Thursday, 26 June 2008

ISO9000 makes you reliable, myopic, efficient and dull – and unable to invent post-it notes

Sometimes, management practices, intended to improve the functioning of the organisation, have unanticipated consequences. Sometimes these consequences are negative, but also only apparent in the long-run, making firms adopt techniques which are really not very healthy for them (at least in the long-run).

Take ISO9000. ISO9000 certification constitutes a process management technique through which firms are expected to follow (and document) a number of procedures, aimed at creating consistent, efficient processes, in which best practices are standardised and deviations from the best practice are avoided. It leads to efficient, high-quality products with minimal digression from the standard.

This all sounds very logical, justified and desirable, right?! So what am I whining about?

Well, professors Mary Benner from the University of Pennsylvania and Mike Tushman from the Harvard Business School examined what happened to the innovation output of firms adopting ISO9000 techniques. They collected information on 98 firms in the photography industry and 17 firms in the paint industry, which they all followed from 1980 till 1999. They measured, among others, all their patents and documented whether these innovations were really “close to home” for the firm (representing minor variations on what they were already doing) or more exploratory discoveries (representing truly new potential avenues for growth). And they found a very clear pattern.

Firms that adopted ISO9000 norms started doing significantly more “close to home” inventions at the expense of truly new, exploratory innovation. The “more of the same” patents, induced by the ISO9000 processes, crowded out the discovery of truly new techniques and products.

How come? Well, by definition, ISO9000 minimises deviations from “the best way of doing things” in the firm. Yet, often, the best innovations are discovered by accident. Just like random genetic mutations can produce whole new species in nature, random deviations from the norm in organisations sometimes turn out to be “mistakes” which become the firm’s next big blockbuster product. Think of how the post-it note came into existence: A bloke named Spencer Silver was working in the 3M research laboratories in 1970 trying to find a super-strong adhesive. Spencer developed a new adhesive, but it was ridiculously weak. It was so weak that although it stuck to objects, it could easily be lifted off. It was a clear error. Yet, ultimately, this super-weak adhesive became 3M’s famous, money-spinning post-it note.

Although usually deviations from the norm merely produce plain, sheer mistakes, which should get corrected quickly, if you rule out all mistakes, you will never be fortunate enough to develop a “mistake” that turns out to be your post-it note. ISO9000 annuls all deviations from the norm. But, as a (unintended) result, you become a lousy inventor.

Tuesday, 24 June 2008

Numbers and strategy – do they mix?

In your firm, when you come up with an idea for a new product line or service, or some other project that you think has great potential and want your company to invest in, what do they want to see? My guess is it’s “payback time”, a “net present value” calculation, or some other number in a business plan, right? And if you can’t produce the numbers, you won’t get the dosh.

But that’s also a bit of a problem; sometimes the most promising projects with long-term strategic implications are exactly those that are impossible to quantify.

Take Intel’s invention of the microprocessor. In the early days, when they were working on and (quite heavily) investing in it, did they have a business plan, a net present value calculation and a payback time? Heck no. They didn’t even know what they were going to use them for – they had no sense of a potential explanation (dreaming of sticking them into handheld calculators and lamp-posts) till IBM showed up and worked hard to convince them that putting the darn things in their PCs really had a future.

Would microprocessors ever have seen the light of day in that firm if Intel’s management had insisted on a “payback time” calculation? Nope, we’d still be using an abacus if they had (ok, now I may be exaggerating) and Intel would never have been the mega-success as we know it now (not exaggerating).

So why do we so incessantly insist on producing numbers if we’re talking strategy? Genuine strategy, by definition, deals with long-term issues, uncertainty and ambiguity. Hence, numbers don’t work very well; they are unreliable, potentially misleading and sometimes sheer impossible to produce in such a situation.

And I guess that is exactly why we/companies are so eager to see them. The long-term, uncertain aspects of strategic investment decisions make us rather insecure whether we’d be doing the right thing; therefore, we really really would like to see some numbers to lull ourselves into the belief that we’ve been thorough and have uncovered the facts and have a solid basis on which we’re accepting or rejecting the proposed course of action. Of course that’s just make-belief (you can make numbers say whatever you want them to say) and may make you quite myopic; missing the things that are difficult to quantify but much more important.

