By Joseph Weber When the White House tapped Kellogg (K) Chief Executive Carlos M. Gutierrez to be Commerce Secretary in the fall of 2004, few people were more surprised than the directors of the Battle Creek (Mich.) cereal maker. Gutierrez, then 51, had led an impressive six-year turnaround, and they expected him to lead the company for another 15 years or so. Thus the call from the Bush Administration was a shocker on a par with, say, Tony the Tiger quitting to work for animal rights. "It fell into the emergency category," recalls director John T. Dillon.
Luckily, the board had a plan--or actually two, both a short-run fix and one for the long haul. First, the directors tapped one of their own, James M. Jenness, to move in temporarily as CEO. He had served on the board for four years and worked cheek by jowl with prior CEOs for two decades as a Kellogg Co.'s adman at the Leo Burnett Co. agency. Jenness' biggest job: make the board's long-term plan work by buffing up their ultimate CEO choice, President A.D. David Mackay, now 51. Jenness, 60, put Mackay through a nearly two-year crash-course in life at the top--a time that Jenness says "just gave him more ways to mature and to see some more of the game"--before Mackay took the CEO's title on Dec. 31, 2006.
The directors swiftly rejected one option that many boards in a similar situation would have considered: tapping a high-profile outsider. Even though Mackay was not quite ready to assume the top job, the directors did not want to entrust the nearly 100-year-old company to someone who hadn't spent his professional life hip-deep in corn flakes, Rice Krispies, and Froot Loops. Kellogg insiders "understand the company and its culture. They're tuned in," says director Dillon, a former International Paper Co. (IP) CEO who has served on the Kellogg board for six years. Going outside for a long-term CEO, he adds, "would confuse our shareowners, our employees, and the trade. It would send a signal that the board is not confident in its people development, and not confident in the performance and strategy."
Fashions are changing in the boardroom: Outsiders are suddenly out. Mackay is among the 85% of CEOs appointed to S&P 500 companies last year who hailed from inside their companies: 61 out of 72 appointments, reports executive search firm Spencer Stuart. This is a sharp increase from prior years. Only 60% of a total 60 CEO appointments were internal in 2005 and 66% of 67 in 2004. White knight saviors with stellar records at other companies, once all the rage among boards that sought to shake up tired management teams, are becoming increasingly pass?. "People have been burned by the glamorous outsider," says Warren G. Bennis, a professor of business at the University of Southern California. Witness the unhappy departures of Gap's (GPS) Paul Pressler, Home Depot's (HD) Robert Nardelli, and Hewlett-Packard's (HPQ) Carleton Fiorina in recent years.
WHILE AN UNFORGIVING Wall Street and relentless competition combine to give outsiders little time to learn the business, insiders can hit the ground running. They usually boast personal relationships with customers and suppliers, and already know which executives can deliver.
There's a proven payoff to having an insider CEO: After studying shareholder returns from 1995 to 2005 for some 1,595 companies around the world, consulting firm Booz Allen Hamilton Inc. found that outside CEOs typically do better in their first few years than insiders--but that the bloom goes off the rose once the payoffs from quick fixes, such as cost-cutting, fade away. The outside CEOs produced shareholder returns in the first half of their stints that were nearly four times better than those achieved by insiders, a median annual gain of 8.6%. But the second halves of their tenures fizzled, posting declines of 2.6% in yearly returns, while insiders chugged along, racking up annual hikes of 1.1%. The imports "make bold moves but run out of moves after three or four years," says Booz Allen Senior Vice-President Paul F. Kocourek. "Either they don't know the industries or the players well enough, or don't think through the growth strategies."
AT KELLOGG, TOP LEADERS HAVE LONG COME from the inside. Before Jenness and Mackay took over, the previous five CEOs each clocked between 24 and 36 years at the cereal maker before moving to the corner office. Mackay started at Kellogg in 1985 in Australia, where he grew up, and he moved up in assignments in Ireland, Britain, and the U.S. The New Zealand-born executive, who sometimes calls colleagues "mates" and pronounces his name like "McKie," often breaks into an easy laugh and seems surprised at how far he's gone professionally. He rose from job to job every three to five years with no clear career ladder in mind, just taking every challenge in stride. But after declining a move to Asia, he felt his career at Kellogg was stymied, so left in 1992 for a rival, an Australian bakery unit of Sara Lee Corp. (SLE) Wooed back in 1998, he rose to head the all-important U.S. unit of Kellogg in 2000 before being tapped as president and chief operating officer in 2003.
