies a new market, which is analogous to a petroleum corporation finding an oil field. The
company develops a product that is accepted by consumers, which is, again, analogous to a firm
beginning to tap the oil in the field. The organization then builds up the operational manage-
ment infrastructure necessary to operate the day-to-day business, while simultaneously preparing
an infrastructure that is necessary to continue the operation after its first product has been used up.
Thus the challenge of Stage V is essentially long-run organizational sustainability. This is analo-
gous to finding another oil well. If the organization is prudent, it will not wait until its markets are
sufficiently dried up to begin locating new markets and building new products. Accordingly, it will
be engaged in a process of research and development designed to identify new oil fields and begin
their production while its current oil fields are still producing.

Typically, an organization can only expect that a given product vehicle will carry it to the range
of $100 to $500 million in annual revenue. As discussed previously, this is simply the normal curve
for this phenomenon, and certain companies may not experience the need for a new product vehicle
until significantly after $500 million in revenue is reached. A number of companies have reached

Growth beyond Stage IV 75

$1 billion in annual revenue before they experienced the need for a new product vehicle; however,
these are the exception rather than the general rule. The upper limit for growth through a single
product or line of business may be reached well before a company generates $500 million in annual
revenues. For example, Bell-Carter Foods—a family-owned business that is the largest producer of
table olives in the United States and the second-largest in the world—faced this problem at about
$100 million, because at that size they had captured about 80% of the market for their core product
(ripe black olives).

A variation on this problem was experienced by Amazon.com. The cost of developing the infras-
tructure to operate the business of selling books over the Internet was sufficiently great that the
company needed to diversify its product line. Today, Amazon sells a variety of products over the
Internet, including magazines, music, DVDs, videos, electronics, computers, software, apparel and
accessories, and shoes—as well as books.

If the diversification is attributable to a decline in growth, the transition to Stage V will require
a redeployment of entrepreneurial skills. The entrepreneurship that was the basis of founding the
business in Stage I must reemerge and become a dominant force in Stage V. Because the original
product vehicle was sufficient to carry the company along in its chosen market, the managerial
problems of Stages II through IV involved building the operational and management infrastructure
to support the growing organization. However, the need to diversify translates into the need to be
entrepreneurial again.

Unfortunately, it may not be possible for the company to simply go back to its original
entrepreneur and have that person repeat the entire process that began some time ago in Stage I.
In some cases, the entrepreneur is no longer with the organization and may be deceased. For
example, when The Walt Disney Company required revitalization and diversification, its founder
and namesake Walt Disney was deceased and so a new team of executives needed to lead this effort.

There are many examples in business where the original entrepreneur has not been available to
grow with the firm as it developed from one stage to the next. For example, Steve Jobs and Steve
Wozniak both left Apple Computer. Jobs returned in the late 1990s and, in fact, served as the cham-
pion of that company’s diversification through the development of its “i” line (iPod, iPad, etc.) of
products. Even if the entrepreneur is still with the company, a significant amount of time has usually
elapsed, as it has passed from Stage I through Stage IV, and at this point the entrepreneur is now bur-
dened by a significant number of organizationalactivities.This means that the entrepreneurmay not
have the time or mindset available for thinking entrepreneurially about new products and markets.

It is often, then, extremely difficult for entrepreneurs to repeat their earlier success. There are
many examples of companies where there was a brilliant entrepreneurial success but a failure to
repeat that success at any significant level. Accordingly, what is needed is to reestablish entrepre-
neurship in the organization, but it must be done in a different way. Rather than looking to a single
entrepreneur, organizations at Stage V must develop a cadre of so-called entrepreneurial managers.

An entrepreneurialmanager is different from a pure entrepreneur.Howard Schultz, the late Steve
Jobs, Jack Ma, and Michael Dell are relatively pure entrepreneurial types—very different from pro-
fessional managers. As described in Chapter 1, an entrepreneur is typically someone who is above
average in intelligence and has a very strong sense of the way he or she wants things to be done
in the organization—that is, has a high need for control. Some people might even consider the

http://Amazon.com

76 Managing the Advanced Stages of Growth

entrepreneur to be a workaholic or to have an obsessive personality. Nevertheless, these are the
very personality traits that are both necessary and useful to a company during its early stages of
growth. Although a Stage V organization needs to develop a cadre of entrepreneurial managers, it
is not necessary for these managers to have the same personality as an entrepreneur; rather, what
is necessary is to train the entrepreneurial manager to mimic or simulate some of the behavioral
patterns of the entrepreneur.

A number of organizations have experimented with the reintroduction of entrepreneurship and
the training of entrepreneurial managers. The term corporate entrepreneurship has been used to dis-
tinguish this process of reintroducing entrepreneurship through entrepreneurial managers from
the entrepreneurs required to start a new company. The entrepreneur is someone who can cre-
ate a new business where none existed previously. In contrast to the entrepreneur, the corporate
entrepreneurial manager is someone who can create a new business venture within an established
organization. The challenge, then, is to create development programs that will help people make
the transition to being entrepreneurial managers. Further, the company must develop systems and a
way of thinking (a culture) that supportscorporateentrepreneurship.3M is the classic company that
has demonstrated this as a core competency. This company’s focus on corporate entrepreneurship
has resulted in many innovative products—including Post-it, which has become a multimillion-
dollar business.

Diversification Attributable to New Opportunities. Diversification can also occur simply
because the core business creates opportunities for expansion in quasi-related areas. For example,
Tommy Bahama, a men’s clothing line, developed Tommy Bahama as a lifestyle brand. The iconic
advertising figure of Tommy Bahama and its South Seas image led other companies to seek license
relationships with Tommy Bahama and has led to Tommy Bahama stores that sell not just clothing
but watches, cologne, and related accessories. It also led to the development of a Tommy Bahama
restaurant chain and Tommy Bahama furniture.

Another example of diversification attributable to extension of an organization’s core capabili-
ties is Techmer PM (Techmer). Founded in 1981 by John Manuck, a chemical engineer who had
worked for Monsanto, Techmer PM provides design and technical support for colorants and vari-
ous additives that modify and enhance the physical and visual properties of plastic products that
are used by automotive, home furnishing, hospital supply, food packaging, construction, and many
other industries. By 2014, the company had grown to over 600 employees and had manufactur-
ing sites in California, Tennessee, Ohio, Illinois, Kansas, Georgia, and Pennsylvania, as well as a
presence in many international markets.

In 1982, Techmer PM began selling colorants to industrial trash bag producers. Manuck noticed
that while the trash bag makers normally purchased the cheapest colorants they could find, they
occasionally purchased red colorant at a much higher price. He learned that the red was for a new
market segment to indicate biohazard—the variation of shade was unimportant, as long as it was
red. The other important property was the high opacity of the bag so that you could not see the
physical contents. With a flash of brilliant insight, Manuck had the idea of developing a specially
formulated red colorant by adding a low-cost iron oxide pigment to the usual red formula that
dramatically increased the opacity while lowering the cost. The only negative was that the bright

Growth beyond Stage IV 77

red color became a dull red color. When the customer pointed out the change in color, he was
asked if he would be interested in trying a test run using 20% less of the colorant to achieve his
desired opacity while paying the same price per pound that he had been paying for his previous red.
It became an instant success and quickly became known as Techmer hospital red.

There is also a more recent example of diversification at Techmer PM. In 2014, Techmer became
involved with the new technology of 3D printing because this manufacturingprocess utilizes specific
polymer properties. Also, it is an example of innovation via collaboration. Techmer’s largest facility
is located in Tennessee and is about 20 miles from the Oak Ridge National Laboratory (ORNL).
In early 2014, Techmer and ORNL began working together to produce parts using Big Area Addi-
tive Manufacturing (BAMM), large parts that are 3D printed. In December 2014, they produced a
3D-printed electric motor version of the 50th anniversary Shelby Cobra. The thermoplastic/carbon
fiber composite used for the chassis was designed and produced by Techmer. This innovation was
viewed as sufficiently important that it led to a visit by President Obama to the Techmer plant in
Clinton, Tennessee, one month later.

Another example of diversification concerns the authors’ own firm, Management Systems
Consulting Corporation (Management Systems). Founded in 1978 by Eric Flamholtz to assist orga-
nizations in applying the methods and tools presented in this book, Management Systems engages
in research to develop methods and tools to help build sustainably successful organizations®. Our
clients have ranged from start-ups to members of the Fortune 500—including Amgen, American
Century Investments, Baskin-Robbins, City National Bank, Guggenheim Partners, The Disney
Store, IBM, Kusto Group (Kazakhstan and Singapore), Li-Ning (China), Navistar, Neutrogena,
99 Cents Only Stores, Mövenpick Gastronomy International (Switzerland), PIMCO, PowerBar,
Princess Cruises, Simon Property Group, Starbucks, Techcombank (Vietnam), The Riverside
Group (China), Westfield, Wolfgang Puck Food Company, and many others.

For many years, Management Systems received inquiries from consultants around the world who
were interested in becoming affiliated with the firm and in licensing its methodology and tools to
apply them in their own countries. Finally, in 2011, at the request of Vladimir Kuryakov, associate
professor at the Russian Presidential Academy of National Economy and Public Administration,
our firm initiated a program to license, train, and certify affiliates to deliver our methodology and
tools in their countries.

By 2015, Management Systems had licensed and certified affiliates in Argentina, Bulgaria, Italy,
Israel, Kazakhstan, Poland, Russia, and the Ukraine as well as in the United States, and Canada. In
addition, the firm had associates who represented it in Australia, China, Hong Kong, and Vietnam.

Management Systems’ global affiliates business was a diversification from its core business of
researching and developing methodologies and tools to deliver directly to companies to enhance
their effectiveness. By 2014, approximately 50% of Management Systems’ revenues were derived
directly from royalties paid by affiliates for its intellectual property and/or indirectly from client
referrals created by its affiliates business.

Failure to Achieve Diversification. When an organization fails to diversify successfully, the
result can be stagnation, sale of the company, or even bankruptcy. Even companies with well-
established iconic brands can ultimately suffer or meet their demise. A classic example is Cuisinart.

78 Managing the Advanced Stages of Growth

Cuisinart was an upscale brand well-known for its food processors that were highly popular in the
1970s. Yet, the company filed for bankruptcy under Chapter 11 of the federal Bankruptcy Code in
1989. The food-processing business had become saturated, and though the company still controlled
about 45% of the food-processing market, it experienced difficulties.

Cuisinart had not done effective strategic planning and failed to capitalize on its famous
name. By the time it filed for Chapter 11, the company had only recently begun branching out
to items such as cooking utensils, hand blenders, and other cooking products. Cuisinart had
defined its business as the “food-processing business,” rather than more broadly, and unfortunately
its traditional market dried up before it found a new one. It should be noted that Cuisinart was
purchased by Conair Corporation in 1989, rebuilt its brand and business, and became a company
offering what it refers to as “culinary tools,” including bakeware, coffee makers, microwaves, and,
of course, food processors.

Two other companies that had iconic brands but suffered due to lack of diversification were
Smith Corona and Schwinn. A leading maker of typewriters, Smith Corona filed for bankruptcy,
in part, because the market for typewriters disappeared. Typewriters had been replaced by personal
computers, and the company had not effectively responded with new products to meet changing
customer needs. This company no longer exists. Schwinn, once a leading brand of bicycles, failed
to recognize the changing needs and preferences of potential customers. The type of cycle that
had become popular was quite different from those offered by Schwinn, and the company filed for
bankruptcy in the early 1990s and was purchased by another company.

Starbucks Illustrates Successful Diversification. One spectacular example of a company that
has taken both internal and external routes to achieve successful diversification is Starbucks. The
company has diversified from its original core product (coffee) with the addition of other bever-
ages and products sold within its cafés/stores. It has also leveraged the Starbucks brand with other
products such as ice cream (a joint venture with Dreyer’s) and has made acquisitions in the United
States and Europe. Starbucks had the infrastructure to do this. Even though Starbucks seems to
have saturated the U.S. market for cafés, growth in stores continues with its expansion into teas,
juices, and food.

