In today's marketplace, increasing globalization, continuous technological advances, and other competitive pressures are accelerating the pace at which companies need to change. Executives have placed innovation near the top of their priority lists, yet in many organizations, innovation success has been sporadic at best.

At IBM Global Business Services, our research and experience show that the right operations strategy can help companies make innovation a regular occurrence. Such a strategy, if focused not just on efficiency but also on growth, can serve as a foundation for innovation throughout an organization — far beyond operations to products, services, markets, and even a company's underlying business model. Simply put, this sort of strategy is not about doing things better; it is about doing better things.

As part of a recent analysis of innovation, we examined several leading companies that have implemented operations strategies based on a relatively well-known management philosophy that we call Lean Six Sigma. It is also sometimes referred to as Six Sigma Lean. At some of the companies we studied, leaders still refer to their initiatives as Six Sigma or 6 Sigma, even though (from our perspective) they have moved past Six Sigma's original definition and scope by incorporating Lean features as well. Regardless of the terminology it uses, each of the companies that we included in this research has established a corporate environment that promotes a disciplined focus on customer needs; detailed data analysis; and facts — not theories. The results are remarkable.

At Caterpillar Inc., stagnant revenue growth prompted the company to undertake a massive transformation in January 2001. Through a Lean Six Sigma initiative, the company developed a strategic vision and a road map for change guided by fact-based analysis. The initiative led to product innovations, like Caterpillar's phenomenally successful low-emissions diesel engine, and to redesigned processes, including a streamlined supply chain. By 2005, the company's revenues had grown by 80 percent.

The subject of our second case study, Korean steelmaker POSCO, faced fierce competition as it privatized in 2000. With the help of Lean Six Sigma, the company escaped its competitive position as a regional, low-cost provider and elevated itself onto the global stage as a premier provider of innovative steel products and services. Fact-based analysis brought to light high-potential markets and unmet needs, which led the company to introduce differentiated products with entirely new applications. In just a few years as a private enterprise, POSCO has become the world's third-largest steelmaker.

Finally, ScottishPower began losing customers when its market was deregulated. Determined to reverse the trend, the company used Lean Six Sigma to identify its problem areas and reinvent its customer service function. By innovating based on facts rather than assumptions, ScottishPower halted a steady decline in its customer base and increased its market share by 60 percent in four years.

As we analyzed the ways in which these three companies used Lean Six Sigma to achieve broad-based innovation and superior financial performance, we identified distinguishing characteristics of each organization's approach that set it apart from companies with a traditional operational-improvement mind-set. All three of our case study companies share four characteristics that helped them use Lean Six Sigma to embed an innovation mind-set into the fabric of their organization: an innovation vision based on factual customer and market insights, a leadership team that is committed to perpetual innovation, alignment across the extended enterprise, and organizational capabilities that have made innovation habitual.

Lean Six Sigma: A Foundation for Innovation

Although CEOs might instinctively think of Lean Six Sigma in terms of process improvement and cost reduction, our case studies suggest that this perspective is shortsighted. As its name suggests, Lean Six Sigma is a combination of Lean methods, which focus on reducing costs through process optimization, and Six Sigma approaches, which are about meeting customer requirements and stakeholder expectations and about improving quality by measuring and eliminating defects. Lean Six Sigma draws on the philosophies, principles, and tools of both.

In the past, companies used Lean Six Sigma primarily for operational improvement, for refining existing processes to reduce costs, improve performance, and provide better customer value. However, dramatic upheavals in the competitive marketplace are prompting business change on a much more massive scale than in the past. Companies today must innovate, not just improve. Around the world, CEOs are searching for blockbuster products and services, making major operational changes, and even redesigning their fundamental business models. IBM's conversations with 765 corporate and government leaders worldwide, conducted as part of the 2006 IBM Global CEO Study, found that chief executives' innovation priorities are spread across all of these different dimensions. And yet CEOs ranked an “unsupportive culture and climate” as their biggest obstacle to innovation success. Their organizations lack the processes, discipline, and organizational mind-set to foster meaningful innovation on a continuous basis.

