When a foreign company acquires a domestic firm, it often leads to outcries of indignation, nostalgia (“another of our once great companies in foreign hands”), and calls for legislation to prevent any more foreign poaching. Politicians and union leaders proclaim that the foreign owners may not be dedicated to keep up investment in the subsidiary, and that the take-over threatens national jobs and other economic interests. “Most governments are reluctant to see their corporate treasures fall into foreign hands”, the BBC wrote in an article devoted to the topic.
But is all this (slightly xenophobic) fear justified? Well, maybe not; at least not on all dimensions. Because we have increasing evidence that foreign ownership of a firm may actually also benefit firms, specifically in terms of their innovativeness. And this increased innovativeness may clearly benefit the host country.
Professor Annique Un, from Northeastern University in Boston, for example, did a pointy study. She collected data on 761 manufacturing firms operating in Spain, examined which ones were foreign hands and what their innovation output was in terms of new products introduced in the market. And the answer was pretty clear: foreign owned firms were more innovative than purely domestic firms.
Interestingly, Annique also corrected her models for the amount of R&D investments spent in the companies, and it turned out that this was not what was driving it; foreign owned companies were not just more innovative because they were investing more. Instead, they were more innovative irrespective of R&D. As a matter of fact, they were able to generate more product innovations for the same level of investment; meaning that they were simply better at it.
The study’s results suggested that they were better at it for two reasons. First, foreign parents seemed to use their domestic subsidiary to channel innovation into the country. Put differently, it seemed a foreign-owned company could tap into its parent’s superior repository of innovative stuff, and most of them gratefully made ample use of that option. Secondly, the foreign-owned companies were simply also better at coming up with new stuff on their own, in comparison to their domestic counterparts. Apparently, something about them being foreign-owned stimulated them to be more agile and creative, which resulted in more product introductions.
Whatever the reason behind this foreign-driven surge in innovation, the host country was better off for it; the evidence clearly showed that the foreign mercenaries stimulated diversity in the markets, giving customers more choice, while raising the bar for everyone. And this is not a benefit we hear many politicians, newspapers, and union leaders proclaim and acknowledge, when yet another foreign corporation is eyeing up their country’s corporate treasures.
Showing posts with label Growth. Show all posts
Showing posts with label Growth. Show all posts
Wednesday, September 28, 2011
Thursday, March 17, 2011
Big firm innovators: What large companies can do to be just as innovative as small entrepreneurial ones
Big companies are thought to rarely be the real innovators in an industry. Usually, radical change – whether a new technology or an entirely new business model – comes from outside the industry, and is introduced by an entrant into the field. On average that is true – research confirms it – and there are various reasons for that. It pertains to a phenomenon I called “collective inertia”; established players often seem paralysed when significant, paradigm-busting change is sweeping through their business.
Why big firms are often slow to adapt
That is because those existing players usually do not see an interest in destroying their own business and competitive advantage; newspapers were reluctant to move into on-line media because it cannabilised their existing business, traditional airlines were reluctant to embrace the low-cost model, and steel companies shunned away from minimill technology. These new technologies and business models ate into their current business and therefore they were not keen, to say the least.
There is often also a softer, almost psychological component to it. It pertains to phenomena such as the success trap, escalation of commitment, and the Icarus paradox in business. Years of continued success have wedded the firm to its own proven formula and business model, and the new, initially often inferior technology is not something they believe in and particularly want to get involved with.
Hence, we see that existing players in an industry usually are not the inventors of radical new innovations and often even late adopters – often too late… Quite a few of them do not survive the transformational turbulence in their business as a result of their own inertia.
However, Professors Lin Jiang and Marie Thursby from Georgia Tech and Justin Tan from York University discovered that there are some exceptions to this rule, and some incumbents do manage to be inventors during the stage of technological dirsruption. And that is pretty interesting, because those firms teach us what existing players can do to prevent missing the boat, and becoming obsolete when their environments change – a problem that clearly bugs many of them.
Big firm innovators
Lin, Justin, and Marie examined the semi-conductor industry, where the initial reliance on vacuum tubes was replaced by bipolar technology, which in turn was replaced by complementary metal-oxide semiconductors (CMOS). At present, that technology is under threat from nanotechnology. Using extensive patent analysis, Lin and colleagues examined which existing players did not succumb to the new entrants, and were able to contribute to the new technology. And they found three key, related characteristics:
First, the firms that were able to contribute significantly to fresh knowledge in the new and emerging domain had forced themselves to continue to scan for new technological areas. They had not just rested on their laurels, trying to make the most out of an existing technology. In spite of the technology not being under threat yet, their R&D engineers had continued to scan the environment for new, substitute technologies. And now this paid off.
Second, the firms that did manage to be inventors in the newly emerging domain had maintained a broad portfolio of alliances – specifically a portfolio of alliances that consisted of both firms that were pretty close to its current set of activities and firms that were in entirely different domains. Such a combination of alliance partners is thought to assure that the firm is exposed to really radically different things, but at the same time also to things that are more within its own familiar domain of comprehension!
Finally, the successful inventors had always maintained clear ties to sources of scientific knowledge in the public domain, by collaborating with university scientists, reading scientific publications, and so on.
Innovations usually consist of some form of recombination of other, existing sources of knowledge. The aforementioned results show that if existing, successful players in an industry force themselves to continue to access a variety of external knowledge sources – in the form of experimenting with new technologies, maintaining alliances, and accessing university sources – they can not only survive a radical change in their business but even contribute to it. Hence, do keep an active, open mind and door, and let knowledge flow in, even if you think you are currently doing just fine.
Why big firms are often slow to adapt
That is because those existing players usually do not see an interest in destroying their own business and competitive advantage; newspapers were reluctant to move into on-line media because it cannabilised their existing business, traditional airlines were reluctant to embrace the low-cost model, and steel companies shunned away from minimill technology. These new technologies and business models ate into their current business and therefore they were not keen, to say the least.
There is often also a softer, almost psychological component to it. It pertains to phenomena such as the success trap, escalation of commitment, and the Icarus paradox in business. Years of continued success have wedded the firm to its own proven formula and business model, and the new, initially often inferior technology is not something they believe in and particularly want to get involved with.
