Friday, 31 October 2008

Say what…?! Making strategy made simple

“Successful firms are characterized by maintaining bottom-up driven internal experimentation and selection processes while simultaneously maintaining top driven strategic intent” Stanford professor Robert Burgelman once wrote.

And I thought “What…?!”

What (on earth) might Robert mean with that? I don’t know but I am willing to take a guess. Let’s take the first part: “Bottom-up driven internal experimentation and selection processes”. You have to realise that Robert spent much of his academic life in Intel, studying how they developed strategy. And he found that for instance their big success – microprocessors – wasn’t the result of some planned analytical strategy-making process at all. Instead, Intel’s top management had allowed employees to work on some of their pet projects and technologies that these individuals were very enthusiastic about, but from which is was actually quite unclear if they would ever lead to anything useful (and profitable).

Many of these pet projects failed, some of them became reasonably successful (e.g. a product called EPROMS), but there was one which turned out to be this multi-billion dollar product called microprocessors. That’s the “experimentation” part of Robert’s statement (I think...).

Intel’s management did not only allow for this experimentation stuff to happen, it also made sure that at some point, a choice – i.e. a “selection” – would be made in terms of what (pet) products were going to receive priority and be continued, and which ones were going to get the chop. One such selection mechanism was a complex production capacity allocation formula which determined what was and what was not going to be manufactured. Another element concerned high levels of autonomy for middle managers, which made sure that those things most people thought were important for the future of the company would get done, but the things nobody quite believed in (anymore) would die out…

So that’s the “internal experimentation and selection processes” bit (I think). But what is this “maintaining top driven strategic intent”…?

It would be a mistake to believe that companies – including Intel – can be successful without a clear strategic direction (or “intent”) and can just rely on some bottom-up experimentation stuff. If you have bottom-up experimentation without a clear strategic direction in your organisation, soon you will be all over the place. Hence, although these “experimentation and selection processes” are useful, top management will still need to develop a clear strategic course for the firm, to make sure they’re coherent and going somewhere.

Yet, just having a top-down strategy (without the bottom-up stuff) won’t work either; it will likely make you rigid, myopic and simply unsuccessful. You need the top-down strategic intent to give you direction, but you simultaneously need the bottom-up thing to get you the unpredictable, unforeseeable successes that you really can’t dream up as a lone top dog.

Hence, as Robert said (be is slightly awkwardly), you need both, at the same time.

Tuesday, 28 October 2008

The process of making strategy (or just gibberish?)

Strategy making in the emergent stage can be viewed as a social learning process in which managerial action and cognition are intrinsically intertwined”, Stanford professor Robert Burgelman once wrote.

And I thought “What…?!”

But the more times I read the sentence, and the more I thought about it, and the more I compared it to the strategy-making processes in the (successful) companies I have seen from up close, it actually started to make sense… (although I acknowledge that I have no confirmation that the interpretation I came up with, of Robert’s gibberish, is actually what he meant with it!)

1) In a strategy-making process “managerial action and cognition are intrinsically intertwined”; what the heck might he mean with that? Well, if I think about the companies I’ve analysed, in pretty much all cases, strategy was not the result of a one-time rational analytical process but there was quite a bit of trail-and-error to it.

The firm, for whatever reason, tries something new – a new product, service or process. Or they simply happen to run it to something by accident. For example, Hornby, when they outsourced production of their model trains to China, added additional detail and quality to their products. That’s the “action”.

Then, the firm receives feedback from the market. In Hornby’s case, for example, sales went up. People in the company then stop, take notice and try to understand what led to the result. People in Hornby, for example, discovered that it was now hobbyists and collectors buying their products, instead of children, and they concluded they were moving out of the toy market into the hobby market; that’s the element of “reflection”.

