Don't get emotional about strategy

Some time ago, a London friend of mine in was diagnosed with a severe medical condition, which required urgent yet complex surgery. The condition is rare but, fortunately, there appeared to be several specialists both in Germany and France who had each treated hundreds of cases during their careers. When it comes to specialist operations, experience is key, so he was going to visit each of them and then make a decision.

However, when I spoke to him again, he had just decided where he was going to have the operation: in the hospital in his hometown in Spain. I was surprised; there was no specialist in that hospital. But he explained to me that he had flown to his home country for another opinion and that the local surgeon had made a good impression and was very pleasant. Moreover – he added – after the surgery, he would have to stay in the hospital for two weeks and it would be nice to do that near his family.

I was stunned. My friend is a rational guy, in charge of a large company.  I have no doubt that, if he had been making this decision for me, he would have immediately recommended me to go to one of the real specialists, wherever they were in the world. He would have told me that where I would spend the two weeks in a hospital bed and whether the surgeon was a good conversationalist are quite immaterial. But, when making this important decision for himself, emotional considerations took over. And unfortunately, the initial operation was not successful, and my friend ended up having to travel abroad to see one of the specialists anyway.

And many of us would make the same irrational decision, with the same troubling consequences. Whether it’s a personal choice or a strategic business decision, emotions often crowd out objectivity. Precisely because they are such important choices, loaded with anxiety and uncertainty, when faced with a major decision people start to “follow their heart”, “rely on intuition” and “gut feeling”, overestimate their chances of success, and let their commitment escalate.

Good leaders don’t let their emotional bonds  cloud their judgment. Sound leadership requires objectivity. What can executives do to remain objective, when it comes to strategic choices: what businesses to enter, what to focus on and invest in, when to pull the plug and abandon a previous course of action?

Make decision rules beforehand. One way is to develop and set a clear decision rule beforehand, when there is nothing concrete to decide upon yet. When Intel was still a company focused on producing memory chips, Stanford professor Robert Burgelman documented that CEO Gordon Moore had emotional trouble abandoning this product, which was losing them money, because it “had made the company” (famously declaring “but, that would be like Ford getting out of cars!?”), in favor of the much more profitable microprocessors. Yet, the change happened, because they relied on their so-called “production capacity allocation rule”.

Gordon Moore and Andy Grove, well before this actual dilemma became relevant, had put together a formula – the production capacity allocation rule – to decide what products would receive priority in their manufacturing plant. When top management had emotional difficulty deciding to abandon memory chips, microprocessors were automatically receiving more production capacity anyway, because middle managers sturdily followed the rule that they had been given before. Because top management had made the decision what sort of product should receive production priority well before it became a concrete issue, the strategic choice became detached from their emotion of the moment.

Tap into the wisdom of your crowd. A second method to depersonalize difficult decisions is to not leave pivotal choices in the hands of one or just a few individuals – usually top managers – but, instead, to tap into the wisdom of the company’s internal crowd. When I asked Tony Cohen – the previous CEO of television producer Fremantle Media, of programs such as the X-factor, American Idol, Family Feud, and The Price is Right – how he decided what new programs to invest in he replied “I don’t make that decision”. He resisted making such crucial investment decisions himself; instead he designed an internal system that identified the most promising ideas, by tapping into the collective opinion of his television executives across the world.

For example, every year, he organized the “Fremantle Market”; an internal meeting in London where Fremantle executives from all over the world presented their new ideas (usually in the form of a trail episode). Subsequently, an internal licensing system made sure that prototype programs that many of them liked automatically got funded. A particular idea that hardly any of them believed in would not receive any investment – even if Tony Cohen happened to like the idea himself. This way, the decision did not rest in the hands of any individual; no matter how senior.

The revolving door approach. Finally, a valuable technique is to explicitly adopt an outside perspective. Andy Grove, regarding his debates with Gordon Moore whether to abandon DRAMs, said “I recall going to see Gordon and asking him what a new management would do if we were replaced. The answer was clear: Get out of DRAMs. So I suggested to Gordon that we go through the revolving door, come back in, and just do it ourselves.”  Taking the perspective of an outsider – a new CEO, private equity firm, or turnaround manager – can help see things more clearly. Research shows, for example, that people are very bad at estimating the time it will take for them to complete a project (e.g., write an assignment; refurbish a house) but they are good at estimating it for someone else. Asking them to take a third-person perspective has been shown to help objectivize a process, making someone’s judgment more accurate and realistic.