Hence, we see that existing players in an industry usually are not the inventors of radical new innovations and often even late adopters – often too late… Quite a few of them do not survive the transformational turbulence in their business as a result of their own inertia.
However, Professors Lin Jiang and Marie Thursby from Georgia Tech and Justin Tan from York University discovered that there are some exceptions to this rule, and some incumbents do manage to be inventors during the stage of technological dirsruption. And that is pretty interesting, because those firms teach us what existing players can do to prevent missing the boat, and becoming obsolete when their environments change – a problem that clearly bugs many of them.
Big firm innovators
Lin, Justin, and Marie examined the semi-conductor industry, where the initial reliance on vacuum tubes was replaced by bipolar technology, which in turn was replaced by complementary metal-oxide semiconductors (CMOS). At present, that technology is under threat from nanotechnology. Using extensive patent analysis, Lin and colleagues examined which existing players did not succumb to the new entrants, and were able to contribute to the new technology. And they found three key, related characteristics:
First, the firms that were able to contribute significantly to fresh knowledge in the new and emerging domain had forced themselves to continue to scan for new technological areas. They had not just rested on their laurels, trying to make the most out of an existing technology. In spite of the technology not being under threat yet, their R&D engineers had continued to scan the environment for new, substitute technologies. And now this paid off.
Second, the firms that did manage to be inventors in the newly emerging domain had maintained a broad portfolio of alliances – specifically a portfolio of alliances that consisted of both firms that were pretty close to its current set of activities and firms that were in entirely different domains. Such a combination of alliance partners is thought to assure that the firm is exposed to really radically different things, but at the same time also to things that are more within its own familiar domain of comprehension!
Finally, the successful inventors had always maintained clear ties to sources of scientific knowledge in the public domain, by collaborating with university scientists, reading scientific publications, and so on.
Innovations usually consist of some form of recombination of other, existing sources of knowledge. The aforementioned results show that if existing, successful players in an industry force themselves to continue to access a variety of external knowledge sources – in the form of experimenting with new technologies, maintaining alliances, and accessing university sources – they can not only survive a radical change in their business but even contribute to it. Hence, do keep an active, open mind and door, and let knowledge flow in, even if you think you are currently doing just fine.
Tuesday, January 18, 2011
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.
***********
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.
***********
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)”. 
***********
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.
***********
‘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.
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.
***********
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.
***********
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)”.
***********
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.
***********
‘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.
Thursday, January 13, 2011
‘Stretch goals’ tend to stretch all the way into fraud
Goal setting works. Give your employees some concrete goals and they will work harder to reach them than when you just tell them “do the best you can”. There are ample studies confirming that relationship. Professors Edwin Locke and Gary Latham, from the University of Maryland and the University of Texas, even called goal-setting “the most effective managerial tool available”.
So, I am not arguing with the effectiveness of goal-setting, but I would say it should come with a health warning. And that is because it also induces some more dubious behavior.
Let me explain. “Stretch goals” is one of these terms that have persistently entered managerial vocabulaire, earning a prominent and enduring place in consultant speak. The idea is that you set your people goals that they might just reach if try really really hard – or just not. Hence, they stretch your people’s effort to the limit.
However, there is a little catch to that. We also know from research that if people almost reach this goal (but, crucially, not entirely…) they tend to make it up.
Cooking the books
Really – quite literally. If they almost reached the stretch goal but not entirely, they will be inclined to pretend they did, and cook the books. Professors Maurice Schweitzer for the University of Pennsylvania, Lisa Ordonez from the University of Arizona, and Bambi Douma from the University of Montana designed a clever experiment. They gave seven random letters to 154 participants and asked them to create as many words as they could within a minute, writing them on a workbook. If they came up with 9 words or more they would get a monetary award. And they did that 7 times. The participants had to record themselves how many words they got each round and, at the end of the experiment, hand in a notebook of their achievements and take the corresponding amount of money out of an envelope. The experiment was guaranteed to be entirely anonymous.
But, unknown to the participants, there was a trick… Although the experiment was indeed anonymous, the researchers could match the workbooks to the notebooks and envelopes with the remaining money. Thus, they could look up how many people cheated (although they were not able to identify their names). And the answer was pretty clear and precise.
Each time people got 5 or 6 words or so – pretty far off the mark of 9 – they reported it honestly and left the money in the envelope. However, things were markedly different when people had reached 8; just one word short off the mark. In that case, a significant number of people cheated: they filled out that they had come up with 9 words and took the money out of the envelope, although their workbooks clearly showed they had missed the mark by 1 word. They cooked the books and deceptively misappropriated the corresponding monetary award.
It reminded me of organizations like Enron, Ahold, or Worldcom, where management habitually set their people ambituous goals. These firms may have gone down attributing their fall to fraud, but the fraud was induced by the organizational context created, which stimulated their people to cheat. Stretch goals may stretch employees’ effort to the limits, it also stretches their sense of ethics.
Self-justification
Because the interesting question is also, who were they cheating? When people reached only 5 or 6 they could have just as easily cooked the books and taken the money as when they had reached 8. But they didn’t. As a matter of fact, there was no need to fraudulently fill out the notebook at all; they could just have taken the money out of the envelope and leave. But only one out of the 154 participants took more money out of the envelope than reported on the notebook (and even that could have been an honest mistake). So why did people only commit fraud when they fell just short of the goal, and not when they missed it by a mile? And why did they insist on writing the false information in the books, when they could have just taken the money and run?
It has to do with self-justification. It seems we are inclined, when we have been set a stretch goal that we just did not reach, to tell ourselves that we sort of did, and really do deserve the reward. We can’t tell that to ourselves when we are way underperforming and very far off the mark. We also can’t justify to ourselves to just grab all of the money. But when we almost reached the stretch goal (but not entirely…) we humans are perfectly able to tell ourselves a nice little story that permits us to take the loot after all. And the people at Enron, Ahold, and Worldcom were just as human as the rest of us.
So, I am not arguing with the effectiveness of goal-setting, but I would say it should come with a health warning. And that is because it also induces some more dubious behavior.
Let me explain. “Stretch goals” is one of these terms that have persistently entered managerial vocabulaire, earning a prominent and enduring place in consultant speak. The idea is that you set your people goals that they might just reach if try really really hard – or just not. Hence, they stretch your people’s effort to the limit.
