Haier Group's Zhang Ruimin talks about his company's evolution and what drives its success.

Zhang Ruimin, chairman and CEO of the Haier Group, took charge of a struggling refrigerator factory in the 1980s and turned it into a global powerhouse of consumer electronics and home appliances. Zhang believes that the company’s Rendanheyi model — a concept that encourages entrepreneurship and empowers every department to operate like a micro-enterprise — is a key pillar of its success. Rendanheyi, he says, allows every employee to connect with the end users, understand their needs and create value for them.

In a recent conversation with Knowledge at Wharton in New York City, Zhang spoke about his early days at Haier, the transformation through Rendanheyi and the new challenges of the Internet of Things (IoT) era.

An edited transcript of the conversation follows.

Knowledge at Wharton: If you think back to the beginning of your leadership journey, who were your earliest role models? What lessons did you learn from them that have stood the test of time?

Zhang Ruimin: In the past, Chinese businesses weren’t very mature in terms of management methods. We learned a lot from Panasonic and its president, Konosuke Matsushita’s method of effective management. I read a lot of books by Peter Drucker. That was a time when his books were not yet available in Chinese translation. I had to get a copy from Taiwan. One book that I remember very clearly was titled The Effective Executive, where Drucker talked about what kinds of things an executive should do to make his work effective and what are the ineffective things that should not be done. I remember, in particular, he wrote that in a well-managed company there shouldn’t be anything too exciting happening because the routine and rules have been established. Whereas, back in China at that time, people thought there should be a lot of exciting things happening, there should be a lot of activity going on. So that struck me as a very distinctive idea. I admire Drucker and his ideas. He approached management not just as different management models, but focused on people. We think we should focus internally on our employees and externally on our customers and users.

One lesson I learned from Peter Drucker is that managing, or being a manager, is not about how many people you are managing or how large your team is, but about the results and value that you can create. You can be very highly skilled. You can have very high-ranking positions in the company, but if you do not produce any real results, it is still ineffective.

I have used his idea in our Rendanheyi model, where we encourage members of our team to become entrepreneurial and start their own micro-enterprises. In this process, we eliminated 10,000 middle-level managers who didn’t create value for the users. The micro-enterprises are not about having power or having a high position. They are about creating value for the user. I think this is the most important thing.

Knowledge at Wharton: When you spoke at Wharton in 2001, you told this story about how you took over a struggling refrigerator factory at the age of 35. What were the biggest challenges you faced at that time, and how did you overcome them?

Zhang: The challenges were two-fold. First, there were financial challenges. Our products didn’t sell very well in the beginning and I had to borrow money for the first six months to pay our workers’ salaries. We were a collectively owned enterprise and not a state-owned enterprise. Banks were unwilling to lend to us and I had to find other means to borrow that money. The second set of challenges was even more important: We lacked highly skilled and high-caliber talent. This was a problem that was widespread in the Chinese corporate world. Even large, state-owned enterprises had this problem. When we tried to import advanced technologies, there was a gap between the people who could operate them and the technology that we could get. We took a long time to solve this problem.

Knowledge at Wharton: How did you solve this problem, and what are the lessons you learned from this experience?

Zhang: Many large companies, especially state-owned companies, could turn to the government to ask for more college graduates or highly skilled technicians to help them. That was one way to solve the problem. But we turned inward. We turned to our own people and we tried to help them grow and train them — especially to help them change their mindset, their attitude towards working. Drucker has said that a mindset change does not change the fact itself. It changes the perspective that you have towards the fact. An important aspect of the mindset is having the spirit of teamwork. Back then, we started what we called “autonomous groups,” which are smaller teams of workers who help each other work more effectively. That’s an earlier version of our micro-enterprises that are running today. This is how we solved this problem. By helping our people grow and helping them change their mindset.

“We believe innovation is about how to use new ways to create value for the user.”

Knowledge at Wharton: What is the origin of the concept of Rendanheyi and why was this developed as a philosophy at Haier?

Zhang: When our company was still small, we were a very energetic team. But as we scaled, we witnessed a lot more problems, such as silos between different departments. They become self-centered instead of working together. We got this so-called “big enterprise disease.” That’s why we thought it was important to change our business model and to develop this new model of management.

Knowledge at Wharton: What has been the impact of this new model on Haier’s performance in terms of different aspects like revenue growth, profitability, employee engagement and agility in decision-making?

Zhang: We first proposed the Rendanheyi model in September 2005. For the first few years, our performance didn’t really pick up. We had two listed companies in China and our stock price did not grow significantly. Some of the shareholders expressed concerns. In our shareholders meetings we explained that this is the model that we believe will lead to success, especially in this changing world where we were entering the Internet era. However, we still faced a lot of pressure and questioning. Our performance started picking up in 2016. Our stock price doubled that year. In 2017, our stock price doubled again. This pick-up in performance was no coincidence. It was the accumulated effect of many years of working in the micro-enterprise model.

