A refreshing tip for 2008: tear up the textbook

IT’S 2008 (ALMOST), and time for some management reappraisals. On the one hand, the excesses of the private equity era are so last year – its end being signalled by the disappearance of Martin Lukes, head of a-b global and hero of the FT’s email soap, behind bars at Christmas. So if management by sticks, carrots and over-the-top exhortation is over, it’s back to basics. But, on the other hand, just what are the basics today?

Every half-way successful business knows that it is just that: half-way to doing what it could. At least half the energy, intelligence and creativity of its people is leaching away unused. Improving co-ordination and flexibility, speeding up innovation and reacting faster to changing customer needs calls for engagement, initiative and creativity. But these are just the things that conventional organisation – ‘Management 1.0’, command and control or whatever – doesn’t do. In fact, it destroys them. So what next?

One option that companies longingly consider is trying to make themselves more like markets. After all, markets are unsentimental at weeding out inefficiencies and great at allocating resources. A market-like company would surely move faster, adapt more quickly and be more efficient than a conventional hierarchy.

But although tempting, imitating markets leads companies to a dead end. Think about it. The point about organisations is that they aren’t markets, otherwise they wouldn’t need to exist. The vigour of capitalism is the result of the interaction of both markets and companies, each doing its different thing. Companies and markets differ in three main ways. First, companies innovate and make strategies while markets can’t, since, second, while companies have purpose and intention, markets don’t. Third, markets are about self-interest and competition, while organisations are about collective interest, based ultimately on trust and forbearance.

As the late Sumantra Ghoshal put it, an economy without organisations would be unbearably coercive, while an economy without markets would be unbearably bureaucratic. Each disciplines each other in what economist Joseph Schumpeter called capitalism’s ‘waves of creative destruction’. A company innovates and creates an advantage, for which it can charge high prices; the market then competes the advantage away, to the benefit of society as a whole.

It follows that for companies to imitate markets is to betray their ‘company-ness’. Organisations exist to provide a (temporary) shelter from market pressures in which people can do the things markets can’t: innovate and strategise. The better they do that, the more they remove themselves from market pressures. Look at Apple.

‘Never teach a pig to sing. It wastes your time, and annoys the pig.’ Rather than trying to make their organisations into inferior markets, companies would do better studying those of their peers that most emphasise their distinctiveness, even eccentricity, as organisations. A surprising number of outstanding performers are organisational outliers – those that do things differently from the textbook. Toyota is one such. It focuses on making it easier for customers, whether external or internal, to ‘pull’ what they need from the organisation.

Or take WL Gore, maker of Gore-Tex, a pounds 1bn-a-year private company that has been profitable for 50 years. As described by Gary Hamel in The Future of Management, Gore has no organisational chart and no management layers. ‘Few people have titles and no one has a boss… The core operating units at Gore are small, self-managing teams.’

In that it is similar to Whole Foods, the fast-growing US organic supermarket chain, where all key operating decisions – including pricing, ordering and staffing – are devolved not only to individual stores, but departmental teams within the stores who are closest to the customer. To aid decision-making, Whole Foods maintains open books: all teams have access to necessary commercial and operating information. Salary details are available to everyone. No executive can make more than 19 times average pay (current ratios in large US companies are 400 times) and 95 per cent of stock options have gone to non-executives.

There are plenty more examples of organisations whose success has come from turning the orthodoxies upside down: always radically decentralising responsibility and leadership, and generating their own distinctive certainties, rather than pursuing generic alternatives such as the market. Google is one; the Brazilian Semco, where there is no company rule book, another; Linux and the open source movement, now reportedly comprising 150,000 projects and 1.6 million people, another. Much of their secret lies in their self-confidence as organisations, reflected in management frameworks that allow them to control their own destiny but also in the timorousness or wrongheadedness of their peers that fail to do the same.

The Observer, 30 Demcember 2008

Gradgrind is seriously lacking in know-how

THE LATE Peter Drucker claimed to have invented the term ‘the knowledge economy’ in the 1960s. Whereas industrial-age workers toiled with their hands and produced ‘stuff’, he posited, today’s employees work with their brains and produce ideas and knowledge. Even in the material world, success has increasingly come to depend on knowledge: an iPod (and Apple) or Yaris (and Toyota) win by delivering more, and better, crystallised ideas per buck than rivals.

But in other domains ideas about managing knowledge still seem stuck in the industrial age. In 1994, an influential publication distinguished two main approaches to the creation of knowledge. ‘Mode 1’ regards it as an economic commodity – dematerialised ‘stuff’ – and treats it as a production-line issue: ramping up production of ideas in university research departments (increasingly funded by industry), handing them on to company development labs through spin-outs and knowledge transfer activities, where they are translated into marketable products or services.

‘Mode 1’ is ‘hard’, linear, and simple. That’s why government and many business people like it. It has become pervasive, particularly in the public sector. University research and teaching assessments are based on this approach to knowledge, of which Dickens’ oppressive schoolmaster Thomas Gradgrind would have been proud. Even in the humanities, whole areas of study are increasingly specified by the funding research councils.

