P&G: New and Improved

How A.G. Lafley is revolutionizing a bastion of corporate conservatism

It's Mother's Day, and Alan G. "A.G." Lafley, chief executive of Procter & Gamble Co., is meeting with the person he shares time with every Sunday evening -- Richard L. Antoine, the company's head of human resources. Lafley doesn't invite the chief financial officer of the $43 billion business, nor does he ask the executive in charge of marketing at the world's largest consumer-products company. He doesn't invite friends over to watch The Sopranos, either. No, on most Sunday nights it's just Lafley, Antoine, and stacks of reports on the performance of the company's 200 most senior executives. This is the boss's signature gesture. It shows his determination to nurture talent and serves notice that little escapes his attention. If you worked for P&G, you would have to be both impressed and slightly intimidated by that kind of diligence.

On this May evening, the two executives sit at the dining-room table in Antoine's Cincinnati home hashing over the work of a manager who distinguished himself on one major assignment but hasn't quite lived up to that since. "We need to get him in a position where we can stretch him," Lafley says. Then he rises from his chair and stands next to Antoine to peer more closely at a spreadsheet detailing P&G's seven management layers. Lafley points to one group while tapping an empty water bottle against his leg. "It's not being felt strongly enough in the middle of the company," he says in his slightly high-pitched voice. "They don't feel the hot breath of the consumer."

If they don't feel it yet, they will. Lafley, who took over when Durk I. Jager was pressured to resign in June, 2000, is in the midst of engineering a remarkable turnaround. The first thing Lafley told his managers when he took the job was just what they wanted to hear: Focus on what you do well -- selling the company's major brands such as Tide, Pampers, and Crest -- instead of trying to develop the next big thing.

Now, those old reliable products have gained so much market share that they are again the envy of the industry. So is the company's stock price, which has climbed 58%, to $92 a share, since Lafley started, while the Standard & Poor's 500-stock index has declined 32%. Banc of America analyst William H. Steele forecasts that P&G's profits for its current fiscal year, which ended June 30, will rise by 13%, to $5.57 billion, on an 8% increase in sales, to $43.23 billion. That exceeds most rivals'. Volume growth has averaged 7% over the past six quarters, excluding acquisitions, well above Lafley's goal and the industry average.

The conventional thinking is that the soft-spoken Lafley was exactly the antidote P&G needed after Jager. After all, Jager had charged into office determined to rip apart P&G's insular culture and remake it from the bottom up. Instead of pushing P&G to excel, however, the torrent of proclamations and initiatives during Jager's 17-month reign nearly brought the venerable company to a grinding halt.

Enter Lafley. A 23-year P&G veteran, he wasn't supposed to bring fundamental change; he was asked simply to restore the company's equilibrium. In fact, he came in warning that Jager had tried to implement too many changes too quickly (which Jager readily admits now). Since then, the mild-mannered 56-year-old chief executive has worked to revive both urgency and hope: urgency because, in the previous 15 years, P&G had developed exactly one successful new brand, the Swiffer dust mop; and hope because, after Jager, employees needed reassurance that the old ways still had value. Clearly, Lafley has undone the damage at P&G.

What's less obvious is that, in his quiet way, Lafley has proved to be even more of a revolutionary than the flamboyant Jager. Lafley is leading the most sweeping transformation of the company since it was founded by William Procter and James Gamble in 1837 as a maker of soap and candles. Long before he became CEO, Lafley had been pondering how to make P&G relevant in the 21st century, when speed and agility would matter more than heft. As president of North American operations, he even spoke with Jager about the need to remake the company.

So how has Lafley succeeded where Jager so spectacularly failed? In a word, style. Where Jager was gruff, Lafley is soothing. Where Jager bullied, Lafley persuades. He listens more than he talks. He is living proof that the messenger is just as important as the message. As he says, "I'm not a screamer, not a yeller. But don't get confused by my style. I am very decisive." Or as Robert A. McDonald, president of P&G's global fabric and home-care division, says, "people want to follow him. I frankly love him like my brother."

