Brit Does Qualitative Strategy Research Without Quite Meaning To

This post at the Dabbler, while not quite ethnography, qualifies as qualitative strategy research of the (somewhat déclassé) "go ask someone who knows" school.

It is left to the reader to decide if Bath Ales has a valuable, rare, inimitable and nonsubstitutable strategic resource.

A New Tool in the Quest for a Knowledge Spiral

A seminal paper in the academic literature on organizational learning was Ikujiro Nonaka's 1994 article in Organization Science. In it, Nonaka eloquently describes how personal and codified (externalized) knowledge work together across individuals and organizations to create a "knowledge spiral". This is a compelling idea: individual learning followed by codifying some of that learning, which frees up the individual to leave behind that which can be codified to others so that she/he can learn new things. Mentoring processes can work this way. They have two benefits: one, they train a new mentee; and two, they free up the mentor to do more challenging, creative work so that he/she can learn more.

There is a new tool in the works that can aid a knowledge spiral process substantially: "intentional software". This is software that seeks to capture the intent behind knowledge work by making software development accessible to non-developers. There's an interesting article in a recent issue of Fortune magazine that describes the phenomenon (http://tech.fortune.cnn.com/2010/11/11/out-of-this-world-software-engineering/) and the company that is seeking to develop it (http://intentsoft.com/index.html). The company "Intentional Software" is led by Dr. Charles Simonyi, a Microsoft alumnus who has been working on this project for some time.

It's an exciting idea for knowledge development, obviously. If top knowledge workers could more easily codify their work, such knowledge could be shared more broadly, and it could lead to all sorts of new knowledge being developed. It's interesting, too, to think of the intellectual capital in knowledge workers being made more divisible not by sharing it with other knowledge workers, but rather by putting it into a machine. As goes the factory worker, so goes the knowledge worker, perhaps!

Thoughts After Getting Coffee With My Wife

My adviser, who is well-published, tells me that one of the keys to publishing is to have a 2x2 matrix. Management academics love 2x2 matrices, where we show the interaction of two orthogonal (i.e., independent; the level of one doesn't tell you anything about the level of the other) constructs. At the moment, behavior v. attitude matrices are all the rage.

Having gone out for coffee and a danish this morning, my wife and I were discussing the interaction of "friendly" and "competent," illustrated by this 2x2 matrix.

Obviously, we prefer our counter-help to be competent and friendly, and least prefer incompetent and unfriendly. But how would you rank second and third? It does depend on context -- this is what we would call a contingent model. My car mechanic can be unfriendly if competent. What we couldn't decide is, at the coffee shop, is it better to be friendly but incompetent or competent and unfriendly.

For those wondering, what we got this morning was an order-taker who as unfriendly and incompetent and a barista (used generically, as we weren't at Starbucks) who was friendly but incompetent.

Randy "VRIN" Moss And Bill "Dynamic Capability" Belichick

There are a good number of strategy papers that use sports as a context. This isn't so much because strategy academics like sports or that sports are more interesting than other contexts, though both statements are true. It's mostly because sports (at least insofar as on-field activities are concerned) are more transparent than other businesses. Players are a resource, there are lots of performance metrics available, there's a relatively efficient market for players, and information about their cost is usually available. Sports can be a natural experiment for various theories in strategy.

They are also useful in explaining what it means to have a valuable, rare, inimitable and nonsubstitutable resource, and what it means to have a dynamic capability.

Throughout his career, Randy Moss has been a VRIN resource. Players like Moss (one of the top five wide receivers in NFL history) are not easy to find, nor can you just go to the Patriots and buy him out if you think he'd be more valuable to you than to them. But Moss's role doesn't really change over time. He runs faster and jumps higher than most defensive corners covering him, so he can gather in long passes in or near the end zone. Over the last three years, he's done so more often than anyone else in football. In 2007, he did that more than anyone ever has in a single season, and except for one bitter exception, the Pats outperformed everyone else in the league.

There can't be much doubt that, as a player, Randy Moss is valuable, rare, inimitable and nonsubstitutable, and that this led the Pats to outperform other NFL teams. But athletes are wasting resources; Moss only has so many years left until he no longer outperforms. Nor do athletes, as a rule, reinvent themselves in ways that add to their ability to outperform the competition.

Bill Belichick, on the other hand, is a capability rather than a resource. A capability uses resources, and Belichick, and any head coach, is in the business of deploying resources as best as possible. If Belichick is special as a head coach -- and how can anyone doubt it -- it is because he is dynamic in his capability. That is, he doesn't simply deploy his resources in the same way over time. Rather, he is good at changing how his resources act depending upon that year's team and that week's opponent.

But Belichick's dynamic capability has an odd effect -- it reduces the value of his resources. With one (exceptional) exception, Belichick doesn't seem to much care about the identity or skills of his athletes. Randy Moss is a valuable resource (he's VRIN) but is value to the Patriots seems to be less than his value to other NFL teams. This is consistent with the Patriots' general approach to highly skilled players (with, again, that one exception).

