BUSINESS EXPOSED

Fraud and the Road to Abilene

2012-01-23T13:14:00.001Z

Over the weekend, an (anonymized) interview was published in a Dutch national newspaper with the three “whistle blowers” who exposed the enormous fraud of Professor Diederik Stapel. Stapel had gained stardom status in the field of social psychology but, simply speaking, had been making up all his data all the time. There are two things that struck me:

First, in a previous post I wrote about the fraud, based on a flurry of newspaper articles and the interim report that a committee examining the fraud has put together, I wrote that it eventually was his clumsiness faking the data that got him caught. Although that general picture certainly remained – he wasn’t very good at faking data; I think I could have easily done a better job (although I have never even tried anything like that, honest!) – but it wasn’t as clumsy as the newspapers sometimes made it out to be.

Specifically, I wrote “eventually, he did not even bother anymore to really make up newly faked data. He used the same (fake) numbers for different experiments, gave those to his various PhD students to analyze, who then in disbelief slaving away in their adjacent cubicles discovered that their very different experiments led to exactly the same statistical values (a near impossibility). When they compared their databases, there was substantial overlap”. Now, it now seems the “substantial overlap” was merely a part of one column of data. Plus, there were various other things that got him caught.

I don’t beat myself too hard over the head with my keyboard about repeating this misrepresentation by the newspapers (although I have given myself a small slap on the wrist – after having received a verbal one from one of the whistlers) because my piece focused on the “why did he do it?” rather than the “how did he get caught”, but it does show that we have to give the three whistle blowers (quite) a bit more credit than I – and others – originally thought.

The second point that caught my attention is that, since the fraught was exposed, various people have come out admitting that they had “had suspicions all the time”. You could say “yeah right” but there do appear to be quite a few signs that various people indeed had been having their doubts for a longer time. For instance, I have read an interview with a former colleague of Stapel at Tilburg University credibly admitting to this, I have directly spoken to people who said there had been rumors for longer, and the article with the whistle blowers suggests even Stapel’s faculty dean might not have been entirely dumbfounded that it had all been too good to be true after all... All the people who admit to having doubts in private state that they did not feel comfortable raising the issue while everyone just seemed to applaud Stapel and his Science publications.

This reminded me of the Abilene Paradox, first described by Professor Jerry Harvey, from the George Washington University. He described 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 – or at least not disagreed with – 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”

The Abilene Paradox describes the situation where everyone goes along with something, mistakenly assuming that others’ people’s silence implies that they agree. And the (erroneous) feeling to be the only one who disagrees makes a person shut up as well, all the way to Abilene.

People had suspicions about Stapel’s “too good to be true” research record and findings but did not dare to speak up while no-one else did.

It seems there are two things that eventually made the three whistle blowers speak up and expose Stapel: Friendship and alcohol.

They had struck up a friendship and one night, fuelled by alcohol, raised their suspicions to one another. And, crucially, decided to do something about it. Perhaps there are some lessons in this for the world of business. For example, Jim Westphal, who has done extensive, thorough research on boards of directors, showed that boards often suffer from the Abilene Paradox, for instance when confronted with their company’s new strategy. Yet, Jim and colleagues also showed that friendship ties within top management teams might not be such a bad thing. We are often suspicious of social ties between boards and top managers, fearful that it might cloud their judgment and make them reluctant to discipline a CEO. But it may be that such friendship ties – whether fuelled by alcohol or not – might also help to lower the barriers to resolving the Abilene Paradox. So perhaps we should make friendships and alcohol mandatory – religion permitting – both during board meetings and academic gatherings. It would undoubtedly help making them more tolerable as well.

Bias (or why you can’t trust any of the research you read)

2012-01-11T10:08:00.002Z

Researchers in Management and Strategy worry a lot about bias – statistical bias. In case you’re not such an academic researcher, let me briefly explain.

Suppose you want to find out how many members of a rugby club have their nipples pierced (to pick a random example). The problem is, the club has 200 members and you don’t want to ask them all to take their shirts off. Therefore, you select a sample of 20 of them guys and ask them to bare their chests. After some friendly bantering they agree, and then it appears that no fewer than 15 of them have their nipples pierced, so you conclude that the majority of players in the club likely have undergone the slightly painful (or so I am told) aesthetic enhancement.

The problem is, there is a chance that you’re wrong. There is a chance that due to sheer coincidence you happened to select 15 pierced pairs of nipples where among the full set of 200 members they are very much the minority. For example, if in reality out of the 200 rugby blokes only 30 have their nipples pierced, due to sheer chance you could happen to pick 15 of them in your sample of 20, and your conclusion that “the majority of players in this club has them” is wrong.

Now, in our research, there is no real way around this. Therefore, the convention among academic researchers is that it is ok, and you can claim your conclusion based on only a sample of observations, as long as the probability that you are wrong is no bigger than 5%. If it ain’t – and one can relatively easily compute that probability – we say the result is “statistically significant”. Out of sheer joy, we then mark that number with a cheerful asterisk * and say amen.

Now, I just said that “one can relatively easily compute that probability” but that is not always entirely true. In fact, over the years statisticians have come up with increasingly complex procedures to correct for all sorts of potential statistical biases that can occur in research projects of various natures. They treat horrifying statistical conditions such as unobserved heterogeneity, selection bias, heteroscedasticity, and autocorrelation. Let me not try to explain to you what they are, but believe me they’re nasty. You don’t want to be caught with one of those.

Fortunately, the life of the researcher is made easy by standard statistical software packages. They offer nice user-friendly menus where one can press buttons to solve problems. For example, if you have identified a heteroscedasticity problem in your data, there are various buttons to press that can cure it for you. Now, note that it is my personal estimate (but notice, no claims of an asterisk!) that about 95 out of a 100 researchers have no clue what happens within their computers when they press one of those magical buttons, but that does not mean it does not solve the problem. Professional statisticians will frown and smirk at the thought alone, but if you have correctly identified the condition and the way to treat it, you don’t necessarily have to fully understand how the cure works (although I think it often would help selecting the correct treatment). So far, so good.

Here comes the trick: All of those statistical biases are pretty much irrelevant. They are irrelevant because they are all dwarfed by another bias (for which there is no life-saving cure available in any of the statistical packages): publication bias.

The problem is that if you have collected a whole bunch of data and you don’t find anything or at least nothing really interesting and new, no journal is going to publish it. For example, the prestigious journal Administrative Science Quarterly proclaims in its “Invitation to Contributors” that it seeks to publish “counterintuitive work that disconfirms prevailing assumptions”. And perhaps rightly so; we’re all interested in learning something new. So if you, as a researcher, don’t find anything counterintuitive that disconfirms prevailing assumptions, you are usually not even going to bother writing it up. And in case you’re dumb enough to write it up and send it to a journal requesting them to publish it, you will swiftly (or less swiftly, dependent on what journal you sent it to) receive a reply that has the word “reject” firmly embedded in it.

Yet, unintended, this publication reality completely messes up the “5% convention”, i.e. that you can only claim a finding as real if there is only a 5% chance that what you found is sheer coincidence (rather than a counterintuitive insight that disconfirms prevailing assumptions). In fact, the chance that what you are reporting is bogus is much higher than the 5% you so cheerfully claimed with your poignant asterisk. Because journals will only publish novel, interesting findings – and therefore researchers only bother to write up seemingly intriguing counterintuitive findings – the chance that what they eventually are publishing is BS unwittingly is vast.

A recent article by Simmons, Nelson, and Simonsohn in Psychological Science (cheerfully entitled “False-Positive Psychology: Undisclosed Flexibility in Data Collection and Analysis Allows Presenting Anything as Significant”) summed it up prickly clearly. If a researcher, running a particular experiment, does not find the result he was expecting, he may initially think “that’s because I did not collect enough data” and collect some more. He can also think “I used the wrong measure; let me use the other measure I also collected” or “I need to correct my models for whether the respondent was male or female” or “examine a slightly different set of conditions”. Yet, taking these (extremely common) measures raises the probability that what the researcher finds in his data is due to sheer chance from the conventional 5% to a whopping 60.7%, without the researcher realising it. He will still cheerfully put the all-important asterisk in his table and declare that he has found a counterintuitive insight that disconfirms some important prevailing assumption.

In management and strategy research we do highly similar things. We for instance collect data with two or three ideas in mind in terms of what we want to examine and test with them. If the first idea does not lead to a desired result, the researcher moves on to his second idea and then one can hear a sigh of relief behind a computer screen that “at least this idea was a good one”. In fact, you might only be moving on to “the next good idea” till you have hit on a purely coincidental result: 15 bulky guys with pierced nipples.

Things get really “funny” when one realises that what is considered interesting and publishable is different in different fields in Business Studies. For example, in fields like Finance and Economics, academics are likely to be fairly skeptical whether Corporate Social Responsibility is good for a firm’s financial performance. In the subfield of Management people are much more receptive to the idea that Corporate Social Responsibility should also benefit a firm in terms of its profitability. Indeed, as shown by a simple yet nifty study by Marc Orlitzky, recently published in Business Ethics Quarterly, articles published on this topic in Management journals report a statistical relationship between the two variables which is about twice as big as the ones reported in Economics, Finance, or Accounting journals. Of course, who does the research and where it gets printed should not have any bearing on what the actual relationship is but, apparently, preferences and publication bias do come into the picture with quite some force.

Hence, publication bias vastly dominates any of the statistical biases we get so worked up about, making them pretty much irrelevant. Is this a sad state of affairs? Ehm…. I think yes. Is there an easy solution for it? Ehm… I think no. And that is why we will likely all be suffering from publication bias for quite some time to come.

Most People Don't Know Their Business (so asking them is useless)

2011-12-12T16:26:00.002Z

I’ll admit it; I am rapidly becoming a skeptic when it comes to interview-based data. And the reason is that people (interviewees) just don’t know their business – although, of course, they think they do.

For example, in an intriguing research project with my (rather exceptional) PhD student Amandine Ody, we asked lots of people in the Champagne industry whether different Champagne houses paid different prices for a kilogram of their raw material: grapes. The answer was unanimously and unambiguously “no”; everybody pays more or less the same price. But when we looked at the actual data (which are opaque at first sight and pretty hard to get), the price differences appeared huge: some paid 6 euros for a kilogram, others 8, and yet other 10 or even 12. Thinking it might be the (poor) quality of the data, we obtained a large sample of similar data from a different source: supplier contracts. Which showed exactly the same thing. But the people within the business really did not know; they thought everybody was paying about the same price. They were wrong.

Then Amandine asked them which houses supplied Champagne for supermarket brands (a practice many in the industry thoroughly detest, but it is very difficult to observe who is hiding behind those supermarket labels). They mentioned a bunch of houses, both in terms of the type of houses and specific named ones, who they “were sure were behind it”. And they quite invariably were completely wrong. Using a clever but painstaking method, Amandine deduced who was really supplying the Champagne to the supermarkets, and she found out it was not the usual suspects. In fact, the houses that did it were exactly the ones no-one suspected, and the houses everyone thought were doing it were as innocent as a newborn baby. They were – again – dead wrong.

And this is not the only context and project where I have had such experiences, i.e. it is not just a French thing. With a colleague at University College London – Mihaela Stan – we analyzed the British IVF industry. One prominent practice in this industry is the role of a so-called integrator; one medical professional who is always “the face” towards the patient, i.e. a patient is always dealing with one and the same doctor or nurse, and not a different one very time the treatment is in a different stage. All interviewees told us that this really had no substance; it was just a way of comforting the patient. However, when we analyzed the practice’s actual influence – together with my good friend and colleague Phanish Puranam – we quickly discovered that the use of such an integrator had a very real impact on the efficacy of the IVF process; women simply had a substantially higher probability of getting pregnant when such an integrator, who coordinates across the various stages of the IVF cycle, was used. But the interviewees had no clue about the actual effects of the practice.*

My examples are just conjectures, but there is also some serious research on the topic. Olav Sorenson and David Waguespack published a study on film distributors in which they showed that these distributors’ beliefs about what would make a film a success were plain wrong (they just made them come true by assigning them more resources based on this belief). John Mezias and Bill Starbuck published several articles in which they showed how people do not even know basic facts about their own companies, such as the sales of their own business unit, error rates, or quality indicators. People more often than not were several hundreds of percentages of the mark, when asked to report a number.

Of course interviews can sometimes be interesting; you can ask people about their perceptions, why they think they are doing something, and how they think things work. Just don’t make the mistake of believing them.

Much the same is true for the use of questionnaires. They are often used to ask for basic facts and assessments: e.g. “how big is your company”, “how good are you at practice X”, and so on. Sheer nonsense is the most likely result. People do not know their business, both in terms of the simple facts and in terms of the complex processes that lead to success or failure. Therefore, do yourself (and us) a favor: don’t ask; get the facts.

* Although this was not necessarily a “direct effect”; the impact of the practice is more subtle than that.

The Lying Dutchman: Fraud in the Ivory Tower

2011-12-07T11:04:00.002Z

The fraud of Diederik Stapel – professor of social psychology at Tilburg University in the Netherlands – was enormous. His list of publications was truly impressive, both in terms of the content of the articles as well as its sheer number and the prestige of the journals in which it was published: dozens of articles in all the top psychology journals in academia with a number of them in famous general science outlets such as Science. His seemingly careful research was very thorough in terms of its research design, and was thought to reveal many intriguing insights about fundamental human nature. The problem was, he had made it all up…

For years – so we know now – Diederik Stapel made up all his data. He would carefully review the literature, design all the studies (with his various co-authors), set up the experiments, print out all the questionnaires, and then, instead of actually doing the experiments and distributing the questionnaires, made it all up. Just like that.

He finally got caught because, eventually, he did not even bother anymore to really make up newly faked data. He used the same (fake) numbers for different experiments, gave those to his various PhD students to analyze, who then in disbelief slaving away in their adjacent cubicles discovered that their very different experiments led to exactly the same statistical values (a near impossibility). When they compared their databases, there was substantial overlap. There was no denying it any longer; Diederik Stapel, was making it up; he was immediately fired by the university, admitted to his lengthy fraud, and handed back his PhD degree.

In an open letter, sent to Dutch newspapers to try to explain his actions, he cited the huge pressures to come up with interesting findings that he had been under, in the publish or perish culture that exist in the academic world, which he had been unable to resist, and which led him to his extreme actions.

There are various things I find truly remarkable and puzzling about the case of Diederik Stapel.
• The first one is the sheer scale and (eventually) outright clumsiness of his fraud. It also makes me realize that there must be dozens, maybe hundreds of others just like him. They just do it a little bit less, less extreme, and are probably a bit more sophisticated about it, but they’re subject to the exact same pressures and temptations as Diederik Stapel. Surely others give in to them as well. He got caught because he was flying so high, he did it so much, and so clumsily. But I am guessing that for every fraud that gets caught, due to hubris, there are at least ten other ones that don’t.
• The second one is that he did it at all. Of course because it is fraud, unethical, and unacceptable, but also because it sort of seems he did not really need it. You have to realize that “getting the data” is just a very small proportion of all the skills and capabilities one needs to get published. You have to really know and understand the literature; you have to be able to carefully design an experiment, ruling out any potential statistical biases, alternative explanations, and other pitfalls; you have to be able to write it up so that it catches people’s interest and imagination; and you have to be able to see the article through the various reviewers and steps in the publication process that every prestigious academic journal operates. Those are substantial and difficult skills; all of which Diederik Stapel possessed. All he did is make up the data; something which is just a small proportion of the total set of skills required, and something that he could have easily outsourced to one of his many PhD students. Sure, you then would not have had the guarantee that the experiment would come out the way you wanted them, but who knows, they could.
• That’s what I find puzzling as well; that at no point he seems to have become curious whether his experiments might actually work without him making it all up. They were interesting experiments; wouldn’t you at some point be tempted to see whether they might work…?
• Truly amazing I also find the fact that he never stopped. It seems he has much in common with Bernard Madoff and his Ponzi Scheme, or the notorious traders in investments banks such as 827 million Nick Leeson, who brought down Barings Bank with his massive fraudulent trades, Societe Generale’s 4.9 billion Jerome Kerviel, and UBS’s 2.3 billion Kweku Adoboli. The difference: Stapel could have stopped. For people like Madoff or the rogue traders, there was no way back; once they had started the fraud there was no stopping it. But Stapel could have stopped at any point. Surely at some point he must have at least considered this? I guess he was addicted; addicted to the status and aura of continued success.
• Finally, what I find truly amazing is that he was teaching the Ethics course at Tilburg University. You just don’t make that one up; that’s Dutch irony at its best.

What's wrong with senior executive pay – lots in my view

2011-11-16T12:21:00.001Z

There are three things I do not like about top management pay: 1) they usually get paid too much, 2) way too large a part is flexible, performance-related pay, 3) often, a very sizeable chunk of it is paid through stock options.

I used to think - naively - that high top management pay was high simply due to supply and demand: these smart people with lots of business acumen and experience are hard to come by; therefore you have to pay them lots. These grumpy anti-corporates claiming their pay is too high are just envious and naive. Turns out I was (maybe not envious, but certainly naive).

Pay level

Because digging into the rigorous research on the topic - and there is quite a bit of it - I learned that there is really not much of a relationship between firm performance and top management pay. These guys (mostly guys) get paid a lot whether or not their company's performance is any good. Moreover, I learned what sort of factors push up top managers' remuneration - and it ain't supply and demand. It has much more to do with selecting the right company directors (to serve on your remumeration committee) and making sure you are well networked and socialized into the business elite.* Now I have to conclude: top management pay is generally too high, and quite a bit too high.

Flexible pay

Secondly: where does this absurd idea come from that 80+ percent of these guys' remuneration has to be performance related?! "To reward them for good performance and stimulate them to act in the best interest of the company and its shareholders" you might say? To which I would reply "oh, come on!?" If your CEO is the type of guy who needs 90 percent performance-related pay or otherwise he won't act in the best interest of the company, I would say the perfect time to get rid of him is yesterday. You and I do not need 90 percent performance related pay to do our best, do we? So why would it be allowed to hold for top managers? As Henry Mintzberg put it: "Real leaders don't take bonuses".

Moreover, one should only pay performance-related remuneration if you can actually measure the person's performance. And that is - especially for top managers - actually pretty darn hard to do. The strategic decisions one takes this year will often only be felt 5 or 10 years from now, if not longer. Moreover, the performance of the company - which we always take to proxy the CEO's performance - is influenced by a whole bunch of other things; many not under a CEO's control. Hence, short term financial performance figures are a terrible indicator of a top manager's performance in the job and long-term performance contracts all but impossible to specify. If you can't reliably measure performance, don't have performance-related pay, and certainly not 80+ percent of it. We know from ample research that humans start manipulating their performance when you tie their remuneration to some strange metric and, guess what, CEOs are pretty human (at least in that respect); they do too.

Options

Finally: stock options... Once again, I have to say "oh, come on...". We pretty much take for granted that we pay top managers by awarding them options, but don't quite realize any more why. When I ask this question to my students or the executives in my lecture room ("why do we actually pay them in options...?") usually a stunned silence follows after which someone mumbles "because they are cheap to hand out...?". I usually try to remain polite after such an answer but why would they be cheap; cheaper than cash, or shares for that matter? True, it does not cost you anything out of pocket if you give them an option to buy shares for say 100 one year from now, while your present share price is 90, but if the share price by that time is 150 it does cost you 50. Moreover, you could have sold that stock option to someone who would have happily paid you good money for it, so in terms of opportunity costs it is realy money too. No, stock options are not cheaper than cash, shares, or whatever.

We give them options to stimulate them to take more risk. "Risk?! We want them to take more risk?!" thou might think. Yes, that's what you are doing if you give them options. If the share price is 150 at the time the option expires, the CEO can buy the shares at 100 and thus make 50. However, if the share price is 90 the option is worthless, and the CEO does not make anything. However, the trick is that the CEO then does not care whether the share price is 90 or, say, 50 - in either case he does not make any money; worthless is worthless. As a consequence, when his options (i.e. the right to buy shares at 100) are about to expire and the company's share price is still 90, he has a great incentive to quickly take a massive amount of risk. Going to a roulette table would already be a rational to do.

Because if you placed the company's capital on red, and the ball hits red, share price may jump from 90 to 130, and suddenly your options are worth a lot of money (130-100 to be precise). However, if your bet fails, the ball hits black and you lose a ton of money, who cares; the share price may fall from 90 to 50, but your options were worthless anyway. Hence, options give a top manager the upside risk, as we say, but do not give them the downside risk. Therefore, we incentivize them to take risk. You might think "I seldom see herds of CEOs in a casino by the time options expire, so this grumpy Vermeulen guy must be exaggerating" but I'd reply we have seen quite a lot of casino-type strategy in various businesses lately (e.g. banks). More importantly, we know from research that CEOs do take excessive risk due to stock options (see for instance Sanders and Hambrick, 2007; Zhang e.a. 2008). I think it would be naive to think that we give CEOs 90 percent performance related pay and most of it in stock options, and then think that they will not start acting in the way the remuneration system stimulates them to do. Of course it influences their decisions, and if it didn't, there would be no reason left to make their pay flexible and based on options, now would there?

Therefore, I would say, out with the performance-related pay for top managers (a good bottle of wine at Christmas and, if you insist, a small cheque like the rest of us would do). And while we're at it, let's try to reduce the level as well.

* e.g. O’Reilly, Main, and Crystal, 1988; Porac, Wade, and Pollock, 1999; Westphal and Zajac, 1995.

Can entrepreneurship be taught?

2011-11-06T22:13:00.001Z

“Entrepreneurship can only be self-taught. There are many ways to do it right and even more wrong, but it cannot be processed, bottled, packaged, and delivered from a lectern”, one of my readers – Michael Marotta – commented on an earlier post.

I am not sure I agree with the suggestion of that statement, namely that "entrepreneurship can only be self-taught". Of course we hear it more often - "you cannot teach entrepreneurship" - but I have yet to see any evidence of it. Granted, this is a weak statement, since the evidence that business education helps with anything is rather scarce (although there is some)!

However, the fact that the majority of entrepreneurs did not have formal business education does not tell me anything. Suppose out of 1000 attempted entrepreneurs indeed only 100 had formal business education. It might still be very possible that out of the 100, 50 of them became successful, where out of the 900 others only 300 became successful. This means that out of the 350 successful entrepreneurs, a mere 50 had formal business education. However, 50% of business educated entrepreneurs became successful, while only 1/3 of entrepreneurs without business education did.

My feeling about the potentially influence of business education on the odds of becoming a successful entrepreneur are quite the opposite of Marotta’s. I see quite a few attempted entrepreneurs with good business ideas and energy, however, they make some basic mistakes when attempting to build it into a business. The sheer logic of how to set up a viable business - once you have had a good idea - is something that is open to being "processed, bottled, packaged, and delivered from a lectern" (although that is hardly what we do in B-school).

Having a great idea and ample vision and energy perhaps is a necessary condition for becoming a successful entrepreneur, but it is not sufficient; this requires many other skills, and for some of them, education helps. Out of the 10 different skills needed to become a successful entrepreneur, perhaps only 5 can be taught or enhanced through business education, but those 5 will clearly improve your odds of making it.

Perhaps the majority of successful entrepreneurs do not have formal business education, but I have yet to meet a successful enterpreneur who did go to business school who proclaims his/her education was not a great help in becoming a success. Invariably, those people claim their education helped them a lot. In fact, many of such business school alumni donate generously to their alma mater. For example, one of London Business School's successful alumni entrepreneurs, Tony Wheeler (founder of Lonely Planet travel guides) regularly donates very substantial amounts of money to the School, because he believes his education there helped him greatly in making his business a success, and he wants others to have the same experience and opportunity.

In the absence of any formal evidence on whether business school education helps or hinders becoming a successful entrepreneur, I am inclined to rely on their judgement: business school education helps, if you want to become a successful entrepreneur.

Steve Jobs’ deification serves a very basic and fundamental human need

2011-10-28T15:58:00.001+01:00

“I am not that surprised that an academic of entrepreneurship (are you kidding me?) would lead a story about one of the world's best innovators and CEO's about that he actually and in fact ! OMG had body odour as a teenager because of his diet, not to mention the rest of your embarrassing piece. Forbes would be best sticking with writers that are inspired by such great entrepreneurs as Steve Jobs, and not with writers such as this, who are unhappy they have not had the courage to 'live the life they love and not settle' and so sit in front of their computer with not much else to do but trying to bring others down. Shame on you Mr Vermeulen”.

This is just one of the comments I received on my earlier piece “Steve Jobs – the man was fallible” (also published on my Forbes blog). Of course, this was not unanticipated; having the audacity to suggest that, in fact, the great man did not possess the ability to walk on water was the closest thing to business blasphemy. And indeed a written stoning duly followed.

But why is suggesting that a human being like Steve Jobs was in fact fallible – who, in the same piece, I also called “a management phenomenon”, “fantastically able”, “a legend”, and “a great leader” – by some considered to be such an act of blasphemy? All I did was claim that he was “fallible”, “not omnipotent”, and “not always right”, which as far as I can see comes with the definition of being human?

And I guess that’s exactly it; in life and certainly in death Steve Jobs transcended the status of being human and reached the status of deity. A journalist of the Guardian compared the reaction (especially in the US) to the death of Steve Jobs with the reaction in England to the death of Princess Diana; a collective outpour of almost aggressive emotion by people who only ever saw the person they are grieving about briefly on television or at best in a distance. Suggesting Princess Diana was fallible was not a healthy idea immediately following her death (and still isn’t); nor was suggesting Steve Jobs was human.

We are inclined to deify successful people in the public eye, and in our time that certainly includes CEOs. In the past, in various cultures, it may have been ancient warriors, Olympians, or saints. They became mythical and transcended humanity, quite literally reaching God-like status.

Historians and geneticists argue that this inclination for deification is actually deeply embedded in the human psyche, and we have evolved to be prone to worship. There is increasing consensus that man came to dominate the earth – and for instance drive out Neanderthalers, who were in fact stronger, likely more intelligent, and had more sophisticated tools – because of our superior ability to organize into larger social systems. And a crucial role in this, fostering social cohesion, was religion, which centers on myths and deities. This inclination for worship very likely became embedded into our genetic system, and it is yearning to come out and be satisfied, and great people such as Jack Welch, Steve Jobs, and Lady Di serve to fulfill this need.

But that of course does not mean that they were infallible and could in fact walk on water. We just don’t want to hear it. Great CEOs realize that their near deification is a gross exaggeration, and sometimes even get annoyed by its suggestion – Amex’s Ken Chenault told me that he did not like it at all, and I have seen that same reaction in Southwest’s Herb Kelleher. Slightly less-great CEOs do start to believe their own status, and people like Enron’s Jeff Skilling or Ahold’s Cees van der Hoeven come to mind; not coincidentally they are often associated with spectacular business downfalls. I have never spoken to Steve Jobs, but I am guessing he might not have disagreed with the qualifications “not omnipotent”, “not always right” and, most of all, “human”.

Steve Jobs – the man was fallible

2011-10-26T15:07:00.002+01:00

As a student, at Reed College, Steve Jobs came to believe that if he ate only fruits he would eliminate all mucus and not need to shower anymore. It didn’t work. He didn’t smell good. When he got a job at Atari, given his odor, he was swiftly moved into the night shift, where he would be less disruptive to the nostrils of his fellow colleagues.

The job at Atari exposed him to the earliest generation of video games. It also exposed him to the world business and what it meant build up and run a company. Some years later, with Steve Wozniak, he founded Apple in Silicon Valley (of course in a garage) and quite quickly, although just in his late twenties, grew to be a management phenomenon, featuring in the legendary business book by Tom Peters and Bob Waterman “In Search of Excellence”.

But, in fact, shortly after the book became a bestseller, by the mid 1980s, Apple was in trouble. Although their computers were far ahead of their time in terms of usability – mostly thanks to the Graphical User Interface (based on an idea he had cunningly copied from Xerox) – they were just bloody expensive. Too expensive for most people. For example, the so-called Lisa retailed for no less than $10,000 (and that is 1982 dollars!). John Sculley – CEO – recalled “We were so insular, that we could not manufacture a product to sell for under $3,000.” Steve Jobs was fantastically able to assemble and motivate a team op people that managed to invent a truly revolutionary product, but he also was unable to turn it into profit.

When Jobs was fired from Apple – in 1985 – CEO John Sculley took control. Sculley is often described as a bit of a failure, because “nothing revolutionary came out of Apple under his watch”, “he could have done so much more with the company” and especially for “being stupid enough to boot out a genius like Steve Jobs”. However, the years after Sculley took over were some of Apple’s most profitable. The man did something right, and that was focus on exploiting the competitive advantage that Apple had built up.

