Page 1

SEPTEMBER 2014

46 The Big Idea

The Problem with Stock Buybacks William Lazonick 119 Case Study

Is It Ever OK to Break a Promise? Neil Bearden 94 Risk Management

Preventing Insider Attacks David M. Upton and Sadie Creese

ADAPT YOUR STRATEGY TO ANY LOCATION PAGE 57


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hbr.org

September 2014

Cover Artist Bruce Peterson

Contents

SPOTLIGHT ON MANAGING ACROSS BORDERS 58 Contextual Intelligence Best practices simply don’t travel well across borders. Global businesses must learn how to adapt. Tarun Khanna PHOTOGRAPHY: STUDIO TOMÁS SARACENO © 2012

70 What’s Your Language Strategy? Companies that hope to penetrate multiple markets and coordinate work among them must factor language skills into the hiring, training, assessment, and promotion of talent. Tsedal Neeley and Robert Steven Kaplan 77 Voices from the Front Lines Executives from Michelin, Telefónica, Hitachi, and Honeywell share their experiences managing global organizations.

ABOVE Tomás Saraceno On the Roof: Cloud City 2012, New York

HBR.ORG Everything you need to know about the new marketing organization. hbr.org/ insights/ marketing September 2014 Harvard Business Review 5


HBR.ORG

Features September 2014

46 84 94 103

THE BIG IDEA

Profits Without Prosperity Executives are using massive stock buybacks to manipulate share prices and boost their own pay— at great cost to innovation and employment. William Lazonick Digital-Physical Mashups Companies need to catch up with their customers—by fusing brick-andmortar operations with online ones. Darrell K. Rigby VIDEO Analysis and tips from the leading minds in management. hbr.org/video

46

The Danger from Within The most common cybersecurity safeguards are designed to fend off outsiders. But what about people who exploit legitimate access to your systems? David M. Upton and Sadie Creese 84

94 41 HOW I DID IT

The CEO of Williams-Sonoma on Blending Instinct with Analysis Analytics creates a more relevant, personalized experience for the company’s 57 million customers. Laura Alber 103 THE GLOBE

A Chinese Approach to Management The entrepreneurs that prevail in China’s turbulent market are masters of improvisation, flexibility, and speed. Thomas Hout and David Michael 6 Harvard Business Review September 2014

41

America’s preeminent home retailer uses data to make smarter decisions.


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HBR.ORG

Departments September 2014 14 18 From the Editor Interaction In transformation lie threats—and great opportunities. page 23 THE HOTLIST HBR’s best of the week, delivered to your in-box. enewsletters. hbr.org PREP TIME How to spend the first 10 minutes of your day. hbr.org/go/ 10-minutes

23

Idea Watch 23 STRATEGY

32 VISION STATEMENT

Sharing’s Not Just for Start-Ups Traditional companies are finding ways into the collaborative economy. PLUS How to identify and empower the real experts on your team, and collective leadership capabilities that drive M&A success 30 DEFEND YOUR RESEARCH

The Chart That Organized the 20th Century A look back at railroads and the birth of decentralized management 34 STRATEGIC HUMOR COLUMNS 36 DENISE M. MORRISON Bringing forth the courage to change 38 GEORGE HALVORSON The power of “us”

Just Thinking You Slept Poorly Can Hurt Your Performance A new study reveals the powerful effects of perception.

Identifying collaborative opportunities page 23

Organizing one of the largest, most complex enterprises of its time—the railroad page 32

“Business is the way to drive science forward.” page 132

111 Experience 111 MANAGING YOURSELF

Work + Home + Community + Self Balance is bunk. To reduce stress and increase your sense of fulfillment, you need to skillfully integrate the four domains of your life. Stewart D. Friedman 119 CASE STUDY

124 SYNTHESIS Do customers let companies mine their personal data because they just don’t care—or are companies willfully misleading them about the trade-offs? Scott Berinato 129 EXECUTIVE SUMMARIES 132 LIFE’S WORK

Is It Ever OK to Break a Promise? Approached by a headhunter with the job of his dreams, an MBA student weighs his loyalty to the firm that sponsored his degree. Neil Bearden 10 Harvard Business Review September 2014

J. Craig Venter The biologist who led the for-profit effort to sequence the human genome shares his thoughts on commercializing science.


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HBR.ORG

hbr.org September 2014 AUDIO To bundle or unbundle? Marc Andreessen, Jim Barksdale, and Justin Fox discuss this timely question. hbr.org/ideacast/bundling

BOOK PREVIEW Download a free chapter from The Innovator’s Method: Bringing the Lean Startup into Your Organization, by Nathan Furr and Jeff Dyer. hbr.org/chapters/furr

DAILY STAT

No One Wants to Buy This Drill What people really want to buy is a hole. To understand why, watch this two-minute animated explanation of marketing myopia, Theodore Levitt’s classic idea. hbr.org/ video/levitt

Facts and figures to stimulate thought and action. blogs.hbr.org/daily-stat

MANAGEMENT TIPS Quick, practical advice for you, your manager, and your business. hbr.org/tip

FOLLOW HBR @HarvardBiz facebook.com/HBR hbr.org/linkedin

HBR in Your In-Box Get e-mail updates with the latest on management and leadership. Sign up at enewsletters.hbr.org.

HBR on Your Phone Our mobile site is optimized for fast browsing. Visit hbr.org anywhere.

HBR on Your iPad Find the enhanced magazine, the latest blog posts, and selected books. Available in iTunes

12 Harvard Business Review September 2014


HBR.ORG

From the Editor

A Call for Courage “Profits Without Prosperity” (page 46), William Lazonick pinpoints one critical culprit: the growing trend of allocating corporate profits to stock buybacks. Lazonick, a professor of economics at the University of Massachusetts Lowell, has done a study of S&P 500 companies that were publicly listed from 2003 to 2012. It shows that during that time they used 54% of their earnings—a total of $2.4 trillion—to buy back their own stock. An additional 37% went toward dividends. This, he says, left little for investment in their productive capabilities, let alone higher pay for their employees. What’s needed, Lazonick says, is “courage in Washington”—to rein in stock buybacks and executive pay, and to encourage productive capital formation. His article is the latest in HBR’s effort to publish ideas aimed at improving the competitiveness of U.S. (and global) companies and fixing a financial system that let us down during the recent recession. It follows a pair of features in the June issue—one by Clayton Christensen and Derek van Bever, the other by Gautam Mukunda—that together posed the question “Are investors bad for business?” Mukunda tried to show that the growing influence of the financial sector is actually destabilizing the economy, while Christensen and van Bever argued that the tools commonly used to guide investments are thwarting long-term prosperity. Government action would be one response to all these critiques—but it’s not the only one. As Dominic Barton, the global managing director of McKinsey and an advocate for long-term corporate thinking, wrote in the March 2011 HBR, “Business leaders today face a choice: We can reform capitalism, or we can let capitalism be reformed for us, through political measures and the pressures of an angry public.” In this spirit, we invite readers and contributors to continue the dialogue and to propose changes to a system that isn’t delivering.

I

t’s been five years since the official end of the Great Recession, yet the U.S.

economy continues to lag. True, corporate profits are healthy, and the stock market has soared—but most Americans aren’t sharing in the recovery. In

Adi Ignatius, Editor in Chief

14 Harvard Business Review September 2014

PHOTOGRAPHY: ELIE HONEIN


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Interaction Managers Need to Invest in New-Market Innovation HBR article by Clayton M. Christensen and Derek van Bever, June You have to produce and innovate with the proceeds of previous production and innovation; that’s where real capital comes from. Dan Pedersen, writer/consultant, Dan Pedersen Resources

Despite low interest rates and massive piles of cash, corporations aren’t investing in innovations that could create new markets and foster growth. At the root of the problem: Different types of innovation are evaluated using the same flawed metrics, which are based on the idea that capital is scarce. But capital is no longer scarce, the authors point out. Our tools for guiding investments must be updated. While it’s true that capital is no longer scarce, not all capital is created equal. The type referred to in this article— which is sitting on corporate balance sheets because the Federal Reserve has helped lower interest rates and increase liquidity—is phony capital. The Fed creates this money out of thin air; it’s not the result of an increase in production (the lifeblood of an economy). The underlying problem is not a lack of innovation owing to companies’ hoarding of cash.

The authors are correct that in weak economic conditions, research and development seems to be a comparatively less attractive use of capital, but what U.S. companies never “got” is that when the economy begins expanding, you have to be ready with new products to take advantage of it. U.S. manufacturers are now, and have been, totally out of sync with the ebbs and flows of the economy, expanding R&D when the economy is strong, gutting R&D when the economy is questionable, and rarely in a position to take advantage of economic expansion. F. Elliot Siemon, retired R&D specialist

The bottom line is that we need to get back to the 1950s-era product-value-merit model and definancialize the economy. There is such an oversupply of people trying to eat growth in every conceivable business interaction that growth itself is becoming nearly impossible. Until the economy definancializes and fair-market-value pricing can be reachieved with entrepreneurs (as opposed to finance-imposed

HBR article by Kathryn Heath, Jill Flynn, and Mary Davis Holt, June

Women, Find Your Voice Women often struggle to be heard in meetings, but if they master the premeeting and keep an even keel, they can be more effective. Why is it that women have to adapt all the time? If women fail to make their point when given a chance, it could be that men don’t get their perspective, because men are mostly used to hearing other men speaking. Ashwinee Khaladkar, senior development manager, Oracle USA

Women don’t need to act like men to succeed. Their biggest problem is not being heard and then getting frustrated or rattled. With this article, I believe women will know how to interpret their male colleagues’ responses correctly, so they will stop being reactive to them. Zhuo Jiang, business major, Chuo University

While women have made great strides in breaking that glass ceiling, we’re not considered as assertive as our male counterparts are in the boardroom.

18 Harvard Business Review September 2014


HBR.ORG

Interact with Us The best way to comment on any article is on HBR.ORG. You can also reach us via E-MAIL: hbr_letters@hbr.org FACEBOOK: facebook.com/HBR TWITTER: twitter.com/HarvardBiz Correspondence may be edited for space and style.

“managers”) running their own companies again, we aren’t going to see much growth in the United States. Kyle Lussier, founder and CEO, Tickle.me

Unless the monopoly that a few banks hold on the money supply and the economy goes away, we will not see change, and we will simply muddle along with dismal growth. If we are so concerned with the short term, related rates of returns, and bonus packages, capitalism has already been defeated. It is time for capitalism in the United States to grow up. Shahin Khourdepaz, CEO, Lusso

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A renewal of corporate economic culture might fail simply because energy is becoming scarce and expensive, and the population too big for sustainability. That will pressure corporations to drive for efficiency, because infinite growth is impossible with finite resources. Any new corporate model needs to take that into account. Phillip Percival, consultant/director, IC Science

UPCOMING PROGRAMS Most women have been taught to listen more and think before speaking, which places them at an immediate disadvantage. Elaine H. White, senior consultant, Darton Group

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The larger issue is workplace cultures that actively promote, condone, or conveniently overlook political maneuvering and “setting the stage” for one’s own agenda. Mary Beth West, principal, Mary Beth West Communications


HBR.ORG

Interaction The Price of Wall Street’s Power HBR article by Gautam Mukunda, June

21st-Century Talent Spotting HBR article by Claudio Fernández-Aráoz, June

The financial sector’s power has grown enormously in the past few decades, and legislation has failed to keep it in check. The “financialization” of the economy inhibits growth and shifts resources from wealth creation to wealth distribution. Balance needs to be restored. Limiting the size and leverage of banks and changing the tax code would be good places to start, Mukunda argues. Readers offered a few ideas of their own: The function of capital markets is to provide a channel for capital to flow from where it’s in surplus to where it’s needed. The financial sector has grown far beyond meeting that need. The overly loose monetary policies of the Fed since the bubble in the 2000s are partly responsible. The Fed has kept interest rates too low for far too long and has even pumped cash into the economy. The excess money sloshing around was a chief cause of the 2008 financial crisis; the liquidity overhang inspired financial players to take reckless risks. The solution is to raise interest rates from their near-zero levels. That would help correct the massive distortions in the economy and restore some semblance of sanity in the runaway jamboree that the world financial markets have become. Vivek Pai Kochikar, independent researcher and innovator-at-large

investors. Some new valuations and leaner capital distribution systems could not hurt. Zachary Lave Margulies, revenue assurance process analyst, Ecova

As business grows more volatile and complex, it ushers in a new era of talent spotting. It’s no longer enough for your employees and leaders to have the right skills. You need to hire people with the potential to learn new ones. Potential is harder to recognize than competence, says the author, so look for motivation, curiosity, and insight. Hiring for potential is the key for situations characterized by “VUCA” (volatility, uncertainty, complexity, ambiguity). The challenge is making managers capable of evaluating potential objectively and accurately. Rakesh K. Ranjan, HR business partner, Vodafone India

This article is too biased toward “Blame Wall Street.” How about remembering that Wall Street also helps start-ups and businesses? The “financial tail is wagging the economic dog” is rather old news. There are many parties, policy makers included, to blame. Ana Gonzalez Laucirica, MBA student, Simon Business School, University of Rochester

Why not take the idea of taxing financial transactions one step further and make it progressive? If the too-big-to-fail institutions, which get reduced interest rates because everyone expects the government to bail them out, had to pay a higher tax on their borrowing, it would level the playing field and reduce their appetite and ability to grow too large. David Rosenblatt, general manager, NurTech

Because of economic and financial instruments, the expectations and the psychology of investors have changed a lot. Using popular investment instruments, more and more people desire short-term returns. Thus, the balance between the longterm investors (value investors) and the short-term investors (technical investors) has been disrupted. Relying on technical investments will result in an unhealthy market that is unproductive and zero- or negative-sum, as the author discussed. Jeff Lee, student, Hebei Finance University

People buy into the idea of hiring for potential, but most are too risk-averse to hire someone without the desired skills and experience. Most employers don’t know what to measure and assess in lieu of those. You can measure curiosity by asking, “How do you react when someone challenges you?” But how do you objectively assess how good the answer is? Ji-A Min, research analyst, Ideal Candidate

It’s easy to pick on the financial sector. Finance has become a lightning rod for criticisms of what is wrong with business and the economy—used frequently with justifiable reasons but abused just as much. The financial sector needs to take more responsibility for its actions, but so do we as 20 Harvard Business Review September 2014

Banks need some healthy competition, and that will come with the increased use of cryptocurrencies such as Bitcoin. With Bitcoin there is no need for a middleman (banks), and people don’t need banks to store their money. Of course, banks will not cease to exist, but their power will be reduced. This will be revolutionary and will change how we relate to money. Tobias Nehm, IT and management consultant, Claremont

If you hire for potential, you need to create development opportunities to realize it. If you can’t invest the time to support someone, don’t hire him. Zakie Khoury Millar, business improvement consultant, Holcim Australia

I wonder about executives’ reliance on impressionistic judgments of potential— as in “I know it when I see it.” That leads to hires who may or may not have the capability to lead in the future. Jonathan Magid, vice president, strategy, The Hunter Group


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STRATEGIES 28 The human factors that can make or break M&A

DEFEND YOUR RESEARCH 30 Just thinking you slept poorly can hurt your performance

VISION STATEMENT 32 Railroads and the birth of the C-suite

COLUMN 36 Denise Morrison on cultivating the courage to change

New Thinking, Research in Progress hbr.org

STRATEGY

Sharing’s Not Just for Start-Ups ILLUSTRATION: MATT DORFMAN

What Marriott, GE, and other traditional companies are learning about the collaborative economy by Rachel Botsman

wo years ago Peggy Fang Roe noticed a frustrating phenomenon. The chief sales and marketing officer in Marriott’s Asia Pacific division, Fang Roe knows that hotel conference rooms are underutilized—yet she often saw people searching Marriott’s lobbies and restaurants for a quiet spot to work. “I thought it was crazy that our guests couldn’t get easy access to our vacant spaces,” she says. So at her initiative, in 2012 Marriott partnered with LiquidSpace, an online platform that lets people quickly book flexible workspaces by the hour or day, testing the idea in 40 hotels in Washington, DC, and San Francisco. “It wasn’t just hotel guests reserving spaces, but also locals—from lawyers to independent workers to consultants,” Fang Roe says. Currently 432 Marriott hotels have meeting spaces listed with LiquidSpace—and because many of the people reserving space aren’t guests, the arrangement helps Marriott reach new consumers. “The Workspace on Demand program is proof that Marriott is…willing to disrupt what hotels are about,” says Glen Harvell, who now leads the program.

September 2014 Harvard Business Review 23


IDEA WATCH

Marriott is just one example of an established company that’s starting to take a serious interest in the collaborative economy. Many observers associate the sector only with start-ups such as Airbnb (which lets people rent out unused rooms, apartments, or homes) and Uber (an ondemand car service). In fact the concept is being adopted by large companies and applied to intangible assets, not just cars and rooms. I define the collaborative economy as a system that activates the untapped value of all kinds of assets through models and marketplaces that enable greater efficiency and access. Increasingly, those assets include such things as skills, utilities, and time. The space includes peer-to-peer money services such as Lending Club (recently valued at $3.8 billion), massive open online course (MOOC) providers such as Coursera, and idiosyncratic concepts such as BorrowMyDoggy (through which pet owners make their pooches available for walks or playdates). Over the past four years I have studied more than 500 collaborative economy start-ups worldwide, and I have developed an innovation framework to help established companies identify collaborative opportunities. In my work I uncovered five types of vulnerability that open the door to disruption: redundancy, broken trust, limited access, waste, and complexity. For each I’ve identified an innovation principle—a key idea that companies can use to counter disruption and create value. These are directness, openness, empowerment, efficiency, and simplicity. Together these concepts allow companies to identify where they are most likely to be disrupted and also where they can disrupt themselves in order to enter or create a new market.

Collaborative economy models innovate around five key problems:

PROBLEM Redundancy SOLUTION The Food Assembly removes extra intermediaries in the supply chain by making direct online matches between local farmers and other food producers and consumers.

PROBLEM Broken trust SOLUTION Friendsurance addresses lack of trust in the insurance industry by enabling people to form peer-topeer networks to insure one another, which creates empowerment.

PROBLEM Limited access SOLUTION Coursera, a big player in massive open online courses (MOOCs), overcomes constraints on university education by offering internet-based classes free to anyone.

PROBLEM Waste SOLUTION Airbnb makes unused housing spaces available for rent, thus maximizing the spaces’ efficiency.

Gaining a Toehold Direct investments and acquisitions are two of the easiest ways for established companies to enter the collaborative economy. For instance, instead of trying to use its existing business to compete with car-sharing services, in 2013 Avis acquired Zipcar for $500 million. Google invested 24 Harvard Business Review September 2014

PROBLEM Complexity SOLUTION TransferWise eliminates the need for complicated currency transfers by making it inexpensive and simple for people to send money abroad.

$125 million in Lending Club, GE invested $30 million in Quirky (a marketplace for crowdsourcing invention ideas), GM invested $3 million in RelayRides (a peer-topeer car-sharing marketplace), and BMW i Ventures invested in ParkatmyHouse (which matches parking spot owners with people needing places to park) and ChargeatmyHouse (which matches electric vehicle drivers with homeowners willing to share their charging stations). Partnerships between established companies and start-ups in the collaborative space are also increasing. TaskRabbit, an online marketplace for outsourcing errands, has teamed up with brands including Pepsi, GE, and Walgreens. It offered delivery of Walgreens products during flu season: If you were home sick in bed, you could use the Walgreens button on TaskRabbit’s app or website to have medication brought to you by an errand runner. “These partnerships are great in terms of raising brand awareness and demonstrating a specific use case for the service,” says Jamie Viggiano, TaskRabbit’s head of marketing. A key challenge for established brands is to move beyond investments and shortterm marketing initiatives and fundamentally reevaluate their own business models. Some large companies have begun conducting ambitious experiments. For instance, the logistics and parcel delivery giant DHL has realized that in a number of emerging markets, it does not offer lastmile delivery—and frequently, no one else does either. People have to pick up their parcels at a designated spot, which makes for a frustrating customer experience. Thus DHL faces two of the five disruption drivers described earlier—limited access and complexity. So in September 2013 it launched MyWays, a mobile app connecting customers (both senders and recipients) with people willing to transport parcels on demand. It piloted the program in Sweden, charging delivery fees of 30 to 150 kronor, or about $4 to $20. Peter Hesslin, the CEO of DHL Freight in Sweden, says, “MyWays is not only a service for those requesting flexible deliveries; it is also for those who would


HBR.ORG

PEGGY FANG ROE is Marriott’s chief sales and marketing officer for Asia Pacific. She spoke with HBR about creating the company’s Workspace on Demand pilot. Edited excerpts:

Where did the idea come from? It was partly driven by research we did on Gen Y. They blend work and life differently. They’re mobile. They use coworking spaces in cities. We noticed that they were ordering room service in the lobby because they prefer to work outside their rooms. Our hotels have a lot of unused meeting spaces, but to reserve them you needed to talk with our sales staff, sign a contract, and agree to order food and beverages from our caterer. I tried to do it for a meeting with my team, and I thought, Why does this have to be so hard? We began looking for a simpler, on-demand solution. What was the goal? It wasn’t just revenue generation—it was also to find out whether there really is demand for this and whether we could execute it. In my view, it was also about changing consumer perceptions of our hotels and becoming more relevant to how people live and work today. We’ve renovated the interiors of many of our hotels—especially the lobbies—but you won’t know that unless you come inside. Some of our hotels offer free workspace just to get people in the door.

consider delivering a package to earn a little extra money.”

Assessing the Threat Certain sectors are particularly prone to disruption from the collaborative economy. Consider financial services, which is affected by all five of the disruption drivers. The banking industry is rife with middlemen and has too many retail branches— both examples of redundancy. Trust in the system is low. Many people have limited access to bank accounts, venture funding, and loans. Customers often have untapped value in assets with near-zero interest rates—a form of waste. And complex fees and processes are common. Crowdfunding platforms such as Kickstarter, social

lending systems such as Lending Club, and peer-to-peer currency transfer platforms such as TransferWise are shifting control toward a collaborative model, much as other platforms have already transformed how news and music are distributed. Why haven’t big brands been quicker to capitalize on the massive innovation opportunities in the collaborative economy? One reason is that many of the initial ideas have seemed fringe or even downright stupid. In 2008, when Airbnb launched, it presented itself as a marketplace for air beds on the floors of strangers’ living rooms. I remember speaking to audiences in those days about Airbnb; many people wanted to know “Who would do that?” But within months the company had moved up the

PHOTOGRAPHY: MEGAN NADOLSKI

accommodations continuum and had listings for spare rooms, holiday homes, and even castles and private islands. By 2013 it had amassed 650,000 rooms in 192 countries—more rooms than Hilton has built during its 93-year history. Last year more than 6 million guests stayed in Airbnb rentals, and the all-time total is now more than 15 million. Established companies must keep in mind the large ambitions of the start-ups in this space. If you visit Airbnb’s headquarters, in San Francisco, you will see two large storyboards that document the entire host and guest experience, frame by frame. Brian Chesky, the cofounder and CEO, commissioned a Pixar animator to create the display. The goal was to help his team feel empathy for the service’s users and to bring to life the role of Airbnb in people’s lives. The storyboards show that Airbnb doesn’t have to limit itself to booking rooms—it could eventually innovate around all parts of the travel experience, from payments to theater reservations to travel to and from airports. The firm isn’t a threat only to the hotel industry—it’s beginning to target the entire hospitality sector. How will on-demand access to cars, luxury goods, and office spaces change the way we think about owning things? What will peer-to-peer courier services mean for how we move local goods? How might on-demand ridesharing affect the way we perceive mobility? Could errand and skill marketplaces help define the future of labor? The real power of the collaborative economy is that it can serve as a zoom lens, offering a transformative perspective on the social, environmental, and economic value that can be created from any of a number of assets in ways and on a scale that did not exist before. In that transformation lie threats—and great opportunities. HBR Reprint F1409A Rachel Botsman is the founder of the Collaborative Lab and a coauthor of What’s Mine Is Yours: The Rise of Collaborative Consumption (Harper Business, 2010). She has invested in some of the start-ups mentioned here. September 2014 Harvard Business Review 25


51 IDEA WATCH

Stat Watch

of a set of mental arithmetic problems were correctly solved by university freshmen asked to visualize their remaining undergraduate years as locations along a path extending into the distance, whereas students asked to visualize those years as a series of containers solved just 39%, says a team led by Mark J. Landau, of the University of Kansas. The findings suggest that managers might use journey metaphors to encourage goal-directed action.

%

HBR.ORG DAILY STAT To receive HBR’s Daily Stat by e-mail, sign up at hbr.org/dailystat.

ORGANIZATIONS by Bryan L. Bonner and Alexander R. Bolinger

Bring Out the Best in Your Team then brought the results to the team; the rest compiled the information as a group. Other teams—our control condition—were given no guidance. The teams in the control condition tended to defer to whoever seemed the most confident, and they had the worst performance. The best performance came from teams that had inventoried their members’ knowledge as a group. Those teams were more likely than the others to use their knowledge to devise strategies for solving the problems, perhaps because the process of collectively assembling knowledge increased members’ understanding of the task and what it meant to be expert at it. The process may sound simple, but it represents a significant departure: On their own, teams rarely pause for this kind of reflection. Team leaders should take advantage of our finding and encourage the group to assess members’ knowledge and discuss its relevance to the task at hand. That will change the criterion for power on the team from social influence to informational influence and help members tune out irrelevant factors—not just confidence and extroversion but also status, experience, tenure, assertiveness, gender, and race. HBR Reprint F1409B

hen teams form to take on tasks, they are seldom able to tap the full knowledge of every member, in large part because the most confident, outgoing people get the most airtime, even if they’re not the most expert. Meanwhile, the real experts take a backseat and therefore have a limited impact. But we’ve found that this dynamic can be changed through a brief intervention: Early in a task, team members should be encouraged to discuss the relevant knowledge each brings to the table. In a series of lab experiments, groups that underwent this intervention outperformed other groups. We recruited university students, placed them on three-person teams, and gave them estimation problems such as “What is the elevation of Kings Peak, Utah?” (answer: 13,528 feet) and “How much did the Guinness record holder for the heaviest person of all time weigh?” (1,400 pounds). Teams discussed the problems until they reached a consensus. We instructed the members of some teams to begin by coming up with two bits of information apiece that they thought could be useful. (Examples: “I hiked Kings Peak last summer, so I know how high it is” and “Record-holding statistics are usually greater than you’d expect, so bump up the heaviest-personof-all-time estimate.”) On some of the teams, people did this individually and 26 Harvard Business Review September 2014

EARLY IN A TASK, TEAM MEMBERS SHOULD DISCUSS THE KNOWLEDGE EACH BRINGS TO THE TABLE. THAT CHANGES THE CRITERION FOR POWER FROM SOCIAL INFLUENCE TO INFORMATIONAL INFLUENCE.

Bryan L. Bonner is a professor at the University of Utah. Alexander R. Bolinger is an assistant professor at Idaho State University.


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IDEA WATCH

HBR.ORG

Research Watch Amateur auto racers are actually more rational about risk than most of us, according to a study by Mary Riddel, of the University of Nevada, Las Vegas, and Sonja Kolstoe, of the University of Oregon. Surveys show that they are less prone to the “possibility bias”—an exaggerated fear of low-probability negative events and an exaggerated expectation of low-probability positive ones. The possibility bias can lead to, among other things, poor financial decisions, such as overinsuring against unlikely losses and overinvesting in unlikely schemes.

SAFE AT ANY SPEED STRATEGIES by J. Keith Dunbar

The Leaders Who Make M&A Work

D

espite the popularity of growth strategies based on mergers and acquisitions, the challenges of execution are substantial—40% to 80% of mergers fail to meet objectives. To understand the high failure rate, prior researchers have examined financial characteristics, capability matches, and human factors such as culture. What was missing was substantive quantitative research on collective leadership capability as a driver of M&A success. To fill that gap, I conducted a five-year study that aggregated individual leadership assessment data (obtained from Korn Ferry 360-degree evaluations) from acquiring and targeted companies in order to create a picture of collective leadership capability. My investigation encompassed

94 mergers that took place from 2004 to 2008 and sought to answer two questions: What leadership areas and competencies in acquiring and targeted companies affect the financial performance of a merger? and What is the relative importance of senior executive versus middle manager collective leadership capability in M&As? To measure financial performance, I compared total shareholder returns for each company with a large-cap index for the country where it is headquartered and with an industry index for the sector in which it operates. The study revealed three major findings. First, leadership capabilities in acquiring companies (specifically, skill in the broad areas of thought leadership, results leadership, and people leadership) predict

BUILD RELATIONSHIPS DEVELOP OTHERS ACT WITH INTEGRITY SHOW ADAPTABILITY FOCUS ON CUSTOMER NEEDS

BUILD RELATIONSHIPS PROVIDE DIRECTION

A study of 94 mergers, using 360-degree evaluations of managers, identified these skills as the most crucial in acquiring and targeted companies:

J. Keith Dunbar is the president of Potentious, a Washington, DC–based consulting firm.

28 Harvard Business Review September 2014

PHOTOGRAPHY: JACOM STEPHENS/GETTY IMAGES

Leadership Competencies That Predict M&A Success

ACQUIRERS MOTIVATE OTHERS INFLUENCE OTHERS

TARGETS MOTIVATE OTHERS INFLUENCE OTHERS

M&A success, but leadership capabilities in targeted companies are equally important. Second, seven leadership competencies for acquirers and four for target companies predict success. Third, senior leadership capabilities in acquiring companies and middle management leadership in targeted companies have the greatest effect on success. In a second part of the study, I examined the financial returns of M&A deals that had both positive and negative performance and evaluated how the seven leadership competencies affected those returns. Among positively performing deals, companies with all seven capabilities outperformed their country index by 8.4% and their industry index by 10.4%. Among negatively performing deals, companies without some of the seven capabilities suffered significantly more than other firms. These results suggest that assessing the collective leadership capabilities of acquiring and target companies should be part of the due diligence that precedes an M&A offer and supports integration planning. It also suggests that middle managers at targeted companies are crucial to success, and efforts to retain them (through contracts typically given to higher-level leaders) could be beneficial. HBR Reprint F1409C


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IDEA WATCH

Defend Your Research HBR puts some surprising findings to the test

Kristi Erdal is a professor of psychology at Colorado College.

Just Thinking You Slept Poorly Can Hurt Your Performance The study: Colorado College professor Kristi Erdal and psychology student Christina Draganich tricked subjects into believing that the quality of their previous night’s sleep could be determined by measuring their brain waves. Those randomly selected to be told that they’d had a below-average percentage of REM sleep significantly underperformed on an auditory math test, regardless of how they had actually slept—mirroring the effects of real sleep deprivation. The challenge: Do our perceptions about sleep matter just as much as the sleep we get? Professor Erdal, defend your research. Erdal: Most of us know that lack of sleep causes a number of problems: Your concentration flags, your reaction time slows, you remember less, your reasoning skills are impaired. What our research shows is that if you’ve had average or high-quality sleep but are led to believe it was poor, you might see the same negative effects. Experiments using fake alcohol have generated similar results: When people think they’re drinking something potent, they’ll start to behave as if they were drunk. HBR: What about the reverse? Would thinking I’ve had a good night’s sleep help me outperform? Studies on real sleep have shown that people who get a good night’s rest perform on par with adult norms, not above them. And in our first experiment the participants who were told they’d had high-quality REM sleep before doing the math exercises performed within normal limits. But we had an interesting finding in our second 30 Harvard Business Review September 2014

calories rather than a sensible 140 calories. (The actual calorie count was 380.) We’re not talking about conscious changes in behavior here; I mean, most people don’t even know they have gut peptides. These are unconscious changes prompted by nontraditional placebos. We’ve extended the idea into the area of sleep.

What are some other examples of nontraditional placebos? Superstitions. People make an illusory correlation between two things, in essence creating their own placebo. And often—especially with pre-game, pre-swing, or pre-shot routines but also with more-random superstitions like a lucky ball or cap—it can boost performance.

experiment, which included other types of exercises: Participants led to believe they’d had high-quality sleep significantly outscored both control groups and adult norms on a verbal fluency test. This might be a blip—it will need replication—but it could be a sign that positive perceptions about sleep can lead to better performance in some areas.

So how do I convince myself that I’m wellrested? Or get my rivals to think they’ve been tossing and turning all night? An authority figure helps. A full 88% of our participants said they completely believed the story we told them about the new sleep-quality measurement technique, and even those who were initially skeptical told us they ultimately didn’t doubt the information we gave them. In fact, it trumped their preexisting opinions on how they’d slept the previous night, which we’d asked them for before we gave them the phony assessment results. We found no correlation between self-reported sleep quality and performance. So we know a sleep placebo can work when it’s delivered by a knowledgeable source using fancy equipment in a lab setting.

