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.

3 comments:

Emre said...

An insightful point. Yet, I think the underlying assumption you have here is that each and every practice adopted should ideally contribute to the efficiency of a firm. When viewed in isolation, a particular practice may not make any sense at all to that end. However, when considered along with others, the practice could play a key role in the overall business model of a firm.

From another point of view, managers may also well aware of the fact that prevalent use of a practice does not necessarily render this practice as the decisive factor in the Darwinian selection process. However, they still may adopt bad/inefficient practices since it could be seen as a way of gaining legitimacy by participating the crowd. Thus, alternative to seeing it as a peril of vicarious learning, we can see the persistence of a bad practice as an outcome of the trade-off between legitimacy and efficiency. I believe one can find cases in which cost of deviation from institutional norms may outweigh benefits of streamlining the set of organizational practices.

Emre
Stockholm School of Economics

Freek said...

Emre: You're of course very right. Sometimes practices are inefficient but still benefit the firm because they provide them with legitimacy in the eyes of their customers, suppliers, etc. (e.g. ISO9000 in certain industries). However, those are not the ones I am talking about - in my vocabulaire, I would not even call them "bad practices - since they do bring benefits for the firm and increase its "chance of survival".

I'm convinced that there are practices out there that don't even do that (i.e. provide legitimacy); they're bad, lower your survival chances and you'd be better off without them. How come such practices survive, is the topic of my entry.

vlade said...

Easy. Most people find it preferable to fail in company rather than succeed alone.
It's a purely social construct I believe. Unless a figure of authority steps in, or the new way becomes not-easily assailable (i.e. one will not get blamed for using it, regardless whether the failure was or was not a result of abandoning the old way and using a new way), changing your ways takes:
a) personal courage; or
b) an outsider who's not easily influenced by the inmates (sorry, incumbents).
Both of them are rare.
It's (to an extent) similar to smoking - you know it's bad for you, but even so won't necessarily quit if you're in a group of smokers.