Despite its heritage, Lean Six Sigma is well-suited to help. Because of its focus on fact-based analysis and direct customer input, the methodology is equipped to facilitate a broad corporate transformation, helping a company rethink its entire business and create a more innovative climate. The leading companies we examined in depth as part of our recent innovation research are proving that Lean Six Sigma has applications far beyond process improvement. They have deliberately expanded the scope of the methodology, using it to surface significant innovation opportunities that have impacts well beyond operations. Doing so has enabled these companies to improve performance and establish an organizational culture with an inherent inclination toward innovation.

In virtually every industry — and across the public sector — Lean Six Sigma has served as a catalyst for broad-scale innovation. Though the organizations we studied in detail vary in terms of size and mission, all have realized substantial benefits and even earned positive responses from the sometimes fickle financial markets. These organizations' experiences provide valuable lessons for firms that want to cultivate an innovation mind-set.

Innovation Has Legs at Caterpillar

In 2000, Caterpillar found itself stalled: Four years of flat revenues and intense competition showed no signs of letting up. Determined to regain its industry leadership position and to jump-start growth, the company's executives deployed a Lean Six Sigma approach, which they refer to as “6 Sigma,” in January 2001. Caterpillar wanted to revolutionize not only the way its employees work, but also their mind-set. The goal was continuous, customer-driven innovation, and the magnitude of the planned transition was staggering. The Lean Six Sigma initiative involved 27 business units and more than 72,000 employees located on six continents.

The launch began with a nine-month training period for 4,200 employees. Then these trained professionals — with backgrounds ranging from engineering to finance — led their own projects and served as mentors to the rest of the organization.

Perhaps the most far-reaching transformation came from Caterpillar's application of 6 Sigma approaches to strategy development. Using Lean and Six Sigma disciplines to collect and analyze hard data on customers, markets, and the company's capabilities, the CEO and a strategic planning committee crafted a detailed vision for where Caterpillar should be in 2020. The vision was sub-divided into three five-year plans. The immediate plan set out specific, measurable targets for market position, quality, order-to-delivery performance, safety, and other critical success factors. The plan's scope was companywide, spanning all lines of business and cascading down through the organization. Because of the rigor and discipline enforced by the initiative, the entire company aligned behind the same specific objectives.

The initial 6 Sigma launch spawned more than 1,100 projects. Some generated subtle (though financially beneficial) operational improvements, while others resulted in innovative new products and radically different ways of working.

One of the first process changes involved revamping R&D to include more direct interaction with the customer. Engineer to engineer, employees and clients began working collaboratively to pinpoint problems and develop solutions, steadily building closer relationships. Through alliances it built with Canadian mining customers, for example, Caterpillar learned about the nuances involved in extracting oil from sand. These application-specific insights led the company to develop a completely different kind of mining truck. Instead of being one-size-fits-all, the new mining truck is available in five unique configurations, each suited to a particular type of terrain and haul profile. Now customers in extremely cost-sensitive industries, such as oil sands mining, can select the configuration that offers the best blend of price and productivity.

The 6 Sigma approach also led to major operational changes, particularly in Caterpillar's supply chain. Caterpillar has, in its own words, “systematically de-bottlenecked” its order-to-delivery process. For example, teams redesigned the production scheduling process at Caterpillar's manufacturing facilities, which cut lead times by more than 50 percent. The company has also reduced delays caused by supplier-sourced pumps. Historically, if a pump failed during initial testing, Caterpillar had to take time to fix the pump or else wait for the supplier to send someone to repair it. Now, based on suggestions from the 6 Sigma team, the Caterpillar supplier has its own pump test cell, and it breaks in new pumps before sending them to Caterpillar plants. The supplier faces a financial penalty if it fails to meet specific quality goals.