However, there is a little catch to that. We also know from research that if people almost reach this goal (but, crucially, not entirely…) they tend to make it up.
Cooking the books
Really – quite literally. If they almost reached the stretch goal but not entirely, they will be inclined to pretend they did, and cook the books. Professors Maurice Schweitzer for the University of Pennsylvania, Lisa Ordonez from the University of Arizona, and Bambi Douma from the University of Montana designed a clever experiment. They gave seven random letters to 154 participants and asked them to create as many words as they could within a minute, writing them on a workbook. If they came up with 9 words or more they would get a monetary award. And they did that 7 times. The participants had to record themselves how many words they got each round and, at the end of the experiment, hand in a notebook of their achievements and take the corresponding amount of money out of an envelope. The experiment was guaranteed to be entirely anonymous.
But, unknown to the participants, there was a trick… Although the experiment was indeed anonymous, the researchers could match the workbooks to the notebooks and envelopes with the remaining money. Thus, they could look up how many people cheated (although they were not able to identify their names). And the answer was pretty clear and precise.
Each time people got 5 or 6 words or so – pretty far off the mark of 9 – they reported it honestly and left the money in the envelope. However, things were markedly different when people had reached 8; just one word short off the mark. In that case, a significant number of people cheated: they filled out that they had come up with 9 words and took the money out of the envelope, although their workbooks clearly showed they had missed the mark by 1 word. They cooked the books and deceptively misappropriated the corresponding monetary award.
It reminded me of organizations like Enron, Ahold, or Worldcom, where management habitually set their people ambituous goals. These firms may have gone down attributing their fall to fraud, but the fraud was induced by the organizational context created, which stimulated their people to cheat. Stretch goals may stretch employees’ effort to the limits, it also stretches their sense of ethics.
Self-justification
Because the interesting question is also, who were they cheating? When people reached only 5 or 6 they could have just as easily cooked the books and taken the money as when they had reached 8. But they didn’t. As a matter of fact, there was no need to fraudulently fill out the notebook at all; they could just have taken the money out of the envelope and leave. But only one out of the 154 participants took more money out of the envelope than reported on the notebook (and even that could have been an honest mistake). So why did people only commit fraud when they fell just short of the goal, and not when they missed it by a mile? And why did they insist on writing the false information in the books, when they could have just taken the money and run?
It has to do with self-justification. It seems we are inclined, when we have been set a stretch goal that we just did not reach, to tell ourselves that we sort of did, and really do deserve the reward. We can’t tell that to ourselves when we are way underperforming and very far off the mark. We also can’t justify to ourselves to just grab all of the money. But when we almost reached the stretch goal (but not entirely…) we humans are perfectly able to tell ourselves a nice little story that permits us to take the loot after all. And the people at Enron, Ahold, and Worldcom were just as human as the rest of us.
Monday, December 13, 2010
Acquisitions – finally something to cheer about…?
Decades of research scarily consistently shows that most acquisitions destroy value, and only cost the acquirer money. There is really no denying it – all “ifs” and “buts” have been raised, examined and rebutted – about 70 percent of acquisitions fail. That is because acquirers are usually inclined to overpay (under pressure from bankers, the press and their own adrenaline; a take-over premium of 60-80 percent is really nothing unusual) and because managers systematically overestimate their potential for value creation; integration is often much harder to pull off than one thinks and “synergies” carry you only so far. So far the (familiar) bad news.
Slightly to my surprise though – although not unwelcome – over the past years a few studies have emerged that managed to identify categories of acquisitions which on average do create surplus value. And the first category identified is actually quite a sizeable one: the acquisition of private firms. Pretty much all of the research on M&A is conducted on public firms; that is, firms listed on the stock market. And that is understandable because we simply have much more information on them; because they’re public firms, they more consistently gather and report data and, of course, share price data is available. Hence, we can examine them better.
Professors Laurence Capron from INSEAD and Jung-Chin Shen from York University managed to obtain data on a large number of private deals and, guess what, in contrast to the public deals they examined, these did create some value! Where the take-over of a public target made the share price of the average acquirer fall by about 1 percent; the acquisition of a private target raised it by an average of 4 percent. That may not seem overly impressive to you but it’s really quite a bit of peanuts if you calculate its monetary equivalent – certainly in comparison to the abysmal take-over track record of public deals.
But how come these private take-overs do appear to create some value? Well, that’s a bit of speculation, but Laurence and Jung-Chin had an informed suspicion: information asymmetry. Because, by definition, information about private firms is usually not publicly available, there would also be much fewer buyers aware of the juicy take-over target, and that it was possibly available at a bargain. Consequently, there were fewer bidders and more opportunity for value creation for the eventual acquirer.
Consequently, private deals usually do better than public ones. They might be a bit murkier, hidden and not as glamorous, but hey, they actually make you some dosh!
Slightly to my surprise though – although not unwelcome – over the past years a few studies have emerged that managed to identify categories of acquisitions which on average do create surplus value. And the first category identified is actually quite a sizeable one: the acquisition of private firms. Pretty much all of the research on M&A is conducted on public firms; that is, firms listed on the stock market. And that is understandable because we simply have much more information on them; because they’re public firms, they more consistently gather and report data and, of course, share price data is available. Hence, we can examine them better.
Professors Laurence Capron from INSEAD and Jung-Chin Shen from York University managed to obtain data on a large number of private deals and, guess what, in contrast to the public deals they examined, these did create some value! Where the take-over of a public target made the share price of the average acquirer fall by about 1 percent; the acquisition of a private target raised it by an average of 4 percent. That may not seem overly impressive to you but it’s really quite a bit of peanuts if you calculate its monetary equivalent – certainly in comparison to the abysmal take-over track record of public deals.
But how come these private take-overs do appear to create some value? Well, that’s a bit of speculation, but Laurence and Jung-Chin had an informed suspicion: information asymmetry. Because, by definition, information about private firms is usually not publicly available, there would also be much fewer buyers aware of the juicy take-over target, and that it was possibly available at a bargain. Consequently, there were fewer bidders and more opportunity for value creation for the eventual acquirer.
Consequently, private deals usually do better than public ones. They might be a bit murkier, hidden and not as glamorous, but hey, they actually make you some dosh!