Apple Illustrates Successful Diversification. Apple illustrates that successful diversification can
occur in technology as well as in more basic products like coffee and restaurants. With one of its
founders, Steve Jobs, serving as CEO and champion of new products, Apple diversified from its
early dependence on computers with the development of the iPod and then the iPhone. The “i”
products have been spectacularly successful and have led Apple to become an iconic company with
a loyal following. Its products have achieved what some manufacturersdream of—becoming “cool.”
Among its constituency, the use of an Apple product conveys prestige on its user and marks the user
as a member of what can be termed Apple Nation©.

Apple has continued its diversification development with the Apple Watch and Apple Pay.
Apple was not the first to try to enter the mobile payments industry with their Apple Pay services;
however, they were the first to successfully reach mass adoption. Within the first three days of its
launch, Apple Pay had already become the largest mobile payment system with more than 1 million
credit cards registered.1 The success of Apple Pay is largely due to Apple’s leveraging its mobile
hardware, dominant position, and clout in the mobile phone market, and (rather than trying to

Growth beyond Stage IV 79

challenge them) partnering with the major credit card companies (American Express, MasterCard,
Visa) and several of the large banks.2

The Apple Watch was introduced at the same time as the Apple Pay system. The Apple Watch
was designed to integrate with many of Apple’s other productsand services. It provides functionality
beyond telling time, including fitness tracking, mobile alerts, handling messages and calls, providing
directions, and running third-party apps. The majority of the watch’s functionality is dependent on
the iPhone, and each is intended to be integrated with the other.

Keys to Success at Stage V. The central problem of Stage V is to diversify the business so that it is
no longer dependent on its initial product vehicle or the initial market. The key to success in Stage
V is to identify and produce one or more new products(or services) and/or to identify and effectively
enter one or more new markets. This might involve diversifying outside of the organization’s initial
business segment. The company may be developing multiple businesses (typically, but not always
through the creation of new divisions). Thus Stage V is a time when the business should be making
two transitions: (1) from one product, service, and/or market to multiple products, services, and/or
markets; and (2) from a single business to a set of businesses. This can be accomplished through
internal development of new products, identification of new markets, or acquisition of other orga-
nizations. This is not a trivial challenge, and many companies fail to achieve it. However, once
Stage V has been successfully completed, the next challenge is to effectively integrate these new
businesses, which is the focus of stage VI.

Stage VI: Integration
In the process of making the transition to Stage V, an organization sets in motion the forces that
require it to move to Stage VI—the stage of integration. During Stage V, the entity will have
made the transition from a single product line (or service line) company to a multiproduct (or
multiservice) company, and/or it will be operating in very different markets. This means that by
the time the organization completes the diversification process begun in Stage V, it will consist of
a number of individual business entities. As a result, it will need to develop an infrastructure that
will support managing each of these individual units as part of an integrated whole.

Developing an infrastructureto support this new business becomes the key challenge of Stage VI.
The organization now needs to focus on ensuring that it has the appropriate resources, operational
systems, management systems, and corporate culture to support the now very different company
that it has become. A new kind of operational and management infrastructure must be created
and implemented. These new systems at the corporate level must be designed to manage a set of
businesses, rather than just one business.

Issues to be Resolved in the Integration Stage. Several different but related issues must be
addressed during this stage of organizational growth. One issue involves the process of strategic
planning, both at the corporate level and within each division, and the problems involved with
integrating both. There are also issues involving the proper organizational structure of each division
and of the company as a whole. By the time an organization completes Stage V, for example, it will
most likely be (or need to be) organized into divisions (that is, it will be “divisionalized”) and this
brings the need to clearly define the role of “corporate” versus the roles of each division. There are
also issues related to how performance management systems should be designed and implemented

80 Managing the Advanced Stages of Growth

within the now larger, diversified business. The organization needs to focus on ensuring that the
operational systems at both the corporate and divisional levels of the company promote effective
and efficient operations.

Another issue involves questions of managing the corporate culture. Specifically, each of the
separate divisions within a company may have somewhat varying cultures. The systems and culture
of each division may need to be, in some cases, blended so as to promote the cooperation needed
to achieve goals; in other cases, the company needs to promote the belief that differences in sys-
tems and culture between divisions will be maintained in the service of meeting the organization’s
long-term goals. A key challenge at this stage, then, involves deciding how best to integrate the
systems and corporate culture of the various units created in Stage V.

A critical issue underlying the design of the management system for a Stage VI organization
involves the degree of centralization or decentralization of authority accorded to each division.
Companies vary widely in the amount of decentralization that they grant to their operating divi-
sions. This issue can be viewed as points on a continuum. At one end of the continuum are firms
that attempt to control virtually everything their operating divisions do. At the other end of the
continuum, a corporation essentially operates as a passive investor with a “portfolio” containing
various companies. The strategy here is to defer strategic decisions and daily operations to the divi-
sional general managers, while requiring a specified performance in terms of return on investment
or amount of profit. In between are companies that strike a balance between controlling everything
and being a passive investor. This type of managerial philosophy has been used for many years at
Johnson & Johnson.

For example, at Johnson & Johnson, divisions may be required to achieve a 15% pretax return
on investment. The methods of achieving this target return are left to divisional managers. The
corporation also requires that various management systems be in place, such as a planning pro-
cess. In addition, Johnson & Johnson has used its Signature of Quality Award process to motivate
the development of operational and management systems at its individual companies. Companies
must apply for the Signature of Quality Award, and they are evaluated on, for example, business
competitiveness, organizational alignment, and information competitiveness. The specific details
of these categories are less significant than the process that Johnson & Johnson is using to motivate
operating divisions to develop their infrastructure.

The phenomenon of having a number of businesses within a larger entity is not only found in
large, established companies such as Starbucks, Johnson & Johnson, Procter & Gamble (which
now owns Gillette), GE, Citicorp, IBM, Apple, and Microsoft; it also exists in many smaller
organizations. For example, Infotek—a rapidly growing Stage III company, with $40 million in
revenues—had three independent divisions. Similarly, Starbucks had four divisions when it had
approximately $350 million in sales.

Special Issues in Integration of Acquisitions. Another version of the need for integration of
different businesses arises from the acquisition of other companies. In fact, some organizations
use acquisitions as their main vehicle of growth. For example, Emergent BioSolutions—a pub-
licly traded biopharmaceutical company focused on developing, manufacturing, and commercial-
izing vaccines and therapeutics that assist the body’s immune system in preventing or treating
disease—regularly acquires smaller biotech companies as part of its overall growth strategy.

Growth beyond Stage IV 81

When an organization grows by acquiring other companies, it faces the need to integrate. There
are many examples of failed or disappointing acquisitions attributable to the failure of effective
integration. The typical cause of this integration failure is incompatible cultures.

There are, however, some companies (such as Johnson & Johnson) that have developed a core
competency in the successful integration of acquisitions. Johnson & Johnson (J&J) has had a long
history of successful acquisitions that includes companies such as Alza (drug delivery products),
Centocor (biotechnology), LifeScan (diabetic monitoring equipment), Neutrogena (personal care
and cosmetics), and Scios (biotechnology). For example, when Johnson & Johnson acquired Neu-
trogena, it put a J&J person in place to manage the acquisition. The person who became CEO of
Neutrogena was told (in effect), “We put a lot of chips on the table. Don’t screw it up.”

As illustrated in this brief example, a key to Johnson & Johnson’s success is that they acquire
companies that generally fit their culture and gently bring them into the “J&J way” of doing things.
This has contributed not only to successful growth and integration of companies but has led to the
consistent recognition of Johnson & Johnson as one of the most admired companies.3

When acquisitions are used as all or part of the process of diversifying the business, it might also
be the case that certain corporate-wide systems will need to be adjusted to meet the needs of a new
division while at the same time maintaining control. In one $100 million division of a Fortune 500
company, for example, problems were created because the corporate parent mandated that certain
operating systems would be used that did not adequately meet the needs of the smaller firm. Further,
the parent company’s culture promoted cautiousness,while the subsidiary needed to respond quickly
to take advantage of market opportunities.Finally, the compensation system of the parent could not
reward behavior that contributed to business development; it was structured to maintain the status
quo. Without careful management and negotiation with the parent organization, such practices can
adversely affect a division or subsidiary’s ability to succeed.

Overall Aspects of Integration. Problems faced by organizations in Stage VI are, to a great
extent, a function of organizational size, complexity, and geographical dispersion. The greater the
revenues (and, in turn, personnel and transactions), the greater the degree of geographical dis-
persion, and the greater the degree of business variety, the greater the problems of organizational
integration are likely to be.

There is a considerable payoff for successfully meeting the challenges associated with this stage.
Once an organization has completed this stage of development, it will typically have achieved more
than $1 billion in revenue. Our research data (discussed in Chapter 5) suggest that the probability of
continuing to operate successfully after an organization has reached $1 billion or more in revenues is
enhanced. Although some organizations experience difficulty and even fail, organizations are more
likely to continue to grow successfully after completing Stage VI. At that point, they have become
“institutions,” with a variety of self-perpetuating capabilities.

Companies that have been successful as institutions of this kind are Starbucks, GE, Nestlé, Proc-
ter & Gamble, and Johnson & Johnson. All are companies with self-perpetuating capabilities.

Keys to Success at Stage VI. The central problem facing corporations in Stage VI is how to inte-
grate a set of diverse divisions into one unified business entity. Successfully meeting the challenges
of this stage involves integrating the operations of the new businesses created or acquired during
Stage V, while maintaining the organization’s entrepreneurial spirit.

82 Managing the Advanced Stages of Growth

During the integration stage, the company has a simultaneous need to have some degree of cen-
tralized control over the diverse operating units and to allow divisional managers sufficient freedom
to be entrepreneurial in managing their operations. Many companies do not do a good job of strik-
ing this delicate balance and lean too heavily toward organizational control. The price is a loss
of entrepreneurial instinct and culture, and the creation of institutional bureaucracy that is more
concerned with form than with substance.

Stage VII: Decline and Revitalization
The final stage in the organizational life cycle is Stage VII—Decline and Revitalization. The key
issue facing management at Stage VII involves revitalization of the entire organization.

In contrast to most of the other stages, which constitute a sequential hierarchy as an organization
grows in size, an organization can jump to Stage VII from almost any other stage. Although it
is typically the larger organizations that are most in need of revitalization, there are examples of
organizations at $30 million, $50 million, and $100 million that have reached Stage VII and are in
need of revitalization. By the time a company has reached the multibillion-dollar level, however, it
is sure to have the seeds of future potential decline within, even though it appears to outsiders to
be at the apex of its success and power.

The stage of organizational decline and revitalization seems to be inevitable. All organizations,
regardless of their greatness or past success, inevitably experience a period of decline. In the
late nineteenth century, the railroads were the dominant enterprises, but they failed to use their
resources to move into other aspects of transportation. In the early part of the last century, United
States Steel Corporation was the hallmark of the U.S. economy, but it did not retain that position.
In the 1950s, General Motors was at its apex, yet it, too, experienced decline. Other once-great
corporations that have experienced organizational decline include IBM, AT&T, Sears, Kodak,
National Lead, International Harvester, Xerox, Levi Strauss, and Ford.

This phenomenon occurs not only in the United States but in other parts of the world as
well. Examples of once-great companies in other parts of the world experiencing decline include
Reuters, Allied Domecq, Toyota, and Mövenpick. For some, decline led the company to the brink
of bankruptcy; for others, it merely led to stunted growth; for still others, it led to their demise.

Causes of Organizational Decline. The problems that lead to decline and the need for organi-
zational revitalization are frequently caused by an organization’s own success. With organizational
success comes an increase in the organization’s size. Increases in an organization’s size seem to create
a certain degree of resistance to change. This can result from the vested interests of people who con-
trol the organization, or it can be that the organization’s size has made it very ponderous, creating
lengthy delays between the time the organization identifies a trend or problem and the time it takes
action. For example, Kodak, which has a distinguished history as a successful company, missed major
new markets (such as instant photography, videotape recorders, and digital photography) because
its size, structure, and culture all made it move too slowly. It eventually went into bankruptcy and
sold off its patents to a group of companies that included Apple, Facebook, Microsoft, and Amazon.

