RANDOM RANTINGS

2008-07-24T17:33:00.003+01:00

“Shareholder value orientation” – now, where did that come from?!

Well, it came from the US. And, alright then, a bit from the UK.

For the (blissfully) ignorant among us, what is it? It is the view that the purpose of a public corporation is to maximize the value of the company for shareholders. Traditionally, we find this orientation in Anglo-American societies. The view that the public corporation is more a social institution which has to consider the interests of various stakeholders, including shareholders but also employees, customers, the local community, etc. is the traditional soft stuff found in other parts of Europe and Asia (although, over the last decade or two “shareholder value orientation” has been spreading like a forest fire – pardon the analogy – gaining geographic terrain even in previously unlikely homes such as Germany, France and so on).

Whenever I ask a group of executives or MBA students in my classroom “to whom is the primary responsibility of a company?” nine out of ten people will wholeheartedly shout “shareholders!”, with usually a small, minority contingent on the backburner – with a suspected long-term Marketing indoctrination – arguing that “the company should adopt a customer-focus” and always place customers first (because that’s the best thing to do in order to gain shareholder value I guess…).

But why is that? Why do we immediately assume that the primary beneficiaries of organisations should be shareholders? I even find that quite a few people get a bit annoyed if not angry by even raising that question – like it is some God-given truth, which can’t be opened for debate and is even quite embarrassing to think (let alone talk) about.

Don’t get me wrong, I am not saying that companies shouldn’t do it but surely it is not a “law of nature” or so that a company is ultimately (only) responsible to its shareholders. It’s a choice. And like with many choices in business, that means that it is something worth thinking about every now and then; whether it is really the choice you want to make.

My former colleague (the great) Sumantra Ghoshal – who unfortunately died some years ago – would even argue (if inebriated) that shareholders are not owners at all, at least not of the company. He would argue something like the following (and a posthumous pardon to Sumantra if I remember his argument slightly incorrectly; he would often not be the only inebriated party in the conversation…): He’d say, if you own a dog, and the dog jumps into your neighbour’s house and wrecks the place, you are responsible for all the damage. However, if you own shares in an oil company and one of its oil-tankers shipwrecks and causes a billion dollar in damages to the environment, you’re only responsible for the extent of the monetary value of your shares; that’s the maximum you can lose.

Although Sumantra of course realised the legal reality of the situation, his argument was that therefore a shareholder’s ownership rights are just as limited as his responsibilities. As a shareholder, you’re an investor, which gives you the rights to for instance dividends, but it doesn’t make you the “owner” of the place in our traditional sense of the word.

Moreover, he would continue to argue that as an employee you often give a lot more: your intellectual capital, loyalty, ideas, firm-specific skills and investments, etc. And companies would do well to solicit such “gifts”. And if as an employee you give a lot more (than just money), and a lot more of yourself, perhaps you’re also entitled to more, in terms of the company’s loyalties and priorities.

2008-07-20T12:36:00.002+01:00

Are overconfident CEOs born or made?

Most acquisitions fail. That’s not even a point of debate or opinion anymore; the evidence from ample, solid academic research is quite overwhelming: about 70% of acquisitions destroy value, and this has been the case for many, many decades.

The question is, of course, what causes acquisitions to fail, and what causes managers to undertake them in spite of their rather dismal track record? Various complementary explanations have been offered but, remember, “failure” here simply means that the acquiring company does not create sufficient extra value out of the acquisition to recoup its (usually rather hefty) acquisition premium. One prominent explanation is that the average CEO suffers from “hubris”, or “overconfidence”. They think they will be able to create more value through the acquired company than these silly people who are currently running the show, because of “synergies” or simply because they’re much better and smarter than the sorry souls who are currently messing about in that block of bricks they call a firm.

Therefore they’re willing to pay an acquisition premium. Yet, it’s apparent that usually they are overestimating their abilities, because the average CEO/acquisition does not create any surplus value - quite the contrary. Fact is (assuming that managers are well-intended and do expect to create value through their acquisitions; some people even disagree with this assumption), on the whole one can only conclude that most of them are overconfident because in 70% of the cases they don’t manage to pull it off.

But where does their overconfidence come from? Does the average CEO suffer from hubris because that’s the type of person that makes it to the corporate top? That’s one possibility. The other one is that, over the course of their tenure, often top managers gradually become overconfident, rather than that they're suffering from hubris from the get-go.

Professors Matthew Billett and Yiming Qian from the University of Iowa examined this exact issue, using a sample of 2,487 American CEOs undertaking a combined 3,795 deals over the period 1980-2002, and they found some very compelling evidence that overconfident CEOs are made and not born that way.

They initially uncovered four things. 1) They discovered that CEOs’ first deals, on average, did not destroy value: Their effect on a company’s market value was pretty much zero, 2) those CEOs who had experienced a negative stock market effect in response to their first acquisition usually lost their appetite for doing any more deals, 3) in contrast, those CEOs who – hurrah! – had experienced a positive stock market response to their first take-over got the hots for deal-making; they were very likely to undertake even more acquisitions in the ensuing years, 4) those subsequent deals, however – that is, take-overs by CEOs who had done some before – on average did destroy shareholder value! Hence, the consistent finding in academic research that acquisitions destroy value seems to be caused by CEOs’ later deals only. Matthew and Yiming concluded that first-time, successful deals make CEOs overconfident, which not only stimulates them to do even more deals, but also makes them inclined to pay even heftier take-over premiums for subsequent ones, which they usually are unable to recoup after the acquisition.

Finally, they also examined “insider-trading”; whether CEOs would purchase their own company’s stock in the period preceding the acquisition (confident that they would increase in value as a result of the deal). Most CEOs did, whether they were first time deal makers or experienced acquirers. However, the effect for experienced acquirers (people who had done deals before) was twice as big as for the novices. Apparently, overconfident serial acquirers – who mostly ended up destroying shareholder value – most of the time fell into their own hole; they bought the shares whose value they were about to destroy! Guess there’s a hint of justice in this story after all...

2008-07-16T16:02:00.001+01:00

Chief Story Teller

What do CEOs really do? Stevie Spring, CEO of Future Plc (the magazine publisher), recently expressed it to me in the following way: “I am not really the Chief Executive; I am the Chief Story Teller”. What (on earth) did she mean with that?

What really is an organisation? Well, it is a group of people – sometimes a rather large group of people – (supposedly) working towards a common goal. This goal may simply be profit, but it certainly helps if we have a common idea of what we’re trying to do in order to make a profit. Hence, it is about setting a clear strategic direction.

A clear strategic direction is not a 40-page document outlining a firm’s strategy – that’s a drawer-filler. It is a concise set of choices that determines what we do and don’t do. For example, for Future it’s something like “special interest, English-language magazines for young males, possibly with spill-overs on-line and in terms of events”. Hence, they would for instance do a magazine on “guitar rock” but not on “music” (as that is not focused enough to be considered a special interest); they would do such a magazine in the US but not in German (then they might license it); they would cover motorcycle racing, or Xbox or wind-surfing, but not knitting (unless, without me realising it, knitting has recently had a popularity surge in the community of 20-something old males). Thus, it determines what you do, but it also determines what you don’t do, because it doesn’t fit your expertise and capabilities.

And Stevie Spring tells that story – over and over again – to a variety of constituents: to analysts and fund managers, board of directors, employees, customers and even the occasional business school professor.

