The European Business Review Mar/Apr 2013

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The European Business Review March-April 2013

Contents Global Economy

Global Managemnet

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A 'Sigh of Relief' at Davos: Confidence and Caution Shared Center Stage Michael Useem

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Global Recessions: A Survivor’s Manual Irv Rothman

13 Fast-Expanding Markets: Where New Growth Can Be Found!

Terence Tse, Mark Esposito & Khaled Soufani 17 DAFZA Offers Highly Developed Infrustructure and Quality Services to European Companies 19 Structuring Your Organization to Meet Global Aspirations Suzanne Heywood & Roni Katz

24 Building Ethical Business Cultures: BRIC by BRIC Alexandre Ardichvili, Douglas Jondle, Jack Wiley, Edgard Cornacchione, Jessica Li & Thomas Thakadipuram 29 Performance Management Systems in Mexico: The Dual Logics of Evaluating Performance Anabella Davila & Marta M. Elvira

Business Ethics 33 Why Should Managers be Socially Responsible? & Sustainablility Antonio Argandoña 39 How Sustainability and Carbon Footprint Reduction is Transforming the DNA of Leadership. Key Trends for 2013 Nikos Avlonas

Business Operation

43 Predictive Analytics: New-generation Strategic Decision Support Tobias Klatt & Klaus Moeller 48 Flexibility to Improve Forecast Accuracy Karin Bursa 52 Demand Chain Management: Enhancing Customer Value Proposition Pankaj M. Madhani

Innovation

57 Unlocking Innovation Through Business Experimentation Stefan Thomke 62 Why Our Decisions Get Derailed and How to Get Back on Track Francesca Gino

Organization

Editors Jane Liu Peres Kagbala David Lean Elenora Elroy Annabel Jacobs Commissioning Editors Laura Macshane Nisha Khimji Natasha Scott Business Development Editors Ian Love Marcus James Mellisa Ford Head of Production Saul Luckman Production Charlotte Godfrey Illustration Suya Zhang Mark Hithersay Head of Finance Lynn Moses Editor in Chief The European Business Review Publishing Oscar Daniel

READERS PLEASE NOTE The views expressed in articles are the authors’ and not necessarily those of The European Business Review. Authors may have consulting or other business relationships with the companies they discuss.

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65 CEOs, Mind Your Own Business! Why and How Corporate CEOs Need to Pay More Attention to Corporate Functions Andrew Campbell, Sven Kunisch & Günter Müller-Stewens

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71 Making Corporate Learning Work Shlomo Ben-Hur & Nik Kinley

Copyright © 2013 EBR Media Ltd. All rights reserved.

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Companies must be socially responsible not only because it is demanded by society, or because it increases profits, but above all because CSR is part of good management.” Business Ethics, p.33

No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopy, recording, or any information storage and retrieval system, without written permission.

A 'Sigh of Relief ' at Davos:

Confidence and Caution Shared Center Stage

By Michael Useem Wharton management professor Michael Useem, returning from his 11th trip to the World Economic Forum in Davos, reports that confidence in the global economy is back "in the world's inner circles of business and policy." But he also suggests that the challenge ahead lies in efforts to avoid the arrogance and excesses responsible for the 2008 financial crisis. Below is his commentary on the recently concluded Forum.

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ore than 2,600 business, political and thought leaders gathered in Davos, Switzerland, during the last week of January for the 43rd annual meeting of the World Economic Forum. Among them were 50 heads of state, 350 government ministers and the CEOs of CocaCola, Goldman Sachs and Walmart as well as those of Human Rights Watch, Save the Children and Transparency International.

A striking chord running through the four-day talkfest was one of comeback.

No single commentator described it precisely as such, but to my mind, it was the most dominant single thread weaving

through the thousands of conversations that defined Davos this year and distinguished it from prior assemblies.

CNBC anchor Geoff Cutmore expressed it well at a closing plenary on the final day: It was the first Davos of recent years without a crisis hanging over its head, and businesses were feeling re-energized, so much so that it almost seemed as if "peace had broken out." Financial Times associate editor Martin Wolf characterized the meeting as "the-sigh-of-relief Davos."

of Merrill Lynch, Lehman Brothers and AIG. A prominent banker reported he was one of the few financiers who was still willing to go out during the daylight hours.

The temper of Davos in 2013 was far more sober than the exuberance of 1996 and 1997, but it was also far more upbeat than the distressed gatherings of 2008 and 2009. New statistics justified the mood of comeback. International Monetary Fund managing director Christine Lagarde reported that her

It was the first Davos of recent years without a crisis hanging over its head, and businesses were feeling re-energized, so much so that it almost seemed as if "peace had broken out."

I had attended Davos in 1996 and 1997 at a time of strong growth and soaring confidence. When Microsoft's Bill Gates and Intel's Andy Grove strolled together through a crowded reception, the crowd literally parted.

But in 2008, I had also witnessed Merrill Lynch CEO John Thain warn of dark days ahead, and in 2009, I heard angry recriminations in the wake of the financial crisis and the failures

organization had just forecast global GDP growth in 2013 to reach 3.5%, up from 3.2% in 2012. While Germany, Japan and the U.S. are expected to grow more tepidly, at least they will be in the black. And the developing world is on a genuine tear, with the growth rate expected to hit 5.5% – not just for China (8.2%) or India (5.9%). Many African and Latin economies were on track for vigorous expansion as well.

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At the same time, Davos attendees this year repeatedly cautioned themselves about the many risks and uncertainties that remain. Paul Singer, principal of New York-based hedge fund Elliott Management Corp., warned that in the continuing absence of global financial standards, banks are locked in a "race to the bottom." In the five years since the financial Armageddon brought on by the banks, he noted, far too much remains unchanged within them. Former British Prime Minister Gordon Brown cautioned that "we will have financial crises over the next 30 to 40 years" since "we have failed to learn the lessons" of the past crisis.

'Severe Income Inequality' Yet with a Sword of Damocles no longer quite so visible over the global economy, the fire-fighting of the past several years gave way this year to a healthy refocusing on the world's most chronic problems. Both income inequality and inequality of opportunity, warned a host of speakers, had worsened in many countries, including the U.S. – factual points whose toxic consequences were confirmed by the World Economic Forum's 8th annual Global Risks Report. Drawing on a survey of more than 1,000 observers and experts, the report found that "severe income inequality" stood as the number one global risk of the year.

Others singled out the still limited inclusion of women.

IMF's Lagarde, for example, cited a statistic suggesting that full inclusion of women in the American economy could boost the U.S. GDP by several percentage points. Anand

Mahindra, managing director of Mahindra & Mahindra, a $16-billion utility vehicle, information technology and equipment maker based in India, expressed concern about the enormous number of families still at the bottom of the pyramid struggling to overcome the risks of everyday survival. Italian Prime Minister Mario Monti singled out the millions of unemployed, especially young people, across the European Union. "We all have responsibility," he vowed, to help bring them back into the workforce.

“

Our sea-level has risen by as much as eight inches and extreme weather events like Hurricane Sandy are increasing in intensity and frequency. ”

And climate change, pushed to the back of the agenda during the dark days of the financial crisis, reemerged.

Environmental Defense Fund president Fred Krupp articulated the case as well as any: Emissions are far worse than predicted 20 years ago, our sea-level has risen by as much as eight inches and extreme weather events like Hurricane Sandy are increasing in intensity and frequency. Unless action is taken, he said, "at future [Davos Forums] we will be asking, 'How can we have allowed" a climate catastrophe to have occurred – much as we have been musing for the past several years on how bankers and regulators could have allowed the sub-prime mortgage disaster. We are not woolly mammoths, he noted, referring to a species unsuited to surviving the climate change of its era. "We just have to apply our intelligence."

Application of human intelligence is now more likely in the light of events like Hurricane Sandy, added Weather Company CEO David Kenny. "Extreme weather has become everybody's problem," even if many still do not see a direct link to climate change. It is fast becoming a business problem as well. "There's not a business in this room that does not have an extreme-weather risk," said Kenny, and it was thus in the interest of all, even the climate-change skeptics, to find ways, in the apt title of their session, of "avoiding the unimaginable."

Managing Risk and Uncertainty Many of the business leaders in Davos could see commercial opportunities in the risks and uncertainties ahead. Anand Mahindra summed it up from his own experience after completing his MBA degree in the U.S. in 1981. On returning to India, he found that he faced near complete certainty in the suffocating regulations and bureaucracy of India's

Both income inequality and inequality of opportunity, warned a host of speakers, had worsened in many countries, including the U.S. – factual points whose toxic consequences were confirmed by the World Economic Forum's 8th annual Global Risks Report.

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March-April 2013

"license raj." Rules defined or limited a wide range of business decisions, even down to the number of computers that a firm could annually import. "I had thought that regulation was what I had to manage," but now, he continued, "I know it's all about [managing] uncertainty."

Cisco Systems CEO John Chambers offered much the same assessment. "If you are risk averse, you get left behind," he warned, especially in difficult times.

And conversely, the opportunities for companies like Cisco to "break away" from its competitors are heightened in times of uncertainty and change.

That prescription was taken to heart by many of the World Economic Forum's "Young Global Leaders" who were finding traction where others had dared not tread. One young leader, for instance, had pioneered the hiring of autistic, deaf and other handicapped employees at a large corporation in ways that allowed them not only to perform well, but to be even more productive than their counterparts.

columnist Thomas Friedman hosted a panel of experts on the topic, including Bill Gates, investor Peter Thiel, MIT president Rafael Reif, former Harvard president Larry Summers, Udacity founder Sebastian Thrun, Coursera's Daphne Koller and an 11-year-old Pakistani girl, Khadija Niazi, who had taken one of the online physics courses and now planned to become a physicist.

Gates warned that today's courses are sure to evolve over the next several years in ways unforeseen, but other panel members saw their impact as already

The massive-open-online course revolution has become a calling for those at its leading edge. MIT President Rafael Reif noted that an online course by his faculty on circuits had attracted 155,000 students, more than all of MIT's graduates combined.

Capitalizing on the era's risks and uncertainties could even be seen in higher education's massive open online courses – MOOCs – like Coursera, edX and Udacity, which have accelerated from zero to 60 in an instant by university-time standards, where transformative changes usually seem to require decades, if not centuries. Daphne Koller, a Stanford computer scientist and cofounder of Coursera, reported that her year-old company was now offering more than 200 courses drawing more than two million students. It expects to offer 500 courses by summer's end and 10 times that just five years out.

In a private Davos session on "RevolutiOnline.edu" that attracted a large audience, New York Times

enormous. Reif noted that an online course by his faculty on circuits had attracted 155,000 students, more than all of MIT's graduates combined.

The massive-open-online course revolution has become a calling for those at its leading edge. Coursera's Koller described it as a once-in-a-life-time inflection point. Higher education will never be the same, others said, and the impact is sure to extend far beyond the ivory towers. Grameen Bank founder Muhammad Yunus saw the new learning technologies as a unique opportunity to reach the billions of people who have been left out of education altogether.

As a leadership barometer, Davos certainly confirmed that confidence is back

in the world's inner circles of business and policy. Many warned at the same time against any return of the hubris that had occasioned the financial crisis of 2008-09, and many also advocated refocusing on the chronic problems of climate, employment, inequality and inclusion. Others said that doing so will require taking advantage of the risks and uncertainties that still abound to invent new ways for delivering services and learning about the world.

This article was first published on Jan. 30, 2013 in Knowledge@Wharton, http://knowledge. wharton.upenn.edu/article.cfm?articleid=3176, and is published with permission.

About the Author Michael Useem is Professor of Management and Director of the Center for Leadership and Change Management at the Wharton School of the University of Pennsylvania. His university teaching includes MBA and executive-MBA courses on leadership and change, and he offers programs on leadership, teamwork, governance, and decision making for managers in the United States, Asia, Europe, and Latin America. He also works on leadership development and governance with many companies and organizations in the private, public and non-profit sectors. He is the author of The Leader’s Checklist; The Leadership Moment; Investor Capitalism; and The Go Point: When It’s Time to Decide. He is also co-author and co-editor of Learning from Catastrophes, and co-author of The India Way: How India’s Top Business Leaders Are Revolutionizing Management. He can be reached at useem@wharton.upenn.edu.

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Global Recessions: A Survivor’s Manual

By Irv Rothman The article is an excerpt from the book "OutExecuting the Competition: Building and Growing a Financial Services Company in Any Economy", by Irv Rothman.

O

ver my career, I’ve endured recessions of varying size, depth, and duration. Three of those recessions – in the early 1990s, at the start of the new century, and this most recent Great Recession, so debilitating on a worldwide scale – found me in key senior leadership roles, the last two as chief executive officer of a goodsized US-based company.

There is no executive education quite like managing through a recession.

Nothing tests your leadership ability more, or your skill in juggling the myriad demands of your company, customers, and employees. There are no absolute guarantees that any business, no matter how well-managed, can emerge from a near-depression fully intact. Many will sputter and die.

But, if you manage your business intelligently, through clear eyes and guided by a judicious, analytical sense of mission, the damage of any recession can be lessened. I’d say it starts with a

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basic philosophy – do what you’re good at doing. Too many companies decide to branch out in directions and down paths that are all too likely to lead them to disastrous results.

When some stumbled through recessions, frequently it was because they veered from the core businesses that made them so successful in the first place. Too often, an executive wakes up in the morning and decides, “The business isn’t any good anymore; let’s start a new one.” Business cycles are a reality.

Companies improve, they devolve, they change fundamentally over time. As a corporate leader, you have to adjust.

For better than a quarter century, Comdisco was the leading player in the computer leasing industry. That’s actually a gross understatement: it was the glamour puss of a business few knew or cared that much about, yet it gained iconic status as a high flying publicly traded company with a somewhat

notorious corporate culture. Its founder and CEO, Ken Pontikes, was a legendary figure for both his business acumen and flamboyant lifestyle.

But if there was ever a poster child for a company straying from what had made it so remarkably successful to reach a disastrous end, it was Comdisco.

Following Ken’s untimely death, his successor decided that the business that had yielded such fantastic results and wealth for shareowners and employees alike was no longer viable. Rather, it was the promise of dot-com riches that became the focus of the company’s direction and resources.

Venture capital, telecom, Internet, network . . . Comdisco made investment bets across the board. And, what’s more, supported them with a bloated expense and executive structure. When the bubble burst, it all came crashing down. None of the bets paid off, and Comdisco filed for bankruptcy in 2001.

If you manage your business intelligently, through clear eyes and guided by a judicious, analytical sense of mission, the damage of any recession can be lessened.

March-April 2013

The underpinnings of any successful enterprise are what account for its viability and strength. It’s a big world out there.

A lot more opportunity exists during a recessionary period than you might think. At HP Financial Services, we’ve been particularly good at functioning in the enterprise space. We never held a particular funding advantage other than that we had our parent company’s balance sheet. Although some of our competitors didn’t have that, many did.

That doesn’t diminish the need to think long and hard about what we bring to the table when we talk to a customer.

Those metrics don’t change. What’s the real value proposition? How do we make our product attractive to customers? How do we make it a point of differentiation in the marketplace? How do we convince and train the sales staff to sell it?

You maintain your equilibrium during down economic times by conducting business with companies that are more creditworthy. That served us especially well during the late 1990s and the explosion of the dot-coms. We had a set of reliable credit granting philosophies and processes. While not deliberately designed to be recession-proof, they nevertheless served us well when market value fell, businesses contracted, and workers were released.

In this particular recession, we were far better prepared for it than at any other place I’d been. In the early 1990s, when the economy went south, we weren’t ready. I was running the redefined AT&T Credit Corp. Half our customer base was small- and mediumsized businesses, or the SMB space. For small businesses, it’s all about overhead expenses: the cost of operating a factory, for example, and controlling credit losses. Often in bad times, customers are calculating how much they can reasonably stretch the payment schedule.

I had learned an invaluable lesson from that earlier time. We were invested heavily in the SMB space because it was so profitable. AT&T Capital lost sight of its responsibility to manage carefully, even when there was pressure to loosen the reins. We didn’t execute, and

so we got our butts kicked. It was our own fault. It’s good to eat ice cream, but every now and then, you have to eat some spinach, too. We weren’t eating enough spinach.

That was 20 years ago, more than a generation in business years. I’m a way smarter guy now than I was 20 years ago. At the time, we were focused more on growing the business than on running the business. That’s an important distinction, and one that none of us thought about making as the money poured in and our revenues kept rising.

Today, I’m focused like a laser on both growing and running the business. That comes with the territory; you have to balance proactive and reactive thinking.

The lessons I took with me from my days at AT&T served me well a few years later when I was named the CEO of Compaq Financial Services, in 1996. I had a clean sheet of paper. We were going to be a player in the enterprise space. We were not going to be a player in the SMB space. That wasn’t us.

Enterprise was where we needed to be; it was what we did best.

My turn in the CEO’s chair at Compaq Financial Services coincided with the dot-com boom. Businesses with enormous stores of cash accrued through venture capital investment or IPOs were flooding our radar screens.

These were very attractive to many executives. My inclination, however, was to

Today, I’m focused like a laser on both growing and running the business. That comes with the territory; you have to balance proactive and reactive thinking.

I remember doing an interview with an industry publication reporter who asked me what worried me the most about running a business. “An economic boom,” I said. “When the boom stops, as it inevitably will, are our credit-collection people going to be skilled enough or experienced enough to handle workouts and recoveries, and complete all the tasks that must be completed to keep the business running effectively?”

That’s hard to do. But you can ease that by understanding that there will be ups and downs. We’re never going to get as rich in the up periods, but we’re never going to be hit as hard in the down periods as some of our competitors. I genuinely believe that.

I had the following exchange with Mark Hurd, the former CEO of Hewlett-Packard. “When was the last time you saw HP Financial Services in the Wall Street Journal?” I asked him one day. His response: “I’ve never seen your name in the Journal.” To me, that’s an accomplishment. Never get in trouble, never drive off a cliff, and you won’t be news – at least in ways that can hurt the company.

take a step back, assess this unpredictable new wave, and think hard about what it would mean to us and how much of a plunge we should take.

We were cognizant throughout, as we are to this day, of our fiduciary duty to shareholders. Our objective is to deal with the adults, first in the age of Internet start-ups and more recently with social networking and related businesses. In considering a financing arrangement, we have to be practical.

That world had the feel of a digital Wild West. Nothing was assured, and things could turn on a dime. I wasn’t averse to financing some of these new businesses if I thought they had credible backing, but even that wasn’t always enough. In one instance, we financed an online toy store. The primary investor was a major entertainment company with a very successful track record. We thought if they were the primary investor, this was probably one where we could stick our neck out.

So we did. A year later, the investor pulled the plug. The toy store’s performance was from hunger. They were in deep yogurt from the start. Even though

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that venture, supported as it was by the acknowledged leader in family entertainment, failed, it left an impression with me. When it’s a company that is established and indisputably successful, you take the calculated risk. You don’t take a shot with a couple of guys who dropped out of Harvard one afternoon with a kernel of an idea, raised millions of dollars on the flimsiest of business plans, and ended up playing ping pong all day long and frittering away their investment capital.

Recently, a sizable deal in Asia Pacific went bad on us. Fortunately, we did so well during our 2010 fiscal year that we covered it, and eventually we should manage to recover a significant percent above our planned losses. But a post mortem was needed to determine what had happened and whether this deal could have been avoided. What did we miss? Did we fail in our due diligence?

We gathered the Credit Committee around the table, and I asked them to present the deal to me exactly the same way they pitched this business the first time around. I wanted to make sure we weren’t asleep at the switch when we signed off on this transaction.

They re-presented the deal – the pros, cons, upside, reasons to move ahead with it all over again if given the option. And we unanimously agreed, again, that it was a deal well worth doing. It had been an existing customer of HP; there was an established track record. Their business was going through a rough patch, we were all aware of it, but they’d been with us for nine years and always exhibited resiliency and an ability to operate through difficult times. In the end, the forces of the recession this time were too crippling, and they succumbed.

There are no guarantees in our business. Even what seem like rock-solid enterprises can suddenly fall off the face of the earth. Sure, it’s easy enough to see how some companies find themselves in a fix. All these guys who sold home mortgages to people without getting any financials, without getting pay stubs, without realizing these loans were a complete crapshoot, they were doomed

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to failure. If you have reliable creditgranting procedures, the odds of deflecting bad deals increase dramatically. You can be wrong for the right reasons.

Deals don’t disappear when the economy is tight. They didn’t in the early 1990s or at the start of the first decade in the post–9/11 era. They certainly may have been harder to find and book in our most recent conflagration, but they were still out there. In the midst of the recession, I was standing on line in the cafeteria of our New Jersey headquarters next to Fernando Gomez, one of our senior credit managers. We struck up a conversation, and he told me

before an agreement was signed. That was an example of a deal done for the wrong reasons. Avoiding a bad decision based on bad reasoning is Financing 101. You can’t run a business like that.

This most recent recession was longer, deeper, and far more challenging than any that had come before it, at least in my experience. The vast majority of companies retreated to a kind of bunker mentality. Delay, if not fully deny, any and all opportunities. That became the working philosophy. Uncertainty about the next few years continues, with businesses sitting on an estimated $1 trillion or more that they are reluctant to spend.

In times of recession, the job becomes exponentially harder. So stick to the basics. Do what you do. Any movement away from the essential business is too risky. we were still approving a lot of deals – “It’s just taking us a little longer to get there.” The business is out there, but as Fernando noted, it’s taking us a little longer to get to the point where we can push the button.

In the early part of the last decade, when the merger of Hewlett-Packard and Compaq was finalized and we could get rolling on new business, we were presented with an opportunity to finance a Brazilian telecommunications company. They had come to us when I was at Compaq; we turned them down for $50,000. We’d done our due diligence and just thought it prudent to pass. Not Hewlett-Packard Technology Finance (our counter- part at HP premerger). They already had a deal with the company on the books for a half million dollars.

After we finalized the merger in 2002, I asked the people who had been at HP Technology Finance to find out why something we thought so ill advised had looked so good to them. Turns out the telecom had received a visit from an HP senior executive who was impressed by their operation – never mind that they had no creditworthiness to speak of. Not a lot of research had been performed

March-April 2013

In times of recession, the job becomes exponentially harder. So stick to the basics. Do what you do. Any movement away from the essential business is too risky.

Excerpted with permission of the publisher, WILEY, from Out-Executing the Competition: Building and Growing a Financial Services Company in Any Economy by Irv Rothman.

Copyright © 2012 by Irv Rothman. This book is available at all bookstores and online booksellers.

About the Author Irv Rothman is President and CEO of HP Financial Services, a wholly owned subsidiary of HewlettPackard Company, where he is responsible for the worldwide delivery of customized leasing, financing, and financial asset management solutions that simplify customers’ IT life-cycle management and reduce their total cost ownership. Prior to joining HP, Rothman was president and CEO of Compaq Financial Services Corporation (CFS) and a group president of AT&T Capital Corporation.

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Global Management

Fast-Expanding Markets:

Where New Growth Can Be Found!

By Terence Tse, Mark Esposito & Khaled Soufani This article is dedicated to provide a working definition of these markets, which we call “Fast-Expanding Markets” (FEMs). The need to coin a new term for such markets is increasingly urgent, as commonly used terms are deficient. For instance, “emerging economies” or “developed markets”, whilst popular, focus only on markets at the country level. In contrast, the term FEM is far more encompassing, as it is not restricted to traditionally defined boundaries, such as geographical, industrial or firm boundaries. It is sufficiently general to refer to any rapidly growing opportunity, with the market as a focal point, regardless of whether that market exists on a supranational, national, regional, industry, cluster or firm level. While it is possible to argue that the term is too broad or unspecific to pinpoint real economic drivers and determinants of growth, it is exactly this unique characteristic that allows managers and policy makers to find new sources of wealth and prosperity. In short, thinking along the lines of FEM frees our minds from the restrictions and boundaries of geographies or industries, and enables us to consider markets from new perspectives and to find new ways of achieving economic growth.

F

rom the end of the dot-com crash in 2001 to the beginning of the financial crisis in the first decade of this century, markets blossomed and new business opportunities emerged around the world. With property values

and share prices constantly increasing, the general public felt rich. This feeling led to overspending and overconsumption, which in turn promoted more new business opportunities than ever before.

This further fuelled the propensity to spend, supported by the illusion of the potential for new fortunes. While we – the general public – found it easy to part with our money, it was even easier for us to borrow the money that we wanted to spend. Hence, a general impression of wealth emerged. At the same time, manufacturing-based countries – especially China – kept churning out the products that we increasingly desired at ever-lower prices. It was a tremendously prosperous period for companies and businesses, which only had to comply with one requirement: to ensure their place on the map of the evolving world.

However, in the aftermath of the financial crisis, the golden decade has been consigned to history. After the financial crisis and the subsequent economic crisis, we live in a world in which people have no choice but to start (belatedly) exercising financial discipline. Such discipline has taken many forms, ranging from austerity in the countries in which overspending was a habit to parsimony in those that were always prudent. In today’s world, individuals find themselves questioning their ability to hang on to their jobs on a daily basis. Consumer confidence has plummeted, severely affected by diminished prosperity and uncertain job prospects. This, combined with deep cuts in public spending, has left individuals financially conservative and spending savvy (if they spend at all).

In addition, many companies and businesses have shifted their focus away from

We argue that it is far more paramount for firms to concentrate on top-line growth than on lowering costs. While cost cutting can lead to an immediate increase in profit, an expansion of the sources of revenue will lead to far more sustainable advantages.

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Global Management

profitability and towards ensuring their economic survival.

The Importance of Top-Line Growth While the outlook remains bleak, we do not believe that the situation is all “doom and gloom”. Understandably, companies may adopt a policy of retrenchment in response to a real economic recession. In difficult times, firms tend to favour business processes focused on “re-engineering”, “streamlining”, “restructuring”, reorganising”, “downsizing” and “outsourcing” in order to maintain profitability. In fact, in challenging economic contexts, such means are often preferred because they are easier to pursue than revenue growth, which requires the enlarging

then labour productivity tends to be one-third the level in the home country.1 Similarly, reducing costs for parts can have counter-productive effects: cheap parts usually result in an increase in costs associated with quality, service, operations and overhead. This can be a particularly important consideration given that customer retention becomes more important in economically difficult times. If all firms compete on price, thrifty consumers will be more inclined to base their purchase decisions on the quality and unique features of goods and services with similar prices.

Excessive cost slashing can therefore dampen sales. In summary, cost-saving programmes are only effective in maintaining financial profitability if revenues do not shrink.

FEM are distinct from some of the previous concepts related to new markets and new market spaces due to the fact that FEM represent potentially extremely lucrative markets that many people are unaware of or have overlooked. of existing markets or the discovery of new ones. The costs of retrenchment are initially hardly visible. Some strategists suggest that as the level of complexity in the economic landscape rises, these processes “protect” companies from market expansion by enabling them to focus on perfecting corporate introversion or organisational alignment.