Kellogg directors have good reason to favor insiders. Industry veterans know that foodmaking is as much about advertising, marketing, and tracking fast-shifting consumer preferences as about factory capacities, bargaining with retailers, and the subtleties of finance. With Mackay, too, the board had someone who was deeply immersed in Gutierrez's winning turnaround efforts; Mackay was the former CEO's right-hand man and was committed to his game plan.
Gutierrez, who started at Kellogg in 1975 and became CEO in 1999, was proof that an insider could make tough and unsettling changes--he cut staff and even shuttered an original corn flakes plant--and still map a potent growth path. To drive sales, Gutierrez unveiled such novel products as Special K snack bars, bought cookiemaker Keebler Co., and ramped up Kellogg's health-foods presence by snapping up Worthington Foods Inc., a maker of soy and vegetarian products, and cereal maker Kashi. He pushed net earnings up 77%, to $890.6 million, from 1998 to 2004, as sales rose 42%, to $9.6 billion; no wonder the stock soared 54%, to some $42 a share. Now, with Kellogg at $10.9 billion a year in sales and growing nicely, the stock hovers around $52.
When Cuban-born Gutierrez suddenly decamped to answer his adopted country's call in Washington, the directors weren't the only ones surprised. Mackay never expected to get a crack at the corner office. Because he was just a year and a half younger than Gutierrez, he figured he had topped out at Kellogg. "My expectation was I'd be president of the company for many years and then probably retire as president of the company," he says.
A horse veterinarian's son who grew up in tiny Mudgee, 162 miles outside Sydney, Mackay filled most, but not all, of the bill as CEO. His biggest shortcoming was a dearth of experience in the boardroom, where he had made presentations but was scarcely intimate with Kellogg directors and lacked a boardroom insider's view of corporate life. He was immediately invited to join the Kellogg board and, to get even more experience, took a seat on the board at Fortune Brands Inc., (FO) the $8 billion-a-year diversified marketer of Jim Beam whiskey, home hardware goods, and golf gear. The appointment, brokered by Spencer Stuart, gave him a chance to see how another company operated. And, he says, it allowed him to "get a better appreciation of the difficulty of being a director." Mackay was particularly struck by how board members operate with little first-hand information, and must rely on managers whom they can trust. He was coached, too, by Jenness, who remains chairman at Kellogg. Director Dillon suggests that Mackay's internship was a big help to the CEO-apparent: "We're not all brilliant on Day One."
Jenness also slowly brought Mackay, who was chiefly an operating guy, into the spotlight for analysts and investors. He made a point of putting him front and center at the company's annual meetings, quarterly analyst calls, and periodic major analyst meetings, so Wall Street could warm up to the lanky, straight-talking manager. "It gave him time to get to know the ropes," says John M. McMillin, a food industry analyst with Prudential Equity Group (PRU), who added that functioning as both chief executive and chief operating officer might have proved onerous. "It kept the heat off
IT ALSO HELPED THAT JENNESS AND Mackay have been friends for years and, says Mackay, "get on incredibly well." They are regulars at a couple of Battle Creek golf courses and often wager on their matches. (Mackay is the stronger player, Jenness allows, but doesn't always win.) Even today, the chairman has a photo in his office of the pair horsing around and mugging for the camera. While grooming Mackay, Jenness took pains to make it clear to staffers that he and his pupil were "true partners," adding that, "when it's genuine, people can see it and smell it." Jenness also believed his joint appearances with Mackay at company meetings "would set a tone that David was somebody that I very much viewed as a potential successor."
