Late one night in 1988, a curious scene transpired on the floor of an auto parts factory in New Jersey: two Japanese men were shifting machinery around, occasionally turning to each other and chuckling, while a crew of night-shift workers looked on, mildly confused. The Japanese men left in the early hours of the morning, and when they returned just a few hours later, it was their turn to be pleasantly surprised—the factory workers had already put many of their suggestions into practice.
This incident marked the introduction of Lean manufacturing to Danaher—a company that took the principles of Lean so seriously, that over the years it internalised Lean and spat out a version that was uniquely their own. This was the Danaher Business System (DBS). Over the decades, Danaher has changed from a traditional industrial behemoth to a niche, tech-savvy healthcare business, but DBS has remained omnipresent — albeit constantly evolving alongside the company .
The story of Danaher starts with two brothers, Steven and Mitchell Rales, who talked business as they dangled fishing rods on the shores of Danaher Creek, Montana.
When the Rales brothers started a company in the 1980s, they envisioned that it would function like a modern private equity firm. Their business model was simple: buy existing businesses, improve them, and then sell them at a profit. They started with real-estate companies, but it wasn’t long before they switched to manufacturing. This was a curious choice: at the time, the American manufacturing industry was facing serious competition from Japanese products, and to make matters worse, there was a fair amount of unrest in the domestic labour market.
In any event, as the brothers fished at Danaher Creek that summer day, they discussed their vision for a new-age, modern industrial company. The Rales charted out the broad business fundamentals for this company: profitability as a key metric, and goals aligned with the constraint of using leverage for growth. They imagined this would look like a company that generated a steady flow of increasing cash that could be used to service debt. With this concept in hand, the Rales brothers were off to the races. They managed to secure a bank loan and set off to find cheap manufacturing assets to acquire.
The company was not, at that point, named Danaher. It wouldn’t be until a couple of years later, when the brothers merged two of their acquisitions: a vinyl siding company and a tire company, into a public entity that was renamed Danaher. (After the creek where the Rales dreamed up the vision for the company? Perhaps, but we can only guess!)
Note: this is Danaher’s old logo. Danaher switched to a new logo in 2023.
The first deal under the Danaher name was the acquisition of Chicago Pneumatic in 1986. Chicago Pneumatic was your typical American holding company with a multitude of assets, including one that would prove very valuable to Danaher — for more reasons than one, as we'll soon find out — named Jacobs Engine Brake. This division’s main product was the “Jake Brake”, a product engineered to use the engine and the exhaust to assist the braking mechanism of trucks when they went downhill.
At this point, the story of Danaher becomes closely entangled with the general manager of the Jake Brake division, George Koenigsaecker. Koenigsaecker had served as a Green Beret in Vietnam, and after the war, worked for a Japanese-American joint venture in Japan. It was here that Koenigsaecker developed a keen interest in Japanese manufacturing processes, particularly in Lean and kaizen. When Koenigsaecker returned to America, he took a job at Jacobs Engine Brake—and to put it bluntly, he wasn’t happy.
Koenigsaecker was frustrated with the way the division was being run. In particular, he was disappointed with poor productivity levels, inferior product quality, and never-ending delays. In Lessons From the Titans, the authors wrote that Koenigsaecker was a perfectionist who took great pride in his work. Worse, he was becoming increasingly convinced that the business would run itself to the ground.
One day, Koenigsaecker learned that two of the men who had helped create the Toyota Production System were giving a lecture at Hartford, just a couple of hours away. Koenigsaecker attended the lecture and approached the two engineers, Yoshiki Iwata and Chihiro Nakao, afterwards. He managed to convince Iwata and Nakao to meet him for dinner. Koenigsaecker drilled them for advice on his deepening problems at Jake Brake; to his surprise Iwata and Nakao agreed to visit the factory that very night.
Here, we return to the story at the beginning of this case. The Jake Brake factory was a traditional facility in every sense of the word, complete with rigid assembly lines and little scope for workers to voice their concerns. Iwata and Nakao were not impressed. As the night-shift watched, the two men began pointing their fingers at different parts of the production line, and began moving equipment across the factory floor. Iwata and Nakao retired to their hotel to rest for a few hours before returning to the factory the very next day. They were pleased to note that the workers had already put many of their suggestions to practice. This, it turned out, was no accident: the factory workers were eager to follow their advice in part because they had attempted to seek authorization to implement many of the recommendations earlier!