The downside of retrenchment is that it is, at best, a short-term solution that temporarily boosts earnings. It produces few benefits in the long run because it relies on a strict accountancy perspective – costs can only be slashed to a certain point without causing unintended consequences. For example, in order to cut costs, many companies have moved production to countries with less-expensive labour. However, this does not necessarily lower costs – lower labour efficiency alone might cancel out anticipated savings. Furthermore, past studies suggest that if labour costs in a new country are one-third the corresponding costs in the home country,

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From this vantage point, we argue that it is far more paramount for firms to concentrate on top-line growth than on lowering costs. While cost cutting can lead to an immediate increase in profit, an expansion of the sources of revenue will lead to far more sustainable advantages. While new ways of lifting sales in tough times have been widely discussed in the past, we suggest a new possibility: the identification of business opportunities in new markets, which we call “Fast-Expanding Markets” (FEM).

Fast Expanding Markets Put simply, “Fast-Expanding Markets” refers to any rapidly growing opportunity in which the market is the focal point. Such a market may exist at the supranational, national, regional, industrial, cluster, sector, corporate or product level. FEM are everywhere. At times, they grow intuitively, while at other times they grow counter-intuitively, so that the application of traditional market and economic theories is often

March-April 2013

inappropriate. Which place in forecast and predictability a quintessential part of how value is generated. FEM are distinct from some of the previous concepts related to new markets and new market spaces due to the fact that FEM represent potentially extremely lucrative markets that many people are unaware of or have overlooked.

How could so many of us have missed out on these potential markets?

We believe that a combination of limitations inherent in the existing terminologies and the prevalent conservative view on growth play important roles. Thus far, people have associated such expressions as “emerging markets”, “emerging economies”, “frontier markets” and “developing markets/economies” with growth opportunities. In our view, such concepts suffer from various shortcomings when describing new growth opportunities.

First, these terms are obsolete if not misleading. Terms such as “emerging markets” traditionally refer to countries or regions with inadequate economic welfare and structures. However, this label is also applied to those economies that have already “emerged”. For example, until recently, The Economist viewed Singapore and Hong Kong as emerging economies, and the FTSE labels them as “advanced emerging markets”. Nevertheless, according to the World Bank, the purchasing-poweradjusted per capita GDPs of Singapore and Hong Kong in 2010 were USD 43,867 and USD 31,758, respectively.

On this basis, Singapore exceeded Japan, Germany, France and the UK, and both economies ranked above Spain, Israel and Portugal. In contrast, numerous “advanced”, “emerged” and “developed” economies, such as Greece, Spain and Italy, are on the verge of economic contraction. They might even be described as “submerging” markets.

Indeed, some of the stigma attached to the concept of “emerging markets” are no longer valid and should be contested vigorously. Emerging countries tend to be seen as possessing small equity markets with levels of liquidity

The level of corporate governance in various “emerging markets” is moving close to, if not surpassing, levels seen in developed markets. As the distinction between “emerging” and “developed” markets blurs, the applicability of these descriptions becomes increasingly limited. and price fluctuations typical of inefficient capital markets. Their labour efficiency and market size are often believed to be reduced, and they are often assumed to suffer from controversial policies that demonstrate economic inadequacy. In reality, however, equity markets in some “emerging” countries are sufficiently sizeable, with liquidity and volatility levels that match those of their more “advanced” counterparts. At the same time, the level of corporate governance in various “emerging markets” is moving close to, if not surpassing, levels seen in developed markets.2 As the distinction between “emerging” and “developed” markets blurs, the applicability of these descriptions becomes increasingly limited. It is, therefore, no wonder that The Economist (2008) called for the term “emerging markets” to be rendered obsolete. Clearly, a new term is needed to describe growth markets.3 Second, these terms only imply growth. While the difference between "advanced” and “emerging” countries is becoming increasingly ambiguous, one distinction is clear: “emerging” markets are the engines of the world economy, while “developed” economies are experiencing marginal growth, at best.

“Emerging” countries have experienced above-average, if not substantial, GDP growth in recent years, although part of this has been the result of starting from a lower base. Linear extrapolation implies that these economies should continue to show similar growth rates in the coming years. The problem with this line of logic is that growth is only suggestive and structurally contingent, if not conditional. Expressions such as “emerging markets” or “developing countries” imply growth, but they do not explicitly stress this prospect. Given the importance of the search for fresh sources of growth, it is surprising that a proper term dedicated to describing

new growth opportunities is lacking. We believe that the FEM term can serve this purpose.

Third, these terms are overwhelmingly focused on the macroeconomic context. Perhaps the greatest problem with expressions such as “emerging markets”, “developing markets”, “advanced economies” and “developed markets” is that as long as markets are maintained as the unit of analysis, it is easy to miss growth markets in countries with lacklustre overall economic performance. If we only conduct analyses at the macroeconomic level, many growing business opportunities that have yet to contribute substantially to a country’s GDP will go unnoticed. It is exactly the identification of markets that

instance, the popularity of Japanese comics, or manga, has been booming in the US for the past decade, even though this genre is culturally distinct from mainstream US comics.5 The same is true of “cosplay”, a sub-culture originating from Japan in which people dress in costumes and take on the roles of various characters from animated series or computer games. In Japan alone, the cosplay costume industry grew by 5% in 2009, to around USD 500m.6 Cosplay is becoming an important part of Japan's pop-culture exports.

Indeed, a “World Cosplay Summit”, which was sponsored in part by Japan's Trade Ministry and publicised by Japan’s Ministry of Foreign Affairs, was held in the summer of 2011.

We can discover a new configuration of how markets emerge by focusing on or around those pockets of growth, which develop in a much more spontaneous manner than what we have been trained to anticipate. are “off the radar” that create businesses advantages for companies.

For example, many researchers have viewed Japan as a languishing economy for the past two decades: its traditional businesses are facing evermounting cut-throat competition from China and Korea, and it ranks low in competitiveness.4 From this perspective, it may be tempting to view Japan as a nation in continuous decline with few growth prospects and to discount it as a potential source of new opportunities. However, this view reflects a focus on the country’s macroeconomic situations. If we look deep enough, pockets of exceptional growth can be observed.

Whereas Japan’s consumer-electronic industry may appear to have passed its prime, its pop culture-industry has been expanding in the global market. For

While some may argue that “emerging markets” as such are neither sizable nor significant, it is far harder to dispute the fact that they could offer growth opportunities. The above example clearly illustrates that new opportunities exist at more granular levels. We can discover a new configuration of how markets emerge by focusing on or around those pockets of growth, which develop in a much more spontaneous manner than what we have been trained to anticipate. Pockets are spontaneous in nature, rebellious in behaviour, fast and expanding at a rate that would impress in terms of any indicator or in any angular analysis. Pockets of growth are cells of FEM in that they are embryonic transporters of new business opportunities that are often untapped and undetected.

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Global Management

Examples To better understand FEM, we conducted extensive pilot research in an attempt to identify markets that could expand by more than 15% per year over a period of three to five years.

This time span enabled us to exclude distortions arising from speculative behaviour, which can be recursive in several prime and equity markets.

To our surprise, the markets that we identified as “fast” and “expanding” were much more “fast and furious” than we initially assumed. For example, the bio-stoves market in Kenya has been growing by at least 300% annually for the last three years, with growth peaking at 500% in 2012. Similarly, in Uganda, money transfers made through SMS-based technologies totalled USD 17.5 billion in the last five years, with annual growth peaks ranging from 200% to 290%. This highlights an opportunity to turn the cancerous nature of an informal economy into something formal. We also investigated whether a form of FEM could be found in agriculture. We found that, for example, Bolivia’s economy has been supported by the rapid increase in demand for quinoa, which resulted in an annual growth rate of 26% for the last five years. This FEM was not only inspired by technological innovation but also by a truly territorial emergence across a number of organized economic complexities.

The Merits of the Fast-Expanding Markets concept In short, FEM refers to any rapidly growing pocket of excellence. Often, such pockets have gone undetected given the fixation on terms such as “emerging” and “developing” economies. In contrast to these terms, FEM places explicit emphasis on the growth aspect. The adoption of this perspective enables the exploration of markets at more granular levels.

Some may suggest that the term FEM is too broad to be useful. However, we believe that it is exactly this characteristic that allows the term to encompass a vast variety of business opportunities and new sources of wealth, which could truly shape new seeds of prosperity. It is only by broadening our horizons that we can break away from limitations imposed by such popular terms as “emerging”, “developing/developed” or “frontier” markets.

FEM places explicit emphasis on the growth aspect, which enables the exploration of markets at more granular levels.

Moreover, some may argue that FEM are nothing more than conjectures, as forecasting naturally entails disappointments.

This may be true – admittedly, not every FEM will deliver promising results. However, analyses of FEM phenomena should help us prepare for the future. In a sense, these markets are akin to a compass – while they may not provide enough information to pinpoint exactly what lies in the future, they can generate

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March-April 2013

opportunities that honour real economy as the agency of development rather than the financial-based economy that has created the disillusioned need of emerging economies, to despair, divide and impoverish our world even more.

About the Authors Dr. Terence Tse is Associate Professor of Finance at ESCP Europe in the UK. He began his career in investment banking, and later as an independent consultant to a University of Cambridge-based biotech start-up and various major corporations. He worked as a consultant at Ernst & Young in London.

He holds a PhD from the Judge Business School, University of Cambridge, UK. (t.tse@jbs.cam.ac.uk ) Dr. Mark Esposito is Associate Professor of Management at Grenoble Graduate School of Business in France & Instructor at the Harvard Extension School in the USA. He serves as Senior Associate for the University of Cambridge Program for Sustainability Leadership in the UK. He has advised governments, the UN, and the NATO over the past 10 years on development and sustainability issues. He holds a PhD from the International School of Management in Paris/ New York, in a joint program with St. John’s University. (mark.esposito@cpsl.cam.ac.uk) Dr. Khaled Soufani is Associate Professor of Financial Economics at the John Molson School of Business at Concordia University in Canada & member of the teaching faculty at the Judge Business School in the UK. He has published extensively in the area of financial management, corporate restructuring, M&A, private equity, venture capital and family business, and also the financial and economic affairs of small-medium sized enterprises. His work is widely cited and included in policy reports by organizations such as the EU, OECD, and the Institute of Directors. He holds a Masters degree in Applied Economics and a PhD in Financial Economics from the University of Nottingham. (k.soufani@jbs.cam.ac.uk)

References

1. Anderson, David M. (2008) "Build-to-Order & Mass Customization: The Ultimate Supply Chain Management and Lean Manufacturing Strategy for LowCost On-Demand Production without Forecasts or Inventory," CIM Press.

2. Everest Capital (2009) “The End of Emerging Markets,” November, http://evcapan.com/documents/TheEndofEmergingMarkets.pdf, accessed on 7 November 2011.

3. The fact that The Economist uses term “emerging markets” while it simultaneously calls for a halt in the use of the term highlights the genuine need for new term to describe up-and-coming markets.

4. According to the IMD World Competitiveness Yearbook (2011), Japan ranks twenty-sixth, putting it behind Qatar (8), Malaysia (16), China (19) and Korea (22), and just marginally above Thailand (27), the UAE (28), Chile (29) and India (32).

5. Matsui, Takashi (2009) "The Diffusion of Foreign Cultural Products: The Case Analysis of Japanese Comics (Manga) Market in the US", Working Paper #37, Center for Arts and Cultural Policy Studies, Princeton University, Spring.

6. The Economist (2011) “Cosplay with me,” 10 August, http://www.economist.com/blogs/schumpeter/2011/08/japanese-pop-culture, accessed on 9 November 2011.

Feature

DAFZA Offers Highly Developed Infrastructure and Quality Services to European Companies

E

stablished in 1996 as a part of the Dubai Government's strategic plan to be an investment driven economy, DAFZA is one of the fastest growing premium free zones in the region. The free zone is currently home to over 1,600 companies from various industry sectors, including aviation, freight and logistics, IT and telecommunications, pharmaceuticals, engineering, food & beverage, jewelry and cosmetics.

DAFZA has been ranked the best in the world in the 2012 edition of the Global Free Zone Rankings published by the Financial Times' Foreign Direct Investment (FDI) Magazine. The ranking

Dr Mohammad Al Zarooni, Director General of Dubai Airport Freezone

DAFZA has been ranked the best in the world in the 2012 edition of the Global Free Zone Rankings published by the Financial Times' Foreign Direct Investment (FDI) Magazine. reflected the ability of DAFZA to attract foreign investment to the region.

Located strategically within the boundaries of Dubai International Airport, it offers a range of modern facilities with a state-of-the-art infrastructure to its clients from across the world.

DAFZA has emerged as the preferred business destination for European companies looking to base themselves in the Middle East region. In 2012, European companies topped the list of DAFZA tenants at 31% of the total.

European markets have been of significant focus for the Freezone over the past few years. The number of registered UK companies saw an increase of 25%.

German companies represent 20% of the European companies operating in DAFZA. Over the years DAFZA has been playing a vital role in boosting Dubai’s economic ties with Germany. It reported record growth in trade volume throughout 2012 with an increase of

AED 69 billion, a 73 per cent increase on 2011. Sales revenue also witnessed growth of 26 percent compared to 2011.

International firms registered in the Freezone have collectively grown the value of their exported and imported goods by AED 164 billion in 2012, in comparison to AED 95 billion in 2011.

Dr. Mohammed Al Zarooni, Director General of Dubai Airport Freezone said, “We have worked hard to continuously develop the investment climate by training our workforce to best serve clients and satisfy investors.” “After a successful 17 years, DAFZA has become one of the most experienced authorities in attracting foreign capital.”

Contact Information Dubai Airport Freezone PO Box 491 Dubai United Arab Emirates Tel +971 4 299 5555 Fax +971 4 299 5500 http://www.dafz.ae/en/

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17

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Structuring Your Organization to Meet Global Aspirations

By Suzanne Heywood & Roni Katz and navigated structures simplify costs and make sharing of risk and information easier and therefore support many of the benefits of being global. However, global companies are now often finding that they are reaching the limits of this benefit— their standardization has become so thorough that they find it hard to achieve the flexibility needed to respond to local market requirements. Many are therefore starting to revisit the tradeoff between standardization and local flexibility.

A structural challenge faced by global companies is creating the right balance between minimizing complexity and capturing knowledge and innovation.

The matrix structure is here to stay, but its complexity can be minimized, and companies can get more value from it

T

he way a company organizes itself—how it allocates responsibilities, how it organizes support services, and how it groups products, brands, or services—can have a substantial impact on its effectiveness. Global companies, however, find structure difficult: in our recent survey of over 300 senior executives,1 only 44 percent agreed that their organizational structure created clear accountabilities.

Global companies find structure difficult because there are no simple solutions—most global structural options create challenges as well as benefits. For example, many companies have focused for years on standardizing structures; easily understood

Another structural challenge faced by global companies is creating the right balance between minimizing complexity (making it easy to get things done and get decisions made) and capturing knowledge and innovation. It is often hard to get things done in a global organization due to its size and the multiple time zones that it encompasses. In addition, the inevitable duplication of some activities across businesses, regions, and functions creates uncertainty about where to go to get a task completed or a question answered. One way to solve this is to create self-contained, vertically integrated, global businesses within which decisions can be made quickly and complexity is minimized. However, such silos make it much harder to find, share, and benefit from knowledge across businesses.

In our survey, for example, only 46 percent of senior executives felt that ideas and knowledge were freely shared across divisions, functions, and geographies within their companies.

For most global organizations, these trade-offs are greatly influenced by their archetype. For example, the right answer to the trade-off between complexity and knowledge sharing for a customizer company, which tailors its products and services to each market and which therefore needs to create a lot of local innovation wherever it operates, is likely to be very different than it is for a global offerer, which offers standardized products.

Other issues may also affect these trade-offs. For example, the correct answer to the trade-off between standardization and local flexibility may vary across markets even for the same business; there may be a need for greater delegation in dynamic high-growth markets, where decisions need to be taken more quickly, than in established developed markets. Likewise, the way in which a company has grown can also be important.

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Global Management

If, for example, a company has grown organically, it may have a high degree of structural standardization; its biggest challenge may be deciding how to flex the model to allow more local tailoring.

If a company has grown inorganically, it may have the opposite problem: country or business silos may operate relatively independently and be difficult to standardize globally.

Given the complexity of these issues, it is not surprising that many global companies end up creating highly complex structures that incorporate multiple businesses within a matrix of business, functional, and geographic structures.

As one executive told us, “The overall matrix between geography, service line, and global function in our company is, at best, cumbersome: this is no way to out perform local competition in fastmoving markets.”

types of publications and increased innovation. And that added more value than the previous geographic structure, which had only made it easy for people working on different kinds of publications in the same country to share information.

Focus country organizations on what needs to be local. Even as they determine what needs to be global, companies need to be just as deliberate in deciding what should be local.

Globalization can destroy value if the activities globalized in fact need to be locally tailored. The publishing company reorganized with that awareness. Although many activities were globalized, country managers were retained to manage sales and marketing operations, which require much more local customization; some backoffice services (such as local finance and HR support) were also left under local

Given the complexity of these issues, it is not surprising that many global companies end up creating highly complex structures that incorporate multiple businesses within a matrix of business, functional, and geographic structures.

Emerging thinking on new structures Each company will, of course, face a somewhat different mix of the challenges described above, depending on their archetype, their strategy, and their history. Nevertheless, we see a number of approaches emerging that may in time help global companies find the right structure for their situation.

Be clear about what needs to be global. Globalizing businesses, products, or functions can make it easier to capture strategic and cost benefits, and to share knowledge and skills to drive innovation. This could mean moving from a geographic structure—say, three regional product development centers—to a single global structure that groups all related activities together. For example, a global publishing company recently created “global verticals” of people who work on similar publications in every country. This made it easier to exchange ideas on those

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management and they managed the interface with global shared services.

The right answer here will be affected by the organization’s archetype. But this is not the only consideration; other issues can be just as important. In industries where local risks can threaten an entire organization—such as oil and gas, metals and mining, and even audit— global transparency on risk is critical and therefore risk processes need to be more globalized.

The expected growth rate of a market can also be important. Markets that are growing rapidly often require more local decision making on issues needed to compete, such as product innovation, marketing, and partnering. More activities will likely need to be localized when a company first enters a market and is less familiar with it (this may particularly be the case in emerging markets, where building relationships with local stakeholders such as regulators and

March-April 2013

governments is often critical). As the local business grows, some of this decision making may be taken back above the country level to the business division or corporate center. Companies need to think through all these issues systematically in deciding what should be local, and be aware of both the benefits and constraints of localizing decision making as well as the possibility that the right answer may vary by business as well as by country.

Be clear on the logic for regional structures. A traditional rationale for regional structures was the need for a “span breaker” within a global organization, to gather information from local organizations and pass it to the corporate center. As communication and travel across geographies becomes easier, this role is often far less important and does not have to be done within a regional structure. Given that regional structures are often expensive—they quickly start to duplicate corporate functions such as finance, HR, and marketing which also exist at both local and global levels—we are starting to see a trend toward either removing or radically reducing the size of regional offices. In some cases, companies have reduced these offices to small teams of 10 or fewer, which focus on people (rather than business) performance management, coaching, and business intelligence activities such as spotting regional and country risks, competitive risks, and opportunities. These new regional structures typically do not spend time aggregating financial or other data at a regional level and then reaggregating it at a global level.

There are, of course, exceptions to this trend; in organizations where the logic for regional structures is clear, the personnel should be retained. For example, some companies are retaining them if a corporate function tends to operate regionally (procurement, for example, if suppliers operate regionally) or if major competitors are regional. In emerging markets, regional structures can be important if the company seeks to build capabilities that are specific to operating in fastermoving markets (e.g., new innovation

approaches). But even in these cases, companies will benefit from making sure that these structures are not duplicating other activities that add more value by being done globally or locally.

Companies should also consider whether the underlying premise of many regional structures—the traditional logic of managing countries in groups based on their proximity— is still valid. As barriers to travel and communication fall, it may make more sense to group companies according to their strategic needs and rate of growth if these are more important in determining the support needed from a regional office.

However, when doing this, it is important to assess whether the new structures that are being created contain roles that are sustainable over time.

Companies should consider whether the underlying premise of regional structures— the logic of managing countries in groups based on their proximity—is still valid.

Create small physical corporate centers that focus on external reporting, serving the board, and holding the brand and values of the organization. Other elements traditionally housed in the corporate center (such as strategy, HR, procurement, and supply chain) can be retained in the corporate center (or global shared services), but in some cases, they can be relocated to the physical region where they add the most value.

New ways to manage complexity. Inevitably, organizing a global company will require a matrix, but the complexity this creates can be minimized. We know from our research on organizational complexity2 that getting accountabilities right—making it clear who is responsible for what and removing duplications in responsibility—is one of the major ways in which companies can make it easier to get things done. So, for example, a company could create a network of marketing experts to share knowledge and skills across the enterprise on issues such as new communications approaches, while leaving the responsibility for decision making on these issues to the local management. With minimal duplication, and managers who are trained and given incentives to be highly collaborative, this approach will add value from shared knowledge without reducing local flexibility. Standardizing structures—for example, in this case, making marketing roles relatively similar across businesses—makes it easier to create these links. Companies are also now reducing complexity by decreasing the number of cells within the matrix structure rather than assuming that every intersection within the matrix requires separate management: Unilever recently reported that it had reduced the number of its managed organizational units from more than 200 to 32.

Create end-to-end global business services with clear customer interfaces. Most global companies have long since brought widely used services—IT, HR, purchasing, financial reporting, and the like—together across their businesses and

regions. We are now starting to see the next step in the evolution of these services, one that can increase business effectiveness and reduce cost. A few companies, such as P&G, DHL, and Unilever, are integrating back-office services from several functions so that a comprehensive package of services is provided for discrete processes—for example, integrating HR and financial data to support a single reporting process. This approach can remove some hard-to-spot duplication between functional tasks and create services that are better suited for users’ needs. It also means that a senior manager can have a single point of contact for global business services, rather than separate links into each shared service function. And providing all the services needed for a given process can also help firms capture greater economies of scale and create more attractive roles for services leaders.

We believe that the rebalancing of many global companies toward emerging markets combined with the accelerating pace of communication technologies opens up a whole new set of structural options. By being thoughtful about the globallocal balance within their companies, the role of regions, the corporate center and business services, companies can create organizations that capture global benefits while remaining locally agile.

Copyright © 2012 McKinsey & Company. All rights reserved.

About the Authors Suzanne Heywood leads McKinsey’s organisation design practice in Europe, the Middle East and Asia and has co-led, over the last two years, McKinsey’s work on creating effective global organisations. She has previously written on a range of topics including restructuring companies, reducing organisational complexity and on preparing companies for growth.

She serves clients across different industries on topics ranging from increasing efficiency through increasing organisational speed and agility to preparing for growth. She has a science PhD from Cambridge University. Suzanne is a partner in McKinsey’s London office.

Roni Katz works with global companies on organisation topics. She has deep expertise on organisation design: she led much of McKinsey’s thinking on how to structure effective global companies, and is now co-leading an effort to review McKinsey’s practical approach to organisation design. She works extensively with various clients in this area and in performance transformation. While working across industries, Roni has a special interest in advanced industries and technology.

She holds a BSc from Tel Aviv University, and an MBA from INSEAD. Roni Katz is a partner in McKinsey’s London office.

References 1. McKinsey Globalization Survey of more than 300 executives, November 2011 2. Suzanne Heywood, Jessica Spungin, and David Turnbull, “Cracking the complexity code,” McKinsey Quarterly,May 2007.

www.europeanbusinessreview.com

21

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Global Management

Building Ethical Business Cultures: BRIC by BRIC

By Alexandre Ardichvili, Douglas Jondle, Jack Wiley, Edgard Cornacchione, Jessica Li & Thomas Thakadipuram combined GDP of these four countries will be larger than that of the G7 (seven largest developed economies of the world), and multinationals from BRICs are already playing a major role in shaping the way business is done globally.

Business Cultures and Ethics

As the economies of Brazil, Russia, India, and China (BRICs) continue to grow both in size and clout, and their resident multinational corporations become major players in global markets, questions pertaining to trust and integrity, and of universally shared standards for ethical business behavior become important concerns for numerous stakeholders.

Whether or not managers and employees behave ethically depends on how one defines ethical behavior and applies it to an organization’s culture. We start this article by discussing attributes of ethical business behavior and cultures in each of the four BRICs countries, and then present results of our recent large scale survey-based studies, comparing managers’ and employees’ perceptions of ethical cultures in BRICs and in economically developed Western economies.

Scanning the Global Environment Issues of managing corporate culture have long been among central concerns to executives around the world.1 In recent years, the discussion of ethical corporate cultures came to the forefront.

Among the reasons for this growing interest was the realization that the global financial and economic crisis of 2008-2009 was triggered, among other things, by major ethics violations at large multinational corporations and financial institutions; and that, while the negative impact of business activity on the global ecosystem and local communities is rapidly escalating, corporations governed by questionable cultures of ethical behavior are much more likely to behave in irresponsible and unsustainable ways. The importance of promoting ethical cultures in large business organizations from BRICs (Brazil, Russia, India, and China) cannot be overstated: it is projected that by 2050 the

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March-April 2013

Edgar Schein2 a leading authority in organizational psychology, believes organizational culture is a pattern of learned responses where “basic assumptions and beliefs that are shared by members of an organization…define in a basic ‘taken-forgranted’ fashion an organization’s view of itself and its environment.’’ Culture is bifurcated into formal and informal elements.

Formal elements include codes of ethics, mission statements, reward systems, and decision processes. Informal elements include implicit norms of behavior, stories, rituals, and role models. Ethical business cultures are “based on alignment between formal structures, processes, and policies, consistent ethical behavior of top leadership, and informal recognition of heroes, stories, rituals, and language that inspire organizational members to behave in a manner consistent with high ethical standards that have been set by executive leadership.”3

Business Cultures and Ethics in BRICs Brazil. Brazilian managerial culture is characterized by paternalism (defined as a relationship between superiors and their subordinates, in which superiors provide protection and guidance in exchange for loyalty and deference on the part of subordinates), power concentration, personal relationships, strong loyalty to one’s in-group and leader, and flexibility.4 Organizational ethics in Brazilian businesses is based on the preference for social cohesion, which is cemented by employee loyalty to the group leader. The leader, on the other hand, is responsible for group members’ well-being. This web of reciprocal obligations could result in both positive and negative outcomes. On the positive side, it can lead to high performance of individual employees if they feel loyalty to the group and the leader. However, such loyalty can be accompanied by an excessive fear of making damaging mistakes by the group that can result in a reduction in creativity and innovation.

In Brazil the cultural trait that has the greatest impact on business culture is jeitinho (a middle path between what is allowed by numerous laws and regulations, and what is practically possible and makes sense). It emerged as an adaptation mechanism which allows individuals and businesses to function despite the rigid legislative environment, massive bureaucracy, paternalistic management systems, and the oligarchic economic structure, dominated by powerful hereditary clans.5

As an indicator of the growing relevance of business ethics in Brazil6 the corporate sustainability index (ISE) of the Sao Paulo Stock Exchange (BOVESPA) has been introduced. In addition, a recent nationwide survey of 189 organizations out of the top 500 companies operating in Brazil explicitly adopted corporate codes of ethics.7 In summary, the Brazilian business culture is as diverse as the socio-cultural environment of this dynamic country. Such elements as loyalty and flexibility, personal relationships and jeitinho, exist side-by-side with Western-style codes of ethics and formal ethics programs.