When making important strategic decisions, which are going to decide our faiths and those of our organizations, it is important to not let emotions and personal preferences cloud our judgment. Emotional commitment can be good, but not if it gets in the way of sound decision-making. Depersonalizing decisionmaking can sound cold or aloof, but it’s the best way to ensure a better outcome, for ourselves and our companies. 

No need for differentiation

For decades, strategy gurus have been telling firms to differentiate. From Michael Porter to Costas Markides and through the Blue Oceans of Kim and Mauborgne, strategy scholars have been urging executives to distinguish their firm’s offerings and carve out a unique market position. Because if you just do the same thing as your competitors, they claim, there will be nothing left for you than to engage in fierce price competition, which brings everyone’s margins to zero – if not below.

Yet, at the same time, we see many industries in which firms do more or less the same thing. And among those firms offering more or less the same thing, we often see very different levels of success and profitability. How come? What explains the apparent discrepancy?

To understand this, you have to realise that the field of Strategy arose from Economics. The strategy thinkers who first entered the scene in the 1980s and 90s based their recommendations on economic theory, which would indeed suggest that, as a competitor, you have to somehow be different to make money. Over the last decade or two, however, we have been seeing more and more research in Strategy that builds on insights from Sociology, which complements the earlier economics-based theories, yet may be better equipped to understand this particular issue.

Consider, for example, the case of McKinsey. Clearly, McKinsey is a highly successful professional services firm, making rather healthy margins. But is their offering really so different from others, like BCG, or Bain? They all offer more or less the same thing: a bunch of clever, reasonably well-trained analytical people wearing pin-striped suits and using a problem-solving approach to make recommendations about general management problems. McKinsey’s competitive advantage apparently does not come from how it differentiates its offering.

The trick is that when there is uncertainty about the quality of a product or service, firms do not have to rely on differentiation in order to obtain a competitive advantage. Whether you’re a law firm or a hairdresser, people will find it difficult – at least beforehand – to assess how good you really are. But customers, nonetheless, have to pick one.  McKinsey, of course, offers the most uncertain product of all: Strategy advice. When you hire them – or any other consulting firm – you cannot foretell the quality of what they are going to do and deliver. In fact, even when you have the advice in your hands (in the form of a report or, more likely, a powerpoint “deck”), you can still not quite assess its quality. Worse, even years after you might have implemented it, you cannot really say if it was any good, because lots of factors influence firm performance, and whether the advice helped or hampered will forever remain opaque.

Research in Organizational Sociology shows that when there is such uncertainty, buyers rely on other signals to decide whether to purchase, such as the seller’s status, its social network ties, and prior relationships. And that is what McKinsey does so well. They carefully foster their status by claiming to always hire the brightest people and work for the best companies. They also actively nurture their immense network by making sure former employees become “alumni” who then not infrequently end up hiring McKinsey. And they make sure to carefully manage their existing client relationships, so that no less than 85 percent of their business now comes from existing customers.

Status, social networks, and prior relationships are the forgotten drivers of firm performance. Underestimate them at your peril. How you manage them should be as much part of your strategizing as analyses of differentiation, value propositions, and customer segments. 

How Would You Define "A Great Company"?

Last week I was interviewed by a journalist from Korea’s Maeil Business Newspaper (the local equivalent of the Financial Times). After quite a lengthy interview, he ended with the question “How would you define a ‘great company’?”

At the time I thought it was a bit of a lame question, but that my answer to him was at least as lame: I babbled something that I would 1) judge a company by its performance – a long-term record of above-average profits – and 2) that employees should really be enjoying being part of that organisation.

As said, at the time I thought it wasn’t my sharpest answer of the day, but when I thought about it for a while, afterwards, I started to really like the question; and even appreciate my answer to it! This might be my memory playing dirty tricks on me – in a feeble attempt to protect my self-image – but, admittedly, if asked today, I would likely give more or less the same answer to that superb question.

