Brad Smith: Getting rid of friction by Geoff Colvin @FortuneMagazine July 7, 2014, 7:49 AM EST E-mail Tweet Facebook Google Plus Linkedin Share icons Consider how remarkable Intuit’s story is: A specialized financial software company is founded in the era of VisiCalc and Lotus 1-2-3, and after 30 years it hasn’t been disrupted, been bought, or run out of business. Instead it’s stronger than ever, with a recent market cap ($23 billion) greater than that of Macy’s, International Paper, or Humana. The company still makes its original product, the personal finance software Quicken, plus other old-timers such as TurboTax and QuickBooks, which together remain the business’s foundation. Running the show is Brad Smith, who became CEO in January 2008, just at the start of the recession. As the economy picks up, his challenge is to keep Intuit’s multidecade streak going by adapting to the cloud, the ubiquity of mobile devices, and unrealized opportunities worldwide. He talked recently with Fortune’s Geoff Colvin about how the company stays innovative, why he spends 60 hours a year following customers home, Intuit’s INTU decision to open its platform to outsiders, including competitors, and much else. Edited excerpts: Fortune: You have over 50 million customers, and you know a lot about some of them and something about all of them. What is all this information telling you about the state of the U.S. consumer now? Brad Smith: The customers we serve are consumers, small businesses that employ 60% of the U.S., and their most trusted advisers, their accountants. We help them pay their bills, we figure out what kind of goals they’re setting, whether they’re getting a job. The view right now is improving, but not at a pace that gets us to 2007 levels. We can see how many consumers are actually setting goals for themselves in our financial management product, called Mint, and we’ve seen over 7 million goals get established in the past year, and they’re saving now about $1 billion a month toward paying off debt–student loans, their homes. That’s good news. We’re also seeing their charge volume on credit cards go up. They have more confidence in their future, and that’s good for the other side of the equation, which is small businesses. The ultimate proof of confidence for a small-business owner is, are they hiring employees? This past month our small-business employment index–we pay one in 12 Americans–showed that they added 35,000 jobs, which is the biggest one-month increase we’ve seen for well over a year. So things are starting to get better, but it’s a slow, steady progress. Intuit has a lot of competitors, but so far they have mostly not been the giants of finance or tech. As your space heats up, with payments becoming a hot area, won’t the Googles and Apples want some of your turf? We’ve seen a lot of competition over three decades, and we’ve seen some of the big names. Microsoft MSFT has come into our space multiple times. We partner with them closely now. H&R Block HRB competes in the TurboTax space. In payments, with the advent of mobility, businesses are saying there are different ways for me to accept electronic payments. So you have American Express AXP , PayPal EBAY , ourselves, lots of other players. What’s important for us to understand is that we can’t be the point of friction in a small business’s office. So we’ve opened up our platform to allow any of those payment methods to work with our products, and that’s good for the small-business owner, good for the payments players, and it allows us to focus our innovation in other areas. So yeah, it’s a heated space, but it’s not a zero-sum game. We have to open up and expand the total addressable market and make sure they see that that product will work with ours. Inviting other developers to create products that work on Intuit’s platforms–that’s a big change. It is. Our company strategy is that we want to be the operating system behind small-business success around the globe. We want to help do the nation’s taxes. The average small-business owner uses 18 apps to run their business every day, and if those applications don’t allow data to flow seamlessly and they don’t integrate, it’s going to become a point of friction. It’s going to prevent the small business from being successful. So we have to be open, and we embrace that opportunity because our ultimate goal is to help the small business. You must make some judgments about who gets onto your platforms and who doesn’t. It’s a mindset we had to wrestle with, and at the end of the day, where we’ve landed is, open means open. If our product can’t stand toe to toe with a competitor’s product and win in the open market, then we don’t deserve to win. So the open platform is open for all, and then we allow ourselves to stay focused on making sure that our solution is the best if it’s head to head with someone else. And presumably this forces you to be up to date on the latest that’s happening all across your space. It absolutely does. There are lots of reasons this is good for customers, and I’ve described that–it reduces friction. But there are also lots of reasons why it’s good for us as a company. Awesome is always relative to some other alternative, and if your goal is to deliver an awesome experience for customers, like ours is, then you need to know how it stacks up vs. the other alternatives. And there’s no better way than to be able to see all the alternatives in the market and measure yourself against that. Especially since we always hear that the alternative against which they measure anyone is the best experience they’ve ever had, regardless of industry. Absolutely. They’re going to compare their experience to how it felt when they were on Apple’s iTunes or shopped with Amazon Prime or got an overnight package from Federal Express. And if you have not raised the bar on yourself to meet those standards, then you’re not going to keep up. That’s one of the reasons that, I gather, you go to extraordinary lengths to understand your customers. What specifically do you do? When the company was founded 30 years ago, our founder, Scott Cook, developed a method that we still use today called Follow Me Home. We do 10,000 hours of Follow Me Homes with consumers and small businesses every year. I do 60 hours myself. We’re not stalkers–we’re invited into their home or business. We observe them for a day, go through things, and we’ll observe