However, there is increasing evidence that Mode 1 is not just simple: for any of the messy, boundary-spanning issues we face – the ageing of the population, climate change, sustainable energy and global security, funding for which the Department for Innovation, Universities and Skills (DIUS) proudly announced last week – it is simplistic. For these kinds of problems, we need ‘Mode 2’.

Whereas ‘Mode 1’s’ vision of a lab-to-market supply chain is a closed innovation model, Mode 2 is open, diffuse – and much more difficult to command. Knowledge is not produced simply by researchers but by the collision of many scientific, professional, managerial and societal influences, each with its own distinctive angle. Mode 2 is not simply about producing knowledge: it is about absorbing, applying and creatively modifying it into often wholly unpredictable innovations. The iPod, Linux and Google are Mode 2 innovations, products of a melting pot rather than a machine, and of social ties rather than instrumental relationships. This is why it often happens in spontaneous clusters, such as Silicon Valley or Silicon Fen.

How incompatible Mode 1 mechanisms are to Mode 2 initiatives emerges from a study of the government’s Genetic Knowledge Parks (GKP) initiative, by the Evolution of Business Knowledge programme of the Economic and Social Research Council. This had brave beginnings. It emerged in around 2001 from concerns about scientific directions in the wake of BSE and GM foods. Genetic knowledge was obviously important across the biomedical field a correspondingly wide range of stakeholders were co-opted into the arrangements for the parks.

Unfortunately, with no clear lead from the centre, different departments imposed conflicting agendas and priorities. Then the funding process for the new organisations led to fierce competition between existing research centres that had previously co-operated as part of a dispersed, informal research network spread over a number of universities and institutions. Worse, under the new rules the groupings had to be regional, cutting across organic national and even international ties.

The centre’s desire for ‘accountability’ led to classic Mode 1 monitoring and control arrangements, complete with targets and standards (‘name the major scientific advances you have made in the past 12 months…’). Not surprisingly, these measures created fear and loathing among researchers and a crisis of governance and quality control at the centre, leading to pressures for even more monitoring and control. So the GKPs turned inward to concentrate on their own survival, further undermining collaboration. After five years and pounds 15m, the government pulled the funding plug.

This tale has powerful implications for many other areas of public and private endeavour – indeed for every domain where part of the object is to discover and learn from ‘what works’. That might include, for example, the NHS as well as the ‘big issues’ singled out by the DIUS. In all these, the challenge is not so much creating brilliant new science but getting different groups to work together to shape the ideas and bring them to practical fruition. Using the Gradgrind model in such circumstances is worse than ineffective it can actually destroy the capacity for innovation. The knowledge economy cannot be run on 19th-century management lines. It’s not just knowledge creation that urgently needs a Mode 2.

The Observer, 23 December 2007

Command, control… and you ultimately fail

OPTIMISTS ASSUME that management is a linear story of progress – slow perhaps, but we’re getting better at it all the time. This is certainly the message you’d take from its public texts (books promising the secrets of success, prospectuses of business schools, the ‘solution-speak’ of IT firms and consultancies): with more information and research at his/her fingertips than ever, it’s the best a manager can be.

Or maybe not. According to the Chartered Management Institute, which published its 2007 Quality of Working Life report last week, the most commonly experienced management styles in the UK are bureaucratic (the experience of 40 per cent of respondents), reactive (37 per cent) and authoritarian (30 per cent), while just 17 per cent of the 1,500 managers polled experienced management as innovative, 15 per cent as trusting and 13 per cent as entrepreneurial.

These averages hide huge differences in perception: what directors and senior managers saw as accessible, empowering and consensual, junior ranks judged bureaucratic (half the sample), reactive (38 per cent) and authoritarian (40 per cent).

What’s more, management is becoming more overbearing and controlling. Compared with three years ago, all three of the negative rankings have increased. This is ‘clearly disappointing’, says Jo Causon, CMI director of corporate affairs, who points out there will be knock-on effects for engagement, innovation and productivity. While leadership needs to be situational – an emergency service will likely be more directive than a research lab – coercive and rule-bound styles do not bode well for a service-based knowledge economy in which organisations depend on discretionary effort and initiative for excellence rather than obedient compliance with orders.

Why is command-and-control management on the rise, when the report shows evidence that it is associated with declining rather than growing organisations, and that it is self-reinforcing (and, in the long term, defeating)? Why, when domineering management elicits a hostile reaction, does that appear, to a command-and-control management, to justify further controls, and so on?

One reason, Causon suggests, is recruitment and retention. Four-fifths of organisations have problems finding and keeping the right people, according to other CMI research. This means that many companies are operating with underqualified, or at least inappropriately qualified staff. Square pegs in round holes don’t product good results, resulting in managerial browbeating or worse.

A more general reason, believes Lancaster Business School’s Professor Cary Cooper, the report’s co-author, is the creeping, and misguided, importing by UK plc of US business mores. In an increasing number of companies, boards seem to feel they need ‘robust’ management style to deliver bottom-line, short-term results, he says. ‘From shop-floor to top floor, there’s pervasive employment insecurity: long hours, people as disposable assets, no psychological contract – we’ll pay you OK as long as you’re delivering, but don’t expect any employment commitment in return.’