Am I propagating that we should get rid of numbers in strategy altogether? Heck no; forcing yourself to go through some sort of quantifying exercise can sometimes make you uncover and realise things that you hadn’t thought of before. But subsequently you should do what Tony Cohen, CEO of Fremantle Media, told me he always does when they’ve made financial calculations regarding new television production proposals: “Once we’ve carefully and painstakingly produced all the numbers we toss them aside and sort of make a decision based on our gut feel and experience”.

Numbers in strategy may form one (minor) input into your decision-making, but don’t mistake them for the real thing: make them, but then toss them aside and use your judgement and common sense.

Friday, 20 June 2008

A Creosote bush: How "exploitation" drives out "exploration"

Established, very profitable companies often find it difficult to remain innovative (which may get them into trouble in the long run). In contrast, entrepreneurial, innovative companies often find it difficult to start producing efficiently and make a healthy profit out of their inventions. That is because the organisation required to be creative and innovative is usually quite different from the organisation that is suited for efficient, mass-scale production.

Professor Jim March from the Stanford Business School eloquently put it like this: he said there is a fundamental tension between “exploitation and exploration”. Exploration involves innovation and creativity, which often requires a high level of autonomy for people in the organisation and a flat organisational structure. Exploitation is associated with words such as productivity, efficiency and control, which requires hierarchy and clear rules and procedures.

If a company is financially successful, exploitation often starts to crowd out exploration. This relates to the idea of “the success trap”: organisations start to focus more-and-more on what they do well; the thing that brings them success and prosperity. Yet, this comes at the expense of other things, which may not be so profitable now but which could (have) become important for the firm in the long run.

Even the famous Intel fell into this trap. In the 1980s and 1990s, Intel had become hugely successful in the microprocessor business by being extremely innovative and running many experiments in semi-conductors. Yet, once they had developed an enormous advantage in microprocessors, they gradually stopped doing anything else. In 1996, CEO Andy Grove recognised the long-term dangers of this and remarked “There is a hidden danger of Intel becoming very good at this. It is that we become good at one thing”. Yet, he also found himself unable to revive Intel’s entrepreneurial creativity.

In 1993 microprocessors had made up 75% of Intel’s revenues and 85% of its profits. By 1998, this had increased to 80% of its revenues but 100% of its profits! This mega-company basically had only one product on which they relied to bring in all the dosh. That sounds a bit risky... The company’s COO, Craig Barrett remarked about this that Intel’s core microprocessor business “had begun to resemble a creosote bush”. In case you're not a botanist (and, like me, only appreciate plants when they come on plate), a creosote bush is a desert plant that survives by poisoning the ground around it, so that nothing else can grow in its vicinity… Quite a peculiar way to qualify your top-selling product I'd say, but not a bad analogy. Microprocessors were so successful that no other product could grow within Intel, because it would always look bad in comparison to these damn processor things.

Of all organisations that I have been studying over the past few years, the one that has probably impressed me most in this respect is the famous Sadler’s Wells theatre in London. On the one hand, they are phenomenally innovative, putting on the most novel and creative modern dance shows on the planet. But, on the other hand, they also stage a substantial number of shows that are tried and tested, and from which they know that they will reap a healthy profit without much of a doubt.

How do they maintain this balance so well? There are several complementary explanations, but one of them is that they work on it continuously; literally every day. They aim for about 15-30% of totally new innovative shows in the programme (often the result of a collaboration between artists who usually wouldn’t work together, because they have very different styles, background and training) and discuss this issue all the time. They do that in regular formal meetings, which invariably involve people from various departments, but also on an ongoing informal basis (that is, in the corridor, in the restaurant and in the toilet).

They are always discussing which show should go where on the theatre’s calendar, for how long it should be scheduled, what other show needs to be scheduled around the same time, etc. Because they continuously discuss and work on it, they manage to get the balance right. And, as their numbers show, the cool thing is that often, those shows which at the time were exploratory and considered risky and innovative, are now the ones that contribute most to their bank account.

Monday, 16 June 2008

How bad practice prevails

Quite often, when I interview or just talk to a manager about his company and try to figure out why they are organised or managed in a particular way, I hit upon something which I don’t understand. Some practice, management technique, service specification or incentive system from which I simply fail to grasp why they do it like that (just to name a few candidates: detailing in pharmaceuticals, buy-back guarantees in book publishing, insane working hours in investment banking). And when then I ask (“I am not sure I understand; can you explain a bit more?”), I often get a long and winding answer (which suggests to me that they don’t quite know it either…).