In management research, following terminology cornered by the legendary Stanford professor Jim March, we often say that firms have to balance exploration with exploitation. Exploration refers to developing new sources of competitive advantage and growth. Exploitation refers to making money out of them. Steve Jobs was “insanely great” at exploration, but not – at the time – at exploitation. Sculley was.

Now Steve Jobs is a legend. And rightly so; our world literally would have looked different without him. However, what Steve Jobs’ legendary status also tells me is that we – mere mortals – are inclined to overestimate the omnipotence of CEOs. We overdo it when we ascribe the failure of an entire company to just one man or woman (e.g. Enron’s Jeff Skilling) but also when we ascribe the entire success of a company to one individual.

Steve Jobs wasn’t omnipotent (John Sculley had qualities Jobs didn’t) and he wasn’t always right (eating only fruits does not eliminate the need for an occasional shower). His day-to-day influence on Apple over the last years must have been limited, given his rapidly and severely deteriorating health. If anything, he simply would not have been able to be around enough to control and take care of everything. Nevertheless, the company did well in spite of his absence. And of course that is his laudable achievement too; he managed to build a company that could do well without him. And perhaps that may prove to be his best business lesson after all: how a great leader eventually makes himself superfluous.

Can countries benefit from having their domestic firms acquired by foreign companies?

2011-09-28T23:22:00.003+01:00

When a foreign company acquires a domestic firm, it often leads to outcries of indignation, nostalgia (“another of our once great companies in foreign hands”), and calls for legislation to prevent any more foreign poaching. Politicians and union leaders proclaim that the foreign owners may not be dedicated to keep up investment in the subsidiary, and that the take-over threatens national jobs and other economic interests. “Most governments are reluctant to see their corporate treasures fall into foreign hands”, the BBC wrote in an article devoted to the topic.

But is all this (slightly xenophobic) fear justified? Well, maybe not; at least not on all dimensions. Because we have increasing evidence that foreign ownership of a firm may actually also benefit firms, specifically in terms of their innovativeness. And this increased innovativeness may clearly benefit the host country.

Professor Annique Un, from Northeastern University in Boston, for example, did a pointy study. She collected data on 761 manufacturing firms operating in Spain, examined which ones were foreign hands and what their innovation output was in terms of new products introduced in the market. And the answer was pretty clear: foreign owned firms were more innovative than purely domestic firms.

Interestingly, Annique also corrected her models for the amount of R&D investments spent in the companies, and it turned out that this was not what was driving it; foreign owned companies were not just more innovative because they were investing more. Instead, they were more innovative irrespective of R&D. As a matter of fact, they were able to generate more product innovations for the same level of investment; meaning that they were simply better at it.

The study’s results suggested that they were better at it for two reasons. First, foreign parents seemed to use their domestic subsidiary to channel innovation into the country. Put differently, it seemed a foreign-owned company could tap into its parent’s superior repository of innovative stuff, and most of them gratefully made ample use of that option. Secondly, the foreign-owned companies were simply also better at coming up with new stuff on their own, in comparison to their domestic counterparts. Apparently, something about them being foreign-owned stimulated them to be more agile and creative, which resulted in more product introductions.

Whatever the reason behind this foreign-driven surge in innovation, the host country was better off for it; the evidence clearly showed that the foreign mercenaries stimulated diversity in the markets, giving customers more choice, while raising the bar for everyone. And this is not a benefit we hear many politicians, newspapers, and union leaders proclaim and acknowledge, when yet another foreign corporation is eyeing up their country’s corporate treasures.

Don’t be mistaken, bankers kill (but they give life too)

2011-09-17T18:28:00.001+01:00

"In terms of power and influence, you can forget the church, forget politics. There is no more powerful institution in society than business” the equally famous as illustrious CEO and founder of the BodyShop – the late Dame Anita Roddick – said. And of course she was right. The most comprehensive and dominant institution in today’s society is business.

Business is more influential than people often realize, simply because it creates – or destroys – wealth. And wealth impacts pretty much anything we care about. Whether you analyze crime rates in a particular country, malnutrition, happiness, or infant mortality; a huge influence is how wealthy the particular society is. And wealth is created by business.

As a consequence, for example, the 2008 banking crisis undoubtedly killed people. Infant mortality is closely related to wealth and consequently an economic crisis will among others lead to a surge in infant mortality, somewhere, in some country down the road. It also means that the strategic business choices made by CEOs such as Lehman’s Richard Fuld or RBS’s Fred Goodwin indirectly but significantly influence the survival chances of some baby boy or girl born on the outskirts of London, Cairo, or Detroit. And therefore, whether you like it or not, bankers kill.

But let’s not forget that they give life too. The inverse of “bankers kill” is true too. If banks make wise choices, given their pivotal role in our economies, they can trigger a huge boost to the prosperity of many industries. And the profits, employment, and general wealth created through this boost will really improve the health and survival chances of the baby cradled by her mother somewhere on the outskirts of London, Cairo, or Detroit.

Given the research we have on the link between economic prosperity and infant mortality it would not even be too onerous to come up with some estimate of the direct relationship between Royal Bank of Scotland’s balance sheet and the probability of a baby surviving. We could relatively easily calculate the link between profit and the number of lives saved. I could even imagine that the computer terminals that give live updates of a company’s fluctuating share price – which many corporations have dotted across their entrance halls and offices for everyone to see – would be reprogrammed to display the number of children’s lives saved. Traders walking over to their lunch break could have an immediate update of how many baby lives the deal they just closed saved – or destroyed.

A ridiculous thought? Why? Don’t you care (even) more about the life or death of a baby than your company’s fluctuating share price? I am guessing you do. And you know these bankers aren’t so different from (other) human beings. Your company’s performance also creates wealth, and wealth saves lives. Why then only monitor its financial performance? I tell you, the sandwich you’re having for lunch will taste a whole lot better, knowing that this morning you just saved some unknown baby’s life, somewhere on the outskirts of London, Cairo, or Detroit.

Boards and fraud – who gets the sack and who gets to stay?

2011-08-29T15:09:00.001+01:00

We have seen lots of corporate scandals over the past decade, and in many of these cases the boards of directors were up for some heavy criticism. Whether it was Enron, Tyco, WorldCom, or one of the toppled investment banks, their boards took some flack, since of course they are ultimately responsible for the corporation’s actions.

But what happens to such directors? What happens to these people in the business elite when their company, for example, is caught being involved in financial fraud? Well, perhaps not surprisingly – and this may come as a relief – they often get the sack (as research by Professor Arthaud-Day from from Kansas State University and colleagues convincingly showed). Directors associated with financial misrepresentations are often dismissed from the board of their fraudulent company but, interestingly, subsequently they also regularly get the boot at another board. As you may know, outside directors often serve on the boards of multiple companies and a study by Professor Srinivasan from the Harvard Business School showed that they lose about 25 percent of these (rather lucrative) jobs if one of the companies in their portfolio is caught up in fraud.

Yet, this also implies that 75 percent of companies retain a particular board member, even though he or she is compromised having served on the board of another company while it was committing fraud. And that begs the question, what firms decide to retain such a tainted board member, and which ones decide give them the sack?

Professors Amanda Cowen and Jeremy Marcel from the University of Virginia decided to examine this. They managed to collect data on 277 directors who served on multiple boards concurrently, one of which was associated with financial fraud. Their statistical analysis showed that companies that were covered by more equity analysts and governance-rating agencies were more likely to dismiss compromised board members; up to twice as likely. These external observers apparently serve as a bit of watchdog. However, surprisingly, when a company had a relatively large number of public pension fund investors amongst its shareholders, they were less likely to dismiss a compromised board member. Cowen and Marcel speculated that this was because these pension fund shareholders do the monitoring themselves, so that they don’t care much about the company’s directors; tainted or not.

You also have to realize who does the firing; and that is the rest of the board. Cowen and Marcel’s research also showed that very prestigious, well-networked boards were less likely to fire their tainted fellow director. It is well known that boards of directors form a rather cliquish corporate elite. It is not easy to find your way into this world, but once your solidly in, not even a little financial fraud is going to convince your corporate buddies to throw you out.

So, you think you have a strategy? Five poor excuses for a strategy

2011-08-16T18:36:00.001+01:00

Most companies do not have a strategy. Ok, I admit it, I do not have any solid statistics (if such a thing were possible) as evidence to back up this statement, but I do see a heck of a lot of companies, strategy directors, and CEOs present their “strategies” and I tell you, I think 9 out of 10 (at least) don’t actually have one.

Sure, it depends on the all-evasive question “what is strategy?” but even if you would take the most lenient of definitions, few companies actually have one. Let me not tire you with some real strategy textbook definitions but if I would just put it as “you know what you are doing, and why”, most firms would already fall short on this one.

Most companies and CEOs do not have a good rationale of why they are doing the things they are doing, and how this should lead to superior performance.

I’d say there are 3 types of CEOs here: 1) CEOs who think they have a strategy; they are the most abundant; 2) CEOs who pretend to think that they have a strategy, but deep down they are really very hesitant because they fear they don’t actually have one (and they’re probably right); these are generally quite a bit more clever than the first category, but alas fewer in numbers; 3) CEOs who do have a strategy; there are preciously few of them, but invariably they head very successful companies.

So what do all these CEOs do, when confronted with the question “what is your strategy?” Well, of course they will retaliate with a powerpoint presentation, headed by the title “our strategy”, and there is stuff on it. It just ain’t strategy.

Let me present you with five such common excuses for a strategy or, put differently, five examples of why the things on the powerpoint are not strategy:

Are you really making choices?
Strategy, above all, is about making choices; choices in terms of what you do and what you do not do. Future Plc for example has chosen to focus on specialty magazines for young males (decent magazines, by the way…) in English. This contains some very clear choices. The point is that what they are throwing away, i.e. choosing not to focus on is meaningful. They concerns things that could have made them money as well. For example, magazines for middle aged women might potentially be very profitable, but that is just not what they want to do, because they think concentrating on a clear set of consumers and products will help them do better. Most companies don’t do this; they cannot resist the temptation of also doing other things which, on an individual basis, look attractive. As a consequence, they end up with a bunch of stuff that appears attractive, but strangely enough they don’t manage to turn them into a profitable proposition.

Or do you just stick to what you were doing anyway…?
Another variant of this is the straightjacket of path dependency, meaning that companies write up their strategy in such a way that everything fits into it that they were doing anyway. And there might be nothing wrong with that, if it so happens that what you were doing anyway represents a nice coherent set of activities. Yet, more often than not, strategies adapted to what you were doing anyway results in some vague, amorphous statement that would have been better off in a beginners’ class on esoteric poetry, because it is meaningless and does not imply any real choice. The worst of the lot I have seen (although low on poetic value) was Ahold’s poor excuse for a strategy, which ended up doing so many different things in so many different corners of the world that they resided to calling their strategy “multi-format, multi-local, multi-channel”. This – not coincidentally – was shortly before the company collapsed.

Your choices have no relationship with value creation (you’re in “The Matrix”)
Sometimes companies make some choices, but it is wholly unclear why these choices would do you any good? It is not just about making choices, you need a good explanation why these choices are going to create you a heck of a lot of value. Without such logic, I cannot call it a strategy. Let me give you an example, which happens to be the most common strategy I have seen among multinational corporations: The Matrix. On the horizontal axis, one puts countries; on the vertical axis, one puts business lines. And the strategy is to tick boxes, as many as possible, as quickly as possible (preferably through acquisitions). But why would performing all your activities in all your countries be a good strategy? If you can give me an explanation of why this would lead to superior value creation, I might label it a strategy, but such an explanation is usually conspicuously absent. Without a proper rationalisation of why your choices are going to help you create value, I cannot call it a strategy.

You’re mistaking objectives for strategy
“We want to be number 1 or 2 in all the markets we operate in”. Ever heard that one? I think it is bollocks. A CEO who wrote to me the other day, after having read my book (“Business Exposed”), said of most of these things proclaimed to be strategies that they were like saying “I am going to win the 400 meters during the 2012 Olympics by running faster than anyone else”. Yes, that is very nice, but the real question is “how?” We want to be number 1 or 2 in the market; we want to grow 50 percent next year; we want to be the world’s pre-eminent business school, and so on. These are goals; these are objectives, and possibly very good and lofty ones, but strategy they are not. You need an idea and a rationale – a strategy – of how you are going to achieve all this. Without it, they are an aspiration, but certainly not a strategy.

Nobody knows about it
The final mistake I have seen, but scarily common, of why CEOs who think they have a strategy don’t actually have one (despite circumventing all of the above pitfalls), is because none of their lower ranked employees actually knows about it. A strategy is only really a strategy if people in the organisation alter their behaviour as a result of it. And in order to achieve that, they should know about it… Strategy by itself does nothing; the powerpoint presentation – regardless of how colourful and fine-tuned – is not going to resort to improved performance unless the choices and priorities it contains result into actions by middle managers and people on the work floor. A good litmus test is to simply ask around; if people within the organisation do not give you the same coherent story, chances are you do not have a strategy, no matter how colourful your powerpoints.

Five mistaken beliefs business leaders have about innovation

2011-06-03T20:44:00.002+01:00

The vast majority of companies want to be innovative, coming up with new products, business models and better ways of doing things. However, innovation is not so easy to achieve. A CEO cannot just order it, and so it will be. You have to carefully manage an organisation so that, over time, innovations will emerge. And CEOs often make a number of common mistakes, that hamper rather than induce such processes.

Believe the numbers
One common mistake is to insist on “seeing the numbers” too much too soon. “What is the size of the market?”, “what is the Net Presen Value calculation?”, “payback time?”, and so on. What they are forgetting is that, for a truly innovative product, for example, it is impossible to reliably produce any numbers. If a CEO insists on hard numbers before the project is even started, it will by sheer definition kill off any truly innovative ones, simply because you cannot compute the size of a market that does not exist yet.

One CEO who understood this well was Intel’s Andy Grove, at the time that an engineer proposed to him to work on something called a “microprocessor”. The engineer could not produce any numbers, consumer research, and not even a good idea in what sort of applications this product was going to be used, but Grove gave permission and a budget anyway. It made Intel one of the most successful companies the world of business has ever witnessed.

Believe success has been attained
Another innovation killer is sustained financial success. We call it the success trap. When an organisation becomes very good at something, top of its industry, it usually starts to focus on the thing (product, technology, or business model) that made its success, crowding out other options and points of view. Initially, this may make it even more successful, but there is going to come a time that its business context is going to change: new technologies, consumer preferences or foreign entrants emerge. And then the company and its top management finds itself trapped in the one thing it does so well, rigidly believing that what brought it its success, will continue to make it prosper. But, in reality, it is rapidly becoming obsolete.

A great illustration of this is the 43 companies featured in the famous business book “In search of excellence” by Peters and Waterman in 1982. These companies were considered to be the most excellent companies in the world at the time but, at present, only 5 of them would still make the list; many of them having disappeared altogether (e.g. Atari, Tupperware, Digital). It illustrates that, paradoxically, it is especially the most successful companies, the top performers of their industry that find it difficult to adapt and survive when the world around them changes.

Believe they know the competition
What always strikes me, if I ask a CEO (or anyone else in an organisation for that matter) “who is your main competitor?”, they always reply with the company that is most like them. And subsequently they can tell me anything about that firm; its strength, weaknesses, products and plans. But in a way, when it comes to innovation, that is slightly delusional. The company that is most like you is really the least important competitor, simply because they are in the same boat as you are.

The most threatening competition often comes from a completely different angle: an adjacent industry, innovative start-up, or substitute. And that is a phenomenon of all times. Sailing shipping companies suffered from the steam engine, radial tyre champion Firestone was brought to its knees by the introduction of bias tyres, newspapers are being squeezed by the internet, while watchmakers suffer from the fact that nowadays everybody already has the time at hand on a mobile phone or laptop. Thinking your biggest competitor is the company most like you, will leave a company dangerously exposed to outside innovation.

Believe that because everybody had always done it this way, it is the best way of doing things
Industries are rife with habits and business practices from which no-one can quite remember why we do them this way. When challenging a CEO on one of those business practices, he lamented to me “Freek, everybody does it this way, and everybody has always been doing it this way; if it wasn’t the best way of doing things, I am sure it would have disappeared by now”.

And standard economic theory would support his point of view: The market is darwinian, therefore it should be weeding out bad practices. But, in reality, he is wrong. In many businesses, practices emerged with good reason, but once the circumstances changed, firms carried on using them for no reason whatsoever. Did newspapers have to be printed for so long on ridiculously large (and expensive) sheets of paper? Heck no; the english law, set up in 1712, that newspapers were going to be taxed based on the number of pages they printed was abolished in 1855. Could low-cost airlines not have worked many years earlier? Are buyback guarantees in book publishing (set up during the Great Depression) really still needed? Is detailingin the pharmaceutical industry still a useful practice? That everybody does it this way is no reason not to challenge it. The greatest innovations often come from challenging industry convention.

Believe the customer
The final error CEOs often make when it comes to innovation, is to ask their customers for their opinion. Pretty much any company I know has a yearly customer survey. However, there are two things wrong with this. Firstly, these people are already your customer; sure they are going to be satisfied with you; the others have already long voted with their feet. We call it selection bias. You are selecting to ask the ones who already like you, but what about the ones who don’t?

Secondly, even when a company is asking potential customers about their ideas for innovation, in the form of market research, it is tricky. It is usually some shape or form of asking respondents whether they would like (and buy) the new idea. Consumer research often is useful but not for truly innovative ideas and markets that do not exist yet. Research on the fax machine came back unambiguous: every respondent answered that they would never buy a machine like that; likewise for the mobile phone. As Farooq Chaudhry, producer at the highly innovative Akram Khan Dance Company, once put it to me: “Customers? Forget about them”; if you want to be really innovative, you have to be leading the customers; not be led by them.

Is leadership overrated? (maybe not, but only when it is genuine)

2011-05-10T16:11:00.003+01:00

When the famous management professor Henry Mintzberg, in an interview for Dutch television, was asked “what would you recommend for leadership in the 21st century?” he answered, without delay or hesitation: “Less of it”.

Henry clearly thought we need less “leadership”, and more people who actually do stuff. And true; it has become a business buzz word and something that everyone puts on his list of career aspirations. However, not everyone can be a leader. Moreover, their effect often seems overestimated.

In reality, business leaders make very few decisions that really significantly impact the course of action of their firms. When a large corporation does well, we attribute it to the forceful, brilliant individual at the top (e.g. Jack Welch, Steve Jobs). When the corporation fails, we also hold the individual crook at its helm responsible beyond mercy (e.g. Jeff Skilling, Dick Fuld). Yet, these individuals’ influences might be overestimated, both positively and negatively, because their decisions often have very limited impact on the everyday practices in their firms.

Yet, I would say that that does not mean they have no influence. They surely do, but it might not be directly through their decisions. CEOs often have a much more symbolic role, in terms of providing inspiration and motivation. And that type of impact can be very real indeed.

Tolstoy – in his epic novel War & Peace, through the eyes of one of its main characters, Prince Andrei – seemed to understand that well. He described how one of the Russian commanders – prince Bagration – in a battle against Napoleon’s army, had very little real influence on how the battle unfolded: stuff just started to happen once the guns got rattling, whatever commands he did or did not shout. However, his presence, and perhaps his successful pretence of planning and control, did have some genuine impact:

Prince Andrei listened carefully to Bagration’s colloquies with the commanding officers and to the orders he gave them and remarked to his astonishment that in reality no orders were given but that Prince Bagration merely tried to make it appear as though everything that was being done of necessity, by accident or at the will of individual commanders, was performed if not exactly by his orders at least in accordance with his design. Prince Andrei noticed, however, that though what happened was due to chance and independent of the general’s will, the tact shown by Bagration made his presence extremely valuable. Officers who rode up to him with distracted faces regained their composure; soldiers and officers saluted him gaily, recovered their spirits in his presence, and unmistakably took pride in displaying their courage before him.

Hence, the impression we have of leaders’ actions, their determination and vision, do influence people lower in the organization, in terms of their commitment and motivation. For example, a study by professors Ping Ping Fu, of the Chinese University of Hong Kong and colleagues, published in the prestigious academic journal Administrative Science Quarterly, asked 177 executives of 42 companies to rate their CEOs in terms of the questions “the CEO shows determination when accomplishing goals”, “the CEO communicates high performance expectations”, “the CEO articulates a compelling vision of the future”, and “the CEO transmits a sense of mission”. They then surveyed 605 middle managers of these same companies in terms of their commitment to the firm and their intention to leave. And the results clearly showed that middle managers who worked for a company whose CEO seemed more determined and better at communicating and articulating a sense of mission and vision, were more committed to their companies. Hence, the image that a CEO managed to exhibit of his leadership and control had a significant impact on the motivation of his middle managers.

Then Ping Ping and colleagues did something interesting. Using an innovative survey technique (called the Q-sort method) they managed to construct a measure of the CEOs’ values. Particularly, they measured CEOs’ self-transcendence values (the transcendence of self interests, enhancement of others’ happiness, and the acceptance of others as equals) and self-enhancement values (which emphasize the pursuit of one’s own happiness, success, and dominance over others) and, surprisingly, the findings described above were only true for CEOs with a healthy dose of self-transcendence values. By contrast, if the CEO secretly harbored some pretty selfish values (i.e. was high on self-enhancement), middle managers were not much motivated and committed to the firm whatever the CEO said or did.

‘What is surprising about that?’ you might think. Well, it may not be surprising that employees prefer their CEOs to have selfless instead of selfish values – I guess we all prefer our bosses to be selfless – but it is a lot more surprising that they are able to detect these values. Because what this study really shows is that, if you had multiple CEOs behaving in the exact same way – expressing a clear vision, showing determination, setting expectations, and what have you – only some of them would succeed in motivating their employees, where others would hopelessly fail. Because what sets the effective and ineffective leaders apart are the values they harbor, in terms of having their own or others’ interests at heart.

Apparently middle managers see right through you. If you, as a CEO, display all sorts of motivating, leadership type behavior, but secretly harbor some pretty selfish values, it simply ain’t going to work. You can shout and dance and do whatever you like, but this motivational stuff only renders the desired effect if you really mean it.

Six scientific ways to suck up successfully (it is not as easy as you might think it is)

2011-05-02T16:07:00.004+01:00

Sucking up really isn’t so easy. You can’t just tell your boss “you’re the greatest” because (although he might believe you) he is likely to grasp that you’re trying to sweet talk him into giving you this job, a raise, or a positive appraisal. As a result, it might all backfire because, as we know from research, people who think you are trying to trick them are less likely to actually give it to you. No, sucking up – or ingratiation behavior, as we euphemistically call it in management research – is easier said than done.

But now we have some good evidence – from research by professors Ithai Stern from Northwestern and Jim Westphal from the University of Michigan – how you can make it work, so pay attention:

1. Frame your flattery as advice seeking. For example, asking someone “how were you able to pull off that strategy so successfully” is more likely to hide your underlying motive than “gosh you’re good”.
2. Pre-warn your target that you are going to flatter him or her. For example, let your sucking up be preceded by statements such as “you are going to hate me for saying this but… [gosh you’re good]” or “I know you won’t want me to say this but… [gosh you’re good]” or “I don’t want to embarrass you but… [gosh you’re good] – you get the picture.

Now you that you have mastered the previous two relatively simple skills, it is time to up your game. It requires a bit of planning, but then it is likely to be highly effective:

3. Repeat the opinion that your target expressed earlier to a colleague. You can’t just keep agreeing to everything your boss says in every meeting, now can you? So what can you do? Well, when you find out your boss’s opinion on a particular matter from a colleague, who had a meeting with him earlier, bring up that same topic and opinion to your boss next time you’re meeting with him, before he has had a chance to do so. He will be duly impressed with the sharpness of your analysis.
4. Compliment your boss to one of his friends. So, saying face-to-face to your boss over and over again “gosh you’re good” is unlikely to do the trick. What might work though is to say to one of his friends “gosh, he’s good”. That friend is likely to, at some point, mention to your boss “he sure thinks highly of you”. And since you did not say this to his face, he might actually think you were trying to avoid brown-nosing him! Expect a friendly smile and sudden pat on the back.

Now that you have gained these more subtle skills of sucking up, you are ready to move to the advanced level. This one is sure to work, and you do not even have to say to your boss (or anyone else) that he is the greatest. All you have to do is make him feel the two of you are birds of a feather.

5. Engage in value conformity. What we mean by this is that you start a discussion with your boss by expressing commitment to a cause, institution, or other code of conduct that you know your boss feels strongly about. For example, if your boss is a family-man, begin your casual talk with how important family is to you. Or refer to your joint religion, or if he is into environmental protection, become green too (at least verbally). When you start of with statements that indicate that you share the same set of values, your boss is going to look at everything you subsequently say in a different light.
6. Refer to common affiliations. Similar to the previous tactic, refer to your joint political party, religious organization, or alumni club. These tactics build on so called in-group out-group biases; all of us humans see people who are in the same groups as we are in a more positive light, and your boss is no exception. So emphasize your joint group affiliation, and he will like the rest of you too.

Do these things really work? Yes they do. Ithai and Jim examined these tactics constructing and using an elaborate database on 1822 top executives, measuring their ingratiation behavior (assessed through questionnaires) and various other variables. Subsequently, they examined a rather important outcome variable to these folks: how likely their CEO (i.e. their boss; the target of their sucking up) was to nominate and appoint them to another board of directors on which he served. Directorships are highly coveted (and highly paid) jobs - that is, they want them! And all 6 aforementioned ingratiation tactics worked getting them.

Ithai and Jim also examined what sort of people were more likely to use these 6 tactics to their advantage. Executives with a background in engineering, accounting, or finance were plain clumsy at it. It is not that they did not try to suck up to their boss; they did, but they did it the coarse way (“gosh, you’re great”) and therefore were unlikely to succeed.

The people most skilled at successfully using the six sucking up tactics were executives with a background in sales, law, or politics. Perhaps not coincidentally, these are the professions we most mistrust (if not despise) to tell the truth: salesmen, lawyers, and politicians. They have had to practice these subtle ingratiation tactics all their lives. And it seems, also in the brown-nosing domain, practice makes perfect. And now they are reaping the benefits.

Criminals are ugly – yes, really

2011-04-22T15:04:00.003+01:00

Has it ever struck you that in movies the villain is pretty much always ugly? Whether you take a James Bond film, a horror movie, or a Disney character, the bad guy is usually rather ‘esthetically challenged’, dotted with rather unsightly, coarse features.

Well, it now appears that these film makers are rather more realistic in their portrayal of the bad guys than you might have guessed. Criminals – as research by professors Naci Mocan from Louisiana State and Erdal Tekin from Georgia State University showed – are often indeed pretty ugly.

Naci and Erdal obtained data on 20,745 people, who were interviewed and rated at various points during their lives (in the period 1994 – 2002). A small army of independent interviewers rated the person’s level of attractiveness (ranging from very unattractive to very attractive). Subsequently, Naci and Erdal statistically compared this indicator of physical attractiveness with the incidence of the respondent having been involved in a crime, such as property damage, burglary, robbery, theft, assault, or drug-related crimes. And even when they corrected these models for all sorts of background characteristics, such as ethnic background, religion, family situation, income, and so on, the answer was pretty clear: criminals are ugly.

The intriguing question is, of course, how come? Although this involves a healthy dose of speculation, we do know quite a lot from prior research about the influence of physical attractiveness on such things as income and schooling, which might shed some light on the issue. For example, we know from prior studies that good-looking children receive more attention at school, are considered more trustworthy, and are judged to have higher academic potential.*

The problem is that many of these prejudices start to act as self-fulfilling prophecies. Ugly children start to do less well at school because of the low expectations placed on them: they have less belief in themselves, less confidence, they receive less personal attention from their tutors, and so on. And, as a consequence, the prophecy comes true; they do achieve less.

Once on the job market, they are then once again confronted with the same prejudice, making things even more challenging. For example, research has shown that, given the same qualifications, physically attractive applicants are considered more suitable for a particular job. They are also recommended to receive higher starting salaries.* Indeed, the handsome subjects in Naci and Erdal’s study also made substantially more money than their esthetically more challenged counterparts. To conclude, handsome children are helped to achieve more, once they reach adulthood they are more likely to be successful in a job interview, and once they are in the job they get paid more.