Good CEOs have a story. Tony Cohen of Fremantle Media says they want television productions to which they own the rights, with spin-offs in other areas (e.g. on-line), which are replicable in different countries – simple and focused. Alistair Spalding of Sadler’s Wells theatre wants to be involved actively in producing a broad array of cutting-edge modern dance, aimed at a London audience. Frank Martin of Hornby wants to produce near-perfect scale models of model trains (and Scalextric race tracks) for collectors and hobbyist, which appeal to some feeling of nostalgia. Their stories are clear and simple; employees, investors and customers alike can understand and believe in them.

Is being able to tell a convincing story enough for a good strategy? I guess not – for instance, I remember a Goldman Sachs analyst writing about Enron in October 2001 (weeks before its bankruptcy) “Enron is still the best of the best. We recently spoke with most of top management; our confidence level is high."

However, it certainly helps. When you have a lousy strategy, without much focus or logic to it, it will be hard to come up with a coherent and convincing story. And it’s a good story that makes people want to invest in you, that carries the day when you need your board’s support (e.g. when making tough choices what to divest or invest in), and what helps your employees see their task and decisions in light of the company’s overall direction. It's the strength of the story, which makes the CEO.

2008-07-13T22:36:00.005+01:00

Similar, not the same, but just alike

Sometimes CEOs are just like normal people.

Normal people – you and I (well... at least you) – as we know from ample research in social psychology, have an inclination to conform to certain peer groups, in the way we dress, speak, which music we like, how often we brush our teeth, buy a car or go on a holiday. Yet, on the other hand, we also like to stand out from the crowd (if just a little bit). It’s known as “optimal distinctiveness theory”.

We see the same thing in organisations. Some years ago, I was working with an executive (which will remain blissfully anonymous) in charge of expanding his company into foreign markets, mainly through acquisitions. We analysed his strategy and various market characteristics, through which it became obvious that the Scandinavian market, in his line of business, appeared to be particularly attractive. Yet, he clearly did not even want to think about entering this area. When I persisted in probing why, his answer was frank: “Look, none of my major competitors are active in that market, so there must be something wrong with it”.

I was slightly stunned, but that was the end of it.

Until, a few months later, I ran into him again. Having asked what he had been up to he answered, “I’ve just entered the Scandinavian market”. Upbeat, I asked him whether my advice had finally convinced him. His reply was, “not exactly… it is just that [my biggest competitor] has just entered the Scandinavian market, so it must be a good place after all”.

I am not making this up, or even exaggerating (for a change). Was he unusual in this behaviour? I think he was unusual in terms of the frankness of his admission, but not so much in terms of his behaviour. One of the biggest influences on strategic decision-making – if not the biggest influence – is imitation. We do what others do around us. Academic research has indicated over-and-over-again the prevalent nature of imitation among a wide array of management decisions, such as the adoption of conglomerates, choice of location when entering foreign markets, implementation of performance management programmes (such as ISO9000 or Six Sigma), product market entry, matrix organisations, and so on and so forth.

Yet, like individuals in everyday life, CEOs don’t like just doing what everybody else is doing; sometimes they just want to do something a bit different. For example, I recently analysed a large database of about 800 companies in the pharmaceutical industry, focusing on the breadth of their product portfolio, and the statistical results clearly indicated that companies sometimes also choose to do the exact opposite of what their peers are doing, merely for the sake of doing something else.

Similarly, some time ago, I was working with some executives of a British newspaper company, who faced the decision whether or not to also adopt the new small-size paper format, just like several of their peers/competitors had. Ultimately, they decided against it. One of the executives said “had we been the first one to come up with the idea, we would have done it, but now that others have done it before us, we can’t; it just wouldn’t be very original”.

And in a way, I like this attitude. Granted, when you simply do the opposite of what others are doing, or explicitly do not want to do it just because your peers did it, you’re as much influenced by peer behaviour as when you’re an imitator (only 180 degrees opposite). Yet it also brings a bit more variety to the world, and hence makes life a bit more interesting. It gives you the opportunity, as a firm, to not be average and stand out from the crowd. And, who knows, perhaps even make an above-average profit as a result of it.

2008-07-08T15:02:00.001+01:00

Analysts, astrologers and lemmings – three of a kind?

“Financial forecasting appears to be a science that makes astrology respectable”, Burton Malkiel, professor of economics at Princeton, once said.

As you know, analysts, employed by investment banks, follow a number of firms (usually in a particular industry), evaluate them and offer us recommendations – in terms of “buy”, “sell” or “hold” – whether we should invest in their shares.

However, on average, these analysts give the advice “sell” in less than 5 percent of the cases. Yet, clearly, more than 5 percent of listed companies’ share prices go down. So what’s going on?

Well, there are various explanations but one is that, for various reasons (pertaining to incentives in investment banks), analysts are inclined to cover firms that they expect will go up in terms of share price. Therefore, perhaps an even more important decision than whether to recommend “buy, sell or hold” is the decision which firms to cover.

And this is where it gets tricky (and almost a self-fulfilling prophecy). Research has shown that the stock price of firms goes up when they gain analyst coverage. That is, purely the fact that a research department (employing the analyst) decides to start covering the firm will increase its share price, probably simply because the firm becomes more well-known, is exposed to additional investors, which enables it to raise capital more easily, etc.

But how do research departments decide to start covering a firm? Well, research by professors Huggy Rao, Henrich Greve and Jerry Davis shows that this is very much influenced by imitation. They analysed 1442 firms listed on the NASDAQ stock market and the analysts covering them and, through elaborate statistical analysis, showed strong evidence that when one analyst starts covering a firm, his colleagues at other investment banks are inclined to start doing the same (irrespective of this firm’s performance), thus creating a “cascade” of analyst coverage.

However, Huggy and his colleagues showed something else. Their models’ findings also revealed that, in such cascades, the imitating analysts were prone – more than usual – to overestimate the firm’s future performance. And this made it very much a mixed blessing for the firm. Because analysts are inclined to cease coverage of companies which are underperforming in comparison with their predictions – which was very likely in this case, given the analysts’ over-optimism – firms that initially benefited from increased analyst coverage were the same ones that subsequently were likely to suffer from analysts abandoning them.

The analysts, much like lemmings, optimistically jumped in, only to find out that the place they landed in wasn’t as rosy as they had expected. This prompts them to jump out again, saving their skin, but leaving the firm trampled and bruised.

2008-07-04T11:44:00.000+01:00

Inebriated cyclists

Remember the old anecdote of the man looking for his keys under a lamp-post? Here’s my version:

A guy exits a pub in the middle of the night. There, he sees a man on his arms and knees under a lamp-post, clearly looking for something. He asks him “what are you looking for?” and the (slightly inebriated) man answers “the keys to my bicycle; I must have lost them”.

“I will help you look” says the guy, and on his hands and knees he starts to search too. After a good ten minutes have passed though, still not having found the keys, he turns to the inebriated cyclist and says “are you sure you have lost them here, we’ve looked all over and they’re nowhere to be found?!”

“No” says the man (pointing towards a dark spot to the side of the road), “I lost them over there, but there it is so dark, I would never be able to find them”.

The morale of this well-known story is that we often look for solutions where there is light and we can see stuff, while the real cause of the problem lies in an area which is much more difficult to fathom.

Managers are often inebriated cyclists. If a company or division is in financial trouble, they cut costs, slash head-count, disinvest, set stricter targets and so on; the stuff that can be captured in numbers (i.e. “where it is light”), while the real cause of the problem will often be a lot more subtle, and lie in a tainted reputation, low employee morale or low service quality. And looking hard where there’s light won’t make you discover the key to solving your problems any quicker.

Vice versa, the hard stuff (which can be captured in numbers), such as production capacity, headcount, etc., are exactly the things that cannot give you much of a competitive advantage; they often can be bought off the shelf, meaning that your competitor can get it to. It’s usually the soft stuff, such as morale, reputation, organisational culture, etc. (which we don’t spend much time measuring, largely because they’re difficult to observe and capture in numbers) that can make all the difference, because they can’t be bought and take much time and effort to develop.

