Special: CEOs On Innovation
By Ellen Florian; Fred Smith; Craig Barrett; A.G. Lafley; Jim McNerney; Art Collins

(FORTUNE Magazine) – "I Have a Cast-Iron Stomach"

That's what Intel CEO Craig Barrett says about what it takes to cope with gut-wrenching change. But in the business world, it's the essential day-in, day-out process that keeps companies a step ahead of competitors and keeps the economy churning along. Managing change has an art and a science all its own. To find out how the best of the best do it, FORTUNE asked five CEOs who should know: The companies they run have scored in the top 20 for innovation in our America's Most Admired Companies survey at least three times in the past half-dozen years. Here's what they had to say. --Ellen Florian

Fred Smith FedEx FOUNDER, JUNE 1971

ON CHANGE: Change is shorthand for opportunity, and if you can be a little bit ahead of shifts in business, the opportunities can be big. Of course, there will be mistakes, and we've certainly made ours. But I can absolutely promise that you'll get extinguished if you think that you will not have to change. We've been changing ever since I started the company in 1971. First we focused on high-priority medical and technology shipments, then added international service, low-cost ground shipping, and freight. Our acquisition of Kinko's right now is the same kind of change: We'd been moving documents and packages for the back office, and here was an opportunity to do it for the front.

ON GETTING EMPLOYEES TO EMBRACE CHANGE: To be able to change effectively, you have to have a high degree of trust and outstanding communications capability. When we got into the ground business, we didn't want our employees at FedEx Express to feel threatened. So we put a tremendous effort into communicating with them. I got onto our corporate television network. I gave speeches. I went on road trips. We talked to them in e-mails and publications. Anything to make them feel they were part of the change and explain why we were changing. We're doing the same thing with Kinko's. We didn't walk in there and say, Okay, guess what: A lot of people are laid off. We managed it cautiously. You have to spend that time and effort to communicate why change is necessary. If you can put that into a culture that knows change is inevitable and an opportunity, not a threat, then I think you have the potential to have a company that can grow to a very large size.

ON WHAT THE FUTURE HOLDS: The information component of the business is going to become even more important. And though we are already a big international company in terms of revenue, we will be much more global in years to come than we are today. The U.S. accounts for only about 24% of worldwide GDP, so opportunities overseas are vast. Our international business is roughly 23% of our $23 billion total revenue, and it's growing at a double-digit rate. Some of our fastest-growing businesses are in Asia; we have a huge overnight express system that connects all of Asia to itself, and it is growing much faster than our domestic businesses are. Our business from Asia to the U.S. and Asia to Europe is exploding. China to the U.S. is almost incredible--we are seeing 40% year-over-year growth!

Diversifying delivery FedEx's businesses as a % of revenues

FY1997 Express 100%

FY2004 (est.) Express 71% Ground 16% Freight 11% Kinko's 2%*

*Represents one quarter of the fiscal year.

Craig Barrett Intel CEO SINCE MAY 1998

ON POURING BIG BUCKS INTO R&D: We knew that we had to invest our way out of the downturn. So continuing to invest in new products--$28 billion over the past three years--wasn't frightening. I have a cast-iron stomach. It was just the recognition of, that's the way the chip industry works, and that's what we had to do. It's a matter of self-preservation. Our whole product line turns over every year. About 80% to 90% of the revenue that we have in December of each year comes from products that weren't there in January. So unless you are constantly creating new products, new capability, new technology, you can't exist in our ecosystem.

ON NURTURING GREAT IDEAS: We have something called Intel Capital to take advantage of bright ideas outside the company. It is probably the biggest venture capital high-tech investment agency in the world [with a portfolio of $1.3 billion]. There we invest in new ideas that complement our own products. Inside the company we do precisely the same thing: If an employee has a great idea, we fund that on a venture basis and see if that idea can be turned into something real. You saw an example of that recently at the Consumer Electronics Show in Las Vegas: liquid crystal on silicon, our technology to lower the cost of big-screen TV projection capability. We took an individual who had an idea, gave him money to pursue it, and turned it into a business.

ON GRABBING BUSINESS IN CHINA: China is the second-largest market for computers in the world. But you don't have a lot of people who know what computers can do--and you don't have mass media communication. So in the '90s our marketing people came up with the idea of holding personal computer street fairs in Chinese cities. We set up picnic tables on the sidewalk, brought computers out, and had our employees explain to passersby how PCs work and what they can help you do. This has become a common way of selling PCs in China. It's not something that would work in L.A. But in Chinese culture it works wonderfully.

ON MOORE'S LAW: It's been nearly 40 years since [our chairman emeritus] Gordon Moore postulated his law [that the number of transistors on a silicon chip doubles every two years]. The new people who come into our industry think that law is going to hold forever. But the older you get, the more conservative you get on these topics. Forty years is a long time. By anyone's best guess, there's another 15 years or so left in Moore's Law. Nothing doubles forever. Eventually you get to the physical limits.

Riding the China boom Revenue generated in China as a % of Intel's total

2000 6% 2002 12%

A.G. Lafley Procter & Gamble CEO SINCE JUNE 2000

ON THE BIGGEST SHIFT HE'S MADE: This has been incredibly big and incredibly important for us: We've shifted our attention away from commodity businesses in food and beverage, for example, and to the higher-growth, higher-margin, lower-asset-intensive businesses of health care, personal care, and beauty care. We acquired Clairol in 2001 and [a controlling interest in] Wella last March. Five or six years ago about a third of our business was in health and beauty care. By the end of this year, about half of our business [$43 billion last year] will be in that area.