As a consequence of these effects, on the margin, ugly people are more often tempted – or perhaps pushed – into a life of crime than people who are physically attractive. The ugly ducklings amongst us are often devout of the opportunities that befall the beautiful and, therefore, comparatively are more prone to end up in crime. So next time Donald Duck traps the thugs, or 007 eliminates the villain, we should also allow ourselves to feel a slight sense of grief and sympathy for the ugly crooks, who might have achieved so much more in life had mother nature made them just that little bit more pleasing to our eye.

* How fundamental our human inclination is to look upon handsome people more favorably than on uglier ones is evidenced by research that shows that, interestingly, even babies pay more attention to the good-looking people peering into their pram than to their equally enthusiastic but less handsome aunts and uncles (Samuels & Elwy, 1985).

** One exception to this rule is that physically less attractive women are generally deemed more qualified than their attractive counterparts when the job they are being considered for is a stereotypical masculine job (Heilman & Saruwatari, 1979).

Are family-friendly workplace practices worth their money? New evidence

2011-04-14T20:32:00.006+01:00

Do family-friendly work practices – offering flexibility in case of unexpected childcare emergencies, job sharing schemes, subsidy for childcare, entitlement to work from home, switch to part-time work, etc. – enhance the performance of the firm that adopts them?

Quite a bit of research suggests they do: Several studies have provided evidence that firms offering such practices have higher levels of employee retention, organizational citizenship behavior, and work attitudes. However, I also have to admit that I am a bit skeptical of such “evidence from research”… for several reasons:

First, it is often clear that the researchers conducting these studies wanted to find such a positive relationship, and I cannot suppress a suspicion that there might be just as many studies conducted that fail to turn up the same heart-warming evidence but, as a result of this failure, therefore are not published, and hence we never hear about them.

Second – and at least as important – even if we’d accept this evidence as a given, it does not take into account the financial costs of implementing the family-friendly humbug. Sure, higher levels of employee retention, citizenship behavior and so on, are nice things to have, and I am sure they help an organization become better, but they don’t come for free; family-friendly workplace practices are sometimes plain expensive, and it is not clear from the studies conducted whether the (alleged) benefits outweigh these often substantial financial costs. Past research measured the benefits, but did not take into account the costs involved.

New evidence

Fortunately, recently, professors Nick Bloom, Toby Kretschmer, and John van Reenen (from Stanford, the University of Munich, and the London School of Economics) conducted an extensive study examining the effect of family-friendly practices on hard variables such as firm sales per employee and return on capital employed, using a large database of firms from the US, the UK, Germany, and France. What they found was intriguing and surprising, slightly disappointing, but also reassuring – and, yes, all at the same time.

In their initial, relatively simple statistical analysis, they too found a positive relation between how many family-friendly practices a firm employed and its financial performance – that is, companies with a lot of family-friendly practices generally were more profitable than those without them. But then Nick, Toby, and John decided to correct these statistical models for the quality of the firm’s management. They used an extensive survey and interview procedure (using and elaborate so-called double-blind procedure) to determine the quality of each firm’s management. And then they found that those firms that implemented family-friendly practices were already good to start with. It is not that the practices made them any better; well-managed firms adopted them more often than their more poorly managed counterparts.

Happiness for free

Hence, Nick, Toby, and John’s models showed that well-performing firms implemented family-friendly practices, but subsequently those family-friendly practices did not increase their financial performance even further. Don’t be mistaken; this does not mean that the family-friendly practices did not improve these organizations beyond their original starting point; they probably did. It is just that these benefits did not outweigh the costs incurred; at the end of the day, financially it didn’t make any difference whatsoever whether you adopted them or not. To conclude, firms that had implemented a bunch of family-friendly practices fared well as a result of the increased employee retention, citizenship behavior, and improved work attitudes, but the amount of money they had to spent on the practices exactly equaled the financial benefits that resulted from them.

And I would say that that is not so bad. Basically, family-friendly practices come “for free”; sure, they are expensive, but the benefits you experience from them exactly cover those (substantial) costs. Or, as Nick and his colleagues put it: “this rebuts the claim that providing family-friendly workplace practices detracts from profits. Our results show that although providing family friendly workplace practices may not increase profits, they at least pay for themselves”.

And in a way I like that even better than when firms had been implementing them just because they increased financial performance. Now, it shows that firms do not adopt them out of selfish reasons, but because good managers understand that it does not cost them any money (although it doesn’t make them any either). Because when you can basically increase the happiness of your employees without it costing you a single dime, why not do it? Good managers let the world be a nicer place, not because they benefit from it themselves, but just because they can.

In praise of HR: The soft stuff can actually lead to some hard competitive advantage

2011-03-30T21:58:00.004+01:00

It’s not easy being an HR executive. Just when you are about to applaud the cultural compatibility of a proposed merger someone starts talking about upstream synergies in the value chain. Or you unveil an innovative executive training programmed and boardroom colleagues question its net present value and pay-back time calculation. Or there is a crisis and the company needs to cut costs, so your desk is their first stop, since surely training, recruitment and work-life programmers are easily expendable?

Such attitudes are common, but they are also evidence of startling business naivety. A company’s real, sustainable competitive advantage is almost always based on the softer, intangible parts that HR executives care about – and very seldom on the hard stuff that’s easier to capture in numbers, such as production capacity, cash reserves or even brand recognition.

The hard stuff is often also the easiest to imitate. Production capacity, stock and sales points are things money can buy. A skilled and motivated workforce, a company culture which draws commitment and loyalty and effective informal networks and processes, are much harder to emulate, no matter how much money you have.

In fact the world of business is full of habits and beliefs which are taken for granted and rarely questioned. As an academic, I like to examine the research evidence about what actually happens in the real world of business – rather than what executives and consultants think should happen. Much of the evidence shows that HR practices do indeed have bottom line value. Here are a few of my favorite examples.

Downsizing (almost) never works. But good HR practices will be one of the success factors

Firms engage in downsizing to boost their profitability. But does it work? It has obvious advantages – waving the hatchet lowers headcount quite effectively and leaves you with lower staff costs. But there are some risky potential disadvantages, such as lower commitment and loyalty among the survivors. Academic studies indicate unwelcome rises in voluntary turnover rates after downsizing, often leaving a company leaner (and lamer) than intended.

Professors Charlie Trevor and Anthony Nyberg from the University of Wisconsin-Madison decided to examine who could get away with a downsizing programmed or, put differently, what sort of companies did not suffer from a surge in voluntary turnover following a downsizing programmed. The answer was pretty clear: companies that had a history of HR practices that were aimed at assuring procedural fairness and justice – such as having an ombudsman who is designated to address employee complaints; confidential hotlines for problem resolution; the existence of grievance or appeal processes for non-union employees, etc. – did not see their turnover heighten after a downsizing effort. Companies with good work-life balance benefits – such as paid sabbaticals, on-site childcare, defined benefit plans, and flexible working patterns – also did much better. The surviving employees were more understanding of the company’s efforts, had higher commitment, and were confident that the downsizing effort had been fair and unavoidable.

So downsizing can work; but only if you have previously taken commitment to your people seriously.

The individual star never outweighs the organizational environment

Another myth which non-HR executives tend to harbor, is that star employees can easily take their virtual Rolodex and join a competitor – where they will make them just as much money as they did for you.

This is a painful underestimation of the value of a well-designed organization, and overplays the supposed portability of many star employees. Professor Boris Groysberg from the Harvard Business School examined top performing security analysts and what happened to their performance when they moved to another firm (for an even higher pay cheque); it pretty much always plummeted.

Even security analysts (who are often thought to be able to take their skills anywhere) were much more dependent on the specifics of the organization in which they were embedded than they, and their employers, realized. Hence, careful, firm-specific HR practices help certain individuals perform better – and they can’t just replicate that business in another company.

Losing a star performer can be a good thing – especially if they go to a client

Many top executives are just as frightened of clients or customers poaching their top employees, as they are of competitors’ advances. And, of course, losing your well-trained, top-performing employees is hardly ideal.

However, there is definitely a potential upside – as Professors Deepak Somaya, Ian Williamson and Natalia Lorinkova discovered. They examined the movement of patent attorneys between 123 US law firms and 109 Fortune 500 companies from a variety of industries. And they found strong evidence that if a client company recruited a patent attorney from a law firm, that law firm would start to get significantly more business from that company.

Hence, your employees leaving for your clients can be a good thing; they bring you valuable business. McKinsey understands and manages this process particularly well; when you leave McKinsey you automatically become an alumnus of the firm (rather than a deserter). The firm carefully nourishes its relationship with alumni, because they subsequently bring a large chunk of their business through the door.

Soft initiatives have real shareholder value

The final persistent myth that HR skeptics favor, is that HR costs money and that shareholders do not appreciate all sorts of soft measures, such as work-life programs. That used to be true in a bygone era, but no more.

For example, Professor Michelle Arthur, from the University of New Mexico, set out to examine stock market reactions to the announcement of Fortune 500 firms adopting such work-family initiatives. The results were very clear. In the early 1980s, the stock market would hardly react at all to such soft and fluffy initiatives; if anything the effect of the announcement on a firm’s share price was slightly negative (-.35%). However, that changed into the 1990s, when announcement of a work-family initiative caused an immediate rise in stock price by, on average, .48%. That may seem peanuts at first sight, but if you are a £5 billion company, it implies that even one such initiative would immediately increase the value of your firm by £24 million.

So executives who question the (shareholder) value of work-life initiatives are simply stuck in the 1980s; nowadays even the stock market recognizes their value.

Why isn’t this HR wisdom more widely accepted?

You may know the story of the inebriated cyclist searching for his bicycle keys under the lamppost, although he knows he lost them somewhere else. He tells a passer-by that he is looking for them under the lamppost because “it is light there, and I will never be able to find them in the dark” (where he had actually lost them). The story reminds me of the executive who is trying to solve a company crisis or gain a competitive advantage by managing the things that can easily be measured (production capacity, headcount, profit & loss). Those things may be easy to observe and influence but they are seldom the real root of the problem, nor do they really harness your competitive advantage.

To do that, you have to look where things are much more difficult to measure and manage – to the loyalty of your workforce, their motivation and job skills. Manage those things well and you are truly entering the light.

The price of obesity: How your salary depends on your weight

2011-03-24T16:32:00.003Z

The world of business is still rife with discrimination. Women get paid less than men, people who are physically attractive earn more and are more likely to be seen as suitable leaders, and race determines chances of promotion. The business world in that sense is no different than other walks of life.

And the latter category – obesity – seems one of the nastier ones. Where discrimination based on race, religion or gender are at least generally looked upon as despicable, it seems much more socially acceptable to look different upon people based on their weight.

Obesity and income

Various studies have shown that overweight people are seen as less conscientious, less agreeable, less emotionally stable, less productive, lazy, lacking in self-discipline, and even dishonest, sloppy, ugly, socially unattractive, and sexually unskilled; the list goes on and on.* The stereotypes run so deep that even obese people hold these same discriminatory beliefs about other obese people. Therefore, it may come as no surprise that research has provided strong evidence that obese people are paid less than their slimmer counterparts.

However, my colleague at the London Business School, Dan Cable, and his co-author Timothy Judge from the University of Florida, suspected that this (generally) negative body weight–remuneration relationship might be different for men than for women. After all, as their overview of prior research on the topic revealed, the body weight standards that our media portray for women are considerably thinner than the actual female population, and often even thinner than the criteria for anorexia. Instead, the body weight standards for men represent a much proportional physique.

In order to examine this conjecture, they carefully collected weight and income data on 11,253 German employees and, in another study, on 12,686 American workers; the latter who were measured no less than 15 times over a period of 25 years, to also see how change in weight was related to changes in income. Then, they split the data and their statistical models into men and women. And the results clearly showed that men were treated differently than women; also when it comes to their income and weight.

Skinny women versus skinny men

Skinny women got paid substantially higher salaries than heavier women, yet this relationship was much less pronounced at the higher ends of the scale. Meaning that a female employee weighing 50 kilograms would get paid substantially more than someone weighing 60 kilograms, but the difference between 70 and 80 was much less severe. That’s probably because – as Dan and Tim put it – “the social preferences for a feminine body have already been violated”; you’re either skinny or not, but once you’re over the (rather extreme) threshold, we don’t care much anymore about the number on your scale.

Yet, this relationship looked very different for men. In contrast to the women in the sample, men of moderate weight would get paid substantially more than skinny men. But such a man of average weight would also get paid quite a bit more than an obese person. Hence, being skinny for a woman would mean more dosh, but for men it would mean less money – all in the order of magnitude of $10,000-15,000 per year.

Skinny men, indeed, are often regarded as nervous, sneaky, afraid, sad, weak, and sick, where men of well-proportioned build are associated with traits such as having lots of friends, being happy, polite, helpful, brave, smart, and neat. Dan and Timothy concluded that the media – in the broad form of magazines, fashion shows, actors and actresses, beauty pageants, Barbie dolls and GI Joes – distort our views of what is to be considered normal, and that the ripples of these views can be felt all the way onto our pay slip and bank account.

* For a thorough overview of all these findings, see Judge & Cable. Journal of Applied Psychology. 2010.

Big firm innovators: What large companies can do to be just as innovative as small entrepreneurial ones

2011-03-17T14:09:00.001Z

Big companies are thought to rarely be the real innovators in an industry. Usually, radical change – whether a new technology or an entirely new business model – comes from outside the industry, and is introduced by an entrant into the field. On average that is true – research confirms it – and there are various reasons for that. It pertains to a phenomenon I called “collective inertia”; established players often seem paralysed when significant, paradigm-busting change is sweeping through their business.

Why big firms are often slow to adapt

That is because those existing players usually do not see an interest in destroying their own business and competitive advantage; newspapers were reluctant to move into on-line media because it cannabilised their existing business, traditional airlines were reluctant to embrace the low-cost model, and steel companies shunned away from minimill technology. These new technologies and business models ate into their current business and therefore they were not keen, to say the least.

There is often also a softer, almost psychological component to it. It pertains to phenomena such as the success trap, escalation of commitment, and the Icarus paradox in business. Years of continued success have wedded the firm to its own proven formula and business model, and the new, initially often inferior technology is not something they believe in and particularly want to get involved with.

Hence, we see that existing players in an industry usually are not the inventors of radical new innovations and often even late adopters – often too late… Quite a few of them do not survive the transformational turbulence in their business as a result of their own inertia.

However, Professors Lin Jiang and Marie Thursby from Georgia Tech and Justin Tan from York University discovered that there are some exceptions to this rule, and some incumbents do manage to be inventors during the stage of technological dirsruption. And that is pretty interesting, because those firms teach us what existing players can do to prevent missing the boat, and becoming obsolete when their environments change – a problem that clearly bugs many of them.

Big firm innovators

Lin, Justin, and Marie examined the semi-conductor industry, where the initial reliance on vacuum tubes was replaced by bipolar technology, which in turn was replaced by complementary metal-oxide semiconductors (CMOS). At present, that technology is under threat from nanotechnology. Using extensive patent analysis, Lin and colleagues examined which existing players did not succumb to the new entrants, and were able to contribute to the new technology. And they found three key, related characteristics:

First, the firms that were able to contribute significantly to fresh knowledge in the new and emerging domain had forced themselves to continue to scan for new technological areas. They had not just rested on their laurels, trying to make the most out of an existing technology. In spite of the technology not being under threat yet, their R&D engineers had continued to scan the environment for new, substitute technologies. And now this paid off.

Second, the firms that did manage to be inventors in the newly emerging domain had maintained a broad portfolio of alliances – specifically a portfolio of alliances that consisted of both firms that were pretty close to its current set of activities and firms that were in entirely different domains. Such a combination of alliance partners is thought to assure that the firm is exposed to really radically different things, but at the same time also to things that are more within its own familiar domain of comprehension!

Finally, the successful inventors had always maintained clear ties to sources of scientific knowledge in the public domain, by collaborating with university scientists, reading scientific publications, and so on.

Innovations usually consist of some form of recombination of other, existing sources of knowledge. The aforementioned results show that if existing, successful players in an industry force themselves to continue to access a variety of external knowledge sources – in the form of experimenting with new technologies, maintaining alliances, and accessing university sources – they can not only survive a radical change in their business but even contribute to it. Hence, do keep an active, open mind and door, and let knowledge flow in, even if you think you are currently doing just fine.

Flawed remuneration: Large bonuses don’t get the job done

2011-03-08T14:38:00.003Z

The so-called “Yerkes-Dodson law”, not surprisingly, is named after two people called Yerkes and Dodson. Robert Yerkes and John Dodson worked as psychobiologists in the beginning of the previous century. They studied animal behaviour, among others, to try and understand the behaviour of humans.

Rats and electrical shocks

In one of their experiments – in 1908 – they placed a bunch of rats in a cage in order for them to explore one of two passages. One passage, labeled with a white card, contained a reward while the other one, labeled with a black card, led to an electrical shock. They wanted to test how quickly the rats figured out that white was a good thing, while black passages were to be avoided.
The one thing they varied was the voltage of the shock. Some rats received a mild shock which was not much more than a tickle, others were subjected to a shock of an intermediate level, while the third group was nearly fried to death each time the poor suckers merely sniffed at the black passage. Then Yerkes and Dodson compared the results.

Initially, as expected, higher shocks stimulated the rats to learn quicker; rats that received an intermediate shock were quicker to put into their tiny rat brains that black was to be avoided than the animals that received only a minor electrical stimulant. However, then it got interesting (rather than only cruel). The rats that received the high voltage fast-frying shock were much slower at performing the task. It took them much longer to figure out that white was good and black was bad – although they clearly had the highest incentives of all.

Apparently, making the stakes very high hampered these animals’ task performance, rather than making it better. And I could not help but wonder whether this same relationship as found in rats might not apply to, say, bankers.

Bankers and bonuses

Professor Dan Ariely, from Duke University, together with some colleagues designed a series of experiments with humans (rather than with rats) and with monetary rewards (rather than – to my slight disappointment – electrical shocks), to test what the relationship is for us humans between high incentives and task performance. That’s interesting because there are of course a lot of jobs around with pay-for-performance, for which we assume that high pay provides an incentive that leads to higher performance. However, it did not. Apparently, we’re the same as rats.

Dan and colleagues performed most of their experiments in India, where the financial rewards they gave for successfully completing a task could really represent a small fortune for a respondent. Believe me; these people were really motivated to get it right. As expected – and as for the rats – increasing the “pay for performance” relationship initially led to better task results. However, when the stakes were really high, people crumbled and could not get the job done. Apparently, a very stiff pay-for-performance relationship, paying people a near obscene amount of money if they succeed, actually make them less likely to perform well. It is not that these people are not motivated; they are too motivated. The very high pay killed their creativity, clogged their memory, and made them unable to solve the problem at hand. People who received less money for the same task did much better.

We assume that pay-for-performance motivates people, and motivation leads to better performance. However, the last step appears to be a flawed assumption. Large pay can surely motivate people, but too much motivation decreases their task performance. Hence, large task incentives like bonuses – used for traders, bankers an in many other industries – can be counterproductive. They cost you lots of money, but don’t get the job done.

Wage differences between men and women – sexist or functional?

2011-02-28T21:48:00.001Z

There is no denying that women get paid less for doing the exact same jobs as men. Ample research has persistently shown that the wages of women, irrespective of qualifications and experience, are lower for the same kind of work. The only thing to be debated is “why?”

Some researchers have suggested that people who conclude from this finding that women are discriminated against jump too hastily to that conclusion, because the underlying reasons could be more complex and subtle than that. We should be more cheerful, and not immediately make such sinister inferences.

The story of firm specific skills

Instead, their explanation hinges on “firm specific skills”. With firm specific skills we mean the experiences and qualifications that employees may build up over time that are particularly valuable to the person’s employer, because it concerns knowledge about its specific product portfolio, a technology particularly crucial for the firm, relationships with its most important customers, etc. These firm specific skills are very important and pivotal because if this person (who has accumulated this knowledge over the course of his or her tenure at the firm) were to leave, the firm could not just find a replacement somewhere on the job market, because they are by definition not skills anyone can pick up at school or at some other employer. Firms, who are afraid that women are more likely than men to resign from their job at some point (to give birth and take care of children) are more reluctant to assign jobs that lead to such firm specific skills to women. Therefore, on average, women build up less of those crucial firm specific skills. Therefore, they earn less money for what seems to be the same job.

I found this an appealing explanation. Because I guess it might be true that employers make the assumption that women are more likely than men to drop out of employment at some point. It also seems quite possible that two people having the same function might not get paid the same salary because – although we cannot observe this directly from their resumes – one of them might have built up more of those important firm specific skills, which employers reward in the form of a higher salary (because they are more afraid to lose them). So, intuitively appealing indeed, I thought.

Clever research: Temporary employees

But, in spite of its intuitive appeal, no-one has actually provided any evidence for it… And that is because it is incredibly difficult to research; it is just very difficult to measure such firm specific skills, whether certain jobs are associated with more of them than others, etc. Basically, all we can measure is someone’s sex, their job status, and their salary – and not much more.

But sometimes that is enough, if you choose your research setting in a clever way. And clever is exactly what Isabel Fernandez – my colleague at the London Business School – is. She decided to examine and measure wage differences between men and women in the temporary employment sector. And why is this so clever? Well, because by definition, firm specific skills do not matter much in this industry. Temporary employees, employed by staffing firms, are meant to be transcient and hopping between jobs. Firm specific skills are all but irrelevant for the kind of work they do. If Isabel were to find equal wages between men and women in this sector, it would be strong evidence that gender pay differences in other sectors are likely due to firm specific skills, and not some evil discriminatory attitudes amongst employers. On the other hand, if she’d even find wage gaps here, it would be convincing proof that we cannot simply attribute gender differences to firm specific skills (which men might have more off) and justify them in that sense. Then, something else (perhaps more sinister) must be going on...

Thus, Isabel talked a staffing firm – specialized in high skilled IT related contractors – into providing her with their internal databases: resumes, client information, demographic data, project characteristics, prices, and so on. Subsequently she compiled an extensive and detailed database on 250 of its temporary employees who, over a period of several years, jointly were involved in 1462 projects across 462 different companies. She measured their hourly pay rate and statistically corrected the differences between them for things such as years of education, specialist training, experience, project characteristics, and so on. Until there was only one variable left to examine: gender.

And she found that, even in temporary jobs, women get paid substantially less than men, for the same type of work. Women earned an average of $25.08 per hour while men, for the exact same job with the same qualifications, would earn an average of $29.66. And we can’t blame that on firm specific skills.

Hence, “firm specific skills” are a nice story – but not much more than that. They belong to the greater works of fiction. Because, as Isabel showed, they do not explain the difference between male and female wages. And that is rather unfortunate, because it leaves us with the nasty but inevitable conclusion that the world of business does on average still discriminate against female employees. And surely we cannot be cheerful about that.

Equity analysts (and their lunch breaks) force firms to look and act alike

2011-02-16T21:43:00.002Z

The inclination to imitate others is part of human nature. We imitation our peers’ habits, speech, behaviour, taste in clothing and music, and so on. Top executives, making decisions on the strategies of their corporations, are no different. There is evidence from research that companies imitate each other when it comes to the choice of organizational structure, CEO remuneration, acquisition premiums, plant location, foreign market entry decisions, and so on.

As a consequence, in many industries, we end up with a large number of firms doing pretty much the same things, and in the same way. However, this inclination to imitate does not only stem from top executives’ personal propensities and uncertainties; sometimes companies are forced to do similar things and act in similar ways, even if these ways are detrimental.

Forced to act alike

For example, research by professors Benner from the University of Minnesota and Tushman from the Harvard Business School showed that the implementation of ISO9000 (a quality management system) could be detrimental to firms (because, in the long run, it killed off innovation) but even if a firm did not want to implement the system, it was often pretty much forced to do so by various external constituents.

That is because not implementing the popular practice would make a firm look “illegitimate”. As a consequence the company will be likely to get downgraded by analysts, may find it harder to find customers or financiers, and even the firm’s own employees might start to ask questions why the firm is “lagging behind” and not doing what others do. Eventually, top management may decide to implement the practice after all, even if they have doubts it is actually effective.

One powerful group of external constituents in our society who often force firms to act alike (even if it is to their detriment) are equity analysts. The influence of equity analysts in our business society is very substantial. That is because – as research has confirmed – the impact of their stock price recommendation is very real and significant. Thus, they determine the amount of financial resources available to a firm. However, their impact actually goes quite a bit further than that; because of their power to determine a company’s access to financial means, they also have a substantial influence on what sort of strategy the firm is pursuing in the first place. A good setting to illustrate this is firms’ strategic decision regarding corporate diversification and their choice of in what combination of businesses to operate.

The influence of analysts (and their lunch breaks)

In general, where in the 1960s many firms operated in a diversity of businesses, since the 1990s we have witnessed a reversal in that trend towards de-diversification. There might be good economic reasons for that – shareholders are not fond of diversification because they can diversify their stock portfolios themselves; they don’t need companies to do that for them – but sometimes it does make sense for a firm from a strategic, value-creation perspective.

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. Hence, sometimes diversification might make sense. But that something makes sense from a strategy perspective doesn’t mean it makes sense in light of an analyst’s lunch break. What do analysts’ lunch breaks have to do with any of this, you might wonder? 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. Now 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”. (Adopted from Tod Zenger, Professor of Strategy at Washington University.)

Wait a second, you might think, did they just suggest that Monsanto should split up because it requires three (industry-specific) analysts to cover them and these three guys cannot find a mutually convenient time to meet?! Yes, I am afraid they did. Analysts prefer firms who follow their own internal division of labour and if firms do not conform to this requirement, they will downgrade them or stop covering them altogether.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 equity 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.

Conclusion

Hence, analysts rule the (diversification) waves. And their lunch break will determine your stock price. But is this influence really beneficial for companies and society as a whole? I guess one could speculate whether the unifying influence of external constituents on firm strategy in general is a healthy thing; after all, they help both the spread of good and bad management practices.

However, it seems evident and beyond debate that the barriers erected by equity analysts for firms to follow original, contrarian strategies – because it does not suit their lunch schedule and division of labour – is less than positive. That is because such contrarian strategies that cut across different businesses are often the most innovative ones, creating most value for companies, shareholders and society as a whole. Hence, figuring out a way to restrict this detrimental influence of equity analysts seems to anyone’s benefit.

People always finish projects behind schedule and over budget - but here is some help

2011-02-07T14:29:00.005Z

The United Kingdom has a proud tradition of delivering projects way behind schedule and way over budget. For example, the new Wembley stadium in London, which opened in 2007, was originally scheduled to open in 2003. It was also about $450 million over budget. Similarly, the Jubilee Line extension to the London Underground system cost $5.3 billion instead of the estimated $3.2 billion, and was almost two years late; likewise for the prestigious Millennium Bridge covering the Thames; Sadler’s Wells theatre in Islington; the list goes on and on.
But at least it is not as bad as the (in)famous mother of all planning disasters: The Sydney Opera House. This was scheduled to open in 1963 at a cost of $7 million. Eventually, it opened in 1973 and cost $102 million. But I guess that’s simply because all Australians are really British descendants with a gene for criminality.

Anyway… of course there is nothing British about all this. The same happens in many countries, and to most individuals. We all tend to be rather unrealistic in our project planning and for instance consistently underestimate our completion times. Strangely enough, research shows that we only display this so-called “planning fallacy” for our own work. When it comes to estimating the completion time of someone else’s project, we are actually quite accurate. That is why we all snigger at our friends’ project plannings, declaring “they will never make that”, to subsequently make the exact same planning errors for our own work.

Aiding accuracy?

Professors Roger Buehler from Simon Fraser University and colleagues designed a series of experiments to see if he could help people to improve their planning ability. He enlisted a bunch of psychology students and asked them to estimate their completion time as accurately as possible for a particular thesis. At the end, he checked how many of them had been late. Perhaps not surprisingly (if you are also human) more than 70 percent were late. He then ran an experiment in which he asked people to make two plannings: one “if everything went as well as it possibly could” and one “if everything went as poorly as possibly could”, to see if that would make them a bit more realistic. Unfortunately, it didn’t. The majority of people still were way late, even in comparison to their most pessimistic forecast!

Deadlines

Roger then designed another study. He thought, “perhaps giving them a deadline will help?” He asked a large number of respondents to think of a project they were going to undertake in the near future – the projects ranged from all sorts of academic assignments to fixing one’s bicycle or clean their apartment. Then he checked whether there was a real deadline for their project (which was true for about half of them) and asked them for their estimate of their completion time. At the end, he checked how many of them had finished their project before their estimated time of completion. As before, about two thirds of people had been overly optimistic, and finished their project late, regardless of the nature of the project. And there was no difference between the groups with or without a deadline. Apparently, setting a deadline does not help a single bit; we do not become more accurate in our planning forecasts.

