Over the course of nearly 25 years and four best-selling books, Jim Collins has set out to systematically unlock the mystery of what makes great companies tick. In his most recent book, Great by Choice, Collins and his co-author, Morten T. Hansen, examine companies that have turned in exceptional performance—10 times the industry average—despite operating in turbulent environments marked by constant surprises. He says he wrote the book with entrepreneurs in mind—"to help them navigate from small to great, especially when they feel like small, vulnerable specks out there in a tumultuous world." Inc. editor-at-large caught up with Collins at his office in Boulder, Colorado.

As much as you have written about what makes great companies tick, I don't think I have ever actually heard your definition of a great company. You must have one.
Yes, I do. In defining greatness, I think it's important to differentiate between inputs and outputs. People sometimes confuse the two. There are a lot of important inputs, but greatness is in the outputs. For example, I don't think a company is necessarily great because it has a great culture. Culture is an input. Or what about a company with great systems? Also an input.

So what are the outputs? I would say there are three. The first is truly superior performance in the arena in which you operate. In sports, your team has to win championships, or it really can't be called a great team. In business, the measure is financial—return on invested capital. I think that, to be considered great, a company must have sustained returns on invested capital substantially in excess of other companies in its industry. But that's not enough, in my view. To be great, a company also has to make a distinctive impact. I define that by a test: If your company disappeared, would it leave a gaping hole that could not easily be filled by any other enterprise on the planet?

If your company disappeared, would it leave a gaping hole that could not easily be filled by any other enterprise on the planet?

Now, that doesn't mean the company has to be big. A restaurant could have such great relationships with customers—such a great community presence and such great food—that, if it went away, people would feel a gaping hole, and no one could easily come in and fill it.

You are talking about George Bailey, the banker in It's a Wonderful Life.

Exactly. The Wonderful Life factor. People would miss the company if it went away. It could be something unique or different or innovative, or the distinctiveness could be in the execution—you do something so well that you're irreplaceable. If you can't answer what would be missed, then you haven't yet made a distinctive impact.

The third factor is endurance. A truly great enterprise has the capacity to last beyond any product cycle, any founder, any individual leader, and still maintain superior performance and distinctive impact.

Those are, in my view, the three outputs that define greatness: superior performance, a distinctive impact, and endurance. If you fail in any one of those three, you may have done fine. You may have built a good business that's made a real contribution. But I would not use the word great to describe it.

How important is it that we have great companies as you have just defined them? Given that there are relatively few of them, how big an impact can they have?
I think that, as role models, they're very important. Role models are important for all of us. In the end, Bill Hewlett and David Packard may have had their greatest impact in the incredible role-modeling they did for an entire generation of entrepreneurs. People were tremendously inspired when they looked at Hewlett-Packard and realized the kind of company they could build if they put their minds to it. These companies epitomize what I believe is the distinctive American strength. We tend to believe that our ultimate trump card is innovation. But go back to Henry Ford, and then think about Moore's law and about Bill Gates and Microsoft. Maybe the real American strength is our ability to scale innovation. How we scale it varies, depending on the technologies, the times, the way the world's unfolding. But we didn't win the Second World War because we invented tanks. It was our ability to scale production. Maybe job creation is also related to our scaling ability. The great companies I've written about are classic examples of how we've done it.

The Internet has been an integral part of doing business for years now. What do you think has changed the most?
I'll start with an observation about social systems that Peter Drucker made 40 years ago. I think it's one of the most underappreciated insights of the 20th century. The alternative to tyranny, he said, isn't democracy. It's management—because well-managed organizations are what allow a free society to work. They are the only means by which a free society can compete with totalitarian dictatorships, which are very effective.

So what ties that into the changes happening today? It seems to me that this era is marked by something having to do with connectivity and networks and the ability to operate and lead within them. The Internet is all about networks and connectivity across networks. So one possibility is that there's a shift to a new fundamental building of society, namely, the network. We may be moving to a world of networks well led, as opposed to organizations well managed. You can't really manage a network, but you can help lead within a network. In any case, networks are very alive and real and are becoming building blocks.