This implies something interesting about management. Value in organizations may not be cumulative or even additive. Adding one VRIN resource to another, or to a dynamic capability, does not necessarily result in performance equal to the sum of the performance boost that each would add alone. In fact, in sports it's easy to see that the result can be negative. Adding one superstar to another, or giving a great coach another great player might lower performance. This implies, in turn, that management is not simply mechanical.

Professing Professionally

Daniel Drezner (a tenured professor at Tufts) and Megan McArdle (economics editor/blogger at The Atlantic) talk about why elite schools don't care about teaching. I think that Megan overstates the extent to which even the best schools don't care about teaching. Over the summer, I was speaking with a professor at one of the top business schools who protested vigorously that although research drove tenure decisions, a really bad teacher would not get tenure no matter how good his or her research.

The real question, as Dan suggests at the end, is how we tell the good teachers from the bad. There is a lot of attention being paid right now -- particularly at teaching schools -- to student evaluations and, I promise, grad students and new faculty care about their evaluations. But, if learning is the point, then student evaluations are problematic; as Dan says, most students value easy grading without too much work over disciplined learning.

Of course, how any particular school approaches this question is a matter of strategy. How does that school go to market and how does it differentiate itself from its competitors? UMass has a murky strategy, and murky is never good. UMass will never be the high quality competitor in the University industry in Massachusetts, nor is it clear how UMass can differentiate its classroom product. That leaves it with being the low cost competitor, which is good for a state school but not how UMass wants to see itself, or with focusing on campus life. As a large state school campus in the middle of cornfields, UMass has a party school reputation (just Google ZooMass). On the one hand, this is a good market positioning if your target market is underachieving high schoolers (which is exactly UMass's market). On the other hand, the Administration hates this image with the white hot passion of a thousand nuns.

One way for UMass to square this circle is to lobby against partying, which it does, while putting a lot of emphasis on teaching evaluations, which it doesn't do. This leaves UMass with a murky image and an emphasis on the school as the economical alternative for Massachusetts high school students.

There's Nothing You Can Do That Can't Be Done

I've never quite understood what the Beatles meant to tell us with this line, but it turns out to be a very nice way to think about why many innovative new products give companies only a temporary competitive advantage and as an introduction to the strategic management concept of dynamic capabilities.

Unless protected by some effective legal monopoly (for example, a patent, although even that only delays the inevitable), the introduction of even the most brilliantly useful new product is the beginning of the end of its usefulness. There's nothing you can do that can't be done, so upon introduction of your brilliant product, your competitors will start their ultimately successful search for ways to duplicate your achievement. Even if they can't duplicate it exactly, they will ultimately find a way to achieve the same result. Thus, while you might be able to price your product so as to extract above-average returns for a while, once your competitors have found a way to offer customers the same functionality, your days of above-average returns will come to a sudden end.

In real life, the situation is even worse. Developing your brilliant new product might have been costly. You might have made false starts, or perhaps only one in ten of your new product ideas might actually reach the market. For a while, you'll have the customer to yourself, but much of your "above-average return" might actually go to pay off your research and development costs not only for that product but for all of your failures, too. Your competitors, on the other hand, don't have these same costs. Because they can go buy your product and study why customers like it, they don't have to take the risks or pay the price for research and development. You've kindly volunteered to do that for them. Even worse, they'll have the chance to see how your product can be improved to better serve your customers. Free-riding on your investment, they might be able to undercut your price and still make a better overall return. We call this the second-mover advantage.

Assuming you don't have a monopoly, the only way to beat these free-riding second movers is to present them with a moving target: by the time they have managed to copy your brilliant but dated product, you have to have a second even-more-brilliant product ready to go. Thus, one of the truisms of strategy: strategy is not what you do, but what you do next.

If coming up with a new innovative product is not the key to above-average returns, what should the firm do? It can wait for someone else to be an innovator, but that has it's own problems. There is also a first-mover advantage, and letting your competitors go first cedes to them the ability to decide where the industry is going and what the product looks like. Often, the key is to develop a "dynamic capability." A dynamic capability is a organizational talent for doing something useful not just once, but serially. In this example, not simply stumbling across one innovation, but the ability to introduce a series of innovations that always keeps your competitors one step behind.

The idea that a sustained competitive advantage has to be a process, rather than a one-off, comes from Kathy Eisenhardt, a professor at Stanford who studies the tech industry. It's application there seems fairly straight-forward, but it is not only applicable to high-tech companies. McDonald's, for example, pulled itself out of a long-period of sales stagnation by expanding its menu, but once it started it didn't stop. Coffee followed fajitas followed salads followed breakfast followed nuggets. Moreover, a dynamic capability doesn't have to involve new products. Toyota, for example, has a dynamic capability in quality control. It's cars aren't the most advanced, but they work while allowing Toyota to build them more efficiently.

There's nothing you can do that can't be done, but there are things you can do next that won't be done until you've already moved on.

Cars and Environmental Fit: Size Matters

Peter Egan has been writing for Road & Track magazine for several decades. He is an outstanding and thoughtful writer, as well as an engaging story teller. His column in this month's R&T (http://www.roadandtrack.com/column/dog-years-and-englishmen) was as interesting as always, but it also provided some though-provoking ideas on global business.

