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Why do corporations elicit such powerful love-hate responses? On the one hand, amid the decay of influence and legitimacy of other institutions — such as states, political parties, churches, monarchies, or even families — the corporation has emerged as perhaps the most powerful social and economic institution of modern society. Versatile and creative, the corporation is a prodigious amplifier of human effort across national and cultural boundaries. Corporations, not abstract economic forces or governments, create and distribute most of an economy’s wealth, innovate, trade, and raise living standards. Historically, they have served as a pervasive force for civilization, promoting honesty, trust, and respect for contracts. As the market sphere has grown to annex areas such as health and sports, companies loom even larger in the lives of individuals. People look to them for community and identity as well as economic well-being.
Yet, in the closing year of the century, corporations and managers suffer from a profound social ambivalence. Hero-worshipped by the few, they are deeply distrusted by the many. In popular mythology, the corporate manager is Gordon Gecko, the financier who preaches the gospel of greed in Hollywood’s Wall Street. Corporations are “job killers.”
There is so much uncertainty about what companies represent that Bill Clinton in the United States and Tony Blair in the United Kingdom set up reviews of companies’ roles. Big business arouses big suspicion in France, Korea, and Germany. Even in the United States, executive salaries have caused a public furor, while the equally astronomical remuneration of entertainers, entrepreneurs, and bond traders raises scarcely an eyebrow. When asked by pollsters to rank professionals by ethical standing, people consistently rate managers the lowest of the low — below even politicians and journalists.
People are right in their intuition that something is wrong. But this is not because large corporations or management are inherently harmful or evil. It is because of the deeply unrealistic, pessimistic assumptions about the nature of individuals and corporations that underlie current management doctrine and that, in practice, cause managers to undermine their own worth.
It has been said that every living practitioner is a prisoner of the ideas of a dead theorist. Obsessed though they are with the “real world,” managers are no exception. Ironically, in their day-to-day actions and choices, the hardest driving of today’s managers are conforming to theories to which the real “real world” no longer corresponds. To the extent that conformity is unconscious and the assumptions behind the theories untested, the theories are self-fulfilling and therefore doubly debilitating. It is time to expose the old, disabling assumptions and replace them with a different, more realistic set that calls on managers to act out a positive role that can release the vast potential still trapped in the old model. The new role for management breaks from the narrow economic assumptions of the past to recognize that:
- Modern societies are not market economies; they are organizational economies in which companies are the chief actors in creating value and advancing economic progress.
- The growth of firms and, therefore, economies is primarily dependent on the quality of their management.
- The foundation of a firm’s activity is a new “moral contract” with employees and society, replacing paternalistic exploitation and value appropriation with employability and value creation in a relationship of shared destiny.
Between a Rock and a Hard Place
To understand why rethinking is necessary, start by looking at what happened to the corporate world in the 1980s. Driven by vociferous shareholders and global competition, managers have concentrated on enhancing competitiveness by improving their operating efficiencies. Managers have enlisted an array of techniques such as total quality, continuous improvement, and process reengineering to this end. Firms have cut costs, eliminated waste, focused, outsourced, downsized, let go, and generally pared themselves to the bone. The result has been victory — of a sort. Shareholder returns (and senior executives’ pay) have, in many cases, soared. Value has been extracted, but at what price?
Explicit or implicit past contracts with both employees and suppliers were broken. Employee loyalty and commitment have been shattered. So has management confidence in its ability to create instead of cut; witness the vogue of high-growth companies like Reuters handing back cash to shareholders via share buy-backs and special dividends instead of investing it to pursue emerging opportunities. Michael Porter expressed alarm that the obsession with operating efficiencies was “leading more and more companies down the path of mutually destructive competition.”1 Stephen Roach, chief economist of Morgan Stanley, reversed his previous enthusiasm for downsizing and warned that if cutting labor costs and hollowing companies were all there was to the productivity-led recovery, “the nation could well be on a path toward industrial extinction.”2 Perhaps he was thinking of Scott Paper, which was reengineered, restructured, and retrenched until, to the dismay of its remaining work-force, the rump was sold to its traditional enemy, Kimberly Clark. “Chainsaw” Al Dunlop, Scott’s CEO, stoutly defended the process by using what might be called the Vietnam justification of management: to save the company for shareholder value, we must destroy it.
Some companies, however, have never accepted this logic of auto-dismemberment. In the United States, companies like HP, 3M, Disney, and Microsoft have shown no fear of diversity, no timidity about growth. Continuously proliferating new products and technologies, they seem unfazed by the things that most companies find so difficult: innovation, organic expansion, creating new businesses. In Europe, ABB doubled its size in six years, despite the slow growth of its businesses. These companies have created more shareholder wealth than most break-up artists by marching to a drum that the downsizers can’t hear. They have also grown, expanded their geographic reach and global market share, and created an internal environment and external reputation that has made them the preferred employers of the best human talent.