The longer-term consequences are unhealthy. Cooper regrets the mismatch with an overall culture that’s, in general, more caring: ‘A more balanced management style, with employment security and a functioning psychological contract, is more likely to deliver the goods for the UK in the medium term.’

It’s little surprise to note that public-sector management styles score highest on the bureaucratic, reactive and authoritarian measures and lowest on the accessible, empowering, innovative and trusting ones. Cooper is encouraged by the new emphasis the civil service is bringing to developing leaders rather than managers, but the CMI findings suggest just how far there is still to go.

In truth, the deeper reality may be that command-and-control management lives on for the simple reason that, despite the rhetoric, 99 per cent of employees, whether in public or private sector, work in command-and-control organisations: in effect, centrally planned dictatorships that are set up to take orders from the CEO rather than the customer. These organisations don’t work very well – they can’t – and when push comes to shove, as it naturally often does, the knee-jerk reaction is to tighten the reins, not slacken them.

But, as even Tony Blair recognised, flogging the system only gets you so far. This isn’t management progress – it’s the reverse, a manifestation of the desperation of the old model rather than a move towards the new. Will we look back at it as the last gasp of a played-out system, a staging point between the collapse of management 1.0 and the emergence of management 2.0 – or the start of a new management dark age, based on hidden, and not so hidden, coercion? It’s up to us. History suggests that the outcome is not a foregone conclusion.

The Observer, 16 December 2007

We’re in trouble when it’s too risky for Kroll

SO FAR the credit crunch has only affected the UK financial sector. But as the squeeze tightens and the ripples spread, there is likely to be a sharp rise in corporate failures among companies in the wider economy whose management shortcomings have been disguised by the loose credit conditions of the past few years.

This is the diagnosis of risk consultancy Kroll, which as business’s enforcer, as it were, is well placed to spot early signs of distress. With its businesses in risk management, security, investigations and forensic accounting, Kroll is a company ‘you come across on a bad hair day’, in the words of its founder Jules Kroll, and in a recent report, ’20:20 vision: Boom, bang or bust’, it highlights some of the impending hangovers from the UK’s years of easy money.

Thus, the counterpart to the long period of stability the UK has enjoyed since the early 1990s is that managers are much less well equipped to deal with volatility and failure than their forebears. Managers (and shareholders) of weaker companies have certainly benefited from generous credit, but they have only put off the day of reckoning. ‘When the music stops and the bright lights come on,’ says Kroll, ‘it’s a bit frightening what you see… the party’s over, and there will be significant fallout as a result.’

Among a number of things becoming scarily clear as liquidity dries up is that in the more challenging times ahead, managers will no longer be able to rely on their – and the City’s – preferred method of improving perceived performance: doing deals. They will have to do it the hard, old-fashioned way: through operations.

However, not only is there no sign that managers have conquered their traditional weakness in operations, the refinancings of recent years may have made improvement more difficult by lumbering companies with soaring debt levels. Kroll calculates that the ratio of corporate interest payments to operating surplus is at its highest for 15 years. If profitability dips, for some companies these levels will not be sustainable.

Moreover, the fact that corporate (as opposed to individual) insolvencies are at an all-time low may not be the good news that it first appears. The low insolvency rate is likely to be the result of lenders’ willingness to allow firms to refinance themselves out of trouble rather than a product of good management. In other words, there may be a corporate sub-prime bubble out there waiting to be pricked.

Vulnerability is only increased by two other main trends of the past 20 years: technological advance and globalisation. Information technology has certainly played an important role in London’s success as a financial centre, enabling deregulated institutions to invent dizzying new financial instruments and lend ever more aggressively. But it also has downsides that are now becoming apparent, in complexity and lack of transparency that make it hard to estimate the magnitude of risk or where it finally lies. They are also contributing to the mushrooming of white-collar crime.

By multiplying complexity and interdependencies, globalisation adds another dimension to risk. Are UK companies agents or principals for the wall of money passing through London from rich but murky emerging economies such as Russia? Most may be agents, but it’s hard to know. The combination of globalisation and complex debt structures makes restructuring, disposals and debt recovery a harder (and more expensive) job than ever before. Kroll describes one corporate refinancing that involved simultaneous restructuring in 11 different jurisdictions.

One of the big questions now is whether languishing companies will go to the wall or will continue to be propped up. With refinancing more difficult, the likely outcome is a wave of distress selling at every stage and size of the corporate food chain as firms try to unwind rash mergers and bring debt levels down to manageable levels. These will be bargains for sounder corporate citizens with the resources and confidence to undertake industry consolidation.

Although to some extent today’s conditions can be viewed as a natural correction to past financial exuberance, there is unlikely to be a swift and easy way out. The management weaknesses – resistance to change, lack of information, poor rationale and implementation of mergers and acquisitions – that Kroll’s report identifies as a persistent handicap and cause of business failure are likely to become more evident, not less, as capital markets continue to contract.

‘We’ve been nervous for a while about the direction,’ says Kroll. In the interconnected, globalised world, predicting where and in what shape the next bout of turmoil will occur is impossible. But that it will happen is almost certain. ‘Are we seeing more insolvencies yet? No,’ says Kroll. ‘But is the telephone ringing more? Yes.’

