The Upside of Strategic Risk: How Toyota Turned Its Greatest Threat Into a Growth Breakthrough

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by Adrian Slywotzky

This article draws on material from the new book The Upside, published
by Crown Business Books.

At most companies, risk management focuses on three categories of risk that are widely understood: hazard risks (fire, flood, earthquake), financial risks (bad loans, currency and interest rate swings), and operating risks (the computer system fails, the supply chain gets interrupted).

While these kinds of risks are important, even more dangerous are the strategic risks your business faces. For example, your big project fails, your customers change their preferences and leave you for competitors, the margins compress across your industry, or a technology shift makes your product obsolete.

Strategic risk targets one or more of the crucial elements in the design of your business model. In some cases, it shatters the bond between you and your customers. In other cases, it undermines the unique value proposition that is the basis of your revenue stream. In still other cases, it siphons away the profits you depend on. And sometimes it destroys the strategic control that helps your company fend off competition. In the worst case, a major strategic risk can threaten all these pillars of your business.

Not all businesses face every form of strategic risk, but every business faces some. The seven major kinds of strategic risk are: project risk; customer risk; transition risk; unique competitor risk; brand risk; industry risk; and stagnation risk.

Of course, there’s no way to eliminate strategic risk altogether. But understanding and anticipating it, shaping it, and implementing the specific countermeasures that have proven to be effective can enable a company to dramatically improve its odds for surviving and even thriving in today’s risk-rich environment – and to discover the upside potential concealed by the frightening mask of downside risk.

Toyota raises the odds on the Prius

The Japanese automaker Toyota provides a great example of astute management of project risk. At the moment of launching any project, there’s a problem that most of us don’t come to grips with: the inherent, all-too-human tendency to be overly optimistic about the odds of success. In fact, data suggests that the failure rate for many types of projects is in the range of 60% to 80%.

The first step in changing this picture is carefully estimating the true odds – overcoming the natural human tendency to be overly optimistic with a bracing dose of realism and data. Projects live in a tough, probabilistic world. There are so many ways to under invest – not just financially but also in terms of time, energy, emotion, resilience, options considered, conversations held, experiments conducted, simulations run, market trials conducted, tires kicked, and doors slammed.

Making matters worse is the fact that for many types of business initiatives, success is an all-or-nothing matter. Unless all the elements required for success are in place, the project can fail completely. This little-recognized reality of project risk can be described by the simple formula “90% right often = 0.”

Thankfully, there are proven techniques for changing these odds for the better. The Japanese automaker Toyota created several of the most powerful of these techniques while developing the Prius – a blockbuster product whose odds of success were less than 5% when Toyota embarked on its development in the fall of 1993.

In the early 1990s, the company was riding high, enjoying growing market share and unrivaled profitability. But Toyota’s executives were extremely worried. They feared that product maturity was setting in. Hungry, costconscious, hyper-efficient competitors such as Korea’s Hyundai were emerging, eager to do to Toyota what Toyota had done to Detroit’s Big Three.

To make sure that Toyota would remain in the forefront of the auto industry, the company decided to mount an allout effort to create the first great car of the 21st century, almost a decade before that century would arrive. In 1993, 10 Toyota board members met to imagine the qualities that a breakthrough car (which they code-named the G21) for the coming century should have. They envisioned a car that was comfortable, safe, pleasant to drive, appealing to female motorists, low-polluting and environmentally friendly, and highly fuel-efficient – sound ideas, but amorphous. An engineer named Takeshi Uchiyamada was assigned to convert them into a concrete proposal.

Mr. Uchiyamada, a specialist in techniques for eliminating noise and vibration, wasn’t an obvious choice for the role. He had never headed a new-vehicle development team. But from 1991 to 1993, he’d led a task force that reviewed Toyota’s R&D process from head to toe. This turned out to be crucial preparation for the G21 challenge. It exposed him to many parts of the company and deepened his understanding of the disparate technologies that Toyota had developed. He had become an expert in the inner workings of the company – its many strengths and its lessobvious weaknesses.

He had also learned where the company’s most talented engineers were. Now he recruited 10 outstanding engineers representing all of the key technologies that would go into the G21. All were in their early 30s, old enough to have experience but young enough to be flexible.

They worked for months to give a concrete form to the G21 concept, then brought their proposed car to the company’s executive vice president of R&D. Mr. Uchiyamada explained that his team hoped to create a small sedan that delivered 47.5 miles per gallon, about 50% better fuel efficiency than the Corolla, a comparable current car. He was told to double the G21’s fuel efficiency.

Mr. Uchiyamada returned to the drawing board. He would have to rethink his assumptions about the G21. Tinkering with existing technology wouldn’t suffice. It would require a major leap to an unproven system that existed only as a blue-sky concept Toyota had been studying – the hybrid engine.

What’s more, Toyota wasn’t the only company considering the hybrid engine. Everyone in the car business had heard rumors about hybrid experiments at Honda and Ford. It wouldn’t be enough to create a successful new design; he also had to do it faster than the competition.

As a means to finding new ways to surface problems and solve them quickly, Mr. Uchiyamada created a new system designed to facilitate communication and joint problem solving among his team members.