Subsequently, the decided to deliberately try more of this, and add detail and quality to some of their others products as well, refocus their marketing efforts on adults and see what happened (that’s another action). When they noticed that this campaign was a success, they gradually decided to make this market-shift the basis of their new strategy (another moment of reflection). My guess is that’s what Robert meant, with “action and reflection are intrinsically intertwined”.

2) But what did he mean with it is “a social learning process”…? Well, my guess is that he meant a top manager doesn’t do this all by himself. It involves lots of people in the organisation – which is why it is a social process – and even from outside the firm. Hornby employees debated at length what was causing the surge in their sales, after outsourcing their production to China, and where it came from. They even explicitly involved their retailers in this discussion, to try and understand their view on what had happened to them.

3) Finally, what might Robert have meant with strategy making “in the emergent stage”…? Well, all of this means that strategy isn’t necessarily planned, especially in the beginning; organisations try stuff, some of it fails, other things stick and some of them become big successes. As a result of these processes, strategy happens; it emerges from within a (good and effective) organisation, rather than that it is the result of some 100 percent rational model and process. In later stages, it may become more deliberate and planned, just like Hornby nowadays very carefully taylors its products to hobbyists.

And that’s not only a very realistic view of how strategy really happens, but perhaps also one that a good organisation should aspire to. Because purely rational, planned strategies are seldom the big break-through successes. Simply because life is more complex than that. Just like Robert’s language.

Thursday, 23 October 2008

Framing something as a threat or an opportunity dramatically alters what we choose

A famous experiment by Nobel Prize winner Daniel Kahneman and Amos Tversky went as follows:

Imagine that the US is preparing for an outbreak of an unusual Asian disease, which is expected to kill 600 people. Two alternative programmes to combat the disease have been proposed.
Assume that the exact scientific estimates of the consequences of the programmes are as follows:

If programme A is adopted, 200 will be saved.
If programme B is adopted, there is a one-third probability that 600 people will be saved and a two-thirds probability that no people will be saved.

Which one of the two programmes would you prefer?

Kahneman and Tversky found that a substantial majority of people would choose programme A.
Then they gave another group of people the assignment but with the following description of the (same) options:

If programme A is adopted, 400 people will die.
If programme B is adopted, there is a one-third probability that nobody will die and a two-thirds probability that 600 people will die.

They found that, in this case, a clear majority of respondents favoured programme B! But the programmes really are exactly the same in both cases…!? How come people’s preferences flip although they are confronted with the exact same set of choices (be it described slightly differently)?

It is due to what we call “framing effects”, and they greatly affect people’s preferences and decisions. For instance, In the first case, programme A is described in terms of the certainty of surviving (which people like), but in the second case it is described in terms of the certainty of dying (which people don’t like at all!). Therefore, people choose A when confronted with the first programme description, while in the second case they favour B, although the programmes are the same in both situations.

We also see this influence in strategic decision-making, for instance in terms of whether particular environmental developments are “framed” as opportunities (which we like) or threats (which we don’t like). A few years back, Clark Gilbert – at the time a professor at the Harvard Business School – analysed American newspapers’ responses to the rise of on-line media in the mid-1990s.

He found that those newspapers that, in their internal communications and deliberations, described on-line media as an opportunity (e.g. “a new avenue for attracting advertising revenue”) coped quite well. In contrast, those newspapers that framed the exact same technological developments as a threat (e.g. “it will eat into our advertising market share”) didn’t cope very well at all. In light of the threat, they reduced investments in experimentation, adopted a more authoritarian organisation and management style, and focused more narrowly on their existing resources and activities. As a result, they basically ended up copying their physical newspaper onto the web; and that didn’t work at all. Many of them didn’t survive.

And this effect is quite omni-present. How you frame decision-situations to someone (e.g. your boss) is going to influence substantially what option he is going to favour. How the people who work for you frame a situation while presenting to you, is also going to determine what you will choose. And I guess that may be an opportunity (or a threat…) in and of itself.

Tuesday, 21 October 2008

Pay inequality – good or bad for team performance?