Are these exceptions that just prove the rule? Or do these companies know something that others don’t? The answer is that they have escaped the deadly pincer of dominant theory and practice in which other companies are crushing themselves to bits.
The top jaw of the pincer is the doctrine by which managers run their companies. Two generations of top managers have learned to frame their task through the viewfinder of the three Ss: crafting strategy, designing the structure to fit, and locking both in place with supporting systems. In its time, the strategy-structure-systems trilogy was a revolutionary discovery. Invented in the 1920s by Alfred Sloan and others as a technology to support their pioneering strategy of diversification, it served companies well for decades. It supported vertical and horizontal integration, the wave of conglomerate diversification in the 1960s, and the start of globalization in the 1970s and 1980s. But then it began to break down. However sophisticated their structure and systems, the great companies that had been bidding fair to inherit the earth — a French intellectual warned in the early 1980s that IBM had everything it needed to become a world power — were suddenly transformed into stumbling giants. The decline of excellence is well known. So what went wrong?
What happened was that the “real world” changed. The strength — and fundamental weakness — of the classic strategy-structure-systems model was the primacy it gave to control. As Frederick Taylor had made complex assembly repeatable by breaking it down to its simplest component tasks, so the new doctrine, the managerial equivalent of Taylorism, aimed to make the management of complex corporations systematic and predictable. Once strategy had been set at the top, structures and systems would banish troublesome human idiosyncrasy, enabling large, diversified companies to be run in the same machine-like ways. Like the workers on Henry Ford’s assembly lines, all employees were replaceable parts. Harold Geneen, the accountant who ran the quintessential 1970s conglomerate ITT, used to boast that he was building a system that “a monkey will be able to run when I’m gone.”
Famous last words. In the world that today’s companies operate in — a world of converging technologies and markets, swirling competition, and innovation that can outdate established industry structures overnight — machine-like systems of control aren’t helpful. In a situation where the most important corporate resources are not the financial funds in the hands of top management but the knowledge and expertise of the people on the front lines, they are downright unhelpful. To say that they stifle initiative, creativity, and diversity is true — but that was their point. They were designed for an organization man who has turned out to be an evolutionary dead end.
The Tyranny of Theory
The second jaw of the pincer in which companies are gripped is theory. Instead of providing remedies, academic prescriptions mostly have tightened the squeeze on managers and companies. They are part of the problem. Consider two strands of theory that have dominated managerial discourse, both academic and practical, for the past decade.
The first is Michael Porter’s theory of strategy, grounded in industrial organization economics.3 Crudely, under Porter’s theory, the essence of strategy is competition to appropriate value. Companies strive to seize and keep for themselves as much as they can of the value embodied in the products and services they deal with, while allowing as little of this value as possible to fall into the hands of others. Employees, customers, suppliers, and direct or potential competitors are all trying to do the same thing. In short, strategy is positioning to grab all you can, while preventing anyone else from eating your lunch.
The difficulty is that, in this view, the interests of the company are incompatible with those of society. For society, the freer the competition among companies the better. But for individual firms, the purpose of strategy is precisely to restrict the play of competition to get as much as possible for themselves. To do their jobs, managers must prevent free competition, at the cost of social welfare. The destruction of social welfare is not just a coincidental by-product of strategy; it is the fundamental objective of profit-seeking firms and, therefore, of their managers.
The second influential strand of theory addresses a very basic question. Why do companies exist? The answer provided by most economists is so straightforward that it appears compelling; companies exist simply because markets fail. Accept this and it’s only a short step toward the dangerously misleading belief that markets represent some sort of ideal way to organize all economic activities. According to “transaction-cost economics,” the dominant branch of theorizing on this subject, a company is an inferior substitute for markets. Oliver Williamson, a key contributor to one strand of this theory, refers to companies as the organizing means “of last resort, to be employed when all else fails.”4 Markets fail, Williamson presumes, because people are weak. It is only because we, as humans, are limited in our ability to act rationally and because at least some of us are prone to acting “opportunistically” that we need organizations to save us from ourselves. In some of our dealings with others, particularly those requiring complex coordination of tasks, our opportunity to behave strategically is too great for markets to restrain. In these cases, companies are necessary because managers, with their hierarchical authority and their power to monitor and control, can keep the opportunism of employees in check.