The Observer, 9 Decemberr 2007

Toyota’s never-to-be-repeated all-star production

LAST SUMMER, the International Journal of Production Research devoted an entire issue to the Toyota Production System. The TPS is probably the most influential manufacturing model since Henry Ford’s moving assembly line of the early 1900s. It figures among the ‘giant steps in management’ described in a new book of the same name, and is also part of strategy guru Gary Hamel’s ‘management of the future’. The TPS has generated a model of ‘lean production’ not only for the rest of manufacturing but also, increasingly, for the service sector; it has been applied to jurisprudence, house repairs, benefits processing and even the NHS. Its inventor, Toyota, is perhaps the most successful large manufacturing firm in the world.

Why is the TPS so important? Because it’s the nearest thing there is to a learning organisation. It is not strategic brilliance (Toyota makes mistakes just like anyone else) but manufacturing prowess that has turned the company from a joke in the 1950s into the equal largest, by far the most profitable, and the most advanced car maker in the world.

It has managed this through 50 years of problem-solving that has abolished conventional production trade-offs and recast manufacturing economics. Textbooks used to teach that manufacturers had to chose between quality or low price, volume or flexibility. The TPS was among the first to show that built-in quality (‘right first time’) was cheaper, not more expensive. Today, the same lines handle different models and specifications without missing a beat. Tomorrow, Toyota aims to demolish the final trade-off – by building a car that doesn’t despoil the environment.

Unsurprisingly, Toyota’s capability to solve ever larger problems evokes deep envy. Yet the TPS’s success is matched only by its elusiveness. Despite the best (or worst) efforts of consultants and academics, no other large organisation has managed to replicate it. While the component principles are understood, how they work together remains, in the phrase of the article in IJPR , ‘a continuing puzzle’. ‘We don’t really understand what the TPS is,’ admits author Steve New, ‘and it is possible we never will.’

Why not? Because the TPS is a complex self-organising system, the irreproducible product of the interplay of a few simple principles that derived from the particular circumstances of its origins.

At Toyota, the fixed cost is in effect the labour force, whose ingenuity is used to minimise the variables. Thus from the Toyoda Automatic Loom Works, where the firm originated, came the notion of jidoka , or ‘automation with a human touch’. By inventing a machine that automatically stopped when a fault was detected, founder Kiichiro Toyoda prevented the waste of faulty production, allowed the workforce to concentrate on solving problems rather than supervising the looms, and hugely boosted productivity.

With a premium on space, raw materials and capital, Toyota devised frugal production methods that, by ‘pulling’ supplies only when they were needed, minimised inventory, space, capital investment and all kinds of management overhead. The principles were turbocharged by what has come to be called kaizen , ‘continuous improvement’, but in fact could equally well be termed ‘obsessive tinkering’: trial-and-error shopfloor experimentation whose lessons are incorporated into highly standardised work routines. That turns the TPS into a learning system. Given that Toyota’s Japanese workers alone make upwards of 600,000 improvement suggestions a year, most of which are adopted, it’s hardly surprising that the production system in front is Toyota’s.

But while it has evolved into a formidable organism, the TPS is not the product of a grand design. Rather, notes industry observer Takahiro Fujimoto in a new book, the Japanese car makers’ systems emerged through improvisation – ‘piecemeal, ad hoc measures for addressing needs and issues that arose’. Toyota, he believes, would remain formidable even if it abandoned the hallmark practices of the TPS, since its strength resides not in any particular method but in an extraordinary ability to develop new ones.

The TPS, then, is not a blueprint it is organic and emergent, a living thing. Hence the impossibility of replication: other companies can only reinterpret it in the light of their own contexts. This is also why would-be copiers often fail. The commonest mistake is to assume that the essence of the TPS is the tools rather than the purpose for which they have been devised. As many organisations have discovered, in the hands of command-and-control managers, TPS-inspired ideas can do as much harm as good.

Now the TPS faces its biggest challenge: accommodating the results of its own success. Can it maintain its integrity while the company is expanding globally faster than any other firm in the motor industry’s history? It is not just Toyota’s future that is riding on the result.

The Observer, 2 December 2007

Dyslexic management can’t read signs of failure

THE REAL British disease is the unerring talent for putting together entities that are less than the sum of their parts. The comical inability to think in systems terms – call it management dyslexia – was on dazzling display last week, all over the front and back pages.

First up, the England football team. Management is supposed to amplify effort by providing a creative framework for individual expression that benefits the team. But defeat against Croatia was the reverse, the culmination of un management that over several matches has diminished team effort and turned good players into turnips.

It was the opposite of management that left players individually and collectively bereft. At least the England rugby players, in the World Cup, took the initiative to create their own playing system that, although limited, suited the available talent and took them against the odds to the very brink of triumph.

England’s Premiership is the wealthiest football league in the world. Its consistent failure to generate a satisfactory national team is deeply rooted and reflected in other systemic shortcomings. Only one of the top teams, Man chester United, has a British manager the starting line-up of the Premiership leader, Arsenal, contains just one, sometimes no, English player. Oh, and the new pounds 800m Wembley stadium can’t even produce a decent surface to play on. From grass upwards, English football is a system for growing anti-synergies.