You’re describing it as a placebo effect. Yes, in medicine, a placebo is a nonactive drug that achieves the same effect as an active one. Many recent studies have shown that psychological placebos—getting people to shift their mind-set—can affect physiology in the same way. There’s one, for example, that showed that hotel maids lost more weight after learning their duties were equivalent to various exercises. Another found that milkshake drinkers produced more of the gut peptides that regulate appetite when told they were consuming an indulgent 620


HBR.ORG

People told they’d had below-average amounts of REM sleep did worse than the adult norm on a math test, regardless of how much REM sleep they’d really gotten.

ADULT-NORM SCORE

36

TO ORDER, VI HBR.ORG

SIT

MEAN SCORE OF PEOPLE TOLD THEY HADN’T SLEPT WELL

22 because she noticed how obsessed her peers were with sleep. College students constantly talk about how much, or little, they get, and it’s almost a badge of honor to stay up all night to study for a test or finish a paper. And yet Christina comes from a family that stresses the importance of getting nine hours a night. Now she’s working in a hospital pulling shifts.

Take the Plunge It takes courage to be a leader. If you’re ready to set yourself apart from ordinary managers and team players, read this issue of Harvard Business Review OnPoint. ARTICLES INCLUDE:

If your husband rolls over to you in bed in the morning and tells you that you slept like a log, it’s unlikely to have the same effect.

Becoming the Boss by Linda A. Hill

But a sleep-tracking app might. Should I tell my cubemate to stop using his if it’s telling him he’s not getting enough rest? I don’t know what those apps measure or how accurate they are, so I can’t speak to their validity. But I would imagine that the people buying them already have some negative feelings about their sleep, and if you’re sleeping poorly, you don’t want to remind yourself of that fact. At the same time, some research on insomniacs suggests that they’re actually poor reporters of their own sleep—they get more quality rest than they think they do. So if the app is correcting that negative bias, it might be a good thing.

How Managers Become Leaders by Michael D. Watkins

What Leaders Really Do (HBR Classic) by John P. Kotter

Strategic Leadership: The Essential Skills by Paul J.H. Schoemaker, Steve Krupp, and Samantha Howland PLUS:

What advice do you have for organizations like hospitals, law firms, investment banks, or high-tech start-ups, which seem to expect their junior employees to pull all-nighters or sleep at the office? Anyone who needs to listen to new information, be attentive to detail, think on their feet, and give clear directions needs adequate rest. And our study is evidence that perceptions matter too. Even if your people are going into deep REM sleep on a cot or a couch, the simple fact that they got less than eight hours total or weren’t in their own beds might cause them to think they’re fatigued and underperform accordingly. None of these companies have called me to ask, but if they did, I would tell them that sleep deprivation— real or perceived—is a bad idea. HBR Reprint F1409D Interview by Alison Beard

How to Manage Your Former Peers by Amy Gallo

Why Bossy Is Better for Rookie Managers by Stephen J. Sauer and more…

Or maybe developers should just program the apps to tell everyone they’re in REM all night? The world might be a better place, but obviously the apps have to do what they say they’ll do.

FALL ISSUE

NOW Harvard Business Review OnPoint (available quarterly on newsstands and at hbr.org) focuses on a single theme each issue. It includes expertauthored articles from HBR’s rich archives, helpful article summaries, and suggestions for further reading.

ON NEWSSTANDS

Are you a good sleeper? Yes, I have a gift. It was actually my student and research partner Christina who chose these experiments for her undergraduate thesis


IDEA WATCH

Vision Statement The Chart That Organized the 20th Century BY THE EARLY 1900S, THE UNION PACIFIC AND

For more on railroads and the history of business, go to library.hbs.edu/hc/railroads.

Southern Pacific rail systems employed a total of 80,000 workers and managed more than 55,000 miles of rail and steamer lines across North America. Comprising numerous smaller railroads, the organization was one of the largest and most complex of its time. As it grew and consolidated, its leaders had to figure out how to coordinate the enterprise’s many functions—from surveying and engineering to scheduling, finance, distribution, and accounting—on an unprecedented scale. The answer, in part, lay in this org chart of the company’s operations—an early example of the venerable management tool. Published in Railroad Administration in 1910, the chart visualized the pathways by which the president collected reports and recommendations from each branch, making strategic decisions atop the chain while each railroad was run independently. As Julius Kruttschnitt, the company’s director of maintenance and operation, said in 1909, “The theory of the organization is that different properties must be brought into close relationship with each other, yet preserve a full measure of autonomy.” Invented by the Pennsylvania Railroad in the 1870s, the decentralized organizational structure—with independent divisions that reported up to general managers—became the standard for railroad management and eventually for the management of business in general. As “the biggest and richest organizations in the country, and then the world,” observed sociologist Charles Perrow, railroads “set organizational forms that would dominate all of industry for the next century.” Here we present insights from Railroad Administration, written by Ray Morris, editor of the Railway Age Gazette, on how key positions within the decentralized organization HBR Reprint F1409Z functioned. IMAGE COURTESY OF BAKER LIBRARY HISTORICAL COLLECTIONS

32 Harvard Business Review September 2014


HBR.ORG

EIGHT RAILWAY SYSTEMS, ONE ORGANIZATION

This org chart lays out the structure that enabled the eight railways to operate independently within a single company. Each was headed by a VP and general manager, who in turn reported up to an early version of the C-suite. Spanning the divisions were functional leaders in charge of operations; engineering; traffic; and legal, financial, and executive tasks. “It takes four kinds of officers to run a railroad,” Morris observed, “and their duties are, in the main, entirely unlike.”

A STRONG LEADER AT THE TOP

From 1901 to 1909, E.H. Harriman presided over the massive organization. He personally scrutinized nearly every plan and recommendation, often approving “perhaps a million dollars’ worth of work in a half hour.” Morris noted that Harriman’s style produced delays—“sometimes vexatious ones”—and required the carrying of huge batches of paperwork up and down stairs.

RAY MORRIS. RAILROAD ADMINISTRATION. NEW YORK AND APPLETON, 1920. BAKER OLD CLASS COLLECTION, BAKER LIBRARY HISTORICAL COLLECTIONS, HARVARD BUSINESS SCHOOL

PRESERVING LOCAL AUTONOMY

Each vice president headed up “what is in effect a complete railroad.” The VP of the Union Pacific, for example, supervised over 4,000 miles of line, a role that was “in no important respect different from what it would be if the Union Pacific were operated as an independent railroad.”

SPREADING BEST PRACTICES

SUM GREATER THAN THE PARTS

Subdividing under one position was essential, wrote Morris. The director of maintenance and operation “should be relieved of detail; otherwise their time would be frittered away on the affairs of one road...and the property as a whole would not be managed at all.”

Individual efforts can take a company only so far. “It is possible for a strong and gifted leader, by pure force of personality,…to bring about a fair result,” Morris pointed out. That’s why “a test of a good organization is whether the efficiency is appreciably affected by the absence of any one man.”

September 2014 Harvard Business Review 33


IDEA WATCH

HBR.ORG

Strategic Humor

CAPTION CONTEST Now that you’ve come in to some money, perhaps you’d like to take a look at a few of our investment services.

“Apparently ‘adventure capitalists’ wasn’t a typo.” This month’s winning caption was submitted by Andrew Card of Medford, Oregon. 34 Harvard Business Review September 2014

CARTOONS: HARLEY SCHWADRON, SUSAN CAMILLERI KONAR, PAULA PRATT


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COLUMN

HBR.ORG Denise M. Morrison is the president and CEO of Campbell Soup Company.

Morrison The Main Ingredient of Change hen I became Campbell’s CEO, in 2011, our soup sales in the U.S. were down and our innovation pipeline was virtually dry. More concerning, our people seemed content to rest on our past success. How could we get a 145-year-old company to embrace change? We started by pointing to the seismic shifts going on around us. We thoroughly assessed the new consumer demographics and behaviors, global economic realignment, and digital revolution profoundly changing the food industry. We studied the evolution of packaged fresh foods in response to health and wellness trends and the expansion of e-commerce and other channels beyond grocery. We stressed that we needed to build on our past to create the future but that we now had a dual mandate: to strengthen our core business with existing consumers while also expanding into faster-growing spaces to attract new consumers. Then we surveyed our top 300 leaders to discover what might keep us from delivering on that strategy. Two key ingredients, they told us, were missing at Campbell. The first was effective decision making— many felt there was too much emphasis on reaching consensus. (We have since updated our Leadership Model, replacing “Drive organizational consensus” with “Drive decision making.”) The second was the harder problem: We lacked courage. So we set out to remake our “play it safe” culture and empower our people to think bigger and act more boldly. We made “courage” one of our core values and built a new performance management system that encourages employees to take responsible risks and set ambitious goals. People now own the outcomes they deliver, and we reward those whose contributions have an exceptional impact. Cultural values have to be modeled at the top to take hold, so we revamped our leadership team with courage in mind. Virtually everyone on the team is either 36 Harvard Business Review September 2014

We set out to remake our “play it safe” culture and empower our people to think bigger and act more boldly.

new to his or her role or new to Campbell since I became CEO. Of course, I had to resolve to personally model the courage we wanted to see in the organization. I got that chance when we had the opportunity to acquire Bolthouse Farms, a leader in fresh beverages and juices, salad dressings, and fresh carrots. At $1.5 billion, the acquisition was the largest in our history. Naturally there was some skepticism. (“Fresh carrots, Denise? Really?”) Sticking to my convictions about packaged fresh foods (already a $12 billion category) allowed us to make that consumer-driven, on-trend acquisition, and another: Plum Organics, in the fast-growing organic baby food segment. We also acquired Kelsen Group to expand our snacks business globally, starting with China and Hong Kong. You have to live your company’s values as a leader and applaud others when they follow suit. I knew that courage was taking hold at Campbell when, last October, I watched our international leaders forge ahead on a decision that, in the past, we would have debated endlessly. Making the decision to divest our European simple meals business to CVC Capital Partners wasn’t easy. Europe had become an important market for us, and the business, with national brands in Belgium, France, Germany, and Sweden, brought in annual sales of more than $500 million. But our leaders boldly chose to focus our resources on building our global brands, especially in developing markets in Asia and Latin America. Certainly, we are still on our journey, but we are less afraid to fail. With newfound courage, we’re reshaping Campbell’s business and culture for future growth. HBR Reprint F1409E

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COLUMN

HBR.ORG George Halvorson retired as CEO of Kaiser Permanente in 2013. He is the founder of the Institute for InterGroup Understanding.

Halvorson

Getting to “Us”

H

umans are social creatures; we fall readily into group loyalties. We instinctively divide the world into “us” and “them” and treat others very differently according to which category they’re in. Activating us-versus-them energy is the oldest leadership tool in the box. In business settings, the effects can be wonderful. But they can also be terrible, giving rise to warring factions internally and cutting off collaborative possibilities externally. It’s surprising how many business managers are not very thoughtful about wielding this tool. In the 1970s the social psychologist Henri Tajfel gave us the concept of social identity—the understanding that an indi- everyone’s a radiolovidual’s identity is powerfully shaped by gist. Doing similar group allegiances. In experiments he de- work under the same conditions is signed, subjects required only the slightest rationale to identify with a camp strongly enough to make an enough to behave generously to its mem- us. But it doesn’t provide much impetus bers (and punitively to outsiders). In one for the group to align study, for example, boys who were divided its energies and take into two groups after stating their offhand preference between two paintings (one by bold action. Klee and the other by Kandinsky) exhibited If you want a group to move forward just such in-group favoritism and discrimi- or to prevail in competition, you’re better off communicating a compelling mission. nation against others. Researchers since have shown that when people in a work “Our job is to make sure those buildings are setting have a strong sense of being an us, as clean as we would want them for our own family” is the kind of shared goal that morale and productivity rise. Across a long career managing intel- can tie people together. “Our mission is to provide the best health care in this state” ligent and dedicated professionals, I’ve gives people a context for their interactions observed that phenomenon numerous and empowers them to work collaboratimes. But of course it isn’t enough to simply declare to a collection of individu- tively and imaginatively. Just be sure that als that they are a team. If leaders want to see those instinctive energies kick in, they must give people a sense of why they exist as a group. So it’s instructive to consider the reasons that groups develop a sense of us on their own: kinship, mission, or a common enemy. Many workplaces default to a version of kinship based on function. A group’s shared identity reflects a common characteristic of its members—everyone’s an engineer, or

The effects of activating us-versus-them energy can be wonderful— and terrible.

the mission is persuasive and valuable enough to inspire team members to support one another’s efforts. Identifying a common enemy is the most potent means to get a group to snap together. But be careful with this one. When there is a clear loser in some setting, there is inherent instability; the loser often works doubly hard to reverse the situation and even to exact revenge. The energy of both sides can quickly turn purely destructive. The best of all worlds is when you can achieve a glorious sense of us without stoking animosity toward them. It’s tricky to accomplish, and as those fans of Klee or Kandinsky might have told you, it doesn’t happen naturally. That’s why as leaders we need to keep reaching for new tools. I am convinced that great leadership in the 21st century is a matter of endowing groups of individuals with a satisfying sense of us and channeling their collective energy productively toward noble ends. Will everyone agree? Maybe not, but for some it will make all the difference. More power to us. HBR Reprint F1409F

38 Harvard Business Review September 2014

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How I Did It…

The CEO of Williams-Sonoma on Blending Instinct with Analysis

by Laura Alber

THE IDEA PHOTOGRAPHY: STEPHANIE DIANI

Thanks to its catalog heritage, the retailer was well positioned to collect and use data from customers and other sources. Now it has reorganized to take its analytics to a whole new level.

s I walk each day into the Williams-Sonoma headquarters on San Francisco’s waterfront, I’m struck by the varied types of creativity on display. In one area designers are developing textiles, painting furniture, or spinning pottery. In another, brand and merchandise specialists are reviewing photography and revising catalog and website layouts according to projected sales. And in another, data analysts are at their computers, crunching numbers, building models, and analyzing reports. If Williams-Sonoma has a “secret sauce,” it is these teams working together in remarkable alignment to develop and execute our strategic and tactical priorities. In my 19 years at the company and four years as CEO, I’ve found that the very best solutions arise from a willingness to blend art with science, ideas with data, and instinct with analysis. September 2014 Harvard Business Review 41


HOW I DID IT

The recent launch of Mark and Graham, our monogrammed gifts and accessories brand, is a perfect case study in how we apply this kind of thinking to build successful new business concepts. Since we introduced the Pottery Barn Kids brand, in 1999, personalization has been a key component of our business, and by 2010 we could see that it presented a clear opportunity to develop a stand-alone brand. We set up the Mark and Graham website, printed the catalog, and marketed to customers in our database who had previously bought personalized items from us. We also placed ads targeting online shoppers who browsed that category. Mark and Graham is now a scalable brand. The process is the same for nearly every decision we make, from brand introductions to ad buys, website and catalog design, and, increasingly, supplier relationships. We start with a creative idea, test it, prove that it works, and then roll it out. This discipline has allowed us to build WilliamsSonoma into America’s preeminent home retailer, with seven brands and annual revenue approaching $5 billion. We account for 4% of all home furnishings sales in the United States, almost half of which come through the web, making us the 21st largest online retailer in the country.

Inspiration and Expansion Williams-Sonoma started with a brilliant idea. In 1956 the company founder, Chuck Williams, decided that America’s home chefs, himself included, should have access to the high-quality French cookware he had discovered on a recent trip to Paris. He set up shop in Sonoma, California, with a woodcut of a pineapple (symbolizing hospitality) as his logo, and began to welcome customers. So many of them came from San Francisco that he soon decided to move his operations there. In the early 1970s he launched a catalog to serve customers from around the country. That was when the company first began to capture and use data: By observing where our catalog customers lived, we could make better decisions about where to locate our retail 42 Harvard Business Review September 2014

stores. It was an effective strategy that we—and our competitors—still use today. And I am delighted to report that at age 98, Chuck Williams still keeps office hours at our headquarters. As the company grew its brick-andmortar presence, it also built up its mailorder business, first acquiring an existing garden products catalog and then launching the Hold Everything catalog (a brand we later folded into the rest of our portfolio). The company went public in 1983 to finance further expansion, and in 1986 it bought Pottery Barn, a group of home goods stores located predominantly in Manhattan. We kept the name but immediately started changing the merchandise. The following year Pottery Barn’s first catalog was mailed across the United States. I joined Williams-Sonoma as a Pottery Barn senior buyer in 1995, at a time when the company was just developing its “lifestyle” identity, selling its first sofas through a catalog and introducing new product categories. We projected this identity by pioneering the use of photography that featured products in home settings, not just the products alone, and redesigning our stores to inspire our customers in the same way. Our foray into e-commerce began in earnest in 2000, with both the WilliamsSonoma and Pottery Barn brands launching fully transactional websites that year. Hard as it is to imagine now, e-tailing, especially in the furniture category, didn’t feel like a sure thing at the time. We wanted to be certain we could provide the same kind of shopping experience online that we did in our stores and catalogs—offering tips, gift ideas, customer service, and quick and convenient purchasing. So we took small steps, launching an online version of the Williams-Sonoma bridal registry in 1998 and then potterybarn.com, featuring virtual home tours, in 2000. As we began our web data collection efforts, we continued to use purchase information from the catalogs and stores to guide our business decisions. For example, when a catalog-only Williams-Sonoma product immediately

sold out, we not only reordered it from our supplier but put a bigger picture of it in the next mailing and started stocking it in our stores. When we noticed that bed and bath items were some of Pottery Barn’s best sellers, we created a separate catalog for those two categories. Pottery Barn Kids is another case in point. In 1998 I was pregnant with my first daughter and couldn’t find quality furniture and accessories for her nursery. I knew lots of other soon-to-be or new moms (including many colleagues) whose experience was similar, and I saw a business opportunity. But even then instinct wasn’t enough. We decided to test the idea by creating a collection and marketing it in a small, targeted catalog mailing. In some cases we simply scaled down popular adult products, such as our sleigh beds; in others—toys, for instance—we asked our designers to think back to their own childhoods and get creative. Sales were so strong that we didn’t have sufficient inventory to do the second mailing we’d planned. But we had proved that the Pottery Barn Kids concept would work. The next question was whether to open stores. The pitch my team and I made to our then CEO, Howard Lester, and other top leaders again involved both creativity (we set up a mock store in our parking garage) and data (we mapped out the neighborhoods where people had made the most Pottery Barn Kids catalog purchases and found the best-performing shopping centers or streets in each). As a result, the company opened eight stores in 2000 and added many more, plus a website, the next year. PBteen soon followed, and our West Elm and Williams-Sonoma Home brands were born in the same way in 2003 and 2004.

Capitalizing on Data In the years since, Williams-Sonoma has taken its use of data to an entirely new level—one that I know is unique in the retail sector. Today analytics infuses— and enhances—all areas of our business, in decisions both big and small. To cite


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Personalized Shopping When customers come to the website of any Williams-Sonoma brand, they are greeted with pages tailored to their preferences, as indicated by past purchases or browsing history. BANNERS try to entice

customers with deals based on their previous buying behavior. Does she shop sales? Does he wait for free shipping?

PHOTOS of products in room settings were an early differentiator. Brands also use plain product shots and track which approach leads to more sales.

EXTERNAL WEBSITES such as

Pinterest can be an important driver of traffic. Data analysis shows that people clicking through from elsewhere are more likely to buy if they’re presented with multiple products, not just one.

RECOMMENDATIONS are

increasingly algorithm-driven. Someone browsing sofa pillows might also need a new cocktail table. A buyer of bedding for a girl’s room might want to check out girls’ backpacks.

examples in marketing, each brand’s website is designed to have personalized content based on what we know about the customer visiting it: If the previous purchases of registered users or the browsing history of nonregistered users suggests that they’re interested in sales, we’ll make sure current promotions and discounts are featured at the top of the home page. If you always buy boys’ items from PBteen, we’ll send you a catalog with a boy’s bedroom featured on the cover. If we know that you just bought a custom upholstered sofa from Pottery Barn, we’ll send you care tips. If we see that you’ve been looking at

West Elm beds online, you might find a reminder ad on other websites you visit in the future. Our overarching goal is always to enhance the customer experience. Relevance is our guiding principle. We’re beginning to use data in our supply chain in much the same way, tracking not only key service metrics but also design and production processes to ensure that best practices are spread throughout the company. Everyone at Williams-Sonoma now recognizes that our business is both an art (creating products that people will love) and a science (presenting those products to our

customers when they want or need them). Creative curation is what distinguishes us from generalist e-tailers; data analytics is what puts us ahead of other home furnishings retailers. To get to this point, however, we had to refine our thinking in a few key areas: structure, people, tools, and culture.

Organizing for Analytics Our strategy is simple: We help customers create the homes of their dreams by providing them with a best-in-class, multichannel retail experience. But in the early 2000s our organizational structure was preventing us from achieving the second half of that goal. September 2014 Harvard Business Review 43


HOW I DID IT

HBR.ORG

Our businesses were still divided into stores, catalogs, and websites, which meant that people from the same brands were competing with one another for sales. So we restructured, assigning a single president for each brand and all its channels. Since becoming CEO, I’ve worked to bring our information technology and e-commerce teams closer to the brands. We’ve centralized and integrated our marketing, analytics, and IT functions so that we can more easily share and execute on ideas and information that benefit the entire group. We also created two new senior vice president roles: One SVP heads a combined e-commerce engineering and marketing group, reporting to both our CIO and our CMO, and the other oversees multichannel direct marketing across our brand portfolio. Of course, the right organizational structure is nothing without the people supporting it, and Williams-Sonoma is intent on hiring, retaining, and developing the best designers, merchants, marketers, technologists, and data scientists we can. I am proud of the fact that the average tenure of our top 14 executives is almost 14 years. We’ve also worked to attract exceptional advisers. A few years ago we recruited the head of global marketing at Google to join our board, and she’s been instrumental in helping us set and achieve increasingly ambitious goals. Our San Francisco location, close to Silicon Valley, gives us access not only to an extraordinary amount of talent but also to terrific industry knowledge. For example, we were early partners of Pinterest, and we frequently work with tech companies on beta tests. To put data to work, you also need tools, and we’ve made those investments. Our databases document transactions made by our customers across our brands and channels. This information spans 30 years, and more comes in every day to give us insights and create a more relevant, personalized experience for the 57 million people who have bought our products. It informs every customer-facing aspect of the business, from targeted catalogs, ads, and e-mails to the extremely high-touch service that our 44 Harvard Business Review September 2014

Williams-Sonoma Facts & Financials Founded 1956 Headquarters San Francisco Store count 585 Full-time employees 20,300 REVENUE (IN US$B) OPERATING INCOME 4.0 3.7 3.5 3.1 .12 .32 .38 .41 .45

4.4

a world-class merchant team that understands our products and the related items our customers might want to consider. Although I was sure that expertise would always be more effective than a machine in driving cross-selling opportunities, Pottery Barn Kids had had some success with marketing that used predictive analytics, so I agreed to test it in other areas. As it turned out, the brand’s product assortment had grown so rapidly that our merchants had trouble keeping up with shopping recommendations. Algorithms can more easily scale and better use large amounts of customer data. They also perform much better, not only driving incremental revenue, but giving our merchants time to focus on other critical activities that differentiate our user experience.

We Are All Owners 2009 2010 2011 2012 2013

SOURCE WILLIAMS-SONOMA

retail sales associates and customer care centers provide. We have product tracking systems that show the status of every item in our pipeline—what’s on back order, in direct ship, being returned—and allow us to build detailed vendor scorecards, so we can celebrate and spread exceptional performance while also identifying weak spots. None of this would be possible if our whole team didn’t embrace an open, collaborative, cross-disciplinary, “create, test, prove, roll” culture. So I try to emphasize those values every day—with my words and my actions. I encourage colleagues at every level to challenge the status quo and offer their opinions. One of our marketing executives likes to tell a story about my initial reluctance to replace merchant-driven product recommendations on our e-commerce websites with algorithmically driven ones. We have

As our organization has embraced analytics, we’ve found that major decisions have become less stressful. A good example is the launch of West Elm. Initially, some were concerned that it might cannibalize our existing brands: Would mailing the West Elm catalog to previous Pottery Barn customers hurt Pottery Barn sales? We quickly found, from analyzing the data, that people who received both catalogs actually bought more from both brands than those who received only one brand’s catalog. That allowed us to expand West Elm mailings quickly, knowing that the new brand’s offerings were meeting different customer needs. The blending of art and science has also brought us together as an organization. We like to say that “we are all owners.” And we are. Every team member—regardless of level, function, brand, or channel—works for the good of the entire enterprise. We’re a creative group that uses data to make smarter decisions, to strengthen our relationships with customers and suppliers, and to grow our business in the United States and around the world. HBR Reprint R1409A Laura Alber is the CEO of Williams-Sonoma.


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The Big Idea


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PHOTOGRAPHY: ELISE

STOCK BUYBACKS Five years after the official end of the Great Recession, corporate profits are high, and the stock market is MANIPULATE THE booming. Yet most Americans are not sharing in the MARKET AND LEAVE recovery. While the top 0.1% of income recipients— MOST AMERICANS which include most of the highest-ranking corporate executives—reap almost all the income gains, good WORSE OFF. BY WILLIAM LAZONICK

jobs keep disappearing, and new employment opportunities tend to be insecure and underpaid.

September 2014 Harvard Business Review 47


THE BIG IDEA PROFITS WITHOUT PROSPERITY

Corporate profitability is not translating into widespread economic prosperity. The allocation of corporate profits to stock buybacks deserves much of the blame. Consider the 449 companies in the S&P 500 index that were publicly listed from 2003 through 2012. During that period those companies used 54% of their earnings—a total of $2.4 trillion—to buy back their own stock, almost all through purchases on the open market. Dividends absorbed an additional 37% of their earnings. That left very little for investments in productive capabilities or higher incomes for employees. The buyback wave has gotten so big, in fact, that even shareholders—the presumed beneficiaries of all this corporate largesse—are getting worried. “It concerns us that, in the wake of the financial crisis, many companies have shied away from investing in the future growth of their companies,” Laurence Fink, the chairman and CEO of BlackRock, the world’s largest asset manager, wrote in an open letter to corporate America in March. “Too many companies have cut capital expenditure and even increased debt to boost dividends and increase share buybacks.” Why are such massive resources being devoted to stock repurchases? Corporate executives give several

reasons, which I will discuss later. But none of them has close to the explanatory power of this simple truth: Stock-based instruments make up the majority of their pay, and in the short term buybacks drive up stock prices. In 2012 the 500 highest-paid executives named in proxy statements of U.S. public companies received, on average, $30.3 million each; 42% of their compensation came from stock options and 41% from stock awards. By increasing the demand for a company’s shares, open-market buybacks automatically lift its stock price, even if only temporarily, and can enable the company to hit quarterly earnings per share (EPS) targets. As a result, the very people we rely on to make investments in the productive capabilities that will increase our shared prosperity are instead devoting most of their companies’ profits to uses that will increase their own prosperity—with unsurprising results. Even when adjusted for inflation, the compensation of top U.S. executives has doubled or tripled since the first half of the 1990s, when it was already widely viewed as excessive. Meanwhile, overall U.S. economic performance has faltered. If the U.S. is to achieve growth that distributes income equitably and provides stable employment,

WHEN PRODUCTIVITY AND WAGES PARTED WAYS From 1948 to the mid-1970s, increases in productivity and wages went hand in hand. Then a gap opened between the two. 150%

CUMULATIVE ANNUAL CHANGE IN REAL PER HOUR WAGES

CUMULATIVE ANNUAL CHANGE IN PER HOUR PRODUCTIVITY

120%

90%

60%

30%

0 48 50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 SOURCE ECONDATAUS.COM/WAGEGAP12.HTML

48 Harvard Business Review September 2014


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Idea in Brief THE PROBLEM Corporate profitability is not translating into economic prosperity in the United States. Instead of investing profits in innovation and productive capabilities, U.S. executives are spending them on gigantic stock repurchases. THE RESEARCH These buybacks may increase stock prices in the short term, but in the long term they undermine income equality, job stability, and growth. The buybacks mostly serve the interests of executives, much of whose compensation is in the form of stock. THE SOLUTION Corporations should be banned from repurchasing their shares on the open market. Executives’ excessive stock-based pay should be reined in. Workers and taxpayers should be represented on corporate boards. And Congress should reform the tax system so that it rewards value creation, not value extraction.

government and business leaders must take steps to bring both stock buybacks and executive pay under control. The nation’s economic health depends on it.

FROM VALUE CREATION TO VALUE EXTRACTION For three decades I’ve been studying how the resource allocation decisions of major U.S. corporations influence the relationship between value creation and value extraction, and how that relationship affects the U.S. economy. From the end of World War II until the late 1970s, a retain-and-reinvest approach to resource allocation prevailed at major U.S. corporations. They retained earnings and reinvested them in increasing their capabilities, first and foremost in the employees who helped make firms more competitive. They provided workers with higher incomes and greater job security, thus contributing to equitable, stable economic growth—what I call “sustainable prosperity.” This pattern began to break down in the late 1970s, giving way to a downsize-and-distribute regime of reducing costs and then distributing the freed-up cash to financial interests, particularly shareholders. By favoring value extraction over value creation, this approach has contributed to employment instability and income inequality. As documented by the economists Thomas Piketty and Emmanuel Saez, the richest 0.1% of U.S. households collected a record 12.3% of all U.S. income in 2007, surpassing their 11.5% share in 1928, on the eve of the Great Depression. In the financial crisis of 2008–2009, their share fell sharply, but it has since rebounded, hitting 11.3% in 2012. Since the late 1980s, the largest component of the income of the top 0.1% has been compensation, driven by stock-based pay. Meanwhile, the growth of workers’ wages has been slow and sporadic, except during the internet boom of 1998–2000, the

only time in the past 46 years when real wages rose by 2% or more for three years running. Since the late 1970s, average growth in real wages has increasingly lagged productivity growth. (See the exhibit “When Productivity and Wages Parted Ways.”) Not coincidentally, U.S. employment relations have undergone a transformation in the past three decades. Mass plant closings eliminated millions of unionized blue-collar jobs. The norm of a white-collar worker’s spending his or her entire career with one company disappeared. And the seismic shift toward offshoring left all members of the U.S. labor force— even those with advanced education and substantial work experience—vulnerable to displacement. To some extent these structural changes could be justified initially as necessary responses to changes in technology and competition. In the early 1980s permanent plant closings were triggered by the inroads superior Japanese manufacturers had made in consumer-durable and capital-goods industries. In the early 1990s one-company careers fell by the wayside in the IT sector because the open-systems architecture of the microelectronics revolution devalued the skills of older employees versed in proprietary technologies. And in the early 2000s the offshoring of more-routine tasks, such as writing unsophisticated software and manning customer call centers, sped up as a capable labor force emerged in low-wage developing economies and communications costs plunged, allowing U.S. companies to focus their domestic employees on higher-valueadded work. These practices chipped away at the loyalty and dampened the spending power of American workers, and often gave away key competitive capabilities of U.S. companies. Attracted by the quick financial gains they produced, many executives ignored the long-term effects and kept pursuing them well past the time they could be justified. September 2014 Harvard Business Review 49


THE BIG IDEA PROFITS WITHOUT PROSPERITY

WHERE DID THE MONEY FROM PRODUCTIVITY INCREASES GO? Buybacks—as well as dividends—have skyrocketed in the past 20 years. (Note that these data are for the 251 companies that were in the S&P 500 in January 2013 and were public from 1981 through 2012. Inclusion of firms that went public after 1981, such as Microsoft, Cisco, Amgen, Oracle, and Dell, would make the increase in buybacks even more marked.) Though executives say they repurchase only undervalued stocks, buybacks increased when the stock market boomed, casting doubt on that claim. $1,500M

MEAN DIVIDENDS

MEAN REPURCHASES

S&P 500 INDEX

1500

1,200M

1200

900M

900

600M

600

300M

300

0 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 SOURCE STANDARD & POOR’S COMPUSTAT DATABASE; THE ACADEMIC-INDUSTRY RESEARCH NETWORK. NOTE MEAN REPURCHASE AND DIVIDEND AMOUNTS ARE IN 2012 DOLLARS.

A turning point was the wave of hostile takeovers that swept the country in the 1980s. Corporate raiders often claimed that the complacent leaders of the targeted companies were failing to maximize returns to shareholders. That criticism prompted boards of directors to try to align the interests of management and shareholders by making stockbased pay a much bigger component of executive compensation. Given incentives to maximize shareholder value and meet Wall Street’s expectations for ever higher quarterly EPS, top executives turned to massive stock repurchases, which helped them “manage” stock prices. The result: Trillions of dollars that could have been spent on innovation and job creation in the U.S. economy over the past three decades have instead been used to buy back shares for what is effectively stock-price manipulation.