Russia. An analysis of business ethics in post-Communist Russia suggests that the universalist rule-based ethics, central to the Western market economies, failed to develop despite radical economic reforms of the last two decades. Business behavior is based more on considerations of personal loyalty and in-group allegiances, than on universal considerations of right and wrong, or of potential impact on community and society.8 Recent studies suggest that compared to Western managers, Russians tend to display higher reliance on personal networks rather than on legal contracts, and have lower degree of respect for private property and higher tolerance of corruption. Another important issue is the ubiquity of blat, defined as “reliance for favors upon personal contacts with people in influential positions�.9 Daniel McCarthy and Sheila Puffer pointed out that from the position of Western market-oriented business ethics blat would be viewed as a form of corruption, as unethical behavior. But many Russian managers tend to see blat as ethical, while such forms of corruption as bribery and under-the-table payments would be considered as unethical.

There are several significant differences between Russian and Western perceptions of ethical business cultures. First, Russians are more particularistic than universalistic in solving ethical dilemmas. Researchers and consultants in cultural differences Fons Trompenaars and Charles Hampden-Turner10 defined universalism as a belief that laws and rules apply to all equally, regardless of specific circumstances, while the particularistic assumption is that rules can be interpreted more loosely based on the specifics of a situation and the nature of relationships with involved people. Second, Russians tend to consider the exchange of favors with their informal network of business connections (blat) as part of standard and ethical business practices.

India. A study comparing US and Indian managers found significant differences in their attitudes towards ethical business behavior. The US managers rated such practices as gift giving, software piracy, nepotism, sharing insider information, and dishonesty in advertising as significantly more unethical

than did Indian respondents. At the same time, Indians rated harming the environment as more dishonest, than did their US counterparts.11 The rich culture of India, immersed in spirituality and religion, is focused on intuitive ethical decision making, which sets it apart from the Western analytical approach to ethical decision making based on norms. Factors like culture, education, and gender play a significant role in shaping moral perspectives and ethical values.

Factors like culture, education, and gender play a significant role in shaping moral perspectives and ethical values in India.

Terence Jackson12 found that Indian managers consider unconditional loyalty to their organization a highly ethical behavior, being similar in this to the Chinese, but being significantly different from respondents from the US, Europe, and Australia. Professor Jagdish Sheth13 of Emory University identified some unique characteristics of Indian business practices, which may give rise to ethical behavior that may not be compatible with the prevailing Western viewpoint. First, Indian business culture places a premium on favors, friendship and clanship. Friendship is highly valued, whether based on multigenerational family friendships, school friendships or personal friendships. Second, the Western concept of conflict of interest does not always align with the Indian value of loyalty to one’s group. Third, in terms of government rules and regulations, the government acts more as a gatekeeper than an enabler, with slow approval, a complex bureaucracy and excessive corruption. As a result, in order to get things done, money and connections within high levels of management play a pivotal role in overcoming the bureaucratic barriers.

China. Many authors point out strong Confucian influence on Chinese business ethics. Some of the successful Chinese state owned enterprises (SOEs) adhere to the Confucian values: Ren, I, Li, and Chi (Compassion, Appropriateness, Norms, and Wisdom) to deliberately develop corporate cultures with uniquely Chinese characteristics.14 Daryl Koehn15 from the University of St. Thomas emphasized the central importance of the Confucian moral principle of trustworthiness. She argued that, in keeping with Confucian principles, Chinese business people rely less on formal contracts, and prefer to use informal agreements and personal assessment of trustworthiness of business partners.

Koehn also stressed the difference between Confucian and Western concepts of trustworthiness. In Confucianism, blind

Recent studies suggest that compared to Western managers, Russians tend to display higher reliance on personal networks rather than on legal contracts, and have lower degree of respect for private property and higher tolerance of corruption.

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adherence to rules and prior arrangements is not equated with trustworthiness. From Confucian perspective, it is perfectly fine for a person to break a prior arrangement for an important business meeting, if her presence was needed elsewhere to help people in need. Such a person would be perceived as even more trustworthy, since she demonstrated good judgment.

When studying Chinese business ethics, two interrelated concepts, guanxi and mianzi, which are grounded in the Confucian value system, have to be considered. Guanxi is “a deep rooted socio-cultural phenomenon which enhances social harmony, maintains correct relationships and addresses the sensitive issue of face, and is a reciprocal obligation to respond to requests for assistance.”16 Koehn argued that the practice of guanxi is rooted in Confucian concepts of fulfillment of role-base duties, filial piety, and cultivation of reciprocal support relationships between more and less powerful individuals. Mianzi (face) is the image that a person strives to maintain before others. It is “prestige and honor that accrues to a person as a result of successes and/or ostentatious behavior before others”.17 If one violates the rules of guanxi, one can be seriously damaged in terms of social reputation and will lose mianzi. Guanxi enables managers to acquire needed resources, personnel, information, and other supports in substitute of formal institutional structure. It provides privileges to members of in-groups by favoritism and personal benefits, and discriminates against members of out-groups. When guanxi takes precedence, it could skew managers’ judgments in making ethical decisions. For Western managers, working with their Chinese colleagues, it is sometimes difficult to separate reciprocation, driven by guanxi, and corruption.

In all four, paternalism and power concentration are traits of business organizations, and ethical decision making is likely to be more context-specific than universalistic.

The above suggests that ethical practices in Chinese business organizations are based on paternalism, collectivism, and guanxi. In their ethical decision making, Chinese managers and employees are more likely to use situational and particularistic than universalistic criteria. Ethical behavior is shaped by the emphasis on informal agreements as opposed to formal contracts, and by a significant role of informal networks of support and reciprocal exchanges of favors. In addition, business ethics is influenced by the emphasis on personal assessment of individual’s trustworthiness and leaders’ benevolence.

In summary, despite significant cultural differences between the four BRICs, many similarities in business ethics exist among these countries. In all four, paternalism and power concentration are traits of business organizations, and ethical decision making is likely to be more context-specific than universalistic.

Allegiance or loyalty to organizations and in-groups is likely to override the considerations of ethical norms in many cases. All

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four countries have a long history of strong centralized bureaucracies and, as a result, the business organizations have developed various ways of overcoming bureaucracy and getting things done through informal arrangements, which serve as alternative to formal business contracts (jeitinho in Brazil, Russian blat, Chinese guanxi, and Indian emphasis on kinship relationships).

How Managers and Employees view Business Cultures: Comparing BRICs and the US A recent study, conducted by our multinational research team, focused on managers’ and employees’ perceptions of the state of ethical cultures in their businesses. This study was based on survey data collected from more than 13,000 respondents from large business organizations in four BRICs and the United States (US). The data were collected as part of the WorkTrends™ survey of work-related attitudes and behaviors, conducted by the Kenexa Research Institute (KRI), the research branch of Kenexa, an international human resources consulting company.

Our survey measured five aspects of an ethical business culture: • Trust, Integrity and Honesty • Leadership Effectiveness • Stakeholder Balance • Mission, Vision and Values • Process Integrity In addition, we measured formal elements of an ethical culture, which encompass: 1) the commitment of the organization to establish and sustain a compliance program through the adaption of ethics standards and procedures; 2) taking appropriate measures to establish a system for reporting misconduct; and 3) providing the appropriate safeguards to ensure that employees use the reporting system.

Our study yielded some intriguing results. Respondents in India and Brazil provided more favorable assessments of ethical business cultures of their organizations then respondents in China and Russia. One possible reason for observed similarities in ratings, provided by Russian and Chinese respondents, could be that Russian and Chinese societies share a recent legacy of communist economies and political arrangements, which could have shaped the trajectory of development of business cultures.

Respondents from the US generally scored higher when compared to Russia and China indicating significant variation in adapting US paradigms related to business ethics. There was no statistically significant difference between the US and Brazil. The convergence between the US and Brazilian assessments of ethical business cultures could be a reflection of the growing interconnections between the US and Brazilian businesses as evidenced by significant foreign direct investment from the US and associated transfer of best practices in management.18 In addition, the Brazilian postsecondary management education system faces growing external influence, predominantly from North American universities.

In a related study,19 also conducted utilizing the Kenexa research database, we tried to understand whether perceptions of organizational business ethics differ by hierarchical levels.

The respondents included more than 40,000 executives, midlevel managers, and non-managerial employees from business organizations in six countries: three BRICs (Brazil, China and India), and three Western economies – Germany, UK and US. We found that in all countries in our sample, except for India, there were statistically significant differences between three hierarchical levels: executives provided the most positive assessment of ethical business culture within their respective organizations, employees’ assessments were significantly less positive, and mid-level managers’ assessments fell in the middle. An additional finding was the longer the executives’ tenure at the same organization, the higher their ratings of the organization’s ethical culture. At the same time, managers’ and employees’ ratings tended to decrease with time. Our findings confirm what Linda Trevino20 of Penn State and her colleagues have found in studies in large US business organizations: that senior managers’ views of organizational ethics were much “rosier” than the views held by their employees, and this could be explained by executives’ “need to protect the organization’s image as well as their own identity.” On the other hand, more negative ratings, provided by employees, could be explained by “psychological distancing from their employers” and cynicism about their organizations. What is most significant in the findings is that these perceptual differences between hierarchical levels were observed in three of the largest Western economies, and in two of the BRICs (Brazil and China).

Conclusion As the BRICs and their resident MNCs continue to grow in their economic importance, the potential for their cultures to influence the business climate and employee behavior globally increases. As workforces become increasingly diverse, issues pertaining to the universality of applied ethical principles, particularly those based on corporate codes of ethics and compliance developed in Western cultures, are likely to increase, potentially resulting in confusion and misconduct. Businesses regardless of origin must maintain vigilance in building and sustaining ethical business culture while becoming cognoscente of the influences of other customs and cultures on ethical behavior.

This article originates from: Ethical Cultures in Large Business Organizations in Brazil, Russia, India, and China, in the Journal of Business Ethics (2012) 105:415–428.

About the Authors Alexandre Ardichvili, Ph.D., is Professor at the University of Minnesota, Fellow at the Center for Ethical Business Cultures, and Editor-in-Chief of the Human Resource Development International.

Douglas Jondle, Ph.D., is Director of Research at the

Center for Ethical Business Cultures, University of St. Thomas Opus College of Business.

Jack Wiley, Ph.D., is Founder and President of the Kenexa High Performance Institute, Kenexa an IBM Company.

Edgard Cornacchione, Jr., Ph.D., is Professor and Chairman of the Department of Accounting and Actuarial Sciences of the College of Economics, Business and Accounting, University of Sao Paulo, Brazil.

Jessica Li, Ph.D., is Assistant Professor at the University of Illinois at Urbana/Champaign, USA, and Associate Editor of the Human Resource Development International.

Thomas Thakadipuram, Ed.D., is an organization development expert, leadership consultant, and visiting professor, St. Claret College, Bangalore, India.

References

1. Sean Culey, Leadership and Culture, Part 1: The Case for Culture, The European Business Review, 2012, May-June.

2. Edgar Schein, Organizational Culture and Leadership, 2004, Jossey-Bass.

3. Alexandre Ardichvili, James Mitchell, and Douglas Jondle, Characteristics of Ethical Business Cultures, Journal of Business Ethics, 2009, 85, 445-451.

4. Betania Tanure and Roberto Duarte, Leveraging Competitiveness Upon National Cultural Traits: the Management of People in Brazilian Companies, International Journal of Human Resource Management, 2005, 16, 2201-2217.

5. Gilles Amado and Haroldo Brasil, Organizational Behaviors and Cultural Context: The Brazilian ‘Jeitinho’, International Studies of Management & Organization, 1991, 21(3), 38-61 6. Jose Luiz Rossi Jr., What is the Value of Corporate Social Responsibility?

An Answer from Brazilian Sustainability Index’, Journal of International Business and Economics, 2009, 9(3), 169-178.

7. Instituto Brasileiro de Ética nos Negócios [IBEN]: 2009, Pesquisa de Código de Ética Corporativo no Brasil [Survey of Corporate Codes of Ethics in Brazil], Revista Ética nos Negócios, 1(1), 46-70.

8. Avtonomov, V.: 2006, ‘Balancing State, Market and Social Justice: Russian Experiences and Lessons to Learn’, Journal of Business Ethics, 66, 3–9.

9. Daniel McCarthy and Sheila Puffer, Interpreting the Ethicality of Corporate Governance Decisions in Russia: Utilizing Integrative Social Contracts Theory to Evaluate the Relevance of Agency Theory Norms’, Academy of Management Review, 2008, 33(1), 11–31.

10. Fons Trompenaars and Charles Hampden-Turner, Riding the Waves of Culture: Understanding Diversity in Global Business, 1998, McGraw Hill: New York.

11. Christie et al., A Cross-cultural Comparison of Ethical Attitudes of Business Managers: India, Korea and the United States, Journal of Business Ethics, 2003, 46, 263–287.

12. Terence Jackson, Cultural Values and Management Ethics: A 10-nation Study, Human Relations, 2001, 54, 1267–1302.

13. Jagdish Sheth, Chindia Rising: How India and China Will Benefit Your Business, 2008, Tata Mac-Graw Hill, New Delhi.

14. Ip, P-K.: 2003, Business Ethics and a State-owned Enterprise in China, Business Ethics: A European Review, 12(1), 64-77.

15. Daryl Koehn, Confucian Trustworthiness and the Practice of Business in China, 2001, Business Ethics Quarterly, 11(3), 415-429.

16. Chatterjee, S., and Pearson, C.: 2003, Ethical Perceptions of Asian Managers: Evidence of Trends in Six Divergent National Contexts, Business Ethics: A European Review, 12(2), 203-211.

17. Li et. Al, Impact of Chinese Culture Values on Knowledge Sharing through Online Communities of Practice, International Journal of Knowledge Management, 2007, 3(3), 46-59.

18. United States Department of State: 2010, Background Note: Brazil, http://www.state.gov/r/pa/ei/bgn/35640.htm 19. Alexandre Ardichvili, Douglas Jondle, and Brenda Kowske, Minding the Gap: Exploring differences in perceptions of ethical business cultures between executives, mid-level managers and non-managers. Human Resource Development International, 2012, 15(3), 337-352.

20. Linda Trevino, Gary Weaver, and Michael Brown, It’s lovely at the top: Hierarchical levels, identities, and perceptions of organizational ethics.

Business Ethics Quarterly 2008, 18, no. 2: 233–52.

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Performance Management Systems in Mexico: The Dual Logics of Evaluating Performance

By Anabella Davila & Marta M. Elvira Understanding Performance Management systems implementation is critical for multinationals operating in countries with contrasting cultures. For firms interested in Mexico, we share our findings on how successful companies tackle the problematic nature of performance management in practice. First, problems derive from difficulties in defining the content of what is perceived and apprised as performance. Second, problems arise because superior and subordinate face a culturally subjective situation that is difficult to manage: providing and receiving feedback about performance. Subjacent in effective performance management practices is the assumption that improving employee performance will help grow organizational performance, thus appraisal systems acquire strategic importance.

E

conomic development in Mexico over the last two decades has contributed to an attractive environment for business investment and growth. As one of the world's largest economies, Mexico enjoys regional economic and political power among other Latin American countries and is home to major multinational corporations such as Cemex (cement), Cinepolis (movie provider), Nemak (autoparts), Gruma (tortilla maker) and Bimbo (bakery). Contrasting with the endemic economic instability and crises of the past, Mexico experiences a rather stable economic environment today. Nevertheless, for business to succeed in this setting, leaders need to be aware of

its particular management style. This article’s objective is to describe effective performance management (PM) processes in the context of Mexico, a country that is rarely studied in the general management and human resources management (HRM) literatures.

As one of the world's largest economies, Mexico enjoys regional economic among other Latin American countries and is home to major multinational corporations.

From their foundations on traditional values around social bonds and a paternalistic leadership style, Mexican companies are making serious efforts to develop a culture of performance and competitiveness. Our studies on best HRM practices suggest that modern systems are explained and implemented under contrasting logics.1 On the one hand, we observe HRM practices that cater to employees’ silent needs and demands, and positively affect employee commitment and loyalty toward their immediate supervisor and, in turn, toward their company.2 On the other hand, we also note HRM practices aiming to improve firms’ financial results, which are not quite well understood when implemented. The latter is the case of performance management.

Concerning specifically PM systems, our studies of major Mexican companies illustrate this duality of logics when

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Management by objectives is most popular among Mexican businesses. However, this system works best at the managerial level, for which company’s performance objectives are established. Implementing this system has not been effecitve for clerical and manufacturing jobs. it comes to implementation. In what follows, we summarize these findings.

Setting the Stage To be effective, PM systems tend to be complex, require significant amounts of resources and entail a redefinition of the roles of human resources (HR) vs. front-line managers. PM systems fulfill a strategic role in organizations and their implementation requires paying particular attention to the establishment of work goals, performance measurement, work evaluation and appraisal, and feedback processes. PM practices can also have notable benefits for individual workers, because they provide relevant information about training and development needs, while helping define rewards and recognition opportunities.

Finally, PM systems potentially enable companies to set standards for attracting and retaining key human talent.

In Mexico, the main challenge faced

by HR executives is how to design strategies that link individual and organizational performance in practice.

Developing innovative strategies for managing this link requires the development of specific competencies. For example, there is a need to design and use instruments that measure different types of performance, and to manage a diverse range of PM tools. Managing a diversity of tools tests front-line

illustration.3 CompuSoluciones devotes much effort to manage the strategic positioning of its PM systems. First, it carefully defines the different meanings that performance may have depending on the employees’ position in the hierarchy and accompanying responsibility within the organization. Top management’s performance is linked to overall company goals; supervisors’ performance stress employees’ individual results; and employees’ measures focus on attitudes towards collaborative work and a harmonious work environment. As a result, CompuSoluciones is able to implement multiple appraisal tools targeting each specific aspect of performance.

In additional data from interviews we have conducted, it appears that in Mexican organizations the manager tends not to become involved in the PM process because it does not register in his/her psychological contract: PM is viewed as the responsibility of HR. For example, behaviors such as avoiding feedback sessions could be indicative of this. In parallel, employees tend to distance themselves from feedback received. Understanding this post-evaluation process could explain much of the typical negative behavior and rejection of unfavorable appraisal, and contribute to more effective evaluation outcomes.

It appears that in Mexican organizations the manager tends not to become involved in the PM process because it does not register in his/her psychological contract. managers’ work, especially when it comes to giving and receiving feedback on employees’ performance. The case of CompuSoluciones, a medium-size IT company often ranked top in the Great Places to Work rakings, may serve as an

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PM Instruments and Tools Because of the diverse meanings that organizational members grant to performance nowadays, there are different models and tools available according to the organizational level at which

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performance is appraised. The bestknown appraisal tools in Mexico are: Management by Objectives, Economic Value Added, Balanced Scorecard, 360degree Evaluation, Critical Incident Method, and Top Talent Ranking (forced curve).

The Dual Logic of Implementation Management by objectives is most popular among Mexican businesses.

However, organizations have learned that this system works best at the managerial level, for which company’s performance objectives are established.

Implementing this system for clerical and manufacturing jobs has not been effective because of the difficulties in determining the contribution of the employee’s to the organizational performance. Organizations that use this single system face challenging contradictions when assessing their personnel. For example, in Mexico front-line managers feel obliged to give highperformance evaluations in order to justify increases in employee salary, yet evaluations have to be low in order to justify career development plans.

The challenge is to design performance instruments that comply with the two objectives and requirements of the company.

To complement management by objectives, other practices such as performance-based incentive systems are often implemented too. Bonuses are typically tied to the organization’s performance outcomes and the executive’s area of responsibility. To overcome the dual logic in this case, firms need to define a meaningful performance indicator that could measure the company’s effectiveness of the company or one specific functional area. Critical industry success factors also influence performance indicators for top management levels. In our

experience, this system is implemented weighting percentages according to the organizational objectives.

Nowadays, various appraisal methods are used simultaneously; for example, management by objectives is used together with Economic Value Added (EVA) or Balance Scored Card systems. Multi-source instruments such as 360-degree evaluations are also used for top management.

PM methodologies are also affected by modern work systems. This was suggested by interviewees who work in U.S. MNCs. For example, work systems such as Six Sigma, Lean Manufacturing or Quality Star alter the instruments’ performance criteria because employees are asked to document their specific objectives or projects generated by these systems. For one of the interviewees, this PM evolution arises often from management systems “in fashion” and is one of the reasons why HR began to lose credibility in Mexican organizations. Only this interviewee views PM in Mexico as unrelated to performance because it is not associated to the organization’s business plan. From his viewpoint, PM instruments are no longer descriptive but rather evaluative, leaving many gaps for subjective judgments by both superiors and subordinates.

For clerical and manufacturing jobs, Mexican business organizations apply merit systems. A common problem we have observed in implementing merit-based instruments is their reliance on qualitative elements for performance assessment. Employees are rated on scales ranging from very good, to good, neutral, bad and very bad; or using achievement or non-achievement ratings. In the simplest method, percentiles were used, such as achieving 80, 90 or 100 per cent of goals. When we interviewed supervisors we noted severe dissatisfaction with this method, because it typically requires classifying employees into rigid categories. HR executives recognize that as a result of this difficulty, front-line managers often avoid rating employees in the

middle range of normal distribution curves. Despite these criticisms, meritbased tools, also known as comparative/relative evaluation, forced curve, or Top Talent ranking, are still the most common appraisal methods among the executives we interviewed.

The behavioral response of managers in Mexican organizations indicates a clear adherence to bureaucratic procedures. Yet they also control their participation on setting compensation and foster informality in the appraisal process, according to our interviews. It is possible that PM be used as a rational justification for emotional decision making. Both HR directors and line managers need to be sensitive regarding how to apply performance evaluation

factors is offered every three months.

At the end of the year, a worker may have obtained 36 days of extra pay, an incentive that is also extended to nonunionized employees working in the same plant. More examples of performance – and attitude-based compensation include rewards for contributing useful ideas and suggestions. The purpose of these rewards is to foster worker awareness of the need for discipline, responsibility, professionalism, dedication, and keeping a clean working space. In many organizations these rewards are not monetary but in kind, taking the form of vouchers and certificates, or commodities and goods for the home – e. g. a refrigerator, stove or television.

The behavioral response of managers in Mexican organizations indicates a clear adherence to bureaucratic procedures.

Yet they also control their participation on setting compensation and foster informality in the appraisal process. tools to validate ‘intuitions’ or feelings towards employees.

Concerning unionized employees, performance appraisal is limited in Mexico. Blue-collar workers are subject to a collective bargaining agreement containing fixed salary for each job category. Labor laws require adherence to the salaries stipulated in the collective agreement. Consequently, salary raises based upon work performance do not apply. Increases in salaries may only result from a worker being promoted into a higher job category or when the employee is no longer a union member.

Nevertheless, depending on specific collective bargaining agreements, bluecollar workers could be offered rewards based on performance as well as on attitudes and behaviors. For example, one interviewee mentioned that in his organization – a Latin American multinational corporation – productivity indicators such as efficiency, waste, work attendance and punctuality are used at the plant level, and variable compensation based on these

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Sources of a Dual Logic on PM Practices We have used the psychological contract framework to understand employment relationships in Mexico and have learned how the social context plays a major role in shaping these relationships. The need to develop in the employee the commitment and performance that labor contracts do in other societies, in Mexico might be replaced by the psychological contract. Psychological contractual relationships become relevant under certain circumstances such as where labor laws do not provide structural conditions for equality or fairness; where there exists mistrust on institutional agencies that govern employment relationships; or generally, where individuals feel the need to rearrange their personal status within a firm through psychological contracts.

also found that HR’s role is an important variable to consider in the implementation of the appraisal system.

Performance appraisals in Mexico could be better managed when considering the perceptions underlying psychological contracts. These perceptions are influenced by the social contract in which the employment relationship of this country is embedded. In particular, in Mexico individuals understand the intrinsic socio-emotional behaviors that accompany performance evaluation and engage in the process at different levels of commitment. Both parties – managers and employees – respond according to their needs and what they perceive they receive from the company. In terms of structural factors, individuals face the challenge of managing imported rigid bureaucracies that contradict cultural

The need to develop in the employee the commitment and performance that labor contracts do in other societies, in Mexico might be replaced by the psychological contract.

We have argued elsewhere that work in Latin American countries such as Mexico is paramount. Beyond providing a means of sustenance, work plays a central social and emotional role in individuals’ life. This creates an intricate implicit social contract between workers and employers at the firm level that in turn affects individuals’ psychological contracts These phenomena relate to the historical development of employment relationships. Mexican society has not followed economic rationality as a development principle but a different rationale: that of solidarity and a sense of community. Based on this principle we expand prior work on psychological contracts in Mexico relevant to performance evaluation.

Our studies show that contextual factors such as cultural, structural and economic reasons influence the sociopsychodynamics of the manager – subordinate relationship and affect perceptions of performance evaluation.4 We

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values. Finally, perceptions of the performance appraisal’s purpose are altered because the outcome is often more strongly linked to the country’s economic situation than that of the firm.

Our guidelines uncover the dual logic of managing performance systems in Mexico and provides an overview of the main instruments and tools, and implementation. These issues could guide the effectiveness of the implementation of such practices in a country with an incipient performance oriented culture.

About the Authors Anabella Davila (Ph.D. The Pennsylvania State University) is professor and the Research and Ph. D. Program Director at EGADE Business School, Tecnologico de Monterrey (Mexico).

She has co-edited several books on organizational culture and human resources management in Latin America. She holds the Research Chair on Culture, Human Resources and Society. Her main research interests include culture

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and management practices in Latin American organizations, human development, and sustainability. Her work examines the cultural and social logic that govern Latin American business organizations. She is a member of the Mexico's National Researchers System, Tier II. Marta M. Elvira (Ph.D. in Organizational Behavior and Industrial Relations at U.C. Berkeley’s Haas School of Business). Dr. Elvira is the Ph.D. Program Executive Committee member (Associate Director) at IESE Business School, Spain. She has coedited two books: Managing Human Resources in Latin America: An Agenda for International Leaders (with Davila, Routledge, 2005) and Best Practices in HRM in Latin America (with Davila, Routledge, 2008), as well as two special issues on research in Latin America.

Besides human resource practices and incentives in organizations, her research interest is on social inequality and human capital development. Her work examines the political and economic processes involved in designing organizational reward structures, and the joint effects of incentive pay and promotion systems on employee earnings and performance. Her articles have appeared in leading journals including Academy of Management Journal, Organization Science, Work and Occupations, Industrial Relations, and Group and Organization Management.