Indeed, Lafley's charm offensive has so disarmed most P&Gers that he has been able to change the company profoundly. He is responsible for P&G's largest acquisitions ever, buying Clairol in 2001 for $5 billion and agreeing to purchase Germany's Wella in March for a price that now reaches $7 billion. He has replaced more than half of the company's top 30 officers, more than any P&G boss in memory, and cut 9,600 jobs. And he has moved more women into senior positions. Lafley skipped over 78 general managers with more seniority to name 42-year-old Deborah A. Henretta to head P&G's then-troubled North American baby-care division. "The speed at which A.G. has gotten results is five years ahead of the time I expected," says Scott Cook, founder of software maker Intuit (INTU ) Inc., who joined P&G's board shortly after Lafley's appointment.

Still, the Lafley revolution is far from over. Precisely because of his achievements, Lafley is now under enormous pressure to return P&G to what it considers its rightful place in Corporate America: a company that is admired, imitated, and uncommonly profitable. Nowhere are those expectations more apparent than on the second floor of headquarters, where three former chief executives still keep offices. John Pepper, a popular former boss who returned briefly as chairman when Jager left but gave up the post to Lafley last year, leans forward in his chair as he says: "It's now clear to me that A.G. is going to be one of the great CEOs in this company's history."

But here's the rub: What Lafley envisions may be far more radical than what Pepper has in mind. Consider a confidential memo that circulated among P&G's top brass in late 2001 and angered Pepper for its audacity. It argued that P&G could be cut to 25,000 employees, a quarter of its current size. Acknowledging the memo, Lafley admits: "It terrified our organization."

Lafley didn't write the infamous memo, but he may as well have. It reflects the central tenet of his vision -- that P&G should do only what it does best, nothing more. Lafley wants a more outwardly focused, flexible company. That has implications for every facet of the business, from manufacturing to innovation. For example, in April he turned over all bar-soap manufacturing, including Ivory, P&G's oldest surviving brand, to a Canadian contractor. In May, he outsourced P&G's information-technology operation to Hewlett-Packard Co.

No bastion has been more challenged than P&G's research and development operations. Lafley has confronted head-on the stubbornly held notion that everything must be invented within P&G, asserting that half of its new products should come from the outside. (P&G now gets about 20% of its ideas externally -- up from about 10% when he took over.) "He's absolutely breaking many well-set molds at P&G," says eBay (EBAY ) Inc.'s CEO, Margaret C. "Meg" Whitman, whom Lafley appointed to the board.

Lafley's quest to remake P&G could still come to grief. As any scientist will attest, buying innovation is tricky. Picking the winners from other labs is notoriously difficult and often expensive. And P&G will remain uncomfortably reliant on Wal-Mart (WMT ) Stores Inc., which accounts for nearly a fifth of its sales. Lafley is looking to pharmaceuticals and beauty care for growth, where the margins are high but where P&G has considerably less experience than rivals.

The biggest risk, though, is that Lafley will lose the P&Gers themselves. Theirs is a culture famously resistant to new ideas. To call the company insular may not do it justice. Employees aren't kidding when they say they're a family. They often start out there and grow up together at P&G, which only promotes from within. Cincinnati itself is a small town: Employees live near one another, they go to the same health clubs and restaurants. They are today's company men and women -- and proud of it.

Lafley is well aware of his predicament. On a June evening, as he sits on the patio behind his home, he muses about just that. The house, which resembles a Tuscan villa and overlooks the Ohio River and downtown Cincinnati, is infused with P&G history. Lafley bought it from former CEO John G. Smale three years before he was named chief executive. A black-and-gold stray cat the family feeds sits a few feet away and watches Lafley as he sips a Beck's beer. The clouds threaten rain. "I am worried that I will ask the organization to change ahead of its understanding, capability, and commitment," Lafley admits.