Have you actually encountered this phenomenon in any of the work you have done?
Part of my thinking grows out of some work I participated in with the American Society of Association Executives. Associations are, by their nature, networks. They're fluid. But an association has to have some sort of unity and cohesion. So how do you create a great association when it's inherently not self-contained? The association's researchers analyzed some really high-performing associations, in which you can see this network effect and the importance of being able to lead without direct power. I began thinking that associations may actually be on the leading edge of what more people are going to have to learn how to do. Instead of managing a company, you're managing an ecosystem that is networked and connected over the world.

I wonder what effect the Internet is having on the expectations of young people entering the work force. I have a friend who employs a lot of high school kids. He says that, contrary to popular perception, they make great employees, but the old command-and-control approach to managing won't work with them. They want to know why. If you explain the why, they will respond.
I agree on the importance of explaining why, but I think that's a signature of great leadership, not an attribute of a generation. Great leaders in any generation have always helped people understand why. Mediocre leaders don't. We should be careful not to confuse what's rare with what's new. Greatness is rare. It's so rare that, when you come across it, it often feels like it's new.

So what about customers? They seem to be playing a larger role in the decision-making process of companies than they did in the past. An extreme example is Threadless, a T-shirt company that invites its customers to vote on designs and then produces the ones that get the most votes.
That's interesting. Instead of an organization selling a product, it's a network connection that has feedback loops with customers, who are inside their network, not outside. I've also noticed a trend of increasing customer power, and it will very likely continue. Companies have to adjust to it by learning new ways to interact with customers. That's probably good for all of us, because it will lead to better companies and better results.

You have expressed admiration for entrepreneurs who have managed to turn their companies into movements—that is, something that transcends the selling of products and services and inspires actual passion. Movements, it strikes me, are composed of networks.

I think that may be one of the most underappreciated aspects of leadership. I have personal experience with a leader who's done that—Yvon Chouinard, the founder of Patagonia. When I started rock climbing in the early 1970s, we used to pound pitons into the cliffs. That was no big deal at first, but as the number of climbers increased, we started to see cliffs being permanently defaced by the pitons. Chouinard decided to take action. He brought out a set of tools for doing what's called clean climbing. If you use one of his Hexentrics instead of a piton, there's no pounding involved, so it leaves no trace of your having been there.

In the 1970s, he put out a catalog that was actually a manifesto for clean climbing. I still have one. He basically said to all of his customers, "You need to change your behavior and stop destroying the cliffs. Here are the products. You can trust them. You will not die if you use them correctly." I was a young climber at the time and watched the entire behavior of the climbing community change. Chouinard ultimately saved the cliffs. To this day, I am a loyal Patagonia customer. I'm still part of that movement. Yvon did the whole journey from idea to business to company to movement. I see it with Apple as well, which is closer to a movement than a collection of customers who buy its products.

Of course, those are both consumer companies. Does your movement theory apply to other types of businesses as well?
A movement springs up around a cause, and I think there are different kinds of causes. Software that makes people more productive is different from Hexentrics that prevent the defacement of cliffs, but they both can be part of a larger cause. Gordon Moore of Intel projected the freeing power of microelectronics. Intel's founders believed they were revolutionizing the world, and they were. In Southwest Airlines's case, the cause was the workplace. Herb Kelleher, I believe, had incredible faith in what people working together could do. I don't think it was ever really about airlines for him. It was about creating a culture that could defy all odds by having everyone in it together battling against the brutalities of the world, achieving stellar performance in a humane way. That is also a cause. And someone like Kelleher isn't an exception. The great leaders I've studied are all people whose energy and drive are directed outward like that.

"The great leaders I've studied are all people whose energy and drive are directed outward. It's not about themselves. It's about something greater than themselves."