There are two key elements to the micro-enterprise model. The first is that the micro-enterprises are not connected in a traditional cascading way. They are connected in a parallel way and are interconnected so that they can work together to create value for the user. The second point is that these micro-enterprises are user-oriented. They have to create value for their users to get paid. The greater value they create, the better they are paid. They don’t have to rely on decisions from the top; they can take their own decisions to solve customer pain points and to develop their own products. So our organization has become much less hierarchical. These micro-enterprise teams have been empowered with three very important powers: they can make their own business decisions; they can make their own hiring decisions; and they can allocate their resources as well as decide about compensation.

Knowledge at Wharton: What were some of the challenges in the early years when the Rendanheyi model did not succeed? What changed in 2016 and in 2017 that led to such significant growth?

Zhang: It took a very long time for this model to succeed because it takes time to change people’s mindsets. Previously, execution was the most important thing in our organization. We had a very strong culture of execution. To change that to an entrepreneurial mindset took time.

Previously, people worked in siloed departments. They didn’t know who their users were and they didn’t know how to engage with them. As they transitioned to the micro-enterprise model, they needed to take time to think about their end-user and how to engage them. This is not a process that can be completed overnight, especially when we let go more than 10,000 middle level managers. We had to start small, with small pilots, and then replicate those pilots after they showed some success. In 2016, over a decade after we first proposed the model, we saw some great changes in performance. But it was not the result of a single effect or a sudden change.

We believed, at that time, that it was important to start working on connected appliances so that we could directly engage with our users rather than relying on traditional distribution channels. We have our own network and we rely on that network to engage directly with the users through connected appliances.

Knowledge at Wharton: One of the things I find interesting is how this entrepreneurial way of thinking has led to innovation. What has been the impact on innovation within the company? What lessons can other companies learn from Haier’s experience?

Zhang: Innovation, according to [Joseph] Schumpeter’s definition, is “creative destruction.” It means creating a new ability that did not exist before or that others cannot replicate. By creating connected appliances, we are creating an ecosystem to connect and engage with our users. We’re no longer selling them products but making them a lifetime user of our products and services. This is especially important for the 21st century. Ecosystem is how we create value for users. Many other companies believe innovation is in new products or new technologies, but we believe innovation is about developing new ways to create value for the user.

And it’s not at the company level. It’s at every individual employee or entrepreneur’s level. In each micro-enterprise, every member should be able to connect to the user and create value for them. This is a model that is not easily replicated in other companies. I have talked with management scholar Gary Hamel and he said that our model is not seen anywhere in American companies, especially not in very large corporations. In Silicon Valley, too, it is not easily seen. This individual-level innovation, I think, is quite unique.

Knowledge at Wharton: Could you share some examples of connected appliances? I know that Haier has developed a networked refrigerator which has connections with 400 suppliers. I’ve read that it even provides low-glucose products for diabetics. Can you explain how this strategy of connected appliances came about and what are some of the advantages and some of the risks of that strategy? For example, is there a risk of privacy of information when you depend on network products that are not stand-alone products, but are part of a node in a network?

“By having connected appliances, we are creating a network of touchpoints to reach out to customers directly.”

Zhang: By having connected appliances, we are creating a network of touchpoints to reach out to customers directly. This is something that traditional companies cannot do. They just sell products, and it’s very transactional. Even e-commerce is just a trading platform for selling online.

At Haier, we have integrated offline brick-and-mortar stores with online stores, as well as with social selling platforms such as our online store associated to WeChat. We have combined all of these three channels into one and have touchpoints all around it. That has enabled us to reach out to every customer.

The second advantage is that it helps us to develop new products through iterative enhancement. We can develop newer and better generations of products based on feedback from the users. And it’s not just about the products. It’s also about the services, such as, for example, the connected refrigerator. The suppliers and the whole ecosystem are also updated and improved and optimized in this process. I believe these two advantages are unique to our model.

Security is indeed a very big issue. We think about it all the time. What if someone breaks into a smart home system and turns on the gas stove, for example? I think companies around the world are thinking and developing solutions to increase security. However, we are using a different approach. Most connected devices have sensors, but those are product-based sensors. What we are trying to sense is user engagement and user feedback, so that we can directly understand what they need and how they would like the products to be improved.

Knowledge at Wharton: A number of companies are using artificial intelligence (AI) to identify security problems and fraud and so on. Is Haier looking at those kinds of technologies to solve some of the security issues that you mentioned?