For most of its 166 years, P&G was one of America's preeminent companies. Its brands are icons: It launched Tide in 1946 and Pampers, the first disposable diaper, in 1961. Its marketing was innovative: In the 1880s, P&G was one of the first companies to advertise nationally. Fifty years later, P&G invented the soap opera by sponsoring the Ma Perkins radio show and, later, Guiding Light.

Its management techniques, meanwhile, became the gold standard: In the 1930s, P&G developed the idea of brand management -- setting up marketing teams for each brand and urging them to compete against each other. P&G has long been the business world's finest training ground. General Electric (GE ) Co.'s Jeffrey R. Immelt and 3M (MMM ) W. James McNerney Jr. both started out on Ivory. Meg Whitman and Steven M. Case were in toilet goods, while Steven A. Ballmer was an assistant product manager for Duncan Hines cake mix, among other goods. They, of course, went on to lead eBay, AOL Time Warner (AOL ), and Microsoft.

But by the 1990s, P&G was in danger of becoming another Eastman Kodak (EK ) Co. or Xerox (XRX ) Corp., a once-great company that had lost its way. Sales on most of its 18 top brands were slowing; the company was being outhustled by more focused rivals such as Kimberly-Clark (KMB ) Corp. and Colgate-Palmolive (CL ) Co. The only way P&G kept profits growing was by cutting costs, hardly a strategy for the long term. At the same time, the dynamics of the industry were changing as power shifted from manufacturers to massive retailers. Through all of this, much of senior management was in denial. "Nobody wanted to talk about it," Lafley says. "Without a doubt, Durk and I and a few others were in the camp of 'We need a much bigger change."'

When Jager took over in January, 1999, he was hell-bent on providing just that -- with disastrous results. He introduced expensive new products that never caught on while letting existing brands drift. He wanted to buy two huge pharmaceutical companies, a plan that threatened P&G's identity but never was carried out. And he put in place a companywide reorganization that left many employees perplexed and preoccupied. Soaring commodity prices, unfavorable currency trends, and a tech-crazed stock market didn't help either. At a company prized for consistent earnings, Jager missed forecasts twice in six months. In his first and last full fiscal year, earnings per share rose by just 3.5% instead of an estimated 13%. And during that time, the share price slid 52%, cutting P&G's total market capitalization by $85 billion. Employees and retirees hold about 20% of the stock. The family began to turn against its leader.

But Jager's greatest failing was his scorn for the family. Jager, a Dutchman who had joined P&G overseas and worked his way to corporate headquarters, pitted himself against the P&G culture, contending that it was burdensome and insufferable, says Susan E. Arnold, president of P&G's beauty and feminine care division. Some go-ahead employees even wore buttons that read "Old World/New World" to express disdain for P&G's past. "I never wore one," Arnold sneers. "'The old Procter is bad, and the new world is good.' That didn't work."

On June 6, 2000, his 30th wedding anniversary, Lafley was in San Francisco when he received a call from Pepper, then a board member: Would he become CEO? Back in Cincinnati, a boardroom coup unprecedented in P&G's history had taken place.

As Lafley steps into the small study in his house three years later, a Japanese drawing on the wall reminds him of what it was like to become CEO. The room, with its painting of a samurai warrior and red elephant-motif wallpaper, alludes to his stint running P&G's Asian operations. Bookshelves hold leather-bound volumes of Joseph Conrad and Mark Twain. A simple wooden desk faces the window. Lafley focuses on the drawing, which depicts a man caught in a spider's web; it was given to him by the elder of his two sons, Patrick. "In the first few days, you are just trying to figure out what kind of web it is," he says.

In a sense, Lafley had been preparing for this job his entire adult life. He never hid the fact that he wanted to run P&G one day. Or if not the company, then a company. That itself is unusual since, like almost all P&Gers, Lafley has never worked anywhere else. After graduating from Hamilton College in 1969, Lafley decided to pursue a doctorate in medieval and Renaissance history at the University of Virginia. But he dropped out in his first year to join the Navy (and avoid being drafted into the Army). He served in Japan, where he got his first experience as a merchandiser, supplying Navy retail stores. When his tour of duty ended in 1975, he enrolled in the MBA program at Harvard Business School. And from there, he went directly to Cincinnati.

