A good fight clears the mind: On the value of staging a debate

I always enjoy witnessing a good debate. And I mean the type of debate where one person is given a thesis to defend, while the other person speaks in favour of the anti-thesis. Sometimes – when smart people really get into it – seeing two debaters line up the arguments and create the strongest possible defence can really clarify the pros and cons in my mind and hence make me understand the issue better.

For example – be it one in a written format – recently my good friend and colleague at the London Business School, Costas Markides, was asked by Business Week to debate the thesis that “happy workers will produce more and do their jobs better”. Harvard’s Teresa Amabile and Steven Kramer had the (relatively easy) task of defending the “pro”. I say relatively easy, because the thesis seems intuitively appealing, it is what we’d all like to believe, and they have actually done ample research on the topic.

My poor London Business School colleague was given the hapless task to defend the “con”: “no, happy workers don’t do any better”. Hapless indeed.

In fact, in spite of receiving some hate mail in the process, I think he did a rather good job. I am giving him the assessment “good” because indeed he made me think. He argues that having happy, smiley employees all abound might not necessarily be a good sign, because it might be a signal that something is wrong in your organisation, and you’re perhaps not making the tough but necessary choices.

As said, it made me think, and that can’t be bad. Might we not be dealing with a reversal of cause and effect here? Meaning: well-managed companies will get happy employees, but that does not mean that choosing to make your employees happy as a goal in and of itself will get you a better organisation? At least, it is worth thinking about.

In spite that perhaps to you it might seem a natural thing to have in an academic institution – a good debate – it is actually not easy to organise one in business academia. Most people are simply reluctant to do it – as I found out organising our yearly Ghoshal Conference at the London Business School – and perhaps they are right, because even fewer people are any good at it.

I guess that is because, to a professor, it feels unnatural to adopt and defend just one side of the coin, because we are trained to be nuanced about stuff and examine and see all sides of the argument. It is also true that (the more naïve part of) the audience will start to associate you with that side of the argument, “as if you really meant it”. Many of the comments Costas received from the public were of that nature, i.e. “he is that moronic guy who thinks you should make your employees unhappy”. Which of course is not what he meant at all. Nor was it the purpose of the debate.

Yet, I also think it is difficult to find people willing to debate a business issue because academics are simply afraid to have an opinion. We are not only trained to examine and see all sides of an argument, we are also trained to not believe in something – let alone argue in favour of it – until there is research that produced supportive evidence for it. In fact, if in an academic article you would ever suggest the existence of a certain relationship without presenting evidence, you’d be in for a good bellowing and a firm rejection letter. And perhaps rightly so, because providing evidence and thus real understanding is what research is about.

But, at some point, you also have to take a stand. As a paediatric neurologist once told me, “what I do is part art, part science”. What he meant is that he knew all the research on all medications and treatments, but at the end of the day every patient is unique and he would have to make a judgement call on what exact treatment to prescribe. And doing that requires an opinion.

You don’t hear much opinion coming from the ivory tower in business academia. Which means that the average business school professor does not receive much hate mail. It also means he doesn’t have much of an audience outside of the ivory tower.

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

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

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.

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

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.

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

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

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.

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

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.

Does the stock market appreciate management consultants?

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.

Management myths

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

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

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 dangers of outsourcing

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).

Should we stop saying that the market is efficient?

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?

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?

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.

Who can downsize without detriment?

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”.

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

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

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

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)

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.