) to post a 13% increase in net income on 8% higher sales. That would bring P&G's annual compounded earnings growth rate under the three years of Lafley's leadership to 15% -- a rate well above rivals'. During that period, P&G's stock price has climbed by 58%, while the Standard & Poor's 500-stock index fell by 32% (it has recently traded in the low $90s).
Less obvious than his turnaround success, however, is how Lafley is changing P&G. He's undertaking the company's most sweeping remake since it was founded in 1837. Nothing is sacred any longer at the Cincinnati-based maker of Tide, Pampers, and Crest.
Lafley has inverted the invent-it-here mentality by turning outwards for innovation. He's broadening P&G's definition of brands and how it prices goods. He's moving P&G deep into the beauty-care business with its two largest acquisitions ever, Clairol in 2001 and an agreement in March to by Wella. And he's redefining P&G's core business by outsourcing operations -- like information technology and bar-soap manufacturing.
What's surprising is that at the start, Lafley was perceived as a tame pair of hands -- far from a person who would conduct a radical makeover. He followed a forceful change agent, Durk Jager, who had tried to jump-start internal innovation, launching a host of new brands. Jager also criticized P&G's insular culture, which he sought to shake up. In the end, though, he overreached, as P&G missed earnings forecasts and employees bucked under his leadership.
Lafley talked with BusinessWeek Correspondent Robert Berner recently about his views on change and his ultimate direction for P&G. Edited excerpts follow:
Q: When you started, you weren't perceived as a forceful change agent like your predecessor. Yet you're making more dramatic changes. Can you discuss that?
A: Durk and I had believed very strongly that the company had to change and make fundamental changes in a lot of the same directions. There are two simple differences: One is I'm very externally focused. I expressed the change in the context of how we're going to serve consumers better, how we're going to win with the retailer, and how we're going to defeat the competitor in the market place.
The most important thing -- I didn't attack. I avoided saying P&G people are bad. I thought that was a big mistake [on Jager's part]. The difference is, I preserved the core of the culture and pulled people where I wanted to go. I enrolled them in change. I didn't tell them.
Q: Why did you both see a need for change?
A: We were looking at slow growth. An inability to move quickly, to commercialize on innovation and get full advantage out of it. We were looking at new technologies that were changing competition in our industry, retailers, and the supply base. We were looking at a world that all of a sudden was going to go 24/7, and we weren't ready for that kind of world.
Q: Was the view on the need for change widely held within P&G?
A: It depends on who you ask. Without a doubt, Durk and I and a few others were in the camp of "We need a much bigger change."
Q: Jager says he tried to change P&G too fast. What do you think about that?
A: I think he's right.
Q: Are you concerned about the same thing?
A: I'm worried that I will ask the organization to change ahead of its understanding, capability, and commitment, because that's a problem. I have been a catalyst of change and encourager of change and a coach of change management. And I've tried not to drive change for a sake of change.
Q: How do you pace change?
A: I have tremendous trust in my management team. I let them be the brake. I am the accelerator. I help with direction and let them make the business strategic choices.
Q: Did the fact that P&G was in crisis when you came in help you implement change?
A: It was easier. I was lucky. When you have a mess, you have a chance to make more changes.
Q: Jager tried to drive innovation from within. You would like P&G to ultimately get 50% of its ideas from outside. Why?
A: Durk and I both wanted more innovation. We both felt we absolutely, positively had to get more innovation. We had to get more innovation commercialized and more innovation globalized. So we were totally together.
He tried to drive it all internally. He tried to rev the R&D organization, supercharge them, and hoped that enough would come out of there that we would achieve the goals of commercializing more of it and globalizing more of it. We got in trouble cause we pulled stuff out that was half-baked or that was never going to be successful. We hadn't developed it far enough.
The difference is that my hypothesis is that innovation and discovery are likely to come from anywhere. What P&G is really good at is developing innovations and commercializing them. So what I said is, "We need an open marketplace."
We're probably as good as the next guy at inventing. But we are not absolutely and positively better than everybody else at inventing. There are a lot of good inventors out there.
Q: How hard will it be to shift P&G's R&D focus outwards, given that it has historically focused inwards?
A: It will be a challenge, but I think we'll get there. It's like a flywheel. That first turn is really difficult. Then the second turn is a little bit easier. This has been like turning a flywheel. We will have failures. We will have to celebrate that failure.
Q: When you couple your outward focus on innovation with your moves toward outsourcing, it seems you're making P&G a less vertically integrated company.
A: I don't believe in vertical integration. I think it's a trap. I believe in horizontal networked organizations.
Our core capability is to develop and commercialize. Branding is a core capability. Customer business development is a core capability. We concluded in a lot of areas that manufacturing isn't. Therefore, I let the businesses go do more outsourcing. We concluded that running a back room wasn't a core capability. You do what you do best and can do world-class.