Friday, October 15, 2010
How big is your yam? (not that it matters)
Why are so many executives so pre-occupied with the size of their company? Like bigger is always better. It especially annoys me when it is used as an excuse for acquisitions.
“This take-over will immediately make us the largest company in the industry”. So?! What is your point?!
I am sure being the biggest can have certain advantages, but that doesn’t mean that bigger (let alone being the “biggest”) always automatically is better. If you can explain to me why more scale is better, ok, but until then, I remain sceptical.
Of course company size is often associated with (financial) success. For example, the firms that always feature on “the most admired companies” lists are usually Behemoths such as Toyota, Dell, Intel, Wal-Mart, and Pfizer. Several of them became big through acquisitions.
And I am sure a company worth £10 billion attracts quite a bit more attention (for instance in the business press) and admiration than any of the 10 companies that they acquired that were worth a mere £1 billion. But that doesn’t mean that our ten billion Behemoth generates more profits than the 10 smaller ones would have made in combination. It wouldn’t have been as eye-catching, to have 10 small ones instead of one biggie, but it just might have made more sense (and money).
Importantly, managers who opt for a strategy of increasing size reverse cause and effect; although success will likely make you bigger, striving for size per se is not necessarily going to make a company more successful.
They actually remind me of the aboriginals on the Micronesian island of Ponapae. What in their society contributed to a man’s prestige was owning a very large yam. This cultural trait had come into existence because it represented an indication of a person’s skill as a farmer. However, gradually people’s efforts to obtain or grow one big yam started to be detrimental for their welfare, in the sense that it distracted effort and attention away from all other activities, causing malnourishment and hunger. People were putting all their resources, time and effort into growing one giant yam, while their fields were left unattended, their huts crumbled around them and their children cried of hunger.
Similarly, striving for size itself may be counterproductive for companies. It is quite possible that focusing all ones resources and efforts on becoming bigger (for the sake of being big) might actually decrease the firm’s chances of becoming successful. Gaining size may result from firm success, pursuing size per se, rather than success itself, may be quite detrimental.
“This take-over will immediately make us the largest company in the industry”. So?! What is your point?!
I am sure being the biggest can have certain advantages, but that doesn’t mean that bigger (let alone being the “biggest”) always automatically is better. If you can explain to me why more scale is better, ok, but until then, I remain sceptical.
Of course company size is often associated with (financial) success. For example, the firms that always feature on “the most admired companies” lists are usually Behemoths such as Toyota, Dell, Intel, Wal-Mart, and Pfizer. Several of them became big through acquisitions.
And I am sure a company worth £10 billion attracts quite a bit more attention (for instance in the business press) and admiration than any of the 10 companies that they acquired that were worth a mere £1 billion. But that doesn’t mean that our ten billion Behemoth generates more profits than the 10 smaller ones would have made in combination. It wouldn’t have been as eye-catching, to have 10 small ones instead of one biggie, but it just might have made more sense (and money).
Importantly, managers who opt for a strategy of increasing size reverse cause and effect; although success will likely make you bigger, striving for size per se is not necessarily going to make a company more successful.
They actually remind me of the aboriginals on the Micronesian island of Ponapae. What in their society contributed to a man’s prestige was owning a very large yam. This cultural trait had come into existence because it represented an indication of a person’s skill as a farmer. However, gradually people’s efforts to obtain or grow one big yam started to be detrimental for their welfare, in the sense that it distracted effort and attention away from all other activities, causing malnourishment and hunger. People were putting all their resources, time and effort into growing one giant yam, while their fields were left unattended, their huts crumbled around them and their children cried of hunger.
Similarly, striving for size itself may be counterproductive for companies. It is quite possible that focusing all ones resources and efforts on becoming bigger (for the sake of being big) might actually decrease the firm’s chances of becoming successful. Gaining size may result from firm success, pursuing size per se, rather than success itself, may be quite detrimental.
Monday, September 21, 2009
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.
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.
Wednesday, February 11, 2009
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.
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.
Tuesday, December 30, 2008
Too much of a good thing
We know companies can grow too fast; it gets out of hand, they lose control and, eventually, the whole thing comes tumbling down. My favourite examples are still the ancient case of People Express in the 1980s (one of the first, and initially most successful low-cost airlines ever) and, a few years ago, Dutch retailer Ahold.
However, companies can also try too hard to grow. Hence, it is not that there’s too much growth; there’s no growth at all and that’s precisely because they are trying to hard! Let me explain.
Pretty much everyone attempts to grow. And when we look at different “strategies for growth” – that is, where can growth come from – we usually get presented a list of options: You can diversify, innovate, add new products to your portfolio; partnerships can help you grow, etc. Do these well, and the resulting factor will be growth.
However, what we are often inclined to overlook is that growth in and of itself is simply a lot of work. That is, even when just doing more of the same thing – without adding company partnerships, innovations or diversifying into adjacent businesses – growth taxes a firm’s management capacity. For example, you have to find and manage new customer relationships, add distribution capacity, recruit and train new people and business leaders, develop management systems for a larger organisation and workforce, etc. Growing a firm is a heck of lot of work.
Yet, the options to bring about further growth (innovations, partnerships, etc.) tax your management capacity too. Finding and maintaining new collaborations is a lot of work and requires much attention. So does managing the process of innovation, and developing and commercialising its output. Diversification, internationalization and acquisitions equally are a lot of work; you have to get to know new markets, products and customers; you have to work on integration and a newly formed organisational structure, manage increasingly complex management processes, etc. Doing all of it might just be too much of a good thing.
In a recent research project I evaluated the growth rate of firms in the Chinese pharmaceutical industry. This industry is turbulent and fast-changing, with a lot of entry and exit into the market. There are large potential pay-offs, but the ongoing changes in the country’s economy, population and medical system also make it unpredictable. It’s a market with lots of opportunity for growth, but also quite a brutal one in terms of the uncertainty of how to do this.
I measured to what extent firms in this industry engaged in various strategic vehicles aimed at fostering growth: Diversification into adjacent markets, innovation, establishing partnerships and adding new product lines to one’s portfolio. The results showed that, in isolation, each of these initiatives indeed stimulated growth; yet when used excessively or in combination they actually had a negative impact and hampered a firm’s growth prospects.
Hence, stop trying so hard! You might do better...