To Koenigsaecker’s delight, this set Jake Brake on the right path: costs went down, quality increased, and workers, who finally felt that their suggestions were being recognized, were far more engaged and motivated. Koenigsaecker was impressed by the turnaround and hired the Japanese men to consult for the factory for one week every month, until the principles of Lean were embedded into Jake Brake culture.
Of course, Koenigsaecker wasn’t the only one who was delighted. The Rales brothers and their new CFO, Pat Allender, wanted to understand what had occurred at Jake Brake, and more importantly, how they could apply it to the rest of the company. They had Koenigsaecker present on the transformation to all of Danaher’s executives. Scott Davis, Carter Copeland, and Rob Wertheimer write in Lessons from the Titans:
“Thus, the Danaher Production System was born, the predecessor to the more evolved and broader Danaher Business System. Its basic principles, rooted in Lean and continuous improvement, are fundamentally unchanged today.”
From this point on, Danaher began iterating on the processes that would eventually turn into DBS. It is the principles behind this iteration that matters, not the exact trappings of the system that is important. In a 2023 interview, Mark DeLuzio, a Danaher executive who played an instrumental role in creating the system, argues (emphasis added):
“I would say, well, if you want to do the Danaher business system, go work for Danaher. Okay, because you can't do it. You got to do it your own, create your own system with your own culture, your own people, your own industry, and all that. You can't just copy people. You can't copy Toyota.”
In other words, DBS is constantly evolving.
Why has Danaher worked so well? How has an American manufacturing company performed so remarkably over a three decade period?
Our analysis has to start with capital allocation. The Rales and CFO Pat Allender were already good capital allocators to begin with. For instance, one of the big reasons that they pushed for the adoption of Lean across Danaher was the cash flow that Lean freed up. They did this just as corporate America began focusing on a new business metric, Return on Invested Capital (ROIC). The maths was simple: with reduced inventory, faster cycles, and higher quality products, factories could boost ROIC; ROIC was “nearly perfectly correlated” with increasing cash flow.
The Rales, armed with their shiny new processes, were eager to acquire more industrial assets. But they quickly hit a problem: US banks were risk averse, and Wall Street’s debt market was still relatively immature; both sources were wary of lending the company too much capital. This didn’t faze the brothers for long. Danaher found another source of funding, one that was becoming very popular around this time: high-yield bonds. At the time, high-yield bonds were often disparagingly called ‘junk bonds’ because they were rated far below investment grade. The Rales brothers met with junk bond king Michael Milken, and decided quickly that these bonds were the answer to their problems: they used high yield debt to fund the bulk of their expansion plans in the 80s. Junk bonds had high coupon rates, but the returns on the deals Danaher could make were significantly higher. It should be noted that though the company credits Lean with its rapid growth during this time, the junk bonds did, in fact, enable Danaher to grow much faster than it would have otherwise.
Between the years of 1984 and 1990, Danaher acquired a grand total of 12 B2B companies which fit a similar profile — these were primarily solid businesses that were being poorly run. Deal prices were low simply due to the lack of competition. Most companies were more comfortable being on the sell-side because of skyrocketing interest rates, the slow growth of the private equity industry, and the passing age of mighty conglomerates. Danaher took advantage of this. Insiders credit CFO Pat Allender for making sure that Danaher didn’t take on excessive debt. He was quick to remind management that a single bad deal could tank the young company’s growing credibility.
In 1990, the Rales brothers hired a high-profile new CEO, George Sherman of Black & Decker. Sherman and Allender worked together to develop a uniquely shareholder-centric culture at Danaher. This would be one of the company’s iconic mission statements, the catch-phrase being, “we compete for shareholders”. Sherman actively courted analysts and shareholders to build a very loyal shareholder base. Author Scott Davis said of this on a 2023 podcast:
“In the case of Danaher, I think there was always a really big commitment to Capital, T. Rowe Price and Fidelity, three behemoths who at any given time owned fairly substantial amounts of stock. So what does that mean in practice? Well, Danaher would have their Analyst Day every December and I recall executives literally, as soon as the Analyst Day was over going back down to D.C. and they were having breakfast the next day with T. Rowe Price portfolio managers to talk to them about the vision of the next year and such. And then they were jumping on an airplane to go see Capital out in the West Coast right after that. And presumably, there was a trip to Boston probably after that.”