And when I then, stubbornly, poke a bit harder (“sorry, but I still don’t get it…”), the interviewee might get a bit annoyed, after which very often I will receive the momentous reply “look Freek, everybody in our business does it this way, and everybody has always been doing it like this; if this wasn’t the best way to do things, I am sure it would have disappeared by now”.

I never quite bought this answer but, frankly, also did not quite know how to refute it…

Because our well-established theories of economic organisation would propagate exactly that: The market is Darwinian. Firms with bad habits and practices have a lower chance of making it in the market in comparison to smart firms who do everything right. Therefore, those firms will go out of business quicker and, although it may take a while, the ineffective practices will die out with them.

But I still thought they were wrong. I now think I have figured it out. Bad practices can spread and can continue to persist in industries, “till kingdom comes”. Let me attempt to explain to you how and why.

The trick is bad management practices can survive, despite making firms worse off, just like viruses can persist amongst humans. Because they are contagious, and “spread quicker than they kill”, the virus (or management practice) can continue to persist and not die out. It’s the same for certain industry practices.

Moreover, what’s unique about industries is that if everybody is employing the practice, everybody is equally bad. Yet, because competition is based on relative competitive strength, firms might not even notice that they are worse off for continuing the silly habit. Customers might complain about them (e.g. “all those stupid highstreet banks are equally terrible!”) but don’t have a choice; they have to pick one anyway (just like they would when the banks would all be excellent). Hence, the banks don’t suffer.

You can put these things into simulation – which I did – and quite easily model the diffusion and persistence of harmful management practices. So, next time a manager tells you they do it because everybody has always been doing it (whether it’s detailing in pharmaceuticals, buy-back guarantees in book publishing, or insane working hours in investment banking) and they’re sure that therefore it must be the best way of doing things, just smile at him and say “ah! that’s not necessarily true; just because everybody is doing it and has been doing it like this forever, does not mean that it is the best way of doing things”. And I will happily show him my simulation if you have the patience.

Friday, 13 June 2008

Analysts rule the waves (whether we like it or not)

In the 1960s we saw a wave of “diversification” among corporations, resulting in the emergence of many so-called conglomerates. They operated in all sorts of businesses that often didn’t have much to do with each other. For example, a famous conglomerate in the UK was Hanson Plc, whose divisions operated in activities ranging from chemical factories to electrical suppliers, gold mines, cigarettes, batteries, airport duty free stores, clothing shops and department stores. Diversification was popular and conglomerates flourished.

In the 1990s though, the trend reversed, and we witnessed a wave of de-diversification. Firms started to focus on their “core activities”, companies were split up, conglomerates were dismantled, and diversification was generally regarded as unfashionable, evil and simply not-done.

What led the trend to reverse? Economists have argued that it was shareholders fighting back. Shareholders can diversify their stock portfolios; they don’t need companies to do that for them. Managers only do so to serve their own needs, and feed their desire for empire building, size and security. In the 1990s, shareholders said “basta” and forced self-serving managers to de-diversify – or so they claim.

A slightly kinder view is offered by sociologists, who argue that in the 1960s it was considered good practice to spread risk and diversify and hence a “legitimate thing to do”. Managers weren’t selfish and evil; they simply did what was expected of them. When shareholders said, “we don’t want you to do this anymore” (perhaps because the market became more transparent and efficient), they diligently responded and applied more focus to their companies.

Yet, more recently, researchers have started to focus on the role that analysts played and still play in discouraging companies to spread their activities across different industries. After all, sometimes diversification might make sense! For example, a company like Monsanto sort of had to operate in pharmaceuticals, agricultural chemicals and agricultural biotechnology because their expertise bridged these different areas and therefore it was advantageous to operate in all of them. But that something makes sense from a strategy perspective doesn’t mean it makes sense in light of an analyst’s lunch break.

What…?! What do analysts’ lunch breaks have to do with any of this?!