Egan talks of the merits of British and American cars of the 1950's, as restoration projects and in general. He notes that British cars of that era are somewhat temperamental, and were not designed with ease of maintenance in mind. They were also smaller, of course. He attributes these differences in part to the nature of the country (an island a fraction of the size of the good ol' USA) and their roads (narrow, winding, and brief, as opposed to broad, straight, and heading off into the sunset.)

It makes perfect sense and it's consistent with the idea that businesses must adapt to their environment in order to succeed. Cars and trucks in the U.S. continue to be much larger, on balance, than just about anywhere else. When a firm moves to a new environment, it's not just a matter of bringing a great idea across a border. It's unlikely that a 1950's Cadillac with a trunk so large that it would nearly accommodate an MG Midget would have sold well in England or Europe at that time. (When Briggs Cunningham brought a Caddie to race at Le Mans in 1950 it was nicknamed "Le Monstre".)

Environmental adaptation is a key to international business success. A move abroad to a very different environment often requires a firm to move from being a major brand to a niche provider, in order to maintain the status or perception of a global brand. Cadillac, for example, actually lengthened their STS full-sized vehicle for the Chinese market, looking to serve the niche market for chauffeur driven vehicles there. If you're Cadillac, when you go overseas, you go big or go home. Thank goodness, too, for people like Peter Egan. He's created his own interesting niche with unique writing and a love of old British sports cars.

Frugal Innovation in India

I had recently blogged about the innovative $35 computer introduced in India. Along the same lines comes news about inexpensive homes in India (http://www.livemint.com/2010/08/18213720/Jaithirth-Rao-launches-10-lak.html?atype=tp ). So why is this important?

India has been growing very rapidly – in the last quarter GDP grew at 8.8%. This growth has also spurred considerable domestic consumption - not least in the housing sector, where traditionally homes in cities such as Bangalore, have been out of the reach of many middle class citizens. Any initiative that helps address this lack of affordable housing will address a key social need as well as spur the local economy.

This initiative takes an innovation from a structural design company in Kansas City, USA and applies it to the housing sector in Bangalore, India (and other cities soon). The entrepreneurs in this case are successful corporate managers – Jaithirth (Jerry) Rao and PS Jayakumar were colleagues and senior managers of Citibank India, soon after liberalization. It is interesting that they have chosen to enter into a business that they have overseen lending to but not actively engaged in.

Perhaps what frugal innovation to succeed what is needed is a fresh perspective on old problems – similar to what the Indian engineers did with the $35 computer (and what the folks in Silicon Valley did not) and what IT folks did for emergency services in South India. This also raises an interesting question of whether disruptive innovation (frugal innovation is a dramatic illustration of disruptive innovation) is possible with managers who are already in the business. Does what the late CK Prahalad call ‘dominant logic’ block these game changing innovations?

The true test for the model shown by Jerry Rao and PS Jayakumar is going to be whether it is replicable in other cities in India that have even more tough housing markets like Mumbai and Delhi; while also reducing prices as they have promised. In the meantime other famous academics, such as Vijay Govindarajan at the Tuck School of Business at Dartmouth College, are tinkering with the idea of even more frugal housing – catering to the poorest in India, by suggesting a $300 home for the poor (http://blogs.hbr.org/govindarajan/2010/08/the-300-house-a-hands-on-lab-f.html )

The question as I suggested in my earlier blog then becomes – what does this mean for the already battered housing markets in more developed countries? How do they deal with the continuing flood of innovations that radically alter the cost structure of their industries?

Financial Reform: Welcome To The Dark Side

As I might have mentioned a time or two before, there are two fundamental ways to think about Strategic Management. The more common, because it makes us feel and look better, is that, unlike economics, we realize that in the real world there is no equilibrium solution, so we train managers to focus on innovating in the gathering, designing and using of corporate resources. In that way, they can gain a temporary competitive advantage that, we hope, allows them to continue innovating further temporary advantages. Everyone from the manager, to his employer, to society at large gains from efficient new ways to do exciting new things.

There is another way to think about strategy. It can also be seen as the dark side of economics. For example, where economics warns that cartels are bad for society at large, dark side strategy encourages industry to join with regulators to form cartels. If done properly, the cartel can last as long as the regulators last; and we have yet to witness a regulator dying a natural death (except for the Civil Aeronautics Administration, the exception that proves the rule).

With that context in place, let's think about the recent financial reform legislation. I borrow the following two paragraphs from Michael Hirsch at Newsweek:

[B]y midsummer of 2010 the Volcker rule that Obama finally backed was so full of exemptions—allowing banks to invest substantially in hedge and equity funds—that even Volcker expressed dismay. The fundamental structure of Wall Street had hardly changed. On the contrary, the new law effectively anointed the existing banking elite, possibly making them even more powerful. The major firms got to keep the biggest part of their derivatives business in interest-rate and foreign-exchange swaps. (JPMorgan, Goldman Sachs, Citigroup, Bank of America, and Morgan Stanley control more than 95 percent, or about $200 trillion worth, of that market.)

