CONTEXT: Why is passion so much more important in business now than in the past?

DAVID POTTRUCK: To succeed today, a business has to be agile to an unprecedented extent. It has to continuously modify operating procedures, business models, marketing. To keep innovating, companies have to have employees who are passionate about the mission of the company and the meaning of the work. Business has become a battle to find people who will bring their brains, their hearts, and all their energy to work with them. Anything less just is not enough.

TERRY PEARCE: Ideas and commitment are given because people want to, not because they have to. The old model, where work is a matter of trading time for money because you have to feed your family, is pretty much over, regardless of where you work.

CONTEXT: What companies do an especially good job of generating passion?

POTTRUCK: Probably my favorite is Home Depot. Like Schwab, the company is driven by the founders, and employees bring all of themselves to work. Employees view themselves as helping to change customers’ lives by helping them build better places to live. Home Depot has innovated constantly. I think it’s just a magnificent company. The growth record speaks for itself.

The Gap is terrific, too. It has innovated and distinguished itself in an incredibly competitive market. When the Gap bought Banana Republic, the focus on the Safari clothing line didn’t go well. So, Banana Republic was reinvented as an upscale version of the Gap, kind of a competitor to Ralph Lauren. The Gap also invented Old Navy, not just as an off-price brand but as a whole different retailing experience intended for the younger market. If you walk into the Gap headquarters, you just feel the buzz of energy.

CONTEXT: How can a company generate such passion?

POTTRUCK: I think it starts with the CEO. At Home Depot, both Bernie Marcus and now Arthur Blank are constantly in front of their employees, whether face-to-face or via video conferences or voice conferences. Employees think of them as Bernie and Arthur. At the Gap, Millard Drexler is the ultimate merchandiser. He has an incredible flair for fashion and creativity. People know how engaged he is in the business.

Leaders who have that kind of commitment and passion about what they’re doing generate that energy throughout the organization.

PEARCE: The leader has to not only be on fire, but also has to be able to convince employees that they can do something great together. The leader has to be able to articulate a long-term goal. You don’t want to just win a football game or even a championship. You want to build a dynasty, and you can’t do that just by focusing on the short term.

Netscape initially generated great passion, but it never really developed a goal beyond the browser. America Online initially focused on the short term, too, but now it’s on its way to building something important because it’s laid out an inspiring long-term goal.

POTTRUCK: You need to inspire your employees to consider what’s important to them. Great success comes when the employees conclude that their values are aligned with the corporate values, that there is a very clear statement of those corporate values, and that the company lives up to those values. Nothing makes employees more cynical than reading a plaque on the wall that describes corporate values and then seeing that those values never become the litmus test for every policy and every action the company takes.

CONTEXT: How do you take a company that has been slow-moving and turn it into a passionate one?

POTTRUCK: You start by trying to find a higher purpose that explains what the company is all about. If a company is just about making money, you’re going to have a hard time building that business, in my view. Once people earn enough money, there’s no goal left for them to follow.

People are starving for meaning in their lives. If you look at the campaign that John McCain ran for president, you found people looking for someone they can believe in, who seems to be committed to a purpose greater than himself. So, if you’re an airline company, you shouldn’t think of yourself as being just about travel reservations. You’re about giving vacationers that exciting moment away from the humdrum of their lives, or supporting businesspeople as they build their companies.

People will work hard for money. They will devote their lives to meaning.

I’ve actually been part of an effort that I would relate to this. The University of Pennsylvania, where I’m an alumnus and on the board of trustees, is a fine institution that was, to some extent, stagnating. So, we hired a new president, Judy Rodin, who transformed that organization. She engaged the senior team of deans in the vision that the school could become one of the five best institutions of learning in the U.S. By various measures, Penn has broken into the top 10 and is knocking on the door of the top five.

Now, some of the deans had to be replaced. You have to have the courage to make changes. But what Judy also did is find the future within the traditions of the past.

PEARCE: If you can do that in academia, you ought to be a saint. Now, try to get them to do something with their football team.