Unfortunately, the practical consequence of these two theories is to make managers not architects but wreckers of their own corporations. What they have in common, apart from their narrow, instrumental, and largely pessimistic view of human enterprise, is an emphasis on static rather than dynamic efficiencies. Static efficiency is about exploiting available economic options as efficiently as possible — making the economy more efficient by shifting existing resources to their highest valued use. Dynamic efficiency comes from the innovations that create new options and new resources — moving the economy to a different level. Porter’s theory is static in that it focuses strategic thinking on getting the largest possible share of a fixed economic pie. In this zero-sum world, profits must indeed come at the expense of the broader society. Because of its insistence that firms are second-rate market mechanisms, Williamson’s theory too locks firms into the market logic of static efficiency.5 Fit the pieces together and we can see why this unholy alliance of theory and practice should have destructive consequences. In its constant struggle for appropriating value, the company is pitted against its own employees as well as business rivals and the rest of society. The economic challenge for society is to keep human discretion in check. This is accomplished in markets through a focus on individualism and the power of sharp incentives and, within the firm, through hierarchical control. In other words, as Williamson wrote, and Geneen practiced, companies must act as if they were “a continuation of market relations, by other means.” Caught as it is, between the sound logic of efficiency and the harsh reality of human frailties and pathologies, it is no wonder that dominant doctrine focuses managers’ attention almost exclusively on concerns of appropriation and control. The resulting pathological economic role for companies and individuals should also be no surprise. It follows naturally from the premise that “markets rule” that any and all failures to heed the market’s corrective discipline are likely to be futile for firms and individuals and inefficient for society.
When in a hole, the first thing to do is to stop digging. The outlines are beginning to take shape of a different management model, based on a better understanding of both individual and corporate motivation. If downsizing, cost-cutting, and “getting lean and mean” were the mantras of the past decade, the desire for growth and renewal will be the major concern of the next.
A New Management Philosophy
Start by turning the conventional justification for the existence of the company around: markets begin where firms leave off. As Nobel laureate Herbert Simon has put it, modern societies are not primarily market but organizational economies.6 That is, most of their value is created not by individuals transacting individually in the market, as in the economists’ ideal, but by organizations involving people acting collectively, with their motives empowered and their actions coordinated by their companies’ purpose. Far from destroying social welfare, the rise of the corporation over the past century has coincided with a sustained and unprecedented improvement in living standards, fueled by the ability of companies to enhance productivity and create new products and services. Indeed, the clearest evidence for Simon’s contention lies in a strong positive correlation between the relative prosperity of an economy and its quotient of large, healthy companies. Growing, efficient companies help create growing, efficient economies. Not only is the premise of a fundamental conflict between corporate well-being and social welfare wrong; the reality is exactly the reverse.
In terms of static efficiency, much of what happens inside a company is inefficient. That’s its point. It exists precisely to provide a haven and (temporary) respite from the laws of the market in which humans can combine to do something that markets aren’t very good at: innovating. From a static viewpoint, the 15 percent of their time that 3M encourages its employees to spend on their own projects is wasted. And, indeed, a lot of it is. But the company willingly makes this sacrifice, banking that out of their efforts will come products that alter the bounds of the existing market. Sony and Intel duplicate development teams for the same purpose. Companies create fresh value for society by developing new products and services and finding better ways for providing existing ones. Markets relentlessly force the same companies eventually to “hand off” most of the newly created value to others, increasing, not diminishing, social welfare. In this symbiotic coexistence, they jointly drive the process of “creative destruction” that the Austrian economist Joseph Schumpeter identified sixty years ago as the engine of economic progress.7
Reversing the logic pries companies from the crushing hold of the pincer, with liberating effect for their managers and employees. The difference between old and new is not just economic but also philosophical. In an organizational economy in which the essence of the company is value creation, the corporation and society are no longer in conflict. They are interdependent, and the starting point is a new moral contract between them. In this framework, management too wins back its legitimacy: not only is the “destroy it to save it” nightmare banished, but the success of the company and the economy as a whole can be seen to depend on how well management does its job. Far from being villainous or exploitative, management as a profession can be seen for what it is — the primary engine of social and economic progress. Individual inventors and entrepreneurs develop new products and, sometimes, new businesses. A vast majority of new products and new businesses, however, are created by established organizations. Managers build organizations, the embodiments of an economy’s social capital — a factor that is beginning to be recognized as perhaps the key driver of economic growth.8
Companies as Value Creators
The contrast between these two views of a company comes sharply into focus if we compare the management approaches of Norton and 3M, or of Westing-house and ABB. As we have described elsewhere, managers at Norton and Westinghouse lived in the zero-sum, dog-eat-dog world of traditional management theory.9 When they found a company that had created an attractive new product or business, they bought it. When they found the market for a product to be too competitive for them to dictate terms to their buyers and suppliers, they sold those businesses. Their primary management focus was on value appropriation — not only vis-à-vis their customers and suppliers, but also vis-à-vis their own employees.