When you have a team of people working on a common task, who all fullfil a similar role in the team (like a football team, a string quartet, a team of engineers, etc.) should you pay them all pretty much the same, or would you be better off creating quite different levels of remuneration within the team?

This question can stir a fair bit of debate, and I have heard it been argued one way and the other. “You should pay them all the same” some loudly proclaim, “because they’re a team and you don’t want to create envy and inequality within the group!” Others will bellow in agony: “But you need to incentivize people – stupid!; equal pay kills their motivation; you should pay more to people who (seem to) contribute more, to keep them happy while stimulating the others to better themselves!!”.

And who knows whether it is one way or the other. The problem is, it is very difficult to research properly, and find a conclusive and reliable answer. You’d of course need information on the exact remuneration of all people in a team, their individual performance and their team performance, and have a whole bunch of identical teams to make meaningful comparisons. And that’s easier said than done.

Professor Matt Bloom, from the University of Notre Dame, decided to give it a try. And to make sure that he had a clean research sample, with a whole bunch of similar teams doing the same task, for which he could collect all the relevant info, he chose Major League Baseball.

And, although a bit unconventional, that’s perhaps not such a bad idea…! I don’t know much about baseball (and would prefer to keep it that way!) but I assume the rules are the same for everyone, the teams the same size, working on the same task, etc. Thus, Matt collected performance data on 1644 players in 29 teams, assessing their individual performance through batting runs, fielding runs, earned run averages, pitching runs, player ratings and all this (for me) abacadabra. For team performance, he measured a combination of on-field performance and financial performance, using game wins and revenue and valuation data. So, this gave him measures for team performance and the individual performance of each member of the team.

Then he measured player compensation; The newspaper USA Today apparently publishes salary and performance incentives for all players, so he used that. Finally, he created an indicator of “pay dispersion”, or how big are the differences in the levels of pay between the players on a team. Using this data, he computed whether clubs were better off equalising pay, or differentiating their team’s payment levels.

And, so it turned out, it’s the former: that is, baseball teams performed better if the salaries of the players were not too different from each other. The larger the payment differences, the lower the individual players’ performance; mostly so – perhaps not surprisingly – for the players receiving the lowest payment. But – perhaps more surprisingly – also the players who found themselves pretty high in the payment pecking order, receiving an above-avarege salary package, saw their individual performance being negatively affected by the pay dispersion within the team.

Finally, team performance: Those teams with high pay differences among players had markedly poorer performance. It seems substantial differences in pay are more of a de-motivator than an incentive, even for the majority of people who end up in the high payment bracket! And the team suffers from it as a result.

Friday, 17 October 2008

Dirty laundry: Who is hiding the bad stuff?

Are firms sometimes inclined to conceal negative information, for instance in their communication to shareholders?

Some years back, two researchers – Eric Abrahamson from Columbia Business School and Choelsoon Park, at the time at the London Business School – examined this question systematically. Their answer – perhaps not surprisingly – was “yes”.

Fortunately, however, they did not stop there. Because perhaps the more interesting question is, “who is concealing the bad stuff” or, put differently, which firms are inclined to hide their dirty laundry?

Eric and Choelsoon investigated so-called letters to shareholders of 1118 companies as published in these firms’ annual reports. There is quite a bit of evidence that these letters to shareholders form one of the main communication devices of firms to their shareholders and that they have some real impact on companies’ share price. Eric and Choelsoon, through computer analysis of the wording of these letters, made a measure of how much negative information was disclosed in them.

In addition, they collected information on a bunch of other variables, such as the firms’ (subsequent) performance, the percentage of outside directors on their boards, shares held by those outside directors, institutional ownership of the companies, auditor reports, etc. And they uncovered some pretty gritty stuff.

So, their finding number one was: Company Presidents - who formally write these letters - are tempted to lie and hide their company’s bad news. I reckon that is only human. My guess is many of us might be tempted to tone down our failures (and play up our achievements a bit) in such very public statements, to not feel embarrassed and make ourselves look successful. But there are things that can be done, in terms of corporate governance, to stem their & our natural inclination to obscure the truth.