Recalling past experience

Then Roger thought of yet another experiment. He had noticed that when people explained the logic for their planning, they almost always only referred to what might happen in the future, during their project; they never seemed to think about relevant past experiences with similar projects, where surely they had experienced that they tended to be overly optimistic and usually finished late. So he thought, “perhaps that might help; asking them to think about similar past experiences before making their project planning?” And so he did. He ran a similar experiment but first asked people to remember their relevant past experiences. Didn’t help a single bit… His bemused respondents first told him at length about their past planning errors and then, during the subsequent minute, made the exact same planning errors all over again.

Then Roger took a deep breath, and designed one final experiment. Now he did not only ask participants to recall their past experiences before making their project planning but now he also asked them explicitly to actually incorporate these past experiences in their planning. And – beware and behold – that helped. When Roger explicitly forced people to connect their past experiences to their new planning, they finally came up with some quite realistic forecasts.
Hence, the planning fallacy is a pervasive and persistent phenomenon that is not easy to tackle. We are quite good at forecasting someone else’s project, but we are stubbornly overoptimistic about our own. The only way to make us see some sense is to be grabbed by the ear by someone like Roger, and be forced to explicitly take into account the past errors of our ways. Then there is no denying it anymore, not even to ourselves.

Bankers’ bonuses: dubious use more than dubious ethics

2011-01-31T16:14:00.001Z

Bankers’ bonuses continue to receive ample critique, being qualified as immoral and unethical. However, that the bonus system suffers this critique seems largely the result of awkward semantics. “Bonus” suggests a reward for good performance, which seems something at odds with banks over the past few years.

However, in reality, these bonuses do not really serve the role of rewards for good performance. Instead, they are just a form of “flexible pay”. That is, most bankers’ salary consists of a fixed and a flexible component. The flexible component decreases if their firm performs less well, which it has done for most bankers over the past few years.

If banks would just rename their “bonuses” into something like “flexible pay” that might not only be closer to the reality of things, but also shield them from much of the vigorous critique of outraged outsiders. Instead, some might even be inclined to applaud them for taking such a heavy pay cut in these meagre times. I do not see many other job categories agree to such heavy pay cuts as they went through recently; imagine proposing a 40 percent pay cut to Tube drivers or BA crews – bankers accepted it without much grumble.

However, this does not mean that the flexible pay system that banks have grown to use (i.e. their bonus system) is a smart way of rewarding people. It is not; it is outright clumsy. Flexible pay is intended to motivate people, make them emotionally tied to and proud of their firms, and prevent them from leaving. Bonuses do no such thing. People just wait for their bonus to arrive and then leave; it has no influence in terms of retention. Things get even more awkward (or perhaps ridiculous) when they introduce “guaranteed bonuses”; how on earth are they supposed to motivate anyone?

Research on employee remuneration does not look good for them either. Bonuses tend to increase wage differences between people within the same organisation and team. Yet, research by professor Matt Bloom from the University of Notre Dame showed consistent evidence that wage differences actually demotivate people, and make a team perform worse; they even demotivate the team member with the highest relative pay. In comparison, teams with much more homogeneous pay tend to perform much better. In addition, research by professor Dan Ariely from Duke University and colleagues provided evidence that individuals are also negatively affected by extremely high pay, the same people performed better when their remuneration was within more normal bounds.

Thus, rather than being immoral and unethical, the bonus system is simply rather crude and clumsy; it does not get the job done. That is not unusual for banks, which generally seem to be run by people who are excellent bankers but very poor at managing stuff. Common sense would suggest that they rethink the bonus system’s name (and change it into something like flexible pay). Scientific evidence would suggest that they rethink the set-up of the entire system altogether.

Business schools suffer from a dangerous lack of evidence based teaching

2011-01-27T12:57:00.002Z

There is a great divide in business schools, and one that not many outsiders are aware off. It is the divide between research and teaching. There is very little relation between them. What is being taught in management books and classrooms is usually not based on rigorous research. Vice versa, the research that gets published in the prestigious academic journals seldom finds its way into the MBA classroom.

The consequences of this divide are grave. First of all for research: because none of this research is really intended to be used in the classroom, or to be communicated to managers in some other form, it is not suited to serve that purpose. The ultimate goal is publication in a prestigious academic journal, but that does not make it useful, or even offer a guarantee that the research findings provide much insight into the workings of business reality.

It is not a new problem. In 1994, the then president of the leading association of business academics called the Academy of Management, Professor Don Hambrick, noted “We read each others’ papers in our journals and write our own papers so that we may, in turn, have an audience . . . an incestuous, closed loop”. Management research is not required to be relevant. Consequently much of it is not.

But business education clearly also suffers. What is being taught in management courses is usually not based on solid scientific evidence. Instead, it concerns the generalization of individual business cases or the lessons from popular management books. Such books often are based on the simple yet appealing formula that they look at a number of successful companies, see what they have in common, and then conclude that other companies should strive to do the same thing. However, how do you know that the advice provided is fair and reasonable, or whether it comes from tomorrow’s Enrons, Lehmans, and Worldcoms? How do you know that today’s advice and cases will not be soon heralded as the epitome of mismanagement?

How could rigorous – and relevant – management research help? Let me give an example. In the 1990s, ISO9000 (a quality management system) spread through many industries. However, academic research by Professors Mary Benner and Mike Tushman showed that its adoption could actually lead to a decrease in innovation after a few years (because ISO9000 does not allow for deviations from a set standard, which innovation requires), making the adopter worse off. This research was overlooked by practitioners, many business schools continued to applaud the benefits of ISO9000 in their courses, while firms continued – and still continue – to implement the practice, ignorant of its potential pitfalls. Yet this piece of research offers a clear example of the possible benefits of scientific research methods: rigorous research which reveals unintended consequences to expose the true nature of a business practice. However, such research with important practical implications unfortunately is the exception rather than the rule. That even relevant research is largely ignored in business education – as happened to the findings by Benner and Tushman – unfortunately is the rule, and not the exception.

Of course one should not make the mistake that business cases and business books based on personal observation and opinion are without value. They potentially offer a great source of practical experience. Similarly, it would be naïve to assume that scientific research can provide custom-made answers. Like medical research provides general insights that a skilled doctor needs to combine into a unique treatment plan for an individual patient, rigorous management research could and should provide the basis for skilled managers to make better decisions. However, they cannot do that without the in-depth knowledge of their specific organization and circumstances.

Yet, at present, business schools largely fail in providing rigorous, evidence-based teaching. Instead, the near perfect separation between research and teaching causes their courses to largely rely on dangerously simplified generalizations of popular insights, at a time that the corporate pitfalls that rocked our economies over the recent past epitomize a clear need for more sound management in favor of popular fads.

The BP oil rig disaster – better brace yourself: there is surely more to come

2011-01-18T20:42:00.004Z

Last week’s report of the Presidential Commission examining the oil rig disaster in the Macondo well in the Gulf of Mexico draws a sharp and clear conclusion about its cause and who is to blame: it is the systemic failure of management; at BP, its partners and subcontractors Transocean and Halliburton. At the end, it also places a bit of guilt on the US government, which provided inadequate regulation and resources.

The report is to be applauded for its clarity and thoroughness, and for recognising the complex and systemic nature of the cause. However, what it fails to recognise is that the structural failure of management is embedded in an even wider context, namely how in our society we run our economies and corporations. Given this wider economic context, it is inevitable that similar disasters – of similar apocalyptic proportions – will happen in the future.

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Strikingly, when reading the report, the parallels between this debacle and other corporate disasters of the recent and more distant past are stunningly clear. Many of the descriptions of how the oil rig disaster unfolded, as well as the reports’ conclusions, for example, could word for word have been taken from reports on the Union Carbide gas disaster in Bhopal in 1984. Swap some names and dates and a few technicalities and the various reports’ descriptions of a lack of a top-down safety culture, design errors, break-down of communication, and the influence of cost-cutting, and so on are near identical. And that tells us something; if alone that this is unlikely to be the last disaster of its kind that we are going to witness.

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In fairness, the committee has done well to resist the common temptation, when looking at things superficially, to name and blame a particular party, or even a particular person, like the Obama government clearly could not avoid the same temptation in the weeks following the disaster, explicitly and exclusively heaping blame on BP and its CEO Tony Hayward in particular. The same happened to Warren Anderson, Union Carbide’s hapless CEO in the 1980s, whose extradition for manslaughter charges is still being sought by the Indian government.

And I am sure these companies are to blame, and their CEOs do carry responsibility for the disaster, but to name and shame them as the sole cause of the misfortune seems a dangerous oversimplification.

Professors Gabriel Szulanski from INSEAD and Sid Winter from the Wharton School, who examined corporate disasters, wrote about this “When people try to explain a disaster after the fact (an accident in a nuclear plant, for example), they are typically under pressure to name a relatively simple cause so that existing policies can be revised to prevent similar events in the future”. We are eager to find a culprit, and someone to blame, and the CEO of the offending company is the most logical and easiest target for our tar and feathers.

But, as the Presidential Committee rightly concludes “the root causes are systemic”, representing an “overall failure of management”, rather than the actions of a particular individual or even a particular firm. When you analyse the lack of communication systems, safety culture, inadequate decision making processes, and so on, a disaster – somewhere at some point – seemed inevitable and the proverbial accident waiting to happen.

The anthropologists Anthony Oliver-Smith and Susanna Hoffman, who examined a variety of man-made disasters, concluded about this “a disaster becomes unavoidable in the context of a historically produced pattern of vulnerability”. And that is what we saw at BP; a pattern that produced a situation that at some point was going to go off the rails. Hence, the committee is certainly right that “the missteps were rooted in systemic failures by industry management (extending beyond BP)”.

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Where the report falls short, however, probably also because it extends the scope and vision of the committee, is recognising that the way BP, Transocean and Halliburton are managed is the logical consequence of how the world of business operates and is organised in our society. The report for example concludes, with ample surprise and indignation, that safety was not the firm’s top priority. Well, of course it is not, I’d say, because in today’s society we tell our companies that their top priority is shareholder value.

Now, certainly this disaster did not do the shareholders of BP much good, but the point is that, in financial terms, there is an optimal risk-return trade-off to be made. And all BP did and has been doing is to optimise that trade-off for its shareholders – precisely as we expect them to do.

Whenever I ask a group of executives to whom the ultimate responsibility of a company is they proclaim in chorus “shareholders” – some of them even get annoyed if not angry by questioning that very assumption. Because that is what they are supposed to do: maximise the value of the corporation for its owners. And, as said, that implies making risk-return trade-offs. The tricky thing is of course that such trade-offs inevitably at some point somewhere down the line lead to something going seriously off the rails.

In fact, the way we remunerate top managers – including Tony Hayward – is largely through stock options. The only reason to so abundantly use stock options (and not, for instance, stock) is that they stimulate top managers to take more risk. And the world of business and our stock markets in specific are organised in such a way that we believe that that is what we want: top managers who take risks. We applaud them when it goes well, but we vilify them when it goes badly wrong, although that’s simply the other, inevitable side of the same risky coin.

Of course, oil disasters are the type of risk we would like them to avoid, but governance mechanisms such as stock options simply stimulate risk taking and do not discriminate between different types of risk. Research – by professors Gerry Sanders from Rice University and Don Hambrick from Penn State – confirmed that CEOs with more stock options take more risks, but they also experience bigger losses. Furthermore, research by professors Xiaomeng Zhang and colleagues from the American University of Washington showed that option-loaded CEOs are more likely to engage in earnings manipulations. Clearly these are not the risks we want CEOs to take, but they are the logical consequence of the way we remunerate them. We ask and reward them for taking risks, so they do.

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‘But I did not ask them to take more risk’, you might think. But yes, you probably did. Perhaps not directly, but indirectly; very likely. Individual investors select shares with the highest return and track record, consumers select the bank with the best rates, your pension fund invests your savings in companies with the highest risk-return trade-off, and so on. By selecting the best returns, we stimulate those companies to optimise their own risk-return balance. As individuals, we just look at the financial results, and seldom query how they came about.

But at least we are in good company; following the recent banking crisis, even the Church of England was found to have invested in the same financial instruments they so heavily criticised after the collapse of the financial system. However, you just cannot have your cake and eat it too. If we design a system in which firms are expected to maximise shareholder value and CEOs are stimulated to take risks, some of the investments are going to go wrong. And both Union Carbide in Bhopal and BP in the Gulf of Mexico were clearly investments that went wrong.

So the White House committee was right; the Deep Water Horizon rig disaster was caused by a systemic failure of management, but the system surpasses that of the three companies involved. As a matter of fact, whether you analyse the cases of Enron, the old Barings Bank, Lehman or the Royal Bank of Scotland, similar conclusions would be drawn. All these firms and managers operated conditioned by the economic context in which they operated. And since the Presidential Commission is unlikely to change that very context, we will be facing more such corporate disasters of the same kind at some point in the future.

‘Stretch goals’ tend to stretch all the way into fraud

2011-01-13T23:17:00.002Z

Goal setting works. Give your employees some concrete goals and they will work harder to reach them than when you just tell them “do the best you can”. There are ample studies confirming that relationship. Professors Edwin Locke and Gary Latham, from the University of Maryland and the University of Texas, even called goal-setting “the most effective managerial tool available”.

So, I am not arguing with the effectiveness of goal-setting, but I would say it should come with a health warning. And that is because it also induces some more dubious behavior.

Let me explain. “Stretch goals” is one of these terms that have persistently entered managerial vocabulaire, earning a prominent and enduring place in consultant speak. The idea is that you set your people goals that they might just reach if try really really hard – or just not. Hence, they stretch your people’s effort to the limit.

However, there is a little catch to that. We also know from research that if people almost reach this goal (but, crucially, not entirely…) they tend to make it up.

Cooking the books

Really – quite literally. If they almost reached the stretch goal but not entirely, they will be inclined to pretend they did, and cook the books. Professors Maurice Schweitzer for the University of Pennsylvania, Lisa Ordonez from the University of Arizona, and Bambi Douma from the University of Montana designed a clever experiment. They gave seven random letters to 154 participants and asked them to create as many words as they could within a minute, writing them on a workbook. If they came up with 9 words or more they would get a monetary award. And they did that 7 times. The participants had to record themselves how many words they got each round and, at the end of the experiment, hand in a notebook of their achievements and take the corresponding amount of money out of an envelope. The experiment was guaranteed to be entirely anonymous.

But, unknown to the participants, there was a trick… Although the experiment was indeed anonymous, the researchers could match the workbooks to the notebooks and envelopes with the remaining money. Thus, they could look up how many people cheated (although they were not able to identify their names). And the answer was pretty clear and precise.

Each time people got 5 or 6 words or so – pretty far off the mark of 9 – they reported it honestly and left the money in the envelope. However, things were markedly different when people had reached 8; just one word short off the mark. In that case, a significant number of people cheated: they filled out that they had come up with 9 words and took the money out of the envelope, although their workbooks clearly showed they had missed the mark by 1 word. They cooked the books and deceptively misappropriated the corresponding monetary award.

It reminded me of organizations like Enron, Ahold, or Worldcom, where management habitually set their people ambituous goals. These firms may have gone down attributing their fall to fraud, but the fraud was induced by the organizational context created, which stimulated their people to cheat. Stretch goals may stretch employees’ effort to the limits, it also stretches their sense of ethics.

Self-justification

Because the interesting question is also, who were they cheating? When people reached only 5 or 6 they could have just as easily cooked the books and taken the money as when they had reached 8. But they didn’t. As a matter of fact, there was no need to fraudulently fill out the notebook at all; they could just have taken the money out of the envelope and leave. But only one out of the 154 participants took more money out of the envelope than reported on the notebook (and even that could have been an honest mistake). So why did people only commit fraud when they fell just short of the goal, and not when they missed it by a mile? And why did they insist on writing the false information in the books, when they could have just taken the money and run?

It has to do with self-justification. It seems we are inclined, when we have been set a stretch goal that we just did not reach, to tell ourselves that we sort of did, and really do deserve the reward. We can’t tell that to ourselves when we are way underperforming and very far off the mark. We also can’t justify to ourselves to just grab all of the money. But when we almost reached the stretch goal (but not entirely…) we humans are perfectly able to tell ourselves a nice little story that permits us to take the loot after all. And the people at Enron, Ahold, and Worldcom were just as human as the rest of us.

Rethinking employee remuneration: Or why is it difficult to find a taxi when it’s raining

2011-01-06T09:59:00.003Z

How to set up a remuneration system that gets the best out of your employees continues to be a tricky – and sometimes controversial – topic. Whether it concerns labourers or top managers, it seems difficult to get it right. Individual incentives, team incentives, tying bonuses to firm-wide performance, quantitative metrics, qualitative metrics, stock or options; all of them can potentially stimulate desired performance but could also trigger all sorts of unintended and undesired behaviours.

What does not help is that management theory about remuneration seems often to be based on a set of completely erroneous assumptions about human behaviour. And a theory with the wrong foundations can hardly make helpful recommendations.

Basic assumption: they will work more if I pay them more

Consider, for example, what we call the price elasticity of wages, as defined in economics to capture the relationship between pay and employee effort. Simply put, we tend to assume it is positive: If people make a lot of dosh per hour, we expect them to want to put in more hours. If we reduce the hourly wage, they will be less inclined to want to work many hours and, instead, prefer leisure time; catching a movie, go fishing, or crash out on the sofa holding a beer.

Of course, many people in regular jobs often have to work a fixed number of contractual hours (e.g. 9 to 5), so they don’t really face this choice. Similarly, people who in their jobs are largely judged based on their output, regardless of how many hours they put in (e.g. top managers, violists, professors) don’t get paid “overtime” so they also do not face this choice. However, in some professions people do. More importantly, this assumption – of a positive elasticity between hourly wage and how many hours someone is seeking to work – is the basis of much of the theory of remuneration, and therefore also influences how 9-to-5 workers are paid, and how top managers and violists are remunerated.

The slight problem is, the assumption appears to be wrong…

It is actually quite likely that, in reality (which is hardly the same as economic theory), people’s price elasticity is negative: meaning, if they get paid a higher hourly wage, people start to work fewer hours…

No drivin’ in the rain: NYC taxi drivers

A classic study on this topic was conducted by Professor Colin Camerer and colleagues from the California Institute of Technology. They examined New York City taxi drivers – who basically have to charge a fixed price per mile driven, but can determine for themselves how many hours per day they drive their taxi – and measured the relation between how much money they were making per hour and how many hours they were inclined to work on a given day. And basically what they found was that it is harder to find a taxi when it is raining.

“Eh…?” thou might think, and probably something like “of course it is harder to find a taxi when it is raining, because then they are all occupied”. That might be partially true, and admittedly what I used to think sheltering under an umbrella on a London street corner waiting (in vain) for a free taxi, but there is more going on. And that says something about the relation between remuneration and employee effort.

When it is raining, taxi drivers make more money, at least per hour. Because so many people want a taxi when it is pouring down – likewise when there is a Tube strike or a big convention going on – cabbies make more money per hour. That is because they don’t have to wait long for a new customer or drive around empty hoping someone will flag them down; there is such an abundance of potential customers that they’re hardly ever empty. Consequently, they make substantially more per hour when it is raining than when it’s a sunny day.

Economic theory would now predict that taxi drivers make longer days when it is raining because then they make more money per hour. Vice versa, we’d expect that they go home early when it is sunny (to lie down in the park, play with their kids, or take up knitting – or whatever excites taxi drivers). That sounds quite logical, right? Right… The only problem being that Colin’s research pointed out that the exact opposite is true. When it is a sunny day, and taxi drivers are not getting much buck for their hour, they continue driving and make long days. Instead, when it is raining, and taxi drivers have a high hourly wage, they tend to call it a day early… They, en-masse, were doing the exact opposite of what economic theory would predict. And that is a bit of bummer for our whole remuneration system and theory, because apparently it is built on shaky grounds.

But why…?

The question remains, why would they do that? Colin and colleagues speculated – based on a bunch of interviews with NYC taxi drivers – that people simply apply a different rule in their professional lives. They basically tell themselves, at the beginning of the day, that they have to make a certain amount of money and are then allowed to go home. And the taxi drivers continued driving till they had reached that amount. Some days, they (told themselves they) were lucky because it started raining and they allowed themselves to go home early. Other days – bummer – the sun stayed out and they had to drive longer to reach their target for the day. The vast majority of taxi drivers they interviewed uttered this logic; only one taxi driver said “drive a lot when doing well, quite early on a bad day” (the economists’ prediction), and I guess that’s simply because you always need one exception to confirm the rule.

What does this say about human behaviour? In economic terms this behaviour (“drive till I have reached a certain amount of money”) is plain irrational. As a matter of fact, Colin and colleagues computed that by only adopting the simple alternative rule “drive a fixed number of hours every day”, taxi-drivers could already enhance their income by 50-78 percent. They could increase it with 156 percent if they would just drive more hours when it is raining and less when it is sunny (which, incidentally, would also enable them to spend their leisure time in the sun, rather than inside grumbling at the rain!). Plain irrational indeed. But, as we both know, people aren’t always rational… So perhaps it is also time to rethink how to reward them differently.

Perhaps you should promote the poaching?

2010-12-29T11:50:00.003Z

Seeing your star employees being poached by a rival always seems a bit of a bummer. And rightly so. We know from research, on industries as varied as semi-conductors and mutual funds, that they often take valuable knowledge with them and therefore enhance the performance of your rivals. And indeed, research on Silicon Valley law firms as well as on Dutch accounting firms*, shows that moving employees do not only enhance the survival chances of the poaching firms but also decrease the survival probability of the firms from which they were poached. This was especially true if the employees moved in groups and if it concerned geographically proximate rivals, because they are the ones you are especially in competition with.

Customers poaching

So far the bad news. But can there be any upside to your employees being recruited? Well, yes, actually there is definitely a potential upside to that as well – especially if your employees are being hired by your customers, as professors Deepak Somaya, Ian Williamson and Natalia Lorinkova discovered. They examined the movement of patent attorneys between 123 US law firms and 109 Fortune 500 companies from a variety of industries. And they found strong evidence that if a client company recruited a patent attorney from a law firm, subsequently that law firm would start to get significantly more business from that company.

Hence, your employees leaving for your clients can be a good thing; they bring you valuable business. McKinsey – always ranked as one of the most admired professional services firms in the field – understands and manages this process particularly well; once you have been employed by McKinsey you automatically become “an alumnus of The Firm” (rather than a deserter). The firm carefully nourishes its relationship with its “alumni”, because they subsequently bring a large chunk of their business through the door.

Competitors poaching

Recently, professors Rafael Corredoira from the University of Maryland and Lori Rosenkopf from the Wharton School even found a beneficial effect of your employees being poached by rival firms. Using patent analysis studying US semi-conductor firms, they examined the transfer of knowledge between pairs of firms: the firm from which the employee was poached and the poacher. Not surprisingly, there is quite a bit of evidence that when this happens, knowledge transfers to the poacher; it comes in the form of the brains of the newly arrived recruit. However, Rafael and Lori also discovered that, as a result of employees moving to another firm, the old employer also experienced knowledge inflow from the recruiting firm!

Now, how is that possible? Someone moves out and, as a consequence, you gain knowledge from the place they went to?! Well, that’s because in real life we often socialize with our colleagues. When they start to work for a different firm, this does not mean that we stop talking to them. And what do they talk about? Well, work… While having a drink or two, former colleagues exchange information about how things work at their new place, how they solved a particular problem over there, what technology they use, and how they have got their processes organized. And you benefit from that.

Perhaps slightly surprisingly, Rafael and Lori’s findings showed that this exchange of knowledge was especially pertinent if it concerned a geographically distant firm. They conjectured that that is because there are other means in which you can get knowledge from rival firms that are nearby; perhaps then it is likely that you already have friends there, go to the same local conferences anyway, or that your kids go to the same school. Whatever the reason, it seems evident that if your employees are at risk of being poached by a rival firm, make sure it is done by one far away: you don’t suffer the adverse consequences of a strengthened competitor as much, but you do get the knowledge inflow upside.

Hence, scrap the non-compete agreements and gardening leaves, but only on the condition that they are moving far away, and promise them a sumptuous dinner and lavish drinking budget if they come back to visit their old friends at the firm.

Does the stock market appreciate management consultants?

2010-12-22T11:38:00.002Z

Management consultancy has boomed over the past decades. I recently saw a statistic which showed that in 1980 global revenues in the consultancy business equalled $3 billion. By 2005, it was more than $150 billion.

But what does it say about you, as a company and management team, when you are hiring a management consultant to help you out, with your strategy or organizational structure? On the one hand it is a good thing, right; you are not afraid to ask for help, and management consultants can bring in valuable outside knowledge, ideas, and experience. On the other hand, it could be interpreted as a bit of an admission of defeat… “we’re not able to figure it out ourselves”, “we have run out of ideas and options”, “we’re in seriously trouble; we need help” or something along those lines. Plus, these pin-striped guys do not exactly come cheap.

Whatever way you put it, it is some sort of a signal – either openness to outside ideas or a signal of brewing trouble. And signals are what the stock market is always on the lookout for, like a vulture spotting the slightest of limps in a wounded animal or, perhaps more kindly, some green shoots to announce the arrival of spring. So, it is an interesting question: does the stock market usually respond negatively or positively to a firm hiring a management consultant?

Professors Don Bergh from the University of Denver and Patrick Gibbons from University College Dublin set out to examine exactly this question. They collected information on 116 listed firms that publicly announced hiring a management consultancy, and statistically analyzed whether such an announcement increased or decreased the firm’s share price. And the answer was clear: share price increased with an average of 1.4% by the hiring of such an advisory firm. Now that’s value for money for you; the pin-striped guys haven’t even done anything yet and your company has already increased in worth.

But did everybody experience this uplifting effect? Not really: Don and Patrick also found that this entire effect could be attributed to well-performing firms; firms that already were healthy and profitable before bringing in the advisor saw quite an upsurge in their share price – apparently the market thinks that the combined forces will be able to make the company grow even faster. However, underperforming firms – firms with a more dismal financial track record – did not benefit at all from hiring a consultant. As a matter of fact, the stock market’s reaction would even turn negative for the real sub-par performers. Apparently, in that case it is interpreted as a sign that the company is in even more dire straits than originally assumed.

But might this not be dependent on who you hire, thou might wonder? Surely McKinsey, BCG, Bain or Booz Allen must be viewed differently by the market than some second-tier cheap-suit shop? Well, ehm… no. The stock market’s reaction was exactly the same no matter who the firm hired; whether it was McKinsey, some local chaps, or one of the big accounting firms doing a bit consultancy on the side; the market did not care. Apparently, it doesn’t matter whose help you ask, but it sure matters whether you ask for any at all.

The stock market generally hates acquisitions, but here is an exception to the rule

2010-12-17T12:35:00.000Z

In about 70 percent of the cases, the stock market responds negatively to the announcement of an acquisition. Put differently, despite their popularity, the average take-over destroys value for the acquiring firm. There are literally hundreds of good academic studies that consistently show that effect. For long, it was actually quite impossible to find any category of acquisitions that defied this rule and made some money, but lately a few studies have started to emerge that identify types of acquisitions that are seen in a more positive light by the ever elusive stock market.

One such sub-sub-subcategory of acquisitions that do appear to make at least a little bit of money are international acquisitions that were preceded by an alliance between the merging firms, especially if it was a strong form of an alliance, i.e. an R&D or Marketing alliance or prior buyer-supplier relationship (rather than a mere equity stake or licensing agreement). I know, it sounds like a very very specific category but I am already glad we have at least found one.

Although such alliances-turned-acquisitions are pretty rare – as evidenced by research by professor John Hagedoorn from Maastricht University – there are examples of firms doing it that way consistently: Cisco is well-known for turning dozens of small equity alliances into full-fledged take-overs and also Heineken has been using this incremental approach over the years with much success, consistently first cooperating with local breweries before fully acquiring them.

And in a way I find it understandable why, although rare, this type of acquisitions has a pretty decent track record. Acquisitions are just very hard to do. They usually are fraught with information asymmetries; basically most firms don’t have a clue what they’re buying. And due diligence is not going to solve that problem; acquisition integration is often hampered by cultural differences, incompatible systems and plain mistrust – something you don’t just look up in the company’s books beforehand. Hence, the troubles are hard to avoid.

But a preceding alliance might actually do that trick for you. Having lived through a lengthy alliance before the deal (“a lat relation before moving in together”) will have reduced these information asymmetries and unfamiliarities while, crucially, in the process, may well have bred some much needed trust. Because trust is definitely what you require abundantly when merging households (although precisely then, it often is in short supply…).