What do you mean by "directed outward"?
I mean that, as driven as they are, it's not about themselves. It's about something greater than themselves. Take Bill Gates. His deep, abiding passion was for what software could do in the hands of all kinds of people. He wanted Microsoft to be a conduit for it. I don't think it ever crossed his mind that his work could make him a billionaire. That's what I mean by outward. Or take Steve Jobs and his drive for beauty, for making something insanely great because you can, not because of what you will get for it. I think of him as an industrial Beethoven, a product artist, who came to view Apple itself as one of his creations. Or George Rathmann, the co-founder and first CEO of Amgen. He wanted to create products that would affect people's lives. Amgen brought out a drug called EPO for treating anemia in patients with chronic kidney failure, and it ultimately affected Rathmann's own life: When he had to go on dialysis, he became an EPO patient. You see the pattern. Every one of these leaders had the idea of shaping the world around them.

They sound different from the Level 5 leaders you discuss in Good to Great, with their blend of personal humility and professional will. I don't associate humility with people like Steve Jobs.
My concept of humility is somewhat broader now than it was when I wrote Good to Great. I think of it as being in service to something much bigger than yourself. The humility comes from realizing how much bigger that something is.

Humility aside, it seems as though the recurring themes in your books are discipline, preparedness, and persistence. Are those the essential qualities that tie all the companies and their leaders together?
There's also the theme of BHAGs, Big Hairy Audacious Goals, as well as the creativity piece. Discipline stands out in our work because it's so much rarer than creativity, but creativity and discipline go hand in hand. Years ago, I had the privilege of teaching the Creativity and Innovation course at Stanford, developed by Michael Ray and Rochelle Myers. The basic premise of the course was that creativity is the natural state of being human. If you breathe, you're creative. My wife and I are working our way through A History of the World in 100 Objects, by the director of the British Museum. One of the first objects is a piece of art from 13,000 years ago, and some jade hand axes from early civilization were shaped for sheer beauty. The author notes that our creative, artistic urge seems to show up 50,000 years ago.

What do humans do? We create. We don't have to learn to be creative. We have to unlearn what gets in the way of our creativity. Discipline, on the other hand, is not the natural human state. So it's a differentiating factor. What is superrare is the ability to blend creative thinking with discipline and to do it in such a way that the discipline helps rather than hurts the creativity. It's a special group of leaders who can do that.

Do you think every business owner should strive to build a great company? Is that the only good reason to be in business?
No, not at all. I admit it can sometimes sound that way, because I'm so passionate about the subject. I do believe that building a great company is a noble quest. But I view it as a giant "if/then" question. Yes, if you're inspired by the idea of building an enduring great company, if you want to have an impact on the world through business, if that would make you feel great about what you've done with your life, then the stuff I've written will help. But I'm not trying to impose the "if" upon anyone. If people aren't inspired by that idea, I'm not trying to convince them they should be. I would hope there are founders, Inc. readers, who've never really thought about it and—when presented with the possibility—find that it ignites something within them. But I'm not trying to convert anybody. It may not be your hedgehog.

Just to be clear, for those who haven't read Good to Great, a "hedgehog" has to do with the intersection of what you are deeply passionate about, what you can be best at, and what drives your economic engine.
And I should note that building a great, enduring, 10,000-person company is not my hedgehog, either. What drives me is curiosity, questions, teaching. I'm inspired by the subject of building great companies, but I am very unlikely to build one myself.

So it's strictly a matter of choice.
It is. I've been very influenced by our research on that score—not just the research for Great by Choice, but also for Built to Last, Good to Great, and How the Mighty Fall. Altogether, we've looked at 6,500 years of combined corporate history using match-pair comparison. What we see are people who've made different choices and different decisions. This study really nailed it for me. Maybe other people didn't make the same choices because they didn't know any better. That's irrelevant. What's relevant is the differentiator, namely, what people did. Everybody has luck. Clearly some unlucky things can kill you. But I keep coming back to the conclusion that it's mainly about choices. Is it what happens to you, or is it what you do? These leaders come down squarely on the side of, it's what you do. Our luck analysis in Great by Choice bears that out.

