The cornerstones of good business practices

by: Issues: May / June 2012. Tags: Leadership and Strategy. Categories: Leadership and Strategy.

Retailer IKEA did not become one of the most admired companies in the world by trial and error. The company was built on a carefully, well-thought-out foundation that remains firmly in place almost 40 years after the company was founded. The development and importance of each cornerstone is discussed in this article.

What criteria does a business have to meet in order for it to be successful? More importantly: Can a business combine financial success and satisfying shareholders’ demands with the broader objective of contributing to a better society? These are the two critical questions that I addressed in my recently published book, The IKEA Edge, and which I will discuss in this article.

The book is based on my 26 years with IKEA, ten of which I spent as the company’s CEO, from 1999-2009. In the book, I suggest that with the right conditions and building blocks in place, it is possible to contribute to society’s betterment and satisfy shareholders at the same time. In fact, if a company’s ambition is to contribute to a better society, I argue that it can become even more successful than it would be without such a goal.

In my view, a company needs 4 building blocks to be successful:

1. A vision that incorporates a social ambition and a strong value base.

2. Product range and price differentiation achieved by control of the entire value chain.

3. Market leadership and a balanced portfolio of outlets in emerging and mature markets.

4. A company that is controlled by a committed owner.

In my experience, apart from giving guidance and direction, the CEO must articulate the vision and values, which in turn are the foundation for building a strong and positive brand reputation among the many different stakeholders of the company. It is also the main competitive advantage for attracting, retaining and motivating the best people.

1. A vision that incorporates a social ambition and a strong value base

A vision with a social ambition will align the purpose of the company with the expectations that society, customers, co-workers, suppliers and others have of business in general.

This is probably the most controversial of all of my points. It takes guts and determination from any CEO, especially in listed companies with well-diversified ownership, to convince the owners and the board that a vision with a social ambition will meet the narrower, more traditional objective of increasing shareholder wealth.

Let’s look at the IKEA example. One of the company’s biggest strengths is its strong vision – “To create a better everyday life for the majority of people.” This vision was formulated in 1976, when Ingvar Kamprad, IKEA’s founder, pointed out that most objects which are beautiful and of high quality are developed only for the rich. He explained how IKEA wanted to change this and enable people with limited financial means to have access to home furnishings of high design and good quality.

It is easy to write a strong vision like the one above. But the challenge is to make it credible. This is only possible if it is embedded and reflected in the company’s decision-making, strategy and behavior.

One example of this at IKEA is the pricing philosophy. The company’s focus is on lowering prices and making the products affordable for more and more people.

The logic of the financial model — to achieve profits but at the same time to be affordable — is in tune with the company’s vision. Lower prices will deliver high volumes. In combination with keeping costs low, this policy delivered a bottom-line result. Contrary to many retailers, the company did not focus on improving the gross margin. Instead it wanted to develop its top line revenues in order to be profitable.  In line with the vision, savings in costs were passed on to the customers, not the shareholders.

Along with the vision, the company’s values are fundamentally important for building a strong brand and creating loyal, motivated employees.  To attract and retain the best people, a company needs a strong competitive advantage in the labor market – something that is difficult to copy. I believe a strong company culture is such an advantage.                                                                                                       

At IKEA we always recognized the importance of our values. Let me highlight a couple of things.

A company culture should, of course, support the business. But having said that I think it is a mistake for a company – and many companies make this mistake — to be too business-driven when defining their values. Words like business-minded, service-driven or customer-focused are often used. The most important thing in my mind is to have values that speak to very basic human needs…needs like respect, recognition, a feeling of togetherness and the possibility to grow and develop. Satisfying basic needs like these is the way to create true motivation and loyalty, which in turn will deliver the business results.

Another important point is that the company’s values must be integrated in all-important HR processes like recruitment, management review, training programs and promotions. Only then do you stand a chance of anchoring the values deeply and profoundly in the company.

My experience is that building a strong company culture takes time. Therefore, continuity is important. Values must not be changed every time you get a new CEO. A strong owner with a long-term commitment, combined with long-serving, internally recruited CEOs is an advantage. After 65 years, IKEA’s founder is still present in the company; there have only been three CEOs in that time, all internally groomed.

So, in conclusion, my first cornerstone for a successful business is to have a vision with a social ambition and a strong value base. This way you will build a good foundation for the company, with a strong and solid reputation among the many different stakeholders in society, and attract motivated, loyal managers and coworkers. This in turn will deliver the bottom-line results.

2. Differentiation through control of the value chain

My second cornerstone for successful business relates to the business model…what the company does and how it is done.

The key is differentiation of products and prices through control of the value chain. This will contribute in two important ways. It gives you the opportunity to meet basic customer needs — such as a unique, exclusive range, good value for money, service and choice — through your own sales channels. Such differentiation also makes it possible to build a competitive advantage that is difficult to copy.

In many retail sectors, the companies that control product development and brand ownership are generally not the same as those that own the retail outlets. This is the case in big sectors like electronics, white goods, food and DIY. Some examples are Best Buy, Home Depot and Wal-Mart. In the apparel and home-furnishing sectors, some retailers control the brands and retail outlets, such as Inditex, H&M, and IKEA. Because of this division of powers between brand owners and retailers, the differences in the product range, prices, services and store experience among retailers are almost undetectable to the consumers. They sell the same product, use similar store layouts, offer similar services and sell at similar prices. Evidently, the key to profitability and success is differentiation. Many retailers are struggling to achieve this and end up in a situation where they survive on small margins, through either being a little bit better at doing the same thing as everyone else or achieving some marginal advantage through better retail locations.

