Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Welcome to our audience to an episode of our IP Fieldwork podcast. Your hosts are Will Oliver and Will Barnes. Will, we are going to talk about Danaher today. I think it's almost a running joke that IP research picks names where our odds of adding value, just from first principles, must be pretty low. Danaher has not been around for just 10 minutes. This is most definitely not what we like to call a two-foot hurdle.

More like a 200-foot hurdle.

So, what in the world are we doing spending time on 200-foot hurdles? Please enlighten me.

We're making life very difficult for ourselves, I think. However, I believe you have to study these companies, right?

Let's unpack these companies.

The company is not 100x or 1,000x. We should spend some time understanding why. It's really as simple as that regarding when and how I started looking at this company. I came across it probably a decade ago and have been studying it ever since, on and off, and more intensely over the last five years as I've focused on holding companies more deeply.

Part of that study has been a fascination with companies that deploy creative M&A more programmatically to add value, rather than just relying on organic growth. I'm obsessed with finding companies and management teams that can consistently do that over long periods to create shareholder value. The reason I found it is simply because it's one of those rare, outperforming businesses.

When I look deeper, I always go back to find the earliest filing or original source document on a company. There are some HBS case studies on Danaher from the 80s, but you can also find raw filings that show the story and original makeup of the business in the 80s. Danaher is particularly fascinating because it has evolved significantly, probably two or three times.

In the early 80s, the Rales brothers backed a niche manufacturing business into a REIT and seemed to follow more of a PE, LBO-type model. They bought manufacturers at eight to 10 times EBITDA and made operational changes to achieve a four to five times pro forma EBITDA multiple. They were the first US industrial business to bring Lean and Six Sigma and the Toyota Production System values and principles to the US.

Over time, Danaher has gone through multiple iterations. They started with a PE model of making operational improvements to manufacturing assets and gradually improved the portfolio quality. In the early 2000s and 2010s, Larry Culp upgraded the portfolio, sold off some assets, and acquired better ones, leading to today's full life sciences business.

One consistent element, at least in principle and culture, has been the DBS philosophy—the Danaher Business System. This system has been consistent and is quite unique. Danaher is a business that's 1,000x in the public markets, evolving from various underlying businesses and markets. Yet, the constant throughout is this web of behaviors and principles called the DBS that still drive and underpin the whole company today.

Now, I want to ask you to describe the Danaher Business System and, within that description, highlight what in your experience seems to be poorly understood or misunderstood about this system. Before we do that, I want to draw attention to the way we work and highlight an aspect of our process. You've heard Will talk about how he found out about this business 10 years ago. You've been looking at this more seriously, reading the filings for four or five years before actually starting to make calls. We conduct calls on a business regardless of valuation and pick up case studies. We work in a case study-based system where we study mature quality. We describe two categories internally.

One is mature quality or established compounders. The other is a category we call emerging compounders, unproven compounders. That's really what I want to convey; we may spend several years working on something before publishing on it, and we're trying to understand the great businesses of the last few decades as a core part of our work stream. On the DBS, let's describe it. What is this?

Do you want the long answer or the short answer? The short answer is it's common sense deployed rigorously. That's basically what it is. The long answer is obviously more complicated, but it's really as simple as that at a higher level.

If only common sense were common.

Exactly. Yes. The harder part is the rigorously deployed aspect. Practically, it's a set of tools that underpin and define the behavior of Danaher as a company. Various executives we've interviewed call it the soul of Danaher. It originates, at least from my understanding, from the late 80s, early 90s, when Danaher visited Toyota and brought back some Lean and Kaizen principles from Japan to the US.

That's where a potential misconception about DBS comes in. Historically, a large part of DBS has been Lean, Six Sigma, and Kaizen because it's been a manufacturing business. It still manufactures products and equipment today, but it's a life sciences business. What Danaher has done, which is unique from my understanding, is deploy the principles from TPS, Lean, and Kaizen rigorously across the whole organization—in sales, R&D, and even in leadership.

This leads to the results they have historically achieved. We can discuss where the business is today, but one misconception is that this is just a Lean Six Sigma system. It's much more than that, infiltrating the whole organization rather than just manufacturing.

We are discussing a specific piece of work today, which is part of a larger body of work. This particular piece has been condensed, and today's conversation is dedicated to it. It is a published piece called the Danaher Business System, an IP research roundup.

This is a horizontal piece of work that compiles multiple years of interviews and research into a single article. As I look at it on my screen, I see that you have conducted over 10 interviews, spending more than 10 hours in actual interview conversations, and many more hours with experts outside of those interviews.

You have gathered over 10 hours of published work in this research roundup on the Danaher Business System. Let's delve into more detail about your experiences, although we won't have time to discuss each individual piece.

Before we discuss some of the tools, it's important to note that the Danaher Business System (DBS) is effectively a toolset. Some of these tools are very simple, and we can discuss those shortly. What's particularly interesting now is that Danaher is a very different business today than it was historically. They recently acquired Aldevron for a multiple that is biotech like - 50 to 60 times EBITDA, forward EBITDA, at the time of purchase, and multiples of revenue. This is different from their historical acquisitions under Culp in the 1980s and 1990s.