However, companies can also try too hard to grow. Hence, it is not that there’s too much growth; there’s no growth at all and that’s precisely because they are trying to hard! Let me explain.
Pretty much everyone attempts to grow. And when we look at different “strategies for growth” – that is, where can growth come from – we usually get presented a list of options: You can diversify, innovate, add new products to your portfolio; partnerships can help you grow, etc. Do these well, and the resulting factor will be growth.
However, what we are often inclined to overlook is that growth in and of itself is simply a lot of work. That is, even when just doing more of the same thing – without adding company partnerships, innovations or diversifying into adjacent businesses – growth taxes a firm’s management capacity. For example, you have to find and manage new customer relationships, add distribution capacity, recruit and train new people and business leaders, develop management systems for a larger organisation and workforce, etc. Growing a firm is a heck of lot of work.
Yet, the options to bring about further growth (innovations, partnerships, etc.) tax your management capacity too. Finding and maintaining new collaborations is a lot of work and requires much attention. So does managing the process of innovation, and developing and commercialising its output. Diversification, internationalization and acquisitions equally are a lot of work; you have to get to know new markets, products and customers; you have to work on integration and a newly formed organisational structure, manage increasingly complex management processes, etc. Doing all of it might just be too much of a good thing.
In a recent research project I evaluated the growth rate of firms in the Chinese pharmaceutical industry. This industry is turbulent and fast-changing, with a lot of entry and exit into the market. There are large potential pay-offs, but the ongoing changes in the country’s economy, population and medical system also make it unpredictable. It’s a market with lots of opportunity for growth, but also quite a brutal one in terms of the uncertainty of how to do this.
I measured to what extent firms in this industry engaged in various strategic vehicles aimed at fostering growth: Diversification into adjacent markets, innovation, establishing partnerships and adding new product lines to one’s portfolio. The results showed that, in isolation, each of these initiatives indeed stimulated growth; yet when used excessively or in combination they actually had a negative impact and hampered a firm’s growth prospects.
Hence, stop trying so hard! You might do better...
Thursday, December 18, 2008
In a downturn, manage your revenues, not your costs
Here's a hypothesis:
In prosperous times, companies often fall victim to not being able to resist the many opportunities for growth that present themselves to them. In isolation, many initiatives with respect to new products, new markets or new customers look good but when pursued in combination they have a negative effect and hamper growth. Yet, wealthy firms find all these options difficult to resist precisely because in isolation they look so good. They have the funds to spare and therefore they are inclined to do too much of a good thing.
Andrew Grove, former CEO of Intel, understood this well. Their best-selling product – microprocessors – had endowed them with much cash to spare. However, he resisted temptations to spend it on other initiatives and entering adjacent businesses, telling his people “this is all a distraction; focus on job 1 [microprocessors]”. It made them one of the most successful companies ever.
In a down-turn, companies should look different
However, companies in distress – such as in a downturn – often do the reverse. In academic research, we call this the “threat-rigidity” effect. They focus on their core business, shedding all other things, doing more of what they did before, and which they consider their strongest points, while trying to reduce their cost base to weather the storm, till it all blows over and they can come out of hibernation.
By itself, minimising one’s cost base is never a bad idea (also in prosperous times!) but these companies forget one thing: You have to not only manage your costs; you also need to manage your revenues. And, what’s more, the composition of a revenue base in lean times will have to look different from its composition when times are good. Where in happy times firms are often seduced to spread out too much, while they would be better off focusing on job 1, in meagre times firms are often inclined to focus too much, when diversifying one’s revenue base makes more sense.
Accessing different pockets of revenue
So why does spreading one’s revenue base in meagre times make more sense? It is, among others, because no job will be big enough to sustain the whole firm. What keeps firms afloat is accessing a variety of smaller pockets of revenues. Hence, rather than focus on job 1, hoping it will be enough to sustain the firm, the company’s effort should be aimed at identifying and creating additional sources of revenue. In the downturn, none of these additional sources will be big enough by itself. Moreover, many of these sources would not be attractive in prosperous times, because the firm would not be able to make them grow. However, this is not a time of growth, but of survival.
A diversified revenue base will also reduce dependency and with it risk. In a downturn, the probability of individual sources drying up is large, so a firm can’t afford to be focused on just one or a few of them.
But will searching for additional sources of revenue not be costly? If will not be costless but, by definition, it should not be expensive. Paradoxically, firms should not be focused on winning any big accounts, major new products or customers; they should aim for many smaller ones. They are relatively cheap to access and often the firm will already have knowledge about them; they shunned them in the past considering them too small to advance at the time.
Concurrently, this strategy of exploring multiple smaller pockets of revenue will equip firms well for the economic dawn, which will inevitably come. Their diverse revenue base has laid the foundation for new sources of growth. The firm will be able to quickly benefit from the upheaval in the economy. Many of the smaller pockets of revenue will stay small – and the firm would do well to shed quite a few of them – but the newly formed strategic landscape will be conducive to different sources of revenue than before. Although you can’t tell beforehand which ones it will be, some of the small pockets of revenue will be the new stars on the firm’s firmament.
In prosperous times, companies often fall victim to not being able to resist the many opportunities for growth that present themselves to them. In isolation, many initiatives with respect to new products, new markets or new customers look good but when pursued in combination they have a negative effect and hamper growth. Yet, wealthy firms find all these options difficult to resist precisely because in isolation they look so good. They have the funds to spare and therefore they are inclined to do too much of a good thing.
Andrew Grove, former CEO of Intel, understood this well. Their best-selling product – microprocessors – had endowed them with much cash to spare. However, he resisted temptations to spend it on other initiatives and entering adjacent businesses, telling his people “this is all a distraction; focus on job 1 [microprocessors]”. It made them one of the most successful companies ever.
In a down-turn, companies should look different
However, companies in distress – such as in a downturn – often do the reverse. In academic research, we call this the “threat-rigidity” effect. They focus on their core business, shedding all other things, doing more of what they did before, and which they consider their strongest points, while trying to reduce their cost base to weather the storm, till it all blows over and they can come out of hibernation.
By itself, minimising one’s cost base is never a bad idea (also in prosperous times!) but these companies forget one thing: You have to not only manage your costs; you also need to manage your revenues. And, what’s more, the composition of a revenue base in lean times will have to look different from its composition when times are good. Where in happy times firms are often seduced to spread out too much, while they would be better off focusing on job 1, in meagre times firms are often inclined to focus too much, when diversifying one’s revenue base makes more sense.