Innovations in the retail industry are often easy to copy, and differentiation is short lived. Substantial success can, in my opinion, only be achieved when a retailer has a unique product range and is in control of the whole value chain, from product development and production to the retail outlets. The trend at the moment is definitely going in this direction. Many retailers now develop their own product ranges. More and more retailers are developing their own brands, and I believe we will see a reduction of mid- and low-priced brands owned by FMCG companies such as Unilever and Nestle in the coming years (Fast Moving Consumer Goods).

One company that has achieved control of the whole value chain is IKEA. This is one of the key reasons for the company’s success.  Controlling the value chain helped the company set itself apart from the competition and create a distinct and unique brand, different from everyone else. A business model based on an exclusive, Scandinavian product range sold only in IKEA stores, with high functionality and quality at very low prices, that provided inspiration, ideas and solutions, with everything in one place, and on top of all this, a day in the store with children’s playroom and a restaurant. In short, a combination of customer benefits delivered in a way no that no one has so far been able to copy.

Let me just finish this part by pointing out the importance of the low price. IKEA has an obsession with low prices. The internal goal is to always have prices at least 20 percent below the competition on comparable products, and often even more than that. As an example, just consider that prices were reduced by 20 percent between 1999-2009.

You might ask how this was done. In one long sentence I would summarize it as follows: An integrated process of production adapted product development together with the suppliers; global sourcing; a distribution idea with the flat pack; and consideration of the customers’ needs in the selection, distribution and assembly of the products. Also important is a strong focus on cost consciousness and of course, large volumes. Through such control of the entire value chain, IKEA manages to combine low prices, good quality and profitability.

3. Market leadership and a balanced market portfolio

Let me now move on to the third cornerstone of successful retailing, establishing a balance of retail markets with growth potential and profitability in both the short-, mid- and long term perspectives. As an example, think of the Western Europe/U.S.  markets for short-term profitability, Eastern Europe for mid-term growth, and China/India for long-term growth and profitability. You should try to have a good mix/balance of these markets.

This is an important issue for retailers, especially in the zero-growth global economy of today. Why is it important? The answer is that it offers the possibility of growth in a no-growth environment. If your market portfolio consists of developing countries, you can be successful as long as you have a functioning business model for these markets. But most European and North American retailers don’t have such a model. In fact they have a very limited presence in these markets, and in most cases, are doing business with a model that is so far unprofitable.

Being successful as a truly global retailer is a challenge. The different challenges of Europe, North America, Asia, Russia and other markets have proven very demanding for many retailers. But look at the example of IKEA, which is able to things that many of today’s retailers cannot do. For example, IKEA is able to:

  • adapt the offer to fit different markets, while remaining unique
  • have competitive prices, especially in emerging markets
  • have a strong value base that can fit very different cultures
  • approach new markets in such a way that the company is seen to contribute in other ways than just enriching themselves
  • take risks and accept low or no profit for a number of years in future growth markets, and,
  • have a strong profitable home base that can finance all this activity.

4. A committed owner with a long-term perspective

Let’s move to the fourth and last cornerstone of a good business. What kind of ownership or governance is needed for a business to succeed and contribute to a better society?

The full-time presence of a dedicated, knowledgeable founder or owner with majority control is my preferred choice. Such an owner is more likely to have a longer-term perspective of the business and take more risk. Both of these factors are crucial to bringing more fundamental change and providing bigger opportunities to move ahead of the competition. A strong owner is also crucial to establishing a strong heritage and values, and to giving the company a soul, which, in turn, will create loyal, motivated coworkers more easily. No institutional owner or employed CEO (non owner) will stay long enough to be able to take that role. With their competence and knowledge, the owner can challenge the management and restrain them from granting themselves excessive perks and compensation. I also think the likelihood of being a “good company” is greater with a strong owner in charge. Profits can be deployed to support good causes without much debate.

In my opinion, private companies or listed companies with one committed, controlling shareholder has better prerequisites in place to create competitiveness, a dedicated workforce, and to see to it that the company is a good citizen, rather than public companies with a diluted ownership structure. This is, of course, predicated on the founder or owner having the required wisdom, dedication, knowledge, leadership and values.  IKEA is fortunate to be in this position.

So who are the companies that combine responsible business practices with high profitability? In the retail sector, looking at factors such as profit, sales growth, rankings in innovation, respected, attractive employers, and brand recognition, we see that companies like IKEA, H&M and Inditex are always well placed. All these companies meet the criteria of vision and values, differentiation in range and price, market leadership with a balanced portfolio of markets, and strong owners with a long-term perspective.

Eliminating poverty, creating greater equality and a better environment are changing society’s perspectives on the purpose of business. These are noble, fundamental goals but they cannot be achieved by government alone. I believe that a bigger contribution from the business community is necessary. This would most certainly help bridge the lack of trust in business that we are witnessing more and more today.