Organizational size does not seem to protect against decline; indeed, size itself may be one of the
major factors creating the need for revitalization. A wide variety of organizations, including Ameri-
can Express, Hewlett-Packard, General Motors, and Sears have all faced the need for organizational

Growth beyond Stage IV 83

revitalization, despite their many billions of dollars in assets and revenues. Even such an outstanding
organization as IBM has faced the need for a revitalization effort.

Organizational decline is typically a product of many complex factors. Historically, some of
the most common factors include increasing competition in a business’s markets, loss of com-
petitive skills from an erosion of leadership, a sense of complacency that inhibits organizational
change, and, as described throughout this book, the inability of management to build an organiza-
tional infrastructure sufficient to keep pace with the demands of organizational growth. In addition
to these classic forces of decline, there is also the risk of a “disruptive” new technology, such as
the Internet.

Sudden Decline from Disruptive Technology. The development of the Internet and the related
businesses that utilize the platform has caused many companies to experience decline. This can be
thought of as a “sudden decline syndrome.”

Amazon has taken market share away from traditional retailers in many spaces. For example,
Amazon’s sale of books has led to disruptive change and decline for traditional book sellers such
as Barnes & Noble and Borders (a company that actually went into bankruptcy and closed its last
store in 2011). Similarly, Netflix and others have leveraged the Internet to do video streaming for
at-home movie viewing. This, in turn, led to the loss of visits to movie houses, and the closure of
many. It has also led some movie chains to reconceptualize their business as more than movies.
Some chains such as Landmark Theatres have created a broader “entertainment experience” by
using sofas and providing alcoholic beverages and light meals at the seat.

The phenomenon of a disruptive new technology is not new. It is an essential feature of busi-
ness. In the nineteenth century, the development of electricity disrupted the dominance of artificial
lighting via kerosene. It led to a business war between J. P. Morgan, who sponsored the research
and development of Edison, and John D. Rockefeller, who was the entrenched dominant player
with kerosene.

Decline from Market Saturation. The most common causes of decline—competition and the
related phenomenon of market saturation—tend to increase throughoutan organization’s life cycle.
During the early stages of growth after a new market has been identified, an organization typically
grows and prospers, simply as a “reward” for having found the market for that product or service. For
example, Apple found the market for personal computers and grew to approximately $1 billion in
annual revenues. During this period, IBM—potentially a major competitorfor Apple—kept telling
its customers that there was no need for personal computers. Once the market was developed to the
point where it was large enough to attract IBM’s interest, IBM brought out its own version of a
personal computer and took 30 to 35% of the total market, squeezing Apple’s sales and profitabil-
ity. Further, the IBM operating system became the industry standard and put additional pressure
on Apple. Eventually, a number of other companies entered the market with IBM-compatible PCs.
When Apple had the market virtually to itself, it earned premium profitability. Once competition
increased, Apple no longer had the profit cushion that would mask its underlying organizational
problems. While IBM was highly successful with its PCs, competition from Dell Computer ulti-
mately reduced their market share and led them to sell their PC business to Lenovo in 2005.

Decline from Leadership Erosion. Unfortunately, the longer organizations exist and the larger
they grow in size, the greater the likelihood that they will outgrow their founder’s capabilities.

84 Managing the Advanced Stages of Growth

Sometimes, this occurs because there has been inadequate focus on leadership development. In
other cases, it might be that the company has simply increased in size at such a rapid pace that
there hasn’t been time to develop the needed skills. Leadership erosion can also occur when strong
and capable leaders retire and need to be replaced. Phil Knight has retired from Nike, Bill Gates
has retired from Microsoft, and Sam Walton is deceased and long gone from Walmart. When strong
leaders like these are presentand have guided their companiesfor a numberof years,the organization
will face the challenge of replacing them.

Decline from Dysfunctional Culture. Still another contributing cause of organizational decline
is a cultural problem—an increasing sense of complacency. When an organization is successful,
people reasonably expect to be rewarded. Sometimes the rewards are too great for the organization
to sustain. Moreover, the very fact that success has persisted over time may lead people to come to
expect rewards as an entitlement. This form of managerial hubris can create a self-congratulatory
atmosphere that produces a resistance to change and ultimately leads to decline. In many firms, this
is reflected in a lack of concern about whether or not there are new products in the pipeline. It
may also be reflected in an attitude of, “We know best what the customer wants,” without actually
listening to customers. Further, and perhaps more dangerous, is the feeling that the company is
somehow invincible. This attitude can be disastrous when a firm competes in markets where others
have systems in place to both monitor and respond to customer needs. In one $150 million firm, for
example, the belief was, “We found the market and we produce the best product. No one can catch
us.” As the firm basked in the glory of its own success, it watched as competitors slowly took away
a significant percentage of its market share.

Decline from Inadequate Infrastructure. A final, major contributing factor to organizational
decline is the inability of management to develop an organizational infrastructure sufficient for
the organization’s stage of growth. This problem will be one of the key themes throughout this
book. Indeed, the problem is the crucial issue of Stages II through IV, and when management is
unsuccessful in meeting these developmental challenges, organizational decline is inevitable.

The Challenge of Revitalization

An organization in decline must rebuild itself almost from the ground up. This, in turn, requires
that the enterprise become entrepreneurial in nature once again. It also can require a company
to reconceptualize its business. An example of a company that was able to successfully revitalize
by conceptualizing its business is Barnes & Noble. After suffering lost sales to Amazon, Barnes &
Noble has diversified from the sale of only books with the creation of Nook (an e-book reader) as
well as the sale of toys and games and music. In brief, it has reconceptualized its business. In contrast,
Borders, which like Barnes & Noble was also in the book business, went into bankruptcy and no
longer exists.

Some organizations try to achieve revitalization by acquiring other companies that are more
entrepreneurial than the purchaser. For example, in a bid to revitalize, Bank of America bought
Charles Schwab & Company but later sold the company back to Schwab, who has continued to

The Challenge of Revitalization 85

build it into a brokerage powerhouse. The attempt to “buy” entrepreneurship is unlikely to succeed
in most companies. A total revitalization, including a major cultural transformation, is likely to be
the only effective strategy.

Companies such as American Express, The Walt Disney Company, Hewlett-Packard, Simon
Property Group, and IBM are all examples of successful revitalization efforts. For example, during
the 1990s, IBM, a pioneer and leader of computing, transformed from a company where hardware
was the core to a company emphasizing a collection of services and software. In 2015, under the
leadership of CEO Virginia Rometty, the company that once thought of itself as a “big iron” business
because of its mainframe computers, has been transforming again. The company jettisoned its PC
and server operations (once high-margin businesses that had become commodities) to focus on
cloud services, analytics technology (so-called Big Data), and mobile devices. The company also
paid Global Foundries to take over IBM’s semiconductor manufacturing business.4

It is becoming increasingly recognized that beyond a certain point, size may not be a strate-
gic advantage. For example, one company founder and CEO stated: “I would rather see our
billion-dollar company .. . be ten $100 million companies, all strong, growing healthy, and aggres-
sive as hell. The alternative is an aging billion-dollar company that spends more time defending its
turf than growing.”

The Process of Revitalization
Although there are a number of issues involved in any case of organizational decline and revitaliza-
tion, the basic problem that makes revitalization so difficult is that an organization at this stage must
focus on all six of the key organizational development areas at the same time and may also need
to focus on changing its business foundation. The organization must now simultaneously rethink
“who it is,” what it should be working to achieve, how it should be competing, its markets, its prod-
ucts and services, its resources, its operational systems, its management systems, and its corporate
culture. Although organizations at every stage must give some attention to all six levels in the Pyra-
mid of Organizational Development, at Stage VII, it is critical that an organization simultaneously
concentrate on all six areas plus the business foundation, and this makes revitalization complicated
and challenging. Each aspect of the revitalization process (beginning with the business foundation)
is examined next.

Revitalizing the Business Foundation. To exit decline and revitalize, some organizations
may need to broaden, narrow, or completely change their business concepts. For example,
Hewlett-Packard, which was originally in the test and measurement equipment business, is now
in the business of providing personal computers, printers, enterprise server and storage technology,
software, and a wide range of related products and services to individual and enterprise customers
worldwide. If the business concept is changed, the strategic mission will also change because now
the company will be focused on either a broader or more narrow segment of a market or will be
operating in, perhaps, a completely new market. In most cases, however, the strategic mission will
be focused upon “getting our house in order” and getting back to profitability. The core strategy—or
overall way that the company competes—will also need to be examined and may need to be
redefined to reflect the organization’s current status, including the environment in which it is

86 Managing the Advanced Stages of Growth

competing and its internal capabilities. We will explain these concepts further and describe how
to develop them in Chapter 6. The bottom line is that for the organization to survive, it needs to
be willing the change the very basics of how it operates and what it is in the business to do.

Two examples of successful revitalizations that involved a change in business concept were
Disney and Nike. Under Michael Eisner’s leadership, Disney revitalized from a distressed family-
oriented motion picture and theme park company into a global entertainment powerhouse
(a change in business concept). Similarly, Nike broadened its focus from athletic shoes to athletic
wear and built a so-called power brand or “super” brand. Both companies did this as part of
revitalization efforts.

There are also examples of companies who were unable to exit decline because they were unable
to effectively create a solid business foundation. For example, the unsuccessful revitalizations of
Radio Shack, Sears, and Kodak can all be traced to a problem in the business foundation, and
in particular the business concept.5 None of these companies were able to redefine their business
concepts in a workable way. This in turn had an impact on what they could be expected to achieve
(the strategic mission)—particularly in the competitive markets that each faced. If the foundation
of a building or a business is weak, then the structure built on top of it will also be weak or crumble.
That is what happened in all three cases.

Revitalizing Markets. Once the business foundation has been reconceptualized, if it is necessary
to do so, the next task is to revitalize markets. This involves finding ways to more effectively meet
customer needs within the traditional market or identifying new markets to serve. During Stage I,
a business is able to establish itself because it has been successful in identifying a single market. In
Stage V, diversification efforts lead to the development of new markets. One of the fundamental
reasons a Stage VII company experiences difficulty is that the organization’s size has gotten out
of sync with its ability to derive revenue from its traditional (or existing) market segments. The
organization is now typically operating in one or more mature markets, meaning that the rate of
growth in these markets is decreasing, with profit margins being squeezed. The business is trapped
in a scissors effect, facing decreasing revenues from its markets on the one hand and rising operating
costs caused by its increasing size and related inefficiencies on the other. With both blades of the
scissors simultaneously closing in on the organization, management is busy doing its best to hold
them apart.

The primary task now facing management is to identify markets that offer the mostpotential—in
terms of growth rates and profit margins. IBM achieved this by changing its business concept from a
manufacturing company providing computer equipment to an information solutions company, with
a heavy emphasis upon information technology–related services.

Revitalizing Products/Services. Organizations in decline may need to significantly refine or
update existing products and services or develop new ones. A company that is in decline and needs
to be revitalized may have a product or set of products that have reached the mature stage. It might
also be the case that the products and services being offered have become or are becoming obsolete
due to new technology or new products being introduced by competitors. The critical problem in
this situation is that the moment a company becomes aware that its products are no longer com-
petitive in the marketplace, it has already lost a sufficient amount of lead time needed to react.

The Challenge of Revitalization 87

Thus the organization is forced into a crisis. At a time when it needs additional revenues to invest
in new directions, it finds that its revenues are declining for competitive reasons.

Revitalizing Resources. One of the relative advantages of established organizations is that they
should have had the opportunity to accumulate resources over a period of time. At the same time,
however, as an organization enters decline, these resources can dwindle very rapidly. The chal-
lenge for an organization in decline is to find the resources needed—including time—to invest in
revitalization. At a minimum, senior leadership needs to find the time to devote to developing a
revitalization plan. Resources might also need to be invested in product research and development,
new technology, and, perhaps, new people.