When he was hired as a brand assistant for Joy dish detergent in 1977 at age 29, he was older than most of his colleagues and he worried that his late start might hinder his rise at P&G. Twice within a year in the early 1980s, Lafley quit. "Each time, I talked him back in only after drinking vast amounts of Drambuie," says Thomas A. Moore, his boss at the time, who now runs biotech company Biopure (BPUR ) Corp. On the second occasion, then-CEO John Smale met with Lafley, who had accepted a job as a consultant in Connec (NIPNY )ticut. Without making any promises, Smale says he told Lafley that "we thought there was no limit on where he was going to go."

Sure enough, Lafley climbed quickly to head P&G's soap and detergent business, where he introduced Liquid Tide in 1984. A decade later, he was promoted to head the Asian division. Lafley returned from Kobe, Japan, to Cincinnati in 1998 to run the company's entire North American operations. To ease the transition home, he and his younger son, Alex, who was then 12, studied guitar together. Two years later, Lafley was named CEO.

Along the way, he developed a reputation as a boss who stepped back to give his staff plenty of responsibility and helped shape decisions by asking a series of keen questions -- a process he calls "peeling the onion." And he retained a certain humility. He still collects baseball cards, comic books, and rock 'n' roll 45s. Whereas some executives might have a garage full of antique cars or Harley-Davidson (HDI )s; Lafley keeps two Vespa motor scooters. "People wanted him to succeed," says Virginia Lee, a former P&Ger who worked for Lafley at headquarters and overseas.

As CEO, Lafley hasn't made grand pronouncements on the future of P&G. Instead, he has spent an inordinate amount of time patiently communicating how he wants P&G to change. In a company famed for requiring employees to describe every new course of action in a one-page memo, Lafley's preferred approach is the slogan. For example, he felt that P&G was letting technology rather than consumer needs dictate new products. Ergo: "The consumer is boss." P&G wasn't working closely enough with retailers, the place where consumers first see the product on the shelf: "The first moment of truth." P&G wasn't concerned enough with the consumer's experience at home: "The second moment of truth."

Lafley uses these phrases constantly, and they are echoed throughout the organization. At the end of a three-day leadership seminar, 30 young marketing managers from around the world present what they have learned to Lafley. First on the list: "We are the voice of the consumer within P&G, and they are the heart of all we do." Lafley, dressed in a suit, sits on a stool in front of the group and beams. "I love the first one," he laughs as the room erupts in applause.

When he talks about his choice of words later, Lafley is a tad self-conscious. "It's Sesame Street language -- I admit that," he says. "A lot of what we have done is make things simple because the difficulty is making sure everybody knows what the goal is and how to get there."

Lafley has also mastered the art of the symbolic gesture. The 11th floor at corporate headquarters had been the redoubt of senior executives since the 1950s. Lafley did away with it, moving all five division presidents to the same floors as their staff. Then he turned some of the space into a leadership training center. On the rest of the floor, he knocked down the walls so that the remaining executives, including himself, share open offices. Lafley sits next to the two people he talks to the most, which, in true P&G style, was officially established by a flow study: HR head Antoine and Vice-Chairman Bruce Byrnes. As if the Sunday night meetings with Antoine weren't proof enough of Lafley's determination to make sure the best people rise to the top. And Byrnes, whom Lafley refers to as "Yoda" -- the sage-like Star Wars character -- gets a lot of face time because of his marketing expertise. As Lafley says, "the assets at P&G are what? Our people and our brands."