At 3M and ABB, in contrast, a very different management philosophy was at work. While Norton tried to develop increasingly sophisticated strategic resource allocation models, 3M’s entire strategy was based on the value-creating logic of continuous innovation. The same power equipment business that Westing-house abandoned as unattractive (that is, not enough opportunity for value appropriation), ABB rejuvenated, in part by its own investments in productivity and in new technologies to enhance products’ functionality or their appropriateness for new markets.
The difference between these companies is not just that 3M and ABB focused on innovation and improvement while Norton and Westinghouse did not, but that this difference in focus stemmed from very different beliefs about what a company is. At Norton and Westinghouse, managers thought of their companies in market terms: they bought and sold businesses, created internal markets whenever they could, and dealt with their people with market rules. Through the power of sharp, marketlike incentives, they got what they wanted. People began to behave as they would in a market — acting alone as independent agents with an atomistic concern only for their self-interest.
By thinking of their companies in market terms, Norton and Westinghouse became the victims of the very logic that both companies sought to live by — a market logic that left little choice but to squeeze out more efficiency in everything that was attempted. Their strategy focused entirely on productivity improvement and cost cutting. Their structures for controlling behavior rewarded autonomy, while their elaborate systems for monitoring performance were finely tuned to eliminate even the smallest pools of waste. Yet, they could not create any value that was new, not because they explicitly did not want to do so, but because the logic of the market that they adopted internally is simply not very good at anything other than enhancing the efficiency of existing activities. The very sharp sense of self-interest these firms engendered, coupled with the uncertainties inherent in any innovative effort (both in terms of the size of any ultimate benefits and the distribution of those benefits) made people unable to cooperate among themselves or to pool their resources and capabilities in order to create new combinations —particularly, new combinations of knowledge and expertise — that most innovations require.
Visions like ABB’s purpose “to make economic growth and improved living standards a reality for all nations throughout the world,” values such as Kao Corporation’s espoused belief that “we are, first of all, an educational institution,” and norms like 3M’s acceptance that “products belong to divisions but technologies belong to the company” all emphasize the non-marketlike nature of a company, encouraging people to work collectively toward shared goals and values rather than more restrictively, within their narrow self-interests. They can share resources, including knowledge, without having to be certain of how precisely each of them will benefit personally — as long as they believe that the company overall will benefit, to their collective gain.10 It is, ultimately, this philosophical distinction in their beliefs about what a company is that allows these organizations to create innovations through a spirit of collaboration among people that markets, and companies that think of themselves as markets, cannot engender.
The shift of emphasis is as great inside firms. In the logic of a turbulent organizational economy, competitive advantage is anchored in the company’s ability to innovate its way temporarily out of relentless market pressures. As companies change focus from value appropriation to value creation, facilitating cooperation among people takes precedence over enforcing compliance, and initiative becomes more valued than obedience. The manager’s primary task is redefined from institutionalizing control to embedding trust, from maintaining the status quo to leading change. As opposed to being the designers of strategy, managers take on the role of establishing a sense of purpose within the company. Defined in terms of how the company will create value for society, purpose allows strategy to emerge from within the organization, from the energy and alignment created by that sense of purpose. As opposed to playing with the boxes and lines that represent the company’s formal structure, managers focus on building the core organizational processes that would release the entrepreneurs held hostage in the front-line units of that structure; integrate the resources and capabilities across those units to create new combinations of resources and knowledge; and create the stretch that would drive the whole organization into continuously striving for new value creation. And, from being the builders of systems, managers transform into the developers of people, helping each individual in the company become the best he or she can be. The three Ss of strategy, structure, and systems that were at the core of the managerial role give way to the three Ps: purpose, process, and people.
Creating Value for People
This kind of management also demands a qualitatively different employment relationship from that of the past. The contrast is perhaps the clearest statement of the new management philosophy in action. In a value-appropriating, cost-cutting mode, part of the firm’s advantage comes from its monopoly power over people’s capabilities. In return, it takes on, or was understood to take on, responsibility for the employees’ careers. Counterintuitively, the offer of job security has allowed companies to extract the maximum value from their people in the past.