GOOD BUYBACKS AND BAD Not all buybacks undermine shared prosperity. There are two major types: tender offers and openmarket repurchases. With the former, a company contacts shareholders and offers to buy back their 50 Harvard Business Review September 2014

shares at a stipulated price by a certain near-term date, and then shareholders who find the price agreeable tender their shares to the company. Tender offers can be a way for executives who have substantial ownership stakes and care about a company’s long-term competitiveness to take advantage of a low stock price and concentrate ownership in their own hands. This can, among other things, free them from Wall Street’s pressure to maximize shortterm profits and allow them to invest in the business. Henry Singleton was known for using tender offers in this way at Teledyne in the 1970s, and Warren Buffett for using them at GEICO in the 1980s. (GEICO became wholly owned by Buffett’s holding company, Berkshire Hathaway, in 1996.) As Buffett has noted, this kind of tender offer should be made when the share price is below the intrinsic value of the productive capabilities of the company and the company is profitable enough to repurchase the shares without impeding its real investment plans. But tender offers constitute only a small portion of modern buybacks. Most are now done on the open market, and my research shows that they often come at the expense of investment in productive


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capabilities and, consequently, aren’t great for longterm shareholders. Companies have been allowed to repurchase their shares on the open market with virtually no regulatory limits since 1982, when the SEC instituted Rule 10b-18 of the Securities Exchange Act. Under the rule, a corporation’s board of directors can authorize senior executives to repurchase up to a certain dollar amount of stock over a specified or open-ended period of time, and the company must publicly announce the buyback program. After that, management can buy a large number of the company’s shares on any given business day without fear that the SEC will charge it with stock-price manipulation—provided, among other things, that the amount does not exceed a “safe harbor” of 25% of the previous four weeks’ average daily trading volume. The SEC requires companies to report total quarterly repurchases but not daily ones, meaning that it cannot determine whether a company has breached the 25% limit without a special investigation. Despite the escalation in buybacks over the past three decades, the SEC has only rarely launched proceedings against a company for using them to manipulate its stock price. And even within the 25% limit, companies can still make huge purchases: Exxon Mobil, by far the biggest stock repurchaser from 2003 to 2012, can buy back about $300 million worth of shares a day, and Apple up to $1.5 billion a day. In essence, Rule 10b-18 legalized stock market manipulation through open-market repurchases. The rule was a major departure from the agency’s original mandate, laid out in the Securities Exchange Act in 1934. The act was a reaction to a host of unscrupulous activities that had fueled speculation in the Roaring ’20s, leading to the stock market crash of 1929 and the Great Depression. To prevent such shenanigans, the act gave the SEC broad powers to issue rules and regulations. During the Reagan years, the SEC began to roll back those rules. The commission’s chairman from 1981 to 1987 was John Shad, a former vice chairman of E.F. Hutton and the first Wall Street insider to lead the commission in 50 years. He believed that the deregulation of securities markets would channel savings into economic investments more efficiently and that the isolated cases of fraud and manipulation that might go undetected did not justify onerous disclosure requirements for companies. The SEC’s adoption of Rule 10b-18 reflected that point of view.

DEBUNKING THE JUSTIFICATIONS FOR BUYBACKS Executives give three main justifications for openmarket repurchases. Let’s examine them one by one:

1 Buybacks are investments in our undervalued shares that signal our confidence in the company’s future. This makes some sense. But the reality is that over the past two decades major U.S. companies have tended to do buybacks in bull markets and cut back on them, often sharply, in bear markets. (See the exhibit “Where Did the Money from Productivity Increases Go?”) They buy high and, if they sell at all, sell low. Research by the Academic-Industry Research Network, a nonprofit I cofounded and lead, shows that companies that do buybacks never resell the shares at higher prices. Once in a while a company that bought high in a boom has been forced to sell low in a bust to alleviate financial distress. GE, for example, spent $3.2 billion on buybacks in the first three quarters of 2008, paying an average price of $31.84 per share. Then, in the last quarter, as the financial crisis brought about losses at GE Capital, the company did a $12 billion stock issue at an average share price of $22.25, in a failed attempt to protect its triple-A credit rating. In general, when a company buys back shares at what turn out to be high prices, it eventually reduces the value of the stock held by continuing shareholders. “The continuing shareholder is penalized by repurchases above intrinsic value,” Warren Buffett wrote in his 1999 letter to Berkshire Hathaway shareholders. “Buying dollar bills for $1.10 is not good business for those who stick around.”

2 Buybacks are necessary to offset the dilution of earnings per share when employees exercise stock options. Calculations that I have done for high-tech companies with broad-based stock option programs reveal that the volume of open-market repurchases is generally a multiple of the volume of options that employees exercise. In any case, there’s no logical economic rationale for doing repurchases to offset dilution from the exercise of employee stock options. Options are meant to motivate employees to work harder now to produce higher future returns for the company. Therefore, rather than using corporate cash to boost EPS immediately, executives should be willing to wait for the incentive to work. If the company generates higher earnings, employees can exercise their options at higher stock prices, and the company can allocate the increased earnings to investment in the next round of innovation. September 2014 Harvard Business Review 51


THE BIG IDEA PROFITS WITHOUT PROSPERITY

3 Our company is mature and has run out of profitable investment opportunities; therefore, we should return its unneeded cash to shareholders. Some people used to argue that buybacks were a more tax-efficient means of distributing money to shareholders than dividends. But that has not been the case since 2003, when the tax rates on long-term capital gains and qualified dividends were made the same. Much more important issues remain, however: What is the CEO’s main role and his or her responsibility to shareholders? Companies that have built up productive capabilities over long periods typically have huge organizational and financial advantages when they enter related markets. One of the chief functions of top executives is to discover new opportunities for those capabilities. When they opt to do large openmarket repurchases instead, it raises the question of whether these executives are doing their jobs. A related issue is the notion that the CEO’s main obligation is to shareholders. It’s based on a misconception of the shareholders’ role in the modern corporation. The philosophical justification for giving them all excess corporate profits is that they are best positioned to allocate resources because they have the most interest in ensuring that capital generates

the highest returns. This proposition is central to the “maximizing shareholder value” (MSV) arguments espoused over the years, most notably by Michael C. Jensen. The MSV school also posits that companies’ so-called free cash flow should be distributed to shareholders because only they make investments without a guaranteed return—and hence bear risk. But the MSV school ignores other participants in the economy who bear risk by investing without a guaranteed return. Taxpayers take on such risk through government agencies that invest in infrastructure and knowledge creation. And workers take it on by investing in the development of their capabilities at the firms that employ them. As risk bearers, taxpayers, whose dollars support business enterprises, and workers, whose efforts generate productivity improvements, have claims on profits that are at least as strong as the shareholders’. The irony of MSV is that public-company shareholders typically never invest in the value-creating capabilities of the company at all. Rather, they invest in outstanding shares in the hope that the stock price will rise. And a prime way in which corporate executives fuel that hope is by doing buybacks to manipulate the market. The only money that Apple ever raised from public shareholders was $97 million at its IPO in 1980.

WHY MONEY FOR REINVESTMENT HAS DRIED UP Since the early 1980s, when restrictions on open-market buybacks were greatly eased, distributions to shareholders have absorbed a huge portion of net income, leaving much less for reinvestment in companies. 150

DIVIDENDS AS A % OF NET INCOME

REPURCHASES AS A % OF NET INCOME

125

100

75

50

25

0 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 NOTE DATA ARE FOR THE 251 COMPANIES THAT WERE IN THE S&P 500 INDEX IN JANUARY 2013 AND WERE PUBLICLY LISTED FROM 1981 THROUGH 2012. IF THE COMPANIES THAT WENT PUBLIC AFTER 1981, SUCH AS MICROSOFT, CISCO, AMGEN, ORACLE, AND DELL, WERE INCLUDED, REPURCHASES AS A PERCENTAGE OF NET INCOME WOULD BE EVEN HIGHER.

52 Harvard Business Review September 2014


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Yet in recent years, hedge fund activists such as David Einhorn and Carl Icahn—who played absolutely no role in the company’s success over the decades—have purchased large amounts of Apple stock and then pressured the company to announce some of the largest buyback programs in history. The past decade’s huge increase in repurchases, in addition to high levels of dividends, have come at a time when U.S. industrial companies face new competitive challenges. This raises questions about how much of corporate cash flow is really “free” to be distributed to shareholders. Many academics— for example, Gary P. Pisano and Willy C. Shih of Harvard Business School, in their 2009 HBR article “Restoring American Competitiveness” and their book Producing Prosperity—have warned that if U.S. companies don’t start investing much more in research and manufacturing capabilities, they cannot expect to remain competitive in a range of advanced technology industries. Retained earnings have always been the foundation for investments in innovation. Executives who subscribe to MSV are thus copping out of their responsibility to invest broadly and deeply in the productive capabilities their organizations need to continually innovate. MSV as commonly understood is a theory of value extraction, not value creation.

REFORMING THE SYSTEM Buybacks have become an unhealthy corporate obsession. Shifting corporations back to a retain-andreinvest regime that promotes stable and equitable growth will take bold action. Here are three proposals: Put an end to open-market buybacks. In a 2003 update to Rule 10b-18, the SEC explained: “It is not appropriate for the safe harbor to be available when the issuer has a heightened incentive to manipulate its share price.” In practice, though, the stock-based pay of the executives who decide to do repurchases provides just this “heightened incentive.” To correct this glaring problem, the SEC should rescind the safe harbor. A good first step toward that goal would be an extensive SEC study of the possible damage that openmarket repurchases have done to capital formation, industrial corporations, and the U.S. economy over the past three decades. For example, during that period the amount of stock taken out of the market has exceeded the amount issued in almost every year; from 2004 through 2013 this net withdrawal averaged $316 billion a year. In aggregate, the stock market is not functioning as a source of funds for corporate investment. As I’ve already noted, retained earnings have always provided the base for such investment. I believe that the practice of tying executive compensation to stock price is undermining the formation of physical and human capital. Rein in stock-based pay. Many studies have shown that large companies tend to use the same set of consultants to benchmark executive compensation, and that each consultant recommends that the client pay its CEO well above average. As a result, compensation inevitably ratchets up over time. The studies also show that even declines in stock price increase executive pay: When a company’s stock price falls, the board stuffs even more options and stock awards into top executives’ packages, claiming that it must ensure that they won’t jump ship and will do whatever is necessary to get the stock price back up. In 1991 the SEC began allowing top executives to keep the gains from immediately selling stock acquired from options. Previously, they had to hold the stock for six months or give up any “short-swing” gains. That decision has only served to reinforce top executives’ overriding personal interest in boosting stock prices. And because corporations aren’t required to disclose daily buyback activity, it gives executives the opportunity to trade, undetected, on inside information about when buybacks are being September 2014 Harvard Business Review 53

EXECUTIVES ARE SERVING THEIR OWN INTERESTS As I noted earlier, there is a simple, much more plausible explanation for the increase in open-market repurchases: the rise of stock-based pay. Combined with pressure from Wall Street, stock-based incentives make senior executives extremely motivated to do buybacks on a colossal and systemic scale. Consider the 10 largest repurchasers, which spent a combined $859 billion on buybacks, an amount equal to 68% of their combined net income, from 2003 through 2012. (See the exhibit “The Top 10 Stock Repurchasers.”) During the same decade, their CEOs received, on average, a total of $168 million each in compensation. On average, 34% of their compensation was in the form of stock options and 24% in stock awards. At these companies the next four highest-paid senior executives each received, on average, $77 million in compensation during the 10 years—27% of it in stock options and 29% in stock awards. Yet since 2003 only three of the 10 largest repurchasers—Exxon Mobil, IBM, and Procter & Gamble—have outperformed the S&P 500 Index.


THE BIG IDEA PROFITS WITHOUT PROSPERITY

THE TOP 10 STOCK REPURCHASERS 2003–2012 At most of the leading U.S. companies below, distributions to shareholders were well in excess of net income. These distributions came at great cost to innovation, employment, and—in cases such as oil refining and pharmaceuticals—customers who had to pay higher prices for products. EXXON MOBIL NET INCOME REPURCHASES DIVIDENDS TOTAL $347B $207B $80B $287B 83% of NI

#1

MICROSOFT NET INCOME REPURCHASES DIVIDENDS TOTAL $148B $114B $71B $185B 125% of NI $12M 0% $0*

#2

IBM NET INCOME REPURCHASES DIVIDENDS TOTAL $117B $107B $23B $130B 111% of NI

#3

CISCO SYSTEMS NET INCOME REPURCHASES DIVIDENDS TOTAL $64B $75B $2B $77B 121% of NI

#4

PROCTER & GAMBLE NET INCOME REPURCHASES DIVIDENDS TOTAL $93B $66B $42B $108B 116% of NI

#5

$289M CEO PAY 73% % STOCK BASED $211M

CEO PAY % STOCK BASED

$247M CEO PAY 64% % STOCK BASED $158M

$297M CEO PAY 92% % STOCK BASED $273M

$90M CEO PAY 16% % STOCK BASED $14M

SOURCES STANDARD & POOR’S COMPUSTAT DATABASE; STANDARD & POOR’S EXECUCOMP DATABASE; THE ACADEMIC-INDUSTRY RESEARCH NETWORK. NOTE THE PERCENTAGES OF STOCK-BASED PAY INCLUDE GAINS REALIZED FROM EXERCISING STOCK OPTIONS FOR ALL YEARS PLUS, FOR 2003–2005, THE FAIR VALUE OF RESTRICTED STOCK GRANTS OR, FOR 2006–2012, GAINS REALIZED ON VESTING OF STOCK AWARDS. ROUNDING TO THE NEAREST BILLION MAY AFFECT TOTAL DISTRIBUTIONS AND PERCENTAGES OF NET INCOME. *STEVEN BALLMER, MICROSOFT’S CEO FROM JANUARY 2000 TO FEBRUARY 2014, DID NOT RECEIVE ANY STOCKBASED PAY. HE DOES, HOWEVER, OWN ABOUT 4% OF MICROSOFT’S SHARES, VALUED AT MORE THAN $13 BILLION.

done. At the very least, the SEC should stop allowing executives to sell stock immediately after options are exercised. Such a rule could help launch a muchneeded discussion of meaningful reform that goes beyond the 2010 Dodd-Frank Act’s “Say on Pay”—an ineffectual law that gives shareholders the right to make nonbinding recommendations to the board on compensation issues. But overall the use of stock-based pay should be severely limited. Incentive compensation should be subject to performance criteria that reflect investment in innovative capabilities, not stock performance.

would have the insights and incentives to ensure that executives allocate resources to investments in capabilities most likely to generate innovations and value.

COURAGE IN WASHINGTON After the Harvard Law School dean Erwin Griswold published “Are Stock Options Getting out of Hand?” in this magazine in 1960, Senator Albert Gore launched a campaign that persuaded Congress to whittle away special tax advantages for executive stock options. After the Tax Reform Act of 1976, the compensation expert Graef Crystal declared that stock options that qualified for the capital-gains tax rate, “once the most popular of all executive compensation devices...have been given the last rites by Congress.” It also happens that during the 1970s the share of all U.S. income that the top 0.1% of households got was at its lowest point in the past century. The members of the U.S. Congress should show the courage and independence of their predecessors and go beyond “Say on Pay” to do something about excessive executive compensation. In addition, Congress should fix a broken tax regime that frequently rewards value extractors as if they were value creators and ignores the critical role of government investment in the infrastructure and knowledge that are so crucial to the competitiveness of U.S. business. Instead, what we have now are corporations that lobby—often successfully—for federal subsidies for research, development, and exploration, while devoting far greater resources to stock buybacks. Here are three examples of such hypocrisy: Alternative energy. Exxon Mobil, while receiving about $600 million a year in U.S. government subsidies for oil exploration (according to the Center

Transform the boards that determine executive compensation. Boards are currently dominated by other CEOs, who have a strong bias toward ratifying higher pay packages for their peers. When approving enormous distributions to shareholders and stock-based pay for top executives, these directors believe they’re acting in the interests of shareholders. That’s a big part of the problem. The vast majority of shareholders are simply investors in outstanding shares who can easily sell their stock when they want to lock in gains or minimize losses. As I argued earlier, the people who truly invest in the productive capabilities of corporations are taxpayers and workers. Taxpayers have an interest in whether a corporation that uses government investments can generate profits that allow it to pay taxes, which constitute the taxpayers’ returns on those investments. Workers have an interest in whether the company will be able to generate profits with which it can provide pay increases and stable career opportunities. It’s time for the U.S. corporate governance system to enter the 21st century: Taxpayers and workers should have seats on boards. Their representatives 54 Harvard Business Review September 2014


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HEWLETT-PACKARD NET INCOME REPURCHASES DIVIDENDS TOTAL $41B $64B $9B $73B 177% of NI

#6

WALMART NET INCOME REPURCHASES DIVIDENDS TOTAL $134B $62B $35B $97B 73% of NI

#7

INTEL NET INCOME REPURCHASES DIVIDENDS TOTAL $79B $60B $27B $87B 109% of NI

#8

PFIZER NET INCOME REPURCHASES DIVIDENDS TOTAL $84B $59B $63B $122B 146% of NI $91M 25% $23M

#9

GENERAL ELECTRIC NET INCOME REPURCHASES DIVIDENDS TOTAL $165B $45B $87B $132B 81% of NI

#10

$210M CEO PAY 37% % STOCK BASED $78M

$189M CEO PAY 62% % STOCK BASED $117M

$127M CEO PAY 62% % STOCK BASED $79M

CEO PAY % STOCK BASED

$126M CEO PAY 25% % STOCK BASED $32M

GIVEN THE IMPORTANCE of the stock market and corfor American Progress), spends about $21 billion a year on buybacks. It spends virtually no money on porations to the economy and society, U.S. regualternative energy research. lators must step in to check the behavior of those Meanwhile, through the American Energy who are unable or unwilling to control themselves. Innovation Council, top executives of Microsoft, GE, “The mission of the U.S. Securities and Exchange and other companies have lobbied the U.S. govern- Commission,” the SEC’s website explains, “is to proment to triple its investment in alternative energy re- tect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” Yet, as we search and subsidies, to $16 billion a year. Yet these companies had plenty of funds they could have in- have seen, in its rulings on and monitoring of stock buybacks and executive pay over three decades, the vested in alternative energy on their own. Over the SEC has taken a course of action contrary to those past decade Microsoft and GE, combined, have spent objectives. It has enabled the wealthiest 0.1% of about that amount annually on buybacks. Nanotechnology. Intel executives have long society, including top executives, to capture the lion’s share of the gains of U.S. productivity growth lobbied the U.S. government to increase spending on nanotechnology research. In 2005, Intel’s then- while the vast majority of Americans have been left CEO, Craig R. Barrett, argued that “it will take a mas- behind. Rule 10b-18, in particular, has facilitated a sive, coordinated U.S. research effort involving aca- rigged stock market that, by permitting the massive distribution of corporate cash to shareholders, has demia, industry, and state and federal governments undermined capital formation, including human to ensure that America continues to be the world leader in information technology.” Yet from 2001, capital formation. The corporate resource allocation process is when the U.S. government launched the National Nanotechnology Initiative (NNI), through 2013 America’s source of economic security or insecurity, Intel’s expenditures on buybacks were almost four as the case may be. If Americans want an economy in which corporate profits result in shared prostimes the total NNI budget. Pharmaceutical drugs. In response to com- perity, the buyback and executive compensation binges will have to end. As with any addiction, plaints that U.S. drug prices are at least twice those in any other country, Pfizer and other U.S. phar- there will be withdrawal pains. But the best executives may actually get satisfaction out of being paid maceutical companies have argued that the profits from these high prices—enabled by a generous in- a reasonable salary for allocating resources in ways tellectual-property regime and lax price regulation— that sustain the enterprise, provide higher standards of living to the workers who make it succeed, permit more R&D to be done in the United States than elsewhere. Yet from 2003 through 2012, Pfizer and generate tax revenues for the governments that provide it with crucial inputs. funneled an amount equal to 71% of its profits into buybacks, and an amount equal to 75% of its profHBR Reprint R1409B its into dividends. In other words, it spent more on William Lazonick is a professor of economics at the buybacks and dividends than it earned and tapped University of Massachusetts Lowell, the codirector of its capital reserves to help fund them. The reality is, its Center for Industrial Competitiveness, and the president Americans pay high drug prices so that major phar- of the Academic-Industry Research Network. His book Sustainable Prosperity in the New Economy? Business maceutical companies can boost their stock prices Organization and High-Tech Employment in the United and pad executive pay. States won the 2010 Schumpeter Prize. September 2014 Harvard Business Review 55


VITAL. When every move matters, there are no small roles. Four out of five Fortune 500 companies trust Windstream to help realize their team’s full potential. Together, we foster a vision and provide the advanced business technology that drives peak performance. Discover how our team of experts can strengthen your operation every day. windstreambusiness.com


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Spotlight

58

Contextual Intelligence by Tarun Khanna

70

What’s Your Language Strategy? by Tsedal Neeley and Robert Steven Kaplan

77

Voices from the Front Lines

Managing Across Borders

PHOTOGRAPHY: ALESSANDRO COCO

ARTWORK Tomás Saraceno Galaxies Forming Along Filaments, Like Droplets Along the Strands of a Spider’s Web 2009, Venice September 2014 Harvard Business Review 57


SPOTLIGHT ON MANAGING ACROSS BORDERS

Spotlight

ARTWORK Tomรกs Saraceno Poetic Cosmos of the Breath 2013, Hong Kong, China


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Tarun Khanna is the Jorge Paulo Lemann Professor at Harvard Business School and the director of Harvard University’s South Asia Institute.

Contextual Intelligence Despite 30 years of experimentation and study, we are only starting to understand that some managerial knowledge is universal and some is specific to a market or a culture. by Tarun Khanna PHOTOGRAPHY: STUDIO TOMÁS SARACENO, 2013

September 2014 Harvard Business Review 59


W SPOTLIGHT ON MANAGING ACROSS BORDERS

ics, we ormalize it, olve. That’s we write ameworks,

why we read HBR.

I believe deeply in the importance of that work: I’ve spent my career studying business as it is practiced in varied global settings. But I’ve come to a conclusion that may surprise you: Trying to apply management practices uniformly across geographies is a fool’s errand, much as we’d like to think otherwise. To be sure, plenty of aspirations enjoy wide if not universal acceptance. Most entrepreneurs and managers agree, for example, that creating value and motivating talent are at the heart of what they do. But once you drill below the homilies, differences quickly emerge over what constitutes value and how to motivate people. That’s because conditions differ enormously from place to place, in ways that aren’t easy to codify— conditions not just of economic development but of institutional character, physical geography, educational norms, language, and culture. Students of management once thought that best manufacturing practices (to take one example) were sufficiently established that processes merely needed tweaking to fit local conditions. More often, it turns out, they need radical reworking—not because the technology is wrong but because everything surrounding the technology changes how it will work. It’s not that we’re ignoring the problem—not at all. Business schools increasingly offer opportunities

for students and managers to study practices abroad. At Harvard Business School, where I teach, international research is essential to our mission, and we now send first-year MBA students out into the world to briefly experience the challenges local businesses face. Nonetheless, I continually find that people overestimate what they know about how to succeed in other countries. Context matters. This is not news to social scientists, or indeed to my colleagues who study leadership, but we have paid it insufficient attention in the field of management. There is nothing wrong with the analytic tools we have at our disposal, but their application requires careful thought. It requires contextual intelligence: the ability to understand the limits of our knowledge and to adapt that knowledge to an environment different from the one in which it was developed. (The term is not new; my HBS colleagues Anthony Mayo and Nitin Nohria have recently used it in the pages of HBR, and academic references date from the mid-1980s.) Until we acquire and apply this kind of intelligence, the failure rate for cross-border businesses will remain high, our ability to learn from experiments unfolding across the globe will remain limited, and the promise of healthy growth worldwide will remain unfulfilled.

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CONTEXTUAL INTELLIGENCE HBR.ORG

Idea in Brief THE FINDING Most universal truths about management play out differently in different contexts: Best practices don’t necessarily travel. THE IMPLICATIONS Global companies won’t succeed in unfamiliar markets unless they adapt—or even rebuild— their operating models. THE SOLUTION The first steps in that adaptation are the toughest: jettisoning assumptions about what will work and then experimenting to find out what actually does work.

Why Knowledge Often Doesn’t Cross Borders I started thinking about contextual intelligence some years ago, when my colleague Jan Rivkin and I studied how profitable different industries were in various countries. To say that what we found surprised us would be an understatement. First some background. Into the 1990s, empirical economists studying the economies of the OECD member countries, whose data were readily available, concluded that similar industries tended to have similar structures and deliver similar economic returns. This led to a widespread assumption that a given industry would be just as profitable or unprofitable in any country—and that industry analysis, one of the most rigorous tools we have, would support that assumption. But when data from multiple nonOECD countries became available, we could not replicate those results. Knowing something about the performance of a particular industry in one country was no guarantee that we could predict its structure or returns elsewhere. (See “How Well Correlated Is Industry Profitability Across Countries?”) To see why performance might vary so much, consider the cement industry. The technology for manufacturing cement is similar everywhere, but individual cement plants are located within specific contexts that vary widely. Corrupt materials suppliers may adulterate the mixtures that go into cement. Unions may support or impede plant operations. Finished cement may be sold to construction firms in bulk or to individuals in bags. Such variables often outweigh the unifying effect of a common technology. A cement plant manager moving to an unfamiliar setting would indeed have a leg up on someone who had never managed such a plant before, but not by nearly as much as she might think. Rather than assume that technical knowledge will trump local conditions, we should expect in-

stitutional context to significantly affect industry structure. Each of Michael Porter’s five forces (which together describe industry structure) is influenced by local institutions, such as those that enforce contracts and provide capital. In a country where only established players have access to these, incumbent cement producers can prevent the emergence of new rivals. That consolidation of power means they can keep prices high. To use the language of business strategists, the logic of how value is created and divided among industry participants is unchanged, but its application is constrained by contextual variables. The institutional context affects the cement maker’s profitability far more than how good she is at producing cement. Much of my academic work has focused on institutional context. With my colleague Krishna Palepu, I’ve explored the idea that developing countries typically lack the “specialized intermediaries” that allow new enterprises to reach a broad market: courts that adjudicate disputes, venture capitalists that lend money, accreditation agencies that corroborate claims, and so on. Over time these voids are filled by entrepreneurs and better-run governments, and eventually the country “emerges” with a formal economy that functions reasonably well. Our framework has proved useful to businesses and scholars trying to understand a particular country’s institutional context and how to build a business within it. (Our book Winning in Emerging Markets: A Road Map for Strategy and Execution looks at institutional voids in more depth.) Contextual intelligence requires moving far beyond an analysis of institutional context into areas as diverse as intellectual property rights, aesthetic preferences, attitudes toward power, beliefs about the free market, and even religious differences. The most difficult work is often the “soft” work of adjusting mental models, learning to differentiate between

About the Spotlight Artist Each month we illustrate our Spotlight package with a series of works from an accomplished artist. The lively and cerebral creations of these photographers, painters, and installation artists are meant to infuse our pages with additional energy and intelligence to amplify what are often complex and abstract concepts. This month we feature the work of Tomás Saraceno, an Argentinian sculptor working in Frankfurt. Trained as an architect, Saraceno explores new ways for individuals to interact with the environment and one another. More of his work can be seen at tomassaraceno.com.

PHOTOGRAPHY: © SHOTA MATSUMOTO, 2012

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SPOTLIGHT ON MANAGING ACROSS BORDERS

universal principles and their specific embodiments, and being open to new ideas.

Even Good Companies Have a Really Hard Time Businesses that have achieved success in one market invariably have tightly woven operating models and highly disciplined cultures that fit that market’s context—so they sometimes find it more difficult to pull those things apart and rebuild than other companies do. Shifting into a new context may be straightforward if just one or two parts of the model need to change. But generally the adaptations required are far more complicated than that. In addition, executives rarely understand precisely why their operating model works, which makes reverse engineering all the more difficult, even for highly successful companies. Metro Cash & Carry, a big-box wholesaler that provides urban businesses with fresh foods and dry goods, illustrates this point well. Metro successfully expanded from Germany to other parts of Western Europe and then to Eastern Europe and Russia, learning from each experience. So when the company entered the Chinese market, Metro executives knew they’d have to make adjustments but assumed that their basic recipe for success, tempered by what they’d learned, was transferable. They did indeed get a lot right, partly by developing effective partnerships and partly by helping provincial governments experiment with advanced food-safety techniques. Nonetheless, the company ran into multiple challenges it had not fully anticipated. In any given location in China, learning how to work with the constellation of political and economic players took months. Lessons learned in one place often didn’t transfer to other places. Local competition was tougher overall

Though Metro ultimately created more value in India than elsewhere, it did so only after very slow experimentation. 62 Harvard Business Review September 2014

than it had been in Eastern Europe and Russia (which Metro entered in an era of generalized scarcity, in the years after the Berlin Wall came down). Metro managers, who were used to large, formal competitors, experienced the multiplicity of agile rivals in the informal economy as almost a “fog of war.” Other challenges resulted from local tastes: Many consumers preferred to buy live or freshly butchered animals from wet markets, for example. As a result of these difficulties, the company didn’t break even in China until 2008—14 years after entering the market. India turned out to be even tougher, although Metro had good reasons for optimism: It saw a way to cut out middlemen and thereby lower prices. It offered high-quality, standardized products in an environment with endemic food-quality and hygiene problems and staggering waste. Its wide assortment of goods seemed sure to appeal to its target customers—mom-and-pop retailers, which are so tightly packed together that India has the highest retailer density per capita in the world. Still, Metro confronted obstacles different from those it had encountered in other markets. It had trouble getting around an anachronistic law that required farmers to sell all produce through government-run auctions. Traders and retailers that Metro thought would benefit from its presence put up raucous resistance. And for the first time in the company’s experience, no one seemed to be in charge: Metro couldn’t find a single-point political authority willing to advocate for it. In addition, its Indian customers were used to informal sources of credit and found it inconvenient to carry away wholesale quantities of goods and produce, owing to India’s dilapidated infrastructure. Metro’s managers took a long time to understand that their model had to change, but they never really contemplated giving up. Just because a company is “global,” however, doesn’t mean it should do business in every country. Sometimes the amount of adaptation needed is so great that its core operating model would fall apart. Though Metro ultimately created more value in India than elsewhere, I believe, it did so only after very slow experimentation. This was partly because whatever adaptations the local team proposed and headquarters approved had to unfold in the context of an undisciplined political process and constant shrill criticism from unfamiliar media, often in the vernacular. Also, organizational rigidity had inevitably set in, stemming from individual managers’ overconfidence in the formula for


CONTEXTUAL INTELLIGENCE HBR.ORG

How Well Correlated Is Industry Profitability Across Countries? by Tarun Khanna and Jan W. Rivkin Until recently, many strategists believed that patterns of profitability in developed countries would show up in less developed economies as well. They couldn’t know for sure, because empirical research on business strategy had focused on a small handful of advanced economies. But it was often assumed that if an industry was highly profitable in, say, Germany, it would also be highly profitable in Thailand or Brazil. In 2001, as good data on emerging markets started to become available, we checked that assumption by computing the average profitability of individual industries in each of 43 countries and checking correlation between the countries in every pairing. (For a copy of our working paper, write to tkhanna@hbs.edu.) If it were indeed true that profitability is predictable from country to country, most of this chart would be aqua, reflecting significant positive correlation (meaning that industries profitable in one country are likely to be so in others, to a degree beyond the relationship prone to arise by chance). Such correlation, however, exists in only about 11% of cases, and it’s often between similar nations—the United States and Canada, for example. Instead the chart is dominated by magenta: There’s no significant correlation of industry profitability between most of these country pairs. The fact that an industry is highly profitable in Sweden tells us nothing about whether it will be profitable in Singapore. The implications are alarming. Companies enter new markets all the time relying on what they think they know about how their industry works and the technical competencies that have allowed them to succeed in their home markets. But given the results of our study, it’s not much of a stretch to say that what you learn in your home market about a particular industry may have very little to do with what you’ll need to succeed in a new market.

Argentina Austria Belgium Brazil Canada Chile China Colombia Denmark Finland France Germany Greece Hong Kong Hungary India Indonesia Ireland Israel Italy Japan Malaysia Mexico Netherlands New Zealand Norway Pakistan Peru Philippines Poland Portugal S. Korea Singapore South Africa Spain Sweden Switzerland Taiwan Thailand Turkey United Kingdom United States Venezuela

Positive correlation Significant at the 10% level Insignificant correlation Negative correlation Significant at the 10% level

Arg ent Au ina s Bel tria giu m Br Ca azil nad Ch a ile Co China lo De mbia nm Fin ark la Fr nd Ge ance rm any G Ho reec ng e K Hu ong nga ry Ind India one Ire sia lan Isra d e Ita l J ly Ma apan lay s Ne Mex ia t Ne herla ico w Z nd eal s No and r Pak way ista n Phi Pe lipp ru in Po es Por land t S. ugal Sin Kore Sou gap a th ore Afr ic Spa a i S w Sw ed n itze en rla Ta nd Tha iwan ila Un ite Tu nd d K rke Un ing y ite dom d Ven State ezu s ela September 2014 Harvard Business Review 63


SPOTLIGHT ON MANAGING ACROSS BORDERS

past successes. Metro’s managers are first-rate, but contextual intelligence can’t be rushed or mandated into existence. The difficulties I describe aren’t peculiar to developed- country companies trying to enter emerging markets. Metro’s tribulations in India, for example, resemble those that organized commerce faced with the Poujadism of 1950s France, when mom-and-pop businesses were up in arms against the establishment. Germany encountered similar forces in that period. And developing-economy enterprises trying to move into first-world markets have to change their operating models, too. Whereas at home they may have succeeded by managing around—or taking advantage of—conditions such as a cash-only society, intrusive or corrupt government officials, and a shortage of talent, they face different challenges in developed markets. Narayana Health, founded in Bangalore, is an example. Its famous cardiac-surgery group performs 12% of the heart operations done in India each year. CABG (coronary artery bypass graft) surgery costs the patient as little as $2,000, compared with $60,000 to $100,000 in the United States, yet Narayana’s mortality and infection rates are the same as those of its U.S. counterparts. Still, it’s unclear whether the group’s operating model will transfer easily to the Cayman Islands, where Narayana opened a facility in February 2014. Why? Because it achieved success under specifically Indian conditions: A huge number of patients need the surgery, which means that surgeons quickly acquire expertise and thereby reduce costs. Having to overcome the logistical, financial, and behavioral barriers that kept poor patients away taught valuable lessons. Nurses double as respiratory and occupational therapists, and family members are now enlisted to help provide postoperative care. In addition, construction materials are inexpensive and the loose regulatory culture allows for experimentation. In the Caymans, Narayana will inevitably have to pull apart this operating model, and a coherent replacement will emerge only gradually.