It also helped that neither man had clawed his way into the job--and that each could bolster the other. While Mackay had a lot to learn from Jenness' ad expertise and board savvy, Mackay's operating acumen helped Jenness. Having grown close to Kellogg by working on virtually all its brands over 22 years in advertising, Jenness had left Leo Burnett as vice-chairman and COO in 1997 to run a retailing consultancy, and joined the Kellogg board only in mid-2000. He would pop into Battle Creek periodically for board meetings from his home in Chicago and bought a place locally only after he was tapped as CEO. When he was named to the top job, nervous investors trimmed Kellogg stock 3%, as analysts such as McMillin lowered their target prices.
As for Mackay, it would have been reasonable to expect a little champing at the bit over a two-year stretch. But his easygoing style may have kept any impatience in check. Throughout his career, he says, he worked with a two-to-three-year horizon, not knowing that the top rung was even a possibility until he was named head of Kellogg's North America unit in 2000. After earning his bachelor's degree in business at what is now Australia's Charles Sturt University, he admits he had no clue about what to do. One of his most memorable early jobs was as a "raw materials movement manager," handling offal from slaughterhouses at a pet-foods unit of Mars Inc. "Life takes you where it takes you," he muses, noting he didn't even join Kellogg until he was about 30.
KELLOGG IS TRYING TO MAKE THINGS A LOT less random nowadays. The deliberate, painstaking approach to succession through which Jenness led Mackay is now official policy. Kellogg expects executives to always have potential successors in mind, though ambitious executives at the various points along the management chain may not know for sure if they're in the running for their bosses' jobs. Managers must guide the career development of their prot?g?s, trying to move them around the company every three to five years to round them out.
Mackay, who has been in his post for just a few months, is already lining up at least two potential heirs. "I've had a discussion with the board," he says. "You know, 'What happens if I get hit by a bus?'" One of Mackay's potential successors is Jeffrey W. Montie, the 45-year-old president of Kellogg North America. A marketing veteran who joined Kellogg in 1987, he's now working in the intricacies of finance. The other is Chief Financial Officer John A. Bryant, a 41-year-old Australian chartered accountant and former Deloitte & Touche executive who joined the company in 1998. He is now building his operating skills by also serving as president of the international unit. Naturally, there's a built-in rivalry between Mackay's prot?g?s--although both men, predictably, say they have too much to do to squabble. "It doesn't feel like a tension point to me," says Montie.
In addition to making sure that up-and-comers like Montie and Bryant get exposed to different parts of the business, Kellogg calls on outside experts to further the management skills of its CEO candidates. Outside coaches can also help counter any insularity a company veteran might develop. Montie is spending time with a high-profile executive coach, Marshall Goldsmith, who has worked with such executives as newly appointed Ford Motor Co. (F) CEO Alan R. Mulally, former Girl Scouts of the usa head Frances Hesselbein, and General Mills Inc. (GIS) Chief Financial Officer James A. Lawrence. (Goldsmith writes a column for Businessweek.com.)
Goldsmith will visit Montie frequently over an 18-month stretch, touching base with him and 24 of the people who work with him. The coach identifies shortcomings in his manager-clients--for example, an inability to listen or give recognition, or to keep a broad, strategic perspective in business decisions--and helps them develop techniques to fill the gaps. He counsels Montie, an ambitious executive, to be patient and to remember to count his blessings. "My mission is to help highly successful people get better," says Goldsmith. Bryant has also worked with a coach.
Some boards are still appointing glam outsider CEOs, but generally it's only when they have failed to groom a good replacement, want to signal a strategic shift, or face legal problems that demand a change. Among companies that have gone outside for top talent, only to turn inside again lately, are Merck (MRK), Nike (NKE), and Fannie Mae (FNM). Jim Collins, author of leadership best seller Good to Great, sides with such boards. "An outsider is a hired gun," he argues. Wandering executives tend to be ambitious for themselves but not for companies they previously have had little stake in, observes Collins, while an insider may feel a deep commitment to a place that has long been a professional home.
Mackay hopes that theoretical discussions about the relative merits of insiders and outsider CEOs are a moot issue for Kellogg. He plans to lead the company for more than a decade. But if he's suddenly whisked away by, say, a phone call from the Prime Minister of Australia, the cereal giant will be ready. Crows director Dillon: "We've got a deep bench."
Weber is chief of correspondents for BusinessWeek, based in Chicago.