Second up, a performance by HM Revenue & Customs that makes it hard to know where to begin – with the IT outsourcing that makes it an expensive extra to separate bank details from other personal data, to senior management’s decision to dispense with encryption to Gordon Brown’s repeated use of the ‘one bad apple’ excuse: the leak was the result of one individual’s failure to carry out procedures – at the dispatch box.

The spectacle of a general blaming his troops is always distasteful, but in this case is also bankrupt. The HMRC leak is primarily the result not of human error, but poor or non-existent systems design which failed in at least three respects: not segregating sensitive from insensitive information, allowing the two to be sent out together, and omitting to encrypt it. If any of those steps had been followed, the further error, of leaving a junior to decide to put it in the post, would have been harmless. This is called fail-safeing – part of any good systems design.

And by the way, don’t bother with a witch-hunt or a full-scale investigation to find out what went wrong: with the help of readers and the junior HMRC official, this column offers to find the root cause in a day, using a basic problem-solving technique called the ‘five whys’ (asking ‘why’ five times over) – and apply the answers to prevent the problem happening again. The five whys are at the heart of continuous improvement which, in turn, is the motor of systemic performance enhancement.

Last week’s third outbreak of British anti-synergy syndrome centred on Norfolk and Norwich Hospital. On Wednesday, the hospital went into ‘major incident’ alert because it was chocker. At one stage, 10 ambulances (nearly half Norfolk’s total) were immobilised waiting to unload their patients.

So the hospital’s too small, right? Well, hang on a minute. Why was the hospital full? Because of high demand, coupled with high bed-occupancy rates. Why are bed rates so high? Partly because the hospital is ‘efficient’, operating at occupancy rates of more than 90 per cent. But also because 60 beds are occupied by patients who have finished treatment but can’t be discharged. Why can’t they be discharged? Because, for financial reasons, the Norfolk Primary Care Trust is busy closing down the community hospitals that would traditionally have taken recovering patients, and social care, as almost everywhere in the country, is utterly inadequate to cope.

And why is demand so high? An epidemic or major accident? Nope. The extra demand comes from within. It is largely generated by NHS Direct which, terrified of making mistakes, routinely directs callers to A&E or their GP – but since GPs are no longer available out of hours, as a result of the government-imposed contracts, that means A&E.

In other words, the Norfolk NHS crisis, like that of HMRC and team England, was self-generated, the result of complete and continuing system-blindness. ‘Problems in organisations,’ points out Russell Ackoff, one of the first and best systems thinkers, ‘are almost always the product of interactions of parts, never the action of a single part.’ Treating a single part destabilises the whole and demands more fruitless management intervention management becomes a consumer of energy, rather than a creator.

Unfortunately, that’s the hallmark of 21st century UK management. As last week demonstrated, it still shows no sign of recognising it.

The Observer, 25 November 2007

Buccaneering bosses are the worst of all options

THE OLYMPIC-SIZED rewards for failure notched up in the last month by Merrill Lynch’s Stan O’Neal ($8bn write-downs, $161m payoff) and Citigroup’s Chuck Prince ($11bn write-downs, up to $100m payoff, with the use of office, car chauffeur and administrative assistant for five years, plus consultancy) have caused the usual bout of handwringing – and the usual resignation.

Even before the discovery of these performance black holes, US bosses had the grace to acknowledge they were being paid too much. Four in six of them, and 80 per cent of outside directors, admitted in a survey last month that CEOs were overpaid. But while the payoffs pocketed by the deposed bankers may have increased the embarrassment, there is little sign of a correction. On the contrary: instead of proving that the system is broken, each failure is used to justify still greater incentives to get the leaders facing in the same direction as shareholders.

But supposing it could be shown that there was a correlation between the composition of CEO pay and the size of the losses? We’re not quite there yet, but some intriguing US research suggests there is an indirect link – and one that could have considerable implications for the way shareholders think about CEO compensation in the future.

In brief, a study in the influential US Academy of Management Journal finds that the way top managers are paid does influence a firm’s performance – but not in the way the textbooks indicate. The article, by academics Gerard Sanders and Don Hambrick, focuses on the role of stock options, which still constitute the largest proportion of CEOs’ ever-growing pay, and whose effects are surprisingly little researched.

Stock options, you recall, were supposed to stir top managers out of their assumed default mode of cautious self-serving and spur them to become bold, buccaneering entrepreneurs. So they do. CEOs loaded with options do indeed invest lots of shareholders’ money in research and development, new ventures and acquisitions, and the result is extreme performance. What wasn’t envisaged, however, ‘was that the extreme performance delivered by option-loaded CEOs was more likely to be in the form of big losses than big gains’. Like Andrew Flintoff or Ian Botham, option-padded CEOs go for the big hits – but they usually get caught on the boundary rather than score sixes.