Some early signs are encouraging. The Caymans’ material and labor costs are higher than India’s, but construction practices honed at home have already allowed Narayana to build a state-of-the-art hospital in the islands for much less than it would have cost in most Western locations. The health group has another big thing going for it: Its culture has been one of experimentation from the beginning. The Caymans’ very different regulatory systems will limit innovation in health care delivery methods, but an ingrained habit of questioning assumptions, trying out new approaches, and adjusting them in real time should serve Narayana well as it adapts.

How Can We Get Better at This? Some of the ways to acquire contextual intelligence are obvious, though they’re neither easy nor cheap: hiring people who are “fluent” in more than one culture; partnering with local companies; developing local talent; doing more fieldwork and more crossdisciplinary work in business schools and requiring students to do the same; and taking the time to understand the nature and range of local variations. (See the sidebar “Tuning In to Cultural Differences.”) Exploring all those approaches in detail is beyond the scope of this article, but I’d like to highlight a few perhaps less obvious points.

The “hard” stuff is easy (believe it or not). Once you accept up front that you know less than you think you do, and that your operating model will have to change significantly in new markets, researching a country’s institutional context isn’t difficult—in fact, general information is usually available. It can be helpful to work from a road map or a checklist, which will help you recognize and then categorize unfamiliar phenomena. (Winning in Emerging Markets provides a tool for spotting institutional voids along with checklists on product, labor, and capital markets in emerging economies.) The institutional context should influence not just your industry analysis but any other strategic tools you typically use: break-even analysis, identification of key corporate resources, and so on.

One big caveat: Developing economies often lack the data sources that managers in OECD countries take for granted. 64 Harvard Business Review September 2014


CONTEXTUAL INTELLIGENCE HBR.ORG

Tuning In to Cultural Differences Understanding local variations involves observing both customers and employees. On the “buy” side, differing aesthetic tastes aren’t immediately apparent to many managers, but they matter a lot. To succeed in India, Metro Cash & Carry increased the visual density of its stores’ previously uncluttered aisles so that they would more closely resemble crowded Indian street markets. In contrast, eBay stuck with its U.S. playbook in China, allowing Taobao to win the Chinese market in less than three years; the upstart succeeded in part by capitalizing on local responsiveness to colorful, active websites. Computer scientists and cognitive psychologists have demonstrated that different cultural groups have differing tastes in how information and products are represented. (An interactive at labinthewild.org allows you to compare your engagement style with that of diverse other respondents.) Tastes also differ in luxury services; for instance, hotel room décor that appeals to one set of customers may alienate another. Artwork evoking England in its imperial age may be pleasing in York but irritating in Mumbai. Chinese executives accustomed to celebratory red-and-gold furnishings may perceive modernist minimalism in their Berlin or New York hotel rooms as cold and hostile. Religious imagery is similarly controversial: The Hindu goddess of wealth is often used to connect products to prosperity in India, whereas companies in the West rarely use religious iconography to market their wares. Advertising agencies must work with different manifestations of universal values all the time. Bartle Bogle Hegarty’s campaign for Johnnie Walker scotch whisky, for example, sought to link the product to the notion of a continual quest for self-improvement, which research had shown was the most powerful indicator of eventual male success. The iconic brand emblem—a striding man—embodied the idea that one should “keep walking.” But what worked in the West—ads that focused on individual progress—failed in China and Thailand, where customers responded instead to evocations of camaraderie, shared commitment, and collective advancement. (One of the creative leads of the campaign speculated with me recently that the man’s striding from left to right might well play differently in societies that write from right to left.) On the “sell” side, managers must evaluate how to align incentives, motivation, and retention policies with local norms and expectations. If a country lacks efficient stock markets, for example, making stock options part of a compensation package becomes problematic. Similarly, individualized compensation schemes may be ineffective in an environment where collectivist values dominate.

One big caveat: Developing economies often lack the data sources—credit registries, market research firms, financial analysts—that managers in OECD countries take for granted. This absence creates an institutional void in developing economies that companies must fill through investments of their own. HSBC partnered with a local retailer to create Poland’s first credit registry, for example, and Citibank did something similar in India as part of its effort to introduce credit cards there. The soft stuff is hard. We tend to have very persistent mental models, particularly about emerging markets, that are not rooted in the facts and that get in the way of progress. One of these is the view that all countries will eventually converge on a freemarket economy. But considerable evidence suggests that state-managed markets like China’s will

be with us for the foreseeable future. I’ve written elsewhere that the Chinese government is the entrepreneur in that economy; to automatically equate governmental ubiquity with inefficiency, as we often do in the West, is wrong. A second persistent mind-set is the impulse to rely on simple explanations for complex phenomena. Metro’s managers were slow to reconceptualize their operating model in part because they found it easier to address one factor at a time and hope to be done with it. (I see this problem in my classes all the time—sophisticated executives read a case and home in on one particular difficulty, whereas in reality a constellation of intersecting issues must be addressed.) Often the cognitive biases that Kahneman and Tversky first wrote about—such as anchoring and overconfidence—reinforce this tendency. September 2014 Harvard Business Review 65


SPOTLIGHT ON MANAGING ACROSS BORDERS

HBR.ORG

Experimentation is messy—and essential. It’s not enough to identify which of our mental models and biases need to be jettisoned. We must develop new models and frameworks. They will of course be imperfect—but we can’t build a better knowledge base without codifying what we learn along the way. And that requires even billion-dollar corporations to think like entrepreneurs—to create hypotheses about what will work, to document and test assumptions, and to experiment in order to learn, cheaply and quickly, what does or doesn’t work. Like entrepreneurs, companies shouldn’t analyze experimental results to the point of exhaustion but instead develop the capacity to act speedily on results.

What’s Universal? What’s Context-Specific?

Figuring out what will travel from location to location and what won’t is essential for nonprofits and fastgrowing entrepreneurial ventures as well as for the established companies we’ve discussed here. Consider Teach for America, a nonprofit started in the late 1980s, which helps talented college graduates spend a few years teaching in America’s underperforming schools. It has recently mushroomed into a global network called Teach for All. The core ethos remains the same: Match willing, high-needs ORGANIZATION

General ideas travel; specific dimensions may not. Learning to distinguish between the two is key. (Once again, creating value and motivating the workforce are universally considered essential— but the meaning of “value” and the road to “motivation” differ enormously between cultures.) Metro has continued to define itself in the same way across borders: as a B2B wholesaler that gives small and midsize enterprises access to a diverse range of hard and soft goods. But major adjustments were needed to make that definition work in varying contexts. Regarding payment and delivery, for example, Metro learned to manage not just conventional cash-andcarry operations, but also cash-and-no-carry, carryand-no-cash, and no-cash-no-carry. (See the exhibit “What’s Universal? What’s Context-Specific?”) The future can’t be telescoped. We all tend to assume that social and economic transformations occur more quickly than they actually do. Some technological changes have an immediate impact (mobile phones have disseminated rapidly in emerging markets), but they are the exception. Robust research shows that countries take decades, on average, to adopt new technologies invented elsewhere. Institutional change is, if anything, even slower. Research with my colleague Krishna Palepu suggests, for example, that the transition in Chile from a focus on bank loans to a focus on issuing securities (a key transition for entrepreneurship) took much longer than anticipated two decades ago. More was required than the creation of new organizations and new rules: Individuals had to adapt their behavior to the changed context. That didn’t happen until foreign demand for information resulted in the emergence of local financial analysts and investment advisers, who first had to develop deep investing expertise. Similarly, in Korea the shift away from 66 Harvard Business Review September 2014

schools with recent graduates. But adapting the model requires a fair amount of contextual intelligence. Similarly, Aspiring Minds (of which I am a cofounder), an Indian talent-assessment service aimed at democratizing the market for talent, focuses on various outof-the-mainstream job seekers in different markets.

METRO CASH & CARRY TYPE Large, publicly traded company SECTOR Wholesale GEOGRAPHICAL SPREAD Germany to elsewhere in Europe, Russia, China, and India UNIVERSAL ATTRIBUTES Allows small and medium businesses (such as hoteliers, retailers, and caterers) to access a range of hard and soft goods

TEACH FOR ALL Nonprofit

ASPIRING MINDS Entrepreneurial venture

Education

Talent management

U.S./UK to global

India to the U.S., the Middle East, and Africa

Matches accomplished but inexperienced would-be teachers with highneeds schools, over time nurturing a platform from which corporations can recruit talent

Helps mainstream corporations and outof-the-mainstream job seekers find each other using state-of-theart machine learning algorithms

CONTEXT-SPECIFIC ATTRIBUTES Provides multiple payment and delivery models: conventional cash-andcarry; cash plus delivery; credit plus carry; or credit plus delivery

Identifies high-needs schools in the education system; arranges funding in the absence of a culture of philanthropy; augments ordinary corporate recruiting

Identifies different types of job seekers, such as graduates of lesser-known schools, war veterans, and people educated online; adapts tools to reach and serve those pools


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SPOTLIGHT ON MANAGING ACROSS BORDERS

HBR.ORG

overreliance on bank debt and toward equity financing was far slower than proponents expected after the Asian financial crisis of the late 1990s. Analysts needed time to shed their biases, and it was difficult to locate truly independent directors. For reasons akin to what we found in Chile and Korea, the harmonization of accounting, corporate governance, and intellectual property standards proceeds at a glacial pace relative to conventional managerial expectations—often because of political objections at the local level. Generate your own data. To help focus on the facts as they are in a given context, rather than as managers think they should be, companies ought to obtain their own data whenever possible. This is particularly important when Western managers start to operate outside North America and Europe. What some scholars have called WEIRD (Western, educated, industrialized, rich, and democratic) societies may differ from the rest on a number of measures, including beliefs about fairness, a tendency to cooperate, the use of both inductive and moral reasoning, and concepts of self. Therefore, instead of hiring outsiders to do market research and assemble information on how other multinationals have entered a market, managers should conduct their own experiments to learn about the local context and what their company is capable of achieving within it. Some companies are experimenting with crowdsourcing data collection—a practice that’s still in its infancy but showing real promise. Be aware that context matters when eliciting information. In some settings community norms affect behavior more than individual-level incentives do. Thus a company interested in water conservation might learn more from studying how villagers use the communal well than from studying household water use. Focus groups may be ineffective in hierarchical societies, so it is important to figure out what “status” looks like in a given location. Success requires patience. As noted, institutional change can’t be rushed. Neither can enterpriselevel change. Companies must be willing to invest in

immersing their high-potential employees in particular local contexts. The global advertising giant WPP has a fellows program that places 10 recruits annually with its operating companies around the world to develop leaders with a multidisciplinary, culturally flexible perspective. Each fellow gains exposure and engagement while being mentored by senior WPP executives. Viewed as a ticket to success within the organization, the fellows program has resulted in 65% retention (over long time horizons) of these high-potential executives—a significant result in an industry notorious for turnover.

The Universal Importance of Contextual Intelligence Understanding the limits of our knowledge, which is at the heart of contextual intelligence, is a very basic component of human comprehension. Yet it’s also a profoundly difficult, complicated process that has vexed philosophers from Plato to Isaiah Berlin, who distinguished between knowing the facts and making a judgment in a widely read 1996 essay. I believe that contextual intelligence is systematically undervalued in dozens of situations. I’ve focused here on corporations planning to enter new markets. I could as easily have written about giant state-owned enterprises, entrepreneurs, and nonprofits that are tackling even bigger problems—such as how to expand the formal economy to include the 4 billion people who currently make a living in the informal economy. At best, this excluded population engages in rudimentary commerce mediated by personal relationships, which limits the possibility of expanding its networks. Engaging effectively with this population will take massive doses of contextual intelligence. We need to understand so many things better than we currently do: How do they prioritize spending, given their extremely limited resources? What forms of communication will they respond to? How can they accumulate capital in the absence of collateral? The answers to those questions will differ from Mumbai to Nairobi and from Nairobi to Santiago. HBR Reprint R1409C

Instead of relying on conventional market research, managers should conduct their own experiments to learn about the local context. 68 Harvard Business Review September 2014


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SPOTLIGHT ON MANAGING ACROSS BORDERS

Spotlight

ARTWORK Tomás Saraceno, Cloudy Dunes. When Friedman meets Bucky on Air-Port-City, 2006

What’s Your Language Strategy? It should bind your company’s global talent management and vision. by Tsedal Neeley and Robert Steven Kaplan

70 Harvard Business Review September 2014

L

LANGUAGE PERVADES EVERY ASPECT of organizational life. It touches everything. Yet remarkably, leaders of global organizations, whose employees speak a multitude of languages, often pay too little attention to it in their approach to talent management. As we have observed in countless organizations, unrestricted multilingualism creates inefficiency in even the most dedicated and talented workforces. It can lead to friction in cross-border interactions, lost sales, and a host of other serious problems that may jeopardize competitiveness (see also “Global Business Speaks English,” by Tsedal Neeley, HBR May 2012). Developing a comprehensive strategy for managing language can help transform that vulnerability into a source of competitive advantage. Choosing a lingua franca, or common language, can dramatically improve how employees collaborate across borders—even though it also introduces

new challenges. For one thing, the decision to adopt a lingua franca must be balanced with the need to speak local languages and adapt to local cultures. For another, individuals’ proficiency (or lack thereof) in the common language can cloud leaders’ judgment about how suitable those people are for specific assignments and promotions. Decision makers may undervalue or overvalue language skills and therefore misjudge talent. We have learned through more than a decade of Tsedal Neeley’s research on language in global organizations and teams, and more than 20 years of Robert Kaplan’s leadership of global organizations, that language strategy is critical for global talent management. As a leader, you can factor language and cultural skills more deliberately into the hiring, training, assessment, and promotion of talent—and into the management of global teams—whether

PHOTOGRAPHY: ALTROSPAZIO, ROMA


SPOTLIGHT ON MANAGING ACROSS BORDERS

and cultures. To ensure that you are hiring the best people, you may need to accept some limitations on language capabilities and be prepared to provide training to meet both global and local language needs. For example, although IBM long ago adopted English as its lingua franca, the company has identified eight other languages as important to serving local markets. IBM hires global professionals with the expectation of strengthening their language skills through immersive training, private coaching, or online learning. Further, employees know that certain international assignments carry with them a language-training requirement. Another blind spot is a tendency to overrely Hiring and Training When seeking superb job candidates, recruiters at on external lateral hires with a certain degree of language skill to fill midlevel roles rather than hirglobal companies must be aware of potential blind spots regarding language. First, they may allow flu- ing and grooming outstanding junior candidates with the capacity and motivation to learn new ency (either in a lingua franca or in a local language) languages. While the latter approach may initially to overshadow their assessments of a candidate’s take more time, companies often find that entryskills, growth potential, and knowledge of markets level hires ultimately become their best leaders, because they have been trained from an early stage in company culture and practices. Defaulting to lateral hires can make it more difficult to build a cohesive culture—those recruits have been trained elsewhere and may have trouble assimilating. After identifying the languages your global employees should know Excessive churn can be another issue: As months in order to perform at their best, support their efforts to become or years go by, companies may discover that lateral more proficient. hires lack other critical competencies, even if their language skills are strong. CONSIDER ASSESSMENTS AND TRAINING FOR ALL NONNATIVE SPEAKERS. For those reasons, many global companies have Your workforce will improve its language skills as a whole only if all parties improved their entry-level hiring capabilities and are held accountable for progress over an appropriate period. Enforce beefed up their language training. (See the sidebar high standards by requiring training for those who haven’t yet achieved the “Making It Easier to Acquire Language Skills.”) That desired fluency. In most organizations, that’s about 3,500 words of English (if that’s the language of choice)—not the 15,000 words that native speakers approach may require more patience, but it may have mastered, but certainly enough to understand and be understood in actually help you build a cohesive global business most contexts. much more quickly, because you’re not continually rehiring. PAY FOR THE TRAINING. By providing all-expenses-paid courses, you or not your company adopts a shared language. Of course, in a global firm, choices and tactics will vary somewhat according to the needs of each unit and region. But those differences must exist within a cohesive system that allows employees to function effectively across the organization and achieve key strategic priorities. Indeed, your language strategy must fit with your firm’s value proposition to customers if you hope to penetrate various markets and coordinate among them. You need to consider how to infuse language into your core talent practices in order to deliver that value.

Making It Easier to Acquire Language Skills

signal that language proficiency is a corporate priority. And if you frame the training as an investment in employees’ marketable skills, people are more likely to match that with their own investment of time, energy, and determination to succeed. HOLD THE COURSES DURING WORK HOURS. Schedule the training during the workday, and provide an accessible location on-site, further demonstrating corporate investment in the program and emphasizing it as a strategic priority. Treat it as an essential part of employees’ jobs. If you wouldn’t ask employees to learn to use new software or complete other essential training on their own time, you shouldn’t expect them to learn a required language that way.

Evaluating Talent Accurately Once you have improved your ability to hire and train global talent, you will need to keep language in perspective when evaluating employees’ performance and making promotion decisions. Language agility does not necessarily spell high performance. As a result, it is important to assess skills and various attributes through 360-degree evaluations, which solicit feedback from subordinates, peers, supervisors, and (when appropriate) clients. The process allows managers to look beyond verbal agility when

72 Harvard Business Review September 2014


WHAT’S YOUR LANGUAGE STRATEGY? HBR.ORG

Idea in Brief THE PROBLEM Leaders of global organizations often pay little attention to language when hiring, training, assessing, and promoting employees. This can lead to miscommunication and friction, especially among team members who collaborate across borders. The company’s competitiveness may suffer as a result. THE SOLUTION Build language skills and cultural awareness throughout your organization in order to acquire and develop the kind of talent you need to compete both globally and locally. Align your language strategy with your company’s overarching priorities. BENEFITS You will attract top-notch employees and close gaps between native and nonnative speakers, turning a vulnerability into a competitive strength.

gauging performance. It’s a reality check, a way to make sure that you and other leaders are not unduly swayed by fluency. Jim, the head of a global bank’s Japan subsidiary, learned firsthand what can happen when leaders make promotion decisions without proper evaluation tools, such as a 360-degree review process. He had decided to promote Hiroshi Kato to a key leadership role in the unit. Having previously lived in the United States for more than 10 years, Kato was fluent in English as well as Japanese, which made it easy for Jim to communicate with him. Kato appeared to be well versed in Japanese culture and society. And Jim believed that Kato had good relationships with his colleagues and his clients. Because Jim had been sent to Japan with the mission of building an indigenous team in order to develop a sustainable business, he was thrilled to be able to promote a Japanese professional. Initial reactions to the promotion seemed positive. But during a dinner with a senior Japanese employee, Jim discovered that he had judged people’s responses too quickly. The employee commented, “Kato’s peers don’t respect him. He is weaker than others in terms of job performance and relationships with clients. There were several other choices you could have made among Japanese staff that would have been much better. People can’t believe you made this decision.” After digging deeper, Jim realized that he had conflated Kato’s fluency in English with high-level management and client skills. After thinking through how to avoid similar mistakes in the future, he introduced a 360-degree evaluation process. This new tool allowed Jim to consider much broader and deeper assessments of employees’ performance instead of relying on his impressions, which were strongly influenced by language proficiency and his own ability to relate to an employee.

Rethinking the Role of Expatriates Many companies send seasoned professionals to lead business units outside their home countries. Although expatriates may not be familiar with the local language, culture, and business practices, they can bring knowledge of organizational culture along with an understanding of the company’s products, processes, and systems. But hiring, training, and succession planning must be an important part of their assignments. In particular, they need to focus on developing local talent and ensuring that indigenous professionals begin to play leadership roles in the local businesses. Consider the following example. The CEO of a major financial institution grew frustrated with its struggle to establish a strong presence in Asia. The company couldn’t seem to build a cadre of local leaders in the region, even though it continually sent in expatriates in an effort to do so. Each assignment lasted three to five years. Knowing that the current region head would soon return home to the United States, the CEO debriefed him on his experience. The expatriate proudly described his efforts to call on leading clients in the region and explained that he was looking forward to having another expatriate take his place. When the CEO asked him to discuss the top 10 indigenous professionals in the region, it quickly became clear that the expatriate hadn’t made local talent development a high priority. He never actively mentored or coached local lieutenants, nor did he try to improve entry-level hiring. There was no career development committee for high potentials. Even though the expatriate had been trained in Mandarin by the firm, when critical assignments came up he tended to give them to other expats who spoke fluent English and were therefore easier to relate to. Alarmed, the CEO immediately changed his approach with expatriates. He met with the next September 2014 Harvard Business Review 73


SPOTLIGHT ON MANAGING ACROSS BORDERS

Consider a Lingua Franca If Your Company Is... COLLABORATING ACROSS BORDERS INVOLVED IN A CROSS-BORDER MERGER OR ACQUISITION STANDARDIZING TECHNOLOGY PLATFORMS SERVING CUSTOMERS GLOBALLY

Globally dispersed teams need a shared language in order to communicate effectively, whether their work involves the transfer of information, the sharing of best practices, or coordination on joint projects.

A common language helps accelerate the integration of separate companies in different regions. You’ll achieve efficiencies from migrating onto common platforms, sharing resources, strengthening internal communication, and fostering cohesion in the newly formed organization.

Enterprise software in a multinational can proliferate into many disjointed tools that obstruct a clear view into operations, financials, customer insights, and employee data. Full standardization across platforms, built on a common language, can solve that problem.

To access global markets—and build an accessible global brand—dispersed teams must be able to engage with international partners and one another. A common language makes it easier to do that and to synchronize services. But local languages must prevail when customer service employees communicate with clients in their home countries.

region head to clarify performance expectations before the assignment began. “I expect you to develop and train local leaders,” he said. “I don’t want you covering any client without a local partner. I will evaluate you not on how much business you bring in but on how well you develop this office so that we’ve built something sustainable after you’ve returned to headquarters.” The CEO also encouraged the expatriate to take six months of intensive Mandarin classes, which would at least provide him with a minimal level of fluency. This expatriate, realizing that he was sent to Asia to be a leader and manager, not just a producer, did a much better job than his predecessor. In addition to clarifying the role of expatriates, think about the people you’re choosing to send abroad. To build a strong team of local leaders, it’s critical to give expatriate assignments to your best people—not just to solid contributors who happen to have the right language skills and are more easily dispensed with at home. Otherwise, you may find that your firm’s global offices fail to attract, develop, and retain the strong indigenous talent they need for high performance. The CEO of a highly successful global industrial firm learned that lesson after many years of sending expatriates to head up non-U.S. offices, with mixed results. A friend who ran a global consumer goods company suggested, “These overseas assignments are really tough. You have to do more to build an indigenous team, cultivate successors, deal with an unfamiliar market and culture, and probably wrestle with a lower market share than you have in your home market.” While this trusted peer acknowledged that the highest performers were “never available,” his advice was to “make them available” by turning the overseas roles into high-status jobs. “In our company,” he said, “it is widely known that only the very best get these assignments. If you 74 Harvard Business Review September 2014

want to be promoted in our company, you probably need to have done at least one.” Upon hearing this advice, the CEO compiled a list of his 50 most talented leaders and rising stars. When he asked someone near the top of the list to take the next overseas opening, that person’s manager complained vociferously that the employee couldn’t be spared. The CEO realized that this was exactly the caliber of expatriate the firm needed in order to improve its overseas operations. The company then launched a program in which only the very best performers were given expatriate assignments. The CEO reflected, “Our best people are better able to adapt to local cultures….They are less likely to let language differences shade their assessments of performance. They are willing to adapt their own leadership styles to fit the situation and develop local talent. They are confident enough to play the role we need them to play.” Once employees perceived the overseas offices as plum assignments, they began to volunteer for them. Performance radically improved as measured by market share, talent development, and profitability. The company truly began to cultivate strong indigenous successors—a step that was critical to building a global enterprise.

Managing Communication on Global Teams When organizations with globally dispersed teams adopt a lingua franca or require proficiency in local languages, tensions inevitably arise. Our recent studies at a wide variety of global companies reveal, for instance, that managers often unwittingly position native speakers of a lingua franca as “winners” within the firm; consequently, nonnative speakers experience a substantial loss of power and status. If companies don’t take such issues into account, they can cause otherwise talented and engaged professionals to underperform and even withdraw.


WHAT’S YOUR LANGUAGE STRATEGY? HBR.ORG

…And Roll It Out at the Right Pace A common language can be rolled out simultaneously or sequentially across the organization. The decision depends on your circumstances and priorities. SIMULTANEOUSLY SEQUENTIALLY

A concurrent implementation across units and regions requires a larger-scale effort up front to obtain resources, gain buy-in, and create a clear road map for adoption. However, this approach can prevent employee subgroups—verbally advantaged versus disadvantaged—from forming. And it can improve collaborations and reduce language barriers more rapidly than a sequential rollout. The Japanese e-commerce giant Rakuten, the German software company SAP, and the Chinese tech company Lenovo are among the multinationals that have followed this approach.

Shoring up language skills in one part of the company at a time can delay widespread benefits. But it allows you to identify best practices for a broader implementation. For instance, you might focus initially on people who work across borders or on senior managers and high-potential employees, who are often early adopters of new languages. Orange (formerly France Telecom) first asked its high potentials to become English-speakers to help lead its global activities. When leaders jump in first, they show that learning a language is both a high priority and a realistic endeavor.

Take Renée, who works for a $25 billion hightech multinational headquartered in France that chose English as its main language. Renée, whose English fluency is low, describes her experience this way: “When we have a meeting or conference call to discuss an issue or to make decisions, I often feel uncomfortable. Sometimes, I must confess, my solution is to get away with not attending meetings that include English coworkers. It’s just too frustrating and embarrassing because of my limited English language skills.” Yvette, one of Renée’s colleagues, is a highly fluent but nonnative English speaker. She participates in conference calls with her San Francisco counterparts twice a week. Despite her strong language skills, she finds those calls stressful and frustrating. As she explains, “We need to be extra cautious, because the Americans’ mastery of the language may lead them to take advantage of us and try to fool us.” Her coworkers voice similar fears. A German multinational has experienced similar friction between native and nonnative colleagues. Local employees often invite only German-speaking team members to meetings or schedule calls for the middle of the night U.S. time, so that their American counterparts won’t be able to attend. “If we are going to extend the meeting to a larger forum and we have to talk in English, then I say ‘No! No, I don’t want to do this,’” a German employee admits. When employees struggle to express themselves in meetings or get excluded because they aren’t fluent in the chosen language, communication can become wholly unpleasant. Global managers must deal directly with such issues to promote productive global cooperation. They must be sensitive to how employees of varying language proficiency are interacting. The goal is to make it easier for native and nonnative speakers to establish trust and communicate effectively. Managers’ observations should

include the following: Who attends meetings? Who speaks up? Are the best employees contributing, or is language getting in the way? It’s then important to facilitate meetings and calls so that nonnative and native speakers get equal airtime. Often this means coaching primary-language people to speak less and second-language people to speak more. It also involves setting clear agendas up front, considering the mode of communication, and thinking through meeting choreography in advance. Wajid Jalaldin, an experienced global team leader at Oracle, is a master of that kind of orchestration. His current team members, spread across 14 countries, must work closely together to build and maintain customized software systems for clients around the world. Wajid routinely manages meeting airtime to improve the effectiveness of team members with varying levels of English fluency. He models and evaluates inclusive meeting behaviors, such as asking open-ended questions, using silence as a tool to give colleagues an opportunity to speak, and directly addressing team members who haven’t yet participated. Most important, Wajid praises lessfluent team members for their contributions, which instills confidence.

HBR.ORG Visit this article online to watch Tsedal Neeley’s video “Why Everyone at Your Company Should Speak (a Little) English.”

Building Cultural Awareness As we’ve discussed, language training is an important investment in employees. But language fluency does not equal cultural fluency—for either global leaders or their subordinates. Too often leaders underperform because they fail to adapt their management styles and practices to fit a multicultural environment. For them, understanding the cultural background of each team member, the role of the company, its products and services, and the customers it serves within various cultural and regional contexts is as essential as learning to conjugate new verbs. September 2014 Harvard Business Review 75


SPOTLIGHT ON MANAGING ACROSS BORDERS

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The same can be said for employees at all levels: Even when team members are fluent in the lingua franca, a lack of cultural awareness can cause significant misunderstandings and disagreements; it can lead to divergent group norms, practices, and expectations. To prevent such rifts, cross-cultural training must be embedded in language training. This training should focus on the types of negotiations employees might undertake, the decisions they will face, the social events in which they might

Language training is an important investment in employees. But language fluency does not equal cultural fluency—for either global leaders or their subordinates. participate—and the wide variation in behaviors and preferences across cultures. The CEO of a global technology company adopted English as its lingua franca for cross-border contact, although employees spoke their local languages within their home countries. Despite their great efforts to communicate in the shared language with international colleagues, the CEO received numerous reports of friction between offices. He realized that much of the problem stemmed from insensitivity to cultural differences and intolerance on the part of managers. For example, one leader said he found it frustrating that he could never get a clear “yes” or “no” when talking by telephone to a peer in Indonesia. He failed to take into account the importance of building a relationship, the value of faceto-face communication, and the impact of cultural differences. Lacking that awareness, he projected his home-country norms onto his peer. After numerous reports of similar issues, the CEO decided to integrate cultural training into language development programs for senior leaders. In each 76 Harvard Business Review September 2014

training session, the company did a mini-tutorial relating to cultural norms associated with specific countries and languages. For example, Portuguese language training included a mini-tutorial on cultural norms in Brazil. This approach was so effective that the CEO began to use his global senior leadership conferences as an opportunity to help team members learn more about the cultural aspects of their various country counterparts. He also began to emphasize cross-border cultural sensitivity in both year-end reviews and interim coaching sessions. These efforts, he found, improved coordination and reduced friction. That example highlights an important point: Managers must be trained and held accountable for ensuring that language and cultural skills are developed throughout their organizations. Progress should not be solely the responsibility of the HR department and individual managers. Senior executives need to model the behaviors they’re trying to cultivate in their people. In assessing their performance, year-end evaluations should address issues such as respect for others and cultural differences, the ability to foster such respect in subordinates, and the ability to adapt management styles to fit diverse cultural contexts and interact with employees who have varying degrees of fluency. Ultimately, this diversity of language and cultural background should be reflected in the composition of the organization’s senior leadership team. LANGUAGE IS A VITAL LINK to your talent management strategy. Even if your company decides not to adopt a lingua franca, you can’t neglect language. In fact, it should touch every talent decision you make as a global leader. By managing it carefully, you can acquire and develop the very best employees, close gaps between native and nonnative speakers as they collaborate to meet strategic goals, and strengthen your company’s footing in local markets. In short, you can turn language into a source of competitiveness. HBR Reprint R1409D Tsedal Neeley is an associate professor of business administration and a Marvin Bower Fellow at Harvard Business School. She is also the founder of Global Matters, LLC. Twitter: @tsedal. Robert Steven Kaplan is a senior associate dean and the Martin Marshall Professor of Management Practice in Business Administration at Harvard Business School. He is also a cochairman of the Draper Richards Kaplan Foundation, the chairman of Indaba Capital Management, and a former vice chairman of the Goldman Sachs Group. Twitter: @RobSKaplan.


