Illinois Tool Works: Extreme Decentralization
Building a conglomerate with operations in 57 countries one customer at a time.
Illinois Tool Works (ITW) is a manufacturing conglomerate that makes a diversified range of industrial products and equipment with operations in 57 countries. The fact that ITW is a conglomerate might lead you to believe that they operate as a large, cumbersome organization which imposes it’s mile-long list of best practices on every business unit and new acquisition but that is not so. ITW is highly effective at rapid and sustainable innovation due to extreme decentralization uncommonly seen in such a large organization.
ITW’s Business Model:
The business model at ITW is defined by three core elements: 80/20 business process, customer-back innovation and a decentralized entrepreneurial culture.
- The 80/20 business process has been in use for 30 years. The idea is for all of ITW’s business units to focus on the 20% of the customers that generate 80% of the profits. This focus provides two main benefits: maximum impact of dollars spent serving the customer, and greater awareness of customer needs at the small unit level.
- By leveraging deep customer empathy gained through the 80/20 process, ITW is able to devote a lot of energy and resources at building relationships with their best customers, hence their focus on customer-back innovation. Rather than innovating and then attempting to find customers for their new innovation, ITW first works on developing deep empathy with their 80/20 customers and then innovating solutions to problems their current customers have. This enables ITW to keep their expenditures for R&D low when compared to the manufacturing industry and their output of innovation (measured in patents) high.
- Enabling this deep customer empathy is ITW’s extreme focus on it’s decentralized entrepreneurial culture. The company operates through seven separate divisions: Automotive OEM, Test & Measurement and Electronics, Food Equipment, Polymers & Fluids, Welding, Construction Products, and Specialty Products. These divisions are encouraged to “think and act like smaller companies” allowing them to react quickly to their customer’s ever-changing demands (http://www.itw.com).
ITW’s Operating Model:
ITW focuses operations on their high volume products, dedicating entire production lines to only three or four products supported by their 80/20 business model. This enables long production runs with obvious costs savings by limiting changeovers of the lines. Another aspect of their operating model is that they choose to manufacture where they sell. This local production focus further supports their customer-back innovation business model, allowing for a more flexible approach to serving their customers.
Recently, ITW undertook a Portfolio Management initiative which focused on “product line and customer base simplification” (http://investor.itw.com). This initiative is working towards decreasing the focus on the smaller product lines and customers through increased divestitures and is directly linked to their 80/20 business model. In the short-term, the implications of this initiative may result in decreased revenue’s but increased operating margins. In the long-term, as they focus on organic growth of the 80/20 customer that they plan to retain, they expect revenue and profitability growth.
Illinois Tool Work’s business model and their operating model are extremely well aligned. Furthermore, they recognized when the two models starting getting out of alignment and undertook an initiative focused on rapidly achieving realignment.
ITW’s Formula for Innovation. (2005, October 18). Retrieved from http://www.bloomberg.com/bw/stories/2005-10-18/itws-formula-for-innovation
Student comments on Illinois Tool Works: Extreme Decentralization
Very interesting post Jon. You highlighted a key component of operating models which we do not discuss as frequently, which is the governance structure of these companies. I can see how having the seven different divisions allow them to be more entrepreneurial but how do they balance the need for innovation with the benefits that greater centralization can bring? What is the communication among divisions? I can imagine an innovative product with potential that might not be developed further if it does not fit with the core business of a division or does not immediately fulfill the 80/20 focus.
The emphasis on localization for both production as well as designing for customer needs is also very intriguing. What is the quality control process like and what is the role of the central organization? I am curious to learn more about the recent changes they made to realign the business and operating models.