Unlike machines, people cannot be owned. Yet, like machines, the way people become most valuable to a company is by becoming specialized to the company’s businesses and activities. The more specific the employee’s knowledge and skills are to a company’s unique set of customers, technologies, equipment, and so on, the more productive they become and the more efficient the company becomes in all that it does. Without employment security, employees hesitate to invest their time and energy to acquire such specialized knowledge and skills that may be very useful to the company, but may have limited value outside of it. Without any assurance of a long-term association, companies too lack the incentive to commit resources to help employees develop such company-specific expertise. Employment security provides a viable basis for both to make such investments.11
While the company benefits from such specialization directly in terms of efficiency and productivity, it also benefits indirectly because the more specialized an employee is to the unique requirements of the company, the less attractive he or she becomes to other potential employers. Not only does this reduce the risk of losing valuable people, it also reduces wage demands if outsiders do not find the employee as valuable as the employing company does.
Exploitative or not, the “obedience for employment” contract was viable in a stable world in which firms like IBM, Caterpillar, and Xerox could sustain competitive advantage for long periods. But this contract has now broken down. As Jack Welch, the CEO of General Electric, points out, it produces “a paternal, feudal, fuzzy kind of loyalty” that is out of keeping with both the times and the changed needs of firms.12 But even if they wanted to, companies can no longer meaningfully give the kind of job security that was their side of the bargain. One reason is the hyper-competition they have brought on themselves. In any case, security could hardly survive in an unstable world in which competitive advantage in one period becomes competitive disadvantage in another. To adjust to the displacement of its major markets from north and west to south and east, ABB has laid off 54,000 people in the United States and Europe and has taken on 46,000 people in the Asia-Pacific region. In the face of technological and market change of this order, guaranteeing employment is either meaningless or tantamount to committing competitive suicide.
At the same time, a free-market hire-and-fire regime is no alternative, as many companies have come to recognize. Paradoxically, the same forces of ferocious competition and turbulent change that make job security impossible also increase the need for trust and teamwork. These can’t be fostered in an affection-free environment of reciprocal opportunism and continuous spot contracting. On the contrary, firms such as Intel and 3M have intuited that value creation demands something much more inspiring than individual self-interest: a community of purpose in which individuals can share resources, including knowledge, without knowing precisely how they will benefit, but confident of collective gain. In other words, innovation depends on a company acting as a social and an economic institution, in which individuals can behave accordingly.
This requirement is embodied in a new moral contract with employees to anchor the similar contract with society. In the new contract, employees take responsibility for the competitiveness of both themselves and the part of the company to which they belong. In return, the company offers not the dependence of employment security but the independence of employability — a guarantee that they fulfill through continuous education and development. Says GE’s Welch: “The new psychological contract . . . is that jobs at GE are the best in the world for people who are willing to compete. We have the best in training and development resources, and an environment committed to providing opportunities for personal and professional growth.”13 This second reversal of the conventional logic again has a pleasingly ironic twist: by enhancing employees’ value to others, the company obliges itself not just to keep its development promises, but to make jobs so exciting that employees do not exercise their liberty to leave. The result: by abandoning job security, the new contract encourages the development of the durable, mutually satisfying relationship between the individual and the organization that it ruled out as its starting point.
Few companies take their commitment to employability of people more seriously than Motorola. In a context of radical decentralization of resources and decisions to the divisional level, employee education is one activity that Motorola manages at the corporate level, through the large and well-funded Motorola University that has branches all over the world. Each employee, including the chief executive, has to undertake a minimum of forty hours of formal coursework each year. Courses span a wide range of topics — from state-of-the-art coverage of new technologies to broad general management topics and issues, so as to allow Motorola employees around the world to update knowledge and skills in their chosen areas. It is this commitment to adding value to people that allowed Motorola to launch and implement its much-imitated “Six Sigma” total quality initiative. At the same time, the reputation of Motorola University increasingly has become a key source of the company’s competitive advantage in recruiting and retaining the best graduates from leading schools in every country in which it operates.
More recently, Motorola has further upped the ante on its commitment to employability by launching the “Individual Dignity Entitlement” (or IDE) program. The program requires all supervisors to discuss, on a quarterly basis, six questions with everyone whose work they supervise (see the sidebar). A negative response from any employee to any one of these questions is treated as a quality failure, to be redressed in accordance with the principles of total quality management. Yet even Motorola, a company that has invested more in its people than most and that has long been an adherent of employability, was surprised to learn that some of its units reported failures in excess of 70 percent the first time that IDE was implemented. Beginning in 1995, the company began addressing the negatives systematically by identifying and then eliminating their root causes. This is the hard edge of the new moral contract on management’s side — the commitment to help people become the best they can be — that counterbalances the new demands on people which the “employability for competitiveness” contract creates.