Well… it is very important for listed firms to be covered by analysts. We know from ample research that firms who receive less coverage usually trade at a significantly lower share price. Consider this quote, from an analyst report by PaineWebber in 1999:

“The life sciences experiment is not working with respect to our analysis or in reality. Proper analysis of Monsanto requires expertise in three industries: pharmaceutical, agricultural chemicals and agricultural biotechnology. Unfortunately, on Wall Street, these separate industries are analyzed individually because of the complexity of each. At PaineWebber, collaboration among analysts brings together expertise in each area. We can attest to the challenges of making this effort pay off: just coordinating a simple thing like work schedules requires lots of effort. While we are wiling to pay the price that will make the process work, it is a process not likely to be adopted by Wall Street on a widespread basis. Therefore, Monsanto will probably have to change its structure to be more properly analyzed and valued”.*

Wait a second, did they just suggest that Monsanto should split up because it requires three (industry-specific) analysts to cover them and these three buggers can’t find a mutually convenient time to meet?! Yes, I am afraid they did.

Along similar lines, in a large research project, Ezra Zuckerman, professor at MIT, found that firms divested businesses, split up or demerged in order to make themselves easier to understand for analysts. Those firms who, for one reason or another, comprised an unusual combination of businesses in their corporation and therefore were “more difficult to understand” for the poor analysts traded at a significantly lower price. They could try to explain their strategy at length but after a while the only thing left for them to do was to split it. Arthur Stromberg, then CEO of URS Corporation, who initiated its spin-off, declared:

“I realized that analysts are like the rest of us. Give them something easy to understand, and they will go with it. [Before the spin-off,] we had made it tough for them to figure us out”.

Security analysts usually specialise in one or a specific combination of industries. If a firm does not conform to that division of analyst labour, they are more difficult to understand and analyse, which is why they will trade at a lower price. It then makes sense to give in to the analysts’ whims, and focus and simplify, even if that would make you weaker in a strictly business sense. Hence, analysts rule the (diversification) waves. And their lunch break will determine your stock price.

* Adopted from Tod Zenger, Professor of Strategy at Washington University.

Tuesday, 10 June 2008

Women on top

In general, CEOs seem just like normal people. Some of them are nice, some of them unpleasant; some of them are modest, others are nauseatingly self-obsessed; some of them are bright, others more mentally challenged; some of them are helpful, others are cynically egotistic (and I could give you examples of each of these). Most of them are quite rich though… And most of them are men.

Yet, over the years, I have also interviewed quite a few female CEOs. Barbara Cassani when she, way back when, was the CEO of Go Airlines (later acquired by Easyjet), Sly Bailey, when she was still CEO of IPC Media (now she is the CEO of the newspaper group Trinity Mirror), Gail Rebuck, CEO of the book publisher Random House (who confirmed the famous story that she signed a big contract when she was in a hospital bed giving birth) and, very recently, Stevie Spring, CEO of magazine publisher Future, and Ruby McGregor-Smith, CEO of the large property services company MITIE. And they are all so nice…!

I mean really. Not nice as in bringing me cookies and pinching my cheek but nice as in helpful, realistic, sympathetic and down-to-earth. And bright. I have never met a dumb female CEO.

And I wonder why that is. I mean, it’s just not normal.

My guess is the following: Ascending to the position of CEO is a bit of a Darwinian process; many people start at the bottom of the corporate ladder; very few reach the highest step. Climbing the ladder, as a woman, you still need something extra – especially when heading a public company, having to deal with “The City”* – at every step. And I guess that something extra is brains and tact (a fairly rare combination, also among professors by the way). Without brains or tact (or both), men can apparently still navigate and survive the corporate jungle. But women without brains or tact get “selected out” quite quickly. Therefore, when you see a woman step up, she is bound to be quite good!

Don’t get me wrong, I have also met male CEOs who are “nice”, as in helpful, realistic, sympathetic and down-to-earth. And pretty much all female CEOs whom I interviewed displayed the attitude “stop whining about it being so difficult for women; just get on with it”, but they also confirmed that they did feel that they needed something extra at every step of the way. It is also not that I am advocating that we should make it easier for women to reach the top and become CEOs, because that would mean that we’d get more CEOs who are unpleasant, nauseatingly self-obsessed, mentally challenged and cynically egotistic. It is just that, in corporate life, we should treat men more like we treat women. That would be quite “nice”.
* "The City" is London's financial district

Friday, 6 June 2008

Retaining your ability to make money? Causal ambiguity’s the answer

Whenever people hear that I am a professor at a business school, the reply I most often receive is “oh, so you teach people how to make money…?” And I usually nod while I display a weak smile and abide in silence.

