Part 1
The Principles of Intelligent Restraint Chapter 1
When Restraint Is Intelligent
Driving long-term, profitable growth requires you to build capacity and capabilities as if you were an endurance athlete. When you practice Intelligent Restraint, you learn how to push yourself and others to go as far and as fast as you can, but no further.
This concept seems so straightforward when applied to your body, but itâs so easy to ignore it when applied to a business.
Intelligent Restraint doesnât only mean holding back. Sometimes you have to push yourself and others to go further and faster. Getting the balance right is hard, and not achieving it can have dire consequences.
In this opening chapter, I tell three storiesâeach of them trueâto show a range of company approaches to growth. My guess is that you may recognize yourself or your company in one of these stories.
Unchecked Growth Swallows Krispy Kremeâs Potential
Growing up in Knoxville, Tennessee, I liked nothing better than when my family bought a big box of mixed Krispy Kreme donuts and then argued over who got what. As far as donuts go, Krispy Kreme had thenâand still hasâa great product.
As a growth business, itâs another story.
Founded in North Carolina in 1937, the family-owned Krispy Kreme donut chain had grown steadily, establishing itself as a stalwart feature of suburban shopping malls across the American Southeast. In the mid-1990s, company management embarked on a rapid nationwide expansion drive that included opening new stores in high-profile locations like Manhattan and Las Vegas.
As new outlets sprang up, customers lined up before dawn to buy donuts fresh out of the fryer, a trend the stores encouraged with âHOT NOWâ neon signs that lit up when new batches were ready for sale. Dazzled by its new wave of success, Krispy Kreme launched an aggressive franchising effort, opening outlets as fast as it could. Gas stations, shopping malls, kiosksâbasically anywhere that could sell a donutâbecame fair game.6
In April 2000, Krispy Kreme went public. On the first day of trading, investors looking to desert the faltering dot-com bubble piled in and the KKD stock soared 76 percent. Krispy Kreme then experienced huge pressure to sustain expansion quarter after quarter, and growth quickly became the companyâs only story. And it seemed to be delivering. By mid-2003, Krispy Kreme stock was trading near $50, up 235 percent from its IPO price. Fortune magazine labeled the donut maker âthe hottest brand in the land.â7
However, far from Wall Street, on Main Streets everywhere, the brand was suffering. The strategy of selling donuts anywhere and everywhere diluted the appeal of its core product. Piles of day-old donuts in grocery stores and gas stations meant Krispy Kreme became ubiquitous, diluting the âfreshly madeâ appeal and neglecting the donut-making theater that had been part of the brandâs novelty and mystique.
At the same time, Krispy Kremeâs uncontrolled focus on growth for growthâs sake meant the market became rapidly oversaturated as new franchises were opened, often just a few blocks from each other. Although that distribution model enabled the firm to report continued growth, it undermined the franchising system by putting outlets in competition with each other. Adding to pressure on struggling franchisees, the firm required all outlets to buy supplies only from HQ at steeply marked-up prices.8
The cracks in the sugary glaze began to appear in mid-2004. Announcing its first-ever missed quarter and first loss as a public company, Krispy Kremeâs CEO assigned blame to the growing fad for the low-carb Atkins Diet, an explanation that raised eyebrows among investors.9 Meanwhile, accusations grew from franchisees that headquarters was shipping stores up to twice their regular inventory in the final weeks of a quarter so the firm as a whole could bolster its reported profits. Several took legal action.
In early 2005, Krispy Kreme announced it was restating its earnings for the previous year and replacing its CEO with turnaround specialist Stephen Cooper. By April the firm warned of another quarterly loss. Moreover, it advised investors not to rely on published financial reports for fiscal years 2001, 2002, 2003, and the first three quarters of 2004, raising questions over its financial performance since it went public.10
By summer 2005, Krispy Kremeâs stock had nose-dived to around $6. In an effort to avoid bankruptcy, Cooper announced a turnaround plan, shuttering more than 70 of its donut-making stores (about one-fifth of the total) and refocusing its growth efforts on international expansion.11
Krispy Kreme is a case study in how a traditional company can stumble by going faster and further than its capacity and capabilities can support. Krispy Kreme wanted growth and worked hard for it. But its leaders failed to apply the right restraint when it was needed, which led to a wasteful, poorly managed growth boom that was followed by an inevitable splat, a cycle of growth that wastes human and organizational energy. In short:
It was far too aggressive in expanding franchises and thus diluted its brand.
It lacked real insight into how much of its product could be sold within specific geographies and overestimated demand for the product.
It lacked disciplines to take out cost from its system as it grew so that its partners also could be profitable.