Just as emblematic of the Lafley era is the floor's new conference room, where he and P&G's 12 other top executives meet every Monday at 8 a.m. to review results, plan strategy, and set the drumbeat for the week. The table used to be rectangular; now it's round. The execs used to sit where they were told; now they sit where they like. At one of those meetings, an outsider might have trouble distinguishing the CEO: He occasionally joins in the discussion, but most of the time the executives talk as much to each other as to Lafley. "I am more like a coach," Lafley says afterward. "I am always looking for different combinations that will get better results." Jeff Immelt, who asked Lafley to join GE's board in 2002, describes him as "an excellent listener. He's a sponge."

And now, Lafley is carefully using this information to reshape the company's approach to just about everything it does. When Lafley describes the P&G of the future, he says: "We're in the business of creating and building brands." Notice, as P&Gers certainly have, that he makes no mention of manufacturing. While Lafley shies away from saying just how much of the company's factory and back-office operations he may hand over to someone else, he does admit that facing up to the realities of the marketplace "won't always be fun." Of P&G's 102,000 employees, nearly one-half work in its plants. So far, "Lafley has deftly handled the outsourcing deals, which has lessened fear within P&G," says Roger Martin, a close adviser of Lafley's who is dean of the University of Toronto's Joseph L. Rotman School of Management. All 2,000 of the information-technology workers were moved over to HP. At the bar-soap operations, based entirely in Cincinnati, 200 of the 250 employees went to work for the Canadian contractor.

Lafley's approach to selling P&G products is unprecedented at the company, too: He argues that P&G doesn't have to produce just premium-priced goods. So now there's a cheaper formulation for Crest in China. The Clairol deal gave P&G bargain shampoos such as Daily Defense. And with Lafley's encouragement, managers have looked at their most expensive products to make sure they aren't too costly. In many cases, they've actually lowered the prices.

And Lafley is pushing P&G to approach its brands more creatively. Crest, for example, isn't just about toothpaste anymore: There's also an electric toothbrush, SpinBrush, which P&G acquired in January, 2001. P&G is also willing to license its own technologies to get them to the marketplace faster. It joined with Clorox Co., maker of Glad Bags, last October to share a food-wrap technology it had developed. It was unprecedented for P&G to work with a competitor, says licensing head Jeffrey Weedman. The overall effect is undeniable. "Lafley has made P&G far more flexible," says Banc of America's Steele.

But Lafley still faces daunting challenges. Keeping up the earnings growth, for example, will get tougher as competitors fight back and as P&G winds down a large restructuring program -- started under Jager but accelerated under Lafley. Furthermore, some of the gains in profit have resulted from cuts in capital and R&D spending, which Lafley has pared back to the levels of the company's rivals. And already, P&G has missed a big opportunity: It passed up the chance to buy water-soluble strips that contain mouthwash. Now, Listerine is making a bundle on the product.

Nor are all investors comfortable with growth through acquisitions. The deals make it harder for investors to decipher earnings growth from existing operations. Then there's the risk of fumbling the integration, notes Arthur B. Cecil, an analyst at T. Rowe Price Group (TROW ) Inc., which holds 1.74 million P&G shares. "I would prefer they not make acquisitions," he says. Already, Clairol hair color, the most important product in P&G's recent purchase, has lost five points of market share to L'Oréal in the U.S., according to ACNeilsen Corp.

Making deals, however, could be the only way to balance P&G's growing reliance on Wal-Mart. Former and current P&G employees say the discounter could account for one-third of P&G's global sales by the end of the decade. Meanwhile, the pressure from consumers and competitors to keep prices low will only increase. "P&G has improved its ability to take on those challenges, but those challenges are still there," says Lehman analyst Ann Gillin.

Still, Lafley may be uniquely suited to creating a new and improved P&G. Even Jager agrees that Lafley was just what the company needed. "He has calmed down the confusion that happened while I was there," says the former CEO. Jager left a letter on Lafley's desk the day he resigned telling his successor not to feel responsible for his fall. "You earned it," he recalls writing. "Don't start out with guilt."

Lafley says he learned from Jager's biggest mistake. "I avoided saying P&G people were bad," he says. "I enrolled them in change." Lafley, a company man through and through, just can't resist trying out a new slogan.

By Robert Berner

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