Accessing different pockets of revenue
So why does spreading one’s revenue base in meagre times make more sense? It is, among others, because no job will be big enough to sustain the whole firm. What keeps firms afloat is accessing a variety of smaller pockets of revenues. Hence, rather than focus on job 1, hoping it will be enough to sustain the firm, the company’s effort should be aimed at identifying and creating additional sources of revenue. In the downturn, none of these additional sources will be big enough by itself. Moreover, many of these sources would not be attractive in prosperous times, because the firm would not be able to make them grow. However, this is not a time of growth, but of survival.
A diversified revenue base will also reduce dependency and with it risk. In a downturn, the probability of individual sources drying up is large, so a firm can’t afford to be focused on just one or a few of them.
But will searching for additional sources of revenue not be costly? If will not be costless but, by definition, it should not be expensive. Paradoxically, firms should not be focused on winning any big accounts, major new products or customers; they should aim for many smaller ones. They are relatively cheap to access and often the firm will already have knowledge about them; they shunned them in the past considering them too small to advance at the time.
Concurrently, this strategy of exploring multiple smaller pockets of revenue will equip firms well for the economic dawn, which will inevitably come. Their diverse revenue base has laid the foundation for new sources of growth. The firm will be able to quickly benefit from the upheaval in the economy. Many of the smaller pockets of revenue will stay small – and the firm would do well to shed quite a few of them – but the newly formed strategic landscape will be conducive to different sources of revenue than before. Although you can’t tell beforehand which ones it will be, some of the small pockets of revenue will be the new stars on the firm’s firmament.
Tuesday, September 30, 2008
Company cloning – how to change a winning formula
I am sure many of you know some of the ludicrous examples of when companies expanded into a foreign market and failed to adapt to the local circumstances.* It can be because they didn’t adapt their product, their way of doing business, or even their name.
For example, United Airlines famously handed out white flowers on flights from Hong Kong, where white flowers represent death and bad luck. India’s M.P. Been Products was used to printing a swastika on all their products (a symbol of good luck in many far eastern countries); it did not go down well when they launched “German Pilsner”, while also Japan’s “Kinki Nippon Tourist Company” noticed it attracted quite some unwelcome customers when they first expanded abroad.
And it’s a problem of all time. Coca Cola, when entering the Chinese market in the 1920s with less than moderate success, translated the sound of its name into Chinese characters, only to find out later that it, fairly unappealingly, translated into “bite the wax tadpole”. Even further back, England’s East India Company just might have lost control over India in 1857 when it continued to supply bullets encased in pigs wax to its Indian soldiers; the tops of which had to be bitten of before they could be fired. Since it was adamantly against their religion to eat pork, it seemed to have greatly whetted their appetite for pacifism.
The message that always comes with these examples is: “Adapt to local circumstances, stupid!” Don’t just implement what you’ve been doing somewhere else, but implement an altered form of it; adapted to the local context.
Well, in spite of these examples, I am not so sure…
Organisations and their business models are incredibly complex systems, consisting of many tangible and intangible elements. And often we don’t quite know what is causing their success – and, what’s more, often people from the company itself don’t quite know what is making it a success... Take the phenomenally successful Southwest Airlines. Is their success due to their swift logistics, the standardization of their procedures, materials and airplanes, their coherent corporate culture, leadership style, recruitment procedures, etc.? We don’t quite know; probably a combination of all of the above (and more).
Take Starbucks. Is it so successful because of the quality of their coffee, the training of their personnel, the lay-out of their bars, the logistics of the coffee-making processes, the ambiance, etc.? Well… probably all the elements interact, and create the competitive advantage in combination.
The problem of such a complex system is that when you change two or three elements of it, you don’t quite know what will happen… Because all the elements interact, you may be screwing the whole thing up in ways you hadn’t anticipated and won’t even be able to untangle and understand.
Therefore, Professors Gabriel Szulanski and Sid Winter – from INSEAD and the Wharton School – recommend: “replicate”. That is, before even thinking about making local adaptations, copy exactly what you have been doing before at some other locality. Only once you’ve got it working, adapt it, very slowly, one step at a time.
Consider again Starbucks. It was originally replicated by its founder, Howard Schultz, modelled perfectly on an Italian espresso bar. “But it doesn’t look at all like an Italian espresso bar!?” you might shout. Very true. But initially – the first one in Seattle – it did. There was standing room only, full fat milk, opera music, personnel with bow-ties, etc. Only when Howard got that to work, he slowly started to make some alterations, through trial-and-error, one step at a time. Had Howard tried to make all sorts of adaptations right from the outset, it may not have worked at all.
Thus, rather than trying to create local perfection from scratch, first be cautious and modest: replicate exactly, get it to work to an acceptable level, and only then think about very gradually introducing some alterations.
* See, for instance, the book “Blunders in International Business”
For example, United Airlines famously handed out white flowers on flights from Hong Kong, where white flowers represent death and bad luck. India’s M.P. Been Products was used to printing a swastika on all their products (a symbol of good luck in many far eastern countries); it did not go down well when they launched “German Pilsner”, while also Japan’s “Kinki Nippon Tourist Company” noticed it attracted quite some unwelcome customers when they first expanded abroad.
And it’s a problem of all time. Coca Cola, when entering the Chinese market in the 1920s with less than moderate success, translated the sound of its name into Chinese characters, only to find out later that it, fairly unappealingly, translated into “bite the wax tadpole”. Even further back, England’s East India Company just might have lost control over India in 1857 when it continued to supply bullets encased in pigs wax to its Indian soldiers; the tops of which had to be bitten of before they could be fired. Since it was adamantly against their religion to eat pork, it seemed to have greatly whetted their appetite for pacifism.
The message that always comes with these examples is: “Adapt to local circumstances, stupid!” Don’t just implement what you’ve been doing somewhere else, but implement an altered form of it; adapted to the local context.