ON DEVELOPING MARKETS: We've made a major commitment to accelerate our growth in developing markets. To do that, we put in place leaders from those regions who could help us understand the markets fast. We totally changed our systems for innovating and manufacturing products. We needed a much lower cost system. We began working with local suppliers. It's just in the past two years that we've had everything in place, and we are doing well--especially in China, where we are seeing absolutely phenomenal growth.

ON ENCOURAGING INNOVATION THROUGHOUT THE COMPANY: The P&G of five or six years ago depended on 8,000 scientists and engineers for the vast majority of innovation. The P&G we're trying to unleash today asks all 100,000-plus of us to be innovators. We actively solicit good ideas, and if the concept is promising we put it into development. For example, we are now selling a line of hair care for women of color called Pantene Pro-V Relaxed & Natural. A few African-American employees came to me and said we're missing out: The stuff that's on the market really doesn't work, and we can do better. [The line launched early last year and is selling well.]

ON COLLABORATING WITH COMPETITORS: I'm a big believer that we sometimes need help in solving problems. So I have set a goal to get half of our innovation from outside. We're in the 20% range now, up from 10% three or four years ago. We have even worked with competitors. The competitors were nervous, and people in my company were anxious too. But my point of view was, wherever they come from, you've got to get the people with the idea, the technology, and the ability to execute the idea in the marketplace together. For example, one product is the Swiffer--the technology in the duster that helps it pick up so much debris came from a competitor in Japan called Unicharm. Another is our joint venture with Clorox to develop Glad Press 'n Seal. Then there's Prilosec. Everybody forgets that Prilosec was a joint venture with AstraZeneca; we bought the rights to Prilosec OTC [over the counter]. I could go on and on.

Moving to higher margins Health and beauty care as a % of P&G's sales

FY2001 36% FY2004 (6 months) 47%

Jim McNerney 3M CEO SINCE JANUARY 2001

ON WHAT HE MOST NEEDED TO ALTER WHEN HE TOOK OVER: We have a very creative culture. But we needed more discipline. We would come up with ideas, but we would not always implement them well. A lot of our innovations were sitting in warehouses because customers didn't want them as much as we'd thought. All those stories of great inventions that are in our mythology--like Post-it Notes--they would have been introduced faster if there had been more discipline around assessing their market potential, committing resources to them, and creating and hitting a sales plan. And therefore the ideas knocked around, and the potential was realized probably ten years later than it would have been.

ON FINANCIAL DISCIPLINE: Our team decided to set some outrageous goals for ourselves. We had periods in the '60s and '70s where we were growing at a double-digit rate. That's the target we want to reachieve. So we reorganized the company into seven major businesses so that we could move quickly into large, high-growth markets. We started an initiative called 3M Acceleration to speed up innovation and commercialization of products. This initiative and others increased operating income by more than $400 million in 2003. That's on top of $500 million in 2002. And we expect another $400 million in 2004.

ON CREATING PRODUCTS THAT CUSTOMERS WANT: We have such great internal processes of innovation and sharing, but it sometimes makes us too internal. So we made some changes. We put people either in a central lab that focuses on the long term or in our businesses closer to customers. Before, we had people who pursued both roles, and therefore weren't as focused as they could be. We're fighting hard to get our customers into our hallways and our customers into our labs. With some customers, we've loaned them a full-time employee for a couple of years to help them use Six Sigma tools to improve their operations. This is not about getting a fast sale, but we do get something valuable: a much better understanding of our customers' needs. We now believe our product pipeline will yield $5 billion in sales over the next several years, up from an estimate of $3.5 billion a couple of years ago.

Imposing fiscal rigor 3M's operating income as a % of sales

1999 18% 2003 21%

Art Collins Medtronic CEO SINCE APRIL 2001

ON MAKING CHANGE HAPPEN AS AN INSIDER: Jim McNerney, who is a very good friend of mine, was brought in as an outsider to run 3M because a significant change was needed there. But my transition was very different in that I had been with Medtronic [the $7.6 billion medical device maker] for nine years, and I had worked very closely with [former CEO] Bill George. So if I were to come in and immediately change everything that had been put in place, well, I should have done that a long time ago.

ON HIS MOST DRAMATIC MOVE: We've started to change how we view medical devices, not simply as providing therapy but as monitoring a patient's condition. So we've developed a whole new capability in communication and information technology to improve many of our products that are implantable inside the body --a pacemaker, a cardioverter defibrillator. For example, more than 100,000 people around the world now have our implantable cardioverter defibrillators and have the capability to be remotely monitored in real time. The device sends information via modem to a secure server, and medical personnel can review it from a remote location to see if there is any problem.

ON DIVERSIFYING: Five years ago our largest business, cardiac rhythm management, was close to 65% of revenue. Now it's 47%. That's because we got into businesses like diabetes by buying MiniMed in 2001. We entered Parkinson's disease by taking our pacemaker technology and running the electrodes into the subthalamic region of the brain to treat it. We have products that go up through the carotid arteries to treat potential problems in the brain. We're stimulating the stomach for gastrointestinal problems and the sacral nerve for urological problems. We're all over the body.

ON MAKING MISTAKES: The technologies, the strategies and tactics, the outside dynamics and how one deals with them--those are in a constant state of flux. The tough part is that many times you've got to change before the real requirement to change is necessarily seen. That means people will make mistakes. You've got to give people the opportunity to make mistakes, to fail, and not to crucify them for doing that. Now, you don't want them to fail repeatedly, but you've got to encourage them to look at change as an opportunity rather than a risk. That's easy to say, but it's hard to do.

Going beyond the heart Cardiac rhythm management as a % of Medtronic's sales

FY1998 64% FY2003 47%