This fiscal year, analysts expect P&G to post a 6% increase in sales -- the biggest revenue gain in seven years. That jump won't come at the expense of operating profits, which are expected to rise 11%. Meanwhile, cash flow from operations has nearly doubled since Lafley took over.
Within P&G, the 55-year-old executive is making changes that are extraordinary, at least by the outfit's standards and history. He has broken P&G's must-invent-it-here mentality by looking outside to acquire new technology, such as the purchase of SpinBrush, a hot-selling electric toothbrush. To better utilize P&G's assets, he is open to outsourcing operations, even manufacturing.
In perhaps his biggest symbolic move, Lafley is gutting the 11th floor of P&G's corporate headquarters in Cincinnati -- the untouched lair of P&G's top executives since the building went up 50 years ago. Going is the dark wood paneling and the offices of 11 division presidents, who are moving out to be closer with their teams. In its place, a training center that will draw employees from around the world will now occupy most of the floor. Lafley and the 11 executives who remain will share open offices and do some of the teaching at the center. Lafley made this change without alienating P&G employees, a problem that seemed to bedevil his predecessor, Durk I. Jager. In a recent interview with BusinessWeek Chicago Correspondent Robert Berner, Lafley explained his business strategy and spoke about philosophy of change. Here are edited excerpts of the conversation:
Q: Cost savings from the massive restructuring started by your predecessor are winding down. Those savings have given you more financial flexibility. At the same time, the promotional environment in the consumer-products industry is the most aggressive it has ever been. The strong earnings and sales gains this year will make for tough comparisons next year. How will you sustain results?
A: It's going to come down to the quality of our brand creation, and building the quality and batting average of our innovation, and, I think, the increasingly more systemic approach to cash and costs. Let me take the last one first. We have paid a lot of attention to cash. We have paid a lot of attention to total shareholder return, and we are generating a lot of cash. That is different from the old P&G. We are also getting our costs down.
We are also getting our costs down. We have to get our costs down because what is driving the promotional activity in our category is that the consumer wants choice and a better and better value. The retailers that are succeeding tend to be the discounters, and they are offering a better value. We have to get the costs down to stay competitive and, so far, we have been. And the trends in our costs clearly indicate we are gong to be able to deliver a very competitive cost structure -- ideally the best cost structure in most of our industries -- even postrestructuring.
The other two things are: We have spent a lot time on innovation. We have opened up our innovation program to the point where we are trying to do two things. Today, about 20% of our invention comes from outside. We'd like to get it up to 40% to 50% eventually. And if you think about that, that means we would double the productivity of our current investment in R&D. Half would come from inside, and half would come from connecting and developing outside.
And the last one is our core categories. You take a brand like Olay. We still have an incredibly small market share in skin care, and it's going to be a billion-dollar brand next year. I don't know what it is, but we are talking a few percentage points of the skin-care market. As big as our hair-care business is, we are still a single-digit market share. So there is tremendous upside from taking these core business categories and leading brands and upgrading them, extending them, nesting related products and services around them and turning them into real megabrands.
Q: On one side you have stuck to the fundamentals, but on the other, you're a real agent for change, making adjustments P&G likely wouldn't have made in the past. Could you articulate your business strategy in a nutshell?
A: The essence of our strategy is incredibly simple, but I believe the simplicity is its power. And the essence of the strategy is, we are going to build and profit from the core. All the choices we have made are: Let's build from our core strengths, whether that core strength is a leading brand position, a leading country, market-place position, or a leading technology position. We want to make those core capabilities stronger and stronger so that it's an overwhelming competitive position. It's Sesame Street-simple, but it works.
Q: What is your philosophy on change?
A: The first thing is that change is accelerating. It is pervasive, affecting all parts of our consumers' lives, our industry lives, our business lives. It's highly unpredictable and volatile. In that context, you only have three choices: You can hide from change and hope it goes away. That's a losing game. You can try to resist change, and I believe that's a losing game, too. So the only real choice is to lead change, especially where leading that change turns into some type of competitive advantage. I am quite a believer that leaders are change leaders.
We haven't made a big deal about this, but I really have changed a lot of the leadership in the company. Half the top 30 leaders are from outside the U.S. I believe very strongly in people who had to get it done in tough places around the world -- in places where P&G is not the leader, where it's so far behind that it has to fight its way onto the beach. I also selected people who are much more change leaders and much more inspirational leaders, frankly.
And I have made a lot of very symbolic and very physical changes so people understand that we are in the business of leading change.
Q: Might you be referring to your remake of P&G's hallowed 11th floor?
A: Oh my God. People went a little crazy until they realized I was serious. But this place is 50 years old. All the thick paneling. We are basically going to blow it up! Two-thirds to three-quarters of this corporate headquarters is going to be a learning center. That is a powerful statement because I really believe knowledge is power, and translating knowledge into action in the marketplace is one of the things that distinguishes leadership.
And so we will have this leadership-training center full with P&Gers from around the world. The remaining 12 offices are open. I mean I am sitting out there in the middle of stuff. And they are open so we can talk to each other, and we will constantly collaborate and work on things. And we are also right next to the training center because I expect every one of the 12 of us -- the CFO, the chief legal officer, the treasurer -- we need to be doing a lot of the training ourselves.
Q: Durk Jager, your predecessor, was a change agent too. But he didn't get the support of the employees. You seem to have made change with everybody on board. How have you done that?
A: I worked for Durk 7 out of 10 years. Probably 80% of our philosophy and strategy is identical.
There are three main differences. One is I put together the guiding coalition -- the leaders who would go with me. If you are going to make a significant change, you have to declare where are we going and why are we going there. Then you have to put together this guiding coalition. You have to put the true disciples together -- the prophets who believe in it as passionately as you do. And they help you to carry the organization, because you can't carry a 100,000-person organization spread across 80 to 100 countries by yourself.
The second thing is, I built change from the core. I said we are going to preserve the core. In other words, we are a brand-and-innovation company. We create and build brands. I preserved our values and our principles. But then I said we are going to have to change everything else to be more competitive.
The third thing is that I picked a few symbolic things, like changing the 11th floor or very symbolic statements, to try to shake people and just get them to think about things differently. Like we have to realize the consumer is the boss. Sort of simple stuff, but the kind of stuff that gets people to understand what I expect them to do. Then I trust them to do it. I trust them to figure out the strategies and tactics to do it. But I expect them to go in that direction. Those are the differences.
Q: I thought the consumer was always boss at P&G. What is the difference?
A: What happened was we got too focused on the technology side of innovation. And I pushed the innovation focus -- it isn't a great innovation until she loves it and purchases it, and until we commercialize it. So that just sort of flipped it. And so now all the scientists -- and we employ a lot of them -- now they understand that innovation is in the consumer's eyes. Innovation has to be a good value. It's not innovation at any price or cost.