SPOTLIGHT ON MANAGING ACROSS BORDERS

HBR.ORG

Spotlight BELOW Tomás Saraceno In Orbit, 2013

PHOTOGRAPHY: STUDIO TOMÁS SARACENO © 2013; ILLUSTRATION: ANTONY HARE

Voices from the Front Lines Four leaders on the cross-border challenges they’ve faced LUC MINGUET head of group purchasing at Michelin

EDUARDO CARIDE regional director for Spanish-speaking countries in Latin America at Telefónica

TAKEO YAMAGUCHI corporate officer for human capital at Hitachi

SHANE TEDJARATI president and CEO, global high-growth regions, at Honeywell

Creating a Culturally Sensitive Corporation

Diversifying Talent to Suit the Market

Standardizing HR Practices Around the World

Shifting the Focus to Emerging Markets

September 2014 Harvard Business Review 77


SPOTLIGHT ON MANAGING ACROSS BORDERS

I LUC MINGUET

Creating a Culturally Sensitive Corporation I DIDN’T EXPECT to have difficulties adjusting to the United States when I moved there to become the COO of Michelin’s U.S. truck business. Through my work in various international corporations, I had lived in the United Kingdom for seven years, in the Netherlands for two years, in the United States for one year, and in Spain for three. Besides, Michelin has a strong culture, the company’s processes are much the same wherever you work, and everyone uses the same (often French) technical terms. But as I discovered, it’s precisely when you expect to have no problems that you end up having them. After just a couple of months, the HR head took me aside to suggest that I needed to show more sensitivity to U.S. cultural norms. As an American who had spent a lot of time in France, he understood that the two cultures differ sharply in their approaches to interacting with and managing people, and he saw that those differences were causing misunderstandings between my team and me. Take the way I gave feedback. In France, we focus on identifying what’s wrong with someone’s performance. It’s considered unnecessary to mention what’s right. What’s good is taken as a given. A French employee knows this and reacts accordingly. But for a U.S. employee, as I discovered, it is devastating, because Americans tend to sugarcoat one negative with a lot of positives.

Profile Luc Minguet is the head of group purchasing at Michelin, a global tire company based in France. From 2002 to 2007 he was the COO of the group’s U.S. truck business unit.

“Managing across cultures doesn’t stop with a training –Luc Minguet program.” 78 Harvard Business Review September 2014


VOICES FROM THE FRONT LINES HBR.ORG

French managers get their wires crossed the other way. When they get what sounds like glowing feedback from an American boss, they think they’re superstars. Of course, when they don’t get the big pay raise they expected after the great review, they’re bitterly disappointed! With the help of an executive coach who specializes in cultural issues, I was quickly able to make a few adjustments and communicate more clearly with my team about my management approach and our cultural differences. Once my team members and I had a better sense of where we were all coming from, we got along just fine and were very successful. I think we ended up with the best of both cultures: I became less intimidating, and my American colleagues became more open to criticism. Today we train managers across the global organization to embrace that kind of cultural understanding and flexibility. I’m currently heading projects in Asia in which managers from France and many other countries are working with local employees, and I’m using the same kind of training to sensitize both groups of managers to potential culture clashes. It’s especially important to do this in cultures where people are hesitant to voice disagreement. Of course, we’ve always done some culture training, but we generally have focused more on people relocating to obviously different cultures than on the locals. And we’ve tended to underestimate differences with the countries that feel more familiar; for instance, we did not routinely prepare executives moving between America and Europe. I have also learned that it’s important to include the expatriate’s spouse or partner, because if that person has problems adjusting to the new culture, it will affect the manager. Managing across cultures doesn’t stop with a training program, of course. It’s a mind-set, something you have to practice every day, especially in a global company, such as Michelin, that encourages and promotes cultural diversity. When meeting new colleagues from different countries, I’m always careful to say, “Here’s how I give

feedback in my culture. How does it work in yours?” It’s actually a good icebreaker, and listening to others is a sign of respect. People like to talk about their own cultures, and with the talking comes understanding and connection. My experience in the U.S. made me much more careful about paving the way for Michelin’s move into Mexico, which I led from the United States. Since Mexico is

a neighbor to and a major trading partner with the U.S., you’d think that an American operation would have no problems anticipating cultural differences. But, fresh from my own difficulties, I took no chances. I insisted that our U.S. managers and our new Mexican managers do some cultural training together. People loved it. The shared experience created bonds among them—and successful businesses.

EDUARDO CARIDE

Diversifying Talent to Suit the Market TELEFÓNICA IS STILL a very young multinational: Even though we’ve been investing in companies and partnerships outside Spain since 1990, only in 2000 did we start to purchase full ownership stakes, with the goal of becoming a truly global business. We now operate in 14 Latin American countries, six European ones, and China. As a result, we’ve begun to think much more deeply about the portability of our talent and the diversity of our leadership teams. We see several benefits to moving managers across borders. The first is crossfertilization: People can transfer the lessons they’ve learned—the most successful processes and strategies—from one country to another. The second is relationships: When you’ve worked with people in different markets, it’s easier to pick up the phone and ask for help solving a problem. As an Argentine who spent two years in Profile Telefónica’s Miami office and four Eduardo Caride is years at our headquarters in Spain the regional director for Spanish-speaking before returning to Argentina, I countries in Latin can tell you it helps to have been America at Telefónica, on both sides of the world. The the Madrid-based fixed and mobile telephony third benefit is change managecompany. ment: Outsiders can help break September 2014 Harvard Business Review 79


SPOTLIGHT ON MANAGING ACROSS BORDERS HBR.ORG Visit Erin Meyer’s article “Navigating the Cultural Minefield” (HBR May 2014) online and use the interactive map to compare cultures on eight key dimensions.

more than 1,000 employees per year, and the natural tendency of local employees to Telefónica also sponsors local courses and resist new ideas and practices. seminars. But the best managers recogEarly on, the trend was to export nize that you can’t homogenize everything. Spanish managers abroad. Now, the streets run both ways. On our executive committee, For example, retail sales in Guatemala and we currently have people from Argentina, Nicaragua involve standing in a market with a megaphone shouting about the Brazil, Ireland, England, and Germany. On benefits of Movistar, one of our mobile my business development team, I have four brands. That’s different from working in a Argentines, one Frenchman, one Brit, and shop on the nicest street in Buenos Aires five Spaniards. I also manage eight country CEOs and one subregion CEO, each with his or her own executive committee. Within those teams we’ve found that it’s best to let functional roles drive the mix of foreign versus local talent. For example, the person reTAKEO YAMAGUCHI sponsible for selling to large corporate customers needs to be known in the market and have well-established relationships. The same goes for the people overseeing regulatory affairs and sometimes PR (though we often find that it’s helpful to have a Spaniard in the latter role, because politicians and journalists prefer to talk to the head office). For more technical roles, such as IT, executives can easily be transplanted from one country to another. The THREE YEARS AGO, if you’d asked how experience of having already developed a new 3G or 4G network is much more impor- many senior managers worked at Hitachi, or how many employees we had in the tant than local knowledge. United States or India, my colleagues and Some executives have an easier time than others moving between markets, I wouldn’t have been able to give you an answer. We knew that our worldwide head of course. With a few people who have count was about 320,000, and we had come to Latin America from Telefónica’s snapshots of information from the 948 European businesses, we joke that it’s like Dances with Wolves: They’ve gone native. companies under our corporate umbrella. But we had no systematic way of tracking And we’ve exported several people from employees, evaluating their performance, our region not only to headquarters in Spain or identifying future leaders. but also to places like the Czech Republic Today we do. and Slovakia, and many have stayed and I’d been working in one of our U.S. busiexcelled. But not everyone is portable. I’ve learned that the biggest predictor of success nesses for six and a half years when our is the person’s attitude toward learning: Is CEO called me back to Japan to help him he or she willing to listen and understand and other leaders embark on a companyrather than impose personal views? Those wide strategic and structural change initiaskills help ease any of the doubts new col- tive. The aim was to streamline our busileagues or employees might have. nesses into six market-driven groups with Telefónica has its own corporate uni- shared services and processes, creating versity, where management education pro- “one Hitachi”—a global conglomerate able to serve customers (and beat competitors) viders, such as IESE and Oxford Leadership around the world. My task, as the newly Academy, teach global best practices to 80 Harvard Business Review September 2014

showing a customer the apps on a new smartphone. So employees in different markets—even those within Spanishspeaking Latin America—need different skills and coaching. Telefónica’s growth depends on the ability of leaders to embrace this variety, to move fluidly between markets, and to recognize when it’s their job to change the business and when they must adapt to it.

Standardizing HR Practices Around the World appointed head of global HR, was to position us to achieve that goal by overhauling and improving our talent management practices. Our first step was to build a global HR database, capturing basic information— such as name, gender, function, title, pay grade, and performance history—for all our employees worldwide. Some people thought it was impossible because of Hitachi’s size and complexity. How could we put so many businesses on the same platform? But there are now 250,000 people in the system, including 50,000 executives mapped to managerial levels, and we expect to complete the project by 2015. Armed with this information, we’ll begin to standardize grading and performance management across the businesses so that a manager at company A will be reviewed and compensated the same way as a manager at company B in a comparable industry and region. At the same time, we intend to move away from the Japanese


VOICES FROM THE FRONT LINES HBR.ORG

“I found new allies among our regional HR leaders in China, India, and the United States.”

–Takeo Yamaguchi

Profile Takeo Yamaguchi is the corporate officer for human capital at Hitachi, a Tokyo-based conglomerate with operations worldwide.

tradition of seniority pay and promotion toward a system in which advancement is based on results. We want to set clear organizational goals that cascade down to individual goals. The database and the grading will help us give leaders feedback on their teams’ strengths and weaknesses and create benchmarks to improve performance. They also will allow us to gauge our competitiveness as an employer on metrics such as compensation and engagement.

In fact, we’ve already completed our first global employee engagement survey, with 140,000 people participating; we’ll do it again this year and compare the year-onyear results. Another critical initiative is our global leadership development program, which we rolled out in 2012. We’ve asked the CEOs and heads of HR for each market group to identify up-and-coming executives whom they see as the future leaders of Hitachi’s 30 most important businesses. They were

told to imagine the market five years from now, to write down the experience and skill sets those CEOs might need, and to select managers who, with the right training and assignments, could fit the bill. We now have a list of more than 400 high potentials worldwide, whom we’ll target for development. None of this has been easy, of course. It’s an enormous undertaking, with significant challenges. Each of our businesses, and their respective HR departments, had been accustomed to a great deal of autonomy, so the initial reaction from them was pushback and resistance: “Why are we doing this? Why do we have to standardize?” Even at headquarters, as I tried to set this new direction with a Japanese HR team that was in place before I arrived, I felt very alone. But then I brought in allies, from within and outside Hitachi, including six Americans. I found new allies among our regional HR leaders in China, India, and the United States. I consulted the right advisers—Mercer, Deloitte, Towers Watson, Egon Zehnder—and enlisted the right technology partner. And together we’ve begun to convince the local leaders that we’re doing the right thing. The company itself can’t be one Hitachi, with effective cooperation between businesses and market groups, if the HR function isn’t aligned. September 2014 Harvard Business Review 81


SPOTLIGHT ON MANAGING ACROSS BORDERS

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SHANE TEDJARATI

Shifting the Focus to Emerging Markets A LITTLE OVER a decade ago, Honeywell’s CEO, David Cote, embarked on a major transformation of the company. One of the big holes he identified in its strategy was emerging markets. Although Honeywell had sold industrial products and services in the United States and Europe for more than a century, it was not capitalizing on growth in other regions, notably China and India. Cote wanted to change that, so he invited me to join the company as one of his direct reports. This sent a clear message: Globalization would be a strategic priority for Honeywell going forward. I have yet to see a company succeed in emerging markets when the executive leading the charge reports to someone other than the CEO. He asked me to focus first on China, believing that if we succeeded there we’d have a better chance of doing so elsewhere. He gave me an open ticket to work with the board, senior executives, and their teams. To help them understand the importance of China, I didn’t just show a set of pretty slides; I articulated a strategy that spoke to our particular businesses and culture. One of the first pitches I made to my colleagues was titled “The Hungry Chinese Entrepreneur.” It was a story about five people who had built $40 million to $50 million companies in China by developing products that competed with Honeywell’s. Each business was small, but their combined force was like the Red Army’s march. That shocked the top team, and the four 82 Harvard Business Review September 2014

their Chinese counterparts to develop inexpensive products for the local market. Business soon took off there, too; by 2011, China and India together contributed 30% of Honeywell’s growth. We couldn’t devote the same resources to smaller emerging markets, so I came up with a model for countries such as Vietnam and Indonesia. We created a three- to fiveperson team to represent our busiProfile nesses in each country: a senior Shane Tedjarati is the leader, a government relations expresident and CEO, pert (essential in developing counglobal high-growth tries), a marketing executive, and regions, at Honeywell. He is based in Shanghai. one or two others to help execute. When this approach was successbusiness group leaders asked me to engage ful in Vietnam, we deployed it around the with their senior staff. The globalization world in 2012. We call these markets “highgrowth regions” instead of emerging marconversation had begun. Everyone could see that Honeywell had kets because they now account for more only salespeople in China—not strategists, than half of Honeywell’s total growth. marketers, or business owners. That’s why Most country managers come from we hadn’t even been able to estimate the within the company. Although I was market’s size properly. The heads of one brought in from the outside, I want the next unit asked if I could find them a general generation of global leaders to emerge from manager in China, and others soon fol- Honeywell’s fabric. Slowly but surely, the company’s center lowed suit. One by one, we hired about 150 managers in China and started to develop of gravity is shifting. China is our largest market outside the United States, and we products—the first time Honeywell had ever done so outside the United States or see it as ground zero for our globalization Europe. We called the strategy East for East. efforts. That’s why we’ve decided to create all our corporate capabilities there, from To ensure that we would be not only a innovation to after-sales service to prodlocal player but also a local competitor, we benchmarked ourselves against Chinese ri- uct development. China will serve as the vals, using a 100-question self-assessment globalization platform for all our other marthat allows us to evaluate our performance kets outside the United States and Europe, on every aspect of our businesses. Cote per- which is why I am based in Shanghai. David Cote often says that it isn’t the fitsonally reviews this report twice a year. In 2008, we decided that India should be test that survive; it’s the most flexible. At the next priority; Honeywell had a strong Honeywell we are trying to create a lot of engineering presence there, but our local flexibility so that our globalization efforts businesses were tiny. We employed the represent not a series of revolutions but a East for East strategy, but with some tweaks. constant, and successful, evolution. For instance, the Indians teamed up with HBR Reprint R1409E

“We see China as ground zero for our globalization efforts.”

–Shane Tedjarati


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Darrell K. Rigby is a partner in the Boston office of Bain & Company and heads the firm’s global retail practice. He is the author of Winning in Turbulence (Harvard Business Review Press, 2009), among other books.

digital-physical mashups TO CONSUMERS, THE REAL AND VIRTUAL WORLDS ARE ONE. THE SAME SHOULD GO FOR YOUR COMPANY. BY DARRELL K. RIGBY ILLUSTRATION: ISTVAN BANYAI

IN

the early days of the digital revolution, many leaders of established companies did their best to ignore the upheaval, convinced that the threat from new technologies wouldn’t ever amount to much. As that premise faltered, many flipped in their thinking, concluding that digital would inexorably destroy their positions. To survive, it seemed, they’d have to stop throwing money at the old businesses, salvage what they could, and launch independent digital ventures. The existing units probably wouldn’t survive, but disruptive digital businesses could replace the zombies in a company’s portfolio. Both views proved misguided. The failure of the first hardly needs elaboration: No company can safely ignore the changes wrought by digital

technologies. The failure of the second may be less obvious but is now well documented. Companies that milked existing businesses while betting on independent digital start-ups that had no competitive advantages usually wound up discarding decades’ worth of physical assets and gambling away millions in real value. Sears Holdings may be the poster child for this kind of miscalculation: Underinvesting in its stores while pouring resources into online ventures, it has suffered a 75% decline in stock price over the past seven years. Similar examples crop up in many industries. The central problem with either extreme is that it fails to account for how customers have changed: They now weave their digital and physical worlds so

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ILLUSTRATION/PHOTOGRAPHY: NAME

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DIGITAL-PHYSICAL MASHUPS

THE GREATEST BARRIER TO ADOPTING FUSION STRATEGIES IS NOT SKEPTICISM ABOUT THEIR PROMISE BUT INEXPERIENCE WITH THEIR EXECUTION.

tightly together that they can’t fathom why compa- “digical” fusions ultimately prove to be 10- to 20-year transitions toward further disruption, aren’t they still nies haven’t done the same. Let me relate a personal the best way to extend your core business, generate anecdote that illustrates the problem. Last December my daughter Stacy wanted to buy cash to fund continued evolution, and build the capathe Just Dance 4 video game for her little girl. She bilities that will be essential for future success? found it on a major retailer’s website for $29.97. To My colleagues and I have studied more than 300 be on the safe side—Christmas was approaching— companies around the globe and have worked dishe decided to go to the retailer’s local store and pick rectly with hundreds more that are trying to cope it up. There, however, it was selling for $47.97, a 60% with the dazzling but daunting changes reshaping markup. She was surprised, but she remembered the the marketplace. We’ve found that most induscompany’s price-matching guarantee, so she asked tries are still in the early stages of digital-physical for the online price. No dice, said the cashier—the transformation (see the exhibit “Digical’s Growing guarantee applied only to competitors’ prices. Momentum”). We’ve also found that the greatest barrier to adopting fusion strategies is not skepticism about their promise but inexperience with their execution. Executives are intrigued by the possibilities and recognize their potential but are uncertain how to make them work. Not surprisingly, best practices in this area are still emerging. But drawing on our study of leaders from 20 global industries, we have identified five rules that account for much of the difference between success and failure. Some of them are common sense but not “Wait,” Stacy said. “I can buy this game online and commonly practiced. Others may sound heretical, at have it shipped to the store free, right?” The cashier least to the proponents of digital disruption. But the agreed, but cautioned that it might take several days. leaders we studied uncovered big growth opportuniMy daughter replied, “But it’s on your shelf now. ties while rivals stood by wringing their hands. So it’s Can’t I just pay for it online and take one from the worth examining what they did and how. shelf?” Of course not, was the response; the store and the online operation were separate businesses, and that would mess things up. Standing at the regBuild your strategy around digitalister, Stacy ordered the item on her phone, and a few days later she came back to collect it—another exas- physical fusion. It can be your new competitive edge. perating process. People experience disconnects like this one all Some of the world’s leading strategy experts have the time. Here we are, a quarter century into the pronounced sustainable competitive advantage digital revolution, yet many companies still ago- dead. They explain that technology now changes so rapidly, and advantages are copied so quickly, that nize over whether to invest significant resources in companies must learn to leap continually from one digital capabilities. Those that have done so tend to wave of opportunity to the next—even though each run their digital operations as independent business units—the way companies prefer to manage them, new wave will probably be shorter, more crowded, as opposed to the way customers expect to use them. and less connected to the one before. The problem with this approach is that a company may end up As the revolution progresses, some companies throwing away core advantages while pouring rewill go the way of Tower Records, their businesses thoroughly disrupted and destroyed by digital alter- sources into risky ventures that have no competitive edge or right to win. To beat the odds, you have to natives. But most will find that they must fuse the either be very lucky or find some advantage that your digital and physical worlds, just as consumers are core business can provide to the new venture and doing. Look at your own business: Is the physical part of it really going to disappear? Wouldn’t innova- vice versa. These advantages may include proprietary customer insights, distinctive capabilities, and tions that fuse the digital and the physical open up ways to capitalize on a competitor’s vulnerabilities. vast new opportunities? And even if some of these

Rule #1

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Idea in Brief THE PROBLEM Too many companies run their physical and digital operations independently, creating disconnects that annoy customers. THE ANALYSIS Proponents of digital disruption contend that brick-and-mortar operations are dinosaurs. But most companies will find that they need to fuse the digital and physical experiences to allow customers to move easily between the two. THE GUIDANCE A study of global industry leaders reveals five practices that lead to growth. They will help you reconceive your business and create a sustainable competitive advantage.

Digical fusions can leverage a company’s existing strengths to provide just such an edge. Consider the case of Commonwealth Bank of Australia (CBA), which started life in 1911 and today operates with 52,000 employees in a dozen countries. When Ralph Norris was named CEO, in 2005, CBA had the worst customer satisfaction ranking in the industry and was losing market share in several important sectors. Like other major banks, it had been trying to reduce costs—and it was perhaps fearful that the internet would make branch banking obsolete. So it had reduced its branches from 1,756 in 1993 to 1,006 in 2005. The closures not only made it easier for online banks to gain share but also encouraged the entry and expansion of new branch-based competitors, including AHL Investments (Aussie Home Loans) and other nonbanking lenders. These aggressive rivals scooped up many of CBA’s old branch managers, loan officers, and customers. Norris began his tenure by touring the branches and studying customer complaints. He found that customers were criticizing virtually every touchpoint—they spoke of lousy products, long lines, inept employees, and high error rates. Norris, whose background is in IT, also scrutinized the digital infrastructure. He found decades-old systems that made it nearly impossible for even the best employees to do the right thing by customers. Norris’s vision was to build Australia’s finest financial services organization by excelling in customer service. He set a goal to rise from worst to first in customer satisfaction, linked the compensation of all senior executives to that metric, and focused on five areas for improvement: home loans, deposits, term deposits, passbooks, and customer relationship systems. He also set out to develop the digital capabilities that would make his goal possible, hiring and promoting top-tier IT talent that was committed to his vision. He persuaded CBA’s board to undertake

a “core banking modernization” program budgeted at A$580 million over four years (and later expanded to A$1.1 billion over six years). He simultaneously launched a program to revamp the branch network to improve convenience and service levels. These efforts produced an impressive succession of digical innovations. The project Finest Online modernized CBA’s internet banking service and combined it with in-person channels to eliminate all-too-frequent problems such as an inability to link personal accounts to commercial accounts. CBA’s mobile real estate app recognizes photos of properties, shows floor plans, helps customers figure out whether they can afford a given house, and starts the mortgage application process. The bank’s Kaching app was one of the first to allow multiple types of payment from a smartphone, including through Facebook. (The company responds in real time to inquiries on a Facebook wall.) CBA offers online loan approval in 24 hours, as opposed to the 14 to 21 days previously required, and in 2013 it launched SmartSign, a service that allows customers to execute loan documents electronically using a secure online portal. It also rolled out videoconferencing to its branches, enabling customers—particularly those in rural areas—to connect more easily with the bank’s specialists. CBA’s system is now so firmly embedded that it continues to gain steam even as competitors invest in their own systems and service improvements. Its fusion-based strategy helped propel the bank to the highest customer-satisfaction ranking for retail banks in 2013. CBA’s shares rose more than 80% from mid-2006 to mid-2014, compared with a 9% gain in the S&P/ASX 200 index over the same period. Most important, the technology platforms, customerfocused culture, and rapid-fire innovation processes that CBA developed in those eight years seem to be taking even longer for competitors to copy. September 2014 Harvard Business Review 87


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Rule #2 Add links and strengthen linkages in the customer experience. Thomas Edison is thought to have invented the lightbulb, but his carbon-filament bulb actually just improved on existing models. Edison’s real contribution was to create a system of electric-power generation and distribution that made lightbulbs work. He figured out every element of the system, set up a kind of idea factory to develop innovations for each one, and commercialized one after another. The results transformed daily life.

COMMONWEALTH BANK OF AUSTRALIA’S FUSION-BASED STRATEGY HELPED PROPEL THE BANK FROM THE LOWEST CUSTOMER-SATISFACTION RANKING FOR RETAIL BANKS TO THE HIGHEST. ITS SHARES ROSE MORE THAN 80% FROM MID-2006 TO MID-2014. Digical innovations are similar. They don’t just change a company’s existing products or services, as at CBA. They allow companies to identify adjacencies that strengthen the base business and create new revenue streams. Like Edison, a digical-savvy company thinks systematically about each piece of the customer experience. It develops innovative components and weaves them into a holistic system that extends competitive advantages and accelerates growth. Nike illustrates this approach. For many years it was as firmly rooted in the physical world as any company could be, producing shoes, apparel, and sports equipment to be sold through retail stores. It put up a website in 1996 but declined to sell any merchandise online for three years. In 1999 things began to change, starting with the NIKEiD program. Buyers could visit nike.com and customize certain Nike shoes, choosing their base and accent colors and adding a “personal I.D.” to the product. Nike then began introducing digical innovations at other points in the customer experience chain. In 2006 it unveiled the Nike+ app, which connects a shoe that has a built-in sensor and receiver to an iPod Nano. 88 Harvard Business Review September 2014

Runners could see data about their time, distance, calories burned, and pace on the Nano’s screen or hear it through their headphones. After a workout they could sync the Nano with a computer and chart their progress. They could even get personalized coaching. Today more than 30 million customers use Nike+, tracking and sharing runs, workouts, and fitness goals—and providing the company with invaluable data about who its customers are and what they value most. Nike+ FuelBand SE electronic bracelets take postsale involvement further, measuring all a user’s movements throughout the day and recording indicators such as steps taken and calories burned. As with Nike+, users can capture this data, track and record their level of activity, and share the information through social media. The results of all this innovation have been dramatic. Nike enjoys the highest social media engagement with customers in its industry. It has recorded an increased market share in key areas (including Western Europe and soccer—both once dominated by Adidas), a 42% increase in e-commerce sales from FY 2013 to FY 2014, and an overall growth rate that significantly outpaces that of key rivals. And it may be just warming up. “Digital sport is incredibly important to us,” Nike’s CEO, Mark Parker, told CNBC in April 2014. “You’re going to see digital be more and more integrated into other products that we have.” Through its partnerships with Apple and others, he said, the company hopes to expand the reach of the NIKE Fuel system and other applications to 100 million users worldwide.

Rule #3 Transform the way you approach innovation. When traditional companies add digital features to innovation programs, their approach typically resembles a waterfall. Marketers and product designers create ideas, build prototypes, and then throw the ideas downstream to IT, with instructions to develop specific digital features. “We’re launching a new product and marketing campaign. We want the mobile app to help us push out marketing messages and coupons and to make it easier for customers to send us e-mails when they have service questions. The CEO says she needs it in four weeks.” But another way to fuse the digital with the physical is to start by creating a team of complementary


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experts. Teams of this sort are not new, but digical innovation requires dramatically deeper and broader integration. Leaders engage digital experts at every stage, from idea generation to development, testing, and launching, and assemble teams for every possible type of innovation project. Their approach generates more wide-ranging, innovative, and integrated solutions, because team members’ combined expertise can fuse the best of the digital and physical worlds in every aspect of the project. Disney has followed this course since the design of Disneyland began, in 1952. But even Disney’s prodigious digical skills were stretched when the company launched a revolutionary project in 2009. The goals were to create a “more immersive, more seamless, and more personal experience” for Disney guests and to gather real-time data on guest behaviors that would help the company analyze traffic patterns and spending habits, manage labor efficiencies, and optimize the company’s future investment spending. The project would span the entire theme park experience and take in just about every customer touchpoint. Disney decided that the $1 billionplus vision was so much bigger than anything its celebrated Imagineering team of designers and product developers had ever undertaken that it required a new kind of organization. It set up an entrepreneurial unit dubbed Next Generation Experience, which ultimately employed more than 1,000 people from across the company’s functions. Next Generation’s leaders engaged experts from IT, Imagineering, theme park operations, marketing, and other functional areas. Their first release, the MyMagic+ system, combines digital technology with the three-dimensional theme park: My Disney Experience, a new website and mobile app, facilitates vacation planning and collects information about personal preferences; FastPass+ lets guests reserve attraction and character-greeting times and seats for shows; and MagicBands (RFID wristbands) act as tickets, room keys, FastPass+ verifications, and credit cards, allowing guests to charge meals or souvenirs with a flick of the wrist. The bands also interact with sensors in the park and transmit behavioral information that enables Disney to enhance the guest experience still further. Future applications may include the personalization of rides and attractions—for example, Winnie the Pooh might greet a child by name and wish him a happy birthday. Thanks to the initiative, Disney is on target to realize some $500 million in annual

incremental revenue with a 20% operating margin. If those numbers hold up, it will earn a healthy return on its billion-dollar investment.

Rule #4 Organizational separation is just an interim step. The choice between digital disruption and digical transformation has dramatic implications for a company’s operating model and organizational design. But those implications may not be apparent at first, because in either case successful innovators typically start by separating their digital revolutionaries from the core business. Separation enables these companies to attract talented innovators and programmers, locating them in San Francisco, Cambridge, Tel Aviv, Hyderabad, or anywhere else they want to be. A specialized capability—one unimpeded by corporate bureaucracy and uncontaminated by old-style thinking—can be built quickly. An upstart culture can challenge the status quo and seek to develop radical innovations. Compensation plans September 2014 Harvard Business Review 89


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and incentives can be tailored to the needs of the new rather than to the requirements of the old. But at some point these companies must make a decision. If they are facing digital disruption, they’ll leave the businesses separate for a long time—maybe forever. The core, after all, is a rival to be milked and ultimately destroyed. The businesses compete for market share, management attention, and financial resources in a battle to the death. Only one will be left standing. That may be the model Sears chose. Under CEO Edward S. Lampert, Sears has invested heavily in its wholly separate e-commerce business; one Credit Suisse analyst has said, “[Its] website is better than [that of] just about any other retailer I cover.” Online sales have grown steadily, and by late 2013 they were about $1.2 billion a year, according to analysts. But the company’s underinvestment in brick-and-mortar has been significant. In 2012, for instance, Sears spent an average of $1.46 per square foot on its stores, compared with the average of $9.45 per square foot spent by four of its chief competitors, according to the New York Times. Online sales account for only about 2.5% of total sales, which have declined steadily since 90 Harvard Business Review September 2014

2007; e-commerce revenue can’t possibly grow fast enough to replace lost revenue from the stores. Digital-physical transformations have different objectives and thus different operating models. The initial aim is to acquire digital skills as strong as those of any pure play disrupter. But the ultimate goal is to create the best of both worlds, developing capabilities that pure plays will be unable or unwilling to copy. So separation is a transitional step; over time the company will want to build at least some integration, which has advantages of its own: It satisfies customers’ wish for a seamless digital-physical experience, enables greater efficiency and economies of scale, and permits better coordination, avoiding duplicated effort. It also facilitates timely communication and execution of decisions, thus reducing conflict. An integrated business can leverage existing company assets in ways that a separate unit cannot. This kind of fusion is working well for Macy’s. As early as 2005 the company was devoting considerable resources to website and infrastructure capacity, and in 2010 it mapped out an “omnichannel” strategy—a long-term plan that included a host of initiatives designed to create seamless customer experiences both online and in stores. Finding that customers who used both channels to shop were five times as profitable as those who shopped online only, Macy’s invested heavily in its iconic Herald Square store in New York City and hundreds of others as well and began integrating them with its online business. It has turned virtually all of them into omnichannel fulfillment centers: Customers can order online and pick up their items at a local store. The Herald Square store is undergoing a $400 million renovation and will feature interactive directories, the widespread use of RFID tagging to track individual items, and a mobile app to guide customers as they shop. Sales associates equipped with mobile devices will be able to summon shoes from the back room without ever leaving the customer. Organizational changes reflect Macy’s growing integration. In January 2013, for example, Robert B. Harrison, previously the executive vice president for omnichannel strategy, became the first chief omnichannel officer, reporting to CEO Terry Lundgren. He also joined the company’s executive committee. As he continued to manage the development of strategies to closely integrate stores, online, and mobile activities, Harrison assumed responsibility for systems and technology, logistics, and related operating functions.


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Digical’s Growing Momentum “Digical” (combined digital and physical) innovations will hit some businesses much harder and faster than others, so a key first step is to assess your company’s environment. How much has the ongoing transformation already changed your industry’s offerings and competitive dynamics? How much is it likely to do so in the next several years? The figure below captures Bain’s assessment of digical transformation for 20 industries. You can see at a glance some of the key findings: The range of impact is wide. Change has been several times as extensive in media, technology, and telecom as in oil and gas, mining, and construction. The biggest change is yet to come. The next several years will bring far more innovation to most industries than they have seen in the past. Airlines, automobiles, and insurance, for instance, are on the verge of far-reaching digical transformations. Wild cards can affect the pace of change. Some industries will be held back by external factors. Medical technology and health care, in particular, won’t evolve as quickly as they otherwise might, owing to regulations, reimbursement practices, and liability issues.

Macy’s digical fusion has been great for its financial performance. Total sales have grown by $4.4 billion (19%) over the past four years, and the company recently reported a fifth consecutive year of doubledigit earnings growth. Its stock rose steadily from 2010 to 2013, increasing by 43% in 2013 alone (compared with a gain in the S&P 500 of about 30%).