Professors Aks Zaheer, Exequiel Hernandez and Sanjay Banerjee from the University of Minnesota examined such alliances-turned-acquisitions and assessed how the stock market responded to their announcements. Let’s say it was a weak “yes”: unlike the average take-over, the stock market had a weak but positive appreciation of these types of deals. Where the stock market usually responds negatively to an acquisition, they found that if the take-over was preceded by an alliance between the firms, the share price of the acquiring firm increased after the take-over announcement.

This results was really only true though (i.e. “statistically significant”) if it concerned an international acquisition. And in a way I find that understandable, because the issues of information asymmetry, cultural differences, and mistrust are clearly aggravated in the case of a cross-cultural merger. Hence, in these cases, a prior alliance proves particularly helpful.

So, see, there is a glimmer of hope after all, for the track record of M&A. All it needs is a bit of patience and fidgeting around before engaging in the real thing.

Acquisitions – finally something to cheer about…?

2010-12-13T10:14:00.001Z

Decades of research scarily consistently shows that most acquisitions destroy value, and only cost the acquirer money. There is really no denying it – all “ifs” and “buts” have been raised, examined and rebutted – about 70 percent of acquisitions fail. That is because acquirers are usually inclined to overpay (under pressure from bankers, the press and their own adrenaline; a take-over premium of 60-80 percent is really nothing unusual) and because managers systematically overestimate their potential for value creation; integration is often much harder to pull off than one thinks and “synergies” carry you only so far. So far the (familiar) bad news.

Slightly to my surprise though – although not unwelcome – over the past years a few studies have emerged that managed to identify categories of acquisitions which on average do create surplus value. And the first category identified is actually quite a sizeable one: the acquisition of private firms. Pretty much all of the research on M&A is conducted on public firms; that is, firms listed on the stock market. And that is understandable because we simply have much more information on them; because they’re public firms, they more consistently gather and report data and, of course, share price data is available. Hence, we can examine them better.

Professors Laurence Capron from INSEAD and Jung-Chin Shen from York University managed to obtain data on a large number of private deals and, guess what, in contrast to the public deals they examined, these did create some value! Where the take-over of a public target made the share price of the average acquirer fall by about 1 percent; the acquisition of a private target raised it by an average of 4 percent. That may not seem overly impressive to you but it’s really quite a bit of peanuts if you calculate its monetary equivalent – certainly in comparison to the abysmal take-over track record of public deals.

But how come these private take-overs do appear to create some value? Well, that’s a bit of speculation, but Laurence and Jung-Chin had an informed suspicion: information asymmetry. Because, by definition, information about private firms is usually not publicly available, there would also be much fewer buyers aware of the juicy take-over target, and that it was possibly available at a bargain. Consequently, there were fewer bidders and more opportunity for value creation for the eventual acquirer.

Consequently, private deals usually do better than public ones. They might be a bit murkier, hidden and not as glamorous, but hey, they actually make you some dosh!

The looks of a leader

2010-12-06T13:47:00.000Z

Attractive people are generally seen as more competent and fit for their job. For example, experiments using headshot photographs of people mixed with random CVs generally show that people rated as physically more attractive also receive higher ratings in terms of “job competence”. Men deemed to be handsome are more likely to be regarded good business leaders. Yet, we know that, at the same time, for example intelligence and physical attractiveness don’t correlate (positively or negatively!). Hence, it is purely a physical preference; and nothing else.

The most striking example and evidence of this I found was not in an experiment on business leaders but from an experiment on political leaders – although I am sure the situation won’t be much different for business leaders.

Two researchers from the faculty of business and economics at the University of Lausanne - John Antonakis and Olaf Dalgas – ran an experiment in which they gave 684 people in Switzerland photographs – and nothing else – of the pairs of faces (the winner and runner-up) from the run-off stages of the 2002 French parliamentary election. These Swiss people would never have seen and did not know anything about these sets of two candidates. Subsequently they asked them “who do you think will win this election?” In 72 percent of the cases, having seen only the two photographs, people predicted the results of the elections correctly… That’s probably a lot better than most political analysts.

Then they got a little mischievous; they gave the photographs to 681 children and told them “we are going to play boat; who do you want as captain of our ship?” In 71 percent of the cases, the children’s’ choice correctly predicted the winner of the local French parliamentary elections.

We pretend – mostly to ourselves – when selecting a job market candidate, filling out a ballot, or choosing a leader, that we carefully weigh the pros and cons, assess someone’s experience and competence, and make a well-informed rational choice. Yet, in reality, at the end of the day, we’re all just playing boat.

Why analysts appear racist

2010-11-29T10:20:00.001Z

The following experiment caught my eye: Professor Stephen Sauer, from Clarkson University,
together with two colleagues recruited 101 analysts to review information to value the stock of currently privately held company. All analysts were given the exact same information with two “minor” adaptations: In some of them the CEO had gone to a prestigious university; in some of them to a second-tier school. In some of them the CEO was white; in some of them the CEO was black, thus basically creating four groups (prestigious & white; prestigious & black; second-tier & white; second-tier & black). Then the compared the analysts’ valuations…

In spite of it being “the exact same (fictitious) companies” there were major differences in valuation. By far the highest value the analysts assigned to companies whose CEO was white and from a prestigious university, followed by those from second-tier schools who were black, and second-tier schools who were white. Rock bottom were those companies headed by a CEO from a prestigious university who was black…

Stephen and colleagues found this a rather scary find…

So they decided to run yet another experiment: They recruited another 62 analysts and gave them the same company information. However, this time on half of them, they explicitly stated the following about student recruitment at the CEO’s alma mater:
“The university [had used] a double-blind procedure with no special consideration for gender, race, or ethnicity”, so that it was unambiguous that the CEO had made it into the (prestigious) school purely based on merit, and nothing else.

Now the results changed spectacularly: The companies with CEOs from a prestigious university who were black received the exact same valuation as companies with CEOs from a prestigious university who were white. Apparently, people do not just devalue a company because its CEO is black – phew! – there is something else at play.

Why did they then in the first experiment assign the lowest value to those companies with a CEO of a prestigious company who is black? Well, apparently, whenever people see a black person from a prestigious university, they are inclined to assume that he might have been admitted there not based on merit but because of some sort of affirmative action…: positive discrimination. And hence, that it is likely that he is not as good as his credentials might suggest. And of course, statistically they are right…; black males are more likely to have been admitted to B-school due to affirmative action than white males (for the simple reason that the number of white males admitted due to affirmative action is quite certain to be zero). Take away that possibility and analysts don’t care about the colour of someone’s skin.

But that of course does not mean that all black males are admitted to a prestigious school due to affirmative action. It doesn’t even mean that most black males are admitted to a prestigious university for that reason. So analysts do get it wrong rather often, and that must be one darn annoying thing, if you’re a black male at a prestigious university who simply made it in based on merit, and nothing else.

Does an MBA make you unethical? Finally some evidence

2010-11-22T12:40:00.001Z

While, a year or two ago, the dust clouds of the fallen giant investment banks were still settling, at many a place the discussion opened whether it was these CEOs' business school education that caused him (invariably him…) to act in such a selfish, destructive and unethical way.

For example, Forbes debated the issue heavily under the title “are B-schools to blame?” while at the Harvard Business Review a discussion raged under the highly similar header of “are business schools to blame?” (as if they plagiarised each other… which I thought would add some juice to an ethics discussion…). Although there was the occasional stern defendant of the system, most treated the question as a rhetorical one (“yes, of course!”) and vehemently declared denial itself to be almost as unethical as the destructive actions themselves.

But what’s the evidence; was there any presented? Do we actually know whether earning an MBA makes one behave more unethical and less socially responsive? No we don’t. I was asked by a BBC World presenter, after giving a speech at the Rotterdam School of Management, whether it wasn’t true that most of the corporate villains had MBAs? I had to admit I didn’t know but, even if it were true – that most of the disgraced (and sometimes jailed) corporate villains were lauded with an MBA – what does it prove?

Suppose that 60 percent of the villains had MBAs; perhaps 70 percent of all major corporations in the world are headed by MBAs; this would actually imply that of the villains relatively fewer have an MBA than of all (non-villain) corporate big shots! It is irrelevant whether most villains had an MBA; the relevant question is whether getting the MBA made them more likely to be vile. And frankly, that we did not know.

And I say “did” because now we do – at least sort of. Professors Daniel Slater from Union University and Heather Dixon-Fowler from Appalachian State University decided to, rather than contribute yet another 'informed opinion' and 'point of view', actually test the conjecture. And, in retrospect, that wasn’t so hard to do…

Because they simply looked up the “corporate environmental performance” score for 416 Standard & Poors 500 firms as put together by the company KLD Research and Analytics Inc. Nowadays there are quite a few corporate social responsibility rating agencies and systems around but KLD’s is generally regarded a very good one, because they are fully independent and really track a variety of indicators, gathering the information from multiple sources, including extensive inspection of public records, surveys, and on-site facility inspections. Dan and Heather also looked up whether those companies had CEOs with or without an MBA, and used that to compute whether firms with MBAs at the helm performed any worse in terms of corporate environmental performance than firms with a CEO who did not go to B-school.

And the answer was a resounding no. They checked whether this effect could be due to all sorts of confounding variables (like the CEO's functional background, age, education level, firm size, prior financial performance, type of industry, etc.) but, nope, really: the companies headed by MBAs were no more likely to be vile.

As a matter of fact, they were less likely to be vile! Companies with CEOs with an MBA generally did better in terms of corporate environmental performance; it were the non-business-educated chief executives that engaged in the bad stuff. I reckon that’s quite a shocker to the average righteous blogger in leftish spheres: business school actually makes one more socially aware and responsive!

And, on a final note, it didn’t make any difference whether you were from Ivey League Harvard or had your MBA from the University of New South Nebraska State; programme rank had no influence on these blissful results.

And now I am going to take a walk down our corridor to the office of our Ethics Professor and apologise for calling her course “pointless”… See you later.

Management myths

2010-11-18T16:50:00.000Z

Have you ever heard that the Great Wall of China is visible from outer space? Well, it is a myth. But also a very persistent one, despite there being clear evidence that it is not. Similarly, there are quite a few myths in business that are very persistent, despite clear evidence exposing them. Let me tell you about three types of business myths, and give you some examples.

Self-perpetuating myths

First there are self-perpetuating myths, and they exist in pretty much any industry. Take the film industry. Film distributors have preconceived ideas about which films will be really successful. For example, it is generally expected that films with a larger number of stars in them, actors with ample prior successes and an experienced production team will do better at the box office.

And sure enough, usually those films have higher attendance numbers. However, professors Olav Sorenson from Yale and David Waguespack from the University of Maryland discovered that, because of their beliefs, film distributors assign a much bigger proportion of their marketing budget to those films. Once they acknowledged this factor in their statistical models, it became evident that those films, by themselves, did not do any better at all. The distributors’ beliefs were a complete myth, which they subsequently made come true through their own actions. And there are other examples for different industries.

Management fads

The second type of business myths are known as management fads. They concern management practices that at some point emerge and become popular, such as the old Total Quality Management, ISO9000 system or SixSigma. They usually behave like popular fashions, like the ones in design or clothing: they come and go, and sometimes reappear many years later under a slightly different guise.

Although often quite harmless (yet seldom really useful), some of them can actually be quite detrimental, without the adopting firms realising it. Take ISO9000. ISO9000, in a nutshell, helps firms to identify best practices within their organisation, document them, and make sure that everyone in the firm follows that one standardised best practice. Thus it leads to efficiency and productivity gains.

However, unexpectedly and unfortunately, as professors Mary Benner from the University of Minnesota and Mike Tushman from Harvard Business School discovered, the firms that adopted ISO9000 several years down the line saw a decrease in their innovativeness, in terms of new technological inventions. The system of homogenised best practices stimulated efficiency but it also blocked deviations from the standard, consequently limiting the discovery of new innovations.

Reversing cause and effect

The third type of business myth pertains to the issue of so-called reverse causality. Over the years, popular business books such as In Search of Excellence, Built to Last, and Profit from the Core made recommendations to managers by comparing highly successful companies and finding out what they have in common. Although at first sight this may seem like a logical approach, there is one big catch to it: the risk of reversing cause and effect.

Several of these books, for example, recommend that firms should develop a strong, coherent organisational culture. That is because most of these highly successful firms had one at the time of writing the book. However, research tells us that firms often develop a strong coherent culture as a result of having been successful for several years. Hence, their strong culture is not the cause of their success; it is the consequence of it. Trying to develop a strong coherent culture might not help you to become successful at all. Quite possibly it could even be harmful and counterproductive, because a coherent culture could also lead to ‘groupthink’ and a lack of innovation, which could be dangerous especially in a fast-changing business environment.

There are many myths in business; some specific to particular industries and some more general. Some myths merge but also disappear after a while. Other myths though are surprisingly persistent. They almost act like business viruses; they have a detrimental effect on their “host” (the adopting organisation) but they also spread rapidly, because they are easy to replicate.

You could describe this as “the sneeze theory of management myths”; companies affect each other because they do business with one another. For example, ISO9000 is easy to imitate because it concerns a standardised set of rules and procedures. Moreover, firms that have adopted it often start to expect that their suppliers follow the same system, making the practice spread.

Furthermore, we know from research – among others by Professor Mark Zbaracki at the University of Western Ontario – that executives are inclined to overstate the benefits from the adoption of systems such as ISO9000 to other people within their firm and to other firms in their industry, thus stimulating the further diffusion of “the virus” and keeping the business myth alive.

Communicating strategy

2010-11-13T10:00:00.000Z

Whether you are heading up a team, a business unit, or an entire Plc, you’re going to need a strategy. And you are going to have to communicate that strategy clearly to others, because only if others are aware of it can they actually contribute to it, and will it have any effect – a carefully crafted strategy document, no matter how elaborate and sophisticated, is not going to resort to much if it merely disappears in a drawer unnoticed.

There are several rules – litmus tests – that any strategy must adhere to, for it to be communicated effectively, whether you are the CEO or a team leader.

Rule 1: Make some genuine, tough choices. Often you hear things like “our strategy is to be a good employer”, but that is not really a strategic choice. Something is only a genuine, tough choice if the converse is meaningful. “Our strategy is to be a lousy employer” is unlikely to be anyone’s preferred choice. CEO Stevie Spring’s choice for Future plc to focus on making magazines for young males is one; magazines for middle aged women, for example, could have been a genuine option.

Rule 2: You should be able to capture the essence of your strategy in just three of four points. One point (e.g. “we do magazines”) is meaningless and does not provide any direction. If you provide twenty pointers you are basically telling people what to do – moreover, no-one will actually remember them. We “1) do specialty magazines, 2) for young males, 3) in english” provides lots of direction but also leaves ample room for creativity and growth.

Rule 3: Communicate not only the “what” but also the “why”. Trinity Mirror’s CEO Sly Bailey told me recently that if there was one thing she learned about strategy communication it is that we are always inclined to carefully explain what the choice is, but underestimate communicating the reasons behind it. Research on “procedural justice” proves her right; if people understand and believe that the decision making process had been solid and just, they are inclined to cooperate, even if they do not entirely agree with its outcome. Vice versa, people who agree with the choices but feel the process used to arrive at them was wrong are inclined to withold cooperation regardless of their agreement. Hence, carefully explaining the “why” is at least as important as explaining what the strategy is.

The porpoise–Jack Welch connection

2010-11-07T20:45:00.001Z

Porpoises truly are very cute animals. They are fun, playful, cuddly, bubbly, and social. Moreover, in many countries and cultures, stories exist about how porpoises saved sailors whose ships sank in stormy weathers far from land, by tirelessly pushing them to safety with their snout. The saved sailors, once firmly ashore, would of course tell everyone the tale of their miraculous saviour, and the porpoises became revered and adorned.

Yet, somehow, whenever I see one (in SeaWorld or on television), they make me think of Jack Welch…

Not because Jack Welch is fun, playful, cuddly, bubbly, and social – not many would put Neutron Jack in that category – but because of selection bias.

“Selection bias” thou might wonder, “what the heck is that?” Well, it basically is a statistical term that explains how we make mistakes and draw erroneous conclusions if we base our analysis only on what we observe, and not on what we don’t see. Let me explain.

Given the abundance of stories, there probably really are sailors who were pushed ashore by a rather helpful porpoise. Porpoises are playful animals and they like pushing things around – including swimming sailors. However, it is quite likely that they don’t give a rat’s ass where they push their newly found toy. They probably push the sailors found in open sea in all sorts of directions; some of them happen to be headed toward land. Yet, for every sailor safely pushed ashore there probably are several seamen who were pushed in all sorts of directions but to land. Unfortunately, they just did not live to tell…

The sailor who was pushed ashore by the porpoise told everyone about his miraculous rescue but his unfortunate colleague who each time was pushed back into open sea whenever he got land in sight, vigorously cursing the bloody animal, did not quite get to tell his version of events.

That’s selection bias, and the world of business is full of it. We analyze companies, investment strategies, and the chief executives of the cases that became a success, but we don’t quite see how many went under following pretty much the same path. Jack Welch’s famously hard-headed management style worked well for GE and pushed it ashore, but who is to tell how many companies drowned receiving the exact same treatment? Basically, we just don’t know, but it would be unwise to just take any “successful” strategy for granted, and mimic the actions in the determined (but possibly false) belief it will lead us to safety too.

The hidden costs of outsourcing

2010-11-02T16:07:00.001Z

I’d say there are even more hidden dangers to outsourcing than giving up control of key activities. What is also a major risk, is that of the loss of particular capabilities which – and you might not quite realise this at present – are crucial to your performance in further downstream activities.

Let me give you an example. My colleague at the London Business School Markus Reitzig, together with his co-author Stefan Wagner, examined outsourcing in one particular process; a firm’s filing and enforcement of patents. Firms that do R&D usually try to protect their inventions by getting a patent. Once the patent is granted they often need to engage in enforcing it, for example through proactive and reactive litigation. These different types of activities – patent filing and patent enforcement – are such specialised activities that usually they are carried out by different individuals within an organisation.

And now comes the trick: Quite often, firms would chose to outsource the patent filing to some external, specialised law firm – “because they’re the experts and can do it more efficiently than we can”. At first sight, that seems to make sense. However, one of the crucial activities conducted for patent filing is the identification of “prior art”. Prior art encompasses all knowledge disclosed to the public before the patent is applied for. And if a firm outsources the entire patent-filing activity, it also leaves this identification and interpretation of prior art to the external solicitors. The problem is that, in the process, the firm will also lose a rather important “by-product”, namely knowledge about the firm’s technology competitors. That is because, as a result of investigating prior art, firms usually learn an awful lot about competitors working on similar issues. And that knowledge is rather relevant further down the line…

Markus and Stefan examined the firms that had outsourced patent filing and statistically compared them to a bunch of firms which continued to do both activities in-house (despite many telling them “you should really stop doing that, you know; it’s old-fashioned; haven’t you ever heard of outsourcing?!”). And they found that the firms that had not outsourced their patent filing activities were much better at identifying potential technology competitors (and their weaknesses) early on. This gave them the possibly to successfully attack them proactively. Firms that gave up on their own in-house patent filing function, and outsourced it to some external specialist, found themselves ill-equipped for patent enforcement activities. Consequently, their downstream performance plummeted.

My guess is that what Markus and Stefan found for patenting is true for many activities; outsourcing one sub-process might have undesirably (hidden) consequences for some other function somewhere else within the firm. These linkages are largely unknown and often impossible to observe, quantify and measure. However, that does not mean that the costs are not very real!

You have to be careful with outsourcing. What may seem like a relatively tangential activity to you, which you could safely put in some externals’ hands, might accidentally make you lose a capability which is critical further down the line. And once you’ve lost that in-house capability, it will be very hard to get it back.

The hidden dangers of outsourcing

2010-10-28T15:52:00.002+01:00

Outsourcing is one of those words that have become hideously fashionable in corporate lingo in the last 5 to 10 years. A business cynic – which obviously I am not! – might conjecture that perhaps it is popular because it appeals to some fundamental human desires for shirking and procrastination, finally telling managers “to stop doing certain stuff” rather than always pushing them “to do more”. I, as a more thoughtful business observer, on the contrary, think that outsourcing often makes sense, simply because you cannot, and should not try to do everything yourself. Other companies can sometimes do a particular thing better and more efficiently than you, if alone because they can bundle and specialise in it, and then you’re better off buying it from them.

Some companies take it a bit far though… Some time ago I was talking to a senior executive of a major airline and they actually had the idea that in the future they might be able to get rid of all their staff, facilities, pilots, planes, and so forth, and concentrate on “being the director of the chain”; that is, not actually do anything but tie together all the activities conducted by others. Hence, outsource everything accept for the coordination between all the parts. Well… here is my opinion: You can forget about that. Try that, and it won’t be long before nobody needs you anymore.

The classic example of that is IBM’s PC in the 1980s. It was IBM’s plan to outsource everything, add its brand name and just one little microchip connecting all the PC’s ingredients. They outsourced the PC’s microprocessors to some geeky guys who owned one of those founded-in-a-garage little companies in Palo Alto (the little company’s name was Intel) and the operating system to yet another geeky guy with big glasses heading a founded-in-a-garage little company in Seattle (the geeky guy’s name was Billy Gates), in the process provoking the genesis of the most powerful alliance the world of business has ever witnessed: Wintel (Windows and Intel).

Because following in IBM’s footsteps towards Palo Alto and Seattle were all the other computer manufacturers which copied the PC; hence buying their microprocessors from Intel and their operating system from Microsoft. And not for long, Intel, Microsoft and end users alike could not quite remember why they needed IBM in the first place and completely “disintermediated” them. It were Intel and Microsoft that reaped the great big benefits of the booming computer market and not grandfather Big Blue IBM, which ended up in a severe crisis as a result of it.

Hence, be careful with outsourcing; giving up control might get you more than you bargained for (especially if it concerns geeky guys in a garage).

Forced to be stupid

2010-10-21T11:27:00.000+01:00

Jessica Nolan, a researcher at the University of Arkansas, was interested in persuading residents of a particular California Community to conserve more energy at home. For this purpose, she designed four types of notes, to be delivered to people’s homes. These notes (roughly) said the following:

1. do it because it helps the environment
2. do it because it benefits society
3. do it because it saves you money
4. do it because everybody else is already doing it

Before using the notes, she knocked on a number of residents’ doors and asked them which of the four arguments would most likely persuade them. Pretty much everybody said, “Not the fourth! (I care about the environment, I care about society, I certainly care about money, but I couldn’t care less about what everybody else is doing”). But did they?

Subsequently, Jessica sneaked out at night and hammered one of the four notes on each door in the community.

Some time after that, she went back to check people’s meter readings. And guess what: households that had received the fourth note (“everybody else is doing it”) had by far the biggest reduction in energy consumption.

We are hugely affected in our decision-making and behaviour by our notion of what others are doing, although we usually don’t quite realise it (and deny it vigorously!). We might think that “oh no, I don’t care what others are doing” but reality is: we do. It is only human

Even top managers can be almost human (or at least some of them). For example, there is a lot of research on what influences managers’ strategic decisions (e.g. whether to choose strategic option A or B). And guess what, it’s imitation.

There is research on where firms choose to locate their new plants, whether or not they enter a particular market, adopt a new type of organizational structure, a governance instrument, etc. etc. Consistently, results show that managers are led by one simple question: “what are my competitors doing?” And then just do the same thing.

The problem is, sometimes what your competitors are doing is stupid. For example, research has indicated that (in certain industries) ISO9000 quality norms are counter-productive. Yet, throughout the 1990s firms imitated each other anyway and adopted the system.

And it gets worse. Sometimes, if you’re the odd one out that does not adopt the new practice, you start to look “illegitimate”. Analysts, shareholders, customers and so on start asking questions: “everybody else is doing it; shouldn’t you?” “Surely, everybody else can not be wrong”. But yes they can!

In this case – because customers start to shun them, investors criticize them, analysts downgrade them, etc. – firms may actually start to suffer from not having adopted the silly practice.

This places pressure on the firm to also act stupid, just to fit in, and be accepted. It takes a brave firm, to stop such a vicious cycle of imitation.

How big is your yam? (not that it matters)

2010-10-15T11:24:00.000+01:00

Why are so many executives so pre-occupied with the size of their company? Like bigger is always better. It especially annoys me when it is used as an excuse for acquisitions.

“This take-over will immediately make us the largest company in the industry”. So?! What is your point?!

I am sure being the biggest can have certain advantages, but that doesn’t mean that bigger (let alone being the “biggest”) always automatically is better. If you can explain to me why more scale is better, ok, but until then, I remain sceptical.

Of course company size is often associated with (financial) success. For example, the firms that always feature on “the most admired companies” lists are usually Behemoths such as Toyota, Dell, Intel, Wal-Mart, and Pfizer. Several of them became big through acquisitions.

And I am sure a company worth £10 billion attracts quite a bit more attention (for instance in the business press) and admiration than any of the 10 companies that they acquired that were worth a mere £1 billion. But that doesn’t mean that our ten billion Behemoth generates more profits than the 10 smaller ones would have made in combination. It wouldn’t have been as eye-catching, to have 10 small ones instead of one biggie, but it just might have made more sense (and money).

Importantly, managers who opt for a strategy of increasing size reverse cause and effect; although success will likely make you bigger, striving for size per se is not necessarily going to make a company more successful.

They actually remind me of the aboriginals on the Micronesian island of Ponapae. What in their society contributed to a man’s prestige was owning a very large yam. This cultural trait had come into existence because it represented an indication of a person’s skill as a farmer. However, gradually people’s efforts to obtain or grow one big yam started to be detrimental for their welfare, in the sense that it distracted effort and attention away from all other activities, causing malnourishment and hunger. People were putting all their resources, time and effort into growing one giant yam, while their fields were left unattended, their huts crumbled around them and their children cried of hunger.

Similarly, striving for size itself may be counterproductive for companies. It is quite possible that focusing all ones resources and efforts on becoming bigger (for the sake of being big) might actually decrease the firm’s chances of becoming successful. Gaining size may result from firm success, pursuing size per se, rather than success itself, may be quite detrimental.

Should we stop saying that the market is efficient?

2009-10-03T09:30:00.000+01:00

No, we should not stop saying that the market is efficient. We should stop saying that, because the market is efficient, the most efficient firms prevail. Because they do not. And that is because there are always multiple markets going on at the same time.

Take a firm in any market of your choice, and then consider this firm’s internal labor market. It often is a very competitive race who is going to be the CEO of the company. Yet, the characteristics that make a person more likely to win this race do not necessarily make him or her a good person to lead the company. Let me explain.

An interesting line of research in social anthropology analyzed what type of person is more likely to rise through the ranks to become the headman of a tribe. Often, this would be the most fierce, ambitious and aggressive warrior, who would be willing to take on all his opponents in the quest for leadership. Yet, interestingly, although characteristics such as fierceness and ambition would be helpful in becoming tribe leader, these characteristics were not necessarily positive for the future of the settlement, since these type of leaders were prone to take the tribe to war. This would ultimately take its toll on the size, strength and survival chances of the tribe. Thus, the same characteristics that would make people more likely to become the headman were likely to get the tribe in to trouble.

CEOs might not be all that different. Those people who are ambitious, risk-seeking and aggressive enough to be able to rise to the ultimate spot of CEO, just might be the same people who, once they’re there, take their firm on a conquest. Take acquisitions. They often offer the thrill of the chase. You select a target, mobilize resources and lead the attack. Sometimes there are others eyeing your prey but skilful maneuvering and a fierce battle will make you come out victorious again. And another victory means pictures in the newspapers, popping champagne, and a larger tribe to rule and command.

Yet, we have seen many firms going on an acquisition spree, inspired by their ambitious new CEO, who not for long went down in a blaze without much glory. The aggressiveness, boldness, and risk-taking behavior of the person at the helm had brought him or her to that position, but it didn’t translate well into a sensible corporate strategy.

Markets are in some form or another efficient, whether they are internal labor markets or markets for corporate control. But they may not be aligned, and victory in one may very well lead to defeat in another.

Can we please stop saying that the market is efficient?

2009-09-29T09:29:00.000+01:00

The economist Jovanovic wrote, about a quarter of a century ago, “efficient firms grow and survive; inefficient firms decline and fail”. What he meant is that the market is Darwinian; it will rule out the least efficient firms, with habits and practices that make them perform comparatively badly, and it will make sure efficient firms prosper, so that only good business practices prevail.