the things that surprise us. Like, they’ll grimace, they’ll write a Post-it note to themselves, and then we go back afterward and say, “What stumped you?” Or, “What was it that you were puzzled with?” And then we try to find ways to eliminate that friction. Is there any training that goes into this? I can imagine it would be too easy to ask people what they think they need, and that’s often not productive. I’d say the best way to train someone is to remember that you have two ears and one mouth, and use them in that ratio. That’s hard to do, and ultimately what we’ve learned is how many false positives you get from listening to what someone says they’re going to do instead of observing what they actually do. Every year people promise they’re going to go to the health club in January, they’re going to start saving more money, and then just follow up in March and see where they are. Observation is the power of a Follow Me Home. Financially, Intuit has been a remarkable company for its whole life in creating lots of value using very little capital. As you continue to make acquisitions and add infrastructure for the cloud, will it have to become somewhat more capital intensive? Surprisingly not. We have a capital allocation philosophy, which starts with how we produce capital in the first place. We believe the company has the ability to grow organically at double-digit rates, and then we have a discipline to grow our revenue faster than our expense. That produces operating leverage and cash flow. And then we have a commitment that we want to invest that capital in anything that has a 15% [annual] rate of return over a five-year period. Everything gets judged against that–we invest in our internal products, or we make an acquisition, or we return cash to shareholders. Having that rigor and discipline helps us make sure that we’re investing capital in the things that produce the highest return on investment. We’ve learned that many of the companies we admire didn’t build an application, they built a platform, and then that platform is made better by end users who come in and configure it. So now our global platform is actually getting made better by local customers who are helping us fix the language or suggest where the compliance needs to be tweaked. Then we’re able to use their insights to go in and make fast changes. It’s a very low-capital-intensive process for us. To survive, Intuit has long depended on nonstop innovation. What have you learned in the process? Peter Drucker said, “The bottleneck is always at the top of the bottle.” Innovation is not going to come from me. It’s going to come by challenging people to think about new and different ways of solving big, important problems. So we have created 10% unstructured time. All 8,000 employees have the ability to work on a problem that they see getting in the way of a customer, or a way to improve their own process so they can be more productive than their peers can be. We’ve also adopted hypothesis-driven or experimentation methods. I’ll say, here’s my hypothesis, and here’s the test I’m going to quickly run. I’ll prove or disprove whether that hypothesis is right. If it is right, I’ll be able to show my manager–“Look, it worked”–and then we’ll fund it for the next test. If it doesn’t work, then the team will shut it down themselves or they’ll adjust the idea. It enables everyone to be a scientist. Everyone’s an innovator, and they have a methodology. Those have been the real critical ingredients to get 8,000 people to be entrepreneurs. I noticed also that you favor putting them into fairly small teams. How come? This is an idea we borrowed from Amazon AMZN . Jeff [Bezos] was famous for saying he wanted a team no bigger than two pizzas could feed, four to six people. What you find is that they’re able to move with fast cycles of learning. They’re able to get cross-discipline experiences, so they don’t rely on one person to do all the market re search or the Follow Me Homes. They all collectively do it together. It speeds the ability to learn fast and fail fast, so they can ultimately succeed faster. So we try to keep our teams very small. For 13 years now Intuit has been on Fortune’s list of the 100 Best Companies to Work For. What’s the key to getting and keeping the best people? A couple of things that we strive to do every day. First, people want to be part of a cause greater than themselves. They want to solve important problems that matter to their mother, their father, their siblings, their friends. We’re here to improve people’s financial lives so that every generation gets stronger than the last, and that’s a very important cause that every one of us experiences in some way. So have a cause, don’t be just a product. Think about an aspiration that you can continue to strive to do. Second, create an environment where everyone contributes. We say we want to have the world’s greatest environment where the top talent can do the best work of their lives. So 10% unstructured time–everyone gets it. Small teams that move fast without the bureaucracy. Teaching you important techniques like scientific experimentation so that you can run fast experiments. That gives people capabilities and skills, and most important, they can contribute. Your job as a leader is to remove the barriers that get in their way. That’s our job. We work for them, and our job is to get the friction out of the system. I think that’s what continues to help us keep a strong and healthy environment. Brad Smith Age: 50 Birthplace: Kenova, W.Va. Education: Bachelor’s degree in business administration, Marshall University; master’s in management, Aquinas College Notable achievement: Since he became CEO (January 2008), Intuit stock is up 155%–more than twice the Nasdaq’s return (up 67%) and more than four times that of the S&P (up 35%). Career advice: “I never set out to be a CEO, but I did get some very important advice from my father when I was young. He said there are three rules of thumb that I would ask you to think about every time you’re thinking about a job. One, pick something that makes your heart beat really fast. Two, make sure it’s in an organization where you’re surrounded by people smarter than yourself. Three, don’t ever do it just for the money or the title.” WATCH: Intuit CEO: Taxes, there’s an app for that A shorter version of this interview appeared in the July 21, 2014 issue of Fortune.