I think most would agree that you cannot say some firm is a great company when it is habitually underperforming but, to me, great financial performance is not enough. At the end of the day, an organisation is nothing else than a collection of individuals working (more or less) together. If the people who constitute the organisation do not enjoy being part of it, I have a hard time seeing it as a great company.

I realise some of you might prefer to bring customer satisfaction into the mix, if not other stakeholders. Yet, to me, employee satisfaction is the pivotal point of departure. The legendary founder of Southwest Airlines – Herb Kelleher – used to proclaim that employees (“not customers or shareholders”) were most dear to him. That’s because he figured, if you have happy employees, they will make your customers happy. And happy customers will come back, which will eventually make your shareholders happy too (and, not coincidentally, Southwest had a generous profit-sharing scheme, basically turning employees into shareholders). Southwest has been outperforming its peers for decades.

Yet, most of us – including the stock market – still underestimate the power of employee satisfaction. Professor Alex Edmans – my new colleague at the London Business School – recently published a study that examined the effect on future stock returns of a company making it onto Fortune’s list of “100 Best Companies ToWork For in America”.* He found that such a company subsequently generated 3.5 percent higher stock returns per year than their peers. This finding suggests two things: 1) this employee satisfaction thing really works; having happy employees eventually culminates into hard stock returns, but also 2) that the stock market still undervalues its importance. The stock market habitually does not anticipate these extra earnings, owing to employee satisfaction (even though the list of 100 Best Companies To Work For is public knowledge). 

To conclude: there is money to be made from employee satisfaction. Let’s all get rich and happy – be it not necessarily in that order.

* Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices. Edmans, Alex. Journal of Financial Economics 101(3), 621-640, September 2011

* The Link Between Job Satisfaction and Firm Value, With Implications for Corporate Social Responsibility. Edmans, Alex. Academy of Management Perspectives 26(4), 1-19, November 2012

Why Would an Employer Give an Employee an Informal Loan? Commitment

Richard Hunt and Mat Hayward fom the University of Colorado were interested in employees who asked their employer for a loan, because they had no money but, for instance, had to buy a car, pay for their daughter’s wedding, medical bills, buy food and utilities, or faced home eviction. Therefore, they undertook to survey and interview small and medium-sized building contractors in Colorado.  No fewer than 67 percent of companies lent at least one of their employees money, with an average of about $1,100. Hunt and Hayward looked at 83 of them in more depth.

The first thing they found out was that, of the 459 loans that these 83 companies in combination handed out to one of their employees, no fewer than 57 percent were completely informal; meaning without any contract or any other formal enforcement mechanism. Why would firms do this? Even if they wanted to lend them money, why not give them a contract for the loan? This was puzzling because making it an informal, instead of formal loan with a contract, left the employer vulnerable to cheating by the employee. Because the employee simply could not pay back, or eventually even somehow inform the tax authorities (since informal loans are illegal). Why would employers voluntarily take that risk?

Hunt and Hayward theorised that employers granting the loan sometimes deliberately make themselves vulnerable towards the employee - by choosing an informal arrangement rather than a contract – to solicit trust and commitment from the employee. Granting a loan to a valuable employee in his time of need and do that in a way which explicitly makes the employer itself vulnerable could create substantial commitment and reciprocity from the employee, grateful for the loan and honoured by the trust placed upon him.

In conformity with this theoretical perspective, Hunt and Hayward found that informal loans were indeed more often extended when the employee needed the money for something personal and emotional, such as a wedding, a graduation, or to pay medical bills. When the loan concerned buying stuff (e.g. a car), paying off a credit card debt or rent, employers more often resorted to a formal contractual loan.

Moreover, Hunt and Hayward conjectured that employers would be more likely to make such an informal loan (rather than a formal, contract-based one) to employees who they were more eager to keep. And indeed they found that the informal loans were more often extended to better performing employees; those that were neither very young nor old (but just the right age to be both experienced and still have many productive years ahead of them), and at a time when the firm was most dependent on them, because it was still relatively new and small, and did not yet have a big backlog in terms of outstanding work assignments.