Overall, the results from Caterpillar's Lean Six Sigma initiative have been phenomenal. Within the first year, the benefits from the company's global 6 Sigma project surpassed implementation costs. Since then, 6 Sigma has become a critical component of Caterpillar's success. The rigor and discipline of Lean Six Sigma enabled the company to achieve record profits and have helped the company move toward its 2010 strategic goals. According to Caterpillar's vice president and CFO Dave Burritt, “Caterpillar's competitiveness has improved. … 6 Sigma has been applied to increase our percent of industry in all of our principal lines of business. The machine, engine, and financial products businesses have all benefited from the rigor of 6 Sigma. Without question, we are in the best of times at Caterpillar, and the improvements would have been much less without 6 Sigma.”

What can other businesses learn from the Caterpillar experience? One key takeaway is that strong leadership support of a Lean Six Sigma initiative can yield effective strategic alignment, even in the largest of companies. In Caterpillar's case, strong leadership prompted strong participation, unifying 27 disparate organizational units around common strategic goals. Teams saw how their efforts were linked and how they contributed to the whole. Results were measurable and visible to all. And Caterpillar's story is not an isolated case. Applying Lean Six Sigma to strategy development sends a clear message that management teams are serious about making an enduring change. IBM Global Business Services has analyzed the performance of many of our past clients to determine the impact that a company's deployment model and executive sponsorship have on overall results. We've found that most Lean Six Sigma programs demonstrate solid results, and those with a high degree of CEO commitment and a top-down corporate deployment approach experience a much faster transformation.

POSCO Is Strong in the Lackluster Steel Industry

After decades of government ownership, the Korean steel company POSCO was privatized in 2000. Long sheltered from market forces, the company suddenly faced serious competitive pressures. Its positioning as a low-cost provider was challenged as cheaper competitors emerged from other regions — notably, China — and its limited regional footprint left the company exposed to a declining Korean economy. Yet POSCO was determined to remake itself, to shift from a local, low-cost producer to a global, value-added steelmaker. To enact such a dramatic change, the company had to fundamentally change its entire way of working. POSCO decided to use a Lean Six Sigma approach to transform its business and create a market-driven mind-set throughout the enterprise. (Because POSCO launched its transformation efforts before the term Lean Six Sigma came into common use, it continues to refer to its initiative simply as “Six Sigma.”)

The POSCO management team relied on Lean Six Sigma to develop a strategy for becoming a value-added, rather than low-cost, steel provider. First, it enlisted its R&D division to gather data on customer needs. Initially, R&D resisted the Lean Six Sigma approach, feeling it was too Western to be practical for an Asian company. But after special training sessions designed just for them, these engineers' opinions began to shift. Instead of sending marketing or salespeople to research customer needs, senior management sent engineers. This empowered the people who were making pivotal design decisions to talk directly with key customers and make recommendations. It enabled the engineers to learn directly from customers and to pinpoint several product areas in which customers were looking for more innovative solutions. Using the engineering team's input on customer needs, senior management analyzed market potential and the company's capabilities in specific product and service areas. The optimal strategy seemed to revolve around two high-potential markets: shipping and automotive.

Senior managers aligned the entire company behind strategic priorities in the shipping and automotive markets. R&D concentrated on these areas, and pet projects that did not contribute to the vision were cancelled. The resulting shift in POSCO's business model led to major product innovations. For example, the company invented steel that remains rust-free in salt water, creating significant opportunities in shipping and floating-dock construction. And through interactions with global automakers that were driven by Lean Six Sigma, POSCO developed 21 varieties of high-grade steel designed to meet special industry needs, such as coated steel that paint adheres to more easily.

Lean Six Sigma analysis soon led POSCO to another realization: In order to expand its products and markets, the company would have to expand its operations. Although China is the world's biggest producer of steel, and therefore a competitive threat to steel manufacturers, the expanding gap between China's production capabilities and rapidly rising demand provided a growth opportunity for POSCO. To fill this gap, the company has orchestrated 14 joint ventures and invested US$780 million in China. Just a decade ago, that investment figure was zero.

Using Lean Six Sigma's relentless focus on customer demands, POSCO developed process and IT innovations that dramatically reduced finished steel inventories and cut lead times from 28 days to just 14 days by 2003. At the same time, however, the company's focus on customer needs created new challenges. For example, POSCO found that filling orders faster left too many partly used steel slabs, which hurt margins. Determined to meet customer needs profitably, POSCO developed sophisticated production scheduling algorithms that enabled it to pack multiple orders on a single slab. This allowed the company to optimize slab utilization, and profitability, while still responding rapidly to customer demand.

