CHAPTER 1

THE WINNERS AND THE ALSO-RANS

Why do some companies become industry leaders, while others never rise to thetop? For example:

• McDonald's versus Roy Rogers

• Walmart versus Kmart

• Marriott versus Howard Johnson's

• Google versus Yahoo!

• UPS versus Airborne Express

• Amazon versus Borders

What has McDonald's discovered about cooking burgers and fries that has eludedRoy Rogers? Why are Walmart's aisles bustling with customers, while at Kmarteven Blue Light Specials can't fill the stores? Why, after more than 50 years asclose competitors, did HoJo become history and Marriott a megachain? Why doesGoogle appear on the verge of putting Yahoo! into the dustbin of history? Whenyou must get a package delivered on time, why do you dial up the "tightest shipin the shipping business" instead of Airborne Express? And why has Amazonmanaged to leave a host of venerable, already established booksellers at thestarting gate?

Theories abound about the drivers of industry dominance: strategy, leadership,sticking to the knitting, customer centricity—the list goes on and on.While these theories may go far in explaining why some companies rise to thetop, they just do not go far enough.

Take McDonald's. Underlying the Big Macs, Egg McMuffins, french fries, and nowfirst-rate coffee, there is a hidden advantage: McDonald's remarkableconsistency. Visit just about any McDonald's restaurant: from burgers tobathrooms, from coffee to counter service, you know what to expect and you getit. Or look at Walmart. Not too long ago, the pundits were predicting the demiseof the general merchandise stores that had become part of the post-World War IIbusiness landscape. Indeed, Montgomery Ward, Sears, J.C. Penney, Kmart, andothers have either fallen off the charts or appear to be hemorrhaginguncontrollably. Walmart, on the other hand, weathered the most recent economicdownturn quite handily, remaining profitable while so many others in itsindustry were gasping for air.

In yet another industry, consider Google. It certainly did not invent theInternet search engine. In fact, Google was a relatively late bloomer thatsuddenly burst on the scene in 1998, two or three years after a host of othersearch engines—Lycos, AltaVista, InfoSeek, and Yahoo!—were alreadyup and running. And then there is Amazon. It has left every other online mall inits wake, with revenues more than double that of its closest rival.

How do you account for the difference between these stars and the also-rans? Isthere a common denominator that differentiates them from other companies? Thereare undoubtedly a number of reasons for their stellar performance, but one thathas largely gone unnoticed is this: these companies possess an uncannyability to make complex decisions faster, more accurately, and moreconsistently than their competition.

Optimizing Decision Making: The Competitive Edge

In today's fiercely competitive world, the notions of long-term strategy andenduring competitive advantage seem like quaint anachronisms, part of thedetritus of the 1980s and 1990s. Now, "strategy on the run" and tacticaladvantage rule the day. McDonald's, Walmart, Marriott, Google, UPS, Amazon, andmany others have demonstrated that competitive advantage comes from tight focusand riveting attention on making optimal decisions that squeeze every ounce ofvalue from the assets under management. As we will see, Optimization is adecision-making process and a set of related tools that employ mathematics,algorithms, and computer software not only to sort and organize data, but to usethat data to make recommendations faster and better than humans can.

The McDominator

McDonald's vaunted mastery of consistent, cost-conscious quality is a tribute toits laserlike focus on hundreds of microdecisions made by employees every day,all over the world: when to turn hamburgers and dump old coffee; how often tofry a new batch of chicken McNuggets and how many to fry; how many times a dayto clean bathrooms. These decisions have been translated into rules that governthe behavior of McDonald's employees. The rules are deceptively easy to follow,but many factors have to be considered in order to make the right decisions foreach individual restaurant: location, season, weather, day of week, time of day,customer preferences, projected volume, and on and on. Then just the rightbalance must be struck between turning hamburgers and turning a profit. MickeyD's learned early on that the best way to ensure the quality of its decisionswas to introduce Optimization and build a strong culture to support it. Itobviously worked: in 2008, when the U.S. stock market lost two-thirds of itsvalue, McDonald's was one of only two companies among the Dow Industrials whosestock actually gained value. Which was the other? You guessed it:Walmart—another big user of Optimization.

Everyday High Profits at Walmart

Walmart supplies a wide array of decent goods, all at reasonable prices. Howdoes the megachain do it? Volume buying helps, but it is not the realdifferentiator. What makes Walmart unique is its command of logistics. Itcontinually deconstructs its entire supply chain, from supplier to distributioncenters to customers, and treats each link as a decision point, asking a batteryof microquestions: Where and how much to buy and at what price? Where to routegoods? How to resupply and reorder? It optimizes assets all along the supplychain, decision by decision. Its obsession with squeezing value from every linkin the chain has enabled it to develop smart rules for making decisionsand managing its business.