Well, in spite of these examples, I am not so sure…
Organisations and their business models are incredibly complex systems, consisting of many tangible and intangible elements. And often we don’t quite know what is causing their success – and, what’s more, often people from the company itself don’t quite know what is making it a success... Take the phenomenally successful Southwest Airlines. Is their success due to their swift logistics, the standardization of their procedures, materials and airplanes, their coherent corporate culture, leadership style, recruitment procedures, etc.? We don’t quite know; probably a combination of all of the above (and more).
Take Starbucks. Is it so successful because of the quality of their coffee, the training of their personnel, the lay-out of their bars, the logistics of the coffee-making processes, the ambiance, etc.? Well… probably all the elements interact, and create the competitive advantage in combination.
The problem of such a complex system is that when you change two or three elements of it, you don’t quite know what will happen… Because all the elements interact, you may be screwing the whole thing up in ways you hadn’t anticipated and won’t even be able to untangle and understand.
Therefore, Professors Gabriel Szulanski and Sid Winter – from INSEAD and the Wharton School – recommend: “replicate”. That is, before even thinking about making local adaptations, copy exactly what you have been doing before at some other locality. Only once you’ve got it working, adapt it, very slowly, one step at a time.
Consider again Starbucks. It was originally replicated by its founder, Howard Schultz, modelled perfectly on an Italian espresso bar. “But it doesn’t look at all like an Italian espresso bar!?” you might shout. Very true. But initially – the first one in Seattle – it did. There was standing room only, full fat milk, opera music, personnel with bow-ties, etc. Only when Howard got that to work, he slowly started to make some alterations, through trial-and-error, one step at a time. Had Howard tried to make all sorts of adaptations right from the outset, it may not have worked at all.
Thus, rather than trying to create local perfection from scratch, first be cautious and modest: replicate exactly, get it to work to an acceptable level, and only then think about very gradually introducing some alterations.
* See, for instance, the book “Blunders in International Business”
Wednesday, May 21, 2008
“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.
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.
Sunday, May 4, 2008
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.
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.
Wednesday, March 12, 2008
Wanna play Strategy? Get a board game
I agree strategy is simple, but not that simple!
It continues to surprise me what people sometimes pro-claim is their business strategy. Take for instance the principles I often hear people suggest form the basis of their acquisition strategy.
When a particular transaction is being considered, executives have to go out and explain the logic for the deal to directors, investors, and analysts. Regularly, however, a strategic rationale is only being drawn up after it has been decided by management that the deal is “desirable”. Quite often, this logic will appear contrived, overly complex or simply made to fit the acquisition rather than that the deal results from a well thought through strategy in the first place.
For example, I’ve often heard the logic behind a transaction being explained in terms of complementarities; “it is a perfect match because their geographic spread perfectly matches ours” or “their product portfolio complements ours”, and so forth. Yet, just as often I would hear the logic being explained exactly the other way around; in terms of perfect overlap, for instance “it is a perfect match because they are active in the exact same markets as we are”.
Just the fact that you “complement” each other does not constitute a strategy. It might be worthwhile to combine forces, but first you’d need an argument to explain why this would enable you to create extra value. Without such logic, it’s hollow and meaningless. Similarly, just because you have perfect overlap doesn’t automatically imply it’s a good strategy. Why does adding it up enable you to do something you could not do before?
Yet, the one that always gets me is “the matrix”. Yep, really a matrix. On the horizontal axis, one places countries (in which the company is active). On the vertical axis, one places business lines (in which the company is active). Then, on the intersections, one ticks boxes (with a decisive “X”) indicating in which countries we have which line of business. And our strategy is: We fill the boxes. As many as possible.
“This acquisition is expensive, but it enables us to immediately tick six boxes!” Wow, yes, surely this warrants an 80% take-over premium – well done indeed; six boxes! We’re doing well, aren’t we?”
But strategy is really not the same as a game of Risk, placing pawns on a map of the world. Sure, perhaps it can be advantageous to own multiple business lines in that particular set of countries, but without a thorough explanation about why it’s these countries (and not some others), and these lines of business (and not some others), and why it is beneficial to have them all, that’s what it is; an oversized game of Risk. But with real money, and real people.
It continues to surprise me what people sometimes pro-claim is their business strategy. Take for instance the principles I often hear people suggest form the basis of their acquisition strategy.
When a particular transaction is being considered, executives have to go out and explain the logic for the deal to directors, investors, and analysts. Regularly, however, a strategic rationale is only being drawn up after it has been decided by management that the deal is “desirable”. Quite often, this logic will appear contrived, overly complex or simply made to fit the acquisition rather than that the deal results from a well thought through strategy in the first place.
For example, I’ve often heard the logic behind a transaction being explained in terms of complementarities; “it is a perfect match because their geographic spread perfectly matches ours” or “their product portfolio complements ours”, and so forth. Yet, just as often I would hear the logic being explained exactly the other way around; in terms of perfect overlap, for instance “it is a perfect match because they are active in the exact same markets as we are”.
Just the fact that you “complement” each other does not constitute a strategy. It might be worthwhile to combine forces, but first you’d need an argument to explain why this would enable you to create extra value. Without such logic, it’s hollow and meaningless. Similarly, just because you have perfect overlap doesn’t automatically imply it’s a good strategy. Why does adding it up enable you to do something you could not do before?
Yet, the one that always gets me is “the matrix”. Yep, really a matrix. On the horizontal axis, one places countries (in which the company is active). On the vertical axis, one places business lines (in which the company is active). Then, on the intersections, one ticks boxes (with a decisive “X”) indicating in which countries we have which line of business. And our strategy is: We fill the boxes. As many as possible.
“This acquisition is expensive, but it enables us to immediately tick six boxes!” Wow, yes, surely this warrants an 80% take-over premium – well done indeed; six boxes! We’re doing well, aren’t we?”
But strategy is really not the same as a game of Risk, placing pawns on a map of the world. Sure, perhaps it can be advantageous to own multiple business lines in that particular set of countries, but without a thorough explanation about why it’s these countries (and not some others), and these lines of business (and not some others), and why it is beneficial to have them all, that’s what it is; an oversized game of Risk. But with real money, and real people.
Saturday, March 1, 2008
Seeds and fertiliser – how to build a firm
American visitor: “How come you got such a gorgeous lawn?”
Lord: “Well, the quality of the soil is, I dare say, of the utmost importance”.
American visitor: “No problem”.
Lord: “Furthermore, one does need the finest quality seed and fertilisers”.