The same banks may end up controlling or at least dominating the clearinghouses they are being pressed to trade on as well. New capital charges, meanwhile, have created barriers to entry for new firms. This consolidation of the elites has in turn kept alive the “too big to fail” problem. “It makes it way tougher now to kiss somebody off when they get in trouble,” says the former Fed official. Eugene Ludwig, a former comptroller of the currency, believes the new law’s impact will be “profound” in changing the way banks do business. But he worries about a “skewing of the playing field” in favor of the big banks, putting community banks at a disadvantage.

The major financial firms have had to accept new regulation, but that regulation doesn't seem to change what the largest firms can or can't do. More to the point, the new legislation makes it unlikely that a new financial giant can arise, while the government is probably still tacitly on the hook if any of the existing giants look like collapsing. Now, this might be the best political deal that could be struck ("too big to fail" is a legitimate policy problem, not simply a gift to politically connected bankers), but it looks a lot like strategy from the dark side.

Yes, you, too, can be an inventory manager.

The NYT reported recently that Nordstrom has opened up their in-store inventory system to customers. (See: http://www.nytimes.com/2010/08/24/business/24shop.html?scp=2&sq=nordstrom&st=cse). An online customer can order an item they like from any store or from Nordstrom's warehouse system, providing them the access that many stores don't even provide their own workers. In-store customers can have this done by a salesperson.

Nordstrom is famous for taking risks, most notably in the form of their rule book that says that there are no rules. One suspects that they are out in front of a trend in this case, though, and won't be the only firm to offer such a service. (While shopping at another department store recently, in fact, I had a clerk checking for an item I wanted in the store's inventory system. He found one in a nearby store, but when he called there to double-check, no one answered the phone! There's always a right way and a wrong way to do something.)

This is an extension of the idea of co-production of services, wherein customers become temporary employees (unpaid, of course) of the firm in order to enact the service they want. Other examples would include getting your own soft drink in a fast food restaurant, or pumping your own gas (which New Jersey stubbornly refuses to allow.) Here, Nordstrom has made customers a part of their logistics operation, letting online shoppers check and move inventory. Doing so, the article states, has helped to increase Nordstrom's inventory turnover ratio significantly.

In most cases, this is a win-win: customers will generally be happy to help Nordstrom manage their inventory if it results in getting that Hermes tie with just the right shade of green. It will be interesting to see how they manage this, given their reputation for highly personalized service, because that's the only potential downside: the loss of some interaction. A Nordstrom customer that shops by computer is getting the same level of personalized service that they get when they shop online using searchbots.

This is the challenge, then, for using technology and for increasing the level of customer co-production: keeping that personal touch intact. Shopping is still a social experience. In fact, if the customer begins to help to manage the product delivery, perhaps the sales personnel will have more time and inclination to be social.

The Liability Of Foreignness

The liability of foreignness is the social costs imposed upon firms doing business abroad. It depends upon the identity of the host country, the home country and the host country's stereotype of the home country.

The America's Cup, the Winged Keel, and Innovation

Yesterday I had the opportunity to go through the Museum of Yachting in Newport, Rhode Island. In addition to being a very pleasant space on a beautiful spot overlooking the harbor, it has a series of exhibits that would be of interest to anyone even slightly interested in boats. The one that I found the most enjoyable was an exhibit on the history of the America's Cup, which was held in Newport for most of the 20th century.

What is interesting to me about the America's Cup is the paradigmatic shift that occurred beginning with the 'winged keel' of the 1983 race. In 1983, of course, the Australian yachting syndicate won the Cup, prying it from the hands of the NYYC for the first time in decades. Dennis Conner, the losing skipper, was saved from becoming the Bill Buckner of yachting by the Australian team's triple-secret winged keel, which they kept hidden until after the race.

The winged keel is an interesting bit of technology, and, of course, it was quickly imitated by other teams. This is to be expected - innovations are often promptly copied. What makes the America's Cup history a little more interesting is that shortly after the introduction of the winged keel, other, more substantive changes took place. Most notable of these was the introduction of catamarans to the competition - a huge paradigm shift. Catamarans are crazy, and crazy fast. I remember being in a boating store as a kid and seeing one for the first time. They're a completely different sailing experience - you hang out over the water in a harness, they flip over at the drop of a hat, and they are an absolute blast.

In the parlance of the Americas Cup, these are "multihull" boats. The question is, without the winged keel, would the racing world have gone "multihull"? Perhaps, but probably not so quickly. Small innovations can wake up other innovators, and they can create an environment where change is no longer so scary. It took some plucky Aussies to shake up the venerable yachting world, but once they did, the gangway was cleared and sailing innovators were off to the races.

Ratan Tata has announced that Tata Sons – the preeminent family conglomerate (global sales of over $70 billion and 357,000 employees) that touches every Indian with products ranging from soap to hotels to cell phones – is looking for a new head when he steps down at the end of this year (http://in.reuters.com/article/idINIndia-50627620100804 ).