The question is: Did it work? Does extending an informal loan – at thus putting yourself at risk of being cheated on – result in improved (financial) performance? Hunt and Hayward showed that the answer is a resounding yes: their findings indicated that employers were better able to retain employees to whom they had extended such a loan. Furthermore, their calculations showed that it resulted in enhanced employer profit. Hence, making yourself vulnerable (by not asking for a formal contract) eventually paid off in financial terms.

 

Paper presented at the “Sumantra Ghoshal Conference for Managerially Relevant Research” at the London Business School
Our vulnerability is my gain: Linking exchange parties’ vulnerability to informal transactions and firm performance. Richard Hunt & Mathew Hayward (University of Colorado at Boulder)
Paper summary published with permission from the authors.

Why Firms Hire Their Employees' Friends

It is well-documented in the literature on labour markets that personal connections, friendships, and other types of networks matter a lot for finding a job. For example, applicants with friends in the recruiting organisation are more likely to get a job offer.

This may be perfectly rational for the recruiting firm; the friends of the candidate in the organization can be a great source of information about the applicant. As a result, the firm can be more assured of the job qualities of the person. Put differently, the candidate will pose less of a risk – in terms of potentially turning out to be a hiring mistake – if he or she has friends in the firm who have provided inside information. Therefore, employers may be more eager to hire new people who already have friends in the firm.

But professor Adina Sterling from Washington University suspected there might be another reason why job applicants with friends in the firm might be more attractive to an employer than those without. For quite a few jobs – especially if it concerns newly recruited MBA students – applicants will simultaneously apply for multiple jobs and then pick the most attractive offer they receive. And this can be very costly for a firm: the recruitment procedure can be very expensive, with multiple rounds of interviews and tests, but the time the candidate “sits on an offer” before eventually rejecting it may also precisely be the time that the numbers 2 and 3 on the list also secure and accept offers elsewhere. Therefore, understandably, firms are eager to limit the number of rejections they receive from candidates to whom they offered the job, and if they get rejected they want it to happen asap.

And Adina, who did a lot of interviews among employers, theorized that prospective employers would figure that candidates who already have friends in the firm might be more likely to accept an offer or, if they do reject it, do so soon. That is because the internal friendships might make them more attractive as an employee but also because the candidate has a reputation to protect with his or her friends, and feel an obligation towards them and the firm.

But that’s a nice theory and thought, but how on earth can you examine that? Because how could you statistically separate the two effects of 1) employers gain information about a candidate from his or her friends, and 2) the friends might make the candidate more likely to accept an offer?

To solve this problem, Adina chose a clever research setting. She looked at a 158 MBA and law students who had just completed an internship with a company, and then examined whether having friends in that company made them more likely to receive an offer from that firm. This was a clever setting because reason number 1 (gaining information about the candidate through his friends) no longer plays a role here; the employer already knows the candidate very well due to his recently completed internship! Hence, whatever effect is left could be attributed to reason number 2.

Adina indeed found that having friends in the company made it more likely that the applicant received an offer. Overall, her findings indicate that reason number 2 (friends make it more likely that the candidate will accept) is also an important consideration for prospective employers.

 

Paper to be presented at the “Sumantra Ghoshal Conference for Managerially Relevant Research” at the London Business School
Friendships and Strategic Behavior in Labor Markets, Adina Sterling (Washington University)
Paper summary published with the author’s permission.

Caste and Ethnicity still matter for Business in India

Ample research has shown that informal connections between people have a substantial influence on economic life, in terms who deals with whom and how well they perform. We call this “social embeddedness”, meaning that we are all embedded to different degrees in various networks of people, which influences our behaviour and success. One dimension which in a business context has received a lot of research is whether people have a joint educational background, particularly whether they are alumni from the same academic institution.

Guoli Chen, Ravee Chittoor and Bala Vissa thought that this embeddedness research that is focused on educational background could perhaps be especially valid in a Western context (where most of the research has taken place) but that in a different context, such as India, different types of affiliations might also play an important role. Specifically, they wanted to focus on the role of caste (i.e. people being of the same or different castes) and language (in terms of people sharing the same regional dialect).