As the Lean Six Sigma way of thinking spread across POSCO, virtually no area of the business was off-limits. The company was equally comfortable (and confident) applying the approach to corporate strategy and budgeting as manufacturing and logistics. And it's important to note that the company's strategic priorities did not stay static after the first Lean Six Sigma-inspired strategic planning effort. POSCO uses the methodology to maintain a perpetual watch over customer needs and market opportunities. Since initially identifying shipping and automotive, the company has added construction to its list of strategic priorities.

Through its Lean Six Sigma efforts, POSCO has produced over US$1 billion in financial gains to date, including strong savings and record sales volumes. Even in 2001, the first year of its Lean Six Sigma initiative, when 25-year-low prices hit other steelmakers and their investors hard, POSCO achieved double-digit profitability. By 2005, in less than four years, the company had transformed itself from a regional, low-cost producer into a global, value-added provider of high-quality steel. POSCO is now the third-largest steelmaker worldwide. It also ranks high in terms of efficiency and profitability and has been selected as “the world's most competitive steel firm” for three consecutive years in a global study conducted by World Steel Dynamics.

For POSCO, the domino effect of innovation led to a wholesale corporate transformation. As Lean Six Sigma steadily infiltrated the thought processes of employees and company leaders, innovation in one area triggered transformation in another. For example, the business-model decision to focus on high-potential segments such as the auto industry inspired new, innovative steel products. These new products, in turn, led to new processes to produce higher-grade steel. The ripples of innovation created through the Lean Six Sigma program enabled POSCO to accomplish a top-to-bottom transformation — from government-owned business to profitable private enterprise, from low-cost producer to value-added provider, and from regional player to global competitor.

Market Share and Margins Surge at ScottishPower

In 2001, ScottishPower found itself losing market share in the recently deregulated U.K. retail energy marketplace. In addition, regulators who were responsible for maintaining a safe, reliable energy supply were beginning to express concerns over recurring customer service complaints about the company. ScottishPower needed to reverse the trend quickly. It decided to try to regain a market-leading position by radically overhauling its customer service and sales operations. Defying the notion that Lean Six Sigma works primarily for manufacturing firms, ScottishPower decided to use the approach to drive innovation in its services-based business. It launched Lean Six Sigma by establishing a “business transformation” function and training hundreds of employees.

Very quickly, the Lean Six Sigma approach alerted ScottishPower that its initial assumptions about why customers were leaving were off-base. As it turned out, many of the company's customers were departing when they moved from one home to another. When they called to cancel their service, ScottishPower customer service representatives followed their scripts precisely but never inquired whether a caller might need service elsewhere. They were extremely efficient, but not effective.

Once Lean Six Sigma exposed this market-share leak, ScottishPower instituted a “hot key” process by which callers who were changing residences were transferred to advisers who could offer service at the new home. The company also began offering financial incentives to customer service reps to encourage the transfers. Because Lean Six Sigma forced an end-to-end inspection of the customer life cycle, ScottishPower was also able to design a new process that notified a salesperson that the new inhabitant at a customer's recently vacated address might need utility service. So instead of losing one customer when someone moved from one home to another, the firm turned the event into an opportunity to end up with two customers.

In its initial wave, ScottishPower launched 130 Lean Six Sigma projects. In addition to the projects related to customers who were moving, the company initiated a targeted marketing campaign that boosted use of direct debit payments by 14 percent, a simplified sign-up process for business customers that led to a 20 percent increase in acquisition, and new meter-reading processes with lower costs and higher accuracy. All together, the Lean Six Sigma projects helped ScottishPower expand from 3.2 million to 5.1 million customers in just four years. This contrasts sharply with the trend of declining market share for many of the energy providers with which ScottishPower competes for a relatively stable number of households. To date, ScottishPower has realized a total of US$170 million in additional revenue and cost savings through its Lean Six Sigma initiatives.