Hence, don’t be misled by the hard stuff, which you can measure; of course you need it but it will seldom give you a competitive advantage or get you out of trouble. The soft things, which we cannot see and measure, are the ones that you have to carefully nurture and manage.

2008-07-01T23:37:00.000+01:00

Complex yet so simple. Or was it the other way around…?

As a junior professor, starting to teach strategy at the London Business School, one of the first cases I ever discussed was that of a hotel chain in the south of the US, called La Quinta. It was a great example, not only because it came with a video featuring the famous Harvard Business School professor Michael Porter (who was goofy enough to make me look normal), but because it illustrated a particular point well: That, over time, successful organisations become both more complex and more simple.

What the heck did I mean with that (my students tended to ask)?! Well, over time, successful firms fine-tune their organisations to do even better what they already do well. They learn to operate through a particular set of procedures, gradually develop and employ a very appropriate yet intricate incentive system, organise a few specialist departments or functions focused on some specifically thorny issues, and grow a culture which is highly suited for the task at hand. And, as a result, they become quite a subtle and “complex” organisation.

Yet, such an organisation usually is also quite simple. What did I mean with that – complex AND simple…?!

Well, such an organisation becomes extremely suited for the thing it does, but suited for that one thing only. Hence, it’s a complex organisation, but “simple” in terms of what it can do.

For example, at the time, La Quinta hotels tailored to traveling sales people. People who are on the road all the time, work on commission, and often receive a travel budget (which they can spend or pocket). La Quinta targeted those customers (and those customers only). They located themselves literally on the highway, often next to a large parking lot. They did not operate any restaurant or offered any form of room-service but that was fine; opposite the parking lot would always be a diner, McDonalds or Pizzahut, and the salespeople would be happy to use those.

They did have spacious and very quiet rooms, which were standardised across all La Quintas, among others to give the salespeople a familiar feel away from home. And, above all, they offered low prices. It was perfect for the sales people, and every aspect of a La Quinta fell perfectly in line with the sales people’s needs. In this sense, La Quinta’s entire organisation was very subtle and “complex”.

But that would also make it simple. It could only do one thing, and target only one type of customer: the sales people. As soon as something would happen that kept away the sales people – a recession, a large business center in the vicinity moving away, etc. – the hotel would be vulnerable. It could not switch to high-end executives; after all, it didn’t have a restaurant, room service or business center. But it could also not switch to tourists; they were located on a highway for Pete’s sake, at a parking lot across from a diner! Let alone that they operated a family pool.

That’s the danger of being both complex and simple. You learn to do one thing very well; but one thing only… And when the world changes on you – which it usually does – that might get you into trouble.

2008-06-26T17:20:00.001+01:00

ISO9000 makes you reliable, myopic, efficient and dull – and unable to invent post-it notes

Sometimes, management practices, intended to improve the functioning of the organisation, have unanticipated consequences. Sometimes these consequences are negative, but also only apparent in the long-run, making firms adopt techniques which are really not very healthy for them (at least in the long-run).

Take ISO9000. ISO9000 certification constitutes a process management technique through which firms are expected to follow (and document) a number of procedures, aimed at creating consistent, efficient processes, in which best practices are standardised and deviations from the best practice are avoided. It leads to efficient, high-quality products with minimal digression from the standard.

This all sounds very logical, justified and desirable, right?! So what am I whining about?

Well, professors Mary Benner from the University of Pennsylvania and Mike Tushman from the Harvard Business School examined what happened to the innovation output of firms adopting ISO9000 techniques. They collected information on 98 firms in the photography industry and 17 firms in the paint industry, which they all followed from 1980 till 1999. They measured, among others, all their patents and documented whether these innovations were really “close to home” for the firm (representing minor variations on what they were already doing) or more exploratory discoveries (representing truly new potential avenues for growth). And they found a very clear pattern.

Firms that adopted ISO9000 norms started doing significantly more “close to home” inventions at the expense of truly new, exploratory innovation. The “more of the same” patents, induced by the ISO9000 processes, crowded out the discovery of truly new techniques and products.

How come? Well, by definition, ISO9000 minimises deviations from “the best way of doing things” in the firm. Yet, often, the best innovations are discovered by accident. Just like random genetic mutations can produce whole new species in nature, random deviations from the norm in organisations sometimes turn out to be “mistakes” which become the firm’s next big blockbuster product. Think of how the post-it note came into existence: A bloke named Spencer Silver was working in the 3M research laboratories in 1970 trying to find a super-strong adhesive. Spencer developed a new adhesive, but it was ridiculously weak. It was so weak that although it stuck to objects, it could easily be lifted off. It was a clear error. Yet, ultimately, this super-weak adhesive became 3M’s famous, money-spinning post-it note.

Although usually deviations from the norm merely produce plain, sheer mistakes, which should get corrected quickly, if you rule out all mistakes, you will never be fortunate enough to develop a “mistake” that turns out to be your post-it note. ISO9000 annuls all deviations from the norm. But, as a (unintended) result, you become a lousy inventor.

2008-06-24T09:30:00.000+01:00

Numbers and strategy – do they mix?

In your firm, when you come up with an idea for a new product line or service, or some other project that you think has great potential and want your company to invest in, what do they want to see? My guess is it’s “payback time”, a “net present value” calculation, or some other number in a business plan, right? And if you can’t produce the numbers, you won’t get the dosh.

But that’s also a bit of a problem; sometimes the most promising projects with long-term strategic implications are exactly those that are impossible to quantify.

Take Intel’s invention of the microprocessor. In the early days, when they were working on and (quite heavily) investing in it, did they have a business plan, a net present value calculation and a payback time? Heck no. They didn’t even know what they were going to use them for – they had no sense of a potential explanation (dreaming of sticking them into handheld calculators and lamp-posts) till IBM showed up and worked hard to convince them that putting the darn things in their PCs really had a future.

Would microprocessors ever have seen the light of day in that firm if Intel’s management had insisted on a “payback time” calculation? Nope, we’d still be using an abacus if they had (ok, now I may be exaggerating) and Intel would never have been the mega-success as we know it now (not exaggerating).

So why do we so incessantly insist on producing numbers if we’re talking strategy? Genuine strategy, by definition, deals with long-term issues, uncertainty and ambiguity. Hence, numbers don’t work very well; they are unreliable, potentially misleading and sometimes sheer impossible to produce in such a situation.

And I guess that is exactly why we/companies are so eager to see them. The long-term, uncertain aspects of strategic investment decisions make us rather insecure whether we’d be doing the right thing; therefore, we really really would like to see some numbers to lull ourselves into the belief that we’ve been thorough and have uncovered the facts and have a solid basis on which we’re accepting or rejecting the proposed course of action. Of course that’s just make-belief (you can make numbers say whatever you want them to say) and may make you quite myopic; missing the things that are difficult to quantify but much more important.

Am I propagating that we should get rid of numbers in strategy altogether? Heck no; forcing yourself to go through some sort of quantifying exercise can sometimes make you uncover and realise things that you hadn’t thought of before. But subsequently you should do what Tony Cohen, CEO of Fremantle Media, told me he always does when they’ve made financial calculations regarding new television production proposals: “Once we’ve carefully and painstakingly produced all the numbers we toss them aside and sort of make a decision based on our gut feel and experience”.

Numbers in strategy may form one (minor) input into your decision-making, but don’t mistake them for the real thing: make them, but then toss them aside and use your judgement and common sense.