References

1. Davila, A., & Elvira, M.M. (2008).

Performance management in Mexico (pp. 115130). En Varma, A., Budhwar, P.S., & DeNisi, A. (Eds), Performance Management Systems: A Global Perspective, Routledge, Oxford, UK. 2. We also recommend our work on human resources management for an overall state of the art of this area in the country: Elvira, M. M., & Davila, A. (2005a). (Eds.). Managing human resources in Latin America: An agenda for international leaders. Oxford, UK: Routledge.

3. Davila, A., & Elvira, M. M. (2009).

Performance management in a knowledgeintensive firm: The case of CompuSoluciones in Mexico (pp. 113-127). In A. Davila & M. M. Elvira (Eds.). Best Human Resource Management Practices in Latin America. Oxford, UK: Routledge.

4. Davila, A. & Elvira, M. M. (2007).

Psychological contracts and performance management in Mexico. International Journal of Manpower, 28(5), 384-402.

Business Ethics

Why Should Managers Be Socially Responsible?

By Antonio Argandoña This is certainly a step forward in the theory of the firm, but an unsteady step – at least with regards to the reasons for why companies are supposed to be socially responsible.

In this article we propose that companies must be socially responsible not only because it is demanded by society, or because it increases profits, but above all because CSR is part of good management. That is to say, a socially responsible company is a good company, and a manager who manages in accordance with social responsibility criteria is an excellent manager, or at least is in a good position to become one.

In what follows we look first at the traditional arguments in favor of social responsibility in companies, namely the legal, social, moral and business case. After that, we examine what we mean when we say that a company is socially responsible. Finally, we present the management case and the conclusions.

Arguments for Corporate Social Responsibility Why must companies be socially responsible? The arguments put forward in the literature can be summed up as follows:1

The legal case The law defines the responsibilities that directly or indirectly attach to certain acts and their effects, as when we say that a person is responsible for the injuries her dog caused to another person, perhaps because she failed to take the necessary precautions to prevent the attack. However, it is widely agreed that CSR is voluntary and goes beyond the law, which means that the legal case is not a good explanation for why companies must act in a socially responsible way.

Why should managers put Corporate Social Responsibility (CSR) into practice? The so-called legal, ethical, social and business cases provide several reasons. In this paper we discuss these arguments, and we add new reasons that make up the ‘management case.’ By exploring why CSR is good management, this paper explains why CSR make the firm more human and the task of the manager more humanizing.

Introduction In the last years a growing number of academics and practitioners have promoted Corporate Social Responsibility (CSR) as a means of shifting the paradigm of the firm away from a purely economic model oriented to maximizing shareholder value, toward another model that takes ethical, social and humanistic variables into account and is oriented to a broad spectrum of stakeholders.

Companies must be socially responsible not only because it is demanded by society, or because it increases profits, but above all because CSR is part of good management.

The social case According to many accounts of CSR, society expects or demands certain behavior from individuals and organizations, whether as simple citizens, or as bearers of a particular status or role in society (politicians, managers, etc.), or as organizations (firms, unions, political parties, etc).2 The important thing, however, is not that these demands exist but why they create a responsibility for companies. If they do, it is probably for one of the following reasons: 1. Because these societal demands create a moral duty (e.g.,

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Socially responsible companies are believed to have a favorable legal environment, smoother relations with regulatory agencies, better relations with governments; an active role in spreading their good practices; a better image, brand and reputation, and more loyal customers. because acting responsibly is part of companies’ contribution to the common good),3 or because they define that moral duty in specific situations (e.g., they specify what constitutes employment discrimination in a given society at a given time).

2. Because meeting those expectations or demands is a civic responsibility, similar to the rules of behavior among individuals, backed not by the coercive power of the State but by the pressure of society itself. Corporate responsibility is sometimes said to be ‘social’ on the grounds that companies need a ‘social license’ to operate; or that they have an obligation to contribute as good ‘corporate citizens’ to society.4 3. Because CSR prevents costs or brings benefits, economic or otherwise, to the company in the form of lower costs, stronger customer and employee loyalty, higher productivity, enhanced reputation, lower financial costs, etc., which leads into the business case, discussed further below.

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The moral case Responsibility is an ethical term. “To say that a person is responsible […] for a given action is only to say that it is appropriate to take it as a basis of moral appraisal of that person”.5 Ethical responsibility appears when an action and its effects are attributed to a person as a ‘moral’ agent, when she is accountable for her actions and their consequences, not only to herself but above all to others, and not only for what she does, but also for the reasons for which she does it. This responsibility is social, open to others, owed to the community, and it is subject to the normative standards required of interpersonal behavior – external scrutiny, evaluation and sanction – and implies duties of disclosure and transparency.

The business case The business case argues that a socially responsible company is also profitable, and probably more profitable than other firms. In recent years numerous empirical studies have been carried out relating diverse measures of corporate social performance to financial performance.

Many of them come to the conclusion that the relationship is positive; a few find a negative relationship; and others find no statistically significant relationship at all.

The most likely conclusion from these studies is that there appears to be a positive relationship between CSR and profitability, but this conclusion is not definitive, as the relationship depends on other variables,6 and much published research displays major theoretical and empirical limitations.7 On the other hand, the fact that social performance and financial performance are correlated does not necessarily mean that the causality goes from CSR to profits: it may be that CSR actions consist of distributing profits among stakeholder.8

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In any case, a company is unlikely to decide to implement CSR policies simply because empirical studies show that such policies have a positive impact on financial performance. More direct arguments, addressing the details of the relationship between the two variables for a particular sector, location and company, will be needed. Especially where the focus is on the business case, the CSR literature usually mentions a series of advantages enjoyed by responsible companies. First, there are external advantages: socially responsible companies are believed to have a favorable legal environment, smoother relations with regulatory agencies, or a say in the drafting of new regulations; less risk of complaints and fines; better relations with governments (e.g., preferential access to contracts); an active role in spreading their good practices; a better image, brand and reputation, and more loyal customers, who may be willing to pay more for the companies’ goods and services because it is respectful of the environment or human rights. And they may have better relations with society, fewer disputes, less risk of negative advertising and boycotts, better relations with the media, and so on.

Socially responsible companies are also likely to have internal advantages.

For instance, they may well have an edge when it comes to attracting, retaining and motivating the best employees; greater transparency, morale and trust in relations with their internal stakeholders, more satisfactory employment relationships, a better working atmosphere, better supervision of the supply chain, and so on.

All these internal and external outcomes may translate into better financial and economic performance. For instance, they may give a company a strategic advantage over its competitors in the form of higher or more

stable sales, product differentiation, a higher price, and so on.9 They may also run fewer risks and reduce finance and operating costs (e.g., those arising from wastage of resources). A policy of honesty is likely to reduce litigation, complaints and fraud costs, enha-nce employee productivity (through higher motivation and commitment, or selfselection of the best workers), or attracting socially responsible investors, etc.

But even if CSR generates greater value for all its stakeholders, that value is just as likely to be captured by employees (in the form of higher wages or other benefits), customers (in the form of lower prices) or other stakeholders as it is by the owners of the company.

The business case has acquired a new dimension in recent years as CSR is winning legitimacy: academics make efforts to show that CSR is profitable, while managers claim to believe in it, and try to justify this belief in the hoped financial results of CSR. This has led to the development of a big ‘industry,’ ranging from consultants and professors to communication and PR experts, auditors, certification agencies, and CSR professional associations. To sell their products and services, all of these participants need to prove that CSR ‘pays.’

Ultimately, the attitudes of academics, shareholders, managers and CSR players are mutually reinforcing.

Nevertheless, the soundness of the business case has not been proved – and probably cannot be proved once and for all, because if socially responsible companies achieve better financial results, the non-responsible companies can always reproduce these practices, making those better results to vanish.

But this conclusion will not hold if CSR is not just a list of external, easy to imitate practices, but has an impact in the principles and practices of management, as we will show below.

The ‘management case’ An organization is a group of people who coordinate their actions to serve a common purpose aimed at achieving certain results that they all consider desirable, albeit for different reasons, and that they can achieve only through joint action.

These people (owners, managers, employees) who accept being part of

provider of funds for all sorts of social initiatives, even if remote from the company’s goals, and the business case may prompt opportunistic behavior, aimed at obtaining short-term profits.

All the above suggests that being socially responsible is a good way to manage a company – or rather, it is the only way to manage a company well.

But how does this come about?

If CSR is “the responsibility of enterprises for their impacts on society”, a responsible manager will take into account the impact of all his decisions on himself and others, without confining himself to profitability but without neglecting it either. the organization are moved by different motivations, which those who coordinate their activity (i.e. managers) must take into account. The managers’ job is ultimately to ensure, first, that the motivations of the company’s members (economic remuneration, a pleasant environment, satisfactory social relationships) are reasonably satisfied; second, that the desired results are achieved; third, that this is done efficiently; and fourth, that this is done in a way that at least does not work against the company’s longterm survival.10 This list of managers’ tasks combine different arguments: economic (the creation of value for the stakeholders), psychological (the provision of meaningful jobs and the learning of knowledge and abilities), social (the legitimacy of the company) and ethical (the preservation of the ability of the company’s members to take better decisions in the future).

This means that decisions in companies, also CSR decisions, cannot be justified by any one argument, be it social, ethical or economic. Indeed, overemphasizing any one case may well have undesirable consequences. The social case, for example, may turn the company into a

Academics make efforts to show that CSR is profitable, while managers claim to believe in it, and try to justify this belief in the hoped financial results of CSR.

If CSR is “the responsibility of enterprises for their impacts on society”11, a responsible manager will take into account the impact of all his decisions on himself and others, without confining himself to profitability but without neglecting it either. He will seek what is best in each case and find the means to do it; this will enable him to perceive reality in all its facets, specially the consequences of his actions on others and on himself. Before, let’s say, ordering a subordinate to tell a lie for the benefit of the company, he will be able to appreciate all the consequences of that action: he is undermining the employee’s selfesteem, and possibly causing indignation, and he himself is learning to treat his employees unjustly. Similarly, the discovering and assessment of the alternatives will be different. He will develop the capacity to resist the temptation to give in to short-term extrinsic satisfactions, and act with a view to the long term.

The responsible manager’s decisions are also cast on other stakeholders. He will be aware of his own limitations, the capabilities of others, and the opportunities for personal development that arise from dialogue. And through dialogue he will know what kind of stake each stakeholder has in the company, why each collaborates, how each can contribute to the company’s goals12 and how to build trust.

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The responsible manager focuses her interest in people, starting with the manager herself, which allows her to develop her operational and evaluative capabilities, to improve the organization’s core competencies and so contribute to long-term results.

Furthermore, participation will flourish. CSR will be a shared responsibility13, which implies giving responsibility to the different stakeholders, so that they also feel responsible for developing and applying their own capabilities to achieve their own objectives or motivations, within the framework of the common goals of the company.

Being ethical and socially responsible is a way – the only way – to be an excellent manager.

Conclusions The literature on the behavior of socially responsible managers points to a set of duties with respect to their stakeholders and to society; for example, when discussing the duties to customers we find mention of truthfulness in advertising, product safety, a fair price, and so on. This way of addressing issues is attractive because it specifies companies’ responsibility to their stakeholders. However, it confines itself to CSR defined as a responsibility or obligation.

What we have tried to do here is present CSR as an opportunity. We discovered that for managers, acting in a socially responsible way makes possible to capture aspects of reality that without this view would remain undetected. The responsible manager focuses her interest in people, starting with the manager herself, which allows her to develop her operational and evaluative capabilities, to create trust and collaboration, to improve the organization’s core competencies and so contribute to long-term results, including economic results.

Then, the expected outcomes of the business and the social cases are possible, but now they are more the achievements of the ethical managers than the extrinsic

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responses of other persons to the socially responsible actions of the company.

By understanding CSR as an ethical responsibility, we are able to propose a ‘management case’ for CSR, namely that being ethical and socially responsible is a way – the only way – to be an excellent manager. Beyond the business, the social or the moral case, the ‘management case’ is, we believe, the best case argument that can be made to persuade managers that they must be socially responsible.

About the Author Antonio Argandoña is Professor of Economics and holder of “la Caixa” Chair of Corporate Social Responsibility and Corporate Governance, IESE Business School, University of Navarra.

He is a member of the Royal Academy of Economics and Finance, chairperson of the Professional Ethics Committee of the Catalan Economics Association, a member of the Anti-Corruption Committee of the International Chamber of Commerce (Paris) and of the Committe on Standardization in Ethical Management of Aenor (Madrid). He has been a member the Executive Committee of the European Business Ethics Network (EBEN).

References

1. Argandoña, A., 2008a: “Ethical foundations of corporate social responsibility”, in E. Bettini and F. Moscarini, eds., Responsabilità Sociale d’Impresa e Nuovo Humanesimo. Genova: Sangiorgio Editrice, 31-56.

2. Carroll, A.B., 1979: ‘A three-dimensional conceptual model of corporate performance’ Academy of Management Review, 4, 497-505.

Wood, D.J., 1991: “Corporate social performance revisited”, Academy of Management Review, 16, 691-718.

3. Argandoña, A., 1998: “The stakeholder theory and the common good”, Journal of Business Ethics, 17, 1093-1102.

4. McIntosh, M., D. Leipziger, K. Jones and J. Coleman, 1998: Corporate Citizenship: Successful Strategies for Responsible Companies. London: Pitman.

5. Scanlon, T.M., 1998: What We Owe to Each Other. Cambridge, MA: Harvard University Press.

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6. Allouche, J. and P. Laroche, 2005: “A meta-analytical investigation of the relationship between corporate social and financial performance”, Revue de Gestion des Ressources Humaines, 57, 8-41.

Goll, I. and A.A. Rasheed, 2004: “The moderating effect of environmental munificence and dynamism on the relationship between discretionary social responsibility and firm performance”, Journal of Business Ethics, 49, 41-54.

Margolis, J.D. and J.P. Walsh, 2003: “Misery loves companies: Rethinking social initiatives by business”, Administrative Science Quarterly, 48, 268-305.

Margolis, J.D., H.A. Elfenbein and J.P. Walsh, 2007: “Does it pay to be good? A meta-analysis and redirection of research on corporate social and financial performance”, Working Paper, Boston, MA: Harvard Business School.

Orlitzky, M., F.L. Schmidt and S.L. Rynes, 2003: “Corporate social and financial performance: A meta-analysis”, Organization Studies, 24, 403-441.

Vogel, D.J.: 2005, The Market for Virtue: The Potential and Limits of Corporate Social Responsibility. Washington, DC: Brookings Institution Press.

Wu, M., 2006: “Corporate social performance, corporate financial performance, and firm size: A meta-analysis”, Journal of the American Academy of Business, 8, 163-171.

7. McWilliams, A. and D. Siegel, 2000: “Corporate social responsibility and financial performance: Correlation or misspecification?”, Strategic Management Journal, 22, 853-886.

8. Devinney, T.M., 2009: “Is the socially responsible corporation a myth? The good, the bad, and the ugly of corporate social responsibility”, Academy of Management Perspectives, 23, 44-56.

9. Porter, M.E. and M.R. Kramer, 2006: “The link between competitive advantage and corporate social responsibility”, Harvard Business Review, December, 1-16.

10. Argandoña, A., 2008b: “Integrating ethics into action theory and organizational theory”, Journal of Business Ethics, 78, 435-446.

11. European Commision, 2011: “A renewed EU strategy 2011-14 for Corporate Social Responsibility”, Brussels: Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions”, COM(2011) 681 final.

12. McVea, J.F. and R.E. Freeman, 2005: “A names-and-faces approach to stakeholder management. How focusing on stakeholders as individuals can bring ethics and entrepreneurial strategy together”, Journal of Management Inquiry, 14, 57-69.

13. Argandoña, A., 2008a: “Ethical foundations of corporate social responsibility”, in E. Bettini and F. Moscarini, eds., Responsabilità Sociale d’Impresa e Nuovo Humanesimo. Genova: Sangiorgio Editrice, 31-56.

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Feature

How Sustainability and Carbon Footprint Reduction is Transforming the DNA of Leadership Key Trends for 2013

By Nikos Avlonas

2

012 introduced several significant developments in sustainability, most notably around the issues of climate change, risk management, and supply chain ethics.

June’s Rio+20 United Nations Conference for Sustainable Development dominated the year’s discussion, reinforcing the need for corporations to play a larger role in attaining sustainable development goals. PricewaterhouseCoopers’ Low Carbon Economy Index publication1 supports this sentiment, showing only minor improvements in global carbon intensity reduction. As climate change regulation escalates in response to these numbers, we can expect to see more investors and consumers paying attention to corporate sustainable development strategies.

More than two-thirds of Fortune 500 companies now issue sustainability reports, with many also investing in sophisticated methods of tracking and reporting emission data.

Companies anticipate these changes. More than twothirds of Fortune 500 companies now issue sustainability reports, with many also investing in sophisticated methods of tracking and reporting emission data. The Carbon Disclosure Project2 reports that in 2012 alone top firms integrating climate change into their business strategies reduced their emissions by nearly 14%.

2012 was filled with corporate behavior scandals.

Companies like Barclays and Walmart found themselves in

the spotlight amid global concern over lack of corporate and supply chain ethics. Natural disasters raised further questions about the ability of companies to adapt and become resilient to social and environmental challenges. Greater investment in supply chain management, stakeholder engagement and financial-environmental reporting will develop as business leaders seek to address these reputation and environmental risks.

As sustainability becomes more mainstream one trend also continues to hold promise: companies will continue to expand their investments in sustainability, and intensify their focus on pressing issues like energy efficiency, natural resource management, and health & safety. A study by the Massachusetts Institute of Technology shows that greater numbers of companies view corporate environmental and social responsibility as a profit boost.3 2013 will see increased corporate spending on sustainability issues like clean technology, sustainability reporting assurance, and corporate sustainability programs. In 2012 this was already made evident with evermore additions of chief sustainability officers to corporate boards.

Sustainability is Transforming the DNA of Leadership Sustainability is about longevity, but it is also about transformation. “How do we respond to challenges and evolve for the better,” is always a question central to any leadership strategy. But being able to effectively communicate that question, connect it to a larger movement, inspire higher performance, find innovative solutions and influence traditional thinking are all characteristics that pertain to only a certain kind

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receptive to the possibilities of change.

With decisive leadership also comes disruptive leadership. Transformative leaders create controversial strategies that challenge the way sectors and state interact. According to Senate climate guru Barbara Boxer, we can expect to see this approach in upcoming U.S. policy, whether in the form of a revenuegenerating carbon tax or re-energized EPA regulatory schemes aiming to drive businesses to compete in energy markets and pave the path for clean energy.

We’ll also witness this as an increasingly common business strategy for success. According to The Carbon

include categories such as product use phase, end of life phase, and carbon abatement of products and services.

The Business Case The business case is evident in the following graph where organizations that join the Carbon Disclosure Leadership Index (CDLI) have much better financial performance overtime that all the others in the Global 500 Index. The CDLI5 includes Siemens, Coca-Cola, Microsoft and many other industry leaders.

As a result of the expansion of businesses acting as Good Corporate

100

Return over Q4 2005 baseline (%)

of leader. Given the recent flurry of climate change scares, there is no doubt that it is this concept of a “transformative leader” that will be leading the year’s discussion.

What is transformative leadership?

Simply put, transformative leaders focus on their followers: they motivate followers to achieve higher levels of performance, listen and respond to their needs, challenge them to be innovative and creative, and in the process help them to develop their own leadership potential.

A recent report by The Climate Group4 spells out five traits that need to be embraced by business and government in order to create transformative leaders and achieve long-lasting, low-carbon results. The first step? Embrace change.

Many political and business leaders already acknowledge change, but only in recent years have we seen these leaders begin to embrace change as an instrumental part of longevity. For instance, in his second Inaugural Address, US President Obama announced a renewed commitment to clean energy and greenhouse gas reduction. In doing so he warned America of the need to change with changing times: “The path towards sustainable energy sources will be long and sometimes difficult. But America cannot resist this transition; we must lead it.” World Bank President Kim Jong Kim has also recently promised to make tackling climate change a top priority during his term. These leaders are beginning to embrace carbon reduction – not as a goal, but as a long-term and integral strategy for profitability, economic growth, and security. Their brute regulation is not only imminent, but also reflective of a new style of leadership: one that is strategic, determined, and

80

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0

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-20

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Q4 2009

Q2 2010

Q4 2010

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Q4 2011

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CDLI Index Global 500 Index

-40 Source: Carbon Disclosure Project

Disclosure Project, more than two-thirds of business already put climate change at the heart of their business strategies.

Most of these companies are reporting their emissions at the company level.

However, many more are challenging the status quo by learning how to extend emission reporting from the confines of their own operations to the wider effects of their products – redefining the scope of reporting to

March-April 2013

Citizens, in other words embracing Sustainability principles, an array of codes, standards, guidelines and frameworks beyond CDP are available to guide companies in integrating corporate responsibility into their business strategies and management processes.

Needless to say, their purpose is to drive the performance of companies in line with the goals of sustainable development. The largest of such frameworks (in regards to company participation) is the UN Global Compact, which currently has 10,000 participants, including over 7,000 businesses in 145 countries.6 Thus, Business leaders no longer wonder whether to use such tools; on the contrarily, they ponder as to which combination of tools will bring best performance. In 2012 this was made evident with evermore additions of

An array of codes, standards, and guidelines are available to guide companies in integrating corporate responsibility into their business strategies. Business leaders no longer wonder whether to use such tools; they ponder which combination of tools will bring best performance. chief sustainability officers to corporate boards, with Unilever being among many to expand its sustainability teams, and a bright example.

Through a slightly more pessimistic lens, environmental disasters, like Hurricane Sandy coupled with governance lessons learned from 2012, remind us that there are many areas of Leadership we can and should expect businesses to embrace dynamically within the future. Hopefully as a lesson, we will see Sustainability directives become more coordinated across departments, causing a big shift in corporate structure and thinking. Corporate heads will look to leaders that can demonstrate the drive and flexibility needed to collaborate across business units and influence decision makers. Perhaps the latest ‘G4’ revision of the reporting guidelines by the GRI is another way of moving leadership deeper into Sustainability efforts!

At the Centre for Sustainability & Excellence, we observe these progressing trends with a growing number of professionals attending our global Sustainability

“

demand to learn: how to be radical, how to be transformative and how to create impactful, enduring value. Our upcoming trainings held in Chicago on March 7 & 8th (Certified Carbon Strategy Practitioner – IEMA Approved) and London on April 25 & 26th (Certified Sustainability CSR Practitioner Training - IEMA Approved) are designed in response to this maturing mentality. The trainings include all scopes of GHG emission reporting, and incorporate hot topics such as water footprint, Life Cycle Analysis, and carbon reduction via green building as well as Sustainability reporting, stakeholder engagement and identification, CSR Reporting and implementation respectively. As many more begin to follow these trends and pursue such knowledge, simple policies and reporting will no longer be enough. Investors and stakeholders alike will be looking for radical strategies that aim to create long-lasting impact – those professionals without the right amount of knowhow might as well fold their cards to this new era of transformative leadership.

The trainings include all scopes of GHG emission reporting, and incorporate hot topics such as water footprint, Life Cycle Analysis, green building as well as Sustainability reporting, stakeholder engagement, CSR Reporting and implementation.”

and Carbon Strategy Practitioner training programs in all major cities including New York, Chicago, San Francisco, Atlanta, Toronto, Tokyo, Dubai and Brussels. Our registrants hail from forward-thinking companies like United Airlines, Walmart, Unilever and ABM. Their backgrounds are diverse – comprised of Sustainability and CSR Officers, Communications and Marketing Directors, Investor Relations and even Media Relations departments. What unites these individuals is a growing

About the Author Nikos Avlonas, CSE President, was rec­ ognized by Trust Across America as one of the Top 100 Thought Leaders In Trustworthy Business Behavior in 2010, among many other corporate leaders. The Centre for Sustainability and Excellence (CSE) is a global Sustainability (CSR) strategic advisory and training organi­zation

providing in-house and open trainings that meet the needs and requirements of every industry and the business activities of every organization. As an Approved Course and Training Organization under the Institute of Environmental Management and Assessment (IEMA), and a GRI Certified Training Provider, CSE offers intensive professional learn­ ing opportunities to executives and senior level manag­ ers on Corporate Social Responsibility Strategies, Carbon Footprint, CR legislation, Sustainability Reporting and Climate Change Leadership, having trained over 5,000 pro­fessionals from five continents.

CSEs international certified training: Global Certified Sustainability (CSR) Practitioner; Certified Carbon Strategy Practitioner; and GRI Certified Training on Reporting; takes place in New York, Chicago, San Francisco, Brussels, Athens, Dubai, Abu Dhabi, Oman and Tokyo.

For more info about the next training programs visit www.cse-net.org

References

1. PwC (2012), PwC Low Carbon Economy Index 2012: Too late for two degrees? Assessed on 10/2/13, available at: http://www.pwc.com/ gx/en/sustainability/publications/low-carboneconomy-index/index.jhtml 2. Carbon Disclosure Project (2013), Business resilience in an uncertain, resource-constrained world: CDP Global 500 Climate Change Report 2012. Assessed on 14/2/13, available at: https://www.cdproject. net/en-US/Results/Pages/reports.aspx 3. Arthur, D. et al. (2011), Sustainability: The ‘Embracers’ Seize Advantage. Massachusetts Institute of Technology. 52, (3), pp 1-27.

4. The Climate Group (2012), Infographic - The DNA of low carbon leadership: five traits to embrace now. Assessed on 10/2/13, available at: http:// www.theclimategroup.org/what-we-do/newsand-blogs/infographic-the-dna-of-low-carbonleadership-five-traits-to-embrace-now/ 5. Carbon Disclosure Project (2013), CDP 2012 disclosure scores., assessed on 10/2/13, available at: https://www.cdproject.net/en-US/Results/ Pages/CDP-2012-disclosure-scores.aspx 6. Crane & Matten (2013), Should the UN Global Compact have sharper teeth? Assessed on 14/2/13, available at: http://craneandmatten.blogspot. gr/2013/01/should-un-global-compact-havesharper.html

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Business Operation

Predictive Analytics: New-generation Strategic Decision Support

By Tobias Klatt & Klaus Moeller 1. Dynamism and Complexity: The Environment Challenges Traditional Strategic Planning Tools

Environmental turbulence has become a key challenge for companies’ strategic planning. Planning results remain arbitrary and risky, and lack deep knowledge of relevant factors and trends. Traditional instruments such as key performance indicator concepts, strategy maps, and balanced scorecards become increasingly opaque under these conditions, especially owing to their subjective foundations, which are biased because planners are overloaded with information. To overcome these shortcomings, this article integrates predictive analytics throughout the strategic planning process with a special focus on causal reasoning: applications and benefits of knowledge in causal interactions are described for external and internal impact analysis, strategy development, scenario analysis, implementation, and the final checking phase. Our results imply that causality analysis possesses substantial benefits as a new generation of decision support for every company’s strategic planning.

instruments and concepts, a core aspect of which involves the analysis of causalities, which brings completely new insights to traditional planning approaches. However, the idea behind this is not new: causal reasoning was developed in the 1960s by Clive W. Granger. Christopher Sims, who in the 1980s developed operational transfer, in 2011 received the Nobel Prize with Thomas Sargent for their analyses of causes and effects in macroeconomics.3 Nevertheless, their developments also offer substantial benefits to strategic planning practice and science. This article discloses these benefits in strategic planning’s processes and offers insights on connections with prevalent tools, such as strategy maps or the balanced scorecard (BSC).