The company’s meticulous, consistent focus on its shareholders paid big returns. An example of this was several years later, in 2007, when Danaher needed to issue equity to fund its acquisition of Tektronix. Scott recounts how easy it was for them to raise even large sums of money from their shareholders:
“Well, and the postmortem of it was the top shareholders came in and said, well, Danaher is issuing equity to do a transaction that we're favourable towards. Sure, they've got our support. Here's the money. And it was that simple. So I think the point is that being that close to your shareholders, it enables the pivot.”
In December of 2001, Danaher entered a new era when Larry Culp succeeded Sherman as CEO. The company that Culp found himself in charge of was very different from Sherman’s Danaher. The company had matured significantly, with a growing reputation, a compliment which came with its own set of challenges. For instance, Danaher now had to reckon with the expectations of shareholders, who expected to see the stock price increase perennially.
Culp noticed that the efficacy of Lean was the highest when applied to companies with a steady growth rate: one that was not too low, and not too high. Once again, the maths was simple. Lean allows companies to add two to three percent of “free” manufacturing capacity without significantly increasing equipment or labour costs. Now, with a little capital to keep equipment up to date (or investment in better software systems), this percentage can double (i.e. four to six percent). The catch, however, is that if one tries to add an even higher percentage of “free” manufacturing capacity, many of the benefits of Lean are lost. This occurred for a variety of reasons, like supply chain partners not being able to keep up, and the requirement to invest even more capital, such as needing to pay overtime wages. As an aside, this was remarkably consistent with an insight commonly attributed to General Electric’s Jack Welch: in the early days of GE’s adoption of Six Sigma, the company observed that the ideal unit volume growth cadence for rising productivity was four to six percent.
Culp also held the mirror up to Danaher’s acquisition strategy, in an attempt to understand the types of businesses that derived the most benefits from Lean. He found that highly cyclical businesses brought relatively less value because Danaher’s efforts to implement Lean could be undone by a recession. For this reason, Culp chose to focus on businesses with high after-market content. (Aftermarket here means that the company enjoys significant sales in consumables or incidentals after the initial product purchase. Think: buying ink after purchasing a printer for your home office.) Danaher acquired businesses which sold hardware equipment that required a steady stream of consumables to stay in operation. In such companies, the cyclical nature of the hardware was offset by the steady demand for consumables.
The other type of business Culp was focused on was those with high gross margins, in particular those with a big difference between gross and operating margins. He found that DBS worked better in these companies for two reasons: first, there were more opportunities to optimise costs; second, it was easier to improve the gross margins of a high-margin company as compared to a low-margin one. This ran against the prevalent view at the time that low-margin businesses were better suited to cost reduction.
Putting Culp’s new-and-improved acquisition strategy into action, Danaher acquired assets like Videojet (industrial printers that needed ink), Radiometer (imaging equipment), Vision Systems (medical instruments), ChemTreat (water treatment), AB Sciex (measurement equipment), and Beckman Coulter (testing equipment). These assets tended to be more expensive but Culp managed to finance them with low-cost debt, which he managed to wrangle as interest rates fell and rating agencies recognized Danaher’s track record. Further, as the risk of cyclicality reduced, Culp noted that equity markets were willing to pay a premium for equity in a company that was increasingly predictable. He convinced the Rales brothers and the company’s board to pay more for these assets.
Culp’s acquisition strategy selected for companies that were not extremely high-growth and operated in niches. This worked well for Danaher because these targets were not typically pursued by other strategic buyers, who were typically either after high-growth businesses, or looking to consolidate their markets. All the same, Culp was careful to avoid pointedly low-growth businesses because he found that the benefits derived by DBS would be wasted there.