CONTEXT: Once you’ve settled on an inspiring goal, how do you get people to understand and believe in it?

POTTRUCK: One night we had a meeting of the top 120 people in the company worldwide, and after dinner we arranged a little living room scene. I was sitting there in my slippers and bathrobe. We said we were going to share some great old stories about the company. We also asked that people in the audience tell some great new stories about instances where the company had provided for employees or customers in ways that would astound us. We spent a whole evening sharing these stories, and the impact was profound.

People respond to stories and history. They want to know where the company comes from. They want to see the faces of the founding group and the people who led the company through the early days. They want to hear about the company at its best and figure out how they can be the people who carry the company forward.

PEARCE: We use myths to create a context that helps people understand both where we’ve been and why we’re changing so rapidly. We have a saying: People hate change, but they love progress. And the difference between the two is whether people have the right context.

CONTEXT: I like the way you use the word "context."

When you see executives try to inspire people and fail, what is the most common problem?

PEARCE: They’re not inspired themselves. They haven’t spent the time digging deep and finding out why they’re excited about something. If something doesn’t happen in the leader, it’s not going to happen to anybody else.

POTTRUCK: It’s like the guy who reads what’s meant to be an inspirational speech.

PEARCE: Or like taking the woman you’ve dated 15 times up to her doorstep. You stop at the doorstep, look at her and say, "Now I’m going to tell you I love you. I love you." There’s something lost there.

CONTEXT: In your book, you say some other things about what makes a great company, many of which fit well with ideas we’ve been writing about in Context, so I’d like to get your take on them. For instance, would you explain the importance of choosing "and," not "or"?

POTTRUCK: That has become one of my favorite ideas. People at Schwab are so sick of hearing me say that. I just find it to be an incredibly powerful concept.

The world would like you to think you have to pick A or B. Do you want to have low prices or great service? Do you want to have wonderful employees or do you want to offer lower compensation and live with the outcome?

In reality, greatness in business comes from finding the creative solution that allows you to have the best of both. Anybody can do A or B. An exceptional team of executives can find the solution that gives A and B.

CONTEXT: How about the idea of starting small with a new product or business idea and then prototyping, rather than just launching. Could you elaborate?

POTTRUCK: I know that fear of failure is one of the reasons why companies don’t innovate. But I always struggled when people said to me, "Well, you have to reward failure." I just couldn’t imagine myself walking around patting people on the back and saying, "Great miss. You’re promoted. Here’s a raise for screwing up." On the other hand, I really did understand that you have to encourage people to take a chance. So, we came up with the concept of noble failure. The idea is to separate miserable failure, poor execution, and poor thinking from those projects that are well-thought-through and executed well but that still failed.

Now, even if a failure is noble, we don’t want it to sink the company. We want to come back and play another day. So the question is: How do you fail small?

You can’t always test things in a conference room. You can’t just have a focus group tell you how they feel. You have to put something in front of people and see how they really react. But building a whole system is expensive. So we build simple prototypes. We may have to have a million clerical people behind the scenes faking the way a system really would operate. But we want to quickly try a lot of things, get a feeling from the customer, get a feeling from the employee, before we build the real system and roll it out.

The Web has reinvented this whole concept of rapid prototyping, because you can simulate something at far lower cost.

PEARCE: When you test possibilities with people, you learn a lot that you wouldn’t learn if you were doing just computer models.

If you fail, it doesn’t cost you much. As Dave used to say, "I’d rather be called ‘nine-fingered Dave’ than ‘one-armed Dave.’"

CONTEXT: How about the decision to start the on-line brokerage operation as a separate business? What are the principles that made you decide to do it that way rather than as part of the existing business?

POTTRUCK: First of all, let’s admit we got lucky here. It’s true that when we saw the Internet and Web browsers, we realized that this was a transforming technology. But I wish that, years before, we had also seen that AOL was going to be a huge success and gotten on board with it sooner. So we were not always as wonderfully insightful.