Although it is not a manufacturing company, ScottishPower used the specificity and data it generated through Lean Six Sigma to turn its business around. Instead of blindly marketing to enhance its corporate image, ScottishPower was able to identify the real reasons for its customers' dissatisfaction and defection, then redesign those processes that actually impacted its customer relationships. The company no longer needed to rely on guesses or assumptions; it had facts. In the end, the cost of regaining its market share through Lean Six Sigma was much lower than a traditional mass-marketing approach.

Assessing Your Own Innovation Climate

The successful companies we studied took a deliberate detour from the traditional approach to operational improvement. By using Lean Six Sigma in a broader, more strategic fashion, they uncovered innovation opportunities across their business — not just in operations. In the process, they were able to improve business performance and establish an organizational culture that was more naturally inclined to innovate.

As we analyzed these Lean Six Sigma efforts, we identified four shared, distinguishing features that set their approach to the methodology apart from those with a traditional operational improvement mind-set. All of our successful innovators had:

An innovation vision based on factual customer and market insights

In our case study companies, leaders crafted a compelling vision based on a keen understanding of market demands and of their own capabilities. Their objectives were explicit and were few enough in number to enable focus.

Leadership committed to perpetual innovation

CEOs and business-unit leaders played active, enthusiastic roles in Lean Six Sigma. They were clearly committed to making an indelible organizational change, not just launching another initiative.

Alignment across the extended enterprise

The strategic innovation vision was used as a unifying force to align disparate business units and influence supplier and customer relationships.

Organizational capabilities that made innovation habitual

At the outset, these companies' Lean Six Sigma initiatives involved a period of intense training, dedicated resources, and a bubble of projects that jump-started organizational transformation. But over time, as the mind-set became more mainstream, these companies established enduring processes that helped drive continuous innovation throughout the organization.

The challenges these companies faced are not unique. Their peers around the world are feeling similar pressure to innovate. The pivotal question is whether your organization is equipped to do so — and to do so in a sustainable manner. A company that wants to assess its preparedness for developing an innovation culture must answer several questions: Do you have a clear vision of where you want your company to be in two years, in five years, and in 10 years? How closely is this vision tied to the needs of your current and target customers — and is your understanding of these needs based on actual assessments or assumed information? Will your vision require innovations in your business model, in your products or services, or in your markets? What will you need to do at the operational level to enable and drive innovation? And what changes will be required for your management approach, organizational structures, metrics, and skills to support innovation? How are you making innovation happen more systematically; are you establishing the right environment?

CEOs might be tempted to downplay the importance of operations strategy and related management approaches such as Lean Six Sigma, thinking of them in terms of process improvement and cost reduction. But this perspective is competitively shortsighted. Industry leaders — such as the companies in our study — are using Lean Six Sigma approaches to bring to light significant innovation opportunities that have far-reaching impacts on their businesses. Certainly their operations are changing dramatically, but so are their products and services; their target markets; and, in some cases, even the fundamental design of their business model.

The successes of the companies we researched are not anomalies. Through the discipline of Lean Six Sigma, the CEOs and business-unit leaders in these organizations have substantially improved business performance and permanently reoriented their organizations' mind-set, creating the type of environment where innovation can flourish.

Dave Lubowe is the global and Americas operations strategy leader for IBM Global Business Services. You can contact him at dave.lubowe@us.ibm.com.

Amy Blitz is the strategy and change leader at the IBM Institute for Business Value. You can contact her at ablitz@us.ibm.com.

Lean Six Sigma: Does Your Company Have What It Takes?

Companies adopting Lean Six Sigma in hopes of becoming more innovative can improve their chances of success by addressing the following key issues:

  • Leadership

    Lean Six Sigma programs with a high degree of CEO commitment generate a much faster, and more effective, transformation.

  • Scope

    Broadly applying Lean Six Sigma increases its impact; success often stems from using Lean Six Sigma to align disparate business units and to influence relationships with both customers and suppliers.

  • Strategic linkages

    Applying Lean Six Sigma as part of corporate strategy development processes sends a clear message that management teams are serious about making an enduring change.