Danaher benefited greatly by applying Lean to smart acquisition targets. But Culp wanted more than that. He wanted the company and every employee in it to truly live the culture of continuous improvement. One of the measures Culp used to this end was adding modern tools like funnel management, value engineering, and procurement and logistics tools to the DBS toolkit. These tools were typically developed by other organisations that Danaher acquired, but optimised for Danaher prior to adoption. Culp also streamlined all the company’s functions by implementing a process for everything — right down to meetings being limited to 30 minutes (usually conducted standing!), short emails, and simple visual tools being a preferred method of presentation. Further, managers were evaluated not just on the basis of the results they achieved, but also on how they achieved them. This discipline and culture of improvement made Danaher more resilient to mistakes, like a bad acquisition.
To that end, Danaher’s hiring procedures continue to be a major determinant of the company’s enduring culture. Danaher indexes for both talent and character traits, like humility and transparency, which would make a person more likely to embrace a culture of continuous improvement. For this purpose, the company hires an external consultant to administer a personality test of sorts on potential hires. Danaher’s onboarding process is also unique because it involves a two-to-three month immersion program during which new hires don’t actually work; they visit factories and offices and sit in on different functions to learn DBS and its tools. A big commitment to integrating employees into the company culture!
These practices extend well beyond recruitment and are also evident in employee evaluations. As mentioned previously, managers are evaluated on a more holistic measure than the results they achieve. The eight core metrics that Danaher uses to measure manager performance are—organic growth, margins, cash flow, ROIC, on-time delivery, quality measured by defects/million, internal job fill rate, and retention.
The eight metrics aren’t the totality of manager evaluation. Lessons From the Titans has several interesting notes on Danaher’s evaluation practices:
HR at Danaher works on developing managers and pays just as much attention to the “how and why” as to outward performance. A manager who gets results but fails to develop a successor, for example, will be passed up for promotion. Talent development is mandatory, and a manager who scores poorly on employee engagement is on the way out. Danaher believes that people normally quit because of bad managers, not because of pay. If it sees unusually high turnover or some degradation in employee engagement, the manager is usually the root cause. In fact, Danaher sees high employee turnover as a lagging indicator, so the pressure to catch bad actors early is high. Performance reviews go beyond the core Danaher metrics to cover hard-to-measure aspects such as team building, leadership through DBS, and one’s success in “charting the course”.
These eight core metrics are itself an example of Danaher’s culture of constant improvement. Back in 1991, the company tracked 50 financial metrics to measure manager performance (source). The then-CFO of the company, Dan Comas, found this unhelpful, and over the course of multiple trial-and-error iterations, narrowed it down to just eight!
Comas brought other changes to Danaher, chiefly around M&A diligence and integration. Danaher’s standard practice upon acquisition of a new company is to automatically replace the CFO, and then start tracking the set of eight core metrics that allows it to cross-compare with other Danaher businesses. Comas made it a point to ask acquired companies: “Now that the deal is closed, please tell us everything that you failed to tell us during diligence.” His view was that things always go wrong in M&A, so the chief determinant of success was the speed and permanence of fixes.
Comas was also responsible for creating processes to track the eight key metrics each month for about three years after acquiring a new company; Danaher would track the metrics for longer for the biggest deals.
The year 2014 marked the beginning of many big changes for Danaher. The company’s all-star CEO Larry Culp announced his retirement. By this time, the economy had recovered from the financial crisis and Danaher found itself grappling with a competitive M&A environment. The company also noticed that its mixed portfolio, divided between industrial assets and niche businesses, was out of step with the market that was moving toward either very high-tech moonshots or focused industrial plays. The board and the new CEO, Tom Joyce, found a solution for this problem — splitting the company into two. The traditional industrial assets were spun out into a holding company called Fortive, while the niche healthcare business became the new Danaher.
Now, down to the nuts-and-bolts: DBS. After extensively studying Danaher and interviewing its employees, authors Scott Davis says of DBS:
“The Danaher Business System itself is a collection of lots of tools. if they were here on this podcast, I don't think they could actually tell you how many there are. I think they would tell you, well, there might be a dozen, there might be 100. There's a lot of smaller micro tools.”
He goes on to describe how every function in the organisation has a tool — either developed by Danaher, or a best practice identified in an acquisition and optimised for Danaher. The common element between these tools is a preference to represent results visually, in the belief that this would help employees measure their progress. In Lessons from the Titans, the authors write:
“Danaher offices are plastered with Post-it notes, large worksheet paper is marked with different-color pens, and timelines typically resemble more of an eighth grade history project than a sophisticated company. Danaher believes that project management requires some form of visual aid, and that regular (but short) meetings should be held in front of the visual aid.”