In most countries this would not be big news – but in India where family controlled businesses never let “outsiders” i.e. people from outside the family run “their” business – this is huge. The Tatas have always had a history of being pioneers in bringing change to the Indian business milieu. The appointment of a panel to consider suitable replacements for Mr. Tata is in itself a huge innovation, since they are going about their assignment of finding a replacement in a fairly transparent manner. The panel has indicated that they are looking not just beyond the family but that they are looking at individuals from beyond India.

As India rapidly integrates itself into the world economy this decision has ramifications for the country as well as other firms from emerging markets. The lesson that the Tatas seem to be putting out is that if you are going to compete in a global marketplace then your managers need to be equally competitive and simply hoping that family members will be able to take on the mantle of leadership is simply not going to hold.

It is going to be interesting to see how managers of family run businesses from other emerging markets, especially China, are going to react to this news. Leadership in a Chinese setting may be problematic since the state is a big player in the running of businesses even in the private sector; and this may be okay while the macro sentiment is great, however there could be concerns as China faces a more hostile business environment.

If Only They Had A Union

$35 PC from India

A couple of weeks ago the Indian government showcased the debut of a new $35 dollar computer (http://www.pcworld.com/businesscenter/article/201769/indias_35_pc_is_the_future_of_computing.html?tk=hp_pop ). This computer seems like it does most of the functions expected of a PC such as web browsing, word processing, and video-conferencing. The target price for this product is $10 once mass production starts. One can thus forgive PC World magazine when it calls this new product “the future of computing”.

This ‘frugal innovation’ is in line with what Indian organizations have been doing for a while now. The drastic drop in pricing is not simply due to locational advantages but is driven by a fundamental change in the way products are designed and delivered (this PC can use solar power too). At the 2008 Strategic Management Society special conference held in Hyderabad, India, the late Professor CK Prahalad talked about the costs associated with EMRI, which handles emergency calls (such as those made to 911 in the United States) in the state of Andhra Pradesh at a cost which is about 2% of the costs associated with similar services in the US, at comparable quality levels.

There is an increased awareness in India that marginal reductions in product cost are not going to help Indians continue to grow GDP at the 8-9% that they have recently gotten accustomed to. While product ideas typically continue to be generated by firms outside of India, there is urgency in reverse engineering these products and making them available at a fraction of the original cost – but doing so by going beyond the original product’s promise. This appeals to the concept of ‘jukaad’ that most Indians innately understand. Jukaad represents concepts partially captured by words such as ‘somehow’; ‘make-do’; ‘can-do’. What it means is that “okay given that I know what I want – I need to make it happen, no matter what the obstacles are”. This entrepreneurial yet frugal mindset has been a hallmark of key business people from India.

What has changed in recent times is the collaborative nature of the public / private entities; along with policy changes necessary to make it happen. India has had the advantage of superb engineering colleges such as the famed Indian Institutes of Technology (IIT); their graduates populate many of the firms of the west. What is happening now is the IITs are now encouraged to collaborate with private entities to develop products that will be sold not just in India but beyond. It is important to note that this product was launched by the government of India and not by an individual firm. The government of India (HRD ministry and Department of Science & Technology) is starting to take a more active role in innovation, which resembles what MITI did in Japan, in its focus on garnering requisite resources for innovation rather than focus on allocating resources for production.

So what does this mean for India and perhaps the world? Kapil Sibal, the Indian HRD minister who launched this product has suggested that the goal is for the “the solutions for tomorrow” to emerge from India," (http://www.bbc.co.uk/news/world-south-asia-10740817 ). The median age in India is a little over 25 years and about a third of the population is below the age of 15 (https://www.cia.gov/library/publications/the-world-factbook/geos/in.html ). Handing this group of young people a tool that can unleash creativity can only be good for world welfare – which may not be the same as the short term welfare of firms competing in the same product spaces. The option of not taking this building crescendo of frugal innovation (from India and other countries) seriously is one that managers everywhere take at their own (and their shareholders) peril.

Cathedrals and iPhones

Today I happened to hear a song that I really like: "Cathedrals" by the Handsome Family. Aside from being a great piece of gothic country, it has an interesting theme: a skewed view of progress over time. After talking about the cathedral in Cologne, Germany, they sing about a fiberglass cathedral in Wisconsin Dells, Wisconsin, where "kids race go-karts 'round the moat". They go on to talk of trying to find love by the ice machine at their motel, but the comparative study of cathedrals is what always gets me.

Are we moving forward, or are we not? Are we just substituting cheap plastic crap for hand-crafted stonework? Aside from cathedrals, where we seem to have peaked some centuries ago, I am a believer in progress. We see stuff getting better, faster, and cheaper, especially in the tech arena.

That's why Steve Jobs' recent defense of the iPhone 4 was so disappointing. He said that the rumors of poor performance are just that, because, in truth, the data show that the iPhone 4 only drops 1 percent more calls than the iPhone 3. Because it's only a little bit worse, people should just get off his back! Imagine saying, "our plastic cathedral is only 1 percent more tacky than the previous version, and it's no more tacky than everyone else's plastic cathedral." While he was at it, Jobs said that the problem's not unique to the iPhone 4, naming his major competitors as just as bad, and claimed that the data says that the issue has been blown "so out of proportion". Hmmm... not great PR or competitive strategy, and not very aspirational.