Research setting: Equity analysts in India
To examine these different dimensions of inter-personal networks, they focused on a particular set of people and relationships, namely equity analysts. Firms listed on the stock exchange will often be followed and evaluated by analysts, as employed by banks, who make buy and sell recommendations to the public regarding the company’s stock.

Perhaps the most important task of such an equity analyst is to forecast – as accurately as possible – the future earnings of the firm. However, to make an accurate forecast, an analyst often has to at least partly rely on information received directly from the company; not seldom in the form of personal conversations with the Chief Executive. And Guoli, Ravee and Bala suspected that when the analyst happened to share the same background with the company’s CEO it would be much easier for him or her to get access to the CEO and his company information; making his earnings forecasts more accurate.

Findings
They tested this suspicion on a sample of 141 Indian firms, followed by a total of 296 equity analysts, between 2001-2010. First of all, they found clear evidence that equity analysts that are alumni of the same academic institution as the company’s CEO were indeed able to make much more accurate forecasts. But, in addition, the same was true for analysts who shared the same background in terms of caste, and in terms of regional language.  In fact, the effects were roughly the same size, meaning that these old historical patterns (around caste and language) were just as important in India as the more contemporary ones (i.e. university affiliation).

They then examined the conditions under which these different types of informal ties mattered more or less or whether such ties were indeed always beneficial. They found that older CEOs – who could be expected to be influenced more heavily by traditional patterns – were more susceptible to issues of caste and language than younger CEOs. They were less influenced by joint academic affiliation. Hence, although these old historical patterns matter a lot in India; they matter less for younger people, who are relatively more susceptible to joint academic affiliation.

In addition, they found evidence that these informal relationships were particularly beneficial if it concerned a truly Indian firm (part of a traditional business group). In contrast, such informal ties hurted more than they helped, when the firm in question was an Indian subsidiary of a Western multinational corporation.

Overall, what Guoli, Ravee and Bala’s research shows is that, in a country like India, old historical social structures still matter a lot in the world of business, especially when it concerns firms that are part of a traditional business group. The effect of language (which is analogous to ethnicity) was particularly potent. These effects may begin to matter a bit less for younger people (i.e. since they were especially strong for older CEOs) but they still wield considerable influence on economic life.


Paper presented at the “Sumantra Ghoshal Conference for Managerially Relevant Research” at the London Business School.
Which old boy network matters? Basis of social affiliation and the accuracy of equity analysts’ earnings forecast of Indian firms. Guoli Chen (INSEAD), Ravee Chittoor (Indian School of Business), Bala Vissa (INSEAD)
This paper summary is published with permission from the authors.

 

Antiquated & to be Annihilated? Is an On-line Revolution Brewing in Business Education?

We hear more and more talk about how the traditional model of business schools will be annihilated by the disruptive innovation of on-line education, so-called MOOCs (massive open on-line courses). An increasing number of voices can be heard to proclaim that business schools with their lectures and study groups are doomed, antiquated, overpriced, and that people who doubt that are just in denial and one day will wake up finding themselves obsolete and plain wrong.

And, arguably, case studies on the effects of disruptive innovation conducted in industries ranging from airlines and newspapers to photography and steel mills, have shown that often the established players in the market are initially in denial, slow to react, suffering from hubris and, eventually, face crisis and extinction.

Yet, when it comes to on-line education, and its potentially disruptive influence on higher education, including business schools, I doubt that on-line education will replace face-to-face lectures and study groups.

The arguments that people use to proclaim that traditional business schools will be replaced by on-line education include the notions that it is much cheaper, can be more easily accessed by a much wider audience, and customers (students) can access the materials wherever and whenever they want.

And this just reminds me of the printing press.

Oral lectures have been around since the times of Socrates and Plato. I am sure when the printing press was invented and became more widespread and accessible, an increasing number of voices could be heard to proclaim that such lectures and schools were going to be replaced by books. That is because books are much cheaper, can be more easily accessed by a much wider audience, and students can access them wherever and whenever they want. But they did not replace face-to-face lectures and study groups.