2008-06-20T10:29:00.001+01:00

A Creosote bush: How "exploitation" drives out "exploration"

Established, very profitable companies often find it difficult to remain innovative (which may get them into trouble in the long run). In contrast, entrepreneurial, innovative companies often find it difficult to start producing efficiently and make a healthy profit out of their inventions. That is because the organisation required to be creative and innovative is usually quite different from the organisation that is suited for efficient, mass-scale production.

Professor Jim March from the Stanford Business School eloquently put it like this: he said there is a fundamental tension between “exploitation and exploration”. Exploration involves innovation and creativity, which often requires a high level of autonomy for people in the organisation and a flat organisational structure. Exploitation is associated with words such as productivity, efficiency and control, which requires hierarchy and clear rules and procedures.

If a company is financially successful, exploitation often starts to crowd out exploration. This relates to the idea of “the success trap”: organisations start to focus more-and-more on what they do well; the thing that brings them success and prosperity. Yet, this comes at the expense of other things, which may not be so profitable now but which could (have) become important for the firm in the long run.

Even the famous Intel fell into this trap. In the 1980s and 1990s, Intel had become hugely successful in the microprocessor business by being extremely innovative and running many experiments in semi-conductors. Yet, once they had developed an enormous advantage in microprocessors, they gradually stopped doing anything else. In 1996, CEO Andy Grove recognised the long-term dangers of this and remarked “There is a hidden danger of Intel becoming very good at this. It is that we become good at one thing”. Yet, he also found himself unable to revive Intel’s entrepreneurial creativity.

In 1993 microprocessors had made up 75% of Intel’s revenues and 85% of its profits. By 1998, this had increased to 80% of its revenues but 100% of its profits! This mega-company basically had only one product on which they relied to bring in all the dosh. That sounds a bit risky... The company’s COO, Craig Barrett remarked about this that Intel’s core microprocessor business “had begun to resemble a creosote bush”. In case you're not a botanist (and, like me, only appreciate plants when they come on plate), a creosote bush is a desert plant that survives by poisoning the ground around it, so that nothing else can grow in its vicinity… Quite a peculiar way to qualify your top-selling product I'd say, but not a bad analogy. Microprocessors were so successful that no other product could grow within Intel, because it would always look bad in comparison to these damn processor things.

Of all organisations that I have been studying over the past few years, the one that has probably impressed me most in this respect is the famous Sadler’s Wells theatre in London. On the one hand, they are phenomenally innovative, putting on the most novel and creative modern dance shows on the planet. But, on the other hand, they also stage a substantial number of shows that are tried and tested, and from which they know that they will reap a healthy profit without much of a doubt.

How do they maintain this balance so well? There are several complementary explanations, but one of them is that they work on it continuously; literally every day. They aim for about 15-30% of totally new innovative shows in the programme (often the result of a collaboration between artists who usually wouldn’t work together, because they have very different styles, background and training) and discuss this issue all the time. They do that in regular formal meetings, which invariably involve people from various departments, but also on an ongoing informal basis (that is, in the corridor, in the restaurant and in the toilet).

They are always discussing which show should go where on the theatre’s calendar, for how long it should be scheduled, what other show needs to be scheduled around the same time, etc. Because they continuously discuss and work on it, they manage to get the balance right. And, as their numbers show, the cool thing is that often, those shows which at the time were exploratory and considered risky and innovative, are now the ones that contribute most to their bank account.

2008-06-16T00:16:00.000+01:00

How bad practice prevails

Quite often, when I interview or just talk to a manager about his company and try to figure out why they are organised or managed in a particular way, I hit upon something which I don’t understand. Some practice, management technique, service specification or incentive system from which I simply fail to grasp why they do it like that (just to name a few candidates: detailing in pharmaceuticals, buy-back guarantees in book publishing, insane working hours in investment banking). And when then I ask (“I am not sure I understand; can you explain a bit more?”), I often get a long and winding answer (which suggests to me that they don’t quite know it either…).

And when I then, stubbornly, poke a bit harder (“sorry, but I still don’t get it…”), the interviewee might get a bit annoyed, after which very often I will receive the momentous reply “look Freek, everybody in our business does it this way, and everybody has always been doing it like this; if this wasn’t the best way to do things, I am sure it would have disappeared by now”.

I never quite bought this answer but, frankly, also did not quite know how to refute it…

Because our well-established theories of economic organisation would propagate exactly that: The market is Darwinian. Firms with bad habits and practices have a lower chance of making it in the market in comparison to smart firms who do everything right. Therefore, those firms will go out of business quicker and, although it may take a while, the ineffective practices will die out with them.

But I still thought they were wrong. I now think I have figured it out. Bad practices can spread and can continue to persist in industries, “till kingdom comes”. Let me attempt to explain to you how and why.

The trick is bad management practices can survive, despite making firms worse off, just like viruses can persist amongst humans. Because they are contagious, and “spread quicker than they kill”, the virus (or management practice) can continue to persist and not die out. It’s the same for certain industry practices.

Moreover, what’s unique about industries is that if everybody is employing the practice, everybody is equally bad. Yet, because competition is based on relative competitive strength, firms might not even notice that they are worse off for continuing the silly habit. Customers might complain about them (e.g. “all those stupid highstreet banks are equally terrible!”) but don’t have a choice; they have to pick one anyway (just like they would when the banks would all be excellent). Hence, the banks don’t suffer.

You can put these things into simulation – which I did – and quite easily model the diffusion and persistence of harmful management practices. So, next time a manager tells you they do it because everybody has always been doing it (whether it’s detailing in pharmaceuticals, buy-back guarantees in book publishing, or insane working hours in investment banking) and they’re sure that therefore it must be the best way of doing things, just smile at him and say “ah! that’s not necessarily true; just because everybody is doing it and has been doing it like this forever, does not mean that it is the best way of doing things”. And I will happily show him my simulation if you have the patience.

2008-06-13T10:37:00.008+01:00

Analysts rule the waves (whether we like it or not)

In the 1960s we saw a wave of “diversification” among corporations, resulting in the emergence of many so-called conglomerates. They operated in all sorts of businesses that often didn’t have much to do with each other. For example, a famous conglomerate in the UK was Hanson Plc, whose divisions operated in activities ranging from chemical factories to electrical suppliers, gold mines, cigarettes, batteries, airport duty free stores, clothing shops and department stores. Diversification was popular and conglomerates flourished.

In the 1990s though, the trend reversed, and we witnessed a wave of de-diversification. Firms started to focus on their “core activities”, companies were split up, conglomerates were dismantled, and diversification was generally regarded as unfashionable, evil and simply not-done.

What led the trend to reverse? Economists have argued that it was shareholders fighting back. Shareholders can diversify their stock portfolios; they don’t need companies to do that for them. Managers only do so to serve their own needs, and feed their desire for empire building, size and security. In the 1990s, shareholders said “basta” and forced self-serving managers to de-diversify – or so they claim.

A slightly kinder view is offered by sociologists, who argue that in the 1960s it was considered good practice to spread risk and diversify and hence a “legitimate thing to do”. Managers weren’t selfish and evil; they simply did what was expected of them. When shareholders said, “we don’t want you to do this anymore” (perhaps because the market became more transparent and efficient), they diligently responded and applied more focus to their companies.

Yet, more recently, researchers have started to focus on the role that analysts played and still play in discouraging companies to spread their activities across different industries. After all, sometimes diversification might make sense! 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. But that something makes sense from a strategy perspective doesn’t mean it makes sense in light of an analyst’s lunch break.

What…?! What do analysts’ lunch breaks have to do with any of this?!