A company facing revitalization may have a significant amount of resources at its disposal, but
some of these resources will be redundant or obsolete. In brief, they may not be the type of resources
that the company needs to support its exit from the decline stage. Some of its inventory, its plant
and equipment, and even its people will not be appropriate for the new challenges it faces. The
company may also find itself with the need to redeploy some of its assets from one market segment
to another. At this stage, the company may need to make major investments to revitalize the organi-
zation, and unfortunately it may encounter internal resistance to investing in the resources needed
to revitalize itself. While it is important to exercise care in making investments at a time when the
company may be losing money or, at a minimum, experiencing significant challenges in continuing
to successfully grow, these investments in people, technology, equipment, and so on, will be critical
to the organization’s very survival.

Revitalizing Operational Systems. Organizations in decline frequently have well-established
operational systems—which can be both a blessing and a burden. It is a blessing because the com-
pany has systems in place. The problem is that they may not be effectively designed to meet the
organization’s current needs, and they may not be as efficient as they need to be. During revitaliza-
tion, the leadership team may find that one or more of the company’s operational systems simply
“don’t work” anymore, or have become obsolete. In these cases, the company may literally need to
abandon some of its traditional systems and invest in implementing new ones. The time needed to
replace old with new systems can also create problems as people learn how to use them and as they
are debugged. In the shorter term, this might add to the company’s already significant problems.

An effective strategy for identifying the steps that need to be taken to improve a company’s
operational systems in the context of a revitalization is to complete an assessment of the current
systems’ effectiveness. This assessment can be conducted by external consultants, by convening an
internal task force, or a combination of both. If an internal task force is used, care must be taken
to prevent members from protecting their vested interests in preserving certain systems, which may
be beneficial to those members but hurt the overall organization.

A traditional area for operational system problems involves product development. Organizations
needing revitalization frequently possess a functional organization structure in which the responsi-
bility for product development is divided among production, sales, and engineering. This structure
tends to create a very lengthy product development cycle. The revitalization period requires a unity
of purpose within the organization. Accordingly, new products need to be developed with central-
ized coordination of engineering, manufacturing, and sales. The structure most appropriate for this

88 Managing the Advanced Stages of Growth

is a divisional structure. In our judgment, it is not an accident that many of the revitalization efforts
occur in organizations that have been using functional organizational structures.

Revitalizing Management Systems. Companies in decline may need to revise or completely
change their planning systems, their structure,their performance management systems, and the pro-
cesses that they use to develop management capabilities.These companiesmay have well-developed
planning systems, but these systems may not be designed to focus leadership on managing all six fac-
tors that drive long-term success. In fact, the reason that the organization entered decline may be
because its planning system is flawed. This might have led to the company “missing” or ignoring key
environmental trends that contributed to their own products’ obsolescence, to a lack of focus on
developing important operational systems, and to ineffective management of the company’s culture.
An ineffective planning process can also contribute to poor decision making and poor execution
of key goals—which in turn can lead a company into decline. During revitalization, the existing
planning process may need to be refined or completely replaced. Chapter 6 describes an approach
to planning that can be used to both minimize the probability of decline and assist an organization
in decline in identifying and effectively managing the key factors that will lead to revitalization.

The company’s structure may also be contributing to its decline and may therefore need to be
revised. The leadership team needs to assess the extent to which the structure—including func-
tional and individual roles and responsibilities—is aligned with the current strategy (which may
need to change to supportthe company’s revitalization).When there is a lack of alignment, the lead-
ership team should develop a plan for changing the structure to better support the organization’s
revitalization and continued success. The process for managing structure is described in Chapter 7.

Inadequate management and leadership development (including both how the company has
recruited management talent from the outside and how it has been developed within) may have
been a contributing factor to decline. Simply stated, there are not enough “good managers.” When
this is the case, there needs to be a focus on acquiring or developing the appropriate management
skills to take the business into the future. In other cases, it may be that there are not enough
entrepreneurial managers who can help identify and implement new products or services and new
ways of doing things—skills that are absolutely critical to an organization that is in need of revital-
ization. When either of these situations exists, there needs to be a focus on designing and delivering
a leadership development program to “close the gaps” and position the company to exit the decline
stage. Strategies for designing and implementing effective leadership development programs will be
discussed in Chapter 9.

Underdeveloped or flawed performance management systems can significantly contribute to an
organization’s decline. Specific problems that can contribute to decline include having systems that
measure the “wrong things,” inadequate or inaccurate reporting of results, underutilization of mea-
surement results, and lack of action being taken when results suggest that adequate progress is not
being made. Developing or refining performance management systems should be a priority because
these systemswill providethe information needed to help assesswhether the plans being put in place
are, in fact, helping move the company out of the decline stage. The design and implementation of
effective performance management systems will be discussed in Chapter 8.

One of the critical factors in any revitalization effort is, of course, leadership. If existing man-
agement is unable to mount a successful turnaround, companies are likely to seek new leadership.

The Challenge of Revitalization 89

For example, Louis Gerstner was recruited from outside to IBM to lead the revitalization process
after an earlier effort led by an insider had failed.6 Similarly, first Carly Fiorina and later Mark Hurd
were recruited by Hewlett-Packard to lead a revitalization process after an initial effort led by com-
pany insiders was unsuccessful. Fiorina was responsible for Hewlett-Packard’s merger with Compaq,
but she was replaced by Hurd when the company encountered difficulties in making the merger
work effectively.

Revitalizing Corporate Culture. Culture can also contribute to organizational decline and, as
a result, may need to be revitalized. One of the typical problems of established companies is that,
unintentionally, the culture begins to emphasize politics and avoidance of conflict and risk more
than performance, quality, customer service, innovation, and profitability. Many people will have
well-entrenched positions, and some are likely to resist making required changes, even though they
are needed by the organization.

When the culture promotes the status quo versus innovation, ideas that might have prevented
decline are not shared, and so problems go unresolved until it is too late. Sometimes, a company’s
success creates the belief (although is it usually a false belief) that “no matter what we do, we will be
successful.” This belief can result in leaders ignoring very real environmental threats (e.g., changing
customer needs, competitive products that are reducing market share or making the organization’s
product obsolete) or not focusing enough attention on ensuring that the company’s infrastructure
is aligned with current needs. In brief, a culture that promotes the belief that “we will always be
successful,” can actually be a major factor in eventually sending it into decline.

A major focus of revitalization, then, needs to be on creating and managing a culture that fits
with the new goals of the organization—that is, that promotes revitalization. This will include
a strong focus on embracing change, on being willing to make tough decisions in the interest of
preventing further decline, and on holding people accountable for performance against revitali-
zation goals.

Revitalization of Simon Property Group. During the early 1990s, Simon Property Group (for-
merly Melvin Simon & Associates)—one of the largest shopping center developers in the United
States—was experiencing a variety of growing pains. The size of the company had outstripped the
managerial capabilities of its founder, Melvin Simon, and his brother, Herbert Simon, who were
both primarily real estate developers.

The company began a program of revitalization that lasted about five years. This included the
introduction of strategic planning, changes in organizational structure, the implementation of a
formal management development program, and the redesign of the company’s performance man-
agement systems. It also led to the introduction into the company of its current CEO, David Simon
(Melvin Simon’s son), who had an MBA from Columbia University and was more oriented to being
a professional manager than either of the two elder Simons, who were primarily deal-oriented. The
company culminated its successful revitalization by going public as Simon Property Group .

In 2013, David Simon was selected as one of 30 people listed in Barron’s “World’s Best CEOs.”7

During his tenure as CEO, Simon Property Group has had annualized profit of 17.4%.8 In contrast,
the return for the S&P (Standard and Poor’s) 500 was 8.7% during the same period. The company’s
stock price increased from $24 per share in 1995 to $160 per share in 2013.

90 Managing the Advanced Stages of Growth

Keys to Success at Stage VII. The overall challenge for a Stage VII organization is revitalization.
The key to success at Stage VII is the ability to entirely reconceptualize and redevelop an enterprise.
This involves becoming entrepreneurial again and being willing to change, if needed, everything
about the business and how it operates. It also involves having the ability to rebuild the entire
enterprise from the business foundation to its culture. This is an enormous challenge, which many
companies fail to meet.

Summary

Once an organization has completed the development challenges required to take it through Stages
I through IV, it has become a professionally managed organization. However, its life cycle is not
completed, and the organization must now deal with the problems and challenges posed by the
advanced stages of growth—Stages V through VII.

Stage V involves efforts to diversify the company because it can no longer rely on its initial
products (or services) or market for continued profitability. The organization’s success has attracted
competitors, and its products or services are now competing in a saturated market. The company
must develop new products (or services) and/or enter new markets to “restart” another cycle of suc-
cess. A prudent leadership team has not waited until this stage to begin the process of diversification
and has been investing a portion of the company’s profits into the development of new products (or
services). Because the original entrepreneur is often no longer available, many companies are train-
ing managers to mimic the behavior of entrepreneurs, thereby creating “intrapreneurs” who will
serve as catalysts for diversification.

Stage VI involves integrating the new businesses that were created around the new products,
services, and/or markets developed in Stage V. These new businesses may be only partially related.
The challenge is to coordinate these entities while allowing each unit sufficient independence to
derive the benefits of acting in an entrepreneurial manner. Such issues as the amount of central-
ized control over divisions, integrating the separate planning activities, and managing the overall
corporate culture must be addressed.

Finally, an organization in Stage VII—which can, in fact, be entered from any other stage of
growth—must focus on revitalizing its entire business. The factors that led to decline—market sat-
uration, an erosion of management’s entrepreneurialskills, the inability to develop an organizational
infrastructure to support the growth realized from previous stages, a feeling of complacency, and so
on—need to be identified and effectively addressed. Revitalizing the business involves focusing on
all six levels of the Pyramid of Organizational Development simultaneously.

In the next chapter, we examine the nature of organizational growing pains and present a method
for measuring and interpreting them. Recognition and identification of these growing pains is a
necessary part of the organizational evaluation process, which is the first step of the transition from
one stage of growth to the next.

Notes 91

Notes

1. Nathaniel Popper, “Banks Did It Apple’s Way in Payments by Mobile,” New York Times,
September 11, 2014.

2. Lisa Eadicicco, “It Took Apple Just 3 Days to Sign Up 1 Million Credit Cards on Apple Pay,”
Business Insider, October 28, 2014.

3. Vito J. Rancanelli, “The World’s Most Respected Companies,” Barron’s, June 28, 2014, S30.
4. Don Clark and Ann Maria Armetal, “At IBM, a Weak Streak Persists,” The Wall Street Journal,

January 21, 2015, B1–2.
5. See Eric Flamholtz and Yvonne Randle, Changing The Game: Organizational Transformations of

the First, Second, and Third Kinds (New York: Oxford University Press, 1998).
6. Louis V. Gerstner, Who Says Elephants Can’t Dance: Leading a Great Enterprise through Dramatic

Change (New York: Harper Business, 2002).
7. Andrew Bary, “World’s Best CEOs,” Barron’s, March 24, 2013, S32.
8. Ibid.

C H A P T E R

Identifying and Surviving the First
Four Stages of Organizational

Growth

All organizations pass through various stages of development. These stages are, at least in part,determined by the organization’s size, as measured by its annual revenues (or for nonprofits,in terms of annual budget). This chapter presents a framework for identifying and explaining
the major stages through which all organizations grow and develop as they increase in size. It should
be noted that this framework applies to a division of a large company, as well as to an independent
organization.

First, we identify the seven stages of organizational growth comprising the entire life cycle and
then, in this chapter, examine the first four stages from the inception of a new venture to organi-
zational maturity. We identify the emphasis on each level in the Pyramid of Organizational Devel-
opment that is required at each growth stage and explain the nature of the transitions to different
stages. Throughout the discussion we will present selected examples to illustrate success and failure
at each stage. Then, we discuss the differences between an entrepreneurship and a “professionally
managed” organization and what must be done to make the transition between these major growth
stages. Next, we present a case study of a company (99 Cents Only Stores) from its inception as a
new venture through its transition to become an entrepreneurially oriented, professionally managed
organization. Finally, we discuss the keys to success at Stages I to IV. We will discuss the remaining
three stages of growth (stages V to VII) in Chapter 4.