That brings me to finding number two: Eric and Choelsoon showed that having outside directors on the board made firms lie less. The more outside directors firms had the more forthcoming they were with their bad news. Similarly, having large institutional investors prompted firms to be more open about their failures in these letters to shareholders. Large institutional investors tend to monitor the firms they invest in quite closely, which apparently gives them less opportunity to conceal the negative stuff.

But then came finding number three: If we gave our outside directors shares in the company, the results flipped…! Firms that had outside directors who also were quite major shareholders were less forthcoming in disclosing their bad news. It seems that having an ownership stake in the company created a conflict of interest for these people which induced them to stimulate their firm to hide its dirty laundry rather than disclose it.

Moreover, having lots of small institutional investors – who don’t scrutinise companies as strictly – also made the results flip: Firms with lots of small institutional investors hid their bad news more often, probably because they were afraid these investors would run at the slightest hint of bad news (which they are indeed known to do), which could snowball and send the firm’s share price plummeting. To conclude, having outside directors may be a good thing, but only if they don’t have a lot of shares. Institutional investors may be a good thing too, but only if they do have a big stake.

By the way, interestingly, Eric and Choelsoon also found that those companies that did not disclose their bad news were exactly the companies whose top managers would quickly sell a whole bunch of their privately-held shares shortly after the release of the (overoptimistic) letter to shareholders. Guess corporate crooks don’t only lie; they also steal.

Tuesday, 14 October 2008

"Reverse causality" – sorry, but life's not that simple

“In Search of Excellence”, “Built to Last”, “Profit from the Core”; you may have read some of these best-selling business books.

They usually follow a simple yet appealing formula. They look at a number of very successful companies, see what they have in common, and then conclude “this must be a good thing!” Yet, reality – and strategy research – is a bit trickier than that.

One conclusion many of these business books draw is that one should focus on a limited set of “core activities”. For example, “Profit from the Core” authors Chris Zook and James Allan find that 78% of the high-performing firms in their sample of 1,854 companies focus on just one set of core activities, while a mere 22% of the low-performing companies did. Hence, they conclude that companies should focus.* Simple isn't it? Yeah, but a bit too simple...

What this “advice” ignores is that often underperforming companies diversify into other businesses in order to try to find markets that are more rewarding for them. Thus, their “non-focus” is the result of poor performance, rather than the cause! In contrast, it’s very common that very successful companies narrow their strategic focus in order to concentrate on the business that brings them most success. Again, their focus is not the cause of their success; it is the result of it. Our best-selling-business-book-friends may be reversing cause and effect; recommending everybody to apply more focus may be dubious advice at best!

Similarly, many of these business books conclude that the high-performing companies they looked at all had very strong and homogeneous corporate cultures. Hence, they conclude: create a strong corporate culture! Seductively simple again... Unfortunately, not so sound.

It is a well-known effect in academic research that success may gradually start to create a homogeneous organisational culture. Again, the coherent culture is not the cause of the company’s success, but the result of it! What’s worse, a narrow, dogmatic corporate culture may be the foreboding of trouble. When the firm’s business environment changes – and all environments eventually do – it makes the company rigid and unable to adapt; a phenomenon known as the success trap.

Indeed, the authors of “In Search of Excellence” – Peters and Waterman – published in 1982, who analysed 43 of "the most excellent companies in the world", also concluded that a strong corporate culture was a necessity for business stardom. However, if you look at their list of 43 "most excellent companies” today, only three or four might still make the list (Johnson & Johnson, Intel, Wal-Mart, Mars); the remainder has gone down or disappeared altogether.

Hence, remember that “association is not causation”. For example, that successful companies are associated with a very focused set of business activities and strong corporate cultures does not mean that this is what caused their success. Importantly, trying to replicate these symptoms of success may actually prevent you from attaining it.