Zhang: AI is, indeed, growing very quickly. It serves as the foundation of the transition from the mobile Internet era to the Internet of Things era. That’s undeniable and undoubtedly true. However, I also believe that in the foreseeable future, AI cannot acquire human emotions or human awareness. AlphaGo can defeat the world chess champion; however, it cannot experience the joy of victory. Algorithms can solve a lot of problems but they cannot reach out to people at an emotional or human level. We believe community and the sharing economy are critical for this day and age. We need to reach out and interact with our users and to have every stakeholder in the community economy to have their benefits and interests maximized. So, I believe AI is a necessary condition, and indeed a foundation for our world today. But if you bet everything on AI, you probably will not develop a very competitive business model.

Knowledge at Wharton: Coming back to the point of micro-enterprises within Haier, what sets the winners apart from those that don’t succeed?

Zhang: Successful micro-enterprises have three characteristics. First, they are very entrepreneurial and very good at identifying, developing and seizing new market opportunities, so that they can develop those markets and seize the opportunities. Secondly, they are very well self-organized. They are also very open to inviting people from outside their organization to join them in their research and development. We believe the entire world can serve as your HR pool. When you have an idea that’s attractive enough, you can invite the most brilliant minds to join you. The third characteristic is that these successful micro-enterprises are self-driven and very motivated. They are always looking for the next opportunity to grow.

This is something that we call the “second curve.” They may already have reached the peak of the first curve, but in order to grow even further, they have to find the next curve. These three characteristics are interconnected. If a micro-enterprise can have all of these they will be able to create a virtual cycle. If a micro-enterprise is not doing well in any one of these aspects, then they will have to be taken off if they are not successful enough.

Knowledge at Wharton: Can you give examples of micro-enterprises that have embodied these three qualities? What can other micro-enterprises learn from their experience?

Zhang: Thunderobot is a very good example that embodies these three characteristics. It is a micro-enterprise that produces gaming laptops and high-performance laptops for gamers. This is a very niche market. Thunderobot identified many user pain points — as many as 30,000 complaints online — and realized their existing products were unsatisfactory. So they developed their own products and engaged external manufacturers to produce them. After a couple of years, they were able to rise through the industry and have now achieved IPO. They are very good at identifying new markets. In order to grow further, in order to find that next curve, they are now into the gaming business itself. The founders of this micro-enterprise are very young — born in the 1980s.

Knowledge at Wharton: As Haier continues to grow globally, you have bought companies in Western countries. For example, in 2016, Haier bought GE Appliances. Has Haier tried to extend the micro-enterprise model to these new acquisitions which have had traditional management structures? What have been some of the cultural barriers that Haier has faced in trying to extend this model, and how has the company dealt with it?

“If you bet everything on AI, you probably will not develop a very competitive business model.”

Zhang: GE Appliances used a very traditional linear management model. They had rules regarding every aspect of the business. However, in today’s nonlinear world, in order to reach out to users effectively, that model is no longer relevant. To change the GE model from a traditional cascading model that starts from R&D to manufacturing and into distribution, to a parallel interconnected model, we have broken up the original R&D department, which consisted of 600 people, into smaller teams that focus on different categories of products. For example, washing machines and refrigerators. This allows them to be flexible. They can also get external resources if they need extra R&D help. This has helped them to become much more motivated. We wanted to start with one pilot, but now there are seven micro-enterprises already in GE Appliances. One of the best performing micro-enterprises last year made $12 million in profit, in contrast to losing $3 million the year before.

The other thing that has been changed at GE Appliances is the compensation structure. Previously, only the very top executives got stock option incentives. But that’s a very small part of the workforce. Today, in the micro-enterprise model, everybody can share the profit. When they get this extra bonus, it’s not just monetary. It’s something that can encourage people at a personal level.

Knowledge at Wharton: Did Haier face any cultural resistance within GE, or any of the other companies that were acquired, in bringing about these changes? Organizational transformation is extremely difficult. How was that cultural resistance overcome?

Zhang: One of the cultural shifts that needed to take place at GE Appliances was the mindset. The original mindset was shareholder first. But now, the mindset should be employee or people first. This has been a very big cultural issue and very hard to change, especially with the senior executives. Another issue is around changing the mindset of the employees. It’s hard to build a team with a strong team spirit in a micro-enterprise. We believe the effective way to address this is to understand that it is a universal desire to win respect through hard work and to realize personal potential and personal value in a team. When everybody helps one another, when they can create value for the user and get rewarded, and become a truly effective team.

Knowledge at Wharton: What do you see as the biggest risks of this model and how has the company tried to mitigate these risks? For example, how do you manage the balance between competition and cooperation when you have such a large number of micro-enterprises and you are managing an ecosystem?