Increasing environmental turbulence challenges established company strategic planning processes and tasks. The dot-com bubble, the recent financial crisis, and the current turbulence in the Eurozone—to name a few—challenge the planner’s understanding of environmental trends. Increasing competition in established markets, with new players from Asia and the growing importance of upcoming markets such as the BRIC countries create further planning uncertainty.

A plethora of demands appear, and these call for new approaches to dealing with environmental uncertainty, especially regarding the possibility of analysing “interactions among variables.”1 These arguments are based mostly on improved data availability and information techniques over the past years.

As a result, helping managers to use quantitative models to support their decision-making and planning is a key research topic.2 This article addresses this gap by providing evidence on the diverse contributions of predictive analytics as a new way of analysis that offers new

2. Causality Analysis Improves Planning Tool Excellence: A Holistic View of Versatilities Several instruments support planners during the strategic planning process.

While several concepts outline the process itself, this article relies on the detailed structure developed by Mintzberg as well as Goetze and Mikus, which provides a disaggregated view of the particular tasks within the process steps (see Figure 1).

Strategic analysis and forecasting Goa - setting

Environmental analysis and forecasting

A

Strategy development and decision C

Strategy Implementation

Development of strategic alternatives

Company analysis and forecasting

Strategy agreement

Definition of business units

Decision on strategy implementation

B

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Behavioural implementation

D

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E

Figure 1: Empirical causality analysis’ contribution to strategic planning 4

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The instrumental support to the processing of these 9 strategic planning steps gains importance due to the increasingly extensive data and information involved in strategic decision-making in complex and dynamic environments. Traditional instruments offer several contributions to facilitate information processing within strategic planning. However, these tools are mainly based on a subjective instrumental design, such as portfolio concepts or SWOT-type analyses. Even the contribution of numbers-based decisionmaking models, such as AHP or system dynamics, mainly depend on subjective estimates by users or experts. Although these models have impact because they simplify complex problems and merge excessive information, they do not serve to review the strategic planner’s assessments or enhance his or her thinking by offering an objective view of interactions between strategic impact factors.

Causality analysis, as a subfield of predictive analytics, closes this gap.

The processing is based solely on time series data; no subjective estimates on relationships or interactions are necessary. This approach applies enhanced regression models, which include timelagged variables. These time-lags allow for the analysis of time-dependent interactions between the variables. Figure 2 lays out the main idea and benefit: the figure includes the development of the company variable, such as sales, and two possible external planning factors.

A superficial, subjective view of the time series may trigger the assumption that planning factor X is the relevant one for forecasting the dependent company variable, since both variables show a similar trend.

However, a deeper view of the changes in the variables reveals that planning factor Y has, except the trend, nearly the same growth signs with a two-period preceding offset to the company variable. Depending on the time intervals, planning factor Y may be more accurate. For instance, in the case of quarters, current developments of Y indicate similar changes in the company variable six months ahead.

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Variables

Business Operation

Company variable (Sales/Costs)

Planning factor x

Planning factor y

Time

Figure 2: Insights from empirical causality analysis

This article’s integration goal is to enable a comprehensive application of causality analysis to support more accurate strategic planning. Accuracy should lead to a more analytical-rational decision-making style, as an alternative to previous strategic planning processes, which have a purely subjective basis.

Empirical causality analysis’ primary integration opportunities are connected to strategic planning tasks (see the circles in Figure 1 on previous page) and are listed in Figure 2 above.

Empirical causality analysis’ primary integration opportunities are connected to strategic planning tasks.

2.1 A: Environmental impact analysis Against the background of increasing environmental turbulence, the analysis of causal dependencies between strategic impact factors in the environment and the company is the most challenging task. The capability to rapidly glean information on environmental developments such as customers and markets helps to attune companies to changes in the environment and can result in a competitive advantage in contrast to slower competitors.

The most suitable and comprehensive contributions of empirical causality analyses result from strategic questions concerning distribution activities. Companies

March-April 2013

have comprehensive knowledge of their markets, customers, and competitors—both as implicitly experienced by managers as well as explicitly gathered in comprehensive databases. Similarly, large public databases and research institutes provide comprehensive time series data on environmental factors, such as consumer confidence, income development, consumer price index, etc. On this basis, the analysis of causal relationships between environmental impact factors and distribution-oriented target measures such as sales or turnover can contribute to several key aspects in strategic planning. These include: • an empirical examination of planning assumptions, such as whether sales forecasts are related to GDP developments or, instead, to different factors, • an early warning system using leading indicators that are empirically tested on their correspondence with company target figures, • deeper planning processes, which use additional information from empirical analysis rather than subjective estimates of impact factors’ influence, • proactive timing of marketing activities, owing to empirically identified time-lags between changes in early indicators and sales, • customer-oriented product strategies, as interaction effects between the instruments of the marketing mix (product, price, place, promotion) and customer-related factors (e.g., satisfaction) become evident.

Besides these direct contributions of causality checks in environmental analysis, there is one more important aspect concerning the complete strategic planning process: the first strategic analysis steps also represent the primary input for the planner’s strategic learning as long-term input for developing successful strategies. Mintzberg, Ahlstrand, and Lampel emphasise the importance of learning about the environment for the success of the company’s strategic planning: “Above all, learning, in the form of fits and starts, discoveries based on serendipitous events, and the recognition of unexpected patterns, plays a key role, if not the key role, in the development of strategies…”5

2.2 B: Internal causality analysis A key company analysis task is the identification of the firm’s strengths and weaknesses. Subsequently derived performance drivers of the company’s target figures should help to achieve strategies that build on these strengths and eliminate or minimise the weaknesses.

The analysis of causal connections between these performance drivers (such as consumer confidence or scrap rates) and the company’s target measures (such as turnover or shareholder value) can contribute substantially to the planner’s understanding of value generation. This also provides an objective basis for discussing and estimating cause-and-effect relationships within the

The first strategic analysis steps also represent the primary input for the planner’s strategic learning as long-term input for developing successful strategies.

The company’s learning-based ability to gather and use new knowledge from external sources defines the capability to achieve and maintain strategic fit: the contextual environment cannot be influenced directly by individuals or companies, which implies that environmental requirements are given. Changes in these requirements differ from company to company, since the need to acquire resources creates dependencies between organisations and external units. Learning about the environment thereby allows for the clear perception of environmental requirements, depending on managers and planners’ capabilities and perceptions. The deep identification, analysis, and interpretation of environmental effects on company target figures is therefore crucial to the strategic planning success as a whole, since it determines the achievement of strategic fit.

company’s value creation process. Such active management participation in the strategic planning process can amplify the effectiveness of strategic planning.6 Internal causality analysis also prepares much-needed methodological support for strategy implementation (see Section 2.4). Strategy maps are significantly improved through the use of empirically proven cause-and-effect relationships. Strategy maps present “a visual representation of a company’s critical objectives and the crucial relationships among them that drive organizational performance.”7 These maps use cause-and-effect diagrams to describe how a strategy must be carried out to achieve the organisation’s desired outcomes. However, constructing highquality strategy maps is difficult. Kaplan and Norton recommend that employees visually represent cause-and-effect linkages that integrate the different

performance drivers and outcome measures. This approach carries the risk of invalid cause-and-effect-relationships, which can result in dysfunctional organisational behaviour, wrong strategy communication and control, and suboptimal performance. An empirical causality check of these linkages can help to review the theoretical considerations of proposed cause-and-effect-relationships.

2.3 C: Scenario analysis and strategic alternative generation The external and internal analysis results are used during the strategy development and decision phase to generate and evaluate strategic alternatives and measures. Traditional planning approaches in dynamic and complex environments—such as scenario planning—are often criticised for their purely subjective nature, which can lead to biased planning results. Although these qualitative approaches have their specific advantages, empirical causality analysis helps to develop more elaborate scenario planning. On the one hand, the empirical identification of directly and indirectly relevant strategic impact factors is supported. On the other hand, this knowledge enables a more accurate preparation of guidance in the case of scenario changes. Connecting al-ternative scenarios with an early warning system based on causally proven indicators can enable an earlier recognition of environmental changes, as illustrated in the attention-focussing phase (tSC - tA) in Figure 3 (on next page). This time lead represents a strategic advantage to the company and offers more possibilities to develop adequate strategic responses.

Furthermore, this connection counteracts the frequently observed focus on a single baseline or trend scenario in strategic planning, which ignores the scenario planning advantage of building on the consideration of multiple futures.8

Strategy maps are significantly improved through the use of empirically proven cause-andeffect relationships. Strategy maps present “a visual representation of a company’s critical objectives and the crucial relationships among them that drive organizational performance."

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Better case scenario

Environmental early warning indicator

Scenario change

Trend scenario

Attention focussing to

tA

tSC

T Worse case scenario

Figure 3: Causality analysis in scenario planning

Empirically testing the causality between these measures could enhance knowledge of the value creation process and help to identify de facto key performance drivers.

The second advantage enabled by empirical causality analysis is the more precise planning of responses to environmental change. Impulse-response analysis provides a view of the course and delay of responses in the company’s target figures to strategic impact factor changes. This knowledge can lead to better resource allocation: if the response function reveals a two-quarter sales response delay to a change in consumer confidence, marketing expenses can be allocated to promote advertising campaigns one to two quarters ahead.

2.4 D: Implementation Several tools are used during the strategy’s implementation phase to transfer and communicate strategic plans into the organisation. The balanced scorecard has received substantial attention from both managers and researchers; it is the dominant concept in the performance measurement field. The balanced scorecard visualises the company’s strategy using causal relationships among key performance drivers in different units and operationalises them by assigning key performance indicators. Today, a variety of companies use the BSC to link their strategy with their short-term operations.

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However, the BSC is under fire, especially regarding the interrelationships between performance drivers.

The lack of explicit causal models of the relationships between measures makes it difficult to evaluate performance measures’ relative importance.

Furthermore, the linkages between different dimensions of organisational performance should be clearer.

Similarly, survey results show that only half of the companies surveyed in the U.S. that use formal performance measurement systems have implemented and tested causal relationships between their measures.9 Yet these causal relationships help company members to understand how objectives can be achieved and to evaluate performance according to strategically linked measures instead of common and general financial measures.

While some of these measures, especially the financial perspective, are connected by logic, others—such as the consumer or potential perspective—have only a tacit relationship. Empirically testing the causality between these measures could enhance knowledge of the value creation process and help to identify de facto key performance drivers.

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2.5 E: Strategic checking In the aftermath of global distortions in the beginning of this century, regulatory standards that claimed more detailed risk management approaches were enforced: especially the International Financial Reporting Standards (IFRS) 7 and the International Accounting Standards (IAS) 1 require companies to report estimations on their early risk recognition, quantitative statements about the company’s risk exposure, and instruments used in the risk management and foresight process. Such forward-looking risk management should incorporate environmental scanning systems into internal risk analysis.

These regulatory developments were also accompanied by a comprehensive body of literature that developed environmental scanning and early warning systems. However, these concepts and instruments are seldom used by practitioners, primarily owing to insufficient knowledge by managers and planners on the right setup of these systems; some managers and planners may not even know how or where to start, or how to solve problems in design, implementation, or day-to-day operations.10 The state-of-the-art of these environmental warning systems covers four general types: The first generation, developed in the early 1970s, concentrated on risk detection based on projections using past data from internal sources, such as accounting figures. Based on criticism of this system’s purely risk-oriented design and its internal focus, a second generation of early warning systems provided indicator-based surveillance of internal and external developments.

These systems, which were faulty owing to their directedness on single aspects, were followed by a third generation of 360° strategic radar analysis. Fourthgeneration approaches integrated the operational and the strategic perspectives of the second and third generation’s early warning systems. These cover the identification of risks opportunities, and provide the basis for the development of responses, such as systems based on scenario techniques.

company’s specific situation and requirements. These include the existence of databases containing time series data on the company’s target figures. This requirement is a work in progress, since many companies are still in the data storage establishment phase. Furthermore, most of the noted contributions require the presence of traditional management control instruments, such as the BSC or strategy maps. Although these tools are widely known, many companies do not apply them. In these cases, companies face extensive organisational and monetary efforts to exploit the full benefits of empirical causality analysis.

Besides these limitations, our results similarly revealed concepts and opportunities for further research. This article focussed on strategic impact factor analysis in the company environment (outside perspective). By doing this we do not tackled causality analyses in operations management (inside perspective). Furthermore, growing data availability increasingly eases application and its opportunities for more extensive applications.

Predictive analytics, with their causality analysis improvements, contribute to the further development of these fourth-generation models. Exploiting the increasing amounts of available data enables one to identify and use empirically proven early warning indicators.

Together with knowledge about the effects of alternative developments in these indicators, the claimed “comprehensive system for managing risks in the external business environment”11 is supported. Figure 4 (bottom of page) depicts how the empirical causality analysis results can be incorporated into an environmental warning system.

Knowledge about the time-varying relationship between strategic impact factors and company target figures thus enables one to prepare specific response actions, depending on the company’s business model and industry.

3. Lessons Learned: A New Generation of Strategic Planning Support This article provides an approach to comprehensively apply empirical causality analysis in the strategic planning process. The primary contributions are the analysis of external and internal strategic impact factors, the development of scenario plans and their implementation, and early warning systems.

These contributions should enable more analytical-rational decision support, which is considered beneficial to strategic planning effectiveness, and reduces the risk of information overload.

These contributions depend on a

About the Authors Tobias Klatt is research affiliate at the Center for Performance Research and Analytics (CEPRA) at Augsburg University and controller in corporate management, Axel Springer AG, Berlin.

His research concerns the analysis of causal impacts from environmental developments on strategic planning. He earned his PhD at Goettingen University for his thesis on empirical causality

Short term Scanning Environmental factor 1 First quater 20XX - 4,5%

Adaption Analysis

Operations

Forecasted sales reactions in the next 20 quaters

Environmental factor 2 First quater 20XX + 5 Million Euro Environmental factor 3 First quater 20XX - 0,5 Points

Long term

Time

Attention: Sales drop in t+3

Adjustments: • Check current scenario’s planning correctness

Figure 4: Continuous enviromental warning system

Adjustments: • Production s • Capacity ion apt d • Advertising ga • Hedging nin lan p • etc gic

a te S tr

Adjustments: • Scenario change evaluation • Hedging of environmental consequences • Check strategic fit

analysis in strategic planning and completed his diploma in Political Economics at Goettingen University (Germany) and the Department of Business Studies at Uppsala University (Sweden).

Klaus Moeller is professor for Controlling and Performance Management and director of the Institute of Accounting, Control and Auditing at the University of St. Gallen, Switzerland.

He is founder and director of the Center for Performance Research and Analytics (CEPRA) at Augsburg University, and the consulting firm The Performance Management Company (PMC) GmbH, Munich, Germany. He has held chairs at Goettingen University (2007 to 2011) and the Technical University of Munich (2006 to 2007). His research focuses on performance management, predictive analytics, and innovation control.

References

1. Aragon-Correa, J.A. and Sharma, S. (2003).

A contingent resource-based-view of proactive corporate environmental strategy. Academy of Management Review, 28(1), p. 75 2. Möller, K., Batzlen, S. und Klatt, T. (2012), Nutzung von Performance Management Analytics zur Prognose- und Risikoberichterstattung, Schweizer Treuhänder, 86(6-7), pp. 446-450.

3. Granger, C.W.J. (1969). Investigating causal relationships by econometric models and crossspectral methods. Econometrica, 37(3), pp. 424438; Sims, C.A. (1980). Macroeconomics and Reality. Econometrica, 48(1), pp. 1-48.

4. see also: Mintzberg, H. (1994). The rise and fall of strategic planning. New York: Free Press; Goetze, U., Mikus, B. (2006). Strategische Unternehmensplanung – Phasen, Instrumente und ausgewählte Strategien. Chemnitz: Physica Verlag.

5. Mintzberg, H., Ahlstrand, B., and Lampel, J. (1998). Strategy safari. New York: Free Press, p. 73.

6. Elbanna, S. (2008). Planning and participation as determinants of strategic planning effectiveness.

Management Decision, 46(5), pp. 779-796.

7. Kaplan, R.S. and Norton, D.P. (2000).

Having trouble with your strategy map? Then map it. Harvard Business Review, 78(5), p. 168.

8. Bishop, P., Hines, A. and Collins, T. (2007).

The Current State of Scenario Development: An Overview of Techniques. Foresight, 9(1), pp. 5-25.

9. Marr, B. and Schiuma, G. (2003). Business performance measurement – past, present and future.

Management Decision, 41(8), pp. 680-687.

10. Lesca, N. and Caron-Fasan, M.-L (2008).

Strategic scanning project failure and abandonment factors: lessons learned. European Journal of Information Systems, 17, pp. 371-386.

11. Global Intelligence Alliance (2007). Market intelligence for the strategy & planning process, GIA White Paper 1/2007, p. 3.

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Feature

Flexibility to Improve Forecast Accuracy

By Karin Bursa

T

o succeed in a business economy shaped by uncertain demand and rapid market changes, companies must be able to sense and adapt quickly. Today, the supply chain is seen as a key enabler of this flexibility. To face this challenge your supply chain must forecast correctly and then modify the plan as new information is acquired.

To accomplish this, supply chain planners must use multiple forecasting methods tuned to different selling profiles that perform well at different phases of the product life cycle where each method is chosen to best exploit the available historical data and available market knowledge. The key is to pick the most effective and flexible models and shift between them as needed to

Supply chain planners must use multiple forecasting methods tuned to different selling profiles that perform well at different phases of the product life cycle.

Seven Methods for More Accurate Forecasting Type

Best-Fit statistical

The 7 Methods

Description

Modified Holt/ Holt-Winters

Use Holt when demand is trended, but does not vary by the time of the year. Use Holt-Winters when demand is often higher or lower during particular times of the year.

Moving Average

Use for products with demand histories that have random variations, including no seasonality or trend, or a fairly flat demand.

Inhibited Derived Modified Parent-Child Intermittent Demand

Modified Croston

Attributebased

Demand Profile

Causal

Promotions

Use to produce a zero forecast.

Use to forecast products as a percent of the forecast for another product (dependent demand).

Use for products with low demand or for some zero demand periods, such as slow-moving parts.

Employs user-defined attributes to model new product introductions, seasonal or fashion driven products, and product end-of-life retirement.

Use to calculate ‘lift’ from promotions in addition to the normal forecast.

Source: Logility, Inc

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March-April 2013

keep forecast accuracy at its peak. Let’s review some of the methods available and the ideal scenarios for their use.

Models Forecasting models classically fall into three categories: qualitative, quantitative and hybrid. The primary differences between them include the type of input data and the mathematical and statistical methods employed to generate forecasts.

• Qualitative models are experience-driven, relying on subjective inputs from knowledgeable personnel, such as salespeople and account managers.

• Quantitative models are statistically driven, drawing heavily on historical performance data as the basic data input. The calculating logic is defined and operations are purely mathematical.

• Hybrid models typically draw on historical demand information as a starting point, then use empirical data to further refine the forecast.

Best-Fit Statistical Modeling For most levels of management within an organization, aggregated demand

When there are more than four-to-six periods of sales history, Stock Keeping Units (SKUs) can be forecast with moving average and basic trend methods. SKUs with at least one year of sales history offer sufficient information to incorporate a seasonal profile into the projected trend. history for product family, brand, category, country and/or selling region are strong predictors of future performance.

Such demand history also serves as a baseline for effectively forecasting Stock Keeping Units (SKUs). When there are more than four-to-six periods of sales history, SKUs can be forecast with moving average and basic trend methods.

SKUs with at least one year of sales history offer sufficient information to incorporate a seasonal profile into the projected trend.

“

A modified Holt-Winters decomposition model with best-fit analysis can generate forecasts based on demand history that incorporate trends and seasonal information.”

A modified Holt-Winters decomposition model with bestfit analysis can generate forecasts based on demand history that incorporate trends and seasonal information. The method “senses” the amount of history available for each time series or segment to create a basic model that best fits the history. Then it uses the best combination of smoothing factors to enable the model to react to changing conditions going forward without over-reacting to anomalies in demand (such as unplanned seasonal events, transportation disruptions, and so on).

A powerful best-fit statistical method should include flexible features such as trend, seasonal-with-trend, moving average, and low-level pattern fitting, as well as trend models for products with sporadic, low-volume demand.

“Best fit” refers to the ability to change forecast methods as a product evolves. The process may start out as a demand profile method, evolve to a modified Holt-Winters method as the product becomes stable, and ultimately transition to a demand profile method again as the product life cycle comes to an end.

trend and seasonal elements of the associated category. As the forecast for the associated category is adjusted to reflect changing conditions over time, so too is the derived product’s forecast. If the derived product’s point-of-sales (POS) or demand levels deviate from the forecast and exceed a user-defined tolerance, the system can generate a performance management alert to notify forecast analysts to take corrective action.

Intermittent Demand Slow-moving parts typically exhibit irregular demand that may include periods of zero or excessively lumpy demand. A Modified Croston Method handles low and lumpy demand that exhibits either a patterned variation or no pattern.

The patterned variation looks at available history and classifies each demand element relative to those around it. It measures the duration of plateaus and plains, as well as the severity of peaks and valleys and then conducts pattern-fitting analysis to find regularity over time. If no pattern is present, the unpatterned variation method attempts to use averaged highs and lows to create a step-change forecast for future demand.

Both techniques permit zero demand to reside in the history, and will acknowledge such in the future demand forecast.

Derived Modeling One method of generating new product forecasts is to use demand variations or extensions from existing products, families or brands. Consequently, they draw on the historical data of existing products or families. When combined with causal effects or management-selected overrides to accommodate introductory promotions, derived modeling can provide a realistic and dynamic forecast for new products.

Using this approach, new products are assigned a percentage of the parent, family and/or brand, enabling them to proportionately inherit a forecast that contains the base,

Attribute-Based Modeling What if lack of data, short life cycle, or other mitigating factors make it difficult to forecast using time series or qualitative techniques? Forecast creation for new product introductions, short-life or seasonal products, and end-of-life products calls for attribute-based modeling techniques.

The attribute-based model provides a wide variety of demand profiles by which to characterize the product, and

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Feature

can adjust the product’s plan dynamically in response to early demand signals. The method will analyze historical sell-in and/or sell-through data to develop a wide variety of demand and seasonal profiles. These profiles are assigned to individual planning records. Then, as actual demand information is captured, the current profile is validated or alternate profiles identified to dynamically adjust the product’s plan.

Through Relative-Error-Index (REI) calculations the planner can quickly see which demand profile now has the most accurate fit based on current demand trends and can change the current demand profile to the profile that has the lowest REI.

Causal Event Modeling Causal modeling can specifically address the effects of promotional elements such as price discounts, coupons, advertising, and product placements. It supports input from multiple marketing groups, and aids the identification and reconciliation of potential conflicts or overlaps in promotional planning proposals.

combination of qualitative and quantitative techniques to generate reliable forecasts.

As we have seen, attribute-based methods that use demand profiles are often suited to new product introduction and end of product life cycles, at times when reliable historical demand data is lacking or the available data is less relevant.

At the more mature stages of the product life cycle, five different time-

To prevail in today's business economy, all of these forecasting methods must be harnessed... Superior predictive power and real-time reflexes are the keys to coming out ahead of the competition.

Causal modeling enables planners to quickly simulate marketing program options and refine forecasts. Using pretrained neural network technology in causal-based modeling is a unique best practice that lets planners quickly start to model the cause-and-effect relationship of different promotional elements.

Flexibility and Ease of Use are Vital to Good Forecasting Optimal demand planning and forecasting requires comprehensive modeling capabilities plus the flexibility and ease-of-use to shift methods as life cycles progress and market conditions change.

Advanced forecasting systems use a

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series statistical models come into play.

These models are used to create retrospective forecasts that cover prior periods (typically three years) of documented demand. The forecasts are then matched to actual demand history to determine which one best fits the realworld data. The best-fit winner is used to create an objective-based forecast. At this point, planners may include more qualitative calculations based on personal knowledge and experience with intangible market factors.

Causal methods are used throughout the life cycle to adjust forecasts in anticipation of promotional events.

Causal methods allow planners to

March-April 2013

predict how discounting and other promotional factors will affect volume, and layer the impact of these events on top of the underlying base forecast.

Finally, derived models can be used to create a parent-child relationship in which forecasts for closely related products are driven as a percentage of the forecast for a ‘leader’ product. This ensures that when the forecast is modified for the ‘parent’ all the ‘child’ forecasts would be updated accordingly.

To prevail in a business economy shaped by uncertain demand and rapid market changes, all of these forecasting methods must be harnessed. Planners must have access to the best method, be able to spot trends and forecast demand signal changes more quickly, and sense the best time to change methods when a more appropriate approach is indicated. Superior predictive power and realtime reflexes are the keys to coming out ahead of the competition.

About the Author Karin L. Bursa is a vice president at Logility, a provider of collaborative supply chain management solutions.

Ms. Bursa has more than 25 years of experience in the development, support and marketing of software solutions to improve and automate enterprise-wide operations. You can follow her industry insights at www. logility.com/blog. For more information, please visit www.logility.com.

the Visibility to

OUTPLAN OUTPACE OUTPERFORM the Collaboration to

the Velocity to

If you aim to be a top competitor, an optimised supply chain is a mandate.

Logility Voyager Solutions™ can help you leave the competition behind.

With Logility’s proven three-pronged strategy, OUTPLAN, OUTPACE, OUTPERFORM, companies can more profitably satisfy customer demand—and stay in the winner’s circle—by getting the right products at the right cost to the right place at the right time.

Leading companies around the world rely on Logility to achieve dramatic improvements in global supply chain efficiencies, increased visibility and substantial bottom-line results in record time. Compete like never before with Logility Voyager Solutions.

www.logility.com

Worldwide Headquarters: 800-762-5207 EMEA Headquarters: +44 (0) 121 629 7866

Business Operation

Demand Chain Management: Enhancing Customer Value Proposition

By Pankaj M. Madhani the supply chain, but also on the demand chain. The demand chain comprises all the demand processes necessary to understand, create, and stimulate customer demand and is managed within demand chain management (DCM). DCM is defined as “The alignment of demand creation and demand fulfilment processes across functional, organizational, and interorganizational boundaries”.2 Hence, DCM can leverage the strengths of marketing and SCM and meet the challenges of customer value creation in today’s marketplace.

The Need for Marketing and SCM Integration

DCM creates strategic assets for the firm in terms of the overall value creation as it enables the firm to implement and integrate marketing and SCM strategies that improve its overall performance.