48 Identifying and Surviving the First Four

Stages of Organizational Growth

Like all things, organizations have a life cycle. Based upon our research, we have developed a life
cycle model that identifies seven predictable stages of organizational growth. The seven stages in
our model are:

I. New Venture

II. Expansion

III. Professionalization

IV. Consolidation

V. Diversification

VI. Integration

VII. Decline and Revitalization

The first four stages characterize the period from inception of a new venture or start-up to the
attainment of organizational maturity. This period includes the development of an entrepreneur-
ship through the stage when the business becomes a professionally managed organization. Stages V
through VII all deal with the period of a company’s life cycle after the attainment of organizational
maturity through decline and revitalization.

This chapter focuses on the first four stages of organizational growth, because they comprise a
complete era of growth from inception of a new venture to early organizational maturity or young
adulthood. We return to the last three stages in Chapter 4, which presents the challenges posed to
continue success after an organization has reached maturity.

At each of these stages, one or more of the critical tasks of organizational development identi-
fied in Chapter 2 should receive special attention. The stages of organizational growth, the critical
development areas for each stage, and the approximate size (measured in millions of dollars of sales
revenues for for-profit companies and in terms of annual operating budget for nonprofits) at which
an organization will typically pass through each stage are shown in Table 3.1.

Table 3.1 Stages of Organizational Growth

Approximate Organizational Size
(millions of dollars in sales)

Stage Description
Critical Development
Areas

Manufacturing
Firms Service Firms

I. New Venture Markets and Products Less than $1 Less than $0.3

II. Expansion Resources and
Operational Systems

$1 to $10 $0.3 to $3.3

III. Professionalization Management Systems $10 to $100 $3.3 to $33

IV. Consolidation Corporate Culture $100 to $500 $33 to $167

Stages of Organizational Growth 49

A key word in this statement is typically. What this means is that for approximately 90% of man-
ufacturing firms that have revenues in the range of $10 million to $100 million, they will typically
have to encounter the critical issues of Stage III.

There are, however, certain organizations that will have to face these problems at an earlier stage
in their development, or much later. For example, there may well be a $3 million manufacturing
business that is facing the need to professionalize its management systems. Or a few organizations
may well reach $1 billion in annual revenue without really having to face the need to professionalize
their management systems. Accordingly, we need to view the relevant range as designated for the
transition to occur at each stage of development as a normal curve. In statistics, a normal curve
designates the percentage of observations that fall under the area of the curve. This means that
statistically 68% of the cases will fall under one standard deviation of the normal curve, while 95%
of the cases will fall under two standard deviations of the normal curve. There are, of course, always
certain exceptions to this. Similarly, there are exceptions to the revenue parameters used to mark
the various stages of growth.

It should also be noted that in Table 3.1 we use two different ranges of annual revenue to
designate the various stages of growth. Our experience and research indicate that each stage of
growth is reached somewhat earlier for service companies than for manufacturing businesses. This
occurs because of the greater complexity of a service company relative to a manufacturing company
with the same annual revenues. This is, in turn, caused by the fact that manufacturing companies
typically purchase materials that are semi-finished and use them in their manufacturing process.
Accordingly, the manufacturing company’s revenues include a return for the components of cost
of goods sold that are derived from other organization’s work. This means that the manufacturing
company’s value added is less than the comparable value added for a service company at a given size
of annual revenues. This does not mean that the manufacturing company makes a lesser economic
value-added contribution than a service company; it merely means that the service company with
more employees and no raw materials to be recouped as part of sales revenue has a relatively more
complex operation than a comparably sized manufacturing company.

As a result of this phenomenon, we have found it useful to convert a service company’s revenues
into the comparableunits of those of a manufacturingcompany. This processis similar to the conver-
sion from the imperial system to the metric system or from dollars into any foreign currency. Thus to
convert a service company’s revenues into comparable units of a manufacturing company, we mul-
tiply the service company’s revenues by a factor of 3 (as reflected in the figures shown in Table 3.1).
This means that the typical service company is three times more complex to manage than a compa-
rably sized (in revenues) manufacturing company. Alternatively, it means that a $5 million service
company is the rough equivalent of a $15 million manufacturing company. It should be remembered
that this is an experienced-based adjustment that we have found useful rather than a strict formula.

Most nonprofit organizations can be classified as service organizations (providing services or
funding for services to specific populations). Further, many nonprofits—particularly foundations,
charities, and organizations that are government-funded—do not have any revenue per se. In these
cases, the organization’s annual operatingbudgetcan be used as a surrogatefor revenues.The budget,
in this case, represents the size and complexity of the business, in terms of clients served, projects
funded, and so on. We focus specificallyon the growth and developmentof nonprofitsin Chapter 11.

50 Identifying and Surviving the First Four Stages of Organizational Growth

In the following discussion, for convenience, we refer to an organization at a given stage using
the parameters for manufacturing companies as a base. The reader can adjust for service companies
by using the service company adjustment factor of 3, or can simply refer to Table 3.1. Financial
institutions, such as banks, savings and loans, and mutual funds, can be viewed as service compa-
nies under the framework. Distribution companies can be viewed as a hybrid manufacturing-service
organizations, and a multiple of 2 can be used as an adjustment factor. (In other words, a $5 million
distribution company is the same as a $10 million manufacturing company and is, therefore, nearing
Stage II of its development.)

Stage I: New Venture
Stage I of organizational growth involves the inception of a new venture. Stage I typically occurs
from the time an organization has virtually no sales until it reaches approximately $1 million in
annual sales for a manufacturing firm (or $0.3 million for a service firm). During Stage I, the orga-
nization has to perform all the critical tasks necessary for organizational success, but the greatest
emphasis is on the first two tasks: defining markets and developing products. This is represented
schematically in the organizational development pyramid shown in Figure 3.1. These two tasks are
critical to the organization’s survival because without customers and products or services to pro-
vide to them, it simply cannot exist. The ultimate purpose of this stage is to establish proof of the
business concept.

Many businesses have succeeded as new ventures because the entrepreneur was able to iden-
tify a viable market and product. For example Brian and Jennifer Maxwell, both runners, created

Figure 3.1 Developmental Emphasis in a Stage I Organization

Stages of Organizational Growth 51

PowerBar first for their own personal use as a source of competitiveadvantage, and then developed it
into a business. This product led to the creation of an entire new category—the energy bar category.

Similarly, Jerry and Goldie Lippman, the founders of GOJO Industries (the inventor of
PURELL® hand sanitizer) saw the need for something that would serve as a hand cleaner and
sanitizer. The idea for the company’s first product came from Goldie while she was working in one
of Akron’s (Ohio) rubber plants during World War II. Many of the traditional male rubber workers
had gone off to war, and the women who replaced them needed a better way to remove dirt from
their hands than the harsh industrial chemicals used at the time. Jerry, with only a 10th grade
education, sought out chemistry professor Clarence Cook at Kent State University, and together
they invented a product that would remove dirt without irritation. This was sold as GOJO® Hand
Cleaner, and the couple’s first customers were Goldie’s co-workers in the rubber factory. With
Goldie handling administrative matters, Jerry began selling to automotive service and manufac-
turing distributors and, within a few years, a new product category, heavy-duty hand cleaner, was
established. The market remained small because of the high cost of the product, relative to the
“free” cleaning solvents readily available. Jerry solved this problem by developing a portion-control
dispenser and adopting a razor/razor blade approach to placing dispensers and selling proprietary
refills. Today, GOJO is the world leader in institutional hand hygiene and healthy skin.

Other examples of new ventures that came about when an entrepreneur perceived a market need
to be served include Noah’s Bagels (fresh bagels of the highest quality in the western United States),
Federal Express (overnight delivery of packages and mail), and Google (an online search tool that
would enable customers to quickly find and use information).

Once in a while, a new “transformational technological platform” emerges that can be “lever-
aged” by entrepreneurs or existing organizations to create a plethora of new ventures. The Internet
is such a platform. It has helped spawn many new ventures including Amazon.com, Facebook, Net-
flix, and Alibaba. For example, Netflix and Amazon.com leveraged the Internet to enable anyone
with access to the Internet to see a movie or other media content at any time.

Many other new ventures are reasonably successful and profitable but not as famous or glam-
orous. They include businesses engaged in executive search, landscape design, printing, financial
planning, restaurants, graphic design, repair services, catering, equipment leasing, specialty retail-
ing, and many more fields. An example of one of these new ventures is EEZYCUT, founded by
David Jones and Laura Mayes.1 David was university-educated and had even completed an MBA
degree course while working for Bayer PLC. Looking back, David could see that he was not yet
mature enough for a commercial life and still describes himself as a cave diver (explorer) and social
drop-out.

David perceived the need for a new type of cutting tool that divers could use. The old style
diving knife then in use rusted immediately and blunted quickly. While on a “deco stop” (which is
a pause while rising to eliminate dissolved inert gases from the diver’s body and avoid the bends),
David pondered how to make a better device than the one offered at the time. The first design was
a failure, and David found himself starting again. It was a simple engineering design that resolved
the problem with the first cutting device and made the new device (the Trilobite diver’s knife) an
attractive choice for emergency cutting tools. The Trilobite was the first on the diving market that
provided exchangeable blades for the consumer.

http://Amazon.com

52 Identifying and Surviving the First Four Stages of Organizational Growth

David had designed an emergency cutting tool that was intended for use by divers. However,
other non-divers saw the knife and found it had many other applications. This led to another design
called QuattroPod, aimed towards emergency rescue services. EEZYCUT’s Trilobite has been used
by skydivers, hang-gliders, paragliders, kayaking, fire and rescue services, fishermen, yacht owners,
gardeners, prison guards, special forces, ski patrol, public safety officers, emergency room workers
and paramedics, as well as scuba divers. It has also been used in animal rescue of marine life caught
in fishing line!

While David focused on the design and deal aspects of the business, Laura’s role was ubiquitous.
Laura was involved in the business with David from its conception. Since they are married, the
business relationship developed through physical proximity. Their apartment was full of boxes and
sewing machines. Laura took the phone calls, read the emails, paid the bills, and shipped the prod-
uct. According to David, “Laura pretty much did everything, and kept the ship running” while he
barked orders at her from behind the machines. Also, David is a self-described hermit, and Laura
was his only sounding board. So she was fully informed and involved in strategy, business direction,
contracts, and so on. They are a working partnership as well as a family. With no prior distribution
experience, the pair has built their company into a Stage II business selling the EEZYCUT Trilobites
around the globe.

Entrepreneurs do not always have to be first to identify an unserved market segment. Often
they can enter a market with a better product or service. The classic example of an entrepreneur
who succeeded after others failed is Herb Kelleher, founder and former CEO of Southwest Airlines.
Although others had identified the market for low-cost airfare, Kelleher was the first to find the
successful formula for low-cost, no-frills airfare—a market segment that Southwest has grown to
dominate. Coffee is certainly not a new product, but Starbucks has grown to dominate the retail
coffee bar segment. Although girls have played with dolls for many decades, if not throughout his-
tory, Isaac Larian, founder of MGA Entertainment, created Bratz Dolls to appeal to “tween” girls
and grew his business to one of the largest toy companies in the world.

Keys to a Success at Stage I. At stage I, the two keys to success are the ability to identify a
present or potential market need (defining a market) and the ability to develop a product or service
that will satisfy that market need on a profitable basis. Taken together, these two things are necessary
to establish proof of concept.

Stage II: Expansion
If an organization successfully completes the key developmental tasks of Stage I, it will reach Stage
II, which involves rapid expansion in terms of sales revenues, number of employees, and so on. For
most manufacturing firms, Stage II begins at about the $1 million sales level and extends to the
$10 million level. (For service firms, this stage typically begins at approximately $0.3 million and
continues through $3.3 million in revenues.)

Stage II presents a new set of developmental problems and challenges. Organizational resources
are stretched to the limit when increasing sales require a seemingly endless increase in people,
financing, equipment, and space. Similarly, the organization’s day-to-day operational systems for
recruiting, production or service delivery, purchasing, accounting, collections, information, and

Stages of Organizational Growth 53

payables are nearly overwhelmed by the sheer amount of product or service being “pushed out
the door.”