And that is because books and on-line educational resources offer something very different than the traditional lectures and school community. They are complements rather than substitutes. Of course the arrival of the printing press quite substantially changed schools and education; business schools without books would be very different than they are today. Hence, it would be naïve to think that on-line resources are not going to alter traditional business school education; they will and they should. Business schools better think hard how they are going to integrate on-line education into their courses and curricula.

But this means that it offers opportunities rather than a threat. And research on the effects of disruptive innovation – for example in newspapers – has also shown that established players who treat the arrival of a new technology as an opportunity, rather than as direct substitute, are the ones that are most likely to survive and prosper.

Freek Vermeulen is an Associate Professor of Strategy and Entrepreneurship at the London Business School. In 2012, BestOnlineUniversities elected him number 1 in their global list of “top 100 web-savvy professors”. You can find him on-line at www.freekvermeulen.com and at @Freek_Vermeulen. He regularly blogs for Forbes, the Harvard Business Review and The Ghoshal Blog.

The Structure of Competition: How Hidden Patterns Drive Firm Behaviour

In our behaviour and beliefs, we are influenced by various hidden structures and characteristics of the people surrounding us. Over the past decades, for example, hundreds of studies on social networks and "small worlds" have shown that with whom you have had prior relationships, and how these people relate to each other, influences the information we receive, how much personal power we have, how likely we are to find a job, get promoted, how creative and innovatie we are, and so forth.

This research on social networks basically draws lines between you and the people you know, and lines between those people you know who also know each other; lines between them and other people you don't know at all, etcetera, to reveal very different structures. We call these structures networks with or without "structural holes", with more or less "indirect ties", "network closure", and so on.

Ample research has also revealed that, just like individuals, the same type of structures influence firms in their behaviour and performance. In this case, the lines between different firms - referred to as "social ties" - can be determined by prior alliances between these companies, or shared members of their boards of directors (so-called board interlocks), or some other cooperative tie. Firms may not always realise it, but their strategic choices and success can be heavily infuenced by these social networks.

What a former PhD student of mine - Kai-Yu Hsieh (now an assistant professor at the National University of Singapore) - and I did is similar but also very different from this social network research. We started to draw lines between the different firms in an industry, not based on "social ties" but based on who competes with whom. Some firms in an industry namely compete directly with each other where others don't. For example, in the pharmaceutical industry, a firm making anti-epileptic drugs and cardiovascular drugs would be competing with another firm that makes cardivascular drugs but not with a firm that makes antibiotics medicine. The firm's competitors, however, could also be competing with each other, for instance if both also happened to make cancer drugs. The point is that, drawing lines between the different firms in various industries also revealed remarkably different structures - just like social networks do. And we wanted to find out if organizations, in their behaviour, are also influenced by such competitive structures; which we labeled "the structure of competition".

And the answer is "oh yes".

We deliberately selected two very different industries for which to compute these competitive structures. We analysed whom competes with whom among computer hardware manufacturers in Taiwan. And we computed the exact same structures for pharmaceutical firms in China. The type of strategic behaviour that we chose to analyse through these competitive structures was imitative market entry: how inclined would these firms be, dependent on their structure of competition, to follow each other into new markets? Or might certain type of structures induce them not to imitate each other at all, and in fact stay out of certain markets altogether?

Remarkably, in these very different industries the exact same types of competitive structures led to the exact same types of strategic behaviour. And the influence of the structure of competition was substantial: firms could display completely opposite behaviour when facing different structures (flipping from a strong inclination to imitate to an inclination to do the opposite of others).

We interviewed people in these industries to find out why these structures were influencing their behaviour so heavily. The first thing we found out was that, in spite of their strong influence, managers were not aware of the different type of structures. But they were aware of their influence. Our interviews suggested that operating within a particular structure seemed to leave a particular "imprinting effect" on a firm, making it more or less aggressive in its market behaviour and towards its competitors.

In this study, we analyzed the strong influence of these hidden structures of competition on firm's imitative market entry behaviour, but it seems likely that - just as in the case of social networks - they might heavily influence a whole range of other strategic variables and behaviours. Hence, we see our research - due to appear in the academic journal Organization Science - as just a first step to uncovering the hidden influence of the structure of competition on economic life.