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. 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”.*

Wait a second, did they just suggest that Monsanto should split up because it requires three (industry-specific) analysts to cover them and these three buggers can’t find a mutually convenient time to meet?! Yes, I am afraid they did.

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 the poor 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. Hence, analysts rule the (diversification) waves. And their lunch break will determine your stock price.

* Adopted from Tod Zenger, Professor of Strategy at Washington University.

2008-06-10T11:20:00.006+01:00

Women on top

In general, CEOs seem just like normal people. Some of them are nice, some of them unpleasant; some of them are modest, others are nauseatingly self-obsessed; some of them are bright, others more mentally challenged; some of them are helpful, others are cynically egotistic (and I could give you examples of each of these). Most of them are quite rich though… And most of them are men.

Yet, over the years, I have also interviewed quite a few female CEOs. Barbara Cassani when she, way back when, was the CEO of Go Airlines (later acquired by Easyjet), Sly Bailey, when she was still CEO of IPC Media (now she is the CEO of the newspaper group Trinity Mirror), Gail Rebuck, CEO of the book publisher Random House (who confirmed the famous story that she signed a big contract when she was in a hospital bed giving birth) and, very recently, Stevie Spring, CEO of magazine publisher Future, and Ruby McGregor-Smith, CEO of the large property services company MITIE. And they are all so nice…!

I mean really. Not nice as in bringing me cookies and pinching my cheek but nice as in helpful, realistic, sympathetic and down-to-earth. And bright. I have never met a dumb female CEO.

And I wonder why that is. I mean, it’s just not normal.

My guess is the following: Ascending to the position of CEO is a bit of a Darwinian process; many people start at the bottom of the corporate ladder; very few reach the highest step. Climbing the ladder, as a woman, you still need something extra – especially when heading a public company, having to deal with “The City”* – at every step. And I guess that something extra is brains and tact (a fairly rare combination, also among professors by the way). Without brains or tact (or both), men can apparently still navigate and survive the corporate jungle. But women without brains or tact get “selected out” quite quickly. Therefore, when you see a woman step up, she is bound to be quite good!

Don’t get me wrong, I have also met male CEOs who are “nice”, as in helpful, realistic, sympathetic and down-to-earth. And pretty much all female CEOs whom I interviewed displayed the attitude “stop whining about it being so difficult for women; just get on with it”, but they also confirmed that they did feel that they needed something extra at every step of the way. It is also not that I am advocating that we should make it easier for women to reach the top and become CEOs, because that would mean that we’d get more CEOs who are unpleasant, nauseatingly self-obsessed, mentally challenged and cynically egotistic. It is just that, in corporate life, we should treat men more like we treat women. That would be quite “nice”.

* "The City" is London's financial district

2008-06-06T17:26:00.000+01:00

Retaining your ability to make money? Causal ambiguity’s the answer.

Whenever people hear that I am a professor at a business school, the reply I most often receive is “oh, so you teach people how to make money…?” And I usually nod while I display a weak smile and abide in silence.

Some time ago though, I was teaching in New York, at Columbia University’s business school, and took a taxi from JFK airport. The driver, starting a polite chat, said “what do you do?” “I am a professor at a business school” “so you teach people how to make money”, “yeah (sigh), I teach people how to make money”…

But then, the guy continued, “so, what’s the answer?”…. That was a minor credibility crisis, right there on the spot…

I don’t remember what I said, but I remember thinking later what I should have said. It is about “creating value” (and selling it for more than it cost you to create) but also about “retaining value” (namely, why wouldn’t anyone else be able to come in and do exactly the same thing – driving the price down till you can only sell it for what it cost you in the first place)?

And, of all business plans and proposals I get to see, people usually think a lot about the first bit; “how to create value”. They talk about their unique value proposition, and why customers will love it, buy it, scream for it, and so on.

But they often forget about the second bit; why would YOU be able to do it, or at least do it better or cheaper than anyone else? What do you have or own that enables you to retain the value-adding ability, which protects you from immediate imitation by competitors?

For a start-up, that’s often tricky. You don’t have anything yet, so what could you possibly have or do that others couldn’t do too? The trick is that you don’t have to have it now, but you do need it a year or two from now, when you’re starting to have a real business.

Thus, the thing that makes you “difficult to imitate” does not necessarily have to be a patent, brandname, unique location, etc. It could also be found in other sources; something that you build up over time. Over the years, I have found that one of the most powerful sources – of being difficult to imitate – is a rather mundane thing… The firm’s competitive advantage is difficult to imitate because the firm itself doesn’t quite know what they do to make them so good at it…

We call this “causal ambiguity”. It may sound silly but is surprisingly common. Firms for example see that they have a much lower cost base than their competitors, or they see that their sales force is much more effective than theirs, or they manage to have a much lower error rate in their production process, but they don’t quite know why…

Causal ambiguity makes it difficult to exactly put your finger on what it is you do that makes you so much better than your competitors. Yet, don’t worry about it: it’s nice! When you yourself don’t even know what it is you do, it will be rather difficult for your rivals to copy it and do the same…!

2008-06-03T17:52:00.001+01:00

Bloody useless lab rats – or are they?

Can you have a useful R&D department that is perfectly useless? Perhaps I should explain the question... Most R&D departments are supposed to generate new technologies, products, processes, etc. But not all do. Some R&D department seem to never come up with anything that makes it to market. Clearly a waste of money, these lab-rats, right?

Well, maybe not.

For a long time, economists and other folks studying organisations assumed that R&D departments are supposed to come up with stuff. And only if they come up with good stuff – which eventually makes it into a sellable product and reaps a profit – is an R&D department worth the investment. Clearly, if they never come up with anything at all, that’s money down the drain – or at least, that’s what everybody assumed.

Then, two professors of strategy (note, not economists!), Wesley Cohen and Daniel Levinthal, discovered an interesting insight. To put it in a simplified nutshell: sometimes, firms with R&D departments that never come up with anything at all still seemed to benefit from them?! How can such a seemingly useless bunch of Gyro Gearlooses still be worth their while?

The trick is that, in many industries (and in most industries to some extent), whatever firms invent comes into the public domain, much like radio signals or air pollution. Hence, other firms can easily access and imitate it. Economists always assumed that this process is costless; you just pick it up and do it too. Therefore, unless you’re in one of those rare industries in which patents really work, it’s actually kind of nice if your competitor invents something new; you can do it too without having had to spend all this R&D money!

However, this turned out to be a bit of an oversimplistic view of the world. Imitating your competitor is not that easy. It turns out that firms that never invest anything in R&D actually have quite a lot of trouble nicking ideas from others. They just don’t quite understand them well enough. In contrast, firms that do have an R&D department – even if the geeks never invent anything themselves – appear to be much better at copying others. That’s the unexpected benefit of having your own R&D: R&D equips you, as a firm, to be better at “stealing” things from others. Because of your investments in R&D, you are better able to really understand the technology and apply it in your own products and processes.

Wes and Daniel examined this phenomenon at length and wrote a series of articles about it in a bunch of heavy-weight academic journals, with telling titles such as “Innovation and learning: The two faces of R&D”, “Absorptive capacity: A new perspective on learning and innovation” and, my favourite, “Fortune favors the prepared firm”. It shows that there are two benefits from investing in R&D: the first one is to invent stuff; the second one is to build up the capacity to understand, assimilate and apply the things that others come up with in your own products and technologies.

2008-05-30T13:47:00.000+01:00

Change for change’s sake

Have you ever worked for a company that changed its structure, and you couldn’t figure out why? Me too. Ages ago I was working for a consulting company which was organised by “function”: consultants were grouped into departments defined by “strategy”, “operations”, “HR”, etc. But then the company decided that they really should be organised by “industry”, that is, group its employees into a division for fast-moving consumer goods, a division for government, heavy industry, professional services, etc.