Rule #5 Build a digical-savvy leadership team that includes the CEO. If digital technologies are expected to supplant the core business, the CEO’s primary task is to change the mix of businesses, not the fundamental capabilities of people within them. This kind of corporate evolution is much like biological evolution: Individual organisms don’t change, but the population evolves as superior species destroy less adaptable ones. The CEO encourages the physical business to keep up the good fight and siphons money to the new ventures on which the company’s hopes are pinned. CEOs who lead digical transformations face a more complex task. They must change not only the mix of businesses but also the capabilities of people in and around those businesses—including themselves, their board members, their executive teams, and the operating organization. Appointing a chief information or technology or digital officer (titles vary, but it’s a common solution) may be helpful but isn’t sufficient. And it will be harmful if it creates the illusion that the new executive will handle digital capabilities and no one else need get involved. Typically, digitally challenged CEOs are unaware of the extent of their ignorance and have a hard time hiring tech-savvy people. They also have a tendency to starve digital investments, encourage bad ideas, and kill good ones (or at least demand multiple rounds of improvements). But a growing number of CEOs are strengthening their grasp of the issues. They join the boards of digitally advanced companies. They spend more time with technology experts— venture capitalists, high-tech start-up teams, professionals in their own organizations. They read about digital topics, take online courses, acquire mentors, and play with the technologies their customers use. They also invite technology leaders onto their boards and launch “no executive left behind” programs to ensure that every leader in the organization accelerates his or her digital training. CEOs needn’t learn to write code, but they should understand why

SLOW MEDIA TECHNOLOGY TELECOM RETAIL BANKING RETAIL AIRLINES AUTO INSURANCE HOTELS & RESTAURANTS EDUCATION MEDICAL TECHNOLOGY TRANSPORTATION & LOGISTICS HEALTH CARE PAYERS & PROVIDERS CONSUMER PRODUCTS MANUFACTURING PHARMA UTILITIES OIL & GAS MINING CONSTRUCTION SOURCE BAIN

FAST

POTENTIAL CHANGE

CHANGE THROUGH 2020

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technology is important and how it can transform businesses and functions in the company portfolio. The remarkable makeover of Burberry, the august UK-based clothing company, demonstrates some of the possibilities. (See “Burberry’s CEO on Turning an Aging British Icon into a Global Luxury Brand,” HBR January–February 2013.) When Angela Ahrendts took over Burberry’s top job, in 2006, the brand had begun to turn itself around but was struggling to catch on among younger shoppers. Ahrendts brought a new vision. She believed that Burberry should explicitly target previously neglected customers—millennials—and speak to them in their mother tongue: digital. She hired a fresh marketing team, most of its

shortly before she left, Burberry’s stock more than tripled, while the FTSE 100 index rose roughly 19%.

The Digical Future Digical innovations are propelling leading companies in a growing range of businesses. The Ford Fiesta outsells competitors partly because of the company’s pioneering Ford Sync technology; more than half of Fiesta buyers say Ford Sync was a major reason for their purchase decision. Delta Air Lines was bankrupt in 2005 and rated last on Fortune’s list of most admired airlines in 2007, yet it is highly profitable and number one on the magazine’s list today. Among the many reasons for this improvement may be Delta’s sizable investments in digitally augmenting the physical aspects of flight. Its Fly Delta app, for example, not only provides information about flight itineraries, airplanes, and airports, but also lets passengers record their parking spots, check in, change seats, retrieve boarding passes, pay for excess baggage, track checked luggage, and view the ground under the plane (with Glass Bottom Jet). The immensely popular app had been downloaded an estimated 11 million times as of April 2014. Perhaps the surest sign that digital technologies are transforming physical businesses rather than annihilating them is the growing number of digital companies that are themselves moving toward digital-physical fusions. Two early pioneers of online trading—E*Trade and TD Ameritrade—have invested in physical branches. Google, which started life as purely a digital search engine, is now producing smartphones and tablets and smart glasses; it has also been building driverless cars, acquiring robotics companies, laying physical fiber, creating delivery services, and moving into connected devices within the home. Digital retailers such as Warby Parker and Bonobos are launching physical stores. Andy Dunn, the CEO of Bonobos, says, “We were wrong at the beginning. In 2007 we started the company, and we said, ‘The whole world is going online only. All we’re going to do is be online.’ But what we’ve learned recently is that the offline experience of touching and feeling clothes isn’t going away.” A digical lens will change how people perceive and manage nearly every activity in life and business. Try using it. Pick apart your customers’ experience chain to understand how digital technologies apply. Combining the physical and the digital promises to transform nearly every element of nearly every industry, including yours. HBR Reprint R1409F

ANDY DUNN, THE CEO OF BONOBOS, SAYS, “WE WERE WRONG AT THE BEGINNING. IN 2007 WE SAID, ‘THE WHOLE WORLD IS GOING ONLINE ONLY. ALL WE’RE GOING TO DO IS BE ONLINE.’ BUT WHAT WE’VE LEARNED RECENTLY IS THAT THE OFFLINE EXPERIENCE OF TOUCHING AND FEELING CLOTHES ISN’T GOING AWAY.” members under 25, and launched innovations such as the hugely popular Tweetwalk, which showed backstage pictures of Burberry’s collections before the runway show. She also created a new partnership at the top, including herself; the chief creative officer, Christopher Bailey; and the chief technology officer, John Douglas. She established a “strategic innovation council” and staffed it with what she viewed as the youngest and most forward-thinking directors in the company. The council developed digitally immersive physical experiences—live streaming of runway shows, video content on giant screens, digital mirrors that turned into screens displaying catwalk scenes—that made store customers feel like they were stepping into a digical “Burberry World.” Store merchandise carried RFID tags, so a customer picking up an item could instantly see product information and marketing materials on a screen. This digical strategy contributed to a significant increase in share price: From the time Ahrendts arrived to early 2014, 92 Harvard Business Review September 2014


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David M. Upton is the American Standard Companies Professor of Operations Management at Oxford University’s Saïd Business School.

Sadie Creese is the professor of cybersecurity at Oxford and director of its Global Cyber Security Capacity Centre. Upton and Creese are principal investigators in the Corporate Insider Threat Detection research program.

THE DANGER FROM WITHIN The biggest threat to your cybersecurity may be an employee or a vendor. by David M. Upton and Sadie Creese We all know about the 2013 cyberattack on Target, in which criminals stole the payment card numbers of some 40 million customers and the personal data of roughly 70 million. This tarnished the company’s reputation, caused its profits to plunge, and cost its CEO September 2014 Harvard Business Review 95 ILLUSTRATION: DALE EDWIN MURRAY


THE DANGER FROM WITHIN

and CIO their jobs. What’s less well known is that although the thieves were outsiders, they gained entry to the retail chain’s systems by using the credentials of an insider: one of the company’s refrigeration vendors. Target’s misfortune is just one recent example of a growing phenomenon. External attacks—pervasive intellectual-property hacking from China, the Stuxnet virus, the escapades of Eastern European gangsters—get plenty of attention. But attacks involving connected companies or direct employees pose a more pernicious threat. Insiders can do much more serious harm than external hackers can,

“The best way to get into an unprepared company is to sprinkle infected USB sticks with the company’s logo around the car park.” because they have much easier access to systems and a much greater window of opportunity. The damage they cause may include suspension of operations, loss of intellectual property, reputational harm, plummeting investor and customer confidence, and leaks of sensitive information to third parties, including the media. According to various estimates, at least 80 million insider attacks occur in the United States each year. But the number may be much higher, because they often go unreported. Clearly, their impact now totals in the tens of billions of dollars a year. Many organizations admit that they still don’t have adequate safeguards to detect or prevent attacks involving insiders. One reason is that they are still in denial about the magnitude of the threat. 96 Harvard Business Review September 2014

Over the past two years we have been leading an international research project whose goal is to significantly improve the ability of organizations to uncover and neutralize threats from insiders. Sponsored by the Centre for the Protection of National Infrastructure (CPNI), which is part of the United Kingdom’s MI5 security service, our 16- member team combines computer security specialists, business school academics working on corporate governance, management educators, information visualization experts, psychologists, and criminologists from Oxford, the University of Leicester, and Cardiff University. Our cross-disciplinary approach has led to findings that challenge conventional views and practices (see the sidebar “Common Practices That Don’t Work”). For example, many companies now try to prevent employees from using work computers to access websites not directly connected with their jobs, such as Facebook, dating sites, and political sites. We think they should instead give employees the freedom to go where they want on the web but use readily available security software to monitor their activities, thus yielding important information about behaviors and personalities that will help detect danger. In this article we share our findings on effective ways to minimize the likelihood of insider attacks.

An Unappreciated Risk Insider threats come from people who exploit legitimate access to an organization’s cyberassets for unauthorized and malicious purposes or who unwittingly create vulnerabilities. They may be direct employees (from cleaners up to the C-suite), contractors, or third-party suppliers of data and computing services. (Edward Snowden, who famously stole sensitive information from the U.S. National Security Agency, worked for an NSA contractor.) With this legitimate access they can steal, disrupt, or corrupt computer systems and data without detection by ordinary perimeter-based security solutions—controls that focus on points of entry rather than what or who is already inside. According to Vormetric, a leading computer security company, 54% of managers at large and midsize organizations say that detecting and preventing insider attacks is harder today than it was in 2011. What’s more, such attacks are increasing both in number and as a percentage of all cyberattacks reported: A study by KPMG found that they had risen from 4% in 2007 to 20% in 2010. Our research


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Idea in Brief THE THREAT Cyberattacks involving insiders—employees, suppliers, or other companies legitimately connected to a company’s computer systems— are pernicious and on the rise. They account for more than 20% of all cyberattacks. Widely used safeguards are ineffective against them. THE KEY To reduce their vulnerability to insider attacks, companies should apply the same approach they used to improve quality and safety: Make it part of everyone’s job. THE SOLUTION Employees should be monitored rigorously and told what threats are likely so that they can report suspicious activities. Suppliers and distributors should be required to minimize risks and should be regularly audited. Leaders should work closely with their IT departments to ensure that crucial assets are protected.

suggests that the percentage has continued to grow. In addition, external attacks may involve the knowing or unknowing assistance of insiders. The Target incident is a case in point.

Causes of Growth A number of factors in the changing IT landscape explain this rising threat. They aren’t particularly surprising—and that’s just the point. The doors that leave organizations vulnerable to insider attacks are mundane and ubiquitous.

A dramatic increase in the size and complexity of IT. Do you know which individuals are managing your cloud-based services, with whom you cohabit in those servers, and how safe the servers are? How trustworthy are those who provide you with other outsourced activities, such as call centers, logistics, cleaning, HR, and customer relationship management? In 2005 four Citibank account holders in New York were defrauded of nearly $350,000 by call center staffers based in Pune, India. The culprits were employees of a software and services company to which Citibank had outsourced work. They had collected customers’ personal data, PINs, and account numbers. “Dark Web” sites, where unscrupulous middlemen peddle large amounts of sensitive information, now abound. Everything from customers’ passwords and credit card information to intellectual property is sold on these clandestine sites. Insiders are often willing to provide access to those assets in return for sums vastly less than their street value, contributing to the “cybercrime-as-aservice” industry.

Employees who use personal devices for work. Increasingly, insiders—often unwittingly— expose their employers to threats by doing work on electronic gadgets. Our team and others have found that companies’ security groups cannot keep up

with the dangers posed by the explosion of these devices. According to a recent Alcatel-Lucent report, some 11.6 million mobile devices worldwide are infected at any time, and mobile malware infections increased by 20% in 2013. It’s not just smartphones and tablets that are to blame: The devices can be as simple as flash drives or phone memory cards. “The best way to get into an unprepared company is to sprinkle infected USB sticks with the company’s logo around the car park,” says Michael Goldsmith, a member of our team and an associate director of Oxford’s Cyber Security Centre, referring to the 2012 attack on DSM, a Dutch chemical company. “Some employee is bound to try one of them.” It was widely reported that delegates attending a G20 summit near Saint Petersburg in 2013 were given USB storage devices and mobile phone chargers laden with malware designed to help steal information. And the Stuxnet computer worm that sabotaged Iran’s uranium-refinement facility in 2008–2010 was reportedly introduced via USB flash drives into systems not connected to the internet. In truth, we are all vulnerable. The explosion in social media. Social media allow all sorts of information to leak from a company and spread worldwide, often without the company’s knowledge. They also provide opportunities to recruit insiders and use them to access corporate assets. The so-called romance scam, in which an employee is coaxed or tricked into sharing sensitive data by a sophisticated conman posing as a suitor on a dating website, has proved to be particularly effective. Other strategies include using knowledge gained through social networks to pressure employees: A cyberblackmailer may threaten to delete computer files or install pornographic images on a victim’s office PC unless the sensitive information is delivered. September 2014 Harvard Business Review 97


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Why They Do It A number of government and private case studies have established that insiders who knowingly participate in cyberattacks have a broad range of motivations: financial gain, revenge, desire for recognition and power, response to blackmail, loyalty to others in the organization, and political beliefs. One example we heard about during our research was a 2014 attack by a spurned suitor on a small but growing virtual-training company. A manager there had complained to his superior about the person in question—a systems administrator who had been sending him flowers at work and inappropriate text messages and had continually driven past his home. Once clearly rejected, the attacker corrupted the company’s database of

Managers in the Dark We asked 80 senior managers about their awareness of insider cybersecurity threats and followed up with in-depth case studies of actual incidents. Here’s a summary of what we found: • Managers across all countries and most industries (banks and energy firms are the exception) are largely ignorant of insider threats.

• They tend to view security as somebody else’s job—usually the IT department’s. • Few managers recognize the importance of observing unusual employee behavior—such as visiting extremist websites or starting to work at odd times of the day—to obtain advance warning of an attack. • Nearly two-thirds of internal and external security professionals find it difficult to persuade boards of directors of the risks entailed in neglecting the insider-threat issue. • Few IT groups are given guidance regarding which information assets are most critical, what level of risk is acceptable, or how much should be invested to prevent attacks.

training videos and rendered the backups inaccessible. The company fired him. But knowing that it lacked proof of his culpability, he blackmailed it for several thousand euros by threatening to publicize its lack of security, which might have damaged an upcoming IPO. This costly incident—like most other insider crimes—went unreported. Insider collaboration with organized crime and activist groups is becoming increasingly common. Many countries are now operating computer emergency readiness teams (CERTs) to protect themselves against this and other types of attack. Of the 150 cases that were analyzed by the CERT Insider Threat Center at Carnegie Mellon University for its 2012 report Spotlight On: Malicious Insiders and Organized Crime Activity, 16% had links to organized crime. One case was the 2012 theft by a Russian gang of details of 3.8 million unencrypted bank accounts and almost 4 million tax returns from the South Carolina Department of Revenue. Forensics showed that the attack was facilitated by an employee who clicked on a link in an e-mail, enabling the gang to steal the employee’s credentials and access the state’s data servers. Monica Whitty, a psychologist at the University of Leicester and a member of our team, and many others say that insiders who willingly assist or engage in cyberattacks suffer from one or more conditions in the “dark triad”: Machiavellianism, narcissism, and psychopathy. Supporting this view, a 2013 study by CPNI found that inside attackers typically have some combination of these personality traits: immaturity, low self-esteem, amorality or lack of ethics, superficiality, a tendency to fantasize, restlessness and impulsiveness, lack of conscientiousness, manipulativeness, and instability. Roger Duronio, a UBS Wealth Management systems administrator convicted of using a malicious “logic bomb” to damage the company’s computer network in 2006, exhibited a number of these traits. Duronio was worried about the security of his job

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and became livid when he received only $32,000 of the $50,000 bonus he had expected. So he shorted the company’s stock and set off the bomb. It took down as many as 2,000 servers in UBS offices around the United States; some of them couldn’t make trades for several weeks. The company suffered $3.1 million in direct costs and millions of dollars more in undisclosed incidental losses. Duronio was sentenced to 97 months in prison for the crime.

should be fired and prosecuted. A first offense for something less serious, such as sharing passwords to enable trusted colleagues to access corporate systems, might result in a warning that goes into the employee’s record.

How to Think About the Problem Managing insider cybersecurity threats is akin to managing quality and safety. All were once the responsibility of one specialty department. But organizations can no longer anticipate every risk, because the technology environment is so complex and ever changing. Thus the leaders of enterprises large and small need everyone in the organization to be involved. Here are five steps they should take immediately: Adopt a robust insider policy. This should address what people must do or not do to deter insiders who introduce risk through carelessness, negligence, or mistakes. The policy must be concise and easy for everyone—not just security and technology specialists—to understand, access, and adhere to. The rules must apply to all levels of the organization, including senior management. A framework provided by the State of Illinois is one model. Here’s a link to it: www.illinois.gov/ready/SiteCollectionDocuments/ Cyber_SOSSamplePolicy.pdf Employees should be given tools that help them adhere to the policy. For example, systems can be designed to flash a warning message on the screen when someone attempts to log into a subsystem that holds sensitive materials. The system could ask whether the person is authorized to be there and record and track those who are not. Policy violations should incur penalties. Obviously, an employee who commits a serious offense such as selling customers’ personal data or knowingly inserting malware in company systems

Common Practices That Don’t Work The most common cybersecurity safeguards are much less effective against insiders than against outsiders. ACCESS CONTROLS Rules that prohibit people from using corporate devices for personal tasks will not keep them from stealing assets. VULNERABILITY MANAGEMENT Security patches and virus checkers will not prevent or detect access by malevolent authorized employees or third parties using stolen credentials. STRONG BOUNDARY PROTECTION Putting critical assets inside a hardened perimeter will not prevent theft by those authorized to access the protected systems. PASSWORD POLICY Mandating complex or frequently changed passwords means that they often end up on Post-it notes—easy pickings for someone with physical access. AWARENESS PROGRAMS Simply requiring employees to read the company’s IT security policy annually will not magically confer cyberawareness on them. Nor will it prevent staff members from taking harmful actions. September 2014 Harvard Business Review 99


THE DANGER FROM WITHIN

What Can You Do? Some of the most important activities that nontech leaders should ask of their IT departments are: • monitoring all traffic leaving enterprise networks via the internet or portable media, and promptly reporting anything unusual or in violation of policy • staying current with best practices for supporting cybersecurity strategy and policy • rigorously implementing network defense procedures and protocols that take into account the operational priorities of the business • actively updating user accounts to ensure that employees never have more access to sensitive computer systems than is absolutely necessary • making frequent threat assessments and briefing the company’s leadership on them

You should also help employees understand how to safely conduct day-to-day tasks. Policy should be regularly reinforced with information sessions and internal communications campaigns, which might include posters in the workplace. Some companies screen videos demonstrating how policy violations can enable cyberattacks and how safer practices might have prevented them. Raise awareness. Be open about likely threats so that people can detect them and be on guard against anyone who tries to get their assistance in an attack. Customize training to take into account what kinds of attacks workers in a particular operation might encounter. Phishing is a common way to gain entry: Phony e-mails trick employees into sharing personal details or access codes or into clicking on a link that downloads malware. (Many people don’t realize that the “from” address in an e-mail is easy to forge.) It is possible to test your staff’s vulnerability to such attacks—either on your own or by employing an external security service. Even so, it can be difficult to defend insiders against a determined outsider. In April 2013 a French multinational company was the object of 100 Harvard Business Review September 2014

a clever attack. One vice president’s administrative assistant received an e-mail that referenced an invoice on a cloud-based file-sharing service. She had the sense not to open the file, but minutes later she received a phone call from someone who convincingly claimed to be another vice president at the company and instructed her to download and process the invoice. She complied. The invoice contained a remote-access Trojan that enabled a criminal enterprise apparently based in Ukraine to take control of her PC, log her keystrokes, and steal the company’s intellectual property. Encourage employees to report unusual or prohibited technologies (for example, a portable hard drive in an office where employees normally access data and software via the network) and behavior (an unauthorized employee or vendor asking for confidential data files), just as they would report unattended luggage in an airport departure lounge. Look out for threats when hiring. It is more critical than ever to use screening processes and interview techniques designed to assess the honesty of potential hires. Examples include criminal background checks, looking for misrepresentations on résumés, and interview questions that directly probe a candidate’s moral compass. Our team is developing tests that will allow employers to determine whether prospective employees have dangerous personality traits like those identified by CPNI. During the interview process you should also assess cybersafety awareness. Does the candidate know what an insider threat is? When might he share passwords with a team member? Under what circumstances might he allow team members to use his computer as himself? If candidates are strong in all other ways, you may go ahead and hire them, but make sure that they are immediately trained in your organization’s policies and practices. If someone is being considered for a job in a highly sensitive environment, however, you should think carefully about bringing him or her on board.

Employ rigorous subcontracting processes. As the Target breach demonstrates, you must ensure that your suppliers or distributors don’t put you at risk—by, for example, minimizing the likelihood that someone at an external IT provider will create a back door to your systems. If a supplier’s risk of failure or a breach is much smaller than yours, it may not adopt the controls you require. Seek out partners and suppliers that have the same risk appetite and culture your organization does, which will


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make a common approach to cybersecurity much more likely. Ask potential suppliers during precontractual discussions about how they manage insider-related risk. If you hire them, audit them regularly to see that their practices are genuinely maintained. Make it clear that you will conduct audits, and stipulate what they will involve. A company might require of suppliers the same controls it uses itself: screening employees for criminal records, checking the truth of job candidates’ employment histories, monitoring access to its data and applications for unauthorized activity, and preventing intruders from entering sensitive physical premises. Monitor employees. Let them know that you can and will observe their cyberactivity to the extent permitted by law. You cannot afford to leave cybersecurity entirely to the experts; you must raise your own day-to-day awareness of what is leaving your systems as well as what is coming in. That means requiring security teams or service providers to produce regular risk assessments, which should include the sources of threats, vulnerable employees and networks, and the possible consequences if a risk becomes a reality. You should also measure risk-mitigation behaviors, such as response times to alerts. Often routers or firewalls can monitor outgoing channels, but you should make sure that the functionality is activated. If you don’t have the equipment to monitor outgoing traffic, buy it. You must also log and monitor other means of exfiltration— USB flash drives and other portable storage media, printouts, and so on—through spot checks or even permanent, airport-style searches of people entering and exiting your buildings. (General Electric and Wipro use these in Bangalore.) For monitoring to be effective, you must diligently manage the privileges of all employees—including those with the highest levels of access to company systems, who are often the instigators of insider attacks. Prune your list of most privileged users regularly—and then watch the ones who remain to verify that they deserve your trust. Look for insider-threat-detection systems that can predict possibly preventable events as well as find events that have already occurred. Big data can be helpful in linking clues and providing warnings. Malware-detection software can be useful. Particularly in outsider-insider collaborations, a key initial step is introducing malware into the network.

When you find malware, consider that it might be part of an insider attack; an analysis of how the malware is being used may provide clues to the identity and wider objectives of the attacker. Monitoring to this degree will increase everyone’s workload but will pay off by building the resilience of and reducing the risk to your enterprise. THE MOST effective strategy for defusing the cyberthreat posed by insiders is to use the protective technologies available and fix weak points in them, but focus ultimately on getting all insiders to behave in a way that keeps the company safe. People need to know what behaviors are acceptable or unacceptable. Remind them that protecting the organization also protects their jobs. HBR Reprint R1409G

CARTOON: JOHN CALDWELL

“Sorry to see you go, Doug. You leave us with some big shoes to outsource.” September 2014 Harvard Business Review 101


An absolute must-read for any manager or entrepreneur. — Steve Blank, author, The Four Steps to the Epiphany; father of the Lean Start-up Movement

CLAYTON M. CHRISTENSEN Bestselling author of THE INNOVATOR’S DILEMMA With a foreword by

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The Globe

Goodbaby beats its rivals by introducing 100 new products each quarter.

A Chinese Approach to Management A generation of entrepreneurs is writing its own rules. by Thomas Hout and David Michael

C

hina Inc. might appear to be an improbable source of fresh management thinking. Its state-owned enterprises are, for the most part, regulated giants that are experimenting with Western management practices. China has yet to produce a world-class company like GE or Samsung, and outside the country most of its businesspeople are better known for amassing wealth than for innovative management ideas. Yet China offers more management lessons today than do most other countries. Sure, China’s best private companies aren’t yet pioneering radical new management approaches, as Toyota and other Japanese companies did 50 years ago with

total quality management, continuous improvement, and just-in-time systems. Instead, Chinese companies teach us management’s current imperatives: responsiveness, improvisation, flexibility, and speed. These abilities give them a critical edge; studies (such as those by Qiao Liu and Alan Siu of the University of Hong Kong) suggest that China’s private unlisted companies earn higher returns—14%, on average, versus the 4% earned by stateowned companies. Chinese companies have learned to manage differently over the past 30 years because they’ve had to cope with a turbulent environment. What’s commonly perceived to be the highly controlled march of September 2014 Harvard Business Review 103

PHOTOGRAPHY: GETTY IMAGES


THE GLOBE

HAI DI LAO’S KEY SUCCESS FACTOR

The ability to spot, recruit, and retain teenagers capable of growing into store managers by the time they are 21 state capitalism is in reality an enormous and quickly evolving ecosystem, in which companies must scramble to keep pace with runaway growth and dramatic slowdowns, massive urbanization and huge rural markets, fierce competition and endemic corruption. Some scholars, such as Harvard Business School’s Paul Lawrence and Jay Lorsch, have linked companies’ management systems to the economies in which they grow. Stable, complex markets, their thinking goes, require structured organizations and managers capable of tackling several dimensions, such as functions and customer types, simultaneously. Rapidly changing markets favor loosely structured management systems, which can process new information quickly, and managers who can act independently. Chinese companies (barring state-owned enterprises) tend to fall into the second camp. They are higher in energy and much more nimble than most Western corporations are. China’s business leaders also manage people very differently. They’re culturally predisposed to see the members of their organizations as family but, in return, demand a lot from them. CEOs often come from humble beginnings: Three of China’s legendary company founders—Haier’s Zhang Ruimin, ZTE’s Hou Weigui, and Wanxiang’s Lu Guanqiu—all started on the factory floor and fought to free their companies from state or collectivist management. Other enterprises were started by traders, teachers, or clerks. These companies build alliances constantly, develop new products prolifically, and venture into 104 Harvard Business Review September 2014

unrelated businesses all the time. They expect to sustain high rates of growth and are comfortable with a heady pace. Business leaders in China also share two distinct perspectives. One is the view that they have to create their own ecosystems. The Chinese founder-manager believes that he or she will need to build almost everything—basic skills in recruits, suppliers, government ties, capital sources, and often schools for employees’ kids—from scratch and on a large scale. This is what Zhang Yong, who founded the fast-growing hot pot restaurant chain Hai Di Lao, does when he enters a new market. One of his key success factors is the ability to spot, recruit, and retain teenagers capable of growing into store managers by the time they are 21. Zhang tests trainees by assigning them tasks above their responsibility level, such as negotiating the takeover of a rival chain. That allows him to weed out those with low potential. Because management bench strength is the biggest constraint on his company’s growth, Zhang deepens managers’ commitment by offering generous incentives, trips outside China, housing, and education for their children. He creates his own suppliers by offering wannabe entrepreneurs contracts that promise lots of business in the future. He is also a master at pulling together the capital he needs from varied sources: local governments that offer financial incentives and subsidies, Chinese Communist Party angels, provincial investment funds, and friends of friends. To a large extent, the ability to do that depends on forging personal relationships and

showing that he can help bureaucrats meet their goals. Credit ratings aren’t necessary; it’s about who can be trusted. The second view the Chinese founders share is that they have to be as adept at managing the state as they are at managing operations. For decades the Chinese Communist Party barely tolerated private companies. Start-ups had no standing, so conventional sources of raw materials, talent, and money were closed to them. Chinese businesspeople still have to tap officials to get licenses to operate, lease space, find workers, import materials, and raise capital. However, they’ve learned to make the system work for them. The results would have fascinated Charles Darwin, whose research focused on how different species evolve in response to environmental pressures. If there’s a business equivalent to the Cambrian period of explosion and extinction of species, China from 1991 to the present is it. Many entrepreneurs fail in China, but the survivors become resourceful, flexible, and fierce competitors. Indeed, they may well be the vanguard of an era in which the ability to adapt quickly, navigate messy environments, and use unproven talent yields competitive advantage globally.

China’s Unique Management Practices Over the past five years, we’ve studied more than 30 large private Chinese companies. We found that most of them display a trading mentality that values high asset turnover and good timing over perfection; a Confucian preference for simple PHOTOGRAPHY: AP IMAGES


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organizational structures, with everyone reporting to the top; a deep fear, stemming from China’s past instability, of too much debt; and skill in dealing with different levels of the powerful state. The good companies, however, are defined by something more: high aspirations and an openness to experimenting with radically different management techniques and practices.

Structuring organizations simply. China’s business leaders are notorious for controlling companies from the top, but what is less well known is how much they decentralize, which helps them respond to market shifts and rapidly add new business lines. In China the need for adaptation is constant, and it involves keeping pace not just with the market but also with differences in the development of each province and the power of local officials. Because such differences can be stark, Chinese companies create structures that give business units nearly total autonomy. Consider Midea, China’s second-largest home appliances maker, based in Shunde, a city across the border from Hong Kong. Midea manufactures everything from vacuum cleaners and small water heaters to microwaves and air conditioners. Most of the major product lines operate as independent businesses rather than as parts of a larger matrixed organization. Each business has a leader responsible for its P&L, who has the authority to build a sales force, line up suppliers and retailers, and construct factories where the best incentives are available. The notion of synergies across units has been largely set aside; the focus is on autonomy and accountability. Midea employed 126,000 people and generated $18.7 billion in sales in 2013; by comparison, Whirlpool had 69,000 employees and $19 billion in sales globally. Thus, Midea had nearly twice as many employees per unit of sales, reflecting some of the duplication of effort inherent in its organizational approach. Of course, Chinese companies produce more in-house and pay employees less than their Western counterparts, so Chinese enterprises can afford to employ more people. And in a

country with little business infrastructure such as logistics providers, distributors, and retail chains, companies need a lot of manpower to grow. The Chinese founders we’ve studied have as many direct reports as possible; these leaders take the idea of decentralization and flat structures to the extreme. Haier, China’s dominant home appliance maker, comprises thousands of minicompanies, all reporting to the chairman. There are no pure cost centers; even the finance department functions independently, providing financing and advisory services for a fee. Though Western companies believe that multiple reporting lines protect them from risks, such as uneven product standards or hiring practices, while enabling scale efficiencies and learning benefits, most Chinese founder-CEOs eschew this notion. They chase topline growth at any cost and believe in structures that support rapid expansion. Indeed, improvisation and speed, coupled with low costs driven

WANXIANG’S KEY SUCCESS FACTOR

Investing in the companies from which it sources and coaching them in lean management by economies of scale, create considerable disruption inside and outside China. Companies in China operate in two time frames, executing today’s business while preparing to double in size in anywhere from three to five years. This involves not just adding resources but incubating new business models and launching new brands. In the United States or Europe, the business unit head would normally handle both time frames, but Chinese founders usually appoint two managers, each autonomous and responsible for one time frame and, effectively, competing for resources. Chinese leaders prefer direct conflict to

more complex, cooperative management structures that involve all their reports but operate out of their sight. Most would rather hire more arms and legs than create new cross-organizational roles. Smart Chinese executives make decisions in an ad hoc manner and are micromanagers. The most-sought-after employees are entrepreneurial, ready for the rough-and-tumble, and less likely to be top-of-the-class candidates, who tend to gravitate toward state-owned enterprises. Trouble is, entrepreneurial people tend to leave as quickly as they sign on, which is why turnover in China’s private companies is upwards of 20% a year. Moreover, most companies have invested little in talent retention and (unlike Hai Di Lao) are weak when it comes to coaching, feedback, and training. Localizing value propositions. Most of China is still developing, which means that it is marked by inexperienced customers, undercapitalized companies, no-name brands, and unique local business customs and traditions. The definition of quality, for example, reflects local needs. Construction companies will pay a premium for cement that dries quickly or can be poured in freezing temperatures, since they want to build at maximum speed and operate seven days a week. They will not pay a premium for cement that lasts 50 years instead of 30. Similarly, a Chinese retail chain will not pay for longer-lasting fixtures; if you remodel stores every six months, durability isn’t what you want. Localization provides companies a way to capture value—through what they offer customers and partners, and how they go to market. Sany’s march to the top of the construction equipment business in China illustrates how different the task of adapting to local customers and government is there. The company’s two biggest product lines are ready-mix cement trucks and excavators, which in developed countries are sold to contractors and expected to last decades. In China they’re mostly sold to local leasing companies, which rent them to local contractors on a job-by-job basis. The September 2014 Harvard Business Review 105


THE GLOBE

leasing companies, though small, are well connected, so they compete on their preferential access rather than on durability, and demand financing so that they can keep their capital commitments down. Sany builds low-end machines, has very local distribution systems, sells with little or no down payment, and offers the most service. It uses more managers who know more people, in more places—a very different way to go to market. Multinational rivals like Komatsu and Caterpillar, in contrast, serve the upscale market, selling higher-end machines to the few bettercapitalized construction companies. Sany’s business model has generated tremendous economies of scale, so it now has raised its sights, acquiring the German Putzmeister brand and moving into a number of overseas markets. Developing products quickly. The speed with which Chinese companies develop new products from existing technologies and ramp up large-scale production is often impressive. It’s a key reason that the Chinese have come to dominate the global silicon-based solar-panel business, forcing U.S. and Japanese producers to focus on more-exotic thin-film solar technology. Goodbaby International Holdings, China’s market leader in baby carriages and child car seats, beats rivals by introducing 100 new products on average each quarter. Fast-food chains in the country, including KFC China, introduce more new products each year than their U.S. counterparts, because local variations in taste demand it. The ability to launch new offerings is a by-product of heritage. Companies like Midea, Wanxiang, and Goodbaby started out manufacturing goods they didn’t design. They learned how to prototype swiftly to meet buyers’ demand for quick turnaround; to adapt designs to use different materials when the original materials were too expensive or unavailable; to modify equipment so that they could make different products; and, above all, to keep costs down. That flexibility helped Wanxiang, for instance, move from making bicycle parts out of scrap metal, to 106 Harvard Business Review September 2014

manufacturing components for Detroit’s Big Three, to buying and turning around the factories of struggling U.S. automotive component makers. Wanxiang CEO Lu’s approach to the United States was homegrown and experimental and leveraged his trading instincts and low-cost Chinese factories. Lu sent his son-in-law, Ni Pin, to run the American operation. Wanxiang did not have superior production technology or product designs, so it focused on three other levers. One, it brought in cheaper parts from its factories in China to feed the higher-value machining and finishing processes in the United States. Two, it invested in several companies that Wanxiang doesn’t control but from which it sources and to which it provides lean management coaching. And, finally, Wanxiang built stronger relationships with American managers and employees than the component operations’ earlier owners had cared to. Another company that takes a fast and flexible approach is the Broad Group, based in Changsha. It constructs buildings with remarkable speed and in an environmentally friendly fashion, using factory-built modules. Using a modular approach isn’t new, but the company has redesigned the risers and box work that frame a building into smaller, more manageable pieces that can be built more efficiently in the factory, and has created material-handling systems that move the modules around swiftly and allow new layers to be added easily. The units have all the utilities embedded, are plug-compatible, and are shipped to building sites in 40-foot containers for roundthe-clock assembly. As these examples illustrate, the skills Chinese companies rely on are mainly downstream industrial competencies. They don’t involve the upstream creation of technology, original designs, selection of materials, and design of equipment, or customer knowledge and marketing savvy. (The Chinese are just beginning to acquire design capabilities and the higher cost structure they entail.) Because of their downstream orientation, the practices of Chinese

corporations differ from their Western counterparts’ in some key ways:

Chinese companies generally keep engineering and manufacturing close, often colocating them. Multinational firms usually maintain greater organizational distance between the two functions.