Steve Jobs, historically, has not set the bar so low for himself. Hopefully, he'll return to form and Apple will go back to giving us better, faster, cheaper products, like we have come to expect.

Why Do We Organize: Focal Bias

The fundamental question of organization theory, which is strategic management without worrying about performance, is why do people organize? One possible reason is that organizations can be better at making decisions than people are because organizations can know more and process information better (inside joke: without reifying the group mind) than individuals can.

When people make decisions, they are trapped by what they know or can easily find out. They tend to latch onto the first solution they come across. And they tend to think that whatever issue they are focusing on is critically important. Every maintenance worker knows that what the organization really needs is a riding power sweeper.

That last tendency is "focal bias," a cognitive bias that gives outsized importance to a particular detail of a problem because they are focusing on that detail. The classic example is to, say, ask New Englanders in February how much happier they'd be living in Los Angeles, where it's a balmy 72 and sunny. In effect, when focused on a detail, like the weather in LA, people confuse how much nicer the weather is with the answer to the question they've been asked, how much happier they'd be. If the weather is much nicer, then it follows (focal bias suggests) that they'd be much happier. In fact, studies show that weather has almost no impact on average happiness.

In other words (and you knew there had to be some math in here somewhere), if Y is happiness and X is weather, focusing people on the weather leads them to assume that Y = X, so that improving the weather leads directly to improved happiness. In fact, the formula for happiness is probably more like: Y = b1A + b2B + b3C ... + .01X + b25Y + b26Z + e. Happiness results from a host of factors, with weather having such a small impact that it gets lost in the noise.

A nice illustration of focal bias can be found here at the Volokh Conspiracy, where Professor Volokh uses focal bias to make his point.

How does organizing help overcome focal bias? In theory, problems are broken up within organizations so that different people focus on different aspects. To act on their solutions, they have to go to a third party (top management, ultimately) for access to scarce resources. Presumably, that forces them to make their best case for why their portion of the problem matters most. Of course, top managers have their own biases, and studies have shown that CEOs who came up from marketing prefer marketing solutions, while CEOs who came up from Finance prefer financial solutions, etc.

The Un-Greenspan: Bernanke is Unusually Uncertain

Ben Bernanke caught the literary attention of global financial markets last week when he said that the economic outlook is "unusually uncertain". (See, for example, Bloomberg's report on the metals markets:"Gold Declines as Bernanke Cites `Unusually Uncertain' Outlook for Economy"; http://www.bloomberg.com/news/2010-07-21/gold-declines-as-bernanke-cites-unusually-uncertain-outlook-for-economy.html). He went on to say that the Fed does not anticipate a double dip in the economy, which is good to hear. Of course, the sound of a phrase is important to its ultimate success as a catch-phrase, and 'unusually uncertain' has a nice rhythm to it - the same rhythm, arguably, as Greenspan's famous 'irrational exuberance'. Neither man is likely to win a poetry slam, but Bernanke's phrase is likely to meet with some success in the land of economic lore. Bernanke's phrase is a little more user-friendly than Greenspan's, in keeping with the general sense that Bernanke wants to increase transparency somewhat. This is a welcome change from "The Oracle" and his obfuscatory prose, at a time when businesses badly need clear information about the economy.

A search on Google (which is not really yet a verb, imho) indicates that there are 409,000 results for 'unusually uncertain', though Google does not yet anticipate the phrase as you type it in (neither does Bing or Yahoo, for that matter).

If you trade options, you are trading volatility, and Bernanke's assessment tells us that volatility should be high. Interestingly, the VIX (the volatility index on the S&P 500) is trading around 22 today, well off of its highs above 40 from early in the summer. It's above pre-crisis (i.e., pre-2008) levels, but around pre-collapse of the world (i.e., Q4-2009) levels. Perhaps the markets are ahead of the story.

The concern for businesses these days, of course, is that demand will taper off, and this may well underlie the reluctance to hire that's been so frustrating for job seekers. There are really two ways to deal with uncertainty, which is generally defined as a lack of information about the future. One is to go get more information. Managers, however, can't just go back to school or read up on the latest forecasts - if the Fed is unusually uncertain, there's not much hope for the rest of us. The second is to stay flexible, by doing things such as shortening the tenor of contracts, building cash, and coping with demand by paying overtime instead of hiring.

The trouble with uncertainty, if you look at the VIX as a proxy, is that, over the last 5 years at least, it has spiked very quickly and dropped slowly. Hopefully, the positive signs will pick up, we can remove the 'unusually' from our uncertainty, and firms will feel confident enough to hire.

How Harvard Business School Ruined American Business

How did Harvard Business School ruin American business? Basically, it's a story of two post-war trends. First, a belief in planning -- the more massive the better -- as the answer to every problem. Second, the decision of the large foundations -- Ford, Carnegie and Rockefeller -- to pour money into management education so long as it looked "social scientific."