In a complicated formula, the professors looked at the performance of 950 US companies across the size range and related it to the stock-option content of the CEOs’ pay. They found that the more executives were paid in options, the more the company invested and the more extreme its financial performance. It wasn’t high investment that generated extreme performance, but, with stock options, it created a ‘combustible combination’ which encourages executives, the authors say, to take on big bets at long odds, with predictable consequences.

Why CEOs should do this is fairly obvious. If, as is their nature, options carry no downside, then CEOs will simply go for the projects with the largest potential payoff. ‘If we accept the common-sense idea that the projects with the biggest possible upside are likely to also have the biggest possible downside, and then couple it with the assumption that option-loaded CEOs have little concern with the size or probabilities of downside outcomes, it is straightforward to expect that option-loaded CEOs have a relatively high likelihood of delivering big losses,’ the authors say.

In the case of Merrill Lynch and Citigroup, O’Neal and Prince certainly had plenty of options. And although this is not part of the professors’ case, if they don’t have an option downside and, in addition, are certain to benefit from a lucrative exit payoff if they are fired, how much more likely are they to take on big, long-odds bets without fear of the consequences? If the numbers are life-changing enough – which they are – there is not even any danger to a future job, since neither of them will need ever to work again.

The Hambrick and Sanders findings are important because unlike other criticisms of stock options they strike at a feature that is at their heart: it is not that they fail to foster managerial aggressiveness, they do it only too well. They also take a swipe at agency theory, which has allotted options an important role in combating the supposed managerial tendency toward shirking, short-sightedness and risk aversion.

In the professors’ perspective, the problem is fundamental and can’t be fixed by tinkering with the way options are administered. The solution is simple: stop giving so many, or don’t give any at all. ‘These findings may help put the nail in the coffin of executive stock options,’ remarks Hambrick. ‘And even if not, they certainly ought to give the corporate world pause in using them nearly as extensively or heavily as they have been in the recent past.’

The Observer, 18 November 2007

The slow road to perfection

It looks like the set of a sci-fi movie: a roomful of dummies lolling disconcertingly on their seats or spilling electronic innards on lab benches under the gaze of white-coated technicians. The dummies are condemned to endlessly reprising the role of crash victims in the high-speed car smashes that are staged five times a day at Toyota’s Higashi research centre in the shadow of Mount Fuji. They are extras in a drama with a plot as bold as any Hollywood movie: a quest to create a car that doesn’t wreck the planet but saves it.

Sound preposterous? It’s the goal of Toyota president Katsuaki Watanabe, who for the past two years has been piling pressure on his engineers to devise a ‘dream car’ that leaves the air as clean as it found it, avoids crashes and improves the health of those who drive it.

Among today’s car manufacturers, only Toyota would dare to air such an ambition in public – and have it taken remotely seriously. As the Economist put it, ‘There’s the world car industry, and then there’s Toyota.’ This year the Japanese phenomenon is on course to churn out 9 million vehicles from assembly lines in 28 countries, in the process probably overtaking GM as the world’s largest car-maker. Its relentless profitability (the last year it fell into the red was 1950, a record matched only by rival Honda) has been rewarded with a market capitalisation as great as GM, Ford and Daimler put together. Over the past few years the company has been growing faster than any firm in the industry’s history, with the possible exception of Ford during the Model-T era a century ago.

As to the technology, at yen 800m (£3.3m) apiece, the dummies are bit players in the yen 900bn research investment that Toyota is pouring into its attempt to marry the conflicting claims of safety, the environment and individual desires, and create what Watanabe calls ‘sustainable mobility’. He refuses to set a deadline for his dream car vision. ‘But the engineers have developed a road map for achieving the goals,’ he says. ‘I am confident we shall get there.’

In fact, the company is already some distance down the track. At Higashi, engineers have reformulated Watanabe’s challenge as simultaneously to ‘zeronise’ and ‘maximise’: systematically eliminating the car’s negatives while optimising its pluses.

Take safety. Like other car-makers, Toyota began by focusing on passive safety – strengthening the car body and devising restraints to protect passengers in accidents. That’s effective up to a point: Toyota says that fatal accidents in its cars in Japan have halved in a decade. But passive safety incurs other penalties in the form of extra weight – requiring more energy for propulsion and meaning greater waste when crashes do happen.

So the emphasis now is as much on ‘active’ and pre-crash safety – preventing the accident from occurring or at least minimising the damage. Anti-lock brakes, traction control and parking aids fall into this category, as do newer systems warning the driver of an unnoticed lane change, getting too close to the car in front, or even drooping eyelids. The driver remains in control – a fundamental Toyota tenet – while the car takes charge to tighten seat belts and apply braking only when an accident is inevitable. But the aim is to extend safety to every driving stage, from parking to rescue after an accident. This, says Seigo Kuzumaki, Toyota’s head of safety development, involves merging passive and active safety measures into a complete ‘integrated safety management concept’ that will eventually link the car to its surroundings – and to other vehicles.

Toyota uses the same problem-solving cycle to overcome trade-offs between the environment and performance. Not everyone shares Toyota’s faith in hybrid petrol-electric technology, as implemented in its Prius model, believing it to be a distracting half-way house on the road to hydrogen-powered fuel cells. But Toyota insists there is no contradiction, since the issue in both cases is not the propulsion system but obstinately lagging battery technology. It is therefore pushing ahead with both hybrid systems and fuel cells, the twin research teams sitting alongside each other to spur development and share advances.