T

he supply chain comprises all the supply processes necessary to fulfil customer demand and is managed within supply chain management (SCM). SCM focuses on the efficient matching of supply with demand but does not help the firm to find out what the customer perceives as valuable, and how this customer-perceived value can be translated into customer value propositions. Hence, SCM efficiency by itself will not increase customer value and satisfaction. Providing customer service in the value chain is largely the domain of two functional areas – marketing and SCM. Supply chains capable of implementing and executing an integrated and coordinated marketing strategy at the supply chain level focused on the ultimate customers will gain competitive advantage.1 Thus, it is essential to understand the marketing perspective also instead of solely focusing on SCM decisions. Marketing and SCM often operate as self-optimizing, independent entities. Marketing combined with dynamic SCM provides greater flexibility to satisfy customer demand based on the needs of individual customers and their value to a firm. To be successful, firm not only needs to focus on

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As customers are increasingly becoming more demanding, firms place more emphasis on customer service. Achieving better levels of customer service requires working together across different departments or functions of a firm. When working relations between marketing and SCM are poor, the coordination and communication that is crucial for the provision of overall customer value proposition may be lacking. The absence of cross-functional collaboration may result in promises made by the firm’s sales and marketing department that have not been coordinated with SCM and logistics, and marketing promotions that are not synchronized with supply chain delivery schedules. Without marketing/SCM cross-functional collaboration, firms cannot be expected to respond optimally and promptly to customers’ requirements. Collaborative behavior is based on cooperation (willingness), rather than on compliance (requirement). The deleterious results of not integrating the marketing and SCM efforts are becoming increasingly evident. A firm cannot reach its full potential in terms of developing, refining, supporting, or delivering products and services without using marketing insights to shape and refine the SCM. In addition, functional departments may divert considerable attention and effort from serving customers to internal issues like turf protection, and blame game for errors and shortfalls. The inability of marketing and SCM to effectively integrate create significant barriers to identifying and responding to customer demand, optimizing inventories, and servicing the customer base.

Without marketing / SCM cross-functional collaboration, firms cannot be expected to respond optimally and promptly to customers’ requirements.

A demand chain strength that is not linked to a supply chain strength may result in a high-cost base, as well as slow and inefficient product delivery; while a supply chain strength that is not linked to a demand chain strength could result in sub-optimal outcome.

Demand Chain Management Functional managers often consider marketing and SCM as separate and distinct entities from one another as they do not collaborate their activities. Despite strong arguments for an integrated approach, in many firms, the supply side still seems to be disconnected from the demand side and supply chain managers have only a faint idea of the drivers behind customer demand.3 Marketing/logistics interdepartmental relations tend to be characterized by conflict and lack of communication rather than by collaborative integration.

Integrating marketing and logistics is a challenge in any firm, since there is a natural tension between these two functional areas.

A number of firms have focused their efforts on developing sophisticated supply chains such that their managerial focus became myopic, and many lose sight of their markets and their customers. Hence, along with supply chain, firms need to focus on demand chain. The demand chain is defined as “The complex web of business processes and activities that help firms understand, manage, and ultimately create consumer demand.4 An efficient supply chain alone provides only half the solution, hence, complete solution is suggested to be having an effective demand chain also that encourages a strategic approach to market response. Demand chain design is based on a thorough market understanding and has to be managed in such a way as to effectively meet differing customer needs. A demand chain strength that is not linked to a supply chain strength may result in a high-cost base, as well as slow and inefficient product delivery; while a supply chain strength that is not linked to a demand chain strength could result in sub-optimal outcome. DCM is a new business model aimed at creating value in today’s marketplace by combining the complementary strengths of marketing and supply chain competencies.

DCM: Marketing and SCM Integration for Optimal Outcome Marketing is focused on the demand chain and addresses the sell-side of the firm while SCM is focused on the supply chain and deals with the buy-side of the firm. The goal of DCM is to both reduce or if possible eliminate buffers of inventory in the supply chain and at the same time deliver what the customer demand. Marketing and SCM must work together and formulate an effective DCM in order to achieve organization goals. It is relatively common to find discrete functional excellence in marketing side by side with SCM. They frequently operate as separate, self-optimizing – even adversarial – entities. Tackling one independently of the

other, leads to sub-optimal solutions. In the DCM, the marketing and SCM functions are not separate; rather, they are intertwined as explained below in Figure 1.

The view of the consumer as an integral part of the chain is perhaps the most important issue in the shift from SCM to DCM. The focus of DCM is on real-time flow of demandrelated information from point of inception (end-users) to the point of use (suppliers). The goal of DCM is to coordinate the demand creation and the demand fulfillment processes to gain competitive advantage by differentiating not only the products but also the delivery process, as well as to exploit synergies between marketing and SCM. The demand creation processes comprise all the activities necessary for creating demand and are closely linked to marketing, while the demand fulfillment processes comprise all the activities necessary for fulfilling demand and are closely linked to SCM. This implies that a framework of DCM may be constructed based on two interrelated parts: marketing and SCM as shown in Figure 1.

DCM (Optimal)

Sub optimal

Marketing Effectiveness

Sub optimal

SCM Efficiency

Figure 1: DCM: Marketing and SCM Integration for Optimal Outcome (Source: Compiled by author)

Examples of major demand creation processes are strategic marketing planning, market research, market segmentation, product development, and marketing and sales,5 while examples of major demand fulfillment processes are strategic supply chain planning, supply chain design, and supply chain operations.6 DCM highlights the interplay between marketing and SCM as an enabler of customer value creation. The ultimate goal of DCM is to gain competitive advantages by differentiating not only the products, but also the delivery process as well as to exploit the linkages between marketing and SCM. Hence, DCM has been introduced as an approach to capture the synergies between marketing, and SCM.7

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To maximize value creation for customers, it is necessary for the functional areas of the organization such as marketing, SCM to co-ordinate efforts with each other. Collaboration has been called the driving force necessary for effective marketing and SCM integration and DCM development. The integration between the objectives of the marketing concept (to mobilize total organizational effort to satisfy customers and generate a profit) and the concept of SCM (to link organizational and inter-organizational units to improve levels of service and reduce costs) is key concept of DCM as explained in Figure 2. It is through DCM that customer value is achieved as strong collaboration between marketing and SCM leads to an environment where all are focusing on the customer value proposition as explained in Figure 2.

Demand Chain Management (DCM): Major Benefits As in DCM, marketing insight is combined with the SCM side of supply efficiency, and a number of benefits emerge.

The benefits derived from DCM include: 1. Reduced level of inventory from having precise information of inventory availability.

2. Reduced lead times from better visibility of demand for products.

3. Increased sales from being able to confirm availability and delivery of standard and enhanced products in real time.

4. Increased responsiveness by working across various sales channels, while

- Customer Value Proposition - Quick response to customer needs - Processes are focused on efficiency and effectiveness - Best-in-class products and services at lowest price - Overall outcome: Optimal DCM Supply Chain (Demand Fulfillment)

Demand Chain (Demand Creation)

Marketing

Collaboration

- Effectiveness focus - Respond quickly to customer needs - Processes are focused more on planning - Revenue is the key driver - Deliver total solutions - Overall outcome: Sub - Optimal

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- Effficiency focus - Low cost approach - Processes are focused on execution - Cost is the key driver: - Short term oriented, - Overall outcome: Sub - Optimal

Figure 2: DCM: Enhancing Customer Value Proposition through Marketing and SCM Intregration (Source: Compiled by author)

reduce business transaction costs, and reduce inventory. The DCM involves integration between marketing (selling) and SCM (delivering) processes and enables both parties to reduce cycle times, eliminate out-of-stocks and improve customer service in terms of in-store product availability and responsiveness. Effective marketing strategy demands sound SCM because it includes the distribution part of a marketing strategy. In environments with increasing diversity in customer needs and requirements, firms must rapidly adjust their supply to meet demand. The argument for integrating strengths of marketing and SCM is strong and compelling.

In the collaborative system of DCM, marketing and SCM members will seek to reduce markdowns, increase sales, reduce business transaction costs, and reduce inventory. taking into consideration production constraints.

5. Improved customer service and retention resulting from an improved ability to meet delivery on time.

In the collaborative system of DCM, marketing and SCM members will seek to reduce markdowns, increase sales,

SCM

ZARA: Deployment of DCM Spanish ladies’ apparel maker Zara, a unit of Spain’s Inditex SA and a global player in fast fashion segment, has successfully developed DCM by integrating marketing and SCM initiatives. Zara operates in a rapidly changing market characterized by fast response and

March-April 2013

short-product lifecycles. To manage the competition in fast fashion retail, Zara’s business model is focused on high availability of products, and speed of response. Zara uses the internet to gather real-time information on the needs and changing tastes of consumers – changes that are dictated by fashion shifts as well as seasonal transitions. Zara stores use handheld devices i.e. personal digital assistant (PDA) to send Inditex HQ all information regarding sales trends and insights on what customers would like to see, customer feedback and reactions, 'buzz' around a new style as well as their ordering needs. Rather than offering products at the lowest price by holding costs down, Zara concentrates on having the newest, unique, or most advanced products available at most affordable price.

For Zara, strong market research and the ability to bring products to market quickly and efficiently through effective DCM is the cornerstone of success. Zara's demand chain identifies a demographic segment of 17 to 22 year olds that are fashion but budget conscious. The essential features of Zara’s supply chain design are production schedule and quality controls.

Zara brings new fashion design from

In addition to marketing and SCM capability of the organization, major resources contributing to marketing and SCM integration and hence successful development of DCM are: IT, organization culture, and performance management/reward system. sketch to store rack in as little as two weeks and represents strong marketing and SCM capability and collaborative efforts. Zara has made significant operating and financial improvements by better matching supply and demand through better integration of marketing and SCM and effective development of DCM. Zara increase profitability through product availability, delivery accuracy, responsiveness and flexibility by tightly linking customer and supply initiatives.

Illustration In a following hypothetical illustration of a firm, it is envisaged that the DCM capability on integration of the marketing and SCM generates a 1% positive impact across various income statement line items as well as asset

utilization. Table 1, below represents an evaluation framework for a hypothetical illustration of a firm (base case) as well as after positive impact of DCM (new case). All figures are in millions of U.S. dollars.

With 1% improvement in sales revenue, new sales become $ 101 million. As COGS varies directly in proportion with sales, COGS has increased to $ 65.65 million. After considering the impact of 1% reduction in COGS, new COGS is reduced to $ 64.99 million. Similarly, decrease in various line items framework, caused

by DCM approach with integration of marketing and SCM and corresponding increase in operating profit, net income, and ROA is shown in Table 1. Taken together, as calculated in Table 1, even a small cross-functional improvement

Table 1: DCM in a Hypothetical Illustration of a Firm: Impact of 1% Improvement in Key Functional Drivers Net Income Calculation

Key Functional Drivers of DCM

Base Case

(1)

Sales Revenue

Marketing

100

101

1.00

(2)

COGS (Cost of Goods Sold)

SCM

65

64.99

- 0.01

(3)

Gross Profit = (1) - (2)

35

36.01

1.01

(4)

Depreciation

SCM

4

3.96

- 0.04

(5)

Selling Expense

Marketing

7

6.93

- 0.07

(6)

G & A ( General & Administrative) Expense

Marketing

3

2.97

- 0.03

(7)

Logistics Expense

SCM

(8)

Operating Profits = (3) - (4) - (5) - (6) - (7)

(9)

Interest Expense

(10)

Net Income = (8) - (9)

(11)

Increase in Net Income (%)

Serial No.

(12)

Assets

(13)

Decrease in Assets (%)

(14)

Return on Asset (ROA) = (10) / (12)

(15)

Increase in Return on Asset (ROA) (%) =

New Net Case Impact

8

7.92

- 0.08

13

14.23

1.23

SCM

5

4.95

- 0.05

Marketing / SCM

8

9.28

1.28 15.87

Marketing / SCM

130

128.7

- 1.3 1.00

Marketing / SCM

6.15

7.21

1.06 17.24

(Source: Calculated by author)

due to DCM approach can have a profound effect on the bottom line, lift net income of a firm by approximately 16%, and increase ROA by 17%.

Demand Chain Management (DCM): Key Requirements As DCM development is a complex phenomenon, it is influenced by a variety of tangible and intangible resources of a firm. In addition to marketing and SCM capability of the organization, major resources contributing to marketing and SCM integration and hence successful development of DCM are: IT, organization culture, and performance management/reward system.

Information Technology (IT) DCM is an IT-led strategic concept that enables firms to rapidly respond to rapidly changing customer needs that affect market demand. DCM relies on IT capabilities to enable linkages across departments resulting in tighter integration. DCM helps in reducing distortion of demand-related information (bullwhip effects), knowledge-centric decision mechanism, web-based transparent business transactions, sales processes automation and matching of supply with demand.8 Although IT enables connectivity, it does not guarantee proactive information sharing among functional area.

Organization Culture The extent to which the organization’s culture creates a willingness to share information determines how much information is shared,9 irrespective of the amount of investment in IT. To achieve high levels of cultural willingness, firms require top management involvement and the formation of interorganizational teams. This enhances the level of information sharing. Developing an information-sharing culture as an

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Business Operation

Members of both functional areas are encouraged to clearly define mutual objectives and associated performance measures and link their performance and reward systems with decision synchronization, information sharing, and incentive alignment. organizational capability is not easy, as changing the culture within a firm is much more difficult to accomplish. Thus, the firm that can inculcate a culture in which willingness to share information among cross-functional areas are high, can take advantage of a more sustainable, non-imitable competitive advantage that should lead to relatively higher performance levels. Proactive information sharing can improve relationship strength among marketing and SCM members, enhance the ability to coordinate value-added activities of DCM and exploit the collaboration opportunities, hence; organizations with a strong information-sharing culture outperform their counterparts.

capabilities as it is based on a customer-focused organization culture and making customized value offerings and hence creates differential advantage. Through a DCM approach, firms could enhance financial and operating performance by interlinking the marketing and SCM operations, and at the same time meet the long-term strategic goals and enhance customer value. The ideas presented in this article have the potential to improve marketing and supply chain managers’ relational capability and accordingly formulate an effective DCM approach. However, it is important to note that the application of DCM is still in its infancy and needs to be researched further, both from marketing and SCM perspectives.

Performance Measurement and Reward System In order to ensure successful DCM based on effective collaboration between marketing and SCM, members of both functional areas are encouraged to clearly define mutual objectives and associated performance measures and link their performance and reward systems with decision synchronization, information sharing, and incentive alignment. Clear linkage will encourage the marketing and SCM members to improve shared processes that encourage DCM development.

Information sharing is required to signal the marketing and SCM members that incentives for an effective DCM development are available, timely, equitable, and performance-contingent. On the marketing side, the size of the reward can be in the form of increased sales, less price markdowns, increased inventory turns, less stock-outs, reduced inventory, and lower operating costs. On the SCM side, the size of the reward can be measured in terms of less inventory, faster response, and lower supply costs.

About the Author

Conclusions There has been a drastic increase in the pressure on organizations to find new ways to create and deliver value to customers through marketing and SCM initiatives. A new, emerging business model of DCM builds on a close alignment between marketing and SCM resources and capabilities. Effective DCM requires better utilization of organizational resources and capabilities, and hence creates customer value proposition in a constantly changing market. The goal of DCM is to create unique competitive advantages by linking together customer values with a more effective flow of products. DCM approach can help firms provide superior customer value by developing a mutual understanding of responsibilities, sharing ideas, information and resources, and working together as a team to resolve cross-functional problems of marketing and SCM. DCM facilitates firms in enhancing market responsiveness

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Pankaj M. Madhani received an MBA degree from Northern Illinois University, USA and an MS in computer science from Illinois Institute of Technology, Chicago, USA. He holds bachelor’s degrees in chemical engineering and law, both from Gujarat University. He has more than 25 years of corporate and academic experience in India and the United States.

He is currently working as an associate professor at ICFAI Business School (IBS). He has published seven books in the areas of business strategy and ERP and more than 100 book chapters and research articles in several refereed journals. His research interests include technology in business and strategic management.

References

1. Min, S. and Mentzer, J. T. (2000) ‘The role of marketing in supply chain management’, International Journal of Physical Distribution and Logistics Management, Vol.30, No. 9, pp. 765–787.

2. Hilletofth, P., Ericsson, D. and Christopher, M. (2009) ‘Demand chain management: a Swedish industrial case study’, Industrial Management & Data Systems, Vol. 109, No. 9, pp. 1179-1196.

3. Juttner, U., Christopher, M. and Baker, S. (2007) ‘Demand chain management-integrating marketing and supply chain management’, Industrial Marketing Management, Vol. 36, No. 3, pp. 377-392.

4. Langabeer, J. R. and Rose, J. (2001) Creating Demand Driven Supply Chains, Chandos Publishing, Oxford.

5. Kotler, P., Keller, K.L., Brady, M., Goodman, M. and Hansen, T. (2009) Marketing Management, Pearson Education, Harlow.

6. Gibson, B., J. Mentzer, and R. Cook (2005) ‘Supply chain management: The pursuit of a consensus definition’, Journal of Business Logistics, Vol. 26, No. 2, pp. 17-25.

7. Walters, D. (2006) ‘Demand chain effectiveness - supply chain efficiencies: A role for enterprise information management’, Journal of Enterprise Information Management, Vol. 19, No. 3, pp. 246- 261.

8. Beech, J. (1998) ‘The supply-demand nexus: From integration to synchronization’, In J. Gattorna (Ed.), Strategic Supply Chain Alignment (pp.

92–103). London, UK: Gover.

9. Lee, H.L., So, K.C. and Tang, C.S. (2000) ‘The value of information sharing in a two-level supply chain’, Management Science, Vol. 46, No. 5, pp. 626-643.

Innovation

Unlocking Innovation Through Business Experimentation

By Stefan Thomke

There is a downside to businesses that focus heavily on standardization, optimization, and driving out variability: Such organizations leave themselves vulnerable to underinvesting in experimentation and variation, which are the lifeblood of innovation. Good experimentation helps firms better manage myriad sources of uncertainty (such as, does the product work as intended and does it address actual customer needs?) when past experience can be limiting.

And it is only through such experimentation, which might include structured cause-and-effect tests, informal trialand-error experiments, and rigorous randomized field trials, that companies can unlock their true capacity for innovation.

W

hen W. James McNerney Jr. became CEO of 3M in the early 2000s, he quickly went about remaking the company into a leaner, more efficient version of itself.

He tightened budgets, let go thousands of workers, and implemented Six Sigma, the rigorous process-improvement methodology. On the surface, McNerney’s

plan seemed sensible enough. After all, such measures had worked so well at General Electric, where he served as a senior executive for more than a decade. But something was getting lost in 3M’s aggressive drive toward peak efficiency. The company, which had invented Thinsulate, Scotchgard, Post-it notes, and a host of other blockbuster products, was starting to lose its innovation edge. One telling statistic summarized the problem: In the past, one-third of sales had come from new products (released in the past five years), but that fraction had since fallen to one-quarter.1 3M is hardly alone. Many companies have been on a quest to cut waste and increase efficiency. To support that effort, they have adopted quality-control programs like Six Sigma and have encouraged managers to maximize the utilization of resources, to standardize processes, and so forth. And as the worldwide economy took a downturn in the late 2000s, those trends only accelerated. Unfortunately, as 3M discovered, methodologies that were originally designed to stamp out manufacturing variability can sometimes have unintended consequences for innovation when they are applied to the organization as a whole. Indeed, eliminating variability can also drive out experimentation, and experimentation is the lifeblood of innovation.

If anything, companies should experiment more and not less. This is true even when business slows (or, as some might argue, especially during a market downturn). Otherwise, a company’s pipeline of new products, services, and business models could dry up, leaving it extremely vulnerable to the competition.

As we shall see, those companies that maintain their experimentation when business is slow will be all the more prepared when the market eventually picks up. Moreover, it is important to note that experimentation has never been

cheaper. Computer simulations and rapid prototyping, for example, enable companies to run relatively inexpensive experiments that can answer myriad “what if ” questions.2 Also, many companies now have a direct link to their customers, often through the Internet or other IT tools, and this enables timely feedback from various experiments. And analyzing the results of such tests can be done much more cheaply and efficiently than in the past, thanks to more powerful, sophisticated, and cheaper IT tools.

Why, then, have some companies been reluctant to increase their experimentation activities?

Innovation Requires Experimentation Part of the problem is that the average executive does not fully appreciate the crucial role and importance of experimentation. This fundamental issue goes to the very heart of how we learn what we do. To acquire knowledge, we can rely on passive activities (such as reading) or we can participate more actively through observation, exploration, and experimentation. Observers wait for changes to be induced and then carefully study what has been presented to them. Exploration assumes a more proactive role but still lacks the manipulative character of an experiment. In the sciences, astronomers are perhaps the most patient observers while anatomists take on a more active role when they dissect plants or living organisms.

In a perfect business experiment, managers separate an independent variable (the presumed “cause”) from the dependent variable (the “effect”) and then manipulate the former to observe changes in the latter. Ideally, this will then give rise to learning about the relationships between cause and effect that can then be applied to or tested in other settings. In the real world, however, things are much more

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Innovation

complex: Environments are constantly changing, linkages between variables are complex and poorly understood, and the variables are often uncertain or unknown. Managers must therefore not only move between observation, exploration, and experimentation; they must also iterate between experiments. This overall process can be daunting, even for experienced managers, and that explains why so many companies have chosen instead to rely on the intuitions of executives and other so-called experts.

Gary Loveman, the CEO of Caesars Entertainment, has a term for that: “the institutionalization of instinct.”3 But managerial intuition can often be misleading (if not downright wrong) and is simply no substitute for rigorous experimentation. And experimentation need not be an overwhelming task if companies follow some basic principles.

When managers know all the relevant variables, they can use formal statistical techniques and protocols to develop the most efficient design and analysis of experiments. Such structured experiments, which can be traced back to the first half of the 20th century when they were first deployed in the agricultural and biological sciences, are now being used both for incremental process optimization as well as for studies in which large solution spaces are investigated to find an optimal response of a process.4 The techniques have also formed the basis for improving the robustness of production processes and new products.5 But what if the relevant variables are uncertain, unknown, or difficult to measure? In such cases, experimentation must be much more informal or tentative. With informal experiments (and when very small samples are used), the objective is often hypotheses generation rather than rigorous testing. A manager might be interested in investigating what type of employee bonus will lead to higher productivity, or a software designer might want to know if changing a particular line of code will remove a software error. Such trial-anderror types of experiments occur all the time and are so much an integral part of

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innovation processes that they become like breathing – people conduct them but are not fully aware of the fact that they are experiments.

It is important to note that good experimentation goes well beyond the individual tests and their protocols. It is about the way in which companies use such tests to manage, organize, and structure their innovation processes.

Specifically, it is about how firms can learn so that they can better manage various sources of uncertainty when past experience can be limiting. Such sources of uncertainty include those with respect to the R&D process (does the product work as intended?), production (can it be effectively manufactured?), customer needs (does it address actual needs?), and the business itself (does the opportunity justify the investment in resources?). Only by using

implications. In repetitive processes like manufacturing and transaction processing, the goal is to minimize any system slack in order to achieve peak efficiency, and the relationship between added work and required time is straightforward: Add 5% more work, and it may take 5% more time to complete. Things are not so simple with processes that have high variability, such as R&D. The amount of time that projects spend on hold, waiting to be worked on, rises sharply as the system slack decreases.6 Add 5% more work in R&D, and it might take 100% longer to complete the project.

And if R&D work involves experiments, long delays will inhibit feedback and learning. The bottom line is that when R&D employees are working near full tilt, project speed, efficiency, and output quality (namely, innovation) will inevitably suffer.

In other words, no product or service can be a product or service without first having been an idea that was subsequently shaped through experimentation. experimentation to manage those types of uncertainty can companies unlock their capacity for innovation. Indeed, experimentation is inextricably connected to innovation, and managers need to understand that fundamental link. Simply put, there can be no innovation without experimentation. Or, in other words, no product or service can be a product or service without first having been an idea that was subsequently shaped through experimentation.

And that is where companies like 3M make fundamental mistakes when they try to apply a technique like Six Sigma to innovation. In short, companies cannot treat R&D like manufacturing because the two processes are inherently different. In manufacturing, the tasks are mostly repetitive and the activities are reasonably predictable. Not so in R&D, where the tasks are often unique and the activities are difficult to anticipate because of changing project requirements or discoveries along the way. Such fundamental differences have profound

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Learning to Embrace Failures Another difficult lesson about experimentation (and innovation) is that, to be successful, companies need to be willing to fail. Only through such failures can they discard bad ideas, such as a confusing software interface, a packaging concept that will lead to considerable waste, a drug with dangerous side effects, and so on. And eliminating what does not work will then free people to pursue other solutions. But many companies instead have a “get it right the first time” mentality, which discourages people from pursuing breakthrough ideas. The result: incremental product improvements rather than innovative offerings.

That said, companies have to be smart about how they fail. For one thing, failing early on – when an idea is far upstream so that it can be scrapped without wasting considerable time and resources – is far preferable to failing late in the process. The lesson here is that early “failures” can lead to more powerful successes faster. IDEO, an innovative

product development firm, even has a motto for that mindset: “Fail often to succeed sooner.”

Companies, however, are not typically set up to embrace failure. “Our experience has been that most big institutions have forgotten how to test and learn. They seem to prefer analysis and debate to trying something out, and they are paralyzed by fear of failure, however small,” argued T. Peters and R. Waterman in the bestseller “In Search of Excellence.”7 Peters and Waterman wrote those words about 30 years ago, but their keen observation could hardly be truer today.

Of course, not every business has an acute fear of failure.

Some, in fact, have a healthy acceptance that failure is just part of the process. Google, for instance, runs myriad experiments to continually improve its search algorithm. In 2010 alone, the company investigated more than 13,000 proposed changes, of which around 8,200 were tested in side-by-side comparisons that were evaluated by raters. Of those, 2,800 were further evaluated by a tiny fraction of the live traffic in a “sandbox” area of the website. Analysts prepared an independent report of those results, which were then evaluated by a committee.

That process led to 516 improvements that were made to the search algorithm from the initial 13,000 proposals. In other words, Google’s failure rate is higher than 95%.8 “This is a company where it’s absolutely okay to try something that’s very hard, have it not be successful, and take the learning from that,” contends Eric Schmidt, former CEO of Google.9

The Value of Randomized Field Trials When conducting experiments with customers like Google does, companies have a powerful tool at their disposal: the randomized field trial. These tests have been invaluable in medicine, helping researchers determine whether a particular treatment is effective or not. The basic concept is simple. Take a large population of individuals with the same affliction and randomly select two groups. Administer the treatment to just one group and closely monitor everyone’s health. If the treated (or test) group does statistically better than the untreated (or control) group, then the therapy is deemed to be effective.