* For more insight into these type of effects, see for instance the work of Stanford Professor Jerker Denrell

Thursday, 9 October 2008

Successful managers – incompetent for sure

The world of business is risky. That’s inevitable. We can analyse all we want, plan, debate, gather information and think it through till it gives us a migraine, sometimes things just don’t work out and nobody could have foreseen it.

So what makes for a good risk manager? Well, it is someone who carefully chooses the best odds. He will sometimes win, and sometimes lose. But, always, he will make quite deliberate and careful trade-offs between his assessment of risk and return; the most expected return for the least risk. Sometimes good managers accept a low return when it is safe (like buying government bonds); sometimes they accept a lot more risk in return for a higher expected return (like investing in the stock market).

Bad managers are those people who just don’t get it. They accept worse average returns for higher risks. And this is where it gets tricky.

Because if they accept very high risks, in spite of lower average returns, every once in a while one of these morons will actually hit the jack-pot…*

That is, if we take the top 1 percent – and only this 1 percent – of top performers, they’re likely to be those people who don’t get it at all… but just got incredibly lucky!

The same is true – as Stanford’s Professor Jim March asserted – for CEOs. The ones that are the eye-catching top-performers are likely the ones who just don’t get it. The dangerous thing is that they are also the ones with the absolute highest return in their business. Therefore we naively believe that they “do get it” and, in fact, are quite brilliant. Moreover, that’s what they start to believe as well… (“I win again; I must be brilliant…!”). Yet, they got lucky once, the might get lucky twice, or three times (at which point we start to notice them) but eventually their luck will turn (the names of Bernard Tapie, Jeff Skilling, Cees van der Hoeven and Conrad Black come to mind).

The same is often true for fund managers, and other people who are trying to make money on the stock market. The top performing funds are not necessarily the best ones when it comes to ability.

For example, have you ever come across these competitions in which people receive a starting sum to “play the stock market” and after 6 months or so the person with the highest return gets the award or even a job? Stupid scheme by design: The person with the highest return is by definition the one that really did not have a clue. Because the only way to win such a “contest” is by making the most silly, illogical and risky allocation of funds, and get lucky. Skillful, careful players will not lose their money, and likely get a decent return, but won’t be the ones to come out on top.

And the issue is: some bloke will get lucky. Ninety-nine out of a hundred cases it will go wrong, but the ultimate winner is dumbo number one hundred. The contest by sheer design ends up picking a nit-wit.

Hence, watch out for “top performers”, in any business or situation which involves risk. The one coming out on top is likely to be a moron, who just got lucky.

* In statistical terms, good managers have a normal distribution around a relatively high average; bad managers have a lower average return but a distribution with “fat tails”. Consequently, because of the long right-hand tail, the top performers stem from the “bad managers” distribution/pool.

Tuesday, 7 October 2008

The hidden cost of equity

What’s all the noise about being a public company anyway? I recently asked the CEO of a FTSE 250 company “what’s the advantage of being listed?” She shrugged and said “I don’t know; it can give you access to some capital I guess but, apart from that…”.

Of course it is rather “sexy” and exciting. Many CEOs don’t just want to be a CEO; they want to be the CEO of a public company. But what really are the advantages of having your company listed on the stock exchange? Naturally, selling equity is a source of money, but of course there are other sources of capital which could suffice for your investment plans. But, alright, I’ll give you that; it’s one potential source of money.

Yet, I would say this source comes at a cost. Investment bankers will be able to spell out to you – in much much, much detail... – what the advantages and disadvantages are of the various sources of capital, including equity. However, I think they’re forgetting one.