It turned out that these trends left management as an academic discipline a little up in the air. It wasn't wasn't quite clear what business schools should be teaching about management. As a result, a lot of schools hired psychologists and sociologists and focused on what we call micro management (yes, really) or organizational behavior, which is the study of how people behave within organizations. On the one hand, this is clearly important information for managers. On the other hand, it's never been possible to convincingly (i.e., scientifically) show that any particular ob technique leads to better firm performance. Basically, ob focuses on reducing absenteeism and turnover while increasing what's called "organizational citizenship behavior," which is doing things for your employer that aren't, technically, your job. For example, the person who takes it upon herself to empty and clean the lunch room refrigerator is demonstrating OCB. Frankly, it's all sort of a mess of warring medium-term theories and we can't even say with certainty that employee satisfaction is a good thing for the company.

This left Harvard with a problem. HBS does not see itself as being in the business of churning out middle managers and vice presidents of human resources. It sees itself as being in the business of turning out CEOs whose value is in their ability to lead their company to sustained high returns. Before the focus on planning and scientification, they did this by hiring retired CEOs to come in and tell war stories to the graduating MBA students. This is probably as good a way of teaching strategic management to managers as any, and survives today in the Harvard case study method. But it's very ad hoc and highly unscientific.

The other problem facing Harvard was that there's no obvious place for economists in this new management education. Economists are social scientists, but they assume that over time there are no meaningful firm level differences. All firms, in the long run, are fungible in economic theory. So it's not just that economists don't have much to say about the proper strategy to pursue to obtain sustained high returns, it's that they don't think that there can be any such thing.

All this came to a head in the person of a economics student at HBS name Michael Porter. Porter was studying IO (industrial organization) economics, which is the branch of economics that advises policy makers on how the legal environment should be structured to promote competition within industries. Porter, true to his training, accepted that firms within the industry would, in the long term, all look identical and thus there was no point on wasting time on firm strategy. But he turned IO economics on its head and started educating executives on how to use lobbying and industry-level devices (e.g., trade associations and collective bargaining agreements) to reduce competition within the industry and block entry of new firms, allowing all of the established firms in the industry to share sustained high returns. Basically, the Porter school (Porter, by the way, would object to this as an overly simplified summary of his views) teaches that the most important strategic decision made in business is about what industry to enter, after which there isn't much any individual firm can do to set itself apart from its competition. After that, all you can do is work together with your "competition" to try to rig the game at the industry level.

Porter's success at Harvard, and Harvard's success at educating CEOs, seems to me to explain much of what we've witnessed over the last few decades. (Porter published his early and most influential work in the late 70s and early 80s.) The co-dependent corporate state and the corrupt bargains struck by management, labor and government owe quite a bit to the presence, at the top of the corporation, of CEOs educated to think that management consists of rigging the game.

What Is Strategic Management?

The three of us are PhD candidates in Strategic Management. That raises the obvious question: what is Strategic Management?

Strategic Management is a branch of the social sciences that tries to explain variability in organizational performance. In other words, we try to give systematic, causal, "law-like" explanations for why some firms out-perform other firms. Because we're "social," we think that the key is people and their interactions. Because we're "science," we try to find generalizable explanations based on empirical evidence.

The tools that we use to study these questions come from economics, psychology and sociology, which are generally accepted as being Strategy's parent disciplines. Although we use their tools, we are not economists, psychologists or sociologists. We like to think that Strategic Management has its own unique domain. Unlike economists, we think that markets can be inefficient in and thus a particular firm can have a monopoly on know-how or resources that give it a competitive advantage over some period of time. We're not quite psychology because we think that organizations are more than just groups of people and, in fact, that at least part of the reason people organize is to overcome the psychological limitations of the individual. We're not sociology because, um, I'm not quite sure. I think it's because we judge organizational structures based on objective measures of performance rather than the well-being of members of the organization.

So, why do some organizations outperform other organizations? If we really knew, we'd have to stop, but here's what we think we know: A lot has to do with the environment in which the firm finds itself. What nation the organization is operating in makes a difference. The single most important factor is what industry the firm is competing in. Some Strategy scholars would stop there. They don't think that firm strategy makes much difference, or that firms don't really have a choice in strategy. Those of us who think that firms do have a choice, and that it does matter, think that, next to industry, how well the firm's strategy fits its environment is the most important factor in determining performance; firms with better fit outperform firms with worse fit. Finally, we believe that, because markets are inefficient, firms can have unique capabilities or resources (they must be rare, valuable, inimitable and non-substitutable) that allow for sustained above-average risk-adjusted returns. At the moment, the hot area for Strategy scholarship is knowledge: firms perform well if they are better than the competition at gathering, sorting, distributing and exploiting knowledge.