Similarly, randomized field trials can help companies determine whether specific changes (such as a new layout for a chain of retail stores) will lead to improved performance (a significant bump in sales). Consider, for instance, Capital One, the financial services company. From its inception in 1988, the company has based its very existence on the use of randomized field tests to investigate potential innovations, no matter how seemingly trivial. Capital One has used controlled experimentation to test just about everything, including new product and service offerings, operational changes, marketing

Randomized field trials can help companies determine whether specific changes will lead to improved performance.

campaigns, and so on. The company might, for instance, test the color of the envelopes that product offers are mailed in by sending out two batches (one in the test color and the other in white) to determine any differences in the responses.10 Randomized field tests are indeed a powerful experimental tool, but they are not without their challenges. For the results to be valid, the field trials must be conducted in a statistically rigorous fashion. Specifically, people need to be assigned to either the test or control group through a selection process that is purely random to help ensure that the two groups don’t differ in any pertinent way other than with respect to the independent variable being studied. Otherwise, other variables could easily skew the results. In the Capital One envelope example, if a larger percentage of men had been assigned to the test group, a lower response for that group might have nothing to do with envelope color; it might simply mean that men are less apt to respond to such offers. Moreover, both the test and control groups must be representative of the larger customer base. If, for instance, both the test and control groups in the envelope test had contained a much higher percentage of women, then Capital One wouldn’t know for sure whether the results were applicable to men. Thus randomization plays an important role in experimentation: it helps to prevent systematic bias, assigned consciously or unconsciously, and evenly spreads any remaining (and possibly unknown) bias between test and control groups.

Such caveats notwithstanding, randomized field trials have become standard practice in direct marketing, and they have even begun to spread to unlikely areas like the gaming industry. Caesars Entertainment, which operates Harrah’s, Caesars, and other casino resorts, regularly uses controlled experiments to develop and fine-tune its various marketing efforts. The company might, for instance, test which perk – a complementary meal versus a free night of lodging – would ultimately induce customers to spend more during their stays. Gary Loveman, the CEO of Caesars Entertainment, has famously stated that there are three ways to get fired from the hotel and casino company: theft, sexual harassment, or running an experiment without a control group.11

Going Against Instincts Given how valuable experimentation can be, the question must be asked: Why don’t companies experiment more? Certainly the drive toward increased efficiency has been an issue, but another factor might also be at play. Consider how senior management often has strong incentives to focus on the near term and get rewarded for sticking to plans. But innovation activities can be highly variable and difficult to plan and predict, especially over short timeframes. Dan Ariely, the noted behavioral economist, contends that businesses often shy away from experimentation because they are not good at tolerating shortterm losses in order to achieve long-term gains. “Companies (and people) are notoriously bad at making those trade-offs,” he argues.12 And, as mentioned earlier, such business myopia

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Innovation

The point is that management does not oversee the experiments: employees come up with the ideas, design the tests, and run them – all in addition to their normal responsibilities. becomes all the more acute in bad times, when market conditions force many companies to tighten their belts. But not all businesses have fallen into that trap.

Take, for example, ams, the Austrianbased manufacturer of analog semiconductors. Employing around 1,200 people in more than 20 countries, ams develops and manufactures sensors, wireless chips, and other high-performance products for customers in the consumer, industrial, medical, mobile communications, and automotive markets. Typical applications require extreme precision, accuracy, dynamic range, sensitivity, and ultra-low power consumption.

To maintain its technical edge, ams implemented a major initiative for business experimentation in January 2007.

Throughout the company, all employees were encouraged to run experiments and submit them to a central coordinator. These activities have distinct learning objectives, and they do not include regular tasks such as feasibility studies and normal project work. Of the proposed experiments, the company approves about two-thirds, but their costs are not measured or accounted for in timesheets or work statements.

The point is that management does not oversee the experiments: employees come up with the ideas, design the tests, and run them – all in addition to their normal responsibilities.

To document those activities, the company publishes annual proceedings of the experiments. As of November 2012, ams had documented 369 completed tests, of which more than 80% were technical in nature, about 10% were organizational, and the remainder related to marketing and sales. Bonuses have been awarded to the best experiments, with success measured by learning objectives or outcomes. So far, those bonuses have reached a total of 124,000 euros. In addition, ams has also run

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company-wide experiments such as a “24h Day” event during which employees dropped all their regular duties and spent 24 hours nonstop to work on their own ideas.

It should be noted that many of those experiments have become the starting points of new projects, product improvements, patents, and new product proposals. As such, they help ensure that ams will have a healthy number of offerings in the pipeline for when the economy recovers. In other words, while other businesses were cutting back their innovation activities, ams not only stayed the course; it upped the ante by launching a major initiative, successfully managed the delicate balance between efficiency and building a culture of experimentation, and empowered its employees to try out new things. And, as a result, the company should be ready for any market upswing, whereas other businesses could easily be caught off-guard.

According to various accounts, companies have been hoarding cash. In mid-2012, for example, corporations in the S&P 500 had stockpiled about $900 billion.13 Certainly, such financial liquidity has its advantages, and investing recklessly on ill-advised initiatives should never be encouraged. But, when it comes to innovation, being too frugal can also have its drawbacks, particularly if the result is that a company’s pipeline of new products and services begins to dry up. And that’s the danger facing extremely efficient businesses that value standardization, optimization, and low variability: They leave themselves vulnerable to underinvesting in experimentation and variation.

That lesson was something that 3M learned the hard way. After CEO McNerney left the firm, the new CEO George Buckley began to undo some of his predecessor’s actions. He increased

March-April 2013

the R&D budget substantially and freed research scientists from the grips of Six Sigma. “Invention is by its very nature a disorderly process,” explained Buckley.

“You can’t put a Six Sigma process into that area and say, well, I’m getting behind on invention, so I’m going to schedule myself for three good ideas on Wednesday and two on Friday. That’s not how creativity works.”14 Buckley’s wise words capture, in a nutshell, why innovation (and experimentation) will never be a process that is entirely predictable nor highly efficient. Other executives and companies would do well to remember that simple managerial truism.

About the Author Stefan Thomke is the William Barclay Harding Professor of Business Administration at Harvard Business School in Boston.

References

1. Brian Hindo, “At 3M, a Struggle between Efficiency and Creativity,” BusinessWeek (June 6, 2007).

2. To understand how new technologies have changed the economics of experimentation, see Stefan Thomke, Experimentation Matters: Unlocking the Potential of New Technologies for Innovation (Harvard Business School Press, 2003).

3.“The Experimenter,” Technology Review (February 18, 2011).

4. Beginning with Ronald Fisher in 1921, many articles and books have been written on experimental design. Douglas Montgomery’s textbook Design and Analysis of Experiments (Wiley, 1991) provides a very accessible overview and is used widely by students and practitioners.

5. Techniques for improving product and process robustness (also known as Taguchi methods) are discussed in Madhav Phadke's book, Quality Engineering Using Robust Design (Prentice Hall, 1989).

6. Stefan Thomke and Don Reinertsen, "Six Myths of Product Development," Harvard Business Review, May 2012.

7. Thomas J. Peters and Robert H. Waterman Jr., In Search of Excellence: Lessons from America’s Best-Run Companies (Harper & Row, 1982): pages 134-135 8. http://www.google.com/competition/howgooglesearchworks.html 9.http://techcrunch.com/2010/08/04/ google-wave-eric-schmidt/ 10. Jim Manzi, Uncontrolled: The Surprising Payoff of Trial-and-Error for Business, Politics, and Society (Basic Books, 2012): pages 144 – 145.

11.“The Experimenter,” Technology Review (February 18, 2011).

12. Dan Ariely, “Why Businesses Don’t Experiment,” Harvard Business Review (April 2010).

13. “Dead Money,” The Economist (November 3, 2012): p. 71-72.

14. Brian Hindo, “At 3M, a Struggle between Efficiency and Creativity,” BusinessWeek (June 6, 2007).

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Innovation

Why Our Decisions Get Derailed and How to Get Back on Track

By Francesca Gino

T

he Ducati motorcycle racing team, Ducati Corse, decided to compete in a motorcycle racing circuit, the MotoGP, for the first time in 2003. The team had accumulated years of experience and success in other motorcycle racing circuits, but the MotoGP had different rules and required a different type of motorcycle. Consequently, team members approached their first MotoGP as a season of learning – their goal was not to win, but to gain as much knowledge about the race for future years as possible.

The plan of action was clear, and the team tried to set everything up so that implementation would follow smoothly.

For instance, the team’s racing bikes were fitted with sensors to capture performance data, and Ducati Corse engineers held debriefings with the riders after each race to gather feedback on the bike’s handling.

Unfortunately, however, the team’s outcome bore little resemblance to its initial plan. During the 2003 MotoGP season, the team experienced unexpected success, finishing among the top three in nine races and second overall for the season. Instead of focusing on learning from all the data they were gathering, team members focused on celebrating.

The unexpected success also increased the engineers’ confidence in their ability to design high-performing racing bikes.

As a result, the team decided to radically redesign its bike for the MotoGP 2004 season, adding more than 60% new components. But the new racing bike did not perform as well as

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expected in the first few races of the 2004 MotoGP season.

As the team members themselves recognized, their confidence sidetracked them from their goal.

The business press often reports stories of CEOs, managers, and their companies setting out to accomplish specific goals and ending up with very different outcomes. In our own professional lives, similar experiences cause us to question our fundamental ability to make effective decisions that are consistent with our initial plans. In my own study of various organizations, I have observed several circumstances in which decision makers are likely to get sidetracked. Experienced managers may plan carefully for their negotiations but end up with very different deals after being caught up “in the heat of the moment.” Thoughtful executives may introduce new incentive schemes to motivate their employees but discover that the new systems triggered cheating. Similarly, team leaders may plan to spur success by using a participative approach to problem solving but fail due to their difficulty putting themselves in their team members’ shoes.

Why do our plans so often go astray? I spent more than ten years working on research projects that address this question, which I discuss in my recent book Sidetracked: Why Our Decisions Get Derailed and How We Can Stick to the Plan (Harvard Business Review Press, 2013). This research led me to a puzzling conclusion about our nature as human beings: our goals and plans are often inconsistent with how we actually behave.

Like the managers I observed, all of us want to be consistent – that is, we care about following through on our goals.

Yet, even when we spend time developing our plans and are committed to our best intentions, our decisions often veer off course in ways we did not anticipate. Ducati Corse planned to use 2003 as a learning season devoted to gathering the data needed to build high-performing racing bikes in the years to come. In the end, however, the team did not adequately use the information it collected and failed to learn.

Whether we are making plans for today, next week, or many years from now, when the actual moment of decision arrives, subtle forces can sidetrack us. Typically, getting sidetracked leads to disappointing outcomes and negative consequences for both ourselves and our organizations. It also leads

Whether we are making plans for today, next week, or many years from now, when the actual moment of decision arrives, subtle forces can sidetrack us.

us to regret the fact that we didn’t follow through on our plans.

There are three sets of forces that sidetrack our decisions as we implement our plans: (1) forces from within ourselves, (2) forces from our relationships with others, and (3) forces from the outside world. These forces may operate in isolation or, as is frequently the case, work together. Understanding how these forces operate can be helpful in two main ways. First, it can help us stick to our well-thought-out plans going forward.

Second, it can help us understand and decode the often puzzling behavior of our colleagues, friends, and bosses.

Forces from within As it turns out, our own thoughts and feelings can sidetrack us. In a 2006 issue of Inc. magazine focused on entrepreneurial mistakes, Gary Heavin, the founder and former CEO of the U.S. fitness chain Curves International, reflected on his career. Heavin was running his first chain of gyms in Houston, Texas by the time he was 30 but filed for bankruptcy only a few years later. He learned from this first business failure and partnered up with his wife to fund Curves International, a successful Texas-based fitness franchise. When reflecting on his first CEO job, Heavin noted that he used the words “I” and “me” too often and the words “us” and “we” not often enough – that is, he placed too much confidence in himself and too much responsibility on his own shoulders. In the same issue, Gauri Nanda, the creator of the hybrid robot-alarm clock Clocky (which runs away from you when you try to hit the snooze button) describes how she created an entire brand simply to bring Clocky to market because she was unwilling to hand over control of her product. Nanda believed in her goal of developing products that use technological solutions to solve human problems, but she regretted that she hadn’t teamed up with someone with more business experience.

On a wide range of dimensions, from our ability to make good decisions to our success in business, we tend to rate ourselves higher than our colleagues or peers.

A large body of research suggests that most of us think too highly of our skills and abilities. On a wide range of dimensions, from our ability to make good decisions to our success in business, we tend to rate ourselves higher than our colleagues or peers. To take a humorous example, a 1997 U.S. News and World Report survey asked 1,000 Americans a simple question: “Who do you think is most likely to get into heaven?” Overall, the respondents believed that then-president Bill Clinton had a 52% chance of getting into heaven, basketball superstar Michael Jordan had a 65% chance, and Mother Teresa had a 79% chance. Yet, interestingly, someone else ranked even higher: the person completing the survey. Respondents rated themselves as having an 87% chance of passing through the pearly gates – and thus as more divine, overall, than Mother Teresa.

The words “I” and “we” pervade our decision-making because of the positive views we hold of our competence and abilities. Though certainly helpful in many contexts, from our health to our persistence in the face of failure, overly positive beliefs in our abilities can hinder sound decision-making.

For instance, if entrepreneurs think their ideas are better than those of their competitors, they may take unwarranted risks. If CEOs believe they have better information than everyone else in the executive suite, they may invest in the wrong markets or make disadvantageous acquisitions. And if team leaders are too confident in their own knowledge, they may be reluctant to listen to the opinions of team members, even when they would lead to better outcomes for all.

Forces from our relationships with others As you may recall, Tom Hanks won back-to-back Academy Awards for Best Actor in 1993 (for Philadelphia) and in 1994 (for Forrest Gump). Several movie critics later noted that although Hanks’ performance was excellent in these films, it was at least as impressive in some of his subsequent movies, including Apollo 13, Saving Private Ryan, and Castaway. Yet Hanks’ fellow actors did not give him enough votes to even be nominated for an Oscar in any of these movies. Though there are a number of likely explanations for this fact, one cited by movie critics is the possibility that Tom Hanks’ peers, for jealous reasons, did not want him to win a third Oscar. In fact, if Hanks were to win other awards, at least some of his peers would come up short when comparing their Academy Award performance to that of Hanks.1 This anecdote illustrates the common tendency to evaluate ourselves on various dimensions by looking at others. We can often answer the questions that most nag us about ourselves – ranging from “Am I a good leader?” to “Do I make good decisions?” to “Am I a trustworthy person?” – by comparing our attitudes and actions with those of other people, such as peers or colleagues. When we compare ourselves unfavorably to someone else, we are likely to experience distress, jealousy or envy. These emotions can lower our self-esteem and lead us to somewhat dysfunctional behaviors.

For instance, in a recent study, University of Michigan professor Stephen Garcia asked 55 employees at a Midwestern University to imagine that they were working for a company and had either high pay or high decision-making power. The employees were then asked to imagine they had to make recommendations about a new recruit – namely, whether to offer the new recruit high pay or high decision-making power. The participants advised offering the new recruit the opposite of whatever they had (high pay if they themselves had high decision-making power, and vice versa). The results suggest that people who have high standing on a particular dimension (such as pay) protect their view of themselves on the social hierarchy by making recommendations that prevent others from competing in the same social comparison context.

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Innovation

As Hank’s story and this research results show, we like to know where we stand relative to others on a variety of dimensions. But we often fail to appreciate the pervasiveness of these social comparison processes, which influence our choices and can send our plans off course.

Forces from the outside world In 2010, a heated public conflict broke out between FIJI Water, a U.S. supplier of premium bottled water, and the government of Fiji, led by its prime minister and military dictator, Frank Bainimarama. At that time, the Fijian government was struggling financially because of various natural disasters and government corruption. To increase its coffers, the government decided to raise its tax on companies that extracted water above a certain level. As it turns out, FIJI Water was the only water bottler on the island large enough to be affected by the new tax. The tax increase was dramatic: from one third of a Fijian cent to 15 cents per liter. It was expected to net the government $11.7 million annually.

Based on the high prices FIJI Water charged its customers, Bainimarama’s government assumed that the company was highly successful and that the tax increase would be easy for it to swallow. In reality, FIJI Water was a small player in the bottled water industry. In response to the tax increase, the company shut down its bottling plant, laid off its 400 employees, and cancelled its contracts. Calling the new tax increase discriminatory and the Fijian government unstable, FIJI Water representatives publicly threatened to pull out of Fiji completely. In the end, given that the company had built its name and reputation on bottling clean, pure water from Fiji, it decided not to leave the islands. Though FIJI Water ultimately agreed to pay the tax increase, the government’s inaccurate view of the company’s financial situation soured the relationship between the two parties.

All of us are predisposed to make biased attributions of others’ behavior, as Bainimarama and his government did. In particular, we tend to discount the impact of situational factors on others and their actions. This tendency may sidetrack us as we make decisions across a variety of contexts, including HR decisions. For instance, managers may be more likely to promote a salesperson who is performing well in a region with high product demand rather than another salesperson who is performing at lower levels in a more difficult region. Similarly, a senior IT leader may have more confidence in a new software engineer who efficiently writes code in an easy-to-learn programming language rather than one who is less efficient in a more complex language.

Staying on Track Making plans is often easy, but sticking to them turns out to be quite difficult. When developing and implementing our plans, we need to carefully consider the forces that are likely to impede our decisions or the decisions of those we are trying to influence: forces from within, forces from our relationships,

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and forces from the outside world. This is often difficult to do, as we tend to subscribe to this view from Shakespeare (as expressed by Prince Hamlet): “What a piece of work is a man! How noble in Reason! how infinite in faculties! in form and moving how express and admirable! In action how like an Angel! in apprehension how like a god! the beauty of the world!”

When we think about the amazing abilities of the human mind or reflect on the technological and scientific discoveries of the past century, it’s easy to enthusiastically agree with Hamlet’s perspective on human nature. Yet the evidence that I’ve described contradicts this perspective, as it documents the many ways in which our decisions are easily and predictably sidetracked. This evidence, in addition to numerous recent events, from bank failures to political scandals to ecological disasters, point us to the conclusion that, as human beings, we are neither “infinite in faculties” nor “noble in reason.”

By raising your awareness, you can keep your self-views in check and recognize when they may be taking you off track.

In Sidetracked, I present a set of principles one can use to stay on track. For instance, the principle “raise your awareness” can help us modulate our overly positive views of our own competence and skills. By raising your awareness, you can keep your self-views in check and recognize when they may be taking you off track. To avoid the derailment that may result from comparing ourselves to others, you can “check your reference points” – that is, you can uncover the true motives behind your decisions, identify whether they are driven by social comparisons, and readjust accordingly. And to address our tendency to discount how situational factors impact others’ actions as we evaluate them, we can use the principle “consider the source.” Questioning your sources of information should lead you to reach more rational decisions.

If Hamlet were to revisit his words today, he might conclude that, like computer software, the human mind also has bugs. By staying attuned to these mistakes and actively using the principles I discuss in Sidetracked to fix them, we can make good decisions and stay on track.

About the Author Francesca Gino is an associate professor of Business Administration at Harvard Business School and the author of “Sidetracked: Why Our Decisions Get Derailed, and How We Can Stick to the Plan” (Harvard Business Review Press, 2013).

Reference

1. Elizabeth Weitzman, “Movies and Actors Who Were Robbed of Oscar Gold,” New York Daily News, February 21, 2008, http://www.nydailynews.com/entertainment/movies/2008/02/22/2008-02-22_movies_ and_actors_who_were_robbed_of_osc.html.

Organisation

CEOs, Mind Your Own Business!

Why and How Corporate CEOs Should Pay More Attention to Corporate Functions

By Andrew Campbell, Sven Kunisch & Günter Müller-Stewens

The corporate office consists of the CEO and the corporate functions. It is the main vehicle for delivering corporate added value. Yet corporate functions often underperform and corporate offices often fail to add value. We argue that this is because CEOs focus most of their attention on portfolio strategy and business issues and give too little attention to guiding and leading their own business – the corporate office.

S

urprisingly many CEOs give too little attention to the corporate functions that make up their corporate office.

This is because they consider their main priority to be business issues. This lack of attention is well illustrated by the corporate CEO of a global consumer goods company who cancelled a major project aimed at clarifying the role of the corporate functions with the words “I do not have time for this at present. We have too many pressing business problems to afford the luxury of gazing at our corporate centre navels.”

The lack of attention by CEOs to corporate functions is

evident in our research on how heads of corporate functions develop strategies for their functions. We asked these leaders whether the CEO or an executive committee member briefed them thoroughly when they were appointed to lead the function. Surprisingly many said they were given little guidance.

In more than 40 interviews with functional heads who report directly to the CEO, only a few had been briefed about the corporate-level strategy and the role that the function was expected to play in this strategy.

Some corporate functional heads were given the job without any guidance. Others were expected to develop a strategy for the function based on interactions with the executive committee. Some were appointed because they were known to have special skills at centralising or decentralising or setting up shared services or improving functional performance, but often still received little direct guidance. This appears to be an embarrassing critique of corporate CEOs. But, is it? Is it important for CEOs to provide the heads of corporate functions with clear guidance and, if it is, why do they fail to do so?

The purpose of this article is to explain why it is important for CEOs to give more attention to their corporate functions.

We provide three reasons: corporate functions help provide the guidance and constraints that enable the corporate office to add value; without some unifying work by the CEO the work of corporate functions will not be coordinated; left to their own devices corporate functions can be bureaucratic and costly. We will close with some thoughts on how CEOs can become more involved in designing corporate functions and in monitoring their performance.

Corporate functions help deliver corporate strategy Most large companies are organised into business divisions that report to a corporate office.1 The corporate office houses the corporate CEO and a number of corporate functions, such as Finance, Human Resources, Information Technology, Legal, Communications, etc. Of the managers who report directly to the corporate CEO, about half of them are heads of businesses, while the other half are heads of corporate functions.2

In more than 40 interviews with functional heads who report directly to the CEO, only a few had been briefed about the corporate-level strategy and the role that the function was expected to play in this strategy. Why is this the case?

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Organisation

Figure 1: The CEO’s direct reports – The example of ABB3 The functional organization of the ABB Group of companies ABB is a leader in power and automation technologies that enable utility and industry customers to improve their performance while lowering their environmental impact. The ABB Group of companies operates in around 100 countries and employs about 130,000 people. The ABB group is structured into five divisions and runs 28 corporate functions to coordinate and integrate the firm. They all report either directly to the CEO or to a member of the executive committee who directly reports to the CEO. Chief Executive Officer

ECM

ECM

ECM

Corporate Technology

Chief Financial Officer

ECM

ECM

Head of Human Resources

Corporate Communications

Assurance & Internal Control

HR Talent & Learning

Antitrust

Group Account Management

Corporate Strategy

Corporate Taxes

HR Remuneration

Contracts

Group Service

Group Internal Audit

Finance & Controlling

Sustainability Affairs

Corporate & Finance (Legal)

Smart Grids Technology

Mergers & Acquisitions

Group Treasury

Business Excellence

General Legal

Ventures

Quality & Supply Chain OPEX

Real Estate

Integrity

Information Systems

Intellectual Property

Investor Relations

Mergers & Acquisitions (Legal)

Executive Committee Member

Corporate Function

ECM

Global Markets

ECM

ECM

Head of Power Products Division Head of Power Systems Division

ECM

Head of Discrete Automation and Motion Division

ECM

Head of Low Voltage Products Division

ECM

Head of Process Automation Division

Division

While corporate CEOs also need to keep an eye on the businesses, their main responsibility is to define and implement the corporate strategy.4 The corporate strategy involves making decisions in three areas:5 • which businesses and market sectors to focus on, • what guidance and constraints to give to the business divisions so that they perform better as a collective than as independent entities (the added value), and • how to organise the corporate office and corporate processes to ensure that the guidance and constraints are provided and the value added.

We observe that most corporate strategy processes focus on the choice of businesses, on the strategies for those businesses and on how much to invest in each business. Little attention is normally paid to the added value question or to the organisation and processes of the corporate office. This is not to say that there is no discussion on these

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General Counsel

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organisational issues; it is just uncommon for the discussion to be part of the corporate strategy process.

This businesses-based view of corporate strategy creates confusion between corporate-level strategy and businesslevel strategy. While portfolio strategy is clearly a task for the corporate strategy process, decisions about the strategy each business should pursue and the amount each business should invest are

constraints) in ways that help them perform better than they would as independent companies.7 Hence, once the portfolio decisions have been made, the next part of the CEO’s business should be to define how the corporate level helps business managers perform better than they could unaided.

It is worth focusing on this point a little longer. The justification for a corporate whole is the extra performance that can be created over and above that of the individual businesses – the added value.8 Without added value, the corporate office is an extra cost burden on the businesses. In other words, articulating this added value should be a critical agenda for the CEO. Without clarity on the sources of added value, the extra value is unlikely to be created, and managers in corporate functions will not have clear goals around which to develop their strategies.

Once the sources of added value are clear, the final part of the CEO’s business should be to define the executives, skills, functions and processes of the corporate office that will ensure that the value is added. In other words, the CEO should provide guidance to corporate functions so that they can be part of the delivery process for the corporate added value.

So why does this not happen? Why are corporate strategy processes biased towards portfolio decisions? Why is so little attention given to the sources of added value and the role of corporate functions in delivering the added value?

Without added value, the corporate office is an extra cost burden on the businesses. In other words, articulating this added value should be a critical agenda for the CEO. essentially business-level strategy issues,6 not corporate-level strategy issues. In other words the management teams of each business should be proposing the strategies to optimise the positioning of their businesses.

The role of the corporate office is to interact with the management teams of the businesses (guidance and

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In a parallel research project, we uncovered more than a dozen reasons.

These ranged from distractions, such as new governance requirements; issues that arise in the businesses that require immediate attention; political difficulties with regard to reviewing corporate functions; and uncertainty about the best way to define the added value of

the corporate office and align the functions behind this added value. However, one of the most common reasons was that CEOs (and corporate strategists)9 do not see the three parts of corporate strategy as equally important. They focus on portfolio and investment decisions, and do not feel the same responsibility for defining the added value of the corporate office or for designing the corporate functions: they do not see the corporate office as an essential part of their own business.

Corporate functions often develop idiosyncratic strategies Our research also showed that the way corporate functions develop their strategies is highly dependent on the personality and experience of the head of the function rather than on an understanding of the corporate strategy. We found that they developed their functional strategies in a variety of idiosyncratic ways.

Some functional strategies were driven by experiences that the head of the function had had in previous jobs with other companies. As one head of IT explained: “I have always pushed for central control of infrastructure and IT operating systems because this is the only way I have found to raise standards, increase standardisation and control costs.” In contrast, in another company the head of IT suggested the opposite: “Undoubtedly, decentralised IT processes help keep costs down. Once you centralise, each system runs at the same high standards which results in gold-plated projects that do more than the businesses need.”

Other functional strategies were driven by what the business divisions were willing to accept: “You should start by winning the trust of the business divisions. I don’t like to launch any initiative without the full support of the businesses.” In other cases, the head of the function assessed the situation, identified areas in which he or she believed the function could add value and presented the corporate executive committee with a plan of activities for approval.