Some time ago though, I was teaching in New York, at Columbia University’s business school, and took a taxi from JFK airport. The driver, starting a polite chat, said “what do you do?” “I am a professor at a business school” “so you teach people how to make money”, “yeah (sigh), I teach people how to make money”…

But then, the guy continued, “so, what’s the answer?”…. That was a minor credibility crisis, right there on the spot…

I don’t remember what I said, but I remember thinking later what I should have said. It is about “creating value” (and selling it for more than it cost you to create) but also about “retaining value” (namely, why wouldn’t anyone else be able to come in and do exactly the same thing – driving the price down till you can only sell it for what it cost you in the first place)?

And, of all business plans and proposals I get to see, people usually think a lot about the first bit; “how to create value”. They talk about their unique value proposition, and why customers will love it, buy it, scream for it, and so on.

But they often forget about the second bit; why would YOU be able to do it, or at least do it better or cheaper than anyone else? What do you have or own that enables you to retain the value-adding ability, which protects you from immediate imitation by competitors?

For a start-up, that’s often tricky. You don’t have anything yet, so what could you possibly have or do that others couldn’t do too? The trick is that you don’t have to have it now, but you do need it a year or two from now, when you’re starting to have a real business.

Thus, the thing that makes you “difficult to imitate” does not necessarily have to be a patent, brandname, unique location, etc. It could also be found in other sources; something that you build up over time. Over the years, I have found that one of the most powerful sources – of being difficult to imitate – is a rather mundane thing… The firm’s competitive advantage is difficult to imitate because the firm itself doesn’t quite know what they do to make them so good at it…

We call this “causal ambiguity”. It may sound silly but is surprisingly common. Firms for example see that they have a much lower cost base than their competitors, or they see that their sales force is much more effective than theirs, or they manage to have a much lower error rate in their production process, but they don’t quite know why…

Causal ambiguity makes it difficult to exactly put your finger on what it is you do that makes you so much better than your competitors. Yet, don’t worry about it: it’s nice! When you yourself don’t even know what it is you do, it will be rather difficult for your rivals to copy it and do the same…!

Tuesday, 3 June 2008

Bloody useless lab rats – or are they?

Can you have a useful R&D department that is perfectly useless? Perhaps I should explain the question... Most R&D departments are supposed to generate new technologies, products, processes, etc. But not all do. Some R&D department seem to never come up with anything that makes it to market. Clearly a waste of money, these lab-rats, right?

Well, maybe not.

For a long time, economists and other folks studying organisations assumed that R&D departments are supposed to come up with stuff. And only if they come up with good stuff – which eventually makes it into a sellable product and reaps a profit – is an R&D department worth the investment. Clearly, if they never come up with anything at all, that’s money down the drain – or at least, that’s what everybody assumed.

Then, two professors of strategy (note, not economists!), Wesley Cohen and Daniel Levinthal, discovered an interesting insight. To put it in a simplified nutshell: sometimes, firms with R&D departments that never come up with anything at all still seemed to benefit from them?! How can such a seemingly useless bunch of Gyro Gearlooses still be worth their while?

The trick is that, in many industries (and in most industries to some extent), whatever firms invent comes into the public domain, much like radio signals or air pollution. Hence, other firms can easily access and imitate it. Economists always assumed that this process is costless; you just pick it up and do it too. Therefore, unless you’re in one of those rare industries in which patents really work, it’s actually kind of nice if your competitor invents something new; you can do it too without having had to spend all this R&D money!

However, this turned out to be a bit of an oversimplistic view of the world. Imitating your competitor is not that easy. It turns out that firms that never invest anything in R&D actually have quite a lot of trouble nicking ideas from others. They just don’t quite understand them well enough. In contrast, firms that do have an R&D department – even if the geeks never invent anything themselves – appear to be much better at copying others. That’s the unexpected benefit of having your own R&D: R&D equips you, as a firm, to be better at “stealing” things from others. Because of your investments in R&D, you are better able to really understand the technology and apply it in your own products and processes.

Wes and Daniel examined this phenomenon at length and wrote a series of articles about it in a bunch of heavy-weight academic journals, with telling titles such as “Innovation and learning: The two faces of R&D”, “Absorptive capacity: A new perspective on learning and innovation” and, my favourite, “Fortune favors the prepared firm”. It shows that there are two benefits from investing in R&D: the first one is to invent stuff; the second one is to build up the capacity to understand, assimilate and apply the things that others come up with in your own products and technologies.