Take air conditioners, a relatively mundane product in today's hightech world.Many of Walmart's competitors, like Kmart, tend to use simple rules to regulatetheir stock: "In the summer, make sure that every store has lots of airconditioners" or "Stockpile air conditioners for our mid-August sale." NotWalmart, where the management of air conditioners and every other asset isguided by optimization decisions, which employ smart rules, such as: "Inthe summer, track the weather; find out where heat waves are predicted; and beprepared at a moment's notice to redirect air conditioner shipments to the areaswith highest demand."

As a result of its optimization prowess, Walmart—which was originallycreated by Sam Walton to serve rural areas too small for Kmart to botherabout—has driven Kmart to the brink of extinction.

The Price Is Right at Marriott

For decades, Howard Deering Johnson and J. Williard "Bill" Marriott appeared tobe moving in parallel universes. In 1925, Johnson borrowed $2,000 to buy a smalldrugstore in Wollaston, Massachusetts; two years later, Marriott borrowed $6,000to open a nine-stool A&W root beer stand in Washington, D.C. By 1937, Johnsonhad established, through franchising, 56 Howard Johnson's restaurants thatgraced the nation's expanding highway system with their distinctive orangecupolas and 28 flavors of ice cream. Marriott's small root beer stand initiallygrew into eight Hot Shoppes restaurants along the Washington-Baltimore corridor,and by 1938 the company was supplying box lunches to passengers on Eastern AirTransport's 22 daily flights from Washington to New York. Each company openedits first travel lodge in the mid-1950s and for a decade competed in servingtravelers on the country's new interstate highway system. The 1960s and early1970s were boom years for both Howard Johnson's and Hot Shoppes, which changedits name to Marriott in 1967.

The companies' paths, however, soon diverged. As changing public taste, toughereconomic times, and soaring fuel costs caused Americans to cut back on vacationsand long drives, Howard Johnson's profits sagged. Like many executives beforeand since, Johnson and his executive team chose to respond by downsizing, buttheir efforts to cut costs, reduce the number of employees, and serve cheaperfood only accelerated the public's flight from HoJo's doors. Finally, in 1979,the chain accepted an acquisition bid from the Imperial Group PLC of Britain forall of its 1,040 restaurants and 520 motor lodges.

Meanwhile, Marriott was meeting the same challenges in a different way:optimizing rather than downsizing. It moved aggressively first intointernational property management—opening the company's first Europeanhotel in Amsterdam, Holland, in 1975—and in 1982 into the then-lucrativetime-share market. As its properties and assets grew, Marriott took oneadditional important step to strengthen its competitiveness. As a longtimepartner of the airlines, Marriott had a front-row seat as the industry turned tomathematical algorithms and optimization software to make minute-by-minute priceadjustments to maximize plane loads. It soon became the first company in thehospitality industry to adopt the airlines' "revenue management" pricingtechniques.

The end of the story? In 1985, Marriott purchased Howard Johnson's assets fromthe Imperial Group, subsequently selling them to Prime Motor Inns.

Google: Master of the Search

Then there's Google. In 1992 there were only 26 websites; eight years later thatnumber had soared to one billion; another eight years later Google's new contentlinks registered one trillion unique page links. A prodigious rate of"inventory" expansion, indeed! Recent estimates of the number of Googlecustomers are difficult to find, but a study conducted in late 2008 reportedthat Google had registered 7.23 billion search requests that year, orapproximately 10 million search requests per hour. Google's challenge involvesnothing less than deciding in seconds, for each request, which of the trillionpages are most relevant. What is Google's secret, and how has it come todominate Internet search so completely? Quite simply, Google out-optimized itscompetitors. It found a way for its computers to make decisions more quickly andaccurately than everyone else. In 1998, when two Stanford graduate studentsfounded Google, Yahoo! had a four-year head start. Yahoo!'s approach tooptimizing searches involved hiring experts to grade websites for relevance. Theapproach worked well for 26 websites—and maybe even for a million. But fora trillion? There just weren't enough experts!

Google, in contrast, thought like an optimizer and in the process invented a newmodel. Rather than use experts, Google discovered that it could leverage itscustomers themselves! Google could track how often a given Web page wasreferenced, or linked to, by other Web pages. This allowed Google to build itsnow-famous PageRank algorithm. The pages most frequently referenced for aparticular topic became the most relevant sites. No paid experts need apply toGoogle. The decision algorithm that Google developed not only surpassed Yahoo!'spanel of experts in providing relevant content, it proved capable of searchingthrough a trillion pages as many as 10 million times an hour. For a period oftime, Yahoo! actually retained Google to do its index searches, before realizingthat the decision-making optimized search engine was the core competency thatwould propel the winner across the finish line. Google stands as thequintessential decision optimizer. Its competitors have simply not been able tokeep up.