These processes may have all resulted in good functional strategies. However, with these idiosyncratic approaches the strategies of different corporate functions are unlikely to be aligned. None of our interviewees suggested that they had developed their functional strategy in collaboration with other corporate functions.

Unless the CEO gives more attention to corporate functions, there is little chance of achieving alignment within the corporate office and of delivering the coordinated “guidance and constraints” to business divisions that is needed to create the corporate added value.

Corporate functions can become bureaucratic and costly Corporate functions can be a major source of underperformance.10 Left to their own devices, corporate functions, like the rest of us, tend to pursue their own agendas. Believing in the importance of their function, managers look for ways to increase their influence and impact. This can cause functions to set policies, introduce processes and build staff that seem sensible from a functional perspective but impose burdens and constraints on businesses that make it harder for them to succeed. “I am from head office and I am here to help you,” is a widely recognised joke. This is because business divisions the world over have experienced well meant but misguided interference from head office functions.

Corporate functions can be a major source of under-performance. Left to their own devices, corporate functions, like the rest of us, tend to pursue their own agendas.

Our research uncovered numerous situations in which the current head of the function explained that, before he or she arrived, the previous function was underperforming. As one head of HR pointed out “When I joined I was told we had a great performance management system. But when I went out to the businesses, I got a Gallic shrug. They had no connection with the system. Someone in HR had created this huge system that was not understood or used properly.”

Left to their own devices, corporate functions can seek to make their job easier. They standardise processes to simplify the work they need to do. They restrict services to reduce peaks and troughs. They impose constraints on businesses so that they have less variation to deal with. These actions can all lead to efficiency gains within the corporate function, but they can also create difficulties for the businesses. Often the costs imposed on the businesses are greater than the savings in the corporate function.

Left to their own devices, corporate functions can become inefficient. They add staff, fail to raise standards and resist change. As the late Sumantra Ghoshal used to comment: trying to make something happen in some companies is like walking through Calcutta in the monsoon. He compared this to walking in the woods near Fontainebleau in spring. “In one environment, every step saps your last resources of energy. In the other, every new vista brings new energy and excitement.”

Unless the CEO gives more attention to corporate functions, there is little chance of achieving alignment within the corporate office and of delivering the coordinated “guidance and constraints” to business divisions that is needed to create the corporate added value.

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How CEOs can pay more attention to corporate functions Unless CEOs give more time to corporate functions, they will not be aligned with the corporate strategy, they will not be well coordinated, and they will be prone to underperformance. So what should CEOs do? The following suggestions are based on our view of corporate strategy and on insights we have gained from those companies that appear to be doing a better job of managing corporate functions. We distinguish between designing the function and monitoring the function once it has been designed.11 Table 1: Two main responsibilites of the CEO regarding corporate functions

Designing corporate functions

Monitoring and guiding corporate functions

Why is it Important for the CEO?

• To ensure the corporate office is focused on adding value • To ensure the strategies of different corporate functions are aligned with each other

• To maintain focus, and avoid

When is the CEO needed?

• When the corporate strategy is changing • When a new function is being set up • When new projects/initiatives are being launched

• When the annual perfor-

• • • •

• Functional reviews • Internal customer satisfaction measurement

What are the CEO’s tools (illustrative examples)?

10% test Value adding table Governance compliance test Low risk of harm test

bureaucracy and cost • To learn about additional

opportunites to add value

mance monitoring occurs • When conflicts among func-

tions or between functions and business divisions need to resolved

Designing corporate functions CEOs can ensure that the corporate strategy process generates clarity about the sources of corporate added value. One way to do this is to insist that the corporate strategic plan defines a handful of sources of added value, often as few as three, that meet the 10% test: each source of added value is expected to increase the market capitalisation of the overall company by at least 10% above what it would be without the corporate office.12 An example of added value that meets the 10% test is Jack Welch’s requirement in the 1980s that GE’s business divisions generate credible plans to become the global No. 1 or No. 2 in their markets. Those that failed the challenge were fixed, sold or closed. This “guidance” caused the management teams to move their sights from local US markets to global markets and helped GE transition from a strong US company to a world leader.

Another example is the advice Barry Diller, CEO of Interactive Corp, gave his young internet businesses, such as Expedia and Hotels.com. He encouraged them to negotiate harder with suppliers. Moreover, he backed this up with a willingness to lead some of the negotiations himself. As a result, he helped many of his businesses cut their costs by 20-30%.

With a short list of big sources of added value, the CEO can use a simple table to help align the design of corporate functions. The table shows the large sources of added value down

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the left column and lists the main corporate functions along the top row. In the table’s text boxes, the contribution that each function makes to each source of added value can be defined.

Sometimes, there is no contribution. Sometimes all the functions make some contribution. By clarifying the part each function plays in each of the main sources of added value, the CEO is providing guidance for the design of the corporate function.

Once the added value role of each function is clear, functional heads can consider additional layers of functional activity. One source of additional activity comes from nondiscretionary items, such as financial reporting, and controls, such as internal audit. Because functions often attach more importance to their functional controls than is warranted from a commercial perspective, CEOs should check that these nondiscretionary and control activities are really needed. In one company, the CEO requires that each function lists all the mandated policies or controls it will impose on the business divisions, and submits them each year for him to sign off.

The final layer of functional activity involves smaller sources of added value, such as central payroll, accounting services or a planning services unit. These activities do not meet the 10% test, but they can still add value. Here, it is important that the CEO challenges each of these activities to make sure that they do not create any negative side effects for the business divisions. Because the gains are less than 10%, the CEO should take no risks. If there is a chance that these activities will harm the businesses, they should be eliminated.

By helping define the major sources of added value, by checking that non-discretionary and control activities are necessary and by excluding any additional activities that may have negative consequences for the businesses, the CEO can guide the design of the functions in the corporate office.

Monitoring corporate functions There are forces at work that cause corporate functions to lose focus, build bureaucracy and interfere with business divisions.

This is especially true in the current environment as many companies are increasing their degree of centralisation.13 As a result, the CEO and executive committee need to continuously monitor these functions.

CEOs can employ many different tools. For example, corporate functions can be asked to annually present their functional plans so that their peers and the heads of the major businesses can challenge and review them. The agenda of the annual planning process is often crowded with reviews of business plans. Therefore, reviews of corporate functional plans can be carried out at a different time of the year or spread throughout the year. The timing of the review is not critical; the annual discipline of being challenged is the objective.

Another possibility is to regularly score the satisfaction level of each business division with each corporate function. Since the main role of most corporate functions is to add value to the businesses it is helpful to survey the businesses to assess their satisfaction. In one company, the CEO insisted that the

businesses provide monthly feedback on a new central marketing team that he had set up. Monthly feedback is not likely to be appropriate for all functions, but it may be beneficial when a new function is set up. For mature functions an annual satisfaction scorecard helps create an objective benchmark against which the annual functional review can take place.

Corporate functions need the CEO’s attention Over the last few years, many companies have created centralized functional activities and corporate functions have become more influential. This, however, does not seem to be reflected in the attention CEOs devote to corporate functions. Creating a high performing corporate office is not an easy task.

This is partly why many CEOs pay too little attention to this topic. One CEO explained, “I have not tackled the corporate functions because I do not want to open this political minefield. Once you launch a review of the corporate centre you unleash dangerous forces.”

However, the performance of the corporate functions is at least as important to the success of the overall company as the performance of a large business division. Moreover, corporate functions make up the CEO’s personal team. Each divisional management team has a business to run. The CEO’s business is the running of the central team to ensure that, together, the “guidance and constraints” given to the business divisions add value. By ensuring that the corporate strategy process defines the main sources of corporate added value and by linking functional plans to these sources of added value, CEOs can improve the performance of corporate functions and enhance the value of their companies.

About the Authors Andrew Campbell is one of three directors of the Ashridge Strategic Management Centre, which is a research centre devoted to issues concerning the management of multi-business companies. His current work programme includes directing research projects, running management

The CEO’s business is the running of the central team to ensure that, together, the “guidance and constraints” given to the business divisions add value. programmes on strategy, lecturing to large and small audiences and acting as a consultant to client companies.

Sven Kunisch is a senior research fellow and lecturer at the University of St.Gallen (Switzerland) and formerly a visiting fellow at Harvard Business School. His main research interest is strategic management, particularly corporate strategy. He has published several articles on a variety of strategy topics and co-edited three books, most recently From Grey to Silver—Managing the Demographic Change Successfully.

Günter Müller-Stewens is a professor and the managing director of the Institute of Management at the University of St.Gallen (Switzerland).

His research interests centre on corporate strategy, mergers and acquisitions and the strategy process. He has co-authored several strategy books, most recently Corporate Strategy & Governance. He is the academic director of the master of strategy and international management (SIM) programme at the University of St.Gallen, which is ranked number 1 in the Financial Times’s global ranking.

References

1. For example, see: Chandler A. D. (1962), Strategy and Structure: Chapters in the History of the American Industrial Enterprise. MIT Press: Cambridge, MA. Strikwerda J. and Stoelhorst J. W. (2009), ‘The Emergence and Evolution of the Multidimensional Organization,’ California Management Review 51(4): 11-31.

2. Neilson G. L. and Wulf J. (2012), ‘How Many Direct Reports?,’ Harvard Business Review 90(4): 112-119. For more information on functional managers see: Guadalupe M., Wulf J. and Li H. (2012), ‘The Rise of the Functional Manager Changes Afoot in the C-Suite,’ The European Business Review (May-June): 9-13. Menz M. (2012), ‘Functional Top Management Team Members: A Review, Synthesis, and Research Agenda,’ Journal of Management 38(1): 45-80.

3. Source: ABB website (accessed 2013-02-06): http://www.abb.com/cawp/abbzh252/0d19f10 409ed9884c1256aed0048503a.aspx.

4. For more general information on the roles of the CEO, see: Finkelstein S., Hambrick D. C. and Cannella Jr. A. A. (2009), Strategic Leadership:

Theory and Research on Executives, Top Management Teams, and Boards. Oxford University Press: Oxford.

5. Porter M. E. (1987), ‘From Competitive Advantage to Corporate Strategy,’ Harvard Business Review 65(3): 43-59. Goold M., Campbell A. and Alexander M. (1994), Corporate-Level Strategy: Creating Value in the Multibusiness Company. Wiley: New York, NY. 6. Porter M. E. (1980), Competitive Strategy. Free Press: New York. Porter M. E. (1985), Competitive Advantage. Free Press: New York.

7. Chandler A. D. (1991), ‘The Functions of the HQ Unit in the Multibusiness Firm,’ Strategic Management Journal 12: 31-50.

8. Campbell A., Goold M. and Alexander M. (1995), ‘Corporate Strategy: The Quest for Parenting Advantage,’ Harvard Business Review 73(2): 120-132. Collis D. J. and Montgomery C. A. (1998), ‘Creating Corporate Advantage,’ Harvard Business Review 76(3): 71-83.

9. For recent research on the chief strategy officer, see for example: Breene R. T. S., Nunes P. F. and Shill W. E. (2007), ‘The Chief Strategy Officer,’ Harvard Business Review 85(10): 84-93.

Menz M. and Scheef C. (forthcoming), ‘Chief Strategy Officers: Contingency Analysis of their Presence in Top Management Teams,’ Strategic Management Journal, 1-22.

10. Campbell A., Goold M. and Alexander M. (1995), ‘The Value of the Parent Company,’ California Management Review 38(1): 79-97.

Empirical research has shown a huge variety in the performance of the corporate parent. See for example: Collis D. J., Young D. and Goold M. (2007), ‘The Size, Structure, and Performance of Corporate Headquarters,’ Strategic Management Journal 28(4): 383-405. Nell P. C. and Ambos B. (forthcoming), ‘Parenting Advantage in the MNC: An Embeddedness Perspective on the Value Added by Headquarters,’ Strategic Management Journal http://ssrn.com/ abstract=2050359.

11. In a companion article, we suggest an alternative approach. See Campbell A., Kunisch S. and Müller-Stewens G. (2012), ‘Are CEOs Getting the Best from Corporate Functions?,’ MIT Sloan Management Review 53(3): 12-14.

12. This logic is similar to the logic applied in centralization decisions. See: Campbell A., Kunisch S. and Müller-Stewens G. (2011), ‘To Centralize or Not to Centralize,’ McKinsey Quarterly 2011(June): 1-6.

13. Kunisch S., Müller-Stewens G. and Collis D. J. (2012), Housekeeping at Corporate Headquarters: International Trends in Optimizing the Size and Scope of Corporate Headquarters, Survey Report.

University of St.Gallen/Harvard Business School: St.Gallen/Cambridge. Also, see: Rajan R. G. and Wulf J. (2006), ‘The Flattening Firm: Evidence from Panel Data on the Changing Nature of Corporate Hierarchies,’ Review of Economics & Statistics 88(4): 759-773. Wulf J. (2012), ‘The Flattened Firm: Not as Advertised,’ California Management Review 55(1): 5-23.

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Making Corporate Learning Work

By Shlomo Ben-Hur & Nik Kinley Corporate Learning functions are under pressure to deliver like never before. Yet studies have repeatedly shown that business leaders’ satisfaction with the work of their learning functions has remained as low as 20% for the past decade.

For an industry worth over $200 billion per year globally, that is a bad return on investment. In this article the authors lay out five critical changes to the way corporate learning is approached, that businesses need do to put things right and make corporate learning work.

L

ast year, a survey found that more than half of managers believe that employee performance would not change if their company’s learning function were eliminated.1 Some people exclaim a slight derisive laugh on reading this: it seems to play into their stereotypes about corporate learning.

So they smile. Right up to the moment they remember how much learning costs. Then they stop smiling, because it often costs a lot. Globally, figures suggest over $200 billion is spent on corporate learning each year and it seems that the general feeling is that over $100 billion of that may well be wasted.

Alarmingly, this wastage figure may well be on the conservative side. Because over the past ten years survey after survey has repeatedly shown that the proportion of business leaders who are satisfied with their learning function’s performance is around 20 percent.2 The stark reality is that by and large corporate learning is just not working as it should, and has not been for some time. And that is a lot of wasted money. In this article, we explain what needs to change: what businesses need to do to turn things around and finally make learning work.

This not a new issue, but it is one that cannot be ignored any longer. Fuelled by downturn-driven budgetary pressures and apprehension about the efficacy of learning interventions, demand for evidence of the impact and value of learning is growing fast.3 So a lack of progress in improving the impact of learning is suddenly meeting both heightened and hardened expectations. If corporate learning is to retain what remains of its credibility, something needs to change and it needs to change fast.

Of course, for anything to change, there needs to be some recognition that there is a problem. This may sound obvious, but we fear that not everyone is convinced of the need for change. For example, whenever learning leaders have been

asked by surveys over the past few years what their biggest challenge is, they have persistently reported that their number one issue is demonstrating the value of their work.4 There is no doubt that demonstrating the value of corporate learning is a challenge. But we are surprised that it comes out as the number one concern. Our fear is that this finding reveals an assumption that lurks in the background of corporate learning – the idea that there is nothing wrong with what is being done at present, that value is already being added, and that the poor satisfaction ratings are somehow not a fair

Globally, figures suggest over $200 billion is spent on corporate learning each year and it seems that the general feeling is that over $100 billion of that may well be wasted. Alarmingly, this wastage figure may well be on the conservative side.

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reflection of what is being achieved. It is as if the issues are skin-deep, challenges of presentation and political positioning more than the substance of how learning works.

We could not disagree more. We are certain that the learning profession can, and often does, add value. We have seen and been involved in pieces of work that have made a genuine difference to organisations. Yet we also believe that the poor standing of corporate learning is not just

priorities stand out – five critical things that businesses absolutely must do to put things right and make learning work.

Focus on behaviour change, not learning The first priority is a big, hairy, fundamental one and focuses on the overarching question of ‘What is corporate learning?’ This may sound dull and theoretical, but it has massive practical implications.

Corporate learning should be primarily interested in outputs, how the things we learn are used, and how they can be of value to individuals and organisations. about presentation, that it runs deeper than that. Top to toe, something is wrong and it is going to take more than a change in how learning is presented and positioned to put things right. With satisfaction levels hovering around 20 per cent, merely doubling or trebling them will not be sufficient. We need to quadruple them, improve them by a staggering 400 per cent, before we can start saying that corporate learning is in a good place.

Moreover, not only do businesses need to improve how they do learning, but whatever they do needs to be different from and better than what has been tried up to now. Because the apparent lack of progress in improving the standing of corporate learning comes despite significant amounts of effort and activity. In fact, the past ten years have witnessed big changes in the practice of corporate learning and the journals are full of case studies of genuinely fascinating, innovative and apparently excellent practice. It is not that things have not been happening or changing, but that the changes have either not been the right ones or have not been enough.

So what has gone wrong and what do businesses need to start doing? We have spent the past few years exploring this very issue and in our upcoming book The Business of Corporate Learning: Insights from Practice, we describe in detail what the major challenges and opportunities are.

From all our research though, five key

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For the most part, at present people tend to talk and think about corporate learning in the same terms as they talk about traditional, academic learning.

It is assumed to be about the accumulation of knowledge or the acquisition of skills. Something is given or passed on to the learner and the focus is on what is given and the process of how it is passed on. Yet viewing learning this way misses the point that it is not skills or knowledge per se that provides value to organisations, but how they are applied. To use a stereotype: academic learning is primarily focused on inputs, what is taught and what is learned; but corporate learning should be primarily interested in outputs, how the things we learn are used, and how they can be of value to individuals and organisations.

This does not mean that there is no place for traditional academic learning in organisations, especially when it comes to technical training. And we are aware that in some European countries companies have a legal obligation to provide training and continuing education for their employees and that this may sometimes resemble education in the traditional academic sense. But there needs to be a fundamental shift to recognise that, in the majority of organisations, much of corporate learning is not about traditional learning, but about changing people’s behaviour in ways that produce value for the business. And

March-April 2013

in this respect, the very word ‘learning’ misrepresents what organisations are trying to achieve.

The practical importance of this is that behaviour change is at present surprisingly absent from discussions of best practice in corporate learning. And perhaps this accounts for why many learning leaders apparently do not as we do - count developing and delivering effective corporate learning solutions as their number one challenge: because helping people acquire new knowledge and skills is, we would argue, a far simpler task than changing people’s behaviour in ways that improve their performance.

The rising application of behavioural reinforcement techniques such as gameification give cause for hope, as does the increasing influence of disciplines that are more overtly focused on changing behaviour, such as behavioural economics. So there is some change afoot, but it is too little and too slow. Once and for all, corporate learning needs to shake off the shackles of its past and recognise that it is fundamentally different from academic learning, and thereby free itself to face up to the real challenge before it.

Focus on functional alignment The second priority focus is on how corporate learning teams are set up to deliver. Much of the thinking about corporate learning during the past decade has been about how it needs to be strategically aligned with a company’s business objectives. And this is undoubtedly important and critical to the success of corporate learning. But in order to translate such strategic alignment into operational results, learning functions also need to focus on how their internal systems, processes and people are functionally aligned both with their objectives and with one another.

In other words, are the structure of the function, the mindset and capabilities of the people within it, and the design of learning systems, products and services all aligned with and capable of fulfilling the purpose of learning in the business?

This may sound blatantly obvious, and it is. But in our experience it is also too often assumed or overlooked and not explicitly considered. For example, a key question every learning function needs to be able to answer is, ‘How do we create value for the organisation?’ Of course, ultimately, all learning functions are in the same business, that of helping organisations to make money through performance support and improvement.

But there is, as the old adage goes, more than one way to skin a cat. And how you envisage the role of corporate learning in creating value in the organisation can have significant implications for how it should be structured and organised.

For example, if a learning function needs to deliver hundreds of technical training programmes, then their operational model will need to be like that of a manufacturing or retail business. The function is likely to resemble a training factory that will focus on ensuring quality at volume, making efficiencies and delivering economies of scale. Conversely, if it is mainly focused on organisational development and the facilitation of change, then it will need to be operating more like an internal consulting unit.

And if neither is the case and its focus is on the delivery of executive development, then its operating model will probably have a lot of similarities with that of a business school.

These are fundamental questions and our concern is that in too many businesses, the scramble to align learning with business strategy has led to the internal, functional alignment of the various elements that constitute learning functions being overlooked. This has to change.

Step in and out of the business The third priority is to optimise the relationship between learning teams and their customers in the business.

The late psychologist Bruno Bettleheim once allegedly said that the challenge in changing another’s behaviour is not so much being able to step inside the client’s head, to understand their motivations and thinking, as being able to step out again in order to think objectively about what needs to happen. In our view, this is exactly the issue now facing corporate learning. With all the focus on aligning with business needs, demonstrating value to the business, and developing organisational capabilities, there is the risk that learning functions can step in too far and lose their ability to be objective about what needs to happen.

And if they are to achieve and retain credibility, they need to be able to contribute an objective viewpoint.

Part of the challenge here is a legacy issue, common to many of the HR and learning functions we have seen: namely, self-consciousness about how they are viewed and a strong desire to be seen in a positive light. There is nothing unusual about wanting to be perceived positively, of course, but it becomes a potentially negative issue when it is a key driver rather than merely a consideration, since it can constrain the ability to act. The recent research showing that learning leaders’ primary concern is demonstrating their worth to the business may well reflect current budgetary constraints and learning’s generally poor standing in business leaders’ eyes, but it may also reflect some of this self-consciousness.

Whatever the underlying issues, if learning functions are to add value they have to find a way to balance the need to be an integral part of the business with an equally strong ability to step outside it and take an objective view. They must apply, without bias, their expertise in learning science and behaviour change to the task at hand.

If learning functions are to add value they have to find a way to balance the need to be an integral part of the business with an equally strong ability to step outside it and take an objective view.

Apply market forces Corporate learning is effectively a market with competing products and services, and if we want quality, efficacy and efficiency to prevail, we need to apply market forces. By this we mean that businesses need to be able to compare products and know what works and what doesn’t, so that they can make informed judgements about what they want to do, what they can do and what they need to do. And to do this, they need to focus on our fourth priority – getting evaluation right.

It is in very few stakeholders’ interests to find out – or, even worse, admit – that a learning programme has not been successful.

And herein lies a problem because corporate learning has spent much of the past forty years acknowledging this issue and discussing how best to address it, but without actually making any great headway. Faulty and incomplete models, limited resources and lack of expertise have all been cited as culprits.

And there is little doubt that each of these has played its part. Yet after forty years of inertia, we cannot help but wonder if there is a lack of will in play, too – a general lack of desire to evaluate. After all, almost everyone has something to lose from rigorous evaluation, and it is in very few stakeholders’ interests to find out – or, even worse, admit – that a learning programme has not been successful. And we cannot believe that this dynamic has not affected learning functions’ eagerness to properly evaluate the impact of their work.

Of course, it is not only learning functions that are at fault here: one can hardly blame their reluctance, occurring as it does in the current context of failure not being tolerated or at least not forgotten. So any improvement in current evaluation practice is unlikely to happen until businesses understand that learning is a complex and difficult

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Any improvement in current evaluation practice is unlikely to happen until businesses understand that learning is a complex and difficult systemic task that usually does not work perfectly at first attempt, and needs to be evaluated and honed over a period of time. systemic task that usually does not work perfectly at first attempt, and needs to be evaluated and honed over a period of time. This message may not be easy to hear in many business environments, but it must be heard, because without proper evaluation we cannot apply market forces, and without this we cannot make informed decisions. And without that, corporate learning risks descending into mediocrity (or indeed, depending upon your viewpoint, remaining there).

Share accountability for learning Research into corporate learning has persistently thrown up a critical, but often unrecognised finding: namely, that contextual factors such as the workplace environment are actually more important in ensuring the application of learning than the quality of the learning event. This is pretty staggering when you think about it.

Many businesses would say that they fully understand and appreciate this fact. But we are unconvinced. In a recent survey, 71 percent of respondents stated that their organisation expects managerial support as part of the learning process.

However, when asked what managers are expected to actually do, 63 percent stated that they are only required to formally endorse the programme, and only 23 percent reported that managers have to physically do something, such as hold preand post-training discussions. Saying ‘I support you’ while doing nothing to back it up is not support, and businesses need to start accepting and understanding this.

71 percent of respondents stated that their organisation expects managerial support as part of the learning process.

Our fifth and final priority, then, is that the responsibility for ensuring that learning happens, behaviour changes and that performance is indeed improved needs to be shared amongst all the parties involved. If they want learning to work, businesses must not and simply cannot assume or implicitly reinforce the idea that corporate learning is only about learning teams ‘doing something’ to employees.

We believe that these five priorities are at the heart of what corporate learning needs to do to make learning work.

And when we present these ideas to learning leaders, generally speaking, they do not disagree. The jump from learning to behaviour change is bigger for some than for others, but as yet there have been no gasps of disbelief or outraged cries of denial. Indeed, what seems to concern them most is not the ideas themselves, but how to implement them. On the last

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two points, in particular, we have heard the occasional sharp intake of breath or long sigh, at the thought of strong impact evaluation or creating greater visibility around the business’s role in the learning process.

But businesses and learning leaders do need to act and act soon. Indeed, the change is needed now more than ever because the development and deployment of learning solutions has become more challenging by the year. Organisations are increasingly expecting more for their learning money: moving to more cost-effective solutions, demanding faster design and delivery cycles and more accessible content. All of which places pressure on learning solutions by creating greater need for compromise in their development and deployment.

So we have a crisis, and a big one at that. But it is not all doom and gloom. Indeed, we have great hope, because as skill shortages and decreasing opportunities to achieve competitive advantage drive businesses to look internally, learning leaders have the attention of their organisations like never before.

They may be under greater pressure to deliver, but they also have the stage and the opportunity to put things right.

About the Authors Shlomo Ben-Hur is an organizational psychologist and professor of leadership and organizational behaviour at the IMD business school in Switzerland. He has more than 20 years of corporate experience in senior executive positions including vice president of leadership development and learning for the BP Group, and chief learning officer for DaimlerChrysler Services. His new book The Business of Corporate Learning: Insights from Practice, will be published in March 2013.

Nik Kinley is a London-based independent consultant who has specialized in the fields of behaviour change and talent measurement for over twenty years. In that time he has worked with CEOs, life-sentence prisoners, government officials, and children. His prior roles include global head of assessment for the BP Group, and head of learning for Barclays GRBF. His new book Talent Intelligence, written with Shlomo Ben-Hur, will be published in June 2013.

References

1. Corporate Leadership Council. (2012). Driving the Business Impact of L&D Staff. London: The Corporate Executive Board Company.

2. Accenture. (2004). The Rise of the High-Performance Learning Organization.

Results from the Accenture 2004 Survey of Learning Executives. London: Accenture.

3. Giangreco, A., Carugati, A., & Sebastiano, A. (2010). Are We Doing the Right Thing? Food for Thought on Training Evaluation and Its Context. Personnel Review, 39(2), 162-177.

4. Accenture. (2004). The Rise of the High-Performance Learning Organization.

Results from the Accenture 2004 Survey of Learning Executives. London: Accenture.

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