On the hybrid side, Toyota is testing a second-generation Prius that can be plugged into a domestic electricity source overnight, saving a claimed 40 per cent in fuel costs over the original model. It has taken Toyota 10 years to sell a million Priuses after 2010, Watanabe wants that to be a million a year, with eventually a hybrid option for every model, possibly even – provocatively – the company’s Formula 1 car. In the meantime the Prius’s popularity with Hollywood stars such as Leonardo DiCaprio and Kirsten Dunst can surely do no harm.

Fuel cells, even the impatient Watanabe admits, will take longer. Although, like rivals Honda, GM and others, Toyota has made considerable advances in range and durability, daunting obstacles remain: not only the battery bottleneck, but a hundredfold cost reduction for production viability. Watanabe concedes initial ambitions for production were over-optimistic. ‘But we are doing everything we can to speed development up,’ he says. ‘We have to do it for the planet.’

Can Toyota pull it off? Systematically making light of trade-offs that defeat others has always been its trademark, a powerful reason it has pulled ahead of the rest of the pack. Yet Toyota already has its hands full with issues larger than any it has faced before. One is maintaining quality in the face of headlong growth; although for now it retains its high rankings in consumer surveys, over recent years the company has been obliged to recall unprecedented numbers of vehicles, a sequence that has continued this year in Japan.

It also needs to continue to cut costs, both by further simplifying manufacturing (through its fabled kaizen or ‘continuous improvement’ process) and, just as importantly, by improving sales and service. At the same time it must preserve the integrity of its all-important culture as it moves into new territories. It also needs to reinforce both its luxury Lexus brand and what to international buyers remains, despite the success of the Prius, a slightly stodgy Toyota name.

Watanabe makes no bones about it: Toyota must improve on all fronts at the same time, he says. In the face of stern competition, growth will continue only if the company offers high quality, environmental responsibility, service and driving pleasure at the best cost – the right car in the right place at the right time, everywhere in the world.

Being number one in the world for size is irrelevant, he insists. It is important only as a measure of how far Toyota is getting the other things right. If it meets those tests in the years ahead, then at some point, he reasons, the dream car will no longer be a distant ideal – but simply the logical next step.

The Observer, 11 November 2007

Targets can seriously damage your health

FIRST THERE were the truly gruesome events at Maidstone and Tunbridge Wells hospitals where, according to an official report, at least 90 patients died of the superbug Clostridium difficile because of deficiencies in the cleaning regime. Second was the strange embarrassment of the Surrey police chief at his force’s top place in the performance league tables – an achievement, he confessed, that was undeserved. Third, the saga of the National Treatment Agency, which has been rewarding drug addicts who present clean urine samples with bonus drugs, and which last week revealed that a pounds 130m budget increase had resulted in just 70 extra patients kicking the habit.

What do these cases have in common? While the consequences were unintended, they were also no accident. Each was the unerring product of the management regime that ministers have propagated throughout the public services – and for which they, as much as the executives involved, should be in the dock.

At Maidstone, a report by the Health Commission said that the trust had been under such pressure to cut costs and waiting times that it took its eye off the job of cleaning. The drug administration regime is driven by the need to demonstrate that it is getting addicts into treatment, rather than getting results.

Most tellingly, Surrey’s chief constable explained that, to meet government objectives to boost numbers of offenders brought to justice, his coppers were focusing on soft targets such as handing out warnings to shoplifters, instead of more serious and difficult cases. The result, the chief constable said, was that ‘we are at risk of claiming statistical success when real operational issues remain to be addressed’.

Together these cases illustrate once more just why and how top-down target regimes have such baleful effects.

Targets, claim their defenders, are simple, they provide focus, and they work. Yes, they do. Unfortunately, these are also their fatal flaws. The simplicity is a delusion. As Russ Ackoff put it: ‘The only problems that have simple solutions are simple problems. The only managers with simple problems are those with simple minds. Problems that arise in organisations are almost always the product of interactions of parts, never the action of a simple part.’

To focus on the individual parts and ignore the whole always makes things function worse at a system-wide level. Thus, to meet financial and waiting-time targets, Maidstone drove up bed occupancy rates. But that compromised cleaning. At the system-wide level, the cost was making the hospital more dangerous to patients than staying at home.

And if enough pressure is applied, people will meet targets – even if they destroy the organisation in doing so. As quality guru W Edwards Deming put it: ‘What do ‘targets’ accomplish? Nothing. Wrong: their accomplishment is negative.’

These are systemic faults, which is why such regimes can’t be refined by setting ‘better’ or fewer targets. Deming added: ‘Management by numerical goal is an attempt to manage without knowledge of what to do’. This is what makes it so attractive to bad managers. Unfortunately, in absolving them from the effort of thought, it is also junk management, which has the same effect on the consumer as junk food: obesity, flatulence, discontent and demoralisation.