What the New Contract Is Not
While we have described at some length what a moral contract based on employability is, it is important to emphasize what it is not. First, it is not a catchy new slogan to free managers from a sense of responsibility to protect the jobs of their staff. At Intel, Andy Grove could make the kind of demands he did because his own past actions had established, beyond any doubt, the extent to which he was willing to go to protect the interests of his employees. During the memory-products blood bath in the early 1980s, when every other semiconductor company in the United States immediately laid off many people, Grove adopted the 90 percent rule, with everyone, from the chairman down, accepting a 10 percent pay cut, to avoid layoffs. Then, to tide the company over the bad period without losing people he had nurtured for years, Grove sold 20 percent of the company to IBM for $250 million in cash. When cost pressures continued to mount, he implemented the 125 percent rule by asking everyone to work an extra ten hours a week with no pay increase, again to avoid cutbacks. Only after all these efforts proved insufficient did he finally close some operations, with the attending job losses. This kind of proven commitment to people makes a contract based on employability credible, and its hard-edged demands on people acceptable.
Second, the new contract is not an act of altruism, aimed at helping educate and develop people at company cost so they then can find better jobs elsewhere. In fact, this new relationship actually enhances a company’s chances of retaining its best people. Under the old contract based on employment security, those who lost their mobility through over-specialization or skill obsolescence stayed with the company, because they, at least in part, had no alternative. But those who could, typically the very best people, often left, frustrated by the constraints and controls that were the other side of the coin. In contrast, the promise of employability itself is a great motivator for people to remain with a company, because they know that even if they can cash in their current employability at a premium, they run the risk of falling victim to the next round of skill obsolescence in a company that does not have the same commitment to adding value to people. Besides, the same broad and advanced skills that make people employable outside the company also make them more adaptable to different jobs and needs within the company, thereby making it easier for the company to use their expertise more flexibly and in higher value jobs.
Third, the contract based on employability is not some program that can be installed by a company’s HR department. Rather, it must be inculcated as a very different philosophy — one that requires management at every level to work hard, on an ongoing basis, to create an exciting and invigorating work environment, a place of enormous pride and satisfaction that bonds people to the company even more tightly than any bond of dependency that employment security could create. The combination of a moral contract based on employability and a management commitment to empowerment leads, as a consequence, to the durable long-term and mutually satisfying relationship between the individual and the organization that the traditional employment contract abandoned. But, by building the new company-employee relationship on a platform of mutual value-adding and continuous choice, rather than on a self-degrading acceptance of one-way dependence, the new contract is not just functional. It is also moral.
Building Shared Destiny Relationships
Is this notion of the modern corporation focused on creating value externally and internally what the British call “cloud-cuckoo land”? Is it all wishful thinking of wet-behind-the-ears softies who do not know how hard and unforgiving the world of business really is or, worse, of ivory tower academics who preach what they cannot do?
The business world is full of examples of companies that earn healthy profits year after year by focusing continuously on the task of creating value for themselves and others, rather than on expropriating as much value as they can. Canon made its own highly successful laser-printer technology obsolete by inventing and then promoting aggressively the bubble-jet printer on the ground that its functionality-to-cost ratio yielded higher value to customers. Intel fueled the information revolution by relentlessly following “Moore’s law,” creating the next generation of chips that allowed its customers to do new things, while at the same time wiping out its earlier generation of products. Kao decided to enter the cosmetics industry and use its advanced technology to create the high-functionality Sofina range to compete with overpriced mediocre products in expensive jars. In each company, value creation was both the stated objective and the proven outcome.
Without a moral contract based on adding value to people, McKinsey & Company and Andersen Consulting could not be in business. Recruiting the very best talent is the number one success factor in the consulting industry. Yet these companies can make partners of only one in seven of all the people they hire. The rest must leave the company. The promise of employability is a big reason why fresh graduates worldwide seek to join these companies. And to the extent that companies deliver on that promise, the larger and more valued will be their alumni networks.
But these are examples of companies that have practiced the philosophy of value creation for a long time, often from inception. Can others, steeped in the more traditional approach, adopt this new philosophy? Yes, they can.
Unipart, a struggling auto parts manufacturer, is a good example of a company that transformed itself under this powerful management philosophy. At its birth out of the 1987 dismemberment of the chronically sick, government-owned British Leyland, Unipart suffered a two-to-one handicap vis-à-vis Japanese auto parts companies in terms of its costs and an astonishing hundred-to-one gap in quality, according to a U.K. Department of Trade and Industry study. The new company inherited an extremely confrontational work climate, the product of a heavily unionized workforce crossed with a traditional and autocratic management. Furthermore, the company inherited adversarial relationships that extended to its suppliers and its customers, principal among them Rover, the U.K. car company that earlier was a unit within British Leyland.