The authors explain that DBS actually includes simple processes, but what makes Danaher stand out is the concept of “common sense vigorously applied” — the simplicity of a to-do list based on tangible objectives, for executives and factory workers alike, can generate tremendous value over time.
While answering a question about what made DBS successful, former Danaher executive Mark DeLuzio says:
“I would have to say consistency of leadership in the belief of [what] Danaher business system can mean for all stakeholders…was never wavered from CEO to CEO.”
The key thing to understand about DBS is that it is not static. It is a pervasive culture of continuous improvement. Think about it for a moment: DBS has served the company through its transition from a value buyer of industrial assets, to a steady mid-growth cash flow machine, and now to a more traditional growth company — and has evolved to best serve the company’s needs at each stage.
A couple of examples should suffice. When Danaher started making more expensive industrial acquisitions, efficiency on the factory floor gained even more importance. The company was reluctant to put additional capital into each acquired asset and used DBS to enable free or low-cost capacity additions. Since the company also pursued targets which had high gross margins, the opportunity to use DBS was more pronounced in driving efficiency in sales and marketing in those companies, as opposed to reducing manufacturing costs as with the earlier industrial assets. As Danaher evolved into a growth company (its current form) the implementation of DBS in new acquisitions has an emphasis on sales productivity. But across all its phases, Danaher has always attempted to standardise non-factory floor work. DBS requires that each step be documented and some degree of value mapping be conducted for every process. Typically, a kaizen project involves preliminary efforts to recognize standardised procedures, followed by assembling a team to generate ideas for enhancing efficiency. Lessons from the Titans has this throwaway line: “Danaher insiders describe the process as kaizen/implement, and then rinse/repeat. Small increments of improvement, done in steps, become large increments of improvement over time.”
Seasoned Danaher executive DeLuzio gives us more colour on how Danaher thinks about making and deploying business strategy. He says: “First of all, let's talk about what strategy is. How we define it at Danaher, very simply, [is] what game are you playing and how are you going to win? That's it. Forget about all the textbooks and everything else. That's it…you should be able to articulate your strategy and elevator in 20 seconds.” Once you’ve figured out what processes you have in your “game”, DeLuzio stresses the importance of identifying “which three or four of those processes are game changers for you, that are going to really drive your business, then all the other processes are more functional and they just have to be done really darn well.” He explains that enterprises working together as cohesive units is very important, “you have to enlist multifunctional teams to work together for a common breakthrough, because no breakthrough that I've met yet is a single function.” Case in point: In the early days, DBS used to be the “Danaher Production System,” but they changed the name because they realised that in order to be truly effective, the processes needed to apply to the whole business, not just the manufacturing division.
A big reason why Lean doesn’t work in many companies is because they struggle to stay focused on the fundamentals through common occurrences like business cycles and management changes. In Lessons from the Titans, Scott Davis says:
“Danaher says it is a shameless adopter of others’ best practices, because DBS isn’t good enough, never will be good enough, and will always have to change. We just can’t think of another company that exhibits that level of paranoia after such a track record of success or that shows such a willingness to experiment, tweak, and rapidly change. Of course, those experiments often fail, and that willingness to risk failure to change is the point. Truly exceptional people and cultures seem to understand that reinvention is critical in order to continue to thrive. At Danaher, DBS drives constant change and nurtures a culture that embraces such change.”
Davis concludes:
“DBS is simple. At its core, it’s just a set of tools that remind people what to do: To stay focused on what matters. To use visual tools. To keep meetings short and focused and email only what’s necessary. To manage the little details. To measure what matters and improve on those measurements by doing a little every day versus taking big leaps in spurts. To benchmark to the best and be willing to accept the realities that others are getting better too. To hire humble and transparent folks. To develop internal talent so that when you get promoted, someone is ready to take your role. And to get rid of those who don’t live those principles. None of this is rocket science. There are no new paradigms. Danaher and Fortive employees aren’t expected to reinvent the wheel. They’re expected to make that wheel go a little faster and smoother every single day.”
Sources
The primary source for this case is Lessons From The Titans.