Lack of method explains why the public sector absorbs so much resource for so little return. It also explains the stop-go, curiously disembodied experience of engaging with it: it’s not reacting directly to you, the individual citizen, but to management’s abstraction of you, as embod ied in the target. Hence the obsession with ‘choice’, which simply transfers the question of method to you.

Here’s what I mean. On holiday near Aix-en-Provence in September, my mother had a fall. At the small, busy local hospital she was seen, X-rayed and discharged within two hours.

One phone call produced home visits by a local doctor and a nurse to administer a daily injection. On the last day, she showed my mother how to inject herself – a smart move, because the logistical feat of getting a nurse out for an immobile 90-year-old in Primrose Hill subsequently proved beyond the NHS. She also needed a blood test. Several days after the request, a nurse turned up without tourniquet, cotton wool or plaster. She severely bruised the arm, failed to take any blood and said someone would return with a ‘longer needle’. Several weeks later, still no test.

So when Camden Primary Care Trust sends out a document on ‘Improving Health in Camden’ and asks for feedback, this is my reply. Stuff the targets and fancy extra services. I don’t want ‘choice’. I want competent professionals to give objective advice based on medical, not financial, considerations. What use is a health service that isn’t personalised? If it functions properly, as in the wilds of Provence, it doesn’t need personalising. If it works there, why not here?

The Observer, 4 November 2007

Strong leadership? That’s the last thing we need

FOR MORE than a decade, BP was Britain’s proudest corporate monument – a financial colossus with global reach and brand, which yet managed to be the first oil company with credible green credentials. Its CEO, Lord Browne, was the UK’s most respected businessman.

All that changed overnight with an explosion at a US oil refinery. BP wasn’t a great company, after all: in fact, it was a very bad one. Browne’s achievement likewise went up in the smoke of the accident, and he left in unfortunate circumstances. The transformation was completed last week when Tony Hayward, Browne’s successor, said in an interview that (in effect) the company was a bloated, overcomplicated mess in need of a root-and-branch makeover that would take years.

This extraordinary turnabout needs explanation. How does a company go from great to gruesome overnight? And if it wasn’t overnight, why didn’t anyone step in to stop it? Of course, the company was probably never as good as the hype made out, just as it is now not as bad. Both company and CEO were to some extent victims of a ‘halo effect’ – financial excellence imparted a rosy glow to its management processes up to the refinery accident the same processes are now made self-evidently awful by the bad news. Even so, a central question remains: why even at ‘excellent’ companies – think Marks & Spencer, IBM and Sainsbury as well as BP – does it take a crisis to provoke change? Why can’t firms adjust incrementally, avoiding the need for the trauma, job loss and all-round heartache?

The conventional answer is it’s a failure of leadership. While true, the implication drawn from it (find better leaders) is diametrically wrong. The underlying truth is that the current management model makes failure inevitable.

As management thinker Gary Hamel recently noted, ‘Few people would want to live in a planned economy, but almost all of us work in one’. Corporate dictatorships (as 99.9 per cent of companies are in the last resort) are quite good at getting people to carry out orders. The downside is that the dictator, however brilliant, is too far removed from what’s happening at ground level for the orders to be reliably timely or right: 99.9 per cent of what we call management (planning and scheduling, budgeting, market research, performance management) consists of measures to compensate for this basic connection failure, with results that can never be better than mediocre.

Companies, perversely, compound the inbuilt shortcomings of central planning by their much vaunted alignment arrangements. While CEOs boast of their alignment with shareholders, notes Hamel, this is exactly the wrong way round. It’s not shareholders who create shareholder value but customers buying products and services. Alignment should logically go the other way. This is why progressive companies put employees first (because it is they who perform the all-important contact with customers) customers second and shareholders third. ‘To be sure, shareholders have residual rights,’ says Hamel, ‘but to put those first runs the danger of mistaking the scorecard for the game.’

The real enemy of timely corporate change is therefore not poor leadership, but poor design. The corporate change dilemma is not, or shouldn’t be, about finding a superhuman leader with perfect foresight (there is no such thing) but designing an organisation that is capable of thriving without perfect leadership, harnessing instead leadership distributed around the organisation. As another guru, Warren Bennis, wisely put it: ‘None of us is as smart as all of us.’

Averting the need for palace coups and disruptive 180-degree change is in part a matter of setting up feedback loops that allow corporate ecologies to adapt automatically to changes in the environment. Former Intel CEO Andy Grove recounts how when the firm’s top brass were agonising over whether to phase out production of memory chips in favour of the newer microprocessors, he was astonished to find that salespeople dealing with customers had already anticipated the decision. With US memory prices being undercut by Japanese manufacturers, they had had no option but to switch to processors.

Another strategy, suggested by intriguing long-term research undertaken at the Advanced Institute of Management Research, may be tolerance – or even fomentation – of alternative power coalitions to the dominant one at the top, allowing for the emergence and airing of different scenarios and strategies.

The ideal changeover at the top, of course, is one that is so seamless that no one even notices. One study of the motor industry found that the only manufacturer where a change in CEO had no effect on performance was, as you will probably have guessed, Toyota. Its system is so robust and so focused on continuous improvement that appointing a charismatic individual is not only unnecessary: it would wreck it.

The Observer, 21 October 2007