With the Internet, we saw that being the No. 1 player was crucial to our future. How could we do that? We concluded that we had to operate like a start-up. We had to have the energy, the passion, the commitment, the excitement, the sense of ownership, the sense that no legacy systems should slow us down, the belief that everything was up for grabs.

We decided that one of our existing senior people had exactly the right set of talents—the leadership, the understanding of the business, the ability to form partnerships with our other executives, and a fierce desire to show the company and the world what she could do. So we sent her and her team off to build this new enterprise called "E-Schwab."

We felt that if we built it within our existing retail system, it would be always dealing with issues of cannibalization, channel conflict, and things of that nature. So we said, "You guys are going to go off and have your own price, your own systems, your own support structure, your own marketing structure, your own set of technologists. You’re going to be in a different building—not in a different city, but around the corner. You’ll have your own logo, your own T-shirts. Go for it."

And they did. They competed with our existing business, operating as a separate division.

Now, the good news is that the teamwork value at Schwab is so strong that, while there was competition, it was not to the death. There was tremendous cooperation at the top. We helped by making sure our incentive systems didn’t get in the way. We didn’t want the traditional business fighting to keep a client if it was best for that client to go to E-Schwab.

What most people don’t know is that, through mid-1997, the traditional business had its own on-line trading. Customers paid more because they could use our branch offices and our call centers, but—this is the part that people really don’t know—Charles Schwab was the No. 1 on-line brokerage firm in the world. E-Schwab was No. 2. Both were growing. But, when we talked to our customers, they said, "This structure is confusing. Why are you making me choose between the lower prices of E-Schwab and the complete service model of Charles Schwab. Why can’t I have both?" (There’s that "and" idea again.)

Of course, we faced a profitability issue. We were trying to match the two businesses’ prices to their cost structures. But customers don’t want to hear about that. So we asked ourselves a few questions. Are our customers being forced to make compromises they’re unhappy about? Answer: Yes. Is there anyone in the room who believes that the Schwab/E-Schwab structure will be around in five years? Answer: A resounding no. Will it ever be easier or less painful financially to put these companies together than right now? Answer: Nobody could see any benefit to waiting.

So we decided to put the two businesses together. We gathered top management worldwide. We explained that, despite all our financial modeling, we didn’t know how the move would turn out but that we couldn’t see another way of being the dominant leader in five years.

We then put top management in buses and drove them to one side of the Golden Gate Bridge and had them walk across. That walk became an important symbol for us, of our crossing the chasm to a new place.

PEARCE: David says "we" generously. But he made the two critical calls: first to separate the businesses and then to put them together.

When you put something in a different building under a different flag and, at the same time, keep it as part of the company expressing the values of the organization, that’s real leadership. It just takes so much communication. And then to bring the businesses back together....It sounds easy as David describes it, but it was painful as hell.

CONTEXT: Would you look out a few years and hazard a guess on how the Internet and e-commerce will evolve? Just how transforming will they turn out to be?

PEARCE: I think e-commerce will be a nonissue five years from now. The Internet will be so integral to business that it will be taken for granted. It will make the world so connected that it will be the greatest contributor to globalization that we’ve ever experienced. In fact, the term "globalization" will probably disappear five to 10 years from now.

POTTRUCK: It’s going to be extremely rare for companies to build sustaining, competitive, profitable business models on the strength of a Web site. There will be a few exceptions, companies such as eBay that create a marketplace with a self-sustaining dynamic—more buyers bring more sellers, and more sellers bring more buyers. But, by and large, business will be about combining great technology with great service by great people. The best companies will build an entire corporate structure around the new ability to connect with customers, to connect with employees, and to help employees connect with each other.

In the process, advertising will be transformed into customer relationships. Instead of sending intrusive, direct mail to push things that customers don’t want, companies will send much better, carefully targeted alerts about things customers truly desire.

Companies will be able to have employees customize products and services in ways they couldn’t before and in ways that competitors can’t match.

By creating the possibilities for new relationships with customers and employees, the Internet will play a powerful role in separating the winners from the losers in the years ahead.