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Bigger and Smaller Is Better

April 15, 2009 • Scott McMurray

Is General Motors destined to fail? Citigroup bound to be dismantled? Do economies of scale inevitably give way to entropy? Google, are you listening?

History suggests that bigger is better … until it isn’t. At some point in the corporate growth cycle organizations seem to forget what made them successful in the first place. In the staple of B-school case studies, the giant defends the status quo as if it is his birthright, only to be toppled by nimbler, smaller rivals. Of course, nobody said capitalism was easy; creative destruction and all that. Yet every now and then corporate history provides some examples of beating the odds, and in some innovative ways.

Some companies manage to combine the best of the giant with the best of Jack (of bean stock fame). Illinois Tool Works (ITW) was formed in the Chicago area almost 100 years ago. The small toolmaker grew steadily in its formative decades and aspired to gigantism. But as WWII hastened the search for ever greater economies of scale in industrial production to meet wartime demand, company management chose a different approach. They realized that they could respond better and faster to customer demand if they decentralized their operating businesses.

In the postwar years, centralization of corporate organizations and production became an unquestioned article of industrial faith—what was good for General Motors was good for America. ITW, on the other hand, made decentralization one of its core values. And it continues to practice what it preaches.

Decades of strategic acquisitions have created a global enterprise with more than 65,000 employees. But a relentless focus on decentralization keeps operating divisions at an optimal size, and centralized support functions at minimal levels. On the other hand, centralized R&D helps drive innovation throughout the organization. As a result, a handful of senior management teams oversee 875 business units worldwide.

The “giant” corporate parent encourages the business unit “Jacks” to operate as entrepreneurially as possible. Indeed, if a unit gets too big it lops off a portion of its business, creating a new, standalone Jack. At the same time, the Jacks are encouraged to think like giants when it comes to their customer base.

The “little” operating units are directed to focus on their “big” clients. ITW has made the business rule of thumb known as the 80-20 Rule another of its guiding principles. The 80-20 Rule stipulates that 80 percent of revenues tend to be generated by the 20 percent of a company’s largest clients. Every acquisition is put through the 80-20 process, sometimes under duress. Shedding small, less profitable clients isn’t easy, especially for the Jacks of the business world, who too often see themselves in their smaller customers. They tend to gravitate toward businesses that mimic their own, rather than focusing on their biggest clients as the most efficient engines of growth.

Jack-sized business units catering to giant clients. It is not an easy strategy to execute across industries, year in and year out. That may explain why ITW remains such an operating anomaly, and such a successful one.

With significant exposure to the auto and construction industries, ITW has taken its economic lumps lately. When the turnaround comes, however, ITW is going to be as close to its customers as possible, and ready to meet their needs.

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