Yeah right.

When you look around you, in the world of business, one sometimes can’t help wonder where Darwin went wrong… How come we see so many firms that drive us up the wall, how come we see silly business practices persist (excessive risk taking, dubious governance mechanisms, corporate sexism, grey suits and ties to name an eclectic few), and how come so many – sometimes well-educated and intelligent – people continue to have an almost unshakable belief that the market really is efficient, and that it will make the best firms prevail if you just give it time?

That’s because the logic is not entirely wrong. The market is Darwinian, and the firms with the highest level of “fitness” are the ones most likely to prevail. However, our Darwinian view of business is also so incomplete and simplistic that I am unsure whether it would make Mister Charles Robert Darwin cringe, burst out laughing, or pull the hairs from his famously bulging beard in agony. Darwinian mechanisms – or market mechanisms if you prefer – namely work at different levels. And sometimes they conflict. Let me explain.

Some business practices, like the ones mentioned above, will actually reduce the fitness levels of the firms that adopt them, and make them less efficient, yet they persist. That’s because these practices have a fitness level of their own. They survive just like viruses survive among humans. The flu kills many thousands of people every year, and at first glance it seems a slightly flawed strategy of this virus to kill one’s host, yet it persists. Why is that? That’s because it spreads quicker than it kills. It doesn’t matter much, for a virus, that it reduces the fitness of its host, as long as it jumps to someone else before the host snuffs it! And in a way that is what bad business practices do too. They spread easily and kill slowly and stealthily.

Moreover, the flu doesn’t kill everybody that gets it; it often just makes them perform worse. And that is what bad practices do too. Just like an extremely lethal virus dies out – because it kills its host before it can spread – terrible business practices also never quite see the light of day. It is these stealthy, annoying, nasty, creepy, sneaky, and irritating, pains-in-all-sorts-of-bodyparts practices that tend to persist. They don’t kill instantly, but gradually wear a firm down.

And there is another advantage to that – for the practice that is. Firms don’t quite know that the practice is bad. Very bad practices are easy to spot, so nobody adopts them, but not these ones! They’re like a sneaky virus – you catch it before you realize it, and the negative effects only become apparent in the long run.

An example you say? Well, take ISO9000 and apply it in a very innovative industry. Research – by professors Benner from Wharton and Tushman from the Harvard Business School – has shown that ISO9000, in the long run, can have a severe negative impact on a firm because it hampers innovation. Yet, the short-term benefits are clear; adopting ISO9000 often comes with some good reputational effects, an immediate increase in customers, and satisfied stakeholders. However, the negative effect on innovation, in the long run, may outweigh all of this.

Nevertheless, firms adopt the practice because they do see the short-term benefits, but are quite unaware of the long run detrimental stuff. To managers in charge of improving their firms’ performance now, the practice seems attractive because they noticed that companies in other industries (perhaps not so reliant on innovation) benefited greatly at the time they adopted it, many of the firm’s competitors are currently adopting it, and they all see a surge in customer applications too! Of course it looks attractive!

Moreover, once we start to suffer from a shortage of internal innovation, many years will have passed, and no-one quite realizes that the creeping troubles were originally triggered by the adoption of the ISO9000 practice a long time ago. The practice gets adopted by many many firms and continues to persist, despite the fact that everybody would be better off without it.

The same may very well be true for quite a few of our popular governance mechanisms, the practice of excessive risk taking as we saw it in investment banking, many forms of performance management systems, and certainly for corporate sexisms, and pin-striped suits with purple ties on hot summer afternoon. It is not that Darwin is wrong – and the mechanisms he discovered do not rule our markets – it is just that they’re just as difficult to shake off as a common cold. And that they are just as annoying.

Is Your Company Brave Enough to Survive?

2009-09-21T09:24:00.000+01:00

As a professor of strategy, lately I've been getting asked quite a lot, "What can our company do to survive the downturn?" I'm sorry, but the real answer is, "Not a lot."

The market is Darwinian: the strongest ones survive. And an economic downturn is like winter in Alaska; many animals can live a happy life in Alaska all through spring, summer, and fall, but when winter comes, it's not a great place to be. It's a much tougher environment — and only the fittest survive.

If you're not very strong, if you haven't accumulated much body fat or haven't developed the ability to hibernate, I am afraid it is going to be tough for you, too. "But what can I do to become stronger? Get thicker skin? It's getting a bit cold here!" you might cry. Well, I am sorry (again), but winter in Alaska is not a great time to try and become stronger. It is a tiny little bit late for that...

But I do think there are a few survival techniques from looking at firms' downturn survival strategies, although they are not for the faint-hearted.

First, we see quite a lot of firms display what we in management academia call "threat-rigidity effects." When under threat, facing a shortfall in performance, firms are inclined to more narrowly and firmly focus on the one thing they do well (e.g. their core product or service), stop doing other things, and become more hierarchical and top-down in terms of management control.

Unfortunately, this often makes things worse, or at least prevents you from coming up with any solutions. What firms are better off doing, is opening up; exploring new sources of potential revenue and experimenting with bottom-up processes to generate such ideas and innovations. Let me give you an example.

I am in touch with a company, here in London, that provides custom-made software for all sorts of logistics systems, which they offer in combination with personnel training. Unfortunately, the vast majority of their customers are automotive companies, like General Motors and Ford... clearly not a great position to be in right now. This recession has definitely been winter in Alaska for them, and at first they went through the usual cost-cutting and rounds of lay-offs.

After a while, though, the CEO decided to try something a bit different. He initiated some processes for all employees to start generating ideas for potential new sources of revenue, which they enthusiastically participated in (it was not like they had anything better to do...). Most ideas were rubbish; some ideas were so-so, but a few ideas were really good! One of these ideas has now brought them a substantial new source of revenue.

One team had noticed that there was always one business unit doing rather well among their automotive customers; the unit providing spare parts. That's understandable; in a downturn, when people stop buying cars, more people need to have their cars repaired. And this greatly helps the spare parts units. So, this team decided to propose an inventory control product specifically aimed at the spare parts units of automotive companies. And it worked.

This is the opposite of the usual "threat-rigidity effects" — rather than focusing and becoming more narrow and top-down, this company opened up, organized bottom-up processes and tried something new.

This is a brave thing to do, when the winter blizzards are turning your ears frosty, because it feels like spending money rather than saving it. But finding the "spare parts division" among your customers might just see you through the downturn.

CEOs seek external advice – if you pay them for it…

2009-09-13T15:54:00.000+01:00

There is ongoing debate whether performance related pay for top managers – in the form of stock ownership, options, or other types of financial incentives – actually works. We know it alters their behavior but does it improve it?

I’ve quoted some of the research in this area before but, in a way, whether or not it does, it remains a bit strange that top managers would need performance related pay. As I have said before, do you really want someone at the helm of your company if he or she only works hard and smart if they are directly rewarded for it? On the other hand, I have to admit, no matter how rhetorical this question is intended, I do guess it is only human…

It is only human that our behavior is altered due to performance related pay; and you and I are probably no exception. The trick then, of course, is to get the right measurement system, and perhaps to no overdo it; too much performance related pay may alter the behavior of top executives in ways you had not quite in mind when putting the measures in place! We’ve seen ample examples of that over recent years…

So, how might it bias top executives behavior in useful ways? Professors Michael McDonald from the University of Central Florida, Poonam Khanna from Arizona State University, and Jim Westphal from the University of Michigan examined an intriguing aspect of CEO behavior, and that is their inclination to seek advice from others.

CEOs often seek advice on strategic issues from executives of other firms. However, we also know from research that – just like humans – they are often inclined to solicit that “advice” from friends and other people who are just like them. In such cases, it is not really genuine advice-seeking, but it serves more in a self-confirmatory fashion; people seek confirmation that what they are doing is right, and what better way to get that by asking the opinion of your friends and look-a-likes.

To examine which CEOs engage in this pseudo-advice seeking and which ones truly turn to people who might actually disagree with them, McDonald and his colleagues surveyed 225 large American industrial and service firms. They managed to obtain information on how often their CEOs sought the input of other top managers outside their own firm and how well acquainted they were to them. Subsequently, they statistically correlated that to the extent to which these top managers received performance-contingent compensation packages, and found a very clear result.

Those CEOs who had a very small performance-related pay component in their compensation package sought very little true external advice. They relied on asking their friends – and perhaps their wife, uncles, and mother – whether they too thought that what they were doing was great, splendid, and spot-on. I guess it helps people feel more confident and self-assured…

In contrast, CEOs with a relatively large performance-contingent component in their remuneration package much more often sought advice from other executives who were not their friends and who had different backgrounds than themselves. These people may be slightly scary (they may actually tell you that what you’re saying is nonsense!) but perhaps also more useful. Moreover, McDonald and colleagues showed that this true advice-seeking significantly helped the financial performance of the CEOs’ companies, in the form of an increase in the company’s market-to-book and return on assets. Thus, the scary stuff actually led to hard cash!

The pay-for-performance construction paid off; it stimulated executives to repress their “it’s-only-human” inclination to avoid asking people’s opinion who might actually disagree with you. It is much safer and more pleasant to make sure to solicit advice from people who will say that you’re splendid, but it is much more useful – and lucrative – to really put yourself to the test. And if you reward them for it, and only if you reward them for it, CEOs – just like humans – will actually be brave enough to take this test.

Who can downsize without detriment?

2009-09-08T15:53:00.000+01:00

Downsizing has always been a rather popular practice in the corporate world – even for firms not in distress, attempting to boost their share price – but my guess is that, at present, executive courses such as “how to downsize your company” are the last remaining strongholds in many business schools’ executive course offering. So I thought I might as well look into what we know about the effects of such programs from academic research, to see when they can be a good idea.

Let me start by saying: not very often. On average, they simply don’t work. For example, professors James Guthrie, from the University of Kansas, and Deepak Datta, from the University of Texas at Arlington, examined data on 122 firms that had engaged in downsizing and statistically analyzed whether the program had improved their profitability. And the answer was a plain and simple “no”. The average company did not benefit from a downsizing effort, no matter what situation and industry they were in.

So why do they usually not work? Well, for starters, as you can imagine, it is not a great motivator for the survivors. Academic studies confirm that usually organizational commitment decreases after a downsizing program and, for example, voluntary turnover rates surge. Hence, downsizing is not something to be taken lightly, and should be avoided if at all possible.

But sometimes, of course, a company’s situation may have become so dire that it may not be at all possible. What then? Who might be able to get away with?

Professors Charlie Trevor and Anthony Nyberg from the University of Wisconsin-Madison decided to examine exactly this question, surveying several hundreds of companies in the US on their downsizing efforts, voluntary turnover rates, and HR practices. As expected, they too found that for most companies, voluntary turnover rates increased significantly after a downsizing program. Many of the survivors, earmarked to guide the company through its process of recovery, decided to call it a day after all and continue their employment somewhere else – a nasty and unexpected aftershock for many slimmed-down company; they became quite a bit leaner than intended!

Next, however, professors Trevor and Nyberg examined who could get away with a downsizing program or, put differently, what sort of companies did not suffer from such an unexpected surge in voluntary turnover after their downsizing program. And the answer was pretty clear:

Companies that had a history of harboring HR practices that were aimed at assuring procedural fairness and justice – such as having an ombudsman who is designated to address employee complaints; confidential hotlines for problem resolution; the existence of grievance or appeal processes for nonunion employees, etc. – did not see their turnover heighten after a downsizing effort. Apparently, remaining employees were confident that, in such a company, the downsizing effort had been fair and unavoidable.

Similarly, Trevor and Nyberg found that companies with paid sabbaticals, on-site childcare, defined benefit plans, and flexible or nonstandard arrival and departure times did much better in limiting the detrimental effects of a downsizing program. The surviving employees were more understanding of the company’s efforts, had higher commitment, or simply found the firm to good a place to desert!

In general, it shows downsizing can work, but only if you have always taken commitment to your people seriously. Instead, if your employees sense that you may be taking the issue rather lightly, they will vote with their feet. And you may end up losing rather more people than you had bargained for. Or as Fortune Magazine once observed, most firms that downsize, “rather than becoming lean and mean, often end up lean and lame”.

Stock options, CEO risk taking, and earnings manipulations

2009-08-30T15:52:00.000+01:00

Any idea why we continue to reward top executives with stock options? We accept it, nowadays, as a given, but why do we have that practice in the first place?

You might say “because it constitutes performance-related pay; through them, you financially reward top managers for their achievements”. Fair enough. Because for many of us mortals our pay depends to some extent on our performance. However, do realize that for CEOs, for example, this component is often as high as eighty percent. Eighty percent! Do you know many people (employed in the same large corporations that these executives head) whose salary is eighty percent dependent on some measure of their achievements? Not many I suspect.

But, in theory, these large corporations that reward their top managers through stock are right – and I am saying “in theory” for a reason. This practice – of offering CEOs stock-based pay – is a recommendation straight out of something called “agency theory”. It is one of the few academic theories in management academia that has actually influenced the world of management practice. It is basically a theory that stems from economics. It says that you have to align the interests of the people managing the firm (top executives) with those of its shareholders, otherwise they will only do things that are in their own interest, will be inactive, lazy, or plain deceitful. Yep, these economists have an uplifting worldview. But that is why we have such a huge performance-related component in the pay of most top executives.

But are you really sure you want people like that managing your firm? People who will be lazy and only operate in their own interest if given a chance? Do you really want a CEO who really needs performance-related pay and who otherwise, if put on a fixed salary, wouldn’t do much and just hang about? In case you missed it, I intended this as a rhetorical question…

But anyway, we give them stock – and lots of it – to incentivize them. But the question still lingers: why stock OPTIONS? And that’s a story in itself.

Agency theory doesn’t only say that people will be lazy and deceitful if given a chance; it also says that managers are inherently risk-averse; much more risk-averse than shareholders would like them to be. And the theory prescribes that you should give them stock options, rather than stock, to stimulate them to take more risk.

More risk!? you might think. Do we really want CEOs of large corporations to take MORE risk?! Is it not, given recent events in the world of business, that we would like our top executives to be a little less risk taking for a change…? Ah, that’s what you might think now, but it is not what agency theory thinks, and it is not what the incentive structure of most public corporations nowadays is geared to do.

Because stock options do stimulate risk seeking behavior, as we know from academic research. Options, as you might know, represent a right to buy shares at a certain price at some fixed point in the future. If you are given the right to buy a share in company X for $100 in January 2010 and by then the share price of X is $120, you will have made 20 bucks. However, if the company’s share price by then has dropped to $90, your option is worthless; we say it is “out-of-the-money”: you’re not going to exercise your right to buy at 100 when the market price is merely 90.

In that situation, if the CEO of X has many stock options, it stimulates him to be very risk seeking. For example, if by August 2009 the share price is 90, he will be inclined to engage in risky “win or lose” moves. If the risk pays off and the share price rises well above a 100, the stock options will become worth a lot of money. However, if he loses, and the share price plummets even further, say to 60, no worries; it doesn’t matter. The stock options to buy at $100 were worthless anyway; whether the stock trades at 90 or at 60.

And, as said, research by for example Professors Gerry Sanders from Rice University and Don Hambrick from the Penn State University showed that these things work. They examined 950 American CEOs, their stock options, and their risk taking behavior. They found that CEOs with many stock options made much bigger bets; for instance, they would do more and larger acquisitions, bigger capital investments, and higher R&D expenditures

However, they also showed that they weren’t always very good bets… The option-loaded CEOs delivered significantly more big losses than big gains. That’s because they didn’t care much about the losses (their options were worthless anyway); all they were interested in were the potential gains.

Moreover, Professor Xiaomeng Zhang and colleagues, form the American University, examined the relationship between stock options and earnings manipulations; plain illegal behavior. They investigated 365 earnings manipulation cases and showed that CEOs with many “out-of-the-money” options were more likely to misrepresent their company’s financial results (and get caught doing it!).

Hence, even if as a board member or shareholder you’d want to stimulate your CEO to take more risks – and I guess that is a big IF – I am not so sure that stock options will get you the kind of risk you’re after…

When knowledge hurts

2009-08-23T15:47:00.000+01:00

Over the last decade or so companies have been told till it was a nuisance that their knowledge is their ultimate (if not only) source of competitive advantage. They have been encouraged – by management gurus, academics, and ample management consultants alike – that they should invest in knowledge development, protect it, and makes sure it gets identified, codified, and even put on the balance sheet.

The advice was to carefully identify best practices and make sure that you have systems that help these practices to be shared throughout the organization. This way, you will make optimal use of the great good and surely a healthy return will follow – or so the preachers said.

Many companies responded, as advised, by setting up internal systems that could be used to store and access all sorts of documents, as well as systems to aid the identification of experts in the organization and ways to contact them for advice.

But have these knowledge management systems turned out to be as good as was promised to us? Well… let’s say that a few caveats have emerged.

Because what we sort of forgot in the torrent of knowledge euphoria is that this stuff can also come at a cost. The cost of actually finding it, for example, in the jungle of corporate databases, but also the cost that comes with the fact that re-using prior knowledge doesn’t necessarily make you very original. And that’s a problem, especially when you need to stand out from the crowd.

Professors Martine Haas from the Wharton School and Morten Hansen from INSEAD, for example, examined the use of internal knowledge systems by teams of consultants in one of the big four accountancy firms, trying to win sales bids. They measured to what extent these teams accessed electronic documents and how much they sought personal advice from other consultants in the firm. They figured that, surely, accessing more knowledge must be helpful, right?

But they proved themselves wrong; to their surprise they found that the more internal electronic databases were consulted by these teams the more likely they were to lose the bid! Likewise for seeking advise from colleagues. This effect was especially pronounced for very experienced teams. These guys were much better off relying on their own expertise than trying to tap into experiences by others, whether it was in the form of electronic stuff of external advice.

Haas and Hansen figured that the opportunity costs of accessing all this prior knowledge must be huge; big enough to offset any potential benefits. Searching through the plethora of documents and soliciting advice from colleagues actually withheld the teams from making substantial investments into putting together a truly original and suitable proposal.

Things were even worse in situations in which competing firms were simultaneously bidding for the same lead, and being able to differentiate yourself from these rivals became crucial. In these cases, utilizing prior knowledge seemed to lead teams to develop cookie-cutter solutions when being original and innovative was what was really needed. As a result, they lost the bid.

The only times that a team benefited a bit from accessing internal knowledge sources was when it concerned a very inexperienced team. In such instances, talking to a few internal experts improved their chances of putting together a winning proposal. However, the internal document databases were always useless at best. The more these rookies tried to tap into the mountain of electronic documents available to them, they worse their chances of coming up with the winning bid.

The advice to derive from this research? Shut down your expensive document databases; they tend to do more harm than good. They are a nuisance, impossible to navigate, and you can’t really store anything meaningful in them anyway, since real knowledge is quite impossible to put onto a piece of paper. Yet, do maintain your systems that help people identify and contact experts in your firm, because that sometimes can be helpful. But make sure to only give your rookies the password.

Corporate Social Responsibility – nice, but does it earn you any money?

2009-02-18T10:10:00.005Z

The question “should corporations actively invest in socially responsible stuff, or should they simply focus on making money?” continues to linger and re-emerge on the business agenda (especially, it seems, around the time that business-minds receive the call to once more swarm to Davos).

People are then quick to shout “but they are not two different things; behaving in a socially responsible way will, in the long run, also make you better off financially!” but, in spite of the latest tally of 225 academic studies trying to provide hard evidence of the existence of that relationship, proof of that statement is unfortunately actually pretty hard to find…

And I say “unfortunately” because it would of course be nice if the socially responsible companies would also get financially rewarded for their honorable endeavors. But it is hard to provide solid evidence for that. For example, although we do know from research that socially responsible companies are usually the better-performers, the tricky thing is that, as we say, the causality often seems to run the other way around; once firms are beginning to make a healthy profit, they start acting in socially responsible ways. If losses pile up, the responsible stuff is the first to go out of the door. Hence, socially responsible behavior does not make you a better performer; good financial performance leads firms to behave in more responsible ways. It seems it is a bit of a luxury product that we only indulge in if we feel we can afford it.

However, on the bright side, there is certainly no evidence that firms acting in socially responsible ways perform more poorly as a result! So, if it doesn’t cost you anything, why not do it?! Yep, you will have to spend a bit more money, not using suppliers that employ children to produce their stuff, recycling your toxics although you could have had it legally dumped somewhere else, and invest in some services for your local community and the family of your employees although you could have told them to bugger off and take care of themselves. However, these niceties may also appeal to your customers, to green investors, will make you more attractive as an employer, and so on. And apparently these costs and benefits seem to largely average out so at least there seems no reason not to be a good guy!

However, it would still be nice if the socially responsible types were actually better off would’t it…

Professors Paul Godfrey, Craig Merrill, and Jared Hansen, from Brigham Young University and the University of North Carolina, came up with a clever insight why the socially responsible types may be better off after all. They didn’t just look at the social and financial performance of all sorts of companies but they decided to specifically focus on companies that got into trouble because some negative event had happened to them. This could be the initiation of a lawsuit against the firm (e.g. by a customer), the announcement of regulatory action (e.g. fines, penalties) by a government entity, and so on. Then they measured what happened to the share price of the company as result of the event. And the interesting thing was that how much you were punished by the stock market for the negative news depended very much on how much of a socially responsible company you were.

Firms that scored low on a social responsibility index saw their share price plummet if they had to announce a negative event. Firms with very good social track records did not see their share price go down that much. Paul, Craig, and Jared concluded that, apparently, your socially responsible reputation acts as some sort of an insurance; when something bad happens to you (in the form of a serious customer complaint or a government fine) investors conclude that you probably made a genuine mistake, and that you will definitely do better next time, and that there is nothing structurally wrong with you or to worry about. However, when you are much more of a social villain, the stock market washes its hands of you, drops its financial support, and makes your share price plummet.

Thus, good guys are better off after all. And the dollars you spent on being socially responsible do pay themselves back and turn into profit, especially when you are in a rot.

Who to turn to in a downturn? Insights from top performers in meagre times

2009-02-11T17:09:00.002Z

Of course I get asked quite a lot, lately, is there any research on firm strategies in a downturn? And I have to say, the answer is (unfortunately) pretty much “no”.

There is a lot of research in the field of strategy on companies that are in trouble. There is also quite a lot of stuff on companies that operate in industries that are in decline, for instance because their business model is antiquated or their technology has been surpassed. But there is nothing, to the best of my knowledge, on what corporate strategy to follow if the whole planet is in decline…

Someone also asked me, the other day, do you know of any companies that do particularly well in a downturn? And actually, I realised, that’s not a bad place to start. I mean, perhaps we can learn something from these businesses; in terms of insights that other companies can also apply in their attempts to weather the storm. So let me give it a try. I am going to – quite cowardly – not present these deliberations in the form of insights or findings but in the form of questions. Questions you can ask yourself, as a company, to try to think of ways to improve your chances of survival whilst the world is in a downturn.

Be Morrisons (not Waitrose)

The first, fairly obvious, type of business that does relatively well in a downturn are the ones that offer products or services at comparatively low costs. Their price-quality ratio is low, relative to their direct competitors. For example, supermarkets like Morrisons, which compete on price, are currently showing much better numbers than a more upmarket quality provider like Waitrose. These companies always provided that type of price-quality ratio but now more and more customers put higher weight on the price aspect of the ratio, which makes Morrisons flourish.

It seems quite obvious but, nevertheless, it is worth thinking about. Is there anything you can do to offer your (potential) customers lower cost options (probably at the expense of some quality)? I am often a bit surprised by how reluctant businesses are to give up margin when times are tough. It seems many firms think they can’t afford to lower their margins because that’s the remaining source of income while customers are deserting them. However, fewer customers may desert you if you do lower your margins! You may even win a few. Moreover, many customers are willing to sacrifice quality for price, IF you give them the choice.

Be a shoe repair shop

But, as said, that’s the obvious one. One step further are the types of businesses that help companies extend the life of their current resources. Think of car part dealers or shoe repair shops. They actually grow during times of decline (as they are doing now)! People and companies are having their cars repaired rather than invest in a new one. Can you, as a business, think of a product or service that you can offer to help your clients get more out of their old shoes? Can you offer upgrades of existing technologies? Can you offer marketing services that extend the lifecycle of your client’s product?

Moreover, do you have clients that are like shoe repair shops and car part dealers. Or could you make them your clients and offer them something they might be interested in? After all, they can afford it, and probably could use some help handling their exceptional growth.

Be a business school

Finally, can’t you be more like a business school? Seriously. During the last (mini)crisis in 2001, for example, applications to London Business School’s full time MBA programme doubled. What better time to do an MBA then during a crisis? People figured that the opportunity cost of their time was now relatively low; it is not like you’re going to get a huge pay rise or bonus during the crisis years (unless you’re a City investment banker of course…).

Moreover, by the time that they graduate, about one and a half years later, the crisis may have largely blown over and they are in a superior position to catch the first wave. Hence, be more like London Business School; clearly that can never be bad advice.

Soft stuff (such as caring for the community and the environment), shareholder value orientation, and take-over protection mechanisms

2009-02-03T10:31:00.004Z

Caring for the community and the environment, shareholder value orientation, and take-over protection mechanisms?! What do they have to do with one another?

Well, quite a bit it appears. Let me explain.

First of all, do we like it that firms can adopt take-over protection mechanisms (such as poison pill constructions)? “No we don’t!”, do shareholders proclaim in chorus. Because the threat of a potential take-over is a great way to make sure that CEOs don’t do anything that does not maximize the value for shareholders. Remove that possibility and these bloody CEOs will do all sorts of silly things that are not in our interest.

And I am afraid that is at least half true… And one of these silly things is attending to issues such as caring for the natural environment and the community. We – the wider public – may like it if corporations do that kind of stuff but it is hardly clear that shareholders do; after all, caring for such soft stuff comes at the cost of the hard stuff: cash.

Aleksandra Kacperczyck, from the University of Michigan, examined this issue in a clever way. She examined 878 public firms in Delaware between 1991 and 2002. The interesting thing about Delaware is that in the mid 1990s, due to a series of court decisions, hostile take-overs suddenly became a lot more difficult. And what Aleksandra found is that, after that fact, Delaware companies started to pay a lot more attention to catering to the community and to the natural environment. All of a sudden, it was safe for companies to do such stuff, without the threat hanging over them that they could get “punished” for it by means of some hostile take-over by another company that thought it could make more money by getting rid of all that expensive soft stuff.

Did shareholders like it? Well, they didn’t applaud the court decisions (to say the least) and the fact that now corporations could divert valuable cash to such silly things, but they had to grind their teeth and grudgingly accept it.

But were they right; that it was going to cost them money? Well, not exactly.

Aleksandra also measured what happened to the long-term shareholder value of the corporations that started to engage in the fluffy “caring for the environment and community" kinda stuff. Shareholder value actually went up! The long term market-to-book ratio of these firms started to rise as a result of these fluffy actions! The shareholders, in spite of their doubts and grudges, were better off.

A classic win-win situation appeared; having been freed from the threat of hostile take-overs enabled the firms in Delaware to do nice things for the community and the environment, which actually paid off in terms of hard cash in the long run. But there was one catch…

In a brainwave, Aleksandra decided to also look at what happened to the levels of executive compensation (in the form of salary, bonuses, and other annual remuneration perks) of the companies that found themselves shielded from the threat of hostile takeover; CEO remuneration went up… Apparently, now immune to takeover threats, top executives not only started attending more freely to the interest of the wider community but also to their own private interests. They let others share in the wealth, but didn’t forget themselves either…

Information overload – and how to deal with it (if you’re the one loading)

2009-01-27T08:47:00.003Z

Most decisions in organisations require information. And we have to actively look for that information. We approach colleagues who have dealt with similar issues, are knowledgeable about the context, the customer or the technology, and try to incorporate their experiences and insights.

Nowadays, in our “knowledge economy”, many companies have realised the value of this internal expertise and set up databases, accessible through the firm’s intranet, that we can access and search. But now the problem is – more often than not – there is just so much of it…!

We’re swamped with information! How many databases can you access? How many documents can you read?! How many colleagues’ brains and wisdom can you electronically pick?!

And this is actually not only a problem for the people looking for information. In many organisations the providers of knowledge get rewarded when others use their stuff, in the form of increased respect in the company, heightened status, and sometimes even in terms of hard cash after their annual performance evaluations. How can you as a provider make yourself heard and seen in the plethora of the information quackmire?