I recently spoke to Bill Allan; CEO of THUS (the former Scottish Telecom). Some years back, they all of a sudden were elevated into the FTSE 100. He admitted that, at once, he found himself having to spend the majority of his time dealing with fund managers, analysts, investors, the business press, etc. Of course this was a relatively unusual and extreme situation; the telecom bubble launched THUS into the FTSE 100 when they weren’t quite ready for it. However, all the CEOs of public companies that I have talked to, in private, will admit that they spend about 30 percent of their time dealing with “the stock market” (i.e. fund managers, analysts, institutional investors and the wider public). Simply put, they wouldn’t have to do this if they weren’t listed.

Think about it: that’s quite a cost. If you have a good company and you decide to float it (starting to sell equity on the stock market), all of a sudden, you lose 30 percent of your top management capacity!

Are you sure that’s worth it? That’s 30 percent which they could have spent on cultivating the organisation, motivating employees, thinking through opportunities for future growth, integrating acquisitions, etc.

Moreover, many CEOs end up not particularly liking the 30 percent… It is a lot of hassle, pressure and a bit of a pain, having to tell (and defend) your “story” over and over again, to people who really don’t have much in-depth knowledge about the company and its business, often haven’t received any training in developing or even understanding strategy, and occasionally may not have much talent for or affinity with it anyway!

How do you quantify this cost of being listed? I don’t know; it is difficult to put a number on such a thing (which is probably why we don’t pay much attention to it in the first place!). But I will assure you that many CEOs will privately tell you – be it while whispering behind the palm of their hand – that being listed isn’t so sexy and exciting after all. And, if they still had a choice, they would do without it.

Thursday, 2 October 2008

The Abilene Paradox

It is a well-known phenomenon from social psychology that people are reluctant to voice minority opinions. My guess is you may recognise this issue and feel it yourself sometimes; when a whole group of people seems to agree on something (a course of action, proposal, etc.) but you have doubts about it, there is a bit of a psychological hurdle to speak up against it. And if you do collect the courage to speak up against it, you do so reluctantly, ready to take the heat.

And we’re right to be reluctant to speak up. Research also shows that minority dissenters are often “punished”, in the sense that people in the majority group get irritated, will blame you for the deal falling apart, may even start to give you the cold shoulder if not spit in your tea when you’re not looking.

Therefore, quite often, people don’t speak up at all if they disagree with a particular course of action, if they feel they would likely be the only ones against it. Instead, they stay quiet.

And there is an interesting consequence to that. We only know that others disagree if they actually speak up. If they don’t speak up, we are inclined to conclude that they do not disagree! As a result, it may be that we stay quiet because we assume that everybody else is in favour while, in reality, lots of others are making the same erroneous assumption…! In social psychology, this phenomenon is known as pluralistic ignorance or the “Abilene Paradox”.

The first person to describe the Abilene Paradox was Professor Jerry Harvey, from the George Washington University. He describes a leisure trip which he and his wife and parents made in Texas in July, in his parents’ un-airconditioned old Buick to a town called Abilene. It was a trip they had all agreed to but, as it later turned out, none of them had wanted to go on. “Here we were, four reasonably sensible people who, of our own volition, had just taken a 106-mile trip across a godforsaken desert in a furnace-like temperature through a cloud-like dust storm to eat unpalatable food at a hole-in-the-wall cafeteria in Abilene, when none of us had really wanted to go”…

Of course, this phenomenon is not restricted to people in Texas. Actually, it happens in the world of business too. Professor Jim Westphal, from the University of Michigan, for example uncovered evidence of the Abilene Paradox among boards of directors.

He collected data on 228 boards of medium-sized American public companies using a variety of databases and questionnaires. He found out that outside directors often did not speak up against their company’s extant strategy, although they had serious concerns about it. At the same time, they greatly underestimated the extent to which their fellow directors shared these concerns! As a consequence, underperforming companies undertook fewer initiatives to change their strategy, and they persisted with their failing course of action.

That's the Abilene paradox: Nobody may think we’re sailing a good course, but if nobody is willing to rock the boat – thinking we’ll be the only one – we may end up continuing as is, until we all go under...