An interesting question or hypothesis I've been considering is how to deploy DBS to higher quality and higher gross margin assets. Historically, DBS was a Lean and Six Sigma manufacturing operating manual focused on reducing defect rates, shifting from batch to one-piece flow manufacturing, reducing unit costs, and increasing piece flow. These are standard practices today across manufacturers. But how do you apply that when selling reagents and bioprocessing consumables with 70% to 90% gross margins?

Clearly, Danaher believes they can improve these assets and are willing to pay 20 times EBITDA or more. Granted, they're strategic in the wider Danaher system, which is a different strategy, but they must believe they can deploy DBS to improve these assets. This raises a broader question; is there more slack in systems that have way higher margins. I mean, not a bad hypothesis to test. If you look at, historically, the stories that come out of Google on these businesses that have de facto monopolies or high margins business, I wouldn't be surprised if some of these reagents and consumables that are sold by the old Amersham business, now embedded within Cytiva at Danaher where, if you basically have a duopoly or if not oligopoly, if not better, monopoly, for some of these businesses that they are kind of lazy and they might have too much inventory around of these consumables. They might have a slight pricing process. Who knows, in terms of how these businesses are run historically.

Clearly, deploying DBS to manufacturing assets has worked well. It's common practice among big industrial private equity firms to buy something at eight to 10 times EBITDA, improve it post-acquisition to 4 to 5 times EBITDA pro forma, and sell it in five years. This was Danaher's playbook in the early days. But with higher quality assets at 20 times EBITDA, do you get the same operational improvements? Are higher margin businesses typically lazier with more slack? This is part of the context of studying DBS; how can Danaher deploy DBS in these newer life sciences assets and is there more room for operational improvement - higher free cash flow - from deploying DBS into these higher quality assets than historically? I don't really know the answer.

Yes, to be determined. The playbook is out there for all to read, and Danaher talks about it publicly. The set of tools is available. What aspect of this system of operating is really interesting to you that we can spend some time on now?

Let's make this more tangible. There are eight core Danaher Business System (DBS) tools, which we call the DBS fundamentals. The first one, which often comes up when delving into the details, is the PSP process, or problem-solving process. At a high level, these are very straightforward concepts and might seem simple to discuss.

The eight fundamental tools include PSP, standard work, transactional process improvement, Kaizen, 5S, vision and daily management, value stream mapping, and the voice of the customer. The PSP is applied to every decision at Danaher and is effectively part of the employees' language. It's simple at a high level for every problem the company faces, whether it's a defect rate or declining conversion ratios in marketing or sales, which we've discussed.

They follow a simple five-step process. What is the problem? How do you get to the root cause? Simple root cause analysis. Solve the problem. You're asking the Five whys to get there. You keep asking why, why, why until you get the root cause. And there are various techniques to get to that. This is a document, by the way, employees have to fill out. It's a PSP form that, typically, whenever there's a problem, if you want to use management time or you want to discuss this in detail, it's one or two pages you have to fill out. And typically these are either sold or they're used in Kaizen events.

This highlights a cultural point. I'll never forget it; you mentioned to me. Most companies spend 10% of their time thinking about the problem and 90% executing, whereas Danaher is almost the reverse. They want to spend 70%, 80% of the time thinking and understand the problem and the rest designing a solution. They understand the real problem. It's almost very micromanaging, very structured, very disciplined.

Imagine having to fill out a form for every problem before discussing it. But it shows the rigor needed to enforce discipline and really do the five whys to get to the root cause before discussing potential solutions. This underpins every DBS tool. The PSP is a one or two-page form that must be filled out before discussing any problem. Most companies lack the discipline to implement this.

It's not a complicated proprietary process; it's about discipline and culture, which is difficult for other companies to replicate because it requires complete buy-in from everyone, including the CEO and management. I don't think this level of rigor and discipline is suitable for all companies.

We've discussed the odds of success for industrial businesses implementing these practices, and it often seems low. Many find the system interesting and see its success in Danaher's context. There are many consultants, but it's easy to underestimate how it borders on cult-like behavior. Implementing this touches every action.

One avenue of discussion is what type of companies or management teams have the characteristics or potential to create a system like this. There are some similarities with companies like Constellation Software if you look at it conceptually. There's a quote from an executive, which I'll paraphrase, but it's very interesting. He said the main issue is that people are often guided by their experience, which is critical.

One of these tools is "Go to Gemba," a common Kaizen TPS phrase. It means when you're looking to identify and understand a problem, you should go to the factory floor, watch the manufacturing line, or for sales or marketing, go to the customer, sit on a customer call, try to sell something, and see how they behave.

At Danaher, they won't engage with you unless you have what they call Gemba evidence—evidence and data from the factory floor. Someone who has managed over a hundred Kaizen events for Danaher told me that when discussing issues with engineers, they often think they understand the problem. They claim, "We have a problem; this is the problem." He will go to Gemba with the engineers, go to the factory floor, observe the process, and discuss it.