American visitor: “Big deal”.
Lord: “Of course, daily watering and weekly mowing are jolly important”.
American visitor: “No sweat, just leave it to me!”
Lord: “That’s it”.
American visitor: “No kidding?! That’s it?!”
Lord: “Oh, absolutely. There is nothing to it, old boy, just keep it up for five centuries”.
What many firms, trying to grow fast or add scores of acquisitions, often fail to realise: Organisations work much the same way as a lawn. You can buy the machinery, lease the building, hire the people, acquire the assets pretty quickly and relatively easily, and put them together. But this does not mean that you will have a working organisation.
An effective firm requires that the various elements of its organisation - both the "hard" factors (such as its structure, incentive system, etc.) and the "soft" elements (such as the culture of the place, informal communication patterns, etc.) - are fine-tuned, interact and reinforce one another. Building such an organisation implies more than just "owning the parts"; it takes continued dedication, hard work and, most of all, it simply takes time.
Lord: “Well, the quality of the soil is, I dare say, of the utmost importance”.
American visitor: “No problem”.
Lord: “Furthermore, one does need the finest quality seed and fertilisers”.
American visitor: “Big deal”.
Lord: “Of course, daily watering and weekly mowing are jolly important”.
American visitor: “No sweat, just leave it to me!”
Lord: “That’s it”.
American visitor: “No kidding?! That’s it?!”
Lord: “Oh, absolutely. There is nothing to it, old boy, just keep it up for five centuries”.
What many firms, trying to grow fast or add scores of acquisitions, often fail to realise: Organisations work much the same way as a lawn. You can buy the machinery, lease the building, hire the people, acquire the assets pretty quickly and relatively easily, and put them together. But this does not mean that you will have a working organisation.
An effective firm requires that the various elements of its organisation - both the "hard" factors (such as its structure, incentive system, etc.) and the "soft" elements (such as the culture of the place, informal communication patterns, etc.) - are fine-tuned, interact and reinforce one another. Building such an organisation implies more than just "owning the parts"; it takes continued dedication, hard work and, most of all, it simply takes time.
Wednesday, February 6, 2008
“Time compression diseconomies” – too much, too fast
I started playing the cello when I was nine. And ever since, I have worried about time compression diseconomies. Yes really. I didn’t know they were called time compression diseconomies, but I did worry about them.
As a child, I used to have cello lessons on Saturday morning. I would play a certain piece in front of my teacher and then she would give me a new piece to practise for the next week.
Some weeks, I practised for half an hour on Sunday, then half an hour on Monday, the same on Tuesday, etc., so that when my next lesson would be up, I would have practised for a total of three hours (6 days; half an hour each). And I usually would be able to play the piece in front of my teacher reasonably well.
Some weeks, however, I did not practise on Sunday because I was out playing football. On Monday, I was at the Boy scouts, on Tuesday playing at a friend’s house, on Wednesday I forgot about it altogether, and so on. By the time it was Friday, I would realise, “oops, it’s my cello lesson tomorrow, and I haven’t practised at all yet…!”
What then I would usually do, is think, “I will just practise for three hours in a row now; that’s the same amount of time as half an hour each day for six days, and I am sure I will be fine”. But I never was.... It never worked. The noises coming out of my cello would be outright terrifying, reducing innocent passers-by to tears; with my teacher’s ears (and mine) hurting for hours after she'd hastily sent me away.
And I wondered, as a nine year old, how is that possible? Three hours is three hours, right? Why does this not work: three hours on Friday instead of half an hour each day for six days in a row?!
Of course, as adults, we realise that our brain needs rest in between practice sessions. It needs to recuperate before you can put new information and skills into it, and the periods of “inactivity” are just as important as the practice itself. Practice sessions are much less effective if you don’t have the slow periods in between them.
As a child, I used to have cello lessons on Saturday morning. I would play a certain piece in front of my teacher and then she would give me a new piece to practise for the next week.
Some weeks, I practised for half an hour on Sunday, then half an hour on Monday, the same on Tuesday, etc., so that when my next lesson would be up, I would have practised for a total of three hours (6 days; half an hour each). And I usually would be able to play the piece in front of my teacher reasonably well.
Some weeks, however, I did not practise on Sunday because I was out playing football. On Monday, I was at the Boy scouts, on Tuesday playing at a friend’s house, on Wednesday I forgot about it altogether, and so on. By the time it was Friday, I would realise, “oops, it’s my cello lesson tomorrow, and I haven’t practised at all yet…!”
What then I would usually do, is think, “I will just practise for three hours in a row now; that’s the same amount of time as half an hour each day for six days, and I am sure I will be fine”. But I never was.... It never worked. The noises coming out of my cello would be outright terrifying, reducing innocent passers-by to tears; with my teacher’s ears (and mine) hurting for hours after she'd hastily sent me away.
And I wondered, as a nine year old, how is that possible? Three hours is three hours, right? Why does this not work: three hours on Friday instead of half an hour each day for six days in a row?!
Of course, as adults, we realise that our brain needs rest in between practice sessions. It needs to recuperate before you can put new information and skills into it, and the periods of “inactivity” are just as important as the practice itself. Practice sessions are much less effective if you don’t have the slow periods in between them.Yet, nowadays, examining corporate strategy, I see many firms who have set themselves ambitious growth targets fall into the same trap. In order to catch up with competitors, for instance, they enter new markets at double the speed, undertake twice as many acquisitions, or hire double the number of employees. But, unfortunately, it doesn’t work that way. Just like me practising the cello, organisations need rest and time in between growth spurts to recuperate, and digest the effort. Trying twice as hard does not mean you’ll get twice the benefits. There are limits to how fast you can grow, without starting to suffer from it.
We call this “time compression diseconomies” – a term cornered by professors Dierickx and Cool from INSEAD. When you, as an organisation, try to compress lots of effort and growth into a short period, it will not be as effective as when you spread it out over a longer period of time (which is why we call them “diseconomies”).
A large research project I undertook examining the growth strategies of 25 multinational companies showed exactly this: growing at a moderate yet steady pace increased profitability much more than did short outburst of rapid expansion. And, unlike the effect of my youthful cello efforts on my teacher’s auditive organs, these firms’ performance really was music to their shareholders’ ears.
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