BP Wants Back into the Deep End of the Pool: Feedback in Complex Systems

The New York Times reported this week that BP, in spite of the multi-billion costs of the gulf disaster, is "staking its future more than ever on deepwater wells". ("With Sale of Assets, BP Bets More on Deep Wells, by Jad Mouawad, July 20, 2010. See: http://www.nytimes.com/2010/07/21/business/21bp.html?scp=1&sq=BP%20deep&st=cse) This enthusiasm for going off the deep end stands in stark contrast to the response of financial institutions to the recent financial crisis. Banks fell all over themselves to swear off risky lending, wanting to avoid any appearance of appearing to do what they had trumpeted as a key growth business just months prior.

Markets have responded quite differently, too. The equity value of BP has dropped by roughly $80 billion since the explosion of the Deepwater Horizon drilling rig, prompting some analysts to argue that the stock is oversold. Without commenting on the value of the stock, it is interesting to consider the fact that the firm’s equity capital remains at around $100 billion, in spite of what is largely considered to be the worst oil spill in history. As society grapples with this corporate disaster, we’ve recently been reminded of another: the Bhopal, India Union Carbide leak. Last month, seven former employees of Union Carbide in India were convicted of “death by negligence” stemming from the terrible industrial accident in 1984 that left thousands dead. Just as BP survives (to date, anyhow) with very substantial equity value, so did Union Carbide survive the Bhopal disaster, continuing to operate until it was purchased by Dow Chemical in 2001 for roughly $10 billion. Conversely, Lehman Brothers collapsed in 2008, unable to find creditors willing to keep it afloat. It declared bankruptcy in September 2008, having begun the year with the stock trading over $60. Lehman, of course, physically harmed no one, nor did they spill any toxic substances, and yet the firm’s value fell faster and farther than either BP or Union Carbide.

BP’s 40% market capitalization fall in one week, though, would be a move of 10-15 standard deviations (depending on the volatility assumption) – a decidedly non-normal, non-linear result that points to BP being a complex adaptive system (one of the characteristics of which is non-linearity and non-normality). Numerous researchers have written about organizations as complex adaptive systems, and each of these cases noted here show ‘emergent’, i.e., completely unpredictable outcomes that are a part of such systems. Strange, surprising things happen to complex systems – accidents, market collapses, etc.

Complex adaptive systems are also characterized by feedback systems, which is where BP and Union Carbide begin to deviate from Lehman Brothers. Manufacturing firms, or firms that traffic in hard assets, have substantial negative feedback loops, in that outside entities can assess the values of the firm. Oil reserves and manufacturing facilities are both readily valued and readily transferred – the external feedback is clear. However, firms that deal in intangible assets, such as Lehman Brothers, are based on social constructions. Lehman’s output and skill was clearly not readily valued – who could say how good or bad they were? Bernie Madoff, too, famously turned out to be a social construction – he had no value whatsoever.

Firms whose value stems from a social construction have powerful positive feedback loops, and, at times, little to no negative feedback loop. Social construction begets social construction, in that there is more value for me in buying something from Lehman Brothers if you value and buy it too. This type of complex adaptive system can see value perceptions get way out of balance. Even worse, they can correct very quickly: when socially constructed value perceptions turn sour, the negative feedback loop is reinforced, too, and can run unfettered. Thus, banks can’t survive a run on the bank, while manufacturers can survive terrible, terrible catastrophes.

What does this mean? Is there anything to be done for a firm dealing in intangible products and assets? Not much, actually. Where there are no hard assets or readily valued, transferable resources to anchor the firm, it can evaporate (thus, ROA is a meaningless figure for many service firms). Firms can seek to protect themselves with assets that can be valued and transferred, of course. Enron began as a firm dealing in hard assets, but grew its socially constructed trading empire until it dwarfed the hard asset businesses. Firms that deal primarily in intangibles should think about what hard assets they do have. If there’s no relief there, it’s essential to view each business opportunity with regard to both profit potential and reputational risk. Financial firms for years have spoken of "front page Wall Street Journal risk", but clearly many had forgotten about it.

Lastly, this is an area where diversification may offer some help. In fact, Lehman tried to sell its money management subsidiary, Neuberger Bergman, to generate needed cash, but it ran out of time, and it was sold after the bankruptcy declaration. A portfolio of brands can provide the firm protection against reputation loss in one brand, unless they’re linked too closely in the eyes of customers (Neuberger Bergman, as a brand, stood on its own). Of course, strong brands can help bring along weaker brands, so those associations have upside, too. The management of reputational assets is of the utmost importance for service firms, because of the nature of these complex system feedback loops. When those assets go up in smoke, as they can, it becomes, simply: "everybody out of the pool!".

What is 'Three Guys and a Strategy'?

"What is 'Three Guys and a Strategy'? Actually, it's more like three guys and a bunch of ideas about strategic management, applied to today's business world. We are three guys pursuing (as of the moment) doctorates in strategic management who find the world a fascinating place. We've been fortunate to learn a lot of theories on management and organizations from some really smart people, and this is our way of stepping out of the ivory tower (or, more accurately, our grimy doctoral student cubicles) and seeing what those ideas have to say about what's going on.

Please join us by sharing your ideas, too! Thanks for reading."

- David Cohen, Chris Meyer, Sudhir Nair