And when people would ask “why?”, the company’s management would come up with quite convincing answers why it was beneficial for consultants working on the same type of customer to be grouped together. And people shook their head in reluctant understanding and grudgingly eyed up their new colleagues.

But I couldn’t help but think “I could come up with equally convincing reasons for why this company should (still) be organised by function”. And that is usually the case for organisations. For example, you could easily come up with an explanation of why a bank should create divisions organised by geography; after all people located in the same country often need to coordinate and have a joint manager. Yet, you could also come up with an argument of why they should be organised by product type; after all, people working on the same product (wherever in the world) should coordinate and learn from each other. Similarly, you could come up with valid reasons why the bank should be organised by customer-type; after all, big customers often want one point of contact, regardless of the product they require, and where in the world.

And I used to think, unless you can come up with very convincing reasons why being organised by “industry” is now really more beneficial than being organised by “function”, there is no justification for dragging everyone through a hefty reorganisation.

But I’ve changed my mind. Dragging everyone through a hefty reorganisation is exactly what you should do (every now and then), even if it is unclear why.

Now that I have seen many more companies change their structures, I realise that, unless you can come up with very convincing reasons that being organised by function (your old structure) still is a heck of a lot more useful than becoming organised by industry (the proposed new structure), you should change the whole darn thing. Just swap the divisions around, reshuffle them and force your people to work with a new set of colleagues, under a new set of rules.

Let me explain. There is value in the process of re-organising. Usually people in an organisation should coordinate with other employees in their country, just like they should also cooperate with others working on the same product (wherever in the world), and others in the same function, etc. Yet, you’re going to have to make a choice what criterion you will use to organise your departments. Once you’ve for instance chosen to group people by function, inevitably, over the years, employees will start to identify with others in their function, their networks in the firm will be dominated by those people (because that is the people they interact with most), and gradually they may become a bit insular, and not have much understanding or appreciation of people in other functions and departments, even if they are working on the same product or serve the same geographical market.

The trick to resolve this – or even avoid it, if you manage to do it pro-actively – is to simply swap them around. Break up the old functional departments and, for instance, put them all together in departments defined by product (or whatever). The employees won’t like it, because they think these other folks are a bit weird (if not dumb and whining) and they will tell you they felt quite comfortable in their old functional departments – which is precisely the reason you should change them!

Once people become comfortable in their groups, stop communicating and coordinating with others outside their department, and fail to see others’ perspectives, it is time to turn them around. And the good thing is, for the first few years after the reorganisation, they will still have their old social networks, perspectives and knowledge of their previous, functional departments, while already working with the new product structure. As a result, you can actually get a bit of the best of both worlds. And once they start to lose that; just change them again.

2008-05-26T13:37:00.010+01:00

Patent sharks

You never heard of patent sharks?! You’re kidding, right? Ok, I’ll admit it, I had never heard of them either. But they sound pretty scary, right? Well… ok, perhaps not; the word “patent” sort of seems to take the edge of the word “shark” a bit. Yet, now that I have learned more about them, I have to admit, I am starting to believe that they should send some shivers down your corporate spine; they really are quite creepy.

My colleague at the London Business School, Markus Reitzig, has been studying patent sharks at length. I always found IP (intellectual property) a bit of a bore when it comes to research topics but, admittedly, his research did remind me of Jaws III, but then with briefcase, pin-striped suit and, importantly, a mob of solicitors to accompany him. Let me explain.

As you may know, when it comes to the effectiveness of patents, pharmaceuticals are a bit of an exception. In most industries, patents provide only very limited protection against imitation by competitors. Usually, the part of the product that is patent-“protected” can be substituted or “invented around”. Therefore, what firms have started doing is protect their products with as many patents as possible. That is, it is not uncommon in some high-tech industries to have over a 1000 different patents protect many little components in a firm’s product. They figure, one of them may not do the trick but if you have such a bunch of them, collectively they should give some protection.

Yet, since competitors do the same, as a result, researchers have long noticed that patents have become sort of a corporate currency. How does this work? Well, whatever you want to do, in terms of developing a new product or technology, you’re bound to infringe on someone’s patent. Luckily, that someone is likely to need to infringe on some of your patents too. Rather than going to court, firms usually strike a deal: “I will forgive you for infringing on these 84 patents if you just absolve me from infringing on your 63 ones”. And this system generally works quite well.

However, given the plethora of patents in such industries, the difficulty is that you seldom know in advance exactly which patents you will be infringing on; there are just too many of them lying around. What has now happened is that some specialised firms – the infamous “patent sharks” – have started taking advantage of this. They acquire patents not with the intention of using them, but with the aim to extort money from the unknowing infringers.

When a patent shark finds out that a certain firm is using a technology which more or less falls under one of its patents, it waits patiently until that firm has fully committed itself to the technology (and has incorporated it in its products, marketed them, made additional investments, etc.). Then the shark surfaces…

It will demand large sums of money for the infringement. If the firm refuses, they will roar “court action!” and threaten to shut them down. And the nice thing – at least, for the shark – is that the patent doesn’t even have to be a real good one. Even if it is only a half decent patent, with little chance of holding up in court, often they can convince a judge to issue an injunction, forcing the firm to suspend business pending the court’s decision. And this can be so potentially disastrous for the firm that it quickly coughs up the dough to make the shark go away.

For example, NTP, a pure patent-holding company, filed a suit against RIM; the producer of the best-selling Blackberry. RIM was confident that the five patents NTP was throwing at them would not hold up in court – because all of them had already been preliminarily invalidated by the US Patent and Trademark Office while two of them had already received a final rejection! – but when it seemed that a particular US district court judge (“The Honorable Judge James Spencer”) was inclined to grant the injunction, which would have costed RIM billions in lost revenues and deteriorated competitive advantage, they promptly – but undoubtedly grudgingly – decided to hand over 612.5 million dollars to NTP.

Getting scared already? I guess you should. There just might be some shark circling underneath, in your blue ocean… holding some obscure patent which could cost you an arm and a leg, if not more.

2008-05-21T13:28:00.000+01:00

“Heerlijk, helder, Heineken”

The line above probably didn’t mean much to you, unless you’re Dutch.

No I am not getting a commission for rehashing their old marketing slogan (which it is; I guess you could translate it as “heavenly, clear, Heineken”), it just reminds me of the acquisition strategy they used under the reign of their illustruous former chairman Freddy Heineken (who unfortunately died a few years ago).

Since I have been known to sound slightly sceptical (yes, this is a good english eufemism) of the vehicle of corporate take-overs, people sometimes ask me which company’s acquisition strategy I actually like… A painful silence (to this fair question) used to ensue. But no longer! Since I didn’t want to create the erroneous impression that I think all acquisitions and acquirers are bad, I decided to look for one.

And I found Heineken. It happens to be a product that I studied extensively during my student days but some time ago I also really dug into their past acquisition strategy, and whether it made sense. And I have to say “heerlijk, helder, Heineken” or, in english, "yes".

This is what I like about it. Many managers see acquisitions as a relatively easy and quick way to increase the size of their company, in comparison to the painstaking process of organic growth. Yet, they forget that owning a bunch of companies doesn’t necessarily turn them into one organisation. Successful companies often have a high level of coordination between the various activities and parts of their organization. This involves technology and systems but also intangible characteristics such as a shared culture and informal networks. Research by Wenpin Tsai and Sumantra Ghoshal, published in the Academy of Management Journal, showed that these organizational abilities take ample time to grow and develop. Freddy Heineken realised this; he did quite a few acquisitions, but not too many, and carefully added and integrated them into his company.