Chinese companies tend to acquire new technologies either through formal licensing deals or by reverse-engineering them, but they keep the physical work of experimentation and production in-house. Multinationals, with their opposite resource endowments, do the opposite.

Chinese companies hire more midlevel engineering and manufacturing people, even though they’re getting expensive. Multinationals’ process design is usually driven by the desire to save production steps and labor hours, but the added engineering and manufacturing bandwidth gives the Chinese the luxury of tinkering, which can solve difficult problems. As many people know, when Apple had to redesign the screen of its first iPhone at the last minute, its Shenzhen supplier roused its engineers out of bed, developed a better screen, and overhauled the production line—in just four days’ time. Tencent, China’s leading internet service portal, illustrates how companies gain an advantage by quickly rolling out new offerings in China. Tencent now has over 700 million users, but it is often criticized for innovating little and imitating a lot. It was launched in Shenzhen in 1998 by five founders as a free instant-messaging service named QQ, with a friendly-looking penguin wearing a red scarf as its mascot. Its key strengths are the rate at which it has added more features—such as games, search, an e-commerce marketplace, music, microblogs, and even a virtual currency called Q-coins—and the ease with which users can connect with one another. Visit a café anywhere in China, and almost everyone will be connected to QQ but doing different things. Yet, there’s nothing completely new on the website, which earned profits of around $2.5 billion in 2013. Tencent just beats everyone else to it.


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SANY’S KEY SUCCESS FACTOR

Adapting its equipment offerings for local leasing companies, who need low capital commitments, not durability Using nonmarket strategies adroitly. Building relationships with government and other institutions is critical in China; it takes more partners to get anything done there than anywhere else in the world. Smart companies work to understand the party and state agency organization charts, and the underlying power structures, in every province and city. The trick is in knowing which officials to approach for what and where their interests lie, so that mutually beneficial deals can be put together. Chinese executives see forging personal relationships with party bigwigs as an essential way to manage costs, tax obligations, and market access. In turn, the party needs entrepreneurs to create a productive China and grow the tax base. It also needs to bring entrepreneurs into the fold as an important new political constituency. In short, the relationship between founder-managers and officials is often about problem solving rather than corruption. During the 2008–2009 recession, for example, party secretaries and mayors wanted to minimize layoffs. In one city a large private employer was being hounded by a tax collector to settle a contract dispute in an unreliable court—a problem the city’s party secretary could easily fix. The CEO struck a deal with the local party unit, promising no layoffs, and in return got his tax problems resolved fairly and quickly. Consider also the story of China’s biggest IT services firm, Neusoft, which was founded in 1991 in Shenyang by three university teachers. Neusoft bet half its capital on a desktop operating system, but it was quickly pirated. Cofounder and CEO Liu Jiren then had to scramble to develop custom software for B2B customers that would need Neusoft’s services over time. Eventually, Neusoft began helping local and central governments modernize their IT systems, which made it indispensable to China’s drive for modernization. Building on that base, Neusoft developed the capabilities to serve demanding customers overseas, partnering with multinational giants, such as Harman, Intel, SAP, and Toshiba, and establishing strong internal systems. The peculiar mix of a powerful state and a weak infrastructure gives relationshipsavvy founders like Wanxiang’s Lu and Neusoft’s Liu the wherewithal to venture into new industries, because they know how to build from scratch and have the connections to do it fast. They jump into white spaces, undeterred by lack of experience, since there are few dominant incumbents. Wanxiang, for example, is moving into the electric car business, and Neusoft into the medical diagnostic equipment business. Chinese CEOs have plenty of room for creativity and can work around the state if they don’t want to engage with it. That’s

what Wang Shi, the founder of the real estate developer Vanke Group, based in Shenzhen, did. Chinese property development used to be a local affair, with local governments making quick profits by repurposing agricultural land and selling it to construction companies at auction. The latter put up shoddy buildings and created poorly planned communities, leaving middle-class residents dissatisfied and unable to find housing that fit their needs. Wang forged a different path. He avoided the auctions and bought land directly, wherever possible, from cooperatives and governments. That allowed him to reduce land acquisition costs, although the locations were not in prime areas. He then built good-quality residential complexes, created roads and shopping plazas, and turned Vanke into a reputable brand. City officials began to seek him out to do business on his terms, and Vanke leveraged its reputation to become China’s largest residential developer. CHINESE BUSINESS is all about adaptation to the context. Management that grows from the frontierlike conditions in the country is more homemade, vertical, and local. In many ways Chinese management is a throwback to the days of Henry Ford, RCA, and Standard Oil, when national markets and professional management were just taking shape in the United States. In contrast, American multinationals today have to work hard to stay lean and nimble despite using many mechanisms to coordinate, integrate, and control their business units. The future of management lies somewhere between the top-down reform of Western corporations and the bottom-up maturation of Chinese companies. They have much to learn from each other. HBR Reprint R1409J Thomas Hout is a former partner at the Boston Consulting Group, a visiting professor at the Monterey Institute of International Studies, and an adjunct professor at Tufts University’s Fletcher School. David Michael is a senior partner and managing director at the Boston Consulting Group, based in San Francisco, and previously led the firm’s China practice. September 2014 Harvard Business Review 107

PHOTOGRAPHY: AP IMAGES


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In this competitive, rapid-cycle economy, businesses need a true picture of costs to make smart operational and strategic decisions. Getting at that real bottom line can be daunting when companies try to unravel the total cost of running a fleet of trucks to support business operations. Equipment costs are escalating, fuel prices are volatile, and the advanced technology of new equipment has made maintenance more complex and expensive. Those direct costs provide only one dimension; hidden costs for owning and running a fleet are often embedded throughout the organization, but frequently overlooked when organizations try to nail down important business metrics such as a fleet’s true cost per mile.

The new and rapidly changing technologies have also made it harder for businesses to predict how many years they will be able to run their trucks and what those trucks will be worth when they are later sold or disposed of by other means. Without the tools and benchmarks needed to accurately evaluate their total cost of ownership (TCO), companies are missing the opportunity to optimize resources, while improving efficiency and customer satisfaction. “As the economy improves, companies are asking how they can operate more efficiently, so they can focus on improving and growing their core business,” said Marc Thibeau, Senior Vice President, Sales, Ryder. “The decision to own versus outsource fleet operations can be a critical

strategic decision. But having the right information is key: it is a complex equation, and without the right inputs, you won’t get the right output.” The components of a company’s TCO go well beyond the sticker price of a tractor or trailer. A 2012 survey by Ernst & Young found that many fleet owners were surprised at the amount of related salary and labor expenses for employees who indirectly support the fleet, such as accountants handling finance, tax and regulatory reporting. Companies also found it difficult to understand costs of vehicle downtime, when accidents and unscheduled maintenance took trucks off the road and slowed customer deliveries. When the actual numbers were summed up, many companies found their real fleet costs to be higher than they thought, Ernst & Young reported.


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In order to help companies get a comprehensive view of TCO, Ryder has developed a sophisticated, yet simple tool, that helps executives identify and assess the cost of fleet operation across their organizations. The tool draws data from thousands of companies, and then benchmarks those results against organizations with similar fleets and operations. That deep analysis allows organizations to evaluate where costs are high and where outsourcing— whether in purchasing, maintenance, fleet or supply chain operations— would be most valuable. When a company can offload functions such as driver recruitment, tax and compliance reporting, or roundthe-clock road service, it can then redeploy those dollars and related staff time more strategically. In addition to pure cost savings, there is additional upside to be gained from ensuring predictable fleet expenses, as well as reliable, uninterrupted customer service, says Samuel Johnson, Group Director, Marketing, Ryder. “There is a real value in being able to forecast complex costs, such as maintenance, as well as knowing that there will be a high customer service level,” said Johnson. “When you know your costs, you can, in turn, plan more precisely and set your pricing more accurately.” A true picture of the total cost of ownership, along with accurate benchmarking, can help companies

streamline operations, weed out waste and identify opportunities to deploy their resources more strategically. To gain a better understanding of your total cost of fleet ownership, Ryder offers a free TCO assessment that can help every company get a clear

view of (or firm handle on) costs. On average, using the TCO tool, Ryder has been able to identify up to 15% of potential fleet management savings for customers.*

*Source: Ryder Estimates

The Three Areas of a TCO Evaluation Cash costs: Different companies use different models to finance fleet acquisitions. Some pay cash outright or make large down payments and finance the rest. Others finance nearly the entire amount with a balloon payment at the end. Some organizations factor the cost of capital into the total cost of owning a fleet; others do not. Also consider: if cash is paid for the asset, what is the opportunity cost? Is there a better investment to make with that money? Additionally, purchasing power should be factored in; research indicates that bigger fleets find it easier to leverage their buying power as a procurement advantage. Operations: Maintenance costs include labor, tires, parts and supplies, as well as the costs associated with accidents, repair and temporary substitute vehicles. Maintenance costs rise with the age of the fleet and the complexity of the technology. Beyond the costs of keeping each vehicle running, it’s easy to overlook the array of people and systems that indirectly support running the fleet. Such costs may be hidden in functions such as IT, accounting and human resources. In HR, for example, costs associated with recruiting and managing technicians and drivers mount up. Procurement, contracting, driver compensation, insurance and fuel reporting take up resources in the finance and legal departments. Asset depreciation and disposal: Just as companies finance their fleets differently, fleet managers use different methods to depreciate assets and estimate vehicle salvage value. Disposal costs, taxes or gains, should also be factored in, if parts of the fleet are sold.

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CASE STUDY 119 Is it ever OK to break a professional promise?

SYNTHESIS 124 Why personalization is killing privacy

LIFE’S WORK 132 J. Craig Venter on the business of science

Experience

MANAGING YOURSELF PHOTOGRAPHY: KELLY BLAIR

Work + Home + Community + Self Skills for integrating every part of your life by Stewart D. Friedman September 2014 Harvard Business Review 111


EXPERIENCE

OVERCOMMITTED. DISTRACTED. STRESSED OUT. STRETCHED TOO THIN. This is how many of us describe ourselves today. I hear it from men and women; from the young and the old; from executives, MBA students, doctors, retailers, artisans, research scientists, soldiers, stay-at-home parents, teachers, and engineers around the world. In an age of constant communication and economic pressure, everyone is struggling to have meaningful work, domestic bliss, community engagement, and a satisfying inner life. Some have already given up on the idea of having it all: As I discovered last year in a study comparing undergraduates from the classes of 1992 and 2012 at the University of Pennsylvania’s Wharton School, a significant number of Millennials (the generation born from 1980 to 2000) are deciding not to become parents, because they don’t see how they can fit children into their busy lives. A commitment to better “work/life balance” isn’t the solution. As I’ve argued for a long time—and as many more people are now asserting—balance is bunk. It’s a misguided metaphor because it assumes we must always make trade-offs among the four main aspects of our lives: work or school, home or family (however you define that), community (friends, neighbors, religious or social groups), and self (mind, body, spirit). A more realistic and more gratifying goal is better integration between work and the rest of life through the pursuit of four-way wins, which improve performance in all four dimensions. Such integration starts with embracing three key principles—be real, be whole, and be innovative—that I described in a 2008 HBR article, “Be a Better Leader, Have a Richer Life.” It takes certain skills to bring those principles to life. In my 30 years as a professor, researcher, consultant, and executive, as I’ve studied and served thousands of people, I’ve found 18 specific skills that foster greater alignment and harmony among the four life domains. In this article I describe those skills and offer exercises—drawn from the latest findings in organizational psychology 112 Harvard Business Review September 2014

and related fields—to help you hone a few of the skills that business professionals often find most difficult to master. While there’s more you can do to instill the three principles (you’ll find a wider range of exercises in my new book, Leading the Life You Want: Skills for Integrating Work and Life), the advice offered here will help you move down the right path.

Skills for Being Real For well over a decade I’ve run a program called Total Leadership that teaches the three principles to executives, MBA candidates, and many others. It starts with a focus on being real—how to act with authenticity by clarifying what’s important, wherever you are, whatever you’re doing. That requires you to: • • • • • • Know what matters. Embody values consistently. Align actions with values. Convey values with stories. Envision your legacy. Hold yourself accountable.

The ability to do the first two things is especially crucial. Let’s begin with how to know what matters. One exercise that enhances this skill, called four circles, has you examine the importance and congruence of your various roles and responsibilities in life. (You can do it online at this free site: www.myfourcircles.com.) You start by drawing circles representing the four domains—work, home, community, and self—varying the sizes to reflect how much you value each. Next you move the circles to show whether and to what degree they overlap. At this point you think about the values, goals, interests, actions, and results you pursue in each domain. Are they compatible or in opposition? Imagine what your life would be like if your aspirations in all four circles, and the means by which you achieved them, lined up perfectly, like the concentric rings of a tree trunk. For most of us that’s an unattainable ideal, but what actions could you realistically take to move toward that kind of overlap? Could you change how you work, or even how you think about the purpose of your work, without diminishing the personal value you derive from it? Could you help your family to better see how your business life benefits them so that they would be more supportive of it? A complementary exercise, called conversation starter, encourages people to embody values consistently. This involves bringing an object from your nonwork life (such as a family photograph, a travel memento, or a trophy) into the office. If a colleague mentions it, you explain what this part of your life means to you and how it helps you at work. Then you consider asking that person to bring his or her own conversation starter. You might also take something from your work to your home and talk to your roommates, spouse, kids, or dinner guests about it. Tell them about what you do and who you are in your role at work,


HBR.ORG Take an assessment—produced in partnership with Qualitrics—of your Total Leadership skills, and learn how to strengthen them and about people who exemplify them at qualtrics.com/totalleadership.

focusing especially on what this might mean for them. When Victoria, the head of marketing for a pharmaceutical company division, drew her four circles, she initially placed the biggest one, representing work, apart from all the rest. She didn’t see any real connection between her professional identity and her home, community, and inner lives. But when she began to talk about the separation with a few colleagues, friends, and family members, she came to realize that one major aspect of her mission as an executive—promoting greater health—was a lot more compatible with her other circles than she had thought. She could also see how just a few small changes in approach might create

her mission at the office as well as in her family’s support.

Skills for Being Whole The second principle that Total Leadership addresses is being whole—or acting with integrity. What I mean by that is respecting the fact that all the roles you play make up one whole person and encouraging others to view you the same way. To do that you must be able to: • • • • • • Clarify expectations. Help others. Build supportive networks. Apply all your resources. Manage boundaries intelligently. Weave disparate strands.

Balance is bunk. It’s a misguided notion that assumes we must always make trade-offs among the different aspects of our lives. much more overlap. For example, at home she started to talk more with her two daughters about the social impact of her business, sharing stories about all the ways in which her company’s medicines were saving lives. The girls responded with greater pride in, and understanding of, their mom’s commitment to work. As a team leader, Victoria began to reframe core drug-marketing tasks in terms of the products’ benefits to end users—who were all the children, spouses, parents, siblings, friends, or neighbors of someone—just like the families and communities she and her employees had. As a result, her group became more impassioned and hardworking, which ultimately eased her load and gave her more time for other pursuits. Perhaps most important, Victoria felt less guilt about the way she was spending her time and energy, and newly secure in One of the most important skills here is knowing how to apply all your resources (such as your knowledge, skills, and contacts) in the various domains of your life to benefit the other domains. An exercise that helps you do that is called talent transfer. It involves writing a résumé listing all the skills you’ve developed—from mentoring colleagues, organizing family activities, or running a church bake sale— and thinking of how each might be used to achieve different ends. Organizational psychologists call this a strength development approach: You identify your talents and then apply them in new areas, enhancing them further. Another way to do this is to reflect on something that makes you feel good—a work accomplishment, a fruitful friendship, your commitment to salsa dancing—and then consider an area of your life you’d like to improve. How

might the skills you used to achieve the former help you in the latter? To manage boundaries intelligently is another key challenge. I advise people to practice something I call segment and merge, and then decide which strategy works best when. First, think about ways to create separation (in time and space) between your different roles. You might try setting limits on yourself. For example, if there’s an ambitious work project that you’ve been putting off, try dedicating the first two hours of each Saturday morning for the next month to tackling it, and then give yourself the rest of the day off. Or, if your job keeps monopolizing your evenings, you might experiment with a “no smartphones at the dinner table” policy. Now do the opposite: Think about opportunities to bring together two or more parts of your life. You might take a child to a company-sponsored charity run or bring a coworker to a block party in your neighborhood. After you’ve tried a new way of segmenting and a new way of merging, jot down your insights about what worked and what didn’t, for both you and the people around you. Were you more or less productive? Did you find yourself more or less distracted? How did others react? Were they put off, or did they seem to feel closer to and more trusting of you? An example of the segmenting concept in action comes from Brian, a manager in an accounting firm. In a monthlong experiment, he set aside his 40-minute train rides to and from work solely for “downtime.” He caught up on e-mails to family and friends and invested in his own development through reading and reflection— for example, by diagramming the factors affecting his sense of stability, including his stress and energy levels and his feelings about himself, his relationships, and his future. Sometimes, as an alternative to that inward focus, he had conversations with the neighbors, colleagues, and acquaintances he sat next to on the train, exchanging advice about everything from child care to real estate. This simple reallocation of commuting time—from doing work to September 2014 Harvard Business Review 113


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other things—resulted, perhaps paradoxically, in Brian’s being better prepared for work and more proactive about his career progression. He also felt closer to his extended family and the old friends with whom he’d reconnected and to the people in his local community, because he was engaging with more of them on his way to the office and back. Having an after-work buffer period allowed him to reenter his home with less stress and more openness and to develop new insights about how he could be a better father and husband. Personally, he also felt “more grounded and less crazed.” He came to see more clearly the positive impact of rest and recovery on his performance, which led him to experiment with increasing his sleep time by about an hour a day. Again, the small shift in boundaries significantly boosted his productivity, well-being, and relationships. Everyone with whom he interacted daily noticed that he was less cranky and more energetic.

Skills for Being Innovative The third Total Leadership principle is to be innovative—to act with creativity in identifying and pursuing more four-way wins. To do so, you need to: • • • • • • Focus on results. Resolve conflicts among domains. Challenge the status quo. See new ways of doing things. Embrace change courageously. Create cultures of innovation around you.

Scenario exercises are one of several effective methods of increasing your capacity to focus on results, especially on the quality of your contributions rather than the amount of time or energy you spend on them. Scenarios involve identifying a specific goal you want to achieve and then listing three alternative ways to get there, including the resources you’ll need and the challenges you’ll face. This sort 114 Harvard Business Review September 2014

of brainstorming encourages you to keep your eyes on the prize. Another method is experimenting with new patterns of behavior, trying activities at new times or in different places. It could be something as simple as shaving at the gym instead of at home, or practicing your trumpet at the office after hours rather than disturbing your neighbors at home. What were the pros and cons of switching up your routine? How did it affect your results? Crowdsourcing is an exercise that helps you practice how to see new ways of doing things. To try this, gather a group of your most creative friends and describe a problem you’re facing. Then ask for ideas about potential solutions and record what you hear. Select the one you think wisest, draft a plan, and try to make it happen. Stay in touch with your advisers, at least weekly, and after a month or so review your results with them. If the approach you tried didn’t work, or if you need more time to solve

the problem, tweak your behavior or try another idea altogether, drawing on what you learned from the first experiment. Former Bain & Company CEO Tom Tierney took not months but years to think about and solicit advice on what would eventually become the Bridgespan Group—an independent nonprofit that was incubated in and then spun out of Bain—which provides strategic consulting and leadership development to philanthropists, foundations, and other nonprofit organizations. In the 1980s he began to think, write, and talk about his idea for what he then generically called “Make a Difference Company,” picking the brains of colleagues and friends, including the likes of the presidential adviser and founder of Common Cause, John Gardner. Emboldened by those conversations, Tierney at first took small steps to move closer to his vision by, for example, volunteering for the United Way of the Bay Area while he was running Bain’s San Francisco office and eventually joining the nonprofit’s board. This was the first of many on which he would serve. In 1999, Tierney folded all that experience, knowledge, and crowdsourced wisdom into Bridgespan, and a year later he stepped down as chief executive of Bain to focus on the new organization. LEADING THE LIFE you want is a craft. As with music, writing, dance, or any athletic endeavor, you can always get better at it by practicing. That’s why I developed these exercises and many others. Start with these three big ideas: Be real, be whole, and be innovative. Understand the skills you need to accomplish each. And then commit to doing the fun and fruitful work of making them part of your leadership repertoire. HBR Reprint R1409K Stewart D. Friedman is the Practice Professor of Management at the Wharton School and the author of the forthcoming book Leading the Life You Want: Skills for Integrating Work and Life (Harvard Business Review Press, 2014). Twitter: @StewFriedman.


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2 Invest in change management system leadership and these formerly independent practitioners is a new opportunity and a challenge Health care systems are looking for ÂżQDQFLDODQGRSHUDWLRQDOPRGHOVWR manage “population healthâ€? — where providers not only care for patients in hospitals who are experiencing acute health issues such as heart attacks but also focus on well-being and disease management in all kinds of health care settings. As the number of people with chronic diseases such as diabetes rises, federal and private payer programs are beginning to reward providers for keeping patients healthy rather than paying solely for the number of visits or procedures performed. It is a paradigm shift moving health care providers from a reactive focus on sickness to a proactive approach that focuses on wellness and health. To meet the challenge, health care H[HFXWLYHVDUHÂżQGLQJQHZZD\VWR manage infrastructure, personnel, technology, and data. Physician incentives and compensation are being transformed. Collaboration and teamwork between specialties and functions are crucial, said Mike /DSSLQ-'FKLHIDGPLQLVWUDWLYHRIÂżFHU for Aurora Health Care, which has 15 hospitals and more than 30,000 employees. “In this new world, we’re moving away from a very hierarchical structure,â€? he said. “We need to empower people throughout the system, align them around a vision, DQGLQVSLUHWKHPWRIXOÂżOOWKDW´ The increasing power of the consumerpatient also adds a new dimension to health care. New tools are being created to help patients understand and make WKHLURZQGHFLVLRQVDERXWULVNVEHQHÂżWV and costs in their health care options. Time-pressed consumers also want easier access and a better customer experience, which is pressuring health care to adapt to a “retail model,â€? said Karen Haller, PhD, RN, vice president for nursing and patient care services, The Johns Hopkins Hospital. “We have to make care accessible when people want it, not just when we have RIÂżFHKRXUV´VKHVDLGÂł:HKDYHWREH innovative to compete with a pharmacy or clinic in a store.â€? In this period of rapid change and FRQWLQXHGÂżQDQFLDOFKDOOHQJHVKHDOWK systems are looking for new models of care and more productive ways to deliver it. “We are building a delivery model that doesn’t exist yet: It’s not health system-

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centric or insurance company-centric but has the patient at the center,� said Rishi Sikka, MD, senior vice president of clinical transformation at Advocate Health Care, which operates 12 hospitals with 6,300 doctors. “It’s a journey, and it is up to us as leaders of our organizations to try to create that bridge to the future — for our organizations and our patients.� LEARN MORE

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HBR.ORG Neil Bearden is a professor at INSEAD in Singapore.

Case Study

A student must decide whether to leave the company that sponsored his MBA for a dream job. by Neil Bearden

The Experts

Is It Ever OK to Break a Promise? TO: Patrick Fishburn, Asst. Manager, Operations FROM: Sameer Hopskin, Asst. Manager, Operations DATE: January 20, 2012 20:41 SUBJECT: RE: lunch today? thanks for the burritos—and the advice. i’m totally convinced i need to go for the MBA and move into the business side of things. i’ve learned a lot here, but i can’t be a college-educated factory hand forever! but man the tuition is crazy expensive! TO: Ioana Romano, VP, Operations FROM: Sameer Hopskin DATE: January 23, 2012 14:18 SUBJECT: Meeting with Mr. Baba Dear Ioana, I want to ask a big favor: I’d like a meeting with Mr. Baba to discuss the possibility of the company sponsoring me in an MBA program. I’m sure that I could add a lot of value if I had more business training. In my time at BABA, I’ve had four promotions and consistently high evaluations. I can do the job of just about anyone in the factory and can work most of the software the engineering guys use. But I feel pretty far behind on the business side of things. Please help me get a meeting with Mr. Baba. If he agrees to sponsor my MBA, I’ll be able to bring so much more to this company. Sincerely, Sameer TO: Sameer Hopskin FROM: Ioana Romano DATE: January 23, 2012 14:42 SUBJECT: RE: Meeting with Mr. Baba Hi Sameer, Anil doesn’t think it makes sense for us to send people off to do MBAs. He thinks it’s best to have our employees “get their hands dirty” and give them the training they need here. He’s also worried that they’ll leave the company if they get “fancy credentials.” Manufacturing is not the most glamorous business, and MBA recruiters are known for tempting people into more “prestigious” careers. Anil is big on commitment. He still talks about one senior manager—a man he’d spent years teaching the business to—who left a while back after taking September 2014 Harvard Business Review 119

Carolin Oelschlegel, principal, Strategy&

J. Frank Brown, managing director and COO, General Atlantic

ILLUSTRATION: CRAIG & KARL

HBR’s fictionalized case studies present dilemmas faced by company leaders and offer solutions from experts. This one is based on a class exercise used by the author.


EXPERIENCE

an executive education program and being wooed away by one of our competitors. I’ll try to get you a meeting, but I wanted to give you this background first. Anil started this company 20 years ago, and it wasn’t easy to get it where it is today. He’s really a committed boss, and he expects the same from his employees. Regards, Ioana TO: Anil Baba, CEO FROM: Ioana Romano DATE: January 23, 2012 17:52 SUBJECT: Sponsoring an MBA Hi Anil, Sameer Hopskin has worked for us for five years. He joined just after completing his BS in engineering and has had an excellent progression with the company. He’s part of my operations team now, and he hopes to transition to a management position. I think his real goal is to work more closely with you at headquarters. He’s hoping we’ll give him a one-year leave of absence to do an MBA, and that we’ll cover his tuition. I know you don’t like this kind of thing in general, but I think you should meet with Sameer. He’s a real asset to us. Will you do that for me? Respectfully, Ioana TO: Ioana Romano FROM: Anil Baba DATE: January 23, 2012 18:37 SUBJECT: RE: Sponsoring an MBA Fine. Tell him to come to my office tomorrow at 8 a.m. sharp. TO: Ioana Romano FROM: Sameer Hopskin DATE: January 24, 2012 10:17 SUBJECT: Never Give Up Dear Ioana, Thanks for arranging for me to meet with Mr. Baba. I really appreciate it. Unfortunately, Mr. Baba was not keen on my idea. I know he is a very successful man, but I think he may not appreciate fully what I could add to this company with some formal business training. The landscape is getting more competitive and 120 Harvard Business Review September 2014

complex. Surely the company could benefit from a more contemporary perspective. I know Mr. Baba respects you. I would really be grateful if you would talk to him again. I am a loyal employee. Please help me get Mr. Baba to understand that. Thanks in advance, Sameer TO: Ioana Romano FROM: Anil Baba DATE: January 29, 2012 05:02 SUBJECT: RE: Sponsoring an MBA You’re right about that Sameer kid. He reminds me of me. If he works hard for a few more years I can see him on my team. See what we can do to keep him around. TO: Anil Baba FROM: Ioana Romano DATE: February 3, 2012 12:17 SUBJECT: RE: RE: Sponsoring an MBA Dear Anil, I talked with HR, and we can structure a contract so that Sameer Hopskin will be obligated to work here for at least three years after finishing his MBA. If he leaves beforehand—and Legal says there’s nothing we can do to make that impossible— he’ll be required to repay us for his tuition. Sameer is a good kid, and I think he’s right about the advantages of having a few more MBAs around here. This investment might not look so bad if you consider how much we paid those consultants last year. Should I push this forward with HR? All the best, Ioana TO: Ioana Romano FROM: Anil Baba DATE: February 3, 2012 12:27 SUBJECT: RE: RE: RE: Sponsoring an MBA Get HR to draft the contract, and have that guy with the Russian name in Legal look it over. He doesn’t miss a thing. If this kid comes back afterward working for one of those consulting shops and charging us $10,000 a day, we’ll pay him out of your salary. TO: Sameer Hopskin FROM: Ioana Romano DATE: February 6, 2012 13:42 SUBJECT: RE: Never Give Up

Sameer, I talked to Anil, and he’s open to sponsoring your MBA. I also talked with HR about how to formalize this. The deal is the company would pay your tuition and commit to a position (with a promotion) upon completion of the degree. You would be obligated to work here for three full years; otherwise, you would have to repay the tuition. It’s a pretty standard setup— more or less what the consulting firms do. That’s the legal part of it. But I don’t want to offer you this unless we settle something more important. As you know, Anil’s main worry is that you won’t return after your MBA. It’s not about the money. It’s about the precedent. If you set a good example, Anil may see value in sending more of our people to get their MBAs, something I know several others, including your friend Patrick, are interested in. But if you violate his trust, no one else will get the chance. You have to promise that you’re going to bring all your new knowledge and skills back to this company. Sincerely, Ioana TO: Ioana Romano FROM: Sameer Hopskin DATE: February 6, 2012 13:49 SUBJECT: RE: RE: Never Give Up Dear Ioana, Thank you so much. I am fully committed to BABA. I will study hard and come back to really help this company grow. Faithfully, Sameer TO: Sameer Hopskin FROM: Patrick Fishburn DATE: February 6, 2012 20:41 SUBJECT: RE: MBA here I come dude that’s amazing! you’re totally paving the way for the rest of us! TO: Raji Hopskin FROM: Sameer Hopskin DATE: May 12, 2012 21:37 SUBJECT: RE: RE: Back to School Mom, Tell dad I gave Mr. Baba the bottle of whiskey he sent. Mr. Baba asked for your address, so I assume he’ll be sending you


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a thank-you note. He’s old school just like dad. Please thank dad again and tell him I did look Mr. Baba in the eye when I shook his hand today. (By the way, I don’t need any more lessons in “how to be a man.”) Love, Sammy TO: Sameer Hopskin FROM: Lucia Baltimore, VP, HR DATE: August 15, 2012 09:49 SUBJECT: Tuition Payment Confirmation Dear Sameer, Per our signed contract, we have made a bank transfer, and your tuition is paid. Regarding your last question: Yes, your medical insurance will remain active. There is no cost to you. See you in a year. Lucia Baltimore TO: Sameer Hopskin FROM: Patrick Fishburn DATE: June 6, 2013 20:16 SUBJECT: catching up dude, how is b-school wrapping up? things are good here. they gave me your old job, and i’m learning a lot. i’m psyched to do an mba myself. peace, p TO: Sameer Hopskin FROM: Dana Knight, Principal, Zeisberger Assoc. DATE: June 10, 2013 07:12 SUBJECT: Employment Opportunity Mr. Hopskin, I work with Zeisberger Associates, an executive search firm, and we represent a client who is interested in your profile. It is a startup in Silicon Valley with some serious VC backing. Your background in engineering and manufacturing, together with your stellar MBA performance, is really appealing to the company. Can we arrange a meeting to discuss? Cheers, Dana Knight TO: Dana Knight FROM: Sameer Hopskin DATE: June 10, 2013 07:22 SUBJECT: RE: Employment Opportunity Dear Ms. Knight, I have class all day, but I can talk this evening after 6. Sorry to ask, but how did you find me?