You are talking about the last chapter, in which you show that the highest performers—the 10Xers—were no luckier than the comparison companies, but that they differed markedly in the benefit they got from the luck they had. I particularly liked the way you define a luck event—as good or bad. That made it possible to quantify the number of such events experienced by each company during the period you studied. That was pretty cool.
Morten Hansen and I spent months figuring out how to do it. We thought it was important, because you have to wonder: Were the companies we hold up as role models just luckier? When you look at the numbers, the answer is no. What's important is what people did with their luck, how they did it, how they thought about it. The 10Xers achieved a higher "return on luck" by using the leadership concepts we write about. Of all the pieces of analysis we've done in almost 25 years, that, for me, hands down, is the most exciting and the most interesting.

Has it really been almost 25 years? That's quite a journey.
Yes, it began in 1988, when I started teaching the course on Entrepreneurship and Small Business at Stanford. It had always been positioned as a course in starting and managing small businesses. But for some reason, I changed the first line of the syllabus to say it was a course about turning a small business into a great company. I don't know exactly what inspired me to do that.

So, in a sense, you have come full circle. What do you think it all adds up to?
A big part of it can be summed up in the luck analysis. It demonstrates how much success depends on choices and decisions, rather than circumstance and luck. Another part has to do with helping people ignore all the stuff that's just noise.

What do you mean?
I mean it's easy to spend a lot of energy on things that really don't make a difference. You hear about this new trend or that new development, and you wonder if and how you should respond. Yes, you need to pay attention to how your world is changing. But it can also lead to confusion. There is great simplifying power in being able to say, "We need to start first with whatever problem we have." It's a decluttering mechanism. You don't have to be distracted bythe stuff that's not going to determine whether or not you're successful.


Jim Collins's Plan for Growing Companies

Hedgehogs, Cannonballs, BHAGs, and Bullets

Jim Collins has spent a career probing the inner workings of great companies. Below, he boils 25 years of research into 12 questions that leaders must grapple with if they truly want to excel. Collins's advice: Be systematic. Every month, have your leadership team discuss one of the following questions. Repeat the process annually for five years.

1. Do we want to build a great company, and are we willing to do what it takes?
It begins by making a choice, with a clear understanding of what that choice entails.

2. Do we have the right people on the bus and in the key seats?
You need to decide whom you do and don't want to have with you. You should do that even before deciding exactly where you want to go.

3. What are the brutal facts?
You can't make good decisions if you don't confront the facts, especially the most troubling ones, those that could represent a serious threat to your survival. The key is to do it without losing faith.

4. What is our hedgehog: What can we be the best at, with an economic engine, and for which we have unbounded passion?
"The fox knows many things, but the hedgehog knows one big thing," wrote Isaiah Berlin. Your hedgehog combines your passion and your special talents with what you can make money doing.

5. What is our 20-Mile March, and are we hitting it?
That is, what is the specific performance goal you've made a commitment to meeting year in and year out, in good times and bad, and how are you doing with it?

6. Where should we place our big bets, based on empirical validation?
You should devote major resources to a new initiative (fire a cannonball) only if you already know it's likely to succeed. That means first conducting low-cost, low-risk tests on a range of possibilities (shooting bullets).

7. What are the core values and core purpose on which we want to build this enterprise for 100 years?
The challenge is not just to build a company that can endure, but to build one that is worthy of enduring.

8. What is our 15- to 25-year BHAG?
To build a great, enduring company, you need a Big Hairy Audacious Goal that is tangible, energizing, and highly focused and that people can understand immediately with little or no explanation.

9. What could kill us, and how can we protect our flanks?
Paranoia is productive when it helps you survive the inevitable bad surprises that will come along and avoid the disasters that they are capable of producing.

10. What should we stop doing, to increase our discipline and focus?
In creating a culture of discipline, it's as important to determine what you should not be doing as it is to know what you should be doing.

11. How can we increase our return on luck?
All companies experience both good and bad luck. It's what you do with your luck that counts. How can you get the most benefit from it either way, and how can you minimize any damage that a run of bad luck will cause?

12. Are we becoming a Level 5 leadership team and cultivating a Level 5 management culture?
The fifth, and highest, level of leadership builds enduring greatness through a paradoxical blend of personal humility and professional will. Are you providing it?

May 29, 2012