UPS Takes the Right Turn

Although not quite as old as UPS, Airborne Express's history stretched back to1946. The company had developed a U.S. air-and-ground express-delivery service,as well as business logistics services much like those of UPS. However, inAugust 2003, Airborne's shareholders approved the sale of the company toBelgium-based package-delivery service DHL. Five years later—in the faceof stiff competition and a declining economy—DHL shuttered AirborneExpress's U.S. delivery operation.

While the ink was drying on Airborne's sale to DHL, UPS was pondering how itcould increase the fuel efficiency of its delivery trucks. With a fleet of88,000 trucks, even small savings could be leveraged across the fleet, adding upto major economies company wide. One area of waste that UPS identified was thetime its trucks spentidling while waiting to make left-hand turns. UPS'sresponse: optimization routing software that favored right-hand turns. Bydeveloping routes that balanced directness with the fewest possible left-handturns, in 2005 the software helped UPS eliminate 464,000 driving miles inWashington, D.C., alone, saving 51,000 gallons of fuel. The competition andeconomic downturn proved no match for the "tightest ship in the shippingbusiness."

Rewriting the Book at Amazon

Amazon is to the Internet what Walmart is to bricks and mortar. Not only wereits revenues more than double that of its closest Internet rival in 2009, butthe gap is widening. During 2009, Amazon's North American Web sales grew by 25percent, while U.S. online retail as a whole grew by just 6 percent. How doesthis Web behemoth do it? It wasn't the first Internet retailer; it wasn't eventhe first cyberspace bookseller. But Amazon optimized better than itscompetitors—at both its front and its back doors.

At the front of its electronic store, Amazon's Web servers send out millions ofpersonalized recommendations to customers each day, informing them of new andused items that closely match their personal interest. Over the years, Amazonhas become so adept at managing its Web portal that competitors like Bordershave outsourced the management of their websites to Amazon. In May 2008, in aneffort to regain control of its Web sales, Borders launched its own e-commerceengine. The result? While at the height of a recession Amazon reported its "bestChristmas ever" in 2008—with spending per customer growing by 18percent—Borders reported an 11.7 percent decline in 2008 holiday sales onits new, non-Amazon website.

Now consider Amazon's back door. When it opened for business 14 years ago,Amazon shipped just a few items a day out its back door—so few, infact, that employees rang a small bell to celebrate each sale. By December 2008,at the height of the global recession, Amazon was selling 72.9 items asecond. If you stacked the copies of the bestseller Breaking Dawnthat Amazon sold during the 2008 holiday season, they would reach the peak ofMount Everest eight times over! When you stop to consider that orders aretypically filled and shipped one book at a time, the magnitude of theaccomplishment is astounding and undoubtedly keeps competitors awake at night.

Reinventing Decision Making

The importance of effective decision making in business has not gone unnoticed.A quick search—using Google, of course—of "methods for makingcomplex decisions in business" returns a well-prioritized list of 26,200,000 Webpages. A number of consulting firms have made a good living offering structureddecision-making approaches to companies around the world. Nobel laureate DanielKahneman—after a long and illustrious career studying the foibles of humanjudgment and decision making—has argued that decisions are anorganization's most important product and that companies should begin applyingquality-control processes to decision making.

While interest in business decision making is not new, there is a powerful newdecision-making capability available: one that has largely gone unnoticeddespite its success in vaulting a number of companies from bit players toindustry powerhouses in relatively short order. That capability is Optimization,and it is increasingly playing a pivotal role in separating winners from therest of the pack.

Optimization has been around, in various forms, for some time. Originallygrowing out of a discipline labeled "Operations Research," or OR, it began as anacademic discipline and then—as we will see in Chapter2—became a key factor in the Allied victory in World War II. After thewar, Optimization was deployed to help manage large-scale, asset-intensiveoperations such as oil refineries, power plants, and the U.S. space program. Asthe availability, speed, and capacity of computers increased in the last decadesof the 20th century, optimized decision making moved from the public to theprivate sector and was soon adopted by both larger and smaller enterprises in avariety of industries.

Optimization is known by different names in different communities: to thecomputer scientist it is artificial intelligence; to economists it is modeling;mathematicians know it as game theory or applied mathematics; engineers, with anod toward tradition, have stuck with Operations Research. Most recently, it hasbeen referred to in some business circles as advanced analytics. What is commonto all of these groups when they speak of Optimization is that each is typicallyreferring to large data sets, decision algorithms, and an empiricalapproach to deciding what works best. Computers and sophisticated softwareare being used to make increasingly complex decisions more quickly andaccurately. When effectively applied, Optimization can become a competitive gamechanger, as it has for many companies, including computer-chip maker Intel,which is featured in the accompanying sidebar. If your organization is not usingOptimization, it may be strategically vulnerable. Chances are that one of yourcompetitors has already tapped the power of Optimization.

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