Moreover, he did not see them as a substitute for organic growth but, instead, as an enabler of it. He used to undertake acquisitions with the explicit aim to create further opportunities for organic growth for both the acquired company (which benefited from Heineken’s knowledge, purchasing power, etc.) and for the Heineken brand (which benefited from added local distribution).

Heineken’s focus was always on profitability, rather than scale per se. This made him stubbornly resist loud calls (for instance by analysts and investors, and some business school professors…) to merge with a major rival. Freddy used to say, “I don’t want to be the biggest; I want to be the best”. And he was.

2008-05-16T22:49:00.000+01:00

What management bandwagons bring

Management by Objectives, Zero-based Budgeting, T Groups, Theory Y, Theory Z, Diversification, Matrix Organisation, Participative Management, Management by Walking Around, Job Enlargement, Quality Circles, Downsizing, Re-engineering, Total Quality Management, Teams, Six-sigma, ISO9000 and Empowerment.

Surely you must have been subjected to some of those? Most of them have fallen out of favour again. We call them Management Fads. But do they do anything? Well… the answer is yes, but perhaps not what you’d expect them to do, or least what they are intended to do.

Professors Barry Staw and Lisa Epstein, both from University of California in Berkeley, through careful statistical analysis, examined some of the consequences of organizations’ adopting such techniques on a variety of factors. They collected data on exactly 100 Fortune 500 companies, including their adoption of quality techniques (such as Total Quality Management), teams and empowerment, the company’s reputation (through Fortune’s “Most Admired Companies” survey), their financial performance and… of course… CEO’s compensation. This is what they found:

Firms adopting popular management techniques (such as TQM, etc.) did subsequently not perform any better than firms not adopting them. Actually, if Barry and Lisa did find an effect of any of the techniques, it was negative. Usually though the stuff didn’t do a thing at all.

Then they examined the effect of adopting such techniques on the companies’ reputation, measured through their position and ascent on Fortune Magazine’s “Most Admired Companies” list. The analysis revealed clearly that adoption of the popular management techniques significantly increased firms’ position on the “Most Admired Companies” list, irrespective of their performance… To be precise, those firms were rated as being more innovative and as having higher quality management. Apparently, the stuff doesn’t have to work, but it does enhance your reputation in the outside world.

Finally the piece-de-resistance: The influence of the adoption of popular management techniques on a CEO’s compensation package (salary and bonus).... Yep, you guessed it, and the effects were very strong: If a CEO’s firm adopted one of the popular management techniques, his compensation went up.

So what does this tell us? Well, first of all of course that many of these management fads simply don’t work. The organisation doesn’t perform better as a result of adopting any of them. Yet, apparently, it does make you look innovative and legitimate in the eyes of others. This includes fellow executives, who subsequently vote for you as being “much admired” but – hurrah! – also in the eyes of your Board; they enthusiastically pad you on the back for the great achievement and, with grace and thanks, increase the size of your compensation package.

2008-05-12T12:32:00.000+01:00

“Innovation networks” and the size of the pie

It’s becoming a bit of a corporate buzzword – “innovation networks” – but one that (to my slight disappointment) I actually quite believe in.

More and more companies I see and talk to seem to realise that it is quite difficult to be innovative on your own. For true innovation, almost by definition, you need a wide variety of capabilities, knowledge and insights. It is just difficult to find such diversity within one organisation. If you, as a firm, are trying to come up with fundamentally new things, you would likely do well to also look outside your own organisation’s boundaries, whether anyone knows anything that just might be useful and interesting for you.

This is what “innovation networks” are about; combining and tapping into other companies’ knowledge resources to, collectively, come up with something that neither firm could have done by itself.

IBM, for example, does it consistently and in a highly structured way. They work with specific partners on specific projects. Some of these partners are from outside their industry but others could even concern straight competitors. For example, in their Cell Chip project, developing multi-media processors, they work with Sony, Toshiba and Albany Nanotech. In their Foundry R&D project, designing manufacturing processes for mobile phone chips, they work with Chartered, Infineon, Samsung, Freescale and STMicroelectronics. And they have several other similar projects, with yet different groups of partnerships.

However, the networks can also be of a more informal nature. For example, the successful Sadler’s Wells theatre in London, which focuses on the creation of ground-breaking modern dance, has no orchestra or ballet of its own. Instead, it tries to create innovative modern dance shows by putting artists in touch with each other who otherwise would not have worked together. They organise dinners during which those artists meet, they give them some studio time and budget to improvise and experiment, and assist them with advice and other facilities to get them to combine their skills and talents to create new forms of modern dance. What they ask in return is that the artists premiere their performance in Sadler’s Wells.

The most striking example of informal innovation networks I have seen, however, is that of Hornby; the iconic English producer of little model trains and Scalextric slot car racing tracks. They have some more or less formal alliances with software producers and digital electronics companies, which for instance led them to develop virtual reality train systems and digital slot car racing tracks (allowing multiple cars in lanes, which can overtake each other; clearly the most prevalent schoolboy dream since the emergence of Samantha Fox!). Yet, they also have some striking informal networks, which stimulated their innovativeness.

For example, one of their latest innovations is a real steam train (which retails at a whopping £350), and I mean real steam. The little whistler doesn’t run on electricity but on actual steam. The interesting thing is how they came up with it. Well, or actually, they didn’t… One of their customers did. They maintain close networks – on-line, by organising collector clubs, tournaments, etc. – with their collectors. Through these networks, they learned about a hobbyist who had invented a real model steam train. They went to visit him and adopted his rudimentary technology.

But the most striking example of their informal innovation networks I saw when I visited Frank Martin, Hornby’s CEO, at the company in Margate some time ago. In his office lay a piece of slot car racing track. “Look” he said “a very innovative and sophisticated new surface, which is not only much more realistic but also much less slippery for the toy cars. Our Spanish competitor sent it to us”. I said “what?! why would your competitor do that? are you sure it is not a fluke? are you paying them for it?” And he replied “no, whenever they invent something new, they send it to us. And we also send them stuff”.

They have no contracts or any other formal arrangements in place for these exchanges. They just figure, ‘we could shield our innovations from our competitors but we’re all much better off if we share them’. The size of the pie (the total size of the market) will increase as a result of it, and they all benefit; much more than when they would all keep their innovations to themselves.

It is a peculiar type of innovation network, if your customers and even competitors become part of it and share their innovations with you, purely on the basis of trust and reciprocity, but it is certainly a formula that works for Hornby. They managed to quintuple (I had to look up this word) their stock price over the past few years, partly as a result of such innovations. Innovation is important to many companies in many businesses; too important to (merely) leave to your own devices.

2008-05-07T17:52:00.000+01:00

Boardroom friends

Boards of directors, in various countries and systems, lately have been subject to considerable frowning, loathing, smirking and indecent hand gestures. “They’re all part of the same elite”, “corporate amateurs”, “never really objective”, “not really independent”, “an old-boys-network”, etc. etc. Surely, it is said, those directors that are pretty much personal friends of the CEO will be quite useless; they will just protect him and never really be critical, asking the nasty and awkward questions they should be raising.

Yet, is this necessarily so? Are “friends” bad directors? Professor James Westphal, of the University of Michigan, became sceptical of the sceptics. He investigated whether social relations between board members and CEOs really are as harmful as assumed. He extensively surveyed 243 CEOs and 564 of their outside directors and examined whether personal friendships and acquaintances made for less effective board members.

First of all, he found that the boardroom friends hardly ever engaged in less “monitoring” of the CEO (that is, checking strategic decisions, formal performance evaluation, etc.) – the traditional stuff that directors are supposed to do. They were still quite active in that sense, despite being the CEOs personal friend.