Professors Morten Hansen and Martine Haas – at the time at the Harvard Business School – examined exactly this issue. They examined the electronic databases of one of the Big 4 accountancy firms and surveyed its 43 “practice groups” on their strategy of what documents to upload and when. And they came back with some pretty clear insights into what works and not.

You have to understand that these different practice groups face some simple but concrete choices: how selective are we going to be in terms of the documents we upload; are we going to upload pretty much everything we get our hands on or are we only going to put up a mere fraction of what we have? What is the maximum number of files we would like to put onto the system? Do we cover a fairly wide range of sub-topics or are we going to be much more concentrated in terms of the subjects we cover?

The trade-offs are pretty clear; if you upload very few documents, people can only access very few documents. But if you put up many of them, potential users may be turned off, lose the forest for the trees and turn their attention somewhere else in disgust (while swearing at you for the sheer overload and making rude hand gestures to their computer screen). But where does the balance lie?

Hansen & Haas found out that where the balance lies depends on what the topic is that you are publishing on. If the practice group was providing information on a topic that was covered by quite a few other groups (such as for instance “cost management”, “capital & asset management”, “financing & IPOs”), they were much better off being very selective in what they put on their site. Those who made few documents available quickly gained a reputation as the group which always delivered high quality stuff without swamping you with irrelevant, low-quality distractions. More people, as a result, accessed their pages.

In contrast, groups publishing on topics which were much less widely covered (such as “Peoplesoft”, “hospital service delivery” or “call centres”) were better off providing a much wider range of documentation, that readers could really sink their teeth in. They developed the reputation “for topic X you really need to go to practice group A” and flourished as a result.

Hence, the various suppliers of information within the company competed with each other for the attention of the employees looking for relevant knowledge. And, like in any market, they needed to adapt their strategy based on the specific product they were offering.

Human nature: Self-interested bastard or community-builder?

2009-01-19T12:13:00.004Z

Whenever I ask executives how they should make an organisation more entrepreneurial, more customer-focused or simply more profitable they virtually always come back with: “incentivize people”.

Reward people for their ideas, their efforts and initiatives and they will deliver.

But always, when I ask them, if you would be on a fixed salary, would you still do your best to come up with new ideas, be entrepreneurial and deliver the best value you can for your customers? And then the answer is, invariably, “yes I would, because I don’t do it for the money”. Then people say they like being good at what they do, initiate new things, and deliver customers the best they possibly can.

But why do we always assume that other people are motivated – and motivated only – by money, and the way to get them to do stuff is by financially incentivizing them, but we? no we do things out of intrinsic motivation, because we want to do the best we can and contribute to the success of our firm. Is everybody really so different from us?

If you hadn’t noticed: that was a rhetorical question.

So why do we assume other people are only motivated by money? My guess is it goes back to why we organise our firms the way we do. How we, in our society, organise our companies is basically based on two sources: 1) The Roman army (i.e. a hierarchy with unity of command), 2) economics.

Economics has had a huge influence on how we govern our firms. For example, the use of stock options to incentivize and reward top managers comes straight out of “agency theory”, and the spread of this practice has been linked to the spread of “agency theorists” across business schools in the US after which, gradually, the phenomenon started to diffuse. And there are other examples.

Yet, economics – including agency theory – works from the assumption that people are rational and self-interested. The will work if they get rewarded for it. But if they don’t receive a direct reward or nobody can really observe their efforts, they will “shirk” and be lazy. Under this logic, indeed, you have to incentivize people; otherwise they won’t do a thing.

And I guess to some extent, we are indeed rational and self-interested, and hence motivated by money. However, there is another fundamental aspect to our human nature, one which through millions of years of evolution has made us the way we are: we like being part of a community and contribute to the well-being of that group.

Because we, humans, evolved as being part of a tribe. And people who were purely self-interested, shirking and lazy would be kicked out of the tribe, clubbed to death, if not consumed for dinner. So our gene base evolved into making us a bit self-interested but equally also community-lovers. Our deep human nature is that we all like doing things not only for our direct individual reward but also because it contributes to the community that we are part of. This community used to our tribe. Nowadays, it is often our organisation.

And if you, as a manager (i.e., headman) manage to tap into that deep fundamental need among your employees, you can build a powerful firm indeed. People love to do stuff that strengthens their firm, fulfils them with pride, and makes us feel stronger as a whole. We don’t need to be financially incentivized to do that; it’s our human nature.

Managers and leaders: Are they different?

2009-01-13T10:59:00.001Z

All these articles about what are the characteristics of a good leader or CEO always make me feel a bit sceptical. Sometimes even nauseous. It always strikes me, when I look into the history of a company and analyse its strategic development that they seem to need top people with widely different characteristics at different points in time.

Take my favourite little English company; the model train maker Hornby. When they were in trouble about ten years ago, its board appointed a tough guy: Peter Newey. He slashed costs, rigorously cut in their portfolio and fired a bunch of people. He wasn’t the most popular guy on the block (he was wise enough not to live in the company’s home town Margate; he might have ended up with a knife in his back) but – be it in hindsight – people also respected him: it was what the company needed at the time, and it is doubtful they would have survived without him.

But then Hornby hired a people guy: Frank Martin. The first thing employees told me about him was: “he is extremely good at managing relationships” (something Newey wasn’t exactly renowned for; and that’s a euphemism). And he was; he built superb relationships with suppliers, customers, retailers and investors. And the company flourished.

Yet, could he have done the tough turnaround job? Doubtful. He simply has other qualities. He too was the right man for the job at the time – just like Newey was.

You see the same thing at companies over and over again. Take Apple; in its early days, the energetic and charismatic Steve Jobs was exactly what the spawning company needed. However, when down-to-earth CEO John Sculley took over (much to the chagrin of Jobs), the company had one of its most profitable runs ever; Sculley didn’t innovate, inspire bold new moves, or initiated great change; he focused on making money, and did that very well.

And that is what the company needed at that point in time. Later, when they needed to be pushed and driven into a new direction, Sculley could not give them one; it was Jobs’ time again, to inspire, initiate and make the company grow. And again he did that very well. The same happened at the famous Swiss watch-maker Swatch: Ernst Thomke created the organisation that led to the emergence of the innovative Swatch; subsequent CEO Nicolas Hayek took the invention and relentlessly managed the organisation into a long streak of dominance and profitability. There is not one type of leader that fits all; different companies, at different times, need different people.

In the classic Harvard Business Review article “Managers and leaders: Are they different?” author Abraham Zaleznik’s answer to this intriguing (and slightly provocative) question was an unambiguous “yes”: Leaders inspire, are emotional, if not neurotic, and they are born that way. Managers are very different; they are rational, balanced, unemotional and easy to get along with (be it perhaps slightly yawning). And it is not that one is superior over the other; different firms, at different stages of their development, need someone who inspires and does extraordinary things. But at other times, you need someone rational and objective, and perhaps slightly boring. Such a person may never be “a leader”, but is a damn good manager.

Sometimes we need to be inspired, take risks and dream up wacky things. Sometimes not. Banks come to mind. Sometimes, there is nothing wrong with a boring banker. Or a boring politician.

In a crisis, innovate

2009-01-09T08:45:00.002Z

Recently, an executive – an ex-student – told me about his company. The company has a handful of competitors (it is a local business) highly similar to itself, and they’re all losing money in the current economic climate. Now one competitor – the worst-performing of the lot – has started to accept assignments for a fee below its cost price, just enough to cover its variable costs and at least earn back a tiny bit of its fixed costs. My ex-student asked me, “What can we do?”

The answer isn’t easy. But it is of course a rather typical situation to be in. It happens in most industries in trouble; some bloody competitor – often the lousiest one of all – starts to sell below cost price, out of pure desperation. Actually, my ex-student’s company responded in a way that is just as typical: they said, “But their product is inferior; we deliver quality, and customers will always want to pay for that” (and stuck to their comparatively high price). But customers didn’t. And they seldom do. Even if there is a minor quality difference – and it’s usually just minor; at least in the eyes of the customer – if the price difference is large enough, you’ll lose a lot of clients; more than you can afford.

So what can you do? What else can you do than lower your prices too, tighten your belt, hold your breath, and hope the crisis blows over before you bankrupt yourself? Because that’s what companies usually do.

I’d say the phenomenon is rather common, so the solution can’t be.

It reminded me of the English newspaper business some years ago. All quality newspapers were in trouble; stuff had started to move on-line big time, free newspapers such as the Metro had flooded the market and, on top of that, the general trend was that people simply read less. The four main players in London – The Guardian, The Times, The Daily Telegraph and The Independent – were all in decline but The Independent was the one widely expected to fall the first. The others had deep pockets due to rich owners and, due to a price war several years earlier, which had hit The Independent hardest, it was basically broke.

Now, The Independent could have done what most companies in such a situation do: moan about it, cut some more costs (or whatever is left of it) and attempt to prolong an inevitable death. But it didn’t. It took a plunge. It launched a small-sized version of its newspaper; the denounced “tabloid” format. All newspapers had been talking about it for a long time, but everyone had dismissed it as too risky (customers won’t like it), phoney or plain cheap. But The Independent launched it, and it worked (customers loved it). They survived.

Was it a coincidence that out of the four main players it was The Independent that launched the thing? Of course not. It was The Independent who basically had nothing to lose; it would have been the first one to go under had the industry continued as is. But it chose to not just prolong its demise: it took a plunge, and recovered.

The same happened to the famous Southwest Airlines. In its early days, when it was in deep trouble, it had to sell one of its four planes. Yet, it didn’t try to just save some more costs and continue with 75 percent of its operations, prolonging an inevitable decline; it took a plunge. It said “we’re going to run 100 percent of our operations but with just three planes!” and, in the process, invented the widely successful low-cost airline model, having scrapped all frills and complications, combined with the emergence of a must-succeed culture.

So, when you’re down: innovate. Don’t just wait for the inevitable to happen; prolonging your decline out of some false hope that you’ll weather the storm. Storms kill; get out of it while you can.

Operation Market Garden

2009-01-04T08:57:00.002Z

My father was a young boy during World War II. He grew up in a small village in the Netherlands just south of the river Maas, which, parallel to two arms of the river Rhine, flows from East to West, cutting the country in the half. In 1944, while the Allied Forces were moving north, approaching the Netherlands from Belgium after having landed in Normandy, the barn behind his home served as a make-shift German army hospital, while their commanders took up headquarters in the family’s living room. When the German soldiers left, the barn filled up with wounded allied soldiers instead, and the German commanders at his dinner table were replaced with their english speaking counterparts.

He never told me about what he saw in the barn. He did recall with fondness the sweets and cigarettes that the soldiers used to give him (he was 10 years old) – Germans and Americans alike.

Anyway, he used to tell me about the operations that the allied forces conducted to get across the big rivers, trying to advance into the North of the Netherlands. One of them was Operation Market Garden. Operation Market Garden was a huge operation – involving some 35,000 troops – in which soldiers, weaponry, vehicles and equipment were dropped near the bridges crossing the three rivers, to occupy and hold them while the Allied forces advanced through the south of the Netherlands, preventing the German troops from blowing them up.

Years later, I saw the (apparently very accurate) film “A Bridge too Far”, with the likes of Dirk Bogarde, James Caan, Michael Caine, Robert Redford, Sean Connery, Anthony Hopkins, and so on; clearly, a 1970s star cast.

I had become a professional student of organisations by then, having accepted a position as an assistant professor of strategy at the London Business School. It was then that I was struck by how similar the processes are that lead up to spectacular business failures to the processes that made Operation Market Garden a disaster.

Because Operation Market Garden was a huge failure. It became one of the biggest massacres of the whole war; for instance, more people died in Operation Market Garden than on D-day itself. The Allied Forces did not manage to hold the third bridge at Arnhem, and it took another 8 months before the north of the Netherlands was liberated; during the preceding winter, thousands of people, cut off from the agricultural lands of the south, perished in a famine known as “the hungerwinter”.

Yet, the commanders in charge of the operation had received many early warning signs that it was going to be a challenge; perhaps a bridge too far. The Dutch resistance had sent coded messages that that at least one German tank division was located unexpectedly close to the Allied Forces’ drop zone (their warnings were ignored); english spy plane pictures examining the drop zones had taken photographs of the tanks (the photographs were brushed aside), officers and a Polish general had expressed doubts about the preparations for the operation (their hesitations were dismissed), and soldiers questioned whether the radios, to be used for vital coordination and communication on the ground, would work (they didn’t).

So why did the general in charge of the operation (General Browning) ignore all these warning signs and proceed as is? Well, for the same reasons as why top executives go ahead with a big acquisition despite due diligence suggesting it’s a bad idea, and why companies go ahead with a planned product launch despite retailers and sales people warning the product isn’t ready yet: We call it “escalation of commitment”: There is a lot riding on the project, both in terms of what is at stake (the future of the company; the war) and in terms of the personal reputation of the individual in charge. Pulling the plug will make you look stupid and incompetent; succeeding will make you a hero. And you have made a very public commitment to seeing the project through, having championed it from the start. There is no way of stopping it now.

And when you plan an operation of this size – whether it is Operation Market Garden or a huge acquisition – you’re never going to be sure, and nothing is ever going to be perfect. When you pull the plug each time something is amiss, you’re never going to achieve anything; you need a high level of commitment and persistence in the presence of setback.

However, at some point, your commitment may escalate: Your persistence is no longer brave but foolish, as the warning signs are too ubiquitous. The trick is knowing when to pull the plug – but unfortunately it’s not like you can put that in a spreadsheet, hit enter and see the answer; it’s a judgement call.

And being too late to make this call – not realising it is has become too much – is, I am afraid, only human. It is difficult to bite the bullet and pull the plug. Yet the consequences of being human can be disastrous, and truly a bridge too far.

Too much of a good thing

2008-12-30T12:32:00.001Z

We know companies can grow too fast; it gets out of hand, they lose control and, eventually, the whole thing comes tumbling down. My favourite examples are still the ancient case of People Express in the 1980s (one of the first, and initially most successful low-cost airlines ever) and, a few years ago, Dutch retailer Ahold.

However, companies can also try too hard to grow. Hence, it is not that there’s too much growth; there’s no growth at all and that’s precisely because they are trying to hard! Let me explain.

Pretty much everyone attempts to grow. And when we look at different “strategies for growth” – that is, where can growth come from – we usually get presented a list of options: You can diversify, innovate, add new products to your portfolio; partnerships can help you grow, etc. Do these well, and the resulting factor will be growth.

However, what we are often inclined to overlook is that growth in and of itself is simply a lot of work. That is, even when just doing more of the same thing – without adding company partnerships, innovations or diversifying into adjacent businesses – growth taxes a firm’s management capacity. For example, you have to find and manage new customer relationships, add distribution capacity, recruit and train new people and business leaders, develop management systems for a larger organisation and workforce, etc. Growing a firm is a heck of lot of work.

Yet, the options to bring about further growth (innovations, partnerships, etc.) tax your management capacity too. Finding and maintaining new collaborations is a lot of work and requires much attention. So does managing the process of innovation, and developing and commercialising its output. Diversification, internationalization and acquisitions equally are a lot of work; you have to get to know new markets, products and customers; you have to work on integration and a newly formed organisational structure, manage increasingly complex management processes, etc. Doing all of it might just be too much of a good thing.

In a recent research project I evaluated the growth rate of firms in the Chinese pharmaceutical industry. This industry is turbulent and fast-changing, with a lot of entry and exit into the market. There are large potential pay-offs, but the ongoing changes in the country’s economy, population and medical system also make it unpredictable. It’s a market with lots of opportunity for growth, but also quite a brutal one in terms of the uncertainty of how to do this.

I measured to what extent firms in this industry engaged in various strategic vehicles aimed at fostering growth: Diversification into adjacent markets, innovation, establishing partnerships and adding new product lines to one’s portfolio. The results showed that, in isolation, each of these initiatives indeed stimulated growth; yet when used excessively or in combination they actually had a negative impact and hampered a firm’s growth prospects.

Hence, stop trying so hard! You might do better...

CEOs and their stock options… (oh please…)

2008-12-23T11:23:00.001Z

Do you know why we so often remunerate CEOs through stock options? Because we do; that 40-50 percent of a CEO’s pay consists of stock options is nothing unusual.

Of course it is to tie a CEO’s pay more closely to the performance of the firm s/he is heading. Inherent in the design of CEO pay packages is the assumption – driven by what is known as “agency theory” – that if you simply put them on a fixed salary, they will be lazy, won’t take any risks and certainly won’t do a thing that will only show up in the company’s results years from now (and hence only benefit their successor). No, these CEO types really need some pay incentives closely tied to the long-term performance of their firms.*

So, we use stock options to tie their rewards to the long-term performance of the firm. However, that could also be done through other means (e.g. shares), right? Correct; we specifically use options to also make these CEO buggers more risk-seeking.

Say what?! (you might think) More risk-seeking? Is that really what we need?! Yes, this agency theory stuff, which determines how we design CEO pay packages, assumes that CEOs are more risk averse than shareholders typically would want them to be. Therefore, in order to stimulate them to take more risks, we reward them through options.*

But what sort of risk-taking does this really lead to? Because what agency theory has not really acknowledged and explored is that there are various types of risk. Some risks may be good; some are not so good… Are we sure these stock options lead to sensible risk-taking?

No I am not so sure. Also because two strategy professors actually measured this stuff: Gerry Sanders from Rice University and Don Hambrick from the Penn State University. They examined 950 American CEOs, their stock options and their risk taking behavior. They found that CEOs with many stock options made much bigger bets; for instance, they would do more and larger acquisitions, bigger capital investments and higher R&D expenditures. That is, where CEOs with few stock options would prefer to invest $50m in a particular project, they would plunge in a $100m.

However, in addition, they would bet (that rather substantial amount of) money on things that had much higher variability. That is, if there was a project that could make them win or lose 20% of the sum invested and another project that could make them win or lose 50%, they would pick the latter; big bets with lots of variance.

Yet, I guess those could still be regarded “good risks”. Gerry and Don, however, also found something else: Option-loaded CEOs delivered significantly more big losses than big gains…! They would more often lose than win the big bets. Surely that is not something anyone would want.

And why is that? Well, through these stock options, you have created individuals at the helm of your firm who only care about upside, but can’t be bothered with the size of the downside; whether they lose 10 million or a 100 million, their stock options are worthless anyway.

And I guess that’s not something even the biggest risk-loving shareholder would applaud. Stock options lead to risk-seeking behaviour, but they’re not always the risks you’d like them to take.

* Although it always makes me wonder whether, even if these incentives would work fine, you would really want a person like that – someone who needs those type of incentives – to be heading up your firm, or whether you then shouldn’t look for someone who would also do the best they can if on a fixed salary...? But anyway; that’s besides my current point.

* Options – the right to buy the company’s shares at a pre-determined price – have large upside potential but very little downside risk; if by the time that the CEO can exercise the option the actual share price is £10 lower than what he can buy the share at, the option is worthless. Yet, it is equally worthless if the actual share price is £50 less. Worthless is worthless (no matter how far the share price has plummeted!). In contrast, if the actual share price is higher than the price at which he is allowed to buy, he makes money. If the share price is £10 higher, he makes 10; if the share price is £50 higher, he makes 50. Thus, stock options are thought to stimulate risk taking; the owner of the option has all the upside but very little downside.

In a downturn, manage your revenues, not your costs

2008-12-18T09:41:00.003Z

Here's a hypothesis:

In prosperous times, companies often fall victim to not being able to resist the many opportunities for growth that present themselves to them. In isolation, many initiatives with respect to new products, new markets or new customers look good but when pursued in combination they have a negative effect and hamper growth. Yet, wealthy firms find all these options difficult to resist precisely because in isolation they look so good. They have the funds to spare and therefore they are inclined to do too much of a good thing.

Andrew Grove, former CEO of Intel, understood this well. Their best-selling product – microprocessors – had endowed them with much cash to spare. However, he resisted temptations to spend it on other initiatives and entering adjacent businesses, telling his people “this is all a distraction; focus on job 1 [microprocessors]”. It made them one of the most successful companies ever.

In a down-turn, companies should look different

However, companies in distress – such as in a downturn – often do the reverse. In academic research, we call this the “threat-rigidity” effect. They focus on their core business, shedding all other things, doing more of what they did before, and which they consider their strongest points, while trying to reduce their cost base to weather the storm, till it all blows over and they can come out of hibernation.

By itself, minimising one’s cost base is never a bad idea (also in prosperous times!) but these companies forget one thing: You have to not only manage your costs; you also need to manage your revenues. And, what’s more, the composition of a revenue base in lean times will have to look different from its composition when times are good. Where in happy times firms are often seduced to spread out too much, while they would be better off focusing on job 1, in meagre times firms are often inclined to focus too much, when diversifying one’s revenue base makes more sense.

Accessing different pockets of revenue

So why does spreading one’s revenue base in meagre times make more sense? It is, among others, because no job will be big enough to sustain the whole firm. What keeps firms afloat is accessing a variety of smaller pockets of revenues. Hence, rather than focus on job 1, hoping it will be enough to sustain the firm, the company’s effort should be aimed at identifying and creating additional sources of revenue. In the downturn, none of these additional sources will be big enough by itself. Moreover, many of these sources would not be attractive in prosperous times, because the firm would not be able to make them grow. However, this is not a time of growth, but of survival.

A diversified revenue base will also reduce dependency and with it risk. In a downturn, the probability of individual sources drying up is large, so a firm can’t afford to be focused on just one or a few of them.

But will searching for additional sources of revenue not be costly? If will not be costless but, by definition, it should not be expensive. Paradoxically, firms should not be focused on winning any big accounts, major new products or customers; they should aim for many smaller ones. They are relatively cheap to access and often the firm will already have knowledge about them; they shunned them in the past considering them too small to advance at the time.

Concurrently, this strategy of exploring multiple smaller pockets of revenue will equip firms well for the economic dawn, which will inevitably come. Their diverse revenue base has laid the foundation for new sources of growth. The firm will be able to quickly benefit from the upheaval in the economy. Many of the smaller pockets of revenue will stay small – and the firm would do well to shed quite a few of them – but the newly formed strategic landscape will be conducive to different sources of revenue than before. Although you can’t tell beforehand which ones it will be, some of the small pockets of revenue will be the new stars on the firm’s firmament.

Mental models – let's all think within the same box

2008-12-15T11:31:00.003Z

The illustrious former chairman of IBM, Thomas Watson, once said “Whenever an individual or a business decides that success has been attained, progress stops”. What he was speaking about was that successful firms find it very hard to change, for instance in response to changes in their business environment. (Unfortunately he is also the person who allegedly said “I think there is a world market for maybe five computers” so I would say “physician heal thyself”… but I guess that doesn’t make him wrong about the first bit!)

This rigidity-due-to-success effect is partly a mental thing. Once something has brought us much success for a sustained period of time, we sort of forget that there are other ways of doing things. It may even be so bad that we don’t spot the changes in our business environment at all anymore. However, let’s not make the mistake to think that such strong mental models of how we go about doing our business are all bad. They also bring some pretty strong advantages. Consider the following:

Aoccdrnig to rscheearch at an Elingsh uinervtisy, it deosn't mttaer in waht oredr the ltteers in a wrod are, the olny iprmoetnt tihng is taht the frist and the lsat ltteer are at the rghit pclae. The rset can be a toatl mses and you can sitll raed it wouthit a porbelm. Tihs is bcuseae we do not raed ervey lteter by itslef but the wrod as a wlohe.

All of the above is clearly nonsense; they’re not words at all, it is just gibberish. But something makes us able to read it without a problem; that’s because all the right pieces of information are there (all the letters) and roughly in the right shape. Plus, the context (the sentence) makes sense to us. Then, our brain does the rest. We can perfectly understand it precisely because we have seen the individual elements (the words) before and understand the context.

It is the same in business situations; we can quickly grasp and interpret a particular issue if we understand the context and have seen similar problems and situations before. We don’t have to reinvent the wheel every time we see a similar problem but can build on our experience.

Thus, forming mental models is how we learn; they enable us to make quick decisions without the need for complete information. This is a powerful thing to have for every organisation. You don’t want all people thinking out of the box all the time; a coherent group of like-minded people with lots of common experience can be a very useful asset indeed.

The negative effects of common mental models – blindness to changes and viewpoints that don’t fit the model; something known as “groupthink” – you can possibly overcome through smart organisational design. For example, I’ve seen large organisations that created multiple similar sub-units; each of them very coherent, but also very different from each other. They attempt to get the best of both worlds: coherence within units; diversity between them.

Hence, groupthink can be a good thing, as long as you make sure to have multiple groups…

“Framing contests”: What really happens in strategy-making meetings

2008-12-10T22:04:00.002Z

One of the first series of strategy-making meetings I ever attended was in a large newspaper company. I was basically a fly on the wall, watching the process unfold with the mixture of curiosity, puzzlement and amazement, like a Martian watching a cricket game (or so I imagine).

It quickly struck me that there seemed to be a number of pre-formed sub-groups, with their own opinion and agenda. You had the people who wanted to take the company public, those who thought they should diversify into other areas of business, those who thought they should become a “green company”, and so on, and those who thought they shouldn’t care out of a matter of principle.

Of course there were some political motives at play but mostly these people seemed genuinely convinced that their opinion was what was best for the future of the company. And, rather than coming up with new ideas, the strategy meetings seemed to consist of the various people trying to convince each other of their view of the company, its future and the changes required.

Many years later, I read the PhD dissertation work of Sarah Kaplan, a former McKinsey consultant turned Professor at the Wharton Business School. Sarah described such strategy-meetings as “framing contests”. Framing contests, she said, concern “the way actors attempt to transform their personal cognitive frames into predominant collective frames through a series of interactions in the organization”. And although I had to read that sentence a couple of times (before I endeavoured to even begin to believe that I had any clue what the heck she was talking about) it gradually struck me as quite accurate.

In strategy meetings, people try to convince each other by painting a mental image of the future; what would happen if they’d continue as is, and what could happen if they’d follow the course of action proposed by them. They might throw in some numbers based on “research” (put together long after they had made up their mind), and engage in spirited debate, complete with raised voices, rolling eyes and the occasional hand gesture.

And you would win the contest if, through a series of debates, you managed to convince others and get your view of the company and its future adopted as the dominant frame, defining how the organisation sees itself and what it is trying to achieve in the market.

And this may not be a bad way of doing things. I saw the same process unfold – quite successfully – in model train maker Hornby, where the debate centred on divesting, diversifying, investing more or outsourcing production to China (the latter faction won). Similarly, it famously led Intel, over the course of several years, to abandon its memory business in favour of microprocessors.

Former Intel chief executive Andy Grove said about this: “The faction representing the x86 microprocessor business won the debate even though the 386 had not yet become the big revenue generator that it eventually would become”.

Stanford professor Robert Burgelman (who spent a life-time studying Intel), wrote about this same episode: “Some managers sensed that the existing organizational strategy was no longer adequate and that there were competing views about what the new organizational strategy should be. Top management as a group, it seems, was watching how the organization sorted out the conflicting views.”

Later, Andy Grove concurred that that is what happened, and quite deliberately so: “You dance around it a bit, until a wider and wider group in the company becomes clear about it. That’s why continued argument is important. Intel is a very open system. No one is ever told to shut up, but you are asked to come up with better arguments”.

So next time you find yourself debating your company’s strategy and future, realise you’re in a framing contest. Your powers of persuasion will only be as good as your mental imagery.

Spinning clients – the McKinsey effect

2008-12-07T23:26:00.001Z

Some time ago I was having lunch with three McKinsey consultants and they started talking about how different all the people in their organisation were. I was watching them during this conversation and couldn’t help but notice that they even looked alike... They spoke alike, dressed alike and, clearly, thought alike. What seem like huge differences within a group may be miniscule (or even non-existent) if you’re an outsider looking in.

It actually reminded me of a scene in Monty Python’s “Life of Brian”, in which Brian looks out of his window and sees this huge crowd gathered in front of his house waiting for him to speak. And he shouts “you are all different!” After which they dutifully reply in chorus “yes, we are all different”.

[Brian] “You are all individuals!” [Chorus] “Yes! We are all individuals!”
(I particularly like the guy who subsequently says “I’m not”...)

Anyway, McKinsey, like many highly successful individuals and organisations – my great colleague Professor Dominic Houlder tends to call them the most successful religious order since the Jesuits – attracts scorn and admiration in equal measure. And I too believe they do many things right. One of them is that although the average person only stays with McKinsey for barely three years, when you join, you pretty much become a McKinsey person for life. If you "leave", you become an alumnus.