The major purpose or challenge of Stage II is “organizational scale-up.” This means that the busi-
ness concept has been demonstratedto be valid (Stage I), and the organization must now acquire the
resources and develop the systems required to facilitate growth. For example, EEZYCUT (described
earlier) is beginning Stage II. Its founders, David Jones and Laura Mayes (husband and wife) are cur-
rently in the process of what they term “upgrading” the infrastructure of EEZYCUT to better handle
the challenges they face in Stage II of their business. As David states, “It is a lot to handle!”2

The major problems that occur during Stage II are problems of growth rather than survival. It is
during this stage that horror stories begin to accumulate:

• Salespeople sell a product they know is in inventory, only to learn that someone else has
grabbed it for other customers.

• One vendor’s invoices are paid two and three times, while another vendor has not been paid
in six months.

• A precipitous drop in product quality occurs for unknown reasons.
• Turnover increases sharply just when the company needs more personnel.
• Missing letters, files, and reports cause confusion, loss of time, and embarrassment.
• Senior executives find themselves scheduled to be in two widely separated cities on the same

day at the same time, or they arrive in a distant city only to learn that they are a day early.

• The computer system crashes frequently, leaving users without access to valuable information,
basically shutting the company down for hours or sometimes days.

These are what we call growing pains.
The classic organizational growing pains that are typical of Stage II and later-stage companies are

discussed in detail in Chapter 5. The relative emphasis on each key developmental task appropriate
for Stage II is shown schematically in Figure 3.2.

Many companies experience a great deal of difficulty during Stage II and even disappear.
Although it is established that 50% of companies survive until stage II, there are not sufficient data
on the percentage that survive until Stage III. We believe (or hypothesize) that about 50% of the
original 50% surviving companies at Stage II will again survive to stage III. This means that 25%
of the original start-ups will survive until Stage III.

When failure at Stage II occurs, it is usually because the founding entrepreneur is unable to cope
with the managerial problems that arise as the organization grows. A Stage II company needs an
infrastructure of operational systems that lets it operate efficiently and effectively on a day-to-day
basis. Unfortunately, many entrepreneurs are not interested in such organizational plumbing.

Some businesses that are fortunate enough to have discovered an especially rich market find
themselves growing very rapidly. Although most of the development of resources and operational
systems ought to occur during the period when the organization is growing from $1 million to
$10 million in annual revenues, it is not unusual to find companies with $30, $40, $50, or even

54 Identifying and Surviving the First Four Stages of Organizational Growth

Figure 3.2 Developmental Emphasis in a Stage II Organization

more than $100 million in annual revenues with the operational systems of a Stage II organization.
This kind of discrepancy between an organization’s size and the degree of development of its opera-
tional systems leads to serious problems, but these may be masked in the short term by rapidly rising
revenues. This often proves to be the case in some of the most spectacularexamples of organizational
failure, such as Osborne Computer.

Today the name “Osborne Computer” is largely unrecognized, except by “Boomers.” Yet it was
once as high-profile as Apple or Starbucks. Adam Osborne was an entrepreneur who perceived
the need for “portable PCs,” which are now known as “laptops” (even though his product weighed
28 pounds and had a screen about 6 inches wide). He developed a company, which grew to $100 mil-
lion in revenues within two years, but then went bankrupt in its third year. It was a classic example
of meteoric success followed by meteoric failure, brought about, at least in part, by underdeveloped
operational systems. In an article on the rise and fall of Adam Osborne, Steve Coll states, “In retro-
spect, it seems clear that the company’s accounting procedures were so slipshod that no one knew
how things were.”3

The lesson of what happened to Osborne and his fleetingly successful company needs to be
learned by all entrepreneurs. Many companies continue to make the same mistakes, and the end
results are similar. For example, system crashes experienced by several online brokerage firms are a
warning that both the product and related infrastructure are not sufficiently developed to serve as
a sound platform for future growth.

Since rapid growth can create problems as well as opportunities it is essential to be prepared for
it. Preparation for growth typically requires the acquisition of resources of various kinds including

Stages of Organizational Growth 55

money, people, and equipment. It means the development of the day-to-day operational systems to
do what the business is in business to do. We term this the “operational infrastructure,” which refers
to the resources and day-to-day systems required to operate the business.

Keys to Success at Stage II. The keys to successat Stage II are fundamentallydifferent from those
at Stage I. Stage II is all about expansion or scale up, and successful scale up requires operational
infrastructure. The level of infrastructure needs to match the size of the company as measured by its
revenues. It also needs to be designed so that it will support the organization’s continued growth. If
the required infrastructure is in place, the organization will operate well; if not, it will experience
a variety of organizational problems, which we term “growing pains.” Growing pains are described
further in Chapter 5.

Stages I and II Together
Taken together, Stages I and II—the new venture and expansion stages—constitute the
entrepreneurial phase of organizational development. It is during these two stages of growth that
the classic skills of entrepreneurship are most relevant. It is also during this phase that the need
to make the transition from an entrepreneurship to an entrepreneurially oriented, professionally
managed organization begins to occur.

Stage III: Professionalization
Somewhere during the period of explosive growth that characterizes Stage II, senior management
realizes (or ought to realize) that a need for a qualitative change in the organization is arising. The
company cannot merely add people, money, equipment, and space to cope with its growth; it must
undergo a transition or metamorphosis and become a somewhat different type of organization.

Until this point, the enterprise generally will have been totally entrepreneurial. It has operated
with a considerable degree of informality. It may have lacked well-defined goals, roles, plans, or
controls but still prospered. However, once a critical size has been achieved, many of these prac-
tices and procedures must be increasingly formalized. The need for this transition typically occurs
for manufacturing organizations by the time they have reached approximately $10 million in sales.
(For service firms, the need for this transition typically arises when they have reached $3.3 mil-
lion in revenues.) At this level of revenues, the sheer size of the organization requires more formal
planning, regularly scheduled meetings, defined organizational roles and responsibilities, and per-
formance management systems. The people who manage the company and its operations must also
change their skills and capabilities. Until this point, it was possible to be more of a doer or hands-on
manager than a professional manager. At this stage, however, the organization increasingly requires
people who are adept at formal administration, planning, organization, motivation, leadership, and
control. In brief, the focus at this stage of development should be on developing the management
systems required to take the organization to its next stage of development. Developing and imple-
menting these systems, in turn, requires a planned program of organizational development. It also
requires using the managerial tools described in Chapters 6 to 9.

It is at this stage that the company must make a transition from an entrepreneurship to an
entrepreneurially oriented, professionally managed organization. This means that the organization,

56 Identifying and Surviving the First Four Stages of Organizational Growth

while still maintaining its entrepreneurial spirit, will also need to develop the infrastructure and
professional management capabilities required to continue its growth successfully.

This is a delicate balancing act. An organization must never lose its entrepreneurial mindset
or spirit, but it must begin to develop the infrastructure and management systems required to
facilitate its future growth. Although some people equate professional management with bureau-
cracy, we believe they are mistaken. It is true that if professional management exists without an
entrepreneurial mindset or culture, it can become bureaucracy. But it is also true that if entrepreneur-
ship is carried to an extreme in large companies, it can result in chaos, and chaos ultimately leads
to organizational difficulties and even bankruptcy.

As we discuss throughout the remainder of this book, making the successful transition from
an entrepreneurship to a professionally managed organization requires some delicate surgery. At
this point, the key thing we want to point out is that, based on our research and experience, this
transition is not a choice but a requirement or imperative for continued organizational success and
that it involves the development of management systems. We shall provide examples throughout
this book of both organizations that have made this transition successfully and thrived, as well as
others that have failed to make this transition and experienced great difficulties (such as Osborne
Computers and Boston Market).

The relative emphasis on each key developmental task appropriate for Stage III is shown
schematically in Figure 3.3. As the figure indicates, the most important task during this stage is the
development of management systems.

Perf. Mgmt.

Figure 3.3 Developmental Emphasis in a Stage III Organization

Stages of Organizational Growth 57

Although the professionalization and related development of management systems of an organi-
zation ought to occur during the period when sales are growing from $10 million to approximately
$100 million, the rate of growth often outstrips the rate at which the enterprise’s management
systems are developed. This can lead to serious problems, which can either limit the potential
development of a business or cause failure. This was the case at Starbucks Coffee Company in 1994.

At that time, Starbuckswas essentially a Stage II company in the process of making the transition
to Stage III (in terms of its organizational infrastructure), even though its corporate revenues were
more than $100 million (Stage IV). As a result, the business was beginning to experience significant
growing pains, which could have hampered the company’s development and ultimate success.4

Similar problems occurred at the same stage of growth at Jamba Juice, Noah’s Bagels, and Power-
Bar. Other examples include Apple Computer (revenues of more than $2 billion in 1985 but only
Stage II in terms of infrastructure) and Maxicare (revenues of about $1.8 billion). Apple lost mar-
ket share to IBM, and Maxicare had to downsize and ultimately file for bankruptcy. This company
had grown rapidly through acquisitions but had not taken the time to develop an operational and
management infrastructure that would support the much larger organization that it had become.

As noted in Chapter 1, the entrepreneurial personality can be a barrier to success at Stage
III. Making the transition from an entrepreneurship to professional management involves more
than just the development of operational and management systems. It requires a profound mindset
change on the part of people, especially the entrepreneurs who founded the company. We have
been working with companies to help them make this transition for nearly 40 years. One of the
classic obstacles to this process is typically the entrepreneur; many fear becoming bureaucratic, and
then confuse bureaucracy with systems. Some of this is deeply rooted in their personalities; they do
not want to be controlled by anyone or anything—not plans, not role descriptions, not policies,
not procedures.

Because they have been successful in launching a new venture without these things, they assume
(either explicitly or implicitly) that they are not necessary and that they are, in fact, barriers to
success. What they fail to realize is that the game needs to be played differently at different stages
of the organizational life cycle. Without systems or plans or role definitions, the organization will
definitely experience increasing confusion and quite possibly chaos. In spite of what one author has
written, no one thrives on chaos indefinitely!5

As noted in Chapter 1, when Orin Smith (then CFO of Starbucks) invited one of the authors
to work with Starbucks Coffee Company to assist them in making the transition to professional
management, he stated that the biggest challenge would be getting Howard Schultz to buy in to the
concept that a firm could be better managed without losing its entrepreneurial spirit. He cautioned
that Schultz might not have the patience for much process and systems. In fact, Howard Schultz
embraced these notions very quickly. They were consistent with his belief that if you are going to
build a large building, you need a strong foundation.

This issue of the psychological acceptance of the need to transition from early-stage
entrepreneurship to professional management is a traumatic one for many, if not most,
entrepreneurs. It requires a leap of faith because their early experiences suggest that systems
are not essential to success. Without making this leap, however, the entrepreneurs may put what
they have built at risk of decline or even failure.

58 Identifying and Surviving the First Four Stages of Organizational Growth

While some entrepreneurs resist the changes required to transition to professional management,
there are others who readily embrace this notion. Among those who readily embraced the idea of
transitioning to professional management are:

• Brian Maxwell, founder of PowerBar
• Yerkin Tatishev, founder and CEO of Kusto Group (Kazakhstan, Russia, Ukraine, Vietnam,

and Israel)

• Tim and Jud Carter, Bell-Carter Foods, Inc.
• James Stowers, Jr., Founder of American Century Investments
• Melvin and Herbert Simon, Simon Property Group

One of those cited above was James Stowers, Jr. (now deceased), founder of what is now Ameri-
can Century Investments. The experience of American Century Investments and its founder James
Stowers, Jr., in making the transition to professional management is an excellent example of how
this process can be done successfully. It is described in detail in Chapter 13.

Keys to Success at Stage III. In summary, the keys to success at Stage III are (1) the ability to
recognize the need to transform from an early-stage entrepreneurial venture to an entrepreneurially
oriented, professionally managed organization; and (2) the ability to develop the managerial capa-
bilities and management systems required for future sustainable growth, including all of the tools to
be described in Chapters 6 to 9. Chapters 6 to 9 also present case studies of how leaders of Stage III
and beyond organizations developed and used these tools to support continued success.