Thanks, Sameer TO: Sameer Hopskin FROM: Dana Knight DATE: June 10, 2013 07:25 SUBJECT: RE: RE: Employment Opportunity Sameer, we looked through your school’s CV book. Your profile is clearly the best fit. Trust me, it’s a very cool company. Amazing office, tennis court, gourmet lunches, jazz playing all the time, etc. I would so work there! Talk at 6. Cheers, Dana TO: Dana Knight FROM: Sameer Hopskin DATE: June 10, 2013 19:21 SUBJECT: RE: RE: RE: Employment Opportunity Dear Dana, I really appreciate your time today. The job does sound perfect. As I said, however, my company is sponsoring me, and I promised my boss I would return. I wouldn’t be here without their support. I need to think about this. Thanks again, Sameer TO: Sameer Hopskin FROM: Dana Knight DATE: June 14, 2013 19:26 SUBJECT: RE: RE: RE: RE: Employment Opportunity They loved you! But their investors are on their Board, so they’re being pushed to fill critical vacancies ASAP. Sorry but they want a decision quickly. You said your contract requires you to pay back your tuition. I can try to arrange for CloudSkim to cover those costs. As long as you honor the contract, you’re fine. Cheers. TO: Raji Hopskin FROM: Sameer Hopskin DATE: June 14, 2013 23:47 SUBJECT: RE: RE: Tough Decision! Mom, I still can’t figure out what to do. I feel really bad about all this. I didn’t look for it. They came to me! I know how you and dad feel, but the new job is an unbelievable opportunity—with a salary twice what I’d be making at BABA. When I promised Ioana I’d go back, there’s no way I could

have predicted this. Please make sure dad knows that the world is different these days. Things are more competitive now. Love, Sammy TO: Sameer Hopskin FROM: Ioana Romano DATE: June 17, 2013 18:22 SUBJECT: RE: Headhunter Sameer, That’s pretty common. Headhunters have approached me several times in my career. I appreciate the heads-up. (No pun intended.) I presume you told them you already have a job? See you soon, Ioana TO: Sameer Hopskin FROM: Lucy Vinapola, HR Manager, CloudSkim DATE: June 24, 2013 10:14 SUBJECT: Offer of Employment Dear Mr. Hopskin, I have attached your offer, with an annual base salary of $146,000 and a sign-on bonus of 50% of your MBA tuition. Please let me know if you have any questions. Yours, Lucy Vinapola TO: Sameer Hopskin FROM: Ioana Romano DATE: June 25, 2013 18:22 SUBJECT: RE: RE: RE: Headhunter Sameer, The job sounds fantastic. I get it. I just want to remind you that you gave us your word you would come back. I want the person I supported then to make this decision, the one who swore to me he’d help the company that helped him. I trust you’ll do the right thing. Sincerely, Ioana

Q

Should Sameer return to BABA or take the CloudSkim offer? See commentaries on the next page.

September 2014 Harvard Business Review 121


EXPERIENCE

The Experts Respond Carolin Oelschlegel is a principal at Strategy& (formerly Booz & Company) in London and the European lead of the company’s Katzenbach Center.

SAMEER SHOULD take the job with CloudSkim. His intellectual opportunities there will be far better than with BABA. But he has an obligation to respect his agreement with his previous employer. So he must manage the emotional and moral side of things with BABA—and I believe he could make a very good argument that the decision to support him wasn’t a bad one even if he departs the company. Both parties need to take a long view and refrain from burning bridges. For BABA, constraining Sameer and having an unhappy employee seems much less appealing than benefiting from an alumnus with great potential for a stellar career. Let’s put this in perspective: We’re not talking about a marriage. It’s a market contract of sorts, and as with everything in the market, conditions change and people have to adapt. If BABA were to get into trouble, how long would it be before it laid Sameer off, pointing to the unexpected change in fortunes? As long as Sameer honors the contract and repays his tuition, why should he be expected to take a different approach? To be sure, BABA made a major goodwill gesture, which it saw as setting a

precedent. So Sameer has a moral obligation to his former bosses and colleagues to be very open and honest. He needs to make Anil and Ioana—and eventually

This isn’t a marriage— it’s a market contract of sorts. Conditions change, and people have to adapt. Patrick—understand what a big opportunity the CloudSkim job is and how much more he stands to gain in terms of personal development than from what BABA can offer him. Sameer should also try to engage Anil and Ioana in a discussion about how his presence at CloudSkim could benefit BABA in the long term. They might explore how he could maintain ties with the company and perhaps find new market opportunities for it. He should think about people in his new networks who might work for BABA or how he could serve as an adviser. It’s certainly in Sameer’s interests to stay on good terms with BABA. He has spent

several years working hard to build his reputation there. For their part, Anil and Ioana need to adapt to the changed circumstances. In fact, the situation is as much a leadership test for Anil as it is a moral test for Sameer. Does Anil really want to deny a promising young manager such an attractive opportunity? That would give Sameer an even stronger justification for leaving, because the potential for growth at a company run by such a patriarchal leader would be limited. Anil and Ioana should accept that Sameer will leave them and should work with him to find ways to maintain a rewarding long-term relationship. If Sameer was feeling trapped in his job, perhaps Patrick and other bright young managers there are feeling the same way. Sponsoring MBA degrees for promising employees is a smart way to invest in their goodwill and commitment, and as Ioana pointed out, it can bring skills into the company that are more expensive to obtain otherwise. The fact that CloudSkim made Sameer an offer he can’t refuse doesn’t make the decision to support him a bad one. Anil and Ioana might need to think about their value proposition to talent.

WHAT WOULD YOU DO? SOME ADVICE FROM THE HBR.ORG COMMUNITY

SAMEER SHOULD go back. With business as well as technical knowledge, he would be highly valued and a potential successor to Anil. CloudSkim is not an established firm, and there is no guarantee he’ll like or adapt to its culture. Michael Lu, actuarial analyst, Towers Watson

HE SHOULD go to CloudSkim and pay the penalty. Maybe BABA will make a counteroffer, but if it’s below the new company’s, he has the right to switch jobs. Kornelis Wicaksono, master’s student, Lund University, Sweden

IF THE difference between the two jobs is purely monetary, Sameer should go back to BABA. If the new job provides him with an opportunity to better utilize his MBA skills, he should consider joining CloudSkim. Harjeev Sabherwal, MBA, ESSEC Business School, Paris

I DON’T see this as an employee–employer situation. Sameer made a personal commitment to an individual who helped make his MBA possible. I cannot conceive of any reasonable rationale that would justify breaking that promise. Rick Hasz, project management professional, Time Warner Cable

122 Harvard Business Review September 2014


HBR.ORG

J. Frank Brown is the managing director and COO of General Atlantic, a global growth investment firm headquartered in New York. He was previously the dean of INSEAD.

SAMEER SHOULD decline the CloudSkim offer and go back to BABA, as he promised. He should consider the long-term perspective: He has his whole career ahead of him, maybe 40 years. Many people who decide early on to go where the grass looks greener come to regret it. Besides, if Sameer is as smart and hardworking as he seems, I’m certain that more “dream job” opportunities will come his way. This is a chance to prove that he has principles as well as talent, which would only make him more attractive. Any future employer would see three years of successful post-MBA work at the company that sponsored him as a very positive signal. And Sameer should know that the work he’d be doing after his return to BABA would be much more interesting than his previous work there. Anil and Ioana wouldn’t have sent him off to business school if they wanted him to go back to his old job. They’ve gone out of their way to invest in him because they think he’ll be a real asset. Sameer shouldn’t think only about himself, either. If he proves to BABA that there’s ROI in sponsoring employee MBAs, it could help others who, like his friend Patrick, want to develop their skills. If he leaves, however, there is very little chance that anyone else in the company will get the same opportunity he did. In addition, he should be wary of the headhunter’s advice. Dana Knight’s main concern is to fill the post for CloudSkim, not to help Sameer further his career. It’s true that those in executive search firms are interested in long-term relationships with talented people, but that applies mostly at the senior level, not with unproven youngsters. I’d also advise Sameer to be a bit suspicious of the new company itself. I wouldn’t ever want someone to break a promise in order to join my organization. If CloudSkim’s people take a different view, it might say something about their values. Finally, leaving BABA just feels morally wrong. Sameer should reread the e-mail

he sent to Ioana swearing that he would return. I’d find it hard to look at myself in the mirror if I went back on such a firmly expressed commitment.

Many people who decide early on to go where the grass looks greener come to regret it. I have some advice for Anil and Ioana, too. They’re absolutely right to expect Sameer to come back, though I think a three-year requirement is maybe a bit long. (I’d have made it two.) They were perfectly clear with Sameer about the

deal. But they seem to have more or less left him alone during his MBA experience, and that was a mistake. The new environment, with new contacts and distractions, was bound to make BABA feel very far away. It’s much smarter to keep in close touch with the students you sponsor. Consulting firms are good about doing that. They treat the time in school like an assignment for the employee and do their best to make sure it’s a successful one, in many cases setting up regular check-ins with mentors who see what the students are finding interesting, offer help, and share ideas about next steps. The goal is to keep the student engaged with the firm. HBR Reprint R1409L Reprint Case only R1409X Reprint Commentary only R1409Z

CARTOON: ROY DELGADO

“I hate when our grandparent company visits.” September 2014 Harvard Business Review 123


EXPERIENCE

Synthesis A review of emerging ideas in the media

Pushing the Limits of Personalization by Scott Berinato

G

oogle’s newly acquired Nest thermostat tracks people’s movements around their house and “learns” how warm they like to keep the rooms. Facebook offers an app that turns on the microphone of a person’s device and listens to the sounds it picks up, apparently to better target music and TV choices. Amazon’s new smartphone has cameras that not only track pupil and head movements but also can use facial recognition data to estimate the gender, age, and ethnicity of the person looking at the screen. (Amazon says it hasn’t enabled that feature yet.) The recent rearchitecture of Disney World is centered on RFID bracelets that monitor the wearer’s actions and transactions in the park. 124 Harvard Business Review September 2014

We’re now in an age of continuous consumer surveillance; tech, retail, entertainment, and other companies are making multibillion-dollar strategic bets on their ability to tap vast amounts of vastly more personal data—and on our continued willingness to let them. Their reasons are obvious: They cash in by offering customers what they want when they want it and by selling the data to brokers and marketing companies. The promise to consumers is almost always the same: The more data you give us, the better, and less expensive, the service we give you. Nest keeps you comfortable and slashes your energy bill. Facebook connects you with people and things

you didn’t even realize you were missing. Disney promises shorter lines. (For more on Disney’s customer analytics, see “Digital-Physical Mashups” in this issue.) Sometimes the value swap is that clearcut, but for the most part, the trade isn’t nearly so equitable, as several new books point out. The mining is often far more invasive, and the data are used for far more purposes, than consumers realize. How are companies getting away with it? Christian Rudder argues in Dataclysm that although there’s been an uptick in public concern over loss of privacy, consumers are, for the most part, apathetic. “Tech loves to push boundaries, and the boundaries keep giving,” he writes. “Whenever Facebook updates its Terms of Service…to reach deeper into our data, we rage in circles for a day, then are on the site the next.” Rudder founded the online dating site OKCupid, so he understands why companies are obsessed with learning our every move: The data are seductively correlative.

ILLUSTRATION: ANGUS GRIEG


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Seemingly innocuous bread crumbs of information (what movies we like) or even data effluent (word-use frequency) can paint an astonishingly detailed portrait of a consumer and predict traits or behavior with eerie accuracy. Rudder shows, for example, how data scientists’ algorithms can guess a person’s sexual orientation correctly about 90% of the time solely on the basis of his or her Facebook “Likes.” At the same time, he says he’s personally ambivalent about using social media. “I myself know the value of privacy.” This admission from a man who built his business on data mining suggests that something other than apathy is at work here: consumer ignorance. Why else would companies work so hard to obfuscate their data practices, bury their ownership claims in byzantine Terms of Service, or make opting out difficult or dependent on losing other features? If consumers knew exactly what they were ceding, I think they’d opt out just as Rudder has. The problem isn’t just companies’ own data collection; it’s their growing capacity to mine outside sources—some of which they buy, and some of which are just “out there”—to build detailed consumer profiles. That’s the point journalist Adam Tanner makes in What Stays in Vegas, which looks at data collection through a single vertical industry—gambling. The CEO of one major firm Tanner spoke with describes slot machines that will soon recognize gamblers through retina scans, face or voice recognition, or fingerprints,

and then will tailor the experience on that machine to the individual. “It has my family pictures, it has my music, it has my friends,” the CEO says. “I can send a Facebook notification that I just won $300 at the Elvis machine.” Regulation is the sole impediment, she argues—and she dismisses that as a mere speed bump. It will be difficult to put the privacy toothpaste back in the tube. That’s the lesson of More Awesome Than Money, by reporter Jim Dwyer, which follows four NYU

“Whenever Facebook updates its Terms of Service…we rage in circles for a day, then are on the site the next.” Christian Rudder, Dataclysm

undergrads in 2009 as they struggle to launch a Facebook alternative that lets users control their personal data. It’s not a happy story (there’s a suicide), nor is it a hopeful one. You’d have a hard time finding anyone today who’s even heard of their Diaspora social network. None of these books suggests that the tide is turning against data collectors. None even challenges the assumption that companies have a right to own, share, and sell consumers’ personal data. Clearly, the industry hasn’t yet had its Unsafe at Any Speed moment.

Dataclysm: Who We Are (When We Think No One’s Looking) Christian Rudder Crown, 2014

What Stays in Vegas: The World of Personal Data—Lifeblood of Big Business—and the End of Privacy as We Know It Adam Tanner PublicAffairs, 2014

More Awesome Than Money: Four Boys and Their Heroic Quest to Save Your Privacy from Facebook Jim Dwyer Viking, 2014

The Global Information Technology Report World Economic Forum hd.media.mit.edu/ wef_globalit.pdf

What these books offer instead is a fascinating, sometimes scary, look at how fully and relentlessly consumers are being stalked, paired with remarkably watery advice on what to do about it. Tanner’s “simple manifesto” centers mostly on the need for awareness and transparency, with a kind of self-help chapter at the end. Rudder does cite MIT professor Alex “Sandy” Pentland’s proposed New Deal on Data, featured in the 2008–2009 Global Information Technology Report, which would shift rights of ownership over all personal data back to consumers. And yet Rudder, like the Vegas CEO, says he doesn’t really believe that regulation will work. There’s reason to be hopeful, however. Pentland’s ideas are already being tested, most aggressively in the EU. In the U.S., experts say that the FTC is ready to pounce on overly intrusive or covert data collection, citing, for example, a stern warning it recently gave Facebook and WhatsApp—the location-based data company it recently scooped up—about their privacy failings. What will ultimately doom the deeppocketed data collectors, I believe, is their aggressive transition from tracking commodity web transactions to noholds-barred commercializing of deeply personal information. No one incident has yet coalesced opposition, but it’s building. The Atlantic’s report about Mike Seay, a man who lost his daughter in an accident and soon after received a piece of mail addressed to “Mike Seay, Daughter Killed in Car Crash, Or Current Business,” exposes the violative depth of today’s data collection. The harder companies push, the more craven their policies, the more they screw up in disturbingly visceral ways, the more likely they’ll be to find themselves rejected by outraged and empowered consumers—and to see their massive investments crushed by a regulator’s sledgehammer. Scott Berinato is a senior editor at Harvard Business Review. September 2014 Harvard Business Review 125


SPO N S OR ED SECTI ON

Managing Risk in a Constantly Changing World Businesses face increasing levels of risk that threaten both their short-term ability to perform and long-term opportunities to survive and prosper. So it is crucial that leaders have the ability to constantly monitor and manage their organization’s risk exposures. One of Zurich’s principal business leaders, Head of Property, Global Corporate in North America Joe Tinetti, recently talked about My Zurich, an online risk management portal that can help companies more effectively monitor and control their property and casualty insurance and risk engineering programs in order to help them make better decisions.

JOE TINETTI Head of Property, Zurich Global Corporate in North America

What are the challenges of risk management in this rapidcycle economy? Risk management has become increasingly complex as organizations have expanded globally, while systems have become more interconnected. Risk is very complex: The risk picture includes everything from catastrophic risks to the organization’s liability, property and employee safety exposures to multifaceted risks such as supply chain interruption and cyber risk. As you attempt to prepare to deal with risks in multiple locations, it is very challenging to track exposures and then align your insurance and claims administration with the regulations, which can be different and constantly changing in every country where you do business.

about insurance, claims, policy updates, renewals and risk actions as well as global and local regulation. It puts the company’s data as well as Zurich market intelligence and analytics in one central place so risk managers can take action quickly and efficiently. There are also benchmarking tools so risk managers can see trends in a country or region or identify a type of risk or loss where they need to focus on risk improvement programs.

Can the tool track tax and regulatory information across multiple countries? When companies operate globally, aligning with local regulations in a number of different countries can be a huge challenge. Zurich has a dynamic tool embedded in My Zurich that provides comprehensive tax and regulatory information from over 140 countries compiled and updated by a team of legal professionals globally. This is the kind of information risk managers need to have greater assurance that their programs will align with all local regulations and tax requirements, which also helps avoid penalties, fines, or the possibility of voided coverage or claims delays. If you are not prepared with the right policies, processes and plans to tackle complex risk and unpredictable events at home and abroad, the fallout could be severe.

How does My Zurich help focus and improve risk management? My Zurich gives customers direct access to Zurich risk engineers and claims professionals who can provide targeted consulting advice to help mitigate property and casualty risks in each of their locations—whether the risk is to the company’s liability, property or employee safety or a broader strategic risk. Then the tool lets key stakeholders monitor and update the progress of risk improvement actions around the world. It also allows managers to see where they have the biggest risk exposures.

How does My Zurich help meet these challenges of managing insurance and claims management? My Zurich provides real-time information from around the globe

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This is intended as a general description of certain types of insurance and services available to qualified customers through the companies of Zurich in North America, provided solely for informational purposes. Your policy is the contract that specifically and fully describes your coverage. The description of the policy provisions gives a broad overview of coverages and does not revise or amend the policy. Risk Engineering services are provided by The Zurich Services Corporation.


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Executive Summaries September 2014 SPOTLIGHT ON MANAGING ACROSS BORDERS HBR.ORG

Spotlight

58

Contextual Intelligence by Tarun Khanna

70

What’s Your Language Strategy? by Tsedal Neeley and Robert Steven Kaplan

77

Voices from the Front Lines

Managing Across Borders

Succeeding in foreign markets is more difficult— and takes longer—than most practitioners anticipate. This package explores the importance of contextual intelligence (in particular, knowing what you don’t know) and language, and includes perspectives from four executives.

PHOTOGRAPHY: ALESSANDRO COCO

ARTWORK Tomás Saraceno Galaxies Forming Along Filaments, Like Droplets Along the Strands of a Spider’s Web 2009, Venice September 2014 Harvard Business Review 57

GENERAL MANAGEMENT

ORGANIZATION & CULTURE

GLOBALIZATION

Contextual Intelligence Tarun Khanna | page 58

What’s Your Language Strategy? Tsedal Neeley and Robert Steven Kaplan | page 70

Voices from the Front Lines Perspectives from Luc Minguet, Eduardo Caride, Takeo Yamaguchi, and Shane Tedjarati | page 77 Executives on the front lines of managing across borders share their insights: Luc Minguet, of France’s Michelin, talks about the importance of cultural training not just for managers taking on assignments abroad but also for local employees who work with colleagues from around the world. He describes how his own experience learning to communicate across cultures reflects the tire-maker’s broader practices. Eduardo Caride, of Madridbased Telefónica, explains how the relatively young multinational is investing in a diverse talent mix as it strives to become a truly global company. Whereas early on, leaders relied on exporting Spanish managers abroad, he notes, the street now runs both ways. Takeo Yamaguchi, of Japan’s Hitachi, details his efforts to create standardized global HR systems and processes across the conglomerate’s 948 separate companies. “Three years ago, we had no systematic way of tracking employees, evaluating performance, or identifying future leaders,” Yamaguchi says. “Today we do.” And Shane Tedjarati, from the United States’ Honeywell, talks about how the industrial powerhouse is shifting its strategy toward new regions, such as China, India, Vietnam, and Indonesia. “We call these markets ‘high-growth regions’ instead of emerging markets,” says Tedjarati, “because they now account for more than half of Honeywell’s total growth.” HBR Reprint R1409E

The author, a strategy and international-business professor at Harvard Business School, has come to a conclusion that may surprise you: Trying to apply management practices uniformly across geographies is a fool’s errand. Best practices simply don’t travel well across borders. That’s because conditions not just of economic development but of institutional maturity, educational norms, language, and culture vary enormously from place to place. Students of managerial practice once thought that their technical knowledge of best manufacturing practices (to take one example) was sufficiently developed that processes simply needed to be tweaked to fit local conditions. More often, it turns out, they have to be reworked quite radically—not because the technology is wrong but because everything around it changes how it will work. There’s nothing wrong with the tools we have at our disposal, but their application requires contextual intelligence: the ability to understand the limits of our knowledge and to adapt that knowledge to a context different from the one in which it was acquired. Until we can better develop and apply contextual intelligence, failure rates for crossborder businesses will remain high, what we learn from experiments unfolding around the world will remain limited, and the promise of healthy growth in all parts of the world will remain unfulfilled. HBR Reprint R1409C

Language pervades every aspect of organizational life. Yet leaders of global organizations—where unrestricted multilingualism can create friction—often pay too little attention to it in their approach to talent management. By managing language carefully, firms can hire and develop the best employees, improve collaboration on global teams, and strengthen the company’s footing in local markets. Language proficiency—either in a lingua franca, or shared language, or in a local language—does not guarantee high performance. Recruiters may favor fluency over other capabilities. They may rely on external hires with language skills rather than grooming internal candidates with the capacity and motivation to learn new languages. And leaders may give expatriate assignments not to the best candidates but to people who speak certain languages. To hire and promote the best people, firms may need to provide training to meet global and local language needs. Fluency in a language also does not equal cultural fluency. For leaders, understanding the cultural background of each team member and customers is as essential as learning to conjugate new verbs. The same can be said for employees at all levels: Even when they are fluent in the lingua franca, a lack of cultural understanding can cause significant misunderstandings. To prevent such rifts, language training must include cross-cultural education. HBR Reprint R1409D

September 2014 Harvard Business Review 129


EXECUTIVE SUMMARIES

Features THE BIG IDEA POLITICAL ECONOMY STRATEGY & COMPETITION RISK MANAGEMENT THE GLOBE GENERAL MANAGEMENT

Profits Without Prosperity William Lazonick | page 46

Digital-Physical Mashups Darrell K. Rigby | page 84

The Danger from Within David M. Upton and Sadie Creese page 94

A Chinese Approach to Management Thomas Hout and David Michael page 103

The Big Idea

The Globe

digital-physical mashups TO CONSUMERS, THE REAL AND VIRTUAL WORLDS ARE ONE. THE SAME SHOULD GO FOR YOUR COMPANY. BY DARRELL K. RIGBY

THE DANGER FROM WITHIN The biggest threat to your cybersecurity may be an employee or a vendor. by David M. Upton and Sadie Creese We all know about the 2013 cyberattack on Target, in which criminals stole the payment card numbers of some 40 million customers and the personal data of roughly 70 million. This tarnished the company’s reputation, caused its profits to plunge, and cost its CEO

A Chinese Approach to Management A generation of entrepreneurs is writing its own rules. by Thomas Hout and David Michael

STOCK BUYBACKS Five years after the official end of the Great Recession, corporate profits are high, and the stock market is MANIPULATE THE booming. Yet most Americans are not sharing in the MARKET AND LEAVE recovery. While the top 0.1% of income recipients— MOST AMERICANS which include most of the highest-ranking corporate executives—reap almost all the income gains, good WORSE OFF. BY WILLIAM LAZONICK

IN Typically, digitally challenged CEOs are unaware of the extent of their ignorance. A quarter century into the digital revolution, many companies still agonize over whether to invest significant resources in digital capabilities. Meanwhile, customers— who are used to weaving their digital and physical worlds tightly together—wonder why companies haven’t done the same. The author and his colleagues at Bain have worked with and studied hundreds of companies around the globe that are trying to cope with the swiftly changing marketplace. Most industries, he writes, are still in the early stages of what he calls “digical” transformation—and the greatest barrier they face is inexperience with its execution. Drawing on Bain’s study of leaders from 20 global industries, he presents five rules that can help: (1) Build your strategy around digital-physical fusion. It can be your new competitive edge. (2) Add links and strengthen linkages in the customer experience. (3) Transform the way you approach innovation. (4) Organizational separation is just an interim step. (5) Build a digical-savvy leadership team that includes the CEO. Commonwealth Bank of Australia, Nike, Disney, and Burberry are among the companies whose efforts in this realm have paid off mightily. HBR Reprint R1409F

C

jobs keep disappearing, and new employment opportunities tend to be insecure and underpaid.

Though corporate profits are high, and the stock market is booming, most Americans are not sharing in the economic recovery. While the top 0.1% of income recipients reap almost all the income gains, good jobs keep disappearing, and new ones tend to be insecure and underpaid. One of the major causes: Instead of investing their profits in growth opportunities, corporations are using them for stock repurchases. Take the 449 firms in the S&P 500 that were publicly listed from 2003 through 2012. During that period, they used 54% of their earnings—a total of $2.4 trillion—to buy back their own stock. Dividends absorbed an extra 37% of their earnings. That left little to fund productive capabilities or better incomes for workers. Why are such massive resources dedicated to stock buybacks? Because stock-based instruments make up the majority of executives’ pay, and buybacks drive up short-term stock prices. Buybacks contribute to runaway executive compensation and economic inequality in a major way. Because they extract value rather than create it, their overuse undermines the economy’s health. To restore true prosperity to the country, government and business leaders must take steps to rein them in. HBR Reprint R1409B

The 2013 cyberattack on Target is just one recent example of a growing phenomenon: attacks involving connected companies or direct employees. According to various estimates, at least 80 million of these attacks occur in the United States each year—but the number may be much higher, because they often go unreported. Upton and Creese head an international research project whose goal is to aid organizations in detecting and neutralizing threats from insiders. Their team includes computer security specialists, management educators, psychologists, and criminologists, among others, and their findings challenge conventional views and practices. “The doors that leave organizations vulnerable to insider attacks,” they write, “are mundane and ubiquitous.” In this article they discuss the causes of growth in the number of insider cyberattacks, the reasons behind them, and five ways to tackle the problem: Adopt a robust insider policy at every level of the organization; raise awareness of phishing and other ploys; screen new hires thoroughly; employ rigorous subcontracting processes; and let employees know that you will observe their cyberactivity to the extent permitted by law. HBR Reprint R1409G

At first glance, China, which is known for large, often inefficient state-owned enterprises, might appear an unlikely source of fresh management thinking. Yet Chinese companies have a lot to teach the world about today’s business imperatives: responsiveness, improvisation, flexibility, and speed. To cope with their turbulent environment, the Chinese have developed those capabilities and learned to build everything—from skilled recruits to suppliers to capital sources—from scratch. They manage very differently, too: Eschewing Western-style matrix organizations, they favor flat, loose structures that allow them to jump on new opportunities and expand quickly. They roll out new products constantly and localize offerings with a vengeance. They’re also adept at nonmarket strategies, particularly navigating local politics and relationships with the state. Indeed, China’s entrepreneurial companies may well be the vanguard of an era in which the ability to adapt quickly, navigate messy environments, and use unproven talent yields a global competitive advantage. HBR Reprint R1409J

130 Harvard Business Review September 2014


HBR.ORG

How I Did It LEADERSHIP

Managing Yourself Work + Home + Community + Self Stewart D. Friedman | page 111

The CEO of Williams-Sonoma on Blending Instinct with Analysis Laura Alber | page 41

Launched in 1956 in California’s emerging wine region, WilliamsSonoma soon moved to San Francisco because so many of its customers lived there. In 1970 the founder created a catalog to serve people around the country—and that was the beginning of the company’s data collection and analysis. Knowing where its catalog customers lived informed decisions about where to locate its stores. As the company grew its brick-and-mortar presence, it also built up its mail-order business, acquiring a garden products catalog, the Hold Everything catalog, and Pottery Barn. In 2000 it launched fully transactional websites for its two leading brands. Today analytics infuses and enhances all areas of the business, from personalized website content for each visiting shopper to shipping and inventory management to extremely high-touch customer care centers. Williams-Sonoma comprises seven brands and has annual revenue approaching $5 billion. It accounts for 4% of all home furnishings sales in the United States, almost half of which come through the web, making it the 21st largest online retailer in the country. HBR Reprint R1409A How I Did It…

The CEO of Williams-Sonoma on Blending Instinct with Analysis

Experience

by Laura Alber

Thanks to its catalog heritage, the retailer was well positioned to collect and use data from customers and other sources. Now it has reorganized to take its analytics to a whole new level.

Work + Home + Community + Self Skills for integrating every part of your life by Stewart D. Friedman

Stressed out. Overcommitted. Distracted. This is how many people feel today. Everyone is struggling to have meaningful work, domestic bliss, community engagement, and a satisfying inner life. But committing to better work/life balance isn’t the answer. It assumes you must make trade-offs among the four main aspects of your life: work, home, community, and self. A more realistic and gratifying goal is better integration through “four-way wins,” which improve performance in all domains. Integration starts with embracing three principles: be real, be whole, and be innovative. This article outlines the skills that bring those principles to life and shows how to hone several critical skills with exercises such as:

• Four circles, in which you compare the importance of each domain with the attention you devote to it and look at overlap between domains • Talent transfer, in which you examine all your skills, from mentoring colleagues to organizing family activities, and how each might be used to achieve different ends • Crowdsourcing, in which you gather solutions for problems from creative friends and test them out Through these and other exercises, executives can find the path to a more fulfilling and less hectic life. HBR Reprint R1409K

Rise to the Top

POSTMASTER Send domestic address changes, orders, and inquiries to: Harvard Business Review, Subscription Service, P.O. Box 62270, Tampa, FL 33662. GST Registration No. 1247384345. Periodical postage paid at Boston, Massachusetts, and additional mailing offices. Printed in the U.S.A. Harvard Business Review (ISSN 0017-8012; USPS 0236-520), published monthly with combined issues in January–February and July–August for professional managers, is an education program of Harvard Business School, Harvard University; Nitin Nohria, dean. Published by Harvard Business School Publishing Corporation, 60 Harvard Way, Boston, MA 02163.

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EXPERIENCE

HBR.ORG HBR.ORG For Venter’s views on collaboration, go to hbr.org/venter.

Life’s Work

J. Craig Venter made waves in 1998 when he and his for-profit company, Celera, challenged the public Human Genome Project to a DNA-sequencing race. (It ended in a tie two years later.) Fired from Celera in 2002, the biologist now runs a nonprofit institute and two biotech firms, Human Longevity and Synthetic Genomics. Interviewed by Alison Beard HBR: You tend to set audacious goals and then achieve them. Why is that approach effective? Venter: The goals are only considered audacious by other people. With the Human Genome Project, it was only because it had been set up as a 15-year, $5 billion program that it seemed inconceivable that a small group could do it in less time for a fraction of the cost. To me, it seemed reasonable: I had an extraordinary team of people to make it so. One of my early teachers described my method as jumping off a high diving board into an empty pool, expecting my team to fill it before I hit bottom.

What kind of boss are you? Very hands-off. I set the goals and agenda, but in terms of execution, we decide as a team, or the individuals in charge of the programs make the calls. I’m not known for being a patient person, but maybe I’ve mastered that more over time—just realizing that things take a whole lot longer than I’d like.

You’ve faced criticism and career setbacks. How did you push through? You have to believe in what you’re doing and your own processes. My service in Vietnam taught me a lot. As a medic, I dealt with thousands of men who didn’t make it back, so I learned the worst thing you can lose is your life and that taking risks and suffering setbacks is part of moving forward. Having a long-term vision helps too. In our route to the first synthetic cell, it took time to work through all the problems. But I was certain they were solvable.

People accuse you of “commercializing” science. We’re in a dismal period of government funding, and policies are limiting creativity. So business is the way to drive science forward, and people are finding there’s no difference in the goals or outcomes, because for science to impact society, it has to be economically viable. Private government’s letting us down. PHOTOGRAPHY: MICHAEL LEWIS

investment is a way for breakthroughs to keep happening when the

How do you select your scientists and managers? We look for people who are creative, flexible, and self-motivated. People select into my organizations because they like the big challenges and know they bring something to the table that can make a difference.

You gravitate to risky hobbies: sailing, riding motorcycles, racing cars. Why? Diversions that require intense concentration force you to clear your mind and step away from the daily issues. That’s a key part of the creative process for me.

HBR Reprint R1409M

132 Harvard Business Review September 2014


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