In addition, Jim found that boardroom friends engaged a lot in another type of behaviour towards the CEO: ongoing advice and counselling. They gave their CEO informal feedback about the formulation of the firm’s strategy: they acted as a ‘sounding board’, continuously provided general feedback and suggestions, etc. All this happened outside the company’s formal board meetings. Directors who were not personal friends hardly engaged in this type of behaviour.

Usually CEOs don’t easily do this; accept or even ask for ongoing counselling and opinion. It is well-known from research that a primary inhibitor to seeking advice is the perceived effect it could have on the advice seeker’s status. People often believe that others will view their need for assistance as an admission of uncertainty or dependency and as an indication that they are less than fully competent or self-reliant.

Little doubt that CEOs – who are expected to be confident, proud and self-assured – have these tendencies too! Fierce, testosterone-driven CEOs may not take criticism or even advice easily, but if the director is a personal friend, it might just be a bit easier to swallow. Psychologically, it is just a bit more secure to listen to criticism from someone you know and trust than from a formal stranger. Hence, having your friends in the boardroom may not be such a bad thing after all.

2008-05-04T08:53:00.003+01:00

Eating uncle Ed – don’t worry, it’s called downsizing

About a century ago, the Fore people, who inhabited Papua New Guinea, had the habit of burying their deceased relatives, just like many other societies. Yet, on some sunny day, Uncle Ed died, and it was just around lunch time. Uncle Ed’s relatives were about to put him into the ground when one of his cousins (who looked particularly hungry) said “why bury all that good meat; it’s a waste; we might as well eat it”. And so they did.

When the following month another relative died, they did the same thing, and not for long, the whole village was eating their deceased relatives, rather than putting them into the ground. The advantages were obvious; there had actually been quite a bit of famine and malnutrition among the Fore people and this habit enabled them simply to not be so hungry.

Some time later, a visitor from a neighbouring village witnessed the practice. When he got home and his cousin died, he quickly convinced his relatives to rather than bury the good chap, consume him on the spot. Gradually the practice started spreading to all villages in the tribe, until the habit of eating deceased relatives had become the norm and the Fore’s proud tradition.

Yet, unfortunately, they ate everything, including their relatives’ brains. As a consequence, they developed a horrible, lethal disease called Kuru (which is related to Creutzfeld-Jacob, aka mad cow disease). The disease has quite a long incubation time (i.e. it takes several years before it becomes apparent) but eventually the Fore people started getting sick and dying in masses. Of course, they noticed something was seriously wrong but, due to the disease’s long incubation time, had no idea that their misery was caused by the habit of eating their deceased. The practice continued until half of the Fore population had been wiped out and Australian invaders put an end to it (because they thought it was gross, not because they understood it caused the disease).

Why am I telling you this story – after all, you might be reading this just before lunch? The reason is as follows: Many managers and companies remind me of the Fore people.

Let me explain: The Fore’s practice clearly was detrimental; after all, it was killing them! Yet, the reason for them adopting it was clear too: the practice gave them an immediate advantage, namely less hunger and less starvation. In the long run, however, they were definitely worse off for doing it but the problem was that, due to the practice’s incubation time, they could not understand that it was this habit that they had picked up many years ago that was causing the problems.

Quite a few popular management practices have the same characteristics. The problems they cause only occur in the long run and are therefore underestimated or not understood at all. The benefits are immediate.

Take, for example, the practice of “downsizing” (or rationalizing, restructuring, reorganising, etc.: that is, making people redundant). It is a trend that has now been going on for at least a decade and a half; companies – even if they are not in financial difficulties – engage in systematic programmes to reduce the headcount in their organisations. The short-term benefits are clear: It leads to lower costs (sometimes accompanied by a positive response from the stock market to the announcement of the programme). Yet, there is also evidence of sizeable long-term detrimental influences, such as reduced innovation and lower employee commitment and loyalty. However, such consequences are only noticeable in the long run.

Usually, when a firm faces a serious problem, for example due to a lack of new products in the pipeline, top management does not realise that the lack of innovation is caused by the downsizing programme that they engaged in a near decade ago. Just as it did for the Fore people and their illness, the long lead time makes it all but impossible for managers to connect and understand cause and effect. Thus, not only will top management take inappropriate action to solve the problem (not seldom another cost-cutting programme…), it also remains unclear to other firms that downsizing is harmful, leading them to adopt and continue the practice too.

2008-05-01T11:02:00.001+01:00

“A serial changer”…

Some time ago, I interviewed a guy called Al West. And Al is quite a guy. Not only because he is the founder and CEO of SEI, an investment services firm headquartered in Oaks, Pennsylvania, which is worth about 4 billion (of which he still owns about a quarter) but because of the way he runs his company.

For example, I asked for the contact details of his secretary to put an appointment in the diary. He doesn’t have a secretary. Actually, he doesn’t even have an office. And when I went to their London office to speak to him, reported at reception and asked for Al West, the lady behind the desk said “Who? Al West you say? Let me see if we have anyone in this company by that name”. Al doesn’t strike me as the stereotypical autocratic, macho CEO.

What Al does strike me as – and which is the reason why I wanted to talk to him – is a “serial changer”; or at least that is how one of his employees described him to me. He is altering his organisation – in terms of its structure, incentive systems, decision-making procedures, etc. – all the time, never quite satisfied and never quite done. And somehow, I suspect that is part of the key to his company’s success.

In 1990, Al broke his leg in a skiing accident. He lay in the hospital staring at the ceiling for about 3 months. When he came back to work, despite the company growing and performing well, the first thing he did was completely reorganise the entire firm. His employees thought, “why change a winning formula? he must have been quite bored and couldn’t think of anything better to do. I am sure it will pass”. But it didn’t pass. Ever since, Al has been reorganising his company regularly.

And he does it because he doesn’t want to allow his organisation to become settled and “comfortable”. SEI has been growing steadily for decades now, with an impressive – and impressively stable – 30% per year. Yet, Al never does any acquisitions (he feels they would disrupt the smoothly-running organisation). Yet, unlike many other successful companies, SEI doesn’t get trapped in its own success and gradually grow rigid and inert. SEI continues to innovate and grow.

The reason why many very successful companies find themselves in trouble in the long run, is that they become too insular, narrow and set in their ways. This leads to problems when their environment changes. Yet, Al’s regular changes to his organisation prevent it from becoming set in its ways. Moreover, powerful people and groups within an organisation usually, over time, become even more powerful (because they can get their hands on even more resources, budget and people); too powerful for the good of the firm. Yet, in SEI people don’t get a chance to create fiefdoms and accumulate influence beyond what’s good for the company. Al doesn’t give them the time to do it.

Along similar lines, my colleagues Phanish Puranam and Ranjay Gulati examined periodic structural changes within Cisco. And they found that Cisco’s many reorganisations helped to solve some tricky coordination problems within the firm. In many organisations, over time, employees become focused on their own unit, group or department. It’s their perspective that they view things from, that’s where there social networks lie and whose interests they pursue. By regularly reshuffling departments, however, Cisco's people not only are forced to develop new perspectives and cooperate with other people, the contacts and perspective of their old group (now dispersed across the firm) are still available too, so that the firm gets the best of both worlds. Professors Nickerson and Zenger found similar patterns examining Hewlett Packard’s regular switches between centralisation and decentralisation.

The regular changes to the organisation prevent it from becoming rigid and inert. They may be perceived by people working in the firm as a pain (in all sorts of body parts) if not completely unwarranted (“we’re performing well, aren’t we? why would we change anything?") but it helps avoid more serious trouble in the long run.