Stage IV: Consolidation
Once the organization has made the transition to professional management—with workable
systems for planning, organization structure, management development, and performance
management—leadership must turn its attention to an intangible but nevertheless real and
significant asset: corporate culture. Management of the corporate culture is the main task of Stage
IV of organizational development.

The key challenge at Stage IV is to help consolidate or institutionalize the cultural aspects of
the transformation from an entrepreneurship to a professionally managed organization. As the orga-
nization makes the transition required of Stage III and develops management systems, a cultural
transition is also in progress. The company is going from a very loose, free-spirited organization
to a more disciplined one; from an organization with a strategy and perhaps a plan to one with a
well-defined planning process; from one with vague goals to more specific, measurable goals; from
one with loosely defined roles to one with more formal role descriptions; and from one with lim-
ited accountability to one with more accountability. Explicitly or implicitly, this involves a cultural
change, and it is a change that must be managed if the transition is to be made successfully.

Corporate culture can have a powerful effect, not only on day-to-day operations but on the bot-
tom line of profitability as well.6 During the growth that was necessary to reach Stage IV (which
typically seems to begin at about $100 million in sales for manufacturing firms), the organization has
broughtin new waves of people. The firstwave probablyarrived when the organizationwas relatively

Stages of Organizational Growth 59

small and informal, during Stage I. During this period, the organization’s culture (values, beliefs, and
norms) was transmitted by direct day-to-day contact between the founder and personnel. The dif-
fusion or transmission of culture was a by-product of what the organization did. Virtually everybody
knew everybody else. Everybody also knew what the company wanted to achieve and how.

During Stage II, the rapid expansion of the enterprise most likely brought in a second wave of
people. The first-wavepersonnel transmitted the corporateculture to this new generation. However,
at an increased level of organizational size, especially if the organization develops geographically
separate operations, this informal socialization process becomes more attenuated and less effective.
The sheer number of new people simply overwhelms the socialization system.

By the time it reaches $100 million in revenues, a third wave of people usually has joined the
organization, and the informal socialization is no longer adequate to do what it once did so well. At
this stage, leaders must develop a more conscious and formal method of transmitting the corporate
culture throughout the organization, monitoring it and managing it. This is the key challenge faced
by Stage IV organizations. The relative emphasis on each key developmental task appropriate for
Stage IV is pictured in Figure 3.4.

Keys to Success at Stage IV. In summary, the keys to success at Stage IV are (1) the ability to
change the corporate culture or mindset to support the professionalization of the enterprise; and (2)
the ability to develop effective systems for communicating, managing, and reinforcing the culture.
Chapter 10 examines the management of corporate culture in greater detail and presents examples
of companies that have done it successfully and unsuccessfully.

Figure 3.4 Developmental Emphasis in a Stage IV Organization

60 Identifying and Surviving the First Four Stages of Organizational Growth

Differences between Entrepreneurial and Professional Management

Stages I and II, taken together, make up the entrepreneurial phase of organizational development,
while Stages III and IV make up the professional management phase. As an organization passes
from one of these phases of growth to the other, a variety of changes need to occur. There is a
qualitative difference between an entrepreneurship and a professionally managed firm. The former
tends to be characterized by informality, lack of systems, and a free-spirited nature. The latter
tends to be more formal, to have well-developed systems, and to be proud of its disciplined, profit-
oriented approach.

The most important differences between an entrepreneurship and a professionally managed
organization involve nine key result areas: (1) profit, (2) planning, (3) organization, (4) control/
performance management, (5) management/leadership development, (6) budgeting, (7) innova-
tion, (8) leadership, and (9) culture. Table 3.2 summarizes the principal characteristics of profes-
sional management, as compared with entrepreneurialmanagement in each of these key result areas.
We now describe these differences in greater detail.

Profit
In a professionally managed organization, profit is an explicit goal; it is planned, rather than being
a residual or whatever is left over at the end of the year. In an entrepreneurial organization, profit is
sought, but it is not an explicit goal to be attained. The entrepreneur may be willing to invest and
sacrifice current profits for a future big hit.

Planning
Unfortunately, in many entrepreneurial organizations, the plan, if there is one, is in the
entrepreneur’s head. A professionally managed organization has a formal, written business plan.
Planning becomes a way of life as the organization’s leaders develop and use a formal, written
strategic plan as the “roadmap” for success. In addition to strategic planning, operational plans and
budgets are developed. Contingency plans also are developed. The practice of informal, superficial,
ad hoc planning is replaced by a regular planning cycle.

Organization
An entrepreneurial organization has an informal organizational structure with overlapping and
responsibilities. People are expected to do whatever is necessary, without regard to job
titles or positions. This is fine when a company is small. But as it grows, chaos can set in, with people
simply not knowing what they are supposed to do. A professionally managed organization has a set
of written role descriptions that clearly state responsibilities. These descriptions are designed to be
mutually exclusive and exhaustive. They are intended to help people understand what their roles
are and to give focus to their efforts and use of time. There is also a formal organizational chart that
accurately provides information about reporting relationships and helps people understand how this
structure should work.

Differences between Entrepreneurial and Professional Management 61

Table 3.2 Comparison of Professional Management and Entrepreneurial Management

Key Result Areas Professional Management Entrepreneurial Management

Profit Profit orientation; profit as explicit goal Profit as a by-product

Planning Formal, systematic planning:

• Strategic Planning
• Operational Planning
• Contingency Planning

Informal, ad hoc planning

Organization Formal, explicit role descriptions that
are mutually exclusive and exhaustive

Informal structure with
overlapping and
responsibilities

Control/
Performance
Management

Formal, planned system of
organizational control, including
explicit objectives, targets, measures,
evaluations, and rewards

Partial, ad hoc control, seldom
with formal measurement

Management and
Leadership
Development

Planned management development:

• Identification of requirements
• Design of programs

Ad hoc development,
principally through on-the-job
training

Budgeting Management by standards and
variances

Budget not explicit; no
follow-up on variances

Innovation Orientation to incremental
innovations; willingness to take
calculated risks

Orientation toward major
innovations; willingness to
take major risks

Leadership Consultative or participative styles Styles varying from very
directive to laissez-faire

Culture Well-defined culture Loosely defined,
“family”-oriented culture

Control/Performance Management
In an entrepreneurship, control of operations tends to be lacking or at least is often piecemeal. The
organization usually lacks formal measurement or performance appraisal systems. A professionally
managed organization, by contrast, has a formal, planned system of organizational control or per-
formance management. This system makes full use of explicit objectives and goals, measurements
of performance, feedback, evaluation, and rewards.

62 Identifying and Surviving the First Four Stages of Organizational Growth

Management and Leadership Development
Management and leadership development is planned in a professionally managed organization.
There is a conscious, planned effort to develop the managerial and leadership skills of individu-
als and to prepare a pool of managers that will help take the organization into the future. In an
entrepreneurship, however, management and leadership development is unplanned and tends to
occur, if at all, through on-the-job experience.Althoughthe entrepreneurialorganizationmay avoid
the cost of management development programs, people may become victims of the Peter Principle
(being promoted beyond their competence) and cost the company through inefficiency, mistakes,
and replacement costs.

Budgeting
In an entrepreneurship, budgeting tends to lack detail. There is little follow-up on variances or
deviations from the budget. A professionally managed organization’s budget system focuses on stan-
dards and variances.Managers are held accountablefor performance,comparedagainst budgetgoals.
Budgets are not cast in concrete but are there to guide performance.

Innovation
By definition, entrepreneurial companies are oriented toward innovation. Many are willing to make
major innovations in products, services, or operating methods. Some entrepreneurs even “bet the
company” on an innovation because of the possibility of a high payoff for success. They tend to need
quick hits, or fast payoffs. Professionally managed organizations tend to be oriented more toward
incremental innovations. They are less likely to bet the company, and they often spread their risk
among a portfolio of different productsor projects. They are willing to take calculated risks, but they
may seem relatively averse to risks, at least in comparison to entrepreneurial companies. There are
exceptions to this, and established professionally managed companies such as Boeing and IBM are
famous for having bet the company on new technologies a number of times during their history.
Many of the best-managed companies, however, are oriented to continuous, incremental improve-
ments and long-term support of major innovations that do not require fast payoffs.

Leadership
In entrepreneurial companies, leadership typically ranges from very directive styles such as auto-
cratic or benevolent autocratic to very nondirective styles such as laissez-faire. In a professionally
managed organization, the tendency today is toward more interactive styles, such as consultative
and participative management, or, in a few instances, to consensus or team-oriented styles.
Entrepreneurial organizations are more likely to have charismatic leaders than are professionally
managed companies because of the nature of the process of selection for promotion in large
organizations.

Culture
Culture tends to be loosely defined in entrepreneurial organizations and sometimes it is not explic-
itly managed. Often the culture of an entrepreneurial organization is oriented toward a family

Discrepancies between Growth and Organizational Development 63

feeling, which is feasible because of its relatively small size. Professionally managed organizations
are more likely to treat organizational culture explicitly as a variable to be managed and trans-
mitted throughout the enterprise. They tend to understand that culture is a source of sustainable
competitive advantage.

Relevance of Differences
Our discussion of the differences between entrepreneurial and professionally managed organizations
is intended to be descriptive rather than evaluative. Both types of organizations have strengths and
limitations. The significant point is that different ways of operating are appropriate at different
stages of organizational growth.

From an entrepreneurial organization’s standpoint, it is clear that something inevitably will be
lost as the organization makes the transition to professional management. However, something
will also be gained. Just as a plant that has been successful in its pot must be transplanted if it is to
continue to grow and develop properly,an organization that has outgrown its infrastructureand style
of management must also make a transformation. Failure to do so will lead to a variety of problems.

Discrepancies between Growth and Organizational Development

As we have seen, two independent dimensions are involved in each stage of organizational growth:
(1) size and (2) the extent to which the enterprise has developed the systems required to support
its size in each of the six critical development areas included in the Pyramid of Organizational
Development. An organization can be at Stage III in terms of size, as measured in annual revenues,
but only at Stage II in its internal organizational capabilities. In other words, its infrastructure is
not developed to the extent that it needs to be to support the enterprise’s size. For example, after
only a very few years of existence, Osborne Computer was a Stage IV company in size, but it was
only a Stage II company in terms of its infrastructure. The lack of infrastructure to support the firm
contributed to significant problems, which ultimately resulted in the firm filing for bankruptcy.

An organization will face significant problems if its internal development is too far out of step
with its size. As shown in Figure 3.5, the greater the degree of incongruity between an organization’s

Figure 3.5 Causes of Organizational Growing Pains

64 Identifying and Surviving the First Four Stages of Organizational Growth

size and the development of its infrastructure, the greater the probability that it will experience
organizational growing pains (the topic of Chapter 5). Such an organization is like a 12-year-old
boy who is well over six feet tall: He has the body of a man but, most likely, the mind of a child. As a
senior manager in one organizationstated, “We are essentially a $30 million company that happened
to have $350 million in sales.” The manager meant that the firm had the operating systems and
developmental structure of a $30 million company, but its growth had given it revenue that greatly
exceeded (by more than 10 times) its infrastructure’s capacity. Predictably, the company was in
difficulty and was ultimately purchased by a competitor.

Managing the Transition between Growth Stages

What can management do to help make the transition required between growth stages? There are
four steps by which the senior managers of a growing enterprise can help their company make a
smooth transition from one stage of growth to the next and, ultimately, make the transformation
from an entrepreneurship to professional management. They are as follows:

1. Perform an organizational evaluation or assessment of the company’s effectiveness at its cur-
rent stage of development.

2. Formulate an organizational development plan.

3. Implement the plan through action plans and programs.

4. Monitor the programs for effectiveness.

We now examine each of these steps in detail.

Perform an Organizational Evaluation or Assessment
An organizational evaluation or assessment consists of systematic assessment, by means of data anal-
ysis and interviews with organization members, of the extent to which systems are adequate to meet
the company’s current and anticipated future requirements.While this evaluation may be performed
by the organization’s management team, many companies prefer to have independent consultants
conduct the assessment in order to obtain greater objectivity or benefit from their experience with
similar companies facing similar issues. The findings of the evaluation represent a diagnosis of the
organization at its current stage of development. This assessment might include administering and
using results from surveys, such as the Organizational Effectiveness Survey© described in Chapter 2
and the Growing Pains Survey (which will be described in Chapter 5).