From his experience with over a hundred Kaizens, in 95% of cases, the problem is different from what the engineers think. This is a potential takeaway that underpins Danaher's effective operational philosophy. It reminds me of Constellation, TransDigm, and even Amazon, where these unique cultures have strict operating philosophies.

At Danaher, they say, "Do not talk to me unless you have Gemba evidence." At Amazon, you can't engage in a meeting without a two to six page memo. At TransDigm, if you don't talk about the three P's—price, performance, profitable new business—forget it. At Constellation, don't propose an acquisition unless it exceeds the hurdle rate.

These businesses are strict and have found simple ideas that work, and they won't waver. There's a question about how these businesses have slightly different feels, but with Danaher, it's a discussion around intuition. If 95% of an engineer's assumptions about a problem are incorrect, either they're hiring poor engineers, or they don't have the system to evaluate things properly.

It's fascinating how these outperforming businesses have clear and strict philosophies that aren't for everyone. Most people don't last. At Amazon, someone is either there for two or three years or twenty years; they either love it or hate it. If we had to write a six-page memo before a meeting, I'm not sure we would have lasted. Maybe we're doing something wrong or not going to Gemba. It's a whole other level of operating that I find fascinating.

They are in this unique category; these businesses have scaled. They've figured something out.

That's why they scale. That's my point. My point is that it's almost like I believe it's the only way to scale. You find a simple idea at a high level, deploy it rigorously, and don't waver on that. You either fit in or you're out. Within those guardrails, there is room for intuition, but it's within tight guardrails that enable the fabric of the company to keep compounding and to last.

So, I think giving our listeners a sense of our approach to what we found interesting about the Danaher Business System. In the few minutes we have left today, let's look at the application of fieldwork processes and the ways in which you've gone about it. There are 10 interviews curated into a single piece here on DBS. Highlight for us what you've actually looked for from a sourcing perspective in the kind of person that you found over time can really add value on these topics we've been discussing for the last 20 minutes. Let me put it crudely. I can read about DBS in a hundred places. How have we been able, if at all, to go beyond what's publicly disclosed and easily accessible here?

The aim wasn't just to tell you how to do Lean manufacturing. There are a million courses out there for that. On the manufacturing side, I'll call it the traditional DBS metrics. Lean, Six Sigma, Kaizens. There are certain people in Danaher that have done hundreds of these events and I think providing insight into why and how you run these and how that actually works has been important to try and understand how other companies can replicate that. And then most of the work, frankly, has been on how these principles have deployed outside of manufacturing. Shifting from batch to one piece flow manufacturing is very important. But frankly, there's millions of companies out there that do this.

Again, like I said, what is potentially a misconception and what I find more interesting is, how do you deploy this to R&D? How do you measure R&D spend: how do you deploy DBS principles to R&D to make sure that you're evaluating R&D projects efficiently? All these things that people don't really think about. And Danaher has deployed that in sales, in R&D, pretty much in every cost line and every other aspect of the business. And so part of it has been going to look at senior people across leading subsidiaries of Danaher and these guys that actually specialize in running Kaizens in R&D, which is probably pretty weird and not interesting to most people. But I think gives you a unique flavor of how Danaher really works and how it's much more than just a Lean manufacturing system.

I think something that also shines through the work is understanding the limits of this system. It's obviously extremely powerful, and the business has been spectacularly successful. How far can the system be pushed? Are there places where this kind of methodology and philosophy create problems? Could we test the hypothesis that there are real limits to this system in certain business functions? If so, what are they?

There are many limitations, especially if you're paying 50 times EBITDA. That's a whole different story. One thing is clear; this is not for everyone. You almost love it or you hate it; it almost becomes part of you. You are either captured by it and this is the way you live and you operate, or you are like, get me out of here. I'm not filling out your PSP form. Forget it. Which I also understand. It's like, pick your poison, right? Do you want to compound? Or do you want to play around with your own ideas? So I think it depends on what you're interested in.

A common argument is that it stifles innovation; it kind of suppresses intuition, potentially, to some extent, for some people at least. But you hear the same thing from Constellation. How many M&A guys have I spoken to that say, I have to fit some IRR metric before I do an acquisition. But if you didn't have that, then Constellation wouldn't be Constellation. That's where I think there's interesting parallels between some of these cultures that are pretty interesting to study.

We'll keep chipping away at this topic, which will remain interesting for many years to come. As we wrap up, I'll remind our audience that in this roundup format, we've covered topics such as Swedish serial acquirers, third-party logistics, the LTL industry, subprime lending, vertically integrated e-commerce, aero components, and more. We'll continue publishing these every few weeks, and we thank you for listening today.

I'll send you my PSP form afterward to complete.

Yes, I'm not speaking to you unless I get one. If we implemented that, I don't think we'd be speaking much, and maybe the joke's on us.

Maybe that's the answer. As always, this is for informational purposes only and should not be relied upon for investment decisions. Please do your own research.