Addicted to rapid growth, it started to play games with product shipments to get its numbers.
And finally, in its eagerness to show growth, the company lost the trust of investors and partners when it was forced to restate its earnings.
Krispy Kreme didnât fail completely; a new management team turned the firm around by refocusing on international growth and broadening its product offerings. In mid-2016 it was announced that the company would be delisted after it was purchased by JAB Holdings, the investment company owned by Germanyâs billionaire Reimann family, for $1.35 billion.12
Krispy Kremeâs story shows what can happen when companies fail to restrain themselves. However, companies can also be too restrained. Dellâs experience shows what can happen when a great company is too restrained by what it does well.
Being too Direct Keeps Dell from Wooing Customers
Dell Computer Corporation was founded by Michael Dell in 1984 out of his college dorm at the University of Texas, Austin. From these very early days, when having a computer at work, let alone at home, was a rarity, the firm was built around the direct-to-customer model. Customers ordered a computer, had it built to a desired spec, and then got it shipped to their office or home in a few days.
The model was radical at the time and helped Dell grow rapidly when other PC makers were burdened with much more complex supply and distribution chains. Because it had no inventory and low R&D costs, the fast-growing Dell was able to tailor-make computers for customers at unbeatable prices.
It was a great model for the early days of the mass computer ownership era; in fact, it helped create that era. And for Dell it proved hugely successful. In 2005 the company was valued at $100 billionâmore than Apple and HP combined.13 (In early 2016 Apple was valued at $605 billion. How times have changed!)
As the market matured and shifted in the years after 2005, prices of PCs declined across the board. Dellâs competitors began to outsource their manufacturing, building in such large volumes that they were increasingly beating Dell on price. At the same time, competitors became better at segmenting markets and targeting their products to the needs of customers, whether they were gamers, big corporations, or anything in between. And many had another advantage: retail space, which made it easier to introduce new products because customers could try before buying.
In response, Dell stuck resolutely with its direct sales model. After all, this model had made it successful in the past and Michael Dell was convinced that sticking to the model would help the company navigate a changing marketplace.
Dell started to lose market share and as earnings fell, so did its stock value. By late 2005, Dell shares had plunged 28 percent in less than six months as earnings also fell by a third and the company was forced to slash earlier forecasts.14
Michael Dellâs solution was to go back to the model that made the company successful. It tried to sell premium products at a reasonable price. However, for many consumers, although Dell might have been the practical choice, it was also boring. Rivals like Apple, HP, and Acer moved to a model of offering a broader range of innovative new devices that they could sell at a premium. Dell still tried to compete by selling a high-volume, low-margin PC, but since it no longer had a significant cost advantage, the model didnât work very well.
Although Dell had excelled in supply chain innovation, this competency didnât transfer into other successful innovations. As the market shifted away from enterprise sales and into consumer electronics, Dell tried to innovate to keep up with Apple. It created the Digital Jukebox and DJ Jitty to compete with the iPod, the Adamo to compete with the MacBook Air and iPad, and the Aero, Streak, and Venue to compete in the smartphone business. All of these efforts were poor responses to the marketâtoo little, too late. Ironically, three years before the iPad was launched, managers in the company had advocated building a tablet PC to compete in the Japanese market. More importantly, they saw the growth of tablet sales in Japan as a leading indicator that tablets would catch on in other markets. Unfortunately, the company chose not to invest because the tablet market was not large. Instead, it wanted to focus on products where it could leverage its supply chain expertise. Had it invested in tablets earlier, it may have better been able to address the challenges of the iPad.
Dell also launched a series of marketing strategies, even dabbling in retail spots. None made an impact. Eventually Michael Dell fired his CEO and took back control of the firm.15 After a series of unimpressive quarterly reports, he realizedâbelatedlyâthat the company had become too constrained by its direct-to-customer model. The secret of Dellâs success had now become a burden.
In an effort to shift away from the low-margin PC business, Dell in 2009 completed its biggest acquisition ever, paying $3.9 billion for tech services provider Perot Systems. 16 At the same time, Dell brought in a new leadership team, including leaders from GE, Motorola, and IBM. The idea was to transform the business, introduce more consumer electronics, sell through new channels like Walmart, and cut costs.
Again, it was too little, too late. Although it hired the new leaders to reinvigorate the company, almost all left over the course of two to four years.
While Dell computers remain a feature of many offices around the world, the company has struggled to keep pace or find a place for itself as the fast-moving tech industry moved from the PC to the Internet. It also has struggled to compete with cheaper Asian manufacturers. In other words, it has simply run the wrong race.
In 2016, Dell sold Perot Systems and bought data-storage compan...