Formulate an Organizational Development Plan
Once the organizational evaluation has been completed, management must develop a master plan
or blueprint for building the capabilities needed for the organization to function successfully at its
current or next stage of development. This is the strategic organizational development plan, which
will be described in Chapter 6.

Case Example of Growth from Stages I to IV: 99 Cents Only Stores 65

Implement the Organizational Development Plan and Monitor Its Progress
The third and fourth steps in helping an organization make the transition to a new growth stage
are implementing the changes set forth in the organizational development plan and monitoring
their effects. This includes both developing new organizational systems (planning, organization,
and performance management) and developing management’s capabilities through corporate edu-
cation programs. Management development programs may focus on administrative skills (such as
planning), leadership skills, or both. We examine the development of these management systems
and capabilities in Part Two of this book. Once the development program has been implemented,
management needs to monitor its progress in meeting developmental needs. Such monitoring helps
senior managers identify and address any problems related to achieving organizational develop-
ment goals.

These four steps—diagnosing, planning, implementing, and monitoring changes in organiza-
tional capabilities—are the keys to making a smooth transition from an entrepreneurship to a
professionally managed enterprise. The steps are the same regardless of the size, industry, or cur-
rent stage of development of an organization. As such, they can also be applied to organizations
that have grown beyond Stage IV.

It should be noted that these steps may appear simple, but they are often quite complex in prac-
tice. The transition process typically requires one to two years for a Stage I firm; three years or more
may well be required in a Stage IV firm. Some aspects of the change process (such as changes in
personnel—voluntary or otherwise) can be difficult to handle. However, where the process is suit-
ably designed and well-executed, the organization will almost always emerge from it stronger and
more successful than ever.

Failure of senior management to take the necessary steps in negotiating transitions between each
of the stages can have significant consequences. These range from stagnation and blocked growth
to removal of the founders, as has happened at many companies. Or the company may experience
bankruptcy or takeover, as happened with Osborne Computer. However, if the proper steps are
taken, then organizations can experience a great deal of success. Starbucks and Microsoft are good
examples of this.

Case Example of Growth from Stages I to IV: 99 Cents Only Stores

This section presents a case example of a company from its inception as a new venture through its
transition to become an entrepreneurially oriented, professionally managed company. The company
is 99 Cents Only Stores.

Origins of 99 Cents Only Stores
The late Dave Gold and his wife, Sherry, are a classic American entrepreneurial success story. In
1945, Dave’s father, an immigrant from Russia, opened a tiny liquor store in downtown Los Angeles.
In 1957, Dave’s father received an offer to sell his store for $35,000, but he sold it instead to Dave
and his brother-in-law for $2,000 as a down payment, with the rest being paid with no interest over
a long period of time.

66 Identifying and Surviving the First Four Stages of Organizational Growth

The Precursor to 99 Cents Only Stores
In 1961, the two entrepreneurs opened another liquor store nearby in the Grand Central Market
of downtown Los Angeles. As did other, similar stores, they sold beer, wine, and hard liquor for a
variety of prices.

As part of the process of doing business, they noticed that items priced at 99 cents were selling
so fast that they could not keep them in stock. They decided to experiment with pricing, selling all
wines priced between $0.89 and $1.29 at a fixed price of 99 cents. They advertised: “Wines of the
world for 99 cents.” The experiment was a great success. They found that those items formerly sold
at 89 cents sold more when priced at 99 cents! Dave Gold had some additional insights from this
experiment: (1) Customers preferred the digit 9 in pricing, and (2) customers prefer fewer digits in
the price.

Dave Gold had a natural genius for business. He did a number of unorthodox things that worked
quite well. For example, he advertised certain products as “the world’s worst.” He advertised
cigarettes as “the world’s worst cigarettes for 99 cents.” People bought the cigarettes to see how
bad they really were! He also advertised certain wines as “the world’s worst wine for 99 cents,” and
people bought those, too, to see just how awful they were.

The Next Phase
In 1972, the two partners divided the business, with each receiving two liquor stores. Now Dave
could go his own way. He could buy as much as he wanted and experiment however he wanted.

The Opportunistic Buyer. Dave Gold was an aggressive buyer. He was confident he could sell
what he bought, and he was willing to buy in large quantities, including things he had never sold
before. In 1973, Dave bought a supermarket that was going out of business at an auction. The
purchase included many items that Dave had never sold before. He then purchased a general mer-
chandise store in the Grand Central Market in Los Angeles near his liquor store. This was the
beginning of a diversification of his business, and it ultimately led to the development of 99 Cents
Only Stores.

Another example of Dave’s willingness to buy occurred in 1976. Kimberly Clark, manufacturerof
Kotex, had overproducedthe product. Dave purchased six truckloads of Kotex. There was, however,
one little problem: there was no place to store all of this merchandise. At the time, Dave’s father
owned an old garage located in Skid Row in Los Angeles. He let Dave use it as a warehouse to store
the product, and there was also space for more storage of products.

Diversification. After a few months, small retailers began coming to the warehouse to purchase
products. This led, in turn, to the creation of a business unit (which still exists today) called Bargain
Wholesale, which sells merchandise at below-normal wholesale prices to retailers, distributors, and
exporters.

The Genesis of the Concept of 99 Cents Only Stores
It has been said that success is the result of preparation meeting opportunity. One of Dave Gold’s
greatest strengths as an entrepreneur was his willingness to experiment and take risks. He learned
from both successes and difficulties encountered. Since his original experimentation with selling

Case Example of Growth from Stages I to IV: 99 Cents Only Stores 67

wines and cigarettes for a fixed price of 99 cents, Dave had been flirting with the idea of creating a
store that would sell everything for 99 cents. His belief that this would be a good idea was enhanced
by an experiment that he conducted at trade shows.

It is a common practice at trade shows for exhibited items in a booth to be sold at deeply dis-
counted prices rather than being carted back after the show is over. Dave tried an experiment.
Instead of selling the products he brought to a trade show at a variety of prices, he separated his
products into three tables with three price points: $1, $2, and $5. The experiment had two signif-
icant outcomes: (1) total sales exceeded sales of previous years where things were sold at a wide
variety of prices, and (2) the “$1 table” sold the most. Dave was still not ready to launch his idea of
a “99 Cents Only Stores” concept. The idea would, however, continue to intrigue him.

Stage I: Accidental Launch of 99 Cents Only Stores
Dave had been talking about this idea for a very long time with a number of people, including an
old friend named Jimmy Wayner. One day in 1982, while driving near the airport, Dave and Jimmy
spotted a store for lease. His friend said, “I am sick of you talking about your 99 cents idea. You
either rent this building, or you never talk about this with me anymore!”

Dave rented the 3,000-square-foot facility and 99 Cents Only Stores was born. This first store
would be the initial seed of the company that would ultimately become 99 Cents Only Stores. Such
was the accidental launch of the 99 Cents Only Stores concept—the first of its kind in the United
States.

Stage II: Expansion of 99 Cents Only Stores
Dave and Sherry acquired a warehouse to store merchandise and proceeded to expand the business
by opening more stores. Dave and Sherry traveled to trade shows and auctions to find products,
which they purchased for 50 cents per unit; they had a van or truck there so they could ship every-
thing back to Los Angeles.

The company was aided in its development of the business by a great deal of free publicity.
Because the concept was novel, the media were interested. The Herald Examiner, a Los Angeles
newspaper, put the company on the front page with a story. The company also received coverage
from various local channels, as well as CNN.

Dave and Sherry raised three children: Howard, Jeff, and Karen. In 1984, Dave and Sherry
opened their second store. All of Dave and Sherry’s children were involved in the business from an
early age, and all occupied important positions in the firm.

By 1996, 99 Cents Only Stores had a total of 36 stores—all in Southern California. In May
of 1996, the company did an IPO and became a public company on the NYSE, trading under the
symbol NDN. One long-time observer of the company expressed the belief that a major reason Dave
Gold took 99 Cents Only Stores public was to give employees a chance to participate in the value
created by the growth of the company. In fact, the company launched a stock option program in
which employees can participate.

Even after going public, the members of the Gold family were committed to the success of NDN.
In addition, the family knew a great deal about the business from its many years of involvement.

68 Identifying and Surviving the First Four Stages of Organizational Growth

For almost a decade after the IPO, family members continued to be the driving force in the business.
By 2004, the company had grown very large and more complex. It now had more than two hundred
stores and was operating in four states (California, Nevada, Texas, and Arizona).

Like all companies experiencing rapid growth, NDN was beginning to experience some of the
classic growing pains that will be described in Chapter 5. Management focused on dealing with
the company’s growing pains and preparing to take NDN to the next level of success. The com-
pany added new members to its board, added additional depth to its management team, initiated
a new process of strategic planning, developed more sophisticated supply chain operations, revised
and upgraded its operational systems, and put into effect a number of other initiatives designed
to strengthen the company and build on its existing strong foundation. In doing so, the company
applied many of the concepts and tools presented in this book.

Stage III: Transitioning to Professional Management
By 2005, under Dave Gold’s leadership, 99 Cents Only Stores had grown to 225 stores and almost
$1 billion in revenues. The innovative business concept pioneered by Dave Gold had also spawned
a number of imitators and, in fact, had created a new business category: the $1 store concept.

After more than 50 years of involvement in the business and its precursor, Dave Gold made the
decision to retire on December 31, 2004. This led to a management succession at the executive
levels of the company. Dave Gold continued as chairman of the board. His son-in-law, Eric Schif-
fer, who holds an MBA from Harvard Business School and joined the company in 1991, became
CEO. Dave’s son, Jeff Gold, who has been involved in the business for many years, became presi-
dent and COO and took over responsibility for day-to-day operations. Howard Gold, also involved
in the business for many years, became executive vice president (EVP) for special projects. In
addition, the company hired a new CFO and created the position of EVP for supply chain oper-
ations. It also recruited experienced professionals in several other areas of the company, including
human resources.

Stage IV: Consolidation
Under the new leadership of Eric Schiffer and Jeff Gold, the company developed a culture statement
to formalize the values that had been underlying its operation for many years.

Conclusion
The inception, growth, and transition to professional management of 99 Cents Only Stores is truly
an impressive business success story. The company created its business concept and defined a new
business space. The company successfully made the transition from a family-driven business to a
publicly held, professionally managed enterprise.

In 2012, the company went private, in a purchase by Ares Management and the Canada Pension
Plan Investment Board as well as the Gold-Schiffer family in a deal valued at $1.6 billion. At the
time of the buyout, the company had approximately $1.5 billion in revenues. The company still
operates throughout several western states as well as its home state of California.

Notes 69

Summary

This chapter presents a framework to help senior managers understand and guide organizations at
different stages of growth and development. It describes the first four major stages of organizational
growth, from the inception of a new venture (Stage I) to the consolidation of a professionally man-
aged organization (Stage IV). It examines the degree of emphasis that must be placed on each level
of the Pyramid of Organizational Development at each stage of growth. It also examines the dif-
ferences between an entrepreneurial and a professionally managed organization and describes the
steps that must be taken to make a successful transition from one stage of growth to the next.

In the next chapter, we examine the remaining three stages of growth comprising the organiza-
tional life cycle: diversification, integration, and decline-revitalization.

Notes

1. Personal communication with David Jones, February, 15 2015.
2. Ibid.
3. Steve Coll, “The Rise and Fall of Adam Osborne,” California Magazine, November 1983, 92.
4. Howard Schultz and Dori Jones Yang, Pour Your Heart into It: How Starbucks Built a Company

one Cup at a Time (New York: Hyperion, 1997).
5. See Tom Peters, Thriving on Chaos (New York: Alfred A. Knopf, 1987).
6. See Eric Flamholtz, “Corporate Culture and the Bottom Line,” European Management Journal

19, no. 3 (2001): 268–275.

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