And that is a great feeling to foster if you, as an organisation, lose most of your employees to your customers. Because those people become great advocates for The Firm. McKinsey, for instance, proudly showcases them as alumni (although they have been able to keep remarkably quiet the fact that Enron’s Jeff Skilling was among their most high-rising offspring…). Importantly, what do these alumni do, as soon as they start to work in the real world? Yep, they hire McKinsey consultants…

And these type of beneficial effects do not only accrue to McKinsey; mere mortal organisations can reap them too. Professors Deepak Somaya, Ian Williamson and Natalia Lorinkova, for example, examined the movement of patent attorneys between 123 US law firms and 109 Fortune 500 companies from a variety of industries. Indeed, they found that if one of those Fortune 500 firms recruited a patent attorney from a law firm, subsequently that law firm would start to get significantly more business from that company. And I am sure it works that way for many other types of companies too.

In addition, by the way, Deepak, Ian and Natalia also found the reverse: if the law firm would hire a person from one of the Fortune 500 firms, the business it received from that company tended to go up too! Moreover, if the law firm would poach an attorney from one of its competitors, it would see business go up from the companies that were on the books of that attorney’s previous employer. Apparently, customers often follow a job-hopping attorney to his new law firm.

Therefore, like McKinsey, perhaps you shouldn't be too frightened of people moving. You want to hire people from your competitors and your clients, but you may also want your clients to hire yours. Rather than vilify them for leaving and cut all strings, keep them on the books as alumni, and actively cultivate relationships with them, in the form of clubs, Christmas cards and summer-evening barbeques if necessary! The only thing you don’t want is for your people to move to your competitors… They too may take business with them.

Hence, people will move; if they do, just make sure it is to a (potential) client – that’s the McKinsey way. And, of course, make sure to keep it quiet if they mess it up over there (like alumnus Skilling did at Enron) – that’s also the McKinsey way.

Tunnel vision – “in the end, there is only flux”

2008-12-02T10:50:00.002Z

“Tunnel vision is caused by an optic fungus that multiplies when the brain is less energetic than the ego. It is complicated by exposure to politics. When a good idea is run through the filters and compressors of ordinary tunnel vision, it not only comes out reduced in scale and value but in its new dogmatic configuration produces effects the opposite of those for which it originally was intended.” Tom Robbins, in “Still Life with Woodpecker”.

We know, from running statistics on the performance of companies over time, that especially very successful firms have trouble staying successful, and adapt to changing industry conditions. We call this the “success trap”, “competency traps” or the “Icarus paradox” in business.

But where does it come from? What is causing it? There are various parts to the explanation but one of them pertains to how the top managers of those very successful companies perceive the changes in their business environment.

Research by professors Allen Amason from the University of Georgia and Ann Mooney from the Stevens Institute of Technology, for example, showed that CEOs from firms with relatively high performance were significantly more likely to interpret changes in their business environment as a threat than the CEOs of poorly performing companies, who more often interpreted the changes as a positive thing.

And this is understandable. If you are the top performer in your industry, any change looks like a threat, because things can only get worse; you like things just the way they are, thank you very much! In contrast, if you currently look like a sucker because you're the CEO of a company that is not performing very well at all in comparison to your peers, any change is welcome. It represents an opportunity for things to be altered, and your only way is up.

Allan and Ann also showed that, as a consequence, the top managers of the high performing companies were much less comprehensive in formulating a response to the strategic change; they didn’t spend much time evaluating potential alternative courses of action, they didn’t do much research and analysis, and they sure as hell didn’t seek any outside help or opinion.

Most likely, executives in such a situation are going to try to continue as is, resist the change or minimise its impact. However, if the environmental change is profound, ignoring it is likely not going to work! And this is a problem of all times. In the 1970s, The Swiss watch industry, which was superb at making mechanical watches, invented the quartz watch but they didn’t do anything with it. And when companies from Hong Kong and Japan flooded the market with cheap quartz watches they denied the relevance of the change till they had a near-death experience. Around the same time, tyre maker Firestone responded to the introduction of radial technology by trying to beef up its production of bias tyres (they had a genuine death experience). More recently, traditional newspaper companies fought news-reporting on the internet by suing dot-coms and naively copying and pasting their own paper on a website, while Kodak for a long time tried to ignore digital photography mourning its spectacular margins on photo-film.

I guess you could call it old-fashioned tunnel vision. When your company is hugely successful, you don’t want to see that the world is changing. And if you then, eventually, are forced to incorporate the new technology (or whatever it is that is rocking your world), you try to squeeze it into your own version of reality, rather than accept that reality has changed. But reality is that one day the likes of industry dominants like Google, Intel, or Microsoft will go down. Because as Heraclitus already said some five centuries BC: “In the end, there is only flux, everything gives way”.

Why aren't there more films like this [sigh...]?

2008-11-27T14:07:00.001Z

Ever wondered why there are so few films you really like? It has to do with an old choice in strategy: do you focus on a narrow, specific audience and really satisfy their needs or do you try to appeal to a broader audience, having a larger base of customers but risking to not really satisfy anyone? It appears that – perhaps a bit unfortunately – in the film industry, it often pays to do the latter.

Professor Greta Hsu, from the University of California Davis, examined 949 movies in the US film industry and showed that films that fit more clearly into one specific genre (action, romance, comedy, drama, horror, etc.) generally are appreciated more by the audience. However, films that span various genres attract a larger audience, and that pays off at the box office.

Of course it’s a trade-off – do you go for a broad or a specific set of customers? – and one that most firms in most industries face. It depends very much on the characteristics of the industry where the balance lies; towards specialisation or towards being a generalist.

The fact that in the film industry many firms & films come out as quite general can partly be blamed on the role of marketing. You only really know what a film brings you once you’ve gone to see it (and paid for it). Smart marketers can make multi-genre films appeal to a variety of people, without them realising beforehand that it is going to be a bit of a mish-mash.

For example, the film Cocktail was marketed in four different ways by Touchstone Pictures, including different television commercials, each pertaining to a different genre. Similarly, Miramax produced two different ad campaigns to promote their film The English Patient, one emphasizing the film’s action and war components, and the other one emphasizing the romantic elements of the movie. It turned the film into a product that was purchased by a mass audience.

Altman, in his book Film/Genre, describes this Hollywood strategy as “tell [audiences] nothing about the film, but make sure that everyone can imagine something that will bring them to the theatre”.

Thus, although on average multi-genre films are less appreciated by customers than genre-specific films, it is the former that usually bring in the big audiences, and with it the big bucks. As a consequence, genre-specific films are much more of a rarity, although we love them. Once we see one, we may sigh “why aren’t there more films like this…?” but we really only have ourselves to blame: it is because we do let ourselves be tricked into seeing all this other (multi-genre) crap that it becomes relatively unattractive for film makers to make anything specific.

Advice or influence? Why firms ask government officials as directors

2008-11-25T09:43:00.002Z

Let’s face it; outside directors are just a very strange phenomenon in our global economy. They form a business elite that operates as a self-governing clique. Moreover, these people are amateurs. Literally. The supervision of the management of a globally diversified company is just something they do on the side – a couple of days per year or so. Often they are CEOs of other companies – so that might help a bit (or harm a bit…) – but typically they have about half a dozen of these gigs. So, they can’t let any single one of them distract them too much.

It is a bit like we manage our own personal finances – paying bills and filing bank statements etc. In the evening, after a hard day’s work, while watching the X-factor, we quickly glance over the financials and put our signature on the most necessary evils before making a cup of coffee and turning our attention to the newspaper. Bills, bank statements, the accounts of a multinational; what’s the difference really?

But not all outside directors are (ex) CEOs. Quite often, companies also invite ex government officials to serve on their boards. The reasons for that, as research has indicated, are not too hard to fathom: They can provide advice, but they can also provide influence. I guess there’s nothing wrong with buying advice, but the idea of buying influence may be a bit more morally challenged…

Government officials can provide specific advice on how to deal with government-related issues. They have specific knowledge and experiences and can therefore provide valuable advice. But ex officials can also offer contacts for communication which are not accessible to other companies. Then, directorships start to become the currency used to buy influence, which makes it a bit more dubious. It certainly gets dubious if they provide for a direct way to influence political decisions. Some people have even suggested that board memberships for ex government officials are rewards for “services” rendered while they were in government… which would certainly be in the “barely legal” category.

It’s hard to examine which of the aforementioned reasons motivate firms to invite ex government officials onto their board. However, by analysing exactly which individuals get offered the job, we can get a bit of a sense of what’s going on. Professor Richard Lester from Texas A&M University and some his colleagues analysed this question – which government officials are most likely to be approached to serve on a board? – using data from the United States. They tracked all senators, congressmen and presidential cabinet ministers who left office between 1988 and 2003 and figured out which of them got offered directorships.

They found that the longer officials had served in government, the more likely they were to be approached for a directorship. I guess that could be because more experience gives them more influence but also because experience made them better advisors. Presidential cabinet ministers were more likely to receive board invites than senators, who were more likely to be approached than congressmen. I think this starts to lean towards an “influence” explanation for board invites rather than an “advice” one, but I guess one could still argue that cabinet ministers are simply the better advisors.

However, another clear finding was that these people would either get asked for a board very shortly after leaving their government position or not at all. Senators and former cabinet officers would usually be snapped up in the first year after leaving office. This could hardly be because after a year they all of a sudden would make for lousy advisors; it’s much more consistent with the fact that their ability to influence government decisions quickly deteriorates after leaving office. And it seems consistent with the idea that they get offered the job in return for services already delivered…

Finally, Richard and colleagues examined what happened in the case of a government change; that is, if the party in power (in the House, the Senate, or the White House) shifted from Democrat to Republican or vice versa. The effect of this was clear; the ex government official, associated with the party no longer in power, would lose much of his attraction as a potential board member. Because if the wrong party comes to power, you just lost much of your power to influence and with it your value as a potential board member. Clearly this points at an “influence” argument; companies ask ex government officials on their boards to bend political decisions in their favour. And I'm afraid this puts these officials firmly in the barely legal category.

How to tame an analyst

2008-11-20T10:06:00.001Z

Let’s face it; analysts are just a very strange phenomenon in our global economy. These people advise us to buy, sell or hold particular companies’ stock but we also all know that the banks that employ them make money if we buy. More importantly, we know that these very same companies that they advise us on are the banks’ customers (e.g. for their M&A deals), which makes it a rather hefty conflict of interest (especially when the real advice should be “sell, now!”). Moreover, on what information do these analysts base their recommendations? 1) The same o-so-reliable numbers as the rest of us have too, and 2) talking to the company’s sweet-talking CEO. Ooo… that’s comforting…

That is of course a nice, glamorous perk for the average analyst; being invited to personal audiences with a real-life CEO. Mind you though, if you subsequently don’t write nicely about their company, they won’t invite you back! That’ll teach you!

Or do you think I am exaggerating now, and really starting to create a gimmicky parody of what really is a very serious financial business? Well, let me tell you a story. And it is a story about facts.

Professor Jim Westphal from the University of Michigan and Michael Clement from the University of Texas Austin examined exactly this issue: the relationship between CEOs and analysts. They surveyed a total of 4595 American analysts and examined the strategies and performance of the companies they made recommendations on.

In the surveys, they asked the analysts to what extent they had been given the privilege of personal access to certain top executives, in the form of private meetings, returned phone calls or conference calls, and so on. And how often this form of individual access was denied. They also asked them about personal favours that these CEOs might have done for them, such as putting them in contact with the manager of another company, recommending them for a position or giving advice on personal or career matters. Then Jim and Mike ran some numbers.

First of all, their statistical models showed that the CEOs of companies that had to announce relatively low corporate earnings started to significantly increase the number of favours they handed out to analysts, by granting them personal meetings, jovially returning their phone calls and making some much-appreciated introductions. Similarly, CEOs of companies that were about to engage in diversifying acquisitions – a rather controversial if not dubious strategy that the stock market invariably hates – engaged in much the same thing. Clearly, these CEOs were trying to sweet-talk the analysts and mellow the mood ahead of some rather disappointing announcements they were about to make. The question is: did it work…?

What do you think? Is the pope catholic? Is Steve Jobs whizzier than MacGyver? Did Neutron Jack eat all his meat?! Is Bill Clinton heterosexual…?!?! Sorry, let me not get carried away in analogy here, the answer is yes.

Of course it’s yes. It works. Analysts who received more personal favours from a CEO would rate a company’s stock more positively when he announced disappointing results or engaged in questionable strategies. And if they didn’t? Yep, you guessed it: those analysts who in spite of the favours had the indignity of downgrading the company’s stock all of a sudden ceased to see their phone calls returned, would be denied any further personal meetings and sure as hell were not given the phone number of the CEO’s golfing buddies. And the only remaining advice they ever received was to get a life and bend their bodies in ways that would enable self-fertilisation.

And this worked too. Not the self-fertilisation but the social punishment of the degrading analyst; other analysts aware of their colleagues' loss of status would be significantly influenced by their plight when making their own recommendations: they made sure not to follow them into the social abyss and were unlikely to downgrade the firm of such a CEO.

Thus, sweet-talking works. But mostly if followed by a good dose of old-fashioned bullying.

What really caused the 2008 banking crisis?

2008-11-16T10:52:00.007Z

When you compare the 2008 banking crisis with the Enron debacle, with Ahold’s demise or even with the Union Carbide disaster in Bhopal in 1984 some surprisingly clear parallels emerge. Various explanations have been offered for each of these crises, ranging from top management greed, failing watchdogs to insufficient government regulation and inappropriate accounting and governance structures. Yet, there is one common cause underlying all these symptoms and triggers, and that is the structural failure of management.

One central element in each of these disasters, including the banking crisis, is caused by the division of labour and specialisation within and across organisations. In the case of investment banks, financial engineers drew up increasingly complex financial instruments that, among others, incorporated assets based on the American housing market. Yet, the financial engineers didn’t quite understand the situation in the housing market, the people in divisions and banks participating in the instruments didn’t quite understand the financial constructions or the American housing market, and when it all added up to the level of departments, groups, divisions and whole corporations, top managers certainly had no clue what they were exposed to and in what degree.

Similarly, in Enron, managers did not quite understand what its energy traders were up to, Ahold’s executives had long lost track of the dealings of its various subsidiaries scattered all over the world, and also Union Carbide’s administrators had little knowledge of the workings of the chemical plant in faraway Bhopal. The complexity of the organisation, both within and across participating corporations, had outgrown any individual’s comprehension and surpassed the capacity of any of the traditional control systems in place.

Another crucial role was played by the myopia of success. Initially, the approach used by the companies involved was limited and careful, while there were often countervailing voices that expressed doubts and hesitation when gradually less care was taken – there certainly is evidence of all of this in the case of Enron, Ahold and also Union Carbide. However, when things started to work and bring in financial returns, as in the case of the banks, the usage of the instruments increased, sometimes dramatically, and they became bolder and more far-reaching. Iconoclasts and countervailing voices were dismissed or ceased to be raised at all. For example, in Ahold and Enron, the financial success of the firms’ approaches suppressed all hesitation towards their business strategies.

This caused a third element to emerge: it actually became improper not to follow the approach that brought so much success to many. In the case of investment banks, other banks and financial institutions that did not participate to the same extent as others, received criticism for being “too conservative” and “old-fashioned”. Investors, analysts and other stakeholders joined in the criticism, and watchdogs and other regulatory institutions came under increasing pressure to get out of the way and not hamper innovation and progress.

Similarly, Enron was hailed as an example of the modern way of doing business, while analysts (whose investment banks were greatly profiteering from Enron’s success) recommended “buy” till days before its fall. Similarly, Ahold’s CEO Cees van der Hoeven continued to receive awards when the company had already started its freefall. All of these organisations’ courses of action had been further spurned and turned into an irreversible trend by the various parties and stakeholders in its business environment.

This relates to a fourth management factor that contributes to the formation of a crisis. It’s the factor that is related to what was on everyone’s lips in the immediate aftermath of each of the aforementioned crises: greed. Somehow, all organisations and individuals involved seemed to have let short-term financial gain prevail over common sense and good stewardship. But in all these cases, greed was not restricted to the few top managers who ended up in jail or covered in tar and feathers. Ahold’s shareholders initially profited as much as its executives. Investors, politicians and even customers shared in equal measures the early windfalls of Enron; likewise for the investments banks. Even the Church of England made big bucks on the financial practices they so heavily criticized in the days following the collapse of the system.

The greed factor, however, does not stand alone; it is built into the structure of the whole corporate system. Traders are incentivised to concentrate on making money; top managers are supposed to cater to the financial needs of shareholders above anything else – opening themselves up to severe criticism if they don’t – and customers are expected to choose the best deal in town without having to worry where and how the gains were created. However, none of these parties actually see what lies behind the financial benefits, and where they come from. The traders just see the numbers, the investors only see their dividends and earnings per share and the Church of England simply chose the best deal while the archbishops were unaware it amounted to short-selling. The high degree of specialisation and division of labour both within and between the financial institutions may have revealed the result of the process but showed no sign of how these profits were actually produced.

In combination, all these elements create a system that escalates risky short term strategies until it culminates into an irreversible course of action. Consequently, it becomes unseemly to do anything else. As in a pyramid investment scheme, everybody is interlocked and benefits until the whole structure collapses, sometimes with devastating consequences. The 2008 banking crisis is only unique in the sense that it did not concern one organization but a whole global sector of interlocked firms, due to the high degree of similarity between the various corporations and their business strategies and the unprecedented extent of the financial linkages between them.

All these things point to one underlying cause: the structural failure of management. The management systems used to govern these organisations were unable to control the inevitable process towards destruction. Whether analysing Enron, Ahold, Union Carbide in 1984 or banks in 2008, the striking commonality is the sheer inevitability of the disaster; each of them were accidents waiting to happen, given the state of the organisation.

More rules and regulations and more quantitative and financial controls are unlikely to solve the problem, and prevent similar events from happening in the future. All organisations and people involved in these cases, ranging from top managers to traders and customers, were governed and incentivised by means of quantitative and financial controls. However, today’s businesses are too complex to be controlled by rules and financial systems alone.

Instead, organisations will need to tap into the fundamental human inclination to belong to a community (such as an organisation), including people’s desire to do things for the benefit of that community rather than focus on their individual, narrow interests. These are alien concepts in the City today, where incentives are geared towards optimising individual, short-term performance while company loyalty and a sense of community are all but destroyed by the financial incentives and culture in place. Yet, when such human desires to contribute to a community are artificially suppressed through narrow financial incentivation schemes, weird things can happen – and the 2008 banking crisis certainly was one weird thing.

Too hot to handle: Explaining excessive top management remuneration

2008-11-11T14:05:00.001Z

In many countries the topic of “excessive top management compensation” – especially for CEOs – triggers much emotion, social outcry and even calls to arms for politicians to finally regulate the issue and introduce mandatory caps on salaries. And I used to think that this was all nonsense, because the arguably high salaries of CEOs were simply the result of a market mechanism and “the way it is” (and certainly none of politicians’ business). However, the more I learn about academic research on CEO compensation and the workings of boards of directors (who usually determine a CEO’s remuneration package) the more I realise there is more going on than that.

First of all, there has been quite a bit of research that has tried to show that CEO compensation is tied to firm performance. It ain’t. That research has tried, has tried hard and harder, but just could not deliver much evidence that CEO remuneration is determined by firm performance. Admittedly, some studies have uncovered some minor positive relations between pay and performance but it wasn’t much.

The only economic factor that has delivered some consistent results worth mentioning – indicating a positive influence on CEO pay – is firm size: bigger firms pay better. Although this may be an intuitive result, it is actually not that clear why... Why do the CEOs of big firms earn more? Do CEOs of big firms put in more hours? Not that I know. Is managing a firm with 100,000 employees that much harder and more demanding than managing a firm with a tenth of that number on their payroll? Not necessarily. So what is it? I guess one could argue that a top manager of a large firm can do more damage if he messes it up and, since large firms generally have more resources available than smaller firms, they hire (and pay) the best. Yeah... I guess that could be it... Although research has also shown that, on average, large firms are not really more profitable than small ones, so I am not sure these better paid guys actually are better at their jobs. But anyway, we have found one thing that seems to explain top executive pay, so let’s not be too critical about it but accept it with grace.

But, beyond plain size, what then does determine CEO remuneration? Well, let’s start with who determines CEO compensation. In most counties, for public firms, that’ll be the board of directors. And, specifically, the directors that serve on the firm’s remuneration committee (usually 3-5 outside directors). And, yes, there has been some research on these bozos.

Three professors who did research on the relation between CEO compensation and boards of directors were Charles O’Reilly and Graef Crystal from the University of California in Berkeley and Brian Main from the University of St. Andrews. They studied 105 large American companies and first computed the relation between a bunch of economic factors (such as firm performance and firm size) and CEO remuneration. The only thing they found was a connection between company sales and CEO pay. In short, on average, if a firm’s sales increased by $100 million during the CEO’s tenure, his salary would go up by $18,000. That’s hardly impressive, now is it...?

Then, Charles, Graef and Brian did something a bit more interesting. You have to realise that the directors on these committees are usually CEOs or ex-CEOs themselves. Therefore, Charles and his colleagues compared the salaries of these director CEOs to the salaries of the CEOs of the companies for which they served on the remuneration committee. There was a strong relationship between them. An increment in the average salary of such an outside director with, say, $100,000 was associated with a jump in salary of $51,000 for the CEO, after statistically correcting for all the results due to the effects of firm size, profitability, etc.!

Charles, Graef and Brian argued that this association could only be the result of some sort of psychological social comparison process. The directors on the remuneration committee who decide on the CEO’s salary simply determine this guy’s pay by looking at what they themselves make at their companies. And thus, doing this, they don’t feel hindered at all by irrelevant issues such as the firm’s actual performance during the tenure of the CEO or any other silly things like it!

And guess what, who do you think determines who gets asked to serve as an outside director for a firm...? Any guesses...? Yep, it’s usually a company’s CEO who generally nominates new outside directors. That does make it rather tempting for a CEO to be rather selective about which peers you nominate to serve as director and determine your compensation packages, doesn’t it...? Since, according to Charles, Graef and Brian’s research, their wealth may nicely domino into your bank account. The last people you want on your board are those guys who are on a meagre package themselves; because they would likely curb your dosh as well. Instead, bring in the rich guys; they’ll make you rich too!

Deciding stuff – that’s the easy bit

2008-11-07T10:18:00.003Z

Some time ago, my colleague at the London Business School, Phanish Puranam, and I ran a short survey with 111 top managers; all alumni from our School’s senior executive programme. We gave them a list of 35 strategic management topics asking them to rate each of them on a 7-point scale, ranging from unimportant to very important for corporate leaders in today's business environment.

The three things that these senior executives said were the most important issues in their view and experience were:
1. Attract and retain talent
2. Decide on the company’s next avenues of growth
3. Align the organisation towards one common goal

Some further (statistical) analysis showed us that the number one – “attract and retain talent” – pertained to things such as putting together an effective top management team, and managing top management succession. Many business leaders see as their main task to recruit and develop other leaders, and it seems our senior executives were no exception.

The second one – “decide on the company’s next avenues of growth” – reminded me of a survey one of the global consulting firms used to run (I believe it was the then Anderson people). They ran an annual survey asking CEOs “what keeps you awake at night?” It was one of these PR endeavours aimed at getting some free publicity in the business press, bolstering their image as a source of management knowledge & wisdom. However, this survey was not a great success, and they seized to run it, simply because every year the same thing came out on top (which made it rather boring and hardly ideal to get the business press excited…) and that was: “The firm’s next avenue of growth”. Our survey confirmed this result.

The third one – “aligning the organisation towards one common goal” – pertained to this thing that tends to make non-senior executives (including business school professors) smirk: creating a mission and vision statement. These vision things inevitably seem to lead to some generic yet draconian expressions (e.g. “to be the pre-eminent” something) that could only be generated by a de-generated consultant brain. Moreover, inevitably they appear to be highly similar to the terminology on the wall of the firm next door. Nevertheless, our senior executives do seem to take them quite seriously. I guess they’re typical of top managers’ efforts and struggle to “align the organisation towards one common goal”; in their desperation they even turn to hammering a mission or vision statement on the canteen’s wall. Guess it really is a struggle.

What struck me about all these three topics, however, is that none of them are decisions. It seems – also from analysing the remainder of our survey – that top managers are quite unfazed by strategic decisions, no matter how big and far-reaching they are. But things they can’t “decree” – like having an effective team, organic growth, or a common vision – is what keeps them awake.

Indeed, you can’t just declare “I decide that next year our organic growth will be 30 percent”. Instead, you will have to build and nurture an organisation which fosters innovation and motivates people and other stakeholders to achieve autonomous growth. You can’t just decide to have it, like you decide to pursue a particular acquisition, enter a new foreign market, or diversify into a new line of business. Similarly, you can’t just decide to attract and retain talent, or decide that “from now on everybody will believe in the same vision and aspiration”. It simply doesn’t work that way. And apparently top managers are a lot more comfortable with stuff they can decide than with things that are not under their direct control; things they need to foster and carefully build up over a longer period of time. And I don’t blame them: that stuff seems easier said than done.

How to justify paying top managers too much

2008-11-04T21:21:00.003Z

The level of top managers’ compensation is often a contentious topic of much spirited debate. Basically, most people think these buggers get paid too much. The buggers claim it’s simply the result of the market mechanism; supply and demand: Good buggers are scarce and therefore they earn hefty salaries (like movie stars, football players and other half-gods-to-be-worshipped).

Although there is of course a bit of a market at work, it has to be said that the people who determine the pay of a company’s CEO – the board of directors – do face a conflict of interest of sorts. Board memberships are nice jobs to have, in the sense that they are usually rather lucrative gigs and provide a pleasant dosage of power and prestige for those who get them. And – and this is where the conflict of interest arises – it’s mostly the company’s top managers who nominate new board members. In the spirit of “don’t bite the hand that just fed you”, board members may be inclined to nominate their benefactors (i.e. the CEO) handsomely by returning the favour in the form of a nice compensation package.

Moreover, as research has shown, those directors who deviate from this social norm (and for instance vote for a relatively low CEO compensation package) will be frowned upon by the rest of the business elite, spat at and given the cold shoulder until they “come to their senses” and don’t display such ridiculous behaviour any longer.

For this reason, in various countries, boards of directors now have to justify the compensation packages that they give to their CEOs by explicitly comparing the firm and its performance to a “peer group”. The idea is that, due to this forced comparison, it becomes more difficult for boards to step out of line.

The tricky thing is, of course, how do you determine who the company’s peer group is…?

It seems most logical to simply pick a group of firms in the company’s main industry, right? Right… but even firms in one and the same industry are usually not entirely comparable; you have many different types of banks, pharmaceutical companies can be vastly dissimilar, software companies are hardly all alike, and one retailer is not identical to the next one. Therefore, boards have a bit of flexibility regarding who to include in their firm’s “peer group”. And that’s of course a rather inviting opportunity for a bit of old-fashioned manipulation…

Professors Joe Porac, Jim Wade and Tim Pollock analysed the composition of the peer groups chosen by the boards of 280 large American companies. For each peer group, they examined how many firms were in there that were not from the company’s primary industry – thinking that then there just might be something fishy going on. Subsequently, they looked at the financial performance of the peer groups, of the companies in the sample, the performance of each company’s industry and the size of the CEOs’ compensation packages.

They found that boards would usually construct peer groups consisting of firms in the company’s primary industry. On average, there were some 30% of firms in those peer groups that weren’t in a company’s line of business. But, guess what: This figure increased significantly if the firm was performing poorly; then the board would construct a peer group of firms (outside the company’s industry) with quite mediocre performance, to make the firm look better. They did the same thing if everybody in the company’s industry was performing well; then a poorer performing peer group obscured the fact that the good performance of the company was nothing unusual in its industry, again making it look comparatively good.

Finally, boards would compose peer groups that consisted of comparatively poorly performing firms from outside the company’s industry if its CEO received a relatively hefty compensation package; then the seemingly high performance of the firm would come in handy to justify the CEO’s big bucks.

Joe, Jim and Tim concluded “boards selectively define peers in self-protective ways”. Which simply means that they dupe us to pay the buggers too much.

Say what…?! Making strategy made simple

2008-10-31T10:22:00.004Z

“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.

The process of making strategy (or just gibberish?)

2008-10-28T17:19:00.002Z

“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.

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

2008-10-23T21:58:00.004+01:00

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.

Pay inequality – good or bad for team performance?

2008-10-21T21:15:00.003+01:00

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.

Dirty laundry: Who is hiding the bad stuff?

2008-10-17T15:55:00.007+01:00

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.

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

2008-10-14T19:47:00.002+01:00

“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