Zhang: Balancing competition and cooperation isn’t the biggest problem, because everything that our micro-enterprises do is towards creating a smart home. This is the guiding principle of all micro-enterprises. When micro-enterprises grow big, they can be separated into smaller teams — into two or more micro-enterprises. I don’t see many clashes or imbalances in this process. The real challenge, the real risk, is one of self-complacency. When these micro-enterprises grow big and some of them get venture capital and achieve IPO, they become less and less open, and they become much more inward-looking. They stop looking for better talent externally to help them improve further. This is a risk that is very difficult to quantify. Oftentimes, when you discover such a problem, it’s already too late to correct it.

Knowledge at Wharton: What are you doing to correct it?

Zhang: Micro-enterprises should self-assess how they are performing. First, by looking at their user feedback. Are their users expressing dissatisfaction and turning to other products? Secondly, we require all micro-enterprises to attract external funding or venture capitalist funding. If they cannot do that successfully, it shows that their products are not very promising.

Knowledge at Wharton: Technologies like Internet of Things (IoT), robotics and artificial intelligence are bringing about some fundamental changes. How will the Rendanheyi model have to change in response to some of these changes?

Zhang: New technologies are emerging every day. Big data has now become as important as electrical power was to the 20th century. But we should be aware that it’s important not only to look at the big data but also look at personalized data on the user level, which we call “small data.” In the IoT era, small data is more important than big data. Big data brings you user traffic in the mobile Internet era. But in the Internet of Things era, the real opportunity lies in the individualized understanding of each user. Of course, we should not reject new technologies. We should follow their trends, but it is very necessary to understand that everything should still start from the individual needs of the users, rather than from new technologies.

Knowledge at Wharton: What are the leadership implications of this change? What kinds of new leadership skills will be required at different levels of the organization, as this shift happens?

Zhang: In today’s new era, the key to leadership is to transform your employees or workers into entrepreneurs. How to make your employees more entrepreneurial is more important than being entrepreneurial yourself. In this new IoT era, everything is different. So the way we measure leadership should also be different.

“The real challenge, the real risk, is one of self-complacency.”

Things have been turned upside down when it comes to management as well. To give you an analogy, the previous way of management was all about shooting a fixed target. Now, you have a moving target. If you use the traditional model, you can never shoot the moving target. You will fail.

Knowledge at Wharton: If you think back on your life, what do you believe to be your most important successes and your most instructive failures?

Zhang: In terms of most important successes, I think it’s all about timing. I believe the most successful thing is to do the right thing at the right time. To give you a few examples from the history of Haier — when we first started the company back in the 1980s, it was a shortage economy. People had a high demand for high-quality products. It was very hard for them to find quality products. That is why the Japanese home appliances, Japanese products, were very popular among consumers, because they were high quality. We were one of the few appliance manufacturers that successfully solved the problem of quality. That was why we had initial successes in the 1980s.

Another milestone of our so-called “success,” namely doing the right thing at the right time, happened in 1998, when we first built our factory here in the United States. Back then, it was on the brink of China’s accession to the WTO. Everyone was talking about U.S. investment. And back in China, nobody thought that could also be a factor here in the U.S. But we believed it was the right move. That was the start of our internationalization strategy, which turned out to be correct, against the WTO accession and the globalization process.

The next important move was this micro-enterprise model back in 2005. We believe it has proved to be the correct move at the right moment. The current challenge is what we should do to deal with this upcoming IoT era. We have done a lot, but we don’t know whether it will prove to be correct. Everything is evolving so fast. There are so many unknown quantities. We don’t know whether we are on the right track.

Knowledge at Wharton: What are some of the biggest failures that have been most instructive?

Zhang: In terms of day-to-day decisions, there can be many so-called “mistakes” or “failures.” But those are less important. In terms of strategic failures, I think the most astounding one would be the e-commerce opportunity which we failed to seize. Other companies saw the opportunity and became e-commerce giants.

Knowledge at Wharton: What is the most important leadership lesson that you would like other companies to learn from Haier’s experience?

Zhang: We had more than 10,000 companies that visited here last year alone to try to understand and replicate our model. They spoke highly of our model. Yet, they all complained that it was very hard to replicate.

Knowledge at Wharton: How do you define “success?”

Zhang: There is a saying we often use within our company: “There is no such thing as a successful company. There are only failed companies.” So in terms of the definition of “success,” I would say, again, doing the right thing at the right moment. To do that, you have to be correct in every step of the way in predicting the future. But the future is unpredictable, and no one can always predict the future correctly. We should create the future by challenging ourselves.

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