A decade later, the story had utterly changed. Annual revenues had shot up to more than ¥1 billion ($1.6 billion), and profits had quadrupled to ¥32 million. A Department of Trade and Industry study had announced that Unipart was the only U.K.-based company in its business to meet world-class standards on quality.
Behind the company’s transformation was Unipart CEO John Neill and his absolute commitment to what he called “shared destiny relationships.” The philosophy was not an ex-post rationalization of success but was stated clearly and firmly by Neill in 1987 as the fundamental principle on which the company would function:
“We have made a mess of our industry. The short-term power-based relationships have failed us. Many Western companies still believe that it is a superior way to secure competitive advantage. I think they are absolutely wrong. . . . We must create shared destiny relationships with all our stakeholders: customers, employees, suppliers, governments, and the communities in which we operate. It is not altruism; it is commercial self-interest.”14
While acknowledging the interdependence between a company and all its key stakeholders, Neill’s notion of shared destiny relationships is very different from “being and doing good to all,” as the stakeholder concept is often portrayed. With suppliers, his program emphasized the need to work together to radically improve performance across ten criteria ranging from transaction costs and lead times to defect rates and delivery errors — and to ultimately reduce each to as close to zero as possible. These efforts created value, not just for Unipart and its suppliers, but also for the industry, as suppliers worked to transfer what they had learned from working closely with Unipart to their relationships with other buyers. This, in turn, increased the pressure on Unipart to continue striving for new sources of value, this time without their traditional recourse to appropriation from others. Similarly, within the organization, programs like “our contribution counts” emphasized the hard two-way dependence between the company and its employees inherent in the concept of shared destiny, and the need for continuous performance improvement to make that destiny mutually attractive.
Neill’s vision for Unipart came not from some narrowly defined model for achieving profitability through the zero-sum game of extracting value from others. Rather, it was based on an expansive positive-sum value-creation perspective that we found much more typical of successful managers in the companies we have studied. Like Neill, these executives have enormous faith in what they can create by engaging, energizing, and empowering their constituencies to work together for mutual benefit. The result of the collective actions of these executives is generally greater than was originally anticipated. It is the emergence of a more realistic and assertive philosophy of the corporation’s role as an important social institution, as well as a powerful economic entity, that enabled these companies to use their economic resources to add value to society generally and to peoples’ lives individually. These executives are the standard bearers for a new manifesto of companies and managers as value creators.
A Manifesto for Reclaiming Managerial Legitimacy
Institutions decline when they lose their source of legitimacy. This happened to the monarchy, to organized religion, and to the state. This will happen to companies unless managers accord the same priority to the collective task of rebuilding the credibility and legitimacy of their institutions as they do to the individual task of enhancing their company’s economic performance.
Far from thinking of their companies as agents for destroying social welfare, most managers we have met believe that their primary role should be to create value. Their guilt lies in their unwillingness to confront explicitly the role their companies play in society or to articulate a moral philosophy for their own professions. Through this act of omission, they have left others — economists, political scientists, journalists, and so on — to define the normative order that shapes the public’s perception about them and about their institutions. Those perceptions, in turn, have seduced many managers into thinking about their companies in very narrow terms and, in the process, have made them unwitting victims of the value-appropriation logic and have weakened their ability to create new value for society.
We believe that individuals like Chairman of ABB Percy Barnevik, CEO of GE Jack Welch, and Chairman of Kao Yoshio Maruta will each earn a place in history — not because of their firms’ economic performance while they were in the saddle — but because they have regained the initiative to define a new corporate philosophy that explicitly sees companies as value-creating institutions of society. They have not reinvented the old, tired debate of the social responsibility of business; instead they have made value creation for all constituencies their fundamental business. Then they have reshaped their organizational and management processes around this new philosophy to give birth to a new corporate form that we have labeled elsewhere the individualized corporation.15
This new moral contract of creating value for society is not only more satisfying for managers; it is also a more effective basis for protecting and growing their companies. The problem of a strategy of value appropriation is that, ultimately, it is self-defeating. It is like a strategy of holding back the tide, and like the tide, the ability of others to overcome a company’s defenses cannot be held back forever. With such a strategy, the company gets squeezed more and more into a corner, with every round of value appropriation consuming ever more effort, until finally, there is no value left to appropriate. By thinking of themselves as a market, such companies ultimately succumb to the market, as happened in Norton’s acquisition by St. Gobain and by Westinghouse’s dismemberment under Michael Jordan. Hanson Trust followed a classic value appropriation strategy, as did ITT under Harold Geneen. Ultimately, each company fell victim to the same market logic that it had embraced so enthusiastically. In the process, value was destroyed for all constituents, including customers, shareholders, and employees.