The system started with a dedicated physical space. They called it obeya, the big room. It was equipped with personal computers and two computer-aided design workstations. Team members were asked to assemble in this room daily to work together on the G21 project – the first time this had been done at Toyota.

Mr. Uchiyamada also created a virtual space, an electronic mailing list compiled to encourage team members to quickly and broadly disseminate key issues and problems as they arose. Over time, this list grew to include 300 people. Of course, e-mail wasn’t a new technology at Toyota, but the way it was used on the G21 project was new to this relatively hierarchical, formal company.

Toyota replaced its command-and-control communications model with an innovative, equal-access system and sent a clear message in the process: The best minds in the company should focus on any and every problem related to the G21. In retrospect, we can see that this intense focus probably raised the odds of success for the project from the 5% range to perhaps 10%.

Many problems are predictable

Mr. Uchiyamada also spent a great deal of time anticipating problems that, upon a bit of reflection, were entirely predictable. He introduced other innovations designed to preempt them. For example, when a new vehicle is ready to go on line, Toyota usually sends resident engineers (REs) to work at the manufacturing plants so they’ll be available for problems that arise during production. For the G21 project, they assigned reverse REs from the manufacturing plants to take part in the design development process. The point was to eliminate possible manufacturing glitches in the blueprint stage. This move raised the odds to 15%.

Tackling risk reduction in this spirit often meant drastically increasing the demands on the team – for example, considering some 80 different types of hybrid engines early in the life of the project. If the team could find the one true standout option for the engine, they would raise the odds of success to 17%.

On closer inspection, the hybrid team quickly narrowed the engine options to 20. They purchased specialized, readymade computer simulation software with which to run most of their performance tests. Unfortunately, it didn’t meet the unprecedented demands of the brand-new hybrid technology. So Toyota’s engineers set out to rework the software extensively.

Once the new software was ready, the rounds of synthetic testing could begin. The G21 team narrowed 20 systemdesign possibilities down to eight, then four, then had an intense bake-off among the final four. The survivor of all these brutal comparisons was an extraordinary engine – efficient and relatively simple in design. Now the team had to do the same thing for the other parts of the car.

The strategy was one of creating excess options, in order to find the single most powerful answer. It was even applied to the car’s overall styling. Toyota maintains seven separate styling studios around the world, each normally working on a different vehicle category. But for the G21, soon dubbed the Prius, all seven studios were asked to submit designs, which were judged by a panel of 50 Toyota people of various ages. This raised the probability of success to 20%.

As the hybrid development continued, Toyota faced another critical juncture: The Prius required the creation of a new battery that would be just one-tenth the size of existing batteries for electric vehicles and far more impervious to heat and cold. This one challenge could have sunk the entire venture.

Toyota dislikes relying on external expertise, but in this case there was no viable option. The company decided to partner with Matsushita Electric to design and produce the battery, and then later to sell it to other automakers. This step helped reduce financial risk by providing another revenue stream to help pay for the Prius development. And since the battery was built by a Matsushita-Toyota joint venture, Toyota did not lose control of a key technology. This brought the probability of success to 25%.

Another key technological breakthrough lay in recognizing that powerful electronic devices for managing the flow of electricity between the battery and the electric motor were crucial to making the car both quiet and powerful. The hybrid car would need more controls and transition management than a conventional internal combustion engine, including new computer chips to make it work. Toyota spent time with chip specialists to assemble the right electronic pieces for the massive, three-dimensional hybrid puzzle. But the advanced chips needed were not readily available, even from outside sources.

The solution was for Toyota to build its own factory to fabricate self-designed power controller chips. The company hired a team of semiconductor engineers, then educated them about the car business and specifically the new hybrid technology. It was costly and time-consuming, but raised the odds a little further – to 30%.

Every one of these and subsequent, similar moves made by Mr. Uchiyamada and his team kept notching up the odds. Toyota mapped out the new technologies needed, developed a timetable for each, and then set to work on the whole array of projects simultaneously, cross-referencing and cross-fertilizing among teams as needed.

By the time the Prius was introduced to the U.S. market in 2000 (a first-generation Prius made its debut in Japan only in 1997) the odds went up to 50%. And when you factor in Toyota’s superior business design model that is difficult for competitors to match, let alone beat, the odds for success jumped to 90%. We now know that the car was – and remains – a success. When launched, word of mouth in the U.S. was overwhelmingly positive, and in most of the country the waiting list for a new Prius was several months long.

The success of the Prius was systematic – the result of a conscious strategy developed by the Toyota managers in response to a genuine understanding of the true risks and how to deal with them. As such there’s much to be learned by studying the Toyota playbooks.

Every business executive owes it to him or herself to ask: What are my organization’s major risks? What specific steps should we take to address those risks? And how can we change the odds of success?

In this age of increased volatility, intensified competition, and heightened risk, one factor has become more important than ever in sorting the champions from the also-rans. That factor is the foresight, flexibility, realism, and planning that make up the new discipline of strategic risk management. It’s a set of concepts and tools that no manager today can afford to neglect.