In contrast, 3M and Kao continue to grow profitably, spawning new products and businesses, creating customer satisfaction, employee enthusiasm, and shareholder wealth, and ABB continues to expand and strengthen its leadership position in its businesses, at times by acquiring the spent parts of companies like Westinghouse and rejuvenating them with the power of its very different philosophy. They are role models demonstrating the spirit, passion, and moral commitment of which management is capable, and which the dominant doctrine has all but destroyed.
Ideas matter. In a practical discipline like management, the normative influence of ideas can be powerful, as they can manifest themselves as uniquely beneficial or uniquely dangerous. Bad theory and a philosophical vacuum have caused managers to subvert their own practice, trapping them in a vicious circle. But there is a choice. Management can continue down the well-worn path to illegitimacy or begin to chart a new course by laying claim to a higher purpose. When the solution to a recurring problem is always “try harder,” there is usually something wrong with the terms, not the execution. Get out of the pincer’s grip. Throw out the old paradigm while you still can, before the growing gap between companies’ economic power and their social legitimacy proves it right. Take responsibility before management is held to blame for stunting the growth potential of individuals, companies, and society.
1. M.E. Porter, “What Is Strategy?,” Harvard Business Review, volume 74, November–December 1996, pp. 61–78.
2. S.S. Roach, “The Hollow Ring of the Productivity Revival,” Harvard Business Review, volume 74, November–December 1996, pp. 81–89.
3. M.E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Free Press, 1980).
4. O.E. Williamson, “Comparative Economic Organization: The Analysis of Discrete Structural Alternatives,” Administrative Science Quarterly, volume 36, June 1991, pp. 269–296, p. 279. See also:
O.E. Williamson, Economic Institutions of Capitalism (New York: Free Press, 1985).
5. Elsewhere, we have used the terms “allocative” and “adaptive” in place of “static” and “dynamic,” respectively, to better distinguish the type of efficiency that results from two types of resource deployments. Allocatively efficient deployments are those that tend to allocate resources to their best-known use (i.e., “best” as defined by the combination of resources and forces that exist at any time). As Schumpeter cautions, however, these allocatively efficient deployments may prove in the long run to be mistakes. Adaptively efficient deployments are those (often allocatively inefficient) deployments that facilitate the pursuit of new and possibly better uses (thus permitting the resources and forces that define what is allocatively efficient to more efficiently adapt to possibilities that arise). See:
J.A. Schumpeter, Capitalism, Socialism, and Democracy (London: Unwin University Books, 1942), p. 83;
D.C. North, “Institutions,” Journal of Economic Perspectives, volume 5, Winter 1991, pp. 97–112, p. 80; and
P. Moran and S. Ghoshal, “Markets, Firms, and the Process of Economic Development,” Academy of Management Review, forthcoming.
6. H.A. Simon, “Organizations and Markets,” Journal of Economic Perspectives, volume 5, Spring 1991, pp. 25–44.
7. Schumpeter (1942).
8. J. Nahapiet and S. Ghoshal, “Social Capital, Intellectual Capital, and the Organizational Advantage,” Academy of Management Review, volume 23, April 1998, pp. 242–266.
9. C.A. Bartlett and S. Ghoshal, “Rebuilding Behavioral Context: Turn Process Reengineering into People Rejuvenation,” Sloan Management Review, volume 37, Fall 1995, pp. 11–23.
10. This is what Coleman describes as “independent viability” and “global viability” that, according to Moran and Ghoshal, characterize organizations. See:
J.S. Coleman, The Foundations of Social Theory (Cambridge: Harvard University Press, 1990); and
P. Moran and S. Ghoshal, “Value Creation by Firms,” in J.B. Keys and L.N. Dosier, eds., Academy of Management Best Paper Proceedings, 1996.
11. This is a core argument of the theory of internal labor markets. See:
P.B. Doeringer and M.J. Poire, Internal Labor Markets and Manpower Analysis (Lexington, Massachusetts: D.C. Heath, 1971).
12. N. Tichy and R. Charan, “Speed, Simplicity, Self-Confidence: An Interview with Jack Welch,” Harvard Business Review, volume 67, September–October 1989, pp. 112–120.
14. A. Duncan, “Unipart Group of Companies: Uniting Stakeholders to Build a World-Class Enterprise” (London: London Business School Case, 1996), pp. 4–5.
15. S. Ghoshal and C.A. Bartlett, The Individualized Corporation (New York: Harper Collins, 1997).